<PAGE> 1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED APRIL 3, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________ TO ____________
Commission File Number 000-22119
===============================================================================
ACCELGRAPHICS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0450627
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1873 BARBER LANE, MILPITAS, CALIFORNIA 95035
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 546-2100
===============================================================================
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
The number of shares outstanding of the registrant's common stock at May 6, 1998
was 8,473,232.
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ACCELGRAPHICS, INC.
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
PAGE
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<S> <C>
PART I. FINANCIAL INFORMATION:
ITEM 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheet as of March 31, 1998
and December 31, 1997 3
Condensed Consolidated Statement of Operations for the three months
ended March 31, 1998 and 1997 4
Condensed Consolidated Statement of Cash Flows for the three months
ended March 31, 1998 and 1997 5
Notes to Condensed Consolidated Financial Statements 6
ITEM 2. Management's Discussion and Analysis of Financial Condition
And Results of Operations 8
PART II. OTHER INFORMATION
ITEM 6.
Exhibits 23
Signature(s) 23
</TABLE>
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PART I. FINANCIAL INFORMATION:
ITEM 1. Condensed Consolidated Financial Statements (Unaudited)
ACCELGRAPHICS, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
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<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 10,732 $ 9,367
Short-term investments 6,729 6,526
Accounts receivable, net 5,776 6,545
Inventories 1,513 2,566
Prepaid expenses 309 434
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Total current assets 25,059 25,438
Property and equipment, net 792 876
Long-term investments 2,999 1,995
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Total assets $ 28,850 $ 28,309
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term obligations $ 332 $ 230
Accounts payable 2,316 2,066
Accrued liabilities 1,228 1,266
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Total current liabilities 3,876 3,562
Long term obligations, net of current portion 448 482
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Total liabilities 4,324 4,044
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Stockholders' equity:
Preferred Stock, $0.001 par value, 2,000 and 10,000 shares authorized -- --
Common Stock, $0.001 par value, 50,000 shares authorized;
8,451 and 1,253 shares issued and outstanding 8 8
Additional paid-in capital 30,138 30,037
Notes receivable from stockholders (48) (49)
Deferred stock compensation (126) (160)
Cumulative translation adjustment (20) (9)
Accumulated deficit (5,426) (5,562)
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Total stockholders' equity 24,526 24,265
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$ 28,850 $ 28,309
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</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
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ACCELGRAPHICS, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
1998 1997
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<S> <C> <C>
Revenues $ 10,479 $ 11,832
Cost of revenues 7,761 7,584
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Gross profit 2,718 4,248
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Operating expenses:
Research and development 1,034 1,055
Sales and marketing 1,174 1,511
General and administrative 526 475
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Total operating expenses 2,734 3,041
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Income (loss) from operations (16) 1,207
Interest and other income (expense), net 162 (3)
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Income before income tax provision 146 1,204
Income tax provision 10 370
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Net income $ 136 $ 834
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Net income per share:
Basic $ 0.02 $ 0.80
======== ========
Diluted $ 0.02 $ 0.13
======== ========
Shares used to compute net income per share:
Basic 8,415 1,039
======== ========
Diluted 8,973 6,648
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</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
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ACCELGRAPHICS, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1998 1997
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<S> <C> <C>
Cash flows from operating activities:
Net income $ 136 $ 834
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 122 78
Loss on disposal of asset -- 28
Stock compensation expense and other 34 61
Changes in assets and liabilities:
Accounts receivable 769 (1,455)
Inventories 1,053 (433)
Prepaid expenses 125 21
Accounts payable 250 1,928
Accrued liabilities (38) 727
Income taxes payable -- 324
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Net cash provided by operating activities 2,451 2,113
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Cash flows from investing activities:
Acquisition of property and equipment (38) (69)
Purchase of investments, net (1,207) --
-------- --------
Net cash used in investing activities (1,245) (69)
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Cash flows from financing activities:
Repayment of capital lease obligations (14) (2)
Proceeds from repayment of stockholders' notes 1 9
Proceeds from issuance of common stock 101 9
Deferred financing costs -- (429)
Borrowing under term loan 82 --
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Net cash provided by (used in) financing activities 170 (413)
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Effect of exchange rates on cash (11) --
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Net increase in cash and cash equivalents 1,365 1,631
Cash and cash equivalents at beginning of period 9,367 2,979
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Cash and cash equivalents at end of period $ 10,732 $ 4,610
======== ========
Supplemental disclosure of cash flow information:
Income taxes paid during the period $ 4 $ 45
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Interest paid during the period $ 33 $ 47
======== ========
Supplemental disclosure of non-cash financing
and investing activities:
Issuance of capital lease obligations for
acquisition of property and equipment $ -- $ 80
======== ========
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
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ACCELGRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared by AccelGraphics, Inc. (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 fiscal 1997
consolidated financial statements and notes thereto, which are contained in the
Company's Annual Report on Form 10-K.
The Company operates under a 52-53 week fiscal year with thirteen week quarters
that end on the Friday closest to calendar quarter end. For convenience of
presentation, financial information has been shown as ending on the last date of
the calendar quarter.
Operating results for the first quarter of 1998 may not necessarily be
indicative of the results to be expected for any other interim period or for the
full year.
NOTE 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>
MARCH 31, 1998 DECEMBER 31, 1997
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<S> <C> <C>
Raw materials $ 875 $ 1,297
Work in process 182 978
Finished goods 456 291
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$ 1,513 $ 2,566
========= =========
</TABLE>
NOTE 3. NET INCOME PER SHARE
The Company reports earnings per share in accordance with the provisions of
Statement of Financial Accounting Standard No. 128 ("FAS 128"), Earnings per
Share ("EPS") and Staff Accounting Bulletin No. 98. Basic EPS is computed by
dividing income available to common stockholders by the weighted average number
of common shares outstanding for the period. Diluted EPS is computed by giving
effect to all dilutive potential common shares that were outstanding during the
period. Potential dilutive common shares consist of the incremental common
shares issuable upon the exercise of stock options for all periods and
convertible preferred stock for periods prior to the Company's initial public
offering. All prior period EPS amounts have been restated to comply with FAS
128.
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Basic and diluted EPS were calculated as follows during the three months ended
March 31, 1998 and 1997:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1998 1997
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(IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C>
BASIC:
Weighted average common shares 8,415 1,240
Unvested portion of common shares subject
to vesting -- (201)
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Shares used in basic per share calculation 8,415 1,039
======= =======
Net income $ 136 $ 834
======= =======
Basic net income per share $ 0.02 $ 0.80
======= =======
DILUTED:
Weighted average common shares 8,415 1,240
Weighted average preferred shares as if converted -- 4,529
Common equivalent shares from stock
options and warrants 558 879
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Shares used in diluted per share calculation 8,973 6,648
======= =======
Net income $ 136 $ 834
======= =======
Diluted net income per share $ 0.02 $ 0.13
======= =======
</TABLE>
Options to purchase 443,813 shares of common stock at a range of $5.25 to $9.50
per share were outstanding during the first quarter of fiscal 1998 but were not
included in the computation of diluted EPS because the options' exercise price
was greater than the average market price of the common shares for the quarter.
No options were excluded from the computation of diluted EPS during the first
quarter of fiscal 1997.
NOTE 4. CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130 ("FAS 130"), "Reporting Comprehensive Income." This Statement
requires that all items recognized under accounting standards as components of
comprehensive earnings be reported in an annual financial statement that is
displayed with the same prominence as other annual financial statements. FAS 130
also requires that an entity classify items of other comprehensive earnings by
their nature in an annual financial statement. For example, other comprehensive
earnings may include foreign currency translation adjustments, minimum pension
liability adjustments, and unrealized gains and losses on marketable securities
classified as available-for-sale. Annual financial statements for prior periods
will be reclassified, as required. The Company's total comprehensive earnings
were as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1998 1997
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(IN THOUSANDS,)
<S> <C> <C>
Net earnings $ 136 $ 834
Other comprehensive loss (11) --
------ -------
Total comprehensive earnings $ 125 $ 834
====== =======
</TABLE>
NOTE 5. SUBSEQUENT EVENT
On April 22, 1998, the Company signed an Agreement and Plan of Merger (the
"Merger") with Evans & Sutherland Computer Corporation ("E&S") whereby E&S
will acquire the Company. The Merger is expected to be completed in June 1998.
Completion of the Merger is subject to a number of conditions, including certain
regulatory approvals and approval by a majority of the Company's stockholders.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information should be read in conjunction with the Condensed
Consolidated Financial Statements and the notes thereto and in conjunction with
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in the Company's Annual Report on Form 10-K. This quarterly
report on Form 10-Q, and in particular Management's Discussion and Analysis of
Financial Condition and Results of Operations, contains forward-looking
statements regarding future events or the future performance of the Company that
involve certain risks and uncertainties including those discussed in "Risk
Factors" below, in the Company's Annual Report of Form 10-K and in the Company's
Preliminary Proxy Materials filed with the Securities and Exchange Commission on
April 1, 1998 and April 29, 1998, respectively. In this report, the words
"anticipates," "believes", "expects", "future" and similar expressions identify
forward-looking statements. Actual events or the actual future results of the
Company may differ materially from any forward-looking statements due to such
risks and uncertainties as well as to other unanticipated events. The Company
assumes no obligation to update these forward-looking statements to reflect
actual results or changes in factors or assumptions affecting such
forward-looking assumptions. Readers are cautioned not to place undue reliance
on these forward-looking statements, which reflect management's analysis only as
of the date hereof.
OVERVIEW
AccelGraphics, Inc. (the "Company") designs, develops and markets
high-performance, cost-effective, 3-dimensional ("3D") graphics subsystems,
software accelerators and application utility software products for the
professional Windows NT and Windows 95 markets. The Company commenced operations
in late 1994.
The Company's graphic subsystems include the AccelECLIPSE, AccelPRO, and
AccelSTAR product lines, while the Company's application utility software
includes the AccelVIEW product.
The Company's customers include OEMs, distributors and VARs. Revenues
from product sales are generally recognized upon shipment, less an allowance for
estimated future returns and exchanges. The Company's gross margin has varied
with the mix of revenues by sales channel, as OEM revenues generally yield lower
gross margins, product mix and competitive pricing pressures.
The Company has increased its research and development, sales and
marketing and administrative capabilities since its inception and expects to
expand such capabilities in the future. The anticipated increase in the
Company's operating expenses caused by this expansion could have a material
adverse effect on the Company's operating results if revenues and gross profit
do not increase at an equal or greater rate. Also, the Company's expenses for
these and other activities are based in significant part on its expectations
regarding future revenues and are fixed to a large extent in the short term.
Accordingly, the Company may be unable to adjust spending in a timely manner to
compensate for any unexpected revenue shortfall, which would have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company has a limited operating history upon which an evaluation of
the Company and its prospects can be based. The Company's prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered by companies in the early stages of development, particularly
companies in new and rapidly evolving markets. To address these risks, the
Company must, among other things, respond to competitive developments, attract,
retain and motivate qualified persons, continue to upgrade its technologies and
continue to commercialize its products. There can be no assurance that the
Company will be successful in addressing these and other risks.
Although the Company has experienced significant annual revenue growth
since its inception, the Company does not believe that such growth rates are
sustainable. In the first quarter of 1998, revenues declined by 11% from the
first quarter of 1997 and revenues for the fourth quarter of 1997 were 16% lower
than revenues in the fourth quarter of 1996; consequently, past or current
revenue growth rates may not be indicative of future revenue growth, if any, or
future operating results. The Company has incurred losses in each year since its
inception and also incurred losses during each of the last two quarters of 1997.
There can be no assurance that the Company will sustain profitability on a
quarterly basis or will achieve profitability on an annual basis. The Company's
limited operating history makes the prediction of future operating results
difficult, if not impossible.
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RESULTS OF OPERATIONS
The following table sets forth certain consolidated statement of operations
data as a percentage of revenues for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1998 1997
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<S> <C> <C>
Revenues 100.0% 100.0%
Cost of revenues 74.1 64.1
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Gross profit 25.9 35.9
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Operating expenses:
Research and development 9.9 8.9
Sales and marketing 11.2 12.8
General and administrative 5.0 4.0
------ ------
Total operating expenses 26.1 25.7
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Income (loss) from operations (0.2) 10.2
Interest and other income (expense), net 1.6 0.0
------ ------
Income before provision for income taxes 1.4 10.2
Provision for income taxes (0.1) (3.2)
------ ------
Net income 1.3% 7.0%
====== ======
</TABLE>
REVENUES
Revenues decreased by 11% to $10.5 million during the first quarter of 1998
from $11.8 million during the first quarter of 1997. Revenues for first quarter
of 1998 primarily consisted of sales of the Company's AccelECLIPSE II, AccelPRO
MX and AccelSTAR II products, while revenues in the first quarter of 1997
primarily consisted of sales of the Company's AccelPRO TX product. This decrease
in revenue is primarily due to increased unit sales of the Company's current
products at lower average selling prices, offset in part by an increase in
revenue from software licenses and royalty agreements ("License Revenue").
Revenues from product sales are generally recognized upon product shipment,
less an allowance for estimated future returns and exchanges. Provisions for the
costs of technical support services for the Company's hardware products and
estimated future warranty claims are recorded as a cost of revenues upon
recognition of related revenues.
International revenues decreased by 10% to $5.3 million during the first
quarter of 1998 from $5.9 million during the first quarter of 1997, representing
50.5% and 49.9%, respectively, of revenues. The decrease in international
revenues is primarily a result of decreased sales of the Company's products to
its OEM customers in Europe and Asia-Pacific and its distributors in Europe,
offset in part by increased sales to its distributors in Asia-Pacific. Revenues
from the Company's international customers are generally denominated in United
States dollars. Although the effects of currency fluctuations have been
insignificant to date, there can be no assurance that such fluctuations will not
be significant in the future.
Revenues from Hewlett-Packard Company ("HP") and TechnoGraphy Inc. ("TGI"),
the Company's Japanese distributor that sells to Hitachi, Ltd. accounted for
50.5% and 11.7%, respectively, of revenues during the first quarter of 1998.
Revenues from HP, TGI and the Company's former customer, Digital Equipment
Corporation ("Digital"), accounted for 44.7%, 6.6% and 20.8%, respectively, of
revenues during the first quarter of 1997. The Company had no sales to Digital
in the first quarter of 1998. The loss of any major customer, or the delay in or
reduction of orders from such customers could have a material adverse effect on
the Company's business, financial condition and results of operations.
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GROSS PROFIT
Gross profit decreased 36% to $2.7 million during the first quarter of 1998
from $4.2 during the first quarter of 1997, representing 25.9% and 35.9%,
respectively, of revenues. Gross margins in the first quarter of 1998 were
negatively impacted by increased sales to OEMs, which generally carry lower
margins, and by competitive pricing pressures. Gross profit was also impacted by
expenses related to expediting fees on OEM orders and collection issues related
to the bankruptcy of the Company's European distributor. Gross profit in the
first quarter of 1998 was favorably impacted by License Revenue. The absolute
dollar decrease in gross profit resulted from decreased revenues, and lower per
unit margins.
The Company's gross margin is affected by many factors, including the sales
channel mix, the mix of products sold, License Revenue generated during the
period, increased competition and related decreases in unit average selling
prices, introductions of new products and the availability, reliability and cost
of components and products from the Company's subcontractors and suppliers. In
addition, the Company orders products in advance of planned shipments and, due
to rapid technological changes or other factors such as customers curtailing or
changing timing or mix of orders, there is a risk that the Company will forecast
incorrectly and produce excess or insufficient inventories of particular
products. The Company's customers' ability to reschedule or cancel orders
without significant penalty could adversely affect the Company's operating
results, as the Company may be unable to adjust its purchases from its
subcontractors and suppliers to match such customers' changes and cancellations.
OPERATING EXPENSES
Research and Development. Research and development expenses decreased 2% to
$1.0 million during the first quarter of 1998 from $1.1 million during the first
quarter of 1997, representing 9.9% and 8.9%, respectively, of revenues. Research
and development expenses consist primarily of personnel costs and other
personnel-related expenses, including the services of outside consultants. The
Company anticipates that research and development expenses will increase in
absolute dollars as the Company continues to add research and development
personnel and support for new product development activities.
Sales and Marketing. Sales and marketing expenses decreased 22% to $1.2
million during the first quarter of 1998 from $1.5 million during the first
quarter of 1997, representing 11.2% and 12.8%, respectively, of revenues. Sales
and marketing expenses consist primarily of salaries, commissions, marketing
expenses and technical support for the sales organization. The absolute dollar
decrease in sales and marketing expenses was due primarily to higher personnel
related costs in the first quarter of 1997, including commissions. The Company
anticipates that sales and marketing expenses may increase in absolute dollars
due to expansion of the Company's sales efforts in Europe and the Asia-Pacific,
as well as increased marketing and public relations activities.
General and Administrative. General and administrative expenses increased
11% to $530,000 during the first quarter of 1998 from $480,000 during the first
quarter of 1997, representing 5.0% and 4.0%, respectively, of revenues.
Increased general and administrative expenses were due primarily to increased
staffing and other costs incurred to support the Company's growth as well as
costs associated with operating as a public company. The Company anticipates
that general and administrative expenses may increase in absolute dollars due to
costs associated with the Company's pending merger with E & S.
INTEREST AND OTHER INCOME (EXPENSE), NET
Interest and other income (expense), net is comprised of primarily of
interest income on the Company's cash and investments, net of interest expense
on the Company's borrowings. Interest expense decreased to $10,000 in the first
quarter of 1998 from $40,000 during the first quarter of 1997 primarily due to
the repayment of the subordinated convertible note payable to Kubota Corporation
in April 1997. Interest income increased to $230,000 in the first quarter of
1998 from $50,000 during the first quarter of 1997 primarily due to the
increased level of cash and investments as a result of the Company's Initial
Public Offering in April 1997.
PROVISION FOR INCOME TAXES
The provision for income taxes reflects estimated annualized effective tax
rates of 6% and 31%, for the first quarter of 1998 and 1997, respectively,
applied to income before provision for income taxes, and includes consideration
of the Company's anticipated annual taxable income, tax rates and changes in its
valuation allowance.
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LIQUIDITY AND CAPITAL RESOURCES
Cash and equivalents increased by $1.4 million during the first quarter of
1998. Operating activities generated $2.5 million in cash. The primary sources
of cash were decreases in accounts receivable and inventory of $770,000 and $1.1
million, respectively.
Net cash used in investing activities was approximately $1.2 million due
primarily to the purchase of investments. Net cash provided by financing
activities was $170,000 primarily due to issuances of common stock and proceeds
from borrowings under the Company's term-loan.
At March 31, 1998, the Company had $20.5 million of cash, cash equivalents
and investments. The Company has available borrowing facilities of $3.4 million
with a bank, net of borrowings in the aggregate amount of $600,000 which are
outstanding. The borrowings bear interest at rates between 8.75% and 9.0%, are
secured by all of the Company's assets, require that the Company maintain
certain financial ratios and levels of tangible net worth and profitability and
also restrict the Company's ability to pay cash dividends. The Company was in
violation of its debt service covenant at the end of the first quarter of 1998;
however, the bank has waived such covenant. The $3 million line of credit
portion of the borrowing facilities expires in December 1998.
The Company believes that existing cash, cash equivalents and investments
and its available borrowings will be sufficient to finance its working capital
and capital expenditure requirements for at least the next 12 months. In the
event that the Company's proposed merger with E & S is not concluded, the
Company may require additional funds to support its working capital requirements
or for other purposes and may seek to raise such additional funds through bank
borrowings and public or private sales of its securities, including equity and
debt securities. The Company's future capital requirements will depend on
numerous factors, including, without limitation, management of working capital,
the success of marketing, sales and distribution efforts, market acceptance of
the Company's products, the progress of its research and development programs,
the costs involved in defending and enforcing intellectual property rights,
competition, competing technological and market developments, and the
effectiveness of product commercialization activities and arrangements. There
can be no assurance that additional funds, if required, will be available to the
Company on favorable terms or at all.
RISK FACTORS
In addition to other information in this Form 10-Q and in the Company's Form
10-K and Preliminary Proxy Materials filed with the Securities and Exchange
Commission on April 1, 1998 and April 29, 1998, respectively, the following are
important factors that should be considered carefully in evaluating the Company
and its business.
RISKS RELATED TO MERGER AGREEMENT WITH EVANS & SUTHERLAND COMPUTER CORPORATION
Uncertainty Relating to Integration. The Merger involves the integration of
two companies that have previously operated independently. The successful
combination of the two companies will require significant effort from each
company, including the coordination of their research and development,
utilization and successful commercialization of in-process research and
development, integration of the companies' product offerings, coordination of
their sales and marketing efforts and business development efforts. Following
the Merger, in order to maintain and increase profitability, E&S will need to
integrate and streamline overlapping functions successfully. Costs generally
associated with this type of integration that may be incurred by E&S include the
integration of product lines, sales force cross-training and market positioning
of products. While these costs have not been currently identified, any such
costs may have an adverse effect on operating results in the periods in which
they are incurred. Each of E&S and the Company has different systems and
procedures in many operational areas that must be rationalized and integrated.
There may be substantial difficulties associated with integrating two separate
companies, and there can be no assurance that such integration will be
accomplished smoothly, expeditiously or successfully. The integration of certain
operations following the Merger will require the dedication of management
resources that may distract attention from normal operations. The business of
E&S may also be disrupted by employee uncertainty and lack of focus during such
integration. Failure to quickly and effectively accomplish the integration of
the operations of E&S and the Company could have a material adverse effect on
the consolidated business, financial condition and results of operations of E&S.
Moreover, uncertainty in the marketplace or customer concern regarding the
impact of the Merger and related transactions could have a material adverse
effect on the consolidated business, financial condition and results of
operations of E&S.
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Effect of the Merger on Customers and Existing Agreements. Certain of E&S's
and the Company's existing customers may view the Merger as disadvantageous to
them. As a consequence, the future relationship with these customers could be
adversely affected. The Merger will require the consent of certain parties who
have entered into contracts with the Company. There can be no assurance that
such consents will be given and, if not given, that such contracts will not
terminate.
Retention of Employees. The success of E&S and the Company will be dependent
in part on the retention and integration of management, technical, marketing,
sales and customer support personnel. There can be no assurance that the
companies will be able to retain such personnel or that the companies will be
able to attract, hire and retain replacements for employees that leave following
consummation of the Merger. The failure to attract, hire, retain and integrate
such skilled employees could have a material adverse effect on the business,
operating results and financial condition of E&S and the Company.
Rights of Holders of the Company's Common Stock Following the Merger.
Following the Merger, holders of the Company's Common Stock outstanding as of
the effective time of the Merger may become holders of E&S Common Stock. Certain
differences exist between the rights of stockholders of the Company under
Delaware law, the Company's Certificate of Incorporation and the Company's
Bylaws, and the rights of stockholders of E&S under Utah law, the Articles of
Incorporation of E&S and the Bylaws of E&S.
Effect of Merger on Distributors. Certain of E&S's existing distributors may
view themselves as competitors of the combined entity formed by the Merger, and
therefore determine that the Merger is competitively disadvantageous to them. As
a consequence, the combined entity's relationship with these distributors could
be adversely affected.
Potential Dilutive Effect to Stockholders. Although the companies believe
that beneficial synergies will result from the Merger, there can be no assurance
that the combining of the two companies' businesses, even if achieved in an
efficient, effective and timely manner, will result in combined results of
operations and financial condition superior to what would have been achieved by
each company independently, or as to the period of time required to achieve such
result. The issuance of E&S Common Stock in connection with the Merger may have
the effect of reducing E&S's net income per share from levels otherwise expected
and could reduce the market price of the E&S Common Stock unless revenue growth
or cost savings and other business synergies sufficient to offset the effect of
such issuance can be achieved.
Loss of Opportunity for the Company as a Stand-Alone Entity. As a consequence
of the Merger, the Company's stockholders will lose the chance to invest in the
development and exploitation of the Company's products on a stand-alone basis.
It is possible that the Company, if it were to remain independent, could achieve
economic performance superior to that which it could achieve as a subsidiary of
E&S. Consequently, there can be no assurance that stockholders of the Company
would not achieve greater returns on investment if the Company were to remain an
independent company.
LIMITED HISTORY OF PROFITABILITY AND UNCERTAINTY OF FUTURE FINANCIAL RESULTS
The Company has incurred a net operating loss in each year since commencing
operations in late 1994. As a result, the Company had an accumulated deficit as
of March 31, 1998 of approximately $5.4 million. There can be no assurance that
the Company will ever achieve profitability on an annual basis in the future or
that it will sustain profitability on a quarterly basis. In addition, the
Company does not believe that its current annual revenue growth rates are
sustainable. To date, the Company has earned substantially all of its revenues
from sales of its graphics subsystem product lines. The Company has completed
three years of operations and is subject to the risks inherent in the operation
of a new business, such as the difficulties and delays often encountered in the
development and production of new, complex technologies. There can be no
assurance that the Company will be able to adequately mitigate these risks.
The Company may expand its research and development, sales and marketing and
administrative capabilities. The anticipated increase in the Company's operating
expenses which may result from such an expansion could have a material adverse
effect on the Company's operating results if revenues do not increase at an
equal or greater rate. Also, the Company's expenses for these and other
activities are based in significant part on its expectations regarding future
revenues and are fixed to a large extent in the short term. Accordingly, the
Company may be
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unable to adjust spending in a timely manner to compensate for any unexpected
revenue shortfall, which would have a material adverse effect on the Company's
business, financial condition and results of operations.
SIGNIFICANT VARIABILITY IN QUARTERLY RESULTS
Although the Company was profitable in the first quarter of 1998, the Company
incurred losses in the third and fourth quarters of 1997. The Company's
quarterly operating results have varied significantly in the past and are likely
to continue to vary significantly in the future. The Company's quarterly results
are affected by a wide variety of factors including the gain or loss of
significant customers, size and timing of individual orders, timely introduction
and market acceptance of new products offered by the Company and its
competitors, availability, reliability and cost of components, the Company's
success in negotiating OEM and other customer agreements, customer order
deferrals in anticipation of new products, technological changes in operating
systems or applications, variations in manufacturing quality or capacities,
changes in the pricing policies of the Company or its competitors, changes in
demand for 3D graphics functionality, changes in the mix of revenues from
products having differing gross margins, changes in sales channel mix, changes
in average sales prices, warranty expenses, fluctuations in the Company's
expense levels, the Company's success at expanding its direct sales force and
indirect distribution channels, risks related to international operations,
extraordinary events such as litigation or acquisitions and general industry and
economic conditions, as well as other factors. Any of the above risks could have
a material adverse effect on the Company's business, financial condition and
results of operations.
Quarterly revenues and operating results depend primarily on the volume,
timing and shipment of orders during the quarter, which are difficult to
forecast because customers generally place their orders on an as-needed basis
and, accordingly, the Company has historically operated with a relatively small
backlog. The Company's third-party distribution channels provide the Company
with limited information regarding the quantity of the Company's products in the
sales channel. This reduces the Company's ability to predict fluctuations in
revenues resulting from a surplus or a shortage in its distribution channel and
could contribute to volatility in the Company's results of operations and cash
flows. A surplus of inventory in the distribution channel could unexpectedly
cause a reduction in product shipments and revenues. Moreover, a
disproportionate percentage of the Company's revenues in any quarter may be
generated in the last month of a quarter. As a result, a shortfall in revenues
in any quarter as compared to expectations may not be identifiable until near
the end of the quarter. The Company may experience relatively weak demand in
third quarters due to historically weak summer sales in Europe.
The Company's gross margins are impacted by the sales channel mix, mix of
products sold, increased competition and related decreases in unit average
selling prices, introduction of new products and manufacturing of existing older
products, availability, reliability and cost of components from the Company's
subcontractors and suppliers, collection issues and general economic conditions.
Currently, the Company generates a significant portion of its revenue from sales
to OEMs, which have historically yielded lower margins than other channels.
Individual product lines generally provide higher margins at the beginning of
the life cycle and lower margins as the product line matures. In addition, the
Company's markets are characterized by rapidly changing technology and declining
average selling prices. Accordingly, the Company's gross margins may decline
from the levels experienced to date, which would have an adverse effect on the
Company's business, financial condition and results of operations.
A significant portion of the Company's operating expenses are relatively
fixed in the short term and planned expenditures are based on revenue forecasts.
As a result, if revenues are below levels needed to offset these operating
expenses, the Company's business, financial condition and results of operations
may be disproportionately affected because only a portion of the Company's
expenses vary with revenue. The Company generally must plan production, order
components and undertake its development, sales and marketing activities several
months in advance of shipping product and recognizing revenues. Accordingly, any
shortfall in revenues in a given quarter may impact the Company's operating
results and cash balances in a magnified way due to the Company's inability to
adjust expenses or inventory during the quarter to match the level of revenues
for the quarter. In addition, in the event the Company's customers desire to
purchase products in excess of forecasted amounts, the Company may not have
sufficient inventory or access to sufficient manufacturing capacity to meet such
demands. Although the Company has experienced growth in revenues in recent
quarters, there can be no assurance that the Company will sustain such revenue
growth or be profitable on an operating basis in any future period. For the
foregoing reasons, the Company believes that period-to-period comparisons of its
results are not necessarily meaningful and should not be relied upon as
indications of future performance. Further, when the Company announced that its
revenues and net income were below the expectations of market analysts for the
second quarter of 1997 and again in the third quarter of 1997, the Company's
stock price suffered significant declines. Accordingly, it is likely that in
some
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future quarter the Company's revenues or operating results will be below the
expectations of public market analysts and investors. In such event, the price
of the Common Stock could be materially adversely affected.
RAPID TECHNOLOGICAL CHANGE
The computer industry in general, and the markets for the Company's products
in particular, are characterized by ongoing technological developments, evolving
industry standards and rapid changes in customer requirements. Customer
preferences can change rapidly and new technology can quickly render existing
products obsolete. In order to keep pace with this rapidly changing market
environment, the Company must continually develop and incorporate into its
products technological advances and new features desired by customers at
competitive prices. There can be no assurance that the Company will be
successful in developing and marketing, on a timely basis or at all, competitive
products, product enhancements and new products that respond to technological
changes or changes in customer requirements and industry standards, or that the
Company's enhanced or new products will adequately address the changing needs of
the marketplace.
Additionally, application programming interfaces ("APIs") have evolved and
changed over time. Although OpenGL has developed into a leading industry
standard API for professional 3D graphics development, it is likely that
industry standards will continue to evolve to meet rapidly changing customer
requirements. There can be no assurance that the Company will be successful in
developing and marketing product enhancements or new products that respond to
these evolving standards. In addition, Intel has introduced the Accelerated
Graphics Port (AGP) bus structure, an alternative to the existing PCI bus
structure, which is currently gaining increasing acceptance as the standard
graphics bus structure. Recently, Microsoft and Silicon Graphics, Inc. ("SGI")
have announced the Fahrenheit project to create a new suite of APIs. Fahrenheit
is expected to incorporate Microsoft's Direct3D and DirectDraw APIs and SGI's
OpenGL technology. Fahrenheit is expected to become available in the first half
of 1999. Failure by the Company to respond effectively to changes in the 3D
graphics market, to develop or acquire new technology or to successfully conform
to industry standards would have a material adverse effect on the business,
financial condition and results of operations of the Company.
Operating systems and independent software vendor ("ISV") applications are
updated from time to time. The Company must constantly monitor these changes and
upgrade its products to remain compatible with any upgrades in operating systems
and ISV applications. There can be no assurance that the Company will be
successful in developing new versions or enhancements to its products or that
the Company will not experience delays in the upgrade of its products. In the
event that there are delays in the completion of any upgrade to its products,
the Company's business, financial condition and results of operations would be
materially adversely affected. In addition, the Company strives to achieve
compatibility between the Company's products and 3D graphics applications the
Company believes are or will become popular and widely adopted. The Company
invests substantial resources in development efforts aimed at achieving such
compatibility. Any failure by the Company to anticipate or respond adequately to
changes in applications could result in a loss of competitiveness and could
adversely affect the Company's business, financial condition and results of
operations.
COMPETITION
The market for 3D graphics accelerators is extremely competitive and subject
to rapid change. The Company expects competition to increase in the future from
existing competitors and from new market entrants with products that may be less
costly than the Company's products or provide better performance or additional
features not currently provided by the Company's products. The Company competes
with the following three major groups: professional 3D graphics board companies
(including Intergraph Corporation and Dynamic Pictures, Inc.), RISC/UNIX
workstation companies (including Sun Microsystems, Inc. ("Sun") and SGI) and
traditional volume personal computer ("PC") board suppliers (including ELSA
GmbH, Diamond Multimedia Systems, Inc., Matrox Electronic Systems Ltd. and STB
Systems, Inc.). A variety of potential actions by any of the Company's
competitors could have a material adverse effect on the Company's business,
financial condition and results of operations. Such actions may include
reduction of product prices, increased promotion, announcement or accelerated
introduction of new or enhanced products, product giveaways, product bundling or
other competitive actions.
Many of the companies that currently compete with the Company or that may
compete with the Company have longer operating histories and significantly
greater financial, technical, sales, marketing and other resources, as well as
greater name recognition and larger customer bases, than the Company. As a
result, these competitors may be
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able to respond more quickly and effectively to new or emerging technologies and
changes in customer requirements or to devote greater resources to the
development, promotion, sale and support of their products than the Company.
Some of these companies also purchase their components from the Company's
suppliers. Consequently, the Company expects to continue to experience increased
competition, which could result in significant price reductions, loss of market
share and lack of acceptance of new products, any of which could have a material
adverse effect on the Company's business, financial condition and results of
operations. There can be no assurance that the Company will be able to compete
against current or future competitors successfully or that competitive pressures
faced by the Company will not have a material adverse effect upon its business,
financial condition and results of operations.
LIMITED HISTORY OF PRODUCT DEVELOPMENT
The Company's products are complex, are based on relatively new technology
and have a limited history of reliability. The Company generally provides a
three-year warranty for its products. In general, the Company's return policy
permits return within five days after receipt of products that do not meet
product specifications. Companies engaged in the development and production of
new, complex technologies and products often encounter difficulties in
performance and reliability and delays in product introduction and volume
shipments. Additionally, products as complex as those offered by the Company may
contain undetected errors or "bugs" when introduced that, despite testing by the
Company, are discovered only after a product has been installed and used by
customers. There can be no assurance that the Company will be successful in
resolving any problems with the Company's existing or future products. Failure
by the Company to resolve manufacturing or operational problems with any
existing product or any new product in a timely manner would have a material
adverse effect on the Company's business, financial condition and results of
operations.
The success of the Company will likely depend on its ability to develop and
market new products that provide superior performance at competitive prices. Any
quality, reliability or performance problems with such products, regardless of
materiality, or any other actual or perceived problems with the Company's
products, could have a material adverse effect on market acceptance of such
products and the Company's reputation. There can be no assurance that such
problems or perceived problems will not arise or that, even in the absence of
such problems, the Company's products will receive market acceptance. A failure
of the Company's products to receive market acceptance for any reason would have
a material adverse effect on the Company's business, financial condition and
results of operations. In addition, the announcement by the Company of new
products and technologies could cause customers to defer purchases of the
Company's existing products, which would have a material adverse effect on the
Company's business, financial condition and results of operations.
SHORT PRODUCT LIFE CYCLES
The market for the Company's products is characterized by frequent new
product introductions and rapid product obsolescence. The life cycles of the
Company's products are difficult to estimate. Generally, life cycles of personal
computer 3D graphics subsystems are relatively short, approximately six to
fifteen months. The Company must constantly monitor industry trends and select
new technologies and features for its products, as well as monitor the timing of
introduction of new products. Moreover, short product life cycles, coupled with
single-source supply of components used in the Company's products, may prevent
the Company from being able, in a timely manner, to reduce its procurement
commitments, production or inventory levels in response to obsolescence,
unexpected shortfalls in orders, revenues or declines in prices or, conversely,
to increase production in response to unexpected increases in demand. Failure to
respond to the market adequately could have a material adverse effect on the
Company's business, financial condition and results of operations. The timing of
the end of a product's life cycle is difficult to predict and is typically
characterized by steep declines in unit sales, pricing and margins. As new
products are planned and introduced, the Company may not be able to control the
inventory levels of older products and phase out production, potentially
resulting in excess inventory and the expenses associated therewith. The Company
could experience unexpected reductions in revenues from older generation
products as customers anticipate new products. To the extent the Company is
unsuccessful in managing product transitions, its business, financial condition
and results of operations would be adversely affected.
RELIANCE ON THIRD-PARTY DISTRIBUTION AND MAJOR OEMS
The Company relies on OEMs, distributors and VARs for both domestic and
international revenues. In particular, revenues from HP and its former customer,
Digital, accounted for 36.4% and 22.4%, respectively, of
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revenues in 1997, and 22.8% and 27.9%, respectively, of revenues in 1996. The
Company believes that its future success depends upon its ability to broaden its
customer base and attract new significant customers. There can be no assurance
that a major customer will not reduce, delay or eliminate its purchases from the
Company, which could have a material adverse effect on the Company's business,
financial condition and results of operations. For example, in the third quarter
of 1997, revenues from Digital declined to 4.2% of total revenues from 20.8% of
revenues in the second quarter of 1997 and from 44.7% in the first quarter of
1997. In connection with the OEM agreement with HP, HP has a non-exclusive
manufacturing license pursuant to which it is granted the right to manufacture
or have manufactured the Company's products in the event of the Company's
bankruptcy, receivership or failure to supply HP with specified quantities of
products due to a cause not associated with the negligence of either party for
the term of the agreement or until the Company is out of bankruptcy or
receivership. In the event the Company were required to grant such non-exclusive
manufacturing rights to HP or any other OEM that subsequently may obtain such
rights, such grant could have the effect of decreasing the value of the
Company's ownership rights with respect to such products and/or decrease the
Company's revenues, either of which could have an adverse effect on the
Company's business, financial condition or results of operations.
The Company's customer agreements are short term and automatically renew each
year and generally may be canceled for convenience upon written notice by either
party. Generally, there are no minimum purchase requirements for the Company's
OEMs, distributors and VARs. Some of the Company's OEMs, distributors and VARs
offer competitive products manufactured internally or by third parties. There
can be no assurance that the Company's OEMs, distributors and VARs will give a
priority to the marketing of the Company's products as compared to competing
products or alternative solutions or that such OEMs, distributors and VARs will
continue to offer the Company's products. Moreover, there can be no assurance
that the Company will continue to sell substantial quantities of its products to
these OEMs, distributors and VARs, or that upon any termination of the Company's
relationships with any of these OEMs, VARs or distributors, the Company would be
able to obtain suitable alternate distribution channels, or that OEMs will not
internally manufacture 3D graphics subsystems rather than purchase them from the
Company. The inability to attract new significant OEM customers or the loss of
one or more of the Company's OEMs, VARs or distributors could have a material
adverse effect on the Company's business, financial condition and results of
operations. During the first quarter of 1998, the Company's southern and
northern European distributor declared bankruptcy. The Company is in the process
of identifying and qualifying new distributor customers in Europe; however,
until such distribution channels are established, the Company may by unable to
sell its product in southern and northern Europe. Accordingly, the Company may
experience significant backlog and delays in the supply of additional products
dealers and other end-user customers, which could have a material adverse effect
on the Company's business, financial condition and results of operations.
Although the Company seeks information from end users who purchase the
Company's products from OEMs, distributors and VARs, the Company generally does
not sell directly to end users and cannot directly observe their experience with
the Company's products. The Company also does not have direct control over the
marketing and support efforts of its OEMs, distributors and VARs. This lack of
direct control may result in the inability of the Company to identify potential
opportunities with these customers and may cause a potential delay by the
Company in the recognition and correction of any problems with such OEM,
distributor or VAR sales or support organizations. Failure of the Company to
respond to customer preferences or experience with its products or the failure
of OEMs, distributors or VARs to market and support the Company's products
successfully, could have a material adverse effect on the Company's business,
financial condition and results of operations.
INTERNATIONAL REVENUES
International revenues accounted for approximately 50% of the Company's
revenues for the first quarter of fiscal 1998 and primarily consisted of sales
to the European and Asia-Pacific operations of HP as well as to the Company's
Japanese distributor, which sells to Hitachi Ltd., and to other distributors
based in Germany and Japan. The Company expects that international revenues will
continue to account for a significant portion of its total revenues in future
periods. International revenues are subject to certain inherent risks, including
unexpected changes in regulatory requirements and tariffs, government controls,
political instability, longer payment cycles, difficulties in collecting
accounts receivable, difficulties in staffing and managing foreign operations
and potentially adverse tax consequences. The Company's inability to obtain
foreign regulatory approvals on a timely basis could have a material adverse
effect on the Company's business, financial condition and results of operations.
Fluctuations in currency exchange rates could cause the Company's products to
become relatively more expensive to end users in a particular country, leading
to a reduction in sales in that country. The impact of future exchange rate
fluctuations cannot be predicted adequately. To date, the Company has not found
it appropriate to hedge the risks associated
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with fluctuations in exchange rates, as substantially all of the Company's
foreign sales have been denominated in U.S. dollars. However, if future
transactions are denominated in foreign currencies, the Company may undertake to
hedge transactions. There can be no assurance that any hedging techniques
implemented by the Company would be successful or that the Company's results of
operations would not be materially adversely affected by exchange rate
fluctuations. In general, certain seasonal factors and patterns impact the level
of business activities at different times in different regions of the world. For
example, sales in Europe are adversely affected in the third quarter of each
year as many customers and end users reduce their business activities during the
summer months. These seasonal factors and currency fluctuation risks could have
a material adverse effect on the Company's business, financial condition and
results of operations. Further, because the Company operates in different
countries, the Company's management must address differences in regulatory
environments and cultures. Failure to address these differences successfully
could be disruptive to the Company's operations and could have a material
adverse effect on the Company's business, financial condition and results of
operations.
DEPENDENCE ON KEY PERSONNEL; NEED TO ATTRACT AND RETAIN HIGHLY SKILLED PERSONNEL
The success of the Company depends to a large extent upon its ability to
continue to attract and retain highly skilled personnel. Competition for
employees in the high technology sector in general, and in the graphics industry
in particular, is intense, and there can be no assurance that the Company will
be able to attract and retain sufficient numbers of qualified employees. The
Company has recently experienced a significant expansion in the overall level of
its business and the scope of its operations, including research and
development, marketing, sales, technical support and administration. It may
become increasingly difficult to hire, train and assimilate the new employees
needed given the market conditions. If the Company is unable to continue to
attract and retain sufficient numbers of qualified employees, it may be required
to rely on more expensive consultants. The Company has entered into employment
agreements with certain of its key personnel. Such agreements provide, in the
event of certain changes in control, for the acceleration of vesting of stock
options held by such personnel. In addition, if such employee is terminated
within 18 months after the change of control transaction, such employee is to
receive certain termination benefits. Such agreements may have the effect of
discouraging a third party from acquiring the Company. Additionally, the Company
has not required its key personnel to enter into noncompetition agreements with
the Company. The Company's inability to retain, attract and assimilate certain
members of the executive management team or key employees would have a material
adverse effect on the Company's business, financial condition and results of
operations.
UNCERTAINTY REGARDING ASIAN MARKETS
A significant number of the Company's customers and suppliers are in Asia.
Although the recent currency fluctuations and economic turmoil in the Asian
financial markets has, to date, not had a material impact on the Company's
revenues or operations, the financial instability in this region may have an
adverse impact on the financial position of customers and suppliers in the
region which could impact the Company's future revenues and operations,
including the ability of customers to pay the Company or the Company's
customers, which could also impact the ability of such customers to pay the
Company. The Company generally requires sales to Asia to be transacted on a
prepaid wire transfer basis. Should the current volatility in Asia continue, the
Company or the Company's customers may be unable to sell its products in the
region. The inability to generate revenues in this region, or the inability to
collect amounts due, could have a material adverse impact on the Company's
business, financial condition and results of operations.
DIFFICULTIES IN MANAGING GROWTH
The Company has experienced significant growth in its business over the past
three years which has placed demands on the Company's operational and financial
personnel and systems, outside manufacturing capacity, research and development,
technical support and other resources. The Company is expanding its sales and
marketing organizations, developing its distribution channels to penetrate
different and broader markets, funding additional research and development and
increasing its support organization to accommodate its growing customer base.
With continued growth, the Company may find it necessary to enhance existing and
implement new financial and management information systems and controls and
train its personnel to effectively operate such systems. Any delay in the
implementation of or any disruptions in the transition to such new and enhanced
systems and controls and personnel training could adversely affect the Company's
ability to accurately forecast sales demand and adjust third party manufacturing
to such demand, adjust purchasing levels, accurately record and control
inventory levels
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and record and report financial and management information on a timely and
accurate basis. Inaccuracy in demand forecasts in the environment in which the
Company operates can quickly result in either insufficient or excess inventory
and disproportional overhead expenses. Certain of the Company's officers have
recently joined the Company and the Company anticipates further increases in the
number of employees. The Company plans to expand the geographic scope of its
customer base and operations. Failure to manage these changes and to expand
effectively any of these areas would have a material adverse effect on the
Company's business, financial condition and results of operations.
DEPENDENCE ON SUBCONTRACTORS AND SOLE-SOURCE SUPPLIERS
The Company relies on subcontractors to manufacture, subassemble, test and
ship the Company's products. The Company relies on sole-source suppliers for
certain critical components, such as 3Dlabs for its graphics acceleration chips,
Mitsubishi for its graphics acceleration chips and 3DRAM/CDRAM chips, Texas
Instruments Incorporated for its RAMDAC chips, Cirrus Logic Inc. for its VGA
chips and Elec & Eltek Co., Ltd. for its printed circuit boards. In addition,
there is a limited availability of certain application specific integrated
circuit chipsets that provide VRAM and DRAM memory. The Company procures its
components and products through purchase orders and does not have specific
requirement agreements with any of its subcontractors or suppliers. Each of the
Company's subcontractors and suppliers can cease supplying the services,
products or components at any time with no penalty. In the event it becomes
necessary for the Company to replace a key subcontractor or supplier, the
Company could incur significant manufacturing set-up costs and delays while new
sources are located and alternate components are integrated into the design of
the Company's products. There can be no assurance that the Company will be able
to maintain its current subcontractor and supplier relationships or that the
Company will be able to find suitable replacement subcontractors and suppliers,
if necessary. Although the Company maintains ongoing efforts to obtain required
quantities of products, component shortages may exist from time to time, and
there can be no assurance that the Company's current subcontractors and
suppliers will continue to provide sufficient quantities of suitable quality
product components at acceptable prices. The Company's emphasis on maintaining
low inventory may accentuate the effects of any shortages that may result from
sole-source products or subcontractors. The inability of the Company to obtain
product components at their historical cost levels would directly affect the
cost of the Company's products. Also, product components may contain undetected
errors or "bugs" when first supplied to the Company that, despite testing by the
Company, are discovered only after the Company's product has 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 the product components, or that any such
errors will not impair the market acceptance of these products or require
significant product recalls. Problems encountered by customers and product
recalls could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, the Company's
ability to respond to greater than anticipated market demand may be constrained
by availability of services, products or components. The loss of subcontractors
or suppliers or the failure of subcontractors or suppliers to meet the Company's
price, quality, quantity and delivery requirements would have a material adverse
effect on the Company's business, financial condition and results of operations.
DEPENDENCE ON ISV RELATIONSHIPS
The Company's business strategy includes developing strategic relationships
with major ISVs that serve the 3D graphics market. The Company has devoted
substantial engineering and management resources to developing relationships
with its ISV partners. If any of the Company's current or future ISV partners
were to cease supporting the Company's products, such action could have a
material adverse effect on the Company's business, financial condition and
results of operations. Further, there can be no assurance that the Company will
be able to successfully sustain its relationships or enter into new
relationships with major ISVs on terms acceptable to the Company or at all.
UNCERTAINTY REGARDING DEVELOPMENT OF 3D GRAPHICS MARKET
The 3D graphics market on NT workstations has recently begun to develop and
is rapidly evolving. The Company's future financial performance will depend in
large part on the continued growth of this market and the demand for 3D graphics
for professional 3D applications. The failure of the 3D graphics market to
achieve anticipated growth levels or a substantial change in 3D graphics
customer preferences would have a material adverse effect on the Company's
business, financial condition and results of operations. Additionally, demand
for the Company's products is also dependent upon the widespread development of
3D graphics applications by ISVs, the success of the Company's customers in
effectively developing a market for the Company's products and the
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willingness of end users to pay for enhanced 3D capabilities on NT workstations.
The Company's products currently are designed for use on NT and/or Windows 95
workstations. In the event that end users, and particularly businesses, delay
their adoption of or fail to adopt NT or Windows 95, the market for the
Company's products would be diminished and the Company's business, financial
condition and results of operations could be materially adversely affected.
RISK OF MIGRATION TO THE MOTHERBOARD
As technology becomes more widely utilized, it may become economically
feasible to incorporate certain 3D graphics capabilities onto PC motherboards or
into microprocessors. The Company recognizes that migration could occur with
respect to the functionality provided by the Company's current products. The
Company's success is largely dependent on its ability to continue to develop
products which incorporate higher performance technologies and additional
functionality which system manufacturers have not yet fully incorporated into PC
motherboards or microprocessors. While the Company believes that a market will
continue to exist for add-in subsystems that provide additional performance and
advanced functionality and that offer flexibility in systems configuration,
there can be no assurance that the incorporation of certain 3D and 2D
capabilities onto PC motherboards or microprocessors will not adversely affect
the market for the Company's products and consequently, the Company's business,
financial condition and results of operations could be materially adversely
affected.
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 DirectX and ActiveX for Windows 95. Microsoft
has also announced new versions of its operating systems, Windows 98 and Windows
NT 5.0, which are scheduled for release in 1998 and 1999. New operating systems
and operating systems components may require that the Company expend a
significant amount of engineering resources to develop software that is
compatible with the new operating systems. In addition, the Company may be
required to update its existing software for products sold prior to the release
of the new operating system to be compatible with the new operating systems in
order to maintain customer satisfaction. This effort involves substantial
investment in software engineering, compatibility testing and customer technical
support investment with limited or no incremental revenue return since these
software 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 increased customer support calls, thereby generating
expenses that do not have offsetting revenue. Moreover, during the introductory
period of a major new operating system release, the effort required to support
the Company's installed customer base will reduce the research and development
and customer technical support resources available for new products.
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.
MARKET ANTICIPATION OF NEW PRODUCTS, NEW TECHNOLOGIES OR LOWER PRICES
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, this may
have the effect of delaying customers' purchases of the Company's products
thereby negatively impacting the Company's operating results. The substantial
publicity of Microsoft's Windows NT 5.0 upgrade to Windows NT 4.0, which is
expected to be publicly available in the first quarter of 1999, Microsoft's
Windows 98 upgrade to Windows 95, which is expected to be publicly available in
the third quarter of 1998, and Intel's release of newer high performance CPUs
and associated chipset supporting the AGP architectures, among other products,
may cause a delay in customers' purchasing decisions and thereby result in lower
revenues and an adverse effect on the Company's operating results.
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's operating results
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could be adversely affected if the Company makes poor selections of chip
architectures or chip suppliers to pursue its 3D graphics subsystems and, as a
result, may be unable to achieve market acceptance of new products or unable to
secure a sufficient supply of such components.
Also, if the Company, one of its competitors or its chip vendors 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
decline 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.
SOFTWARE DEFECTS
The Company's software products, and its hardware products incorporating any
software, are extremely complex as a result of such factors as advanced
functionality, the diverse operating environments in which they 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 three-year
warranty for its products. In general, the Company's return policy permits
return within five days after receipt of products that do not meet product
specifications. There can be no assurance that, despite testing by the Company
and by current and potential customers, errors will not be found in new products
after commencement of commercial shipments, resulting in loss of or delay in
market acceptance. 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 and ISV 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 the Company experiences delays or is unable
to maintain compatibility with operating systems and ISV applications, the
Company's business, financial condition and results of operations would be
materially adversely affected.
RISKS ASSOCIATED WITH INTELLECTUAL PROPERTY
Although the Company has three patent applications filed in the United
States, these claims are not related to the Company's current product lines.
Instead, the Company relies exclusively on trade secret and copyright protection
for its proprietary technology. Despite the Company's precautions, it may be
possible for a third party to copy or otherwise obtain and use the Company's
technologies without authorization or to develop competing technologies
independently. Furthermore, the laws of certain countries in which the Company
does business, including countries in which the Company does a significant
amount of business, such as the United Kingdom and Germany, may not protect the
Company's software and intellectual property rights to the same extent as the
laws of the United States. There can be no assurance that the Company's means of
protecting its proprietary rights will be adequate or that the Company's
competitors will not independently develop similar technology. If unauthorized
copying or misuse of the Company's products were to occur to any substantial
degree, or if a competitor of the Company were to effectively duplicate the
Company's proprietary technology, the Company's business, financial condition
and results of operations would be materially adversely affected. Furthermore,
while the Company requires employees and consultants to enter into
confidentiality agreements, there can be no assurance that proprietary
information will not be disclosed, that others will not independently develop
substantially equivalent proprietary information and techniques or otherwise
gain access to the Company's trade secrets or disclose such technology, or that
the Company can meaningfully protect its trade secrets. Certain technology used
by the Company's products is licensed from third parties, generally on a
non-exclusive basis. The termination of any such license, or the failure of any
third party licensor to adequately maintain or update its product, could result
in delay in the Company's ability to ship its products while it seeks to
implement technology offered by alternative sources, if any. Any required
replacement licenses could prove to be either unavailable or costly.
Although the Company has not received notices from third parties alleging
infringement claims that the Company believes would have a material adverse
effect on the Company's business, there can be no assurance that third parties
will not claim that the Company's current or future products or manufacturing
processes infringe the proprietary rights of others. Any such claim, with or
without merit, could result in costly litigation or might require
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<PAGE> 21
the Company to enter into royalty or licensing agreements. Such royalty or
licensing agreements, if required, may not be available on terms acceptable to
the Company, or at all, which could have a material adverse effect upon the
Company's business, financial condition and results of operations.
YEAR 2000
The "Year 2000" issue arises because most computer systems and programs were
designed to handle only a two-digit year, not a four-digit year. These computers
may interpret "00" as the year 1900 and could either stop processing
date-related computations or could process them incorrectly. The Company has
been informed by its information systems vendors that the Company's information
systems are able to process the Year 2000 accurately and accordingly does not
anticipate any Year 2000 issues from its own information systems, databases or
programs. However, the Company could be adversely impacted by Year 2000 issues
faced by major distributors, suppliers, customers, vendors and financial service
organizations with which the Company interacts. The Company is in the process of
developing a plan to determine the impact that third parties which are not Year
2000 compliant may have on the operations of the Company. There can be no
assurance that such plan will be able to address fully, or at all, the impact of
the Year 2000 issue on the Company, which could have a material adverse effect
upon the Company's business, financial condition and results of operations.
FUTURE CAPITAL REQUIREMENTS
The Company's future capital requirements will depend upon many factors,
including the development of new products, the success of the Company's research
and development efforts, the expansion of the Company's sales and marketing
efforts and the status of competitive products. The Company believes that
existing cash, cash equivalents and investments and its available borrowings and
lines of credit will be sufficient to finance its working capital and capital
expenditure requirements for at least the next 12 months. There can be no
assurance, however, that the Company will not require additional financing
during such time. Further, there can be no assurance that any additional
financing will be available to the Company on acceptable terms, if at all. If
additional funds are raised by issuing equity securities, further dilution to
the existing stockholders could result. The inability to obtain acceptable
financing would have a material adverse effect on the Company's business,
financial condition and results of operations.
CONCENTRATION OF STOCK OWNERSHIP
As of March 31, 1998, the Company's directors and officers and their
affiliates beneficially owned approximately 38% of the outstanding Common Stock.
As a result, these stockholders will be able to exercise significant influence
over all matters requiring stockholder approval, including the election of
directors and approval of significant corporate transactions. Such concentration
of ownership may have the effect of delaying or preventing a change in control
of the Company.
POSSIBLE VOLATILITY OF STOCK PRICE
The price of the Company's Common Stock has experienced extreme price
fluctuations. Factors such as quarterly variations in actual or anticipated
operating results, changes in earnings estimates by analysts, market conditions
in the industry, announcements by competitors, regulatory actions and general
economic conditions have had and may in the future have a significant effect on
the market price of the Common Stock. Following fluctuations in the market price
of a corporation's securities, securities class action litigation has often
resulted. There can be no assurance that such litigation will not occur in the
future with respect to the Company. Such litigation could result in substantial
costs and a diversion of management's attention and resources, which could have
a material adverse effect on the Company's business, financial condition and
results of operations.
SHARES ELIGIBLE FOR FUTURE SALE
As of March 31, 1998, the Company had 8,451,088 shares of Common Stock
outstanding. As of March 31, 1998, the Company had 8,713,025 shares of Common
Stock eligible for sale in the public market (including approximately 261,937
shares issuable upon exercise of vested options). Certain stockholders holding
4,152,791 shares of Common Stock are entitled to registration rights with
respect to their shares of Common Stock. If such stockholders, by exercising
their demand registration rights, cause a significant number of securities to be
registered
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and sold in the public market, such sales could have an adverse effect on the
market price of the Company's Common Stock.
BLANK CHECK PREFERRED STOCK; ANTI-TAKEOVER PROVISIONS
The Company's Board of Directors has the authority to issue up to 2,000,000
shares of Preferred Stock and to determine the price, rights, preferences and
privileges of those shares without any further vote or action by the
stockholders. The rights of the holders of Common Stock will be subject to, and
may be adversely affected by, the rights of the holders of any Preferred Stock
that may be issued in the future. The issuance of Preferred Stock may have the
effect of delaying, deterring or preventing a change of control of the Company
without further action by the stockholders and may adversely affect the voting
and other rights of the holders of Common Stock. The Company has no current
plans to issue shares of Preferred Stock. The Company's Certificate of
Incorporation and Bylaws have eliminated cumulative voting with respect to the
election of directors, actions to be taken by written consent of the Company's
stockholders and certain procedures such as advance notice procedures with
regard to the nomination, other than by or at the direction of the Board of
Directors, of candidates for election as directors. In addition, the Company's
charter documents provide that the Company's Board of Directors be divided into
three classes, each of which serves for a three-year term. The foregoing
provisions could have the effect of making it more difficult for a third party
to effect a change in the control of the Board of Directors. In addition, these
provisions could have the effect of making it more difficult for a third party
to acquire, or of discouraging a third party from attempting to acquire, or of
making the Company less attractive to a potential acquiror of a majority of the
outstanding voting stock of the Company, and may complicate or discourage a
takeover of the Company. The foregoing provisions may also result in the
Company's stockholders receiving less consideration for their shares than might
otherwise be available in the event of a takeover attempt of the Company.
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PART II. OTHER INFORMATION
None
ITEM 6. EXHIBITS
27.1 Financial Data Schedule
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.
ACCELGRAPHICS, INC.
Date: May 13, 1998 /s/ NANCY E. BUSH
----------------------------------------
Nancy E. Bush
Vice President and
Chief Financial Officer
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<PAGE> 24
INDEX TO EXHIBITS
EXHIBIT DESCRIPTION
27.1 Financial Data Schedule
Page 24
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S CONDENSED CONSOLIDATED BALANCE SHEET AND CONDENSED CONSOLIDATED
STATEMENT OF OPERATIONS AT OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1998
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH QUARTERLY REPORT ON FORM
10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 10,732
<SECURITIES> 6,729
<RECEIVABLES> 6,542
<ALLOWANCES> 776
<INVENTORY> 1,513
<CURRENT-ASSETS> 25,059
<PP&E> 1,696
<DEPRECIATION> 904
<TOTAL-ASSETS> 28,850
<CURRENT-LIABILITIES> 3,876
<BONDS> 448
0
0
<COMMON> 8
<OTHER-SE> 24,518
<TOTAL-LIABILITY-AND-EQUITY> 28,850
<SALES> 10,479
<TOTAL-REVENUES> 10,479
<CGS> 7,761
<TOTAL-COSTS> 2,734
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 146
<INCOME-TAX> 10
<INCOME-CONTINUING> 136
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 136
<EPS-PRIMARY> 0.02
<EPS-DILUTED> 0.02
</TABLE>
