<PAGE>
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SECURITY AND EXCHANGE COMMISSION
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
- ---
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
- ---
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ____________
COMMISSION FILE NUMBER: 0-26312
TELCOM SEMICONDUCTOR, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3186995
(State or other jurisdiction of (I. R. S. Employer
incorporation or organization) Identification No.)
1300 TERRA BELLA, MT. VIEW, CALIFORNIA 94039
(address of principal executive offices)
(Zip Code)
TELEPHONE NUMBER (650) 968-9241
(Registrant's telephone number, including area code)
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 shares outstanding of the registrant's Common Stock as of May 4,
1998 was 16,549,310.
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<PAGE>
TELCOM SEMICONDUCTOR, INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1998
INDEX
PAGE
NO.
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Operations........ 3
Condensed Consolidated Balance Sheets.................. 4
Condensed Consolidated Statements of Cash Flows........ 5
Notes To Condensed Consolidated Financial Statements... 6-8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 9-16
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K....................... 17
Signatures............................................................. 18
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TELCOM SEMICONDUCTOR, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------
Mar. 31, Mar. 31,
1998 1997
--------------- --------------
<S> <C> <C>
Net sales................................................ $15,474 $ 11,123
Cost of sales............................................ 8,895 6,705
------- --------
Gross profit............................................. 6,579 4,418
------- --------
Operating expenses:
Research and development............................. 1,315 1,182
Selling, general and administrative.................. 2,527 2,061
Loss on foundry investment........................... - 8,000
------- --------
Total operating expenses....................... 3,842 11,243
------- --------
Income (loss) from operations............................ 2,737 (6,825)
Interest income (expense), net........................... 96 (174)
------- --------
Income (loss) before income taxes........................ 2,833 (6,999)
Provision for income taxes............................... 765 271
------- --------
Net income (loss)........................................ $ 2,068 $ (7,270)
======= ========
Per share data:
Net income (loss)
Basic......................................... $0.13 $(0.45)
======= ========
Diluted....................................... $0.12 $(0.45)
======= ========
Number of shares used to compute per share data:
Basic......................................... 16,476 16,023
======= ========
Diluted....................................... 17,718 16,023
======= ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE>
TELCOM SEMICONDUCTOR, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Mar. 31, Dec. 31,
1998 1997
-------------- -------------
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents..................... $18,428 $17,110
Marketable securities......................... 1,435 2,469
Accounts receivable........................... 8,047 7,452
Inventory..................................... 9,265 8,289
Deferred income taxes......................... 1,167 1,167
Other current assets.......................... 516 751
------- -------
Total current assets...................... 38,858 37,238
Property and equipment, net....................... 15,575 14,946
Other assets...................................... 1,500 1,500
------- -------
$55,933 $53,684
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable.............. $ 2,529 $ 2,641
Accounts payable.............................. 3,870 3,461
Accrued liabilities........................... 2,313 2,460
Deferred distributor income................... 1,445 1,429
Income taxes payable.......................... 3,003 2,566
------- -------
Total current liabilities................. 13,160 12,557
Notes payable..................................... 2,916 3,462
Deferred income taxes............................. 1,244 1,244
------- -------
Total liabilities......................... 17,320 17,263
------- -------
Stockholders' equity:
Common stock.................................. 17 16
Additional paid-in capital.................... 34,512 34,389
Notes receivable from stockholders............ (2) (2)
Retained earnings............................. 4,086 2,018
------- -------
Total stockholders' equity................ 38,613 36,421
------- -------
$55,933 $53,684
======= =======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
<PAGE>
TELCOM SEMICONDUCTOR, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
-------------------------
Mar. 31,
--------------------------
1998 1997
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)...................................... $ 2,068 $ (7,270)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Loss on foundry investment....................... - 8,000
Depreciation and amortization.................... 1,337 928
Changes in assets and liabilities:
Accounts receivable......................... (595) 237
Inventory................................... (976) (341)
Income tax receivable....................... - 1,430
Other current assets........................ 235 47
Accounts payable............................ 409 761
Accrued liabilities......................... (147) (368)
Deferred distributor income................. 16 88
Income taxes payable........................ 437 (105)
------- --------
Net cash provided by operating activities.............. 2,784 3,407
------- --------
Cash flows from investing activities:
Purchases of property and equipment.............. (1,966) (810)
Sales of marketable securities, net.............. 1,034 (12)
------- --------
Net cash used for investing activities................. (932) (822)
------- --------
Cash flows from financing activities:
Proceeds from sale of common stock............... 124 219
Payments on notes payable........................ (658) (853)
------- --------
Net cash used for financing activities................. (534) (634)
------- --------
Net increase in cash and cash equivalents.............. 1,318 1,951
Cash and cash equivalents at the beginning of period... 17,110 12,761
------- --------
Cash and cash equivalents at the end of period......... $18,428 $ 14,712
======= ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE>
TELCOM SEMICONDUCTOR, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands)
(Unaudited)
1. The Company and Basis of Presentation:
TelCom Semiconductor, Inc. ("TelCom" or the "Company") designs, develops,
manufactures and markets a diversified portfolio of high performance analog
integrated circuits for use in a wide variety of electronic systems. The Company
operates and reports financial results on a 52-53 week fiscal year ending on the
Friday closest to the last day of December. For convenience, the Company has
presented its fiscal year as ending December 31, and its fiscal quarter as
ending March 31.
In the opinion of management, the unaudited condensed consolidated interim
financial statements have been prepared on the same basis as the December 31,
1997 financial statements and include all adjustments, consisting only of normal
recurring adjustments, necessary to fairly state the information set forth
herein.
This report on Form 10-Q for the period ended March 31, 1998 should be read
in conjunction with the Company's Annual Report on Form 10-K for the year ended
December 31, 1997.
2. Net Income (Loss) per Share
The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" ("SFAS 128") during the fourth quarter of fiscal 1997. This
statement simplifies the standards for computing earnings per share (EPS)
previously defined in Accounting Principles Board Opinion No. 15 "Earnings Per
Share". All prior-period earnings per share data has been restated in accordance
with SFAS 128. SFAS 128 requires presentation of both Basic EPS and Diluted EPS
on the face of the income statement. Basic EPS is computed by dividing net
income available to common stockholders (numerator) by the weighted average
number of common shares outstanding (denominator) during the period. Diluted EPS
gives effect to all dilutive potential common shares outstanding during the
period including stock options, using the treasury stock method, and convertible
preferred stock, using the if-converted method. In computing Diluted EPS, the
average stock price for the period is used in determining the number of shares
assumed to be purchased from the exercise of stock options.
6
<PAGE>
Following is a reconciliation of the numerators and denominators of the
Basic and Diluted EPS computations for the periods presented below:
<TABLE>
<CAPTION>
Three Months Ended
----------------------------
Mar. 31, Mar. 31,
------------- -------------
1998 1997
------------- -------------
<S> <C> <C>
Net income (loss) available to common shareholders......... $ 2,068 $(7,270)
======= =======
Weighted average common stock outstanding (basic).......... 16,476 16,023
Effect of dilutive warrants and options.................... 1,242 -
------- -------
Weighted average common stock outstanding (diluted)........ 17,718 16,023
======= =======
Earnings per share:
Basic...................................................... $ 0.13 $ (0.45)
======= =======
Diluted.................................................... $ 0.12 $ (0.45)
======= =======
</TABLE>
Options to purchase 68,500 shares of commons stock at a weighted average
price of $13.67 per share were outstanding at March 31, 1998 but were not
included in the computation of diluted EPS because the options' exercise price
was greater than the average market price of common stock during the period. Due
to the Company's net loss from continuing operations in the period ending March
31, 1997, a calculation of EPS assuming dilution is not required. At March 31,
1997, there were 2,352,000 options and warrants outstanding to purchase common
stock at a weighted average price of $3.15 per share.
7
<PAGE>
3. Balance Sheet Details:
<TABLE>
<CAPTION>
Mar. 31, Dec. 31,
1998 1997
------------- ------------
<S> <C> <C>
Inventory:
Raw material.................. $ 884 $ 871
Work in process............... 5,896 4,385
Finished goods................ 2,485 3,033
-------- --------
$ 9,265 $ 8,289
======== ========
Property and equipment:
Equipment..................... $ 22,518 $ 20,081
Leasehold improvements........ 2,737 2,708
-------- --------
25,255 22,789
Accumulated depreciation...... (11,148) (9,811)
-------- --------
14,107 12,978
Construction in progress...... 1,468 1,968
-------- --------
$ 15,575 $ 14,946
======== ========
Accrued liabilities:
Payroll and related........... $ 2,116 $ 1,667
Other......................... 197 793
-------- --------
$ 2,313 $ 2,460
======== ========
</TABLE>
4. Loss on Foundry Investment
In November 1995, the Company entered into certain agreements with IC
WORKS, Inc. a privately-held company located in San Jose, California. Pursuant
to these agreements, in 1996 the Company purchased $3.0 million of preferred
stock of IC WORKS and provided $10.4 million in capital equipment. In return for
this investment, TelCom received a guarantee of submicron wafer capacity at
specified prices for a period of five years, projected to start in late 1997.
The shortage of wafer capacity projected in late 1995 has diminished and since
late 1995, substantial foundry capacity has been available worldwide while
overall demand has not increased proportionately. Consequently, wafer pricing
has decreased dramatically, which has changed the economic viability of the
foundry business in which the Company invested. As a result, in the first
quarter of 1997, the Company recorded an impairment loss on its foundry
investment of $8.0 million, consisting of a $3.0 million write down of the
preferred stock and a $5.0 million impairment write down of the equipment. In
the fourth quarter of 1997, pursuant to an agreement with IC WORKS, the Company
sold the $10.4 million dollars of equipment at IC WORKS for $5.2 million and
invested an additional $1.5 million in preferred stock of IC WORKS, Inc. This
agreement terminated the Company's operating agreement with IC WORKS.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Report on Form 10-Q contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. Actual results could differ materially from
those projected in the forward-looking statements as a result of the risk
related factors set forth herein.
OVERVIEW
TelCom Semiconductor, Inc. ("TelCom" or the "Company") designs, develops,
manufactures and markets a diversified portfolio of high-performance standard
analog integrated circuits for a wide variety of applications in the industrial,
communications, computer, automotive and medical markets. The Company's products
comprise three principal product families: mixed signal products, which are
analog devices with some digital control functionality, such as display
analog/digital converters: power management products, such as switch node power
supply controllers, whose function is to conserve power, and smart sensors, such
as solid state thermal management devices. Within each family, the Company
markets proprietary and selected second source products offering a range of
performance, functionality and price. Average selling prices for the Company's
proprietary products have tended to decline at a slower rate than have those for
the Company's second source products, which are more susceptible to competitive
pricing pressures. The Company generally recognizes higher gross margins on its
proprietary products than on its second source products.
The Company's quarterly and annual operating results are affected by a wide
variety of factors that could materially and adversely affect net sales, gross
margins and operating income. These factors include the volume and timing of
orders received, changes in the mix of proprietary and second source products
sold, market acceptance of the Company's and its customers' products,
competitive pricing pressures, the Company's ability to introduce new products
on a timely basis, the timing and extent of research and development expenses,
fluctuations in manufacturing yields, cyclical semiconductor industry
conditions, the Company's access to advanced process technologies and the timing
and extent of process development costs. Historically in the semiconductor
industry, average selling prices of products have decreased over time. If the
Company is unable to introduce new products with higher margins, maintain its
product mix between proprietary and second source products or reduce
manufacturing costs to offset decreases in the prices of its existing products,
the Company's operating results will be adversely affected. The Company's
business is characterized by short term orders and shipment schedules, and
customer orders typically can be canceled or rescheduled without penalty to the
customer. Since most of the Company's backlog is cancelable without penalty, the
Company typically plans its production and inventory levels based on internal
forecasts of customer demand, which is highly unpredictable and can fluctuate
substantially. In addition, because of the high fixed costs in the semiconductor
industry, the Company is limited in its ability to reduce costs quickly in
response to any revenue shortfalls. As a result of the forgoing or other
factors, the Company may experience material adverse fluctuations in future
operating results on a quarterly or annual basis, which would materially and
adversely affect the Company's business, financial condition and results of
operations.
In November 1995, the Company entered into certain agreements with IC
WORKS, Inc., a privately-held company located in San Jose, California. Pursuant
to such agreements, the Company purchased $3.0 million of preferred stock of IC
WORKS and provided $10.4 million in capital equipment. In return for this
investment, TelCom received a guarantee of submicron wafer capacity at specified
prices for a period of five years, projected to start in late 1997. The shortage
of wafer capacity projected in late 1995 has diminished and since late 1995,
substantial foundry capacity has been available worldwide while overall demand
has not increased proportionately. Consequently, wafer pricing has decreased
dramatically, which has changed the economic viability of the foundry business
in which the Company invested. As a result, in 1997, the Company recorded a loss
of $8.3 million on its foundry investment which consists of a $3.0 million write
down of the preferred stock, a loss on the sale of the equipment of $5.2
million, and $.1 million of costs associated with prepayment penalties on
financing of the equipment and legal fees. Pursuant to an
9
<PAGE>
agreement with IC WORKS, Inc., in the fourth quarter of 1997, the Company sold
the $10.4 million of equipment at IC WORKS for $5.2 million and invested an
additional $1.5 million in preferred stock of IC WORKS, Inc. This agreement
terminated the Company's operating agreement with IC WORKS and its wafer
production arrangement was amended to allow the Company to purchase wafers
through March 31, 1998. During the period ending March 31, 1998, final
production wafers were received from IC WORKS and the Company was in the process
of qualifying another foundry for future production of submicron wafers.
RESULTS OF OPERATIONS
NET SALES
Net sales for the three month period ended March 31, 1998 increased $4.4
million or 39.1% from the corresponding period in the prior fiscal year. The
increase in sales was primarily due to higher sales volume in the Company's
power management product line. International sales for the three month period
ended March 31, 1998 were 64% of total sales for the period compared to 61% of
total sales for the same period in the prior year. Sales in the European market
increased in the three month period ended March 31, 1998 by $1.8 million, or 45%
compared to the same period in the prior year, primarily due to higher sales of
power management products. For the three month period ended March 31, 1998,
three OEM customers, Motorola, Intel and Compaq Computer, accounted for
approximately 40%, 6% and 5%, respectively, of net sales compared to 29%, 2% and
6%, respectively, of net sales for the same period in the prior year. Future
Electronics, one of the Company's distributors, accounted for 11% of the
Company's net sales for the three month period ended March 31,1998 compared to
12% of net sales for same period in the prior year.
GROSS MARGIN
Gross margin as a percentage of sales for the three month period ended
March 31, 1998 increased to 42.5% from 39.7% in the corresponding period in the
prior year. The increase in gross margin was caused by higher gross margins on
sales of power management products. The Company's ability to increase gross
margins will depend on the successful introduction of its new proprietary
products and increasing manufacturing output at the Company's wafer fabrication
facility to spread the fixed costs over an increasing number of units, thereby
reducing the fixed costs per unit.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses for the three month period ended March
31, 1998 increased to $1.3 million compared to $1.2 million for the
corresponding period in the prior year. This increase was primarily due to an
increase in salaries and wages and associated costs for additional design and
application engineers. Such expenses as a percent of sales decreased in the
three month period ended March 31, 1998 to 8.5% of sales compared to 10.6% of
sales for the corresponding period in the prior year. The Company expects
research and development expenses generally to increase in absolute dollars in
future periods although such expenses may fluctuate as a percentage of net
sales.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the three month period
ended March 31, 1998 increased to $2.5 million compared to $2.1 million for the
corresponding period in the prior year. This increase was primarily due to
increases in salaries and staffing in sales and administration and increased
advertising for new product support. Such expenses as a percent of sales
decreased in the three month period ended March 31, 1998 to 16.3% of sales
compared to 18.5% of sales for the corresponding period in the prior year. The
Company expects selling, general and administrative expenses generally to
increase in absolute dollars in future periods although such expenses may
continue to fluctuate as a percentage of net sales.
10
<PAGE>
INTEREST INCOME (EXPENSE), NET
For the three month period ended March 31, 1998, net interest income was
$96,000 compared to net interest expense of $174,000 for the corresponding
period in the prior year. The increase in net interest income is due to lower
interest expenses associated with equipment financing.
INCOME TAXES
The effective tax rate for the three month period ended March 31, 1998 was
27% which reflects a blended rate of United States, Hong Kong, and German tax
rates. This effective rate compares to (3.9)% for the corresponding period in
the prior year which was a result of a tax rate of 27% reflecting the blended
rate of United States, Hong Kong, and German tax rates, offset by the recording
of a valuation allowance on the income tax benefit of the loss on foundry
investment.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1998, the Company had $19.9 million of cash, cash
equivalents and marketable securities. The Company generated $2.8 million of
cash from operating activities during the three months ended March 31, 1998
primarily reflecting net income of $2.1 million, depreciation of $1.3 million
and a net decrease of $.6 million in working capital items. The net decrease in
working capital items primarily reflects an increase in current liabilities of
$.3 million, an increase in income taxes payable of $.4 million, offset by an
increase in accounts receivable of $.6 million and an increase in inventories of
$1.0 million.
At March 31, 1998, the Company had notes payable of $5.4 million, the
proceeds of which were utilized to purchase certain equipment securing such
notes. These notes bear interest ranging from 9% to 13% per annum and are
payable in monthly installments of principal and interest.
The Company believes that its current cash and cash equivalent balances,
together with anticipated cash flow from operations, will be sufficient to meet
the Company's needs for the next twelve months.
CERTAIN FACTORS AFFECTING FUTURE RESULTS OF OPERATIONS
The Company's future results of operations are dependent upon a number of
factors, including those described below:
Dependence on New Products. The Company's success depends upon its ability
to develop new analog circuits for existing and new markets, to introduce such
products in a timely manner and to have such products gain market acceptance.
The development of new analog circuits is highly complex and from time to time
the Company has experienced delays in developing and introducing new products.
Successful product development and introduction depends on a number of factors
including proper new product definition, timely completion of design and testing
of new products, achievement of acceptable manufacturing yields and market
acceptance of the Company's and its customers' products. Moreover, successful
product design and development is dependent on the Company's ability to attract,
retain and motivate qualified analog design engineers, of which there is a
limited number. There can be no assurance that the Company will be able to meet
these challenges or adjust to changing market conditions as quickly and cost-
effectively as necessary to compete successfully. Due to the complexity and
variety of analog circuits, the limited number of analog circuit designers and
the limited effectiveness of computer-aided design systems in the design of
analog circuits, there can be no assurance that the Company will be able to
continue to successfully develop and introduce new products on a timely basis.
Although the Company seeks to design products that have the potential to become
industry standard products, there can be no assurance that any products
introduced by the Company will be adopted by such market leaders, or that any
product initially accepted by the Company's customers that are market leaders
will become industry standard products. The Company's failure to continue to
develop and introduce new products successfully could materially and adversely
affect its business and operating results.
11
<PAGE>
The Company's results of operations are dependent on the balance between
sales of relatively higher margin but lower volume proprietary products and
relatively higher volume but lower margin second source products. In order to
improve its margins, sales of proprietary products must in the future represent
a greater percentage of the Company's net revenues, requiring the Company to
successfully develop, introduce and market new proprietary products. There can
be no assurance that the Company will be successful in developing new
proprietary products with the features and functionality that customers in its
key markets will demand.
Manufacturing Risks. The fabrication of integrated circuits is a highly
complex and precise process. Minute impurities, contaminants in the
manufacturing environment, difficulties in the fabrication process, defects in
the masks used to print circuits on a wafer, manufacturing equipment failures,
wafer breakage or other factors can cause a substantial percentage of wafers to
be rejected or numerous die on each wafer to be nonfunctional. The majority of
the Company's costs of manufacturing are relatively fixed, and, consequently,
the number of shippable die per wafer for a given product is critical to the
Company's results of operations. To the extent the Company does not achieve
acceptable manufacturing yields or experiences product shipment delays, its
financial condition or results of operations would be materially and adversely
affected. The Company has from time to time in the past experienced lower than
expected production yields, which have delayed product shipments and adversely
affected gross margins. For example, in the quarter ended December 31, 1996,
the Company experienced lower production volumes in an effort to reduce
inventories, which adversely effected gross margins. As the Company continues
to increase its manufacturing output, there can be no assurance that the Company
will not experience a decrease in manufacturing yields. Moreover, there can be
no assurance that the Company will be able to maintain acceptable manufacturing
yields in the future. In order to meet anticipated future demand, the Company
believes that it will need to increase its manufacturing capacity. Failure to
do so could result in a loss of customers, which could materially and adversely
affect the Company's financial condition or results of operations.
The Company currently manufactures substantially all of its products at its
wafer fabrication facility in Mountain View, California. Given the complex
nature of the Company's products, it would be difficult for the Company to
arrange for independent manufacturing facilities to supply such products. Any
prolonged inability to utilize the Company's manufacturing facility as a result
of fire, natural disaster or otherwise would have material adverse effect on the
Company's financial condition and results of operations. During periods of
decreased demand, high fixed wafer fabrication costs could have a material
adverse effect on the Company's financial condition or results of operations.
Furthermore, the Company is dependent on a number of local subcontractors for
certain of its manufacturing processes. The failure of any of these
subcontractors to perform these processes on a timely basis could result in
manufacturing delays, which could materially and adversely affect the Company's
results of operations.
Dependence on New Technologies; Technological Change. The markets for the
Company's products are characterized by rapid technological change and frequent
new product introductions. To remain competitive, the Company must develop or
obtain access to new semiconductor process technologies in order to reduce die
size, increase die performance and functional complexity and improve
manufacturing yields. Semiconductor designs and process methodologies are
subject to rapid technological change, requiring large expenditures for research
and development. If the Company is unable to define, design, develop and
introduce competitive new products on a timely basis, its future operating
results will be materially and adversely affected. In addition, the Company's
ability to compete successfully depends on being able to use advanced analog
process technologies to manufacture its products. There can be no assurance
that the analog process technology utilized by the Company will not become
obsolete.
Intense Competition. The analog semiconductor industry is highly
competitive and subject to rapid technological change. Significant competitive
factors in the analog market include product features, performance, price, the
timing of product introductions, the emergence of new computer standards and
other customer systems, product quality and customer support. Because the
standard products market for analog integrated circuits is diverse and highly
fragmented, the Company encounters different competitors in its
12
<PAGE>
various product markets. The Company's principal competitors include Linear
Technology Corporation, Maxim Integrated Products and Harris Semiconductor in
one or more of its product areas. Other competitors include Motorola, National
Semiconductor Corporation, Unitrode Corporation and certain Japanese
manufacturers. Each of these competitors has substantially greater technical,
financial and marketing resources and greater name recognition than the Company.
The Company expects intensified competition from existing analog circuit
suppliers and the possible entry of new competition. Increased competition could
adversely affect the Company's financial condition or results of operations.
There can be no assurance that the Company will be able to compete successfully
in the future or that competitive pressures will not adversely affect the
Company's financial condition and results of operations. Competitive pressures
could reduce market acceptance of the Company's products and result in price
reductions and increases in expenses that could adversely affect the Company's
financial condition or results of operations.
Dependence on International Sales and Operations. International sales for
the three month period ended March 31, 1998 were 64% of total sales for the
period compared to 61% of total sales for the same period in the prior year. The
Company expects international sales to continue to represent a significant
portion of product sales. International sales and operations involve various
risks, including unexpected changes in regulatory requirements, delays resulting
from difficulty in obtaining export licenses for certain technology, tariffs and
other barriers and restrictions, and the burdens of complying with a variety of
foreign laws. The Company is also subject to general political risks in
connection with its international operations, such as political and economic
instability and changes in diplomatic and trade relationships. In addition,
because a substantial majority of the Company's international sales are
denominated in United States dollars, increases in the value of the dollar would
increase the price in local currencies of the Company's products in foreign
markets and make the Company's products relatively more expensive than
competitors' products, the sales of which are denominated in local currencies.
There can be no assurance that regulatory, political and other factors will not
adversely affect the Company's operations in the future or require the Company
to modify its current business practices.
Customer and Distributor Concentration. A limited number of customers and
distributors has accounted for a significant portion of the Company's net sales.
For the three month period ended March 31, 1998, three OEM customers, Motorola,
Intel and Compaq Computer, accounted for approximately 40%, 6% and 5%,
respectively, of net sales compared to 29%, 2% and 6%, respectively, of net
sales for the same period in the prior year. Future Electronics, one of the
Company's distributors, accounted for 11% of the Company's net sales for the
three month period ended March 31, 1998 compared to 12% of net sales for the
same period in the prior year. The Company anticipates that it will continue to
be dependent or may increase its dependence on a number of key customers and
distributors for a significant portion of its net sales. The reduction, delay
or cancellation of orders from one or more significant customers for any reason
could materially and adversely affect the Company's operating results. The
Company is also dependent on sales representatives and distributors for the sale
of its products to many of its customers. Such distributors sell competitors'
products and are not within the control of the Company. Loss of one or more of
the Company's current distributors or disruption of the Company's sales and
distribution channels could materially and adversely affect the Company's
business and operating results.
Dependence on Key Suppliers; Outsourcing of Assembly Operations. The
packaging of the Company's products is performed by a limited group of
subcontractors and certain of the raw materials included in such products are
obtained from a limited group of suppliers. For example, 5 inch silicon
substrates, which are a key component of the Company's products, are currently
available from only two suppliers and are subject to long ordering lead times.
Although the Company seeks to reduce its dependence on its sole and limited
source suppliers, disruption or termination of any of these sources could occur
and such disruptions could have a material adverse effect on the Company's
financial condition or results of operations. Moreover, a prolonged inability
to obtain raw materials could have a material adverse effect on the Company's
financial condition or results of operations and could result in damage to
customer relationships.
The Company depends on and may in the future depend on third party
subcontractors. For example, all of the Company's products are currently
assembled by independent third parties in Asia. In the event that
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any of the Company's subcontractors were to experience financial, operational,
production or quality assurance difficulties resulting in a reduction or
interruption in supply to the Company, the Company's operating results would be
adversely affected until alternative subcontractors, if any, became available.
Patents and Intellectual Property. The Company's success depends in part
in its ability to obtain patents and licenses and to preserve other intellectual
property rights covering its manufacturing processes, products and development
and testing tools. The Company seeks patent protection for those inventions and
technologies for which it believes such protection is suitable and is likely to
provide a competitive advantage to the Company. The process of seeking patent
protection can be long and expensive and there can be no assurance that its
current patents or any new patents that may be issued will be of sufficient
scope or strength to provide any meaningful protection or any commercial
advantage to the Company. The Company may in the future be subject to or
initiate interference proceedings in the United States Patent and Trademark
office, which can demand significant financial and management resources.
The Company regards elements of its manufacturing process, product design
and equipment as proprietary and seeks to protect its proprietary rights through
a combination of employee and third party non-disclosure agreements, internal
procedures and patent protection. Notwithstanding the Company's attempts to
protect its proprietary rights, the Company believes that its future success
will depend primarily upon the technical expertise, creative skills and
management abilities of its officers and key employees rather than on patent and
copyright ownership. The Company also relies substantially on trade secrets and
proprietary technology to protect technology and manufacturing know-how, and
works actively to foster continuing technological innovation to maintain and
protect its competitive position. There can be no assurance that the Company's
competitors will not independently develop or patent substantially equivalent or
superior technologies.
Although the Company is not currently a party to any material litigation,
the semiconductor industry is characterized by frequent litigation regarding
patent and other intellectual property rights. There can be no assurance that
any patent owned by the Company will not be invalidated, circumvented or
challenged, that the rights granted thereunder will provide competitive
advantages to the Company or that any of the Company's pending or future patent
applications will be issued with the scope of the claims sought by the Company,
if at all. In addition, effective copyright and trade secret protection may be
unavailable or limited in certain foreign countries.
As is typical in the semiconductor industry, the Company has from time to
time received, and may in the future receive, communications from third parties
asserting patents, mask work rights, or copyrights on certain of the Company's
products and technologies. Although the Company is not currently a party to any
material litigation, in the event a third party were to make a valid
intellectual property claim and a license was not available on commercially
reasonable terms, the Company's operating results could be materially and
adversely affected. Litigation, which could result in substantial cost to the
Company and diversion of its resources, may also be necessary to enforce patents
or other intellectual property rights of the Company or to defend the Company
against claimed infringement of the rights of others. The failure to obtain
necessary licenses or the occurrence of litigation relating to patent
infringement or other intellectual property matters could have a material
adverse effect on the Company's business and operating results. There can be no
assurance that the steps taken by the Company to protect its intellectual
property will be adequate to prevent misappropriation or that others will not
develop competitive technologies or products.
Environmental and Other Governmental Regulations. Federal, state and local
regulations impose various controls on the storage, handling, discharge and
disposal of chemicals and gases used in the Company's manufacturing process and
on the facility leased by the Company in Mountain View, California. The Company
believes that its activities conform to present governmental regulations
applicable to its operations and its current facilities including those related
to environmental, land use, public utility utilization and fire code matters.
Increasing public attention has, however, been focused on the environmental
impact of semiconductor operations and the risk to neighbors of chemical
releases from such operations. There can be no assurance that such governmental
regulations will not in the future impose the need for additional capital
14
<PAGE>
equipment or other process requirements upon the Company or restrict the
Company's ability to expand its operations. In this regard, the City of
Mountain View, where the Company's wafer fabrication facility is located,
adopted an ordinance which restricts the storage and use of hazardous materials
within the proximity of certain sensitive uses, including hospitals, day care
facilities and schools. Although the Company's operations have not been
adversely affected by the ordinance, there can be no assurance that this
ordinance will not materially adversely affect the Company's future operations.
The adoption of this ordinance or similar measures or any failure by the Company
to comply with applicable environmental and land use regulations or to restrict
the discharge of hazardous substance could subject the Company to future
liability or could cause its manufacturing operations to be curtailed or
suspended.
The Company acquired the semiconductor manufacturing operations of
Teledyne, Inc. previously conducted at the Company's facility. The
semiconductor manufacturing operations conducted by Teledyne at the facility
allegedly contaminated the soil and groundwater of the facility and the
groundwater of properties located down-gradient of the facility. Although the
Company was indemnified by Teledyne as part of the acquisition transaction
against, among other things, any liabilities arising from any such
contamination, there can be no assurance that claims will not be made against
the Company or that such indemnification will be available or will provide
meaningful protection at the time any such claim is brought. To the extent the
Company is subject to a claim which is not covered by the indemnity from
Teledyne or as to which Teledyne is unable to provide indemnification, the
Company's financial condition or results of operations could be materially and
adversely affected.
Semiconductor Industry. The semiconductor industry is characterized by
rapid technological change, cyclical market patterns, significant price erosion,
periods of over-capacity and production shortages, variations in manufacturing
costs and yields and significant expenditures for capital equipment and product
development. The industry has from time to time experienced depressed business
conditions. There can be no assurance that any future downturn in the industry
will not be severe or that any such downturn will not have a material adverse
effect on the Company's results of operations. There can be no assurance that
the Company will not experience substantial period-to-period fluctuations in
operating costs due to general semiconductor industry conditions or other
factors.
Year 2000 Issues. There is a risk to the Company from unforeseen problems
related to the "Year 2000 issue." The "Year 2000" issue arises because most
computer systems and programs were designed to handle only a two-digit year, not
a four-digit year. When Year 2000 begins, these computers may interpret "00" as
the year 1900 and could either stop processing date related computations or
could process them incorrectly. The Company has performed an initial assessment
of its information system and does not anticipate any internal Year 2000 issues
from its own information systems, databases or programs. However, the Company
could be adversely impacted by Year 2000 issues faced by major distributors,
suppliers, customers, vendors, and financial organizations with which the
Company interacts. The Company is in the process of developing a plan to
determine the impact that third parties who are not Year 2000 compliant may have
on the operations of the Company.
Market Risk Disclosure.
Interest Rate Risk The Company does not use derivative financial
instruments in its investment portfolio. The Company's investment portfolio is
generally comprised of municipal government securities that mature within one
year. The Company places investments in instruments that meet high credit
quality standards. These securities are subject to interest rate risk, and could
decline in value if interest rates fluctuate. Due to the short duration and
conservative nature of the Company's investment portfolio, the Company does not
expect any material loss with respect to its investment portfolio.
Foreign Currency Exchange Rate Risk- Certain of the Company's sales, cost
of manufacturing and marketing are transacted in local currencies. As a result,
the Company's international results of operations are subject to foreign
exchange rate fluctuations. The Company does not currently hedge against foreign
currency rate fluctuations. Gains and losses from such fluctuations have not
been material to the Company's
15
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consolidated results of operations.
16
<PAGE>
PART II. OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are being filed as part of this report.
27.1 Financial Data Schedule
(b) No reports on Form 8-K were filed during the fiscal quarter for
which this report is filed.
17
<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.
TELCOM SEMICONDUCTOR, INC.
(Registrant)
Date: May 4, 1998 By: /s/ Phillip M. Drayer
----------------------------------
Phillip M. Drayer
President
Chief Executive Officer
Date: May 4, 1998 By: /s/ R. Michael O'Malley
----------------------------------
R. Michael O' Malley
Chief Financial Officer
18
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