<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 June 30, 1999
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 August
6, 1999 was 14,214,899.
===============================================================================
<PAGE>
TELCOM SEMICONDUCTOR, INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1999
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 6-10
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11-19
Part II. Other Information
Item 4. Submission of Matters to a Vote of Security Holders 20
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 Six Months Ended
------------------------------------ --------------------------------------
June 30, June 30, June 30, June 30,
1999 1998 1999 1998
---------------- -------------- ---------------- ---------------
<S> <C> <C> <C> <C>
Net sales $ 13,867 $ 14,023 $ 26,675 $ 29,497
Cost of sales 7,351 8,907 15,126 17,802
---------------- -------------- ---------------- ---------------
Gross profit 6,516 5,116 11,549 11,695
---------------- -------------- ---------------- ---------------
Operating expenses:
Research and development 1,885 1,376 3,672 2,691
Selling, general and administrative 2,584 2,757 4,836 5,284
Restructuring & other - - 269 -
---------------- -------------- ---------------- ---------------
Total operating expenses 4,469 4,133 8,777 7,975
---------------- -------------- ---------------- ---------------
Income from operations 2,047 983 2,772 3,720
Interest income (expense), net 4 116 72 212
Gain on sale of investment 813 - 5,819 -
---------------- -------------- ---------------- ---------------
Income before income taxes 2,864 1,099 8,663 3,932
Provision for income taxes 879 296 1,896 1,061
---------------- -------------- ---------------- ---------------
Net income $ 1,985 $ 803 $ 6,767 $ 2,871
================ ============== ================ ===============
Per share data:
Net income
Basic $ 0.14 $ 0.05 $ .47 $ .17
================ ============== ================ ===============
Diluted $ 0.13 $ 0.05 $ .45 $ .16
================ ============== ================ ===============
Number of shares used to compute per
share data
Basic 14,106 16,537 14,310 16,506
================ ============== ================ ===============
Diluted 15,175 17,547 15,164 17,632
================ ============== ================ ===============
</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>
June 30, Dec. 31,
1999 1998
----------------------------- ------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 16,053 $ 14,059
Short term investments 1,271 -
Accounts receivable 8,140 6,944
Inventory 6,058 6,377
Deferred income taxes 826 1,099
Other current assets 1,304 799
------------------------ ------------------------
Total current assets 33,652 29,278
Property and equipment, net 8,404 10,388
Other assets - 1,500
------------------------ ------------------------
$ 42,056 $ 41,166
======================== ========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable $ - $ 1,886
Accounts payable 2,995 3,247
Accrued liabilities 2,489 2,982
Deferred distributor income 1,817 1,484
Income taxes payable 2,771 2,571
------------------------ ------------------------
Total current liabilities 10,072 12,170
Notes payable and other long term obligations, net
of current portion 926 2,678
Deferred income taxes 400 400
------------------------ ------------------------
Total liabilities 11,398 15,248
------------------------ ------------------------
Stockholders' equity:
Common stock 17 17
Additional paid-in capital 35,958 35,355
Treasury stock (10,964) (7,925)
Other comprehensive income 409 -
Retained earnings 5,238 (1,529)
------------------------ ------------------------
Total stockholders' equity 30,658 25,918
------------------------ ------------------------
$ 42,056 $ 41,166
======================== ========================
</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>
Six Months Ended
------------------------------------------
June 30,
------------------------------------------
1999 1998
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 6,767 $ 2,871
Adjustments to reconcile net income to net
cash provided by operating activities:
Gain on sale of investment (5,819) -
Depreciation and amortization 1,395 2,757
Changes in assets and liabilities:
Accounts receivable (1,196) (464)
Inventory 319 (323)
Other current assets (505) 181
Accounts payable (252) (772)
Accrued liabilities (493) (603)
Deferred distributor income 333 78
Income taxes payable 200 (78)
-------- --------
Net cash provided by operating activities 749 3,647
-------- --------
Cash flows from investing activities:
Purchases of property and equipment (374) (4,287)
Net proceeds from sale of equipment 963 -
Sale of investment, net 6,730 -
Sales of marketable securities, net - (544)
-------- --------
Net cash provided by (used for) investing activities 7,319 (4,831)
-------- --------
Cash flows from financing activities:
Proceeds from sale of common stock 603 602
Repurchase of common stock (3,039) -
Payments on notes payable (3,638) (1,319)
-------- --------
Net cash used for financing activities (6,074) (717)
-------- --------
Net increase in cash and cash equivalents 1,994 (1,901)
Cash and cash equivalents at the beginning of period 14,059 17,110
-------- --------
Cash and cash equivalents at the end of period $ 16,053 $ 15,209
======== ========
</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 June 30.
In the opinion of management, the unaudited condensed consolidated interim
financial statements have been prepared on the same basis as the December 31,
1998 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 June 30, 1999 should be read
in conjunction with the Company's Annual Report on Form 10-K for the year ended
December 31, 1998 and Form 10-Q for the period ended March 31, 1999.
2. Net Income per Share
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. 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 Six Months Ended
--------------------------------------- ---------------------------------------
June 30, June 30, June 30, June 30,
1999 1998 1999 1998
---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Net income available to
common shareholders $ 1,985 $ 803 $ 6,767 $ 2,871
======= ======= ======= =======
Weighted average common stock
Outstanding (basic) 14,106 16,537 14,310 16,506
Effect of dilutive warrants and options 1,069 1,010 854 1,126
------- ------- ------- -------
Weighted average common stock
Outstanding (diluted) 15,175 17,547 15,164 17,632
======= ======= ======= =======
Income per share:
Basic $ 0.14 $ 0.05 $ 0.47 $ 0.17
======= ======= ======= =======
Diluted $ 0.13 $ 0.05 $ 0.45 $ 0.16
======= ======= ======= =======
</TABLE>
Options to purchase 126,640 shares of commons stock at a weighted average
price of $8.71 per share were outstanding at June 30, 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. Options
to purchase 67,300 shares of commons stock at a weighted average price of $8.49
per share were outstanding at June 30, 1999 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.
7
<PAGE>
3. Balance Sheet Details:
<TABLE>
<CAPTION>
June 30, Dec. 31,
1999 1998
-------- --------
<S> <C> <C>
Inventory:
Raw material $ 18 $ 108
Work in process 4,305 4,331
Finished goods 1,735 1,938
-------- --------
$ 6,058 $ 6,377
======== ========
Property and equipment:
Equipment $ 15,691 $ 15,077
Leasehold improvements 123 81
-------- --------
15,814 15,158
Accumulated depreciation (9,461) (8,313)
-------- --------
6,353 6,845
Construction in progress 667 949
Carrying value of assets to be disposed of 1,384 2,594
-------- --------
$ 8,404 $ 10,388
======== ========
Accrued liabilities:
Payroll and related $ 1,808 $ 2,074
Other 681 908
-------- --------
$ 2,489 $ 2,982
======== ========
</TABLE>
Note 4. Restructuring and Other Charges
- ---------------------------------------
During 1998, the Company recorded restructuring and other charges totaling
$7,258, consisting of $6,515 of items relating to the closure of the Company's
wafer fabrication facility, and $743 relating to other one-time charges.
In August 1998, the Company announced its 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. In conjunction with the shut-down
of its wafer fabrication foundry, the Company recorded fab closure charges
totaling $6,515 to write down and write off manufacturing equipment and
facilities improvements; accrue for future idle facility space; accrue severance
of manufacturing and other personnel and other costs.
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 were fabricated in the Mountain
View facility. In January 1999, the wafer fabrication facility was shut-down and
the fabrication equipment is no longer in use and is being held for sale.
During the first quarter of 1999, all fabrication of wafers has been transferred
to third party foundries. The facility shutdown is a result of developments in
the semiconductor industry, primarily the availability of low cost wafer
fabrication capacity and the willingness of outside foundries to offer non-
standard processes. Competitive designs use submicron technology which allows
for more die per wafer than the five inch wafer fabrication currently in the old
8
<PAGE>
Mountain View facility. The restructuring charge relating to the write down of
the carrying value of the Company's fabrication equipment to its estimated fair
value was $4,458. The cost and accumulated depreciation of the fabrication
equipment prior to the write down was $13,027 and $6,330, respectively. The fair
value of the fabrication equipment was estimated to be $2,239 and was recorded
as "assets to be disposed of". The fair value of the fabrication equipment was
based on third party estimates of fair value. During the first six months of
1999, net proceeds for the sale of equipment was $963. Given the weakness of the
1998 market for semiconductors, and the resulting oversupply in the used
semiconductor equipment market, the Company is unable to predict the time needed
to dispose of the assets classified as "assets to be disposed of". The
restructuring charge for 1998 also included charges for idle facilities of
$1,406, severance payments totaling $519 for employees terminated upon closing
of the facility and environmental and related clean up costs of $132. Additional
restructuring charges were included in the first quarter of 1999 for employee
severance costs of $243 and environmental and related clean up costs of $26.
The following table sets forth the Company's activity for the restructuring
cost and charges taken against the accrual and the resulting restructuring
accrual balance at June 30, 1999:
<TABLE>
<CAPTION>
Restructuring Cost
(in thousands)
----------------------------------------------------------------------------------------------------
Six months ended
June 30, 1999
Balance ------------------------------------------- Balance
Dec. 31, 1998 Expense Utilized June 30, 1999
------------------ --------------- --------------- ------------------
<S> <C> <C> <C> <C>
Idle facility charge $1,406 $ - $140 $1,266
Employee severance and other 651 269 855 65
------ ---- ---- ------
$2,057 $269 $995 $1,331
====== ==== ==== ======
</TABLE>
Note 5. Gain on Sale of Investment
- ----------------------------------
At the end of the quarter ended March 31, 1999, the Company recognized a
gain of $5,006 on the sale of its investment in IC WORKS. IC WORKS was
purchased by Cypress Semiconductor, Inc., a publicly held company and, as part
of the purchase agreement between IC WORKS and Cypress Semiconductor, the
Company's preferred shares, with a book value of $1,500, were exchanged for
common shares of Cypress Semiconductor with a fair market value of $6,506. As
part of the agreement, ten percent of the common shares received by the Company
are held in escrow pending final closure of the purchase of IC Works by Cypress
Semiconductor or one year from the date of purchase. During the quarter ended
June 30, 1999, the company sold all of the shares it held, except the shares
held in escrow, for $6,730 and recognized an additional gain on the sale of $813
representing the increase in the fair value between the date the shares were
received and the date the shares were sold. The value of the shares held in
escrow at June 30, 1999 is $1,271 and is presented as short term investments.
These shares are accounted for as an available for sale security in accordance
with FAS 115.
9
<PAGE>
Note 6. Comprehensive Income
- ----------------------------
The Company adopted Statement of Financial Accounting Standards No. 130 (SFAS
130), "Reporting Comprehensive Income" in January 1998. SFAS 130 establishes
rules for the reporting and display of comprehensive income and its components;
however, the adoption of this Statement had no impact on the Company's net
income or stockholders' equity.
The following are the components of comprehensive income (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
-------------------------------- ----------------------------------
June 30, June 30, June 30, June 30,
1999 1998 1999 1998
------------ -------------- ------------- ------------
<S> <C> <C> <C> <C>
Net income $ 1,985 $ 803 $ 6,767 $ 2,871
Unrealized gain on short term investment
(net of deferred taxes of $273) 409 - 409 -
------- ------ ------- -------
Comprehensive income $ 2,394 $ 803 $ 7,176 $ 2,871
======= ====== ======= =======
</TABLE>
The components of accumulated other comprehensive income are as follows (in
thousands):
<TABLE>
<CAPTION>
June 30, Dec. 31,
1999 1998
----------- -----------
<S> <C> <C>
Unrealized gain on short term investment
(net of deferred taxes of $273) $ 409 $ -
===== =====
</TABLE>
10
<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") was founded in
December 1993 as the result of a management buyout of the Teledyne Components
Division of Teledyne Industries Inc. The Company designs, manufactures and sells
a variety of analog and mixed-signal integrated circuits. The Company's product
offerings are divided into four primary categories: (1) Power Management, (2)
Thermal Management (3) Data Converters, and (4) Linear Building Blocks. Over the
last several years, the Company has been transitioning its product portfolio
away from the legacy products associated with the Teledyne Division to higher
value proprietary solutions. As a result, the Company's current product offering
consists of both proprietary and second source products. While the primary
emphasis is developing proprietary products, the Company does offer second
source products to enhance its total product portfolio. Average selling prices
for the Company's proprietary products have generally 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.
As the Company transitioned from the legacy products manufactured using
older process technology, it became necessary to develop a source of supply for
more advanced wafer processing technology for its newer, proprietary products.
This transition began at a time when advanced semiconductor capacity was in
short supply and long term forecasts for additional capacity was not improving.
Therefore, in November 1995, the Company entered into certain agreements with IC
WORKS, Inc., a privately-held wafer foundry company. 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. Since then, the wafer
capacity shortage projected in late 1995 diminished. Since late 1995,
substantial foundry capacity became available worldwide while overall demand did
not increase proportionately. Consequently, wafer pricing decreased
dramatically, which changed the economic viability of the foundry business in
which the Company invested. The IC WORKS wafer foundry was subsequently sold to
a captive supplier and 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, 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. This agreement terminated the Company's operating agreement with IC
WORKS.
At the end of the quarter ended March 31, 1999, the Company recognized a
gain of $5.0 million on the sale of its investment in IC WORKS. IC WORKS was
purchased by Cypress Semiconductor, Inc., a publicly held company and, as part
of the purchase agreement between IC WORKS and Cypress Semiconductor, the
Company's preferred shares, with a book value of $1.5 million, were exchanged
for common shares of Cypress Semiconductor with a fair market value of $6.5
million. As part of the agreement, ten percent of the common shares received by
the Company are held in escrow pending final closure of the purchase of IC Works
by Cypress Semiconductor or one year from the date of purchase. During the
quarter ended June 30, 1999, the company sold all of the shares it held, except
the shares held in escrow, for $6.7 million and recognized an additional gain on
the sale of $.8 million representing the increase in the fair value between the
date the shares were received and the date the shares were sold. The value of
the shares held in
11
<PAGE>
escrow at June 30, 1999 is $1.3 million and is presented as short term
investments. These shares are accounted for as an available for sale security in
accordance with FAS 115.
In August 1998, the Company announced its 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. This change was desirable because
of continuing market conditions that made it more economical to purchase wafers
than to produce them internally. 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 were
fabricated in the Mountain View facility. In January 1999, the wafer fabrication
facility was shut-down. The fabrication of wafers has been transferred to third
party foundries during the first quarter of 1999. In connection with the closure
of its wafer fabrication facility, the Company recognized restructuring charges
for the Mountain View, California fabrication facility of $6.5 million. The
restructuring charge includes a write down of fabrication equipment of $4.5
million, costs associated with idle facility space of $1.4 million, employee
severance costs of $.5 million and clean up and environmental related charges of
$.1 million. During the first quarter of 1999, restructuring costs were $.3
million, which was primarily additional employee severance cost.
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.
Results of Operations
Net Sales
Net sales for the three month and six month periods ended June 30, 1999
decreased $.2 million or 1% and $2.8 million or 9.6%, respectively, from the
corresponding periods in the prior fiscal year. The decrease in sales was
primarily due to lower sales volume in the Company's power management product
line. International sales for the three month and six month periods ended June
30, 1999 were 69% and 68% of total sales, respectively, compared to 64% total
sales for the each of the same periods in the prior year. For the three month
and six month periods ended June 30, 1999, an OEM customer, Motorola, accounted
for approximately 30% and 29%, respectively, of net sales compared to 34% and
37%, respectively, of net sales for the same periods in the prior year. Future
Electronics, one of the Company's distributors, accounted for 21% and 16%,
respectively, of the Company's net sales for the three month and six month
periods ended June 30, 1999 compared to 11% of net sales for each of the same
periods in the prior year.
12
<PAGE>
Gross Margin
Gross margin as a percentage of sales for the three month and six month
periods ended June 30, 1999 increased to 47.0% and 43.3%, respectively, from
36.5% and 39.6%, respectively, in the corresponding periods in the prior year.
The increase in gross margin was primarily caused by the lower costs of
utilizing wafer foundries. The Company's ability to increase gross margins will
depend on the successful introduction of its new proprietary products and
controlling its manufacturing costs. Thus, future wafer costs will depend on the
volume and availability of wafers from the Company's wafer foundries.
Research and Development Expenses
Research and development expenses for the three month and six month periods
ended June 30, 1999 increased to $1.9 million and $3.7 million, respectively,
compared to $1.4 million and $2.7 million, respectively, for the corresponding
period in the prior year. This increase was primarily due to an increase in
salaries and wages for additional design and application engineers and increased
costs associated with test wafers and masks for new products. Such expenses as a
percent of sales increased in the three month and six month periods ended June
30, 1999 to 13.6 % and 13.8%, respectively, of sales compared to 9.8% and 9.1%,
respectively, 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 and six
month periods ended June 30, 1999 decreased to $2.6 million and $4.8 million,
respectively, compared to $2.8 million and $5.3 million, respectively, for the
corresponding period in the prior year. This decrease was primarily due to
decreases in salaries and staffing in sales and administration. Such expenses as
a percent of sales decreased in the three month period ended June 30, 1999 to
18.6% of sales compared to 19.7% of sales for the corresponding period in the
prior year. Such expenses as a percent of sales increased in the six month
period ended June 30, 1999 to 18.1% of sales compared to 17.9% 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.
Interest Income (Expense), Net
For the three month and six month periods ended June 30, 1999, net interest
income was $4,000 and $72,000, respectively, compared to $116,000 and $212,000,
respectively, for the corresponding periods in the prior year. The decrease in
net interest income is due to lower cash balances for the period plus additional
finance charges associated with the payoff of the Company's long term debt.
Gain on Sale of Investment
At the end of the quarter ended March 31, 1999, the Company recognized a
gain of $5.0 million on the sale of its investment in IC WORKS. IC WORKS was
purchased by Cypress Semiconductor, Inc., a publicly held company and, as part
of the purchase agreement between IC WORKS and Cypress Semiconductor, the
Company's preferred shares, with a book value of $1.5 million, were exchanged
for common shares of Cypress Semiconductor with a fair market value of $6.5
million. As part of the agreement, ten percent of the common shares received by
the Company are held in escrow pending final closure of the purchase of IC Works
by Cypress Semiconductor or one year from the date of purchase. During the
quarter ended June 30, 1999, the company sold all of the shares it held, except
the shares held in escrow, for $6.7 million and recognized an additional gain on
the sale of $.8 million representing the increase in the fair value between the
date the shares were received and the date the shares were sold. The value of
the shares held in escrow at June 30, 1999 is $1.3 million and is presented as
short term investments. These shares are accounted for as an available for sale
security in accordance with FAS 115.
13
<PAGE>
Income Taxes
The effective tax rate for the three month and six month periods ended June
30, 1999 was 30.7% and 21.9%, respectively, which reflects a 27% blended rate of
United States, Hong Kong, and German tax rates, offset by the tax rate
applicable to the gain on sale of investment. This effective rate compares to
27% for the corresponding period in the prior year which was a result of the
blended rate of United States, Hong Kong, and German tax rates.
Liquidity and Capital Resources
As of June 30, 1999, the Company had $16.1 million of cash and cash
equivalents. The Company generated $.7 million of cash from operating activities
during the six months ended June 30, 1999 primarily reflecting net income of
$6.8 million offset by the non cash gain on sale of investments of $5.8 million.
The net increase in working capital items primarily reflects an increase in
accounts receivable of $1.2 million, an increase of in other current assets of
$.5 million, and a decrease in current liabilities of $.7 million, offset by a
decrease in inventory of $.3 million, an increase if deferred distributor income
reserve of $.3 million and an increase in taxes payable of $.2 million
The Company generated $7.3 million of cash from investing activities during
the six months ended June 30, 1999 primarily reflecting net proceeds from the
sale of investments of $6.7 million, the sale of equipment of $1.0 million,
offset by purchases of property and equipment of $.4 million. During the six
months ended June 30, 1998, the Company used $4.8 million of cash for investing
activities primarily reflecting purchases of property and equipment of $4.3
million and the purchase of marketable securities of $.5 million.
The Company used $6.1 million of cash for financing activities during the
six months ended June 30, 1999 primarily reflecting the repurchase of common
stock of $3.0 million, the payment of notes payable of $3.6 million, offset by
proceeds from the issuance of common stock of $.6 million. During the six
months ended June 30, 1998, the Company used $.7 million of cash for financing
activities primarily reflecting the repayment of notes payable of $1.3 million,
offset by proceeds from the sale of common stock of $.6 million.
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
14
<PAGE>
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.
Manufacturing Risks. The Company utilizes CMOS, Silicon Gate, Bipolar and
BiCMOS process technologies, which are tailored to meet product specifications
and customer requirements. Outside wafers are purchased from one of five
foundries and market conditions could result in wafers being in short supply and
prevent the Company from having adequate supply to meet its customer
requirements. There can be no assurances going forward that the Company will
have the ability to acquire all the wafers it desires.
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 six month periods ended June 30, 1999 were 69% and 68% of
total sales, respectively, compared to 64% total sales for the 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
15
<PAGE>
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 and six month periods ended June 30, 1999, an OEM customer,
Motorola, accounted for approximately 30% and 34%, respectively, of net sales
compared to 34% and 37%, respectively, of net sales for the same period in the
prior year. Future Electronics, one of the Company's distributors, accounted for
21% and 16%, respectively, of the Company's net sales for the three month and
six month periods ended June 30, 1999 compared to 11% 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 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. 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 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
16
<PAGE>
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.
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
- ----------------
The "Year 2000 Issue" is the result of computer programs that were written
using two digits rather
17
<PAGE>
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 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.
1) 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 these 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. These upgrades should be completed
by September 1999. The costs incurred to-date for the assessment performed as
well as the costs to upgrade to the Year 2000 compliant software packages are
not expected to be material to the Company's financial condition or results of
operations. These expenses 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.
2)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 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.
3) 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 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.
4) 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 Company's financial condition or results of
operations and will continue to be expensed in the periods
18
<PAGE>
incurred. In the event that any of the Company's significant customers and
suppliers do not successfully 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.
During 1998, the Company incurred costs of $.1 million related to Year 2000
issues. The Company estimates that it will incur costs of approximately $.3
million during 1999 for costs related to Year 2000 issues.
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>
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
Registrant held its Annual Meeting of Shareholders on April 15, 1999.
At the meeting the following matters were voted upon, and the number of
votes cast for and against, as well as the number of abstentions and broker non
votes, as to each matter, along with separate tabulation with respect to each
nominee for office, set forth below:
1. Election of directors to serve for the ensuing year and until their
successors are duly elected and qualified.
<TABLE>
<CAPTION>
For Against Abstention Non Votes
------------------- ---------------- ------------------ ---------------------
<S> <C> <C> <C> <C>
Phillip M. Drayer 11,793,180 0 587,870 0
T. Peter Thomas 11,821,957 0 559,093 0
Donald E. Fowler 11,816,880 0 564,170 0
Frank Gill 11,820,857 0 560,193 0
</TABLE>
1. Approval of amendment to 1994 Stock Option Plan
<TABLE>
<CAPTION>
For Against Abstention Non Votes
----------- ---------------- ------------------ ---------------------
<S> <C> <C> <C>
5,802,685 1,054,838 20,409 5,494,118
</TABLE>
2. Ratification of the appointment of PricewaterhouseCoopers LLP as the
Company's independent accountants for the current fiscal year ending
December 31, 1998.
<TABLE>
<CAPTION>
For Against Abstention Non Votes
---------- ---------------- ------------------ ---------------------
<S> <C> <C> <C>
12,340,175 19,157 21,718 0
</TABLE>
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: August 10, 1999 By: /s/ Phillip M. Drayer
-----------------------------------
Phillip M. Drayer
President
Chief Executive Officer
Date: August 10, 1999 By: /s/ Robert G. Gargus
-----------------------------------
Robert G. Gargus
Chief Financial Officer
21
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 16,053
<SECURITIES> 1,271
<RECEIVABLES> 8,335
<ALLOWANCES> 195
<INVENTORY> 6,058
<CURRENT-ASSETS> 33,652
<PP&E> 17,865
<DEPRECIATION> 9,461
<TOTAL-ASSETS> 42,056
<CURRENT-LIABILITIES> 10,072
<BONDS> 0
0
0
<COMMON> 17
<OTHER-SE> 30,641
<TOTAL-LIABILITY-AND-EQUITY> 42,056
<SALES> 26,675
<TOTAL-REVENUES> 26,675
<CGS> 15,126
<TOTAL-COSTS> 23,903
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 72
<INCOME-PRETAX> 8,663
<INCOME-TAX> 1,896
<INCOME-CONTINUING> 6,767
<DISCONTINUED> 0
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<CHANGES> 0
<NET-INCOME> 6,767
<EPS-BASIC> 0.47
<EPS-DILUTED> 0.45
</TABLE>
