<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 September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File 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 October 31, 1998, 37,538,349 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
September 30, 1998 and December 31, 1997 .................... 3
Condensed Consolidated Statements of Income
Quarter and nine months ended September 30, 1998 and 1997 ... 3
Condensed Consolidated Statements of Cash Flows
Nine months ended September 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 ......................................... 18
Item 2. Changes in Securities and Use of Proceeds ................. 18
Item 3. Defaults Upon Senior Securities ........................... 18
Item 4. Submission of Matters to a Vote of Security Holders ....... 18
Item 5. Other Information ......................................... 18
Item 6. Exhibits and Reports on Form 8-K .......................... 18
Signatures ........................................................... 19
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<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)
(Unaudited)
September 30, December 31,
1998 1997 (1)
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and equivalents ........................... $ 147,795 $ 145,034
Short-term investments ......................... 30,694 21,316
Accounts receivable -- net ..................... 33,011 40,606
Inventories .................................... 16,549 15,270
Deferred income taxes .......................... 12,599 11,496
Other current assets ........................... 15,920 14,666
------------ ------------
Total current assets ................... 256,568 248,388
Property and equipment -- net .................... 28,709 23,561
Production capacity rights ....................... 14,000 18,200
Distribution rights -- net ....................... 1,524 1,648
Purchased technology -- net ...................... 6,792 9,408
Other assets ..................................... 1,075 2,903
------------ ------------
Total $ 308,668 $ 304,108
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................... $ 16,864 $ 9,221
Accrued liabilities ............................ 26,477 23,806
Income taxes payable ........................... 16,065 2,467
Deferred contract revenue ...................... 5,090 3,895
Current portion of long-term obligations ....... 568 608
------------ ------------
Total current liabilities .............. 65,064 39,997
Long-term obligations ............................ 24,020 87,462
Deferred income taxes ............................ 2,179 869
------------ ------------
Total liabilities ...................... 91,263 128,328
------------ ------------
Minority interest in subsidiary .................. 11 365
Stockholders' equity:
Common stock, $0.001 par value, 150,000 shares
authorized; shares outstanding: 1998 --
37,507; 1997 -- 36,688 ...................... 211,697 203,728
Accumulated translation adjustments ............ (1,911) (1,969)
Unrealized gain (loss) on investments .......... 70 (17)
Retained earnings (deficit) .................... 7,538 (26,327)
------------ ------------
Total stockholders' equity ............. 217,394 175,415
------------ ------------
Total .................................. $ 308,668 $ 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 INCOME
(In thousands, except per share amounts)
(Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net revenues ........................... $ 86,162 $ 81,717 $255,997 $246,947
Costs and expenses:
Cost of revenues ..................... 38,757 36,750 116,768 109,003
Research and development ............. 18,867 16,798 55,134 47,860
Selling, general and administrative .. 15,207 13,555 43,756 38,965
-------- -------- -------- --------
Total ............................. 72,831 67,103 215,658 195,828
-------- -------- -------- --------
Income from operations ................. 13,331 14,614 40,339 51,119
Other income (expense), net ............ 1,636 (33) 2,547 (1,635)
-------- -------- -------- --------
Income before income taxes, minority
interest and extraordinary item ...... 14,967 14,581 42,886 49,484
Income tax expense ..................... 4,490 4,958 12,869 16,865
-------- -------- -------- --------
Income before minority interest and
extraordinary item ................... 10,477 9,623 30,017 32,619
Minority interest in net loss of
subsidiary ........................... (185) (40) (354) (123)
-------- -------- -------- --------
Income before extraordinary item ....... 10,662 9,663 30,371 32,742
Extraordinary gain on repurchase of
convertible notes (net of tax)........ 2,356 -- 3,494 --
-------- -------- -------- --------
Net income ............................. $ 13,018 $ 9,663 $ 33,865 $ 32,742
======== ======== ======== ========
Basic earnings per share:
Income before extraordinary item ..... $ 0.29 $ 0.26 $ 0.82 $ 0.90
Extraordinary item (net of tax) ...... 0.06 -- 0.09 --
-------- -------- -------- --------
Net income ........................... $ 0.35 $ 0.26 $ 0.91 $ 0.90
======== ======== ======== ========
Diluted earnings per share:
Income before extraordinary item ..... $ 0.28 $ 0.25 $ 0.79 $ 0.85
Extraordinary item (net of tax) ...... 0.06 -- 0.09 --
-------- -------- -------- --------
Net income ........................... $ 0.34 $ 0.25 $ 0.88 $ 0.85
======== ======== ======== ========
Shares:
Basic ................................ 37,424 36,606 37,215 36,417
Diluted .............................. 39,686 42,055 40,769 41,521
</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)
Nine Months Ended September 30,
-------------------------------
1998 1997
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income ........................................... $ 33,865 $ 32,742
Adjustments to reconcile net income to net cash
provided by operating activities:
Extraordinary gain on repurchase of
convertible notes ............................... (3,494) --
Minority interest in subsidiary ................... (354) (123)
Depreciation and amortization ..................... 13,327 12,343
Deferred income taxes ............................. 207 2,766
Changes in assets and liabilities:
Receivables .................................... 7,519 (4,441)
Inventories .................................... (1,314) 1,119
Other current assets ........................... 2,926 11,576
Accounts payable ............................... 7,731 (2,895)
Accrued liabilities ............................ 1,946 6,011
Income taxes payable ........................... 11,195 3,373
Deferred revenue ............................... 1,195 --
---------- ----------
Net cash provided by operating activities ............ 74,749 62,471
---------- ----------
Cash flows from investing activities:
Sales and maturities of short-term investments ....... 26,956 12,050
Purchases of short-term investments .................. (36,073) (10,827)
Capital expenditures ................................. (14,778) (10,951)
Other assets ......................................... 592 98
---------- ----------
Net cash used in investing activities ................ (23,303) (9,630)
---------- ----------
Cash flows from financing activities:
Bank borrowings ...................................... 39,541 --
Repayment of bank borrowings ......................... (39,541) --
Repayments of capital lease obligations .............. (411) (460)
Sale of common stock ................................. 7,704 8,090
Collection of stockholder notes receivable ........... -- 305
Repurchase of convertible subordinated notes ......... (56,077) --
---------- ----------
Net cash provided by (used in) financing activities .. (48,784) 7,935
---------- ----------
Exchange rate impact on cash and equivalents ........... 99 (106)
---------- ----------
Net increase in cash and equivalents ................... 2,761 60,670
Cash and equivalents, beginning of period .............. 145,034 76,241
---------- ----------
Cash and equivalents, end of period .................... $ 147,795 $136,911
========== ==========
Supplemental schedule of noncash investing and
financing activities:
Unrealized gain on investments ....................... $ 87 $ 13
Forgiveness of note payable for production
capacity rights .................................... -- 24,500
Equipment acquired under lease ....................... 1,382 --
Cash paid during the period for:
Interest .......................................... $ 3,659 $ 2,914
Income taxes ...................................... 1,011 5,169
</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 September 30, 1998, and the results of operations for the quarters
and nine months ended September 30, 1998 and 1997 and cash flows for the
nine months ended September 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>
September 30, December 31,
1998 1997
------------- ------------
(in thousands)
<S> <C> <C>
Finished goods ........ $ 4,797 $ 9,158
Work-in-process ....... 5,208 3,852
Raw materials ......... 6,544 2,260
----------- ----------
Total ....... $ 16,549 $ 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 Nine Months Ended
September 30, September 30,
------------------ ------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Numerator:
Income before extraordinary item ............ $10,662 $ 9,663 $30,371 $32,742
Extraordinary item .......................... 2,356 -- 3,494 --
------- ------- ------- -------
Numerator for basic earnings per share ...... 13,018 9,663 33,865 32,742
Addback interest income after tax related
to convertible shares ..................... 333 883 2,031 2,649
------- ------- ------- -------
Numerator for diluted earnings per share .... $13,351 $10,546 $35,896 $35,391
======= ======= ======= =======
Denominator:
Weighted-average shares - denominator for
basic earnings per share .................. 37,424 36,606 37,215 36,417
Convertible shares .......................... 1,216 2,809 2,247 2,809
Dilutive common stock equivalents, using
treasury stock method ..................... 1,046 2,640 1,307 2,295
------- ------- ------- -------
Denominator for diluted earnings per share .. 39,686 42,055 40,769 41,521
======= ======= ======= =======
Basic earnings per share ..................... $ 0.35 $ 0.26 $ 0.91 $ 0.90
======= ======= ======= =======
Diluted earnings per share ................... $ 0.34 $ 0.25 $ 0.88 $ 0.85
======= ======= ======= =======
</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 nine months ended September 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 $13.1 million and
$34.0 million, respectively. Comprehensive income for the quarter and
nine months ended September 30, 1997 was $9.5 million and $32.5 million,
respectively.
5. Extraordinary item
During the second and third quarters of the current year, the
Company recognized extraordinary gains of $1.1 million and $2.4 million,
respectively, or $0.03 and $0.06 per diluted share, net of related
income taxes of $0.8 million and $1.6 million. During the second
quarter, 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 the
principal amount, with accrued interest to the date of repurchase.
During the third quarter, the Company repurchased $42.8 million
additional Convertible Subordinated Notes at an average of 88.4% of the
principal amount, with accrued interest to the date of repurchase.
-7-
<PAGE>
6. Recently issued accounting standards
In June 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 131, "Disclosures
about Segments of an Enterprise and Related Information," which
establishes 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.
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities," which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities
in the statement of financial position and measure those instruments at
fair value. Adoption of this statement will not materially impact the
Company's consolidated financial position, results of operations or cash
flows. The Company is required to adopt this statement in the first
quarter of fiscal year 2000, with early adoption permitted.
-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. The forward-looking statements involve risks and
uncertainties. 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, those described elsewhere in this report
and those described in the Company's Form 10-K for the year ended December 31,
1997, other Form 10-Qs and other reports under the Securities Exchange
Act of 1934. Such forward-looking statements include, but are not limited
to, those statements marked with an asterisk (*) in this report. The
Company assumes no obligation to update any forward-looking statements.
Quarter Ended September 30, 1998
The following table sets forth certain operating data as a percentage
of net revenues for the quarters ended September 30, 1998 and 1997:
<TABLE>
Quarter Ended September 30,
---------------------------
1998 1997
------ ------
<C> <C>
Net revenues ........................... 100.0% 100.0%
Costs and expenses:
Cost of revenues ..................... 45.0 45.0
Research and development ............. 21.9 20.6
Selling, general and administrative .. 17.6 16.6
------ ------
Total ........................ 84.5 82.1
------ ------
Income from operations ................. 15.5 17.9
Interest income (expense), net ......... 1.9 (0.0)
------ ------
Income before income taxes, minority
interest and extraordinary item ...... 17.4 17.8
Income tax expense ..................... 5.2 6.1
------ ------
Income before minority interest and
extraordinary item ................... 12.2 11.8
Minority interest in net loss
of subsidiary ........................ (0.2) (0.0)
------ ------
Income before extraordinary item ....... 12.4 11.8
Extraordinary gain (net of tax) ........ 2.7 0.0
------ ------
Net income ............................. 15.1% 11.8%
====== ======
</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, compatibility of new products with
emerging digital video standards, 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
-9-
<PAGE>
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
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 in the future the 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 regions 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 or digital video networking 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.
Year 2000
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 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. C-Cube has initiated a Year 2000 project designed to
identify and assess the risks associated with its information systems,
products, operations and infrastructure, suppliers and customers that are
-10-
<PAGE>
not Year 2000 compliant, and to develop, implement and test remediation and
contingency plans to mitigate these risks. C-Cube is replacing or upgrading
systems, equipment and facilities that are known to be Year 2000 non-
compliant. For the Year 2000 non-compliance issues identified to date, the
cost of upgrade or remediation is not expected to be material to the
Company's operating results.* If implementation of replacement systems is
delayed, or if significant new non-compliance issues are identified, the
Company's results of operations or financial condition could be materially
adversely affected.
INFORMATION SYSTEMS. A review of the Company's information systems has
been completed and the Company has initiated the work necessary for the
existing systems to become Year 2000 compliant. Testing of all information
systems will be conducted over the next year. The Company is also actively
reviewing its hardware and systems infrastructure, such as networks, in
order to ensure that they are Year 2000 compliant. Based on the current
status of the assessments and remediation plans made to date, the Company
does not expect total Year 2000 related costs pertaining to its information
systems and hardware and systems infrastructure to be material.*
PRODUCTS. The Company has assessed the capabilities of its products
sold to customers and has not identified any problems related to Year 2000
compliance. The Company is in the process of identifying and assessing the
risks related to integrated systems that include third party products sold
by its DiviCom subsidiary. The Company believes its current products are
Year 2000 compliant; however, since all customer situations cannot be
anticipated, particularly those involving third party products, C-Cube may
see an increase in warranty and other claims as a result of the Year 2000
transition. In addition, litigation against the Company regarding Year 2000
compliance issues may occur in the future. For these reasons, the impact of
customer claims could have a material adverse impact on the Company's
results of operations or financial condition.
OPERATIONS AND INFRASTRUCTURE. Machinery and equipment and other items
used in the operations and facilities of the Company have been inventoried
and are currently being assessed for Year 2000 compliance. The assessment
to date has not uncovered any material issues.
SUPPLIERS. C-Cube is in the process of contacting its critical
suppliers to determine whether their operations, products and services are
Year 2000 compliant. Where practicable, C-Cube will attempt to mitigate its
risks with respect to the failure of suppliers to be Year 2000 compliant.
In the event that suppliers are not Year 2000 compliant, the Company will
seek alternative sources of supplies. However, such failures remain a
possibility and could have an adverse impact on the Company's results of
operations or financial condition.
CUSTOMERS. The Company is actively responding to all customer requests
for compliance, surveys and other general information related to its
Year 2000 programs. The Company will also request assurance from its key
customers that they, and their products which incorporate C-Cube's
products, are Year 2000 compliant.
GENERAL. The Company does not currently expect its costs associated
with the Year 2000 problem to be material, and expects to be able to fund
these costs through operating cash flows.* However, the Company has not yet
completed its assessments, developed remediation plans for all problems,
developed contingency plans, or completely implemented or tested any of its
remediation plans. The risks associated with the Year 2000 problem can be
difficult to identify and to address, and could result in material adverse
consequences to the Company. Even if the Company, in a timely manner,
completes all of its assessments, identifies and tests remediation plans
believed to be adequate, and develops contingency plans believed to be
adequate, some problems may not be identified or corrected in time to
prevent material adverse consequences to the Company.
-11-
<PAGE>
As the Year 2000 project continues, the Company may discover additional
Year 2000 problems, may not be able to develop, implement, or test
remediation or contingency plans in a timely manner, or may find that the
costs of these activities exceed current expectations and become material.
In many cases, the Company is relying on assurances from suppliers and
customers that new and upgraded information systems and other products will
be Year 2000 compliant. The Company plans to test certain third-party
products, but cannot be sure that its tests will be adequate or that, if
problems are identified, they will be addressed by the supplier in a timely
and satisfactory way.
Because the Company uses a variety of information systems and has
additional systems embedded in its operations and infrastructure, the
Company cannot be sure that all of its systems will work together in a
Year 2000-compliant fashion. Furthermore, the Company cannot be sure that
it will not suffer business interruptions, either because of its own
Year 2000 problems or those of its customers or suppliers whose Year 2000
problems may make it difficult or impossible for them to fulfill their
commitments to the Company. If the Company fails to satisfactorily resolve
Year 2000 issues related to its products in a timely manner, it could be
exposed to liability to third parties.
The Company has not developed a "worst case" scenario with respect to
Year 2000 issues, but instead has focused its resources on identifying
material, remediable problems and reducing uncertainties generally, through
the Year 2000 project described above.
If the Company or the third parties with which it has relationships
were to cease or not successfully complete its or their Year 2000
remediation efforts, the Company would encounter disruptions to its
business that could have a material adverse effect on its business,
financial position and results of operations. The Company could be
materially and adversely impacted by widespread economic or financial
market disruption or by Year 2000 computer system failures at third parties
with which it has relationships.
Net Revenues
Net revenues in the third quarter of 1998 were $86.2 million, an
increase of 5.4% over the $81.7 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 third
quarter of 1997 due to customers' adoption of the Company's AViA and ZiVA
families of decoder chips and the wider acceptance of the DVD format. The
Company also had sales from the introduction of its CVD decoder which is
compliant with the new Chao Ji VCD standard. 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 56% of net revenues for the third
quarter, compared to 65% 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
Chao Ji VCD 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
-12-
<PAGE>
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 45%
of total Company sales in the third 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
Company's products are incorporated. In the third quarter of 1998, most of
the Company's sales in Asia were of decoder chips, which are used in
VideoCD players. The Company believes purchases of VideoCD and Chao Ji VCD
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 third quarter of 1998 was 55.0% compared
to a gross margin of 55.0% for the same quarter last year. Although the
average selling prices of the Company's products has declined, this decline
has been 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 reduction of product costs has been partially offset by higher
product transition and technology integration costs.
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.* 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
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<PAGE>
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 third quarter of 1998, research and development expenses were
$18.9 million, or 22% of net revenues, compared with $16.8 million, or 21%
of net revenues in the third 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.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $15.2 million,
or 18% of net revenues, in the third quarter of 1998, compared to
$13.6 million, or 17% of net revenues, for the same quarter last year. The
increase was primarily due to increased headcount and related expenses.
Other Income (Expense)
Other income, net of other expense, was $1.6 million for the third
quarter of 1998, an increase from the net other expense amount of $33,000
for the third 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 and lower interest expense on lower average
outstanding debt balances.
Income Tax Expense
The Company's effective tax rate for the third 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.
-14-
<PAGE>
Nine Months Ended September 30, 1998
The following table sets forth certain operating data as a percentage
of net revenues for the nine months ended September 30, 1998 and 1997:
<TABLE>
Nine Months Ended September 30,
-------------------------------
1998 1997
------ ------
<S> <C> <C>
Net revenues ........................... 100.0% 100.0%
Costs and expenses:
Cost of revenues ..................... 45.6 44.1
Research and development ............. 21.5 19.4
Selling, general and administrative .. 17.1 15.8
------ ------
Total ........................ 84.2 79.3
------ ------
Income from operations ................. 15.8 20.7
Interest income (expense), net ......... 1.0 (0.7)
------ ------
Income before income taxes, minority
interest and extraordinary item ...... 16.8 20.0
Income tax expense ..................... 5.0 6.8
------ ------
Income before minority interest
and extraordinary item ................. 11.7 13.2
Minority interest in net loss
of subsidiary ........................ (0.1) (0.0)
------ ------
Income before extraordinary item ....... 11.9 13.3
Extraordinary gain (net of tax) ........ 1.4 0.0
------ ------
Net income ............................. 13.2% 13.3%
====== ======
</TABLE>
Net Revenues
Net revenues for the nine months ended September 30, 1998 were
$256.0 million, a 4% increase from $246.9 million in revenues during the
corresponding period in 1997. 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
nine month period of 1997 due to customers' adoption of the Company's AViA
and ZiVA families of decoder chips and the wider acceptance of the DVD
format. The Company also had sales from the introduction of its CVD decoder
which is compliant with the new Chao Ji VCD standard. 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.
Gross Margin
C-Cube's gross margin percentage decreased to 54.4% in the first nine
months of 1998 from 55.9% in the comparable prior year period. The decline
in the gross margin percentage is due primarily to lower average selling
prices and higher product transition and technology integration costs.
Research and Development Expenses
In the first nine months of 1998, research and development expenses
were $55.1 million or 22% of net revenues, compared to $47.9 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.
-15-
<PAGE>
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $43.8 million,
or 17% of net revenues in the first nine months of 1998, compared to
$39 million, or 16% 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 $2.5 million for the first nine
months of 1998, an increase from the net other expense amount of $1.6 million
for the nine months ended September 30, 1997. The increase is primarily
due to higher interest income earned on higher average cash and investment
balances and lower interest expense on lower average outstanding debt
balances during the first nine months of 1998 compared to the same period
last year.
Income Tax Expense
The Company's effective tax rate for the first nine 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.
Liquidity and Capital Resources
Cash, cash equivalents and short-term investments were $178.5 million
at September 30, 1998 compared to $166.4 million at the end of 1997.
Working capital decreased to $191.5 million at September 30, 1998 from
$208.4 million at the end of 1997.
The Company's operating activities generated cash of $74.7 million in
the first nine months of 1998, mainly from operating income, reduced
accounts receivable and increased income taxes payable and accounts
payable. The increase in payables primarily was due to unusually
low accounts payable and income taxes payable balances at the end of 1997.
Receivable days outstanding decreased from 41 days at December 31, 1997 to
34 days at September 30, 1998.
C-Cube's investing activities, exclusive of the sales and maturities of
$27.0 million and purchases of $36.1 million of short-term investments,
used cash of $14.2 million, primarily for capital expenditures.
Cash used in financing activities was $48.8 million, primarily from
$56.1 million used to repurchase a portion of the Company's Convertible
Subordinated Notes, partially offset by proceeds of $7.7 million from sales
of stock pursuant to employee stock plans.
At September 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 September 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 September 30, 1998,
the Company was in compliance with these covenants, and there were no
outstanding balances 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
-16-
<PAGE>
seek other financing sooner or that such financing, if required, will be
available on terms satisfactory to the Company, or at all. 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.
-17-
<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
None.
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description
------- -------------------------------------
10.38 Amendment to Option Agreement dated May 30, 1997
with Taiwan Semiconductor Manufacturing Co., Ltd. 1
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None.
1 The Company has requested confidential treatment from the
Securities and Exchange Commission for the redacted portions of
this exhibit.
-18-
<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: November 12, 1998 By: /s/ Walt Walczykowski
------------------- ---------------------------
Walt Walczykowski
Vice President of Finance
and Chief Financial Officer
-19-
<PAGE>
<PAGE>
Confidential treatment requested pursuant to a confidential
treatment request filed with the Securities and Exchange
Commission.
CONFIDENTIAL TREATMENT REQUESTED
[*] Denotes information for which confidential
treatment has been requested. Confidential portions
omitted have been filed separately with the Commission.
Amendment to Option Agreement
This Amendment, made to Option Agreement between C-Cube
Microsystems, and Taiwan Semiconductor Manufacturing Co., Ltd.,
dated May 18, 1996 (the "Option Agreement"), is effective as of
May 30, 1997 (the "Effective Date") by and between C-Cube
Microsystems, a company organized under the laws of California,
USA, with its registered address at 1778 McCarthy Boulevard,
Milpitas, CA 95035, USA ("Customer"), and Taiwan Semiconductor
Manufacturing Co., Ltd., a company organized under the laws of the
R.O.C, with its registered address at No.121, Park Ave. 3,
Science-Based Industrial Park, Hsinchu, Taiwan, R.O.C ("TSMC").
In consideration of mutual covenants and conditions, both
parties agree to amend the Option Agreement as follows:
I. Defined terms used herein but not defined herein shall have the
meaning set forth in the Option Agreement.
II. Amend Sections 1(a), 1(b), 1 (f), 5(b), 11 and 15 as follows:
1(a) "Base Capacity" used in this Agreement shall mean the base
amount of annual Wafer capacity, which is set forth in
Exhibit B.
1(b)"Customer Committed Capacity" used in this Agreement shall
mean the total of [*] of the Base Capacity and [*] of the Option
Capacity that Customer agrees to purchase from TSMC pursuant to
this Agreement, and is set forth in Exhibit B.
1(f) "Wafer" used in this Agreement shall mean 6" physical
wafer without reference to technology and geometry. The
conversion rate from 6" wafer to 8" wafer shall be [*].
5(b) Within seven (7) days upon execution hereof, TSMC shall
return to Customer the promissory note in the amount of
US$24,500,000 to Customer.
11. This Agreement, including Exhibits B-E and the Amendment,
constitutes the entire agreement between the parties with
respect to the subject matter hereof, and supersedes and
replaces all prior or contemporaneous understanding,
agreements, dealings and negotiations, oral or written,
<PAGE>
regarding the subject matter hereof. In the event any
provision of this Agreement conflicts with the Amendment,
this Amendment shall govern with respect to the subject
matter therein. No modification, alteration or amendment
of this Agreement shall be effective unless made in writing
and signed by both parties. No waiver of any breach or
failure by either party to enforce any provision of this
Agreement shall be deemed a wavier of any other or
subsequent breach, or a waiver of future enforcement of
that or any other provision.
15. Both parties shall keep in strict confidence the existence
and contents of this Agreement and the Amendment, and take
best precaution possible to prevent any unauthorized
disclosure or use thereof. Both parties agree that no
disclosure of this Agreement, the Amendment or any matters
relating hereto may be made without the disclosing party
first providing the proposed disclosure to the other party
two weeks in advance for consent and reasonable changes.
In the event disclosure is required by laws or governmental
regulations, the disclosing parry shall provide the other
party two weeks prior written notice and give the other
party the opportunity to protest, participate in preparing
disclosure or make reasonable changes thereto.
III. Add to the End of Section 6(a)
[*]
Add to the End of Section 7(e)
"In no event shall either party be liable for indirect,
consequential, or special damage arising from this Agreement or
its performance."
IV. Delete Original Exhibit A, Replace Original Exhibits B and D
with New Exhibits B and D.
C-Cube Microsystems Taiwan Semiconductor
Manufacturing Co.,
Ltd.,
BY: /s/ Alexandre A. Balkanski BY: /s/ Morris Chang
---------------------------- ------------------
Alexandre A. Balkanski Morris Chang
President Chairman
Confidential treatment requested pursuant to a confidential
treatment request filed with the Securities and Exchange
Commission.
<PAGE>
EXHIBIT B
C-CUBE MICROSYSTEMS/TSMC
COMMITTED CAPACITY
[*]
Confidential treatment requested pursuant to a confidential
treatment request filed with the Securities and Exchange
Commission.
<PAGE>
EXHIBIT D
OPTION FEE
[*]
Confidential treatment requested pursuant to a confidential
treatment request filed with the Securities and Exchange
Commission.
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 147,795
<SECURITIES> 30,694
<RECEIVABLES> 33,011
<ALLOWANCES> 0
<INVENTORY> 16,549
<CURRENT-ASSETS> 256,568
<PP&E> 70,214
<DEPRECIATION> 41,505
<TOTAL-ASSETS> 308,668
<CURRENT-LIABILITIES> 65,064
<BONDS> 0
0
0
<COMMON> 211,697
<OTHER-SE> 5,697
<TOTAL-LIABILITY-AND-EQUITY> 308,668
<SALES> 255,997
<TOTAL-REVENUES> 255,997
<CGS> 116,768
<TOTAL-COSTS> 116,768
<OTHER-EXPENSES> 98,890
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 42,886
<INCOME-TAX> 12,869
<INCOME-CONTINUING> 30,371
<DISCONTINUED> 0
<EXTRAORDINARY> 3,494
<CHANGES> 0
<NET-INCOME> 33,865
<EPS-PRIMARY> .91
<EPS-DILUTED> .88
</TABLE>
