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, 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 February
1, 1999 was 7,551,753.
<PAGE>
Quality Semiconductor, Inc.
Form 10-Q for the Quarter Ended December 31, 1998
INDEX
PART I. FINANCIAL INFORMATION Page
Item 1 - Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of December 31,
1998 and September 30, 1998 3
Condensed Consolidated Statements of Operations and
Comprehensive Income for the three months ended
December 31, 1998 and December 31, 1997 4
Condensed Consolidated Statements of Cash Flows for
the three months ended December 31, 1998 and December 31,
1997 5
Notes to Condensed Consolidated Financial Statements 6
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 19
PART II. OTHER INFORMATION
Item 6 - Exhibits and Reports on Form 8-K 20
(a) Exhibits
(b) Reports on Form 8-K
Signatures 21
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<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
<TABLE>
Quality Semiconductor, Inc.
Condensed Consolidated Balance Sheets
(In thousands, except par values)
<CAPTION>
December 31, September 30,
1998 1998 (1)
----------- -------------
(Unaudited)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents .......................... $ 6,274 $ 5,938
Short-term investments ............................. -- 1,900
Accounts and other receivables, net ................ 4,815 5,852
Inventories ........................................ 6,765 8,210
Other current assets ............................... 1,174 1,356
-------- --------
Total current assets ............................ 19,028 23,256
Property and equipment, net ............................ 19,111 21,787
Goodwill and other assets .............................. 478 1,270
-------- --------
Total assets .................................... $ 38,617 $ 46,313
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................... $ 5,624 $ 4,432
Accrued liabilities ................................ 4,030 3,775
Deferred income on shipments to distributors ....... 2,059 2,972
Notes payable to related party due within one year . 2,544 2488
Current portion - capital lease obligations ........ 1,228 378
-------- --------
Total current liabilities ....................... 15,485 14,045
Notes payable to related party ......................... 3,510 4,166
Long-term portion - capital lease obligations .......... 38 980
Deferred tax liabilities ............................... 171 832
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 7,525 and 7,503 ........ 8 8
Additional paid-in-capital ......................... 41,871 41,820
Retained earnings .................................. (20,174) (12,956)
Accumulated other comprehensive income (loss) ...... (2,292) (2,582)
-------- --------
Total shareholders' equity ..................... 19,413 26,290
-------- --------
Total liabilities and shareholders' equity ..... $ 38,617 $ 46,313
======== ========
<FN>
See accompanying notes to condensed consolidated financial statements.
(1) The information in this column was derived from the Company's audited
financial statements.
</FN>
</TABLE>
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<PAGE>
Quality Semiconductor, Inc.
Condensed Consolidated Statements of Operations and Comprehensive Income
(Unaudited)
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three months ended
December 31,
<S> C> <C>
1998 1997
-------- --------
Net revenues .................................................. $ 10,646 $ 18,534
Cost of revenues .............................................. 11,058 13,420
-------- --------
Gross margin .................................................. (412) 5,114
Operating expenses:
Research and development .................................... 3,370 2,720
Sales and marketing ......................................... 1,859 2,392
General and administrative .................................. 1,460 1,371
-------- --------
Total operating expenses ........................... 6,689 6,483
-------- --------
Operating income (loss) ....................................... (7,101) (1,369)
Interest expense, net ......................................... (117) (153)
-------- --------
Income (loss) before provision (benefit) for income taxes ..... (7,218) (1,522)
Provision (benefit) for income taxes .......................... -- (533)
-------- --------
Net income (loss) ............................................. (7,218) (989)
Other comprehensive income (loss):
Foreign currency translation adjustment ..................... 290 (270)
-------- --------
Comprehensive income (loss) ................................... $ (6,928) $ (1,259)
======== ========
Net income (loss) per share - Basic ........................... ($ 0.96) ($ 0.13)
======== ========
Net income (loss) per share - Diluted ......................... ($ 0.96) ($ 0.13)
======== ========
Shares used in computing net income (loss) per share - Basic .. 7,508 7,383
======== ========
Shares used in computing net income (loss) per share - Diluted 7,508 7,383
======== ========
<FN>
See accompanying notes to condensed consolidated financial statements.
</FN>
</TABLE>
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<PAGE>
Quality Semiconductor, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Three months ended
December 31,
--------------------
1998 1997
<S> <C> <C>
Operating activities
Net income (loss) ...................................... $(7,218) ($ 989)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization ...................... 3,786 2,151
Accretion on preference shares ..................... -- 48
Deferred income taxes .............................. -- (113)
Deferred compensation amortization ................. -- 57
Changes in operating assets and liabilities ........ 2,827 1,995
-------- --------
Net cash provided by (used in) operating activities .... (605) 3,149
Investing activities
Capital expenditures ................................... (318) (1,807)
Sales of short-term investments, net ................... 1,900 1,498
Deposits and other assets .............................. -- 130
-------- --------
Net cash provided by (used in) investing activities .... 1,582 (179)
Financing activities
Principal payments on long-term debt ................... (692) (502)
Proceeds from issuance of stock, net of repurchases .... 51 (121)
-------- --------
Net cash used in financing activities .................. (641) (623)
-------- --------
Net increase in cash and cash equivalents .............. 336 2,347
Cash and cash equivalents at beginning of period ....... 5,938 9,403
-------- --------
Cash and cash equivalents at end of period ............. $ 6,274 $ 11,750
======== ========
<FN>
See accompanying notes to condensed consolidated financial statements.
</FN>
</TABLE>
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<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, 1998.
On November 1, 1998, the Company signed a definitive agreement to merge
with Integrated Device Technology, Inc. ("IDT"). Under the terms of the
agreement, each issued and outstanding share of the Company's Common Stock will
be exchanged for 0.6875 shares of Common Stock of IDT. The Company will hold a
special shareholders' meeting to approve the merger. If the Company's
shareholders approve the merger, the merger is planned to close during the
second calendar quarter of 1999.
The Company's principal source of funds for operations and capital
expenditures includes cash balances and cash flow from operations. Should the
proposed merger with IDT fail to be completed, these sources of funds may be
inadequate and the Company may be required to reduce or restructure its
operations and/or raise additional capital. Additional capital may not be
available to the Company at favorable terms. Additionally, any restructuring of
the Company's operations could result in charges, including charges to recognize
impairment of the Company's assets, that could be material to the Company's
financial position and results of operations.
The functional currency of the Company's foreign subsidiary is the
Australian Dollar. Subsidiary financial statements are translated into U.S.
Dollars for consolidation.
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 in conformity with
generally accepted accounting principles 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, 1998 may
not necessarily be indicative of the results for the fiscal year ending
September 30, 1999.
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):
6
<PAGE>
<TABLE>
<CAPTION>
December 31, September 30,
1998 1998
------ ------
<S> ............................................................. <C> <C>
Raw Materials ................................................... $1,408 $1,078
Work-in-process ................................................. 2,432 4,270
Finished goods .................................................. 2,925 2,862
------ ------
$6,765 $8,210
====== ======
<FN>
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 demand incorrectly and produce excess or insufficient inventories of
particular products. This inventory risk is heightened because many of the
Company's customers place orders with short lead times. Actual 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 The
following table sets forth the computation of basic and diluted earnings per
share.
</FN>
</TABLE>
<TABLE>
<CAPTION>
Three months ended December 31,
----------------------------
1998 1997
----------- -----------
<S> .................................................. <C> <C>
Numerator - Net Income (loss) ........................ ($7,218) ($ 989)
Denominator for basic earnings per share -
Weighted average shares .............................. 7,508 7,383
Effect of dilutive securities - employee stock options -- --
------- -------
Denominator for diluted earnings per share ........... 7,508 7,383
======= =======
Basic earnings (loss) per share ...................... ($ 0.96) ($ 0.13)
======= =======
Diluted earnings (loss) per share .................... ($ 0.96) ($ 0.13)
======= =======
<FN>
Options and warrants outstanding during the three months ended December
31, 1998 and 1997 were excluded from the computation of diluted net loss per
common share because the effect in periods with a net loss would be
antidilutive.
</FN>
</TABLE>
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<PAGE>
Note 4. Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income"
The Company adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income" (FAS 130) in the first fiscal quarter of 1999.
FAS 130 requires, for all periods presented, comprehensive income be reported
with the same prominence as other financial statements. As such, the Company has
included these amounts on the face of the income statement.
Comprehensive income includes net income plus other comprehensive income.
Other comprehensive income for QSI is comprised of changes in foreign currency
translation adjustments. Accumulated other comprehensive income and changes
thereto in 1999 consist of (thousands):
Accumulated other comprehensive income (loss) at September 30, 1998 $(2,582)
Change for the three months ended December 31, 1998:
Foreign currency translation adjustment 290
Accumulated other comprehensive income (loss) at December 31, 1998 $(2,292)
There is no tax effect on foreign currency translation adjustments.
Note 5. Change in Life of Certain Assets
In its continuing review of wafer fabrication processes and new product
development the Company has determined that beginning in year 2000 the fab
equipment acquired in February 1996 will need to be upgraded with later
generation equipment. It is anticipated that there is an adequate supply of used
equipment available at reasonable cost to accomplish the upgrade. As a result of
this plan, the remaining useful life of this fab equipment was reduced to twelve
months at October 1, 1998, the beginning of fiscal year 1999. Depreciation and
amortization were increased by $1.2 million this quarter as a result of the
change in remaining useful lives.
Note 6. Siemens Credit Corporation
In March 1998 the Company entered into a lease with Siemens Credit
Corporation for the financing of an Etcher for the fab in Australia. The Company
is current with its lease payments, however, is not in compliance with certain
covenants. In January, 1999, Siemens, citing violation of certain covenants,
placed a demand on the Company for full payment of the indebtedness of the
lease. As a result of the demand for full payment, the Company has classified
the indebtedness as a current liability in its December 31, 1998 balance sheet.
In the event that the Company is required to make full payment of the lease
obligation, the amount could be up to $1.4 million which would materially
adversely affect the Company's liquidity.
Note 7. Income Taxes
The Company has not recognized a tax benefit for its operating losses
incurred during the three months ended December 31, 1998. Realization of the tax
benefit of the loss is dependent upon the Company generating sufficient future
earnings.
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<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 Financial Conditions and Results of Operations contained in the Company's
10-K filed with the Securities and Exchange Commission on December 4, 1998 and
subsequent filings with the Securities and Exchange Commission
This report contains forward-looking statements within the meaning Section
21E and Rule 3b-6 under 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.
Proposed Merger with Integrated Device Technology, Inc.
On November 1, 1998, the Company signed a definitive agreement to merge
with Integrated Device Technology, Inc. ("IDT"). Under the terms of the
agreement, each issued and outstanding share of the Company's Common Stock will
be exchanged for 0.6875 shares of Common Stock of IDT. The Company will hold a
special shareholders' meeting to approve the merger. If the Company's
shareholders approve the merger, the merger is planned to close during the
second calendar quarter of 1999.
Results of Operations
Net revenues for the quarter ended December 31, 1998 declined 43% from
the corresponding period in the prior fiscal year. This decrease in revenues was
mainly due to the decrease in networking product revenue. This revenue, which
peaked in the first quarter of fiscal 1998, has been declining as the result of
lower average sales prices and a decline in shipping volumes. Lower revenue for
the FCT logic products, attributable to a decline in both shipping volumes and
in lower average sales prices, and lower average selling prices across all
product lines also contributed to the lower revenues. The Company believes that
the announcement of the merger agreement with IDT did not materially adversely
affect the volume of shipments or the average selling prices of the Company's
products. Rather, the Company attributes such declines to reduced demand and to
intense competition.
Revenues from networking products, which accounted for over 40% of net
revenues in the first quarter of fiscal 1998, declined from $8.6 million in the
first quarter of fiscal 1998 to $2.2 million and accounted for only 20% of net
revenues in the first quarter of fiscal 1999. The Company expects the average
selling prices of the Company's products to generally decline over the lives of
its products. Therefore, to maintain or increase revenues, the Company seeks to
introduce new products and increase unit sales of existing products, principally
by reducing prices, but no assurance can be given that these efforts will be
successful. In addition, there can be no assurance that the demand for the
Company's semiconductor products will 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.
9
<PAGE>
The gross margin was negative 3.9% of net revenues in the first quarter of
fiscal 1999 compared to 28% of net revenues in the first quarter of fiscal 1998.
The lower margin was principally due to charges of $1.8 million for inventory
write offs, and accelerated depreciation of $1.2 million related to wafer
fabrication equipment in Australia. The Company, in its continuing evaluations
of its fabrication processes and new product development, and has determined
that beginning in fiscal year 2000 it will be necessary to begin upgrading this
equipment. The remaining book value of this equipment will be depreciated in
fiscal year 1999.
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 attain
a positive gross margin or not be subject to continued declines in gross margins
in future periods.
Research and development expenses were $3.4 million or 32% of net revenues
in the first quarter of fiscal 1999 as compared to $2.7 million or 15% of net
revenues in the first quarter of fiscal 1998. This increase was mainly the
result of costs associated with the development of new networking products.
These cost increases primarily included outside design services of $500,000, and
depreciation of $81,000. The Company believes that the continued development of
its process technology new products is essential to its ability to maintain
revenues and market share and to attain profitability.
Sales and marketing expenses were $1.9 million or 17% of net revenues in
the first quarter of 1999, as compared to $2.4 million or 13% of net revenues in
the first quarter of fiscal 1998. This decrease in selling expenses was
primarily attributable to decreased sales commissions of $340,000 resulting from
lower net revenues and a decrease in advertising expenses of $89,000. The
Company believes that expenditures 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 were $1.5 million or 14% of net
revenues in the first quarter of fiscal 1999, as compared to $1.4 million or 7%
of net revenues in the first quarter of fiscal 1998. The increase in the first
quarter of fiscal 1999 was due mainly to expenses of approximately $370,000
incurred in connection with the proposed merger with IDT. Lower expenses of
$79,000 for general legal and bad debts of $70,000 partially offset merger
related expenses.
Interest expense, net of interest income, was $117,000 during the three
months ended December 31, 1998 compared to $153,000 during the first quarter of
fiscal 1998. The decrease was mainly due to lower balances on the Kanematsu
loans for the purchase of property and equipment for QSA and the absence of
interest on the redeemable preference shares issued as part of the consideration
for the purchase of QSA which were redeemed in fiscal 1998.
The Company has not recognized a tax benefit for its operating losses
incurred during the three months ended December 31, 1998. Recognition of the tax
benefit of the loss is dependent upon the Company generating sufficient future
earnings.
10
<PAGE>
Liquidity and Capital Resources
During the three months ended December 31, 1998, the Company used $605,000
of net cash in operating activities compared to $3.1 million provided by
operating activities during the first three months of fiscal 1998. The increase
in cash used in operating activities was mainly due to the net loss of $7.2
million for the first quarter of fiscal 1999 which was offset by depreciation of
$3.8 million and changes in operating assets and liabilities which provided $2.8
million in cash for the first three months of fiscal 1999. Cash provided by
investing activities during the first three months of fiscal 1999 totaled $1.6
million as a result of the sale of short-term investments, compared to cash used
in investing activities of $179,000 in the first three months of fiscal 1998.
Cash used in financing activities for both the first three months of 1999 and
1998 was primarily for the payment of debt.
The Company's principal source of funds for operations and capital
expenditures includes cash balances and cash flow from operations. Should the
proposed merger with IDT fail to be completed, these sources of funds may be
inadequate and the Company may be required to reduce operations and/or raise
additional capital. Additional capital may not be available to the Company at
favorable terms. Additionally, any restructuring of the Company's operations
could result in charges, including charges to recognize impairment of the
Company's assets, that could be material to the Company's financial position and
results of operations.
In March 1998 the Company entered into a lease with Siemens Credit
Corporation for the financing of an Etcher for the fab in Australia. The Company
is current with its lease payments, however, is not in compliance with certain
covenants. In January, 1999, Siemens, citing violation of certain covenants,
placed a demand on the Company for full payment of the indebtedness of the
lease. As a result of the demand for full payment, the Company has classified
the indebtedness as a current liability in its December 31, 1998 balance sheet.
In the event that the Company is required to make full payment of the lease
obligation, the amount could be up to $1.4 million which would materially
adversely affect the Company's liquidity.
Factors That May Affect Future Results
Cautionary Statement Concerning Forward Looking Statements
This report contains certain forward-looking statements that are subject to
risks and uncertainties. For such statements the Company claims the protection
of the safe harbor for forward-looking statements contained in Section 21E of
and Rule 3b-6 under the Securities Exchange Act of 1934. Such forward-looking
statements include, without limitations, statements regarding the Company's
expectations, intentions or future strategies and involve known and unknown
risks, uncertainties and other factors. The following factors, in addition to
those discussed elsewhere in the report, could cause the results to differ
materially from those expressed in such forward looking statements. All forward
looking statements included in this document are based on information available
to the Company on the date hereof, and the Company assumes no obligations to
update any such forward looking statements. Actual results could differ
materially from those projected in the forward-looking statements as a result of
the risk factors set forth below. In evaluating the Company's business,
prospective investors should carefully consider the following risk factors in
addition to the other information set forth herein or incorporated herein by
reference.
11
<PAGE>
The Company's Quarterly and Annual Operating Results Are Difficult to
Predict Because They Can Fluctuate Dramatically For a Variety of Reasons, Many
of Which The Company Cannot Control
The Company's quarterly and annual operating results can fluctuate
dramatically. For example, in fiscal 1997, the Company had basic and diluted
earnings per share of $0.03 per share, while in fiscal 1998, it had a basic and
diluted net loss per share of $2.06. Many of the factors affecting the Company's
results are beyond its control. Some of these factors include:
o market demand for the Company's new and existing products;
o the ability of the Company's competitors to offer better products or to
offer similar products at lower prices; and
o the cyclicality of the semiconductor industry in general.
In addition, the factors affecting QSI's quarterly and annual results over
which the Company has some control include:
o the Company's ability to accurately forecast demand for its existing
products;
o the Company's ability to introduce successful new products on a
timely basis;
o the Company's ability to control its expenses; and o the Company's
ability to effectively manage its semiconductor fabrication facility in
Australia.
Each of the above factors is described in more detail below.
The Company's Revenues Are Unpredictable and Subject to Rapid Decline Because
They Depend Significantly On Two Existing Product Lines
Logic products and networking products account for substantially all of
QSI's revenue.
Logic Products. Logic Products accounted for approximately 64%, 69% and 66%
of QSI's revenues for the fiscal years 1998, 1997 and 1996. Demand for the
Company's logic products depends heavily on the market for personal computers.
As a result, any adverse change in the demand for personal computers will
adversely affect the Company's ability to sell its logic products. In addition,
the market for logic products is highly competitive. As a result, if QSI's
competitors offer similar products at lower prices, the Company may be forced to
reduce its sales prices to maintain market share or to clear inventory. This
would adversely affect the Company's gross margin and, consequently, its
operating and financial results. Finally, if the designers of microprocessors
incorporate the logic functions that QSI's products perform into their
microprocessors, the demand for the Company's logic products could diminish
significantly, which would adversely affect the Company's revenues, margins,
operating results and financial condition.
Networking Products. In early winter 1997, QSI introduced its 10 Base T and
100 Base Tx products. These networking products accounted for 31% of the
Company's revenue in fiscal year 1998 and 26% in fiscal year 1997. These
products are CMOS transceiver chips that are used in adapters, repeaters,
switches and bus cards in Fast Ethernet networks. They are also used for
12
<PAGE>
multiplexers and demultiplexers and switches in Asynchronous Transmission Mode
networks. During the remainder of fiscal 1997 and fiscal 1998, the Company
derived significant revenue from the sale of these networking chips, although
quarterly revenues from these products have declined continually from the first
quarter to the present quarter. In late fiscal 1998, the Company's competitors
introduced similar chips with either better performance or lower prices. As a
result of declines in demand and increased competition, sales for these chips
have not met the Company's forecasts and QSI has had to reduce its sales prices
and, in some cases, reduce its inventory valuation to reflect the reduced sales
prices. The Company has taken reserves to account for expected future declines
in sales prices, but there can be no assurance that the Company's reserves are
adequate. Any further declines in sales prices will adversely affect the
Company's revenues, gross margins, operating results and financial condition.
Although QSI is developing new products for this market, which the Company
believes it will be able to sell at higher prices and margins, there can be no
assurance that the Company will successfully develop such products in time, that
the demand for these products will meet expectations, that the Company's
customers will like these new products or that the Company will not face similar
price competition for these products as well.
The Company Must Successfully Develop and Introduce New Products to Stay
Competitive
For QSI to be successful, the Company must continually introduce new
products at better price/performance levels than are currently available. To do
this, the Company must invest significantly in:
o research and development;
o prototype testing;
o the production of high precision quartz plates, known as "photomasks,"
which are used to transfer circuit patterns onto semiconductor wafers; and
o initial inventory build.
In addition, the Company will have to invest in obtaining "design wins."
However, it can be more than a year before a design win results in significant
revenues. For these reasons, the Company has an ongoing need for liquid assets
to fund new product development and introduction. This requires cash, which QSI
must generate from operations, divert from other uses or obtain from external
financing. In addition, even if QSI successfully develops and introduce new
products, there can be no assurance that the products will be successful. The
Company's new products must be timely, must perform to specifications and must
offer a better price/performance level than existing products. If the Company is
unable to generate sufficient cash to invest in developing and introducing new
products, or to introduce new products that are successful, the Company's
results of operations and financial condition will be adversely affected.
The Semiconductor Industry Is Very Competitive
The Company competes in an industry characterized by price erosion,
declining gross margins, product obsolescence and heightened international
competition in many markets. The Company's competitors include large
semiconductor companies like IDT, Texas Instruments Incorporated, National
Semiconductor Corporation, Level One and Cypress Semiconductor Corporation.
13
<PAGE>
These larger companies have greater financial, technical, marketing and
distribution and other resources and offer broader product lines than the
Company does. In addition, they have longer standing relationships with their
customers and suppliers. Therefore, these companies may be better able to
withstand a downturn in the market for their products or sustained price
reductions in the markets in which they compete.
Historically, the average selling prices in the semiconductor industry
decrease over the life of a particular product. If QSI is to remain profitable,
it has to reduce its costs as average selling prices decline and it must
introduce new products with higher average selling prices. The Company cannot
assure you that it will be able to do this successfully, and any failure on its
part to reduce costs or introduce new products in response to competitive
pressures will have a material adverse effect on the Company's operating results
and financial condition.
Operating the Australia Semiconductor Fabrication Facility is Capital
Intensive, Complex and Requires Strict Adherence to Environmental Laws
The Company relies on the Australian fabrication facility for most of the
wafer requirements of its logic product family. The Company purchased the
facility in February 1996 and has been upgrading the facility since then. To
date, the Company has invested more than $14.0 million in equipment and other
capital improvements. Although the facility is currently fully operational, any
disruption in production would adversely affect us because
o the Company would need to seek another source for its wafers, which would
probably raise the Company's cost per wafer and
o the Company would continue to incur the fixed expenses associated with
maintaining the facility even though it wasn't producing wafers for us.
The manufacture of semiconductor wafers is complex and yields are highly
dependent on maintaining a clean environment. Although the fabrication process
is highly controlled, the equipment may not perform flawlessly. A substantial
percentage of wafers could be rejected or individual dies on a wafer could be
nonfunctional due to minor impurities, difficulties in the production process or
defects in the masks. If the Company is unable to maintain acceptable yields
from its wafer fabrication facility, then its operating results and financial
condition would be materially adversely affected. In addition, the Company
relies on external sources for the raw materials used in the wafer fabrication
process. Although the Company has tried to qualify multiple vendors, any
shortage of raw materials or increase in the cost of raw materials would
adversely impact its ability to produce enough wafers to meet its demands and
would raise the Company's cost per wafer, which would adversely affect the
Company's revenues and operating margins.
The wafer fabrication process also requires the Company to store, use and
dispose of chemicals and gases that may be toxic, volatile or otherwise
hazardous. The improper storage, use or disposal of these chemicals and gases
could have materially adverse effects on humans, animals and the environment. In
addition, the storage, use and disposal of these chemicals and gases are subject
to laws and regulations at the national, state and local level. Because the
public is focusing more on environmental issues and the safety hazards
associated with handling hazardous and toxic material, the laws and regulations
governing them may become more stringent. Although the Company diligently tries
to comply with the laws and regulations governing the handling of these
materials, the Company cannot guarantee that the Company will always be in
14
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compliance or that the Company will not have to incur substantial fines or
remediation costs associated with any violation of the laws or regulations or
any environmental damage attributed to the Company's use, storage or disposal of
these materials. In addition, the Company may have to incur additional expenses
in the future in order to comply with more stringent rules or regulations
governing the handling of the chemicals and gases used in the Company's
Australian fabrication facility.
QSI Depends On Third Parties For Fabrication, Assembly and Testing of its
Products
Fabrication. Although the Company fabricates a majority of its wafers in
its Australia facility, the Company still relies on Taiwan Semiconductor
Manufacturing Company, Ltd. (TSMC), for a substantial number of wafers for small
geometry networking products. Under the terms of the Company's agreements with
TSMC, TSMC can terminate the relationship at any time, and the Company would
need to find an alternative source for these wafers, which could be a
time-consuming and expensive process, and could cause the Company to miss order
deadlines, experience reduced revenues and incur higher costs of goods sold. In
addition, there are other risks involved in relying on TSMC as a supplier of
wafers which include:
o the Company has less control over delivery schedules;
o the Company can't be assured that TSMC will always have the capacity
available to meet its needs;
o the Company has less control over quality assurance processes;
o TSMC may experience technical and/or production problems that would
prevent them from being able to fill its orders; and
o there is an increased risk that the Company's intellectual property may
be misappropriated.
In addition, the dependence on a third party wafer supplier tends to slow
the product development cycle because of the need to coordinate design activity
and qualify processes. Because the Company has little control over whether TSMC
continues to improve its processes, such as fabrication in finer geometries, the
Company's competitors who do not rely on third party wafer fabrication may be
better able to transition to improved processes and, as a consequence, offer
products at a better price/performance level than the Company's products.
Assembly and Testing. Substantially all of the Company's assembly is
performed by Digital Testing Services. In addition, the Company relies on SPIC
Electronics Laboratory in India. The Company also relies on SPIC and Digital
Testing to perform substantially all of the Company's testing for its networking
products. Consequently, the Company has less control over the quality and
availability of the services that they provide. If the quality or reliability of
these vendors degrades, or if the Company has to find alternate sources of
assembly and testing, the process of qualifying alternate vendors could delay
product development and product shipment and could result in loss of customers,
limitations or reductions in its revenues and other adverse effects on the
Company's operating results.
The Company's Operating Results Are Subject to Significant Fluctuations
Because the Company Depends on Foreign Suppliers and Foreign Buyers
15
<PAGE>
QSI purchases a significant amount of its wafers and substantially all of
its assembly services from foreign suppliers, primarily in Taiwan and India. In
addition, the Company sells a significant amount of its products to foreign
buyers. Export sales to Asia constituted 24% of the Company's net revenues in
fiscal 1998 and 28% of its net revenues in fiscal 1997, while export sales to
Europe accounted for 10% of its net revenue in fiscal 1998 and 8% of its net
revenue in fiscal 1997. As a result, the Company is subject to the risks
generally associated with doing business abroad. These risks include, but are
not limited to:
o the need to comply with foreign government regulations;
o currency fluctuation; and
o greater risk of disruptions or delays in shipments due to political
unrest, or economic instability.
In addition, to the extent that the Company makes yen-denominated purchases
of wafers from its Japanese suppliers, the Company may be exposed to the risk
that the exchange rate of yen for dollars may decrease from the date that the
purchases are agreed upon and the wafers are delivered and, therefore, the
Company would have underestimated the cost of such wafers.
The Company's Revenues and Operating Results Can Be Adversely Affected by
Litigation Involving Patents and Proprietary Rights
The semiconductor industry is characterized by substantial litigation
regarding patent and other intellectual property rights. In the past the Company
has received correspondence from Cypress Semiconductor, Inc., the Lemelson
Medical, Education & Research Foundation, International Business Machines
Corporation and MUSIC Semiconductor, Inc., claiming that the Company may have
infringed certain patents. The Company's patent counsel is reviewing these
claims. Although the Company believes that it has valid defenses against such
claims, the Company cannot assure you that the Company will not have to litigate
such claims or enter into a settlement or license agreement to dismiss the
claims. However, because the patents others are asserting primarily involve
manufacturing processes, revenues from substantially all of the Company's
products could be subject to the alleged infringement claims. The Company has in
the past filed claims against other companies alleging that they have
misappropriated its trade secrets. Intellectual property litigation can be
expensive and can divert the energy of the Company's management and engineers.
In addition, if any of the Company's products are found to infringe a third
party's valid patent, then the Company might be subject to injunctions and
significant damages. In addition, the Company would have to either design around
such patents or obtain a license. If the Company is unable to successfully
design around the patents or obtain a license, then the Company might be unable
to offer the product and its revenues and operating results could be materially
adversely affected.
The Company Depends On Certain Key Personnel To Manage its Operations and
Develop New Products
The Company's success depends on its ability to recruit and retain highly
skilled engineers, marketing personnel and managers. In particular, the Company
has a strong need for highly skilled design, process and test engineers, for
whom competition is intense. The Company cannot assure you that it will be
successful in hiring or retaining such key personnel or that any of its key
personnel will remain employed with us.
16
<PAGE>
The Company's Customers Are Highly Concentrated And Its Revenues Could Be
Adversely Affected By the Loss of Key Customers
Most of the Company's revenue typically comes from a relatively small
number of customers. If the Company were to lose any of these customers, its
revenues and operating results would be materially adversely affected. In
addition, the Company typically has to provide volume pricing discounts to these
customers, which reduces the Company's gross margin.
The Company Depends Significantly On Manufacturer Representatives and
Distributors
QSI markets and distributes its products primarily through manufacturers'
representatives and independent distributors. This reduces the Company's ability
to control the channels of distribution for its products and requires it to
respond to rapid changes in the channel due to factors such as consolidation or
distributor financial difficulties. For example, many of the Company's
distributors typically offer competing products. If the Company's distributors
or representatives were to reduce the number of the Company's products that it
carries or to terminate its relationship with us, the Company could experience
reduced revenues and would incur additional sales expenses associated with
finding a replacement.
Impact of Year 2000 on QSI's Operations
General. QSI is currently conducting a company-wide Year 2000 readiness
program. The QSI Y2K Program is addressing the issue of computer programs and
embedded computer chips being unable to distinguish between the Year 1900 and
the Year 2000. Therefore, some computer hardware and software will need to be
modified prior to the Year 2000 in order to remain functional. The Company
anticipates that Year 2000 compliance will be substantially complete by June
1999.
QSI Y2K Program. The QSI Y2K Program is divided into four major sections --
QSI manufactured products, internal information technology system, non-IT system
(e.g., testing equipment) and third-party suppliers and customers. The general
phases common to all sections are: Phase 1, inventorying Year 2000 items; Phase
2, assessing the Year 2000 compliance of items determined to be material to QSI;
and Phase 3, repairing or replacing material items that are determined not to be
Year 2000 compliant.
The Company has completed the review of its manufactured products. The
Company did not find any Year 2000 related issues in products that the Company
sells to its customers.
With respect to its internal IT computer systems, QSI has completed the
inventory and review phases of the QSI Y2K Program. The Company expects to
complete the repair and replacement phase by June 1999.
The Company has completed the inventory phase and review phases of its
non-IT systems and determined that about 50 percent of its non-IT systems are
Year 2000 compliant. Those that are not yet Year 2000 compliant will be repaired
or replaced by June 1999.
The Company has been working with its key suppliers and contract
manufacturers to assess the possible effects of their Year 2000 readiness on its
operations. The Company's reliance on suppliers and contract manufacturers and,
therefore, on the proper functioning of their information systems and software,
means that failure to address Year 2000 issues could have a material impact on
17
<PAGE>
its operations and financial results; however, the potential impact and related
costs are not known at this time.
Costs. QSI does not have a separate budget for the QSI Y2K Program. The
Company has paid for the cost related to the QSI Y2K Program out of its budget
allocated for annual maintenance. The total cost associated with required
modifications to become Year 2000 compliant is not expected to be material to
QSI's financial position. Through December 1998, the Company estimates that it
has spent approximately $231,000 on its Y2K Program. The Company estimates that
it may spend up to an additional $300,000 for other repairs, replacements or
upgrades and for communicating with key suppliers and customers.
Risks. The failure to correct a material Year 2000 problem could result in
an interruption in, or a failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Year 2000 problem resulting in part from the
uncertainty of the Year 2000 readiness of third-party suppliers and customers,
the Company is unable to determine at this time whether the consequences of Year
2000 failures will have a material impact on its results of operations,
liquidity or financial condition. However, in the most reasonably likely worst
case scenario, failure of QSI's manufacturing, order processing or accounting
systems or equipment to achieve Year 2000 compliance or of its third party
suppliers or customers to achieve Year 2000 readiness could result in delays in
the production or shipment of products to its customers or delays in the
Company's ability to collect accounts receivable from its customers. In the
aggregate these delays could adversely affect the Company's results of
operations, liquidity or supplier and customer relations. The QSI Y2K Program is
expected to significantly reduce the Company's level of uncertainty about the
Year 2000 problem and, in particular, about the Year 2000 compliance and
readiness of the Company's material key suppliers and customers. QSI believes
that, with the implementation of new business systems and completion of the QSI
Y2K Program as scheduled, the possibility of significant interruptions of normal
operations should be reduced.
QSI does not yet have a contingency plan to address the Year 2000 problem,
but the Company expects to create one by June 1999.
The dates on which the Company believes that the QSI Y2K Program will be
completed are based on the best estimates of its management, which were derived
utilizing numerous assumptions of future events, including the continued
availability of certain resources, third-party modification plans and other
factors. However, the Company cannot guarantee that these estimates will be
achieved, or that there will not be a delay in, or increased costs associated
with, the implementation of the QSI Y2K Program. Specific factors that might
cause differences between the estimates and actual results include, but are not
limited to, the availability and cost of personnel trained in these areas, the
ability to locate and correct all relevant computer code, timely responses to
and corrections by third-parties and suppliers, the ability to implement
interfaces between the new systems and the systems not being replaced, and
similar uncertainties. Due to the general uncertainty inherent in the Year 2000
problem, resulting in part from the uncertainty of the Year 2000 readiness of
third-parties and the interconnection of global businesses, the Company cannot
guarantee that it will be able to timely and cost-effectively resolve problems
associated with the Year 2000 issue. Any failure to adequately address this Year
2000 problem, could have a material adverse effect on the Company's operations
and business, or expose it to third-party liability.
18
<PAGE>
The Semiconductor Industry is Cyclical and Subject to Rapid Change
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 average selling prices and
overcapacity. In addition, the end-markets for systems that incorporate QSI'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.
The Company's Stock Price is Volatile
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 QSI 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 its stock on November 17, 1994. In addition, this low trading
volume may continue and could affect the ability of shareholders to sell their
shares.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
For financial market risks related to changes in interest rates and foreign
currency exchange rates, reference is made to Part II, Item 7A, Quantitative and
Qualitative Disclosures About Market Risk, in the Registrant's Annual Report on
Form 10-K for the year ended September 28, 1998, filed on December 4, 1998.
- 19 -
<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 - Not applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.20 - Agreement and Plan of Merger by and among
Integrated Device Technology, Inc., Penguin
Acquisition, Inc., and Quality Semiconductor, Inc.,
dated November 1, 1998<-1- 42><-1- 42> Incorporated by
reference to the identically numbered exhibit filed
with the Company's Form 8-K dated November 4, 1998.
27.1 - Financial Data Schedule
(b) Reports on Form 8-K
On November 4, 1998, the Company filed a Form 8-K,
reporting under Item 5, the agreement to merge
with Integrated Device Technologies, Inc.
- 20 -
<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, 1999 By: / s / R. Paul Gupta
R. Paul Gupta
Director, President and Chief Executive Officer
Date: February 10, 1999 By: / s / Stephen H. Vonderach
Stephen H. Vonderach
Vice President of Finance, Chief Financial
Officer, and Chief Accounting Officer
21
<PAGE>
Exhibit 27.1
QUALITY SEMICONDUCTOR, INC.
Financial Data Schedule
(In thousands, except per share data)
(Unaudited)
Fiscal Year End September 30, 1999
Period Beginning October 1, 1998
Period Ending December 31, 1998
Cash and cash equivalents ....................................... $ 6,274
Marketable securities ........................................... --
Notes and accounts receivable - trade ........................... 5,686
Allowances for doubtful accounts ................................ (871)
Inventory ....................................................... 6,765
Total current assets ............................................ 19,028
Property, plant and equipment ................................... 44,526
Accumulated depreciation ........................................ (25,415)
Total assets .................................................... 38,617
Total current liabilities ....................................... 15,485
Bonds, mortgages and similar debt ............................... -0-
Preferred stock - mandatory redemption .......................... -0-
Preferred Stock - non-mandatory redemption ...................... -0-
Common Stock .................................................... 8
Other Stockholders' Equity ...................................... 41,871
Total liabilities and stockholders' equity ...................... 38,617
Net sales of tangible products .................................. 10,646
Total revenue ................................................... 10,646
Cost of tangible goods sold ..................................... 11,058
Total costs and expenses applicable to sales and revenue ........ 6,689
Other costs and expenses ........................................ -0-
Provision for doubtful accounts and notes ....................... -0-
Interest and amortization of debt discount ...................... (117)
Income (loss) before taxes ...................................... (7,218)
Income tax expense (benefit) .................................... 0
Income/loss continuing operations ............................... (7,218)
Discontinued operations ......................................... -0-
Extraordinary items ............................................. -0-
Cumulative effect-changes in accounting principles .............. -0-
Net income (loss) ............................................... (7,218)
Earnings per share - basic ...................................... (0.96)
Earnings per share - diluted .................................... (0.96)
22
<PAGE>
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<NAME> Financial Data Schedule
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