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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 September 30, 1997
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 0-25580
DIAMOND MULTIMEDIA SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0390654
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2880 JUNCTION AVENUE, SAN JOSE, CALIFORNIA 95134
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 325-7000
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 September 30, 1997 was 34,435,719.
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DIAMOND MULTIMEDIA SYSTEMS, INC.
INDEX TO FORM 10-Q
<TABLE>
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Page
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PART I - FINANCIAL INFORMATION:
ITEM 1- Financial Statements
Consolidated Condensed Balance Sheets as of September 30, 1997
and December 31, 1996 3
Consolidated Condensed Statements of Operations for the three
and nine months ended September 30, 1997 and 1996 4
Consolidated Condensed Statements of Cash Flows
for the nine months ended September 30, 1997 and 1996 5
Notes to Consolidated Condensed Financial Statements 6
ITEM 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 8
PART II - OTHER INFORMATION
ITEM 1 - Legal proceedings 26
ITEM 2 - Changes in securities 26
ITEM 3 - Defaults Upon Senior Securities 26
ITEM 4 - Submission of Matters to a Vote of Security Holders 26
ITEM 5 - Other Information 26
ITEM 6 - Exhibits and Reports on Form 8-K 26
SIGNATURES 27
</TABLE>
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PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
DIAMOND MULTIMEDIA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 98,284 $ 120,147
Trade accounts receivable, net of allowance for
doubtful accounts of $2,237 and $1,943 as of
September 30, 1997 and December 31, 1996 50,718 85,268
Inventories 72,208 63,704
Prepaid expenses and other current assets 6,154 9,043
Deferred income taxes 42,270 21,944
--------- ---------
Total current assets 269,634 300,106
Property, plant and equipment, net 14,555 12,883
Other assets 3,617 3,222
Goodwill and other intangibles, net 3,487 16,227
--------- ---------
Total assets $ 291,293 $ 332,438
========= =========
LIABILITIES
Current liabilities:
Current portion of long-term debt $ 29,174 $ 18,068
Trade accounts payable 72,055 68,770
Other accrued liabilities 14,760 17,740
--------- ---------
Total current liabilities 115,989 104,578
Long-term debt, net of current portion 2,036 2,730
Deferred income taxes -- 835
--------- ---------
Total liabilities 118,025 108,143
--------- ---------
STOCKHOLDERS' EQUITY
Preferred stock, par value $.001; Authorized - 8,000
shares at September 30, 1997 and December 31, 1996;
none issued and outstanding -- --
Common stock, par value $.001;
Authorized - 75,000 at September 30, 1997 and
December 31, 1996 Issued and outstanding - 34,436
at September 30, 1997 and 34,163 at December 31, 1996 34 34
Additional paid-in capital 307,632 306,046
Distributions in excess of net book value (56,775) (56,775)
Accumulated deficit (77,623) (25,010)
--------- ---------
Total stockholders' equity 173,268 224,295
--------- ---------
Total liabilities and stockholders' equity $ 291,293 $ 332,438
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated
condensed financial statements.
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DIAMOND MULTIMEDIA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
1997 1996 1997 1996
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net sales $ 92,028 $ 123,729 $ 257,413 $ 431,553
Cost of sales 73,850 98,706 242,767 355,301
--------- --------- --------- ---------
Gross profit 18,178 25,023 14,646 76,252
--------- --------- --------- ---------
Operating expenses:
Research and development 5,899 4,435 18,121 13,869
Selling, general and administrative 16,474 16,587 61,557 46,421
Amortization of intangibles 172 1,292 2,831 3,686
Write-off of intangibles -- -- 9,938 --
--------- --------- --------- ---------
Total operating expenses 22,545 22,314 92,447 63,976
--------- --------- --------- ---------
Income (loss) from operations (4,367) 2,709 (77,801) 12,276
Interest income, net 388 544 1,426 1,429
Other income (expense), net 50 (59) 783 (99)
--------- --------- --------- ---------
Income (loss) before provision for
income taxes (3,929) 3,194 (75,592) 13,606
Provision (benefit) for income taxes (1,376) 1,094 (22,979) 5,102
--------- --------- --------- ---------
Net income (loss) $ (2,553) $ 2,100 $ (52,613) $ 8,504
========= ========= ========= =========
Net income (loss) per share $ (0.07) $ 0.06 $ (1.54) $ 0.24
========= ========= ========= =========
Shares used in computing per share
amounts 34,389 34,930 34,274 35,051
</TABLE>
The accompanying notes are an integral part of these consolidated
condensed financial statements.
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DIAMOND MULTIMEDIA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED; IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
1997 1996
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ($ 52,613) $ 8,504
Adjustments to reconcile net income (loss)
to net cash
provided by (used in) operating activities
Depreciation and amortization 6,631 6,290
Provision for doubtful accounts 691 606
Provision for excess and obsolete inventories 7,093 13,767
Loss on disposal of fixed assets 287 --
Write-off of intangibles 9,938 --
Deferred income taxes (21,161) (6,212)
Changes in assets and liabilities:
Trade accounts and other receivables 33,859 34,534
Inventories (15,597) 3,303
Prepaid expenses and other assets 2,494 (76)
Trade accounts payable and other liabilities 305 (26,365)
--------- ---------
Net cash provided by (used in) operating activities (28,073) 34,351
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment (5,788) (5,041)
Proceeds from the sale of short-term investments -- 12,232
--------- ---------
Net cash provided by (used in) investing
activities (5,788) 7,191
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock 1,593 813
Repurchases of common stock (7) (20)
Proceeds from term loans and revolving credit facilities 100,942 21,546
Payments of term loans and revolving credit facilities (89,929) (35,679)
Repayments of capital lease financings, net of
proceeds from capital lease financings (601) (390)
--------- ---------
Net cash provided by (used in) financing activities 11,998 (13,730)
--------- ---------
Net increase (decrease) in cash and cash equivalents (21,863) 27,812
Cash and cash equivalents at beginning of period 120,147 93,971
--------- ---------
Cash and cash equivalents at end of period $ 98,284 $ 121,783
========= =========
Supplemental Disclosure of cash flow information:
Income taxes paid during the period $ 1,400 $ 13,293
========= =========
Interest paid during the period $ 783 $ 1,260
========= =========
Supplemental disclosure of non-cash financing activities:
Issuance of common stock in settlement of
Note Receivable $-- $ 3,196
========= =========
Issuance of common stock in settlement of
contingencies in Spea acquisition $-- $ 580
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated
condensed financial statements.
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DIAMOND MULTIMEDIA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared by the Company in accordance with generally accepted accounting
principles for interim financial information and pursuant to rules and
regulations of the Securities and Exchange Commission. In the opinion of
management, all adjustments (consisting only of normal recurring adjustments)
considered necessary for a fair presentation have been included. These financial
statements should be read in conjunction with the Company's consolidated
financial statements and notes thereto contained in the Company's Form 10-K for
the fiscal year ended December 31, 1996.
The Company operates under a fiscal year with thirteen week quarters that end on
the Sunday closest to calendar quarter end. For convenience of presentation, the
accompanying consolidated financial statements have been shown as ending on
September 30. Subsequent to the quarter ended September 30, 1997, the Company
made a determination to change its fiscal 1997 year-end to December 31,1997.
(Refer to Subsequent Event in Note 5).
Operating results for the quarter and nine months ended September 30, 1997 may
not necessarily be indicative of the results to be expected for any other
interim period or for the full year.
2. INVENTORIES
Inventories are stated at the lower of cost (determined on a first-in, first-out
basis) or market. Inventories consisted of (in thousands):
<TABLE>
<CAPTION>
September 30, 1997 December 31, 1996
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<S> <C> <C>
Raw materials $26,981 $22,080
Work in process 36,427 20,847
Finished goods 8,800 20,777
------- -------
$72,208 $63,704
======= =======
</TABLE>
The Company has approximately $3 million of inventory in excess of its normal
short-term needs for certain product lines at September 30, 1997. Management has
developed a program to reduce this inventory to desired levels over the near
term; however, it is reasonably possible that the program will not be wholly
successful and a material loss could ultimately result on the disposal of this
inventory. No estimate can be made of the range of amounts of such loss.
3. LITIGATION
The Company has been named as a defendant in several putative class action
lawsuits which were filed in June and July, 1996 and June, 1997 in the
California Superior Court for Santa Clara County and the U.S. District Court for
the Northern District of California. Certain executive officers and directors of
the Company are also named as defendants. The plaintiffs purport to represent a
class of all persons who purchased the Company's Common Stock between October
18, 1995 and June 20, 1996 (the "Class Period"). The complaints allege claims
under the federal securities laws and California law. The plaintiffs allege that
the Company and the other defendants made various material misrepresentations
and omissions during the Class Period. The complaints do not specify the amount
of damages sought. The Company believes that it has good defenses to the claims
alleged in the lawsuits and will defend itself vigorously against these actions.
These cases are in the early stages and no trial date has been set. The ultimate
outcome of these actions cannot be presently determined.
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Accordingly, no provision for any liability or loss that may result from
adjudication or settlement thereof has been made in the accompanying
consolidated financial statements.
The Company is also party to other claims and pending legal proceedings that
generally involve employment and trademark issues. These cases are, in the
opinion of management, ordinary and routine matters incidental to the normal
business conducted by the Company. In the opinion of management, the ultimate
disposition of such proceedings will not have a materially adverse effect on the
Company's consolidated financial position or future results of operations.
4. RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS 128), which
specifies the computation, presentation and disclosure requirements for earnings
per share. SFAS 128 supersedes Accounting Principles Board Opinion No. 15 and is
effective for financial statements issued for periods ending after December 15,
1997. SFAS 128 requires restatement of all prior-period earnings per share data
presented after the effective date. SFAS will not have a material impact on the
Company's financial position, results of operations or cash flows.
In June 1997, the Financial Accounting Standards Board issued a Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS
130). SFAS 130 establishes standards for reporting and display of comprehensive
income and its components in a full set of general-purpose financial statements.
Comprehensive income is defined as the "change in equity of a business
enterprise during a period from transactions and other events and circumstances
from nonowner sources. It includes all changes in equity during a period except
those resulting from investments by owners and distributions to owners." SFAS
130 is effective for fiscal years beginning after December 15, 1997, and
reclassification of financial statements for earlier periods provided for
comparative purposes is required. SFAS 130 is not expected to have a material
impact on the Company's financial position, results of operations or cash flows.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS 131). SFAS 131 establishes standards
for the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to stockholders. SFAS 131 generally supersedes Statement of
Financial Accounting Standards No. 14, "Financial Reporting for Segments of a
Business Enterprise." Under SFAS 131, operating segments are components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. Generally, financial
information is required to be reported on the basis it is used internally. SFAS
131 is effective for financial statements for periods beginning after December
15, 1997, and restatement of comparative information for earlier years is
required. However, SFAS 131 is not required to be applied to interim financial
statements in the initial year of application. SFAS 131 will not have a material
impact on the Company's financial position, results of operations or cash flows.
5. SUBSEQUENT EVENT
On October 15, 1997, the Company determined to change its fiscal year end 1997.
Previously, the year-end date was the Sunday closest to the end of the last
month of the calendar year. The date of the new 1997 fiscal year-end is December
31, 1997. The Company has filed a Form 8-K with the Securites and Exchange
Commission on October 28, 1997 for the change in the fiscal year-end.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The discussion and analysis below contains trend analysis and other
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual
results could differ materially from those projected in the forward-looking
statements as a result of the risk factors set forth under "Certain Factors That
May Affect Future Performance" below and elsewhere in this report.
The following discussion should be read in conjunction with the Company's
consolidated financial statements and the notes thereto. All references to years
represent fiscal years unless otherwise noted.
OVERVIEW
The Company develops, manufactures, markets and supports multimedia and
connectivity solutions for home, business and professional desktop computer
users, enabling them to create, access and experience compelling new media
content from their desktops and through the Internet. Products include the
Stealth and Monster 3D(TM) series of media accelerators, the Fire series of
professional 3D graphics accelerators, and SCSI I/O adapters, and the Supra(R)
series of fax/modems and ISDN adapters. Diamond also markets multimedia and
video phone upgrade kits. Headquartered in San Jose, CA, Diamond has sales,
marketing or technical offices in Vancouver (Wash.), Singapore, Sydney, Hong
Kong, Seoul, Tokyo, Starnberg (Germany), Saarbrecken (Germany), Paris, Winnersh
(U.K.) and Sweden. Diamond's products are sold through regional, national and
international distributors as well as directly to major computer retailers, VARs
and OEMs worldwide.
NET SALES
Net sales for the third quarter of 1997 decreased $31.7 million (26%) to
$92.0 million compared to the third quarter of 1996 while net sales for the
first nine months of 1997 decreased $174.1 million (40%) to $257.4 million
compared to the corresponding prior year period. The decrease in net sales has
been primarily attributable to significant price erosion in the Company's base
business of multimedia accelerator systems and modems, particularly during the
first and second quarters of 1997, which triggered large price protection
charges during those periods. Further, the product transition from 33.6Kbps to
56Kbps modems was much slower than expected in the first six months of 1997, and
while the product transition gathered momentum in the third quarter of 1997, the
slow growth of the 56Kbps modems has not compensated for the decline in 33.6K
modem shipments.
As a percentage of net sales, international net sales represented 38% in the
third quarter of 1997 compared to 33% in the third quarter of 1996, and 37% in
the first nine months of 1997 compared to 34% in the corresponding prior year
period. The increases in the percentage of international sales were primarily
due to the growth of European demand in the third quarter of 1997 as well as
large price protection charges and relatively weak demand in the domestic market
during the second quarter of 1997. The increases in the percentage of
international sales, for the periods discussed, were partially offset by a
decline of net sales in Asia during 1997.
Inventory levels of the Company's products in the two-tier distribution
channels used by the Company ("Channel Inventory Levels") generally are
maintained in a range of one to three months of customer demand. These Channel
Inventory Levels tend toward the low end of the months-of-supply range when
demand is stronger, sales are higher and products are in short supply.
Conversely, when demand is slower, sales are lower and products are abundant,
then Channel Inventory Levels tend toward the high end of the months-of-supply
range. Frequently, in such situations, the Company attempts to ensure that
distributors devote their working capital, sales and logistics resources to the
Company's products to a greater degree than to those of competitors. Similarly,
the Company's competitors attempt to ensure that their own products are
receiving a disproportionately higher share of the distributors' working capital
and logistics resources. In an environment of slower demand and abundant supply
of products, price declines are more likely to occur and, should they occur, are
more likely to be severe. Further, in such an event, high Channel Inventory
Levels may result in substantial
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<PAGE> 9
price protection charges. Such price protection charges have the effect of
reducing net revenue and gross profit. Consequently, the Company, in taking
steps to bring its Channel Inventory Levels down to a more desirable level, may
cause a shortfall in revenue during one or more accounting periods. This
situation may result in future price protection charges as prices are decreased
having an adverse impact on operating results. While the Company believes that
its Channel Inventory Levels for most of its products are appropriate at this
time, there may be certain products which have a Channel Inventory Level that is
higher than desirable. This situation may lead to significant price protection
charges which would have a material adverse effect on operating results.
When the PC or PC peripherals markets emerge from a period of oversupply,
such as experienced in the second quarter of 1997, certain manufacturers,
distributors and resellers may be unprepared for a possible rapid increase in
market demand. Accordingly, the Company may not have sufficient inventory,
scheduled component purchase orders or available manufacturing capacity to meet
any rapid increase in market demand, thereby missing orders and revenue
opportunities, causing customer dissatisfaction and losing market share. The
Company experienced such a situation in the third quarter of 1997, and may
experience a continuation of that situation in the fourth quarter of 1997 as
recent customer demand for the Company's products has increased over that of the
second and third quarters of 1997. In addition, the Company believes that it is
moving into a period of tight supply and increasing prices on certain
semiconductor components including graphics controllers and memories. The
inability of the Company to obtain product components at their historical cost
levels resulting in the Company being forced to pay higher prices to achieve
timely delivery would directly affect the cost of the Company's products and
could materially and adversely affect the Company's gross margin. There can be
no assurance that the Company will be able to obtain adequate supplies of
components or that such shortages or the costs of these components will not
adversely impact the Company's future operating results.
GROSS MARGIN
Gross margin for the third quarter of 1997 decreased $6.8 million to $18.2
million compared to $25.0 million in the third quarter of 1996, and decreased
$61.6 million to $14.6 million in the first nine months of 1997 compared to
$76.3 million in the corresponding prior year period. Gross margin decreased to
19.8% of net sales during the third quarter of 1997 from 20.2% for the third
quarter of 1996 and decreased to 5.7% in the first nine months of 1997 compared
to 17.7% for the corresponding prior year period. The large decrease in gross
margin in absolute terms in the first nine months of 1997 compared to the prior
year period was primarily due to price protection credits granted to customers
as a result of sales price decreases, inventory write-down charges to record
inventory at lower-of-cost or market value, sales rebate deductions, and
competitive pricing pressures across most product lines. These factors were
particularly significant during the first six months of 1997. Further, the gross
margin was adversely impacted by significantly lower shipment volume levels over
which indirect manufacturing costs could be absorbed.
RESEARCH AND DEVELOPMENT
Research and development (R&D) expenses increased $1.5 million (33%) and $4.3
million (31%) for the third quarter and the first nine months of 1997,
respectively, compared to the corresponding periods in 1996. These increases
were primarily due to higher personnel-related expenses and, to a lesser extent,
the material and outside service costs associated with new product development,
including products that will offer various functions or combinations of
functions including graphics, digital video, 3D animation, 3D CAD, sound, ISDN
adapter, analog modem, telephony, television, MPEG-2, AC-3 and other functions
increasingly being implemented on personal computers. As a percentage of sales,
R&D expenses were 6% and 4% in the third quarters of 1997 and 1996,
respectively, and 7% and 3% in the first nine months of 1997 and 1996,
respectively. The increase in expenses as a percentage of net sales resulted
primarily from the large decline in net sales and, to a lesser extent, increases
in engineering expenses.
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SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative (SG&A) expenses decreased only $0.1
million (1%) for the third quarter compared to the third quarter of 1996 and
increased $15.1 million (33%) in the first nine months of 1997 compared to the
corresponding periods in 1996. The large increase in the first nine months of
1997 was primarily due to higher costs incurred in the first and second quarters
related to sales incentive and promotion programs, including a channel sales
incentive program, higher advertising, marketing and personnel-related expenses
associated with increased sales efforts. The Company also incurred an
approximately $1.2 million restructuring charge in the second quarter of 1997
associated with a Company-wide reorganization and reduction in force.
As a percentage of sales, SG&A expenses were 18% and 13% in the third
quarters of 1997 and 1996, respectively, and 24% and 11% for the first nine
months of 1997 and 1996, respectively. The increase in expenses, as a percentage
of sales, during both the third quarter of 1997 and the first nine months of
1997 resulted primarily from the significant decline in net sales during the
those periods compared to the corresponding periods of 1996. Additionally, the
expense ratio in the first nine months of 1997 was negatively impacted
particularly during the first and second quarters of 1997 from high sales and
marketing costs associated primarily with greater sales incentive program costs,
increased marketing development costs, increased advertising and increased sales
personnel headcount.
AMORTIZATION OF INTANGIBLE ASSETS
The Company incurred amortization expense of $0.2 million and $2.8 million in
the third quarter and the first nine months of 1997 compared to $1.3 million and
$3.7 million in the corresponding prior year periods. The decrease in expense in
the third quarter and first nine months of 1997 is primarily due to the
write-off of $9.9 million of intangible assets during the second quarter of 1997
which significantly reduced the remaining outstanding balance to be amortized.
These expenses relate to amortization of purchased technology and goodwill from
the Supra Corporation and SPEA Software AG acquisitions, which occurred in the
third and fourth quarters of 1995, respectively.
WRITE-OFF OF INTANGIBLE ASSETS
The Company recorded a write-off of intangible assets of $9.9 million in
the second quarter of 1997 to reflect a decrease in the carrying value of
goodwill and purchased technology associated with the acquisitions of Supra and
Spea. The carrying value of the assets was deemed to be impaired based on the
current financial condition of the Company and an analysis using the discounted
cash flow method for those products incorporating the intangible benefit of the
goodwill and existing technology. The anticipated future cash flows related to
those products indicated that the recoverability of the assets was not
reasonably assured.
INTEREST AND OTHER INCOME, NET
Interest and Other income was $0.4 million and $2.2 million in the third
quarter and first nine months of 1997 compared to $0.5 million and $1.3 million
in the corresponding periods in 1996, respectively. The decrease in net interest
and other income in the third quarter of 1997 resulted from increased interest
expense on higher bank borrowings outstanding during the period compared to the
corresponding period of 1996. The increase in net interest and other income for
the first nine months of 1997 compared to the corresponding period of 1997 was
primarily due to recording approximately $0.6 million gain on a settlement of
certain litigation and due to an increase in foreign currency translation gains.
PROVISION (BENEFIT) FOR INCOME TAXES
The Company's effective tax rate in the third quarter and first nine months
of 1997 was 35%, excluding the write-off during the second quarter of 1997 of
goodwill and existing technology which is not deductible for tax purposes,
compared to 34% and 37.5% for the corresponding periods in 1996. The increase in
the effective tax
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rate in the third quarter of 1997 compared to the corresponding prior year
period is due to the effective rate for the third quarter of 1996 incorporating
the positive impact of a decline in the estimated annual rate from that of the
first six months of 1996. The annual effective tax rate for the first nine
months of 1997 has decreased from that of the first nine months of 1996 due
primarily to the impact of large, pre-tax losses incurred in the first nine
months in 1997 which had the effect of creating an income tax benefit.
Differences from the statutory rate consisted principally of the effect of state
income taxes, federal tax-exempt interest income and the research and
development tax credit.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS 128),
which specifies the computation, presentation and disclosure requirements for
earnings per share. SFAS 128 supersedes Accounting Principles Board Opinion No.
15 and is effective for financial statements issued for periods ending after
December 15, 1997. SFAS 128 requires restatement of all prior-period earnings
per share data presented after the effective date. SFAS will not have a material
impact on the Company's financial position, results of operations or cash flows.
In June 1997, the Financial Accounting Standards Board issued a Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS
130). SFAS 130 establishes standards for reporting and display of comprehensive
income and its components in a full set of general-purpose financial statements.
Comprehensive income is defined as the "change in equity of a business
enterprise during a period from transactions and other events and circumstances
from nonowner sources. It includes all changes in equity during a period except
those resulting from investments by owners and distributions to owners." SFAS
130 is effective for fiscal years beginning after December 15, 1997, and
reclassification of financial statements for earlier periods provided for
comparative purposes is required. SFAS 130 is not expected to have a material
impact on the Company's financial position, results of operations or cash flows.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS 131). SFAS 131 establishes standards
for the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to stockholders. SFAS 131 generally supersedes Statement of
Financial Accounting Standards No. 14, "Financial Reporting for Segments of a
Business Enterprise." Under SFAS 131, operating segments are components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. Generally, financial
information is required to be reported on the basis it is used internally. SFAS
131 is effective for financial statements for periods beginning after December
15, 1997, and restatement of comparative information for earlier years is
required. However, SFAS 131 is not required to be applied to interim financial
statements in the initial year of application. SFAS 131 will not have a material
impact on the Company's financial position, results of operations or cash flows.
LIQUIDITY AND CAPITAL RESOURCES
Cash and equivalents decreased by $21.9 million during the first nine months
of 1997. Operating activities used $28.1 million in cash and the primary uses of
cash were as follows: a net loss of $52.6 million; an increase in deferred
income taxes of $21.2 million, and an increase in inventories, net of the
provision for excess and obsolete inventories, of $8.5 million. These uses of
cash from operating activities were offset, in part, by a decrease in trade
receivables, net of the provision for doubtful accounts of $34.6 million, the
non-cash write-off of intangible assets of $9.9 million, depreciation and
amortization expense of $6.6 million, and a decrease in prepaid expenses and
other assets of $2.5 million.
The Company used $5.8 million in cash from investing activities due
primarily to purchases of property and equipment. Net cash provided by financing
activities was $12.0 million, primarily due to proceeds of
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$100.9 million on term loans and revolving credit facilities and $1.6
million from the issuance of common stock, offset in part by $89.9 million of
payments on debt financings and facilities.
At September 30, 1997, the Company had $98.3 million of cash and cash
equivalents. Further, as of such date, the Company had lines of credit and bank
credit facilities totaling $62.5 million, of which $31.3 million was unused and
available. At September 30, 1997, the Company was in default with its loan
covenants regarding tangible net worth and profitability. The Company has
received waivers for these violations.
The Company currently expects to spend approximately $8 million for capital
equipment in 1997, principally relating to computer and office equipment. The
Company believes that its cash balances, short-term investments and available
credit under existing bank lines will be sufficient to meet anticipated
operating and investing requirements for the foreseeable future. However, there
can be no assurance that additional capital beyond the amounts currently
forecasted by the Company will not be required or that any such required
additional capital will be available on reasonable terms, if at all, at such
time or times as required by the Company.
CERTAIN FACTORS THAT MAY AFFECT FUTURE PERFORMANCE
In addition to other information in this Form 10-Q, the following are
important factors that should be considered carefully in evaluating the Company
and its business.
POTENTIAL FLUCTUATIONS IN FUTURE OPERATING RESULTS
The Company's future operating results may vary significantly from period to
period as a result of a number of factors. The Company's revenue in a given
period depends on the volume and timing of orders received during the period,
the timing of new product introductions by the Company and its competitors,
product line maturation, the impact of price competition on the Company's
average selling prices, the availability of components for the Company's
products, changes in product or distribution channel mix, the level of inventory
carried by the Company's distribution and retail channel customers, and product
returns and price protection charges from customers. For example, the Company's
operating results in the second quarter of 1997 were particularly impacted by
lower demand and significant price erosion in its base business, which in the
second quarter was largely in a commodity phase. In addition, the Company
believes that it is currently, in the fourth quarter of 1997, moving into a
period of tight supply and increasing prices on certain semiconductor
components, including graphics controllers and memories. There can be no
assurances that the Company will be able to obtain adequate supplies of
components or obtain such supplies at competitive cost levels that will not
impact the Company's operating results.
The Company's gross margins are also impacted by short product life cycles,
the mix of products sold, the mix of distribution channels, competitive price
pressures, the availability and cost of components from the Company's suppliers,
component price inflation or deflation, end-of-life inventory write downs and
general economic conditions. For example, the Company intends to increase the
proportion of its revenue generated by sales to OEMs, which historically have
yielded lower gross margins, and to the retail/mass merchant channel, which
typically provides higher gross margins than OEM sales but requires higher sales
and marketing expenses and carries price-protection, stock-rotation and
customer-return liabilities. Individual product lines generally provide higher
margins at the beginning of the typical six-to-twelve-month product life cycle,
and lower margins as the product line matures. Product lines with less
technology value-added, however, such as multimedia upgrade kits, generally
provide lower margins than product lines with higher technology value-added,
such as professional graphics. Moreover, if a product's life should end prior to
expectations, then there is also a risk of unexpected channel inventory returns
and end-of-life and obsolete inventory charges, which could depress the
Company's revenue and gross margin in the affected period.
Many of these factors are beyond the Company's control. For example, the
Company's operating results in the second and third quarters of 1996 and the
first nine months of 1997 were adversely impacted by significantly
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lower unit prices as a result of competitive pricing pressures, and, in the
second quarters of 1996 and 1997, lower unit volumes due in part to weak market
conditions. There can be no assurance that lower unit prices or volumes will not
affect the Company's operating results in the future. In addition, due to the
short product life cycles that characterize the Company's markets, the Company's
failure to successfully introduce competitive products in a timely manner would
adversely affect operating results for one or more product cycles.
Due to the foregoing factors, it is likely that the operating results of the
Company for some future quarter or quarters will fall below the expectations of
securities analysts and investors. In such an event, the trading price of the
Company's Common Stock could be materially and adversely affected.
REVENUE VOLATILITY AND DEPENDENCE ON ORDERS RECEIVED AND SHIPPED IN A QUARTER
The volume and timing of orders received during a quarter are difficult to
forecast. Customers generally order on an as-needed basis and, accordingly, the
Company has historically operated with a relatively small backlog. Moreover, the
Company has emphasized its ability to respond quickly to customer orders as part
of its competitive strategy. This strategy, combined with current industry
supply-demand conditions and emphasis on just-in-time inventory management, has
resulted in customers placing orders with relatively short delivery schedules.
This has the effect of increasing such short-lead orders ("turns orders") as a
portion of the Company's business and reducing the Company's ability to
accurately forecast net revenue. Because turns orders are more difficult to
predict, there can be no assurance that the combination of turns orders and
backlog in any quarter will be sufficient to achieve either sequential or
year-over-year growth in net revenue during that quarter. If the Company does
not achieve a sufficient level of turns orders in a particular quarter, the
Company's revenues and operating results would be materially adversely affected.
Also, at any time and with no advance notice, during periods of uncertainty
in the personal computer industry's outlook for future demand or pricing, the
Company's customers may choose to draw down their inventory levels thereby
adversely impacting the Company's revenue during the period of adjustment. The
second quarter of 1997 comprised such a period due to the transition from older,
legacy 33.6 kilobits per second (Kbps) modems and 2D graphics products to new 56
Kbps modems and 3D graphics products. This major product transition period will
likely continue through the rest of 1997. Also, as is common and frequent in the
personal computer industry, a disproportionate percentage of the Company's
revenue in any quarter may be generated in the last month or weeks of a quarter.
As a result, a shortfall in sales in any quarter as compared to expectations may
not be identifiable until at or near the end of the quarter. In addition, from
time to time, a significant portion of the Company's revenue may be derived from
a limited number of customers, the loss of one or more of which could adversely
impact operating results.
Notwithstanding the difficulty in forecasting future sales and the
relatively small level of backlog at any given time, the Company generally must
plan production, order components and undertake its development, sales and
marketing activities and other commitments months in advance. Accordingly, any
shortfall in revenue in a given quarter may materially impact the Company's
operating results and cash balances in a magnified way due to the Company's
inability to adjust expenses or inventory levels during the quarter to match the
level of revenue for the quarter. Excess inventory could also result in cash
flow difficulties as well as added costs of goods sold and expenses associated
with inventory write-offs or sell-offs. Conversely, in its efforts to adjust
inventory levels to a slower order rate, the Company may overcorrect its
component purchases and inventory levels, thereby experiencing periodic
shortages of inventory and delivery delays and negatively impacting its revenue,
market share and customer satisfaction levels in the current quarter or in
future quarters. This type of situation developed, for example, in the third
quarter of 1997 and could occur again in future quarters, including the fourth
quarter of 1997. There can be no assurances that such an occurence will not
adversely impact the Company operating results.
DECLINING SELLING PRICES
The Company's markets are characterized by intense ongoing competition and
coupled with a past history and a current trend of declining average selling
prices. A decline in selling prices may cause the revenue in a quarter to be
lower than the revenue of a preceding quarter or corresponding prior year's
quarter even if more
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units were sold during such quarter than in the preceding or corresponding
prior year's quarter. Accordingly, it is likely that the Company's average
selling prices will decline, and the Company's revenue and margins may decline
in the future, from the levels experienced to date. The Company's gross margins
may also be adversely affected by shortages of, or higher prices for, key
components for the Company's products, including its modems, 3-D graphics
accelerators, SCSI I/O adapters, 3D audio accelerators and DVD/MPEG-2 video
products, some of which have been impacted from time-to-time by a scarcity in
the supply of associated chipsets and other components. In addition, the
Company's revenues, average selling prices and gross margins will be adversely
affected if the market prices for certain components used or expected to be used
by the Company, such as DRAM, VRAM, SGRAM, RDRAM, DVD drives, multimedia
controller chips or bundled software, decline more rapidly than the Company is
able to process component inventory bought earlier at higher prices into
finished products, book and ship the related orders, and move such products
through third-party distribution channels, some of which may be price protected,
to the final customer. For example, operating results were negatively impacted
in the second and third quarters of 1996 by declining market prices for the
Company's products, caused in part by a sharp reduction in the market price for
DRAMs. Conversely, an increase in the price of semiconductor components may
adversely impact the Company's gross margin due to higher unit costs, and a
decrease in the supply of semiconductor components may adversely impact the
Company's revenue due to lower unit shipments.
SEASONALITY
The Company believes that, due to industry seasonality, demand for its
products is strongest during the fourth calendar quarter of each year. This
seasonality may become more pronounced and material in the future to the extent
that a greater proportion of the Company's sales consist of sales into the
retail/mass merchant channel, that PCs become more consumer-oriented or
entertainment-driven products, or that the Company's revenue becomes
increasingly based on entertainment-centric products. Also, to the extent the
Company is successful in expanding its European operations, it may experience
relatively weak demand in third calendar quarters due to historically weak
summer sales in Europe. The potential material effect of seasonality on the
Company's revenue is illustrated through market research results published by
International Data Corporation (Worldwide Quarterly PC Market Tracker, 1997)
showing that worldwide personal computer shipments in the world were spread
across the four (4) calendar quarters of 1996 in the ratio of 23%, 23%, 24% and
30%, respectively. The foregoing example is merely an illustration of historical
trends, however, and in no way is intended to be a prediction or any indication
of how the Company's sales will develop.
MANAGEMENT OF GROWTH
In recent years, the Company has experienced a significant expansion in the
overall level of its business and the scope of its operations, including
manufacturing, research and development, marketing, technical support, customer
service, sales and logistics. In addition, through its acquisitions of Supra in
September 1995 and Spea in November 1995, the Company increased the scope of its
product lines and multinational operations. This expansion in scope has resulted
in a need for significant investment in infrastructure, processes and
information systems, as well as the integration of Supra and Spea into the
Company's infrastructure. This requirement includes, without limitation:
Securing adequate financial resources to successfully integrate and manage the
acquired businesses; retention of key employees; integration of management
information, control and telecommunications systems; consolidation of
geographically dispersed manufacturing and distribution facilities;
consolidation and coordination of suppliers; rationalization of distribution
channels; establishment and documentation of business processes; and integration
of various functions and groups of employees. Each of these requirements could
pose significant, material challenges. For example, the Company established a
restructuring reserve in the second quarter of 1997 to account for the expected
expenses of, among other actions, integrating customer service and distribution
from Supra into Diamond, transitioning manufacturing from Supra's facility in
Oregon to a subcontractor facility in Mexico, and integrating technical support
from Diamond's San Jose, CA facility to Supra's technical support organization
in Oregon. Moreover, Spea historically has not been profitable and the Company's
management has taken significant steps to reduce expenses at Spea and integrate
its operations with those of the Company. Accordingly, the Company has
reorganized Spea to function principally as follows: a product localization and
marketing operation for Europe; a sales, technical support and customer service
operation for Germany; and a product development and launch
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facility for professional 3D graphics, including CAD and digital animation,
for the Company's worldwide markets. The Company discontinued manufacturing,
test, packaging and logistics operations at Spea effective October 1, 1996.
Since the acquisition of Spea in November 1995, the Company's efforts to improve
Spea's financial performance have been adversely impacted by economic recession
in Germany and the associated downturn in the German computer market, and there
can be no assurance that the Company will be successful in improving the
financial performance of its operations in Europe. Moreover, prior to its
acquisition by the Company, Spea made certain investments including entering
into the shared ownership (at 49.5%) with Philips Semiconductor (at 50.5%) of a
3D graphics semiconductor design subsidiary, SP3D. The Company's 49.5% ownership
of SP3D is carried on the Company's balance sheet at the same approximately $3.4
million value as it was on Spea's balance sheet prior to the acquisition.
Philips Semiconductor has full day-to-day operating management control of SP3D
and holds the majority of seats on the SP3D board. There can be no assurance
that the Company will be able to achieve a reasonable return on this asset, or
that the asset will not need to be written down, in whole or in part, during
subsequent accounting periods.
The Company's future operating results will depend in large measure on its
success in implementing operating, manufacturing and financial procedures and
controls, improving communication and coordination among the different operating
functions, integrating certain functions such as sales, procurement and
operations, strengthening management information and telecommunications systems,
and continuing to hire additional qualified personnel in all areas. Moreover,
the Company has determined that it must select and fully implement a new
enterprise resource planning (ERP) system no later than 1999 in order to
properly manage the increasing complexity of its global multi-product business
and avert potential Year 2000 issues with its current management information
system. There can be no assurance that the Company will be able to manage these
activities and implement these additional systems, procedures and controls
successfully, and any failure to do so could have a material adverse effect upon
the Company's short-term and long-term operating results.
SHORT PRODUCT LIFE CYCLES; DEPENDENCE ON NEW PRODUCTS
The market for the Company's products is characterized by frequent new
product introductions and rapid product obsolescence. These factors typically
result in short product life cycles, frequently ranging from six to twelve
months. The Company must develop and introduce new products in a timely manner
that compete effectively on the basis of price and performance and that address
customer needs and meet customer requirements. To do this, the Company must
continually monitor industry trends and make difficult choices regarding the
selection of new technologies and features to incorporate into its new products,
as well as the timing of when to introduce such new products, all of which may
impair the orders for or the prices of the Company's existing products. The
success of new product introductions depends on various factors, some of which
are outside the Company's direct control. Such factors may include: selection of
new products; selection of controller or memory chip architectures; timely
completion and introduction of new product designs; trade-offs between the time
of first customer shipment and the optimization of software for speed, stability
and compatibility; development of supporting content by independent software
vendors ("ISV"s); development and production of collateral product literature;
prompt delivery to OEM accounts of such prototypes; support of such prototypes;
and coordination of advertising, press relations, channel promotion and VAR
evaluation programs.
In the current transition of mainstream PC graphics subsystem architectures
from 2D graphics and the PCI bus to 3D graphics and the accelerated graphics
port (AGP), expected to occur during 1997 and 1998, controller and memory chip
selection and the timely introduction of new products will be key factors in
achieving market success. In addition, in the current transition from the widely
accepted V.34 modem protocol (33.6Kbps) to the new higher speed V.PCM protocol
(56Kbps), including its initial proprietary implementations under the current
"split-standard" of both K56flex and x2 versions, selection of the appropriate
future protocol version or versions to support, the timing of such support, the
chip selection to implement and deploy such support, and the industry alliances
to convert such support into revenue and market share growth will all be key
factors in achieving market success. There can be no assurance that the Company
will select the proper chips to implement and support its efforts in the various
markets or that the Company will execute its strategy in a timely manner during
this transition period.
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Each new product cycle presents new opportunities for current or prospective
competitors of the Company to gain a product advantage or increase their market
share. If the Company does not successfully introduce new products within a
given product cycle, the Company's sales will be adversely affected for that
cycle and possibly for subsequent cycles. Any such failure could also impair the
Company's brand name and ability to command retail shelf space in future
periods. Moreover, because of the short product life cycles coupled with the
long lead times for procuring many of the components used in the Company's
products, the Company may not be able, in a timely manner, or at all, to reduce
its component procurement commitments, software license commitments, production
rates or inventory levels in response to unexpected delays in product launch,
shortfalls in sales, technological obsolescence or declines in prices or,
conversely, to increase production in response to unexpected increases in
demand, particularly if such demand increases are in a new product or new
technology area where component supply may be hard to secure. Therefore, changes
in actual or expected demand could result in excess inventory, inventory write
downs, price protection and gross margin compression or, conversely, in lost
sales and revenue compression due to product or component unavailability.
NEW OPERATING SYSTEMS
The PC industry has recently been characterized by significant operating
system changes, such as the introduction of Windows 95 in 1995 and Windows NT
4.0 in 1996, and the introduction of significant new operating systems
components, such as Microsoft's Direct X and ActiveX for Windows 95. While new
operating systems can provide new market opportunities, such as the growing
market for graphical user interface ("GUI") accelerators that occurred with the
introduction of Windows 3.0 and the growth in the PC games market with the
introduction of Windows 95, new operating systems and operating systems
components also place a significant research and development burden on the
Company. New drivers, applications and user interfaces must be developed for the
new operating systems and operating systems components in order to maintain
revenue levels and customer satisfaction. Perhaps more significantly, such
drivers, applications and interfaces customarily are ported to the recently
shipped portion of the Company's installed base. This effort involves a
substantial software engineering, compatibility testing and customer technical
support investment with only limited near-term incremental revenue return since
these driver updates are usually provided via electronic distribution free to
the Company's installed customer base. In addition, the installation of this
software may result in technical support calls, thereby generating expenses that
do not have offsetting revenue. Moreover, during the introductory period of a
major new operating system release such as Windows 95, such installed base
support may reduce the research and development and customer technical support
resources available for launching new products. For example, after substantial
investment in porting the Company's software, graphics accelerator and modem
products over to Windows 95, the Company was at year-end 1996 still developing
for final release improved, accelerated Windows 95 drivers for the Viper Pro
Video series of accelerator add-in cards (since completed). While this product
line did not at that time represent a revenue opportunity for the Company, the
Company nevertheless believed that it was important to make the significant
software development investment represented by this effort in order to maintain
relations with its installed customer base and its reputation for reliable
on-going product support. Furthermore, new operating systems for which the
Company prospectively develops driver support may not be successful, or the
drivers themselves may not be successful or accepted by customers, and a
reasonable financial return on the corollary research and development investment
may never be achieved.
DEPENDENCE ON THIRD PARTY SOFTWARE DEVELOPERS
The Company's business strategy includes developing relationships with
major ISVs that serve the 3D graphics and 3D audio markets, including the 3D
computer games market and the professional 3D graphics market. The Company
believes that the availability of a sufficient number of high quality,
commercially successful entertainment 3D software titles will be a significant
factor in the sale of multimedia hardware to the PC-based interactive 3D
entertainment market. The Company also believes that compelling professional 3D
graphics applications developed for PCs or ported from traditional workstations,
such as those supplied by Silicon Graphics and Sun Microsystems, to PCs based on
advanced Intel microprocessors and Microsoft's NT 4.0 operating system will be
significant factors in the sale of 3D graphics hardware to the PC-based NT
workstation market. The Company depends on third party software developers and
publishers to create, produce and market software entertainment titles and
professional graphics applications that will operate with the
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Company's 3D products, such as Monster, Stealth, Viper and Fire GL. Only a
limited number of software developers are capable of creating high quality
professional 3D and entertainment 3D software. Competition for these resources
is intense and is expected to increase. There can be no assurance that the
Company will be able to attract the number and quality of software developers
and publishers necessary to develop a sufficient number of high quality,
commercially successful software titles and applications that are compatible
with the Company's 3D products.
Further, in the case of the Company's entertainment 3D products, there can
be no assurance that third parties will publish a substantial number of
entertainment 3D software titles or, if entertainment 3D software titles are
available, that they will be of high quality or that they will achieve market
acceptance. The development and marketing of game titles that do not fully
demonstrate the technical capabilities of the Company's entertainment 3D
products could create the impression that the Company's products offer less
compelling performance over competing 3D games platforms, such as TV games
console platforms. This may slow or stop any migration from the current
widespread use of TV games consoles to the use of computer games on PCs, or the
enhancement of PCs to operate such games. Further, because the Company has no
control over the content of the entertainment titles produced by software
developers and publishers, the entertainment 3D software titles developed may
represent only a limited number of game categories and are likely to be of
varying quality.
SEMICONDUCTOR OR SOFTWARE DEFECTS
Product components may contain undetected errors or "bugs" when first
supplied to the Company that, despite testing by the Company, are discovered
only after certain of the Company's products have been installed and used by
customers. There can be no assurance that errors will not be found in the
Company's products due to errors in such products' components, or that any such
errors will not impair the market acceptance of these products or require
significant product recalls. Problems encountered by customers or product
recalls could materially adversely affect the Company's business, financial
condition and results of operations. Further, the Company continues to upgrade
the firmware, software drivers and software utilities that are incorporated into
or included with its hardware products. The Company's software products, and its
hardware products incorporating such software, are extremely complex as a result
of factors including advanced functionality, the diverse operating environments
in which the products may be deployed, the need for interoperability, and the
multiple versions of such products that must be supported for diverse operating
platforms, languages and standards. These products may contain undetected errors
or failures when first introduced or as new versions are released. The Company
generally provides a five-year warranty for its products and, in general, the
Company's return policies permit return within thirty days after receipt of
products that do not meet product specifications. There can be no assurance
that, despite testing by the Company, by its suppliers and by current or
potential customers, errors will not be found in new products after commencement
of commercial shipments, resulting in loss of or delay in market acceptance or
product acceptance or in warranty returns. Such loss or delay would likely have
a material adverse effect on the Company's business, financial condition and
results of operations.
Additionally, new versions or upgrades to operating systems or ISV titles
or applications may require upgrades to the Company's software products to
maintain compatibility with these new versions or upgrades. There can be no
assurance that the Company will be successful in developing new versions or
enhancements to its software or that the Company will not experience delays in
the upgrade of its software products. In the event that the Company experiences
delays or is unable to maintain compatibility with operating systems and ISV
titles or applications, the Company's business, financial condition and results
of operations could be materially adversely affected.
MARKET ANTICIPATION OF NEW PRODUCTS, NEW TECHNOLOGIES OR LOWER PRICES
Since the environment in which the Company operates is characterized by
rapid new product and technology introductions and generally falling prices for
existing products, the Company's customers may from time to time postpone
purchases in anticipation of such new product introductions or lower prices. If
such anticipated changes are viewed as significant by the market, such as the
introduction of a new operating system or microprocessor architecture, then this
may have the effect of temporarily slowing overall market demand and
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negatively impacting the Company's operating results. For example, the
substantial pre-release publicity surrounding the release of Windows 95 may have
contributed to a slowing of the consumer PC market in the summer of 1995.
Moreover, a similar reaction has likely occurred in the modem market as a result
of the recent announcements of modems based on 56 Kbps technology which became
available in 1997, or in the overall PC market in anticipation of Intel
Corporation's transition to MMX-based microprocessors during 1997. Additionally,
the substantial publicity by Intel Corporation on its MMX technology may have
confused and slowed the market for add-in multimedia accelerators, such as those
sold by the Company, during the first half of 1997. If so, this effect may
continue into future periods. Other anticipated new product releases that may
influence future market growth or the timing of such growth include Microsoft's
release of its "Memphis" upgrade to Windows 95, now anticipated to be generally
available to the public in the second quarter of 1998 as Windows 98, Intel's
release of its Pentium II CPU and the associated chipsets supporting the AGP and
2x AGP architectures, and Intel's release of its "Merced" workstation CPU slated
for first customer shipment in 1999.
The potential negative impact on the Company's operating results as a result
of customer decisions to postpone purchases in favor of new and "publicized"
technology can be further magnified if products or components based on such new
technology are not available in a timely manner or in sufficient supply to meet
the demand caused by the market's shift to the new technology from an older
technology. For example, the Company believes that the PC market may have slowed
in early 1997 in part as customers waited for the availability of Intel's new
MMX-enabled Pentium CPUs. Further, the Company's operating results could be
adversely affected if the Company makes poor selections of chip architectures or
chip suppliers to pursue 3D graphics, AGP or 56Kbps modem market opportunities
and, as a result, is unable to achieve market acceptance of its new products or
is unable to secure enough supply of such components.
Also, if the Company announces a product that the market views as having
more desirable features or pricing than the Company's existing products, demand
for the Company's existing products may be curtailed even though the new product
is not yet available. Similarly, if the Company's customers anticipate that the
Company may reduce its prices in the near term, they may postpone their
purchases until such price reductions are effected, reducing the Company's
near-term shipments and revenue. In general, market anticipation of new
products, new technologies or lower prices, even though potentially positive in
the longer term, can negatively impact the Company's operating results in the
short term.
COMPONENT SHORTAGES; RELIANCE ON SOLE OR LIMITED SOURCE SUPPLIERS
The Company is dependent on sole or limited source suppliers for certain key
components used in its products, particularly chipsets that provide graphics,
digital video, DVD control, television (TV), sound or other multimedia
functions, random access memory (including VRAM, DRAM, RDRAM and SGRAM) chips,
and speakerphone modem and fax/modem chipsets. Although the price and
availability of many semiconductor components improved during 1996 and the first
half of 1997, these components are periodically in short supply and on
allocation by semiconductor manufacturers. For example, it is expected that the
Company may experience substantial constraints in the supply of high-performance
SGRAMs and high-performance 3D graphics chips for the foreseeable future. There
can be no assurances that the Company can obtain adequate supplies of such
components, or that such shortages or the costs of these components will not
adversely affect future operating results. The Company's dependence on sole or
limited source suppliers, and the risks associated with any delay or shortfall
in supply, can be exacerbated by the short life cycles that characterize
multimedia and communications ASIC chipsets and the Company's products in
general. Although the Company maintains ongoing efforts to obtain required
supplies of components, including working closely with vendors and qualifying
alternative components for inclusion in the Company's products, component
shortages continue to exist from time to time, and there can be no assurances
that the Company can continue to obtain adequate supplies or obtain such
supplies at their historical or competitive cost levels. Conversely, in its
attempt to counter actual or perceived component shortages, the Company may
overpurchase certain components, resulting in excess inventory and reducing the
Company's liquidity or, in the event of unexpected inventory obsolescence or a
decline in the market value of such inventory, causing inventory write-offs or
sell-offs that adversely affect the Company's gross margin and profitability. In
addition, such inventory sell-offs by the Company or its competitors could
trigger channel price protection charges, further reducing the Company's gross
margins and profitability.
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As noted above, supply-demand conditions for semiconductor components are
unpredictable and may change from time to time. During periods of oversupply,
prices are likely to fall and certain vendors of such semiconductor chips may
liquidate their inventories in a rapid manner. If such semiconductor vendors are
suppliers to the Company's competitors, then such actions could enable
competitors of the Company to enjoy a cost advantage vis-a-vis the Company, and
any resultant price reduction for such competitors' products could in turn
require the Company to reduce its prices, thereby depressing the Company's
revenues or margins in one or more operating periods.
During periods of component oversupply and associated price deflation,
customers of the Company, particularly those comprising channels that do not
receive price protection from the Company, may seek to draw down the inventory
they hold since such inventory likely would bear a price deflation risk. As a
consequence, the Company may see its orders, unit shipments and average selling
prices depressed from time to time during such price-deflation and
inventory-reduction periods, which could adversely affect revenues or gross
margin in the related operating period or periods.
When the PC or PC peripherals markets emerge from a period of oversupply,
such as experienced in the second quarter of 1997, certain manufacturers,
distributors and resellers may be unprepared for a possible rapid increase in
market demand. Accordingly, the Company may not have sufficient inventory,
scheduled component purchase orders or available manufacturing capacity to meet
any rapid increase in market demand, thereby missing orders and revenue
opportunities, causing customer dissatisfaction and losing market share. The
Company experienced such a situation in the third quarter of 1997, and may
experience a continuation of that situation in the fourth quarter of 1997 as
recent customer demand for the Company's products has increased over that of the
second and third quarters of 1997. In addition, the Company believes that it is
moving into a period of tight supply and increasing prices on certain
semiconductor components including graphics controllers and memories. The
inability of the Company to obtain product components at their historical cost
levels resulting in the Company being forced to pay higher prices to achieve
timely delivery would directly affect the cost of the Company's products and
could materially and adversely affect the Company's gross margin. There can be
no assurance that the Company will be able to obtain adequate supplies of
components or that such shortages or the costs of these components will not
adversely impact the Company's future operating results.
DEPENDENCE ON SUBCONTRACTORS
The Company relies on independent surface mount technology ("SMT") and
printed circuit board ("PCB") subcontractors to manufacture, assemble or test
the Company's products. The Company procures its components and products through
purchase orders and does not have specific volume purchase agreements with each
of its subcontractors. Most of the Company's subcontractors could cease
supplying the services, products or components at any time with limited or no
penalty. In the event that it becomes necessary for the Company to replace a key
subcontractor, the Company could incur significant manufacturing set-up costs
and delays. Moreover, there can be no assurance that the Company would be able
to find suitable replacement subcontractors. In addition, the Company's emphasis
on maintaining low inventory may accentuate the effects of any shortages that
may result from sole-source subcontractors during periods of tight supply or
rapid order growth The Company's ability to respond to greater than anticipated
market demand may be constrained by the availability of SMT or PCB
subcontracting services. Further, various of the Company's subcontractors are
located in international locations that, while offering low labor costs, may
comprise process control, quality control, political, infrastructure,
transportation, tariff, regulatory, legal, import, export, economic or supply
risks.
DEPENDENCE ON GRAPHICS AND MULTIMEDIA ACCELERATOR MARKET
Sales of graphics and multimedia accelerator subsystems accounted for
greater than 75% and 70% of the Company's revenue in the third quarter and first
nine months of 1997, respectively, and greater than 75% in the corresponding
prior year periods. Although the Company has introduced audio subsystems, ISDN
adapters and SCSI host adapters, entered the modem market through the
acquisition of Supra Corporation and is developing DVD/MPEG-2 products, graphics
accelerator subsystems are expected to continue to account for a majority of the
Company's sales for the foreseeable future. A decline in demand or average
selling prices for graphics
19
<PAGE> 20
accelerator subsystems, whether as a result of new competitive product
introductions, price competition, excess supply, widespread cost reduction,
technological change, incorporation of the products' functionality onto personal
computer motherboards or otherwise, would have a material adverse effect on the
Company's sales and operating results.
MIGRATION TO PERSONAL COMPUTER MOTHERBOARDS
The Company's graphics and multimedia accelerator subsystems are individual
products that function within personal computers to provide additional
multimedia functionality. Historically, as a given functionality becomes
technologically stable and widely accepted by personal computer users, the cost
of providing such functionality is typically reduced by means of large scale
integration into semiconductor chips, which can be subsequently incorporated
onto personal computer motherboards. The Company expects that such migration
will not occur in a substantial way with 3D graphics or Intel's accelerated
graphics port (AGP) in the near term, although the Company recognizes that such
migration could occur with respect to the functionality provided by the
Company's current products. While the Company believes that a market will
continue to exist for add-in subsystems that provide advanced or multiple
functions and offer flexibility in systems configuration, such as 3D graphics,
3D audio, MPEG-2 digital video, high-speed I/O and modems, there can be no
assurance that the incorporation of new multimedia functions onto personal
computer motherboards or into CPU microprocessors, such as under Intel's MMX or
AGP technologies, will not adversely affect the future market for the Company's
products. In large part, the continuation of a robust market for add-in graphics
and video subsystems may depend on the timing and market acceptance of 3D
graphics and digital video MPEG-2 acceleration. This, in turn, may depend on the
availability of compelling 3D and MPEG-2 content, including games and
entertainment, broadcast digital video, PC video phones, desktop video
conferencing, and digital video, audio and VRML on the Internet. Similarly, the
robustness of the modem market may depend largely on the widespread adoption of
56 Kbps and digital subscriber line (xDSL) technologies in both client-side
modems attached to the PC and server-side modems provided by Internet Service
Providers and telephone network central offices. The timing of major technology
introductions and the market acceptance of these new technologies and standards
is largely out of the control of the Company. For example, the new 56 Kbps modem
technology currently has two competing protocols: K56flex supported by Rockwell
Semiconductor and Lucent Technologies and x2 supported by 3Com Corporation. The
Company believes that most industry experts are of the opinion that the
International Telecommunications Union will not ratify a 56Kbps standard until
the latter half of 1998, thereby potentially causing further market confusion
and slowing market acceptance of the new 56 Kbps modem technology for an
extended period.
COMPETITION
The market for the Company's products is highly competitive. The Company
competes directly against a large number of suppliers of add-in visual and audio
subsystems and data communications products for the PC such as Matrox Graphics,
Inc. and ATI Technologies Inc., and indirectly against PC systems OEMs to the
extent that they manufacture their own add-in subsystems or incorporate on PC
motherboards the functionality provided by the Company's products. In certain
markets where the Company is a relatively new entrant, such as modems, sound
cards and SCSI host adapters, the Company may face dominant competitors
including 3Com (modems), Creative Technology (sound cards) and Adaptec (SCSI
host adapters). In addition, the Company's markets are expected to become
increasingly competitive as multimedia functions continue to converge and
companies that previously supplied products providing distinct functions (for
example, companies today primarily in the sound, fax/modem, telephony, digital
signal processing, central processing unit or motherboard markets) emerge as
competitors across broader or more integrated product categories.
In addition, manufacturers of chipsets or other components used in the
Company's products could become future competitors of the Company to the extent
that such manufacturers elect to integrate forward into the add-in subsystem or
value-added software market, or as such multimedia chipset manufacturers provide
increasingly higher quality and more sophisticated software to their chipset
customers, including subsystem suppliers competitive to the Company. Also,
certain of the Company's current and potential competitors have significantly
greater market presence, name recognition and financial and technical resources
relative to the Company, and many have long-standing market positions and
established brand names in their respective markets. In addition,
20
<PAGE> 21
certain of the Company's current and potential competitors also have a
competitive cost advantage as a result of being located in areas that impose
significantly lower taxes than the United States or offer a substantially lower
cost of labor or provide governmental subsidies, such as research and
development and training funds. Many of the Company's current and potential
competitors also design and manufacture their own graphics acceleration, video,
sound, fax/modem or other multimedia processing chipsets. While the Company
believes that its semiconductor vendor flexibility enables it to select, within
certain limits, from among the most advanced and price competitive chipsets
available on the open market, the captive semiconductor operations of certain of
the Company's current and potential competitors could provide them with
significant advantages, including greater control over semiconductor
architecture and technology, component design, component performance, systems
and software design, availability and cost.
The Company also believes that the strategy of certain of its current and
potential competitors is to compete largely on the basis of price, which may
result in significant price competition and lead to lower margins for the
Company's products or otherwise adversely affect the market for the Company's
products. To the extent that semiconductor availability is relatively robust and
software drivers and reference hardware designs from multimedia chipset
manufacturers are of high quality and sophistication, then competitors who sell
such reference designs and compete largely on price with little valued added
engineering may have a competitive cost or expense advantage relative to the
Company. There can be no assurance that the Company will be able to continue to
compete successfully in its current and future markets, or will be able to
compete successfully against current and new competitors, as the Company's
technology, markets and products continue to evolve.
DISTRIBUTION RISKS
The Company sells its products through a network of domestic and
international distributors, and directly to major retailers/mass merchants, VARs
and OEM customers. The Company's future success is dependent on the continued
viability and financial stability of its customer base. The computer
distribution and retail channels historically have been characterized by rapid
change, including periods of widespread financial difficulties and consolidation
and the emergence of alternative sales channels, such as direct mail order,
telephone sales by PC manufacturers and electronic commerce on the World Wide
Web. The loss of, or reduction in, sales to certain of the Company's key
customers as a result of changing market conditions, competition, or customer
credit problems could have a material adverse effect on the Company's operating
results. Likewise, changes in distribution channel patterns, such as increased
commerce on the Internet, increased use of mail-order catalogues, increased use
of consumer-electronics channels for personal computer sales, or increased use
of channel assembly to configure PC systems to fit customers' requirements could
affect the Company in ways not yet known. Moreover, additions to or changes in
the types of products the Company sells, such as the introduction of
professional-grade products or the migration toward more communications-centric
products, may require specialized value-added reseller channels, relations with
which the Company has only begun to establish.
Inventory levels of the Company's products in the two-tier distribution
channels used by the Company ("Channel Inventory Levels") generally are
maintained in a range of one to three months of customer demand. These Channel
Inventory Levels tend toward the low end of the months-of-supply range when
demand is stronger, sales are higher and products are in short supply.
Conversely, when demand is slower, sales are lower and products are abundant,
then Channel Inventory Levels tend toward the high end of the months-of-supply
range. Frequently, in such situations, the Company attempts to ensure that
distributors devote their working capital, sales and logistics resources to the
Company's products to a greater degree than to those of competitors. Similarly,
the Company's competitors attempt to ensure that their own products are
receiving a disproportionately higher share of the distributors' working capital
and logistics resources. In an environment of slower demand and abundant supply
of products, price declines are more likely to occur and, should they occur, are
more likely to be severe. Further, in such an event, high Channel Inventory
Levels may result in substantial price protection charges. Such price protection
charges have the effect of reducing net revenue and gross profit. Consequently,
the Company, in taking steps to bring its Channel Inventory Levels down to a
more desirable level, may cause a shortfall in revenue during one or more
accounting periods. This situation may result in future price protection charges
as prices are decreased having an adverse impact on operating results. While the
Company believes that its Channel Inventory Levels for most of its products are
appropriate at this time, there
21
<PAGE> 22
may be certain products which have a Channel Inventory Level that is higher
than desirable. This situation may lead to significant price protection charges
which would have a material adverse effect on operating results.
PRODUCT RETURNS; PRICE PROTECTION
The Company frequently grants limited rights to customers to return certain
unsold inventories of the Company's products in exchange for new purchases
("Stock Rotation"), as well as price protection on unsold inventory. Moreover,
certain of the Company's retail customers will readily accept returned product
from their own retail customers, and these returned products are, in turn,
returned to the Company for credit. The Company estimates returns and accrues
for potential price protection on unsold channel inventory. However, there can
be no assurance that these estimates or accruals will be sufficient, or that any
future returns or price reductions will not have a material adverse effect on
operating results, including through the mechanisms of Stock Rotation or price
protection, particularly in light of the rapid product obsolescence which often
occurs during product transitions. The short product life cycles of the
Company's products, the evolving markets for new multimedia and connectivity
technologies such as the new 56 Kbps modem and 3D graphics technologies, and the
difficulty in predicting future sales through the distribution channels to the
final end customer all increase the risk that new product introductions, price
reductions by the Company or its competitors, or other factors affecting the
personal computer and add-in subsystems industry could result in significant and
unforeseen product returns, with such returns creating a material adverse effect
on the Company's financial performance. In addition, there can be no assurance
that new product introductions by competitors or other market factors, such as
the integration of graphics acceleration or modem connectivity by OEMs onto
system motherboards, will not require the Company to reduce prices in a manner
or at a time that gives rise to significant price protection charges and has a
material adverse impact upon the Company's gross margins.
Furthermore, the markets that the Company serves include end users who buy
from computer retail and consumer electronics mass merchant outlets to upgrade
their existing PCs. Such customers frequently decide to return products to the
retail outlets from which they earlier purchased the product. Such returns are
made for a variety of reasons, including the customer changing his or her mind
regarding his or her purchase decision, the customer has difficulty with the
installation or use of the product, the product does not offer the features,
functions, or performance that the customer expected or the customer experiences
incompatibilities between the product and his or her existing PC hardware or
software. Since many of the products that the Company sells incorporate advanced
computer technology, the Company expects that end-user customer returns,
including warranty returns, will be a continuing negative attribute of the PC
installed-base upgrade market. There can be no assurance that the Company will
be able to achieve gross margins in the PC installed-base upgrade market that
will be high enough to offset the expenses of end-user customer returns and
still generate an acceptable return on sales to the Company.
OEM CUSTOMER RISKS
The Company currently has only a limited number of OEM customers. While the
Company is seeking to increase its sales to OEMs, certain OEMs maintain internal
add-in subsystem design and manufacturing capabilities or have long-standing
relationships with competitors of the Company, and there can be no assurance
that the Company will be successful in its efforts to increase its OEM sales.
Moreover, developing supplier relationships with major PC systems OEMs and
installing the processes, procedures and controls required by such OEMs can be
an expensive and time-consuming process, and there can be no assurance that the
Company will achieve an acceptable financial return on this investment. Further,
to the extent that PC systems OEMs' selection criteria are weighted toward
multimedia subsystem suppliers that have their own captive SMT manufacturing
operations, then the Company's sole reliance on outside SMT subcontract
manufacturers may be a negative factor in winning such PC systems suppliers' OEM
contracts.
It is expected that OEM revenue will carry a lower gross margin percentage
compared to sales to other channels due to perceived lower expenses to support
such OEM revenue and the buying power exercised by large OEMs. Furthermore, the
Company's products are priced for and generally aimed at the higher performance
and higher quality segment of the market. Therefore, to the extent that OEMs
focus on low-cost solutions rather than high-performance solutions, an increase
in the proportion of the Company's sales to OEMs may result in an
22
<PAGE> 23
increase in the proportion of the Company's revenue that is generated by
lower-selling-price or lower-gross-margin products, which could adversely affect
future gross margins and operating results of the Company.
RAPID TECHNOLOGICAL CHANGE
The markets for the Company's products are characterized by rapidly changing
technology, evolving industry standards, frequent new product introductions and
rapid product obsolescence. For example, 3D technology is evolving rapidly in
the graphics and audio markets, DVD and MPEG-2 decryption techniques and
navigation technologies are still being refined, and two competing 56 Kbps
proprietary protocols were deployed by the modem industry during 1997. Product
life cycles in the Company's markets frequently range from six to twelve months.
The Company's success will be substantially dependent upon its ability to
continue to develop and introduce competitive products and technologies on a
timely basis with features and functionalities that meet changing customer
requirements in a cost-effective manner. Further, if the Company is successful
in the development and market introduction of new products, it must still
correctly forecast customer demand for such new products so as to avoid either
excessive unsold inventory or excessive unfilled orders related to the products.
The task of forecasting such customer demand is unusually difficult for new
products, for which there is little sales history, and for indirect channels,
where the Company's customers are not the final end customers. Moreover,
whenever the Company launches new products, it must also successfully manage the
corollary obsolescence and price erosion of those of its older products that are
impacted by such new products, as well as any resulting price protection charges
and Stock Rotations from its distribution channels.
RISKS OF INTERNATIONAL SALES
The Company's international sales are subject to a number of risks generally
associated with international business operations, including the effect on
demand for the Company's products in international markets as a result of a
strengthening or weakening U.S. dollar, the effect of currency fluctuations on
consolidated multinational financial results, any state-imposed restrictions on
the repatriation of funds, any import and export duties and restrictions,
certain international economic conditions, the expenses, time and technical
resources required to localize the Company's various products and to support
local languages, the logistical difficulties of managing multinational
operations and dispersed product inventory designed or manufactured to meet
specific countries' requirements, and the delays and expenses associated with
homologating the Company's telecommunications products and securing the
necessary governmental approvals for shipment to various countries.
The Company's international sales can also be affected if inventory sold by
the Company to its international distributors and OEMs and held by them or their
customers does not sell through to final end customers, which may impact
international distributor or OEM orders in the succeeding periods. The Company
believes that at this stage of its development it has generally less information
with respect to the inventory levels held by its international OEMs and
distributors vis-a-vis their domestic counterparts, and therefore generally less
visibility on how this held inventory might affect future orders to and sales by
the Company.
INFORMATION TECHNOLOGY AND TELECOMMUNICATIONS SYSTEMS
The Company is currently making significant investments in establishing
systems, processes and procedures to more efficiently and effectively manage its
worldwide business and enable communications and data sharing among its
employees and various business units. This effort comprises a significant
investment of expense and capital funds, as well as a drain on management
resources, for the installation of information technology ("IT") and
telecommunications equipment and IT applications. As part of this program to
install IT systems throughout the Company, management believes that the Company
will be required to install an enhanced enterprise-wide business management,
resource planning and decision support application. Further, in order to more
effectively manage the Company's business and avert Year 2000 issues, the
Company believes that this new ERP application and the associated IT equipment
will need to be installed and operational no later than by early 1999. Such an
effort is expected to comprise a further substantial investment of expenses and
management resources by the Company.
23
<PAGE> 24
CAPITAL NEEDS
There can be no assurance that additional capital beyond the amounts
currently forecasted by the Company will not be required or that any required
additional capital will be available on reasonable terms, if at all, at such
time or times as required by the Company. Any shortfall in capital resources
compared to the Company's level of operations or any inability to secure
additional capital as needed could impair the Company's ability to finance
inventory, accounts receivable and other operational needs. Such capital
limitations could also impair the Company's ability to invest in research and
development, improve customer service and support, deploy information technology
systems, and expand manufacturing and other operations. Failure to keep pace
with competitive requirements in any of these areas could have a material
adverse effect on the Company's business and operating results. Moreover, any
need to raise additional capital through the issuance of equity securities may
result in additional dilution to earnings per share.
PROPRIETARY RIGHTS
While the Company had one (1) issued U.S. Patent and 17 pending U.S. Patent
Applications at September 30, 1997, it nonetheless relies primarily on a
combination of trademark, copyright and trade secret protection together with
licensing arrangements and nondisclosure and confidentiality agreements to
establish and protect its proprietary rights. There can be no assurance that the
Company's measures to protect its proprietary rights will deter or prevent
unauthorized use of the Company's technology, brand or other proprietary or
intellectual property. In addition, the laws of certain foreign countries may
not protect the Company's proprietary rights to the same extent as do the laws
of the United States or the EC. As is typical in its industry, the Company from
time to time is subject to legal claims asserting that the Company has violated
the proprietary rights of third parties. In the event that a third party was to
sustain a valid claim against the Company, and any required licenses were not
available on commercially reasonable terms, the Company's operating results
could be materially and adversely affected. Litigation, which could result in
substantial cost to and diversion of the resources of the Company, may also be
necessary to enforce proprietary rights of the Company or to defend the Company
against claimed infringement of the proprietary rights of others.
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
systems 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,
market conditions for PC or semiconductor stocks, changes in earnings estimates
by analysts, or other events or factors. In this regard, the Company does not
endorse and accepts no responsibility for the estimates or recommendations
issued by stock research analysts from time to time. In addition, the public
stock markets in general, and technology stocks in particular, have experienced
extreme price and trading volume volatility. This volatility has significantly
affected the market prices of securities of many high technology companies for
reasons frequently unrelated to the operating performance of the specific
companies. These broad market fluctuations may adversely affect the market price
of the Company's Common Stock.
DEPENDENCE ON 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,
particularly in the San Jose, CA area ("Silicon Valley"). 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. The loss of services of one or more of its key personnel or the
inability to add or replace key personnel could have a material adverse effect
on the Company. The salary, performance bonus and stock option packages
necessary to recruit or retain key personnel, particularly in Silicon Valley,
may
24
<PAGE> 25
significantly increase the Company's expense levels or result in dilution to
the Company's earnings per share. The Company does not carry "key person" life
insurance on any of its employees.
LEGAL MATTERS
The Company has been named as a defendant in several putative class action
lawsuits which were filed in June and July, 1996 and June, 1997 in the
California Superior Court for Santa Clara County and the U.S. District Court for
the Northern District of California. Certain executive officers and directors of
the Company are also named as defendants. The plaintiffs purport to represent a
class of all persons who purchased the Company's Common Stock between October
18, 1995 and June 20, 1996 (the "Class Period"). The complaints allege claims
under the federal securities laws and California law. The plaintiffs allege that
the Company and the other defendants made various material misrepresentations
and omissions during the Class Period. The complaints do not specify the amount
of damages sought. The Company believes that it has good defenses to the claims
alleged in the lawsuits and will defend itself vigorously against these actions.
These cases are in the early stages and no trial date has been set. The ultimate
outcome of these actions cannot be presently determined. Accordingly, no
provision for any liability or loss that may result from adjudication or
settlement thereof has been made in the accompanying consolidated financial
statements.
The Company is also party to other claims and pending legal proceedings
that generally involve employment and trademark issues. These cases are, in the
opinion of management, ordinary and routine matters incidental to the normal
business conducted by the Company. In the opinion of management, the ultimate
disposition of such proceedings will not have a materially adverse effect on the
Company's consolidated financial position or future results of operations.
25
<PAGE> 26
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company has been named as a defendant in several putative class action
lawsuits which were filed in June and July, 1996 and June, 1997 in the
California Superior Court for Santa Clara County and the U.S. District Court for
the Northern District of California. Certain executive officers and directors of
the Company are also named as defendants. The plaintiffs purport to represent a
class of all persons who purchased the Company's Common Stock between October
18, 1995 and June 20, 1996 (the "Class Period"). The complaints allege claims
under the federal securities laws and California law. The plaintiffs allege that
the Company and the other defendants made various material misrepresentations
and omissions during the Class Period. The complaints do not specify the amount
of damages sought. The Company believes that it has good defenses to the claims
alleged in the lawsuits and will defend itself vigorously against these actions.
These cases are in the early stages and no trial date has been set. The ultimate
outcome of these actions cannot be presently determined. Accordingly, no
provision for any liability or loss that may result from adjudication or
settlement thereof has been made in the accompanying consolidated financial
statements.
The Company is also party to other claims and pending legal proceedings
that generally involve employment and trademark issues. These cases are, in the
opinion of management, ordinary and routine matters incidental to the normal
business conducted by the Company. In the opinion of management, the ultimate
disposition of such proceedings will not have a materially adverse effect on the
Company's consolidated financial position or future results of operations.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibit
Exhibit # Description of Document
--------- -----------------------
11.1 Statement Regarding Computation of Net Income
(Loss) per Share
B. Reports on Form 8-K
The Company did not file any reports on Form 8-K during the
quarter ended September 30, 1997.
26
<PAGE> 27
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.
DIAMOND MULTIMEDIA SYSTEMS, INC.
Date: November 10, 1997 /s/ William J. Schroeder
-------------------------
William J. Schroeder
President and Chief Executive Officer
Date: November 10, 1997 /s/ James M. Walker
--------------------
James M. Walker
Senior Vice President and
Chief Financial Officer
27
<PAGE> 28
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit # Description
- --------- -----------
<S> <C>
11.1 Statement regarding computation of net income (loss) per share
27 Financial Data Schedule
</TABLE>
28
<PAGE> 1
EXHIBIT 11.1
DIAMOND MULTIMEDIA SYSTEMS, INC.
STATEMENT REGARDING COMPUTATION OF NET INCOME (LOSS) PER SHARE
(unaudited, in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Weighted average common shares outstanding
for period 34,389 34,290 34,274 34,390
Dilutive employee stock options -- 640 -- 661
-------- -------- -------- --------
Shares used in per share calculations 34,389 34,930 34,274 35,051
======== ======== ======== ========
Net income (loss) ($ 2,553) $ 2,100 ($52,613) $ 8,504
======== ======== ======== ========
Net income (loss) per share ($0.07) $0.06 ($1.54) $0.24
======== ======== ======== ========
</TABLE>
The difference between the calculation of net income (loss) per share calculated
on the primary and fully diluted basis is not material.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 98,284
<SECURITIES> 0
<RECEIVABLES> 52,955
<ALLOWANCES> 2,237
<INVENTORY> 72,208
<CURRENT-ASSETS> 269,634
<PP&E> 23,094
<DEPRECIATION> 8,539
<TOTAL-ASSETS> 291,293
<CURRENT-LIABILITIES> 115,989
<BONDS> 2,036
0
0
<COMMON> 34
<OTHER-SE> 173,234
<TOTAL-LIABILITY-AND-EQUITY> 291,293
<SALES> 257,413
<TOTAL-REVENUES> 257,413
<CGS> 242,767
<TOTAL-COSTS> 242,767
<OTHER-EXPENSES> 91,756
<LOSS-PROVISION> 691
<INTEREST-EXPENSE> (1,426)
<INCOME-PRETAX> (75,592)
<INCOME-TAX> (22,979)
<INCOME-CONTINUING> (52,613)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (52,613)
<EPS-PRIMARY> (1.54)
<EPS-DILUTED> (1.54)
</TABLE>
