UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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X QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
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OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
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OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from ________ to ___________
Commission File Number 2-23128
Quality Semiconductor, Inc.
(Exact name of registrant as specified in it charter)
California 77-0199189
(State of Incorporation) (IRS Employer
Identification Number)
851 Martin Avenue
Santa Clara, California 95050
(Address of principal executive office)
Registrant's telephone number, including area code: (408) 450-8000
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 outstanding shares of the Registrant's Common Stock as of
June 30, 1998 was 7,419,322.
<PAGE>
Quality Semiconductor, Inc.
Form 10-Q for the Quarter Ended June 30, 1998
INDEX
PART I. FINANCIAL INFORMATION Page
Item 1 Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 1998
and September 30, 1997 3
Condensed Consolidated Statements of Operations for the
three months and nine months ended June 30, 1998 and
June 30, 1997 4
Condensed Consolidated Statements of Cash Flows for the
nine months ended June 30, 1998 and June 30, 1997 5
Notes to Condensed Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operation 8
PART II OTHER INFORMATION
Item 6 Exhibits and Reports on Form 8-K 15
Signatures 16
<PAGE>
PART I. FINANCIAL INFORMATION
Quality Semiconductor, Inc.
Condensed Consolidated Balance Sheets
(In thousands, except par values)
June 30, September 30,
1998 1997 (1)
--------- -------------
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents ................................. $ 5,940 $ 9,403
Short-term investments .................................... -- 3,656
Accounts and other receivables, net ....................... 6,128 8,748
Inventories ............................................... 12,527 17,689
Other current assets ...................................... 5,998 5,327
-------- --------
Total current assets ............................... 30,593 44,823
Property and equipment, net ............................... 22,384 22,859
Goodwill and other assets ................................. 1,419 2,150
-------- --------
Total assets ....................................... $ 54,396 $ 69,832
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities:
Accounts payable ...................................... $ 4,934 $ 5,711
Accrued liabilities ................................... 3,626 2,676
Deferred income on shipments to distributors .......... 2,302 2,995
Redeemable preference shares of subsidiary ............ -- 3,982
Line of credit ........................................ 229 --
Current portion of long-term leases ................... 431 --
Notes payable to related party due within one year ........ 2,434 1,684
-------- --------
Total current liabilities .......................... 13,956 17,048
Long-term lease obligation ................................ 1,058 --
Notes payable to related party ............................ 4,808 7,202
Deferred tax liabilities .................................. 1,613 1,945
Shareholders' equity:
Preferred stock, $.001 par value: Authorized
1,000; Issued and outstanding - none ............ -- --
Common stock, $.001 par value, Authorized -
30,000, Issued and outstanding 7,419
and 7,393 ............................................ 7 7
Additional paid-in-capital ........................... 41,648 41,600
Retained earnings (accumulated deficit) .............. (8,674) 2,221
Deferred compensation ................................ (20) (191)
-------- --------
Total shareholders' equity ...................... 32,961 43,637
-------- --------
Total liabilities and shareholders' equity .....$ 54,396 $ 69,832
======== ========
See accompanying notes to condensed consolidated financial statements.
(1) The information in this column was derived from the Company's audited
financial statements.
<PAGE>
Quality Semiconductor, Inc.
Condensed Consolidated Statements of Operations
(Unaudited)
(In thousands, except per share data)
<TABLE>
Three months ended Nine months ended
June 30, June 30,
-------------------- --------------------
1998 1997 1998 1997
-------- -------- -------- --------
<CAPTION>
<S> <C> <C> <C> <C>
Net revenues ........................................... $ 14,015 $ 16,542 $ 48,645 $ 42,189
Cost of revenues ....................................... 9,606 9,487 34,202 24,414
Inventory write-downs .................................. 3,500 -- 3,500 --
-------- -------- -------- --------
Gross margin ........................................... 909 7,055 10,943 17,775
Operating expenses:
Research and development ............................. 2,517 2,325 7,953 6,539
Sales and marketing .................................. 2,375 2,119 7,161 5,803
General and administrative ........................... 1,278 1,145 3,985 3,027
-------- -------- -------- --------
Total operating expenses .................... 6,170 5,589 19,099 15,369
-------- -------- -------- --------
Operating income (loss) ................................ (5,261) 1,466 (8,156) 2,406
Interest income (expense), net ......................... (146) (101) (517) (268)
-------- -------- -------- --------
Income (loss) before provision for income taxes ........ (5,407) 1,365 (8,673) 2,138
Provision for income taxes ............................. -- 478 -- 748
-------- -------- -------- --------
Net income (loss) ...................................... ($ 5,407) $ 887 ($ 8,673) $ 1,390
======== ======== ======== ========
Net income (loss) per share - Basic .................... ($ 0.73) $ 0.14 ($ 1.17) $ 0.23
======== ======== ======== ========
Net income (loss) per share - Diluted .................. ($ 0.73) $ 0.13 ($ 1.17) $ 0.21
======== ======== ======== ========
Shares used in computing net income (loss)
per share - Basic .................................... 7,419 6,461 7,403 6,041
======== ======== ======== ========
Shares used in computing net income (loss)
per share - Diluted .................................. 7,419 7,096 7,403 6,632
======== ======== ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE>
Quality Semiconductor, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
Nine months ended
June 30,
---------------------
1998 1997
---------- ---------
Operating activities
Net income (loss) .................................. $ (8,673) $ 1,390
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization .................. 4,874 4,074
Accretion on preference shares ................. 48 239
Deferred income taxes .......................... (332) (39)
Deferred compensation amortization ............. 171 172
Changes in operating assets and liabilities .... 7,656 (7,327)
-------- --------
Net cash provided by (used in) operating activities 3,744 (1,491)
Investing activities
Capital expenditures ............................... (3,593) (2,830)
Sales of short-term investments, net ............... 3,656 (1,864)
Goodwill and other assets .......................... 437 48
Repurchase of common stock ......................... (156) (229)
-------- --------
Net cash provided by (used in) investing activities 344 (4,875)
-------- --------
Financing activities
Principal payments on long-term debt ............... (1,555) (822)
Proceeds from line of credit ....................... 229 --
Payment of preference shares ........................ (6,431) --
Proceeds from issuance of stock, net of offering
costs .......................................... 206 9,581
Proceeds from issuance of stock, net of issuance
costs .......................................... -- --
-------- --------
Net cash provided by (used in) financing activities (7,707) 11,609
-------- --------
(7,551)
Net increase (decrease) in cash and cash equivalents (3,463) 5,243
Cash and cash equivalents at beginning of period ... 9,403 4,930
-------- --------
Cash and cash equivalents at end of period ......... $ 5,940 $ 10,173
======== ========
Supplemental disclosures of significant non-cash investing and financing
activities:
Conversion of promissory notes into common stock .... -- $ 3,000
Acquisition of property and equipment for
issuance of long term debt ....................... -- $ 2,984
Purchase of equipment under capital lease obligations $ 1,400 --
See accompanying notes to condensed consolidated financial statements.
<PAGE>
QUALITY SEMICONDUCTOR, INC.
QUALITY SEMICONDUCTOR, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
The accompanying financial statements have been prepared by the Company
without audit and reflect all adjustments (consisting of normal recurring
accruals) which are, in the opinion of management, necessary to present fairly
the financial information included therein. The consolidated financial
statements include the accounts of the Company and its wholly owned subsidiary,
Quality Semiconductor Australia, Pty., Ltd. (QSA). Intercompany accounts and
transactions have been eliminated in consolidation. The Company has recorded a
currency translation adjustment included in retained earnings. This adjustment
has been allocated in the Statement of Cash Flows to the items to which it
relates. This financial data should be read in conjunction with the Company's
September 30, 1997 annual financial statements.
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.
The results of operations for the nine months ended June 30, 1998 may not
necessarily be indicative of the results for the fiscal year ending September
30, 1998.
Note 2. Inventories
Inventories consisted of (in thousands):
June 30, September 30,
1998 1997
---------------- ----------------
Raw Materials $4,505 $5,421
Work-in-process 2,163 3,770
Finished goods 5,859 8,498
---------------- ----------------
$12,527 $17,689
================ ================
The Company produces inventory based on orders received and forecasted
demand. The Company must order wafers and build inventory well in advance of
product shipments. Because the Company's markets are volatile and subject to
rapid technology and price changes, there is a risk that the Company will
forecast incorrectly and produce excess or insufficient inventories on
particular products. This inventory risk is heightened because many of the
Company's customers place orders with short lead times. Demand will differ from
forecasts and such difference may have a material effect on actual results of
operations.
Given the volatility of the market for the Company's products, the Company
makes inventory provisions for potentially excess and obsolete inventory based
on backlog and forecast demand. However, such backlog demand is subject to
revisions, cancellations, and rescheduling. Actual demand will inevitability
differ from such backlog and forecast demand, and such differences may be
material to the financial statements. Excess inventory increases the risk of
obsolescence, is a non-productive use of capital resources, increases inventory
handling costs, and delays realization of the price and performance benefits
associated with more advanced manufacturing processes.
At June 30, 1998, inventory of one of the Company's products was at a high
level relative to its revenue for the three months ended June 30, 1998 and the
Company wrote this inventory down by $ 3.5 million. However, management has
developed a program to further reduce the inventory to desired levels over the
near term, and believes no additional loss will be incurred on its disposition.
At this time, management cannot estimate a range of amounts of loss that could
occur if the program is not successful.
Note 3. Net Income (Loss) Per Share
The following table sets forth the computation of basic and diluted net
income (loss) per share.
<TABLE>
Three months ended Nine months ended
June 30, June 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Numerator - Net Income (loss) ............. ($5,407) $ 887 ($8,673) $1,390
Denominator for Basic net income (loss) per
share - Weighted average shares ......... 7,419 6,461 7,403 6,041
Effect of dilutive securities - ........... -- -- -- --
employee stock options and warrants ..... -- 635 -- 591
Denominator for diluted net income (loss)
per share ............................... 7,419 7,096 7,403 6,632
======= ======= ====== ======
Basic net income (loss) per share ......... ($ 0.73) $ 0.14 ($1.17) $ 0.23
======= ======= ====== ======
Diluted earnings (loss) per share ......... ($ 0.73) $ 0.13 ($1.17) $ 0.21
======= ======= ====== ======
</TABLE>
Note 4. Income Taxes
The Company has not recognized a tax benefit for its operating losses
incurred during the nine months ended June 30, 1998. Recognition of the tax
benefit of the losses is dependent upon the Company generating sufficient
earnings.
Note 5. Impact of Recently Issued Accounting Standards
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting and display of comprehensive
income and its components (revenues, expenses, gains, and losses) in a full set
of general-purpose financial statements. The Company will adopt SFAS No. 130 in
its fiscal year 1999.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of
an Enterprise and Related Information," which changes the way public companies
report information about operating segments. SFAS No. 131, which is based on the
management approach to segment reporting, establishes requirements to report
selected segment information quarterly and to report entity-wide disclosures
about products and services, major customers, and the material countries in
which the entity holds assets and reports revenue. Management has not yet
evaluated the effects of this change on its reporting of segment information.
The Company will adopt SFAS No. 131 in its fiscal year 1999
<PAGE>
QUALITY SEMICONDUCTOR, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following information should be read in conjunction with the unaudited
interim financial statements and the notes thereto included in Item 1 of this
Quarterly Report on Form 10-Q, the Management's Discussion and Analysis of
Finacial Conditions and Results of Operations contained in the Company's 10-K
filed with the Securities and Exchange Commission on December 19, 1997 and
subsequent filings with the Securities and Exchange Commission.
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Actual results could differ from
those projected in the forward-looking statements as a result of the factors set
forth in "Factors That May Affect Future Results" and elsewhere in this report,
as well as factors set forth in the Company's Annual Report on Form 10-K on file
with the Securities and Exchange Commission.
Results of Operations
Net revenues for the quarter ended June 30, 1998 decreased 15% from the
corresponding period in the prior fiscal year. Net revenues for the nine months
ended June 30, 1998 increased 15% from the same period in fiscal 1997. The
decrease in net revenues for the three months ended June 30, 1998 as compared to
the same quarter a year ago was mainly the result of a decline in networking
product revenue and lower revenues in the Far East. The increase for the nine
months ended June 30, 1998 over the nine month period last year was due to an
increase in sales of proprietary networking, QuickSwitch and clock management
products, partially offset by lower average selling prices. As is typical in the
semiconductor industry, the average selling prices of the Company's products
generally decline over the lives of such products. To maintain or increase
revenues, therefore, the Company must introduce and sell new products at higher
prices and increase unit sales of existing products, primarily through reducing
prices in conjunction with cost reduction programs. There can be no assurance,
however, that the Company will be successful in these efforts, that the demand
for semiconductor products will continue at present levels or that the Company
will be able to sustain its current market share or historic rate of revenue
growth.
Gross margin before the charge for inventory write-down was 31% of net
revenues in the third quarter of fiscal 1998 as compared to 43% in the third
quarter of fiscal 1997. The lower margins were principally due to changes in
product mix and lower average selling prices which were offset in part by the
sale of higher margin clock management products. In the third quarter of fiscal
year 1998 the Company wrote down inventory relating to networking products by
$3.5 million. This write-down was primarily the result of intense competition
and a shifting of the market from single PHY to quad PHY, which the Company does
not currently offer. This shift began in 1997 when the Company was shipping its
single PHY product at record levels and had to make commitments for wafers to
its fab. These factors combined to create the excess inventory. Higher than
expected testing costs and related lower than expected yields for the Company's
networking products also contributed to the lower margins. The gross margin for
the nine months ended June 30, 1998, before the charge for inventory write-down,
was 30% compared to 42% for the nine months ended June 30, 1997. This decrease
also reflected the same factors affecting the decrease in margins for the third
quarter of fiscal 1998 from the third quarter of fiscal 1997. The Company's
gross margin can be affected by a number of factors including changes in product
or distribution channel mix, cost and availability of parts, and competitive
pressures on pricing. The Company continues to experience increasing pricing
pressure from its competitors. The Company's margins can also 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.
Research and development expenses increased 8% for the three months June
30, 1998 over the same period ending June 30, 1997. This increase was due
primarily to the increase in product and process development. Research and
development expenses increased 22% for the nine months ended June 30, 1998 over
the same period ending June 30, 1997. This increase also reflected the increase
in product and process development. The Company's research and development
expenses may vary as a percentage of net revenues in future periods. The Company
believes that the continued development of its process technology and new
products and its continued investment in research and development are needed to
maintain a competitive technological position in the industry.
Sales and marketing expenses increased 12% for the third quarter of fiscal
1998 over the same period of fiscal 1997. This increase was mainly due to
increased payroll expenses and marketing communications expense. Sales and
marketing expenses increased 23% for the nine months ended June 30, 1998 as
compared to the nine months ended June 30, 1997. The increase in selling
expenses for the nine month period was mainly due to increased sales commissions
as a result of higher revenues and increased marketing communications expense.
The Company believes that expenses for sales and marketing activities,
particularly in export markets, are essential to maintaining its competitive
position. The Company expects that selling and marketing expenses may vary as a
percentage of net revenues in future periods.
General and administrative expenses increased 12% for the third quarter of
fiscal 1998 over the third quarter of fiscal 1997 and 32% for the nine month
period ended June 30, 1998 over the same period of a year ago. The increase for
the three month period was due mainly to higher payroll related expenses while
the increase for the nine month period relected increased legal expenses as well
as higher payroll related expenses.
Interest expense, net of interest income, was $146,000 during the three
months ended June 30, 1998 compared to $101,000 during the second quarter of
fiscal 1997. Net interest expense was $517,000 for the nine month period ending
June 30, 1998 compared to $268,000 for the same period of fiscal 1997. These
increases were mainly due to increased debt to Kanematsu Semiconductor Corp. for
the purchase of wafer fabrication equipment for Quality Semiconductor Australia,
Pty. Ltd. ("QSA") and, interest on the redeemable preference shares issued as
part of the consideration for the purchase of QSA.
The Company has not recognized a tax benefit for its operating losses
incurred during the nine months ended June 30, 1998. Recognition of the tax
benefit of the losses is dependent upon the Company generating sufficient
earnings.
Liquidity and Capital Resources
During the nine months ended June 30, 1998 the Company used $7.6 million in
cash for financing activities due mainly to the final payment of preference
shares in connection with the purchase of the wafer fabrication facility in
Australia. This compares to $11.6 million generated in financing activities
during the first nine months of fiscal 1997, which was mainly generated from the
receipt of $9.2 million from the completion of a private placement in May 1997
and the receipt of $2.9 million from issuance of notes payable which were
subsequently converted to common stock. The $229,000 outstanding loan is related
to the Company's Australian subsidiary. Cash provided by investing activities
during the first nine months of fiscal 1998 totaled $344,000 compared to cash
used of $4.9 million in the first nine months of fiscal 1997. The latter
reflected mainly the purchase of property and equipment for $2.8 million and
$1.9 million for short-term investments. The increase in cash provided by
operating activities was mainly due to the change in operating assets and
liabilities which provided $7.7 million in cash for the nine months of fiscal
1998 compared to the use of $7.3 million of cash from the change in operating
activities for the nine months of fiscal 1997.
The Company's principal sources of funds for operations and capital
expenditures include cash balances and cash flow from operations. The Company's
line of credit expired in May 1998, however, it expects to negotiate a new line
of credit. The Company generated cash from operations of approximately $3.7
million during the nine month period ended June 30, 1998. This compares to $1.5
million of cash used during the nine months ended June 30, 1997. If the Company
invests in the buildup of new product inventory or is unable to negotiate a new
line of credit or generate sufficient cash from operations through fiscal 1998,
the Company may need to seek additional capital from external sources. There can
be no assurance, however, that the Company will be able to secure such
additional capital or that the terms of such additional financing will be
favorable to the Company. In such events the Company may be required to reduce
its capital expenditure plans or operations and its financial condition and
results of operations could be materially adversely affected.
FACTORS THAT MAY AFFECT RESULTS
Factors Affecting Annual and Quarterly Operating 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) the
Company's operation of a wafer fabrication facility which involves significant
risks typically inherent in any manufacturing endeavor, as well as additional
risks associated with production yields, technical difficulties with process
control, expenses associated with responding to increases in environmental
pollution regulation or disposal of environmentally hazardous waste and events
limiting production, such as fires or other damage, and the inability to keep
production at a high level; (vi) expenses that may be incurred in obtaining,
enforcing and defending claims with respect to intellectual property rights;
(vii) sales and marketing, such as loss of significant distributor,
concentration of customers, and volume discounts that may be granted to
significant customers; (viii) 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.
In addition, the semiconductor industry is intensely competitive and is
characterized by price erosion, declining gross margins, rapid technological
change, product obsolescence and heightened international competition in many
markets. The Company's competitors include large semiconductor companies that
have substantially greater financial, technical, marketing, distribution and
other resources, broader product lines and longer standing relationships with
customers than the Company, as well as emerging companies attempting to sell
products to specialized markets such as those addressed by the Company. As a
result, average selling prices "ASPs" in the semiconductor industry generally,
and for the Company's products in particular, have decreased significantly over
the life of each product. The Company expects that ASPs for its existing
products will continue to decline over time and that ASPs for each new product
will decline significantly over the life of the product. Declines in ASPs in the
Company's products, if not offset by reductions in the cost of producing those
products or by sales of new products with higher gross margins, would decrease
the Company's overall gross margins, could cause a negative adjustment to the
valuation of the Company's inventories and could materially and adversely affect
the Company's operating results.
At June 30, 1998, inventory of one of the Company's products was at a high
level relative to its revenue for the three months ended June 30, 1998 and the
Company wrote this inventory down by $3.5 million. However, management is
following a program to further reduce the inventory to desired levels over the
near term, and believes no additional loss will be incurred on its disposition.
At this time, management cannot estimate a range of amounts of loss that could
occur if the program is not successful.
<PAGE>
Dependence on QSFCT, QuickSwitch and Networking Product Lines
A significant amount of the Company's revenues are derived from sales of
interface logic devices and, in particular, products in the Company's QSFCT and
QuickSwitch logic family. The Company anticipates that sales of these products
will continue to comprise the bulk of the Company's revenues for the foreseeable
future. The demand for such products may be sharply reduced by competition and
by microprocessors or other system devices that increasingly include interface
logic. Because of the Company's dependence on sales of these products, declines
in gross margins for these products resulting from declines in ASPs or otherwise
could have a material adverse effect on the Company's operating results.
During fiscal 1997, the Company commenced shipping its advanced CMOS Fast
Ethenet transceiver chips that provide high integration solutions for the
adapter, repeater, switch and card bus markets, and ATM mux/demux for the ATM
multiplexer and switch markets. The Company has generated a significant amount
of its revenue from these products since their introduction, however, these
products have met with intense competition. Additionally, demand for such
products has not met the Company's expectations and average selling prices and
demand for such products have declined as competition and availability have
increased and more advanced products are introduced.
The Company commenced shipping these units to its customers with their
approval prior to the completion of qualification during fiscal 1997. Management
has made estimates on future returns of these products and provided necessary
reserves. However, these estimates could change and the actual return rate could
be higher. The Company completed the qualification process during the quarter
ended March 31, 1998 and the Company believes the performance of these products
meet specifications, however there is no assurance that customers will not
cancel existing orders. In addition, functionality and demand for such products
may not meet the Company's or customers expectations, and the demand and pricing
for such products will decline as competition and availability increase and more
advanced products are introduced.
Dependence on New Products
The Company's future success is highly dependent upon the timely completion
and introduction of new products at competitive price/performance levels. Among
other things, the introduction of new products requires significant investments
by the Company to cover the cost of prototype testing, mask making and initial
inventory building, which can impact the Company's liquidity and capital
resources and require the Company to seek additional external financing. The
failure of the Company to obtain such financing or to timely complete and
introduce new products at competitive price/performance levels could materially
and adversely affect the Company's operating results. 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.
Risk Associated with Operating Australian Fabrication Facility
In February 1996, the Company purchased a fully functional wafer
fabrication facility and product design center located in Australia. The Company
receives a significant amount of its wafer requirements for its logic and memory
products from this facility. Any disruption of the Company's wafer fab facility
or the Company's inability to keep the production of wafers at a high level due
to technical factors or lack of customer demand could have a materially adverse
impact on the Company's operations.
The process technology for the fabrication of the Company's wafers at this
facility is highly complex and sensitive to dust and other contaminants.
Although the fabrication process is highly controlled, the equipment may not
perform flawlessly. Minute impurities, difficulties in the production process or
defects in the masks can cause a substantial percentage of the wafers to be
rejected or individual die on each wafer to be nonfunctional. Accordingly, any
failure by the Company to achieve acceptable product yields, could have a
material and adverse effect on the Company's operating results.
Raw materials essential to the Company's wafer fabrication business are
generally available from multiple sources and the Company has thus far not
experienced production problems or delays due to shortages in materials or
components. There can be no assurance, however, that future shortages will not
occur, any such shortages could have a material adverse effect on the Company's
business, financial condition or results of operations.
Government regulations impose various environmental controls on the
storage, use and disposal of chemicals and gases used in semiconductor
processing. Although the Company strives to conform the activities of its
manufacturing facilities to applicable environmental regulations, there can be
no assurance that the Company will not incur unanticipated future costs based on
inadvertent violations of such regulations or on the implementation of more
stringent regulations in the future.
Dependence on Fabrication, Assembly and Test Subcontractors
The Company has completed the transfer of all wafers with the exception of
those fabricated by Taiwan Semiconductor Manufacturing Company Ltd. ("TSMC") to
its wafer fabricaton facility in Australia. The Company's reliance on TSMC to
fabricate its wafers at its production facilities in Taiwan involves significant
risks, including reduced control over delivery schedules, potential lack of
adequate capacity, technical difficulties and events limiting production, such
as fires or other damage to production facilities. The Company has from time to
time experienced significant delays in receiving fabricated wafers from its
suppliers, and there can be no assurance that the Company will not experience
similar or more severe delays from its suppliers in the future. Any inability or
unwillingness of the Company's fabrication providers to provide adequate
quantities of finished wafers to meet the Company's needs could delay shipments
and have a material adverse effect on the Company's operating results. The
Company's reliance on third-party wafer fabrication suppliers also increases the
length of the development cycle for the Company's products, which may provide
time to market advantages to competitors that have in-house fabrication
capacity. The Company also depends upon its fabrication suppliers to participate
in process improvement efforts, such as the transition to finer geometries, and
any inability or unwillingness of such suppliers to do so could adversely affect
the Company's development and introduction of new products. Competitors having
their own wafer fabrication facilities, or access to suppliers having such
facilities, using superior process technologies at the same geometries or
manufacturing products at smaller geometries, could manufacture and sell
competitive, higher performance products at a lower price. The introduction of
such products by competitors could materially and adversely affect the Company's
operating results.
The Company relies on overseas subcontractors for the assembly and
testing of its finished products. Any significant disruption in adequate
supplies from, or degradation in the quality of components or services supplied
by, these subcontractors, or any other circumstance that would require the
Company to qualify alternative sources of supply, could delay shipment and
result in the loss of customers, limitations or reductions in the Company's
revenues, and other adverse effects on the Company's operating results.
Risks of International Purchases and Sales
The Company purchases a significant amount of its semiconductor wafers and
substantially all of its assembly services from foreign suppliers. In addition,
sales outside of North America historically have been substantial. As a result,
the Company's business is subject to the risks generally associated with doing
business abroad, such as foreign governmental regulations, reduced protection
for intellectual property rights, political unrest, disruptions or delays and
shipments and changes in economic conditions in countries in which the Company's
manufacturing and test assembly sources are located and the Company's products
are sold. For example, due to the recent uncertainties in the Asian capital
markets and slowed growth in certain Asian economies, the Company's revenues in
Asia declined from 33% of the Company's total revenues in the third quarter of
fiscal year 1997 to 16% of total revenues in the third quarter of fiscal year
1998. These international factor scould have a material adverse effect on future
sources and buyers of the Company's products and, consequently the Company's
business, operating results and financial conditions.
Patents and Proprietary Rights
The semiconductor industry is characterized by substantial litigation
regarding patent and other intellectual property rights. There can be no
assurance that third parties will not assert claims against the Company that
result in litigation. Any such litigation could result in significant expense
and divert the Company's attention from other matters. If any of the Company's
products were found to infringe any third party patent, and such patent were
determined to be valid, the third party would be entitled to injunctive relief,
which would prevent the Company from selling any such infringing products. In
addition, the Company could suffer significant monetary damages, which could
include treble damages for any infringement that is determined to be willful.
Dependence on Key Personnel
The Company's future success will depend to a large extent on the
continued contributions of key employees, who would be difficult to replace, and
its ability to attract and retain qualified marketing, technical and management
personnel, particularly highly skilled design, process and test engineers, for
whom competition is intense. The loss of or failure to attract and retain any
such persons could have a material adverse effect on the Company's business. To
manage recent and potential future growth effectively, the Company will need to
continue to implement and improve its operational, financial and management
information systems and to hire, train, motivate and manage its employees. There
can be no assurance that the Company will be able effectively to achieve growth
or manage any such growth, and failure to do so could have a material adverse
effect on the Company's operating results.
Customer Concentration
A relatively small number of customers have accounted for a significant
portion of the Company's revenue in the past. Loss of one or more of the
Company's current customers could materially and adversely affect the Company's
business, operating results and financial condition. In addition, the Company
has experienced and may continue to experience lower margins on sales to
significant customers as a result of volume pricing arrangements.
Dependence on Manufacturer Representatives and Distributors
The Company markets and distributes its products primarily through
manufacturers' representatives and independent distributors. The Company's
distributors typically offer competing products. The distribution channels have
been characterized by rapid change, including consolidations and financial
difficulties. The loss of one or more manufacturers' representatives or
distributors, or the decision by one or more distributors to reduce the number
of the Company's products offered by such distributors or to carry the product
lines of the Company's competitors, could have a material adverse effect on the
Company's operating results.
Year 2000 Compliance
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. These date code fields
will need to accept four digits entries to distinguish 21st Century dates from
20th century dates. Therefore, any of such computer systems and software
products that recognize a date code field of "00" as the year 1900 rather than
the year 2000 could result in errors or system failures. As a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to make such systems, equipment and software Year 2000 compliant. The
Company has not completed its assessment of its internal computer systems,
equipment or software to determine the extent to which such systems are not Year
2000 compliant, but the Company has determined to date that certain of the
Company's internal computer systems may not be Year 2000 compliant, and that the
Company uses third-party equipment and software that may not be Year 2000
compliant. Failure of the Company's internal computer systems or of such
third-party equipment or software of systems maintained by the Company's
suppliers, to operate properly without regard to the Year 2000 and thereafter
could require the Company to incur unanticipated expenses to remedy any
problems, which could have a material adverese effect on the Company's business,
operating results and financial condition. Futhermore, the purchasing patterns
of of customers or potential customers may be affected by Year 2000 issues as
companies expend significant resources to correct their current systems for Year
2000 compliance. These expenditures may result in reduced funds available to
purchase the Company's products, which could have a material adverse effect on
the Company's business, operating results and financial condition.
Semiconductor Economic Conditions
The semiconductor industry has historically been cyclical and subject to
significant economic downturns at various times and has been characterized by
diminished product demand, accelerated erosion of ASPs and over capacity. In
addition, the end-markets for systems that incorporate the Company's products
are characterized by rapidly changing technology and evolving industry
standards. The Company may experience substantial period-to-period fluctuations
in future operating results due to general semiconductor industry conditions,
overall economic conditions or other factors.
Volatility of the Company's Stock Price
The Company's earnings and stock price have been and may continue to 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. The Company's stock price is also subject to
potentially large volatility due to the very low trading volumes of the
Company's stock on most days since the initial public offering of the Company's
stock on November 17, 1994. In addition, this low trading volume may continue
and could affect the ability of shareholders to sell their shares.
<PAGE>
PART II OTHER INFORMATION
Item 1. Legal Proceedings - Not Applicable
Item 2. Changes in Securities and Use of Proceeds - Not Applicable
Item 3. Defaults Upon Senior Securities - Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders - Not Applicable
Item 5. Other Information
The Securities and Exchange Commission has recently amended Rule
14a-4(c)(1) promulgated under the Securities and Exchange Act of 1934, as
amended. As amended, Rule 14a-4(c)(1) provides that if a proponent fails to
notify the Company of a proposal at least 45 days prior to the month and day of
mailing of the prior year's proxy statement, then management would be allowed to
use its discretionary voting authority when the proposal is raised at the Annual
Meeting, without any discussion of the matter in the proxy statement. The proxy
statement for the Company's 1998 Annual Meeting of Shareholders was mailed to
shareholders on January 23, 1998. Accordingly, if a proponent does not notify
the Compnany on or before December 9, 1998 of a proposal for the 1999 Annual
Meeting of Shareholders, management may use its discretionary voting authority
to vote on such proposal, even if the matter is not discussed in the proxy
statement for the 1999 Annual Meeting of Shareholders.
Item 6. Exhibits and Reports
on Form 8-K
(a) Exhibits
Exhibit 27.1 - Financial Data Schedule, Nine Months Ended
June 30, 1998
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during
the quarter.
<PAGE>
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.
Quality Semiconductor, Inc.
(Registrant)
Date: August 12, 1998 By: / s / R. Paul Gupta
R. Paul Gupta
Chief Executive Officer
Date: August 12, 1998 By: / s / Stephen H. Vonderach
Stephen H. Vonderach
Chief Financial Officer
Chief Accounting Officer
<PAGE>
Exhibit 27.1
QUALITY SEMICONDUCTOR, INC.
Financial Data Schedule
(In thousands, except per share data)
(Unaudited)
Fiscal Year End September 30, 1998
Period Beginning October 1, 1997
Period Ending June 30, 1998
Cash and cash items .................................... $ 5,940
Marketable securities .................................. 0
Notes and accounts receivable - trade .................. 7,124
Allowances for doubtful accounts ....................... (996)
Inventory .............................................. 12,527
Total current assets ................................... 30,593
Property, plant and equipment .......................... 43,139
Accumulated depreciation ............................... (20,755)
Total assets ........................................... 54,396
Total current liabilities .............................. 13,956
Bonds, mortgages and similar debt ...................... 0
Preferred stock - mandatory redemption ................. 0
Preferred Stock - non-mandatory redemption ............. 0
Common Stock ........................................... 7
Other Stockholders' Equity ............................. 32,954
Total liabilities and stockholders' equity ............. 54,396
Net sales of tangible products ......................... 48,645
Total revenue .......................................... 48,645
Cost of tangible goods sold ............................ 37,702
Total costs and expenses applicable to sales and revenue 56,801
Other costs and expenses ............................... 0
Provision for doubtful accounts and notes .............. 0
Interest and amortization of debt discount ............. (517)
Income before taxes .................................... (8,673)
Income tax expense ..................................... 0
Income/loss continuing operations ...................... (8,673)
Discontinued operations ................................ 0
Extraordinary items .................................... 0
Cumulative effect-changes in accounting principles ..... 0
Net income or loss ..................................... (8,673)
Earnings per share -basic .............................. (1.17)
Earnings per share - diluted ........................... (1.17)
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<NAME> Financial Data Schedule
<MULTIPLIER> 1,000
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-1-1998
<PERIOD-END> JUN-1-1998
<EXCHANGE-RATE> 1,000
<CASH> 5,940
<SECURITIES> 0
<RECEIVABLES> 7,124
<ALLOWANCES> (996)
<INVENTORY> 12,527
<CURRENT-ASSETS> 30,593
<PP&E> 43,139
<DEPRECIATION> (20,755)
<TOTAL-ASSETS> 54,396
<CURRENT-LIABILITIES> 13,956
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0
0
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<TOTAL-LIABILITY-AND-EQUITY> 54,396
<SALES> 48,645
<TOTAL-REVENUES> 48,645
<CGS> 37,702
<TOTAL-COSTS> 56,801
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (517)
<INCOME-PRETAX> (8,673)
<INCOME-TAX> 0
<INCOME-CONTINUING> (8,673)
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<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,673)
<EPS-PRIMARY> (1.17)
<EPS-DILUTED> (1.17)
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