<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the quarterly period ended March 31, 1997.
OR
[ ] Transitional Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the transition period from:_____to:____.
Commission file number 0-26660
ESS TECHNOLOGY, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 94-2928582
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
48401 FREMONT BOULEVARD
FREMONT, CALIFORNIA 94538
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE )
(510) 492-1088
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
As of March 31, 1997, the registrant had 38,588,918 shares of common stock
outstanding.
<PAGE> 2
ESS TECHNOLOGY, INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page
<S> <C>
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets - March 31, 1997 3
and December 31, 1996, unaudited
Condensed Consolidated Statements of Operations - three months 4
ended March 31, 1997 and 1996, unaudited
Condensed Consolidated Statements of Cash Flows - three 5
months ended March 31, 1997 and 1996, unaudited
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and 8
Results of Operations
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURES 18
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ESS TECHNOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands)
<TABLE>
<CAPTION>
Mar. 31, 1997 Dec. 31, 1996
------------- -------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 48,091 $ 49,055
Short-term investments 16,945 20,149
Accounts receivable, net 33,966 22,054
Inventories 34,497 33,150
Deferred income taxes 3,270 3,270
Prepaid expenses and other assets 4,727 6,338
-------- --------
Total current assets 141,496 134,016
Property and equipment, net 22,352 22,366
Other assets 55,322 55,603
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$219,170 $211,985
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LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 23,825 $ 29,504
Advances payable to vendors 15,960 28,929
Income taxes payable 11,690 4,964
Deferred income taxes 5,412 5,412
-------- --------
Total current liabilities 56,887 68,809
-------- --------
Commitments and contingencies (See Note 4)
Shareholders' equity:
Preferred stock, no par value, 10,000 shares authorized;
none issued and outstanding -- --
Common stock, no par value, 100,000 shares authorized;
38,589 and 38,127 shares issued and outstanding 99,935 98,655
Retained earnings 62,348 44,521
-------- --------
Total shareholders' equity 162,283 143,176
-------- --------
Total liabilities and shareholders' equity $219,170 $211,985
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
<PAGE> 4
ESS TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended
------------------------------
Mar. 31, 1997 Mar. 31, 1996
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<S> <C> <C>
Net revenues $81,468 $ 41,188
Cost of revenues 41,772 17,637
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Gross profit 39,696 23,551
Operating expenses:
Research and development 5,571 3,631
Research and development in-process -- 30,355
Selling, general and administrative 5,611 2,935
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Operating income (loss) 28,514 (13,370)
Nonoperating income, net 640 699
------- --------
Income (loss) before provision for
income taxes 29,154 (12,671)
Provision for income taxes 11,327 7,250
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Net income (loss) $17,827 $(19,921)
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Net income (loss) per share $ 0.43 $ (0.55)
------- --------
Weighted average common and common
equivalent shares 41,469 36,234
------- --------
</TABLE>
See notes to condensed consolidated financial statements
<PAGE> 5
ESS TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
<TABLE>
<CAPTION>
Three Months Ended
-------------------------------
Mar. 31, 1997 Mar. 31, 1996
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 17,827 $(19,921)
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,077 432
Charges for research and development in-process -- 30,355
Compensation related to stock options -- 15
Change in assets and liabilities (net of effects of VideoCore and OSEE
acquisitions):
Accounts receivable (11,912) (3,265)
Inventories (1,347) (1,342)
Prepaid expenses and other assets 1,603 (820)
Accounts payable and accrued expenses (18,648) (3,256)
Income taxes payable 6,726 3,944
-------- --------
Net cash provided by (used in) operating activities (4,674) 6,142
-------- --------
Cash flows from investing activities:
Acquisition of property and equipment (775) (1,941)
Sale of marketable equity securities and short-term investments 3,204 --
Purchase of marketable equity securities and short-term investments -- (10,376)
Cash paid for VideoCore and OSEE acquisitions -- (9,288)
-------- --------
Net cash provided by (used in) investing activities 2,429 (21,605)
-------- --------
Cash flows from financing activities:
Issuance of common stock 1,281 355
-------- --------
Net cash provided by financing activities 1,281 355
-------- --------
Net increase (decrease) in cash and cash equivalents (964) (15,108)
Cash and cash equivalents at beginning of period 49,055 51,881
-------- --------
Cash and cash equivalents at end of period $ 48,091 $ 36,773
======== ========
Supplemental disclosures of cash flow information:
Common stock issued for VideoCore and OSEE acquisitions $ -- $ 23,352
======== ========
Income taxes $ 4,600 $ 3,300
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
<PAGE> 6
ESS TECHNOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The unaudited Consolidated Financial Statements have been prepared by the
Company pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. In the opinion of management, the financial statements reflect all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair statement of the financial position, operating results and cash flows for
those periods presented. These Consolidated Financial Statements should be read
in conjunction with the Consolidated Financial Statements and notes thereto for
the years ended December 31, 1996 and 1995, included in the Company's Form 10-K.
The results of operations for the interim periods are not necessarily indicative
of the results that may be expected for any other period or for the fiscal year
which ends December 31, 1997.
Cash and Cash equivalents and Short-Term Investments.
The Company considers all highly liquid investments with an initial maturity
of 90 days or less to be cash equivalents and investments with original maturity
dates of greater than 90 days to be short-term investments. The Company accounts
for its short-term investments under Financial Accounting Standard No. 115
"Accounting for Certain Investments in Debt or Equity Securities" (SFAS 115),
which requires investment securities to be classified as either held to
maturity, trading or available for sale.
All of the Company's short-term investments, comprising primarily debt
instruments with contractual maturities of less than two years and marketable
equity securities have been classified as available for sale and therefore are
reported at fair value with unrealized gains and losses presented as a separate
component of shareholders' equity. Management determines the appropriate
classification of securities at the time of purchase and reevaluates the
classification at each reporting date. Interest income is accrued as earned. At
March 31, 1997 the fair value of the Company's investments approximated cost.
NOTE 2. BALANCE SHEET COMPONENTS (IN THOUSANDS)
<TABLE>
<CAPTION>
Mar. 31, 1997 Dec. 31, 1996
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<S> <C> <C>
Inventories:
Raw materials $ 2,043 $ 2,192
Work-in-process 14,415 14,302
Finished goods 20,180 18,797
------- -------
36,638 35,291
Less: inventory reserves (2,141) (2,141)
------- -------
$34,497 $33,150
------- -------
</TABLE>
NOTE 3. NET INCOME PER SHARE
Net income per share is computed using the weighted average number of common
and common equivalent shares ("weighted average share") outstanding during the
period. Common equivalent shares consist of the Company's common stock issuable
upon exercise of stock options during the period (using the treasury stock
method) except when anti-dilutive. Common stock issued and stock options granted
subsequent to July 31, 1994 through October 5, 1995 (the date of the initial
public offering) have been included in the calculation of weighted average
shares outstanding as if they were outstanding for reporting periods occurring
between these dates. The Company used the treasury stock method and the initial
public offering price of $15.00 per share for these calculations.
<PAGE> 7
NOTE 4. WAFER CAPACITY COMMITMENTS
In November 1995, the Company entered into agreements with two wafer
foundries, Taiwan Semiconductor Manufacturing Company Ltd. ("TSMC") and United
Microelectronics Corporation ("UMC"), in which the Company secured access to
additional manufacturing capacity and to certain technology.
Under the TSMC agreement, in exchange for TSMC's increased wafer capacity
commitments, the Company agreed to pay approximately $32 million over the next
two years as deposits for wafers through 1999. The cash requirements associated
with this agreement are two $16 million payments due on June 30, 1996 and 1997.
The Company issued two promissory notes totaling $32 million securing these
payments. The Company paid the first $16 million installment by making payments
of $12.6 million and $3.4 million on June 28th and July 1, 1996, respectively.
The Company also obtained an option to expand the TSMC wafer capacity
commitments further for years 1997 through 2000. If the Company exercises its
option for TSMC to provide additional wafer capacity, the Company would be
committed to an additional $30.8 million in deposits to be paid in two $15.4
million payments due on June 30, 1997 and 1998. If the Company is not able to
use, assign, or sell the additional wafer quantities, a portion of the deposits
may be forfeited.
Under the UMC agreement, the Company entered into a joint venture arrangement
with UMC, together with other US semiconductor companies, to build a separate
semiconductor manufacturing facility located in Taiwan at an estimated cost of
$1 billion. The Company agreed to invest approximately $26.4 million in three
installments over the projected eighteen-month period required to build the
facility. The Company made the first installment payment of $6.9 million in the
first quarter of 1996 and the second installment payment of $13.0 million in the
first quarter of 1997. Under the terms of the agreement, the Company will
receive a 5% equity ownership in the joint venture company and certain capacity
rights. The new fabrication facility is currently projected to commence
production in 1997.
NOTE 5. RECENT ACCOUNTING PRONOUNCEMENT
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128 ("FAS 128"), "Earnings per Share."
This statement redefines earnings per share under generally accepted accounting
principles. Under the new standard, primary earnings per share is replaced by
basic earnings per share and fully diluted earnings per share is replaced by
diluted earnings per share. The Company is required to adopt the new standard
in the fourth calendar quarter of 1997. The following table sets forth primary
earnings per share as reported and unaudited pro forma basic and diluted
earnings per share assuming FAS 128 had been applied during the periods
presented:
<TABLE>
<CAPTION>
Three Months Ended
------------------------------
Mar. 31, 1997 Mar. 31, 1996
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<S> <C> <C>
Primary earnings per share as reported $0.43 $(0.55)
Pro forma basic net income per share 0.46 (0.55)
Pro forma diluted net income per share 0.43 (0.55)
</TABLE>
NOTE 6. SUBSEQUENT EVENTS
On April 16, 1997, the Company announced that it had agreed to acquire
Platform Technology, Inc. ("Platform"), a developer of multimedia subsystems
for 2.2 million shares of the Company's common stock. The acquisition would be
accounted for as a pooling of interests transaction and is expected to be
completed by June 30, 1997. On April 29, 1997, the Company announced it had
changed its recent agreement to acquire Platform from a pooling of interest to
a purchase and changed the number of shares to be issued from 2.2 million to
2.54 million shares of the Company's common stock to shareholders of Platform.
The conversion of the acquisition to a purchase is expected to result in a
one-time charge in the second quarter for in-process research and development
expenses.
In addition, on April 29, 1997, the Company's board of directors authorized
the repurchase of up to two million of the Company's common shares at market
prices and as market and business conditions warrants. Such repurchases will be
made at management's discretion. At May 15, 1997, the Company had not
repurchased shares.
<PAGE> 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Statements contained in this discussion that are not statements of historical
fact may be deemed to be forward-looking statements. A number of important
factors could cause actual events or the Company's actual results to differ
materially from those indicated by such forward-looking statements, including
dependence on continued growth in demand for PC multimedia capabilities for
notebook and desktop computers, as well as consumer electronic products; the
Company's ability to take advantage of new markets; increased competition and
pricing pressures, general economic conditions and conditions specific to the
semiconductor industry; the timing and market acceptance of new product
introductions; the timely development of new products; continued availability of
quality foundry capacity; and other risks set forth in this filing and in the
Company's filings from time to time with the Securities and Exchange Commission.
This information should be read along with the unaudited condensed
consolidated financial statements and notes thereto included in Item I of this
Quarterly Report and the audited Consolidated Financial Statements and notes
thereto and Management's Discussion and Analysis of Financial Condition and
Results of Operations for the fiscal years ended December 31, 1996 and 1995,
contained in the Company's Annual Report filed on Form 10-K.
RESULTS OF OPERATIONS
The following table discloses key elements of the statements of operations,
expressed as a percentage of revenues.
<TABLE>
<CAPTION>
Three Months Ended
-------------------------------
Mar. 31, 1997 Mar. 31, 1996
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<S> <C> <C>
Net revenues 100.0% 100.0%
Cost of revenues 51.3 42.8
----- -----
Gross margin 48.7 57.2
Operating expenses:
Research and development 6.8 8.9
Research and development in-process -- 73.7
Selling, general and administrative 6.9 7.1
----- -----
Operating income (loss) 35.0 (32.5)
Nonoperating income, net 0.8 1.7
----- -----
Income (loss) before provision for income taxes 35.8 (30.8)
Provision for income taxes 13.9 17.6
----- -----
Net income (loss) 21.9% (48.4)%
===== =====
</TABLE>
Net Revenues. The Company's net revenues increased from $41.2 million in the
first quarter of 1996 to $81.5 million in the first quarter of 1997. Net
revenues for the first quarter 1997 increased 98% from 1996 as a result of the
increased sales of the Company's existing PC audio products and sales of new PC
audio and video semiconductor products. International revenues accounted for
approximately 95% and 89% of the Company's net revenues in the first quarter of
1997 and 1996, respectively, reflecting continued growth in the Company's
international sales. The increase in international sales as a percentage of net
revenues between 1996 and 1997 primarily reflects the transfer of production by
U.S. based PC customers from U.S. to Asia and growth in the sales of video
products which are sold in Asian markets.
Gross Profit. The Company's gross profit increased from $23.6 million in the
first quarter of 1996 to $39.7 million in the first quarter of 1997. The
increase in gross profit in the first quarter of 1997 as compared to the same
period in 1996 was primarily the result of the increase in unit shipments of
the Company's PC audio and video semiconductor products. Gross margin declined
in comparison to the prior period as a result of lower average selling prices
("ASPs") on existing products arising from highly competitive market conditions.
The Company's overall gross margin is subject to change due to various factors,
including among others, competitive product pricing, yields, wafer costs,
assembly costs and product mix. The Company has encountered increased
competition from other suppliers who are offering competitive single chip
products. In addition, the Company expects that overall ASPs for its existing
products will continue to decline over time and that selling prices for each
product will decline significantly over the life of the product. The Company
believes that in order to maintain or increase gross profit, it must achieve
higher unit volume shipments, cost reductions, new features and new product
introductions. However, no assurance can be given that the Company will be able
to ship higher volumes, reduce costs, add new features or introduce new products
that gain market acceptance.
<PAGE> 9
Research and Development. Research and development expenses were $5.6 million
in the first quarter of 1997 or 7% of net revenues compared to $3.6 million or
9% of net revenues in the first quarter of 1996, excluding a one-time pre and
post-tax charge of $30.4 million related to acquired research and development
in-process from the acquisition of VideoCore and OSEE in the first quarter of
1996. The increase in absolute dollars was primarily due to the increase in the
Company's engineering staff, engineering test runs, masks, internal and external
consulting expenses associated with increased research and development efforts
to support the introduction of new PC audio products and multimedia products.
Selling, General and Administrative. Selling, general and administrative
expenses were $5.6 million in the first quarter of 1997 compared to $2.9 million
in the first quarter of 1996. The increase in absolute dollars was primarily due
to the increase in commissions on higher sales volumes, added personnel and
related expenses and, to a lesser extent, promotional expenses and costs
associated with the expansion of the Company's sales activities. The Company
expects to incur higher selling, general and administrative expenses due to
increased selling activities and reporting and other requirements of a public
company, although these expenses are expected to remain relatively constant as a
percentage of net revenues. The Company strives to manage total operating
expenses in line with revenue growth and gross margin levels.
Non-Operating Income, Net. Non-operating income, net was $640,000 in the
first quarter of 1997 compared to $699,000 in the first quarter of 1996.
Non-operating income, net consisted of interest income net of interest expense
and gains on sale of securities.
Provision for Income Taxes. The Company's effective tax rate was 41% and 39%
for the first quarter of 1996 and 1997, respectively. The tax rate for the first
quarter of 1996 of 41% excludes the one-time pre and post-tax charge of $30.4
million related to acquired research and development in-process from the
acquisition of VideoCore and OSEE in the first quarter 1996. The effective tax
rate for the first three months of 1997 was lower than the combined federal and
state statutory rates as a result of tax exempt interest income and research and
development credits.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its cash requirements
from cash generated from operations, the sale of equity securities, bank lines
of credit and long-term and short-term debt. At March 31, 1997, ESS had cash
and cash equivalents and short-term investments of $65.0 million and working
capital of $84.6 million. As of March 31, 1997, the Company had two $10.0
million bank lines of credit expiring on March 31, 1997 and May 1, 1997. One
line of credit was increased from $10 million to $20 million and will expire on
May 31, 1999. The second line of credit was renewed for $10 million and will
expire on June 10, 1998. These lines of credit require the Company to achieve
certain financial ratios and operating results. There were no borrowings
under these lines of credit as of March 31, 1997.
In the first three months of 1997, the Company generated cash of $18.9
million from operating activities consisting of net income of $17.8 million and
depreciation and amortization of $1.1 million. The Company received net
proceeds of $3.2 million from sale of marketable equity securities, $1.3
million from issuance of common stock from exercise of stock options and
employee stock purchase plan. Approximately $23.6 million was used to finance
working capital, primarily due to increases in accounts receivable and
inventories reflecting a growth in sales and a higher percentage of customers
having credit terms compared to customers on letter of credit, coupled with a
decrease in accounts payable and accrued expenses. $0.8 million was used to
purchase property, plant and equipment. During the first three months of 1997,
the Company paid approximately $13.0 million to UMC in exchange for equity
ownership in a joint venture with UMC.
The Company believes that its existing cash and cash equivalents as of
March 31, 1997, together with the cash generated from operations and available
borrowings under its line of credit, will be sufficient to fund acquisitions of
property and equipment and provide adequate working capital through at least
the next twelve months. Capital expenditures for the next twelve months are
anticipated to be approximately $20.0 million of which approximately $10.0
million will be used to fund construction of additional facilities
<PAGE> 10
and approximately $10.0 million will be used to acquire capital equipment. In
addition, the Company is obligated to pay approximately $16.0 million over the
next 3 months to TSMC in exchange for certain wafer capacity commitments and
will invest approximately $7.0 million over the next 3 months in exchange for an
equity ownership in a joint venture with UMC to build a new foundry and for
certain wafer capacity commitments. The Company also has an option to expand the
TSMC wafer capacity commitment further for the years 1997 through 2000. If the
Company exercises its option for TSMC to provide additional wafer capacity, the
Company would be committed to an additional $30.8 million in deposits to be paid
in two $15.4 million due on June 30, 1997 and 1998. In addition, on April 29,
1997, the Company's board of directors authorized the repurchase of up to two
million of the Company's common shares at market prices and as market and
business conditions warrants. Such repurchases will be made at management's
discretion. At May 15, 1997, the Company had not repurchased shares. The Company
may also utilize cash to acquire or invest in complementary businesses or
products or to obtain the right to use complementary technologies. From time to
time, in the ordinary course of business, the Company may evaluate potential
acquisitions of or investment in such businesses, products or technologies owned
by third parties. The Company also has bank lines of credit which may be
utilized to provide additional cash.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Except for the historical information contained in this Quarterly Report on
Form 10-Q, the matters discussed in this report are forward looking statements
which involve risks and uncertainties that could cause actual results to differ
from those indicated by such forward looking statements. Such risks and
uncertainties include but are not limited to those set forth below. In any
event, the matters set forth below should be carefully considered when
evaluating the Company's business and prospects.
Potential Fluctuations in Operating Results. The Company's operating results
are subject to quarterly and other fluctuations due to a variety of factors,
including the gain or loss of significant customers, increased competitive
pressures, changes in pricing policies by the Company, its competitors or its
suppliers, including decreases in unit ASPs of the Company's products, the
timing of new product announcements and introductions by the Company or its
competitors and market acceptance of new or enhanced versions of the Company's
and its customers' products. Other factors include the availability of foundry
capacity, fluctuations in manufacturing yields, availability and cost of raw
materials, changes in the mix of products sold, the cyclical nature of both the
semiconductor industry and the market for PCs, seasonal customer demand, the
timing of significant orders and significant increases in expenses associated
with the expansion of operations. The Company's operating results could also be
adversely affected by economic conditions generally in various geographic areas
where the Company or its customers do business, or order cancellations or
rescheduling. 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.
<PAGE> 11
Competition; Pricing Pressures. The markets in which the Company competes are
intensely competitive and are characterized by rapid technological change, price
declines and rapid product obsolescence. The Company currently competes with
add-in card suppliers and semiconductor manufacturers. The Company expects
competition to increase in the future from existing competitors and from other
companies that may enter the Company's existing or future markets with products
that may be at lower costs or provide higher levels of integration, higher
performance or additional features. The Company is unable to predict the timing
and nature of any such competitive product offerings. The announcement and
commercial shipment of competitive products could adversely affect sales of the
Company's products and may result in increased price competition that would
adversely affect the ASPs and margins of the Company's products. In general,
product prices in the semiconductor industry have decreased over the life of a
particular product. The markets for most of the applications for the Company's
products, particularly the PC market, are characterized by intense price
competition. The willingness of prospective customers to design the Company's
products into their products depends to a significant extent upon the ability of
the Company to sell its products at a price that is cost-effective for such
customers. As the markets for the Company's products mature and competition
increases, the Company anticipates that prices for its products will continue to
decline. If the Company is unable to reduce its costs sufficiently to offset
declines in product prices or is unable to introduce more advanced products with
higher product prices, the Company's business, financial condition and results
of operations would be materially adversely affected.
The Company's existing and potential competitors consist principally of large
domestic and international companies that have substantially greater financial,
manufacturing, technical, marketing, distribution and other resources, greater
intellectual property rights, broader product lines and longer-standing
relationships with customers than the Company. The Company's competitors also
include a number of smaller and emerging companies. The Company's principal
audio competitors include Cirrus Logic, Creative Technology, OPTi and Yamaha.
The Company's principal video competitors include C-Cube, Hyundai, LSI Logic and
SGS Thompson. The Company's principal fax/modem competitors include Cirrus
Logic, Lucent, Rockwell and Texas Instruments. Certain of the Company's current
and potential competitors maintain their own semiconductor foundries and may
therefore benefit from certain capacity, cost and technical advantages. The
Company believes that its ability to compete successfully depends on a number of
factors, both within and outside of its control, including the price, quality
and performance of the Company's and its competitors' products, the timing and
success of new product introductions by the Company, its customers and its
competitors, the emergence of new multimedia standards, the development of
technical innovations, the ability to obtain adequate foundry capacity and
sources of raw materials, the efficiency of production, the rate at which the
Company's customers design the Company's products into their products, the
number and nature of the Company's competitors in a given market, the assertion
of intellectual property rights and general market and economic conditions.
There can be no assurance that the Company will be able to compete successfully
in the future.
Each successive generation of microprocessors has provided increased
performance, which could in the future result in a microprocessor capable of
performing multimedia functions. In this regard, Intel Corporation has developed
Native Signal Processing ("NSP") capability and an extended multimedia system
architecture ("MMX") for use in conjunction with its Pentium microprocessor, and
is promoting the processing power of the Pentium for data and signal intensive
functions such as graphics acceleration and other multimedia functions. There
can be no assurance that the increased capabilities of microprocessors will not
adversely affect demand for the Company's products.
Dependence on Single Product Line and PC Industry. In the first quarter of
1997, sales of PC audio semiconductors accounted for approximately 57% of the
Company's net revenues, and the Company expects that sales of audio
semiconductors will continue to account for a majority of its net revenues for
the foreseeable future. Any reduction in ASPs for audio products or demand for
the Company's audio semiconductors, whether because of a reduction in demand for
PCs in general or PC audio, increased
<PAGE> 12
competition or otherwise, would have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company is currently engaged in the development and introduction of new PC
audio products as well as new multimedia products for the PC and consumer
markets that provide capabilities such as video and fax/ modem/voice
applications. There can be no assurance that the Company will be able to
identify market trends or new product opportunities, develop and market new
products, achieve design wins or respond effectively to new technological
changes or product announcements by others. A failure in any of these areas
would have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company's audio products are sold for incorporation into multimedia
desktop and notebook computers. ESS audio semiconductors are incorporated into
motherboards by multimedia PC original equipment manufacturers ("OEMs") or in
add-in sound cards. Therefore, the Company is heavily dependent on the continued
growth of the markets for multimedia desktop and notebook computers and
multimedia applications utilizing high quality audio. There can be no assurance
that these markets will be able to sustain continued growth. A slowing in unit
volume and a decrease in ASPs could result in a decline in revenues in
the PC industry which could result in a corresponding decline in demand for the
Company's products, which would have a material adverse effect on the Company's
business, financial condition and results of operations.
Importance of New Products and Technological Change. The markets for the
Company's products are characterized by evolving industry standards, rapid
technological change and product obsolescence. The Company's success is highly
dependent upon the successful development and timely introduction of new
products at competitive price and performance levels. The success of new
products depends on a number of factors, including timely completion of product
development, market acceptance of the Company's and its customers' new products,
securing sufficient foundry capacity for volume manufacturing of wafers,
achievement of acceptable wafer fabrication yields by the Company's independent
foundries and the Company's ability to offer new products at competitive prices.
In order to succeed in having the Company's products incorporated into new
products being designed by desktop and notebook computer manufacturers, the
Company must anticipate market trends and performance and functionality
requirements of such manufacturers and must successfully develop and manufacture
products that meet these requirements. In addition, the Company must meet the
timing and price requirements of such manufacturers and must make such products
available in sufficient quantities. Accordingly, in selling to OEMs, the Company
can often incur significant expenditures prior to volume sales of new products,
if any. In order to help accomplish these goals, the Company has in the past and
will continue to consider in the future the acquisition of other companies or
the products and technologies of other companies. Such acquisitions carry
additional risks such as a lack of integration with existing products and
corporate culture, the potential for large write-offs and the diversion of
management attention. The Company is currently engaged in the development of new
PC audio products as well as new multimedia products that provide telephony
capabilities such as fax/modem/voice and video applications. There can be no
assurance that the Company will be able to identify market trends or new product
opportunities, develop and market new products, achieve design wins or respond
effectively to new technological changes or product announcements by others. A
failure in any of these areas would have a material adverse effect on the
Company's business, financial condition and results of operations.
Dependence on TSMC and Other Third Parties. The Company relies on independent
foundries to manufacture all of its products. A substantial majority of the
Company's products are currently manufactured by TSMC, which has manufactured
certain of the Company's products since 1989. The Company also has foundry
arrangements with Sharp Corporation ("Sharp"), IC Works ("ICW"), and UMC, which
have been manufacturing certain of the Company's products since 1986, 1991 and
1995, respectively. TSMC, in particular, provides the Company with access to
advanced process technology necessary for the manufacture of the Company's
products. These foundries fabricate products for other
<PAGE> 13
companies and, with the exception of TSMC, manufacture products of their
own design. In November 1995, the Company entered into long-term agreements with
TSMC and UMC in which the Company has secured access to additional capacity and
to leading edge technology. The Company is obligated to pay approximately
$16.0 million over the next three months to TSMC in exchange for certain wafer
capacity commitments. The Company also has an option to expand the TSMC wafer
capacity commitment further for the years 1997 through 2000. If the Company
exercises its option for TSMC to provide additional wafer capacity, the
Company would be committed to an additional $30.8 million in deposits to be
paid in two $15.4 million due on June 30, 1997 and 1998. If the Company is not
able to use, assign, or sell the additional wafer quantities, a portion of the
deposits may be forfeited. In addition, the Company will invest approximately
$7.0 million in one installments over the next three months in exchange for
an equity ownership in a joint venture with UMC to build a new foundry and
for certain wafer capacity commitments.
While the Company has entered into long-term agreements with two of its
foundries, the Company's reliance on these and other independent foundries
involves a number of risks, including the absence of adequate capacity, the
unavailability of, or interruption in access to, certain process technologies
and reduced control over delivery schedules, manufacturing yields and costs, and
the international risks more fully described below. The Company expects to rely
upon TSMC and UMC to manufacture a substantial majority of the Company's
products for the foreseeable future. In the event that TSMC and UMC are unable
to continue to manufacture the Company's key products in required volumes, the
Company will have to identify and secure additional foundry capacity. In such an
event, the Company may be unable to identify or secure additional foundry
capacity from another manufacturer, particularly at the levels that the Company
currently expects TSMC and UMC to provide. Even if such capacity is available
from another manufacturer, the qualification process could take six months or
longer. The loss of any of its foundries as a supplier, the inability of the
Company to acquire additional capacity at its current suppliers or qualify other
wafer manufacturers for additional foundry capacity should additional capacity
be necessary, or any other circumstances causing a significant interruption in
the supply of semiconductors to the Company would have a material adverse effect
on the Company's business, financial condition and results of operations.
To address potential foundry capacity constraints in the future, ESS will
continue to consider and may be required to enter into additional arrangements,
including equity investments in or loans to independent wafer manufacturers in
exchange for guaranteed production capacity, joint ventures to own and operate
foundries, or "take or pay" contracts that commit the Company to purchase
specified quantities of wafers over extended periods. Any such arrangements
could require the Company to commit substantial capital and grant licenses to
its technology. The need to commit substantial capital may require the Company
to obtain additional debt or equity financing, which could result in dilution to
the Company's shareholders. There can be no assurance that such additional
financing, if required, will be available when needed or, if available, will be
obtained on terms acceptable to the Company.
All of the Company's semiconductor products are assembled and tested by
third-party vendors, primarily Amkor ANAM in Korea, Advanced Semiconductor
Engineering in Taiwan, ASAT in Hong Kong, Astra Microtronics in Indonesia and
OSE in Taiwan. The Company has internally designed and developed its own test
software and certain test equipment, which is provided to the Company's test
vendors. Shortages of raw materials or disruptions in the provision of services
by the Company's assembly vendors could lead to supply constraints or delays in
the delivery of the Company's products. Such constraints or delays might result
in the loss of customers, limitations or reductions in the Company's revenues or
other material adverse effects on the Company's business, financial condition
and results of operations. The Company's reliance on third-party assembly and
testing vendors involves a number of other risks, including reduced control over
delivery schedules, quality assurance and costs. The inability of such third
parties to deliver products of acceptable quality and in a timely manner could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Customer Concentration. A limited number of customers have accounted for a
substantial portion of the Company's net revenues. In the first three months of
1997, sales to the Company's top five customers, including sales to the
Company's international distributor, accounted for approximately 53% of the
Company's net revenues, with the top two customers accounting for 29%
<PAGE> 14
of the Company's net revenues. Sales to distributors are generally subject to
agreements allowing limited rights of return and price protection with respect
to unsold products. While the Company has not experienced returns and allowances
in excess of the Company's reserves, returns and allowances in excess of
reserves could have a material adverse impact on the Company's business,
financial condition and results of operation. The Company expects that a limited
number of customers may account for a substantial portion of its net revenues
for the foreseeable future. The Company has experienced changes from year to
year in the composition of its major customer base and believes this pattern may
continue. For example, Compaq has been a significant customer of the Company
since 1995. The Company does not have long-term purchase agreements with any of
its customers. The reduction, delay or cancellation of orders from one or more
major customers for any reason or the loss of one or more of such major
customers could materially and adversely affect the Company's business,
financial condition and results of operations. In addition, since the Company's
products are often sole sourced to its customers, the Company's operating
results could be materially and adversely affected if one or more of its major
customers were to develop other sources of supply. There can be no assurance
that the Company's current customers will continue to place orders with the
Company, that orders by existing customers will not be canceled or will continue
at the levels of previous periods or that the Company will be able to obtain
orders from new customers. The Company currently places noncancelable orders to
purchase its products from independent foundries on an approximately three month
rolling basis, while its customers generally place purchase orders with the
Company less than four weeks prior to delivery that may be canceled without
significant penalty. Consequently, if anticipated sales and shipments in any
quarter are canceled or do not occur as quickly as expected, expense and
inventory levels could be disproportionately high and the Company's business,
financial condition and results of operations could be materially adversely
affected.
Management of Growth. The Company has recently experienced significant growth
in revenues and the addition of multiple product lines that require additional
management systems and processes. To manage its future operations and growth
effectively, the Company will need to continue to improve its operational,
financial and management information systems, implement additional systems and
controls, and hire, train, motivate, manage and retain its employees. There can
be no assurance that the Company will be able to manage such growth effectively,
and the failure to do so could have a material adverse effect on the Company's
business, financial condition and results of operations.
International Operations. In the first three months of 1997, international
sales accounted for approximately 95% of the Company's net revenues.
Substantially all of the Company's international sales were to customers in
Taiwan, Japan, Hong Kong and Singapore. The Company expects that international
sales will continue to represent a significant portion of its net revenues for
the foreseeable future. In addition, substantially all of the Company's products
are manufactured, assembled and tested by independent third parties in Asia. Due
to its reliance on international sales and foreign third-party manufacturing,
assembly and testing operations, the Company is subject to the risks of
conducting business outside of the United States. These risks include unexpected
changes in, or impositions of legislative or regulatory requirements, delays
resulting from difficulty in obtaining export licenses for certain technology,
tariffs, quotas and other trade barriers and restrictions, longer payment
cycles, greater difficulty in accounts receivable collection, potentially
adverse taxes, the burdens of complying with a variety of foreign laws and other
factors beyond the Company's control. The Company is also subject to general
geopolitical risks in connection with its international trade relationships. In
particular, mainland China, which represents a large potential market for the
Company's products, has recently experienced the death of its leader Deng
Xiaoping. Should the death of Deng Xiaoping result in instability in the
government, it is possible that sales to mainland China will be impeded. Such
instability could also lead to disruption in the Company's ability
to trade with Taiwan, which represents a majority of the Company's sales and is
the location of its major foundries and two test facilities. Should such
disruption occur, it is possible that purchases by Taiwanese customers will
decline and semiconductor manufacturing in Taiwan will be impeded, cutting off
the Company's main supply of guaranteed wafer production. This could also lead
to capacity constraints at non-Taiwanese foundries. Although the Company has
not to date
<PAGE> 15
experienced any material adverse effect on its business, financial
condition or results of operations as a result of such regulatory, geopolitical
and other factors, there can be no assurance that such factors will not have a
material adverse effect on the Company's business, financial condition and
results of operations in the future or require the Company to modify its current
business practices.
In addition, the laws of certain foreign countries in which the Company's
products are or may be manufactured or sold, including various countries in
Asia, may not protect the Company's products or intellectual property rights to
the same extent as do the laws of the United States and thus make the
possibility of piracy of the Company's technology and products more likely.
Currently, all of the Company's product sales and all of its arrangements with
foundries and assembly and test vendors, other than its foundry arrangement with
Sharp Corporation, provide for pricing and payment in U.S. dollars. To date,
although the effect of currency fluctuations have been insignificant, there can
be no assurance that fluctuations in currency exchange rates will not have a
material adverse effect on the Company's business, financial condition and
results of operations. In addition, to date the Company has not engaged in any
currency hedging activities, although the Company may do so in the future.
Further, there can be no assurance that one or more of the foregoing factors
will not have a material adverse effect on the Company's business, financial
condition and results of operations or require the Company to modify its current
business practices.
Semiconductor Industry. The semiconductor industry has historically been
characterized by rapid technological change, cyclical market patterns,
significant price erosion, periods of over-capacity and production shortages,
variations in manufacturing costs and yields and significant expenditures for
capital equipment and product development. In addition, the industry has
experienced significant economic downturns at various times, characterized by
diminished product demand and accelerated erosion of product prices. Although
the semiconductor industry in recent periods has experienced increased demand,
it is uncertain how long these conditions will continue. The Company may
experience substantial period-to-period fluctuations in operating results due to
general semiconductor industry conditions.
Patents and Proprietary Rights. The Company relies on a combination of
patents, trademarks, copyrights, trade secret laws and confidentiality
procedures to protect its intellectual property rights. As of March 31, 1997,
the Company had 10 patents granted in the United States, which expire over time,
commencing in 1997 and ending in 2013, and 9 corresponding foreign patents. In
addition, the Company intends to seek further United States and international
patents on its technology. There can be no assurance that patents will be issued
from any of the Company's pending applications or applications in preparation or
that any claims allowed from pending applications or applications in preparation
will be of sufficient scope or strength, or be issued in all countries where the
Company's products can be sold, to provide meaningful protection or any
commercial advantage to the Company. Also, competitors of the Company may be
able to design around the Company's patents. The laws of certain foreign
countries in which the Company's products are or may be 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. Although the Company is not aware of the development,
distribution or sales of any illegal copies of the Company's hardware or
software, any infringements of its patents, copyrights or trademarks, or any
violation of its trade secrets, confidentiality procedures or licensing
agreements to date, there can be no assurance that the steps taken by the
Company to protect its proprietary information will be adequate to prevent
misappropriation of its technology or that the Company's competitors will not
independently develop technologies that are substantially equivalent or superior
to the Company's technology.
The semiconductor industry is characterized by vigorous protection and
pursuit of intellectual property rights or positions, which have resulted in
significant and often protracted and expensive litigation. There is no pending
intellectual property litigation against the Company. However, the Company or
its foundries may from time to time receive notice of claims that the Company
has infringed patents or other intellectual property rights owned by others.
The Company may seek licenses under such patents or other intellectual property
rights. However, there can be no assurance that licenses will be offered or
that the terms of any offered licenses will be acceptable to the Company. The
failure to obtain a license from a third party for technology used by the
Company could cause the Company to incur substantial liabilities and to suspend
the manufacture of products or the use by the Company's foundries of processes
requiring the technology. Furthermore, the Company may initiate claims or
litigation against third parties for infringement of the Company's proprietary
rights or to establish the validity of the Company's proprietary rights.
Litigation by or against the Company could result in significant expense to the
Company and divert the efforts of the Company's technical and management
personnel, whether or not such litigation results in a favorable determination
for the Company. In the event of an adverse result in any such litigation, the
Company could be required to pay substantial damages, cease the manufacture,
use and sale of infringing products, expend significant resources to develop
non-infringing technology, discontinue the use of certain processes or obtain
licenses for the infringing technology. There can be no assurance that the
Company would be successful in such development or that such licenses would be
available on reasonable terms, or at all, and any such development or license
could require expenditures by the Company of substantial time and other
resources. Although patent disputes in the semiconductor industry have often
been settled through cross-licensing arrangements, there can be no assurance
that, in the event that any third party makes a successful claim against the
Company or its customers, a cross-licensing arrangement could be reached. In
such a case, if a license is not made available to the Company on commercially
reasonable terms, the Company's business, financial condition and results of
operations could be materially adversely affected.
The Company currently licenses certain of the technology utilized by the
Company in its products, and expects to continue to do so in the future. The
Company has no current plans to grant licenses with respect to its products or
technology; however, it may become necessary for the Company to enter into
product licenses in the future in order, among other things, to secure foundry
capacity. Although the Company has in the past granted licenses to certain of
its technology, some of which have expired, such licenses have been limited and
the Company has not derived material revenues from such licenses in recent
periods.
Dependence on Key Personnel. The Company's success depends to a significant
degree upon the continued contributions of Fred S.L. Chan, the Company's Chief
Executive Officer and Chairman of the Board of Directors. As of March 31, 1997,
Mr. Chan, together with his spouse, Annie M.H. Chan, a director of the Company
and certain trusts for the benefit of the Chan's children and certain charities
beneficially own, in the aggregate, approximately 40% of the Company's Common
Stock. The future success of the Company depends on its ability to continue to
attract, retain and motivate qualified senior management, sales and technical
personnel, particularly highly skilled semiconductor design personnel and
software engineers, for whom competition is intense. Recently, the Company has
hired a number of key executives and management personnel. The loss of Mr. Chan,
other key executive officers, key design personnel or software engineers or the
inability to hire and retain sufficient qualified personnel could have a
material adverse effect on the Company's business, financial condition and
results of operations. There can be no assurance that the Company will be able
to retain these employees. The Company currently does not maintain any key man
life insurance on the life of any of its key employees.
Control by Existing Shareholders. As of March 31, 1997, Fred S.L. Chan, the
Company's Chief Executive Officer and Chairman of the Board of Directors,
together with his spouse, Annie M. H. Chan, a director of the Company, and
certain other shareholders related to Mr. and Mrs. Chan owned, in the aggregate,
40% of the Company's outstanding Common Stock. As a result, these shareholders,
acting together, possess significant voting power over the Company, giving them
the ability among other things to influence significantly the election of the
Company's Board of Directors and approve significant corporate transactions.
Such control could delay, defer or prevent a change in control of the Company,
impede a merger, consolidation, takeover or other business combination involving
the Company, or
<PAGE> 16
discourage a potential acquiror from making a tender offer or otherwise
attempting to obtain control of the Company.
Possible Volatility of Stock Price. The price of the Company's Common Stock
has in the past and may continue in the future to fluctuate widely. Future
announcements concerning the Company, its competitors or its principal
customers, including quarterly operating results, changes in earnings estimates
by analysts, technological innovations, new product introductions, governmental
regulations or litigation may cause the market price of the Common Stock to
continue to fluctuate substantially. Further, in recent years the stock market
has experienced extreme price and volume fluctuations that have particularly
affected the market prices of equity securities of many high technology
companies and that often have been unrelated or disproportionate to the
operating performance of such companies. These fluctuations, as well as general
economic, political and market conditions such as recessions or international
currency fluctuations, may materially adversely affect the market price of the
Common Stock.
<PAGE> 17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
27.01 -- Financial Data schedule
(b) Reports on Form 8-K. No reports were filed on Form 8-K for the quarter
ended March 31, 1997.
<PAGE> 18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this amendment to report on Form 10-Q to be signed on
its behalf by the undersigned, thereunto duly authorized.
ESS TECHNOLOGY, INC.
(Registrant)
Date: May 15, 1997 By: /s/ FRED S.L. CHAN
-------------------
Fred S.L. Chan
President, Chief Executive Officer
and Chairman of the Board
Date: May 15, 1997 By: /s/ JOHN H. BARNET
-------------------
John H. Barnet
Vice President, Chief
Financial Officer and Secretary
<PAGE> 19
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
<S> <C>
27.01 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<EXCHANGE-RATE> 1
<CASH> 48,091
<SECURITIES> 16,945
<RECEIVABLES> 34,452
<ALLOWANCES> 486
<INVENTORY> 34,497
<CURRENT-ASSETS> 141,496
<PP&E> 27,931
<DEPRECIATION> 5,579
<TOTAL-ASSETS> 219,170
<CURRENT-LIABILITIES> 56,887
<BONDS> 0
0
0
<COMMON> 99,935
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 219,170
<SALES> 81,468
<TOTAL-REVENUES> 81,468
<CGS> 41,772
<TOTAL-COSTS> 41,772
<OTHER-EXPENSES> 11,182
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (640)
<INCOME-PRETAX> 29,154
<INCOME-TAX> 11,327
<INCOME-CONTINUING> 17,827
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 17,827
<EPS-PRIMARY> 0.43
<EPS-DILUTED> 0.43
</TABLE>
