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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 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 May 10,
1999 was 14,121,521.
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TELCOM SEMICONDUCTOR, INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1999
INDEX
PAGE
NO.
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Operations 3
Condensed Consolidated Balance Sheets 4
Condensed Consolidated Statements of Cash Flows 5
Notes To Condensed Consolidated Financial Statements 6-9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10-18
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
TELCOM SEMICONDUCTOR, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
--------------------------------------------------------
Mar. 31, Mar. 31,
1999 1998
--------------------- ---------------------
<S> <C> <C>
Net sales $12,808 $15,474
Cost of sales 7,775 8,895
--------------------- ---------------------
Gross profit 5,033 6,579
--------------------- ---------------------
Operating expenses:
Research and development 1,787 1,315
Selling, general and administrative 2,252 2,527
Restructuring & other 269 -
--------------------- ---------------------
Total operating expenses 4,308 3,842
--------------------- ---------------------
Income from operations 725 2,737
Interest income, net 68 96
Gain on sale of investment 5,006 -
--------------------- ---------------------
Income before income taxes 5,799 2,833
Provision for income taxes 1,017 765
--------------------- ---------------------
Net income $ 4,782 $ 2,068
===================== =====================
Per share data:
Net income
Basic $0.33 $0.13
===================== =====================
Diluted $0.32 $0.12
===================== =====================
Number of shares used to compute per share data:
Basic 14,514 16,476
===================== =====================
Diluted 15,147 17,718
===================== =====================
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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TELCOM SEMICONDUCTOR, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Mar. 31, Dec. 31,
1999 1998
------------------------ -----------------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 11,402 $14,059
Short term investments 6,506 -
Accounts receivable 7,664 6,944
Inventory 5,670 6,377
Deferred income taxes 1,099 1,099
Other current assets 1,233 799
------------------------ -----------------------
Total current assets 33,574 29,278
Property and equipment, net 9,288 10,388
Other assets - 1,500
------------------------ -----------------------
$ 42,862 $41,166
======================== =======================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable $ 1,369 $ 1,886
Accounts payable 3,202 3,247
Accrued liabilities 2,494 2,982
Deferred distributor income 1,494 1,484
Income taxes payable 3,325 2,571
------------------------ -----------------------
Total current liabilities 11,884 12,170
Notes payable and other long term obligations, net
of current portion 2,159 2,678
Deferred income taxes 400 400
------------------------ -----------------------
Total liabilities 14,443 15,248
------------------------ -----------------------
Stockholders' equity:
Common stock 17 17
Additional paid-in capital 35,547 35,355
Treasury stock (10,398) (7,925)
Retained earnings 3,253 (1,529)
------------------------ -----------------------
Total stockholders' equity 28,419 25,918
------------------------ -----------------------
$ 42,862 $41,166
======================== =======================
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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TELCOM SEMICONDUCTOR, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
---------------------------------------------------
Mar. 31,
---------------------------------------------------
1999 1998
--------------------- ----------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 4,782 $ 2,068
Adjustments to reconcile net income to net
cash provided by operating activities:
Pretax gain on sale of investment (5,006) -
Depreciation and amortization 757 1,337
Changes in assets and liabilities:
Accounts receivable (720) (595)
Inventory 707 (976)
Other current assets (434) 235
Accounts payable (45) 409
Accrued liabilities (488) (147)
Deferred distributor income 10 16
Income taxes payable 754 437
--------------------- ----------------------
Net cash provided by operating activities 317 2,784
--------------------- ----------------------
Cash flows from investing activities:
Purchases of property and equipment (91) (1,966)
Net proceeds from sale of equipment 434 -
Sales of marketable securities, net - 1,034
--------------------- ----------------------
Net cash provided by (used for) investing activities 343 (932)
--------------------- ----------------------
Cash flows from financing activities:
Proceeds from sale of common stock 192 124
Repurchase of common stock (2,473) -
Payments on notes payable (1,036) (658)
--------------------- ----------------------
Net cash used for financing activities (3,317) (534)
--------------------- ----------------------
Net increase in cash and cash equivalents (2,657) 1,318
Cash and cash equivalents at the beginning of period 14,059 17,110
--------------------- ----------------------
Cash and cash equivalents at the end of period $11,402 $18,428
===================== ======================
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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TELCOM SEMICONDUCTOR, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands)
(Unaudited)
1. The Company and Basis of Presentation:
TelCom Semiconductor, Inc. ("TelCom" or the "Company") designs, develops,
manufactures and markets a diversified portfolio of high performance analog
integrated circuits for use in a wide variety of electronic systems. The Company
operates and reports financial results on a 52-53 week fiscal year ending on the
Friday closest to the last day of December. For convenience, the Company has
presented its fiscal year as ending December 31, and its fiscal quarter as
ending March 31.
In the opinion of management, the unaudited condensed consolidated interim
financial statements have been prepared on the same basis as the December 31,
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 March 31, 1999 should be read
in conjunction with the Company's Annual Report on Form 10-K for the year ended
December 31, 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". 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. 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.
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Following is a reconciliation of the numerators and denominators of the
Basic and Diluted EPS computations for the periods presented below:
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------------------------------
Mar. 31, Mar. 31,
1999 1998
------------------------ ----------------------
<S> <C> <C>
Net income available to common shareholders $ 4,782 $ 2,068
======================== ======================
Weighted average common stock outstanding (basic) 14,514 16,476
Effect of dilutive warrants and options 633 1,242
------------------------ ----------------------
Weighted average common stock outstanding (diluted) 15,147 17,718
======================== ======================
Earnings per share:
Basic $ 0.33 $ 0.13
======================== ======================
Diluted $ 0.32 $ 0.12
======================== ======================
</TABLE>
Options to purchase 68,500 shares of commons stock at a weighted average
price of $13.67 per share were outstanding at March 31, 1998 but were not
included in the computation of diluted EPS because the options' exercise price
was greater than the average market price of common stock during the period.
Options to purchase 554,407 shares of commons stock at a weighted average price
of $5.46 per share were outstanding at March 31, 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.
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3. Balance Sheet Details:
<TABLE>
<CAPTION>
Mar. 31, Dec. 31,
1999 1998
----------------- -----------------
<S> <C> <C> <C>
Inventory :
Raw material $ 87 $ 108
Work in process 3,912 4,331
Finished goods 1,671 1,938
----------------- -----------------
$ 5,670 $ 6,377
================= =================
Property and equipment:
Equipment $15,743 $15,077
Leasehold improvements 122 81
----------------- -----------------
15,865 15,158
Accumulated depreciation (9,070) (8,313)
----------------- -----------------
6,795 6,845
Construction in progress 333 949
Carrying value of assets to be
disposed of 2,160 2,594
----------------- -----------------
$ 9,288 $10,388
================= =================
Accrued liabilities:
Payroll and related $ 1,746 $ 2,074
Other 748 908
----------------- -----------------
$ 2,494 $ 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
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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 quarter of 1999,
net proceeds for the sale of equipment was $434. 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 are 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 March 31, 1999:
<TABLE>
<CAPTION>
Restructuring Cost
(in thousands)
----------------------------------------------------------------------------------------------
Three months ended
Mar. 31, 1999
Balance ------------------------------------------ Balance
Dec. 31, 1998 Expense Utilized Mar. 31, 1999
--------------------- ----------------- ------------------- ---------------------
<S> <C> <C> <C> <C>
Idle facility charge $1,406 $ - $ 84 $1,322
Employee severance and other 651 269 733 187
--------------------- ----------------- ------------------- ---------------------
$2,057 $269 $817 $1,509
===================== ================= =================== =====================
</TABLE>
Note 5. Gain on Sale of Investment
- ----------------------------------
At the end of the quarter ended March 31, 1999, the Company recognized a gain of
$5.0 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.
9
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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.
During the first quarter of 1999, IC WORKS was sold to Cypress
Semiconductor, Inc., a publicly held corporation. The Company's shares in IC
WORKS were exchanged for common shares of Cypress Semiconductor, Inc. and as a
result, the Company recognized a gain of $5.0 million on the sale of its IC
WORKS investment.
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
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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 period ended March 31, 1999 decreased $2.7
million or 17.2% from the corresponding period 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 period ended
March 31, 1999 were 67% of total sales for the period compared to 64% of total
sales for the same period in the prior year. For the three month period ended
March 31, 1999, three OEM customers, Motorola, Intel and Compaq Computer,
accounted for approximately 28%, 3% and 4%, respectively, of net sales compared
to 40%, 6% and 5%, respectively, of net sales for the same period in the prior
year. Future Electronics, one of the Company's distributors, accounted for 11%
of the Company's net sales for the three month period ended March 31,1999
compared to 11% of net sales for same period in the prior year.
Gross Margin
Gross margin as a percentage of sales for the three month period ended
March 31, 1999 decreased to 39.3% from 42.5% in the corresponding period in the
prior year. The decrease in gross margin was caused by a decrease in unit
selling prices for products sold to Motorola and the Company's mix of high
volume low priced commodity products. 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.
11
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Research and Development Expenses
Research and development expenses for the three month period ended March
31, 1999 increased to $1.8 million compared to $1.3 million 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 period ended March
31, 1999 to 14.0% of sales compared to 8.5% of sales for the corresponding
period in the prior year. The Company expects research and development expenses
generally to increase in absolute dollars in future periods although such
expenses may fluctuate as a percentage of net sales.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the three month period
ended March 31, 1999 decreased to $2.3 million compared to $2.5 million for the
corresponding period in the prior year. This increase was primarily due to
decreases in salaries and staffing in sales and administration. Such expenses as
a percent of sales increased in the three month period ended March 31, 1999 to
17.6% of sales compared to 16.3% 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 period ended March 31, 1999, net interest income was
$68,000 compared to $96,000 for the corresponding period in the prior year. The
decrease in net interest income is due to lower cash balances for the period.
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.
Income Taxes
The effective tax rate for the three month period ended March 31, 1999 was
17.5% 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 March 31, 1999, the Company had $11.4 million of cash and cash
equivalents. The Company generated $.3 million of cash from operating activities
during the three months ended March 31, 1999 primarily reflecting net income of
$4.8 million offset by the non cash gain on sale of investments of $5.0 million.
The net decrease in working capital items primarily reflects a decrease in
current liabilities of $.5 million, an increase in income taxes payable of $.8
million, a decrease in inventories of $.7 million, offset by an increase in
accounts receivable of $.7 million and an increase in other assets of $.4
million.
The Company generated $.3 million of cash from investing activities during
the three months ended March 31, 1999 primarily reflecting net proceeds from the
sale of equipment of $.4 million, offset by purchases of property and equipment
of $.1 million. During the three months ended March 31, 1998, the
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Company used $.9 million of cash for investing activities primarily reflecting
purchases of property and equipment of $1.9 million, offset by proceeds from the
sale of marketable securities of $1 million.
The Company used $3.3 million of cash for financing activities during the
three months ended March 31, 1999 primarily reflecting the repurchase of common
stock of $2.5 million, the repayment of notes payable of $1 million, offset by
proceeds from the issuance of common stock of $.2 million. During the three
months ended March 31, 1998, the Company used $.5 million of cash for financing
activities primarily reflecting the repayment of notes payable of $.6 million,
offset by proceeds from the sale of common stock of $.1 million.
At March 31, 1999, the Company had notes payable of $2.5 million, the
proceeds of which were utilized to purchase certain equipment securing such
notes. These notes bear interest ranging from 9% to 13% per annum and are
payable in monthly installments of principal and interest.
The Company believes that its current cash and cash equivalent balances,
together with anticipated cash flow from operations, will be sufficient to meet
the Company's needs for the next twelve months.
Certain Factors Affecting Future Results of Operations
The Company's future results of operations are dependent upon a number of
factors, including those described below:
Dependence on New Products. The Company's success depends upon its ability
to develop new analog circuits for existing and new markets, to introduce such
products in a timely manner and to have such products gain market acceptance.
The development of new analog circuits is highly complex and from time to time
the Company has experienced delays in developing and introducing new products.
Successful product development and introduction depends on a number of factors
including proper new product definition, timely completion of design and testing
of new products, achievement of acceptable manufacturing yields and market
acceptance of the Company's and its customers' products. Moreover, successful
product design and development is dependent on the Company's ability to attract,
retain and motivate qualified analog design engineers, of which there is a
limited number. There can be no assurance that the Company will be able to meet
these challenges or adjust to changing market conditions as quickly and cost-
effectively as necessary to compete successfully. Due to the complexity and
variety of analog circuits, the limited number of analog circuit designers and
the limited effectiveness of computer-aided design systems in the design of
analog circuits, there can be no assurance that the Company will be able to
continue to successfully develop and introduce new products on a timely basis.
Although the Company seeks to design products that have the potential to become
industry standard products, there can be no assurance that any products
introduced by the Company will be adopted by such market leaders, or that any
product initially accepted by the Company's customers that are market leaders
will become industry standard products. The Company's failure to continue to
develop and introduce new products successfully could materially and adversely
affect its business and operating results.
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
13
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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 period ended March 31, 1999 were 67% of total sales for the
period compared to 64% of total sales for the same period in the prior year. The
Company expects international sales to continue to represent a significant
portion of product sales. International sales and operations involve various
risks, including unexpected changes in regulatory requirements, delays resulting
from difficulty in obtaining export licenses for certain technology, tariffs and
other barriers and restrictions, and the burdens of complying with a variety of
foreign laws. The Company is also subject to general political risks in
connection with its international operations, such as political and economic
instability and changes in diplomatic and trade relationships. In addition,
because a substantial majority of the Company's international sales are
denominated in United States dollars, increases in the value of the dollar would
increase the price in local currencies of the Company's products in foreign
markets and make the Company's products relatively more expensive than
competitors' products, the sales of which are denominated in local currencies.
There can be no assurance that regulatory, political and other factors will not
adversely affect the Company's operations in the future or require the Company
to modify its current business practices.
Customer and Distributor Concentration. A limited number of customers and
distributors has accounted for a significant portion of the Company's net sales.
For the three month period ended March 31, 1999, three OEM customers, Motorola,
Intel and Compaq Computer, accounted for approximately 28%, 3% and 4%,
respectively, of net sales compared to 40%, 6% and 5%, respectively, of net
sales for the same period in the prior year. Future Electronics, one of the
Company's distributors, accounted for 11% of the Company's net sales for the
three month period ended March 31, 1999 compared to 11% of net sales for the
same period in the prior year. The Company anticipates that it will continue to
be dependent or may increase its dependence on a number of key customers and
distributors for a significant portion of its net sales. The
14
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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 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
15
<PAGE>
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 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 June 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
16
<PAGE>
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 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.
17
<PAGE>
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.
18
<PAGE>
PART II. OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are being filed as part of this report.
27.1 Financial Data Schedule
(b) No reports on Form 8-K were filed during the fiscal quarter for
which this report is filed.
19
<PAGE>
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TELCOM SEMICONDUCTOR, INC.
(Registrant)
Date: May 12, 1999 By: /s/ Phillip M. Drayer
----------------------------------
Phillip M. Drayer
President
Chief Executive Officer
Date: May 12, 1999 By: /s/ Robert G. Gargus
----------------------------------
Robert G. Gargus
Chief Financial Officer
20
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