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 December 31, 1997
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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 February
2, 1998 was 7,373,081.
<PAGE>
Quality Semiconductor, Inc.
Form 10-Q for the Quarter Ended December 31, 1997
INDEX
PART I. FINANCIAL INFORMATION Page
Item 1 - Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of December 31, 1997
and September 30, 1997 3
Condensed Consolidated Statements of Operations for the three
months ended December 31, 1997 and December 31,1996 4
Condensed Consolidated Statements of Cash Flows for the three
months ended December 31, 1997 and December 31, 1996 5
Notes to Condensed Consolidated Financial Statements 6
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
PART II. OTHER INFORMATION
Item 6 - Exhibits and Reports on Form 8-K 17
(a) Exhibits
(b) Reports on Form 8-K
Signatures 18
<PAGE>
PART I. FINANCIAL INFORMATION
Quality Semiconductor, Inc.
Condensed Consolidated Balance Sheets
(In thousands, except par values)
<TABLE>
<S> <C> <C>
December 31, September 30,
1997 1997 (1)
----------------- ----------------
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents $11,750 $9,403
Short-term investments 2,158 3,656
Accounts and other receivables, net 9,223 8,748
Inventories 13,725 17,689
Other current assets 5,791 5,327
----------------- ----------------
Total current assets 42,647 44,823
Property and equipment, net 22,382 22,859
Goodwill and other assets 1,883 2,150
================= ================
Total assets $66,912 $69,832
================= ================
LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities:
Accounts payable $4,714 $5,711
Accrued liabilities 2,306 2,676
Deferred income on shipments to distributors 3,551 2,995
Redeemable preference shares of subsidiary 3,811 3,982
Notes payable to related party due within one year 2,330 1,684
----------------- ----------------
Total current liabilities 16,712 17,048
Notes payable to related party 6,054 7,202
Deferred tax liabilities 1,832 1,945
Shareholders' equity:
Preferred stock, $.001 par value: Authorized 1,000;
Issued and outstanding - none - -
Common stock, $.001 par value, Authorized - 25,500
Issued and outstanding 7,373 and 7,393 7 7
Additional paid-in-capital 41,478 41,600
Retained earnings 963 2,221
Deferred compensation (134) (191)
----------------- ----------------
Total shareholders' equity 42,314 43,637
================= ================
Total liabilities and shareholders' equity $66,912 $69,832
================= ================
</TABLE>
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)
Three months ended
December 31,
-----------------------------------
1997 1996
-------------- --------------
Net revenues $18,534 $12,345
Cost of revenues 13,420 7,238
-------------- --------------
Gross margin 5,114 5,107
Operating expenses:
Research and development 2,720 2,110
Sales and marketing 2,392 1,788
General and administrative 1,371 925
-------------- --------------
Total operating expenses 6,483 4,823
-------------- --------------
Operating income (loss) (1,369) 284
Interest expense, net (153) (83)
-------------- --------------
Income (loss) before provision (benefit)
for income taxes (1,522) 201
Provision (benefit) for income taxes (533) 70
============== ==============
Net income (loss) (989) 131
============== ==============
Net income (loss) per share - Basic ($0.13) $0.02
============== ==============
Net income (loss) per share - Diluted ($0.13) $0.02
============== ==============
Shares used in computing net income (loss)
per share - Basic 7,383 5,664
============== ==============
Shares used in computing net income (loss)
per share - Diluted 7,383 6,185
============== ==============
See accompanying notes to condensed consolidated financial statements.
<PAGE>
Quality Semiconductor, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
Three months ended
December 31,
-----------------------
1997 1996
---------- ----------
Operating activities
Net income (loss) ($989) $131
Adjustments to reconcile net income (loss) to net
cash
provided by (used in) operating activities:
Depreciation and amortization 2,151 1,420
Accretion on preference shares 48 152
Deferred income taxes (113) 17
Translation adjustment, preference shares (219)
Deferred compensation amortization 57 58
Changes in operating asset and 2,214 (1,832)
liabilities
---------- ---------
Net cash provided by (used in) operating activities 3,149 (54)
Investing activities
Capital expenditures (1,807) (1,136)
Sales of short-term investments, net 1,498 393
Deposits and other assets 130 66
---------- ---------
Net cash used in investing activities (179) (677)
Financing activities
Principal payments on long-term debt (502) (131)
Proceeds from notes payable, net of issuance costs - 2,850
Proceeds from issuance of stock, net of repurchases (121)
(28)
---------- ---------
Net cash provided by (used in) financing activities (623) 2,691
---------- ---------
Net increase in cash and cash equivalents 2,347 1,960
Cash and cash equivalents at beginning of period 9,403 4,930
========== =========
Cash and cash equivalents at end of period $11,750 $6,890
========== =========
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 - $2,192
See accompanying notes to condensed consolidated financial statements.
<PAGE>
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. This financial data should
be read in conjunction with the financial statements in the Company's Annual
Report on Form 10-K for the year ended September 30, 1997.
The functional currency of the Company's foreign subsidiary is the
Australian Dollar. Subsidiary financial statements are remeasured into U.S.
Dollars for consolidation. Translation adjustments, which result from the
process of translating foreign currency financial statements into US dollars,
are included in shareholders' equity.
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 preparation of the consolidated financial statements are in conformity
with generally accepted accounting principles and requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements. These estimates include provisions for excess and obsolete
inventory, sales return reserves and product warranty claims. Actual results
could differ materially from estimates. The Company's operating results are
subject to a variety of risks common to the semiconductor industry, including
bookings and shipment uncertainties, wafer yield fluctuations, and price
erosion, as well as general economic conditions.
The results of operations for the three months ended December 31, 1997 may
not necessarily be indicative of the results for the fiscal year ending
September 30, 1998.
Note 2. Inventories
Inventories are stated at the lower of standard cost which approximates
actual (first-in, first-out method) or market (estimated net realizable value).
Inventories consisted of (in thousands):
December 31, September 30,
1997 1997
--------------------- ----------------------
Raw Materials $3,021 $5,421
Work-in-process 4,271 3,770
Finished goods 6,433 8,498
===================== ======================
$13,725 $17,689
===================== ======================
<PAGE>
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 and forecast 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.
Note 3. Earnings Per Share
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, Earnings Per Share ("FAS 128"). As
required, the Company adopted FAS 128 during this quarter ended December 30,
1997. Under the requirements of FAS 128, the Company is required to disclose
both basic earnings per share and diluted earnings per share in place of primary
earnings per share previously reported by the Company. Basic earnings per share
is based upon the weighted average number of shares of common stock outstanding
during the period and, unlike primary earnings per share, excludes the dilutive
effect of employee stock options. Diluted earnings per share includes the
dilutive effect of employee stock options and accordingly, is comparable to
primary earnings per share previously reported by the Company. All earnings per
share amounts for the periods presented have been restated to conform to the
requirements of FAS 128. The following table sets forth the computation of basic
and diluted earnings per share.
Three months ended
December 30,
-----------------------------------
1997 1996
-------------- --------------
Numerator - Net Income (loss) ($989) $131
Denominator for basic earnings per share -
Weighted average shares 7,383 5,664
Effect of dilutive securities -
employee stock options - 521
Denominator for diluted earnings per share 7,383 6,185
-------------- --------------
Basic earnings (loss) per share ($0.13) $0.02
============== ==============
============== ==============
Diluted earnings (loss) per share ($0.13) $0.02
============== ==============
<PAGE>
Note 4. 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
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21 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. The
preparation of the consolidated financial statements are in conformity with
generally accepted principles and requires management to make estimates and
assumptions that affect the amounts reported in the financial statements. These
estimates include provisions for excess and obsolete inventory, sales returns
and product warranty claims. Actual results could differ materially from
estimates.
Results of Operations
Net revenues for the quarter ended December 31, 1997 increased 50% from the
corresponding period in the prior fiscal year. This increase in revenues was due
to an increase in sales of proprietary networking products partially offset by
lower unit shipment and average selling prices of the Company's logic product
lines. Revenues from networking products accounted for over 40% of net revenues
in the first quarter of fiscal 1998, compared to under 10% of net revenues in
the corresponding period a year ago. 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 increase revenues, the Company seeks to
introduce new products and increase unit sales of existing products, principally
by reducing prices. No assurance can be given that these efforts will be
successful. There can be no assurance that the market for semiconductor products
will either remain at its current level or grow in future periods. Furthermore,
there can be no assurance that the Company will be able to increase or maintain
its market share in the future or to sustain historical growth rates.
The gross margin was 28% of net revenues in the first quarter of fiscal
1998 as compared to 41% in the first quarter of fiscal 1997. The lower margins
were principally due to changes in product mix as a higher percentage of lower
margin networking products were sold in the first quarter of fiscal 1998, and
lower average selling prices on logic products, which were offset in part by the
Company's cost reduction programs. 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 pressure 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.
Research and development expenses were $2.7 million or 15% of net revenues
in the first quarter of fiscal 1998 as compared to $2.1 million or 17% of net
revenues in the first quarter of fiscal 1997. This increase was mainly the
result of costs associated with the development of new products and processes.
These costs included material and outside services related to the development of
networking and clock products and the qualification of 0.5-micron process at
QSA. The Company expects that its research and development expenses will
increase, although such expenses may vary as a percentage of revenues in future
periods. The company believes that the continued development of its process
technology and new products is essential to continue its investment in research
and development to maintain a strong technological position in the industry.
<PAGE>
Sales and marketing expenses were $2.4 million or 13% of net revenues in
the first quarter of 1998, as compared to $1.8 million or 14% of net revenues in
the first quarter of fiscal 1997. This increase in selling expenses was
primarily attributed to increased sales commissions as a result of higher net
revenues and advertising expenses. The Company believes that increased 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 will continue to increase but may vary as a
percentage of total revenue in future periods. However, 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 expenses were $1.4 million or 7% of net revenues
in the first quarter of fiscal 1998, as compared to $0.9 million or 7% of net
revenues in the first quarter of fiscal 1997. The increase in the first quarter
of fiscal 1998 was due mainly to increased legal expenses and higher payroll
related costs.
Interest expense, net of interest income, was $153,000 during the three
months ended December 31, 1997 compared to $83,000 during the first quarter of
fiscal 1997. The increase was mainly due to increased debt to Kanematsu for the
purchase of property and equipment for QSA and, interest on the redeemable
preference shares issued as part of the consideration for the purchase of QSA.
The Company has recorded a tax benefit of $533,000 for the quarter ended
December 31, 1997. The deferred tax asset recorded as a result of this tax
benefit is dependent on generating sufficient future taxable income. Although
realization is not assured, management believes that it is more likely then not
that the deferred tax asset will be realized. The amount of the deferred tax
aset considered realized, however, could be reduced in the near term if
estimates of future taxable income are reduced.
Factors That May Affect Future 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 involves significant risks
typically inherent in any manufacturing endeavor, as well as additional risks
<PAGE>
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.
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.
Dependence on QSFCT and QuickSwitch Product Lines
A significant amount of the Company's net 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 a significant portion 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.
Dependence on Networking Product Line
During fiscal 1997, the Company commenced shipping its advanced CMOS Fast
Ethernet 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. These products are in the early stages of
production and test results may vary more than for products in later stages of
production. There can be no assurance that production yields will meet
management projections or that the performance of these products will meet
actual specifications. Additionally, demand for such products may not meet the
Company's expectations. In addition the demand for such products may decline as
competition and availability increase, 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
<PAGE>
be higher. Should the Company not complete the qualification process on a timely
basis, or if the performance of these products do not meet specifications there
is no assurance that the customer 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.
During the early stage of new product introductions, the parts are
generally marked as "engineering samples" and shipped to potential customers for
evaluation. Based on successful evaluation by the customer, products are shipped
in volume to customers prior to the successful completion of qualification. Upon
successful completion of qualification the engineering samples markings are
removed from the product. There is no assurance that upon completion of
successful qualification, current and future customers will accept product
marked as engineering samples. If the Company is unable to sell through all such
marked parts, there is no assurance that the Company will not need to writedown
all such inventory on hand or in production to zero or minimal value.
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. The
failure of the Company 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.
Risks 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 operations 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.
<PAGE>
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
A substantial number of the wafers for the Company's semiconductor products
are fabricated by Taiwan Semiconductor Manufacturing LTD. ("TSMC"), and a
limited number of wafers are manufactured by Seiko Instruments Inc. ("Seiko")
and Ricoh Corporation "("Ricoh"). The Company's reliance on its suppliers to
fabricate its wafers at their production facilities in Japan and 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 these 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
quality 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 Sales
The Company purchases a significant amount of its semiconductor wafers and
substantially all of its assembly services from foreign suppliers. 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. The Company's purchases of
wafers from Seiko Instruments Inc. are denominated in Japanese yen. Although the
Company has from time to time engaged in hedging activities to mitigate exchange
rate risks, there can be no assurance that the Company will not be materially
adversely affected by a change in exchange rate.
<PAGE>
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 net 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 effect on the
Company's operating results.
<PAGE>
Year 2000 Compliance
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. Beginning in the year
2000, these date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, in
approximately two years, computer systems and/or software used by many companies
may need to be upgraded to comply with such "Year 2000" requirements.
Significant uncertainty exists concerning the potential effects associated with
such compliance. Any year 2000 compliance problem of either the Company, its
suppliers, its service providers or its customers could result in a materially
adverse effect on the Company's business, financial condition and operating
results.
Manufacturing Systems
The Company currently has separate manufacturing and financial data
collection systems. These systems, which are manufactured by different vendors,
are not fully integrated together and require significant amounts of manual
reconciliation's and reporting. In connection with the Company's audit for the
fiscal year ended September 28, 1997, the Company's independent auditors
considered such use to be a reportable condition. Reportable condition involve
matters coming to the auditors' attention relating to siginifiat deficiencies in
the design or operation of the internal control structure that, in their
judgment, could adversely affect the organization's ability to record, process,
summarize, and report financial data consistent with the assertions of
management in the consolidated financial statements. The Company is currently
reviewing alternative solutions, reporting and controls in order to minimize the
chance of error in the financial statements. There is no assurance that the
Company will be able to develop or implement an acceptable solution or that an
error in the current or future financial statements may not occur or not be
recognized timely. Any failure to develop or implement an acceptable solution or
an error in the current or future financial statements could have a materially
adverse effect on the Company's operating results.
Cyclical Nature of the Semiconductor Industry
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.
<PAGE>
Volatility of the Company's Stock Price
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.
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. Liquidity and Capital Resources
During the first three months ended December 31, 1997 the Company generated
$3.1 million in cash from operating activities compared to $54,000 used in
operatig acticvities during the first three months of fiscal 1997. The increase
in cash provided by operating activities was mainly due to the change in
operating assets and liabilities which provided $2.2 million in cash for the
first three months of fiscal 1998 compared to the use of cash of $1.8 million
from the change in operating activities for the first three months of fiscal
1997. Cash used in investing activities during the first three months of fiscal
1998 totaled $179,000 compared to $677,000 in the first three months of fiscal
1997. The former reflected mainly the purchase of property and equipment of $1.8
million offset by the sale of investments of $1.5 million. Cash used in
financing activities of $623,000 for the first three months of 1998 were
primarily due to payments of debt. Cash provided by investing activities of $2.7
million in the first quarter of fiscal 1997 was mainly generated from the
receipt of $2,850,000 from the completion of the private placement in December
1996.
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 1998. However, there can be no assurance that events in the future will
not require the Company to seek additional capital or, if so required, that
adequate capital will be available to the Company.
<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
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
No. 27.1 - Financial Data Schedule
(b) Reports on Form 8-K
On November 20, 1997, the Company filed a report on
Form 8-K reporting under Item 5 thereof, regarding
the announcement of the resignation of John P.
Goldsberry, Vice President and Chief Financial
Officer.
On December 10, 1997, the Company filed a report on
Form 8-K reporting under Item 5 thereof, regarding
the Company's first quarter of fiscal 1998 outlook.
On January 20, 1998, the Company filed a report on
Form 8-K reporting under Item 5 thereof, regarding
the hiring of Dr. David Sear, as Executive Vice
President and Chief Operating Officer.
On January 30, 1998, the Company filed a report on
Form 8-K reporting under Item 5 thereof, regarding
the financial results of the first quarter of fiscal
1998.
<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: February 10, 1998 By: /s/ R. Paul Gupta
-----------------------------------
R. Paul Gupta
Chief Executive Officer
Date: February 10, 1998 By: /s/ Richard A. Bottomley
-----------------------------------
Richard A. Bottomley
Acting Chief Financial Officer
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