-----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, K9w4gkOeBBrzLoURVnDnI04dwuCMHXOrZrU5hVJPUcWB30NiCX6hq5+r38euOWlo ME7g9TBDaXOLGhx9LanJVw== 0000891618-99-000616.txt : 19990217 0000891618-99-000616.hdr.sgml : 19990217 ACCESSION NUMBER: 0000891618-99-000616 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990216 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTEGRATED SILICON SOLUTION INC CENTRAL INDEX KEY: 0000854701 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 770199971 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-23084 FILM NUMBER: 99540893 BUSINESS ADDRESS: STREET 1: 2231 LAWSON LANE CITY: SANTA CLARA STATE: CA ZIP: 95054-3311 BUSINESS PHONE: 4085880800 MAIL ADDRESS: STREET 1: 680 ALMANOR AVE CITY: SUNNYVALE STATE: CA ZIP: 94086 10-Q 1 FORM 10-Q DATED 12/31/1998 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 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 number 000-23084. INTEGRATED SILICON SOLUTION, INC. Delaware 77-0199971. - ------------------------------- ----------------- (State or other jurisdiction of (I.R.S Employer incorporation or organization) Identification No.) 2231 Lawson Lane, Santa Clara, California 95054. - ----------------------------------------- ----------------- (Address of principal executive offices) zip code Registrant's telephone number, including area code (408) 588-0800. --------------- 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 as of February 5, 1999 was 19,566,863 2 INTEGRATED SILICON SOLUTION, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)
Three Months Ended December 31, -------------------------- 1998 1997 -------- -------- (Unaudited) Net sales $ 26,801 $ 39,414 Cost of sales 22,796 30,218 -------- -------- Gross Profit 4,005 9,196 -------- -------- Operating Expenses: Research and development 5,773 7,401 Selling, general and administrative 3,622 4,650 In-process technology charge -- 7,078 -------- -------- Total operating expenses 9,395 19,129 -------- -------- Operating loss (5,390) (9,933) Other income, net 1,586 255 -------- -------- Loss before income taxes and minority interest (3,804) (9,678) Provision for income taxes 633 58 -------- -------- Net loss before minority interest (4,437) (9,736) Minority interest in net loss of consolidated subsidiary (472) -- -------- -------- Net loss $ (3,965) $ (9,736) ======== ======== Basic and diluted net loss per share $ (0.20) $ (0.53) ======== ======== Shares used in per share calculation 19,418 18,199 ======== ========
See accompanying notes to condensed consolidated financial statements. 3 INTEGRATED SILICON SOLUTION, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)
December 31, September 30, 1998 1998 --------- --------- (unaudited) (1) ASSETS Current assets: Cash and cash equivalents $ 13,354 $ 27,776 Restricted cash -- 333 Short-term investments 7,700 7,800 Accounts receivable 10,646 19,069 Inventories 30,620 46,484 Other current assets 9,506 4,938 --------- --------- Total current assets 71,826 106,400 Property, equipment, and leasehold improvements, net 5,657 44,316 Other assets 63,491 51,452 --------- --------- Total assets $ 140,974 $ 202,168 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable $ 100 $ 18,325 Accounts payable 34,641 40,642 Accrued compensation and benefits 1,887 2,945 Accrued expenses 7,587 8,036 Income tax payable 477 524 Current portion of long-term obligations -- 3,339 --------- --------- Total current liabilities 44,692 73,811 Income tax payable - non-current 4,996 4,996 Long-term obligations -- 12,127 Minority interest in consolidated subsidiary -- 20,314 Stockholders' equity: Preferred stock -- -- Common stock 2 2 Additional paid-in capital 118,140 116,199 Accumulated deficit (22,306) (18,341) Cumulative translation adjustment (4,465) (6,787) Unearned compensation (85) (153) --------- --------- Total stockholders' equity 91,286 90,920 --------- --------- Total liabilities and stockholders' equity $ 140,974 $ 202,168 ========= =========
(1) Derived from audited financial statements. See accompanying notes to condensed consolidated financial statements. 4 INTEGRATED SILICON SOLUTION, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands)
Three Months Ended December 31, ------------------------- 1998 1997 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES Net Income (loss) $ (3,965) $ (9,736) In-process technology charge -- 7,078 Gain on partial sale of ISSI-Taiwan (1,211) -- Other charges to net income (loss) not affecting cash 1,297 1,715 Net effect of changes in current and other assets and current liabilities (503) 4,508 -------- -------- Cash provided by (used in) operating activities (4,382) 3,565 CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures (2,250) (5,043) Purchases of available-for-sale securities (13,900) (20,350) Sales of available-for-sale securities 14,000 33,300 Partial sale of ISSI-Taiwan 4,957 -- Deconsolidation of ISSI-Taiwan (12,818) -- Investment in Wafertech, LLC -- (12,480) Investment in UICC -- (4,730) Investment in NexFlash (1,000) -- Investment in DynaChip (500) -- Acquisition of Nexcom -- (869) -------- -------- Cash used in investing activities (11,511) (10,172) CASH FLOWS FROM FINANCING ACTIVITIES Borrowings under notes payable and long-term obligations 33,435 14,508 Proceeds from issuance of common stock 2 165 Principal payments on notes payable and long-term obligations (32,293) (15,876) Increase in restricted cash -- (1,100) -------- -------- Cash provided by (used in) financing activities 1,144 (2,303) -------- -------- Effect of exchange rate changes on cash and cash equivalents 327 (1,420) -------- -------- Net increase (decrease) in cash and cash equivalents (14,422) (10,330) Cash and cash equivalents at beginning of period 27,776 22,334 -------- -------- Cash and cash equivalents at end of period $ 13,354 $ 12,004 ======== ========
See accompanying notes to condensed consolidated financial statements. 5 INTEGRATED SILICON SOLUTION, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION The accompanying condensed financial statements include the accounts of Integrated Silicon Solution, Inc. (the "Company") and its consolidated majority owned subsidiaries (See note 14), after elimination of all significant intercompany accounts and transactions and have been prepared in accordance with generally accepted accounting principles for interim financial information and with Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included. Operating results for the three months ended December 31, 1998 are not necessarily indicative of the results that may be expected for the year ending September 30, 1999. 2. CONCENTRATIONS Sales to one customer accounted for approximately 15% and 18% of total net sales for the quarters ended December 31, 1998 and December 31, 1997, respectively. The Company uses ISSI-Taiwan for coordinating wafer purchases, assembly, and testing for substantially all its inventory. 3. CASH, CASH EQUIVALENTS, RESTRICTED CASH AND SHORT-TERM INVESTMENTS Cash, cash equivalents, restricted cash, and short-term investments consisted of the following:
(In thousands) December 31 September 30 1998 1998 ------- ------- Cash $12,743 $23,893 Money market instruments 386 195 Certificates of deposit 225 4,021 Auction preferred stock 1,200 1,000 Municipal bonds due in more than 3 years 6,500 6,800 ------- ------- $21,477 $35,909 ======= =======
4. INVENTORIES The following is a summary of inventories by major category:
(In thousands) December 31 September 30 1998 1998 ------- ------- Raw materials $ 2,234 $ 5,447 Work-in-process 13,753 14,868 Finished goods 14,633 26,169 ------- ------- $30,620 $46,484 ======= =======
4 6 INTEGRATED SILICON SOLUTION, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. OTHER ASSETS Other assets consisted of the following:
(In thousands) December 31 September 30 1998 1998 ------- ------- Investment in WaferTech LLC $31,200 $31,200 Investment in United Integrated Circuits Corp. 7,371 16,486 Investment in ISSI-Taiwan 19,413 -- Investment in NexFlash 2,576 -- Other 2,931 3,766 ------- ------- $63,491 $51,452 ======= =======
6. INCOME TAXES The income tax provision for the three month period ended December 31, 1998 is based on an annual estimate of Taiwan taxable income after the exemption for the Taiwan tax holiday plus withholding taxes primarily related to the sale of ISSI-Taiwan stock. Due to U.S. losses, there is no U.S. tax provision. The effective tax rate for the three months ended December 31, 1998 differs from the federal statutory rate primarily as a result of a valuation allowance established to cover federal net operating losses and foreign withholding taxes which will not be realized on a current basis based on management's expectations of future taxable income and actual taxable income for the prior years. 7. NET LOSS PER SHARE The Company calculates earnings per share in accordance with the Financial Accounting Standards Board Statement No. 128, "Earnings Per Share." The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):
Three Months Ended December 31, 1998 1997 ------- -------- Numerator for basic and diluted loss per share: Net loss $(3,965) $ (9,736) ======= ======== Denominator for basic and diluted loss per share: Weighted average of common shares 19,418 18,199 ======= ======== Basic and diluted loss per share $ (0.20) $ (0.53) ======= ========
The above diluted calculation does not include approximately 3,492,000 and 3,608,000 shares attributable to options as of December 31, 1998 and 1997, respectively, and 981,659 shares attributable to warrants as of December 31, 1998 as their impact would be anti-dilutive. 5 7 INTEGRATED SILICON SOLUTION, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. 9. COMPREHENSIVE INCOME The Company has adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income," (FAS No. 130) as of the beginning of the three month period ending December 31, 1998. FAS No. 130 establishes new rules for the reporting and display of comprehensive income and its components. However, it has no impact on the Company's net income or total stockholders' equity. The components of comprehensive income, net of related tax, are as follows (in thousands):
Three Months Ended December 31, 1998 1997 -------- -------- Net loss $ (3,965) $ (9,736) Change in cumulative translation adjustment 2,322 (8,130) -------- -------- Comprehensive income $ (1,643) $(17,866) ======== ========
Comprehensive income consists entirely of the cumulative translation adjustment on the Company's Condensed Consolidated Balance Sheets. 10. LITIGATION On April 22, 1998, the U.S. Department of Commerce ("DOC") published an amended antidumping duty order on imports of SRAMs from Taiwan from where the Company currently imports a majority of its SRAMs. As a consequence of this antidumping duty order, the Company is required to post a cash deposit on imports of Taiwan fabricated SRAM wafers or devices, at the ad valorem rate of 7.56%. The cash deposits subsequently could be returned to the Company or, alternatively, the Company could forfeit amounts deposited and owe duties and interest in addition to the amounts deposited. The outcome is dependent on whether the DOC conducts an administrative review of imports entered after the imposition of the antidumping order, and if so, on the results of the DOC review. The decision on whether to conduct a review will be made in 1999 and the results of the review will be issued in the year 2000. The Company has retained legal counsel to defend and assist in its interests in the antidumping proceedings. In addition, certain aspects of the antidumping determination are being challenged in federal court proceedings by some of the respondents to the investigation, and these proceedings could result in the termination of this antidumping case. Duties calculated and assessed by the government could have a material adverse affect on the Company's gross margins and profits. There can be no assurance that any reviews or proceedings will mitigate or eliminate antidumping duties. 6 8 INTEGRATED SILICON SOLUTION, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) On October 22, 1998, Micron Technology filed an anti-dumping petition against DRAMs fabricated in Taiwan. Currently, the Company's DRAM products are fabricated in Taiwan. The case is expected to take from 12 to 18 months to complete. If the petition is upheld, the Company could face DRAM duties unless it is able to secure DRAM from outside of Taiwan. Currently, DRAM accounts for less than 10% of the Company's revenue. 11. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board issued Statement No. 131 "Disclosures About Segments of An Enterprise and Related Information" (FAS No. 131). FAS No. 131 will require the Company to use the "management approach" in disclosing segment information. FAS No. 131 became effective for the Company during fiscal 1999. The Company does not believe that the adoption of FAS No. 131 will have a material impact on the Company's results of operations, cash flows, or financial position. In June 1998, the Financial Accounting Standards Board issued Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities" (FAS No. 133). FAS No. 133 will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings. The change in a derivative's fair value related to the ineffective portion of a hedge, if any will be immediately recognized in earnings. The Company expects to adopt FAS No. 133 as of the beginning of its fiscal year 2000. The Company does not believe that the adoption of FAS No. 133 will have a material impact on the Company's results of operations, cash flows, or financial position. 12. SPIN-OFF OF NEXFLASH TECHNOLOGIES, INC. Effective October 1, 1998, the Company transferred certain employees and joint ownership of certain patents and related Flash technology to a newly formed company, NexFlash Technologies, Inc. The Company and NexFlash jointly own existing Flash related patents, and NexFlash will continue development of Flash products. The Company owns approximately 32% of NexFlash, and ISSI-Taiwan owns approximately 17%, which includes approximately 6% of NexFlash purchased for $1,000,000. ISSI's President is temporarily acting as Chief Executive Officer of NexFlash. In connection with the NexFlash transaction, the Company issued warrants to purchase an aggregate of 981,659 shares of ISSI Common Stock at an exercise price of $3.76 per share to the NexFlash investors. The warrants expire on November 4, 2000. As a result of this transaction and after recording its equity in the net loss of NexFlash of $0.5 million for the quarter ended December 31, 1998, the Company is carrying an equity investment in NexFlash of $2.6 million. 7 9 INTEGRATED SILICON SOLUTION, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 13. OTHER TRANSACTIONS 1998 ISSI-TAIWAN STOCK PLAN On October 29, 1998, the Company adopted the 1998 ISSI-Taiwan Stock Plan "Taiwan Stock Plan" that provides for non-statutory stock options in the common stock of ISSI-Taiwan for employees, consultants, and directors of the Company. Upon exercise, if any, the Company would sell its shares in ISSI-Taiwan to the optionee. Under terms of the Taiwan Stock Plan, the maximum aggregate number of shares of ISSI-Taiwan stock which may be optioned and sold is 12,000,000. This represents approximately 10% of the outstanding shares of ISSI-Taiwan. At December 31, 1998, 11,999,000 shares were outstanding under the ISSI-Taiwan Stock Plan. Under the terms of the Taiwan Stock Plan, the exercise price, which is deemed to be fair value, and the exercise period of the non-statutory stock option grants are determined by the Board of Directors on the date of grant. Generally, the stock options vest one-third annually on the anniversary of the date of grant. The options expire upon the earlier of ten years from the date of grant or 30 days following termination of employment or consultancy. In the event of an optionee's termination of status as an employee or consultant of the Company, without cause, within twelve months of certain changes of control of the Company, the Taiwan Stock Plan provides for full acceleration of the exercisability of all outstanding options. REPRICE OF STOCK OPTIONS On December 2, 1998, the Board of Directors approved the repricing of certain options outstanding previously granted to employees of the Company. Approximately 2,007,000 shares with an aggregate exercise price of approximately $17.3 million were repriced to an exercise price of $3.1562 per share. In connection with the repricing, certain vesting and exercise rights were surrendered. 14. PARTIAL SALE OF INTEGRATED SILICON SOLUTION (TAIWAN) INC. In December 1998, the Company sold an additional 20% of its holdings in ISSI-Taiwan to a group of private investors resulting in a pre-tax gain of $1.2 million. Proceeds from the transaction net of withholding and transaction taxes totaled $6.6 million (including cash of $4.3 million). Effective December 31, 1998, the Company owned approximately 43% of ISSI-Taiwan and accounted for ISSI-Taiwan on the equity basis. ISSI-Taiwan was consolidated in the accompanying statement of operations until December 31, 1998 when the additional 20% of its holdings were sold. The accompanying consolidated balance sheet as of December 31, 1998 reflects ISSI-Taiwan as an investment accounted for on the equity basis. 15. RESTATEMENT The Company's retained earnings as reported in its Form 10-K for the year ended September 30, 1998 was restated. The impact of the restatement was to increase accumulated deficit and decrease cumulative translation adjustment by $6.7 million. There was no impact on income reported for any of the periods presented herein. 8 10 INTEGRATED SILICON SOLUTION, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 16. SUBSEQUENT EVENT PARTIAL SALE OF INVESTMENT IN WAFERTECH, LLC. In December 1998, the Company agreed to sell approximately 33% of its investment in WaferTech to TSMC for approximately $10.0 million. The transaction was completed in January 1999, and the Company retains a 2.67% interest in WaferTech. The Company will record a loss of approximately $0.4 million in the March 1999 quarter related to this transaction. 9 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934. All forward looking statements contained herein are subject to certain factors that could cause actual results to differ materially from those projected in the forward-looking statements. Such factors include, but are not limited to the risk related factors set forth in this report on Form 10-Q. BACKGROUND The Company designs, develops and markets high performance memory devices including static random access memory ("SRAM"), specialty dynamic random access memory ("DRAM"), and nonvolatile memory ("NVM"). The Company also designs, develops and markets embedded memory devices which include voice recording chips and certain microcontroller devices. The Company's memory devices are used in networking applications, telecommunications, personal computers ("PCs"), disk drives and other peripherals, data communications, office automation, instrumentation and consumer products. SRAM products include both asynchronous and synchronous devices ranging in densities from 64K to 4 megabit. DRAM products focus on high speed, low density devices with densities of 2, 4, and 16 megabits. Nonvolatile memory products include EEPROMs (electrically erasable programmable read only memories) and EPROMs (erasable programmable read only memories). The Company has its headquarters in Santa Clara, California and markets its products on a worldwide basis. The Company leverages its SRAM design and advanced complimentary metal oxide semiconductor ("CMOS") process technology expertise to establish collaborative manufacturing relationships with Asian semiconductor manufacturers which use the Company's memory products as a vehicle for the development of advanced process technology. Although the Company believes that these relationships assist in securing access to leading edge process technology and a committed source for wafer processing, there are also certain risks associated with dependence on foundries for wafer manufacturing. See "Dependence on Independent Wafer Foundries." The Company's principal collaborative manufacturing relationship is with Taiwan Semiconductor Manufacturing Corporation ("TSMC"), with which it jointly develops process technology for producing the Company's SRAMs. The Company also has a collaborative program with Chartered Semiconductor Manufacturing ("Chartered") in Singapore. In addition, the Company has a manufacturing program with United Microelectronics Corporation ("UMC") in Taiwan. To further strengthen its manufacturing relationships, the Company has made an equity investment in a business venture with TSMC and an equity investment in a business venture with UMC. RESULTS OF OPERATIONS The Company's financial results for fiscal 1998 are presented on a consolidated basis and include the results of the operations which were transferred to NexFlash as well as those of ISSI-Taiwan. Effective November 1998, the Company's financial results no longer consolidate the results of NexFlash, as the Company's ownership of NexFlash became less than 50%. Effective November 1998, the Company accounts for NexFlash on the equity basis and includes in its financial statements its percentage share of NexFlash's results of operations. This change is expected to have a minimal effect on the Company's consolidated revenue and will result in a decrease in the Company's consolidated research and development expenses. In late December 1998, the Company sold an additional 20% of its interest in ISSI-Taiwan and, as a result, reduced its ownership interest in ISSI-Taiwan to approximately 43%. The Balance Sheet as of December 31, 1998 reflects the accounting for ISSI-Taiwan on the equity basis. Beginning with the second quarter of fiscal 1999, the Company's Statement of Operations will no longer consolidate the results of ISSI-Taiwan, but will instead account for ISSI-Taiwan on the equity basis and will include its percentage share of ISSI-Taiwan's results of operations. Beginning in the second quarter of fiscal 1999, as the Company's consolidated results will no longer include ISSI-Taiwan, there will be a significant decline in the Company's consolidated revenue and operating expenses and there may be an increase in the Company's effective tax rate. 10 12 THREE MONTHS ENDED DECEMBER 31, 1998 COMPARED TO THREE MONTHS ENDED DECEMBER 31, 1997 Net Sales. Net sales consist principally of total product sales less estimated sales returns. Net sales decreased by 32% to $26.8 million in the three months ended December 31, 1998, from $39.4 million in the three months ended December 31, 1997. The decrease in sales was principally due to a decrease in the average selling prices of the Company's SRAM products, as well as a significant decline in unit shipments of the Company's 256K SRAM. Additionally, shipments and average selling prices of the Company's DRAM products declined significantly in the three months ended December 31, 1998 compared to the three months ended December 31, 1997. The Company anticipates that the average selling prices of its existing products will continue to decline over time, although the rate of decline may fluctuate for certain products. There can be no assurance that such declines will be offset by higher volumes or by higher prices on newer products. See "Quarterly Fluctuations in Operating Results" and "Declines in Average Selling Prices." Net sales includes approximately $1.2 million in sales to NexFlash in the three months ended December 31, 1998. Additionally, included in net sales for the three months ended December 31, 1998 were sales of ISSI-Taiwan of approximately $9.7 million. Effective January 1, 1999, the Company's financials results will no longer consolidate the sales of ISSI-Taiwan. Sales to 3Com accounted for approximately 15% and 18% of total net sales for the quarter ended December 31, 1998 and December 31, 1997, respectively. As sales to this customer are executed pursuant to purchase orders and no purchasing contract exists, the customer can cease doing business with the Company at any time. Gross Profit. The Company's cost of sales includes die cost from the wafers acquired from foundries, subcontracted package and assembly costs, costs associated with in-house product testing, quality assurance and import duties. Gross profit decreased 56% to $4.0 million in the three months ended December 31, 1998, from $9.2 million in the three months ended December 31, 1997. As a percentage of net sales, gross profit decreased to 14.9% in the three months ended December 31, 1998 from 23.3% in the three months ended December 31, 1997. The December 31, 1997 quarter included a $2.6 million inventory write-down, of which $1.8 million related to lower of cost or market issues on certain of the Company's NVM products and $0.8 million related to the write-down of a specific DRAM product, for which the Company's six month forecast showed minimal demand at December 31, 1997. Excluding the inventory write-down in the December 1997 quarter, the decrease in gross profit was primarily due to a decrease in the average selling prices of the Company's SRAM products, as well as a significant decline in unit shipments of the Company's 256K SRAM. Additionally, shipments and average selling prices of the Company's DRAM products declined significantly in the three months ended December 31, 1998 compared to the three months ended December 31, 1997. Although product unit costs were lower in the December 1998 quarter compared to the December 1997 quarter, such reductions did not offset the declines in average selling prices resulting in lower gross margins. The Company believes that the average selling price of its products will continue to decline and, unless the Company is able to reduce its cost per unit to the extent necessary to offset such declines, the decline in average selling prices will result in a material decline in the Company's gross margin. Although the Company has product cost reduction programs in place for certain products that involve efforts to reduce internal costs and supplier costs, there can be no assurance that product costs will be reduced or that such reductions will be sufficient to offset the expected declines in average selling prices. The Company does not believe that such cost reduction efforts are likely to have a material adverse impact on the quality of its products or the level of service provided by the Company. Research and Development. Research and development expenses decreased by 22% to $5.8 million in the three months ended December 31, 1998, from $7.4 million in the three months ended December 31, 1997. As a percentage of net sales, research and development expenses increased to 21.5% in the three months ended December 31, 1998, from 18.8% in the three months ended December 31, 1997. The decreases in absolute dollars were primarily the result of the Company's transfer of Flash development efforts to NexFlash, as well as the Company's expense reduction efforts, which include a reduction in workforce during fiscal 1998, salary cuts, and limitations on discretionary spending. The Company anticipates research and development expenses will decline next quarter primarily as a result of its no longer consolidating the financial results of ISSI-Taiwan, and believes that such expenses in subsequent quarters may fluctuate as a percentage of net sales. 11 13 In-process Technology. In December 1997, the Company completed its acquisition of Nexcom in exchange for the issuance of 772,693 shares of Common Stock, $0.5 million in cash, and the assumption of $1.2 million of net liabilities (total consideration of approximately $8.5 million). In addition, the Company incurred approximately $400,000 in other costs related to this transaction. The transaction was accounted for as a purchase and resulted in an in-process technology charge of $7.1 million in the Company's December 31, 1997 quarter. Selling, General and Administrative. Selling, general and administrative expenses decreased by 22% to $3.6 million in the three months ended December 31, 1998 from $4.7 million in the three months ended December 31, 1997. As a percentage of net sales, selling, general and administrative expenses increased to 13.5% in the three months ended December 31, 1998, from 11.8% in the three months ended December 31, 1997. The decrease in absolute dollars was primarily the result of decreased selling commissions associated with lower revenues and, to a lesser extent, decreased payroll resulting from the spin-off of NexFlash. The Company expects its selling, general and administrative expenses to decline next quarter primarily as a result of its no longer consolidating the financial results of ISSI-Taiwan and believes that such expenses in subsequent quarters may fluctuate as a percentage of net sales. Other income, Net. Other income, net increased to $1.6 million in the three months ended December 31, 1998 from $0.3 million in the three months ended December 31, 1997. In December 1998, the Company sold an additional 20% of its holdings in ISSI-Taiwan to a group of private investors resulting in a pre-tax gain of $1.2 million. After completion of this transaction, the Company owns approximately 43% of ISSI-Taiwan. Proceeds from the transaction net of withholding and transaction taxes totaled $6.6 million (including cash of $4.3 million). Provision (benefit) for Income Taxes. The income tax provision for the three month period ended December 31, 1997 is based on an annual estimate of Taiwan taxable income after the exemption for the Taiwan tax holiday plus withholding taxes. The effective tax rate for the three months ended December 31, 1998 is higher than for the same period for 1997 due to higher withholding taxes related to the sale of ISSI-Taiwan stock. Subsequent to the sale of additional ISSI-Taiwan shares and the transfer of NexFlash to joint ownership, the Company's effective tax rate may increase if profits are earned in the U.S. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1998, the Company's principal sources of liquidity included cash, cash equivalents and short-term investments of approximately $21.1 million. During the first three months of fiscal 1999, operating activities used cash of approximately $4.4 million. Cash used by operations was primarily due to decreases in accounts payable and net loss partially offset by decreases in inventory, accounts receivable, and other assets. Inventory decreased to $30.6 million at December 31, 1998 from $46.5 million at September 30, 1998. The decrease in inventory was primarily the result of accounting for ISSI-Taiwan on the equity basis. Accounts payable decreased to $34.6 million at December 31, 1998 from $40.6 million at September 30, 1998. The balance of accounts payable is principally related to inventory purchases. In the first three months of fiscal 1999, the Company used $11.5 million for investing activities compared to $10.2 million in the first three months of fiscal 1998. The cash used for investing activities was primarily the result of a net cash outflow of $7.9 million from the partial sale of ISSI-Taiwan which represents the pre-tax cash received from the partial sale net of the cash excluded from the balance sheet as a result of accounting for ISSI-Taiwan on the equity basis. In addition, $2.3 million was used for the acquisition of fixed assets, $1.0 million invested by ISSI-Taiwan in NexFlash, and $0.5 million was invested in Dynachip which includes $0.3 million invested by ISSI-Taiwan. 12 14 In the first three months of fiscal 1999, the Company made capital expenditures of approximately $2.3 million, of which substantially all was by ISSI-Taiwan for the purchase of test equipment. The Company expects to spend approximately $2.5 million to purchase capital equipment during the next twelve months, principally for the purchase of computer software and hardware, design and engineering tools and additional test equipment. In June 1998, the Company sold approximately 46% of ISSI-Taiwan to a group of private investors. In December 1998, the Company sold an additional 20% of its holdings in ISSI-Taiwan to a group of private investors resulting in a pre-tax gain of $1.2 million. Proceeds from the transaction net of withholding and transaction taxes totaled $6.6 million (including cash of $4.3 million). After completion of this transaction the Company owns approximately 43% of ISSI-Taiwan and will account for ISSI-Taiwan on the equity basis. In June 1996, the Company entered into a business venture "WaferTech, LLC" with TSMC, Altera, Analog Devices, and private investors to build a wafer fabrication facility in Camas, Washington. The Company agreed to invest $31.2 million for a 4% equity interest in the venture and, as of September 30, 1998, all of this amount had been paid. The last scheduled payment to WaferTech by the Company of $12.5 million was made in November 1997. In December 1998, the Company agreed to sell approximately 33% of its investment in WaferTech to TSMC for approximately $10.0 million. The transaction was completed in January 1999, and the Company retains a 2.67% interest in WaferTech. The Company will record a loss of approximately $0.4 million in the March 1999 quarter related to this transaction. The Company has also agreed to certain minimum wafer purchase commitments with its foundry partners in exchange for wafer capacity commitments. In fiscal 1995, the Company entered into an agreement with TSMC pursuant to which the Company agreed to acquire specified wafer capacity through 2001. The Company also agreed to make certain annual payments totaling approximately $19.2 million through 2001 to TSMC for additional capacity above the annual base capacity. Wafer purchases in any given year are first applied to the base capacity and then to the Company's $19.2 million obligation. As a result, the $19.2 million may be subject to forfeiture if the Company does not purchase the base capacity and additional capacity for which it has contracted. The Company also has minimum purchase obligations to TSMC related to WaferTech LLC. The Company is obligated to purchase from WaferTech or TSMC a minimum of 2.3% of WaferTech's installed capacity. Initial wafer outs occurred in the second half of calendar 1998. Additionally, in fiscal 1995, the Company entered into a business venture "United Integrated Circuits Corp" ("UICC") with UMC and other investors to build a wafer fabrication facility in Hsinchu, Taiwan. The Company has invested approximately $7.4 million for approximately a 1.7% equity interest and ISSI-Taiwan has invested approximately $9.8 million (subject to fluctuations in the New Taiwanese Dollar) for approximately a 2.1% equity interest in the venture of which UMC retains 55% ownership. The final payment of approximately $4.7 million was made to UICC in December 1997. The UICC facility was severely damaged by fire in October 1997. It is the Company's understanding that the damage was covered by insurance. UICC has undertaken a clean up of the facility but reconstruction has not commenced as an alternative site is being evaluated. A decision as to whether to build on the existing site or the alternative site has not yet been made. The Company believes that its investment of $7.4 million is recoverable. The Company generated $1.1 million from financing activities during the first three months of fiscal 1999, as compared to using $2.3 million in the first three months of fiscal 1998. The source of financing for the current quarter was from net borrowings under short-term and long-term lines of credit. On April 22, 1998, the U.S. Department of Commerce ("DOC") published an amended antidumping duty order on imports of SRAMs from Taiwan from where the Company currently imports a majority of its SRAMs. As a consequence of this antidumping duty order, the Company is required to post a cash deposit on imports of Taiwan fabricated SRAM wafers or devices, at the ad valorem rate of 7.56%. The cash deposits subsequently could be returned to the Company or, alternatively, the Company could forfeit amounts deposited and owe duties and interest in addition to the amounts deposited, depending on whether the DOC conducts an administrative review of imports entered after the imposition of the antidumping order, and if so, on the results of the DOC review. The decision on whether to conduct a review will be made in 1999, and the results of the review would be issued in the year 2000. 13 15 The Company has retained legal counsel to defend and assist in its interests in the antidumping proceedings. In addition, certain aspects of the antidumping determination are being challenged in federal court proceedings by some of the respondents to the investigation, and these proceedings could result in the termination of this antidumping case. Duties calculated and assessed by the government could have a material adverse affect on the Company's gross margins and profits. There can be no assurance that any reviews or proceedings will mitigate or eliminate antidumping duties. On October 22, 1998, Micron Technology filed an antidumping petition against DRAMs fabricated in Taiwan. Currently, the Company's DRAM products are fabricated in Taiwan. The case is expected to take from 12 to 18 months to complete. If the petition is upheld, the Company could face DRAM duties, unless it is able to secure DRAM from outside of Taiwan. Currently, DRAM accounts for less than 10% of the Company's revenue. The Company believes that its existing funds together with available financing will satisfy the Company's anticipated working capital and other cash requirements through the next 12 months. The Company may evaluate actions to further increase its cash position such as bank borrowings, sales of additional shares of ISSI-Taiwan, the disposition of certain assets, equity financing, and debt financing. The Company, from time to time, evaluates potential acquisitions and equity investments complementary to its memory expertise and market strategy. To the extent the Company pursues such transactions, any such transactions could require the Company to seek additional equity or debt financing to fund such activities. There can be no assurance that any such additional financing could be obtained on terms acceptable to the Company, if at all. 14 16 CERTAIN FACTORS WHICH MAY AFFECT THE COMPANY'S BUSINESS OR FUTURE OPERATING RESULTS DEPENDENCE ON SRAM PRODUCTS; DECLINE IN AVERAGE SELLING PRICES FOR SRAM PRODUCTS A substantial majority of the Company's net sales are derived from the sale of SRAM products, which are subject to unit volume fluctuations and declines in average selling prices. For example, in the June 1998 quarter, the Company's net sales decreased by 38% to $25.0 million from $40.7 million in the March 1998 quarter, principally due to a decrease in unit shipments of the Company's SRAM products. In fiscal 1997, the Company's net sales decreased by 18% to $108.3 million from $132.0 million in fiscal 1996. This decrease in sales was principally due to significant deterioration in the average selling prices of the Company's SRAM and NVM products. The Company anticipates that the average selling prices of its existing products will continue to decline over time, although the rate of decline may fluctuate for certain products. There can be no assurance that such declines will be offset by higher volumes or by higher prices on newer products. QUARTERLY FLUCTUATIONS IN OPERATING RESULTS The Company's future quarterly and annual operating results are subject to fluctuations due to a wide variety of factors, many of which are outside of its control, including declines in average selling prices of the Company's products, oversupply of memory products in the market, failure to introduce new products and to implement technologies on a timely basis, the timing and announcement of new product introductions by the Company and its competitors, market acceptance of the Company's and its customers' products, the failure to anticipate changing customer product requirements, fluctuations in manufacturing yields, disruption in delivery and order fulfillment, and disruption in the supply of wafers or assembly services. Other factors include changes in product mix, seasonal fluctuations in customer demand for the Company's products, the timing of significant orders, increased expenses associated with new product introductions or process changes, the ability of customers to make payments to the Company, increases in material costs, increases in antidumping duties, increases in costs associated with the expansion of sales channels, increases in general and administrative expenses, and certain production and other risks associated with using independent manufacturers. In this regard, in the June 1998 quarter, the Company's net sales decreased by 38% to $25.0 million from $40.7 million in the March 1998 quarter principally due to a decrease in unit shipments of the Company's SRAM products. In addition, in fiscal 1997, the Company's net sales decreased by 18% to $108.3 million from $132.0 million in fiscal 1996. This decrease in sales was principally due to significant deterioration in the average selling prices of the Company's SRAM and NVM products. In the first three months of fiscal 1999, approximately 42% of the Company's net sales was attributable to customers located in the United States, 14% was attributable to customers located in Europe and 44% was attributable to customers located in Asia. In fiscal 1998, approximately 43% of the Company's net sales was attributable to customers located in the United States, 18% was attributable to customers located in Europe and 39% was attributable to customers located in Asia. In fiscal 1997, approximately 45% of the Company's net sales was attributable to customers located in the United States, 13% was attributable to customers located in Europe and 42% was attributable to customers located in Asia. In the first three months of fiscal 1999, in fiscal 1998 and 1997, international sales (sales by ISSI-Taiwan and export sales by ISSI-U.S.) comprised approximately 58%, 57% and 55% of the Company's net sales, respectively. Accordingly, the Company's future operating results will also depend in part on general economic conditions in Asia, the United States and its other markets. In this regard, since late 1997 many Asian countries, including Korea, Japan and Thailand, have experienced significant economic downturns and significant declines in the value of their currencies relative to the U.S. dollar. The Company is unable to predict what future effect, if any, these factors will have on its ability to maintain or increase its sales in these markets. In addition, there can be no assurance that the markets for the Company's products, which are highly cyclical, will continue to grow. In late December 1998, the Company sold an additional 20% of its interest in ISSI-Taiwan and, as a result, reduced its ownership interest in ISSI-Taiwan to approximately 43%. Beginning with the second quarter of fiscal 1999, the Company's Statement of Operations will no longer consolidate the results of ISSI-Taiwan, but will instead account for ISSI-Taiwan on the equity basis and will include its percentage share of 15 17 ISSI-Taiwan's results of operations. Beginning in the second quarter of fiscal 1999, as the Company's consolidated results no longer include ISSI-Taiwan, there will be a significant decline in the Company's consolidated revenue and operating expenses, and there may be an increase in the Company's effective tax rate. DECLINES IN AVERAGE SELLING PRICES Competitive pricing pressures due to an industry-wide oversupply of wafer capacity resulted in significant price decreases for the Company's products during 1996, 1997 and 1998. Historically, average selling prices for semiconductor memory products have declined, and the Company expects that average selling prices will decline in the future. Accordingly, the Company's ability to maintain or increase revenues will be highly dependent upon its ability to increase unit sales volume of existing products and introduce and sell new products which compensate for the anticipated declines in the average selling prices of its existing products. Declining average selling prices will also adversely affect the Company's gross margins and profits unless the Company is able to introduce new products with higher margins or reduce its cost per unit to offset declines in average selling prices. There can be no assurance that the Company will be able to increase unit sales volumes, introduce and sell new products or reduce its cost per unit. In this regard, the Company has a cost reduction program in place, which involves efforts to reduce internal costs and supplier costs, in an effort to reduce its cost per unit for certain products. The Company does not believe that such cost reduction efforts are likely to have a material adverse impact on the quality of its products or the level of service provided by the Company. RISK OF INVENTORY WRITE-DOWNS Shifts in industry-wide capacity from shortages to oversupply or from oversupply to shortages may result in significant fluctuations in the Company's quarterly or annual operating results. The semiconductor industry is highly cyclical and is subject to significant downturns resulting from excess capacity, overproduction, reduced demand or technological obsolescence. These factors can result in a decline in average selling prices and the stated value of inventory. In fiscal 1998, the Company recorded inventory write-downs of $23.0 million, including $9.6 million in the September 1998 quarter. The inventory write-downs were predominately for lower of cost or market issues on certain of the Company's products, primarily SRAMs. The September 1998 quarter included a $2.9 million write-down of certain of the Company's Flash inventories due to obsolescence resulting from the Company's decision to spin off the Flash product business to form NexFlash. In addition, in the December 1997 quarter, the Company wrote-off $0.8 million worth of a specific DRAM product, for which the Company's six month forecast showed minimal demand at December 31, 1997 and for which the Company has had minimal sales to date. It is the Company's practice to write-down to zero carrying value inventory on hand in excess of six months estimated sales volumes to cover estimated exposures unless adjustments are made to the forecast based on management's judgments for newer products, end of life products or planned inventory increases. Management's judgments take into account the product life cycles which can range from 6 to 24 months, the maturity of the product as to whether it is newly introduced or is approaching its end of life, the impact of competitor announcements and product introductions on the Company's products and purchasing opportunities due to excess wafer capacity. The Company believes that six months is an appropriate period because it is difficult to accurately forecast for a specific product beyond this time frame due to potential introduction of products by competitors, technology obsolescence or fluctuations in demand. In this regard, in the June 1996 quarter, the Company recorded a $15 million write-down for various SRAM and NVM products that the Company's forecast indicated would not be sold in the next six months. The Company did not expect to sell the excess inventory at the time because the volume and price declines from the December 1995 quarter to the June 1996 quarter resulted in a decrease in revenues of 38%. During this period, market conditions were extremely uncertain. Furthermore, during the fourth fiscal quarter of 1996 the Company experienced a continued decline in revenue of 16% from the June 1996 quarter. While the Company continued to focus on the selling of this product, sales reached a bottom in its decline in the September 1996 quarter and stayed relatively flat in the December 1996 quarter. Subsequently, as market conditions improved in the latter part of the December 1996 quarter, the Company was able to sell certain of these products. As a result of improving market conditions during fiscal 1997, the Company was able to sell 16 18 $13.9 million of the written-off product. However, the Company considers such sales unusual and there can be no assurance that in the future written-off inventory can be sold. Historically, the Company has consistently applied this practice in valuing inventory and, until the events that transpired in the first through third quarters of fiscal 1996, had never recorded material write-downs or recoveries. The Company believes that based on the factors noted above, its six month write-off policy is still appropriate as a method to identify and estimate inventory exposure. There can be no assurance that in the future additional inventory write-downs will not occur. PRODUCT CONCENTRATION AND DEPENDENCE ON PERSONAL COMPUTER INDUSTRY A majority of the Company's products are incorporated into products such as modems, networking equipment, disk drives and PC cache. The PC and PC peripherals industry has from time to time experienced cyclical, depressed business conditions, often in connection with, or in anticipation of, a decline in general economic conditions. Such industry downturns have resulted in reduced product demand and declining average selling prices. The Company's business and operating results would be materially and adversely affected by any future downturns in the peripherals industry or in PCs. CUSTOMER CONCENTRATION The Company's sales are concentrated within a limited customer base. Sales to one customer, 3Com, accounted for approximately 15% and 18% of total net sales for the quarter ended December 31, 1998 and December 31, 1997, respectively. As sales to this customer are executed pursuant to purchase orders and no purchasing contract exists, the customer can cease doing business with the Company at any time. The Company expects a significant portion of its future sales to remain concentrated within a limited number of strategic customers. There can be no assurance that the Company will be able to retain its strategic customers or that such customers will not otherwise cancel or reschedule orders, or in the event of canceled orders, that such orders will be replaced by other sales. In addition, sales to any particular customer may fluctuate significantly from quarter to quarter. The occurrence of any such events could have a material adverse effect on the Company's business and operating results. DEPENDENCE ON INDEPENDENT WAFER FOUNDRIES The Company has combined its fabless manufacturing strategy with technology partnerships and equity investments. This hybrid approach, which the Company calls "Fab-Lite(TM)", has provided advanced process technology and a committed wafer supply. To date, the Company's principal manufacturing relationship has been with TSMC, from which the Company has obtained a substantial majority of its wafers. The Company also receives wafers from Chartered Semiconductor and UMC. Each of the Company's wafer suppliers also fabricates for other integrated circuit companies, including certain of the Company's competitors. Although the Company has written commitments specifying wafer capacities from its suppliers, if these suppliers experience manufacturing failures or yield shortfalls, choose to prioritize capacity for other use or reduce or eliminate deliveries to the Company, there can be no assurance that the Company could enforce fulfillment of the delivery commitments. There can be no assurance that the Company would be able to qualify additional manufacturing sources for existing or new products in a timely manner or that such additional manufacturing sources would agree to deliver an adequate supply of wafers. If the Company were unable to obtain an adequate supply of wafers from its current or any alternative sources in a timely manner, its business and operating results would be materially and adversely affected. The Company has certain minimum wafer purchase commitments with its foundry partners in exchange for wafer capacity commitments. The Company has agreed to make certain annual purchases totaling, in aggregate, approximately $19.2 million through 2001 from TSMC for additional capacity above the annual base capacity. Wafer purchases in any given year are first applied to the base capacity and then to the Company's $19.2 million obligation. As a result, the $19.2 million may be subject to forfeiture if the Company does not purchase the base capacity and additional capacity for which it has contracted. The Company has minimum purchase obligations to TSMC related to WaferTech LLC, a business venture in 17 19 which the Company is an investor. The Company is obligated to purchase from WaferTech or TSMC a minimum of 2.3% of WaferTech's installed capacity. Although the Company has rights to re-schedule or assign capacity to another party, there can be no assurance that such re-schedule or assignment would be successfully accomplished. Should the Company fail to re-schedule or assign unneeded capacity, the Company will be required to make payments for the unused capacity and its business and operating results would be materially and adversely affected. INTERNATIONAL OPERATIONS The Company is subject to the risks of conducting business internationally, including economic conditions in Asia, particularly Taiwan, changes in trade policy and regulatory requirements, tariffs and other trade barriers and restrictions, the burdens of complying with foreign laws, and possibly, political instability. The Company anticipates that sales to international customers will continue to represent a significant percentage of net sales. In addition, substantially all of the Company's foundries and assembly and test operations are located in Asia. The Company transacts business predominately in U.S. and New Taiwan dollars. Such transactions expose the Company to the risk of exchange rate fluctuations. The Company monitors its exposure to foreign currency fluctuations, and has from time to time taken action to hedge against such exposure, but has not to date adopted any formal hedging strategy. The Company's business and results of operations have been negatively impacted by exchange rate fluctuations in the past and there can be no assurance that exchange rate fluctuations will not materially and adversely affect its business and operating results in the future. COMPETITION The semiconductor memory market is intensely competitive and has been characterized by an oversupply of product, price erosion, rapid technological change, short product life cycles, cyclical market patterns and heightened foreign and domestic competition. The ability of the Company to compete successfully in the high performance memory market depends on factors both within and outside of its control, including imbalances in supply and demand, product pricing, the rate at which OEM customers incorporate the Company's products into their systems, access to advance process technologies at competitive prices, product functionality, performance, and reliability, successful and timely product development, wafer supply, wafer costs, achievement of acceptable yields of functional die, the gain or loss of significant customers, the nature of its competitors and general economic conditions. There can be no assurance that the Company will be able to compete successfully in the future as to any of these factors. The failure of the Company to compete successfully in these or other areas could materially and adversely affect the Company's business and operating results. In addition, the Company is vulnerable to technology advances utilized by competitors to manufacture higher performance or lower cost products. CLAIMS REGARDING INTELLECTUAL PROPERTY In the semiconductor industry it is typical for companies to receive notices from time to time alleging infringement of patents or other intellectual property rights of others. The Company has been, and from time-to-time expects to be, notified of claims that it may be infringing patents, maskwork rights or copyrights owned by third parties. Although none of these companies have pursued a claim against the Company, there can be no assurance that other companies will not in the future pursue claims against the Company with respect to the alleged infringement of patents, maskwork rights, copyrights or other intellectual property owned by third parties. If it appears necessary or desirable, the Company may seek licenses under patents that it is alleged to be infringing. Although patent holders commonly offer such licenses, there is no assurance that any licenses will be offered or that the terms of any offered licenses will be acceptable to the Company. The failure to obtain a license under a key patent or intellectual property right from a third party for technology used by the Company could cause the Company to incur substantial liabilities and to suspend the manufacture of the products utilizing the invention or to attempt to develop non-infringing products, any of which could materially and adversely affect the Company's business and operating results. 18 20 RISK OF INCREASED TAXES The Company's tax rate could fluctuate for a number of reasons. For example, if the proportions of taxable income shifted such that a greater proportion of taxable income is earned by U.S. operations, the Company's effective tax rate may increase. In addition, the Company's taxes would increase if all or a portion of the earnings of ISSI-Taiwan were to become subject to U.S. tax as the result of actual dividends or through U.S. rules for taxing controlled foreign corporations. Further, if profits of ISSI-Taiwan are distributed to the Company as dividends they become subject to Taiwan withholding tax as well as U.S. tax (with an offset for underlying Taiwan taxes paid) and the tax rate would increase. Through December 1998, ISSI-Taiwan was a controlled foreign corporation ("CFC") for U.S. income tax purposes. Under U.S. rules for taxing CFCs, all or a portion of the earnings of ISSI-Taiwan may become subject to U.S. tax as inclusions in the U.S. taxable income of the Company (with a credit for foreign taxes paid by ISSI-Taiwan) if one or more of a number of events occur. Such events include, but are not limited to, ISSI-Taiwan lending funds to the Company or otherwise investing in certain proscribed assets and ISSI-Taiwan engaging in various types of transactions defined in the Subpart F provisions of the U.S. Internal Revenue Code. The Company believes that its existing plans will minimize the impact of the CFC rules for the immediate future, subject to such changes in U.S. tax laws as may occur. However, over time the CFC rules may cause the Company's tax rate to increase. YEAR 2000 READINESS DISCLOSURE The Company is aware of the issues associated with computer systems as the Year 2000 approaches. The Year 2000 issues are the result of common computer programming techniques that result in systems that do not function properly when manipulating dates later than December 31, 1999. The problem may affect internal information technology (IT) systems used by the Company for product design, product test, accounting, distribution and planning. The problem may also affect non-IT systems such as security systems, communication equipment and other equipment. The Company has done an initial assessment of its critical IT systems and has identified at least one area (accounting software) that is not Year 2000 compliant. The Company has selected an alternative software package and intends to have implementation completed by October 1999. However, there can be no assurance that there will not be a delay in the implementation of such systems. It is estimated that the cost of implementing the new software will range between $0.3 million to $0.6 million. With respect to critical non-IT systems, the Company has assessed the compliance of these systems and believes that these systems are Year 2000 compliant. There can be no assurance that the Company has successfully identified all its internal Year 2000 issues. The failure to identify and address internal Year 2000 issues in a timely fashion could have a material adverse affect on the Company's business and results of operations. The Company could possibly be adversely impacted by Year 2000 issues faced by major suppliers, subcontractors, and customers. The Company is in the process of determining the potential impact on its operations as a result of the Year 2000 readiness of these third parties. Their failure to address Year 2000 issues could have an impact on the Company's operations and financial results. The extent of this impact, if any, is not known at this time. The above discussion regarding costs, risks and estimated completion dates for the Year 2000 is based on the Company's best estimates given information that is currently available, and is subject to change. As the Company proceeds with this project, it may discover that actual results will differ materially from these estimates. 19 21 VOLATILITY OF STOCK PRICE The trading price of the Company's Common Stock has been subject to wide fluctuations in response to quarter-to-quarter variations in operating results, announcements by the Company or its competitors, increases or decreases in wafer capacity, general conditions in the semiconductor or computer industries, governmental regulations, trade laws and import duties, litigation, new or revised earnings estimates, comments or recommendations issued by analysts who follow the Company, its competitors or the semiconductor industry and other events or factors. In addition, stock markets have experienced extreme price and trading volume volatility in recent years. This volatility has had a substantial effect on the market prices of securities of many high technology companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. 20 22 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On April 22, 1998, the U.S. Department of Commerce ("DOC") published an amended antidumping duty order on imports of SRAMs from Taiwan from where the Company currently imports a majority of its SRAMs. As a consequence of this antidumping duty order, the Company is required to post a cash deposit on imports of Taiwan fabricated SRAM wafers or devices, at the ad valorem rate of 7.56%. The cash deposits subsequently could be returned to the Company or, alternatively, the Company could forfeit amounts deposited and owe duties and interest in addition to the amounts deposited. The outcome is dependent on whether the DOC conducts an administrative review of imports entered after the imposition of the antidumping order, and if so, on the results of the DOC review. The decision on whether to conduct a review will be made in 1999 and the results of the review will be issued in the year 2000. The Company has retained legal counsel to defend and assist in its interests in the antidumping proceedings. In addition, certain aspects of the antidumping determination are being challenged in federal court proceedings by some of the respondents to the investigation, and these proceedings could result in the termination of this antidumping case. Duties calculated and assessed by the government could have a material adverse affect on the Company's gross margins and profits. There can be no assurance that any reviews or proceedings will mitigate or eliminate antidumping duties. On October 22, 1998, Micron Technology filed an anti-dumping petition against DRAMs fabricated in Taiwan. Currently, the Company's DRAM products are fabricated in Taiwan. The case is expected to take from 12 to 18 months to complete. If the petition is upheld, the Company could face DRAM duties unless it is able to secure DRAM from outside of Taiwan. Currently, DRAM accounts for less than 10% of the Company's revenue. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are filed as a part of this report. Exhibit 27 Financial Data Schedule. (b) Reports on Form 8-K. The registrant did not file any reports on Form 8-K during the quarter ended December 31, 1998. ITEM 7A. FINANCIAL MARKET RISK The Company's principal financial market risk relates to the interest rates associated with our available-for-sale securities. At December 31, 1998, our market risk related to these investments was immaterial. 21 23 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 Silicon Solution, Inc. (Registrant) Dated: February 16, 1999 /s/ Gary L. Fischer ----------------------------------------- Gary L. Fischer Executive Vice President, Office of the President, and Chief Financial Officer (Principal Financial and Accounting Officer) 22 24 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 27 Financial Data Schedule.
EX-27 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE UNAUDITED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH UNAUDITED FINANCIAL STATEMENTS FOR THE PERIOD ENDING DECEMBER 31, 1998 1,000 3-MOS SEP-30-1999 OCT-01-1998 DEC-31-1998 13,354 7,700 12,142 1,496 30,620 71,826 22,502 16,845 140,974 44,692 0 0 0 2 91,284 140,974 26,801 26,801 22,796 22,796 0 0 976 (3,804) 633 (3,965) 0 0 0 (3,965) (0.20) (0.20)
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