<PAGE>
===============================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 0-23596
___________________
C-CUBE MICROSYSTEMS INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0192108
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1778 McCarthy Boulevard
Milpitas, California 95035
(Address and zip code of principal executive offices)
Registrant's telephone number, including area code: (408) 944-6300
Former name, former address and former fiscal year, if changed since last
year: N/A
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.
[X] Yes [ ] No
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
As of July 31, 1998, 37,376,773 shares of the registrant's Common Stock
were outstanding.
===============================================================================
<PAGE>
C-CUBE MICROSYSTEMS INC.
TABLE OF CONTENTS
Page
Part I. Financial Information
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets
June 30, 1998 and December 31, 1997........................ 3
Condensed Consolidated Statements of Operations
Quarter and six months ended June 30, 1998 and 1997........ 4
Condensed Consolidated Statements of Cash Flows
Six months ended June 30, 1998 and 1997.................... 5
Notes to Condensed Consolidated Financial Statements....... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................ 9
Part II. Other Information
Item 1. Legal Proceedings.......................................... 16
Item 2. Changes in Securities and Use of Proceeds.................. 16
Item 3. Defaults Upon Senior Securities............................ 16
Item 4. Submission of Matters to a Vote of Security Holders........ 16
Item 5. Other Information.......................................... 16
Item 6. Exhibits and Reports on Form 8-K........................... 16
Signatures........................................................... 17
-2-
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
C-CUBE MICROSYSTEMS INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value amounts)
June 30, December 31,
1998 1997 (1)
---------- ------------
<S> <C> <C>
(Unaudited) (Unaudited)
ASSETS
Current assets:
Cash and equivalents....................... $ 194,498 $ 145,034
Short-term investments..................... 2,306 21,316
Accounts receivable -- net................. 34,050 40,606
Inventories................................ 20,412 15,270
Deferred income taxes...................... 29,034 11,496
Other current assets....................... 1,379 14,666
---------- ----------
Total current assets............... 281,679 248,388
Property and equipment -- net................ 26,077 23,561
Production capacity rights................... 15,400 18,200
Distribution rights -- net................... 1,565 1,648
Purchased technology -- net.................. 7,664 9,408
Other assets................................. 2,170 2,903
---------- ----------
Total.............................. $ 334,555 $ 304,108
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable........................... $ 21,577 $ 9,221
Accrued liabilities........................ 25,848 23,806
Income taxes payable....................... 10,817 2,467
Deferred contract revenue.................. 5,182 3,895
Current portion of long-term obligations... 246 608
---------- ----------
Total current liabilities.......... 63,670 39,997
Long-term obligations........................ 65,771 87,462
Deferred income taxes........................ 2,043 869
---------- ----------
Total liabilities.................. 131,484 128,328
Minority interest in subsidiary.............. 196 365
Stockholders' equity:
Common stock, $0.001 par value, 150,000
shares authorized; shares outstanding:
1998 -- 37,342; 1997 -- 36,787.......... 210,303 203,728
Accumulated translation adjustments........ (1,944) (1,969)
Unrealized loss on investments............. (4) (17)
Accumulated deficit........................ (5,480) (26,327)
---------- ----------
Total stockholders' equity......... 202,875 175,415
---------- ----------
Total.............................. $ 334,555 $ 304,108
========== ==========
</TABLE>
(1) Derived from the December 31, 1997 audited balance sheet included in
the 1997 Annual Report on Form 10-K of C-Cube Microsystems Inc.
See notes to condensed consolidated financial statements.
-3-
<PAGE>
<TABLE>
<CAPTION>
C-CUBE MICROSYSTEMS INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
Quarter Ended June 30, Six Months Ended June 30,
---------------------- -------------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net revenues........................... $ 82,518 $ 71,098 $169,835 $165,230
Costs and expenses:
Cost of revenues..................... 36,997 31,278 78,011 72,253
Research and development............. 18,596 15,450 36,267 31,062
Selling, general and administrative.. 13,963 12,340 28,549 25,410
--------- --------- --------- ---------
Total............................. 69,556 59,068 142,827 128,725
--------- --------- --------- ---------
Income from operations................. 12,962 12,030 27,008 36,505
Other income (expense), net............ 638 (535) 911 (1,602)
--------- --------- --------- ---------
Income before income taxes, minority
interest and extraordinary item...... 13,600 11,495 27,919 34,903
Income tax expense..................... 4,083 3,949 8,379 11,907
--------- --------- --------- ---------
Income before minority interest
and extraordinary item............... 9,517 7,546 19,540 22,996
Minority interest in net loss of
subsidiary........................... (28) (138) (169) (83)
--------- --------- --------- ---------
Income before extraordinary item....... 9,545 7,684 19,709 23,079
Extraordinary gain on repurchase
of convertible notes (net of tax).... 1,138 -- 1,138 --
--------- --------- --------- ---------
Net income............................. $ 10,683 $ 7,684 $ 20,847 $ 23,079
========= ========= ========= =========
Basic earnings per share:
Income before extraordinary item..... $ 0.26 $ 0.21 $ 0.53 $ 0.64
Extraordinary item (net of tax)...... 0.03 -- 0.03 --
--------- --------- --------- ---------
Net income........................... $ 0.29 $ 0.21 $ 0.56 $ 0.64
========= ========= ========= =========
Diluted earnings per share:
Income before extraordinary item..... $ 0.25 $ 0.21 $ 0.52 $ 0.60
Extraordinary item (net of tax)...... 0.03 -- 0.03 --
--------- --------- --------- ---------
Net income........................... $ 0.28 $ 0.21 $ 0.54 $ 0.60
========= ========= ========= =========
Shares:
Basic................................ 37,238 36,431 37,110 36,323
Diluted.............................. 41,485 40,938 41,311 41,189
</TABLE>
See notes to condensed consolidated financial statements.
-4-
<PAGE>
<TABLE>
<CAPTION>
C-CUBE MICROSYSTEMS INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Six Months Ended June 30,
-------------------------
1998 1997
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income........................................ $ 20,847 $ 23,079
Adjustments to reconcile net income to net cash
provided by operating activities:
Extraordinary gain on repurchase of
convertible notes............................. (1,138) --
Minority interest in subsidiary................. (169) (83)
Depreciation and amortization................... 8,528 7,727
Deferred income taxes........................... (281) (1,133)
Changes in assets and liabilities:
Receivables.................................. 6,489 (2,211)
Inventories.................................. (5,179) 6,596
Other current assets......................... (107) 8,730
Accounts payable............................. 12,559 (1,209)
Accrued liabilities.......................... 1,739 2,274
Income taxes payable......................... 7,552 4,411
--------- ---------
Net cash provided by operating activities.......... 50,840 48,181
--------- ---------
Cash flows from investing activities:
Sales and maturities of short-term investments..... 24,646 4,000
Purchases of short-term investments................ (5,408) (7,496)
Capital expenditures............................... (9,382) (8,674)
Other assets....................................... 241 154
--------- ---------
Net cash provided by (used in) investing activities 10,097 (12,016)
--------- ---------
Cash flows from financing activities:
Repayments of capital lease obligations............ (491) (283)
Sale of common stock............................... 6,537 4,737
Collection of stockholder notes receivable......... -- 305
Repurchase of convertible subordinated notes....... (17,468) --
--------- ---------
Net cash provided by (used in) financing activities (11,422) 4,759
--------- ---------
Exchange rate impact on cash and equivalents......... (51) (36)
--------- ---------
Net increase in cash and equivalents................. 49,464 40,888
Cash and equivalents, beginning of period............ 145,034 76,241
--------- ---------
Cash and equivalents, end of period.................. $194,498 $117,129
========= =========
Supplemental schedule of noncash investing and
financing activities:
Unrealized loss on investments..................... $ (13) $ (25)
Forgiveness of note payable for production
capacity rights.................................. -- 24,500
Cash paid during the period for:
Interest........................................ $ 2,899 $ 2,726
Income taxes.................................... 941 3,685
</TABLE>
See notes to condensed consolidated financial statements.
-5-
<PAGE>
C-CUBE MICROSYSTEMS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of presentation
The unaudited condensed consolidated financial statements contained
in this report have been prepared by C-Cube Microsystems Inc. ("C-Cube"
or the "Company"). In the opinion of management, such financial
statements include all normal recurring adjustments and accruals
necessary for a fair presentation of the Company's financial position as
of June 30, 1998, and the results of operations for the quarters and six
months ended June 30, 1998 and 1997 and cash flows for the six months
ended June 30, 1998 and 1997. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted in accordance with the rules and regulations of the
Securities and Exchange Commission. This unaudited quarterly information
should be read in conjunction with the audited consolidated financial
statements of C-Cube and the notes thereto included in the Company's
Annual Report on Form 10-K for the year ended December 31, 1997.
2. Inventories
Inventories are stated at the lower of cost (first-in, first-out)
or market. Cost is computed on a currently adjusted standard basis
(which approximates actual cost on a current average or first-in, first-
out basis). Inventories consist of:
<TABLE>
June 30, December 31,
1998 1997
--------- ----------
<S> <C> <C>
(in thousands)
Finished goods $ 9,448 $ 9,158
Work-in-process 5,855 3,852
Raw materials 5,109 2,260
--------- ----------
Total $ 20,412 $ 15,270
========= ==========
</TABLE>
-6-
<PAGE>
3. Earnings per share
The following table sets forth the computation of basic and diluted
earnings per share (in thousands, except per share amounts):
<TABLE>
Quarter Ended June 30, Six Months Ended June 30,
---------------------- -------------------------
1998 1997 1998 1997
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Numerator:
Income before extraordinary item.......... $ 9,545 $ 7,684 $ 19,709 $ 23,079
Extraordinary item........................ 1,138 -- 1,138 --
--------- --------- ---------- ----------
Numerator for basic earnings per share.... 10,683 7,684 20,847 23,079
Addback interest income after tax
related to convertible shares........... 761 883 1,608 1,766
--------- --------- ---------- ----------
Numerator for diluted earnings per share.. $ 11,444 $ 8,567 $ 22,455 $ 24,845
========= ========= ========== ==========
Denominator:
Weighted-average shares - denominator
for basic earnings per share............ 37,238 36,431 37,110 36,323
Convertible shares........................ 2,714 2,809 2,762 2,809
Dilutive common stock equivalents,
using treasury stock method............. 1,533 1,698 1,439 2,057
--------- --------- ---------- ----------
Denominator for diluted earnings
per share............................... 41,485 40,938 41,311 41,189
========= ========= ========== ==========
Basic earnings per share................... $ 0.29 $ 0.21 $ 0.56 $ 0.64
========= ========= ========== ==========
Diluted earnings per share................. $ 0.28 $ 0.21 $ 0.54 $ 0.60
========= ========= ========== ==========
</TABLE>
4. Comprehensive income
In the first quarter of 1998, the Company adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive
Income," which requires an enterprise to report, by major components and
as a single total, the change in net assets during the period from
nonowner sources. For the quarter and six months ended June 30, 1998,
comprehensive income, which was comprised of the Company's net income
for the periods, changes in accumulated translation adjustments and
unrealized gains (losses) on investments, was $10.7 million and
$20.9 million, respectively. Comprehensive income for the quarter and six
months ended June 30, 1997 was $7.8 million and $23 million, respectively.
5. Extraordinary item
During the second quarter of the current year, the Company recognized
an extraordinary gain of $1.1 million, or $0.03 per diluted share, net
of related income taxes of $0.8 million. The Company repurchased
$20.7 million of the face value of the Company's 5-7/8% Convertible
Subordinated Notes due 2005 at 88.4% of principal amount, with accrued
interest to the date of repurchase. Subsequent to June 30, 1998, the
Company used $32.4 million to repurchase additional Convertible
Subordinated Notes at an average of 89.1% of the principal amount,
plus related accrued interest at the dates of repurchase.
6. Recently issued accounting standard
In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information," which establishes
-7-
<PAGE>
annual and interim reporting standards for an enterprise's business
segments and related disclosures about its products, services,
geographic areas and major customers. Adoption of this statement will
not impact the Company's consolidated financial position, results of
operations or cash flows. The Company will adopt this statement in its
financial statements for the year ending December 31, 1998.
-8-
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Actual results could differ materially from those
projected in the forward-looking statements as a result of certain factors,
including those set forth in this Item 2 and elsewhere in, or incorporated
by reference into, this report. The Company has attempted to identify
forward-looking statements in this report by placing an asterisk (*)
following each sentence containing such statements.
QUARTER ENDED JUNE 30, 1998
The following table sets forth certain operating data as a percentage
of net revenues for the quarters ended June 30, 1998 and 1997:
<TABLE>
Quarter Ended June 30,
----------------------
1998 1997
------ ------
<S> <C> <C>
Net revenues........................... 100.0% 100.0%
Costs and expenses:
Cost of revenues..................... 44.8 44.0
Research and development............. 22.5 21.7
Selling, general and administrative.. 16.9 17.4
------ ------
Total........................ 84.3 83.1
------ ------
Income from operations................. 15.7 16.9
Interest income (expense), net......... 0.8 (0.8)
------ ------
Income before income taxes,
minority interest and
extraordinary item................... 16.5 16.2
Income tax expense..................... 4.9 5.6
------ ------
Income before minority interest
and extraordinary item............... 11.5 10.6
Minority interest in net loss
of subsidiary........................ 0.0 (0.2)
------ ------
Income before extraordinary item....... 11.6 10.8
Extraordinary gain (net of tax)........ 1.4 0.0
------ ------
Net income............................. 12.9% 10.8%
====== ======
</TABLE>
The Company's quarterly and annual operating results have been, and
will continue to be, affected by a wide variety of factors that could have
a material adverse effect on revenues and profitability during any
particular period, including the level of orders which are received and can
be shipped in a quarter, the rescheduling or cancellation of orders by its
customers, competitive pressures on selling prices, changes in product or
customer mix, availability and cost of foundry capacity and raw materials,
fluctuations in yield, loss of any strategic relationships, C-Cube's
ability to introduce new products and technologies on a timely basis,
unanticipated problems in the performance of the Company's next generation
or cost-reduced products, the ability to successfully introduce products in
accordance with OEM design requirements and design cycles, new product
introductions by the Company's competitors, market acceptance of products
of both C-Cube and its customers, supply constraints for other components
incorporated into its customers' products, fluctuations in foreign currency
exchange rates to the U.S. dollar, and the level of expenditures in
manufacturing, research and development, and sales, general and
administrative functions.
In addition, C-Cube's operating results are subject to fluctuations in
the markets for its customers' products, particularly the consumer
electronics and personal computer markets, which have been extremely
volatile in the past, and the satellite broadcast and wireless cable
markets, which are in an early stage, creating uncertainty with respect to
product volume and timing. The Company has devoted a substantial portion of
its research and development efforts in recent quarters to developing chips
used in Digital Video Disk (DVD) systems. The Company's DVD products are
-9-
<PAGE>
subject to the new product risks described in the preceding paragraph,
including in particular C-Cube's ability to timely introduce these products
and the market's acceptance of them, which could have a materially adverse
affect on its operating results. Furthermore, to the extent the Company is
unable to fulfill its customers' purchase orders on a timely basis, these
orders may be canceled due to changes in demand in the markets for its
customers' products. Historically, the Company has shipped a substantial
portion of its product in the last month of a given quarter. A significant
portion of C-Cube's expenses are fixed in the short term, and the timing of
increases in expenses is based in large part on the Company's forecast of
future revenues. As a result, if revenues do not meet the Company's
expectations, it may be unable to quickly adjust expenses to levels
appropriate to actual revenues, which could have a material adverse effect
on the Company's business and results of operations.
Due to the Company's dependence on the consumer electronics market, the
substantial seasonality of sales in that market could impact the Company's
revenues and net income. In particular, C-Cube believes that there may be
seasonality in the Asia-Pacific region related to the Chinese New Year,
which falls within the first calendar quarter, which could result in
relatively lower product demand during the second and third quarters of
each year.* If the future geographic mix of the Company's sales shifts
towards the U.S. and Europe, C-Cube would anticipate higher revenues and
net income in the third and fourth calendar quarters as system
manufacturers in these areas make purchases in preparation for the holiday
season, and comparatively less revenues and net income in the first and
second calendar quarters.*
As a result of the foregoing, the Company's operating results and stock
price may be subject to significant volatility, particularly on a quarterly
basis. Any shortfall in net revenues or net income from levels expected by
securities analysts could have an immediate and significant adverse effect
on the trading price of the Company's common stock.
The market price of C-Cube's common stock has fluctuated significantly
since its initial public offering in April 1994. The market price of the
common stock could be subject to significant fluctuations in the future
based on factors such as announcements of new products by C-Cube or its
competitors, quarterly fluctuations in C-Cube's financial results or other
semiconductor companies' financial results, changes in analysts' estimates
of C-Cube's financial performance, general conditions in the semiconductor
and digital video networking industries, conditions in the financial
markets and general conditions in the global economy which might adversely
affect consumer purchasing. In addition, the stock market in general has
experienced extreme price and volume fluctuations, which have particularly
affected the market prices for many high technology companies and which
have often been unrelated to the operating performance of the specific
companies. The market price of C-Cube's common stock has declined
substantially from its historic highs, and may continue to experience
significant fluctuations in the future.
The Company is aware of the issues associated with the programming code
in existing computer systems as the millennium (year 2000) approaches. The
"year 2000" problem is pervasive and complex, as virtually every computer
operation will be affected in the same way by the rollover of the two digit
year value to 00. The issue is whether computer systems will properly
recognize date sensitive information when the year changes to 2000. Systems
that do not properly recognize such information could generate erroneous
data or cause a system to fail. The Company is utilizing both internal and
external resources to identify, correct or reprogram, and test its computer
systems for year 2000 compliance. It is anticipated that all reprogramming
efforts will be completed by December 31, 1998, allowing adequate time for
testing.* This process includes getting confirmation from the Company's
primary vendors that plans are being developed or are already in place to
address processing of transactions in the year 2000. However, there can be
no assurance that the systems of other companies on which the Company's
systems rely will also be converted in a timely manner or that any such
failure by another company would not have an adverse effect on the
Company's systems. Management is in the process of completing its
-10-
<PAGE>
assessment of the year 2000 compliance costs and, based on information to
date (excluding the possible impact of vendor systems), management believes
that total costs of year 2000 related issues will not exceed $500,000.*
These costs will be funded through operating cash flows and will be
expensed as incurred.
Net Revenues
Net revenues in the second quarter of 1998 were $82.5 million, an
increase of 16% over the $71.1 million reported in the corresponding
quarter a year ago. Revenue from the Company's family of encoder products
increased due to growth in sales of communications products, which was led
by DiviCom, and increased sales of the Company's DVxpress and DVxpert
families of codecs. Revenue from MPEG-2 decoder chips used primarily in
digital settop boxes and in DVD-ROMs on PCs increased from the second
quarter of 1997 due to customers' adoption of the Company's AViA and ZiVA
families of decoder chips. The Company also had sales from the introduction
of its CVDx1 decoder based on the new China Video Disc (CVD) platform.
These increases were partially offset by a decrease in revenues from MPEG-1
decoder chips used in VideoCD players sold primarily in China, due to price
reductions made in response to competitive pricing pressures.
International revenues accounted for 61% of net revenues for the second
quarter, compared to 63% for the same period last year. The Company expects
that international revenues will continue to represent a significant
portion of net revenues.* The Company's success will depend in part upon
its ability to manage international marketing and sales operations. In
addition, C-Cube purchases a substantial portion of its manufacturing
services from foreign suppliers. C-Cube's international manufacturing and
sales are subject to changes in foreign political and economic conditions
and to other risks including currency or export/import controls, changes in
tax laws, tariffs and freight rates and changes in the ownership and/or
leadership of international customers that may result in delayed or
canceled orders. For example, China is the primary market for VideoCD and
CVD players utilizing the Company's decoder products. As a consequence, any
political or economic instability in China could significantly reduce
demand for the Company's products. The Company has made a significant
investment in additional foundry capacity in Taiwan and is subject to the
risk of political instability in Taiwan, including but not limited to the
potential for conflict between Taiwan and the People's Republic of China.
The Company sells products to customers in Korea and is subject to the risk
of economic and political instability in Korea, including the potential for
conflict between North and South Korea. In addition, the Company sells
certain of its products in international markets and buys certain products
from its foundries in currencies other than the U.S. dollar and, as a
result, currency fluctuations could have a material adverse effect on the
Company's business and results of operations. With respect to international
sales that are denominated in U.S. dollars, increases in the value of the
U.S. dollar relative to foreign currencies can increase the effective price
of and reduce demand for the Company's products relative to competitive
products priced in the local currency. The United States has considered
trade sanctions against Japan and has had disputes with China relating to
trade and human rights issues. If trade sanctions were imposed, Japan or
China could enact trade sanctions in response. Because a number of the
Company's current and prospective customers and suppliers are located in
Japan and China, trade sanctions, if imposed, could have a material adverse
effect on C-Cube's business and results of operations. Similarly,
protectionist trade legislation in either the United States or foreign
countries could have a material adverse effect on the Company's ability to
manufacture or sell its products in foreign markets.
The Asian consumer electronics markets accounted for approximately 43%
of total Company sales in the second quarter of 1998 and are expected to
continue to account for a substantial, though declining, percentage of
sales in the future.* The economic crisis in Asia has been characterized by
increases in idle production capacity, real estate vacancies, unemployment
and bank failures, and has resulted in currency devaluation, falling
consumer spending and domestic price deflation. Any of these factors could
significantly reduce the demand for the end user goods in which the
-11-
<PAGE>
Company's products are incorporated. In the second quarter of 1998, most of
the Company's sales in Asia were of decoder chips, which are used in
VideoCD and CVD players, respectively. The Company believes purchases of
VideoCD players are not as likely to be deferred as are purchases of higher
priced consumer durables and production equipment, which have dramatically
impacted U.S. export sales.* However, there can be no assurance that the
Company will not experience reduced sales of its products into Asia because
of declining consumer spending or because of its customers' increasing
difficulty in obtaining letters of credit, which the Company has required
prior to shipment.
Gross Margin
C-Cube's gross margin for the second quarter of 1998 was 55.2% as
compared to a gross margin of 56% for the same quarter last year. The
decline in margin percentage is due to a decline in the average selling
prices of the Company's products, although this decline has been mostly
offset by reduced product costs. The Company has been able to reduce
product costs through the negotiation of lower foundry wafer prices, the
adoption of finer geometry fabrication processes, the redesign of products
to reduce die size and the use of lower priced assembly and test vendors.
The markets into which C-Cube sells its products are subject to extreme
price competition. Thus, the Company expects to continue to experience
declines in the selling prices of its products over the life cycle of each
product.* In particular, C-Cube expects to continue to experience
significant price competition in the markets for decoder chips.* Due to an
increasing percentage of sales represented by lower margin decoder chips
and lower margin communication systems, the Company anticipates that its
gross margin percentages may decrease in the future.* In order to offset or
partially offset declines in the selling prices of its products, C-Cube
must continue to reduce the costs of products through product design
changes, manufacturing process changes, volume discounts, yield
improvements and other savings negotiated with its manufacturing
subcontractors. Since the Company does not believe that it can continually
achieve cost reductions which fully offset the price declines of its
products, it expects gross margin percentages to decline for existing
products over their life cycles.*
C-Cube does not operate its own manufacturing facilities and must make
volume commitments to subcontractors at prices that remain fixed over
certain periods of time. Therefore, the Company may not be able to reduce
its costs as rapidly as its competitors who perform their own
manufacturing. Failure of the Company to design and introduce, in a timely
manner, lower cost versions of existing products or higher gross margin new
products, or to successfully manage its manufacturing subcontractor
relationships, would have a material adverse effect on C-Cube's gross
margins.
Research and Development Expenses
In the second quarter of 1998, research and development expenses were
$18.6 million, or 23% of net revenues, as compared with $15.5 million, or
22% of net revenues in the second quarter of 1997. The increase in research
and development expenses primarily represents additional employee-related
costs associated with increases in product engineering staff, reflecting
the Company's continuing efforts to provide industry leading digital video
solutions at the chip and systems levels.
-12-
<PAGE>
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $14.0 million,
or 17% of net revenues, in the second quarter of 1998, as compared to
$12.3 million, or 17% of net revenues, for the same quarter last year.
The increase in spending was primarily due to higher advertising costs and
increased field sales and applications support in China and other foreign
markets.
Other Income (Expense)
Other income, net of other expense, was $0.6 million for the second
quarter of 1998, an increase from the net other expense amount of
$0.5 million for the second quarter of 1997. The improvement over the prior
year quarter is primarily due to higher interest income earned on higher
average cash and investment balances.
Income Tax Expense
The Company's effective tax rate for the second quarter of 1998 was
30%. The Company's effective tax rate is less than the combined federal and
state statutory rate primarily due to tax credits and lower foreign tax
rates.
SIX MONTHS ENDED JUNE 30, 1998
The following table sets forth certain operating data as a percentage
of net revenues for the six months ended June 30, 1998 and 1997:
<TABLE>
Six Months Ended June 30,
-------------------------
1998 1997
-------- --------
<S> <C> <C>
Net revenues............................... 100.0% 100.0%
Costs and expenses:
Cost of revenues......................... 45.9 43.7
Research and development................. 21.4 18.8
Selling, general and administrative...... 16.8 15.4
-------- --------
Total............................ 84.1 77.9
-------- --------
Income from operations..................... 15.9 22.1
Interest income (expense), net............. 0.5 (1.0)
-------- --------
Income before income taxes, minority
interest and extraordinary item.......... 16.4 21.1
Income tax expense......................... 4.9 7.2
-------- --------
Income before minority interest and
extraordinary item....................... 11.5 13.9
Minority interest in net loss of subsidiary. (0.1) (0.1)
-------- --------
Income before extraordinary item............ 11.6 14.0
Extraordinary gain (net of tax)............. 0.7 0.0
-------- --------
Net income.................................. 12.3% 14.0%
======== ========
</TABLE>
-13-
<PAGE>
Net Revenues
Net revenues for the six months ending June 30, 1998 were $169.8 million,
a 3% increase from $165.2 million in revenues during the corresponding period
in 1997. Revenues from the Company's MPEG-2 decoder chips used in DVD ROMs on
PCs and digital settop boxes increased as volume shipments of the current
generation chips did not begin until after June 30, 1997. The Company also
experienced growth in sales of communications products, which was led by
DiviCom. Revenue from MPEG-1 decoder chips used in VideoCD players decreased
from the comparable six month period of 1997 due to price reductions made in
response to competition. The decreased prices were partially offset by a
significant increase in volume shipments of such products.
Gross Margin
C-Cube's gross margin percentage decreased to 54.1% in the first six
months of 1998 from 56.3% in the comparable prior year period. The decline
in the gross margin percentage is due primarily to higher product
transition and technology integration costs.
Research and Development Expenses
In the first six months of 1998, research and development expenses were
$36.3 million or 21% of net revenues, as compared to $31.1 million, or 19%
of net revenues, in the comparable prior year period. The increase in
research and development expenses primarily represents additional employee-
related costs associated with increases in product engineering staff,
reflecting the Company's continuing efforts to provide digital video
solutions at the chip and systems levels.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $28.5 million,
or 17% of net revenues in the first six months of 1998, as compared to
$25.4 million, or 15% of net revenues for the same period last year. The
increase was primarily due to increased headcount and related expenses.
Other Income (Expense)
Other income, net of other expense, was $0.9 million for the first six
months of 1998, an increase from the net other expense amount of
$1.6 million for the six months ending June 30, 1997. The increase is
primarily due to higher interest income earned on higher average cash and
investment balances during the first six months of 1998 compared to the same
period last year.
Income Tax Expense
The Company's effective tax rate for the first six months of 1998 was
30%. The Company's effective tax rate is less than the combined federal and
state statutory rate primarily due to tax credits and lower foreign tax
rates.
-14-
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and short-term investments were $196.8 million
at June 30, 1998 as compared to $166.4 million at the end of 1997. Working
capital increased to $218.0 million at June 30, 1998 from $208.4 million at
the end of 1997.
The Company's operating activities generated cash of $50.8 million in
the first six months of 1998, mainly from operating income, reduced
accounts receivable and increased accounts payable, partially offset by an
increase in inventory. The increase in accounts payable primarily was due
to receipts of inventory near the end of the quarter in 1998. Inventory
increased to a level adequate to support future demand. Receivable days
outstanding decreased from 41 days at December 31, 1997 to 37 days at
June 30, 1998.
C-Cube's investing activities, exclusive of the sales and maturities of
$24.6 million and purchases of $5.4 million of short-term investments, used
cash of $9.1 million, primarily for capital expenditures.
Cash used in financing activities was $11.4 million, primarily from
$17.5 million used to repurchase some of the Company's Convertible
Subordinated Notes, partially offset by proceeds of $6.5 million from sales
of stock pursuant to employee stock plans. Subsequent to June 30, 1998, the
Company used $32.4 million to repurchase additional Convertible
Subordinated Notes at an average of 89.1% of the principal amount, plus
related accrued interest at the dates of repurchase.
At June 30, 1998, the Company had an available bank line of credit of
$30 million which expires May 1, 1999. Borrowings bear interest at LIBOR
plus 1.25% or the bank's prime rate (8.50% at June 30, 1998). The line of
credit agreement requires that the Company, among other things, maintain a
minimum tangible net worth, a minimum annual net income (no quarterly loss
exceeding $3 million), and certain financial ratios. In addition, this
agreement prohibits the payment of cash dividends. At June 30, 1998, the
Company was in compliance with these covenants, and there were no
borrowings under this line.
Based on current plans and business conditions, C-Cube expects that its
cash, cash equivalents and short-term investments together with any amounts
generated from operations and available borrowings, will be sufficient to
meet the Company's cash requirements for at least the next 12 months.*
However, there can be no assurance that the Company will not be required to
seek other financing sooner or that such financing, if required, will be
available on terms satisfactory to the Company. In addition, the Company
has considered and will continue to consider various possible transactions
with foundries to secure additional foundry capacity, which could include,
without limitation, equity investments, prepayments, non-refundable
deposits or loans in exchange for guaranteed capacity, "take or pay"
contracts that commit the Company to purchase specified quantities of
wafers over extended periods, joint ventures or other partnership
relationships.
-15-
<PAGE>
C-CUBE MICROSYSTEMS INC.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
From time to time the Company is party to certain litigation or
legal claims. Management has reviewed all pending legal matters and
believes that the resolution of such matters will not have a
significant adverse effect on the Company's financial position or
results of operations.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Stockholders was held on May 8, 1998. At the
meeting, the following actions were taken:
<TABLE>
Number of Common Shares Voted
-----------------------------------------------
Votes Broker
Proposal For Against Withheld Non-Votes
---------------------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
1) Election of Class I
director for a three-
year term
Donald McKinney 34,129,268 -- 579,127 --
2) Ratification and
approval of 1998
Employee Stock
Purchase Plan 13,602,770 1,521,758 220,661 19,363,206
3) Ratification of
Deloitte & Touche LLP
as the Company's
independent public
accountants for
fiscal year ending
December 31, 1998. 33,062,022 197,633 1,448,740 --
</TABLE>
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description
------- -------------
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None.
-16-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
C-Cube Microsystems Inc.
(Registrant)
Dated: August 12, 1998 By: /s/ Walt Walczykowski
----------------- ------------------------
Walt Walczykowski
Vice President of Finance and
Administration and Chief Financial Officer
-17-
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 194,498
<SECURITIES> 2,306
<RECEIVABLES> 34,050
<ALLOWANCES> 0
<INVENTORY> 20,412
<CURRENT-ASSETS> 281,679
<PP&E> 64,579
<DEPRECIATION> 38,502
<TOTAL-ASSETS> 334,555
<CURRENT-LIABILITIES> 63,670
<BONDS> 0
0
0
<COMMON> 210,303
<OTHER-SE> (7,428)
<TOTAL-LIABILITY-AND-EQUITY> 334,555
<SALES> 169,835
<TOTAL-REVENUES> 169,835
<CGS> 78,011
<TOTAL-COSTS> 78,011
<OTHER-EXPENSES> 64,816
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 27,919
<INCOME-TAX> 8,379
<INCOME-CONTINUING> 19,709
<DISCONTINUED> 0
<EXTRAORDINARY> 1,138
<CHANGES> 0
<NET-INCOME> 20,847
<EPS-PRIMARY> .56
<EPS-DILUTED> .54
</TABLE>
