UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the quarterly period ended September 30, 2001.
OR
[ ] Transitional Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934.
For the transition period from: ___________ to: __________ .
Commission file number 0-32809
VIALTA, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 94-3337326
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
48461 Fremont Boulevard
Fremont, California 94538
(Address, including zip code, of Registrant's principal executive offices)
(510) 870-3088
(Registrant's telephone number, including area code)
Indicate by check whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes [ ] No [X]
The number of outstanding shares of the registrant's Class A common stock,
par value $0.001 per share, on November 7, 2001 was 46,656,636 shares. The
number of outstanding shares of the registrant's Class B common stock, par value
$0.001 per share, on November 7, 2001 was 40,580,375 shares.
VIALTA, INC.
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION 2
Item 1. Financial Statements, unaudited: 2
Consolidated Balance Sheets - September 30, 2001, and
December 31, 2000 2
Consolidated Statements of Operations - three months
and nine months ended September 30, 2001 and 2000 3
Consolidated Statements of Cash Flows - nine months
ended September 30, 2001 and 2000 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25
PART II. OTHER INFORMATION 25
Item 1 Legal Proceedings 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 26
1
PART I. FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
VIALTA, INC.
(A Development Stage Company)
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except per share amounts)
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------ -----------
ASSETS
Current assets:
Cash and cash equivalents $ 72,722 $ 109,378
Short-term investments 4,806 27,112
Receivables from related party -- 650
Inventories 3,443 2,057
Prepaid expenses and other current assets 6,044 4,207
--------- ---------
Total current assets 87,015 143,404
Property and equipment, net 9,279 9,230
Long term investments 4,582 --
Other assets 324 1,057
--------- ---------
Total assets $ 101,200 $ 153,691
========= =========
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 927 $ 1,376
Accrued expenses and other current liabilities 2,750 2,218
Payable to related party 901 30,000
--------- ---------
Total current liabilities 4,578 33,594
--------- ---------
Redeemable convertible preferred stock, $0.001 par value;
30,000 shares authorized, 0 and 91,000 shares issued
and outstanding, at September 30, 2001 and
December 31, 2000, respectively -- 142,600
--------- ---------
Stockholders' equity (deficit):
Common stock $0.001 par value, 400,000 shares
authorized, 91,536 and 6,231 shares issued, 90,048
and 6,231 shares outstanding at September 30, 2001
and December 31, 2000 respectively 92 6
Additional paid in capital 144,160 1,629
Treasury stock (290) --
Other comprehensive income 155 --
Deficit accumulated during the development stage (47,495) (24,138)
--------- ---------
Total stockholders' equity (deficit) 96,622 (22,503)
--------- ---------
Total liabilities, redeemable convertible preferred stock
and stockholders' equity (deficit) $ 101,200 $ 153,691
========= =========
The accompanying notes are an integral part of these Consolidated Financial Statements.
2
VIALTA, INC.
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(in thousands, except per share data)
Period from
April 20, 1999
(date of
Three Months Ended Nine Months Ended inception)
------------------ ----------------- through
September 30, September 30, September 30, September 30, September 30,
2001 2000 2001 2000 2001
-------- -------- -------- -------- --------
Operating expenses:
Research and development $ 5,446 $ 3,733 $ 15,337 $ 13,438 $ 36,264
Selling and marketing 838 816 2,995 1,981 6,585
General and administrative 2,412 1,935 7,016 4,853 14,225
-------- -------- -------- -------- --------
Operating expenses: 8,696 6,484 25,348 20,272 57,074
-------- -------- -------- -------- --------
Operating loss (8,696) (6,484) (25,348) (20,272) (57,074)
Interest income 801 1,944 3,086 5,910 11,510
Interest expense -- -- -- -- (224)
Operating expenses (net) (1,097) (1,679) (1,101) (1,343) (2,774)
-------- -------- -------- -------- --------
Loss before income tax benefit (8,992) (6,219) (23,363) (15,705) (48,562)
Income tax benefit -- 65 -- 195 1,060
-------- -------- -------- -------- --------
Net loss $ (8,992) $ (6,154) $(23,363) $(15,510) $(47,502)
======== ======== ======== ======== ========
Net loss per share attributable to
common shares -- basic and diluted $ (0.13) $ (0.99) $ (0.35) $ (2.49)
======== ======== ======== ========
Weighted average common shares
outstanding 67,497 6,220 67,201 6,220
======== ======== ======== ========
The accompanying notes are an integral part of these Consolidated Financial Statements.
3
VIALTA, INC.
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
PERIOD FROM
APRIL 20, 1999
(DATE OF
NINE MONTHS ENDED INCEPTION)
----------------- THROUGH
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (23,363) $ (15,510) $ (47,501)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 3,941 1,738 7,833
Write-down of long-term investment 1,083 1,667 2,750
Income tax benefit on disqualifying disposition of common
stock options (77)
Unrealized gain on marketable securities 155 -- 155
Non-cash interest receivable 158 -- 158
Changes in assets and liabilities:
Prepaid expenses and other current assets (1,972) (1,689) (6,179)
Receivable from ESS 1,551 411 978
Receivable/payable from/to other related party 60 (60) --
Inventories (1,386) (4,401) (3,443)
Other assets -- (3) (53)
Accounts payable and accrued liabilities 62 3,006 3,733
Net cash used in operating activities (19,711) (14,841) (41,646)
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (1,754) (4,175) (13,487)
Purchase of marketable securities (9,389) (44,085) (130,177)
Proceeds from sale of marketable securities 27,113 22,344 120,789
Purchase of long-term investments (2,641) (4,000) (6,641)
---------- ---------- ----------
Net cash provided by investing activities 13,329 (29,916) (29,516)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable to related party (30,000) -- --
Proceeds from issuance of preferred stock- -- 27,820 142,600
Proceeds from issuance of common stock 16 1,475 1,574
Repurchase of common stock (290) (290)
---------- ---------- ----------
Net cash provided by financing activities (30,274) 29,295 143,884
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents (36,656) (15,462) 72,722
Cash and cash equivalents at beginning of period 109,378 90,500 --
---------- ---------- ----------
Cash and cash equivalents at end of period $ 72,722 $ 75,038 $ 72,722
---------- ---------- ----------
SUPPLEMENTAL NONCASH FINANCING ACTIVITY:
Issuance of note receivable in connection with issuance
of common stock
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest 194 194
========== ==========
The accompanying notes are an integral part of these
Consolidated Financial Statements.
4
NOTE 1. THE COMPANY
Vialta, Inc. ("Vialta or The Company") was incorporated in California in
April 1999. Vialta has developed a multi-purpose DVD player ("ViDVD") that
offers Internet access and other features, such as CD, MP3, karaoke, and support
for other audio and video formats. These features differentiate it from most DVD
players currently available in the U.S. consumer market. This ViDVD player is
the first product offering from Vialta's "Digital Home System" platform, which
the Company anticipates will grow to support a family of multimedia Internet
appliances. Vialta commenced shipments of the ViDVD through retail distribution
channels in the third quarter of 2001, but no revenue will be recognized until
contractual obligations under the sales agreements have been satisfied.
On April 21, 2001, the board of directors of ESS Technology, Inc. ("ESS")
approved the spin-off of ESS's interest in Vialta to ESS's shareholders. The
transaction was completed on August 21, 2001 when ESS distributed approximately
50,560,328 shares of Class A common stock of Vialta, Inc., resulting in Vialta
operating as a stand alone business, independent from ESS.
On May 25, 2001, Vialta was reincorporated in the State of Delaware. As
part of the reincorporation, Vialta was authorized to issue 180,000,000 shares
of preferred stock, $0.001 par value per share, and 300,000,000 shares of common
stock, $0.001 par value per share. All common stock and preferred stock amounts
in the accompanying financial statements have been restated to give effect to
the reincorporation.
Since its inception, Vialta has been in the development stage. Vialta has
been successful in completing its private equity financing with its last round
totaling approximately $132.6 million. However, Vialta has incurred substantial
losses and negative cash flows from operations in every fiscal period since
inception. For the cumulative period ended September 30, 2001, Vialta incurred a
loss from operations of approximately $57.1 million (unaudited) and negative
cash flows from operations of $41.6 million (unaudited). Management expects
operating losses and negative cash flows to continue for the foreseeable future
and anticipates that losses will increase significantly from current levels
because of additional costs and expenses related to marketing activities,
continued expansion of operations, continued development of Vialta's web site
and information technology infrastructure, expansion of product offerings and
development of relationships with other businesses. Management believes that
Vialta has sufficient cash, cash equivalents, and short term investments to fund
its development and growth. However, in the longer term, failure to generate
sufficient revenues, raise additional capital or reduce certain discretionary
spending could have a material adverse effect on Vialta's ability to achieve its
intended business objectives
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The accompanying financial statements include the consolidated accounts of
Vialta and its wholly owned subsidiaries. The accompanying unaudited Financial
Statements have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles ("GAAP") have been
condensed or omitted pursuant to such rules and regulations. In the opinion of
management, the financial statements reflect only those normal recurring
adjustments necessary for a fair statement of the financial position, operating
results and cash flows of the Company for the periods presented. These
Consolidated Financial Statements should be read in conjunction with the
Consolidated Financial Statements and notes thereto for the year ended December
31, 2000 and the period from April 1999 (date of inception) through December 31,
1999, included in the Company's Form 10. The results of operations for this
interim period are not necessarily indicative of the results that may be
expected for any other period or for the fiscal year, which ends December 31,
2001.
Interim unaudited information
Preparing the Company's financial statements in accordance with GAAP requires
management to make estimates and assumptions that affect the reported amount of
assets and liabilities, disclosure of contingent assets and liabilities at the
close of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from these
estimates. Certain reclassifications have been made to present the financial
statements on a consistent basis.
Recent accounting pronouncements
5
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations." SFAS 141 requires the purchase method of accounting for business
combinations initiated after June 30, 2001 and eliminates the
pooling-of-interests method. The adoption of SFAS 141 does not have a
significant impact on our financial statements.
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which is effective for
fiscal years beginning after December 15, 2001. SFAS 142 requires, among other
things, the discontinuance of goodwill amortization. In addition, the standard
includes provisions upon adoption for the reclassification of certain existing
recognized intangibles as goodwill, reassessment of the useful lives of existing
recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill and the testing for impairment of existing goodwill
and other intangibles. The adoption of SFAS 142 will not have a significant
impact on our financial position and results of operations.
On October 3, 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets". SFAS 144 supercedes SFAS 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of." SFAS 144 applies to all long-lived assets (including discontinued
operations) and consequently amends Accounting Principles Board Opinion No. 30.
SFAS 144 develops one accounting model for long-lived assets that are to be
disposed of by sale. SFAS 144 requires that long-lived assets that are to be
disposed of by sale be measured at the lower of book value or fair value less
cost to sell. Additionally, SFAS 144 expands the scope of discontinued
operations to include all components of an entity with operations that (1) can
be distinguished from the rest of the entity and (2) will be eliminated from the
ongoing operations of the entity in a disposal transaction. SFAS 144 is
effective for the Company for all financial statements issued in fiscal 2002.
We are currently assessing the impact of SFAS 144 on our financial position and
results of operations.
NOTE 3: RECAPITALIZATION OF EQUITY
On July 24, 2001, Vialta was re-capitalized, pursuant to which it
separated its common stock into Class A common stock with 3.8 votes per share
and Class B common stock with one vote per share. Upon exchange of 5,891,000
shares of common stock for Class B common stock, Vialta issued 589,000
additional shares of Class B common stock to non-ESS common stockholders.
Besides the voting power, Class A and Class B stockholders have the same rights.
Vialta authorized 30,000,000 shares of preferred stock and 400,000,000 shares of
common stock, 100,000,000 shares of which are designated Class A common stock,
50,000,000 of which are designated Class B common stock and 250,000,000 of which
are designated non-classified common stock.
As part of the spin-off transaction, all preferred stock owned by ESS
converted to Class A common stock based on a ration of 1 to 1. All other
preferred stock converted to Class B common stock based on a ratio of 1.1 to 1.
As a result, 91,000,000 shares of preferred stock were converted to 60,000,000
shares of Class A common stock and 34,100,000 shares of Class B common stock.
As part of the spin-off transaction, ESS returned 9,818,000 shares of
Class A common stock to Vialta at no cost. These shares are reserved by Vialta
for issuance upon exercise of stapled stock options that were granted by Vialta
to ESS optionees as part of the spin-off transaction. In accordance with FIN 44,
no compensation expense will result from these stock option grants.
NOTE 4. BALANCE SHEET COMPONENTS (IN THOUSANDS)
September 30, December 31,
2001 2000
-------- --------
INVENTORY
Raw Materials $ 3,327 $ 1,853
Finished Goods 116 204
-------- --------
$ 3,443 $ 2,057
======== ========
PROPERTY AND EQUIPMENT
Machinery and equipment $ 6,973 $ 6,275
Furniture and fixtures 1,723 1,212
Software and web site development cost 5,026 4,246
-------- --------
13,722 11,733
Less: Accumulated Depreciation (4,443) (2,503)
-------- --------
$ 9,279 $ 9,230
======== ========
6
September 30, December 31,
2001 2000
-------- --------
ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued payroll and compensation expenses $ 2,422 $ 2,178
Other 328 40
-------- --------
$ 2,750 $ 2,218
======== ========
OTHER ASSETS
Investment $ 321 $ 997
Deposit 3 --
Receivable from related party -- 60
-------- --------
$ 324 $ 1,057
======== ========
NOTE 5. EARNINGS PER SHARE
EPS are calculated in accordance with the provisions of Statement of Financial
Accounting Standards No. 128 "Earnings per Share" ("SFAS No. 128"). SFAS No.
128, requires the Company to report both basic EPS, which are based on the
weighted-average number of common shares outstanding, and diluted earnings per
share, which are based on the weighted average number of common shares
outstanding and all dilutive potential common shares outstanding. Diluted EPS
reflects the potential dilution that would occur if securities or other
contracts to issue common stock were exercised or converted into common stock.
Three Months Ended
-----------------------------------------------------------------------------------------
September 30, 2001 September 30, 2000
------------------------------------------- ---------------------------------------
Per Per
Net Share Net Share
Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
Basic and Diluted EPS $(8,992) 67,497 $ (0.13) $(6,154) 6,220 $(0.99)
------- ====== ======== ======= ===== =====
Nine Months Ended
-----------------------------------------------------------------------------------------
September 30, 2001 September 30, 2000
------------------------------------------- ---------------------------------------
Per Per
Net Share Net Share
Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
Basic and Diluted EPS $(23,363) $(67,201) $ (0.35) $(15,510) 6,220 $ (2.49)
======== ======== ======== ======== ===== ========
The following table sets forth potential shares of common stock that are not
included in the diluted net loss per share calculation above because to do so
would be antidilutive for the periods indicated (in thousands):
As of September 30,
2001 2000
------ ------
Effect of common stock equivalents:
Options outstanding 13,581 2,236
Shares resulting from the conversion of the
preferred stock -- 91,000
------ ------
Total common stock equivalents excluded from the computation of basic and diluted
earnings per share as their effect was antidilutive
13,581 93,236
====== ======
7
NOTE 6. TRANSACTIONS WITH AFFILIATES
Effective August 1, 1999, the Company entered into a Research and
Development Service Agreement with ESS whereby ESS provides certain research and
development services to the Company in exchange for a service fee. In addition,
the Company signed a reciprocal agreement with ESS whereby Vialta provides
certain non-recurring expense services for the design and development of
Internet related products and technologies to ESS in exchange for a service fee.
In the periods presented, the Company did not provide such services to ESS.
Effective August 1, 1999, the Company entered into an Administrative and
Management Service Agreement with ESS whereby ESS provides certain
administrative and managerial services to Vialta including, without limitation,
sales support, marketing support, production and logistical support, financial
oversight, accounting assistance, contract review, personnel services (including
training of employees) and such other general and administrative services as
Vialta requires. ESS performs these services in consideration for a service fee.
In addition, Vialta signed a reciprocal agreement whereby Vialta provides the
services mentioned above to ESS in exchange for a service fee. In the periods
presented, Vialta did not provide such services to ESS.
Effective August 1, 1999, the Company entered into a Purchase Agreement
with ESS whereby Vialta will purchase certain products from ESS.
In January 2000, Vialta entered into an Assignment of Intellectual
Property Agreement with ESS whereby Vialta paid ESS $2.0 million for the
transfer of the Videophone and EnReach-based web browser technologies. Such
transfer was done based on actual costs incurred.
On August 20, 2001, Vialta re-executed certain existing agreements with
ESS as a result of the spin-off of Vialta from ESS.
On August 20, 2001, Vialta entered into a Commercial Lease Agreement with
ESS whereby ESS will lease a freestanding building in Fremont, California to
Vialta for a fixed monthly fee. The terms of the lease expire on December 31,
2003.
On August 20, 2001, Vialta entered into an Employee Matters Agreement with
ESS whereby Vialta will continue to provide employment and employee benefits to
all active employees and former employees subject to certain limitations.
The Company anticipates that it will continue to receive such services
from ESS under the terms of the agreements. The following is a summary of major
transactions that resulted in charges by ESS to Vialta for the periods presented
(in thousands):
Three Months Ended Nine Months Ended
------------------ -----------------
Intercompany Agreements September 30, September 30, September 30, September 30,
----------------------- ------------- ------------- ------------- -------------
2001 2000 2001 2000
------ ------ ------ ------
Research and Development Service Agreement $ 626 $ 672 $1,896 $2,326
Administrative and Management Service Agreement 848 745 3,000 2,576
Assignment of Intellectual Property Agreement -- -- -- 2,000
Purchase Agreement -- 245 1,127 1,003
Commercial Lease Agreement $ 155 $ -- $ 155 $ --
------ ------ ------ ------
Total $1,629 $1,662 $6,178 $7,905
====== ====== ====== ======
NOTE 7. SEGMENT AND GEOGRAPHIC INFORMATION
Vialta operates as one segment. Information about long-lived assets is as
follows (amounts in thousands):
September 30, December 31,
2001 2000
------ -------
United States $8,661 $ 9,362
Hong Kong 40 32
Canada 902 833
------ -------
Total long-lived assets, excluding investments $9,603 $10,227
====== =======
8
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT
TO OUR FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM
THOSE CURRENTLY ANTICIPATED DEPENDING ON A VARIETY OF FACTORS, INCLUDING THOSE
DESCRIBED BELOW UNDER THE SUB-HEADING, "FUTURE PERFORMANCE AND RISK FACTORS" AND
DISCUSSED MORE FULLY IN OUR REGISTRATION STATEMENT ON FORM 10 FILED MAY 25, 2001
AND LAST AMENDED ON AUGUST 6, 2001. THIS FOLLOWING DISCUSSION SHOULD BE READ IN
CONJUNCTION WITH THE UNAUDITED FINANCIAL STATEMENTS AND NOTES THERETO IN ITEM 1
OF THIS QUARTERLY REPORT AND THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND
NOTES THERETO AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS FOR THE FISCAL YEARS ENDED DECEMBER 31, 2000 AND 1999
CONTAINED IN SUCH FORM 10.
OVERVIEW
We were incorporated as a wholly-owned subsidiary of ESS on April 20,
1999. We have developed a multi-featured DVD player that offers Internet access
and other features that differentiate it from most DVD players currently
available in the U.S. consumer market. Our ViDVD player is the first product
offering from our "Digital Home System" platform, which we anticipate will grow
to support a family of multimedia Internet appliances, as well as a
complementary system for the delivery of home entertainment content. The ViDVD
is a multi-purpose home entertainment device that enables consumers to play DVD,
CD, MP3, karaoke, Kodak Picture CD and other audio and video formats and to
browse the Internet through their television. The ViDVD also will be compatible
with our proprietary, encrypted ViMedia discs, which will provide consumers with
the opportunity to select and purchase one or more selections from a variety of
videos, karaoke titles and other home entertainment content. Our goal is to make
the ViDVD the centerpiece of consumers' home entertainment systems, combining
Internet access with the features of several current consumer electronics
devices into a single affordable product.
We have had no revenues from operations and have historically used vendor
credit and private offerings of convertible preferred stock and common stock to
fund our operations and provide for capital requirements during our development
stage. For the three months ended September 30, 2001 and September 30, 2000, we
had net losses of $9.0 million and $6.2 million, respectively, and expect to
continue to incur losses in the fourth quarter of 2001. The losses reflect our
cash burn rate for the periods indicated. From inception through September 30,
2001, we had a net loss of $47.5 million. We commenced shipments of the ViDVD
during the third quarter of 2001 and, as a result, experienced a significant
increase in working capital requirements due to internal and channel inventory
requirements, which were partially offset by extended credit terms from
suppliers.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE THREE MONTHS ENDED
SEPTEMBER 30, 2000
The following table discloses key elements of the statements of
operations, expressed as a percentage of total operating expenses.
THREE MONTHS ENDED
------------------
SEPTEMBER 30, 2001 SEPTEMBER 30, 2000
Operating expenses:
Research and development 62.6 % 57.6 %
Sales and marketing 9.7 12.6
General and administrative 27.7 29.8
----- -----
Operating loss 100.0 % 100.0 %
Non-operating income (expense), net (3.4) 4.1
----- -----
Loss before income tax benefit 103.4 95.9
Income tax benefit -- 1.0
----- -----
Net loss 103.4 % 94.9 %
===== =====
Research and Development. Research and development expenses were $5.4
million for the three months ended September
9
30, 2001, or 62.6% of operating expenses, compared to $3.7 million, or 57.6% of
operating expenses for the three months ended September 30, 2000. The increase
was primarily in payroll and related expenses due to increased headcount and
operating supplies as we have expanded development efforts. We expect research
and development spending to be lower in future periods since we have completed
the core development of our first series of products.
Sales and Marketing. Sales and marketing expenses were $0.8 million for
the three months ended September 30, 2001, or 9.7% of operating expenses,
compared to approximately $0.8 million, or 12.6% of operating expenses, for the
three months ended September 30, 2000. Increases in payroll and marketing
expenses due to increased headcount and product introduction were offset by
lower infrastructure allocations. We expect sales and marketing spending to
increase in future periods as we increase our sales and marketing activities for
brand and channel development.
General and Administrative. General and administrative expenses were $2.4
million for the three months ended September 30, 2001, or 27.7% of operating
expenses, compared to $1.9 million, or 29.8% of operating expenses, for the
three months ended September 30, 2000. The increase was primarily due to
increases in payroll and other expenses due to increased headcount and
administrative fees as we have supported expanded development efforts. We expect
general and administrative expense spending to increase in future periods as we
continue to build our infrastructure to meet our administrative and operational
needs as a stand-alone company.
Non-operating Income (Expense). Net non-operating expense was $0.3 million
for the three months ended September 30, 2001 compared to net non-operating
income of $0.3 million for the three months ended September 30, 2000. Net
non-operating income consists primarily of net interest income and loss on
investments. Net interest income totaled $0.8 million and $1.9 million for the
quarters ending September 30, 2001 and 2000, respectively. The decrease in net
interest income was due to lower cash balances for the three months ended
September 30, 2001.
Interest income was offset by a write off of investments in the amount of
$1.1 million in the third quarter of 2001. In the third quarter of 2000, we
wrote off an investment in the amount of $1.7 million. In both instances, we
wrote off investments because we concluded that the investments had suffered an
other than temporary decline in value based on our assessment of the financial
condition of the companies in which we had invested and the markets that they
serve.
Income Tax Provision (Benefit). Because of pre-tax losses, there was no
provision for income taxes for the three months ended September 30, 2001
compared to recording an income tax benefit of $65,000 for the three months
ended September 30, 2000. The income tax benefit for the three months ended
September 30, 2000 was a reimbursement of $65,000 from ESS pursuant to tax
arrangements between ESS and us as a result of ESS realizing a tax benefit for
utilizing our net operating losses in the three months ended September 30, 2000.
No tax benefit has been recognized during the three months ended September 30,
2001 since ESS does not expect to benefit during 2001 from our net operating
losses. Also, we do not expect any tax expenses during 2001 because we do not
anticipate any net taxable income during this year.
Net Loss. We incurred a net loss of $9.0 million for the three months
ended September 30, 2001, compared to $6.2 million for the three months ended
September 30, 2000. The $2.8 million increase in net loss was primarily due to
increased operating expenses associated with ourgoing into production with
ViDVD, increased development in ViMedia and internal infrastructure.
10
NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE NINE MONTHS ENDED
SEPTEMBER 30, 2000
The following table discloses key elements of the statements of
operations, expressed as a percentage of total operating expenses.
NINE MONTHS ENDED
-----------------
SEPTEMBER 30, 2001 SEPTEMBER 30, 2000
Operating expenses:
Research and development 60.5 % 66.3 %
Sales and marketing 11.8 9.8
General and administrative 27.7 23.9
---- ----
Operating loss 100.0 % 100.0 %
Non-operating income, net 7.8 22.5
---- ----
Loss before income tax benefit 92.2 77.5
Income tax benefit -- 1.0
---- ----
Net loss 92.2 % 76.5 %
==== ====
Research and Development. Research and development expenses were $15.3
million for the nine months ended September 30, 2001, or 60.5% of operating
expenses, compared to $13.4 million, or 66.3% of operating expenses for the nine
months ended September 30, 2000. The increase was primarily due to increases in
payroll and related expenses due to increased headcount and operating supplies
as we have expanded development efforts. The increase was offset by a
nonrecurring purchase of technology from ESS, then a related party, in the
amount of $2.0 million in the first quarter of 2000. We expect research and
development spending to be lower in future periods since we have completed the
core development of our first series of products.
Sales and Marketing. Sales and marketing expenses were $3.0 million for
the nine months ended September 30, 2001, or 11.8% of operating expenses,
compared to $2.0 million, or 9.8% of operating expenses, for the nine months
ended September 30, 2000. The increase was primarily due to increases in payroll
and marketing expenses due to increased headcount and product introduction. We
expect sales and marketing spending to increase in future periods as we increase
our sales and marketing activities for brand and channel development.
General and Administrative. General and administrative expenses were $7.0
million for the nine months ended September 30, 2001, or 27.7% of operating
expenses, compared to $4.9 million, or 23.9% of operating expenses, for the nine
months ended September 30, 2000. The increase was primarily due to increases in
payroll and other expenses due to increased headcount and administrative fees as
we have supported expanded development efforts. We expect general and
administrative expense spending to increase in future periods as we have built
our infrastructure to meet our administrative and operational needs as a
stand-alone company.
Non-operating Income. Net non-operating income was $2.0 million for the
nine months ended September 30, 2001 compared to $4.6 million for the nine
months ended September 30, 2000. Net non-operating income consists primarily of
net interest income and loss on investments. Net interest income fell to $3.1
million for the nine months ended September 20, 2001 from $5.9 million for the
nine months ended September 30, 2000. The decrease in net interest income was
due to lower cash balances for the nine months ended June 30, 2001.
Partially offsetting interest income were investment write offs in an
amount of $1.1 million for the nine months ending September 30, 2001 and $1.7
million for the nine months ending September 30, 2000. We wrote these
investments off because we concluded that the investments had suffered an other
than temporary decline in value based on our assessment of the financial
condition of the companies in which we had invested and the markets that they
serve.
11
Income Tax Provision (Benefit). Because of pre-tax losses, there was no
provision for income taxes for the nine months ended September 30, 2001 compared
to recording an income tax benefit of $195,000 for the nine months ended
September 30, 2000. The income tax benefit for the nine months ended September
30, 2000 was a reimbursement of $195,000 from ESS pursuant to tax arrangements
between ESS and us as a result of ESS realizing a tax benefit for utilizing our
net operating losses in the nine months ended September 30, 2000. No tax benefit
has been recognized during the nine months ended September 30, 2001 since ESS
does not expect to benefit during 2001 from our net operating losses. Also, we
do not expect any tax expenses during 2001 because we do not anticipate any net
taxable income during this year.
Net Loss. We incurred a net loss of $23.4 million for the nine months
ended September 30, 2001, compared to $15.5 million for the nine months ended
September 30, 2000. The $7.9 million increase in net loss was primarily due to
increased operating expenses associated with our going into production with
ViDVD, increased development of ViMedia and internal infrastructure coupled with
lower interest income associated with lower cash balances for the nine months
ending September 30, 2001.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2001, we had $82.1 million in cash, cash equivalents
and marketable securities compared to $136.5 million as of December 31, 2000,
representing a decrease of $54.4 million. The December 31, 2000 figure includes
proceeds from a $30.0 million loan from a related party controlled by Annie M.H.
Chan, the spouse of Fred S.L. Chan, our Chairman. The $30.0 million short-term
loan along with $194,000 in accrued interest was repaid in January 2001.
Our principal sources of liquidity were cash, cash equivalents and
short-term investments. Net cash used in operating activities was approximately
$19.7 million and $14.8 million for the nine months ended September 30, 2001 and
September 30, 2000, respectively, representing an increase of approximately $4.9
million. The increase was primarily due to increased operating expenses incurred
by us in our efforts to complete development of our first commercial products
and prepare for the product launch by September 2001. For the nine months ended
September 30, 2001 and 2000, we incurred net losses of $23.4 million and $15.5
million, respectively, and we expect to continue to incur losses in the fourth
quarter of 2001. The losses reflect our cash burn rate for the periods
indicated. We began shipment of our first product during the third quarter of
2001 and, as a result, we experienced a significant increase in working capital
requirements due to internal and channel inventory requirements, which increases
were partially offset by extended credit terms from suppliers.
The Company generated $13.3 million net cash through its investing
activities for the nine months ended September 30, 2001. The Company's cash
increased by $27.1 million through its sale of marketable securities and
decreased by $9.4 million through its purchase of marketable securities.
The Company used $30.3 million net cash through its financing activities
for the nine months ended September 30, 2001. The Company's cash decreased by
$30.0 million due to repayment of a note payable to related party and by
$290,000 due to repurchase of common stock.
We believe that our existing cash and cash equivalents as of September 30,
2001 will be sufficient to fund acquisitions of inventory, property and
equipment and provide adequate working capital through at least the 12-month
period ending September 30, 2002. However, to achieve our longer term goals of
introducing additional products and services to consumers beyond September 30,
2002, we believe we will need to raise additional capital, which may not be
available on acceptable terms, if at all. Capital expenditures for the 12-month
period ending September 30, 2002 are anticipated to be approximately $24.0
million to be used primarily for the acquisition of media content licenses and
capital equipment. Net inventory build requirements are expected to be
approximately $25.5 million during the 12-month period ending September 30,
2002. We may also utilize cash to acquire or invest in complementary businesses
or products or to obtain the right to use complementary technologies and media
content which may significantly increase our planned requirements for capital.
In addition, from time to time, in the ordinary course of business, we may
evaluate potential acquisitions of or investments in such businesses, products
or technologies owned by third parties.
We have historically used vendor credit as well as private offerings of
convertible preferred stock and common stock to fund operations and provide for
capital requirements during the development stage. We believe our current cash
and cash equivalents together with future private and public equity offerings,
as well as private debt offerings including bank financing and credit lines and
leases will be sufficient to fund future operations plus planned and unplanned
capital and investment activities. However, the price per share of any future
equity-related financing will be determined at about the time the offering is
made and cannot be determined or anticipated at this time. If additional funds
are raised through the issuance of equity securities, the percentage ownership
of current stockholders may be reduced and such equity securities may have
rights, preferences or privileges senior to those of current stockholders. We
cannot assure you that additional financing will be available or that, if
available, it can be obtained on terms favorable to us and our stockholders. If
adequate funds are not available if and when needed, we would be required to
delay, limit or eliminate some or all of our proposed operations.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations." SFAS 141 requires the purchase method of accounting for business
combinations initiated after June 30, 2001 and eliminates the
pooling-of-interests method. The adoption of SFAS 141 does not have a
significant impact on our financial statements.
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which is
effective for fiscal years beginning after December 15, 2001. SFAS 142
requires, among other things, the discontinuance of goodwill amortization. In
addition, the standard includes provisions upon adoption for the
reclassification of certain existing recognized intangibles as goodwill,
reassessment of the useful lives of existing recognized intangibles,
reclassification of certain intangibles out of previously reported goodwill and
the testing for impairment of existing goodwill and other intangibles. The
adoption of SFAS 142 will not have a significant impact on our financial
position and results of operations.
On October 3, 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS 144 supercedes SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of." SFAS 144 applies to all long-lived assets (including
discontinued operations) and consequently amends Accounting Principles Board
Opinion No. 30. SFAS 144 develops one accounting model for long-lived assets
that are to be disposed of by sale. SFAS 144 requires that long-lived assets
that are to be disposed of by sale be measured at the lower of book value or
fair value less cost to sell. Additionally, SFAS 144 expands the scope of
discontinued operations to include all components of an entity with operations
that (1) can be distinguished from the rest of the entity and (2) will be
eliminated from the ongoing operations of the entity in a disposal transaction.
SFAS 144 is effective for the Company for all financial statements issued in
fiscal 2002. We are currently assessing the impact of SFAS 144 on our financial
position and results of operations.
12
FUTURE PERFORMANCE AND RISK FACTORS
Our future business, operating results and financial condition are subject to
various risks and uncertainties, including those described below.
IF OUR RETAIL LAUNCH IS UNSUCCESSFUL, OR IF THE VIDVD DOES NOT ACHIEVE BROAD
MARKET ACCEPTANCE, WE MAY NOT BE ABLE TO CONTINUE OPERATING OUR BUSINESS.
Our success is highly dependent upon a successful retail launch of our
initial Digital Home System product, the ViDVD, which began shipping in the
third quarter of 2001. A successful retail launch requires, among other things,
that we:
- coordinate all of the logistical elements necessary to complete the
launch in a timely manner;
- educate consumers on the benefits of the ViDVD;
- commit a substantial amount of human and financial resources to
secure partnerships supporting the retail distribution of the ViDVD
and our related ViMedia content delivery service;
- develop our own sales, marketing and support activities with
targeted customers; and
- develop consumer acceptance of the ViDVD and our related ViMedia
content delivery service.
We may not achieve any or all of these objectives. Moreover, we expect the ViDVD
initially will be sold through a limited number of regional consumer electronics
retail stores, and not through mass merchant and national consumer electronics
retail stores. As a result, even after our retail launch, consumers may be less
aware of the ViDVD than the product offerings of our competitors, and our
ability to achieve broad market acceptance of the ViDVD could be harmed. Any
failure to launch the ViDVD successfully or achieve broad market acceptance of
the ViDVD after launch would impair our ability to continue operating our
business.
WE ARE A DEVELOPMENT STAGE ENTERPRISE, HAVE NOT RECOGNIZED ANY REVENUE, HAVE
INCURRED SIGNIFICANT NET LOSSES AND MAY NEVER ACHIEVE SIGNIFICANT REVENUES OR
PROFITABILITY.
We are a development stage enterprise that is still in the process of
developing and introducing our first product. We have not recognized any
revenue, have incurred significant losses and have had substantial negative cash
flow. As of September 30, 2001, we had an accumulated deficit of $47.5 million.
We expect to incur significant operating expenses over the next several years in
connection with the continued development and expansion of our business. As a
result, we expect to continue to lose money for the foreseeable future. Although
the size of these net losses will depend in part on the success of our product
launch, the growth in sales of our products and services and the rate of
increase in our expenses, our losses have been increasing and are expected to
continue to increase in future periods. With increased expenses, our need to
generate significant revenues to achieve profitability. Several factors,
including market acceptance, competitive factors and our ability to successfully
develop and market our ViMedia content delivery service, make it impossible to
predict with any degree of assurance when or whether we will generate sufficient
revenues to attain profitability. Consequently, we may never achieve significant
revenues or profitability, and even if we do, we may not sustain or increase
profitability on a quarterly or annual basis in the future.
IF THE INTERNAL REVENUE SERVICE DETERMINES THAT ESS' DISTRIBUTION OF OUR STOCK
TO ITS SHAREHOLDERS DOES NOT QUALIFY AS A TAX-FREE DISTRIBUTION, THEN ESS WILL
TREAT THE DISTRIBUTION AS A TAXABLE DISTRIBUTION AND RECIPIENTS OF OUR STOCK IN
THE DISTRIBUTION MAY BE REQUIRED TO PAY INCOME TAXES AS A RESULT OF RECEIVING
THE STOCK.
Unless the Internal Revenue Service determines that the distribution
qualifies as a tax-free distribution for U.S. federal income tax purposes,
recipients of our stock in distribution may be required to pay income taxes as a
result of the distribution, with the amount of ordinary income and gain
dependent upon the value of the stock they received, their share of ESS'
earnings and profits, and their adjusted tax basis in their ESS stock.
Determining whether or not the distribution will qualify for tax-free status
requires a complex analysis of many factors, including, among others, the
business purpose for the distribution, the nature of the business to be engaged
in by ESS and us following the distribution, and the extent to which ESS remains
in control of us following the distribution. Because of the fact-intensive
nature of this analysis, there will be substantial uncertainty as to whether the
distribution will qualify for tax-free treatment until the IRS makes a
determination as to the tax status of the transaction.
13
Although ESS has applied for a ruling from the IRS, it is not anticipated
that the IRS will make its determination until several months after the
distribution has been completed. In addition, ESS has not obtained an opinion of
its tax advisors regarding the tax treatment of the transaction. ACCORDINGLY, WE
CANNOT ASSURE RECIPIENTS OF OUR STOCK IN THE DISTRIBUTION THAT A FAVORABLE
RULING FROM THE IRS WILL BE OBTAINED. MOREOVER, EVEN IF A FAVORABLE IRS
DETERMINATION IS OBTAINED, SUCH RECIPIENTS STILL MAY BE TAXED BY THE STATE,
LOCAL OR FOREIGN JURISDICTION IN WHICH THEY RESIDE. Accordingly, all recipients
of our stock in the distribution are strongly urged to consult with their own
financial advisors regarding the potential tax impact to them of the
distribution and to prepare for the significant possibility that the transaction
will be taxable to them.
If the distribution is taxable to them, the value of the shares they
receive will be treated as taxable ordinary income, return of cost or as taxable
capital gain up to the value of the stock distributed. Absent a favorable ruling
from the IRS, they will incur this tax whether or not they decide to sell the
shares they receive in the distribution. Unless a recipient of shares in the
distribution is required to make quarterly estimated tax payments to the IRS,
this tax would generally have to be paid on or before the April 15, 2002 due
date for the 2001 tax return. If such recipients do not have cash available to
pay the tax at or before the time it is due, they may have to sell all or a
portion of their shares of our stock to pay the tax or risk incurring interest
and penalties imposed by the IRS. If holders of a significant percentage our
stock are also forced to sell in order to pay their taxes, or if there is for
any other reason a decline in the trading price of our shares following the
distribution, recipients of our stock in the distribution may have to sell their
shares of our stock at a lower price than they might otherwise have obtained.
Moreover, if such recipients continue to hold all of their shares of our stock
until after the IRS ruling is obtained and the market price of those shares
declines, the proceeds from the subsequent sale of all of those shares may not
be sufficient to cover the tax due if the transaction is determined to be
taxable to them.
IF WE ARE UNABLE TO RAISE ADDITIONAL CAPITAL ON ACCEPTABLE TERMS, OUR ABILITY TO
DEVELOP AND MARKET OUR PRODUCTS AND SERVICES AND GROW AND OPERATE OUR BUSINESS
COULD BE HARMED.
To emerge from the development stage, introduce our follow-on products and
services and sustain and grow our business, we must continue to make significant
investments in research and development to develop, enhance and market our
products and services. We will also need significant working capital to take
advantage of future opportunities and to respond to competitive pressures or
unanticipated requirements. We expect that our existing capital resources will
be sufficient to meet our cash requirements through September 30, 2002, although
our current resources could be exhausted more quickly depending on the payment
terms that we are able to negotiate with our vendors and suppliers and our
success in collecting on accounts receivable. The magnitude of our future
capital requirements will depend on many factors, including, among others,
product development expense levels, investments in working capital, and the
amount of income generated by operations. When we do need to raise additional
capital, that capital may not be available on acceptable terms, or at all. If we
cannot raise necessary additional capital on acceptable terms, we may not be
able to develop or enhance our products and services, take advantage of future
opportunities, respond to competitive pressures or unanticipated requirements or
even continue operating our business.
If additional capital is raised through the issuance of equity securities,
the percentage ownership of our existing stockholders will decline, stockholders
may experience dilution in net book value per share, and these equity securities
may have rights, preferences or privileges senior to those of the holders of our
common stock. Any debt financing, if available, may involve covenants limiting
or restricting our operations or future opportunities.
SINCE THE DISTRIBUTION OF OUR STOCK BY ESS TECHNOLOGY, INC. TO ITS SHAREHOLDERS,
WE WILL NO LONGER BE ABLE TO RELY ON ESS AS A MAJOR SOURCE OF CAPITAL FUNDING,
WHICH COULD LIMIT OUR ABILITY TO GROW OR SUSTAIN OUR BUSINESS.
We have traditionally relied on ESS as a major source of capital funding.
Following the completion of the distribution (which occurred on August 21,
2001), ESS ceased being a majority stockholder of us and may choose to no longer
provide funding to us. Even if ESS were to choose to provide additional funding
to us in the future, ESS may not have funds available to provide such funding or
may not choose to provide such funding on terms favorable to us and our
stockholders. As our business continues to grow, we will need to raise
additional capital, which may not be available on acceptable terms, or at all.
If we cannot raise necessary additional capital on acceptable terms, we may not
be able to grow or sustain our business.
14
OUR AGREEMENT TO INDEMNIFY ESS FOR TAX LIABILITIES UNDER CERTAIN CIRCUMSTANCES
MAY AFFECT OUR CASH FLOW, DISCOURAGE POTENTIAL ACQUISITION PROPOSALS OR DELAY OR
PREVENT A CHANGE IN CONTROL OF US, AND LIMIT THE SIZE OF ANY FUTURE OFFERINGS OF
OUR STOCK.
Even if ESS' distribution of our stock to its shareholders is otherwise a
tax-free distribution, ESS may, under certain circumstances, recognize gain for
U.S. federal and state income tax purposes with respect to the distribution if a
50% or greater interest in us is acquired during the two-year period following
the distribution. Certain sales of shares by us that occurred during the
two-year period immediately prior to the distribution may be counted towards the
50% threshold. The amount of such gain would be the difference between the fair
market value of the stock distributed, as of the date of distribution, and ESS'
adjusted tax basis in the stock. Under a tax sharing and indemnity agreement, we
have agreed under certain circumstances to indemnify ESS for ESS' U.S. federal
and state income tax liability which results as a direct consequence of any
acquisition of a 50% or greater interest in us after the distribution. This
indemnity obligation, if triggered, could have a substantial effect on our
available cash. In addition, the existence of the indemnity obligation may
discourage potential acquisition proposals and could delay or prevent an
acquisition of a 50% or greater interest in us. Because future sales of stock
could be deemed to be part of a related transaction that results in an
acquisition of a 50% or greater interest in us, our desire to avoid triggering
the indemnity obligation could limit the size of any offerings of stock by us
during the two-year period following the distribution.
OUR LIMITED OPERATING HISTORY MAY MAKE IT DIFFICULT FOR US OR INVESTORS TO
EVALUATE TRENDS AND OTHER FACTORS THAT AFFECT OUR BUSINESS.
We were incorporated in April 1999 and our operations to date have
consisted primarily of product development efforts. To date, we have only
manufactured and shipped a limited number of commercial ViDVD units. In
addition, we have only entered into a limited number of agreements to acquire
the content to be delivered as part of our ViMedia content delivery service, and
no ViMedia discs have been distributed. As a result of our limited operating
history, our historical financial and operating information is of limited value
in evaluating our future operating results. In addition, any evaluation of our
business and prospects must be made in light of the risks and difficulties
encountered by companies offering products or services in new and rapidly
evolving markets. For example, it may be difficult to accurately predict our
future revenues, costs of revenues, expenses or results of operations. The
ViDVD, the ViMedia content delivery service and our other anticipated Digital
Home System products and services represent new product and service offerings
for most consumers, and it may be difficult to predict the future growth rate,
if any, or size of the market for those products and services. We may be unable
to accurately forecast customer behavior and recognize or respond to emerging
trends, changing preferences or competitive factors facing us. As a result, we
may be unable to make accurate financial forecasts and adjust our spending in a
timely manner to compensate for any unexpected revenue shortfall. This inability
could cause our net losses in a given quarter to be greater than expected, which
could cause the price of our stock to decline.
OUR HISTORICAL FINANCIAL INFORMATION MAY NOT BE REPRESENTATIVE OF OUR FUTURE
OPERATING RESULTS AS A SEPARATE COMPANY.
Our historical financial information does not necessarily reflect what our
financial position, operating results and cash flows would have been had we been
a stand-alone entity during the periods presented. In addition, our historical
information is not necessarily indicative of what our operating results,
financial position and cash flows will be in the future. We may have to make
significant changes to our cost structure, funding and operations as a result of
our no longer being a majority-owned subsidiary of ESS after its distribution of
our stock to its shareholders, including changes to our employee base, costs
associated with establishing and maintaining a separate administrative
infrastructure, costs associated with reduced economies of scale, and costs
associated with being a stand-alone company.
WE FACE INTENSE COMPETITION FROM PARTICIPANTS IN BOTH THE MULTIMEDIA APPLIANCE
AND THE HOME ENTERTAINMENT MARKETS, WHICH MAY IMPAIR OUR REVENUES AND ABILITY TO
GENERATE CUSTOMERS.
The multimedia appliance and home entertainment markets are intensely
competitive and rapidly evolving. In addition, there are few barriers to entry
into the multimedia appliance and home entertainment markets, and new entrants
to these markets may develop and offer products that will compete directly with
our products and services.
15
The multimedia appliance industry in particular is characterized by rapid
technological innovation and intense price competition, and the competition for
consumer spending and acceptance is intense. The ViDVD will compete directly
with several other currently available or soon to be introduced multimedia
appliance offerings from major consumer electronics manufacturers, such as
Compaq, Hewlett Packard and Samsung, and with products developed by smaller
companies, including the Neon, nReady and TVPC products. Like the ViDVD, nearly
all of these products accommodate media in DVD, CD and MP3 format, many offer
Internet access capabilities, and some include a karaoke feature.
In addition, as a home entertainment product, we expect that the ViDVD
will also compete with:
- standard DVD and CD players;
- the Sony PlayStation 2, the Microsoft Xbox and other web-enabled,
multi-function game players;
- personal computers;
- WebTV and other television-based Internet appliances;
- Web-enabled wireless telephones and PDAs;
- karaoke machines; and
- video cassette recorders and laser disc players.
As a home entertainment content delivery medium, we also expect that
our ViMedia content delivery service will compete with:
- video-on-demand services;
- traditional broadcast, cable or satellite television programming;
and
- video cassette, DVD and video game cartridge rental stores and
retailers.
Most of these products and services are already widely available through
retail distribution channels, and many of these products are already familiar to
and accepted by consumers. In addition, most of the manufacturers and
distributors of these competing home entertainment products and services have
substantially greater brand recognition, market presence, distribution channels,
advertising and marketing budgets and promotional and other strategic partners
than us.
WE HAVE NOT OBTAINED ALL OF THE LICENSES OF INTELLECTUAL PROPERTY REQUIRED FOR
THE OPERATION OF OUR BUSINESS AND ANY FAILURE TO OBTAIN REQUIRED LICENSES ON
ACCEPTABLE TERMS COULD ADVERSELY AFFECT OUR OPERATING RESULTS.
We rely on licenses of intellectual property from third parties for use in
our business. We have identified all of the licenses we believe are necessary
for the manufacture and distribution of the ViDVD. We have yet to obtain all of
these licenses. While we have contacted each of the entities from which we could
obtain these licenses, the licenses may not be available on favorable terms and
may require us to pay new or additional royalties on the sale of the ViDVD.
Also, we will have to negotiate to acquire any licenses required for the
development, manufacture and sale of our future Digital Home System products and
services. In addition, although we have already licensed selected audio and
video content to be distributed as part of the ViMedia content delivery service,
we will need to obtain licenses to a substantially greater volume of content for
the ViMedia service to be successful. Any failure to obtain the licenses of
intellectual property required for the operation of our business on acceptable
terms could adversely affect our operating results.
WE EXPECT THE AVERAGE SELLING PRICES OF OUR DIGITAL HOME SYSTEM PRODUCTS TO
DECREASE, WHICH MAY REDUCE OUR GROSS MARGINS AND/OR REVENUE.
The prices of multimedia appliance products are expected to decline
rapidly as more products enter retail distribution and competition and volume
increase. In particular, we expect significant price reductions and increased
sales discounts in the fourth quarter of 2001 as numerous competing
manufacturers attempt to establish their microprocessors as the standard in the
industry in
16
connection with the holiday selling season. We anticipate that the average
selling prices of our Digital Home System products will decrease in response to
these competitive pricing pressures as well as in response to new product
introductions by us or our competitors and increasing availability of relatively
inexpensive products that can perform some of our products' functions. If we are
unable to sufficiently reduce costs and increase sales volumes, this decline in
average selling prices will reduce our revenue and gross margins.
IF WE FAIL TO OVERCOME TECHNICAL CHALLENGES ASSOCIATED WITH THE FULL DEVELOPMENT
AND IMPLEMENTATION OF OUR VIMEDIA CONTENT DELIVERY SERVICE OR OBTAIN SUFFICIENT
CONTENT TO ATTRACT CUSTOMERS, THE VIMEDIA CONTENT DELIVERY SERVICE MAY NOT
ACHIEVE MARKET ACCEPTANCE OR GENERATE SUFFICIENT REVENUE TO SUSTAIN ITS
OPERATION.
The success of the ViMedia content delivery service depends in part on our
ability to acquire and deliver content that interests our customers. Most of the
major producers of audio and video content in the entertainment industry will
only permit their content to be distributed at commercially attractive prices if
it is protected using approved encryption technologies. Our own proprietary
encryption system has not yet been adopted by the entertainment industry as an
approved encryption technology, and, unless or until that occurs, we may not be
able to distribute content licensed from major entertainment companies in our
proprietary ViMedia format. Although discs that include content in DVD and CD
format may be played on a ViDVD player, content that is encoded in those
conventional formats takes significantly more disc space, and we are still in
the process of conducting research and development to enable certain aspects of
our encryption technology to work with those other formats. Unless we are able
to either obtain entertainment industry acceptance of our proprietary encryption
system or overcome the technical challenges associated with using our encryption
with conventional formats, the ViMedia content delivery service may not achieve
market acceptance or generate sufficient revenue to sustain its operation.
IF WE FAIL TO DEVELOP AND MARKET NEW DIGITAL HOME SYSTEM PRODUCTS OR TO ADD
FEATURES TO OUR EXISTING DIGITAL HOME SYSTEM PRODUCT, WE MAY NOT BE ABLE TO
GENERATE SUFFICIENT REVENUES TO SUSTAIN OUR BUSINESS.
Our success is highly dependent upon the continued successful development
and timely introduction of new Digital Home System products and new models of
our existing Digital Home System product containing additional features. The
success of new products and new models with additional features depends on a
number of factors, including strategic allocation of limited financial and
technical resources, accurate forecasting of consumer demand, timely completion
of product development, and market and industry acceptance of our existing
Digital Home System product. Many of our planned product and feature
introductions are still in the early stages of development and will require
substantial engineering and technical resources to bring to market. The success
of some of our planned products may also require industry acceptance of our
proprietary technologies or the adaptation of our products and technologies to
accommodate the use of existing industry-accepted technologies. If we fail to
develop and market new products and features, we may not be able to generate
sufficient revenues from our initial Digital Home System product to sustain our
business.
IT MAY TAKE A SUBSTANTIAL AMOUNT OF TIME AND RESOURCES TO ACHIEVE BROAD MARKET
ACCEPTANCE OF OUR PRODUCTS AND SERVICES, AND WE CANNOT BE SURE THAT THESE
EFFORTS WILL GENERATE THE LEVEL OF BROAD MARKET ACCEPTANCE OF OUR PRODUCTS AND
SERVICES NECESSARY TO GENERATE SUFFICIENT REVENUES TO SUSTAIN OUR BUSINESS.
Although many consumers are familiar with standard DVD players, our ViDVD
player initially will be one of only a few DVD products to include Internet
access and MP3 and karaoke player capability. Consumers may perceive little or
no benefit from combining these functionalities in one unit or may already own
other products that provide one or more of these functionalities. As a result,
consumers may not value, and may be unwilling to pay for the ViDVD. In addition,
the ViMedia content delivery service is expected to be the first home
entertainment content provider to enable consumers to purchase the specific
content that interests them from a variety of content made available to the
consumer on a previously distributed disc. Potential customers may not perceive
a benefit in purchasing content in this manner and may already subscribe to or
otherwise have access to similar content from other sources. We also do not have
an established brand image, nor do we expect to spend significant marketing
expenses to build and promote a brand image. Accordingly, to develop market
acceptance of the ViDVD player, the ViMedia content delivery service and our
anticipated future Digital Home System products and services, we will need to
devote a substantial amount of resources to educate consumers about the features
and benefits of our products and services, and broad market acceptance of the
ViDVD may not be obtained for a period of two years or more from the launch date
of the ViDVD, if at all. Moreover, we cannot assure you that this commitment of
time and resources will be successful in developing the broad market acceptance
of our Digital Home System products and services necessary to generate the
revenues required to sustain our business.
17
WE MAY NOT BE ABLE TO GENERATE SUFFICIENT REVENUE FROM THE VIMEDIA CONTENT
DELIVERY SERVICE TO SUPPORT ITS CONTINUED OPERATION, AND ANY TERMINATION OF THE
VIMEDIA SERVICE COULD REDUCE DEMAND FOR THE VIDVD PLAYER.
In the future, we expect to charge customers content access fees for
access to portions of the content distributed via our ViMedia content delivery
service. Many potential ViMedia end users already pay monthly fees for cable or
satellite television services. When we begin to charge customers for specific
content, we must convince these consumers to pay additional fees to gain access
to the content delivered on our ViMedia discs. The availability of competing
services that do not require subscription or other access fees will harm our
ability to effectively attract paying end users. In addition, the ViDVD player
that enables the consumer to access the content provided by our ViMedia service
can be used to view or listen to other DVDs and CDs or to access material on the
Internet without payment for any of our ViMedia content. If a significant number
of purchasers of our ViDVD players use these devices without purchasing ViMedia
content, the ViMedia service may not generate sufficient revenue to support its
continued operation, which could reduce demand for the ViDVD player.
WE EXPECT TO DEPEND ON ESS AND A LIMITED NUMBER OF OTHER THIRD PARTIES TO
MANUFACTURE AND SUPPLY CRITICAL COMPONENTS FOR OUR DIGITAL HOME SYSTEM PRODUCTS
AND SERVICES, AND WE MAY BE UNABLE TO OPERATE OUR BUSINESS IF THOSE PARTIES DO
NOT PERFORM THEIR OBLIGATIONS.
We expect to rely on ESS and a limited number of other third party
suppliers for a number of key components of our Digital Home System products,
including DRAM chips and flash memory chips. We do not have long-term agreements
in place with our suppliers. We also expect to rely on a limited number of third
party content providers to supply the content to be distributed as part of the
ViMedia content delivery service. We do not control the time and resources that
these third parties devote to our business. We cannot be sure that these parties
will perform their obligations as expected or that any revenue, cost savings or
other benefits will be derived from the efforts of these parties. Our need for
semiconductors as a key component of our Digital Home System products indirectly
subjects us to a number of risks relating to ESS' and any future semiconductor
suppliers' reliance on independent foundries to produce those semiconductors,
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 risks related to the
international location of most major foundries. If any of our third party
suppliers or content providers breaches or terminates its agreement with us or
otherwise fails to perform its obligations in a timely manner, we may be delayed
or prevented from commercializing our products and services. Because our
relationships with these parties are non-exclusive, they may also support
products or services that compete directly with ours, or offer similar or
greater support to our competitors. Any of these events could require us to
undertake unforeseen additional responsibilities or devote additional resources
to commercialize our products and services. This outcome would harm our ability
to compete effectively and quickly achieve market acceptance and brand
recognition.
WE MAY HAVE POTENTIAL BUSINESS CONFLICTS OF INTEREST WITH ESS WITH RESPECT TO
THE COMPANIES' ONGOING RELATIONSHIPS, AND WE MAY NOT BE ABLE TO RESOLVE THESE
CONFLICTS ON TERMS FAVORABLE TO US.
Conflicts of interest may arise between ESS and us in a number of areas
relating to ongoing relationships between the companies, including:
- Although we will be entering into agreements with ESS that will
govern our business relationship after the completion of ESS'
distribution of our stock to its shareholders, ESS will have no
obligation to extend the terms of those agreements to us beyond the
stated duration of those agreements;
- ESS will be supplying semiconductors to our competitors, which may
affect ESS' capacity to supply semiconductors to us;
- we will be competing with ESS in employee recruiting; and
- we may compete with ESS with respect to business opportunities that
are attractive to both companies, and ESS is not restricted from
competing with our business.
18
IF WE ARE UNABLE TO ESTABLISH AND MAINTAIN SATISFACTORY RELATIONSHIPS WITH THE
DISTRIBUTORS AND RETAILERS THAT WE EXPECT TO SELL OUR PRODUCTS AND SERVICES, OUR
BUSINESS WILL SUFFER.
With the exception of one retailer, we have not yet entered into
agreements with the distributors and retailers that we expect to sell our
products and services, and we may not be able to retain or attract a sufficient
number of qualified distributors and retailers. In establishing relationships
with distributors and retailers, we may be forced to accept arrangements under
which we will not receive payment for our products until these products are sold
to end users. Even though product shipments began in the third quarter of 2001,
under Staff Accounting Bulletin No. 101 issued by the Securities and Exchange
Commission, the recording of revenues will be delayed depending on the terms of
such shipments and our ability to estimate potential returns and future price
adjustments. We may also have to enter into revenue sharing or other
arrangements with these distributors and retailers in order to provide
additional incentives for such entities to actively market our products. In
addition, we expect that our distributors and retailers will sell products and
services offered by our competitors. If our competitors offer our distributors
and retailers more favorable terms or have more products available to meet their
needs, those distributors and retailers may decline to carry our products and
services. Other retailers may decline to carry our products because they believe
the ViDVD and the potential complementary ViMedia content delivery service will
decrease their sales of content such as DVDs and CDs. Further, even if they do
carry our products, distributors and retailers may not recommend, or continue to
recommend, those products. If we are unable to maintain successful relationships
with distributors and retailers or to expand our distribution channels, our
business will suffer.
WE PLAN TO EXPAND OUR BUSINESS, AND OUR FAILURE TO MANAGE GROWTH COULD DISRUPT
BUSINESS AND IMPAIR OUR ABILITY TO GENERATE REVENUES.
Since we began our business in April 1999, we have significantly expanded
our headcount, facilities and infrastructure. We anticipate continued expansion
in these areas to support potential sales growth and to allow us to pursue
market opportunities. This expansion has placed, and will continue to place, a
significant strain on our management, operational and financial resources and
systems. Specific risks we face as our business expands include:
- We will need to attract and retain qualified personnel, and any
failure to do so may impair our ability to offer new products or
grow our business. Our success will depend on our ability to
attract, retain and motivate managerial, technical, marketing,
administrative and customer support personnel. Competition for such
employees is intense, and we may be unable to successfully attract,
integrate or retain sufficiently qualified personnel. If we are
unable to hire, train, retain and manage required personnel, we may
be unable to successfully introduce new products or otherwise
implement our business strategy.
- Any inability of our systems to accommodate growth in the number of
users of the ViMedia content delivery service may cause service
interruptions. We have internally developed or are in the process of
developing the systems that will be used to run the ViMedia content
delivery service and perform other processing functions. The ability
of these systems to scale as we add new subscribers is unproven. We
will have to continually improve these systems to accommodate growth
in the number of users. Any inability by us to add additional
software and hardware or to upgrade our technology, systems or
network infrastructure in response to subscriber growth could
adversely affect our business or cause service interruptions.
- We will need to provide acceptable customer support, and any
inability to do so will impair our ability to develop consumer
acceptance of our products. We expect that some of our customers
will require significant support when installing the ViDVD player
and becoming acquainted with the features and functionality of the
ViDVD and its interface. In addition, our customers who elect to use
us as their Internet service provider may require frequent support
when accessing the Internet. We also anticipate that purchasers of
future Digital Home System products and services will require
support in their use of such products and services. We do not have
experience with widespread deployment of our products and services
to a diverse customer base, and we may not have adequate personnel
to provide the levels of support that our customers will require.
Our failure to provide adequate customer support for our Digital
Home System products or services will damage our reputation in the
consumer electronics marketplace and strain our relationships with
customers and strategic partners. This could prevent us from gaining
new or retaining existing customers and could harm our reputation
and brand.
- We will need to build an infrastructure to support the anticipated
sale of ViDVD players over the Internet. This infrastructure will
include the operational systems and controls necessary to conduct
sales over the Internet, including transaction processing, inventory
management and payment processing functions. Any failure by us to
develop and
19
maintain this infrastructure could hurt our ability to successfully
conduct sales over the Internet, which could prevent us from
establishing and maintaining customer relationships and increasing
our sales volume.
- We will need to improve our operational and financial systems to
support our expected growth, and any inability to do so will
adversely impact our ability to grow our business. To manage the
expected growth of our operations and personnel, we will need to
improve our operational and financial systems, procedures and
controls. Our current and planned systems, procedures and controls
may not be adequate to support our future operations and expected
growth. Delays or problems associated with any improvement or
expansion of our operational systems and controls could adversely
impact our relationships with customers and harm our reputation and
brand.
PRODUCT DEFECTS, SYSTEM FAILURES OR INTERRUPTIONS MAY HAVE A NEGATIVE IMPACT ON
OUR REVENUES, DAMAGE OUR REPUTATION AND DECREASE OUR ABILITY TO ATTRACT NEW
CUSTOMERS.
Errors and product defects can result in significant warranty and repair
problems, which could cause customer relations problems. Correcting product
defects requires significant time and resources, which could delay product
releases and affect market acceptance of our products. Any delivery by us of
products with undetected material product defects could harm our credibility and
market acceptance of our products.
Our ability to process purchases of content from our ViMedia content
delivery service and to provide uninterrupted access to the Internet will depend
on the efficient and uninterrupted operation of our computer and communications
systems. Our computer hardware and other operating systems are vulnerable to
damage or interruption from earthquakes, floods, fires, power loss,
telecommunication failures and similar events. They are also subject to
break-ins, sabotage, intentional acts of vandalism and similar misconduct.
Although we have taken precautions against such damage, including installing
backup servers as part of our network infrastructure, a natural disaster or
other unanticipated problems at one or more of our facilities could result in
interruptions in our business. These types of interruptions may reduce our
revenues and profits. Our business also will be harmed if consumers believe our
ViMedia content delivery service or our Internet service is unreliable. In
addition to placing increased burdens on our technical staff, service outages
may create a large number of customer questions and complaints that must be
responded to by our customer support personnel. Any damage to, or failure of,
our systems could result in reductions in, or terminations of, services supplied
to our customers, which could have a material adverse effect on our business and
irreparably damage our reputation and ability to attract new customers.
OUR FUTURE RESULTS COULD BE HARMED BY ECONOMIC, POLITICAL, REGULATORY AND OTHER
RISKS ASSOCIATED WITH OUR RELIANCE ON INTERNATIONAL SALES AND OPERATIONS.
Substantially all of our products are anticipated to be manufactured,
assembled and tested by independent third parties in China. In addition, most of
our suppliers are located in China, Hong Kong and Taiwan. We also anticipate
that revenue from international sales will represent a significant portion of
our total revenue, as one of our strategic partners is also located in China and
we expect that we will enter into sales and distribution arrangements with other
firms located in China, Taiwan and other foreign countries. Because of our
international operations and relationships, and our reliance on foreign
third-party manufacturing, assembly and testing operations, we are subject to
the risks of conducting business outside of the United States, including:
- changes in political and strategic relations between China, Taiwan
and the U.S.;
- changes in foreign currency exchange rates;
- changes in a specific country's or region's political or economic
conditions, particularly in China, Taiwan and other emerging Asian
markets;
- trade protection measures and import or export licensing
requirements;
- potentially negative consequences from changes in tax laws;
- difficulty in managing widespread sales and manufacturing
operations; and
- less effective protection of intellectual property.
20
OUR SUCCESS PARTLY DEPENDS ON OUR ABILITY TO SECURE AND PROTECT OUR PROPRIETARY
RIGHTS.
Our success and ability to compete are partly dependent upon our
internally developed technology. We rely on patent, trademark and copyright law,
trade secret protection and confidentiality or license agreements with our
employees, customers, partners and others to protect our proprietary rights.
However, the steps we take to protect our proprietary rights may be inadequate.
We have filed two U.S. patent applications, one to cover ViDVD proprietary
functions and digital encoder and decoder solutions and another to cover digital
audio signal compression and processing. In addition, we have filed
corresponding applications in Taiwan and with the patent cooperation treaty,
which reserves the right to file in foreign countries. To date, no patents have
been issued, and we cannot assure you that any patents will ever be issued, that
any issued patents will protect our intellectual property or that third parties
will not challenge any issued patents. Moreover, other parties may independently
develop similar or competing technologies designed around any patents that may
be issued to us.
The laws of certain foreign countries in which our products are or may be
designed, manufactured or sold, including various countries in Asia, may not
protect our products or intellectual property rights to the same extent as do
the laws of the U.S., and thus make the possibility of piracy of our technology
more likely. We cannot assure you that the steps taken by us to protect our
proprietary information will be adequate to prevent misappropriation of our
technology or that our competitors will not independently develop technologies
that are substantially equivalent or superior to our technology. Our failure to
protect our proprietary rights could harm our business.
WE MAY BE SUBJECT TO CLAIMS THAT OUR INTELLECTUAL PROPERTY INFRINGES UPON THE
PROPRIETARY RIGHTS OF OTHERS, AND A SUCCESSFUL CLAIM COULD HARM OUR ABILITY TO
SELL AND DEVELOP OUR PRODUCTS.
If other parties claim that our products infringe upon their intellectual
property, we could be forced to defend ourselves or our customers, manufacturers
or suppliers against those claims. We could incur substantial costs to prosecute
or defend those claims. A successful claim of infringement against us, or any
failure or inability of us to develop non-infringing technology or license the
infringed technology on acceptable terms and on a timely basis, could harm our
business, financial condition and results of operations.
IF WE LOSE KEY MANAGEMENT PERSONNEL, WE MAY NOT BE ABLE TO SUCCESSFULLY OPERATE
OUR BUSINESS.
Our future performance will be substantially dependent on the continued
services of our senior management, especially our Chairman , Fred S.L. Chan, our
President and Chief Executive Officer, Didier Pietri, and other key personnel.
The loss of any members of our executive management team and our inability to
hire additional executive management could harm our business and results of
operations. We employ our key personnel on an at-will basis. We intend to obtain
key person insurance for Mr. Chan, but we do not maintain key person insurance
policies on any of the other members of our executive management team.
IF WE ARE UNABLE TO ATTRACT AND RETAIN THE QUALIFIED PERSONNEL REQUIRED TO
TIMELY AND COST-EFFECTIVELY IMPLEMENT NEW ADMINISTRATIVE SYSTEMS TO REPLACE THE
PORTIONS OF ESS' ADMINISTRATIVE INFRASTRUCTURE ON WHICH WE CURRENTLY RELY, OUR
BUSINESS COULD BE HARMED.
We currently use duplicated versions of ESS' systems to support our
operations, including systems to manage human resources, accounting, payroll and
internal computing operations. Following ESS' distribution of our stock to its
shareholders, ESS has no obligation to provide assistance to us other than the
interim services which are provided by ESS pursuant to a transition services
agreement between us and ESS. These interim services include, among others,
information technology systems, human resources, administration, product order
administration, customer service, buildings and facilities, and legal, finance
and accounting services.
Over the next several months, we will be implementing new systems to
replace the duplicated versions of ESS' systems, and we expect to have fully
independent systems in place by the in 2002. The implementation of these new
information systems will require the services of employees with extensive
knowledge of these information systems and the business environment in which we
operate. In order to successfully implement and operate our systems, we must be
able to attract and retain a significant number of qualified employees. If we
fail to attract and retain the qualified personnel required to implement,
maintain and operate our information systems, our business could suffer. Even if
we are able to attract and retain the required personnel, we may not be
successful in implementing the new systems and transitioning data from the
duplicated versions of ESS' systems to our new systems. Any failure or
significant downtime in ESS' or our own information systems could harm our
business.
21
ANY FUTURE BUSINESS ACQUISITIONS MAY DISRUPT OUR BUSINESS, DILUTE STOCKHOLDER
VALUE OR DISTRACT MANAGEMENT ATTENTION.
As part of our ongoing business strategy, we may consider additional
acquisitions of, or significant investments in, businesses that offer products,
services and technologies complementary to our own. In particular, we may pursue
acquisitions and strategic alliances as a means of acquiring content to be
included on our ViMedia discs. Such acquisitions could materially adversely
affect our operating results and/or the price of our stock. Acquisitions also
entail numerous risks, including:
- difficulty of assimilating the operations, products and personnel of
the acquired businesses;
- potential disruption of our ongoing business;
- unanticipated costs associated with the acquisition;
- inability of management to manage the financial and strategic
position of acquired or developed products, services and
technologies;
- inability to maintain uniform standards, controls, policies and
procedures; and
- impairment of relationships with employees and customers that may
occur as a result of integration of the acquired business.
To the extent that shares of our stock or other rights to purchase stock
are issued in connection with any future acquisitions, dilution to our existing
stockholders will result and our earnings per share may suffer. Any future
acquisitions or strategic investments may not generate additional revenue or
provide any benefit to our business, and we may not achieve a satisfactory
return on our investment in any acquired businesses.
LAWS OR REGULATIONS THAT GOVERN THE CONSUMER ELECTRONICS INDUSTRY, THE
TELECOMMUNICATIONS INDUSTRY, COPYRIGHTED WORKS OR THE INTERNET COULD EXPOSE US
TO LEGAL ACTION IF WE FAIL TO COMPLY OR COULD REQUIRE US TO CHANGE OUR BUSINESS.
Because our Digital Home System products and services are expected to
provide our customers with access to a variety of entertainment media and
methods of electronic communication, it is difficult to predict what laws or
regulations will be applicable to our business. Therefore, it is difficult to
anticipate the impact of current or future laws and regulations on our business.
Among the many regulations that may be applicable to our business are the
following:
- Federal Communications Commission regulations relating to the
electronic emissions of consumer products;
- Federal Communications Commission regulations relating to consumer
products that connect to the public telephone network;
- regulations relating to the access and use of the Internet issued by
various federal and state governmental agencies, legislative bodies
and courts, including the Federal Communications Commission and the
Federal Trade Commission;
- copyright laws relating to the use of copyrighted audio and video
media; and
- federal export regulations relating to the export of sensitive
computer technologies such as encryption and authentication
software.
Changes in the regulatory climate or the enforcement or interpretation of
existing laws could expose us to legal action if we fail to comply. In addition,
any of these regulatory bodies could promulgate new regulations or interpret
existing regulations in a manner that would cause us to incur significant
compliance costs or force us to alter the features or functionality of our
products and services.
22
WE AND MANY OF OUR SUPPLIERS RELY ON A CONTINUOUS POWER SUPPLY TO CONDUCT
OPERATIONS, AND CALIFORNIA'S CURRENT ENERGY CRISIS COULD DISRUPT OUR BUSINESS
AND INCREASE OUR EXPENSES.
California is in the midst of an energy crisis that could disrupt our
operations and increase our expenses. In the event of an acute power shortage,
that is, when power reserves for California fall below certain levels,
California has on some occasions implemented, and may in the future continue to
implement, rolling blackouts throughout California. Some of our suppliers,
particularly ESS, are also located in California. In addition, a significant
portion of our non-manufacturing operations are located in California. If
blackouts interrupt our power supply, we may be temporarily unable to continue
operations at our California facilities. Any such interruption in our ability to
continue operations at our California facilities could harm our business and
results of operations.
OUR STOCK WILL MOST LIKELY BE SUBJECT TO THE REQUIREMENTS FOR PENNY STOCKS,
WHICH COULD ADVERSELY AFFECT YOUR ABILITY TO SELL AND THE MARKET PRICE OF YOUR
SHARES.
We currently expect that our stock will fit the definition of a penny
stock. The Securities and Exchange Act of 1934 defines a penny stock as any
equity security that is not traded on a national securities exchange or
authorized for quotation on The Nasdaq National Market and that has a market
price of less than $5.00 per share, with certain exceptions. Penny stocks are
subject to Rule 15g under the Securities and Exchange Act of 1934, which imposes
additional sales practice requirements on broker-dealers who sell such
securities. In general, a broker-dealer, prior to a transaction in a penny
stock, must deliver a standardized risk disclosure document that provides
information about penny stocks and the risks in the penny stock market. The
broker-dealer must provide the customer with current bid and offer quotations
for the penny stock, information about the commission payable to the
broker-dealer and its salesperson in the transaction and monthly statements that
disclose recent price information for each penny stock in the customer's
account. Finally, prior to any transaction in a penny stock, the broker-dealer
must make a special written suitability determination for the purchaser and
receive the purchaser's written consent to the transaction prior to sale. All of
these requirements may restrict your ability to sell our stock and could limit
the trading volume of our stock and adversely affect the price investors are
willing to pay for our stock.
IN THE FUTURE, OUR REVENUES AND QUARTERLY OPERATING RESULTS MAY FLUCTUATE
SIGNIFICANTLY, WHICH MAY ADVERSELY AFFECT THE MARKET PRICES OF OUR STOCK AND
COULD LEAD TO US BECOMING THE TARGET OF COSTLY SECURITIES CLASS ACTION
LITIGATION.
We expect our revenues and operating results to fluctuate significantly
due to a number of factors, many of which are outside of our control. Therefore,
you should not rely on period-to-period comparisons of results of operations as
an indication of our future performance. It is possible that in some future
periods our operating results may fall below the expectations of market analysts
and investors. In this event, the market prices of our stock would likely fall.
Factors that may affect our quarterly operating results include:
- unsuccessful launch of the ViDVD;
- ongoing demand and supply for ViDVD players;
- seasonality and other consumer and advertising trends;
- changes in the economic terms of our relationships with our
strategic partners;
- unanticipated shortfalls in the supply of components necessary for
the manufacture of our products;
- changes in our pricing policies, the pricing policies of our
competitors and general pricing trends in the multimedia appliance
market;
- unanticipated shortfalls in revenue due to the fact that our
expenses precede associated revenues;
- changes in estimates of our financial performance or changes in
recommendations by securities analysts;
- release of new or enhanced products or services or introduction of
new marketing initiatives by us or our competitors;
- announcements by us or our competitors of the creation or
termination of significant strategic partnerships, joint
23
ventures, significant contracts, or acquisitions;
- the market price generally for consumer electronics and home
entertainment industry stocks;
- market conditions affecting the home entertainment industry;
- additions or departures of key personnel;
- demand for and consumer acceptance of other anticipated future
Digital Home System product and services offerings; and
- general economic conditions.
In the past, securities class action litigation has often been brought
against a company following stock price declines. We may be the target of
similar litigation in the future if the price of our common stock declines.
Securities litigation could result in substantial costs and diversion of
management attention and resources, all of which could materially harm our
business, financial condition and results of operations.
SEASONAL TRENDS MAY CAUSE OUR QUARTERLY OPERATING RESULTS TO FLUCTUATE, WHICH
MAY ADVERSELY AFFECT THE MARKET PRICE OF OUR STOCK.
Domestic consumer electronic product sales have traditionally been much
higher during the holiday shopping season than during other times of the year.
Although predicting consumer demand for our products will be very difficult, we
believe that sales of ViDVD players will be disproportionately high during these
periods when compared to other times of the year. As a result, if we are unable
to complete the launch of the ViDVD in advance of the 2001 holiday shopping
season, our operating results for the fourth quarter of 2001 will be
significantly lower than anticipated. Even if we are successful in completing
the launch of the ViDVD in advance of the 2001 holiday shopping season, our
quarterly operating results will still be affected by our success in the 2001
holiday season and in future holiday seasons. Any fluctuation in our quarterly
operating results may cause the market price of our stock to decline, and that
decline may be substantial if the fluctuation is caused by a delay in the launch
of the ViDVD. Finally, if we are unable to accurately forecast and respond to
consumer demand for our Digital Home System products, our reputation and brand
will suffer, and the market price of our stock would likely fall.
CONFLICTS OF INTEREST MAY ARISE BECAUSE TWO OF OUR DIRECTORS, INCLUDING OUR
CHAIRMAN , WHO WILL OWN SECURITIES OF BOTH ESS AND US AND THESE TWO DIRECTORS
ALSO SERVE AS DIRECTORS OF ESS.
Fred S.L. Chan, our Chairman, owns a significant amount of ESS stock and
our stock and options to purchase ESS stock and our stock. In addition, Matthew
K. Fong, a member of our board of directors, owns ESS stock and options to
purchase ESS stock. These individuals will receive additional shares of our
stock in ESS' distribution of our stock to its shareholders. Mr. Chan is the
Chairman and a board member of ESS. These factors could create, or appear to
create, potential conflicts of interest when these directors and executive
officers are faced with decisions that could have different implications for ESS
and us.
PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY DELAY OR PREVENT
ACQUISITION OF US, WHICH COULD DECREASE THE VALUE OF OUR SHARES.
Our amended and restated certificate of incorporation, amended and
restated bylaws and Delaware law contain provisions that could make it more
difficult for a third party to acquire us without the consent of our board of
directors. Delaware law also imposes some restrictions on mergers and other
business combinations between us and any holder of 15% or more of our
outstanding shares. Although we believe these provisions provide for an
opportunity to receive a higher bid by requiring potential acquirers to
negotiate with our board of directors, these provisions apply even if the offer
may be considered beneficial by some stockholders.
24
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Interest Rate Risks. We invest in short-term investments. Consequently, we
are exposed to fluctuation in interest rates on these investments. Increases or
decreases in interest rates generally translate into decreases and increases in
the fair value of these investments. In addition, the credit worthiness of the
issuer, relative values of alternative investments, the liquidity of the
instrument, and other general market conditions may affect the fair values of
interest rate sensitive investments. In order to reduce the risk from
fluctuation in rates, we invest in highly liquid governmental notes and bonds
with contractual maturities of less than two years. All of the investments have
been classified as available for sale, and at September 30, 2001, are recorded
at market values.
Foreign Exchange Risks. Because our products are manufactured primarily in
Asia, we are exposed to market risk from changes in foreign exchange rates,
which could affect its results of operations and financial condition. In order
to reduce the risk from fluctuation in foreign exchange rates, our product sales
and all of our arrangements with our third party manufacturers and component
vendors are denominated in U.S. dollars. We do not engage in any currency
hedging activities.
PART II: OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
In August 2001, Professional Staffing Corporation ("PSC") filed a lawsuit
against the Company in The Superior Court of California, County of Alameda, Case
No. 2001-22331, alleging causes of action for breach of contract and fraud. The
Company has answered the complaint by way of a Demurrer, which is scheduled to
be heard on December 4, 2001. In the past, PSC has provided temporary
information technology workers to the Company on an ongoing basis, and prior to
the suit being filed, the Company in July voluntarily withheld payment to PSC on
$92,095.00 of outstanding invoices pending the results of an in-house audit. The
Company believes that PSC has in fact breached the contract and that the Company
may have been substantially overcharged for services provided by PSC. This
matter is in pre-trial discovery and currently there is no date set for trial.
The Company will vigorously defend the litigation, and is engaging in settlement
negotiations.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On July 20, 2001, holders of a majority of Vialta stock amended and
restated the Company's certificate of incorporation such that (i) the Company
has the authority to issue up to 400,000,000 shares of common stock at par value
of $0.001 per share, of which 100,000,000 shares shall be designated Class A
common stock, 50,000,000 shares shall be designated Class B common stock and
250,000,000 shares shall be designated non-classified common stock and (ii)
30,000,000 shares of preferred stock at par value $0.001. The majority of
shareholders approved of the adoption of amended and restated bylaws. The
majority of shareholders also adopted the 2001 employee stock purchase plan.
On July 23, 2001, holders of a majority of outstanding shares of capital
stock approved the 2001 nonstatutory stock option plan whereby 8,939,219 shares
of repurchased stock may be issued upon exercise of options granted under the
plan.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits. None.
(b) Reports on Form 8-K. No reports were filed on Form 8-K for the
quarter ended September 30, 2001.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report on Form 10-Q to be signed on its behalf
by the undersigned, thereunto duly authorized.
VIALTA, INC. (Registrant)
Date: November 9, 2001 By: /s/ Fred S.L. Chan
---------------------------
Fred S.L. Chan
Chairman
(Principal Financial and Accounting Officer)
26