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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September 30, 1998
Commission File Number 0-25520
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THRUSTMASTER, INC.
(Exact name of registrant as specified in its charter)
OREGON 93-1040330
(State or jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
7175 N.W. EVERGREEN PARKWAY #400
HILLSBORO, OREGON, 97124-5839
(Address of principal executive offices)
(Zip Code)
(503) 615-3200
(Registrant's telephone number)
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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 issuer's classes of
common stock, as of the latest practical date.
Common stock, no par value 4,399,495 shares
(Class) (Outstanding at October 31, 1998)
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THRUSTMASTER, INC.
Index to Form 10-Q
PART I - FINANCIAL INFORMATION Page No.
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Item 1. Financial Statements
Consolidated Condensed Balance Sheets . . . . . . . . . . . . 2
Consolidated Condensed Statements of Operations . . . . . . . 3
Consolidated Condensed Statements of Cash Flows . . . . . . . 4
Consolidated Condensed Statements of Changes in
Shareholders' Equity. . . . . . . . . . . . . . . . . . . . 5
Notes to Consolidated Condensed Financial Statements. . . . . 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . 8
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
THRUSTMASTER, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands)
September 30, December 31,
1998 1997
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(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 61 $ 449
Accounts receivable, net 5,042 16,604
Inventories 6,103 6,974
Prepaid expenses and other 359 294
Deferred income taxes 4,720 409
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Total current assets 16,285 24,730
Plant and equipment, net 2,440 2,119
Other 28 28
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Total assets $18,753 $26,877
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------- -------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Note payable $ 1,055 $ 1,110
Accounts payable 3,093 2,919
Accrued liabilities 2,076 3,504
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Total current liabilities 6,224 7,533
Deferred income taxes 103 64
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Total liabilities 6,327 7,597
Shareholders' equity:
Preferred stock - -
Common stock 13,984 13,486
Retained earnings (accumulated deficit) (1,558) 5,794
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Total shareholders' equity 12,426 19,280
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Total liabilities and shareholders' equity $18,753 $26,877
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The accompanying notes are an integral part of these consolidated condensed
financial statements.
2
THRUSTMASTER, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
1998 1997 1998 1997
------- ------- ------- -------
Revenues $ 4,167 $10,509 $14,585 $23,930
Cost of goods sold 5,369 6,548 14,216 14,814
------- ------- ------- -------
Gross margin (1,202) 3,961 369 9,116
Operating expenses:
Research and engineering 508 603 2,028 1,807
Selling, general and administrative 3,339 2,201 9,709 5,349
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Total operating expenses 3,847 2,804 11,737 7,156
Income (loss) from operations (5,049) 1,157 (11,368) 1,960
Interest income - 105 57 284
------- ------- ------- -------
Income (loss) before income taxes (5,049) 1,262 (11,311) 2,244
Income tax provision (benefit) (1,767) 426 (3,959) 790
------- ------- ------- -------
Net income (loss) $(3,282) $ 836 $(7,352) $ 1,454
------- ------- ------- -------
------- ------- ------- -------
Net income (loss) per share:
Basic $ (0.75) $ 0.20 $ (1.69) $ 0.34
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------- ------- ------- -------
Diluted $ (0.75) $ 0.18 $ (1.69) $ 0.31
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------- ------- ------- -------
Weighted average shares outstanding:
Basic 4,385 4,276 4,353 4,255
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------- ------- ------- -------
Diluted 4,385 4,723 4,353 4,620
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------- ------- ------- -------
The accompanying notes are an integral part of these consolidated condensed
financial statements.
3
THRUSTMASTER, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended
September 30,
---------------------
1998 1997
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Cash flows from operating activities:
Net income (loss) $(7,352) $ 1,454
Adjustments to reconcile net income (loss) to cash
provided by (used in) operating activities:
Depreciation 1,122 403
Deferred income taxes (4,272) (25)
Changes in assets and liabilities:
Accounts receivable 11,562 185
Inventories 871 (1,740)
Prepaid expenses and other assets (65) (245)
Payables and accrued liabilities (1,254) 74
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Net cash provided by operating activities 612 106
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Cash flows from investing activities:
Purchase of plant and equipment (1,443) (1,200)
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Cash flows from financing activities:
Payment of long-term debt (55) (9)
Proceeds from issuance of common stock 175 59
Tax benefit for stock options exercised 323 -
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Net cash provided by (used in) financing activities 443 50
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Net increase (decrease) in cash
and cash equivalents (388) (1,044)
Cash and cash equivalents, beginning of period 449 6,420
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Cash and cash equivalents, end of period $ 61 $ 5,376
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The accompanying notes are an integral part of these consolidated condensed
financial statements.
4
THRUSTMASTER, INC.
CONSOLIDATED CONDENSED STATEMENTS
OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands)
(Unaudited)
Common Stock
------------------- Retained
Shares Amount Earnings
------- ------- --------
Balance, January 1, 1998 4,294 $13,486 $ 5,794
Stock options exercised 91 175 -
Tax benefits from stock options exercised - 323 -
Net loss - - (7,352)
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Balance, September 30, 1998 4,385 $13,984 $(1,558)
----- ------- -------
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The accompanying notes are an integral part of these consolidated condensed
financial statements.
5
THRUSTMASTER, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(In thousands, except per share data)
NOTE 1 -- Basis of Presentation
The accompanying consolidated condensed financial statements include the
accounts of ThrustMaster, Inc., and its wholly-owned subsidiaries,
Thrustmaster Europe Limited, and its wholly owned subsidiary Thrustmaster
(Deutschland) GMBH, and have been prepared by the Company without audit and
in conformity with generally accepted accounting principles for interim
financial information pursuant to rules and regulations of the Securities and
Exchange Commission. In the opinion of management, the unaudited
consolidated condensed financial statements include all necessary adjustments
(which are of a normal and recurring nature) for the fair presentation of the
results of the interim periods presented. These consolidated condensed
financial statements should be read in conjunction with the Company's audited
financial statements and notes thereto included in the Company's annual
report on Form 10-K for the year ended December 31, 1997. The results of
operations for the periods presented are not necessarily indicative of the
results that may be expected for the entire fiscal year.
NOTE 2 -- Inventories
Inventories are stated at the lower of cost (first-in, first-out) or
market. Inventories are as follows (in thousands):
September 30, December 31,
1998 1997
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Raw materials $1,043 $1,062
Work in progress 41 49
Finished goods 5,019 5,863
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$6,103 $6,974
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NOTE 3 -- Impact of Recently Issued Accounting Standards
On January 1, 1998, the Company adopted Financial Accounting Standards
Board ("FASB") Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130"), which establishes requirements for
disclosure of comprehensive income. The objective of SFAS 130 is to report a
measure of all changes in equity that result from transactions and economic
events other than transactions with owners. Comprehensive income is the total
of net income and all other non-owner changes in equity. Comprehensive income
did not differ materially from reported net income in the periods presented.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related information" ("SFAS 131"). This statement will change
the way public
6
companies report information about segments of their business in their annual
financial statements and requires them to report selected segment information
in their quarterly reports issued to shareholders. It also requires
entity-wide disclosures about the products and services an entity provides,
the material countries in which it holds assets and earns revenues and its
major customers. This statement is effective for fiscal years beginning
after December 15, 1997, but is not required to be presented in interim
financial information in the year of adoption. The Company's management has
studied the implications of SFAS 131 and based on the initial evaluation,
expects the adoption to have no material impact on the Company's financial
condition or results of operations, but will require revised disclosures when
the respective statements become effective.
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The discussion and analysis below contains trend analysis and other
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual
results could differ materially from those projected in the forward-looking
statements as a result of risk factors set forth under "Certain Factors That May
Affect Future Performance" below and elsewhere in this report.
The following discussion should be read in conjunction with the Company's
consolidated condensed financial statements and the notes thereto.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
of revenues represented by certain items included in the Company's Consolidated
Condensed Statements of Operations:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- -----------------------
1998 1997 1998 1997
------- ------- ------- -------
Revenues 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 128.9 62.3 97.5 61.9
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Gross margin (28.9) 37.7 2.5 38.1
Operating expenses:
Research and engineering 12.2 5.7 13.9 7.5
Selling, general and administrative 80.1 21.0 66.5 22.4
------ ------ ------ ------
Total operating expenses 92.3 26.7 80.4 29.9
------ ------ ------ ------
Income (loss) from operations (121.2) 11.0 (77.9) 8.2
Interest income - 1.0 0.3 1.2
------ ------ ------ ------
Income (loss) before income taxes (121.2) 12.0 (77.6) 9.4
Income tax provision (benefit) (42.4) 4.0 (27.2) 3.3
------ ------ ------ ------
Net income (loss) (78.8)% 8.0% (50.4)% 6.1%
------ ------ ------ ------
------ ------ ------ ------
REVENUES
Revenues for the three months ended September 30, 1998 were $4,167,000, a
decrease of $6,342,000, or 60.4%, compared to $10,509,000 for the three months
ended September 30, 1997 while revenues for the nine months of 1998 were
$14,585,000, a decrease of $9,345,000, or 39.1%, compared to $23,930,000 from
the corresponding prior year period. Revenues declined primarily as
8
a result of an extreme seasonal slowdown resulting in retail distribution
channel customers selling existing inventory that was acquired in earlier
periods and not replenishing such inventory. Further, the decline was
impacted by significant delays in new product introductions and strong
competitive pricing pressures.
GROSS MARGIN
The Company continued to experience higher than normal returns and
related selling costs due to competitive pressures causing a significant
decrease in gross margin for the quarter and nine months ended September 30,
1998 compared to the same periods of the prior year. Gross margin for the
three months ended September 30, 1998 was a negative $1,202,000, a decrease
of $5,163,000, or (130.4%), compared to $3,961,000 for the three months ended
September 30, 1997 while the gross margin for the nine months ended September
30, 1998 was $369,000, a decrease of $8,747,000, or 96.0%, compared to
$9,116,000 for the nine months ended September 30, 1997. As a percentage of
revenues, gross margin was (28.9%) and 2.5% for the three and nine months
ended September 30, 1998, respectively, and 37.7% and 38.1% for the three and
nine months ended September 30, 1997, respectively. Gross margin decreased
primarily due to: a continuation of higher than normal returns as a result of
retail customers returning excess inventory and general end-user product
installation challenges in a Windows environment; price protection credits
granted to customers as a result of sales price decreases; inventory
write-down charges to record inventory at lower-of-cost or market value; and
competitive pricing pressures. Further, the gross margin was adversely
affected by significantly lower shipment volume levels during the three
months and nine months ended September 30, 1998 over which indirect
manufacturing costs could be absorbed.
RESEARCH AND ENGINEERING
Research and engineering expenses were $508,000 for the quarter ended
September 30, 1998, a decrease of $95,000, or 15.8%, compared to $603,000 for
the quarter ended September 30, 1997. Research and engineering expenses were
$2,028,000 for the nine months ended September 30, 1998, an increase of
$221,000, or 12.2%, compared to $1,807,000 for the nine months ended
September 30, 1997. This decrease was a result of a reduction in personnel
in the second quarter of 1998. The increase for the nine month period was due
primarily to higher personnel-related expenses and, to a lesser extent, the
material and outside service costs associated with an increase in new product
development activity. As a percentage of revenues, research and engineering
expenses were 12.2% and 13.9% for the quarter and nine months ended September
30, 1998, respectively, compared to 5.7% and 7.5% for the quarter and nine
months ended September 30, 1997, respectively. The increases in research and
engineering expenses as a percentage of revenues resulted primarily from the
large decline in revenues and, to a lesser extent, an increase in product
development activity.
SELLING, GENERAL, AND ADMINISTRATIVE
Selling, general and administrative expenses were $3,339,000 for the
three months ended September 30, 1998, an increase of $1,138,000, or 51.7%,
compared to $2,201,000 for the quarter ended September 30, 1997. For the
nine months ended September 30, 1998, selling, general and administrative
expenses were $9,709,000, an increase of $4,360,000, or 81.5%, compared to
$5,349,000 for the nine months ended September 30, 1997. The increases were
primarily due to higher costs related to sales incentive and promotion
programs including higher advertising, marketing, and personnel-related
expenses associated with increased sales efforts.
9
As a percentage of revenues, selling, general and administrative expenses
increased to 80.1% and 66.5% for the quarter and nine months ended September 30,
1998, respectively, compared to 21.0% and 22.4% for the quarter and nine months
ended September 30, 1997, respectively. The expense increase, as a percentage
of revenues, resulted primarily from the significant decline in revenues in the
third quarter and first nine months of 1998, and from an increase in sales and
marketing costs associated primarily with greater sales incentive program costs,
increased marketing development costs, and increased advertising.
INTEREST INCOME
Interest income was derived from the investment of the cash balances of
the Company. Interest income for the three and nine month periods ended
September 30, 1998 was $0 and $57,000, respectively. This compares with
$105,000 and $284,000 for the same periods in 1997, respectively. The
decreases were primarily due to lower investment balances in the current year
compared to those of the same periods a year ago.
PROVISION (BENEFIT) FOR INCOME TAXES
The provision for income taxes for the three-month period ended
September 30, 1998, reflects an effective tax rate of 35.0%. This compares
to a tax rate of 33.8% for the three-month period ended September 30, 1997.
The deferred income tax asset of $4.7 million primarily consists of a net
operating loss tax benefit of approximately $4 million, of which approximately
$3 million results from a carry back to years ended December 31, 1996 and
December 31, 1997. The remaining tax benefit net operating loss of
approximately $1 million will be carried forward to future years and will
expire in 2018.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its activities to date with a combination of
cash flow from operations, borrowed funds, and proceeds from the sale of
equity securities.
The Company has a line of credit pursuant to which it may borrow up to
the lesser of $4,000,000 or 70% of eligible receivables and is collateralized
by substantially all the Company's assets. The line of credit requires the
Company to maintain certain working capital and debt-to-equity ratios. At
September 30, 1998, $1,055,000 was outstanding under the facility and the
Company was in compliance with all loan covenants. In addition, on October
12, 1998 the Company entered into a new $16,000,000 credit facility which
allows the Company to borrow the lesser of $16,000,000 or 65% of eligible
receivables and 50% of eligible inventory (subject to an inventory sub-limit
of $2,500,000).
Net cash provided by operating activities was $612,000 for the nine
months ended September 30, 1998. The primary sources of cash were decreases
in accounts receivable and inventory of $11,562,000 and $871,000,
respectively. These sources of cash were largely offset by a net loss of
$7,352,000, an increase in prepaid expenses and other assets of $65,000 and a
decrease in payables and accrued liabilities of $1,253,000. This compares to
net cash provided by operating activities of $106,000 for the nine months
ended September 30, 1997.
10
Capital expenditures for the nine-month period ended September 30, 1998
were $1,443,000 compared to $1,200,000 for the same period in the prior year.
These expenditures were primarily for new product tooling.
The Company believes that available funds together with borrowings from
its new credit facility will be adequate to meet the Company's anticipated
cash needs during the immediate term. There can be no assurance that
additional capital beyond the amounts currently forecasted by the Company
will not be required nor that any such required additional capital will be
available on reasonable terms, if at all, at such time or times as required
by the Company.
YEAR 2000 COMPLIANCE
Many existing computer systems and applications, and other control
devices, use only two digits to identify a year in the date field, without
considering the impact of the upcoming change in the century. As a result,
such systems and applications could fail or create erroneous results unless
corrected so that they can process data related to the year 2000. The Company
relies on its systems, applications and devices in operating and monitoring
all major aspects of its business, including financial systems (such as
general ledger, accounts payable and payroll modules), customer services,
infrastructure, embedded computer chips, networks and telecommunications
equipment and end products. The Company also relies, directly and indirectly,
on external systems of business enterprises such as customers, suppliers,
creditors, financial organizations, and of governmental entities, both
domestic and international, for accurate exchange of data. The Company's
current estimate is that the costs associated with the year 2000 issue, and
the consequences of incomplete or untimely resolution of the year 2000 issue,
will not have a material adverse effect on the result of operations or
financial position of the Company in any given year. The Company is currently
engaged in a project to upgrade the computer hardware and software it uses to
operate, monitor and manage its business on a day to day basis. The vendors
have indicated that their products accurately accommodate dates beyond the
year 1999. The Company is testing such capabilities as part of its
implementation process. However, despite the Company's efforts to address the
year 2000 impact on its internal systems, the Company has not fully
identified such impact or whether it can resolve it without disruption of its
business and without incurring significant expense. In addition, even if the
internal systems of the Company are not materially affected by the year 2000
issue, the Company could be affected through disruption in the operation of
the enterprises with which the Company interacts.
11
CERTAIN FACTORS THAT MAY AFFECT FUTURE PERFORMANCE
In addition to other information in this Form 10-Q, the following are
important factors that should be considered carefully in evaluating the
Company and its business.
POTENTIAL FLUCTUATIONS IN FUTURE OPERATING RESULTS
The Company's future operating results may vary significantly from
period to period as a result of a number of factors. The Company's revenue
in a given period depends on the volume and timing of orders received during
the period, the timing of new product introductions by the Company and its
competitors, product line maturation, the impact of price competition on the
Company's average selling prices, the availability of components for the
Company's products, changes in product or distribution channel mix, the level
of inventory carried by the Company's distribution and retail channel
customers, and product returns and price protection charges from customers.
For example, the Company's operating results in the third quarter of 1998
were impacted by lower than normal distribution channel inventories and
higher than normal product returns.
The Company's gross margins are also impacted by short product life
cycles, the mix of products sold, the mix of distribution channels,
competitive price pressures, the availability and cost of components from the
Company's suppliers, component price inflation or deflation, end-of-life
inventory write downs and general economic conditions. Individual product
lines generally provide higher margins at the beginning of the typical
twelve-to-eighteen-month product life cycle, and lower margins as the product
line matures. Moreover, if a product's life should end prior to
expectations, then there is also a risk of unexpected channel inventory
returns and end-of-life and obsolete inventory and tooling charges, which
could depress the Company's revenue and gross margin in the affected period.
Many of these factors are beyond the Company's control. There can be no
assurance that lower unit prices or volumes will not affect the Company's
operating results in the future. In addition, due to the short product life
cycles that characterize the Companies' markets, the Company's failure to
successfully introduce competitive products in a timely manner would
adversely affect operating results for one or more product cycles.
Due to the foregoing factors, it is always possible that the operating
results of the Company for some future quarter or quarters will fall below
the expectations of securities analysts and investors. In such an event, the
trading price of the Company's Common Stock could be materially and adversely
affected.
REVENUE VOLATILITY AND DEPENDENCE ON ORDERS RECEIVED AND SHIPPED IN A QUARTER
The volume and timing of orders received during a quarter are difficult
to forecast. Customers generally order on an as-needed basis and,
accordingly, the Company has historically operated with a relatively small
backlog. Moreover, the Company has strived to respond quickly to customer
orders as part of its competitive strategy. This strategy, combined with
current industry supply-demand conditions and emphasis on just-in-time
inventory management, has resulted in customers placing orders with relatively
short delivery schedules.
12
This has the effect of increasing such short-lead orders ("turns orders") as
a portion of the Company's business and reducing the Company's ability to
accurately forecast net revenue. Because turns orders are more difficult to
predict, there can be no assurance that the combination of turns orders and
backlog in any quarter will be sufficient to achieve either sequential or
year-over-year growth in net revenue during that quarter. If the Company
does not achieve a sufficient level of turns orders in a particular quarter,
the Company's revenues and operating results would be materially adversely
affected.
Also, at any time and with no advance notice, during periods of
uncertainty in the personal computer industry's outlook for future demand or
pricing, the Company's customers may choose to draw down their inventory
levels thereby adversely impacting the Company's revenue during the period of
adjustment. The third quarter of 1998 comprised such a period of declining
distributor inventory levels. Also, as is common and frequent in the
personal computer industry, a disproportionate percentage of the Company's
revenue in any quarter may be generated in the last month or weeks of a
quarter. As a result, a shortfall in sales in any quarter as compared to
expectations may not be identifiable until at or near the end of the quarter.
In addition, from time to time, a significant portion of the Company's
revenue may be derived from a limited number of customers, the loss of one or
more of which could adversely impact operating results.
Notwithstanding the difficulty in forecasting future sales and the
relatively small level of backlog at any given time, the Company generally
must plan production, order components and undertake its development, sales
and marketing activities and other commitments months in advance.
Accordingly, any shortfall in revenue in a given quarter may materially
impact the Company's operating results and cash balances in a magnified way
due to the Company's inability to adjust expenses or inventory levels during
the quarter to match the level of revenue for the quarter. Excess inventory
could also result in cash flow as well as added costs of goods sold and
expenses associated with inventory write-offs or sell-offs. These conditions
were present during the first nine months of 1998. Conversely, in its
efforts to adjust inventory levels to a slower order rate, the Company may
overcorrect its component purchases and inventory levels, thereby
experiencing periodic shortages of inventory and delivery delays and
negatively impacting its revenue, market share and customer satisfaction
levels in the current quarter or in future quarters.
DECLINING SELLING PRICES
The Company's markets are characterized by intense ongoing competition
coupled with a past history and a current trend of declining average selling
prices. A decline in selling prices may cause the revenue in a quarter to be
lower than the revenue of a preceding quarter or corresponding prior year's
quarter even if more units were sold during such quarter than in the
preceding or corresponding prior year's quarter. Accordingly, it is possible
that the Company's average selling prices, measured over a given period of
time, will decline from the levels experienced to date. Such a decline could
cause the Company's revenue and gross margins to decline relative to prior
periods. The Company's gross margins may also be adversely affected by
shortages of, or higher prices for, key components for the Company's
products. In addition, the Company's revenues, average selling prices and
gross margins will be adversely affected if the market prices for certain
components used or expected to be used by the Company, decline more rapidly
than the Company is able to process component inventory bought earlier at
higher prices into finished products, book and ship the related orders, and
move such products through third-party distribution channels, some of which
may be price protected, to the final customer.
13
SEASONALITY
The Company believes that, due to industry seasonality, demand for its
products is strongest during the fourth calendar quarter of each year. This
seasonality may become more pronounced and material in the future to the
extent that a greater proportion of the Company's sales consist of sales into
the retail/mass merchant channel and as PCs become more consumer-oriented and
entertainment-driven products. Historical trends have consistently shown
higher fourth quarter demand than in the other quarters during the year.
However, there can be no assurance that the historical trend will continue.
MANAGEMENT OF GROWTH
In recent years, the Company has experienced a significant expansion in
the overall level of its business and the scope of its operations, including
manufacturing, research and development, marketing, technical support,
customer service, sales and logistics. This expansion in scope has resulted
in a need for significant investment in infrastructure, processes and
information systems. This requirement includes, without limitation: securing
adequate financial resources to successfully integrate and manage the
expanding businesses; retention of key employees; integration of management
information, control and telecommunications systems; management of
geographically dispersed contract manufacturing and distribution facilities;
consolidation and coordination of suppliers; rationalization of distribution
channels; establishment and documentation of business processes; and
integration of various functions and groups of employees. Each of these
requirements could pose significant, material challenges.
The Company's future operating results will depend in large measure on
its success in implementing operating, manufacturing and financial procedures
and controls, improving communication and coordination among the different
operating functions, integrating certain functions such as sales, procurement
and operations, strengthening management information and telecommunications
systems, and continuing to hire additional qualified personnel in all areas.
There can be no assurance that the Company will be able to manage these
activities and implement these additional systems, procedures and controls
successfully, and any failure to do so could have a material adverse effect
upon the Company's short-term and long-term operating results.
The market for the Company's products is characterized by frequent new
product introductions and product obsolescence. These factors typically
result in short product life cycles, frequently ranging from twelve to
eighteen months. The Company must develop and introduce new products in a
timely manner that compete effectively on the basis of price and performance
and that address customer needs and meet customer requirements. To do this,
the Company must continually monitor industry trends and make difficult
choices regarding the selection of new technologies and features to
incorporate into its new products, as well as the timing of when to introduce
such new products, all of which may impair the orders for or the prices of the
Company's existing products.
14
The success of new product introductions depends on various factors, some of
which are outside the Company's direct control. Such factors may include:
selection of new products; selection of controller architectures; timely
completion and introduction of new product designs; trade-offs between the
time of first customer shipment and the optimization of software for
installation and compatibility; development of supporting content by
independent software vendors ("ISV"s); development and production of
collateral product literature; and coordination of advertising, press
relations, and channel promotion.
Each new product cycle presents new opportunities for current or
prospective competitors of the Company to gain a product advantage or
increase their market share. If the Company does not successfully introduce
new products within a given product cycle, the Company's sales will be
adversely affected for that cycle and possibly for subsequent cycles. Any
such failure could also impair the Company's brand name and ability to
command retail shelf space in future periods. Moreover, because of the short
product life cycles coupled with the long lead times for procuring many of
the components used in the Company's products, the Company may not be able,
in a timely manner, or at all, to reduce its component procurement
commitments, software license or trademark commitments, production rates or
inventory levels in response to unexpected delays in product launch,
shortfalls in sales, product obsolescence or declines in prices or,
conversely, to increase production in response to unexpected increases in
demand, particularly if such demand increases are in a new product or area
where component supply may be hard to secure. Therefore, changes in actual
or expected demand could result in excess inventory, inventory write downs,
price protection and gross margin compression or, conversely, in lost sales
and revenue compression due to product or component unavailability.
COMPONENT OR SOFTWARE DEFECTS
Product components may contain undetected errors or "bugs" when first
supplied to the Company that, despite testing by the Company, are discovered
only after certain of the Company's products have been installed and used by
customers. There can be no assurance that errors will not be found in the
Company's products due to errors in such products' components, or that any
such errors will not impair the market acceptance of these products or
require significant product recalls. Problems encountered by customers or
product recalls could materially adversely affect the Company's business,
financial condition and results of operations. Further, the Company continues
to upgrade the firmware, software drivers and software utilities that are
incorporated into or included with its hardware products. The Company's
products, incorporating such firmware and software drivers, are extremely
complex as a result of factors including advanced functionality, the diverse
operating environments in which the products may be deployed, the need for
interoperability, and the multiple versions of such products that must be
supported for diverse operating platforms, languages and standards. These
products may contain undetected errors or failures when first introduced or
as new versions are released. The Company generally provides a one-year
warranty for its products and, in general, the Company's return policies
permit return within thirty days after receipt of products that do not meet
product specifications. There can be no assurance that, despite testing by
the Company, by its suppliers and by current or potential customers, errors
will not be found in new products after commencement of commercial shipments,
15
resulting in loss of or delay in market acceptance or product acceptance or
in warranty returns. Such loss or delay would likely have a material adverse
effect on the Company's business, financial condition and results of
operations.
Additionally, new versions or upgrades to operating systems or software
applications may require upgrades to the Company's products to maintain
compatibility with these new versions or upgrades. There can be no assurance
that the Company will be successful in developing new versions or
enhancements to its products or that the Company will not experience delays
in the upgrade of its products. In the event that the Company experiences
delays or is unable to maintain compatibility with operating systems and ISV
titles or applications, the Company's business, financial condition and
results of operations could be materially adversely affected.
DISTRIBUTION RISKS
The Company sells its products through a network of domestic and
international distributors, and directly to major retailers/mass merchants.
The Company's future success is dependent on the continued viability and
financial stability of its customer base. The computer distribution and
retail channels historically have been characterized by rapid change,
including periods of widespread financial difficulties and consolidation and
the emergence of alternative sales channels, such as direct mail order,
telephone sales by PC manufacturers and electronic commerce on the World Wide
Web. The loss of, or reduction in, sales to certain of the Company's key
customers as a result of changing market conditions, competition, or customer
credit problems could have a material adverse effect on the Company's
operating results. Likewise, changes in distribution channel patterns, such
as increased commerce on the Internet, increased use of mail-order
catalogues, increased use of consumer-electronics channels for personal
computer sales, or increased use of channel assembly to configure PC systems
to fit customers' requirements could affect the Company in ways not yet
known. Moreover, additions to or changes in the types of products the
Company sells, such as the introduction of non-gaming products or the
migration toward more communications-centric products, may require
specialized channel partnerships; relationships which the Company has only
begun to establish.
Inventory levels of the Company's distribution channels used by the
Company ("Channel Inventory Levels") generally are maintained in a range of
one to three months of customer demand. These Channel Inventory Levels tend
toward the low end of the months-of-supply range when demand is stronger,
sales are higher and products are in short supply. Conversely, when demand
is slower, sales are lower and products are abundant, then Channel Inventory
Levels tend toward the high end of the months-of-supply range. Frequently,
in such situations, the Company attempts to ensure that distributors and
retailers devote their working capital, sales and logistics resources to the
Company's products to a greater degree than to those of competitors.
Similarly, the Company's competitors attempt to ensure that their own
products are receiving a disproportionately higher share of the distributors'
working capital and logistics resources. The Company believes that it is
currently operating in a period of slower demand, lower sales and abundant
products, leading to existing Channel Inventory Levels of older product that
are higher than desirable. Further, in such an environment of slower demand
and abundant supply of products, price declines are more likely to occur and,
should they occur, are more likely to be severe. In such an event, high
Channel Inventory Levels may result in substantial price protection charges.
Such price protection charges have the effect of reducing net revenue and
gross profit.
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RISKS OF INTERNATIONAL SALES
The Company's international sales are subject to a number of risks
generally associated with international business operations, including the
effect on demand for the Company's products in international markets as a
result of a strengthening or weakening U.S. dollar, the effect of currency
fluctuations on consolidated multinational financial results, any
state-imposed restrictions on the repatriation of funds, any import and
export duties and restrictions, certain international economic conditions,
the expenses, time and technical resources required to localize the Company's
various products and to support local languages, the logistical difficulties
of managing multinational operations and dispersed product inventory designed
or manufactured to meet specific countries' requirements, and securing the
necessary governmental approvals for shipment to various countries.
This Report on Form 10-Q contains forward-looking statements (as defined
in Section 21E of the Securities Exchange Act of 1934, as amended) which
reflect management's current views with respect to future events and
financial performance. This report should be read in conjunction with the
Company's other SEC reports, including the Company's Report on Form 10-K for
the fiscal year December 31, 1997.
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PART II -- OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Number Description
--------- ------------
*3.1 Articles of Incorporation, as amended
**3.2 Amended and Restated Bylaws
4.1 Description of Capital Stock contained in the Articles of
Incorporation, as amended (See Exhibit 3.1)
4.2 Description of Rights of Security Holders contained in the Amended
and Restated Bylaws (See Exhibit 3.2)
*4.3 Form of Certificate for Shares of Common Stock
*4.4 Form of Representatives' Warrant Agreement among the Company,
Cruttenden Roth and Black & Company, Inc.
*10.1 Consulting Agreement, dated December 1, 1993, between the Company
and BOCAR, Inc.
*10.2 1994 Incentive Compensation Plan
*10.3 Directors' Nonqualified Stock Option Plan, as amended
*10.4 1994 Stock Option Plan, as amended (the amendment to the underlying
document is incorporated by reference to Exhibit B attached to the
Company's definitive Proxy Statement for 1998 Annual Meeting of
Shareholders)
***10.5 Letter agreement, dated October 8, 1997 from United States National
Bank of Oregon to the Company regarding a revolving line of credit
*10.6 Voicecom Development Agreement, dated November 4, 1994, between the
Company and Advanced Protocol Systems, Inc.
10.7 1990 Stock Option Plan (incorporated by reference to Exhibit 4.3 to
the Registration Statement on Form S-8 filed on June 5, 1995 (File
No. 33-93082))
**10.8 Leases, dated March 13, 1996, between Pacific Realty Associates,
L.P. and the Company, as amended
**10.9 Summary of 1997 Bonus Program (Bonus Program Extended for 1998)
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Number Description
--------- ------------
****10.10 Lease dated January 7, 1998, between Stargas Nominees Limited, and
the Company
10.11 1998 Stock Option Plan (incorporated by reference to Exhibit A
attached to the Company's definitive Proxy Statement for 1998 Annual
Meeting of Shareholders)
11.1 Statement re Computation of Per Share Earnings
27 Financial Data Schedule
- -------------------------
*Incorporated by reference to the same exhibit number from the Registration
Statement on Form SB-2 filed on January 5, 1995, as amended on February 7,
1995, and February 24, 1995 (File No. 33-88252-LA).
**Incorporated by reference to the same exhibit number to the Company's Annual
Report on Form 10-K for the year ended December 31, 1996.
***Incorporated by reference to the same exhibit number to the Company's Annual
Report on Form 10-K for the year ended December 31, 1997.
****Incorporated by reference to the same exhibit number to the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1998.
(b) Reports on Form 8-K
No reports on Form 8-K have been filed during the period for which
this report is filed.
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.
THRUSTMASTER, INC.
Date: November 15, 1998 By /s/ Frank G. Hausmann, Jr.
-------------------------------------
Frank G. Hausmann, Jr.
President and Chief Executive Officer
19