<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 September 30, 1998 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-21126
S3 INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0204341
---------------------------- ----------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
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 October 30, 1998 was 51,239,104.
<PAGE> 2
S3 INCORPORATED
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets
September 30, 1998 and December 31, 1997 3
Condensed Consolidated Statements of Income
Three months ended and nine months ended
September 30, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows
Nine months ended September 30, 1998 and 1997 5
Notes to Unaudited Condensed Consolidated Financial Statements 6-9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9-23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 23
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 23
Signatures 24
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
S3 INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except shares and per share data)
(Unaudited)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31
1998 1997
------------- -----------
<S> <C> <C>
Current assets:
Cash and equivalents $ 54,779 $ 90,484
Short-term investments 73,924 27,186
Accounts receivable (net of allowances
of $8,222 in 1998 and $5,664 in 1997) 24,836 60,713
Inventories 33,877 71,882
Prepaid expenses and other 58,676 51,172
--------- ---------
Total current assets 246,092 301,437
Property and equipment, net 28,616 46,628
Production capacity rights -- 4,800
Investment in joint venture 80,794 104,465
Other assets 52,746 35,524
--------- ---------
Total $ 408,248 $ 492,854
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 29,329 $ 42,819
Notes payable 16,877 26,717
Accrued liabilities 9,974 10,987
Deferred revenue 72 10,921
--------- ---------
Total current liabilities 56,252 91,444
Notes payable -- 4,800
Other liabilities 20,202 22,270
Convertible subordinated notes 103,500 103,500
Commitments and contingencies
(Notes 5 and 6)
Stockholders' equity:
Common stock, $.0001 par value;
70,000,000 shares authorized; 51,220,932
and 50,549,279 shares outstanding in 1998 and 1997 190,296 187,276
Unrealized gain on investments (975) 3,666
Accumulated translation adjustment (17,956) (19,944)
Retained earnings 56,929 99,842
--------- ---------
Total stockholders' equity 228,294 270,840
--------- ---------
Total $ 408,248 $ 492,854
========= =========
</TABLE>
See accompanying notes to the unaudited condensed
consolidated financial statements.
3
<PAGE> 4
S3 INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------- -------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net sales $ 47,286 $ 119,604 $ 183,092 $ 334,448
Cost of sales 55,206 86,191 168,842 225,717
--------- --------- --------- ---------
Gross margin (loss) (7,920) 33,413 14,250 108,731
Operating expenses:
Research and development 19,752 20,057 60,119 60,028
Selling, marketing and administrative 10,024 13,763 33,161 39,895
Write-off of acquired in-process technology -- -- 8,000 --
Restructuring charge 6,109 -- 6,109 --
--------- --------- --------- ---------
Total operating expenses 35,885 33,820 107,389 99,923
--------- --------- --------- ---------
Income (loss) from operations (43,805) (407) (93,139) 8,808
Gain on sale of joint venture -- -- 26,561 --
Other income (expense), net 127 (737) (4,057) (1,008)
Income (loss) before income taxes and equity
in net income of joint venture (43,678) (1,144) (70,635) 7,800
Provision (benefit) for income taxes -- (984) (11,956) 2,270
--------- --------- --------- ---------
Income before equity in net income of joint
venture (43,678) (160) (58,679) 5,530
Equity in net income of joint venture (includes
tax recovery of $4,705 for first half of 1998) 8,277 4,544 15,766 11,470
--------- --------- --------- ---------
Net income (loss) $ (35,401) $ 4,384 $ (42,913) $ 17,000
========= ========= ========= =========
Per share amounts:
Basic $ (0.69) $ 0.09 $ (0.84) $ 0.35
Diluted $ (0.69) $ 0.08 $ (0.84) $ 0.33
Shares used in computing per share amounts:
Basic 51,174 49,764 50,920 49,212
Diluted 51,174 52,380 50,920 51,805
</TABLE>
See accompanying notes to the unaudited condensed
consolidated financial statements.
4
<PAGE> 5
S3 INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
------------------------------
SEPTEMBER 30, SEPTEMBER 30,
1998 1997
------------- -------------
<S> <C> <C>
Operating activities:
Net income (loss) $(42,913) $ 17,000
Adjustments to reconcile net income to net
cash provided by operating activities:
Deferred income taxes 8,846 3,229
Depreciation and amortization 18,476 13,203
Loss on disposals of property and equipment 8,072 --
Write-off of acquired in-process technology 8,000 --
Gain on sale of joint venture (26,561) --
Equity in net income of joint venture (15,805) (18,678)
Changes in assets and
liabilities:
Accounts receivable 35,877 (41,338)
Inventories 38,005 2,739
Prepaid expenses and other 1,115 (3,221)
Accounts payable (13,490) 14,879
Accrued liabilities and other (4,161) 4,937
Restructuring reserve (391) --
Deferred revenue (10,849) 9,647
Income taxes payable (12,665) (2,651)
-------- --------
Net cash used for by operating activities (8,444) (254)
-------- --------
Investing activities:
Property and equipment purchases, net (3,970) (25,435)
Sale of joint venture 68,025 --
Sales/maturities (purchase) of short-term investments, net (46,379) 18,169
Technology investment -- (16,200)
Other assets 5,212 (12,875)
Purchase of technology (40,000) --
-------- --------
Net cash used for investing activities (17,112) (36,341)
-------- --------
Financing activities:
Sale of common stock, net 3,020 9,576
Net borrowings (repayments) of equipment financing (3,169) 9,402
Net borrowings (repayments) of notes payable (10,000) (9,600)
-------- --------
Net cash provided by (used for) financing activities (10,149) 9,378
-------- --------
Net decrease in cash and equivalents (35,705) (27,217)
Cash and cash equivalents at beginning of period 90,484 94,616
-------- --------
Cash and cash equivalents at end of period $ 54,779 $ 67,399
======== ========
</TABLE>
See accompanying notes to the unaudited
condensed consolidated financial statements.
5
<PAGE> 6
S3 INCORPORATED
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"). All
significant inter-company balances and transactions have been eliminated.
Investments in entities in which the Company does not have control, but has the
ability to exercise significant influence over operating and financial policies
are accounted for by the equity method. 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 September 30, 1998 and December 31, 1997, and the operating results
and cash flows for the nine months ended September 30, 1998 and 1997. 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,
1997, included in the Company's Form 10-K filed with the Securities and Exchange
Commission.
The results of operations for the three and nine months ended September 30,
1998 are not necessarily indicative of the results that may be expected for the
future quarters or the year ending December 31, 1998. Certain reclassifications
of 1997 amounts were made in order to conform to 1998 presentation.
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>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- -------------
<S> <C> <C>
INVENTORIES CONSIST OF:
Work in process $ 9,420 $28,392
Finished goods 24,457 43,490
------- -------
Total $33,877 $71,882
======= =======
</TABLE>
3. Technology Exchange:
In January 1998, the Company entered into a $40 million technology
exchange with Cirrus Logic, Inc. to obtain graphic functionality technologies.
As a result of the exchange, the Company acquired the technology covered by 10
graphic patents and 25 graphic patent applications, as well as cross-licensed
Cirrus Logic's remaining patents. Under the terms of the cross-licensing
provisions, the Company and Cirrus Logic have a perpetual license to each
other's graphic patents and additional licenses with respect to the other
party's patents for agreed upon periods of time.
The Company wrote-off $8 million of the acquired technologies not
utilized in current products as in-process technology in the first quarter of
1998. The remaining $32 million will be amortized to cost of sales based on the
lives of the currently utilized core technologies, which is generally five
years.
4. Earnings per share:
Basic earnings per share (EPS) is computed by dividing income available to
common stockholders by the weighted average number of common shares outstanding
for the period. Diluted EPS reflects the potential dilution that would occur
from any instrument or options which could result in additional common shares
being issued.
6
<PAGE> 7
The following table sets forth the computation of basic and diluted earnings
per share:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------ ------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
NUMERATOR
Net Income (loss)
Basic $(35,401) $ 4,384 $(42,913) $ 17,000
Interest expense on
subordinated debt -- -- -- --
-------- -------- -------- --------
Diluted $(35,401) $ 4,384 $(42,913) $ 17,000
======== ======== ======== ========
DENOMINATOR
Denominator for basic earnings
per share 51,174 49,764 50,920 49,212
Common stock equivalents -- 2,616 -- 2,593
Subordinated debt -- --
-------- -------- -------- --------
Denominator for diluted
earnings per share 51,174 52,380 50,920 51,805
======== ======== ======== ========
Basic earnings (loss) per share $ (0.69) $ 0.09 $ (0.84) $ 0.35
Diluted earnings (loss) per share $ (0.69) $ 0.08 $ (0.84) $ 0.33
</TABLE>
5. 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 invested a total of $89.4 million for its equity
interest of 23.75%. On December 31, 1997, the Company entered into an agreement
with UMC to sell to UMC 80 million shares of stock of USC for a purchase price
of 2.4 billion New Taiwan dollars. The Company received the purchase price
(approximately $68 million in cash) in January 1998 upon closing. As a result of
the January 1998 sale to UMC, S3's percentage ownership in USC decreased to
15.75%. 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 September 30, 1998, the
remaining advance payments and corresponding promissory notes totaled $14.4
million.
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.
6. 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.
Since November 1997, a number of complaints have been filed in federal and
state courts seeking an unspecified amount of damages on behalf of an alleged
class of persons who purchased shares of the Company's Common Stock at various
times between April 17, 1996 and November 3, 1997. The complaints name as
defendants the Company, certain of its officers and former officers, certain
directors of the Company and the Company's former auditors, asserting that they
violated federal and state securities laws by misrepresenting and failing to
disclose certain information about the Company's business. The plaintiffs in the
federal class actions
7
<PAGE> 8
moved to dismiss those cases and that request was granted. In addition, certain
stockholders have filed derivative actions seeking recovery on behalf of the
Company, alleging, among other things, breach of fiduciary duties by such
individual defendants. While management intends to defend the actions against
the Company vigorously, there can be no assurance that an adverse result or
settlement with regards to these lawsuits would not have a material adverse
effect on the Company's financial condition or results of operations.
The Company has received from the United States Securities and Exchange
Commission a request for information relating to the Company's recent
restatement announcement in November 1997. The Company has responded and intends
to continue to respond to such requests.
7. Restructuring Costs
In July 1998, the Company implemented a restructuring plan in order to
align resources with a new business model and to lower the Company's overall
cost structure. In connection with the restructuring, the Company reduced its
headcount and consolidated facilities. The following analysis sets forth the
significant components of the restructuring reserve at September 30, 1998:
<TABLE>
<CAPTION>
SEVERANCE AND FACILITY FURNITURE AND
BENEFITS CLOSURE EQUIPMENT TOTAL
------------- -------- ------------- -------
<S> <C> <C> <C> <C>
Restructuring charge $ 1,024 $ 2,474 $ 2,611 $ 6,109
Cash charge (633) -- -- (633)
Non-cash charge -- (2,474) (2,611) (5,085)
------- ------- ------- -------
Reserve balance September 30, 1998 $ 391 -- -- $ 391
======= ======= ======= =======
</TABLE>
Severance and related benefits represented the reduction of approximately
70 employees. The number of temporary employees and contractors was also
reduced. Write-off of assets include the write-off or write-down in carrying
value of equipment, which consists primarily of workstations, personal computers
and furniture that will no longer be utilized in the Company's operations. These
assets were written down to their fair value less cost to sell. Facility closure
expenses were incurred as a result of the Company's plan to vacate one of two
leased buildings at the Company's headquarters facility, and include leasehold
improvements, furniture, fixtures and network costs.
The Company expects to complete all of the actions associated with its
restructuring by the end of fiscal 1998.
8. Income Taxes
The 1998 effective tax rate (22%) reflects the expected benefit of current
year loss carrybacks and the establishment of a valuation allowance against the
beginning of the year balance of net deferred tax assets of $8.8 million.
Management believes that such net deferred tax assets are not realizable on a
more likely than not basis. Included in the Equity in Net Income of Joint
Venture on the Consolidated Statement of Income is a $4.7 million reversal of
income tax expense provided in the first and second quarters of 1998. Due to the
Company's losses in excess of expected carryback benefits, no provision for
eventual U.S. taxes on the remittance of joint venture income is necessary, and
the entire 1998 income tax benefit is allocated to income before equity in net
income of joint venture.
9. Recently Issued Accounting Standard
As of January 1, 1998, the Company adopted Statement 130, Reporting
Comprehensive Income. Statement 130 establishes new rules for the reporting and
display of comprehensive income and its components; however, the adoption of
this Statement had no impact on the Company's net income or shareholders'
equity. Statement 130 requires unrealized gains or losses on the Company's
available-for-sale securities and foreign currency translation adjustments,
which prior to adoption were reported separately in
8
<PAGE> 9
stockholders' equity to be included in other comprehensive income. Prior year
financial statements have been reclassified to conform to the requirements of
Statement 130.
Comprehensive income (loss) for the three months ended September 30, 1998
and 1997 was ($ 36.5) million and $4.4 million, respectively. Comprehensive loss
for the nine months ended September 30, 1998 $50.4 million and comprehensive
income for the nine months ended September 30, 1997 was $17.0 million.
10. Subsequent Events
On November 2, 1998, the Company announced that it appointed Kenneth
Potashner as President and Chief Executive Officer. The Board of Directors of
the Company also increased the size of the board by one, elected Mr. Potashner
to fill the newly created vacancy and elected Mr. Potashner Chairman of the
Board. Terry N. Holdt, who returned from his retirement in January 1998 to
assume the role of interim President, Chief Executive Officer and Chairman of
the Company, will remain Vice Chairman of the Company's Board of Directors.
In connection with his employment, Mr. Potashner entered into a three year
employment agreement which provides for a base salary of $500,000 per year and
participation in the Company's executive bonus plan and other executive benefit
programs. Under the agreement, Mr. Potashner is eligible to receive an annual
cash bonus of up to 200% of his base salary, with a minimum bonus payable of
$250,000 after the first year. Mr. Potashner also received two options to
purchase an aggregate of 4,500,000 shares of Common Stock of the Company. One
option for 1,500,000 shares vests upon the earlier of (i) six months from the
date of his employment, (ii) a change in control of the Company, or (iii)
termination of his employment without cause. A second option for 3,000,000
shares vests over four years from the date of his employment or earlier in
certain circumstances. In addition, Mr. Potashner is eligible for a one-time
"special cash bonus" on the third anniversary of the date of his employment in
the event that the Company's Common Stock has not achieved a $4.67 per share
increase in value ($7,000,000 divided by 1,500,000) from the date of his
employment. The one-time special cash bonus, if payable, will be equal to
$7,000,000 minus any increase above the stock price on his employment date for
1,500,000 shares. Such one-time bonus may also be payable in the event Mr.
Potashner's employment is terminated without cause following a change of control
of the Company. As a result of this special cash bonus, the Company may be
required to record a charge to earnings on a quarterly basis.
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, the availability and cost of
products from the Company's suppliers, and Year 2000 related actions, are
subject to risks and uncertainties, including those set forth below under "Year
2000 Compliance" and "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 environment and applications.
9
<PAGE> 10
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 NINE MONTHS ENDED
----------------------------- -------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 116.7 72.1 92.2 67.5
----- ----- ----- -----
Gross margin (loss) (16.7) 27.9 7.8 32.5
Operating expenses:
Research and development 41.8 16.8 32.8 18.0
Selling, marketing and administrative 21.2 11.5 18.1 11.9
Write-off of acquired in-process
technology -- -- 4.4 --
Restructuring charge 12.9 -- 3.3 --
----- ----- ----- -----
Total operating expenses 75.9 28.3 58.6 29.9
----- ----- ----- -----
Income (loss) from operations (92.6) (0.4) (50.8) 2.6
Gain on sale of joint venture -- -- 14.5 --
Other income (expense), net 0.2 (0.6) (2.2) (0.3)
----- ----- ----- -----
Income (loss) before income taxes and
equity in net income of joint venture (92.4) (1.0) (38.5) 2.3
Provision (benefit) for income taxes -- (0.8) (6.5) 0.6
Equity in net income of joint venture 17.5 3.8 8.6 3.4
----- ----- ----- -----
Net income (loss) (74.9)% 3.6% (23.4)% 5.1%
===== ===== ===== =====
</TABLE>
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, the
timing of significant orders, and operating results of USC, the Company's
manufacturing joint venture. Due to the industry, customer, competition and
company product offering related issues discussed below, the Company expects to
incur net losses for at least the next two quarters.
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 upon, the personal computer industry with sales
primarily in the U.S., Asia, and Europe. Net sales were $47.3 million for the
three months ended September 30, 1998, a 60.5% decrease from the $119.6 million
of net sales for the three months ended September 30, 1997. Net sales were
$183.1 million for the nine months ended September 30, 1998, a 45.3% decrease
from $334.4 million of net sales for the nine months ended September 30, 1997.
Net sales decreased as a result of declining unit average selling prices due to
aggressive pricing from certain of the Company's competitors, the sale of older
generation products at lower prices, as well as a significant decrease in number
of units sold. Unit volumes significantly decreased for the three months and
nine months ended September 30, 1998 as compared to the same periods in 1997,
which also impacted net sales. 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. Net sales for the three and
nine months ended September 30, 1998 were also adversely affected by the
economic downturn in Asia.
10
<PAGE> 11
The pricing environment for graphics accelerators has experienced and is
expected to continue to experience increasing pricing pressures due in part to
aggressive pricing from certain of the Company's competitors as well as the sale
of older generation products. In particular, the Company's Virge family of 2D/3D
and Trio 3D accelerators continue to experience decreases in average selling
prices. 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 and Trio 3D accelerators. The Company commenced shipment of its Savage 3D
family during the third quarter of 1998. Although the product has achieved a
degree of market acceptance, certain functionality characteristics have
precluded the product from competing in the high performance segment of the
market. If the Company is unable to introduce and successfully market higher
performance products, if the Company's products do not achieve market
acceptance, or if the pricing pressures increase above anticipated levels, the
Company's operating results could be adversely affected.
Export sales accounted for 94% and 76% of net sales for the three months
ended September 30, 1998 and 1997, respectively. Export sales accounted for 88%
and 68% of net sales for the nine months ended September 30, 1998 and 1997,
respectively. Approximately 35% and 26% of export sales for the three and nine
months ended September 30, 1998 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 37%, 27% and 15% of net sales for the three
months ended September 30, 1998. Four customers accounted for 24%, 17%, 15%, and
11% of net sales for the three months ended September 30, 1997. Two customers
accounted for 37% and 13% of net sales for the nine months ended September 30,
1998 and three customers accounted for 24%, 15% and 11% of net sales for the
nine months ended September 30, 1997. The Company's largest customer for the
first nine months of 1998 was the Company's largest Asian distributor, and a
substantial percentage of the Company's net sales for the first nine months were
made through distributors. The Company expects a significant portion of its
future sales to remain concentrated within a limited number of strategic
customers and distributors. There can be no assurance that the Company will be
able to retain its strategic customers and distributors or that such customers
and distributors 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 or distributor may fluctuate
significantly from quarter to quarter. The occurrence of any such events or the
loss of a strategic customer or distributor 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 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 (loss) percentage decreased to (16.7)% for the three months
ended September 30, 1998 from 27.9% for the three months ended September 30,
1997. Gross margin percentage decreased to 7.8% for the nine months ended
September 30, 1998 from 32.5% for the nine months ended September 30, 1997.
Gross margin percentage decreased due to declines in overall average selling
prices of the ViRGE and Trio family of accelerators, which resulted in part from
the increased proportion of the Company's export sales to Asian customers and
the substantial price competition experienced in the Asian market. In addition,
the Company does not currently offer products addressing the high performance
segment of the 3D acceleration market, which adversely affects the Company's
gross margin. The Company commenced shipment of the Savage 3D in the third
quarter at volumes lower than what the Company had anticipated. The Company had
anticipated that the Savage 3D product would address the high performance
segment of the graphics accelerator market. Although Savage 3D has achieved a
degree of market acceptance, certain functionality characteristics preclude the
product from competing in the high performance market. The Company experienced
certain yield losses on the Savage 3D product ramp during the third quarter
which impacted gross margin negatively. The Company recorded expenses relating
to reserves for certain excess and obsolete inventory and inventory write downs
for lower of cost or market in the third quarter of 1998 primarily for its 2D
products as well as some of its 3D products inventory. Gross margins for the
nine months ended
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September 30, 1998 were impacted by certain write downs for excess and obsolete
inventory and lower of cost or market reserves. The Company's gross margin was
also impacted in the three and nine months ended September 30, 1998 by the
amortization of license fees and will continue to be impacted in future quarters
by license fees.
In the future, the Company's gross margin percentages may be affected by
increased competition and related decreases in the 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 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 and systems OEMs.
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 $19.8 million for the three
months ended September 30, 1998, a decrease of $0.3 million from $20.1 million
for the three months ended September 30, 1997. Included in the third quarter
1998 research and development expenses were the write off of approximately $1.2
million of capital equipment related to idle or obsolete assets. Research and
development expenses were $60.1 million for the nine months ended September 30,
1998, an increase of $0.1 million from the $60.0 million for the nine months
ended September 30, 1997. The Company has experienced a decrease in headcount
for the three and nine months ended September 30, 1998 compared to the three and
nine months ended September 30, 1997. These were offset in the current year by
certain one time engineering costs incurred during the first quarter of 1998
associated with the discontinued audio and communications products line as well
as the write-off of idle, excess and obsolete capital equipment associated with
terminated projects in the third quarter of 1998.
Products in the Company's market typically have a life cycle of 12 to 18
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 motherboard and add-in card
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 $10.0 million for the
three months ended September 30, 1998, a decrease of $3.8 million from $13.8
million for the three months ended September 30, 1997. Selling, marketing and
administrative expenses were $33.2 million for the nine months ended September
30, 1998, a decrease of $6.7 million from $39.9 million for the nine months
ended September 30, 1997. Included in selling, marketing and administrative
expenses for the third quarter of 1998 was approximately $0.7 of capital
equipment write-offs related to idle, excess and obsolete fixed assets. The
decrease in selling, marketing and administrative expenses for the three and
nine month periods ended September 30, 1998 is primarily attributable to
decreased headcount and commission related expenses.
WRITE-OFF OF ACQUIRED IN-PROCESS TECHNOLOGY
In January 1998, the Company entered into a $40 million technology
exchange with Cirrus Logic, Inc. to obtain graphic functionality technologies.
As a result of the exchange, the Company acquired the technology covered by 10
graphic patents and 25 graphic patent applications, as well as cross-licensed
Cirrus Logic's remaining patents. Under the terms of the cross-licensing
provisions, the Company and Cirrus Logic have a perpetual license to each
other's graphic patents and additional licenses with respect to the other
party's patents for agreed upon periods of time.
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The Company wrote-off $8 million of the acquired technologies not
utilized in current products as in-process technology in the first quarter of
1998. The remaining $32 million will be amortized to cost of sales based on the
lives of the currently utilized core technologies, which is generally five
years.
RESTRUCTURING CHARGE
In July 1998, the Company implemented a restructuring plan in order to
align resources with a new business model and to lower the Company's overall
cost structure. In connection with the restructuring, the Company reduced its
headcount and consolidated facilities.
Severance and related benefits represented the reduction of
approximately 70 employees. The number of temporary employees and contractors
used by the Company was also reduced. Write-off of assets include the write-off
or write-down in carrying value of equipment, which consists primarily of
workstations, personal computers and furniture that will no longer be utilized
in the Company's operations. These assets were written down to their fair value
less cost to sell. Facility closure expenses were incurred as a result of the
Company's plan to vacate one of two leased buildings at the Company's
headquarters facility, and include leasehold improvements, furniture, fixtures
and network costs.
The Company expects to complete all of the actions associated with its
restructuring by the end of fiscal 1998. See Note 7 of Notes to Condensed
Consolidated Financial Statements.
GAIN ON SALE OF JOINT VENTURE
On December 31, 1997, the Company entered into an agreement with UMC to
sell to UMC 80 million shares of stock of USC for a purchase price of 2.4
billion New Taiwan dollars. The Company received the purchase price
(approximately $68 million in cash) in January 1998 upon closing. The gain on
the sale of stock of USC was $26.6 million.
OTHER INCOME /EXPENSE, NET
Other income, net was $0.1 million for the three months ended September
30, 1998 an increase of $0.8 million from $0.7 million of other expense, net for
the three months ended September 30, 1997. The increase in other income for the
three months ended September 30, 1998 compared to the three months ended
September 30, 1997 is attributable to an increase in interest income as a result
of higher cash balances in the third quarter of 1998 versus the third quarter of
1997. Other expense, net was $4.1 million for the nine months ended September
30, 1998 an increase of $3.1 million from $1.0 million of expense for the nine
months ended September 30, 1997. The increase was primarily associated with the
write off of certain equity technology investments and capital equipment for the
nine months ended September 30, 1998.
INCOME TAXES
The Company's effective tax rate benefit for the three and nine months ended
September 30, 1998 was 0% and 22%, respectively, compared to the 38% effective
tax rate for the three and nine months ended September 30, 1997. The effective
tax rate benefit for the three and nine months ended September 30, 1998 has been
limited by the overall expected benefit from current year loss carrybacks.
EQUITY IN NET INCOME OF JOINT VENTURE
As discussed in "Liquidity and Capital Resources", the Company entered into
an agreement with other parties to form a separate Taiwanese company, USC. This
investment is accounted for under the equity method of accounting in reporting
the Company's share of results for the entity. Equity in net income of joint
venture reflects the Company's share of income earned by USC for the current
quarter. The Company reported $8.3 million for the three months ended September
30, 1998. Included was a $4.7 million reversal of income tax expense provided in
the first and second quarters of 1998. Due to the Company's losses in excess of
expected
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carryback benefits (see "Income Taxes"), no provision for eventual U.S. taxes on
the remittance of joint venture income is necessary, and the entire 1998 income
tax benefit is allocated to income before equity in net income of joint venture.
The Company recorded $4.5 million net of tax of equity in net income of joint
venture, for the three months ended September 30,1997. The Company reported
$15.8 million of equity in net income of joint venture for the nine months ended
September 30, 1998, and it recorded $11.5 million net of tax for the nine months
ended September 30, 1997.
LIQUIDITY AND CAPITAL RESOURCES
Cash used for operating activities for the nine months ended September 30,
1998 was $8.4 million, as compared to $0.2 million of cash used for operating
activities for the nine months ended September 30, 1997. The Company's operating
loss, net of non-cash items, for the nine months ended September 30, 1998
consumed $41.9 million of cash. This was offset by the net change in certain
working capital accounts including accounts receivable, inventory and accounts
payable. Accounts receivable decreased as the result of lower sales for the
first nine months of 1998 and were offset in part by a decrease in accounts
payable associated with lower inventory production levels. By contrast, the
Company's operating activities, net of non-cash items, for the nine months ended
September 30, 1997 provided $14.8 million of cash. This was offset by certain
working capital accounts including accounts receivable, accounts payable and
deferred revenue. Accounts receivable increased as a substantial portion of the
Company's revenue was generated in September of 1997. This was offset by
increased accounts payable and deferred revenue during the first nine months of
1997.
Cash used for investing activities for the nine months ended September 30,
1998 of $17.1 million consisted primarily of the cash received from the sale of
USC shares, offset by cash used in the technology exchange with Cirrus Logic,
Inc. and purchases of short term investments, net of sales and maturities.
Investing activities for the nine months ended September 30, 1997 of $36.3
million consisted primarily of net purchases of property and equipment, an
equity investment in Faroudja Laboratories, Inc and various patent technology
investments offset by the sales and maturities of short term investments, net of
purchases.
Financing activities used cash of $10.1 million and provided cash of $9.4
million for the nine months ended September 30, 1998 and 1997 respectively.
Repayment on the line of credit and equipment financing were the principal
financing activities that used cash for the nine months ended September 30,
1998. Borrowings on the equipment line of credit and the issuance of common
stock were the principal financing activities that provided cash for the nine
months ended September 30, 1997, offset by the repayment of the line of credit.
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. In January 1998, the Company reduced its equity interest to
15.75% through the sale of a portion of its USC shares, and received
approximately $68.0 million in cash. Under the terms of the agreement, if at any
time a "Liquidity Event" occurs, S3 will be entitled to receive, in addition to
the initial payment of 2.4 billion New Taiwan dollars, a contingent payment of
up to 19 New Taiwan dollars per share, or up to an additional 1.5 billion New
Taiwan dollars (approximately U.S. $43.6 million at exchange rates prevailing on
September 30, 1998). A "Liquidity Event" is defined as any event by which UMC,
or its successor, will have the opportunity to receive value from transfer of
its ownership of shares of stock in USC in an arms-length transaction other than
by way of transfer to employees for incentives, whether or not UMC or its
successor, in fact, participates in such opportunity. A Liquidity Event will
include, for example, completion of a public offering of USC securities on a
recognized securities exchange; a sale of USC stock owned by UMC (or by a UMC
successor) in an arms-length transaction; or a sale of all or substantially all
of the assets of USC. 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. At September 30, 1998, the remaining
advance payments and corresponding promissory notes totaled $14.4 million.
Working capital at September 30, 1998 and December 31, 1997 was $189.8
million and $210.0 million, respectively. At September 30, 1998, the Company's
principal sources of liquidity included cash and equivalents of $54.8 million
and $73.9 million in short-term investments. In addition, the Company has one
secured equipment line of credit totaling $6.5 million. The Company had
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$2.5 million outstanding under this secured equipment line of credit at
September 30, 1998. The Company believes that its available funds will satisfy
the Company's projected working capital and capital expenditure requirements for
at least the next 12 months.
In January 1998, the Company entered into patent purchase and
cross-licensing agreements with Cirrus Logic, Inc. to enable a patent portfolio
exchange between the two companies for $40 million.
Since November 1997, a number of complaints have been filed in federal and
state courts seeking an unspecified amount of damages on behalf of an alleged
class of persons who purchased shares of the Company's Common Stock at various
times between April 17, 1996 and November 3, 1997. The complaints name as
defendants the Company, certain of its officers and former officers, certain
directors of the Company and the Company's former auditors, asserting that they
violated federal and state securities laws by misrepresenting and failing to
disclose certain information about the Company's business. The plaintiffs in the
federal class actions moved to dismiss those cases and that request was granted.
In addition, certain stockholders have filed derivative actions seeking recovery
on behalf of the Company, alleging, among other things, breach of fiduciary
duties by such individual defendants. While management intends to defend the
actions against the Company vigorously, there can be no assurance that an
adverse result or settlement with regards to these lawsuits would not have a
material adverse effect on the Company's financial condition or results of
operations.
The Company has received from the United States Securities and Exchange
Commission a request for information relating to the Company's recent
restatement announcement in November 1997. The Company has responded and intends
to continue to respond to such requests.
YEAR 2000 COMPLIANCE
As a result of computer programs being written using two digits, rather than
four, to represent year dates, the performance of the Company's computer systems
and those of its suppliers and customers in the Year 2000 is uncertain. Any
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in other normal business activities.
The Company's plans to address the Year 2000 issue involve the following
phases: (i) inventory/risk assessment, (ii) remediation, (iii) testing, and (iv)
full compliance and/or the creation of contingency plans. The Company has
completed an inventory and assessment of its systems for Year 2000 readiness.
The assessment indicated that most of the Company's significant information
technology systems could be affected, particularly the general ledger, billing,
and inventory systems. That assessment also indicated that software and hardware
(embedded chips) used in development, production and manufacturing systems also
are at risk. Based on a review of its product line, the Company believes that
its products do not require remediation to be Year 2000 compliant. Accordingly,
the Company believes that the Company's products will not expose the Company to
material Year 2000 related liabilities. The Company has also queried its
significant suppliers and subcontractors that do not share information systems
with the Company ("external agents"). Although the Company is not aware of any
external agent with a Year 2000 issue that would materially affect the Company's
results of operations or financial condition, the failure of an external agent
to be Year 2000 compliant could have a material adverse effect on the Company's
results of operations or financial condition. The Company intends to
periodically review its external agents to monitor their progress toward
completion of their Year 2000 compliance.
The Company is implementing the remediation and testing phases of its Year
2000 program. To date, the Company is approximately 80% complete on the
remediation phase for its information technology systems and expects to complete
software reprogramming and replacement in the first half of 1999. Once software
is reprogrammed or replaced for a system, the Company begins testing and
implementation. These phases run concurrently for different systems. To date,
the Company has completed approximately 25% of its testing. Completion of the
testing phase for all remediated systems is expected to occur in the first half
of 1999. The Company's order entry system interfaces directly with significant
third party vendors. The Company is in the process of working with third party
vendors to ensure that the Company's systems that interface directly with third
parties are Year 2000 compliant by the third quarter of 1999.
The Company will utilize both internal and external resources to reprogram,
or replace, test, and implement its software and operating equipment for Year
2000 modifications. The Company believes that costs for remediation, testing and
implementation are immaterial.
The Company currently has no contingency plans in place in the event it does
not complete all phases of the Year 2000 program. The Company plans to evaluate
the status of completion in January 1999 and determine whether such a plan is
necessary. The failure of either the Company's critical systems or those of its
material third parties to be Year 2000 compliant would result in the
interruption of its business, which could have a material adverse affect on the
results of operations or financial condition of the Company.
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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, the
timing of significant orders, and operating results of USC, the Company's
manufacturing joint venture. 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, order cancellations or
rescheduling and the other factors discussed below. These factors have adversely
affected 1998 results and could adversely affect demand for the Company's
products in the future. In addition, the pricing environment for graphics
accelerators has recently experienced increasing pricing pressures and is
expected to continue to experience pricing pressures, due in part to aggressive
pricing from certain of the Company's competitors. The graphics accelerator
market is transitioning from 2D acceleration to 3D acceleration, and the Company
does not currently offer products addressing the high performance 3D
acceleration market, which adversely affects the Company's gross margin and
profitability. 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 its ViRGE
family of 2D/3D accelerators. The Company commenced shipments of Savage3D during
the third quarter of 1998, which was designed to address the high performance 3D
acceleration market. Although Savage 3D has achieved a degree of market
acceptance, the product does not compete in the high end performance segment of
the market. If the Company is unable to introduce and successfully market higher
performance products, if the Company's products do not achieve market
acceptance, or if pricing pressures increase above normal anticipated levels,
the Company's operating results could be adversely affected. 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
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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 generally 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 18 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 has not offered products addressing the high performance
3D acceleration market, which has adversely affected the Company's business and
operating results. The Company is continually developing new products, such as
the Savage3D, 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. Market acceptance of the
Company's products will also depend upon acceptance of other components, such as
memory, that the Company's products are designed to work with.
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. 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,
together with United Microelectronics Corporation ("UMC") and Alliance
Semiconductor Corporation, owns
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USC. The Company currently owns 15.75% of USC and maintains the right to
purchase up to 31.25% of USC's output. 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 over-capacity 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 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. 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 1998. 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.
Dependence on Accelerator Product Line
S3's products are designed to improve the graphics and multimedia
performance of Pentium-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
18
<PAGE> 19
general purpose computing capabilities will be integrated into future versions
of Intel and other Pentium-based microprocessors and that standard multimedia
accelerators in the future will likely integrate memory, system logic, audio,
communications or other additional functions. In particular, Intel and other
manufactures have announced plans to develop chips that integrate graphics and
processor functions to serve the lower cost PC market. A substantial portion of
the Company's 1997 sales were derived from products addressing the lower cost PC
market, and the Company anticipates that a substantial portion of its 1998 sales
will also be derived from products addressing this market. 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 Pentium-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. The
Company's initial product containing a number of these functions, Plato/PX, has
been discontinued. In addition, in 1997 the Company wrote off approximately
$17.2 million of intangible assets including certain licenses, patents and other
technology as a result of management's decision to focus on the core graphics
business. In the first quarter of 1998, the Company discontinued its audio and
communication products line. 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 and Silicon Graphics has introduced OpenGL, which have emerged as
the standard APIs for 3D acceleration. While the Company's 3D accelerators
currently support the Company's proprietary API, Microsoft's Direct 3D API and
OpenGL, there can be no assurance that another API will emerge as an industry
standard that the Company's accelerators will not support. Also, due to the
widespread industry acceptance of Intel's microprocessor architecture and
interface architecture, including its AGP bus, Intel exercises significant
influence over the PC industry generally, and the inability of the Company to
develop successfully products that are compatible with the AGP technology, Intel
microprocessors or other aspects of the PC microprocessor architecture, whether
the need for compatibility results from significant modifications by Intel to
its existing technology, architecture or standards, would have a material
adverse effect on the Company's business, financial condition and results of
operations. Any delay in the public release of information relating to any such
modifications could also have a material adverse effect on the Company's
business, financial condition and results of operations. 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.
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., Matrox Graphics Inc.,
Intel 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
are a significant number of established and emerging companies that have
developed, are developing or have announced plans to develop 3D graphics chips.
These include Intel, which recently commenced shipments of the Intel740 3D
graphics processor. In addition, Intel has acquired Chips and Technologies,
Inc., a leading provider of accelerators for the mobile PC market, and has
announced a collaboration with 3Dlabs, Inc., Ltd. to develop a graphics
processor targeting the high end workstation market. To the extent that Intel's
initiatives in the graphics sector are successful, the Company's business,
financial condition and results of operations could be materially and adversely
affected. 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 for the remainder of 1998 and future periods could be
materially and adversely affected. The Company's current products, including its
recently introduced Savage 3D accelerator, do not
19
<PAGE> 20
address the high performance segment of the market, which has resulted in
substantial pricing and margin pressures on the Company's products and adversely
affected the Company's recent results of operations. There are a significant
number of companies, including Intel, that offer products addressing this market
segment. 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, it will
encounter substantial competition from established semiconductor companies and
may experience competition from companies designing chips based on different
technologies. Furthermore, 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, 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. Three customers
accounted for 37%, 27% and 15% of net sales for the three months ended September
30, 1998. Four customers accounted for 24%, 17%, 15% and 11% of net sales for
the three months ended September 30, 1997. Two customers accounted for 37% and
13% of net sales for the nine months ended September 30, 1998 and three
customers accounted for 24%, 15% and 11% of net sales for the nine months ended
September 30, 1997. 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 Company's distributors are
permitted to return to the Company the products purchased by them, and the
Company provides its distributors with price protection in the event that the
Company reduces the prices of its products. The Company's largest customer in
the first nine months of 1998, is the Company's largest Asian distributor, and a
substantial percentage of the Company's net sales for the nine months ended
September 30, 1998 were made through distributors.
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. Any
problems encountered in the implementation of such a 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
December 1997, Terry N. Holdt returned to the Company as its interim Chief
Executive Officer and President and Chairman of the Board and in November 1998,
Kenneth Potashner was appointed interim Chief Executive Officer and President
and Chairman of the Board of Directors of the Company and Mr. Holdt became Vice
Chairman. 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. See Note 9 of Notes to Condensed Consolidated Financial Statements.
20
<PAGE> 21
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 resulted in, 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 an adverse result in any such litigation,
the Company could be required to pay substantial damages, cease the manufacture,
use, sale, offer for sale and importation 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.
In October 1995, Brooktree filed a complaint against the Company in the
United States District Court for the Southern District of California, alleging
that certain of the Company's products infringed 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. The Company has
experienced an adverse impact associated with the economic downturn in Asia and
there can be no assurance that the volatility in the Asian economy will not
continue to adversely affect the Company's business, financial condition and
results of operations. 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 1998. 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 to date not 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.
21
<PAGE> 22
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. Although the Company currently believes that the need
for such additional capital is minimal for the next two years, if such capital
is needed, 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.
Volatility of Stock Price
The market price of the shares of the Company's 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 Company's 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 earnings estimates by
securities analysts, market conditions for high technology stocks in general,
and other events or factors.
Year 2000 Compliance
As a result of computer programs being written using two digits, rather than
four, to represent year dates, the performance of the Company's computer systems
and those of its suppliers and customers in the Year 2000 is uncertain. Any
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in other normal business activities.
The Company's plans to address the Year 2000 issue involve the following
phases: (i) inventory/risk assessment, (ii) remediation, (iii) testing, and (iv)
full compliance and/or the creation of contingency plans. The Company has
completed an inventory and assessment of its systems for Year 2000 readiness.
The assessment indicated that most of the Company's significant information
technology systems could be affected, particularly the general ledger, billing,
and inventory systems. That assessment also indicated that software and hardware
(embedded chips) used in development, production and manufacturing systems also
are at risk. Based on a review of its product line, the Company believes that
its products do not require remediation to be Year 2000 compliant. Accordingly,
the Company believes that the Company's products will not expose the Company to
material Year 2000 related liabilities. The Company has also queried its
significant suppliers and subcontractors that do not share information systems
with the Company ("external agents"). Although the Company is not aware of any
external agent with a Year 2000 issue that would materially affect the Company's
results of operations or financial condition, the failure of an external agent
to be Year 2000 compliant could have a material adverse effect on the Company's
results of operations or financial condition. The Company intends to
periodically review its external agents to monitor their progress toward
completion of their Year 2000 compliance.
The Company is implementing the remediation and testing phases of its Year
2000 program. To date, the Company is approximately 80% complete on the
remediation phase for its information technology systems and expects to complete
software reprogramming and replacement in the first half of 1999. Once software
is reprogrammed or replaced for a system, the Company begins testing and
implementation. These phases run concurrently for different systems. To date,
the Company has completed approximately 25% of its testing. Completion of the
testing phase for all remediated systems is expected to occur in the first half
of 1999. The Company's order entry system interfaces directly with significant
third party vendors. The Company is in the process of working with third party
vendors to ensure that the Company's systems that interface directly with third
parties are Year 2000 compliant by the third quarter of 1999.
22
<PAGE> 23
The Company will utilize both internal and external resources to reprogram,
or replace, test, and implement its software and operating equipment for Year
2000 modifications. The Company believes that costs for remediation, testing and
implementation are immaterial.
The Company currently has no contingency plans in place in the event it does
not complete all phases of the Year 2000 program. The Company plans to evaluate
the status of completion in January 1999 and determine whether such a plan is
necessary. The failure of either the Company's critical systems or those of its
material third parties to be Year 2000 compliant would result in the
interruption of its business, which could have a material adverse affect on the
results of operations or financial condition of the Company.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Since November 1997, a number of complaints have been filed in federal and
state courts seeking an unspecified amount of damages on behalf of an alleged
class of persons who purchased shares of the Company's common stock at various
times between April 17, 1996 and November 3, 1997. The complaints name as
defendants the Company, certain of its officers and former officers, certain
directors of the Company and the Company's former auditors, asserting that they
violated federal and state securities laws by misrepresenting and failing to
disclose certain information about the Company's business. The plaintiffs in the
federal class actions moved to dismiss those cases and that request was granted.
In addition, certain stockholders have filed derivative actions in California
and Delaware state courts seeking recovery on behalf of the Company, alleging,
among other things, breach of fiduciary duties by such individual defendants.
While management intends to defend the actions against the Company vigorously,
there can be no assurance that an adverse result or settlement with regards to
these lawsuits would not have a material adverse effect on the Company's
financial condition or results of operations.
The Company has received from the United States Securities and Exchange
Commission a request for information relating to the Company's restatement
announcement in November 1997. The Company has responded and intends to continue
to respond to such requests.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
23
<PAGE> 24
12 Statement of Computation of Earnings to Fixed Charges
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 September 30, 1998.
24
<PAGE> 25
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/ WALTER D. AMARAL
--------------------
WALTER D. AMARAL
Senior Vice President Finance
and Chief Financial Officer
(Principal Financial and Accounting Officer)
November 13, 1998
25
<PAGE> 26
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBITS
-------- --------
<S> <C>
12 Statement of Computation of Earnings to Fixed Charges
27 Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 12
S3 INCORPORATED
STATEMENT OF COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(in thousands, except ratios)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------------------- -------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Income (loss) before income taxes and equity
in net income of joint venture $(43,678) $ (1,144) $(70,635) $ 7,800
Add fixed charges 2,137 2,201 6,382 6,539
-------- -------- -------- --------
Earnings (as defined) $(41,541) $ 1,057 $(65,116) $ 13,476
======== ======== ======== ========
Fixed Charges:
Interest expense $ 1,583 $ 1,648 $ 4,722 $ 4,878
Amortization of debt issuance costs 122 121 365 366
Estimated interest component
of rent expense 432 432 1,295 1,295
-------- -------- -------- --------
Total fixed charges $ 2,137 $ 2,201 $ 6,382 $ 6,539
======== ======== ======== ========
Ratio of earnings to fixed charges -- -- -- 2.1
======== ======== ======== ========
</TABLE>
For the three and nine months ended September 30, 1998 and for the three months
ended September 30, 1997, earnings were insufficient to cover fixed charges as
evidenced by a less than one-to-one coverage ratio. Additional earnings of $43.7
million and $71.5 million were necessary for the three and nine months ended
September 30, 1998 respectively, to provide a one-to-one coverage ratio.
Additional earnings of $1.1 million were necessary for the three months ended
September 30, 1997 to provide a one-to-one coverage ratio.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 54,779
<SECURITIES> 73,924
<RECEIVABLES> 33,058
<ALLOWANCES> 8,222
<INVENTORY> 33,877
<CURRENT-ASSETS> 246,092
<PP&E> 60,535
<DEPRECIATION> 31,919
<TOTAL-ASSETS> 408,248
<CURRENT-LIABILITIES> 56,252
<BONDS> 0
0
0
<COMMON> 190,296
<OTHER-SE> 37,998
<TOTAL-LIABILITY-AND-EQUITY> 228,294
<SALES> 183,092
<TOTAL-REVENUES> 183,092
<CGS> 168,842
<TOTAL-COSTS> 168,842
<OTHER-EXPENSES> 107,389
<LOSS-PROVISION> 400
<INTEREST-EXPENSE> 5,087
<INCOME-PRETAX> (70,635)
<INCOME-TAX> (11,956)
<INCOME-CONTINUING> (42,913)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (42,913)
<EPS-PRIMARY> (0.84)
<EPS-DILUTED> (0.84)
</TABLE>
