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Technology Stocks : S3 (A LONGER TERM PERSPECTIVE) -- Ignore unavailable to you. Want to Upgrade?

To: stock talk who wrote (8858)	1/20/1998 2:57:00 PM
From: Cosmo Kramer	Read Replies (1) \| Respond to of 14577

The suit costs me nothing, I can only gain a few bucks. <Maybe> Just to know it puts pressure on S3's management is a bonus. Cheers, Mark

To: stock talk who wrote (8858)	1/21/1998 12:40:00 AM
From: Ken Muller	Read Replies (1) \| Respond to of 14577

Frank and all the long term posters: Well, it's been a long time coming. Here it is! Stages of Grief with S3 Well, I've gone through all the stages of grief with the S3 debacle: Shock, Disbelief, Anger, Guilt, Despair, and finally, Acceptance. I didn't think this was supposed to be part of the investment experience. In any case, I can now write about what went on within S3 without losing any sleep. I have spent a good deal of December and part of January doing analysis on S3's numbers. They are greatly simplified but if anyone needs more data please let me know and I'll be glad to provide it. It'll be tough sledding to read through it all, but it should be rewarding On November 3, 1997, S3 Inc announced that they had discovered that all was not well with their books. The statements indicated that distribution revenue had been improperly recognized ahead of time. However, tightened controls had been put into place to prevent a re-occurrence. No reason was given for the accounting errors. Subsequent audit results showed a cumulative $58 million reduction in revenue YTD starting 3/30/96 along with a cumulative reduction in profits of approx $.20/share for the same period. After the usual flurry of class action lawsuits, the company's actions have faded from the limelight. They have faded everywhere.... everywhere except here at my desk. After reviewing all the numbers, I have come to the conclusion that something went terribly wrong within S3. The question which most people should have asked (but didn't) after the reduction in revenue restatements were: 1. Why did S3 have a cumulative reduction in earnings over time when the distribution revenue was merely recognized at the time of shipment rather than at the time it was sold by the distributor. (This would merely shift revenue forward a quarter or two, not change it.) My original thought was that distribution might have sold the material at lower prices than it was shipped at. This might have led to losses. To find the answer, I examined the original and restated 10K filings for year end 1996. How did S3 rectify the accounting numbers? (During 1996, S3 indicated they had a restated reduced revenue of $25.04 million; see chart below) Original Revenue by Quarter ($000) - not restated 1st qtr 96 - 110,072 2nd qtr 96 - 103,825 3rd qtr 96 - 119,440 4th qtr 96 - 132,041 1st qtr 97 - 138,066 2nd qtr 97 - 108,892 3rd qtr 97 - 120,439 After re-statement, increases(reductions) in Revenue 1st & 2nd qtr 96 - (12,655) 3rd qtr 96 - (9355) 4th qtr 96 - (3031) 1st & 2nd qtr 97 - (32,214) 3rd qtr 97 - (745) Total revenue reductions = 58,000 (1/1/96-9/30/97) There are three accounts of interest: Accounts Payable, Inventory and a new listing named "Deferred Revenue" Accounts Receivable $76,120 - 12/31/96 $76,120 - 12/31/96 (re-stated) Inventories $53,466 - 12/31/96 $53,466 - 12/31/96 (re-stated) Deferred Revenue $0 - 12/31/96 $12,113 - 12/31/96 (restated) Under normal accounting practices when a product is shipped out , the accounts receivable should reflect an increase (invoice amount) and the inventory should be reduced (COG). But when we examine the S3 balance sheet restatements, we note that there was no change in the restatements of those accounts. How could this be? Instead, we have only the addition of a new liability account called "Deferred Revenue". The only plausible answer is that during 1996, S3 was keeping accurate count of both their inventory and their accounts receivable. Unfortunately, this means S3 was correctly accounting for their distribution sales (and the change in inventory and A/R) at the time of the distributor sale to the end customer. Thus no changes were necessary. The unhappy result of the restatements can only be the acknowledgment that no changes to the A/R or Inventory accounts were made at the time of the initial distributor shipments. In layman's language, this represents a double counting of distributor shipments as revenue: 1. Once at the time of the factory shipment (w/o A/R and Inventory changes) to the distributor and 2. Once at the time of the distributor sale to the end customer. The "Deferred Revenue" liability introduced in the year end 1996 restatements appears to increase the company's liability by the total of cost of goods of the initial distributor shipments minus the federal tax refund due to lower restated profits. No other changes (with the exception of federal taxes) were noted. We do not yet have the audited breakdown for the 1st and 2nd quarters for 1997, but the cumulative numbers show the situation getting worse with a cumulative revenue reduction of $32,959,000 and "Deferred Revenue" number of $21,760,000 as of 9/30/97. It appears this practice was maintained for all quarterly periods since 1st quarter 1996. For those who have made it this far, this raises a lot of questions: How did this get by the year end audit? Who was responsible? Why didn't anyone say anything? Why is S3 still silent? AND....what happens now. I'll post my comments on those issues tomorrow. Unemotionally, Ken