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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 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)
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DELAWARE 77-0204341
(STATE OR OTHER JURISDICTION OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NO.)
OR ORGANIZATION)
2841 MISSION COLLEGE BOULEVARD 95054
SANTA CLARA, CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 588-8000
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.0001 PAR VALUE
SERIES A PARTICIPATING PREFERRED STOCK PURCHASE RIGHTS
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference to Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $420,458,976 as of March 1, 1999, based upon the
closing price on the Nasdaq National Market reported for such date. This
calculation does not reflect a determination that certain persons are affiliates
of the Registrant for any other purpose.
51,848,023 shares of the Registrant's Common stock, $.0001 par value, were
outstanding at March 1, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
Items 10 (as to directors), 11 and 12 of Part III incorporate by reference
information from the Registrant's Proxy Statement to be filed with the
Securities and Exchange Commission in connection with the solicitation of
proxies for the Registrant's 1999 Annual Meeting of Stockholders.
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S3 INCORPORATED
FORM 10-K
INDEX
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PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 8
Item 3. Legal Proceedings........................................... 9
Item 4. Submission of Matters to a Vote of Security Holders......... 9
PART II
Item 5. Market For Registrant's Common Equity and Related
Stockholder Matters......................................... 10
Item 6. Selected Consolidated Financial Data........................ 11
Item 7. Management's Discussion and Analysis of Financial Condition
and
Results of Operations....................................... 12
Item 7A. Quantitative and Qualitative Disclosure About Market Risk... 26
Item 8. Financial Statements and Supplementary Data................. 28
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................... 72
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 72
Item 11. Executive Compensation...................................... 73
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 73
Item 13. Certain Relationships and Related Transactions.............. 73
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 73
SIGNATURES............................................................ 77
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PART I
ITEM 1. BUSINESS.
When used in this Report, 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, trends in the personal computer
("PC") market, the percentage of export sales and sales to strategic customers,
and the adoption or retention of industry standards, and the availability and
cost of products from the Company's suppliers, are subject to risks and
uncertainties, including those set forth under "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Factors That May
Affect Our Results" and elsewhere in this report, 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 such statement is based.
GENERAL
S3(R) Incorporated ("S3" or the "Company") is a leading supplier of
multimedia acceleration hardware and its associated software 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 multimedia user interface and
applications. By complementing the computing power of the general purpose CPU,
the Company's integrated software and silicon-based accelerator solutions
significantly improve the multimedia performance of PCs while reducing overall
system cost and complexity. S3 has been a pioneer in graphics acceleration since
1991, when it was the first company to ship in volume a single chip graphics
accelerator with a local bus interface. S3 has since delivered new generations
of high performance accelerator solutions from the first 32-bit and 64-bit
graphics accelerator families to the first 128-bit, full-featured integrated
two-dimensional ("2D") and three-dimensional ("3D") graphics and video
accelerator specifically designed for today's 3D and digital versatile disc
("DVD")-based applications. As the demand for greater multimedia capabilities in
PCs increases, particularly the demand for 2D/3D technology, the Company is
focused on delivering accelerator solutions for use in business desktop, home
and mobile computing systems. S3's families of accelerator products and software
are currently used by many of the world's leading original equipment PC
manufacturers ("OEMs") and add-in card and motherboard manufacturers.
S3 was incorporated on January 9, 1989 in the State of Delaware. The
Company operates in one principal industry segment.
MARKETS AND RECENT DEVELOPMENTS
S3 supplies integrated 2D, 3D and video accelerators for the desktop and
mobile markets. The desktop market is the largest segment of the PC industry for
the Company's accelerator products and is characterized by intense competition
and rapid technological advances. In 1998, S3 introduced the Savage3D
accelerator. With the Savage3D chip, the Company redesigned its 3D architecture
to deliver high-performance multimedia graphics, utilizing S3 texture
compression ("S3TC") and single-pass trilinear filtering technologies. S3TC(TM)
is a compression technology that compresses data up to one-sixth the normally
required space, which allows for cost effectiveness, and was selected by
Microsoft Corporation ("Microsoft") as the standard compression technique in
DirectX(TM). The compression technique is also able to deliver photo-realistic
3D quality for the first time on the PC. Rapidly gaining industry support, S3TC
has been widely adopted for use in 1999's top 3D software game titles, including
Unreal and Unreal Tournament, Quake3 Arena, Half Life, Anachronox, Expendable
and TrueSpace4 and is being incorporated in future software titles.(1) Combined
with
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1The software titles set forth above may be trademarks or registered
trademarks of their respective owners.
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S3TC, the single-pass trilinear filtering enhances image quality over
traditional bilinear filtering and enables high 3D graphics performance by
removing motion artifacts for smoother images without performance degradation.
The Company entered into the mobile market with the introduction of the
Aurora64V+ product. The Company's mobile strategy is to combine the same level
of 2D, 3D and video capabilities found in S3's desktop accelerators with
advanced power management and flat panel display support. S3's second-generation
mobile product, the ViRGE/MX accelerator, brings powerful capabilities to
notebook PC users that exceeds the performance and functionality levels of core
feature available for the mobile PC platform by providing industry-first
technologies such as fully-integrated TV-out, DuoView dual display capability
and AGP support.
In December 1998, S3 announced a long-term strategic relationship with
Intel Corporation ("Intel"). The agreements with Intel include a 10-year
cross-license agreement for all S3 and Intel patents for the development of
certain semiconductor products, a bus license for current and future Intel
general purpose processors, and the selection of S3 as an Intel Accelerated
Graphics Port ("AGP") 4X validation partner. S3 had previously acquired certain
patents and patent applications from Cirrus Logic Inc. to which Intel already
had a license. The graphics industry is transitioning from 2X AGP to 4X AGP and
the Company intends to take advantage of this opportunity to create a
differentiating advantage in graphics as well as to create major opportunities
outside the traditional desktop and mobile space. To do this, the Company
intends to pursue an integration strategy that involves both integrating core
logic and graphics.
In February 1999, S3 introduced the second generation of the Savage family.
The Savage4 accelerator features industry-first 4X AGP, S3TC and advanced
digital flat panel display support.
PRODUCTS
S3's product strategy is to offer an integrated 2D/3D multimedia solution
comprised of hardware and software designed around a common architecture that
will become the standard graphics engine and a cost-effective package for the
desktop and mobile markets. The Company has developed a series of advanced
graphics and video accelerators for use by mainstream multimedia computer
suppliers in high performance, cost effective products for the business, home
and mobile markets. All of S3's accelerator solutions are designed to complement
the CPU by executing those functions most appropriate to a dedicated accelerator
while allowing the CPU to execute the more general purpose computing functions.
The Company's graphics and video accelerator product line includes a broad array
of products to support PC add-in card, motherboard and computer system OEM
designs in both desktop and mobile markets. S3's family of products range from
accelerators designed for the desktop market that target cost-conscious
consumers to fully-featured multimedia systems designed for high-end mobile and
desktop markets. The Company works closely with its key customers in each of
those areas to design the products that meet the needs of the individual
markets.
GRAPHICS AND VIDEO ACCELERATOR PRODUCTS
ViRGE/MX. ViRGE/MX is the second generation 3D graphics accelerator for
notebook PCs, which combines the same level of 2D/3D video acceleration found in
the Company's desktop accelerators with advanced power management and flat panel
display support. The product features DuoView, integrated TV-out and a full set
of 3D rendering, including MIP mapping, tri-linear filtering and perspective
correction textures. The product also supports the AGP standard.
Trio3D. Trio3D is the third generation of the Trio family of accelerators.
It features a 128-bit pipeline architecture, support for 125 MHz SGRAM memory
and S3's Burst Command Interface(TM) -- a proprietary protocol technology that
works in conjunction with either the PCI or AGP bus to increase the command and
data efficiency of the Trio3D architecture. Trio3D also supports 3D rendering
and is the first accelerator to fully implement the industry standard Video
Interface Port ("VIP") bus which provides a dedicated interface from the
graphics accelerator to digital video devices and streamlines the movement of
this data versus current PCI bus solutions. The Trio3D allows for a low-cost,
easy-to-implement interface to third party multimedia peripherals such as video
cameras, TV-tuners and DVD/MPEG-2 decoders. It also provides support for AGP
standard and is designed to be pin-compatible with existing Trio and ViRGE-based
designs. In addition,
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Trio3D's software compatibility with previous generations of S3 products is
intended to enable faster time-to-market for manufacturers.
Savage3D. Savage3D is the first generation of a newly designed multimedia
solution for 2D, 3D and DVD/video acceleration. It features a 128-bit single
cycle trilinear architecture, support for 4X AGP and Microsoft-endorsed texture
compression technology. The single trilinear filtering enables the high 3D
graphics performance. Savage3D is the first 3D accelerator to utilize S3TC, a
Microsoft-endorsed texture compression technology. Savage3D produces images
through its true color rendering, which enables the use of 16 million colors and
is optimized for full 2X AGP. Savage3D is pin-compatible with the Trio3D.
Savage4. Savage4 is the second generation of the Savage family of
accelerators. Designed for the consumer and commercial PC markets, S3's Savage4
delivers 2D graphics and video acceleration, as well as 3D rendering
capabilities equivalent to high-end, niche gaming solutions. Savage4 features a
128-bit 3D engine, AGP 4X technology, true 32-bit 3D rendering, S3TC, trilinear
filtered single-pass multi-texturing, hardware accelerated DVD, 32 MB memory
support and complete digital flat panel support. Currently, Savage4 comes in two
configurations: the Savage4 PRO and the Savage4 GT. The Savage4 PRO incorporates
industry-first AGP 4X technology, 143MHz memory support and up to a 32MB local
frame buffer, while the Savage4 GT incorporates AGP 2X technology, 125MHz memory
support and up to a 16MB local frame buffer for low-end PC markets.
SOFTWARE
The Company believes that a complete solution for its customers must
include not only high performance acceleration features implemented in silicon,
but also a broad line of software, including BIOS, drivers and utilities, that
are designed to optimize the performance of its accelerators. The software is
shipped as an integral part of the Company's accelerator products. The Company
maintains a flexible driver architecture, allowing its drivers to be easily
upgraded for the enhanced features supported in next generation accelerator
products. S3 uses a combination of in-house software developers and independent
contractors to develop its software drivers. The Company's in-house software
development team develops strategic software, including BIOS and drivers for the
Windows family of operating systems. The Company believes that software
expertise is vital to determining the optimal trade-off between silicon and
software for next generation accelerator performance and functionality
enhancements. The Company has also developed extensive capabilities for testing
its accelerators, software drivers and BIOS across a range of applications and
OEM system configurations.
S3 is also actively developing software drivers for what have emerged as
the standard APIs for 3D acceleration. Microsoft's Direct3D has emerged as the
standard API for the mainstream PC platform and Silicon Graphics, Inc.'s
("Silicon Graphics") OpenGL emerged as the standard API for high-performance 3D
graphics. S3 intends to support its proprietary API, OpenGL, Direct3D and
third-party APIs based on market acceptance of such APIs and S3's needs to
support and promote new features of future accelerators. S3 has developed an
OpenGL driver for the ViRGE, Trio and Savage family of 2D/3D accelerators to
support CAD/engineering, modeling/rendering and other high-end 3D applications
traditionally supported on workstation platforms. In August 1997, the Company
and Silicon Graphics announced a long term licensing agreement whereby S3 will
distribute OpenGL. The Company will provide its OEM customers with source and
object code for OpenGL, a proven, highly versatile 2D and 3D graphics API that
enables PC, workstation and supercomputing hardware vendors to provide
high-performance graphics solutions.
FUTURE ACCELERATORS AND SOFTWARE
The Company has in development several graphics and video accelerators and
related software products for currently scheduled introduction throughout 1999.
S3 believes that its extensive software, systems and silicon expertise, use of
advanced design tools, centralized engineering group with strong design
expertise and close working relationships with strategic customers and software
developers should position the Company to continue to rapidly and
cost-effectively define, develop and market advanced accelerators and related
software for the PC market. The Company analyzes and uses industry tools such as
Ziff Davis 3-D benchmark, 3-D
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Winbench 98 and other independent benchmarking software in its efforts to
provide the highest level of accelerator and feature compliance. In future
products, the Company plans to be fully compliant with the graphics initiative
from Intel for AGP as defined by the PC98 and PC99 system design guides, which
are a reference for designing PCs and peripherals for the Microsoft Windows
family of operating systems and are primarily driven by Microsoft, Intel and
other industry leaders.
Recognizing the rapid conversion of consumer electronic products from
analog to digital technology, the convergence of consumer and computing systems
into new and evolving information access devices and the personal computer's
inherent position as the most advanced and well-positioned digital platform, the
Company intends to leverage its PC system architecture and multimedia
acceleration expertise to develop new products for both computer and consumer
applications that exploit these trends.
SALES, MARKETING AND DISTRIBUTION
S3 markets and distributes its products through a direct sales organization
supported by field applications engineers, as well as through a network of
independent manufacturers' representatives and regional distributors. In North
America, the Company uses a combination of independent manufacturers'
representatives and a direct sales force operating from the Company's sales
offices in California, Georgia, North Carolina and Texas. In Asia, the Company
operates from sales and distribution offices in Hong Kong, Japan, Singapore and
Taiwan, and through manufacturers' representatives and local distributors
located in Hong Kong, Japan, Korea and Taiwan. In Europe, the Company uses
organizations that are both manufacturers' representatives and distributors in
France, Germany and the United Kingdom. The loss of one or more representatives
could have an adverse effect on the Company's operating results. The Company has
a global shipment program pursuant to which certain finished products are
shipped directly to customers from the Company's independent assembly and
testing houses. This program is intended to provide more timely delivery of such
products to those customers by eliminating the intermediate step of shipping
finished products to the Company's Santa Clara, California facility for
repackaging and reshipment.
The Company sells multimedia accelerators to original equipment
manufacturers, third party subsystem manufacturers, motherboard manufacturers
and distributors. Sales to these customers are typically made pursuant to
specific purchase orders, which are cancelable without significant penalties. In
1998, three customers, Synnex Technology, Inc. ("Synnex"), IBM Corporation and
Promate Electronics Co., accounted for 39%, 14% and 13%, respectively, of net
sales. In 1997, three customers, Synnex, CNW International Limited, and Compaq
Computer Corporation, accounted for 20%, 13% and 12%, respectively, of net
sales. In 1996, two customers, Diamond Multimedia Systems, Inc., and Synnex,
accounted for 16% and 15%, respectively, of net sales. Synnex, CNW International
Limited and Promate Electronics Co. are distributors. The Company expects a
significant portion of its future sales to remain concentrated within a limited
number of strategic customers. There can be no assurance that the Company will
be able to retain its strategic customers or that such customers will not
otherwise cancel or reschedule orders, or in the event of canceled orders, that
such orders will be replaced by other sales. In addition, sales to any
particular customer may fluctuate significantly from quarter to quarter. The
occurrence of any such event could have a material adverse effect on the
Company's operating results. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Factors That May Affect Our
Results -- We Have Significant Exposure to International Markets."
Export sales accounted for 89%, 70% and 58%, of net sales in 1998, 1997 and
1996 respectively. Approximately 29% of export sales in 1998 were to affiliates
of United States customers. Due to its export sales, the Company is subject to
the risks of conducting business internationally, including those set forth
under " Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Factors That May Affect Our Results -- We Have Significant
Exposure to International Markets."
CUSTOMER SUPPORT AND SERVICE
The Company believes that customer service and technical support are
important competitive factors in the accelerator market. The Company provides
technical support for customers in major markets in North
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America, Europe and Asia. Distributors and manufacturers' representatives
supplement the Company's efforts by providing additional customer service and
technical support for the Company's products. The Company also provides several
other types of technical support, including software distribution through the
World Wide Web, product demonstration software, evaluation boards and
application notes.
The Company works closely with its customers in tracking the progress of
its product designs, providing applications design support and upgrading the
customers' software to provide the latest enhancements. The Company believes
that close contact with its customers not only improves their level of
satisfaction, but also provides important insights into defining the system
requirements for next generation accelerators and related software products.
MANUFACTURING AND DESIGN METHODOLOGY
The Company currently relies on two independent foundries to manufacture
all of its products. The Company's strategy is to utilize a number of qualified
foundries that it believes provide cost, technology or capacity advantages for
specific products. This "fabless" strategy allows the Company to avoid the
significant capital investment to construct an in-house wafer fabrication
facility and is a well entrenched business model within the semiconductor
industry. As a result, the Company is able to focus its resources on product
design and development, quality assurance, marketing and customer support. The
Company's accelerators are currently manufactured using a five level metal
complementary metal oxide semiconductor ("CMOS") process with line geometries as
small as 0.25 micron. The Company will utilize a six level metal CMOS process
with 0.18 micron line geometries for certain of its products scheduled for 1999
production. In order to provide increased functionality to meet the needs of the
multimedia market without substantially increasing die size, the Company's
products will have to be manufactured using increasingly smaller line
geometries. The Company designs its products using proprietary circuit modules
that are scalable in size to enable more rapid adoption of smaller line geometry
manufacturing processes and a common design rule approach to operate within the
process parameters of multiple foundries. Multiple sources for certain products
increase the Company's ability to supply its customers with those products and
reduce the Company's dependence on any single foundry. However, the Company has
not developed alternate sources of supply for certain products, and its newly
introduced products are typically produced initially by a single foundry until
alternate sources can be qualified. The Company currently has long-term
manufacturing capacity arrangements with two suppliers as described below. The
Company conducts business with one of its current foundry suppliers by
delivering written purchase orders specifying the particular product ordered,
quantity, price, delivery date and shipping terms and, therefore, this foundry
is 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, the Company may not
have a sufficient amount of time to replace the supply of products manufactured
by that foundry.
Historically, certain subcontract suppliers have also provided packaging
and testing for the Company's products and other activities necessary to deliver
finished products. The Company pays those suppliers for assembled or fully
tested products meeting predetermined specifications. In the assembly process,
the silicon wafers are separated into individual die after wafer level testing
that are then assembled into packages and tested in accordance with the
Company's test procedures. Following assembly, the packaged devices are further
tested and inspected pursuant to the Company's quality assurance program before
shipment to customers. Due to increasing complexity and high pin counts required
by the Company's products, the Company is increasing its use of Ball Grid Array
("BGA") packaging. This package technology is now widely sourced in the industry
and the Company presently has three sources of supply qualified and in
production. To ensure the integrity of its foundries' quality assurance
procedures, the Company develops detailed test procedures and specifications for
each product and requires the foundry to use those procedures and specifications
before shipping finished products or wafers. Product returns to date have not
been significant.
In 1995, the Company entered into two long-term manufacturing capacity
arrangements. The Company entered into an agreement with United Microelectronics
Co., Ltd. ("UMC") and Alliance Semiconductor Corporation to form United
Semiconductor Corporation ("USC"), a separate Taiwanese company, for the
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purpose of building and managing a semiconductor manufacturing facility in the
Science-Based Industrial Park in Hsin Chu City, Taiwan. The facility began
production utilizing advanced submicron semiconductor manufacturing processes in
1996. The Company has the right to purchase 31.25% of the output from the
foundry. See Note 3 of Notes to Consolidated Financial Statements for a
description of the sale of a portion of the Company's investment in USC. In
addition, 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. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
There can be no assurance that the Company will obtain sufficient sources
of supply of product to meet customer demand in the future. Obtaining sufficient
foundry capacity is particularly difficult during periods of high growth, and
may become substantially more difficult if the Company's product requirements
increase significantly. In addition, because the Company must order products and
build inventory substantially in advance of product shipments, there is a risk
that the Company will forecast incorrectly and produce excess or insufficient
inventories of particular products. This inventory risk is heightened because
certain of the Company's key customers place orders with short lead times. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Factors That May Affect Our Results -- We are a Fabless
Semiconductor Company and Depend on Independent Foundries for the Manufacture of
Our Products."
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.
The Company uses an automated design environment based on advanced
workstations, dedicated product simulators, system simulation with hardware and
software modeling, and the use of a high level design description language in
order to more rapidly define, develop and deliver new and enhanced products. The
Company considers its computer-aided engineering ("CAE") and computer-aided
design ("CAD") capabilities to be important to its future success in all areas
of new product development and intends to continue to enhance its CAE/CAD
systems. Although the Company extensively tests its software and hardware
products prior to their introduction, it is possible that design errors may be
discovered after initial product sampling, resulting in delays in volume
production or recall of products sold. The occurrence of any such errors could
have a material adverse effect on the Company's product introduction schedule
and operating results.
RESEARCH AND DEVELOPMENT
The Company believes that continued timely development and introduction of
new products are essential to maintaining its competitive position. The Company
currently conducts most of its product development effort in-house and, at
December 31, 1998, had a staff of 276 research and development personnel, of
whom approximately 34% are involved in software development. The Company also
employs outside consultants to assist with software testing. The Company is
focusing its current development efforts primarily on the development of
enhanced versions of its existing family of graphics and multimedia accelerators
and adding new functionality to its products for business desktop, mobile and
home PC markets. In addition, the Company intends to continue to devote
significant resources to the development of a broad range of high-performance
software drivers to support its products. During 1998, 1997 and 1996, the
Company spent approximately $78.6 million, $78.6 million and $63.4 million,
respectively, on research and development activities.
COMPETITION
The markets in which the Company competes are extremely competitive and the
Company expects that competition will increase. The principal factors of
competition in the Company's markets include 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 and
customer support. Price competition in the industry is intense and may increase,
which may have a material adverse effect on the
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Company's operating results. There can be no assurance that the Company will be
able to compete successfully as to price or any of these other factors.
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 3DFX Interactive Inc., ATI Technologies, Inc.,
Intel Corporation, Matrox Graphics Inc., NVIDIA Corporation and Trident
Microsystems, Inc. The Company's principal competitors in the multimedia market
include the companies named in the preceding sentence and a number of smaller
companies which may have greater flexibility to address specific market needs.
Potential competitors in these markets include both large and emerging domestic
and foreign semiconductor companies. In particular, there is a significant
number of established and emerging companies that have developed, are developing
or have announced plans to develop 3D graphics chips. There can be no assurance
that the Company's product offerings to address the demand for the next
generation of 2D/3D accelerators will be competitive, and if such product
offerings are not competitive, the Company's results of operations in 1999 and
future periods could be materially and adversely affected. The Company's current
products do not 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. 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 companies 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.
LICENSES, PATENTS AND TRADEMARKS
The Company has filed several United States patent applications for its
technology and to date has been issued 16 United States patents. The Company has
also built its patent portfolio substantially through acquisitions. In 1997, the
Company acquired certain microprocessor patents from Exponential Technology Inc.
In January 1998, the Company entered into a patent purchase and cross-licensing
agreement with Cirrus Logic, Inc. pursuant to which the Company purchased 10
graphics patents and 25 graphics patent applications and cross-licensed other
graphics-related technology. Since the purchase date, 11 of these patent
applications have become issued patents. The Company attempts to protect its
trade secrets and other proprietary information through agreements with its
customers, suppliers, employees and consultants, and through other security
measures. Although the Company intends to protect its rights vigorously, there
can be no assurance that these measures will be successful or that any issued
patents will provide the Company with adequate protection with respect to the
covered products, technology or processes.
7
<PAGE> 10
The Company has applied to the United States Patent and Trademark Office
for registration of a number of trademarks and also holds common law rights in a
number of trademarks. A U.S. trademark registration has been issued to the
Company for the marks S3, S3 (stylized), S3 ON BOARD, S3 ON BOARD and Design,
S3D(stylized), Trio, True Acceleration and ViRGE.
The S3 corporate logo, the Aurora family of marks, Cooperative Accelerator
Architecture, Burst Command Interface, DuoView, InfiniPatch, InfiniRate,
Innovations In Acceleration, No Compromise Acceleration, No Compromise
Integration, QuickRamp, RIO!, S3FM, S3RAM, S3S, SAVAGE3D, SAVAGE4, Scenic
Highway, Sight. Sound. Speed., Silicon Film, SmartFilter, Streams Processor, the
Trio family of marks, TV-Tuner and the ViRGE family of marks are trademarks of
the Company. The Company has also applied for trademark registration of some of
its trademarks in certain foreign jurisdictions. There can be no assurance that
the Company will obtain the registrations for which it has applied. Other
trademarks referenced in this document are owned by their respective companies.
If the Company's use of a registered or unregistered trademark were found
to violate a third party's common law or statutory trademark rights, the
Company's business could be adversely affected. In addition, the laws of certain
countries in which the Company's products are or may be developed, manufactured
or sold, including Hong Kong, Japan and Taiwan, may not protect the Company's
products and intellectual property rights to the same extent as the laws of the
United States.
BACKLOG
Sales of the Company's products are made pursuant to standard purchase
orders that are cancelable without significant penalties. In addition, purchase
orders are subject to price renegotiations and to changes in quantities of
products and delivery schedules in order to reflect changes in customers'
requirements and manufacturing availability. The Company's business, and to a
large and growing extent that of the entire semiconductor industry, is
characterized by short lead time orders and quick delivery schedules. In
addition, the Company's actual shipments depend on the manufacturing capacity of
the Company's suppliers and the availability of products from such suppliers. As
a result of the foregoing factors, the Company does not believe that backlog at
any given time is a meaningful indicator of future sales.
EMPLOYEES
At December 31, 1998, the Company employed 434 individuals, of whom 34 were
employed in operations, 276 in research and development, 61 in sales, marketing
and technical support and 63 in administration and other support functions.
Competition for personnel in the semiconductor, software and the PC industry in
general is intense. The Company believes that its future success will depend, in
part, on its ability to continue to attract, train, motivate, retain and manage
highly skilled technical, marketing and management personnel. None of the
Company's employees is represented by a labor union or is subject to a
collective bargaining agreement. The Company believes that its relations with
its employees are good.
ITEM 2. PROPERTIES.
In December 1995, the Company entered into a limited partnership
arrangement with a developer to obtain a ground lease and develop and operate
the Company's future Santa Clara facilities. In January 1997, the Company
relocated its principal administrative, sales, marketing, research and
development facility consisting of approximately 300,000 square feet of space in
two buildings located in Santa Clara, California, the initial phase of the
development. This space is leased for an initial 12-year term. In October 1998,
the Company sublet one of the buildings for the remaining term of the lease. The
Company had an option, which expired in January 1999, to build an additional two
buildings comprising approximately 300,000 square feet. In January 1999, the
Company entered into a demand for arbitration related to the option. The demand
for arbitration arose out of the disputed exercise date of the option. The
Company believes that it exercised the option in December 1998 and the developer
believes that the Company's option was not exercised.
The Company has vacated its previous Santa Clara facilities prior to the
expiration of their lease terms in order to occupy the new facilities. The
previous facilities consisted of approximately 159,000 square feet in
8
<PAGE> 11
four buildings in Santa Clara, California. The Company has sublet two of the
buildings and terminated the leases on the remaining two buildings. The Company
also leases office space in Texas, Hong Kong, Japan, Taiwan and a warehouse in
Singapore in order to provide sales, distribution and technical support to
customers in the United States and Asia. The facilities leased are currently
sufficient for the Company's operations.
In connection with the Company's investment in the real estate partnership,
in February 1997 the real estate partnership obtained permanent nonrecourse
financing for the construction of the Santa Clara facilities. The Company is not
a guarantor on the permanent financing.
ITEM 3. 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 18, 1996 and November 3, 1997. The complaints name as
defendants the Company, certain of its officers and former officers and certain
directors of the Company, asserting that they violated federal and state
securities laws by misrepresenting and failing to disclose certain information
about the Company's business. In addition, certain stockholders have filed
derivative actions in the state courts of California and Delaware seeking
recovery on behalf of the Company, alleging, among other things, breach of
fiduciary duties by such individual defendants. The derivative cases in
California state court have been consolidated, and plaintiffs have filed a
consolidated amended complaint. The court has entered a stipulated order in
those derivative cases suspending court proceedings and coordinating discovery
in them with discovery in the class actions in California state courts. On
plaintiffs' motion, the federal court has dismissed the federal class actions
without prejudice. The class actions in California state court have been
consolidated, and plaintiffs have filed a consolidated amended complaint. The
Company has answered that complaint. Discovery is pending. 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.
The semiconductor industry is 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company and their ages as of March 31, 1999
are as follows:
<TABLE>
<CAPTION>
NAME AGE
---- ---
<S> <C> <C>
Kenneth F. Potashner 41 President and Chief Executive Officer,
Chairman of the Board
Walter D. Amaral 47 Sr. Vice President Finance, Chief Financial
Officer
Daniel A. Karr 39 Vice President of Sales
Paul G. Franklin 55 Sr. Vice President of Operations
</TABLE>
Mr. Kenneth F. Potashner joined the Company as Chairman of the Board, Chief
Executive Officer and President of the Company in November 1998. From April 1996
to November 1998, Mr. Potashner served as President, Chief Executive Officer and
Chairman of Maxwell Technologies, Inc., an electronics computer company. Mr.
Potashner served as Executive Vice President, Operations and General Manager of
the Disk
9
<PAGE> 12
Driver Operations at Conner Peripherals, Inc. from 1994 to 1996. Prior to 1994,
Mr. Potashner held various management positions at Quantum Corporation, Digital
Equipment Corporation and Texas Instruments Incorporated. Mr. Potashner holds a
B.S.E.E. from Lafayette College and an M.S.E.E. from Southern Methodist
University. Mr. Potashner is also a member of the Board of Directors of Maxwell
Technologies, Inc., Newport Corporation and High Technology Solutions.
Mr. Amaral, Senior Vice President and Chief Financial Officer, joined the
Company in August 1997. From April 1995 to August 1997, Mr. Amaral served as
Senior Vice President, Finance and Chief Financial Officer of NetManage
Incorporated, a supplier of networking software. From April 1992 to April 1995,
Mr. Amaral was Senior Vice President and Chief Financial Officer of Maxtor
Corporation, a disk drive manufacturer. From 1977 to 1992, Mr. Amaral held
numerous positions at Intel Corporation, where he was most recently Corporate
Controller. Mr. Amaral holds a B.S. in Business with a concentration in
Accounting from San Jose State University.
Mr. Karr, Vice President of Sales, joined the Company in April 1996. From
January 1988 to April 1996, Mr. Karr held various positions at Cirrus Logic,
Inc., a manufacturer of integrated circuits, where he was most recently Sales
Director. From May 1985 to January 1988, Mr. Karr held marketing and technical
support positions at Adaptec, Inc., a supplier of bandwidth management
solutions, where he was most recently Product Manager. Mr. Karr earned a B.A. in
Physics and Mathematics from Linfield College.
Mr. Franklin, Senior Vice President of Operations, joined the Company in
September 1992. From March 1991 to September 1992 he was a consultant to the
Company. Mr. Franklin was a consultant for a number of semiconductor companies
from January 1990 through March 1991. From March 1986 to December 1989, Mr.
Franklin was Vice President of Operations of Actel Corporation, a supplier of
field programmable gate arrays. Prior to 1986 Mr. Franklin held various
management positions at Monolithic Memories Inc., a supplier of semiconductor
memories and programmable logic.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's common stock is traded on the Nasdaq National Market under
the symbol "SIII". See "Selected Quarterly Consolidated Financial Data
(Unaudited)" in "Item 8. -- Financial Statements and Supplementary Data" for the
range of high and low closing sales prices for the common stock on the Nasdaq
National Market, as reported by Nasdaq.
In December 1998, the Company entered into an agreement pursuant to which
it agreed to issue to Intel Corporation a warrant to purchase 1,000,000 shares
of the Company's Common Stock at an exercise price of $9.00 per share. The
purchase price for the warrant was $990,000. The warrant expires in December
2000. The Company relied upon the exemption provided by Section 4(2) of the
Securities Act of 1933, as amended (the "Act"), because the transaction did not
involve a public offering and the purchaser represented that it was an
"accredited investor" as such term is defined in rules of the SEC promulgated
under the Act.
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<PAGE> 13
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------------
1998 1997 1996 1995 1994
--------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND RATIOS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA
Net sales.................................. $ 224,639 $436,359 $439,243 $316,309 $140,309
Gross margin (loss)........................ (2,072) 135,174 168,876 126,542 42,334
Research and development expenses.......... 78,566 78,612 63,382 42,080 17,913
Selling, marketing and administrative
expenses................................. 41,926 55,879 48,800 33,510 18,310
Other operating expense(1)................. 41,335 17,180 -- -- --
Income (loss) from operations.............. (163,899) (16,497) 56,694 50,952 6,111
Net income (loss).......................... $(113,204) $ 8,878 $ 41,588 $ 35,374 $ 5,502
Net income per share
Basic.................................... $ (2.22) $ 0.18 $ 0.88 $ 0.83 $ 0.15
Diluted(2)............................... $ (2.22) $ 0.17 $ 0.81 $ 0.75 $ 0.14
Shares used in computing per share amounts:
Basic.................................... 51,078 49,519 47,460 42,691 36,032
Diluted(2)............................... 51,078 51,740 52,451 47,013 39,621
Ratio of earnings to fixed charges(3)...... -- -- 23.68x -- 165.98x
BALANCE SHEET DATA
Cash and equivalents....................... $ 31,022 $ 90,484 $ 94,616 $ 69,289 $ 25,772
Short-term investments..................... 88,553 27,186 62,768 24,630 8,800
Working capital............................ 152,244 209,993 225,550 144,620 59,727
Total assets............................... 325,801 492,854 485,172 321,643 89,460
Long-term obligations...................... 13,837 27,070 20,852 24,761 813
Convertible subordinated notes............. 103,500 103,500 103,500 -- --
Stockholders' equity....................... $ 163,530 $270,840 $260,321 $205,864 $ 68,878
</TABLE>
- ---------------
(1) Other operating expense for 1998 includes a write-off of acquired
technologies of $8.0 million, a charge for impairment of long-lived assets
of $27.2 million and a restructuring charge of $6.1 million. Other operating
expense for 1997 includes a charge for impairment of long-lived assets of
$17.2 million.
(2) Diluted earnings per share includes the effect of incremental shares
issuable upon the conversion of the convertible subordinated notes, the
dilutive effect of outstanding options and an adjustment to net income for
the interest expense (net of income taxes) related to the notes unless the
impact of such conversion is anti-dilutive. The effect of the conversion was
anti-dilutive in 1998.
(3) For purposes of calculating the ratio of earnings to fixed charges, (i)
earnings consist of consolidated income before income taxes and equity in
net income of joint venture plus fixed charges and (ii) fixed charges
consist of interest expense incurred and the portion of rental expense under
operating leases deemed by the Company to be representative of the interest
factor. Earnings were insufficient to cover fixed charges in the years ended
December 31, 1998 and 1997, as evidenced by the less than 1:1 coverage
ratio. Additional earnings of $142.6 million and $18.6 million were
necessary to provide a 1:1 coverage ratio for December 31, 1998 and 1997,
respectively. The Company had no fixed charges in 1995.
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<PAGE> 14
ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
When used in this discussion, the words "expects," "anticipates,"
"estimates" and similar expressions are intended to identify forward-looking
statements. Such statements, which include statements concerning the timing of
availability and functionality of products under development, product mix,
trends in average selling prices, trends in the PC market, the percentage of
export sales and sales to strategic customers and the availability and cost of
products from the Company's suppliers, are subject to risks and uncertainties,
including those set forth below under "Factors That May Affect Our 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.
RESULTS OF OPERATIONS
The following table sets forth for the years indicated certain financial
data as a percentage of net sales:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Net sales........................................... 100.0% 100.0% 100.0%
Cost of sales....................................... 100.9 69.0 61.6
----- ----- -----
Gross margin (loss)................................. (0.9) 31.0 38.4
Operating expenses:
Research and development.......................... 35.0 18.0 14.4
Selling, marketing and administrative............. 18.7 12.8 11.1
Other operating expense........................... 18.4 4.0 --
----- ----- -----
Total operating expenses.................. 72.1 34.8 25.5
----- ----- -----
Income (loss) from operations....................... (73.0) (3.8) 12.9
Gain on sale of joint venture..................... 11.8 -- --
Other income (expense)............................ (2.3) (0.5) 0.5
----- ----- -----
Income (loss) before income taxes and equity in
income of manufacturing joint venture............. (63.5) (4.3) 13.4
Provision (benefit) for income taxes................ (5.3) (2.0) 4.5
----- ----- -----
Income (loss) before equity in income of
manufacturing joint venture....................... (58.2) (2.3) 8.9
Equity in income from manufacturing joint venture... 7.8 4.3 0.6
----- ----- -----
Net income (loss)................................... (50.4)% 2.0% 9.5%
===== ===== =====
</TABLE>
NET SALES
The Company's net sales to date have been generated from the sale of its
graphics and multimedia accelerators. The Company's products are used in, and
its business is dependent on, the personal computer industry with sales
primarily in the U.S., Asia and Europe. Net sales were $224.6 million in 1998, a
decrease of 49% from $436.4 million in 1997. Net sales for 1998 consisted
primarily of the Company's 2D and 3D products. Sales decreased from 1997 to 1998
because 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, a significant decrease in unit volumes and the lack of products
available at the high end of the market. The Company expects that the percentage
of its net sales represented by any one product or type of product may change
significantly from period to period as new products are introduced and existing
products reach the end of their product life cycles. Due to competitive price
pressures, the Company's products experience declining unit average selling
prices over time, which at times can be substantial. The Company's Savage4
family of products is expected to address the mainstream graphics market.
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<PAGE> 15
Net sales were $436.4 million in 1997, a 1% decrease from $439.2 million in
1996. Net sales for 1997 consisted primarily of the Company's ViRGE and Trio
families of integrated accelerators. The decrease in sales from 1996 to 1997 was
a result of declining unit average selling prices due to aggressive pricing from
certain of the Company's competitors as well as the sale of older generation
products, offset by an increase in unit shipments.
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.
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 normal anticipated levels, the Company's
operating results could be adversely affected.
Export sales accounted for 89%, 70% and 58% of net sales in 1998, 1997 and
1996 respectively. Approximately 29% of export sales in 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 are denominated in U.S. dollars.
Three customers accounted for 39%, 14% and 13% of net sales in 1998. Three
customers accounted for 20%, 13% and 12% of net sales in 1997. Two customers
accounted for 16% and 15% of net sales in 1996. The Company expects a
significant portion of its future sales to remain concentrated within a limited
number of strategic customers. Sales to any particular customer may fluctuate
significantly from quarter to quarter. The Company's largest customer in 1998
was the Company's largest Asian distributor, and more than 50% of the Company's
1998 net sales were made through distributors.
GROSS MARGIN
The Company had a negative gross margin percentage of 1% in 1998 and gross
margin percentages of 31% and 38% in 1997 and 1996, respectively. The negative
gross margin in 1998 was impacted by decreases in overall average selling prices
of the ViRGE and Trio family of accelerators. Also impacting the negative gross
margin were charges for excess and obsolete inventory, lower of cost or market
reserves established for the Company's 2D and 3D products, a $4.0 million charge
for underutilized prepaid production capacity and yield losses.
The gross margin in 1997 was impacted by decreases in overall average
selling prices of the 64-bit Trio family and ViRGE 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 did not offer products addressing the high
performance 3D acceleration market, which adversely affected the Company's gross
margin. These factors were offset in part by the decrease in unit average costs
resulting from the Company's foundries' conversion to 8-inch wafer utilizing .35
micron technology.
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.
The Company expects gross margin to increase in 1999 as the result of new
product introductions.
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
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<PAGE> 16
expenses were $78.6 million in 1998, $78.6 million in 1997 and $63.4 million in
1996. Research and development expenses for 1998 reflect approximately $3.0
million in charges for the Company's discontinued audio and communications
product lines and the write-offs of idle, excess and obsolete capital equipment
associated with research and development projects terminated during the year.
Excluding these charges, research and development expenses decreased from 1997
to 1998 as a result of reductions in engineering staff due to discontinuing
certain product lines during the year. The increase in research and development
expenses from 1996 to 1997 reflect additions to the Company's engineering staff
and initial product verification and nonrecurring engineering expenses related
to the introduction of new products, including product development for the
desktop, mobile and home PC markets. The Company expects research and
development expenses in absolute dollars to decrease in 1999.
SELLING, MARKETING AND ADMINISTRATIVE EXPENSES
Selling, marketing and administrative expenses were $41.9 million in 1998,
$55.9 million in 1997 and $48.8 million in 1996. Selling, marketing and
administrative headcount decreased by 33% and commission expense decreased by
approximately $7.0 million from 1997 to 1998. From 1996 to 1997 selling,
marketing and administrative headcount increased by 8% and marketing spending
increased $3.2 million which included costs associated with the introduction of
new products.
OTHER OPERATING EXPENSE
Other operating expense in 1998 includes a write-off of acquired
technologies of $8.0 million, a charge for impairment of long-lived assets of
$27.2 million and a restructuring charge of $6.1 million.
In January 1998, the Company entered into a $40.0 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 $8.0
million of the value of the acquired technologies that were not realizable based
on estimated cash flows from the sale of products currently sold by the Company.
The remaining $32.0 million intangible asset was being amortized to cost of
sales based on the estimated lives of the currently utilized core technologies,
which was generally five years until the fourth quarter of 1998.
During the fourth quarter of 1998, management reevaluated the carrying
value of the intangible assets recorded in connection with the technology
exchange with Cirrus Logic, Inc., and related to the patents obtained from
Brooktree, as well as other long-lived assets, including property and equipment.
This revaluation was necessitated by management's determination based on recent
results of operations and that the future expected sales and cash flows for the
Company's operations would be substantially lower than had been previously
expected by management. Expected undiscounted future cash flows were not
sufficient to recover the carrying value of such assets. Accordingly, an
impairment loss of $27.2 million, representing the excess of the carrying value
over the estimated fair value of the assets, was recognized for write-downs of a
substantial portion of the intangible assets. The estimated fair value of the
intangible assets was based on management's best estimate of the patent
portfolio based on a comparison to other graphics technology portfolios in the
marketplace. The Company determined that no write-down of property and equipment
was necessary at December 31, 1998 based on its estimate of the fair value of
such assets. Due to technological changes in the graphics marketplace, the
Company concluded it should accelerate its amortization of its remaining patent
portfolio, of approximately $4.0 million, over the current estimated life of the
currently utilized core technologies, which is two years.
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, of which 69 have been
paid and separated from the Company as of
14
<PAGE> 17
December 31, 1998. All severance packages will be paid by the end of the second
quarter of 1999. The number of temporary employees and contractors used by the
Company was also reduced. The restructuring expense included the write-off and
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 estimated
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 plans to complete its move by the end of
the second quarter of 1999.
During the fourth quarter of 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 attention on the core
graphics business. As a result of this decision, no future cash flows were
expected related to these assets.
GAIN ON SALE OF MANUFACTURING 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 $68.0 million in cash) in January 1998 upon closing. The gain on
the sale of stock in USC was $26.6 million.
OTHER INCOME (EXPENSE), NET
Other expense, net, increased in 1998 to $5.3 million from $2.1 million in
1997. The increase was primarily the result of write-offs of certain equity
investments in technology companies. Other expense, net, decreased in 1997 to
$2.1 million of expense from $2.2 million of income in 1996. The decrease is
attributable to the interest expense incurred on $103.5 million aggregate
principal amount of convertible subordinated notes, which were issued by the
Company in September 1996, as well as lower average cash and short-term
investments balances, which resulted in a decrease in interest income.
INCOME TAXES
The Company's effective tax rate for 1998 was a benefit of 8.4%, compared
to the 46% and 34% effective tax rates for 1997 and 1996, respectively. The
effective tax rate for 1998 reflects the expected benefits of current year loss
carrybacks net of the establishment of a valuation allowance in 1998 against the
beginning of the year balance of net deferred tax assets. The 1997 tax rate
reflects the full benefit of operating losses at statutory rates plus the
benefit of tax credits generated.
LIQUIDITY AND CAPITAL RESOURCES
Cash and equivalents and short-term investments increased in 1998 by $1.9
million to $119.6 million from $117.7 million at the end of 1997. The Company
used $9.3 million for operating activities and used $38.9 million for investing
activities in 1998. In addition, the Company used $11.3 million of cash for
financing activities.
Cash used for operating activities was $9.3 million in 1998, as compared to
$18.8 million in 1997. The Company's operating loss of $113.2 million was offset
by non cash charges including deferred income taxes, depreciation, amortization,
loss on the disposal of equipment, write-off of prepaid production capacity, the
utilization of production capacity rights, write-off of impaired assets and the
write-off of acquired technologies. The Company sold a portion of its interest
in USC during 1998 and recognized a gain of $26.6 million. In addition the
Company recognized $17.5 million in income from their 15.75% equity investment
in USC. The non cash charges were offset by decreases in accounts receivable and
inventories of $36.8 million and $60.5 million, respectively. Accounts
receivable decreased as a result of lower net sales by the Company while
inventories decreased as the result of lower production volumes and charges
taken during 1998 for excess and obsolete inventory, lower of cost or market
reserves and yield losses. Accounts payable decreased as a direct result of
lower inventory purchases.
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<PAGE> 18
Cash used for operating activities was $18.8 million in 1997, as compared
to cash provided by operating activities of $34.2 million in 1996. The decrease
in 1997 was due to lower net income, an increase in inventories, prepaid
expenses and other and a decrease in accounts payable, partially offset by a
write-off of impaired assets and a decrease in accounts receivable. The increase
in inventories was due to the Company's effort to reduce the amount of inventory
in the channel, which resulted in increased inventories on hand at December 31,
1997. The decrease in accounts receivable was a result of lower sales in the
fourth quarter of 1997 as compared to the fourth quarter of 1996.
Investing activities for the years ended December 31, 1998, 1997 and 1996
used $38.9 million, $6.4 million and $120.5 million, respectively. The primary
investing activities in 1998 included $40.0 million used in a patent purchase
and cross-licensing agreement with Cirrus Logic, Inc., $5.9 million of property
and equipment purchases, $125.4 million of short term investment purchases,
offset by $66.7 million of maturities of short-term investments and $68.0
million from the sale of a portion of the Company's joint venture in USC. The
Company's primary investing activities in 1997 included $30.3 million of
property and equipment purchases, $16.4 million of short term investment
purchases, offset by $55.7 million of maturities of short term investments. The
primary investing activities in 1996 included $23.4 million of property and
equipment purchases, $74.8 million of short term investment purchases and a
$53.0 million investment in the USC joint venture offset by $36.6 million of
maturities of short term investments. The Company expects capital requirements
for 1999 to be consistent with those for 1998.
Financing activities used cash of $11.3 million in 1998 and provided cash
of $21.1 million and $111.6 million in 1997 and 1996, respectively. The decrease
in 1998 was primarily the result of the $10.0 million repayment of notes
payable. Financing activities in 1997 included the sales of common stock
pursuant to employee stock option and stock purchase plans as well as $10.0
million in borrowings on notes payable. This $10.0 million source of funds in
1997 was repaid in 1998. The increase in 1996 primarily reflects the offering of
$103.5 million aggregate principal amount of convertible subordinated notes
completed in September 1996. Net proceeds from the sale of the notes were
approximately $100.1 million.
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. 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 $68.0 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%. 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. $46.6 million at exchange rates prevailing on December 31,
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. The Company has signed promissory notes
to secure these payments, which total $14.4 million as of December 31, 1998,
over the term of the agreement. The Company made no payments in 1998, and paid
$9.6 million in 1997 and $7.2 million in 1996. See Note 5 of Notes to
Consolidated Financial Statements.
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Working capital at December 31, 1998 and December 31, 1997 was $152.2
million and $210.0 million, respectively. At December 31, 1998, the Company's
principal sources of liquidity included cash and equivalents of $31.0 million
and $88.6 million in short-term investments. At December 31, 1997, the Company's
principal sources of liquidity included cash and equivalents of $90.5 million
and $27.2 million in short-term investments. Additionally, the Company had a
$75.0 million unsecured revolving line of credit at December 31, 1997. The line
of credit was cancelled during 1998. In addition, the Company had available two
separate secured equipment lines of credit totaling $10.0 million. The Company
terminated these lines during 1998. The Company had $5.6 million outstanding
under these secured equipment lines of credit at December 31, 1997. The Company
was required to maintain certain financial covenants in connection with these
lines of credit. See Note 5 of Notes to Consolidated Financial Statements. 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, other than expenditures for future potential manufacturing agreements.
In order to obtain an adequate supply of wafers, especially wafers
manufactured using advanced process technologies, the Company has entered into
and will continue to consider various possible transactions, including the use
of "take or pay" contracts that commit the Company to purchase specified
quantities of wafers over extended periods, equity investments in, advances or
issuances of equity securities to wafer manufacturing companies in exchange for
guaranteed production or the formation of joint ventures to own and operate or
construct wafer fabrication facilities. Manufacturing arrangements such as these
may require substantial capital investments, which may require the Company to
seek additional equity or debt financing. There can be no assurance that such
additional financing, if required, will be available when needed or, if
available, will be on satisfactory terms. In addition, the Company may, from
time to time, as business conditions warrant, invest in or acquire businesses,
technology or products that complement the business of the Company.
The Company is currently a party to certain legal proceedings. Litigation
could result in substantial expense to the Company. See "Item 3. Legal
Proceedings."
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 supplier 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 has completed 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 reprogram-
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med 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 50% of its testing. Completion of the testing phase for
all remediated systems is expected to occur by the first half of 1999, with all
remediated systems fully tested and implemented by the second quarter 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 not significant.
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 by the first half of 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 complaint would
result in the interruption of its business, which could have material adverse
affect on the results of operations or financial condition of the Company.
FACTORS THAT MAY AFFECT OUR RESULTS
OUR OPERATING RESULTS MAY FLUCTUATE
Our operating results have in the past varied significantly and are
expected to vary significantly in the future due to several factors, some of
which are beyond our control. Those factors include:
- changes in our pricing policies or those of our competitors or suppliers;
- competitive pressures on average selling prices;
- the availability and cost of products from our suppliers;
- changes in the mix of products sold by us or in the mix of distribution
channels through which those products are sold;
- the timing of new product introductions by us or our competitors;
- market acceptance of new or enhanced versions of our products;
- disruptions in our production or shipping processes;
- the gain or loss of significant customers;
- seasonal customer demand;
- the operating results of USC, our manufacturing joint venture; and
- general economic conditions, including economic conditions in Asia in
particular, that could affect the timing of customer orders and capital
spending and result in order cancellations or rescheduling.
Some or all of those factors could adversely affect demand for our products
and, therefore, our operating results, in the future.
In addition, we generally ship more products in the third month of each
quarter than in either of the first two months of the quarter, with levels of
shipment in the third month higher towards the end of the month. This pattern,
which is common in the semiconductor industry, is likely to continue and makes
future quarterly operating results less predictable.
WE MAY NOT RETURN TO PROFITABILITY
We had a net loss of $113.2 million in 1998. Our net sales decreased 49%
from 1997 to 1998 and we experienced a negative gross margin in 1998. These
results occurred primarily because we did not offer competitive products in the
high end of the graphics and multimedia accelerator market. As a result, our
sales
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consisted of sales of primarily older generation and lower price products that
were sold into markets that had significant price competition. We took a charge
for excess and obsolete inventory. Our manufacturing yields were lower than
expected which required us to take a charge for yield losses. We also took a
$4.0 million charge for underutilized prepaid production capacity. We may not be
able to return to profitability.
OUR PRODUCTS ARE SUBJECT TO SIGNIFICANT PRICING PRESSURES
Prices for graphics accelerators tend to decline over time, and prices for
newly introduced products are under significant pricing pressures due in part to
aggressive pricing from some of our competitors. We have experienced and
anticipate that we will continue to experience increased pricing pressures on
average selling prices for our ViRGE, Trio and Savage families of accelerators.
WE HAVE ONLY RECENTLY STARTED TO OFFER A PRODUCT THAT SPANS ALL VOLUMES OF THE
COMMERCIAL AND CONSUMER PC MARKET
The graphics accelerator market is transitioning from 2D acceleration to 3D
acceleration and products that compete in the high performance segment of that
market have higher gross margins than products in the mainstream PC or in the
sub-$1,000, or "segment zero," PC market. We commenced shipment of our Savage3D
product during the third quarter of 1998. This product was intended to address
the high performance 3D acceleration market. However, the Savage3D failed to
achieve significant market acceptance. We have recently introduced our Savage4,
which is designed to compete in multiple performance segments of the commercial
and consumer PC markets of the 3D acceleration market. We do not know whether
Savage4 will be able to compete successfully in that segment. If we are not able
to introduce and successfully market higher performance products, our gross
margin and profitability could be negatively affected.
WE MAY NOT ADEQUATELY FORECAST DEMAND FOR OUR PRODUCTS
Because we are "fabless" and must order products and build inventory
substantially in advance of product shipments, and because the markets for the
our products are volatile and subject to rapid technological and price changes,
we might forecast product demand incorrectly and produce excessive or
insufficient inventories of particular products. In addition, our customers may
change delivery schedules or cancel orders without significant penalty. If we
produce excessive or insufficient inventories of particular products, our
operating results could be negatively affected, as they were in 1998.
WE FACE SUBSTANTIAL COMPETITION
The market for our products is extremely competitive and is characterized
by declining selling prices over the life of a particular product and rapid
technological changes. Our principal competitors for graphics accelerators
include 3DFX Interactive, Inc., ATI Technologies, Inc., Intel Corporation,
Matrox Graphics Inc., NVIDIA Corporation, and Trident Microsystems, Inc. Our
principal competitors in the multimedia market include the companies just named
as well as a number of smaller companies that 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. Our product offerings may not address the demand for the next
generation of accelerators or be competitive. If we expand our product line to
add products with additional functionality, we 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
system OEMs to the purchase of graphics and multimedia add-in cards provided by
others. Some of our competitors supply both add-in cards and accelerator chips,
which may provide those competitors with an advantage over suppliers that offer
only accelerator chips. In addition, some of our potential competitors, such as
Intel, that supply add-in cards and/or motherboards may seek to use their
card/board business to leverage their graphics accelerator business. Some of our
current and
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potential competitors have greater technical, manufacturing, financial and
marketing resources than we do. We believe that our ability to compete
successfully will depend upon a number of factors both within and outside of our
control, including:
- product performance and quality;
- product features;
- product availability;
- the prices that we charge;
- the timing of new product introductions by us and our competitors;
- the emergence of new graphics and PC standards;
- the level of customer support we offer; and
- industry and general economic trends.
We may not have the financial resources, technical expertise or marketing,
distribution and support capabilities to compete successfully.
OUR SUCCESS DEPENDS UPON OUR ABILITY TO DEVELOP NEW PRODUCTS AND KEEP PACE WITH
RAPID TECHNOLOGICAL CHANGE
The PC industry in general, and the market for our products in particular,
is characterized by rapidly changing technology, evolving industry standards and
frequent new product introductions. Products in our 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 our products by leading systems suppliers and add-in card
and motherboard manufacturers for design into their products. There can be no
assurance that we will successfully identify new product opportunities and
develop and bring to market new products in a timely manner. Furthermore, there
can be no assurance that products or technologies developed by others will not
render our products or technologies noncompetitive, or that our products will be
selected for design into its customers' products.
Our 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. We expect that additional specialized graphics processing and
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 has announced
plans to develop chips that integrate graphics and processor functions to serve
the lower cost PC market. A substantial portion of our 1998 sales were derived
from products addressing the lower cost PC market, and we anticipate that a
substantial portion of our 1999 sales will also be derived from products
addressing that market. We have 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. We
have and will continue to expand the scope of our 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
our design and engineering groups. Alternatively, we may find it necessary or
desirable to license or acquire technology to enable us 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 us.
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 our 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
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additional functionality, there can be no assurance that we will be able to
develop such new or enhanced products in a timely manner or correctly anticipate
the additional functionality that will be needed to compete effectively in this
market. Our initial product containing a number of additional functions,
Plato/PX, has been discontinued. There can be no assurance that, if developed,
our new or enhanced products that incorporate additional functions will achieve
market acceptance.
We are continually developing new products, such as Savage4, to address
changing market needs. If new products are not brought to market in a timely
manner or do not address market needs or achieve market acceptance, then our
operating results could be negatively affected. Market acceptance of our
products depends upon a number of factors, some of which are significantly
beyond our control, such as the acceptance of other components, such as memory,
that our products are designed to work with.
WE MUST KEEP PACE WITH EVOLVING INDUSTRY STANDARDS
Our 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 us to develop new products. We cannot be
certain that new technological developments or changes in standards will not
result in decreased demand for graphics and multimedia accelerators or for our
products that are not compatible with such changed standards.
In 1996, for example, there was an absence of an industry standard 3D
graphics API. As a result, we developed and promoted our 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 our 3D accelerators currently support our proprietary API, Direct 3D API
and OpenGL, it is possible that another API will emerge as an industry standard
and that our accelerators will not support such a new standard, which would have
a materially negative effect on our business, financial condition and results of
operations.
Furthermore, 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. From time
to time, Intel significantly modifies its existing technology, architecture and
standards. If we fail to develop products that are compatible with such
modifications, that failure would have a material adverse effect on our
business, financial condition and results of operations. Likewise, any delay in
the public release of information relating to any such modifications could have
a material adverse effect on us.
WE ARE A FABLESS SEMICONDUCTOR COMPANY AND DEPEND ON INDEPENDENT FOUNDRIES FOR
THE MANUFACTURE OF OUR PRODUCTS
We currently rely on two independent foundries to manufacture all of our
products either in finished form or wafer form. We have a "take or pay" contract
with Taiwan Semiconductor Manufacturing Company ("TSMC") and a joint venture
foundry, United Semiconductor Corporation ("USC"). In 1995, we expanded and
formalized our relationship with TSMC to provide additional capacity over the
1996 to 2000 time frame. The foundry agreement with TSMC requires us 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 the fourth quarter, we wrote off approximately $4.0
million of the 1998 prepaid production capacity because we did not fully utilize
the capacity related to the advance payment. Our current note payable to TSMC is
$14.4 million. During 1998, we commenced negotiations with TSMC to modify and
amend the foundry agreement. Although the terms have not been finalized, we are
requesting TSMC to reduce its option capacity and extend the term of the
agreement. If we purchase excess inventories of particular products or choose to
forfeit advance payments, our operating results could be negatively affected.
We conduct business with one of our current foundries by delivering written
purchase orders specifying the particular product ordered, quantity, price,
delivery date and shipping terms. This foundry is therefore not obligated to
supply products to us for any specific period, in any specific quantity or at
any specific price, except as may be provided in a particular purchase order. To
the extent a foundry terminates its relationship with us or our supply from a
foundry is interrupted or terminated for any other reason, such as a natural
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disaster or an injunction arising from alleged violations of third party
intellectual property rights, we may not have a sufficient amount of time to
replace the supply of products manufactured by that foundry. There can be no
assurance that we will obtain sufficient advanced process technology foundry
capacity to meet customer demand in the future. From time to time we may
evaluate 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 our requirements on a timely
basis or at acceptable quality or per unit prices.
TSMC and USC are both located in the Science-Based Industrial Park in Hsin
Chu City, Taiwan. We currently expect these foundries to supply the substantial
portion of our products in 1999. Disruption of operations at these foundries for
any reason, including work stoppages, fire, earthquakes or other natural
disasters, would cause delays in shipments of our products, and could have a
material adverse effect on our operating results. 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 our foundries' ability to supply our products, which could have
a material adverse effect on our operating results.
WE ARE SUBJECT TO THE RISK OF OPERATING LOSSES FROM OUR JOINT VENTURE
We currently own 15.75% of USC and maintain the right to purchase up to
31.25% of USC's output. If USC experiences operating losses, we will recognize
our proportionate share of those losses and may be required to contribute
additional capital. We believe 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 these
operating losses will not have a material adverse effect on our operating
results.
WE RELY ON THIRD PARTIES TO ASSEMBLE AND TEST OUR PRODUCTS
Our products are assembled and tested by a variety of independent
subcontractors. Our 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.
COMMITMENTS WE HAVE MADE TO OBTAIN MANUFACTURING CAPACITY COULD EXPOSE US TO
SIGNIFICANT FINANCIAL RISKS AND GIVE RISE TO FUTURE CAPITAL NEEDS
In order to obtain an adequate supply of wafers, especially wafers
manufactured using advanced process technologies, we have entered into and may
consider in the future various transactions, including:
- the use of "take or pay" contracts that commit us 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 such transactions would involve financial risk to us and could require
us to commit substantial capital or provide technology licenses in return for
guaranteed production capacity.
In particular, we have entered into a "take or pay" contract with TSMC and
have entered into the USC joint venture. The need to commit substantial capital
may require us to seek additional equity or debt financing. Although we
currently believe that the need for such additional capital will be 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 our stockholders. There can be no assurance that such additional
financing, if
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required, will be available when needed or, if available, will be on terms
acceptable to us. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources" and
"Business -- Manufacturing and Design Methodology."
OUR SALES ARE CONCENTRATED WITHIN A LIMITED NUMBER OF CUSTOMERS
We expect a significant portion of our future sales to remain concentrated
within a limited number of strategic customers. This concentration is reflected
in our accounts receivable where greater than 75% of the balance is represented
by three customers at December 31, 1998.
Three customers, Synnex Technology, Inc. ("Synnex"), IBM Corporation and
Promate Electronic Co. ("Promate"), accounted for 39%, 14% and 13%,
respectively, of net sales in 1998. Three customers, Synnex, CNW International
Limited ("CNW"), and Compaq Computer Corporation, accounted for 20%, 13% and
12%, respectively, of net sales in 1997. Two customers, Diamond Multimedia
Systems, Inc. and Synnex, accounted for 16% and 15%, respectively, of net sales
in 1996. Synnex, Promate and CNW are distributors. We expect a significant
portion of our future sales to remain concentrated within a limited number of
strategic customers. There can be no assurance that we will be able to retain
our strategic customers or that these customers will not otherwise cancel or
reschedule orders, or in the event of canceled orders, that such orders will be
replaced by other sales.
OUR SALES MAY BE HURT BY SHORTAGES OF COMPONENTS AND PRODUCT DEFECTS
PC graphics and multimedia subsystems include, in addition to our products,
a number of other components that are supplied by third-party manufacturers. Any
shortage of such components in the future could negatively impact our business
and operating results.
Furthermore, it is possible that our products may be found to be defective
after we have already shipped significant volumes. If that were to occur, there
can be no assurance that we would be able to correct such defects successfully
or that such corrections would be acceptable to our customers. The occurrence of
such an event could have a materially negative effect on our business and
operating results.
WE DEPEND ON SALES THROUGH DISTRIBUTORS
A substantial percentage of our products are distributed in the
distribution channel through add-in card manufacturers that in turn sell to
Value Added Resellers ("VARS"), System Integrators ("SI"), Original Equipment
Manufacturers ("OEM") and distributors. Accordingly, we are dependent upon these
add-in card manufacturers to assist in promoting market acceptance of our
products. The board manufacturers that purchase our products are generally not
committed to make future purchases of our products and therefore could
discontinue incorporating our products into their graphics boards in favor of a
competitor's product, or for any other reason.
In addition, our distributors are given limited rights to return to us the
products purchased by them, and we provide our distributors with price
protection in the event that we reduce the price of our products.
NEARLY ALL OF OUR SALES ARE MADE ON THE BASIS OF PURCHASE ORDERS
Nearly all of our sales are made on the basis of purchase orders rather
than long-term agreements. As a result, we may commit resources to the
production of products without having received advance purchase commitments from
customers. Any inability to sell products to which we have devoted significant
resources could have a material adverse effect on our business, financial
condition or operating results. In addition, cancellation or deferral of product
orders could result in us holding excess inventory, which could have a material
adverse effect on our profit margins and restrict our ability to fund our
operations.
WE MAY NOT BE ABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS AND PROPRIETARY
INFORMATION
Our ability to compete is affected by our ability to protect our
intellectual property rights and proprietary information. We have filed several
United States and foreign patent applications and to date have a number of
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issued United States patents. We rely primarily on our trade secrets and
technological know-how in the conduct of our business. The steps taken by us to
protect our intellectual property might not be adequate to prevent
misappropriation of our technology. Also, our competitors might independently
develop technologies that are substantially equivalent or superior to our
technology. The semiconductor and software industries are characterized by
frequent claims and related litigation regarding patent and other intellectual
property rights. We are party to various claims of this nature. Although the
ultimate outcome of these matters is not presently determinable, our management
presently believes that the resolution of all such pending matters will not have
a material adverse effect on our operating results. There can be no assurance
that third parties will not assert additional claims or initiate litigation
against us, our foundries or our customers with respect to existing or future
products. In addition, we may initiate claims or litigation against third
parties for infringement of our proprietary rights or to determine the scope and
validity of our proprietary rights or those of others.
Litigation by or against us has in the past resulted in, and could in the
future result in, substantial expense to us and diversion of the efforts of our
technical and management personnel, whether or not litigation is determined in
favor of us. In the event of an adverse result in any such litigation, we 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 we 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 us of substantial time and other
resources. Any such litigation or unfavorable outcome of litigation could have a
material adverse effect on our operating results. For example, in October 1995,
Brooktree alleged that certain of our products infringed a Brooktree patent. The
resulting lawsuit resulted in substantial expense to us to defend the action and
diverted the efforts of our technical and management personnel. In a settlement
of that suit, we agreed to pay to Brooktree a license fee and royalties relating
to certain product revenues over a five-year period.
WE MUST ATTRACT, INTEGRATE, TRAIN AND RETAIN KEY PERSONNEL KNOWLEDGEABLE ABOUT
OUR BUSINESS
Our future success depends in part on the continued service of certain key
engineering, sales, marketing and executive personnel, including highly skilled
semiconductor design personnel and software developers, and our ability to
identify and hire additional personnel. Competition for such personnel is
intense, particularly in the technology sectors and in the regions where our
facilities are located. We cannot be certain that we will be able to retain
existing personnel or attract, hire or retain additional qualified personnel.
The loss of services of any of our senior management team or other key employees
or our failure to attract, integrate, train and retain additional key employees
could harm our business.
WE HAVE RECENTLY UNDERGONE A MANAGEMENT TRANSITION
In November 1998, we appointed Kenneth F. Potashner as President and Chief
Executive Officer. Our Board of Directors 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 Board, remains as Vice Chairman of our
Board of Directors. There can be no assurance as to the effects of this
management transition on our business and operating results. The loss of key
personnel could have a material adverse effect on our business and operating
results. We do not maintain key man insurance on any of our employees.
24
<PAGE> 27
WE HAVE SIGNIFICANT EXPOSURE TO INTERNATIONAL MARKETS
Export sales accounted for 89%, 70% and 58% of our net sales in 1998, 1997
and 1996, respectively, and we expect 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 our products are manufactured,
assembled and tested by independent third parties in Asia. As a result, we are
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 price in local
currencies of our products in foreign markets or increase the cost of
wafers purchased by us;
- delays resulting from difficulty in obtaining export licenses for certain
technology;
- tariffs and other trade barriers and restrictions;
- potentially longer payment cycles;
- greater difficulty in accounts receivable collection;
- potentially adverse tax treatment; and
- the burdens of complying with a variety of foreign laws.
We have experienced an adverse impact associated with the economic downturn
in Asia which contributed to our decrease in net sales in 1998. In addition, our
international operations are subject to general geopolitical risks, such as
political and economic instability and changes in diplomatic and trade
relationships. Our foundries, TSMC and USC, are located in Taiwan. The People's
Republic of China and Taiwan at times experienced strained relations in 1995 and
1996, and a worsening of relations or the development of hostilities between the
two parties could have a material adverse effect on us. Finally, the laws of
certain foreign countries may not protect our intellectual property rights to
the same extent as do the laws of the United States.
WE HAVE A SIGNIFICANT LEVEL OF DEBT
As a result of the sale by us of $103,500,000 aggregate principal amount of
Convertible Subordinated Notes in September 1996, our ratio of long-term debt to
total capitalization increased from approximately 9.5% at June 30, 1996 to
approximately 31.2% at December 31, 1996. At December 31, 1998, this ratio
increased to 38.8%. The increase in this ratio is the result of the decrease in
the Company's total capitalization as the result of its net loss for 1998. The
degree to which we are leveraged could adversely affect our ability to obtain
additional financing for working capital or other purposes and could make us
more vulnerable to economic downturns and competitive pressures. Our increased
leverage could also adversely affect our liquidity, as a substantial portion of
available cash from operations may have to be applied to meet debt service
requirements. In the event of a cash shortfall, we could be forced to reduce
other expenditures to be able to meet such debt service requirements. See
"Selected Consolidated Financial Data," and "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
OUR STOCK PRICE IS HIGHLY VOLATILE
The market price of our common stock, like that of the common stock of many
other semiconductor companies, has been and is likely to be highly volatile.
This volatility may result from:
- general market conditions and market conditions affecting technology and
semiconductor stocks generally;
- actual or anticipated fluctuations in our quarterly operating results;
25
<PAGE> 28
- announcements of design wins, technological innovations, acquisitions,
investments or business alliances; and
- the commencement of, developments in or outcome of litigation.
The market price of our common stock also has been and is likely to
continue to be significantly affected by expectations of analysts and investors,
especially if our operating results do not meet those expectations. Reports and
statements of analysts do not necessarily reflect our views. The fact that we
have in the past met or exceeded analyst or investor expectations does not
necessarily mean that we will do so in the future.
In the past, following periods of volatility in the market price of a
particular company's securities, securities class action litigation has often
been brought. Such litigation could result in substantial costs and a diversion
of our management's attention and resources. Such litigation was brought against
the Company in 1994 and the Company is currently involved in another such
proceeding. See "Item 3. -- Legal Proceedings."
WE ARE PARTY TO LEGAL PROCEEDINGS ALLEGING SECURITIES VIOLATIONS THAT COULD HAVE
A NEGATIVE FINANCIAL IMPACT ON US
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 our common stock at various times
between April 18, 1996 and November 3, 1997. The complaints name us as
defendants as well as certain of our officers and former officers and certain of
our directors, asserting that we and they violated federal and state securities
laws by misrepresenting and failing to disclose certain information about our
business. In addition, certain shareholders have filed derivative actions in the
state courts of California and Delaware seeking recovery on our behalf,
alleging, among other things, breach of fiduciary duties by such individual
defendants. Discovery is currently proceeding. While our management intends to
defend the actions against us 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 our financial condition or results of operations.
We have also received from the United States Securities and Exchange
Commission ("SEC") a request for information relating to our financial
restatement announcement in November 1997. We have responded and intend to
continue to respond to the SEC requests.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
INVESTMENT PORTFOLIO
The Company does not use derivative financial instruments in its investment
portfolio. The Company places its investments in instruments that meet high
credit quality standards, as specified in the Company's investment policy. The
Company also limits the amount of credit exposure to any one issue, issuer or
type of investment. The Company does not expect any material loss with respect
to its investment portfolio.
The table below summarizes the Company's investment portfolio. The table
represents principal cash flows and related average fixed interest rates by
expected maturity date. The Company's policy requires that all investments
mature within twenty months.
26
<PAGE> 29
Principal (Notional) Amounts Maturing in 1999 in U.S. Dollars:
<TABLE>
<CAPTION>
FAIR VALUE AT
DECEMBER 31, 1998
-------------------------------------
(IN THOUSANDS, EXCEPT INTEREST RATES)
<S> <C>
At December 31, 1998:
Cash and equivalents............................ $ 31,022
Weighted average interest rate.................. 4.94%
Short term-investments.......................... $ 88,553
Weighted average interest rate.................. 5.67%
Total portfolio................................. $119,575
Weighted average interest rate.................. 5.48%
</TABLE>
CONVERTIBLE SUBORDINATED NOTES
In September 1996, the Company completed a private placement of $103.5
million aggregate principal amount of convertible subordinated notes. The notes
mature in 2003. Interest is payable semi-annually at 5 3/4% per annum. The notes
are convertible at the option of the note holders into the Company's common
stock at an initial conversion price of $19.22 per share, subject to adjustment.
Beginning in October 1999, the notes are redeemable at the option of the Company
at an initial redemption price of 102% of the principal amount. The fair value
of the convertible subordinated notes at December 31, 1998 was approximately
$76.75 million.
IMPACT OF FOREIGN CURRENCY RATE CHANGES
The Company invoices its customers in US dollars for all products. The
Company is exposed to foreign exchange rate fluctuations as the financial
results of its foreign subsidiaries are translated into US dollars in
consolidation. The foreign subsidiaries maintain their accounts in the local
currency of the foreign location in order to centralize the foreign exchange
risk with the parent company. To date this risk has not been material.
The effect of foreign exchange rate fluctuations on the Company's financial
statements for the years ended December 31, 1998 and 1997 was not material.
Since foreign currency exposure increases as intercompany receivables grow, the
Company is using foreign exchange forward contracts as a means for hedging these
balances. In general, these foreign exchange forward contracts mature in three
months. As of December 31, 1998, the Company held the following forward exchange
contracts which mature within three months:
<TABLE>
<CAPTION>
NOTIONAL FAIR VALUE
-------- ----------
(IN THOUSANDS)
<S> <C> <C>
Foreign Currency Forward Exchange Contracts:
1,500,000 Singapore Dollars............................. $879 $25
</TABLE>
27
<PAGE> 30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF S3 INCORPORATED
<TABLE>
<CAPTION>
PAGE(S)
-------
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........... 29
Report of Deloitte & Touche LLP, Independent Auditors....... 30
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996.......................... 31
Consolidated Balance Sheets as of December 31, 1998 and
1997...................................................... 32
Consolidated Statements of Stockholders' Equity for the
years ended
December 31, 1998, 1997 and 1996.......................... 33
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996.......................... 34
Notes to Consolidated Financial Statements.................. 35
Selected Quarterly Consolidated Financial Data
(Unaudited)............................................... 52
INDEX TO FINANCIAL STATEMENTS OF UNITED SEMICONDUCTOR CORPORATION
Report of PricewaterhouseCoopers............................ 54
United Semiconductor Corporation Balance Sheet as of
December 31, 1998 and 1997................................ 55
United Semiconductor Corporation Statement of Income for the
Years Ended
December 31, 1998 and 1997................................ 57
United Semiconductor Corporation Statement of Changes in
Stockholders' Equity for the Years Ended December 31, 1998
and 1997.................................................. 58
United Semiconductor Corporation Statement of Cash Flows for
the Years Ended
December 31, 1998 and 1997................................ 59
United Semiconductor Corporation Notes to Financial
Statements................................................ 60
</TABLE>
28
<PAGE> 31
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
S3 Incorporated
We have audited the accompanying consolidated balance sheet of S3
Incorporated as of December 31, 1998, and the related consolidated statements of
operations, stockholders' equity and cash flows for the year then ended. Our
audit also included the financial statement schedule for the year ended December
31, 1998 listed in the Index at Item 14(a)(2). These financial statements and
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedule based on our
audit. The financial statements of United Semiconductor Corporation (a
corporation in which the Company has a 15.75% interest), have been audited by
other auditors whose report has been furnished to us; insofar as our opinion on
the consolidated financial statements relates to data included for United
Semiconductor Corporation, it is based solely on their report.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe our audit and the report of other auditors provide a reasonable basis
for our opinion.
In our opinion, based on our audit and the report of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of S3 Incorporated at
December 31, 1998, and the consolidated results of its operations and its cash
flows for the year then ended, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
San Jose, California
January 21, 1999
29
<PAGE> 32
REPORT OF DELOITTE & TOUCHE LLP, INDEPENDENT AUDITORS
Board of Directors and Stockholders
S3 Incorporated:
We have audited the accompanying consolidated balance sheet of S3
Incorporated and subsidiaries as of December 31, 1997, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the two years in the period ended December 31, 1997. Our audits also
included the financial statement schedule at Item 14(a)(2) for the years ended
December 31, 1997 and 1996. These financial statements and financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits. We did not audit the financial statements of
United Semiconductor Corporation ("USC"), the Company's investment in which is
accounted for by use of the equity method. The Company's equity of $104,465,000
in USC's net assets at December 31, 1997, and of $19,012,000 in that company's
net income (after investor's applicable taxes) for the year then ended are
included in the accompanying financial statements. The financial statements of
USC were audited by other auditors whose report was furnished to us, and our
opinion, insofar as it relates to the amounts included for such company, is
based solely on the report of such other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits and the report of the other auditors,
such consolidated financial statements present fairly, in all material respects,
the financial position of S3 Incorporated and subsidiaries at December 31, 1997,
and the results of their operations and their cash flows for each of the two
years in the period ended December 31, 1997 in conformity with generally
accepted accounting principles. Also, in our opinion, the financial statement
schedule for the years ended December 31, 1997 and 1996, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
San Jose, California
January 23, 1998
30
<PAGE> 33
S3 INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1998 1997 1996
--------- -------- --------
<S> <C> <C> <C>
Net sales................................................. $ 224,639 $436,359 $439,243
Cost of sales............................................. 226,711 301,185 270,367
--------- -------- --------
Gross margin (loss)....................................... (2,072) 135,174 168,876
Operating expenses:
Research and development................................ 78,566 78,612 63,382
Selling, marketing and administrative................... 41,926 55,879 48,800
Other operating expense................................. 41,335 17,180 --
--------- -------- --------
Total operating expenses........................ 161,827 151,671 112,182
--------- -------- --------
Income (loss) from operations............................. (163,899) (16,497) 56,694
Gain on sale of joint venture........................... 26,561 -- --
Interest income......................................... 7,253 5,295 4,328
Interest expense........................................ (6,235) (6,477) (1,971)
Other income (expense).................................. (6,309) (952) (128)
--------- -------- --------
Income (loss) before income taxes and equity in income of
manufacturing joint venture............................. (142,629) (18,631) 58,923
Provision (benefit) for income taxes...................... (11,956) (8,497) 19,792
--------- -------- --------
Income (loss) before equity in income of manufacturing
joint venture........................................... (130,673) (10,134) 39,131
Equity in income from manufacturing joint venture......... 17,469 19,012 2,457
--------- -------- --------
Net income (loss)......................................... $(113,204) $ 8,878 $ 41,588
========= ======== ========
Per share amounts:
Basic................................................... $ (2.22) $ 0.18 $ 0.88
Diluted................................................. $ (2.22) $ 0.17 $ 0.81
Shares used in computing per share amounts:
Basic................................................... 51,078 49,519 47,460
Diluted................................................. 51,078 51,740 52,451
</TABLE>
See accompanying notes to consolidated financial statements.
31
<PAGE> 34
S3 INCORPORATED
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARES AND PER SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
-------- --------
<S> <C> <C>
Current assets:
Cash and equivalents...................................... $ 31,022 $ 90,484
Short-term investments.................................... 88,553 27,186
Accounts receivable (net of allowances of $6,525 in 1998
and $5,664 in 1997).................................... 23,864 60,713
Inventories............................................... 11,383 71,882
Production capacity rights................................ 15,709 19,200
Prepaid taxes............................................. 20,203 8,367
Prepaid expenses and other................................ 6,444 23,605
-------- --------
Total current assets.............................. 197,178 301,437
Property and equipment -- net............................... 22,392 46,628
Production capacity rights.................................. -- 4,800
Investment in joint venture................................. 88,056 104,465
Other assets................................................ 18,175 35,524
-------- --------
Total............................................. $325,801 $492,854
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 16,315 $ 42,819
Notes payable............................................. 14,400 25,246
Accrued compensation and benefits......................... 6,491 8,888
Accrued liabilities....................................... 5,823 3,570
Deferred revenue.......................................... 1,905 10,921
-------- --------
Total current liabilities......................... 44,934 91,444
Notes payable............................................... -- 4,800
Other liabilities........................................... 13,837 22,270
Convertible subordinated notes.............................. 103,500 103,500
Commitments and contingencies (Notes 7 and 11)
Stockholders' equity:
Preferred stock, $.0001 par value; 5,000,000 shares
authorized; none outstanding........................... -- --
Common stock, $.0001 par value; 70,000,000 shares
authorized; 51,716,171,and 50,549,279, shares
outstanding in 1998 and 1997 respectively.............. 5 5
Additional paid-in capital................................ 191,642 187,271
Accumulated other comprehensive loss...................... (14,755) (16,278)
Retained earnings (accumulated deficit)................... (13,362) 99,842
-------- --------
Total stockholders' equity........................ 163,530 270,840
-------- --------
Total............................................. $325,801 $492,854
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
32
<PAGE> 35
S3 INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARES)
<TABLE>
<CAPTION>
ACCUMULATED
OTHER RETAINED
COMMON STOCK ADDITIONAL COMPREHENSIVE EARNINGS
------------------- PAID-IN INCOME (ACCUMULATED
SHARES AMOUNT CAPITAL (LOSS) DEFICIT) TOTAL
---------- ------ ---------- ------------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31,
1995....................... 46,797,327 $5 $156,469 $ 14 $ 49,376 $ 205,864
Comprehensive Income
Net income.............. -- -- -- -- 41,588 41,588
Other comprehensive
loss, net of tax:
Change in unrealized
loss on investments... -- -- -- (68) -- (68)
---------
Other comprehensive
loss.................. (68)
---------
Comprehensive income....... 41,520
Exercise of stock
options................. 1,204,235 -- 4,550 -- -- 4,550
Employee stock purchase
plan.................... 231,161 -- 2,467 -- -- 2,467
Tax benefit of stock option
transactions............ -- -- 4,725 -- -- 4,725
Stock compensation plan.... 99,071 -- 1,195 -- -- 1,195
---------- -- -------- -------- --------- ---------
BALANCE AT DECEMBER 31,
1996....................... 48,331,794 5 169,406 (54) 90,964 260,321
Comprehensive loss
Net income.............. -- -- -- -- 8,878 8,878
Other comprehensive
loss, net of tax:
Change in unrealized
gain on
investments........ -- -- -- 3,720 -- 3,720
Change in foreign
currency
translation
adjustment......... -- -- -- (19,944) -- (19,944)
---------
Other comprehensive
loss.................. (16,224)
---------
Comprehensive loss......... (7,346)
Exercise of stock
options................. 1,703,768 -- 8,796 -- -- 8,796
Employee stock purchase
plan.................... 414,646 -- 3,180 -- -- 3,180
Tax benefit of stock option
transactions............ -- -- 3,825 -- -- 3,825
Stock compensation plan.... 99,071 -- 2,064 -- -- 2,064
---------- -- -------- -------- --------- ---------
BALANCE AT DECEMBER 31,
1997....................... 50,549,279 5 187,271 (16,278) 99,842 270,840
Comprehensive loss
Net loss................ -- -- -- -- (113,204) (113,204)
Other comprehensive
income, net of tax:
Change in unrealized
loss on
investments........ -- -- -- (5,995) -- (5,995)
Change in foreign
currency
translation
adjustment......... -- -- -- 7,518 -- 7,518
---------
Other comprehensive
income................ 1,523
---------
Comprehensive loss......... (111,681)
Exercise of stock
options................. 560,546 -- 1,984 -- -- 1,984
Employee stock purchase
plan.................... 606,346 -- 2,387 -- -- 2,387
---------- -- -------- -------- --------- ---------
BALANCE AT DECEMBER 31,
1998....................... 51,716,171 $5 $191,642 $(14,755) $ (13,362) $ 163,530
========== == ======== ======== ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
33
<PAGE> 36
S3 INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
--------- -------- ---------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)...................................... $(113,204) $ 8,878 $ 41,588
Adjustments to reconcile net income to net cash
provided by (used for) operating activities:
Deferred income taxes............................... 15,453 5,432 (10,469)
Depreciation........................................ 18,844 15,504 10,713
Amortization........................................ 8,347 2,987 --
Write-off of prepaid production capacity............ 4,000 -- --
Utilization of production capacity rights........... 4,291 (2,400) (7,200)
Loss on disposal of property and equipment.......... 11,308 2,214 --
Write-off of impaired assets........................ 27,226 17,180 --
Write-off of acquired technologies.................. 8,000 -- --
Gain on sale of shares of joint venture............. (26,561) -- --
Stock compensation.................................. -- 2,064 1,195
Equity in income from joint venture................. (17,469) (30,962) (3,999)
Changes in assets and liabilities:
Accounts receivable............................... 36,849 15,407 8,090
Inventories....................................... 60,499 (18,416) (10,173)
Prepaid expenses and other........................ 1,158 (25,451) (6,975)
Accounts payable.................................. (26,573) (8,341) (10,921)
Accrued compensation and benefits................. (2,397) (1,574) (802)
Accrued liabilities............................... 1,515 3,362 5,237
Deferred revenue.................................. (9,015) (1,192) 12,079
Income taxes payable.............................. (11,576) (3,536) 5,810
--------- -------- ---------
Net cash provided by (used for) operating activities... (9,305) (18,844) 34,173
--------- -------- ---------
INVESTING ACTIVITIES
Property and equipment purchases, net.................. (5,916) (30,299) (23,403)
Purchases of short-term investments.................... (125,406) (16,404) (74,798)
Maturities of short-term investments................... 66,691 55,705 36,592
Investment in real estate partnership.................. -- -- (2,100)
Sale of joint venture.................................. 68,025 -- --
Equity investment in technology company................ -- (5,000) --
Investment in joint venture............................ -- -- (53,006)
Purchase of technology................................. (40,000) -- --
Other assets........................................... (2,276) (10,412) (3,778)
--------- -------- ---------
Net cash used for investing activities................. (38,882) (6,410) (120,493)
--------- -------- ---------
FINANCING ACTIVITIES
Sale of common stock, net.............................. 4,371 11,976 7,017
Sale of convertible subordinated notes................. -- -- 103,500
Debt issuance costs.................................... -- -- (3,370)
Net borrowings (repayments) of notes payable........... (10,000) 10,000 (2,000)
Net borrowings (repayments) on equipment financing..... (5,646) (854) 6,500
--------- -------- ---------
Net cash provided by (used for) financing activities... (11,275) 21,122 111,647
--------- -------- ---------
Net increase (decrease) in cash and equivalents........ (59,462) (4,132) 25,327
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD.............. 90,484 94,616 69,289
--------- -------- ---------
CASH AND EQUIVALENTS AT END OF PERIOD.................... $ 31,022 $ 90,484 $ 94,616
========= ======== =========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid.......................................... $ 6,235 $ 6,665 $ 231
Income taxes paid (refunded), net...................... $ (15,900) $ 10,119 $ 20,483
</TABLE>
See accompanying notes to consolidated financial statements.
34
<PAGE> 37
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization
S3 Incorporated ("S3" or the "Company") was incorporated on January 9, 1989
and is a leading supplier of high performance multimedia accelerator solutions.
The Company's products are used in, and its business is dependent on, the
personal computer industry with sales primarily in the U.S., Asia and Europe
(see Note 10). Its products are manufactured, assembled and tested by
independent wafer foundries and contract manufacturers.
Basis of Presentation
The consolidated financial statements include the accounts of S3
Incorporated and its wholly-owned subsidiaries. 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.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Significant estimates include allowances for doubtful accounts
and customer returns, deferred tax assets, the useful lives of fixed assets and
intangible assets, inventory reserves and other reserves. Actual results could
differ from those estimates, and such differences may be material to the
financial statements.
Cash, Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with a remaining
maturity of 90 days or less at the time of purchase to be cash equivalents. Cash
equivalents are carried at cost, which approximates fair value. The Company's
short-term investments primarily comprise readily marketable debt and equity
securities with remaining maturities of more than 90 days at the time of
purchase.
The Company has classified its entire investment portfolio as
available-for-sale. Available-for-sale securities are classified as cash
equivalents or short-term investments and are stated at fair value with
unrealized gains and losses included in accumulated other comprehensive income
(loss). The amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization and accretion
are included in interest income. Realized gains and losses are included in other
income (expense). The cost of securities sold is based on the specific
identification method.
Fair Value of Financial Instruments
The carrying value of cash and cash equivalents approximates fair value.
The fair values of short-term investments, convertible subordinated notes and
foreign currency forward exchange contracts are estimated based on quoted market
prices.
Derivative Financial Instruments
The Company periodically enters forward foreign exchange contracts
primarily to hedge the value of accounts receivable denominated in foreign
currencies against fluctuations in exchange rates until such receivables are
collected. The Company does not enter into forward foreign exchange contracts
for speculative or trading purposes. The Company's accounting policies for these
contracts are based on the Company's designation of the contracts as hedges of
firm foreign currency commitments. Gains and losses on forward
35
<PAGE> 38
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
foreign exchange contracts are deferred and recognized in income in the same
period as losses and gains on the underlying transactions are recognized and
generally offset. As of December 31, 1998, the Company had one foreign exchange
forward contract outstanding. The Company purchased a forward contract allowing
them to acquire approximately 1,500,000 Singapore Dollars for approximately
$879,000. The contract expires March 31, 1999.
Inventories
Inventories consist of work in process and finished goods and are stated at
the lower of cost (first-in, first-out) or market. The Company's products
typically experience short product life cycles and the Company estimates the
market value of its inventory based on anticipated selling prices adjusted for
completion and selling costs. Should the Company experience a substantial
unanticipated decline in the selling price of its products and/or demand
thereof, a material valuation adjustment and corresponding charge to operations
could result.
Required payments under a wafer supply agreement to secure future
production capacity are capitalized and amortized to inventory costs as the
related product is received.
Inventories consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1998 1997
------- -------
(IN THOUSANDS)
<S> <C> <C>
Work in process.......................................... $ 6,340 $28,392
Finished goods........................................... 5,043 43,490
------- -------
Total.......................................... $11,383 $71,882
======= =======
</TABLE>
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over estimated useful lives of three years for
machinery and equipment and five years for furniture and fixtures. Leasehold
improvements are amortized using the straight-line method over the shorter of
the lease term or the assets' useful lives.
Property and equipment consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1998 1997
------- -------
(IN THOUSANDS)
<S> <C> <C>
Machinery and equipment.................................. $37,718 $71,340
Furniture and fixtures................................... 3,622 5,460
Leasehold improvements................................... 4,347 3,688
------- -------
Total.......................................... 45,687 80,488
Accumulated depreciation and amortization................ (23,295) (33,860)
------- -------
Property and equipment, net.............................. $22,392 $46,628
======= =======
</TABLE>
Long-Lived Assets
In accordance with Statement of Financial Accounting Standards No. 121
("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of," the Company recognizes impairment losses
on long-lived assets used in operations when indicators of impairment are
present and the undiscounted cash flows estimated to be generated by those
assets are less than the assets'
36
<PAGE> 39
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
carrying amounts. The impairment loss is measured by comparing the fair value of
the asset to its carrying amount. The Company annually evaluates the
recoverability of its long-lived assets based on the estimated future
undiscounted cash flows. See Note 12 for further discussion of impairment
charges.
Foreign Currency Translation
The Company translates the accounts of its foreign subsidiaries using the
local currency as the functional currency. Consequently, the assets and
liabilities of the Company's subsidiaries and joint venture are translated into
U.S. dollars at current exchange rates and revenues and expenses are translated
at average monthly exchange rates. The resulting translation adjustments are
recorded as a separate component of accumulated other comprehensive income
(loss).
Revenue Recognition
Revenue from product sales made directly to customers is generally
recognized upon shipment. Accruals for estimated sales returns and allowances
are recorded at the time of sale. Certain of the Company's sales are made to
distributors under agreements allowing price protection and rights of return on
unsold products by the distributors. The Company defers recognition of revenue
on such sales until the product is sold by the distributors.
Concentration of Credit Risk
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of cash equivalents, short-term
investments, trade accounts receivable and foreign exchange contracts. The
Company invests only in high credit quality short-term debt instruments and
limits the amount of credit exposure to any one entity. A majority of the
Company's trade receivables is derived from sales to manufacturers in the
computer industry. Three customers accounted for greater than 75% of the
Company's accounts receivable balance at December 31, 1998. The Company performs
ongoing credit evaluations of its customers' financial condition and limits the
amount of credit extended when deemed necessary but generally requires no
collateral. The Company maintains reserves for potential credit losses, and all
such losses to date have been within management's expectations.
Research and Development Expenses
Research and development is expensed as incurred. To the extent research
and development costs include the development of computer software, the Company
believes that software development is an integral part of the semiconductor
design and expenses all such costs as incurred.
Income Taxes
The Company accounts for income taxes using the asset and liability
approach pursuant to SFAS No. 109, "Accounting for Income Taxes."
Stock-Based Compensation
The Company accounts for stock-based awards to employees using the
intrinsic value method in accordance with Accounting Principles Board No. 25
("APB 25"), "Accounting for Stock Issued to Employees." The Company adopted the
disclosure requirements of SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), which require the disclosure of pro forma net income
and earnings per share as if the Company adopted the fair value-based method in
measuring compensation expense as of the beginning of fiscal 1995.
37
<PAGE> 40
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board issued Statement No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133")
which provides a comprehensive and consistent standard for the recognition and
measurement of derivatives and hedging activities. The statement is effective
for fiscal years commencing after June 15, 1999. The Company does not believe
that SFAS 133 will have a material impact on earnings or the financial condition
of the Company.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year presentation. Such reclassifications had no effect on net income (loss) or
stockholders' equity.
2. FINANCIAL INSTRUMENTS
The following is a summary of available-for-sale securities:
<TABLE>
<CAPTION>
UNREALIZED UNREALIZED
AMORTIZED MARKET HOLDING HOLDING
COST VALUE GAINS LOSSES
--------- -------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
DECEMBER 31, 1998:
Corporate Debt Securities:
Money market mutual funds................... $ 15,645 $ 15,645 $ -- $ --
Commercial paper............................ 5,475 5,470 -- (5)
Corporate bonds............................. 35,802 35,860 68 (10)
Municipal bonds............................. 5,000 5,000 -- --
Market auction preferreds................... 25,500 25,500 -- --
Certificates of deposit..................... 19,002 19,016 16 (2)
-------- -------- ------ -------
Total Corporate Debt Securities..... 106,424 106,491 84 (17)
-------- -------- ------ -------
Corporate Equity Securities................... 6,600 4,204 -- (2,396)
-------- -------- ------ -------
$113,024 $110,695 $ 84 $ (2413)
======== ======== ====== =======
Included in short-term investments............ $ 90,881 $ 88,553 $ 84 $(2,412)
Included in cash and cash equivalents......... 22,143 22,142 -- (1)
-------- -------- ------ -------
$113,024 $110,695 $ 84 $(2,413)
======== ======== ====== =======
DECEMBER 31, 1997:
Corporate Debt Securities..................... $ 21,931 $ 21,954 $ 42 $ (19)
Mortgage-Backed Securities.................... 3,197 3,197 -- --
Debt securities of states of the United States
and political subdivisions of the states.... 2,038 2,035 -- (3)
-------- -------- ------ -------
Total short-term investments........ 27,166 27,186 42 (22)
-------- -------- ------ -------
Corporate Equity Securities................... 5,000 8,646 3,646 --
-------- -------- ------ -------
Total short-term and long-term
investments....................... $ 32,166 $ 35,832 $3,688 $ (22)
======== ======== ====== =======
</TABLE>
38
<PAGE> 41
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
Fair Value Disclosures
The carrying values and fair values of the Company's financial instruments
are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
---------------------- ----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
--------- ---------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Cash and cash equivalents................... $ 31,022 $31,022 $ 90,484 $90,484
Short-term investments...................... 88,553 88,553 27,186 27,186
Convertible subordinated notes.............. (103,500) (76,750) (103,500) (68,880)
Foreign currency forward exchange
contracts................................. -- 25 -- --
</TABLE>
3. INVESTMENTS
Investment in USC
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 the Science
Based Industrial Park in Hsin Chu City, Taiwan, Republic of China. The Company
invested $36.4 million in 1995 and $53.0 in 1996 for its 23.75% equity interest.
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 $68.0
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 facility
commenced production utilizing advanced submicron semiconductor manufacturing
processes in 1996. The Company has the right to purchase up to 31.25% of the
output from the foundry.
The Company accounts for its investment in USC using the equity method of
accounting. The Company records its share of the earnings or losses of the
investment in its income statement. The Company believes that the equity method
of accounting is appropriate due to the significant influence it has in the
financial and operating decisions of USC.
Summarized financial information below uses the respective year-end
exchange rate for the financial position and an average exchange rate for the
respective year for results of operations. Summarized financial information of
USC at December 31, 1998, 1997 and 1996 is as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------
1998 1997 1996
------------- ------------- ------------
<S> <C> <C> <C>
RESULTS OF OPERATIONS
Net sales...................... U.S. $352,827 U.S. $328,966 U.S. $60,656
Gross profit................... 152,566 151,037 16,941
Net income..................... 112,151 136,969 577
</TABLE>
39
<PAGE> 42
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1998 1997
------------- -------------
<S> <C> <C>
FINANCIAL POSITION
Current Assets................................ U.S. $398,284 U.S. $349,419
Non-current Assets............................ 526,175 370,394
Current Liabilities........................... 151,418 127,873
Non-current Liabilities....................... 219,697 159,644
Stockholders' Equity.......................... 553,344 432,296
</TABLE>
Interest in Partnership
In 1995, the Company entered into a limited partnership arrangement with a
developer to obtain a ground lease and develop and operate the Company's current
Santa Clara facilities. The Company's investment of $2.1 million represents a
50% interest in Mission Real Estate L.P. (the partnership), in which the Company
is a limited partner. Permanent nonrecourse financing has been obtained. The
Company is not a guarantor on the permanent financing.
4. CONVERTIBLE SUBORDINATED NOTES
In September 1996, the Company completed a private placement of $103.5
million aggregate principal amount of convertible subordinated notes. The notes
mature in 2003. Interest is payable semi-annually at 5 3/4% per annum. The notes
are convertible at the option of the note holders into the Company's common
stock at an initial conversion price of $19.22 per share, subject to adjustment.
Beginning in October 1999, the notes are redeemable at the option of the Company
at an initial redemption price of 102% of the principal amount. The Company has
reserved 5,385,015 shares of common stock (plus such additional number of shares
that may be required pursuant to the operation of anti-dilution provisions) for
the conversion of these notes. Offering costs of approximately $3.4 million are
included in other assets and are amortized on a straight-line basis over the
term of the notes. The fair value of the convertible subordinated notes at
December 31, 1998 was approximately $76.75 million.
5. LINE OF CREDIT AND NOTES PAYABLE
As of December 31, 1997, the Company had $10.0 million outstanding under a
$75.0 million unsecured revolving line of credit that expired September 26,
1998. Borrowings were charged interest at the bank's prime rate. The Company was
not in compliance with one financial covenant at December 31, 1997. Subsequent
to year-end, the lender waived non-compliance with the violated debt covenant
for the period ended December 31, 1997. During 1998, the Company repaid all
amounts outstanding and terminated this unsecured revolving line of credit.
The Company had two separate secured equipment lines of credit totaling
$10.0 million at December 31, 1997. Borrowings were charged interest at the
prime rate. The Company had $5.6 million outstanding under these secured
equipment lines at December 31, 1997. During 1998, the Company repaid all
amounts outstanding and terminated these two secured equipment lines of credit.
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. The notes bear interest at 10% per annum commencing
on the individual notes' maturity dates if such notes are not paid. The Company
made no payments in 1998, and paid $9.6 million in 1997 and
40
<PAGE> 43
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
$7.2 million in 1996. At December 31, 1998, the remaining advance payments (and
corresponding promissory notes) totaled $14.4 million which the Company is
obligated to pay in 1999. During 1998, the Company commenced negotiations with
TSMC to modify and amend its capacity agreement. Although the terms have not
been finalized, the Company is requesting TSMC to reduce its option capacity and
extend the term of the agreement.
6. STOCKHOLDERS' EQUITY
Preferred Stock
The number of shares of preferred stock authorized to be issued is
5,000,000 with a par of $0.0001 per share. The preferred stock may be issued
from time to time in one or more series. The Board of Directors is authorized to
provide rights, preferences, privileges and restrictions of the shares of such
series. As of December 31, 1998, no shares of preferred stock had been issued.
Stockholder Rights Plan
On May 14, 1997, the Board adopted a Stockholder Rights Plan. To implement
the plan, S3's Board declared a dividend of one preferred stock purchase right
(a "Right") for each outstanding share of S3 common stock held of record on June
1, 1997. Each Right represents a contingent right to purchase, under certain
circumstances, a fractional share of a newly created series of S3 preferred
stock. The Rights would become exercisable and trade independently from S3
common stock upon the public announcement of the acquisition by a person or
group of 15 percent or more of S3's common stock, or ten days after commencement
of a tender or exchange offer for S3 common stock that would result in the
acquisition of 15 percent or more of S3's common stock. In the event one of the
limited conditions is triggered, each Right entitles the registered holder to
purchase one one-thousandth of a share of Preferred Stock at an exercise price
of $85.00 per right. The Rights may be redeemed at $0.01 per Right pursuant to
the plan by the Board of Directors. The Rights expire May 14, 2007.
Employee Stock Purchase Plan
Under the Company's 1993 Employee Stock Purchase Plan (the "Purchase Plan")
2,800,000 shares of common stock are reserved for issuance pursuant thereto. The
Purchase Plan permits eligible employees to purchase shares at a price equal to
85% of the lower of the fair market value at the beginning or end of the
offering period. At December 31, 1998, 1,618,169 shares have been issued under
the Purchase Plan and 1,181,831 shares have been reserved for further issuance.
Stock Plan
Under the Company's stock option plan (the "Option Plan") at December 31,
1998, 26,253,692 shares of common stock have been authorized for the grant of
incentive or nonstatutory stock options and the direct award or sale of shares
to employees, directors and consultants. Incentive stock options must be granted
at not less than fair market value at the date of grant. The exercise price of
nonstatutory options and the share price for shares sold generally may be no
less than 85% of fair market value at the date of the grant or sale. At December
31, 1998, 16,562,258 shares of common stock are reserved for issuance under the
Option Plan and 1,547,576 shares were available for future grant.
41
<PAGE> 44
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
A summary of stock option activity is as follows:
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED AVERAGE
SHARES PRICE PER SHARE
---------- ----------------
<S> <C> <C>
BALANCE, JANUARY 1, 1996........................ 6,984,939 $ 8.37
Options granted................................. 6,538,362 12.09
Options exercised............................... (1,204,235) 3.83
Options cancelled............................... (3,398,967) 15.28
----------
BALANCE, DECEMBER 31, 1996...................... 8,920,099 9.06
Options granted................................. 11,950,388 7.77
Options exercised............................... (1,703,768) 5.16
Options cancelled............................... (9,114,879) 11.17
----------
BALANCE, DECEMBER 31, 1997...................... 10,051,840 6.28
Options granted................................. 9,609,391 4.26
Options exercised............................... (560,546) 3.57
Options cancelled............................... (4,057,968) 7.09
----------
BALANCE, DECEMBER 31, 1998...................... 15,042,717 4.86
==========
</TABLE>
Options to purchase 4,400,697, 2,284,502 and 2,267,969 shares were
exercisable at December 31, 1998, 1997 and 1996, respectively, with a weighted
average exercise price of $5.89, $7.16 and $4.29, respectively. Options to
purchase 4,500,000 shares granted in October 1998 to Kenneth F. Potashner were
granted outside of the plan.
Options generally vest over a period of four years and generally become
exercisable beginning either six months or one year from the date of employment
or grant. Options generally expire ten years from the date of grant. The Company
repriced options on 6,520,033 shares to $5.125, the fair market value on
December 18, 1997. The repriced options are treated as cancelled and regranted,
however, they retained their original vesting terms and expiration dates. All
replacement options were subject to a one-year blackout on exercise (with the
exception of those options held by employees whose employment was terminated on
January 20, 1998 as part of a reduction in force announced by the Company). With
regard to other employees whose employment was not terminated on January 20,
1998, if their employment was terminated prior to the end of the blackout
period, any repriced options were forfeited.
In October 1998, the Company entered into an employment agreement with
Kenneth F. Potashner, pursuant to which Mr. Potashner is employed as the
President, Chief Executive Officer and Chairman of the Board. Mr. Potashner
received two options to purchase an aggregate of 4,500,000 shares of the Common
Stock of the Company. One option for 1,500,000 shares vests upon the earlier of
(i) six months from the date Mr. Potashner was hired by the Company, (ii) a
change in control of the Company, (iii) the termination of Mr. Potashner's
employment without cause or (iv) the termination of Mr. Potashner's employment
following the occurrence of among other things, a diminution in Mr. Potashner's
duties or a reduction in Mr. Potashner's compensation, each of which is deemed a
"constructive termination" and treated similarly to a termination without cause.
The second option for 3,000,000 shares vests over a four year period in
accordance with the following schedule: 750,000 shares shall vest on the first
anniversary of Mr. Potashner's employment with the Company; thereafter, the
options shall vest in equal monthly installments of 62,500 shares.
42
<PAGE> 45
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
Stock Compensation Arrangement
Pursuant to an incentive compensation plan for certain employees, the
Company issued 99,071 shares of common stock on June 30, 1997 and on June 30,
1996. No shares were issued under this plan during 1998. The Company accrued the
related compensation cost ratably over the periods.
Stock-Based Compensation
Under APB 25, the Company generally recognizes no compensation expense with
respect to stock-based awards to employees. Pro forma information regarding net
income (loss) and net income (loss) per share is required by SFAS 123 for awards
granted after December 31, 1994, as if the Company had accounted for its
stock-based awards to employees under the fair value method of SFAS 123. The
fair value method of the Company's stock-based awards to employees was estimated
using the Black-Scholes option pricing model. The Black-Scholes option valuation
model was developed for use in estimating fair value of traded options that have
no vesting restrictions and are fully transferable. The Black-Scholes model
requires the input of highly subjective assumptions including the expected stock
price volatility. Because the Company's stock-based awards to employees have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its stock-
based awards to employees.
The following table summarizes significant ranges of outstanding and
exercisable options at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------------ OPTIONS EXERCISABLE
WEIGHTED ----------------------
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE (YRS) PRICE EXERCISABLE PRICE
- --------------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ 0.12 - $ 4.88 7,125,131 7.89 $3.51 717,886 $3.43
4.91 - 8.63 7,103,676 8.36 5.40 3,119,888 5.37
10.00 - 14.50 738,187 7.52 11.45 509,021 11.30
16.13 - 20.19 75,723 7.66 17.20 53,902 17.37
---------- ---------
$ 0.12 - $20.19 15,042,717 8.09 $4.86 4,400,697 $5.89
========== =========
</TABLE>
The fair value of the Company's stock-based awards to employees was
estimated assuming no expected dividends and the following weighted-average
assumptions:
<TABLE>
<CAPTION>
STOCK OPTION PLAN EMPLOYEE STOCK PURCHASE PLAN
-------------------------------- --------------------------------
1998 1997 1996 1998 1997 1996
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
0.5
Expected life from vest date yrs..... 0.5 yrs. 0.5 yrs. 0.0 yrs. 0.0 yrs. 0.0 yrs.
Volatility....................... 84% 69% 60% 84% 65% 60%
Risk-free interest rate.......... 4.9% 5.9% 6.1% 5.0% 5.5% 6.1%
</TABLE>
The weighted-average estimated fair value of stock options granted during
1998, 1997 and 1996 was $2.21, $3.53 and $4.97 per share, respectively. The
weighted-average estimated fair value of shares granted under the Purchase Plan
during 1998, 1997 and 1996 was $3.46, $5.17 and $6.97 per share, respectively.
43
<PAGE> 46
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
For pro forma purposes, the estimated fair value of the Company's
stock-based awards to employees is generally amortized over the vesting period
of four years (for options) and the offering period (for stock purchases under
the Purchase Plan). The Company's pro forma information is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1998 1997 1996
------------ ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Pro forma net income (loss)................. $(127,967) $(7,575) $28,504
Pro forma per share amounts:
Basic..................................... $ (2.51) $ (0.15) $ 0.60
Diluted................................... $ (2.51) $ (0.15) $ 0.56
</TABLE>
Because SFAS 123 is applicable only to awards granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until
approximately 1999.
Intel Warrant
In December 1998, the Company entered into an agreement pursuant to which
it agreed to issue to Intel Corporation a warrant to purchase 1,000,000 shares
of the Company's Common Stock at an exercise price of $9.00 per share. The
purchase price for the warrant was $990,000. The warrant expires in December
2000.
7. LEASES AND COMMITMENTS
Operating Leases
The Company leases administrative facilities under operating leases that
expire in 2008. During 1995, the Company entered into a limited partnership
arrangement with a developer to obtain a ground lease and develop and operate
the Company's Santa Clara, California facilities. In January 1997, prior to the
expiration of the lease terms of the previous facilities, the Company relocated
its principal administrative facilities to the new Santa Clara facilities at
which time the Company's minimum operating lease payment of $369,000 commenced
for the initial 12 year term. During 1997, the Company sublet a portion of its
previous facilities for the remaining lease terms and negotiated a lease
termination on the other two previous facilities. During 1998, the Company
sublet a portion of its current facilities through 2008.
Future minimum annual payments under operating leases are as follows:
<TABLE>
<CAPTION>
OPERATING LEASES
----------------
(IN THOUSANDS)
<S> <C>
1999.................................. $ 8,571
2000.................................. 6,756
2001.................................. 5,186
2002.................................. 4,426
2003.................................. 4,426
Thereafter............................ 22,129
-------
Total minimum lease
payments.................. $51,494
=======
</TABLE>
The total of minimal rentals to be received in the future under
non-cancelable subleases is $45.1 million as of December 31, 1998.
44
<PAGE> 47
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
Rent expense for 1998, 1997 and 1996, was $8.9 million, $7.1 million and
$3.5 million, respectively. Sublease income for 1998, 1997 and 1996 was $2.6
million, $1.5 million and $0, respectively. Net rent expense for 1998, 1997 and
1996 was $6.3 million, $5.6 million and $3.5 million, respectively.
8. INCOME TAXES
The provision for income taxes consists of:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
CURRENT TAX EXPENSE:
Federal.................................... $(20,802) $(6,102) $27,838
State...................................... -- 4,123 3,966
-------- ------- -------
(20,802) (1,979) 31,804
-------- ------- -------
DEFERRED TAX EXPENSE:
Federal.................................... 4,995 (3,248) (10,722)
State...................................... 3,851 (3,270) (1,290)
-------- ------- -------
8,846 (6,518) (12,012)
-------- ------- -------
Total.............................. $(11,956) $ 8,497 $19,792
======== ======= =======
</TABLE>
The tax benefits resulting from disqualifying dispositions of shares
acquired under the Company's incentive stock option plan and from the exercise
of non-qualified stock options reduced taxes currently payable as shown by
$3,825,000 in 1997 which is reflected as additional paid-in capital. There was
no tax benefit in 1998 associated with stock option activity.
The difference between the provision for taxes on income and the amount
computed by applying the federal statutory income tax rate to income before
taxes is explained below:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Tax computed at 35%.......................... $(49,920) $(6,521) $20,623
State income taxes, net of federal effect.... -- 554 1,739
Tax credits.................................. (2,800) (2,200) (3,396)
Valuation allowance for tax losses and
credits.................................... 40,729 -- --
Other........................................ 35 (330) 826
-------- ------- -------
Provision for income taxes................... $(11,956) $(8,497) $19,792
======== ======= =======
Effective tax rate........................... 8.4% 45.6% 33.6%
======== ======= =======
</TABLE>
45
<PAGE> 48
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
Significant components of the Company's deferred income tax asset are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1997
------- --------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Reserves not currently deductible..................... $10,682 $ 5,138
Deferred revenue...................................... -- 4,214
Compensation expense not currently deductible......... 4,185 3,762
Depreciation/Amortization............................. 16,851 4,021
Credits and net operating loss carryforwards.......... 16,653 5,307
------- --------
Total deferred tax assets..................... 48,371 22,442
Valuation allowance for deferred tax assets........... (40,729) --
------- --------
Net deferred tax assets....................... 7,642 22,442
------- --------
Deferred tax liabilities:
Earnings from foreign joint venture................... (7,642) (13,573)
Other................................................. -- (23)
------- --------
Total deferred tax liabilities................ (7,642) (13,596)
------- --------
Net deferred tax asset........................ $ -- $ 8,846
======= ========
</TABLE>
The Company has net operating loss carryforwards for federal and state tax
purposes of approximately $16.0 million and $25.0 million, respectively,
expiring in 2002 through 2018. The Company has tax credit carry-forwards for
federal and state purposes of approximately $6.4 million and $5.0 million,
respectively, most of which will expire between 2005 and 2018.
9. EMPLOYEE BENEFIT PLANS
The Company implemented a non-qualified cash profit sharing plan in 1994
under which all employees of the Company, including officers are eligible to
receive, on an annual basis, an equal cash bonus based on pretax profits,
prorated for service with the Company. The cash bonus under this plan was $0,
$0, and $2.0 million in 1998, 1997 and 1996, respectively.
As part of his employment agreement, the President and CEO of the Company
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 as determined from the date of the
President and CEO's date of employment. The one-time special cash bonus, if
payable, will be equal to $7,000,000 less an amount which adjusts for any
increase in the share price of the Company's Common Stock above the exercise
price per share of the 1,500,000 Share Option granted to the President and CEO
pursuant to his employment agreement with the Company. The one-time special cash
bonus may also be payable in the event the President and CEO's employment is
terminated without cause. If employment is terminated without cause, the
one-time special cash bonus will be calculated and paid as of the date of the
termination. The Company will continue to pay the President and CEO his maximum
bonus for twelve months following his termination. During such twelve-month
period, the vesting on the 3,000,000 Share Option will continue (See Note 6). If
termination without cause occurs following a change in control of the Company,
the twelve-month period for compensation and benefit continuation will be
extended to eighteen months, and Mr. Potashner will receive an additional cash
payment to the extent that the sum of his continued compensation, special cash
payment and the net exercise value of the 3,000,000 Share Option does not exceed
$10,000,000.
46
<PAGE> 49
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
In November 1998, the Company instituted a bonus plan for certain key
individuals that provides for cash payments of $3.0 million and a contingent
payment of $8.0 million upon the initial public offering of its investment in
USC. These payments will be paid out if the individuals meet certain employment
milestones.
The Company has a 401(k) tax-deferred savings plan whereby all employees
meeting certain age and service requirements may contribute up to 20% of their
eligible compensation (up to a maximum allowed under IRS rules). Contributions
may be made by the Company at the discretion of the Board of Directors. No
contributions by the Company have been made to the plan since its inception.
10. EXPORT SALES AND SIGNIFICANT CUSTOMERS
The Company's primary operations are located in the United States. The
Company sells its products into the personal computer market primarily in the
U.S., Asia and Europe. Export sales accounted for 89%, 70% and 58% of net sales
in 1998, 1997 and 1996, respectively. Approximately 29%, 28% and 37% of export
sales in 1998, 1997 and 1996, respectively, were to affiliates of United States
customers. In 1998, 18% and 55% of export sales were shipped to Hong Kong and
Taiwan, respectively. In 1997, 14% and 53% of export sales were shipped to Hong
Kong and Taiwan, respectively. In 1996, 16% and 45% of export sales were shipped
to Hong Kong and Taiwan, respectively. Three customers accounted for 39%, 14%
and 13%, respectively, of net sales in 1998. Three customers accounted for 20%,
13% and 12%, respectively, of net sales in 1997. Two customers accounted for 16%
and 15% respectively, of net sales in 1996.
In June 1997, SFAS No. 131, "Disclosure about Segments of an Enterprise and
Related Information" was issued and adopted by the Company in 1998. SFAS 131
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports issued to stockholders. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. The Company operates and tracks its results in one segment. The
Company's chief operating decision maker believes that management decisions
regarding products, geographic areas and customers can be made with Company wide
data at the current time. Accordingly, there are no additional disclosure
requirements involved with the Company's adoption of SFAS 131.
11. CONTINGENCIES
The semiconductor industry is 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 18, 1996 and November 3, 1997. The complaints name as
defendants the Company, certain of its officers and former officers, and certain
directors of the Company, asserting that they violated federal and state
securities laws by misrepresenting and failing to disclose certain information
about the Company's business. In addition, certain stockholders have filed
derivative actions in the state courts of California and Delaware seeking
recovery on behalf of the Company, alleging, among other things, breach of
fiduciary duties by such individual defendants. The derivative cases in
California state court have been consolidated, and plaintiffs have filed a
consolidated amended complaint. The court has entered a stipulated order in
those derivative cases suspending court proceedings and coordinating discovery
in them with discovery in the class actions in California state courts. On
plaintiffs' motion, the federal court has dismissed the federal class actions
without prejudice. The class actions in California state court have been
consolidated, and plaintiffs have filed a consolidated amended complaint. The
Company has
47
<PAGE> 50
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
answered that complaint. Discovery is pending. 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.
12. OTHER OPERATING EXPENSES
Other operating expense is as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Write-off of acquired technologies............ $ 8,000 $ -- $ --
Impairment of long-lived assets............... 27,226 17,180 --
Restructuring................................. 6,109 -- --
------- ------- -------
Total............................... $41,335 $17,180 $ --
======= ======= =======
</TABLE>
In January 1998, the Company entered into a $40.0 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 $8.0
million of the value of the acquired technologies that were not realizable based
on estimated cash flows from the sale of products currently sold by the Company.
The remaining $32.0 million intangible asset was being amortized to cost of
sales based on the estimated lives of the currently utilized core technologies,
which was generally five years until the fourth quarter of 1998.
During the fourth quarter of 1998, management reevaluated the carrying
value of the intangible assets recorded in connection with the technology
exchange with Cirrus Logic, Inc., and related to the patents obtained from
Brooktree, as well as other long-lived assets, including property and equipment.
This revaluation was necessitated by management's determination based on recent
results of operations and that the future expected sales and cash flows for the
Company's operations would be substantially lower than had been previously
expected by management. Expected undiscounted future cash flows were not
sufficient to recover the carrying value of such assets. Accordingly, an
impairment loss of $27.2 million, representing the excess of the carrying value
over the estimated fair value of the assets, was recognized for write-downs of a
substantial portion of the intangible assets. The estimated fair value of the
intangible assets was based on management's best estimate of the patent
portfolio based on a comparison to other graphics technology portfolios in the
marketplace. The Company determined that no write-down of property and equipment
was necessary at December 31, 1998 based on its estimate of the fair value of
such assets. Due to technological changes in the graphics marketplace, the
Company concluded it should accelerate its amortization of its remaining patent
portfolio, of approximately $4.0 million, over the current estimated life of the
currently utilized core technologies, which is two years.
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
48
<PAGE> 51
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
Company reduced its headcount and consolidated facilities. The following
analysis sets forth the significant components of the restructuring reserve at
December 31, 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................... (804) -- -- (804)
Non-cash charge............... -- (2,474) (2,611) (5,085)
------ ------- ------- -------
Reserve balance December 31,
1998........................ $ 220 $ -- $ -- $ 220
====== ======= ======= =======
</TABLE>
Severance and related benefits represented the reduction of approximately
70 employees, of which 69 have been paid and separated from the Company as of
December 31, 1998. All severance packages will be paid by the end of the second
quarter of 1999. The number of temporary employees and contractors used by the
Company was also reduced. The restructuring expense included 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 estimated
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 plans to complete its move by the end of
the second quarter of 1999.
During the fourth quarter of 1997, the Company wrote-off approximately
$17.2 million of intangible assets including certain license, patents and other
technology, as a result of management's decision to focus attention on the core
graphics business. As a result of this decision, no future cash flows were
expected related to these assets.
13. EARNINGS PER SHARE
When computing diluted earnings per share, the Company includes only
potential common shares that are dilutive. Exercise of approximately 15,042,000
options in 1998 and the conversion of approximately 5,385,000 convertible
securities in 1998 and 1997 is not assumed because the result would have been
anti-dilutive.
49
<PAGE> 52
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1998 1997 1996
--------- ------ -------
(IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
NUMERATOR
Net Income (Loss)
Basic................................... $(113,204) $8,878 $41,588
Interest expense on subordinated debt... -- -- 1,071
--------- ------ -------
Diluted................................. $(113,204) $8,878 $42,659
========= ====== =======
DENOMINATOR
Denominator for basic earnings per share... 51,078 49,519 47,460
Common stock equivalents................... -- 2,221 3,469
Subordinated debt.......................... -- 0 1,522
--------- ------ -------
Denominator for diluted earnings per
share................................... 51,078 51,740 52,451
========= ====== =======
Basic earnings per share..................... $ (2.22) $ 0.18 $ 0.88
Diluted earnings per share................... $ (2.22) $ 0.17 $ 0.81
</TABLE>
14. COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income" ("SFAS 130"). SFAS 130 establishes new rules for the
reporting and display of comprehensive income and its components; however, the
adoption of the Statement had no impact on the Company's net income (loss) or
stockholders' equity. SFAS 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 stockholders'
equity, to be included in other comprehensive income. Prior year financial
statements have been reclassified to conform to the requirements of SFAS 130.
The following are the components of accumulated other comprehensive loss,
net of tax:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1998 1997 1996
-------- -------- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Unrealized gain (loss) on investments.......... $ (2,329) $ 3,666 $(54)
Foreign currency translation adjustments....... (12,426) (19,944) --
-------- -------- ----
Accumulated other comprehensive loss......... $(14,755) $(16,278) $(54)
======== ======== ====
</TABLE>
The following schedule of other comprehensive income (loss) shows the gross
current-period gain (loss) and the reclassification adjustment. Due to the
Company's 1998 and 1997 operating losses and the immaterial components of other
comprehensive income in 1996, tax amounts were nominal.
50
<PAGE> 53
S3 INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------
1998 1997 1996
------- -------- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Unrealized gain (loss) on investments
Unrealized gain (loss) on available-for-sale
securities................................. $(5,967) $ 3,715 $(92)
Less: reclassification adjustment for (gain)
loss realized in net income................ (28) 5 24
------- -------- ----
Net unrealized gain (loss) on investments....... (5,995) 3,720 (68)
Foreign currency translation adjustments........ 7,518 (19,944) --
------- -------- ----
Other comprehensive income (loss)............... $ 1,523 $(16,224) $(68)
======= ======== ====
</TABLE>
51
<PAGE> 54
SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED)(1)
<TABLE>
<CAPTION>
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1998
Net sales....................................... $ 41,547 $ 47,286 $ 53,299 $ 82,507
Gross margin (loss)............................. (16,322) (7,920) 6,492 15,678
Income (loss) from operations(2)................ (70,760) (43,805) (22,485) (26,849)
Net income (loss)(3)............................ $(70,290) $(35,401) $(11,634) $ 4,121
Per share amounts:
Basic......................................... $ (1.36) $ (0.69) $ (0.23) $ 0.08
Diluted(4).................................... $ (1.36) $ (0.69) $ (0.23) $ 0.08
Shares used in computing per share amounts:
Basic......................................... 51,554 51,174 50,985 50,601
Diluted(4).................................... 51,554 51,174 50,985 52,148
Stock prices:(5)
High............................................ $ 8.25 $ 5.38 $ 7.97 $ 7.88
Low............................................. $ 2.00 $ 2.81 $ 5.00 $ 4.94
YEAR ENDED DECEMBER 31, 1997
Net sales....................................... $101,911 $119,604 $ 84,589 $130,255
Gross margin.................................... 26,443 33,413 24,883 50,435
Income (loss) from operations(2)................ (25,305) (407) (9,648) 18,863
Net income (loss)............................... $ (8,122) $ 4,384 $ (1,766) $ 14,382
Per share amounts:
Basic......................................... $ (0.16) $ 0.09 $ (0.04) $ 0.30
Diluted(4).................................... $ (0.16) $ 0.08 $ (0.04) $ 0.27
Shares used in computing per share amounts:
Basic......................................... 50,440 49,764 49,201 48,672
Diluted(4).................................... 50,440 52,380 49,201 57,503
Stock prices:(5)
High............................................ $ 13.19 $ 17.44 $ 13.13 $ 18.88
Low............................................. $ 4.81 $ 10.56 $ 9.19 $ 12.44
</TABLE>
- ---------------
(1) The preceding table presents selected unaudited consolidated financial
results for each of the eight quarters in the two-year period ended December
31, 1998. In the Company's opinion, this unaudited information has been
prepared on the same basis as the audited information and includes all
adjustments (consisting of only normal recurring adjustments) necessary for
a fair statement of the financial information for the period presented.
(2) Loss from operations for 1998 includes a write-off of acquired technologies
of $8.0 million in the first quarter of 1998, a charge for impairment of
long-lived assets of $27.2 million in the fourth quarter of 1998 and a
restructuring charge of $6.1 million in the third quarter of 1998. Income
(loss) from operations for 1997 includes a charge for impairment of
long-lived assets of $17.2 million in the fourth quarter of 1997.
(3) Net income (loss) includes gain on sale of joint venture of $26.6 million in
the first quarter of 1998.
(4) Diluted earnings per share includes the effect of incremental shares
issuable upon the conversion of the convertible subordinated notes, the
dilutive effect of outstanding options and an adjustment to net income for
the interest expense (net of income taxes) related to the notes unless the
impact of such conversion is anti-dilutive. The effect of the conversion was
anti-dilutive in the second and fourth quarters of 1997 and all quarters of
1998.
(5) The Company's common stock trades on the Nasdaq National Market under the
symbol SIII. The table indicates the range of the high and low closing
prices, as reported by Nasdaq.
At December 31, 1998, there were approximately 665 stockholders of record
of the Company's common stock and approximately 35,000 beneficial stockholders.
The Company has never declared or paid cash dividends on its capital stock and
does not anticipate paying any cash dividends in the foreseeable future. The
Company currently intends to retain future earnings for the development of its
business.
52
<PAGE> 55
UNITED SEMICONDUCTOR CORPORATION
FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
53
<PAGE> 56
January 22, 1999
(99)B.L36P4065
To the Board of Directors of United Semiconductor Corporation
We have examined the accompanying balance sheets of United Semiconductor
Corporation as of December 31, 1998 and 1997, and the related statements of
income, of changes in stockholders' equity and of cash flows for the years then
ended. Our examinations were made in accordance with the "Rules Governing the
Certification of Financial Statements by Certified Public Accountants" and
generally accepted auditing standards and accordingly included such tests of the
accounting records and such other auditing procedures as we considered necessary
in the circumstances.
In our opinion, the financial statements examined by us present fairly the
financial position of United Semiconductor Corporation as of December 31, 1998
and 1997, and the results of its operations and its cash flows for the years
then ended, in conformity with generally accepted accounting principles
consistently applied.
PricewaterhouseCoopers
Hsinchu, Taiwan R.O.C.
54
<PAGE> 57
UNITED SEMICONDUCTOR CORPORATION
BALANCE SHEET
DECEMBER 31,
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS)
ASSETS
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents (Note 4(1))..................... $ 7,516,907 $ 5,469,227
Marketable securities (Note 4(2))......................... 3,138,393 3,190,746
Notes receivable
-- third parties....................................... 189 --
-- related parties (Note 5)............................ 8,352 781
Accounts receivable
-- third parties (Note 4(3))........................... 778,399 937,320
-- related parties (Note 5)............................ 436,937 939,664
Other receivables......................................... 165,146 88,905
Inventories (Note 4(4))................................... 665,344 511,486
Prepaid expenses.......................................... 7,803 17,669
Other current assets (Note 4(12))......................... 93,353 230,381
----------- -----------
12,810,823 11,386,179
----------- -----------
LONG-TERM INVESTMENTS (NOTES 4(5))
Long-term investment...................................... 105,759 --
Prepaid long-term investment.............................. 250,400 --
----------- -----------
356,159 --
----------- -----------
PROPERTY, PLANT AND EQUIPMENT (NOTES 4(6) AND 6)
Cost
Machinery and equipment................................... 18,591,271 10,169,495
Transportation equipment.................................. 3,206 3,206
Furniture and fixtures.................................... 217,742 130,771
Leasehold improvements.................................... 10,966 10,966
Other equipment........................................... 40,974 14,270
----------- -----------
18,864,159 10,328,708
Accumulated depreciation.................................. (4,452,290) (1,944,961)
Construction in progress and prepayments.................. 967,065 2,460,306
----------- -----------
15,378,934 10,844,053
----------- -----------
INTANGIBLE ASSET
Other intangible assets................................... 813,455 1,037,500
----------- -----------
OTHER ASSETS
Deposit-out............................................... 1,475 30,979
Deferred expense.......................................... 134,044 54,027
Deferred income tax assets (Note 4 (12)).................. 238,121 103,102
Other assets.............................................. 2,231 --
----------- -----------
375,871 188,108
----------- -----------
TOTAL ASSETS...................................... $29,735,242 $23,455,840
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
55
<PAGE> 58
UNITED SEMICONDUCTOR CORPORATION
BALANCE SHEET
DECEMBER 31,
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS)
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
CURRENT LIABILITIES
Short-term loans (Note 4(7)).............................. $ 781,944 $ 1,911,632
Notes payable (Note 5).................................... -- 125,209
Accounts payable
-- third parties....................................... 461,646 513,371
-- related parties (Note 5)............................ 23,634 21,485
Accrued expenses (Note 5)................................. 811,301 578,013
Other payables............................................ 1,213,782 359,172
Current portion of long-term loans (Note 4(8))............ 1,571,458 656,744
Other current liabilities................................... 6,607 1,268
----------- -----------
4,870,372 4,166,894
----------- -----------
LONG-TERM LIABILITIES
Long-term loans (Note 4(8))............................... 7,041,589 5,190,525
----------- -----------
OTHER LIABILITIES
Accrued pension liabilities............................... 24,958 11,619
----------- -----------
Total Liabilities................................. 11,936,919 9,369,038
----------- -----------
STOCKHOLDERS' EQUITY
Common stock (Note 4(10))................................. 13,367,809 10,000,000
Capital reserve generated from the gain on disposal of
fixed assets........................................... 40 40
Retained earnings (Note 4(11))
-- Legal reserve....................................... 408,676 --
-- Unappropriated earnings............................. 4,022,045 4,086,762
Cumulative translation adjustment......................... (247) --
----------- -----------
Total stockholders' equity........................ 17,798,323 14,086,802
----------- -----------
COMMITMENTS AND CONTINGENT LIABILITIES (NOTE 7)
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........ $29,735,242 $23,455,840
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
56
<PAGE> 59
UNITED SEMICONDUCTOR CORPORATION
STATEMENT OF INCOME
FOR THE YEARS ENDED DECEMBER 31,
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS
EXCEPT EARNINGS PER SHARE DATA)
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Operating Revenues
Sales revenues............................................ $12,614,679 $10,003,022
Sales returns............................................. (186,848) (21,216)
Sales allowance........................................... (634,954) (302,184)
----------- -----------
Net sales................................................. 11,792,877 9,679,622
Other operating revenues.................................. 183,553 81,542
----------- -----------
Net operating revenues.................................... 11,976,430 9,761,164
----------- -----------
Operating Cost
Cost of goods sold........................................ (6,748,200) (5,278,405)
Other operating cost...................................... (129,181) (38,604)
----------- -----------
(6,877,381) (5,317,009)
----------- -----------
Gross Profit................................................ 5,099,049 4,444,155
----------- -----------
Operating Expenses
Selling expenses.......................................... (218,789) (88,841)
Administrative expenses................................... (214,364) (265,943)
Research and development expenses......................... (701,179) (443,866)
----------- -----------
(1,134,332) (798,650)
----------- -----------
Operating Income............................................ 3,964,717 3,645,505
----------- -----------
Non-operating Income
Interest income........................................... 368,695 264,153
Dividends revenue......................................... 28,010 21,420
Gain on disposal of investment............................ 41,516 16,956
Foreign exchange gain..................................... -- 397,616
Gain on reverse of allowance on inventory loss............ 59,540 --
Other income.............................................. 5,370 6,853
----------- -----------
503,131 706,998
----------- -----------
Non-operating Expenses
Interest expense.......................................... (464,199) (354,973)
Foreign exchange loss..................................... (71,071) --
Provision for loss on obsolescence of inventories......... -- (50,562)
Financial expense......................................... (10,919) (391)
Other loss................................................ (103,307) (419)
----------- -----------
(649,496) (406,345)
----------- -----------
Income before income tax.................................... 3,818,352 3,946,158
Income tax (expense) benefit (Note 4(12))................... (69,803) 84,057
----------- -----------
Net income.................................................. $ 3,748,549 $ 4,030,215
=========== ===========
Earnings per share (Note 4(13))
Net income................................................ $ 2.80 $ 3.01
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
57
<PAGE> 60
UNITED SEMICONDUCTOR CORPORATION
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31,
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS)
<TABLE>
<CAPTION>
RETAINED EARNINGS CUMULATIVE TRANSLATION
------------------------- ADJUSTMENT FROM TOTAL
CAPITAL LEGAL UNAPPROPRIATED LONG-TERM STOCKHOLDERS'
COMMON STOCK RESERVE RESERVE EARNINGS INVESTMENTS EQUITY
------------ ------- -------- -------------- ---------------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1997... $10,000,000 $-- $ -- $ 56,587 $ -- $10,056,587
Net income for 1997.......... -- -- -- 4,030,215 -- 4,030,215
Transfer of the gain on
disposal of fixed assets to
capital reserve............ -- 40 -- (40) -- --
----------- --- -------- ----------- ----- -----------
Balance at December 31,
1997....................... 10,000,000 40 -- 4,086,762 -- 14,086,802
Appropriation of 1997
earnings:
Appropriation for legal
reserve................. -- -- 408,676 (408,676) -- --
Capitalization of
employees' bonus........ 367,809 -- -- (367,809) -- --
Directors' and supervisors'
renumeration............ -- -- -- (36,781) -- (36,781)
Stock dividends............ 3,000,000 -- -- (3,000,000) -- --
Net income for 1998.......... -- -- -- 3,748,549 -- 3,748,549
Cumulative translation
adjustment................. -- -- -- -- (247) (247)
----------- --- -------- ----------- ----- -----------
Balance at December 31,
1998....................... $13,367,809 $40 $408,676 $ 4,022,045 $(247) $17,798,323
=========== === ======== =========== ===== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
58
<PAGE> 61
UNITED SEMICONDUCTOR CORPORATION
STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS)
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income................................................ $ 3,748,549 $ 4,030,215
Adjustments to reconcile net income to net cash provided
by (used in) operating activities
Depreciation.............................................. 2,510,951 1,591,371
Amortization.............................................. 363,314 320,071
(Reverse of) Provision for loss on obsolescence of
inventories............................................... (47,943) 38,403
(Loss) gain on disposal of fixed assets................... 15 (40)
Fixed assets transferred to expenses...................... 4,759 26,516
Changes in asset and liability accounts:
Accounts and notes receivable............................. 653,888 (1,026,445)
Other receivables......................................... (76,241) (24,017)
Inventories............................................... (105,915) (64,203)
Prepaid expenses.......................................... 9,866 (5,673)
Other current assets...................................... 137,028 (208,429)
Deferred income tax assets................................ (135,019) 116,684
Other assets.............................................. (2,231) --
Accounts and notes payable................................ (174,785) 213,748
Accrued expenses and other payable........................ 233,288 283,571
Other current liabilities................................. (908) 5,911
Accrued pension liabilities............................... 13,339 11,619
----------- -----------
Net cash provided by operating activities................. 7,131,955 5,309,302
----------- -----------
INVESTING ACTIVITIES:
Acquisition of fixed assets............................... (6,280,177) (4,644,743)
Proceeds from disposal of fixed assets.................... -- 9,180
Decrease (increase) in marketable securities.............. 52,353 (2,987,926)
Increase in long-term investment.......................... (356,406) --
Increase in deferred expense and intangible assets........ (128,858) (25,882)
Decrease (increase) in deposits-out....................... 29,504 (915)
----------- -----------
Net cash used in investing activities..................... (6,683,584) (7,650,286)
----------- -----------
FINANCING ACTIVITIES:
Decrease (increase) in short-term loans................... (1,129,688) 1,750,112
Proceeds from long-term loans............................. 2,765,778 1,517,771
Appropriation of directors' and supervisors'
renumeration........................................... (36,781) --
----------- -----------
Net cash provided by financing activities................. 1,599,309 3,267,883
----------- -----------
Net increase in cash and cash equivalents................. 2,047,680 926,899
Cash and cash equivalents at the beginning of year........ 5,469,227 4,542,328
----------- -----------
Cash and cash equivalents at the end of year.............. $ 7,516,907 $ 5,469,227
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest (excluding interest capitalized)... $ 444,233 $ 345,781
=========== ===========
Cash paid for income tax.................................. $ 1,744 $ 51,501
=========== ===========
INVESTING ACTIVITIES PARTIALLY PAID BY CASH
Acquisition of fixed assets............................... $ 7,154,510 $ 3,445,946
Add: payable at the beginning of year..................... 352,925 1,551,722
Less: payable at the end of year.......................... (1,213,782) (352,925)
Fixed assets exchange.................................. (13,476) --
----------- -----------
Cash paid................................................. $ 6,280,177 $ 4,644,743
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
59
<PAGE> 62
UNITED SEMICONDUCTOR CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS)
1. HISTORY AND ORGANIZATION
United Semiconductor Corporation was incorporated as a company limited by
shares on October 6, 1995 and commenced its operations in June, 1996. As of
December 31, 1998, the paid-in capital is $13,367,809. The Company's major
business activities are as follows:
a. Semiconductor and semiconductor device foundry;
b. Providing the mask tooling, package, burn-in, and testing services
for the above-mentioned products; and
c. Research and development for the technology of wafer fabrication.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Translation of foreign currency transactions
The accounts of the Company are maintained in New Taiwan dollars.
Transactions denominated in foreign currencies are translated into New Taiwan
dollars at the rates of exchange prevailing on the transaction dates.
Receivables, other monetary assets and liabilities denominated in foreign
currencies are translated into New Taiwan dollars at the rates of exchange
prevailing at the balance sheet date. Exchange gains or losses are included in
the current year's results.
Cash equivalents
Cash equivalents are short-term, highly liquid investments, which are
readily convertible to known amounts of cash and with maturity dates that do not
present significant risk of changes in value because of changes in interest
rates.
Marketable securities
Marketable securities are recorded at cost when acquired. The carrying
amount of the marketable securities portfolio is stated at the lower of its
aggregate cost or market value at the balance sheet date. The market value for
listed equity securities or close-ended funds are determined by the average
closing prices occurred during the last month of the fiscal year. The market
value for open-ended funds are determined by their equity per unit at balance
sheet date.
Inventories
Inventories, except raw materials stated at actual, are stated at standard
cost which is adjusted to actual cost based on weighted average method at month
end. Inventories are valued at the lower of cost or market value at the year
end. An allowance for loss on obsolescence and decline in market value is
provided when necessary.
Long-term investments
A. If the investee company is listed and the Company owns less than
20% of the outstanding shares and has no significant influence on
operational decisions of the listed company, such investment is accounted
for by the lower of cost or market value method. The unrealized loss
resulting from the decline in market value of such investment is deducted
from stockholders' equity. The Company's investment in a company which is
not listed is accounted for under the cost method.
60
<PAGE> 63
UNITED SEMICONDUCTOR CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS)
B. Investment income or loss from investments in both listed and
unlisted companies is accounted for under equity method provided that the
Company owns over 20% of the outstanding shares or has significant
influence on operational decisions of the listed and unlisted companies.
C. For long-term investments in which the Company owns more than 50%
of the subsidiary, consolidated financial statements are prepared, if the
total assets and the operating income of the subsidiary are less than 10%
of the respective nonconsolidated total assets and income of the Company,
the subsidiary's financial statements are not consolidated and instead are
accounted for using the equity method. Irrespective of the above test, when
the total combined assets or operating income of all such nonconsolidated
subsidiaries constitute more than 30% of the Company's nonconsolidated
total assets or income, then each individual subsidiary with total assets
or operating income greater than 3% of the Company's respective
nonconsolidated total assets and income is included in the consolidation.
D. In evaluation of overseas long-term investment, the cumulative
translation adjustment derived from the investee's foreign currency
financial statements is treated as adjusted item of the Company's
stockholders' equity account.
Property, plant and equipment
A. Property, plant and equipment are stated at cost. Interest incurred
on loans used to finance the construction of property and plant is
capitalized and depreciated accordingly.
B. Depreciation is provided on the straight-line method using the
assets' economic service lives. When the economic service lives are
completed, fixed assets which are still in use are depreciated based on the
residual value. The service lives of the fixed assets are five to ten
years.
C. Maintenance and repairs are charged to expenses as incurred.
Significant renewals and improvements are treated as capital expenditures
and are depreciated accordingly.
Intangible assets
A. Technology knowhow was provided by a major shareholder as part of
paid-in capital. The asset is amortized over five years on the
straight-line method starting from the date of operation.
B. Royalties are stated at cost and amortized on a straight-line basis
over the contract period.
Deferred charges
Deferred charges are stated at cost and amortized on a straight-line basis
over the following years: software -- 3 years; organization cost -- 5 years.
Retirement plan
A. The Company has a non-contributory and funded defined benefit
retirement plan covering all its regular employees.
B. The net pension cost is computed based on an actuarial valuation in
accordance with the provision of FASB No. 18 of the R.O.C., which requires
consideration of cost components such as service cost, interest cost,
expected return on plan assets and amortization of net obligation at
transition.
61
<PAGE> 64
UNITED SEMICONDUCTOR CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS)
Income tax
Income tax is provided based on accounting income after adjusting for
permanent differences. The provision for income tax includes deferred tax
resulting from items reported in different periods for tax and financial
reporting purposes and from investment tax credits. A valuation allowance is
provided for deferred tax asset to the extent that it is more likely than not
that the tax benefits will not be realized. Deferred tax assets or liabilities
are further classified into current or noncurrent items and are presented in the
financial statements as net balance. Over or under provision of prior years'
income tax liabilities are included in the current year's income tax expense.
3. EFFECT OF CHANGE IN ACCOUNTING PRINCIPLES
None.
4. CONTENTS OF SIGNIFICANT ACCOUNTS
(1) CASH AND CASH EQUIVALENTS
<TABLE>
<CAPTION>
DECEMBER 31
------------------------
1998 1997
---------- ----------
<S> <C> <C>
Cash:
Cash on hand........................................ $ 2,355 $ 1,817
Demand accounts..................................... 387,694 58,655
Checking accounts................................... 169,402 16,607
Time deposits....................................... 6,054,016 5,342,348
---------- ----------
6,613,467 5,419,427
Cash equivalents:
Bonds with repurchase agreement..................... 903,440 49,800
---------- ----------
$7,516,907 $5,469,227
========== ==========
</TABLE>
(2) MARKETABLE SECURITIES
<TABLE>
<CAPTION>
DECEMBER 31
------------------------
1998 1997
---------- ----------
<S> <C> <C>
Mutual funds........................................ $ 199,040 $ 251,393
Listed equity securities stocks..................... 2,939,353 2,939,353
---------- ----------
$3,138,393 $3,190,746
========== ==========
</TABLE>
(3) ACCOUNTS RECEIVABLE -- NET
<TABLE>
<CAPTION>
DECEMBER 31
----------------------
1998 1997
-------- --------
<S> <C> <C>
Accounts receivable -- third parties................. $863,417 $959,159
Less: Allowance for doubtful accounts................ (20,982) (21,839)
Less: Allowance for sales returns and discounts...... (64,036) --
-------- --------
$778,399 $937,320
======== ========
</TABLE>
62
<PAGE> 65
UNITED SEMICONDUCTOR CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS)
(4) INVENTORIES
<TABLE>
<CAPTION>
DECEMBER 31
--------------------
1998 1997
-------- --------
<S> <C> <C>
Raw materials, supplies and spare parts................ $ 88,653 $226,426
Work in process........................................ 445,414 315,274
Finished goods......................................... 171,737 58,189
-------- --------
705,804 599,889
Less: Allowance for loss on obsolescence............... (40,460) (88,403)
-------- --------
$665,344 $511,486
======== ========
</TABLE>
(5) LONG-TERM INVESTMENT
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------------------------------
1998 1997
------------------------ ----------------------
PERCENTAGE PERCENTAGE
INVESTEE COMPANY AMOUNT OF OWNERSHIP AMOUNT OF OWNERSHIP
---------------- -------- ------------ ------ ------------
<S> <C> <C> <C> <C>
Investment accounted for under equity method:
UMC-USA...................................... $106,006 20% $-- --
Cumulative translation adjustment............ (247) --
-------- --
Subtotal..................................... 105,759 --
-------- --
Prepaid long-term investment:
Industrial Bank of Taiwan.................... 250,000 --
SBIP Administration Recycle Co............... 400 --
-------- --
Subtotal.................................. 250,400 --
-------- --
Grand total.......................... $356,159 $--
======== ==
</TABLE>
63
<PAGE> 66
UNITED SEMICONDUCTOR CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS)
(6) PROPERTY, PLANT AND EQUIPMENT
<TABLE>
<CAPTION>
ACCUMULATED
COST DEPRECIATION BOOK VALUE
----------- ------------ -----------
<S> <C> <C> <C>
DECEMBER 31, 1998
Machinery and equipment............. $18,591,271 $(4,387,198) $14,204,073
Transportation equipment............ 3,206 (1,122) 2,084
Furniture and fixtures.............. 217,742 (53,978) 163,764
Leasehold improvements.............. 10,966 (4,142) 6,824
Other equipment..................... 40,974 (5,850) 35,124
Construction in progress and
prepayments....................... 967,065 -- 967,065
----------- ----------- -----------
$19,831,224 (4,452,290) 15,378,934
=========== =========== ===========
DECEMBER 31, 1997
Machinery and equipment............. $10,169,495 $(1,915,540) $ 8,253,955
Transportation equipment............ 3,206 (587) 2,619
Furniture and fixtures.............. 130,771 (24,341) 106,430
Leasehold improvements.............. 10,966 (2,315) 8,651
Other equipment..................... 14,270 (2,178) 12,092
Construction in progress and
prepayments....................... 2,460,306 -- 2,460,306
----------- ----------- -----------
$12,789,014 $(1,944,961) $10,844,053
=========== =========== ===========
</TABLE>
Interest expense amounting to $118,745 and $24,321 were capitalized in 1998
and 1997, respectively.
(7) SHORT-TERM LOANS
<TABLE>
<CAPTION>
DECEMBER 31
------------------------------
1998 1997
------------- -------------
<S> <C> <C>
Unsecured loans................................ $781,944 $1,911,632
============= =============
Annual interest rates.......................... 0.73% - 8.22% 1.25% - 7.66%
============= =============
</TABLE>
(8) LONG-TERM LOANS
<TABLE>
<CAPTION>
DECEMBER 31
------------------------------
1998 1997
------------- -------------
<S> <C> <C>
Long-term loans................................ $ 8,613,047 $5,847,269
Less: Current portion.......................... (1,571,458) (656,744)
------------- -------------
$ 7,041,589 $5,190,525
============= =============
Annual interest rates.......................... 1.25% - 7.60% 1.31% - 7.20%
============= =============
</TABLE>
(9) RETIREMENT PLAN
A. All of the regular employees of the Company are covered by the pension
plan. Under the plan, the Company contributes an amount equal to 2% of total
wages on a monthly basis to the pension fund deposited in the Central Trust of
China. Pension benefits are generally based on service years (two points per
year for service years 15 years and below and one point per year for service
years over 15 years). Each employee is limited up to 45 points. During 1998 and
1997, the Company recognized pension cost amounting to $22,262
64
<PAGE> 67
UNITED SEMICONDUCTOR CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS)
and $17,793, respectively. The balances of the Company's employees' retirement
fund in Central Trust of China was $18,068 and $9,270 at December 31, 1998 and
1997, respectively.
B. Based on actuarial assumptions for the years of 1998 and 1997, both the
discount rate and expected rate of return on plan asset are 6.25% and 6.5%,
respectively and the rates of compensation increase are both 8%. The
unrecognized net obligation at transition is amortized equally over 15 years.
The funded status of pension plan is listed as follows:
<TABLE>
<CAPTION>
DECEMBER 31
--------------------
1998 1997
-------- --------
<S> <C> <C>
Vested benefit obligation.............................. $ -- $ --
Non-vested benefit obligation.......................... (11,417) (4,947)
-------- --------
Accumulated benefit obligation......................... (11,417) (4,947)
Effect on projected salary increase.................... (57,082) (25,388)
-------- --------
Projected benefit obligation........................... (68,499) (30,335)
Market-related value of plan assets.................... 18,068 8,638
-------- --------
Projected benefit obligation exceeds plan asset........ (50,431) (21,697)
Unrecognized net obligation at transition.............. 260 281
Unrecognized pension gain or loss...................... 26,647 11,360
-------- --------
Accrued pension liability.............................. $(23,524) $(10,056)
======== ========
</TABLE>
(10) COMMON STOCK
A. As of December 31, 1998, the Company's authorized capital was
$23,000,000, representing 2,300,000 thousand shares, with par value of NT$10.
The total issued and outstanding capital at December 31, 1998 and 1997 were
$13,367,809 and $10,000,000, respectively.
B. Based on the resolution of the shareholders' meeting on May 26, 1998,
the Company issued new shares of 336,781 thousand shares from the capitalization
of retained earnings of $3,000,000 and employees' bonus of $367,809. The Company
has completed the amendment procedures for registration.
(11) RETAINED EARNINGS
A. According to the Company's Articles of Incorporation, current year's
earnings, if any, shall be distributed in the following order:
(1) paying all taxes and dues;
(2) covering prior years' operating losses, if any;
(3) setting aside 10% of the remaining amount, after deducting (1) and
(2), as legal reserve;
(4) allocating not over 10% of par value of common stocks as interest
of capital to common stockholders;
(5) allocating 1% of the remaining amount, after deducting (1), (2),
(3) and (4) above from the current year's earnings, as directors' and
supervisors' remuneration;
(6) allocating not below 10% of the remaining amount, after deducting
(1), (2), (3) and (4) above from the current year's earnings, as employees'
bonus; and
65
<PAGE> 68
UNITED SEMICONDUCTOR CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS)
(7) distributing the remaining amount in accordance with the
resolution of the board of directors and stockholders.
(12) INCOME TAX
A. Income tax receivable at December 31, 1998 and 1997 was derived as
follows:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Income tax expense (benefit)........................... $ 69,803 $(84,057)
Net effect of the change in deferred income tax assets
and liabilities...................................... (54,187) 89,634
Adjustment of prior year's income tax expense.......... (3,101) --
Withholding income tax................................. (34,994) (51,259)
Tax on interest which is subject to separate
withholding income tax............................... (1,744) (242)
-------- --------
Income tax receivable (shown in other current
assets).............................................. $(24,223) $(45,924)
======== ========
</TABLE>
B. Deferred income tax assets and liabilities as of December 31, 1998 and
1997 were as follows:
<TABLE>
<CAPTION>
DECEMBER 31
------------------------
1998 1997
---------- ----------
<S> <C> <C>
Deferred income tax assets -- current............... $ 43,335 $ 228,270
Deferred income tax liabilities -- current.......... (4,271) --
---------- ----------
39,064 228,270
---------- ----------
Deferred income tax assets -- noncurrent............ 1,526,536 1,262,960
Deferred income tax liabilities -- noncurrent....... (470,012) (611,435)
Valuation allowance for deferred income tax
assets -- noncurrent.............................. (818,403) (548,423)
---------- ----------
238,121 103,102
---------- ----------
$ 277,185 $ 331,372
========== ==========
</TABLE>
66
<PAGE> 69
UNITED SEMICONDUCTOR CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS)
C. Components of deferred income tax assets and liabilities as of December
31, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
------------------------- -------------------------
AMOUNT TAX EFFECT AMOUNT TAX EFFECT
----------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Current items:
Temporary differences
Unrealized foreign
exchange gain......... $ 195,322 $ 39,064 $ 1,141,350 $ 228,270
----------- ---------- ----------- ----------
Non-current items:
Temporary differences
Depreciation............ (2,350,062) (470,012) (3,057,175) (611,435)
Amortization of
technology knowhow,
etc................... 135,180 27,036 956,290 191,258
Investment tax
credits............... -- 1,499,500 -- 1,071,702
Valuation allowance for
deferred income tax
assets................ -- (818,403) -- (548,423)
----------- ---------- ----------- ----------
$(2,214,882) 238,121 $(2,100,885) 103,102
=========== ---------- =========== ----------
$ 277,185 $ 331,372
========== ==========
</TABLE>
D. The Company's income tax return for 1996 has been assessed and approved
by the Tax Authority.
E. Pursuant to the "Statute For The Establishment and Administration of
Science-Based Industrial Park", the Company was granted several periods of tax
holidays with respect to income derived from approved investments. The tax
holidays will be expired on December, 2001.
F. As of December 31, 1998, the unused investment tax credits amounting to
$1,499,500 resulting from the acquisition of equipment and expenditures on
research and development will expire on December 31, 2002.
G. As of December 31, 1998, the Company's deductible credit account
balance for shareholders' income tax is $36,733. The ending balance of
unappropriated earnings amounting to $4,022,045, of which $3,748,549 came from
the year of 1998 and $273,496 came from and before the years of 1997. The
estimated ratio of deductible tax credit for the appropriation of 1998's
earnings is 0.33%.
(13) EARNINGS PER SHARE
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Net income.......................................... $3,748,549 $4,030,215
========== ==========
Weighted average outstanding common stock (Expressed
in thousand shares)............................... 1,336,781 1,000,000
========== ==========
Retroactively adjusted weighted average outstanding
common stock (Expressed in thousand shares)....... 1,336,781 1,336,781
========== ==========
Earnings per share (Expressed in New Taiwan
dollars).......................................... $ 2.80 $ 4.03
========== ==========
Retroactively adjusted weighted average earnings per
share............................................. $ 2.80 $ 3.01
========== ==========
</TABLE>
67
<PAGE> 70
UNITED SEMICONDUCTOR CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS)
5. RELATED PARTY TRANSACTION
(1) NAMES AND RELATIONSHIPS OF RELATED PARTIES
<TABLE>
<CAPTION>
NAME OF THE RELATED PARTIES THE RELATIONSHIP WITH THE COMPANY
--------------------------- ---------------------------------
<S> <C>
United Microelectronics Co., Ltd.
(UMC) The major investor of the Company
United Integrated Circuits
Corporation Common board chairman
United Silicon Incorporated Common board chairman
Utek Semiconductor Inc. Common board chairman
AMIC Technology, Incorporated The affiliate of UMC
Faraday Technology Corporation Common major investor
NOVATEK Microelectronics Corp. Common major investor
Integrated Technology Express Common major investor
MediaTek Incorporation Common major investor
Industrial Bank of Taiwan The Company is the promoter
Chiao Tung Bank The Company's chairman is a board
member of the Bank
S3 Inc. A director of the Company
S3 International Ltd. 100% investee of S3 Inc.
ALLIANCE Semiconductor Corp.
(Alliance) A director of the Company
UMC-USA The investee of the Company
</TABLE>
(2) SIGNIFICANT RELATED PARTY TRANSACTIONS
a. Sales
<TABLE>
<CAPTION>
1998 1997
-------------------------- --------------------------
PERCENTAGE PERCENTAGE
AMOUNT OF NET SALES AMOUNT OF NET SALES
---------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
United Microelectronics Co.,
Ltd....................... $1,562,443 13% $2,503,897 26%
United Integrated Circuit
Co., Ltd.................. 229,583 2% 302,866 3%
S3 International Ltd........ 1,456,778 12% -- --
Alliance.................. 271,453 2% -- --
Others...................... 108,098 1% 425,071 4%
---------- -- ---------- --
$3,628,355 30% $3,231,834 33%
========== == ========== ==
</TABLE>
The above sales are dealt with in the ordinary course of business similar
to those with other companies. The actual collection period is approximately two
months.
68
<PAGE> 71
UNITED SEMICONDUCTOR CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS)
b. Purchases
<TABLE>
<CAPTION>
1998 1997
---------------------- ---------------------
PERCENTAGE PERCENTAGE
OF NET OF NET
AMOUNT PURCHASES AMOUNT PURCHASES
-------- ---------- ------- ----------
<S> <C> <C> <C> <C>
United Microelectronics Co.,
Ltd............................ $ 69,942 3% $15,912 2%
United Silicon Incorporated...... 17,115 1% -- --
United Integrated Circuit Co.,
Ltd............................ 19,060 1% -- --
-------- -- ------- --
$106,117 5% $ 15912 2%
======== == ======= ==
</TABLE>
The above purchases are dealt with in the ordinary course of business
similar to those with other companies and are payable after two months from the
date of transaction entries.
c. Notes receivable
<TABLE>
<CAPTION>
1998 1997
-------------------- --------------------
PERCENTAGE PERCENTAGE
OF NOTES OF NOTES
AMOUNT RECEIVABLE AMOUNT RECEIVABLE
------ ---------- ------ ----------
<S> <C> <C> <C> <C>
United Microelectronics Co., Ltd.... $ -- -- $781 100%
AMIC Technology Incorporated........ 6,736 79% -- --
Faraday Technology Corporation...... 812 10% -- --
Integrated Technology Express....... 804 9% -- --
------ -- ---- ---
$8,352 98% $781 100%
====== == ==== ===
</TABLE>
d. Accounts receivable
<TABLE>
<CAPTION>
1998 1997
----------------------- -----------------------
PERCENTAGE PERCENTAGE
OF ACCOUNTS OF ACCOUNTS
AMOUNT RECEIVABLE AMOUNT RECEIVABLE
-------- ----------- -------- -----------
<S> <C> <C> <C> <C>
United Microelectronics
Co., Ltd. ................... $303,987 22% $218,633 11%
United Integrated Circuits Co.,
Ltd.......................... -- -- 317,533 17%
S3 International Ltd........... 140,624 10% 263,252 14%
Others......................... 79,157 6% 148,453 8%
-------- -- -------- --
523,768 38% 947,871 50%
Less: Allowance for doubtful
accounts..................... (4,541) -- (8,207) --
Less: Allowance for sales
returns and discounts........ (82,290) (6)% -- --
-------- -- -------- --
$436,937 32% $939,664 50%
======== == ======== ==
</TABLE>
e. Notes payable
<TABLE>
<CAPTION>
1998 1997
-------------------- ---------------------
PERCENTAGE PERCENTAGE
OF NOTES OF NOTES
AMOUNT PAYABLE AMOUNT PAYABLE
------ ---------- ------- ----------
<S> <C> <C> <C> <C>
United Microelectronics Co., Ltd... $-- -- $25,992 21%
== == ======= ==
</TABLE>
69
<PAGE> 72
UNITED SEMICONDUCTOR CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS)
f. Accounts payable
<TABLE>
<CAPTION>
1998 1997
---------------------- ----------------------
PERCENTAGE PERCENTAGE
OF ACCOUNTS OF ACCOUNTS
AMOUNT PAYABLE AMOUNT PAYABLE
------- ----------- ------- -----------
<S> <C> <C> <C> <C>
United Microelectronics Co.,
Ltd............................ $20,776 4% $ 9,428 2%
United Integrated Circuit Co.,
Ltd............................ 1,281 -- 12,057 2%
United Silicon Incorporated...... 1,577 1% -- --
------- -- ------- --
$23,634 5% $21,485 4%
======= == ======= ==
</TABLE>
g. Accrued expenses
<TABLE>
<CAPTION>
1998 1997
---------------------- ---------------------
PERCENTAGE PERCENTAGE
OF ACCRUED OF ACCRUED
AMOUNT EXPENSES AMOUNT EXPENSES
-------- ---------- ------- ----------
<S> <C> <C> <C> <C>
United Microelectronics Co.,
Ltd............................ $190,761 24% 77,387 $13%
Others........................... 197 -- -- --
-------- -- ------- ---
$190,958 24% $77,387 13%
======== == ======= ===
</TABLE>
h.Property transaction
1998: None.
1997: The Company sold one set of machinery and equipment to
United Integrated Circuit Co., Ltd. for $9,180. The gain on the
transaction was $40.
i. Financing transaction -- Long-term loan
<TABLE>
<CAPTION>
THE HIGHEST BALANCE
------------------------
TIME AMOUNT ENDING BALANCE INTEREST RATE INTEREST EXPENSE PAID
------------- -------- -------------- --------------- ---------------------
<S> <C> <C> <C> <C> <C>
1998
Chiao-Tung Bank...... February 1998 $720,144 $576,112 6.575% - 6.975% $44,824
======== ======== =======
1997
Chiao-Tung Bank...... December 1997 $720,144 $720,144 6.575% $40,409
======== ======== =======
</TABLE>
j. Other transactions
<TABLE>
<CAPTION>
RELATED PARTIES ITEM 1998 1997
--------------- ----------------------------- -------- --------
<S> <C> <C> <C>
United Microelectronics Co.,
Ltd. ......................... Rental $201,211 $199,329
United Microelectronics Co.,
Ltd. ......................... Fab service charge 87,696 64,954
United Microelectronics Co.,
Ltd. ......................... Research & design expense 168,420 76,992
United Microelectronics Co.,
Ltd. ......................... Technology developing expense 145,911 --
United Microelectronics Co.,
Ltd. ......................... Management allocation fee 69,915 --
-------- --------
673,153 341,275
UMC-USA......................... Commission 137,272 --
-------- --------
$810,425 $341,275
======== ========
</TABLE>
70
<PAGE> 73
UNITED SEMICONDUCTOR CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
(EXPRESSED IN NEW TAIWAN THOUSAND DOLLARS)
6. ASSETS PLEDGED AS COLLATERAL
<TABLE>
<CAPTION>
DECEMBER 31
-------------------------
1998 1997 SUBJECT OF COLLATERAL
----------- ---------- ---------------------
<S> <C> <C> <C>
Machinery and equipment....... $12,575,024 $6,272,029 Long-term loan
Deferred assets-software...... 53,690 -- Long-term loan
Time deposits................. 2,231 2,111 Guaranty for Customs Duties
----------- ----------
$12,630,945 $6,274,140
=========== ==========
</TABLE>
7. COMMITMENTS AND CONTINGENT LIABILITIES
a. The Company's unused letters of credit for import machinery were
approximately USD25,510 thousand dollars, JPY3,516,992 thousand dollars, and
DEM120 thousand dollars at December 31, 1998.
b. The Company has signed several contracts for the purchase of equipment
amounting to USD1,204,098 thousand dollars, JPY91,153,936 thousand dollars, and
DEM703 thousand dollars. As of December 31, 1998, the amount of unrecorded
outstanding obligations under these contracts are USD1,101,281 thousand dollars,
JPY77,117,921 thousand dollars, and DEM120 thousand dollars.
c. On September 24, 1997, the Department of Commerce (DOC) of the United
States of America (USA) made a preliminary determination that Static Random
Access Memory (SRAM) manufactured in Taiwan are being sold at less than fair
market value, i.e. dumped prices. In March, 1998, the DOC issued its final
determination, setting the duty rate at 41.75% for "all others" not named as
direct participants in the investigation (such as customers who used the Company
to fabricate SRAM). Management believes that this final ruling of the case will
not have a material adverse effect on the Company's financial position because
the volume of SRAM products exported by the Company to the USA is not
significant.
d. On December 7, 1998, the International Trade Commission (ITC) of the
USA issued a statement to the DOC that there was a reasonable indication that
the U.S. industry is suffering a material injury as a result of Dynamic Random
Access Memory (DRAM), which are manufactured in Taiwan and being sold at less
than fair market value in the USA. Based on the precedent set in the SRAM
investigation described above, the Company expects that foundry customers who
were not participants in the investigation will also be subject to the "all
other" rate with respect to DRAM. Management believes that the final outcome of
the investigation will not have a material adverse effect to the Company's
financial position because the Company's volume of export sales of DRAM to the
USA is not significant.
e. A number of third parties hold patents in the area of semiconductor
processing, and some have notified the Company demanding that the Company obtain
a license for various semiconductor fabrication techniques and circuit designs.
The third parties involved include Texas Instruments, EMI, Intel, Chou H. Li,
NEC, and Sanyo. Management has indicated a willingness to obtain licenses
wherever required and necessary to continue its business.
8. COMPARATIVE FIGURES RECLASSIFICATION
Certain accounts in the 1997 financial statements have been reclassified to
conform with the presentation adopted for the 1998 financial statements.
71
<PAGE> 74
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
On March 31, 1998, the Company informed Deloitte & Touche LLP ("Deloitte"),
its former independent accountants, that effective immediately they had been
dismissed as the Company's principal independent accountants. During the
Company's fiscal year ended December 31, 1996 and through March 31, 1998, there
were no disagreements with Deloitte on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure which,
if not resolved to Deloitte's satisfaction, would have caused them to make
reference to the subject matter of such disagreement in connection with their
Report on the financial statement for such periods, except as follows: in
connection with the audit of the Company's financial statements for the year
ended December 31, 1997, there was a disagreement between Deloitte and the
Company regarding the appropriate period in which to recognize the gain on the
sale of stock of an investee. Deloitte believed that recognition of such gain
should be deferred until the period in which the exchange actually occurred
(first quarter of 1998) while the Company initially believed that recognition of
such gain was appropriate in the period the irrevocable contract was signed
(fourth quarter of 1997). Recognition of the gain was deferred as proposed by
Deloitte. On January 21, 1998, Deloitte discussed this disagreement with the
Audit Committee of the Company. The Company has authorized Deloitte to respond
fully to the inquiries of the successor accountant concerning the subject matter
of such disagreement.
Deloitte's Report dated January 23, 1998 on the Company's financial
statements for the year ended December 31, 1997 did not contain an adverse
opinion or a disclaimer of opinion, and such Report was not qualified or
modified as to uncertainty, audit scope or accounting principles.
The decision to dismiss Deloitte was recommended by the Company's Audit
Committee and approved by its Board of Directors.
On April 13, 1998, the Company engaged the firm of Ernst & Young LLP as
accountants to audit the Company's financial statements commencing with its 1998
fiscal year.
The Company did not, during its fiscal year ended December 31, 1997 and
through April 13, 1998 consult with or receive any written or oral advice from
Ernst & Young LLP regarding (i) any matter, including the application of
accounting principles to a specified transaction or the type of audit opinion
that might be rendered on the Company's financial statements, which advice was
an important factor considered by the Company in reaching a decision as to such
accounting, auditing or financial reporting issue or (ii) any disagreement with
Deloitte, its former accountants, or any reportable event.
During the Company's fiscal ended December 31, 1997 and 1998, there have
been no reportable events.
PART III
Certain information required by Part III is incorporated by reference from
the Company's definitive Proxy Statement to be filed with the Securities and
Exchange Commission in connection with the solicitation of proxies for the
Company's 1999 Annual Meeting of Stockholders (the "Proxy Statement").
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this section is incorporated by reference from
the information in the section entitled "Proposal 1 -- Election of Directors" in
the Proxy Statement. The required information concerning executive officers of
the Company is contained in the section entitled "Executive Officers of the
Registrant" in Part I of this Form 10-K.
Item 405 of Regulation S-K calls for disclosure of any known late filing or
failure by an insider to file a report required by Section 16 of the Exchange
Act. This disclosure is contained in the section entitled "Section 16(a)
Beneficial Ownership Reporting Compliance" in the Proxy Statement and is
incorporated herein by reference.
72
<PAGE> 75
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this section is incorporated by reference from
the information in the sections entitled "Proposal 1 -- Election of
Directors -- Directors' Compensation", "Executive Compensation" and "Stock Price
Performance Graph" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this section is incorporated by reference from
the information in the section entitled "Proposal 1 -- Election of
Directors -- Security Ownership of Certain Beneficial Owners and Management" in
the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Not applicable.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this Form 10-K:
(1) Financial Statements:
Reference is made to the Index to Consolidated Financial Statements of
S3 Incorporated and the Index to Financial Statements of United
Semiconductor Corporation under Item 8 in Part II of this Form 10-K.
(2) Financial Statement Schedules:
The following financial statement schedule of S3 Incorporated for the
years ended December 31, 1998, 1997 and 1996 is filed as part of this
Report and should be read in conjunction with the Consolidated Financial
Statements of S3 Incorporated.
<TABLE>
<CAPTION>
REFERENCE
PAGE
---------
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........... 29
Report of Deloitte & Touche LLP, Independent Auditors....... 30
Schedule II -- Valuation and Qualifying Accounts............ 76
</TABLE>
All other schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes
thereto.
(3) Exhibits:
The exhibits listed below are required by Item 601 of Regulation S-K.
Each management contract or compensatory plan or arrangement required to
be filed as an exhibit to this Form 10-K has been identified.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER NOTES DESCRIPTION OF DOCUMENT
------- ----- -----------------------
<S> <C> <C>
3(i).1 (1) Restated Certificate of Incorporation.
3(i).2 (6) Certificate of Amendment of Restated Certificate of
Incorporation.
3(i).3 (10) Certificate of Designation of Series A Participating
Preferred Stock.
3(i).4 Certificate of Amendment of Restated Certificate of
Incorporation.
3(ii) (10) Amended and Restated Bylaws.
</TABLE>
73
<PAGE> 76
<TABLE>
<CAPTION>
EXHIBIT
NUMBER NOTES DESCRIPTION OF DOCUMENT
------- ----- -----------------------
<S> <C> <C>
4.1 (1) Specimen common stock certificate.
4.2 (8) Indenture, dated as of September 12, 1996 between Registrant
and State Street Bank and Trust Company of California, N.A.,
as Trustee, including the form of Note.
4.3 (9) Rights Agreement dated as of May 14, 1997 between S3
Incorporated and The First National Bank of Boston, Rights
Agent.
10.1* 1989 Stock Plan of S3 Incorporated (Amended and Restated as
of December 14, 1998) (the "1989 Plan").
10.2* Form of Incentive Stock Option Agreement under the 1989
Plan.
10.3* (1) Form of common stock Purchase Agreement under the 1989 Plan.
10.4* (2) S3 Incorporated 1993 Employee Stock Purchase Plan.
10.5 (1) Form of Indemnification Agreement between the Registrant and
its directors.
10.6 (7) Lease between Mission Real Estate, L.P. and Registrant dated
November 29, 1995.
10.7 (3) Office Lease dated May 13, 1993, between the Registrant and
San Tomas No. 2 Limited Partnership.
10.8 (3) First Amendment of Office Lease dated September 9, 1993,
between the Registrant and San Tomas No. 2 Limited
Partnership.
10.9 (5) Foundry Venture Agreement among Registrant, Alliance
Semiconductor Corporation and United Microelectronics
Corporation dated as of July 8, 1995.
10.10 (4) Office Lease dated March 30, 1994, between the Registrant
and San Tomas No. 1 Limited Partnership.
10.11 (4) Second Amendment of Office Lease dated March 30, 1994,
between the Registrant and San Tomas No. 2 Limited
Partnership.
10.12* (11) Employment Agreement between Registrant and Terry N. Holdt
dated December 18, 1997.
10.13* Employment Agreement between Registrant and Kenneth F.
Potashner, dated October 30, 1998
10.14* Employment Agreement between Registrant and Ronald T. Yara,
dated November 20, 1998
10.15* Involuntary Termination Agreement between Registrant and
Paul G. Franklin, dated September 22, 1998
10.16* Involuntary Termination Agreement between Registrant and
Walter D. Amaral, dated September 30, 1998
10.17* Involuntary Termination Agreement between Registrant and
Daniel A. Karr, dated October 29, 1998
12.1 Statement of Computation of Ratio of Earnings to Fixed
Charges
16.1 (12) Letter of Deloitte and Touche LLP regarding change in
certifying public accountant
21.1 Subsidiaries of Registrant.
23.1 Consent of Ernst and Young LLP, Independent Auditors (San
Jose, California).
23.2 Consent of Deloitte and Touche LLP (San Jose, California).
23.3 Consent of PricewaterhouseCoopers LLP (Hsinchu, Taiwan).
24.1 Power of Attorney (see page 77 of this Form 10-K).
27.1 Financial Data Schedule.
</TABLE>
- ---------------
* Indicates management contract or compensatory plan or arrangement.
(1) Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (File No. 33-57114).
(2) Incorporated by reference to Exhibit 10.15 to the Registrant's Registration
Statement on Form S-8 (File No. 33-65186).
(3) Incorporated by reference to the exhibit of the same number to the
Registrant's Annual Report on Form 10-K for the year ended December 31,
1993.
74
<PAGE> 77
(4) Incorporated by reference to the exhibit of the same number to the
Registrant's Annual Report on Form 10-K for the year ended December 31,
1994.
(5) Incorporated by reference to the exhibit of the same number to the
Registrant's Current Report on Form 8-K filed July 25, 1995.
(6) Incorporated by reference to the exhibit of the same number to the
Registrant's Annual Report on Form 10-K for the year ended December 31,
1995.
(7) Incorporated by reference to Exhibit 10.14 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1995.
(8) Incorporated by reference to Exhibit 4.1 to Registrant's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1996.
(9) Incorporated by reference to Exhibit 4.2 to Registrant's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1996.
(10) Incorporated by reference to the exhibit of the same number to Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997.
(11) Incorporated by reference to Exhibit 10.14 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1997.
(12) Incorporated by reference to Exhibit 16 to the Registrant's Current Report
on Form 8-K filed April 7, 1998.
(b) Reports on Form 8-K:
The following reports on Form 8-K were filed by the Company during the
three months ended December 31, 1998: On November 6, 1998, the Company filed a
Current Report on Form 8-K with the Securities and Exchange Commission that
disclosed, among other things: (i) the appointment of Kenneth F. Potashner as
the Company's President and Chief Executive Officer, (ii) the increase in the
size of the Company's Board of Directors from five directors to six directors,
(iii) the election of Mr. Potashner as Chairman of the Board and (iv) the terms
of Mr. Potashner's employment agreement.
75
<PAGE> 78
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
REVERSALS
BALANCE AT CHARGED TO TO COSTS BALANCE AT
BEGINNING COSTS AND AND END OF
DESCRIPTION OF PERIOD EXPENSES EXPENSES (DEDUCTIONS) PERIOD
----------- ---------- ---------- --------- ------------ ----------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts:
1998...................................... $1,507 $ 600 $ -- $ 189 $2,296
1997...................................... 1,438 1,200 -- (1,131) 1,507
1996...................................... 645 1,522 -- (729) 1,438
Sales returns and allowances:
1998...................................... $4,157 $1,453 $(631) $ (750) $4,229
1997...................................... 1,210 4,680 -- (1,733) 4,157
1996...................................... 969 241 -- -- 1,210
</TABLE>
76
<PAGE> 79
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on March 31, 1999.
S3 INCORPORATED
(Registrant)
By: /s/ KENNETH F. POTASHNER
------------------------------------
Kenneth F. Potashner
President
Chief Executive Officer
Chairman of the Board
March 31, 1999
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Kenneth F. Potashner, Walter D. Amaral,
and Ronald T. Yara, and each of them, his or her true and lawful
attorneys-in-fact, each with full power of substitution, for him or her in any
and all capacities, to sign any amendments to this report on Form 10-K and to
file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that each of said attorneys-in-fact or their substitute or
substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ KENNETH F. POTASHNER President, Chief Executive March 31, 1999
- --------------------------------------------------- Officer Chairman of the Board
Kenneth F. Potashner
/s/ ROBERT P. LEE Director March 31, 1999
- ---------------------------------------------------
Robert P. Lee
/s/ WALTER D. AMARAL Senior Vice President & Chief March 31, 1999
- --------------------------------------------------- Financial Officer (Principal
Walter D. Amaral Financial and Accounting Officer)
/s/ JOHN C. COLLIGAN Director March 31, 1999
- ---------------------------------------------------
John C. Colligan
/s/ TERRY N. HOLDT Vice Chairman of the Board March 31, 1999
- ---------------------------------------------------
Terry N. Holdt
/s/ CARMELO J. SANTORO Director March 31, 1999
- ---------------------------------------------------
Carmelo J. Santoro
/s/ RONALD T. YARA Director March 31, 1999
- ---------------------------------------------------
Ronald T. Yara
</TABLE>
77
<PAGE> 80
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER NOTES DESCRIPTION OF DOCUMENT
- ------- ----- -----------------------
<S> <C> <C>
3(i).1 (1) Restated Certificate of Incorporation.
3(i).2 (6) Certificate of Amendment of Restated Certificate of
Incorporation.
3(i).3 (10) Certificate of Designation of Series A Participating
Preferred Stock.
3(i).4 Certificate of Amendment of Restated Certificate of
Incorporation.
3(ii) (10) Amended and Restated Bylaws.
4.1 (1) Specimen common stock certificate.
4.2 (8) Indenture, dated as of September 12, 1996 between Registrant
and State Street Bank and Trust Company of California, N.A.,
as Trustee, including the form of Note.
4.3 (9) Rights Agreement dated as of May 14, 1997 between S3
Incorporated and The First National Bank of Boston, Rights
Agent.
10.1* 1989 Stock Plan of S3 Incorporated (Amended and Restated as
of December 14, 1998 (the "1989 Plan").
10.2* Form of Incentive Stock Option Agreement under the 1989
Plan.
10.3* (1) Form of common stock Purchase Agreement under the 1989 Plan.
10.4* (2) S3 Incorporated 1993 Employee Stock Purchase Plan.
10.5 (1) Form of Indemnification Agreement between the Registrant and
its directors.
10.6 (7) Lease between Mission Real Estate, L.P. and Registrant dated
November 29, 1995.
10.7 (3) Office Lease dated May 13, 1993, between the Registrant and
San Tomas No. 2 Limited Partnership.
10.8 (3) First Amendment of Office Lease dated September 9, 1993,
between the Registrant and San Tomas No. 2 Limited
Partnership.
10.9 (5) Foundry Venture Agreement among Registrant, Alliance
Semiconductor Corporation and United Microelectronics
Corporation dated as of July 8, 1995.
10.10 (4) Office Lease dated March 30, 1994, between the Registrant
and San Tomas No. 1 Limited Partnership.
10.11 (4) Second Amendment of Office Lease dated March 30, 1994,
between the Registrant and San Tomas No. 2 Limited
Partnership.
10.12* (11) Employment Agreement between Registrant and Terry N. Holdt
dated December 18, 1997.
10.13* Employment Agreement between Registrant and Kenneth F.
Potashner, dated October 30, 1998
10.14* Employment Agreement between Registrant and Ronald T. Yara,
dated November 20, 1998
10.15* Involuntary Termination Agreement between Registrant and
Paul G. Franklin, dated September 22, 1998
10.16* Involuntary Termination Agreement between Registrant and
Walter D. Amaral, dated September 30, 1998
10.17* Involuntary Termination Agreement between Registrant and
Daniel A. Karr, dated October 29, 1998
12.1 Statement of Computation of Ratio of Earnings to Fixed
Charges
</TABLE>
<PAGE> 81
<TABLE>
<CAPTION>
EXHIBIT
NUMBER NOTES DESCRIPTION OF DOCUMENT
- ------- ----- -----------------------
<S> <C> <C>
16.1 (12) Letter of Deloitte and Touche LLP regarding change in
certifying public accountant
21.1 Subsidiaries of Registrant.
23.1 Consent of Ernst and Young LLP, Independent Auditors (San
Jose, California).
23.2 Consent of Deloitte and Touche LLP (San Jose, California).
23.3 Consent of PricewaterhouseCoopers LLP (Hsinchu, Taiwan).
24.1 Power of Attorney (see page 77 of this Form 10-K).
27.1 Financial Data Schedule.
</TABLE>
- ---------------
* Indicates management contract or compensatory plan or arrangement.
(1) Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (File No. 33-57114).
(2) Incorporated by reference to Exhibit 10.15 to the Registrant's Registration
Statement on Form S-8 (File No. 33-65186).
(3) Incorporated by reference to the exhibit of the same number to the
Registrant's Annual Report on Form 10-K for the year ended December 31,
1993.
(4) Incorporated by reference to the exhibit of the same number to the
Registrant's Annual Report on Form 10-K for the year ended December 31,
1994.
(5) Incorporated by reference to the exhibit of the same number to the
Registrant's Current Report on Form 8-K filed July 25, 1995.
(6) Incorporated by reference to the exhibit of the same number to the
Registrant's Annual Report on Form 10-K for the year ended December 31,
1995.
(7) Incorporated by reference to Exhibit 10.14 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1995.
(8) Incorporated by reference to Exhibit 4.1 to Registrant's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1996.
(9) Incorporated by reference to Exhibit 4.2 to Registrant's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1996.
(10) Incorporated by reference to the exhibit of the same number to Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997.
(11) Incorporated by reference to Exhibit 10.14 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1997.
(12) Incorporated by reference to Exhibit 16 to the Registrant's Current Report
on Form 8-K filed April 7, 1998.
<PAGE> 1
EXHIBIT 3(i).4
CERTIFICATE OF AMENDMENT
OF
RESTATED CERTIFICATE OF INCORPORATION
OF
S3 INCORPORATED
S3 Incorporated, a corporation organized and existing under and by
virtue of the General Corporation Law of the State of Delaware, DOES HEREBY
CERTIFY:
FIRST: That the Board of Directors of said corporation at a regular
meeting of said Board held on January 14, 1999, duly adopted a resolution
proposing and declaring advisable the following amendment to Article IV of the
Restated Certificate of Incorporation of said corporation:
ARTICLE IV
A. Number and Classes of Stock. This Corporation is authorized to issue
two classes of stock, designated "Preferred Stock" and "Common Stock,"
respectively. The total number of shares which this Corporation shall have
authority to issue is one hundred twenty-five million (125,000,000). The number
of shares of Common Stock authorized to be issued is one hundred twenty million
(120,000,000) with a par value of $0.0001. The number of shares of Preferred
Stock authorized to be issued is five million (5,000,000) with a par value of
$0.0001. The number of authorized shares of Common Stock or Preferred Stock may
be increased or decreased (but not below the number of shares thereof then
outstanding) by the affirmative vote of the holders of a majority of the then
outstanding shares of Common Stock, without a vote of the holders of the
Preferred Stock, or of any series thereof, unless a vote of any such Preferred
Stock holders is required pursuant to the provisions established by the Board of
Directors of this Corporation (the "Board of Directors") in the resolution or
resolutions providing for the issue of such Preferred Stock, and if such holders
of such Preferred Stock are so entitled to vote thereon, then, except as may
otherwise be set forth in this Restated Certificate of Incorporation, the only
stockholder approval required shall be the affirmative vote of a majority of the
combined voting power of the Common Stock and the Preferred Stock so entitled to
vote.
B. Preferred Stock. The Preferred Stock may be issued from time to time
in one or more series. The Board of Directors is expressly authorized to provide
for the issue, in one or more series, of all or any of the remaining shares of
Preferred Stock and, in the resolution or resolutions providing for such issue,
to establish for each such series the number of its shares, the voting powers,
full or limited, of the shares of such series, or that such shares shall have no
voting powers, and the designations, preferences and relative, participating,
optional or other special rights of the shares of such series, and the
qualifications, limitations or restrictions
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thereof. The Board of Directors is also expressly authorized (unless forbidden
in the resolution or resolutions providing for such issue) to increase or
decrease (but not below the number of shares of the series then outstanding) the
number of shares of any series subsequent to the issuance of shares of that
series. In case the number of shares of any such series shall be so decreased,
the shares constituting such decrease shall resume the status that they had
prior to the adoption of the resolution originally fixing the number of shares
of such series.
C. Common Stock.
1. Relative Rights of Preferred Stock and Common Stock. All
preferences, voting powers, relative, participating, optional or other special
rights and privileges, and qualifications, limitations or restrictions of the
Common Stock are expressly made subject and subordinate to those that may be
fixed with respect to any shares of the Preferred Stock.
2. Voting Rights. Except as otherwise required by law or this Restated
Certificate of Incorporation, each holder of Common Stock shall have one vote in
respect of each share of stock held by such holder of record on the books of the
corporation for the election of directors and on all matters submitted to a vote
of stockholders of the corporation.
3. Dividends. Subject to the preferential rights of the Preferred
Stock, the holders of shares of Common Stock shall be entitled to receive, when
and if declared by the Board of Directors, out of the assets of this Corporation
which are by law available therefor, dividends payable either in cash, in
property or in shares of capital stock.
4. Dissolution, Liquidation or Winding Up. In the event of any
dissolution, liquidation or winding up of the affairs of this Corporation, after
distribution in full of the preferential amounts, if any, to be distributed to
the holders of shares of the Preferred Stock, holders of Common Stock shall be
entitled, unless otherwise provided by law or this Restated Certificate of
Incorporation, to receive all of the remaining assets of the corporation of
whatever kind available for distribution to stockholders ratably in proportion
to the number of shares of Common Stock held by them respectively.
SECOND: Pursuant to a special meeting and vote of stockholders, the
stockholders have given consent to said amendment in accordance with the
provisions of Section 242 of the General Corporation Law of Delaware.
THIRD: That the aforesaid amendment was duly adopted in accordance with
the applicable provisions of Section 242 of the General Corporation Law of the
State of Delaware.
IN WITNESS WHEREOF, S3 Incorporated has caused this certificate to be
signed this 25th day of February, 1999.
By /s/ Walter D. Amaral
-------------------------------
Walter D. Amaral
Senior Vice President and
Chief Financial Officer
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EXHIBIT 10.1
1989 STOCK PLAN OF
S3 INCORPORATED
(Amended and Restated as of December 14, 1998)
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
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<S> <C> <C>
SECTION 1. ESTABLISHMENT AND PURPOSE............................... 1
SECTION 2. DEFINITIONS............................................. 1
(a) "Board of Directors".................................... 1
(b) "Change in Control"..................................... 1
(c) "Code".................................................. 2
(d) "Committee"............................................. 2
(e) "Company"............................................... 2
(f) "Employee".............................................. 2
(g) "Exchange Act".......................................... 2
(h) "Exercise Price"........................................ 2
(i) "Fair Market Value"..................................... 2
(j) "ISO"................................................... 2
(k) "Nonstatutory Option"................................... 2
(l) "Offeree"............................................... 3
(m) "Option"................................................ 3
(n) "Optionee".............................................. 3
(o) "Outside Director"...................................... 3
(p) "Plan".................................................. 3
(q) "Purchase Price"........................................ 3
(r) "Service"............................................... 3
(s) "Share"................................................. 3
(t) "Stock"................................................. 3
(u) "Stock Option Agreement"................................ 3
(v) "Stock Purchase Agreement".............................. 3
(w) "Subsidiary"............................................ 3
(x) "Total and Permanent Disability"........................ 3
SECTION 3. ADMINISTRATION.......................................... 4
(a) Committee Procedures.................................... 4
(b) Committee Responsibilities.............................. 4
SECTION 4. ELIGIBILITY............................................. 5
(a) General Rule............................................ 5
(b) Outside Directors....................................... 5
(c) Limitation On Grants.................................... 7
(d) Ten-Percent Stockholders................................ 7
(e) Attribution Rules....................................... 7
(f) Outstanding Stock....................................... 7
SECTION 5. STOCK SUBJECT TO PLAN................................... 7
(a) Basic Limitation........................................ 7
(b) Additional Shares....................................... 7
</TABLE>
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<TABLE>
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<S> <C> <C>
SECTION 6. TERMS AND CONDITIONS OF AWARDS OR SALES................. 8
(a) Stock Purchase Agreement................................ 8
(b) Duration of Offers and Nontransferability of Rights..... 8
(c) Purchase Price.......................................... 8
(d) Withholding Taxes....................................... 8
(e) Restrictions on Transfer of Shares...................... 8
SECTION 7. TERMS AND CONDITIONS OF OPTIONS......................... 8
(a) Stock Option Agreement.................................. 8
(b) Number of Shares........................................ 9
(c) Exercise Price.......................................... 9
(d) Withholding Taxes....................................... 9
(e) Exercisability and Term................................. 9
(f) Nontransferability...................................... 9
(g) Exercise of Options Upon Termination of Service......... 9
(h) Leaves of Absence....................................... 9
(i) No Rights as a Stockholder.............................. 10
(j) Modification, Extension and Renewal of Options.......... 10
(k) Restrictions on Transfer of Shares...................... 10
SECTION 8. PAYMENT FOR SHARES...................................... 10
(a) General Rule............................................ 10
(b) Surrender of Stock...................................... 10
(c) Services Rendered....................................... 10
(d) Cashless Exercise....................................... 10
SECTION 9. ADJUSTMENT OF SHARES.................................... 11
(a) General................................................. 11
(b) Reorganizations......................................... 11
(c) Reservation of Rights................................... 11
SECTION 10. LEGAL AND REGULATORY REQUIREMENTS....................... 11
SECTION 11. NO EMPLOYMENT RIGHTS.................................... 12
SECTION 12. DURATION AND AMENDMENTS................................. 12
(a) Term of the Plan........................................ 12
(b) Right to Amend or Terminate the Plan.................... 12
(c) Effect of Amendment or Termination...................... 12
SECTION 13. EMPLOYEES BASED OUTSIDE OF THE UNITED STATES............ 12
SECTION 14. EXECUTION............................................... 13
</TABLE>
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<PAGE> 4
1989 STOCK PLAN OF
S3 INCORPORATED
(Amended and Restated as of December 14, 1998)
SECTION 1. ESTABLISHMENT AND PURPOSE.
The Plan was established in 1989 to offer selected employees, directors,
advisers and consultants an opportunity to acquire a proprietary interest in the
success of the Company, or to increase such interest, by purchasing Shares of
the Company's Common Stock. The Plan provides both for the direct award or sale
of Shares and for the grant of Options to purchase Shares. Options granted under
the Plan may include Nonstatutory Options as well as ISOs intended to qualify
under Code section 422.
The Plan was amended and restated as of December 14, 1998 to incorporate
prior amendments, to amend the provisions governing grants to Outside Directors,
to increase the number of shares which may be issued upon the exercise of ISOs
and to extend the term of the Plan.
SECTION 2. DEFINITIONS.
(a) "Board of Directors" shall mean the Board of Directors of the Company,
as constituted from time to time.
(b) "Change in Control" means the occurrence of either of the following
events:
(i) A change in the composition of the Board of Directors, as a
result of which fewer than one-half of the incumbent directors are directors who
either:
(A) Had been directors of the Company twenty-four (24) months
prior to such change; or
(B) Were elected, or nominated for election, to the Board of
Directors with the affirmative votes of at least a majority of the directors who
had been directors of the Company twenty-four (24) months prior to such change
and who were still in office at the time of the election or nomination; or
(ii) Any "person" (as such term is used in sections 13(d) and 14(d) of
the Exchange Act) by the acquisition or aggregation of securities is or becomes
the beneficial owner, directly or indirectly, of securities of the Company
representing twenty percent (20%) or more of the combined voting power of the
Company's then outstanding securities ordinarily (and apart from rights accruing
under special circumstances) having the right to vote at elections of directors
(the "Base Capital Stock"); except that any
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<PAGE> 5
change in the relative beneficial ownership of the Company's securities by any
person resulting solely from a reduction in the aggregate number of outstanding
shares of Base Capital Stock, and any decrease thereafter in such person's
ownership of securities, shall be disregarded until such person increases in any
manner, directly or indirectly, such person's beneficial ownership of any
securities of the Company. For purposes of this Subsection (ii), the term
"person" shall not include an employee benefit plan maintained by the Company.
(c) "Code" shall mean the Internal Revenue Code of 1986, as amended.
(d) "Committee" shall mean the committee designated by the Board of
Directors, which is authorized to administer the Plan under Section 3 hereof.
The Committee shall have membership composition which enables the Options or
other rights granted under the Plan to qualify for exemption under Rule 16b-3
with respect to persons who are subject to Section 16 of the Exchange Act.
(e) "Company" shall mean S3 Incorporated, a Delaware corporation.
(f) "Employee" shall mean (i) any individual who is a common-law employee
of the Company or of a Subsidiary, (ii) a member of the Board of Directors and
(iii) an independent contractor or advisor who performs services for the Company
or a Subsidiary. Service as a member of the Board of Directors or as an
independent contractor or advisor shall be considered employment for all
purposes of the Plan except the second sentence of Section 4(a) and Section
4(b).
(g) "Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended.
(h) "Exercise Price" shall mean the amount for which one Share may be
purchased upon exercise of an Option, as specified by the Committee in the
applicable Stock Option Agreement.
(i) "Fair Market Value" shall mean (i) the closing price of a Share on the
principal exchange which the Shares are trading, on the date on which the Fair
Market Value is determined (if Fair Market Value is determined on a date which
the principal exchange is closed, Fair Market Value shall be determined on the
last immediately preceding trading day), or (ii) if the Shares are not traded on
an exchange but are quoted on the Nasdaq National Market or a successor
quotation system, the closing price on the date on which the Fair Market Value
is determined, or (iii) if the Shares are not traded on an exchange or quoted on
the Nasdaq National Market or a successor quotation system, the fair market
value of a Share, as determined by the Committee in good faith. Such
determination shall be conclusive and binding on all persons.
(j) "ISO" shall mean an employee incentive stock option described in Code
section 422.
(k) "Nonstatutory Option" shall mean an employee stock option that is not
an ISO.
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(l) "Offeree" shall mean an individual to whom the Committee has offered
the right to acquire Shares under the Plan (other than upon exercise of an
Option).
(m) "Option" shall mean an ISO or Nonstatutory Option granted under the
Plan and entitling the holder to purchase Shares.
(n) "Optionee" shall mean an individual who holds an Option.
(o) "Outside Director" shall mean a member of the Board of Directors who
is not a common-law employee of the Company or of a Subsidiary.
(p) "Plan" shall mean this 1989 Stock Plan of S3 Incorporated, as amended
from time to time.
(q) "Purchase Price" shall mean the consideration for which one Share may
be acquired under the Plan (other than upon exercise of an Option), as specified
by the Committee.
(r) "Service" shall mean service as an Employee."
(s) "Share" shall mean one share of Stock, as adjusted in accordance with
Section 9 (if applicable).
(t) "Stock" shall mean the Common Stock of the Company.
(u) "Stock Option Agreement" shall mean the agreement between the Company
and an Optionee which contains the terms, conditions and restrictions pertaining
to his Option.
(v) "Stock Purchase Agreement" shall mean the agreement between the
Company and an Offeree who acquires Shares under the Plan which contains the
terms, conditions and restrictions pertaining to the acquisition of such Shares.
(w) "Subsidiary" shall mean any corporation, if the Company and/or one or
more other Subsidiaries own not less than 50 percent of the total combined
voting power of all classes of outstanding stock of such corporation. A
corporation that attains the status of a Subsidiary on a date after the adoption
of the Plan shall be considered a Subsidiary commencing as of such date.
(x) "Total and Permanent Disability" shall mean that the Optionee is
unable to engage in any substantial gainful activity by reason of any medically
determinable physical or mental impairment which can be expected to result in
death or which has lasted, or can be expected to last, for a continuous period
of not less than six (6) months.
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<PAGE> 7
SECTION 3. ADMINISTRATION.
(a) Committee Procedures. The Board of Directors shall designate one of
the members of the Committee as chairman. The Committee may hold meetings at
such times and places as it shall determine. The acts of a majority of the
Committee members present at meetings at which a quorum exists, or acts reduced
to or approved in writing by all Committee members, shall be valid acts of the
Committee.
(b) Committee Responsibilities. Subject to the provisions of the Plan, the
Committee shall have full authority and discretion to take the following
actions:
(i) To interpret the Plan and to apply its provisions;
(ii) To adopt, amend or rescind rules, procedures and forms relating
to the Plan;
(iii) To authorize any person to execute, on behalf of the Company,
any instrument required to carry out the purposes of the Plan;
(iv) To determine when Shares are to be awarded or offered for sale
and when Options are to be granted under the Plan;
(v) To select the Offerees and Optionees;
(vi) To determine the number of Shares to be offered to each Offeree
or to be made subject to each Option;
(vii) To prescribe the terms and conditions of each award or sale of
Shares, including (without limitation) the Purchase Price, the vesting of the
award (including accelerating the vesting of awards) and to specify the
provisions of the Stock Purchase Agreement relating to such award or sale;
(viii) To prescribe the terms and conditions of each Option, including
(without limitation) the Exercise Price, the vesting or duration of the Option
(including accelerating the vesting of the Option), to determine whether such
Option is to be classified as an ISO or as a Nonstatutory Option, and to specify
the provisions of the Stock Option Agreement relating to such Option;
(ix) To amend any outstanding Stock Purchase Agreement or Stock Option
Agreement, subject to applicable legal restrictions and to the consent of the
Offeree or Optionee who entered into such agreement;
(x) To prescribe the consideration for the grant of each Option or
other right under the Plan and to determine the sufficiency of such
consideration;
(xi) To determine the disposition of each Option or other right under
the Plan in the event of an Optionee's or Offeree's divorce or dissolution of
marriage;
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(xii) To determine whether Options or other rights under the Plan will
be granted in replacement of other grants under an incentive or other
compensation plan of an acquired business;
(xiii) To correct any defect, supply any omission, or reconcile any
inconsistency in the Plan, any Stock Option Agreement or any Stock Purchase
Agreement; and
(xiv) To take any other actions deemed necessary or advisable for the
administration of the Plan.
Subject to the requirements of applicable law, the Committee may designate
persons other than members of the Committee to carry out its responsibilities
and may prescribe such conditions and limitations as it may deem appropriate,
except that the Committee may not delegate its authority with regard to the
selection for participation of or the granting of Options or other rights under
the Plan to persons subject to Section 16 of the Exchange Act. All decisions,
interpretations and other actions of the Committee shall be final and binding on
all Offerees, all Optionees, and all persons deriving their rights from an
Offeree or Optionee. No member of the Committee shall be liable for any action
that he has taken or has failed to take in good faith with respect to the Plan,
any Option, or any right to acquire Shares under the Plan.
SECTION 4. ELIGIBILITY.
(a) General Rule. Only Employees shall be eligible for designation as
Optionees or Offerees by the Committee. In addition, only individuals who are
employed as common-law employees by the Company or a Subsidiary shall be
eligible for the grant of ISOs.
(b) Outside Directors. Any other provision of the Plan notwithstanding,
the participation of Outside Directors in the Plan shall be subject to the
following restrictions:
(i) Outside Directors shall only be eligible for the grant of
Nonstatutory Options as described in this Section 4(b).
(ii) Each Outside Director shall automatically be granted a
Nonstatutory Option to purchase 40,000 Shares (subject to adjustment under
Section 9) as a result of their appointment as an Outside Director. Subject to
paragraph (iii) below, upon the conclusion of each regular annual meeting of the
Company's stockholders following the meeting at which they were appointed, each
Outside Director who will continue serving as a member of the Board thereafter
shall receive a Nonstatutory Option to purchase 20,000 Shares (subject to
adjustment under Section 9). All such Nonstatutory Options shall vest and become
exercisable at the rate of twenty-five percent (25%) upon each one (1) year
anniversary of the date the
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<PAGE> 9
option is granted to the Outside Director. No Shares shall vest after
termination of the Outside Director's Service.
(iii) Each Outside Director who serves on the Board on December 14,
1998 shall automatically be granted a Nonstatutory Option to purchase 100,000
Shares (subject to adjustment under Section 9); provided that such Nonstatutory
Options shall be lieu of any Nonstatutory Options that would otherwise be
granted to the Outside Director pursuant to paragraph (ii) above before the 2004
annual meeting of the Company's stockholders. Such Nonstatutory Options shall
vest and become exercisable as follows: 20,000 shares vest and become
exercisable at the rate of twenty-five percent (25%) upon each one (1) year
anniversary of the regular annual meeting of the Company's stockholders
occurring in calendar year 1999; 20,000 shares vest and become exercisable at
the rate of twenty-five percent (25%) upon each one (1) year anniversary of the
regular annual meeting of the Company's stockholders occurring in calendar year
2000; 20,000 shares vest and become exercisable at the rate of twenty-five
percent (25%) upon each one (1) year anniversary of the regular annual meeting
of the Company's stockholders occurring in calendar year 2001; 20,000 shares
vest and become exercisable at the rate of twenty-five percent (25%) upon each
one (1) year anniversary of the regular annual meeting of the Company's
stockholders occurring in calendar year 2002; and 20,000 shares vest and become
exercisable at the rate of twenty-five percent (25%) upon each one (1) year
anniversary of the regular annual meeting of the Company's stockholders
occurring in calendar year 2003. No Shares shall vest after termination of the
Outside Director's Service.
(iv) All Nonstatutory Options granted to an Outside Director under
this Section 4(b) shall also become exercisable in full in the event of (A) the
termination of such Outside Director's service because of death or Total and
Permanent Disability or (B) a Change in Control of the Company.
(v) The Exercise Price of all Nonstatutory Options granted to an
Outside Director under this Section 4(b) shall be equal to one hundred percent
(100%) of the Fair Market Value of a Share on the date of grant, payable in one
of the forms described in Sections 8(a), (b) and (d).
(vi) All Nonstatutory Options granted to an Outside Director under
this Section 4(b) shall terminate on the earliest of (A) the 10th anniversary of
the date of grant of such Options, (B) the date ninety (90) days after the
termination of such Outside Director's service for any reason other than death,
Total and Permanent Disability or voluntary retirement as an Outside Director at
or after the age of 60, or (C) the date twelve (12) months after the termination
of such Outside Director's service because of death, Total and Permanent
Disability or voluntary retirement as an Outside Director at or after the age of
60.
(c) Limitation On Grants. No Employee shall be granted Options to purchase
more than 1,500,000 Shares in any fiscal year of the Company; provided, however,
that with respect to fiscal year 1998, the 1,500,000 Share limit shall be
increased to 4,500,000 Shares.
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<PAGE> 10
(d) Ten-Percent Stockholders. An Employee who owns more than 10 percent of
the total combined voting power of all classes of outstanding stock of the
Company or any of its Subsidiaries shall not be eligible for the grant of an ISO
unless such grant satisfies the requirements of Code section 422(c)(6).
(e) Attribution Rules. For purposes of Subsection (d) above, in
determining stock ownership, an Employee shall be deemed to own the stock owned,
directly or indirectly, by or for his brothers, sisters, spouse, ancestors and
lineal descendants. Stock owned, directly or indirectly, by or for a
corporation, partnership, estate or trust shall be deemed to be owned
proportionately by or for its shareholders, partners or beneficiaries.
(f) Outstanding Stock. For purposes of Subsection (d) above, "outstanding
stock" shall include all stock actually issued and outstanding immediately after
the grant. "Outstanding stock" shall not include shares authorized for issuance
under outstanding options held by the Employee or by any other person.
SECTION 5. STOCK SUBJECT TO PLAN.
(a) Basic Limitation. Shares offered under the Plan shall be authorized
but unissued Shares or treasury Shares. As of December 14, 1999, 26,253,105
shares have been reserved for issuance under the Plan (upon exercise of Options
or other rights to acquire Shares), which includes the 4,500,000 Shares reserved
for issuance on October 20, 1998. On each January 1 for the remaining term of
the Plan, the aggregate number of Shares which may be issued under the Plan to
individuals other than Outside Directors (upon exercise of Options or other
rights to acquire Shares) shall be increased by a number of Shares equal to 3
1/4 percent of the total number of Shares of the Common Stock of the Company
outstanding at the end of the most recently concluded calendar year. Any Shares
that have been reserved but not issued as Shares or Options during any calendar
year shall remain available for grant during any subsequent calendar year.
Notwithstanding the foregoing, no more than 36,000,000 Shares may be issued
under ISOs for the remaining term of the Plan. The aggregate number of Shares
which may be issued under the Plan shall at all times be subject to adjustment
pursuant to Section 9. The number of Shares which are subject to Options or
other rights outstanding at any time under the Plan shall not exceed the number
of Shares which then remain available for issuance under the Plan. The Company,
during the term of the Plan, shall at all times reserve and keep available
sufficient Shares to satisfy the requirements of the Plan.
(b) Additional Shares. In the event that any outstanding Option or other
right for any reason expires or is canceled or otherwise terminated, the Shares
allocable to the unexercised portion of such Option or other right shall again
be available for the purposes of the Plan. If Shares are forfeited before any
dividends have been paid with respect to the Shares, then such Shares shall
again be available for award or sale under the Plan.
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SECTION 6. TERMS AND CONDITIONS OF AWARDS OR SALES.
(a) Stock Purchase Agreement. Each award or sale of Shares under the Plan
(other than upon exercise of an Option) shall be evidenced by a Stock Purchase
Agreement between the Offeree and the Company. Such award or sale shall be
subject to all applicable terms and conditions of the Plan and may be subject to
any other terms and conditions which are not inconsistent with the Plan and
which the Committee deems appropriate for inclusion in a Stock Purchase
Agreement. The provisions of the various Stock Purchase Agreements entered into
under the Plan need not be identical.
(b) Duration of Offers and . Any right to acquire Shares under the Plan
(other than an Option) shall automatically expire if not exercised by the
Offeree within thirty (30) days after the grant of such right was communicated
to him by the Committee. Such right shall not be transferable and shall be
exercisable only by the Offeree to whom such right was granted.
(c) Purchase Price. The Purchase Price shall be determined by the
Committee at its sole discretion. The Purchase Price shall be payable in one of
the forms described in Sections 8(a) and (c).
(d) Withholding Taxes. As a condition to the purchase of Shares, the
Offeree shall make such arrangements as the Committee may require for the
satisfaction of any federal, state or local withholding tax obligations that may
arise in connection with such purchase.
(e) Restrictions on Transfer of Shares. Any Shares awarded or sold under
the Plan shall be subject to such special forfeiture conditions, rights of
repurchase, rights of first refusal and other transfer restrictions as the
Committee may determine. Such restrictions shall be set forth in the applicable
Stock Purchase Agreement and shall apply in addition to any general restrictions
that may apply to all holders of Shares.
SECTION 7. TERMS AND CONDITIONS OF OPTIONS.
(a) Stock Option Agreement. Each grant of an Option under the Plan shall
be evidenced by a Stock Option Agreement between the Optionee and the Company.
Such Option shall be subject to all applicable terms and conditions of the Plan
and may be subject to any other terms and conditions which are not inconsistent
with the Plan and which the Committee deems appropriate for inclusion in a Stock
Option Agreement. The provisions of the various Stock Option Agreements entered
into under the Plan need not be identical.
(b) Number of Shares. Each Stock Option Agreement shall specify the number
of Shares that are subject to the Option and shall provide for the
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<PAGE> 12
adjustment of such number in accordance with Section 9. The Stock Option
Agreement shall also specify whether the Option is an ISO or a Nonstatutory
Option.
(c) Exercise Price. Each Stock Option Agreement shall specify the Exercise
Price. The Exercise Price of an ISO shall not be less than 100 percent of the
Fair Market Value of a Share on the date of grant, except as otherwise provided
in Section 4(d). Subject to the preceding sentence, the Exercise Price under any
Option shall be determined by the Committee at its sole discretion. The Exercise
Price shall be payable in one of the forms described in Sections 8(a), (b) and
(d).
(d) Withholding Taxes. As a condition to the exercise of an Option, the
Optionee shall make such arrangements as the Committee may require for the
satisfaction of any federal, state or local withholding tax obligations that may
arise in connection with such exercise. The Optionee shall also make such
arrangements as the Committee may require for the satisfaction of any federal,
state or local withholding tax obligations that may arise in connection with the
disposition of Shares acquired by exercising an Option.
(e) Exercisability and Term. Each Stock Option Agreement shall specify the
date when all or any installment of the Option is to become exercisable. The
Stock Option Agreement shall also specify the term of the Option. The term shall
not exceed ten (10) years from the date of grant, except as otherwise provided
in Section 4(d). Subject to the preceding three sentences, the Committee at its
sole discretion shall determine when all or any installment of an Option is to
become exercisable and when an Option is to expire.
(f) Nontransferability. During an Optionee's lifetime, his Option(s) shall
be exercisable only by him and shall not be transferable. In the event of an
Optionee's death, his Option(s) shall not be transferable other than by will or
by the laws of descent and distribution.
(g) Exercise of Options Upon Termination of Service. Each Stock Option
Agreement shall set forth the extent to which the Optionee shall have the right
to exercise the Option following termination of the Optionee's Service with the
Company and its Subsidiaries, and the right to exercise the Option of any
executors or administrators of the Optionee's estate or any person who has
acquired such Option(s) directly from the Optionee by bequest or inheritance.
Such provisions shall be determined in the sole discretion of the Committee,
need not be uniform among all Options issued pursuant to the Plan, and may
reflect distinctions based on the reasons for termination of Service.
(h) Leaves of Absence. An Optionee's Service shall be deemed to continue
while the Optionee is on military leave, sick leave or other bona fide leave of
absence (as determined by the Committee). The foregoing notwithstanding, in the
case of an ISO granted under the Plan, Service shall not be deemed to continue
beyond the first ninety (90) days of such leave, unless the Optionee's
reemployment rights are guaranteed by statute or by contract.
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(i) No Rights as a Stockholder. An Optionee, or a transferee of an
Optionee, shall have no rights as a stockholder with respect to any Shares
covered by his Option until the date of the issuance of a stock certificate for
such Shares. No adjustments shall be made, except as provided in Section 9.
(j) Modification, Extension and Renewal of Options. Within the limitations
of the Plan, the Committee may modify, extend or renew outstanding options or
may accept the cancellation of outstanding options (to the extent not previously
exercised), whether or not granted hereunder, in return for the grant of new
Options at the same or a different price. The foregoing notwithstanding, no
modification of an Option shall, without the consent of the Optionee, impair his
rights or increase his obligations under such Option.
(k) Restrictions on Transfer of Shares. Any Shares issued upon exercise of
an Option shall be subject to such special forfeiture conditions, rights of
repurchase, rights of first refusal and other transfer restrictions as the
Committee may determine. Such restrictions shall be set forth in the applicable
Stock Option Agreement and shall apply in addition to any general restrictions
that may apply to all holders of Shares.
SECTION 8. PAYMENT FOR SHARES.
(a) General Rule. The entire Purchase Price or Exercise Price of Shares
issued under the Plan shall be payable in lawful money of the United States of
America at the time when such Shares are purchased, except as provided in
Subsections (b), (c) and (d) below.
(b) Surrender of Stock. To the extent that a Stock Option Agreement so
provides, payment may be made all or in part with Shares which have already been
owned by the Optionee or his representative for more than twelve (12) months and
which are surrendered to the Company in good form for transfer. Such Shares
shall be valued at their Fair Market Value on the date when the new Shares are
purchased under the Plan.
(c) Services Rendered. At the discretion of the Committee, Shares may be
awarded under the Plan in consideration of services rendered to the Company or a
Subsidiary prior to the award. If Shares are awarded without the payment of a
Purchase Price in cash, the Committee shall make a determination (at the time of
the award) of the value of the services rendered by the Offeree and the
sufficiency of the consideration to meet the requirements of Section 6(c).
(d) Cashless Exercise. To the extent that a Stock Option Agreement so
provides, payment may be made all or in part by delivery (on a form prescribed
by the Committee) of an irrevocable direction to a securities broker to sell
Shares and to deliver all or part of the sale proceeds to the Company in payment
of the aggregate Exercise Price.
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<PAGE> 14
SECTION 9. ADJUSTMENT OF SHARES.
(a) General. In the event of a subdivision of the outstanding Stock, a
declaration of a dividend payable in Shares, a declaration of a dividend payable
in a form other than Shares in an amount that has a material effect on the value
of Shares, a combination or consolidation of the outstanding Stock (by
reclassification or otherwise) into a lesser number of Shares, a
recapitalization or a similar occurrence, the Committee shall make appropriate
adjustments in one or more of (i) the number of Shares available for future
grants under Section 5, (ii) the number of Shares available for grants under
Section 4(c), (iii) the number of Shares covered by each outstanding Option,
(iv) the Exercise Price under each outstanding Option, (v) the number of shares
covered by each outstanding award or (vi) the Purchase Price of each outstanding
award.
(b) Reorganizations. In the event that the Company is a party to a merger
or other reorganization, outstanding Options shall be subject to the agreement
of merger or reorganization. Such agreement may provide for the assumption of
outstanding Options by the surviving corporation or its parent or for their
continuation by the Company (if the Company is a surviving corporation);
provided, however, that if assumption or continuation of the outstanding Options
is not provided by such agreement then the Committee shall have the option of
offering the payment of a cash settlement equal to the difference between the
amount to be paid for one Share under such agreement and the Exercise Price, in
all cases without the Optionees' consent.
(c) Reservation of Rights. Except as provided in this Section 9, an
Optionee or Offeree shall have no rights by reason of any subdivision or
consolidation of shares of stock of any class, the payment of any dividend or
any other increase or decrease in the number of shares of stock of any class.
Any issue by the Company of shares of stock of any class, or securities
convertible into shares of stock of any class, shall not affect, and no
adjustment by reason thereof shall be made with respect to, the number or
Exercise Price of Shares subject to an Option. The grant of an Option pursuant
to the Plan shall not affect in any way the right or power of the Company to
make adjustments, reclassifications, reorganizations or changes of its capital
or business structure, to merge or consolidate or to dissolve, liquidate, sell
or transfer all or any part of its business or assets.
SECTION 10. LEGAL AND REGULATORY REQUIREMENTS.
Shares shall not be issued under the Plan unless the issuance and delivery
of such Shares complies with (or is exempt from) all applicable requirements of
law, including (without limitation) the Securities Act of 1933, as amended, the
rules and regulations promulgated thereunder, state securities laws and
regulations and the regulations of any stock exchange on which the Company's
securities may then be listed, and the Company has obtained the approval or
favorable ruling from any governmental agency which the Company determines is
necessary or advisable.
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<PAGE> 15
SECTION 11. NO EMPLOYMENT RIGHTS.
No provision of the Plan, nor any right or Option granted under the Plan,
shall be construed to give any person any right to become, to be treated as, or
to remain an Employee. The Company and its Subsidiaries reserve the right to
terminate any person's Service at any time and for any reason, with or without
notice.
SECTION 12. DURATION AND AMENDMENTS.
(a) Term of the Plan. The amended and restated Plan, as set forth herein,
shall terminate automatically on December 13, 2008 and may be terminated on any
earlier date pursuant to Subsection (b) below.
(b) Right to Amend or Terminate the Plan. The Board of Directors may amend
the Plan at any time and from time to time. Rights and obligations under any
Option granted before amendment of the Plan shall not be materially altered, or
impaired adversely, by such amendment, except with consent of the person to whom
the Option was granted. An amendment of the Plan shall be subject to the
approval of the Company's stockholders only to the extent required by applicable
laws, regulations or rules.
(c) Effect of Amendment or Termination. No Shares shall be issued or sold
under the Plan after the termination thereof, except upon exercise of an Option
granted prior to such termination. The termination of the Plan, or any amendment
thereof, shall not affect any Share previously issued or any Option previously
granted under the Plan.
SECTION 13. EMPLOYEES BASED OUTSIDE OF THE UNITED STATES.
Notwithstanding any provision of the Plan to the contrary, in order to
foster and promote achievement of the purposes of the Plan or to comply with
provisions of laws or regulations in other countries in which the Company and
its Subsidiaries operate or have employees, the Committee, in its sole
discretion, shall have the power and authority to (a) determine which Employees
outside the United States are eligible to participate in the Plan, (b) modify
the terms and conditions of any Options granted to Employees outside the United
States and (c) establish subplans, modified option exercise procedures and other
terms and procedures to the extent such actions may be necessary or advisable.
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<PAGE> 16
SECTION 14. EXECUTION
To record the adoption of the amended and restated Plan by the Board of
Directors effective as of December 14, 1998, the Company has caused its
authorized officer to execute the same.
S3 INCORPORATED
By
--------------------------------------------
Walter D. Amaral
Senior Vice President Finance and
Chief Financial Officer
<PAGE> 1
EXHIBIT 10.2
1989 STOCK PLAN OF S3 INCORPORATED
INCENTIVE STOCK OPTION AGREEMENT
INCENTIVE STOCK This option is intended to be an incentive stock option
OPTION under section 422 of the Internal Revenue Code and will
be interpreted accordingly. Nevertheless, to the extent
that it exceeds the $100,000 rule of section 422(d) of
the Internal Revenue Code, this option will be treated
as a nonstatutory stock option.
VESTING Your right to exercise this Option vests daily over the
four year period beginning on the Grant Date ("Effective
Date") shown on the cover sheet. In addition, if your
Service terminates due to your death or Total and
Permanent Disability, your right to exercise this Option
will vest as to an additional 50% of the Shares subject
to this Option at that time (or, if less, the entire
remaining unvested Shares). All vested Share
calculations will be rounded up to the nearest whole
number. No additional Shares vest after your Company
Service has terminated for any reason.
Notwithstanding the foregoing, if your Service
terminates within one year of the Effective Date you
will not be entitled to exercise any portion of this
Option, unless your Service terminates due to your death
or Total and Permanent Disability. If your Service
terminates within one year of the Effective Date due to
your death or Total and Permanent Disability, then your
right to exercise this Option shall vest as to the
number of Shares subject to the Option calculated under
the daily vesting schedule set forth above, plus an
additional 50% of the Shares subject to this Option.
TERM Your Option will expire in any event at the close of
business at Company headquarters on the day before the
10th anniversary of the Date of Grant, as shown on the
cover sheet. (It will expire earlier if your Company
Service terminates, as described below.)
REGULAR TERMINATION If your Service terminates for any reason except death
or Total and Permanent Disability, then your Option will
expire at the close of business at Company headquarters
three months after your termination date. During that
three-month period, you may exercise the portion of your
Option that was vested on the termination date.
Subject to the vesting rules above, in the event that
your Service terminates within one year from the
Effective Date for any reason, all rights to purchase
Shares under this Option shall immediately terminate,
unless your Service terminates within one year from the
Effective Date due to your death or your Total and
Permanent Disability.
The Company determines when your Service terminates for
all purposes under the Plan and this Agreement.
DEATH If you die prior to termination of Service, then your
Option will expire at the close of business at Company
headquarters on the date six months
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<PAGE> 2
after the date of death. During that six-month period,
your estate or heirs may exercise the portion of your
Option that was vested on the date of death as set forth
above.
DISABILITY If your Service terminates because of your Total and
Permanent Disability, then your Option will expire at
the close of business at Company headquarters on the
date six months after your termination date. During that
six-month period, you may exercise the portion of your
Option that was vested on the date of termination as set
forth above.
"Total and Permanent Disability" means that you are
unable to engage in any substantial gainful activity by
reason of any medically determinable physical or mental
impairment which can be expected to result in death or
which has lasted, or can be expected to last, for a
continuous period of not less than six months.
LEAVES OF ABSENCE For purposes of this option, your Service does not
terminate when you go on a military leave, a sick leave
or another bona fide leave of absence, if the leave was
approved by the Company in writing, if the terms of the
leave provide for continued service crediting, or when
continued service crediting is required by applicable
law. However, your Service will be treated as
terminating 90 days after you went on leave, unless your
right to return to active work is guaranteed by law or
by a contract. Your Service terminates in any event when
the approved leave ends, unless you immediately return
to active work.
The Company determines which leaves count for this
purpose and the extent to which the vested portion of an
Option may be exercised during a leave of absence..
RESTRICTIONS ON
EXERCISE The Company will not permit you to exercise this Option
if the issuance of Shares at that time would violate any
law or regulation.
NOTICE OF EXERCISE When you wish to exercise this Option, you must notify
the Company by filing the proper "Notice of Exercise"
form at the address given on the form. Your Notice of
Exercise must specify how many Shares you wish to
purchase. Your Notice of Exercise must also specify how
your Shares should be registered (in your name only, in
your and your spouse's names as community property or as
joint tenants with right of survivorship or in a trust
for your benefit). The Notice of Exercise will be
effective when it is received by the Company.
If someone else wants to exercise this Option after your
death, that person must prove to the Company's
satisfaction that he or she is entitled to do so.
FORM OF PAYMENT When you submit your Notice of Exercise, you must
include payment of the Exercise Price for the Shares you
are purchasing. Payment may be made in one (or a
combination) of the following forms:
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<PAGE> 3
o Your personal check, a cashier's check or a money
order.
o Irrevocable directions to a securities broker
approved by the Company to sell the Shares acquired
upon exercise of your Option and to deliver all or a
portion of the sale proceeds to the Company in
payment of the Exercise Price. The balance of the
sale proceeds, if any, will be delivered to you. The
directions must be given by signing a special "Notice
of Exercise" form provided by the Company.
o Shares which have already been owned by you for more
than twelve months and which are surrendered to the
Company. The value of the Shares, determined as of
the effective date of the Option exercise, will be
applied to the Exercise Price.
WITHHOLDING TAXES You will not be allowed to exercise this Option unless
you make acceptable arrangements to pay any withholding
taxes that may be due as a result of the Option
exercise.
RESTRICTIONS ON RESALE By signing this Agreement, you agree not to sell any
Shares acquired upon exercise of this Option at a time
when applicable laws, regulations or Company or
underwriter trading policies prohibit a sale.
TRANSFER OF OPTIONS Prior to your death, only you may exercise this Option.
You cannot transfer or assign this Option. For instance,
you may not sell this Option or use it as security for a
loan. If you attempt to do any of these things, this
Option will immediately become invalid. You may,
however, dispose of this Option in your will.
Regardless of any marital property settlement agreement,
the Company is not obligated to honor a Notice of
Exercise from your former spouse, nor is the Company
obligated to recognize your former spouse's interest in
your Option in any other way.
RETENTION RIGHTS Neither your Option nor this Agreement give you the
right to be retained by the Company in any capacity. The
Company reserves the right to terminate your Service at
any time and for any reason.
STOCKHOLDER RIGHTS Neither you, nor your estate or heirs, have any rights
as a stockholder of the Company until a certificate for
the Shares acquired upon exercise of your Option has
been issued. No adjustments are made for dividends or
other rights if the applicable record date occurs before
your stock certificate is issued, except as described in
the Plan.
ADJUSTMENTS In the event of a stock split, a stock dividend or a
similar change in the Company Stock, the number of
Shares covered by this Option and the Exercise Price per
Share may be adjusted pursuant to the Plan. Your Option
shall be subject to the terms of the agreement of
merger, liquidation or reorganization in the event the
Company is subject to such corporate activity.
-3-
<PAGE> 4
APPLICABLE LAW This Agreement will be interpreted and enforced under
the laws of the State of California.
THE PLAN AND OTHER The text of the Plan is incorporated in this Agreement
by reference. Capitalized terms that are used in this
Agreement but not defined, herein are defined in the
Plan as such may be amended from time to time.
This Agreement and the Plan constitute the entire understanding between you
and the Company regarding this Option. Any prior agreements, commitments or
negotiations concerning this Option are superseded.
BY SIGNING THE COVER SHEET OF THIS AGREEMENT, YOU AGREE TO ALL OF THE TERMS
AND CONDITIONS DESCRIBED ABOVE AND IN THE PLAN.
-4-
<PAGE> 1
EXHIBIT 10.13
S3 INCORPORATED
P. O. BOX 58058
2801 MISSION COLLEGE BLVD.
SANTA CLARA, CA 95052-8058
TELEPHONE: (408) 588-8000
FACSIMILE: (408) 980-5445
October 30, 1998
Mr. Kenneth Potashner
16452 Avenida de los Olivos
Rancho Santa Fe, CA 92067
Dear Ken:
This letter agreement (the "Agreement") sets forth the terms and
conditions of your employment with S3 Incorporated (the "Company").
In consideration of the mutual covenants and promises made in this
Agreement, you and the Company agree as follows:
1. Employment. Commencing as of October 30, 1998 (the "Effective Date")
and during the Term, you will be employed on a full-time basis as President and
Chief Executive Officer of the Company. The Company's Board of Directors (the
"Board") has also elected you to serve as a director and as its Chairman,
effective as of such date. During the Term, you will be given such duties,
responsibilities and authority as are appropriate to such positions. During the
Term, you will perform and discharge well and faithfully such duties for the
Company as are set forth in the bylaws of the Company regarding its Chairman of
the Board, President and Chief Executive Officer and such other duties relating
to the Company's business, administration and policies as may be reasonably
assigned or requested from time to time by the Company's Board of Directors (the
"Board"). You will devote your full working time, attention and efforts to the
affairs of the Company during the Term; provided, however, (i) you may continue
to serve as a member of the Board of Directors of Maxwell Technologies, Inc.
("Maxwell") during your employment with the Company, and (ii) you may provide
transition services of limited duration to Maxwell following the termination of
your employment with Maxwell, provided that such services will in no event
interfere in any material respect with your obligations to provide full-time
services to the Company. You agree and understand that your obligations to the
Company under this Agreement will require your highest level of attention and
commitment.
2. Term. The term of this Agreement will commence on the Effective Date
and will continue for three years thereafter, unless earlier terminated as
provided herein (the "Term"). Either you or the Company can terminate your
employment hereunder, and your services as an officer and employee of the
Company and Chairman of its Board, at any time and for any reason, with or
without cause and with or without notice. Under certain circumstances you will
be entitled to certain payments and other consideration on such termination,
pursuant to the terms and provisions of paragraph 10 below.
<PAGE> 2
Mr. Kenneth Potashner
October 30, 1998
Page 2
3. Base Salary. For your services to the Company, you will be paid a
base salary, payable in accordance with the Company's usual payroll practices
during your full-time employment as President and Chief Executive Officer, at an
annualized rate of $500,000 per year. The Board may, in its sole discretion,
increase but not decrease, your base salary each year after review of your
performance.
4. Regular Bonus. You will be eligible to receive an annual bonus of up
to 200% of your base salary subject to your achievement of performance goals to
be mutually determined and your continued full-time employment as President and
Chief Executive Officer though the end of each relevant bonus period (typically,
a calendar year). The performance goals for the first year will be determined in
the first three months following the Effective Date. Your minimum bonus payable
immediately following the first anniversary of the Effective Date will be
$250,000. No minimum bonus shall be payable with respect to other periods.
5. Definitions. For purposes of this Agreement:
"Change in Control" means: (i) the consummation of a merger or
consolidation of the Company with or into another entity or any other corporate
reorganization, if more than 50% of the combined voting power of the continuing
or surviving entity's securities outstanding immediately after such merger,
consolidation or other reorganization is owned by persons who were not
stockholders of the Company immediately prior to such merger, consolidation or
other reorganization; or (ii) the sale, transfer or other disposition of all or
substantially all of the Company's assets. A transaction will not constitute a
Change in Control if its sole purpose is to change the state of the Company's
incorporation or to create a holding company that will be owned in substantially
the same proportions by the persons who held the Company's securities
immediately before such transaction.
"Cause" for termination of your employment with the Company will exist
when one or more of the following events has occurred: (i) your fraud or
criminal conduct affecting your employment or toward the Company, (ii) your
willful gross misconduct, willful gross neglect of duties or failure to act
which materially and adversely affects the business of the Company, or (iii)
your engaging in any activity in competition with Company in a material manner
(excluding a less than 5% investment in any public company, and excluding your
ongoing services as a director of Maxwell if it remains in substantially the
same business or another business that does not compete with the Company).
"Constructive Termination" means your termination of your employment
with the Company following the occurrence, without your written consent, of one
or more of the following events: (i) a diminution in your duties or the
assignment to you of duties which are materially inconsistent with your position
or which significantly impair your ability to function in your then current
position, provided that you provide notice of your objection in writing to such
diminution or assignment and the Company fails to rescind the same within two
(2) weeks after receipt of your notice; (ii) a reduction in compensation or
material reduction in benefits under this Agreement, which reduction is not
cured within two (2) weeks following written notice thereof from you; (iii) the
Company's requiring you to relocate your residence without your prior written
consent from the San Francisco Bay Area, or from any other area to which
<PAGE> 3
Mr. Kenneth Potashner
October 30, 1998
Page 3
you may voluntarily move with the Company's prior written consent during the
Term; or (iv) the unconsented (by you) relocation of the principal place for the
rendering of services hereunder to a location more than fifty (50) miles from
the present location of the principal executive office of Company.
None of the foregoing will constitute a Constructive Termination to the extent
mutually agreed upon in writing by you and the Company in advance of the
occurrence thereof. A Constructive Termination will be treated as an involuntary
termination by the Company without Cause.
"Disability" means your failure to effectively discharge your duties
and to render the services required hereunder due to physical or mental injury,
illness or disability for six (6) or more consecutive months or for more than
six (6) months in the aggregate during any period of twelve (12) calendar months
following the commencement of employment hereunder.
6. Stock Options. You will be granted two stock options. First, you
will be granted a nonstatutory stock option (the "1,500,000 Share Option"), in
substantially the form of Exhibit A attached hereto, to purchase 1,500,000
shares of the Common Stock of the Company (the "Common Stock") with an exercise
price per share equal to the closing price of the Common Stock on the Effective
Date. The 1,500,000 Share Option will be fully vested and exercisable upon the
earliest of (i) the six month anniversary of the Effective Date if you are then
employed by the Company on a full-time basis, (ii) upon the consummation of a
Change in Control if you are employed by the Company immediately prior to such
Change in Control on a full-time basis, (iii) the Company's termination of your
full-time employment without Cause, or (iv) a Constructive Termination. The
1,500,000 Share Option will terminate on the earlier of the third anniversary of
the Effective Date (the Payment Date defined in Section 7 below) or 90 days
after termination of your full-time employment by the Company.
Second, you will be granted an incentive stock option (to the extent
incentive stock option treatment is available under the annual $100,000 limit of
Section 422(d) of the Internal Revenue Code) in substantially the form attached
hereto as Exhibit B to purchase 3,000,000 shares of the Common Stock (the
"3,000,000 Share Option") with an exercise price per share equal to the closing
price of the Common Stock on the Effective Date. An example of the effect of
Section 422(d) of the Internal Revenue Code is set forth on Exhibit C. Subject
to the provisions of paragraph 10(b)(iii) and 10(c)(iii) below (which provide
for vesting continuation under certain circumstances following a termination
without Cause or by Constructive Termination) the 3,000,000 Share Option will
vest and become fully exercisable as to 750,000 shares on the first anniversary
of the Effective Date if you are then employed by the Company on a full-time
basis, and so long as you are so employed by the Company will vest thereafter in
equal monthly installments of 62,500 shares, resulting in full vesting in four
years if you are still employed on a full-time basis by the Company on the
fourth anniversary of the Effective Date. Subject to the aforesaid provisions of
paragraph 10(b)(iii) and 10(c)(iii), the 3,000,000 Share Option will terminate
on the earlier of the tenth anniversary of the Effective Date or 90 days after
termination of your full-time employment by the Company.
7. Special Cash Bonus. On the third anniversary of the Effective Date
(or, if applicable, on the date specified in Section 10) (the "Payment Date")
you will be paid a "Special Cash Bonus" if:
<PAGE> 4
Mr. Kenneth Potashner
October 30, 1998
Page 4
(a) Minimum Per Share Spread Not Achieved at End of Applicable Term.
The average closing price of the Common Stock over the last 10 trading
days immediately preceding the Payment Date is less than the sum of:
(i) $4.67 ($7,000,000 divided by 1,500,000) plus (ii) the exercise
price per share of the 1,500,000 Share Option; and
(b) Minimum Per Share Spread Not Achieved During Each 10-day Period
During Three-Year Term. The average closing price of the Common Stock
during each and every 10 trading day period that occurs during an open
officers' trading window and that commences six months after the
Effective Date and ends on or before the Payment Date is less than the
sum of (i) $4.67 ($7,000,000 divided by 1,500,000) plus (ii) the
exercise price per share of the 1,500,000 Share Option. See Exhibit C
for an example of this paragraph (b). For this purpose, an "open
officers' trading window" means a period during which officers of the
Company are permitted to trade in the Company's Common Stock under the
Company's insider trading policy; and
(c) No Hedging. You do not engage in any hedging transaction with
respect to the Common Stock prior to the date the Special Cash Bonus
would otherwise be payable. A hedging transaction for these purposes
shall mean any transaction (other than the exercise of the options and
any subsequent sale of any of the Common Stock issued upon exercise
thereof) which offsets or reduces or is intended to offset or reduce,
in whole or in part, any risk that the value of the Common Stock will
decline, including but not limited to a short sale, hedging options and
swaps, selling calls, costless calls (i.e., selling puts and using the
proceeds to buy calls), pledging of shares of Company common stock to
secure a loan on a nonrecourse (to your other assets) basis, or an
equity swap; and
(d) Employed For Three Years or Certain Terminations. Either (i) you
are still employed by the Company on a full-time basis as its Chief
Executive Officer and President on the day prior to the Payment Date,
or (ii) your employment is terminated by the Company prior to the
Payment Date without Cause or by Constructive Termination.
The Special Cash Bonus, if payable, will be equal to $7,000,000, less
the sum of:
(i) the number of shares subject to the unexercised
portion of the 1,500,000 Share Option, multiplied by
the excess of the average closing price of the Common
Stock over the 10 trading days immediately preceding
the Payment Date over the exercise price per share of
the 1,500,000 Share Option; and
(ii) the greater of (x) the amount of any net built-in
gain (closing price on the date(s) of exercise over
exercise price(s)) on any portions of the 1,500,000
Share Option which you exercised prior to the Payment
Date and (y) the number of shares that have been
issued under the exercised portion of the 1,500,000
Share Option, multiplied by the excess of the average
closing price of the Common Stock over the 10 trading
days
<PAGE> 5
Mr. Kenneth Potashner
October 30, 1998
Page 5
immediately preceding the Payment Date over the
exercise price per share of the 1,500,000 Share
Option.
The Special Cash Bonus will be payable through net exercise of the
1,500,000 Share Option (with the excess of the closing price of the Common Stock
on the trading day immediately preceding the Payment Date over the aggregate
exercise price for such shares being applied to reduce on a dollar for dollar
basis the Special Cash Bonus otherwise payable), and a lump sum cash payment by
the Company of the remainder of the Special Cash Bonus. All references to
"closing price" in this Agreement shall refer to such price on the applicable
day as quoted in the Wall Street Journal.
(e) Rabbi Trust. In the event the cash and cash equivalents held by the
Company (determined in accordance with Generally Accepted Accounting Principles)
are valued at $25 million or less, the Company shall immediately contribute
$7,000,000 to a rabbi trust established for your benefit. The rabbi trust shall
be in substantially the form of the model rabbi trust prepared by the Internal
Revenue Service and shall be trusteed by a bank trustee. The Special Cash Bonus
shall be the sole benefit payable from such rabbi trust; provided that the
Company may, at its sole discretion, pay the Special Cash Bonus from other
sources, in which event the assets of the rabbi trust shall revert to the
Company. In no event shall the Special Cash Bonus paid to you from the rabbi
trust exceed the amounts due under paragraph (d) above after taking into account
the net exercise of the 1,500,000 Share Option. The rabbi trust shall terminate
following payment of the Special Cash Bonus, and any remainder left in the rabbi
trust following payment of the Special Cash Bonus shall revert to the Company.
8. Relocation Assistance. Your primary residence is located in Southern
California. You will move your primary residence to the San Francisco Bay Area
by July 1, 1999. Until the relocation of your primary residence, the Company
will reimburse you for all reasonable travel expenses incurred in commuting from
your residence in Southern California to the Company's offices to provide
services hereunder, as well as the reasonable costs of maintaining a second
residence and a leased car in the San Francisco Bay Area, including up to two
trips a month for your family to the Bay Area. The Company will pay for your
reasonable moving expenses attributable to the relocation of your primary
residence to the San Francisco Bay Area. After you move your residence to the
San Francisco Bay Area, the Company shall not require you to relocate your
residence from the San Francisco Bay Area without your prior written consent, or
from any other area to which you may voluntarily move with the Company's prior
written consent during the Term. The Company shall not be required to pay all or
any part of the cost of your new residence in the San Francisco Bay Area. In
addition, the Company will pay you a tax gross-up payment in an amount
sufficient to ensure that you do not incur any net income tax liability due to
the payments described in this Section 8.
9. Employee Benefit Programs. Commencing on the Effective Date, and
during the period of your full-time employment, you will be entitled to
participate in all Company employee benefit plans and compensation and
perquisite programs made available to the Company's executives or salaried
employees generally, including the Company's Employee Stock Purchase Plan,
401(k) Plan and Executive Deferred Compensation Plan. You will be entitled to
reimbursement of reasonable work-related expenses. You will be entitled to four
weeks of paid vacation per year, provided that you will not accrue unused
vacation of more
<PAGE> 6
Mr. Kenneth Potashner
October 30, 1998
Page 6
than eight weeks. You will be paid for unused vacation time.
10. Consequences of Termination of Employment.
(a) Involuntary Termination By Company For Cause. In the event the
Company terminates your full-time employment during the term of this Agreement
for Cause, you will be entitled to any unpaid salary, bonus and vacation due you
pursuant to paragraphs 3, 4 and 9 above through the date of termination and you
will be entitled to no other compensation from the Company.
(b) Involuntary Termination (i) By Company Without Cause or (ii) by
Constructive Termination - Before Change in Control. In the event either (i) the
Company terminates your full-time employment without Cause during the Term and
before the consummation of a Change in Control or (ii) your employment is
terminated during the Term and before the consummation of a Change in Control by
Constructive Termination, you will be entitled to the following:
(i) the Company will pay you any unpaid salary, bonus and vacation
due you pursuant to paragraphs 3, 4 and 9 above through the
date of termination. For 12 months thereafter, your base
salary and benefits will continue, and each month during that
12-month period you will be paid 1/12th of the maximum (200%
of base salary) regular bonus payable under paragraph 4;
(ii) the 1,500,000 Share Option will be fully vested and
exercisable, as set forth in paragraph 6 above;
(iii) the 3,000,000 Share Option will continue to vest during the
12-month compensation and benefit continuation period, subject
to your provision, if requested to do so by the Company, of
consulting services to the Company and your agreement to, and
compliance with, nonsolicitation and noncompetition agreements
in favor of the Company (substantially in the form attached as
Exhibit E) during such 12-month period. The 3,000,000 Share
Option, in such event shall terminate 90 days after the end of
such vesting continuation period; and
(iv) the Special Cash Bonus will be paid as set forth in paragraph
7 above, provided that the amount of the Special Cash Bonus
will be calculated as of the date of termination of your
full-time employment and paid three business days after such
termination (and such payment date will be deemed the "Payment
Date"). The net exercise value of the 1,500,000 Share Option
shall, for purposes of determining the amount of Special Cash
Bonus payable, if any, be determined based on the closing
price of the Common Stock on the trading day immediately
preceding the date of termination of your full-time
employment.
(c) Involuntary Termination (i) By Company Without Cause or (ii) by
Constructive Termination - Upon or After Change in Control. In the event either
(i) the Company terminates your employment without Cause during the Term upon or
after the consummation of a Change
<PAGE> 7
Mr. Kenneth Potashner
October 30, 1998
Page 7
in Control or (ii) your employment is terminated during the Term on or after the
consummation of a Change in Control of a Constructive Termination, you will be
entitled to the following:
(i) the Company will pay you any unpaid salary, bonus and vacation
due you pursuant to paragraphs 3, 4 and 9 above through the
date of termination. For 18 months thereafter, your base
salary and benefits will continue, and each month during that
18-month period you will be paid 1/12th of the maximum (200%
of base salary) regular bonus payable under paragraph 4;
(ii) the 1,500,000 Share Option will be fully vested and
exercisable, as set forth in paragraph 6 above;
(iii) the 3,000,000 Share Option will continue to vest as follows:
if the termination precedes the second anniversary of the
Effective Date, the 3,000,000 Share Option will continue to
vest over the 18-month compensation and benefit continuation
period, subject to your provision, if requested to do so, of
consulting services to the Company and your agreement to, and
compliance with, nonsolicitation and noncompetition agreements
in favor of the Company (substantially in the form attached as
Exhibit E) during the 18-month period. If the termination is
on or after the second anniversary of the Effective Date, the
3,000,000 Share Option will continue to vest over the 18-month
compensation and benefit continuation period, subject to your
provision, if requested to do so, of consulting services to
the Company and your agreement to, and compliance with,
nonsolicitation and noncompetition agreements in favor of the
Company (substantially in the form attached as Exhibit E)
during the 18-month period, and any portion of the 3,000,000
Share Option that would not vest during the 18-month
continuation period will be fully vested at the date of
termination. The 3,000,000 Share Option in either event would
terminate 90 days after the end of such vesting continuation
period;
(iv) the Special Cash Bonus will be paid as set forth in paragraph
7 above, provided that the amount of the Special Cash Bonus
will be calculated as of the date of termination of your
full-time employment and paid three business days after such
termination (and such payment date will be deemed the "Payment
Date"). The net exercise value of the 1,500,000 Share Option
shall, for purposes of determining the amount of Special Cash
Bonus payable, if any, be determined based on the closing
price of the Common Stock on the trading day immediately
preceding the date of termination of your full-time
employment; and
(v) you will be paid an additional payment equal to the excess, if
any, of (x) $10,000,000, over (y) the Special Cash Bonus, plus
the total salary and bonus continuation payments payable
pursuant to clause (i) of paragraph 10(c), plus the net
exercise value of the 3,000,000 Share Option (including any
exercised portion thereof). Net exercise value for these
purposes will be determined by taking any built-in gain
(greater of closing price on the date of exercise or closing
price on your termination of full-time employment over
exercise price) on any portion of the 3,000,000 Share Option
which you exercised prior to the
<PAGE> 8
Mr. Kenneth Potashner
October 30, 1998
Page 8
termination date of your full-time employment, and adding
thereto the product of the number of shares of Common Stock
that are still subject to the 3,000,000 Share Option times the
excess of the closing price of the Common Stock on the last
trading day immediately preceding your termination of
full-time employment over the exercise price per share of the
3,000,000 Share Option. If the amount referenced in (y)
exceeds $10,000,000, the Company will have no claim to the
excess and you shall have no rights to any payments pursuant
to this clause (v).
(d) Voluntary Termination, Death or Disability. In the event you
terminate your employment with the Company of your own volition (other than a
Constructive Termination) or as a result of death or Disability, such
termination will have the same consequences as a termination for Cause.
(e) Examples. Examples of the operation of this paragraph 10 and
paragraph 7 are attached hereto as Exhibit C.
11. Conditions to Receipt of Payments and Benefits.
(a) Release of Claims. As a condition to the receipt of any the
payments and other consideration described in paragraph 10, you must execute and
deliver to the Company a full and complete release and covenant not to sue
substantially in the form of Exhibit F (the "Release") of all past, present and
future claims you may have against the Company or any of its officers,
directors, shareholders, employees, consultants and agents arising directly or
indirectly from your employment relationship with the Company, this Agreement or
any act or omission predating the execution of the Release and thereafter take
no action to void or otherwise limit or terminate the Release within any
applicable statutory periods providing such rights.
(b) Proprietary Information. In view of your position and access to
proprietary information, as a condition to the receipt of payments and other
consideration described in this Agreement, during the term of your employment by
the Company you will not, without the Company's written consent, directly or
indirectly, alone or as a partner, joint venturer, officer, director, employee,
consultant, agent or stockholder (other than a less than 5% stockholder of a
publicly traded company) (i) engage in any activity which is in competition with
the business, the products or services of the Company, (ii) solicit any of the
Company's employees, consultants or customers, (iii) hire any of the Company's
employees or consultants in an unlawful manner or actively encourage employees
or consultants to leave the Company, or (iv) otherwise breach your proprietary
information obligations. You agree to execute and comply with the Company's
standard form of Proprietary Information and Inventions Agreement, attached as
Exhibit D as a condition to receipt of any payments or other consideration under
this Agreement.
12. Assignability; Binding Nature. Commencing on the Effective Date,
this Agreement will be binding upon you and the Company and your respective
successors, heirs, and assigns. This Agreement may not be assigned by you except
that your rights to compensation and benefits hereunder, subject to the
limitations of this Agreement, may be transferred by will or operation of law.
No rights or obligations of the Company under this Agreement may be
<PAGE> 9
Mr. Kenneth Potashner
October 30, 1998
Page 9
assigned or transferred except by operation of law in the event of a merger or
consolidation in which the Company is not the continuing entity, or the sale or
liquidation of all or substantially all of the assets of the Company, provided
that the assignee or transferee is the successor to all or substantially all of
the assets of the Company and assumes the Company's obligations under this
Agreement contractually or as a matter of law.
13. Notice. Any notice to be delivered pursuant to this Agreement shall
be in writing and shall be deemed delivered upon service, if served personally,
or three days after deposit in the United States Mail, if mailed by first class
mail, postage prepaid, registered or certified with return receipt requested,
addressed to the other party at the address set forth herein, or such other
address as may be designated in accordance herewith:
If to you: Kenneth Potashner
16452 Avenida de los Olivos
Rancho Santa Fe, CA 92067
with a copy to his counsel
at: Deidra Schneider
Latham & Watkins
701 B Street, Suite 2100
San Diego, CA 92101-8197
If to the Company: S3 Incorporated
2801 Mission College Boulevard
P. O. Box 58058
Santa Clara, CA
with a copy to its counsel
at: Jorge del Calvo, Esq.
Pillsbury Madison & Sutro LLP
2550 Hanover Street
Palo Alto, CA 94304
14. Dispute Resolution. Any disputes between you and the Company,
including but not limited to disputes arising out of or related to the Agreement
and disputes arising out of or related to the agreements evidencing your Company
stock options, shall be resolved by using the following procedures, except that
paragraphs (c) and (d) will not be followed in cases where the law specifically
forbids the use of arbitration as a final and binding remedy, or where paragraph
(d) below specifically allows a different remedy.
(a) The party claiming to be aggrieved shall furnish to the other party
a written statement of the grievance identifying any witnesses or documents that
support the grievance and the relief requested or proposed.
(b) If the other party does not agree to furnish the relief requested
or proposed, or otherwise does not satisfy the demand of the party claiming to
be aggrieved, the parties shall submit the dispute to nonbinding mediation
before a mediator to be jointly selected by the
<PAGE> 10
Mr. Kenneth Potashner
October 30, 1998
Page 10
parties. The Company will pay the cost of the mediation.
(c) If the mediation does not produce a resolution of the dispute, the
parties agree that the dispute shall be resolved by final and binding
arbitration. The parties shall attempt to agree to the identity of an
arbitrator, and, if they are unable to do so, they will obtain a list of
arbitrators from the Federal Mediation and Conciliation Service and select an
arbitrator by striking names from that list. The arbitrator shall have the
authority to determine whether the conduct complained of in paragraph (a)
violates the rights of the complaining party and, if so, to grant any relief
authorized by law; subject to the exclusions of paragraph (d) below. The
arbitrator shall not have the authority to modify, change or refuse to enforce
the terms of this Agreement.
The hearing shall be transcribed. The Company shall bear the costs of
the arbitration if you prevail. If the Company prevails, you will pay half the
cost of the arbitration. The prevailing party in the arbitration shall be
entitled to recover from the other party his or its reasonable attorney fees and
its costs incurred in connnection with the arbitration, as determined by the
arbitrator.
(d) Arbitration shall be the exclusive final remedy for any dispute
between the parties, and the parties agree that no dispute shall be submitted to
arbitration where the party claiming to be aggrieved has not complied with the
preliminary steps provided for above. The parties agree that the arbitration
award shall be enforceable in any court having jurisdiction to enforce this
Agreement, so long as the arbitrator's findings of fact are supported by
substantial evidence on the whole and the arbitrator has not made errors of law;
provided however, that either party may bring an action, including but not
limited to an action for injunctive relief, in a court of competent
jurisdiction, regarding or related to matters involving the Company's
confidential, proprietary or trade secret information, or regarding or related
to inventions that the you may claim to have developed prior to joining the
Company or after joining the Company, pursuant to California Labor Code 2870.
The parties further agree that for violations of my confidential, proprietary
information or trade secret obligations which the parties have elected to submit
to arbitration, the Company retains the right to seek preliminary injunctive
relief in court in order to preserve the status quo or prevent irreparable
injury before the matter can be heard in arbitration.
15. Governing Law. This Agreement will be deemed a contract made under,
and for all purposes will be construed in accordance with, the laws of
California applicable to contracts between California residents and wholly to be
performed in California, notwithstanding California, without regard to
California choice of law provisions or principles of conflicts of law.
16. Withholding. Anything to the contrary notwithstanding, following
the Effective Date all payments made by the Company hereunder to you or your
estate or beneficiaries will be subject to tax withholding pursuant to any
applicable laws or regulations. In lieu of withholding, the Company may, in its
sole discretion, accept other provision for payment of taxes as required by law,
provided it is satisfied that all requirements of law affecting its
responsibilities to withhold such taxes have been satisfied.
<PAGE> 11
Mr. Kenneth Potashner
October 30, 1998
Page 11
17. Entire Agreement. Except as otherwise specifically provided in this
Agreement, this Agreement together with all Exhibits thereto, contains all the
legally binding understandings and agreements between you and the Company
pertaining to the subject matter of this Agreement and supersedes all such
agreements, whether oral or in writing, previously entered into between the
parties.
18. Miscellaneous. No provision of this Agreement may be amended or
waived unless such amendment or waiver is agreed to by you and the Board in
writing. No waiver by you or the Company of the breach of any condition or
provision of this Agreement will be deemed a waiver of a similar or dissimilar
provision or condition at the same or any prior or subsequent time. In the event
any portion of this Agreement is determined to be invalid or unenforceable for
any reason, the remaining portions will be unaffected thereby and will remain in
full force and effect to the fullest extent permitted by law.
The offer made by this letter will terminate if you do not return a
signed copy of this letter by ______________, 1998.
Sincerely,
S3 Incorporated
By
-------------------------------------------
Its
-------------------------------------------
ACKNOWLEDGED AND AGREED:
/s/ Kenneth Potashner
- ------------------------------
Kenneth Potashner
Dated: October 30, 1998
----------------
<PAGE> 12
EXHIBIT C
EXAMPLES
I. $100,000 LIMITATION ON INCENTIVE STOCK OPTIONS
Internal Revenue Code section 422(d) states that to the extent the aggregate
fair market value of an incentive stock option ("ISO") that first becomes
exercisable in a calendar year exceeds $100,000 in a given year, the option will
not be an ISO. For this purpose, the fair market value is determined on the date
of grant (which, for an ISO, cannot precede the first day of employment).
For example, if the 3,000,000 Share Option is granted on November 2, 1998, and
the fair market value of a share of Company common stock on that date is $3.50,
then the portion of the 3,000,000 Share Option that will be an ISO will be as
follows:
* Of the 750,000 shares vesting on 11/2/99, 28,571 shares
($100,000 divided by $3.50) will be ISOs;
* No other shares vesting in 1999 will be ISOs;
* The first 28,571 shares vesting in each subsequent calendar
year will be ISOs.
II. SPECIAL CASH BONUS
Assumptions
1,500,000 Share Option has $3.00 exercise price
Closing price @ 1-year anniversary, and for preceding 10 trading days, is $4.00
Closing price @ 2-year anniversary, and for preceding 10 trading days, is $5.00
Closing price @ 3-year anniversary, and for preceding 10 trading days, is $6.00
Threshold Conditions to Payment of Special Cash Bonus
- Average closing price over last 10 trading days in 3-year term
is less than $7.67 ($4.67 plus $3.00)
- During each and every 10 trading day period that occurs in an
open officers trading window, the average closing price is
less than $7.67.
- No hedging transactions
- Employed on a full-time basis @ 3 year anniversary.
<PAGE> 13
Amount of Special Cash Bonus
Example 1 - No Option Exercise;
Special Cash Bonus payable @ 3-year anniversary
Special Cash Bonus = $7,000,000
- 1,500,000 x ($6.00 - $3.00)
-----------------------------------
= $2,500,000
Example 2 - No Option Exercise;
Terminated Without Cause @ 2-year anniversary
Special Cash Bonus payable @ termination
Special Cash Bonus = $7,000,000
- 1,500,000 x ($5.00 - $3.00)
-----------------------------------
= $4,000,000
Example 3 - Option exercised @ 2-year anniversary for 400,000 Shares;
Special Cash Bonus payable @ 3-year anniversary
Special Cash Bonus = $7,000,000
- 1,100,000 x ($6.00 - $3.00)
- greater of:
(i) 400,000 x ($5.00-$3.00); or
(ii)400,000 x ($6.00-$3.00) - 1,200,000
-------------------------------------------------
= $2,500,000
Note that the formula results in the same bonus, whether you exercise or not,
unless the closing price is higher at exercise than the closing price at payment
of the Special Cash Bonus.
III. SECTION 7(b) CRITERION
Assume an exercise price per share of $3.50 per share for the 1,500,000 Share
Option. Assume further that during every 10 trading day period occurring during
an open trading window, the average closing price per share is less than $ 8.17
(the sum of $3.50 and $4.67). Section 7(b) shall not bar the payment of the
Special Cash Bonus.
Assume now the same facts, but during one 10 trading day period occurring during
an open trading window, the average closing price is $8.25. No Special Cash
Bonus will be payable.
IV. SECTION 10(c)(v) PAYMENT
Assumptions 3,000,000 Share Option exercise price is $3.00
Total Salary and Bonus Continuation is $2,250,000
(18 months @ 500,000 + 200% bonus)
<PAGE> 14
Example 1: 3,000,000 Share Option is not exercised. Closing price on
last trading day preceding termination is $5.00. At this
price, the Special Cash Bonus is approximately $4,000,000.
The Section 10(c)(v) payment will be:
$10,000,000
less $4,000,000(option bonus)
less $2,250,000(salary and bonus continuation) [constant]
less 3,000,000 x ($5.00 - $3.00)
----------------------------------------------------
(negative number)
No Section 10(c)(v) payment will be made.
Example 2 - Same facts as 1, except that the closing price is $6.00,
so the Special Cash Bonus will be $2,500,000.
$10,000,000
less 2,500,000
less 2,250,000
less 9,000,000
-----------
(negative number)
No Section 10(c)(v) payment will be made.
Example 3: Same facts as 2, except that the closing price is $1.00.
The Special Cash Bonus will be $7,000,000.
$10,000,000
less $7,000,000(option bonus)
less $2,250,000(salary/bonus continuation)
less 3,000,000x ($1.00-$3.00) = 0 (built-in gain)
-----------------------------------------------
$750,000
The Section 10(c)(v) payment will be $750,000.
<PAGE> 15
EXHIBIT D
PROPRIETARY INFORMATION AND INVENTIONS AGREEMENT
<PAGE> 1
EXHIBIT 10.14
EMPLOYMENT AGREEMENT
THIS EMPLOYMENT AGREEMENT is entered into effective as of November 20,
1998 between S3 INCORPORATED, a Delaware corporation (the "Company") and RON
YARA ("Mr. Yara").
RECITALS:
A. Mr. Yara is a member of the S3 Board of Directors.
B. The Company desires to employ Mr. Yara on the terms set forth
herein.
The parties hereby agree as follows:
1. Employment. The Company shall employ Mr. Yara [to perform the
services as may be reasonably requested of him from time to time by
_____________][as its _______________________], and Mr. Yara accepts such
employment.
2. Compensation.
(a) For all Mr. Yara's services to be performed by Mr. Yara under this
Agreement from Mr. Yara's residence, the Company shall pay Mr. Yara, or cause
him to be paid, a salary of not less than $2,000 per month, payable in
accordance with the Company's payroll policy as constituted from time to time.
Such salary may be increased by the Board but may not be decreased without Mr.
Yara's consent. In addition, should Mr. Yara's duties require him to perform
such services away from his residence or in excess of 20 hours in any month, Mr.
Yara shall be paid at the rate of $2,000 per single day, $3,500 for a
consecutive 2-day period and $7,000 per week for a continuous week for any such
services rendered. This compensation shall be in addition to any benefits that
accrue to Mr. Yara under any stock option, insurance, or other plan of the
Company but shall not be payable for services performed by Mr. Yara in his
capacity as a member of the Board. Mr. Yara shall not participate in the
Company's executive bonus plan. The Board, however, in its sole discretion, may
award Mr. Yara a bonus for services rendered.
(b) Continued Vesting Under Options. Vesting under all of Mr. Yara's
option agreements with the Company shall continue during the term of this
Agreement. During the term of this Agreement, Mr. Yara shall continue to have
the status as an employee Director and shall not be entitled to receive cash
compensation as a Director, other than reimbursement of expenses.
(c) Reimbursement of Expenses. The Company shall pay or reimburse Mr.
Yara for all reasonable travel and other expenses incurred or paid by Mr. Yara
in connection with the performance of his duties under this Agreement; such
payment or reimbursement shall be in accordance with the Company's reimbursement
policy as established from time to time by the
-1-
<PAGE> 2
Company's Board or, in absence of any such policy, in accordance with comparable
standards used in the conduct of the Company's business prior to the date
hereof.
3. Benefits. Mr. Yara shall be entitled to participate in any plan or
arrangement for, or to receive any other employment benefits normally available
to, part-time employees of the Company, on the same basis that such
participation or such benefits are normally granted to such other employees.
4. Option Grants.
(a) Mr. Yara shall receive, if he is then serving as a Director, an NSO
to purchase 20,000 shares at each regular annual meeting of the Company's
shareholders at which he is re-elected as a director. These NSOs will have an
exercise price equal to one hundred percent (100%) of the fair market value of a
share of the Company's common stock on the date of grant and shall vest and
become exercisable at the rate of 25% on each one year anniversary of the date
of grant. All such options granted shall become fully exercisable upon Mr.
Yara's death, disability or a "change of control" as defined in the 1989 Stock
Plan. All such options shall expire on the earliest of (b) the tenth anniversary
of the date of grant, (c) ninety (90) days after termination of Mr. Yara's
service as an employee, consultant or director, or (d) twelve (12) months after
termination of such service on account of death, disability or retirement as a
director or employee after age 60.
5. Confidentiality. The obligations of Mr. Yara under the Mr. Yara's
Proprietary Information and Inventions Agreement or any similar agreement he has
entered into with the Company shall remain in full force and effect during the
term of employment hereunder.
6. Termination. This Agreement, and Mr. Yara's employment hereunder,
may be terminated by either party at any time, with or without cause. Any
termination by the Company must be approved by a majority vote by the Board
(excluding for purposes of such vote, Mr. Yara if he is a member of the Board at
the time of such vote).
7. Term. This Agreement shall continue indefinitely unless terminated
in accordance with paragraph 6 above.
8. No Assurance of Continued Service as Member of the Board of
Directors. Nothing herein shall assure Mr. Yara of any rights to continue as a
member of the Company's Board of Directors.
-2-
<PAGE> 3
9. Miscellaneous. This Agreement shall be binding upon, and inure to
the benefit of, Mr. Yara and his heirs, personal representatives, executors and
administrators, and shall inure to the benefit of and be binding upon the
Company, its successors and assigns. This Agreement may be modified or amended
only by written consent of both parties. This Agreement shall be governed and
enforced in accordance with the laws of the State of California applicable to
contracts between California residents and wholly to be performed in California,
notwithstanding California choice of law rules. This instrument contains the
entire agreement of the parties relating to the subject matter hereof, and
supersedes all prior and contemporaneous negotiations, correspondence,
understandings and agreements of the parties relating to the subject matter
hereof. In the event that any provision of this Agreement is held to be invalid
or unenforceable for any reason, the Company and Mr. Yara shall replace such
provision with a valid provision which most closely approximates the intent and
economic effect of the invalid or unenforceable provision, and the remaining
provisions of the Agreement shall continue in full force and effect. The waiver
by any party of any provision of this Agreement or any breach of this Agreement
shall not operate or be interpreted as a waiver of any other provision or breach
existing then or arising in the future. Any subject headings of paragraphs of
this Agreement are included for convenience only and shall not affect the
construction or interpretation of any of its provisions.
IN WITNESS WHEREOF, the undersigned have executed this Agreement as of
the date first written above.
S3 INCORPORATED
By /s/ Kenneth Potashner
--------------------------------
Title Chief Executive Officer
--------------------------------
/s/ Ron Yara
--------------------------------
Ron Yara
-3-
<PAGE> 1
EXHIBIT 10.15
S3 INCORPORATED [S3 Incorporated Logo]
2801 Mission College Blvd.
P.O. Box 58058
Santa Clara, CA 95052-8058
September 22, 1998
TO: Paul Franklin
Re: Agreement Regarding Severance
Dear Paul,
This letter agreement sets forth the terms and conditions of severance
that will be paid to you in the event your employment with S3 Incorporated (the
"Company") is involuntarily terminated other than for Cause.
By signing below, you and the Company agree as follows:
1. Severance Payment. Subject to the release requirement of paragraph
2, if your employment is terminated at the behest of the company other than for
Cause, you will be paid a lump sum payment equal to six months of your base
salary, plus one month of base salary for every full year of your service to the
Company. In addition, the term for exercise of your outstanding options will be
extended until six months after your termination (although you will not continue
to vest after your termination). You should be aware that the extension of your
option exercise term will cause an incentive stock option to become a
nonstatutory stock option, which means that you could be taxed at exercise.
Please advise the Company if you have any concerns about this consequence before
signing below. Your severance will be reduced for applicable withholding.
2. Release Requirement. No severance will be paid, and your option
exercise term will not be extended, unless you execute and deliver to the
Company a full and complete release and covenant not to sue (prepared by, and in
form and substance acceptable to, the Company (the "Release") of all past,
present and future claims you may have against the Company or any of its
officers, directors, shareholders, employees, consultants and agents arising
directly or indirectly from your employment relationship with the Company, this
letter agreement or any act or omission predating the execution of the Release
and thereafter take no action to void or otherwise limit or terminate the
Release within any applicable statutory periods providing such rights.
3. Cause. For purposes of this letter agreement, "Cause" means: (i)
failure to substantially perform the duties and obligations of your employment,
(ii) misconduct which could reasonably be expected to cause substantial injury
to the Company or any of its affiliates, (iii) material breach of any agreement
between you and the Company or any of its affiliates, or (iv) violation or
breach of any obligation under any confidentiality, assignment of inventions, or
non-solicitation agreement between you and the Company.
<PAGE> 2
Paul Franklin
September 22, 1998
Page 2
4. Adjustments to Minimize Taxes Under Golden Parachute Rules. In the
event that any severance payments hereunder are determined to be "excess
parachute payments" pursuant to Section 28OG of the Internal Revenue Code of
1986, as amended, such severance payments shall be reduced to the extent
necessary to maximize your after-tax income.
5. Binding On Successors. This letter agreement will be binding upon
you and any person who is a successor by merger, acquisition, consolidation or
otherwise to the business formerly carried on by the Company, or an affiliate of
any such person, and becomes your employer by reason of (or as the direct result
of) any direct or indirect sale or other disposition of the Company or
substantially all of the assets of the business currently carried on by the
Company, without regard to whether or not such person actively adopts this
letter agreement.
6. Nonassignability. You may not sell, assign or otherwise transfer any
right or interest you may have under this letter agreement other than by will or
by operation of law.
7. Dispute Resolution. You and the Company agree to be bound by the
Dispute Resolution procedures attached hereto.
8. Severability. If any provision of this letter agreement is held
invalid or unenforceable, its invalidity or unenforceability will not affect any
other provision of the letter agreement, and the letter agreement will be
construed and enforced as if such provision had not been included.
9. Governing Law. This letter agreement will be deemed a contract made
under, and for all purposes shall be construed in accordance with, the laws of
California (without regard to its choice of law provisions).
Sincerely,
/s/ Terry Holdt
- ---------------------------
Terry Holdt
President, CEO and Chairman
S3 Incorporated
Dated: September 22, 1998
ACKNOWLEDGED AND AGREED
/s/ Paul Franklin
- ----------------------------
Dated: September 22, 1998
<PAGE> 3
DISPUTE RESOLUTION
Any disputes between you and the Company, including but not limited to disputes
arising out of or related to the letter agreement shall be resolved by using the
following procedures, except that paragraphs (c) and (d) will not be followed in
cases where the law specifically forbids the use of arbitration as a final and
binding remedy, or where paragraph (d) below specifically allows a different
remedy.
(a) The party claiming to be aggrieved shall furnish to the other party a
written statement of the grievance identifying any witnesses or documents that
support the grievance and the relief requested or proposed.
(b) If the other party does not agree to furnish the relief requested or
proposed, or otherwise does not satisfy the demand of the party claiming to be
aggrieved, the parties shall submit the dispute to nonbinding mediation before a
mediator to be jointly selected by the parties. The Company will pay the cost of
the mediation.
(c) If the mediation does not produce a resolution of the dispute, the parties
agree that the dispute shall be resolved by final and binding arbitration. The
parties shall attempt to agree to the identity of an arbitrator, and, if they
are unable to do so, they will obtain a list of arbitrators from the Federal
Mediation and Conciliation Service and select an arbitrator by striking names
from that list. The arbitrator shall have the authority to determine whether the
conduct complained of in paragraph (a) violates the rights of the complaining
party and, if so, to grant any relief authorized by law; subject to the
exclusions of paragraph (d) below. The arbitrator shall not have the authority
to modify, change or refuse to enforce the terms of this letter agreement.
The hearing shall be transcribed. The Company shall bear the costs of the
arbitration if you prevail. If the Company prevails, you will pay half the cost
of the arbitration or $500, whichever is less. Each party shall be responsible
for paying its own attorneys' fees, unless the arbitrator orders otherwise,
pursuant to applicable law.
(d) Arbitration shall be the exclusive final remedy for any dispute between the
parties, and the parties agree that no dispute shall be submitted to arbitration
where the party claiming to be aggrieved has not complied with the preliminary
steps provided for above. The parties agree that the arbitration award shall be
enforceable in any court having jurisdiction to enforce this letter agreement,
so long as the arbitrator's findings of fact are supported by substantial
evidence on the whole and the arbitrator has not made errors of law; provided
however, that either party may bring an action, including but not limited to an
action for injunctive relief, in a court of competent jurisdiction, regarding or
related to matters involving the Company's confidential, proprietary or trade
secret information, or regarding or related to inventions that you may claim to
have developed prior to joining the Company or after joining the Company,
pursuant to California Labor Code 2870. The parties further agree that for
violations of any confidential, proprietary information or trade secret
obligations which the parties have elected to submit to arbitration, the Company
retains the right to seek preliminary injunctive relief in court in order to
preserve the status quo or prevent irreparable injury before the matter can be
heard in arbitration.
<PAGE> 1
EXHIBIT 10.16
S3 INCORPORATED [S3 Incorporated Logo]
2801 Mission College Blvd.
P.O. Box 58058
Santa Clara, CA 95052-8058
September 22, 1998
TO: Walt Amaral
Re: Agreement Regarding Severance
Dear Walt,
This letter agreement sets forth the terms and conditions of severance
that will be paid to you in the event your employment with S3 Incorporated (the
"Company") is involuntarily terminated other than for Cause.
By signing below, you and the Company agree as follows:
1. Severance Payment. Subject to the release requirement of paragraph
2, if your employment is terminated at the behest of the company other than for
Cause, you will be paid a lump sum payment equal to six months of your base
salary, plus one month of base salary for every full year of your service to the
Company. In addition, the term for exercise of your outstanding options will be
extended until six months after your termination (although you will not continue
to vest after your termination). You should be aware that the extension of your
option exercise term will cause an incentive stock option to become a
nonstatutory stock option, which means that you could be taxed at exercise.
Please advise the Company if you have any concerns about this consequence before
signing below. Your severance will be reduced for applicable withholding.
2. Release Requirement. No severance will be paid, and your option
exercise term will not be extended, unless you execute and deliver to the
Company a full and complete release and covenant not to sue (prepared by, and in
form and substance acceptable to, the Company (the "Release") of all past,
present and future claims you may have against the Company or any of its
officers, directors, shareholders, employees, consultants and agents arising
directly or indirectly from your employment relationship with the Company, this
letter agreement or any act or omission predating the execution of the Release
and thereafter take no action to void or otherwise limit or terminate the
Release within any applicable statutory periods providing such rights.
3. Cause. For purposes of this letter agreement, "Cause" means: (i)
failure to substantially perform the duties and obligations of your employment,
(ii) misconduct which could reasonably be expected to cause substantial injury
to the Company or any of its affiliates, (iii) material breach of any agreement
between you and the Company or any of its affiliates, or (iv) violation or
breach of any obligation under any confidentiality, assignment of inventions, or
non-solicitation agreement between you and the Company.
<PAGE> 2
Walt Amaral
September 22, 1998
Page 2
4. Adjustments to Minimize Taxes Under Golden Parachute Rules. In the
event that any severance payments hereunder are determined to be "excess
parachute payments" pursuant to Section 28OG of the Internal Revenue Code of
1986, as amended, such severance payments shall be reduced to the extent
necessary to maximize your after-tax income.
5. Binding On Successors. This letter agreement will be binding upon
you and any person who is a successor by merger, acquisition, consolidation or
otherwise to the business formerly carried on by the Company, or an affiliate of
any such person, and becomes your employer by reason of (or as the direct result
of) any direct or indirect sale or other disposition of the Company or
substantially all of the assets of the business currently carried on by the
Company, without regard to whether or not such person actively adopts this
letter agreement.
6. Nonassignability. You may not sell, assign or otherwise transfer any
right or interest you may have under this letter agreement other than by will or
by operation of law.
7. Dispute Resolution. You and the Company agree to be bound by the
Dispute Resolution procedures attached hereto.
8. Severability. If any provision of this letter agreement is held
invalid or unenforceable, its invalidity or unenforceability will not affect any
other provision of the letter agreement, and the letter agreement will be
construed and enforced as if such provision had not been included.
9. Governing Law. This letter agreement will be deemed a contract made
under, and for all purposes shall be construed in accordance with, the laws of
California (without regard to its choice of law provisions).
Sincerely,
/s/ Terry Holdt
- ----------------------------------
Terry Holdt
President, CEO and Chairman
S3 Incorporated
Dated: September 22, 1998
ACKNOWLEDGED AND AGREED
/s/ Walt Amaral
- -----------------------------------
Dated: September 30, 1998
<PAGE> 3
DISPUTE RESOLUTION
Any disputes between you and the Company, including but not limited to disputes
arising out of or related to the letter agreement shall be resolved by using the
following procedures, except that paragraphs (c) and (d) will not be followed in
cases where the law specifically forbids the use of arbitration as a final and
binding remedy, or where paragraph (d) below specifically allows a different
remedy.
(a) The party claiming to be aggrieved shall furnish to the other party a
written statement of the grievance identifying any witnesses or documents that
support the grievance and the relief requested or proposed.
(b) If the other party does not agree to furnish the relief requested or
proposed, or otherwise does not satisfy the demand of the party claiming to be
aggrieved, the parties shall submit the dispute to nonbinding mediation before a
mediator to be jointly selected by the parties. The Company will pay the cost of
the mediation.
(c) If the mediation does not produce a resolution of the dispute, the parties
agree that the dispute shall be resolved by final and binding arbitration. The
parties shall attempt to agree to the identity of an arbitrator, and, if they
are unable to do so, they will obtain a list of arbitrators from the Federal
Mediation and Conciliation Service and select an arbitrator by striking names
from that list. The arbitrator shall have the authority to determine whether the
conduct complained of in paragraph (a) violates the rights of the complaining
party and, if so, to grant any relief authorized by law; subject to the
exclusions of paragraph (d) below. The arbitrator shall not have the authority
to modify, change or refuse to enforce the terms of this letter agreement.
The hearing shall be transcribed. The Company shall bear the costs of the
arbitration if you prevail. If the Company prevails, you will pay half the cost
of the arbitration or $500, whichever is less. Each party shall be responsible
for paying its own attorneys' fees, unless the arbitrator orders otherwise,
pursuant to applicable law.
(d) Arbitration shall be the exclusive final remedy for any dispute between the
parties, and the parties agree that no dispute shall be submitted to arbitration
where the party claiming to be aggrieved has not complied with the preliminary
steps provided for above. The parties agree that the arbitration award shall be
enforceable in any court having jurisdiction to enforce this letter agreement,
so long as the arbitrator's findings of fact are supported by substantial
evidence on the whole and the arbitrator has not made errors of law; provided
however, that either party may bring an action, including but not limited to an
action for injunctive relief, in a court of competent jurisdiction, regarding or
related to matters involving the Company's confidential, proprietary or trade
secret information, or regarding or related to inventions that you may claim to
have developed prior to joining the Company or after joining the Company,
pursuant to California Labor Code 2870. The parties further agree that for
violations of any confidential, proprietary information or trade secret
obligations which the parties have elected to submit to arbitration, the Company
retains the right to seek preliminary injunctive relief in court in order to
preserve the status quo or prevent irreparable injury before the matter can be
heard in arbitration.
<PAGE> 1
EXHIBIT 10.17
S3 INCORPORATED [S3 Incorporated Logo]
2801 Mission College Blvd.
P.O. Box 58058
Santa Clara, CA 95052-8058
September 22, 1998
TO: Dan Karr
Re: Agreement Regarding Severance
Dear Dan,
This letter agreement sets forth the terms and conditions of severance
that will be paid to you in the event your employment with S3 Incorporated (the
"Company") is involuntarily terminated other than for Cause.
By signing below, you and the Company agree as follows:
1. Severance Payment. Subject to the release requirement of paragraph
2, if your employment is terminated at the behest of the company other than for
Cause, you will be paid a lump sum payment equal to six months of your base
salary, plus one month of base salary for every full year of your service to the
Company. In addition, the term for exercise of your outstanding options will be
extended until six months after your termination (although you will not continue
to vest after your termination). You should be aware that the extension of your
option exercise term will cause an incentive stock option to become a
nonstatutory stock option, which means that you could be taxed at exercise.
Please advise the Company if you have any concerns about this consequence before
signing below. Your severance will be reduced for applicable withholding.
2. Release Requirement. No severance will be paid, and your option
exercise term will not be extended, unless you execute and deliver to the
Company a full and complete release and covenant not to sue (prepared by, and in
form and substance acceptable to, the Company (the "Release") of all past,
present and future claims you may have against the Company or any of its
officers, directors, shareholders, employees, consultants and agents arising
directly or indirectly from your employment relationship with the Company, this
letter agreement or any act or omission predating the execution of the Release
and thereafter take no action to void or otherwise limit or terminate the
Release within any applicable statutory periods providing such rights.
3. Cause. For purposes of this letter agreement, "Cause" means: (i)
failure to substantially perform the duties and obligations of your employment,
(ii) misconduct which could reasonably be expected to cause substantial injury
to the Company or any of its affiliates, (iii) material breach of any agreement
between you and the Company or any of its affiliates, or (iv) violation or
breach of any obligation under any confidentiality, assignment of inventions, or
non-solicitation agreement between you and the Company.
<PAGE> 2
Dan Karr
September 22, 1998
Page 2
4. Adjustments to Minimize Taxes Under Golden Parachute Rules. In the
event that any severance payments hereunder are determined to be "excess
parachute payments" pursuant to Section 28OG of the Internal Revenue Code of
1986, as amended, such severance payments shall be reduced to the extent
necessary to maximize your after-tax income.
5. Binding On Successors. This letter agreement will be binding upon
you and any person who is a successor by merger, acquisition, consolidation or
otherwise to the business formerly carried on by the Company, or an affiliate of
any such person, and becomes your employer by reason of (or as the direct result
of) any direct or indirect sale or other disposition of the Company or
substantially all of the assets of the business currently carried on by the
Company, without regard to whether or not such person actively adopts this
letter agreement.
6. Nonassignability. You may not sell, assign or otherwise transfer any
right or interest you may have under this letter agreement other than by will or
by operation of law.
7. Dispute Resolution. You and the Company agree to be bound by the
Dispute Resolution procedures attached hereto.
8. Severability. If any provision of this letter agreement is held
invalid or unenforceable, its invalidity or unenforceability will not affect any
other provision of the letter agreement, and the letter agreement will be
construed and enforced as if such provision had not been included.
9. Governing Law. This letter agreement will be deemed a contract made
under, and for all purposes shall be construed in accordance with, the laws of
California (without regard to its choice of law provisions).
Sincerely,
/s/ Terry Holdt
- -----------------------------
Terry Holdt
President, CEO and Chairman
S3 Incorporated
Dated: September 22, 1998
ACKNOWLEDGED AND AGREED
/s/ Dan Karr
- ------------------------------
Dated: October 29, 1998
<PAGE> 3
DISPUTE RESOLUTION
Any disputes between you and the Company, including but not limited to disputes
arising out of or related to the letter agreement shall be resolved by using the
following procedures, except that paragraphs (c) and (d) will not be followed in
cases where the law specifically forbids the use of arbitration as a final and
binding remedy, or where paragraph (d) below specifically allows a different
remedy.
(a) The party claiming to be aggrieved shall furnish to the other party a
written statement of the grievance identifying any witnesses or documents that
support the grievance and the relief requested or proposed.
(b) If the other party does not agree to furnish the relief requested or
proposed, or otherwise does not satisfy the demand of the party claiming to be
aggrieved, the parties shall submit the dispute to nonbinding mediation before a
mediator to be jointly selected by the parties. The Company will pay the cost of
the mediation.
(c) If the mediation does not produce a resolution of the dispute, the parties
agree that the dispute shall be resolved by final and binding arbitration. The
parties shall attempt to agree to the identity of an arbitrator, and, if they
are unable to do so, they will obtain a list of arbitrators from the Federal
Mediation and Conciliation Service and select an arbitrator by striking names
from that list. The arbitrator shall have the authority to determine whether the
conduct complained of in paragraph (a) violates the rights of the complaining
party and, if so, to grant any relief authorized by law; subject to the
exclusions of paragraph (d) below. The arbitrator shall not have the authority
to modify, change or refuse to enforce the terms of this letter agreement.
The hearing shall be transcribed. The Company shall bear the costs of the
arbitration if you prevail. If the Company prevails, you will pay half the cost
of the arbitration or $500, whichever is less. Each party shall be responsible
for paying its own attorneys' fees, unless the arbitrator orders otherwise,
pursuant to applicable law.
(d) Arbitration shall be the exclusive final remedy for any dispute between the
parties, and the parties agree that no dispute shall be submitted to arbitration
where the party claiming to be aggrieved has not complied with the preliminary
steps provided for above. The parties agree that the arbitration award shall be
enforceable in any court having jurisdiction to enforce this letter agreement,
so long as the arbitrator's findings of fact are supported by substantial
evidence on the whole and the arbitrator has not made errors of law; provided
however, that either party may bring an action, including but not limited to an
action for injunctive relief, in a court of competent jurisdiction, regarding or
related to matters involving the Company's confidential, proprietary or trade
secret information, or regarding or related to inventions that you may claim to
have developed prior to joining the Company or after joining the Company,
pursuant to California Labor Code 2870. The parties further agree that for
violations of any confidential, proprietary information or trade secret
obligations which the parties have elected to submit to arbitration, the Company
retains the right to seek preliminary injunctive relief in court in order to
preserve the status quo or prevent irreparable injury before the matter can be
heard in arbitration.
<PAGE> 1
EXHIBIT 12.1
STATEMENT OF COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS, EXCEPT RATIOS)
<TABLE>
<CAPTION>
1998 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Income (loss) before income taxes and equity
in net income of joint venture $(142,629) $ (18,631) $ 58,923
Add fixed charges 8,256 8,692 2,598
--------- --------- ---------
Earnings (as defined) $(134,373) $ (9,939) $ 61,521
========= ========= =========
Fixed Charges:
Interest expense $ 6,235 $ 6,477 $ 1,971
Amortization of debt issuance costs 487 488 132
Estimated interest component of rent expense 1,534 1,727 495
--------- --------- ---------
Total fixed charges $ 8,256 $ 8,692 $ 2,598
========= ========= =========
Ratio of earnings to fixed charges -- -- 23.68
========= ========= =========
</TABLE>
Earnings were insufficient to cover fixed charges in the years ended December
31, 1998 and 1997, as evidenced by the less than 1:1 coverage ratio. Additional
earnings of $142.6 million and $18.6 million were necessary to provide a 1:1
coverage ratio for December 31, 1998 and 1997, respectively.
<PAGE> 1
EXHIBIT 21.1
S3 INCORPORATED
SUBSIDIARIES OF REGISTRANT
Subsidiary
S3 International Limited (Bermuda Corporation)
S3 Europe Limited (United Kingdom Corporation)
S3 Japan K.K. (Japan Corporation)
S3 Asia Pacific Limited (Hong Kong Corporation)
S3 Singapore Pte Ltd (Singapore Corporation)
<PAGE> 1
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 333-71869) pertaining to the 1989 Stock Plan of S3, Inc. and
Registration Statement (Form S-3 No. 333-17519) filed in conjunction with the
Company's issuance of convertible subordinated notes and in the related
Prospectuses of our report dated January 21, 1999, with respect to the
consolidated financial statements and schedule of S3, Inc. included in this
Annual Report (Form 10-K) for the year ended December 31, 1998.
San Jose, California
March 26, 1999
<PAGE> 1
EXHIBIT 23.2
CONSENT OF DELOITTE AND TOUCHE LLP
We consent to the incorporation by reference in the Registration Statements No.
33-60666, 33-82280, 33-89388, 33-65186, 33-92372, 33-96030, 33-33726, 333-04439,
333-16067, 333-16211, 333-21573, 333-23819, 333-59799, 333-48189 and 333-71869
of S3 Incorporated on Form S-8 and No. 333-17519 on Form S-3 of our report dated
January 23, 1998, appearing in the Annual Report on Form 10-K of S3 Incorporated
for the year ended December 31, 1998.
DELOITTE & TOUCHE LLP
San Jose, California
March 26, 1999
<PAGE> 1
EXHIBIT 23.3
[PRICEWATERHOUSECOOPERS LETTERHEAD]
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (No. 33-98402 and No. 333-13461) of S3 Incorporated of
our report dated January 22, 1999 appearing in this Annual Report on Form 10-K
for the years ended December 31, 1998 and 1997.
/s/ PRICEWATERHOUSECOOPERS
- ---------------------------
PricewaterhouseCoopers
Hsinchu, Taiwan R.O.C.
February 24, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM S3
INCORPORATED CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1998 AND CONSOLIDATED
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 31,022
<SECURITIES> 88,553
<RECEIVABLES> 30,389
<ALLOWANCES> 6,525
<INVENTORY> 11,383
<CURRENT-ASSETS> 197,178
<PP&E> 45,687
<DEPRECIATION> 23,295
<TOTAL-ASSETS> 325,801
<CURRENT-LIABILITIES> 44,934
<BONDS> 0
0
0
<COMMON> 5
<OTHER-SE> 163,525
<TOTAL-LIABILITY-AND-EQUITY> 325,801
<SALES> 224,639
<TOTAL-REVENUES> 224,639
<CGS> 226,711
<TOTAL-COSTS> 226,711
<OTHER-EXPENSES> 161,827
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,235
<INCOME-PRETAX> (142,629)
<INCOME-TAX> (11,956)
<INCOME-CONTINUING> (130,673)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (113,204)
<EPS-PRIMARY> (2.22)
<EPS-DILUTED> (2.22)
</TABLE>
