-----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, B6EKK8mtrWoYvioJC6oPt4Kvv0ns19+kcvbPxKYlLBuPsShoRIKXe6z8mn3OOctq 84YJ24b1mYh+KSKiZ29IKw== 0000891618-99-001048.txt : 19990323 0000891618-99-001048.hdr.sgml : 19990323 ACCESSION NUMBER: 0000891618-99-001048 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19980927 FILED AS OF DATE: 19990322 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTEGRATED DEVICE TECHNOLOGY INC CENTRAL INDEX KEY: 0000703361 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 942669985 STATE OF INCORPORATION: DE FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 000-12695 FILM NUMBER: 99570048 BUSINESS ADDRESS: STREET 1: 2975 STENDER WAY CITY: SANTA CLARA STATE: CA ZIP: 95054 BUSINESS PHONE: 4087276116 MAIL ADDRESS: STREET 1: 2975 STENDER WAY CITY: SANTA CLARA STATE: CA ZIP: 95054 10-Q/A 1 AMENDMENT #1 TO THE FORM 10-Q 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 27, 1998 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 No. 0-12695 INTEGRATED DEVICE TECHNOLOGY, INC. (Exact name of registrant as specified in its charter) DELAWARE 94-2669985 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2975 STENDER WAY, SANTA CLARA, CALIFORNIA 95054 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (408) 727-6116 NONE Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No ( ) The number of outstanding shares of the registrant's Common Stock, $.001 par value, as of October 25, 1998, was approximately 82,278,000. ================================================================================ 2 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS INTEGRATED DEVICE TECHNOLOGY, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended Six Months Ended Sep. 27, Sep. 28, Sep. 27, Sep. 28, 1998 1997 1998 1997 -------------------- -------------------- Revenues $ 130,635 $ 143,807 $ 265,122 $ 292,680 Cost of revenues 89,983 88,643 183,181 181,180 Asset impairment and other 131,944 -- 160,860 -- Restructuring charges 46,384 -- 46,384 -- -------------------- -------------------- Gross profit (137,676) 55,164 (125,303) 111,500 -------------------- -------------------- Operating expenses: Research and development 36,440 30,632 75,865 60,454 Selling, general and administrative 25,709 20,048 52,243 42,412 -------------------- -------------------- Total operating expenses 62,149 50,680 128,108 102,866 -------------------- -------------------- Operating income (loss) (199,825) 4,484 (253,411) 8,634 Interest expense (3,515) (3,512) (6,802) (7,255) Interest income and other, net 1,428 2,641 2,794 4,860 -------------------- -------------------- Income (loss) before income taxes (201,912) 3,613 (257,419) 6,239 Provision for income taxes 35,173 1,012 29,622 1,747 -------------------- -------------------- Net income (loss) $(237,085) $ 2,601 $(287,041) $ 4,492 ==================== ==================== Basic net income (loss) per share $ (2.88) $ 0.03 $ (3.50) $ 0.06 Diluted net income (loss) per share $ (2.88) $ 0.03 $ (3.50) $ 0.05 Weighted average shares: Basic 82,412 80,010 82,040 79,889 Diluted 82,412 83,669 82,040 83,412
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 Page 2 INTEGRATED DEVICE TECHNOLOGY, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED; IN THOUSANDS)
Sep. 27, Mar. 29, 1998 1998 ------------------------- ASSETS Current assets: Cash and cash equivalents $128,976 $146,114 Short-term investments 73,946 74,481 Accounts receivable, net 48,499 68,840 Inventories, net 55,693 60,737 Prepayments and other current assets 36,954 74,431 ------------------------- Total current assets 344,068 424,603 Property, plant and equipment, net 307,952 475,440 Other assets 68,582 68,912 ------------------------- TOTAL ASSETS $720,602 $968,955 ========================= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 34,517 $ 57,572 Accrued compensation and related expenses 14,894 15,853 Deferred income on shipments to distributors 38,905 51,835 Other accrued liabilities 69,221 33,821 ----------------------- Total current liabilities 157,537 159,081 Convertible subordinated notes, net 184,055 183,756 Other liabilities 107,703 79,727 ------------------------ Total liabilities 449,295 422,564 Stockholders' equity: Preferred stock -- -- Common stock and additional paid-in capital 329,672 318,623 Retained earnings (deficit) (58,077) 228,964 Accumulated other comprehensive loss (288) (1,196) ------------------------ Total stockholders' equity 271,307 546,391 ------------------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $720,602 $968,955 ========================
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 Page 3 INTEGRATED DEVICE TECHNOLOGY, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED; IN THOUSANDS)
Six Months Ended -------------------------- Sep. 27, Sep. 28, 1998 1997 -------------------------- OPERATING ACTIVITIES: Net income (loss) $(287,041) $ 4,492 Adjustments: Depreciation and amortization 64,361 55,109 Loss on sale of property, plant and equipment 792 -- Deferred tax assets 29,145 -- Restructuring, asset impairment and other 179,428 -- Changes in assets and liabilities: Accounts receivable 20,341 13,593 Inventories 5,044 (4,517) Income tax receivable 7,309 33,613 Prepayments and other assets 5,805 365 Accounts payable (23,055) 3,269 Accrued compensation and related expenses (959) 947 Deferred income on shipments to distributors (12,930) 8,107 Other accrued liabilities 36,837 4,143 -------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 25,077 119,121 -------------------------- INVESTING ACTIVITIES: Purchases of property, plant and equipment (77,895) (73,540) Proceeds from sales of property, plant and equipment 1,354 192 Purchases of short-term investments (38,503) (16,119) Proceeds from sales of short-term investments 39,932 4,905 Purchases of equity investments -- (12,090) -------------------------- NET CASH USED FOR INVESTING ACTIVITIES (75,112) (96,652) -------------------------- FINANCING ACTIVITIES: Issuance of common stock, net 4,756 3,079 Proceeds from secured equipment financing 31,764 -- Payments on capital leases and other debt (3,623) (2,959) -------------------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 32,897 120 -------------------------- Net increase (decrease) in cash and cash equivalents (17,138) 22,589 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 146,114 155,149 -------------------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 128,976 $ 177,738 ==========================
The accompanying notes are an integral part of these condensed consolidated financial statements. 5 Page 4 INTEGRATED DEVICE TECHNOLOGY, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. In the opinion of Integrated Device Technology, Inc. ("IDT" or the "Company"), the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the financial information included therein. These financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company's Annual Report on Form 10-K for the year ended March 29, 1998. The results of operations for the three- and six-month periods ended September 27, 1998 are not necessarily indicative of the results to be expected for the full year. 2. Certain fiscal 1998 amounts have been reclassified to conform to the fiscal 1999 presentation. 3. In the first quarter of fiscal 1999, the Company recorded a $34.6 million charge, relating primarily to excess SRAM manufacturing equipment and technology licensing matters. The charge is reflected in the Condensed Consolidated Statements of Operations as follows: $28.9 million as cost of revenues, $5.5 million as research and development and $.2 million as general and administrative. The $28.9 million charge includes a provision of $15.1 million for writedown to fair market value of excess manufacturing equipment. Reflecting current economic conditions in the SRAM marketplace, which continues to experience declines in both demand and price, the Company identified specific items of manufacturing equipment which were excess to its needs. The carrying value of excess equipment was reduced to its estimated fair market value, based primarily on appraisals and estimates from third parties. As described in Note 4, time to liquidate surplus semiconductor equipment is uncertain. Also included in the $28.9 million charge is $10 million to settle certain patent claims against the Company. The $5.5 million charge reported in research and development expenses reflects the Company's narrowing the focus of its business development activities associated with the development of a graphics chip and a specialized logic chip. The Company discontinued these development efforts and provided for remaining payments required under technology license agreements and recognized other related costs. The Company also provided for other intellectual property-related matters. 4. In the second quarter of fiscal 1999, the Company recorded charges of $46.4 million for restructuring and $131.9 million for asset impairment and other which are specifically identified in the Condensed Consolidated Statements of Operations as a reduction in gross profit. The $46.4 million restructuring charge relates primarily to a provision for exit and closure costs associated with the San Jose, Calif. wafer fabrication facility, which the Board of Directors decided to close. Manufacturing activities in this facility are expected to cease by the end of 1998, at which time the Company plans to complete the termination of approximately 400 employees, primarily in manufacturing departments. IDT is pursuing the sale of surplus used equipment from the San Jose facility. However, as there is currently a significant oversupply of such equipment available for sale, IDT cannot determine the amount of time required to completely liquidate the surplus equipment. The Company expects annual cost savings of approximately $45 million as a result of these restructuring actions. 6 Page 5 The following table sets forth the Company's restructuring expense for the quarter ended September 27, 1998 and the reserve balance as of that date:
Q2 1999 Balance Expense Utilized Sep. 27, 1998 ------- ---------- ------------- Write-down of fixed assets $33,047 $(33,047) -- Severance and other employee related charges 2,620 (308) 2,312 Closure costs for manufacturing facility 10,717 (496) 10,221 ------- -------- ------- $46,384 $(33,851) $12,533 ======= ======== =======
The $131.9 million asset impairment and other charge relates primarily to an asset impairment reserve recorded against the manufacturing assets of IDT's eight-inch wafer fabrication facility in Oregon. The Company determined that due to excess industry capacity and low prices for semiconductor products manufactured in the Oregon facility, future undiscounted cash flows related to its wafer fabrication assets were insufficient to recover the carrying value of the assets. As a result, the Company wrote down these assets to estimated fair market value based primarily on appraisals and estimates from independent parties. Of the $131.9 million, $5.0 million is to settle certain patent claims against the Company. Additionally, the Company recorded a charge of $3.3 million relating primarily to retention costs for manufacturing and research and development staff employed at the San Jose fabrication facility which were recorded as cost of revenues and research and development expenses in the Condensed Consolidated Statements of Operations. These costs are being expensed ratably over the retention period of the employees. 5. Basic net income (loss) per share is based upon weighted-average common shares outstanding. Diluted net income (loss) per share is computed using the weighted-average common shares outstanding plus any potentially dilutive securities. Dilutive securities include stock options using the treasury stock method, and convertible debt using the if converted method. Following is a reconciliation of the numerators and denominators of the basic and diluted net income (loss) per share computations for the periods presented below: 7 Page 6
Three Months Ended Six Months Ended -------------------- -------------------- (in thousands except per Sep. 27, Sep. 28, Sep. 27, Sep. 28, share amounts) 1998 1997 1998 1997 -------------------- -------------------- Basic: Net income (loss)(numerator) $(237,085) $ 2,601 $(287,041) $ 4,492 =================== =================== Weighted average shares outstanding (denominator) 82,412 80,010 82,040 79,889 =================== =================== Net income (loss) per share $ (2.88) $ .03 $ (3.50) $ .06 =================== =================== Diluted: Net income (loss)(numerator) $(237,085) $ 2,601 $(287,041) $ 4,492 =================== =================== Weighted average shares outstanding 82,412 80,010 82,040 79,889 Net effect of dilutive stock options -- 3,659 -- 3,523 ------------------- ------------------- Total shares (denominator) 82,412 83,669 82,040 83,412 =================== =================== Net income (loss) per share $ (2.88) $ .03 $ (3.50) $ .05 =================== ===================
Options to purchase approximately 19.0 million shares were outstanding at September 27, 1998 (13.4 million at September 28, 1997) but have been excluded because they were antidilutive. 6. On November 2, 1998, IDT and Quality Semiconductor, Inc. ("QSI") announced the signing of a definitive agreement for QSI to be acquired by IDT through the merger of a new wholly owned subsidiary of IDT into QSI. Under the terms of the agreement, each issued and outstanding common share of QSI will be exchanged for .6875 shares of IDT Common Stock. The merger is planned to close during the fourth quarter of IDT's fiscal 1999 and is intended to be accounted for as a pooling of interests. 7. The Company adopted Statement of Financial Accounting Standards No. 130 ("SFAS No. 130"), "Reporting Comprehensive Income," as of the first quarter of fiscal 1999. SFAS No. 130 establishes new rules for the reporting and display of comprehensive income and its components. Adoption had no impact on the Company's net income (loss) or stockholders' equity. 8 Page 7 The components of comprehensive income (loss) were as follows:
Three months ended (in thousands) ---------------------- Sep. 27 Sep. 28 1998 1997 ---------------------- Net income (loss) $(237,085) $ 2,601 Currency translation adjustments 282 (697) Unrealized gain on available-for-sale investments 812 743 ---------------------- Comprehensive income (loss) $(235,991) $ 2,647 ====================== Six months ended (in thousands) ---------------------- Sep. 27 Sep. 28 1998 1997 ---------------------- Net income (loss) $(287,041) $ 4,492 Currency translation adjustments 14 (371) Unrealized gain on available-for-sale investments 894 897 ---------------------- Comprehensive income (loss) $(286,133) $ 5,018 ======================
The components of accumulated other comprehensive income (loss) were as follows:
Sep. 27 Mar. 29, (in thousands) 1998 1998 ---------------------- Cumulative translation adjustments $ (1,182) $ (1,196) Unrealized gain on available-for-sale investments 894 -- ---------------------- $ (288) $ (1,196) ======================
8. Inventories, net, consisted of the following:
Sep. 27 Mar. 29, (in thousands) 1998 1998 ---------------------- Raw materials $ 4,056 $ 6,647 Work-in-process 37,204 40,276 Finished goods 14,433 13,814 ---------------------- $ 55,693 $ 60,737 ======================
9 Page 8 9. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 ("SFAS No. 133"), "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes standards for accounting and reporting on derivatives and is effective for periods beginning after June 15, 1999. Early adoption is permitted. SFAS No. 133 requires that all derivatives be recognized in the balance sheet as assets or liabilities and measured at fair value. SFAS No. 133 also requires current recognition in earnings of changes in these fair values, depending on the intended use and designation of the derivative. The Company is currently evaluating the effects of SFAS No. 133 and has not determined its method or timing of adoption, nor the impact on its financial statements. However, the new requirement to report currency hedging derivatives at fair value could result in fluctuations in stockholders' equity. 10. On July 31, 1998, a lawsuit was filed by Lemelson Medical Education & Research Foundation, Limited Partnership ("plaintiff"), against the Company and 25 other corporate defendants. The lawsuit, which alleges that the defendants are infringing upon 16 patents issued to the plaintiff, was filed in the United States District Court for the District of Arizona. The plaintiff seeks an injunction and damages in an unspecified amount. In the opinion of management, the ultimate outcome of this litigation will not have a material adverse impact on the Company's results of operations or financial position. 10 Page 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS All references are to the Company's fiscal quarters ended September 27, 1998 ("Q2 1999"), September 28, 1997 ("Q2 1998"), June 28, 1998 ("Q1 1999") and June 29, 1997 ("Q1 1998"), unless otherwise indicated. Quarterly financial results may not be indicative of the financial results of future periods. All non-historical information contained in the following discussion constitutes forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements are not guarantees of future performance and involve a number of risks and uncertainties, including but not limited to: operating results, new product introductions and sales, including the IDT WinChip(TM) microprocessor, competitive conditions, capital expenditures and capital resources, cash flows, manufacturing capacity utilization, customer demand, customer inventory levels, protection of intellectual property in the semiconductor industry, and the risk factors set forth in the section "Factors Affecting Future Results." Future results may differ materially from such forward looking statements as a result of such risks. The Company undertakes no obligation to publicly release the results of any revisions to these forward-looking statements which may be made to reflect events or circumstances after the date hereof. HISTORICAL INFORMATION RELATING TO FISCAL 1999 RESTRUCTURING AND ASSET IMPAIRMENT AND OTHER CHARGES AND ACTIONS TAKEN In the first two quarters of fiscal 1999, IDT recorded $207.2 million in charges related to asset impairment and restructuring, which are specifically identified in the Condensed Consolidated Statements of Operations, and an additional $9.0 million of charges, which were recorded as operating expenses. These charges relate principally to closure of one of three wafer fabrication facilities located in the United States, reducing the carrying value of one of the remaining facilities, discontinuing research initiatives and costs associated with intellectual property matters. These charges are discussed below under the captions "Gross Profit," "Research and Development" and "Selling, General and Administrative." During the period from fiscal 1994 through fiscal 1996, IDT's sales volume grew significantly, from $330 million more than doubling to $680 million. The growth was principally based upon strong demand for SRAM products, especially cache memory products for use in personal computers. At the peak of demand for IDT's SRAM products, sales of SRAM and related products accounted for approximately 45% of IDT's revenues. As business conditions in the semiconductor industry improved through the mid-1990s, the Company took steps to significantly expand its manufacturing capacity. Most notably, the Company constructed the Oregon fabrication facility and the assembly and test facility located in Manila, the Philippines. During the period fiscal 1995 through fiscal 1998, IDT expended in excess of $700 million for acquisitions of property, plant and equipment. In addition to providing incremental manufacturing capacity, the Oregon facility provides the Company with advanced wafer fabrication technology and capability. However, the cost of such advanced wafer manufacturing technology and capability is significant. To recover such costs, semiconductor manufacturers must be able to amortize device design, 11 Page 10 equipment and facility acquisition costs over a significant volume of products whose selling price reasonably reflects the advanced level of technology employed in their design and manufacture. As IDT's additions to manufacturing capacity became available for use in fiscal 1997, business conditions in the memory sector of the semiconductor industry changed dramatically. Selling prices of industry standard SRAM components fell as much as 80% over an approximate 12 month period. The price decreases were the result of a significant increase in market supply of industry standard SRAM parts attributable to IDT's principally foreign competitors, such as Samsung, Winbond, UMC, other Taiwanese and Korean companies allocating increased capacity to SRAM products. Also, U.S. based companies with Taiwan- and Korean-sourced SRAM wafers from foundries such as TSMC provided additional product supply. These competitors employed market pricing strategies at a time when market demand slowed as customers reduced the level of inventories carried. As a result of the difficult operating conditions which have existed in the semiconductor industry for the past few years, and which intensified in the middle of calendar 1998, including excess product supply and low prices, IDT is consolidating and streamlining manufacturing operations within the Company, including closing its wafer fabrication facility located in San Jose, California. This operational decision primarily reflects industry oversupply conditions. The Company has moved away from dependence on industry standard products, plans to expand the range of its products manufactured in Oregon, and, as noted above, has taken active steps to increase the level of manufacturing facility utilization. However, the products historically manufactured in the Oregon facility and planned for the near term are principally SRAM and x86 microprocessor products (which x86 products represent a small percentage of IDT's total revenues). The pricing of these products in today's marketplace remains low. As a result of current low market prices, the cash flows generated by sales of products manufactured in Oregon are disproportionate to the cost of the facility and are significantly less than the cash flows generated by IDT's other comparable manufacturing activities. The Company performed an asset impairment review for the Oregon facility based upon IDT's operating conditions, and concluded that, despite the closure of its San Jose facility, IDT is still in a position of overcapacity. The impairment review revealed that currently projected production volumes and related cash flows from the Oregon facility would not be sufficient to recover the carrying value of that manufacturing facility. Therefore, in accordance with current accounting literature, IDT concluded that the carrying value of the Oregon manufacturing assets is impaired and has written down the carrying values of these assets to fair market value, as estimated by third parties with significant experience in marketing and selling used semiconductor equipment. As discussed below, the semiconductor industry is cyclical in nature, and while demand and prices for the products manufactured at the Oregon facility may improve, the timing and degree of any such recovery is uncertain. 12 Page 11 RESULTS OF OPERATIONS REVENUES Revenues for Q2 1999 and the six months ended September 27, 1998 were $130.6 million and $265.1 million, respectively. Sales for Q2 1999 decreased 2.9% from $134.5 million recognized in Q1 1999 and decreased 9.2% compared to revenues of $143.8 million for Q2 1998. Revenues of $265.1 million for the six-month period ended September 27, 1998 were 9.4% lower than the $292.7 million recognized in the comparable period of the prior fiscal year. When comparing revenues for Q2 1999 to Q1 1999, revenues from the sale of the Company's WinChip(TM) x86 microprocessors increased, and sales of SRAM memory products remained essentially unchanged. However, product sales volumes for other IDT products, which include communications memories, logic products and RISC microprocessors, decreased, primarily reflecting an ongoing period of product oversupply, related contraction of inventories held by customers, and continued economic uncertainty in the semiconductor marketplace in Asia. Net units shipped in Q2 1999 decreased approximately 6.4% and 9.0%, respectively, compared to Q1 1999 and Q2 1998. Net units shipped during the first six months of fiscal 1999 decreased 7.0% compared to the same period in fiscal 1998. Sales of WinChip microprocessors in Q2 1999 increased in relation to sales for all comparative periods. In addition to selling WinChip products in the United States, IDT has increased unit sales through product distribution channels in emerging markets such as those in Asia and Europe. The average selling price realized per unit decreased, reflecting what has become a very competitive marketplace for x86 microprocessors positioned at the low end of the product-performance range. For other IDT products, when comparing Q2 1999 to Q2 1998 sales, RISC microprocessor revenues increased, primarily because of greater sales to IDT's computer network infrastructure equipment customers. While communications memories, SRAM and logic revenues declined in Q2 1999 compared to Q2 1998, generally because of the semiconductor industry market conditions described above. Also during the intervening period, IDT effectively exited the market for personal computer SRAM cache memory. The factors described above resulting in decreased revenues in Q1 1999 and Q2 1999 are also the primary reasons revenue decreased during the first 6 months of fiscal 1999, when compared to the same period of fiscal 1998. As discussed below, the semiconductor marketplace is cyclical in nature. The Company believes revenues and costs associated with new products will increase in future quarters as the Company continues to execute product introduction strategies and overall levels of industry demand improve during the traditionally stronger fourth calendar quarter. In future quarters, excluding transaction related costs and potential costs to combine manufacturing operations, the merger of Quality Semiconductor with IDT is expected to benefit operating results. Information on risks associated with the expansion of IDT's product families is included in "Factors Affecting Future Results." - -------- (TM) WinChip and C6 are trademarks of Integrated Device Technology, Inc. All other brand names and products names are trademarks, registered trademarks or trade names of their respective holders. 13 Page 12 The semiconductor industry is highly cyclical and subject to significant downturns. Such downturns are characterized by diminished product demand, production over-capacity and accelerated average selling price erosion. The price the Company receives for its industry standard SRAM and other products is therefore dependent upon industry-wide demand and capacity, and such prices have been historically subject to rapid change. Low SRAM prices have adversely affected, and will likely continue to adversely affect, the Company's operating results. GROSS PROFIT In Q1 1999, the Company recorded a charge of $28.9 million which is specifically identified in the Company's Condensed Consolidated Statements of Operations as a reduction in gross profit. The $28.9 million charge relates primarily to excess SRAM manufacturing equipment ($18.9 million) and certain technology licensing matters ($10.0 million). The net carrying value of equipment before writedown was $17.4 million, and after writedown was $2.3 million. The portion of the charge which pertains to excess SRAM related equipment is associated with equipment which is no longer used in the Company's normal operations because of changes in demand in the semiconductor marketplace or changes in the Company's product strategy. The equipment related portion of the charge was computed as the difference between the net book value of the equipment and estimates of fair market value, as estimated by third parties with significant experience in marketing and selling used semiconductor equipment. As a result of the charge related to excess manufacturing equipment, IDT expects an immediate reduction in annual depreciation expense in future quarters of approximately $4 million. Additionally, the Company recorded a charge of $5.7 million relating primarily to discontinuing certain technology development initiatives, which have been classified as research and development expenses in the Company's Condensed Statements of Operations. In Q2 1999, the Company recorded non-recurring charges of $46.4 million for restructuring and $131.9 million for asset impairment and other which are specifically identified in the Company's Condensed Statements of Operations as a reduction in gross profit. The $46.4 million restructuring charge relates primarily to a provision for exit and closure costs associated with the San Jose, Calif. wafer fabrication facility. Included in this charge are $33 million for fabrication and assembly-and-test equipment, which was written down to liquidation value; severance and other employee related expenses of $2.6 million; and closure costs of $10.7 million. Closure costs of $10.7 million consist of $4.5 million in costs associated with de-installing equipment previously placed in service, which IDT expects to pay in Q3 1999; estimated costs of $3.3 million to decommission the facility, which are expected to be paid in Q4 1999 through Q1 2000; and contract cancellation costs of $2.9 million, which the Company expects to pay in Q1 2000. The $131.9 million asset impairment and other charge relates primarily to the asset impairment charge which reduced the carrying value of the manufacturing assets of the Oregon fabrication facility. Included in the charges is the writedown of equipment with a net carrying value of approximately $189 million before writedown and $62 million after writedown. Additionally, the Company recorded a charge of $3.3 million relating primarily to retention costs earned in Q2 1999 by manufacturing and research and development staff employed at the San Jose fabrication facility which were recorded as cost of revenues and research and development expenses in the Company's Condensed Statements of Operations. The Company expects annual cost savings of approximately $45 million as a result of the manufacturing restructuring action. The cost savings associated with the manufacturing restructuring are expected to be partially realized in the fourth quarter of fiscal 1999 and fully realized beginning in the first quarter of IDT's fiscal 2000. As a result of the asset impairment charge, which reduced the carrying value of manufacturing equipment, IDT expects an immediate reduction in annual depreciation expense in future quarters of approximately $25 million. Gross profit for Q2 1999 was ($137.7) million, including a $181.6 million charge for restructuring, asset impairment and other costs, compared to $55.2 million for Q2 1998. Excluding the $181.6 million in charges for restructuring, asset impairment and other, gross profit in Q2 1999 increased when compared to Q1 1999 from 30.7% to 33.1%. Excluding these charges, gross profit decreased by $11.9 million from $55.2 million, and gross margin decreased from to 33.1% from 38.4%, for Q2 1999 compared to Q2 1998. For the first 6 months of fiscal 1999, excluding restructuring, asset impairment and other related costs, gross margin also decreased when compared to the first 6 months of fiscal 1998. Excluding the charges, the decline in gross margin is associated with lower revenues, higher manufacturing costs and the fixed nature of many of the costs associated with semiconductor manufacturing facilities. In fiscal 1999, IDT planned to manufacture and sell greater 14 Page 13 volumes of its products. However, because of changes in marketplace demand, especially for WinChip microprocessors and continued weakness in SRAM markets, greater manufacturing volumes and sales revenues did not materialize. Also, costs associated with the eight-inch wafer fabrication facility in Oregon continued to adversely impact gross margin for the first half of fiscal 1999, as these costs were not fully absorbed by additional revenues. In order to improve gross margin, as outlined above, IDT is consolidating its wafer manufacturing facilities from three facilities to two. The Company expects that it will be able to produce sufficient volumes of products at its remaining wafer fabrication facilities to offset the product volumes currently manufactured at the facility which will be closed. Further, the Company believes that incremental available capacity, primarily at IDT's facility in Hillsboro, Oregon, together with available capacity at the Company's foundry partners, provide IDT with sufficient capacity to take advantage of improved business conditions when they occur. The Company also believes that the consolidation of production volumes will improve planned levels of capacity utilization. RESEARCH AND DEVELOPMENT Research and development ("R&D") expenses decreased by $3.0 million (7.6%) from Q1 1999 and increased by $5.8 million (19.0%) compared to Q2 1998. R&D costs for the 6 month period ended September 27, 1998 increased $15.4 million when compared to the same period in FY 1998. R&D expenses for Q1 1999 included $5.5 million in charges, primarily associated with discontinuing certain development efforts, severance and termination costs associated with development personnel and related payments under technology license agreements associated with such development efforts. Development efforts discontinued included a graphics chip and a specialized logic chip. Cost savings associated with discontinuing these development efforts are approximately $1 million per quarter and are expected to be fully realized by the fourth quarter of fiscal 1999. R&D expenses for Q2 1999 included $.6 million in costs, primarily associated with retention costs earned by research and development staff during Q2 1999 which are employed at the San Jose fabrication facility. Excluding the charges and related costs, when compared to Q1 1999, Q2 1999 R&D spending increased because of greater costs associated with product design initiatives and process R&D. With respect to process R&D, the Company allocates costs associated with its manufacturing facilities between cost of goods sold and process R&D based upon activities performed. Therefore, because of lower production volumes associated with reduced demand in Q1 1999 and relatively constant process R&D activity, the allocation of manufacturing costs to process R&D expense increased. The factors described above resulting in increased R&D costs in Q1 1999 and Q2 1999 are also the primary reasons R&D increased during the first 6 months of fiscal 1999, when compared to the same period of fiscal 1998. Management expects that in the coming quarters, R&D expense will decrease as the allocation of manufacturing costs associated with process R&D declines as a result of manufacturing facility consolidation. Current R&D activities include developing the next generation of WinChip microprocessors for use in personal computer applications, conducting research into applications of high-speed DRAM technology for the communications market, developing RISC microprocessors for primarily communications and embedded control applications, developing an advanced SRAM architecture that significantly improves performance of communications applications requiring frequent switches between reads and writes, expanding the logic product family, and developing a family of specialty memory products for the communications and networking markets. 15 Page 14 SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative ("SG&A") expenses decreased by $.8 million and increased by $5.7 million for Q2 1999 compared to Q1 1999 and Q2 1998, respectively. SG&A costs for the 6 month period ended September 27, 1998 increased $9.8 million when compared to the same period in FY 1998. When comparing Q2 1999 to Q2 1998, SG&A costs associated with marketing efforts for WinChip microprocessors and other products and costs associated with initiatives to implement and upgrade enterprise-wide management information systems, which are expected to increase the availability and quality of management information, both increased. The factors described above resulting in increased SG&A costs in Q1 1999 and Q2 1999 are also the primary reasons SG&A increased during the first 6 months of fiscal 1999, when compared to the same period of fiscal 1998. The Company expects that in the coming quarters, excluding the impact of merging Quality Semiconductor with IDT, recurring SG&A costs will remain relatively constant, except for costs such as sales commissions and bonus which will vary in relation to sales volumes. INTEREST EXPENSE Interest expense is primarily associated with the 5.5% Convertible Subordinated Notes, due in 2002, and $21.0 million of secured equipment financing agreements completed in September 1996, which amortize over the term of the financing agreements. Interest expense for Q2 1999 decreased by approximately $.2 million from $3.3 million for Q1 1999 and was essentially unchanged from Q2 1998. INTEREST INCOME AND OTHER, NET Interest income and other, net, was essentially flat in Q2 1999 compared to Q1 1999. Compared to Q2 1998, interest income and other, net, for Q2 1999 decreased by $1.2 million, primarily due to IDT's share of net losses from unconsolidated affiliates. TAXES The $35.2 million tax expense for Q2 1999 is primarily due to a reserve taken against the value of the Company's net deferred tax assets. For Q3 1999 and Q4 1999, management expects to incur no additional federal tax liability, because it anticipates a federal tax loss for the full year. Income taxes in state jurisdictions are not significant, principally due to IDT's projected FY 1999 loss for state income tax purposes. For the remainder of fiscal 1999, a small amount of foreign tax expense is expected, due to anticipated profits in certain of the Company's foreign subsidiaries. LIQUIDITY AND CAPITAL RESOURCES At September 27, 1998, cash and cash equivalents were $129.0 million, a decrease of $17.1 million from $146.1 million at March 29, 1998. The Company generated $25.1 million in cash from operating activities for the first six months of fiscal 1999, down from $119.1 million for the same period in fiscal 1998. During the first half of fiscal 1999, the Company's net cash used for investing activities was $75.1 million, including $77.9 million for capital expenditures. 16 Page 15 Cash provided by financing activities during the first six months of fiscal 1999 was $32.9 million as compared to $.1 million during the same period in fiscal 1998. The Company completed several equipment financing transactions during the first six months of fiscal 1999. The Company entered into capital leases under which it sold certain previously purchased semiconductor manufacturing equipment to leasing companies which leased the equipment back to IDT for use at the Oregon fabrication facility. These lease transactions generated $26.7 million in cash proceeds. The Company also entered into other capital leases for manufacturing equipment during this period. In total, the Company's lease obligations under capital leases increased by $31.8 million in connection with these transactions. During Q1 1999, under another leasing arrangement, equipment purchased for the Oregon fabrication facility with a net book value of $11.9 million at the time of the sale and leaseback transaction was sold to a leasing company and leased back for use at the Oregon facility under a lease classified as operating. The Company also entered into a $5.0 million secured loan arrangement which is collateralized by certain manufacturing assets. The Company is not required to maintain compliance with any financial covenants under any of these new financing and leasing arrangements. IDT anticipates capital expenditures of approximately $50 million during the remainder of fiscal 1999. The Company intends to finance these expenditures primarily through existing cash and investments. The Company may also investigate other financing alternatives, depending on whether available terms are favorable to the Company. The Company believes that existing cash and cash equivalents, cash flow from operations and existing credit facilities will be sufficient to meet its working capital, mandatory debt repayment and anticipated capital expenditure requirements for the next twelve months. However, there can be no assurance that the Company will not be required to seek other financing sooner or that such financing, if required, will be available on terms satisfactory to the Company. If the Company is required to seek additional financing sooner, the unavailability of financing on terms satisfactory to IDT could have a material adverse effect on the Company. SUBSEQUENT EVENTS In September 1998, the Company's Board of Directors authorized a repurchase program whereby up to ten million shares of IDT common stock may be purchased in the open market from time to time. No shares were repurchased during Q2 1999. The Company initiated buyback activity in Q3 1999 and repurchased approximately 900,000 shares at an approximate aggregate cost of $4.6 million as of the date of this filing. On November 2, 1998, IDT and Quality Semiconductor, Inc. ("QSI") announced the signing of a definitive agreement for QSI to be acquired by IDT. Under the terms of the agreement, each issued and outstanding common share of QSI will be exchanged for .6875 shares of IDT Common Stock. The merger is planned to close during the fourth quarter of IDT's fiscal 1999 and is intended to be accounted for as a pooling of interests. On November 6, 1998, IDT announced that its Board of Directors had terminated the authorization to repurchase shares. The decision to terminate this program was a result of the Securities and Exchange Commission's position on share repurchase programs in Staff Accounting 17 Page 16 Bulletin 96 (SAB 96). Specifically, under SAB 96 there are circumstances where companies that have ongoing stock repurchase programs do not have the ability to employ the pooling-of-interest accounting method when making acquisitions. Continuing the repurchase program would restrict IDT's ability to utilize pooling of interest accounting for the merger with Quality Semiconductor and could restrict IDT's future ability to pursue the full range of strategic business development opportunities in which the Company may engage to further enhance its market position. FACTORS AFFECTING FUTURE RESULTS The preceding discussion contains forward-looking statements, which are based on management's current expectations. These include, in particular, the statements related to revenues and gross profit, R&D and SG&A expenses and activities, interest expense, interest income and other, taxes, capital spending and financing transactions, as well as statements regarding successful development and market acceptance of new products, industry conditions and demand, effects of consolidation of production in Oregon, capacity utilization and the acquisition of QSI. Actual results may differ materially. The Company's results of operations and financial condition are subject to the following risk factors: FLUCTUATIONS IN OPERATING RESULTS. IDT's operating results have been, and in the future may be, subject to fluctuations due to a wide variety of factors including the timing of or delays in new product and process technology announcements and introductions by the Company or its competitors; competitive pricing pressures, particularly in the SRAM commodity semiconductor memory and x86 microprocessor markets; fluctuations in manufacturing yields; changes in the mix of product sold; availability and costs of raw materials; the cyclical nature of the semiconductor industry; industry-wide wafer processing capacity; economic conditions in various geographic areas; and costs associated with other events, such as underutilization or expansion of production capacity, intellectual property disputes, or other litigation. Additionally, many of the preceding factors also impact the recoverability of the cost of manufacturing, taxes and other assets, and as business conditions change, future writedowns or abandonment of these assets may occur. Further, there can be no assurance that the Company will be able to compete successfully in the future against existing or potential competitors or that the Company's operating results will not be adversely affected by increased competition. CYCLICALITY OF THE SEMICONDUCTOR INDUSTRY. The semiconductor industry is highly cyclical. Market conditions characterized by excess supply of SRAMs relative to demand and resultant pricing declines have occurred in the past and may occur in the future. Although some competitors have made adjustments to the rate at which they will implement capacity expansion programs, the Company is unable to accurately estimate the amount of worldwide production capacity dedicated to industry-standard commodity SRAM products which it produces. A material increase in industry-wide production capacity, shift in industry capacity toward products competitive with the Company's products, reduced demand, or other factors could result in material declines in product pricing and could especially adversely affect that portion of the Company's operating results derived from the sale of industry-standard products. The Company seeks to manage costs, but there can be no assurance that these efforts will be sufficient to return to profitability. 18 Page 17 The Company ships a substantial portion of its products in the last month of a quarter. If anticipated shipments in any quarter do not occur, the Company's operating results for that quarter could be adversely affected. In addition, a substantial percentage of the Company's products, which include SRAM and x86 microprocessor products, are incorporated into computer and computer-related products, which have historically been characterized by significant fluctuations in demand. Demand for certain of the Company's products is dependent upon growth in the communications market. Any slowdown in the computer and related peripherals or communications markets could adversely affect the Company's operating results. In order to achieve more full and effective use of the facilities, the Company continues to install new equipment at all of its fabrication and assembly and test facilities. Additional planned production capacity and yield improvements by the Company's competitors could dramatically increase the worldwide supply of products which compete with the Company's products and could, if customer demand does not absorb increased product quantities, create further downward pressure on pricing. RISKS ASSOCIATED WITH EXPANSION OF PRODUCT FAMILIES - X86 MICROPROCESSORS. The Company commenced shipments of the WinChip microprocessor, IDT's first member of its x86 microprocessor product family in the third quarter of fiscal 1998. This product represents the Company's first offering to the PC microprocessor market, which is characterized as a large market dominated by Intel Corporation ("Intel"), with a very limited number of other competitors. IDT's success in competing in this market, and therefore the financial results associated with selling products to this market, are subject, but not limited to, the following significant risks and uncertainties: Competition. Intel holds a dominant position in the market for PC microprocessors. Intel has held its dominant position over all other x86 microprocessor competitors for a substantial period of time, and has significantly greater financial, technical, manufacturing and marketing strength than IDT does. Currently, Intel's dominant market position allows it to set and control x86 microprocessor standards and, therefore, dictate many aspects of the products that PC manufacturers require in this market. In addition, IDT's x86 microprocessor products are currently targeted at the low cost desktop and mobile product categories of the microprocessor market. Intel also offers products which are purchased by PC manufacturers in these market categories. Intel's financial strength and market dominance have enabled it to reduce prices on its microprocessor products within a short period of time following their introduction, which reduces the margins and profitability of its competitors. Further, Intel's marketing resources are far greater than IDT's. Therefore, Intel's pricing and marketing strategies in the categories of the microprocessor market targeted by IDT significantly impact IDT's efforts to serve this market and, therefore, IDT's results of operations. In order for customers to purchase IDT's x86 microprocessors, IDT's products must be compatible with other components supplied to PC manufacturers such as core-logic chip sets, motherboards, basic input/output system (BIOS) software and others which are manufactured or produced by other companies, including Intel and companies in which Intel has strategic investments. In addition, these companies are able 19 Page 18 to produce chip sets, motherboards, BIOS software and other components to support each new generation of Intel's microprocessors only to the extent that Intel makes its related proprietary technology available. New versions of microprocessor products that Intel sells are available primarily in the form of a chip module that is not compatible with "Socket 7" motherboards. Therefore, Intel has reduced and may cease support for the Socket 7 motherboard infrastructure. Because IDT's processor is designed to be Socket 7 compatible, and will not work with motherboards designed for Intel's new chip module, should IDT and other companies serving the x86 microprocessor market not be successful in offering products which extend the life of the Socket 7 infrastructure, IDT would be required to expend potentially significant resources to redesign its microprocessor product offerings. There can be no assurance that the Company would be successful in such efforts. The market for x86 microprocessors is currently characterized by short product life cycles, rapid decreases in ASP's, and migration to increasingly higher performance microprocessors. Failure by IDT to offer WinChip microprocessors in sufficient quantities and with the speed and other performance characteristics desired by customers could adversely impact the Company's results of operations. In addition to Intel, AMD and National Semiconductor's Cyrix subsidiary also currently offer commercial quantities of x86 microprocessors for sale. From time to time, intellectual property rights disputes have arisen between companies competing in the x86 microprocessor markets (See Intellectual Property Risks discussion below). Manufacturing. The pace at which IDT is able to enter its target market category for x86 microprocessors depends, in part, on how quickly it is able to ramp production of its microprocessor products in its wafer fabrication and assembly and test facilities. Before fiscal 1998, the Company had not previously manufactured x86 microprocessors and has processed only limited quantities of x86 microprocessors to date. Therefore, as production volumes of x86 microprocessors increase, the Company could encounter unexpected production problems or delays as a result of, among other things, changes required to process technologies, product design limitations, installation of equipment, and development of programs and methodologies which test overall product quality. If IDT is unable to ramp production of its x86 microprocessor successfully, the Company's operating results would be adversely affected. As described above, in fiscal 1998, IDT contracted with IBM for x86 microprocessor wafer manufacturing services using IBM's CMOS process technology. As IDT increases the number of products offered within the WinChip family of microprocessors and should demand for these products increases, IDT may begin to utilize IBM's manufacturing services to increase the available volume of WinChip microprocessors. The terms and conditions of the IBM manufacturing services agreement require IDT to forecast in advance production quantities that it will purchase and, once production quantities are ordered, the contract limits IDT's ability to change desired quantities of IBM manufactured products. Products purchased under the IBM manufacturing services agreement must meet certain agreed to acceptance criteria. However, these acceptance criteria do not include the number of usable WinChip processors per wafer nor the speed at which they will operate. Should IDT not accurately forecast the demand for IBM manufactured WinChip products, or should the number of good WinChip processors per IBM manufactured wafer and the speed at which they operate not meet or exceed these and other characteristics of IDT manufactured products, IDT's results of operations will be adversely impacted. 20 Page 19 Compatibility With Software and Performance Certifications. IDT has obtained WinChip certifications from Microsoft Corp. and other appropriate certifications from recognized testing organizations. Failure to obtain and maintain such certifications for future microprocessor products could substantially impair the Company's ability to market and sell its future x86 products. PC Market. Because IDT's target market for its x86 microprocessor product is initially limited to certain segments of the PC industry, the growth and acceptance of the product is closely tied to trends in and growth of the PC industry. The Company believes that PC manufacturers will continue their trend towards accepting and using microprocessor products manufactured by companies other than Intel and that generally the market for PCs and related components will continue to grow. However, should these industry trends and growth patterns not occur or IDT not be able to produce products which meet customers needs, for whatever reason, IDT's ability to sell x86 microprocessor products would be impaired. Rights of Others. In exchange for payments towards product development costs, IDT licensed the right to make, use and sell the WinChip C6(TM) microprocessor to a third party. Thus, the Company may face competition from the third party in the future. Future Products. IDT's ability to bring future x86 products to market depends on several primary factors including the following three: First, it must be able to finance such future development. Second, to compete with Intel and other competitors in the market for future generation x86 microprocessors, IDT must be able to design and develop the microprocessors themselves, and must ensure they can be used in PC platforms, including motherboards, designed to support future Intel or other microprocessors. Third, a failure, for whatever reason, of the designers and producers of motherboards, chip sets and other system components to support IDT's x86 microprocessor offerings, including Socket 7 compatibility, would limit IDT's ability to sell products to the PC market. MANUFACTURING RISKS. Historically, the Company has utilized subcontractors for the majority of its incremental assembly requirements, typically at higher costs than its own Malaysian and Philippines assembly and test operations. The Company expects to continue utilizing subcontractors extensively to supplement its own production volume capacity. Due to production lead times, any failure by the Company to adequately forecast the mix of product demand could adversely affect the Company's sales and operating results. The Company is increasing the production capacity of its Oregon facility to manufacture IDT WinChip products and absorb the production volumes from its San Jose wafer fabrication facility, which the Company plans to close. This capacity expansion program in Oregon faces a number of substantial risks including, but not limited to, equipment delays or shortages, power interruptions or failures, and manufacturing start-up or process problems. From time to time, the Company has experienced production difficulties that have caused delivery delays and quality problems. The Company could experience manufacturing problems and product delivery delays in the future as a result of, among other things, changes to its process technologies, and ramping production and installing new equipment at its facilities, including the facility in Oregon. 21 Page 20 The Company's older wafer fabrication facilities are located relatively near each other in Northern California. If the Company were unable to use these facilities, as a result of a natural disaster or otherwise, the Company's operations would be materially adversely affected until the Company was able to obtain other production capability. The Company does not carry earthquake insurance on its facilities, as adequate protection is not offered at economically justifiable rates. The Company's capacity additions have resulted in a significant increase in fixed and variable operating expenses which may not be fully offset by additional revenues for some time. Historically, the Company has expensed the operating expenses associated with bringing a new fabrication facility to commercial production status as R&D in the period such expenses were incurred. However, as commercial production at a new fabrication facility commences, the operating costs are classified as cost of revenues, and the Company begins to recognize depreciation expense relating to the facility. Accordingly, as the Oregon fabrication facility now contributes to revenues, the Company recognizes substantial operating expenses associated with the facility as cost of revenues, which has reduced gross margins. As commercial production continues in fiscal 1999, the Company anticipates incurring substantial additional operating costs and depreciation expenses relating to this facility. Accordingly, if revenue levels do not increase sufficiently to offset these additional expense levels, or if the Company is unable to achieve gross margins from products produced at the Oregon facility that are comparable to the Company's current products, the Company's future results of operations could be adversely impacted. The Company has announced plans to improve its operating results through consolidation of certain manufacturing and other activities, together with headcount reductions and other actions. The expected cost savings from these plans might not be sufficient to return the Company to profitability. DEPENDENCE ON NEW PRODUCTS. New products and process technology costs associated with the Oregon wafer fabrication facility will continue to require significant R&D expenditures. However, there can be no assurance that the Company will be able to develop and introduce new products in a timely manner, that new products will gain market acceptance or that new process technologies can be successfully implemented. If the Company is unable to develop new products in a timely manner, and to sell them at gross margins comparable to the Company's current products, its future results of operations could be adversely impacted. DEPENDENCE ON LIMITED SUPPLIERS. The Company's manufacturing operations depend upon obtaining adequate raw materials on a timely basis. The number of vendors of certain raw materials, such as silicon wafers, ultra-pure metals and certain chemicals and gases, is very limited. In addition, certain packages used by the Company require long lead times and are available from only a few suppliers. From time to time, vendors have extended lead times or limited supply to the Company due to capacity constraints. The Company's results of operations would be adversely affected if it were unable to obtain adequate supplies of raw materials in a timely manner or if there were significant increases in the costs of raw materials. Historically, IDT has been significantly dependent on the design capabilities of Quantum Effect Design, Inc. ("QED"), an equity affiliate of the Company, for the design and development of derivatives of 64-bit MIPS(R) RISC-based microprocessors. Currently there are no development contracts in effect between QED and IDT, and the Company is now 22 Page 21 designing and developing derivatives of MIPS RISC-based microprocessors in-house as necessary to supplement its in-house design capabilities. From time to time, IDT may contract with third party semiconductor designers other than QED. As with all new products, there is significant risk that the Company or its contractors will not do so successfully. See "Business -- Products and Markets" and "-- Research and Development." CAPITAL NEEDS. The semiconductor industry is extremely capital intensive. To remain competitive, the Company must continue to invest in advanced manufacturing and test equipment. The Company expects to expend approximately $50 million for capital additions during the remaining two quarters of fiscal 1999, and anticipates significant continuing capital expenditures, especially in connection with the introduction of products for the WinChip microprocessor family, in the next several years. The Company could be required to seek financing to satisfy its cash and capital needs, and such financing might not be available on terms satisfactory to the Company. If such financing is required and if such financing is not available on terms satisfactory to the Company, its operations could be materially adversely affected. INTELLECTUAL PROPERTY RISKS. The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights, which have resulted in significant and often protracted and expensive litigation. In recent years, there has been a growing trend by companies to resort to litigation to protect their semiconductor technology from unauthorized use by others. The Company in the past has been involved in patent litigation, which adversely affected its operating results. Although the Company has obtained patent licenses from certain semiconductor manufacturers, the Company does not have licenses from a number of semiconductor manufacturers who have a broad portfolio of patents. The Company has been notified that it may be infringing on patents issued to certain semiconductor manufacturers and other parties and is currently involved in several license negotiations. There can be no assurance that additional claims alleging infringement of intellectual property rights will not be asserted in the future. The intellectual property claims that have been made or that may be asserted against the Company could require that the Company discontinue the use of certain processes or cease the manufacture, use and sale of infringing products, to incur significant litigation costs and damages and to develop non-infringing technology. The Company might not be able to obtain such licenses on acceptable terms or to develop non-infringing technology. Further, the failure to renew or renegotiate existing licenses on favorable terms, or the inability to obtain a key license, could have a material adverse effect on the Company. RISKS OF INTERNATIONAL OPERATIONS. A substantial percentage of the Company's revenues are derived from non-U.S. sales. In addition, the Company's offshore assembly and test operations incur payroll, facilities and other expenses in local currencies. Accordingly, movements in foreign currency exchange rates, such as those seen recently in the Far East, can impact both pricing and demand for the Company's products as well as its cost of goods sold. The Company's offshore operations and export sales are also subject to risks associated with foreign operations, including political instability, currency controls and fluctuations, changes in local economic conditions and import and export controls, as well as changes in tax laws, tariffs and freight rates. Contract pricing for raw materials used in the fabrication and assembly processes, as well as for subcontract assembly services, can be impacted by currency exchange rate fluctuations. 23 Page 22 ENVIRONMENTAL RISKS. The Company is subject to a variety of regulations related to hazardous materials used in its manufacturing process. Any failure by the Company to control the use of, or to restrict adequately the discharge of, hazardous materials under present or future regulations could subject it to substantial liability or could cause its manufacturing operations to be suspended. VOLATILITY OF COMMON STOCK AND NOTES PRICES. The Company's Common Stock and Convertible Subordinated Notes ("Notes") have experienced substantial price volatility. Such volatility may occur in the future, particularly as a result of quarter-to-quarter variations in the actual or anticipated financial results of the Company, the companies in the semiconductor industry or in the markets served by the Company. In addition, announcements by the Company or its competitors regarding new product introductions. The stock market has experienced extreme price and volume fluctuations that have affected the market price of many technology companies' stock in particular. These factors may adversely affect the price of the Common Stock and Notes. IMPACT OF YEAR 2000 ON THE COMPANY'S OPERATIONS Year 2000 Problem Defined. In brief, the Year 2000 problem is a programming problem found in many computer applications which conform to older commonly accepted standards. These applications might not function properly after December 31, 1999 or after the start of a company's fiscal year 2000. The problem dates back to the days when computer memory was limited and data storage was expensive. To save space, some dates are stored using only two digits (1998 is stored as 98). This poses no problem when the "missing" digits are all the same (e.g. 19). However, when two dates are compared, used in a calculation or sorted and the dates span the January 1, 2000 boundary, problems can occur. For example, 1999 is earlier than 2000, but without the first two digits, the result would be that 00 is earlier than 99. The fact that most business software is heavily dependent on dates means the problem is widespread. Some systems will fail in very visible and obvious ways, but others will continue to process, producing erroneous results which might not surface until later. The longer it takes before these problems are found, the more difficult, and costly, they will be to correct. All aspects of operations at any company could be impacted, from financial to shipping, and even such areas as elevators and security systems can be affected. The Company utilizes numerous software programs throughout its operations which include dates and make date-sensitive calculations based on two-digit fields which are assumed to begin with the year 1900. Software programs written based on this assumption are vulnerable, as the year 2000 approaches, to miscalculations and other operational errors which may be significant to their overall effectiveness. In addition, the Company relies upon products and information from critical suppliers, large customers and other outside parties, in the normal course of business, whose software programs are also subject to the same problem. Should miscalculations or other operational errors occur as a result of the Year 2000 issue, the Company or the parties on which it depends may be unable to produce reliable information or process routine transactions. Furthermore, in the worse case, the Company or the parties on which it depends may, for an extended period of time, be incapable of conducting critical business activities, which include but are not limited to, manufacturing and shipping products, invoicing customers and paying vendors. 24 Page 23 IDT's Approach. In October 1997, IDT engaged the services of Keane, Inc., a software services firm with over 30 years of relevant experience, to assist in defining IDT's approach. To date, the Company has paid approximately $165,000 in consulting fees to Keane. The methodology IDT is using consists of the following five phases: o Inventory - In this initial phase, an inventory is taken of all software and hardware that may be affected by the Year 2000 problem. o Impact Assessment - In the second phase, the impact of the Year 2000 problem is assessed for the items identified in the Inventory phase. The assessment includes estimates of how large the impact really is, along with rough estimates for fixing the problem. o Strategy Development and Confirmation - Using the information from the previous two steps, IDT develops and maintains a strategy for each affected item. This phase includes the development of any contingency plans that may be required to mitigate IDT' s risk in a particular area. o Remediation Plan - In this phase, fixes necessary to bring hardware and software into Year 2000 compliance are defined. This may include code modifications, software upgrades, or hardware upgrades. o Remediation and Testing - In this phase, Year 2000 affected items are remediated and tested to verify their proper operation into the Year 2000 and beyond. IDT's rule is that any item in the critical business path must be tested. The goal is to complete all initial testing by December 31, 1998. Once initial testing is complete, there will be an ongoing process of remediation followed by testing until all testing is completed. The target date for all testing to be completed is June 1, 1999. The Company has completed the Inventory, Impact Assessment, Strategy Development and Confirmation and Remediation Plan phases of its Year 2000 plan. The Remediation and Testing phase is in process as of the date of this filing. IDT Products. The Company has completed an initial assessment of the extent to which Year 2000 issues may be incorporated into products which it sells to its customers. It did not find any Year 2000 related issues in products which IDT sells to customers. IDT Business Partners. The Company has contacted all of its major suppliers and other critical business partners in an effort to identify and mitigate Year 2000 matters originating from third parties which may adversely affect the Company. Contingency plans, if required, will be developed for transactions with suppliers that appear to be lagging with their Year 2000 readiness programs. This may include replacing these suppliers. The Company is currently reviewing supplier responses and is obtaining additional information. IDT Business Systems. Based on the Company's continuing assessment, IDT needs to replace or materially modify many of its software applications, including those critical to the Company's normal operations, in order to both meet the Company's business requirements and avoid significant Year 2000 issues. The Company is in the process of installing business and planning software licensed from SAP America, Inc. and i2 Technologies, Inc. With the installation of these software systems, and upgrades to a small number of in-house developed legacy software applications, the Company 25 Page 24 believes its critical business systems will be Year 2000 compliant. In February 1999, the Company expects to bring the first portion of the SAP implementation on-line. At that time, it will evaluate the need for contingency plans. Manufacturing Systems. Each manufacturing site has taken an inventory of its equipment and is working closely with the equipment vendors regarding Year 2000 issues. The Company is awaiting software and/or hardware upgrades from its vendors. It is the Company's goal to have all equipment compliant by June 1999. Contingency plans include such techniques as rolling back the date on equipment and custom upgrades and interfaces. By the year 2000, over a five-year period, the Company will have replaced substantially all of its enterprise wide systems. The Company has not allocated a portion of the total project cost to the Year 2000 issue. While the Company continues to monitor its system implementation costs, IDT does not believe the incremental project cost associated with Year 2000 compliance to be material, as this feature is included with software purchased by the Company to satisfy its business needs. There can be no assurance that all critical Year 2000 problems have or will be identified or that the Company will be able to procure all of the resources necessary to replace all critical Year 2000-deficient software applications on a timely basis. In addition, the critical Year 2000-deficient software programs of the parties on which the Company depends might not be converted on a timely basis or could be converted to systems which are incompatible with the Company's systems. 26 Page 25 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On July 31, 1998, a lawsuit was filed by Lemelson Medical Education & Research Foundation, Limited Partnership ("plaintiff"), against the Company and 25 other corporate defendants. The lawsuit, which alleges that the defendants are infringing upon 16 patents issued to plaintiff, was filed in the United States District Court for the District of Arizona, case no. 98 1413PHXPGR. In the lawsuit, plaintiff seeks an injunction and damages in an unspecified amount. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On August 27, 1998, the Company held its 1998 Annual Meeting of Stockholders. On the record date of July 1, 1998, 82,118,047 shares of the Company's Common Stock were issued, outstanding and entitled to vote. Tabulated proxies at the meeting represented 72,230,645, or 88.0%, of the total eligible shares. Voting results of the proposals presented were as follows: (1) Proposal I - To elect two Class II directors for a term to expire at the 2001 Annual Meeting of Stockholders: Name Votes For Authority Withheld --------------------------------------------------------------------- Federico Faggin 70,603,185 1,627,460 John C. Bolger 70,703,693 1,526,952 (2) Proposal II - To approve an amendment to the Company's 1994 Stock Purchase Plan to increase the number of shares reserved for issuance thereunder from 5,050,000 to 7,000,000: Votes For Votes Against Votes Abstained Non-Votes --------------------------------------------------------------------- 63,864,483 7,906,765 459,397 0 (3) Proposal III - To ratify the appointment of PricewaterhouseCoopers LLP as independent accountants of the Company for fiscal 1999: Votes For Votes Against Votes Abstained Non-Votes --------------------------------------------------------------------- 71,609,465 339,829 281,351 0 27 Page 26 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibit is filed herewith:
Exhibit No. Description ----------- ----------- 27* Financial Data Schedule
- --------- *Previously filed. (b) Reports on Form 8-K: No reports have been filed on Form 8-K during this quarter. 28 Page 27 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. INTEGRATED DEVICE TECHNOLOGY, INC. Date: March 16, 1999 /s/ Leonard C. Perham --------------------------------------- Leonard C. Perham Chief Executive Officer (duly authorized officer) Date: March 16, 1999 /s/ Alan F. Krock --------------------------------------- Alan F. Krock Vice President, Chief Financial Officer (principal accounting officer) 29 Page 28 INDEX TO EXHIBITS
Exhibit No. Description ----------- ----------- 27* Financial Data Schedule
- --------- *Previously filed. -----END PRIVACY-ENHANCED MESSAGE-----