<PAGE>
================================================================================
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 SEPTEMBER 30, 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
November 9, 1998 was 14,479,676.
================================================================================
<PAGE>
TELCOM SEMICONDUCTOR, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
INDEX
<TABLE>
<CAPTION>
PAGE
NO.
<S> <C>
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 6-9
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10-19
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
</TABLE>
2
<PAGE>
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 Nine Months Ended
--------------------------------- ----------------------------------
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
1998 1997 1998 1997
-------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
Net sales $ 12,702 $ 15,564 $ 42,199 $ 40,420
Cost of sales 8,790 8,556 26,592 22,942
-------------- ------------- -------------- -------------
Gross profit 3,912 7,008 15,607 17,478
-------------- ------------- -------------- -------------
Operating expenses:
Research and development 1,440 1,637 4,131 4,212
Selling, general and administrative 2,159 2,455 7,443 6,842
Restructuring and other 6,781 - 6,781 -
Loss on foundry investment - - - 8,000
-------------- ------------- -------------- -------------
Total operating expenses 10,380 4,092 18,355 19,054
-------------- ------------- -------------- -------------
Income (loss) from operations (6,468) 2,916 (2,748) (1,576)
Interest income (expense), net 106 (76) 318 (345)
-------------- ------------- -------------- -------------
Income (loss) before income taxes (6,362) 2,840 (2,430) (1,921)
Provision (benefit) for income taxes (250) 766 811 1,641
-------------- ------------- -------------- -------------
Net income (loss) $ (6,112) $ 2,074 $ (3,241) $ (3,562)
============== ============= ============== =============
Per share data:
Net income (loss)
Basic $ (0.38) $ 0.13 $ (0.20) $ (0.22)
============== ============= ============== =============
Diluted $ (0.38) $ 0.12 $ (0.20) $ (0.22)
============== ============= ============== =============
Number of shares used to compute per
share data:
Basic 16,111 16,255 16,375 16,130
============== ============= ============== =============
Diluted 16,111 17,753 16,375 16,130
============== ============= ============== =============
</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>
Sept. 30, Dec. 31,
1998 1997
------------- -------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 15,500 $ 17,110
Marketable securities - 2,469
Accounts receivable 7,556 7,452
Inventory 7,117 8,289
Deferred income taxes 1,167 1,167
Other current assets 935 751
------------- -------------
Total current assets 32,275 37,238
Property and equipment, net 10,973 14,946
Other assets 1,500 1,500
------------- -------------
$ 44,748 $ 53,684
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable $ 2,097 $ 2,641
Accounts payable 3,221 3,461
Accrued liabilities 3,422 2,460
Deferred distributor income 1,740 1,429
Income taxes payable 1,895 2,566
------------- -------------
Total current liabilities 12,375 12,557
Notes payable 2,027 3,462
Other long term liabilities 1,066 -
Deferred income taxes 1,244 1,244
------------- -------------
Total liabilities 16,712 17,263
------------- -------------
Stockholders' equity:
Common stock 15 16
Additional paid-in capital 35,062 34,389
Notes receivable from stockholders (2) (2)
Treasury stock (5,816) -
Retained earnings (accumulated deficit) (1,223) 2,018
------------- -------------
Total stockholders' equity 28,036 36,421
------------- -------------
$ 44,748 $ 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>
Nine Months Ended
----------------------------------
Sept. 30,
----------------------------------
1998 1997
-------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (3,241) $ (3,562)
Adjustments to reconcile net income (loss) to net
cash provided by (used for) operating activities:
Loss on foundry investment - 8,000
Restructuring and other 6,781 -
Depreciation and amortization 4,277 2,874
Changes in assets and liabilities:
Accounts receivable (104) (2,167)
Inventory 1,172 (1,155)
Income tax receivable - 1,430
Other current assets 116 54
Accounts payable (240) 3,724
Accrued liabilities 96 760
Deferred distributor income 311 292
Income taxes payable (671) 1,273
-------------- --------------
Net cash provided by operating activities 8,497 11,523
-------------- --------------
Cash flows from investing activities:
Purchases of property and equipment (5,453) (5,656)
Sales of marketable securities, net 2,469 5,202
-------------- --------------
Net cash used for investing activities (2,984) (454)
-------------- --------------
Cash flows from financing activities:
Proceeds from sale of common stock 672 787
Repurchase of common stock (5,816)
Notes receivable from stockholders - 9
Borrowings on notes payable - 283
Payments on notes payable (1,979) (2,550)
-------------- --------------
Net cash used for financing activities (7,123) (1,471)
-------------- --------------
Net increase (decrease) in cash and cash
Equivalents (1,610) 9,598
Cash and cash equivalents at the beginning of period 17,110 12,761
-------------- --------------
Cash and equivalents at the end of period $ 15,500 $ 22,359
============== ==============
</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 September 30.
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 September 30, 1998 should be
read in conjunction with the Company's Annual Report on Form 10-K for the year
ended December 31, 1997 and its quarterly reports on Form 10-Q for the periods
ended March 31, 1998 and June 30, 1998.
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 Nine Months Ended
------------------------------------ -----------------------------------
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
1998 1997 1998 1997
-------------- --------------- -------------- --------------
<S> <C> <C> <C> <C>
Net income (loss) available to
common shareholders $ (6,112) $ 2,074 $ (3,241) $ (3,562)
============== =============== ============== ==============
Weighted average common stock
outstanding (basic) 16,111 16,255 16,375 16,130
Effect of dilutive warrants and - 1,498 - -
options
-------------- --------------- -------------- --------------
Weighted average common stock
outstanding (diluted) 16,111 17,753 16,375 16,130
============== =============== ============== ==============
Net income (loss) per share:
Basic $ (0.38) $ 0.13 $ (0.20) $ (0.22)
============== =============== ============== ==============
Diluted $ (0.38) $ 0.12 $ (0.20) $ (0.22)
============== =============== ============== ==============
</TABLE>
Due to the company's net loss from operations for the three and nine month
periods ended September 30, 1998, a calculation of EPS assuming dilution is not
required. At September 30, 1998, there were 2,925,075 options and warrants
outstanding to purchase common stock at a weighted average exercise price of
$3.78 per share.
Due to the company's net loss from operations for the nine months ended
September 30, 1997, a calculation of EPS assuming dilution is not required. At
September 30, 1997, there were 2,054,185 options and warrants outstanding to
purchase common stock at a weighted average exercise price of $3.69 per share.
In June 1998, the Company's Board of Directors approved a repricing of
outstanding employee stock options. As a result of the repricing, 934,243
options with exercise prices ranging from $7.00 to $15.94 were exchanged for new
stock options with an exercise price of $4.31 per share.
In July 1998, the Company's Board of Directors approved a stock repurchase
program whereby up to 2,000,000 shares of the Company's common stock may be
purchased in the open market from time to time. As of September 30, 1998,
1,317,500 shares have been repurchased for $5.8 million.
In October 1998, the Company's Board of Directors approved a stock
repurchase program whereby an additional 2,000,000 shares of the Company's
common stock may be purchased in the open market from time to time. Subsequent
to September 30, 1998, 959,500 shares had been repurchased for $2 million.
7
<PAGE>
3. Balance Sheet Details:
<TABLE>
<CAPTION>
Sept. 30, Dec. 31,
1998 1997
--------------- --------------
<S> <C> <C> <C>
Inventory:
Raw material $ 651 $ 871
Work in process 4,652 4,385
Finished goods 1,814 3,033
--------------- --------------
$ 7,117 $ 8,289
=============== ==============
Property and equipment:
Equipment $ 15,674 $ 20,081
Carrying value of fab assets to be
disposed of 2,239 -
Leasehold improvements 81 2,708
--------------- --------------
17,994 22,789
Accumulated depreciation (7,523) (9,811)
--------------- --------------
10,471 12,978
Construction in progress 502 1,968
--------------- --------------
$ 10,973 $ 14,946
=============== ==============
Accrued liabilities:
Payroll and related $ 2,695 $ 1,667
Customer deposits and other 727 793
--------------- --------------
$ 3,422 $ 2,460
=============== ==============
</TABLE>
4. Restructuring and Other Charges
In September 1998, the Company recorded a $6.1 million restructuring charge
to write down and write off manufacturing equipment and facilities improvements;
accrue for future idle facility space; the severance of manufacturing and other
personnel and other costs.
The Company plans to shut down its five-inch wafer fabrication facility in
Mountain View, California and use third party foundries for all of its wafer
fabrication. A majority of the Company's new products that have been developed
in the past year utilize sub-micron wafer technology and are currently
fabricated by outside foundries. All other remaining wafers are fabricated in
the Mountain View facility. The fabrication of these wafers is anticipated to be
transferred to third party foundries prior to the end of 1998. The facility
shutdown is a result of developments in the semiconductor industry, primarily
decreasing average selling prices, and the availability of low cost wafer
fabrication capacity. Competitive designs use submicron technology which allows
for more die per wafer than the five inch wafer fabrication currently used in
the Mountain View facility. To convert the Mountain View facility to a six inch
submicron facility the Company would be required to make substantial investments
in its facility and equipment over a period of time. By utilizing wafer
foundries with six inch submicron facilities, the Company believes that it will
be able to qualify and purchase wafers in a shorter time period and at a lower
cost. The majority of the third quarter charge relates to the write down of the
carrying value of the Company's fabrication equipment to estimated fair value.
The
8
<PAGE>
cost and accumulated depreciation of the fabrication equipment prior to the
write down was $13,027,000 and $6,330,000, respectively. The fair value of the
fabrication equipment was estimated to be $2,239,000 resulting in a write down
of $4,458,000 during the third quarter. The fair value of the fabrication
equipment was based on third party estimates of fair value.
The third quarter restructuring charge also included accrued future lease costs
for the facility that will be left idle as a result of the facility closure. The
Company has a five year operating lease for the facility which expires in
December 2004. As a result of the fabrication facility closure, the facility
will remain idle for the remainder of the lease term.
Additionally, the third quarter restructuring charge included severance payments
for approximately 38 employees, to be terminated upon closing of the facility.
Because of the structure of the severance plan, the Company anticipates
recording an additional $400,000 in the fourth quarter of 1998 related to
severance costs for such employees.
The following table sets forth the Company's accruals for third quarter
restructuring expense and charges taken against the accrual for the quarter
ended September 30, 1998 and the remaining restructuring accrual balance at
September 30, 1998:
(in thousands)
<TABLE>
<CAPTION>
1998
Restructuring Balance
Expense Utilized Sept. 30, 1998
----------------- --------------- ----------------
<S> <C> <C> <C>
Future idle facility charge $ 1,406 $ - $ 1,406
Employee severance and other 276 - 276
----------------- --------------- ----------------
$ 1,682 $ - $ 1,682
================= =============== ================
</TABLE>
Separately, the Company recorded other one time charges of $641,000 during the
third quarter of 1998, comprised of $391,000 for the write-off of certain
equipment in Hong Kong and $250,000 for certain litigation settlement costs.
These charges were included in Restructuring and other as a separate component
of operating expenses.
5. 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 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 its $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.
9
<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 plans to shut down its five-inch wafer fabrication facility in
Mountain View, California and use third party foundries for all of its wafer
fabrication. A majority of the Company's new products that have been developed
in the past year utilize sub-micron wafer technology and are currently
fabricated by outside foundries. All other remaining wafers are fabricated in
the Mountain View facility. The fabrication of these wafers is anticipated to be
transferred to third party foundries prior to the end of 1998. The facility
shutdown is a result of developments in the semiconductor industry, primarily
decreasing average selling prices, and the availability of low cost wafer
fabrication capacity. Competitive designs use submicron technology which allows
for more die per wafer than the five inch wafer fabrication currently used in
the Mountain View facility. To convert the Mountain View facility to a six inch
submicron facility the Company would be required to make substantial investments
in its facility and equipment over a period of time. By utilizing wafer
foundries with six inch submicron facilities, the Company believes that it will
be able to qualify and purchase wafers in a shorter time period and at a lower
cost. As a result, the Company recorded restructuring and other charges
totaling $6.8 million during the three months ended September 30, 1998. The
majority of the estimated third quarter charge relates to the write down of the
carrying value of the Company's fabrication equipment to estimated fair value.
The fair value of the fabrication equipment is based on third party estimates of
fair value.
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
10
<PAGE>
customer demand, which is highly unpredictable and can fluctuate substantially.
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 agreement with IC
WORKS, Inc., in the fourth quarter of 1997, the Company sold its $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 final production wafers were
received from IC WORKS in the quarter ending March 1998.
RESULTS OF OPERATIONS
NET SALES
Net sales for the three month and nine month periods ended September 30,
1998 decreased $2.9 million or 18.4% and increased $1.8 million or 4.4%,
respectively, from the corresponding periods in the prior fiscal year. The
decrease in net sales for the three month period ending September 30, 1998 was
primarily due to lower sales volume in the Company's mixed signal and sensor
product lines. The increase in net sales for the nine month period ending
September 30, 1998 was primarily due to higher volume of sales in the Company's
power management product line offset by lower sales volume in the Company's
mixed signal and sensor product lines. International sales for the three month
and nine month periods ended September 30, 1998 were 67% and 65%, respectively,
of total sales compared to 64% of total sales for each of the same periods in
the prior year. Sales in the European market decreased in the three month period
ended September 30, 1998 by $1.3 million, or 27% and increased in the nine month
period ended September 30, 1998 by $1.5 million, or 12% compared to the three
month and nine month periods ended September 30, 1997, primarily due to changes
in sales of power management products. For the three month period ended
September 30, 1998, three OEM customers, Motorola, Intel and Compaq Computer,
accounted for approximately 40%, 10% and 3%, respectively, of net sales compared
to 33%, 2% and 8%, respectively, of net sales for the same period in the prior
year. In the nine month period ended September 30, 1998, Motorola, Intel and
Compaq Computer accounted for approximately 38%, 8% and 5%, respectively, of net
sales compared to 30%, 3% and 7%, respectively, of net sales for the same period
in the prior year. Future Electronics, one of the Company's distributors,
accounted for 13% and 12%, respectively, of the Company's net sales for the
three month and nine month periods ended September 30,1998 compared to 10% of
net sales for each of the same periods in the prior year.
GROSS PROFIT
Gross profit as a percentage of sales (gross margin) for the three month
and nine month periods ended September 30, 1998 decreased to 30.8% and 37.0%,
respectively, from 45.0% and 43.2%, respectively, in the corresponding periods
in the prior year. The decreases in gross margin were caused by lower production
volume in the Company's wafer fabrication facility due to lower wafer starts
associated with a planned inventory reduction program. The Company's ability to
increase gross margins will depend on the successful introduction of its new
proprietary products and controlling its wafer costs. As part of the
11
<PAGE>
Company's restructuring plan, the Company is closing its wafer fabrication
facility and will rely on wafer foundries for fabricated wafers. Thus, future
wafer costs will depend on the volume and availability of wafers from the
Company's wafer fabrication foundries.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses for the three month and nine month
periods ended September 30, 1998 decreased to $1.4 million and $4.1 million,
respectively, compared to $1.6 million and $4.2 million, respectively, for the
corresponding periods in the prior year. Such expenses as a percentage of sales
increased to 11.3% and 9.8% of sales in the three month and nine month periods
ending September 30, 1998, respectively, compared to 10.5% and 10.4%,
respectively, for the corresponding periods 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 September 30, 1998 decreased to $2.2 million compared to $2.5 million for
the corresponding period in the prior year. Selling, general and administrative
expenses for the nine month period ended September 30, 1998 increased to $7.4
million compared to $6.8 million for the corresponding period in the prior year.
The decrease over the third quarter period was primarily due to decreases in
outside sales commissions from lower sales and a decrease in advertising costs.
Such expenses as a percentage of sales increased in the three month and nine
month periods ended September 30, 1998 to 17.0% and 17.6% of sales,
respectively, compared to 15.8% and 16.9% of sales, respectively, for the
corresponding periods 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.
RESTRUCTURING AND OTHER
During the third quarter of 1998, the Company recognized restructuring and
other charges of $6.8 million related to the closure of its Mountain View,
California fabrication facility. The restructuring charge includes a write down
of fabrication equipment of $4.5 million, costs associated with idle facility
space of $1.4 million and severance costs of $.2 million associated with the
closure. During the third quarter of 1998, the Company also recorded one time
charges of $.4 million for the disposition of certain equipment in Hong Kong and
$.3 million related to certain litigation settlement costs.
INTEREST INCOME (EXPENSE), NET
For the three month and nine month periods ended September 30, 1998, net
interest income was $106,000 and $318,000, respectively, compared to net
interest expense of $76,000 and $345,000, respectively, for the corresponding
periods in the prior year. The increase in net interest income over the three
month and nine month periods is due to lower interest cost associated with
equipment financing.
12
<PAGE>
INCOME TAXES
The effective tax rate for the three month and the nine month periods ended
September 30, 1998 was 4% and (33%), respectively, compared to 27% and (85%),
respectively, for the corresponding periods in the prior year. These rates are
a result of the mix of income (loss) from the United States, Hong Kong, and
Germany and the result of recording a valuation allowance relating to the
benefit of future tax deductions, the realization of which is not assured.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 1998, the Company had $15.5 million of cash, cash
equivalents and marketable securities. The Company generated $8.5 million of
cash from operating activities during the nine months ended September 30, 1998
primarily reflecting net income of $3.5 million before restructuring and other
charges, depreciation of $4.3 million and a net increase of $.7 million in
working capital items. The net increase in working capital primarily reflects an
decrease in inventories of $1.2 million.
The Company utilized $3.0 million of cash from investing activities during
the nine months ended September 30, 1998 primarily reflecting the purchase of
production equipment for $5.5 million offset by the sale of marketable
securities of $2.5 million.
The Company utilized $7.1 million of cash from financing activities during
the nine months ended September 30, 1998 primarily due to the repurchase of the
Company's common stock for $5.8 million and payments on notes payable of $2.0
million.
At September 30, 1998, the Company had notes payable of $4.1 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, cash equivalent and marketable
securities balances, together with anticipated cash flow from operations, will
be sufficient to meet the Company's needs for the next twelve months.
RECENTLY ISSUED ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes a new model for
accounting for derivatives and hedging activities and supercedes and amends a
number of existing accounting standards. SFAS 133 requires that all derivatives
be recognized in the balance sheet at their fair market value, and the
corresponding derivative gains or losses be either reported in the statement of
operations or as a deferred item depending on the type of hedge relationship
that exists with respect to such derivative. Adopting the provisions of SFAS
133 are not expected to have a material effect on the Company's consolidated
financial statements. The standard is effective for the Company in fiscal 2000.
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
13
<PAGE>
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.
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.
Increased Dependence On Wafer Suppliers. The Company has historically
obtained at least a majority of it wafers from its own wafer fabrication
facility. Since the quarter ended December 31, 1997, the Company has obtained
wafers for a majority of its new products from independent wafer fabrication
foundries. The Company is currently planning to shut down its wafer fabrication
facility, and, as a result, within the next six months, the Company expects that
all of its wafer requirements will be supplied by outside foundries. There are
certain significant risks associated with the Company's increased reliance on
outside foundries, including the lack of assured wafer supply and control over
delivery schedules, the unavailability of or delay in obtaining access to key
process technologies and limited control over manufacturing yields and
production costs. In addition, the manufacture of integrated circuits is a
highly complex and technically demanding process. Although the Company has
undertaken to diversify its sources of wafer supply and works closely with its
foundries to minimize the likelihood of reduced manufacturing yields, all of the
major wafer foundries have from time to time experienced lower than anticipated
manufacturing yields, particularly in connection with the introduction of new
products and the installation and start-up of new process technologies. Lower
than expected yields at foundries that supply the Company could materially and
adversely affect the Company's operating results. In addition, the Company's
reliance upon offshore foundries will subject the Company to risks of exchange
rate fluctuations, export and import restrictions, trade sanctions, tariff
increases and political instability.
The Company's current and expected purchases of wafers from outside
foundries are pursuant to purchase orders and, accordingly, the Company does not
and will not have a guaranteed level of wafer capacity. Therefore, the Company's
wafer suppliers could choose to prioritize capacity for other uses or reduce or
eliminate deliveries to the Company on short notice. Although there is currently
ample available capacity in the industry, the semiconductor industry is highly
cyclical and in recent years, wafer capacity has been quite scarce. Thus,
particularly in times of scarce capacity, there can be no assurance that the
Company's foundries will allocate sufficient wafer capacity to satisfy the
Company's requirements. Any material disruptions in the supply of wafers to the
Company would materially and adversely affect the Company's operating results.
In the event of any such disruption, if the Company were unable to qualify
alternative manufacturing sources for existing and new products in a timely
manner or if such sources were unable to produce wafers with acceptable
manufacturing yields, the Company's business and operating results would be
materially and adversely affected.
14
<PAGE>
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 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 and nine month periods ended September 30, 1998 were 67% and
65%, respectively, of total sales compared to 64% of total sales for each of the
same periods 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 September 30, 1998, three OEM customers,
Motorola, Intel and Compaq Computer, accounted for approximately 40%, 10% and
3%, respectively, of net sales compared to 33%, 2% and 8%, respectively, of net
sales for the same period in the prior year. In the nine month period ended
September 30, 1998, Motorola, Intel and Compaq Computer accounted for
approximately 38%, 8% and 5%, respectively, of net sales compared to 30%, 3% and
7%, respectively, of net sales for the same period in the prior year. Future
Electronics, one of the Company's distributors, accounted for 13% and 12%,
respectively, of the Company's net sales for the three month and nine month
periods ended September 30, 1998 compared to 10% of net sales for each of the
same periods in the prior year. The Company anticipates that it will continue to
be dependent or may increase its
15
<PAGE>
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 would 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 also 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. 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 currently depends on third party subcontractors for all of its
assembly and a significant portion of its wafer fabrication needs. In connection
with its restructuring, the Company will rely on foundries for all of its future
fabricated wafer requirements. In the event that any of the Company's foundries
or 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 foundries or 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 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
16
<PAGE>
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
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. Over the last several quarters, depressed industry conditions have
adversely affected the Company's business and results of operations. The Company
expects these soft market conditions to continue into the second quarter of
1999. 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. The "Year 2000 Issue" is the result of computer programs
that were written using two digits rather than four to define the applicable
year. If the Company's computer programs with date-sensitive functions are not
Year 2000 compliant, they may recognize a date using "00" as the Year 1900
rather than the Year 2000. This could result in a system failure or
miscalculations causing disruptions of
17
<PAGE>
operations, including, among other things, a temporary inability to process
transactions, send invoices or engage in similar normal business activities.
The Company has identified its Year 2000 risk in four categories: internal
information systems; internal non-financial software and imbedded chip
technology; product compliance; and external noncompliance by third parties.
INTERNAL INFORMATION SYSTEMS. During 1997, the Company inventoried all of its
mission critical systems, programs and databases. Such systems, if failure
occurred, could result in a disruption in business operations that could have a
material adverse affect on the Company's operations. During 1998, the Company
completed an assessment of its mission critical systems. As a result of the
assessment, the Company does not anticipate any significant issues from its
internal information systems. Certain software packages will require upgrading
to Year 2000 compliant versions. The upgrades are expected to be completed by
June 1999. The costs incurred to-date for the assessment performed and the
anticipated costs to be incurred in the future to upgrade the software packages
to compliant versions are not expected to be material to the Company's financial
condition or results of operations and have been and will continue to be
expensed in the periods incurred. Since the Company has completed its
assessment and is in the process of making the necessary changes, the Company
has not developed a contingency plan for its internal information systems.
INTERNAL NON-FINANCIAL SOFTWARE AND IMBEDDED CHIP TECHNOLOGY. During 1998, the
Company completed an assessment of its non-financial software and imbedded chip
technology regarding the impact of the Year 2000 on such non-financial systems
as manufacturing equipment, and security equipment. As a result of the
assessment, the Company does not anticipate any significant issues from its non-
financial software and imbedded chip technology. If the Company is unable to
achieve Year 2000 compliance for its major non-financial systems, the Year 2000
could have a material impact on the operations of the Company. The costs
incurred to-date for the assessment performed and any anticipated costs to be
incurred in the future related to internal non-financial software and imbedded
chip technology are not expected to be material to the Company's financial
condition or results of operations and have been and will continue to be
expensed in the periods incurred. Since the Company has completed its
assessment and has not found any significant issues, the Company has not
developed a contingency plan for its internal non-financial software and
imbedded chip technology.
PRODUCT COMPLIANCE
The Company designs, develops, manufactures and markets a wide portfolio of high
performance integrated circuits. During 1998, the Company completed an
assessment of its current products regarding its compliance with the Year 2000
issue. As a result of the assessment, the Company believes its products are
Year 2000 compliant and does not anticipate any significant Year 2000 compliance
issues. If the Company's products were found not to be Year 2000 compliant, the
Year 2000 issue could have a material impact on the operations of the Company.
The costs incurred to-date, for the assessment performed and any anticipated
costs to be incurred in the future are not expected to be material to the
Company's financial condition or results of operations and have been and will
continue to be expensed in the periods incurred. Since the Company has
completed its assessment and has not found any significant issues, the Company
has not developed a contingency plan for its products.
EXTERNAL NONCOMPLIANCE BY CUSTOMERS AND SUPPLIERS. The Company is in the process
of identifying and contacting its critical suppliers, service providers and
contractors to determine the extent to which the Company's interface systems are
vulnerable to those third parties' failure to remedy their own Year 2000 issues.
It is expected that full identification of any noncompliance issues in this area
will be completed in the third quarter of 1999. To the extent that responses to
Year 2000 readiness are unsatisfactory, the Company intends to change suppliers,
service providers or contractors to those who have demonstrated Year 2000
readiness. However, there can be no assurance that the Company will be
successful in finding such alternative suppliers, service providers and
contractors. The costs incurred to-date for the assessment performed and any
anticipated costs to be incurred in the future are not expected to be material
to the
18
<PAGE>
Company's financial condition or results of operations and have been and will
continue to be expensed in the periods incurred. In the event that any of the
Company's significant customers and suppliers do not successfully and timely
achieve Year 2000 compliance, and the Company is unable to replace them with new
customers or alternate suppliers, the Company's business or operations could be
materially adversely affected.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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 consolidated results of operations.
19
<PAGE>
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.
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.
TELCOM SEMICONDUCTOR, INC.
(Registrant)
Date: November 13, 1998 By: /s/ Phillip M. Drayer
----------------------------------
Phillip M. Drayer
President
Chief Executive Officer
Date: November 13, 1998 By: /s/ Robert G. Gargus
----------------------------------
Robert G. Gargus
Chief Financial Officer
21
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