MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Annual Results
The following table sets forth certain operating data as a percentage of
revenues for the periods indicated:
Years Ending September 30,
1995 1994 1993
Total revenues 100.0% 100.0% 100.0%
Cost of revenues 50.9 49.3 52.2
Gross margin 49.1 50.7 47.8
Operating expense
Research and development 13.7 12.8 10.4
Sales and marketing 14.8 16.5 17.8
General and administrative 6.8 7.4 8.3
Total operating expenses 35.3 36.7 36.5
Operating income 13.8 14.0 11.3
Interest, net 1.1 (0.5) (1.4)
Income before taxes 14.9 13.5 9.9
Provision for taxes 4.6 4.7 0.8
Net income 10.3% 8.8% 9.1%
The Company has derived revenues principally from product revenues and
technology development and license revenues, as illustrated in the table below:
Years Ending September 30,
1995 1994 1995
(in thousands)
Net product revenues $46,189 $36,247 $26,723
Technology development and license
revenues from related parties -- 719 958
Total revenues $46,189 $36,966 $27,681
As a result of the Company's focus on interface logic devices and growing
acceptance of such products, net product revenues increased 27% in fiscal 1995
and 36% in fiscal 1994 due to increased sales of interface logic devices which
comprised a substantial majority of the Company's total revenues in each period.
Sales of interface logic devices are expected to continue to account for a
significant majority of net product revenues in the foreseeable future. ASPs for
products declined substantially during fiscal 1995 and 1994, and the Company
anticipates additional declines in the ASPs for these products in the future.
The Company believes that during fiscal 1993, its sales of QSFCT logic devices
were affected favorably by an increase in the demand for interface logic devices
generally, that was not met by a corresponding increase in the production of
lower-performance logic devices that could have satisfied a portion of the
demand. The Company did not experience this benefit in fiscal 1995 or 1994 and
does not expect to be able to take advantage of this favorable effect in the
future.
As is common in the semiconductor industry, the Company sells a significant
portion of its products through distributors. Domestic distributors accounted
for approximately 21% and 30% of the Company's total product sales during fiscal
1995 and 1994, respectively. Sales by Arrow Electronics Inc. accounted for
approximately 16% and 21% of total product sales during fiscal 1995 and 1994,
respectively, and the remainder of domestic distributor sales were made
primarily through Bell Microproducts Inc., (Bell) and Nu-Horizons Electronics
Corp. The relationship with Bell was terminated in fiscal year 1995 and the
Company replaced Bell with Bell Industries, Inc. late in the year. Recognition
of sales to distributors and the related cost of sales is deferred until such
distributors resell the products to their customers. There can be no assurance
that future sales by distributors will continue at the present levels. The loss
of one or more distributors could have an adverse effect on the Company's
operating results.
The Company has received technology development and license revenues from
its wafer fabrication suppliers in connection with certain new product
development projects and licenses for QCMOS process technology and certain
product designs. Technology development and license revenues, which included
cash payments and the market value of free wafers provided to the Company,
constituted 2% and 3% of net revenues in fiscal 1994 and 1993. There was no
technology development and license revenue in fiscal 1995. Although the Company
may accept business involving technology development and license revenues, the
Company does not expect these revenues to constitute a significant portion of
net revenues in future periods.
Export sales, primarily consisting of sales to countries in Europe and the
Far East, constituted 29%, 21% and 21% of net product revenues for fiscal 1995,
fiscal 1994 and fiscal 1993, respectively. All sales are denominated in U.S.
dollars.
During fiscal 1993, two system manufacturers accounted for 13% and 10% of
total product revenues, respectively. No systems manufacturer accounted for 10%
or more of total product revenues in fiscal 1995 or 1994.
<PAGE>
Gross Margin on Product Revenue
The following table sets forth the Company's net product revenues and
product gross margin:
Years Ending September 30,
1995 1994 1993
Net product revenues $46,189 $36,247 $26,723
Cost of product revenues 23,524 18,192 14,357
Product gross margin $22,665 $18,055 $12,366
Product gross margin as a percentage
of product revenues 49.1% 49.8% 46.3%
The Company's cost of product sales includes the cost of wafer fabrication,
assembly performed by third party vendors, testing by third party vendors and
direct and indirect costs associated with the testing, procurement, scheduling
and quality assurance functions performed by the Company.
Although ASPs for the Company's products, including interface logic
components continued to decline in fiscal 1995 and 1994, the Company's product
gross margin percentage increased from fiscal 1993 to 1994 primarily due to
continued reduction in procurement costs for assembly services and wafers. The
decrease in gross margin from fiscal 1994 to 1995 primarily reflects increased
costs resulting from the unfavorable exchange rate on yen-based wafer purchases,
changes in product mix and lower average selling prices which were partially
offset by cost reductions. The Company purchases wafers in yen-denominated
transactions and is subject to exchange rate risk. The Company attempts to
manage its exposure to this risk by entering into forward exchange contracts to
hedge all of its yen-denominated firm purchase commitments.
The Company's gross margin can be affected by a number of factors including
changes in product or distribution channel mix, cost or availability of parts,
foreign exchange rates, and competitive pressures on pricing. The Company
continues to experience increasing pricing pressure from its competitors. The
Company's margins can vary depending upon the mix of distributor and direct
sales in any particular fiscal period and the Company anticipates that this mix
will continue to fluctuate in future periods. As a result of the above factors,
gross margin fluctuations are difficult to predict, and there can be no
assurance that the Company will maintain gross margins at current levels in
future periods.
<PAGE>
Research and Development
Research and development expenses increased 64% from fiscal 1993 to fiscal
1994 and 34% from fiscal 1994 to fiscal 1995. The Company's research and
development activities include process development and new product development.
The Company believes that the continued development of its process technology
and new products is essential to its success and is committed to continue its
investment in research and development to maintain a strong technological
position in the industry. No research and development expense has been
capitalized. The Company currently expects to incur higher research and
development expenses in fiscal 1996, although these expenses are expected to
remain constant as a percentage of revenues. However there can be no assurance
that revenues will grow at the same rate as expenditures for research and
development are incurred.
The Company believes that future product revenue growth will depend in
substantial part on the success of new products and the continued success and
sales of existing products. New products are generally incorporated into a
customer's product or system at the design stage. However, design wins, which
can often require significant expenditures by the Company, may precede the
generation of volume sales, if any, by a year or more. No assurance can be given
that the Company will achieve design wins or that any design win will result in
significant future revenues.
Sales and Marketing
Sales and marketing expenses increased 12% and 23% in fiscal 1995 and 1994,
respectively. The increase in sales and marketing expenses during 1994 was
primarily the result of increased personnel costs and sales commissions relating
to increased revenues and the inclusion of a full fiscal year's level of
expenses associated with the offices and personnel added in Los Angeles,
California and the United Kingdom during fiscal 1993. The sales and marketing
expense increase in fiscal 1995 was due primarily to increased commission
expense resulting from higher revenues in 1995. The Company anticipates that
these expenses will remain relatively constant as a percentage of revenues,
although there can be no assurance that the revenues will grow at the same rate
as expenditures for sales and marketing are incurred.
General and Administrative
General and administrative expenses increased 15% from fiscal 1994 to
fiscal 1995 and 18% from fiscal 1993 to fiscal 1994. The Company's general and
administrative expenses have increased commensurate with increases in revenues
and related payroll expenses. The increase in general and administrative
expenses in fiscal 1995 were due mainly to costs associated with being a public
company and compensation expenses. Although general and administrative expenses
have increased in amount over the last three years these expenses have decreased
as a percentage of revenues. There can be no assurance that revenues will
continue to grow at the same rate as expenditures for general and administrative
expenses are incurred.
<PAGE>
Interest, Net
The net interest income of $520,000 in fiscal 1995 was mainly due to
interest earned on the proceeds from the Company's initial public offering in
November 1994 as compared to net interest expense of $192,000 due primarily to
interest on leases and other long-term obligations. The decrease in net interest
expense from fiscal 1993 to 1994 reflected lower interest payments on maturing
loans.
Provision for Taxes
The Company's effective tax rate was 31%, 35% and 8% for fiscal 1995, 1994
and 1993, respectively. The decrease in the Company's effective tax rate from
1994 to 1995 was primarily due to the recognition of deferred tax assets. The
tax provision for 1993 arose from foreign income taxes withheld on technology
revenue and federal and state taxes that could not be offset by net operating
loss carryforwards.
Foreign Exchange Contracts
The Company makes yen-denominated purchases of wafers from Japanese
suppliers. In fiscal year 1995 this resulted in material unfavorable foreign
exchange transactions included in cost of product revenues. The Company entered
into forward exchange contracts beginning in the fourth quarter of fiscal 1995
primarily to hedge against the short-term impact of foreign currency
fluctuations on purchases denominated in yen. The maturities of forward exchange
contracts are short-term in nature. Notwithstanding, these precautions, however,
the Company remains subject to the transaction exposures that arise from foreign
exchange movements between the dates of foreign currency purchase transactions
are recorded and the dates cash payments are made in foreign currencies.
Additional Factors That May Affect Results
The Company's quarterly and annual operating results are affected by a wide
variety of factors that could materially and adversely affect revenues and
profitability, including, among others, factors pertaining to (i) competition,
such as competitive pressures on average selling prices of the Company's
products and the introduction of new products by competitors; (ii) the current
and anticipated future dependence on the Company's existing product lines; (iii)
new product development, such as increased research, development and marketing
expenses associated with new product introductions, the Company's ability to
introduce new products and technologies on a timely basis and the amount and
timing of recognition of non-recurring development revenue; (iv) manufacturing
and operations, such as fluctuations in manufacturing yields, inventory
management, raw materials, and production and assembly capacity; (v) expenses
that may be incurred in obtaining, enforcing and defending claims with respect
to intellectual property rights: (vi) sales and marketing, such as loss of
significant distributor, concentration of customers; and volume discounts that
may be granted to significant customers; (vii) customer demand, such as market
acceptance of products, the timing, cancellation or delay of customer orders and
general economic conditions in the semiconductor and electronic systems
industries: as well as other factors, such as risks associated with doing
business abroad, retention of key personnel and management of growth and
volatility in the Company's revenues and stock price.
<PAGE>
The Company's earnings and stock price have been, and may be subject to
significant volatility, particularly on a quarterly basis. Any shortfall in
revenue, gross margins or earnings from expected levels could have an immediate
and significant adverse effect on the trading price of the Company's stock in
any given period. The Company may not learn of, or be able to confirm revenue,
gross margin or earnings shortfalls until late in the quarter, or following the
end of the quarter, because a significant portion of the Company's revenue in a
quarter typically is shipped in the last few weeks of that quarter. In addition,
future announcements concerning the Company or its competitors, including
technological innovations, new product introductions, governmental regulations,
litigation, or changes in earnings estimates by analysts, may cause the market
price of the Company's stock to fluctuate substantially. Stock prices for many
technology companies fluctuate widely for reasons that may be unrelated to
operating results, such as general economic, political and market conditions.
Liquidity and Capital Resources
Since its inception, the Company has financed its operations and investment
in property, plant and equipment primarily through the sale of equity securities
for net proceeds of approximately $27 million, and technology development and
license fees of approximately $13 million. The Company's principal sources of
liquidity as of September 30, 1995 consisted of $7.6 million in cash and cash
equivalents and $9.5 million in short-term investments. In November 1994, the
Company entered into a $3 million secured line of credit which expires December
31, 1995. The Company is currently negotiating an increase and new term for this
credit arrangement. The borrowings under this line are limited to eligible
accounts receivable, as defined in an agreement. Borrowings bear interest at the
bank's prime rate (8.75% at November 30, 1995) plus .75%. The loan agreement
requires the Company to maintain certain financial ratios, minimum working
capital and minimum net worth and requires the bank's consent for payment of
cash dividends. There were no borrowings outstanding under the line as of
September 30, 1995.
The Company generated approximately $3.1 million in fiscal 1995 and used
approximately $600,000 of cash in fiscal 1994. In fiscal 1995 and fiscal 1994,
operations generated $1.8 million and $1.5 million, respectively, of cash
primarily from net income.
The Company increased its overall inventory levels during fiscal 1995 and
1994 in accordance with higher sales levels. Raw materials inventories were
increased in fiscal 1994 as a result of the Company's decision to hold
additional wafers in inventory in an effort to reduce the potential for
inventory shortages. The net increase in work-in-process and finished goods
inventories reflects the Company's effort to build available quantities of
products having higher demand and reduce lead times for product delivery.
Cash used for investing activities was $11.6 million in fiscal 1995 and
$919,000 in fiscal 1994. Cash used in fiscal 1994 was related primarily to
capital expenditures while in fiscal 1995 a net $9.5 million was invested in
short-term investments. In order to diversify the Company's source for wafer
fabrication, the Company also may, from time to time, consider transactions
involving, fabrication suppliers, which may include acquisition of fabrication
capacity or equity investments in or loans to fabrication suppliers, in exchange
for production commitments.
<PAGE>
Financing activities in fiscal 1995 provided $12.9 million primarily from
the net proceeds of $13.3 million after deducting offering expenses, from its
public offering completed in November 1994. During fiscal 1994, $1.2 million was
used in financing activities, primarily as a result of payments on long-term
debt and capital leases.
The Company believes that current available cash, short-term investments,
cash generated from operations, and credit arrangements will be sufficient to
finance the Company's anticipated operations and capital equipment requirements
through at least the next twelve months. However, there can be no assurance that
events in the future will not require the Company to seek additional capital
sooner or, if so required, that adequate capital will be available on terms
acceptable to the Company.
<PAGE>
BALANCE SHEETS
(In thousands, except per share amounts)
1995 1994
Assets
Current Assets:
Cash and cash equivalents $7,637 $4,509
Short-term investments 9,480
Accounts receivable, net of allowances of $123
and $164 at September 30, 1995 and 1994,
respectively 5,851 3,460
Accounts receivable from related parties 295
Other receivables 996 57
Inventories 12,610 8,637
Prepaid expenses 466 811
Deferred tax assets 1,609 1,053
Total current assets 38,649 18,822
Property and equipment, net 3,886 4,030
Deposits and other assets 244 294
Total assets $42,779 $23,146
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $2,892 $1,201
Accounts payable to related parties 2,011 2,694
Accrued compensation 1,167 1,238
Other accrued liabilities 424 499
Income taxes payable 2,070 1,064
Deferred rent 303 366
Deferred income on shipments to distributors 1,898 1,859
Capital lease obligations due within one year 194 293
Long-term obligations to related party due within
one year 311 1,148
Total current liabilities 11,270 10,362
Capital lease obligations 5 182
Long-term obligations to related party 311
Deferred tax liabilities 283 403
Shareholders' Equity
Preferred stock, $.001 par value: Authorized 1,000;
Issued and outstandingnone
Convertible preferred stock, Series A, B and C, $.001 par value:
Authorized8,250;
Issued and outstanding; none and 2,176 2
Common stock, $.001 par value, Authorized 25,500,
Issued and outstanding 5,475 and 1,315 5 2
Additional paid in capital 28,386 14,059
Retained earnings (deficit) 3,478 (1,288)
Deferred compensation (648) (876)
31,221 11,899
Notes receivable from shareholders (11)
Total shareholders' equity 31,221 11,888
Total liabilities and shareholders' equity $42,779 $23,146
See accompanying notes to financial statements.
<PAGE>
STATEMENTS OF INCOME
(In thousands, except per share data)
Years Ended September 30,
1995 1994 1993
Revenues:
Net product revenues (1) $46,189 $36,247 $26,723
Technology development and license
revenues from related parties 719 958
Total revenues 46,189 36,966 27,681
Cost of Revenues:
Cost of product revenues (1) 23,524 18,192 14,357
Cost of technology development and license
revenues 40 82
Total cost of revenues 23,524 18,232 14,439
Gross margin 22,665 18,734 13,242
Operating Expenses:
Research and development 6,326 4,722 2,871
Sales and marketing 6,808 6,096 4,944
General and administrative 3,145 2,727 2,305
Total operating expenses 16,279 13,545 10,120
Operating Income 6,386 5,189 3,122
Interest Income 678 126 85
Interest Expense (158) (318) (462)
Income before provision for taxes 6,906 4,997 2,745
Provision for taxes 2,140 1,754 232
Net income $4,766 $3,243 $2,513
Net income per share $ 0.84 $ 0.79 $ 0.67
Shares used in computing per share amounts 5,649 4,104 3,742
(1) See Note 7 for Related Party Transactions
See accompanying notes to financial statements.
<PAGE>
STATEMENTS OF CASH FLOWS
(In thousands)
Years Ended September 30,
1995 1994 1993
Operating Activities
Net income $4,766 $3,243 $2,513
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 2,305 1,558 1,364
Deferred income taxes (676) (650) -
Technology development and license
revenues from related parties (70)
Deferred compensation amortization 228 109
Changes in operating assets and liabilities:
Accounts and related parties receivable,
net (2,096) (582) (1,025)
Other receivables (939) (12) (15)
Inventories (3,973) (3,212) (1,743)
Prepaid expenses 345 (590) (28)
Accounts payable including related
parties 1,008 942 (320)
Income taxes payable 1,006 920 144
Accrued compensation (71) 372 612
Other accrued liabilities and deferred
rent (138) (366) 492
Deferred income on shipments
to distributors 39 (197) 1,546
Total adjustments (2,962) (1,708) 957
Net cash provided by (used in)
operating activities 1,804 1,535 3,470
INVESTING ACTIVITIES
Capital expenditures (2,161) (1,272) (1,060)
Purchase of short-term investments (109,744)
Sales and maturities of short-term
investments 100,264
Deposits and other assets 50 353 (75)
Net cash used in investing activities (11,591) (919) (1,135)
FINANCING ACTIVITIES
Principal payments on capital lease obligations (276) (276) (250)
Principal payments on long-term debt (1,148) (1,010) (836)
Proceeds from issuance of common stock, net of
notes receivable and issuance costs 14,328 40 12
Proceeds from issuance of preferred stock,
net of issuance costs 731
Proceeds from reduction in notes receivable
from shareholders 11 1 35
Net cash provided by (used in) financing
activities 12,915 (1,245) (308)
Net increase (decrease) in cash and cash
equivalents 3,128 (629) 2,027
Cash and cash equivalents at beginning
of period 4,509 5,138 3,111
Cash and cash equivalents at end of period $7,637 $4,509 $5,138
Supplemental Disclosures of Cash Flow
Information Cash paid during this period
for:
Interest $195 $302 $470
Taxes $1,442 $1,438 $90
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
Common stock repurchased by redemption of
notes receivable from shareholders as payment
of notes receivable from shareholders -- -- $22
Capital equipment acquired under capital
lease financing -- -- $16
Capital equipment purchased through long-term
financing with related party -- -- $365
See accompanying notes to financial statements.
<PAGE>
STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands)
Notes
Convertible Add'l Accum. Recv Total
Pref. Stock Comm. Stock Paid-In Income Def. From Shhlds
Shares Amt. Shares Amt. Capital Deficit Comp Shhlds Equity
--------------------------------------------------------------
Balance at 9/30/92 2,091 $2 1,285 $1 $12,314 $(7,044) -- $(69) $5,204
Sale of preferred
stock for cash 85 -- -- -- 731 -- -- -- 731
Sale of common stock
for cash -- -- 13 -- 12 -- -- -- 12
Repurchase of common
stock -- -- (31) -- (22) -- -- 22 --
Repayment of notes
receivable -- -- -- -- -- -- -- 35 35
Deferred compensation
related to stock
options -- -- -- -- 133 -- (133) -- --
Net Income -- -- -- -- -- 2,513 -- -- 2,513
Balance at 9/30/93 2,176 2 1,267 1 13,168 (4,531)(133) (12) 8,495
Sale of common stock
for cash -- -- 48 1 39 -- -- -- 40
Repayment of notes
receivable -- -- -- -- -- -- -- 1 1
Deferred compensation re-
lated to stock options-- -- -- -- 852 -- (852) -- --
Amortization of deferred
compensation -- -- -- -- -- -- 109 -- 109
Net Income -- -- -- -- -- 3,243 -- -- 3,243
Balance at 9/30/94 2,176 2 1,315 2 14,059 (1,288) (876) (11) 11,888
Conversion of preferred
to common stock (2,176) (2) 2,176 2 -- -- -- -- --
Sale of common stock
for cash -- -- 1,984 1 14,327 -- -- -- 14,328
Repayment of notes
receivable -- -- -- -- -- -- -- 11 11
Amortization of deferred
compensation -- -- -- -- -- -- 228 -- 228
Net Income -- -- -- -- -- 4,766 4,766
Balance at 9/30/95 -- -- 5,475 $5 $28,386 $3,478 $(648) $-- $31,221
<PAGE>
1. Organization and Summary of Significant Accounting Policies
Quality Semiconductor, Inc. (the Company), a California corporation,
is engaged in designing and marketing high performance
CMOS logic and memory integrated circuit products.
Basis of Presentation
The Company's fiscal year ends on the last Sunday in September. Fiscal
years 1995, 1994, and 1993 ended on September 24, 25, and 26, respectively. The
Company's fiscal quarters end on the last Sunday of each calendar quarter. For
convenience, the accompanying financial statements have been shown as ending on
the last day of the calendar month.
Cash Equivalents and Short-Term Investments
In May 1993, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 115, " Accounting for Certain Investments in
Debt and Equity Securities." The Company adopted the provisions of the new
standard on October 1, 1994. There was no cumulative effect as of October 1,1994
of adopting FAS 115 on operations or shareholders' equity.
Management determines the appropriate classifications of debt securities at
the time of purchase and reevaluates such designations as of each balance sheet
date. Marketable equity securities and debt securities are classified as
available-for-sale. Available-for-sale securities are carried at fair value,
with the unrealized gains and losses, net of tax, reported in a separate
component of shareholders' equity. The amortized cost of debt securities in this
category is adjusted for amortization of premiums and accretion of discounts to
maturity. Such amortization is included in investment income. Realized gains and
losses and declines in value judged to be other-than-temporary on
available-for-sale securities are included in interest income. The cost of
securities sold is based on the specific identification method. Interest and
dividends on securities classified as available-for-sale are included in
interest income.
All short-term investments, by contractual maturity, mature in less than
one year. The fair value of available-for-sales short-term investments held at
September 30, 1995 are summarized as follows (in thousands):
Estimated Fair Value
Money Market $ 58
Commercial paper 3,510
State and municipal obligations 10,416
$13,984
Amounts included in cash and cash equivalents $ 4,258
Amounts included in short-term investments 9,480
Amounts included in interest receivable (interest) 246
$13,984
Both gross unrealized gains and losses as of September 30, 1995 and
realized gains and losses on sales of securities for the year ended September
30, 1995 were immaterial. At September 30, 1995, fair market value approximates
amortized cost. Maturities and proceeds from sales of available-for-sale
securities were approximately $81 million and $19 million, respectively, during
the year ended September 30, 1995.
Revenue Recognition and Deferred Revenue
Revenue from product sales to customers other than sales to distributors
are recorded when products are shipped. Sales made to distributors, under
agreements allowing price protection and right of return on merchandise unsold
by the distributors, are deferred until the merchandise is sold by the
distributors.
During 1994 and 1993, the Company had agreements under which it receives
fees for certain rights to technology and products currently under development.
Revenues associated with these technology development and license agreements are
recognized using the percentage-of-completion method.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization
are computed using the straight-line method over the assets' estimated useful
lives of two to seven years. Capitalized leases and leasehold improvements are
amortized using the straight-line method over the shorter of the useful lives of
the assets or the terms of the lease.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents. The Company is
exposed to credit risk in the event of default by the financial institutions to
the extent of amounts recorded on the balance sheet.
Inventories
Inventories are stated at the lower of standard cost which approximates
actual (first-in, first out method) or market (estimated net realizable value).
Concentration of Credit Risk
The Company uses financial instruments that potentially subject it to
concentrations of credit risk. Such instruments include cash equivalents,
short-term investments, accounts receivable, and financial instruments used in
hedging activities. The Company invests its cash in cash deposits, money market
funds, commercial paper or readily marketable debt securities. The Company
places its investments with high-credit-quality financial institutions and
limits the credit exposure to any one financial institution or instrument. To
date, the Company has not experienced losses on these investments. The Company
primarily sells its products to original equipment manufacturers and
distributors. The Company performs ongoing credit evaluations of its customers'
financial positions and generally requires no collateral. The Company maintains
reserves for potential credit losses, and such losses have been within
management's expectations. The Company has an exposure to nonperformance by a
counterparty on the foreign exchange contracts used in hedging activities. This
counterparty is a large international financial institution and to date, it has
not failed to meet its financial obligations to the Company. The Company does
not believe there is a significant risk of non-performance by this counterparty
because the Company periodically monitors its position and the credit ratings of
the counterparty. The Company continuously evaluates the need for hedging
fluctuations in foreign currencies.
<PAGE>
Foreign Exchange Contracts
The Company makes yen-denominated purchases of wafers from Japanese
suppliers. In fiscal year 1995 this resulted in material unfavorable foreign
exchange transactions included in cost of product revenues. The Company entered
into forward exchange contracts beginning in the fourth quarter of fiscal 1995
primarily to hedge against the short-term impact of foreign currency
fluctuations on purchases denominated in yen. The maturities of forward exchange
contracts are short-term in nature. Notwithstanding, these precautions, however,
the Company remains subject to the transaction exposures that arise from foreign
exchange movements between the dates of foreign currency purchase transactions
are recorded and the dates cash payments are made in foreign currencies. At
September 30, 1995, commitments under such contracts to purchase yen maturing
through December 1995 were outstanding in the aggregate amount of approximately
$2,550,000. These contracts are accounted for as hedges of firm wafer purchase
commitments.
Net Income Per Share
Net income per share is computed using the weighted average number of
shares of common stock and common equivalent shares, when dilutive, from
convertible preferred stock (using the as-if-converted method) and from stock
options and warrants (using the treasury stock method). Pursuant to the
Securities and Exchange Commission Staff Accounting Bulletins, common and common
equivalent shares issued by the Company at prices below the initial public
offering price during the twelve month period prior to the November, 1994
initial public offering have been included in the calculation as if they were
outstanding for all periods presented (using the treasury stock method until
shares are issued) have been included in the calculation of common and
equivalent shares outstanding for all periods prior to the initial public
offering.
<PAGE>
2. Balance Sheet Components
September 30,
1995 1994
(In thousands)
Inventories:
Raw materials $4,259 $3,505
Work-in-process 4,027 2,016
Finished goods 4,324 3,116
$12,610 $8,637
Property and Equipment:
Equipment and software $11,139 $9,131
Furniture and fixtures 363 333
Leasehold improvement 195 72
11,697 9,536
Less accumulated depreciation
and amortization 7,811 5,506
$3,886 $4,030
3. Long-Term Obligations to Related Party
The Company has several notes payable to a shareholder. The notes are
secured by certain equipment, payable in monthly installments through December
1995, of approximately $106,000, including interest at rates of 12% to 14% per
annum.
<PAGE>
4. Commitments
The Company leases its operating facility and certain equipment under
noncancelable operating leases expiring through 1999. The Company's operating
facility lease contains scheduled rent increases over the term of the lease.
Rental expense is charged to operations on a straight-line basis over the lease
term. The facility lease is secured by a deposit of $47,500 included in deposits
and other assets.
The Company leases certain equipment under noncancelable lease agreements
that are accounted for as "capital leases". Equipment under capital lease
arrangements and included in property and equipment, aggregated approximately
$885,000 at September 30, 1995 and $1,199,000 at September 30, 1994. Related
accumulated amortization was approximately $723,000 and $894,000 at September
30, 1995 and 1994, respectively.
Future minimum lease payments under noncancelable operating leases and
capital leases are as follows:
September 30, 1995
Capital Leases Operating Leases
(In thousands)
1996 $199 $760
1997 5 776
1998 -- 318
1999 -- 3
2000 -- --
Total minimum payments 204 $1,857
Less amount
representing interest 5
199
Less current portion 194
$ 5
Total rent expense for fiscal 1995, 1994, and 1993 was approximately
$756,000, $580,000, and $477,000 respectively.
In November 1993, the company secured a $1.5 million line of credit with an
equipment leasing company, of which, $1.2 million was available at September 30,
1995. The lease line expires December 31, 1995, and is subject to certain
financial covenants and the Company was in compliance with such covenants at
September 30, 1995.
In November 1994, the company secured a $3 million line of credit with a
major bank, of which $3 million was available at September 30, 1995. The line
bears interest at the bank's prime rate plus 0.75% per annum, is secured by the
assets of the Company, and is subject to certain financial covenants. The
Company was in compliance with such covenants at September 30, 1995.
<PAGE>
5. Shareholders' Equity
Initial Public Offering
The Company sold a total of 1,725,000 shares of common stock at $9.00 per
share through its initial public offering (IPO) in November, 1994. The net
proceeds (after underwriters` discounts and commissions and other costs
associated with the IPO of $1,225,000) totaled $14,300,000. The outstanding
shares of series A through C preferred stock were converted into 2,176,000
shares of common stock. In addition, warrants to purchase 3,333 shares of series
B preferred stock at $6.75 per share were exercised.
Warrants
At September 30, 1995 warrants are outstanding to purchase approximately
13,000 shares of common stock at $9.00 per share. The warrants are currently
exercisable, subject to certain antidilution provisions and expire in October,
1996.
Stock Option Plan
The Company's 1989 Stock Option Plan (the plan) provides for the grant of
incentive stock options and nonstatutory stock options to employees, directors,
and consultants of the Company at prices ranging from 85% to 120% (depending on
the type of grant) of the fair market value of the common stock on the date of
grant as determined by the Board of Directors. The options generally vest at a
rate of 25% one year after the date of the grant and 12.5 % every six months
thereafter. The vesting and exercise provisions of the option grants are
determined by the Board of Directors.
The following is a summary of option activity (in thousands, except per share
amounts):
Options Outstanding
Available Aggregate Price Per
for Grant Shares Exercise Price Share
Balance at 9/30/92 50 274 $281 $0.15-$1.20
Authorized 583
Granted (367) 367 786 $1.20-$2.97
Exercised (13) (12) $0.75-$1.20
Canceled 25 (25) (30) $0.75-$1.20
Balance at 9/30/93 291 603 1,025 $0.15-$2.97
Authorized 200
Granted (333) 333 1,047 $2.70-$8.50
Exercised (48) (40) $0.15-$2.70
Canceled 138 (138) (472) $0.75-$8.50
Balance at 9/ 30/94 296 750 1,560 $0.15-$2.97
Authorized 200
Granted (471) 471 4,804 $2.70-$15.00
Exercised (213) (338) $0.45-$7.20
Canceled 80 (80) (246) $0.75-$7.20
Balance at 9/30/95 105 928 $5,780 $0.75-$15.00
Options to purchase approximately 233,000 and 244,000 shares were exercisable at
September 30, 1995 and 1994, respectively.
<PAGE>
For certain options granted, the Company recognized as compensation the
excess of the deemed value for accounting purposes of the common stock issuable
upon exercise of such options over the aggregate exercise price of such options
based on the fair value of the stock as determined by the Company's Board of
Directors. Additionally, in May 1994, the Board of Directors approved the
repricing of options previously granted during fiscal 1994. Approximately
144,000 stock option grants were repriced at $2.70 per share and the Company
recognized approximately $376,000 of compensation for the excess of the deemed
value of the common stock issuable upon exercise of such options over the
aggregate exercise price of such options. The compensation expense is amortized
ratably over the vesting period of the options. Deferred compensation recorded
for fiscal 1995 and 1994 totaled approximately $0 and $852,000, respectively.
Amortization of deferred compensation commenced October 1, 1993 and the Company
recognizes approximately $228,000 and $109,000 in compensation expense as of
September 30, 1995 and 1994, respectively.
January 1994, the shareholders approved the adoption of the 1993 Employee
Stock purchase Plan (the "1993 Purchase Plan") covering 200,000 shares of common
stock for issuance under the plan and adoption of the 1993 Directors' Stock
Option Plan (the "Directors" Plan) covering 100,000 shares of common stock
issuance under the plan. Under the 1993 Purchase Plan, employees may be granted
the opportunity to purchase common stock at 85% of market value on the first or
last day of the offering period (as defined by the plan), whichever is lower.
The Directors' Plan provides for the issuance of stock options to directors of
the Company. During 1995, the Company sold 43,365 shares of common stock under
the 1993 Purchase Plan and granted 40,000 options under the Directors` Plan and
o options were exercised.
Common stock was reserved for issuance as follows (in thousands of shares):
September 30,
1995 1994
Preferred stock 2,176
1989 Stock Option Plan 1,033 1,046
1993 Purchase Plan and
Directors` Plan 217 300
Warrants 13 20
1,263 3,542
<PAGE>
6. Provision for Taxes
The Company adopted Statement of Financial Accounting Standards No. 109
(SFAS 109), "Accounting for Income Taxes," effective October 1, 1992
The provision for income taxes consists of the following:
September 30,
1995 1994 1993
(In thousands)
Federal:
Current $2,352 $2,058 $ 60
Deferred (522) (650)
1,830 1,408 60
State:
Current 464 306 84
Deferred (154)
310 306 84
Foreign withholding tax 40 88
Total $2,140 $1,754 $232
A reconciliation of the income tax provision at the federal statutory rate
(35% in 1995 and 1994 and 34% in 1993) to the income tax provision at the
effective tax rate is as follows:
September 30,
1995 1994 1993
(In thousands)
Income tax computed at the
federal statutory rate $2,417 $1,749 $933
State taxes (net of federal benefit) 201 202 55
Operating losses (utilized) (912)
Alternative minimum taxes 60
Foreign withholding tax 40 88
Variation of temporary differences (641) (234)
Other individually immaterial items 163 (3) 8
$2,140 $1,754 $232
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax liabilities and assets as of September 30, 1995 and
1994 are as follows:
September 30,
1995 1994
(in thousdands)
Deferred tax assets:
Vacation accrual $ 106 $--
State taxes 130 104
Inventory reserve 704 533
Distributor reserve 441 557
Distributor price protection reserve 193
Capitalized research and develop-
ment costs 81 93
Other individually immaterial items 147 378
Total deferred tax assets 1,609 1,858
Valuation allowance (805)
Net deferred tax assets $1,609 $1,053
Deferred tax liabilities:
Depreciation $(283) $(403)
Total deferred tax liabilities $(283) $(403)
The valuation allowance decreased by $1,960,000 and $727,000 for fiscal 1994 and
fiscal 1993.
7. Related Party Transactions
Under agreements with two preferred shareholders, the Company recognized
technology development and license revenues of approximately $0, $292,000, and
$888,000 in fiscal 1995, 1994, and 1993, respectively. In addition, royalty
payments may be received for future sales of products by the licensees, and the
licensees are required to provide certain products to the Company at a reduced
cost. The Company accounts for the difference between its cost for products and
the current market value of the products as technology development and license
revenues, which totaled approximately $0, $427,000, and $70,000 in fiscal 1995,
1994, and 1993, respectively. In addition, the Company purchased approximately
$10,372,000, $8,284,000, and $6,643,000 of raw products manufactured at the
shareholders' factories in fiscal 1995, 1994 and 1993, respectively.
A shareholder acts as an intermediary in the purchase of products from the
factories discussed above. The Company pays a commission for the service and in
return receives extended payment terms, foreign exchange services, and inventory
handling services. The Company paid commissions of approximately $469,000,
$389,000, and $261,000 in fiscal 1995, 1994, and 1993, respectively. The Company
has a recorded payable to the shareholder of approximately $2,011,000,
$2,694,000, and $1,880,000 at September 30, 1995, 1994 and 1993, respectively,
for commissions and inventory purchases. In another arrangement, the Company
paid fees to a subsidiary of the preferred shareholder for services rendered in
securing license agreements and other consulting totaling approximately $0,
$13,000, and $20,000 in fiscal 1995, 1994, and 1993, respectively. The Company
also had product shipments of approximately $3,377,000, $2,171,000, and $589,000
to another subsidiary of the shareholder during the years ended September 30,
1995, 1994, and 1993, respectively.
The Company purchased photo masks amounting to approximately $257,000,
$301,000, and $299,000 in fiscal 1995, 1994, and 1993, respectively, from a
shareholder.
During fiscal 1995, 1994, and 1993, the Company purchased approximately
$82,000, $94,000, and $89,000, respectively, of computer equipment from a
company owned by affiliates of an executive officer of the Company.
8. Industry and Geographic Information
The Company operates in a single industry segment. The Company markets its
products in the United States and in foreign countries through its sales
personnel, independent sales representatives, and distributors. The Company's
geographic sales as a percent of net product sales are as follows:
Years Ended September 30,
1995 1994 1993
United States 71% 79% 79%
Export:
Far East 21 13 15
Europe 8 8 6
100% 100% 100%
During fiscal 1995, one customer accounted for 16% of total product revenues.
During fiscal 1994, one customer accounted for 21% of total product revenues.
During fiscal 1993, three customers accounted for 15%, 13%, and 10% of total
product revenues.
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Quality Semiconductor, Inc.
We have audited the accompanying balance sheets of Quality Semiconductor,
Inc. as of September 30, 1995 and 1994, and the related statements of income,
shareholders' equity, and cash flows for each of the three years in the period
ended September 30, 1995. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Quality Semiconductor, Inc.
at September 30, 1995 and 1994, and the results of its operations and its cash
flows for each of the three years in the period ended September 30, 1995, in
conformity with generally accepted accounting principles.
San Jose, California
October 17, 1995
SELECTED FINANCIAL DATA
(In thousands, except per share data)
Years Ended September 30,
1995 1994 1993 1992 1991
Revenues:
Net product revenues $46,189 $36,247 $26,723 $14,200 $10,016
Technology revenues -- 719 958 3,620 4,627
Total revenues 46,189 36,966 27,681 17,820 14,643
Operating income (loss) 6,386 5,189 3,122 (4,953) (479)
Interest, net 520 (192) (377) (290) 25
Income (loss) before provision
for taxes 6,906 4,997 2,745 (5,243) (454)
Net income (loss) 4,766 3,243 2,513 (5,404) (640)
Net income (loss) per share 0.84 0.79 0.67 (3.61) (0.43)
Weighted average shares
outstanding 5,649 4,104 3,742 1,498 1,473
Working capital 27,379 8,460 5,857 3,277 6,349
Total assets 42,779 23,146 19,371 13,905 15,767
Long-term obligations
(less current portion) 5 493 1,919 2,884 2,551
Shareholders' equity 31,221 11,888 8,495 5,204 7,817
Dividends $ -- $ --$ -- $ --$ --
SELECTED FINANCIAL DATA
(In thousands, except per share data)
Year Ended September 30, 1995
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
Net revenues $10,813 $11,726 $12,492 $11,158
Gross margin 5,309 5,770 6,097 5,489
Net income 1,014 1,342 1,412 998
Net income per share $0.21 $0.23 $0.24 $0.17
Year Ended September 30, 1994
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
Net revenues $8,761 $9,094 $9,255 $9,856
Gross margin 4,553 4,712 4,590 4,879
Net income 883 880 748 732
Net income per share $0.22 $0.22 $0.18 $0.18
<PAGE>
CORPORATE DIRECTORY
Board of Directors Executive Officers Transfer Agent and
Chun P. Chiu Chun P. Chiu Registrar
Chief Executive Officer Chief Executive Officer The First National Bank of
Boston
Manohar L Malwah Manohar L. Malwah PO Box 644 M/S 45-02-09
Chief Technical Officer Chief Technical Officer Boston, MA 02102-0644
Andrew J. S. Kang R. Paul Gupta 150 Royall St.,
M/S 45-02-09
President, President and Canton, MA 02021
Technology Associates Chief Operating Officer
Corporation Shareholders may call
(a venture capital firm) Stephen H. Vonderach 617-575-3120
Vice President of with any questions
Robert L. Puette Finance and regarding transfer of
President and Chief Financial Officer ownership of Quality
Chief Executive Officer, Semiconductor stock.
NetFRAME Systems Inc. George Anderl
(a computer company) Vice President of Sales Legal Counsel
Venture Law Group
Masaharu Shinya Corporate Headquarters Menlo Park, California
President, 851 Martin Ave
Kanematsu Semiconductor Santa Clara, CA Independent Auditors
Corporation 95050-2903 Ernst & Young LLP
(an electronics company) 408-450-8000 San Jose, California
Form 10-K A copy of the Company's Form 10-K, as
filed with the Securities and Exchange Commission,
is available on request to V.P. Finance, Quality
Semiconductor, Inc., 851 Martin Ave., Santa Clara,
CA 95050.
