<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM 10-Q
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(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED APRIL 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 0-25540
STB SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
TEXAS 75-1855896
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1651 NORTH GLENVILLE DRIVE, RICHARDSON, TEXAS 75081
(Address of principal executive offices)
(972) 234-8750
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Number of Shares Outstanding as of
Title of each class: June 15, 1998:
Common Stock, $.01 par value 13,291,017
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<PAGE>
STB SYSTEMS, INC.
INDEX
<TABLE>
PAGE
PART I FINANCIAL INFORMATION NUMBER
<S> <C> <C>
Item 1 Consolidated Financial Statements:
Consolidated Balance Sheets at April 30, 1998
(Unaudited) and October 31, 1997 2
Consolidated Statements of Operations for the
three months ended April 30, 1998 and 1997 (Unaudited) 3
Consolidated Statements of Operations for the
six months ended April 30, 1998 and 1997 (Unaudited) 4
Consolidated Statements of Cash Flows for the
six months ended April 30, 1998 and 1997 (Unaudited) 5
Notes to Consolidated Financial Statements 6 - 7
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 8 - 15
PART II OTHER INFORMATION
Items 1 through 4 have been omitted since the registrant has no
reportable events in relation to these items.
Item 5 Other Information - Risk Factors 15 -28
Item 6 Exhibits and Reports on Form 8-K 29
Signatures 30
</TABLE>
- 1 -
<PAGE>
PART I FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
STB SYSTEMS, INC. and SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- ---------------------------------------------------------------------------
(Dollars in thousands except per share data)
<TABLE>
April 30, October 31,
1998 1997
--------------------------
(Unaudited)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 33,611 $ 3,869
Accounts receivable - trade, net of allowance
for doubtful accounts of $580 and $465 46,829 47,208
Inventories, net 48,487 41,295
Other current assets 3,222 1,970
--------------------------
Total current assets 132,149 94,342
Property and equipment, net 10,638 12,348
Other assets 1,848 2,864
--------------------------
Total assets $ 144,635 $ 109,554
--------------------------
--------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Short-term debt $ 5,000 $ 21,520
Accounts payable - trade 25,485 36,801
Accrued wages, commissions and bonuses 1,102 1,466
Other accrued liabilities 1,826 2,027
Current portion of long-term liabilities 586 1,167
--------------------------
Total current liabilities 33,999 62,981
--------------------------
Long-term Liabilities:
Long-term notes payable - 500
Obligations under capital leases and other
Long-term liabilities 2,395 2,611
--------------------------
Total long-term liabilities 2,395 3,111
--------------------------
Shareholders' Equity:
Preferred stock, 2,000,000 shares authorized,
None issued or outstanding - -
Common stock, $.01 par value, 25,000,000 shares
authorized, 13,288,405 and 10,452,473 shares issued,
respectively 133 105
Additional paid-in capital 83,494 25,357
Retained earnings 24,859 18,245
--------------------------
108,486 43,707
Treasury stock, 35 shares, at cost (245) (245)
--------------------------
Total shareholders' equity 108,241 43,462
--------------------------
Total liabilities and shareholders' equity $ 144,635 $ 109,554
--------------------------
--------------------------
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements
- 2 -
<PAGE>
STB SYSTEMS, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
- ---------------------------------------------------------------------------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
Three months ended
April 30,
1998 1997
-------------------------
<S> <C> <C>
Net sales $ 73,795 $ 48,700
Cost of sales 59,933 36,922
-------------------------
Gross profit 13,862 11,778
-------------------------
Operating expenses:
Research and development 2,559 1,556
Sales and marketing 4,192 3,637
General and administrative 2,613 2,408
-------------------------
Total operating expenses 9,364 7,601
-------------------------
Income from operations 4,498 4,177
Interest expense, net 246 383
-------------------------
Income before income taxes 4,252 3,794
Provision for income taxes 1,443 1,376
-------------------------
Net income $ 2,809 $ 2,418
-------------------------
-------------------------
Net income per share:
Basic $ 0.24 $ 0.24
-------------------------
-------------------------
Diluted $ 0.22 $ 0.22
-------------------------
-------------------------
Weighted average shares outstanding:
Basic 11,804,905 10,249,345
-------------------------
-------------------------
Diluted 12,824,517 11,051,405
-------------------------
-------------------------
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
- 3 -
<PAGE>
STB SYSTEMS, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
- --------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
Six months ended
April 30,
1998 1997
---------------------------
<S> <C> <C>
Net sales $ 152,552 $ 96,792
Cost of sales 122,475 74,381
---------------------------
Gross profit 30,077 22,411
---------------------------
Operating expenses:
Research and development 4,898 2,794
Sales and marketing 8,615 6,923
General and administrative 5,847 4,791
---------------------------
Total operating expenses 19,360 14,508
---------------------------
Income from operations 10,717 7,903
Interest expense, net 764 759
---------------------------
Income before income taxes 9,953 7,144
Provision for income taxes 3,339 2,474
---------------------------
Net income $ 6,614 $ 4,670
---------------------------
---------------------------
Net income per share:
Basic $ 0.59 $ 0.46
---------------------------
---------------------------
Diluted $ 0.55 $ 0.43
---------------------------
---------------------------
Weighted average shares outstanding:
Basic 11,122,210 10,203,192
---------------------------
---------------------------
Diluted 12,095,445 10,890,259
---------------------------
---------------------------
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
- 4 -
<PAGE>
STB SYSTEMS, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(DOLLARS IN THOUSANDS)
<TABLE>
Six months ended
April 30,
1998 1997
-------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 6,614 $ 4,670
Adjustments to reconcile net income to net cash
from operating activities:
Depreciation and amortization 1,378 940
Changes in assets and liabilities:
Accounts receivable - trade 379 (8,476)
Inventories (7,192) 2,329
Other current assets (1,252) (330)
Other assets 1,016 (1,558)
Accounts payable - trade (11,318) (3,501)
Accrued wages, commissions, and bonuses (364) (109)
Other accrued liabilities (201) 194
-------------------------
Net cash used in operating activities (10,940) (5,842)
-------------------------
Cash flows from investing activities -
Sales (purchase) of property and equipment 332 (2,800)
Cash flows from financing activities:
Borrowings (payments) on short-term debt (16,520) 6,695
Payments on long-term debt (1,297) (365)
Issuance of common stock, net of issue costs 58,167 1,140
-------------------------
Net cash provided by financing activities 40,350 7,800
-------------------------
Net increase (decrease) in cash and cash equivalents 29,742 (841)
Cash and cash equivalents at beginning of period 3,869 3,420
-------------------------
Cash and cash equivalents at end of period $ 33,611 $ 2,579
-------------------------
-------------------------
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements
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<PAGE>
STB SYSTEMS, INC.
Notes To Consolidated Financial Statements
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
STB Systems, Inc. develops, manufactures and sells a wide selection of
multimedia accelerator subsystems, other multimedia subsystem products and
specialized technology products for use in mid-range and high-end personal
computers ("PCs"). STB Assembly, Inc. is a wholly-owned subsidiary and provides
manufacturing services to STB Systems, Inc. Symmetric Simulation Systems, Inc.,
also a wholly-owned subsidiary of STB Systems, Inc., designs high-end 3D
graphics acceleration products for use in applications such as computer-aided
design, product visualization and animation.
The accompanying financial statements include the consolidated accounts of STB
Systems, Inc., STB Assembly, Inc. and Symmetric Simulation Systems, Inc.,
(collectively referred to as the "Company"). STB Assembly, Inc. has two
majority-owned subsidiaries, STB de Mexico S.A. de C.V. ("STB de Mexico") and
Maquilados Continentales de Ciudad Juarez, S.A. de C.V. ("MCC"). STB de Mexico
is a Mexican corporation operated as a maquiladora that performs assembly
services for STB Systems, Inc. MCC entered into an agreement in January 1990 to
provide subcontract manufacturing services for STB Systems, Inc. As of December
1992, MCC became an inactive entity. All significant intercompany accounts and
transactions have been eliminated in consolidation. Minority interests in the
subsidiaries are insignificant for financial reporting purposes.
In February 1997, the Financial Accounting Standards Board issued FAS No. 128
"Earnings per Share", (SFAS 128). The Company has adopted SFAS 128, which
establishes standards for computing and presenting earnings per share (EPS).
This statement requires dual presentation of basic and diluted EPS on the face
of the income statement for entities with complex capital structures and
requires a reconciliation of the numerator and denominator of the basic EPS
computation to the numerator and denominator of the diluted EPS computation.
Basic EPS excludes the effect of potentially dilutive securities while diluted
EPS reflects the potential dilution that would occur if securities or other
contracts to issue common stock were exercised, converted into or resulted in
the issuance of common stock. The provision and disclosure requirements of SFAS
128 were required to be adopted for interim and annual periods ending after
December 15, 1997, with restatement of EPS for prior periods. Accordingly, EPS
data for all periods has been restated to reflect the computation of EPS in
accordance with the provisions of SFAS 128.
The financial information presented herein should be read in conjunction with
the Company's annual consolidated financial statements for the year ended
October 31, 1997. The foregoing unaudited interim consolidated financial
statements reflect all adjustments (all of which are of a normal recurring
nature) which are, in the opinion of management, necessary for a fair
presentation of the results of the interim periods. The results for the interim
periods are not necessarily indicative of the results to be expected for the
year.
NOTE 2 - INVENTORIES
Inventories at April 30, 1998 and October 31, 1997 consist of the following (in
thousands):
<TABLE>
January 31, 1998 October 31, 1997
---------------- ----------------
<S> <C> <C>
Raw materials $ 26,815 $ 22,416
Work-in-process 13,572 13,416
Finished goods 8,100 5,463
----------- -----------
Total $ 48,487 $ 41,295
----------- -----------
----------- -----------
</TABLE>
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<PAGE>
NOTE 3 - SHORT TERM DEBT
In January 1998, the Company increased its borrowing capacity under its
revolving credit facility ("Revolving Credit Facility") to $40,000,000 from
$30,000,000. The Revolving Credit Facility bears interest at LIBOR plus 175
basis points (7.406% at April 30, 1998). Availability under the Revolving
Credit Facility is subject to limitation determined by the Company's borrowing
base, which is calculated based on eligible accounts receivable, as defined in
the Revolving Credit Facility Agreement.
NOTE 4 - STOCK SPLIT
On January 27, 1998, the Company declared a three-for-two split of the Company's
common stock. The stock split was effected in the form of a stock dividend on
February 20, 1998, to shareholders of record on February 11, 1998. Share and
per share amounts in the accompanying consolidated financial statements have
been retroactively adjusted to reflect the stock split.
NOTE 5 - EARNINGS PER SHARE
The following table sets forth the reconciliation of the numerators and
denominators of the basic and diluted EPS computations:
<TABLE>
Three months ended Six months ended
April 30, April 30,
1998 1997 1998 1997
-------------------------- --------------------------
<S> <C> <C> <C> <C>
Net income (in thousands) $ 2,809 $ 2,418 $ 6,614 $ 4,670
-------------------------- --------------------------
-------------------------- --------------------------
BASIC
Weighted average number of shares outstanding 11,804,905 10,249,345 11,122,210 10,203,192
-------------------------- --------------------------
-------------------------- --------------------------
Net income per share $ 0.24 $ 0.24 $ 0.59 $ 0.46
-------------------------- --------------------------
-------------------------- --------------------------
DILUTED
Weighted average number of shares outstanding 11,804,905 10,249,345 11,122,210 10,203,192
Additional weighted average shares from assumed
exercise of dilutive stock options, net of shares
assumed to be repurchased with exercise proceeds 1,019,612 802,060 973,235 687,067
-------------------------- --------------------------
Dilutive weighted average shares outstanding 12,824,517 11,051,405 12,095,445 10,890,259
-------------------------- --------------------------
Net income per share $ 0.22 $ 0.22 $ 0.55 $ 0.43
-------------------------- --------------------------
-------------------------- --------------------------
</TABLE>
Options to purchase 33,875 shares of common stock ranging in price from $21.27
to $25.67 per share were outstanding during the second quarter and the six
months ended April 30, 1998 but were not included in the computation of diluted
EPS because the options' exercise price was greater than the average market
price of the common shares. The options will expire in 2007.
NOTE 6 - SECONDARY OFFERING
On February 25, 1998 the Company filed a registration statement on Form S-3 to
offer 3,000,000 shares of its common stock to the public in a secondary
offering. On March 20, 1998, the offering was completed and of the shares being
offered, 2,775,000 shares were sold by the Company and 225,000 were sold by
certain selling shareholders. Net proceeds from the offering were used to
reduce indebtedness outstanding under the Company's revolving credit facility
and the balance retained for general corporate purposes.
- 7 -
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company designs, manufactures and sells multimedia subsystem and
specialized technology products, primarily for use in desktop personal
computers (PCs). These products supplement a PC's CPU to enhance multimedia
performance and accelerate the computationally intensive operations and
processing requirements necessary to perform advanced multimedia
applications. The Company focuses primarily on the sale of its products to
major original equipment manufacturers, "OEMs", and works closely with its
component suppliers and OEM customers to develop products that are responsive
to technological trends and consumer demand. STB manufactures substantially
all of its products at its ISO 9002 certified facility in Juarez, Mexico,
which the Company believes enables it to respond more quickly to changing
customer needs, maintain product quality and achieve economies of scale.
The Company currently sells multimedia subsystems and specialized technology
products. The Company's multimedia subsystem product line includes a wide
selection of multimedia accelerator subsystems designed primarily for use in
mid-range to high-end PCs as well as several complementary products, including
DVD decoder subsystems, PC/TV convergence subsystems and sound cards. STB's
specialized technology products include products designed to enable a single
computer to control the display of up to 32 monitors and a recently introduced
line of flat panel display products.
The Company sells its products to OEM customers, the commercial market, and
the specialized technology market. The Company sells its multimedia subsystems
primarily to major OEMs and, to a lesser extent, the commercial market. Sales of
the Company's products to OEMs represented approximately 83% and 79% of total
net sales for the first six months of fiscal 1998 and fiscal year 1997,
respectively. The Company's three largest OEM customers accounted in the
aggregate for approximately 76% and 66% of total net sales for the first six
months of fiscal 1998 and fiscal year 1997, respectively. Sales of multimedia
subsystems to the commercial market accounted for approximately 10% and 12% of
total net sales for the first six months of fiscal 1998 and fiscal year 1997
respectively, and sales of specialized technology products accounted for
approximately 6% and 8% of total net sales for the first six months of fiscal
1998 and fiscal year 1997, respectively. The balance of total net sales was
derived primarily from third party contract assembly services, which accounted
for approximately 1% of total net sales for the first six months of fiscal 1998
and fiscal year 1997. The Company has no long-term commitments or contracts
with any of its customers and the loss of any of the Company's key customers
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Risk Factors - Customer
Concentration; Dependence on PC Market."
Sales of multimedia accelerator subsystems and other multimedia subsystems
to OEMs have typically been characterized by relatively high unit volumes and
relatively low gross profit margins. Sales of multimedia subsystem products to
the commercial market are characterized by relatively modest unit volumes and
moderate gross profit margins. Sales of the Company's specialized technology
products are characterized by relatively low unit volumes and relatively high
gross profit margins. Shifts in the mix of products sold or in the sales
channels into which such products are sold could have a material adverse effect
on the Company's business, financial condition and results of operations. See
"Risk Factors - Change in Product Mix or Sales Channel." In addition, a
substantial majority of the Company's net sales have been derived from sales of
multimedia accelerator subsystems and, from time to time, a substantial majority
of the Company's net sales in a given fiscal quarter have been derived from the
sales of a single or a limited number of multimedia accelerator subsystems. See
"Risk Factors - Product Concentration." The markets for the Company's products
in general, and its multimedia accelerator subsystems in particular, are
characterized by short product life cycles, evolving industry standards and
frequent introductions of new products. See "Risk Factors - Limited Product
Life Cycle; Rapid Techological Change; Management of Product Introductions."
- 8 -
<PAGE>
The Company recognizes revenue upon shipment of its products. For products sold
through the commercial channel, the Company generally provides credits for
returns in the form of stock rotation and price protection. The Company's
current stock rotation policies permit a commercial channel customer to return
approximately 10% of products purchased within the previous 90 days if the
customer has placed an order for other Company products of equal or greater
value. The Company also provides price protection to commercial channel
customers in the form of credits for price reductions on products remaining in
customer inventories at the time of the price reduction. The Company maintains
reserves related to these sales programs, which it believes are adequate. See
"Risk Factors - Price Protection and Stock Rotations."
The Company has no guaranteed supply arrangements with any of its suppliers.
The Company obtains most of the primary components for its current products,
consisting mainly of controller chips and memory chips, directly from the
component manufacturers. The prices of such components can change significantly
from time to time. In the past, the Company has experienced, and may in the
future experience, increases in its unit component costs without being able to
increase the price of the products incorporating such components. Such an
increase in component costs could impair the Company's gross profit margins and
results of operations. In particular, occasional worldwide shortages of memory
and controller chips and international tariff disputes have in the past resulted
in substantial component cost increases that have had a material adverse effect
on the Company's gross profit margins and its results of operations. The
Company's total gross profit margins and gross profits will likely continue to
fluctuate from period to period as a result of the Company's product mix, sales
channel mix, component costs and competitive pricing pressures on the Company's
products. See "Risk Factors - Dependence on Suppliers" and "--Change in Product
or Sales Channel Mix."
In recent periods, the Company's business has been strongly influenced by the
following trends: the growth of the PC market in general; the ability of several
major PC manufacturers to expand their respective market shares of the PC market
in general; the Company's ability to establish and expand OEM relationships with
several of these major PC manufacturers; the expansion of the market for
multimedia subsystems and, in particular, the market for multimedia accelerator
subsystems; the ability of the Company to identify and source key components,
such as graphics controller chips, that enable the Company's products to compete
effectively with its competitors; and the Company's ability to design, develop
and manufacture successive generations of multimedia accelerator subsystems that
secure design wins with major OEM customers and achieve wide market acceptance.
Although the Company is currently attempting to diversify its product offerings,
expand its existing OEM customer relationships, establish new OEM customer
relationships and expand sales into the commercial market, there can be no
assurance that the Company will be successful with respect to any of these
efforts. The failure by the Company to further diversify its product offerings
and to expand its distribution channels could have a material adverse effect on
the Company's business, financial condition and results of operations. See
"Risk Factor - Customer Concentration; Dependence on PC Market," "--Dependence
on Multimedia Accelerator Market; Migration to Motherboards," "--Dependence on
Suppliers" and "--Limited Product Life Cycle; Rapid Technological Change;
Management of Product Transitions."
During the fiscal quarter ended April 30, 1997, the Company acquired all of the
outstanding shares of Symmetric Simulation Systems, Inc. ("Symmetric"), a
designer and builder of high-end 3D graphics acceleration subsystems used in
applications such as computer-aided design product visualization, architectural
walk-throughs and multimedia authoring. The Company believes that the Symmetric
product line complements the Company's existing products and enables the Company
to market products to the high-end 3D market.
On February 25, 1998 the Company filed a registration statement on Form S-3 to
offer 3,000,000 shares of its common stock to the public in a secondary
offering. On March 20, 1998, the offering was completed and of the shares being
offered, 2,775,000 shares were sold by the Company and 225,000 were sold by
certain selling shareholders. The net proceeds received by the Company from the
offering were used to repay certain indebtedness outstanding under the Company's
revolving credit facility and for other general corporate purposes.
- 9 -
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth certain items from the Company's
Consolidated Statement of Operations as a percentage of net sales from
continuing operations:
<TABLE>
Percentage of Net Sales
------------------------------------------------
Three months ended Six months ended
April 30, April 30,
1998 1997 1998 1997
--------------------- ---------------------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 81.2% 75.8% 80.3% 76.8%
-------------------- --------------------
Gross profit 18.8% 24.2% 19.7% 23.2%
-------------------- --------------------
Operating expenses:
Research and development 3.5% 3.2% 3.2% 2.9%
Sales and marketing 5.7% 7.5% 5.7% 7.2%
General and administrative 3.5% 4.9% 3.8% 4.9%
-------------------- --------------------
Total operating expenses 12.7% 15.6% 12.7% 15.0%
-------------------- --------------------
Income from operations 6.1% 8.6% 7.0% 8.2%
Interest expense, net 0.3% 0.8% 0.5% 0.8%
-------------------- --------------------
Income before income taxes 5.8% 7.8% 6.5% 7.4%
Provision for income taxes 2.0% 2.8% 2.2% 2.6%
-------------------- --------------------
Net income 3.8% 5.0% 4.3% 4.8%
-------------------- --------------------
-------------------- --------------------
</TABLE>
THREE MONTHS ENDED APRIL 30, 1998 COMPARED TO THREE MONTHS ENDED APRIL 30, 1997.
NET SALES. Net sales increased to $73.8 million in the second quarter of
fiscal 1998 from $48.7 million in the second quarter of fiscal 1997,
representing an increase of 51.5%. Unit volume for the second quarter of fiscal
1998 increased by 44.5% over the second quarter of fiscal 1997, while the
Company's overall average unit selling prices increased slightly. OEM channel
sales increased to approximately $61.0 million in the second quarter of fiscal
1998 from $38.6 million in the second quarter of fiscal 1997, representing an
increase of 58.2%. Commercial channel sales increased to $7.6 million in the
second quarter of fiscal 1998 from $4.9 million in the second quarter of fiscal
1997, an increase of 53.5%. Sales growth in the OEM and commercial channels was
primarily the result of increased unit sales of the Company's Velocity 128
multimedia accelerator. See "Risk Factors - Product Concentration". The
Company experienced some delays in shipping the new Black Magic Voodoo2 product
to the commercial channel due to a vendor's inability to deliver confirmed
memory orders. Sales in the specialized technology market increased to $4.9
million in the second quarter of fiscal 1998 from $3.4 million in the second
quarter of fiscal 1997, or 42.7%, which was primarily a result of increased
sales to OEM customers for financial services workstations and a broader
specialized technology product offering. Revenues for the quarter were
negatively impacted, as a major customer re-scheduled the shipment of an STB
workstation product into the coming months.
- 10 -
<PAGE>
GROSS PROFIT. Gross profit consists of net sales less cost of sales. Cost
of sales primarily consists of the cost of materials and manufacturing costs
associated with the production of the Company's products. Gross profit
increased to $13.9 million in the second quarter of fiscal 1998 from $11.8
million in the second quarter of fiscal 1997, representing an increase of
17.7%. The increase in the amount of gross profit resulted primarily from
increases in sales volumes of the Company's products (and, in particular, the
Company's Velocity 128 multimedia accelerator). During the period, gross
profit as a percentage of net sales decreased to 18.8% in the second quarter
of fiscal 1998 from 24.2% in the second quarter of fiscal 1997. The decrease
in gross profit as a percentage of net sales resulted primarily from (i)
increased pricing pressure on the Velocity 128 and other products, (ii)
delays beyond the end of the quarter in the shipment of certain of the
Company's higher margin products, namely the Black Magic Voodoo 2 and
workstation products mentioned above, and (iii) an increase in the percentage
of sales to the OEM market, which typically is characterized by lower gross
profit margins. These increases were partially offset by the economies of
scale resulting from higher production volumes and increased operating
efficiencies. The pricing and margin pressure on the Company's products was
due in part to the introduction by a competitor of a new type of product
employing the less expensive SDRAM memory, rather than the SGRAM memory that
has been used by the Company and most other competitors. Gross margins are
expected to continue to fluctuate as a result of sales channel, product mix
and other factors. See "Risk Factors -- Potential for Fluctuating Operating
Results; Seasonality" and "-- Dependence on Suppliers".
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
primarily consist of compensation and associated expenses relating to
engineering personnel, development tool expenses, prototyping expenses and
product enhancement expenses. Research and development expenses increased to
$2.6 million in the second quarter of fiscal 1998 from $1.6 million in the
second quarter of fiscal 1997, representing an increase of 64.5%. Research
and development expenses as a percentage of net sales increased to 3.5% in
the second quarter of fiscal 1998 from 3.2% in the second quarter of fiscal
1997. The increase in research and development expenses on both a dollar and
percentage basis resulted primarily from increased staffing at the Company's
corporate headquarters, as well as other expenses associated with the
development of new products. Expenses associated with software and driver
development also contributed to the increase in research and development
expenses.
SALES AND MARKETING EXPENSES. Sales and marketing expenses primarily consist
of personnel and related overhead expenses for sales, marketing and customer
support activities, promotional and advertising expenses, and commissions
paid to independent sales representatives. Sales and marketing expenses
increased to $4.2 million in the second quarter of fiscal 1998 from $3.6
million in the second quarter of fiscal 1997, representing an increase of
15.3%. Sales and marketing expenses as a percentage of net sales decreased
to 5.7% in the second quarter of fiscal 1998 from 7.5% in the second quarter
of fiscal 1997, primarily due to increases in net sales at a rate faster than
that of sales and marketing expenses. The increase in sales and marketing
expenses resulted primarily from additional staffing and commissions paid as
a result of higher sales, partially offset by decreases in commissions paid
to independent sales representatives. Increased expenses for advertising and
promotional programs in the commercial channel, the specialized technology
channel and the international market also contributed to the increased
expenses.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
primarily consist of personnel and related overhead expenses for management,
finance, management information systems, legal and human resources, as well
as expenses associated with occupancy and other general operating expenses.
General and administrative expenses increased to $2.6 million in the second
quarter of fiscal 1998 from $2.4 million in the second quarter of fiscal
1997, representing an increase of 8.5%. General and administrative expenses
as a percentage of net sales decreased to 3.5% in the second quarter of
fiscal 1998 from 4.9% in the second quarter of fiscal 1997. The increase in
the amount of general and administrative expenses was primarily due to
increased expenses associated with the Company's growth, including increased
staffing, occupancy and other general operating expenses. The Company
recently commenced construction of a new headquarters facility that it plans
to occupy in the first fiscal quarter of 1999. The terms of the lease
relating to the new headquarters facility provide for increased occupancy
expense from current levels beginning at the date of occupancy and are
subject to adjustment based on prevailing interest rates. See "--Liquidity
and Capital Resources."
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<PAGE>
INTEREST EXPENSE, NET. Interest expense, net, primarily consists of the
interest expense associated with the Company's Revolving Credit Facility,
Mezzanine Facility (as defined below) and capital leases, offset partially by
the interest income earned on the Company's cash and cash equivalents. Net
interest expense decreased to approximately $246,000 in the second quarter of
fiscal 1998 from approximately $383,000 in the second quarter of fiscal 1997,
representing a decrease of 35.7%. The decrease in the amount of net interest
expense was primarily attributable to the reduction of short-term debt and
the interest income earned on short-term investments associated with the
investment of the proceeds from the secondary offering.
SIX MONTHS ENDED APRIL 30, 1998 COMPARED TO SIX MONTHS ENDED APRIL 30, 1997.
NET SALES. Net sales increased to $152.6 million in the first six months of
fiscal 1998 from $96.8 million in the first six months of fiscal 1997,
representing an increase of 57.6%. Unit volume for the period increased by
53.9% over the same period last year. OEM channel sales increased to
approximately $127.3 million in the first six months of fiscal 1998 from
$73.3 million in the first six months of fiscal 1997, representing an
increase of 73.7%. Sales growth in the OEM channel was primarily the result
of increased unit sales of the Company's Velocity 128 multimedia accelerator.
See "Risk Factors - Product Concentration". Commercial channel sales
increased to $15.0 million in the first six months of fiscal 1998 from $14.4
million in the first six months of fiscal 1997, an increase of 4.3%. Sales
in the specialized technology market increased to $9.1 million in the first
six months of fiscal 1998 from $6.1 million in the first six months of fiscal
1997, or 47.3%, which was primarily a result of increased sales to OEM
customers for financial services workstations and a broader specialized
technology product offering.
GROSS PROFIT. Gross profit increased to $30.1 million in the first six
months of fiscal 1998 from $22.4 million in the first six months of fiscal
1997, representing an increase of 34.2%. During the period, gross profit as
a percentage of net sales decreased to 19.7% in the first six months of
fiscal 1998 from 23.2% in the first six months of fiscal 1997. The increase
in the amount of gross profit resulted primarily from increases in sales
volumes of the Company's products (and, in particular, the Company's Velocity
128 multimedia accelerator). The decrease in gross profit as a percentage of
net sales resulted primarily from (i) increased pricing pressure on the
Velocity 128 and other products, (ii) delays beyond the end of the quarter in
the shipment of certain of the Company's higher margin products, namely the
Black Magic Voodoo 2 and workstation products mentioned above, (iii) an
increase in the precentage of sales to the OEM market, which typically is
characterized by lower gross profit margins, and (iv) increased overtime
labor costs caused by the higher rates of production necessary to meet
increased product demand. These increases were partially offset by the
economies of scale resulting from higher production volumes and increased
operating efficiencies. Gross margins are expected to continue to fluctuate
as a result of sales channel, product mix and other factors. See "Risk
Factors -- Potential for Fluctuating Operating Results; Seasonality" and "--
Dependence on Suppliers".
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased to $4.9 million in the first six months of fiscal 1998 from $2.8
million in the first six months fiscal 1997, representing an increase of
75.3%. Research and development expenses as a percentage of net sales
increased to 3.2% in the first six months of fiscal 1998 from 2.9% in the
first six months of fiscal 1997. The increase in research and development
expenses on a dollar and percentage basis resulted primarily from increased
staffing at the Company's corporate headquarters and at each of the design
centers in Houston, Texas; Eugene, Oregon; and Belfast, Northern Ireland.
Other expenses associated with the development of new products and increased
expenses associated with software and driver development also contributed to
the increase in research and development expenses.
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased to $8.6
million in the first six months of fiscal 1998 from $6.9 million in the first
six months of fiscal 1997, representing an increase of 24.4%. Sales and
marketing expenses as a percentage of net sales decreased to 5.7% in the
first six months of fiscal 1998 from 7.2% in the first six months of fiscal
1997, primarily due to increases in net sales at a rate faster than that of
sales and marketing expenses. The increase in sales and marketing expenses
resulted primarily from additional staffing and commissions paid as a result
of higher sales, partially offset by decreases in commissions paid to
independent sales representatives. Increased expenses for advertising and
promotional programs in the commercial channel, the specialized technology
channel and the international market also contributed to the increased
expenses.
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GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to $5.8 million in the first six months of fiscal 1998 from $4.8
million in the first six months of fiscal 1997, representing an increase of
22.0%. General and administrative expenses as a percentage of net sales
decreased to 3.8% in the first six months of fiscal 1998 from 4.9% in the
first six months of fiscal 1997. The increase in the amount of general and
administrative expenses was primarily due to increased expenses associated
with the Company's growth, including increased staffing, occupancy costs and
other general operating expenses.
INTEREST EXPENSE, NET. Net interest expense increased to approximately
$764,000 in the first six months of fiscal 1998 from approximately $759,000
in the first six months of fiscal 1997, representing an increase of 0.7%.
The slight increase in the amount of net interest expense was primarily the
result of the increase in the average total debt and obligations under
capital leases outstanding during the period partially offset by the
reduction in interest rates and the interest income earned on short-term
investments of the proceeds from the secondary offering.
SEASONALITY. The Company's quarterly operating results vary significantly
depending on a number of factors, including, but not limited to: the timely
introduction by the Company of new or enhanced products and the market's
acceptance of these products; the Company's ability to introduce and market
products in accordance with its OEM customers' design requirements and design
cycles; changes in demand for functionality of the Company's products and the
products of its OEM customers; the gain or loss of significant OEM customers;
the volume and timing of significant customer orders received during the
period; the availability, pricing and timeliness of component delivery for
the Company's products; increased competition from existing competitors and
new entrants to the market; the timing of new product announcements or
product introductions by the Company's competitors; product obsolescence,
management of product transitions and unanticipated delays or problems in the
introduction or production of products by the Company or its OEM customers;
product reviews and other media coverage; anticipated and unanticipated
decreases in average selling prices of the Company's products; changes in the
mix of products sold by the Company's OEM and other customers; changes in the
pricing policies of the Company, its suppliers and customers; management of
inventory by the Company and its customers; changes in the Company's sales
channel mix or in the sourcing strategies of its OEM customers; and product
returns or price protection charges by the Company's customers. Because the
timing of these factors may vary, the results of any particular quarter may
not be indicative of results for the full year or any future period. In
addition, the PC market generally experiences weaker sales during the summer
months. It is likely that in some future period the Company's operating
results or business outlook will be below the expectations of securities
analysts or investors, which would likely result in a significant reduction
in the market price of the Company's Common Stock. See "Risk Factors -
Potential for Fluctuating Operating Results; Seasonality" and " - Stock Price
Volatility."
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal capital and liquidity needs are for financing
inventory and accounts receivable and for manufacturing and other equipment
expenditures. The Company has generally financed these capital and liquidity
needs and its operations through a combination of cash generated from
operations, trade credit from vendors, bank borrowings and the net proceeds
from its initial public offering. As a result of the Company's rapid growth
in recent years and its capital requirements, during the quarter the Company
completed a public offering of 2,775,000 shares of Common Stock. Net proceeds
from the offering were used to reduce indebtedness and the balance retained
for general corporate purposes. Future growth, if any, may require
additional capital, particularly to support increased working capital needs,
staffing requirements, promotional expenses, manufacturing facilities and
equipment requirements.
Cash used in operating activities of $10.9 million in the first six months of
fiscal 1998 was primarily attributable to increases in inventory and
reductions in accounts payable, partially offset by increased earnings.
Cash used in operating activities of $5.8 million in the first six months of
fiscal 1997, was primarily attributable to increases in accounts receivable
as a result of higher sales and reductions in accounts payable, partially
offset by increases in earnings. At October 31, 1997, the Company's working
capital was $31.4 million, compared to $98.2 million at April 30, 1998. Cash
and cash equivalents was $3.9 million and $33.6 million at October 31, 1997
and April 30, 1998, respectively.
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The Company invested $9.6 million in capital equipment in fiscal 1997, and as
a result of converting previously capitalized equipment to an operating
lease, cash generated from investing activities for the first six months of
fiscal 1998 was $332,000. The Company's investment in equipment is primarily
attributable to manufacturing equipment additions and upgrades of existing
equipment to support the increased demand for and complexity of the Company's
products. During the 1998 first fiscal quarter, the Company completed a move
to a new 137,000 square foot manufacturing facility in Juarez, Mexico,
located immediately adjacent to its previous facility. The Company has
retained one-half of its previous facility for expansion, with an option to
occupy, vacate or sublease the remaining half. During the 1997 fourth fiscal
quarter, the Company installed two new high-speed surface-mount technology
("SMT") assembly lines at its new facility, at a total cost of approximately
$6.3 million. This equipment was financed by two separate operating leases.
During the 1996 fourth fiscal quarter, the Company installed four SMT
assembly lines, at an approximate total cost of $4.2 million. This equipment
was also financed through operating lease financing arrangements. The
Company's aggregate obligations under all such equipment lease financing
arrangements totaled approximately $9.5 million at October 31, 1997 and
approximately $8.9 million at April 30, 1998. The Company expects that
additional capital expenditures for similar types of equipment may be
necessary to support additional future customer demand and production
requirements, although there can be no assurance in this regard.
The Company has a $40.0 million Revolving Credit Facility, as well as a $3.0
million term loan (the "Mezzanine Facility"). As of April 30, 1998, the
Company had $5.0 million and $2.8 million outstanding under the Revolving
Credit Facility and the Mezzanine Facility, respectively. The principal
amount outstanding under the Revolving Credit Facility bears interest at
LIBOR plus 175 basis points (7.406% at April 30, 1998). The principal amount
outstanding under the Mezzanine Facility bears interest at LIBOR plus 250
basis points (8.156% at April 30, 1998) and is payable in 60 equal monthly
installments of principal and interest, which began on November 1, 1997.
Availability under the Revolving Credit Facility is calculated using formulas
based on eligible accounts receivable, as defined by the Revolving Credit
Facility Agreement. The indebtedness under the Revolving Credit Facility
matures on November 21, 1999 and the indebtedness under the Mezzanine
Facility matures on November 1, 2002.
In December 1997, the Company entered into a five year agreement to construct
and lease a new corporate headquarters in Richardson, Texas. Construction on
the 210,000 square foot facility began in December 1997, and the total cost
is estimated to be approximately $22.8 million (including land). The lessor
has agreed to fund the cost of the land and construction of the building
(subject to reductions based on certain conditions in the lease agreement).
The Company plans to occupy the facility during the 1999 first fiscal quarter
with rental payments commencing upon occupancy. The Company estimates that
its monthly rent for this facility will be approximately $225,000 for the
four year period following completion of the facility. This amount is in
excess of the current facilities expense, as local rental rates have
increased and the Company is increasing the square footage of its corporate
headquarters. The lease agreement also provides that the amount of lease
payments are subject to adjustment based upon prevailing interest rates. As
a consequence, an increase in prevailing interest rates will increase the
Company's facilities expense. The Company is currently exploring strategies
to hedge this interest rate exposure. The Company is also seeking
opportunities to sublease that portion of its new headquarters facility which
the Company does not expect to utilize immediately following its occupancy of
the new facility. The monthly rent currently paid for the Company's
headquarters facility will be eliminated with the move to the new facility.
At the end of the lease for the new facility, the Company may elect to either
renew the lease, pay off the underlying debt on the facility or cause the
building to be sold. In the event of a sale, the proceeds will be used to
retire the underlying debt with any excess to be paid to the Company. The
Company is responsible for any outstanding balance due on the underlying
obligation after the sale of the facility. See "Risk Factors - Headquarters
Relocation."
From time to time, the Company evaluates acquisitions of businesses, products
or technologies that complement the Company's business. Any such
transactions, if consummated, may use a portion of the Company's working
capital or require the issuance of securities which may result in further
dilution to the Company's shareholders. See "Risk Factors - Potential Future
Acquisitions."
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The Company believes that the net proceeds from the sale of the Common Stock
offered by the Company in its public offering, together with existing capital
resources and anticipated funds from operations, will satisfy the Company's
anticipated capital requirements for at least the next twelve months. After
such period, depending on its financial condition and results of operations,
the Company may require additional equity or debt financing to meet its
capital requirements. There can be no assurance that additional financing
will be available when required, or, if available, that such financing can be
obtained on terms satisfactory to the Company.
PART II OTHER INFORMATION
ITEM 5. OTHER INFORMATION - RISK FACTORS
All statements other than statements of historical fact contained in this
report are forward-looking statements within the meaning of the federal
securities laws. These forward-looking statements involve risks and
uncertainties, and the Company's actual results may differ materially form
the results discussed in the forward-looking statements. Factors that might
cause such a difference include, but are not limited to, the risks described
below.
POTENTIAL FOR FLUCTUATING OPERATING RESULTS; SEASONALITY
The Company's results of operations have fluctuated significantly in the past
and are expected to continue to fluctuate in the future as a result of a
number of factors, many of which are beyond the Company's control. These
factors include, but are not limited to: the timely introduction by the
Company of new or enhanced products and the market acceptance of these
products; the Company's ability to introduce and market products in
accordance with its OEM customers' design requirements and design cycles;
changes in demand for functionality of the Company's products and the
products of its OEM customers; the gain or loss of significant OEM customers;
the volume and timing of significant customer orders received during the
period; the availability, pricing and timeliness of component delivery for
the Company's products; increased competition from existing competitors and
new entrants to the market; the timing of new product announcements or
product introductions by the Company's competitors; product obsolescence,
management of product transitions and unanticipated delays or problems in the
introduction or production of products by the Company or its OEM customers;
product reviews and other media coverage; anticipated and unanticipated
decreases in average selling prices of the Company's products; changes in the
mix of products sold by its OEM and other customers; changes in the pricing
policies of the Company, its suppliers and customers; management of inventory
by the Company and its customers; changes in the Company's sales channel mix
or in the sourcing strategies of its OEM customers; and product returns or
price protection charges by customers. Because a significant portion of the
Company's business has been and is expected to continue to be derived from
orders placed by a limited number of larger OEM customers, any gain or loss
or variations in the timing of such orders can cause significant fluctuations
in the Customer's operating results. Anticipated orders from customers may
fail to materialize and delivery schedules may be deferred or canceled for a
number of reasons, including changes in specific customer requirements. The
volume and timing of orders received during a quarter are difficult to
forecast. Customers generally order on an as-needed basis. Consequently,
the Company operates with a relatively small backlog. Moreover, as is common
in the PC industry, a disproportionate percentage of the Company's net sales
in any quarter have historically been, and are expected in the future to be,
generated in the last month of a quarter. As a result, a shortfall in sales
in any quarter as compared to expectations may not be identifiable until near
the end of the quarter.
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The Company's gross profit margins are affected by a number of factors,
including sales channel mix, product mix, pricing pressures, the availability
and cost of components from the Company's suppliers, level of absorption of
fixed manufacturing costs, product cycles and general economic conditions.
Moreover, the Company operates its own manufacturing facility. As a result,
the Company incurs relatively high fixed overhead and labor costs compared
with those of its competitors that outsource their manufacturing
requirements. Any failure to generate the level of product revenues needed
to absorb such fixed overhead and labor costs will have a material adverse
effect on the Company's business, financial condition and results of
operations.
In addition, the Company has experienced in the past and may experience in
the future excess demand for its products from its OEM customers and has
elected in the past and may elect in the future to pay its employees overtime
and purchase components on the spot market at prices higher than would have
been available if the Company had purchased such components in advance in
order to meet its production requirements. Such activities have resulted in
the past and may result in the future in lower gross margins for the
additional products being manufactured. The Company's markets are
characterized by intense competition and its products typically have a
limited life cycle (usually six to nine months) and declining average unit
selling prices over time. Accordingly, the Company's margins may decline
from current levels with respect to its existing product lines. In addition,
the Company's margins may be materially adversely affected by shortages in
the availability of key components for the Company's products, as well as by
fluctations in the value of certain foreign currencies.
The Company's expenditures for research and development, selling and
marketing, and general and administrative functions are based in part on
future revenue projections. The Company may be unable to adjust spending in
a timely manner in response to any unanticipated declines in revenues. Any
failure to adjust spending in a timely manner may have a material adverse
effect on the Company's business, financial condition and results of
operations.
The Company's quarterly results are also subject to seasonal fluctuations,
with generally weaker fiscal third quarter results. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Selected Quarterly Operating Results and Seasonality."
As a result of the factors listed above and other factors, the Company
believes that period-to-period comparisons of its operating results must not
be relied upon as an indication of future performance. In particular, the
Company has recently experienced consistent growth in its annual unit sales
volumes and annual revenues and has reported nine consecutive quarters of
record net income. There can be no assurance that the Company's recent growth
in unit sales volumes, revenues or net income will be sustainable or will not
decline. It is likely that in some future period of the Company's operating
results or business outlook will be below the expectations of securities
analysts or investors, which would likely result in a significant reduction
in the market price for the Company's Common Stock.
DEPENDENCE ON SUPPLIERS
The Company has in the past obtained and expects in the future to obtain
several of the components used in its products from single or limited sources
and, in the instances in which component manufacturers have not or do not
allocate a sufficient supply of components to meet the Company's needs, the
Company has obtained in the past and may obtain in the future such components
from distributors or on the spot market at a higher cost. The Company has no
guaranteed supply arrangements with any of its suppliers, and there can be no
assurance that current suppliers will be able to meet the Company's current
or future component requirements. From time to time, the Company has relied,
and in the future expects to rely, substantially upon a limited number of
sole source suppliers for multimedia controller chips, which can, in large
part, determine the performance of a multimedia subsystem.
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<PAGE>
In the event that the Company experiences difficulty obtaining a particular
multimedia controller chip, the Company could be forced to pay higher prices
for comparable multimedia controller chips, alter product designs to use
alternative and potentially inferior components, reduce its production of the
related product, or delay product shipment schedules. The Company believes
that with respect to its single and limited source components, it generally
could obtain similar components from other sources but likely would be
required to pay significantly more for such products, alter product designs
to use alternative components (which would cause significant delays and could
require product recertification from the Company's OEM customers) or reduce
its production of the related products; however, no assurance can be given
with respect to the availablility of alternative sources for single and
limited source components in future products.
The Company has from time to time experienced difficulty meeting certain
product shipment dates to customers as a result of various causes, including
component delivery delays, component availability shortages, system
compatibility difficulties and supplier product quality deficiencies, which
in some instances has resulted in impaired margins, reduced production
volumes, strained customer relations and loss of business. In addition,
software drivers, which are essential to the performance of substantially all
of the Company's products, are included with some of these single and limited
source components. The Company has from time to time experienced product
delivery delays due to the inadequacy or the incompatibility of software
drivers provided by component suppliers or developed internally by the
Company. The Company expects that component delivery delays, component
shortages, system compatibility difficulties, supplier product quality
deficiencies and software driver problems will continue to occur in the
future, and such delays or problems could have a material adverse effect on
the Company's business, financial condition and results of operations.
Additionally, in an effort to counter actual or perceived component
shortages, the Company may overpurchase certain components. Excess inventory
resulting from such overpurchases, obsolescence or a decline in the market
value of such inventory, could result in inventory write-offs, which would
have material adverse effect on the Company's business, financial condition
and results of operations.
Significant increases in the prices of components, such as controller chips
or memory chips, have occurred from time to time, and the Company has not
always been able to increase its products' prices accordingly. Worldwide
shortages of controller chips or memory chips and international tariff
disputes have resulted from time to time in substantial component cost
increases that have had a material adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance
that such price increases will not take place in the future, or that such
price increases will not have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company relies upon its suppliers to continue to develop, introduce and
manufacture controller chips, memory chips and other components in sufficient
volumes to satisfy the Company's requirements. These components must compare
favorably in terms of functionality, performance and price with competitive
offerings from other manufacturers, including competitors of the Company that
have internally developed computer chips or manufacturing expertise. Any
failure by the Company to continue to obtain components from its suppliers
that are competitive in terms of functionality, performance and price with
the components that are available to its competitors would have a material
adverse effect on the Company's business, financial condition and results of
operations.
CUSTOMER CONCENTRATION; DEPENDENCE ON PC MARKET
The Company's three largest OEM customers accounted for approximately 76% of
net sales during the first six months of fiscal 1998, with Gateway 2000, Inc.
("Gateway 2000"), Dell Computer Corporation ("Dell") and Compaq Computer
Corporation ("Compaq") accounting for approximately 40%, 32% and 4%,
respectively, of the Company's net sales for such period. The Company's
three largest OEM customers accounted for approximately 66% of net sales in
fiscal year 1997, with Gateway 2000, Dell and Compaq accounting for
approximately 35%, 20% and 11%, respectively, of the Company's net sales for
such period. Historically, Gateway 2000 has been the Company's largest
customer, while Dell and Compaq have become more significant customers in
recent periods. The Company's other significant customers have changed from
period to period.
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<PAGE>
The Company has no long-term commitments or contracts with any of its
customers. Any reduction of business from Gateway 2000, Dell or Compaq or the
loss of Gateway 2000, Dell or Compaq as a major customer would have a
material adverse effect on the Company's business, financial condition and
results of operations. Due to their purchasing power, the Company's OEM
customers are able to exert significant pressure on the prices of the
Company's products, which could impair the Company's gross profit margins and
have a material adverse effect on the Company's business, financial condition
and results of operations. In addition, the Company believes that its future
prospects will largely depend from time to time upon the success of a limited
number of key component suppliers (currently, its graphics controller chip
suppliers) and a few major OEM customers (currently, Gateway 2000, Dell and
Compaq). Because a limited number of major OEMs currently ship the majority
of the PCs products, the number of potential customers that the Company can
target is currently limited. There can be no assurance that the Company will
be successful in maintaining its existing relationships with its major OEM
customers or in securing additional major OEM customers and there can be no
assurance that the Company will be able to retain or increase the volume or
profitability of products currently manufactured by the Company for such
customers. Any failure by the Company to retain its existing OEM customers,
or establish profitable relationships with additional major OEM customers, or
to maintain and increase the volume and profitability of the products
manufactured for such customers would have material adverse effect on the
Company's business, financial condition and results of operations.
Substantially all of the Company's revenues are currently derived from
products sold for use in PCs, and the Company expects to continue to derive
substantially all of its revenues from the sales of products for use in PCs.
The PC market is characterized by rapidly changing technology, evolving
industry standards, frequent new product introductions and fierce price
competition, all of which contribute to short product life cycles and regular
reductions of average selling prices over the life of a specific product.
Although the PC market has grown substantially in recent years and continued
growth is currently forecasted, there can be no assurance that such growth
will continue. A reduction in sales of PCs, or a reduction in the growth
rate of such sales, would likely reduce demand for the Company's products.
Moreover, such changes in demand could be large and sudden. Since PC
manufacturers often build inventories during periods of anticipated growth,
they may be left with excess inventories if growth slows or if they have
incorrectly forecasted product transitions. In such cases, PC manufacturers
may abruptly suspend substantially all purchases of additional products from
suppliers, such as the Company, until the excess inventory has been absorbed.
Any reduction in demand for PCs generally, or for particular products that
incorporate the Company's multimedia subsystem or specialized technology
products, would have a material adverse effect on the Company's business,
financial condition and results of operations.
DEPENDENCE ON MULTIMEDIA ACCELERATION SUBSYSTEM MARKET; MIGRATION TO
MOTHERBOARDS
A substantial majority of the Company's net sales are derived from the sale
of multimedia accelerator subsystems. According to Jon Peddie Associates, an
independent industry research firm, approximately 69% of all graphics
controller chips manufactured in the twelve month period ended September 30,
1997 were incorporated onto multimedia accelerator subsystems, and
approximately 31% were incorporated onto motherboards. Generally, multimedia
accelerator subsystems are used in higher-end PCs offering the latest
technology and performance features. However, as a given functionality
becomes technologically stable and widely accepted by PC users, it typically
migrates to the PC motherboard. The Company expects this trend to continue
with respect to the functionality provided by many of its current products,
notably, in the near term, with respect to its low-end multimedia accelerator
subsystems. In this regard, the MMX instruction set from Intel Corporation
("Intel") and the expanded capabilities provided by the Direct X Applications
Programming Interfaces ("APIs") from Microsoft Corporation ("Microsoft") have
increased the capability of its operating systems to control display features
that have traditionally been performed by multimedia accelerator subsystems.
In addition, single chip solutions currently are available that provide
16-bit sound functionality for implementation directly onto PC motherboards.
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As a result of this tendency of technology to migrate to the PC motherboard,
the Company's prospects are largely dependent on its ability to continue to
develop products that incorporate new and rapidly evolving technologies that
manufacturers have not yet fully incorporated onto PC motherboards and to
develop PC motherboard products that incorporate multimedia accelerator
subsystems and other features demanded by the PC motherboard market. In
response to this trend of migration, the Company is now actively seeking
orders from OEMs for PC motherboards that incorporate STB's graphics
circuitry, but there can be no assurance that the Company will secure any
such orders or that, if it secures any such orders, it could produce such PC
motherboards in profitable quantities, if at all. The Company has no prior
experience designing, developing or marketing PC motherboards, and there can
be no assurance that the Company will be successful in developing this
business.
While the Company believes that a market will continue to exist in the near
term for add-in subsystems that provide advanced functionalities and offer
flexible systems configuration, there can be no assurance that the
incorporation of multimedia functions onto PC motherboards will not have a
material adverse effect on the market for the Company's add-in subsystems.
In addition, OEMs may choose to develop multimedia accelerator subsystems
internally rather than purchase such products from external suppliers. An
increase in the number or percentage of PCs that incorporate graphics
circuitry on the motherboard at the expense of add-in multimedia accelerator
subsystems, an increase in the number or percentage of multimedia accelerator
subsystems manufactured internally by OEMs, or a decrease in PC sales volumes
could effectively shrink the market for the Company's current products, which
would have a material adverse effect on the Company's business, financial
condition and results of operations.
LIMITED PRODUCT LIFE CYCLE; RAPID TECHNOLOGICAL CHANGE; MANAGEMENT OF PRODUCT
TRANSITIONS
The market for the Company's products is characterized by short product life
cycles, evolving industry standards and frequent introductions of new
products. The Company's major OEM customers typically introduce new system
configurations as often as twice a year, and the life cycles of the Company's
multimedia accelerators subsystems typically range from six to nine months.
The Company's failure to successfully introduce new products within a given
product cycle could have a material adverse affect on the Company's business,
financial condition and results of operations for that cycle and possibly for
subsequent cycles. Any such failure could also impair the Company's brand
name, reputation and relationships with its OEM customers and have a longer
term material adverse effect on the Company's business, financial condition
and results of operations. The Company's submits most of its products for
compatibility and performance testing to the Microsoft Windows Hardware
Quality Lab ("WHQL"). WHQL certification typically requires up to several
weeks to complete and entitles the Company to claim that a particular product
is "Designed for Microsoft Windows". The Company's OEM customers typically
require the Company's product to be Designed for Microsoft Windows prior to
making volume purchases. There can be no assurance that the Company will
receive WHQL certification for any particular future product in a timely
fashion, and any failure to receive WHQL certification could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The PC industry in general, and the market for the Company's multimedia
subsystem products in particular, is characterized by rapidly changing
technologies, evolving industry standards, rapid changes in customer
requirements and fierce price competition. The Company's prospects depend
upon market acceptance of its existing products, its ability to enhance its
existing products, and its ability to continually develop and introduce new
products and features to meet changing customer requirements. Each new
product cycle presents new opportunities for current or prospective
competitors of the Company to gain market share. The Company's competitors
include manufacturers of products that directly compete with the Company's
products, as well as competitors that can produce products that have a
similar functionality to the Company's products.
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For instance, Intel has added new functionalities, such as the MMX
instruction set, to its controller chips to enhance the power of the central
processing unit (the "CPU") to manage the display features of a PC.
Similarly, Microsoft is introducing new versions of its operating systems
with features, such as the Direct 3D API, that increase the capability of its
operating systems to control a PC's display features. Moreover, Intel's
recently completed acquisition of Chips and Technologies, Inc. as well as
Intel's introduction of the i740 graphics controller chip could accelerate
migration of graphics functionality to the motherboard or onto the CPU. The
introduction of products embodying new technologies and the emergence of new
industry standards and practices can significantly impair the average selling
prices of the Company's multimedia subsystem and other products, or render
such products unmarketable or obsolete. In the event that the Company's
products are unable to support or interface with these new products,
standards and technologies in a timely manner, demand for the Company's
products could be reduced significantly, which would have a material adverse
effect on the Company's business, financial condition and results of
operations.
Because of the short product life cycles and the long lead times for many
components used in the Company's products, the Company may not be able to
quickly reduce its production or inventory levels in response to unexpected
shortfalls in sales or, conversely, to increase production in response to
unexpected demand. There can be no assurance of the continued acceptance of
the Company's existing products or that the Company will be successful in
enhancing its existing products or identifying, developing, manufacturing or
marketing new products. Delays in developing new products or product
enhancements or the failure of such products or product enhancements to gain
market acceptance would have a material adverse effect on the Company's
business, financial condition and results of operations.
Sales of individual products and product lines are typically characterized by
declines in unit volumes, pricing and margins toward the end of the product's
life cycle, the precise timing of which may be difficult to predict. As new
products are planned and introduced, the Company attempts to monitor closely
the inventory of older products (and older components) and to phase out
their manufacture in a controlled manner. Nevertheless, the Company has
experienced from time to time in the past, and expects to experience from
time to time in the future, unexpected reductions in sales of older products
as customers anticipate new products. These reductions have in the past and
may in the future give rise to additional charges for obsolete or excess
inventory, returns of older products by retailers or commercial distributors
or substantial price protection claims. The Company's failure to
successfully manage product transitions could have a material adverse effect
on its business, financial condition and results of operations.
COMPETITION
The market for the Company's products is intensely competitive and the
Company expects competition to increase. The Company competes with
independent manufacturers of brand name multimedia subsystem products, as
well as contract manufacturers and certain OEM manufacturing operations that
produce multimedia subsystem products. The Company's major competitors in
the multimedia subsystems market include Diamond Multimedia Systems, Inc.,
ATI Technologies, Inc., Matrox Graphics, Inc., ELSA GmbH, AccelGraphics,
Inc., Creative Labs, Inc., CEI Inc., Number Nine Visual Technology
Corporation, and Hauppauge ComputerWorks, Inc. In the specialized technology
product market, the Company's major competitors include Colorgraphic
Communications Corporation, Datapath Ltd, and Appian Graphics Corp.
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<PAGE>
In addition to its major competitors, certain of the Company's suppliers sell
graphics controller chips directly to OEMs for use in internally produced
multimedia accelerator subsystems, other multimedia subsystems or on
motherboards. If one or more of the Company's significant OEM customers were to
commence or increase internal production of multimedia accelerator subsystems or
other multimedia subsystems, the Company's business, financial condition and
results of operations could be materially adversely affected. Furthermore,
several major OEMs currently integrate graphics controller chips on the
motherboard of their PCs. If one or more of the Company's major OEM customers
begin to incorporate graphics controller chips or other controller chips onto
motherboards rather than incorporating the Company's products, the Company's
business, financial condition and results of operations could be materially
adversely affected. See "--Dependence on Multimedia Acceleration Subsystem
Market; Migration to Motherboards."
The Company expects Intel to continue to invest heavily in research and
development and new manufacturing facilities in order to maintain its
position as one of the largest manufacturers of motherboards, and to promote
its product offerings through extensive advertising campaigns designed to
increase brand loyalty by PC users. Intel is in the process of developing
multimedia subsystems or multimedia-enabled motherboards using its i740 3D
graphics processor, or other graphics controllers which is likely to directly
compete with products that the Company may develop. In addition, Intel
exerts significant influence over the 3D graphics industry due to the
widespread acceptance of its microprocessor architecture and its development
of new interface architectures such as the Advanced Graphics Port ("AGP")
bus. Any significant modifications by Intel to the AGP or future graphics
interface architectures could render the Company's products obsolete,
incompatible or less competitive.
Any broad-scale introduction of multimedia subsystems or multimedia-enabled
motherboards or significant modifications to the graphics interface bus by Intel
which the Company is unable to access, and which consequently render the
Company's products less competitive or reduces their potential market, could
have a material adverse effect on the Company's business, financial condition
and results of operations.
The Company competes in its markets on the basis of a number of factors,
including the price, performance, reliability and compatibility of its products,
its ability to reach the market quickly with new products, its ability to meet
customer delivery and reliability requirements, the quality of its technical
support and its ability to develop and maintain relationships with customers and
suppliers. Many of the Company's competitors and potential competitors have
greater financial, marketing, manufacturing and technical resources than the
Company. In addition, some of the Company's competitors manufacture their own
controller chips, which provide these competitors with a significant advantage
over the Company when their internally produced controller chips cost less or
maintain higher price/performance levels than the controller chips available to
the Company from independent suppliers. Furthermore, while the Company believes
it is the only supplier of brand name multimedia accelerator subsystems that
manufactures its own products, some of the Company's competitors internally
manufacture other multimedia subsystems, such as sound cards and PC/TV cards.
The rapid pace of change in the industry and in the markets in which the Company
competes places a premium on the knowledge and experience of a company's
management, engineers and other personnel, and their ability to continuously
develop, enhance and transition new products. The Company believes that
increasing its hardware and software engineering staff is an important factor to
its future competitiveness.
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PRODUCT CONCENTRATION
Historically, a substantial majority of the Company's net sales have been
derived from sales of multimedia accelerator subsystems and, from time to time,
a substantial majority of the Company's net sales in a given fiscal quarter have
been derived from the sale of a single or a limited number of multimedia
accelerator subsystems. Factors that increase the probability of a single or a
limited number of products accounting for a substantial majority of sales during
a given fiscal quarter may include one or more of the following factors: the
development and timely introduction of new and enhanced products by the Company
that meet OEM design requirements and design cycles and achieve wide market
acceptance; the selection of key components (such as multimedia controller
chips) at the design stage that provide the Company's products with distinct
advantages compared with the key components available to its competitors; the
availability of key components (such as multimedia controller chips) in
sufficient quantities to meet production schedules once the Company commences
manufacturing its products; favorable product reviews and other media coverage;
the volume and timing of significant customer orders received during the period;
and product obsolescence, maturation, or mismanagement of product transitions by
the Company's competitors. Because the market for the Company's products is
characterized by short product life cycles, evolving industry standards and
frequent introductions of new products, the Company's product offerings may
change significantly from quarter to quarter. There can be no assurance that a
product which was an industry leader and a major source of revenue and gross
profit in one fiscal quarter will not be rendered less competitive or obsolete
in a subsequent fiscal quarter. Moreover, in any given quarter, one or more of
the Company's competitors may introduce an industry dominating product for one
or more of the same factors noted above. Accordingly, the Company's future
prospects largely depend upon its ability to continuously develop and introduce
new products that generate sufficient net sales to replace net sales from
existing products as they mature. Any inability to develop and introduce new
products that compete favorably in the marketplace and meet customer demand in
future fiscal periods will have a material adverse effect on the Company's
business, financial condition and results of operations.
SINGLE MANUFACTURING FACILITY
The Company's sole manufacturing facility is located in Juarez, Mexico. The
Company recently relocated a portion of its manufacturing operations to an
adjacent, larger building, thus expanding the overall facility square footage,
and transitioned to new or reconfigured manufacturing equipment. Since the
Company is substantially dependent on this single manufacturing facility, any
disruption of the Company's manufacturing operations at this facility would have
a material adverse effect on the Company's business, financial condition and
results of operations. Such disruption could result from various factors,
including difficulties in attracting and retaining qualifed manufacturing
employees, difficulties associated with the transition to new, reconfigured or
upgraded manufacturing equipment, a labor dispute, human error, governmental or
political risks or a natural disaster such as an earthquake, tornado, fire or
flood. In addition, in comparison to those of its competitors that do not
maintain their own manufacturing facilities, the Company incurs higher relative
fixed overhead and labor costs as a result of operating its own manufacturing
facility. Any failure to generate the level of product revenues needed to
absorb these overhead and labor costs would have a material adverse effect on
the Company's business, financial condition and results of operations.
MANAGEMENT OF GROWTH
The Company has recently experienced rapid growth and consequently has increased
its expenditures in a number of areas and made certain long-term commitments
(such as the expansion of production lines at its Juarez manufacturing facility
and the forthcoming relocation of its corporate headquarters to a larger
facility in Richardson, Texas), a number of which would be difficult to reduce
quickly in the event of a reduction in the rate of growth or a decrease in the
Company's business.
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<PAGE>
In the event that the Company experiences further growth, such growth will place
additional strain on the Company's management and operations, including its
sales, customer support, research and development, and finance and
administrative operations and require larger quantities of components,
additional personnel and manufacturing equipment and improved operating,
financial and adminsitrative controls, any of which could require significant
additional capital expenditures. The Company may experience difficulty securing
adequate quantities of components or additional manufacturing equipment,
attracting or retaining skilled personnel, improving infrastructure and
management information systems or overcoming other difficulties associated with
growth. In addition, gross profit margins derived from initial orders with new
OEM customers are frequently lower than the Company's typical gross profit
margins, which could reduce the Company's overall gross profit margin. There
can be no asssurance that the Company will be able to manage future changes in
the size of its business successfully or that difficulties in doing so will not
have a material adverse effect on the Company's business, financial condition
and results of operations.
CHANGE IN PRODUCT OR SALES CHANNEL MIX
The Company offers two broad categories of products: multimedia subsystems that
are primarily sold to major OEMs and, to a lesser degree, to commercial
customers, and specialized technology products that are primarily sold to
resellers, the workstation groups of OEMs and corporate customers in certain
industries. Sales of multimedia accelerator subsystems to OEMs, which currently
account for a substantial majority of the Company's net sales of OEM multimedia
subsystems, are characterized by relatively high unit volumes and relatively low
gross profit margins. Sales of the Company's multimedia subsystems to the
commercial market are characterized by relatively modest volumes and moderate
gross profit margins. Sales of the Company's specialized technology products
are characterized by relatively low unit volumes and relatively high gross
profit margins. Shifts in the mix of products sold or in the sales channels
into which such products are sold could have a material adverse effect on the
Company's business, financial condition and results of operations.
In particular, a decrease in sales of multimedia subsystems to the commercial
market or in sales of specialized technology products could result in a
disproportionately greater decrease in the Company's gross profit margin because
sales of multimedia subsystems in the commercial market and sales of specialized
technology products currently have higher gross profit margins than sales of
multimedia subsystem products to the Company's OEM customers. On the other
hand, any decrease in the volume of multimedia subsystems sold to the Company's
OEM customers would significantly reduce total net sales, which would also have
a material adverse effect on the Company's business, financial condition and
results of operations. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Overview."
ENTRY INTO NEW PRODUCT MARKETS
While the Company's business historically has focused primarily on the design,
manufacture and sale of multimedia accelerator subsystems, the Company commenced
commercial shipments of its DVD decoder subsystems in the 1997 third fiscal
quarter and its flat panel display products in the 1998 first fiscal quarter.
Further, as a substantial number of PCs incorporate graphics circuitry on the
motherboard (particularly in lower cost PCs), the Company is now actively
soliciting orders for such motherboards from OEMs and, in the event that the
Company secures any orders, the Company plans to undertake the design,
manufacture and sales of motherboards incorporating the Company's multimedia
accelerator subsystem capabilities. There are numerous risks inherent in the
entry into new product markets, including the reallocation of limited
management, engineering and capital resources to unproven product ventures, a
greater likelihood of encountering technical problems and a greater likelihood
that the Company's new products (or the PCs into which they are incorporated)
will not gain market acceptance.
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<PAGE>
In addition, a new product line, like the Company's line of flat panel display
products, requires significant investment in long-lead time inventories as well
as certain manufacturing equipment. The failure of one or more of such
products, or any adverse effect such new products may have upon the Company's
reputation in its core multimedia accelerator subsystem business as a result of
such failure, could have a material adverse effect on the Company's business,
financial condition and results of operations.
PROPRIETARY TECHNOLOGY; INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS
The Company's success depends in part upon its proprietary technology,
including, in particular, its software drivers and utilities and its hardware
designs. The Company primarily relies upon copyright and trade secret laws and
agreements with its suppliers and customers to protect its proprietary
technology, and occasionally seeks patent protection on selected inventions.
The Company generally also enters into non-disclosure agreements with persons to
whom it reveals its proprietary information, such as OEMs that the Company works
with, concerning future products. There can be no assurance that the Company's
present protective measures will be adequate to prevent misappropriation of its
technology or independent third party development of the same or similar
technology. Many foreign jurisdictions offer less protection of intellectual
property rights than the United States, and there can be no assurance that the
protection provided to the Company's proprietary technology by the laws of the
United States or foreign jurisdictions will be sufficient to protect the
Company's technology.
The Company has in the past and may in the future find it necessary or desirable
to procure licenses from third parties relating to current or future products or
technologies; however, there can be no assurance that the Company will continue
to be able to obtain such licenses or other rights or, if it is able to obtain
them, that it will be able to do so on commercially acceptable terms. The
Company could be placed at a disadvantage if its competitors obtain licenses
with lower royalty fee payments or other terms more favorable than those
received by the Company. If the Company or its suppliers or customers were
unable to obtain licenses relating to current or future products or
technologies, the Company could be forced to market products without certain
technological features. The Company's inability to obtain licenses necessary to
use certain technology or its inability to obtain such licenses on competitive
terms could have a material adverse effect on the Company's business, financial
condition and results of operations.
It is common in the PC industry for companies to assert intellectual property
infringement claims against other companies. As a consequence, the Company
indemnifies some OEM customers in certain respects against intellectual property
claims relating to its products. Several OEM customers recently sent the
Company notices of potential indemnity claims based upon a notice of
infringement of his patent. Subsequently, the patent owner filed patent
infringement lawsuits in the U.S. and elsewhere against several of such OEM
customers and a number of other major PC systems manufacturers. The Company
provides multimedia subsystems to its OEM customers for use in such OEM
customers' products that are alleged to infringe on the patent owner's rights.
Based upon the Company's preliminary evaluation of the patent, it does not
believe the infringement claims are meritorious as to its products sold to its
customer. However, pursuant to such indemnity agreements or in the event, the
Company is directly sued, the Company may be required to dedicate significant
management time and expense to defending itself or assisting its OEM customers
in their defense of this or other infringement claims, whether meritorious or
not, which could have material adverse effect on the Company's business,
financial condition and results of operations. If this or another intellectual
property claim were to be brought against the Company, or one or more of its OEM
customers, and the Company, or one or more of its OEM customers, were found to
be infringing upon the rights of others, the Company could be required to pay
infringement damages, pay licensing fees, modify its products so that they are
not infringing or discontinue offering products that were found to be
infringing, any of which could have a material adverse effect on the Company's
business, financial condition and results of operations.
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<PAGE>
If an intellectual property claim were to be brought against one or more of the
Company's suppliers and the supplier were found to be infringing upon the rights
of others, the supplier could be enjoined from further shipments of its products
to the Company, which could have a material adverse effect on the Company's
business, financial condition and results of operations.
DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL
The Company's prospects depend largely upon the services of its management,
sales, marketing and engineering personnel. While the Company has entered into
employment agreements with a number of its officers and key personnel, the loss
of the services of one or more of such personnel could have a material adverse
effect on the Company's business, financial condition and results of operations.
The prospects of the Company also depend on its ability to retain its key
management, sales, marketing and engineering personnel and to attract other
personnel to satisfy the Company's current and future needs. There is
substantial competition for skilled personnel in the PC industry (and, in
particular, multimedia hardware and software engineers), and the failure to
retain key personnel or to attract additional personnel to satisfy the Company's
needs could have a material adverse effect on the Company's business, financial
condition and results of operations.
POTENTIAL FUTURE ACQUISITIONS
The Company has in the past pursued, and may in the future pursue, acquisitions
of product lines, technologies or businesses. Future acquisitions by the
Company may result in the use of significant amounts of cash, potentially
dilutive issuances of equity securities, incurrence of debt and amortization
expenses related to goodwill and other intangible assets, each of which could
have a material adverse effect on the Company's business, financial condition
and results of operations. In addition, acquisitions involve numerous risks,
including difficulties in the assimilation of the operations, technologies and
products acquired, the diversion of management's attention from other business
concerns, the risks of entering markets in which the Company has limited or no
prior experience, and the potential loss of key employees. There are currently
no negotiations, commitments or agreements with respect to any acquisition. In
the event that an acquisition does occur, such acquisition may have a material
adverse effect on the Company's business, financial condition and results of
operations.
INTERNATIONAL OPERATIONS
Substantially all of the Company's manufacturing operations are carried out in
Juarez, Mexico. The Company's export sales (which primarily consist of European
sales) were approximately 26% and 27% of net sales in the first six months of
fiscal 1998 and fiscal year 1997, respectively. The Company is subject to
the general risks of conducting business internationally, including
unexpected changes in regulatory requirements, fluctuations in currency
exchange rates, delays resulting from difficulty in obtaining export licenses
for certain technology, state imposed restrictions on the repatriation of
funds, tarriffs and other barriers and the restrictions and burdens of
complying with a variety of foreign laws. In addition, the Company is
subject to general geopolitical risks, such as political instability and
changes in diplomatic and trade relationships, in connection with its
international operations. Although to date the Company has not experienced
any material adverse effects on its business, financial condition or results
of operations as a result of such factors, there can be no assurance that
such factors will not have such effects in the future, or require the Company
to modify its business practices. The Company currently sells its products
at prices denominated in U.S. dollars, and an increase in the value of the
U.S. dollar relative to foreign currencies could make the Company's products
more expensive and potentially less competitive in foreign markets. The
Company expects to sell a portion of its products in the future at prices
denominated in other currencies and will therefore increase its currency
exposure risk. In addition, a substantial portion of the Company's
manufacturing labor costs are paid in Mexican pesos. Any decrease in the
value of the U.S. dollar relative to the Mexican peso would increase the
Company's manufacturing costs, which could have a material effect on the
Company's business, financial condition and results of operations.
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PRICE PROTECTION AND STOCK ROTATION RISKS
As is common practice in its industry, the Company's arrangements with its
commercial customers generally allow such customers, in the event of a price
decrease, credit equal to the difference between the price originally paid and
the new decreased price on units in the customers' inventories on the date of
the price decrease. In addition, commercial customers generally have the right
to return slow-moving or excess inventory for product credit equal to an agreed
upon percentage of shipments within specified time periods. While the Company
establishes reserves to cover these practices, there can be no assurance that
these reserves will be sufficient or that any future price protection claims or
returns will not have a material adverse effect on the Company's business,
financial condition and results of operations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Overview."
ENVIRONMENTAL REGULATIONS
The Company is subject to a variety of local, state, federal and foreign
governmental regulations relating to the storage, discharge, handling, emission,
generation, manufacture and disposal of toxic or other hazardous substances used
to manufacture the Company's products. The failure to comply with current or
future regulations could result in the imposition of substantial fines on the
Company, suspension of production, alteration of its manufacturing processes or
cessation of operations and have a material effect on the Company's business,
financial condition and results of operations.
POTENTIAL LIABILITY CLAIMS
The Company's purchase agreements with its major OEM customers typically contain
provisions that require the Company to indemnify the OEM customer and any
end-users for potential product liability claims. Although the Company has
not experienced product liability claims to date, there can be no assurance
that the Company will not become subject to such claims in the future. A
successful product liability claim against the Company could have a material
adverse effect on its business, financial condition and results of operations.
HEADQUARTERS RELOCATION
The Company recently commenced construction of a new 210,000 square foot
headquarters facility near its current location in Richardson, Texas and it is
anticipated that this facility will be completed by December 1998. In
connection with the transition to its new headquarter, the Company may
experience interruptions in certain aspects of its operations, including but not
limited to, those relating to its various engineering, sales and administrative
functions. There can be no assurance that any such interruptions, or other
consequences arising out of the Company's transition to its new headquarters,
will not have a material adverse effect on the Company's business, financial
condition or results of operations. In addition, pursuant to the terms of its
new headquarters lease, the Company will incur additional occupancy expense.
The amount of this additional occupancy expense will be dependent on prevailing
interest rates. Moreover, the Company will bear the economic risk upon the sale
of such facility. If this facility is sold for less than the amount of the
underlying debt on the facility then oustanding, the Company would be required
to cover any shortfall, which could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
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YEAR 2000 COMPLIANCE
The Company uses a significant number of computer software programs and
operating systems in its internal operations, including applications used in
financial business systems and various administration functions, and also
includes software programs in its products. To the extent that these software
applications contain code that is unable to appropriately interpret the upcoming
calendar year 2000, some level of modification or possible replacement of such
source code or applications will be necessary. The Company is still analyzing
its software applications and, to the extent they are not fully year 2000
compliant, the costs necessary to update software or potential systems
interruptions may have a material adverse effect on the Company's business,
financial condition and results of operations. Furthermore, there can be no
assurance that the Company's customers and suppliers are or will be year 2000
compliant. The failure of the Company's customers and suppliers to achieve year
2000 compliance could have a material adverse effect on the Company's business,
financial condition and results of operations.
NO INTENTION TO PAY DIVIDENDS
Since the Company's initial public offering in February 1995, it has not
declared or paid any cash dividends on its Common Stock or other securities, and
does not anticipate paying any cash dividends in the foreseeable future. The
Company intends to retain any earnings for use in its business. The decision to
pay dividends in the future will be at the discretion of the Board of Directors
and will depend, among other things, upon future earnings, operations, capital
requirements, restrictions in financing agreements, the general financial
condition of the Company and general business conditions. The Company's
existing revolving credit facility prohibits the Company from paying cash
dividends.
NEED FOR ADDITIONAL CAPITAL
The Company requires substantial working capital to fund its business,
particularly to finance its inventory and accounts receivable and for capital
expenditures. The Company's future capital requirements will depend on many
factors, including the rate of revenue growth, if any; the Company's financial
condition; any need to expand the Company's manufacturing capacity; the timing
and extent of spending to support research and development programs; the
expansion of selling and marketing and administrative activities; the timing of
new product introductions and product enhancements; and the level of market
acceptance of the Company's products. The Company expects that it may need to
raise additional equity or debt financing in the future. There can be no
assurance that additional equity or debt financing, if required, will be
available on acceptable terms or at all. If the Company is unable to obtain
such additional capital, the Company may be required to reduce the scope of its
planned product development, manufacturing expansion or selling and marketing
activities, which would have a material adverse effect on the Company's
business, financial condition and results of operations. In the event that the
Company does raise additional equity financing, the Company's existing
shareholders could experience substantial dilution. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources."
ANTI-TAKEOVER MEASURES
The Company is a Texas corporation and is therefore subject to the provisions of
the Texas Business Corporation Act, including the terms of the Texas Business
Combination Law ("TBCL") that became effective on September 1, 1997. In
general, the OBCL prohibits a Texas "issuing public corporation" (such as the
Company) from engaging in a "business combination" with any shareholder who is a
beneficial owner of 20% or more of the corporation's outstanding stock for a
period of three years after such shareholder's acquisition of a 20% ownership
interest, unless: (i) the board of directors of the corporation approves the
transaction or the shareholder's acquisition of shares prior to the acquisition
or (ii) two-thirds of the unaffiliated shareholders of the corporation approve
the transaction at a shareholders' meeting. The TBCL may have the effect of
inhibiting a non-negotiated merger or other business combination involving the
Company. The Company is subject to the terms of the TBCL, unless its
shareholders or directors take action electing not to be governed by its terms
(which action is not currently contemplated). The Company is also a party to
certain agreements that could be deemed to have an anti-takeover effect.
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The Company's Board of Directors has the authority to issue up to 2,000,000
shares of preferred stock in one or more series and to determine the price,
rights, preferences and privileges of those shares without any further vote or
action by the Company's shareholders. The rights of the holders of Common Stock
of the Company are subject to, and may be adversely affected by, the rights of
the holders of any shares of preferred stock which may be issued in the future.
While the Company has no present intention to issue shares of preferred stock,
such issuance, while providing desirable flexibility in connection with possible
acquistions and other corporate purposes, could have the effect of making it
more difficult for a third party to acquire a majority of the outstanding voting
stock of the Company. In addition, such preferred stock may have other rights,
including economic rights senior to the Common Stock, and as a result the
issuance thereof could have a material adverse effect on the market value of
such Common Stock.
STOCK PRICE VOLATILITY
The trading price of the Company's Common Stock has in the past and may in the
future be subject to wide fluctuations in response to factors such as actual or
anticipated variations in the Company's operating results; announcements of
technological innovations by the Company or its competitors; new products,
contracts or OEM design wins by the Company or its competitors; developments
with respect to patents, copyrights or proprietary rights; changes in
recommendations or financial estimates by securities analysts; conditions and
trends in the PC and technology industries; adoption of new accounting standards
affecting the Company's industry; general market conditions and other factors.
Further, the stock market has experienced in recent months and may continue in
the future to experience extreme price and volume fluctuations that particularly
affect the market prices or equity securities of high technology companies and
that often are unrelated or disproportionate to the operating performance of
such companies. The trading prices of many high technology companies' stocks
have recently been at or near historical highs and reflect price to earnings
ratios that are substantially above historical levels. There can be no
assurance that these trading prices and price to earnings ratios will be
sustained. These broad market fluctuations, as well as general economic,
policitcal and market conditions, may adversely affect the market price of the
Company's Common Stock. In the past, following periods of volatility in the
market price of a company's stock, securities class action litigation has often
been instituted against the issuing company. There can be no assurance that
such litigation will not occur in the future with respect to the Company. Such
litigation could result in substantial costs and would at a minimum divert
management's attention and resources, which could have a material adverse effect
on the Company's business, financial condition and results of operations. Any
adverse determination in such litigation could also subject the Company to
significant liabilities.
SHARES ELIGIBLE FOR FUTURE SALE
The executive officers and directors and the Founding Shareholders of the
Company, who beneficially own a substantial portion of the outstanding shares of
Common Stock, are free to sell the shares beneficially owned by them, subject to
compliance with the Securities Act of 1933, as amended (the "Securities Act"),
including Rule 144 promulgated thereunder, and the terms of a Right of First
Refusal Agreement, to which certain of such shares are subject. A large portion
of the shares held by such beneficial owners may be sold into the public market
effectively free of significant restrictions. No prediction can be made as to
the effect, if any, that market sales of the above shares or the availability of
such shares for future sales will have on the market price of shares of Common
Stock prevailing from time to time. Future sales of substantial amounts of
Common Stock by existing shareholders could adversely affect the prevailing
market price of the Common Stock and the Company's ability to raise additional
capital.
-28-
<PAGE>
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
Exhibit Number
- --------------
<S> <C>
10.41 Underwriting Agreement by and among the Company, William E. Ogle, Mark
S. Sims, William D. Balthaser and CIBC Oppenheimer (in its own
capacity and on behalf of an underwriting syndicate) (incorporated by
reference to Exhibit 1.1 of the Company's Registration Statement on
Form S-3, Registration No. 333-4684)
27.1 Financial Data Schedule
(b) Current Reports on Form 8-K
Form 8-K filed February 25, 1998 and Form 8-K/A filed March 2, 1998
reporting materials under Item 5, including a 3-for-2 stock split
</TABLE>
-29-
<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.
STB SYSTEMS, INC.
Dated: June 15, 1998 By: /s/ William E. Ogle
------------------------------------------------
President and Chief Executive Officer
Dated: June 15, 1998 By: /s/ Bryan F. Keyes
------------------------------------------------
Bryan F. Keyes, Vice President of Administration
and General Counsel
-30-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF STB SYSTEMS, INC. INCLUDED IN ITS QUARTERLY
REPORT ON FORM 10Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> OCT-31-1998
<PERIOD-START> NOV-01-1997
<PERIOD-END> APR-30-1998
<CASH> 33,611
<SECURITIES> 0
<RECEIVABLES> 47,409
<ALLOWANCES> 580
<INVENTORY> 48,487
<CURRENT-ASSETS> 132,149
<PP&E> 16,899
<DEPRECIATION> 6,261
<TOTAL-ASSETS> 144,635
<CURRENT-LIABILITIES> 33,999
<BONDS> 0
0
0
<COMMON> 133
<OTHER-SE> 108,108
<TOTAL-LIABILITY-AND-EQUITY> 144,635
<SALES> 152,552
<TOTAL-REVENUES> 152,552
<CGS> 122,475
<TOTAL-COSTS> 122,475
<OTHER-EXPENSES> 19,360
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 764
<INCOME-PRETAX> 9,953
<INCOME-TAX> 3,339
<INCOME-CONTINUING> 6,614
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,614
<EPS-PRIMARY> .59<F2>
<EPS-DILUTED> .55
<FN>
<F1>EARNINGS PER SHARE NUMBERS HAVE BEEN ADJUSTED TO REFLECT A THREE-FOR-TWO
STOCK SPLIT OF THE COMPANY'S COMMON STOCK ON FEB. 20, 1998.
<F2>"EPS-PRIMARY" REPRESENTS BASIC EARNINGS PER SHARE, AS DEFINED BY SFAS 128.
</FN>
</TABLE>
