ITEM 1. DESCRIPTION OF BUSINESS - --------------------------------
TelCom Semiconductor, Inc. (the "Company" or "TelCom") designs, develops, manufactures and markets a diversified portfolio of high-performance analog integrated circuits for a wide variety of applications in the industrial, wireless communications, computing, networking and medical markets. The Company's products comprise four principal product families: 1) Power Management ---------------- Products such as MOSFET drivers, low drop-out regulators, DC to DC converters, - -------- and CMOS voltage detectors (including microprocessor supervisory circuits); 2) Data Converter Products which include data acquisition system and display analog - ----------------------- to digital converters; 3) Thermal Management Products that provide thermal --------------------------- control information, and 4) Linear Products such as operational amplifiers, --------------- voltage references and comparators that act as linear building blocks in a wide range of electronic systems. Within each family, the Company markets proprietary and selected second source products offering a range of performance, functionality, and price.
The Company was organized in Delaware in June 1993 and began operations in December 1993 after purchasing the semiconductor operations of Teledyne, Inc. ("Teledyne") which principally consisted of its Teledyne Components Division ("Teledyne Components"). The Company's principal executive offices are located at 1300 Terra Bella Avenue, Mountain View, California 94039, and its telephone number is (650) 968-9241.
CUSTOMERS AND MARKETS - ---------------------
TelCom's basic marketing strategy is to identify and work with leading customers within each of its targeted market segments to jointly develop product solutions that offer a combination of high performance and increased functionality. An additional benefit of working with leading customers is the ability to gain insight into their next generation product requirements and to identify second source product needs that the Company may be in a position to fulfill. TelCom believes that its relationships with market leaders, such as Motorola and QualComm in the cellular telephone market and Compaq Computer and Intel in the PC market, enable the Company to sell such product solutions to other significant participants in such markets. TelCom also relies on its worldwide distribution network to accumulate information about other possible applications for the Company's products.
The Company uses strategic partners to augment its product portfolio and core competencies, and to achieve new channels to market. In addition these strategic relationships are expected to allow the Company to more rapidly identify and respond to market opportunities.
The Company's products are used in a broad range of applications within the industrial, wireless communications, networking, and computing markets. These categories are discussed below:
WIRELESS AND NETWORKING MARKET The proliferation of hand-held ------------------------------ communications devices such as cellular telephones, pocket pagers and personal two-way radios has created a demand for analog devices that monitor and reduce power consumption. TelCom offers a range of analog circuits to address the demands of these products for longer battery life. These circuits include battery full/low charge detection and DC-DC converters for the generation of voltages to drive liquid crystal displays, including backlighting. These devices are offered in miniature packages resulting in savings in space and weight. The Company's family of high current MOSFET drivers are used with TelCom's switch mode power supply controllers to regulate AC to DC power in cellular base stations, PBX and telephone and data communication equipment.
COMPUTER MARKET The rapid adoption of networked PCs, workstations and --------------- servers and the deployment of
machines using high performance microprocessors have given rise to the need for reliable temperature rise detection for power supply shutdown and fan speed control. As part of its smart sensor product family, TelCom has a patented solid state temperature sensor that facilitates rapid temperature rise detection that can be used for controlled shutdown of equipment with no loss of data or destruction of critical or expensive components. This trend to protect critical components by replacing older mechanical solutions with high performance analog devices is extending into notebook computers, modular power supplies and industrial and consumer product temperature alarms. The reliability and robust nature of silicon make analog devices preferable to mechanical devices in many respects. TelCom also makes power analog circuits for use in laptop/notebook computers, palmtop computers, personal digital assistants, disk drives, pocket organizers, facsimile modems and CD-ROM products. These products offer low operating current and/or high current drive capability for deriving additional voltages from battery or line powered equipment.
INDUSTRIAL MARKET Increased demand for precision and reliability has ----------------- resulted in higher semiconductor content in industrial instruments and manufacturing equipment. TelCom offers a broad range of integrating analog to digital converters that address the measurement of DC and AC voltages and currents, resistance and capacitance. These devices are commonly used in digital multimeters, panel meters, temperature meters, digital scales and digital oscilloscopes. This broad line of power management circuits offers the ability to detect and regulate voltages for use in battery and line powered industrial equipment.
PRODUCTS - --------
The Company's basic product strategy is to address an increasing spectrum of customer applications by introducing proprietary and selected second source products that increase the range of performance and capabilities of its product portfolios. To accomplish this the Company focuses on providing customer value via both higher analog performance as well as integration. Integration is the process of adding more functionality on a single piece of silicon and adding value to the customer from the improved reliability and lower cost associated with reduced component count. The Company's internal development activities focus on technology, high quality, and fast time to market. Maintaining a proper mix of platform and derivative products is also important. A platform product is the first product aimed at a market segment while a derivative product takes a platform product and adds new functionality or packaging to create a follow on product.
The Company offers a diversified portfolio of over 500 analog and mixed signal integrated circuit products for a wide range of market applications. The Company's long term goal is to have a broad range of customers and products such that dependencies on any one product, customer, or industry is small. Through 1998 the company has not been successful in achieving this goal as Motorola and the wireless market segment remain a significant portion of the Company's revenue.
POWER MANAGEMENT PRODUCTS The power management circuits offered by the ------------------------- Company are power MOSFET drivers, low drop-out regulators, DC-DC converters, and CMOS voltage detectors (including microprocessor supervisory circuits). The Company's CMOS LDO (low drop-out) regulators offer dropout voltages (minimum voltage needed across the device to maintain output voltage regulation) of 50 milli-volts and efficient current consumption to maximize the time before the battery is exhausted
DATA CONVERTER PRODUCTS TelCom's data converter products include data ----------------------- acquisition system and display analog-to-digital (A/D) converters. The Company is expanding its position as a supplier of A/D converters by introducing devices with higher accuracy (resolution) and increased functionality. The Company is also developing relationships with customers in the field of portable measuring instrumentation used in temperature monitoring, automotive diagnostics and field test equipment process control and data acquisition systems also benefit from the inherent capability of dual slope and sigma-delta A/D converters to reject line interference.
THERMAL MANAGEMENT PRODUCTS The increasing trend towards lightweight, high --------------------------- performance PCs and other products has necessitated smaller enclosures and faster microprocessors, resulting in a significant increase in the amount of heat generated within such products. TelCom's range of solid state thermal management devices is aimed at monitoring and warning of fault conditions and solving thermal management problems. For example, the
Company's proprietary TC620 temperature sensor protects advanced microprocessor- based systems by monitoring the temperature of the microprocessor and automatically turning off the system when the system temperature exceeds a specified threshold. Other devices have various analog or digital output signals that provide thermal control information for both consumer electronics and industrial system applications.
LINEAR PRODUCTS TelCom produces operational amplifiers, voltage references, --------------- and comparators that act as linear building blocks in a wide range of electronic systems. The Company has developed a new family of precision CMOS devices whose supply voltage rail-to-rail operation, low (microamp level) current drain, and small packages make them well suited for portable, battery-operated equipment. The Company's chopper stabilized amplifiers are used in precision amplification of very low level signals in the microvolt (1 millionth of a volt) range often encountered with strain gauges. These amplifiers have extremely low drift over both temperature and time.
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 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 products initially accepted by the Company's customers that are market leaders will become industry standard products. The Company's failure 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.
DESIGN AND PROCESS TECHNOLOGY - -----------------------------
DESIGN TECHNOLOGY. The design of analog circuits involves the design and ----------------- interconnection of a variety of circuits and features to achieve the desired function. The specific placement and interrelationship of these circuits is both complex and critical to the performance of the analog circuit. Computer- aided design and engineering tools, which have proliferated and enhanced the design effort for digital integrated circuits, have proven to be useful but less effective for analog devices. Consequently, analog circuit design has traditionally been highly dependent on the skills and expertise of individual design engineers. The Company's design engineers principally focus on developing next generation standard products, using computer simulation models to design products that both meet the high performance characteristics required by customers and adjust for process and temperature variations. TelCom's new product development strategy emphasizes a broad line of standard products that are based on customer input and needs. The Company is currently developing products to further expand the number of offerings within each of the power management, data converter, thermal management, and linear product families.
PROCESS TECHNOLOGY. TelCom utilizes CMOS, Bipolar and BICMOS process ------------------ technologies. The process technology used for a particular product is driven by the product specifications and customer requirements. CMOS
technology is the technology best suited for low power battery operated applications, has the advantages of low power consumption and high packing density, and enables the combination of analog and digital circuits on the same chip. A substantial majority of the Company's current products utilize some version of CMOS. Bipolar technology is best suited for high gain, high speed, high precision and high voltage product applications.
The Company competes in markets that 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. In order to have access to new semiconductor process technologies, particularly for products requiring sub-micron processing, the Company has entered into relationship with outside foundries to provide the processes and wafers the Company needs to produce its products. Semiconductor design and process methodologies are subject to rapid technological change, requiring large expenditures for research and development. The Company's future operating results could be adversely impacted if the Company fails to develop or obtain access to advanced wafer processing technologies, or if it fails to define, design and introduce competitive new products on a timely basis. Also, 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.
SALES, DISTRIBUTION AND MARKETING ---------------------------------
The Company's sales and marketing effort is focused on the development of relationships with leading companies in its targeted markets, and its sales and marketing resources are deployed to establish and enhance such relationships. TelCom currently employs sales managers and application engineers in sales, marketing and applications organizations in the United States, Europe, and Asia.
The Company's products are sold to over 5,000 end-user customers throughout the world, either directly or through its distributor network. Sales to customers in North America, Asia and Europe accounted for 35%, 33% and 32%%, respectively, of the Company's net sales for 1997, and 35%, 34% and 31%, respectively, of the Company's net sales for 1998. The Company's three largest OEM customers, Motorola, Intel, and Compaq Computer, accounted for 30%, 3% and 7%, respectively, of the Company's net sales for 1997, and 35%, 9%, and 4%, respectively, of the Company's net sales for 1998. The Company anticipates that it will continue to be dependent on a number of key customers and distributors for a significant portion of its net sales. The reduction, delay or cancellation of orders from one or more significant customers for any reason could materially and adversely affect the Company's operating results.
The Company sells its products through a direct sales staff and a worldwide network of independent sales representatives and distributors. The direct sales staff works with leading customers to determine customer requirements and interfaces with design engineers to achieve client solutions and also manages the Company's network of sales representatives and distributors. The Company sells its products in Europe through an independent sales representative firm and various independent stocking representative/distributor firms. Sales in Asia are handled through various independent stocking representative/distributor firms. The stocking representatives/distributor firms may buy and stock the Company's products for resale or act as the Company's agent in arranging for direct sales from the Company to an OEM customer. The Company's sales organization provides direction and support to the independent sales representative firms, the distributor firms and the overseas independent stocking representatives/distributor firms.
The Company currently utilizes independent sales representative firms at various locations in the United States and Canada. The Company also sells its products through national distributor firms. Sales through Future Electronics, the Company's principal national distributor, accounted for 10% and 11% of the Company's net sales for 1997 and 1998, respectively. Consistent with standard industry practice, the national and regional distributor firms are entitled to certain price rebates and are allowed to return to the Company a portion of the products purchased by them. The Company's 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 in the Company's sales and distribution channels could materially and adversely affect the Company's business and operating results.
The Company has contracts with all of its international distributors, the material terms of which typically include the following: (a) the distributor is appointed as a non-exclusive authorized distributor for a designated territory, (b) the distributor may return up to 5-10% of its net sales in the prior 6-12 month period as a credit against a new order of equal or greater amount of product, (c) the distributor is obligated to meet certain information reporting requirements, (d) the term of the contract is one year and is automatically renewable for one year periods and (e) the contract may be terminated at any time by either party upon 30 days' written notice. The Company also has contracts with its national distributors, including Future Electronics, which are substantially similar to the international distributor agreements.
International sales accounted for approximately 65% of the Company's net sales for 1997 and 1998. 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, 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. 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.
The Company attempts to stock products in quantities that are sufficient to meet customer demand. Due to the product manufacturing cycle characteristic of semiconductor manufacturing and the inherent imprecision in forecasting customer demand, product inventories may not always correspond to product demand, leading to shortages or surpluses of certain products. The Company warrants that its products are free from defects in workmanship and materials for one year and that they meet the published specifications. Warranty expenses to date have been nominal.
MANUFACTURING - -------------
Until February 1999, TelCom produced the majority of its wafers at its manufacturing facility in Mountain View, California. During the 1993 to 1998 time frame the Company believed that its in-house wafer fabrication facility provided a competitive advantage because it facilitated a close collaboration between design and process engineers, provided control over wafer supply, and offered the potential for lower manufacturing costs and accelerated new product introduction. By early 1998, market conditions had changed significantly resulting in outside foundries willing to run non standard processes and with market prices below the Company's internal cost to manufacture. As a result, in August 1998, the Company announced its plans to shut down its five-inch wafer fabrication facility and use third party foundries for all of its wafer fabrication. The fabrication of wafers is in the process of being transferred to third party foundries and it is anticipated that the transfer will be complete prior to the end of the first quarter of 1999. In connection with the closure of its wafer fabrication facility, the Company recognized restructuring and other charges of $7.3 million in 1998. Restructuring costs for the Mountain View, California fabrication facility were $6.5 million, while other one-time charges totaled $.8 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. The other one time charges included the write down of $.4 million of certain test equipment in Hong Kong, , the write down of certain equipment in Mountain View totaling $.3 million, and $.3 million related to certain licensing and royalty costs, offset by a decrease of $.2 million in amounts previously accrued due to a change in the Company's employee sabbatical policy. Approximately 20,000 square feet of the Mountain View facility has been idled by this move to outside foundries.
The Company utilizes CMOS, Silicon Gate, Bipolar and BiCMOS process technologies, which are tailored to meet product specifications and customer requirements. Outside wafers are purchased from one of five foundries and market conditions could result in wafers being in short supply and prevent the Company from having adequate
supply to meet its customer requirements. There can be no assurances going forward that the Company will have the ability to acquire all the wafers it desires.
The wafers are sent to the Company's wholly-owned subsidiary in Hong Kong which tests the individual die in wafer form, and distributes them to contract assembly houses, primarily in Malaysia and Thailand, to be packaged. Upon completion of the packaging operation, the units are returned to TelCom Hong Kong for final testing in assembled form and are then shipped to customers worldwide. The Hong Kong facility, which is leased by the Company, is approximately 30,000 square feet and is presently testing approximately eight million units per month.
The packaging of the Company's products is performed by a limited group of subcontractors and certain of the raw materials included in such products are obtained from a limited group of suppliers. Although the Company seeks to reduce its dependence on its sole and limited source suppliers, disruption or termination of any of these sources could occur and such disruptions could have a material adverse effect on the Company's financial condition or results of operations. 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 alternate subcontractors, if any, became available.
TelCom designs and manufactures its own test equipment which can test both the individual die in wafer form and the finished assembled unit. The Company believes the cost of its in-house tester is substantially less than the cost of purchasing an equivalent tester from an outside vendor. In addition to the cost advantages, the Company can also standardize its operations on one tester type and can therefore upgrade tester capability more easily than if it had purchased different testers from more than one vendor. The Company believes it is better able to meet its internal demand for test capacity by building its own testers because it is not subject to long lead times from outside vendors in times of rising demand for such equipment. The Company could purchase testers from outside vendors if it experienced problems in producing its own testers, but such equipment would be more costly.
A large portion of the Company's costs of manufacturing are relatively fixed, and, consequently, the Company's results of operation are volume sensitive. A reduction in manufacturing yields or delays to product shipments would impact its operational results unfavorably. The Company has from time to time in the past experienced lower than expected production yields, which have delayed product shipments and adversely affected gross margins. There can be no assurance that the Company in general will be able to maintain acceptable manufacturing yields in the future.
RESEARCH AND DEVELOPMENT - ------------------------
The ability of the Company to compete successfully will depend substantially on its ability to define, design, develop and introduce on a timely basis new products offering design or technology innovations. Research and development in the analog integrated circuit industry is characterized primarily by circuit design and product engineering that enables new functionality or improved performance. The Company's research and development efforts are also directed at improving process technologies, reducing the cost of existing manufacturing processes, developing new process capabilities to manufacture new products and adding new features to existing products. With respect to more established products, the Company's research and development efforts also include product redesign, shrinkage of device size and reduction of mask steps in order to improve yields per wafer and reduce per device costs.
As of December 31, 1998, the Company had 35 employees engaged in research and development. The Company's research and development efforts are dependent upon attracting and retaining qualified analog design engineers. The Company also utilizes independent contractors for certain research and development projects.
In 1996, 1997 and 1998, the Company spent approximately $4.3 million, $5.5 million and $5.6 million, respectively, on research and development. The Company expects that it will continue to invest substantial funds in
research and development activities. There can be no assurance that the Company will be able to identify new product opportunities successfully and develop and bring to market such new products or that the Company will be able to respond effectively to new technological changes or new product announcements by others. There also can be no assurance that the Company's new products will be accepted by the market. Moreover, the end markets for the Company's new products, such as the communications and computer markets, are subject to rapid technological change and there can be no assurance that as such markets change the Company's product offerings will remain current and suitable for them.
INTELLECTUAL PROPERTY - ---------------------
The Company's success depends in part on 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 Company currently holds 26 United States patents on semiconductor devices and methods with various expiration dates, none earlier than May 2003. The Company has applications for six United States patents currently pending. The Company also holds one foreign patent. 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. 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, maskwork 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 relating to such intellectual property was not available on commercially reasonable terms, the Company's operating results could be materially and adversely affected. Litigation, which could result in substantial cost to the Company and diversion of its resources, may also be necessary to enforce patents or other intellectual property rights of the Company or to defend the Company against claimed infringement of the rights of others. The failure to obtain necessary licenses or the occurrence of litigation relating to patent infringement or other intellectual property matters could have a material adverse effect on the Company's business and operating results. There can be no assurance that the steps taken by the Company to protect its intellectual property will be adequate to prevent misappropriation or that others will not develop competitive technologies or products.
COMPETITION - -----------
The analog semiconductor industry is highly competitive and subject to rapid technological change. Significant competitive factors in the analog market for standard products include product features, performance, price, the timing of product introductions, the emergence of new computer standards, quality and customer support. The Company believes that it competes favorably in each of these areas.
Because the standard products market for analog integrated circuits is diverse and highly fragmented, the Company encounters different competitors in 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 companies has substantially greater technical, financial and marketing resources and greater name recognition than the Company. Due to the increasing demands for analog circuits, the Company expects continued competition from existing analog circuit suppliers and the entry of new competition.
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 business, 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 results of operations.
BACKLOG - -------
The Company's backlog consists of Distributor and OEM customer orders required to be shipped within six months following the order date. Customers may generally cancel or reschedule orders to purchase products without significant penalty to the customer. As a result, the quantities of the Company's products to be delivered and their delivery schedules are frequently revised by customers to reflect changes in their needs. Since backlog can be canceled or rescheduled without significant penalty, the Company does not believe its backlog is a meaningful indicator of future revenue.
EMPLOYEES - ---------
As of December 31, 1998, the Company had 305 full-time employees, 210 of whom were engaged in manufacturing (including testing, quality and materials functions), 35 in research and development, 29 in marketing and sales, and 31 in finance and administration. Of such employees, 135 are located in Hong Kong, 7 are located in Europe, and the remainder in the United States. As part of the wafer fabrication facility closure, the Company anticipates that approximately 50 manufacturing employees will be laid off in Mountain View during the first two quarters of 1999. The Company's employees are not represented by any collective bargaining agreements, and the Company has never experienced a work stoppage. The Company believes that its employee relations are good.
The Company's success depends to a significant extent upon its people. This includes the continued service of its executive officers, management teams, and all other technical personnel. The Company's ability to attract, retain and motivate qualified personnel is a challenge in today's competitive market place. The loss of the services of any key personnel, and/or the Company's inability to successfully recruit qualified replacements could have a material adverse effect on the Company. There can be no assurance that the Company will be successful in attracting and retaining key personnel.
EXECUTIVE OFFICERS - ------------------
The executive officers of the Company and certain information about them are as follows:
PHILLIP M. DRAYER has been Chief Executive Officer, President and a director of the Company since the Company commenced operations in December 1993. From 1990 through 1993, Mr. Drayer was President and Chief Executive Officer of Teledyne Components, a division of Teledyne. From 1980 to 1990, he was President and Chief Executive Officer for EPI Technologies, a semiconductor testing company, and from 1976 to 1979, he was Manufacturing Manager at Mostek, a semiconductor manufacturer. Mr. Drayer earned his B.S.E.E. degree from Lamar University and his J.D. degree from South Texas College of Law. Mr. Drayer is a member of the Texas bar.
EDWARD H. BROWDER has been Vice President, Manufacturing Operations and Chief Operating Officer of the Company since April 1998. From January 1996 to December 1997, Mr. Browder was President and Chief Operating Officer of Unitrode Corporation, a mixed signal/analog semiconductor company. From 1994 through 1995, he was President of Seacliff Technologies, a privately held company that was a distributor of specialty programmable semiconductor devices. From 1990 to 1993, he was President and Chief Executive Officer of Concurrent Logic, Inc., a supplier of high density semiconductor field programmable gate arrays. Mr. Browder also held positions with Saratoga Semiconductor, Falco Data Products and Fairchild Semiconductor. Mr. Browder earned his B.S. degree in physics from Stetson University.
ROBERT G. GARGUS has been Vice President, Finance and Administration and Chief Financial Officer of the Company since May 1998. From 1984 to May of 1998, he held a number of financial and non-financial positions at Tandem Computers (now Compaq Computer). His last two positions at Tandem were as President and General Manager of their Atalla Security Products Division and as the Corporate Controller. He also has 14 years of experience in a number of financial positions at Unisys Corporation. Mr. Gargus earned his B.S. degree in accounting and an MBA in Finance from the University of Detroit.
DONALD R. HERMAN has been Vice President, Human Resources and Information Technology of the Company since July 1998 and he has been Vice President, Human Resources since February 1997. From 1996 to 1997, he was with VLSI Technology, a semiconductor manufacturing company, as Worldwide Staffing Manager. From 1981 to 1996, he was employed at Schlumberger, LTD, a diversified technology company, most recently serving as Director, Human Resources. Mr. Herman earned his B.S. degree in mechanical engineering from Purdue University.
EDWARD D. MITCHELL has been Vice President, Engineering and Chief Technical Officer of the Company since November 1996, was Vice President, Quality, Product and Test Engineering from November 1994 to
November 1996, and was Vice President, Quality Management from December 1993 to November 1994. From 1991 through 1993, he was Vice President, Quality Management for Teledyne Components. From 1982 to 1990, he was with Seeq Technology, a semiconductor manufacturer, most recently serving as Director of Quality and Reliability Assurance, and from 1980 to 1982, he was Product Engineering Supervisor for NEC Electronics, a semiconductor manufacturer. Prior thereto, he was employed at National Semiconductor Corporation and Advanced Micro Devices in various engineering positions. Mr. Mitchell earned his B.S.E.E. degree from the University of California at Berkeley.
KENNETH J. ROSE has been Chief Accounting Officer of the Company since December 1995 and has also been Corporate Controller of the Company since December 1993. From 1990 to 1993, he was Vice President, Finance and Administration of Teledyne Components. From 1985 to 1990, he was Vice President, Finance and Administration of Teledyne CME, a division of Teledyne. From 1982 to 1985, he was Controller of Teledyne Micronetics, a division of Teledyne. Prior thereto, he held various positions in accounting at Teledyne Ryan Aeronautical, a division of Teledyne. Mr. Rose earned his B.S. degree from the University of San Diego.
ITEM 2.
ITEM 2. DESCRIPTION OF PROPERTY - ---------------------------------
The Company's main executive, administrative, and technical offices are located in a 70,000 square foot facility in Mountain View, California. The lease on this facility expires in December 2003. The Company also leases 30,000 square feet of additional space in Hong Kong in which it conducts testing and from which it ships products to customers worldwide. The lease on the Hong Kong facility expires in July 2000. The Company believes that its existing facilities are adequate to meet its needs for at least the next 12 months.
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 occupied by the Company. The Company no longer produces wafers in the Mountain View Facility and believes that its past activities conformed to all environmental and land use regulations applicable to its operations.
The Company acquired the semiconductor manufacturing operations of Teledyne, Inc. previously conducted at the Company's facility. The semiconductor manufacturing operations conducted by Teledyne Components 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 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. Although the Company may be considered a successor in interest to Teledyne's operations at the Mountain View facility, the Company believes that it is unlikely to be subject to any material environmental liabilities relating to the operations of the facility conducted by Teledyne because (i) the Company has received no notice from any regulatory authority or any other person claiming that the Company is responsible for the contamination caused by Teledyne or the cost of any clean-up relating thereto and (ii) the Company is indemnified by Teledyne under the acquisition agreements and lease between the Company and Teledyne with respect to any such liabilities.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS - --------------------------
None.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - -------------------------------------------------------------
Not Applicable.
PART II -------
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER - -------------------------------------------------------------------------- MATTERS - -------
The Company effected the initial public offering of its Common Stock on July 27, 1995. As of February 24, 1999, there were approximately 3,580 beneficial holders of the Company's Common Stock. The Company's Common Stock is listed for quotation in the Nasdaq National Market under the Symbol "TLCM." The following table sets forth for the periods indicated, the high and low prices of the Company's Common Stock as quoted in the Nasdaq National Market.
The trading price of the Company's Common Stock is expected to continue to be subject to wide fluctuations in response to quarter-to-quarter variations in operating results, announcements of technological innovations or new products by the Company or its competitors, general conditions in the computer and electronic industries, changes in earnings estimates or recommendations by analysts, or other events or factors. In addition, the public stock markets have recently experienced extreme price and trading volume volatility. This volatility has significantly affected the market prices of securities of many high technology companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. The Company has not paid any cash dividends on its Common Stock and currently intends to retain any future earnings for use in its business. Accordingly, the Company does not anticipate that any cash dividends will be declared or paid on the Common Stock in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA - --------------------------------------------
The selected consolidated financial data of the Company set forth below should be read in conjunction with the consolidated financial statements of the Company, including the notes thereto, and Management's Discussion and Analysis included elsewhere herein.
(1) All per share amounts have been restated in accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share". See Note 2 to the Notes to the Consolidated Financial Statements.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - ------------------------------------------------------------------------------- OF OPERATIONS - -------------
This Report on Form 10-K 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 - --------
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 has been available worldwide while overall demand has not increased proportionately. Consequently, wafer pricing has decreased dramatically, which has changed the economic viability of the foundry business in which the Company invested. 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 terminates the Company's operating agreement with IC WORKS.
In August 1998, the Company announced its plans to shut down its five-inch wafer fabrication facility in Mountain View, California and use third party foundries for all of its wafer fabrication. This change was desirable because of continuing market conditions that made it more economical to purchase wafers than to produce them internally. A majority of the Company's new products that have been developed in the past year utilize sub-micron wafer technology and are currently
fabricated by outside foundries. All other remaining wafers were fabricated in the Mountain View facility. In January 1999, the wafer fabrication facility was shut-down. The fabrication of wafers is in the process of being transferred to third party foundries and it is anticipated that the transfer will be complete prior to the end of the first quarter of 1999. In connection with the closure of its wafer fabrication facility, the Company recognized restructuring and other charges of $7.3 million. Restructuring costs for the Mountain View, California fabrication facility were $6.5 million, while other one-time charges totaled $.8 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. The other one time charges included the write down of $.4 million of certain test equipment in Hong Kong, the write down of certain equipment in Mountain View totaling $.3 million, and $.3 million related to certain licensing and royalty costs, offset by a decrease of $.2 million in amounts previously accrued due to a change in the Company's employee sabbatical policy. Net income from operations, excluding these charges, was $3.6 million for 1998 or $.21 in earnings per share. Including these charges, the net loss was $3.5 million. The Company expects annual savings of approximately $2.0 million on completion of the restructuring activities.
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 cost to offset decreases in the prices of its existing products, then 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. Customer demand remains highly unpredictable and variances to the forecast can fluctuate substantially. In addition, because of high fixed costs on 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 foregoing or other factors, the Company has experienced and may in the future experience material adverse fluctuations in its operating results on a quarterly or annual basis, which have in the past and would in the future materially affect the Company's business, financial condition and results of operations.
RESULTS OF OPERATIONS - ---------------------
The following table sets forth certain consolidated statement of operations data of the Company as a percentage of net sales.
YEARS ENDED DECEMBER 31, 1998 AND 1997 - --------------------------------------
NET SALES. Net sales in 1998 were $54.3 million, a decrease of $1.1 million or 2.0%, compared to $55.4 million in 1997. The decrease in net sales was primarily due to lower average selling prices caused by product mix and a change by Motorola from a device which had a higher average sales price to a device with a lower average sales price for the same
application. Net sales in 1998 for the Company's geographical areas of the United States, Asia and Europe accounted for 35%, 34%, and 31%, respectively, compared to 35%, 33%, and 32%, respectively, in 1997. Sales to the Company's three largest OEM customers, Motorola, Intel and Compaq were $18.8 million or 35%, $4.6 million or 9%, and $2.4 million or 4%, respectively, of net sales in 1998 compared to $16.5 million or 30%, $1.5 million or 3% and $4.1 million or 7%, respectively, of net sales in 1997.
GROSS MARGIN. Gross margin decreased to 35.7% in 1998 from 43.7% in 1997. The decrease in gross margin was caused by decreased production volume in the Company's wafer fabrication facility due to lower demand, a decrease in unit selling prices for products sold to Motorola, and an additional charge related to surplus inventory related to the closure of the Company's wafer fabrication facility. 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 fabrication foundries.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were $5.6 million, or 10.3% of net sales, in 1998, compared to $5.5 million, or 9.8% of net sales, in 1997. The increase in research and development expenses, in absolute dollars, was primarily attributable an increase in design engineers and product engineers and the costs associated with the purchase and maintenance of computer-aided design (CAD) systems for design engineers. The Company expects research and development expenses 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 were $9.5 million, or 17.5% of net sales, in 1998 compared to $9.5 million, or 17.2% of net sales, in 1997. The Company expects selling, general and administrative expenses generally to increase in absolute dollars in the future periods although such expenses may fluctuate as a percentage of sales.
RESTRUCTURING AND OTHER CHARGES. During 1998, the Company recognized restructuring and other charges of $7.3 million. Restructuring costs for the Mountain View, California fabrication facility were $6.5 million, while other one-time charges totaled $.8 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. The other one time charges included the write down of $.4 million of certain test equipment in Hong Kong, the write down of certain equipment in Mountain View totaling $.3 million, and $.3 million related to certain licensing and royalty costs, offset by a decrease of $.2 million in amounts previously accrued due to a change in the Company's employee sabbatical policy.
INTEREST INCOME (EXPENSE), NET. Net interest income increased from an expense of $228,000 in 1997 to an income of $386,000 in 1998, reflecting lower interest expense associated with equipment financing.
INCOME TAXES. The Company recorded an income tax provision of $1.0 million in 1998 at an effective rate of negative 37% compared to $2.4 million in 1997 at an effective rate of 336%. The decrease in the effective tax rate is due to the non deductibility of certain foundry investment losses and a tax charge relating to the repatriation of certain of the Company's foreign subsidiaries undistributed earnings, offset by an increase in the 1998 valuation allowance relating to the Company's net deferred tax assets.
YEARS ENDED DECEMBER 31, 1997 AND 1996 - --------------------------------------
NET SALES. Net sales in 1997 were $55.4 million, an increase of $17.6 million or 46.8%, compared to $37.8 million in 1996. The increase in net sales was primarily due to higher sales volume in the Company's power management product line. Net sales in 1997 for the Company's geographical areas of the United States, Asia and Europe accounted for 35%, 33%, and 32%, respectively, compared to 37%, 38%, and 25%, respectively, in 1996. Sales to the Company's two largest OEM customers, Motorola and Compaq were $16.5 million or 30% and $4.1 million or 7%, respectively, of net sales in 1997 compared to $4.4 million or 12% and $3.1 million or 9%, respectively, of net sales in 1996.
GROSS MARGIN. Gross margin increased to 43.7% in 1997 from 29.0% in 1996. The increase in gross margin was caused by increased production volume in the Company's wafer fabrication facility due to higher demand, increased efficiency in wafer fabrication and higher gross margins on sales of power management products.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were $5.5 million, or 9.8% of net sales, in 1997, compared to $4.3 million, or 11.3% of net sales, in 1996. The increase in research and development expenses, in absolute dollars, was primarily attributable to cost of wafers and associated expense for new products, and costs associated with the
purchase and maintenance of computer-aided design (CAD) systems for design engineers.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased to $9.5 million, or 17.2% of net sales, in 1997 from $7.7 million, or 20.4% of net sales, in 1996. Selling, general and administrative expenses increased, in absolute dollars, primarily as a result of (i) the hiring of sales personnel, (ii) an increase in outside sales commissions due to higher sales, and (iii) the distribution of management bonus and company wide profit sharing to all employees.
LOSS ON FOUNDRY INVESTMENT. In November 1995, the Company entered into certain agreements with IC WORKS. Pursuant to these agreements, in 1996 the Company purchased $3.0 million of preferred stock of IC WORKS and provided $10.4 million in capital equipment. In return for this investment, the Company received a guarantee of submicron wafer capacity at specified prices for a period of five years, projected to start in late 1997. In 1997, the Company recorded a loss of $8.3 million on its foundry investment which consists of a $3.0 million write down of the preferred stock, a loss on the sale of the equipment of $5.2 million, and $.1 million of costs associated with prepayment penalties on financing of the equipment and legal fees. Pursuant to an agreement with IC WORKS, Inc., in the fourth quarter of 1997, the Company sold the $10.4 million of equipment at IC WORKS for $5.2 million and invested an additional $1.5 million in preferred stock of IC WORKS Inc.
INTEREST INCOME (EXPENSE), NET. Net interest income decreased from $162,000 in 1996 to an expense of $288,000 in 1997, reflecting higher interest expense associated with equipment financing.
INCOME TAXES. The Company recorded an income tax provision of $2.4 million in 1997 at an effective rate of 336% compared to an income tax benefit of $233,000 in 1996 at an effective rate of 27%. The increase in the effective tax rate is due to the non deductibility of certain foundry investment losses and a tax charge relating to repatriation of certain of the Company's foreign subsidiaries' undistributed earnings.
LIQUIDITY AND CAPITAL RESOURCES - -------------------------------
In 1996, the Company generated approximately $1.3 million from operating activities, principally attributable to net loss adjusted for non cash items, including depreciation of $3.3 million, and a decrease in accounts receivable of $900. These increases in cash were primarily offset by taxes receivable of $1.4 million and taxes payable of $1.2 million. At December 31, 1996, the Company had cash and cash equivalents of $12.8 million.
The Company invested $13.7 million in capital equipment and leasehold improvements of which $10.4 million was for purchases of capital equipment pursuant to an agreement with IC WORKS in 1996. The Company financed part of this investment through notes payable, which increased $9.0 million on a net basis.
Pursuant to an agreement with IC WORKS, the Company invested $3.0 million in preferred stock of IC WORKS in 1996.
In 1997, the Company generated approximately $11.9 million from operating activities, primarily from income before the loss on foundry investment, depreciation of $4.1 million and a net increase of $1.2 million in working capital items. The net increase in working capital primarily reflects a decrease of income tax receivable of $1.4 million, due to collection of tax refunds recorded in the prior year, an increase in accounts payable of $1.4 million, an increase in taxes payable of $1.8 million, offset by an increase in accounts receivable from higher fourth quarter sales of $2.2 million, and an increase in sensor product inventory of $1.8 million. At December 31, 1997, the Company had cash and cash equivalents of $17.1 million.
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 terminates the Company's operating agreement with IC WORKS and its wafer production arrangement was amended to allow the Company to purchase wafers for a period of time prior to finding an alternative supplier, up to April 1998.
In 1997, the Company invested $7.6 million in capital equipment and leasehold improvements. The Company financed $3.3 million of this investment through notes payable and paid $10.8 million in principal payments of which $7.7 million was for equipment sold as part of the IC WORKS agreement and $3.1 million was principal payments on other equipment financing for prior years.
In 1998, the Company generated approximately $9.9 million of cash from operating activities primarily from income
before restructuring and other charges, depreciation of $5.2 million and a net increase of $.9 million in working capital items. The net increase in working capital primarily reflects decreases in accounts receivable of $.5 million, inventory of $1.9 million, accounts payable of $.2 million, accrued liabilities of $.5 million and deferred income taxes of $.8 million.
In 1998, the Company invested or used $5.8 million to fund capital equipment and leasehold improvements. The Company expects capital expenditures of $3.0 million in 1999. As of December 31, 1998, the Company had no material commitments related to such expenditures. The Company also used $9.6 million of cash to repurchase Company's common stock for $7.9 million and to pay down notes payable (debt) by $2.6 million. These were partially offset by cash generated from the sale of stock through the employee stock option and stock purchase plans of $1.0 million.
The Company believes that the existing cash and cash equivalents, expected cash flow from operations and its existing financing sources will be sufficient to support its operating and capital needs for at least the next 12 months. Any major change in the nature of the Company's business, such as the acquisition of products, the need for significant new capital expenditures or the acquisition of an existing business, could change the Company's capital requirements. To the extent the Company requires additional cash, there can be no assurances that the Company will be able to obtain such financing on terms favorable to the Company, or at all.
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 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. At December 31, 1997, the Company's investment portfolio is comprised of municipal government securities that mature within one year. The Company places investments in instruments that meet high credit quality standards. These securities are subject to interest rate risk, and could decline in value if interest rates fluctuate. Due to the short duration and conservative nature of the Company's investment portfolio, the Company does not expect any material loss with respect to its investment portfolio.
FOREIGN CURRENCY EXCHANGE RATE RISK - Certain of the Company's sales, cost of manufacturing and marketing are transacted in local currencies. As a result, the Company's international results of operations are subject to foreign exchange rate fluctuations. The Company does not currently hedge against foreign currency rate fluctuations. Gains and losses from such fluctuations have not been material to the Company's consolidated results of operations. A 10% move in local currencies against the US dollar as of December 31, 1998 would have an immaterial effect on the Company's pretax earnings over the next fiscal year.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS - ----------------------------
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS - ---------------------------------
To the Board of Directors and Stockholders of TelCom Semiconductor, Inc.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of stockholders' equity and of cash flows present fairly, in all material respects, the financial position of TelCom Semiconductor, Inc. and its subsidiaries at December 31, 1997 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California January 20, 1999
TELCOM SEMICONDUCTOR, INC.
CONSOLIDATED BALANCE SHEETS (In thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
TELCOM SEMICONDUCTOR, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
TELCOM SEMICONDUCTOR, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
TELCOM SEMICONDUCTOR, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
TELCOM SEMICONDUCTOR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except per share data)
NOTE 1 - THE COMPANY AND BASIS OF PRESENTATION: - -----------------------------------------------
TelCom Semiconductor, Inc. ("TelCom" or the "Company") designs, develops and markets a diversified portfolio of high performance analog integrated circuits for use in a wide variety of electronic systems. The Company was organized in Delaware in June 1993 and began operations in December 1993 after the management-led buyout of the semiconductor operations of Teledyne, Inc. The Company has operations in the United States, Hong Kong and Germany. The Company operates and reports financial results on a 52-53 week fiscal year. During 1997, the Company changed its fiscal year end from the last Friday of December to the Friday closest to the last day of December. Fiscal year 1997 is a 53 week year ended on January 2, 1998. Fiscal 1996 and 1998 are 52 week years ended on December 27, 1996 and January 1, 1999, respectively. For convenience, the Company presents its fiscal years as ending on December 31.
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the period. Actual results could differ from those estimates.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: - ----------------------------------------------------
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All material intercompany accounts and transactions have been eliminated.
REVENUE RECOGNITION
Revenue from product sales to customers other than domestic distributors is recognized upon shipment. The Company estimates returns from these customers and provides an allowance at the time revenue is recognized. Sales to domestic distributors are generally subject to agreements allowing certain rights of return and price protection with respect to unsold merchandise held by each distributor. The Company defers recognition of revenue and related gross margin on the sales to domestic distributors until the product is sold by these distributors.
SALES TO SIGNIFICANT CUSTOMERS
Sales to one customer represented 12%, 30% and 35% of the Company's net sales for the years ended December 31, 1996, 1997 and 1998, respectively. Accounts receivable from this customer totaled $777 and $1,771 at December 31, 1997 and 1998, respectively. Sales to two other customers represented 12% and 9%, 10% and 7%, and 11% and 4% of the Company's net sales for the years ended December 31, 1996, 1997 and 1998, respectively.
CASH EQUIVALENTS
All highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents. The fair values of these investments approximated their costs at the respective balance sheet dates.
MARKETABLE SECURITIES
At December 31, 1997, the Company's marketable securities, which are municipal government obligations, are classified as available for sale and are reported at fair market value, which approximates cost. Realized gains and losses are based on the book value of the specific securities sold and were not material in 1996, 1997 and 1998. At December 31, 1998, the Company had no marketable securities.
FOREIGN CURRENCY TRANSLATION
The functional currency of the Company's foreign entities is the U.S. dollar; however, certain of the Company's costs and expenses are paid in currencies other than the U.S. dollar. The Company does not currently hedge against foreign currency exchange rate fluctuations and gains and losses arising from the translation of foreign currency balances and transactions are included in consolidated results of operations. Gains and losses from such fluctuations have not been material to the Company's consolidated results of operations.
INVENTORY
Inventory is stated at the lower of cost, determined on a first-in, first- out basis, or market.
PROPERTY AND EQUIPMENT
Equipment acquired pursuant to the management-led buyout from Teledyne, Inc. aggregating $2,167 is stated at fair value at the date of purchase less the excess of the fair value of all net assets acquired over the purchase price. All other equipment and leasehold improvements are stated at cost, or fair market value at the time of impairment for impaired assets. Depreciation is computed using the straight-line method with estimated useful lives of three to five years for equipment. Leasehold improvements consist of improvements to the Company's facilities and are amortized over the remaining term of the lease or useful life of the asset, whichever is less.
LONG-LIVED ASSETS
The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company assesses the impairment of long-lived assets based upon the estimated future cash flows from these assets.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to significant concentration of credit risk consist principally of trade accounts receivable. The Company sells its integrated circuits to customers throughout the world. The Company performs ongoing credit evaluations of its customers' financial condition and, generally, requires no collateral from its customers. The Company maintains an allowance for uncollectable accounts receivable. The Company's write-offs of accounts receivable were not significant in 1996, 1997 and 1998. Five customers accounted for 56% and 59% of the Company's gross accounts receivable at December 31, 1997 and 1998, respectively.
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. All prior-period earnings per share data has been restated in accordance with SFAS 128. SFAS 128 requires presentation of both Basic EPS and Diluted EPS on the face of the income statement. Basic EPS is computed by dividing net income available to common stockholders (numerator) by the weighted average number of common shares outstanding (denominator) during the period. Diluted EPS gives effect to all dilutive potential common shares outstanding during the period including stock options, using the treasury stock method, and convertible preferred stock, using the if-converted method. In computing Diluted EPS, the average stock price for the period is used in determining the number of shares assumed to be purchased from the exercise of stock options.
Following is a reconciliation of the numerators and denominators of the Basic and Diluted EPS computations:
Due to the Company's net loss from continuing operations in 1996, 1997 and 1998, a calculation of EPS assuming dilution is not required. At December 31, 1996, there were 2,509 options and warrants outstanding to purchase common stock at a weighted average price of $2.38 per share. At December 31, 1997, there were 2,386 options and warrants outstanding to purchase common stock at a weighted average price of $4.40 per share. At December 31, 1998, there were 2,975 options outstanding to purchase common stock at a weighted average price of $3.65 per share. The securities have been excluded from the computation of dilutive EPS because the inclusion of such warrants and options would have been anti- dilutive.
STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees." The Company's policy is to grant options with an exercise price equal to the quoted market price of the Company's stock on the date of the grant. Accordingly, no compensation cost has been recognized in the Company's statements of operations. The Company provides additional pro forma disclosures as required under Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation."
COMPREHENSIVE INCOME
In 1998, the Company adopted Statement of Financial Accounting Standards No. 130 ("SFAS 130"), Reporting Comprehensive Income. The adoption of FAS 130 did not affect the results of the Company's operations.
SEGMENT REPORTING
In 1998, the Company adopted Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information." SFAS 131 supersedes SFAS 14, "Financial Reporting for Segments of a Business Enterprise", replacing the "Industry Segment" approach with the "Management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. SFAS 131 also requires disclosures about products and services, geographic areas, and major customers. The Company operates in one industry segment comprising the design, development, manufacture and sale of integrated circuits. The adoption of SFAS 131 did not affect results of the Company's operations or financial position or the segments reported in 1998.
ACCOUNTING FOR DERIVATIVES
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative Instruments and Hedging Activities." SFAS no. 133 establishes standards for
accounting and reporting on derivative instruments for periods beginning After June 15, 1999 and early adoption is permitted. SFAS No. 133 requires that all derivative instruments be recognized in the balance sheet as either assets or liabilities and measured at fair value. Furthermore, SFAS no. 133 requires current recognition in earnings of changes in the fair value of derivative instruments depending on the intended use of the derivative and the resulting designation. The Company is currently evaluating the effects of the new standard and has not determined its method or timing of adopting SFAS No. 133 or the impact on its financial statements.
NOTE 3 - BALANCE SHEET DETAILS: - -------------------------------
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; the 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. The fabrication of wafers is in the process of being transferred to third party foundries and it is anticipated that the transfer will be complete prior to the end of the first quarter of 1999. 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 used in the 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 is $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 is recorded as "assets to be disposed of". Given the current downturn in the semiconductor industry, 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 fair value of the fabrication equipment was based on third party estimates of fair value. The restructuring charge also includes charges for idle facilities of $1,406, severance payments totaling $519 for approximately 50 employees, to be terminated upon closing of the facility and environmental and related clean up costs of $132.
The following table sets forth the Company's accruals in 1998 for restructuring expense and charges taken against the accrual in 1999 and the remaining restructuring accrual balance at December 31, 1998:
Separately, the Company recorded other one time charges of $743 during 1998, comprised of $391 for the write-off of certain test equipment in Hong Kong, $278 for the write-off of certain equipment in Mountain View, California and $250 for certain licensing and royalty costs, offset by a decrease of $176 in amounts previously accrued due to a change in the Company's employee sabbatical policy. The cost and accumulated depreciation of the equipment in Mountain View prior to and the write down was $814 and $181, respectively. The fair value of the equipment was estimated to be $355 is recorded as "assets to be disposed of". The equipment is no longer in use and is currently held for sale. These charges are included in Restructuring and Other in the accompanying statement of operations.
NOTE 5 - NOTES PAYABLE: - -----------------------
The Company financed its acquisition of certain equipment with secured notes payable bearing interest ranging from 9% to 13% per annum and payable in equal monthly installments of principal and interest. At December 31, 1998, future maturities of notes payable are as follows:
1999 $1,886 2000 850 2001 762 -------------- 3,498 Less: current portion 1,886 -------------- $1,612 ==============
The net book value of the equipment pledged under these notes amounted to $2,229 at December 31, 1998.
NOTE 6 - INCOME TAXES: - ----------------------
The Company accounts for income taxes under an asset and liability approach that requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or income tax returns. Provisions are made for estimated United States and foreign income taxes, less available tax credits and deductions, which may be incurred on the remittance of certain of the Company's foreign subsidiaries' undistributed earnings. Deferred taxes have not been provided for the cumulative undistributed earnings of foreign subsidiaries which are considered by management to be permanently reinvested.
The components of income (loss) before income taxes were as follows:
The components of the provision (benefit) for income taxes were as follows:
The components of deferred taxes are as follows:
Due to the uncertainty of the realization of a portion of deferred tax assets, the Company has provided a valuation allowance on these assets to the extent there is no current realization at December 31, 1997 and 1998. Upon recognition of the Company's deferred tax assets, approximately $1,600 will be credited directly to equity as a result of previous exercises of non qualified stock options and disqualifying dispositions of incentive stock options.
The provision (benefit) for income taxes differs from the amount computed by applying the U.S. statutory federal rate to income before extraordinary item as a result of the following:
NOTE 7 - PREFERRED STOCK: - -------------------------
The Company has authorized 5,000,000 shares of undesignated Preferred Stock. The Board of Directors has the authority to issue the undesignated Preferred Stock in one or more series and to fix the rights, preferences, privileges and restrictions granted to or imposed upon any wholly unissued shares of undesignated Preferred Stock and to fix the number of shares constituting any series in the designations of such series, without any further vote or action by the stockholders. The Board of Directors, without stockholder approval, can issue Preferred Stock with voting and conversion rights which could adversely affect the voting power of the holders of Common Stock. In November 1998, the Company designated 30,000 shares of Preferred Stock as Series A of Participating Preferred Stock in connection with the adoption of a shareholders rights program. The issuance of Preferred Stock may have the effect of delaying, deferring or preventing a change in control of the Company.
NOTE 8 - COMMON STOCK: - ----------------------
COMMON STOCK OPTION AGREEMENT
In December 1993, the Company granted to certain entities affiliated with U.S. Venture Partners (collectively USVP) options to purchase an aggregate of 237,500 shares of the Company's Common Stock. The purchase price for the option shares is $0.10 per share. During January 1997, USVP elected to exercise its options to purchase all 237,500 shares. As provided in the option agreement, USVP received a reduced number of shares in exchange for the aggregate exercise price due, resulting in the issuance by the Company of 233,183 shares to USVP.
STOCK PURCHASE RIGHTS PLAN
In November 1998, the Company implemented a plan to protect shareholders' rights in the event of a proposed takeover of the Company. Under the plan, each share of the Company's outstanding common stock carries one right to purchase one-thousandth of a share of the Company's Series A Participating Preferred Stock (the "Right") at an exercise price of $30.00 per share. The Right enables the holder to purchase common stock of the Company or of the acquiring company ten days after a person or group publicly announces it has acquired or has tendered an offer for 15% or more of the Company's outstanding common stock. The Rights are redeemable by the Company at $0.001 per Right at any time on or before the tenth day following acquisition by a person or group of 15% or more of the Company's common stock. If prior to redemption of the Rights, a person or group acquires 15% or more of the Company's common stock, each Right not owned by a holder of 15% or more of the common stock (or an affiliate of such holder) will entitle the holder to purchase, at the Right's then current exercise price, that number of shares of common stock of the Company having a market value at the time of twice the Right's exercise price. The Rights expire in November 2008.
EMPLOYEE STOCK OPTION PLAN
In February 1994, the Company adopted its 1994 Stock Option Plan (the "Option Plan") which provides for the granting of incentive stock options and nonstatutory stock options to officers, employees and consultants of the Company. Incentive stock options are granted at an amount not less than 100% of the fair market value of the stock on the grant date.
During 1996, the Board of Directors and shareholders approved an increase to the number of shares that may be issued under the plan from 2,050,000 shares to 2,800,000 shares. During 1997, the Board of Directors and shareholders approved an increase to the number of shares that may be issued under the plan from 2,800,000 shares to 3,300,000 shares. During 1998, the Board of Directors and shareholders approved an increase to the number of shares that may be issued under the plan from 3,300,000 shares to 4,300,000 shares. At December 31, 1995, options to purchase 56,166 shares had been granted subject to such approval and are included in the table below. In January 1996, the Board of Directors approved an option exchange program whereby certain employees were able to exchange their existing options to purchase an aggregate of 418,500 shares of Common Stock at exercise prices ranging from $6.00 to $8.75 for new options to purchase an aggregate of 418,500 shares at $4.87 per share. In June 1998, the Board of Directors approved an option exchange program whereby certain employees were able to exchange their existing options to purchase an aggregate of 934,243 shares of Common Stock at exercise prices ranging from $7.88 to $15.94 for new options to purchase an aggregate of 934,243 shares at $4.31 per share. Generally all employees exchanged their existing options for new options. Options generally vest over a four year period. Option terms may not exceed ten years from the date of grant and unexercised options expire upon termination of employment. At December 31, 1998, 996,960 options were exercisable. The weighted average fair value of options granted during 1996, 1997, 1998 was $2.08, $3.78 and $2.50, respectively.
The Option Plan activity is summarized as follows:
DIRECTOR STOCK OPTION PLAN
During 1996, the Company adopted and approved the Company's 1996 Director Stock Option Plan (the "Director Plan") with 100,000 shares of Common Stock reserved for issuance thereunder. Under the Director Plan, each non-employee director who joins the Board will automatically be granted a non-statutory option to purchase 12,000 shares of Common Stock on the date upon which such person first becomes a director. In addition, each non-employee director will automatically receive a non-statutory option to purchase 3,000 shares of Common Stock upon such director's annual re-election to the Board, provided the director has been a member of the Board for at least six (6) months upon the date of reelection. The exercise price of each option granted under the Director Plan must be equal to the fair market value of the Common Stock on the date of the grant. The 12,000 share grant vests at the rate of twenty-five percent (25%) of the option shares upon the first anniversary of the date of grant and as to twenty-five (25%) of the shares each year thereafter and the 3,000 share grant vests monthly over a twelve (12) month period. Options granted under the Director Plan have a term of ten (10) years unless terminated sooner, whether upon termination of the optionee's status as a director or otherwise pursuant to the Director Plan. Options for 9,000 shares were granted under the Director Plan in each of 1996 and 1997 and options for 27,000 shares were granted during 1998. The weighted average fair values of the options granted during 1996, 1997 and 1998 was $4.83, $3.22 and $7.14 per share,
respectively. At December 31, 1998, 33,000 options are outstanding and 8,000 options are exercisable. The Board believes that the Director Plan is necessary to attract and retain highly qualified individuals to serve as non-employee members of the Board of Directors.
Information relating to stock options outstanding under the Option Plan and Director Plan at December 31, 1998 is as follows:
The fair value of each option is estimated on the date of grant using the Black-Scholes model with the following assumptions used for grants during 1996, 1997 and 1998: annual dividend yield of 0.0% for all periods; risk-free annual interest rates of 5.38% to 6.51% for options granted during the year ended December 31, 1996, 5.87% to 6.67% for options granted during the year ended December 31, 1997 and 4.25% to 5.62% for options granted during the year ended December 31, 1998; a weighted average expected option term of five years for all periods; and an expected volatility factor of 60% for 1996 and 1997 and 72% for 1998.
EMPLOYEE STOCK PURCHASE PLAN
In May 1995, the Company adopted its 1995 Employee Stock Purchase Plan ("Purchase Plan"). Under the Purchase Plan, an eligible employee may purchase shares of Common Stock from the Company through payroll deductions of up to 10% of their base compensation plus commissions, at a price per share equal to 85% of the fair market value as of the first day or the last day, whichever is lower, of each six-month offering period under the Purchase Plan. An employee can purchase at the lowest offering period's purchase price going back for up to two years of participation. The offering periods commence on July 1 and January 1 of each year. The Company has reserved 200,000 shares of Common Stock for issuance under the Purchase Plan. During 1996, the Purchase Plan was amended to increase the shares reserved for issuance by 200,000 shares, bringing the total number of shares issuable under the Purchase Plan to 400,000. During 1998, the Purchase Plan was amended to increase the shares reserved for issuance by 500,000 shares, bringing the total number of shares issuable under the Purchase Plan to 900,000. At December 31, 1998, 352,405 shares of Common Stock had been issued under the Purchase Plan, and 547,595 shares remained available for future issuance under the Purchase Plan.
The fair value of each stock award is estimated on the date of grant using the Black-Scholes model with the following assumptions used for grants during 1996, 1997 and 1998: annual dividend yield of 0.0% for all periods; risk-free annual interest rates of 5.18% to 5.46% for stock awards granted during the year ended December 31, 1996 and 5.49% to 5.66% for stock awards granted during the year ended December 31, 1997 and 5.27% to 5.79% for stock awards granted during the year ended December 31, 1998; a weighted average expected stock award term of six months for all periods; and an expected volatility factor of 60% for 1996 and 1997 and 72% for 1998.
FAIR VALUE DISCLOSURES
Had compensation cost for the Company's stock option and stock purchase plans been determined based on the fair value of the options at the grant dates using the Black-Scholes model as provided by FAS 123, the Company's net income (loss) and net income (loss) per share for the years ended December 31, 1996, 1997 and 1998 would have been as follows:
The pro forma amounts reflect compensation expenses related to 1996, 1997 and 1998 employee and director option grants and employee stock purchase plan awards only. In future years, the annual compensation expense will increase due to the expense associated with future grants.
NOTE 9 - TREASURY STOCK - -----------------------
In July 1998, the Company's Board of Directors approved a plan to repurchase an aggregate of up to 2.0 million shares of common stock. In October 1998, the Company's Board of Directors approved a plan to repurchase an additional 2.0 million shares of common stock, for a total repurchase of up to 4.0 million shares. At December 31, 1998, a total of 2.3 million shares have been repurchased by the Company at an aggregate cost of $7,925.
NOTE 10 - COMMITMENTS AND CONTINGENCIES: - ----------------------------------------
The Company occupies its present principal facilities under non-cancelable operating leases expiring December 2003 and July 2000. The Company is required to pay taxes, insurance and maintenance expenses.
Future minimum lease payments under non-cancelable leases at December 31, 1998 are as follows (amounts include payments accrued for idle facility charges see Note 4):
Year Ending December 31, ------------------------ 1999 $1,484 2000 1,350 2001 1,201 2002 1,201 2003 1,201 --------------- Minimum lease payments $6,437 ===============
Rent expense for the years ended December 31, 1996, 1997 and 1998 was $745, $767 and $867, respectively.
NOTE 11 - SEGMENT INFORMATION: - ------------------------------
The Company operates in one industry segment comprising the design, development, manufacture and sale of integrated circuits. The following is a summary of the Company's operations:
NOTE 12 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION - ----------------------------------------------------------
NOTE 13 - LOSS ON FOUNDRY INVESTMENT - ------------------------------------
In November 1995, the Company entered into certain agreements with IC WORKS, Inc. a privately-held company located in San Jose, California. Pursuant to these agreements, in 1996 the Company purchased $3.0 million of preferred stock of IC WORKS and provided $10.4 million in capital equipment. In return for this investment, TelCom received a guarantee of submicron wafer capacity at specified prices for a period of five years, projected to start in late 1997. The shortage of wafer capacity projected in late 1995 has diminished and since late 1995, substantial foundry capacity has been available worldwide while overall demand has not increased proportionately. Consequently, wafer pricing has decreased dramatically, which has changed the economic viability of the foundry business in which the Company invested. As a result, in the first quarter of 1997, the Company recorded an impairment loss on its foundry investment of $8.0 million, consisting of a $3.0 million write down of the preferred stock and a $5.0 million impairment write down of the equipment. In the fourth quarter of 1997, pursuant to an agreement with IC WORKS, the Company sold the $10.4 million dollars of equipment at IC WORKS for $5.2 million and invested an additional $1.5 million in preferred stock of IC WORKS. This agreement terminates the Company's operating agreement with IC WORKS. As a result of these events and transactions, the Company recorded a loss of $8.3 million on its foundry investment in 1997 (of which $8.0 million was recorded in the first quarter of 1997), 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. Two of the Company's directors who served during 1997 also served as directors of IC WORKS.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND - ----------------------------------------------------------------------- FINANCIAL DISCLOSURE - ---------------------
None.
PART III --------
Certain information required by Part III is omitted from this Report on Form 10-K in that the Registrant will file its definitive Proxy Statement for its Annual Meeting of Stockholders to be held on April 15, 1999, pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended (the "Proxy Statement"), not later than 120 days after the end of the fiscal year covered by this Report, and certain information included in the Proxy Statement is incorporated herein by reference.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------
(a) Executive Officers -- See the section entitled "Executive Officers" in Part I, Item 1 hereof.
(b) Directors -- The information required by this Item is incorporated by reference to the section entitled "Election of Directors" in the Proxy Statement.
The disclosure required by Item 405 of Regulation S-K is incorporated by reference to the section entitled "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION - --------------------------------
The information required by this Item is incorporated by reference to the sections entitled "Compensation of Executive Officers" and "Compensation of Directors" in the Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------
The information required by this Item is incorporated by reference to the sections entitled "Principal Share Ownership" and "Security Ownership of Management" in the Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------
The information required by this Item is incorporated by reference to the section entitled "Certain Transactions" in the Proxy Statement.
PART IV -------
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - -------------------------------------------------------------------------
14(a) Exhibits
Exhibit Number Description of Document - --------- -----------------------------------------------------------------
3.1+ Restated Certificate of Incorporation of Registrant.
3.2+ Bylaws of Registrant.
3.3+ Certificate of Ownership and Merger merging TelCom Semiconductor, Inc., a California Corporation, with and into TelCom Semiconductor, Inc., a Delaware Corporation
10.1+ Form of Indemnification Agreement for Executive Officers and Directors.
10.2+* 1994 Stock Option Plan and form of Stock Option Agreement.
10.3+* Employee Stock Purchase Plan and form of Subscription Agreement.
10.4+ Investor Rights Agreement dated as of December 20, 1993 by and among the Registrant and certain investors, including amendments thereto.
10.5+ Lease Agreement dated December 20, 1993 related to premises located at 1300 Terra Bella Avenue, Mountain View, California.
10.6+ Tenancy Agreements dated September 16, 1992 related to a portion of the premises located at the Jing Wah Building No. 10 Sam Chuk Street, Hong Kong.
10.7+ Loan and Security Agreement dated November 17, 1994 between the Registrant and PhoenixCor Corporation
10.8+ Authorized Distributor Agreement between Future Electronics, Inc. and the Registrant.
10.9+ 1995 Distributor/Sales Representative Warrant Plan.
10.10+ First Amendment to Lease dated as of July 10, 1995.
10.11++ Operating Agreement between the Registrant and IC Works, Inc. dated as of November 2, 1995
10.12++ Wafer Production Agreement between the Registrant and IC Works, Inc. dated as of November 2, 1995
10.13+++ Amendment to Lease Agreement dated December 20, 1993 related to premises located at 1300 Terra Bella Avenue, Mountain View, California
10.14++++ Tenancy Agreements dated July 28, 1997 related to a portion of the premises located at the Jing Wah Building No. 10 Sam Chuk Street, Hong Kong.
10.15+++++* Director Option Plan
10.16* Executive Retention Agreement - Phil Drayer
10.17* Executive Retention Agreement - Robert Gargus
10.18* Executive Retention Agreement - Other Executive Officers
21.1+ List of subsidiaries.
23.1 Consent of PricewaterhouseCoopers LLP, Independent Accountants
27.1 Financial Data Schedule
________________ + Incorporated by reference from the Registrant's Registration Statement on Form SB-2 (file no. 33-93840-LA), as amended, filed on June 22, 1995. ++ Incorporated by reference from the Registrant's Quarterly Report on Form 10-QSB for the period ended September 30, 1995. +++ Incorporated by reference from the Registrant's Annual Report on Form 10-KSB for the period ended December 31, 1995. ++++ Incorporated by reference from the Registrant's Annual Report on Form 10-Q for the period ended June 30, 1997. +++++ Incorporated by reference from the Registrant's Registration Statement on Form S8 (file no. 333-31433), as amended, filed on June 22, 1995. * Management contract or compensatory plan or arrangement required to be filed as an exhibit to this form.
14 (b) Reports on Form 8-K: None
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act"), the Registrant caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Mountain View, State of California, on March 8, 1999.
TELCOM SEMICONDUCTOR, INC.
By: /s/ Phillip M. Drayer ----------------------------------------- Phillip M. Drayer Chief Executive Officer and President
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Phillip M. Drayer and Robert G. Gargus, and each of them acting individually, as his attorney-in-fact, each with full power of substitution for him in any and all capacities, to sign any and all amendments to this report on Form 10-K, and file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming our signatures as they may be signed by our attorney to any and all amendments to said Report.
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
TELCOM SEMICONDUCTOR, INC.
INDEX TO EXHIBITS -----------------
Exhibit Number Description of Document
3.1+ Restated Certificate of Incorporation of Registrant.
3.2+ Bylaws of Registrant.
3.3+ Certificate of Ownership and Merger merging TelCom Semiconductor, Inc., a California Corporation, with and into TelCom Semiconductor, Inc., a Delaware corporation
10.1+ Form of Indemnification Agreement for Executive Officers and Directors.
10.2+* 1994 Stock Option Plan and form of Stock Option Agreement.
10.3+* Employee Stock Purchase Plan and form of Subscription Agreement.
10.4+ Investor Rights Agreement dated as of December 20, 1993 by and among the Registrant and certain investors, including amendments thereto.
10.5+ Lease Agreement dated December 20, 1993 related to premises located at 1300 Terra Bella Avenue, Mountain View, California.
10.6+ Tenancy Agreements dated September 16, 1992 related to a portion of the premises located at the Jing Wah Building No. 10 Sam Chuk Street, Hong Kong.
10.7+ Loan and Security Agreement dated November 17, 1994 between the Registrant and PhoenixCor Corporation.
10.8+ Authorized Distributor Agreement between Future Electronics, Inc. and the Registrant.
10.9+ 1995 Distributor/Sales Representative Warrant Plan.
10.10+ First Amendment to Lease dated as of July 10, 1995.
10.11++ Operating Agreement between the Registrant and IC Works, Inc. dated as of November 2, 1995
10.12++ Wafer Production Agreement between the Registrant and IC Works, Inc. dated as of November 2, 1995.
10.13+++ Amendment to Lease Agreement dated December 20, 1993 related to premises located at 1300 Terra Bella Avenue, Mountain View, California.
10.14++++ Tenancy Agreements dated July 28, 1997 related to a portion of the premises located at the Jing Wah Building No. 10 Sam Chuk Street, Hong Kong.
10.15+++++* Director Option Plan
10.16* Executive Retention Agreement - Phil Drayer
10.17* Executive Retention Agreement - Robert Gargus
10.18* Executive Retention Agreement - Other Executive Officers
21.1+ List of subsidiaries.
23.1 Consent of PricewaterhouseCoopers LLP, Independent Accountants
27.1 Financial Data Schedule
________________ + Incorporated by reference from the Registrant's Registration Statement on Form SB-2 (file no. 33-93840-LA), as amended, filed on June 22, 1995. ++ Incorporated by reference from the Registrant's Quarterly Report on Form 10-QSB for the period ended September 30, 1995. +++ Incorporated by reference from the Registrant's Annual Report on Form 10-KSB for the period ended December 31, 1995. ++++ Incorporated by reference from the Registrant's Annual Report on Form 10-Q for the period ended June 30, 1997. +++++ Incorporated by reference from the Registrant's Registration Statement on Form S8 (file no. 333-31433), as amended, filed on June 22, 1995. * Management contract or compensatory plan or arrangement required to be filed as an exhibit to this form.