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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C., 20549
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended October 3, 1998
---------------
or
--
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to ___________
Commission File Number 0-25898
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NUMBER NINE VISUAL TECHNOLOGY CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 04-2821358
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
18 HARTWELL AVENUE, LEXINGTON, MA 02421-3141
- - --------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (781) 674-0009
--------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
The number of shares outstanding of the registrant's common stock at
November 16, 1998 was 9,394,385.
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NUMBER NINE VISUAL TECHNOLOGY CORPORATION
INDEX TO FORM 10-Q
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PAGE
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Part I - Financial Information:
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Item 1 - Financial Statements
Condensed Consolidated Balance Sheets as of October 3, 1998 and
December 27, 1997 1
Condensed Consolidated Statements of Operations for the three and
nine months ended October 3, 1998 and September 27, 1997 2
Condensed Consolidated Statements of Cash Flows for the nine months
ended October 3, 1998 and September 27, 1997 3
Notes to Condensed Consolidated Financial Statements 4
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
Part II - Other Information:
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Item 1 - Legal Proceedings 21
Item 2 - Changes in Securities and Use of Proceeds 21
Item 3 - Defaults Upon Senior Securities 22
Item 4 - Submission of Matters to a Vote of Security Holders 23
Item 5 - Other Information 23
Item 6 Exhibits and Reports on Form 8-K 24
(a) Exhibits
Financial Data Schedule
(b) - Reports on Form 8-K
SIGNATURE(S) 25
</TABLE>
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Part I Financial Information:
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Item 1 Financial Statements
NUMBER NINE VISUAL TECHNOLOGY CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
OCTOBER 3, 1998 DECEMBER 27, 1997
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(unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 634 $ 2,481
Accounts receivable, trade, net of allowances for doubtful
accounts of $13 and $193, at October 3, 1998 and December 27, 1997 2,477 10,506
Receivable from manufacturing contractor - 1,678
Inventories 1,189 2,864
Prepaid expenses 945 274
-------- --------
Total current assets 5,245 17,803
Property and equipment, net 3,192 3,906
Other assets 38 150
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Total assets $ 8,475 $ 21,859
======== ========
CURRENT LIABILITIES:
Revolving line of credit $ 669 $ 8,500
Note payable to manufacturing contractor 469 -
Accounts payable 2,647 6,148
Accrued expenses and other current liabilities 683 1,429
-------- --------
Total current liabilities 4,468 16,077
Commitments and contingencies - -
STOCKHOLDERS' EQUITY:
Series A Convertible Preferred Stock, $.01 par value; 5,000,000
shares authorized; 3,350,894 shares issued and outstanding at
October 3, 1998, no shares issued and outstanding at
December 27, 1997 34 -
Common Stock, $.01 par value; 20,000,000 shares authorized; 94 92
9,394,385 shares issued and outstanding at October 3, 1998;
9,172,548 shares issued and outstanding at December 27, 1997
Additional paid-in capital 45,241 35,994
Accumulated deficit (41,362) (30,304)
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Total stockholders' equity 4,007 5,782
-------- --------
Total liabilities and stockholders' equity $ 8,475 $ 21,859
======== ========
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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NUMBER NINE VISUAL TECHNOLOGY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 3, 1998 SEPTEMBER 27, 1997 OCTOBER 3, 1998 SEPTEMBER 27, 1997
--------------- ------------------ ---------------- ------------------
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Net sales $ 1,471 $11,526 $ 13,397 $ 32,584
Cost of sales 1,894 9,521 14,003 29,364
------- ------- -------- --------
Gross margin (423) 2,005 (606) 3,220
Operating expenses:
Selling, general, and
administrative 1,576 3,270 5,963 10,495
Research and development 1,364 2,193 4,293 6,387
------- ------- -------- --------
Total operating expenses 2,940 5,463 10,256 16,882
Loss from operations (3,363) (3,458) (10,862) (13,662)
Other income (expense):
Interest expense (81) (46) (374) (229)
Other income, net (84) 66 178 305
------- ------- -------- --------
Loss before income taxes (3,528) (3,438) (11,058) (13,586)
Provision for income taxes - - - 1,838
------- ------- -------- --------
Net loss $(3,528) $(3,438) $(11,058) $(15,424)
======= ======= ======== ========
Net loss per common share
- diluted $(0.38) $(0.38) $(1.19) $(1.69)
======= ======= ======== ========
- basic $(0.38) $(0.38) $(1.19) $(1.69)
======= ======= ======== ========
Common shares used in computing
Net loss per share
- diluted 9,361 9,132 9,294 9,103
======= ======= ======== ========
- basic 9,361 9,132 9,294 9,103
======= ======= ======== ========
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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NUMBER NINE VISUAL TECHNOLOGY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
OCTOBER 3, 1998 SEPTEMBER 27, 1997
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<S> <C> <C>
Cash flows from operating activities:
Net loss $(11,058) $(15,424)
Adjustments to reconcile net income to net cash
Provided by (used for) operating activities:
Depreciation and amortization 1,089 928
Amortization of capitalized software costs - 648
Provision for bad debts 159 (266)
Deferred taxes - 1,839
Change in operating assets and liabilities:
Accounts receivable 7,870 2,639
Receivable due from manufacturing contractor 1,678 (50)
Inventories 1,675 5,713
Prepaids and other assets (559) 227
Accounts payable (3,501) 39
Accrued expenses and other current liabilities (746) (1,278)
-------- --------
Net cash provided by (used for) operating activities (3,393) (4,985)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment (375) (2,117)
-------- --------
Net cash used for investing activities (375) (2,117)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock and
exercise of common stock options, net 35 228
Payments on revolving line of credit, net (7,831) (3,350)
Advances on convertible subordinated promissory note 9,000
Advances on notes payable with manufacturing contractor, net 469 -
Interest converted to Series A Preferred Stock 248 -
Principal payments on capital lease obligations - (58)
-------- --------
Net cash provided by (used for) financing activities 1,921 (3,180)
-------- --------
Net change in cash and cash equivalents (1,847) (10,282)
Cash and cash equivalents, beginning of period 2,481 13,895
-------- --------
Cash and cash equivalents, end of period $ 634 $ 3,613
======== ========
Supplemental disclosure of non-cash financing transactions:
Conversion of convertible subordinated promissory note to
Series A Preferred Stock, net $ 9,000 $ -
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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NUMBER NINE VISUAL TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
A. BASIS OF PRESENTATION:
----------------------
The accompanying financial statements have been presented on a going concern
basis that contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business.
Number Nine Visual Technology Corporation (the "Company") has continued to
incur substantial losses from operations, is not in compliance with all of the
covenants required by its lender, has unresolved class action litigation
concerning alleged violations of securities laws and needs additional financing
to continue operations, all of which raise substantial doubt about its ability
to continue as a going concern. The Company has hired financial management with
experience in working with financially troubled companies. The Company also has
retained investment-banking counsel to advise it on the possible sale of equity
securities, as well as to introduce and assist it in the evaluation of potential
merger and partnering opportunities. The financial statements do not include
any adjustments relating to the recovery and classification of recorded asset
amounts or the amounts and classification of liabilities that might be necessary
should the Company be unable to continue as a going concern. However, no
assurance can be provided that the Company will be successful in raising
additional capital, continuing this strategic alliance, or entering into a new
business alliance.
On May 7, 1998 the Company secured a portion of its required funding by
entering into a Securities Purchase Agreement (the "Agreement") with Silicon
Graphics, Inc. ("SGI") pursuant to which the Company established a strategic and
financial partnership with SGI. Under the Agreement, the Company issued, during
the second quarter ended June 27, 1998, a series of secured subordinated
convertible promissory notes (the "Notes") in the aggregate principal amount of
$9.0 million and a Series A Convertible Preferred Stock Purchase Warrant (the
"Warrant"). The Notes were subordinated to the Company's existing secured line
of credit, were secured by essentially all of the Company's assets, bear
interest at a rate per annum equal to the prime rate plus 2% and were
convertible, at SGI's option, into shares of the Company's Series A Convertible
Preferred Stock, par value $.01 per share (the "Preferred Stock"), at a
conversion price equal to $2.75 per share.
As of August 10, 1998, SGI converted the Notes, including all accrued
interest, into an aggregate of 3,350,894 shares of Preferred Stock, which
represents approximately 26.4% of the issued and outstanding equity of the
Company. In connection with the conversion, the Warrant was canceled and the
Company issued to SGI a replacement Series A Convertible Preferred Stock
Purchase Warrant (the "Replacement Warrant"). The Replacement Warrant entitles
the holder to purchase for a period of three years at an exercise price of $2.75
per share that number of shares of Preferred Stock equal to 3% of the Company's
then issued and outstanding Common Stock. If exercised on October 3, 1998, the
Replacement Warrant would have entitled the holder to purchase up to 295,577
shares of Preferred Stock. At SGI's option, each share of Series A Convertible
Preferred Stock is immediately convertible into one share of the Company's
Common Stock. The Company has agreed with SGI to use best efforts to elect an
SGI representative to the Company's board of directors at the 1999 annual
meeting of the stockholders.
The accompanying condensed unaudited consolidated financial statements have
been prepared by the Company in accordance with generally accepted accounting
principles for interim financial information and pursuant to the applicable
rules and regulations of the Securities and Exchange Commission. The condensed
unaudited consolidated financial statements include the accounts of the Company,
its foreign sales corporation and its wholly-owned German subsidiary. All
material intercompany accounts and transactions have been eliminated in
consolidation. In the opinion of management, the accompanying financial
statements contain all adjustments (consisting of normal and recurring accruals)
necessary to present fairly all financial statements. The financial
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statements herein should be read in conjunction with the Company's consolidated
financial statements and notes thereto contained in the Company's Annual Report
on Form 10-K, as amended, for its fiscal year ended December 27, 1997. Operating
results for the three month period and nine month period ended October 3, 1998
may not necessarily be indicative of the results to be expected for any other
interim period or for the full year.
B. CASH AND CASH EQUIVALENTS:
--------------------------
As of October 3, 1998, cash and cash equivalents consists of $634,000
invested in overnight and money market mutual funds comprised of obligations
which are issued or guaranteed as to principal and interest by the U.S.
government and thus constitute direct obligations of the United States of
America with a dollar-weighted average maturity of 90 days or less.
C. INVENTORIES:
------------
Inventories consisted of (in thousands):
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<CAPTION>
OCTOBER 3, 1998 DECEMBER 27, 1997
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Raw materials $ 440 $ 527
Work in process 497 715
Finished goods 252 1,622
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$1,189 $2,864
====== ======
</TABLE>
The market for the Company's products is characterized by rapid technological
advances, frequent new product life cycles, product obsolescence, changes in
customer requirements, evolving industry standards, significant competition and
rapidly changing pricing.
At December 27, 1997, the Company had a $1.7 million due from a manufacturing
contractor, which arose from components sold by the Company at cost to the
contractor for assembly into finished goods. The Company did not have
receivables due from its manufacturing contractors, on October 3, 1998. The
Company may continue to sell components to its manufacturing contractors in the
future.
D. DEBT:
-----
The Company is party to an amended loan and security agreement with a
commercial bank providing for a revolving credit facility of $15 million.
Pursuant to this agreement, the Company may borrow an amount equal to 65% of
qualified accounts receivable (as defined in the agreement) up to the maximum
amount at an interest rate per annum equal to either the prime rate (8.25% as
of October 3, 1998) plus 1.25% or at the Libor Rate (as defined in the
agreement) plus 2.5%, plus an unused line fee at a rate of 0.5% per annum on the
unused portion of the maximum borrowing amount. The loan balance is
collateralized by substantially all of the Company's assets. The agreement
expires on December 2, 1998. The Company has been informed by the lender that
this agreement will not be renewed. The Company is currently negotiating with a
major commercial bank for a secured working capital line of credit to replace
the current borrowing facility.
The agreement contains financial covenants including, but not limited to, a
minimum current ratio, minimum tangible net worth, a maximum debt to tangible
net worth ratio, and minimum quarterly net loss. The agreement also gives the
lender the right to call the loan in the event of a material adverse change in
the Company's business and prohibits the Company from paying dividends without
the consent of the lender. The Company is not in compliance with certain
covenants currently. The Company has received a forebearance arrangement from
the lender for noncompliance with certain covenants in the agreement, which is
effective until December 31, 1998. Under the forebearance agreement, the
maximum amount the Company can borrow cannot exceed $4.5 million. If the
Company is not in compliance with all of the covenants of the lender, there can
be no assurance that the lender
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will grant additional waivers and/or amendments, nor can there be any assurance
that alternative financing will be available. The Company believes that the
lender will continue to allow the Company to operate under its forebearance
agreement while the Company seeks to secure additional permanent financing.
Should the lender refuse to grant any future waiver or amendment, and the line
of credit is not available to the Company, management anticipates that it would
require alternative financing. However, if the Company is not able to secure
alternative financing, the Company's liquidity would be adversely affected.
The Company has entered into a note payable with one of its manufacturing
contractors. Under the terms of the note payable, the Company converted
approximately $1.4 million of accounts payable with the manufacturing contractor
into a note payable. The note payable is a six (6) month note, bears interest
at the rate of 5.99% per annum, and is to be repaid in six equal monthly
installments. The first principal and interest payment was made in June 1998.
The last payment is scheduled to occur in December 1998. Should the Company
fail to pay any of its monthly installments, the manufacturing contractor would
be entitled to demand immediate payment in full of the note payable. As of
October 3, 1998, the total amount due under this note payable was $469,000.
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E. RECENTLY ISSUED ACCOUNTING STANDARDS
------------------------------------
Financial Accounting Standards Board Statement No. 129 ("FAS 129")
"Disclosure of Information about Capital Structure" is effective for financial
statements issued for periods ending after December 31, 1997. FAS 129
establishes standards for disclosure of information about securities,
liquidation preference of preferred stock and redeemable stock.
Financial Accounting Standards Board Statement No. 131 ("FAS 131")
"Disclosure about Segments of an Enterprise and Related Information" is
effective for financial statements issued for periods beginning after December
15, 1997. FAS 131 requires disclosures about segments of an enterprise and
related information regarding the different types of business activities in
which an enterprise engages and the different economic environments in which it
operates.
Financial Accounting Standards Board Statement No. 132 ("FAS 132")
"Employers' Capital Disclosures about Pensions and other Postretirement
Benefits" is effective for fiscal years beginning after December 15, 1997,
although earlier application is encouraged. FAS 132 establishes standards
related to the disclosure requirements for pensions and other postretirement
benefits. FAS 132 requires additional information to be disclosed regarding
changes in the benefit obligation and fair value of plan assets, as well as
eliminates other disclosures no longer considered useful.
Financial Accounting Standards Board Statement No. 133 ("FAS 133")
"Accounting for Derivative Instruments and Hedging Activities" is effective for
fiscal years beginning after June 15, 1999, although earlier application is
encouraged. FAS 133 established standards related to the Company's financial
risks associated with its activity as it relates to financial activities with
respect to derivative instruments and hedging. The Company currently does not
engage and has no plans to engage in the practice of using financial derivative
instruments and hedging activities.
The Company does not believe that the implementation of FAS 129, FAS 131, FAS
132 or FAS 133 will have a material impact on the Company's financial position
or results of operations.
Financial Accounting Standards Board Statement No. 130 ("FAS 130")
"Reporting Comprehensive Income" is effective for fiscal years beginning after
December 31, 1997, although earlier application is permitted. The Company
adopted the requirements of this pronouncement in its financial statements for
the quarter ended March 28, 1998. FAS 130 establishes standards for reporting
and display of comprehensive income and its components in a full set of general-
purpose financial statements. FAS 130 requires that all components of
comprehensive income shall be reported in the financial statements in the period
in which they are recognized. Furthermore, a total amount for comprehensive
income shall be displayed in the financial statement where the components of
other comprehensive income are reported. The Company was not previously required
to present comprehensive income or the components thereof in its financial
statements under generally accepted accounting principles. The Company had no
additional comprehensive income other than reported on the income statement for
the quarter ended October 3, 1998.
F. INCOME TAXES:
-------------
At December 27, 1997, the Company had net operating loss carryforwards of
approximately $28.9 million and $32.6 million available to offset future federal
and state taxable income, respectively. The federal net carryforwards begin to
expire in 2010 and the state net carryforwards begin to expire in 2000.
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G. CONTINGENCIES:
--------------
On June 11, 1996, a complaint was filed in the United States District Court
for the District of Massachusetts by named plaintiff RBI, an Alaskan limited
partnership, against the Company, Andrew Najda and Stanley W. Bialek (the
"Selling Stockholders") and the managing underwriters of the Company's initial
public offering, Robertson, Stephens & Company, Cowen & Company and Unterberg
Harris (the "Managing Underwriters"). On or about July 17, 1996, a complaint
was filed in the United States District Court for the District of Massachusetts
by named plaintiff John Foley against the Company, each member of the Company's
Board of Directors, other than John G. Thompson, (Andrew Najda, Stanley W.
Bialek, Gill Cogan, Dr. Paul R. Low, Dr. Fouad H. Nader and William H.
Thalheimer), Kevin M. Hanks, former Chief Financial Officer and Treasurer of the
Company, and the Managing Underwriters. On or about October 16, 1996, an
additional complaint was filed in the United States District Court for the
District of Massachusetts by named plaintiff Robert Schoenhofer against the
Company, each member of the Company's Board of Directors (other than John G.
Thompson), Mr. Hanks, and the Managing Underwriters. Each of the plaintiffs
purports to represent a class of purchasers of the Common Stock of the Company
between and including May 26, 1995 through January 31, 1996. Each complaint
alleges that the named defendants violated the Securities Act of 1933 and the
Securities Exchange Act of 1934 by, among other things, issuing to the investing
public false and misleading statements regarding the Company's business,
products, sales and earnings during the class period in question. The plaintiffs
seek unspecified damages, interest, costs and fees. By order of the District
Court, these actions have been consolidated into a single action. It is possible
that other claims may be made against the Company or that there may be other
consequences from the lawsuits. The defendants deny any liability, believe they
have meritorious defenses, and intend to vigorously defend these and any similar
lawsuits that may be filed, although the ultimate outcome of these matters
cannot yet be determined. If the lawsuits are not resolved satisfactorily for
the Company, there could be a material adverse effect on the Company's future
financial condition and results of operations and, accordingly, income (loss).
The Company does not believe that the ultimate liability, if any, is estimable
or probable, and therefore no provision for any liability that may result from
the actions has been recognized in the accompanying consolidated financial
statements.
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Item 2 -
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
"Management's Discussion and Analysis of Financial Condition and Results of
Operation" and other parts of this Form 10-Q contain forward-looking statements
involving risks and uncertainties as defined in the Private Securities
Litigation Reform Act of 1995. The Company's actual results may differ
significantly from the results discussed in the forward-looking statements.
Factors that might cause such a difference include, but are not limited to,
those discussed here and those included in publicly available filings with the
Securities and Exchange Commission, such as this report.
OVERVIEW
Since its founding in 1982, Number Nine has introduced successive generations
of video/graphics subsystems providing advanced video/graphics performance in
desktop PCs. The Company has focused on providing a broad line of high-
performance hardware and software video/graphics solutions, targeting both OEMs
and two-tier and retail distribution customers. The Company's series of 128-bit
proprietary accelerators have been recognized as some of the highest performance
graphics products available to the desktop PC market. During the third quarter
of 1997, the Company began shipping products utilizing its third generation
proprietary 128-bit graphics accelerator chip technology, Ticket to Ride(TM).
During the third quarter of 1998, the Company began shipping its fourth
generation proprietary 128-bit video/graphics accelerator chip, Ticket to
Ride(TM) IV, and the related graphics board product, Revolution(R) IV. Also
during the third quarter of 1998, the Company announced its first jointly
developed product with its strategic partner, Silicon Graphics, Inc., the
Digital Flat Panel Solution Pack, a digital flat panel monitor containing the
first all digital high resolution display system, the Silicon Graphics 1600 SW
Digital Flat Panel. In addition, the Company began to develop its fifth
generation proprietary 128-bit video/graphics accelerator chip. There can be no
assurance that the Company's latest generation product, Revolution3D utilizing
the Ticket to Ride(TM) chip and Revolution(R) IV utilizing the Ticket to
Ride(TM) IV chip, will be successful or that the fifth generation product will
be completed and marketed successfully.
The Company also markets Hawkeye, a display control utilities and driver
software suite, which enhances user control over various graphics functions and
is designed to improve PC system graphics performance under Windows95.
The Company's past operating results have been, and its future operating
results will continue to be, subject to fluctuations from quarter to quarter due
to a variety of factors, including: the gain or loss of significant customers;
changes in the mix of products sold and in the mix of sales by distribution
channels; the Company's ability to introduce new technologies and products on a
timely basis; availability and timing of component shipments and cost of
components obtained from the Company's suppliers; availability and cost of
manufacturing and foundry capacity; new product introductions by the Company's
competitors; delays in related product introductions by others; market
acceptance of the Company's products; product returns or price protection
charges from customers; reductions in sales of older generation products as
customers anticipate new products, giving rise to charges for obsolete or excess
inventory; and changes in product prices by the Company, its competitors and
suppliers, including possible decreases in unit average selling prices of the
Company's products caused by competitive pressures. Operating results can also
be adversely affected by general economic and other conditions affecting the
timing of customer orders, a downturn in the market for PCs, and order
cancellations or rescheduling. The Company's sales to original equipment
manufacturers ("OEMs"), which accounted for 85.1% of net sales for the first
nine months of 1998, 43.8% of net sales in 1997, and 68.3% of net sales in
1996, are particularly susceptible to fluctuations.
The Company's sales to OEMs typically generate lower gross margins than retail
and distributor sales, but also generally entail lower marketing, sales and
product support costs. The Company's net sales, gross margins and profits have
in the past, and may in the future, vary significantly depending on the
proportion of its sales to OEMs and other distribution channels, as well as the
mix of products sold in each channel. The Company's sales of merchant-based
technology products are typically at a significantly lower margin than the sales
of its proprietary technology products. The gross margin on all of the Company's
products is significantly impacted by costs of components, particularly memory
costs and controller chips, which have varied widely over the past several
years, as well as significant pricing pressure on its products as a result of
competition.
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RESULTS OF OPERATIONS FOR THE QUARTERS ENDED OCTOBER 3, 1998 AND
SEPTEMBER 27, 1997
Net Sales: Net sales decreased 87%, to approximately $1.5 million in the
third quarter of 1998 from approximately $11.5 million in the third quarter of
1997. This decrease was primarily attributable to lower sales of the Company's
proprietary 128-bit products to the Company's OEM customers, as well as lower
sales in international two-tier and retail distribution customers, as the
Company's third generation proprietary 128-bit video/graphics accelerator chip
nears the end of its product life cycle. Net sales of the Company's proprietary
128-bit products decreased 94% to $538,000 in the third quarter of 1998 from
$9.0 million in the third quarter of 1997, representing 35.9% of net sales in
the third quarter of 1998, compared to 78.2% in net sales in the third quarter
of 1997. Sales of 64-bit products represented the remaining $933,000 or 62.2% of
net sales during the third quarter of 1998 compared to approximately $2.5
million or 21.7% of net sales in the third quarter of 1997. Sales to OEMs
decreased 58%, to approximately $1.9 million in the third quarter of 1998 from
approximately $4.5 million in the third quarter of 1997, representing 126.7% in
the third quarter of 1998 compared to 39.1% of net sales in the third quarter of
1997. The decrease in OEM sales was primarily a result of essentially no sales
to either Digital Computer Corporation, now Compaq Computer Corporation, or
Packard Bell NEC during the third quarter of 1998 compared to net sales of $2.3
million or approximately 20.0% of net sales in the third quarter of 1997. Net
sales to International Business Machines Corporation ("IBM") in the third
quarter of 1998 decreased 45% to $864,000 or 57.6% of net sales from $1.6
million or 42.1% of net sales in the second quarter of 1998. Net sales to the
Company's retail and two-tier distribution customers decreased 83%, to $696,000
during the third quarter of 1998 compared to $4.0 million during the third
quarter of 1997. Total international sales decreased 115% to ($472,000) million
in the third quarter of 1998 from approximately $3.2 million in the third
quarter of 1997. This decrease was primarily due to product returns and price
protection actions.
Gross Margin: Gross margin was a loss of approximately $423,000 million in
the third quarter of 1998 compared to gross profit of $2.0 million in the third
quarter of 1997. The Company's gross profit margin decreased to (28.8)% in the
third quarter of 1998 from 17.4% in the third quarter of 1997, due primarily to
the significantly lower net sales level and continued pricing pressure, in the
form of stock rotation and price protection in the two-tier and retail
distribution customers worldwide, when compared to the third quarter of 1997.
The Company's future prospects will depend in part on its ability to
successfully manage its product transitions and fluctuating component costs,
particularly memory, and control inventory as new products are introduced. There
can be no assurance that the Company will be successful in managing these
changes. While the Company reserves for anticipated charges based upon
historical rates of product returns, price protection claims, component cost
fluctuations, and other factors, there can be no assurance that reductions in
sales and returns of older generation products will not give rise to charges for
obsolete or excess inventory or substantial price protection charges. The
effects of planned new product introductions, anticipated stock rotations and
sales activity during future periods, as further described in "Certain Factors
That May Affect Future Results of Operations" may have a negative impact on
gross margin.
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Selling, General and Administrative Expenses: Selling, general and
administrative expenses decreased 52%, to approximately $1.6 million in the
third quarter of 1998 from $3.3 million in the third quarter of 1997, primarily
as a result of decreased headcount and lower marketing costs as the Company
reduced variable discretionary spending. As a percentage of net sales, selling,
general and administrative expenses increased to 106.7% in the third quarter of
1998 from 27.8% in the third quarter of 1997, primarily attributable to lower
sales in the recent quarter. The Company currently expects that selling,
general and administrative expenses will increase during subsequent quarters,
although not necessarily as a percentage of net sales, as the Company begins to
market and sell its newer technology.
Research and Development Expenses: Research and development expenses
decreased 36%, to approximately $1.4 million in the third quarter of 1998 from
approximately $2.2 million in the third quarter of 1997, resulting primarily
from incurring one-time costs associated with completing development efforts on
the Ticket to Ride(TM) accelerator chip, and Revolution3D products in the third
quarter of 1997. During the third quarter of 1998, the Company released its
fourth generation proprietary 128-bit video/graphics accelerator chip, Ticket to
Ride(TM) IV, and the related graphics board product, Revolution(R) IV. In
addition, the Company began to develop its fifth generation proprietary 128-bit
video/graphics accelerator chip. As a percentage of net sales, research and
development expenses increased to 93.3% in the third quarter of 1998 from 19.1%
in the third quarter of 1997. The Company currently expects that research and
development expenses will increase in subsequent quarters, although not
necessarily as a percentage of net sales, primarily as a result of continued
investment in the Company's proprietary technology efforts.
Interest Expense: Net interest expense for the third quarter of 1998 was
$81,000 compared to interest expense of $46,000 in the third quarter of 1997,
primarily attributable to higher average levels of debt in the third quarter of
1998.
Other Expense/Income: Other expense totaled approximately $84,000 in the
third quarter of 1998 compared to other income of $66,000 in the third quarter
of 1997. Other income during the third quarter of 1998 was primarily
attributable to the settlement of certain accounts payable balances, while other
income during the third quarter of 1997 was primarily attributable to interest
income.
Provision for Income Taxes: During the third quarter of 1998, the Company did
not provide an income tax benefit due to the uncertainty of realizing the
benefit from future taxable income. In the third quarter of 1997, the Company
increased its valuation allowance against the remainder of its net deferred tax
asset, of approximately $1.8 million. Valuation of the net deferred tax asset
was dependent upon generating sufficient taxable income in near-term periods.
Principally as a result of the net losses incurred in 1997, management estimates
of future taxable income have been reduced. As a result, management believes it
is less likely than not that the remaining net deferred tax asset will be
realized.
RESULTS OF OPERATIONS FOR THE NINE MONTH PERIODS ENDED OCTOBER 3, 1998 AND
SEPTEMBER 27, 1997
Net Sales: Net sales decreased 59%, to $13.4 million in the first nine
months of 1998 from approximately $32.6 million in the first nine months of
1997. This decrease was primarily attributable to lower sales of the Company's
proprietary 128-bit products to the Company's OEM customers, as well as lower
sales in international two-tier and retail distribution customers, as the
Company's third generation proprietary 128-bit video/graphics accelerator chip
nears the end of its product life cycle. Net sales of the Company's proprietary
128-bit products decreased 72% to $6.4 million in the first nine months of 1998
from $23.1 million in the first nine months of 1997, representing 47.8% of net
sales in the first nine months of 1998 compared to 70.9% in net sales in the
first nine months of 1997. Sales of 64-bit products represented the remaining
$7.0 million or 52.2% of net sales during the first nine months of 1998 compared
to approximately $9.5 million or 29.1% of net sales in the first nine months of
1997. Sales to OEMs decreased 31%, to approximately $11.4 million in the first
nine months of 1998 from
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approximately $16.6 million in the first nine months of 1997, representing 85.1%
in the first nine months of 1998 compared to 50.9% of net sales in the first
nine months of 1997. The decrease in OEM sales was primarily a result of
essentially no sales to either Dell Computer Corporation ("Dell") or Packard
Bell NEC during the first nine months of 1998 compared to net sales of $6.5
million or approximately 21.1% during the first nine months of 1997. The loss of
net sales to Dell was offset by new sales activity with IBM, which represented
approximately $5.1 million or 38.1% of net sales in the first nine months of
1998. Sales to Micron represented 8.2% in the first nine months of 1998 compared
to 9.5% of net sales in the first nine months of 1997. Net sales to the
Company's retail and two-tier distribution customers decreased 79%, to $1.8
million during the first nine months of 1998 compared to $8.4 million during the
first nine months of 1997. Total international sales decreased 57% to $4.8
million in the first nine months of 1998 from approximately $11.1 million in the
first nine months of 1997.
Gross Margin: Gross margin was a loss of approximately $606,000 in the first
nine months of 1998 compared to gross profit of approximately $3.2 million in
the first nine months of 1997. The decrease in gross profit during the first
nine months of 1998 was largely attributable to the significantly lower net
sales level and continued pricing pressure across the Company's products
compared to the first nine months of 1997. The Company's gross profit margin
decreased to (4.5)% in the first nine months of 1998 from 9.9% in the first nine
months of 1997, due primarily to significantly lower net sales and continued
price pressure, as the Company's third generation proprietary 128-bit
video/graphics accelerator chip nears the end of its product life cycle,
compared to the first nine months of 1997. The Company's future prospects will
depend in part on its ability to successfully manage its product transitions and
fluctuating component costs, particularly memory, and control inventory as new
products are introduced. There can be no assurance that the Company will be
successful in managing these changes. While the Company reserves for anticipated
charges based upon historical rates of product returns, price protection claims,
component cost fluctuations, and other factors, there can be no assurance that
reductions in sales and returns of older generation products will not give rise
to charges for obsolete or excess inventory or substantial price protection
charges. The effects of planned new product introductions, anticipated stock
rotations and sales activity during future periods, as further described in
"Certain Factors That May Affect Future Results of Operations" may have a
negative impact on gross margin.
Selling, General and Administrative Expenses: Selling, general and
administrative expenses decreased 43%, to approximately $6.0 million in the
first nine months of 1998 from $10.5 million in the first nine months of 1997,
primarily as a result of decreased headcount and lower marketing costs as the
Company controlled variable discretionary spending. As a percentage of net
sales, selling, general and administrative expenses increased to 44.8% in the
first nine months of 1998 from 32.2% in the first nine months of 1997, primarily
attributable to lower sales in the recent quarter. The Company currently
expects that selling, general and administrative expenses will increase during
subsequent quarters, although not necessarily as a percentage of net sales, as
the Company begins to market and sell its newer technology.
Research and Development Expenses: Research and development expenses
decreased 33%, to approximately $4.3 million in the first nine months of 1998
from approximately $6.4 million in the first nine months of 1997, resulting
primarily from incurring one-time costs associated with completing development
efforts on the Ticket to Ride(TM) accelerator chip, and Revolution3D products
during the first nine months of 1997. During the first nine months of 1998, the
Company began shipping its fourth generation proprietary 128-bit video/graphics
accelerator chip, Ticket to Ride(TM) IV, and the related graphics board product,
Revolution(R) IV. In addition, the Company began to develop its fifth
generation proprietary 128-bit video/graphics accelerator chip. As a
percentage of net sales, research and development expenses increased to 32.1% in
the first nine months of 1998 from 19.6% in the first nine months of 1997,
primarily attributable to lower sales in the recent quarter. The Company
currently expects that research and development expenses will increase in
subsequent quarters, although not necessarily as a percentage of net sales,
primarily as a result of continued investment in the Company's proprietary
technology efforts.
Interest Expense: Net interest expense for the first nine months of 1998 was
$374,000 compared to interest expense of $229,000 in the first nine months of
1997. This increase was attributable to higher average outstanding loan balances
during the first nine months of 1998, as compared to the first nine months of
1997.
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Other Expense/Income: Other income totaled approximately $178,000 in the
first nine months of 1998 compared to other income of $305,000 in the first nine
months of 1997. Other income during the first nine months of 1998 was primarily
attributable to the settlement of certain accounts payable balances, while other
income during the first nine months of 1997 was primarily attributable to
interest income.
Provision for Income Taxes: During the first nine months of 1998 and the
first nine months of 1997, the Company did not provide an income tax benefit due
to the uncertainty of realizing the benefit from future taxable income. In 1997,
the Company increased its valuation allowance against the remainder of its net
deferred tax asset, of approximately $1.8 million. Valuation of the net deferred
tax asset was dependent upon generating sufficient taxable income in near-term
periods. Principally as a result of the net losses incurred in 1997, management
estimates of future taxable income have been reduced. As a result, management
believes it is less likely than not that the remaining net deferred tax asset
will be realized.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
This report contains forward-looking statements as that term is defined in
the Private Securities Litigation Reform Act of 1995. Such statements are based
on management's current expectations and are subject to a number of factors and
uncertainties, which could cause actual results to differ materially from those,
described in the forward-looking statements. The Company cautions investors that
there can be no assurance that actual results or business conditions will not
differ materially from those projected or suggested in such forward-looking
statements as a result of various factors, including, but not limited to the
following:
Product Life Cycle Management
The PC industry in general, and the market for the Company's products in
particular, are characterized by rapid technological advances, frequent new
product introductions, short product life cycles, product obsolescence, changes
in customer requirements or preferences for competing products, evolving
industry standards, significant competition, and rapidly changing pricing. In
this regard, the life cycle of products in the Company's markets is often as
short as nine to twelve months. Therefore, the Company's future prospects will
depend in part on its ability to enhance the functionality of its existing
products in a timely manner and to continue to identify, develop and achieve
market acceptance of products that incorporate new technologies and standards
and meet evolving customer needs. There can be no assurance that the Company
will be successful in managing product transitions, including controlling
inventory of older generation products as new products are introduced. The
Company has in the past experienced and could in the future experience
reductions in sales of older generation products as customers anticipate new
product introductions. The Company's ability to successfully transition its
Revolution3D products to its fourth generation proprietary-based 128-bit
products will depend on such factors. While the Company reserves for anticipated
returns based upon historical rates of product returns and other factors, there
can be no assurance that reductions in sales and returns of older generation
products by distributors, which are primarily attributable to customer stock
rotation, will not give rise to charges for obsolete or excess inventory or
substantial price protection charges.
The volume and timing of orders received during a particular quarter are very
difficult to forecast. The Company's customers can change delivery schedules or
cancel orders with limited or no penalties. For example, in September 1996 the
Company received notice from Dell that Dell would discontinue buying its
merchant graphics solution from the Company in the fourth quarter of 1996. In
addition, during the third quarter of 1997, Dell reduced its purchases of the
Company's proprietary Imagine 128 Series 2 4MB VRAM product. As a result, the
Company's net sales to Dell in 1997 were not significant, $4.9 million during
1997 compared to $62.7 million during 1996. Future sales to Dell are uncertain
and depend upon the performance and pricing of new Company products and their
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acceptance by Dell. Customers generally order on an as-needed basis, and as a
result, the Company has historically operated without significant backlog.
Moreover, as is often the case in the PC industry, a disproportionate percentage
of the Company's net sales in any quarter may be generated in the final month or
weeks of a quarter. Consequently, a shortfall in sales in any quarter as
compared to management expectations may not be identifiable until the end of the
quarter. Because significant portions of operating expense levels are relatively
fixed, the timing of expense levels is based in large part on the Company's
expectations of future sales. If sales do not meet the Company's expectations,
it may be unable to quickly adjust spending, which could have a material adverse
effect on the Company's operating results.
Dependence upon the PC Industry
The Company has focused on providing a broad line of high-performance
hardware and software video/graphics solutions, targeting both OEMs and two-tier
and retail distribution customers. The PC industry is characterized by a limited
number of major OEMs driving the majority of PC sales. While the Company is
pursuing a significant portion of its business derived from the limited number
of major OEMs, there is no assurance that the Company will be successful in
establishing profitable relationships with major OEMs. In addition, major OEMs
exercise significant price pressure on their suppliers, generating lower gross
margins than retail and distribution customers do. Any failure by the Company
to establish profitable relationships with major OEM customers, or to maintain
and increase the volume and profitability of the products manufactured for such
customers would have a material adverse effect on the Company's business,
financial condition and results of operations.
Proprietary Technology: Product Mix
The Company's products have historically been based both on merchant and
proprietary-based video/graphic accelerator chips. These product lines have each
contributed gross profit for the Company during the last few years. However, the
Company believes that over the long-term, its proprietary-based products will
become an increasingly more important factor in determining success for the
Company, and the Company currently anticipates reduced sales of merchant based
products. If sales of the Company's proprietary-based products do not meet the
Company's expectations or if there are delays in the completion and availability
of these proprietary-based products, the Company may have significantly reduced
sales, which could have a material adverse effect on the Company's operating
results.
Competition
The market for the Company's products is highly competitive. The Company
believes that its ability to compete successfully depends upon a number of
factors both within and beyond its control, including product performance,
product features, product availability, price, quality, timing of new product
introductions by the Company and its competitors, the emergence of new
video/graphics and PC standards, customer support, and industry and general
economic trends. The Company seeks to compete by offering products emphasizing
high performance and quality and with a continuing commitment to product
improvements and new product introductions and the ability to provide a broad
product line where demand justifies it. The Company's principal competitors
include ATI Technologies, Inc. ("ATI"), Diamond Multimedia Systems, Inc., Matrox
Electronic Systems, Inc. ("Matrox") and STB Systems, Inc. Each of these named
competitors has graphics accelerator products that are marketed in competition
with the Company's 64-bit and 128-bit graphics accelerator products. The
Company's principal competitors on chip technology include Intel Corporation,
3DFX Interactive, Inc., 3DLabs Inc., Ltd., Nvidia Corporation, ATI and Matrox.
Numerous competitors, particularly in higher-volume, lower-priced product
categories, compete primarily on the basis of price, which may result in reduced
sales and/or lower margins for the Company's products. In addition, many
companies compete on the basis of their integrated circuit design capabilities,
by supplying accelerator chips on a merchant basis, by producing board-level
products, by integrating the accelerator chip that will be placed directly on
the CPU motherboard. The Company expects this trend to continue for low-end
video/graphic accelerator subsystems; however, it believes the market for
video/graphic accelerator subsystems in mid-range to high-end PCs will continue
to exist.
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Several of the Company's board-level competitors, as well as various
independent software developers, produce software utilities offering features
comparable to HawkEye. Future enhancements to such competing software products
that are not matched by the Company, or the inclusion of comparable features in
future versions of the Windows operating system, could diminish the relative
attractiveness of the Company's HawkEye utilities software. In addition, the
Company may in the future experience indirect competition from suppliers of
memory components, CPU manufacturers and others to the extent they integrate
advanced graphics processing capabilities into future generations of products.
The Company's current and prospective competitors include many companies that
have substantially greater name recognition and financial, technical,
manufacturing and marketing resources than the Company. There can be no
assurance that the Company will be able to compete successfully against current
and future competitors.
Dependence upon Suppliers
The Company is dependent on sole or limited source suppliers for certain key
components and has experienced limited availability, delays in shipments and
unanticipated cost fluctuations related to the supply of components,
particularly memory chips. The Company is actively working with memory component
suppliers to secure pricing and volume commitments for future production.
Additionally, the Company's suppliers could impact the availability of key
components, particularly memory and graphics accelerator chips, to the extent
that they reduce the Company's lines of credit and payment terms. In such an
event, the Company could have difficulty securing sufficient supply to meet
customer requirements. There can be no assurance that commitments will be
secured in sufficient amounts to meet the needs of the Company or at prices that
will enable the Company to attain profitability.
Dependence upon Key Personnel
The Company's future success will depend, to a significant extent, upon the
efforts and abilities of its senior management and professional, technical,
sales and marketing personnel. The competition for such personnel is intense.
There can be no assurance that the Company will be successful in retaining its
existing key personnel or in attracting and retaining the additional key
personnel that it requires. 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
operation.
Year 2000 Compliance
BACKGROUND: The Company uses a 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. The Year 2000 Issue refers to
potential problems with computer systems or any equipment with computer chips or
software that use dates where the date has been stored as just two digits such
as 97 for 1997. On January 1, 2000, any clock or date recording mechanism
incorporating date sensitive software using only two digits to represent the
year may recognize a date using 00 as the year 1900 rather than the year 2000.
This could result in a system failure or miscalculations, causing disruption of
operations, including, among other things, a temporary inability to process
transactions, send invoices, or engage in normal operating business activities.
ASSESSMENT: The Company has conducted an assessment of its internal
information systems to determine the extent of any Year 2000 problem. This
assessment revealed that its principal information systems correctly define the
year 2000 and do not require any modification. As a result, the Company does
not expect to incur any material costs associated with Year 2000 issues.
However, there can be no assurances that, to date, the Company has identified
all material Year 2000 issues associated with internal information systems which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
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<PAGE>
THIRD PARTIES: The Company is in the process of contacting its customers,
suppliers, financial institutions, creditors, service providers and governmental
agencies, with which the Company has a material relationship, in an effort to
verify the Year 2000 readiness of these third parties that could cause a
material impact on the Company. The Company has limited or no control over the
actions of these third parties. Thus, while the Company expects that it will be
able to resolve any significant Year 2000 problems, there can be no assurances
that all material Year 2000 issues associated with third parties will be
identified and corrected on a timely basis, or that corrections made by third-
parties will be compatible with Company's information systems. The Company's
business, financial condition and results of operations could be materially
adversely affected by the failure of its systems and applications or those
operated by third parties to properly operate or manage dates beyond 1999.
MOST LIKELY CONSEQUENCES OF YEAR 2000 PROBLEMS: The Company has not yet
designed a contingency plan to address any Year 2000 issues that may arise,
partially as a result of the favorable responses regarding Year 2000 readiness
received to date. The Company intends to design and implement such a
contingency plan prior to the end of the current fiscal year, which will be
based in part upon the balance of the responses the Company expects to receive.
The Company expects to identify and resolve all Year 2000 Problems that could
materially affect its business operations. However, management believes that it
is not possible to, determine with complete certainty that all Year 2000
Problems affecting the Company have been identified or corrected. The number of
devices that could be affected and the interactions among these devices are
simply too numerous. In addition, the Company cannot accurately predict how many
Year 2000 Problem-related failures will occur or the severity, duration or
financial consequences of these perhaps inevitable and unforeseen failures. As a
result, management expects that the Company could likely suffer the following
consequences:
1. A significant number of operational inconveniences and inefficiencies
for the Company and its clients that may divert management's time and
attention, and financial and human resources from its ordinary business
activities and
2. A lesser number of serious system failures that may require significant
efforts by the Company or its clients to prevent or alleviate material
business disruptions.
Based on the activities described above, the Company does not believe that the
Year 2000 Problem will have a material adverse effect on the Company's business
or results of operations.
DISCLAIMER. The discussion of the Company's efforts, and management's
expectations, relating to Year 2000 compliance are forward-looking statements.
The Company's ability to achieve Year 2000 compliance and the level of
incremental costs associated therewith could be adversely impacted by, among
other things, the availability and cost of programming and testing resources,
vendors' abilities to modify proprietary software and unanticipated problems
identified in the ongoing compliance review
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Stock Price Volatility
The trading price of the Company's Common Stock has been subject to
significant fluctuations to date, and could be subject to wide fluctuations in
the future, in response to quarter-to-quarter variations in operating results,
announcements of technological innovations, new products or significant OEM
system design wins by the Company or its competitors, general conditions in the
markets for the Company's products or the computer industry, the price and
availability of purchased components, general financial market conditions,
changes in earnings estimates by analysts, or other events or factors. In this
regard, the Company does not endorse or accept responsibility for the estimates
or recommendations issued by stock research analysts from time to time. The
volatility of public stock markets, and technology stocks specifically, have
frequently been unrelated to the operating performance of the specific
companies. These market fluctuations may adversely affect the market price of
the Company's Common Stock.
Shareholder Litigation
The Company has been served notice of three lawsuits seeking class action
status on or about June 11, 1996, July 16, 1996 and October 16, 1996,
respectively, filed in the United States District Court for the District of
Massachusetts naming as defendants the Company, the members of the Board of
Directors during the period in question, the former Chief Financial Officer and
Treasurer of the Company, and the Selling Shareholders and Managing Underwriters
of the Company's 1995 initial public offering. The alleged class of plaintiffs
consists of all persons who purchased shares of the Company's Common Stock on
the open market between and including May 26, 1995 through January 31, 1996. The
plaintiffs, who seek unspecified damages, interest, costs and fees, allege,
among other things, that the Company's Registration Statement and Prospectus in
its initial public offering and other public statements and reports filed with
the Securities and Exchange Commission during the class period in question
contained false and materially misleading statements. The defendants deny
liability, believe they have meritorious defenses and intend to vigorously
defend against these and any similar lawsuits that may be filed, although the
ultimate outcome of these matters cannot yet be determined. By order of the
District Court, these actions have been consolidated into a single action. If
the lawsuit is not resolved satisfactorily for the Company, there could be a
material adverse effect on the Company's future financial performance and
results of operations and accordingly, income (loss).
Intellectual Property Infringement
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 notices of infringement
that they have received from a patent owner. 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 a 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. 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.
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LIQUIDITY AND CAPITAL RESOURCES
The accompanying financial statements have been presented on a going concern
basis that contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. (See Note B of Condensed
Consolidated Financial Statements included in the Company's Annual Report on
Form 10-K for the year ended December 27, 1997 as filed with the Commission.)
The Company has continued to incur substantial losses from operations, lost a
significant customer, is not in compliance with all of the covenants required by
its lender, has unresolved class action litigation concerning alleged violations
of securities laws, and needs additional financing to continue operations, all
of which raises substantial doubt about its ability to continue as a going
concern. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty. The Company has retained
investment-banking counsel to advise it on the possible sale of equity
securities, as well as to introduce and assist it in the evaluation of potential
merger and partnering opportunities.
During the second quarter of 1998, the Company has secured a portion of its
required funding through a strategic and financial partnership with Silicon
Graphics, Inc., which is further described below. However, no assurance can be
provided that the Company will be successful in raising additional capital,
continuing this strategic alliance, or entering into a new business alliance.
The financial statements do not include any adjustments relating to the recovery
and classifications of recorded asset amounts or the amounts and classifications
of liabilities that might be necessary should the Company be unable to continue
as a going concern.
Several factors in the development of the Company's business during 1995,
1996 and 1997 have had a significant impact on its balance sheet and cash flows.
During 1995 and 1996, the Company experienced significantly higher sales to two-
tier and retail distribution channel customers. These customers tend to order
toward the end of each quarter and to pay more slowly than OEM customers. The
Company has since shifted its business, to focus on sales to its OEM customers.
In addition, the Company's manufacturing strategy has focused on purchasing a
higher proportion of components directly from manufacturers, which reduces
component costs but requires longer-term commitments and faster payment compared
to distributor suppliers. Finally, the fluctuating cost of memory components has
resulted in variable gross and operating margins, and limited availability at
times has required the use of cash when necessary to secure supplies of memory.
Significant pricing pressure for the Company's products has been experienced
during 1997 and to date in 1998, resulting in lower gross margin and less net
income. In combination, these factors have resulted in the Company requiring
more working capital and generating less cash flow from operations than
anticipated.
In the third quarter ending October 3, 1998, the Company continued to incur
losses on reduced revenue while marketplace pricing pressure has increased. The
Company's operating activities used cash of approximately $3.4 million in the
first nine months of 1998, compared to operating activities which used cash of
approximately $5.0 million in the first nine months of 1997. In the first nine
months of 1998, net decreases to accounts receivable, receivable due from
manufacturing contractors and inventory generated cash of approximately $7.9
million, $1.7 million and $1.7 million, respectively. In addition, a net
decrease to accounts payable used cash of approximately $3.5 million. Decreases
in accounts receivable have primarily been attributable to lower sales levels in
the third quarter of 1998. The Company believes it can operate with lower levels
of working capital relative to net sales and has committed additional resources
to the management and control of its receivables and inventories. At October 3,
1998, the Company's principal sources of liquidity consisted of approximately
$634,000 of cash and cash equivalents and approximately $4.5 million available
under its revolving line of credit, as described below.
In the first nine months of 1998, investing activities used cash of
approximately $375,000 for purchases of computer and office equipment compared
to $2.1 million for purchases and office equipment in the first nine months of
1997. Financing activities provided cash of $1.9 million during the first nine
months of 1998, attributable to the $9.0 million proceeds from the convertible
subordinated promissory note, and $469,000 million of
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trade accounts payable to a manufacturing subcontractor converted to a short-
term note payable, offset by a reduction of the outstanding balance of the
revolving credit facility by $7.8 million. During the first nine months of 1997,
financing activities used cash of $3.2 million, attributable to the reduction of
the outstanding balance of the revolving credit facility by $3.3 million.
As of October 3, 1998, approximately $669,000 was outstanding under the
Company's revolving credit facility (the "Loan Agreement"). The Loan Agreement
contains financial covenants including, but not limited to, a minimum current
ratio, minimum tangible net worth, a maximum debt to tangible net worth ratio,
and maximum quarterly net loss. The Loan Agreement also gives the lender the
right to call the loan in the event of a material adverse change in the
Company's business and prohibits the Company from paying dividends without the
consent of the lender. The Company has been out of compliance with certain terms
of its Loan Agreement from time to time and as a result has entered into
amendments revising certain covenants in such Loan Agreement or has required a
waiver from its lender. The Company has received a forbearance arrangement from
the lender for noncompliance with certain covenants in the agreement, which is
effective until December 31, 1998. Under the forbearance agreement, the maximum
amount the Company can borrow cannot exceed $4.5 million. If the Company is not
in compliance with all of the covenants of the lender, there can be no assurance
that the lender will grant additional waivers and/or amendments, nor can there
be any assurance that alternative financing will be available. The Company
believes that the lender will continue to allow the Company to operate under its
forbearance agreement while the Company seeks to secure additional permanent
financing. Should the lender refuse to grant any future waiver or amendment, and
the line of credit is not available to the Company, management anticipates that
it would require alternative financing. However, if the Company is not able to
secure alternative financing, the Company's liquidity would be adversely
affected.
The Loan Agreement expires on December 2, 1998. The Company has been informed
by the lender that this agreement will not be renewed. The Company is currently
negotiating with a major commercial bank for a secured working capital line of
credit to replace the current borrowing facility. If the Company is not in
compliance with all of the covenants of the lender, there can be no assurance
that the lender will grant additional waivers and/or amendments, nor can there
be any assurance that alternative financing will be available. The Company
believes that the lender will continue to allow the Company to operate under its
forbearance agreement while the Company seeks to secure additional permanent
financing. Should the lender refuse to grant any future waiver or amendment, and
the line of credit is not available to the Company, management anticipates that
it would require alternative financing. However, if the Company is not able to
secure alternative financing, the Company's liquidity would be adversely
affected.
On April 17, 1998, the Company received a short term loan of $3.0 million
from Silicon Graphics, Inc. ("SGI") which was due on May 17, 1998. On May 7,
1998 the Company and SGI refinanced the short term loan by entering into a
Securities Purchase Agreement (the "Agreement") pursuant to which the Company
issued during the second quarter ended June 27, 1998 a series of secured
subordinated convertible promissory notes (the "Notes") in the aggregate
principal amount of $9.0 million and a Series A Convertible Preferred Stock
Purchase Warrant (the "Warrant"). The Notes were subordinated to the Company's
existing secured line of credit, were secured by essentially all of the
Company's assets, bear interest at a rate per annum equal to the prime rate plus
2% and were convertible, at SGI's option, into shares of the Company's Series A
Convertible Preferred Stock, par value $.01 per share (the "Preferred Stock"),
at a conversion price equal to $2.75 per share. If the Company paid any of the
outstanding principal and interest due under any of the Notes, then on such date
(the "Payment Date") the Warrant would have entitled the holder until the third
anniversary of the Payment Date to purchase at an exercise price of $2.75 per
share that number of shares of Preferred Stock equal to 3% of the Company's then
issued and outstanding Common Stock. Following issuance each share of Preferred
Stock would be convertible into one share of the Company's Common Stock.
-19-
<PAGE>
As of August 10, 1998, SGI converted the Notes, including all accrued
interest, into an aggregate of 3,350,894 shares of Preferred Stock. In
connection with the conversion, the Warrant was canceled and the Company issued
to SGI the Replacement Warrant which entitles the holder to purchase for a
period of three years at an exercise price of $2.75 per share that number of
shares of Preferred Stock equal to 3% of the Company's then issued and
outstanding Common Stock. If exercised on October 3, 1998, the Replacement
Warrant would have entitled the holder to purchase up to 295,577 shares of
Preferred Stock. At SGI's option, each share of Series A Convertible Preferred
Stock is immediately convertible into one share of the Company's Common Stock.
The Company has agreed with SGI to use best efforts to elect an SGI
representative to the Company's board of directors at the 1999 annual meeting of
the stockholders.
The Company has entered into a note payable with one of its manufacturing
contractors. Under the terms of the note payable, the Company converted
approximately $1.4 million of accounts payable with the manufacturing contractor
into a note payable. The note payable is a six (6) month note, bears interest
at the rate of 5.99% per annum, and is to be repaid in six equal monthly
installments. The first principal and interest payment was made in June 1998.
The last payment is scheduled to occur in December 1998. Should the Company
fail to pay any of its monthly installments, the manufacturing contractor would
be entitled to demand immediate payment in full of the note payable.
The Company believes that its existing cash balances plus funds generated
from product sales, and financing arrangements described above will not be
sufficient to fund operations at anticipated levels through the fourth quarter
of 1998. Future growth in sales, significant losses and limitations of
credit/terms by suppliers, and/or continued increases in working capital
required by the Company's business results in the need for the Company to obtain
additional equity or debt financing. Additionally, the Company believes that
working capital requirements for future product releases, as well as continued
investments in operations, particularly research and development will require
additional equity or debt financing. The Company is currently negotiating with
strategic partners and a major commercial bank for required additional funding.
No assurances can be given that any additional financing will be available to
the Company on acceptable terms, if at all.
-20-
<PAGE>
PART II. OTHER INFORMATION:
- - -------- ------------------
Item 1 - Legal Proceedings
From time to time, the Company is involved in litigation relating to claims
arising out of its operation in the normal course of business. Other than the
litigation discussed below, the Company is currently not a party to any
additional legal proceeding the adverse outcome of which, individually or in the
aggregate, management believes would have a material adverse effect on the
financial position or results of operations of the Company.
On June 11, 1996, a complaint was filed in the United States District Court
for the District of Massachusetts by named plaintiff RBI, an Alaskan limited
partnership, against the Company, Andrew Najda and Stanley W. Bialek (the
"Selling Stockholders") and the managing underwriters of the Company's initial
public offering, Robertson, Stephens & Company, Cowen & Company and Unterberg
Harris (the "Managing Underwriters"). On or about July 17, 1996, a complaint
was filed in the United States District Court for the District of Massachusetts
by named plaintiff John Foley against the Company, each member of the Company's
Board of Directors, (Andrew Najda, Stanley W. Bialek, Gill Cogan, Dr. Paul R.
Low, Dr. Fouad H. Nader and William H. Thalheimer), Kevin M. Hanks, former Chief
Financial Officer and Treasurer of the Company, and the Managing Underwriters.
On or about October 16, 1996, an additional complaint was filed in the United
States District Court for the District of Massachusetts by named plaintiff
Robert Schoenhofer against the Company, each member of the Company's Board of
Directors, Mr. Hanks, and the Managing Underwriters. Each of the plaintiffs
purports to represent a class of purchasers of the Common Stock of the Company
between and including May 26, 1995 through January 31, 1996. Each complaint
alleges that the named defendants violated the Securities Act of 1933, as
amended, and the Securities Exchange Act of 1934, as amended, by, among other
things, issuing to the investing public false and misleading statements
regarding the Company's business, products, sales and earnings during the class
period in question. The plaintiffs seek unspecified damages, interest, costs and
fees. By order of the District Court, these actions have been consolidated into
a single action. It is possible that other claims may be made against the
Company or that there may be other consequences from the lawsuits. The
defendants deny any liability, believe they have meritorious defenses, and
intend to vigorously defend these and any similar lawsuits that may be filed,
although the ultimate outcome of these matters cannot yet be determined. If the
lawsuits are not resolved satisfactorily for the Company, there could be a
material adverse effect on the Company's future financial condition and results
of operations and, accordingly, income (loss). The Company does not believe that
the ultimate liability, if any, is estimable or probable, and therefore no
provision for any liability that may result from the actions has been recognized
in the accompanying consolidated financial statements.
A foreign inventor has asserted claims against several PC manufacturers,
including customers of the Company, that the graphics technology included in
their systems infringes the inventor's patents. Certain of the Company's
customers have notified the Company of these assertions and their intent to seek
indemnification from the Company in the event these claims are successful and
the infringing technology was included in products sold by the Company. The
Company believes there are meritorious defenses to these claims and that if the
technology in fact infringes the inventor's rights, the Company would have
rights of indemnification from its suppliers. While there can be no assurance,
the Company does not expect this matter to have a material adverse effect on the
Company.
Item 2 - Changes in Securities and Use of Proceeds
(a) Not applicable.
(b) Not applicable.
(c) (1) Securities sold. (A) As of August 11, 1998, the Company issued
3,350,894 shares of Series A Convertible Preferred Stock
("Preferred Stock"), in exchange for conversion of a series of
secured subordinated promissory notes as described below. As of
August 11, 1998 the Company also issued a Series A Convertible
Preferred Stock Purchase Warrant (the "Replacement Warrant") to
replace the original warrant previously issued to Silicon
Graphics, Inc. ("SGI") on May 7, 1998. The Replacement Warrant
entitles the holder of the Replacement Warrant to purchase Series
A Convertible Preferred Stock, par value .01 per share, up to an
amount equal to 3% of the then issued and outstanding common stock
of the Company, par value .01 per share ("Common Stock"), which is
immediately convertible into the Company's Common Stock on a one
for one basis. (B) During the period between June 27, 1998 and
October 3, 1998 the Company issued and sold an aggregate of 18,150
shares pursuant to exercises of certain options held by employees
of the Company (the "Option Shares").
(2) Underwriter and other purchasers. (A) No underwriters were
involved in the transaction. The Company sold 3,350,894 shares of
its Series A Convertible Preferred Stock to SGI. (B) The Company
issued the Option Shares pursuant to certain exercises of options
granted to certain employees under the Company's 1989 Stock Option
Plan.
(3) Consideration. (A) The Company sold the Preferred Stock in
connection with the conversion of a series of secured subordinated
convertible promissory notes (the "Notes") issued by the Company
to SGI pursuant to a Securities Purchase Agreement dated May 7,
1998 by and between the Company and SGI, for an aggregate amount
of approximately $9.0 million dollars and accrued interest thereon
from May 7, 1998 to August 11, 1998 in the amount of approximately
$217,000. (B) The Option Shares were issued at an exercise price
of $0.27 per share for an aggregate exercise price of $4,900.50.
-21-
<PAGE>
(4) Exemption from registration claimed. (A) The Company issued the
Series A Convertible Preferred Stock in reliance upon Regulation D
under Section 4(2) of the Securities Act of 1933, as amended (the
"Act"). (B) The Option Shares were issued in reliance upon the
exemption from registration set forth in Rule 701 under the Act,
because each transaction involved an exercise of a stock option
that was granted by the Company pursuant to a written compensatory
benefit plan and before the Company became subject to the
reporting requirements of Section 13 or 15(d) of the Act.
(5) Terms of conversion or exercise. (A) Each share of Preferred Stock
is immediately convertible at the option of SGI into one share of
the Company's Common Stock. The Replacement Warrant (as defined in
1 above) is exercisable by SGI to purchase a number of shares of
Preferred Stock up to an amount equal to 3% of the then issued and
outstanding Common Stock of the Company at an exercise price of
$2.75 per share until the expiration date of the Replacement
Warrant, August 11, 2001. Each share of Preferred Stock is then
immediately convertible into one share of the Company's Common
Stock at SGI's option. If exercised on October 3, 1998, the
Replacement Warrant would have entitled the holder to purchase up
to 295,577 shares of Preferred Stock.
(6) Use of Proceeds. (A) Not applicable. (B) Not applicable.
(d) Not applicable.
Item 3 - Defaults Upon Senior Securities
Not Applicable
-22-
<PAGE>
Item 4 - Submission of Matters to a Vote of Security Holders
Not Applicable
Item 5- Other Information
To be considered for inclusion in the proxy statement relating to the
Annual Meeting of stockholders to be held in 1999, stockholder proposals must be
received no later than January 29, 1999. To be considered for presentation at
the Annual Meeting, although not included in the proxy statement, proposals must
be received no later than April 26, 1999. All stockholder proposals should be
marked for the attention of: Assistant Treasurer, Number Nine Visual Technology
Corporation, 18 Hartwell Avenue, Lexington, Massachusetts 02173.
-23-
<PAGE>
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
--------
The following is a list of exhibits filed as part of this Quarterly Report on
Form 10-Q.
Exhibit Number Description
- - -------------- -----------
10.1 Employment Letter Agreement, dated 4/20/98, between the
Registrant and Lawrence McIntosh
10.2 Employment Resignation Agreement, dated 8/19/98, between
the Registrant and Michael Romanies
10.3 Consultant Agreement, dated 8/25/98, between the Registrant
and Michael Romanies
27 Financial Data Schedule
- - ----------------------
(b) Reports on Form 8-K
-------------------
No reports on Form 8-K were filed during the quarterly period ended
October 3, 1998.
-24-
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NUMBER NINE VISUAL TECHNOLOGY CORPORATION
Date: November 16, 1998 By: /s/ Andrew Najda
---------------------------------
Andrew Najda
Chairman and Chief Executive Officer
(Principal Executive Officer)
Date: November 16, 1998 By: /s/ Timothy J. Burns
---------------------------------
Timothy J. Burns
Acting Chief Financial Officer
(Principal Financial and Accounting Officer)
-25-
<PAGE>
EXHIBIT INDEX
Exhibit Number Description
- - -------------- -----------
10.1 Employment Letter Agreement, dated 4/20/98, between the
Registrant and Lawrence McIntosh
10.2 Employment Resignation Agreement, dated 8/19/98, between
the Registrant and Michael Romanies
10.3 Consultant Agreement, dated 8/25/98, between the
Registrant and Michael Romanies
27 Financial Data Schedule
<PAGE>
MEMO TO: Larry Mcintosh
SUBJECT: Terms & Conditions of Continued Employment
DATE: April 20, 1998
Resultant of our discussions during the week of April 13, 1998, the following
items represent your agreement to the terms and conditions as mutually
negotiated to remain as an employee of Number Nine in your present capacity as
VP OEM Sales. The following conditions/terms are part of this agreement:
(1) Your new salary will be $6,250 per pay period, paid twice a month
annualized at $150,000. The effective date of your new salary will be
April 30, 1998.
(2) The Company will grant you an option to purchase 100,000 shares of
common stock (normal vesting terms) at a purchase price at fair market
value on the day of the grant with acceleration based on mutually
agreed performance goals being met on time.
(3) Should the Company engage in a change of control for all or
substantially all of the Company's assets (greater than (50%) fifty
percent) prior to the completion of the performance goal arrangement
stated in #2 above, you and the Company will review the ability to
achieve these goals as a result of the change of control. If the goals
are determined to be unachievable or new goals cannot be reasonably
established, acceleration of all or a portion of these shares will be
addressed.
(4) Should the Company terminate your employment for reasons other than
for cause, the Company will continue to pay your salary for a ninety
day period from the official date of termination. The Company will
also continue your health and medical benefit coverage for the same
ninety day period at the level of benefit in place at the time of the
official date of termination.
(5) Upon the vacancy of the VP Worldwide Sales position, you will assume
the duties, title, responsibilities and accountabilities as assigned
to the position. In addition, you will be expected to perform such
other duties, responsibilities and accountabilities that may be
assigned to you by the Company from time to time.
(6) The Company agrees to the acceleration of the unvested shares granted
on August 21, 1997.
Accepted and Agreed: Date: 4/22/98
/s/ Larry Mcintosh /s/ Andy Najda
- - ---------------------------------- -----------------------------
Larry Mcintosh Andy Najda
Chairman, CEO
Number Nine Visual Technology
<PAGE>
[NUMBER 9 VISUAL TECHNOLOGY LOGO APPEARS HERE]
M E M O R A N D U M
To: William Ralph
CC:
From: Michael Romanies
Date: 08/19/98
Re: Resignation
- - --------------------------------------------------------------------------------
Pursuant with our discussions yesterday, please accept this memorandum as
official notice of my resignation as Vice President, Marketing at NUMBER NINE
VISUAL TECHNOLOGY, Corporation.
The dedicated efforts of my staff and the other groups within the organization
have made significant impact on the position and stature of the company and its
products within the industry. The recent announcements and pending shipments of
the Revolution(R) IV and Ticket Ride(TM) products are positioned to follow the
lead of the Award winning Revolution 3D products. The company is now poised for
the next phase of its growth.
The recent partnership and equity interest of Silicon Graphics marks the
culmination of the efforts by the executive team and employees of Number Nine
achieving another significant milestone for the company.
In recognition of the personal goals and objectives that my team and I have
achieved over the past two years, I am now ready to pursue other personal and
professional challenges.
I appreciate the opportunity to work with the "Niners" and look forward to
maintaining the relationships I have made.
Thank you,
<PAGE>
[NUMBER 9 VISUAL TECHNOLOGY LOGO APPEARS HERE]
August 25, 1998
Mr. Michael Romanies
Dear Michael;
Pursuant to your intended departure from Number Nine and subsequent agreement to
be retained by Number Nine in an on-call consulting capacity through October 23,
1998, the following will constitute the terms of separation and retention as a
consultant to the Company.
It is agreed that:
1. When engaged as a Consultant, you will be paid at your current
rate of compensation plus all reasonable expenses.
2. All of the Company paid insurance will remain in effect through
October 23, 1998 including those benefits extended to you as an
Officer of the Company. As of October 23, 1998 you will be
eligible for COBRA coverage and need to notify Number Nine of
your intent to take/not take advantage of this benefit
continuation, as it is made available to you under Federal Law.
3. The stock option grant of June, 1998 will continue to vest under
the terms of the grant through the period of this consultant
agreement.
4. The stock option grant of August, 1997 will continue to vest
under the terms of the grant through the period of this
consultant agreement.
By affixing signatures below, both parties understand the terms and conditions
of this agreement.
/s/ William Ralph /s/ Michael Romanies
- - --------------------------------- ---------------------------------
Number Nine Visual Technology Michael Romanies
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