-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AxY6NRUIZUebwXOKxTrUJ9aGEGxKm/wtoN/pN8vme4RhwF8+klYNCaOeT1ylHUQ7 oP2acguvO8FpmZuAyoRsFA== 0000891618-99-001049.txt : 19990323 0000891618-99-001049.hdr.sgml : 19990323 ACCESSION NUMBER: 0000891618-99-001049 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990131 FILED AS OF DATE: 19990322 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CATALYST SEMICONDUCTOR INC CENTRAL INDEX KEY: 0000899636 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 770083129 STATE OF INCORPORATION: DE FISCAL YEAR END: 0430 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-21488 FILM NUMBER: 99570075 BUSINESS ADDRESS: STREET 1: 1250 BORREGAS AVE CITY: SUNNYVALE STATE: CA ZIP: 94089 BUSINESS PHONE: 4085421000 MAIL ADDRESS: STREET 1: 1250 BORREGAS AVE CITY: SUNNYVALE STATE: CA ZIP: 94089 10-Q 1 FORM 10-Q 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended January 31, 1999 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _________ to _________. COMMISSION FILE NUMBER: 0-21488 CATALYST SEMICONDUCTOR, INC. (Exact name of Registrant as specified in its charter) DELAWARE 77-0083129 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1250 BORREGAS AVENUE, SUNNYVALE, CALIFORNIA 94089 (Address, including zip code, of Registrant's principal executive offices) (408) 542-1000 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] The number of shares outstanding of the Registrant's Common Stock as of March 13, 1999 was 13,948,061 =============================================================================== 2 CATALYST SEMICONDUCTOR, INC. PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Unaudited Condensed Consolidated Balance Sheets at January 31, 1999 and April 30, 1998.................................................... Page 3 Unaudited Condensed Consolidated Statements of Operations for the three and nine month periods ended January 31, 1999 and 1998................................................... Page 4 Unaudited Condensed Consolidated Statements of Cash Flows for the nine month periods ended January 31, 1999 and 1998........................................................... Page 5 Notes to Unaudited Condensed Consolidated Financial Statements.............................. Pages 6-9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION.......................................................... Pages 9-18 PART II - OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......................................... Page II-1 ITEM 5. OTHER INFORMATION........................................................................... Page II-2 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................................................ Page II-2 SIGNATURES........................................................................................... Page II-3
-2- 3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CATALYST SEMICONDUCTOR, INC. UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands)
Jan. 31, April 30, 1999 1998 ---------- ---------- ASSETS Current assets: Cash ............................................................ $ 2,746 $ 534 Restricted cash ................................................. 0 5,750 Accounts receivable, net ........................................ 4,570 4,726 Inventories ..................................................... 2,676 4,194 Other assets .................................................... 1,067 815 ---------- ---------- Total current assets ........................................ 11,059 16,019 Property and equipment, net ..................................... 2,109 2,834 ---------- ---------- $ 13,168 $ 18,853 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Line of credit .................................................. $ 3,117 $ 3,225 Accounts payable ................................................ 7,410 13,400 Accrued expenses ................................................ 2,338 3,650 Deferred gross profit on shipments to distributors .............. 976 475 Current portion of long-term debt and capital lease obligations . 1,122 1,471 ---------- ---------- Total current liabilities ................................... 14,963 22,221 Long-term debt and capital lease obligations ......................... 316 501 ---------- ---------- Total liabilities ........................................... 15,279 22,722 Total stockholders' equity (deficit) ................................. (2,111) (3,869) ---------- ---------- $ 13,168 $ 18,853 ========== ==========
See accompanying notes to the unaudited condensed consolidated financial statements. -3- 4 CATALYST SEMICONDUCTOR, INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data)
Three Months Ended Nine Months Ended -------------------------------- -------------------------------- Jan. 31, 1999 Jan. 31, 1998 Jan. 31, 1999 Jan. 31, 1998 ------------- ------------- ------------- ------------- Net revenues ...................... $ 8,441 $ 10,034 $ 23,872 $ 29,757 Cost of revenues .................. 5,806 11,989 16,647 28,183 ---------- ---------- ---------- ---------- Gross profit ...................... 2,635 (1,955) 7,225 1,574 Research and development .......... 591 1,299 1,741 3,527 Selling, general and administrative 1,520 2,625 5,537 6,268 ---------- ---------- ---------- ---------- Income (loss) from operations ..... 524 (5,879) (53) (8,221) Interest income (expense), net .... (134) (161) (622) (549) ---------- ---------- ---------- ---------- Net income (loss) ................. $ 390 $ (6,040) $ (675) $ (8,770) ========== ========== ========== ========== Net income (loss) per share: Basic ........................ $ 0.03 $ (0.72) $ (0.06) $ (1.07) ========== ========== ========== ========== Diluted ...................... $ 0.02 $ (0.72) $ (0.06) $ (1.07) ========== ========== ========== ========== Weighted average common shares: Basic ........................ 13,948 8,417 11,653 8,188 ========== ========== ========== ========== Diluted ...................... 19,186 8,417 11,653 8,188 ========== ========== ========== ==========
See accompanying notes to the unaudited condensed consolidated financial statements. -4- 5 CATALYST SEMICONDUCTOR, INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Nine Months Ended ------------------------------- Jan. 31, 1999 Jan. 31, 1998 ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) ........................................... $ (675) $ (8,770) Adjustments to reconcile net income (loss) to net Cash provided by (used in) operating activities: Depreciation and amortization ........................... 957 1,491 Loss on impairment of equipment ......................... - - - 855 Changes in working capital: Accounts receivable ................................ 156 (103) Inventories ........................................ 1,518 5,540 Other assets ....................................... (252) (123) Accounts payable ................................... (5,990) 1,315 Accrued expenses ................................... (1,312) 299 Deferred gross profit on shipments to distributors . 501 (146) ---------- ---------- Net cash used in operating activities ............................ (5,097) 358 ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Cash used for the acquisition of equipment .................. (232) (1,652) ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Common stock transactions, net .............................. 2,433 228 Restricted cash ............................................. 5,750 - - - Net proceeds from (payment of) line of credit ............... (108) (12) Payment of long-term debt and capital lease obligations .... (534) (386) ---------- ---------- Cash provided by (used in) financing activities ......... 7,541 (170) ---------- ---------- Net increase (decrease) in cash and cash equivalents ............. 2,212 (1,464) Cash and cash equivalents at beginning of the period ............. 534 2,695 ---------- ---------- Cash at end of the period ........................................ $ 2,746 $ 1,231 ========== ========== SUPPLEMENTAL CASH FLOW DISCLOSURES: Cash activity: Interest paid (net) .................................. $ 622 $ 549 Non cash activity: Common stock issued in settlement of accounts payable - - - $ 675
See accompanying notes to the unaudited condensed consolidated financial statements. -5- 6 CATALYST SEMICONDUCTOR, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - BASIS OF PRESENTATION In the opinion of management, the unaudited condensed consolidated interim financial statements included herein have been prepared on the same basis as the April 30, 1998 audited consolidated financial statements and include all adjustments, consisting of only normal recurring adjustments, necessary to fairly state the information set forth herein. The statements have been prepared in accordance with the regulations of the Securities and Exchange Commission, but omit certain information and footnote disclosures necessary to present the statements in accordance with generally accepted accounting principles. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended April 30, 1998. The results of operations for the nine month period ended January 31, 1999 are not necessarily indicative of the results to be expected for the entire year. The Company's business is highly cyclical and has been subject to significant downturns at various times which have been characterized by reduced product demand, production overcapacity, and significant erosion of average selling prices. Throughout fiscal 1998 and thus far in fiscal 1999, the market for certain FLASH and EEPROM devices, which comprise the majority of Catalyst's business, experienced an excess market supply relative to demand which resulted in a significant downward trend in prices. The Company could continue to experience a downward trend in product pricing which could further adversely affect the Company's operating results. The Company's operating results in the past year have consumed substantial amounts of cash. The reduction in cash has also placed restrictions on wafer purchases which, during the fourth quarter of 1998, resulted in the cancellation of some customer sales orders. In May 1998, the Company received net proceeds of $1.5 million from the sale of 1,500,000 shares of its Common Stock in a private placement. In September 1998, the Company completed the sale of 4,000,000 additional shares of its Common Stock to the same investor for $1.0 million. Management believes, however, that it will require additional cash from similar or related private placements or other sources of liquidity to meet the Company's projected working capital and other cash requirements for fiscal 1999, and is currently pursuing other sources of liquidity. As a result of these circumstances, the Company's independent accountants' opinion on the Company's April 30, 1998 consolidated financial statements includes an explanatory paragraph indicating that these matters raise substantial doubt about the Company's ability to continue as a going concern. The Company's fiscal year and its first, second and third fiscal quarters end the Sunday closest to April 30, July 31, October 31 and January 31, respectively. For purposes of financial statement presentation, the year end date is expressed as April 30 and the quarter end dates are expressed as July 31, October 31 or January 31. NOTE 2 - INCOME (LOSS) PER SHARE During the quarter ended January 31, 1998, the Company adopted SFAS No. 128, "Earnings Per Share". SFAS No. 128 requires presentation of both basic and diluted net income per share on the face of the income statement. All prior period net income per share data presented has been restated in accordance with SFAS No. 128. Basic net income per share is computed by dividing net income available to common shareholders (numerator) by the weighted average number of common shares outstanding (denominator) during the period and excludes the dilutive effect of stock options. Diluted net income per share gives effect to all dilutive potential common shares outstanding during a period. In computing diluted net income per share, the average stock price for the period is used in determining the number of shares assumed to be purchased from exercise of stock options. -6- 7
Three Months Ended Nine Months Ended --------------------------------- -------------------------------- Jan. 31, 1999 Jan. 31, 1998 Jan. 31, 1999 Jan. 31, 1998 ------------- ------------- ------------- ------------- Net income (loss) ......................... $ 390 $ (6,040) $ (675) $ (8,770) ========== ========== ========== ========== Shares calculation: Weighted avg shares outstanding-basic 13,948 8,417 11,653 8,188 Effect of diluted securities: Stock options ........................ 5,238 -- -- -- ---------- ---------- ---------- ---------- Weighted average shares outstanding-diluted 19,186 8,417 11,653 8,188 ========== ========== ========== ========== Net loss per share: Basic ................................ $ 0.03 $ (0.72) $ (0.06) $ (1.07) ========== ========== ========== ========== Diluted .............................. $ 0.02 $ (0.72) $ (0.06) $ (1.07) ========== ========== ========== ==========
Options to purchase 6,506,000 shares of common stock at prices ranging from $0.11 to $6.30 per share were outstanding during the quarter ended January 31, 1999. Options to purchase 2,675,000 shares of common stock at prices from $1.08 to $7.25 per share outstanding during the quarter ended January 31, 1998 were not included in the computation of diluted EPS because the inclusion of such options would have been antidilutive. NOTE 3 - BALANCE SHEET COMPONENTS (IN THOUSANDS):
Jan. 31, April 30, 1999 1998 ---------- ---------- Accounts receivable: Accounts receivable ........................... $ 4,878 $ 5,052 Less: Allowance for doubtful accounts ........ (308) (326) ---------- ---------- $ 4,570 $ 4,726 ========== ========== Inventories: Work-in-process ............................... $ 2,059 $ 2,410 Finished goods ................................ 617 1,784 ---------- ---------- $ 2,676 $ 4,194 ========== ========== Property and equipment: Engineering and test equipment ................ $ 7,908 $ 7,691 Computer hardware and software ................ 3,485 3,470 Furniture and office equipment ................ 1,275 1,275 ---------- ---------- 12,668 12,436 Less: accumulated depreciation and amortization (10,559) (9,602) ---------- ---------- $ 2,109 $ 2,834 ========== ==========
NOTE 4 - DEBT: Under the terms of a bank revolving line of credit, the Company can borrow the lesser of $13.5 million or an amount determined by a formula applied to eligible accounts receivable at a variable interest rate of prime plus 5.25% (13.0% at January 31, 1999). The revolving line of credit is subject to compliance with loan covenants. At July 31, 1998, the Company was not in compliance with certain of the loan covenants and the bank has agreed in a letter of forbearance not to enforce certain of its rights to which it is entitled under such condition. Such forbearance is granted until March 31, 1999 for each condition of non-compliance on July 31, 1998. As a result of such non-compliance with the terms of the loan, the Company cannot currently borrow any additional funds under the line without the permission of the bank. During the nine months ended January 31, 1999, the bank has continued to loan amounts in accordance with the loan agreement. -7- 8 The credit line with the Company's bank automatically renewed on February 19, 1999, extending the term by a one year period ending June 19, 2000. The Company has requested and the bank has agreed to consider changing various terms and conditions of the agreement to reduce the amount of the credit limit to a more appropriate amount, to reduce other fees and expenses and modify various covenants such that the Company will no longer be in default and therefore not require any further letters of forbearance from the bank. The Company and the bank have agreed to make a reasonable effort to have the new agreement in place before March 31, 1999 when the current letter of forbearance expires. On February 15, 1997, a vendor loaned $1.2 million to the Company in settlement of billings for assembly and test services totaling the same. The loan, which bears interest at 18%, was originally due and payable on May 15, 1998. A subsequent agreement has been negotiated allowing the Company to satisfy the obligation by making monthly payments of $0.1 million principal and interest beginning on November 15, 1998 until paid in full. As of January 31, 1999 the balance remaining was $0.9 million and all payments had been made as agreed. NOTE 5 - SALE OF COMMON STOCK: In May 1998, a private investor purchased 1,500,000 shares of the Company's common stock in a private placement for $1.00 per share. The offer and sale of the securities was exempt from registration under the Securities Act of 1933, as amended, pursuant to Section 4(2) of such Act. In connection with such issuance, the investor agreed to various standstill and voting provisions including not acquiring additional shares of Company Stock or taking actions to control the Company. The Company also has repurchase rights with respect to the shares sold over the twelve months from the date of issuance. In September 1998, the same shareholder purchased an additional 4,000,000 shares of the Company's common stock for $.25 per share. The terms and conditions applicable to this additional purchase are the same as the shares purchased in May 1998. In addition, for a period of twelve months following the closing of the foregoing sale of shares, the Company has the right to require the shareholder to purchase up to 4,000,000 additional shares of common stock at a purchase price of $.25 per share. NOTE 6 - STOCK OPTION PLAN REPRICING: In September 1998, the Board of Directors repriced all outstanding options held by employees and consultants to the then current fair market value of the Common Stock. As a consequence, all such outstanding options were cancelled and an equivalent number of new options with an exercise price of $.125 were issued in replacement thereof. The terms and conditions applicable to the new options, including the vesting provisions, were the same as the old options except that the price was lowered and the expiration date of the options was extended to a date ten years from the date of the repricing. NOTE 7 - 1998 SPECIAL EQUITY INCENTIVE PLAN In December 1998, the Board of Directors adopted a special equity incentive plan to provide additional incentives to eligible employees, consultants, officers and directors whose present and potential contributions are important to the continued success of the Company. The Board reserved 3.5 million shares for issuance under such plan. At the annual shareholders meeting held January 14, 1999 the shareholders approved the grant of 3.25 million shares at a price of $0.125 per share to certain directors and officers as originally granted December 8, 1998 by the board. As a result of these grants the Company will recognize approximately $0.6 million of compensation expense over the four year vesting period of the options. The grants to officers and directors will vest 25% at the end of the first year with the balance to vest monthly for the following 36 months. NOTE 8 - RELATED PARTY TRANSACTIONS The Company has an arrangement to obtain engineering services from Essex com SRL ("Essex"), a wholly owned Romanian subsidiary of Lxi Corporation, a California corporation ("Lxi"), a provider of engineering services. The services relate to key development projects of the Company including development, design, layout and test program development services. Messrs. Vanco, Voicu and Gay own approximately 91%, 3% and 1%, respectively, of Lxi. The fees for such engineering services are on terms believed by the Company to be fair to the Company and no less favorable to the Company than arms length commercial terms. During the fiscal year ended May 3, 1998, the Company recorded $413,000 of engineering fees to Essex for engineering design services. For the current fiscal year through the date covered by this report (May 4, 1998 through January 31, 1999), the Company recorded $294,000 of -8- 9 engineering fees to Essex and Lxi. As of January 31, 1999 the total amount owed to Essex and Lxi was $119,000. Messrs. Vanco, Voicu and Gay received no payments during the fiscal year ended May 3, 1998 and through January 31, 1999 of the current fiscal year, except Mr. Gay who received $3,000 and $1,200 from Lxi during such respective periods. Such payments to Mr. Gay were made for services rendered prior to his joining the Company in connection with his duties as Treasurer of Lxi. Mr. Gay resigned such position immediately prior to joining the Company. Mr. Gay continues to serve as a director of Lxi. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following discussion should be read in conjunction with the accompanying condensed consolidated financial statements and notes thereto included in this report. In addition, the Company desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. Specifically, the Company wishes to alert readers that the factors set forth in "Certain Factors that May Affect the Company's Future Results" as set forth below in this Item 2, as well as other factors, in the past have affected and in the future could affect the Company's actual results, and could cause the Company's results for future quarters to differ materially from those expressed in any forward looking statements made by or on behalf of the Company. OVERVIEW Catalyst Semiconductor, Inc., incorporated October 8, 1985, designs, develops and markets nonvolatile semiconductor memory products and is in the process of developing mixed signal and micro-controller supervisory products. Revenues are derived from sales of semiconductor products designed by the Company and manufactured by other companies. The Company's business is highly cyclical and has been subject to significant downturns at various times which have been characterized by reduced product demand, production overcapacity, and significant erosion of average selling prices. Throughout fiscal 1998 and through the nine months ended January 31, 1999, the market for certain FLASH and EEPROM devices, which comprise the majority of Catalyst's business, experienced an excess market supply relative to demand which resulted in a significant downward trend in prices. The Company could continue to experience a downward trend in product pricing which could further adversely affect the Company's operating results. The Company's operating results in the past year have consumed substantial amounts of cash. The reduction in cash has also placed restrictions on wafer purchases which, during the fourth quarter of fiscal 1998 and the first quarter of fiscal 1999, resulted in the cancellation of some customer sales orders. In May 1998, the Company received net proceeds of $1.5 million from the sale of 1,500,000 shares of its Common Stock in a private placement. In September 1998, the Company sold 4,000,000 additional shares of its Common Stock for $1.0 million in another private placement to the same investor. Management believes, however, that it may require additional cash from similar or related private placements or other sources of liquidity to meet the Company's projected working capital and other cash requirements for fiscal 1999 and beyond, and is currently pursuing these sources of liquidity. As a result of these circumstances, the Company's independent accountants' opinion on the Company's April 30, 1998 consolidated financial statements includes an explanatory paragraph indicating that these matters raise substantial doubt about the Company's ability to continue as a going concern. RESULTS OF OPERATIONS Revenues. Total revenues consist primarily of net product sales. A substantial portion of net product sales has been made through independent distributors. Revenue from product sales to original equipment manufacturers and from sales to distributors who have no, or limited, product return rights and no price protection rights, is recognized upon shipment net of allowances for estimated returns. When distributors have rights to return products or price protection rights, the Company defers revenue recognition until the distributor sells the product to the end customer. Total revenues decreased 16% to $8.4 million for the quarter ended January 31, 1999 from $10.0 million for the quarter ended January 31, 1998. For the nine months ended January 31, 1999, total revenues decreased 20% to $23.9 million from $29.8 million for the nine months ended January 31, 1998. The decreases were primarily attributable to a decrease in sales of the Company's Flash products, the resignation of the Company's Japanese distributor, price erosion caused by excess supply and other adverse industry-wide conditions. Shipments of the -9- 10 Company's Flash memory devices decreased by $8.5 million to 26% of revenues for the first three quarters of fiscal 1999 compared to 51% of revenues or $14.4 million in the comparable period of the prior year. The decrease in Flash product sales is attributable to ASP erosion and that the majority of the market is for devices with larger memory capacity than the 2 megabyte devices that the Company has developed. Marubun, the Company's Japanese distributor which resigned effective the end of fiscal 1998, represented sales of approximately $5.9 million in the nine months ended January 31, 1998. The Company has been seeking replacement distribution relationships in Japan but such sales have only totaled $0.3 million during the nine months of fiscal 1999. Total revenues of $8.4 million for the quarter ended January 31, 1999 increased by 4% from $8.1 million for the quarter ended October 31, 1998. The increase is primarily attributable to an increase in units shipped that exceeded the effects of average sales price erosion experienced during the quarter. The Company is reliant upon receiving and fulfilling a significant quantity of orders within the same quarter to meet or exceed its current revenue levels. A continuation of weak demand, capital deficiencies and price erosion for the Company's products could lead to continued poor operating results. For the nine months ended January 31, 1999, approximately 50% of the Company's revenues were derived from shipments to international customers compared with 64% and 63% of net product sales in fiscal 1998 and 1997, respectively. The decrease in international revenues is attributable to the loss of the Company's Japanese distributor and the Company's inability to compete effectively at the low prices prevalent in certain markets in the Far East. All sales of the Company's products are in US dollars, minimizing the effects of currency fluctuations. Gross Profit (Loss). Gross profit for the quarter ended January 31, 1999 was $2.6 million, or 31% of revenues, compared to a gross loss of $2.0 million, or 19% of revenues, for the quarter ended January 31, 1998. The increase was attributable to $2.7 million of inventory valuation charges and expenses of $0.8 million for impaired manufacturing assets taken in the quarter ended January 31, 1998. For the nine months ended January 31, 1999, gross profits increased by 350% to $7.2 million or 30% of revenues, from $1.6 million, or 5% of revenues, for the nine months ended January 31, 1998. The gross profits for the nine months ended January 31, 1998 were decreased by the $3.5 million in charges for inventory valuation adjustments and impaired equipment charges in the quarter ended January 31, 1998 as contrasted with the benefit of $1.2 million in credits and vendor debt reductions negotiated by management in the nine months ended January 31, 1999. The $2.7 million of inventory valuation adjustments in the quarter ended January 1998 were due to the rapid decrease in demand for and the selling prices for the Company's products. In addition, the Company's ability to forecast future demand and selling prices diminished. It is the policy of the Company to fully reserve all inventory that is not expected to be sold in a reasonable period of time from the balance sheet date, generally within the ensuing six months. As a result of a reduction in estimated demand for the Company's products, the Company provided additional reserves for excess quantities and obsolescence for certain products, primarily the Company's Flash and EEPROM products. The rapid erosion of selling prices also left the Company with significant amounts of inventory with a carrying value that exceeded its current selling price resulting in adjustments to the carrying value of the inventory to the lower of cost or market value. Additionally, certain masks valued at $0.6 million and other manufacturing assets valued at $0.2 million associated with the production of the Company's inventory were written off in the quarter ended January 31, 1998. The Company pays certain foreign manufacturing expenses in local currency, primarily Baht in Thailand and Yen in Japan. Such expenses are not material to the Company and are paid mostly within 30 days, minimizing the effects of currency fluctuations. Research and Development. Research and development (R&D) expenses consist principally of salaries for engineering, technical and support personnel, depreciation of equipment, and the cost of wafers used to evaluate new products and new versions of current products. R&D expenses decreased by 54% to $0.6 million, or 7% of revenues, for the quarter ended January 31, 1999 from $1.3 million, or 13% of revenues, for the quarter ended January 31, 1998. The decrease is primarily attributable to a $0.5 million reduction in personnel costs due to a reduction in force and employee attrition. For the nine months ended January 31, 1999, R&D expenses decreased 51% to $1.7 million, or 7% of revenues, from $3.5 million, or 12% of revenues, for the nine months ended January 31, 1997. The decrease in absolute dollars spent was attributable to a $1.4 million reduction in labor and headcount related expenses resulting from a general reduction in force and a transfer of development to more cost effective off share sources and $0.2 million reduction in depreciation due to the lack of new asset purchases. Selling, General and Administrative. Selling, general and administrative (SG&A) expenses consist principally of salaries for sales, marketing and administrative personnel, commissions and promotional activities. SG&A expenses decreased by 42% to $1.5 million, or 18% of revenues, for the quarter ended January 31, 1999, from $2.6 million, or 26% of revenues, for the quarter ended January 31, 1998. The decreases were attributable to $0.5 in bad debt expense in 1998 as compared to no such expense in 1999 and a reduction of $0.4 in personnel and related costs due to the accrual of severance expense for a general reduction in force in March 1998. The fiscal 1998 results included $0.3 million for additional provisions for the write-off of trade receivables from a distributor in Taiwan. The SG&A expense was reduced in the quarter ended January 31, 1999 by the settlement of executive -10- 11 severance benefits for $0.1 million less than previously reserved. For the nine months ended January 31, 1999, SG&A expenses decreased 13% to $5.5 million, or 23% of revenues, from $6.3 million, or 21% of revenues, for the nine months ended January 31, 1998. The decrease is attributable to a reduction of $0.6 in personnel and related costs including the $0.4 million accrual of severance expense for a general reduction in force in March 1998 and $0.3 million reduction of bad debt expenses. The primary reason for the increase in the percentage of revenue is the decrease in revenues primarily attributable to the erosion of prices to the Company's customers. Net Interest Income (Expense.) Net interest expense decreased by 17% to $134,000 for the quarter ended January 31, 1999 from $161,000 for the quarter ended January 31, 1998. The decrease is primarily related to the decreased average outstanding borrowings. Net interest expense for the nine months ended January 31, 1999 increased 13% to $622,000 compared to $549,000 for the nine months ended January 31, 1998. The increase is primarily attributable to higher interest rates on the Company's outstanding borrowings. Income Tax Provision. As a result of the Company's losses, the provision for income taxes remained at zero for the quarter ended January 31, 1999. As of April 30, 1998 the Company had available net operating loss carryforwards of approximately $37.0 million and credit carryforwards of approximately $1.0 million for federal tax purposes, which begin to expire in 2001. Availability of the net operating loss and general business credit carryforwards may potentially be reduced in the event of substantial changes in equity ownership. LIQUIDITY AND CAPITAL RESOURCES Cash increased $2.2 million to $2.7 million as of January 31, 1999 from $0.5 million as of April 30, 1998. The increase was primarily attributable to $2.5 million received from the sale of common stock to an investor. Restricted cash decreased to zero as of January 31, 1998 from $5.8 million as of April 30, 1998. The restricted cash was pledged as security on a $7.0 million letter of credit that had been required by certain of the Company's wafer foundries. The Company utilized such restricted cash and additional borrowings from its bank to make a payment of $7.0 million in September 1998 to terminate the letter of credit. Under the terms of a bank revolving line of credit, the Company can borrow the lesser of $13.5 million or an amount determined by a formula applied to eligible accounts receivable at a variable interest rate of prime plus 5.25% (13.0% at January 31, 1999). The revolving line of credit is subject to compliance with loan covenants. At January 31, 1999, the Company was not in compliance with certain of the loan covenants and the bank agreed in a letter of forbearance not to enforce certain of its rights resulting from such noncompliance. Such forbearance has been granted until March 31, 1999 for each condition of non-compliance on July 31, 1998. As a result of such non-compliance with the terms of the loan, the Company cannot currently borrow any additional funds under the line without the permission of the bank. During the nine months ended January 31, 1999, the bank has continued to loan amounts in accordance with the loan agreement. Due to continued losses by the Company, the borrowings against the backlog from certain foreign customers have been eliminated. On February 15, 1997, a vendor loaned $1.2 million to the Company in settlement of billings for assembly and test services totaling the same. The loan, which bears interest at 18%, was originally due and payable on May 15, 1998. The Company has renegotiated the terms of the note and agreed to satisfy the obligation with monthly payments of $0.1 million applied to principal and interest beginning on November 15, 1998 until paid in full. There can be no assurance that the Company will be able to make such payments to the satisfaction of the vendor or, if the Company fails to comply with the agreement that the vendor will not seek to enforce its right to collect the unpaid balance. As of January 31, 1999, the Company had made all payments as agreed and was in compliance with the payment schedule. The Company has been seeking additional equity or debt financing to address its working capital needs and to provide funding for capital expenditures. In September 1998, the Company entered into an agreement to issue Common Stock in exchange for $1.0 million with the right to obtain an additional $1.0 million of equity financing on the same terms and conditions. There can be no assurances, however, that further financing will be available on terms acceptable to the Company, if at all. If the Company is not successful in raising additional capital, in view of the uncertainties relating to arrangements with its bank and other lenders, the Company can not reasonably assess how long its current cash balances, cash generated from operations and borrowings available under any remaining -11- 12 loans or lines of credit and from equipment financing, even with substantial reductions in operating expenses and capital expenditures, will permit the Company to continue operations. CERTAIN FACTORS THAT MAY AFFECT THE COMPANY'S FUTURE RESULTS THE COMPANY DESIRES TO TAKE ADVANTAGE OF CERTAIN PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, ENACTED IN DECEMBER 1995 (THE "REFORM ACT") THAT PROVIDES A "SAFE HARBOR" FOR FORWARD-LOOKING STATEMENTS MADE BY OR ON BEHALF OF THE COMPANY. THE COMPANY HEREBY CAUTIONS STOCKHOLDERS, PROSPECTIVE INVESTORS IN THE COMPANY AND OTHER READERS THAT THE FOLLOWING IMPORTANT FACTORS, AMONG OTHERS, IN SOME CASES HAVE AFFECTED, AND IN THE FUTURE COULD AFFECT, THE COMPANY'S STOCK PRICE OR CAUSE THE COMPANY'S ACTUAL RESULTS FOR THE FISCAL YEAR ENDING APRIL 30, 1999, FOR THE FISCAL QUARTER ENDING APRIL 30, 1999, AND FUTURE FISCAL YEARS AND QUARTERS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN ANY FORWARD-LOOKING STATEMENTS, ORAL OR WRITTEN, MADE BY OR ON BEHALF OF THE COMPANY. The Company's business and future operating results are subject to potential fluctuations due to a number of factors including the following: Defaults under Outstanding Loans; Risk of Bankruptcy. The Company has approximately $3.1 million of secured loans owing to its bank. As a result of the Company's financial condition and results of operations, the bank has determined that the Company is in default under various provisions of the loan agreement entitling the bank to terminate the loan agreement and declare the loans immediately due and payable. Although the Company has obtained letters of forbearance from the bank taking any action with respect to existing defaults, such forbearance only extends until March 31, 1999 and only as to the specified defaults claimed through September 21, 1998. The Company is working to persuade the bank to continue to forebear taking action on the events of default and not to declare the loan immediately due and payable. In that regard the Company has received $1.0 million in equity financing and a twelve month right to obtain up to an additional $1.0 million of equity financing. There can be no assurance that efforts to obtain additional funding will be successful or, if successful, that the bank will continue to forbear action on or otherwise waive the existing defaults. There can be no assurance the Company's efforts will be successful. If the Company's efforts are unsuccessful, the bank is likely to declare the loans due and payable. Under such circumstances the Company would be unable to continue operations which would result in bankruptcy. The Company is also indebted to other creditors in the amount of approximately $7.4 million. Continued operation of the Company would also require such other creditors to forbear taking action or waiving defaults under such other debt. Moreover, it is anticipated that any continued forbearance by the bank would require such other creditors to take similar action under the other loans. In addition, although the Company is current on its lease payments under the lease of its headquarters facility, as a result of its financial condition, the Company is in violation of certain terms of its lease. Similar violations have resulted under certain equipment lease agreements. Need for Additional Capital. The Company has incurred significant losses and experienced significant negative cash flow from operations for over two years. Such negative cash flow has significantly reduced the Company's available capital. The Company has thus far been successful in having its lenders agree to waive or forbear actions on defaults under existing loans or to renegotiate the terms of such loans to enable the Company to keep such loans outstanding but there can be no assurance that such lenders will continue to agree to such favorable actions. The Company may, as a condition to such waivers or forbearances, need to obtain additional capital. If the Company is not successful in raising additional capital, in view of the uncertainties relating to arrangements with its bank and other lenders, the Company can not reasonably assess how long its current cash balances, cash generated from operations and borrowings available under any remaining loans or lines of credit and from equipment financing, even with substantial reductions in operating expenses and capital expenditures, will permit the Company to continue operations. There can be no assurance that the Company will generate sufficient revenue to fund its operations in the absence of additional funding sources. The Company has pursued and continues to pursue measures designed to reduce expenses and conserve cash such as deferring payments to vendors and other suppliers, headcount reductions, deferrals of planned expenditures, other expense reductions and other measures. Although such activities help preserve cash and enable the Company to continue operations, the lack of available capital hinders the Company's ability to continue manufacturing, sales, product development and other ongoing operational activities necessary to generating revenues. Such activities could have a material, adverse affect on the Company's business, financial condition and operating results. Furthermore, to the extent the Company suffers further adverse effects to its revenues or margins because of delays in new product introductions, price competition or other competitive factors, the Company's cash position and its business, operating results and financial condition could be further adversely affected. -12- 13 The Company obtained additional capital of $1.5 million in the quarter ended July 31, 1998 and $1.0 million equity financing in the quarter ended October 31, 1998 and a twelve month right to obtain up to an additional $1.0 million of equity financing. The Company may seek additional equity or debt financing to address its working capital needs and to provide funding for capital expenditures. There can be no assurance that additional funding will continue to be available at acceptable terms, if at all. If the Company is successful in raising additional funds through the issuance of equity securities, existing stockholders of the Company would likely experience substantial dilution, or the securities may have rights, preferences or privileges senior to those of the Company's Common Stock. If adequate funds are not available or are not available on acceptable terms, further reductions in its operating expenses and capital expenditures would be required to continue operations either of which could have a material adverse effect on the Company's business, operating results and financial condition. Recent Operating Results; Anticipated Future Losses. Although the Company's operating results for the quarter ended January 31, 1999 reflect an increase in revenues and profitability from the previous two quarters, the year to date results still reflect a loss of $0.7 million. Total revenues for the quarter ended January 31, 1999 were $8.4 million compared to revenues of $8.1 million in the quarter ended October 31, 1998 and revenues of $10.0 million for the comparable period of the prior year. In addition, the Company had net income for the quarter ended January 31, 1999 of $0.4 million compared to a net loss for the quarter ended October 31, 1998 of $.4 million and to a net loss of $6.0 million for the comparable period in the prior year. The Company lost $18.9 million in the fiscal year ended April 30, 1998 and the Company's last profitable year was the fiscal year ended April 30, 1996. For the preceding two years, the Company has experienced significant negative cash flow from operations. The Company has taken many steps to reduce its operating expenses including reducing its headcount from 71 in December, 1996 to 42 in January 1999. Although reductions in headcount could help the Company meet its operating expense objectives, such reductions could adversely impact the Company's sales, marketing and product development efforts. The Company anticipates that negative cash flow from operations will continue for the foreseeable future. There can be no assurance that the Company can generate revenue growth, or that any revenue growth that is achieved can be sustained. To the extent that increases in such operating expenses precede and are not subsequently followed by increased revenues, the Company's business, results of operations and financial condition would be materially adversely affected. There can be no assurance that the Company will ever achieve or sustain profitability. Fluctuations in Operating Results. The Company's operating results have historically been and in future quarters may be adversely affected or otherwise fluctuate due to factors such as timing of new product introductions and announcements by the Company and its competitors, fluctuations in customer demand for the Company's products, volatility in supply and demand affecting market prices generally (such as the increases in supply of competitive products and significant declines in average selling prices experienced by the Company in the nine months ended January 31, 1999 and in the fiscal years ended April 30, 1998 and 1997), increased expenses associated with new product introductions or process changes, increased expenditures related to expanding the Company's sales channels, gains or losses of significant customers, timing of significant orders of the Company's products, fluctuations in manufacturing yields, changes in product mix, wafer price increases due to foreign currency fluctuations and general economic conditions. The Company anticipates that a significant portion of its revenue will be derived from a limited number of large orders, and the timing of receipt and fulfillment of any such orders is expected to cause material fluctuations in the Company's operating results, particularly on a quarterly basis. Due to the foregoing factors, quarterly revenue and operating results are difficult to forecast. The Company's expense levels are based, in significant part, on the Company's expectations as to future revenue and are therefore relatively fixed in the short term. If revenue levels fall below expectations, as has occurred during the nine months ended January 31, 1999 and the years ended April 30, 1998 and 1997, net income is likely to be disproportionately adversely affected because a proportionately smaller amount of the Company's expenses varies with its revenue. There can be no assurance that the Company will be able to continue to achieve or maintain profitability on a quarterly or annual basis in the future. Due to the foregoing factors, the Company's operating results may fall below the expectations of securities analysts and investors, which could have a material adverse effect on the market price of the Company's Common Stock. Reductions in revenue expectations can also require the Company to take additional reserves against inventory valuations based upon the reduced likelihood that the Company will be able to liquidate its inventories at profitable prices. Inventory. The cyclical nature of the semiconductor industry periodically results in oversupply or shortages of wafer fabrication capacity such as the Company has experienced from time to time. Since the Company must order products and build inventory substantially in advance of product shipments, there is a risk that the Company will forecast incorrectly and produce excess or insufficient inventories of particular products because -13- 14 demand for the Company's products is volatile and customers place orders with short lead times. The ability of the Company's customers to reschedule or cancel orders without significant penalty could adversely affect the Company's liquidity, as the Company may be unable to adjust its purchases from its wafer suppliers to match such customer changes and cancellations. There can be no assurance that the Company's inventory will be reduced by the fulfillment of customer orders or that in the future the Company will not produce excess quantities of its products. To the extent the Company produces excess inventories of particular products, the Company's operating results could be adversely affected by charges that the Company could recognize due to significant reductions in demand for its products, rapid declines in the market value of inventory resulting in inventory writedowns or other related factors. The Company recorded $2.7 million of inventory valuation adjustments in the quarter ended January 1998 due to the rapid decrease in demand for and the selling prices for the Company's products. In addition, the Company's ability to forecast future demand and selling prices diminished. It is the policy of the Company to fully reserve all inventory that is not expected to be sold in a reasonable period of time from the balance sheet date, generally within the ensuing six months. As a result of a reduction in estimated demand for the Company's products, the Company provided additional reserves for excess quantities and obsolescence for certain products, primarily the Company's Flash and EEPROM products. The rapid erosion of selling prices also left the Company with significant amounts of inventory with a carrying value that exceeded its current selling price resulting in adjustments to the carrying value of the inventory to the lower of cost or market value. Additionally, during the last half of fiscal 1998, the Company recorded charges of approximately $7.5 million attributable to reserves for similar excess and obsolete inventory valuation adjustments for lower of cost or market adjustments. Such adjustments have amounted to $0.6 million in the nine month period ended January 31, 1999. There can be no assurance that the Company will not suffer similar reductions in values of its inventories in the future or that the Company will be able to liquidate its inventory at acceptable prices. Competition. The semiconductor industry is intensely competitive and has been characterized by rapid price erosion, declining gross margins, rapid technological change, product obsolescence and heightened international competition in many markets. Average selling prices in the semiconductor industry generally, and for the Company's products in particular, have decreased significantly and rapidly over the life of each product. The Company expects that average selling prices for its existing products will continue to decline rapidly for the foreseeable future and that average selling prices for each new product will decline significantly over the life of the product. Declines in average selling prices for the Company's products, if not offset by reductions in the cost of producing those products or by sales of new products with higher gross margins, would decrease the Company's overall gross margins, could cause a negative adjustment to the valuation of the Company's inventories and could materially and adversely affect the Company's operating results. The Company competes with major domestic and international semiconductor companies, many of which have substantially greater financial, technical, sales, marketing, production, distribution and other resources than the Company. There can be no assurance that the Company will be able to compete successfully in the future. The Company's more mature products, such as Serial and Parallel EEPROM devices, compete on the basis of product performance, price and customer service. The Company believes it competes successfully with respect to each of these competitive attributes; however price competition is significant and expected to continue. Principal competitors with respect to the Company's EEPROM products currently include SGS-Thomson, National Semiconductor, Atmel and Xicor, all of which have substantially greater resources than the Company. The market for Flash memory products has been characterized by long production cycles, irregular yields, competing technologies and, particularly since the first quarter of fiscal 1997, intense price competition resulting in major reductions in average selling prices and corresponding reductions in margins. The Company's Flash memory products compete on the basis of product performance, price and customer service. However, given the development of higher density/lower cost products and the intense price competition prevalent for these products, there can be no assurance that the Company will be able to compete successfully in the future against its competitors on the bases of these or other competitive factors. Dependence on Independent Foreign Manufacturers and Subcontractors; Manufacturing Risks. The Company does not manufacture the semiconductor wafers used for its products. The Company principally utilizes facilities of Oki Electric Industry Co., Ltd. ("OKI") in Japan to fabricate the Company's wafers and subcontractors in Southeast Asia to assemble and test its integrated circuits. To date, a majority of these wafers have been manufactured by OKI. The manufacture of semiconductor products is highly complex and sensitive to a wide variety of factors and, as is typical in the semiconductor industry, the Company's outside wafer foundries from time to time have experienced lower than anticipated production yields. While the Company believes it has an adequate wafer supply to meet its currently anticipated needs, there can be no assurance that the Company will continue to -14- 15 receive sufficient quantities of wafers at favorable prices on a timely basis, if at all, or that the Company will be able to attain higher levels of wafer supply as demand requires. Material disruptions in the supply of wafers as a result of manufacturing yield or other manufacturing problems are not uncommon in the semiconductor industry. The Company may also be subject to production transition delays. There can be no assurance that the Company will not experience such problems in the future. Moreover, delays in the Company's payments to wafer suppliers resulting from the Company's current cash constraints can often result in delays or reductions in wafer deliveries and assembly and test services from the Company's suppliers. Such delays and reductions can result in cancellations of customer orders thereby adversely affecting the Company's ability to generate future revenues. The loss of OKI as a supplier, any prolonged inability to obtain adequate yields or deliveries from OKI or other subcontractor manufacturers, or any other circumstance that would require the Company to seek and qualify alternative sources of supply of products or services, could delay shipments, result in the loss of customers and have a material adverse effect on the Company's business and operating results. Moreover, the inability to procure supplies and services from these foreign subcontractor manufacturers on commercially reasonable terms as a result of foreign currency exchange rate fluctuations may have a material adverse effect on the Company's operating results. The Company also has concerns about the financial viability of its primary test and assembly contractor. Although the Company is exploring alternative contractors, there can be no assurance that it will be able to obtain such alternative services or that the Company will have adequate test and assembly facilities available. Failure to have such services available would have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company's business is subject to other risks generally associated with doing business with foreign subcontractors including, but not limited to, foreign government regulations, political and financial unrest which may cause disruptions or delays in shipments to the Company's customers or access to the Company's inventories. International Operations. For the nine months ended January 31, 1999 and fiscal 1998, 1997 and 1996 international sales accounted for approximately 50%, 64%, 63% and 60%, respectively, of the Company's product sales. The decrease in international sales is attributable to the transition in Japan from Marubun who resigned in fiscal 1998 to various smaller alternative distributors that serve similar markets and the inability of the Company to compete with the low selling prices in certain Far East markets. The Company expects that international sales will continue to represent a significant portion of its product sales in the future. The Company's international operations may be adversely affected by fluctuations in exchange rates, imposition of government controls, political and financial instability, trade restrictions, changes in regulatory requirements, difficulties in staffing international operations and longer payment cycles. Except for a few sales through the Company's subsidiary in Japan, NCKK, all sales are invoiced and paid in dollars, reducing the Company's direct exposure to currency fluctuations. Except for Yoshikawa Semiconductor in Japan, and some payroll and incidental manufacturing supply purchases in Thailand, over 95% of the Company's purchases are in US dollars, minimizing any direct currency fluctuation risk. However, recent adverse developments in the economic environment in the Far East may have a material adverse effect on the Company's subcontractors. There can be no assurance these or other factors related to international operations will not have a material adverse affect on the Company's business, financial condition and results of operations. New Product Development and Technological Change. The markets for the Company's products are characterized by rapidly changing technology and product obsolescence. The timely introduction of new products at competitive price/performance levels is a key factor to the success of the Company's business. In particular, the Company's future success will depend on its ability to develop and implement new design and process technologies which enable the Company to achieve higher product densities and thereby reduce product costs. For example, most of the Company's products are currently designed and manufactured using a 0.8 micron CMOS EEPROM process or a 0.5 micron Flash memory process. There can be no assurance that the Company will be able to select and develop new products and technologies and introduce them to the market in a timely manner and with acceptable fabrication yields and production costs. Furthermore, there can be no assurance that the Company's products will achieve market acceptance. The failure of the Company to complete and introduce new products at competitive price/performance levels could materially and adversely affect the Company's business, financial condition and operating results. Delays in developing new products, achieving volume production of new products, successfully completing technology transitions with acceptable yields and reliability or the lack of commercial acceptance of new products introduced by the Company, could have a material adverse effect on the Company's business, financial condition and results of operations. Flash Memory Market. A significant amount of the Company's net revenues during the nine months ended January 31, 1999 and the fiscal year ended April 1998 were derived from sales of Flash memory products. The market for Flash memory products has been characterized by intense price competition, long production cycles, inconsistent yields, competing technologies, rapidly declining average selling prices, declines in gross margins and -15- 16 intense overall competition. The Company's operating results in fiscal 1997, 1998 and for the first nine months of fiscal 1999 have been adversely affected by intense price competition caused by increased supplies of products and other adverse industry-wide conditions. Intel and other competitors (which include Advanced Micro Devices, Atmel, Fujitsu, Hitachi, Micron, Mitsubishi, SGS-Thomson, Sharp, Texas Instruments and Toshiba) are expected to further increase Flash memory production. There can be no assurance that the Company will be able to sustain the market acceptance for its Flash memory products. The Company anticipates continued price and other competitive pressures, which adversely affected fiscal 1997, fiscal 1998 and the first half of fiscal 1999 operating results, to adversely affect the Company's future operating results. Semiconductor Industry. The semiconductor industry is highly cyclical and has been subject to significant economic downturns at various times, characterized by diminished product demand, accelerated erosion of average selling prices and gross margins, and production overcapacity. Accordingly, the Company may experience substantial period to period fluctuations in future operating results due to general semiconductor industry conditions, overall economic conditions or other factors. For example, the Company experienced and continues to experience accelerated erosion of average selling prices caused by adverse industry-wide conditions in fiscal 1997, fiscal 1998 and thus far in fiscal 1999. Dependence on Proprietary Technology; Risk of Intellectual Property Litigation. In the semiconductor industry companies place extensive reliance upon their intellectual property and proprietary technology and it is typical for companies to receive notices from time to time that allege infringement of patents or other intellectual property rights of others. There can be no assurance that the Company will not receive any such notification or that proceedings alleging infringement of intellectual property rights will not be commenced against the Company in the future. In such event, there can be no assurances that the Company could obtain any required licenses of third party intellectual property rights or could obtain such licenses on commercially reasonable terms. Failure to obtain such a license in any event could require the Company to cease production of its products until the Company develops a non-infringing design or process. Moreover, the cost of litigation of any such claim or damages resulting therefore could be substantial and could materially and adversely affect the Company's business, financial condition and results of operations. Dependence upon Key Personnel. The Company's ability to operate successfully will depend, to a large extent, upon the continued service of certain key employees, and the continued ability to attract and retain additional highly qualified personnel. Competition for such personnel, particularly for highly skilled design, process and test engineers, is intense and there can be no assurance that the Company can retain such personnel or that it can attract other highly qualified personnel. The loss of or failure to attract and retain any such highly qualified personnel could have a material adverse affect on the Company's business, financial condition and results of operations. Customer Concentration. A relatively small number of customers have accounted for a significant portion of the Company's net revenue in the past. During the nine month period ended January 31, 1999, only one customer, Intel Corporation, represented more than 10% of the Company's product revenues, which represented 11% of the Company's shipments. During the fiscal years 1998, 1997 and 1996, the only customer which represented more than ten percent of Catalyst's product revenue was Marubun Corporation, a Japanese distributor (21%, 14% and 12%, respectively). In December 1997, Marubun resigned as a distributor effective in or about March 1998. The Company is working to develop alternative distributors in Japan to replace Marubun. Such efforts take substantial time and may not completely replace the sales volumes achieved through Marubun. Loss of one or more of the Company's current customers could materially and adversely affect the Company's business, operating results and financial condition. In addition, the Company has experienced and may continue to experience lower margins on sales to significant customers as a result of volume pricing arrangements. Dependence on Manufacturer Representatives and Distributors. The Company markets and distributes its products primarily through manufacturers' representatives and independent distributors. The Company's distributors typically offer competing products. The distribution channels have been characterized by rapid change, including consolidations and financial difficulties. The loss of one or more manufacturers' representatives or distributors, or the decision by one or more distributors to reduce the number of the Company's products offered by such distributors or to carry the product lines of the Company's competitors, could have a material, adverse effect on the Company's operating results. Year 2000 Program, General. The Company is currently conducting a company-wide Year 2000 readiness program ("Y2K Program") with a task force meeting weekly. The Y2K Program is addressing the issue of computer programs and embedded computer chips being unable to distinguish between the year 1900 and the -16- 17 year 2000. Therefore, some computer hardware and software will need to be modified prior to the Year 2000 in order to remain functional. The Company anticipates that Year 2000 compliance will be substantially complete by July 1999. The Company's Y2K Program is divided into four major sections - --Catalyst manufactured products, internal information ("IT") system, non-IT system, and third-party suppliers and customers. The general phases common to all sections are: (1) inventorying Year 2000 items; (2) assessing the Year 2000 compliance of items determined to be material to the company; and (3) repairing or replacing material items that are determined not to be Year 2000 compliant. The Company has completed the review of all Catalyst manufactured products for Year 2000 compliance purposes. The Company believes that all of the Company's products are Y2000 compliant since the Company's products do not create or calculate date related information. The Company is currently evaluating and addressing Year 2000 issues associated with its internal IT systems. The supplier of the Company's financial system has provided an update under its software maintenance contract that is designed to make the system Year 2000 compliant. The Company expects to finish its evaluation and installation of the update in or about June 1999. Other internal computer systems that have been identified as non-compliant will be upgraded to be Year 2000 compliant in or about July 1999. The Company has completed the evaluation of Year 2000 issues associated with its non-IP systems. Most of them are Year 2000 compliant. Those non-IT systems that are not Year 2000 are expected to be repaired or replaced in or about June 1999. The Company is currently assessing the possible effects on the Company's operations of the Year 2000 readiness of its key suppliers and contract manufacturers. See "Dependence on Independent Foreign Manufacturers and Subcontractors; Manufacturing Risks." The Company expects this assessment will be completed in or about June 1999. The Company's reliance on suppliers and contract manufacturers and, therefore, on the proper functioning of their information systems and software, means that failure to address Year 2000 issues could have a material impact on the Company's operations and financial results; however, the potential impact and related costs are not known at this time. The Company has received detailed reports of Year 2000 readiness from all its major contract suppliers. Such reports show that their programs are substantially complete and that all Year 2000 issues have been resolved. The suppliers that represent more than 10% of each of its manufacturing activities are: Oki Semiconductor, the Company's principal wafer fabricator, Yoshikawa Semiconductor Co, Ltd., provider of wafer testing services and NS Electronics Bangkok (1998) Ltd. and Gateway Electronics Corporation, its primary contract assembly and test service providers. The Company intends to discuss the Y2K statements of each major supplier during visits to each such manufacturer and to audit the state of readiness in the Y2K readiness reports received. Year 2000 Costs. The total cost associated with required modifications to become Year 2000 compliant is not expected to be material to the Company's financial position. Through January 31, 1999, the Company has spent less than $1,000 of out of pocket expenses to implement its Year 2000 compliance program. That amount has been expensed. The Company estimates that it may spend up to an additional $25,000 for other replacements or upgrades and for audits and communicating with key suppliers and customers. That amount will also be expensed as incurred. Year 2000 Risks. The failure to correct a material Year 2000 problem could result in an interruption in, or a failure of, certain normal business activities or operations. Such failures could materially and adversely affect the Company's results of operations, liquidity and financial condition. Due to the general uncertainty inherent in the Year 2000 problem resulting in part from the uncertainty of the Year 2000 readiness of third-party suppliers and customers, the Company is unable to determine at this time whether the consequences of Year 2000 failures will have a material impact on the Company's results of operations, liquidity or financial condition. The Y2K Program is expected to significantly reduce the Company's level of uncertainty about the Year 2000 problem and, in particular, about the Year 2000 compliance and readiness of its material key suppliers and customers. The Company believes that, with the implementation of new business systems and completion of the Y2K Program as scheduled, the possibility of significant interruptions of normal operations should be reduced. Year 2000 Contingency Plans. The Company has developed a contingency plan to address the Y2000 problem that is expected to minimize any interruption to its supplies and shipments of its products to its customers in January 2000. Such plan includes an increase of manufacturing activity during November and December 1999 to -17- 18 have all products on order for the month of January 2000 completed and in finished goods inventory. The Company may not be able to fulfill any orders for immediate shipment during January if its suppliers do experience any disruptions that may have a material adverse impact on the Company's operations. Takeover Resistive Measures. The Company's Stockholder Rights Plan, which provides stockholders with certain rights to acquire shares of Common Stock in the event a third party acquires more than 15% of the Company's stock, the Board's ability to issue "blank check" Preferred Stock without stockholder approval and the Company's staggered terms for its directors, could have the effect of delaying or preventing a change in control of the Company. Volatility of Stock Price. The Company's stock price has been and may continue to be subject to significant volatility. Any shortfall in revenues or earnings from levels expected or projected by securities analysts or others could have an immediate and significant adverse effect on the trading price of the Company's Common Stock in any given period. In addition, the stock market in general has experienced extreme price and volume fluctuations particularly affecting the market prices for many high technology companies and small capitalization companies, and these fluctuations have often been unrelated to the operating performance of the specific companies. These broad fluctuations may adversely affect the market price for the Company's Common Stock. -18- 19 CATALYST SEMICONDUCTOR, INC. PART II - OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At the Company's Annual meeting of Stockholders held on January 14, 1999 the following proposals were adopted by the margins indicated.
Number of Voted Shares For Withheld ----------- ---------- 1. To elect one Class II director to serve for a two-year term expiring upon the Annual Meeting of Stockholders next following April 30, 2000 and to elect one Class III director to serve for a three-year period expiring upon the Annual Meeting of Stockholders next following April 30, 2001, or until such directors respective successors are duly elected and qualified. Patrick Verderico - Class II Director 12,033,545 269,577 Lionel M. Allan - Class III Director 12,027,645 275,477 Voted Voted Broker For Against Abstain Nonvote ----- ------- ------- ------- 2. To approve an amendment and restatement of the Company's Restated Certificate of Incorporation to increase the number of authorized shares of Common Stock from 25,000,000 shares to 45,000,000 shares. 11,649,973 622,349 30,800 0 3. To approve amendments to the Company's Stock Option Plan to increase the number of shares of Common Stock reserved for issuance thereunder by 1,800,000 shares, to increase the maximum number of shares subject to options that may be issued to any one employee during a fiscal year to 1,000,000 shares and to make changes in the Plan necessary to comply with applicable state securities law. 6,492,905 733,509 54,325 5,022,383 4. To approve the adoption of the 1998 Special Equity Incentive Plan and the reservation of 3,500,000 shares for issuance thereunder. 6,505,960 704,544 70,255 5,022,383 5. To approve the following option grants under the 1998 Special Equity Incentive Plan: 1,000,000 to Radu M. Vanco; 200,000 to each of Marc Cremer, Thomas E. Gay III, Bassam Khoury, Gelu Voicu, Lionel M. Allan, Hideyuki Tanigami and Patrick Verderico; 250,000 each to Irv Kovalik and Juzer Mogri; 150,000 shares to William Priestner; and 100,000 shares to Frank Reynolds. 6,333,144 885,021 62,574 5,022,383 6. To ratify the appointment of Pricewaterhouse Coopers LLP as independent accountants of the Company for the fiscal year ending April 30, 1999. 12,100,193 136,904 66,025 0
II-1 20 ITEM 5. OTHER INFORMATION The Company has an arrangement to obtain engineering services from Essex com SRL ("Essex"), a wholly owned Romanian subsidiary of Lxi Corporation, a California corporation ("Lxi"), a provider of engineering services. The services relate to key development projects of the Company including development, design, layout and test program development services. Messrs. Vanco, Voicu and Gay own approximately 91%, 3% and 1%, respectively, of Lxi. The fees for such engineering services are on terms believed by the Company to be fair to the Company and no less favorable to the Company than arms length commercial terms. During the fiscal year ended May 3, 1998, the Company recorded $413,000 of engineering fees to Essex for engineering design services. For the current fiscal year through the date covered by this report (May 4, 1998 through January 31, 1999), the Company recorded $294,000 of engineering fees to Essex and Lxi. As of January 31, 1999 the total amount owed to Essex and Lxi was $119,000. Messrs. Vanco, Voicu and Gay received no payments during the fiscal year ended May 3, 1998 and through January 31, 1999 of the current fiscal year, except Mr. Gay who received $3,000 and $1,200 from Lxi during such respective periods. Such payments to Mr. Gay were made for services rendered prior to his joining the Company in connection with his duties as Treasurer of Lxi. Mr. Gay resigned such position immediately prior to joining the Company. Mr. Gay continues to serve as a director of Lxi. Effective November 1, 1998 Mr. Vanco's salary was adjusted to $325,000 per year. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 10.67 Modification of Consulting Agreement dated January 1, 1999 between the Company and Allan Advisors, Inc. 27 Financial Data Schedule (b) REPORTS ON FORM 8-K There were no reports on Form 8-K filed during the quarter ended January 31, 1999. II-2 21 CATALYST SEMICONDUCTOR, INC. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the City of Sunnyvale and State of California. Date: March 22, 1999 By: /s/ Radu M. Vanco --------------------------------------- Radu M. Vanco President and Chief Executive Officer Date: March 22, 1999 By: /s/ Thomas E. Gay III --------------------------------------- Thomas E. Gay III Vice President of Finance and Administration and Chief Financial Officer II-3 22 EXHIBIT INDEX EXHIBIT DESCRIPTION - ------- ----------- 10.67 Modification of Consulting Agreement dated January 1, 1999 between the Company and Allan Advisors, Inc. 27 Financial Data Schedule EX-10.67 2 MODIFICATION OF CONSULTING AGREEMENT 1 EXHIBIT 10.67 MODIFICATION OF CONSULTING AGREEMENT This Modification of Consulting Agreement is entered into at Sunnyvale, California as of January 1, 1999 between Catalyst Semiconductor, Inc. (the "Company") and Allan Advisors, Inc. ("Consultant"). A. Recitals: Company and Consultant entered into a Consulting Agreement on August 14, 1995, which Agreement was extended on June 3, 1998 until August 14, 2001. Company and Consultant wish to modify that Agreement as set forth herein. B. Compensation. In that the consulting fee has not been increased since August 14, 1995, Company and Consultant agree to modify Paragraph 3 of the 1995 Agreement to increase the consulting fee to $8,333 per month effective as of this date and to discontinue the office allowance of $1000 per month. C. Term. Company and Consultant hereby agree modify Paragraph 4 of the 1995 Agreement to provide for termination fee of 12 months of consulting fees. Except as expressly modified herein, Company and Consultant ratify and affirm all the terms and conditions in the Consulting Agreement entered into on August 14, 1995 and extended on June 3, 1998. Catalyst Semiconductor, Inc. Allan Advisors, Inc. /s/ Radu Vanco /s/ Lionel M. Allan - ---------------------------------- ------------------------------------ Radu Vanco Lionel M. Allan President and CEO President and CEO EX-27 3 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE UNAUDITED FINANCIAL RESULTS FOR THE NINE MONTH PERIOD ENDED JANUARY 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH 10-Q. 1,000 9-MOS APR-30-1999 MAY-01-1998 JAN-31-1999 2,746 0 4,878 (308) 2,676 11,059 12,668 (10,559) 13,168 14,963 0 0 0 45,222 (47,333) 13,168 23,872 23,872 16,647 16,647 7,278 75 622 (675) 0 (675) 0 0 0 (675) (.06) (.06)
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