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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER 0-26660
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ESS TECHNOLOGY, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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CALIFORNIA 94-2928582
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
48401 FREMONT BLVD., FREMONT, CALIFORNIA 94538
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(510) 492-1088
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, NO PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
State the aggregate market value of the voting and non-voting common equity
held by non-affiliates of the registrant, based upon the closing sale price of
the Common Stock on February 27, 1998 ($7.625) as reported on the Nasdaq
National Market, was approximately $195,708,000. Shares of Common Stock held by
each officer and director and by each person who owned 5% or more of the
registrant's outstanding Common Stock on that date have been excluded in that
such persons may be deemed to be affiliates. This determination of affiliate
status is not necessarily a conclusive determination for other purposes.
As of February 27, 1998, registrant had outstanding 40,833,580 shares of
Common Stock.
------------------------
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for Registrant's 1998 Annual Meeting of
Stockholders are incorporated by reference in Part III.
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ESS TECHNOLOGY, INC.
1997 FORM 10-K
TABLE OF CONTENTS
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PAGE
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PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 10
Item 3. Legal Proceedings........................................... 10
Item 4. Submission of Matters to a Vote of Security Holders......... 11
Item 4A. Executive Officers of the Registrant........................ 11
PART II
Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters......................................... 13
Item 6. Selected Financial Data..................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 15
Item 8. Financial Statements and Supplementary Data................. 24
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures................................... 43
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 44
Item 11. Executive Compensation...................................... 44
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 44
Item 13. Certain Relationships and Related Transactions.............. 44
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 44
Signatures............................................................. 48
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Statements contained in this filing that are not statements of historical
fact may be deemed to be forward-looking statements. A number of important
factors could cause actual events or the Company's actual results to differ
materially from those indicated by such forward-looking statements, including
dependence on continued growth in demand for PC audio, video and other
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.
PART I
ITEM 1. BUSINESS
ESS Technology, Inc. ("ESS" or the "Company"), a California corporation,
designs, markets and supports highly integrated mixed signal semiconductor and
software solutions for multimedia applications in the personal computer ("PC")
and consumer marketplaces. The Company offers comprehensive solutions for audio,
video and modem applications. ESS has established itself as a leading supplier
of mixed-signal PC audio solutions that integrate all essential audio components
on a single chip. During 1997, ESS expanded its core audio family to include PCI
audio solutions which address more advanced audio applications including
positional 3D, sample rate conversion, and hardware accelerated wavetable
synthesis and speaker virtualization.
AudioDrive Products
ESS' single chip AudioDrive products enable PC manufacturers to provide
audio capabilities on add-on sound cards and directly on the motherboards of
desktop and notebook computers. The Company has established itself as a leader
in integrated audio solutions and counts many of the leading manufacturers of
personal computers and sound cards among its customers.
Recently, demand for audio products has increased due to four dynamic
factors: (1) increased market demand for PCs incorporating audio
functionalities; (2) growth in PC entertainment, educational and business
applications; (3) increases in use of on-line services; and (4) the low cost of
these solutions.
The Company's AudioDrive products are based on ESS' audio technologies,
design methodologies, and software and firmware expertise. ESS has developed a
proven set of ISA and PCI product solutions for the PC market.
The AudioDrive ISA product family integrates ESFM(TM), a proprietary FM
sound synthesis technology, that produces superior sound quality by enhancing
traditional FM synthesis techniques, with hardware, software and music database
technology. ESS also utilizes its proprietary advanced analog and mixed signal
design methodologies, together with its library of audio semiconductor designs,
to produce highly integrated mixed signal audio chips. ESS software technology
is bundled as part of its comprehensive solution and consists of its AudioDrive
device drivers for Microsoft(R) Windows(R)3.1, Windows NT(R) Windows 95(R), IBM
OS/2(R)Warp(R), DirectX(TM)PC games, and audio applications, including ESS
AudioRack(TM) controller, an integrated graphical controller for the entire PC
audio system.
ISA AudioDrive Products
ES692: a wavetable music synthesizer chip. The ES692 includes reverb
special effects without need for external RAM. With its embedded
microcontroller, the ES692 supports General MIDI, providing for 128 melodic
instruments with ability to play back 32 voices of 16-bit data at a sampling
rate of 44.1kHz. Music is produced in high fidelity with the realism of a live
symphony orchestra. The ES692 includes a 1MB wavetable ROM to provide a complete
wavetable solution. This internal ROM provides digitally recorded sound samples
of musical instruments.
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ES1868: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer, plug-and-play, full-duplex operation and game support. The ES1868
integrates digital logic and a microcontroller with audio CODEC and other analog
functions onto one chip, and includes ESFM synthesis. The ES1868 is PC games
compatible in SB and SB Pro modes and is compatible with Microsoft Windows and
other operating systems. The ES1868 provides full ISA plug-and-play support and
includes hardware volume control, 64 step volume control and dual game/joystick
port for game support. The ES1868 also supports full-duplex operation with
simultaneous record and playback with two DMA channels.
ES1869: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer, plug-and-play, full-duplex operation, Zoom Video support, game
support and three-dimensional sound effect. The ES1869 integrates digital logic
and a microcontroller with audio CODEC and other analog functions onto one chip,
and includes ESFM synthesis. The ES1869 is PC games compatible in SB and SB Pro
modes and is compatible with Microsoft Windows and other operating systems. The
ES1869 provides full ISA plug-and-play support and includes hardware volume
control, 64 step volume control and dual game/joystick port for game support.
The ES1869 supports full-duplex operation with simultaneous record and playback
with two DMA channels and contains an I2S interface to support Zoom Video port
for MPEG audio. It also integrates circuitry to produce a three-dimensional
sound effect from two speakers.
ES1878: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer, full-duplex operation, Zoom Video support, and game support. The
ES1878 integrates digital logic and a microcontrol-ler with audio CODEC and
other analog functions onto one chip, and includes ESFM synthesis. The ES1878 is
PC games compatible in SB and SB Pro modes and is compatible with Microsoft
Windows and other operating systems. The ES1878 includes hardware volume
control, 64 step volume control and dual game/joystick port for game support.
The ES1878 provides full plug-and-play support. The ES1878 also includes support
for full-duplex operation with simultaneous record and playback, and it contains
an I2S interface to support the PCMCIA Zoom Video port specification for MPEG
input to PCs. The ES1878 provides full plug-and-play support and provides an
interface to a docking station unit.
ES1879: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer, full-duplex operation, Zoom Video support, telegaming and game
support and three-dimensional sound effect. The ES1879 combines the features of
the ES1878 with I2S interface for Zoom Video support, as well as circuitry to
produce three-dimensional sound effect from two speakers. The ES1879 provides
full plug-and-play support and provides interface to a docking station unit.
ES1887: a single mixed signal 16-bit stereo audio chip with integrated ESFM
synthesizer, full-duplex operation, game support and plug-and-play through the
PC's BIOS. The ES1887 integrates digital logic and a microcontroller with audio
CODEC and other analog functions onto one chip, and includes ESFM synthesis. The
ES1887 is PC games compatible in SB and SB Pro modes and is compatible with
Microsoft Windows and other operating systems. The ES1887 includes hardware
volume control, 64 step volume control and dual game/joystick port for game
support. The ES1887 also includes support for full-duplex operation with
simultaneous stereo record and playback with two DMA channels. The ES1887
supports plug-and-play through the PC's BIOS.
PCI AudioDrive Products
ES1918: Maestro PCI audio CODEC. The ES1918 is a single mixed signal AC '97
CODEC and mixer for a digital audio controller. The ES1918 meets PC97 and Audio
CODEC '97 specifications.
ES1948: Maestro-1: a PCI digital audio accelerator. The Maestro-1 provides
enhanced audio, utilizing the additional bandwidth provided by the PCI bus and
taking advantage of the Intel AC-97 architecture. The Maestro-1 implements
positional 3D and 64 channel hardware wavetable using system memory to
dramatically improve the multimedia gaming experience. The Maestro-1 uses ESS
proprietary technology called TDMA to provide legacy compatibility for DOS games
which is a requirement for multimedia PCs.
ES1968: Maestro-2: a PCI digital audio accelerator. The Maestro-2 provides
enhanced audio, utilizing the additional bandwidth provided by the PCI bus and
taking advantage of the Intel AC-97 architecture. The
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Maestro-2 implements positional 3D using CRL's Digital Ear(TM) and Sensura(TM)
3D audio technology to dramatically improve the multimedia gaming experience.
The Maestro-2 implements 64 channel hardware wavetable using system memory to
reduce size, cost and host utilization while increasing sound quality for MIDI.
The Maestro-2 utilizes ACPI and small form factor to enable low power designs
for notebooks and motherboards. The Maestro-2 also uses ESS proprietary
technology, TDMA to provide legacy compatibility for DOS games, a requirement
for multimedia PCs.
ES1938: Solo-1: A PCI single mixed signal audio chip. The ES1938 provides a
single chip PCI audio solution providing high-quality audio processing while
maintaining full legacy DOS game compatibility. The ES1938 has 16-bit stereo
with 7 channel record and playback mixers and an integrated 3-D sound effects
processor. It supports ACPI, PPMI and PCI Mobile Design Guide specifications.
TeleDrive Products
Internet-related applications, such as voice e-mail, Internet radio, audio
home pages, and news on demand, are increasing the demand for integrated audio
and computer fax/modem functions on the personal computer. ESS TeleDrive
products enable PC manufacturers to provide fax/modem capabilities to add-on
cards and directly onto the motherboards of desktop and notebook PCs.
ES336V: a V.34bis chipset data/fax/voice controller-less modem
solution. The ES336V provides base data, full duplex speaker phone, telephone
answer machine and V.80 support for H.324 video conferencing applications.
ES56V: a X2 or V.90 chipset data/fax/voice controller-less modem
solution. The ES56V is a superset of the ES336V and is compliant with the V.90
worldwide modem standard via proprietary software.
ES56CV: a ES336V/ES56V modem solution with 16 or 32 bit full duplex
stereo. The ES56CV combines the ES336V/ES56V modem solution with a single mixed
signal 16 or 32 bit stereo audio chip with integrated ESFM synthesizer,
plug-and-play full-duplex operation and game support.
VideoDrive Products
ESS VideoDrive products provide consumer original equipment manufacturers
("OEMs") of VCD and DVD players with total programmable system solutions. The
VideoDrive products provide OEMs of VCD players with a programmable single-chip
processor which includes MPEG-1 video, audio and system decoder. It delivers
full-screen, full-motion video at 30 frames per second with selectable
CD-quality audio and can be combined with memory and video/audio DACs. The
products also provide OEMs of DVD players with a programmable single chip
processor which includes MPEG-2 audio/video/system and transport layer decoder,
AC3 and video post-processing. These chips are designed for a variety of
applications in consumer electronics such as set-top boxes and DVD players.
VCD Player Products
ES3204: Single chip programmable VCD processor which includes MPEG-1
audio/video/system decoder for use in VCD players. The ES3204 is a single chip
that supports MPEG-1 video decoding and provides on-screen display, Karaoke
functions, programmable playback control for VCD 2.0 and trick play mode
features.
ES3207: Analog companion chip. The ES3207 provides echo, surround sound, 3D
audio, TV encoder with clock generation and audio DAC functions.
ES3209: Analog companion chip to VDC processor chip. The ES3209
incorporates the ES3207 features of echo, surround sound, 3D audio, TV encoder
with clock generation, audio DAC functions with HTML, hyperlink and a graphic
user interface.
ES3210: Single chip programmable VCD processor which includes MPEG-1
audio/video/system decoder for use in standalone and portable VCD players. The
ES3210 is a single chip that supports MPEG-1 video decoding and incorporates
on-screen display, Karaoke functions, programmable playback control, trick play
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mode features, an integrated SRAM and remote control interface logic in a
smaller form factor allowing a more compact design.
ES3211: Arcade accelerator. The ES3211 enables direct interface with
external games controllers to allow CD-ROM games to be played on a VCD player.
DVD Player Products
ES3301: Audio/video Transport Demultiplexer and Descrambler. The ES3301 is
a transport-layer demultiplexer, parser and descrambler designed for the set-top
box, DVD and Broadcast PC applications.
ES3308: Single chip programmable DVD processor that includes MPEG-2
audio/video/system decoder for use in DVD players and digital set-top boxes. The
ES3308 is a single chip solution that supports MPEG-2 video decoding and
provides on-screen display and transport layer compliance with DVD standard as
well as Digital Broadcast Signal standards.
Software and Support
ESS provides comprehensive support for its products including software that
can be bundled with its products. This software includes device drivers for
Microsoft Windows 3.1, Windows NT, Windows 95 and Windows 98, IBM OS/2 Warp,
Intel NSP and PC games, for PC products and systems support for the Company's
VCD and DVD products. Other support software that is available to customers
includes localization software and installation software that allows customers
to tailor their products for specific applications and needs.
Customer development support includes an Evaluation Kit that contains a
reference add-in card design with all the necessary information to incorporate
an ESS chip in the customer's product. To assist customers in further reducing
their time to market, ESS also provides a Manufacturing Kit that contains
manufacturing information, including a bill-of-materials, printed circuit board
layout and production test software.
CUSTOMERS
ESS sells its product principally to OEMs of PCs, PC-related add-in boards
and consumer electronics systems. The Company sells its product through a direct
sales force in the United States and through direct sales and distributors in
Asia and Europe. The following table shows representative customers worldwide:
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HONG KONG UNITED STATES TAIWAN JAPAN(1) REST OF THE WORLD
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Eastbase Compaq Acer Fujitsu Best Union
Dynax(2) Diamond Multimedia BTC Hitachi Hyundai
Weikeng(2) Digital Equipment FIC Matsushita Multiwave
EDO GVC NEC Philips
Hewlett Packard Inventec Sanyo Pineview
IBM Labway Sony Samsung
Mitac Trigem
Quanta Wearnes
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(1) Sales in Japan are made through a distributor.
(2) Distributors of the Company.
A limited number of customers have historically accounted for a substantial
portion of the Company's net revenues. In 1995, 1996 and 1997, sales to the
Company's top five customers, including sales to its international distributors,
accounted for approximately 48%, 40% and 49%, respectively, of the Company's net
revenues. In 1995, Compaq and Universe Electron Corporation, a Japanese
distributor, each accounted for approximately 17% of the Company's net revenues.
In 1996, Compaq and Universe Electron Corporation each accounted for
approximately 12% and 13%, respectively, of the Company's net revenues. In 1997,
Eastbase and Dynax, a Hong Kong distributor, each accounted for approximately
13% of the Company's net revenues. The Company expects that a limited number of
customers may continue to account for a substantial portion of
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its net revenues for the foreseeable future. The Company has experienced changes
from year to year in the composition of its major customer base and believes
this will continue in the future.
SALES AND MARKETING
The Company sells and markets to leading PC and consumer OEM's worldwide.
The Company markets its products through its direct sales force, distributors
and manufacturer representatives.
In 1995, 1996 and 1997, international sales comprised approximately 73%,
92% and 89% of the Company's net revenues, respectively. The Company's
international revenues in 1995, 1996 and 1997 have been derived primarily from
Asian customers who manufacture PCs, PC-related add-in boards and consumer OEM's
of VCD players. A large percentage of the worldwide supply of these products is
manufactured by suppliers in Asia. ESS has direct sales personnel and technical
staff located in Taiwan. A significant portion of the Company's Asian sales have
been to customers located in Taiwan. See "Factors That May Affect Future
Results -- International Operations." The Company has opened new customer and
technical support centers in Shenzhen-China, Hong Kong and Korea in order to
support its broadening customer base. The Company's products are also sold
internationally through distributors and manufacturer representatives located in
Hong Kong, Taiwan, Japan, India, Singapore, Korea and Germany. The Company's
manufacturer representatives and distributors are not subject to minimum
purchase requirements and can discontinue marketing any of the Company's
products at any time. In addition, certain of the Company's manufacturer
representatives, distributors and customers typically are authorized certain
rights of return for unsold product or pricing allowances to compensate for
rapid, unexpected prices changes. See "Factors That May Affect Future
Results -- Customer Concentration."
The Company believes that customer service and technical support are
important competitive factors in selling to major customers. The Company
provides technical support to its customers. Manufacturer representatives and
distributors supplement the Company's efforts by providing additional customer
service at the local level. The Company believes that close contact with its
customers not only improves the customers' level of satisfaction, but also
provides important insight into future market direction.
Sales of the Company's products are generally made pursuant to standard
purchase orders, which are frequently revised to reflect changes in the
customer's requirements. Product deliveries are scheduled upon the Company's
receipt of purchase orders. Generally, these purchase orders allow customers to
reschedule delivery dates and cancel purchase orders without significant
penalties. For these reasons, the Company believes that its backlog, while
useful for scheduling production, is not necessarily a reliable indicator of
future revenues. See "Factors That May Affect Future Results -- Potential
Fluctuations in Operating Results."
RESEARCH AND DEVELOPMENT
In order to compete successfully, the Company believes that it must
continually design, develop and introduce new products that take advantage of
market opportunities and address emerging technical standards. The Company's
strategy is to leverage its base of design expertise, analog, digital and mixed
signal design capabilities and process technologies, and software and systems
expertise to develop audio, modem and video solutions for the PC and consumer
marketplace. ESS has in the past acquired and in the future will consider
acquiring technology and product lines to enhance its own product offerings and
to accelerate its time-to-market. The Company intends to continue to provide
comprehensive solutions for its customers by developing state of the art
semiconductor chips, device drivers, firmware and application software in its
chosen markets.
ESS utilizes a design environment based on workstations, dedicated product
simulators, system simulation with hardware and software modeling, and a high
level design description language. The Company invests regularly in new advanced
equipment and software tools and intends to maintain and enhance its library of
core cells. The Company opened a new design center in Beijing-China during 1997
in order to gain access to additional engineering talent.
At December 31, 1997, ESS had a staff of 209 research and development
personnel, 148 of which were involved in semiconductor design and process
development and 61 of which were involved in software
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development. In addition, ESS has engaged outside developers to develop certain
technologies to the Company's specifications and intends to continue to utilize
outside developers in the future. During 1995, 1996 and 1997 the Company spent
approximately $8.7 million, $20.3 million and $29.5 million, respectively, on
research and development activities, excluding a one-time pre and post-tax
charge of $30.4 million related to acquired research and development in-process
from the acquisitions of VideoCore Technology, Inc. ("VideoCore") and OSEE
Technology, Inc. ("OSEE") in the first quarter of 1996 and a one-time pre and
post-tax charge of $22.2 million related to acquired research and development
in-process from the acquisition of Platform Technologies, Inc. ("Platform") in
the second quarter of 1997.
In June 1997, the Company completed its acquisition of Platform pursuant to
which the Company obtained all the outstanding capital stock of Platform in
exchange for approximately 2.54 million shares of the Company's Common Stock
including approximately 954,000 options with a value of $32.7 million. Platform
is a wholly owned subsidiary of the Company. The acquisition of Platform
provided the Company with certain PCI audio expertise and designs in process,
along with significant engineering talent. In January 1996, the Company
completed its acquisition of VideoCore pursuant to which the Company acquired
all of the outstanding capital stock of VideoCore in exchange for approximately
525,000 shares of the Company's Common Stock and $5.7 million in cash.
VideoCore, a wholly owned subsidiary of the Company, is developing integrated
circuits which incorporates advanced compression technology for digital video
products. In March 1996, the Company completed its acquisition of OSEE pursuant
to which the Company acquired all of the outstanding capital stock of OSEE in
exchange for approximately 217,000 shares of the Company's Common Stock and $3.6
million in cash. OSEE, a wholly owned subsidiary of the Company, is developing
algorithm technology which enables the Company to offer modem applications to
its customers. The Company may continue to utilize cash and equity to acquire or
invest in complementary businesses or products or to obtain the right to use
complementary technologies. From time to time, in the ordinary course of
business, the Company may evaluate potential acquisitions of or investments in
such businesses, products or technologies owned by third parties.
MANUFACTURING
The Company contracts with independent foundries and assembly and test
service providers to manufacture all of its products. This manufacturing
strategy enables the Company to focus on its design strengths, minimize fixed
costs and capital expenditures and gain access to advanced manufacturing
capabilities. Semiconductor manufacturing consists of foundry activity where
wafer fabrication takes place, and assembly and test activities. Wafer
fabrication is performed by two independent foundries, which utilize advanced
manufacturing technologies. A substantial majority of the Company's products are
manufactured by Taiwan Semiconductor Manufacturing Company Ltd. ("TSMC"), which
has manufactured certain of the Company's products since 1989. The Company also
has a foundry arrangement with United Microelectronics Corporation ("UMC") in
Taiwan. Most of the Company's devices are currently fabricated using a mixed
signal CMOS 0.5 and 0.35 micron process technology. The Company is currently
developing new products and converting some existing products to a 0.25 micron
process technology.
The Company is dependent on its foundries to allocate to the Company a
portion of their foundry capacity sufficient to meet the Company's needs and to
produce products of acceptable quality and with acceptable manufacturing yields
in a timely manner. These foundries fabricate products for other companies and
manufacture products of their own design. In November 1995, the Company entered
into long-term agreements with TSMC and UMC. Under the Company's long-term
agreement with TSMC, in exchange for TSMC's wafer capacity commitments for the
years 1996 through 1999, the Company made payments of approximately $32 million
in two installments in 1996 and 1997.
Under the Company's agreement with UMC, the Company entered into a joint
venture arrangement with UMC and other U.S. semiconductor companies to build a
separate semiconductor manufacturing facility to be located in Taiwan at an
estimated cost of $1 billion. The Company has invested approximately $24.6
million in this joint venture. Under the terms of the agreement, the Company
will receive approximately a 5% equity ownership in the joint venture company
and capacity rights. The new fabrication facility is currently projected to
commence production of 8-inch wafers in 1999. The facility was scheduled to open
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during 1998, but several fires during construction impeded progress. UMC has
stated that it expects insurance will cover its recent fire losses at the joint
venture foundry. There can be no assurance that the Company will be able to
obtain additional capacity when necessary.
All of the Company's semiconductor products are assembled and tested by
third-party vendors, primarily OSE and Advanced Semiconductor Engineering in
Taiwan, ASAT in Hong Kong, and Astra Microtronics in Indonesia. The Company has
internally designed and developed its own test software and certain test
equipment, which 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. See "Factors That May Affect Future Results -- Dependence
on TSMC and Other Third Parties" and " -- International Operations."
COMPETITION
The markets in which the Company competes are intensely competitive and are
characterized by rapid technological change, price declines and rapid product
obsolescence. The Company currently competes with add-in card suppliers and
other semiconductor manufacturers. The Company expects competition to increase
in the future from existing competitors and from other companies that may enter
the Company's existing or future markets with products that may be at lower
costs or provide higher levels of integration, higher performance or additional
features. The Company is unable to predict the timing and nature of any such
competitive product offerings. The announcement and commercial shipment of
competitive products could adversely affect sales of the Company's products and
may result in increased price competition that would adversely affect the
average selling prices ("ASPs") and margins of the Company's products. In
general, product prices in the semiconductor industry have decreased over the
life of a particular product. The markets for most of the applications for the
Company's products are characterized by intense price competition. The
willingness of prospective customers to design the Company's products into their
products depends to a significant extent upon the ability of the Company to sell
its products at a price that is cost-effective for such customers. As the
markets for the Company's products mature and competition increases, the Company
anticipates that prices for its products will continue to decline. If the
Company is unable to reduce its costs sufficiently to offset declines in product
prices or is unable to introduce more advanced products with higher product
prices, the Company's business, financial condition and results of operations
would be materially adversely affected. See "Factors That May Affect Future
Results -- Potential Fluctuations in Operating Results."
The Company's existing and potential competitors consist principally of
large domestic and international companies that have substantially greater
financial, manufacturing, technical, marketing, distribution and other
resources, greater intellectual property rights, broader product lines and
longer-standing relationships with customers than the Company. The Company's
competitors also include a number of smaller and emerging companies. The
Company's principal audio competitors include Cirrus Logic, Creative Technology
and Yamaha. The Company's principal video competitors include C-Cube, Windbond,
LSI Logic and SGS Thompson. The Company's principal modem competitors include
Cirrus Logic, Lucent, Rockwell, 3Com and Texas Instruments. Certain of the
Company's current and potential competitors maintain their own semiconductor
foundries and may therefore benefit from certain capacity, cost and technical
advantages. The Company believes that its ability to compete successfully
depends on a number of factors, both within and outside of its control,
including the price, quality and performance of the Company's and its
competitors' products, the timing and success of new product introductions by
the Company, its customers and its competitors, the emergence of new multimedia
standards, the development of technical innovations, the ability to obtain
adequate foundry capacity and sources of raw materials, the efficiency of
production, the rate
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at which the Company's customers design the Company's products into their
products, the number and nature of the Company's competitors in a given market,
the assertion of intellectual property rights and general market and economic
conditions. There can be no assurance that the Company will be able to compete
successfully in the future.
Each successive generation of microprocessors has provided increased
performance, which could in the future result in a microprocessor capable of
performing multimedia functions. In this regard, Intel Corporation has developed
Native Signal Processing ("NSP") capability and an extended multimedia system
architecture ("MMX") for use in conjunction with its Pentium microprocessor, and
is promoting the processing power of the Pentium for data and signal intensive
functions such as graphics acceleration and other multimedia functions. There
can be no assurance that the increased capabilities of microprocessors will not
adversely affect demand for the Company's products. See "Factors That May Affect
Future Results -- Importance of New Products and Technological Changes."
PATENTS AND PROPRIETARY RIGHTS
The Company relies on a combination of patents, trademarks, copyrights,
trade secret laws and confidentiality procedures to protect its intellectual
property rights. As of December 31, 1997, the Company had 9 patents granted in
the United States, which expire over time, commencing in 1999 and ending in
2013, and 10 corresponding foreign patents. In addition, the Company intends to
seek further United States and international patents on its technology. There
can be no assurance that patents will be issued from any of the Company's
pending applications or applications in preparation or that any claims allowed
from pending applications or applications in preparation will be of sufficient
scope or strength, or be issued in all countries where the Company's products
can be sold, to provide meaningful protection or any commercial advantage to the
Company. Also, competitors of the Company may be able to design around the
Company's patents. The laws of certain foreign countries in which the Company's
products are or may be designed, manufactured or sold, including various
countries in Asia, may not protect the Company's products or intellectual
property rights to the same extent as do the laws of the United States and thus
make the possibility of piracy of the Company's technology and products more
likely. Although the Company is not aware of the development, distribution or
sales of any illegal copies of the Company's hardware or software, any
infringements of its patents, copyrights or trademarks, or any violation of its
trade secrets, confidentiality procedures or licensing agreements to date, there
can be no assurance that the steps taken by the Company to protect its
proprietary information will be adequate to prevent misappropriation of its
technology or that the Company's competitors will not independently develop
technologies that are substantially equivalent or superior to the Company's
technology.
The semiconductor industry is characterized by vigorous protection and
pursuit of intellectual property rights or positions, which have resulted in
significant and often protracted and expensive litigation. Except for the
Creative Technology litigation (See "Item 3. Legal Proceedings"), 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
9
<PAGE> 11
available on reasonable terms, or at all, and any such development or license
could require expenditures by the Company of substantial time and other
resources. Although patent disputes in the semiconductor industry have often
been settled through cross-licensing arrangements, there can be no assurance
that in the event that any third party makes a successful claim against the
Company or its customers, a cross-licensing arrangement could be reached. In
such a case, if a license is not made available to the Company on commercially
reasonable terms, the Company's business, financial condition and results of
operations could be materially adversely affected.
The Company currently licenses certain of the technology utilized by the
Company in its products, and expects to continue to do so in the future. The
Company has no current plans to grant licenses with respect to its products or
technology; however, it may become necessary for the Company to enter into
product licenses in the future in order, among other things, to secure foundry
capacity. Although the Company has in the past granted licenses to certain of
its technology, some of which have expired, such licenses have been limited and
the Company has not derived material revenues from such licenses in recent
periods. See "Factors That May Affect Future Results -- Uncertainty Regarding
Patents and Protection of Proprietary Rights."
EMPLOYEES
As of December 31, 1997, the Company had 447 full-time employees, including
209 in research and development, 110 in marketing, sales and support and 128 in
operations, finance and administration. The Company's future success will
depend, in part, on its ability to continue to attract, retain and motivate
highly qualified technical and management personnel, particularly highly skilled
semiconductor design personnel and software engineers involved in new product
development, for whom competition is intense. The Company's employees are not
represented by any collective bargaining unit, and the Company has never
experienced a work stoppage. See "Factors That May Affect Future
Results -- Dependence on Key Personnel."
ITEM 2. PROPERTIES
Prior to October 1996, the Company leased two facilities in Fremont,
California. The leases for such facilities expired on June 30 and October 31,
1996. The facilities consisted of two buildings comprising approximately 62,000
square feet, which were used as the Company's headquarters. In October 1995, the
Company purchased approximately 16 acres of land near its previous Fremont
headquarters and constructed a new headquarters facility of 93,000 square feet.
The Company relocated its operations from the leased facility to the new
facility in September 1996. The Company anticipates that it will complete
construction of an additional building to house research and development efforts
on the existing land in the spring of 1998. The Company also plans to construct
a dormitory to house visitors and guest workers during 1998.
ITEM 3. LEGAL PROCEEDINGS
On March 11, 1998, Creative Technology Ltd. and its subsidiary E-mu
Systems, Inc. (together, "Creative") filed a lawsuit against the Company and one
of its customers, Diamond Multimedia Systems, Inc. ("Diamond"), alleging
infringement of U.S. Patent No. 5,698,803 (the "803 patent"), by the Company's
Maestro products, one of which is included in products sold by Diamond. The
complaint requests preliminary and permanent injunctions, and unspecified
damages. Creative also claims willful infringement and requests treble damages
and attorney's fees. The lawsuit, entitled Creative Technology Ltd. et al v. ESS
Technology, Inc. et al, is pending in the U.S. District Court for the Central
District of California.
No date has been set for any hearing or for trial of the matter. The
Company is still engaged in investigating the claim. Although the Company
believes that it does not infringe any valid claim of the 803 patent, the
Company cannot predict the ultimate resolution of the lawsuit.
The grant of a preliminary or permanent injunction enjoining the sales of
the Maestro products could result in a material adverse effect on the Company's
business, financial condition and results of operations, including a reduction
in the Company's revenues and income, losses for an extended period of time and
a
10
<PAGE> 12
depletion in the Company's financial resources. In addition, the Company could
be required to pay monetary damages to Creative, which are subject to trebling
in the event of a finding of willful infringement. Further, the Company may have
to indemnify Diamond from liability with respect to claimed infringements of the
803 patent and, in the event of a determination of infringement and the grant of
an injunction, the Company may have to compensate Diamond for damages related to
such determination and secure a license for Diamond to continue using the
enjoined chips, replace the chips with non-infringing chips or remove the chips
and refund the purchase price of such chips. Such indemnification could increase
the Company's exposure to, and amount of, potential costs and liability in such
event, and could have a material adverse effect on the Company's business,
financial condition and results of operations.
In connection with the Creative litigation, the Company may incur
substantial legal and other expenses. In addition, the Creative litigation may
divert the efforts and attention of the Company's management and technical
personnel. Patent litigation is highly complex and can extend for a protracted
period of time, which can substantially increase the cost of such litigation.
Accordingly, the expenses and diversion of resources associated with the
Creative litigation could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Item 1.
Business -- Patents and Proprietary Rights."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter
ended December 31, 1997.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding the Company's
current executive officers:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Fred S.L. Chan......................... 51 President, Chief Executive Officer and
Chairman of the Board of Directors
John H. Barnet......................... 62 Vice President, Chief Financial Officer and
Secretary
Chi-Shin Wang.......................... 51 Chief Technical Officer
Robert L. Blair........................ 50 Executive Vice President, Operations
Nicholas Aretakis...................... 36 Vice President Marketing and Sales, - PC
Products
Johnston Chen.......................... 37 Vice President, Sales - Consumer Products
Howard Hideshima....................... 38 Controller and Chief Accounting Officer
</TABLE>
Mr. Chan joined the Company in November 1985 as President and has been a
director since January 1986. He was appointed Chairman of the Board of Directors
in October 1992 and Chief Executive Officer in June 1994. Mr. Chan has been
serving as President since February 1997. Mr. Chan served as Secretary from
October 1992 to August 1995 and Chief Financial Officer from October 1992 to May
1995. From 1984 to 1985, Mr. Chan was founder, President and Chief Executive
Officer of AC Design Inc., a VLSI chip design center providing CAD, engineering
and design services. From 1982 to 1984, he was co-founder, President and Chief
Executive Officer of CADCAM Technology, Inc., a company in the business of CAE
systems development. Mr. Chan holds B.S.E.E. and M.S.C. degrees from the
University of Hawaii. Mr. Chan is the husband of Annie M. H. Chan, a director of
the Company.
Mr. Barnet joined the Company in September 1996 as Vice President, Finance,
Chief Financial Officer and Secretary. Prior to joining the Company, he was
Executive Vice President, Finance and Chief Financial Officer of Trimble
Navigation Limited from 1993. From mid 1992 to mid 1993 he served as Senior Vice
President, Finance and Chief Financial Officer of Centex Telemanagement, Inc., a
telecommunications management company. From 1988 to 1992, he was Vice President,
Finance and Chief Financial Officer of Acurex Corporation, a conglomerate
engaged in military and commercial aerospace, environmental systems, and
industrial process controls. Previously he held executive positions at
BankAmerica Corporation, Signetic Corporation and Teledyne, Inc. Mr. Barnet
received a BS degree in Industrial Engineering from Stanford University in 1957
and an MBA degree from Columbia University Graduate Business School in 1961.
11
<PAGE> 13
Dr. Wang has been Chief Technical Officer of the Company since December
1995. Prior to joining the Company he was a co-founder of Integrated Information
Technology, a semiconductor company, and served as President and Chief Executive
Officer from 1987 to December 1995. From 1981 to 1986, he was a co-founder of
Weitek Corporation and served as Vice President of Engineering. Dr. Wang was a
member of the technical staff of Hughes Aircraft Company from 1973 to 1976 and a
project manager of Hewlett Packard from 1976 to 1981. He holds a M.S. degree in
Physics from the California Institute of Technology and a Ph.D.E.E. from
Stanford University.
Mr. Blair has been Executive Vice President, Operations of the Company
since April 1997. From December 1994 to March 1997, he was Vice President of
Operations of the Company. From December 1991 to November 1994, he was Senior
Vice President Operations (Software Packaging & Printing Division) of Logistix
Corporation, a software turnkey company, and from 1989 to November 1991, he was
Vice President and co-owner of Rock Canyon Investments, a real estate
development planning firm in California. From 1986 to 1989, he held various
positions at Xidex Corporation, a computer diskette manufacturer, including
President/General Manager, at XEMAG, a division of Xidex Corporation. From 1973
to 1986 he was Vice President, High Reliability Operations at Precision
Monolithics, Inc.
Mr. Aretakis has been Vice President, Marketing and Sales -- PC Products of
the Company since December 1997. From January 1997 to November 1997, he was Vice
President Sales -- PC Products of the Company. From August 1994 to December
1996, he was Vice President of Sales of the Company. Prior to joining the
Company, he held sales positions in various semiconductor companies, including
Director of OEM Sales at Media Vision, a computer peripherals manufacturer, from
March 1993 to July 1994 and Director of Sales at SEEQ from 1988 to January 1993.
From 1984 through 1988, Mr. Aretakis held various marketing positions at
Microchip Technology Inc. Mr. Aretakis holds a B.S.E.E. degree from Columbia
University and a BA degree in Mathematics from Hobart College.
Mr. Chen has been Vice President, Sales - Consumer Products of the Company
since January 1997. From February 1995 to December 1996, he was Director of APAC
Sales of the Company. Prior to joining the Company, he was co-owner of Internet
Corporation, a semiconductor sales representation company for the Far East
market, and served as Director of Sales and Marketing from February 1992 to
February 1995. From 1988 to 1992, he was Product Marketing Manager at FIFO
Division of Integrated Device Technology. From 1983 to 1988, Mr. Chen held
various engineering, marketing, and management positions at PMI Division of
Analog Devices, Inc., Siliconix, and Soletron. Mr. Chen holds a B.S.E.E. degree
from San Jose State University and an MBA degree from Santa Clara University.
Mr. Hideshima has been Chief Accounting Officer since July 1997 and
Controller of the Company since December 1994. Prior to joining the Company, he
was Controller of Hoya MicroMask, Inc., a semiconductor mask company from August
1991 to November 1994 and Accounting Manager at Hoya Corporation USA from July
1990 to July 1991. From June 1985 through June 1990, Mr. Hideshima was an
auditor with Arthur Andersen & Company. Mr. Hideshima holds a MBA degree from
San Francisco State University and BS degree in Business from University of
California -- Berkeley.
12
<PAGE> 14
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has been trading on the NASDAQ National Market
under the symbol "ESST" since October 6, 1995. The following table sets forth
the high and low last reported sales prices for the Common Stock as reported by
the NASDAQ National Market during the period indicated.
<TABLE>
<CAPTION>
HIGH LOW
---- ----
<S> <C> <C>
FISCAL 1995:
Fourth Quarter (since October 6, 1995)...................... $39 $14 1/16
FISCAL 1996:
First Quarter............................................... 24 16
Second Quarter.............................................. 25 1/4 16 1/4
Third Quarter............................................... 18 1/2 9 1/4
Fourth Quarter.............................................. 30 15 1/8
FISCAL 1997:
First Quarter............................................... 34 1/4 21 1/2
Second Quarter.............................................. 29 1/2 11 7/8
Third Quarter............................................... 18 1/4 13 1/4
Fourth Quarter.............................................. 14 3/8 7 9/16
</TABLE>
As of February 27, 1998, there were approximately 272 record holders of the
Company's Common Stock.
The Company has never declared or paid any cash dividends on its Common
Stock. The Company currently anticipates that it will retain all future earnings
for use in its business and does not anticipate paying any cash dividends in the
foreseeable future.
13
<PAGE> 15
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements and related notes thereto
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere in this Form 10-K.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues.......................... $ 15,218 $ 33,435 $105,744 $226,455 $249,517
Cost of revenues...................... 6,733 12,047 39,584 106,818 171,859
-------- -------- -------- -------- --------
Gross profit........................ 8,485 21,388 66,160 119,637 77,658
Operating expenses:
Research and development............ 2,915 3,711 8,665 20,270 29,471
Research and development
in-process....................... -- -- -- 30,355 22,200
Selling, general and
administrative................... 3,005 3,233 9,758 16,814 25,198
-------- -------- -------- -------- --------
Operating income...................... 2,565 14,444 47,737 52,198 789
Nonoperating income, net.............. 598 283 2,694 3,241 2,183
-------- -------- -------- -------- --------
Income before income taxes............ 3,163 14,727 50,431 55,439 2,972
Provision for income taxes............ 2,880 6,346 20,545 33,813 13,838
-------- -------- -------- -------- --------
Net income (loss)..................... $ 283 $ 8,381 $ 29,886 $ 21,626 $(10,866)
-------- -------- -------- -------- --------
Net income (loss) per share --basic... $ 0.01 $ 0.25 $ 0.96 $ 0.57 $ (0.27)
======== ======== ======== ======== ========
Net income (loss) per
share -- diluted(1)................. $ 0.01 $ 0.22 $ 0.79 $ 0.52 $ (0.27)
======== ======== ======== ======== ========
Shares used in calculating net income
(loss) per share -- basic........... 31,641 33,510 31,265 37,702 39,593
======== ======== ======== ======== ========
Shares used in calculating net income
(loss) per share -- diluted(1)...... 35,849 37,413 37,775 41,588 39,593
======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------------
1993 1994 1995 1996 1997
------- ------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments......................... $ 8,114 $10,860 $ 78,124 $ 69,204 $ 42,284
Working capital....................... 2,940 11,135 70,602 65,207 74,238
Total assets.......................... 15,108 24,014 162,703 211,985 231,654
Long-term debt, less current
portion............................. -- -- 15,960 -- --
Total shareholders' equity............ 5,889 14,458 105,208 143,176 171,107
</TABLE>
- ---------------
(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of shares used in calculating net income (loss) per share -- diluted.
14
<PAGE> 16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
ESS designs, develops and markets highly integrated mixed signal
semiconductor products for sale to the PC and consumer marketplace. In 1997, ESS
had revenues totaling $249.5 million, a 10% increase from the 1996 total of
$226.5 million and 136% increase from 1995 revenues of $105.7 million. Net
income decreased by 78% from $52.0 million in 1996, excluding a one-time pre and
post-tax charge of $30.4 million related to acquired research and development
in-process for the VideoCore and OSEE acquisitions, to $11.3 million in 1997,
excluding a one-time pre and post-tax charge of $22.2 million related to
acquired research and development in process for the acquisition of Platform.
1996 net income, excluding the one time pre and post-tax charge for acquired
research and development in-process, increased by 74% over 1995 net income of
$29.9 million. The gross margin for 1997 was 31%, reflecting price competition
and an inventory reserve charge of $18.3 million in the fourth quarter of 1997
offset in part by manufacturing cost reductions, compared to gross margin in
1996 of 53%. 1996 margin declined from 63% in 1995 primarily due to price
competition in the audio segment offset in part by manufacturing cost
reductions.
The Company is a leader in semiconductor audio products for the PC
marketplace and semiconductor video products for the VCD player market. In 1996,
the Company entered the VCD player market after its January 1996 acquisition of
VideoCore pursuant to which the Company acquired all of the outstanding capital
stock of VideoCore in exchange for approximately 525,000 shares of the Company's
Common Stock and $5.7 million in cash. VideoCore develops integrated circuits
which incorporate advanced compression technology in digital video products
under the trade-name VideoDrive. In March 1996, the Company completed its
acquisition of OSEE pursuant to which the Company acquired all of the
outstanding capital stock of OSEE in exchange for approximately 217,000 shares
of the Company's Common Stock and $3.6 million in cash. OSEE develops advanced
modem algorithm technology that enables the Company to provide modem products
under the trade name TeleDrive. Both acquisitions were accounted for as
purchases and the portion of the purchase prices attributable to research and
development in-process was expensed in the first quarter of 1996. In 1995, 1996
and 1997, the Company's AudioDrive products served the market for the ISA
standard. In June 1997, the Company completed its acquisition of Platform
pursuant to which the Company acquired all the outstanding capital stock of
Platform in exchange for approximately 2.54 million shares of the Company's
Common Stock including approximately 954,000 options. The acquisition was
accounted for as a purchase and the portion of the purchase price attributable
to research and development in-process was expensed in the second quarter of
1997. The acquisition of Platform allowed the Company to develop and
subsequently introduce products for the PCI standard.
In 1996, the Company introduced its VideoDrive product, a single-chip
MPEG-1 decoder that provides full-screen, full-motion video and selectable
CD-quality audio for VCD players. Shipments of these chips to the VCD player
market began in the second quarter of 1996. The Company introduced its first
MPEG-2 video chip solution, a fully programmable, single-chip processor that
incorporates the additional features needed for consumer electronics
applications such as DVD players, set-top boxes, multimedia personal computers
and home entertainment units.
The TeleDrive products for the Internet and other modem markets were
developed following the Company's first quarter of 1996 acquisition of OSEE. In
1997, the Company began production volume shipments of V.34bis modem solutions
and introduced the V.90 56K modem solutions. The Company is currently shipping
both V.34bis and V.90 56K modem solutions.
At the end of 1995, ESS purchased 16 acres of land in Fremont, California,
near its previous facilities. By the end of 1996, the Company completed and
occupied a two-story, 93,000-square-foot headquarters. During 1997, the Company
began construction of another building to be completed in the spring of 1998 to
house additional engineering capacity and other needs. A dormitory is also
planned to be built during 1998.
In 1997, the Company's growth was focused on sales of VCD player products
to the Asia/Pacific region. ESS supplemented its existing sales and technical
support centers with new centers in Shenzhen-China, Hong Kong and Korea. These
new centers are supporting the Company's new video products.
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<PAGE> 17
During the fourth quarter of 1997, the Company established a wholly owned
foreign subsidiary in the Cayman Islands, British West Indies and transferred a
substantial portion of its business operations to it. The Company expects to
generate significant future tax benefits from the transfer of these operations.
RESULTS OF OPERATIONS
The following table sets forth certain items from the Company's
consolidated statement of operations as a percentage of net revenues for the
periods indicated.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------
1995 1996 1997
----- ----- -----
<S> <C> <C> <C>
Net revenues.................................... 100.0% 100.0% 100.0%
Cost of revenues................................ 37.4 47.2 68.9
----- ----- -----
Gross margin.................................. 62.6 52.8 31.1
Operating expenses:
Research and development...................... 8.2 9.0 11.8
Research and development in-process........... -- 13.4 8.9
Selling, general and administrative........... 9.2 7.4 10.1
----- ----- -----
Operating income................................ 45.2 23.0 0.3
Nonoperating income, net........................ 2.5 1.5 0.9
----- ----- -----
Income before income taxes...................... 47.7 24.5 1.2
Income taxes.................................... (19.4) (14.9) (5.5)
----- ----- -----
Net income (loss)............................... 28.3% 9.6%* (4.3)%**
===== ===== =====
</TABLE>
- ---------------
* Includes a one-time pre and post-tax charge of 13.4% related to acquired
research and development in-process.
** Includes a one-time pre and post-tax charge of 8.9% related to acquired
research and development in-process.
Net Revenues. Net revenues were $105.7 million, $226.5 million and $249.5
million in 1995, 1996 and 1997, respectively. Net revenues rose by 10% between
1996 and 1997 primarily from increased sales of the Company's video products.
During 1997, the Company experienced severe average selling price ("ASP")
erosion in a highly competitive sales environment in both the audio and video
markets. Net revenues for 1996 increased 114% from 1995 primarily as a result of
the increased sales growth of the Company's existing PC audio products as well
as from the introduction of new PC audio and video semiconductor products. The
Company's PC audio products accounted for substantially all of the Company's net
revenues for 1996 and a majority in 1997. International revenues accounted for
approximately 73%, 92% and 89% of net revenues for 1995, 1996 and 1997,
respectively. The significant increase in international sales as a percentage of
net revenues between 1995 and 1996 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. The Company expects that its
percentage of international sales will remain high in the future.
Gross Margin. Gross profit was $66.2 million, $119.6 million and $77.7
million in 1995, 1996 and 1997, respectively, representing corresponding gross
margins of 62.6%, 52.8% and 31.1% of net revenues for such years. Gross margin
declined from 1995 to 1996 as a result of lower ASPs on existing products
arising from highly competitive market conditions and manufacturing startup
costs associated with the Company's new PC audio, video and modem products.
These lower ASPs on existing products were partially offset by a reduction in
product costs and higher ASPs associated with the new PC audio and video
products. The decrease in gross margins from 1996 to 1997 were a result of lower
ASPs on the Company's products throughout the year and an inventory charge to
cost of goods sold during the fourth quarter of $18.3 million for inventory
reserves. The charge was for excess inventory positions. During the third
quarter, indication of strong demand led to a high order rate. After
non-cancelable production orders were placed, yields improved dramatically and
the marketplace demand was lower than expected. The Company was under
contractual agreement to pay a pre-
16
<PAGE> 18
established per-die price, and was unable to realize the benefit of the enhanced
yields and was committed to take the increased volume. These factors led to the
inventory charge and the decrease in gross profit. The Company's overall gross
profit and margin are subject to change due to various factors, including among
others, competitive product pricing, unit volumes shipped, new product
introductions, yields, wafer costs, assembly costs and product mix. The Company
has encountered increased competition from other suppliers who are offering
competitive products and new features. In addition, the Company expects the
overall ASPs for its existing products to decline significantly over the life of
the products. The Company believes that in order to maintain or increase gross
profit, it must achieve higher unit volume shipments, cost reductions, new
features and 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.
Research and Development Expenses. On-going research and development
expenses were $8.7 million, $20.3 million and $29.5 million, or 8.2%, 9.0% and
11.8% of net revenues, in 1995, 1996 and 1997, respectively. Research and
development in-process represents one-time pre and post-tax charges of $30.4
million from the acquisition of VideoCore and OSEE in the first quarter of 1996
and of $22.2 million from the acquisition of Platform in the second quarter of
1997. The increase in absolute dollars in research and development expenses from
1995 to 1996 is primarily due to the increase in the Company's engineering
staff, engineering test runs, masks, internal and external consultants and
one-time license fees. The growth in on-going research and development expenses
between 1996 and 1997 was primarily due to the increase in the Company's
engineering staff, engineering test runs, masks, internal and external
consulting expenses and licensing fees associated with the research and
development efforts to support the introduction of new products. The Company
expects that research and development expenses will remain relatively constant
as a percentage of net revenues. There can be no assurance, however, that
revenues will grow at the same rate as the anticipated research and development
expenses.
Selling, General and Administration Expenses. Selling, general and
administrative expenses were $9.8 million, $16.8 million and $25.2 million, or
9.2%, 7.4% and 10.1% of net revenues, in 1995, 1996 and 1997, respectively. The
increase in selling, general and administration expenses from 1995 to 1996 was
primarily due to increase in commissions and bonuses on higher sales volumes,
increased personnel and related expenses resulting from Company's status as a
public company. The increase in selling, general and administration expenses
from 1996 to 1997 was primarily attributable to increased spending for
additional sales and administrative employees. The increase in expense was also
due to commissions on higher sales levels and, to a lesser extent, promotional
expenses and costs associated with the expansion of the Company's sales
activities. The Company expects to incur higher selling, general and
administrative expenses in the future due to the need to increase selling
activities, although these expenses are expected to remain relatively constant
as a percentage of net revenues. There can be no assurance, however, that
revenues will grow at the same rate as the anticipated selling, general and
administrative expenses.
Non-Operating Income, Net. Non-operating income, net was $2.7 million, $3.2
million and $2.2 million in 1995, 1996 and 1997 respectively. In 1995, 1996 and
1997 non-operating income, net consisted primarily of interest income and gains
on sale of marketable securities, net of interest expense.
Provision for Income Taxes. The Company's effective tax rate was 41%, 61%
and 466% for 1995, 1996 and 1997, respectively. The Company's tax rate for 1995
was at the combined federal and state statutory rate of 41%. The tax rate for
1996 of 61% reflects a non-deductible expense for the one-time pre and post-tax
charge of $30.4 million related to acquired research and development in-process
from the acquisition of VideoCore and OSEE in the first quarter 1996. The pro
forma tax rate excluding this charge of $30.4 million was 39%. The Company's pro
forma tax rate for 1996 was slightly lower than the combined federal and state
statutory rate of 41% as a result of tax exempt interest income and research and
development credits. The reported tax rate for 1997 of 466% of pre-tax income
significantly exceeds the combined federal and statutory tax rate of 41% due to
two charges that are not deductible in the federal and state returns. The first
charge is the one-time pre- and post-tax charge of $22.2 million for the
acquisition of Platform in the second quarter of 1997. The second is the charge
to increase inventory reserves in the fourth quarter of 1997. Because the
majority of the inventories were held by a foreign subsidiary, a majority of the
charges are not deductible on the U.S. and state income tax returns. See Note 4
of Notes to Consolidated Financial Statements.
17
<PAGE> 19
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its cash requirements from
cash generated by operations, the sale of equity securities, bank lines of
credit and short-term and long-term debt. At December 31, 1997, ESS had cash and
cash equivalents and short-term investments of $42.3 million and working capital
of $74.2 million. As of December 31, 1997, the Company had a $20.0 million line
of credit expiring on May 31, 1999, and a $10.0 million line of credit expiring
on June 10, 1998. These lines of credit require the Company to achieve certain
financial ratios and operating results. At December 31, 1997, a criteria on one
of the lines was not met. A waiver was obtained during the first quarter of
1998, and the Company is in conformity with its borrowing criteria under these
lines. There were no borrowings under these lines of credit as of December 31,
1997.
In 1997, the Company used net cash of $20.3 million in operating
activities. This resulted from a net loss of $10.9 million, a one-time non-cash
charge for research and development in-process of $22.2 million and depreciation
and amortization of $7.9 million, less a gain on sale of short-term investments
of $0.1 million and investment in working capital of $39.5 million. The company
received net proceeds of $5.6 million from sale of marketable equity securities,
$3.1 million from the issuance of common stock from exercise of stock options
and employee stock purchase plan, $3.0 million in income tax credits from
disqualifying disposition of common stock options and $2.5 million from the
acquisition of Platform. The Company invested $15.2 million in property and
equipment. For the year, cash and cash equivalents declined $21.3 million.
In 1996, the Company generated net cash from operating activities of $36.4
million. This resulted from net income of $21.6 million, a one-time non-cash
charge for research and development in-process of $30.4 million and depreciation
and amortization of $3.2 million, less a gain on sale of short-term investments
of $1.0 million and investment in working capital of $17.8 million. The Company
received net proceeds of $7.1 million from sale of marketable equity securities,
$3.8 million from the issuance of common stock from exercise of stock options
and employee stock purchase plan, and $8.9 million in income tax credits from
disqualifying disposition of common stock options. The Company invested $14.0
million in property and equipment, repurchased stock for $19.7 million, paid
$16.0 million on capacity commitments and $9.3 million for acquisition of
VideoCore and OSEE. For the year, cash and cash equivalents declined $2.8
million.
In 1995, the Company generated net cash from operating activities of $13.5
million. This resulted from net income of $29.9 million, depreciation and
amortization of $0.9 million less a gain on sale of marketable equity securities
of $1.3 million and investment in working capital of $16.0 million. The Company
received net proceeds of $60.8 million from the issuance of common stock related
to its initial public offering. The Company purchased $24.9 million in
short-term investments and invested $8.4 million in property and equipment. For
the year, cash and cash equivalents increased $41.0 million.
The Company believes that its existing cash and cash equivalents as of
December 31, 1997 together with the cash generated from operations, available
borrowings under its line of credit and other financing options, will be
sufficient to fund acquisitions of property and equipment and provide adequate
working capital through at least the next twelve months. Capital expenditures
for the next twelve months are anticipated to be approximately $19.0 million of
which approximately $5.0 million will be used to fund construction of additional
facilities and approximately $14.0 million will be used to acquire capital
equipment. The Company may also utilize cash to acquire or invest in
complementary businesses or products or to obtain the right to use complementary
technologies. From time to time, in the ordinary course of business, the Company
may evaluate potential acquisitions of or investment in such businesses,
products or technologies owned by third parties. 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 Annual Report on
Form 10-K, 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
18
<PAGE> 20
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. 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. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Competition; Pricing Pressures. The markets in which the Company competes
are intensely competitive and are characterized by rapid technological change,
price declines and rapid product obsolescence. See "Item 1.
Business -- Competition."
Dependence on the PC and Consumer Markets. In 1995, 1996 and 1997 sales of
PC audio semiconductor chips accounted for a majority of the Company's net
revenues, and the Company expects that sales of audio semiconductors will
continue to account for a significant portion of its net revenues for the
foreseeable future. In 1997, sales of video semiconductor chips to the VCD
player market accounted for a significant portion of the Company's revenues. Any
reduction in ASPs or demand for the Company's semiconductor chips, whether
because of a reduction in demand for PCs or VCD players in general, increased
competition or otherwise, would have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company is currently engaged in the development and introduction of new
PC audio, video and fax/ modem semiconductor devices for the PC and consumer
markets. There can be no assurance that the Company will be able to identify
market trends or new product opportunities, develop and market new products,
achieve design wins or respond effectively to new technological changes or
product announcements by others. A failure in any of these areas would have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Item 1. Business -- AudioDrive Products,"
" -- VideoDrive Products" and " -- TeleDrive Products."
The Company's products are sold for incorporation into desktop and notebook
computers and VCD players. Therefore, the Company is heavily dependent on the
continued growth of the markets and the cost requirements for desktop and
notebook computers and VCD players. There can be no assurance that these markets
will be able to sustain continued growth. A slowing in unit volume and a
decrease in ASPs could result in a decline in revenues which would have a
material adverse effect on the Company's business, financial condition and
results of operations.
Importance of New Products and Technological 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
19
<PAGE> 21
products at competitive price and performance levels. The success of new
products depends on a number of factors, including timely completion of product
development, market acceptance of the Company's and its customers' new products,
securing sufficient foundry capacity for volume manufacturing of wafers,
achievement of acceptable wafer fabrication yields by the Company's independent
foundries and the Company's ability to offer new products at competitive prices.
In order to succeed in having the Company's products incorporated into new
products being designed by its customers, the Company must anticipate market
trends and meet performance, quality and functionality requirements of such OEMs
and must successfully develop and manufacture products that adhere to these
requirements. In addition, the Company must meet the timing and price
requirements of such manufacturers and must make such products available in
sufficient quantities. Accordingly, in selling to OEMs, the Company can often
incur significant expenditures prior to volume sales of new products, if any. In
order to help accomplish these goals, the Company has in the past and will
continue to consider in the future the acquisition of other companies or the
products and technologies of other companies. Such acquisitions carry additional
risks such as a lack of integration with existing products and corporate
culture, the potential for large write-offs and the diversion of management
attention. There can be no assurance that the Company will be able to identify
market trends or new product opportunities, develop and market new products,
achieve design wins or respond effectively to new technological changes or
product announcements by others. A failure in any of these areas would have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Item 1. Business -- Research and Development."
Dependence on TSMC and Other Third Parties. The Company relies on
independent foundries to manufacture all of its products. A substantial majority
of the Company's products are currently manufactured by TSMC, which has
manufactured certain of the Company's products since 1989. The Company also has
foundry arrangements with UMC, which has manufactured certain of the Company's
products since 1995. These relationships provide the Company with access to
advanced process technology necessary for the manufacture of the Company's
products. These foundries fabricate products for other companies and, in certain
cases, manufacture products of their own design. In November 1995, the Company
entered into long-term agreements with TSMC and UMC in which the Company has
secured access to additional capacity and to leading edge technology. See "Item
1. Business -- Manufacturing."
While the Company has entered into long-term agreements with its two
foundries, the Company's reliance on these independent foundries involves a
number of risks, including the absence of adequate capacity, the unavailability
of, or interruption in access to, certain process technologies and reduced
control over delivery schedules, manufacturing yields and costs, and the
international risks more fully described below. In addition, the Company has
pre-negotiated certain of its purchase orders and could be unable to benefit
from enhanced yields realized by its vendors. The Company expects to rely upon
TSMC and UMC to manufacture substantially all of the Company's products for the
foreseeable future. In the event that TSMC and UMC are unable to continue to
manufacture the Company's key products in required volumes, the Company will
have to identify and secure additional foundry capacity. In such an event, the
Company may be unable to identify or secure additional foundry capacity from
another manufacturer. Even if such capacity is available from another
manufacturer, the qualification process could take six months or longer. The
loss of any of its foundries as a supplier, the inability of the Company to
acquire additional capacity at its current suppliers or qualify other wafer
manufacturers for additional foundry capacity should additional capacity be
necessary, or any other circumstances causing a significant interruption in the
supply of semiconductors to the Company would have a material adverse effect on
the Company's business, financial condition and results of operations.
To address potential foundry capacity constraints in the future, ESS will
continue to consider and may be required to enter into additional arrangements,
including equity investments in or loans to independent wafer manufacturers in
exchange for guaranteed production capacity, joint ventures to own and operate
foundries, or "take or pay" contracts that commit the Company to purchase
specified quantities of wafers over extended periods. Any such arrangements
could require the Company to commit substantial capital and grant licenses to
its technology. The need to commit substantial capital may require the Company
to obtain additional debt or equity financing, which could result in dilution to
the Company's shareholders. There can be no assurance
20
<PAGE> 22
that such additional financing, if required, will be available when needed or,
if available, will be obtained on terms acceptable to the Company.
Customer Concentration. A limited number of customers have accounted for a
substantial portion of the Company's net revenues. In 1995, 1996 and 1997, sales
to the Company's top five customers, including sales to distributors, accounted
for approximately 48%, 40% and 49% respectively, of the Company's net revenues.
In 1995, Compaq and Universe Electron Corporation, the Company's Japanese
distributor, each accounted for approximately 17% of the Company's net revenues.
In 1996, Compaq and Universe Electron Corporation each accounted for
approximately 12% and 13%, respectively, of the Company's net revenues. In 1997,
Eastbase and Dynax, a Hong Kong distributor, each accounted for approximately
13% of the Company's net revenues. These customers purchased VCD devices,
reflecting the Company's revenue growth in that market. Sales to distributors
are generally subject to agreements allowing limited rights of return and price
protection with respect to unsold products. Returns and allowances in excess of
reserves could have a material adverse impact on the Company's business,
financial condition and results of operation. During 1997, the Company adopted a
policy of deferring revenue recognition on sales of devices to distributors in
Hong Kong and Taiwan until devices are sold to the end customers. This has led
to increased operational visibility on product moving through the channel. The
Company expects that a limited number of customers may account for a substantial
portion of its net revenues for the foreseeable future. The Company has
experienced changes from year to year in the composition of its major customer
base and believes this pattern may continue. The Company does not have long-term
purchase agreements with any of its customers. The reduction, delay or
cancellation of orders from one or more major customers for any reason or the
loss of one or more of such major customers could materially and adversely
affect the Company's business, financial condition and results of operations. In
addition, since the Company's products are often sole sourced to its customers,
the Company's operating results could be materially and adversely affected if
one or more of its major customers were to develop other sources of supply.
There can be no assurance that the Company's current customers will continue to
place orders with the Company, that orders by existing customers will not be
canceled or will continue at the levels of previous periods or that the Company
will be able to obtain orders from new customers.
Management of Growth. During 1997, the Company experienced significant
growth in unit shipments and the addition of multiple product lines that require
additional management systems and processes. To manage its future operations and
growth effectively, the Company will need to 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. During 1995, 1996 and 1997, international sales
accounted for approximately 73%, 92% and 89% of the Company's net revenues,
respectively. Substantially all of the Company's international sales were to
customers in Hong Kong, Taiwan, Japan, Korea 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. Although the Company has not to date experienced any material
adverse effect on its business, financial condition or results of operations as
a result of such regulatory, geopolitical and other factors, there can be no
assurance that such factors will not have a material adverse effect on the
Company's business, financial condition and results of operations in the future
or require the Company to modify its current business practices.
21
<PAGE> 23
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 provide for pricing and payment in U.S.
dollars. In 1997, the effect of significant currency fluctuations in Asia had no
material impact on the Company. There can be no assurance that future
fluctuations in currency exchange rates will not have a material adverse effect
on the Company's business, financial condition and results of operations. To
date the Company has not engaged in any currency hedging activities, although
the Company may do so in the future. Further, there can be no assurance that one
or more of the foregoing factors will not have a material adverse effect on the
Company's business, financial condition and results of operations or require the
Company to modify its current business practices.
Semiconductor Industry. The semiconductor industry has historically been
characterized by rapid technological change, cyclical market patterns,
significant price erosion, periods of over-capacity and production shortages,
variations in manufacturing costs and yields and significant expenditures for
capital equipment and product development. In addition, the industry has
experienced significant economic downturns at various times, characterized by
diminished product demand and accelerated erosion of product prices. 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.
Uncertainty Regarding Patents and Protection of Proprietary Rights. The
Company relies on a combination of patents, trademarks, copyrights, trade secret
laws and confidentiality procedures to protect its intellectual property rights.
See "Item 1. Business -- Patents and Proprietary Rights," "Item 3. Legal
Proceedings."
Dependence on Key Personnel. The Company's success depends to a significant
degree upon the continued contributions of Fred S.L. Chan, the Company's Chief
Executive Officer and Chairman of the Board of Directors. As of February 27,
1998, 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 owned in the aggregate, approximately 37% of the
Company's Common Stock. The present and future success of the Company depends on
its ability to continue to attract, retain and motivate qualified senior
management, sales and technical personnel, particularly highly skilled
semiconductor design personnel and software engineers, for whom competition is
intense. The loss of Mr. Chan, other key executive officers, key design
personnel or software engineers or the inability to hire and retain sufficient
qualified personnel could have a material adverse effect on the Company's
business, financial condition and results of operations. There can be no
assurance that the Company will be able to retain these employees. The Company
currently does not maintain any key man life insurance on the life of any of its
key employees.
Control by Existing Shareholders. As of February 27, 1998, 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,
37% of the Company's outstanding Common Stock. As a result, these shareholders,
acting together, possess significant voting power over the Company, giving them
the ability among other things to influence significantly the election of the
Company's Board of Directors and approve significant corporate transactions.
Such control could delay, defer or prevent a change in control of the Company,
impede a merger, consolidation, takeover or other business combination involving
the Company, or discourage a potential acquirer from making a tender offer or
otherwise attempting to obtain control of the Company.
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
22
<PAGE> 24
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.
Year 2000 Compliance. 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, many
companies' software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" requirements. Certain of the Company's
internal computer systems are not Year 2000 compliant, and the Company utilizes
third-party equipment and software that may not be Year 2000 compliant. Failure
of the Company's internal computer systems or of such third-party equipment or
software, or of systems maintained by the Company's suppliers, to operate
properly with regard to the Year 2000 and thereafter could require the Company
to incur unanticipated expenses to remedy any problems, which could have a
material adverse effect on the Company's business, operating results and
financial condition. Furthermore, the purchasing patterns of customers or
potential customers may be affected by Year 2000 issues as companies expend
significant resources to correct their current systems for Year 2000 compliance.
These expenditures may result in reduced funds available to purchase the
Company's products, which could have a material adverse effect on the Company's
business, operating results and financial condition.
Patent Litigation with Creative Technology, Ltd. On March 11, 1998,
Creative Technology Ltd. and its subsidiary E-mu Systems, Inc. (together,
"Creative") filed a lawsuit against the Company and one of its customers,
Diamond Multimedia Systems, Inc. ("Diamond"), alleging infringement of U.S.
Patent No. 5,698,803 (the "803 patent"), by the Company's Maestro products, one
of which is included in products sold by Diamond. The complaint requests
preliminary and permanent injunctions, and unspecified damages. Creative also
claims willful infringement and requests treble damages and attorney's fees. The
lawsuit, entitled Creative Technology Ltd. et al v. ESS Technology, Inc. et al,
is pending in the U.S. District Court for the Central District of California.
No date has been set for any hearing or for trial of the matter. The
Company is still engaged in investigating the claim. Although the Company
believes that it does not infringe any valid claim of the 803 patent, the
Company cannot predict the ultimate resolution of the lawsuit.
The grant of a preliminary or permanent injunction enjoining the sale of
Maestro products could result in a material adverse effect on the Company's
business, financial condition and results of operations, including a reduction
in the Company's revenues and income, losses for an extended period of time and
a depletion in the Company's financial resources. In addition, the Company could
be required to pay monetary damages to Creative, which are subject to trebling
in the event of a finding of willful infringement. Further, the Company may have
to indemnify Diamond from liability with respect to claimed infringements of the
803 patent and, in the event of a determination of infringement and the grant of
an injunction, the Company may have to compensate Diamond for damages related to
such determination and secure a license for Diamond to continue using the
enjoined chips, replace the chips with non-infringing chips or remove the chips
and refund the purchase price of such chips. Such indemnification could increase
the Company's exposure to, and amount of, potential costs and liability in such
event, and could have a material adverse effect on the Company's business,
financial condition and results of operations.
In connection with the Creative litigation, the Company may incur
substantial legal and other expenses. In addition, the Creative litigation may
divert the efforts and attention of the Company's management and technical
personnel. Patent litigation is highly complex and can extend for a protracted
period of time, which can substantially increase the cost of such litigation.
Accordingly, the expenses and diversion of resources associated with the
Creative litigation could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Item 1.
Business -- Patents and Proprietary Rights."
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<PAGE> 25
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) The following documents are filed as part of this Report.
(1) Financial Statements:
<TABLE>
<CAPTION>
<S> <C>
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1996 and 1997
Consolidated Statements of Operations for the years ended
December 31, 1995, 1996 and 1997
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1995, 1996 and 1997
Consolidated Statements of Cash Flows for the years ended
December 31, 1995, 1996 and 1997
Notes to Consolidated Financial Statements
</TABLE>
(2) Financial Statement Schedules:
Financial Statement Schedules have been omitted because they are not
required or applicable, or the information required to be set forth
therein is included in the Financial Statements or notes thereto.
24
<PAGE> 26
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
ESS Technology, Inc.
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, shareholders' equity and cash
flows present fairly, in all material respects, the financial position of ESS
Technology, Inc. and its subsidiaries at December 31, 1996 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
San Jose, California
January 21, 1998, except as to Note 11,
which is as of March 23, 1998
25
<PAGE> 27
ESS TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
(AMOUNTS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1997
-------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 49,055 $ 27,760
Short-term investments.................................... 20,149 14,524
Accounts receivable, net.................................. 22,054 36,265
Inventories............................................... 33,150 47,285
Deferred income taxes..................................... 3,270 4,898
Prepaid expenses and other assets......................... 6,338 4,053
-------- --------
Total current assets.............................. 134,016 134,785
Property and equipment, net................................. 22,366 32,922
Other assets................................................ 55,603 63,947
-------- --------
$211,985 $231,654
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses..................... $ 58,433 $ 50,858
Income taxes payable...................................... 4,964 183
Deferred income taxes..................................... 5,412 9,506
-------- --------
Total current liabilities......................... 68,809 60,547
-------- --------
Commitments and Contingencies (Notes 9 and 11)
Shareholders' equity:
Preferred stock, no par value, 10,000 shares authorized;
none issued and outstanding............................ -- --
Common stock, no par value, 100,000 shares authorized;
38,127 and 40,674 shares issued and outstanding at
December 31, 1996 and 1997, respectively............... 98,655 137,452
Retained earnings......................................... 44,521 33,655
-------- --------
Total shareholders' equity........................ 143,176 171,107
-------- --------
Total liabilities and shareholders' equity........ $211,985 $231,654
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
26
<PAGE> 28
ESS TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Net revenues............................................... $105,744 $226,455 $249,517
Cost of revenues........................................... 39,584 106,818 171,859
-------- -------- --------
Gross profit............................................. 66,160 119,637 77,658
Operating expenses:
Research and development................................. 8,665 20,270 29,471
Research and development in-process...................... -- 30,355 22,200
Selling, general and administrative...................... 9,758 16,814 25,198
-------- -------- --------
Operating income........................................... 47,737 52,198 789
Interest income, net....................................... 1,348 2,276 2,117
Gain on short-term investments............................. 1,346 965 66
-------- -------- --------
Income before provision for income taxes................... 50,431 55,439 2,972
Provision for income taxes................................. (20,545) (33,813) (13,838)
-------- -------- --------
Net income (loss).......................................... $ 29,886 $ 21,626 $(10,866)
======== ======== ========
Net income (loss) per share -- basic....................... $ 0.96 $ 0.57 $ (0.27)
======== ======== ========
Net income (loss) per share -- diluted..................... $ 0.79 $ 0.52 $ (0.27)
======== ======== ========
Shares used in calculating net income (loss) per
share -- basic........................................... 31,265 37,702 39,593
======== ======== ========
Shares used in calculating net income (loss) per
share -- diluted......................................... 37,775 41,588 39,593
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
27
<PAGE> 29
ESS TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK
----------------- DEFERRED RETAINED
SHARES AMOUNT COMPENSATION EARNINGS TOTAL
------ -------- ------------ --------- --------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1994............. 30,248 $ 6,087 $(120) $ 8,491 $ 14,458
Issuance of common stock in initial
public offering, net of issuance
costs of $1,081..................... 4,428 60,682 -- -- 60,682
Issuance of common stock upon exercise
of options.......................... 797 122 -- -- 122
Amortization of deferred
compensation........................ -- -- 60 -- 60
Net income............................. -- -- -- 29,886 29,886
------ -------- ----- ------- --------
Balance at December 31, 1995............. 35,473 66,891 (60) 38,377 105,208
Issuance of common stock upon exercise
of options.......................... 3,667 3,152 -- -- 3,152
Issuance of common stock for
acquisitions........................ 743 23,352 -- -- 23,352
Issuance of common stock for employee
stock purchase plan................. 47 621 -- -- 621
Amortization of deferred
compensation........................ -- -- 60 -- 60
Repurchase of common stock............. (1,803) (4,249) -- (15,482) (19,731)
Income tax benefit on disqualifying
disposition of common stock
options............................. -- 8,888 -- -- 8,888
Net income............................. -- -- -- 21,626 21,626
------ -------- ----- ------- --------
Balance at December 31, 1996............. 38,127 98,655 -- 44,521 143,176
Issuance of common stock upon exercise
of options.......................... 886 2,294 -- -- 2,294
Issuance of common stock for
acquisition......................... 1,586 32,703 -- -- 32,703
Issuance of common stock for employee
stock purchase plan................. 75 817 -- -- 817
Income tax benefit on disqualifying
disposition of common stock
options............................. -- 2,983 -- -- 2,983
Net loss............................... -- -- -- (10,866) (10,866)
------ -------- ----- ------- --------
Balance at December 31, 1997............. 40,674 $137,452 -- $33,655 $171,107
====== ======== ===== ======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
28
<PAGE> 30
ESS TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1995 1996 1997
------- ------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)......................................... $29,886 $21,626 $(10,866)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization.......................... 934 3,234 7,865
Charges for research and development in-process........ -- 30,355 22,200
Gain on sale of short-term investments................. (1,346) (965) (66)
Deemed compensation expense and compensation related to
stock options........................................ 60 60 --
Change in assets and liabilities (net of effect of
acquisitions) Accounts receivable.................... (5,935) (11,818) (14,197)
Inventories.......................................... (15,140) (13,969) (14,038)
Deferred income taxes................................ (1,061) (1,430) (2,739)
Prepaid expenses and other assets.................... (41,837) (15,969) 4,645
Accounts payable and accrued expenses................ 31,073 24,082 (8,359)
Long-term advances payable to foundries.............. 15,960 -- --
Income taxes payable................................. 906 1,242 (4,781)
------- ------- --------
Net cash provided by (used in) operating
activities...................................... 13,500 36,448 (20,336)
------- ------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment..................... (8,386) (14,015) (15,207)
Sale of marketable equity securities...................... 1,346 17,435 24,916
Purchase of short-term investments........................ (26,243) (10,376) (19,291)
Payments associated with capacity commitments............. -- (15,960) --
Cash received from (paid for) acquisitions................ -- (9,288) 2,529
------- ------- --------
Net cash used in investing activities............. (33,283) (32,204) (7,053)
------- ------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repurchase of common stock................................ -- (19,731) --
Issuance of common stock.................................. 60,804 3,773 3,111
Income tax benefit on disqualifying disposition of common
stock options.......................................... -- 8,888 2,983
------- ------- --------
Net cash provided by (used in) financing
activities...................................... 60,804 (7,070) 6,094
------- ------- --------
Net increase (decrease) in cash and cash equivalents........ 41,021 (2,826) (21,295)
Cash and cash equivalents at beginning of period............ 10,860 51,881 49,055
------- ------- --------
Cash and cash equivalents at end of period.................. $51,881 $49,055 $ 27,760
======= ======= ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Common stock issued for acquisitions...................... $ -- $23,352 $ 32,703
Cash paid for income taxes................................ $20,702 $23,576 $ 18,300
======= ======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
29
<PAGE> 31
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES
ESS Technology, Inc. (the "Company") was incorporated in California in
February 1984. The Company and its wholly-owned subsidiaries design, develop and
market highly integrated mixed signal semiconductor products for PC and consumer
marketplaces.
In October 1995, the Company completed its initial public offering of
8,050,000 shares of common stock including the shares from an over-allotment
option. Of the total shares offered, 4,427,500 shares were sold by the Company
and 3,622,500 shares were sold by shareholders. Net proceeds to the Company were
$61,763,000 before deducting offering expenses of $1,081,000.
Use of Estimates
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
Cash 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.
All of the Company's short-term investments, comprising primarily debt
instruments with contractual maturities of less than two years, have been
classified as available for sale. Management determines the appropriate
classification of securities at the time of purchase and reevaluates the
classification at each reporting date. Interest income is accrued as earned. At
December 31, 1997, the fair value of the Company's investments approximated
their cost.
Inventories
Inventories are stated at the lower of cost or market, with cost being
determined by the first-in, first-out (FIFO) method.
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is provided using the straight-line method over estimated useful lives
that range from 3 to 5 years for machinery and equipment and furniture and
fixtures and 4 to 30 years for buildings and building improvements.
Technical Infrastructure and Covenants not to Compete
Technical infrastructure and covenants not to compete are amortized over
estimated useful lives that range from 3 to 4 years.
Impairment of Long-Lived Assets
Pursuant to Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-lived Assets and for Long-Lived Assets to
be Disposed of" ("SFAS 121"), the Company reviews long-
30
<PAGE> 32
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
lived assets based upon a gross cash flow basis and will reserve for impairment
whenever events or changes in circumstances indicate the carrying amount of the
assets may not be fully recoverable. Based on its most recent analysis, the
Company believes that there was no impairment of its long-lived assets as of
December 31, 1997.
Revenue Recognition
Revenue from products sales is recognized at the time of shipment except
for certain shipments to distributors with rights of return and allowances, in
which case revenue is deferred until the distributor resells the product. For
sales recognized at the time of shipment, reserves for estimated returns and
price adjustments are provided at the time of shipment.
Research and Development
Research and development costs are expensed as incurred.
Income Taxes
The Company accounts for income taxes under an asset and liability approach
that requires the recognition of deferred tax liabilities and assets for the
expected future tax consequences of timing differences between the carrying
amounts and the tax bases of assets and liabilities. U.S. deferred income taxes
are provided on unremitted earnings of the Company's foreign subsidiaries to the
extent that such earnings are not considered permanently invested.
Stock Based Compensation
The Company accounts for stock based employee compensation arrangements
using the intrinsic value method as prescribed in Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations thereof. Accordingly, compensation costs for stock options is
measured as the excess, if any, of the market price of the Company's stock at
the date of grant over the stock option exercise price. In addition, the Company
complies with the disclosure provisions of Statement of Financial Accounting
Standard No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123").
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 potential common shares
outstanding during the period, except if anti-dilutive. Potential common shares
consist of the incremental common shares issuable upon the exercise of stock
options (using the treasury stock method).
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (SFAS No. 130), "Reporting Comprehensive
Income" and No. 131 (SFAS No. 131), "Disclosures About Segments of an Enterprise
and Related Information."SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components in a full set of
general-purpose financial statements. SFAS No. 130 is effective for fiscal years
beginning after December 15, 1997. Reclassification of financial statements for
earlier periods provided for comparative purposes is required. SFAS No. 131
supersedes SFAS No. 14 and requires segment information be reported on the basis
that it is used internally for evaluating segment performance and deciding how
to allocate resources to segments in quarterly and annual reports. SFAS No. 131
is effective for annual reports for fiscal years beginning after December 15,
31
<PAGE> 33
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1997 and applicable to interim financial statements beginning in the second year
of application, along with comparative information for interim periods in the
initial year of applications. The Company believes that adoption of the new
standards will not have a material impact on the Company's consolidated
financial statements.
32
<PAGE> 34
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. BALANCE SHEET COMPONENTS (IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
------- -------
<S> <C> <C>
Cash and cash equivalents:
Cash and money market accounts......................... $46,569 $23,318
Municipal notes and bonds.............................. 2,386 4,342
Certificates of deposit................................ 100 100
------- -------
$49,055 $27,760
======= =======
Short-term investments:
Municipal notes and bonds.............................. $20,149 $14,524
======= =======
Accounts receivable:
Accounts receivable.................................... $22,540 $37,251
Less: allowance for doubtful accounts.................. (486) (986)
------- -------
$22,054 $36,265
======= =======
Inventories:
Raw materials.......................................... $ 2,192 $ 2,989
Work-in-process........................................ 14,302 27,416
Finished goods......................................... 18,797 37,664
------- -------
Gross inventories...................................... 35,291 68,069
Less: inventory reserves............................... (2,141) (20,784)
------- -------
$33,150 $47,285
======= =======
Property and equipment:
Land................................................... $ 4,128 $ 3,899
Buildings and building improvements.................... 11,809 15,838
Machinery and equipment................................ 10,601 22,080
Furniture and fixtures................................. 618 824
------- -------
Cost of property and equipment......................... 27,156 42,641
Less: accumulated depreciation and amortization........ (4,790) (9,719)
------- -------
$22,366 $32,922
======= =======
Other assets:
Foundry prepayments and investments.................... $50,057 $44,733
Prepaid license fees................................... 1,350 1,725
Covenants not to compete............................... 3,507 10,262
Technical infrastructure............................... -- 6,339
Other.................................................. 689 888
------- -------
$55,603 $63,947
======= =======
Accounts payable and accrued expenses:
Accounts payable....................................... $22,597 $42,373
Accrued compensation costs............................. 2,513 2,449
Advances payable to vendors............................ 28,929 --
Accrued commission and royalties....................... 2,074 1,196
Other accrued liabilities.............................. 2,320 4,840
------- -------
$58,433 $50,858
======= =======
</TABLE>
33
<PAGE> 35
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. DEBT
The Company has an unsecured short-term line of credit agreement with a
foreign bank of $20 million which expires on May 31, 1999. Under the terms of
the agreement, the Company may borrow at a fixed rate of LIBOR plus 1% or a
variable rate at the foreign bank's reference rate minus 1%. The Company also
has a second unsecured short-term line of credit agreement with another bank for
$10 million, which expires on June 10, 1998. Under the terms of the agreement,
the Company may borrow at a variable rate of either LIBOR plus 1% or at the
bank's reference rate minus 1%. Both lines of credit require the Company to
achieve certain financial ratios and operating results. A covenant of one of the
lines was not met in the fourth quarter of 1997. A waiver has been obtained
during the first quarter of 1998. There were no borrowings under the lines of
credit as of December 31, 1997.
4. INCOME TAXES
Income before provision for income taxes consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1995 1996 1997
------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Domestic..................................... $50,363 $55,191 $ 13,947
Foreign...................................... 68 248 (10,975)
------- ------- --------
$50,431 $55,439 $ 2,972
======= ======= ========
</TABLE>
Provision for income taxes consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1995 1996 1997
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal..................................... $18,382 $29,406 $15,011
State....................................... 3,200 3,955 1,769
Foreign..................................... 24 42 38
------- ------- -------
21,606 33,403 16,818
------- ------- -------
Deferred:
Federal..................................... (1,056) 330 (2,550)
State....................................... (5) 80 (430)
------- ------- -------
(1,061) 410 (2,980)
------- ------- -------
Total............................... $20,545 $33,813 $13,838
======= ======= =======
</TABLE>
34
<PAGE> 36
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A reconciliation between the provision for income taxes computed at the
federal statutory rate of 35% for the years ended December 31, 1995, 1996 and
1997 and the provision for income taxes is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1995 1996 1997
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Provision at statutory rate................... $17,651 $19,404 $ 1,040
Taxes (benefits)/costs of earnings of foreign
subsidiary.................................. -- -- 4,275
State income taxes, net of federal tax
benefit..................................... 3,048 1,843 94
Tax-exempt interest income.................... -- (509) (333)
General business credit....................... -- (371) (643)
Nondeductible research and development
costs....................................... -- 12,758 8,480
Other......................................... (154) 688 925
------- ------- -------
Provision for income taxes.................... $20,545 $33,813 $13,838
======= ======= =======
</TABLE>
Deferred tax assets (liabilities) are comprised of the following:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------------
1996 1997
------- -------
(IN THOUSANDS)
<S> <C> <C>
State income taxes....................................... $ 974 $ 533
Accounts receivable and inventory reserves............... 1,006 3,680
Accrued expenses......................................... 754 370
Legal reserves and other................................. 536 315
------- -------
Total deferred tax assets...................... 3,270 4,898
Unremitted earnings of foreign subsidiary................ (4,069) (4,069)
Covenants not to compete and technical infrastructure.... (1,343) (5,437)
------- -------
Net deferred tax liabilities................... $(2,142) $(4,608)
======= =======
</TABLE>
5. SHAREHOLDERS' EQUITY
Common Stock
On July 15, 1996, the Company's Board of Directors authorized repurchase at
management's discretion of up to 2.0 million of the Company's shares of Common
Stock over the subsequent 12 months at market prices and as the market and
business conditions warrant. At December 31, 1996, the Company had repurchased
1,802,500 shares at market prices ranging from $9.41 to $16.75 per share.
On April 29, 1997, the Company's Board of Directors authorized repurchase
at management's discretion of up to 2 million of the Company's shares of Common
Stock over the subsequent 12 months at market prices and as the market and
business conditions warrant. There were no repurchases under this program as of
December 31, 1997.
1986 Stock Option Plan
In February 1986, the Company adopted the 1986 Stock Option Plan (the "1986
Plan"). Under the 1986 Plan, 3,600,000 shares of Common Stock were reserved for
issuance to employees, consultants and investors as approved by the Board of
Directors. The 1986 Plan provides for incentive stock options and the Board may
terminate the 1986 Plan at any time. Options under the 1986 Plan are granted,
subject to certain conditions, at estimated fair value as determined by the
Board of Directors. Options granted under the 1986 Plan generally
35
<PAGE> 37
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
vest 25% each year after the date of grant. Options are adjusted on a pro rata
basis for certain changes in the capitalization of the Company, such as stock
splits and stock dividends. In addition, the outstanding options issued under
the 1986 Plan terminate within 90 days after termination of an option holder's
employment with the Company.
1992 Stock Option Plan
In January 1992, the Company adopted the 1992 Stock Option Plan (the "1992
Plan"). The 1992 Plan authorized 6,966,000 shares to be reserved for issuance.
The terms of the 1992 Plan are generally similar to those of the 1986 Plan
outlined above.
Executive Plan
In January 1990 and March 1991, the Company granted 5,400,000 and 1,080,000
options, respectively, outside of the 1986 Plan to officers of the Company under
the Executive Plan. The options were granted at the then fair value of $0.083
per share, as determined by the Board of Directors. The options generally vested
over periods of one to four years.
Equity Incentive Plan
In August 1995, the Company adopted the 1995 Equity Incentive Plan (the
"Incentive Plan"), which provides for the grant of stock options and stock
bonuses and the issuance of restricted stock by the Company to its employees,
directors and others. The Company has reserved 3,000,000 shares of the Company's
Common Stock for issuance under the Incentive Plan.
In September 1996, the Company canceled 326,000 shares under the Incentive
Plan with exercise prices greater than $14.75 and reissued the options with an
exercise price of $14.75.
In May 1997, the Company canceled 720,000 shares under the Incentive Plan
with exercise prices greater than $13.94 and reissued the options with an
exercise price of $13.94.
Employee Stock Purchase Plan
In August 1995, the Company adopted the 1995 Employee Stock Purchase Plan
(the "Purchase Plan") and reserved a total of 225,000 shares of the Company's
Common Stock for issuance thereunder. The Purchase Plan permits eligible
employees to acquire shares of the Company's Common Stock through payroll
deductions.
Directors Plan
In August 1995, the Company adopted the Directors Plan and reserved a total
of 300,000 shares of the Company's Common Stock for issuance thereunder. The
Directors Plan allows for granting of stock options to members of the Board of
Directors of the Company.
1997 Equity Incentive Plan
In May 1997, the Company adopted the 1997 Equity Incentive Plan (the "1997
Incentive Plan") and reserved a total of 3,000,000 shares of the Company's
Common Stock for issuance thereunder. The terms of the 1997 Incentive Plan are
generally similar to those of the Incentive Plan outlined above.
Platform Stock Option Plan
In June 1997, in connection with the acquisition of Platform Technologies,
Inc. ("Platform"), the Company assumed the Platform Stock Option Plan (the
"Platform Plan"). The Company does not plan to
36
<PAGE> 38
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
issue any additional options under the Platform Plan and has reserved
approximately 954,000 shares of Common Stock for issuance under the Platform
Plan pursuant to the exercise of options that were outstanding at the time of
the Platform acquisition. The Platform options vest ratably over four years.
Stock Based Compensation:
Transactions under the Company's various Stock Option Plans are summarized
as follows (in thousands except per share amounts):
<TABLE>
<CAPTION>
AVAILABLE
FOR OPTIONS WEIGHTED AVERAGE
GRANT OUTSTANDING EXERCISE PRICE
--------- ----------- ----------------
<S> <C> <C> <C>
Balance at December 31, 1994........................... 2,324 5,813 $ 0.65
Authorized........................................... 3,300 -- --
Granted.............................................. (2,048) 2,048 $ 5.88
Exercised............................................ -- (799) $ 0.15
Canceled............................................. 295 (295) $ 4.97
------ ------ ------
Balance at December 31, 1995........................... 3,871 6,767 $ 2.11
Granted.............................................. (2,595) 2,595 $15.79
Exercised............................................ -- (3,666) $ 0.85
Canceled............................................. 863 (863) $13.79
------ ------ ------
Balance at December 31, 1996........................... 2,139 4,833 $ 8.30
Authorized........................................... 3,000 -- --
Reserved for Platform acquisition.................... 954 -- --
Granted.............................................. (4,129) 4,129 $11.78
Exercised............................................ -- (886) $ 2.59
Canceled............................................. 1,426 (1,426) $17.70
------ ------ ------
Balance at December 31, 1997........................... 3,390 6,650 $ 9.20
====== ====== ======
</TABLE>
The options exercisable at December 31, 1997 was 1,719,000 shares. The
weighted average grant date fair value of options granted during the years ended
December 31, 1995, 1996 and 1997 were $2.16, $8.68 and $8.91, respectively.
The following table summarizes information about stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------------- ------------------------------------
NUMBER NUMBER
OUTSTANDING AT AVERAGE REMAINING EXERCISABLE AT
RANGE OF DECEMBER 31, 1997 CONTRACTUAL LIFE WEIGHTED AVERAGE DECEMBER 31, 1997 WEIGHTED AVERAGE
EXERCISE PRICES (IN THOUSANDS) (YEARS) EXERCISE PRICE (IN THOUSANDS) EXERCISE PRICE
- --------------------- ----------------- ----------------- ---------------- ----------------- ----------------
<S> <C> <C> <C> <C> <C>
$ 0.03 - $ 1.40...... 1,796 6.71 $ 0.57 1,060 $ 0.48
2.67 - 5.33...... 760 5.44 3.15 249 1.05
7.56 - 12.88...... 826 6.40 10.78 136 10.62
12.94 - 16.00...... 2,934 7.26 14.39 191 14.96
$16.25 - $30.88...... 334 6.54 19.83 83 19.13
----- ---- ------ ----- ------
6,650 6.76 $ 9.20 1,719 $ 4.15
===== ==== ====== ===== ======
</TABLE>
37
<PAGE> 39
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Fair Value Disclosures
The Company's pro forma net income (loss) and pro forma net income (loss)
per share would have been as follows had compensation costs for options granted
since 1995 under the Company's option plans been determined based on the fair
value at the grant dates, as prescribed in SFAS 123, (in thousands except per
share amounts):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
----------------------------
1995 1996 1997
------- ------- --------
<S> <C> <C> <C>
Net income (loss):
As reported............................ $29,886 $21,626 $(10,866)
Pro forma.............................. $29,454 $18,902 $(17,278)
Net income (loss) per share -- basic:
As reported............................ $ 0.96 $ 0.57 $ (0.27)
Pro forma.............................. $ 0.94 $ 0.50 $ (0.44)
Net income (loss) per share -- diluted:
As reported............................ $ 0.79 $ 0.52 $ (0.27)
Pro forma.............................. $ 0.78 $ 0.45 $ (0.44)
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes model with the following assumptions used for grants during
the years ended December 31, 1995, 1996 and 1997: dividend yield of 0.0% for
these periods; expected volatility of 0% for the period between January 1, 1995
through October 5, 1995 (the date of the initial public offering), expected
volatility of 67% for the period between October 6, 1995 and December 31, 1995,
64% for the year ended December 31, 1996 and 70% for the year ended December 31,
1997; risk-free interest rates of 6.20%, 6.30% and 6.23% for the years ended
December 31, 1995, 1996 and 1997, respectively; and a weighted average expected
option term of 5 years for these periods.
Sales under the Purchase Plan in 1996 and 1997 were approximately 47,000
shares and 75,000 shares, respectively, at an average price per share of $13.19
and $10.89, respectively. Compensation cost (included in pro forma net income
(loss) and net income (loss) per share amounts) for the grant date fair value,
as defined by SFAS 123, of the purchase rights granted under the Purchase Plan
was calculated using the Black-Scholes model with the following assumptions for
1995, 1996 and 1997: an expected life of six months for these periods; expected
volatility of 63%, 69% and 70%, respectively; expected dividend yield of 0% for
these periods and risk-free interest rates of 5.81%, 5.31% and 6.00%,
respectively. The weighted average estimated grant date fair value, as defined
by SFAS 123, of rights to purchase stock under the Purchase Plan in 1995, 1996
and 1997 were $7.50, $5.34 and $5.00 per share, respectively.
Because additional option grants are expected to be made each year, the
above pro forma disclosures are not representative of pro forma effects of
reported net income for future years.
38
<PAGE> 40
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. EARNINGS PER SHARE
Earnings per share are calculated in accordance with the provisions of
Statement of Financial Accounting Standards No. 128 -- "Earnings per Share"
(SFAS No. 128), effective for 1997. SFAS No. 128 requires the Company to report
both basic earnings per share, which is based on the weighted-average number of
common shares outstanding, and diluted earnings per share, which is based on the
weighted average number of common shares outstanding and all dilutive potential
common shares outstanding. All prior years' earnings per share data in this
report have been recalculated to reflect the provisions of SFAS No. 128. All
earnings per share data in this report reflect basic earnings per share, unless
otherwise indicated.
<TABLE>
<CAPTION>
PER SHARE
INCOME SHARES AMOUNT
-------- ------- ---------
<S> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1995
Earnings per share of common stock.......................... $ 29,886 31,265 $ 0.96
-------
Effect of dilutive securities:
Stock options............................................. -- 3,225
Cheap stock............................................... -- 3,285
-------- -------
Earnings per share of common stock -- assuming dilution..... $ 29,886 37,775 $ 0.79
-------- ------- ------
YEAR ENDED DECEMBER 31, 1996
Earnings per share of common stock.......................... $ 21,626 37,702 $ 0.57
-------
Effect of dilutive securities:
Stock options............................................. -- 3,886
-------- -------
Earnings per share of common stock -- assuming dilution..... $ 21,626 41,588 $ 0.52
-------- -------
YEAR ENDED DECEMBER 31, 1997
Loss per share of common stock.............................. $(10,866) 39,593 $(0.27)
--------
Effect of dilutive securities:
Stock options............................................. -- --
-------- -------
Loss per share of common stock -- assuming dilution......... $(10,866) 39,593 $(0.27)
======== ======= ======
</TABLE>
7. INDUSTRY SEGMENT AND FOREIGN OPERATIONS
The Company and its wholly-owned subsidiaries are engaged in the design,
manufacture and marketing of semiconductor products for the PC and consumer
marketplaces. Sales and purchase transactions are generally denominated in U.S.
dollars. Most of the Company's revenues outside the U.S. are made in the Far
East. Most of the identified assets located outside the U.S. are in the Far
East.
The following is a summary of the Company's geographic operations:
<TABLE>
<CAPTION>
DOMESTIC FOREIGN TOTAL
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Year ended December 31, 1995:
Net revenues............................................. $ 29,024 $ 76,720 $105,744
Income from operations................................... 47,737 -- 47,737
Identifiable assets...................................... 161,873 830 162,703
Year ended December 31, 1996:
Net revenues............................................. $ 18,790 $207,665 $226,455
Income from operations................................... 52,198 -- 52,198
Identifiable assets...................................... 210,964 1,021 211,985
Year ended December 31, 1997:
Net revenues............................................. $ 26,793 $222,724 $249,517
Income from operations................................... 10,025 (9,236) 789
Identifiable assets...................................... 194,053 37,601 231,654
</TABLE>
39
<PAGE> 41
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In October 1997, the Company established a wholly owned subsidiary in the
Cayman Island, British West Indies. The Cayman Island subsidiary and its branch
offices are responsible for the manufacturing and for the international sales of
the Company's products.
8. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF RISK
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of cash equivalents, short-term investments and
trade accounts receivable. Cash equivalents and short-term investments, which
primarily comprised of investments in money market funds and municipal debt
instruments, are maintained with high quality institutions and the composition
and maturities are regularly monitored by management.
The following table summarizes the percentage of net revenues accounted for
by the Company's significant customers for any year in which a customer or
distributor accounts for 10% or more of revenues.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Compaq Computer............................. 17% 12% --
Dynax....................................... -- -- 13%
Eastbase.................................... -- -- 13%
Universe Electron........................... 17% 13% --
</TABLE>
A majority of the Company's trade receivables are derived from sales to
manufacturers of computer systems. The Company generally extends 30-day credit
terms to its customers, which is consistent with industry business practices.
The Company performs ongoing credit evaluations of its customers' financial
condition and generally, requires letters of credit from international
customers. The Company maintains an allowance for doubtful accounts on its
receivables based upon the expected collectibility of all accounts receivable.
To date, the Company has not incurred any significant losses due to
uncollectible accounts receivable. At December 31, 1996 and 1997, approximately
30% and 35%, respectively, of trade accounts receivable represent amounts due
from two customers.
9. WAFER CAPACITY COMMITMENTS
In November 1995, the Company entered into agreements with two wafer
foundries, TSMC and UMC, in which the Company secured access to additional
manufacturing capacity and to certain technology.
Under the TSMC agreement, in exchange for TSMC's increased wafer capacity
commitments, the Company committed to pay approximately $32 million over two
years as deposits for wafers through 1999. The cash requirements associated with
this agreement were paid by the Company in the form of two $16 million payments
in 1996 and 1997. The payments can be applied to offset wafers purchased from
1996 to 1999 provided that the Company purchases not less than a certain
specified number of wafers during each of the four years ending December 31,
1999. As of December 31, 1997, $11.8 million of the payment was applied and
$20.1 million was included in other assets.
Under the UMC agreement, the Company entered into a joint venture
arrangement with UMC, together with other US semiconductor companies, to build a
separate semiconductor manufacturing facility located in Taiwan at an estimated
cost of $1 billion. The Company has invested approximately $24.6 million in the
joint venture. Under the terms of the agreement, the Company will receive a 5%
equity ownership in the joint venture company and certain capacity rights. The
facility was scheduled to open during 1998, but several fires during
construction have delayed construction. UMC has stated that it expects insurance
will cover its recent fire losses at the joint venture foundry.
40
<PAGE> 42
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. ACQUISITIONS AND RELATED CHARGES
On June 11, 1997, the Company completed its acquisition of Platform
Technologies, Inc. ("Platform"), a California based company, pursuant to which
the Company acquired all of the outstanding capital stock of Platform in
exchange for approximately 2.54 million shares of the Company's Common Stock
including approximately 954,000 options with a value of $32.7 million. Platform,
a wholly owned subsidiary of the Company, is developing integrated circuits for
the PC audio market incorporating the PCI standard.
On January 3, 1996, the Company completed its acquisition of VideoCore
Technology, Inc. ("VideoCore"), a California based company, pursuant to which
the Company acquired all of the outstanding capital stock of VideoCore in
exchange for approximately 525,000 shares of the Company's Common Stock and $5.7
million in cash. VideoCore, a wholly owned subsidiary of the Company, is
developing integrated circuits which incorporates advanced compression
technology for digital video products. On March 29, 1996, the Company completed
its acquisition of OSEE Technology, Inc. ("OSEE"), a California based company,
pursuant to which the Company acquired all of the outstanding capital stock of
OSEE in exchange for approximately 217,000 shares of the Company's Common Stock
and $3.6 million in cash. Also outstanding stock options of OSEE were exchanged
for 85,000 stock options of the Company. OSEE, a wholly owned subsidiary of the
Company, is a developer of advanced fax/modem algorithm technology which enables
the Company to provide modem and computer fax/modem applications on the
Company's multimedia processor.
The purchase price of these companies was allocated to assets acquired and
liabilities assumed based upon the book value of VideoCore's, OSEE's and
Platform's current assets, equipment and liabilities, which management believes
approximates their fair value, and independent appraisal for all other
identifiable assets as follows:
<TABLE>
<CAPTION>
VIDEOCORE
& OSEE PLATFORM
--------- --------------
(IN THOUSANDS)
<S> <C> <C>
Research and development in-process................. $30,355 $22,200
Technical infrastructure............................ -- 7,245
Covenants not to compete............................ 4,600 6,100
Current assets...................................... 12 3,209
Property and equipment.............................. 120 222
Current liabilities assumed......................... (607) (369)
Other liabilities assumed........................... (1,541) (5,204)
------- -------
$32,939 $33,403
Acquisition costs................................... (299) (700)
------- -------
Value of consideration issued for acquisition....... $32,640 $32,703
======= =======
</TABLE>
These acquisitions were recorded using the purchase method of accounting
and accordingly, the results of operations and cash flows of such acquisitions
have been included from the applicable dates of acquisition. Acquired research
and development in-process aggregating $22.2 million for the Platform
acquisition and $30.4 million for the VideoCore and OSEE acquisitions were
charged in the second quarter of 1997 and in the first quarter of 1996,
respectively. Additionally, the pro forma effect of the 1996 and 1997
acquisitions were not significant on the Company's reported operating results
for the fiscal years 1995, 1996 or 1997.
11. SUBSEQUENT EVENTS
On February 11, 1998, the Company announced that it had renegotiated
certain inventory purchases made prior to December 31, 1997. As a result, the
Company reported a net loss for the year of $10.9 million versus a net loss of
$16.2 million, as reported in the Company's January 22, 1998 press release.
41
<PAGE> 43
ESS TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
On February 13, 1998, the Compensation Committee of the Company's Board of
Directors announced that it had reviewed the status of outstanding options
issued to non-officers and officers of the Company and offered to exchange those
options held by non-officers with an exercise price exceeding the closing price
of the Company's Common Stock on February 13, 1998 (the "New Price") for options
with an exercise price equal to the New Price and with the same original vesting
start date and vesting schedule as the exchanged option, but with a restriction
on the exercisability of such repriced options until February 13, 1999. In
addition, the Compensation Committee offered to exchange those options held by
the executive officers of the Company (excluding Mr. Chan) with an exercise
price exceeding the New Price for options with an exercise price equal to the
New Price but with a restriction on the exercisability of such repriced options
until the later of February 17, 1999 or the earlier of the day following the
tenth consecutive trading day in which the closing price of the Company's Common
Stock is at or above $15.00 per share or February 17, 2001. Pursuant to the
offer, those repriced options held by officers that were not vested as of
February 17, 1998 will have a new vesting schedule of one-third of such unvested
repriced options at the end of each year commencing on February 17, 1998. If a
non-officer or officer voluntarily terminates his or her employment prior to the
end of the term of the applicable restriction on exercisability, the exchanged
options will be forfeited. Pursuant to the repricing, approximately 3,380,000
options with an exercise price greater than $7.69 were exchanged for options
with an exercise price of $7.69.
In March 1998, Creative Technology, Ltd. ("Creative") and E-mu Systems
Incorporated ("E-mu") filed a lawsuit against the Company and Diamond Multimedia
Incorporated alleging that the Company's Maestro family of products infringe
upon an E-mu patent which has been exclusively licensed by Creative. The
complaint seeks an injunction against future infringement, damages for past
infringement, fees and costs. If the Company were found to be infringing a valid
E-mu patent, then the Company could be required to cease sales of the infringing
products. The Company is vigorously contesting Creative's claims. In connection
with the Creative litigation, the Company has incurred and will continue to
incur legal and other expenses. While the outcome of such lawsuits cannot be
accurately predicted, based on the facts currently known, management does not
believe the ultimate resolution of this matter will have a material adverse
impact on the Company's financial position or results of operation.
42
<PAGE> 44
SELECTED QUARTERLY OPERATING RESULTS (UNAUDITED)
The following table presents unaudited quarterly financial information for
each of the Company's last eight quarters. This information has been derived
from the Company's unaudited financial statements and has been prepared on the
same basis as the audited Consolidated Financial Statements appearing elsewhere
in this Form 10-K. In the opinion of management, all necessary adjustments,
consisting only of normal recurring adjustments, have been included to present
fairly the quarterly results.
<TABLE>
<CAPTION>
1996 1997
---------------------------------------- ----------------------------------------
MAR. 31 JUNE 30 SEPT. 30 DEC. 31 MAR. 31 JUNE 30 SEPT. 30 DEC. 31
-------- ------- -------- -------- ------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenues............................. $ 41,188 $48,450 $60,138 $ 76,679 $81,468 $ 45,142 $52,172 $ 70,735
Cost of revenues......................... 17,637 21,889 29,540 37,752 41,772 27,220 35,200 67,668
-------- ------- ------- -------- ------- -------- ------- --------
Gross profit........................... 23,551 26,561 30,598 38,927 39,696 17,922 16,972 3,067
Operating expenses:
Research and development............... 3,631 4,551 5,577 6,511 5,571 7,057 8,343 8,501
Research and development in-process.... 30,355 -- -- -- -- 22,200 -- --
Selling, general and administrative.... 2,935 3,253 4,352 6,274 5,611 5,560 6,303 7,722
-------- ------- ------- -------- ------- -------- ------- --------
Operating income (loss).................. (13,370) 18,757 20,669 26,142 28,514 (16,895) 2,326 (13,156)
Nonoperating income, net................. 699 640 418 1,484 640 806 417 320
-------- ------- ------- -------- ------- -------- ------- --------
Income (loss) before income taxes........ (12,671) 19,397 21,087 27,626 29,154 (16,089) 2,743 (12,836)
Provision for (benefit from) income
taxes.................................. 7,250 7,565 8,224 10,774 11,327 2,284 1,025 (798)
-------- ------- ------- -------- ------- -------- ------- --------
Net income (loss)........................ $(19,921) $11,832 $12,863 $ 16,852 $17,827 $(18,373) $ 1,718 $(12,038)
======== ======= ======= ======== ======= ======== ======= ========
Net income (loss) per share -- basic..... $ (0.55) $ 0.31 $ 0.34 $ 0.45 $ 0.46 $ (0.47) $ 0.04 $ (0.30)
======== ======= ======= ======== ======= ======== ======= ========
Net income (loss) per share -- diluted... $ (0.55) $ 0.28 $ 0.31 $ 0.41 $ 0.43 $ (0.47) $ 0.04 $ (0.30)
======== ======= ======= ======== ======= ======== ======= ========
Shares used in calculating net income
(loss) per share -- basic.............. 36,234 38,660 38,050 37,821 38,440 38,990 40,376 40,537
======== ======= ======= ======== ======= ======== ======= ========
Shares used in calculating net income
(loss) per share -- diluted............ 36,234 42,414 41,128 41,011 41,469 38,990 43,390 40,537
======== ======= ======= ======== ======= ======== ======= ========
</TABLE>
The following table sets forth the above quarterly financial information as
a percentage of net revenues:
<TABLE>
<CAPTION>
1996 1997
-------------------------------------- --------------------------------------
MAR. 31 JUNE 30 SEPT. 30 DEC. 31 MAR. 31 JUNE 30 SEPT. 30 DEC. 31
------- ------- -------- ------- ------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenues......................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues..................... 42.8 45.2 49.1 49.2 51.3 60.3 67.5 95.7
----- ----- ----- ----- ----- ----- ----- -----
Gross margin....................... 57.2 54.8 50.9 50.8 48.7 39.7 32.5 4.3
Operating expenses:
Research and development........... 8.8 9.4 9.3 8.5 6.8 15.6 16.0 12.0
Research and development
in-process....................... 73.7 -- -- -- -- 49.2 -- --
Selling, general and
administrative................... 7.2 6.7 7.2 8.2 6.9 12.3 12.1 10.9
----- ----- ----- ----- ----- ----- ----- -----
Operating income (loss).............. (32.5) 38.7 34.4 34.1 35.0 (37.4) 4.4 (18.6)
Nonoperating income, net............. 1.7 1.3 0.7 1.9 0.8 1.8 0.8 0.5
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) before income taxes.... (30.8) 40.0 35.1 36.0 35.8 (35.6) 5.2 (18.1)
Provision for (benefit from) income
taxes.............................. 17.6 15.6 13.7 14.0 13.9 5.1 2.0 (1.1)
----- ----- ----- ----- ----- ----- ----- -----
Net income (loss).................... (48.4)% 24.4% 21.4% 22.0% 21.9% (40.7)% 3.2% (17.0)%
===== ===== ===== ===== ===== ===== ===== =====
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
Not applicable.
PART III
Certain information required by Part III is omitted from this Report since
the Company plans to file with the Securities and Exchange Commission the
definitive proxy statement for its 1998 Annual Meeting of
43
<PAGE> 45
Shareholders (the "Proxy Statement") not later than 120 days after the end of
the fiscal year covered by this Report, and certain information included therein
is incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning the Company's directors required by this Item is
incorporated by reference to the section in the Company's Proxy Statement
entitled "Proposal No. 1 -- Election of Directors -- Directors/ Nominees."
The information concerning the Company's executive officers required by
this Item is incorporated by reference herein to Part I, Item 4A, entitled
"Executive Officers of the Registrant" on page 11 of this Report.
The information concerning compliance with Section 16 of the Securities
Exchange Act of 1934 is incorporated by reference to the section in the
Company's proxy statement entitled "Compliance under Section 16(a) of the
Securities Exchange Act of 1934."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the
sections in the Company's Proxy Statement entitled "Executive Compensation,"
"Compensation of Directors and "Compensation Committee Interlocks and Insider
Participation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to the
section in the Company's Proxy Statement entitled "Security Ownership of Certain
Beneficial Owners and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to the
section in the Company's Proxy Statement entitled "Certain Transactions."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1)(2)FINANCIAL STATEMENTS.
The financial statements and schedules filed as part of this
report are listed in Item 8 on page 24.
3. EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
------- -------------
<C> <S>
2.01 Agreement and Plan of Reorganization dated December 12, 1995
among Registrant, ESS Acquisition Corporation and VideoCore
Technology, Inc. ("VideoCore") (Incorporated herein by
reference to Exhibit 2.1 to the Registrant's Current Report
on Form 8-K dated January 17, 1996 (the "Form 8-K")).
2.02 Agreement of Merger dated as of January 3, 1996 among
Registrant, ESS Acquisition Corporation and VideoCore.
(Incorporated herein by reference to Exhibit 2.2 to the Form
8-K).
2.03 First Amended and Restated Agreement and Plan of
Reorganization dated as of April 27, 1997 among Registrant,
EP Acquisition Corporation and Platform Technologies, Inc.
(Incorporated herein by reference to Exhibit 2.1 to the
Registrant's Current Report on Form 8-K dated April 30,
1997).
</TABLE>
44
<PAGE> 46
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
------- -------------
<C> <S>
3.01 Registrant's Articles of Incorporation (Incorporated herein
by reference to Exhibit 3.01 to the Registrant's Form S-1
registration statement (File No. 33-95388) declared
effective by the Securities and Exchange Commission on
October 5, 1995 (the "Form S-1")).
3.02 Registrant's Bylaws (Incorporated herein by reference to
Exhibit 3.02 to the Form S-1).
4.01 Form of Specimen Certificate for Registrant's Common Stock
(Incorporated herein by reference to Exhibit 4.01 to the
Form S-1).
4.02 Reference is made to Exhibit 3.01.
4.03 Registrant's Rights Agreement dated May 28, 1993 among the
Registrant and certain security holders (Incorporated herein
by reference to Exhibit 10.07 to the Form S-1).
10.01 Registrant's 1986 Stock Option Plan and related documents
(Incorporated herein by reference to Exhibit 10.01 to the
Form S-1).*
10.02 Registrant's 1992 Stock Option Plan and related documents
(Incorporated herein by reference to Exhibit 10.02 to the
Form S-1).*
10.03 Registrant's 1995 Equity Incentive Plan and related
documents (Incorporated herein by reference to Exhibit 10.03
to the Form S-1).*
10.04 Registrant's 1995 Directors Stock Option Plan and related
documents (Incorporated herein by reference to Exhibit 10.04
to the Form S-1).*
10.05 Registrant's 1995 Employee Stock Purchase Plan and related
documents (Incorporated herein by reference to Exhibit 10.05
to the Form S-1).*
10.06 Registrant's Amended 401(k) Plan (Incorporated herein by
reference to Exhibit 10.06 to the Form S-1).*
10.07 Registrant's Rights Agreement dated May 28, 1993 among the
Registrant and certain security holders (Incorporated herein
by reference to Exhibit 10.07 to the Form S-1).
10.08 Stock Transfer Agreement dated May 22, 1995 among WK
Technology Fund, WK Technology Fund II, WK Technology Fund
III, Fred S.L. Chan, Annie M.H. Chan and Fred S.L. and Annie
M.H. Chan Charitable Trust, dated November 20, 1992
(Incorporated herein by reference to Exhibit 10.08 to the
Form S-1).
10.09 Stock Transfer Agreement dated May 22, 1995 among Technology
Associates Corporation, Tekkang Management Consulting Inc.,
Kummell Investments Limited, Fred S.L. Chan, Annie M.H. Chan
and Fred S.L. and Annie M.H. Chan Charitable Trust, dated
November 20, 1992 (Incorporated herein by reference to
Exhibit 10.09 to the Form S-1).
10.10 Stock Transfer Agreement dated May 22, 1995 among Universe
Electron Corporation, Fred S.L. Chan, Annie M.H. Chan and
Fred S.L. and Annie M.H. Chan Charitable Trust, dated
November 20, 1992 (Incorporated herein by reference to
Exhibit 10.10 to the Form S-1).
10.11 Form of Indemnity Agreement entered into by Registrant with
each of its directors and executive officers (Incorporated
herein by reference to Exhibit 10.11 to the Form S-1).
10.12 Sublease dated October 15, 1992 between Raychem Corporation
(as successor in interest to Remtek Corporation) and
Registrant, as amended November 1, 1993, and September 1,
1994; Master Lease dated April 11, 1986 between Renco
Equities III and Remtek Corporation, as amended January 29,
1994; and Option to Renew Lease dated January 25, 1989
between Renco Equities III and Remtek Corporation
(Incorporated herein by reference to Exhibit 10.12 to the
Form S-1).
10.13 Standard Industrial/Commercial Multi-Tenant
Lease -- Modified Net dated April 3, 1995 between Gagos
Living Trust and Registrant, as amended May 1, 1995; and
Addendum thereto dated as of April 8, 1995 (Incorporated
herein by reference to Exhibit 10.13 to the Form S-1).
</TABLE>
45
<PAGE> 47
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
------- -------------
<C> <S>
10.14 Real Property Purchase Agreement and Deposit Receipt dated
July 5, 1995 between King & Lyons and Registrant
(Incorporated herein by reference to Exhibit 10.14 to the
Form S-1).
10.15 License Agreement dated November 12, 1987 among Forrest S.
Mozer, Registrant and Sharp Kabushiki Kaisha (Incorporated
herein by reference to Exhibit 10.15 to the Form S-1).**
10.16 License Agreement dated September 20, 1991 between
Registrant and Zilog, Inc. (Incorporated herein by reference
to Exhibit 10.16 to the Form S-1).**
10.17 Software License Agreement dated July 18, 1995 among
Registrant, Sensory Circuits, Inc. and Forrest Mozer
(Incorporated herein by reference to Exhibit 10.17 to the
Form S-1).**
10.18 Foundry Agreement dated March 29, 1993 between Registrant
and Integrated Circuit Works Incorporated (Incorporated
herein by reference to Exhibit 10.18 to the Form S-1).**
10.19 Purchase Agreement dated June 17, 1994 between Compaq
Computer Corporation and Registrant (Incorporated herein by
reference to Exhibit 10.19 to the Form S-1).**
10.20 International Distributorship Agreement dated July 1, 1994
between Registrant and Universe Electron Corporation
(Incorporated herein by reference to Exhibit 10.20 to the
Form S-1).
10.21 Option I Agreement between Registrant and Taiwan
Semiconductor Manufacturing Co., Ltd. ("TSMC") dated
November 30, 1995, as amended December 28, 1995.
(Incorporated herein by reference to Exhibit 10.21 to the
Registrant's Annual Report on Form 10-K, dated February 29,
1996 as amended March 29, 1996 (the "1995 Form 10-K").***
10.22 Option II Agreement between Registrant and TSMC dated
November 30, 1995. (Incorporated herein by reference to
Exhibit 10.22 to the 1995 Form 10-K).***
10.23 Foundry Venture Agreement between Registrant and United
Microelectronics Corporation ("UMC") dated November 28,
1995, as amended January 31, 1996. (Incorporated herein by
reference to Exhibit 10.23 to the 1995 Form 10-K).***
10.24 FabVen Foundry Capacity Agreement among FabVen, UMC and
Registrant dated November 28, 1995. (Incorporated herein by
reference to Exhibit 10.24 to the 1995 Form 10-K).***
10.25 Form of Employment and Non-Competition Agreement among the
Registrant, VideoCore and Jan Fandrianto dated December 12,
1995. (Incorporated herein by reference to Exhibit 2.1 to
the Form 8-K).*
10.26 Form of Employment and Non-Competition Agreement among the
Registrant, VideoCore and Chi-Shin Wang dated December 12,
1995. (Incorporated herein by reference to Exhibit 2.1 to
the Form 8-K).*
10.27 Form of Employment Agreement and Promissory Note among the
Registrant and John H. Barnet dated August 22 and September
16, 1996, respectively. (Incorporated herein by reference to
Exhibit 10.27 to the Registrant's Report on Form 10-Q, dated
November 14, 1996.)*
10.28 Form of Consulting and Employment Agreements among the
Registrant and Herbert J. Martin dated October 23, 1996
(Incorporated herein by reference to Exhibit 10.28 to the
Registrant's Annual Report Form 10-K, dated March 18, 1997
as amended on March 20, 1997 (the "1996 Form 10-K")).*
10.29 Form of Termination and Consulting Agreements among the
Registrant and Herbert J. Martin dated February 13, 1997
(Incorporated herein by reference to Exhibit 10.29 to the
1996 10-K).*
10.30 1997 Equity Incentive Plan and related agreements
(Incorporated herein by reference to Appendix I filed in the
Registrant's Proxy Statement for the 1997 Annual Meeting of
Shareholders, filed on April 30, 1997).*
10.31 Form of Exit Agreement between the Registrant and Bo
Ericsson dated November 26, 1997.*
</TABLE>
46
<PAGE> 48
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
------- -------------
<C> <S>
21.01 List of Registrant's subsidiaries.
23.01 Consent of Independent Accountants.
27.01 Financial Data Schedule.
</TABLE>
- ---------------
* Represents a management contract or compensatory plan of arrangement.
** Confidential treatment has been granted with respect to certain portions of
this agreement.
*** Confidential treatment has been requested with respect to certain portions
of this agreement.
(b) Reports on Form 8-K: The Company did not file a report on Form 8-K
during the quarter ended December 31, 1997.
With the exception of the information incorporated by reference to the
Company's Proxy Statement for the 1998 Annual Meeting of Shareholders in Items
10, 11, 12 and 13 of Part III, the Proxy Statement is not deemed to be filed as
part of this Report.
47
<PAGE> 49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, ESS Technology, Inc. has duly caused this Annual Report on
Form 10-K to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Fremont, State of California, on March 31, 1998.
ESS TECHNOLOGY, INC.
By: /s/ JOHN H. BARNET
------------------------------------
John H. Barnet
Vice President, Finance and
Chief Financial Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below hereby constitutes and appoints Fred S.L. Chan and John H. Barnet,
jointly and severally, his or her true and lawful attorneys-in-fact, each with
full power of substitution, for him or her in any and all capacities, to sign
any and all amendments to this Annual Report or Form 10-K, and to file the same,
with all exhibits thereto and all documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact or any of them, or his or their substitute or
substitutes, may lawfully do or cause to be done or by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------------ ------------------------------------ --------------
<S> <C> <C>
/s/ FRED S.L. CHAN President, Chief Executive Officer March 31, 1998
- ------------------------------------------------ and Chairman of the Board of
Fred S.L. Chan Directors (Principal Executive
Officer)
/s/ JOHN H. BARNET Vice President, Finance and March 31, 1998
- ------------------------------------------------ Chief Financial Officer
John H. Barnet (Principal Financial Officer)
/s/ HOWARD N. HIDESHIMA Controller March 31, 1998
- ------------------------------------------------ (Principal Accounting Officer)
Howard N. Hideshima
/s/ ANNIE M.H. CHAN Director March 31, 1998
- ------------------------------------------------
Annie M.H. Chan
Director March , 1998
- ------------------------------------------------
Michael A. Aymar
Director March , 1998
- ------------------------------------------------
Ilbok Lee
/s/ PETER T. MOK Director March 31, 1998
- ------------------------------------------------
Peter T. Mok
</TABLE>
48
<PAGE> 50
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
- ------- -------------
<S> <C> <C>
2.01 -- Agreement and Plan of Reorganization dated December 12, 1995
among Registrant, ESS Acquisition Corporation and VideoCore
Technology, Inc. ("VideoCore") (Incorporated herein by
reference to Exhibit 2.1 to the Registrant's Current Report
on Form 8-K dated January 17, 1996 (the "Form 8-K")).
2.02 -- Agreement of Merger dated as of January 3, 1996 among
Registrant, ESS Acquisition Corporation and VideoCore.
(Incorporated herein by reference to Exhibit 2.2 to the Form
8-K).
2.03 -- First Amended and Restated Agreement and Plan of
Reorganization dated as of April 27, 1997 among Registrant,
EP Acquisition Corporation and Platform Technologies, Inc.
(Incorporated herein by reference to Exhibit 2.1 to the
Registrant's Current Report on Form 8-K dated April 30,
1997).
3.01 -- Registrant's Articles of Incorporation (Incorporated herein
by reference to Exhibit 3.01 to the Registrant's Form S-1
registration statement (File No. 33-95388) declared
effective by the Securities and Exchange Commission on
October 5, 1995 (the "Form S-1")).
3.02 -- Registrant's Bylaws (Incorporated herein by reference to
Exhibit 3.02 to the Form S-1).
4.01 -- Form of Specimen Certificate for Registrant's Common Stock
(Incorporated herein by reference to Exhibit 4.01 to the
Form S-1).
4.02 -- Reference is made to Exhibit 3.01.
4.03 -- Registrant's Rights Agreement dated May 28, 1993 among the
Registrant and certain security holders (Incorporated herein
by reference to Exhibit 10.07 to the Form S-1).
10.01 -- Registrant's 1986 Stock Option Plan and related documents
(Incorporated herein by reference to Exhibit 10.01 to the
Form S-1).*
10.02 -- Registrant's 1992 Stock Option Plan and related documents
(Incorporated herein by reference to Exhibit 10.02 to the
Form S-1).*
10.03 -- Registrant's 1995 Equity Incentive Plan and related
documents (Incorporated herein by reference to Exhibit 10.03
to the Form S-1).*
10.04 -- Registrant's 1995 Directors Stock Option Plan and related
documents (Incorporated herein by reference to Exhibit 10.04
to the Form S-1).*
10.05 -- Registrant's 1995 Employee Stock Purchase Plan and related
documents (Incorporated herein by reference to Exhibit 10.05
to the Form S-1).*
10.06 -- Registrant's Amended 401(k) Plan (Incorporated herein by
reference to Exhibit 10.06 to the Form S-1).*
10.07 -- Registrant's Rights Agreement dated May 28, 1993 among the
Registrant and certain security holders (Incorporated herein
by reference to Exhibit 10.07 to the Form S-1).
10.08 -- Stock Transfer Agreement dated May 22, 1995 among WK
Technology Fund, WK Technology Fund II, WK Technology Fund
III, Fred S.L. Chan, Annie M.H. Chan and Fred S.L. and Annie
M.H. Chan Charitable Trust, dated November 20, 1992
(Incorporated herein by reference to Exhibit 10.08 to the
Form S-1).
10.09 -- Stock Transfer Agreement dated May 22, 1995 among Technology
Associates Corporation, Tekkang Management Consulting Inc.,
Kummell Investments Limited, Fred S.L. Chan, Annie M.H. Chan
and Fred S.L. and Annie M.H. Chan Charitable Trust, dated
November 20, 1992 (Incorporated herein by reference to
Exhibit 10.09 to the Form S-1).
</TABLE>
<PAGE> 51
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
- ------- -------------
<S> <C> <C>
10.10 -- Stock Transfer Agreement dated May 22, 1995 among Universe
Electron Corporation, Fred S.L. Chan, Annie M.H. Chan and
Fred S.L. and Annie M.H. Chan Charitable Trust, dated
November 20, 1992 (Incorporated herein by reference to
Exhibit 10.10 to the Form S-1).
10.11 -- Form of Indemnity Agreement entered into by Registrant with
each of its directors and executive officers (Incorporated
herein by reference to Exhibit 10.11 to the Form S-1).
10.12 -- Sublease dated October 15, 1992 between Raychem Corporation
(as successor in interest to Remtek Corporation) and
Registrant, as amended November 1, 1993, and September 1,
1994; Master Lease dated April 11, 1986 between Renco
Equities III and Remtek Corporation, as amended January 29,
1994; and Option to Renew Lease dated January 25, 1989
between Renco Equities III and Remtek Corporation
(Incorporated herein by reference to Exhibit 10.12 to the
Form S-1).
10.13 -- Standard Industrial/Commercial Multi-Tenant
Lease -- Modified Net dated April 3, 1995 between Gagos
Living Trust and Registrant, as amended May 1, 1995; and
Addendum thereto dated as of April 8, 1995 (Incorporated
herein by reference to Exhibit 10.13 to the Form S-1).
10.14 -- Real Property Purchase Agreement and Deposit Receipt dated
July 5, 1995 between King & Lyons and Registrant
(Incorporated herein by reference to Exhibit 10.14 to the
Form S-1).
10.15 -- License Agreement dated November 12, 1987 among Forrest S.
Mozer, Registrant and Sharp Kabushiki Kaisha (Incorporated
herein by reference to Exhibit 10.15 to the Form S-1).**
10.16 -- License Agreement dated September 20, 1991 between
Registrant and Zilog, Inc. (Incorporated herein by reference
to Exhibit 10.16 to the Form S-1).**
10.17 -- Software License Agreement dated July 18, 1995 among
Registrant, Sensory Circuits, Inc. and Forrest Mozer
(Incorporated herein by reference to Exhibit 10.17 to the
Form S-1).**
10.18 -- Foundry Agreement dated March 29, 1993 between Registrant
and Integrated Circuit Works Incorporated (Incorporated
herein by reference to Exhibit 10.18 to the Form S-1).**
10.19 -- Purchase Agreement dated June 17, 1994 between Compaq
Computer Corporation and Registrant (Incorporated herein by
reference to Exhibit 10.19 to the Form S-1).**
10.20 -- International Distributorship Agreement dated July 1, 1994
between Registrant and Universe Electron Corporation
(Incorporated herein by reference to Exhibit 10.20 to the
Form S-1).
10.21 -- Option I Agreement between Registrant and Taiwan
Semiconductor Manufacturing Co., Ltd. ("TSMC") dated
November 30, 1995, as amended December 28, 1995.
(Incorporated herein by reference to Exhibit 10.21 to the
Registrant's Annual Report on Form 10-K, dated February 29,
1996 as amended March 29, 1996 (the "1995 Form 10-K").***
10.22 -- Option II Agreement between Registrant and TSMC dated
November 30, 1995. (Incorporated herein by reference to
Exhibit 10.22 to the 1995 Form 10-K).***
10.23 -- Foundry Venture Agreement between Registrant and United
Microelectronics Corporation ("UMC") dated November 28,
1995, as amended January 31, 1996. (Incorporated herein by
reference to Exhibit 10.23 to the 1995 Form 10-K).***
10.24 -- FabVen Foundry Capacity Agreement among FabVen, UMC and
Registrant dated November 28, 1995. (Incorporated herein by
reference to Exhibit 10.24 to the 1995 Form 10-K).***
10.25 -- Form of Employment and Non-Competition Agreement among the
Registrant, VideoCore and Jan Fandrianto dated December 12,
1995. (Incorporated herein by reference to Exhibit 2.1 to
the Form 8-K).*
</TABLE>
<PAGE> 52
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
- ------- -------------
<S> <C> <C>
10.26 -- Form of Employment and Non-Competition Agreement among the
Registrant, VideoCore and Chi-Shin Wang dated December 12,
1995. (Incorporated herein by reference to Exhibit 2.1 to
the Form 8-K).*
10.27 -- Form of Employment Agreement and Promissory Note among the
Registrant and John H. Barnet dated August 22 and September
16, 1996, respectively. (Incorporated herein by reference to
Exhibit 10.27 to the Registrant's Report on Form 10-Q, dated
November 14, 1996.)*
10.28 -- Form of Consulting and Employment Agreements among the
Registrant and Herbert J. Martin dated October 23, 1996
(Incorporated herein by reference to Exhibit 10.28 to the
Registrant's Annual Report Form 10-K, dated March 18, 1997
as amended on March 20, 1997 (the "1996 Form 10-K")).*
10.29 -- Form of Termination and Consulting Agreements among the
Registrant and Herbert J. Martin dated February 13, 1997
(Incorporated herein by reference to Exhibit 10.29 to the
1996 10-K).*
10.30 -- 1997 Equity Incentive Plan and related agreements
(Incorporated herein by reference to Appendix I filed in the
Registrant's Proxy Statement for the 1997 Annual Meeting of
Shareholders, filed on April 30, 1997).*
10.31 -- Form of Exit Agreement between the Registrant and Bo
Ericsson dated November 26, 1997.*
21.01 -- List of Registrant's subsidiaries.
23.01 -- Consent of Independent Accountants.
27.01 -- Financial Data Schedule.
</TABLE>
- ---------------
* Represents a management contract or compensatory plan of arrangement.
** Confidential treatment has been granted with respect to certain portions of
this agreement.
*** Confidential treatment has been requested with respect to certain portions
of this agreement.
(b) Reports on Form 8-K: The Company did not file a report on Form 8-K
during the quarter ended December 31, 1997.
With the exception of the information incorporated by reference to the
Company's Proxy Statement for the 1998 Annual Meeting of Shareholders in Items
10, 11, 12 and 13 of Part III, the Proxy Statement is not deemed to be filed as
part of this Report.
<PAGE> 1
Exhibit 10.31
ESS
To: Fred Chan
From: Bo Ericsson
Date: November 26, 1997
Re: EXIT AGREEMENT
1. Ericsson's last date of full time employment will be Dec 12 1997.
Ericsson will serve as a consultant, reporting to Nicholas Aretakis, on a
part time basis for an additional four weeks (max 20 hours a week).
Ericsson's salary will end on Dec 12.
2. Ericsson's primary responsibility during his remaining time with ESS
will be a) generating candidates for the open VP marketing position, b)
transfer of the marketing organization to Nicholas Aretakis and c)
developing a business plan for ESS' personal computer business
3. On Dec 12 1997, ESS will pay Ericsson his 1997 bonus of 37.5K plus 60K
in severance payment, plus remaining salary balance. Upon receipt on
Dec 12 of these payments, ESS will have fulfilled all of its obligations
to Ericsson, per Ericsson's amended employment agreement, and Ericsson
will have no further claims against ESS.
/s/ Fred Chan /s/ Bo Ericsson
- ------------------------- -------------------------
Fred Chan, CEO Bo Ericsson
<PAGE> 1
EXHIBIT 21.01
LIST OF REGISTRANT'S SUBSIDIARIES
<TABLE>
<CAPTION>
PERCENTAGE OWNED
NAME JURISDICTION OF ORGANIZATION BY REGISTRANT
---- ---------------------------- ----------------
<S> <C> <C>
ESS (Far East) Ltd...................................... Hong Kong 100%
ESS Technology International, Inc....................... Cayman Islands 100%
OSEE Technology, Inc.................................... US 100%
VideoCore Technology, Inc............................... US 100%
Platform Technologies, Inc.............................. US 100%
</TABLE>
<PAGE> 1
EXHIBIT 23.01
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 33-97830) of ESS Technology, Inc. of our report dated
January 21, 1998, appearing on page XX of this Form 10-K.
PRICE WATERHOUSE LLP
San Jose, California
March 20, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 27,760
<SECURITIES> 14,524
<RECEIVABLES> 37,251
<ALLOWANCES> 986
<INVENTORY> 47,285
<CURRENT-ASSETS> 134,785
<PP&E> 42,641
<DEPRECIATION> 9,719
<TOTAL-ASSETS> 231,654
<CURRENT-LIABILITIES> 60,547
<BONDS> 0
0
0
<COMMON> 137,452
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 231,654
<SALES> 249,517
<TOTAL-REVENUES> 249,517
<CGS> 171,859
<TOTAL-COSTS> 171,859
<OTHER-EXPENSES> 76,869
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (2,183)
<INCOME-PRETAX> 2,972
<INCOME-TAX> 13,838
<INCOME-CONTINUING> (10,866)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (10,866)
<EPS-PRIMARY> (0.27)
<EPS-DILUTED> (0.27)
</TABLE>
