-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FW4Z3rDQ3ECe8t82hCOuz1XT/ZWWSJZLwCEDPpWymN5eXRNzNpjRWIMe2vSe3O/H EGO89duy3bSTqTBWpOH2iw== 0000891618-00-002848.txt : 20000516 0000891618-00-002848.hdr.sgml : 20000516 ACCESSION NUMBER: 0000891618-00-002848 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000331 FILED AS OF DATE: 20000515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: S3 INC CENTRAL INDEX KEY: 0000850519 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER COMMUNICATIONS EQUIPMENT [3576] IRS NUMBER: 770204341 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-21126 FILM NUMBER: 633048 BUSINESS ADDRESS: STREET 1: 2841 MISSION COLLEGE BLVD CITY: SANTA CLARA STATE: CA ZIP: 95054 BUSINESS PHONE: 4155888000 MAIL ADDRESS: STREET 1: 2801 MISSION COLLEGE BOULEVARD STREET 2: P.O. BOX 58058 CITY: SANTA CLARA STATE: CA ZIP: 95052-8058 10-Q 1 FORM 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended March 31, 2000 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 0-21126 S3 INCORPORATED (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 77-0204341 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 2841 Mission College Boulevard Santa Clara, California 95054 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (408) 588-8000 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 of the Registrant's Common Stock, $.0001 par value, outstanding at May 1, 2000 was 91,341,531. 2 S3 INCORPORATED FORM 10-Q INDEX
PAGE -------------- PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements: Condensed Consolidated Balance Sheets March 31, 2000 and December 31, 1999 3 Condensed Consolidated Statements of Operations three months ended March 31, 2000 and 1999 4 Condensed Consolidated Statements of Cash Flows three months ended March 31, 2000 and 1999 5 Notes to Unaudited Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of 13 Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk 29 PART II. OTHER INFORMATION Item 1. Legal Proceedings 30 Item 2. Changes in Securities 31 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 31 Signatures 32
2 3 PART I. FINANCIAL INFORMATION Item 1. Financial Statements S3 INCORPORATED CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data)
MARCH 31, DECEMBER 31, 2000 1999 ----------- ------------ (UNAUDITED) ASSETS Current assets: Cash and cash equivalents $ 126,871 $ 45,825 Investment - UMC 487,491 -- Other short-term investments 25,338 58,918 Accounts receivable (net of allowances of $15,525 in 2000 and $19,298 in 1999) 87,623 78,312 Inventories 120,306 97,161 Deferred income taxes 30,431 19,658 Prepaid expenses and other 23,190 24,779 ----------- ----------- Total current assets 901,250 324,653 Property and equipment, net 35,974 34,404 Investment - UMC 487,636 -- Other investments 1,851 92,763 Deferred taxes 56,458 56,458 Goodwill and intangible assets 194,629 199,139 Other assets 13,944 15,230 ----------- ----------- Total $ 1,691,742 $ 722,647 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 79,605 $ 117,539 Notes payable 47,082 51,261 Accrued liabilities 44,577 45,751 Deferred taxes 178,869 -- Deferred revenue 14,170 9,953 ----------- ----------- Total current liabilities 364,303 224,504 Long-term deferred taxes 181,264 -- Other liabilities 11,858 12,010 Convertible subordinated notes 103,500 103,500 Stockholders' equity: Common stock, $.0001 par value; 175,000,000 shares authorized; 91,194,255 and 78,139,745 shares outstanding in 2000 and 1999 591,244 434,338 Accumulated other comprehensive loss (8,528) (7,563) Accumulated deficit 448,101 (44,142) ----------- ----------- Total stockholders' equity 1,030,817 382,633 ----------- ----------- Total $ 1,691,742 $ 722,647 =========== ===========
See accompanying notes to the unaudited condensed consolidated financial statements. 3 4 S3 INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts) (Unaudited)
THREE MONTHS ENDED MARCH 31, ------------------------- 2000 1999 --------- --------- Net sales $ 161,719 $ 44,300 Cost of sales 148,315 34,033 --------- --------- Gross margin 13,404 10,267 Operating expenses: Research and development 20,757 18,037 Selling, marketing and administrative 29,612 7,788 Amortization of goodwill and intangibles 10,476 -- --------- --------- Total operating expenses 60,845 25,825 --------- --------- Loss from operations (47,441) (15,558) Gain on sale of manufacturing joint venture 7,472 -- Gain on UMC investment 880,166 -- Gain on VIA investment 3,239 -- Other income (expense), net (177) 157 --------- --------- Income (loss) before income taxes and equity in income of manufacturing joint venture and minority interest in RioPort.com, Inc. 843,259 (15,401) Provision for income taxes 350,659 -- --------- --------- Income (loss) before equity in income of manufacturing joint venture and minority interest in RioPort.com, Inc. 492,600 (15,401) Equity in income from manufacturing joint venture -- 1,522 Minority interest in RioPort.com, Inc. (357) -- --------- --------- Net income (loss) $ 492,243 $ (13,879) ========= ========= Per share amounts: Basic $ 5.84 $ (0.27) Diluted $ 5.04 $ (0.27) Shares used in computing per share amounts: Basic 84,272 51,856 Diluted 97,864 51,856
See accompanying notes to the unaudited condensed consolidated financial statements. 4 5 S3 INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)
THREE MONTHS ENDED MARCH 31, ------------------------- 2000 1999 --------- --------- Operating activities: Net income (loss) $ 492,243 $ (13,879) Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities: Deferred income taxes 349,360 -- Depreciation 5,406 4,819 Amortization 10,976 -- Gain on sale of manufacturing joint venture (7,472) -- Gain on UMC investment (880,166) -- Gain on VIA investment (3,239) -- Equity in income of joint venture -- (1,522) Minority interest 357 -- Changes in assets and liabilities: Accounts receivable (9,311) 3,709 Inventories (23,146) 2,561 Prepaid expenses and other 1,589 4,414 Accounts payable (37,934) 4,491 Accrued liabilities and other liabilities (7,164) 2,884 Deferred revenue 4,217 56 --------- --------- Net cash provided by (used for) operating activities (104,284) 7,533 --------- --------- Investing activities: Property and equipment purchases, net (6,204) (2,071) Purchase of short-term investments, net (66,480) (3,145) Sale of manufacturing joint venture 7,472 -- Gain on VIA investment 3,239 -- Investment in Number Nine (5,327) -- Investment in VIA (501) -- Other assets 1,164 811 --------- --------- Net cash used for investing activities (66,637) (4,405) --------- --------- Financing activities: Sale of common stock, net 156,906 1,766 Sale of warrant -- 990 Repayments of notes payable (4,179) -- --------- --------- Net cash provided by financing activities 152,727 2,756 --------- --------- Effect of exchange rate changes (9) -- --------- --------- Net increase (decrease) in cash and equivalents (18,203) 5,884 Cash and cash equivalents at beginning of period 45,825 31,022 --------- --------- Cash and cash equivalents at end of period $ 27,622 $ 36,906 ========= =========
See accompanying notes to the unaudited condensed consolidated financial statements. 5 6 S3 INCORPORATED NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation The condensed consolidated financial statements have been prepared by S3 Incorporated, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission and include the accounts of S3 Incorporated and its wholly-owned subsidiaries ("S3" or collectively the "Company"). All significant inter-company balances and transactions have been eliminated. Investments in entities in which the Company does not have control, but has the ability to exercise significant influence over operating and financial policies, are accounted for by the equity method. Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to such principles and the rules and regulations of the Securities and Exchange Commission. In the opinion of the Company, the financial statements reflect all adjustments, consisting only of normal recurring adjustments with the exception of the in-process research and development charge discussed in Note 2, necessary for a fair presentation of the financial position at March 31, 2000 and December 31, 1999, and the operating results and cash flows for the three months ended March 31, 2000 and 1999. These financial statements and notes should be read in conjunction with the Company's audited financial statements and notes thereto for the year ended December 31, 1999, included in the Company's Form 10-K filed with the Securities and Exchange Commission. The results of operations for the three months ended March 31, 2000 are not necessarily indicative of the results that may be expected for the future quarters or the year ending December 31, 2000. Certain reclassifications of 1999 amounts were made in order to conform to the 2000 presentation. This Quarterly Report on Form 10-Q contains 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. In particular, the assumptions set forth in Note 2 and the Management's Discussion and Analysis section of this Quarterly Report on Form 10-Q regarding revenue growth, gross margin increases, cost decreases and cost of capital which underlie the Company's calculation of the in-process research and development expenses contain forward-looking statements and are qualified by the risks detailed in "Factors That May Affect Our Results" and other risks detailed in the Company's Annual Report on Form 10-K for the year ended December 31, 1999 and other reports filed by S3 with the Securities and Exchange Commission from time to time. Actual results could differ materially from those projected in these forward-looking statements as a result of the risks described above as well as other risks set forth in S3's periodic reports both previously and hereafter filed with the Securities and Exchange Commission. 2. Business Combinations Merger with Diamond On September 24, 1999, the Company completed the acquisition of all of the outstanding common stock of Diamond Multimedia Systems, Inc. ("Diamond"). Diamond designs, develops, manufactures and markets multimedia and connectivity products for personal computers. The transaction was accounted for as a purchase and, accordingly, the results of operations of Diamond and the estimated fair value of assets acquired and liabilities assumed are included in the Company's consolidated financial statements as of September 24, 1999, the effective date of the purchase. Pursuant to the Merger Agreement, each share of Diamond common stock was converted into the right to receive 0.52 shares of the Company's common stock. No fractional shares were issued. Stockholders otherwise entitled to a fractional share received cash. In addition, each option and right to acquire Diamond common stock granted under Diamond's stock-based incentive plans was converted into an option to purchase Company common stock. Approximately 18.7 million common shares of S3 stock were issued to Diamond stockholders and approximately 1.3 million options were assumed. The purchase price of $218.3 million includes $172.2 million of stock issued at fair value (fair value being determined as the average price of the S3 stock for a period three days before and after the announcement of the merger), $11.7 million in Diamond stock option costs (being determined under both the Black-Scholes formula and in accordance with the Merger Agreement), cash paid to Diamond of $20.0 million and $14.4 million in estimated expenses of the transaction. The purchase price was allocated as follows: $0.8 million to the estimated fair value of Diamond net liabilities assumed (as of September 24, 1999), $6.7 million to purchased in-process research and development, $6.8 million to purchased existing technology, $11.4 million to tradenames, $5.5 million to workforce-in-place, $12.5 million to Diamond distribution channel relationships and $174.6 million to goodwill. Goodwill is recorded as a result of consideration paid in excess of the fair value of net tangible and intangible assets acquired. Goodwill and identified 6 7 acquisition related intangible assets are amortized on a straight-line basis over the periods indicated below. The allocation of the purchase price to intangibles was based upon management's estimates. The purchase price and the related allocation are subject to further refinement and change over the initial year of combined operations. Management has completed its integration plans related to Diamond. The integration plans included initiatives to combine the operations of Diamond and S3 and consolidate duplicative operations. Areas where management estimates may be revised primarily relate to employee severance and relocation costs and other exit costs. Adjustments to accrued integration costs related to Diamond will be recorded as adjustments to the fair value of net assets in the purchase price allocation. Accrued integration charges included $3.8 million related to involuntary employee separation and relocation benefits for employees and $2.2 million in other exit costs primarily relating to the closing or consolidation of facilities and the termination of certain contractual relationships. The accruals recorded related to the integration of Diamond are based upon management's current estimate of integration costs. The intangible assets and goodwill acquired have estimated useful lives and estimated first year amortization, as follows (dollars in thousands):
CALCULATED ESTIMATED FIRST YEAR AMOUNT USEFUL LIFE AMORTIZATION -------- ----------- ------------ Purchased existing technology $ 6,800 2-5 years $ 2,708 Tradenames 11,400 7 years 1,629 Workforce-in-place 5,500 4 years 1,375 Diamond distribution channel relationships 12,500 5 years 2,500 Goodwill 174,563 5 years 34,913
The value assigned and written off as purchased in-process research and development ("IPR&D") of $6.7 million was determined by identifying research projects in areas for which technological feasibility had not been established. The value was determined by estimating the expected cash flows from the projects once commercially viable, discounting the net cash flows back to their present value and then applying a percentage of completion to the calculated value. The discount rate used in discounting the net cash flows from IPR&D ranged from 25% to 35%. Relatively high discount rates were used to reflect the inherent uncertainties surrounding the successful development of the IPR&D, market acceptance of the technology, the useful life of such technology and the uncertainty of technological advances which could potentially impact the estimates described above. The percentage of completion for each project was determined using costs incurred to date on each project as compared to the remaining research and development to be completed to bring each project to technological feasibility. The percentage of completion varied by individual project ranging from 20% to 60%. If the projects discussed above are not successfully developed, the sales and profitability of the combined company may be adversely affected in future periods. Purchase of Number Nine On February 1, 2000, the Company completed the acquisition of all of the assets of Number Nine Visual Technology Corporation ("Number Nine"). The purchase price of $5.3 million includes $5.1 million of cash and $0.2 million in estimated expenses of the transaction. The purchase price was allocated as follows: $0.7 million to the estimated fair value of Number Nine net assets (as of February 1, 2000), $0.5 million to workforce-in-place and $4.1 million to goodwill. Goodwill is recorded as a result of consideration paid in excess of the fair value of net tangible and intangible assets acquired. Goodwill and identified acquisition related intangible assets are amortized on a straight-line basis over five years. The allocation of the purchase price to intangibles was based upon management's estimates. The purchase price and the related allocation are subject to further refinement and change over the initial year of combined operations. 3. Inventories Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market. Inventories consisted of:
MARCH 31, DECEMBER 31, 2000 1999 --------- ------------ (IN THOUSANDS)
7 8 Raw materials $ 57,605 $ 40,132 Work in process 16,637 10,418 Finished goods 46,064 46,611 -------- -------- Total $120,306 $ 97,161 ======== ========
4. Investments Investment in USC In June of 1999, the Company announced that it would receive $42.0 million for a patent license and release associated with the sale of 80 million shares of stock of USC in January 1998. Payments will be received over five fiscal quarters beginning in the quarter ended June 30, 1999. Under the terms of the agreement, S3 will license UMC 29 patents covering multimedia products and integrated circuit manufacturing technology for use in products manufactured by UMC. In June 1999, UMC announced that it would provide one share of UMC for every share of USC stock. The expected transaction was a result of UMC's foundry consolidation plans whereby USC, United Integrated Circuits Corporation, United Silicon Incorporated and UTEK Semiconductor Corporation, were merged into UMC. As the Company owned 252 million shares of USC, this resulted in the transfer of 252 million UMC shares of stock to the Company on January 4, 2000. The Company recorded a gain on the transfer of the shares of $880.2 million to recognize the difference in the carrying value of its investment in USC and the fair market value of the UMC shares on the date of the transfer. Approximately half of the shares received are subject to sale restrictions and are carried at market value as of January 4, 2000 as long-term assets in the accompanying balance sheet at March 31, 2000. As the remaining shares are publicly traded, the investment is adjusted to fair market value in accordance with SFAS 115 and classified as short-term investments. Interest in Partnership In 1995, the Company entered into a limited partnership arrangement (the "partnership") with a developer to obtain a ground lease and develop and operate the Company's current Santa Clara facilities. The Company invested $2.1 million for a 50% limited partnership interest. On June 29, 1999, the Company entered into an agreement to assign to the general partner the Company's entire interest in the partnership for $7.8 million. The gain on the assignment of the Company's partnership interest is being recognized over the term of the facilities lease, which expires in 2008. Investment in OneStep, LLC and RioPort.com, Inc. In July 1999, the Company acquired OneStep, LLC, a software development company that supplies the Rio Audio Manager to RioPort.com, Inc., for $10.9 million in cash. The Rio Audio Manager is designed to allow audio enthusiasts to easily acquire, create, organize and playback music or spoken audio programming in one simple application. In October 1999, S3 caused RioPort.com, Inc., which was a wholly owned subsidiary, to sell shares of its preferred stock to third party investors. RioPort.com, Inc. is developing an integrated platform for acquiring, managing and experiencing music and spoken audio programming from the Internet. As a result, the Company retains a minority investment in RioPort.com, Inc. and accounts for its investment using the equity method of accounting. In addition, in November 1999, the Company received $10.9 million for the sale of OneStep, LLC to RioPort.com, Inc. Investment in S3-VIA, Inc. In November 1999, the Company established a joint venture with VIA Technologies, Inc. to bring high-performance integrated graphics and core logic chip sets to the volume OEM desktop and notebook PC markets. The newly formed S3-VIA, Inc. will have joint funding, exclusive access to both companies' technology and distribution rights for developed products between S3 and VIA. The Company owns 50.1% of the voting common stock of the joint venture. Accordingly, the Company consolidates the accounts of S3-VIA, Inc. in its consolidated financial statements. 5. Notes Payable 8 9 In 1995 the Company expanded and formalized its relationship with Taiwan Semiconductor Manufacturing Company ("TSMC") to provide additional capacity over the 1996 to 2000 timeframe. The agreement with TSMC requires the Company to make certain annual advance payments to be applied against the following year's capacity. The Company has signed promissory notes to secure these payments over the term of the agreement. The notes bear interest at 10% per annum commencing on the individual note's maturity dates if such notes are not paid. At March 31, 2000, the remaining advance payments totaled $14.3 million and the corresponding promissory notes totaled $9.6 million. During the second quarter of 1999, the Company and TSMC agreed to extend the term of the agreement two years to 2002. The corresponding notes payable were extended with the final payment due in 2001. At March 31, 2000, the Company has a $50.0 million domestic bank facility permitting borrowings at the prime rate. This bank facility expires in January 2001. The covenants covering this debt agreement pertain to minimum levels of collateral coverage and tangible net worth, quarterly profitability and minimum levels of liquidity. As of March 31, 2000, the Company is in compliance with all loan covenants. Additionally, the Company has credit facilities under foreign lines of credit. The Company has a foreign line of credit of 10 million DeutscheMarks (approximately $4.9 million at March 31, 2000). The Company also has a foreign line of credit of 400,000 British Pounds (approximately $639,000 at March 31, 2000). Borrowings were $37.5 million under these facilities at March 31, 2000. As of March 31, 2000, the Company's future payments on debt related to notes payable, lines of credit and capital lease obligations are due in 2000, therefore all amounts have been classified as current. 6. Earnings (Loss) Per Share Basic earnings (loss) per share ("EPS") is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that would occur from any instrument or options which could result in additional common shares being issued. When computing earnings (loss) per share, the Company includes only potential common shares that are dilutive. Exercise of options and conversion of convertible debt in the three months ended March 31, 1999 are not assumed because the result would have been anti-dilutive. The following table sets forth the computation of basic and diluted earnings (loss) per share:
THREE MONTHS ENDED MARCH 31, ---------------------- 2000 1999 -------- -------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NUMERATOR Net income (loss) Basic $492,243 $(13,879) Interest expense on subordinated debt 966 -- -------- -------- Diluted $493,209 $(13,879) ======== ======== DENOMINATOR Denominator for basic earnings per share 84,272 51,856 Common stock equivalents 8,207 -- Subordinated debt 5,385 -- -------- -------- Denominator for diluted earnings (loss) per share 97,864 51,856 ======== ======== Basic earnings (loss) per share $ 5.84 $ (0.27) Diluted earnings (loss) per share $ 5.04 $ (0.27)
7. Comprehensive Income (Loss) The Company's available-for-sale securities and foreign currency translation adjustments are included in other comprehensive income (loss). The following are the components of accumulated other comprehensive loss, net of tax:
MARCH 31, DECEMBER 31, 2000 1999 --------- ------------ (IN THOUSANDS) Unrealized gain (loss) on investments $ (153) $ 803 Foreign currency translation adjustments (8,375) (8,366) ------- ------- Accumulated other comprehensive loss $(8,528) $(7,563) ======= =======
9 10 The following schedule of other comprehensive loss shows the gross current-period gain (loss) and the reclassification adjustment:
THREE MONTHS ENDED MARCH 31, --------------------- 2000 1999 ------- ------- (IN THOUSANDS) Unrealized gain (loss) on investments: Unrealized gain on available-for-sale securities, net of tax of $735 and $0 in 2000 and 1999, respectively $ 892 $ 379 Less: reclassification adjustment for (gain) loss realized in net income, net of tax of $0 and $0 in 2000 and 1999, respectively (1,994) 46 ------- ------- Net unrealized gain (loss) on investments (1,102) 425 Foreign currency translation adjustments (9) (2,704) ------- ------- Other comprehensive loss $(1,111) $(2,279) ======= =======
8. Contingencies The semiconductor and personal computing products industries are characterized by frequent litigation, including litigation regarding patent and other intellectual property rights. The Company is party to various legal proceedings that arise in the ordinary course of business. Although the ultimate outcome of these matters is not presently determinable, management believes that the resolution of all such pending matters will not have a material adverse effect on the Company's financial position or results of operations. Since November 1997, a number of complaints have been filed in federal and state courts seeking unspecified damages on behalf of an alleged class of persons who purchased shares of the Company's common stock at various times between April 18, 1996 and November 3, 1997. The complaints name as defendants the Company, certain of its officers and former officers, and certain directors of the Company, asserting that they violated federal and state securities laws by misrepresenting and failing to disclose certain information about the Company's business. In addition, certain stockholders have filed derivative actions in the state courts of California and Delaware seeking recovery on behalf of the Company, alleging, among other things, breach of fiduciary duties by such individual defendants. The plaintiffs in the derivative action in Delaware have not taken any steps to pursue their case. The derivative cases in California state court have been consolidated, and plaintiffs have filed a consolidated amended complaint. The court has entered a stipulated order in those derivative cases suspending court proceedings and coordinating discovery in them with discovery in the class actions in California state courts. On plaintiffs' motion, the federal court has dismissed the federal class actions without prejudice. The class actions in California state court have been consolidated, and plaintiffs have filed a consolidated amended complaint. The Company has answered that complaint. Discovery is pending. While management intends to defend the actions against the Company vigorously, there can be no assurance that an adverse result or settlement with regard to these lawsuits would not have a material adverse effect on the Company's financial condition or results of operations. The Company has received from the Securities and Exchange Commission a request for information relating to the Company's restatement announcement in November 1997. The Company has responded and intends to continue to respond to such requests. The Company is also defending several putative class action lawsuits naming Diamond, 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 former executive officers and directors of Diamond are also named as defendants. The plaintiffs purport to represent a class of all persons who purchased Diamond'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 Diamond and the other defendants made various material misrepresentations and omissions during the Class Period. The complaints do not specify the amount of damages sought. On March 24, 2000, the District Court for the Northern District of California dismissed the federal action without prejudice. The Company believes that it has good defenses to the claims alleged in the California Superior Court lawsuit and will defend itself vigorously against this action. No trial date has been set for this action. In addition, the Company has been named, with Diamond, as a defendant in litigation relating to the merger of the Company with Diamond. On August 4, 1999, two alleged stockholders of Diamond filed a lawsuit, captioned Strum v. Schroeder, et al., in the Superior Court of the State of California for the County of Santa Clara. Plaintiffs, on behalf of themselves and a class of all former Diamond stockholders similarly situated whom they purportedly represent, challenge the terms of the merger. The complaint names Diamond, the former directors of Diamond and the Company as defendants. The complaint alleges generally that Diamond's directors breached their fiduciary duties to stockholders of Diamond and seeks rescission and the recovery of unspecified damages, fees and 10 11 expenses. The Company believes, as do the individual defendants, that it has meritorious defenses to the lawsuit and the Company intends to defend the suit vigorously. On April 23, 1999, 3Dfx Interactive, Inc. ("3Dfx") filed a lawsuit against Diamond for breach of contract based upon unpaid invoices in the amount of $3,895,225. On June 4, 1999, the Company filed an answer and cross-complaint alleging breach of contract, breach of the implied covenant of good faith and fair dealing, breach of implied warranty and negligence. On February 10, 2000, this matter was settled. As part of the settlement, the Company paid $1,950,000 to 3Dfx. This amount was expensed at December 31, 1999. Sega initiated a claim for arbitration in Tokyo, Japan against Diamond in December 1998. The claim arises out of an agreement entered into between Sega and Diamond in September 1995, in which Sega agreed to provide Diamond with Sega game software that Diamond would bundle with its 3-D graphics board "The Edge." Sega claims that Diamond breached the parties' agreement by failing to pay Sega a contractual minimum royalty fee for the games as set forth in the agreement. Sega claims as damages $3,800,000 in unpaid royalties and pre-judgment interest. On May 28, 1999, Diamond responded to Sega's claims by filing an answer in which it denied the material allegations of Sega's claims. The parties have filed additional briefs in support of their claims and defenses. An evidentiary hearing on this action has not yet been scheduled. The Company contests the material allegations of Sega's claims. In addition, the Company has pleaded that Sega's failure to provide it with 3-D optimized game software on a timely basis adversely affected sales of The Edge. The Company claims that these lost sales and profits should provide an offset to Sega's claims in the arbitration and intends to defend the suit vigorously. C3 Sales, Inc. ("C3") filed suit against S3 on October 6, 1999 in the Harris County (Houston), Texas District Court. The petition sought a judicial declaration that a Sales Representative Agreement entered into between C3 and S3 on May 19, 1999 was a valid contract that governed the relationship between the two parties. On November 8, 1999, S3 answered acknowledging that the May 19, 1999 agreement was a contract between the two parties. C3 failed to respond to informal requests by S3 to dismiss the declaratory relief action on grounds that no justiciable controversy existed between the parties. On December 3, 1999, S3 filed a summary judgment motion seeking judgment against C3 on the grounds that no issues of material fact remain to be determined regarding the declaratory judgment sought by C3. C3 responded by filing an amended petition raising new matters. Specifically, C3's new claims allege that the Sales Representative Agreement applies to Diamond products, and that certain commissions due under the agreement have not been paid. S3 intends to defend this action vigorously. On January 6, 2000, PhoneTel Communications, Inc. ("PhoneTel") filed a complaint for patent infringement against a group of defendants, including Diamond, in the United States District Court for the Northern District of Texas. PhoneTel generally alleges that Diamond and the other defendants are infringing its two patents by making, using, selling, offering to sell and/or importing digital synthesizers, personal computers, sound cards, or console game systems. PhoneTel does not specify which Diamond products allegedly infringe its patents. S3 filed Diamond's answer to the complaint on March 28, 2000. S3 believes that the complaint is without merit and will vigorously defend itself against the allegations made in the complaint. On May 11, 1998, the Company filed a lawsuit in the United States District Court for the Northern District of California against nVidia Corporation ("nVidia") alleging that nVidia was infringing three of the Company's patents and an injunction restraining nVidia from manufacturing and distributing a family of nVidia multimedia accelerators and seeking other forms of relief. nVidia answered the Company's complaint and counter-claimed for declaratory relief, alleging that the three patents were invalid and not infringed. On August 16, 1999, the court found that some of the claims in the patents are invalid, found that the remaining claims in the patents are valid and set a trial date to adjudicate the validity of the remaining claims and whether nVidia was infringing the valid patent claims. On December 9, 1999, nVidia filed a complaint for patent infringement against the Company alleging infringement of five patents relating to sound and/or multimedia products sold by the Company. On February 1, 2000, the Company and nVidia agreed to drop their respective lawsuits and enter into a settlement and cross-license agreement. 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 of the lawsuits has been made in the accompanying condensed consolidated financial statements. 9. Subsequent Events The Company, and VIA Technologies, Inc., a corporation organized under the laws of Taiwan ("VIA"), entered into an Investment Agreement, dated as of April 10, 2000 (the "Agreement"). Pursuant to the Agreement, the Company and VIA will form a new joint venture (the "Joint Venture") for the purpose of manufacturing and distributing graphics products and conducting related research and 11 12 development activities. At the closing of the transactions contemplated by the Agreement, the Company will transfer to the Joint Venture its graphics chip business in exchange for 100,000,000 shares of Class A common stock of the Joint Venture. In addition, at the closing, VIA will deliver to the Joint Venture $79.9 million in cash or a combination of cash and Via or S3 equity securities, which in turn will be delivered by the Joint Venture to the Company (minus an amount retained by the Joint Venture for the benefit of employees of the Joint Venture), in exchange for 10,000,000 shares of Class B common stock of the Joint Venture. The Joint Venture will assume $38.5 million in debt from the Company. The Joint Venture will also issue to the Company a promissory note with an aggregate principal amount of $239.6 million, which will be payable in equal annual installments on each of the first three anniversaries of the closing date of the formation of the Joint Venture. The payments may be made, at the Joint Venture's option, in cash or a combination of cash and Via or S3 equity securities. The note will be secured by certain assets of the Joint Venture. In addition, the Company will receive additional payments from the Joint Venture if certain specified financial milestones are achieved by the Joint Venture. The closing of the transactions contemplated by the Agreement is conditioned upon certain closing conditions, including the expiration or early termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvement Act. In addition, the closing is conditioned upon the issuance by the Company to VIA or an affiliate thereof of 3,000,000 shares of the Company's common stock at a price per share of $17.875, and the election of a designee of VIA to the Board of Directors of the Company. 12 13 PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations When used in this Report, the words "expects," "anticipates," "estimates" and similar expressions are intended to identify forward-looking statements. Such statements, which include statements concerning the timing of availability and functionality of products under development, product mix, trends in average selling prices, trends in the personal computer ("PC") market, the percentage of export sales and sales to strategic customers and the availability and cost of products from the Company's suppliers, are subject to risks and uncertainties, including those set forth below under "Factors That May Affect Our Results" and elsewhere in this report, that could cause actual results to differ materially from those projected. These forward-looking statements speak only as of the date hereof. The Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in the Company's expectations with regard thereto or any change in events, conditions or circumstances on which any statement is based. OVERVIEW S3(R) Incorporated ("S3" or the "Company") designs, develops, manufactures and distributes multimedia, connectivity and Internet appliance products for the PC and consumer appliance markets. The Company has been a leading supplier of graphics and multimedia accelerator subsystems for PCs for over ten years. In September 1999, S3 made a significant strategic shift by merging with Diamond Multimedia Systems, Inc. ("Diamond"), an established original PC equipment manufacturer ("OEM") and retail provider of communications and home networking solutions, PC graphics and audio add-in boards, digital audio players and Internet appliances. Diamond products include the Rio line of Internet music players, the Stealth and Viper series of video accelerators, the Monster series of gaming accelerators, the Fire series of NT workstation 3D graphics accelerators, the Supra series of modems and the HomeFree line of home networking products. The transaction was accounted for as a purchase and, accordingly, the results of operations of Diamond and the estimated fair value of assets acquired and liabilities assumed are included in the Company's consolidated financial statements as of September 24, 1999, the effective date of the purchase. In October 1999, S3 announced that it caused RioPort.com Inc., which was a wholly owned subsidiary, to sell shares of its preferred stock to third party venture capital and strategic investors. RioPort.com, Inc. is developing an integrated platform for acquiring, managing and experiencing music and spoken audio programming from the Internet. As a result of the preferred stock financing, the Company retained a minority investment in RioPort.com, Inc. and accounts for its investment using the equity method of accounting. In addition, in November 1999, as part of the equity partnership, the Company received $10.9 million for the sale of OneStep, LLC to RioPort.com, Inc. In November 1999, the Company established a joint venture with VIA Technologies, Inc., a corporation organized under the laws of Taiwan ("VIA"), to bring high-performance integrated graphics and core logic chip sets to the volume OEM desktop and notebook PC markets. The newly formed S3-VIA Inc. will have joint funding, exclusive access to both companies' technology and distribution rights for developed products between S3 and VIA. The Company owns 50.1% of the voting common stock of the joint venture. Accordingly, the Company consolidates the accounts of S3-VIA Inc. in its consolidated financial statements. On April 10, 2000, the Company and VIA entered into an Investment Agreement. Pursuant to the Agreement, the Company and VIA will form a new joint venture (the "Joint Venture") for the purposes of manufacturing and distributing graphics products and conducting related research and development activities. See "Recent Developments." RESULTS OF OPERATIONS The following table sets forth certain financial data for the periods indicated as a percentage of net sales:
THREE MONTHS ENDED MARCH 31, ------------------ 2000 1999 ----- ----- Net sales 100.0% 100.0% Cost of sales 91.7 76.8 ----- ----- Gross margin 8.3 23.2 Operating expenses:
13 14 Research and development 12.8 40.7 Selling, marketing and administrative 18.3 17.6 Amortization of goodwill and intangibles 6.5 -- ----- ----- Total operating expenses 37.6 58.3 ----- ----- Loss from operations (29.3) (35.1) Gain on sale of manufacturing joint venture 4.6 -- Gain on UMC investment 544.3 -- Gain on VIA investment 2.0 -- Other income (expense), net (0.2) 0.4 ----- ----- Income (loss) before income taxes and equity in income of manufacturing joint venture and minority interest in RioPort.com, Inc. 521.4 (34.7) Provision for income taxes 216.8 -- ----- ----- Income (loss) before equity in income of manufacturing joint venture and minority interest in RioPort.com, Inc. 304.6 (34.7) Equity in income from manufacturing joint venture -- 3.4 Minority interest in RioPort.com, Inc. (0.2) -- ----- ----- Net income (loss) 304.4% (31.3)% ===== =====
NET SALES The Company's net sales year to date have been generated from the sale of its graphics and multimedia accelerators, connectivity products for the home and products for acquiring, managing and experiencing music and spoken audio programming from the Internet. The Company's products are used in, and its business is dependent upon, the personal computer industry and growth of the Internet with sales primarily in the U.S., Asia and Europe. Net sales were $161.7 million for the three months ended March 31, 2000, a 265.0% increase from the $44.3 million of net sales for the three months ended March 31, 1999. Sales increased from 1999 to 2000 because of the acquisition of Diamond and the inclusion of the revenue of its products in the Company's financial results of operations in the three months ended March 31, 2000. Net sales for the three months ended March 31, 2000 consisted primarily of the Company's graphics chips, Diamond brand graphics add-in cards, modem and communication products and Rio digital audio players while net sales for the three months ended March 31, 1999 consisted primarily of the Company's graphics chips. The net sales for the three months ended March 31, 2000 for the Company's graphics chips, excluding graphics chips integrated into the Company's Diamond brand graphics add-in cards, were $37.4 million. The Company expects that the percentage of its net sales represented by any one product or type of product may change significantly from period to period as new products are introduced and existing products reach the end of their product life cycles. Due to competitive price pressures, the Company's products experience declining unit average selling prices over time, which at times can be substantial. International sales accounted for 54% and 99% of net sales for the three months ended March 31, 2000 and 1999, respectively. Approximately 26% and 44% of international sales for the three months ended March 31, 2000 and 1999, respectively, were to affiliates of United States customers. The shift in international and domestic sales distribution in 2000 was primarily the result of the inclusion of the acquired multimedia and communications products from the Diamond acquisition. The Company expects that international sales will continue to represent a significant portion of net sales, although there can be no assurance that international sales as a percentage of net sales will remain at current levels. All sales transactions were denominated in U.S. dollars. One customer accounted for 14.5% of net sales for the three months ended March 31, 2000. One customer and two distributors accounted for 34%, 26% and 15% of net sales, respectively, for the three months ended March 31, 1999. The Company expects a significant portion of its future sales to remain concentrated within a limited number of strategic customers. There can be no assurance that the Company will be able to retain its strategic customers or that such customers will not otherwise cancel or reschedule orders, or in the event of canceled orders, that such orders will be replaced by other sales. In addition, sales to any particular customer may fluctuate significantly from quarter to quarter. The occurrence of any such events or the loss of a strategic customer could have a material adverse effect on the Company's operating results. GROSS MARGIN Gross margin percentage decreased to 8.3% for the three months ended March 31, 2000 from 23.2% for the three months ended March 31, 1999. The decrease was primarily the result of inclusion of manufacturing costs for the Diamond products. Another factor resulting in the decreased gross margin is the highly competitive pricing pressures in the market for mainstream and entertainment graphics accelerators. This was partially offset by improving margins on the Company's desktop chips and communications products. 14 15 In the future, the Company's gross margin percentages may be affected by increased competition and related decreases in the unit average selling prices (particularly with respect to older generation products), timing of volume shipments of new products, the availability and cost of products from the Company's suppliers, changes in the mix of products sold, the extent to which the Company forfeits or utilizes its production capacity rights with Taiwan Semiconductor Manufacturing Company ("TSMC"), the extent to which the Company will incur additional licensing fees and shifts in sales mix between add-in card and motherboard manufacturers and systems OEMs. RESEARCH AND DEVELOPMENT EXPENSES The Company has made and intends to continue to make significant investments in research and development to remain competitive by developing new and enhanced products. Research and development expenses were $20.8 million for the three months ended March 31, 2000, an increase of $2.8 million from $18.0 million for the three months ended March 31, 1999. This increase was due primarily to inclusion of headcount and related expenses associated with the Diamond acquisition savings partially offset by an increased focus on core technology and products. Concentration of research and development efforts resulted in lower overhead, headcount and related costs. Write-offs of idle and excess capital equipment resulted in lower depreciation and maintenance charges. SELLING, MARKETING AND ADMINISTRATIVE EXPENSES Selling, marketing and administrative expenses consist primarily of salaries, related benefits and fees for professional services, such as legal and accounting services. Selling, marketing and administrative expenses were $29.6 million for the three months ended March 31, 2000, an increase of $21.8 million from $7.8 million for the three months ended March 31, 1999. Selling, marketing and administrative expenses increased from the prior year due primarily to the integration and combination of selling, marketing and administrative headcount and related expenses due to the acquisition of Diamond. As a percentage of revenue, selling, marketing and administrative expenses increased from 17.6% in 1999 to 18.3% in 2000. GAIN ON SALE OF MANUFACTURING JOINT VENTURE On December 31, 1997, the Company entered into an agreement to sell to UMC 80 million shares of stock of United Semiconductor Corporation ("USC") for a purchase price of 2.4 billion New Taiwan dollars. The Company received the purchase price (approximately $68.0 million in cash) in January 1998 upon closing. The gain on the sale of stock of USC was $26.6 million. In June 1999, the Company amended its agreements with UMC. Under the terms of the amended agreements, UMC has agreed to pay the Company, subject to certain conditions, 1.4 billion New Taiwan dollars (approximately $43.3 million in cash) and the Company has agreed to release UMC from contingencies associated with the sale in January 1988 of 80 million shares of stock of USC and to grant a license to patents covering multimedia products and integrated circuit manufacturing technology for use in products manufactured by UMC. Payments are being received over five fiscal quarters beginning in the quarter ended June 30, 1999. The gain on the sale of stock in USC was $7.5 million for the three months ended March 31, 2000. OTHER INCOME (EXPENSE), NET Other expense was $0.2 million for the three months ended March 31, 2000, a decrease of $0.4 million from other income of $0.2 million for the three months ended March 31, 1999. The decrease was due primarily to increases in interest expense associated with the lines of credit assumed in the merger with Diamond, partially offset by foreign currency translation gains. INCOME TAXES The Company's effective tax rates for the three months ended March 31, 2000 and 1999 are 41.6% and 0%, respectively. The effective tax rate for 2000 reflects expected tax payment on the adjusted taxable income at the federal, state and international statutory rates. The effective tax rate for 1999 reflects net operating losses with no realized tax benefit. LIQUIDITY AND CAPITAL RESOURCES Cash used for operating activities for the three months ended March 31, 2000 was $104.3 million, as compared to $7.5 million cash provided by operating activities for the three months ended March 31, 1999. The Company's net income of $492.2 million for the three months ended March 31, 2000 included a non-cash gain on UMC investment of $880.2 million, and non operating gains on VIA investment of $3.2 million and the sale of manufacturing joint venture of $7.5 million. Cash used for operations for the three months 15 16 ended March 31, 2000 was unfavorably impacted by increases in accounts receivable and inventories and decreases in accounts payable and accrued liabilities and other liabilities. In addition, cash used for operations for the three months ended March 31, 2000 was favorably impacted by depreciation, amortization, increases in deferred income taxes and deferred revenue and decreases in prepaid expenses and other. The Company's net loss for the three months ended March 31, 1999 was offset by depreciation, decreases in accounts receivable, inventories and prepaid expenses and other and increases in accounts payable, accrued liabilities and other liabilities and deferred revenue. Investing activities used cash of $66.6 million for the three months ended March 31, 2000 and consisted primarily of purchases of short-term investments, net, investments in Number Nine and VIA and purchases of property and equipment, partially offset by cash received from UMC related to the sale of USC shares, and the increases in other assets. Investing activities used $4.4 million during the three months ended March 31, 1999 and consisted primarily of the net purchases of short term investments and purchases of property and equipment. Financing activities provided cash of $152.7 million and $2.8 million for the three months ended March 31, 2000 and 1999, respectively. Sales of common stock, including $145.5 million received from the sale of stock to VIA, was the financing activity generating cash during the three months ended March 31, 2000 which was offset partially by repayments of notes payable. Sales of common stock and the sale of a warrant to Intel were the financing activities that provided cash for the three months ended March 31, 1999. Working capital at March 31, 2000 and December 31, 1999 was $536.9 million and $100.1 million, respectively. At March 31, 2000, the Company's principal sources of liquidity included cash and equivalents of $126.9 million and $25.3 million in short-term investments. In addition, the Company held shares of UMC valued at $487.5 million at March 31, 2000 based upon then existing New Taiwan dollar to U.S. dollar exchange rates and UMC's market prices on the Taiwan Stock Exchange. The Company's principle sources of liquidity at December 31, 1999 included cash and equivalents of $45.8 million and $58.9 million of short-term investments. As of March 31, 2000, the Company had short-term lines of credit and bank credit facilities totaling $55.5 million, of which approximately $18.0 million was unused and available. At December 31, 1999, the Company was in default with its loan covenants regarding liquidity. The Company obtained a waiver for this violation. The Company believes that its available funds will satisfy the Company's projected working capital and capital expenditure requirements for at least the next 12 months, other than expenditures for future potential manufacturing agreements. The Company is currently a party to certain legal proceedings. Litigation could result in substantial expense to the Company. See "Part II- Item 1. Legal Proceedings." RECENT DEVELOPMENTS In February 2000, the Company purchased substantially all of the assets of Number Nine Visual Technology Corporation ("Number Nine"). Number Nine was a supplier of graphics accelerator subsystems for PCs using S3 graphics chips. The acquisition of the assets of Number Nine, a supplier to IBM, allows S3 to consolidate its graphics business with IBM into a single source distribution model and furthered S3's strategy of becoming a single graphics solution provider to the PC graphics market. The acquisition also added skilled hardware and software engineering resources to S3's existing teams. In February 2000, VIA purchased from the Company 10,775,000 shares of the Company's Common Stock for an aggregate purchase price of $145,462,500 pursuant to the terms of an agreement entered into in December 1999. The Company and VIA entered into an Investment Agreement on April 10, 2000 (the "Investment Agreement"). Pursuant to the Investment Agreement, the Company and VIA will form a new joint venture (the "Joint Venture") for the purpose of manufacturing and distributing graphics products and conducting related research and development activities. At the closing of the transactions contemplated by the Investment Agreement, the Company will transfer to the Joint Venture its graphics chip business in exchange for 100,000,000 shares of Class A common stock of the Joint Venture. In addition, at the closing, VIA will deliver to the Joint Venture $79.9 million in cash or a combination of cash and Via or S3 equity securities, which in turn will be delivered by the Joint Venture to the Company (minus an amount retained by the Joint Venture for the benefit of employees of the Joint Venture), in exchange for 10,000,000 shares of Class B common stock of the Joint Venture. The Joint Venture will assume $38.5 million in debt from the Company. The Joint Venture will also issue to the Company a promissory note with an aggregate principal amount of $239.6 million, which will be payable in equal annual installments on each of the first three anniversaries of the closing date of the formation of the Joint Venture. The payments may be made, at the Joint Venture's option, in cash or a combination of cash and Via or S3 equity securities. The note will be secured by certain assets of the Joint Venture. 16 17 In addition, the Company will receive additional payments from the Joint Venture if certain specified financial milestones are achieved by the Joint Venture. The closing of the transactions contemplated by the Investment Agreement is conditioned upon certain closing conditions, including the expiration or early termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvement Act. In addition, the closing is conditioned upon the issuance by the Company to VIA or an affiliate thereof of 3,000,000 shares of the Company's common stock at a price per share of $17.875, and the election of a designee of VIA to the Board of Directors of the Company. YEAR 2000 COMPLIANCE The Company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products or services of third parties. The Company will continue to monitor its critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 issues that may arise are addressed promptly. FACTORS THAT MAY AFFECT OUR RESULTS We have recently changed the focus of our business and may be unsuccessful or experience difficulties in implementing this change. If this occurs, our net losses could increase significantly. In April 2000, we announced that we agreed to transfer our PC graphics semiconductor business to a newly formed joint venture with VIA Technologies and have realigned our resources to focus on our Internet-related businesses. We have a limited operating history with our Internet-related businesses and our shift in focus may prove to be unsuccessful. Our Internet-related businesses compete with larger, more established competitors, and we may be unable to achieve market success. If we cannot complete the formation of our new joint venture with VIA Technologies, we could incur substantial losses. The formation of the VIA joint venture is subject to customary closing conditions, including the receipt of antitrust and other regulatory approvals. We cannot assure you that these conditions will be satisfied. We may be required to pay substantial sums to VIA if other conditions in the joint venture agreement are not satisfied. If we are unable to complete the formation of the joint venture, our graphics chip business could be severely harmed because, among other things, we would have to bear the expenses of that business while we have refocused our sales and marketing resources elsewhere. Also, we have retained our obligations under our agreements with our semiconductor foundries, and we may be required to purchase specified quantities of wafers or semiconductors, which could result in excess inventory of those products and corresponding writeoffs. Our quarterly and annual operating results are subject to fluctuations caused by many factors, which could result in failing to achieve our revenue or profitability expectations, resulting in a drop in the price of our common stock. Our quarterly and annual results of operations have varied significantly in the past and are likely to continue to vary in the future due to a number of factors, many of which are beyond our control. Any one or more of the factors listed below or other factors could cause us to fail to achieve our revenue or profitability expectations. The failure to meet market expectations could cause a drop in our stock price. These factors include: - - our ability to develop, introduce and market successfully new or enhanced products; - - our ability to introduce and market products in accordance with specialized customer design requirements and short design cycles; - - changes in the relative volume of sales of various products with sometimes significantly different margins; - - changes in demand for our products and our customers' products; - - rapid changes in electronic commerce on which we or our customers may not capitalize or which erode our traditional business base; - - frequent gains or losses of significant customers or strategic relationships; 17 18 - - unpredictable volume and timing of customer orders; - - the availability, pricing and timeliness of delivery of components for our products; - - the availability of manufacturing capacity, including wafer capacity using advanced process technologies; - - the timing of new product announcements or introductions by us or by our competitors; - - product obsolescence and the management of product transitions; - - production delays; - - decreases in the average selling prices of products; - - seasonal fluctuations in sales; and - - general economic conditions, including economic conditions in Asia and Europe in particular, that could affect the timing of customer orders and capital spending and result in order cancellations or rescheduling. Some or all of these factors could adversely affect demand for our products and our future operating results. Most of our operating expenses are relatively fixed in the short term. We may be unable to rapidly adjust spending to compensate for any unexpected sales shortfall, which could harm our quarterly operating results. Because the lead times of firm orders are typically short in the graphics industry, we do not have the ability to predict future operating results with any certainty. Therefore, sudden changes that are outside our control, such as general economic conditions, the actions or inaction of competitors, customers, third-party vendors of operating systems software, and independent software application vendors, may materially and adversely affect our performance. We generally ship more products in the third month of each quarter than in either of the first two months of the quarter, with levels of shipment in the third month higher towards the end of the month. This pattern, which is common in the semiconductor and multimedia communication industries, is likely to continue and makes future quarterly operating results less predictable. Because of the above factors, you should not rely on period-to-period comparisons of results of operations as an indication of future performance. We experienced a net loss for the last two years and we may continue to experience net losses in the future. We had a net loss of $30.8 million for 1999 and a net loss of $113.2 million for 1998. These results occurred primarily because we did not offer competitive products in the high end of the graphics and multimedia accelerator market. As a result, our sales consisted of primarily older generation and lower price products that were sold into markets that had significant price competition. Our ability to achieve profitability depends on our success in refocusing our business resources and in executing our business plan for our refocused business. We cannot assure you that we will be able to achieve or maintain profitability. If we do not continue to develop and market new and enhanced products, we will not be able to compete successfully in our markets. The markets for which our products are designed are intensely competitive and are characterized by short product life cycles, rapidly changing technology, evolving industry standards and declining average selling prices. As a result, we cannot succeed unless we consistently develop and market new products. We believe this will require expenditures for research and development in the future consistent with our historical research and development expenditures. To succeed in this environment, we must anticipate the features and functionality that customers will demand. We must then incorporate those features and functionality into products that meet the design, performance, quality and pricing requirements of the personal computer market and the timing requirements of PC OEMs and retail selling seasons. For example, we have a joint venture with VIA Technologies to bring integrated graphics and core logic chip sets to the OEM desktop and notebook PC markets. There can be no assurance that the joint venture will be successful or that our existing products will be compatible with new products. We have in the past experienced delays in completing the development and introduction of new products, as well as compatibility issues with integrated products and we cannot assure you that we will not experience similar delays in the future. In the past, our business has been seriously harmed when we developed products 18 19 that failed to achieve significant market acceptance and therefore were unable to compete successfully in our markets. Such a failure could occur again in the future. The demand for our products has historically been weaker in certain quarters. Due to industry seasonality, demand for PCs and PC related products is strongest during the fourth quarter of each year and is generally slower in the period from April through August. This seasonality may become more pronounced and material in the future to the extent that: - - a greater proportion of our sales consist of sales into the retail/mass merchant channel; - - PCs become more consumer-oriented or entertainment-driven products; or - - our net revenue becomes increasingly based on entertainment-related products, including our Internet-related products such as our Rio digital music players. Also, to the extent we expand our European sales, we may experience relatively weak demand in third calendar quarters due to historically weak summer sales in Europe. We operate in markets that are intensely and increasingly competitive. The consumer Internet device, personal computer multimedia and communications markets in which we compete are intensely competitive and are likely to become more competitive in the future. Because of this competition, we face a constant and increasing risk of losing customers to our competitors. The competitive environment also creates downward pressure on prices and requires higher spending to address the competition, both of which tend to keep profit margins lower. We believe that the principal competitive factors for our products are: - - performance and quality; - - conformity to industry standard application programming interfaces, or APIs; - - access to customers and distribution channels; - - reputation for quality and strength of brand; - - manufacturing capabilities and cost of manufacturing; - - price; - - product support; and - - ability to bring new products to the market in a timely manner. Historically, the gross profit margins on Diamond's products have been lower than the margins on our products. As a result of the Diamond merger, our average gross margins will likely be lower than they were prior to the merger, thereby decreasing our average gross margins. Many of our current and potential competitors have substantially greater financial, technical, manufacturing, marketing, distribution and other resources. These competitors may also have greater name recognition and market presence, longer operating histories, greater market power and product breadth, lower cost structures and larger customer bases. As a result, these competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements. In addition, some of our principal competitors offer a single vendor solution because they maintain their own semiconductor foundries and may therefore benefit from certain capacity, cost and technical advantages. In some markets where we are a relatively new entrant, such as modems, home networking, sound cards and consumer electronics, including Internet music players, we face dominant competitors that include 3Com (home networking and modems), Creative Technologies (sound cards, modems and Internet music players), Intel (home networking) and Sony (consumer electronic music players). In addition, the markets in which we compete are expected to become 19 20 increasingly competitive as PC products support increasingly more robust multimedia functions and companies that previously supplied products providing distinct functions (for example, companies today primarily in the sound, modem, microprocessor or motherboard markets) emerge as competitors across broader or more integrated product categories. In addition to graphics board manufacturers, our competitors include OEMs that internally produce graphics chips or integrate graphics chips on the main computer processing board of their personal computers, commonly known as the motherboard, and makers of other personal computer components and software that are increasingly providing graphics or video processing capabilities. We operate in markets that are rapidly changing, highly cyclical and vulnerable to sharp declines in demand and average selling prices. We operate in the personal computer, graphics/video chip, Internet appliance, and home networking markets. These markets are constantly and rapidly changing and have in the past, and may in the future, experience significant downturns. These downturns are characterized by lower product demand and accelerated product price reductions. In the event of a downturn, we would likely experience significantly reduced demand for our products. Although we have changed our focus to concentrate on our Internet-related businesses, substantially all of our revenues are currently derived from products sold for use in or with personal computers. In the near term, we expect to continue to derive almost all of our revenues from the sale of products for use in or with personal computers. Changes in demand in the personal computer and graphics/video chip markets could be large and sudden. Since graphics board and personal computer manufacturers often build inventories during periods of anticipated growth, they may be left with excess inventories if growth slows or if they have incorrectly forecasted product transitions. In such cases, the manufacturers may abruptly stop purchasing additional inventory from suppliers like us until the excess inventory has been used. This suspension of purchases or any reduction in demand for personal computers generally, or for particular products that incorporate our products, would negatively impact our revenues and financial results. We may experience substantial period-to-period fluctuations in results of operations due to these general semiconductor industry conditions. If we are unable to continue to develop and market new and enhanced products, our average selling prices and gross profits will likely decline. We must continue to develop new products in order to maintain average selling prices and gross margins. As the markets for our products continue to develop and competition increases, we anticipate that product life cycles will shorten and average selling prices will decline. In particular, average selling prices and, in some cases, gross margins, for each of our products will decline as products mature. A decline in selling prices may cause the net sales in a quarter to be lower than those of a preceding quarter or corresponding quarter in a prior year, even if more units were sold during that quarter than in the preceding or corresponding quarter of a prior year. To avoid that, we must successfully identify new product opportunities and develop and bring new higher-end and higher-margin products to market in time to meet market demand. The availability of new products is typically restricted in volume early in a product's life cycle. If customers choose to wait for the new version of a product instead of purchasing the current version, our ability to procure sufficient volumes of these new products to meet higher customer demand will be limited. If this happens, our revenues and operating margins could be harmed. Our products have short product life cycles, requiring us to manage product transitions successfully in order to remain competitive. Our products have short product life cycles. If we fail to introduce new products successfully within a given time frame, our competitors could gain market share, which could cause us to lose revenue. Further, continued failure to introduce competitive new products on time could also damage our brand name, reputation and relationships with our customers and cause longer-term harm to our financial condition. Also, we anticipate that the transition of the design of Diamond's boards based on new graphics chip architectures by us will require significant effort. Our major OEM customers typically introduce new computer system configurations as often as twice a year. The life cycles of Diamond's graphics boards typically range from six to twelve months and the life cycles of our graphic chips typically range from twelve to eighteen months. Short product life cycles are the result of frequent transitions in the computer market and in the consumer market in which products rapidly incorporate new features and performance standards on an industry-wide basis. Our graphics products must be able to support the new features and performance levels being required by personal computer manufacturers at the beginning of these transitions. Otherwise, we would likely lose business as well as the opportunity to compete for new design contracts until the next product transition. Failing to develop products with required features and performance levels or a delay as short as a few months in bringing a new product to market could significantly reduce our revenues for a substantial period. We may face inventory risks that are increased by a combination of short product life cycles and long component lead times. 20 21 The short product life cycles of our board-based products also give rise to a number of risks involving product and component inventories. These risks are heightened by the long lead times that are necessary to acquire some components of our products. We may not be able to reduce our production or inventory levels quickly in response to unexpected shortfalls in sales. This could leave us with significant and costly obsolete inventory. Long component lead times could cause these inventory levels to be higher than they otherwise would be and may also prevent us from quickly taking advantage of an unexpected new product cycle. This can lead to costly lost sales opportunities and loss of market share, which could result in a loss of revenues. For example, the timing and speed of the PCI-to-AGP bus transition and the SGRAM-to-SDRAM memory transition led to an excess inventory of PCI and SGRAM-based products at Diamond and in its distribution channel, which in turn resulted in lower average selling prices, lower gross margins, end-of-life inventory write-offs, and higher price protection charges during the second and third quarters of 1998. Further, declining demand for an excess supply of Monster 3D II and competitive 3D gaming products in the channel during the third quarter of 1998 resulted in rapidly declining revenue and prices vis-a-vis the second quarter of 1998, and resulted in price protection charges for this class of product in the third quarter of 1998. Our Internet-related device sales could be affected in the future by the availability of flash memory, which is a key component of our Rio digital music players and is currently subject to high market demand and allocations from suppliers. We estimate and accrue for potential inventory write-offs and price protection charges, but we cannot assure you that these estimates and accruals will be sufficient in future periods, or that additional inventory write-offs and price protection charges will not be required. The impact of these charges on Diamond's operating results in 1998 and the first quarter of 1999 was material. Any similar occurrence in the future could materially and adversely affect our operating results because as our subsidiary, Diamond's charges will be included in our operating results on a going forward basis. We have only recently started to offer products intended to address all performance segments of the commercial and consumer PC market. We recently commenced shipments of our Savage2000 product, which is designed to compete in multiple performance segments of the commercial and consumer PC markets and to satisfy multiple-function market needs, such as graphics, video and DVD support. We do not know whether Savage2000 will be able to compete successfully in those segments. If we are not able to introduce and successfully market higher performance products, our gross margin and profitability could be negatively affected. Demand for our products may decrease if the same capabilities provided by our products become available in operating systems or embedded in other personal computer components. A majority of our net sales are derived from the sale of graphics boards and multimedia accelerators for PC subsystems. However, there is a trend within the industry for lower performance graphics and video functionality to migrate from the graphics board to other personal computer components or into operating systems. We expect that additional specialized graphics processing and general purpose computing capabilities will be integrated into future versions of Intel and other Pentium-based microprocessors and that standard multimedia accelerators in the future will likely integrate memory, system logic, audio, communications or other additional functions. In particular, Intel and others have announced plans to develop chips that integrate graphics and processor functions to serve the lower-cost PC market. These could significantly reduce the demand for our products. Graphics boards are usually used in higher-end personal computers offering the latest technology and performance features. However, as graphics functionality becomes technologically stable and widely accepted by personal computer users, it typically migrates to the personal computer motherboard. We expect this trend to continue, especially with respect to low-end graphics boards. In this regard, the MMX instruction set from Intel and the expanded capabilities provided by the DirectX applications programming interface from Microsoft have increased the capability of Microsoft's operating systems to control display features that have traditionally been performed by graphics boards. As a result of these trends of technology migration, our success largely depends on our ability to continue to develop products that incorporate new and rapidly evolving technologies that manufacturers have not yet fully incorporated onto personal computer motherboards or into operating systems. Although our joint venture with VIA is intended to produce integrated graphics/core logic accelerator products that provide these functions, we have traditionally offered only single function graphics accelerator chips or chipsets. We have and intend to continue to expand the scope of our research and development efforts to provide integrated graphics/core logic accelerator products, which will require that we hire engineers skilled in these areas and promote additional coordination among our design and engineering groups. Alternatively, we may find it necessary or desirable to license or acquire technology to enable us to provide these functions, and we cannot assure you that any such technology will be available for license or purchase on terms acceptable to us. We believe that a large portion of the growth in the sales of personal computers may be in sealed systems that contain most functionality on a single systems board and are not upgradeable in the same manner as are most personal computers. These sealed 21 22 computers would contain a systems board that could include CPU, system memory, graphics, audio and Internet or network connectivity functionality on a single board. Although Diamond acquired Micronics Computers in 1998 for the purposes of obtaining technical and marketing expertise and brand acceptance in CPU motherboard design and developing integrated multimedia system board products, we cannot assure you that a significant market will exist for low-cost fixed system boards or that the acquisition of Micronics will enable us to compete successfully in this emerging market or in the current motherboard market. We depend on third parties for the manufacture of our products. We currently rely on two independent foundries to manufacture all of our products either in finished form or wafer form. We have a "take or pay" contract with Taiwan Semiconductor Manufacturing Company ("TSMC") and a foundry relationship with United Microelectronics Corporation ("UMC"). Our agreement with TSMC provides capacity through 2002 and requires us to make annual advance payments to purchase specified capacity to be applied against the following year's capacity or to forfeit advance payments against those amounts. For example, in the fourth quarter of 1998, we wrote off approximately $4.0 million of the 1998 prepaid production capacity because it did not fully utilize the capacity related to the advance payment. As of March 31, 1999, our note payable to TSMC was $9.6 million. If we purchase excess inventories of particular products or choose to forfeit advance payments, our operating results could be harmed. In 1999, UMC, the majority owner of our United Semiconductor Corporation ("USC") foundry joint venture, merged USC with UMC. As a result, we lost our ability to influence the USC board and any veto power we had over actions to be taken by USC. Our relationship with UMC is therefore based on a foundry capacity agreement rather than a joint venture. Although we are currently unaware of any changes that UMC may propose in the future to the foundry relationship, we will have less ability to influence this relationship if changes adverse to us are made in the future. We conduct business with one of our current foundries by delivering written purchase orders specifying the particular product ordered, quantity, price, delivery date and shipping terms. This foundry is therefore not obligated to supply products to us for any specific period, in any specific quantity or at any specific price, except as may be provided in a particular purchase order. To the extent a foundry terminates its relationship with us or our supply from a foundry is interrupted or terminated for any other reason, such as a natural disaster or an injunction arising from alleged violations of third party intellectual property rights, we may not have a sufficient amount of time to replace the supply of products manufactured by that foundry. We may be unable to obtain sufficient advanced process technology foundry capacity to meet customer demand in the future. From time to time, we may evaluate potential new sources of supply. However, the qualification process and the production ramp-up for additional foundries has in the past taken, and could in the future take, longer than anticipated. Accordingly, there can be no assurance that such sources will be able or willing to satisfy our requirements on a timely basis or at acceptable quality or per unit prices. TSMC and UMC are both located in the Science-Based Industrial Park in Hsin Chu City, Taiwan. We currently expect these foundries to supply the substantial portion of our graphics accelerator chips and S3-VIA joint venture products in 2000 and 2001. Disruption of operations at these foundries for any reason, including work stoppages, political or military conflicts, earthquakes or other natural disasters, could cause delays in shipments of our products which could have a material adverse effect on our operating results. For example, in September 1999, Taiwan experienced a major earthquake. The earthquake and its resulting aftershocks caused power outages and significant damage to Taiwan's infrastructure. The result was delays of shipments of our products from the TSMC and UMC foundries in Taiwan. Any such future delays could have a material adverse effect on our operating results. In addition, as a result of the rapid growth of the semiconductor industry based in the Science-Based Industrial Park, severe constraints have been placed on the water and electricity supply in that region. Any shortages of water or electricity could adversely affect our foundries' ability to supply our products, which could have a material adverse effect on operating results. We rely on independent subcontractors to manufacture, assemble or test certain of our products. We procure our components, assembly and test services and assembled products through purchase orders and we do not have specific volume purchase agreements with each of our subcontractors. Most of our subcontractors could cease supplying the services, products or components at any time with limited or no penalty. If we need to replace a key subcontractor, we could incur significant manufacturing set-up costs and delays. Also, we may be unable to find suitable replacement subcontractors. Our emphasis on maintaining low internal and channel inventory levels may exacerbate the effects of any shortage that may result from the use of sole-source subcontractors during periods of tight supply or rapid order growth. Further, some of our subcontractors are located outside the United States, which may present heightened process control, quality control, political, infrastructure, transportation, tariff, regulatory, legal, import, export, economic or supply chain management risks. 22 23 We historically have had significant product concentration and significantly depend on the health of the graphics and multimedia accelerator market, which means that a decline in demand for a single product, or in the graphics and multimedia accelerator market in general, could severely impact overall revenues and financial results. Our revenues are dependent on the markets for graphics/video chips for PCs and on our ability to compete in those markets. Our business would be materially harmed if we are unsuccessful in selling these graphic chips. We have agreed to transfer our PC graphics semiconductor business to a newly formed joint venture with VIA Technologies but our remaining business will continue to have significant product concentration after the transfer. Historically, over 75% of the net sales of our subsidiary, Diamond, have come from sales of graphics and video accelerator subsystems. Diamond has introduced audio subsystems, has entered the PC modem and home networking markets, and has entered into the PC consumer electronics market with the Rio digital audio player, but graphics and video accelerator subsystems are expected to continue to account for a significant portion of our sales for the foreseeable future. A decline in demand or average selling prices for graphics and video accelerator subsystems, digital audio players, PC modem and home networking markets, 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 our sales and operating results. We may not be able to successfully manage the growth and expansion of our business. In the past year, and particularly with the merger with Diamond, 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. This expansion in scope has resulted in a need for significant investment in infrastructure, process development and information systems. This requirement includes, without limitation: securing adequate financial resources to successfully integrate and manage the growing businesses and acquired companies; retention of key employees; integration of management information, product data management, control, accounting, telecommunications and networking systems; establishment of a significant worldwide web and e-commerce presence; consolidation of geographically dispersed manufacturing and distribution facilities; coordination of suppliers; rationalization of distribution channels; establishment and documentation of business processes and procedures; and integration of various functions and groups of employees. Each of these requirements poses significant, material challenges. 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 certain areas. 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. A significant portion of our sales are concentrated within a limited number of customers. We expect a significant portion of our future sales to remain concentrated within a limited number of strategic customers. If we lose one or more of these customers, our operating results would be harmed. One customer accounted for 14.5% of net sales for the three months ended March 31, 2000. One customer and two distributors accounted for 34%, 26% and 15% of net sales, respectively, for the three months ended March 31, 1999. The Company expects a significant portion of its future sales to remain concentrated within a limited number of strategic customers. There can be no assurance that the Company will be able to retain its strategic customers or that such customers will not otherwise cancel or reschedule orders, or in the event of canceled orders, that such orders will be replaced by other sales. In addition, sales to any particular customer may fluctuate significantly from quarter to quarter. From the date of the merger, all sales to Diamond have been, and will be, eliminated in consolidation. The occurrence of any such events or the loss of a strategic customer could have a material adverse effect on the Company's operating results. The manufacturers on which we depend may experience manufacturing yield problems that could increase our per unit costs and otherwise jeopardize the success of our products. Our primary products, graphics chips, are difficult to manufacture. The production of graphic chips requires a complex and precise process that often presents problems that are difficult to diagnose and time-consuming or expensive to solve. As a result, companies like us often experience problems in achieving acceptable wafer manufacturing yields. Our chips are manufactured from round wafers 23 24 made of silicon. During manufacturing, each wafer is processed to contain numerous individual integrated circuits, or chips. We may reject or be unable to sell a percentage of wafers or chips on a given wafer because of: - - minute impurities, - - difficulties in the fabrication process, - - defects in the masks used to print circuits on a wafer, - - electrical performance, - - wafer breakage, or - - other factors. We refer to the proportion of final good chips that have been processed, assembled and tested relative to the gross number of chips that could be constructed from the raw materials as our manufacturing yields. These yields reflect the quality of a particular wafer. Depending on the specific product, in the past, we negotiated with our manufacturers to pay either an agreed upon price for all wafers or a price that is typically higher for only wafers of acceptable quality. If the payment terms for a specific product require us to pay for all wafers, and if yields associated with that product are poor, we bear the risk of those poor manufacturing yields. Our products could have design 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 due to a number of factors, including the products' advanced functionality, the diverse operating environments in which the products may be deployed, the rapid pace of technology development and change in the Company's target product categories, 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's return policies for its graphics chips and boards may permit OEMs to return these products for full credit within thirty days after receipt of products that do not meet product specifications. In addition, the Company generally provides warranties for its retail products allowing the return or repair of defective products. 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, independent software vendor titles or applications may require upgrades to the Company's software products to maintain compatibility with such 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 independent software vendor titles or applications, the Company's business, financial condition and results of operations could be materially adversely affected. We are subject to risks relating to product returns and price protection. We often grant limited rights to customers to return unsold inventories of our products in exchange for new purchases, also known as "stock rotation." We also often grant price protection on unsold inventory, which allows customers to receive a price adjustment on existing inventory when our published price is reduced. Also, some of our retail customers will readily accept returned products from their own retail customers. These returned products are then returned to us for credit. We estimate returns and potential price protection on unsold inventory in our distribution channel. We accrue reserves for estimated returns, including warranty returns and price protection, and since the fourth quarter of 1998, we reserve the gross margin associated with channel inventory levels that 24 25 exceed four weeks of demand. We may be faced with further significant price protection charges as our competitors move to reduce channel inventory levels of current products, such as our Monster Fusion, as new product introductions are made. We depend on sales through distributors. If relationships with or sales through distributors decline, our operating results will be harmed. We sell our products through a network of domestic and international distributors, and directly to major retailers/mass merchants, value-added resellers and OEM customers. Our future success is dependent on the continued viability and financial stability of our customer base. 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 worldwide web. The loss of, or a reduction in, sales to certain of our key distribution customers as a result of changing market conditions, competition or customer credit problems could materially and adversely affect our operating results. Likewise, changes in distribution channel patterns, such as: - - increased electronic commerce via 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 us in ways not yet known. For example, the rapid emergence of Internet-based e-commerce, in which products are sold directly to consumers at low prices, is putting substantial strain on some of our traditional distribution channels. Inventory levels of our products in the two-tier distribution channels generally are maintained in a range of one to two 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, during periods when demand is slower, sales are lower and products are abundant, channel inventory levels tend toward the high end of the months-of-supply range. Frequently, in these situations, we attempt to ensure that distributors devote a greater degree of their working capital, sales and logistics resources to our products instead of to our competitors. Similarly, our 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 and channel promotional expenses are more likely to occur and, should they occur, are more likely to have a significant impact on our operating results. Further, in an event like this, high channel inventory levels may result in substantial price protection charges. These price protection charges have the effect of reducing net sales and gross profit. Consequently, in taking steps to bring our channel inventory levels down to a more desirable level, we may cause a shortfall in net sales during one or more accounting periods. These efforts to reduce channel inventory might also result in price protection charges if prices are decreased to move product out to final consumers, having a further adverse impact on operating results. We accrue for potential price protection charges on unsold channel inventory. We cannot assure you, however, that any estimates, reserves or accruals will be sufficient or that any future price reductions will not seriously harm our operating results. We rely on intellectual property and other proprietary information that may not be adequately protected and that may be expensive to protect. The industry in which we compete is characterized by vigorous protection and pursuit of intellectual property rights. We rely heavily on a combination of patent, trademark, copyright, and trade secret laws, employee and third-party nondisclosure agreements and licensing arrangements to protect our intellectual property. If we are unable to adequately protect our intellectual property, our business may suffer from the piracy of our technology and the associated loss of sales. Also, the protection provided to our proprietary technology by the laws of foreign jurisdictions, many of which offer less protection than the United States, may not be sufficient to protect our technology. It is common in the personal computer industry for companies to assert intellectual property infringement claims against other companies. Therefore, our products may also become the target of infringement claims. These infringement claims or any future claims could cause us to spend significant time and money to defend our products, redesign our products or develop or license a substitute technology. We may be unsuccessful in acquiring or developing substitute technology and any required license may be unavailable on commercially reasonable terms, if at all. In addition, an adverse result in litigation could require us to pay substantial damages, cease the manufacture, use, sale, offer for sale and importation of infringing products, or discontinue the use of certain processes. Any of those events could materially harm our business. Litigation by or against us could result in significant 25 26 expense to us and could divert the efforts of our technical and management personnel, regardless of the outcome of such litigation. However, even if claims do not have merit, we may be required to dedicate significant management time and expense to defending ourselves if we are directly sued, or assisting our OEM customers in their defense of these or other infringement claims pursuant to indemnity agreements. This could have a negative effect on our financial results. For example, Intel Corporation is currently in litigation with VIA, with whom we recently entered into a joint venture to bring high-performance integrated graphics and core logic chip sets to the volume OEM desktop and notebook PC markets and with whom we recently agreed to form a new joint venture into which our graphics chip business would be transferred. The result of such litigation could have an adverse effect on us. Our products depend upon third-party certifications, which may not be granted for future products, resulting in product shipment delays and lost sales. We submit most of our products for compatibility and performance testing to the Microsoft Windows Hardware Quality Lab because our OEM customers typically require our products to have this certification prior to making volume purchases. This certification typically requires up to several weeks to complete and entitles us to claim that a particular product is "Designed for Microsoft Windows." We may not receive this certification for future products in a timely fashion, or at all, which could result in product shipment delays and lost sales. We may not be able to retain or integrate key personnel, which may prevent us from succeeding. We may not be able to retain our key personnel or attract other qualified personnel in the future. Our success will depend upon the continued service of key management personnel. The loss of services of any of the key members of our management team or our failure to attract and retain other key personnel could disrupt our operations and have a negative effect on employee productivity and morale, decreasing production and harming our financial results. In addition, the competition to attract, retain and motivate qualified technical, sales and operations personnel is intense. We have at times experienced, and continue to experience, difficulty recruiting qualified software and hardware development engineers. We depend on a limited number of third party developers and publishers that develop graphics software products that will operate with and fully utilize the capabilities of our products to generate demand for our products. Only a limited number of software developers are capable of creating high quality entertainment software. Because competition for these resources is intense and is expected to increase, a sufficient number of high quality, commercially successful software titles compatible with our products may not be developed. We believe that the availability of numerous high quality, commercially successful software entertainment titles and applications significantly affects sales of multimedia hardware to the PC-based interactive 3D entertainment market. We depend on third party software developers and publishers to create, produce and market software titles that will operate with our 3D graphics accelerators. If a sufficient number of successful software titles are not developed, our product sales and revenues could be negatively impacted. In addition, the development and marketing of game titles that do not fully demonstrate the technical capabilities of our products could create the impression that our technology offers only marginal or no performance improvements over competing products. Either of these effects could have an adverse effect on our product sales and financial results. We depend on a limited number of suppliers from whom we do not have a guarantee of adequate supplies, increasing the risk that a loss of or problems with a single supplier could result in impaired margins, reduced production volumes, strained customer relations and loss of business. We obtain several of the components used in our products from single or limited sources. If component manufacturers do not allocate a sufficient supply of components to meet our needs or if current suppliers do not provide components of adequate quality or compatibility, we may have to obtain these components from distributors or on the spot market at a higher cost. We rarely have guaranteed supply arrangements with our suppliers, and suppliers may not be able to meet our current or future component requirements. If we are forced to use alternative suppliers of components, we may have to alter our product designs to accommodate these components. Alteration of product designs to use alternative components could cause significant delays and could require product recertification by our OEM customers or reduce our production of the related products. In addition, from time to time we have experienced difficulty meeting certain product shipment dates to customers for various reasons. These reasons include component delivery delays, component shortages, system compatibility difficulties and component quality deficiencies. Delays in the delivery of components, component shortages, system compatibility difficulties and supplier product quality deficiencies will continue to occur in the future. These delays or problems have in the past and could in the future result in impaired margins, reduced production volumes, strained customer relations and loss of business. For example, DRAM and flash memory components, which are used in our graphics 26 27 boards and Rio digital audio players, significantly increased in price in September 1999 due in part to supply interruptions arising from the earthquake in Taiwan. In addition, industry-wide demand for flash memory components has increased dramatically, causing increases in price and shortages in supply. These price increases may have an adverse impact on our gross margin in future periods. Also, in an effort to avoid actual or perceived component shortages, we may purchase more of certain components than we otherwise require. Excess inventory resulting from such over-purchases, obsolescence or a decline in the market value of such inventory could result in inventory write-offs, which would have a negative effect on our financial results as happened in the first and second quarters of 1998. Similarly, Diamond's perception of component shortages caused Diamond to over-purchase certain components and pay surcharges for components that subsequently declined in value in the second, third and fourth quarters of 1998. In addition, our inventory sell-offs or sell-offs by our competitors could trigger channel price protection charges, further reducing our gross margins and profitability, as occurred with the Monster 3D II product line in the third and fourth quarters of 1998. We may experience product delivery delays due to the inadequacy or incompatibility of software drivers. Such delays could hurt our sales. Some components of our products require software drivers in order for those components to work properly in a PC. These software drivers are essential to the performance of nearly all of our products and must be compatible with the other components of the graphics board and PC in order for the product to work. Some of these products that include software drivers are among those products based on components, including software drivers, that are supplied by a limited number of suppliers. From time to time, we have experienced product delivery delays due to inadequacy or incompatibility of software drivers either provided by component suppliers or developed internally by them. These delays could cause us to lose sales, revenues and customers. Software driver problems will continue to occur in the future, and those problems could negatively affect our operating results. We have significant exposure to international markets. International sales accounted for 54% and 99% of our net sales for the three months ended March 31, 2000 and 1999, respectively. We expect that international sales will continue to represent a significant portion of net sales, although there can be no assurance that international sales, as a percentage of net sales, will remain at current levels. Diamond's net sales in Europe accounted for 36% and 26% of total net sales during 1998 and 1997, respectively. Diamond's other international net sales accounted for 10% and 12% of total net sales during 1998 and 1997, respectively. In addition, a substantial proportion of our products are manufactured, assembled and tested by independent third parties in Asia. As a result, we are subject to the risks of conducting business internationally, including: - - unexpected changes in, or impositions of, legislative or regulatory requirements; - - fluctuations in the U.S. dollar, which could increase the price in local currencies of our products in foreign markets or increase the cost of wafers and components purchased by us; - - delays resulting from difficulty in obtaining export licenses for certain technology; - - tariffs and other trade barriers and restrictions; - - potentially longer payment cycles; - - greater difficulty in accounts receivable collection; - - potentially adverse tax treatment; and - - the burdens of complying with a variety of foreign laws. In the past, we have experienced an adverse impact associated with the economic downturn in Asia that contributed to decreases in net sales. In addition, our international operations are subject to general geopolitical risks, such as political and economic instability and changes in diplomatic and trade relationships. The People's Republic of China and Taiwan have in the past experienced and are currently experiencing strained relations, and a worsening of relations or the development of hostilities between them could disrupt operations at our foundries and affect our Taiwanese customers. As a result of the merger with Diamond, we expect that some of our suppliers may not do business with us, which could cause a decline in our sales. 27 28 The consummation of the merger is expected to cause some of our add-in card and motherboard customers to end or curtail their relationships with us. The loss of these customers could cause a decline in our sales unless new sales resulting from the integration of Diamond have an offsetting effect. For example, Creative Technology Ltd., a competitor of Diamond and previously an S3 customer, has discontinued its relationship with us. Additional customers may discontinue their relationships with us in the future. This may occur because our products comprise both graphics chips and graphics boards. Thus, as a result of the merger, we are competing with some of our current customers, which are graphics board manufacturers. As a result, we expect that sales to some of our existing customers will be reduced significantly from prior levels and that these customers will no longer continue to be significant customers. Unless we are able to offset the loss of these sales with new customers or sales of alternative products, our revenues may decline. We are dependent on a limited source of graphics chips and graphics boards because S3 and Diamond are each suppliers to each other, resulting in heightened risks because one company's suppliers may not meet the other company's requirements. As a result of the merger with Diamond, we have become significantly dependent on our graphics chip design and development capabilities and significantly dependent on Diamond's graphics board design, manufacturing and marketing capabilities. This occurred because we are now more restricted in our ability to select and use products produced by our competitors prior to the merger. If either our graphics chips or Diamond's graphics boards fail to meet the requirements of the market and our customers, our relationship with those customers could be hurt, negatively affecting our financial performance. In addition, we will be highly dependent on our ability to provide graphics chips on a timely basis meeting the rigid scheduling and product specification requirements of OEMs. If our graphics chips are not competitive or not provided on a timely basis, we will most likely not be able to readily obtain suitable alternative graphics chips, which would result in our loss of revenue and customers. We have a significant level of debt. At March 31, 2000, we had total debt and other long-term liabilities outstanding of $296.6 million. The degree to which we are leveraged could adversely affect our ability to obtain additional financing for working capital or other purposes and could make us more vulnerable to economic downturns and competitive pressures. Our significant leverage could also adversely affect our liquidity, as a substantial portion of available cash from operations may have to be applied to meet debt service requirements. In the event of a cash shortfall, we could be forced to reduce other expenditures to be able to meet such debt service requirements. Our stock price is highly volatile and we expect that our stock price will continue to be highly volatile. The market price of our common stock has been highly volatile, like that of the common stock of many other semiconductor companies. We expect our common stock to remain volatile. This volatility may result from: - - general market conditions and market conditions affecting technology and semiconductor stocks generally; - - actual or anticipated fluctuations in our quarterly operating results; - - announcements of design wins, technological innovations, acquisitions, investments or business alliances, by us or our competitors; and - - the commencement of, developments in or outcome of litigation. The market price of our common stock also has been and is likely to continue to be significantly affected by expectations of analysts and investors, especially if our operating results do not meet those expectations. Reports and statements of analysts do not necessarily reflect our views. The fact that we have in the past met or exceeded analyst or investor expectations does not necessarily mean that we will do so in the future. In the past, following periods of volatility in the market price of a particular company's securities, securities class action litigation has often been brought. This litigation could result in substantial costs and a diversion of our management's attention and resources. We are currently involved in securities class action litigation and Diamond is also involved in similar proceedings. We are a party to legal proceedings alleging securities violations that could have a negative financial impact on us. 28 29 Since November 1997, a number of complaints have been filed in federal and state courts seeking an unspecified amount of damages on behalf of an alleged class of persons who purchased shares of our common stock at various times between April 18, 1996 and November 3, 1997. The complaints name us as defendants as well as certain of our officers and former officers and certain of our directors, asserting that we and they violated federal and state securities laws by misrepresenting and failing to disclose certain information about our business. In addition, certain shareholders have filed derivative actions in the state courts of California and Delaware seeking recovery on our behalf, alleging, among other things, breach of fiduciary duties by such individual defendants. The plaintiffs in the derivative action in Delaware have not taken any steps to pursue their case. The derivative cases in California state court have been consolidated, and plaintiffs have filed a consolidated amended complaint. The court has entered a stipulated order in those derivative cases suspending court proceedings and coordinating discovery in them with discovery in the class actions in California state courts. On plaintiffs' motion, the federal court has dismissed the federal class actions without prejudice. The class actions in California state court have been consolidated, and plaintiffs have filed a consolidated amended complaint. The Company has answered that complaint. Discovery is pending. While our management intends to defend the actions against us vigorously, there can be no assurance that an adverse result or settlement with regard to these lawsuits would not have a material adverse effect on our financial condition or results of operations. We are also defending several putative class action lawsuits naming Diamond 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 former executive officers and directors of Diamond are also named as defendants. The plaintiffs purport to represent a class of all persons who purchased Diamond'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 Diamond and the other defendants made various material misrepresentations and omissions during the Class Period. The complaints do not specify the amount of damages sought. On March 24, 2000, the District Court for the Northern District of California dismissed the federal action without prejudice. We believe that we have good defenses to the claims alleged in the California Superior Court lawsuit and will defend ourselves vigorously against this action. No trial date has been set for this action. The ultimate outcome of this action 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. In addition, we have been named, with Diamond, as a defendant in litigation relating to the merger. On August 4, 1999, two alleged stockholders of Diamond filed a lawsuit, captioned Strum v. Schroeder, et al., in the Superior Court of the State of California for the County of Santa Clara. Plaintiffs, on behalf of themselves and a class of all former Diamond stockholders similarly situated whom they purportedly represent, challenge the terms of the merger. The complaint names Diamond, the former directors of Diamond and us as defendants. The complaint alleges generally that Diamond's directors breached their fiduciary duties to stockholders of Diamond and seeks rescission and the recovery of unspecified damages, fees and expenses. While our management intends to defend the actions against us vigorously, there can be no assurance that an adverse result or settlement with regards to these lawsuits would not have a material adverse effect on our financial condition or results of operations. We have also received from the SEC a request for information relating to our financial restatement announcement in November 1997. We have responded and intend to continue to respond to the SEC requests. Item 3. Quantitative and Qualitative Disclosures About Market Risk. INVESTMENT PORTFOLIO The Company does not use derivative financial instruments in its investment portfolio. The Company places its investments in instruments that meet high credit quality standards, as specified in the Company's investment policy. The Company also limits the amount of credit exposure to any one issue, issuer or type of investment. The Company does not expect any material loss with respect to its investment portfolio. The table below summarizes the Company's investment portfolio. The table represents principal cash flows and related average fixed interest rates by expected maturity date. The Company's policy requires that all investments mature within twenty months. Principal (Notional) Amounts Maturing in 2000 in U.S. Dollars:
FAIR VALUE AT MARCH 31, 2000 ---------------------- (IN THOUSANDS, EXCEPT INTEREST RATES)
29 30 Cash and cash equivalents $126,871 Weighted average interest rate 5.63% Other short-term investments $ 25,338 Weighted average interest rate 5.91% Total portfolio $152,209 Weighted average interest rate 5.68%
CONVERTIBLE SUBORDINATED NOTES In September 1996, the Company completed a private placement of $103.5 million aggregate principal amount of convertible subordinated notes. The notes mature in 2003. Interest is payable semi-annually at 5 3/4% per annum. The notes are convertible at the option of the note holders into the Company's common stock at an initial conversion price of $19.22 per share, subject to adjustment. Beginning in October 1999, the notes are redeemable at the option of the Company at an initial redemption price of 102% of the principal amount. The fair value of the convertible subordinated notes at March 31, 2000 was approximately $117.1 million. IMPACT OF FOREIGN CURRENCY RATE CHANGES The Company invoices its customers in US dollars for all products. The Company is exposed to foreign exchange rate fluctuations as the financial results of its foreign subsidiaries are translated into US dollars in consolidation. The foreign subsidiaries maintain their accounts in the local currency of the foreign location in order to centralize the foreign exchange risk with the parent company. To date this risk has not been material. The effect of foreign exchange rate fluctuations on the Company's financial statements for the three months ended March 31, 2000 and 1999 was not material. Since foreign currency exposure increases as intercompany receivables grow, from time to time the Company uses foreign exchange forward contracts as a means for hedging these balances. As of March 31, 2000, the Company held the following forward exchange contracts:
MATURITY DATE NOTIONAL FAIR VALUE ------------- -------- ---------- (IN THOUSANDS) Foreign Currency Forward Exchange Contracts: 275,905,000 New Taiwan Dollars April 3, 2000 $ 8,489 $ (577) 275,905,000 New Taiwan Dollars July 5, 2000 $ 8,466 $ (595)
PART II. OTHER INFORMATION Item 1. Legal Proceedings The semiconductor and personal computing products industries are characterized by frequent litigation, including litigation regarding patent and other intellectual property rights. The Company is party to various legal proceedings that arise in the ordinary course of business. See Note 8 to the Company's Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report. Although the ultimate outcome of these matters is not presently determinable, management believes that the resolution of all such pending matters will not have a material adverse effect on the Company's financial position or results of operations. On January 6, 2000, PhoneTel Communications, Inc. ("PhoneTel") filed a complaint for patent infringement against a group of defendants, including Diamond, in the United States District Court for the Northern District of Texas. PhoneTel generally alleges that Diamond and the other defendants are infringing its two patents by making, using, selling, offering to sell and/or importing digital synthesizers, personal computers, sound cards, or console game systems. PhoneTel does not specify which Diamond products allegedly infringe its patents. S3 filed Diamond's answer to the complaint on March 28, 2000. S3 believes that the complaint is without merit and will vigorously defend itself against the allegations made in the complaint. On April 23, 1999, 3Dfx Interactive, Inc. ("3Dfx") filed a lawsuit against Diamond for breach of contract based upon unpaid invoices in the amount of $3,895,225. On June 4, 1999 the Company filed an answer and cross-complaint alleging breach of contract, breach of the implied covenant of good faith and fair dealing, breach of implied warranty and negligence. On February 10, 2000, this matter was settled. As part of the settlement, the Company paid $1,950,000 to 3Dfx. This amount was expensed at December 31, 1999. The Company has been defending several putative class action lawsuits naming Diamond, 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 former executive officers and directors of Diamond are also named as defendants. The plaintiffs purport to represent a class of all persons who purchased Diamond's Common Stock between October 18, 1995 and June 20, 1996 (the "Class 30 31 Period"). The complaints allege claims under the federal securities laws and California law. The plaintiffs allege that Diamond and the other defendants made various material misrepresentations and omissions during the Class Period. The complaints do not specify the amount of damages sought. On March 24, 2000, the District Court for the Northern District of California dismissed the federal action without prejudice. The Company believes that it has good defenses to the claims alleged in the California Superior Court lawsuit and will defend itself vigorously against this action. No trial date has been set for this action. The Company continues to defend several securities class action lawsuits as well as a class action lawsuit relating to its merger with Diamond. See Note 8 to the Company's Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report. On May 11, 1998, the Company filed a lawsuit in the United States District Court for the Northern District of California against nVidia Corporation ("nVidia") alleging that nVidia was infringing three of the Company's patents and an injunction restraining nVidia from manufacturing and distributing a family of nVidia multimedia accelerators and seeking other forms of relief. nVidia answered the Company's complaint and counter-claimed for declaratory relief, alleging that the three patents were invalid and not infringed. On August 16, 1999, the court found that some of the claims in the patents are invalid, found that the remaining claims in the patents are valid and set a trail date to adjudicate the validity of the remaining claims and whether nVidia was infringing the valid patent claims. On December 9, 1999, nVidia filed a complaint for patent infringement against the Company alleging infringement of five patents relating to sound and/or multimedia products sold by the Company. On February 1, 2000, the Company and nVidia agreed to drop their respective lawsuits and enter into a settlement and cross-license agreement. 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 of the lawsuits has been made in the accompanying condensed consolidated financial statements. Item 2. Changes in Securities On February 20, 2000, the Company issued and sold 10,775,000 shares of its Common Stock to VIA at an aggregate purchase price of $145,462,500. The Company relied upon the exemption provided by Section 4(2) of the Securities Act of 1933, as amended (the "Act"), because the transaction did not involve a public offering and VIA represented that it was an "accredited investor" as such term is defined in rules of the SEC promulgated under the Act. In December 1998, the Company entered into an agreement pursuant to which it agreed to issue to Intel Corporation ("Intel") a warrant to purchase 1,000,000 shares of the Company's Common Stock at an exercise price of $9.00 per share. The purchase price for the warrant was $990,000. In February 2000, Intel exercised its warrant on a net issuance basis and acquired 429,477 shares of the Company's Common Stock. The Company relied upon the exemption provided by Section 4(2) of the Act, because the transaction did not involve a public offering and Intel represented that it was an "accredited investor" as such term is defined in rules of the SEC promulgated under the Act. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits
EXHIBIT NUMBER NOTES DESCRIPTION OF DOCUMENT ------ ----- ----------------------- 27.1 Financial Data Schedule (filed only with the electronic submission of Form 10-Q in accordance with the EDGAR requirements)
(b) Reports on Form 8-K: No reports on Form 8-K were filed during the quarter for which this report is filed. 31 32 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. S3 INCORPORATED (Registrant) /s/ WALTER D. AMARAL ------------------------------------- WALTER D. AMARAL Senior Vice President Finance and Chief Financial Officer (Principal Financial and Accounting Officer) May 15, 2000 32 33 EXHIBIT INDEX
Exhibit # Description - --------- ----------- 27.1 Financial Data Schedule
EX-27.1 2 EXHIBIT 27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM S3 INCORPORATED CONSOLIDATED BALANCE SHEET AS OF MARCH 31, 2000 AND CONSOLIDATED STATEMENT OF OPERATIONS FOR THE QUARTER ENDED MARCH 31, 2000 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-2000 JAN-01-2000 MAR-31-2000 126,871 512,829 103,148 15,525 120,306 901,250 105,068 69,094 1,691,742 364,303 0 0 0 591,244 439,573 1,691,742 161,719 161,719 148,315 148,315 60,845 0 2,250 843,259 350,659 492,600 0 0 0 492,243 5.84 5.04
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