<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
--- EXCHANGE ACT OF 1934
For the quarter ended March 31, 1997 OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
--- EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-21126
S3 INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0204341
- ---------------------------------------- -----------------------------------
[State or other jurisdiction [I.R.S. Employer Identification No.]
of incorporation or organization]
2801 Mission College Boulevard
Santa Clara, California 95052-8058
- ---------------------------------------- -----------------------------------
[Address of principal executive offices] [Zip Code]
Registrant's telephone number, including area code: (408) 588-8000
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ----
The number of shares of the Registrant's Common Stock, $.0001 par value,
outstanding at May 7, 1997 was 49,217,199
- --------------------------------------------------------------------------------
<PAGE> 2
S3 INCORPORATED
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C>
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets
March 31, 1997 and December 31, 1996 3
Condensed Consolidated Statements of Income
Three months ended March 31, 1997 and 1996 4
Condensed Consolidated Statements of Cash Flows
Three months ended March 31, 1997 and 1996 5
Notes to Unaudited Condensed Consolidated Financial Statements 6-7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8-20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings Not Applicable
Item 2. Changes in Securities Not Applicable
Item 3. Defaults Upon Senior Securities Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders Not Applicable
Item 5. Other Information Not Applicable
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
</TABLE>
Page 2 of 22
<PAGE> 3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
S3 INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
ASSETS
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
--------------- ---------------
(Unaudited)
<S> <C> <C>
Current assets:
Cash and equivalents $82,164 $94,616
Short-term investments 64,413 62,768
Accounts receivable (net of allowances of $2,181 in 1997
and $2,648 in 1996) 96,883 76,120
Inventories, net 53,316 53,466
Prepaid expenses and other 34,071 34,369
--------------- ---------------
Total current assets 330,847 321,339
Property and equipment, net 39,498 34,047
Production capacity rights 14,400 14,400
Investment in joint venture 97,631 93,430
Other assets 28,860 17,246
--------------- ---------------
Total $511,236 $480,462
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $49,674 $51,160
Notes payable 24,335 17,802
Accrued liabilities 15,466 12,687
Income taxes payable 10,108 7,361
--------------- ---------------
Total current liabilities 99,583 89,010
Notes payable 14,400 14,400
Other liabilities 8,651 6,452
--------------- ---------------
Total liabilities 122,634 109,862
--------------- ---------------
Convertible Subordinated Notes 103,500 103,500
Commitments and contingencies (Notes 4 and 5)
Stockholders' equity:
Common Stock, $.0001 par value; 70,000,000 shares authorized;
48,998,325 and 48,331,794 shares outstanding in 1997 and 1996 171,590 169,411
Unrealized loss on short-term investments (152) (54)
Retained earnings 113,664 97,743
--------------- ---------------
Total stockholders' equity 285,102 267,100
--------------- ---------------
Total $511,236 $480,462
=============== ===============
</TABLE>
See accompanying notes to the unaudited condensed consolidated financial
statements.
Page 3 of 22
<PAGE> 4
S3 INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
--------------------------------
March 31, March 31,
1997 1996
-------------- -------------
<S> <C> <C>
Net sales $138,166 $110,072
Cost of sales 80,923 66,510
-------------- -------------
Gross margin 57,243 43,562
Operating expenses:
Research and development 18,942 14,721
Selling, marketing and administrative 12,630 10,914
-------------- -------------
Total operating expenses 31,572 25,635
-------------- -------------
Income from operations 25,671 17,927
Interest income 1,752 1,006
Interest expense (1,622) -
Other income (expense) (122) -
-------------- -------------
Other income, net 8 1,006
-------------- -------------
Income before income taxes 25,679 18,933
Provision for income taxes 9,758 6,625
-------------- -------------
Net income $15,921 $12,308
============== =============
Net income per share:
Primary $0.31 $0.25
============== =============
Assuming full dilution $0.30 $0.25
============== =============
Common and equivalent shares used in computing per share amounts:
Primary 52,118 50,047
============== =============
Assuming full dilution 57,481 50,047
============== =============
</TABLE>
See accompanying notes to the unaudited condensed consolidated financial
statements.
Page 4 of 22
<PAGE> 5
S3 INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
--------------------------
March 31, March 31,
1997 1996
---------- ---------
<S> <C> <C>
Operating activities:
Net income $15,921 $12,308
Adjustments to reconcile net income to net cash provided by
operating activities:
Deferred income taxes 3,378 (472)
Depreciation and amortization 3,697 2,276
Equity in income from joint venture (4,201) -
Changes in assets and liabilities:
Accounts receivable (20,763) 3,056
Inventories 150 (4,596)
Prepaid expenses and other (1,726) (2,874)
Accounts payable (1,486) (10,973)
Accrued liabilities and other 4,622 4,864
Income taxes payable 2,747 1,210
---------- ---------
Net cash provided by operating activities 2,339 4,799
---------- ---------
Investing activities:
Property and equipment purchases, net (8,375) (5,331)
Investment in real estate partnership - (2,100)
Sales/maturities of short-term investments, net (1,743) 1,835
Other assets (11,855) -
---------- ---------
Net cash used for investing activities (21,973) (5,596)
---------- ---------
Financing activities:
Sale of common stock, net 2,182 639
Borrowings of notes payable, net 5,000 2,000
---------- ---------
Net cash provided by financing activities 7,182 2,639
---------- ---------
Net increase (decrease) in cash and equivalents (12,452) 1,842
Cash and cash equivalents at beginning of period 94,616 69,289
---------- ---------
Cash and cash equivalents at end of period $82,164 $71,131
========== =========
</TABLE>
<PAGE> 6
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
1. Basis of Presentation:
The condensed consolidated financial statements have been prepared by S3
Incorporated, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission and include the accounts of S3 Incorporated
and its wholly-owned subsidiaries ("S3" or collectively the "Company"). Certain
information and footnote disclosures, normally included in financial statements
prepared in accordance with generally accepted accounting principles, have been
condensed or omitted pursuant to such rules and regulations. In the opinion of
the Company, the financial statements reflect all adjustments, consisting only
of normal recurring adjustments, necessary for a fair presentation of the
financial position at March 31, 1997 and December 31, 1996, and the operating
results and cash flows for the three months ended March 31, 1997 and 1996. These
financial statements and notes should be read in conjunction with the Company's
audited financial statements and notes thereto for the year ended December 31,
1996, included in the Company's Form 10-K filed with the Securities and Exchange
Commission.
The results of operations for the three months ended March 31, 1997 are not
necessarily indicative of the results that may be expected for the future
quarters or the year ending December 31, 1997.
2. Inventories:
Inventories consist of work in process and finished goods and are stated at
the lower of cost (first-in, first-out) or market.
<TABLE>
<CAPTION>
March 31, December 31,
Inventories consist of: 1997 1996
----------- -----------
(in thousands)
<S> <C> <C>
Work in progress $23,468 $22,556
Finished goods 29,848 30,910
----------- -----------
Total $53,316 $53,466
=========== ===========
</TABLE>
3. Net income per share:
Primary per share data is computed based on the weighted average number of
common and dilutive common equivalent shares outstanding. Common equivalent
shares include stock options and shares subscribed under the employee stock
purchase plan (computed using the treasury stock method). Fully diluted per
share data is computed using the most dilutive assumptions and by adjusting the
primary per share data and net income for the potential effect of the conversion
of the 5 3/4% Convertible Subordinated Notes outstanding during the period and
the elimination of the related interest and deferred issue costs, net of income
taxes.
Page 6 of 22
<PAGE> 7
4. Wafer supply agreements and commitments
During 1995, the Company entered into two long-term manufacturing
capacity arrangements. The Company entered into an agreement with United
Microelectronics Corporation (UMC) and Alliance Semiconductor Corporation to
form United Semiconductor Corporation (USC), a separate Taiwanese company,
for the purpose of building and managing a semiconductor manufacturing
facility in Taiwan, Republic of China. The Company has invested a total of
$89.4 million for its equity interest of 23.75%. The Company has the right
to purchase up to 31.25% of the output from the foundry.
In addition, in 1995 the Company expanded and formalized its
relationship with Taiwan Semiconductor Manufacturing Company (TSMC) to
provide additional capacity over the 1996 to 2000 timeframe. The agreement
with TSMC requires the Company to make certain annual advance payments to be
applied against the following year's capacity. The Company has signed
promissory notes to secure these payments over the term of the agreement. At
March 31, 1997, the remaining advance payments (and corresponding promissory
notes) totaled $24.0 million ($9.6 million in prepaid expenses and $14.4
million in production capacity rights).
In the ordinary course of business, the Company places purchase orders
with its wafer suppliers based on its existing and anticipated customer
orders for its products. Should the Company experience a substantial
unanticipated decline in the selling price of its products and/or demand
thereof, it could result in a material loss on such purchase commitments.
5. Contingencies
The semiconductor and software industries are characterized by frequent
litigation regarding patent and other intellectual property rights. The
Company is party to various claims of this nature. Although the ultimate
outcome of these matters is not presently determinable, management believes
that the resolution of all such pending matters will not have a material
adverse effect on the Company's financial position or results of operations.
6. Recently Issued Accounting Standard
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings per Share"
(SFAS 128). The Company is required to adopt SFAS 128 in the fourth quarter
of fiscal 1997 and will restate at that time earnings per share (EPS) data
for prior periods to conform with SFAS 128. Earlier application is not
permitted.
SFAS 128 replaces current EPS reporting requirements and requires a dual
presentation of basic and diluted EPS. Basic EPS excludes dilution and is
computed by dividing net income available to common shareholders by the
weighted average of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common
stock.
If SFAS 128 had been in effect during the current and prior year
periods, basic EPS would have been $0.33 and $0.26 for the quarters ended
March 31, 1997 and 1996, respectively. Diluted EPS under SFAS 128 would not
have been significantly different than fully diluted EPS reported for those
periods.
Page 7 of 22
<PAGE> 8
PART I. FINANCIAL INFORMATION
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
When used in this discussion, the words "expects," "anticipates,"
"estimates" and similar expressions are intended to identify forward-looking
statements. Such statements, which include statements concerning the timing
of availability and functionality of products under development, product
mix, trends in average selling prices, trends in the PC market, the
percentage of export sales and sales to strategic customers and the
availability and cost of products from the Company's suppliers, are subject
to risks and uncertainties, including those set forth below under "Factors
That May Affect Results," that could cause actual results to differ
materially from those projected. These forward-looking statements speak only
as of the date hereof. The Company expressly disclaims any obligation or
undertaking to release publicly any updates or revisions to any
forward-looking statements contained herein to reflect any change in the
Company's expectations with regard thereto or any change in events,
conditions or circumstances on which any statement is based.
OVERVIEW
The Company is a leading supplier of high performance multimedia
acceleration solutions for the PC market. The Company's accelerators are
designed to work cooperatively with a PC's central processing unit ("CPU"),
implementing functions best suited for a dedicated accelerator while
allowing the CPU to perform the more general purpose computing functions of
today's advanced graphical user interface ("GUI") environment and
applications.
The following information should be read in conjunction with the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" on pages 23 through 28 of the Company's annual report on Form
10-K for the year ended December 31, 1996.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain financial
data as a percentage of net sales:
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------
March 31, March 31,
1997 1996
---------------- ------------------
<S> <C> <C>
Net sales 100.0% 100.0%
Cost of sales 58.6 60.4
---------------- ------------------
Gross margin 41.4 39.6
---------------- ------------------
Operating expenses:
Research and development 13.7 13.4
Selling, marketing and administrative 9.1 9.9
---------------- ------------------
Total operating expenses 22.8 23.3
---------------- ------------------
Income from operations 18.6 16.3
Other income, net - .9
---------------- ------------------
Income before income taxes 18.6 17.2
Provision for income taxes 7.1 6.0
---------------- ------------------
Net income 11.5% 11.2%
================ ==================
</TABLE>
Page 8 of 22
<PAGE> 9
The Company's operating results have historically been, and will
continue to be, subject to quarterly and other fluctuations due to a variety
of factors, including changes in pricing policies by the Company, its
competitors or its suppliers, anticipated and unanticipated decreases in
unit average selling prices of the Company's products, availability and cost
of products from the Company's suppliers, changes in the mix of products
sold and in the mix of sales by distribution channels, the gain or loss of
significant customers, new product introductions by the Company or its
competitors, marketing acceptance of new or enhanced versions of the
Company's products, seasonal customer demand, and the timing of significant
orders.
The Company's operating results may fluctuate from those in prior
quarters or may be adversely affected in quarters in which it is undergoing
a product line transition in which production and sales of new products are
ramping up and in which existing products are under extreme price pressures
due to competitive factors. If new products are not brought to market in a
timely manner or do not address market needs or performance requirements,
then the Company's operating results will be adversely affected. As a result
of the foregoing, the Company's operating results and stock price may be
subject to significant volatility, particularly on a quarterly basis. Any
shortfall in net sales or net income from levels expected by securities
analysts could have an immediate and significant adverse effect on the
trading price of the Company's common stock.
NET SALES
The Company's net sales to date have been generated from the sale of its
graphics and multimedia accelerators. The Company's products are used in,
and its business is dependent on, the personal computer industry with sales
primarily in the U.S., Asia, and Europe. Net sales were $138.2 million for
the three months ended March 31, 1997, a 26% increase above the $110.1
million of net sales for the three months ended March 31, 1996. Net sales
increased primarily as a result of the addition of the ViRGE product line
and strong demand for the Company's 64-bit products that resulted in
increased unit shipments. The increase in unit shipments was partially
offset by lower overall average selling prices. Sales for the three months
ended March 31, 1997 consisted primarily of the ViRGE and Trio families of
integrated accelerators while sales for the three months ended March 31,
1996 consisted primarily of the Trio family of integrated accelerators. The
Company expects that the percentage of its net sales represented by any one
product or type of product may change significantly from period to period as
new products are introduced and existing products reach the end of their
product life cycles. Due to competitive price pressures, the Company's
products experience declining unit average selling prices over time, which
at times can be substantial.
The pricing environment for 2D graphics accelerators, which accounted
for a majority of the Company's net sales in 1996, has recently experienced
and is expected to continue to experience increasing pricing pressures due
to aggressive pricing from certain of the Company's competitors. In
particular, the Company's Trio family of integrated 2D accelerators
experienced significant decreases in average selling prices in 1996 which
continued in the first quarter of 1997. The Company expects that the
graphics accelerator market will transition from 2D acceleration to 3D
acceleration, and the Company introduced its ViRGE family of 2D/3D
accelerators in response to this expected transition. As a result of the
entry of competitors into the 3D acceleration market, the Company has
experienced and anticipates that it may continue to experience increased
pricing pressures on average selling prices for the ViRGE family of 2D/3D
accelerators. If the transition occurs slower than expected, if the
Company's graphic products do not achieve market acceptance, or if the
pricing pressures increase, then the Company's operating results could be
adversely affected. The Company currently expects that net sales for the
three months ended June 30, 1997 will be below net sales for the three
months ended March 31, 1997 due to seasonal factors and to substantial
pricing pressures currently experienced by the Company's products.
Page 9 of 22
<PAGE> 10
Export sales accounted for 63% and 56% of net sales for the three months
ended March 31, 1997 and 1996, respectively. Approximately 15% of export
sales for the three months ended March 31, 1997 were to affiliates of United
States customers. The Company expects that export sales will continue to
represent a significant portion of net sales, although there can be no
assurance that export sales as a percentage of net sales will remain at
current levels. All sales transactions were denominated in U.S. dollars.
Three customers accounted for 15%, 15% and 13% of net sales for the
three months ended March 31, 1997 and three customers accounted for 16%, 13%
and 12% of net sales for the three months ended March 31, 1996. The Company
expects a significant portion of its future sales to remain concentrated
within a limited number of strategic customers. There can be no assurance
that the Company will be able to retain its strategic customers or that such
customers will not cancel or reschedule orders or, in the event orders are
canceled, that such orders will be replaced by other sales. In addition,
sales to any particular customer may fluctuate significantly from quarter to
quarter. The occurrence of any such events or the loss of a strategic
customer could have a material adverse effect on the Company's operating
results.
The occurrence of any supply problems for the Company's products may
adversely affect the rate of growth in net sales. Net sales may also be
adversely affected by delays in the production ramp of customers' new
programs and systems which incorporate the Company's products. In addition,
the Company ships more product in the third month of each quarter than in
either of the first two months of the quarter, with shipments in the third
month higher at the end of the month. This pattern, which is common in the
semiconductor industry, is likely to continue. The concentration of sales in
the last month of the quarter may cause the Company's quarterly results of
operations to be more difficult to predict. Moreover, a disruption in the
Company's production or shipping near the end of a quarter could materially
reduce the Company's net sales for that quarter. The Company's reliance on
outside foundries and independent assembly and testing houses reduces the
Company's ability to control, among other things, delivery schedules.
GROSS MARGIN
Gross margin percentage increased to 41.4% for the three months ended
March 31, 1997 from 39.6% for the three months ended March 31, 1996. The
increase was due to the Company achieving proportionately greater decreases
in unit average costs compared to decreases in overall average selling
prices. The unit average cost decreases were principally the result of
changes in the Company's design method and manufacturing strategy and shifts
to lower cost foundries. The Company currently expects its gross margin
percentage to decrease below historical levels in the three months ended
June 30, 1997 due to substantial pricing pressures and to fixed costs being
spread over a revenue base that is expected to be smaller.
In the future, the Company's gross margin percentages may be affected by
increased competition and related decreases in unit average selling prices
(particularly with respect to older generation products), timing of volume
shipments of new products, the availability and cost of products from the
Company's suppliers, changes in the mix of products sold, the profitability
of the USC joint venture (the Company recognizes its proportionate share of
USC profits and losses), the extent to which the Company forfeits or
utilizes its production capacity rights with TSMC, the extent to which the
Company will incur additional licensing fees and shifts in sales mix between
add-in card and motherboard manufacturers to systems OEMs.
Page 10 of 22
<PAGE> 11
RESEARCH AND DEVELOPMENT EXPENSES
The Company has made and intends to continue to make significant
investments in research and development to remain competitive by developing
new and enhanced products. Research and development expenses were $18.9
million for the three months ended March 31, 1997, an increase of $4.2
million from $14.7 million for the three months ended March 31, 1996.
Research and development spending increases reflect additions to the
Company's engineering staff and nonrecurring engineering and initial product
verification expenses related to the expected introduction of new products.
Research and development spending is expected to increase in absolute
dollars in 1997 as a result of the product development activities currently
underway for the desktop, mobile and home PC markets with a focus on video,
3D, audio and communications.
Products in the Company's market typically have a life cycle of 12 to 24
months. The successful development and commercialization of new products
required to replace or supplement existing products involve many risks,
including the identification of new product opportunities, the successful
and timely completion of the development process, and the selection of the
Company's products by leading systems suppliers and board manufacturers for
design into their products. There can be no assurance that the Company will
successfully identify new product opportunities and develop and bring to the
market in a timely manner successful new products, that products or
technologies developed by others will not render the Company's products
noncompetitive, or that the Company's products will be selected for design
into its customers' products. In addition, it is possible that the Company's
products may be found defective after the Company has already shipped
significant volume production. There can be no assurance that the Company
would be able to successfully correct such problems or that such corrections
would be acceptable to customers. The occurrence of any such events would
have a material adverse effect on the Company's operating results.
SELLING, MARKETING AND ADMINISTRATIVE EXPENSES
Selling, marketing and administrative expenses were $12.6 million for
the three months ended March 31, 1997, an increase of $1.7 million from
$10.9 million for the three months ended March 31, 1996. Selling and
marketing costs increased as a result of additional personnel, increased
commissions associated with higher sales levels and increased marketing
costs associated with the expected introduction of new products.
Administrative costs have increased due to the hiring of additional
personnel necessary to support the increased level of operations. The
Company anticipates that selling, marketing and administrative expenses will
increase in absolute dollars in 1997.
OTHER INCOME, NET
Other income, net, decreased to $8,000 for the three months ended March
31, 1997, from $1.0 million for the three months ended March 31, 1996. The
decrease is attributable to the interest expense incurred on $103.5 million
aggregate principal amount of convertible subordinated notes, which were
issued by the Company in September 1996. The interest expense is partially
offset by the interest income due to the higher average amounts of cash and
short-term investments as a result of the net proceeds of approximately
$100.1 million from the sale of the convertible subordinated notes.
INCOME TAXES
The Company's effective tax rate for the three months ended March 31,
1997 is 38%, compared to the 35% effective rate for the three months ended
March 31, 1996. The increased tax rate is primarily attributable to the
expiration of the federal research and development credit as of May 31,
1997.
Page 11 of 22
<PAGE> 12
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities for the three months ended March
31, 1997 was $2.3 million, as compared to $4.8 million for the three months
ended March 31, 1996. The Company experienced an increase from December 31,
1996 in accounts receivable, prepaid expenses and other, income tax payable
and accrued liabilities and other. These increases were partially offset by
a decrease in accounts payable. The Company experienced an increase in
accounts receivable from the level at December 31, 1996 due to the
substantial concentration of sales in March 1997 resulting from increased
shipments in the third month of that quarter over either of the first two
months of the quarter relative to what the Company experienced in previous
quarters.
Investing activities for the three months ended March 31, 1997 and 1996
reflected property and equipment purchases, net, of $8.4 million and $5.3
million, respectively, short term investments, and deferred royalties.
Continued expansion of the Company's business may require higher levels of
capital equipment purchases, technology investments, foundry investments and
other payments to secure manufacturing capacity. In the first quarter of
1996, the Company established a $20 million equity program for identifying
and seeding technology investments in the areas of Internet development, 3D,
graphics, video, audio and other technology growth areas.
Financing activities provided cash of $7.2 million. Borrowings on the
line of credit and proceeds from the issuance of common stock were the
principal financing activities that generated cash in the period.
In 1995, the Company entered into two long-term manufacturing capacity
arrangements. The Company entered into an agreement with UMC and Alliance
Semiconductor Corporation to form USC, a separate Taiwanese company, for the
purpose of building and managing a semiconductor manufacturing facility in
the Science Based Industrial Park in Hsin Chu City, Taiwan, Republic of
China. The Company invested $53.0 million in 1996 and $36.4 million in 1995
for its 23.75% equity interest. The facility commenced production utilizing
advanced submicron semiconductor manufacturing processes in late 1996. The
Company has the right to purchase up to 31.25% of the output from the
foundry. In addition, the Company expanded and formalized its relationship
with TSMC to provide additional capacity over the 1996 to 2000 timeframe.
The agreement with TSMC requires the Company to make certain annual advance
payments to be applied against the following year's capacity. The Company
has signed promissory notes to secure these payments, which total $24.0
million as of March 31, 1997, over the term of the agreement. The Company
paid $7.2 million in 1996.
Working capital at March 31, 1997 and March 31, 1996 was $231.3 million
and $153.1 million, respectively. At March 31, 1997, the Company's principal
sources of liquidity included cash and equivalents of $82.2 million and
$64.4 million in short-term investments. In addition, the Company has a
$25.0 million unsecured revolving line of credit that expires June 1, 1997.
The Company is currently in the process of renewing the line of credit. The
Company had $5.0 million outstanding under the line of credit as of March
31, 1997. In addition, the Company has two separate secured equipment lines
of credit totaling $10.0 million. The Company had $6.5 million outstanding
under these secured equipment lines of credit at March 31, 1997. The Company
believes that its available funds and its anticipated funds from operations
will satisfy the Company's projected working capital, existing foundry
supply agreement and capital expenditure requirements for at least the next
12 months, other than expenditures for future potential manufacturing
agreements.
In order to obtain an adequate supply of wafers, especially wafers
manufactured using advanced process technologies, the Company has entered
into and will continue to consider various possible transactions, including
the use of "take or pay" contracts that commit the Company to purchase
specified quantities of wafers over extended periods, equity investments in,
advances or issuances of equity securities to wafer manufacturing companies
in exchange for guaranteed production or the formation of joint ventures to
own and operate or
Page 12 of 22
<PAGE> 13
construct wafer fabrication facilities. Manufacturing arrangements such as
these may require substantial capital investments, which may require the
Company to seek additional equity or debt financing. There can be no
assurance that such additional financing, if required, will be available
when needed or, if available, will be on satisfactory terms. In addition,
the Company may, from time to time, as business conditions warrant, invest
in or acquire businesses, technology or products that complement the
business of the Company.
The cyclical nature of the semiconductor industry periodically results
in shortages of advanced process wafer fabrication capacity such as the
Company experiences from time to time. The Company's ability to maintain
adequate levels of inventory is primarily dependent upon the Company
obtaining sufficient supply of products to meet future demand, and any
inability of the Company to maintain adequate inventory levels may adversely
affect its relations with its customers. In addition, because the Company
must order products and build inventory substantially in advance of product
shipments, there is a risk that the Company will forecast incorrectly and
produce excess or insufficient inventories of particular products because
the Company's products are volatile and subject to rapid technology and
price change. This inventory risk is heightened because certain of the
Company's key customers place orders with short lead times. The Company's
customers' ability to reschedule or cancel orders without significant
penalty could adversely affect the Company's liquidity, as the Company may
be unable to adjust its purchases from its independent foundries to match
such customer changes and cancellations. To the extent the Company produces
excess or insufficient inventories of particular products, the Company's
operating results could be adversely affected.
FACTORS THAT MAY AFFECT RESULTS
Fluctuations in Quarterly Operating Results
The Company's operating results have historically been, and will
continue to be, subject to quarterly and other fluctuations due to a variety
of factors, including changes in pricing policies by the Company, its
competitors or its suppliers, anticipated and unanticipated decreases in
unit average selling prices of the Company's products, availability and cost
of products from the Company's suppliers, changes in the mix of products
sold and in the mix of sales by distribution channels, the gain or loss of
significant customers, new product introductions by the Company or its
competitors, market acceptance of new or enhanced versions of the Company's
products, seasonal customer demand, and the timing of significant orders.
Operating results could also be adversely affected by general economic and
other conditions affecting the timing of customer orders and capital
spending, a downturn in the market for PCs, and order cancellations or
rescheduling. In particular, the market for PCs in 1996 experienced a
weakening in the trends for demand as compared with 1995 and grew at a lower
rate as compared with 1995. These factors could adversely affect demand for
the Company's products. In addition, the pricing environment for graphics
accelerators has recently experienced and is expected to continue to
experience increasing pricing pressures due in part to the alleviation of
supply constraints that contributed to more stable pricing in 1995 and to
aggressive pricing from certain of the Company's competitors. In particular,
the Company's Trio family of integrated 2D accelerators, which accounted for
a majority of the Company's revenues in 1996, experienced significant
decreases in average selling prices in 1996. The Company expects that the
graphics accelerator market will transition from 2D acceleration to 3D
acceleration, and the Company has introduced its ViRGE family of 2D/3D
accelerators in response to this expected transition. As a result of the
entry of competitors into the 3D acceleration market, the Company has
experienced and anticipates that it may continue to experience increased
pricing pressures on average selling prices for the ViRGE family of 2D/3D
accelerators. If the transition occurs slower than expected, if the
Company's 2D/3D products do not achieve market acceptance, or if pricing
pressures increase, the Company's operating results could be adversely
affected. Further, because the Company is continuing to increase its
operating expenses for personnel and new product development, the Company's
operating results would be adversely affected if such budgeted sales levels
were not
Page 13 of 22
<PAGE> 14
achieved. PC graphics and multimedia subsystems include, in addition to the
Company's products, a number of other components which are supplied by
third-party manufacturers. Any shortage of such components in the future
could adversely affect the Company's business and operating results.
Furthermore, it is possible that the Company's products may be found to be
defective after the Company has already shipped significant volume
production. There can be no assurance that the Company would be able to
successfully correct such defects or that such corrections would be
acceptable to customers, and the occurrence of such events could have a
material adverse effect on the Company's business and operating results.
Because the Company must order products and build inventory
substantially in advance of product shipments, and because the markets for
the Company's products are volatile and subject to rapid technological and
price changes, there is a risk that the Company will forecast incorrectly
and produce excess or insufficient inventories of particular products. In
addition, the Company's customers may change delivery schedules or cancel
orders without significant penalty. To the extent the Company produces
excess or insufficient inventories of particular products, the Company's
operating results could be adversely affected.
The Company ships more product in the third month of each quarter than
in either of the first two months of the quarter, with shipments in the
third month higher at the end of the month. This pattern, which is common in
the semiconductor industry, is likely to continue. The concentration of
sales in the last month of the quarter may cause the Company's quarterly
results of operations to be more difficult to predict. Moreover, a
disruption in the Company's production or shipping near the end of a quarter
could materially reduce the Company's net sales for that quarter. The
Company's reliance on outside foundries and independent assembly and testing
houses reduces the Company's ability to control, among other things,
delivery schedules.
Due to the foregoing factors, it is likely that in some future quarter
or quarters the Company's operating results may be below the expectations of
public market analysts and investors. In such event, the price of the
Company's Common Stock would likely be materially and adversely affected.
Importance of New Products; Rapid Technological Change
The PC industry in general, and the market for the Company's products in
particular, is characterized by rapidly changing technology, evolving
industry standards, frequent new product introductions and significant price
competition, resulting in short product life cycles and regular reductions
of unit average selling prices over the life of a specific product. Products
in the Company's market typically have a life cycle of 12 to 24 months, with
regular reductions of unit average selling prices over the life of a
specific product. The successful development and commercialization of new
products required to replace or supplement existing products involve many
risks, including the identification of new product opportunities, the
successful and timely completion of the development process, and the
selection of the Company's products by leading systems suppliers and add-in
card and motherboard manufacturers for design into their products. There can
be no assurance that the Company will successfully identify new product
opportunities and develop and bring to market in a timely manner successful
new products, that products or technologies developed by others will not
render the Company's products or technologies noncompetitive, or that the
Company's products will be selected for design into its customers' products.
The Company is continually developing new products to address changing
market needs, and its operating results may fluctuate from those in prior
quarters or may be adversely affected in quarters in which it is undergoing
a product transition or in which existing products are under price pressures
due to competitive factors. The Company also intends to add increased
functionality to its multimedia products, such as system logic, audio,
communications or other additional functions. Market acceptance of the
Company's products will also depend
Page 14 of 22
<PAGE> 15
upon acceptance of other components, such as memory, that the Company's
products are designed to work with. For example, the Company has recently
introduced accelerators designed to work with synchronous graphics RAM
("SGRAM") and/or synchronous DRAM ("SDRAM") which the Company believes offer
better performance for its price than the more expensive video RAM ("VRAM").
However, there can be no assurance that other memory technologies, such as
Rambus DRAM, will not achieve a greater degree of market acceptance than
SGRAMs or SDRAMs. If new products are not brought to market in a timely
manner or do not address market needs or achieve market acceptance, then the
Company's operating results will be adversely affected. The Company's 1994
operating results were adversely affected in part because the Company had
made a strategic decision to transition its product offerings from 32-bit to
64-bit accelerators during the first half of 1994, but due to a lack of PC
system logic chipsets based on the PCI bus standard and a slower than
anticipated shift from 32-to 64-bit graphics, sales of S3's PCI-based
Vision64 family of accelerators were less than expected. During the same
period of time, competitors' 32-bit integrated accelerator products offered
a more competitive solution to the Company's customers and ultimately
necessitated an adjustment in the valuation of the Company's 32-bit
non-integrated inventory. In anticipation of a shift in demand from 2D to 3D
technology, the Company has introduced and is continuing to develop products
in its ViRGE family of 2D/3D multimedia accelerators. If the transition from
2D to 3D in the PC market is slower than the Company expects or if these
products are not brought to market in a timely manner or do not address
market needs or achieve market acceptance, the Company's operating results
could be adversely affected. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Dependence on Foundries and Other Third Parties
The Company currently relies on several independent foundries to
manufacture its products either in finished form or wafer form. The Company
currently has long-term supply arrangements with two of its foundries, a
"take or pay" contract with Taiwan Semiconductor Manufacturing Company
("TSMC") and a joint venture foundry, United Semiconductor Corporation
("USC"). In 1995, the Company expanded and formalized its relationship with
TSMC to provide additional capacity over the 1996 to 2000 timeframe. The
foundry agreement with TSMC requires the Company to make certain annual
advance payments to purchase certain committed capacity amounts to be
applied against the following year's capacity or forfeit advance payments
against such amounts. In addition, the Company entered into an agreement
with United Microelectronics Corporation ("UMC") and Alliance Semiconductor
Corporation to form a separate Taiwanese company, USC, for the purpose of
building and managing a semiconductor manufacturing facility. The Company
invested $53.0 million in 1996 and $36.4 million in 1995 for its 23.75%
equity interest. The facility commenced production utilizing advanced
submicron semiconductor manufacturing processes in late 1996. The Company
has the right to purchase up to 31.25% of the output from the foundry. To
the extent the Company purchases excess inventories of particular products
or chooses to forfeit advance payments, the Company's operating results
could be adversely affected. To the extent USC experiences operating losses,
the Company will recognize its proportionate share of such losses and may be
required to contribute additional capital. The Company believes that a
number of manufacturers are expanding or planning to expand their
fabrication capacity over the next several years, which could lead to
overcapacity in the market and resulting decreases in costs of finished
wafers. If the wafers produced by USC cannot be produced at competitive
prices, USC could sustain operating losses. There can be no assurance that
such operating losses will not have a material adverse effect on the
Company's results of operations.
The Company conducts business with its other current foundries by
delivering written purchase orders specifying the particular product
ordered, quantity, price, delivery date and shipping terms and, therefore,
such foundries are generally not obligated to supply products to the Company
for any specific period, in any specific quantity or at any specified price,
except as may be provided in a particular purchase order. To the extent a
foundry terminates
Page 15 of 22
<PAGE> 16
its relationship with the Company or should the Company's supply from a
foundry be interrupted or terminated for any other reason, such as a natural
disaster or an injunction arising from alleged violations of third party
intellectual property rights, the Company may not have a sufficient amount
of time to replace the supply of products manufactured by that foundry.
Until 1996, due to worldwide semiconductor supply constraints, especially
with respect to advanced process technologies required by the Company's
products, the Company was unable to obtain a sufficient supply of products
to enable it to meet demand and was required to allocate available supply of
its products among its customers. There can be no assurance that the Company
will obtain sufficient advanced process technology foundry capacity to meet
customer demand in the future. The Company is continuously evaluating
potential new sources of supply. However, the qualification process and the
production ramp-up for additional foundries has in the past taken, and could
in the future take, longer than anticipated, and there can be no assurance
that such sources will be able or willing to satisfy the Company's
requirements on a timely basis or at acceptable quality or per unit prices.
Two of the Company's principal foundries, TSMC and UMC, and the
Company's foundry joint venture, USC, are located in the Science-Based
Industrial Park in Hsin Chu City, Taiwan. The Company currently expects
these three foundries to supply the substantial portion of the Company's
products in 1997. Disruption of operations at these foundries for any
reason, including work stoppages, fire, earthquakes or other natural
disasters, would cause delays in shipments of the Company's products, and
could have a material adverse effect on the Company's results of operations.
In addition, as a result of the rapid growth of the semiconductor industry
based in the Science-Based Industrial Park, severe constraints have been
placed on the water and electricity supply in that region. Any shortages of
water or electricity could adversely affect the Company's foundries' ability
to supply the Company's products, which could have a material adverse effect
on the Company's results of operations.
The Company is using multiple sources for certain of its products, which
may require the Company's customers to perform separate product
qualifications. The Company has not, however, developed alternate sources of
supply for certain other products, and its newly introduced products are
typically produced initially by a single foundry until alternate sources can
be qualified. The requirement that a customer perform separate product
qualifications or a customer's inability to obtain a sufficient supply of
products from the Company may cause that customer to satisfy its product
requirements from the Company's competitors, which would adversely affect
the Company's results of operations.
The Company's products are assembled and tested by a variety of
independent subcontractors. The Company's reliance on independent assembly
and testing houses to provide these services involves a number of risks,
including the absence of adequate availability of certain packaging
technologies, the absence of guaranteed capacity and reduced control over
delivery schedules, quality assurance and costs. The Company also is subject
to the risks of shortages and increases in the cost of raw materials used in
the manufacture or assembly of the Company's products.
Constraints or delays in the supply of the Company's products, whether
because of capacity constraints, unexpected disruptions at the foundries or
assembly or testing houses, delays in obtaining additional production at
existing foundries or in obtaining production from new foundries, shortages
of raw materials, or other reasons, could result in the loss of customers
and other material adverse effects on the Company's operating results,
including effects that may result should the Company be forced to purchase
products from higher cost foundries or pay expediting charges to obtain
additional supply.
Page 16 of 22
<PAGE> 17
Transactions to Obtain Manufacturing Capacity; Future Capital Needs
In order to obtain an adequate supply of wafers, especially wafers
manufactured using advanced process technologies, the Company has entered
into and may consider in the future various transactions, including the use
of "take or pay" contracts that commit the Company to purchase specified
quantities of wafers over extended periods, equity investments in or
advances or issuances of equity securities to wafer manufacturing companies
in exchange for guaranteed production capacity, or the formation of joint
ventures to own and operate or construct foundries or to develop certain
products. Any of such transactions would involve financial risk to the
Company and could require the Company to commit substantial capital or
provide technology licenses in return for guaranteed production capacity. In
particular, the Company has entered into a "take or pay" contract with TSMC
and has entered into the USC joint venture. The need to commit substantial
capital may require the Company to seek additional equity or debt financing.
The sale or issuance of additional equity or convertible debt securities
could result in additional dilution to the Company's stockholders. There can
be no assurance that such additional financing, if required, will be
available when needed or, if available, will be on terms acceptable to the
Company.
Dependence on Accelerator Product Line
S3's products are designed to improve the graphics and multimedia
performance of x86-based PCs and Microsoft Windows, Windows NT and IBM OS/2
operating systems, the predominant standards in today's PC market. Any shift
away from such standards would require the Company to develop new products.
The Company expects that additional specialized graphics processing and
general purpose computing capabilities will be integrated into future
versions of Intel and other x86-based microprocessors and that standard
multimedia accelerators in the future will likely integrate memory, system
logic, audio, communications or other additional functions. The Company has
not previously offered either single function or integrated accelerator
products that provide these functions, which have traditionally been
provided by separate single function chips or chipsets. The Company has been
and will continue to be required to expand the scope of its research and
development efforts to provide these functions, which will require the
hiring of engineers skilled in the respective areas and additional
management and coordination among the Company's design and engineering
groups. Alternatively, the Company may find it necessary or desirable to
license or acquire technology to enable the Company to provide these
functions, and there can be no assurance that any such technology will be
available for license or purchase on terms acceptable to the Company.
Furthermore, there is a limited amount of space on PC motherboards, and
companies that offer solutions that provide the greatest amount of
functionality within this limited space may have a competitive advantage.
While the Company's strategy is to develop new and enhanced graphics and
multimedia accelerator products that will be complementary to present and
future versions of Intel and other x86-based microprocessors and integrate
additional functionality, there can be no assurance that the Company will be
able to develop such new or enhanced products in a timely manner or
correctly anticipate the additional functionality that will be required to
compete effectively in this market. There can be no assurance that, if
developed, the Company's new or enhanced products that incorporate these
functions will achieve market acceptance. There also can be no assurance
that the market for graphics and multimedia accelerators will continue to
grow in the future or that new technological developments or changes in
standards will not result in decreased demand for graphics and multimedia
accelerators or for the Company's products that are not compatible with such
changed standards. For example, in 1996, there was an absence of an industry
standard 3D graphics API. As a result, the Company developed and promoted
its proprietary API. Microsoft has since introduced its Direct3D API, which
has emerged as the standard API for 3D acceleration. While the Company's 3D
accelerators currently support the Company's proprietary API and Microsoft's
Direct 3D API, there can be no assurance that another API will emerge as an
industry standard that the Company's accelerators will not support. While
the PC industry in recent periods has been characterized by substantial
demand, such demand has historically been cyclical, and there can be no
assurance that this demand will continue in future periods or that demand
for the Company's products will continue. The occurrence of any such events
would have a material adverse effect on the Company's operating results.
Page 17 of 22
<PAGE> 18
Substantial Competition
The market for the Company's products is extremely competitive and is
characterized by declining selling prices over the life of a particular
product and rapid technological changes. The Company's principal competitors
for graphics accelerators include ATI Technologies, Inc., Cirrus Logic,
Inc., Matrox Graphics Inc., and Trident Microsystems, Inc. The Company's
principal competitors in the multimedia market include the companies named
in the preceding sentence and a number of smaller companies which may have
greater flexibility to address specific market needs. Potential competitors
in these markets include both large and emerging domestic and foreign
semiconductor companies. In particular, there is a significant number of
established and emerging companies that have developed, are developing or
have announced plans to develop 3D graphics chips, including Intel
Corporation and Lockheed Martin Corporation, which have announced that they
are jointly developing such chips, which are currently expected to become
available in the second half of 1997, and Texas Instruments Incorporated,
which has announced a development and marketing agreement with 3Dlabs Inc.,
Ltd. In addition, Microsoft has announced that it is developing a reference
architecture, Talisman, with an alternative method of providing 3D
functionality. Microsoft is working with a number of companies, including
Cirrus Logic, Inc., Samsung Electronics Co., Ltd., Philips N.V. and Fujitsu
Ltd., to implement this architecture. There can be no assurance that the
Company's product offerings to address the demand for the next generation of
2D/3D accelerators will be competitive, and if such product offerings are
not competitive, the Company's results of operations in 1997 and future
periods could be materially and adversely affected. The entry of additional
competitors into the 2D/3D accelerator market has resulted in and is
expected to continue to result in pricing pressures on average selling
prices of the Company's products. To the extent the Company expands its
product line to add products with additional functionality, such as audio,
communications and system logic functions, it will encounter substantial
competition from established semiconductor companies and may experience
competition from companies designing chips based on different technologies,
such as software-centric multimedia processors. Further, the need of PC
manufacturers to rapidly introduce a variety of products aimed at different
segments of the PC market may lead to the shift by such system OEMs to the
purchase of graphics and multimedia add-in cards provided by others. Certain
of the Company's competitors supply both add-in cards and accelerator chips,
which may provide those competitors with an advantage over suppliers such as
the Company that supply only accelerator chips. In addition, certain of the
Company's potential competitors that supply add-in cards and/or
motherboards, such as Intel Corporation, may seek to use their card/board
business to leverage the startup of their graphics accelerator business.
Certain of the Company's current and potential competitors have greater
technical, manufacturing, financial and marketing resources than the
Company. The Company believes that its ability to compete successfully
depends upon a number of factors both within and outside of its control,
including product performance, product features, product availability,
price, quality, timing of new product introductions by the Company and its
competitors, the emergence of new graphics and PC standards, customer
support, and industry and general economic trends. There can be no assurance
that the Company will have the financial resources, technical expertise, or
marketing, distribution and support capabilities to compete successfully.
The Company's future success will be highly dependent upon the successful
development and introduction of new products that are responsive to market
needs. There can be no assurance that the Company will be able to
successfully develop or market any such products.
Customer Concentration
The Company expects a significant portion of its future sales to remain
concentrated within a limited number of strategic customers. There can be no
assurance that the Company will be able to retain its strategic customers or
that such customers will not otherwise cancel or reschedule orders, or in
the event of canceled orders, that such orders will be replaced by other
sales. In addition, sales to any particular customer may fluctuate
significantly from quarter to quarter. The occurrence of any such events
could have a material adverse effect on the Company's operating results.
Page 18 of 22
<PAGE> 19
Management of Growth; Dependence on Key Personnel
Since its inception, the Company has experienced significant growth in
the number of its employees and in the scope of its operating and financial
systems, resulting in increased responsibilities for the Company's
management. To manage future growth effectively, the Company will need to
continue to improve its operational, financial and management information
systems, procedures and controls, and expand, train, motivate, retain and
manage its employee base. The Company is in the final stage of implementing
a new management information system. Any problems encountered with the new
system could adversely affect the Company's operations. There can be no
assurance that the Company will be able to manage its growth effectively,
and failure to do so could have a material adverse effect on the Company's
operating results.
The Company's future success depends in part on the continued service of
its key engineering, sales, marketing and executive personnel, including
highly skilled semiconductor design personnel and software developers, and
its ability to identify and hire additional personnel. Competition for such
personnel is intense and there can be no assurance that the Company can
retain and recruit necessary personnel to operate its business and support
its future growth. In August 1996, the Company appointed a new President and
Chief Executive Officer to replace Terry N. Holdt, who retired, and in March
1997, the Company's Chief Financial Officer resigned, and there can be no
assurance as to the effects of this management transition on the Company's
business and operating results. The loss of key personnel could have a
material adverse effect on the Company's business and operating results. The
Company does not maintain key man insurance on any of its employees.
Importance of Intellectual Property; Litigation Involving Intellectual
Property
The Company's ability to compete will be affected by its ability to
protect its proprietary information. The Company has filed several United
States and foreign patent applications and to date has a number of issued
United States patents. The Company relies primarily on its trade secrets and
technological know-how in the conduct of its business. There can be no
assurance that the steps taken by the Company to protect its intellectual
property will be adequate to prevent misappropriation of its technology or
that the Company's competitors will not independently develop technologies
that are substantially equivalent or superior to the Company's technology.
The semiconductor and software industries are characterized by frequent
claims and related litigation regarding patent and other intellectual
property rights. The Company is party to various claims of this nature.
Although the ultimate outcome of these matters is not presently
determinable, management presently believes that the resolution of all such
pending matters will not have a material adverse effect on the Company's
operating results. There can be no assurance that third parties will not
assert additional claims or initiate litigation against the Company, its
foundries, or its customers with respect to existing or future products. In
addition, the Company may initiate claims or litigation against third
parties for infringement of the Company's proprietary rights or to determine
the scope and validity of the proprietary rights of the Company or others.
Litigation by or against the Company has in the past, in the case of the
Brooktree Corporation ("Brooktree") litigation, resulted and could in the
future result in substantial expense to the Company and diversion of the
efforts of the Company's technical and management personnel, whether or not
litigation is determined in favor of the Company. In the event of litigation
to determine the validity of any third-party claims, such litigation could
result in significant expense to the Company and divert the efforts of the
Company's technical and management personnel, whether or not litigation is
determined in favor of the Company. In the event of an adverse result in any
such litigation, the Company could be required to pay substantial damages,
cease the manufacture, use, sale, offer for sale andimportation of
infringing products, expend significant resources to develop or obtain
non-infringing technology, discontinue the use of certain processes or
obtain licenses to the technology which is the subject of the litigation.
There can be no assurance that the Company would be successful in such
development or acquisition or that any such licenses, if available, would be
available on commercially reasonable terms, and any such development or
acquisition could require expenditures by the Company of substantial time
and other resources. Any such litigation or adverse result therefrom could
have a material adverse effect on the Company's operating results.
Page 19 of 22
<PAGE> 20
In October 1995, Brooktree filed a complaint against the Company in the
United States District Court for the Southern District of California,
alleging that the Company's current products infringe a Brooktree patent.
Such a lawsuit resulted in substantial expense to the Company to defend the
action and diverted the efforts of the Company's technical and management
personnel. In August 1996, the Company and Brooktree entered into a
settlement and license agreement pursuant to which all claims and
counterclaims between the parties were dismissed and the Company agreed to
pay to Brooktree a license fee and royalties related to certain product
revenues over a five-year period.
International Operations
The Company expects that export sales will continue to represent a
significant portion of net sales, although there can be no assurance that
export sales, as a percentage of net sales, will remain at current levels.
In addition, a substantial proportion of the Company's products are
manufactured, assembled and tested by independent third parties in Asia. Due
to its export sales and independent third party manufacturing, assembly and
testing operations, and its joint venture foundry, the Company is subject to
the risks of conducting business internationally, including unexpected
changes in, or impositions of, legislative or regulatory requirements,
fluctuations in the U.S. dollar, which could increase the sales price in
local currencies of the Company's products in foreign markets or increase
the cost of wafers purchased by the Company, delays resulting from
difficulty in obtaining export licenses for certain technology, tariffs and
other barriers and restrictions, potentially longer payment cycles, greater
difficulty in accounts receivable collection, potentially adverse taxes, and
the burdens of complying with a variety of foreign laws. In addition, the
Company is subject to general geopolitical risks, such as political and
economic instability and changes in diplomatic and trade relationships, in
connection with its international operations. Two of the Company's
independent foundries, UMC and TSMC, and the Company's joint venture
foundry, USC, are located in Taiwan. The Company currently expects these
three foundries to supply the substantial portion of the Company's products
in 1997. The People's Republic of China and Taiwan at times experienced
strained relations in 1995 and 1996, and the worsening of relations or the
development of hostilities between the two parties could have a material
adverse effect on the Company. Although the Company has not to date
experienced any material adverse effect on its operations as a result of
such regulatory, geopolitical, economic and other factors, there can be no
assurance that such factors will not adversely impact the Company's
operations in the future or require the Company to modify its current
business practices. In addition, the laws of certain foreign countries may
not protect the Company's intellectual property rights to the same extent as
do the laws of the United States.
Volatility of Stock Price
The market price of the shares of Common Stock, like that of the common
stock of many other semiconductor companies, has been and is likely to be
highly volatile, and the market has from time to time experienced
significant price and volume fluctuations that are unrelated to the
operating performance of particular companies. The market price of the
Common Stock could be subject to significant fluctuations in response to
quarter-to-quarter variations in the Company's anticipated or actual
operating results, announcements of new products, technological innovations
or setbacks by the Company or its competitors, conditions in the
semiconductor and PC industries, the commencement of, developments in or
outcome of litigation, changes in or the failure by the Company to meet
estimates of the Company's performance by securities analysts, market
conditions for high technology stocks in general, and other events or
factors.
Page 20 of 22
<PAGE> 21
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27 Financial Data Schedule (filed only with the electronic submission of
Form 10-Q in accordance with the Edgar requirements)
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the three months
ended March 31, 1997.
Page 21 of 22
<PAGE> 22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
S3 INCORPORATED
(Registrant)
/S/DALE R. LINDLY
------------------------------
DALE R. LINDLY
Acting Chief Financial Officer
(Principal Financial and Accounting Officer)
May 12, 1997
Page 22 of 22
<PAGE> 23
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
No. Description
- -------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from S3
Incorporated Condensed Consolidated Balance Sheet as of March 31, 1997 and
Condensed Consolidated Statement of Income for the three months ended March 31,
1997 and is qualified in its entirety by reference to such 10-Q filing.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<EXCHANGE-RATE> 1
<CASH> 82,164
<SECURITIES> 64,413
<RECEIVABLES> 99,064
<ALLOWANCES> 2,181
<INVENTORY> 53,316
<CURRENT-ASSETS> 330,847
<PP&E> 61,611
<DEPRECIATION> 22,113
<TOTAL-ASSETS> 511,236
<CURRENT-LIABILITIES> 99,583
<BONDS> 103,500
0
0
<COMMON> 171,590
<OTHER-SE> 113,512
<TOTAL-LIABILITY-AND-EQUITY> 511,236
<SALES> 138,166
<TOTAL-REVENUES> 138,166
<CGS> 80,923
<TOTAL-COSTS> 80,923
<OTHER-EXPENSES> 31,572
<LOSS-PROVISION> 300
<INTEREST-EXPENSE> 1,622
<INCOME-PRETAX> 25,679
<INCOME-TAX> 9,758
<INCOME-CONTINUING> 15,921
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 15,921
<EPS-PRIMARY> 0.31
<EPS-DILUTED> 0.30
</TABLE>
