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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
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 0-25580
DIAMOND MULTIMEDIA SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0390654
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2880 JUNCTION AVENUE, SAN JOSE, CALIFORNIA 95134
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 325-7000
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 outstanding of the registrant's common
stock at April 17, 1998 was 34,767,973.
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DIAMOND MULTIMEDIA SYSTEMS, INC.
INDEX TO FORM 10-Q
Page
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PART I - FINANCIAL INFORMATION:
ITEM 1- Financial Statements
Consolidated Condensed Balance Sheets as of March 31, 1998
and December 31, 1997 3
Consolidated Condensed Statements of Operations for the three
months ended March 31, 1998 and 1997 4
Consolidated Condensed Statements of Cash Flows
for the three months ended March 31, 1998 and 1997 5
Notes to Consolidated Condensed Financial Statements 6
ITEM 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 8
PART II - OTHER INFORMATION
ITEM 1 - Legal proceedings 26
ITEM 2 - Changes in securities 26
ITEM 3 - Defaults Upon Senior Securities 26
ITEM 4 - Submission of Matters to a Vote of Security Holders 26
ITEM 5 - Other Information 26
ITEM 6 - Exhibits and Reports on Form 8-K 26
SIGNATURES 27
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PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
DIAMOND MULTIMEDIA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
MARCH 31, DECEMBER 31,
1998 1997
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 94,787 $ 85,929
Short-term investments 6,142 4,136
Trade accounts receivable, net of allowance for doubtful accounts
of $2,034 and $2,440 as of March 31, 1998 and
December 31, 1997 102,856 98,777
Inventories 92,456 78,647
Prepaid expenses and other current assets 6,958 6,350
Income taxes receivable 5,915 24,929
Deferred income taxes 13,731 14,679
--------- ---------
Total current assets 322,845 313,447
Property, plant and equipment, net 18,470 15,216
Other assets 3,416 3,616
Goodwill and other intangibles, net 5,031 5,275
--------- ---------
Total assets $ 349,762 $ 337,554
========= =========
LIABILITIES
Current liabilities:
Current portion of long-term debt $ 35,301 $ 36,455
Trade accounts payable 95,471 98,764
Accrued liabilities 20,883 17,667
Income taxes payable 5,518 2,274
--------- ---------
Total current liabilities 157,173 155,160
Long-term debt, net of current portion 1,747 1,873
--------- ---------
Total liabilities 158,920 157,033
--------- ---------
STOCKHOLDERS' EQUITY
Preferred stock, par value $.001; Authorized - 8,000 shares at March 31, 1998
and December 31, 1997; none issued and
outstanding -- --
Common stock, par value $.001;
Authorized - 75,000 at March 31, 1998 and December 31, 1997 Issued and
outstanding - 34,742 at March 31, 1998 and 34,491
at December 31, 1997 35 34
Additional paid-in capital 310,270 307,877
Distributions in excess of net book value (56,775) (56,775)
Accumulated deficit (62,688) (70,615)
--------- ---------
Total stockholders' equity 190,842 180,521
--------- ---------
Total liabilities and stockholders' equity $ 349,762 $ 337,554
========= =========
The accompanying notes are an integral part of these
consolidated condensed financial statements.
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DIAMOND MULTIMEDIA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
MARCH 31,
--------------------------
1998 1997
--------- ---------
Net sales $ 186,196 $ 112,402
Cost of sales 144,570 92,817
--------- ---------
Gross profit 41,626 19,585
--------- ---------
Operating expenses:
Research and development 7,092 5,692
Selling, general and administrative 23,158 22,511
Amortization of intangibles 244 1,316
--------- ---------
Total operating expenses 30,494 29,519
--------- ---------
Income (loss) from operations 11,132 (9,934)
Interest income, net 336 543
Other expense, net (144) (55)
--------- ---------
Income (loss) before provision (benefit) for income taxes
11,324 (9,446)
Provision (benefit) for income taxes 3,397 (3,495)
--------- ---------
Net income (loss) $ 7,927 ($ 5,951)
========= =========
Net income (loss) per share:
Basic $ 0.23 $( 0.17)
Diluted $ 0.22 $( 0.17)
Shares used in per share calculations:
Basic 34,781 34,179
Diluted 36,521 34,179
The accompanying notes are an integral part of these
consolidated condensed financial statements.
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DIAMOND MULTIMEDIA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED; IN THOUSANDS)
THREE MONTHS ENDED MARCH 31,
----------------------------
1998 1997
--------- ---------
Cash flows from operating activities:
Net income (loss) $ 7,927 $( 5,951)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,701 2,619
Provision for doubtful accounts (54) 429
Provision for excess and obsolete inventories 4,920 556
Deferred income taxes 948 (1,660)
Changes in assets and liabilities:
Trade accounts receivables (4,025) 4,421
Inventories (18,729) (3,215)
Prepaid expenses and other assets (408) 2,003
Income taxes receivable 19,014 --
Trade accounts payable and other liabilities 3,167 (25,080)
--------- ---------
Net cash provided by (used in) operating activities 14,461 (25,878)
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment (4,711) (1,970)
Purchases of short-term investments (2,006) --
--------- ---------
Net cash used in investing activities (6,717) (1,970)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock 2,394 268
Repurchases of common stock -- (4)
Proceeds from term loans and revolving credit facilities 22,971 7,064
Payments and maturities of term loans and revolving credit
facilities (24,032) (1,365)
Repayments of capital lease financings (219) (195)
--------- ---------
Net cash provided by financing activities 1,114 5,768
--------- ---------
Net increase (decrease) in cash and cash equivalents 8,858 (22,080)
Cash and cash equivalents at beginning of period 85,929 120,147
--------- ---------
Cash and cash equivalents at end of period $ 94,787 $ 98,067
========= =========
Supplemental Disclosure of cash flow information:
Income taxes paid during the period $ 10 $ 1,400
========= =========
Interest paid during the period $ 553 $ 155
========= =========
The accompanying notes are an integral part of these consolidated
condensed financial statements.
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DIAMOND MULTIMEDIA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared by the Company in accordance with generally accepted
accounting principles for interim financial information and pursuant to rules
and regulations of the Securities and Exchange Commission. In the opinion of
management, all adjustments (consisting only of normal recurring adjustments)
considered necessary for a fair presentation have been included. These financial
statements should be read in conjunction with the Company's consolidated
financial statements and notes thereto contained in the Company's Form 10-K for
the fiscal year ended December 31, 1997.
Operating results for the quarter ended March 31, 1998 may not necessarily
be indicative of the results to be expected for any other interim period or for
the full year.
2. INVENTORIES
Inventories are stated at the lower of cost (determined on a first-in,
first-out basis) or market. Inventories consisted of (in thousands):
March 31, 1998 December 31, 1997
-------------- -----------------
Raw materials $35,550 $29,876
Work in process 45,465 40,286
Finished goods 11,441 8,485
------- -------
$92,456 $78,647
======= =======
The Company had approximately $4 million of inventory in excess of its
normal short-term needs for certain product lines at March 31, 1998. Management
has developed a program to reduce this inventory to desired levels over the near
term; however, it is reasonably possible that the program will not be wholly
successful and that a material loss could ultimately result on the disposal of
this inventory. No estimate can be made of the range of amounts of such loss.
3. COMPUTATION OF NET INCOME (LOSS) PER SHARE
The Company adopted Financial Accounting Standards Board No. 128 "Earnings
Per Share" (EPS) and accordingly all prior periods have been restated. Basic EPS
is computed as net income (loss) divided by the weighted average number of
common shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur from common shares issuable through stock options,
warrants and other convertible securities. Common equivalent shares are excluded
from the computation of net loss per share as their effect is antidilutive.
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The following is a reconciliation of the numerator (net income) and
denominator (number of shares) used in the basic and diluted EPS calculation:
(Dollar amounts, in thousands)
Three Months Ended March 31,
-------------------------------
1998 1997
-------- --------
Basic:
Net income (loss) $ 7,927 $( 5,951)
Average Common
Shares Outstanding 34,781 34,179
-------- --------
Basic EPS $ 0.23 $( 0.17)
======== ========
Diluted:
Net income (loss) $ 7,927 $( 5,951)
Average Common
Shares Outstanding 34,781 34,179
Stock options 1,740 --
Total Shares 36,521 34,179
-------- --------
Diluted EPS $ 0.22 $( 0.17)
======== ========
Common equivalent shares of 1,222,000 have been excluded from the
calculation of dilituve earnings per share for the three months ended March 31,
1998 as their effect is anti-dilutive.
4. LITIGATION
The Company has been named as a defendant in several putative class action
lawsuits which were filed in June and July 1996 and June 1997 in the California
Superior Court for Santa Clara County and the U.S. District Court for the
Northern District of California. Certain executive officers and directors of the
Company are also named as defendants. The plaintiffs purport to represent a
class of all persons who purchased the Company's Common Stock between October
18, 1995 and June 20, 1996 (the "Class Period"). The complaints allege claims
under the federal securities laws and California law. The plaintiffs allege that
the Company and the other defendants made various material misrepresentations
and omissions during the Class Period. The complaints do not specify the amount
of damages sought. The Company believes that it has good defenses to the claims
alleged in the lawsuits and will defend itself vigorously against these actions.
These cases are in the early stages and no trial date has been set. The ultimate
outcome of these actions cannot be presently determined. Accordingly, no
provision for any liability or loss that may result from adjudication or
settlement thereof has been made in the accompanying consolidated financial
statements.
The Company is also party to other claims and pending legal proceedings
that generally involve employment and trademark issues. These cases are, in the
opinion of management, ordinary and routine matters incidental to the normal
business conducted by the Company. In the opinion of management, the ultimate
disposition of such proceedings will not have a materially adverse effect on the
Company's consolidated financial position or future results of operations.
5. COMPREHENSIVE NET INCOME
The Company has adopted the provisions of Statement of Financial
Accounting Standards No. 132, "Reporting Comprehensive Income", effective
January 1, 1998. This statement requires the disclosure of comprehensive income
and its components in a full set of general-purpose financial statements.
Comprehensive income is defined as net income plus revenues, expenses, gains and
losses that, under generally accepted accounting principles, are excluded from
net income. The components of comprehensive income which are
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excluded from net income are not significant, individually or in the aggregate,
and therefore, no separate statement of comprehenisve income has been presented.
6. SUBSEQUENT EVENT
On May 11, 1998 Diamond Multimedia Systems, Inc. announced that it entered
into an agreement to acquire Micronics Computers, Inc. ("Micronics") at a price
of $2.45 per share, or approximately $31.6 million, to be consummated as a cash
tender offer. Micronics is a supplier of high-performance system boards and
multimedia peripherals for personal computers. The acquisition, if completed,
will be treated as a purchase for accounting purposes and is subject to
regulatory approval and other customary conditions. The Company expects to take
a one-time charge during the second quarter in connection with the acquisition
of Micronics.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The discussion and analysis below contains trend analysis and other
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual
results could differ materially from those projected in the forward-looking
statements as a result of the risk factors set forth under "Certain Factors That
May Affect Future Performance" below and elsewhere in this report.
The following discussion should be read in conjunction with the Company's
consolidated financial statements and the notes thereto. All references to years
represent fiscal years unless otherwise noted.
OVERVIEW
Diamond Multimedia Systems, Inc. ("Diamond" or the "Company") designs,
develops, manufactures and markets multimedia and connectivity products for
IBM-compatible personal computers ("PCs"). The Company is a leading supplier of
graphics and multimedia accelerator subsystems for PCs, and is expanding its
position in the interactive multimedia market by providing advanced solutions
for home, business and professional desktop computer users, enabling them to
create, access and experience compelling new media content from their desktops
and through the Internet. Diamond accelerates multimedia from the Internet to
the hard drive with products that include the Stealth series of media
accelerators, the Monster series of entertainment 3D and audio accelerators, the
Fire series of professional 3D graphics and SCSI accelerators, and the Supra(R)
series of modems. Headquartered in San Jose, CA, Diamond has sales, marketing
and technical facilities in several locations including Vancouver (WA), Albany
(OR), Atlanta (GA), Dallas (TX), Singapore, Sydney, Hong Kong, Seoul, Tokyo,
Starnberg (Germany), Saarbrecken (Germany), Paris, and Winnersh (U.K.).
Diamond's products are sold through regional, national and international
distributors as well as directly to major computer retailers, VARs and OEMs
worldwide.
NET SALES
Net sales for the first quarter of 1998 increased $73.8 million (66%) to
$186.2 million compared to the first quarter of 1997. The increase in net sales
was primarily attributable to strong shipments of the Viper and Monster 3D
series of graphic accelerator cards as well as an increase in sales of the Fire
series of professional 3D graphics.
As a percentage of net sales, international net sales represented 46% of
net sales in the first quarter of 1998 compared to 30% of net sales in the first
quarter of 1997. The increase in the percentage of international sales was
primarily due to significant increases in product shipments to Europe in the
first quarter of 1998 relative to the corresponding prior year period.
Additionally, the percentage of international net sales derived from shipments
to countries outside of Europe also increased, albeit at a slower rate than in
Europe, in the first quarter of 1998 compared to corresponding prior year
period.
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In the current transition of mainstream PC graphics subsystem
architectures from 2D graphics and the PCI bus to 3D graphics and the
accelerated graphics port (AGP), which began in 1997 and is expected to continue
through 1998, controller and memory chip selection and the timely introduction
of new products have been and will continue to be critical factors. The Company
expects that the timing and speed of the PCI-to-AGP bus transition and the
SGRAM-to-SDRAM memory transition are likely to lead to an excess inventory of
PCI and SGRAM-based products at the Company and in the distribution channel that
is likely to result in lower average selling prices, lower gross margins,
end-of-life inventory write-offs, and higher price protection charges during the
second quarter of 1998. The Company estimates and accrues for potential
inventory write-offs and price protection charges. However, there can be no
assurance that these estimates and accruals will be sufficient, and additional
inventory write-offs and price protection charges may be required, the result of
which could have a material effect on operating results during the second
quarter of 1998.
Inventory levels of the Company's products in the two-tier distribution
channels used by the Company ("Channel Inventory Levels") generally are
maintained in a range of one to three months of customer demand. These Channel
Inventory Levels tend toward the low end of the months-of-supply range when
demand is stronger, sales are higher and products are in short supply.
Conversely, when demand is slower, sales are lower and products are abundant,
then Channel Inventory Levels tend toward the high end of the months-of-supply
range. Frequently, in such situations, the Company attempts to ensure that
distributors devote their working capital, sales and logistics resources to the
Company's products to a greater degree than to those of competitors. Similarly,
the Company's competitors attempt to ensure that their own products are
receiving a disproportionately higher share of the distributors' working capital
and logistics resources. In an environment of slower demand and abundant supply
of products, price declines are more likely to occur and, should they occur, are
more likely to be severe. Further, in such an event, high Channel Inventory
Levels may result in substantial price protection charges. Such price protection
charges have the effect of reducing net sales and gross profit. Consequently,
the Company, in taking steps to bring its Channel Inventory Levels down to a
more desirable level, may cause a shortfall in net sales during one or more
accounting periods. This situation may also result in price protection charges
as prices are decreased, having an adverse impact on operating results. While
the Company believes that its Channel Inventory Levels for many of its products
are appropriate at this time, there are certain products which currently have a
Channel Inventory Level that is higher than desirable. The Company accrues for
potential price protection on unsold channel inventory. However, there can be no
assurance that these estimates or accruals will be sufficient. Should the
estimates or accruals not be sufficient, additional price protection charges may
be required, the result of which could have a material adverse effect on
operating results during the second quarter of 1998.
GROSS MARGIN
Gross profit for the first quarter of 1998 increased $22.0 million to
$41.6 million compared to $19.6 million in the first quarter of 1997. Gross
margin (gross profit as a percentage of net sales) increased to 22.4% of net
sales during the first quarter of 1998 from 17.4% for the first quarter of 1997.
The increase was primarily due to the relatively high margin obtained from the
Company's Viper, Monster 3D and Fire GL series of graphic accelerator cards,
which experienced strong shipments in the first quarter of 1998. Further, the
gross margin was positively impacted by significantly higher shipment volume
levels over which indirect manufacturing costs could be absorbed.
RESEARCH AND DEVELOPMENT
Research and development (R&D) expenses increased $1.4 million (25%) to
$7.1 million for the first quarter of 1998, compared to the corresponding period
in 1997. This increase was primarily due to higher personnel-related expenses
and the material and outside service costs associated with new product
development, including products that will offer various functions or
combinations of functions including graphics, digital video, 3D animation, 3D
CAD, sound, modem, telephony and other functions increasingly being implemented
on personal computers. As a percentage of sales, R&D expenses were 3.8% and 5.1%
in the first quarter of 1998 and 1997, respectively. The decrease in expenses as
a percentage of net sales is primarily attributable to the increase in net sales
during the first quarter of 1998 compared to the first quarter of 1997.
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SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative (SG&A) expenses increased $0.6 million
(3%) to $23.2 million for the first quarter of 1998 compared to the first
quarter of 1997. This increase in expense was partially offset by a decline in
sales and promotional expenses, including fewer expenses attributable to channel
sales incentive programs during the first quarter of 1998 compared to the first
quarter of 1997. As a percentage of sales, SG&A expenses were 12.4% and 20.0% in
the first quarter of 1998 and 1997, respectively. The decrease in expenses, as a
percentage of sales, is primarily from the increase in net sales during the
first quarter of 1998 compared to the corresponding period of 1997.
AMORTIZATION OF INTANGIBLE ASSETS
The Company incurred amortization expense of $0.2 million in the first
quarter of 1998 compared to $1.3 million in the corresponding prior year period.
The decrease in expense in the first quarter of 1998 is primarily due to the
write-off of $9.9 million of intangible assets during the second quarter of 1997
which significantly reduced the remaining outstanding balance to be amortized.
These expenses relate to amortization of purchased technology and goodwill from
the Supra Corporation and SPEA Software AG acquisitions, which occurred in the
third and fourth quarters of 1995, respectively. This decrease in expense was
offset in part by amortization expense arising from the $2 million of goodwill
created by Company's acquisition of Binar Graphics, Inc. which occurred in
November 1997.
NET INTEREST INCOME (EXPENSE) AND OTHER EXPENSE
Net interest income was $0.3 million and $0.5 million in the first quarter
of 1998 and 1997, respectively. Net interest income declined due to higher
interest expense incurred because of larger average borrowings outstanding
during the first quarter of 1998 compared to the first quarter of 1997. Other
expense remained relatively flat during the first quarters of 1998 and 1997.
PROVISION (BENEFIT) FOR INCOME TAXES
The Company's effective tax rate in the first quarter of 1998 was 30%
compared to an income tax benefit rate of 37% for the corresponding period in
1997 when a pre-tax loss was incurred. Differences from the statutory rate
consisted principally of the effect of state income taxes, federal tax-exempt
interest income and the research and development tax credit.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased by $8.9 million during the first
quarter of 1998. Operating activities provided $14.5 million in cash, and the
primary sources of cash were as follows: net income of $7.9 million; a decrease
in income taxes receivables and a decrease in trade accounts payable and other
liabilities of $19.0 million and $3.2 million, respectively, and depreciation
and amortization expense of $1.7 million. These sources of cash from operating
activities were offset in part by an increase in inventories, net of the
provision for obsolescence, of $13.8 million, and an increase in trade
receivables, net of the provision for doubtful accounts of $4.0 million.
The Company used $6.7 million in cash from investing activities for the
purchase of property and equipment of $4.7 million and purchases of short-term
investments of $2.0 million. Net cash provided by financing activities was $1.1
million, primarily due to proceeds of $23.0 million from term loans and
revolving credit facilities and proceeds of $2.4 million from the issuance of
common stock. These proceeds were partially offset by payments and maturities of
term loans and revolving credit facilities of $24.0 million.
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At March 31, 1998, the Company had $94.8 million of cash and cash
equivalents and $6.1 million of short-term investments. Further, as of such
date, the Company had lines of credit and bank credit facilities totaling $61.2
million, of which $24.2 million was unused and available.
The Company expects to spend approximately $12 million for capital
equipment in 1998, principally relating to computer and office equipment and
including, in particular, an enhanced enterprise-wide business management,
resource planning and decision support application.
On May 11, 1998 Diamond Multimedia Systems, Inc. announced that it entered
into an agreement to acquire Micronics Computers, Inc. ("Micronics") at a price
of $2.45 per share, or approximately $31.6 million, to be consummated as a cash
tender offer. Micronics is a supplier of high-performance system boards and
multimedia peripherals for personal computers. The acquisition, if completed,
will be treated as a purchase for accounting purposes and is subject to
regulatory approval and other customary conditions. The Company expects to take
a one-time charge during the second quarter in connection with the acquisition
of Micronics.
The Company believes that its cash balances and available credit under
existing bank lines will be sufficient to meet anticipated operating and
investing requirements for the short term. There can be no assurance that
additional capital beyond the amounts currently forecasted by the Company will
not be required nor that any such required additional capital will be available
on reasonable terms, if at all, at such time or times as required by the
Company.
CERTAIN FACTORS THAT MAY AFFECT FUTURE PERFORMANCE
In addition to other information in this Form 10-Q, the following are
important factors that should be considered carefully in evaluating the Company
and its business.
POTENTIAL FLUCTUATIONS IN FUTURE OPERATING RESULTS
The Company's operating results have fluctuated significantly in the past
on a quarterly and an annual basis and is likely to continue to fluctuate
significantly in the future depending on a number of factors. The accompanying
sections explain in greater detail certain important factors that the Company
has identified which may affect the future performance of the Company.
The Company develops products in the highly competitive multimedia
graphics, video, sound, modem and SCSI adapter markets. These products are very
susceptible to product obsolescence and typically exhibit a high degree of
volatility of shipment volumes over their relatively short product life cycles.
The timing of introductions of new products in one calendar quarter as opposed
to an adjacent quarter can materially affect the relative sales volumes in those
quarters. In addition, product releases by competitors and accompanying pricing
actions can materially and adversely affect the Company's revenues and gross
margins.
Similarly, the Company sells its products to retail customers (mass
merchandisers and large chains who sell products primarily off-the-shelf
directly to end users) retail distribution customers (distributors which resell
to smaller retail chains and large individual end users) and OEM customers
(customers which use the Company's products in conjunction with other products
to produce complete computer systems for sales through both direct and indirect
distribution channels to end users). Reliance on these customers for almost all
of the Company's sales means that the Company typically has little or no direct
visibility into end user customer demand. OEM customers tend to provide the
Company with forecasts for product requirements but actual order lead times
remain less than 90 days. Retail and retail distribution customers typically do
not forecast product requirements and order lead times are typically very short,
as these customers tend to reorder for stock in quantities that approximate
recent sales volumes. Accordingly, this means that future operating results are
dependent on continued sales to customers where the vast majority of the normal
volume of orders are placed with the Company within the same calendar quarter as
the requested date of shipment by the customer.
Because the lead times of firm orders are typically short, the Company does
not have the ability to predict with any certainty the future operating results
of the Company. Therefore, sudden changes that are out of the control of the
Company such as general economic conditions, the actions or inaction of
competitors, customers, third party vendors of operating system software,
central processing unit hardware, and independent software application vendors
can have and have had material adverse effects on the Company's performance.
Other factors which may have a material adverse effect on the Company's
future performance, include the management of growth of the Company, latent
defects that can exist in the Company's products, competition for
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the available supply of components, dependence on subcontract manufacturers,
dependence on and development of adequate information technology systems,
intellectual property rights and dependence on key personnel.
Each of these factors is discussed more thoroughly in the accompanying
sections and all of these sections should be read carefully together to evaluate
the risks associated with the Company's Common Stock. Due to these factors, it
is likely that the operating results of the Company in some future quarter or
quarters will fall below the expectations of securities analysts and investors.
In such an event, the trading price of the Company's Common Stock could be
materially and adversely affected.
REVENUE VOLATILITY AND DEPENDENCE ON ORDERS RECEIVED AND SHIPPED IN A QUARTER
The volume and timing of orders received during a quarter are difficult to
forecast. Retail and retail distribution customers generally order without
forecasts on an as-needed basis and, accordingly, the Company has historically
operated with a relatively small backlog. Moreover, the Company has emphasized
its ability to respond quickly to customer orders as part of its competitive
strategy. This strategy, combined with current industry supply and demand
conditions as well as the Company's emphasis on minimizing inventory levels, has
resulted in customers placing orders with relatively short delivery schedules
and increased demand on the Company to carry inventory for its customer base.
This has the effect of increasing such short lead time orders as a portion of
the Company's business and reducing the Company's ability to accurately forecast
net sales. Because retail and retail distribution customers' orders are more
difficult to predict, there can be no assurance that the combination of these
orders, OEM's orders, and backlog in any quarter will be sufficient to achieve
either sequential or year-over-year growth in net sales during that quarter. If
the Company does not achieve a sufficient level of retail and retail
distribution orders in a particular quarter, the Company's revenues and
operating results would be materially adversely affected.
Also, at any time and with no advance notice, during periods of
uncertainty in the personal computer industry's outlook for future demand or
pricing, the Company's customers may choose to draw down their inventory levels
thereby adversely impacting the Company's revenue during the period of
adjustment. The second and third quarters of 1997 comprised such a period due to
the transition from older slower speed modems and 2D graphics products to new
higher speed modems and 3D graphics products. In the current transition of
mainstream PC graphics subsystem architectures from 2D graphics and the PCI bus
to 3D graphics and the accelerated graphics port (AGP), which began in 1997 and
is expected to continue through 1998, controller and memory chip selection and
the timely introduction of new products have been and will continue to be
critical factors. The Company expects to see the effects of the PCI-to-AGP
transition and the SGRAM-to-SDRAM memory transition in the second quarter of
1998, which will result in significant pricing pressures on the Company's
remaining PCI-based and SGRAM-based graphics inventory and the inventory of such
products in the distribution channel. As a result, the net sales and gross
margins of the Company are likely to be materially and adversely affected by
declining prices for the PCI-based and SGRAM-based products and any significant
price protection claims associated with such price declines. Also, as is common
in the personal computer industry, a disproportionate percentage of the
Company's net sales in any quarter may be generated in the last month or weeks
of a quarter. As a result, a shortfall in sales in any quarter as compared to
expectations may not be identifiable until at or near the end of the quarter. In
addition, from time to time, a significant portion of the Company's net sales
may be derived from a limited number of customers, the loss of one or more of
which could adversely impact operating results.
Notwithstanding the difficulty in forecasting future sales and the
relatively small level of backlog at any given time, the Company generally must
plan production, order components and undertake its development, sales and
marketing activities and other commitments months in advance. Accordingly, any
shortfall in net sales in a given quarter may materially impact the Company's
operating results and cash balances in a magnified way due to the Company's
inability to adjust expenses or inventory levels during the quarter to match the
level of net sales for the quarter. Excess inventory could also result in cash
flow difficulties as well as added costs of goods sold and expenses associated
with inventory write-offs or sell-offs. Conversely, in its efforts to adjust
inventory levels to a slower order rate, the Company may overcorrect its
component purchases and inventory levels, thereby experiencing periodic
shortages of inventory and delivery delays, and negatively impacting its net
sales,
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market share and customer satisfaction levels in the current quarter or in
future quarters. There can be no assurances that such an occurrence will not
adversely impact the Company operating results.
DECLINING SELLING PRICES AND OTHER FACTORS AFFECTING GROSS MARGINS
The Company's markets are characterized by intense ongoing competition and
coupled with a past history and a current trend of declining average selling
prices. A decline in selling prices may cause the net sales in a quarter to be
lower than the revenue of a preceding quarter or corresponding prior year's
quarter even if more units were sold during such quarter than in the preceding
or corresponding prior year's quarter. Accordingly, it is likely that the
Company's average selling prices will decline, and that the Company's net sales
and margins may decline in the future, from the levels experienced to date. (See
also Short Product Life Cycles; Dependence on New Products) The Company's gross
margins may also be adversely affected by shortages of, or higher prices for,
key components for the Company's products, including its modems, 3D graphics
accelerators, SCSI I/O host bus adapters and 3D audio accelerators products,
some of which have been impacted from time-to-time by a scarcity in the supply
of associated chipsets and other components. For example, the recent agreement
by Symbios (the sole supplier of the Company's SCSI controllers) to be acquired
by Adaptec (the Company's chief competitor in the SCSI host bus adapter card
market) may, if such acquisition is consummated, result in the unavailability of
SCSI controllers for the Company's SCSI products, or the unavailability of such
controllers or software support under economically reasonable prices, terms,
conditions or timing. Additionally, the acquisition, if consummated, may lead to
caution or reluctance on the part of the Company's customers or potential
customers, both direct and indirect, to do business with Adaptec's competitors
who have historically used Symbios controllers.
In addition, the Company's net sales, average selling prices and gross
margins will be adversely affected if the market prices for certain components
used or expected to be used by the Company, such as DRAM, SDRAM, SGRAM or RDRAM
memory, DVD drives, multimedia controller chips or bundled software, decline
more rapidly than the Company is able to process component inventory bought
earlier at higher prices into finished products, book and ship the related
orders, and move such products through third-party distribution channels, some
of which may be price protected, to the final customer. For example, operating
results were negatively impacted in the second and third quarters of 1996 by
declining market prices for the Company's products, caused in part by a sharp
reduction in the market price for DRAMs. The Company might experience such
declining prices and tighter margins in the second quarter of 1998 due to the
effect of product transitions, including the PCI-to-AGP transition and the
SGRAM-to-SDRAM memory transition. Conversely, an increase in the price of
semiconductor components that are in scarce supply, such as high-speed DRAMs,
may adversely impact the Company's gross margin due to higher unit costs, and a
decrease in the supply of such semiconductor components may adversely impact the
Company's net sales due to lower unit shipments.
SEASONALITY
The Company believes that, due to industry seasonality, demand for its
products is strongest during the fourth quarter of each year and is generally
slower in the period from April through August. This seasonality may become more
pronounced and material in the future to the extent that a greater proportion of
the Company's sales consist of sales into the retail/mass merchant channel, that
PCs become more consumer-oriented or entertainment-driven products, or that the
Company's net sales becomes increasingly based on entertainment-centric
products. Also, to the extent the Company is successful in expanding its
European operations, it may experience relatively weak demand in third calendar
quarters due to historically weak summer sales in Europe.
MANAGEMENT OF GROWTH
In recent years, the Company has experienced a significant expansion in the
overall level of its business and the scope of its operations, including
manufacturing, research and development, marketing, technical support, customer
service, sales and logistics. In addition, through its acquisitions of Supra in
September 1995 and Spea in November 1995, the Company increased the scope of its
product lines and multinational operations. This expansion in scope has resulted
in a need for significant investment in infrastructure, processes and
information systems, as well as the integration of the operations of Supra and
Spea into the Company's infrastructure. This
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requirement includes, without limitation: Securing adequate financial resources
to successfully integrate and manage the acquired businesses; retention of key
employees; integration of management information, product data management,
control and telecommunications systems; consolidation of geographically
dispersed manufacturing and distribution facilities; consolidation and
coordination of suppliers; rationalization of distribution channels;
establishment and documentation of business processes; and integration of
various functions and groups of employees. Each of these requirements poses
significant, material challenges. For example, the Company established a
restructuring reserve in the second quarter of 1997 to account for the expected
expenses of, among other actions, integrating customer service and distribution
from Supra into Diamond, transitioning manufacturing from Supra's facility in
Oregon to a subcontractor facility in Mexico, and integrating technical support
from Diamond's San Jose, California facility to Supra's technical support
organization in Oregon. Moreover, Spea historically has not been profitable and
the Company's management took significant steps to reduce expenses at Spea and
integrate its operations with those of the Company. Accordingly, the Company
reorganized Spea to function principally as follows: a product localization and
marketing operation for Europe; a sales, technical support and customer service
operation for Central Europe; and a product development and launch facility for
professional 3D graphics, including CAD and digital animation, for the Company's
worldwide markets. The Company discontinued manufacturing, test, packaging and
logistics operations at Spea effective October 1, 1996. Prior to its acquisition
by the Company, Spea made certain investments including entering into the shared
ownership (at 49.5%) with Philips Semiconductor (at 50.5%) of a 3D graphics
semiconductor design subsidiary, SP3D. The Company's 49.5% ownership of SP3D is
carried on the Company's balance sheet at approximately $3.4 million. Philips
Semiconductor has full day-to-day operating management control of SP3D and holds
the majority of seats on the SP3D board. There can be no assurance that the
Company will be able to achieve a reasonable return on this asset, or that the
asset will not need to be written down, in whole or in part, during subsequent
accounting periods.
The Company's future operating results will depend in large measure on its
success in implementing operating, manufacturing and financial procedures and
controls, improving communication and coordination among the different operating
functions, integrating certain functions such as sales, procurement and
operations, strengthening management information and telecommunications systems,
and continuing to hire additional qualified personnel in all areas. Moreover,
the Company has selected and is implementing a new enterprise resource planning
(ERP) system to be fully operational in late 1998 in order to properly manage
the increasing complexity of its international multi-product business and avert
potential Year 2000 issues with its current management information system. There
can be no assurance that the Company will be able to manage these activities and
implement these additional systems, procedures and controls successfully, and
any failure to do so could have a material adverse effect upon the Company's
short-term and long-term operating results.
SHORT PRODUCT LIFE CYCLES; DEPENDENCE ON NEW PRODUCTS
The market for the Company's products is characterized by frequent new
product introductions and rapid product obsolescence. These factors typically
result in short product life cycles, frequently ranging from six to twelve
months. The Company must develop and introduce new products in a timely manner
that compete effectively on the basis of price and performance and that address
customer needs and meet customer requirements. To do this, the Company must
continually monitor industry trends and make difficult choices regarding the
selection of new technologies and features to incorporate into its new products,
as well as the timing of the introduction of such new products, all of which may
impair the orders for or the prices of the Company's existing products. The
success of new product introductions depends on various factors, some of which
are outside the Company's direct control. Such factors may include: selection of
new products; selection of controller or memory chip architectures; timely
completion and introduction of new product designs; trade-offs between the time
of first customer shipment and the optimization of software for speed, stability
and compatibility; development of supporting content by independent software
application vendors; development and production of collateral product
literature; prompt delivery to OEM accounts of prototypes; support of OEM
prototypes; ability to rapidly ramp manufacturing volumes; and coordination of
advertising, press relations, channel promotion and VAR evaluation programs.
In the current transition of mainstream PC graphics subsystem
architectures from 2D graphics and the PCI bus to 3D graphics and the
accelerated graphics port (AGP), which began in 1997 and is expected to continue
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through 1998, controller and memory chip selection and the timely introduction
of new products have been and will continue to be critical factors. The Company
expects to see the effects of the PCI-to-AGP transition and the SGRAM-to-SDRAM
memory transition in the second quarter of 1998, which will result in
significant pricing pressures on the Company's remaining PCI-based and
SGRAM-based graphics inventory and the inventory of such products in the
distribution channel. As a result, the net sales and gross margins of the
Company are likely to be materially and adversely affected by declining prices
for the PCI-based and SGRAM-based products and any significant price protection
claims associated with such price declines. In addition, in the current
transition from the widely accepted V.34 modem protocol (33.6Kbps) through the
new higher speed proprietary K56flex and x2 protocols (56Kbps) to the new
international standard V.90 protocol (56Kbps), the chip selection to implement
and deploy such a standard and the industry alliances to convert such support
into revenue and market share have been and will continue to be critical
factors. There can be no assurance that the Company will select the proper chips
to implement and support its efforts in the various markets or that the Company
will execute its strategy in a timely manner during this transition period.
Each new product cycle presents new opportunities for current or
prospective competitors of the Company to gain a product advantage or increase
their market share. If the Company does not successfully introduce new products
within a given product cycle, the Company's sales will be adversely affected for
that cycle and possibly for subsequent cycles. Any such failure could also
impair the Company's brand name and ability to command retail shelf space and
OEM design wins in future periods. Moreover, because of the short product life
cycles coupled with the long lead times for procuring many of the components
used in the Company's products, the Company may not be able, in a timely manner,
or at all, to reduce its component procurement commitments, software license
commitments, production rates or inventory levels in response to unexpected
delays in product launch, shortfalls in sales, technological obsolescence or
declines in prices or, conversely, to increase production in response to
unexpected increases in demand, particularly if such demand increases are in a
new product or new technology area where component supply may be hard to secure.
Therefore, changes in actual or expected demand could result in excess
inventory, inventory write downs, price protection and gross margin compression
or, conversely, in lost sales and revenue compression due to product or
component unavailability. The Company expects that the timing and speed of the
PCI-to-AGP bus transition and the SGRAM-to-SDRAM memory transition are likely to
lead to an excess inventory of PCI and SGRAM-based products at the Company and
in the distribution channel that is likely to result in lower average selling
prices, lower gross margins and higher price protection charges during the
second quarter of 1998. The Company estimates and accrues for potential
inventory write-offs and price protection charges. However, there can be no
assurance that these estimates and accruals will be sufficient, and additional
inventory write-offs and price protection charges may be required, the result of
which could have a material effect on operating results during the second
quarter of 1998.
NEW OPERATING SYSTEMS
The PC industry has been characterized by significant operating system
changes, such as the introduction of Windows 95 in 1995 and Windows NT 4.0 in
1996, and the introduction of significant new operating system components, such
as Microsoft's Direct X and ActiveX for Windows 95. While new operating systems
can provide new market opportunities, such as the growing market for graphical
user interface (GUI) accelerators that occurred with the introduction of Windows
3.0 and the growth in the PC games market with the introduction of Windows 95,
new operating systems and operating system components also place a significant
research and development burden on the Company. New drivers, applications and
user interfaces must be developed for new operating systems and operating system
components in order to maintain net sales levels and customer satisfaction.
Perhaps more significantly, such drivers, applications and interfaces
customarily are ported to the recently shipped portion of the Company's
installed base. This effort involves a substantial software engineering,
compatibility testing and customer technical support investment with only
limited near-term incremental revenue return since these driver updates are
usually provided via electronic distribution at no cost to the Company's
installed customer base. In addition, the installation of this software may
result in technical support calls, thereby generating expenses that do not have
offsetting revenue. Moreover, during the introductory period of a major new
operating system release such as Windows 95, such installed base support may
reduce the research and development and customer technical support resources
available for launching new products. For example, after substantial investment
in porting the Company's software, graphics accelerator and modem products to
Windows 95, the Company was at year-end 1996 still developing for final release
improved, accelerated Windows 95 drivers for the Viper Pro Video series of
accelerator add-in cards. While this product line did not at that time represent
a revenue opportunity for the Company, the Company nevertheless believed that it
was important to make the significant software development investment
represented by this effort in order to maintain relations with its installed
customer base and its reputation for reliable on-going product support.
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Furthermore, new operating systems for which the Company prospectively develops
driver support may not be successful, or the drivers themselves may not be
successful or accepted by customers, and a reasonable financial return on the
corollary research and development investment may never be achieved.
Microsoft has announced that it expects to release for initial end-user
shipment in June 1998 a new operating system, Windows 98, an upgrade to the
Windows 95 operating system. The Company expects that there will be hesitation
on the part of end users to purchase new computer equipment incorporating
Windows 95 as the date of the introduction of Windows 98 nears, and possibly for
a period of time immediately following such introduction. If an unusually large
number of customers delay purchase of new systems, or add-on multimedia
peripherals, such a delay could affect the short term timing of the sales of the
Company which may have a negative effect on the Company's results in the second
and third quarters of 1998.
DEPENDENCE ON THIRD PARTY SOFTWARE DEVELOPERS
The Company's business strategy includes developing relationships with
major independent software application vendors that serve the 3D graphics and 3D
audio markets, including the 3D computer games market and the professional 3D
graphics market. The Company believes that the availability of a sufficient
number of high quality, commercially successful entertainment 3D software titles
will be a significant factor in the sale of multimedia hardware to the PC-based
interactive 3D entertainment market. The Company also believes that compelling
professional 3D graphics applications developed for PCs or ported from
traditional workstations, such as those supplied by Silicon Graphics and Sun
Microsystems, to PCs based on advanced Intel microprocessors and the Microsoft
NT operating system will be significant factors in the sale of 3D graphics
hardware to the PC-based NT workstation market. The Company depends on
independent software application developers and publishers to create, produce
and market software entertainment titles and professional graphics applications
that will operate with the Company's 3D products, such as Monster, Stealth,
Viper and Fire GL. Only a limited number of software developers are capable of
creating high quality professional 3D and entertainment 3D software. Competition
for these resources is intense and is expected to increase. There can be no
assurance that the Company will be able to attract the number and quality of
software developers and publishers necessary to develop a sufficient number of
high quality, commercially successful software titles and applications that are
compatible with the Company's 3D products.
Further, in the case of the Company's entertainment 3D products, there can
be no assurance that third parties will publish a substantial number of
entertainment 3D software titles or, if entertainment 3D software titles are
available, that they will be of high quality or that they will achieve market
acceptance. The development and marketing of game titles that do not fully
demonstrate the technical capabilities of the Company's entertainment 3D
products could create the impression that the Company's products offer less
compelling performance over competing 3D games platforms, such as TV games
console platforms. This may slow or stop any migration from the current
widespread use of TV games consoles to the use of computer games on PCs, or the
enhancement of PCs to operate such games. Further, because the Company has no
control over the content of the entertainment titles produced by software
developers and publishers, the entertainment 3D software titles developed may
represent only a limited number of game categories and are likely to be of
varying quality.
SEMICONDUCTOR OR SOFTWARE DEFECTS
Product components may contain undetected errors or "bugs" when first
supplied to the Company that, despite testing by the Company, are discovered
only after certain of the Company's products have been installed and used by
customers. There can be no assurance that errors will not be found in the
Company's products due to errors in such products' components, or that any such
errors will not impair the market acceptance of these products or require
significant product recalls. Problems encountered by customers or product
recalls could materially adversely affect the Company's business, financial
condition and results of operations. Further, the Company continues to upgrade
the firmware, software drivers and software utilities that are incorporated into
or included with its hardware products. The Company's software products, and its
hardware products incorporating such software, are extremely complex due to a
number of factors including the products' advanced functionality, the diverse
operating environments in which the products may be deployed, the need for
interoperability, and the multiple versions of such products that must be
supported for diverse operating
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platforms, languages and standards. These products may contain undetected errors
or failures when first introduced or as new versions are released. The Company
generally provides a five-year warranty for its products and, in general, the
Company's return policies permit return within thirty days after receipt of
products that do not meet product specifications. There can be no assurance
that, despite testing by the Company, by its suppliers and by current or
potential customers, errors will not be found in new products after commencement
of commercial shipments, resulting in loss of or delay in market acceptance or
product acceptance or in warranty returns. Such loss or delay would likely have
a material adverse effect on the Company's business, financial condition and
results of operations.
Additionally, new versions or upgrades to operating systems or
independent software vendor titles or applications may require upgrades to the
Company's software products to maintain compatibility with these new versions or
upgrades. There can be no assurance that the Company will be successful in
developing new versions or enhancements to its software or that the Company will
not experience delays in the upgrade of its software products. In the event that
the Company experiences delays or is unable to maintain compatibility with
operating systems and independent software vendor titles or applications, the
Company's business, financial condition and results of operations could be
materially adversely affected.
MARKET ANTICIPATION OF NEW PRODUCTS, NEW TECHNOLOGIES OR LOWER PRICES
Since the environment in which the Company operates is characterized by
rapid new product and technology introductions and generally declining prices
for existing products, the Company's customers may from time to time postpone
purchases in anticipation of such new product introductions or lower prices. If
such anticipated changes are viewed as significant by the market, such as the
introduction of a new operating system or microprocessor architecture, then this
may have the effect of temporarily slowing overall market demand and negatively
impacting the Company's operating results. For example, the substantial
pre-release publicity surrounding the release of Windows 95 may have contributed
to a slowing of the consumer PC market in the summer of 1995. Moreover, a
similar reaction has likely occurred in the modem market as a result of the
announcements of modems based on 56 Kbps technology which became available in
1997, or in the overall PC market in anticipation of Intel Corporation's
transition to MMX-based microprocessors during 1997. Additionally, the
substantial publicity by Intel Corporation for its MMX technology may have
confused and slowed the market for add-in multimedia accelerators, such as those
sold by the Company, during the first half of 1997. If so, these effects may
continue into future periods for these or similar events. Other anticipated new
product releases that may influence future market growth or the timing of such
growth include Microsoft's expected release of its Windows 98 operating system
in June 1998, Intel's release of its Pentium II CPU and the associated chipsets
supporting the AGP and 2x AGP architectures, and Intel's release of its "Merced"
workstation CPU slated for first customer shipment in 1999.
The potential negative impact on the Company's operating results as a
result of customer decisions to postpone purchases in favor of new and
"publicized" technology can be further magnified if products or components based
on such new technology are not available in a timely manner or in sufficient
supply to meet the demand caused by the market's shift to the new technology
from an older technology. For example, the Company believes that the PC market
may have slowed in early 1997 in part as customers waited for the availability
of Intel's new MMX-enabled Pentium CPUs. Further, the Company's operating
results could be adversely affected if the Company makes poor selections of chip
architectures or chip suppliers to pursue 3D graphics, AGP or 56Kbps modem
market opportunities and, as a result, is unable to achieve market acceptance of
its new products or is unable to secure enough supply of such components.
If the Company or any of its competitors were to announce a product that
the market viewed as having more desirable features or pricing than the
Company's existing products, demand for the Company's existing products could be
curtailed, even though the new product is not yet available. For example, the
Company's next-generation eight-megabyte SDRAM-based graphics accelerators, due
to commence shipment in the second quarter of 1998, has a memory cost component
roughly equivalent to four-megabyte SGRAM-based graphics accelerators. There can
be no assurance that market anticipation of this new product release or similar
competitive releases will not reduce demand for the Company's current graphics
products and materially and adversely affect the Company's operating results for
the second quarter of 1998. Similarly, if the Company's
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customers anticipate that the Company may reduce its prices in the near term,
they might postpone their purchases until such price reductions are effected,
reducing the Company's near-term shipments and revenue. In general, market
anticipation of new products, new technologies or lower prices, even though
potentially positive in the longer term, can negatively impact the Company's
operating results in the short term.
COMPONENT SHORTAGES; RELIANCE ON SOLE OR LIMITED SOURCE SUPPLIERS
The Company is dependent on sole or limited source suppliers for certain
key components used in its products, particularly chipsets that provide
graphics, digital video, DVD, television (TV), sound or other multimedia
functions, random access memory (including DRAM, RDRAM, SDRAM and SGRAM) chips,
and speakerphone modem and fax/modem chipsets. Although the price and
availability of many semiconductor components improved during 1996 and 1997,
these components are periodically in short supply and on allocation by
semiconductor manufacturers. For example, it is expected that the Company may
experience substantial constraints in the supply of high-performance SGRAMs and
high-performance 3D graphics chips for the foreseeable future. There can be no
assurances that the Company can obtain adequate supplies of such components, or
that such shortages or the costs of these components will not adversely affect
future operating results. The Company's dependence on sole or limited source
suppliers, and the risks associated with any delay or shortfall in supply, can
be exacerbated by the short life cycles that characterize multimedia and
communications ASIC chipsets and the Company's products in general. Although the
Company maintains ongoing efforts to obtain required supplies of components,
including working closely with vendors and qualifying alternative components for
inclusion in the Company's products, component shortages continue to exist from
time to time, and there can be no assurances that the Company can continue to
obtain adequate supplies or obtain such supplies at their historical or
competitive cost levels. Conversely, in its attempt to counter actual or
perceived component shortages, the Company may overpurchase certain components,
resulting in excess inventory and reducing the Company's liquidity or, in the
event of unexpected inventory obsolescence or a decline in the market value of
such inventory, causing inventory write-offs or sell-offs that adversely affect
the Company's gross margin and profitability. In addition, such inventory
sell-offs by the Company or its competitors could trigger channel price
protection charges, further reducing the Company's gross margins and
profitability.
As noted above, supply and demand conditions for semiconductor components
are unpredictable and may change from time to time. During periods of
oversupply, prices are likely to fall and certain vendors of such semiconductor
chips may liquidate their inventories in a rapid manner. If such semiconductor
vendors are suppliers to the Company's competitors, then such actions could
enable competitors of the Company to enjoy a cost advantage vis-a-vis the
Company, and any resultant price reduction for such competitors' products could
force the Company to reduce its prices, thereby depressing the Company's net
sales and gross margins in one or more operating periods. For example, the
recent agreement by Symbios (the sole supplier of the Company's SCSI
controllers) to be acquired by Adaptec (the Company's chief competitor in the
SCSI host bus adapter card market) may, if such acquisition is consummated,
result in the unavailability of SCSI controllers for the Company's SCSI
products, or the unavailability of such controllers or software support under
economically reasonable prices, terms, conditions or timing. Additionally, the
acquisition, if consummated, may lead to caution or reluctance on the part of
the Company's customers or potential customers, both direct and indirect, to do
business with Adaptec's competitors who have historically used Symbios
controllers.
During periods of component oversupply and associated price deflation,
customers of the Company, particularly those comprising channels that do not
receive price protection from the Company, may seek to draw down the inventory
that they hold since such inventory likely would bear a price deflation risk. As
a consequence, the Company may see its orders, unit shipments or average selling
prices depressed from time to time during such price-deflation and
inventory-reduction periods, including potentially the second quarter of 1998,
which could adversely affect net sales and gross margin in the related operating
period or periods.
When the PC or PC peripherals markets emerge from a period of oversupply,
such as that experienced in the second quarter of 1997, certain manufacturers,
distributors and resellers may be unprepared for a possible rapid increase in
market demand. Accordingly, the Company may not have sufficient inventory,
scheduled component purchase orders or available manufacturing capacity to meet
any rapid increase in market demand,
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thereby missing orders and revenue opportunities, causing customer
dissatisfaction and losing market share. The Company experienced such a
situation in the second half of 1997 and in the first quarter of 1998 as the
Company experienced a shortage of various components, restricting the Company's
ability to manufacture quantities of certain products in sufficient quantities
or in a linear fashion during the quarter to meet market demand. For certain
products, the Company continues to experience such restrictions in the second
quarter of 1998. In addition, the Company believes that in the near term the
Company will continue to be subjected to restricted supply and increasing prices
on certain semiconductor components including certain graphics controllers and
memories. The inability of the Company to obtain product components at their
historical or planned cost levels, resulting in the Company being forced to pay
higher prices to achieve timely delivery, would directly affect the cost of the
Company's products and could materially and adversely affect the Company's gross
margin. There can be no assurance that the Company will be able to obtain
adequate supplies of components or that such shortages or the costs of these
components will not adversely impact the Company's future operating results.
Conversely, there can be no assurance that the Company will not see the value of
its inventory depreciate if components in a shortage condition emerge from that
condition and experience a significant oversupply condition. For example, this
situation may occur during the second quarter of 1998 with certain graphics
chips that support only SGRAM memory.
DEPENDENCE ON SUBCONTRACTORS
The Company relies on independent surface mount technology ("SMT") and
printed circuit board ("PCB") subcontractors to manufacture, assemble or test
the Company's products. The Company typically procures its components, assembly
and test services and assembled products through purchase orders and does not
have specific volume purchase agreements with each of its subcontractors. Most
of the Company's subcontractors could cease supplying the services, products or
components at any time with limited or no penalty. In the event that it becomes
necessary for the Company to replace a key subcontractor, the Company could
incur significant manufacturing set-up costs and delays. There can be no
assurance that the Company would be able to find suitable replacement
subcontractors. The Company's emphasis on maintaining low inventory may
exacerbate the effects of any shortage that may result from the use of
sole-source subcontractors during periods of tight supply or rapid order growth.
The Company's ability to respond to greater than anticipated market demand may
be constrained by the availability of SMT or PCB subcontracting services.
Further, various of the Company's subcontractors are located in international
locations that, while offering low labor costs, may present heightened process
control, quality control, political, infrastructure, transportation, tariff,
regulatory, legal, import, export, economic or supply risks.
DEPENDENCE ON GRAPHICS AND MULTIMEDIA ACCELERATOR MARKET
Sales of graphics and multimedia accelerator subsystems accounted for
greater than 80% and 65% of the Company's net sales in the first quarter of 1998
and 1997, respectively. Although the Company has introduced DVD and audio
subsystems, ISDN adapters and SCSI host bus adapters, and has entered the PC
modem and communications market through the acquisition of Supra Corporation,
graphics accelerator subsystems are expected to continue to account for a
majority of the Company's sales for the foreseeable future. A decline in demand
or average selling prices for graphics accelerator subsystems, whether as a
result of new competitive product introductions, price competition, excess
supply, widespread cost reduction, technological change, incorporation of the
products' functionality onto personal computer motherboards or otherwise, would
have a material adverse effect on the Company's sales and operating results.
MIGRATION TO PERSONAL COMPUTER MOTHERBOARDS
The Company's graphics and multimedia accelerator subsystems are
individual products that function within personal computers to provide
additional multimedia functionality. Historically, as a given functionality
becomes technologically stable and widely accepted by personal computer users,
the cost of providing such functionality is typically reduced by means of large
scale integration into semiconductor chips, which can be subsequently
incorporated onto personal computer motherboards. The Company expects that such
migration will not occur in a substantial way with 3D graphics or Intel's
accelerated graphics port (AGP) in the near term, although the Company
recognizes that such migration could occur with respect to the functionality
provided by some of the Company's current products. While the Company believes
that a market will continue to exist for add-in subsystems that provide advanced
or multiple functions and offer flexibility in systems configuration, such as 3D
graphics, 3D audio, MPEG-2 digital video, high-speed I/O and modems, there can
be no assurance
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that the incorporation of new multimedia functions onto personal computer
motherboards or into CPU microprocessors, such as under Intel's MMX or AGP
technologies, will not adversely affect the future market for the Company's
products. In large part, the continuation of a robust market for add-in graphics
and video subsystems may depend on the timing and market acceptance of 3D
graphics and digital video MPEG-2 acceleration. This, in turn, may depend on the
availability of compelling 3D and MPEG-2 content, including games and
entertainment, broadcast digital video, PC video phones, desktop video
conferencing, and digital video, audio and VRML on the Internet. Similarly, the
robustness of the modem market may depend largely on the widespread adoption of
56Kbps and digital subscriber line (xDSL) technologies in both client-side
modems attached to the PC and server-side modems provided by Internet Service
Providers and telephone network central offices. The timing of major technology
introductions and the market acceptance of these new technologies and standards
are largely out of the control of the Company.
RISKS ASSOCIATED WITH RECENTLY ANNOUNCED ACQUISITION
In addition to the risks described under "-Management of Growth," the
Company faces significant risks associated with its proposed acquisition of
Micronics Computers, Inc. ("Micronics"). There can be no assurance that the
Company will realize the benefits of this transaction. In order to successfully
integrate Micronics, the Company must, among other things, retain key personnel;
integrate, from an engineering, manufacturing and sales and marketing
perspective, the acquired business into the Company's overall operations; and
consolidate excess facilities. The diversion of the attention of management from
the day-to-day operations of the Company, or difficulties encountered in the
integration process, could have a material adverse effect on the Company's
operating results. See Note 6 of Notes to Consolidated Condensed Financial
Statements.
COMPETITION
The market for the Company's products is highly competitive. The Company
competes directly against a large number of suppliers of graphics and multimedia
accelerator products for the PC such as Matrox Graphics Inc., STB Systems Inc.
and ATI Technologies Inc., and indirectly against PC systems OEMs to the extent
that they manufacture their own add-in subsystems or incorporate on PC
motherboards the functionality provided by the Company's products. In certain
markets where the Company is a relatively new entrant, such as modems, sound
cards and SCSI host adapters, the Company may face dominant competitors
including 3Com (modems), Creative Technology (sound cards) and Adaptec (SCSI
host bus adapters). In addition, the Company's markets are expected to become
increasingly competitive as multimedia functions continue to converge and
companies that previously supplied products providing distinct functions (for
example, companies today primarily in the sound, fax/modem, telephony, digital
signal processing, central processing unit or motherboard markets) emerge as
competitors across broader or more integrated product categories.
In addition, manufacturers of chipsets or other components used in the
Company's products could become future competitors of the Company to the extent
that such manufacturers elect to integrate forward into the add-in subsystem or
value-added software market, or as such multimedia chipset manufacturers provide
increasingly higher quality and more sophisticated software to their chipset
customers, including subsystem suppliers competitive to the Company. Also,
certain of the Company's current and potential competitors have significantly
greater market presence, name recognition and financial and technical resources
relative to the Company, and many have long-standing market positions and
established brand names in their respective markets. In addition, certain of the
Company's current and potential competitors also have a competitive cost
advantage as a result of being located in areas that impose significantly lower
taxes than the United States or offer a substantially lower cost of labor or
provide governmental subsidies, such as research and development and training
funds. Many of the Company's current and potential competitors also design and
manufacture their own graphics acceleration, video, sound, fax/modem or other
multimedia processing chipsets. While the Company believes that its
semiconductor vendor flexibility enables it to select, within certain limits,
from among the most advanced and price competitive chipsets available on the
open market, the captive semiconductor operations of certain of the Company's
current and potential competitors could provide them with significant
advantages, including greater control over semiconductor architecture and
technology, component design, component performance, systems and software
design, availability and cost.
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The Company also believes that the strategy of certain of its current and
potential competitors is to compete largely on the basis of price, which may
result in significant price competition and lead to lower margins for the
Company's products or otherwise adversely affect the market for the Company's
products. To the extent that semiconductor availability is relatively robust and
software drivers and reference hardware designs from multimedia chipset
manufacturers are of high quality and sophistication, then competitors who sell
such reference designs and compete largely on price with little valued added
engineering may have a competitive cost or expense advantage relative to the
Company. There can be no assurance that the Company will be able to continue to
compete successfully in its current and future markets, or will be able to
compete successfully against current and new competitors, as the Company's
technology, markets and products continue to evolve.
DISTRIBUTION RISKS
The Company sells its products through a network of domestic and
international distributors, and directly to major retailers/mass merchants, VARs
and OEM customers. The Company's future success is dependent on the continued
viability and financial stability of its customer base. The computer
distribution and retail channels historically have been characterized by rapid
change, including periods of widespread financial difficulties and consolidation
and the emergence of alternative sales channels, such as direct mail order,
telephone sales by PC manufacturers and electronic commerce on the World Wide
Web. The loss of, or reduction in, sales to certain of the Company's key
customers as a result of changing market conditions, competition, or customer
credit problems could have a material adverse effect on the Company's operating
results. Likewise, changes in distribution channel patterns, such as increased
commerce on the Internet, increased use of mail-order catalogues, increased use
of consumer-electronics channels for personal computer sales, or increased use
of channel assembly to configure PC systems to fit customers' requirements could
affect the Company in ways not yet known. Moreover, additions to or changes in
the types of products the Company sells, such as the introduction of
professional-grade products or the migration toward more communications-centric
products, may require specialized value-added reseller channels, relations with
which the Company has only begun to establish.
Inventory levels of the Company's products in the two-tier distribution channels
used by the Company ("Channel Inventory Levels") generally are maintained in a
range of one to three months of customer demand. These Channel Inventory Levels
tend toward the low end of the months-of-supply range when demand is stronger,
sales are higher and products are in short supply. Conversely, when demand is
slower, sales are lower and products are abundant, then Channel Inventory Levels
tend toward the high end of the months-of-supply range. Frequently, in such
situations, the Company attempts to ensure that distributors devote their
working capital, sales and logistics resources to the Company's products to a
greater degree than to those of competitors. Similarly, the Company's
competitors attempt to ensure that their own products are receiving a
disproportionately higher share of the distributors' working capital and
logistics resources. In an environment of slower demand and abundant supply of
products, price declines are more likely to occur and, should they occur, are
more likely to be severe. Further, in such an event, high Channel Inventory
Levels may result in substantial price protection charges. Such price protection
charges have the effect of reducing net sales and gross profit. Consequently,
the Company, in taking steps to bring its Channel Inventory Levels down to a
more desirable level, may cause a shortfall in net sales during one or more
accounting periods. This situation may also result in price protection charges
as prices are decreased, having an adverse impact on operating results. While
the Company believes that its Channel Inventory Levels for many of its products
are appropriate at this time, there are certain products which have a Channel
Inventory Level that is higher than desirable. The Company accrues for potential
price protection on unsold channel inventory. However, there can be no assurance
that any estimates, reserves or accruals will be sufficient or that any future
price reductions will not have a material adverse effect on operating results,
including during the second quarter of 1998.
PRODUCT RETURNS; PRICE PROTECTION
The Company frequently grants limited rights to customers to return
certain unsold inventories of the Company's products in exchange for new
purchases ("Stock Rotation"), as well as price protection on unsold inventory.
Moreover, certain of the Company's retail customers will readily accept returned
product from their own retail customers, and these returned products are, in
turn, returned to the Company for credit. The Company estimates returns and
accrues for potential price protection on unsold channel inventory. The Company
expects
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significant price protection charges due to the transition from PCI to AGP-based
graphics accelerators and from SGRAM to SDRAM-based graphics accelerators during
the second quarter of 1998. However, there can be no assurance that any
estimates, reserves or accruals will be sufficient or that any future returns or
price reductions will not have a material adverse effect on operating results,
including through the mechanisms of Stock Rotation or price protection,
particularly in light of the rapid product obsolescence which often occurs
during product transitions. The short product life cycles of the Company's
products, the evolving markets for new multimedia and connectivity technologies
such as the new 56 Kbps modem and 3D graphics technologies, and the difficulty
in predicting future sales through the distribution channels to the final end
customer all increase the risk that new product introductions, price reductions
by the Company or its competitors, or other factors affecting the personal
computer and add-in subsystems industry could result in significant and
unforeseen product returns, with such returns creating a material adverse effect
on the Company's financial performance. In addition, there can be no assurance
that new product introductions by competitors or other market factors, such as
the integration of graphics acceleration or modem connectivity by OEMs onto
system motherboards, will not require the Company to reduce prices in a manner
or at a time that gives rise to significant price protection charges and has a
material adverse impact upon the Company's gross margins.
Furthermore, the markets that the Company serves include end users who buy
from computer retail and consumer electronics mass merchant outlets to upgrade
their existing PCs. Such customers frequently decide to return products to the
retail outlets from which they earlier purchased the product. Such returns are
made for a variety of reasons, including the customer changing his or her mind
regarding his or her purchase decision, the customer has difficulty with the
installation or use of the product, the product does not offer the features,
functions, or performance that the customer expected or the customer experiences
incompatibilities between the product and his or her existing PC hardware or
software. Since many of the products that the Company sells incorporate advanced
computer technology, the Company expects that end-user customer returns,
including warranty returns, will be a continuing negative attribute of the PC
installed-base upgrade market. There can be no assurance that the Company will
be able to achieve gross margins in the PC installed-base upgrade market that
will be high enough to offset the expenses of end-user customer returns and
still generate an acceptable return on sales to the Company.
OEM CUSTOMER RISKS
The Company currently has a limited number of OEM customers. While the
Company is seeking to increase its sales to OEMs, certain OEMs maintain internal
add-in subsystem design and manufacturing capabilities or have long-standing
relationships with competitors of the Company, and there can be no assurance
that the Company will be successful in its efforts to increase its OEM sales.
Moreover, developing supplier relationships with major PC systems OEMs and
installing the processes, procedures and controls required by such OEMs can be
an expensive and time-consuming process, and there can be no assurance that the
Company will achieve an acceptable financial return on this investment. Further,
to the extent that PC systems OEM's selection criteria are weighted toward
multimedia subsystem suppliers that have their own captive SMT manufacturing
operations, then the Company's sole reliance on outside SMT subcontract
manufacturers may be a negative factor in winning such PC systems suppliers' OEM
contracts.
It is expected that OEM revenue will carry a lower gross margin percentage
compared to sales to other channels due to perceived lower expenses to support
such OEM revenue and the buying power exercised by large OEMs. Furthermore, many
large OEMs require that distribution hubs be established local to their
factories to supply such factories on very short notice. Such hubs represent a
cash drain on the Company to support the required inventory, and a product
obsolescence and inventory write-off risk as the price of such inventory may
decline or reach the end of its useful life or design-in life before such
inventory, which may be specific to a certain OEM, is completely consumed. The
Company's contractual relationship with Dell Computer Corporation may represent
such a product obsolescence and inventory write-off risk.
The Company's products are priced for and generally aimed at the higher
performance and higher quality segment of the market. Therefore, to the extent
that OEMs focus on low-cost solutions rather than high-performance solutions, an
increase in the proportion of the Company's sales to OEMs may result in an
increase in the proportion of the Company's revenue that is generated by
lower-selling-price or lower-gross-margin
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products, particularly with respect to the Company's audio and modem products,
which could adversely affect future gross margins and operating results of the
Company.
RAPID TECHNOLOGICAL CHANGE
The markets for the Company's products are characterized by rapidly
changing technology, evolving industry standards, frequent new product
introductions and rapid product obsolescence. For example, 3D technology is
evolving rapidly in the graphics and audio markets, memory architectures and
speeds are changing rapidly, and DVD and MPEG-2 decryption techniques and
navigation technologies are still being refined. Product life cycles in the
Company's markets frequently range from six to twelve months. The Company's
success will be substantially dependent upon its ability to continue to develop
and introduce competitive products and technologies on a timely basis with
features and functionalities that meet changing customer requirements in a
cost-effective manner. Further, if the Company is successful in the development
and market introduction of new products, it must still correctly forecast
customer demand for such new products so as to avoid either excessive unsold
inventory or excessive unfilled orders related to the products. The task of
forecasting such customer demand is unusually difficult for new products, for
which there is little sales history, and for indirect channels, where the
Company's customers are not the final end customers. Moreover, whenever the
Company launches new products, it must also successfully manage the corollary
obsolescence and price erosion of those of its older products that are impacted
by such new products, as well as any resulting price protection charges and
Stock Rotations from its distribution channels. In the second quarter of 1998,
the Company expects to face product technology cycle challenges in the
PCI-to-AGP graphics bus transition, the SGRAM-to-SDRAM memory architecture
transition and the K56flex to V.90 modem protocol transition.
RISKS OF INTERNATIONAL SALES
The Company's international sales are subject to a number of risks
generally associated with international business operations, including the
effect on demand for the Company's products in international markets as a result
of a strengthening or weakening U.S. dollar, the effect of currency fluctuations
on consolidated multinational financial results, any state-imposed restrictions
on the repatriation of funds, any import and export duties and restrictions,
certain international economic conditions, the expenses, time and technical
resources required to localize the Company's various products and to support
local languages, the logistical difficulties of managing multinational
operations and dispersed product inventory designed or manufactured to meet
specific countries' requirements, and the delays and expenses associated with
homologating the Company's telecommunications products and securing the
necessary governmental approvals for shipment to various countries.
The Company's international sales can also be affected if inventory sold
by the Company to its international distributors and OEMs and held by them or
their customers does not sell through to final end customers, which may impact
international distributor or OEM orders in the succeeding periods. The Company
believes that it generally has less information with respect to the inventory
levels held by its international OEMs and distributors as compared to their
domestic counterparts, and that the supply chain to such international customers
is longer, and that therefore the Company generally has less visibility on how
this held inventory might affect future orders to and sales by the Company. In
the event that international OEMs or distributors change their desired inventory
levels, there can be no assurance that the Company's net sales to such customers
will not decline at such time or in future periods, or that the Company will not
incur price protection charges with respect to such customers.
INFORMATION TECHNOLOGY AND TELECOMMUNICATIONS SYSTEMS
The Company is currently making significant investments in establishing
systems, processes and procedures to more efficiently and effectively manage its
worldwide business and enable communications and data sharing among its
employees and various business units. This effort comprises a significant
investment of expense and capital funds, as well as a drain on management
resources, for the installation of information technology ("IT") and
telecommunications equipment and IT applications. As part of this program to
install IT systems throughout the Company, management has begun installation of
an enhanced enterprise-wide business management,
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resource planning and decision support application. Further, in order to more
effectively manage the Company's business and avert Year 2000 issues, the
Company is implementing this new ERP application and the associated IT equipment
in order for it to be fully operational no later than by the beginning of 1999.
Such an effort is expected to comprise a further substantial investment of
expenses and management resources by the Company.
YEAR 2000 COMPLIANCE
Many existing computer systems and applications, and other control
devices, use only two digits to identify a year in the date field, without
considering the impact of the upcoming change in the century. As a result, such
systems and applications could fail or create erroneous results unless corrected
so that they can process data related to the year 2000. The Company relies on
its systems, applications and devices in operating and monitoring all major
aspects of its business, including financial systems (such as general ledger,
accounts payable and payroll modules), customer services, infrastructure,
embedded computer chips, networks and telecommunications equipment and end
products. The Company also relies, directly and indirectly, on external systems
of business enterprises such as customers, suppliers, creditors, financial
organizations, and of governmental entities, both domestic and international,
for accurate exchange of data. The Company's current estimate is that the costs
associated with the year 2000 issue, and the consequences of incomplete or
untimely resolution of the year 2000 issue, will not have a material adverse
effect on the result of operations or financial position of the Company in any
given year. However, despite the Company's efforts to address the year 2000
impact on its internal systems, the Company has not fully identified such impact
or whether it can resolve it without disruption of its business and without
incurring significant expense. In addition, even if the internal systems of the
Company are not materially affected by the year 2000 issue, the Company could be
affected through disruption in the operation of the enterprises with which the
Company interacts. See "--Information Technology and Telecommunications
Systems."
CAPITAL NEEDS
There can be no assurance that additional capital beyond the amounts
currently forecasted by the Company will not be required or that any required
additional capital will be available on reasonable terms, if at all, at such
time or times as required by the Company. Any shortfall in capital resources
compared to the Company's level of operations or any inability to secure
additional capital as needed could impair the Company's ability to finance
inventory, accounts receivable and other operational needs. Such capital
limitations could also impair the Company's ability to invest in research and
development, improve customer service and support, deploy information technology
systems, and expand manufacturing and other operations. Failure to keep pace
with competitive requirements in any of these areas could have a material
adverse effect on the Company's business and operating results. Moreover, any
need to raise additional capital through the issuance of equity securities may
result in additional dilution to earnings per share.
PROPRIETARY RIGHTS
While the Company had 4 issued U.S. Patents and 18 pending U.S. Patent
Applications at March 31, 1998, it nonetheless relies primarily on a combination
of trademark, copyright and trade secret protection together with licensing
arrangements and nondisclosure and confidentiality agreements to establish and
protect its proprietary rights. There can be no assurance that the Company's
measures to protect its proprietary rights will deter or prevent unauthorized
use of the Company's technology, brand or other proprietary or intellectual
property. In addition, the laws of certain foreign countries may not protect the
Company's proprietary rights to the same extent as do the laws of the United
States or the EC. As is typical in its industry, the Company from time to time
is subject to legal claims asserting that the Company has violated the
proprietary rights of third parties. In the event that a third party was to
sustain a valid claim against the Company, and any required licenses were not
available on commercially reasonable terms, the Company's operating results
could be materially and adversely affected. Litigation, which could result in
substantial cost to and diversion of the resources of the Company, may also be
necessary to enforce proprietary rights of the Company or to defend the Company
against claimed infringement of the proprietary rights of others.
STOCK PRICE VOLATILITY
The trading price of the Company's Common Stock has been subject to
significant fluctuations to date, and could be subject to wide fluctuations in
the future in response to quarter-to-quarter variations in operating results,
announcements of technological innovations, new products or significant OEM
systems design wins by the Company or its competitors, general conditions in the
markets for the Company's products or the computer industry, the price and
availability of purchased components, general financial market conditions,
market conditions for PC or semiconductor stocks, changes in earnings estimates
by analysts, or other events or factors. In this regard, the Company does not
endorse and accepts no responsibility for the estimates or recommendations
issued by stock research analysts from time to time. In addition, the public
stock markets in general, and technology stocks in particular, have experienced
extreme price and trading volume volatility. This volatility has significantly
affected the market prices of securities of many high technology companies for
reasons frequently unrelated to the operating performance of the specific
companies. These broad market fluctuations may adversely affect the market price
of the Company's Common Stock.
DEPENDENCE ON KEY PERSONNEL
The Company's future success will depend to a significant extent upon the
efforts and abilities of its senior management and professional, technical,
sales and marketing personnel. The competition for such personnel is intense,
particularly in the San Jose, California area ("Silicon Valley"). There can be
no assurance that the Company will be successful in retaining its existing key
personnel or in attracting and retaining the additional
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key personnel that it requires. The loss of services of one or more of its key
personnel or the inability to add or replace key personnel could have a material
adverse effect on the Company. The salary, performance bonus and stock option
packages necessary to recruit or retain key personnel, particularly in Silicon
Valley, may significantly increase the Company's expense levels or result in
dilution to the Company's earnings per share. The Company does not carry "key
person" life insurance on any of its employees.
LEGAL MATTERS
The Company has been named as a defendant in several putative class action
lawsuits which were filed in June and July, 1996 and June, 1997 in the
California Superior Court for Santa Clara County and the U.S. District Court for
the Northern District of California. Certain executive officers and directors of
the Company are also named as defendants. The plaintiffs purport to represent a
class of all persons who purchased the Company's Common Stock between October
18, 1995 and June 20, 1996 (the "Class Period"). The complaints allege claims
under the federal securities laws and California law. The plaintiffs allege that
the Company and the other defendants made various material misrepresentations
and omissions during the Class Period. The complaints do not specify the amount
of damages sought. The Company believes that it has good defenses to the claims
alleged in the lawsuits and will defend itself vigorously against these actions.
These cases are in the early stages and no trial date has been set. The ultimate
outcome of these actions cannot be presently determined. Accordingly, no
provision for any liability or loss that may result from adjudication or
settlement thereof has been made in the accompanying consolidated financial
statements.
The Company is also party to other claims and pending legal proceedings
that generally involve employment and patent issues. These cases are, in the
opinion of management, ordinary and routine matters incidental to the normal
business conducted by the Company. In the opinion of management, the ultimate
disposition of such proceedings will not have a materially adverse effect on the
Company's consolidated financial position or future results of operations.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company has been named as a defendant in several putative class action
lawsuits which were filed in June and July 1996 and June 1997 in the California
Superior Court for Santa Clara County and the U.S. District Court for the
Northern District of California. Certain executive officers and directors of the
Company are also named as defendants. The plaintiffs purport to represent a
class of all persons who purchased the Company's Common Stock between October
18, 1995 and June 20, 1996 (the "Class Period"). The complaints allege claims
under the federal securities laws and California law. The plaintiffs allege that
the Company and the other defendants made various material misrepresentations
and omissions during the Class Period. The complaints do not specify the amount
of damages sought. The Company believes that it has good defenses to the claims
alleged in the lawsuits and will defend itself vigorously against these actions.
These cases are in the early stages and no trial date has been set. The ultimate
outcome of these actions cannot be presently determined. Accordingly, no
provision for any liability or loss that may result from adjudication or
settlement thereof has been made in the accompanying consolidated financial
statements.
The Company is also party to other claims and pending legal proceedings
that generally involve employment and trademark issues. These cases are, in the
opinion of management, ordinary and routine matters incidental to the normal
business conducted by the Company. In the opinion of management, the ultimate
disposition of such proceedings will not have a materially adverse effect on the
Company's consolidated financial position or future results of operations.
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
A. Exhibit
Exhibit # Description of Document
--------- -----------------------
10.27 Line of Credit Agreement between the
Registrant and Imperial Bank dated
January 23, 1998.
27.1 Financial Data Schedule
B. Reports on Form 8-K
The Company did not file any reports on Form 8-K during the
quarter ended March 31, 1998.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DIAMOND MULTIMEDIA SYSTEMS, INC.
Date: May 14, 1998 /s/ William J. Schroeder
------------------------------------------
William J. Schroeder
President and Chief Executive Officer
Date: May 14, 1998 /s/ James M. Walker
------------------------------------------
James M. Walker
Senior Vice President and
Chief Financial Officer
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INDEX TO EXHIBITS
Exhibit
Number Description
- ------- -----------
10.27 Line of Credit Agreement between the Registrant
and Imperial Bank dated January 23, 1998.
27.1 Financial Data Schedule
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