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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JULY 31, 1998
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: September 14, 1998:
Common Stock, $.01 par value 13,069,487
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STB SYSTEMS, INC.
INDEX
PAGE
PART I FINANCIAL INFORMATION NUMBER
Item 1 Consolidated Financial Statements: 1
Consolidated Balance Sheets at July 31, 1998 (Unaudited)
and October 31, 1997 2
Consolidated Statements of Operations for the
three months ended July 31, 1998 and 1997 (Unaudited) 3
Consolidated Statements of Operations for the
nine months ended July 31, 1998 and 1997 (Unaudited) 4
Consolidated Statements of Cash Flows for the
nine months ended July 31, 1998 and 1997 (Unaudited) 5
Notes to Consolidated Financial Statements 6-7
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 8-14
PART II OTHER INFORMATION
Items 1 through 4 have been omitted since the registrant has no
reportable events in relation to these items.
Item 5 Other Information - Risk Factors 15-26
Item 6 Exhibits and Reports on Form 8-K 27
Signatures 28
-1-
PART I FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
STB SYSTEMS, INC. and SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
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(Dollars in thousands except per share data)
July 31, October 31,
1998 1997
------------------------
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents $ 30,797 $ 3,869
Accounts receivable - trade, net of allowance
For doubtful accounts of $720 and $465 39,002 47,208
Inventories, net 45,101 41,295
Other current assets 6,010 1,970
------------------------
Total current assets 120,910 94,342
Property and equipment, net 10,662 12,348
Other assets 1,751 2,864
------------------------
Total assets $ 133,323 $ 109,554
------------------------
------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Short-term debt $ 2,000 $ 21,520
Accounts payable - trade 16,774 36,801
Accrued wages, commissions and bonuses 826 1,466
Other accrued liabilities 2,184 2,027
Current portion of long-term liabilities 582 1,167
------------------------
Total current liabilities 22,366 62,981
Long-term Liabilities:
Long-term notes payable - 500
Obligations under capital leases and other
long-term liabilities 2,246 2,611
------------------------
Total long-term liabilities 2,246 3,111
------------------------
Shareholders' Equity:
Preferred stock, 2,000,000 shares authorized,
none issued or outstanding - -
Common stock, $.01 par value, 25,000,000 shares
authorized, 13,292,897 and 10,452,473 shares issued,
respectively 133 105
Additional paid-in capital 82,990 25,357
Retained earnings 25,833 18,245
------------------------
108,956 43,707
Treasury stock, 35 shares, at cost (245) (245)
------------------------
Total shareholders' equity 108,711 43,462
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Total liabilities and shareholders' equity $ 133,323 $ 109,554
------------------------
------------------------
The accompanying notes are an integral part of
these consolidated financial statements
-2-
STB SYSTEMS, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
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(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
Three months ended
July 31,
1998 1997
--------------------------
Net sales $ 58,795 $ 42,019
Cost of sales 46,777 29,594
--------------------------
Gross profit 12,018 12,425
--------------------------
Operating expenses:
Research and development 2,985 1,673
Sales and marketing 4,454 3,775
General and administrative 3,167 2,819
--------------------------
Total operating expenses 10,606 8,267
--------------------------
Income from operations 1,412 4,158
Interest (income) expense, net (179) 426
--------------------------
Income before income taxes 1,591 3,732
Provision for income taxes 617 1,263
--------------------------
Net income $ 974 $ 2,469
--------------------------
--------------------------
Net income per share:
Basic $ 0.07 $ 0.24
--------------------------
--------------------------
Diluted $ 0.07 $ 0.22
--------------------------
--------------------------
Weighted average shares outstanding:
Basic 13,290,776 10,352,843
--------------------------
--------------------------
Diluted 13,740,038 11,229,985
--------------------------
--------------------------
The accompanying notes are an integral part of
these consolidated financial statements
-3-
STB SYSTEMS, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
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(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
Nine months ended
July 31,
1998 1997
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Net sales $ 211,347 $ 138,811
Cost of sales 169,253 103,975
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Gross profit 42,094 34,836
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Operating expenses:
Research and development 7,883 4,468
Sales and marketing 13,069 10,698
General and administrative 9,013 7,609
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Total operating expenses 29,965 22,775
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Income from operations 12,129 12,061
Interest expense, net 585 1,185
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Income before income taxes 11,544 10,876
Provision for income taxes 3,956 3,737
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Net income $ 7,588 $ 7,139
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Net income per share:
Basic $ 0.64 $ 0.70
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-------------------------
Diluted $ 0.60 $ 0.65
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Basic 11,853,066 10,253,579
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-------------------------
Diluted 12,686,230 11,004,005
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The accompanying notes are an integral part of
these consolidated financial statements
-4-
STB SYSTEMS, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
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(DOLLARS IN THOUSANDS)
Nine months ended
July 31,
1998 1997
-----------------------
Cash flows from operating activities:
Net income $ 7,588 $ 7,139
Adjustments to reconcile net income to net cash
from operating activities:
Depreciation and amortization 2,463 1,626
Changes in assets and liabilities:
Accounts receivable - trade 8,206 (2,464)
Inventories (3,806) (1,501)
Other current assets (4,040) (925)
Other assets 1,113 (1,503)
Accounts payable - trade (20,027) (3,072)
Accrued wages, commissions, and bonuses (640) (128)
Other accrued liabilities 157 (222)
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Net cash used in operating activities (8,986) (1,050)
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Cash flows from investing activities -
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Purchases of property and equipment (777) (3,998)
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Cash flows from financing activities:
Borrowings (payments) on short-term debt (19,520) 3,996
Payments on long-term debt (1,450) (539)
Issuance of common stock, net of issue costs 57,661 1,716
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Net cash provided by financing activities 36,691 5,173
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Net increase in cash and cash equivalents 26,928 125
Cash and cash equivalents at beginning of period 3,869 3,420
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Cash and cash equivalents at end of period $ 30,797 $ 3,545
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The accompanying notes are an integral part of
these consolidated financial statements
-5-
STB SYSTEMS, INC.
Notes To Consolidated Financial Statements
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
STB Systems, Inc. develops, manufactures and sells a wide selection of
multimedia accelerator subsystems, other multimedia subsystem 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. Symmetric Simulation Systems, Inc.,
also a wholly-owned subsidiary of STB Systems, Inc., designs high-end 3D
graphics acceleration products for use in applications such as computer-aided
design, product visualization and animation.
The accompanying financial statements include the consolidated accounts of STB
Systems, Inc., STB Assembly, Inc. and Symmetric Simulation Systems, 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 that 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.
In February 1997, the Financial Accounting Standards Board issued FAS No. 128
"Earnings per Share", (SFAS 128). The Company has adopted SFAS 128, which
establishes standards for computing and presenting earnings per share (EPS).
This statement requires dual presentation of basic and diluted EPS on the face
of the income statement for entities with complex capital structures and
requires a reconciliation of the numerator and denominator of the basic EPS
computation to the numerator and denominator of the diluted EPS computation.
Basic EPS excludes the effect of potentially dilutive securities while diluted
EPS reflects the potential dilution that would occur if securities or other
contracts to issue common stock were exercised, converted into or resulted in
the issuance of common stock. The provision and disclosure requirements of SFAS
128 were required to be adopted for interim and annual periods ending after
December 15, 1997, with restatement of EPS for prior periods. Accordingly, EPS
data for all periods has been restated to reflect the computation of EPS in
accordance with the provisions of SFAS 128.
The financial information presented herein should be read in conjunction with
the Company's annual consolidated financial statements for the year ended
October 31, 1997. 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.
NOTE 2 - INVENTORIES
Inventories at July 31, 1998 and October 31, 1997 consist of the following (in
thousands):
July 31, 1998 October 31, 1997
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Raw materials $ 22,339 $ 22,416
Work-in-process 12,701 13,416
Finished goods 10,061 5,463
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Total $ 45,101 $ 41,295
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-6-
NOTE 3 - OTHER ASSETS
During the quarter, the Company invested $3 million in a supplier. The
investment is in the form of a Convertible Subordinated Note. In the event the
supplier sells common stock in an initial public offering prior to December 31,
1998, the investment will convert to common stock at a discount from the price
per share of the common stock in the initial public offering. In the event the
supplier does not complete an initial public offering prior to December 31,
1998, then on January 15, 1999, the investment shall automatically convert into
common stock of the supplier. The investment is included in other current
assets.
NOTE 4 - SHORT TERM DEBT
In January 1998, the Company increased its borrowing capacity under its
revolving credit facility ("Revolving Credit Facility") to $40,000,000 from
$30,000,000. The Revolving Credit Facility bears interest at LIBOR plus 175
basis points (7.406% at July 31, 1998). Availability under the Revolving Credit
Facility is subject to limitation determined by the Company's borrowing base,
which is calculated based on eligible accounts receivable, as defined in the
Revolving Credit Facility Agreement.
NOTE 5 - STOCK SPLIT
On January 27, 1998, the Company declared a three-for-two split of the Company's
common stock. The stock split was effected in the form of a stock dividend on
February 20, 1998, to shareholders of record on February 11, 1998. Share and
per share amounts in the accompanying consolidated financial statements have
been retroactively adjusted to reflect the stock split.
NOTE 6 - EARNINGS PER SHARE
The following table sets forth the reconciliation of the numerators and
denominators of the basic and diluted EPS computations:
Three months ended Nine months ended
July 31, July 31,
1998 1997 1998 1997
-------------------------- --------------------------
Net income (in thousands) $ 974 $ 2,469 $ 7,588 $ 7,139
-------------------------- --------------------------
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BASIC
Weighted average number of shares outstanding 13,290,776 10,352,843 11,853,066 10,253,579
-------------------------- --------------------------
-------------------------- --------------------------
Net income per share $ 0.07 $ 0.24 $ 0.64 $ 0.70
-------------------------- --------------------------
-------------------------- --------------------------
DILUTED
Weighted average number of shares outstanding 13,290,776 10,352,843 11,853,066 10,253,579
Additional weighted average shares from assumed
exercise of dilutive stock options, net of
shares assumed to be repurchased with exercise
proceeds 449,262 877,142 833,164 750,426
-------------------------- --------------------------
Dilutive weighted average shares outstanding 13,740,038 11,229,985 12,686,230 11,004,005
-------------------------- --------------------------
-------------------------- --------------------------
Net income per share $ 0.07 $ 0.22 $ 0.60 $ 0.65
-------------------------- --------------------------
-------------------------- --------------------------
Options to purchase 382,500 shares of common stock were outstanding during
the third quarter ended July 31, 1998, but were not included in the
computation of diluted EPS because the options' exercise price was greater
than the average market price. These shares range in price from $10.31 to
$25.94 per share for the third quarter. The options will expire in 2007.
NOTE 7 - SECONDARY OFFERING
On February 25, 1998 the Company filed a registration statement on Form S-3 to
offer 3,000,000 shares of its common stock to the public in a secondary
offering. On March 20, 1998, the offering was completed and of the shares being
offered, 2,775,000 shares were sold by the Company and 225,000 were sold by
certain selling shareholders. Net proceeds from the offering were used to
reduce indebtedness outstanding under the Company's Revolving Credit Facility
and the balance retained for general corporate purposes.
-7-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company designs, manufactures and sells multimedia subsystem and
specialized technology products, primarily for use in desktop personal
computers (PCs). These products supplement a PC's CPU to enhance multimedia
performance and accelerate the computationally intensive operations and
processing requirements necessary to perform advanced multimedia
applications. The Company focuses primarily on the sale of its products to
major original equipment manufacturers, "OEMs", and works closely with its
component suppliers and OEM customers to develop products that are responsive
to technological trends and consumer demand. STB manufactures substantially
all of its products at its ISO 9002 certified facility in Juarez, Mexico,
which the Company believes enables it to respond more quickly to changing
customer needs, maintain product quality and achieve economies of scale.
The Company currently sells multimedia subsystems and specialized technology
products. The Company's multimedia subsystem product line includes a wide
selection of multimedia accelerator subsystems designed primarily for use in
mid-range to high-end PCs as well as several complementary products, including
DVD decoder subsystems, PC/TV convergence subsystems and sound cards. STB's
specialized technology products include products designed to enable a single
computer to control the display of up to 32 monitors and a recently introduced
line of flat panel display products.
The Company sells its products to OEM customers, the commercial market, and
the specialized technology market. The Company sells its multimedia subsystems
primarily to major OEMs and, to a lesser extent, the commercial market. Sales of
the Company's products to OEMs represented approximately 82% and 79% of total
net sales for the first nine months of fiscal 1998 and fiscal year 1997,
respectively. The Company's three largest OEM customers accounted in the
aggregate for approximately 75% and 66% of total net sales for the first nine
months of fiscal 1998 and fiscal year 1997, respectively. Sales of multimedia
subsystems to the commercial market accounted for approximately 11% and 12% of
total net sales for the first nine months of fiscal 1998 and fiscal year 1997
respectively, and sales of specialized technology products accounted for
approximately 6% and 8% of total net sales for the first nine months of fiscal
1998 and fiscal year 1997, respectively. The balance of total net sales was
derived primarily from third party contract assembly services, which accounted
for approximately 1% of total net sales for the first nine months of fiscal 1998
and fiscal year 1997. The Company has no long-term commitments or contracts
with any of its customers and the loss of any of the Company's key customers
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Risk Factors - Customer
Concentration; Dependence on PC Market."
Sales of multimedia accelerator subsystems and other multimedia subsystems
to OEMs have typically been characterized by relatively high unit volumes and
relatively low gross profit margins. Sales of multimedia subsystem products to
the commercial market are characterized by relatively modest unit volumes and
moderate gross profit margins. Sales of the Company's specialized technology
products are characterized by relatively low unit volumes and relatively high
gross profit margins. Shifts in the mix of products sold or in the sales
channels into which such products are sold could have a material adverse effect
on the Company's business, financial condition and results of operations. See
"Risk Factors - Change in Product Mix or Sales Channel." In addition, a
substantial majority of the Company's net sales have been derived from sales of
multimedia accelerator subsystems and, from time to time, a substantial majority
of the Company's net sales in a given fiscal quarter have been derived from the
sales of a single or a limited number of multimedia accelerator subsystems. See
"Risk Factors - Product Concentration." The markets for the Company's products
in general, and its multimedia accelerator subsystems in particular, are
characterized by short product life cycles, evolving industry standards and
frequent introductions of new products. See "Risk Factors - Limited Product
Life Cycle; Rapid Techological Change; Management of Product Introductions."
The Company recognizes revenue upon shipment of its products. For products sold
through the commercial channel, the Company generally provides credits for
returns in the form of stock rotation and price protection. The Company's
current stock rotation policies permit a commercial channel customer to return
approximately 10% of products purchased within the previous 90 days if the
customer has placed an order for other Company products of equal or greater
value.
-8-
The Company also provides price protection to commercial channel customers in
the form of credits for price reductions on products remaining in customer
inventories at the time of the price reduction. The Company maintains reserves
related to these sales programs, which it believes are adequate. See "Risk
Factors - Price Protection and Stock Rotations."
The Company has no guaranteed supply arrangements with any of its suppliers.
The Company obtains most of the primary components for its current products,
consisting mainly of controller chips and memory chips, directly from the
component manufacturers. The prices of such components can change significantly
from time to time. In the past, the Company has experienced, and may in the
future experience, increases in its unit component costs without being able to
increase the price of the products incorporating such components. Such an
increase in component costs could impair the Company's gross profit margins and
results of operations. In particular, occasional worldwide shortages of memory
and controller chips and international tariff disputes have in the past resulted
in substantial component cost increases that have had a material adverse effect
on the Company's gross profit margins and its results of operations. The
Company's total gross profit margins and gross profits will likely continue to
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. See "Risk Factors - Dependence on Suppliers" and "--Change in Product
or Sales Channel Mix."
In recent periods, the Company's business has been strongly influenced by the
following trends: the growth of the PC market in general; the ability of several
major PC manufacturers to expand their respective market shares of the PC market
in general; the Company's ability to establish and expand OEM relationships with
several of these major PC manufacturers; the expansion of the market for
multimedia subsystems and, in particular, the market for multimedia accelerator
subsystems; the ability of the Company to identify and source key components,
such as graphics controller chips, that enable the Company's products to compete
effectively with its competitors; and the Company's ability to design, develop
and manufacture successive generations of multimedia accelerator subsystems that
secure design wins with major OEM customers and achieve wide market acceptance.
Although the Company is currently attempting to diversify its product offerings,
expand its existing OEM customer relationships, establish new OEM customer
relationships and expand sales into the commercial market, there can be no
assurance that the Company will be successful with respect to any of these
efforts. The failure by the Company to further diversify its product offerings
and to expand its distribution channels could have a material adverse effect on
the Company's business, financial condition and results of operations. See
"Risk Factor - Customer Concentration; Dependence on PC Market," "--Dependence
on Multimedia Accelerator Market; Migration to Motherboards," "--Dependence on
Suppliers" and "--Limited Product Life Cycle; Rapid Technological Change;
Management of Product Transitions."
During the fiscal quarter ended April 30, 1997, the Company acquired all of the
outstanding shares of Symmetric Simulation Systems, Inc. ("Symmetric"), a
designer and builder of high-end 3D graphics acceleration subsystems used in
applications such as computer-aided design product visualization, architectural
walk-throughs and multimedia authoring. The Company believes that the Symmetric
product line complements the Company's existing products and enables the Company
to market products to the high-end 3D market.
On February 25, 1998 the Company filed a registration statement on Form S-3 to
offer 3,000,000 shares of its common stock to the public in a secondary
offering. On March 20, 1998, the offering was completed and of the shares being
offered, 2,775,000 shares were sold by the Company and 225,000 were sold by
certain selling shareholders. The net proceeds received by the Company from the
offering were used to repay certain indebtedness outstanding under the Company's
Revolving Credit Facility and for other general corporate purposes.
-9-
RESULTS OF OPERATIONS
The following table sets forth certain items from the Company's Consolidated
Statements of Operations as a percentage of net sales from continuing
operations:
Percentage of Net Sales
---------------------------------------------
Three months ended Nine months ended
July 31, July 31,
1998 1997 1998 1997
-------------------- -------------------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 79.6% 70.4% 80.1% 74.9%
-------------------- -------------------
Gross profit 20.4% 29.6% 19.9% 25.1%
-------------------- -------------------
Operating expenses:
Research and development 5.1% 4.0% 3.7% 3.2%
Sales and marketing 7.6% 9.0% 6.2% 7.7%
General and administrative 5.3% 6.7% 4.3% 5.5%
-------------------- -------------------
Total operating expenses 18.0% 19.7% 14.2% 16.4%
-------------------- -------------------
Income from operations 2.4% 9.9% 5.7% 8.7%
Interest (income) expense, net -0.3% 1.0% 0.2% 0.9%
-------------------- -------------------
Income before income taxes 2.7% 8.9% 5.5% 7.8%
Provision for income taxes 1.0% 3.0% 1.9% 2.7%
-------------------- -------------------
Net income 1.7% 5.9% 3.6% 5.1%
-------------------- -------------------
-------------------- -------------------
THREE MONTHS ENDED JULY 31, 1998 COMPARED TO THREE MONTHS ENDED JULY 31, 1997.
NET SALES. Net sales increased to $58.8 million in the third quarter of
fiscal 1998 from $42.0 million in the third quarter of fiscal 1997, representing
an increase of 39.9%. Unit volume for the third quarter of fiscal 1998
increased by 19.1% over the third quarter of fiscal 1997, while the Company's
overall average unit selling prices increased slightly. OEM channel sales
increased to approximately $45.7 million in the third quarter of fiscal 1998
from $32.0 million in the third quarter of fiscal 1997, representing an increase
of 43.0%. Commercial channel sales increased to $8.2 million in the third
quarter of fiscal 1998 from $3.1 million in the third quarter of fiscal 1997, an
increase of 160.7%. Sales growth in the OEM and commercial channels was
primarily the result of increased unit sales of the Company's Velocity 128 and
the Black Magic Voodoo2 multimedia accelerators. See "Risk Factors - Product
Concentration". Sales in the specialized technology market decreased to $3.6
million in the third quarter of fiscal 1998 from $4.8 million in the third
quarter of fiscal 1997, or 25.5%. The decline in specialized technology sales
was primarily a result of a decline in average unit selling prices due to
increased competition in the market, as well as the transition in product
offering from the MVP Workstation to the MVP PRO series.
GROSS PROFIT. Gross profit consists of net sales less cost of sales. Cost
of sales primarily consists of the cost of materials and manufacturing costs
associated with the production of the Company's products. Gross profit
decreased to $12.0 million in the third quarter of fiscal 1998 from $12.4
million in the third quarter of fiscal 1997, representing a decrease of 3.3%.
The decrease in the amount of gross profit resulted primarily from the decline
in average selling prices in the specialized technology market and increased
pricing pressures in the Commercial and OEM markets. During the period, gross
profit as a percentage of net sales decreased to 20.4% in the third quarter of
fiscal 1998 from 29.6% in the third quarter of fiscal 1997. The decrease in
gross profit as a percentage of net sales resulted primarily from (i) increased
pricing pressure on the Velocity 128 and other products, (ii) decrease in higher
margin specialized technology sales as a percentage of total sales, and (iii)
price protection credits granted during the quarter for the Velocity 128 and
Black Majic Voodoo2 products.
-10-
During the quarter, the Company introduced a new SDRAM based product to
compete with a competitors' product, also based on the lower cost memory,
however, early in the quarter the Company faced pricing and margin pressure
as the Company initially only offered the more expensive SGRAM based product.
Gross margins are expected to continue to fluctuate as a result of sales
channel mix, product mix and other factors. See "Risk Factors -- Potential
for Fluctuating Operating Results; Seasonality" and "--Dependence on
Suppliers".
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses primarily
consist of compensation and associated expenses relating to engineering
personnel, development tool expenses, prototyping expenses and product
enhancement expenses. Research and development expenses increased to $3.0
million in the third quarter of fiscal 1998 from $1.7 million in the third
quarter of fiscal 1997, representing an increase of 78.4%. Research and
development expenses as a percentage of net sales increased to 5.1% in the third
quarter of fiscal 1998 from 4.0% in the third quarter of fiscal 1997. The
increase in research and development expenses on both a dollar and percentage
basis resulted primarily from increased staffing at the Company's corporate
headquarters. Expenses associated with software and driver development, as well
as other expenses associated with the development of new products also
contributed to the increase in research and development expenses.
SALES AND MARKETING EXPENSES. Sales and marketing expenses primarily consist
of personnel and related overhead expenses for sales, marketing and customer
support activities, promotional and advertising expenses, and commissions
paid to independent sales representatives. Sales and marketing expenses
increased to $4.5 million in the third quarter of fiscal 1998 from $3.8
million in the third quarter of fiscal 1997, representing an increase of
18.0%. Sales and marketing expenses as a percentage of net sales decreased to
7.6% in the third quarter of fiscal 1998 from 9.0% in the third quarter of
fiscal 1997, primarily due to increases in net sales at a rate faster than
that of sales and marketing expenses. The increase in sales and marketing
expenses resulted primarily from additional staffing and expenses associated
with corporate travel. Increased expenses for advertising and promotional
programs in the commercial channel, the specialized technology channel and
the international market also contributed to the increased expenses.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
primarily consist of personnel and related overhead expenses for management,
finance, management information systems, legal and human resources, as well
as expenses associated with occupancy and other general operating expenses.
General and administrative expenses increased to $3.2 million in the third
quarter of fiscal 1998 from $2.8 million in the third quarter of fiscal 1997,
representing an increase of 12.3%. General and administrative expenses as a
percentage of net sales decreased to 5.3% in the third quarter of fiscal 1998
from 6.7% in the third quarter of fiscal 1997. The increase in the amount of
general and administrative expenses was primarily due to increased expenses
associated with the Company's growth, including increased staffing, occupancy
and other general operating expenses. The Company recently commenced
construction of a new headquarters facility that it plans to occupy in the
first fiscal quarter of 1999. The terms of the lease relating to the new
headquarters facility provide for increased occupancy expense from current
levels beginning at the date of occupancy. See "--Liquidity and Capital
Resources."
INTEREST (INCOME) EXPENSE, NET. Interest (income) expense, net, primarily
consists of the interest expense associated with the Company's Revolving
Credit Facility, Mezzanine Facility (as defined below) and capital leases,
offset partially by the interest income earned on the Company's cash and cash
equivalents. Net interest income was approximately $179,000 in the third
quarter of fiscal 1998, compared to net interest expense of approximately
$426,000 in the third quarter of fiscal 1997. The decrease in the amount of
net interest (income) expense was primarily attributable to the interest
income earned on short-term investments associated with the investment of the
proceeds from the secondary offering and the reduction of short-term debt.
-11-
NINE MONTHS ENDED JULY 31, 1998 COMPARED TO NINE MONTHS ENDED JULY 31, 1997.
NET SALES. Net sales increased to $211.3 million in the first nine months of
fiscal 1998 from $138.8 million in the first nine months of fiscal 1997,
representing an increase of 52.3%. Unit volume for the period increased by
42.0% over the same period last year. OEM channel sales increased to
approximately $173.0 million in the first nine months of fiscal 1998 from
$105.3 million in the first nine months of fiscal 1997, representing an
increase of 64.3%. Sales growth in the OEM channel was primarily the result
of increased unit sales of the Company's Velocity 128 multimedia accelerator.
See "Risk Factors - Product Concentration". Commercial channel sales
increased to $23.2 million in the first nine months of fiscal 1998 from $17.5
million in the first nine months of fiscal 1997, an increase of 32.4%, which
was primarily the result of the introduction of the Black Magic Voodoo2
multimedia accelerator. Sales in the specialized technology market increased
to $12.6 million in the first nine months of fiscal 1998 from $11.0 million
in the first nine months of fiscal 1997, or 15.4%, which was primarily a
result of increased sales to OEM customers for financial services
workstations and a broader specialized technology product offering.
GROSS PROFIT. Gross profit increased to $42.1 million in the first nine
months of fiscal 1998 from $34.8 million in the first nine months of fiscal
1997, representing an increase of 20.8%. During the period, gross profit as
a percentage of net sales decreased to 19.9% in the first nine months of
fiscal 1998 from 25.1% in the first nine months of fiscal 1997. The increase
in the amount of gross profit resulted primarily from increases in sales
volumes of the Company's products (and, in particular, the Company's Velocity
128 and Black Magic Voodoo2 multimedia accelerators). The decrease in gross
profit as a percentage of net sales resulted primarily from increased pricing
pressure on the Velocity 128 and other products and increased overtime and
labor costs caused by the higher rates of production necessary to meet
increased product demand. These increases were partially offset by the
economies of scale resulting from higher production volumes and increased
operating efficiencies. Gross margins are expected to continue to fluctuate
as a result of sales channel mix, product mix and other factors. See "Risk
Factors -- Potential for Fluctuating Operating Results; Seasonality" and
"-- Dependence on Suppliers".
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses increased
to $7.9 million in the first nine months of fiscal 1998 from $4.5 million in the
first nine months fiscal 1997, representing an increase of 76.4%. Research and
development expenses as a percentage of net sales increased to 3.7% in the first
nine months of fiscal 1998 from 3.2% in the first nine months of fiscal 1997.
The increase in research and development expenses on a dollar and percentage
basis resulted primarily from increased staffing at the Company's corporate
headquarters and at each of the design centers in Austin, Texas; Eugene, Oregon;
and Belfast, Northern Ireland. Other expenses associated with the development
of new products and increased expenses associated with software and driver
development also contributed to the increase in research and development
expenses.
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased to $13.1
million in the first nine months of fiscal 1998 from $10.7 million in the first
nine months of fiscal 1997, representing an increase of 22.2%. Sales and
marketing expenses as a percentage of net sales decreased to 6.2% in the first
nine months of fiscal 1998 from 7.7% in the first nine months of fiscal 1997,
primarily due to increases in net sales at a rate faster than that of sales and
marketing expenses. The increase in sales and marketing expenses resulted
primarily from additional staffing and commissions paid as a result of higher
sales, partially offset by decreases in commissions paid to independent sales
representatives. Increased expenses for advertising and promotional programs in
the commercial channel, the specialized technology channel and the international
market also contributed to the increased expenses.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to $9.0 million in the first nine months of fiscal 1998 from $7.6
million in the first nine months of fiscal 1997, representing an increase of
18.5%. General and administrative expenses as a percentage of net sales
decreased to 4.3% in the first nine months of fiscal 1998 from 5.5% in the first
nine months of fiscal 1997. The increase in the amount of general and
administrative expenses was primarily due to increased expenses associated with
the Company's growth, including increased staffing, occupancy costs and other
general operating expenses.
-12-
INTEREST (INCOME) EXPENSE, NET. Net interest (income) expense decreased to
approximately $585,000 in the first nine months of fiscal 1998 from
approximately $1.2 million in the first nine months of fiscal 1997,
representing an decrease of 50.6%. The decrease in the amount of net
interest (income) expense was primarily the result of the interest income
earned on short-term investments of the proceeds from the secondary offering
and the reduction in total average debt and interest rates, partially offset
by the increase in obligations under capital leases outstanding during the
period.
SEASONALITY. The Company's quarterly operating results vary significantly
depending on a number of factors, including, but not limited to: the timely
introduction by the Company of new or enhanced products and the market's
acceptance of these products; the Company's ability to introduce and market
products in accordance with its OEM customers' design requirements and design
cycles; changes in demand for functionality of the Company's products and the
products of its OEM customers; the gain or loss of significant OEM customers;
the volume and timing of significant customer orders received during the period;
the availability, pricing and timeliness of component delivery for the Company's
products; increased competition from existing competitors and new entrants to
the market; the timing of new product announcements or product introductions by
the Company's competitors; product obsolescence, management of product
transitions and unanticipated delays or problems in the introduction or
production of products by the Company or its OEM customers; product reviews and
other media coverage; anticipated and unanticipated decreases in average selling
prices of the Company's products; changes in the mix of products sold by the
Company's OEM and other customers; changes in the pricing policies of the
Company, its suppliers and customers; management of inventory by the Company and
its customers; changes in the Company's sales channel mix or in the sourcing
strategies of its OEM customers; and product returns or price protection charges
by the Company's customers. 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. It is likely that in some future period
the Company's operating results or business outlook will be below the
expectations of securities analysts or investors, which would likely result in a
significant reduction in the market price of the Company's Common Stock. See
"Risk Factors - Potential for Fluctuating Operating Results; Seasonality" and
"- Stock Price Volatility."
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal capital and liquidity needs are for financing
inventory and accounts receivable and for manufacturing and other equipment
expenditures. The Company has generally financed these capital and liquidity
needs and its operations through a combination of cash generated from
operations, trade credit from vendors, bank borrowings and the net proceeds
from its initial public offering. As a result of the Company's rapid growth
in recent years and its capital requirements, during the second quarter of
fiscal 1998 the Company completed a public offering of 2,775,000 shares of
Common Stock. Net proceeds from the offering were used to reduce indebtedness
and the balance was retained for general corporate purposes. Future growth,
if any, may require additional capital, particularly to support increased
working capital needs, staffing requirements, promotional expenses,
manufacturing facilities and equipment requirements.
Cash used in operating activities of $9.0 million in the first nine months of
fiscal 1998 was primarily attributable to reductions in accounts payable,
partially offset by reductions in accounts receivable and increased earnings.
Cash used in operating activities of $1.1 million in the first nine months of
fiscal 1997, was primarily attributable to increases in accounts receivable as a
result of higher sales and reductions in accounts payable, partially offset by
increases in earnings. At October 31, 1997, the Company's working capital was
$31.4 million, compared to $98.5 million at July 31, 1998. Cash and cash
equivalents was $3.9 million and $30.8 million at October 31, 1997 and July 31,
1998, respectively.
The Company invested $9.6 million in capital equipment in fiscal 1997, and an
additional $777,000 during the first nine months of fiscal 1998. The Company's
investment in equipment is primarily attributable to manufacturing equipment
additions and upgrades of existing equipment to support the increased demand for
and complexity of the Company's products. During the 1998 first fiscal quarter,
the Company completed a move to a new 137,000 square foot manufacturing facility
in Juarez, Mexico, located immediately adjacent to its previous facility. The
Company has retained one-half of its previous facility for expansion.
-13-
During the 1997 fourth fiscal quarter, the Company installed two new high-speed
surface-mount technology ("SMT") assembly lines at its new facility, at a total
cost of approximately $6.3 million. An additional line was installed during the
third fiscal quarter of 1998, at a cost of $2.9 million. This equipment has
been financed through operating lease finance arrangements. During the 1996
fourth fiscal quarter, the Company installed four SMT assembly lines, at an
approximate total cost of $4.2 million. This equipment was also financed
through operating lease financing arrangements. The Company's aggregate
obligations under all such equipment lease financing arrangements totaled
approximately $9.5 million at October 31, 1997 and approximately $10.6 million
at July 31, 1998. The Company expects that additional capital expenditures for
similar types of equipment may be necessary to support additional future
customer demand and production requirements, although there can be no assurance
in this regard.
The Company has a $40.0 million Revolving Credit Facility, as well as a $3.0
million term loan (the "Mezzanine Facility"). As of July 31, 1998, the Company
had $2.0 million and $2.7 million outstanding under the Revolving Credit
Facility and the Mezzanine Facility, respectively. The principal amount
outstanding under the Revolving Credit Facility bears interest at LIBOR plus 175
basis points (7.406% at July 31, 1998). The principal amount outstanding under
the Mezzanine Facility bears interest at LIBOR plus 250 basis points (8.156% at
July 31, 1998) and is payable in 60 equal monthly installments of principal and
interest, which began on November 1, 1997. Availability under the Revolving
Credit Facility is calculated using formulas based on eligible accounts
receivable, as defined by the Revolving Credit Facility Agreement. The
indebtedness under the Revolving Credit Facility matures on November 21, 1999
and the indebtedness under the Mezzanine Facility matures on November 1, 2002.
In December 1997, the Company entered into a five year agreement to construct
and lease a new corporate headquarters in Richardson, Texas. Construction on the
210,000 square foot facility began in December 1997, and the total cost is
estimated to be approximately $22.8 million (including land). The lessor has
agreed to fund the cost of the land and construction of the building (subject to
reductions based on certain conditions in the lease agreement). The Company
plans to occupy the facility during the 1999 first fiscal quarter with rental
payments commencing upon occupancy. The Company estimates that its monthly rent
for this facility will be approximately $225,000 for the four year period
following completion of the facility. This amount is in excess of the current
facilities expense, as local rental rates have increased and the Company is
increasing the square footage of its corporate headquarters. The lease
agreement also provides that the amount of lease payments are subject to
adjustment based upon prevailing interest rates. As a consequence, an increase
in prevailing interest rates will increase the Company's facilities expense.
The Company has recently entered into an interest rate swap agreement, whereby
the interest rate on a majority of the obligation is fixed at 7.55%. The Company
is also seeking opportunities to sublease that portion of its new headquarters
facility which the Company does not expect to utilize immediately following its
occupancy of the new facility. The monthly rent currently paid for the
Company's headquarters facility will be eliminated with the move to the new
facility. At the end of the lease for the new facility, the Company may elect
to either renew the lease, pay off the underlying debt on the facility or cause
the building to be sold. In the event of a sale, the proceeds will be used to
retire the underlying debt with any excess to be paid to the Company. The
Company is responsible for any outstanding balance due on the underlying
obligation after the sale of the facility. See "Risk Factors - Headquarters
Relocation."
From time to time, the Company evaluates acquisitions of businesses, products or
technologies that complement the Company's business. Any such transactions, if
consummated, may use a portion of the Company's working capital or require the
issuance of securities which may result in further dilution to the Company's
shareholders. See "Risk Factors - Potential Future Acquisitions."
The Company believes that the net proceeds from the sale of the Common Stock
offered by the Company in its public offering, together with existing capital
resources and anticipated funds from operations, will satisfy the Company's
anticipated capital requirements for at least the next twelve months. After
such period, depending on its financial condition and results of operations, the
Company may require additional equity or debt financing to meet its capital
requirements. There can be no assurance that additional financing will be
available when required, or, if available, that such financing can be obtained
on terms satisfactory to the Company.
-14-
PART II OTHER INFORMATION
ITEM 5. OTHER INFORMATION -RISK FACTORS
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 form the results discussed in the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, the risks described below.
POTENTIAL FOR FLUCTUATING OPERATING RESULTS; SEASONALITY
The Company's results of operations have fluctuated significantly in the past
and are expected to continue to fluctuate in the future as a result of a
number of factors, many of which are beyond the Company's control. These
factors include, but are not limited to: the timely introduction by the
Company of new or enhanced products and the market acceptance of these
products; the Company's ability to introduce and market products in
accordance with its OEM customers' design requirements and design cycles;
changes in demand for functionality of the Company's products and the
products of its OEM customers; the gain or loss of significant OEM customers;
the volume and timing of significant customer orders received during the
period; the availability, pricing and timeliness of component delivery for
the Company's products; increased competition from existing competitors and
new entrants to the market; the timing of new product announcements or
product introductions by the Company's competitors; product obsolescence,
management of product transitions and unanticipated delays or problems in the
introduction or production of products by the Company or its OEM customers;
product reviews and other media coverage; anticipated and unanticipated
decreases in average selling prices of the Company's products; changes in the
mix of products sold by its OEM and other customers; changes in the pricing
policies of the Company, its suppliers and customers; management of inventory
by the Company and its customers; changes in the Company's sales channel mix
or in the sourcing strategies of its OEM customers; and product returns or
price protection charges by customers. Because a significant portion of the
Company's business has been and is expected to continue to be derived from
orders placed by a limited number of larger OEM customers, any gain or loss
or variations in the timing of such orders can cause significant fluctuations
in the Customer's operating results. Anticipated orders from customers may
fail to materialize and delivery schedules may be deferred or canceled for a
number of reasons, including changes in specific customer requirements. The
volume and timing of orders received during a quarter are difficult to
forecast. Customers generally order on an as-needed basis. Consequently,
the Company operates with a relatively small backlog. Moreover, as is common
in the PC industry, a disproportionate percentage of the Company's net sales
in any quarter have historically been, and are expected in the future to be,
generated in the last month of a quarter. As a result, a shortfall in sales
in any quarter as compared to expectations may not be identifiable until near
the end of the quarter.
The Company's gross profit margins are affected by a number of factors,
including sales channel mix, product mix, pricing pressures, the availability
and cost of components from the Company's suppliers, level of absorption of
fixed manufacturing costs, product cycles and general economic conditions.
Moreover, the Company operates its own manufacturing facility. As a result, the
Company incurs relatively high fixed overhead and labor costs compared with
those of its competitors that outsource their manufacturing requirements. Any
failure to generate the level of product revenues needed to absorb such fixed
overhead and labor costs will have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, the
Company has experienced in the past and may experience in the future excess
demand for its products from its OEM customers and has elected in the past and
may elect in the future to pay its employees overtime and purchase components on
the spot market at prices higher than would have been available if the Company
had purchased such components in advance in order to meet its production
requirements. Such activities have resulted in the past and may result in the
future in lower gross margins for the additional products being manufactured.
The Company's markets are characterized by intense competition and its products
typically have a limited life cycle (usually six to nine months) and declining
average unit selling prices over time. Accordingly, the Company's margins may
decline from current levels with respect to its existing product lines. In
addition, the Company's margins may be materially adversely affected by
shortages in the availability of key components for the Company's products, as
well as by fluctations in the value of certain foreign currencies.
-15-
The Company's expenditures for research and development, selling and
marketing, and general and administrative functions are based in part on
future revenue projections. The Company may be unable to adjust spending in
a timely manner in response to any unanticipated declines in revenues. Any
failure to adjust spending in a timely manner may have a material adverse
effect on the Company's business, financial condition and results of
operations.
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 -
Selected Quarterly Operating Results and Seasonality."
As a result of the factors listed above and other factors, the Company
believes that period-to-period comparisons of its operating results must not
be relied upon as an indication of future performance. In particular, the
Company has recently experienced consistent growth in its annual unit sales
volumes and annual revenues and has reported nine consecutive quarters of
record net income. There can be no assurance that the Company's recent growth
in unit sales volumes, revenues or net income will be sustainable or will not
decline. It is likely that in some future period of the Company's operating
results or business outlook will be below the expectations of securities
analysts or investors, which would likely result in a significant reduction
in the market price for the Company's Common Stock.
DEPENDENCE ON SUPPLIERS
The Company has in the past obtained and expects in the future to obtain
several of the components used in its products from single or limited sources
and, in the instances in which component manufacturers have not or do not
allocate a sufficient supply of components to meet the Company's needs, the
Company has obtained in the past and may obtain in the future such 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 the Company's current
or future component requirements. From time to time, the Company has relied,
and in the future expects to rely, substantially upon a limited number of
sole source suppliers for multimedia controller chips, which can, in large
part, determine the performance of a multimedia subsystem.
In the event that the Company experiences difficulty obtaining a particular
multimedia controller chip, the Company could be forced to pay higher prices
for comparable multimedia controller chips, alter product designs to use
alternative and potentially inferior components, reduce its production of the
related product, or delay product shipment schedules. The Company believes
that with respect to its single and limited source components, it generally
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 and could
require product recertification from the Company's OEM customers) or reduce
its production of the related products; however, no assurance can be given
with respect to the availablility of alternative sources for single and
limited source components in future products.
The Company has from time to time experienced difficulty meeting certain
product shipment dates to customers as a result of various causes, including
component delivery delays, component availability shortages, system
compatibility difficulties and supplier product quality deficiencies, which
in some instances has resulted in impaired margins, reduced production
volumes, strained customer relations and loss of business. In addition,
software drivers, which are essential to the performance of substantially all
of the Company's products, are included with some of these single and limited
source components. The Company has from time to time experienced product
delivery delays due to the inadequacy or the incompatibility of software
drivers provided by component suppliers or developed internally by the
Company. The Company expects that component delivery delays, component
shortages, system compatibility difficulties, supplier product quality
deficiencies and software driver problems will continue to occur in the
future, and such delays or problems could have a material adverse effect on
the Company's business, financial condition and results of operations.
Additionally, in an effort to counter actual or perceived component
shortages, the Company may overpurchase certain components. Excess inventory
resulting from such overpurchases, obsolescence or a decline in the market
value of such inventory, could result in inventory write-offs, which would
have material adverse effect on the Company's business, financial condition
and results of operations.
- 16 -
Significant increases in the prices of components, such as controller chips
or memory chips, have occurred from time to time, and the Company has not
always been able to increase its products' prices accordingly. Worldwide
shortages of controller chips or memory chips and international tariff
disputes have resulted from time to time in substantial component cost
increases that have had a material adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance
that such price increases will not take place in the future, or that such
price increases will not have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company relies upon its suppliers to continue to develop, introduce and
manufacture controller chips, memory chips and other components in sufficient
volumes to satisfy the Company's requirements. These components must compare
favorably in terms of functionality, performance and price with competitive
offerings from other manufacturers, including competitors of the Company that
have internally developed computer chips or manufacturing expertise. Any
failure by the Company to continue to obtain components from its suppliers
that are competitive in terms of functionality, performance and price with
the components that are available to its competitors would have a material
adverse effect on the Company's business, financial condition and results of
operations.
CUSTOMER CONCENTRATION; DEPENDENCE ON PC MARKET
The Company's three largest OEM customers accounted for approximately 75% of
net sales during the first nine months of fiscal 1998, with Gateway,
Inc. ("Gateway"), Dell Computer Corporation ("Dell") and Compaq Computer
Corporation ("Compaq") accounting for approximately 39%, 32% and 4%,
respectively, of the Company's net sales for such period. The Company's
three largest OEM customers accounted for approximately 66% of net sales in
fiscal year 1997, with Gateway, Dell and Compaq accounting for approximately
35%, 20% and 11%, respectively, of the Company's net sales for such period.
Historically, Gateway has been the Company's largest customer, while Dell and
Compaq have become more significant customers in recent periods. The
Company's other significant customers have changed from period to period.
The Company has no long-term commitments or contracts with any of its
customers. Any reduction of business from Gateway, Dell or Compaq or the loss
of Gateway, Dell or Compaq as a major customer would have a material adverse
effect on the Company's business, financial condition and results of
operations. Due to their purchasing power, the Company's OEM customers are
able to exert significant pressure on the prices of the Company's products,
which could impair the Company's gross profit margins and have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, the Company believes that its future prospects will
largely depend from time to time upon the success of a limited number of key
component suppliers (currently, its graphics controller chip suppliers) and a
few major OEM customers (currently, Gateway, Dell and Compaq). Because a
limited number of major OEMs currently ship the majority of the PCs
products, the number of potential customers that the Company can target is
currently limited. There can be no assurance that the Company will be
successful in maintaining its existing relationships with its major OEM
customers or in securing additional major OEM customers and there can be no
assurance that the Company will be able to retain or increase the volume or
profitability of products currently manufactured by the Company for such
customers. Any failure by the Company to retain its existing OEM customers,
or establish profitable relationships with additional major OEM customers, or
to maintain and increase the volume and profitability of the products
manufactured for such customers would have material adverse effect on the
Company's business, financial condition and results of operations.
Substantially all of the Company's revenues are currently derived from
products sold for use in PCs, and the Company expects to continue to derive
substantially all of its revenues from the sales of products for use in PCs.
The PC market is characterized by rapidly changing technology, evolving
industry standards, frequent new product introductions and fierce price
competition, all of which contribute to short product life cycles and regular
reductions of average selling prices over the life of a specific product.
Although the PC market has grown substantially in recent years and continued
growth is currently forecasted, there can be no assurance that such growth
will continue. A reduction in sales of PCs, or a reduction in the growth
rate of such sales, would likely reduce demand for the Company's products.
Moreover, such changes in demand could be large and sudden. Since PC
manufacturers often build inventories during periods of anticipated growth,
they may be left with excess inventories if growth slows or if they have
incorrectly forecasted product transitions. In such cases, PC manufacturers
may abruptly suspend substantially all purchases of additional products from
suppliers, such as the Company, until the excess inventory has been absorbed.
- 17 -
Any reduction in demand for PCs generally, or for particular products that
incorporate the Company's multimedia subsystem or specialized technology
products, would have a material adverse effect on the Company's business,
financial condition and results of operations.
DEPENDENCE ON MULTIMEDIA ACCELERATION SUBSYSTEM MARKET; MIGRATION TO
MOTHERBOARDS
A substantial majority of the Company's net sales are derived from the
sale of multimedia accelerator subsystems. According to Jon Peddie
Associates, an independent industry research firm, approximately 69% of all
graphics controller chips manufactured in the twelve month period ended
September 30, 1997 were incorporated onto multimedia accelerator subsystems,
and approximately 31% were incorporated onto motherboards. Generally,
multimedia accelerator subsystems are used in higher-end PCs offering the
latest technology and performance features. However, as a given
functionality becomes technologically stable and widely accepted by PC users,
it typically migrates to the PC motherboard. The Company expects this trend
to continue with respect to the functionality provided by many of its current
products, notably, in the near term, with respect to its low-end multimedia
accelerator subsystems. In this regard, the MMX instruction set from Intel
Corporation ("Intel") and the expanded capabilities provided by the Direct X
Applications Programming Interfaces ("APIs") from Microsoft Corporation
("Microsoft") have increased the capability of its operating systems to
control display features that have traditionally been performed by multimedia
accelerator subsystems. In addition, single chip solutions currently are
available that provide 16-bit sound functionality for implementation directly
onto PC motherboards. As a result of this tendency of technology to migrate
to the PC motherboard, the Company's prospects are largely dependent on its
ability to continue to develop products that incorporate new and rapidly
evolving technologies that manufacturers have not yet fully incorporated onto
PC motherboards and to develop PC motherboard products that incorporate
multimedia accelerator subsystems and other features demanded by the PC
motherboard market. In response to this trend of migration, the Company is
now actively seeking orders from OEMs for PC motherboards that incorporate
STB's graphics circuitry, but there can be no assurance that the Company will
secure any such orders or that, if it secures any such orders, it could
produce such PC motherboards in profitable quantities, if at all. The
Company has no prior experience designing, developing or marketing PC
motherboards, and there can be no assurance that the Company will be
successful in developing this business.
While the Company believes that a market will continue to exist in the near
term for add-in subsystems that provide advanced functionalities and offer
flexible systems configuration, there can be no assurance that the
incorporation of multimedia functions onto PC motherboards will not have a
material adverse effect on the market for the Company's add-in subsystems.
In addition, OEMs may choose to develop multimedia accelerator subsystems
internally rather than purchase such products from external suppliers. An
increase in the number or percentage of PCs that incorporate graphics
circuitry on the motherboard at the expense of add-in multimedia accelerator
subsystems, an increase in the number or percentage of multimedia accelerator
subsystems manufactured internally by OEMs, or a decrease in PC sales volumes
could effectively shrink the market for the Company's current products, which
would have a material adverse effect on the Company's business, financial
condition and results of operations.
LIMITED PRODUCT LIFE CYCLE; RAPID TECHNOLOGICAL CHANGE; MANAGEMENT OF PRODUCT
TRANSITIONS
The market for the Company's products is characterized by short product life
cycles, evolving industry standards and frequent introductions of new
products. The Company's major OEM customers typically introduce new system
configurations as often as twice a year, and the life cycles of the Company's
multimedia accelerators subsystems typically range from six to nine months.
The Company's failure to successfully introduce new products within a given
product cycle could have a material adverse affect on the Company's business,
financial condition and results of operations for that cycle and possibly for
subsequent cycles. Any such failure could also impair the Company's brand
name, reputation and relationships with its OEM customers and have a longer
term material adverse effect on the Company's business, financial condition
and results of operations. The Company's submits most of its products for
compatibility and performance testing to the Microsoft Windows Hardware
Quality Lab ("WHQL"). WHQL certification typically requires up to several
weeks to complete and entitles the Company to claim that a particular product
is "Designed for Microsoft Windows". The Company's OEM customers typically
require the Company's product to be Designed for Microsoft Windows prior to
making volume purchases. There can be no assurance that the Company will
receive WHQL certification for any particular future product in a timely
fashion, and any failure to receive WHQL certification could have a material
adverse effect on the Company's business, financial condition and results of
operations.
- 18 -
The PC industry in general, and the market for the Company's multimedia
subsystem products in particular, is characterized by rapidly changing
technologies, evolving industry standards, rapid changes in customer
requirements and fierce price competition. The Company's prospects depend
upon market acceptance of its existing products, its ability to enhance its
existing products, and its ability to continually develop and introduce new
products and features to meet changing customer requirements. Each new
product cycle presents new opportunities for current or prospective
competitors of the Company to gain market share. The Company's competitors
include manufacturers of products that directly compete with the Company's
products, as well as competitors that can produce products that have a
similar functionality to the Company's products. For instance, Intel has
added new functionalities, such as the MMX instruction set, to its controller
chips to enhance the power of the central processing unit (the "CPU") to
manage the display features of a PC. Similarly, Microsoft is introducing new
versions of its operating systems with features, such as the Direct 3D API,
that increase the capability of its operating systems to control a PC's
display features. Moreover, Intel's recently completed acquisition of Chips
and Technologies, Inc. as well as Intel's introduction of the i740 graphics
controller chip could accelerate migration of graphics functionality to the
motherboard or onto the CPU. The introduction of products embodying new
technologies and the emergence of new industry standards and practices can
significantly impair the average selling prices of the Company's multimedia
subsystem and other products, or render such products unmarketable or
obsolete. In the event that the Company's products are unable to support or
interface with these new products, standards and technologies in a timely
manner, demand for the Company's products could be reduced significantly,
which would have a material adverse effect on the Company's business,
financial condition and results of operations.
Because of the short product life cycles and the long lead times for many
components used in the Company's products, the Company may not be able to
quickly reduce its production or inventory levels in response to unexpected
shortfalls in sales or, conversely, to increase production in response to
unexpected demand. 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 product
enhancements or the failure of such products or product enhancements to gain
market acceptance would have a material adverse effect on the Company's
business, financial condition and results of operations.
Sales of individual products and product lines are typically characterized by
declines in unit 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 has
experienced from time to time in the past, and expects to experience from
time to time in the future, unexpected reductions in sales of older products
as customers anticipate new products. These reductions have in the past and
may in the future give rise to additional charges for obsolete or excess
inventory, returns of older products by retailers or commercial distributors
or substantial price protection claims. The Company's failure to
successfully manage product transitions could have a material adverse effect
on its business, financial condition and results of operations.
COMPETITION
The market for the Company's products is intensely competitive and the
Company expects competition to increase. The Company competes with
independent manufacturers of brand name multimedia subsystem products, as
well as contract manufacturers and certain OEM manufacturing operations that
produce multimedia subsystem products. The Company's major competitors in
the multimedia subsystems market include Diamond Multimedia Systems, Inc.,
ATI Technologies, Inc., Matrox Graphics, Inc., ELSA GmbH, AccelGraphics,
Inc., Creative Labs, Inc., CEI Inc., Number Nine Visual Technology
Corporation, and Hauppauge ComputerWorks, Inc. In the specialized technology
product market, the Company's major competitors include Colorgraphic
Communications Corporation, Datapath Ltd, and Appian Graphics Corp. In
addition to its major competitors, certain of the Company's suppliers sell
graphics controller chips directly to OEMs for use in internally produced
multimedia accelerator subsystems, other multimedia subsystems or on
motherboards. If one or more of the Company's significant OEM customers were
to commence or increase internal production of multimedia accelerator
subsystems or other multimedia subsystems, the Company's business, financial
condition and results of operations could be materially adversely affected.
- 19 -
Furthermore, several major OEMs currently integrate graphics controller chips
on the motherboard of their PCs. If one or more of the Company's major OEM
customers begin to incorporate graphics controller chips or other controller
chips onto motherboards rather than incorporating the Company's products, the
Company's business, financial condition and results of operations could be
materially adversely affected. See "--Dependence on Multimedia Acceleration
Subsystem Market; Migration to Motherboards."
The Company expects Intel to continue to invest heavily in research and
development and new manufacturing facilities in order to maintain its
position as one of the largest manufacturers of motherboards, and to promote
its product offerings through extensive advertising campaigns designed to
increase brand loyalty by PC users. Intel is in the process of developing
multimedia subsystems or multimedia-enabled motherboards using its i740 3D
graphics processor, or other graphics controllers which is likely to directly
compete with products that the Company may develop. In addition, Intel
exerts significant influence over the 3D graphics industry due to the
widespread acceptance of its microprocessor architecture and its development
of new interface architectures such as the Advanced Graphics Port ("AGP")
bus. Any significant modifications by Intel to the AGP or future graphics
interface architectures could render the Company's products obsolete,
incompatible or less competitive.
Any broad-scale introduction of multimedia subsystems or multimedia-enabled
motherboards or significant modifications to the graphics interface bus by
Intel which the Company is unable to access, and which consequently render
the Company's products less competitive or reduces their potential market,
could have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company competes in its markets on the basis of a number of factors,
including the price, performance, reliability and compatibility of its
products, its ability to reach the market quickly with new products, its
ability to meet customer delivery and reliability requirements, the quality
of its technical support and its ability to develop and maintain
relationships with customers and suppliers. Many of the Company's
competitors and potential competitors have greater financial, marketing,
manufacturing and technical resources than the Company. In addition, some of
the Company's competitors manufacture their own controller chips, which
provide these competitors with a significant advantage over the Company when
their internally produced controller chips cost less or maintain higher
price/performance levels than the controller chips available to the Company
from independent suppliers. Furthermore, while the Company believes it is
the only supplier of brand name multimedia accelerator subsystems that
manufactures its own products, some of the Company's competitors internally
manufacture other multimedia subsystems, such as sound cards and PC/TV cards.
The rapid pace of change in the industry and in the markets in which the
Company competes places a premium on the knowledge and experience of a
company's management, engineers and other personnel, and their ability to
continuously develop, enhance and transition new products. The Company
believes that increasing its hardware and software engineering staff is an
important factor to its future competitiveness.
PRODUCT CONCENTRATION
Historically, a substantial majority of the Company's net sales have been
derived from sales of multimedia accelerator subsystems and, from time to
time, a substantial majority of the Company's net sales in a given fiscal
quarter have been derived from the sale of a single or a limited number of
multimedia accelerator subsystems. Factors that increase the probability of
a single or a limited number of products accounting for a substantial
majority of sales during a given fiscal quarter may include one or more of
the following factors: the development and timely introduction of new and
enhanced products by the Company that meet OEM design requirements and design
cycles and achieve wide market acceptance; the selection of key components
(such as multimedia controller chips) at the design stage that provide the
Company's products with distinct advantages compared with the key components
available to its competitors; the availability of key components (such as
multimedia controller chips) in sufficient quantities to meet production
schedules once the Company commences manufacturing its products; favorable
product reviews and other media coverage; the volume and timing of
significant customer orders received during the period; and product
obsolescence, maturation, or mismanagement of product transitions by the
Company's competitors. Because the market for the Company's products is
characterized by short product life cycles, evolving industry standards and
frequent introductions of new products, the Company's product offerings may
change significantly from quarter to quarter.
- 20 -
There can be no assurance that a product which was an industry leader and a
major source of revenue and gross profit in one fiscal quarter will not be
rendered less competitive or obsolete in a subsequent fiscal quarter.
Moreover, in any given quarter, one or more of the Company's competitors may
introduce an industry dominating product for one or more of the same factors
noted above. Accordingly, the Company's future prospects largely depend upon
its ability to continuously develop and introduce new products that generate
sufficient net sales to replace net sales from existing products as they
mature. Any inability to develop and introduce new products that compete
favorably in the marketplace and meet customer demand in future fiscal
periods will have a material adverse effect on the Company's business,
financial condition and results of operations.
SINGLE MANUFACTURING FACILITY
The Company's sole manufacturing facility is located in Juarez, Mexico. The
Company recently relocated a portion of its manufacturing operations to an
adjacent, larger building, thus expanding the overall facility square
footage, and transitioned to new or reconfigured manufacturing equipment.
Since the Company is substantially dependent on this single manufacturing
facility, any disruption of the Company's manufacturing operations at this
facility would have a material adverse effect on the Company's business,
financial condition and results of operations. Such disruption could result
from various factors, including difficulties in attracting and retaining
qualifed manufacturing employees, difficulties associated with the transition
to new, reconfigured or upgraded manufacturing equipment, 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 effect on the Company's business, financial condition
and results of operations.
MANAGEMENT OF GROWTH
The Company has recently experienced rapid growth and consequently has
increased its expenditures in a number of areas and made certain long-term
commitments (such as the expansion of production lines at its Juarez
manufacturing facility and the forthcoming relocation of its corporate
headquarters to a larger facility in Richardson, Texas), a number of which
would be difficult to reduce quickly in the event of a reduction in the rate
of growth or a decrease in the Company's business. In the event that the
Company experiences further growth, such growth will place additional strain
on the Company's management and operations, including its sales, customer
support, research and development, and finance and administrative operations
and require larger quantities of components, additional personnel and
manufacturing equipment and improved operating, financial and adminsitrative
controls, any of which could require significant additional capital
expenditures. The Company may experience difficulty securing adequate
quantities of components or additional manufacturing equipment, attracting or
retaining skilled personnel, improving infrastructure and management
information systems or overcoming other difficulties associated with growth.
In addition, gross profit margins derived from initial orders with new OEM
customers are frequently lower than the Company's typical gross profit
margins, which could reduce the Company's overall gross profit margin. There
can be no asssurance that the Company will be able to manage future changes
in the size of its business successfully or that difficulties in doing so
will not have a material adverse effect on the Company's business, financial
condition and results of operations.
CHANGE IN PRODUCT OR SALES CHANNEL MIX
The Company offers two broad categories of products: multimedia subsystems
that are primarily sold to major OEMs and, to a lesser degree, to commercial
customers, and specialized technology products that are primarily sold to
resellers, the workstation groups of OEMs and corporate customers in certain
industries. Sales of multimedia accelerator subsystems to OEMs, which
currently account for a substantial majority of the Company's net sales of
OEM multimedia subsystems, are characterized by relatively high unit volumes
and relatively low gross profit margins. Sales of the Company's multimedia
subsystems to the commercial market are characterized by relatively modest
volumes and moderate gross profit margins. Sales of the Company's
specialized technology products are characterized by relatively low unit
volumes and relatively high gross profit margins. Shifts in the mix of
products sold or in the sales channels into which such products are sold
could have a material adverse effect on the Company's business, financial
condition and results of operations.
- 21 -
In particular, a decrease in sales of multimedia subsystems to the commercial
market or in sales of specialized technology products could result in a
disproportionately greater decrease in the Company's gross profit margin
because sales of multimedia subsystems in the commercial market and sales of
specialized technology products currently have higher gross profit margins
than sales of multimedia subsystem products to the Company's OEM customers.
On the other hand, any decrease in the volume of multimedia subsystems sold
to the Company's OEM customers would significantly reduce total net sales,
which would also have a material adverse effect on the Company's business,
financial condition and results of operations. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Overview."
ENTRY INTO NEW PRODUCT MARKETS
While the Company's business historically has focused primarily on the
design, manufacture and sale of multimedia accelerator subsystems, the
Company commenced commercial shipments of its DVD decoder subsystems in the
1997 third fiscal quarter and its flat panel display products in the 1998
first fiscal quarter. Further, as a substantial number of PCs incorporate
graphics circuitry on the motherboard (particularly in lower cost PCs), the
Company is now actively soliciting orders for such motherboards from OEMs
and, in the event that the Company secures any orders, the Company plans to
undertake the design, manufacture and sales of motherboards incorporating the
Company's multimedia accelerator subsystem capabilities. 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 of encountering technical
problems and a greater likelihood that the Company's new products (or the PCs
into which they are incorporated) will not gain market acceptance. In
addition, a new product line, like the Company's line of flat panel display
products, requires significant investment in long-lead time inventories as
well as certain manufacturing equipment. The failure of one or more of such
products, or any adverse effect such new products may have upon the Company's
reputation in its core multimedia accelerator subsystem business as a result
of such failure, could have a material adverse effect on the Company's
business, financial condition and results of operations.
PROPRIETARY TECHNOLOGY; INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS
The Company's success depends in part upon its proprietary technology,
including, in particular, its software drivers and utilities and its hardware
designs. The Company primarily relies upon copyright and trade secret laws
and agreements with its suppliers and customers to protect its proprietary
technology, and occasionally seeks patent protection on selected inventions.
The Company generally also enters into non-disclosure agreements with persons
to whom it reveals its proprietary information, such as OEMs that the Company
works with, concerning future products. 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 in the past and may in the future find it necessary or
desirable to procure licenses from third parties relating to current or
future products or technologies; however, 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 or customers 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 to
obtain such licenses on competitive terms could have a material adverse
effect on the Company's business, financial condition and results of
operations.
It is common in the PC 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. Several OEM customers recently
sent the Company notices of potential indemnity claims based upon a notice of
infringement of his patent. Subsequently, the patent owner filed patent
infringement lawsuits in the U.S. and elsewhere against several of such OEM
customers and a number of other major PC systems manufacturers.
- 22 -
The Company provides multimedia subsystems to its OEM customers for use in
such OEM customers' products that are alleged to infringe on the patent
owner's rights. Based upon the Company's preliminary evaluation of the
patent, it does not believe the infringement claims are meritorious as to its
products sold to its customer. However, pursuant to such indemnity
agreements or in the event, the Company is directly sued, the Company may be
required to dedicate significant management time and expense to defending
itself or assisting its OEM customers in their defense of this or other
infringement claims, whether meritorious or not, which could have material
adverse effect on the Company's business, financial condition and results of
operations. If this or another intellectual property claim were to be
brought against the Company, or one or more of its OEM customers, and the
Company, or one or more of its OEM customers, were 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 have a material adverse effect on the Company's business,
financial condition and results of operations. If an intellectual property
claim were to be brought against one or more of the Company's suppliers and
the supplier were 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 have a material adverse effect on the Company's
business, financial condition and results of operations.
DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL
The Company's prospects depend largely upon the services of its management,
sales, marketing and engineering personnel. While the Company has entered
into employment agreements with a number of its officers and key personnel,
the loss of the services of one or more of such personnel could have a
material adverse effect on the Company's business, financial condition and
results of operations. The prospects of the Company also depend 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 skilled personnel in the
PC industry (and, in particular, multimedia hardware and software engineers),
and the failure to retain key personnel or to attract additional personnel to
satisfy the Company's needs could have a material adverse effect on the
Company's business, financial condition and results of operations.
POTENTIAL FUTURE ACQUISITIONS
The Company has in the past pursued, and may in the future pursue,
acquisitions of product lines, technologies or businesses. Future
acquisitions by the Company may result in the use of significant amounts of
cash, potentially dilutive issuances of equity securities, incurrence of debt
and amortization expenses related to goodwill and other intangible assets,
each of which could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, acquisitions
involve numerous risks, including difficulties in the assimilation of the
operations, technologies and products acquired, the diversion of management's
attention from other business concerns, the risks of entering markets in
which the Company has limited or no prior experience, and the potential loss
of key employees. There are currently no negotiations, commitments or
agreements with respect to any acquisition. In the event that an acquisition
does occur, such acquisition may have a material adverse effect on the
Company's business, financial condition and results of operations.
INTERNATIONAL OPERATIONS
Substantially all of the Company's manufacturing operations are carried out
in Juarez, Mexico. The Company's export sales (which primarily consist of
European sales) were approximately 26% and 27% of net sales in the first nine
months of fiscal 1998 and fiscal year 1997, respectively. 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, tarriffs and other barriers and the restrictions and
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 to date the Company has not
experienced any material adverse effects on its business, financial condition
or results of operations as a result of such factors, there can be no
assurance that such factors will not have such effects in the future, or
require the Company to modify its business practices.
- 23 -
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. Any decrease in the value of the U.S. dollar relative to the
Mexican peso would increase the Company's manufacturing costs, which could
have a material effect on the Company's business, financial condition and
results of operations.
PRICE PROTECTION AND STOCK ROTATION RISKS
As is common practice in its industry, the Company's arrangements with its
commercial customers generally allow such 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 equal
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's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Overview."
ENVIRONMENTAL REGULATIONS
The Company is subject to a variety of local, state, federal and foreign
governmental regulations relating to the storage, discharge, handling,
emission, generation, manufacture and disposal of toxic or other hazardous
substances used to manufacture the Company's products. The failure to comply
with current or future regulations could result in the imposition of
substantial fines on the Company, suspension of production, alteration of its
manufacturing processes or cessation of operations and have a material effect
on the Company's business, financial condition and results of operations.
POTENTIAL LIABILITY CLAIMS
The Company's purchase agreements with its major OEM customers typically
contain provisions that require the Company to indemnify the OEM customer and
any end-users for potential product liability claims. Although the Company
has not experienced product liability claims to date, there can be no
assurance that the Company will not become subject to such claims in the
future. A successful product liability claim against the Company could have
a material adverse effect on its business, financial condition and results of
operations.
HEADQUARTERS RELOCATION
The Company recently commenced construction of a new 210,000 square foot
headquarters facility near its current location in Richardson, Texas and it
is anticipated that this facility will be completed by December 1998. In
connection with the transition to its new headquarter, the Company may
experience interruptions in certain aspects of its operations, including but
not limited to, those relating to its various engineering, sales and
administrative functions. There can be no assurance that any such
interruptions, or other consequences arising out of the Company's transition
to its new headquarters, will not have a material adverse effect on the
Company's business, financial condition or results of operations. In
addition, pursuant to the terms of its new headquarters lease, the Company
will incur additional occupancy expense. Moreover, the Company will bear the
economic risk upon the sale of such facility. If this facility is sold for
less than the amount of the underlying debt on the facility then oustanding,
the Company would be required to cover any shortfall, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital
Resources."
- 24 -
YEAR 2000 COMPLIANCE
The Company uses a significant number of computer software programs and
operating systems in its internal operations, including applications used in
financial business systems and various administration functions, and also
includes software programs in its products. To the extent that these
software applications contain code that is unable to appropriately interpret
the upcoming calendar year 2000, some level of modification or possible
replacement of such source code or applications will be necessary. The
Company is still analyzing its software applications and, to the extent they
are not fully year 2000 compliant, the costs necessary to update software or
potential systems interruptions may have a material adverse effect on the
Company's business, financial condition and results of operations.
Furthermore, there can be no assurance that the Company's customers and
suppliers are or will be year 2000 compliant. The failure of the Company's
customers and suppliers to achieve year 2000 compliance could have a material
adverse effect on the Company's business, financial condition and results of
operations.
NO INTENTION TO PAY DIVIDENDS
Since the Company's initial public offering in February 1995, it has not
declared or paid any cash dividends on its Common Stock or other securities,
and does not anticipate paying any cash dividends in the foreseeable future.
The Company intends to retain any earnings for use in its business. The
decision to pay dividends in the future will be at the discretion of the
Board of Directors and will depend, among other things, upon future earnings,
operations, capital requirements, restrictions in financing agreements, the
general financial condition of the Company and general business conditions.
The Company's existing revolving credit facility prohibits the Company from
paying cash dividends.
NEED FOR ADDITIONAL CAPITAL
The Company requires substantial working capital to fund its business,
particularly to finance its inventory and accounts receivable and for capital
expenditures. The Company's future capital requirements will depend on many
factors, including the rate of revenue growth, if any; the Company's
financial condition; any need to expand the Company's manufacturing capacity;
the timing and extent of spending to support research and development
programs; the expansion of selling and marketing and administrative
activities; the timing of new product introductions and product enhancements;
and the level of market acceptance of the Company's products. The Company
expects that it may need to raise additional equity or debt financing in the
future. There can be no assurance that additional equity or debt financing,
if required, will be available on acceptable terms or at all. If the Company
is unable to obtain such additional capital, the Company may be required to
reduce the scope of its planned product development, manufacturing expansion
or selling and marketing activities, which would have a material adverse
effect on the Company's business, financial condition and results of
operations. In the event that the Company does raise additional equity
financing, the Company's existing shareholders could experience substantial
dilution. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Liquidity and Capital Resources."
ANTI-TAKEOVER MEASURES
The Company is a Texas corporation and is therefore subject to the provisions
of the Texas Business Corporation Act, including the terms of the Texas
Business Combination Law ("TBCL") that became effective on September 1, 1997.
In general, the OBCL prohibits a Texas "issuing public corporation" (such as
the Company) from engaging in a "business combination" with any shareholder
who is a beneficial owner of 20% or more of the corporation's outstanding
stock for a period of three years after such shareholder's acquisition of a
20% ownership interest, unless: (i) the board of directors of the
corporation approves the transaction or the shareholder's acquisition of
shares prior to the acquisition or (ii) two-thirds of the unaffiliated
shareholders of the corporation approve the transaction at a shareholders'
meeting. The TBCL may have the effect of inhibiting a non-negotiated merger
or other business combination involving the Company. The Company is subject
to the terms of the TBCL, unless its shareholders or directors take action
electing not to be governed by its terms (which action is not currently
contemplated). The Company is also a party to certain agreements that could
be deemed to have an anti-takeover effect.
- 25 -
The Company's Board of Directors has the authority to issue up to 2,000,000
shares of preferred stock in one or more series and to determine the price,
rights, preferences and privileges of those shares without any further vote
or action by the Company's shareholders. The rights of the holders of Common
Stock of the Company are subject to, and may be adversely affected by, the
rights of the holders of any shares of preferred stock which may be issued in
the future. While the Company has no present intention to issue shares of
preferred stock, such issuance, while providing desirable flexibility in
connection with possible acquistions and other corporate purposes, could have
the effect of making it more difficult for a third party to acquire a
majority of the outstanding voting stock of the Company. In addition, such
preferred stock may have other rights, including economic rights senior to
the Common Stock, and as a result the issuance thereof could have a material
adverse effect on the market value of such Common Stock.
STOCK PRICE VOLATILITY
The trading price of the Company's Common Stock has in the past and may in
the future be subject to wide fluctuations in response to factors such as
actual or anticipated variations in the Company's operating results;
announcements of technological innovations by the Company or its competitors;
new products, contracts or OEM design wins by the Company or its competitors;
developments with respect to patents, copyrights or proprietary rights;
changes in recommendations or financial estimates by securities analysts;
conditions and trends in the PC and technology industries; adoption of new
accounting standards affecting the Company's industry; general market
conditions and other factors. Further, the stock market has experienced in
recent months and may continue in the future to experience extreme price and
volume fluctuations that particularly affect the market prices or equity
securities of high technology companies and that often are unrelated or
disproportionate to the operating performance of such companies. These broad
market fluctuations, as well as general economic, policitcal and market
conditions, may adversely affect the market price of the Company's Common
Stock. In the past, following periods of volatility in the market price of a
company's stock, securities class action litigation has often been instituted
against the issuing company. There can be no assurance that such litigation
will not occur in the future with respect to the Company. Such litigation
could result in substantial costs and would at a minimum divert management's
attention and resources, which could have a material adverse effect on the
Company's business, financial condition and results of operations. Any
adverse determination in such litigation could also subject the Company to
significant liabilities.
SHARES ELIGIBLE FOR FUTURE SALE
The executive officers and directors and the Founding Shareholders of the
Company, who beneficially own a substantial portion of the outstanding shares
of Common Stock, are free to sell the shares beneficially owned by them,
subject to compliance with the Securities Act of 1933, as amended (the
"Securities Act"), including Rule 144 promulgated thereunder, and the terms
of a Right of First Refusal Agreement, to which certain of such shares are
subject. A large portion of the shares held by such beneficial owners may be
sold into the public market effectively free of significant restrictions. No
prediction can be made as to the effect, if any, that market sales of the
above shares or the availability of such shares for future sales will have on
the market price of shares of Common Stock prevailing from time to time.
Future sales of substantial amounts of Common Stock by existing shareholders
could adversely affect the prevailing market price of the Common Stock and
the Company's ability to raise additional capital.
- 26 -
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT NUMBER
--------------
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 July 31, 1998.
- 27 -
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: September 14, 1998 By: /s/ William E. Ogle
------------------------------------
President and Chief Executive Officer
Dated September 14, 1998 By: /s/ Bryan F. Keyes
------------------------------------
Bryan F. Keyes, Vice President of
Administration and General Counsel
- 28 -