<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________
FORM 10-QSB
(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 0-23841
____________________
INTEGRATED SENSOR SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0212047
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
625 River Oaks Parkway, San Jose, California 95134
(Address of principal executive offices) (Zip code)
(408) 324-1044
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of Exchange on which registered
------------------- ------------------------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
(Title of Class)
_____________________________
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 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 [ ]
Outstanding shares of registrant's common stock, $.001 par value, as of August
12, 1999: 7,940,109.
This Report on Form 10-QSB includes 27 pages with the Index to Exhibits located
on page 24.
<PAGE>
<TABLE>
<CAPTION>
INTEGRATED SENSOR SOLUTIONS, INC.
REPORT ON FORM 10-QSB
FOR QUARTER ENDED JUNE 30, 1999
TABLE OF CONTENTS
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets - June 30, 1999 and
March 31, 1999............................................. 3
Condensed Consolidated Statements of Operations - Three
Months Ended June 30, 1999 and 1998........................ 4
Condensed Consolidated Statements of Cash Flows - Three
Months Ended June 30, 1999 and 1998........................ 5
Notes to Condensed Consolidated Financial Statements......... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................. 24
Item 5. Other Information............................................. 24
Item 6. Exhibits and Reports on Form 8-K.............................. 24
Signatures.................................................... 25
</TABLE>
2
<PAGE> 3
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
INTEGRATED SENSOR SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
June 30, March 31,
1999 1999 (1)
----------- -----------
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 553 $ 5,063
Short-term investments - 2,217
Accounts receivable, net 4,849 4,701
Accounts receivable from related parties 713 1,072
Inventories 8,896 7,131
Prepaid expenses and other current assets 159 233
----------- -----------
Total current assets 15,170 20,417
PROPERTY AND EQUIPMENT, NET 10,064 7,786
Goodwill 2,079 183
----------- -----------
TOTAL ASSETS $ 27,313 $ 28,386
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit $ - $ 400
Accounts payable-trade 5,639 4,389
Accounts payable to related parties 2,720 2,412
Current portion of capital lease obligations 36 176
Other current liabilities 858 815
----------- -----------
Total current liabilities 9,253 8,192
LONG-TERM PORTION OF CAPITAL LEASE OBLIGATIONS 8 147
STOCKHOLDERS' EQUITY:
Noncumulative convertible preferred stock - -
Common stock 8 8
Additional paid-in capital 34,074 33,948
Accumulated deficit (15,284) (13,324)
Cumulative translation adjustment (510) (323)
Deferred compensation (236) (262)
----------- -----------
Total stockholders' equity 18,052 20,047
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 27,313 $ 28,386
=========== ===========
</TABLE>
(1) Derived from the March 31, 1999 audited balance sheet included in the 1999
Annual Report on Form 10-KSB of Integrated Sensor Solutions, Inc.
See notes to condensed consolidated financial statements.
3
<PAGE> 4
<TABLE>
<CAPTION>
INTEGRATED SENSOR SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Three Months Ended
June 30,
------------------------
1999 1998
---------- ----------
<S> <C> <C>
REVENUES:
Product revenue $ 7,502 $ 4,360
Contract revenue 164 504
---------- ----------
Total revenues (related party revenues of $734
and $1,595 for 1999 and 1998, respectively) 7,666 4,864
---------- ----------
COST OF REVENUES:
Cost of product revenue 6,491 3,353
Cost of contract revenue 814 592
---------- ----------
Total cost of revenues 7,305 3,945
---------- ----------
GROSS PROFIT 361 919
---------- ----------
OPERATING EXPENSES:
Research and development 1,217 1,024
Sales, general, and administrative 947 631
---------- ----------
Total operating expenses 2,164 1,655
---------- ----------
LOSS FROM OPERATIONS (1,803) (736)
INTEREST INCOME 38 211
INTEREST EXPENSE (9) (45)
OTHER EXPENSE, NET (185) (30)
MINORITY INTEREST IN NET LOSS OF CONSOLIDATED
SUBSIDIARY - 17
---------- ----------
NET LOSS $ (1,959) $ (583)
========== ==========
Basic and diluted net loss per share $ (0.26) $ (0.08)
========== ==========
Shares used in computing basic net loss per share 7,682 7,559
========== ==========
Shares used in computing diluted net loss per share 7,682 7,559
========== ==========
See notes to condensed consolidated financial statements.
</TABLE>
4
<PAGE> 5
<TABLE>
<CAPTION>
INTEGRATED SENSOR SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Three Months Ended
June 30,
------------------------
1999 1998
---------- ----------
<S> <C> <C>
Operating activities
Net loss $ (1,959) $ (583)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 416 280
Amortization of deferred compensation 26 36
Minority interest in net income (loss) of subsidiary 17
Foreign currency (gains) losses 201 (12)
Gain on sale of interest in joint venture - -
Changes in operating assets and liabilities:
Accounts receivable, net 211 (18)
Inventories (1,765) (518)
Prepaid expenses 74 (304)
Accounts payable 1,558 (2,255)
Other current liabilities 43 (16)
---------- ----------
Net cash used in operating activities (1,195) (3,373)
---------- ----------
Investing activities
Proceeds of short-term investments 2,217 (9,006)
Purchase of property and equipment (3,073) (487)
Purchase of interest in joint venture (1,906) -
---------- ----------
Net cash provided by (used in) investing activities (2,762) (9,493)
Financing activities
Payments on line of credit (400) (500)
Payments of principal on notes payable - -
Payments of principal on capital lease obligations (279) (35)
Issuance of convertible preferred stock, net of
issuance costs - -
Net proceeds from issuance of common stock 126 2,745
---------- ----------
Net cash provided by (used in) financing activities (553) 2,210
---------- ----------
Decrease in cash and cash equivalents (4,510) (10,656)
Cash and cash equivalents at beginning of period 5,063 17,610
---------- ----------
Cash and cash equivalents at end of period $ 553 $ 6,954
========== ==========
Supplemental disclosure of cash flow information
Interest paid $ 8 $ 45
========== ==========
Schedule of noncash financing activities
Equipment acquired under capital leases $ - $ 86
========== ==========
Accounts payable converted to capital leases $ - $ 79
========== ==========
See notes to condensed consolidated financial statements.
</TABLE>
5
<PAGE> 6
INTEGRATED SENSOR SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES
Interim Financial Information
The accompanying condensed consolidated financial statements of Integrated
Sensor Solutions, Inc. and its majority-owned subsidiary ("ISS" or the
"Company") as of June 30, 1999 and for the three months ended June 30, 1999 and
1998 are unaudited. In the opinion of management, the condensed consolidated
financial statements include all adjustments (consisting only of normal
recurring accruals) that management considers necessary for a fair presentation
of its financial position, operating results and cash flows for the interim
periods presented. Operating results and cash flows for interim periods are not
necessarily indicative of results for the entire year.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Prior to July 31, 1997 the Company owned 52% of ISS-Nagano GmbH. On July
31, 1997, the Company entered into an agreement to increase its ownership of
ISS-Nagano GmbH by converting approximately $1,000,000 in long-term
intercompany indebtedness owed by ISS-Nagano GmbH into an increased equity
interest. Accordingly, the Company owned 74% of the equity of ISS-Nagano GmbH.
For periods between July 31, 1997 and November 30, 1998, 26% of ISS-Nagano
GmbH's net income (loss) has been attributed to the minority shareholders'
interest. Effective November 30, 1998, the Company purchased an additional
7.50% of ISS-Nagano GmbH, for approximately $211,000. As a result of the
transaction, the Company's results of operations between November 1998 and June
30, 1999 reflect 81.5% of ISS-Nagano's net income (loss). Effective June 30,
1999, the Company purchased the remaining interest of shares in it subsidiary
ISS-Nagano GmbH for 3.5 million DM or approximately $1.9 million.
This financial data should be read in conjunction with the audited
consolidated financial statements and notes thereto included in the Company's
Annual Report on Form 10-KSB for the year ended March 31, 1999.
Major Customers and Concentration of Credit Risks
Many of the Company's customers are primarily involved in the automotive
market. The Company performs ongoing credit evaluations of its customers and
generally does not require collateral. The Company maintains reserves for
potential credit losses, and such losses have been within management's
expectations.
Significant customers accounted for the following percentages of revenues:
<TABLE>
<CAPTION>
Three Months
Ended June 30,
------------------------
1999 1998
---------- ----------
<S> <C> <C>
Robert Bosch GmbH 79 % 35 %
Nagano Keiki Co., Ltd. 9 % 32 %
Echlin Corporation 4 % 17 %
</TABLE>
2. INVENTORIES
Inventories consist of the following (in thousands):
6
<PAGE> 7
INTEGRATED SENSOR SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
<TABLE>
<CAPTION>
June 30, March 31,
1999 1999
---------- ----------
<S> <C> <C>
Finished goods $ 672 $ 2,977
Work-in-process 2,857 3,681
Raw materials 5,367 473
---------- ----------
$ 8,896 $ 7,131
========== ==========
</TABLE>
3. LINE OF CREDIT/TERM LOAN
The Company has a bank line of credit agreement that expires on August 20,
1999 and allows for the company to borrow $3,500,000. Borrowings under the line
of credit bear interest at the bank's prime rate plus 0.50% (8.50% at June 30,
1999) and are secured by the assets of the Company. As of June 30, 1999 the
Company had no borrowings against the line compared to $400,000 at June 30,
1998. The Company has a $1,500,000 term loan facility for equipment which is
also secured by the assets of the company, as well, that bears interest at the
bank's prime rate plus 1.25% (9.25% at June 30, 1999). As of June 30, 1999, the
Company had no borrowings as compared to approximately $238,600 at March 31,
1999 (which are included with capital leases on the balance sheet.) These
agreements require the Company to maintain certain financial covenants on a
quarterly basis. At June 30, 1999, the Company was not in compliance with its
profitability covenant.
4. COMPREHENSIVE INCOME (LOSS)
Effective April 1, 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS
No. 130 requires an enterprise to report, by major components and as a single
total, the change in net assets during the period from non-owner sources.
Comprehensive loss includes all changes in equity during a period except those
resulting from investments by and distributions to the Company's stockholders.
For the three months ended June 30, 1999 and 1998, comprehensive loss, which
was comprised of the Company's net loss for the periods and cumulative
translation adjustment, was approximately ($1,772,000) and ($496,000),
respectively.
5. GEOGRAPHIC AND SEGMENT INFORMATION
The Company operates in one business segment, which is to design,
manufacture, and sell end-market specific integrated subsystems and perform
nonrecurring engineering projects for the sensor control applications market.
The following table summarizes the Company's operations in different geographic
areas (in thousands):
<TABLE>
<CAPTION>
Three Months ended June 30, 1999
-----------------------------------------------------
Adjustments/
United States Germany Eliminations Consolidated
------------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
Revenues to unaffiliated
customers $ 1,133 $ 6,533 $ - $ 7,666
Transfers between
geographic areas 2,115 337 (2,452) -
---------- ---------- ---------- ----------
Total net revenues $ 3,248 $ 6,870 $ (2,452) $ 7,666
========== ========== ========== ==========
Loss from operations $ ( 2,109) $ 306 $ - $ (1,803)
========== ========== ========== ==========
Identifiable assets $ 23,936 $ 15,748 $ (12,371) $ 27,313
========== ========== ========== ==========
</TABLE>
7
<PAGE> 8
INTEGRATED SENSOR SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
<TABLE>
<CAPTION>
Three Months ended June 30, 1998
-----------------------------------------------------
Adjustments/
United States Germany Eliminations Consolidated
------------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
Revenues to unaffiliated
Customers $ 2,774 $ 2,090 $ - $ 4,864
Transfers between
geographic areas 665 328 (993) -
---------- ---------- ---------- ----------
Total net revenues $ 3,439 $ 2,418 $ (993) $ 4,864
========== ========== ========== ==========
Loss from operations $ (713) $ (22) $ (1) $ (736)
========== ========== ========== ==========
Identifiable assets $ 27,018 $ 4,909 $ (4,618) $ 27,309
========== ========== ========== ==========
</TABLE>
Export revenues consisting of sales from the Company's U.S. operations to
nonaffiliated customers were as follows (in thousands):
<TABLE>
<CAPTION>
Three Months
Ended June 30,
------------------------
1999 1998
---------- ----------
<S> <C> <C>
Canada $ 26 $ 73
Japan and Korea 734 1,625
---------- ----------
Total $ 760 $ 1,698
========== ==========
</TABLE>
6. NET LOSS PER SHARE
The following table sets forth the computation of basic and diluted net
loss per share (in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months ended June 30,
1999 1998
---------- ----------
<S> <C> <C>
Numerator for basic and diluted net loss per share:
Net loss $ (1,959) $ (583)
========== ==========
Denominator:
Weighted average common shares outstanding 7,682 7,559
---------- ----------
Denominator for basic and diluted net loss per share 7,682 7,559
========== ==========
Basic and diluted net loss per share $ (0.26) $ (0.08)
========== ==========
</TABLE>
Securities (including options and warrants) that could potentially dilute
basic EPS in the future were not included in the computation of diluted EPS for
the three months ended June 30, 1999 and 1998 because to do so would have been
antidilutive for the periods presented.
8
<PAGE> 9
INTEGRATED SENSOR SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
7. PROPOSED ACQUISITION BY TEXAS INSTRUMENTS, INC.
On May 3, 1999, the Company and Texas Instruments, Inc. ("TI") announced
that they had entered into an agreement for TI to acquire the Company. The
agreement is for an all-cash tender offer for all outstanding shares of ISS's
common stock at $8.05 per share, or about $62 million. According to the terms
of the agreement, the company will become part of the Automotive Sensors &
Controls group of TI's Materials and Controls ("M&C") business based in
Attleboro, Massachusetts.
TI commenced the all cash tender offer on May 7, 1999, and the tender
offer was originally scheduled to expire at midnight EDT on June 4, 1999. TI
extended the offer several times due to the fact that German antitrust
authorities had not completed their review of the proposed transaction. On
August 6, 1999, German authorities completed their review of the transaction
and granted consent for the consummation of the acquisition The latest tender
offer expired on August 13, 1999. On August 11, 1999, 7,541,374 shares were
tendered. The Company and TI currently anticipate that the transaction will be
completed no later than August 18, 1999. TI intends to acquire the Company's
common stock through a wholly-owned subsidiary of TI. Any shares not purchased
in the tender offer will be acquired for the tender offer price in cash in a
second-step merger.
9
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Management's Discussion and Analysis includes a number of forward-
looking statements which reflect the Company's current views with respect to
future events and financial performance. These forward-looking statements are
subject to certain risks and uncertainties, including those discussed in the
Risk Factors section of this Item 2 and elsewhere in this Form 10-QSB that
could cause actual results to differ materially from historical results or
those anticipated. In this report, the words "anticipates," "believes,"
"expects," "future," "intends," and similar expressions identify forward-
looking statements. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof.
Overview
ISS designs, manufactures and markets high performance, intelligent sensor
products that are used in electronic control systems by customers in the
automotive and industrial markets. The Company was incorporated in March 1989
and was principally engaged in research and development through fiscal 1993. In
fiscal 1991, the Company shipped its first product; an application specific
integrated circuit ("ASIC") designed for use with a very low-pressure sensor
used in industrial flow measurements. In fiscal 1992, the Company introduced
its first integrated sensor device ("ISD"), an aftermarket product for manifold
absolute pressure ("MAP") sensor applications for General Motors automobile
engines. The Company subsequently developed and introduced a variety of other
ASICs and ISDs. Principally as a result of an increase in product sales, the
Company's total revenues have increased to $7.7 million for the three months
ended June 30, 1999 from $4.9 million for the three months ended June 30, 1998
The Company has experienced operating losses in each year since its inception
and had an accumulated deficit of $15.3 million as of June 30, 1999.
The Company experienced higher product costs during the three months ended
June 30, 1999 largely due to lower production yields for ISDs produced at its
German operation, coupled with declining average selling prices for these
products as the unit volumes increased. Lower production yields were largely
due to using the existing manufacturing line for two different products, which
created manufacturing inefficiencies.
The Company derives its revenues from sales of its ASICs and ISDs and from
product development contracts. Beginning in fiscal 1995, product sales have
accounted for a significant majority of the Company's revenues, and the Company
anticipates that the percentage will increase in the future. The Company sells
a substantial portion of its products pursuant to long-term, exclusive
contracts that typically contain volume-pricing provisions that require the
Company to reduce its per unit price as certain volume levels are achieved. If
the Company is unable to make corresponding product cost reductions, the
resulting decline in the average selling prices of the Company's products sold
pursuant to such contracts will reduce the Company's product gross margin. The
Company anticipates that all of its products will experience declining average
selling prices over their life cycles with a similar potential impact on
product gross margin if the Company is unable to reduce corresponding costs or
introduce new products with higher gross margins. The Company's strategy is to
improve its product gross margin despite the declining average selling prices
by reducing cost of product revenues, introducing new products with higher
gross margins and addressing new markets.
The Company's revenues in any period are substantially dependent upon
sales to and product development contracts with a small number of customers.
Revenues from customers that represented at least 10% of total revenues in each
of the three months ended June 30, 1999 and 1998 accounted for 79% and 84% of
total revenues, respectively. The Company expects that this trend will continue
for the foreseeable future.
The Company's cost of product revenues includes the costs of wafer
fabrication, raw materials, third party assembly and direct and indirect costs
of procurement, scheduling, testing, calibration of ISDs, housing assembly for
ISDs and quality assurance. The Company is actively attempting to reduce these
costs by, among other things, improving yields on existing products,
fabricating its ASICs on larger wafers using smaller geometries and performing
more manufacturing, assembly and test operations in-house. In addition, to the
extent that the volume of product shipments increases, the Company may be able
to obtain volume discounts to lower its costs of raw materials, components and
10
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
services. Higher volumes may also result in allocation of fixed costs over a
larger revenue base and a corresponding reduction in per unit product costs.
Nonetheless, the Company's ability to reduce product costs may be adversely
affected by a number of factors outside the Company's control including, among
other things, fluctuations in manufacturing yields and availability and cost of
manufacturing and assembly capacity and of raw materials. In the past, the
Company has experienced significant, unanticipated price increases for wafer
fabrication and significant assembly supply disruptions which materially
adversely affected the Company's operating results. In addition to its efforts
to reduce cost of product revenues, the Company believes it can mitigate the
effects of declining average selling prices by continually introducing new
products and addressing new markets with existing and new products. The Company
has made significant investments in its product development resources to
address these issues. The Company has been not been successful in its efforts
to reduce product costs and there can be no assurance that the Company will be
able to reduce its product costs or introduce new products in a timely manner
to improve product gross margin levels. Any failure to improve gross margins
could have a material adverse effect on the Company's business, financial
condition or operating results.
On May 3, 1999, the Company and Texas Instruments ("TI") announced that
they had entered into an agreement for TI to acquire the Company. The agreement
is for an all-cash tender offer for all outstanding shares of ISS's common
stock at $8.05 per share, or about $62 million. According to the terms of the
agreement, the company will become part of the Automotive Sensors & Controls
group of TI's Materials and Controls ("M&C") business based in Attleboro,
Massachusetts. The Company and TI currently anticipate that the transaction
will be completed by August 18, 1999. After completion, the Company will
terminate its registration under the Securities Exchange Act of 1934 and cease
filing public reports.
TI commenced the all cash tender offer on May 7, 1999, and the tender
offer was originally scheduled to expire at midnight EDT on June 4, 1999. TI
extended the offer several times due to the fact that German antitrust
authorities had not completed their review of the proposed transaction. On
August 6, 1999, German authorities completed their review of the transaction
and granted consent for the consummation of the acquisition. The latest tender
offer expired on August 13, 1999. On August 11, 1999, 7,541,374 shares were
tendered. TI intends to acquire the Company's common stock through a wholly-
owned subsidiary of TI. Any shares not purchased in the tender offer will be
acquired for the tender offer price in cash in a second-step merger.
The boards of directors of both companies have unanimously approved the
acquisition, and the Company's board of directors has recommended that the
Company's stockholders accept TI's all cash tender offer. Consummation of the
acquisition is contingent upon the tender of a majority of ISS's outstanding
common stock on a fully-diluted basis, antitrust agency approvals in the United
States and Germany and certain other conditions.
The Company's revenues in any period are substantially dependent upon
sales to and product development contracts with a small number of customers.
Revenues from customers that represented at least 10% of total revenues in each
of the three months ended June 30, 1999 and 1998 accounted for 79% and 84% of
total revenues, respectively. The Company expects that this trend will continue
for the foreseeable future.
Results of Operations
The following table sets forth for the periods indicated selected
consolidated statements of operations data as a percentage of total revenues:
<TABLE>
<CAPTION>
Three Months Ended
June 30,
------------------------
1999 1998
---------- ----------
<S> <C> <C>
Revenues:
Product revenues 97.9% 89.6%
Contract revenues 2.1 10.4
------- -------
Total revenues 100.0 100.0
------- -------
11
<PAGE> 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
Cost of revenues:
Cost of product revenue 84.7 68.9
Cost of contract revenue 10.6 12.2
------- -------
Total cost of revenues 95.3 81.1
------- -------
Gross profit 4.7 18.9
------- -------
Operating expenses:
Research and development 15.9 21.0
Sales, general and administration 12.3 13.0
------- -------
Total operating expenses 28.2 34.0
------- -------
Loss from operations (23.5) (15.1)
Interest income 0.4 4.3
Interest expense (0.1) (0.9)
Other expense (2.4) (0.6)
Minority interest in net loss of ISS-Nagano - 0.3
------- -------
Net loss (25.6)% (12.0)%
======= =======
</TABLE>
Comparison of Three Months Ended June 30, 1999 and 1998
Revenues
The Company derives its revenues from sales of ASICs and ISDs and from
fees earned under product development contracts. The Company recognizes
revenues from product sales upon shipment. Contract revenues are recognized
only when applicable customer milestones, including deliverables, have been
met, but not in excess of the amount that would be recognized using the
percentage of completion method.
Product Revenues. Product revenues increased by 72% to $7.5 million in
----------------
the three months ended June 30, 1999 from $4.4 million for the three months
ended June 30, 1998. The increase was principally due to increased shipments of
ISDs for Common Rail Diesel Injection and Vehicle Stability Control Systems as
well as ASICs incorporated into sensors for the gasoline direct injection
systems. Consistent with the Company's long-term strategy, product revenue
increased to 97.9% of total revenues for the three month ended June 30, 1999
from 89.6% for the similar period in the prior year. This increase was
principally the result of an increase in ISD product revenues at ISS-Nagano
GmbH, the Company's majority owned subsidiary ("ISS-Nagano"). The Company
believes that product revenue is likely to account for substantially all of the
Company's future revenues.
Contract Revenues. Contract revenues decreased by 68% to $163,000 for the
-----------------
three months ended June 30, 1999 from $504,000 for the comparable period in
1998. The decrease was primarily due to fewer new development contracts in the
three months ended June 30, 1999 compared to the similar period in 1998 as the
Company focused on completing existing contract milestones. Contract revenue as
a percentage of total revenues for the three months ended June 30, 1999
decreased to 2.1% from 10.4% for the comparable period in 1998, respectively.
International revenues (export revenues and revenues of ISS-Nagano) were
$7.3 million and $3.8 million for the three months ended June 30, 1999 and
1998, respectively, representing 95.1% and 77.9% of total revenues,
respectively. The increase in international revenues for the three months ended
June 30, 1999 as compared to the similar period in 1998 was principally the
result of increased sales in Germany. All of the Company's sales in Europe are
denominated in Deutschemarks. Accordingly, a portion of the Company's
international revenues is subject to foreign currency fluctuation risks, and
fluctuations in the value of the Deutschemark could adversely affect the
profitability of sales made in Europe and therefore materially adversely affect
the Company's business, financial condition or operating results. The Company
has not engaged in any hedging transactions to minimize its risk to foreign
currency fluctuations. The Company may, however, engage in such transactions in
the future.
12
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
Cost of Revenues
- ----------------
Cost of Product Revenue. The Company's product revenue gross margin
-----------------------
decreased 9.6% to 13.5% for the three months ended June 30, 1999 from 23.1% for
the three months ended June 30, 1998. The decline in product gross margin for
the three months ended June 30, 1999 compared to 1998 was due, in part, to the
reduction in average selling prices of ISD products for volume based contracts
with customers, as well as manufacturing inefficiencies including yield issues
associated with the production ramp-up of the Company's HVP and FDR media-
compatible ISDs.
Cost of Contract Revenues. The Company's cost of contract revenue
-------------------------
increased to $814,000 in the three months ended June 30, 1999 from $592,000 in
the comparable 1998 period. The increase in contract costs was primarily due
to fewer contact programs and a greater focus on existing programs in the first
quarter of 1999 compared to 1998. Expenses related to contracts are recorded as
incurred, while recognition of revenues occurs when contractual milestones are
reached. The Company does not anticipate that the gross margin on contract
revenues will grow or even be positive in future periods.
Operating Expenses
- ------------------
Research and Development Expenses. Research and development expense
---------------------------------
consists primarily of personnel expenses, including salary and benefits, and
other product development related engineering expenses not associated with
contract revenue. Research and development expenses increased by 19% to $1.2
million for the three months ended June 30, 1999 from $1.0 million for the
three months ended June 30, 1998 in the comparable period in 1998. This higher
level of expenses reflects an overall increase in resources for ASIC and ISD
product test development, tire pressure monitoring programs, and an increase in
resources at the Company's ISS-Nagano operations. Research and development
expenses as a percentage of total revenues decreased to 15.9% for the three
months ended June 30, 1999 from 21.0% for the similar period in 1998. The
Company believes that research and development is essential to the Company's
ability to increase revenues. The Company expects research and development
expenses to increase in absolute dollars but expects such expenses to decrease
as a percentage of total revenues.
Sales, General and Administrative Expenses. Sales, general and
------------------------------------------
administrative expense consists primarily of personnel expenses, including
salary and benefits, and professional fees. Sales, general and administrative
expenses increased by 50% to $947,000 for the three months ended June 30, 1999
from $631,000 for the three months ended June 30, 1998. This higher level of
expense reflects an increase in personnel and professional fees necessary to
manage the financial, legal and administrative aspects of operating as a public
company. Sales, general and administrative expenses as a percentage of total
revenues declined to 12.3% for the three months ended June 30, 1999 compared to
13.0% for the three months ended June 30, 1998. The Company expects sales,
general and administrative expenses to increase in absolute dollars, reflecting
growth in operations and costs associated with being a public entity, but to be
stable or decline as a percentage of total revenues.
Interest Income
- ---------------
Interest income decreased to $38,000 for the three months ended June 30,
1999 from $211,000 for the three months ended June 30, 1998. The decrease in
interest income was the result of lower interest-bearing cash balances and a
decline in interest rates during the three months ended June 30, 1999 compared
to the similar period in 1998.
13
<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
Interest Expense
- ----------------
Interest expense decreased to $9,000 for the three months ended June 30,
1999 from $45,000 for the three months ended June 30, 1998 due to lower average
borrowings resulting from the repayment of debt during fiscal 1999 and the
repayment of all balances outstanding under the Company's line of credit during
the three months ended June 30, 1999.
Other Expense, Net
- ------------------
Other expense, net was $185,000 for the three months ended June 30, 1999
compared $30,000 for the three months ended June 30, 1998. Other expense
changed primarily due to foreign currency exchange losses of $201,000 in the
three months ended June 30, 1999 related to Deutschemark-denominated loans that
the Company has with ISS-Nagano partially offset by other income totaling
$16,000.
Minority Interest in Net (Income) Loss of ISS-Nagano
- ----------------------------------------------------
Minority interest in net loss of ISS-Nagano for the three months ended
June 30, 1999 was none compared to the minority interest in the net loss of
$17,000 for the similar period in 1998 due to the Company's purchase in June
1999 of the remaining interest of shares in its subsidiary ISS-Nagano GmbH for
3.5 million German Deutschemarks or approximately $1.9 million.
Income Taxes
- ------------
Due to the Company's loss position, there was no provision for income
taxes in the three months ended June 30, 1999 and 1998, respectively. The tax
rate for the three months ended June 30, 1999 and 1998 differ from the federal
statutory rate primarily as a result of providing no benefit for federal net
operating losses.
Year 2000 Compliance
- --------------------
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Computer programs
that have date-sensitive software may recognize a date using "00" as the year
1900 rather than the year 2000. The Company considers a product to be in "Year
2000 compliance" if the product's performance and functionality are unaffected
by processing of dates prior to, during and after the year 2000, but only if
all products (for example, hardware, software and firmware) used with the
product properly exchange accurate date data with it. The Company has a program
to assess the capability of its products to determine whether or not they are
in Year 2000 compliance. With respect to the Company's products, Year 2000,
product's performance and functionality are unaffected by processing of dates
provided that all other technologies and products used in combination with the
ISS products are in Year 2000 compliance.
The table below indicates the phases of the Year 2000 Project related to
the Company's critical and priority internal systems and the expected time
frames.
<TABLE>
<CAPTION>
Phases Of The Project Start Date End Date
--------------------- ---------- --------
<S> <C> <C>
Internal Operating Systems Q4 FY98 Q2 FY00
Manufacturing In Line Test Software and
Embedded Controllers Q4 FY99 Q3 FY00
TMT Test Systems Q3 FY99 Q3 FY00
</TABLE>
The Company does not believe it is legally responsible for costs incurred
by customers related to ensuring such customers' or end-users' Year 2000
capability. The Company has contacted many of its major customers to determine
whether their products into which the Company's products have been and will be
integrated are Year 2000 compliant. The Company has received assurances of Year
14
<PAGE> 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
2000 compliance from a number of those customers. The Company anticipates that
substantial litigation may be brought against vendors, including the Company,
of all component products of systems that are unable to properly manage data
related to the Year 2000. The Company's agreements with customers typically
contain provisions designed to limit the Company's liability for such claims.
It is possible, however, that these measures will not provide protection from
liability claims, as a result of existing or future federal, state or local
laws or ordinances or unfavorable judicial decisions. Any such claims, with or
without merit, could result in a material adverse affect on the Company's
business, financial condition and results of operations, including increased
warranty costs, customer satisfaction issues and potential lawsuits. The
Company has also initiated formal communications with its critical suppliers
and financial institutions to determine the extent to which the Company is
vulnerable to those third parties' failure to remedy their own Year 2000 issue.
To date the Company has received assurances of Year 2000 compliance from a
number of those contacted. Most of the suppliers under existing contracts with
the Company are under no contractual obligation to provide such information to
the Company. The Company is taking steps with respect to new supplier
agreements to ensure that the suppliers' products and internal systems are Year
2000 compliant.
In fiscal 1999, a high level assessment was performed on the Company's
internal systems. This high level assessment identified all critical and non-
critical internal systems and the resources required to ensure these systems
are Year 2000 compliant. With this assessment, the Company has developed and
initiated a comprehensive program to address both Year 2000 readiness in its
internal systems and with its customers and suppliers. The Company's program
has been designed to address its most critical internal systems first and to
gather information regarding the Year 2000 compliance of products supplied to
it and into which the Company's products are integrated. The Company has formed
internal teams to address Year 2000 readiness at each of its manufacturing
locations. Detailed assessment and remediation, deployment, and integration
testing of the Company's internal systems are proceeding simultaneously, and
the Company intends to have its critical internal systems Year 2000 compliant
by October 1, 1999, the first day of the Company's 3rd Quarter of fiscal year
2000. These activities are intended to encompass all major categories of
systems in use by the Company, including manufacturing, engineering, sales,
finance and human resources and will involve both the use of internal resources
and outside consultants. Certain of the Company's manufacturing, engineering,
facilities, finance and human resource systems are deemed to be Year 2000
compliant as of March 31, 1999.
The costs incurred by the Company during the three months ended June 30,
1999, related to its Year 2000 readiness program were less than $10,000 and
cumulatively to date have been less than $25,000. The Company currently expects
that the total cost of its Year 2000 readiness programs, excluding redeployed
resources, will not exceed $100,000 over the current fiscal year. The total
cost estimate does not include potential costs related to any customer, vendor,
or other claims or the costs of internal software or hardware replaced in the
normal course of business. The total cost estimate is based on the current
assessment of the Company's Year 2000 readiness needs, as defined by the high
level assessment performed in fiscal 1999, and is subject to change as the
projects proceed. The Company is identifying Year 2000 dependencies in its
equipment, processes and systems and is implementing changes to or replacements
of affected equipment, processes and systems to make them Year 2000 compliant.
There can be no assurance that the Company will have identified all such
dependencies (including those on its vendors, customers, or financial
institutions) or that it will implement its changes in an efficient and timely
manner or that any new systems will be adequate to support the Company's
operations. Problems with installation or initial operation of the changed
systems or replacements could cause substantial management difficulties in
operations planning, financial reporting and management and thus could have a
material adverse effect on the Company's business, financial condition and
results of operations. The cost of bringing the Company's systems into Year
2000 compliance is not expected to have a material effect on the Company's
financial condition or results of operations.
While the Company currently expects that the Year 2000 issue will not pose
significant operational problems, delays in the implementation of changes in or
replacements of information systems or a failure to fully identify all Year
2000 dependencies in the Company's systems and in the systems of its suppliers,
customers and financial institutions could have material adverse effect in the
Company's business, financial condition and results of operations. Therefore,
the Company is developing contingency plans for continuing operations in the
event such problems arise.
15
<PAGE> 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
Liquidity and Capital Resources
- -------------------------------
Since inception, the Company has financed its operations principally
through sales of equity securities, product revenues and contract revenues. The
Company completed its initial public offering on March 13, 1998, in which it
raised approximately $20,391,000, including the underwriter's exercise of their
over-allotment option on April 8, 1998, after deducting costs associated with
the initial public offering. At June 30, 1999, the Company had cash, cash
equivalents and short-term investments of $553,000 and working capital of $5.9
million. The Company also has a $3.5 million bank line of credit agreement
secured by the assets of the Company that permits borrowings of the lesser of
$3.5 million or 80% of eligible accounts receivable. Eligible accounts
receivable are defined as those outstanding less than 90 days from date of
invoice. Borrowings under the line of credit bear interest at the bank's prime
rate plus 0.50%. At June 30, 1999, the Company also had a $1.5 million term
loan facility for capital equipment that bears interest at the bank's prime
rate plus 1.50%. The bank line of credit agreement and term loan facility will
expire August 21, 1999. At June 30, 1999, the Company had no outstanding
borrowings under the line of credit agreement and term loan facility. These
agreements require the Company to maintain certain financial covenants on a
quarterly basis. At June 30, 1999, the Company was not in compliance with its
profitability covenant.
Net cash used in operating activities was $1.2 million and $3.4 million in
three months ended June 30, 1999 and 1998, respectively. For the three months
ended June 30, 1999, net cash used in operations was primarily attributable to
the Company's net loss and an increase in inventory levels for anticipated
higher sales demand partially offset by an increase in accounts payable. For
the three months ended June 30, 1998, net cash used in operations was primarily
attributable to a decrease in accounts payable, an increase in inventory levels
in anticipation of higher sales demand and the Company's net loss.
Net cash used in investing activities was $2.8 million, and $9.5 million
in three months ended June 30, 1999 and 1998, respectively. Cash used in
investing activities for the three months ended June 30, 1999 was primarily
related to purchases of property and equipment and payment of $1.9 million for
the remaining 18.5% of ISS-Nagano GmbH. Cash used in investing activities for
the three months ended June 30, 1998 was primarily related to the Company's
purchase of $9.0 million in short-term investments.
Net cash used in financing activities was $555,000 for the three months
ended June 30, 1999 and net cash provided by financing activities was $2.2
million for the three months ended June 30, 1998. Cash used in financing
activities for the three months ended June 30, 1999 was primarily due to the
repayment of $400,000 outstanding under its line of credit and $240,000
outstanding under its term loan facility for equipment. Cash provided by
financing activities for the three months ended June 30, 1998 was primarily due
to the sale of common stock upon exercise of the over allotment option held by
the underwriters of the Company's initial public offering. The Company also
repaid $500,000 outstanding under its line of credit
As of June 30, 1999 the Company had outstanding noncancelable purchase
orders of approximately $15.5 million, primarily relating to inventory and
fixed asset purchases.
The Company anticipates the transaction with TI will conclude no later
than August 18, 1999. In the event that the transaction does not take place,
the Company anticipates that it will be able to fund its operations through
cash generated by operations and by renewing its currently existing line of
credit and term loan. There can be no assurance that the Company will be able
to renew its credit facilities on commercially reasonable terms, or at all. The
Company may also be required to seek equity financing which may be on terms
that would be dilutive to current stockholders. If the Company is unable to
obtain adequate financing, it could be required to significantly reduce its
operations.
16
<PAGE> 17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
To date, the Company has not invested in derivative securities or any
other financial instruments that involve a high degree of risk. The Company
expects that, in the future, cash in excess of current requirements will be
invested in short-term, investment grade, interest-bearing securities.
Factors That May Affect Operating Results
The statements contained in this Report on Form 10-QSB that are not purely
historical are 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, including statements regarding the Company's expectations, hopes,
intentions or strategies regarding the future. Forward-looking statements
include but are not limited to: statements regarding future products or product
development; statements regarding future research and development spending and
the Company's product development strategy; statements regarding the levels of
international sales; and statements regarding future expenditures. All forward-
looking statements included in this document are based on information available
to the Company on the date hereof, and the Company assumes no obligation to
update any such forward-looking statements. It is important to note that the
Company's actual results could differ materially from those in such forward-
looking statements. Some of the factors that could cause actual results to
differ materially are set forth below. In addition to the other information in
this Form 10-QSB, the following factors should be considered carefully in
evaluating the Company and its business.
Risks Relating to Transaction with TI. ISS believes that an important
-------------------------------------
benefit to be realized from the acquisition of the Company by TI will be the
integration of the Company's management, strategies, operations and product
lines with those of TI. This integration process has caused an interruption
of, or a loss of momentum in, the activities of the Company as an independent
entity, because of significant delays. Additionally, the Company has incurred
significant expenses and made resource commitments in connection with the sale
to TI that would materially adversely affect the Company's business and
financial condition if the transaction were not consummated. Although the
Company is not aware of any circumstance which would interfere with the
consummation of the sale to TI, the Company cannot assure stockholders that the
transaction will be completed, and a cancellation or further significant delay
in completion of the transaction could materially adversely affect the
Company's business, financial condition and results of operations.
Ongoing Operating Losses. The Company has experienced operating losses in
------------------------
each fiscal year since inception and in each fiscal quarter since September
1997. The losses have been largely attributable to increased costs associated
with the manufacture of the Company's ISDs combined with declining average
selling prices of the ISDs. If the Company remains independent and is not
acquired by TI, in addition to the risks described above, the Company may never
be able to achieve profitability or generate sufficient operating income to
continue operations.
Implementation of New Automated Manufacturing Line. The Company is
---------------------------------------------------
currently developing a new automated manufacturing line at its German facility
for the manufacture of Vehicle Stability Control System ISDs which will involve
existing technologies currently employed by the Company's Common Rail Diesel
Injection ISD manufacturing line at the same facility. There can be no
assurance that the transition of Vehicle Stability Control System ISDs
processing to the new line will be achieved on schedule without encountering
any delays in the process implementation. Nor can there be any assurance that
the Company will achieve acceptable manufacturing yields or that the operating
income margins on such products will be comparable to those realized in
connection with the Company's current manufacturing line. Failure to achieve
acceptable yields or margins could adversely affect the Company's financial
condition and results of operations. In developing the new line, there can be
no assurance that the Company will be able to meet customer demands or there
can be no assurance while implementing the new line there will be no line shut
downs at the Company's end, which in turn may cause shut downs at the customers
and/or end user such as a vehicle manufacturer. The cost of such a shut down
17
<PAGE> 18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
may have a material adverse effects on the Company's financial condition,
results of operations and business. There can be no assurance that the Company
can manage the cost of or handle such a shut down without materially adversely
affecting the Company's financial condition, results of operations or business.
Dependence on Customer Specific Products; Lengthy Sales and Development
-----------------------------------------------------------------------
Cycle. A substantial portion of the Company's products is designed to address
- -----
the specific needs of individual customers. As a result, the sales and
development cycle for these products can be lengthy, with the development cycle
alone ranging up to thirty months for new products in new applications in the
automotive industry and up to eighteen months for new products in new
applications in the industrial market. Because customer specific products are
developed for particular customers' applications, some of the Company's current
and future customer specific products may never be produced in high volume, or
at all, due to the Company's inability to introduce custom products in a timely
manner, delays in the introduction of the Company's customers' products, the
failure of the Company's customers' products to achieve and sustain commercial
success or the discontinuation of a customer's product line. Any of these
occurrences could have a material adverse effect on the Company's business,
financial condition or operating results.
Fluctuations in Operating Results. The Company's revenues and operating
---------------------------------
results have varied on a quarterly and an annual basis in the past and may vary
significantly in the future. The Company's revenues and operating results are
difficult to forecast and could be materially adversely affected by many
factors, some of which are outside the control of the Company, including, among
others, fluctuations in yields, the relatively long sales and development cycle
for the Company's products, the ability to obtain product development contracts
and the amount and timing of recognition of product development contract
revenue and expense associated with such contracts, the Company's ability to
introduce new products and technologies on a timely basis, market acceptance of
the Company's and its customers' products, the timing, deferral or cancellation
of customer orders and related shipments, competitive pressures on selling
prices, availability of foundry capacity, availability of raw materials,
changes in product mix, changes in the lead time required to ship products
after receipt of an order, introduction of products and technologies by the
Company's competitors and customers, quality control of products sold,
personnel changes and difficulties in attracting and retaining qualified
technical personnel, foreign currency exchange rates and economic conditions
generally and in the automotive and industrial markets.
Significant portions of the Company's product sales are made pursuant to
standard purchase orders that are cancelable without significant penalties. In
addition, purchase orders are often subject to price renegotiations and to
changes in quantities of products and delivery schedules to reflect changes in
customers' requirements and manufacturing availability. The Company's actual
shipments depend in part on the manufacturing capacity of the Company's
suppliers and the availability of products from such suppliers. The Company's
expense levels are based, in part, on its expectations as to future revenues
and to a large extent are fixed in the short term. Accordingly, the Company may
be unable to adjust spending in a timely manner to compensate for any
unexpected shortfall in revenues, and any significant shortfall of demand in
relation to the Company's expectations or any material delay or deferral of
customer orders would have a material adverse effect on the Company's business,
financial condition or operating results.
As a result of the foregoing and other factors, it is likely that in some
future period the Company's operating results will fail to meet the
expectations of public market analysts or investors. In such event or in the
event that adverse conditions prevail or are perceived to prevail generally or
with respect to the Company's business, the trading price of the Company's
Common Stock could drop significantly.
Variability of Manufacturing Yields. Manufacturing yields of the
-----------------------------------
Company's ASICs and ISDs may vary significantly depending on a variety of
factors. ASIC yields can be adversely affected by the level of contaminants in
the manufacturing environment, impurities in the materials used and the
performance of fabrication personnel and equipment, all of which are outside
the control of the Company. ISD yields can be adversely affected by defective
sensing elements, component quality and performance of assembly personnel and
equipment. Historically, the Company has experienced fluctuations in yields of
its products, particularly during initial production of new products, which
have adversely affected product gross margin. The Company believes that any new
18
<PAGE> 19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
product lines or manufacturing processes that it undertakes may create
difficulties in achieving acceptable yields, and, as a result, the Company may
experience production problems or shipment delays which could have a material
adverse effect on the Company's business, financial condition or operating
results. Regardless of the process technology used, the manufacturing of ASICs
and ISDs is a highly complex and precise process, and there can be no assurance
that the Company will be able to achieve or maintain acceptable yields on its
products in the future. Any such failure could have a material adverse effect
on the Company's business, financial condition or operating results.
Significant Customer Concentration. Historically, a relatively small
----------------------------------
number of customers have accounted for a significant percentage of the
Company's total revenues, and the Company expects that this trend will
continue. In each of the three month periods ended June 30, 1999 and 1998, the
Company has had one or more customers, which each accounted for more than 10%
of total revenues. In the three months ended June 30, 1999, one customer
accounted for 78.9% of total revenues. In the three months ended June 30,
1998, three customers accounted for 84% of total revenues. The Company's
ability to achieve sales in the future will depend upon its ability to obtain
orders from, maintain relationships with and provide support to a small number
of existing and new customers. As a result, any cancellation, reduction,
rescheduling or delay in orders by or shipments to any customer or the
discontinuation or redesign by any customer of its products which currently
incorporate one or more of the Company's products would have a material adverse
effect on the Company's business, financial condition or operating results.
Dependence on Automotive Industry; Need to Penetrate New Markets. In
----------------------------------------------------------------
fiscal 1999, the Company derived approximately 90% of its total revenues from
products sold for applications in the automotive industry. Accordingly,
improvement in the Company's future operating results will depend in part on
its ability to increase its market share in the automotive industry. Further,
the Company believes that its operating results may be affected by the cyclical
nature of the automotive industry. Any downturn in any customer's business or
the economy in general may cause purchases of the Company's products to be
deferred, reduced or canceled resulting in a material adverse effect on the
Company's business, financial condition or operating results. The Company's
future operating results will also depend on its ability to continue to
penetrate the industrial market and to penetrate new markets such as the
consumer and office products markets. While the Company may devote substantial
resources to penetrate new markets in the future, it has not committed a
material amount of resources to such effort to date, and there can be no
assurance that the Company will commit significant resources to this effort, or
if committed, that the revenues generated from these efforts, if any, will
exceed the costs of such efforts. To the extent that the Company is unable to
penetrate new markets, its future success will be dependent upon its ability to
further penetrate the automotive industry and on the continued growth of that
industry. If the Company were unable to successfully penetrate new markets or
to expand its penetration of the automotive market, its business, financial
condition or operating results would be materially adversely affected.
Declining Average Selling Prices. The Company sells a substantial portion
--------------------------------
of its products pursuant to exclusive contracts which typically contain volume-
pricing provisions that require the Company to reduce its per unit price as
certain volume levels are achieved. If the Company is unable to make
corresponding product cost reductions, the resulting decline in the average
selling prices of the products sold pursuant to such contracts may reduce the
Company's product gross margin. The Company has experienced declining average
selling prices on certain of its products in the past when shipments have
reached specified volume levels, and the Company anticipates that all of its
products will eventually experience declining average selling prices over their
life cycles. Declining average selling prices may have a material adverse
effect on gross margins in the future if the Company is unable to reduce
corresponding costs or introduce new products with higher gross margins. If the
Company is unable to sufficiently reduce its costs on existing products or
introduce new products with higher margins in a timely manner, the Company's
business, financial condition or operating results will be materially adversely
affected.
Dependence on Sensing Element Suppliers. The Company is currently
---------------------------------------
dependent upon a small number of third party vendors for substantially all of
the sensing elements incorporated into its ISDs. The Company currently
purchases a pressure-sensing element incorporated in certain of its ISDs from a
single source, Nagano Keiki Co., Ltd. ("Nagano"). The Company believes that
19
<PAGE> 20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
Nagano is currently the only high volume supplier of this type of sensing
element. The Company also manufactures ISDs that incorporate sensing elements
purchased solely from Lucas NovaSensor. The Company historically has not
manufactured sensing elements and anticipates that it will continue to obtain
sensing elements from third parties for the foreseeable future. The Company's
future success will be dependent upon its ability to identify and work closely
with manufacturers who are able to provide high volume, technologically
advanced and cost-effective sensing elements. Any failure of the Company to
maintain its existing relationships with sensing element suppliers or to
identify and work with new sensing element suppliers could have a material
adverse effect on the Company's business, financial condition or operating
results.
Narrow Product Base. The Company currently depends upon the sale and
-------------------
success of a limited number of product lines. Because the Company's primary
source of revenue is dependent upon a narrow product base, any interruption or
reduction in these sales due to production problems, lack of adequate demand,
replacement by new technologies or other internal or external problems
resulting in the failure of such product lines to win broad acceptance in the
marketplace would have a material adverse effect on the Company's business,
financial condition or operating results.
Rapid Technological Change; Need to Develop New Products. The markets for
--------------------------------------------------------
the Company's products are characterized by rapid technological change as well
as evolving industry standards that may render existing products obsolete. As a
result, the success of new products depends on a variety of factors, including
effective definition of products that meet evolving market needs, successful
and timely completion of development and introduction of these products,
successful design wins in new systems and the ability to offer products at
competitive prices. The development of new mixed signal integrated circuits is
highly complex, and from time to time the Company has experienced delays in
developing and introducing new products. There can be no assurance that the
Company will be able to define new products successfully and develop and bring
to market new and enhanced products on a timely and cost effective basis,
develop or access new process technologies, secure design wins or respond
effectively to new technological changes or new product announcements by
others. A failure in any of these areas could have a material adverse effect on
the Company's business, financial condition or operating results.
Competition. The markets in which the Company competes are highly
-----------
competitive and characterized by diverse industry requirements and severe
pricing pressure in many applications. In the ASIC market, the Company competes
with analog and mixed signal semiconductor companies such as Motorola, Inc.
("Motorola"), Texas Instruments Incorporated ("TI") and Analog Devices, Inc.
The Company's products also compete indirectly with conventional hybrid
circuits and standard analog and mixed signal ICs. In the ISD market, the
Company competes with Delco, a subsidiary of General Motors ("GM"), Motorola,
TI, Kavlico and Denso Corporation ("Denso"). These companies all have
substantially greater financial, technical, manufacturing, marketing,
distribution, personnel and other resources than the Company. In addition, in
the industrial market, the Company competes with many small companies that have
developed specialized electronic sensor products and formed close relationships
with their customers. The Company also competes with the in-house development
staff of certain of its current and potential customers.
The Company also anticipates that additional competitors may enter the
Company's markets, resulting in even greater competition. Many of the Company's
current or prospective competitors own or have investments in wafer foundries,
which provide dedicated capacity to these competitors and enable them to
influence or control costs more effectively than the Company. There can be no
assurance that the Company will be able to compete successfully with existing
or new competitors. Increased competition could result in significant price
reductions or the loss of current or potential customers or design wins which
could materially adversely affect the Company's business, financial condition
or operating results.
Dependence on Key Personnel; Need for Additional Technical Personnel. The
--------------------------------------------------------------------
Company is substantially dependent upon the services of its executive officers.
The Company's future success depends on the continued contributions of such
20
<PAGE> 21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
officers, including the maintenance, enhancement and establishment of key
customer relationships and the management of operations. The loss of the
services of any of these officers by the Company could have a material adverse
effect on the Company's business, financial condition or operating results.
Such officers have not entered into employment agreements with the Company.
The Company believes that a key factor for competing successfully in the
mixed signal integrated circuit business is to attract and retain creative and
knowledgeable complementary metal oxide semiconductor ("CMOS") mixed signal
designers. The number of design engineers who have the training, creativity and
experience to design complex mixed signal integrated circuits is very limited,
and the competition for such personnel is intense. The Company's future success
will be heavily dependent upon its ability to attract and retain qualified
design, technical and management personnel. There can be no assurance that the
Company will be able to continue to attract and retain these personnel, and the
failure to do so could have a material adverse effect on the Company's
business, financial condition or operating results.
Dependence on Sole Source Suppliers. Certain components of the Company's
-----------------------------------
current products, such as fabricated wafers, sensing elements, packages and PC
boards, are acquired from single source suppliers. The Company purchases these
components on a purchase order basis and may not carry significant inventories.
If the Company were required to change any sole source component vendor or to
add vendors, the Company could be required to requalify its products
incorporating the new components with its existing customers. The
requalification process could prevent or delay product shipments which could
have a material adverse effect on the Company's business, financial condition
or operating results. In addition, the Company's reliance on sole source
component vendors involves several risks, including reduced control over the
price, timely delivery, performance, reliability and quality of the components.
Any inability of the Company to obtain timely deliveries of components of
acceptable quality or any significant increase in the prices of components for
which the Company does not have alternative sources could result in delays,
cancellations or reductions in product shipments which would have a material
adverse effect on the Company's business, financial condition or operating
results.
Dependence on Independent Assembly Contractors. All of the Company's
----------------------------------------------
ASICs, other than those incorporated in its ISDs, are packaged by one of two
independent contractors, one in Hong Kong, and the other in the Philippines. In
addition, the Company relies on an independent contractor in Thailand for PC
board level assembly of the electronic portion of the Company's ISDs. The
Company selects its contractors on the basis of a number of factors, including
technical capabilities, size and capacity, end-markets served, customer
references, quality certification status and economic competitiveness. The
Company negotiates prices for assembly services based on unit volumes and does
business on a purchase order basis. The Company currently has no supply
contracts with any of its assembly contractors.
The Company's reliance on independent contractors to assemble and package
its products involves significant risks, including reduced control over quality
and delivery schedules, the potential lack of adequate capacity and
discontinuance or phase-out of such contractors' assembly processes.
Historically, due to a lack of significant volumes, the Company has experienced
difficulty ensuring that independent assembly contractors would continue to
assemble or package the Company's products and that alternative independent
assembly contractors would be available in such instances. In 1994, the
independent contractor responsible for the Company's PC board level assembly
ceased its operations on very short notice which materially adversely affected
the Company's operating results for fiscal 1994 and 1995. There can be no
assurance that the Company's current or future contractors will continue to
assemble and package products for the Company or that alternate contractors
will be available to assemble or package the Company's products as necessary.
Further, because the Company's assembly contractors are located in foreign
countries, the Company is subject to certain risks generally associated with
contracting with foreign suppliers, including currency exchange fluctuations,
political and economic instability, trade restrictions and changes in tariff
and freight rates. There can be no assurance that the Company will not
experience problems in timeliness, adequacy or quality of product deliveries,
any of which could have a material adverse affect on the Company's business,
financial condition or operating results.
21
<PAGE> 22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
Dependence on Independent Wafer Suppliers. The Company relies on a small
-----------------------------------------
number of independent foundries for the manufacture of all of its ASICs,
including those incorporated into its ISDs. Although the Company has initiated
efforts to qualify second sources for certain of its key components, none of
the Company's ASICs is currently fabricated by more than one foundry. Although
processed wafer capacity in the semiconductor industry is currently widely
available, there can be no assurance that the Company's foundries will continue
to provide the Company an adequate supply of wafers to meet its customers'
demands.
The Company believes that as a result of fluctuations in demand and
changing technologies, wafer processing capacity may become limited from time
to time, resulting in greater difficulty in obtaining adequate supplies of
wafers, increased prices and increased lead times. Any increase in the demand
for processed wafers over expected levels or any failure of processed wafer
supply in the industry to grow at anticipated rates will magnify these
shortages. The Company currently receives fabricated wafers from American
Microsystems, Inc., Micrel Semiconductor, Inc. and Silicon Systems, Inc. In an
effort to secure a second source for certain ASICs, the Company has recently
begun to receive fabricated wafers from Alcatel Microelectronics ("Alcatel")
and is in the process of qualifying products manufactured by Alcatel. The
Company has also began qualification of Chartered Semiconductor ("Chartered")
as another foundry. There can be no assurance that the Company will be able to
complete qualification of products fabricated by Alcatel, Chartered
Semiconductor or any other new wafer supplier, in a timely manner or at all,
and any such failure could have a material adverse effect on the Company's
business, financial condition or operating results. Although the Company
receives supply assurances from its foundry partners, the Company obtains all
of its wafers on a purchase order basis, and, as a result, there can be no
assurance that wafer foundries will allocate sufficient capacity or any
capacity to the Company to meet its processed wafer supply needs. In the event
that the Company's foundry partners are unable or unwilling to continue
supplying wafers to the Company, there can be no assurance that the Company
will be able to identify and qualify additional manufacturing sources in a
timely manner, that any such additional manufacturing sources would be able to
produce wafers with acceptable manufacturing yields or that the Company would
not experience delays in product availability, quality problems, increased
costs or disruption in product development activities. The Company is engaged
in an ongoing and continuous program to reduce its product costs by increasing
the number of functional die per wafer by utilizing smaller geometry processes
and improving designs. As a result of this program, the Company believes that
it will be required to shift the fabrication of its wafers to new semiconductor
processes or potentially to new foundries. The Company expects that the shift
to new fabrication processes and foundries will occur on a product by product
basis in response to customer requests and as part of the Company's product
cost reduction strategy, and that the cost of such shift may be borne wholly or
in part by the Company. Shifting the manufacture of its wafers to new processes
or to new foundries is a highly complex undertaking requiring substantial
commitments of engineering personnel and other resources, which could
materially adversely affect the Company's business, financial condition or
operating results.
The use of independent wafer foundries entails certain other risks,
including reduced control over manufacturing yields and production costs. The
Company has from time to time experienced lower than anticipated manufacturing
yields in connection with the introduction of new products. For instance, the
Company encountered a substantial yield problem with certain of its ISD
products during the quarter ended March 31, 1998 due to a limitation of an ASIC
design with respect to a particular variation in the foundry wafer process.
These yield losses had a material adverse effect on the Company's operating
results. There can be no assurance that the Company's wafer foundries will not
produce wafers with lower than expected manufacturing yields in the future,
which could materially adversely affect the Company's business, financial
condition or operating results.
Dependence on Patents and Proprietary Rights. The Company relies on a
--------------------------------------------
combination of patents, maskwork rights, trade secret laws, copyrights,
trademarks and employee and third party non-disclosure agreements to protect
its intellectual property rights. The Company has been issued six patents and
has filed four additional patent applications in the United States and three
foreign patent applications. There can be no assurance that any patents will
issue from any of the Company's pending applications or that claims allowed
from pending applications will be of sufficient scope or strength, or be issued
in all countries where the Company's products can be sold, to provide
meaningful protection or any commercial advantage to the Company. Also,
competitors of the Company may be able to design around the Company's patents.
22
<PAGE> 23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
The laws of certain foreign countries in which the Company's products are or
may be developed, manufactured or sold, including various countries in Asia,
may not protect the Company's products or intellectual property rights to the
same extent as the laws of the United States and thus make the possibility of
piracy of the Company's technology and products more likely. There can be no
assurance that the steps taken by the Company to protect its proprietary
information will be adequate to prevent misappropriation of its technology or
that the Company's competitors will not independently develop technologies that
are substantially equivalent or superior to the Company's technology.
The semiconductor industry is characterized by vigorous protection and
pursuit of intellectual property rights or positions which have resulted in
significant and often protracted and expensive litigation. Although there is
currently no pending intellectual property litigation against the Company, the
Company may from time to time be notified of claims that the Company may be
infringing patents or other intellectual property rights owned by third
parties. If it is necessary or desirable, the Company may seek licenses under
such patents or other intellectual property rights. However, there can be no
assurance that licenses will be offered or that the terms of any licenses will
be acceptable to the Company. A failure to obtain a license from a third party
for technology used by the Company could cause the Company to incur substantial
liabilities and to suspend the manufacture of products requiring the
technology. Furthermore, the Company may initiate claims or litigation against
third parties for infringement of the Company's proprietary rights or to
establish the validity of the Company's proprietary rights. Litigation by or
against the Company could result in significant expense to the Company and
divert the efforts of the Company's technical and management personnel, whether
or not such litigation results in a favorable determination for the Company. In
the event of any adverse result in any such litigation against the Company, the
Company could be required to pay substantial damages, cease the manufacture,
use and sale of infringing products, expend significant resources to develop
noninfringing technology, discontinue the use of certain processes or obtain
licenses to the infringing technology. There can be no assurance that the
Company would be successful in such development or that such licenses would be
available on commercially reasonable terms or at all, and any such development
or license could require expenditures by the Company of substantial time and
resources. In the event that a third party makes a successful claim against the
Company or its customers and a license is not made available to the Company on
commercially reasonable terms, or at all, the Company's business, financial
condition or operating results could be materially adversely affected.
Dependence on International Sales and Suppliers. Sales to customers
-----------------------------------------------
located outside the United States accounted for approximately 95% and 78% of
the Company's total revenues for the three months ended June 30, 1999 and 1998,
respectively. The Company's sales to customers outside the United States are
subject to a variety of risks, including those arising from fluctuations in
currency exchange rates, tariffs, import restrictions and other trade barriers,
unexpected changes in regulatory and governmental licensing requirements,
longer accounts receivable payment cycles and potentially adverse tax
consequences. Because a significant portion of the Company's international
sales and in particular its European sales have to date been made through its
German subsidiary and have been denominated in Deutsche Marks, fluctuations in
the value of the Deutsche Mark relative to the U.S. Dollar or other currencies
could adversely affect the pricing of the Company's products in foreign markets
and make the Company's products relatively more expensive. In addition,
fluctuations in the Deutsche Mark could adversely affect the profitability of
sales made in Europe and therefore materially adversely affect the Company's
business, financial condition or operating results.
Several Asian countries including South Korea, Japan and Thailand, have
experienced significant economic downturns and significant declines in the
value of their currencies relative to the U.S. dollar. Due to these conditions,
it is possible that certain of the Company's customers will delay, reschedule
or cancel significant current or future orders for the Company's products. If
any such orders are delayed, rescheduled or canceled, the Company's business,
financial condition and results of operations would be adversely affected.
As a result of conducting business internationally, the Company is subject
to general geopolitical risks, such as political and economic instability and
changes in diplomatic and trade relationships. There can be no assurance that
such factors will not have a material adverse effect on the Company's business,
financial condition or operating results or require the Company to modify its
current business practices.
23
<PAGE> 24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
Need for QS-9000 Certification. The Company currently does not have QS-
------------------------------
9000 certification, which increasingly is being required by motor vehicle
manufacturers. The Company has invested significant financial and other
resources to obtain such certification, but there can be no assurance that the
Company will be successful in obtaining such certification in a timely manner,
or at all. Although the Company has not lost any sales to date as a result of
its lack of QS-9000 certification, the lack of such certification may make it
more difficult or impossible for the Company to qualify its products with new
customers or to continue to sell products to existing customers, either of
which could have a material adverse effect on the Company's business, financial
condition or operating results.
Risks of Product Liability. The automotive industry is characterized by
--------------------------
potential risks of product liability. The use of the Company's products in
various industrial or consumer applications in the future may also subject the
Company to potential risks of product liability claims. The Company's
agreements with its customers typically contain provisions designed to limit
the Company's exposure to product liability claims, and, although the Company
has not experienced any product liability claims to date, the sale of products
by the Company may entail the risk of such claims. Further, notwithstanding
liability limitation provisions in its agreements with its customers, due to
various industry or business practices or the need to maintain good customer
relationships, the Company may be placed in a position whereby it may make
payments related to such product liability claims. The Company currently
maintains product liability insurance, but there can be no assurance that
product liability claims will be covered by such insurance or will not exceed
insurance coverage limits or that such insurance will continue to be available
on commercially reasonable terms or at all. Notwithstanding the provisions in
the agreements with its customers, a product liability claim brought against
the Company could have a material adverse effect upon the Company's reputation,
business, financial condition or operating results.
Risks of Product Recalls. The automotive industry is heavily regulated by
------------------------
government agencies which establish various vehicle safety standards that are
often indirectly related to the components and subcomponents in their vehicles.
To the extent that any vehicles or any parts therein are required to be or are
voluntarily recalled and the recall involves vehicles or parts that are
directly or indirectly related to any of the Company's products, the Company
may be required to repair or replace its products, redesign or reproduce its
products or halt production or shipment of its products. Further, any recall of
vehicles or parts directly or indirectly related to any of the Company's
products may have the effect of damaging the Company's reputation. Although no
such recall has involved the Company or its products in the past, there can be
no assurance that such a recall will not occur in the future or that if such a
recall does occur that the Company's reputation, business, financial condition
or operating results will not be materially adversely affected.
24
<PAGE> 25
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As of the date hereof, to the Company's knowledge, there are no legal
proceedings in which the Company is involved or litigation pending against the
Company.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
--------
Exhibit
Number Description
------- -------------------------------------------------
27.1 Financial Data Schedule.
(b) Reports on Form 8-K. The Company filed a Report on Form 8-K on May 5, 1999,
in connection with the announcement of the Company's acquisition by Texas
Instruments which contained disclosures under Item 5. "Other Events" and
Item 7. "Financial Statements, Pro Forma Financial Information and
Exhibits".
25
<PAGE> 26
SIGNATURE
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.
INTEGRATED SENSOR SOLUTIONS, INC.
---------------------------------
(Registrant)
Date: August 16, 1999 By: /s/ DAVID SATTERFIELD
---------------------------------
David Satterfield
Vice President Finance & Administration,
Corporate Secretary
(Authorized Officer and
Principal Financial Officer)
26
<PAGE> 27
<TABLE> <S> <C>
<S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-QSB
FOR THE PERIOD ENDED JUNE 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-2000
<PERIOD-START> APR-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 553
<SECURITIES> 0
<RECEIVABLES> 4,849 <F1>
<ALLOWANCES> 0
<INVENTORY> 8,896
<CURRENT-ASSETS> 15,170
<PP&E> 10,064 <F1>
<DEPRECIATION> 0
<TOTAL-ASSETS> 27,313
<CURRENT-LIABILITIES> 9,253
<BONDS> 8
0
0
<COMMON> 8
<OTHER-SE> 18,790
<TOTAL-LIABILITY-AND-EQUITY> 18,052
<SALES> 7,502
<TOTAL-REVENUES> 7,666
<CGS> 6,491
<TOTAL-COSTS> 7,305
<OTHER-EXPENSES> 1,217 <F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 9
<INCOME-PRETAX> (1,959)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,959)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,959)
<EPS-BASIC> (0.26) <F3>
<EPS-DILUTED> (0.26)
<FN>
<F1> Item shown net of allowance, consistent with the balance sheet
presentation.
<F2> Item consists of research and development.
<F3> Item consists of basic earnings per share.
</FN>
</TABLE>
