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 JANUARY 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 0-25540 STB SYSTEMS, INC. (Exact name of registrant as specified in its charter) Texas 75-1855896 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 1651 North Glenville Drive, Richardson, Texas 75081 (Address of principal executive offices) (972) 234-8750 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. Number of Shares Outstanding as of Title of each class: March 14, 1997: Common Stock, $.01 par value 4,544,490 STB SYSTEMS, INC. INDEX PAGE PART I FINANCIAL INFORMATION NUMBER Item 1 Consolidated Financial Statements (unaudited) : Consolidated Balance Sheet at January 31, 1997 and October 31, 1996 2 Consolidated Statement of Operations for the quarter ended January 31, 1997 and 1996 3 Consolidated Statement of Cash Flows for the three months ended January 31, 1997 and 1996 4 Notes to Consolidated Financial Statements 5 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 6-9 PART II OTHER INFORMATION Item 1 Legal Proceedings 9 Items 2 through 4 have been omitted since the registrant has no reportable events in relation to these items. Item 5 Other Information - Business Risks 9-13 Item 6 Exhibits and Reports on Form 8-K 13 Signatures 14 -1- STB SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (UNAUDITED) (DOLLARS IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS) JANUARY 31, OCTOBER 31, 1997 1996 -------------------------- ASSETS Current Assets: Cash and cash equivalents $ 3,736 $ 3,420 Accounts receivable - trade, net of allowance for doubtful Accounts of $436 and $332 27,365 28,032 Inventories, net 26,690 27,148 Other current assets 1,609 1,348 -------------------------- Total current assets 59,400 59,948 Property and equipment, net 5,896 5,231 Other assets 417 450 -------------------------- Total assets $ 65,713 $ 65,629 -------------------------- -------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Short-term debt $ 13,906 $ 11,760 Accounts payable - trade 15,054 19,538 Accrued wages, commissions and bonuses 1,036 1,144 Other accrued liabilities 1,972 1,609 Current portion of long-term liabilities 681 705 -------------------------- Total current liabilities 32,649 34,756 -------------------------- Long-term liabilities: Long-term notes payable 875 1,000 Obligations under capital leases and other long-term liabilities 241 76 -------------------------- Total long-term liabilities 1,116 1,276 -------------------------- Shareholders' equity: Preferred stock, 2,000,000 shares authorized, none issued or outstanding - - Common stock, $.01 par value, 20,000,000 shares authorized, 4,521,394 and 4,513,598 shares issued and outstanding 45 45 Additional paid-in capital 22,417 22,318 Retained earnings 9,731 7,479 -------------------------- 32,193 29,842 Treasury stock, 35 shares, at cost (245) (245) -------------------------- Total shareholders' equity 31,948 29,597 -------------------------- Total liabilities and shareholders' equity $ 65,713 $ 65,629 -------------------------- -------------------------- The accompanying notes are an integral part of these financial statements. -2- STB SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED) - ----------------------------------------------------------------------------- (DOLLARS IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS) THREE MONTHS ENDED JANUARY 31, 1997 1996 -------------------------- Net sales $ 48,092 $ 44,905 Cost of sales 37,459 37,643 -------------------------- Gross profit 10,633 7,262 -------------------------- Operating expenses: Research and development 1,238 773 Sales and marketing 3,286 2,413 General and administrative 2,383 1,897 -------------------------- Total operating expenses 6,907 5,083 -------------------------- Income from operations 3,726 2,179 Interest expense, net 376 333 -------------------------- Income before income taxes 3,350 1,846 Provision for income taxes 1,098 632 -------------------------- Net income $ 2,252 $ 1,214 -------------------------- -------------------------- Net income per share $ 0.47 $ 0.27 -------------------------- -------------------------- Weighted average shares outstanding 4,787,743 4,500,000 -------------------------- -------------------------- The accompanying notes are an integral part of these financial statements. -3- STB SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) - ----------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) THREE MONTHS ENDED JANUARY 31, 1997 1996 ---------------------- Cash flows from operating activities: Net income $ 2,252 $ 1,214 Adjustments to reconcile net income to net cash From operating activities: Depreciation and amortization 420 240 Changes in assets and liabilities: Accounts receivable - trade 667 1,467 Inventories 457 1,241 Other current assets (260) 452 Other assets 33 (399) Accounts payable - trade (4,483) 150 Accrued wages, commissions, and bonuses (109) 121 Other accrued liabilities 365 146 ---------------------- Net cash provided by (used in) operating activities (658) 4,632 ---------------------- Cash flows from investing activities - Purchases of property and equipment (1,085) (250) ---------------------- Cash flows from financing activities: Borrowings on(payments of) short-term debt 2,145 (2,565) Payments on Founding Shareholder Notes - (523) Payments on long-term debt (185) (227) Issuance of common stock, net of issue costs 99 - ---------------------- Net cash provided by(used in) financing activities 2,059 (3,315) ---------------------- Net increase in cash and cash equivalents 316 1,067 Cash and cash equivalents at beginning of period 3,420 4,162 ---------------------- Cash and cash equivalents at end of period $ 3,736 $ 5,229 ---------------------- ---------------------- The accompanying notes are an integral part of these financial statements -4- STB SYSTEMS, INC. Notes To Consolidated Financial Statements (Unaudited) 1. BASIS OF PRESENTATION STB Systems, Inc. develops, manufactures and sells a wide selection of multimedia accelerators, other multimedia subsystems products and specialized technology products for use in mid-range and high-end personal computers ("PCs"). STB Assembly, Inc. is a wholly-owned subsidiary and provides manufacturing services to STB Systems, Inc. The accompanying financial statements include the consolidated accounts of STB Systems, Inc. and STB Assembly, Inc. (collectively referred to as the "Company"). STB Assembly, Inc. has two majority owned subsidiaries, STB de Mexico S.A. de C.V. ("STB de Mexico") and Maquilados Continentales de Ciudad Juarez, S.A. de C.V. ("MCC"). STB de Mexico is a Mexican corporation operated as a maquiladora and performs assembly services for STB Systems, Inc. MCC entered into an agreement in January 1990 to provide subcontract manufacturing services for STB Systems, Inc. As of December 1992, MCC became an inactive entity. All significant intercompany accounts and transactions have been eliminated in consolidation. Minority interests in the subsidiaries are insignificant for financial reporting purposes. The financial information presented herein should be read in conjunction with the Company's annual consolidated financial statements for the year ended October 31, 1996. The foregoing unaudited interim consolidated financial statements reflect all adjustments (all of which are of a normal recurring nature) which are, in the opinion of management, necessary for a fair presentation of the results of the interim periods. The results for the interim periods are not necessarily indicative of the results to be expected for the year. 2. INVENTORIES Inventories at January 31, 1997 and October 31, 1996 consist of the following: (in thousands) January 31, 1997 October 31, 1996 ---------------- ---------------- Raw materials $ 10,762 $ 10,667 Work-in-process 11,978 14,358 Finished goods 3,950 2,123 ---------------- ---------------- Totals $ 26,690 $ 27,148 ---------------- ---------------- 3. SHORT TERM DEBT On January 5, 1996, the Company increased its existing revolving credit facility ("Revolving Credit Facility") from $13,000,000 to $23,000,000. At January 31, 1997, $13,906,000 was outstanding under this credit facility. All indebtedness under the Revolving Credit Facility matures on November 1, 1999. Availability under the Revolving Credit Facility is subject to limitations determined by the Company's borrowing base, which is calculated based upon eligible accounts receivable and inventory as defined in the Revolving Credit Facility agreement. -5- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company currently sells two broad categories of products, which the Company refers to as multimedia subsystem products and specialized technology products. The Company's multimedia subsystem product line includes a wide selection of multimedia accelerators designed for use in mid-range to high-end personal computers (PCs) and also features several complementary products, including digital video products and sound cards. STB's specialized technology products incorporate graphics technologies and are primarily designed to enable one computer to simultaneously control the display of multiple monitors. The Company sells its products to original equipment manufacturers (OEM's), the commercial market, and the specialized technology market. Multimedia subsystem products are sold both to OEMs as subsystems for their PC products and to the commercial market. Sales of multimedia accelerators and other multimedia subsystem products to OEMs are characterized by higher unit volumes and lower gross profit margins. Sales of multimedia products to the commercial market are characterized by modest volumes and higher gross profit margins than the sale of similar products to OEMs. Although sales of specialized technology products are relatively low, the Company realizes higher gross profit margins from the sale of these products than from the sale of multimedia subsystem products. The Company began shipping significant unit volumes of certain new multimedia products (products other than multimedia accelerators) in the third quarter of the 1996 fiscal year. Revenues generated from the sale of these multimedia subsystem products have been characterized as OEM channel sales in the discussion below. The Company is not yet in a position to forecast the effect that the sales of these new products will have upon the Company's results of operations. Sales of the Company's products to OEMs represented approximately 81% (of which approximately 4.5% was comprised of sales of new multimedia subsystem products) of total net sales for the fiscal year 1996. Sales to the commercial market and the specialized technology market represented approximately 11% and 6%, respectively. The balance of total net sales was derived primarily from third party assembly services, which accounted for approximately 2% of total net sales in fiscal year 1996. The Company's total gross profit margins and gross profits will likely fluctuate from period to period as a result of the Company's product mix, sales channel mix, component costs and competitive pricing pressures on the Company's products. The Company recognizes revenue upon shipment of its products. For products sold through the commercial channel, the Company generally allows returns in the form of stock rotation and price protection in the form of credits. The Company's current stock rotation policies permits a commercial channel customer to return recently purchased products, provided that the customer places an order for other Company products of equal or greater value. The Company has historically been able to resell products returned through the stock rotation program. The Company also provides price protection to commercial channel customers in the form of credits for price reductions on products remaining in inventories at the time of the price reduction. The Company maintains reserves related to these programs, which it believes are adequate. -6- RESULTS OF OPERATIONS The following table sets forth certain items from the Company's consolidated statement of operations as a percentage of net sales from continuing operations: PERCENTAGE OF NET SALES THREE MONTHS ENDED JANUARY 31, 1997 1996 ------------------------- Net sales 100.0% 100.0% Cost of sales 77.9% 83.8% ------------------------- Gross profit 22.1% 16.2% ------------------------- Operating expenses: Research and development 2.6% 1.7% Sales and marketing 6.8% 5.4% General and administrative 5.0% 4.2% ------------------------- Total operating expenses 14.4% 11.3% ------------------------- Income from operations 7.7% 4.9% Interest expense, net 0.7% 0.7% ------------------------- Income before income taxes 7.0% 4.2% Provision for income taxes 2.3% 1.4% ------------------------- Net income 4.7% 2.8% ------------------------- ------------------------- QUARTER ENDED JANUARY 31, 1997 COMPARED TO QUARTER ENDED JANUARY 31, 1996. Net Sales. Net sales increased by $3.2 million, or 7.1%, from $44.9 million in the first quarter of fiscal 1996 to $48.1 million in the first quarter of fiscal 1997. This increase resulted primarily from continuing growth in sales of the Company's products to the commercial channel, offset somewhat by declining unit prices due to continuing decreases in the cost of memory. For the first quarter of fiscal 1997, OEM channel sales of $36.2 million represented approximately 75% of total net sales, compared to OEM channel sales of $38.0 million, representing approximately 85% of total net sales, for the first quarter of fiscal 1996. Domestic shipments to OEMs remained strong during the first quarter of fiscal 1997. The Company's sales into the retail channel increased by $5.7 million, or 205%, from $2.8 million in the first quarter of fiscal 1996 to $8.5 million in the first quarter of fiscal 1997. Sales of specialized technology products increased by $555,000, or 23%, from $2.4 million in the first quarter of fiscal 1996 to $3.0 million in the first quarter of fiscal 1997. Gross Profit. Gross profit increased by $3.3 million, or 46%, from $7.3 million in the first quarter of fiscal 1996 to $10.6 million in the first quarter of fiscal 1997. During the period, gross profit as a percentage of net sales increased from 16.2% to 22.1%. The increase in the amount of gross profit resulted primarily from increases in sales volumes of the Company's products, partially offset by decreasing unit prices. The increase in gross profit as a percentage of net sales resulted primarily from the economies of scale resulting from higher production volumes and increased operating efficiencies. In addition, increased revenues and margins from the commercial channel also contributed to the overall higher margin percentage. The gross profit margin for the quarter however, was down slightly from the 22.9% achieved during the previous quarter. The decline was due to modest increases in overall manufacturing costs combined with lower overall overhead absorption resulting from lower production volumes during the holiday season. -7- Research and Development Expenses. Research and development expenses increased by $465,000, or 60.2%, from $773,000 in the first quarter of fiscal 1996 to $1.2 million in the first quarter of fiscal 1997. This increase resulted from increased staffing levels at the Company's corporate office and Eugene, Oregon design center and the initial staffing of the recently established engineering office in Belfast, Northern Ireland. Expenses associated with the development of new products as well as the continuing enhancement and support of the Company's existing products also contributed to the increase in research and development expenses. During the periods, the expenses as a percentage of net sales increased from 1.7% to 2.6%. Sales and Marketing Expenses. Sales and marketing expenses increased by $873,000, or 36.2%, from $2.4 million in the first quarter of fiscal 1996 to $3.3 million in the first quarter of fiscal 1997. This increase in expenses resulted primarily from additional staffing and commissions paid as a result of higher sales. Increased expenses associated with the incremental sales and promotional activities in the commercial and specialized technology channels also attributed to the increased expenses. During the periods, the expenses as a percentage of net sales increased from 5.4% to 6.8%. General and Administrative Expenses. General and administrative expenses increased by $486,000, or 25.6%, from $1.9 million in the first quarter of fiscal 1996 to $2.4 million in the first quarter of fiscal 1997. This increase in the amount of general and administrative expenses was due primarily to expenses associated with the Company's growth, including increased personnel expenses, occupancy costs, data processing costs and other operating expenses. During the periods, these expenses as a percentage of net sales increased from 4.2% to 5.0%. LIQUIDITY AND CAPITAL RESOURCES The Company's principal capital and liquidity needs are for financing inventory and accounts receivable and manufacturing equipment expenditures. The Company has financed these requirements, and its operations, generally, through a combination of cash generated from operations, trade credit from vendors, bank borrowings and the Company's initial public offering. The Company recognizes that future growth will require additional capital, particularly to support increased working capital needs, engineering and other staffing expenses, promotional expenses, manufacturing facilities and equipment requirements. The Company believes its various sources of available financing will be adequate to meet its capital requirements for the foreseeable future. Cash used in operating activities was $658,000 in the first three months of fiscal 1997 resulting primarily from reductions in accounts payable, partially offset by net income and reductions in inventory and accounts receivable, compared to cash generated from operating activities of $4.6 million in the first three months of fiscal 1996. Working capital was $26.7 million at January 31, 1997, compared to $25.2 million at October 31, 1996, and cash was $3.7 million at January 31, 1997, compared to $3.4 million at October 31, 1996. The Company's investment in equipment totaled $1.1 million in the first three months of fiscal 1997, compared with net purchases of equipment of $250,000 in the first three months of fiscal 1996. The investments in equipment are primarily for manufacturing equipment additions and upgrades of existing equipment to support the increased demand for the Company's products from existing as well as new customers and to a lesser degree for upgrades of the systems and equipment used at the Company's corporate offices. The Company expects that additional capital expenditures for similar types of equipment will be required to support future customer demand and product requirements. The Company currently has an available line of credit of $25 million under a secured revolving credit facility (the "Revolving Credit Facility") which includes a $2 million term loan (the "Mezzanine Facility"). During fiscal 1996, the Company increased the size of its Revolving Credit Facility by $10 million to its current level. At January 31, 1997, $13.9 million and $1.4 million was outstanding under the Revolving Credit Facility and the Mezzanine Facility, respectively. Principal amounts under both the Revolving Credit Facility and the Mezzanine Facility bear interest at the rate of prime plus .75%. The Revolving Credit Facility agreement provides for a minimum monthly interest charge of $25,000, which can be satisfied by interest accrued pursuant to both the Revolving Credit Facility and the Mezzanine Facility. Availability under the -8- Revolving Credit Facility is subject to limitations determined by the Company's borrowing base, which is calculated based on eligible accounts receivable and inventory, as defined in the Revolving Credit Facility agreement. All indebtedness under these facilities matures on November 1, 1999. On February 14, 1995, the Company completed an initial public offering (the Offering) of 2.0 million shares of Common Stock. Proceeds from the Offering totaled $21.7 million, net of underwriters' discounts and other Offering expenses totalling $2.3 million. The Company applied a portion of the Offering proceeds to reduce indebtedness owed under the Revolving Credit Facility by $5.5 million and to repay $3.0 million in trade debt. In addition, just prior to the Offering, the Company issued notes to its founding shareholders in the principal amount of $2.0 million representing a portion of the dividend distribution of the Company's undistributed S Corporation earnings. These notes provide for twelve equal monthly payments of principal and interest to the founding shareholders, the final payment of which was made in February, 1996. The remaining portion of the Company's undistributed S Corporation earnings in the amount of $2.1 million was paid to the founding shareholders from the Offering proceeds. SEASONALITY The Company's quarterly operating results vary significantly depending on factors such as the timing of new product introductions, adequacy of component supply, changes in component costs, variations in the Company's product mix, seasonal promotions by the Company and its customers and competitive pricing pressures. Because the timing of these factors may vary, the results of any particular quarter may not be indicative of results for the full year or any future period. In addition, the PC market generally experiences weaker sales during the summer months. Although the Company has experienced sales growth for each year since fiscal 1990, there can be no assurance that this growth will continue on a quarterly or annual basis. PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company was served notice of the filing of a plaintiff class action lawsuit on September 6, 1995 in the 134th Judicial District Court of Dallas County, Texas against the Company and certain officers and directors of the Company. The alleged class of Plaintiffs consisted of all persons who purchased shares of the Company's stock on the open market between February 14, 1995 and May 25, 1995. The Plaintiffs, who sought unspecified damages, allege that the Company's Registration Statement and Prospectus in its initial public offering contained false and materially misleading statements. The Company and the individual defendants deny the Plaintiffs' allegations and have defended this action. In August, 1996, the trial court dismissed the compliant for want of prosecution. The deadline for the plaintiffs to file a motion with the trial court to reinstate the compliant has passed. The plaintiffs have had an additional period within which to appeal this dismissal. This additional period has now passed without any such appeal being filed. ITEM 5. OTHER INFORMATION - FOREWORD LOOKING INFORMATION; BUSINESS RISKS All statements other than statements of historical fact contained in this report are forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve risks and uncertainties, and the Company's actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, the risks described under "Risk Factors" in Part I of the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 1996, as amended, and those discussed below. POTENTIAL FOR FLUCTUATING OPERATING RESULTS The Company's historical operating results have fluctuated significantly from period to period, and will likely fluctuate in the future. Fluctuations result from a wide variety of factors, including the timing and availability of components, changes in product mix and pricing, the timing of customer orders, new product developments or introductions, production interruptions and product reviews and other media coverage. The Company's quarterly results are also subject to seasonal fluctuations, with generally weaker fiscal third quarter results. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Seasonality". In addition, as all of the Company's products are sold for use in PCs, the Company's sales and operating results are influenced significantly by fluctuations in the PC market. -9- DEPENDENCE ON SUPPLIERS Several components used in the Company's products are obtained from single or limited sources and, in instances where the component manufacturer does not allocate a sufficient supply of components to meet the Company's needs, the Company must obtain specific components from distributors or on the spot market at a higher cost. The Company has no guaranteed supply arrangements with any of its suppliers, and there can be no assurance that current suppliers will be able to meet its requirements. The Company believes that with respect to its single and limited source components, it could obtain similar components from other sources but likely would be required to pay significantly more for such products, alter product designs to use alternative components (which would cause significant delays) or reduce its production of the related multimedia accelerators. As a result of delays in the delivery of components, lack of available components, or the lack of available software drivers from component vendors, the Company has in the past experienced difficulty in meeting certain product shipment dates to customers, which in some instances has resulted in a loss of business. It is likely that delays in delivery of components, shortages of components and the lack of available software drivers will continue to occur in the future, and such delays, or inconsistencies in the quality or reliability of components or related software, could materially adversely affect the Company and its results of operations. In addition, significant increases in the prices of components, such as graphics controller chips or memory chips, occur from time to time, and often the Company is not able to adjust the price of its products accordingly. In the past, both occasional worldwide shortages of DRAM video memory and international tariff disputes have resulted in substantial component cost increases that have materially adversely affected the Company and its results of operations. DEPENDENCE ON KEY CUSTOMERS The Company's top three customers accounted for 55.5% and 59.7% of net sales during fiscal years 1995 and 1996, respectively. In recent years, Gateway 2000 has been the Company's top customer, although STB's other significant customers have changed from period to period. The loss or reduction of the business of Gateway 2000 or one or more of the Company's other major customers would have a material adverse effect on the Company's results of operations. In addition, the Company's future success will depend significantly upon the success of its customers, particularly its OEM customers. The Company has no long-term commitments or contracts with its customer. The Company has no long-term commitments or contracts with its customers. While a number of the Company's OEM customers have achieved strong PC sales in recent periods, such customers, and the PC industry in general are subject to dynamic competitive conditions. In particular, the loss of sales by the Company's OEM customers to other OEMs or a decrease in the popularity of desktop PCs that incorporate the Company's products would adversely affect the Company and its results of operations. DEPENDENCE ON MULTIMEDIA ACCELERATION MARKET -- MIGRATION TO MOTHERBOARDS Substantially all of the Company's net sales are derived from the sale of multimedia accelerators. Multimedia accelerators generally are used in higher end PCs offering the latest technology and performance features, while graphics circuitry usually is included on the motherboard of entry-level PC models. An increase in the number or percentage of manufactured PCs that incorporate graphics circuitry on the motherboard, at the expense of add-in multimedia accelerators, an increase in the number or percentage of multimedia accelerators manufactured internally by OEMs or a decrease in PC sales volumes would effectively shrink the market for the Company's products and could materially adversely affect the Company's business. In addition, it is possible that graphics circuitry could be incorporated into the CPU, which could materially adversely affect the Company and its results of operations. -10- NEW PRODUCTS AND TECHNOLOGICAL CHANGE The market for the Company's products is characterized by short product life cycles, rapidly changing technology, evolving industry standards and frequent introductions of new products. The Company's success depends upon market acceptance of its existing products and its ability to enhance its existing products and its ability to continually develop and introduce new products and features to meet changing customer requirements. There can be no assurance of the continued acceptance of the Company's existing products or that the Company will be successful in enhancing its existing products or identifying, developing, manufacturing or marketing new products. Delays in developing new products or enhancements or the failure of such products or enhancements to gain market acceptance could materially adversely affect the Company and its results of operations. Sales of individual products and product lines are typically characterized by declines in volumes, pricing and margins toward the end of the product's life cycle, the precise timing of which may be difficult to predict. As new products are planned and introduced, the Company attempts to monitor closely the inventory of older products (and older components) and to phase out their manufacture in a controlled manner. Nevertheless, the Company could experience unexpected reductions in sales of older generation products as customers anticipate new products. These reductions could give rise to additional charges for obsolete or excess inventory, returns of older generation products by retailers or commercial distributors or substantial price protection claims. To the extent that the Company is unsuccessful in managing product transitions, its business and operating results would be materially adversely affected. INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS It is common in the computer industry for companies to assert intellectual property infringement claims against other companies. As a consequence, the Company indemnifies some OEM customers in certain respects against intellectual property claims relating to its products. If an intellectual property claim were to be brought against the Company and the Company was found to be infringing upon the rights of others, the Company could be required to pay infringement damages, pay licensing fees, modify its products so that they are not infringing or discontinue offering products that were found to be infringing, any of which could materially adversely affect the Company and its results of operations. If an intellectual property claim were to be brought against one or more of the Company's suppliers and the supplier was found to be infringing upon the rights of others, the supplier could be enjoined from further shipments of its products to the Company which could materially adversely affect the Company and its results of operations. ENTRY INTO NEW PRODUCT MARKETS While the Company's business historically has focused on the design, manufacture and sales of multimedia accelerators, in the third quarter of fiscal 1996 the Company first began shipping significant unit volumes of new multimedia subsystem products and has announced other new multimedia subsystem products expected to be introduced in the near future. There are numerous risks inherent in the entry into new product markets, including the reallocation of limited management, engineering and capital resources to unproven product ventures, a greater likelihood for encountering technical problems and a greater likelihood that the market will not accept the Company's new products or the PCs into which they are incorporated. The failure of one or more of such products, or any negative effects upon the Company's core multimedia accelerator business, could materially adversely affect the Company and its results of operations. INTERNATIONAL OPERATIONS The Company is subject to the general risks of conducting business internationally, including unexpected changes in regulatory requirements, fluctuations in currency exchange rates, delays resulting from difficulty in obtaining export licenses for certain technology, state imposed restrictions on the repatriation of funds, tariffs and other barriers and restrictions and the burdens of complying with a variety of foreign laws. In addition, the Company is subject to general geopolitical risks, such as political instability and changes in diplomatic and trade relationships, in connection with its international operations. Although the Company has not to date experienced any material adverse effect on its operations as a result of such factors, there can be no assurance that such factors will not materially adversely impact the Company and its results of operations -11- in the future or require the Company to modify its current business practices. The Company currently sells its products at prices denominated in U.S. dollars and an increase in the value of the U.S. dollar relative to foreign currencies could make the Company's products more expensive and potentially less competitive in foreign markets. The Company expects to sell a portion of its products in the future at prices denominated in other currencies and will therefore increase its currency exposure risk. In addition, a substantial portion of the Company's manufacturing labor costs are paid in Mexican pesos, so any decrease in the value of the U.S. dollar relative to the Mexican peso could increase the Company's manufacturing costs and adversely affect the Company and its results of operations. PRICE PROTECTION AND STOCK ROTATION RISKS As is common practice in this industry, the Company's arrangements with its commercial customers generally allow customers, in the event of a price decrease, credit equal to the difference between the price originally paid and the new decreased price on units in the customers' inventories on the date of the price decrease. In addition, commercial customers generally have the right to return slow-moving or excess inventory for product credit up to an agreed upon percentage of shipments within specified time periods. While the Company establishes reserves to cover these practices, there can be no assurance that these reserves will be sufficient or that any future price protection claims or returns will not have a material adverse effect on the Company and its results of operations, particularly because results are heavily dependent on products for which the Company has little or no operating history. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview" DEPENDENCE ON KEY PERSONNEL The Company's success depends upon the services of its management, sales, marketing and engineering personnel. While the Company has entered into employment agreements with a number of such personnel, the loss of the services of one or more of such personnel could have a material adverse effect on the Company and its results of operations. The success of the Company will depend, in part, on its ability to retain its key management, sales, marketing and engineering personnel and to attract other personnel to satisfy the Company's current and future needs. There is substantial competition for such personnel in the computer industry, and the inability to retain key personnel or to attract additional personnel to satisfy the Company's needs could have a material adverse effect on the Company and its results of operations. SINGLE MANUFACTURING FACILITY The Company's primary manufacturing facility is located in Juarez, Mexico. Since the Company is substantially dependent on this single manufacturing facility, a disruption of the Company's manufacturing operations at this facility would have a material adverse effect on the Company and its results of operations. Such disruption could result from various factors, including a labor dispute, human error, governmental or political risks or a natural disaster such as an earthquake, tornado, fire or flood. In addition, in comparison to those of its competitors that do not maintain their own manufacturing facilities, the Company incurs higher relative fixed overhead and labor costs as a result of operating its own manufacturing facility. Any failure to generate the level of product revenues needed to absorb these overhead and labor costs would have a material adverse on the Company and its results of operations. DEPENDENCE ON SALES REPRESENTATIVES AND DISTRIBUTORS The Company markets and distributes a significant portion of its products in the United States to OEM customers and commercial channel customers through independent sales representatives and distributors. The Company's sales representatives work in tandem with the Company's sales force and are organized by customer account. The services of an independent sales representative are important in obtaining and maintaining a customer relationship. The Company's distributors resell the Company's products to retailers and other resellers in the commercial market. The Company's agreements with its sales representatives and -12- distributors are cancelable upon 30-days' notice. There can be no assurance that future sales by sales representatives or distributors will continue at present levels. The loss of one or more sales representatives or distributors, or the decision by one or more distributors to reduce the number of the Company's products offered or to carry the product lines of the Company's competitors, could have a material adverse effect on the Company and its results of operations. PROPRIETARY TECHNOLOGY The Company's success partially depends upon its proprietary technology, consisting of its software drivers and utilities and, to a lesser extent, its hardware designs. The Company relies upon copyright and trade secret laws and agreements with its suppliers and customers to protect its proprietary technology. There can be no assurance that the Company's present protective measures will be adequate to prevent misappropriation of its technology or independent third party development of the same or similar technology. Many foreign jurisdictions offer less protection of intellectual property rights than the United States, and there can be no assurance that the protection provided to the Company's proprietary technology by the laws of the United States or foreign jurisdictions will be sufficient to protect the Company's technology. The Company has and may in the future find it necessary or desirable to procure licenses from third parties relating to current or future products or technologies, but there can be no assurance that the Company will continue to be able to obtain such licenses or other rights or, if it is able to obtain them, that it will be able to do so on commercially acceptable terms. The Company could be placed at a disadvantage if its competitors obtain licenses with lower royalty fee payments or other terms more favorable than those received by the Company. If the Company or its suppliers were unable to obtain licenses relating to current or future products or technologies, the Company could be forced to market products without certain technological features. The Company's inability to obtain licenses necessary to use certain technology or its inability obtain such licenses on competitive terms could have a material adverse effect on the Company and its results of operations. ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit Number ------- 11.1 Computation of Earnings Per Common Share and Common Equivalent Share 27.1 Financial Data Schedule (b) Current Reports on Form 8-K There were no reports filed on Form 8-K during the quarterly period ended January 31, 1997. -13- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. STB SYSTEMS, INC. Dated: March 17, 1997 By: /s/ William E. Ogle --------------------------------------- President and Chief Executive Officer Dated: March 17, 1997 By: /s/ Bryan F. Keyes --------------------------------------- Bryan F. Keyes, Treasurer and Director of Legal -14-