<PAGE>
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 March 28, 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
-------
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 02173
- --------------------------------- -----
(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 May 4, 1998 was 9,306,925
<PAGE>
NUMBER NINE VISUAL TECHNOLOGY CORPORATION
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
Page
----
<S> <C>
Part I - Financial Information:
- -------------------------------
Item 1 - Financial Statements
Condensed Consolidated Balance Sheets as of March 28, 1998 and
December 27, 1997 3
Condensed Consolidated Statements of Operations for the three months ended
March 28, 1998 and March 29, 1997 4
Condensed Consolidated Statements of Cash Flows for the three months ended
March 28, 1998 and March 29, 1997 5
Notes to Condensed Consolidated Financial Statements 6
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
Part II - Other Information: 15
- ----------------------------
Item 1 - Legal Proceedings
Item 2 - Changes in Securities
Item 3 - Defaults Upon Senior Securities
Item 4 - Submission of Matters to a Vote of Security Holders
Item 5 - Other Information
Item 6(a) - Exhibits
10.24 Securities Purchase Agreement
10.25 Secured Subordinated Convertible Promissory Note
10.26 Three Year Warrant
11 Statement Regarding Computation of Net Income (Loss) per Share
27 Financial Data Schedule
6(b) - Reports on Form 8-K
SIGNATURE(S) 17
</TABLE>
2
<PAGE>
NUMBER NINE VISUAL TECHNOLOGY CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
MARCH 28, 1998 DECEMBER 27, 1997
------------------- --------------------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 616 $ 2,481
Accounts receivable, trade, net of allowances for doubtful accounts
of $131 and $193, at March 28, 1998 and December 27, 1997 8,235 10,506
Receivables from manufacturing contractor 1,699 1,678
Inventories 3,332 2,864
Prepaid expenses 386 274
-------- --------
Total current assets 14,268 17,803
Property and equipment, net 3,571 3,906
Other assets 89 150
-------- --------
TOTAL ASSETS $ 17,928 $ 21,859
======== ========
CURRENT LIABILITIES:
Revolving line of credit $ 5,976 $ 8,500
Accounts payable 7,781 6,148
Accrued expenses and other current liabilities 1,238 1,429
-------- --------
Total current liabilities 14,995 16,077
Commitments and contingencies - -
STOCKHOLDERS' EQUITY:
Preferred Stock, $.01 par value; 5,000,000 shares
authorized; no shares issued or outstanding - -
Common Stock, $.01 par value; 20,000,000 shares authorized;
9,298,405 shares issued and outstanding at March 28, 1998;
9,172,548 shares issued and outstanding at December 27, 1997 93 92
Additional paid-in capital 36,176 35,994
Accumulated deficit (33,336) (30,304)
-------- --------
Total stockholders' equity 2,933 5,782
-------- --------
Total liabilities and stockholders' equity $ 17,928 $ 21,859
======== ========
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
3
<PAGE>
NUMBER NINE VISUAL TECHNOLOGY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 28, 1998 MARCH 29, 1997
---------------------- ----------------------
<S> <C> <C>
Net sales $ 8,141 $13,964
Cost of sales 7,309 11,550
------- -------
Gross profit 832 2,414
Operating expenses:
Selling, general, and 2,154 3,299
administrative
Research and development 1,639 1,481
------- -------
Total operating expenses 3,793 4,780
Income (loss) from operations (2,961) (2,366)
Other expense (income):
Interest expense 109 106
Other expense (income) (38) (115)
------- -------
Income (loss) before income taxes (3,032) (2,357)
Provision (benefit) for income taxes - -
------- -------
Net income (loss) $(3,032) $(2,357)
======= =======
Net income (loss) per common and
equivalent share - diluted $ (0.33) $ (0.26)
======= =======
Net income (loss) per common and
equivalent share - primary $ (0.33) $ (0.26)
======= =======
Common and equivalent shares used
in computing net income (loss) per
share - diluted 9,199 9,077
======= =======
Common and equivalent shares used
in computing net income (loss) per
share - primary 9,199 9,077
======= =======
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
4
<PAGE>
<TABLE>
<CAPTION>
NUMBER NINE VISUAL TECHNOLOGY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(in thousands)
THREE MONTHS ENDED
MARCH 28, 1998 MARCH 29, 1997
----------------------- ------------------------
<S> <C> <C>
Cash flows provided by (used for) operating activities:
Net income (loss) $(3,032) $(2,357)
Adjustments to reconcile net income to net cash
provided by (used for) operating activities:
Depreciation and amortization 407 265
Amortization of capitalized software costs - 201
Provision for bad debts - 361
Change in operating assets and liabilities:
Accounts receivable 2,271 3,032
Receivable due from manufacturing contractor (21) 1,181
Inventories (468) 2,982
Prepaids and other assets (51) (192)
Accounts payable 1,633 (2,493)
Accrued expenses and other current liabilities (191) (979)
------- -------
Net cash provided by (used for) operating activities 548 2,001
Cash flows provided by (used for) investing activities:
Purchase of property and equipment (72) (280)
------- -------
Net cash used for investing activities (72) (280)
Cash flows provided by (used for) financing activities:
Proceeds from issuance of common stock and
exercise of common stock options 183 80
Proceeds (payments) from revolving line of credit, net (2,524) (5,500)
Principal payments on capital lease obligations - (21)
------- -------
Net cash provided by (used for) financing activities (2,341) (5,441)
------- -------
Net change in cash and cash equivalents (1,865) (3,720)
Cash and cash equivalents, beginning of period 2,481 13,895
------- -------
Cash and cash equivalents, end of period $ 616 $10,175
======= =======
Supplemental disclosures of cash flow information:
Interest paid: $ 102 $ 146
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
5
<PAGE>
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.
The Company has continued to incur substantial losses from operations, has
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 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. However, no assurance can be provided that
the Company will be successful in raising capital or entering into a business
alliance. 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.
The accompanying condensed unaudited consolidated financial statements have
been prepared by Number Nine Visual Technology Corporation (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 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 ended March 28, 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 March 28, 1998, included in cash and cash equivalents is approximately
$616,000 invested in overnight or 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):
<TABLE>
<CAPTION>
MARCH 28, 1998 DECEMBER 27, 1997
-------------- -----------------
<S> <C> <C>
Raw materials $ 784 $ 527
Work in process 580 715
Finished goods 1,968 1,622
------ ------
$3,332 $2,864
====== ======
</TABLE>
6
<PAGE>
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 30, 1995 and June 28, 1996, a portion of inventory related to
several of the Company's products was identified as in excess of current
requirements based on a number of factors such as an acceleration of product
transitions, further deterioration of memory inventory value, continued pressure
on pricing of older products, lower than expected sales activity of certain
products and excess component inventories. Accordingly, during the fourth
quarter of 1995 and second quarter of 1996, the Company wrote off approximately
$8.0 and $5.7 million of inventory, respectively related to these products.
Management has developed a program to reduce the remaining inventory to desired
levels over the near term and believes no loss will be incurred on its
disposition. No estimate can be made of a range of amounts of loss that are
reasonably possible should the program not be successful. At March 28, 1998 and
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.
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 (8.50% as of
March 28, 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 agreement expires on December 2,
1998 and is renewable on a yearly basis thereafter. The loan balance is
collateralized by substantially all of the Company's assets.
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 waiver from the lender for
noncompliance with certain covenants in the agreement, which is effective until
September 30, 1998. 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 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.
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.
7
<PAGE>
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.
The Company does not believe that the implementation of FAS 129, FAS 131 or
FAS 132 will have a material impact on the Company's financial statements.
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
intends to adopt the requirements of this pronouncement in its financial
statements for the quarter ending 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 March 28, 1998.
F. Income Taxes:
-------------
At March 28, 1998, 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 carry-forwards begin to
expire in 2010 and the state net carry-forwards begin to expire in 2000.
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.
8
<PAGE>
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.
Additionally, the Company has begun development of its fourth generation 128-bit
graphics accelerator chip technology. There can be no assurance that the
Company's latest generation product, Revolution3D utilizing the Ticket to Ride
chip will be successful or that the fourth generation product will be completed
and marketed successfully. The Company also markets Hawkeye95, 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. In addition, the Company has begun to ship several new
video/graphics products, including the second and third generations of its
Imagine 128 accelerator board for Apple PowerMac PCI computers, and next-
generation merchant accelerator chip based products in its Vision, Motion and
Reality product families. During 1998, the Company currently plans to develop
several different products with 3-D capabilities and anticipates that most of
its products will also incorporate motion video acceleration.
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. In particular, in the second
quarter of 1996, the Company identified charges of approximately $5.7 million of
obsolete and excess finished goods and component inventory. There were a number
of events during the second quarter of 1996 that were the primary drivers for
this provision. These include an acceleration of product transitions, further
deterioration of memory inventory value, continued pressure on pricing of older
products, lower than expected sales activity of certain products and excess
component inventories. 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 43.8% of net sales in 1997, 68.3% of net sales in 1996, and 52.8% of net
sales during 1995, 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
9
<PAGE>
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, which have varied widely over the past several years, as well as
significant pricing pressure on its products as a result of competition.
RESULTS OF OPERATIONS FOR THE QUARTERS ENDED MARCH 28, 1998 AND MARCH 29, 1997
Net Sales: Net sales decreased 42%, to $8.1 million in the first quarter of
1998 from approximately $14.0 million in the first quarter of 1997. This
decrease was primarily attributable to lower sales of the Company's prorprietary
128-bit products to the Company's OEM customers. Net sales of the Company's
proprietary 128-bit products decreased 62% to $3.9 million in the first quarter
of 1998 from $10.3 million in the first quarter of 1997, representing 48.1% of
net sales in the first quarter of 1998 compared to 73.6% in net sales in the
first quarter of 1997. Sales of 64-bit products represented the remaining $4.2
million or 51.9% of net sales during the first quarter of 1998 compared to
approximately $3.7 million or 26.4% of net sales in the first quarter of 1997.
Sales to OEMs decreased 33%, to approximately $5.9 million in the first quarter
of 1998 from approximately $8.8 million in the first quarter of 1997,
representing 72.8% in the first quarter of 1998 compared to 62.9% of net sales
in the first quarter of 1997. The decrease in OEM sales was primarily a result
of essentially no sales to Dell Computer Corporation ("Dell") during the first
quarter of 1998 compared to net sales of 35.7% or approximately $5.0 million
during the first quarter of 1997. The loss of net sales to Dell was partially
offset by new sales activity with International Business Machines Corporation
("IBM"), which represented approximately $2.6 million or 32.1% of net sales in
the first quarter of 1998. Sales to Micron Electronics, Inc. represented 12.3%
in the first quarter of 1998 compared to 12.9% of net sales in the first quarter
of 1997. Net sales to the Company's retail and two-tier distribution customers
decreased 62%, to $1.0 million during the first quarter of 1998 compared to $2.6
million during the first quarter of 1997. Total international sales decreased
19% to $3.5 million in the first quarter of 1998 from approximately $4.3 million
in the first quarter of 1997.
Gross Profit: Gross profit decreased 66%, to $832,000 in the first quarter
of 1998 from $2.4 million in the first quarter of 1997. The decrease in gross
profit during the first quarter 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 quarter of 1997. The Company's gross
profit margin decreased to 10.2% in the first quarter of 1998 from 17.3% in the
first quarter of 1997, due primarily to decreased net sales of the Company's
proprietary 128-bit products, which tend to generate higher gross margins than
products utilizing merchant 64-bit chip technology, as well as continued pricing
pressure across the Company's products. 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, 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 33%, to approximately $2.2 million in the
first quarter of 1998 from $3.3 million in the first quarter 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 27.2% in the first
quarter of 1998 from 23.6% in the first 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
10
<PAGE>
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
increased 7%, to $1.6 million in the first quarter of 1998 from approximately
$1.5 million in the first quarter of 1997, resulting primarily from increased
staffing to support continued development of both proprietary based
video/graphics products. During the first quarter of 1998, the Company continued
the development of its fourth generation proprietary 128-bit video/graphics
accelerator chip, and 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 19.8% in the first quarter of 1998 from 10.7%
in the first quarter of 1997, primarily attributable to lower sales in the
recent quarter and increased expenditures on research and development. The
Company currently expects that research and development expenses will continue
to increase, 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/Income: Net interest expense for the first quarter of 1998
was $109,000 compared to interest expense of $106,000 in the first quarter of
1997.
Other Expense/Income: Other income totaled $43,000 in the first quarter of
1998 compared to other income of $115,000 in the first quarter of 1997. Other
income during the first quarter of 1998 and the first quarter of 1997 was
primarily attributable to interest earned on cash and cash equivalents.
Provision (Benefit) for Income Taxes: During the first quarter of 1998 and
the first quarter 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:
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.
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
11
<PAGE>
competition, and rapidly changing pricing. In this regard, the life cycle of
products in the Company's markets is often as short as six 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. For example, the
Company is currently completing its development efforts on its fourth generation
proprietary 128-bit video/graphics accelerator chip, while its third generation
proprietary 128-bit video/graphics accelerator chip is nearing the end of its
product life cycle. The Company's ability to successfully transition its
Revolution 3D 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 first 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
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 a significant portion 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. As a result of the decline in net sales
to the Company's OEM customers, primarily Dell, and product transitions, net
sales declined in the first quarter of 1998 compared to the first quarter of
1997. 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.
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. For example, during 1996, the Company's reliance on its proprietary
products increased as a percentage of net sales and gross profit throughout
1996. 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.
Due primarily to industry seasonality, demand for the Company's products
historically has been strongest during the fourth calendar quarter, and sales in
the subsequent calendar quarter have tended to decline. Net sales decreased
44.3% in the first quarter of 1998 from the fourth quarter of 1997 and 40.8% in
the first quarter of 1997 from the fourth quarter of 1996, although period-to-
period comparisons of financial results should not be relied upon as an
indication of future performance. Quarterly peaks in sales also tend to coincide
with peak working capital requirements.
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
12
<PAGE>
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. If the lawsuits are
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).
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 including in the Company's Annual Report on
Form 10-K for the year ending Decmeber 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 actions 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. However, no assurance can be
provided that the Company will be successful in raising capital or entering into
a 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, increasing 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.
The Company incurred valuation adjustments for inventory during the fourth
quarter of 1995 and second quarter of 1996, and recorded charges to cost of
sales associated with obsolete and excess inventory of $8.0 million and $5.7
million, respectively. The Company determined that the market value for this
material was substantially less than the cost to procure and build, and the
Company has written down the components to estimated net realizable value less
selling costs. Significant pricing pressure for the Company's products has been
experienced during 1997 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 first quarter ending March 28, 1998, the Company continued to incur
losses on reduced revenue while marketplace pricing pressure has increased. The
Company's operating activities provided cash of approximately $549,000 in the
first quarter of 1998, compared to operating activities which provided cash of
approximately $2.0
13
<PAGE>
million in the first quarter of 1997. In the first quarter of 1998, a net
decrease in accounts receivable and an increase in accounts payable, provided
cash of approximately $2.3 million and $1.6 million, respectively, which was
offset by a net loss from operations of $3.0 million and an increase of
inventories of $467,000. Decreases in accounts receivable have primarily been
attributable to lower sales levels in the first 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 March 28, 1998, the Company's principal
sources of liquidity consisted of approximately $616,000 of cash and cash
equivalents and approximately $8.8 million available under its revolving line of
credit, pending approval of the debt covenant waivers and subject to the
Company's receivables described below.
In the first quarter of 1998, investing activities used cash of approximately
$72,000 for purchases of computer and office equipment compared to $280,000 for
purchases and office equipment in the first quarter of 1997. Financing
activities used cash of $2.3 million during the first quarter of 1998,
attributable to the reduction of the outstanding balance of the revolving credit
facility by $2.5 million. During the first quarter of 1997, financing activities
used cash of $5.4 attributable to the reduction of the outstanding balance of
the revolving credit facility by $5.5 million.
As of March 28, 1998, approximately $6.0 million 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. On May 7, 1998, The Company executed a forebearance
agreement with this lender which the Company is required to have its outstanding
loan balance within its defined borrowing capacity by June 19, 1998. This
agreement will also permit the Company to borrow within this borrowing capacity
through September 30, 1998 up to a maximum amount of $4.5 million.
On April 17, 1998, the Company received a short term loan of $3.0 million
due May 17, 1998 from a stratgic partner as part of a technology and financial
relationship. On May 7, 1998, the Companies signed financing and technology
agreements. The financing is structured as a loan pursuant to which the Company
may borrow up to $9.0 million, of which $3.0 was borrowed in April, 1998. This
loan is convertible into preferred stock at a conversion price of $2.75 per
share. The loan, if not converted, is payable on demand 180 days after September
30, 1998. The loan is subordinate to the Company's existing secured line of
credit and is secured by essentially all of the Company's assets. The strategic
partner was issued a 3-year warrant to purchase up to 3% of the outstanding
common stock at the time of exercise at a price of $2.75 per share only if the
Company repays outstanding princial and interest under this loan.
The Company believes that its existing cash balances plus funds generated
from product sales, and financing arrangements described above would be
sufficient to fund operations at anticipated levels through the third quarter of
1998. However, after the third 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 would
result 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. No assurances can be given that any additional financing will be
available to the Company on acceptable terms, if at all.
PART II. OTHER INFORMATION:
- -------- ------------------
Item 1 - Legal Proceedings
14
<PAGE>
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
On March 26, 1998, the Company issued and sold 15,000 shares of Common Stock
to one person pursuant to the exercise of an option granted under its 1989 Stock
Option Plan. The purchase price paid upon the exercise of this option was $0.27
per share. These shares were issued in reliance upon the exemption from
registration set forth in Rule 701 promulgated under the Securities Act of 1933,
as amended.
Item 3 - Defaults Upon Senior Securities
Not Applicable
15
<PAGE>
Item 4 - Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the first
quarter ended March 28, 1998.
Item 5- Other Information
On May 7, 1998, the Company entered into a loan agreement under which it may
borrow up to $9.0 million. The loan is convertible into preferred stock at a
conversion price of $2.75 per share. The loan, if not converted, is payable on
demand 180 days after September 30, 1998 and is subordinated to the Company's
existing secured line of credit and is secured by essentially all of the
Company's assets. The Company also issued a 3-year warrant to purchase up to 3%
of the outstanding common stock at the time of exercise at $2.75 per share if
the Company repays the outstanding principal and interest under the loan.
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.
<TABLE>
<CAPTION>
Exhibit
Number Description
------ -----------
<C> <S>
10.24 Securities Purchase Agreement
10.25 Secured Subordinated Convertible Promissory Note
10.26 Three Year Warrant
27 Financial Data Schedule
</TABLE>
---------------------------------
(b) Reports on Form 8-K
-------------------
No reports on Form 8-K were filed during the quarterly period ended March 28,
1998.
16
<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: May 12, 1998 /s/ Andrew Najda .
----------------------------------------------
Andrew Najda
Chairman and Chief Executive Officer
(Principal Executive Officer)
Date: May 12, 1998 /s/ Timothy J. Burns .
------------------------------------------------
Timothy J. Burns
Acting Chief Financial Officer
(Principal Financial and Accounting Officer)
17
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Number Description of Exhibits Page
- -------------- ----------------------- ----
<C> <S> <C>
10.24 Securities Purchase Agreement (to be filed by amendment)
10.25 Secured Subordinated Convertible Promissory Note (to be filed by amendment)
10.26 Three Year Warrant (to be filed by amendment)
27 Financial Data Schedule
</TABLE>
18
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-02-1999
<PERIOD-START> DEC-28-1997
<PERIOD-END> MAR-28-1998
<CASH> 616
<SECURITIES> 0
<RECEIVABLES> 9,934
<ALLOWANCES> 131
<INVENTORY> 3,332
<CURRENT-ASSETS> 14,268
<PP&E> 3,571
<DEPRECIATION> 0
<TOTAL-ASSETS> 17,928
<CURRENT-LIABILITIES> 14,995
<BONDS> 0
0
0
<COMMON> 93
<OTHER-SE> 2,840
<TOTAL-LIABILITY-AND-EQUITY> 17,928
<SALES> 8,141
<TOTAL-REVENUES> 8,141
<CGS> 7,309
<TOTAL-COSTS> 11,102
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 109
<INCOME-PRETAX> (3,032)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,032)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,032)
<EPS-PRIMARY> (0.33)
<EPS-DILUTED> (0.33)
</TABLE>
