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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For The Fiscal Year Ended June 30, 1998 Commission File No. 0-25298
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
OAK TECHNOLOGY, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 77-0161486
(State or other jurisdiction of (I.R.S. Employer
incorporation of organization) Identification No.)
139 KIFER COURT 94086
SUNNYVALE, CALIFORNIA (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (408) 737-0888
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
Preferred Stock Purchase Rights
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the past 12 months (or for such shorter period that the Registrant was required
to file such reports, and (2) has been subject to such filing requirements for
the past 90 days. Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference to Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of voting stock held by non-affiliates of the
Registrant was $75,920,142 as of September 21, 1998, based upon
the closing price of the Registrant's Common Stock on the Nasdaq National Market
reported for September 21, 1998. Shares of Common Stock held by each executive
officer and Director and by each person who beneficially owns more than 5% of
the outstanding Common Stock have been excluded in that such persons may under
certain circumstances be deemed to be affiliates. This determination of
affiliate status is not necessarily a conclusive determination of affiliate
status for any other purpose.
40,656,495 shares of the Registrant's $.001 par value Common Stock were
outstanding at September 21, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
The following documents (or portions thereof) are incorporated by reference into
the Parts of this Form 10-K noted:
Part III incorporates by reference from the definitive proxy statement for the
Registrant's 1998 Annual Meeting of Stockholders to be filed with the Commission
pursuant to Regulation 14A not later than 120 days after the end of the fiscal
year covered by this Form.
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PART I
ITEM 1. BUSINESS
EXCEPT FOR THE HISTORICAL FINANCIAL INFORMATION CONTAINED HEREIN,
THE MATTERS DISCUSSED IN THIS ANNUAL REPORT ON FORM 10-K MAY BE CONSIDERED
"FORWARD-LOOKING" STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE
SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES ACT OF
1934, AS AMENDED. SUCH STATEMENTS INCLUDE DECLARATIONS REGARDING THE INTENT,
BELIEF OR CURRENT EXPECTATIONS OF THE COMPANY AND ITS MANAGEMENT. SUCH
FORWARD-LOOKING STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND
INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES. ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE INDICATED BY SUCH FORWARD-LOOKING STATEMENTS. THE
COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY RELEASE THE RESULTS OF ANY
REVISION TO THESE FORWARD-LOOKING STATEMENTS WHICH MAY BE MADE TO REFLECT
EVENTS OR CIRCUMSTANCES AFTER THE DATES HEREOF OR TO REFLECT THE OCCURRENCE
OF UNANTICIPATED EVENTS. AMONG THE IMPORTANT FACTORS THAT COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED BY SUCH FORWARD-LOOKING
STATEMENTS ARE: (I) THAT THE INFORMATION IS OF A PRELIMINARY NATURE AND MAY
BE SUBJECT TO FURTHER ADJUSTMENT, (II) VARIABILITY IN THE COMPANY'S QUARTERLY
OPERATING RESULTS, (III) GENERAL CONDITIONS IN THE SEMICONDUCTOR INDUSTRY,
(IV) RISKS RELATED TO PENDING LEGAL PROCEEDINGS, (V) DEVELOPMENT BY
COMPETITORS OF NEW OR SUPERIOR PRODUCTS OR THE ENTRY OF NEW COMPETITORS INTO
THE COMPANY'S MARKETS, (VI) THE COMPANY'S ABILITY TO DIVERSIFY ITS PRODUCT
AND MARKET BASE BY DEVELOPING AND INTRODUCING NEW PRODUCTS WITHIN DESIGNATED
MARKET WINDOWS AT COMPETITIVE PRICE AND PERFORMANCE LEVELS, (VII) WILLINGNESS
OF PROSPECTIVE CUSTOMERS TO DESIGN THE COMPANY'S PRODUCTS INTO THEIR
PRODUCTS, (VIII) AVAILABILITY OF ADEQUATE FOUNDRY CAPACITY AND ACCESS TO
PROCESS TECHNOLOGIES, (IX) THE COMPANY'S ABILITY TO PROTECT ITS PROPRIETARY
INFORMATION AND OBTAIN ADEQUATE ACCESS TO THIRD PARTY TECHNOLOGY ON
ACCEPTABLE TERMS, (X) RISKS RELATED TO USE OF INDEPENDENT MANUFACTURERS AND
THIRD PARTY ASSEMBLY AND TEST VENDORS, (XI) DEPENDENCE ON KEY PERSONNEL,
(XII) RELIANCE ON A LIMITED NUMBER OF LARGE CUSTOMERS, (XIII) DEPENDENCE ON
SALES OF CD-ROM CONTROLLER PRODUCTS AND THE PC MARKET, (XIV) RISKS RELATED TO
INTERNATIONAL BUSINESS OPERATIONS, (XV) DEPENDENCE ON SALES TO THE ASIAN
MARKETS; (XVI) ABILITY OF THE COMPANY TO MAINTAIN ADEQUATE PRICE LEVELS AND
MARGINS WITH RESPECT TO ITS PRODUCTS, (XVII) MANAGEMENT OF CHANGING
OPERATIONS RELATED TO THE COMPANY'S RESTRUCTURING AND MANAGEMENT CHANGES,
(XVIII) RISKS RELATED TO ACQUISITIONS, (XIX) THE ABILITY TO ATTRACT AND
RETAIN QUALIFIED MANAGEMENT AND TECHNICAL PERSONNEL AND (XX) OTHER RISKS
IDENTIFIED FROM TIME TO TIME IN THE COMPANY'S REPORTS AND REGISTRATION
STATEMENTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.
GENERAL
BUSINESS
Oak Technology provides high-performance, integrated
semiconductors to original equipment manufacturers (OEMs) worldwide who serve
the optical storage, consumer electronics and digital office equipment
markets. The Company's products, consisting primarily of integrated circuits
and supporting software and firmware, enable its OEM customers to deliver
cost-effective, powerful systems to the end-user for storage, home
entertainment and imaging (copy, fax, print) applications. One of the world's
leading merchant suppliers of controllers for CD-ROM and CD-RW drives, the
Company's planned product offerings for its three target market segments also
include MPEG-1 and MPEG-2 audio/video decoders for VideoCD (VCD) and DVD
players, and integrated circuits for digital broadcast systems such as cable,
satellite and terrestrial set-top boxes. In addition, the Company's
subsidiary, Pixel Magic, Inc. (Pixel Magic) designs multitasking, imaging and
compression processors for the emerging class of digital office equipment.
The Company's mission is to continue to seek opportunities for value-added
silicon in these emerging market segments where it can leverage its core
competencies to offer powerful, cost-effective and complete solutions to its
OEM partners.
In the second half of fiscal 1998, the Company began a period of
redirection and restructuring in an effort to redefine its strategic direction
and focus on its key strengths and core competencies. A key decision was made
to exit markets where the Company saw limited potential for profitability and a
significant dependency on the PC market and redirect resources to market
opportunities where the Company could utilize its core technical competencies.
The Company initiated several changes in the fiscal year to support this
redirection.
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In March 1998, the Company restructured its operations along
three market-focused groups: Optical Storage Group, Consumer Group and the
Digital Office Equipment Group (Pixel Magic). All product development and
marketing efforts in the PC audio and 3D graphics businesses, businesses
solely dependent on the PC market, were discontinued in the fiscal third
quarter ended March 31, 1998, as the Company prepared to exit these markets.
In tandem, the Company initiated several actions to expand its interests in
the consumer electronics arena by targeting new opportunities presented by
the digital broadcast market. Subsidiaries were established in Bristol, UK
(Oak Technology, Ltd.) and Munich, Germany (Oak Technology GmbH) in the
second half of the fiscal year to support the Company's expanded product
charter for the consumer electronics market. The Company also announced its
intention to continue to grow its digital office equipment business through
research investment and acquisition.
In an effort to strengthen its product offering base, the
Company initiated three acquisitions, one in each of its target markets, and
completed one in fiscal 1998. In April 1998, the Company acquired key assets
of ODEUM Microsystems, Inc. (ODEUM), a subsidiary of Hyundai Electronics
America and developer of integrated circuits for cable, satellite and
terrestrial digital broadcast markets for approximately $4.0 million. The
acquisition included two products currently in production -- an integrated
MPEG-2 audio/video decoder and transport demultiplexer, and a DVB-S compliant
QPSK demodulator. Both products are used predominantly in "free-to-air" cable
and satellite set-top boxes for MPEG-2 encoded digital television
broadcasting. In July 1998, the Company acquired ViewPoint Technology, Inc.
(ViewPoint), a privately held developer of CD-RW technology, for
approximately $10.1 million. The acquisition added key intellectual property
to the Company's CD-RW development program, an area of immediate interest to
the Company in fiscal 1999. In August 1998, the Company completed its
acquisition of Xerographic Laser Images Corporation (XLI), a developer of key
image enhancement and dot modulation technology for imaging applications in
the digital office equipment market, for a cash purchase price of
approximately $3.7 million. Additional payments up to $11.3 million are due,
subject to the achievement of certain milestones by XLI, over a three-year
period ending December 31, 2000. XLI will operate as a division of Pixel
Magic.
Despite these restructuring and redirection initiatives, for the
foreseeable future, the Company will continue to be heavily dependent on sales
of its core CD-ROM controller product line, and therefore, dependent on the PC
market, and the majority of its revenues in fiscal 1999 will be generated by
sales of these products. However, the Company expects that as a result of its
recent restructuring efforts, its future performance will be driven by and
dependent on successful execution of its new product introductions for emerging
markets, such as CD-RW and DVD, digital broadcasting, and digital office
equipment.
TARGET MARKETS AND PRODUCTS
The Company's three target markets include optical storage,
consumer electronics and digital office equipment. The Company's business
strategy and product offerings (current and planned for fiscal 1999) for each
of the target market segments are described below.
OPTICAL STORAGE
BUSINESS OVERVIEW/STRATEGY
Multimedia computer applications have driven the demand for
low-cost, high-density storage mechanisms in recent years. The adoption of
CD-ROM technology as the mainstream optical storage medium on the desktop was
fueled in large measure by data-intensive, graphics/audio/video-rich
applications that required a universal, high-density storage medium. Oak
Technology pioneered the IDE/ATAPI controller for CD-ROM drives in 1993 and
has, ever since, maintained its position as a leading player in the optical
storage controller market. The Company today is a leading merchant supplier
of high-performance controllers for CD-ROM and CD-RW drives to OEMs who serve
the optical storage market. Additionally, the Company has products for
DVD-ROM drives in development.
While the growth of the sub-$1000 PC has extended the life of
CD-ROM drives on the desktop, the optical storage market is likely to witness
an accelerated adoption of CD-RW and DVD-ROM drives in the coming year. The
Company is preparing for this transition by focusing its development efforts
on these next-generation devices.
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The Company's strategy in increasing its market penetration focuses on three key
elements: technology innovation, protection of intellectual property, and
aggressive marketing/pricing programs, including strategic alliances with drive
manufacturers.
In the CD-ROM controller business, the Company experienced
several challenges in fiscal 1998 as a result of a mix of market factors:
declining average selling prices (ASPs) and gross margins on CD-ROM
controllers, increased competition in Taiwan - one of its key customer bases
- - and delays in its integrated controller product introductions. The
Company is addressing these challenges with a two-pronged strategy: first, by
leveraging its intellectual property to form licensing partnerships with
leading drive OEMs and second, by vigorously protecting its patented
technology in optical storage. In addition, the Company will continue to push
for higher levels of integration in its next-generation CD-ROM controller
offerings. The Company expects to be in volume production with its first
integrated controller offering - the OTI-9335 - in calendar 1999. This
solution is a high-performance, three-in-one integrated controller combining
three discrete functions on a single chip - the block decoder, CD-DSP, and
Servo. Supporting drive speeds in excess of 40X, this solution caters to
today's high-performance desktop and notebook computers, but can also be used
in stand-alone CD-ROM drives, navigation systems and game machines.
To protect its patented technology, the Company initiated
several actions in both fiscal 1997 and fiscal 1998 with the International
Trade Commission (ITC). The complaints filed by the Company allege that
several Taiwan-based companies are violating U.S. trade laws by importing or
selling CD-ROM controllers that infringe one or more U.S. patents owned by
the Company. With respect to the action initiated in fiscal 1997, the
Company recorded as non-operating income in fiscal 1998 approximately $10.6
million in settlements received from one of the companies and obtained a royalty
bearing license with another company. The action commenced in fiscal 1998
is scheduled for trial on January 11, 1999. (See "LEGAL PROCEEDINGS").
The CD-RW market has been picking up momentum as more consumers
discover the advantages of this rewritable medium, not the least of which is
its access to the vast installed base of CD-ROM drives. Rewritable CD drives
are quickly emerging as a strong contender to CD-ROM drives and though
primarily offered today in the retail after market, these optical storage
devices are anticipated to emerge in the coming year as the preferred mechanism
on the desktop for archival and data interchange applications.
The Company is currently a leading merchant supplier of
controller chips for CD-RW drives. As with CD-ROM controllers, the Company
expects that functional integration will play an important role in cost
reduction of these drives, thereby fueling its mass adoption by PC OEMs. The
Company intends to extend its market penetration in this area, both through
aggressive product development activities for integrated CD-RW solutions as
well as strategic acquisitions. In July 1998, the Company completed its
acquisition of ViewPoint, a privately held developer of CD-RW technology.
ViewPoint brings strong encoder and write strategy expertise, both key
functional areas in CD-RW drives, to the Company's existing technology
portfolio in the CD-RW area. In addition, the Company has an aggressive
development program in the DVD area.
The following table shows the Company's current mix of optical
storage products for calendar 1999. The Company also has several
next-generation products currently in development.
OPTICAL STORAGE PRODUCTS
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NAME DESCRIPTION STATUS
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<S> <C> <C>
OTI-912 Oak's IDE CD-ROM controller offering peak In production.
data rates of up to 40X. The OTI-912 can Mature part.
provide an increase of over 400% in host Expected to be
throughput at peak disk speeds while using replaced with the
the same clock and DRAM speed. OTI-9150 or OTI-
9335.
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NAME DESCRIPTION STATUS
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<S> <C> <C>
OTI-9220 Oak's four-in-one IDE/ATAPI CD-ROM In production.
controller. Combines four major functions
of a CD-ROM drive (CD-DSP, servo, block
decoder, and 1Mb DRAM) to deliver an
industry-first single-chip solution,
reducing system cost, size, and power
requirements.
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OTI-9150 Oak's first CD-ROM block decoder fully In production.
exploiting the state-of-the-art UDMA
(Ultra DMA) interface. Supports drive
speeds of more than 40X.
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OTI-9325/35 Oak's three-in-one integrated CD-ROM Sampling now.
controller product. Has a UDMA interface. Production
The 9325 supports drive speeds of 32X and shipments in CY99.
the 9335 supports drive speeds of 40X.
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OTI-970/975 Oak's first-generation CD-R/RW controllers In production.
used in leading CD-R/RW drives today. Mature parts.
Expected to be
replaced by Oak's
second-generation
CD-RW controller.
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CONSUMER ELECTRONICS
BUSINESS OVERVIEW/STRATEGY
The emergence of digital video in recent years has created several
market opportunities to enable the delivery of digital content to the home by
means of entertainment systems such as DVD players, digital television (DTV)
systems and set-top boxes (STBs). The rapid migration away from analog to
digital technology in the entertainment system market is creating a need for
cost-effective digital integrated circuits in the consumer electronics
market. This trend is presenting significant opportunities for companies with
expertise in the development of digital integrated circuits such as Oak
Technology.
In the second half of fiscal 1998, as part of its business redirection
efforts, the Company established its Consumer Group to target the emerging
digital entertainment system market, with focus on integrated circuits for video
disk player systems (DVD and VCD) and digital broadcast applications.
In its video disk player business, the Consumer Group currently has a VCD
and DVD product line. The Company expects that DVD technology will begin to be
more broadly adopted worldwide in the coming year, impacting the VCD market in
China and SouthEast Asia. The Company, therefore, does not expect to make any
further investments in its VCD business and intends to focus instead on the DVD
player market. The Company's strategy is to focus on developing cost-optimized
integrated circuits for this market which leverage its intellectual property in
MPEG and servo technology. During the fiscal year, the Company will also be
developing robust DVD player reference designs based on the OTI-226 DVD decoder
to provide target OEMs with a ready-to-manufacture system solution, thereby
accelerating their time to market.
The digital broadcast market presents several opportunities for the Company
to leverage its existing technology investments in MPEG video and audio,
graphics processing and analog cores. In view of this, the Company initiated
several measures in the second half of fiscal 1998 to begin building a position
in these markets, including establishing a subsidiary in Bristol, U.K. (Oak
Technology, Limited), Munich, Germany (Oak Technology GmbH) and acquiring key
assets of ODEUM, a supplier of digital broadcast integrated circuits. The
Company is currently developing a portfolio of products, including demodulator
devices and other integrated circuits for cable, satellite and terrestrial STBs.
Another strategy in the Company's new consumer electronics business is to
focus on strategic alliances and partnerships with top-tier OEMs early in new
product development efforts. The Company recently executed a Joint Development
Agreement with one of the world's leading digital TV tuner manufacturers on its
first-generation demodulator product for the terrestrial DTV market. Similarly,
in its consumer DVD business, the Company partnered with Orion, one of the
leading consumer electronics manufacturers in Japan, on a DVD player design
using the OTI-226 MPEG-2 decoder. The Company believes that similar partnerships
and alliances will be critical in order for it to gain a strong foothold in the
growing and highly competitive digital broadcast semiconductor business.
CONSUMER PRODUCTS
The following table shows the Company's current mix of consumer products
for fiscal 1999. The Company also has several other products currently in
development.
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NAME DESCRIPTION STATUS
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OTI-226 Oak's single-chip MPEG-2 decoder for Shipping production
consumer applications. Supports CSS quantities to first
authentication and decryption, Dolby AC-3 customer.
sound.
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NAME DESCRIPTION STATUS
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OTI-257 Oak's third-generation highly integrated In production and
MPEG-1 decoder for VCD players. Combines currently shipping
MPEG-1 audio/video decoding, CD-ROM to OEMs in China.
decoding, and complete karaoke functions Targets a mature
with full-screen, on-screen display. market. The Company
does not plan on
developing a
follow-on offering.
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OTI-8211 Oak's single-chip, integrated MPEG-2 Currently shipping
decoder for digital cable/satellite set- to customers in
top box applications. Asia/Europe/US.
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OTI-8511 Oak's DVB-compliant digital QPSK Currently shipping
demodulator for satellite set-top boxes. to customers in
Asia/Europe.
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OTI-8521 Oak's first-generation DVB/DSS-compliant Sampling now.
QAM demodulator for cable set-top boxes.
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DIGITAL OFFICE EQUIPMENT
BUSINESS OVERVIEW/STRATEGY
Pixel Magic, the Company's subsidiary in Andover, MA, develops
high-performance, full-featured imaging solutions for the digital office
environment. Pixel Magic offers a broad suite of products, including silicon and
embedded controller-board solutions, to major OEMs in the digital office
equipment market to power a variety of digital office systems, such as digital
laser copiers and printers (monochrome and color) and copycentric, faxcentric
and printcentric multifunction peripherals (MFPs). Pixel Magic's customers for
these products include Canon, Fujitsu, Fuji-Xerox, Hewlett-Packard, Kodak,
Matsushita and Xerox. Pixel Magic was acquired by Oak Technology in November
1995. In August 1998, the Company completed the acquisition of Xerographic Laser
Images (XLI), which will operate as a division of Pixel Magic. XLI is a supplier
of leading dot modulation and resolution enhancement products to digital office
equipment manufacturers.
Pixel Magic's chip solutions include its PM-2x/3x family of JBIG/JPEG
compression codecs, the PM-4x family of high-speed imaging DSPs, and XLI's
family of resolution enhancement technology (RET) products. In addition, Pixel
Magic combines its silicon solutions with firmware and software to deliver
customized embedded controller board solutions to its customers.
Going forward, Pixel Magic will extend its reach beyond the high-end
imaging systems market to target high-volume opportunities, such as the low- to
mid-range laser and inkjet products (including color systems). One of Pixel
Magic's new product initiatives for fiscal 1999 includes the development of a
high-speed, low-cost imaging DSP (iDSP) for the growing inkjet MFP market.
Pixel Magic is also developing a new modular architecture for MFP designs,
leveraging its iDSP and compression technology as well as XLI's dot modulation
technology to create differentiated embedded controller products. Pixel Magic's
strategy for its coming generations of products is to leverage this architecture
to build more standardized, cost-effective system-level solutions, thereby
minimizing engineering resources typically spent on customization efforts for
its OEMs, while accelerating its customers' time-to-market and increasing cost
effectiveness.
DIGITAL OFFICE EQUIPMENT PRODUCTS
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PRODUCT DESCRIPTION STATUS
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<S> <C> <C>
PM-1V High-speed bitonal image processor In production.
providing single-pass compression or
decompression of image data.
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PM-2m 40 MHz bitonal JBIG codec with In production.
multitasking capability. Provides single
pass compression or decompression, as
well as scaling and rotation of bitonal
image data.
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PM-22 66 MHz bitonal JBIG codec with a 32- Sampling now.
bit I/O. Provides single pass
compression or decompression, as well
as scaling and rotation of bi-tonal
image data.
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<CAPTION>
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PRODUCT DESCRIPTION STATUS
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<S> <C> <C>
PM-35 A fixed function JPEG compression Engineering samples
and decompression processor, the PM- available now.
35 is designed to sustain a data rate of
up to 70MB/sec.
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PM-44+ A programmable 85 MHz image In production.
processing device designed for use in
imaging applications. Single
instruction, four data paths.
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XLI-2050, Family of image enhancement processors In production.
2032,2016 for laser copiers, printers and MFPs.
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</TABLE>
MANUFACTURING AND DESIGN METHODOLOGY
MANUFACTURING
The Company contracts with independent foundries to manufacture all of its
semiconductor products, enabling the Company to focus on its design strengths,
minimize fixed costs and capital expenditures and gain access to advanced
manufacturing facilities. The Company's primary suppliers under such
arrangements during fiscal 1998 were Taiwan Semiconductor Manufacturing Company
(TSMC) and LG Semicon Co. Ltd. in Korea. The Company also uses wafer
fabrication facilities at Chartered Semiconductor Manufacturing Pte. Ltd.
(Chartered), Rohm, NEC and Sony. Except as described in the paragraphs below,
the foundries generally are not obligated to supply products to the Company for
any specific period, in any specific quantity or at a specific price, except as
may be provided in a particular purchase order.
In June and November 1995, the Company entered into agreements with TSMC
and Chartered to obtain certain additional wafer capacity through the year 2001.
The agreements call for the Company to commit to certain future wafer purchases
and to deposit funds with the suppliers as either a portion of the price of the
additional wafers in advance of their delivery or as a non-interest bearing
deposit to secure the availability of additional wafers. The price of such
wafers will be determined in the future periods in which specific orders are
actually placed. If the Company is not able to use, assign, or sell the
additional wafer quantities, all or a portion of the deposits may be forfeited.
In October 1996, the Company amended its previous agreement with TSMC
resulting in a reduction of the Company's future wafer purchases required under
the original agreement and the elimination of required future cash prepayments
of approximately $73 million. Under the amended agreement, no additional
prepayment is required; however the Company must utilize the entire amount of
the prepayment paid as of October 1996 through a certain committed amount of
wafer purchases in calendar years 1997, 1998, and 1999 or a portion of the
prepayment will be forfeited. In March 1998, the Company further amended its
agreement with TSMC allowing the Company to utilize excess wafer purchases in
1997 and 1998 to reduce the Company's committed wafer purchases in the following
years. This amendment resulted in the Company utilizing calendar 1998 committed
wafer purchases beginning in calendar 1997 after the committed wafer purchases
for calendar 1997 were met. As a result of this amendment, the Company recorded
a credit to foundry deposits of approximately $13.0 million which was used to
offset payables to TSMC during fiscal 1998. The Company currently believes the
terms and conditions of the agreement, as amended, will be met although no
assurance can be given in this regard.
In September 1996, April 1997 and September 1997, the Company amended its
agreement with Chartered. The amendments resulted in a reduction of the
Company's future wafer purchase commitments and the elimination of required
future cash deposits under the original agreement of approximately $36 million.
Under the amended agreement, the required future cash deposits of approximately
$36 million could be reinstated if certain conditions are not met. The Company
currently believes the terms and conditions of the agreement, as amended, will
be met and that these commitments will not be reinstated although no assurance
can be given in this regard.
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The deposits and prepayments under the amended foundry agreements described
above are recorded at cost and total approximately $21.2 million as of June 30,
1998. The Company currently anticipates being able to utilize and fully recover
the value of all foundry prepayments and deposits under the terms of the amended
agreements although no assurance can be given in this regard.
In October 1995, the Company entered into a series of agreements with
United Microelectronics Corporation (UMC) to form, along with other investors, a
separate Taiwanese company, United Integrated Circuits Corporation (UICC), for
the purpose of building and managing a semiconductor manufacturing facility in
the Science Based Industrial Park in Hsin Chu City, Taiwan, Republic of China.
As an investor in this venture, the Company has rights to a portion of the total
wafer capacity for the manufacture of its proprietary products. The Company
paid approximately $51.2 million for approximately 9.3% of the total outstanding
shares of the foundry venture. The investment in UICC has been accounted for
under the cost method of accounting.
In October 1997, a fire damaged the UICC facility. UICC management has
publicly stated that a majority of the equipment and inventory and a significant
portion of the building were completely destroyed at an estimated loss of
approximately $324 million (based on year-end exchange rates). UICC management
has also stated that it has reached a $300 million insurance settlement for
claims stemming from the fire and that in accordance with the coinsurance
clause, UICC had to pay $23.5 million of the damage. Despite the damages
payment, UICC management has represented that UICC's financial status has
remained unaffected given significant investment gains made during the year.
UICC has further stated that it expects to complete reinforcement of the
building structure before the end of the year, to install fab equipment by May
1999, and to be in production by the last quarter of Calendar 1999, using
primarily .18 micron process technology. Given the fire, the Company has
evaluated its investment in the UICC facility to determine whether there has
been an impairment and as the Company believes that estimated future cash
inflows expected to be generated by the facility and/or disposition of the
investment are in excess of the carrying amount of the investment, no impairment
loss has been recognized as of June 30, 1998. Representations have been made
by UICC management that the facility's foundry capacity that has been guaranteed
to the Company will be available through substitute capacity arrangements. To
date, the Company has not requested that UICC make such substitute capacity
available to the Company. Therefore, there can be no assurance that such
substitute foundry capacity will be available to the Company should the Company
require it. Additionally, there can be no assurance that a market will develop
for the shares representing the Company's equity investment at any time in the
future.
The Company is dependent on its foundries to allocate to the Company a
portion of their foundry capacity sufficient to meet the Company's needs to
produce products of acceptable quality and with acceptable manufacturing yields
and to deliver products to the Company in a timely manner. These foundries
fabricate products for other companies and some manufacture products of their
own design. The loss of any of these foundries as a supplier, the inability of
the Company in a period of increased demand for its products to expand the
foundry capacity of its current suppliers or qualify other wafer manufacturers
for additional foundry capacity, any inability to obtain timely and adequate
deliveries from the Company's current or future suppliers or any other
circumstances that would require the Company to seek alternative sources of
supply could delay shipments of the Company's products, which could damage
relationships with its current and prospective customers, provide an advantage
to the Company's competitors and have a material adverse effect on the Company's
business, financial condition and results of operations. Most of the Company's
devices are currently fabricated using complementary metal oxide semiconductor
(CMOS) process technology with 0.5 micron and 0.35 micron feature sizes. The
Company expects to design products for 0.25 micron feature sizes in the future.
All of the Company's semiconductor products are assembled and tested by
independent subcontractors.
The Company's reliance on independent manufacturers and third party
assembly and testing vendors involves a number of additional risks, including
the unavailability of, or interruption in access to, certain process
technologies and reduced control over delivery schedules, quality assurance and
costs. In addition, as a result of the Company's dependence on foreign
subcontractors, the Company is subject to the risks of conducting business
internationally, including foreign government regulation and general political
risks, such as political and economic instability, potential hostilities,
changes in diplomatic and trade relationships, currency fluctuations, unexpected
changes in, or imposition of, regulatory requirements, tariffs, import and
export restrictions, and other barriers and
9
<PAGE>
restrictions, potentially adverse tax consequences, the burdens of complying
with a variety of foreign laws and other factors beyond the Company's control.
Substantially all of the Company's agreements with its offshore wafer
fabrication and assembly facilities provide for pricing and payment in U.S.
dollars.
The manufacture of semiconductors is a highly complex and precise
process. In addition, the Company's products are particularly complex and
difficult to manufacture. Minute levels of contaminants in the manufacturing
environment, defects in the masks used to print circuits on a wafer,
difficulties in the fabrication process or other factors can cause a
substantial percentage of wafers to be rejected or a significant number of
die on each wafer to be nonfunctional. Many of these problems are difficult
to diagnose, time consuming and expensive to remedy, all of which can affect
the Company's time to market with a particular product. There can be no
assurance that the Company's foundries will not experience irregularities or
adverse yield fluctuations in their manufacturing processes. Any yield or
other production problems or shortages of supply experienced by the Company
or its foundries could have a material adverse effect on the Company's
business, financial condition and results of operations.
DESIGN METHODOLOGY
The Company's products compete in markets that are characterized by
rapidly-developing technology and evolving industry standards. The Company
addresses these issues with a design environment based on workstations,
dedicated product simulators, system simulation with hardware and software
modeling, and use of a high level design description language in order to
define, develop and deliver new and enhanced products more rapidly. The
Company's engineering and design capabilities are significant to its future
performance, and the Company has invested regularly in new advanced equipment
and software tools in an effort to keep these tools updated with the latest
technology. The Company's library of core cells is key to its ability to reduce
the time needed to design new products. Examples of core cells include a CD-ROM
decoder core, CD-RW encoder/decoder core, CD-DSP & CD-Servo core, a parallel,
multi-pipelined microprocessor core, MPEG2 core, DVD-DSP core, a .5 and .35
micron memory compiler and a .5 and .35 micron I/O library. Design methodology,
including equipment and software tools, is a critical factor with respect to the
Company's ability to successfully develop technology and products, and there can
be no assurance that the Company will be able to obtain the equipment, software
tools and other resources needed to develop technically advanced products in a
timely manner.
MARKETING AND CUSTOMERS
From its inception, the Company has been committed to a worldwide marketing
strategy. The Company utilizes a direct sales force in the United States,
Germany, Japan, Taiwan and the Peoples Republic of China and a worldwide network
of manufacturers' representatives and distributors in North America, Europe and
Asia. While customers around the world have many needs in common, each region
has its own requirements. In order to support customers in key geographic
markets, the Company has established sales and support offices in Andover,
Massachusetts; Munich, Germany; Tokyo, Japan; Taipei, Taiwan and Shenzhen,
China, in addition to its corporate headquarters in Sunnyvale, California. The
Company believes that sales and technical support personnel based in the
Company's regional offices understand the technical needs, business philosophy
and culture of their respective customers. On-site personnel are trained to
respond to customer needs efficiently and effectively.
Sales of the Company's products are made pursuant to purchase orders and
the Company has no long-term sales agreements with any of its customers.
Purchase orders are subject to price renegotiations and to changes in
quantities of products and delivery schedules in order to reflect changes in
the customers' requirements. The Company's business, consistent with that of
others in the semiconductor industry, is generally characterized by short
lead time orders. The Company's actual shipments depend on the manufacturing
capacity of the Company's foundries. Therefore, as foundry capacity
tightens, the Company may not be able to meet the customer's requested
delivery date or the Company may have to put its customers on allocation.
Accordingly, due to its dependence on third party manufacturing capacity, the
Company believes that backlog at any particular date may not be indicative of
actual net revenues for any future period. In addition, the Company currently
places noncancelable orders to purchase its products from independent
foundries on an approximately three month rolling basis and is currently
committed with two of its foundries for certain minimum amounts of capacity
for the next several years while its customers generally place purchase
orders with the Company less than four weeks prior to delivery that may be
rescheduled or under certain circumstances may be canceled without penalty.
Consequently, if anticipated sales and shipments in any quarter are
rescheduled, canceled or do not occur as quickly as expected, expense and
inventory levels could be disproportionately high and the Company's business,
financial condition and results of operations for that quarter or for the
year would be materially adversely affected.
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Sales of the Company's CD-ROM controller products comprised 81%, 84% and
91% of the Company's net revenues in fiscal 1998, 1997 and 1996,
respectively. Sales of CD-ROM controller products are expected to continue to
account for a majority of the Company's total revenues for fiscal 1999. The
Company expects that as the market for CD-ROM controller products matures or
becomes obsolete due to the introduction of CD-RW and DVD-ROM products, sales
of such products will decline. Although the Company is currently shipping a
CD-RW controller and pursuing the development of optical storage
semiconductors for use in DVD-ROM drives, there can be no assurance that the
Company will develop successive generations of its CD-RW product or its first
DVD-ROM product, that such products will be available within an acceptable
market window or that with such products the Company will be able to sustain
the current level of optical storage product sales. In addition, there can
be no assurance that the market for CD-ROM controller products in general, or
the Company's CD-ROM controller products in particular, will support the
Company's planned operations in the future, in particular, its heightened
investment in the consumer electronics and digital office equipment markets.
Any decrease in the overall level of sales of, or the prices for, the
Company's CD-ROM controller products, due to introductions of products by
present or future competitors, a decline in demand for CD-ROM controller
products, product obsolescence or any other reason would have a material
adverse effect on the Company's business, financial condition and results of
operations. Due to the maturation of the CD-ROM controller market, pressure
from the sub-$1000 PC segment for lower components, new competitors,
uncertain demand for personal computers and the Company's delay in the next
generation CD-ROM product releases, the Company has experienced for the past
several quarters and expects to continue to experience both a decrease in
units sales and prices of its CD-ROM controller products, which in turn has
had a material adverse effect on the Company's business, financial condition
and results of operation. Although the Company has recently introduced
several new products from its Consumer and Digital Imaging Groups in its
attempt to diversify its product and market base, there can be no assurance
that these products will be successfully designed, accepted by the Company's
customers, and brought to production or that the Company's customer's
products will be accepted in the marketplace.
The Company believes that customer service and technical support are
important competitive factors in the optical storage, consumer electronics and
digital office equipment markets. The Company provides technical support to its
customers worldwide. Using its headquarters and subsidiary offices in
Sunnyvale, California; Munich, Germany; Tokyo, Japan; Taipei, Taiwan; Shenzhen,
China, and Andover, Massachusetts, the Company is able to provide prompt
technical support to its customers. In addition, the Company's representatives
travel frequently to customer sites to assist in design-in activity. The
Company provides several other types of technical support, including software
distribution through an electronic bulletin board, evaluation boards, product
demonstration software, engineering design kits and application notes. The
Company works closely with its customers in qualification of its products and
providing needed quality and reliability data. In addition, the Company makes
the latest revision of its software available to its customers and can customize
the Company's software to a customer's specific requirements.
A substantial majority of the Company's revenues in fiscal 1998, 1997 and
1996 were derived outside of the United States, primarily in Asia. The
geographical areas accounting for the Company's net revenues in fiscal 1998,
1997, and 1996 are as follows:
<TABLE>
<CAPTION>
Year ended June 30,
--------------------------------
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Japan................................... 38.6% 40.3% 66.1%
Other international..................... 53.4 56.1 31.5
North America........................... 8.0 3.6 2.4
</TABLE>
Accordingly, the Company is subject to the risks of conducting business
outside of the United States. These risks include unexpected changes in, or
impositions of, legislative or regulatory requirements, delays resulting from
difficulty in obtaining export licenses for certain technology, tariffs, quotas
and other trade barriers and
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restrictions, longer payment cycles, greater difficulty in accounts receivable
collection, potentially adverse taxes, the burdens of complying with a variety
of foreign laws and other factors beyond the Company's control. The Company is
also subject to general geopolitical risks in connection with its international
operations, such as political, social and economic instability, potential
hostilities and changes in diplomatic and trade relationships. There can be no
assurance that such factors will not materially adversely affect the Company's
operations in the future or require the Company to modify its current business
practices. The Company believes that the current economic problems in Asia have
caused a decrease in demand for its optical storage and digital imaging
products. In addition, the laws of certain foreign countries in which the
Company's products are or may be developed, manufactured or sold, including
various countries in Asia, may not protect the Company's products or
intellectual property rights to the same extent as do the laws of the United
States and thus make the possibility of piracy of the Company's technology and
products more likely. Most of the Company's foreign sales are negotiated in
U.S. dollars; however, invoicing is generally done in local currency. As a
result, the Company may be subject to the risks of currency fluctuations.
There can be no assurance that one or more of the foregoing factors will not
have a material adverse effect on the Company's business, financial condition
or results of operations or require the Company to modify its current
business practices.
The Company sells its products principally to manufacturers of CD-ROM
drives, PCs and add-in boards. CD-ROM drives, in turn, are sold to PC OEMs such
as Acer, AST Research, Compaq, Dell, Gateway 2000, IBM, NEC and Packard Bell.
Add-in boards are in turn sold to PC manufacturers or distributors for the
distribution or retail channel. Other customers include OEMs for the digital
video and digital broadcast markets and OEMs for the digital office equipment
market.
A limited number of customers historically has accounted for a substantial
portion of the Company's net revenues. In fiscal 1998, 1997 and 1996, sales to
the Company's top ten customers accounted for approximately 81%, 78% and 80%,
respectively, of the Company's net revenues. These customers were all
purchasers of the Company's CD-ROM and CD-RW products. In fiscal 1998, Mitsumi
accounted for 17% and LG Electronics accounted for 14% of the Company's net
revenues. In fiscal 1997, Mitsumi accounted for 14% and LG Electronics
accounted for 13%. In fiscal 1996, Mitsumi accounted for 26%, Kanematsu
accounted for 19% and NEC accounted for 13% of the Company's net revenues.
Kanematsu, a Japanese trading company, purchases product from the Company and
resells the product to Japanese manufacturers. Although the Company is
currently attempting to diversify its products, markets, and customers base,
the Company expects that sales to a limited number of customers will continue
to account for a substantial portion of its net revenues for the foreseeable
future. The Company has experienced significant changes from year to year in
the composition of its major customer base and believes this pattern will
continue. The Company does not have long-term purchase agreements with any
of its customers. Customers generally purchase the Company's products
subject to cancelable short-term purchase orders. The loss of, or a
significant reduction in, purchases by current major customers such as
Mitsumi, NEC, Philips or LG Electronics would have a material adverse effect
on the Company's business, financial condition and results of operations.
There can be no assurance that the Company's current customers will continue
to place orders or that existing orders will not be canceled. If sales to
current customers cease or are reduced, there can be no assurance that the
Company will be able to continue to obtain the orders from new customers
necessary to offset any such losses or reductions. Moreover, there can be no
assurance that the Company could qualify its foundries for potential new
customers or that it could do so in a timely manner.
The Company currently places noncancelable orders to purchase its products
from independent foundries on an approximately three month rolling basis and is
currently committed with two of its foundries for certain minimum amounts of
capacity for the next several years while its customers generally place purchase
orders with the Company less than four weeks prior to delivery that may be
rescheduled or under certain circumstances may be canceled without penalty.
Consequently, if anticipated sales and shipments in any quarter are rescheduled,
canceled or do not occur as quickly as expected, expense and inventory levels
could be disproportionately high and the Company's business, financial condition
and results of operations for that quarter or for the year would be materially
adversely affected.
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COMPETITION
The optical storage and consumer electronics (particularly, video disk
player) markets in which the Company competes are intensely competitive and are
characterized by rapid technological change, declining ASPs and rapid product
obsolescence. The Company is currently experiencing intense competition in both
the optical storage and consumer electronics markets and expects competition to
increase in the future from existing competitors and from other companies that
may enter the Company's existing or future markets with solutions that may be
less costly or provide higher performance or additional features. The Company's
existing and potential competitors include many large domestic and international
companies that have substantially greater financial, manufacturing, technical,
marketing, distribution and other resources, broader product lines and longer
standing relationships with customers than the Company. The Company's
competitors also include a number of emerging companies. Certain of the
Company's principal competitors in the optical storage market maintain their own
semiconductor foundries and may therefore benefit from certain capacity, cost,
quality control and technological advantages. In its effort to diversify its
customer and market base, the Company is currently attempting to enter several
new markets in which the Company has not operated previously. In general,
the Company believes that its ability to compete successfully depends on a
number of factors, both within and outside of its control, including the price,
quality and performance of the Company's and its customers' products, the timing
and success of new product introductions by the Company, its customers and its
competitors, the emergence of new industry standards, the development of
technical innovations, the ability to obtain adequate foundry capacity and
sources of raw materials, the efficiency of production, the rate at which the
Company's customers design the Company's products into their products, the
market acceptance of the products of the Company's customers, the assertion of
intellectual property rights and general market and economic conditions. There
can be no assurance that the Company will be able to compete successfully in the
future.
The willingness of prospective customers to design the Company's products
into their products depends to a significant extent upon the ability of the
Company to have product available at the appropriate market window and to price
its products at a level that is cost effective for such customers. The markets
for most of the applications for the Company's products, particularly the
optical market and the consumer market, are characterized by intense price
competition. As the markets for the Company's products mature and competition
increases, the Company anticipates that ASPs on its products will decline. If
the Company is unable to reduce its costs sufficiently to offset declines in
ASPs or is unable to successfully introduce new higher-performance products with
higher ASPs, the Company's business, financial condition and result of
operations will be materially adversely affected. If the Company experiences
yield or other production problems or shortages of supply that increase its
manufacturing costs, or fails to reduce its manufacturing costs, the result
could have a materially adverse effect on the Company's business, financial
condition and operating results.
Prior to the Company's entry into the optical storage market, merchant
suppliers such as Sanyo and captive suppliers such as Panasonic, Sony and
Toshiba supplied semiconductor solutions for proprietary and SCSI drives.
Although the Company was the first company to sell a single-chip IDE/ATAPI
CD-ROM controller, many market suppliers including Cirrus Logic, MediaTek and
Sanyo now offer single-chip solutions. Furthermore, captive suppliers such
as Toshiba, Panasonic and Sony have developed their own IDE/ATAPI CD-ROM
controllers and, in addition to using them internally, sell these controllers
to the merchant market in competition with the Company's products. As the
Company integrates more functionality into its products, companies which had
previously supplied complementary products may also become competitors. The
Company expects increased competition in the optical storage market from
large, international companies that have their own manufacturing capabilities
as this market transitions to DVD. The Company's strength in competing
against this increased competition in the future will be the technological
leadership and customer relationships that it has developed and cultivated
over the past several years.
In the video disk player market, comprised of the Company's VCD and DVD
products, the Company competes primarily with C-Cube Microsystems, ESS
Technology, Toshiba, Matsushita and LSI Logic. Approximately one-third of the
total available market of the video disk player market is comprised of captive
suppliers. These captive suppliers are Japanese companies that make both chips
and players and are members of the DVD Forum. As members of the DVD Forum,
these companies generally pay a lower patent royalty fee to the
13
<PAGE>
Forum, enjoying a cost advantage over the Company's targeted customers making
it more difficult for the Company's customers and thereby the Company to
compete successfully. In the cable, satellite and terrestrial digital
television markets, the Company competes with SGS Thompson, LSI Logic, VLSI
Technology and Broadcom. For the most part, these companies are all large,
international companies with a much larger infrastructure than the Company.
The cable, satellite and terrestrial markets are all new markets for the
Company and although these markets are still emerging, as a new entrant, the
Company will be competing with companies who already have a strong
relationship with the Company's targeted customers. Furthermore, the Company
expects competition to increase in the future. For the Company to compete
successfully in the satellite and terrestrial market, it must develop
alliances with tuner and mechanism providers. The Company recently executed
a joint development agreement with one of the world's leading digital TV
tuner manufacturers on its first generation demodulator chip for the
terrestrial market; however, additional alliances are still necessary if the
Company is to compete successfully in the cable, satellite and terrestrial
markets.
In the digital office equipment market, the Company's primary product
offerings target the niche, high-end market and the Company's merchant
competition does not offer directly competitive products. In some cases, the
merchant competition offers a subset of the Company's product features. In
other cases, the merchant competition offers a software alternative to the
Company's hardware solution. However, the Company expects direct merchant
competition in the niche, high-end digital office equipment market to emerge in
the near future. Despite this lack of direct competition in the merchant
market, the Company does experience competition with its DSP, compression and
resolution enhancement products from internal design groups within the Company's
targeted customers, such as Xerox, HP, Canon, Hitachi, NEC and Texas
Instruments. As with the merchant market, the Company's strength in competing
with these internal design teams comes from the breadth of the solution the
Company is able to provide. With respect to the Company's embedded controller
board products, the Company competes with Peerless, Xionics, Electronics for
Imaging and AHT. Although the Company is currently able to provide more silicon
on a controller board than its competition providing it with a cost advantage,
for the Company to compete successfully against these companies, it must
continue to enhance and strengthen its software capabilities. As to the new
lower-end products the Company is developing for the digital office equipment
market, the Company expects greater direct competition than it currently
experiences in the niche, high-end market.
RESEARCH AND DEVELOPMENT
The Company currently invests substantial resources in its product
development efforts. During fiscal 1998, 1997 and 1996, the Company spent
approximately $49.7 million, $34.7 million and $30.7 million, respectively, on
research and development activities. The Company intends to continue to invest
in the development of products in each of its core technologies and in products
that integrate its core technologies.
The majority of the Company's revenues are currently generated from mature
products. The Company's performance is highly dependent upon the successful
development and timely introduction of new products at competitive price and
performance levels. There can be no assurance that products currently under
development or any other new products will be successfully developed or will
achieve market acceptance. The failure of the Company to introduce new products
successfully or the failure of new products to achieve market acceptance would
have a material adverse effect on the Company's business, financial condition
and results of operations. The success of new product introductions is
dependent on several factors, including recognition of market requirements,
product cost, timely completion and introduction of new product designs, quality
of new products and achievement of acceptable manufacturing yields from the
Company's contract manufacturers. Due to the design complexity of its products,
the Company has experienced delays in completing development and introduction of
new products, and there can be no assurance that the Company will not encounter
such delays in the development and introduction of future products. There can
be no assurance that the Company will successfully identify new product
opportunities and develop and bring new products to market in a timely manner,
that the Company's products will be selected for design into the products of its
targeted customers or that products or technologies developed by others will not
render the Company's products or technologies obsolete or noncompetitive. The
failure of the Company's new product development efforts or the failure of the
Company to achieve market acceptance of its new products would have a material
adverse effect on the Company's business, financial condition and results of
operations.
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<PAGE>
PROPRIETARY RIGHTS AND LICENSES
The Company's ability to compete is affected by its ability to protect its
proprietary information. The Company considers its technology to be proprietary
and relies on a combination of patents, trademarks, copyrights, trade secret
laws, confidentiality procedures and licensing arrangements to protect its
intellectual property rights. The Company currently has eleven patents granted,
forty-seven patents in preparation in the United States, fifty-three patents
pending in the United States and twenty-two international patents pending. The
Company intends to seek additional international patents and additional United
States patents on its technology. There can be no assurance that additional
patents will issue from any of the Company's pending applications or
applications in preparation, or be issued in all countries where the Company's
products can be sold, or that any claims allowed from pending applications or
applications in preparation will be of sufficient scope or strength to provide
meaningful protection or any commercial advantage to the Company. Additionally,
competitors of the Company may be able to design around the Company's patents.
There can be no assurance that any patents held by the Company will not be
challenged, invalidated or circumvented, or that the rights granted thereunder
will provide competitive advantages to the Company. An action is currently
pending in the Federal District Court for the Northern District of California
seeking to invalidate one of the Company's patents relating to its optical
storage products. Moreover, while the Company holds or has applied for patents
relating to the design of its products, the Company's products are based in part
on standards, including MPEG-1, MPEG-2, JPEG and JBIG and the Company does not
hold patents or other intellectual property rights for such standards. The laws
of certain foreign countries in which the Company's products are or may be
manufactured or sold, including various countries in Asia, may not protect the
Company's products or intellectual property rights to the same extent as do the
laws of the United States and thus make the possibility of piracy of the
Company's technology and products more likely. There can be no assurance that
the steps taken by the Company to protect its proprietary information will be
adequate to prevent misappropriation of its technology or that the Company's
competitors will not independently develop technologies that are substantially
equivalent or superior to the Company's technology.
The semiconductor industry is characterized by vigorous protection and
pursuit of intellectual property rights, which has resulted in significant,
often protracted and expensive litigation. Although there is currently no
pending intellectual property litigation against the Company, the Company or
its foundries may, from time to time, be notified of claims that the Company
may be infringing patents or other intellectual property rights owned by
third parties. If it is necessary or desirable, the Company may seek licenses
under such patents or other intellectual property rights. However, there can
be no assurance that licenses will be offered or that the terms of any
offered licenses will be acceptable to the Company. The failure to obtain a
license from a third party for technology used by the Company could cause the
Company to incur substantial liabilities and to suspend the manufacture of
products or the use by the Company's foundries of processes requiring the
technology. Furthermore, the Company may initiate claims or litigation
against third parties for infringement of the Company's proprietary rights or
to establish the validity of the Company's proprietary rights. In fiscal
1997 and again in fiscal 1998, the Company filed a complaint with the ITC
against certain Asian manufacturers of optical storage controller devices
based on the Company's belief that such devices infringed one or more of the
Company's patents. The complaint seeks a ban on the importation into the
United States of any infringing CD-ROM controller or products containing such
infringing CD-ROM controllers. (See "Legal Proceedings"). Litigation by or
against the Company could result in significant expense to the Company and
divert the efforts of the Company's technical and management personnel,
whether or not such litigation results in a favorable determination for the
Company. In the event of an adverse result in any such litigation, the
Company could be required to pay substantial damages, cease the manufacture,
use and sale of infringing products, expend significant resources to develop
non-infringing technology, discontinue the use of certain processes or obtain
licenses to the infringing technology. There can be no assurance that the
Company would be successful in such development or that such licenses would
be available on reasonable terms, or at all, and any such development or
license could require expenditures by the Company of substantial time and
other resources. Patent disputes in the semiconductor industry have often
been settled through cross-licensing arrangements. Because the Company has a
limited portfolio of patents, the Company may not be able to settle an
alleged patent infringement claim through a cross-licensing arrangement. If
a successful claim is made against the Company or its customers and a license
is not made available to the Company on commercially reasonable terms or the
Company is required to pay substantial damages or awards, the Company's
business, financial condition and results of operations would be materially
adversely affected.
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The Company generally enters into confidentiality agreements with its
employees and confidentiality and license agreements with its customers and
potential customers, and limits access to and distribution of the source and
object code of its software and other proprietary information. Under some
circumstances, the Company grants licenses that give its customers limited
access to the source code of the Company's software which increases the
likelihood of misappropriation or misuse of the Company's technology.
Accordingly, despite precautions taken by the Company, it may be possible for
unauthorized third parties to copy certain portions of the Company's technology
or to obtain and use information that the Company regards as proprietary. There
can be no assurance that the steps taken by the Company will be adequate to
prevent misappropriation of its technology or to provide an adequate remedy in
the event of a breach or misappropriation by others.
Certain technology used in the Company's products is licensed or purchased
from third parties. In 1990, the Company entered into an agreement with
Advanced Micro Devices, Inc. (AMD) relating to a video compression/expansion
processor (VCEP) developed by AMD. Pursuant to this agreement, AMD granted to
the Company a perpetual, worldwide, non-exclusive license to make, use,
distribute and sell products resulting from the VCEP and certain related patents
and software. The Company has paid AMD a technology license fee pursuant to
this agreement and is obligated to pay a royalty based on a percentage of net
revenues derived from its PM-1V product. The agreement has no specified term
and may be terminated in the event either party breaches the agreement and such
breach is not cured within 30 days after delivery of notice of the breach.
The Company has licensed technology from third parties for use in its
optical storage, consumer and digital office equipment business, and pursuant
thereto is required to fulfill confidentiality obligations and in certain cases
pay royalties. Certain of the Company's products require that certain copy
protection software or other software be obtained if the products are to be
marketable and exportable. Should the Company lose its rights to or be unable
to obtain the necessary copy protection software, the Company would be unable to
sell and market certain of its MPEG and optical storage products geared for the
DVD market. The Company licenses the Sun Microsystems SPARC core for use with a
number of its consumer products for which it is obligated to pay a royalty based
on a percentage of the net selling price of such products. The Company has also
entered into a number of joint development and supply arrangements pursuant to
which the Company jointly develops a product with another company or contracts
with another company to develop a product or component for it and then purchases
the product or component from such company for resale as bundled with other
Company products. In addition, the Company has on occasion purchased off the
shelf products to resell bundled with its own product. In the future, it may
be necessary or desirable for the Company to seek additional licenses to
intellectual property rights held by third parties or purchase products
manufactured and/or sold by third parties with respect to some or all of its
product offerings. There can be no assurance that such licenses or purchases
will be available on terms acceptable to the Company, if at all. The
inability of the Company to enter into such license arrangements on
acceptable terms or to maintain its current licenses on acceptable terms
could have a material adverse effect on the Company's business, financial
condition and results of operations.
EMPLOYEES
As of June 30, 1998, the Company had 511 full-time employees, including
282 in research and development, 98 in sales and marketing, and 131 in finance,
administration and operations. The Company believes that its future performance
will depend, in part, on its ability to continue to attract and retain qualified
technical and management personnel, particularly highly skilled design engineers
and software programmers involved in new product development, for whom
competition is intense. In addition, the Company is currently seeking to hire
additional senior management personnel. Three of the Company's most senior
finance personnel, including the chief financial officer, as well as the
president of the Company's Optical Storage Group recently left the Company and
the Company is actively recruiting their replacements. The Company's success
in the future will in part depend on the successful assimilation of such new
personnel. The Company's employees are not represented by any collective
bargaining unit and the Company has never experienced a work stoppage. The
Company believes that its employee relations are good.
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ACQUISITIONS
On April 2, 1998, the Company acquired certain assets from ODEUM
Microsystems, Inc. (ODEUM), a subsidiary of Hyundai Electronics America.
With the acquisition, the Company acquired an integrated MPEG-2 audio/video
decoder and transport demultiplexor and a DVB-S compliant QSPK demodulator as
well as a core group of hardware and software engineers. The products
acquired from ODEUM are used predominately in "free to air" satellite and
cable set-top boxes for MPEG -2 encoded digital television broadcasting and
therefore, represented the Company's first step in expanding its Consumer
Group and serving the digital television market. The assets of ODEUM were
acquired for $4,010,000 in cash.
On April 30, 1998, the Company entered into several agreements with Omni
Peripherals Pte. Ltd., a private Singapore company (Omni) and two other
investors pursuant to which the Company acquired a preferred equity interest in
Omni. Omni is in the business of designing, developing, and marketing
mechatronics modules for optical storage drives. The Company intends to assist
Omni in the design and marketing of its mechatronics modules thereby enabling
the Company to offer a complete solution to its customers. The Company paid
approximately $800,000 for its interest, representing approximately 20% of the
issued stock of Omni.
On July 2, 1998, the Company acquired ViewPoint, a privately held company
that was developing solutions for the CD-RW drive market. ViewPoint had
developed a controller that supports high encoding speeds for CD-RW drives and
this component complements the Company's expertise in the block decoder area and
will be utilized in the Company's next generation CD-RW drives. The Company
paid $10,100,000 in cash for all the outstanding shares of ViewPoint.
On August 11, 1998, the Company acquired XLI, a provider of print quality
enhancement technology for the digital office equipment market. XLI will
operate as a division of the Company's wholly owned subsidiary, Pixel Magic and
will serve to leverage Pixel Magic's position in the digital office equipment
market by broadening Pixel Magic's expertise in resolution enhancement
technology. As the customer base for both Pixel Magic and XLI are nearly
identical, the benefits for current and potential customers include the meshing
of technology expertise in silicon integration and manufacturing, image
processing and resolution enhancement. The Company made a cash payment of
$3,650,000 to the XLI shareholders on the effective date of the merger and the
shareholders have the right to receive additional payments of up to $11,350,000
subject to the achievement of certain milestones by XLI over a three year period
ending December 31, 2000.
ITEM 2. PROPERTIES
The Company's executive offices and its principal marketing, sales and
product development operations are located in approximately 80,000 square feet
of leased space in Sunnyvale, California under a noncancelable operating lease
that expires in December 2001. The Company has approximately 33,425 square feet
of additional leased facilities in Sunnyvale, California under a noncancellable
lease that expires in February, 2000. The Company owns a portion of a building
in Taipei, Taiwan, and leases facilities, primarily for sales, product
development, and technical support, in Andover, Massachusetts; Tokyo, Japan;
Bristol, England; Munich, Germany; Shenzhen, China; Boca Raton, Florida; and
Austin, Texas. The Company is currently attempting to sublease its facilities in
Boca Raton and Austin where it has 5,208 and 3,766 square feet, respectively.
The Company believes its existing facilities will be adequate to meet its
requirements for at least the next fiscal year.
ITEM 3. LEGAL PROCEEDINGS
The Company and various of its current and former officers and Directors
are parties to several lawsuits which purport to be class actions filed on
behalf of all persons who purchased or acquired the Company's stock (excluding
the defendants and parties related to them) for the period July 27, 1995 through
May 22, 1996. The first, a state court proceeding designated IN RE OAK
TECHNOLOGY SECURITIES LITIGATION, Master File No. CV758510 pending in Santa
Clara County Superior Court in Santa Clara, California, consolidates five
putative class actions. This
17
<PAGE>
lawsuit also names as defendants several of the Company's venture capital fund
investors, two of its investment bankers and two securities analysts. The
plaintiffs allege violations of California securities laws and statutory deceit
provisions as well as breaches of fiduciary duty and abuse of control. On
December 6, 1996, the state court judge sustained the Oak defendants' demurrer
to all causes of action alleged in plaintiffs' First Amended Consolidated
Complaint, but allowed plaintiffs the opportunity to amend. The plaintiffs'
Second Amended Consolidated Complaint was filed on August 1, 1997. On December
3, 1997, the state court judge sustained the Oak defendants' demurrer to
plaintiffs' Second Amended Consolidated Complaint without leave to amend to the
causes of action for breach of fiduciary duty and abuse of control, and to the
California Corporations Code Sections 25400/25500 claims with respect to the
Company, a number of the individual officers and directors, and the venture
capital investors. The judge also sustained the demurrer with leave to amend to
the California Civil Code Sections 1709/1710 claims, however plaintiffs elected
not to amend this claim. Accordingly, the only remaining claim in state court,
IN RE OAK TECHNOLOGY SECURITIES LITIGATION, is the California Corporations Code
Sections 25400/25500 cause of action against four officers of the Company and
the Company's investment bankers. On July 16, 1998, the state court
provisionally certified a national class of all persons who purchased the
Company's stock during the class period. The court stayed any action on this
order until the California Supreme Court resolves the Diamond Multimedia writ
petition.
The Company and various of its current and former officers and Directors
are also parties to four putative class action lawsuits pending in the U.S.
District Court for the Northern District of California. These actions have been
consolidated as IN RE OAK TECHNOLOGY, INC. SECURITIES LITIGATION, Case No.
C-96-20552-SW(PVT). This action alleges certain violations of federal
securities laws and is brought on behalf of purchasers of the Company's stock
for the period July 27, 1995 through May 22, 1996. This action also names as a
defendant one of the Company's investment bankers. On July 29, 1997, the
federal court judge granted the Oak defendants' Motion to Dismiss the
plaintiff's First Amended Consolidated Complaint, but granted plaintiffs leave
to amend most claims. The plaintiffs' Second Amended Consolidated Complaint was
filed on September 4, 1997. Defendants' Motion to Dismiss was heard on December
17, 1997. The federal court judge took the matter under submission and has not
yet issued a ruling.
Additionally, various of the Company's current and former officers and
Directors are defendants in three consolidated derivative actions pending in
Santa Clara County Superior Court in Santa Clara, California, entitled IN RE OAK
TECHNOLOGY DERIVATIVE ACTION. This lawsuit, which asserts a claim for breach of
fiduciary duty and a claim under California securities law based upon the
officers' and Directors' trading in securities of the Company, has been stayed
pending resolution of the class actions.
In all of the putative state and federal class actions, the plaintiffs are
seeking monetary damages and equitable relief. In the derivative action, the
plaintiffs are also seeking an accounting for the defendants' sales of Company
stock and the payment of monetary damages to the Company.
All of these actions are in the early stages of proceedings. Based on its
current information, the Company believes the suits to be without merit and will
defend its position vigorously. Although it is reasonably possible the Company
may incur a loss upon conclusion of these claims, an estimate of any loss or
range of loss cannot be made. No provision for any liability that may result
upon adjudication has been made in the Company's Consolidated Financial
Statements.
In connection with these legal proceedings, the Company has incurred, and
expects to continue to incur, substantial legal and other expenses. Shareholder
suits of this kind are highly complex and can extend for a protracted period of
time, which can substantially increase the cost of such litigation and divert
the attention of the Company's management.
On July 21, 1997, the Company filed a complaint with the ITC alleging a
violation of U.S. trade laws based on the Company's belief that certain
CD-ROM controllers infringed one or more of the Company's U.S. patents. The
complaint seeks a ban on the importation into the United States of any
infringing CD-ROM controller or product containing such infringing CD-ROM
controller. A formal investigative proceeding was instituted by the ITC
(Investigation No. 337-TA-401) on August 19, 1997, naming as respondents:
Winbond Electronics Corporation (Winbond); Winbond Electronics North
18
<PAGE>
America Corporation; Wearnes Technology (Private) Ltd.; Wearnes Electronics
Malaysia Sendirian Berhad; and Wearnes Peripheal International (Pte.).
On March 16, 1998, the Company and Winbond entered into a settlement
agreement pursuant to which Winbond obtained a nonexclusive, royalty-bearing
license to the Company's U.S. patents No.'s 5,535,327 and 5,581,715 and the
Company obtained a nonexclusive, royalty-free license to several Winbond
patents. The settlement agreement provided that the parties would jointly seek
termination and dismissal of investigation No. 337-TA-401 as to Winbond and its
four affiliated companies: Winbond Electronics North America Corporation;
Wearnes Technology (Private) Ltd.; Wearnes Electronics Malaysia Sendirian
Berhad; and Wearnes Peripheal International (Pte.). On April 15, 1998,
Investigation No. 337-TA-401 was ordered terminated as to all parties.
As originally filed with the ITC, the Company's complaint also identified
as proposed respondents: United Microelectronics Corporation (UMC); Lite-On
Group; Lite-On Technology Corp.; Behavior Tech Computer Corp. and Behavior Tech
Computer (USA) Corp. Prior to the ITC's institution of the formal investigation
proceeding, the Company and UMC entered into a settlement agreement, effective
July 31, 1997, pursuant to which UMC agreed to cease and desist the manufacture
of its specified CD-ROM controllers, except under certain limited conditions
which expired on January 31, 1998. The settlement agreement additionally
provided for the withdrawal of the Company's ITC complaint against UMC and the
above-named Lite-On and Behavior Tech companies. In September 1997, October
1997, February 1998 and April 1998, the Company received $2.6 million, $4.7
million, $0.7 million and $2.6 million, respectively, pursuant to this
settlement. Proceeds from the settlement were recorded as miscellaneous income
and included in nonoperating income for the periods ended September 30, 1997,
December 31, 1997, March 31, 1998 and June 30, 1998, respectively.
On October 27, 1997, the Company filed a complaint in the United States
District Court, Northern District of California against UMC for breach of
contract, breach of the covenant of good faith and fair dealing and fraud based
on UMC's breach of the settlement agreement arising out of the ITC action.
Together with the filing of the complaint, the Company filed a motion for a
preliminary injunction against UMC, seeking to enjoin UMC from selling the
CD-ROM controllers that were the subject of the ITC action and related
settlement agreement, through or to a UMC-affiliated, Taiwanese entity called
MediaTek. On February 23, 1998, the federal court judge denied the Company's
request for a preliminary injunction based on the court's findings that there
was no evidence that UMC was presently engaged in the manufacture of CD-ROM
controllers or other products covered by the settlement agreement. On December
24, 1997, UMC answered the Company's complaint and counterclaimed asserting
causes of action for recission, restitution, fraudulent concealment, mistake,
lack of mutuality, interference and declaratory judgment of non-infringement,
invalidity and unenforceability of the Oak patent that was the subject of the
original ITC action filed against UMC. The Company believes these counterclaims
to be without merit and will vigorously defend its patent. Both the Company and
UMC seek compensatory and punitive damages. In addition, the Company seeks
permanent injunctive relief. On June 11, 1998, this case was consolidated for
all purposes with a related case brought against the Company by MediaTek
(described below). On the same date, pursuant to UMC's request, the court
ordered that the civil action involves the same issues involved in Investigation
No. 337-TA-409 before the ITC, initiated by Oak (described below).
In a related action to the lawsuit that was commenced by the Company
against UMC (described above), on December 19, 1997, MediaTek, a UMC
affiliated Taiwanese entity, filed a complaint in the United States District
Court, Northern District of California, against the Company for declaratory
judgment of non-infringement, invalidity and unenforceability of the Oak
patent that was the subject of the original ITC action against UMC, and
intentional interference with prospective economic advantage. MediaTek seeks
compensatory damages of not less than $10 million and punitive damages. The
Company filed its answer on January 8, 1998 denying all the allegations. The
Company believes the suit to be without merit and will vigorously defend its
patent. On June 11, 1998, this case was consolidated for all purposes with a
related case brought by the Company against UMC (described above). On the
same date, pursuant to UMC's request, the court ordered the consolidated
action stayed under 28 U.S.C. Section 1659, based on the court's conclusion
that the civil action involves the same issues involved in Investigation No.
337-TA-409 before the ITC, initiated by Oak (described below).
19
<PAGE>
On April 7, 1998, the Company filed a new complaint with the ITC alleging
that five Asian companies, are violating U.S. trade laws by importing or selling
CD-ROM drive controllers that infringe a United States patent owned by the
Company. The Company's complaint is asserted against United Microelectronics
Corp.; MediaTek, Inc.; Lite-On Group; Lite-On Technology Corp. and AOpen, Inc.
In its complaint, the Company requests the ITC to investigate the five
above-named companies and to enter an order barring imports into the United
States of their allegedly infringing products and products containing them,
including CD-ROM drives and personal computers. A formal investigative
proceeding was instituted by the ITC (Investigation No. 337-TA-409) on May 8,
1998 naming as respondents United Microelectronics Corp. MediaTek, Inc., Lite-On
Technology Corp. and AOpen, Inc. On August 28, 1998, the Administrative law
Judge (ALJ) supervising the investigation entered an initial determination that
the investigation be terminated as to respondent UMC. On September 4, 1998, the
Company filed a petition with the Commission for review of the initial
determination. The initial determination does not affect the ongoing
investigation with respect to any of the other respondents. Trial before the
ALJ is presently scheduled to commence on January 11, 1999. In most cases, the
ITC decides within 12 to 15 months after the filing of a complaint whether or
not to issue an order excluding foreign products that allegedly infringe U.S.
patents. In connection with this legal proceeding, the Company will incur
substantial legal and other expenses.
If any of the above pending actions are decided adversely to the Company,
it would likely have a material adverse affect on the Company's financial
condition and results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
20
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
The Company has paid no cash dividends on its Common Stock since its
incorporation and anticipates that for the foreseeable future it will continue
to retain any earnings for use in its business. In addition, the Company's bank
arrangements currently prohibit the Company from issuing cash dividends.
The Company's Common Stock trades on the Nasdaq National Market under the
symbol OAKT. The following table indicates the range of the high and low
closing prices as reported by Nasdaq for the past twelve fiscal quarters ended
June 30, 1998.
<TABLE>
<CAPTION>
High Low
-------- --------
<S> <C> <C>
FISCAL 1996
First Quarter...................................... $ 23-5/8 $ 18-1/4
Second Quarter..................................... $ 29-1/8 $ 17-1/2
Third Quarter...................................... $ 30 $ 17-1/2
Fourth Quarter..................................... $ 22-3/4 $ 8-7/8
FISCAL 1997
First Quarter...................................... $ 11 $ 5-1/2
Second Quarter..................................... $ 13-3/4 $ 8-11/16
Third Quarter...................................... $ 14-9/16 $ 9-1/2
Fourth Quarter..................................... $ 10-1/2 $ 7-9/16
FISCAL 1998
First Quarter...................................... $ 12 $ 9-5/16
Second Quarter..................................... $ 11-1/2 $ 6-1/32
Third Quarter...................................... $ 7-9/16 $ 5-19/32
Fourth Quarter..................................... $ 6-7/16 $ 4-1/4
</TABLE>
On September 21, 1998, the closing price of the Common Stock on the Nasdaq
National Market was $2.15 per share. As of September 21, 1998, there were 330
holders of record of the Common Stock of the Company.
All share and per share information in this Annual Report on Form 10-K
give effect to a two-for-one split of the Company's Common Stock, which was
effected on March 28, 1996.
21
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
OAK TECHNOLOGY, INC. AND SUBSIDIARIES
SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues (1)......................... $ 157,106 $ 167,395 $ 247,984 $ 110,982 $ 42,562
Gross profit............................. 74,548 94,181 109,485 54,616 16,572
Operating (loss) income.................. (9,104) 32,848 57,147 29,440 4,200
Net income............................... $ 5,947 $ 23,719 $ 37,133 $ 21,222 $ 3,823
Diluted income per share................. $ 0.14 $ 0.55 $ 0.87 $ 0.67 $ 0.15
Shares used in diluted per share
calculations (2)...................... 42,493 42,757 42,614 31,474 25,756
<CAPTION>
As of June 30,
----------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and
short-term investments................ $ 117,225 $ 145,269 $ 113,284 $ 150,943 $ 3,738
Working capital.......................... 144,314 168,168 134,686 156,258 7,723
Total assets............................. 261,411 287,595 256,308 193,953 27,413
Long-term debt, excluding
current portion....................... 27 2,496 2,858 2,227 1,950
Total stockholders' equity............... 241,208 238,697 210,827 162,643 11,736
</TABLE>
(1) Net revenues include non-refundable technology license fees. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
(2) Computed on the basis described in Note 2 of Notes to Consolidated
Financial Statements.
22
<PAGE>
SELECTED QUARTERLY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Three Months Ended
--------------------------------------------------------------------------------------
June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31, Dec. 31, Sept. 30,
1998 1998 1997 1997 1997 1997 1996 1996
-------- -------- -------- -------- -------- -------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenues (1)................ $ 28,910 $ 35,550 $ 49,353 $ 43,293 $ 50,224 $ 50,634 $ 47,611 $ 18,926
Gross profit.................... 11,485 14,405 26,120 22,538 25,280 27,805 32,386 8,710
Operating income (loss)......... (12,031) (8,578) 6,109 5,396 3,553 13,533 19,439 (3,677)
Net income (loss)............... $ (4,844) $ (3,004) $ 7,602 $ 6,193 $ 2,644 $ 9,540 $ 13,188 $ (1,653)
Diluted income (loss)
per share (2)................ $ (0.12) $ (0.07) $ 0.18 $ 0.15 $ 0.06 $ 0.22 $ 0.31 $ (0.04)
Shares used in diluted
per share calculations (2)... 41,532 42,000 42,653 42,569 42,347 42,801 42,701 40,297
</TABLE>
(1) Net revenues include non-refundable technology license fees. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
(2) Computed on the basis described in Note 2 of Notes to Consolidated
Financial Statements.
23
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
EXCEPT FOR THE HISTORICAL FINANCIAL INFORMATION CONTAINED HEREIN, THE
MATTERS DISCUSSED IN THIS ANNUAL REPORT ON FORM 10-K MAY BE CONSIDERED
"FORWARD-LOOKING" STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES ACT OF 1934, AS
AMENDED. SUCH STATEMENTS INCLUDE DECLARATIONS REGARDING THE INTENT, BELIEF OR
CURRENT EXPECTATIONS OF THE COMPANY AND ITS MANAGEMENT. SUCH FORWARD-LOOKING
STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE A NUMBER OF
RISKS AND UNCERTAINTIES. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE
INDICATED BY SUCH FORWARD-LOOKING STATEMENTS. THE COMPANY UNDERTAKES NO
OBLIGATION TO PUBLICLY RELEASE THE RESULTS OF ANY REVISION TO THESE
FORWARD-LOOKING STATEMENTS WHICH MAY BE MADE TO REFLECT EVENTS OR CIRCUMSTANCES
AFTER THE DATES HEREOF OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS.
AMONG THE IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY
FROM THOSE INDICATED BY SUCH FORWARD-LOOKING STATEMENTS ARE: (I) THAT THE
INFORMATION IS OF A PRELIMINARY NATURE AND MAY BE SUBJECT TO FURTHER ADJUSTMENT,
(II) VARIABILITY IN THE COMPANY'S QUARTERLY OPERATING RESULTS, (III) GENERAL
CONDITIONS IN THE SEMICONDUCTOR INDUSTRY, (IV) RISKS RELATED TO PENDING LEGAL
PROCEEDINGS, (V) DEVELOPMENT BY COMPETITORS OF NEW OR SUPERIOR PRODUCTS OR THE
ENTRY OF NEW COMPETITORS INTO THE COMPANY'S MARKETS, (VI) THE COMPANY'S ABILITY
TO DIVERSIFY ITS PRODUCT AND MARKET BASE BY DEVELOPING AND INTRODUCING NEW
PRODUCTS WITHIN DESIGNATED MARKET WINDOWS AT COMPETITIVE PRICE AND PERFORMANCE
LEVELS, (VII) WILLINGNESS OF PROSPECTIVE CUSTOMERS TO DESIGN THE COMPANY'S
PRODUCTS INTO THEIR PRODUCTS, (VIII) AVAILABILITY OF ADEQUATE FOUNDRY CAPACITY
AND ACCESS TO PROCESS TECHNOLOGIES, (IX) THE COMPANY'S ABILITY TO PROTECT ITS
PROPRIETARY INFORMATION AND OBTAIN ADEQUATE ACCESS TO THIRD PARTY TECHNOLOGY ON
ACCEPTABLE TERMS, (X) RISKS RELATED TO USE OF INDEPENDENT MANUFACTURERS AND
THIRD PARTY ASSEMBLY AND TEST VENDORS, (XI) DEPENDENCE ON KEY PERSONNEL, (XII)
RELIANCE ON A LIMITED NUMBER OF LARGE CUSTOMERS, (XIII) DEPENDENCE ON SALES OF
CD-ROM CONTROLLER PRODUCTS AND THE PC MARKET, (XIV) RISKS RELATED TO
INTERNATIONAL BUSINESS OPERATIONS, (XV) DEPENDENCE ON SALES TO THE ASIAN
MARKETS; (XVI) ABILITY OF THE COMPANY TO MAINTAIN ADEQUATE PRICE LEVELS AND
MARGINS WITH RESPECT TO ITS PRODUCTS, (XVII) MANAGEMENT OF CHANGING OPERATIONS
RELATED TO THE COMPANY'S RECENT RESTRUCTURING AND MANAGEMENT CHANGES, (XVIII)
RISKS RELATED TO ACQUISITIONS, (XIX) THE ABILITY TO ATTRACT AND RETAIN QUALIFIED
MANAGEMENT AND TECHNICAL PERSONNEL AND (XX) OTHER RISKS IDENTIFIED FROM TIME TO
TIME IN THE COMPANY'S REPORTS AND REGISTRATION STATEMENTS FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION.
OVERVIEW
In the second half of fiscal 1998, the Company began a period of
redirection and restructuring in an effort to redefine its strategic direction
and focus on its key strengths and core competencies. A key decision was made
to exit markets where the Company saw limited potential for profitability and a
significant dependency on the PC market and redirect resources to market
opportunities where the Company could utilize its core technical competencies.
The Company initiated several changes in the second half of the fiscal year
necessary to implement and support this redirection.
In January of 1998, the Company made a change in management by electing Mr.
Richard Black as President to lead the operational activities of the Company.
Mr. Black has served on the Board of Directors of the Company for a number of
years. David D. Tsang continued as the Company's Chief Executive Officer
focusing on strategic direction for the Company and customer relations. In
addition, in an effort to bring additional industry experience to its Board,
the Company also elected Mr. Young Sohn, president of Quantum Corporation's
Enterprise and Personal Storage Group, to its Board of Directors.
During the third quarter of fiscal 1998, the Company restructured its
operations along three market-focused groups: Optical Storage Group, Consumer
Group and the Digital Office Equipment Group (Pixel Magic). All product
development and marketing efforts in the Company's PC audio and 3D graphics
businesses, businesses significantly dependent on the PC market and to which the
Company was a new entrant, were discontinued in the fiscal third quarter ending
March 31, 1998. As a result of the discontinuation of these businesses, the
Company laid off 56 employees and recorded a restructuring charge of $1.8
million to operations and a $3.5 million inventory-related charge to cost of
revenues related to this restructuring during the quarter ended March 31, 1998.
The $1.8 million charge consisted of approximately $1.0 million for the
writedown of prepaid royalties, $0.6 million for severance pay and $0.2 million
in miscellaneous charges.
24
<PAGE>
The Company initiated several actions to expand its interests in its
consumer business and digital office equipment business. In the third
quarter of the fiscal year, the Company announced it would expand in the
consumer products area by targeting new opportunities presented by the
digital broadcast market by developing integrated circuits for cable,
satellite and terrestrial set-top boxes. Towards this end, in April of 1998,
the Company acquired certain integrated circuits for the demodulation of
cable and satellite digital television signals from ODEUM Microsystems, Inc.
(ODEUM). With the acquisition, the Company acquired an integrated MPEG-2
audio/video decoder and transport demultiplexor and a DVB-S compliant QSPK
demodulator as well as a core group of hardware and software engineers. The
products acquired from ODEUM are used predominately in "free to air"
satellite and cable set-top boxes for MPEG -2 encoded digital television
broadcasting and therefore, represented the Company's first step in expanding
its Consumer Group and serving the digital broadcast market. The assets of
ODEUM were acquired for $4,010,000 in cash. The Company also established a
subsidiary in Germany (Oak Technology GmbH) to support the sales and
engineering efforts associated with the digital television market. In
addition, a subsidiary was established in Bristol, UK (Oak Technology, Ltd.)
in the third quarter of the fiscal year to house the design team the Company
hired to design integrated circuits for the digital terrestrial broadcast
market.
In the third quarter of the fiscal year, the Company also announced its
intention to continue to grow its digital office equipment business through
research investment and acquisition and acted on its intention by acquiring
XLI, a company with resolution enhancement technology. Xerographic Laser
Images Corporation (XLI) is a provider of print quality enhancement
technology for the digital office equipment market. XLI will operate as a
division of the Company's wholly owned subsidiary, Pixel Magic, and will
serve to leverage Pixel Magic's position in the digital office equipment
market by broadening Pixel Magic's expertise in resolution enhancement
technology. As the customer base for both Pixel Magic and XLI are nearly
identical, the benefits for current and potential customers include the
meshing of technology expertise in silicon integration and manufacturing,
image processing and resolution enhancement. The Company made a cash payment
of $3,650,000 to the XLI shareholders on the effective date of the merger and
such shareholders have the right to receive additional payments of up to
$11,350,000 subject to the achievement of certain milestones by XLI over a
three year period ending December 31, 2000.
In July 1998, the Company continued its restructuring efforts by cutting
development projects of minimal value to the redirection of the Company and
reducing engineering headcount associated with those projects in the first
quarter of fiscal 1999. The Company also reduced its administrative overhead
by cutting administrative projects and headcount. The reduction represented
a headcount of 55 and an annual permanent saving in salaries and benefits of
approximately six million dollars.
During the second half of the fiscal year, as evidence of its commitment to
its redirection and restructuring, the Company initiated three acquisitions in
each of its three target markets and one additional investment related to its
optical storage market. Two acquisitions, ODEUM and XLI, are described above.
One acquisition and the investment were completed in fiscal 1998 and the other
two acquisitions were completed in fiscal 1999.
In July 1998, the Company acquired ViewPoint, a privately held company
that was developing solutions for the CD-RW drive market. ViewPoint
Technology, Inc. (ViewPoint) had developed a controller that supports high
encoding speeds for CD-RW drives and this component complements the
Company's expertise in the block decoder area and will be utilized in the
Company's next generation CD-RW drives. The Company paid $10,100,000 in cash
for all the outstanding shares of ViewPoint.
In April 1998, the Company entered into several agreements with Omni
Peripherals Pte. Ltd. (Omni) and two other investors pursuant to which the
Company acquired a preferred equity interest in Omni. As a group, the three
preferred investors own 51% of the issued stock of Omni. Omni was incorporated
in Singapore on January 2, 1996, and is in the business of designing,
developing, and marketing mechatronics modules for optical storage drives.
The Company intends to assist Omni in the design and marketing of its
mechatronics modules thereby enabling the Company to offer a complete
solution to its customers. The Company paid approximately $800,000 for its
interest, representing approximately 20% of the issued stock of Omni.
25
<PAGE>
The acquisitions of ODEUM, XLI and ViewPoint have been or will be accounted
for under the purchase method of accounting. The investment in Omni has been
recorded under the equity method of accounting. See notes 5 and 14 to the
Consolidated Financial Statements.
As repositioned, the Company provides high-performance, integrated
semiconductors to original equipment manufacturers (OEMs) worldwide who serve
the optical storage, consumer electronics and digital office equipment
markets. The Company's products, consisting primarily of integrated circuits
and supporting software and firmware, enable its OEM customers to deliver
cost-effective, powerful systems to the end-user for storage, home
entertainment and imaging (copy, fax, print) applications. One of the world's
leading merchant suppliers of controllers for CD-ROM and CD-RW drives, the
Company's planned product offerings for its three target market segments have
expanded to include, in addition to optical storage controllers, MPEG-1 and
MPEG-2 audio/video decoders for VideoCD (VCD) and DVD players, and integrated
circuits for digital broadcast systems such as cable, satellite and
terrestrial set-top boxes. In addition, the Company's subsidiary, Pixel
Magic, designs multitasking imaging and compression processors for the
emerging class of digital office equipment. The Company's mission is to
continue to seek opportunities for value-added silicon in these emerging
market segments where it can leverage its core competencies to offer
powerful, cost-effective and complete solutions to its OEM partners.
The Company reported a net loss for the third and fourth fiscal quarters of
1998 of approximately $3.0 million and $4.8 million, respectively. These losses
were due to a number of factors currently affecting the Company's optical
storage business, including, but not limited to, new competitors entering the
market, a maturation of the CD-ROM controller market, pressure from the
sub-$1000 PC segment for low cost components, uncertain demand for personal
computers and delays in new product releases. Together with its fourth quarter
fiscal 1998 earnings announcement, in July of fiscal 1999 the Company announced
that it expected a loss for the first fiscal quarter of 1999 as ongoing pricing
and competitive pressures in the CD-ROM controller market as well as previous
delays in product development in the optical storage area continued to affect
revenue. For fiscal 1999, the Company expects that a majority of its revenue
will continue to be generated by its CD-ROM controller product line as the
Company transitions to its next generation CD-RW product and its first
generation product for DVD and continues its development in products for the
emerging digital broadcast and digital office equipment markets.
In both fiscal 1997 and fiscal 1998, the Company initiated actions with
the International Trade Commission (ITC) in an effort to protect its
intellectual property. The complaints filed by the Company allege that
certain Asian importers or sellers of optical storage controller devices are
violating U.S. trade laws by importing or reselling devices that infringe one
or more U.S. patent owned by the Company. With respect to the ITC action
initiated in fiscal 1997, the Company recorded as non-operating income in
1998 approximately $10.6 million in settlement from one of the companies and
obtained a royalty bearing license from another company. The ITC action
commenced in fiscal 1998 is scheduled for trial on January 11, 1999. In
connection with this remaining ITC action, as well as related legal
proceedings, the Company has incurred and expects to continue to incur
substantial legal and other expenses (see "Legal Proceedings").
In the third quarter of the fiscal year, the Company announced that its
Board of Directors had authorized the repurchase of up to 2.0 million shares of
its common stock, either in the open market or in private transactions. The
repurchase program was authorized for one year, unless further extended by the
Company's Board of Directors. As of June 30, 1998, the Company had purchased
approximately 1,143,000 shares for approximately $6.7 million.
26
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RESULTS OF OPERATIONS
The following table sets forth, as a percentage of net revenues, certain
consolidated statement of operations data for the periods indicated:
<TABLE>
<CAPTION>
Year ended June 30,
------------------------------
1998 1997 1996
------------------------------
<S> <C> <C> <C>
Net revenues.......................... 100.0% 100.0% 100.0%
Cost of revenues...................... 52.5 43.7 55.8
------------------------------
Gross margin....................... 47.5 56.3 44.2
Research and development expenses..... 31.6 20.7 12.4
Selling, general and administrative
expenses.............................. 19.7 12.9 6.8
Acquisition-related charges........... 1.0 3.0 2.0
Restructuring charges................. 1.0 - -
------------------------------
Operating income (loss)............ (5.8) 19.7 23.0
Non-operating income, net............. 10.3 3.2 2.5
------------------------------
Income before income taxes......... 4.5 22.9 25.5
Income taxes.......................... 0.7 8.7 10.5
------------------------------
Net income......................... 3.8% 14.2% 15.0%
------------------------------
</TABLE>
FISCAL 1998 COMPARED TO FISCAL 1997
NET REVENUES. The Company's net revenues in the comparison periods were
primarily derived from product sales. Net revenues decreased 6% to $157.1
million in fiscal 1998 from $167.4 million in fiscal 1997. This decrease was
primarily the result of a decrease in revenues from the sales of CD-ROM
controller products and VideoCD products partially offset by an increase in
revenues from the sale of digital office equipment products. The decrease in
revenues from CD-ROM controller products was primarily due to a decrease in the
ASPs of the products partially offset by an increase in unit sales. The
decrease in revenues from VideoCD products was primarily due to a decrease in
unit sales as well as a decrease in ASPs. The increase in revenues from the
sales of digital office equipment products was primarily the result of an
increase in unit sales partially offset by a decrease in ASPs.
Net revenues from sales of the Company's CD-ROM controller products were
approximately $127.4 million in fiscal 1998 compared to $140.8 million in fiscal
1997, accounting for 81% and 84% of net revenues, respectively. Although the
Company is attempting to diversify its revenue product base in the three core
markets of optical storage, consumer electronics and digital office equipment,
it anticipates that CD-ROM controller sales will continue to account for a
substantial majority of its revenue in the foreseeable future.
Net revenues from sales to the Company's top ten customers in fiscal 1998
and 1997 accounted for approximately 81% and 78%, respectively, of the Company's
net revenues.
International sales, principally to Japan, Taiwan, Korea and Belgium
accounted for approximately 92% and 96% of the Company's net revenues in fiscal
1998 and 1997, respectively. This decrease in international sales, as a
percentage of total sales, is primarily attributable to a decrease in revenues
as well as an increase in revenues of Pixel Magic, which are primarily domestic,
in the comparison periods.
Included in net revenues for fiscal 1998 and fiscal 1997 were $1.2 million
and $0.2 million, respectively, of nonrefundable technology license fees.
27
<PAGE>
Sales of products related to the graphics and audio/communications
businesses which the Company discontinued in the quarter ended March 31, 1998,
accounted for approximately 2% and 1% of the Company's net revenues in fiscal
1998 and 1997, respectively.
GROSS MARGIN. Cost of revenues includes the cost of wafer fabrication,
assembly and testing performed by third-party vendors and direct and indirect
costs associated with the procurement, scheduling and quality assurance
functions performed by the Company. The Company's gross margin decreased to
47.5% in fiscal 1998 as compared to 56.3% in fiscal 1997. Gross margin in fiscal
1998 includes the impact of a charge to cost of revenues related to increases in
inventory reserves of $3.3 million recorded during the year as well as a $3.5
million charge related to the discontinuation of the graphics and
audio/communications businesses. Excluding the impact of these
inventory-related charges, gross margin in fiscal 1998 would have been 51.8%.
Gross margin in fiscal 1997 includes the impact of a charge to cost of revenues
related to increases in inventory reserves of $2.6 million recorded during the
year. Additionally, gross margin in fiscal 1997 includes the impact of
favorable adjustments to cost of revenues of approximately $18.7 million
associated with the sale of products which had been fully reserved in a prior
period as well as manufacturing cost adjustments of $3.0 million related to
foundry agreements. Excluding the impact of these adjustments, gross margin for
fiscal 1997 would have been 44.9%. The increase in gross margin during the
comparison periods, excluding the impact of the adjustments recorded in fiscal
1998 and fiscal 1997, is primarily the result of a product mix shift to higher
margin CD-RW controllers and digital office equipment products during the
comparison periods. Gross margins related to the graphics and
audio/communications businesses which the Company discontinued in the quarter
ended March 31, 1998 accounted for less than 2% and 1% of the Company's total
gross margin contribution in fiscal 1998 and 1997, respectively.
The Company's overall gross margin is subject to change due to various
factors, including, among others, competitive product pricing, yields, wafer
costs, assembly and test costs, product design changes and product mix. The
Company expects that ASPs for its existing products will continue to decline
over time and that ASPs for each new product will decline significantly over the
life of the product. The Company is currently experiencing severe price
pressure on its CD-ROM controller and VideoCD products and expects such price
erosion to continue. A decline in ASPs that is not offset by cost reductions
through product design changes, manufacturing process changes, yield
improvement, savings negotiated with its manufacturing subcontractors or by
sales of new products with higher gross margins would decrease the Company's
overall gross margin and could materially adversely affect the Company's
operating results. The Company does not believe that it can achieve cost
reductions or sales of new products with higher gross margins which fully offset
the expected price declines of its CD-ROM and VideoCD products and therefore,
it expects gross margin percentages to decline for such products. In addition,
the Company believes that gross margins for new products in its optical storage
market and the video disk portion of the consumer markets will be lower than
historical levels and that, as a result, gross margins in general will decline
in the future.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development costs are all
expensed as incurred. Research and development expenses were $49.7 million and
$34.7 million, and expressed as a percentage of net revenues were 31.6% and
20.7% in fiscal 1998 and 1997, respectively. This increase in research and
development expenditures in fiscal 1998, both in terms of absolute dollars and
as a percentage of net revenues was primarily the result of the hiring of
additional personnel and related expenses. The Company will continue to invest
substantial resources in research and development in an effort to complete the
development of its new products in the Company's core technologies: optical
storage, consumer electronics and digital office equipment. The Company
expects to hold research and development expenses flat in absolute dollar
terms in fiscal 1999.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses include costs related to salaries, commissions, legal
fees, consulting and other costs related to the sales, marketing and
administrative functions of the Company. Selling, general and administrative
expenses increased 42% to $30.9 million in fiscal 1998 from $21.7 million in
fiscal 1997. Additionally, selling, general and administrative expenses
increased as a percentage of net revenues to 19.7% in fiscal 1998 from 12.9% in
fiscal 1997. This increase was principally the result of the hiring of
additional management and administrative personnel and associated expenses,
costs associated with the implementation of a new management information system
as well as increases in legal expenses. The increase in legal expenses relates
primarily to the complaints the Company filed with the
28
<PAGE>
ITC on July 21, 1997 and April 7, 1998 (ITC Complaints) and additional
litigation related to a settlement agreement with one of the parties in the
July 21 ITC Complaint. See "Legal Proceedings." The Company expects to incur
higher selling, general and administrative expenses as a percentage of
revenues in fiscal 1999.
ACQUISITION-RELATED CHARGES. Acquisition-related charges include the costs
associated with the acquisitions of Pixel Magic and the acquisition of certain
assets of ODEUM.
In March 1998, the Company entered into an asset purchase agreement with
ODEUM and Hyundai Electronics America pursuant to which the Company agreed to
acquire certain assets of ODEUM for $4.0 million. The transaction was
consummated in April 1998 and was accounted for under the purchase method of
accounting. Approximately $1.3 million of the purchase price was allocated
to in-process research and development and was charged to operations in
fiscal 1998.
In November 1995, the Company acquired Pixel Magic, a privately-held
company based in Andover, Massachusetts for $10.5 million in cash, of which $5.0
million was contingent upon the achievement of certain performance criteria over
a three-year period. Approximately $4.8 million of the initial cash payment was
allocated to in-process research and development and was charged to operations
in fiscal 1996. In June 1997, the Company waived certain of the performance
criteria and agreed to pay the contingent amount of $5.0 million in two
installments during calendar 1998. The first payment of $3.0 million was paid
in January 1998 and the second payment of $2.0 million is due in December 1998.
As a result of this agreement and because the contingent amount was based, in
part, on the continued employment of the former shareholder/employees of Pixel
Magic, the Company recorded a compensation charge of $5.0 million in fiscal
1997.
RESTRUCTURING CHARGES. During 1998, the Company discontinued its graphics
and audio/communications businesses and incurred a charge to operations of
approximately $1.8 million related to these discontinued businesses. The $1.8
million charge consisted of $1.0 million related to a write-off of prepaid
royalties, approximately $0.6 million for severance pay and $0.2 for
miscellaneous charges. See Note 11 of Notes to Consolidated Financial
Statements.
NON-OPERATING INCOME, NET. Non-operating income, net consisted
primarily of net interest income of $7.4 million, net foreign currency
exchange losses of $2.5 million and approximately $10.6 million related to
the settlement agreement between the Company and United Microelectronics
Corporation in connection with a complaint the Company filed with the ITC on
July 21, 1997. See "Legal Proceedings".
INCOME TAXES. The Company's effective tax rate was 15.0% and 38.0% in
fiscal 1998 and 1997, respectively. The decrease in effective rate is primarily
due to the Company's continued decrease in taxable income along with the
substantial research and development credits earned by the Company, offset by a
partial valuation allowance recorded during 1998. See Note 6 of Notes to
Consolidated Financial Statements.
FISCAL 1997 COMPARED TO FISCAL 1996
NET REVENUES. The Company's net revenues in the comparison periods were
primarily derived from product sales. Net revenues decreased 32% to $167.4
million in fiscal 1997 from $248.0 million in fiscal 1996. This decrease was
primarily attributable to a reduction in unit sales and average selling prices
of CD-ROM controllers in fiscal 1997 compared to fiscal 1996. The decrease in
unit sales resulted from the Company receiving substantially fewer orders for
its CD-ROM controller products in fiscal 1997 than in fiscal 1996.
Net revenues from sales of the Company's CD-ROM controller products were
approximately $127.4 million in fiscal 1997 compared to $225.3 million in fiscal
1996, accounting for 84% and 91% of net revenues, respectively. Net revenues
from sales to the Company's top ten customers in fiscal 1997 and 1996 accounted
for approximately 78% and 80%, respectively, of the Company's net revenues.
International sales, principally to Japan, Taiwan, Korea and Singapore accounted
for approximately 96% and 98% of the Company's net revenues in fiscal 1997 and
1996, respectively. Included in net revenues for fiscal 1997 and fiscal 1996
were $0.2 million and $3.0 million, respectively, of nonrefundable technology
license fees.
29
<PAGE>
GROSS MARGIN. Cost of revenues includes the cost of wafer fabrication,
assembly and testing performed by third-party vendors and direct and indirect
costs associated with the procurement, scheduling and quality assurance
functions performed by the Company. The Company's gross margin increased to
56.1% in fiscal 1997 from 44.2% in fiscal 1996. The increase in gross margin
from fiscal 1996 to fiscal 1997 was primarily the result of adjustments of
approximately $18.7 million to cost of revenues associated with the sale of
products which had been fully reserved in prior periods as well as manufacturing
cost adjustments of $3.0 million related to foundry agreements. Additionally,
fiscal 1996 gross margins were reduced as a result of inventory-related charges
to cost of sales of $24.0 million. Excluding the impact of these adjustments,
gross margin for fiscal 1997 and 1996 would have been approximately 43.3% and
53.8% respectively. This adjusted gross margin decreased from the comparable
period in fiscal 1996 primarily as a result of a decrease in ASPs of the
Company's CD-ROM controller products that was not offset by a comparable
decrease in product costs.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were
$34.7 million and $30.7 million, and expressed as a percentage of net revenues
20.7% and 12.4% in fiscal 1997 and 1996, respectively. Research and development
expenses increased in fiscal 1997 primarily due to the hiring of additional
personnel and associated expenses. Research and development expenses increased
as percentage of net revenues in fiscal 1997 primarily due to the decrease in
the Company's net revenues.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses were $21.7 million and $16.8 million and expressed as a
percentage of net revenues 12.9% and 6.8% in fiscal 1997 and fiscal 1996,
respectively. The increase in absolute dollars was primarily the result of the
hiring of additional personnel and associated expenses. The increase as a
percentage of net revenues was due primarily to the decrease in the Company's
net revenues.
ACQUISITION-RELATED CHARGES. In November 1995, the Company acquired Pixel
Magic, a privately-held company based in Andover, Massachusetts for $10.5
million in cash, of which $5.0 million was paid up front and $5.0 million was
contingent upon the achievement of certain performance criteria over a
three-year period. In June 1997, the Company waived certain of the performance
criteria and agreed to pay the contingent amount of $5.0 million in two
installments during calendar 1998. The first payment of $3.0 million was paid
in January 1998 and the second payment of $2.0 million is due in December 1998.
As a result of this agreement and because the contingent earn-out was based, in
part, on the continued employment of the former shareholder/employees of Pixel
Magic, the Company recorded a compensation charge of $5.0 million in the quarter
ended June 30, 1997.
NON-OPERATING INCOME, NET. Non-operating income, net consisted primarily
of net interest income in fiscal 1997. Non-operating income, net was $5.4
million in fiscal 1997 and $6.0 million in fiscal 1996. The decrease is
primarily the result of lower net interest income in fiscal 1997 compared to
fiscal 1996.
INCOME TAXES. The Company's effective tax rate was 38.0% and 41.2% in
fiscal 1997 and 1996, respectively. The lower tax rate in 1997 was primarily
attributable to the effect of the reinstated research and development tax credit
on fiscal 1997 results as well as geographical shift in the sources of taxable
income in fiscal 1997. See Note 6 of Notes to Consolidated Financial
Statements.
30
<PAGE>
FACTORS THAT MAY AFFECT FUTURE RESULTS
The following factors should be carefully considered in evaluating the
Company and its business.
QUARTERLY FLUCTUATIONS
The Company's operating results are subject to quarterly and other
fluctuations due to a variety of factors, including the gain or loss of
significant customers, increased competitive pressures, the timing of new
product announcements and introductions by the Company or its competitors and
market acceptance of new or enhanced versions of the Company's and its
customers' products. Other factors include the availability of foundry
capacity, fluctuations in manufacturing yields, availability and cost of raw
materials and manufacturing capacity, the cyclical nature of the semiconductor
industry in general, the market for PCs and the markets addressed by the
Company's products, seasonal customer demand, the Company's ability to diversify
its product offerings, short product life cycles, the competitiveness of the
Company's customers, the timing of significant orders, significant increases in
expenses associated with the expansion of operations and development of the
Company's support infrastructure, high fixed costs and changes in pricing
policies by the Company, its competitors or its suppliers, including decreases
in ASPs of the Company's products. In addition, the Company's quarterly
operating results could be materially adversely affected by legal expenses
incurred in connection with, or any adverse judgment in, the Company's ongoing
shareholder legal proceedings and ITC actions. The Company's operating results
could also be adversely affected by economic conditions generally in various
geographic areas where the Company or its customers do business, or by order
cancellations or rescheduling. These factors are difficult to forecast, and
these or other factors could materially affect the Company's quarterly or annual
operating results. There can be no assurance as to the level of sales or
earnings that may be attained by the Company in any given period in the future.
The semiconductor industry has historically been characterized by rapid
technological change, cyclical market patterns, significant price erosion,
periods of over-capacity and production shortages, variations in manufacturing
costs and yields and significant expenditures for capital equipment and product
development. In addition, the industry has experienced significant economic
downturns at various times, characterized by diminished product demand and
accelerated erosion of product prices. The Company may experience substantial
period-to-period fluctuations in operating results due to general semiconductor
industry conditions. The downturns in the industry often occur in connection
with, or in anticipation of, maturing product cycles (of both the semiconductor
companies and their customers) and declines in general economic conditions.
These downturns have been characterized by abrupt fluctuations in product
demand, production overcapacity and subsequent accelerated erosion of average
selling prices, and in some cases, have lasted for more than a year. The Company
may experience substantial period-to-period fluctuations in future operating
results due to general industry conditions or events occurring in the general
economy, and the Company's operating results and financial condition could be
materially and adversely impacted by a significant industry-wide downturn. The
semiconductor industry also has been characterized by periods of rapid expansion
of production capacity. Even if customers' aggregate demand were not to decline,
the availability of additional capacity can adversely impact pricing levels,
which can also depress revenue levels. Also, during such periods, customers
benefiting from shorter lead times may delay some purchases into future periods.
There can be no assurance the Company will not experience such downturns in the
future, which could have a material impact on the Company's operating results
and financial condition.
In addition, the Company currently places noncancelable orders to purchase
its products from independent foundries on an approximately three month rolling
basis and is currently committed with two of its foundries for certain minimum
amounts of capacity for the next several years, while its customers generally
place purchase orders with the Company less than four weeks prior to delivery
that may be rescheduled or under certain circumstances may be canceled without
significant penalty. Due to the Company's relatively narrow customer base for
certain devices and the short product life cycles of such products, such
cancellations can leave the Company with significant inventory exposure, which
could have a material adverse effect on the Company's operating results.
Consequently, if anticipated sales and shipments in any quarter are rescheduled,
canceled, or do not occur as quickly as expected, expense and inventory levels
could be disproportionately high and the Company's business, financial condition
and results of operations for that quarter or for the year would be materially
adversely affected.
31
<PAGE>
LEGAL PROCEEDINGS
The Company and various of its current and former officers and Directors
are parties to certain legal proceedings. See "Legal Proceedings." All of these
actions are in the early stages of proceedings and the Company is currently
investigating the allegations. Based on its current information, the Company
believes the suits to be without merit and will defend its position vigorously.
No provision for any liability that may result upon adjudication has been made
in the Company's Consolidated Financial Statements. In connection with these
legal proceedings, the Company has incurred, and expects to continue to incur,
substantial legal and other expenses. Shareholder suits of this kind are highly
complex and can extend for a protracted period of time, which can substantially
increase the cost of such litigation and divert the attention of the Company's
management.
PRICING ISSUES
The willingness of prospective customers to design the Company's products
into their products depends to a significant extent upon the ability of the
Company to have products available at the appropriate market window and to price
its products at a level that is cost effective for such customers. The markets
for most of the applications for the Company's products, particularly the
consumer products market and optical storage market, are characterized by
intense price competition. As the markets for the Company's products mature
and competition increases, as has been the trend for the CD-ROM market, the
Company anticipates that ASPs on its products will decline. The Company
continually attempts to pursue cost reductions, including process enhancements,
in order to maintain acceptable gross profit margins. Gross profit margins
also vary reflecting the impact of changes in the general condition of the
economy, capacity utilization levels in the semiconductor industry, customer
acceptance of new technologies and products, product functionality and
capabilities, shifts in product mix, manufacturing yields and the effect of
ongoing manufacturing cost reduction activities. If the Company is unable to
reduce its costs sufficiently to offset declines in ASPs or is unable to
successfully introduce new higher performance products with higher ASPs,
the Company's operating results will be materially adversely affected.
In addition, if the Company experiences yield or other production problems
or shortages of supply that increase its manufacturing costs, or fails to
reduce its manufacturing costs, the result would be a material adverse
effect on the Company's business, financial condition and operating results.
NEW PRODUCT INTRODUCTIONS
The markets for the Company's products are characterized by evolving
industry standards, rapid technological change and product obsolescence. The
Company's performance is highly dependent upon the successful development and
timely introduction of new products at competitive price and performance levels.
Currently, the majority of the Company's revenues are generated from sales
of mature CD-ROM controller products and therefore, Company's financial
performance is dependent upon timely and successful execution of new
products in the optical storage business. The Company has recently
experienced some product development delays in this area. In an effort to
diversify its product and market base, the Company has invested substantial
resources in optical storage as well as in its other core technologies,
consumer electronics and digital imaging. There can be no assurance that
products currently under development in these core technologies or any other
new products will be successfully developed or will achieve market
acceptance, thereby affecting the Company's ability to achieve
diversification of its products and markets, and thereby revenue
diversification. The failure of the Company to introduce new products
successfully or the failure of new products to achieve market acceptance
would have a material adverse effect on the Company's business, financial
condition and results of operations. The success of new product
introductions is dependent on several factors, including recognition of
market requirements, product cost, timely completion and introduction of new
product designs, improvement of existing technologies and development and
implementation of new process technologies in order to continue to reduce
semiconductor die size, improve device performance and manufacturing yields,
adapt products and processes to technological changes and adopt emerging
industry standards. The Company's success is also dependent upon securing
sufficient foundry capacity for volume manufacturing of wafers and
achievement of acceptable manufacturing yields from the Company's contract
manufacturers. Semiconductor design and process methodologies are subject to
rapid technological change. Decreases in geometries call for sophisticated
design efforts, advanced manufacturing equipment and cleaner fabrication
environments. Due to the design complexity of its products, the Company has
experienced delays in completing development and introduction of new
products, and
32
<PAGE>
there can be no assurance that the Company will not encounter such delays in
the development and introduction of future products. There can be no
assurance that the Company will successfully identify new product
opportunities and develop and bring new products to market in a timely
manner, that the Company's products will be selected for design into the
products of its targeted customers or that products or technologies developed
by others will not render the Company's products or technologies obsolete or
noncompetitive. Furthermore, there can be no assurance that the products of
the Company's customers will be successfully introduced into the market. The
failure of the Company's new product development efforts, the failure of the
Company to achieve market acceptance of its new products and the failure of
the products of the Company's customers to achieve market acceptance would
have a material adverse effect on the Company's business, financial condition
and operating results.
NEED FOR ADDITIONAL CAPITAL
The semiconductor industry is capital intensive. In order to remain
competitive, the Company must continue to make significant investments in new
facilities and capital equipment. The Company spent $12.0 million on capital
additions in 1998 and expects to spend significant amounts in future years. The
Company believes that existing liquid resources and funds generated from
operations, if any, combined with its ability to borrow funds will be adequate
to meet its operating and capital requirements and obligations into the
foreseeable future. The Company believes that a company's level of financial
resources is an important factor in its industry. Accordingly, the Company may
from time to time seek additional equity or debt financing. There can be no
assurance that such funds will be available on terms acceptable to the Company
when needed. Any future equity financing will also lead to dilution to the
existing stockholders.
ACQUISITIONS
The Company has begun to pursue, and will continue to pursue, opportunities
to acquire key technology to augment its technical capabilities or to achieve
faster time to market as alternatives to internally developing such technology.
Acquisitions involve numerous risks, including difficulties in integration of
the operations, technologies, and products of the acquired companies; the risk
of diverting management's attention from normal daily operations of the
business; risks of entering markets in which the Company has no or limited
direct prior experience and where competitors in such markets have stronger
market positions; the coordination of sales, marketing and research and
development; and the potential loss of key employees of the acquired company.
In addition, investments in emerging technology present risks of loss of value
of one or more of the investments due to failure of the technology to gain the
predicted market acceptance.
The Company, in order to remain competitive, must also maintain its ability
to manage any growth effectively. Failure to manage growth effectively and
successfully integrate acquisitions made by the Company could adversely affect
the Company's business and operating results. In addition, with such
acquisitions, there is the risk that future operating performance may be
unfavorably impacted due to acquisition related costs such as, but not limited
to, in-process research and development charges, additional development
expenses, lower gross margins generated by the sales of acquired products and
restructuring costs associated with duplicate facilities.
INTELLECTUAL PROPERTY MATTERS
The Company's ability to compete is affected by its ability to protect its
proprietary information. The Company considers its technology to be proprietary
and relies on a combination of patents, trademarks, copyrights, trade secret
laws, confidentiality procedures and licensing arrangements to protect its
intellectual property rights. The Company currently has eleven patents granted,
forty-seven patents in preparation in the United States, fifty-three patents
pending in the United States and tewnty-two international patents pending. The
Company intends to seek additional international patents and additional United
States patents on its technology. There can be no assurance that additional
patents will issue from any of the Company's pending applications or
applications in preparation, or be issued in all countries where the Company's
products can be sold, or that any claims allowed from pending applications or
applications in preparation will be of sufficient scope or strength to provide
meaningful
33
<PAGE>
protection or any commercial advantage to the Company. Additionally,
competitors of the Company may be able to design around the Company's patents.
There can be no assurance that any patents held by the Company will not be
challenged, invalidated or circumvented, or that the rights granted thereunder
will provide competitive advantages to the Company. An action is currently
pending in the Federal District Court for the Northern District of California
seeking to invalidate one of the Company's patents relating to it's optical
storage products. Moreover, while the Company holds or has applied for patents
relating to the design of its products, the Company's products are based in part
on standards, including MPEG-1, MPEG-2, JPEG and JBIG and the Company does not
hold patents or other intellectual property rights for such standards. The laws
of certain foreign countries in which the Company's products are or may be
manufactured or sold, including various countries in Asia, may not protect the
Company's products or intellectual property rights to the same extent as do the
laws of the United States and thus make the possibility of piracy of the
Company's technology and products more likely. There can be no assurance that
the steps taken by the Company to protect its proprietary information will be
adequate to prevent misappropriation of its technology or that the Company's
competitors will not independently develop technologies that are substantially
equivalent or superior to the Company's technology.
The semiconductor industry is characterized by vigorous protection and
pursuit of intellectual property rights, which has resulted in significant,
often protracted and expensive litigation. Although there is currently no
pending intellectual property litigation against the Company, the Company or its
foundries may, from time to time, be notified of claims that the Company may be
infringing patents or other intellectual property rights owned by third parties.
If it is necessary or desirable, the Company may seek licenses under such
patents or other intellectual property rights. However, there can be no
assurance that licenses will be offered or that the terms of any offered
licenses will be acceptable to the Company. The failure to obtain a license
from a third party for technology used by the Company could cause the Company to
incur substantial liabilities and to suspend the manufacture of products or the
use by the Company's foundries of processes requiring the technology.
Furthermore, the Company may initiate claims or litigation against third parties
for infringement of the Company's proprietary rights or to establish the
validity of the Company's proprietary rights. In fiscal 1997 and again in
fiscal 1998, the Company filed a complaint with the ITC against certain Asian
manufacturers of optical storage controller devices based on the Company's
belief that such devices infringed one or more of the Company's patents. The
complaint seeks a ban on the importation into the United States of any
infringing CD-ROM controller or products containing such infringing CD-ROM
controllers. (See "Legal Proceedings"). Litigation by or against the Company
could result in significant expense to the Company and divert the efforts of the
Company's technical and management personnel, whether or not such litigation
results in a favorable determination for the Company. In the event of an
adverse result in any such litigation, the Company could be required to pay
substantial damages, cease the manufacture, use and sale of infringing products,
expend significant resources to develop non-infringing technology, discontinue
the use of certain processes or obtain licenses to the infringing technology.
There can be no assurance that the Company would be successful in such
development or that such licenses would be available on reasonable terms, or at
all, and any such development or license could require expenditures by the
Company of substantial time and other resources. Patent disputes in the
semiconductor industry have often been settled through cross-licensing
arrangements. Because the Company has a limited portfolio of patents, the
Company may not be able to settle an alleged patent infringement claim through a
cross-licensing arrangement. If a successful claim is made against the Company
or its customers and a license is not made available to the Company on
commercially reasonable terms or the Company is required to pay substantial
damages or awards, the Company's business, financial condition and results of
operations would be materially adversely affected.
In addition, certain technology used in the Company's products is licensed
from third parties, and pursuant thereto the Company is required to fulfill
confidentiality obligations and in certain cases pay royalties. Some of the
Company's products, particularly those targeted for the DVD market, require
certain types of copy protection software that the Company must license from
third parties. Should the Company lose its rights to or be unable to obtain the
necessary copy protection software, the Company would unable to sell and market
certain of its products. The Company licenses technology from Sun Microsystems,
Inc. for use in its consumer products under an agreement requiring royalty
payments, and also has a number of joint development and supply arrangements,
and on occasion buys products off the shelf for use with its own products. The
Company's agreements with third parties, such as Advanced Micro Devices, Inc.,
often have no specified term and may be terminated by either party in the event
of breach by the other. The Company's business could be adversely affected by
the loss for any reason
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of this and other agreements. In the future, it may be necessary or desirable
for the Company to seek additional licenses to intellectual property rights held
by third parties or purchase products manufactured and/or sold by third parties
with respect to some or all of its product offerings. There can be no
assurance that such licenses or purchases will be available on terms
acceptable to the Company, if at all. The inability of the Company to enter
into such license arrangements on acceptable terms or to maintain its current
licenses on acceptable terms could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company also generally enters into confidentiality agreements with its
employees and confidentiality and license agreements with its customers and
potential customers, and limits access to and distribution of the source and
object code of its software and other proprietary information. Under some
circumstances, the Company grants licenses that give its customers limited
access to the source code of the Company's software which increases the
likelihood of misappropriation or misuse of the Company's technology.
Accordingly, despite precautions taken by the Company, it may be possible for
unauthorized third parties to copy certain portions of the Company's technology
or to obtain and use information that the Company regards as proprietary. There
can be no assurance that the steps taken by the Company will be adequate to
prevent misappropriation of its technology or to provide an adequate remedy in
the event of a breach or misappropriation by others.
MANUFACTURING ISSUES
The Company contracts with independent foundries to manufacture all of its
products, enabling the Company to focus on its design strengths, minimize fixed
costs and capital expenditures and gain access to advanced manufacturing
facilities. Certain of the Company's foundry agreements require up-front,
nonrefundable prepayments or deposits and these fixed costs could affect the
Company's operating margins if the Company is unable to utilize the minimum
number of wafers required under the agreements. The Company is dependent on its
foundries to allocate to the Company a portion of their foundry capacity
sufficient to meet the Company's needs to produce products of acceptable quality
and with acceptable manufacturing yields and to deliver products to the Company
in a timely manner. These foundries fabricate products for other companies and
some manufacture products of their own design. While the Company believes there
is adequate foundry capacity available to meet its current requirements, there
can be no assurance that the Company will continue to have access to sufficient
capacity to meet its needs in the future. If there is a decrease in available
foundry capacity, it is likely that the lead time required to manufacture the
Company's products will increase.
Product supply and demand fluctuations common to the semiconductor industry
are historically characterized by periods of manufacturing capacity shortages
immediately followed by periods of overcapacity, which are caused by the
additions of manufacturing capacity in large increments. The industry has moved
from a period of capacity shortages in 1995 to what appears to be a current
period of excess capacity for the immediate future. During a period of industry
overcapacity, profitability can drop sharply as factory utilization declines and
high fixed costs of operating a wafer fabrication facility are spread over a
lower net revenue base. Despite industry overcapacity, there can be no assurance
that the Company can achieve timely, cost-effective access to such capacity when
needed.
The Company generally does not have long-term volume production contracts
with its customers. Whether any specific product design will result in volume
production orders and, if so, the quantities included in any such orders, are
factors beyond the control of the Company. Insufficient orders could result
in an inability to utilize the Company's foundry deposits and prepayments with
TSMC and Chartered, thereby adversely impacting the Company's business,
financial condition and operating results.
The Company's results of operations could also be adversely affected if
particular suppliers are unable to provide a sufficient and timely supply of
product, whether because of raw material shortages, capacity constraints,
unexpected disruptions at the plants, delays in qualifying new suppliers or
other reasons, or if the Company is forced to purchase materials from higher
cost suppliers or to pay expediting charges to obtain additional supply, or if
the Company's test facilities are disrupted for an extended period of time.
Production could also be constrained
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by delays if there is a need to move production from one facility to another.
Such problems with supply could adversely affect the Company's business,
financial condition and operating results.
The Company had anticipated that it would be able to satisfy a small
portion of its manufacturing requirements from UICC; however, due to the October
1997 fire at the UICC, the Company will not be able to utilize this foundry in
the foreseeable future. UICC management has indicated that capacity will be
available through substitute capacity arrangements; however, no assurance can be
given as to the availability of such capacity. The loss of any of the Company's
foundries as a supplier, the inability of the Company in a period of increased
demand for its products to expand the foundry capacity of its current suppliers
or qualify other wafer manufacturers for additional foundry capacity, industry
overcapacity, any inability to obtain timely and adequate deliveries from the
Company's current or future suppliers or any other circumstances that would
require the Company to seek alternative sources of supply could delay shipments
of the Company's products, which could damage relationships with its current and
prospective customers, provide an advantage to the Company's competitors and
have a material adverse effect on the Company's business, financial condition
and operating results.
Disruption of operations at any of the manufacturing facilities utilized by
the Company or any of its subcontractors for any reason, including work
stoppages, fire, earthquake, flooding or other natural disasters, would cause
delays in shipments of the Company's products. There can be no assurance that
alternative capacity would be available on a timely basis on terms acceptable to
the Company, if at all, thereby resulting in a loss of customers. This could
have a material adverse effect on the Company's business, financial condition
and operating results. In October 1997, a fire damaged the UICC facility. UICC
management has publicly stated that a majority of the equipment and inventory
and a significant portion of the building were completely destroyed at an
estimated loss of approximately $324 million (based on year-end exchange rates).
UICC management has also stated that it has reached a $300 million insurance
settlement for claims stemming from the fire and that in accordance with the
coinsurance clause, UICC had to pay $23.5 million of the damage. Despite the
damages payment, UICC management has represented that UICC's financial status
has remained unaffected given significant investment gains made during the year.
UICC has further stated that it expects to complete reinforcement of the
building structure before the end of the year, to install fab equipment by May
1999, and to be in production by the last quarter of Calendar 1999, using
primarily .18 micron process technology. Given the fire, the Company has
evaluated its investment in the UICC facility to determine whether there has
been an impairment and as the Company believes that estimated future cash
inflows expected to be generated by the facility and/or disposition of the
investment are in excess of the carrying amount of the investment, no impairment
loss has been recognized as of June 30, 1998. Representations have been made
by UICC management that the facility's foundry capacity that has been guaranteed
to the Company will be available through substitute capacity arrangements. To
date, the Company has not requested that UICC make such substitute capacity
available to the Company. Therefore, there can be no assurance that such
substitute foundry capacity will be available to the Company should the Company
require it. Additionally, there can be no assurance that a market will develop
for the shares representing the Company's equity investment at any time in the
future.
The manufacture of semiconductors is a highly complex and precise process,
with current trends in the Company's markets leading to increasingly complex
products. Minute levels of contaminants in the manufacturing environment,
defects in the masks used to print circuits on a wafer, difficulties in the
fabrication process or other factors can cause a substantial percentage of
wafers to be rejected or a significant number of die on each wafer to be
nonfunctional. Many of these problems are difficult to diagnose and time
consuming or expensive to remedy. The Company's products are particularly
complex and difficult to manufacture. The greater integration of functions and
complexity of operations of the Company's products increase the risk that latent
defects or subtle faults could be discovered by customers or end users after
volumes of product have been shipped. If such defects were significant, the
Company could incur material recall and replacement costs for product warranty.
The relationships with customers could also be adversely impacted. There can be
no assurance that the Company's foundries will not experience irregularities or
adverse yield fluctuations in their manufacturing processes. Any yield or other
production problems or shortages of supply experienced by the Company or its
foundries could have a material adverse effect on the Company's business,
financial condition and results of operations.
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The Company's reliance on independent manufacturers and third party
assembly and testing vendors involves a number of additional risks, including
the unavailability of, or interruption in access to, certain process
technologies and reduced control over delivery schedules, quality assurance and
costs. In addition, as a result of the Company's dependence on foreign
subcontractors, the Company is subject to the risks of conducting business
internationally, including foreign government regulation and general political
risks, such as political and economic instability, potential hostilities,
changes in diplomatic and trade relationships, currency fluctuations, unexpected
changes in, or imposition of, regulatory requirements, tariffs, import and
export restrictions, and other barriers and restrictions, potentially adverse
tax consequences, the burdens of complying with a variety of foreign laws and
other factors beyond the Company's control.
DEPENDENCE ON CD-ROM CONTROLLER MARKET
Sales of the Company's CD-ROM controller products comprised 81%, 84% and
91% of the Company's net revenues in fiscal 1998, 1997 and 1996, respectively.
Sales of CD-ROM controller products are expected to continue to account for a
substantial portion of the Company's total revenues for fiscal 1999. The
market for CD-ROM controller products continues to mature and therefore, it
is expected that sales of such products will not necessarily continue to grow
at historical rates and will be influenced by the traditional seasonality and
volatility associated with the PC market. It is further anticipated that the
proliferation of CD-RW and DVD drives will impact the demand for CD-ROM
controller products. Due to the backward compatibility of DVD-ROM drives, it
is critical that the Company maintain its CD-ROM customer base throughout
this transition to DVD-ROM. Although the Company is currently shipping a
CD-RW controller and is pursuing the development of optical storage
semiconductors for use in DVD-ROM drives, there can be no assurance that the
Company will develop successive generations of its CD-RW product or its first
DVD product, that such product will be available within an acceptable market
window, or that such product will be able to sustain the current level of
optical storage product sales. As the CD-ROM market has begun to mature and
transition toward the emerging CD-RW and DVD-ROM markets, there have been a
number of new competitors entering the market. This increased competition
combined with the pressure from the sub-$1000 PC segment for lower cost
components have caused tremendous price erosion on CD-ROM controller prices.
In addition, as a majority of the new competitors are located in Asia,
together with a majority of the Company's customers, the Company is currently
hampered in its ability to effectively compete given the effects of the
strong dollar versus Asian currencies. Furthermore, there is currently a
trend toward integrating increased functionality on the CD-ROM controller.
Therefore, the Company's revenues and its gross margins from its CD-ROM
controller products will be dependent on the Company's ability to introduce
such integrated products in a commercially competitive manner. The Company
has not previously offered an integrated CD-ROM controller product that
provides functions that had traditionally been supplied by separate,
single-function chips. The Company is currently experiencing development
delays with its first integrated CD-ROM controller product. To provide
integrated CD-ROM controller products, the Company has been and will continue
to be required to expand the scope of its research and development efforts to
provide these new functions, which will require the hiring of engineers
skilled in the respective areas and additional management coordination among
the Company's engineering and marketing groups. Alternatively, the Company
may find it necessary or desirable to license or acquire technology to enable
the Company to provide these functions, and there can be no assurance that
any such technology will be available for license or purchase on acceptable
terms to the Company. In addition, with new functions being added to the
CD-ROM controller product, companies that historically provided chips with
these functions are now entering the CD-ROM controller market with integrated
products containing these functions as well as the controller function.
Accordingly, given the above-stated factors, there can be no assurance that
the Company will be able to sustain the current level of such product sales
or current operating margins. In addition, there can be no assurance that the
market for CD-ROM controller products in general, or the Company's CD-ROM
controller products in particular, will support the Company's planned
operations in the future. Any decrease in the overall level of sales of, or
the prices for, the Company's CD-ROM controller products, due to
introductions of products by present or future competitors, a decline in
demand for CD-ROM controller products, product obsolescence or any other
reason would have a material adverse effect on the Company's business,
financial condition and results of operations.
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RISKS PERTAINING TO INTERNATIONAL BUSINESS
During fiscal 1998, 1997 and 1996, 92%, 96% and 98%, respectively, of the
Company's net revenues were derived from international sales. A substantial
portion of the Company's international revenues in fiscal 1998, 1997 and 1996
were derived from manufacturers of CD-ROM drives in Japan, Taiwan, Korean,
Belgium and Singapore. Most of the Company's foreign sales are negotiated in US
dollars; however, invoicing is generally done in local currency. As a result,
the Company may be subject to the risks of currency fluctuations. Assets and
liabilities which are denominated in non-functional currencies are remeasured
into the functional currency on a monthly basis and the resulting gain or loss
is recorded within non-operating income in the statement of operations. Many of
the Company's non-functional currency receivables and payables are hedged
through managing net asset positions, product pricing and other means. The
Company's strategy is to minimize its non-functional currency net assets or net
liabilities in its foreign subsidiaries. The Company's policy is not to
speculate in financial instruments for profit on the exchange rate price
fluctuations, trade in currencies for which there are not underlying exposures,
or enter into trades for any currency to intentionally increase the underlying
exposure. The Company uses financial instruments, including local currency debt
arrangements, to offset the gains or losses of the financial instruments against
gains or losses on the underlying operations cash flows or investments. The
Company expects that there could be hedges of anticipated transactions or
investments in foreign subsidiaries in the future. The Company is also subject
to the additional risks of conducting business outside of the United States.
These risks include unexpected changes in, or impositions of, legislative or
regulatory requirements, delays resulting from difficulty in obtaining export
licenses for certain technology, tariffs, quotas and other trade barriers and
restrictions, longer payment cycles, greater difficulty in accounts receivable
collection, potentially adverse taxes, the burdens of complying with a variety
of foreign laws and other factors beyond the Company's control. With the
current economic problems in Asia and the strengthening of the dollar, the
Company has recently experienced a more conservative buying pattern from its
customers and increased price pressure on its products. The Company is also
subject to general geopolitical risks in connection with its international
operations, such as political, social and economic instability, potential
hostilities and changes in diplomatic and trade relationships. There can be no
assurance that such factors will not adversely affect the Company's operations
in the future or require the Company to modify its current business practices.
In addition, the laws of certain foreign countries in which the Company's
products are or may be developed, manufactured or sold, including various
countries in Asia, may not protect the Company's products or intellectual
property rights to the same extent as do the laws of the United States and thus
make the possibility of piracy of the Company's technology and products more
likely. There can be no assurance that one or more of the foregoing factors
will not have a material adverse effect on the Company's business, financial
condition or operating results or require the Company to modify its current
business practices.
LIMITED CUSTOMER BASE
A limited number of customers historically has accounted for a substantial
portion of the Company's net revenues. In fiscal 1998, 1997 and 1996, sales to
the Company's top ten customers accounted for approximately 81%, 78% and 80%,
respectively, of the Company's net revenues. These customers were all
purchasers of the Company's CD-ROM product. In fiscal 1998, Mitsumi accounted
for 17% and LG Electronics accounted for 14% of the Company's net revenues. In
fiscal 1997, Mitsumi accounted for 14% and LG Electronics accounted for 13% of
the Company's net revenues. Kanematsu, a Japanese trading company, purchases
product from the Company and resells the product to Japanese manufacturers. In
fiscal 1996, Mitsumi accounted for 26%, Kanematsu accounted for 19% and NEC
accounted for 13% of the Company's net revenues. Although the Company is
currently attempting to diversify its products, markets, and customer base, the
Company expects that sales to a limited number of customers will continue to
account for a substantial portion of its net revenues for the foreseeable
future. The Company has experienced significant changes from year to year in
the composition of its major customer base and believes this pattern will
continue. For example, Mitsumi has only been a significant customer of the
Company since fiscal 1994. The Company does not have long term purchase
agreements with any of its customers. Customers generally purchase the
Company's products pursuant to short-term purchase orders. The loss of, or
significant reduction in purchases by, current major customers such as Mitsumi
or LG Electronics would have a material adverse effect on the Company's
business, financial condition and operating results. There can be no assurances
that the Company's current customers will continue to place orders or that
existing orders will not be canceled. If sales to current customers cease or
are reduced, there can be no assurance that the Company will be
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able to continue to obtain the orders from new customers necessary to offset any
such losses or reductions. The loss of business or cancellation of orders from
any key customers, significant changes in scheduled deliveries to any of these
customers or decreases in the prices of products sold to any of these customers
could have a material adverse effect on the Company's business, financial
condition and results of operations.
COMPETITION
The markets in which the Company competes are intensely competitive and are
characterized by rapid technological change, declining unit ASPs and rapid
product obsolescence. The Company expects competition to increase in the future
from existing competitors and from other companies that may enter the Company's
existing or future markets with solutions that may be less costly or provide
higher performance or additional features. The Company's existing and potential
competitors include many large domestic and international companies that have
substantially greater financial, manufacturing, technical, marketing,
distribution and other resources, broader product lines and longer standing
relationships with customers than the Company. The Company's competitors also
include a number of emerging companies as well as some of the Company's own
customers and suppliers. The Company is currently attempting to enter several
new markets in which the Company has not previously operated. These markets are
intensely competitive and the Company will have to compete with large domestic
and international companies that have long standing relationships with the
Company's target customers. Specifically, the Company's ability to compete
successfully in the DVD and other markets will depend on its ability to develop
partnerships with other companies established in the industries and to gain
recognition in such markets. In the DVD area, it is important that the
Company form alliances with those companies that are members of the DVD forum.
There can be no assurance that participation in these new markets will
produce positive results for the Company. Certain of the Company's principal
competitors maintain their own semiconductor foundries and may therefore
benefit from certain capacity, cost and technological advantages. The Company
believes that its ability to compete successfully depends on a number of
factors, both within and outside of its control, including the price, quality
and performance of the Company's and its customers' products, the timing and
success of new product introductions by the Company, its customers and its
competitors, the emergence of new PC standards, the development of technical
innovations, the ability to obtain adequate foundry capacity and sources of
raw materials, the efficiency of production, the rate at which the Company's
customers design the Company's products into their products, the market
acceptance of the products of the Company's customers, the number and nature
of the Company's competitors in a given market, the assertion of intellectual
property rights and general market and economic conditions. There can be no
assurance that the Company will be able to compete successfully in the future.
DEPENDENCE ON KEY PERSONNEL
The Company's future performance depends, to a significant degree, on the
retention and contribution of members of the Company's senior management as well
as other key personnel. Three of the Company's most senior finance personnel,
including the Chief Financial Officer, as well as the President of the Company's
Optical Storage Group recently left the Company. The Company is in the process
of recruiting their replacements as well as additional senior managers and
technical personnel. Competition for these persons is intense and there can be
no assurance that the Company will be able to attract and retain qualified
replacements or additional senior managers and technical personnel.
YEAR 2000 RISK FACTOR
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. As a result, in less than two years, computer systems
and/or software used by many companies may need to be upgraded to comply with
such "Year 2000" requirements. The Company is currently installing various new
internal information systems in connection with operating its business. The
Company believes that these systems are Year 2000 compliant, although there can
be no assurance that unexpected problems will not occur. The Company is
assessing its products to ensure that they are Year 2000 compliant. The ongoing
assessment has not revealed any significant compliance issues. However, the
inability of these products to properly manage and manipulate data in the year
2000 could result in increased warranty costs, customer satisfaction issues,
potential lawsuits and other material problems. The Company has also initiated
communications with its suppliers
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and customers to determine the extent to which the Company's capabilities are
vulnerable to those third parties' own Year 2000 issues. There is no guarantee
that the systems and products of other companies on which the Company relies
will be timely converted or that they will not have a material adverse effect on
the Company. The Company is currently evaluating the impact of the Year 2000 on
its products, suppliers and customers, but has not yet completed the process.
As a result, the Company has no reasonable basis to conclude that the Year 2000
problem will not materially affect the Company's operations. Upon completion of
its assessment process, the Company will determine a contingency plan if the
assessment process leads the Company to believe that the Year 2000 problem will
materially affect its operations.
CHANGES TO MANAGEMENT INFORMATION SYSTEMS
Since its inception, the Company has experienced significant growth in the
number of its employees and in the scope of its operating and financial systems.
To manage growth effectively, the Company will need to continue to improve its
operational, financial and marketing information systems, procedures and
controls, and expand, train, and manage its employee base. The Company is in
the final stages of implementing a new management information system. Any
problems encountered with the new system could materially adversely affect the
Company's operations.
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LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its cash requirements from
cash generated from operations, the sale of equity securities, bank lines of
credit and long-term and short-term debt. The Company's principal sources of
liquidity as of June 30, 1998 consisted of approximately $117.2 million in cash,
cash equivalents and short-term investments. The Company also has approximately
$13.1 million in lines of letters of credit with Taiwanese financial
institutions, of which all but $38,000 was available at June 30, 1998.
Additionally, approximately $25.0 million in lines of credit exist with Japanese
financial institutions, of which approximately $22.5 million was available at
June 30, 1998.
In fiscal 1998, operating activities provided net cash of approximately
$12.2 million. This cash resulted primarily from net income of approximately
$5.9 million, utilization of foundry deposits of $13.0 million, an increase in
accounts receivable and inventory of $8.5 million, and the non-cash effect of
depreciation and amortization on income of $7.4 million offset primarily by a
decrease in accounts payable, accrued expenses and taxes payable of $20.7
million. Investing activities utilized cash of approximately $29.0 million
primarily due to an investment in the foundry joint venture of $11.6 million and
additions to property, plant and equipment of $12.0 million. In fiscal 1997,
the Company's operating activities provided net cash of approximately $65.4
million. This cash resulted primarily from net income of approximately $23.7
million. Approximately $6.9 million in cash was used to finance additions to
property and equipment and $25.9 million to finance an investment in a foundry
joint venture. In fiscal 1996, the Company's operating activities provided net
cash of approximately $30.7 million. This cash resulted primarily from net
income of approximately $37.1 million. Approximately $12.7 million in cash was
used to finance additions to property and equipment.
In November 1995, the Company acquired Pixel Magic, a privately-held
company based in Andover, Massachusetts for $10.5 million in cash, of which $5.0
million was contingent upon the achievement of certain performance criteria over
a three-year period. Approximately $4.8 million of the initial cash payment was
allocated to in-process research and development and was charged to operations
in fiscal 1996. In June 1997, the Company waived certain of the performance
criteria and agreed to pay the contingent amount of $5.0 million in two
installments during calendar 1998. The first payment of $3.0 million is due in
January 1998 and the second payment of $2.0 million is due in December 1998. As
a result of this agreement and because the contingent amount was based, in part,
on the continued employment of the former shareholder/employees of Pixel Magic,
the Company recorded a compensation charge of $5.0 million in the quarter ended
June 30, 1997.
On August 11, 1998, the Company acquired Xerographic Laser Images, Inc.
(XLI) to operate as a division of Pixel Magic. The Company made a cash
payment of $3,650,000 to the XLI shareholders on the effective date of the
merger and the shareholders have the right to receive additional payments of
up to $11,350,000 subject to the achievement of certain milestones by XLI
over a 3-year period ending December 31, 2000. On July 2, 1998, the Company
acquired ViewPoint Technology, Inc. (ViewPoint), paying approximately
$10,100,000 in cash for all the outstanding shares of ViewPoint. On April 2,
1998, the Company acquired certain assets from ODEM Microsystems, Inc. (ODEUM)
for $4,010,000 in cash. On April 30, 1998, the Company entered into
agreements whereby it acquired a preferred equity interest in Omni
Peripherals Pte. Ltd. (Omni), paying approximately $800,000 for its minority
interest.
The Company believes that its existing cash, cash equivalents, short-term
investments and credit facilities will be sufficient to provide adequate working
capital and to fund necessary purchases of property and equipment through at
least the next twelve months. Capital expenditures for fiscal 1999 are
anticipated to be approximately $3.9 million. The Company may also utilize cash
to acquire or invest in complementary businesses or products or to obtain the
right to use complementary technologies. From time to time, in the ordinary
course of business, the Company evaluates potential acquisitions of such
businesses, products or technologies. However, the Company has no present
understandings, commitments or agreements with respect to any material
acquisition of other businesses, products or technologies.
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FOUNDRY DEPOSITS AND INVESTMENT IN FOUNDRY VENTURE
The Company contracts with independent foundries to manufacture all of its
semiconductor products, enabling the Company to focus on its design strengths,
minimize fixed costs and capital expenditures and gain access to advanced
manufacturing facilities. The Company's primary suppliers under such
arrangements during fiscal 1998 were TSMC and LG Semicon Co. Ltd. in Korea. The
Company also uses wafer fabrication facilities at Chartered, Rohm, NEC and Sony.
Except as described in the paragraphs below, the foundries generally are not
obligated to supply products to the Company for any specific period, in any
specific quantity or at a specific price, except as may be provided in a
particular purchase order.
In June and November 1995, the Company entered into agreements with TSMC
and Chartered to obtain certain additional wafer capacity through the year 2001.
The agreements call for the Company to commit to certain future wafer purchases
and to deposit funds with the suppliers as either a portion of the price of the
additional wafers in advance of their delivery or as a non-interest bearing
deposit to secure the availability of additional wafers. The price of such
wafers will be determined in the future periods in which specific orders are
actually placed. If the Company is not able to use, assign, or sell the
additional wafer quantities, all or a portion of the deposits may be forfeited.
In October 1996, the Company amended its previous agreement with TSMC
resulting in a reduction of the Company's future wafer purchases required under
the original agreement and the elimination of required future cash prepayments
of approximately $73 million. Under the amended agreement, no additional
prepayment is required; however the Company must utilize the entire amount of
the prepayment paid as of October 1996 through a certain committed amount of
wafer purchases in calendar years 1997, 1998, and 1999 or a portion of the
prepayment will be forfeited. In March 1998, the Company further amended its
agreement with TSMC allowing the Company to utilize excess wafer purchases in
1997 and 1998 to reduce the Company's committed wafer purchases in the following
years. This amendment resulted in the Company utilizing calendar 1998 committed
wafer purchases beginning in calendar 1997 after the committed wafer purchases
for calendar 1997 were met. As a result of this amendment, the Company recorded
a credit to foundry deposits of approximately $13.0 million which was used to
offset payables to TSMC during fiscal 1998. The Company currently believes the
terms and conditions of the agreement, as amended, will be met although no
assurance can be given in this regard.
In September 1996, April 1997 and September 1997, the Company amended its
agreement with Chartered. The amendments resulted in a reduction of the
Company's future wafer purchase commitments and the elimination of required
future cash deposits under the original agreement of approximately $36 million.
Under the amended agreement, the required future cash deposits of approximately
$36 million could be reinstated if certain conditions are not met. The Company
currently believes the terms and conditions of the agreement, as amended, will
be met and that these commitments will not be reinstated although no assurance
can be given in this regard.
The deposits and prepayments under the amended foundry agreements described
above are recorded at cost and total approximately $21.2 million as of June 30,
1998. The Company currently anticipates being able to utilize and fully recover
the value of all foundry prepayments and deposits under the terms of the amended
agreements although no assurance can be given in this regard.
In October 1995, the Company entered into a series of agreements with
United Microelectronics Corporation (UMC) to form, along with other investors, a
separate Taiwanese company, United Integrated Circuits Corporation (UICC), for
the purpose of building and managing a semiconductor manufacturing facility in
the Science Based Industrial Park in Hsin Chu City, Taiwan, Republic of China.
As an investor in this venture, the Company has rights to a portion of the total
wafer capacity for the manufacture of its proprietary products. The Company
paid approximately $51.2 million for approximately 9.3% of the total outstanding
shares of the foundry venture. The investment in UICC has been accounted for
under the cost method of accounting.
In October 1997, a fire damaged the UICC facility. UICC management has
publicly stated that a majority of the equipment and inventory and a significant
portion of the building were completely destroyed at an estimated loss of
approximately $324 million (based on year-end exchange rates). UICC management
has also stated that it
42
<PAGE>
has reached a $300 million insurance settlement for claims stemming from the
fire and that in accordance with the coinsurance clause, UICC had to pay $23.5
million of the damage. Despite the damages payment, UICC management has
represented that UICC's financial status has remained unaffected given
significant investment gains made during the year. UICC has further stated that
it expects to complete reinforcement of the building structure before the end of
the year, to install fab equipment by May 1999, and to be in production by the
last quarter of Calendar 1999, using primarily .18 micron process technology.
Given the fire, the Company has evaluated its investment in the UICC facility to
determine whether there has been an impairment and as the Company believes that
estimated future cash inflows expected to be generated by the facility and/or
disposition of the investment are in excess of the carrying amount of the
investment, no impairment loss has been recognized as of June 30, 1998.
Representations have been made by UICC management that the facility's foundry
capacity that has been guaranteed to the Company will be available through
substitute capacity arrangements. To date, the Company has not requested that
UICC make such substitute capacity available to the Company. Therefore, there
can be no assurance that such substitute foundry capacity will be available to
the Company should the Company require it. Additionally, there can be no
assurance that a market will develop for the shares representing the Company's
equity investment at any time in the future.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to financial market risks, including changes in
interest rates and foreign currency exchange rates. To mitigate some of these
risks, the Company utilzes derivative financial instruments. The Company does
not use derivative financial instruments for speculative or trading purposes.
The fair value of the Company's investment portfolio or related income would
not be significantly impacted by a 100 basis point increase or decrease in
interest rates due mainly to the short-term nature of the major portion of
the Company's investment portfolio. An increase or decrease in interest rates
would not significantly increase or decrease interest expense on the
Company's debt obligations due to the fixed nature of the Company's debt
obligations as well the fact that such obligations are not significant.
A substantial majority of the Company's revenue and capital spending is
transacted in U.S. dollars. However, the Company does enter into these
transactions in other currencies, primarily Japanese yen and New Taiwan
dollars. To protect against reductions in value and the volatility of future
cash flows caused by changes in foreign exchange rates, the Company has
established certain revenue and balance sheet hedging programs. The Company's
hedging programs are designed to reduce, but do not always eliminate, the
impact of foreign currency exchange rate movements. An adverse change
(defined as 20 percent in certain Asian currencies) in exchange rates would
result in a decline in income before taxes of less than $2.0 million. The
calculation assumes that each exchange rate would change in the same
direction relative to the U.S. dollar. In addition to the direct effects of
changes in exchange rates, such changes typically affect the volume of sales
or foreign currency sales price as competitors' products become more or less
attractive. The Company's sensitivity analysis of the effects of changes in
foreign currency exchange rates does not factor in a potential change in
sales levels or local currency selling prices. All of the potential changes
noted above are based on sensitivity analyses performed on the Company's
balances as of June 30, 1998.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements and Supplementary Data of the Company required by
this item are set forth at the pages indicated at Item 14(a).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
43
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
As of August 31, 1998, the Directors of the Company, and the executive
officers of the Company, who are elected by and serve at the discretion of the
Board of Directors, were as follows:
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
David D. Tsang 56 Chairman of the Board of Directors of Oak
and Pixel Magic and Chief Executive
Officer
Richard B. Black 65 President and Director, Acting President
of Optical Storage Group
Kenji Fujimoto 49 Vice President of Oak, General Manager,
Oak Technology, K.K.
Abel S. Lo 48 Vice President of Oak, General Manager,
Oak Technology, Taiwan
Richard Simone 54 Vice President of Operations and
Technology
Shawn M. Soderberg 37 Vice President, General Counsel and
Secretary
Peter Besen 43 Vice President of Oak, President of Pixel
Magic
Paul H.F. Vroomen 41 Vice President of Oak, President of
Consumer Products Group
Ta-Lin Hsu, Ph.D. 55 Director
Timothy Tomlinson 48 Director
Young K. Sohn 42 Director
</TABLE>
Mr. Tsang has been Chief Executive Officer of the Company since he founded
the Company in July 1987 and a Director of the Company since October 1987. He
has also served as Chairman of the Board of Directors of the Company since
January 1991. Mr. Tsang has also held the positions of Chief Financial Officer
from July 1987 to March 1993, Secretary of the Company from July 1987 to
December 1994 and President of the Company from July 1987 to January 1998. He
has served as Chairman of the Board of Directors to Pixel Magic, Oak's
subsidiary, since November 1995. He has also been a Director of Quality
Semiconductor, Inc. since June 1996 and Enable Semiconductor, Inc. since January
1997, both developers of semiconductor products, ASE Test, Inc. since January
1997, a semiconductor assembly and testing company, and Headway Technologies,
Inc. since April 1998, a manufacturer of recording head for the magnetic
storage industry. Prior to joining Oak, Mr. Tsang was the founder and served
in various positions including President, Chief Executive Officer and
Chairman of Data Technology Corp., a manufacturer of disk controllers and
high density disk drives, from 1979 to 1987, and co-founded Xebec Data Corp.,
a manufacturer of disk controllers, where he was employed from 1974 to 1979.
Mr. Tsang holds a B.S. degree in electrical engineering from Brigham Young
University and an M.S. degree in electrical engineering from the Santa Clara
University.
Mr. Black has been President of the Company since January 1998, a Director
of the Company since November 1992 and was also a Director from 1987 to 1990.
In addition to these duties, Mr. Black has been acting President of the
Company's Optical Storage Group since August of 1998. He has been the
Chairman of the Board of Directors of ECRM Incorporated, an electronic
publishing equipment manufacturer, since 1983 and a general partner of KBA
Partners,
44
<PAGE>
L.P., an investment company, since 1987. He has also been Chairman of the Board
of Directors of CycleOps Products, Inc. since January 1997. He is currently a
director at Gabelli Funds, Inc., Benedetto Gartland Company, General Scanning,
Inc., Grand Eagle Companies, Inc. and Morgan Group, Inc. Mr. Black holds a B.S.
degree in civil engineering from Texas A&M University and an M.B.A. from Harvard
University.
Mr. Fujimoto has been General Manager of Oak Technology, K.K., the
Company's Japanese subsidiary, since joining the Company in March 1991 and
became a Vice President of Oak in April 1995. He served as Chairman of Oak
Science, a Japanese company, from April 1996 to March 1998. Prior to joining
Oak, Mr. Fujimoto served as Senior Manager, Marketing and Applications of AMD
Japan from 1976 to January 1991. He holds a B.S. degree in electrical
engineering from the University of Electrocommunications (Japan).
Mr. Lo joined the Company as Engineering Design Manager in 1987. He has
been General Manager of Oak Technology, Taiwan since 1989 and became a Vice
President of Oak in April 1995. Prior to joining Oak, he was Software
Manager at Convergent Technologies, Ltd., a computer system manufacturer, from
June 1986 to May 1987, and Software Manager at the Systems Division of ITT
Corp. from May 1985 to June 1986. Mr. Lo holds a B.S. degree in electrical
engineering from Seattle University, an M.S. degree in electrical engineering
from the University of Washington and an M.S. degree in computer science from
Rensselaer Polytechnic Institute.
Mr. Simone joined the Company as Vice President of Operations and
Technology in June of 1998. Prior to joining Oak, he was a private
consultant from April of 1996 to June of 1998. He served as Senior Director
of IC Design at Hal Computer Systems, Inc. from 1992 to 1996, Strategic
Program Manager at Sun Microsystems, Inc. from 1990 to 1992 and held a number
of senior management positions at Intel Corporation from 1983 to 1990. Mr.
Simone holds and M.S.E.E. from Iowa State University and a B.S.E.E. from
Milwaukee School of Engineering.
Ms. Soderberg was appointed Vice President, General Counsel and Secretary
in May of 1998. She joined the Company in February of 1996 as General Counsel.
Prior to joining the Company, she was General Counsel for Microtec Research,
Inc., a software provider for embedded systems from April of 1994 to February of
1996. Ms. Soderberg holds a B.S. in accounting from the University of Santa
Clara, a J.D. from Seattle University and an L.L.M. in taxation from New York
University.
Mr. Besen joined the Company as President of Pixel Magic in October of
1995. He was appointed as a Vice President of Oak in July of 1998. Prior to
joining Oak, Mr. Besen spent eight years at LaserData, Inc., a document image
processing company, most recently as Vice President of OEM sales. Mr. Besen
holds an S.B.E.E. from Massachusetts Institute of Technology.
Mr. Vroomen joined the Company as Vice President, Strategic Marketing in
September 1997. He has been President of the Consumer Products Group since
January 1998. From May 1996 to June 1997, Mr. Vroomen was Vice President and
General Manager of the Consumer Digital Entertainment business unit at VLSI
Technology, Inc. From November 1994 to May 1996, Mr. Vroomen was Vice President,
Sales & Marketing at Array Microsystems, Inc., a developer of codec chips for
digital video applications and from March 1989 to November 1994, Mr. Vroomen was
at Zilog, Inc. where he was Vice President of the Computer Peripherals business
unit. He holds an M.S.E.E. from the Philips International Institute in
Eindhoven, the Netherlands, and a Managerial Advancement Program diploma from
the University of the Witwatersrand Graduate School of Business in Johannesburg,
South Africa.
Dr. Hsu has been a Director of the Company since January 1991. He has been
employed by H&Q Asia Pacific, Ltd., the parent company of H&Q Taiwan Co., Ltd.,
since February 1985, most recently as Chairman. Since October 1992, he has
acted as a Managing Director of Asia Pacific Growth Fund and as Chairman of Asia
Pacific Growth Fund, GP, members of a venture group. Since June 1996 he has
also served as a Managing Director of Asia Pacific Growth Fund II. Dr. Hsu is a
director at numerous companies, including H&Q Asia Ventures, Ltd. and H&Q Asia
Ventures II, Ltd., as well as a number of private companies. Dr. Hsu holds a
B.S. degree in physics from National Taiwan University, an M.S. degree in
electrophysics from Polytechnic Institute of Brooklyn and a Ph.D. in electrical
engineering from the University of California, Berkeley.
45
<PAGE>
Mr. Tomlinson has been a Director of the Company since June 1988. He
has been a partner of Tomlinson Zisko Morosoli & Maser LLP, a law firm, since
1983. Mr. Tomlinson has been a Director and Secretary of VeriSign, Inc., a
maker of security software, since April 1995, and is also a Director of
Portola Packaging, Inc., a manufacturer of tamper evident closures and
related equipment. Mr. Tomlinson holds a B.A. degree in economics, an M.B.A.
and a J.D. from Stanford University.
Mr. Sohn has been a Director of the Company since January 1998. He has
acted as Director of Marketing at Intel Corporation since August 1983, and has
been employed at Quantum Corporation since January 1993, most recently as
President of its Hard Drive Business. Mr. Sohn currently serves on the Board of
Directors of i-Planet, Inc. He holds a B.S. in electrical engineering from the
University of Pennsylvania and an M.S. (M.B.A.) from Massachusetts Institute of
Technology.
The information required by Item 10 with respect to compliance with Section
16(a) of the Securities Exchange Act of 1934 is incorporated by reference from
the Proxy Statement under the Caption "Executive Compensation And Other
Matters."
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 of Form 10-K is incorporated by
reference to the information contained in the section captioned "Executive
Compensation and Other Matters" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 of Form 10-K is incorporated by
reference to the information contained in the section captioned "Stock Ownership
of Certain Beneficial Holders and Management" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 of Form 10-K is incorporated by
reference to the information contained in the section captioned "Certain
Relationships and Related Transactions" in the Proxy Statement.
46
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this Report:
<TABLE>
<CAPTION>
1. Financial Statements Page
<S> <C>
Independent Auditor's Report. . . . . . . . . . . . . . . . . . . . 51
Consolidated Balance Sheets -- As of June 30, 1998 and 1997 . . . . 52
Consolidated Statements of Operations -- For the Three Year Period
Ended June 30, 1998 . . . . . . . . . . . . . . . . . . . . . . . . 53
Consolidated Statements of Stockholders' Equity - For the Three
Year Period Ended June 30, 1998 . . . . . . . . . . . . . . . . . . 54
Consolidated Statements of Cash Flows - For the Three Year Period
Ended June 30, 1998 . . . . . . . . . . . . . . . . . . . . . . . . 55
Notes to Consolidated Financial Statements. . . . . . . . . . . . . 56
2. Financial Statement Schedule. The following Financial Statement
Schedule of the Registrant is filed as part of this report:
Schedule II - Valuation and Qualifying Accounts . . . . . . . . . . 79
All other schedules are omitted because they are not applicable or
the required information is shown in the Consolidated Financial
Statements or notes thereto.
3. Exhibits. The following Exhibits are filed as part of, or
incorporated by reference into, this report:
<CAPTION>
Exhibit
Number Exhibit Title
<S> <C>
3.01 The Company's Restated Certificate of Incorporation, amended (1)
3.02 The Company's Restated Bylaws (2)
3.03 Certificate of Correction to the Restated Certificate of
Incorporation of the Company (16)
4.01 Form of Specimen Certificate for the Company's Common Stock (3)
4.02 Amended and Restated Registration Rights Agreement dated as of
October 15, 1993 among the Company and various investors (3)
4.03 The Company's Restated Certificate of Incorporation, as amended
(See Exhibit 3.01)
4.04 The Company's Restated Bylaws (See Exhibit 3.02)
4.05 Form of Certificate of Designation of Series A Junior
Participating Preferred Stock of the Company dated August 18,
1997 (16)
4.06 Rights Agreement between the Company and BankBoston, N.A. dated
August 19, 1997 (16)
10.01 1988 Stock Option Plan, as amended and related documents (3)*
10.02 1994 Stock Option Plan and related documents (3) and amendment
thereto dated February 1, 1996 (4)*
10.03 1994 Outside Directors' Stock Option Plan and related documents
(3)*
47
<PAGE>
10.04 1994 Employee Stock Purchase Plan (3)*
10.05 401(k) Plan and related documents (3) and Amendment Number One
and Supplemental Participation Agreement thereto (5)*
10.06 Lease Agreement dated August 3, 1988 between John Arrillaga,
Trustee, or his Successor Trustee, UTA dated 7/20/77 (John
Arrillaga Separate Property Trust) as amended and Richard T.
Peery, Trustee, or his Successor Trustee, UTA dated 7/20/77
(Richard T. Peery Separate Property Trust) as amended, and Justin
Jacobs, Jr., dba Siri-Kifer Investments, a joint venture, and the
Company, as amended June 1, 1990, and Consent to Alterations
dated March 26, 1991 (lease agreement for 139 Kifer Court,
Sunnyvale, California) (3), and amendments thereto dated June 15,
1995 and July 19, 1995 (5)
10.07 Lease Agreement dated August 22, 1994 between John Arrillaga,
Trustee, or his Successor Trustee, UTA dated 7/20/77 (John
Arrillaga Separate Property Trust) as amended and Richard T.
Peery, Trustee, or his Successor Trustee, UTA dated 7/20/77
(Richard T. Peery Separate Property Trust) as amended, and Justin
Jacobs, Jr., dba Siri-Kifer Investments, a joint venture, and the
Company (lease agreement for 140 Kifer Court, Sunnyvale,
California) (3), and amendment thereto dated June 15, 1995 (5)
10.08 Form of Indemnification Agreement, between the Company and each
of its Directors and executive officers (14)
10.09 VCEP Agreement dated July 30, 1990 between the Company and
Advanced Micro Devices, Inc. (3)
10.10 Product License Agreement dated April 13, 1993 between the
Company and Media Chips, Inc., as amended September 16, 1993 (3)
10.11 Resolutions of the Board of Directors of the Company dated July
27, 1994 setting forth the provisions of the Executive Bonus Plan
(3) (12)*
10.12 Employee Incentive Plan effective January 1, 1995 (3)*
10.13 Option Agreement between Oak Technology, Inc., and Taiwan
Semiconductor Manufacturing Co., Ltd. dated as of August 8, 1996
(14)**
10.14 Foundry Venture Agreement between the Company and United
Microelectronics Corporation dated as of October 2, 1995 (6) (12)
10.15 Fab Ven Foundry Capacity Agreement among the Company, Fab Ven and
United Microelectronics Corporation dated as of October 2, 1995
(7) (12)
10.16 Written Assurances Re: Foundry Venture Agreement among the
Company, United Microelectronics Corporation and Fab Ven dated as
of October 2, 1995 (8) (12)
10.17 Lease Agreement dated June 15, 1995 between John Arrillaga,
Trustee, or his Successor Trustee, UTA dated 7/20/77 (John
Arrillaga Separate Property Trust) as amended and Richard T.
Peery, Trustee, or his Successor Trustee, UTA dated 7/20/77
(Richard T. Peery Separate Property Trust) as amended, and the
Company (lease agreement for 130 Kifer Court, Sunnyvale,
California) (9), and amendments thereto dated June 15, 1995 and
August 18, 1995 (10)
10.18 Deposit Agreement dated November 8, 1995 between Chartered
Semiconductor Manufacturing Ltd. and the Company (11), and
Amendment Agreement (No. 1) thereto dated September 25, 1996
(13)**
10.19 Amendment Agreement (No. 2) dated April 7, 1997 to Deposit
Agreement dated November 8, 1995 between Chartered Semiconductor
Manufacturing Ltd. and the Company(15) and addendum thereto dated
September 26, 1997 (17)**
10.20 First Amendment to Plan of Reorganization and Agreement of Merger
dated October 27, 1995 among the Company, Oak Acquisition
Corporation, Pixel Magic, Inc. and the then shareholders of Pixel
dated June 25, 1996 and Second Amendment thereto dated
June 13, 1997 (16)
10.21 First Amendment to Non-Compete and Technology Transfer Agreement
by and among the Company, Pixel Magic, Inc. and Peter D. Besen
dated June 13, 1997 (16)**
48
<PAGE>
10.22 Agreement of Termination of Employment Agreement between Pixel
Magic, Inc. and Peter D. Besen dated June 13, 1997 (16)
10.23 Agreement of Termination of Employment Agreement between Pixel
Magic, Inc. and Don Schulsinger dated June 13, 1997 (16)
10.24 Release and Settlement Agreement between the Company and United
Microelectronics Corporation dated July 31, 1997 (16)**
10.25 Sublease Agreement dated December 1, 1997 between Global Village
Communication, Inc. and the Company (lease agreement for 1150
East Arques Avenue, Sunnyvale, California) and accompanying lease
and amendment thereto (18)
10.26 Amendment to Option Agreement by and between Taiwan Semiconductor
Manufacturing Co., Ltd., and the Company (19)**
10.27 Settlement Agreement between Winbond Electronics Corporation and
the Company (19)**
23.01 Consent of Independent Auditors
24.01 Power of Attorney (see page 80 of this Form 10-K)
27.01 Financial Data Schedule
</TABLE>
- ------------------------------
(1) Incorporated herein by reference to exhibit 3.01 of the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1996.
(2) Incorporated herein by reference to exhibit 3.05 filed with the Company's
Registration Statement on Form S-1 (File No. 33-87518) declared effective
by the Securities and Exchange Commission on February 13, 1995 (the
"February 1995 Form S-1").
(3) Incorporated herein by reference to the exhibit with the same number filed
with the February 1995 Form S-1.
(4) Incorporated herein by reference to Exhibit 10.1 filed with the Company's
Registration Statement on Form S-8 (File No. 333-4334) on May 2, 1996.
(5) Incorporated herein by reference to the exhibit with the same number filed
with the Company's Annual Report on Form 10-K for the year ended June 30,
1996.
(6) Incorporated herein by reference to Exhibit 2.1 filed with the Company's
Form 8-K dated October 2, 1995 (the "October 1995 form 8-K").
(7) Incorporated herein by reference to Exhibit 2.2 filed with the October
1995 Form 8-K.
(8) Incorporated herein by reference to Exhibit 2.3 filed with the October
1995 Form 8-K.
(9) Incorporated herein by reference to Exhibit 10.08 filed with the Company's
Annual Report on Form 10-K for the year ended June 30, 1995.
(10) Incorporated herein by reference to Exhibit 10.08 filed with the Company's
Annual Report on Form 10-K for the year ended June 30, 1996.
(11) Incorporated herein by reference to Exhibit 10.04 filed with the Company's
Quarterly Report on Form 10-Q for the quarter ended December 31, 1995.
(12) Confidential treatment has been granted with respect to portions of this
exhibit.
(13) Incorporated herein by reference to Exhibit 10.17 filed with the Company's
Annual Report on Form 10-K for the year ended June 30, 1996.
(14) Incorporated herein by reference to the exhibit with the same number filed
with the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996.
(15) Incorporated herein by reference to the exhibit with the same number filed
with the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1997.
(16) Incorporated herein by reference to the exhibit with the same number filed
with the Company's Annual Report on Form 10-K for the year ended June 30,
1997.
(17) Incorporated herein by reference to the exhibit with the same number filed
with the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1997.
(18) Incorporated herein by reference to the exhibit with the same number filed
with the Company's Quarterly Report on Form 10-Q for the quarter ended
December 31, 1997.
(19) Incorporated herein by reference to the exhibit with the same number filed
with the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1998.
* Indicates Management Incentive Plan.
** Confidential treatment granted and/or requested as to portions of the
exhibit.
(b) The Company filed a Report on Form 8-K on June 12, 1998, making an Item 5
disclosure related to the resignation of the President of its Optical Storage
Group.
The Company filed a Report on Form 8-K on July 31, 1998, making an Item 5
disclosure related to the resignation of its Chief Financial Officer.
49
<PAGE>
TRADEMARK ACKNOWLEDGMENTS
- Oak Technology, Inc., the Oak logo and XLI are registered trademarks
of the Company. Pixel Magic and Xerographic Laser Images are
trademarks of the Company.
- All other brand names or trademarks appearing in the Form 10-K are the
property of their respective owners.
50
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Oak Technology, Inc.:
We have audited the accompanying consolidated balance sheets of Oak Technology,
Inc. and subsidiaries as of June 30, 1998 and 1997, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
years in the three-year period ended June 30, 1998. In connection with our
audits of the consolidated financial statements, we have also audited the
consolidated financial statement schedule, insofar as it relates to the
three-year period ended June 30, 1998. These consolidated financial statements
and consolidated financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and consolidated financial statement schedule
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 financial position of Oak Technology, Inc.
and subsidiaries as of June 30, 1998 and 1997, and the results of their
operations and their cash flows for each of the years in the three-year period
ended June 30, 1998, in conformity with generally accepted accounting
principles. Also, in our opinion, the related consolidated financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
KPMG Peat Marwick LLP
Mountain View, California
July 28, 1998, except as to note 14 which is
as of August 12, 1998
51
<PAGE>
OAK TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
June 30,
----------------------
1998 1997
--------- ---------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................................... $ 59,803 $ 87,609
Short-term investments...................................................... 57,422 57,660
Accounts receivable, net of allowance for doubtful accounts of
$809 and $663, respectively............................................... 17,605 24,872
Inventories................................................................. 7,558 12,322
Current portion of foundry deposits......................................... 2,944 15,015
Deferred tax asset.......................................................... 5,356 4,350
Prepaid expenses and other current assets................................... 10,967 4,107
--------- ---------
Total current assets..................................................... 161,655 205,935
Property and equipment, net..................................................... 25,114 19,958
Foundry deposits................................................................ 18,231 19,145
Investment in foundry venture................................................... 51,216 39,618
Other assets.................................................................... 5,195 2,939
--------- ---------
Total assets............................................................. $ 261,411 $ 287,595
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable and current portion of long-term debt......................... $ 2,625 $ 7,264
Accounts payable............................................................ 6,236 16,144
Accrued expenses............................................................ 8,217 9,882
Income taxes payable........................................................ - 3,893
Deferred revenue............................................................ 263 584
--------- ---------
Total current liabilities................................................ 17,341 37,767
Long-term debt.................................................................. 27 2,496
Deferred income taxes........................................................... 2,607 6,344
Other long-term liabilities..................................................... 228 2,291
--------- ---------
Total liabilities........................................................ 20,203 48,898
--------- ---------
Stockholders' equity:
Preferred stock, $0.001 par value; 2,000,000 shares authorized;
none issued and outstanding as of June 30, 1998 and 1997................. - -
Common stock, $0.001 par value; 60,000,000 shares authorized;
41,147,969 shares issued and outstanding as of June 30, 1998 and
41,086,754 shares issued and outstanding as of June 30, 1997............. 42 41
Additional paid-in capital.................................................. 156,464 159,901
Retained earnings........................................................... 84,702 78,755
--------- ---------
Total stockholders' equity............................................... 241,208 238,697
--------- ---------
Total liabilities and stockholders' equity............................... $ 261,411 $ 287,595
--------- ---------
--------- ---------
</TABLE>
See accompanying notes to consolidated financial statements
52
<PAGE>
OAK TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Net revenues.......................................... $ 157,106 $ 167,395 $ 247,984
Cost of revenues...................................... 82,558 73,214 138,499
---------- ---------- ----------
Gross profit..................................... 74,548 94,181 109,485
Research and development expenses..................... 49,658 34,660 30,718
Selling, general, and administrative expenses......... 30,905 21,673 16,783
Acquisition related expenses.......................... 1,323 5,000 4,837
Restructuring charges................................. 1,766 - -
---------- ---------- ----------
Operating income (loss).......................... (9,104) 32,848 57,147
Non-operating income, net............................. 16,101 5,408 6,011
---------- ---------- ----------
Income before income taxes....................... 6,997 38,256 63,158
Income taxes.......................................... 1,050 14,537 26,025
---------- ---------- ----------
Net income....................................... $ 5,947 $ 23,719 $ 37,133
---------- ---------- ----------
---------- ---------- ----------
Net income per share:
Basic............................................ $ 0.14 $ 0.58 $ 0.95
---------- ---------- ----------
---------- ---------- ----------
Diluted.......................................... $ 0.14 $ 0.55 $ 0.87
---------- ---------- ----------
---------- ---------- ----------
Shares used in computing net income
per share:
Basic............................................ 41,739 40,751 39,262
---------- ---------- ----------
---------- ---------- ----------
Diluted.......................................... 42,493 42,757 42,614
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
53
<PAGE>
OAK TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
Total
Common stock Additional Retained Stockholders'
Shares Amount Paid-in Capital Earnings Equity
----------- ----------- --------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
Balances, June 30, 1995 .................. 37,588,498 38 144,702 17,903 162,643
Exercise of warrants ..................... 807,430 - 1,211 - 1,211
Repurchase of common stock ............... (57,780) - (1,211) - (1,211)
Exercise of stock options ................ 1,784,508 2 1,469 - 1,471
Employee stock purchase plan ............. 74,140 - 909 - -
Tax benefit on exercise of
stock options ........................... - - 8,671 8,671
Net income ............................... - - - 37,133 37,133
----------- ----------- ----------- ----------- -----------
Balances, June 30, 1996 .................. 40,196,796 40 155,751 55,036 210,827
Exercise of stock options ................ 748,682 1 1,048 - 1,049
Employee stock purchase plan ............. 141,276 - 1,169 - 1,169
Tax benefit on exercise of stock options.. - - 1,933 - 1,933
Net income ............................... - - - 23,719 23,719
----------- ----------- ----------- ----------- -----------
Balances, June 30, 1997 .................. 41,086,754 41 159,901 78,755 238,697
Exercise of warrants ..................... 150,339 - - - -
Repurchase of common stock ............... (1,142,580) - (6,708) - (6,708)
Exercise of stock options ................ 798,730 1 1,196 - 1,197
Employee stock purchase plan ............. 254,726 - 1,555 - 1,555
Tax benefit on exercise of stock options.. - - 520 - 520
Net income ............................... - - - 5,947 5,947
----------- ----------- ----------- ----------- -----------
Balances, June 30, 1998 .................. 41,147,969 $ 42 $ 156,464 $ 84,702 $ 241,208
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
54
<PAGE>
OAK TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income................................................ $ 5,947 $ 23,719 $ 37,133
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization........................... 7,386 5,502 3,586
Inventory-related adjustments........................... 3,545 (21,754) 24,845
Equity in (income) or loss of unconsolidated affiliates. - 602 (442)
Acquisition-related charges............................. 1,323 5,000 4,837
Non-cash restructuring charges.......................... 1,047 - -
Deferred income taxes................................... (4,743) 9,448 (5,491)
Foundry deposits utilized............................... 12,985 11,035 -
Changes in operating assets and liabilities:
Accounts receivable.................................... 7,267 (4,700) 2,050
Inventories............................................ 1,219 21,195 (30,533)
Prepaid expenses and other current assets.............. (3,056) (298) (2,362)
Accounts payable and accrued expenses.................. (13,566) 10,315 (4,915)
Income taxes payable, deferred revenue and other
liabilities.......................................... (7,139) 5,286 2,008
--------- --------- ---------
Net cash provided by operating activities........... 12,215 65,350 30,716
--------- --------- ---------
Cash flows from investing activities:
Purchases of short-term investments....................... (65,290) (66,791) (107,150)
Proceeds from matured short-term investments.............. 65,528 77,481 64,607
Additions to property and equipment, net.................. (12,035) (6,908) (12,665)
Acquisition of Pixel Magic, Inc., net of cash acquired.... - - (5,126)
Acquisition of ODEUM Microsystems......................... (4,010) - -
Investment in Omni Peripherals Pte. Ltd. ................. (802) - -
Investment in foundry venture............................. (11,616) (25,922) (13,696)
Foundry deposits.......................................... - - (45,520)
Other assets.............................................. (732) (1,993) (161)
--------- --------- ---------
Net cash used in investing activities.................. (28,957) (24,133) (119,711)
--------- --------- ---------
Cash flows from financing activities:
Issuance of debt.......................................... 12,544 32,730 54,865
Repayment of debt......................................... (19,652) (33,490) (48,452)
Treasury stock acquisition................................ (6,708) - -
Issuance of common stock.................................. 2,752 2,218 2,380
--------- --------- ---------
Net cash provided by financing activities.................... (11,064) 1,458 8,793
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents......... (27,806) 42,675 (80,202)
Cash and cash equivalents, beginning of period............... 87,609 44,934 125,136
--------- --------- ---------
Cash and cash equivalents, end of period..................... $ 59,803 $ 87,609 $ 44,934
--------- --------- ---------
--------- --------- ---------
Supplemental information:
Cash paid during the period:
Interest................................................ $ 280 $ 465 $ 680
--------- --------- ---------
--------- --------- ---------
Income taxes............................................ $ 14,548 $ - $ 28,514
--------- --------- ---------
--------- --------- ---------
Non-cash investing and financing activities:
Accrual of foundry commitments.......................... $ - $ (14,400) $ 14,400
--------- --------- ---------
--------- --------- ---------
Utilization of foundry deposits......................... $ 12,985 $ 11,035 $ -
--------- --------- ---------
--------- --------- ---------
Tax benefit related to stock plans...................... $ 520 $ 1,933 $ 8,671
--------- --------- ---------
--------- --------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
55
<PAGE>
OAK TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) THE COMPANY
Oak Technology, Inc. (the "Company") commenced operations in August 1987,
as a California corporation. The Company is engaged in the design,
development and marketing of high performance multimedia semiconductors and
related software to the PC, consumer electronics, and digital office
equipment markets. The Company formed a subsidiary in Taipei, Taiwan, in
January 1989, and in Tokyo, Japan, in January 1991. In December 1994, the
Board of Directors approved the re-incorporation of the Company as a
Delaware corporation.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND PREPARATION
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant
intercompany transactions and accounts have been eliminated in
consolidation.
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 reported amount of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
CASH EQUIVALENTS AND INVESTMENTS
The Company's policy is to invest cash in excess of operating requirements
in interest-bearing investments. Securities purchased with remaining
maturities of three months or less at the date of acquisition are
considered to be cash equivalents. Securities purchased with remaining
maturities greater than three months at the date of acquisition are
included in short-term investments.
The Company has adopted Statement of Financial Accounting Standards (SFAS)
No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES,
effective July 1, 1994. SFAS No. 115 requires entities to classify
investments in debt and equity securities with readily determined fair
values as "held-to-maturity," "available-for-sale" or "trading" and
establishes accounting and reporting requirements for each classification.
In accordance with SFAS No. 115, the Company has classified all securities
held as available-for-sale securities. Such securities are reported at
fair value with unrealized gains or losses, if material, excluded from
earnings and reported as a separate component of stockholders' equity. To
date, unrealized gains and losses have not been significant.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk are primarily cash and cash equivalents,
short-term investments and accounts receivable. The Company's cash
equivalents and short-term investments are primarily in money market
accounts, certificates of deposit, corporate notes and US government
obligations. The Company's short-term investments have maturities ranging
from 1998 through 1999. Also included in cash and cash equivalents as of
June 30, 1998, and 1997, are approximately $3,500,000 and $19,000,000,
respectively, in accounts with foreign banks and financial institutions (in
Taiwan, Japan and UK). The Company periodically discounts notes receivable
with recourse due from some customers with banks in Japan. As of June 30,
1998, the Company had no discounted notes receivable outstanding.
56
<PAGE>
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Generally, the Company requires no collateral on trade receivables,
although a substantial portion of export international sales are guaranteed
by letters of credit. The Company believes that any credit risks are
substantially mitigated by its credit evaluation process and its
maintenance of reserves for estimated credit losses.
INVENTORIES
Inventories are stated at the lower of cost (first in, first out) or
market. The Company periodically reviews its inventories for potential
slow-moving or obsolete items and writes down specific items to net
realizable value as appropriate.
DEPRECIATION AND AMORTIZATION
Property and equipment is stated at cost. Depreciation and amortization
are computed using the straight-line method. Useful lives of three to five
years are used for computer equipment, purchased software and furniture and
fixtures; useful lives of up to five years are used for leasehold
improvements and a useful life of 60 years is used for a building.
FOUNDRY DEPOSITS AND PREPAYMENTS
Deposits and prepayments paid under agreements to secure additional wafer
capacity are carried at the lower of cost or net realizable value.
LONG LIVED ASSETS
The Company reviews its long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets held and used is measured by
a comparison of the carrying amount of an asset to future undiscounted net
cash flows expected to be generated. If the carrying amount is in excess
of the future undiscounted net cash flows of such assets, an impairment is
recognized and is measured by the amount by which the carrying value of the
asset exceeds its fair value. Assets to be disposed of are reported at the
lower of their carrying amount or fair value less cost to sell.
REVENUE RECOGNITION
Product revenue is recognized upon shipment, with provisions for estimated
returns and allowances. Revenue from non-refundable technology license
fees is recognized upon transfer of the associated technology. Product
design revenue is recognized upon completion of contractual milestones.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
The Company's transactions are generally denominated in US dollars, which
is considered to be the functional currency of the Company and its
subsidiaries. Sales to customers in Japan and Taiwan are invoiced in local
currencies. Assets and liabilities of the Company's foreign subsidiaries
are remeasured into the functional currency from the local currency at
rates in effect at period-end, except for inventories, property and
equipment, and intangible assets, which are remeasured at historical rates.
Revenues and expenses are remeasured at average rates during the period.
Adjustments arising from the remeasurement of local currency financial
statements are included in non-operating results.
The Company enters into forward contracts to hedge certain exposures
related to certain foreign currency transactions. Gains and losses on
contracts are recognized in the same period as the transactions being
hedged and are charged to non-operating income. As of June 30, 1998 and
1997, the Company had forward contracts to exchange yen for approximately
$4,690,000 and $4,100,000, respectively.
57
<PAGE>
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
The Company records income taxes using an asset and liability approach that
results in the recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been recognized in the
Company's consolidated financial statements or tax returns. In estimating
future tax consequences, all expected future events other than enactment of
changes in tax laws or rates are considered.
US income taxes are provided on income from foreign subsidiaries to the
extent the Company plans to repatriate such income.
NET INCOME PER SHARE
Basic net income per share is computed using the weighted average number of
common shares outstanding during the period. Diluted net income per share
is computed using the weighted average number of common and dilutive common
equivalent shares outstanding during the period, using the treasury stock
method for options and warrants. The following is a reconciliation of the
numerators and denominators of the basic and diluted earnings per share
(EPS) computations for the periods presented (in thousands except per share
amounts):
<TABLE>
<CAPTION>
Years Ended June 30,
---------------------------------------------------
1998 1997 1996
------------- -------------- -------------
<S> <C> <C> <C>
Net income $ 5,947 $ 23,719 $ 37,133
------------- -------------- -------------
------------- -------------- -------------
Shares:
Weighted average common
shares................ 41,739 40,751 39,262
Dilutive stock options
and other common
stock equivalents..... 754 2,006 3,352
------------- -------------- -------------
Dilutive potential
common shares......... 42,493 42,757 42,614
------------- -------------- -------------
Earnings Per Share:
Basic.............. $ 0.14 $ 0.58 $ 0.95
------------- -------------- -------------
------------- -------------- -------------
Diluted............ $ 0.14 $ 0.55 $ 0.87
------------- -------------- -------------
------------- -------------- -------------
</TABLE>
The number of anti-dilutive shares excluded from the diluted EPS
computations, representing options outstanding with an exercise price
greater than the average market price for the periods, were 1,694,000,
345,000 and 576,000 for the fiscal years ended June 30, 1998, 1997 and
1996, respectively.
STOCK-BASED COMPENSATION
The Company accounts for its stock option plan in accordance with the
provisions of the Accounting Principles Board (APB) Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations. As
such, compensation expense would be recorded on the date of grant only if
the current market price of the underlying stock exceeded the exercise
price. On January 1, 1996, the Company adopted the disclosure requirements
of Statement of Financial Accounting Standards (SFAS) No. 123, ACCOUNTING
FOR STOCK-BASED COMPENSATION. Under SFAS No. 123 the Company must disclose
pro forma net income and pro forma earnings per share disclosures for
employee stock option grants made in 1996 and future years as if the fair
value-based method defined in SFAS No. 123 had been applied.
58
<PAGE>
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 establishes standards for
reporting and displaying comprehensive income and its components in the
consolidated financial statements. It does not, however, require a
specific format for the statement, but requires the Company to display an
amount representing total comprehensive income for the period in that
financial statement. The Company is in the process of determining its
preferred format. SFAS No. 130 is effective for fiscal years beginning
after December 15, 1997.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information."
SFAS No. 131 establishes standards for the way public business enterprises
are to report information about operating segments in annual financial
statements and requires those enterprises to report selected information
about operating segments in interim financial reports issued to
stockholders. SFAS No 131 is effective for financial statements for
periods beginning after December 15, 1997.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities", which will
be effective for the Company's fiscal year 2000. SFAS No. 133 establishes
accounting and reporting standards requiring that every derivative
instrument, including certain derivative instruments imbedded in other
contracts, be recorded in the balance sheet as either an asset or liability
measured at its fair value. The statement also requires that changes in
the derivative's fair value be recognized in earnings unless specific hedge
accounting criteria are met. The Company is currently assessing the impact
of this new statement on its consolidated financial position, liquidity,
and results of operations.
(3) BALANCE SHEET AND OPERATING STATEMENT COMPONENTS
INVESTMENTS
As of June 30, 1998, all investments were considered available-for-sale
securities and consisted of the following (in thousands):
<TABLE>
<CAPTION>
Estimated
Accrued Fair
Cost Interest Value
---------- ---------- -----------
<S> <C> <C> <C>
Money market funds................... $ 47,945 $ 6 $ 47,951
Certificates of deposit.............. 12,047 - 12,047
Corporate notes...................... 28,708 462 29,170
US government obligations............ 28,525 226 28,751
---------- ---------- -----------
$ 117,225 $ 694 $ 117,919
---------- ---------- -----------
---------- ---------- -----------
</TABLE>
59
<PAGE>
(3) BALANCE SHEET AND OPERATING STATEMENT COMPONENTS (CONTINUED)
As of June 30, 1998, approximately $60.3 million of these investments had
contractual maturities within one year and approximately $57.2 million had
contractual maturities between one and two years. These investments were
classified on the consolidated balance sheet as follows (in thousands):
<TABLE>
<S> <C>
Cash equivalents................................................. $ 59,803
Short-term investments........................................... 57,422
-----------
$ 117,225
-----------
-----------
</TABLE>
As of June 30, 1997, all investments were considered available-for-sale
securities and consisted of the following (in thousands):
<TABLE>
<CAPTION>
Estimated
Accrued Fair
Cost Interest Value
---------- ----------- -----------
<S> <C> <C> <C>
Money market funds................... $ 63,002 $ 5 $ 63,007
Certificates of deposit.............. 34,916 18 34,934
Corporate notes...................... 16,521 285 16,806
US government obligations............ 30,046 225 30,271
---------- ----------- -----------
$ 144,485 $ 533 $ 145,018
---------- ----------- -----------
---------- ----------- -----------
</TABLE>
As of June 30, 1997, approximately $97.9 million of these investments had
contractual maturities within one year and approximately $46.6 million had
contractual maturities between one and two years. These investments were
classified on the consolidated balance sheet as follows (in thousands):
<TABLE>
<S> <C>
Cash equivalents.................................................... $ 86,825
Short-term investments.............................................. 57,660
----------
$ 144,485
----------
----------
</TABLE>
INVENTORIES
Inventories consisted of the following (in thousands):
<TABLE>
<CAPTION>
June 30,
------------------------
1998 1997
--------- ---------
<S> <C> <C>
Purchased parts and work in process................ $ 5,612 $ 5,521
Finished goods..................................... 1,946 6,801
--------- ---------
$ 7,558 $ 12,322
--------- ---------
--------- ---------
</TABLE>
During the quarter ended March 31, 1998 the Company recorded a $3.5 million
write-off of inventory related to the discontinuation of the graphics and
audio/communications businesses. See note 11 for discussion of the
business restructuring.
60
<PAGE>
(3) BALANCE SHEET AND OPERATING STATEMENT COMPONENTS (CONTINUED)
In 1996, the Company recorded a charge of approximately $21.0 million to
increase the allowance against inventory to reflect a deterioration in the
net realizable value of excess or obsolete inventory, the majority of which
was composed of one of the Company's CD-ROM controller products. In 1997,
due to more favorable market and economic conditions, the Company sold
$18.7 million of the inventory which had been reserved in 1996 resulting in
a favorable adjustment to cost of revenues.
PROPERTY AND EQUIPMENT
Property and equipment consisted of the following (in thousands):
<TABLE>
<CAPTION>
June 30,
------------------------
1998 1997
--------- ---------
<S> <C> <C>
Land............................................... $ 3,487 $ 3,487
Building and leasehold improvements................ 2,687 2,152
Computers, equipment and purchased software........ 31,636 24,190
Furniture and fixtures............................. 2,463 1,126
--------- ---------
40,273 30,955
Less accumulated depreciation and amortization..... 15,159 10,997
--------- ---------
$ 25,114 $ 19,958
--------- ---------
--------- ---------
</TABLE>
ACCRUED EXPENSES
Accrued expenses consisted of the following (in thousands):
<TABLE>
<CAPTION>
June 30,
-----------------------
1998 1997
-------- --------
<S> <C> <C>
Commission and payroll-related items................ $ 4,345 $ 4,510
Royalties........................................... 963 788
Current portion of acquisition-related accrued
liability to former Pixel Magic shareholders..... 1,986 3,000
Other............................................... 923 1,584
-------- --------
$ 8,217 $ 9,882
-------- --------
-------- --------
</TABLE>
LICENSE FEES
Non-refundable technology license fees of approximately $1,191,000,
$235,000 and $3,003,000 were recorded as revenue in fiscal 1998, 1997 and
1996 respectively.
61
<PAGE>
(3) BALANCE SHEET AND OPERATING STATEMENT COMPONENTS (CONTINUED)
NON-OPERATING INCOME, NET
Non-operating income, net consisted of the following (in thousands):
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Interest income....................... $ 7,665 $ 6,614 $ 7,299
Interest expense...................... (286) (468) (725)
Foreign currency
translation/transaction loss........ (2,521) (722) (1,082)
Income (loss) on equity method - 442
investee............................ (602)
Settlement proceeds................... 10,589 - -
Other income, net..................... 654 586 77
----------- ----------- -----------
$ 16,101 $ 5,408 $ 6,011
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
During the year ended June 30, 1998 the Company recorded as non-operating
income the proceeds from a Settlement Agreement entered into on July 31,
1997 between the Company and United Microelectronics Corporation ("UMC") in
connection with a complaint the Company had filed with the International
Trade Commission on July 21, 1997 based on the Company's belief that
certain UMC CD-ROM controllers infringed on one of the Company's patents.
(4) NOTES PAYABLE AND LONG-TERM DEBT
Notes payable and long-term debt consisted of the following (in thousands):
<TABLE>
<CAPTION>
June 30,
------------------------
1998 1997
---------- ----------
<S> <C> <C>
Short-term bank loans............................... 2,482 7,105
Short-term notes.................................... 109 158
Mortgage notes...................................... - 2,446
Capital lease obligations........................... 61 51
---------- ----------
2,652 9,760
Less current portion................................ 2,625 7,264
---------- ----------
$ 27 $ 2,496
---------- ----------
---------- ----------
</TABLE>
Short-term bank loans consist of borrowings from two Japanese financial
institutions, collateralized by standby letters of credit drawn on U.S.
banks, and bear interest based on the Japanese prime rate. Under
arrangements with these two financial institutions, as of June 30, 1998,
the Company may borrow up to an aggregate of approximately $25 million
subject to annual renewal. Borrowings as of June 30, 1998, bore interest
ranging from 1.06% to 1.625%.
62
<PAGE>
(4) NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED)
Short-term notes consist primarily of revolving borrowings from three
Taiwanese financial institutions, collateralized by land and a building in
Taiwan, and bear interest at rates determined at the time of each
borrowing. Under arrangements with the three financial institutions, as of
June 30, 1998, the Company may borrow up to an aggregate of approximately
$13,143,000 subject to annual renewal. Compensating balances ranging from
20% to 30% of outstanding borrowings are required for individual balances
exceeding established minimums, however no compensating balances were
required as of June 30, 1998. Borrowings as of June 30, 1998 bore interest
at 6.55%.
Mortgage notes were payable in monthly installments of principal and
interest and were collateralized by land and a building in Taiwan. These
notes matured at various dates through March 2012 and bore interest at
variable rates, based on the Taiwan Bank reference rate. The Company paid
the remaining balance of the mortgage notes outstanding in November 1997.
Future principal payments under all outstanding capital lease obligations
as of June 30, 1998 are approximately $61,000 of which approximately
$34,000 is due in fiscal 1999.
63
<PAGE>
(5) ACQUISITIONS AND INVESTMENTS
PIXEL MAGIC, INC.
In November 1995, the Company acquired all of the outstanding stock of
Pixel Magic, Inc. (Pixel Magic), a privately held company based in Andover,
Massachusetts, specializing in the design and manufacture of
compression/decompression and image enhancement technology for the digital
equipment product market, for $10.5 million of which $5.0 million was
contingent upon the achievement of certain performance criteria over a
three year period. In June 1997, the Company waived certain of the
performance criteria and agreed to pay the entire contingent amount of $5.0
million in two installments during calendar 1998. The first payment of
$3.0 million is due in January 1998 and the second payment of $2.0 million
is due in December 1998. As a result of this agreement and because the
contingent earn-out was based, in part, on the continued employment of the
former shareholder/employees of Pixel Magic, the Company recorded a
compensation charge of $5.0 million in the quarter and fiscal year ended
June 30, 1997. The acquisition was accounted for using the purchase method
of accounting and accordingly, the operating results of Pixel Magic have
been included in the consolidated financial statements of the company from
the date of acquisition. The initial cash payment was allocated as follows
(in thousands):
<TABLE>
<S> <C>
Net liabilities assumed................................... $ (191)
In-process research and development....................... 4,837
Purchased technology...................................... 854
-----------
$ 5,500
-----------
-----------
</TABLE>
Approximately $4.8 million of the initial cash payment was allocated to
in-process research and development and was charged to operations in the
quarter ended December 31, 1995. The remainder of the cost was allocated
to purchased software and assets and liabilities based upon management's
estimate of their fair market values as of the acquisition date. The
amount allocated to purchased technology is fully amortized at June 30,
1998.
The following unaudited pro forma combined results of operations for the
twelve months ended June 30, 1996 is presented as if the acquisition had
occurred at the beginning of the period. The one-time charge for the
write-off of in-process research and development and the compensation
expense associated with the waiver of the performance criteria associated
with the contingent payment amount have not been reflected in the following
pro forma summary as they are non-recurring. This pro forma summary does
not necessarily reflect the results of operations as they would have been
if the Company and Pixel Magic had constituted a consolidated entity during
such period (in thousands, except per share data):
<TABLE>
<CAPTION>
June 30,
-----------
1996
-----------
<S> <C>
Net revenues.................................................. $ 249,170
Net income.................................................... $ 39,857
Basic net income per share.................................... $ 1.02
Diluted net income per share.................................. $ 0.94
</TABLE>
64
<PAGE>
(5) ACQUISITIONS AND INVESTMENTS (CONTINUED)
ODEUM MICROSYSTEMS
On April 2, 1998, the Company acquired certain assets from ODEUM
Microsystems, Inc. (ODEUM), a subsidiary of Hyundai Electronics America.
With the acquisition, the Company acquired an integrated MPEG-2 audio/video
decoder and transport demultiplexor and a DVB-S compliant QSPK demodulator
as well as a core group of hardware and software engineers. The products
acquired from ODEUM are used predominately in "free to air" satellite and
cable set-top boxes for MPEG-2 encoded digital television broadcasting and
therefore, represented the Company's first step in expanding its Consumer
Group and serving the digital television market. The assets of ODEUM were
acquired for $4,010,000 in cash.
The acquisition was accounted for using the purchase method of accounting
and the product acquired was integrated into the Company's product
offerings from the date of acquisition. Approximately $1,300,000 of the
purchase price was allocated to in-process research and development with
the remaining amount allocated to purchased technology.
OMNI PERIPHERALS
On April 30, 1998, the Company entered into several agreements with Omni
Peripherals Pte. Ltd. (Omni) and two other investors pursuant to which the
Company acquired a preferred equity interest in Omni. Omni was
incorporated in Singapore on January 2, 1996, and is in the business of
designing, developing, and marketing mechatronics modules for optical
storage drives. The Company intends to assist Omni in the design and
marketing of its mechatronics modules thereby enabling the Company to offer
a complete solution to its customers. The Company paid approximately
$800,000 for its interest, representing approximately 20% of the issued
stock of Omni. The Company accounts for this investment under the equity
method in which the Company records its pro-rata share of the income/(loss)
in the investee as other income/(expense).
65
<PAGE>
(6) INCOME TAXES
The components of the income tax expense are as follows (in thousands):
<TABLE>
<CAPTION>
June 30,
----------------------------------------
1998 1997 1996
------------ ------------ -----------
<S> <C> <C> <C>
Current:
Federal and state................. $ 2,448 $ 1,087 $ 21,622
Foreign........................... 2,825 2,069 1,223
Deferred:
Federal and state................. (1,146) 9,771 (9,984)
Foreign........................... (3,597) (323) 4,493
Charge in lieu of taxes attributable
to employee stock option plans.... 520 1,933 8,671
------------ ------------ -----------
Total tax provision $ 1,050 $ 14,537 $ 26,025
------------ ------------ -----------
------------ ------------ -----------
</TABLE>
A reconciliation between the income tax provision computed at the federal
statutory rate and the effective tax rate is as follows (in thousands):
<TABLE>
<CAPTION>
June 30,
----------------------------------------
1998 1997 1996
------------ ------------ -----------
<S> <C> <C> <C>
Expense at federal statutory tax rate $ 2,379 $ 13,390 $ 22,105
State income tax, net of federal
benefit............................ 300 523 1,209
Rate differential on foreign income.. (538) (327) 1,615
Pixel Magic acquisition.............. - 1,667 1,773
Research credit...................... (1,650) (1,033) -
Other................................ 559 317 (677)
------------ ------------ -----------
Total tax provision $ 1,050 $ 14,537 $ 26,025
------------ ------------ -----------
------------ ------------ -----------
</TABLE>
66
<PAGE>
(6) INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to deferred tax
assets and deferred tax liabilities are as follows (in thousands):
<TABLE>
<CAPTION>
June 30,
-------------------------
1998 1997
----------- ----------
<S> <C> <C>
Various reserves and accruals....................... $ 2,877 $ 4,086
Deferred research and development expenses......... - 66
Acquired intangibles................................ 556 -
Tax credits......................................... 3,190 412
Other............................................... 53 -
----------- ----------
Total gross deferred tax assets 6,676 4,564
----------- ----------
Less valuation allowance (1,075) -
----------- ----------
5,601 4,564
----------- ----------
Fixed assets depreciation differences............... (546) (334)
Other foreign liabilities........................... (2,306) (6,214)
----------- ----------
Total gross deferred tax liabilities (2,852) (6,558)
----------- ----------
Net deferred tax assets (liabilities) $ 2,749 $ (1,994)
----------- ----------
----------- ----------
</TABLE>
The Company has set up a valuation allowance $1,075,000 as of June 30,
1998. Based upon the results of the current year operations, the Company's
projected operating results, and all other available objective information,
the Company's management does not believe it is more likely than not that
projected future taxable income will be generated to sufficiently realize
all of the net deferred tax assets.
As of June 30, 1998 the Company has federal research and experimentation
credit carryforwards of $1,650,000 which expire from 2012 to 2013. The
Company also has state tax credit carryforwards of approximately
$1,570,000; if not utilized, approximately $300,000 of these credits will
expire in 2006. As of June 30, 1998 and 1997, the cumulative amount of
unremitted earnings of non-US subsidiaries on which the Company had not
provided US taxes approximated $12,900,000 and $15,000,000, respectively.
The additional taxes that could arise if those earnings were to be remitted
to the US would not be material after consideration of existing foreign
taxes. It is management's intent that these earnings will remain
indefinitely invested.
The Company is currently undergoing examination by the Internal Revenue
Service. The Company believes that additional liabilities, if any, that
may arise from this examination will not be material to the Company's
consolidated financial statements.
(7) FOUNDRY AGREEMENTS AND INVESTMENT IN FOUNDRY VENTURE
FOUNDRY AGREEMENTS
In June and November 1995, the Company entered into agreements with TSMC
and Chartered to obtain certain additional wafer capacity through the year
2001. The agreements call for the Company to commit to certain future
wafer purchases and to deposit funds with the suppliers as either a portion
of the price of the additional wafers in advance of their delivery or as a
non-interest bearing deposit to secure the availability of additional
wafers. The price of such wafers will be determined in the future periods
in which specific orders are actually placed. If the Company is not able
to use, assign, or sell the additional wafer quantities, all or a portion
of the deposits may be forfeited.
67
<PAGE>
(7) FOUNDRY AGREEMENTS AND INVESTMENT IN FOUNDRY VENTURE (CONTINUED)
In October 1996, the Company amended its previous agreement with TSMC
resulting in a reduction of the Company's future wafer purchases required
under the original agreement and the elimination of required future cash
prepayments of approximately $73 million. Under the amended agreement, no
additional prepayment is required; however the Company must utilize the
entire amount of the prepayment paid as of October 1996 through a certain
committed amount of wafer purchases in calendar years 1997, 1998, and 1999
or a portion of the prepayment will be forfeited. In March 1998, the
Company further amended its agreement with TSMC allowing the Company to
utilize excess wafer purchases in 1997 and 1998 to reduce the Company's
committed wafer purchases in the following years. This amendment resulted
in the Company utilizing calendar 1998 committed wafer purchases beginning
in calendar 1997 after the committed wafer purchases for calendar 1997 were
met. As a result of this amendment, the Company recorded a credit to
foundry deposits of approximately $13.0 million which was used to offset
payables to TSMC during fiscal 1998. The Company currently believes the
terms and conditions of the agreement, as amended, will be met although no
assurance can be given in this regard.
In September 1996, April 1997 and September 1997, the Company amended its
agreement with Chartered. The amendments resulted in a reduction of the
Company's future wafer purchase commitments and the elimination of required
future cash deposits under the original agreement of approximately $36
million. Under the amended agreement, the required future cash deposits of
approximately $36 million could be reinstated if certain conditions are not
met. The Company currently believes the terms and conditions of the
agreement, as amended, will be met and that these commitments will not be
reinstated although no assurance can be given in this regard.
The deposits and prepayments under the amended foundry agreements described
above are recorded at cost and total approximately $21.2 million as of June
30, 1998. The Company currently anticipates being able to utilize and
fully recover the value of all foundry prepayments and deposits under the
terms of the amended agreements although no assurance can be given in this
regard.
INVESTMENT IN FOUNDRY VENTURE
In October 1995, the Company entered into a series of agreements with UMC
to form, along with other investors, a separate Taiwanese company, UICC,
for the purpose of building and managing a semiconductor manufacturing
facility in the Science Based Industrial Park in Hsin Chu City, Taiwan,
Republic of China. As an investor in this venture, the Company has rights
to a portion of the total wafer capacity for the manufacture of its
proprietary products. The Company paid approximately $51.2 million for
approximately 9.3% of the total outstanding shares of the foundry venture.
The investment in UICC has been accounted for under the cost method of
accounting.
In October 1997, a fire damaged the UICC facility. UICC management has
publicly stated that a majority of the equipment, majority of the equipment
and inventory and a significant portion of the building were completely
destroyed at an estimated loss of approximately $324 million (based on
year-end exchange rates). UICC management has also stated that it has
reached a $300 million insurance settlement for claims stemming from the
fire and that in accordance with the coinsurance clause, UICC had to pay
$23.5 million of the damages. Despite the damages payment, UICC management
has represented that UICC's financial status has remained unaffected given
significant investment gains made during the year. UICC has further stated
that it expects to complete reinforcement of the building structure before
the end of the year, to install fab equipment by May 1999, and to be in
production by the last quarter of Calendar 1999, using primarily .18 micron
process technology. Given the fire, the Company has evaluated its
investment in the UICC facility to determine whether there has been an
impairment and as the Company believes that estimated future cash inflows
expected to be generated by the facility and/or disposition of the
investment are in excess of the carrying amount of the investment, no
impairment loss has been recognized as of June 30, 1998.
68
<PAGE>
(8) COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases its US headquarters and certain facilities and equipment
under non-cancelable operating leases. The Company is responsible for its
share of expenses under the terms of certain of the leases.
Future minimum lease payments under non-cancelable operating leases are as
follows:
<TABLE>
<CAPTION>
Year Ending June 30,
--------------------
<S> <C>
1999....................................................... $ 2,857
2000....................................................... 2,347
2001....................................................... 1,753
2002....................................................... 1,146
2003....................................................... 532
Thereafter................................................. 819
-----------
$ 9,454
-----------
-----------
</TABLE>
Rent expense was approximately $2,498,000, $1,781,000 and $1,720,000 for
the years ended June 30, 1998, 1997 and 1996, respectively.
INVENTORY PURCHASE COMMITMENTS
The Company subcontracts all of its manufacturing to independent foundries.
As of June 30, 1998 and 1997, the Company had approximately $3,164,000 and
$4,688,000, respectively, in non-cancelable purchase commitments with
various wafer fabrication subcontractors.
CONTINGENCIES
The Company and various of its current and former officers and Directors
are parties to several lawsuits which purport to be class actions filed on
behalf of all persons who purchased or acquired the Company's stock
(excluding the defendants and parties related to them) for the period
July 27, 1995 through May 22, 1996. The first, a state court proceeding
designated IN RE OAK TECHNOLOGY SECURITIES LITIGATION, Master File No.
CV758510 pending in Santa Clara County Superior Court in Santa Clara,
California, consolidates five putative class actions. This lawsuit also
names as defendants several of the Company's venture capital fund
investors, two of its investment bankers and two securities analysts. The
plaintiffs allege violations of California securities laws and statutory
deceit provisions as well as breaches of fiduciary duty and abuse of
control. On December 6, 1996, the state court judge sustained the Oak
defendants' demurrer to all causes of action alleged in plaintiffs' First
Amended Consolidated Complaint, but allowed plaintiffs the opportunity to
amend. The plaintiffs' Second Amended Consolidated Complaint was filed on
August 1, 1997. On December 3, 1997, the state court judge sustained the
Oak defendants' demurrer to plaintiffs' Second Amended Consolidated
Complaint without leave to amend to the causes of action for breach of
fiduciary duty and abuse of control, and to the California Corporations
Code Sections 25400/25500 claims with respect to the Company, a number of
the individual officers and directors, and the venture capital investors.
The judge also sustained the demurrer with leave to amend to the California
Civil Code Sections 1709/1710 claims, however plaintiffs elected not to
amend this claim. Accordingly, the only remaining claim in state court, IN
RE OAK TECHNOLOGY SECURITIES LITIGATION, is the California Corporations
Code Sections 25400/25500 cause of action against four officers of the
Company and the Company's investment bankers. On July 16, 1998, the state
court provisionally certified a national class of all persons who purchased
the Company's stock during the class period. The court stayed any action
on this order until the California Supreme Court resolves the Diamond
Multimedia writ petition.
69
<PAGE>
(8) COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company and various of its current and former officers and Directors
are also parties to four putative class action lawsuits pending in the U.S.
District Court for the Northern District of California. These actions have
been consolidated as IN RE OAK TECHNOLOGY, INC. SECURITIES LITIGATION, Case
No. C-96-20552-SW(PVT). This action alleges certain violations of federal
securities laws and is brought on behalf of purchasers of the Company's
stock for the period July 27, 1995 through May 22, 1996. This action also
names as a defendant one of the Company's investment bankers. On July 29,
1997, the federal court judge granted the Oak defendants' Motion to Dismiss
the plaintiff's First Amended Consolidated Complaint, but granted
plaintiffs leave to amend most claims. The plaintiffs' Second Amended
Consolidated Complaint was filed on September 4, 1997. Defendants' Motion
to Dismiss was heard on December 17, 1997. The federal court judge took
the matter under submission and has not yet issued a ruling.
Additionally, various of the Company's current and former officers and
Directors are defendants in three consolidated derivative actions pending
in Santa Clara County Superior Court in Santa Clara, California, entitled
IN RE OAK TECHNOLOGY DERIVATIVE ACTION. This lawsuit, which asserts a
claim for breach of fiduciary duty and a claim under California securities
law based upon the officers' and Directors' trading in securities of the
Company, has been stayed pending resolution of the class actions.
In all of the putative state and federal class actions, the plaintiffs are
seeking monetary damages and equitable relief. In the derivative action,
the plaintiffs are also seeking an accounting for the defendants' sales of
Company stock and the payment of monetary damages to the Company.
All of these actions are in the early stages of proceedings. Based on its
current information, the Company believes the suits to be without merit and
will defend its position vigorously. Although it is reasonably possible
the Company may incur a loss upon conclusion of these claims, an estimate
of any loss or range of loss cannot be made. No provision for any
liability that may result upon adjudication has been made in the Company's
Consolidated Financial Statements.
In connection with these legal proceedings, the Company has incurred, and
expects to continue to incur, substantial legal and other expenses.
Shareholder suits of this kind are highly complex and can extend for a
protracted period of time, which can substantially increase the cost of
such litigation and divert the attention of the Company's management.
The Company is party to various other legal proceedings, including a number
of patent-related matters. In the opinion of management, including
internal counsel, these proceedings will not have a material adverse effect
on the Company's consolidated financial position or overall results of
operations. In connection with these matters, however, the Company has
incurred, and expects to continue to incur, substantial legal and other
expenses.
The estimate of the potential impact on the Company's consolidated
financial position or overall results of operations for all of the
aforementioned legal proceedings could change in the future.
70
<PAGE>
(9) STOCKHOLDERS' EQUITY
The Company is authorized to issue two classes of stock, preferred stock
and common stock, each with a par value of $0.001 per share.
STOCK REPURCHASE PLAN
On January 22, 1998, the Company announced that its board of directors had
authorized the repurchase of up to 2.0 million shares of its common stock,
either in the open market or in private transactions. The repurchase
program is authorized for one year, unless further extended by the
Company's Board of Directors. As of June 30, 1998, the Company has
purchased 1,142,580 shares for approximately $6.7 million.
PREFERRED STOCK
Upon conversion of all of the outstanding preferred stock at the effective
date of the Company's initial public offering in February 1995, the number
of preferred shares authorized was reduced to 14,760,708 undesignated
shares. In April 1995 the number of preferred shares authorized was reduced
to 4,000,000 undesignated shares and in March 1996, to 2,000,000
undesignated shares; none of these preferred shares have been issued;
400,000 of the preferred shares have been designated as Series A Junior
Participating Preferred Stock and reserved for issuance pursuant to the
preferred stock purchase rights issued pursuant to the Company's Rights
Agreement dated August 19, 1997. The Board of Directors is authorized,
subject to any limitations prescribed by Delaware law, to provide for the
issuance of shares of preferred stock in one or more series, to establish
the number of shares to be included in each series, and to fix the powers,
preferences and rights of the shares.
WARRANTS
Warrants to purchase an aggregate of 796,644 shares of Series D preferred
stock at $2.25 per share were outstanding as of June 30, 1994. The warrants
are exercisable at any time on or prior to December 15, 1997. Following
the conversion of Series D preferred stock to common stock upon the
Company's initial public offering in February 1995, these warrants
represented the right to purchase 1,194,948 shares of common stock at $1.50
per share. Warrants representing the right to purchase 807,448 shares of
common stock were exercised under the warrants' cashless exercise
provisions, resulting in the issuance of 749,650 shares of common stock in
1996. Warrants representing the right to purchase 182,528 shares of
common stock were outstanding as of June 30, 1997 and in fiscal 1998
resulted in the issuance of 150,339 shares of common stock under the
warrants' cashless exercise provision.
STOCK OPTIONS
Upon the re-incorporation of the Company in Delaware in February 1995, the
Company assumed the obligations of its predecessor under the 1988 Stock
Option Plan (the "1988 Plan"), as amended and restated. The Company does
not intend to issue any additional options under the 1988 Plan.
In December 1994, the Board of Directors approved the 1994 Stock Option
Plan (the "1994 Plan") under which 3,000,000 shares of Common Stock were
reserved for issuance; 3,000,000 additional shares were approved in
February 1996. Under the 1994 Plan, either incentive or non-qualified
options to purchase the Company's common stock may be granted to employees
as determined by the Board of Directors at prices generally at fair market
value at the date of grant (110% in certain cases of non-qualified
options). Non-qualified options may be granted to employees and
consultants as determined by the Board of Directors at prices not lower
than 85% of fair market value at the date of grant. The Board of Directors
also has the authority to set exercise dates (generally no longer than five
years from date of grant), payment terms and other provisions for each
grant.
71
<PAGE>
(9) STOCKHOLDERS' EQUITY (CONTINUED)
On August 1, 1996 the Company repriced 1,800,370 options under the 1994
Plan to $6.50, the fair market value as of that date. The repriced shares
were treated as canceled and re-granted; however, they retained their
original vesting terms and were not exercisable until after April 30, 1997.
In December 1994 the Board of Directors also approved the 1994 Outside
Directors' Stock Option Plan (the "Directors Plan"), under which 500,000
shares of Common Stock were reserved for issuance. The Directors Plan
provides for the automatic grant of options to purchase shares of Common
Stock to non-employee Directors of the Company.
Stock options are subject to vesting, generally over 50 months. Under the
1988 Plan, shares are exercisable prior to vesting and are held in escrow
until vested; however, unvested shares are subject to a right of repurchase
by the Company at their original purchase price upon termination of
employment. Unexercised options expire 90 days after termination of
employment with the Company.
A summary of all the Company's stock option plans is set forth below:
<TABLE>
<CAPTION>
Weighted Weighted
Average Average
Options Exercise Options Exercise
Outstanding Price Exercisable Price
-------------- ------------ ----------------- ------------
<S> <C> <C> <C> <C>
Balances, June 30, 1995.................. 4,695,480 $ 2.82 4,092,280 $ 1.15
Granted............................... 1,576,400 22.33
Exercised............................. (1,784,508) 0.82
Canceled.............................. (495,862) 13.55
-------------- ------------ ----------------- ------------
Balances, June 30, 1996.................. 3,991,510 $ 10.08 2,257,424 $ 2.11
Granted............................... 3,118,240 7.69
Exercised............................. (748,682) 1.41
Canceled.............................. (2,579,072) 15.82
-------------- ------------ ----------------- ------------
Balances, June 30, 1997.................. 3,781,996 $ 5.91 1,459,573 $ 3.33
Granted............................... 2,730,900 8.29
Exercised............................. (798,330) 1.50
Canceled.............................. (1,352,928) 7.83
-------------- ------------ ----------------- ------------
Balances, June 30, 1998.................. 4,361,638 $ 7.61 1,153,658 $ 6.06
-------------- ------------ ----------------- ------------
-------------- ------------ ----------------- ------------
</TABLE>
The weighted average fair values of options granted in fiscal years 1998
and 1997 were $4.60 and $3.82, respectively.
72
<PAGE>
(9) STOCKHOLDERS' EQUITY (CONTINUED)
The following table summarizes information about the stock options
outstanding as of June 30, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------- ---------------------------
Weighted
Average
Shares Remaining Weighted Shares Weighted
at Contractual Average at Average
June 30, Life Exercise June 30, Exercise
Exercise Prices 1998 (Years) Price 1998 Price
------------------ ---------- ----------- -------- ---------- --------
<S> <C> <C> <C> <C> <C>
$0.43 to $5.00 252,316 0.75 $ 1.44 239,395 $ 1.38
$6.50 1,784,542 3.56 6.14 651,255 6.23
$6.81 to $10.13 1,680,470 4.25 8.48 182,728 8.26
$10.38 to $14.25 626,310 4.10 11.48 70,200 12.06
$25.00 18,000 7.59 25.00 10,080 25.00
--------- ---- ------ --------- ------
$0.43 to $25.00 4,361,638 3.76 $ 7.61 1,153,658 $ 6.06
--------- ---- ------ --------- ------
--------- ---- ------ --------- ------
</TABLE>
STOCK PURCHASE PLAN
In December 1994, the Board of Directors approved the 1994 Stock Purchase
Plan (the "Stock Purchase Plan") under which 600,000 shares of common stock
were reserved for issuance. The Stock Purchase Plan permits eligible
employees to purchase shares at a price equal to 85% of the lower of the
fair market value at the beginning or end of each six-month offering
period. Under the Stock Purchase Plan, 254,726 and 141,276 shares were
issued in fiscal years 1998 and 1997 at weighted average prices of $6.10
and $8.28, and weighted average fair values of $2.94 and $3.84,
respectively.
STOCKHOLDER RIGHTS PLAN
On August 19, 1997 the Board of Directors of the Company declared a
dividend of one preferred stock purchase right (a "Right") for each
outstanding share of Common Stock, par value $0.001 per share (the "Common
Stock"), of the Company. The dividend is payable on August 29, 1997 (the
"Record Date") to the stockholders of record on that date and to the
holders of shares of Common Stock issued subsequent to the Record Date.
Each Right entitles the registered holder to purchase from the Company one
one-thousandth of a share (a "Unit") of Series A Junior Participating
Preferred Stock, par value $0.001 per share of the Company at a price of
$60.00 per Unit subject to adjustment. The Rights become exercisable in
certain circumstances including upon an entity acquiring or announcing the
intention to acquire the beneficial ownership of 15% or more of the
Company's Common Stock without the approval of the Board of Directors of
the Company. The Rights expire on August 19, 2007. The description and
terms of the Rights are set forth in a Rights Agreement dated as of August
19, 1997 between the Company and BankBoston, N.A., as Rights Agent.
73
<PAGE>
(9) STOCKHOLDERS' EQUITY (CONTINUED)
FAIR VALUE INFORMATION
The Company applies APB Opinion 25 and related Interpretations in
accounting for its stock options plans. Accordingly, no compensation cost
has been recognized for its stock option plans nor its Stock Purchase Plan.
Had compensation cost for the Company's option plans been determined
consistent with FASB Statement No. 123, the Company's net income and net
income per share would have been reduced to the pro forma amounts indicated
below (in thousands, except per share data):
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net income:
As reported $ 5,947 $ 23,719 $ 37,133
Pro forma $ (197) $ 18,890 $ 35,014
Basic net income per share:
As reported $ 0.14 $ 0.58 $ 0.95
Pro forma $ (0.00) $ 0.46 $ 0.89
Diluted net income per share:
As reported $ 0.14 $ 0.55 $ 0.87
Pro forma $ (0.00) $ 0.44 $ 0.82
</TABLE>
Pro forma net income reflects options granted in fiscal 1998, 1997 and
1996. Therefore, the full impact of calculating compensation cost for
stock options under SFAS No. 123 is not reflected in the pro forma net
income amounts presented above because compensation cost is reflected over
the options' vesting period of three to four years and compensation cost
for options granted prior to July 1, 1995, is not considered.
74
<PAGE>
(9) STOCKHOLDERS' EQUITY (CONTINUED)
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with a dividend yield of 0% and the
following weighted average assumptions:
<TABLE>
<CAPTION>
Stock Option Plans Stock Purchase Plan
------------------ -------------------
1998 1997 1996 1998 1997 1996
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Expected life (years) 3.760 3.745 3.745 0.500 0.500 0.500
Expected volatility 70% 85% 85% 70% 85% 85%
Risk-free interest rate 5.73% 6.51% 5.82% 5.51% 5.29% 5.38%
</TABLE>
(10) EMPLOYEE BENEFIT PLAN
In July 1990, the Company adopted a 401(k) Profit Sharing Plan ("401(k)
Plan") which is intended to qualify under section 401(k) of the Internal
Revenue Code of 1986, as amended. The 401(k) Plan covers substantially all
of the Company's US employees. Participants may elect to contribute a
percentage of their compensation to this plan, up to the statutory maximum
amount. The Company makes contributions to the 401(k) Plan based on 25% of
an employee's contribution up to a maximum of 1.25% of total compensation;
approximately $288,000 and $199,000 in matching contributions were recorded
during fiscal 1998 and fiscal 1997, respectively. No matching
contributions were made in prior years.
(11) BUSINESS REORGANIZATION
In January 1998, the Company announced its intention to discontinue its
graphics and audio/communications businesses and focus on three core
markets: optical storage, consumer electronics and digital office
equipment. Unable to locate a buyer for either its graphics or its
audio/communications businesses, the Company discontinued all product
development, marketing, selling and other efforts related to these
businesses during the quarter ended March 31, 1998.
In connection with the reorganization, the Company recorded a charge of
$1.8 million which included non-cash expense of $1.0 million and cash
expense of $0.8 million. The non-cash charge was related to prepaid
royalties which will not be utilized. Cash outlays related to the
headcount reduction of 56 individuals. As of June 30, 1998 all amounts
have been paid and there is no accrual remaining relating to the
restructuring.
(12) INDUSTRY SEGMENT AND MAJOR CUSTOMERS
The Company designs, develops and markets high performance multimedia
semiconductors and related software to original equipment manufacturers
worldwide who serve the PC, consumer electronics and digital office
equipment markets.
75
<PAGE>
(12) INDUSTRY SEGMENT AND MAJOR CUSTOMERS (CONTINUED)
The following table summarizes the annual percentage contribution to net
revenues by customers when sales to such customers exceeded 10% of net
revenues and the percentage of total accounts receivable due from these
customers.
<TABLE>
<CAPTION>
Percentage of Net Revenues
--------------------------
Year Ended June 30,
--------------------------
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Mitsumi Electronic Co., Ltd. . . . . . . 17% 14% 26%
LG Electronics . . . . . . . . . . . . . 14% 13% 2%
NEC Home Electronics, Ltd. . . . . . . . 10% 8% 13%
Kanematsu Semiconductor Corporation. . . 5% 7% 19%
</TABLE>
<TABLE>
<CAPTION>
Percentage of Total Accounts Receivable
---------------------------------------
As of June 30,
---------------------------------------
1998 1997 1996
----------- ----------- ------------
<S> <C> <C> <C>
Mitsumi Electronic Co., Ltd. . . . . . . 19% 23% 31%
LG Electronics . . . . . . . . . . . . . 8% 1% -
NEC Home Electronics, Ltd. . . . . . . . 13% 22% 20%
Kanematsu Semiconductor Corporation. . . 3% 6% 7%
</TABLE>
Sales of the Company's CD-ROM controller products comprised 81%, 84%, and
91% of the net revenues in fiscal 1998, 1997, and 1996, respectively.
(13) GEOGRAPHIC SEGMENT REPORTING
The Company maintains significant operations in the United States, Taiwan
and Japan. Activities in the United States consist of corporate
administration, product development, logistics and worldwide sales
management. Foreign operations consist of regional sales and limited
board-level manufacturing.
76
<PAGE>
(13) GEOGRAPHIC SEGMENT REPORTING (CONTINUED)
The following is a summary of operations by geographic areas (in
thousands):
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------
1998 1997 1996
----------- ----------- ----------
<S> <C> <C> <C>
Revenue from unaffiliated customers
originating from:
United States. . . . . . . . . . . . . . $ 33,890 $ 15,139 $ 37,142
Taiwan . . . . . . . . . . . . . . . . . 63,201 82,613 47,963
Japan. . . . . . . . . . . . . . . . . . 60,015 69,643 162,879
----------- ----------- ----------
$ 157,106 $ 167,395 $ 247,984
----------- ----------- ----------
----------- ----------- ----------
Transfers between geographic areas
(eliminated in consolidation):
United States. . . . . . . . . . . . . . $ 111,631 $ 130,102 $ 180,569
Taiwan . . . . . . . . . . . . . . . . . - 1 4,175
Japan. . . . . . . . . . . . . . . . . . 2,569 710 233
United Kingdom . . . . . . . . . . . . . 1,079 - -
----------- ----------- ----------
$ 115,279 $ 130,813 $ 184,977
----------- ----------- ----------
----------- ----------- ----------
Income (loss) before income taxes:
United States. . . . . . . . . . . . . . $ 10,509 $ 31,767 $ 48,349
Taiwan . . . . . . . . . . . . . . . . . (1,306) 6,041 2,536
Japan. . . . . . . . . . . . . . . . . . (2,335) 834 8,574
United Kingdom . . . . . . . . . . . . . 51 - -
Eliminations . . . . . . . . . . . . . . 78 (386) 3,699
----------- ----------- ----------
$ 6,997 $ 38,256 $ 63,158
----------- ----------- ----------
----------- ----------- ----------
Identifiable assets:
United States. . . . . . . . . . . . . . $ 243,733 $ 251,706 $ 226,039
Taiwan . . . . . . . . . . . . . . . . . 12,679 27,743 14,778
Japan. . . . . . . . . . . . . . . . . . 14,563 25,731 22,848
United Kingdom . . . . . . . . . . . . . 2,036 - -
Eliminations . . . . . . . . . . . . . . (11,044) (17,585) (7,357)
----------- ----------- ----------
$ 261,967 $ 287,595 $ 256,308
----------- ----------- ----------
----------- ----------- ----------
Export sales from United States to
unaffiliated customers:
Europe . . . . . . . . . . . . . . . . . $ 13,950 $ 1,212 $ 3,668
Other Asia . . . . . . . . . . . . . . . 5,735 6,621 26,189
Japan. . . . . . . . . . . . . . . . . . 1,089 211 1,273
Taiwan . . . . . . . . . . . . . . . . . 71 190 9
Canada . . . . . . . . . . . . . . . . . 39 51 50
----------- ----------- ----------
$ 20,884 $ 8,285 $ 31,189
----------- ----------- ----------
----------- ----------- ----------
</TABLE>
77
<PAGE>
(14) SUBSEQUENT EVENTS
ACQUISITIONS
On August 11, 1998, the Company acquired Xerographic Laser Images
Corporation (XLI), a provider of print quality enhancement technology for
the digital office equipment market. XLI will operate as a division of
the Company's wholly owned subsidiary, Pixel Magic and will serve to
leverage Pixel Magic's position in the digital office equipment market by
broadening Pixel Magic's expertise in resolution enhancement technology.
As the customer base for both Pixel Magic and XLI are nearly identical, the
benefits for current and potential customers include the meshing of
technology expertise in silicon integration and manufacturing, image
processing and resolution enhancement. The Company made a cash payment of
$3,650,000 to the XLI shareholders on the effective date of the merger and
the shareholders have the right to receive additional payments of up to
$11,350,000 subject to the achievement of certain milestones by XLI over a
three year period ending December 31, 2000. The acquisition will be
accounted for under the purchase method of accounting.
On July 2, 1998, the Company acquired ViewPoint Technology, Inc.
(ViewPoint), a privately held company that was developing solutions for the
CD-RW drive market. ViewPoint had developed a controller that supports
high encoding speeds for CD-RW drives and this component is expected to
complement the Company's expertise in the block decoder area and be
utilized in the Company's next generation CD-RW drives. The Company paid
$10,100,000 in cash for all the outstanding shares of ViewPoint. The
acquisition will be accounted for under the purchase method of accounting.
STOCK REPRICING
On August 12, 1998 the Company repriced 2,638,750 options to employees and
certain officers under the 1994 Plan to $3.25, the fair market value as of
that date. The repriced shares were treated as canceled and regranted and
did not retain their original vesting terms.
78
<PAGE>
SCHEDULE II
OAK TECHNOLOGY, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>
Additions
Charged to
Beginning Costs and Deductions Ending
Allowance for Doubtful Accounts Balance Expenses Write-Offs Balance
- ------------------------------- --------- ---------- ----------- --------
<S> <C> <C> <C> <C>
Year ended June 30, 1998..... $ 663 $ 353 $ (207) $ 809
Year ended June 30, 1997..... 916 286 (539) 663
Year ended June 30, 1996..... 534 866 (484) 916
</TABLE>
79
<PAGE>
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.
Date: September 28, 1998 OAK TECHNOLOGY, INC.
By: /s/ Richard B. Black
---------------------------------
Richard B. Black, President
(Principal Executive Officer)
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Richard B. Black and David D. Tsang, and
each of them, his or her true and lawful attorneys-in-fact, each with full power
of substitution, for him or her in any and all capacities, to sign any
amendments to this report on Form 10-K and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact or their substitute or substitutes may do or cause to be done
by virtue hereof.
Pursuant to the requirements of 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 Title Date
- --------- ----- ----
/s/ Richard B. Black President and Director September 28, 1998
- ----------------------- (Principal Executive Officer)
Richard B. Black
/s/ David D. Tsang Chairman of the Board of September 28, 1998
- ----------------------- Directors and Chief Executive
David D. Tsang Officer
/s/ Ta-lin Hsu Director September 28, 1998
- -----------------------
Ta-Lin Hsu
/s/ Timothy Tomlinson Director September 28, 1998
- -----------------------
Timothy Tomlinson
/s/ Young K. Sohn Director September 28, 1998
- -----------------------
Young K. Sohn
80
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Title
- ------ -------------
<S> <C>
23.01 Consent of Independent Auditors
24.01 Power of Attorney (see page 80 of this Form 10-K)
27.01 Financial Data Schedule
</TABLE>
81
<PAGE>
EXHIBIT 23.01
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Oak Technology, Inc.:
We consent to incorporation by reference in the registration statements (No.
33-89446 and 333-04334) on Form S-8 of Oak Technology, Inc. of our report dated
July 28, 1998, except as to note 14 which is as of August 12, 1998, relating to
the consolidated balance sheets of Oak Technology, Inc. and subsidiaries as of
June 30, 1998 and 1997, and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of the years in the three-year
period ended June 30, 1998, and related schedule, which report appears in the
June 30, 1998 annual report on Form 10-K of Oak Technology, Inc.
KPMG Peat Marwick LLP
Mountain View, California
September 28, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS AS FOUND
ON PAGES 52 AND 53 OF THE COMPANY'S FORM 10-K FOR THE FISCAL YEAR ENDED JUNE 30,
1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> JUN-30-1998
<CASH> 59,803
<SECURITIES> 57,422
<RECEIVABLES> 18,414
<ALLOWANCES> 809
<INVENTORY> 7,558
<CURRENT-ASSETS> 161,655
<PP&E> 40,273
<DEPRECIATION> 15,159
<TOTAL-ASSETS> 261,411
<CURRENT-LIABILITIES> 17,341
<BONDS> 27
0
0
<COMMON> 42
<OTHER-SE> 241,208
<TOTAL-LIABILITY-AND-EQUITY> 261,411
<SALES> 157,106
<TOTAL-REVENUES> 157,106
<CGS> 82,558
<TOTAL-COSTS> 82,558
<OTHER-EXPENSES> 83,652
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 286
<INCOME-PRETAX> 6,997
<INCOME-TAX> 1,050
<INCOME-CONTINUING> 5,947
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,947
<EPS-PRIMARY> .14
<EPS-DILUTED> .14
</TABLE>
