1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q/A
AMENDMENT NO. 1 TO
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarter ended March 31, 1997 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-21126
S3 INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0204341
- --------------------------------- ------------------------------------
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
2801 Mission College Boulevard
Santa Clara, California 95052-8058
- --------------------------------------- ----------
(Address of principal executive offices (Zip Code)
Registrant's telephone number, including area code: (408) 588-8000
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No [ ]
The number of shares of the Registrant's Common Stock, $.0001 par value,
outstanding at May 7, 1997 was 49,217,199
2
S3 INCORPORATED
FORM 10-Q/A
This report on Form 10-Q/A constitutes Amendment No. 1 to the Registrant's Form
10-Q for the quarter ended March 31, 1997. This report is intended to amend
certain information contained in Part I, Items 1 and 2, and Part II, Item 1 and
6. See "Management's Discussion and Analysis of Financial Condition and Results
of Operations" for a discussion of the basis for such amendments.
INDEX
PAGE
----
PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets
March 31, 1997 and December 31, 1996 3
Condensed Consolidated Statements of Income
Three months ended March 31, 1997 and 1996 4
Condensed Consolidated Statements of Cash Flows
Three months ended March 31, 1997 and 1996 5
Notes to Unaudited Condensed Consolidated Financial Statements 6-9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10-22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 2. Changes in Securities Not Applicable
Item 3. Defaults Upon Senior Securities Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders Not Applicable
Item 5. Other Information Not Applicable
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 24
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
S3 INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
(Unaudited)
March 31, December 31,
1997 1996
--------- ------------
(As Restated) (As Restated)
ASSETS
Current assets:
Cash and equivalents $ 82,164 $ 94,616
Short-term investments 64,413 62,768
Accounts receivable (net of allowances
of $2,181 in 1997 and $2,648 in 1996 96,883 76,120
Inventories, net 53,316 53,466
Prepaid expenses and other 39,851 39,079
--------- ---------
Total current assets 336,627 326,049
Property and equipment, net 39,498 34,047
Production capacity rights 14,400 14,400
Investment in joint venture 97,631 93,430
Other assets 28,860 17,246
--------- ---------
Total $ 517,016 $ 485,172
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 49,674 $ 51,160
Notes payable 24,335 17,802
Accrued liabilities 15,466 12,063
Deferred revenue 14,097 12,113
Income taxes payable 10,108 7,361
--------- ---------
Total current liabilities 113,680 100,499
Notes payable 14,400 14,400
Other liabilities 8,651 6,452
Convertible subordinated notes 103,500 103,500
Commitments and contingencies
(Notes 5 and 6)
Stockholders' equity:
Common Stock, $.0001 par value;
70,000,000 shares authorized; 48,998,325
and 48,331,794 shares outstanding in 1997 and 1996 171,590 169,411
Unrealized loss on short-term investments (152) (54)
Retained earnings 105,347 90,964
--------- ---------
Total stockholders' equity 276,785 260,321
--------- ---------
Total $ 517,016 $ 485,172
========= =========
See accompanying notes to the unaudited condensed
consolidated financial statements.
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S3 INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except share data)
(Unaudited)
Three Months Ended
-----------------------------
March 31, March 31,
1997 1996
------------ ------------
(As Restated) (As Restated)
Net sales $ 130,255 $ 102,120
Cost of sales 75,620 61,827
--------- ---------
Gross margin 54,635 40,293
Operating expenses:
Research and development 18,942 14,721
Selling, marketing and administrative 12,630 10,914
--------- ---------
Total operating expenses 31,572 25,635
--------- ---------
Income from operations 23,063 14,658
Interest income 1,752 1,006
Interest expense (1,622) --
Other income (expense) (122) --
--------- ---------
Other income, net 8 1,006
--------- ---------
Income before income taxes 23,071 15,664
Provision for income taxes 8,689 5,285
--------- ---------
Net income $ 14,382 $ 10,379
========= =========
Net income per share:
Primary $ 0.28 $ 0.21
========= =========
Assuming full dilution $ 0.27 $ 0.21
========= =========
Common and equivalent shares used
in computing per share amounts:
Primary 52,118 50,047
========= =========
Assuming full dilution 57,481 50,047
========= =========
See accompanying notes to the unaudited condensed
consolidated financial statements.
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S3 INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
Three Months Ended
----------------------------
March 31, March 31,
1997 1996
------------ ------------
(As Restated) (As Restated)
Operating activities:
Net income $ 14,382 $ 10,379
Adjustments to reconcile net income to net
cash provided by operating activities:
Deferred income taxes 2,308 (1,812)
Depreciation and amortization 3,697 2,276
Equity in income from joint venture (4,201)
Changes in assets and
liabilities:
Accounts receivable (20,763) 3,056
Inventories 150 (4,596)
Prepaid expenses and other (1,726) (2,874)
Accounts payable (1,486) (10,973)
Accrued liabilities and other 5,247 2,253
Deferred revenue 1,984 5,881
Income taxes payable 2,747 1,209
-------- --------
Net cash provided by operating activities 2,339 4,799
-------- --------
Investing activities:
Property and equipment purchases, net (8,375) (5,331)
Investment in real estate partnership -- (2,100)
Sales/maturities of short-term investments, net (1,743) 1,835
Other assets (11,855) --
-------- --------
Net cash used for investing activities (21,973) (5,596)
-------- --------
Financing activities:
Sale of common stock, net 2,182 639
Borrowings of notes payable, net 5,000 2,000
-------- --------
Net cash provided by financing activities 7,182 2,639
-------- --------
Net increase (decrease) in cash and equivalents (12,452) 1,842
Cash and cash equivalents at beginning of period 94,616 69,289
-------- --------
Cash and cash equivalents at end of period $ 82,164 $ 71,131
======== ========
See accompanying notes to the unaudited
condensed consolidated financial statements.
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S3 INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation:
The condensed consolidated financial statements have been prepared by S3
Incorporated, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission and include the accounts of S3 Incorporated
and its wholly-owned subsidiaries ("S3" or collectively the "Company"). Certain
information and footnote disclosures, normally included in financial statements
prepared in accordance with generally accepted accounting principles, have been
condensed or omitted pursuant to such rules and regulations. In the opinion of
the Company, the financial statements reflect all adjustments, consisting only
of normal recurring adjustments, necessary for a fair presentation of the
financial position at March 31, 1997 and December 31, 1996, and the operating
results and cash flows for the three months ended March 31, 1997 and 1996. These
financial statements and notes should be read in conjunction with the Company's
audited financial statements and notes thereto for the year ended December 31,
1996, included in the Company's Form 10-K filed with the Securities and Exchange
Commission.
The results of operations for the three months ended March 31, 1997 are
not necessarily indicative of the results that may be expected for the
future quarters or the year ending December 31, 1997.
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2. Restatement of Financial Statements for Previous Periods
Subsequent to the issuance of the Company's financial statements for the
quarter ended March 31, 1997, the Company discovered that its accounting
policies with respect to revenue recognition for international sales had not
been fully followed. The Company's policy is to defer recognition of revenue on
all sales to distributors until the period the product is sold by each
distributor to its customers. Based on its review of this matter, the Company
determined that in certain instances, revenue was recognized prematurely, prior
to sale by the Company's distributors. Accordingly, the accompanying
consolidated condensed financial statements have been restated to properly defer
revenue recognition on products shipped to certain distributors.
The effects of such restatements are summarized as follows in thousands
except per share amounts:
Three Months Ended
----------------------
March 31, March 31,
1997 1996
-------- --------
Net sales before restatement $138,166 $110,072
Net sales after restatement $130,255 $102,120
Cost of sales before restatement $ 80,923 $ 66,510
Cost of sales after restatement $ 75,620 $ 61,827
Net income before restatement $ 15,921 $ 12,308
Net income after restatement $ 14,382 $ 10,379
Net income per common and equivalent share before restatement $ 0.31 $ 0.25
Net income per common and equivalent share after restatement $ 0.28 $ 0.21
At March 31, 1997 At December 31, 1996
----------------- --------------------
Deferred revenue before restatement $ -- $ 624
Deferred revenue after restatement $ 14,097 $ 12,113
Total stockholders' equity before restatement $285,102 $267,100
Total stockholders' equity after restatement $276,785 $260,321
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3. Inventories:
Inventories consist of work in process and finished goods and are stated
at the lower of cost (first-in, first-out) or market.
March 31, December 31,
Inventories consist of: 1997 1996
---------- ------------
(in thousands)
Work in process $23,468 $22,556
Finished goods 29,848 30,910
======= =======
Total $53,316 $53,466
======= =======
4. Net income per share:
Primary per share data is computed based on the weighted average number
of common and dilutive common equivalent shares outstanding. Common
equivalent shares include stock options and shares subscribed under the
employee stock purchase plan (computed using the treasury stock method).
Fully diluted per share data is computed using the most dilutive assumptions
and by adjusting the primary per share data and net income for the potential
effect of the conversion of the 5 3/4% Convertible Subordinated Notes
outstanding during the period and the elimination of the related interest
and deferred issue costs, net of income taxes.
5. Wafer supply agreements and commitments
During 1995, the Company entered into two long-term manufacturing
capacity arrangements. The Company entered into an agreement with United
Microelectronics Corporation (UMC) and Alliance Semiconductor Corporation to
form United Semiconductor Corporation (USC), a separate Taiwanese company,
for the purpose of building and managing a semiconductor manufacturing
facility in Taiwan, Republic of China. The Company has invested a total of
$89.4 million for its equity interest of 23.75%. The Company has the right
to purchase up to 31.25% of the output from the foundry.
In addition, in 1995 the Company expanded and formalized its
relationship with Taiwan Semiconductor Manufacturing Company (TSMC) to provide
additional capacity over the 1996 to 2000 timeframe. The agreement with TSMC
requires the Company to make certain annual advance payments to be applied
against the following year's capacity. The Company has signed promissory notes
to secure these payments over the term of the agreement. At March 31, 1997, the
remaining advance payments (and corresponding promissory notes) totaled $24.0
million ($9.6 million in prepaid expenses and $14.4 million in production
capacity rights).
In the ordinary course of business, the Company places purchase orders
with its wafer suppliers based on its existing and anticipated customer
orders for its products. Should the Company experience a substantial
unanticipated decline in the selling price of its products and/or demand
thereof, it could result in a material loss on such purchase commitments.
6. Contingencies
The semiconductor and software industries are characterized by frequent
litigation regarding patent and other intellectual property rights. The
Company is party to various claims of this nature. Although the ultimate
outcome of these matters is not presently determinable, management believes
that the resolution of all such pending matters will not have a material
adverse effect on the Company's financial position or results of operations.
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7. Recently Issued Accounting Standard
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings per Share"
(SFAS 128). The Company is required to adopt SFAS 128 in the fourth quarter
of fiscal 1997 and will restate at that time earnings per share (EPS) data
for prior periods to conform with SFAS 128. Earlier application is not
permitted.
SFAS 128 replaces current EPS reporting requirements and requires a dual
presentation of basic and diluted EPS. Basic EPS excludes dilution and is
computed by dividing net income available to common shareholders by the
weighted average of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common
stock.
If SFAS 128 had been in effect during the current and prior year
periods, basic EPS would have been $0.30 and $0.22 for the quarters ended March
31, 1997 and 1996, respectively. Diluted EPS under SFAS 128 would have been
$0.27 and $0.21 for the quarters ended March 31, 1997 and 1996, respectively.
8. Subsequent Events
Since November 1997, a number of complaints have been filed in federal and
state courts seeking an unspecified amount of damages on behalf of an alleged
class of persons who purchased shares of the Company's Common Stock at various
times between January 1, 1995 and November 3, 1997. The complaints name as
defendants the Company, certain of its officers and former officers and certain
directors of the Company, asserting that they violated federal and state
securities laws by misrepresenting and failing to disclose certain information
about the Company's business. In addition, certain shareholders have filed
derivative actions seeking recovery on behalf of the Company alleging, among
other things, breach of fiduciary duties by such individual defendants. The
Company has not formally responded to these complaints. While management intends
to defend the actions against the Company vigorously, there can be no assurance
that an adverse result or settlement with regards to such lawsuits would not
have a material adverse effect on the Company's financial condition or results
of operations.
The Company has received from the United States Securities and Exchange
Commission a request for information relating to the Company's recent
restatement announcement. The Company has responded and intends to continue to
respond to such requests.
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PART I. FINANCIAL INFORMATION
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
When used in this discussion, the words "expects," "anticipates," "estimates"
and similar expressions are intended to identify forward-looking statements.
Such statements, which include statements concerning the timing of availability
and functionality of products under development, product mix, trends in average
selling prices, trends in the PC market, the percentage of export sales and
sales to strategic customers and the availability and cost of products from the
Company's suppliers, are subject to risks and uncertainties, including those set
forth below under "Factors That May Affect Results," that could cause actual
results to differ materially from those projected. These forward-looking
statements speak only as of the date hereof. The Company expressly disclaims any
obligation or undertaking to release publicly any updates or revisions to any
forward-looking statements contained herein to reflect any change in the
Company's expectations with regard thereto or any change in events, conditions
or circumstances on which any statement is based.
OVERVIEW
The Company is a leading supplier of high performance multimedia acceleration
solutions for the PC market. The Company's accelerators are designed to work
cooperatively with a PC's central processing unit ("CPU"), implementing
functions best suited for a dedicated accelerator while allowing the CPU to
perform the more general purpose computing functions of today's advanced
graphical user interface ("GUI") environment and applications.
Subsequent to the filing of the Company's Form 10-Q for the quarter ended
March 31, 1997, the Company discovered that its accounting policies with respect
to revenue recognition for international sales had not been fully followed. The
Company's policy is to defer recognition of revenue on all sales to distributors
until the period the product is sold by each distributor to its customers. Based
on its review of this matter, the Company determined that in certain instances,
revenue was recognized prematurely, prior to sale by the Company's distributors.
The Company's review of this matter has been supervised by the Audit Committee
of the Board of Directors. The Company's accompanying quarterly financial
statements have been restated from the amounts previously reported to defer the
recognition of revenue until the time of sale by the distributor to the
customer. See note 2 of notes to unaudited condensed consolidated financial
statements.
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RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain financial data
as a percentage of net sales:
Three Months Ended
March 31, March 31,
1997 1996
--------- ---------
Net sales 100.0% 100.0%
Cost of sales 58.1 60.5
----- -----
Gross margin 41.9 39.5
----- -----
Operating expenses:
Research and development 14.5 14.4
Selling, marketing and administrative 9.7 10.7
----- -----
Total operating expenses 24.2 25.1
----- -----
Income from operations 17.7 14.4
Other income, net -- 0.9
----- -----
Income before income taxes 17.7 15.3
Provision for income taxes 6.7 5.2
----- -----
Net income 11.0% 10.1%
===== =====
The Company's operating results have historically been, and will
continue to be, subject to quarterly and other fluctuations due to a variety of
factors, including changes in pricing policies by the Company, its competitors
or its suppliers, anticipated and unanticipated decreases in unit average
selling prices of the Company's products, availability and cost of products from
the Company's suppliers, changes in the mix of products sold and in the mix of
sales by distribution channels, the gain or loss of significant customers, new
product introductions by the Company or its competitors, marketing acceptance of
new or enhanced versions of the Company's products, seasonal customer demand,
and the timing of significant orders.
The Company's operating results may fluctuate from those in prior
quarters or may be adversely affected in quarters in which it is undergoing a
product line transition in which production and sales of new products are
ramping up and in which existing products are under extreme price pressures due
to competitive factors. If new products are not brought to market in a timely
manner or do not address market needs or performance requirements, then the
Company's operating results will be adversely affected. As a result of the
foregoing, the Company's operating results and stock price may be subject to
significant volatility, particularly on a quarterly basis. Any shortfall in net
sales or net income from levels expected by securities analysts could have an
immediate and significant adverse effect on the trading price of the Company's
common stock.
NET SALES
The Company's net sales to date have been generated from the sale of its
graphics and multimedia accelerators. The Company's products are used in, and
its business is dependent on, the personal computer industry with sales
primarily in the U.S., Asia, and Europe. Net sales were $130.3 million for the
three months ended March 31, 1997, a 27.6% increase above the $102.1 million of
net sales for the three months ended March 31, 1996. Net sales increased
primarily as a result of the addition of the ViRGE product line and strong
demand for the Company's 64-bit products that resulted in increased unit
shipments. The increase in unit shipments was partially offset by lower overall
average selling prices. Sales for the three months ended March 31, 1997
consisted primarily of the ViRGE and Trio families of integrated accelerators
while sales for the three months ended March 31, 1996 consisted primarily of the
Trio family of integrated accelerators. The Company expects that the percentage
of its net sales represented by any one product or type of product may change
significantly from period to period as new products are introduced and existing
products reach the end of their product life
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cycles. Due to competitive price pressures, the Company's products experience
declining unit average selling prices over time, which at times can be
substantial.
The pricing environment for 2D graphics accelerators, which accounted
for a majority of the Company's net sales in 1996, has recently experienced and
is expected to continue to experience increasing pricing pressures due to
aggressive pricing from certain of the Company's competitors. In particular, the
Company's Trio family of integrated 2D accelerators experienced significant
decreases in average selling prices in 1996 which continued in the first quarter
of 1997. The Company expects that the graphics accelerator market will
transition from 2D acceleration to 3D acceleration, and the Company introduced
its ViRGE family of 2D/3D accelerators in response to this expected transition.
As a result of the entry of competitors into the 3D acceleration market, the
Company has experienced and anticipates that it may continue to experience
increased pricing pressures on average selling prices for the ViRGE family of
2D/3D accelerators. If the transition occurs slower than expected, if the
Company's graphic products do not achieve market acceptance, or if the pricing
pressures increase, then the Company's operating results could be adversely
affected. The Company currently expects that net sales for the three months
ended June 30, 1997 will be below net sales for the three months ended March 31,
1997 due to seasonal factors and to substantial pricing pressures currently
experienced by the Company's products.
Export sales accounted for 61% and 51% of net sales for the three months
ended March 31, 1997 and 1996, respectively. Approximately 16% of export sales
for the three months ended March 31, 1997 were to affiliates of United States
customers. The Company expects that export sales will continue to represent a
significant portion of net sales, although there can be no assurance that export
sales as a percentage of net sales will remain at current levels. All sales
transactions were denominated in U.S. dollars.
One customer accounted for 15% and 17% of net sales for the three months
ended March 31, 1997 and 1996 respectively. Two customer accounted for 17%, and
12% of net sales for the three months ended March 31, 1997 and two different
customers accounted for 15% and 14% of net sales for the three months ended
March 31, 1996. The Company expects a significant portion of its future sales to
remain concentrated within a limited number of strategic customers. There can be
no assurance that the Company will be able to retain its strategic customers or
that such customers will not cancel or reschedule orders or, in the event orders
are canceled, that such orders will be replaced by other sales. In addition,
sales to any particular customer may fluctuate significantly from quarter to
quarter. The occurrence of any such events or the loss of a strategic customer
could have a material adverse effect on the Company's operating results.
The occurrence of any supply problems for the Company's products may
adversely affect the rate of growth in net sales. Net sales may also be
adversely affected by delays in the production ramp of customers' new programs
and systems which incorporate the Company's products. In addition, the Company
ships more product in the third month of each quarter than in either of the
first two months of the quarter, with shipments in the third month higher at the
end of the month. This pattern, which is common in the semiconductor industry,
is likely to continue. The concentration of sales in the last month of the
quarter may cause the Company's quarterly results of operations to be more
difficult to predict. Moreover, a disruption in the Company's production or
shipping near the end of a quarter could materially reduce the Company's net
sales for that quarter. The Company's reliance on outside foundries and
independent assembly and testing houses reduces the Company's ability to
control, among other things, delivery schedules.
GROSS MARGIN
Gross margin percentage increased to 41.9% for the three months ended
March 31, 1997 from 39.5% for the three months ended March 31, 1996. The
increase was due to the Company achieving proportionately greater decreases in
unit average costs compared to decreases in overall average selling prices. The
unit average cost decreases were principally the result of changes in the
Company's design method and manufacturing strategy and shifts to lower cost
foundries. The Company currently expects its gross margin percentage to decrease
below
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historical levels in the three months ended June 30, 1997 due to substantial
pricing pressures and to fixed costs being spread over a revenue base that is
expected to be smaller.
In the future, the Company's gross margin percentages may be affected by
increased competition and related decreases in unit average selling prices
(particularly with respect to older generation products), timing of volume
shipments of new products, the availability and cost of products from the
Company's suppliers, changes in the mix of products sold, the profitability of
the USC joint venture (the Company recognizes its proportionate share of USC
profits and losses), the extent to which the Company forfeits or utilizes its
production capacity rights with TSMC, the extent to which the Company will incur
additional licensing fees and shifts in sales mix between add-in card and
motherboard manufacturers to systems OEMs.
RESEARCH AND DEVELOPMENT EXPENSES
The Company has made and intends to continue to make significant
investments in research and development to remain competitive by developing new
and enhanced products. Research and development expenses were $18.9 million for
the three months ended March 31, 1997, an increase of $4.2 million from $14.7
million for the three months ended March 31, 1996. Research and development
spending increases reflect additions to the Company's engineering staff and
nonrecurring engineering and initial product verification expenses related to
the expected introduction of new products. Research and development spending is
expected to increase in absolute dollars in 1997 as a result of the product
development activities currently underway for the desktop, mobile and home PC
markets with a focus on video, 3D, audio and communications.
Products in the Company's market typically have a life cycle of 12 to 24
months. The successful development and commercialization of new products
required to replace or supplement existing products involve many risks,
including the identification of new product opportunities, the successful and
timely completion of the development process, and the selection of the Company's
products by leading systems suppliers and board manufacturers for design into
their products. There can be no assurance that the Company will successfully
identify new product opportunities and develop and bring to the market in a
timely manner successful new products, that products or technologies developed
by others will not render the Company's products noncompetitive, or that the
Company's products will be selected for design into its customers' products. In
addition, it is possible that the Company's products may be found defective
after the Company has already shipped significant volume production. There can
be no assurance that the Company would be able to successfully correct such
problems or that such corrections would be acceptable to customers. The
occurrence of any such events would have a material adverse effect on the
Company's operating results.
SELLING, MARKETING AND ADMINISTRATIVE EXPENSES
Selling, marketing and administrative expenses were $12.6 million for
the three months ended March 31, 1997, an increase of $1.7 million from $10.9
million for the three months ended March 31, 1996. Selling and marketing costs
increased as a result of additional personnel, increased commissions associated
with higher sales levels and increased marketing costs associated with the
expected introduction of new products. Administrative costs have increased due
to the hiring of additional personnel necessary to support the increased level
of operations. The Company anticipates that selling, marketing and
administrative expenses will increase in absolute dollars in 1997.
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OTHER INCOME, NET
Other income, net, decreased to $8,000 for the three months ended March
31, 1997, from $1.0 million for the three months ended March 31, 1996. The
decrease is attributable to the interest expense incurred on $103.5 million
aggregate principal amount of convertible subordinated notes, which were issued
by the Company in September 1996. The interest expense is partially offset by
the interest income due to the higher average amounts of cash and short-term
investments as a result of the net proceeds of approximately $100.1 million from
the sale of the convertible subordinated notes.
INCOME TAXES
The Company's effective tax rate for the three months ended March 31,
1997 is 38%, compared to the 34% effective rate for the three months ended March
31, 1996. The increased tax rate is primarily attributable to the expiration of
the federal research and development credit as of May 31, 1997.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities for the three months ended March
31, 1997 was $2.3 million, as compared to $4.8 million for the three months
ended March 31, 1996. The Company experienced an increase from December 31, 1996
in accounts receivable, prepaid expenses and other, income tax payable and
accrued liabilities and other. These increases were partially offset by a
decrease in accounts payable. The Company experienced an increase in accounts
receivable from the level at December 31, 1996 due to the substantial
concentration of sales in March 1997 resulting from increased shipments in the
third month of that quarter over either of the first two months of the quarter
relative to what the Company experienced in previous quarters.
Investing activities for the three months ended March 31, 1997 and 1996
reflected property and equipment purchases, net, of $8.4 million and $5.3
million, respectively, short term investments, and deferred royalties. Continued
expansion of the Company's business may require higher levels of capital
equipment purchases, technology investments, foundry investments and other
payments to secure manufacturing capacity. In the first quarter of 1996, the
Company established a $20 million equity program for identifying and seeding
technology investments in the areas of Internet development, 3D, graphics,
video, audio and other technology growth areas.
Financing activities provided cash of $7.2 million and $2.6 million for
the three months ended March 31, 1997 and 1996 respectively. Borrowings on the
line of credit and proceeds from the issuance of common stock were the principal
financing activities that generated cash in both periods respectively.
In 1995, the Company entered into two long-term manufacturing capacity
arrangements. The Company entered into an agreement with UMC and Alliance
Semiconductor Corporation to form USC, a separate Taiwanese company, for the
purpose of building and managing a semiconductor manufacturing facility in the
Science Based Industrial Park in Hsin Chu City, Taiwan, Republic of China. The
Company invested $53.0 million in 1996 and $36.4 million in 1995 for its 23.75%
equity interest. The facility commenced production utilizing advanced submicron
semiconductor manufacturing processes in late 1996. The Company has the right to
purchase up to 31.25% of the output from the foundry. In addition, the Company
expanded and formalized its relationship with TSMC to provide additional
capacity over the 1996 to 2000 timeframe. The agreement with TSMC requires the
Company to make certain annual advance payments to be applied against the
following year's capacity. The Company has signed promissory notes to secure
these payments, which total $24.0 million as of March 31, 1997, over the term of
the agreement. The Company paid $7.2 million in 1996.
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Working capital at March 31, 1997 and December 31, 1996 was $222.9
million and $225.6 million, respectively. At March 31, 1997, the Company's
principal sources of liquidity included cash and equivalents of $82.2 million
and $64.4 million in short-term investments. In addition, the Company has a
$25.0 million unsecured revolving line of credit that expires June 1, 1997. The
Company is currently in the process of renewing the line of credit. The Company
had $5.0 million outstanding under the line of credit as of March 31, 1997. In
addition, the Company has two separate secured equipment lines of credit
totaling $10.0 million. The Company had $6.5 million outstanding under these
secured equipment lines of credit at March 31, 1997. The Company believes that
its available funds and its anticipated funds from operations will satisfy the
Company's projected working capital, existing foundry supply agreement and
capital expenditure requirements for at least the next 12 months, other than
expenditures for future potential manufacturing agreements.
In order to obtain an adequate supply of wafers, especially wafers
manufactured using advanced process technologies, the Company has entered into
and will continue to consider various possible transactions, including the use
of "take or pay" contracts that commit the Company to purchase specified
quantities of wafers over extended periods, equity investments in, advances or
issuances of equity securities to wafer manufacturing companies in exchange for
guaranteed production or the formation of joint ventures to own and operate or
construct wafer fabrication facilities. Manufacturing arrangements such as these
may require substantial capital investments, which may require the Company to
seek additional equity or debt financing. There can be no assurance that such
additional financing, if required, will be available when needed or, if
available, will be on satisfactory terms. In addition, the Company may, from
time to time, as business conditions warrant, invest in or acquire businesses,
technology or products that complement the business of the Company.
The cyclical nature of the semiconductor industry periodically results
in shortages of advanced process wafer fabrication capacity such as the Company
experiences from time to time. The Company's ability to maintain adequate levels
of inventory is primarily dependent upon the Company obtaining sufficient supply
of products to meet future demand, and any inability of the Company to maintain
adequate inventory levels may adversely affect its relations with its customers.
In addition, because the Company must order products and build inventory
substantially in advance of product shipments, there is a risk that the Company
will forecast incorrectly and produce excess or insufficient inventories of
particular products because the Company's products are volatile and subject to
rapid technology and price change. This inventory risk is heightened because
certain of the Company's key customers place orders with short lead times. The
Company's customers' ability to reschedule or cancel orders without significant
penalty could adversely affect the Company's liquidity, as the Company may be
unable to adjust its purchases from its independent foundries to match such
customer changes and cancellations. To the extent the Company produces excess or
insufficient inventories of particular products, the Company's operating results
could be adversely affected.
FACTORS THAT MAY AFFECT RESULTS
Fluctuations in Quarterly Operating Results
The Company's operating results have historically been, and will
continue to be, subject to quarterly and other fluctuations due to a variety of
factors, including changes in pricing policies by the Company, its competitors
or its suppliers, anticipated and unanticipated decreases in unit average
selling prices of the Company's products, availability and cost of products from
the Company's suppliers, changes in the mix of products sold and in the mix of
sales by distribution channels, the gain or loss of significant customers, new
product introductions by the Company or its competitors, market acceptance of
new or enhanced versions of the Company's products, seasonal customer demand,
and the timing of significant orders. Operating results could also be adversely
affected by general economic and other conditions affecting the timing of
customer orders and capital spending, a downturn in the market for PCs, and
order cancellations or rescheduling. In particular, the market for PCs in 1996
experienced a weakening in the trends for demand as compared with 1995 and grew
at a lower rate as compared with 1995. These factors could adversely affect
demand for the Company's products. In addition, the pricing environment for
graphics accelerators has recently experienced and is expected to continue
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to experience increasing pricing pressures due in part to the alleviation of
supply constraints that contributed to more stable pricing in 1995 and to
aggressive pricing from certain of the Company's competitors. In particular, the
Company's Trio family of integrated 2D accelerators, which accounted for a
majority of the Company's revenues in 1996, experienced significant decreases in
average selling prices in 1996. The Company expects that the graphics
accelerator market will transition from 2D acceleration to 3D acceleration, and
the Company has introduced its ViRGE family of 2D/3D accelerators in response to
this expected transition. As a result of the entry of competitors into the 3D
acceleration market, the Company has experienced and anticipates that it may
continue to experience increased pricing pressures on average selling prices for
the ViRGE family of 2D/3D accelerators. If the transition occurs slower than
expected, if the Company's 2D/3D products do not achieve market acceptance, or
if pricing pressures increase, the Company's operating results could be
adversely affected. Further, because the Company is continuing to increase its
operating expenses for personnel and new product development, the Company's
operating results would be adversely affected if such budgeted sales levels were
not achieved. PC graphics and multimedia subsystems include, in addition to the
Company's products, a number of other components which are supplied by
third-party manufacturers. Any shortage of such components in the future could
adversely affect the Company's business and operating results. Furthermore, it
is possible that the Company's products may be found to be defective after the
Company has already shipped significant volume production. There can be no
assurance that the Company would be able to successfully correct such defects or
that such corrections would be acceptable to customers, and the occurrence of
such events could have a material adverse effect on the Company's business and
operating results.
Because the Company must order products and build inventory
substantially in advance of product shipments, and because the markets for the
Company's products are volatile and subject to rapid technological and price
changes, there is a risk that the Company will forecast incorrectly and produce
excess or insufficient inventories of particular products. In addition, the
Company's customers may change delivery schedules or cancel orders without
significant penalty. To the extent the Company produces excess or insufficient
inventories of particular products, the Company's operating results could be
adversely affected.
The Company ships more product in the third month of each quarter than
in either of the first two months of the quarter, with shipments in the third
month higher at the end of the month. This pattern, which is common in the
semiconductor industry, is likely to continue. The concentration of sales in the
last month of the quarter may cause the Company's quarterly results of
operations to be more difficult to predict. Moreover, a disruption in the
Company's production or shipping near the end of a quarter could materially
reduce the Company's net sales for that quarter. The Company's reliance on
outside foundries and independent assembly and testing houses reduces the
Company's ability to control, among other things, delivery schedules.
Due to the foregoing factors, it is likely that in some future quarter
or quarters the Company's operating results may be below the expectations of
public market analysts and investors. In such event, the price of the Company's
Common Stock would likely be materially and adversely affected.
Importance of New Products; Rapid Technological Change
The PC industry in general, and the market for the Company's products in
particular, is characterized by rapidly changing technology, evolving industry
standards, frequent new product introductions and significant price competition,
resulting in short product life cycles and regular reductions of unit average
selling prices over the life of a specific product. Products in the Company's
market typically have a life cycle of 12 to 24 months, with regular reductions
of unit average selling prices over the life of a specific product. The
successful development and commercialization of new products required to replace
or supplement existing products involve many risks, including the identification
of new product opportunities, the successful and timely completion of the
development process, and the selection of the Company's products by leading
systems suppliers and add-in card and motherboard manufacturers for design into
their products. There can be no assurance that the Company will successfully
identify new product opportunities and develop and bring to market in a timely
manner successful new products, that products or technologies developed by
others will not render the Company's products or
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technologies noncompetitive, or that the Company's products will be selected for
design into its customers' products.
The Company is continually developing new products to address changing
market needs, and its operating results may fluctuate from those in prior
quarters or may be adversely affected in quarters in which it is undergoing a
product transition or in which existing products are under price pressures due
to competitive factors. The Company also intends to add increased functionality
to its multimedia products, such as system logic, audio, communications or other
additional functions. Market acceptance of the Company's products will also
depend upon acceptance of other components, such as memory, that the Company's
products are designed to work with. For example, the Company has recently
introduced accelerators designed to work with synchronous graphics RAM ("SGRAM")
and/or synchronous DRAM ("SDRAM") which the Company believes offer better
performance for its price than the more expensive video RAM ("VRAM"). However,
there can be no assurance that other memory technologies, such as Rambus DRAM,
will not achieve a greater degree of market acceptance than SGRAMs or SDRAMs. If
new products are not brought to market in a timely manner or do not address
market needs or achieve market acceptance, then the Company's operating results
will be adversely affected. The Company's 1994 operating results were adversely
affected in part because the Company had made a strategic decision to transition
its product offerings from 32-bit to 64-bit accelerators during the first half
of 1994, but due to a lack of PC system logic chipsets based on the PCI bus
standard and a slower than anticipated shift from 32-to 64-bit graphics, sales
of S3's PCI-based Vision64 family of accelerators were less than expected.
During the same period of time, competitors' 32-bit integrated accelerator
products offered a more competitive solution to the Company's customers and
ultimately necessitated an adjustment in the valuation of the Company's 32-bit
non-integrated inventory. In anticipation of a shift in demand from 2D to 3D
technology, the Company has introduced and is continuing to develop products in
its ViRGE family of 2D/3D multimedia accelerators. If the transition from 2D to
3D in the PC market is slower than the Company expects or if these products are
not brought to market in a timely manner or do not address market needs or
achieve market acceptance, the Company's operating results could be adversely
affected. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Dependence on Foundries and Other Third Parties
The Company currently relies on several independent foundries to
manufacture its products either in finished form or wafer form. The Company
currently has long-term supply arrangements with two of its foundries, a "take
or pay" contract with Taiwan Semiconductor Manufacturing Company ("TSMC") and a
joint venture foundry, United Semiconductor Corporation ("USC"). In 1995, the
Company expanded and formalized its relationship with TSMC to provide additional
capacity over the 1996 to 2000 timeframe. The foundry agreement with TSMC
requires the Company to make certain annual advance payments to purchase certain
committed capacity amounts to be applied against the following year's capacity
or forfeit advance payments against such amounts. In addition, the Company
entered into an agreement with United Microelectronics Corporation ("UMC") and
Alliance Semiconductor Corporation to form a separate Taiwanese company, USC,
for the purpose of building and managing a semiconductor manufacturing facility.
The Company invested $53.0 million in 1996 and $36.4 million in 1995 for its
23.75% equity interest. The facility commenced production utilizing advanced
submicron semiconductor manufacturing processes in late 1996. The Company has
the right to purchase up to 31.25% of the output from the foundry. To the extent
the Company purchases excess inventories of particular products or chooses to
forfeit advance payments, the Company's operating results could be adversely
affected. To the extent USC experiences operating losses, the Company will
recognize its proportionate share of such losses and may be required to
contribute additional capital. The Company believes that a number of
manufacturers are expanding or planning to expand their fabrication capacity
over the next several years, which could lead to overcapacity in the market and
resulting decreases in costs of finished wafers. If the wafers produced by USC
cannot be produced at competitive prices, USC could sustain operating losses.
There can be no assurance that such operating losses will not have a material
adverse effect on the Company's results of operations.
The Company conducts business with its other current foundries by
delivering written purchase orders specifying the particular product ordered,
quantity, price, delivery date and shipping terms and, therefore, such
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foundries are generally not obligated to supply products to the Company for any
specific period, in any specific quantity or at any specified price, except as
may be provided in a particular purchase order. To the extent a foundry
terminates its relationship with the Company or should the Company's supply from
a foundry be interrupted or terminated for any other reason, such as a natural
disaster or an injunction arising from alleged violations of third party
intellectual property rights, the Company may not have a sufficient amount of
time to replace the supply of products manufactured by that foundry. Until 1996,
due to worldwide semiconductor supply constraints, especially with respect to
advanced process technologies required by the Company's products, the Company
was unable to obtain a sufficient supply of products to enable it to meet demand
and was required to allocate available supply of its products among its
customers. There can be no assurance that the Company will obtain sufficient
advanced process technology foundry capacity to meet customer demand in the
future. The Company is continuously evaluating potential new sources of supply.
However, the qualification process and the production ramp-up for additional
foundries has in the past taken, and could in the future take, longer than
anticipated, and there can be no assurance that such sources will be able or
willing to satisfy the Company's requirements on a timely basis or at acceptable
quality or per unit prices.
Two of the Company's principal foundries, TSMC and UMC, and the
Company's foundry joint venture, USC, are located in the Science-Based
Industrial Park in Hsin Chu City, Taiwan. The Company currently expects these
three foundries to supply the substantial portion of the Company's products in
1997. Disruption of operations at these foundries for any reason, including work
stoppages, fire, earthquakes or other natural disasters, would cause delays in
shipments of the Company's products, and could have a material adverse effect on
the Company's results of operations. In addition, as a result of the rapid
growth of the semiconductor industry based in the Science-Based Industrial Park,
severe constraints have been placed on the water and electricity supply in that
region. Any shortages of water or electricity could adversely affect the
Company's foundries' ability to supply the Company's products, which could have
a material adverse effect on the Company's results of operations.
The Company is using multiple sources for certain of its products, which
may require the Company's customers to perform separate product qualifications.
The Company has not, however, developed alternate sources of supply for certain
other products, and its newly introduced products are typically produced
initially by a single foundry until alternate sources can be qualified. The
requirement that a customer perform separate product qualifications or a
customer's inability to obtain a sufficient supply of products from the Company
may cause that customer to satisfy its product requirements from the Company's
competitors, which would adversely affect the Company's results of operations.
The Company's products are assembled and tested by a variety of
independent subcontractors. The Company's reliance on independent assembly and
testing houses to provide these services involves a number of risks, including
the absence of adequate availability of certain packaging technologies, the
absence of guaranteed capacity and reduced control over delivery schedules,
quality assurance and costs. The Company also is subject to the risks of
shortages and increases in the cost of raw materials used in the manufacture or
assembly of the Company's products.
Constraints or delays in the supply of the Company's products, whether
because of capacity constraints, unexpected disruptions at the foundries or
assembly or testing houses, delays in obtaining additional production at
existing foundries or in obtaining production from new foundries, shortages of
raw materials, or other reasons, could result in the loss of customers and other
material adverse effects on the Company's operating results, including effects
that may result should the Company be forced to purchase products from higher
cost foundries or pay expediting charges to obtain additional supply.
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Transactions to Obtain Manufacturing Capacity; Future Capital Needs
In order to obtain an adequate supply of wafers, especially wafers
manufactured using advanced process technologies, the Company has entered into
and may consider in the future various transactions, including the use of "take
or pay" contracts that commit the Company to purchase specified quantities of
wafers over extended periods, equity investments in or advances or issuances of
equity securities to wafer manufacturing companies in exchange for guaranteed
production capacity, or the formation of joint ventures to own and operate or
construct foundries or to develop certain products. Any of such transactions
would involve financial risk to the Company and could require the Company to
commit substantial capital or provide technology licenses in return for
guaranteed production capacity. In particular, the Company has entered into a
"take or pay" contract with TSMC and has entered into the USC joint venture. The
need to commit substantial capital may require the Company to seek additional
equity or debt financing. The sale or issuance of additional equity or
convertible debt securities could result in additional dilution to the Company's
stockholders. There can be no assurance that such additional financing, if
required, will be available when needed or, if available, will be on terms
acceptable to the Company.
Dependence on Accelerator Product Line
S3's products are designed to improve the graphics and multimedia
performance of x86-based PCs and Microsoft Windows, Windows NT and IBM OS/2
operating systems, the predominant standards in today's PC market. Any shift
away from such standards would require the Company to develop new products. The
Company expects that additional specialized graphics processing and general
purpose computing capabilities will be integrated into future versions of Intel
and other x86-based microprocessors and that standard multimedia accelerators in
the future will likely integrate memory, system logic, audio, communications or
other additional functions. The Company has not previously offered either single
function or integrated accelerator products that provide these functions, which
have traditionally been provided by separate single function chips or chipsets.
The Company has been and will continue to be required to expand the scope of its
research and development efforts to provide these functions, which will require
the hiring of engineers skilled in the respective areas and additional
management and coordination among the Company's design and engineering groups.
Alternatively, the Company may find it necessary or desirable to license or
acquire technology to enable the Company to provide these functions, and there
can be no assurance that any such technology will be available for license or
purchase on terms acceptable to the Company. Furthermore, there is a limited
amount of space on PC motherboards, and companies that offer solutions that
provide the greatest amount of functionality within this limited space may have
a competitive advantage. While the Company's strategy is to develop new and
enhanced graphics and multimedia accelerator products that will be complementary
to present and future versions of Intel and other x86-based microprocessors and
integrate additional functionality, there can be no assurance that the Company
will be able to develop such new or enhanced products in a timely manner or
correctly anticipate the additional functionality that will be required to
compete effectively in this market. There can be no assurance that, if
developed, the Company's new or enhanced products that incorporate these
functions will achieve market acceptance. There also can be no assurance that
the market for graphics and multimedia accelerators will continue to grow in the
future or that new technological developments or changes in standards will not
result in decreased demand for graphics and multimedia accelerators or for the
Company's products that are not compatible with such changed standards. For
example, in 1996, there was an absence of an industry standard 3D graphics API.
As a result, the Company developed and promoted its proprietary API. Microsoft
has since introduced its Direct3D API, which has emerged as the standard API for
3D acceleration. While the Company's 3D accelerators currently support the
Company's proprietary API and Microsoft's Direct 3D API, there can be no
assurance that another API will emerge as an industry standard that the
Company's accelerators will not support. While the PC industry in recent periods
has been characterized by substantial demand, such demand has historically been
cyclical, and there can be no assurance that this demand will continue in future
periods or that demand for the Company's products will continue. The occurrence
of any such events would have a material adverse effect on the Company's
operating results.
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Substantial Competition
The market for the Company's products is extremely competitive and is
characterized by declining selling prices over the life of a particular product
and rapid technological changes. The Company's principal competitors for
graphics accelerators include ATI Technologies, Inc., Cirrus Logic, Inc., Matrox
Graphics Inc., and Trident Microsystems, Inc. The Company's principal
competitors in the multimedia market include the companies named in the
preceding sentence and a number of smaller companies which may have greater
flexibility to address specific market needs. Potential competitors in these
markets include both large and emerging domestic and foreign semiconductor
companies. In particular, there is a significant number of established and
emerging companies that have developed, are developing or have announced plans
to develop 3D graphics chips, including Intel Corporation and Lockheed Martin
Corporation, which have announced that they are jointly developing such chips,
which are currently expected to become available in the second half of 1997, and
Texas Instruments Incorporated, which has announced a development and marketing
agreement with 3Dlabs Inc., Ltd. In addition, Microsoft has announced that it is
developing a reference architecture, Talisman, with an alternative method of
providing 3D functionality. Microsoft is working with a number of companies,
including Cirrus Logic, Inc., Samsung Electronics Co., Ltd., Philips N.V. and
Fujitsu Ltd., to implement this architecture. There can be no assurance that the
Company's product offerings to address the demand for the next generation of
2D/3D accelerators will be competitive, and if such product offerings are not
competitive, the Company's results of operations in 1997 and future periods
could be materially and adversely affected. The entry of additional competitors
into the 2D/3D accelerator market has resulted in and is expected to continue to
result in pricing pressures on average selling prices of the Company's products.
To the extent the Company expands its product line to add products with
additional functionality, such as audio, communications and system logic
functions, it will encounter substantial competition from established
semiconductor companies and may experience competition from companies designing
chips based on different technologies, such as software-centric multimedia
processors. Further, the need of PC manufacturers to rapidly introduce a variety
of products aimed at different segments of the PC market may lead to the shift
by such system OEMs to the purchase of graphics and multimedia add-in cards
provided by others. Certain of the Company's competitors supply both add-in
cards and accelerator chips, which may provide those competitors with an
advantage over suppliers such as the Company that supply only accelerator chips.
In addition, certain of the Company's potential competitors that supply add-in
cards and/or motherboards, such as Intel Corporation, may seek to use their
card/board business to leverage the startup of their graphics accelerator
business. Certain of the Company's current and potential competitors have
greater technical, manufacturing, financial and marketing resources than the
Company. The Company believes that its ability to compete successfully depends
upon a number of factors both within and outside of its control, including
product performance, product features, product availability, price, quality,
timing of new product introductions by the Company and its competitors, the
emergence of new graphics and PC standards, customer support, and industry and
general economic trends. There can be no assurance that the Company will have
the financial resources, technical expertise, or marketing, distribution and
support capabilities to compete successfully. The Company's future success will
be highly dependent upon the successful development and introduction of new
products that are responsive to market needs. There can be no assurance that the
Company will be able to successfully develop or market any such products.
Customer Concentration
The Company expects a significant portion of its future sales to remain
concentrated within a limited number of strategic customers. There can be no
assurance that the Company will be able to retain its strategic customers or
that such customers will not otherwise cancel or reschedule orders, or in the
event of canceled orders, that such orders will be replaced by other sales. In
addition, sales to any particular customer may fluctuate significantly from
quarter to quarter. The occurrence of any such events could have a material
adverse effect on the Company's operating results.
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Management of Growth; Dependence on Key Personnel
Since its inception, the Company has experienced significant growth in
the number of its employees and in the scope of its operating and financial
systems, resulting in increased responsibilities for the Company's management.
To manage future growth effectively, the Company will need to continue to
improve its operational, financial and management information systems,
procedures and controls, and expand, train, motivate, retain and manage its
employee base. The Company is in the final stage of implementing a new
management information system. Any problems encountered with the new system
could adversely affect the Company's operations. There can be no assurance that
the Company will be able to manage its growth effectively, and failure to do so
could have a material adverse effect on the Company's operating results.
The Company's future success depends in part on the continued service
of its key engineering, sales, marketing and executive personnel, including
highly skilled semiconductor design personnel and software developers, and its
ability to identify and hire additional personnel. Competition for such
personnel is intense and there can be no assurance that the Company can retain
and recruit necessary personnel to operate its business and support its future
growth. In August 1996, the Company appointed a new President and Chief
Executive Officer to replace Terry N. Holdt, who retired, and in March 1997,
the Company's Chief Financial Officer resigned, and there can be no assurance
as to the effects of this management transition on the Company's business and
operating results. The loss of key personnel could have a material adverse
effect on the Company's business and operating results. The Company does not
maintain key man insurance on any of its employees.
Importance of Intellectual Property; Litigation Involving Intellectual Property
The Company's ability to compete will be affected by its ability to
protect its proprietary information. The Company has filed several United States
and foreign patent applications and to date has a number of issued United States
patents. The Company relies primarily on its trade secrets and technological
know-how in the conduct of its business. There can be no assurance that the
steps taken by the Company to protect its intellectual property will be adequate
to prevent misappropriation of its technology or that the Company's competitors
will not independently develop technologies that are substantially equivalent or
superior to the Company's technology. The semiconductor and software industries
are characterized by frequent claims and related litigation regarding patent and
other intellectual property rights. The Company is party to various claims of
this nature. Although the ultimate outcome of these matters is not presently
determinable, management presently believes that the resolution of all such
pending matters will not have a material adverse effect on the Company's
operating results. There can be no assurance that third parties will not assert
additional claims or initiate litigation against the Company, its foundries, or
its customers with respect to existing or future products. In addition, the
Company may initiate claims or litigation against third parties for infringement
of the Company's proprietary rights or to determine the scope and validity of
the proprietary rights of the Company or others. Litigation by or against the
Company has in the past, in the case of the Brooktree Corporation ("Brooktree")
litigation, resulted and could in the future result in substantial expense to
the Company and diversion of the efforts of the Company's technical and
management personnel, whether or not litigation is determined in favor of the
Company. In the event of litigation to determine the validity of any third-party
claims, such litigation could result in significant expense to the Company and
divert the efforts of the Company's technical and management personnel, whether
or not litigation is determined in favor of the Company. In the event of an
adverse result in any such litigation, the Company could be required to pay
substantial damages, cease the manufacture, use, sale, offer for sale and
importation of infringing products, expend significant resources to develop or
obtain non-infringing technology, discontinue the use of certain processes or
obtain licenses to the technology which is the subject of the litigation. There
can be no assurance that the Company would be successful in such development or
acquisition or that any such licenses, if available, would be available on
commercially reasonable terms, and any such development or acquisition could
require expenditures by the Company of substantial time and other resources. Any
such litigation or adverse result therefrom could have a material adverse effect
on the Company's operating results.
In October 1995, Brooktree filed a complaint against the Company in the
United States District Court for the Southern District of California, alleging
that the Company's current products infringe a Brooktree patent. Such a lawsuit
resulted in substantial expense to the Company to defend the action and diverted
the efforts of the
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Company's technical and management personnel. In August 1996, the Company and
Brooktree entered into a settlement and license agreement pursuant to which all
claims and counterclaims between the parties were dismissed and the Company
agreed to pay to Brooktree a license fee and royalties related to certain
product revenues over a five-year period. See Part II, Item 1. Legal
Proceedings.
International Operations
The Company expects that export sales will continue to represent a
significant portion of net sales, although there can be no assurance that export
sales, as a percentage of net sales, will remain at current levels. In addition,
a substantial proportion of the Company's products are manufactured, assembled
and tested by independent third parties in Asia. Due to its export sales and
independent third party manufacturing, assembly and testing operations, and its
joint venture foundry, the Company is subject to the risks of conducting
business internationally, including unexpected changes in, or impositions of,
legislative or regulatory requirements, fluctuations in the U.S. dollar, which
could increase the sales price in local currencies of the Company's products in
foreign markets or increase the cost of wafers purchased by the Company, delays
resulting from difficulty in obtaining export licenses for certain technology,
tariffs and other barriers and restrictions, potentially longer payment cycles,
greater difficulty in accounts receivable collection, potentially adverse taxes,
and the burdens of complying with a variety of foreign laws. In addition, the
Company is subject to general geopolitical risks, such as political and economic
instability and changes in diplomatic and trade relationships, in connection
with its international operations. Two of the Company's independent foundries,
UMC and TSMC, and the Company's joint venture foundry, USC, are located in
Taiwan. The Company currently expects these three foundries to supply the
substantial portion of the Company's products in 1997. The People's Republic of
China and Taiwan at times experienced strained relations in 1995 and 1996, and
the worsening of relations or the development of hostilities between the two
parties could have a material adverse effect on the Company. Although the
Company has not to date experienced any material adverse effect on its
operations as a result of such regulatory, geopolitical, economic and other
factors, there can be no assurance that such factors will not adversely impact
the Company's operations in the future or require the Company to modify its
current business practices. In addition, the laws of certain foreign countries
may not protect the Company's intellectual property rights to the same extent as
do the laws of the United States.
Volatility of Stock Price
The market price of the shares of Common Stock, like that of the common
stock of many other semiconductor companies, has been and is likely to be highly
volatile, and the market has from time to time experienced significant price and
volume fluctuations that are unrelated to the operating performance of
particular companies. The market price of the Common Stock could be subject to
significant fluctuations in response to quarter-to-quarter variations in the
Company's anticipated or actual operating results, announcements of new
products, technological innovations or setbacks by the Company or its
competitors, conditions in the semiconductor and PC industries, the commencement
of, developments in or outcome of litigation, changes in or the failure by the
Company to meet estimates of the Company's performance by securities analysts,
market conditions for high technology stocks in general, and other events or
factors.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Since November 1997, a number of complaints have been filed in federal and
state courts seeking an unspecified amount of damages on behalf of an alleged
class of persons who purchased shares of the Company's Common Stock at various
times between January 1, 1995 and November 3, 1997. The complaints name as
defendants the Company, certain of its officers and former officers and certain
directors of the Company, asserting that they violated federal and state
securities laws by misrepresenting and failing to disclose certain information
about the Company's business. In addition, certain shareholders have filed
derivative actions seeking recovery on behalf of the Company alleging, among
other things, breach of fiduciary duties by such individual defendants. The
Company has not formally responded to these complaints. While management intends
to defend the actions against the Company vigorously, there can be no assurance
that an adverse result or settlement with regards to such lawsuits would not
have a material adverse effect on the Company's financial condition or results
of operations.
The Company has received from the United States Securities and Exchange
Commission a request for information relating to the Company's recent
restatement announcement. The Company has responded and intends to continue to
respond to such requests.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27 Financial Data Schedule (filed only with the electronic submission of Form
10-Q in accordance with the Edgar requirements)
23 of 24
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
S3 INCORPORATED
(Registrant)
/s/ WALTER D. AMARAL
--------------------
WALTER D. AMARAL
Senior Vice President Finance
and Chief Financial Officer
(Principal Financial and Accounting Officer)
February 25, 1998
24 of 24
25
INDEX TO EXHIBITS
Exhibit
Number Exhibits
- ------- --------
27 Financial Data Schedule