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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
 
                            ------------------------
 
                                   FORM 10-K
                            ------------------------
 
                 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
 
                  FOR THE FISCAL YEAR ENDED SEPTEMBER 27, 1998
                         COMMISSION FILE NUMBER 2-23128
 
                          QUALITY SEMICONDUCTOR, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                            <C>
                  CALIFORNIA                                     77-0199189
           (STATE OF INCORPORATION)                           (I.R.S. EMPLOYER
                                                           IDENTIFICATION NUMBER)
</TABLE>
 
                               851 MARTIN AVENUE
                             SANTA CLARA, CA 95050
                    (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
 
       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 450-8000
 
        SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
 
                                 TITLE OF CLASS
 
                         Common Stock, $.001 par value
                        Preferred Share Purchase Rights
 
     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 [ ]
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  [ ]
 
     The aggregate market value of the voting stock held by non-affiliates of
the registrant on November 10, 1998 was $26,930,741 based upon the closing price
as reported on the Nasdaq National Market for such date. Shares of Common Stock
held by each executive officer and director and by each person who owns 5% or
more of the outstanding Common Stock have been excluded in that such persons may
be deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes. The number of
outstanding shares of the registrant's Common Stock as of November 10, 1998 was
7,502,690.
 
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                                     PART I
 
ITEM 1. BUSINESS
 
     Information set forth in this report constitutes and includes forward
looking information. The accuracy of such information is subject to a variety of
risks and uncertainties, including product mix, the Company's ability to obtain
or maintain design wins, market conditions in the personal computer and
semiconductor industries, product development schedules and other matters.
Actual results may differ from the results discussed in such forward looking
statements.
 
INTRODUCTION
 
     Quality Semiconductor, Inc. ("QSI" or the "Company") and its subsidiaries
(collectively called "QSI," the "Company" or the Registrant) operates
predominantly in one industry segment. The Company designs, develops and markets
high-performance logic, clock management and QuickSwitch(R) devices and advanced
networking semiconductor products. The Company targets systems manufacturers
principally in the networking, computer, workstation, and telecommunications
markets. QSI's logic products include the 5-volt QSFCT and 3.3-volt LCX and LVC
families of high-speed, low-noise interface devices that interconnect various
elements in a microprocessor-based system, and the QuickSwitch(R) family of
high-speed, low resistance bus switches, which can be used for many
applications, such as facilitating the use of mixed voltages in a
microprocessor-based system. QSI's networking products include two Fast Ethernet
CMOS transceivers that provide high integration solutions for the adapter,
repeater, switch and card bus markets and an ATM multiplexer/demultiplexer
device.
 
     QSI was incorporated in 1988 under the laws of California. The Company's
principal executive offices are located at 851 Martin Avenue, Santa Clara,
California 95050-2903 and its telephone number is (408) 450-8000.
 
     On November 1, 1998, the Company signed a definitive agreement to merge
with Integrated Device Technology, Inc. ("IDT"). Under the terms of the
agreement, each issued and outstanding share of the Company's Common Stock will
be exchanged for 0.6875 shares of Common Stock of IDT. The merger is planned to
close during the first calendar quarter of 1999.
 
QSI PRODUCTS
 
     The Company offers a wide range of high performance logic, logic intensive
specialty memory, and networking products for systems manufacturers in a variety
of markets, including the networking, personal computer, workstation,
peripherals, I/O subsystems, telecommunications and portable systems industries.
 
  High Performance Networking Products
 
     The Company has several networking products that provide high integration
solutions for the adapter, repeater, switch and card bus markets. The Company's
product development in the networking market is directed to multimedia
applications and interoperability. The QS6810 Asynchronous Transfer Mode 4:1
Multiplexer/ Demultiplexer serves the Asynchronous Transfer Mode ("ATM") Switch
and Transmission Market. The QS6611 10/100 TX/Fast Ethernet Symbol Transceiver
and the QS6612 10/100 Base TX Ethernet MII Transceivers are the first members of
a family of networking products to serve the LAN and WAN markets. See "Factors
That May Affect Future Results -- Dependence on Two Existing Product Lines."
 
  High Performance Logic Products
 
     The Company offers more than 100 interface logic products, which support
bus interfaces, memory interfaces and other logic support applications where
high speed is critical. QSI's family of logic products is available in a variety
of small packages, enabling efficient use of board area. Many of these products
are
 
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designed for fast growing applications, such as mobile computing and
communications, in which small size and low power consumption may be as
important as high speed.
 
  Bus Interface Logic Products
 
     The Company offers FCT family of logic devices for the 5 volt
high-performance segment of the interface logic market. Demand for these
products comes primarily from bus interface applications where low propagation
delays, low power consumption and space-efficient packaging are principal
concerns. The Company has continued to address common system design problems
with value-added new product solutions, including multiple-width logic, which
satisfy the need for logic applications of more than 8-bits. The Company also
offers the LCX and LCXPlus families of 3.3 volt logic products which address the
need for high performance mixed 5v/3.3v supply applications.
 
  QuickSwitch(R) Products
 
     The Company's innovative QuickSwitch(R) family of products consists of
high-speed switches for direct bus connection with virtually no delay (250
picoseconds, or 0.25 nanosecond), no added ground bounce, no added power
dissipation, and requirement for no directional control. QuickSwitch(R) devices
provide higher performance alternatives to FCT and other families of interface
logic where high current drive capability is not required. In addition, they can
replace traditional TTL buffers and transceivers (components that can both
transmit and receive signals) to reduce overall propagation delay, noise,
control complexity and power consumption. The Company has experienced growth in
sales of the QuickSwitch(R) product family in the data communication,
telecommunication, workstation and peripheral interface markets because of the
products' signal switching and routing capabilities. QSI's current
QuickSwitch(R) offering includes products designed for applications such as
digital and analog switching, 5.0-to-3.3-volt conversion, signal swapping,
multiplexing, and pin-for-pin replacement of standard logic components. The
Company is developing new products in the QuickSwitch(R) family by incorporating
features of the QuickSwitch(R) design into higher integration products, such as
a series of crossbar switches and QuickScan(TM) devices for boundary scan test
applications.
 
  Clock Management Products
 
     As clock speeds of microprocessors increase, previously acceptable levels
of clock signal skew (timing variance of clock signals within a system) can
cause fatal timing errors. QSI's product solutions for clock signal distribution
are intended to enable system designers to achieve low-skew clock signal
distribution, which can eliminate the need for higher-cost high-speed logic
devices. The clock buffer family of products allows single or multiple clock
inputs to be distributed across up to 22 output pins with guaranteed low skew.
The Company's PLL (Phase-Locked-Loop) clock driver was designed to duplicate an
input clock while also providing various output options. See "Factors That May
Affect Future Results -- Year 2000 Compliance."
 
  FIFO Memory Products
 
     In October 1997, the Company made a strategic decision to exit the FIFO
memory product market. This decision was made in order to focus the Company's
resources on other faster growing segments of the semiconductor industry,
including networking and telecommunication markets. The FIFO market accounted
for a small percentage of the Company's revenues. As part of this decision, the
Company wrote off approximately $2.5 million of inventory and other costs in the
fourth quarter of fiscal 1997 primarily related to the FIFO product line.
 
CUSTOMERS AND APPLICATIONS
 
     QSI's customers are performance-oriented systems manufacturers in
industries such as networking, personal computers and workstations. QSI ships
products to customers on an OEM (Original Equipment Manufacturer) basis and to
customers through the Company's distributors.
 
     A relatively small number of customers have accounted for a significant
portion of the Company's net revenue in each of the past several fiscal years.
In fiscal 1998 seven customers accounted for 53% of revenues
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compared to six customers which accounted for over 56% of net revenues in fiscal
1997 and eleven customers which accounted for over 66% of net revenues in fiscal
1996. The fiscal 1998, sales to Arrow Electronics, Inc. and Kanematsu, USA, a
subsidiary of Kanematsu Semiconductor Corporation, represented 15% and 12% of
total revenues, respectively. Masaharu Shinya, a director of the Company, is the
President of Kanematsu Semiconductor Corporation. No other customer accounted
for more than 10% of total revenue in fiscal 1998. See "Factors That May Affect
Future Results -- Customer Concentration."
 
BACKLOG
 
     QSI primarily manufactures and markets standard products. Sales are
generally made pursuant to purchase orders, which are frequently revised to
reflect changes in customer's requirements. As of September 27, 1998, the
Company's backlog was approximately $9.3 million, as compared to approximately
$15.3 million at September 28, 1997. The Company's backlog includes OEM and
distributor purchase orders accepted by the Company for products scheduled for
shipment within the following six months. Orders constituting the Company's
backlog are subject to delivery rescheduling, price renegotiation and
cancellation at the option of the buyer without significant penalty. The
Company's business, like that of much of the semiconductor industry, is
characterized by short lead-time orders and quick delivery schedules. In
addition, the Company's actual shipments depend upon the manufacturing capacity
and timely delivery of the Company's wafer fabrication suppliers. Although
useful for the purposes of short-term scheduling, backlog as of any particular
date may not be a reliable measure of sales for any future period.
 
SALES AND DISTRIBUTION
 
     The Company markets its products primarily to systems manufacturers in
North America through its distributors and independent manufacturers
representatives, and internationally through foreign distributors. The Company
had three principal North American distributors during fiscal 1998 -- Arrow,
Nu-Horizons and Bell Industries. During the second half of fiscal 1998, the
distribution agreement with Bell Industries was terminated and Future
Electronics, Incorporated became a principal distributor. Domestic distributors
accounted for approximately 21% of the Company's net revenues during fiscal 1998
as compared to 19% in fiscal 1997. Arrow Electronics accounted for more than
half of such sales in each year. The Company defers recognition of revenue and
related gross profit from sales of products to these North American distributors
until after the distributors have resold these products to their customers. In
addition, QSI's independent manufacturers' sales representatives in the United
States and Canada generally assist the Company in achieving design wins and
procuring purchase orders from systems manufacturers.
 
     To assist the Company's distributor and independent sales representative,
the Company has 6 sales professionals located at the Company's sales offices in
northern and southern California, Georgia, Massachusetts and the United Kingdom
as of September 28, 1997. The Company also employs field application engineers
who work directly with the Company's customers to assist them in designing
systems incorporating the Company's products.
 
     Sales outside of the United States accounted for approximately 36%, 44% and
43% of net product revenues for fiscal years ended 1998, 1997, and 1996,
respectively. The Company expects that export sales will continue to represent a
significant portion of its product sales. Export sales are subject to certain
risks, including currency controls and fluctuations, changes in local economic
conditions, import and export controls and changes in tax laws, tariffs and
freight rates. See Note 12 to Financial Statements attached hereto for
information on the amount of net product revenue attributable to the Company's
geographic regions.
 
     The Company's manufacturers' representatives and distributors are not
subject to minimum purchase requirements and can discontinue marketing any of
the Company's products at any time. The Company's distributors typically offer
competing products. Although the Company believes that to date it has provided
adequate allowances for exchanges and returns, there can be no assurance that
actual returns or exchanges will not exceed the Company's allowance,
particularly in connection with the introduction of new products or enhancements
or existing products. In addition there can be no assurance that future sales by
distributors or
 
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representatives will continue at present levels. The loss of one or more
manufacturers' representatives or distributors, or the decision by one or more
distributors to reduce the number of the Company's products offered by such
distributor or to carry the product lines of the Company's competitors, could
have a material adverse effect on the Company's operating results. See "Factors
That May Affect Future Results -- Dependence on Manufacturing Representatives
and Distributors."
 
COMPETITION
 
     The Company competes in different product areas, to varying degrees, on the
basis of technical innovation and performance of its products, including their
speed, density, power usage, reliability, and space-saving package options, as
well as on price, quality and product availability. The Company's competitive
strategy is to offer high-performance, small packaged products.
 
     The semiconductor industry is intensely competitive and is characterized by
price erosion, declining gross margins, rapid technology changes, product
obsolescence and heightened international competition in many markets. The
Company's competitors include large semiconductor companies, such as Integrated
Device Technology, Inc., Texas Instruments Incorporated, National Semiconductor
Corporation, Level One and Cypress Semiconductor Corporation, that have
substantially greater financial, technical, marketing, distribution and other
resources, broader product lines and longer standing relationships with
customers than the Company. In addition, the Company competes with emerging
companies attempting to sell products to specialized markets such as those
addressed by the Company. In the event of a downturn in the market for the
Company's products, companies that have broader product lines and longer
standing customer relationships may be in a stronger competitive position than
the Company. Competitors with greater financial resources or broader product
lines also may have more resources than the Company to engage in sustained price
reductions in the Company's primary markets to gain market share.
 
     The Company is continually in the process of designing new improved
products to maintain its competitive position. Because of continual improvements
in semiconductor design and processing technology, the Company believes that its
future success will depend on its ability to continue to improve its products
and processes and develop new technologies and products in order to remain
competitive. The Company has been developing capacity for the fabrication of its
products since the acquisition of a fully functional wafer fabrication facility
in Australia in February 1996. Many of the Company's competitors have this
capacity which may provide such companies with more reliable manufacturing
capability, shorter development and manufacturing cycles and time-to-market
advantages. Competitors having their own wafer fabrication facilities, or access
to suppliers having such facilities, with smaller geometries or superior process
technologies at the same geometries could manufacture and sell competitive,
higher performance products at a lower price. Introduction of products by
competitors that are manufactured with improved process technology could
materially and adversely affect the Company's operating results.
 
     As is typical in the semiconductor industry, competitors of the Company
have developed and market products having similar or identical design and
functionality as the Company's products, and the Company expects that this will
continue in the future. For example, products that are pin-compatible with many
of the Company's QSFCT products are available from competitors. To the extent
the Company's products do not achieve performance, size or other advantages over
products offered by competitors, the Company will experience greater price
competition with respect to such products. The Company also faces competition
from the makers of microprocessors or other system devices, including ASICs,
that have been and may be developed for particular systems. These devices
increasingly include interface logic and specialty memory functions and as a
result may eliminate the need or sharply reduce the demand for the Company's
products in particular applications.
 
     Historically, average selling prices ("ASPs") in the semiconductor industry
have decreased over the life of the particular product. The willingness of
prospective customers to design the Company's products into their products
depends to a significant extent upon the ability of the Company to price its
products at a level that is cost effective for such customers. If the Company is
unable to reduce its costs sufficiently to offset declines in ASPs or is unable
to introduce new higher performance products with higher ASPs, the Company's
 
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operating results would be materially and adversely affected. Any yield or other
production problems, shortages of supply that increase the Company's
manufacturing costs, or failure to reduce manufacturing costs, would have a
material adverse effect on the Company's operating results.
 
     The Company believes that its ability to compete successfully depends on a
number of factors both within and outside of its control, including price,
product quality, performance, success in developing new products, adequate
fabrication capacity and sources of raw materials, efficiency of production,
timing of new product introductions by competitors, protection of Company
products by effective utilization of intellectual property laws, and general
market and economic conditions. There can be no assurance that the Company will
be able to compete successfully in the future.
 
MANUFACTURING
 
  Wafer Fabrication
 
     In February 1996, the Company purchased a fully functional wafer
fabrication facility and product design center located in Australia. The Company
receives substantially all of its wafer requirements for its logic products from
this facility. After acquiring the wafer fabrication facility in 1996, the
Company began to plan for the transfer of wafer production of logic products
from its subcontractors to its wafer fabrication facility. This transfer was
completed in fiscal year 1998. The Company believes that maintaining its own
wafer fabrication capability provides a reliable source of supply of
semiconductors and ability to develop new products and technology. To increase
its competitive position, the Company has introduced programs to reduce
manufacturing cycle time, improve yields and lower costs. See "Factors That May
Affect Future Results -- Risks Associated With Operating Australian
Semiconductor Fabrication Facility."
 
     Additionally, substantially all of the Company's more advanced, smaller
geometry networking products are fabricated by Taiwan Semiconductor
Manufacturing Company ("TSMC"). Furthermore, from time to time the Company
purchases wafers from Ricoh Corporation ("Ricoh"). Prior to fiscal 1998, the
Company utilized Seiko Instruments Inc. ("Seiko"), Ricoh and Yamaha Corporation
("Yamaha") for additional wafer capacity but no longer relies on Seiko or Yamaha
for wafer fabrications. See "Factors That May Affect Future
Results -- Dependence on Fabrication, Assembly and Test Subcontractors."
 
  Assembly
 
     The Company performs circuit assembly through four main overseas
subcontractors. In the assembly process, silicon wafers are cut into individual
die that are then assembled into packages in accordance with procedures
developed by the Company. While the timeliness and quality of product deliveries
from the Company's subcontractors have been acceptable to date, there can be no
assurance that difficulties will not occur in the future. Any significant
disruption in adequate supplies from, or degradation in the quality of
components supplied by, these subcontractors, or any other circumstance that
would require the Company to qualify alternative sources of supply, could delay
shipment of products and have a material adverse effect on the Company's
operating results. Although the Company believes it has gained certain
competitive advantages through reduced-size packaging innovations, the Company
does not have exclusive rights to use such designs or related packaging methods
and many of the Company's packaging designs, such as the QSOP and QVSOP
packages, are currently available for products sold by the Company's
competitors. Also, there can be no assurance that the Company's assembly
subcontractors, who have gained significant expertise in the application of the
Company's packaging designs and methods, such as QSOP, QVSOP or HQSOP, will not
use such expertise in providing product assembly for the Company's competitors,
which could have an adverse effect on the Company's competitive position and its
results of operations.
 
  Test
 
     Following assembly, the packaged devices currently are tested and inspected
by the Company's domestic test contractor or overseas assembly contractors in
accordance with the Company's quality assurance program before shipment to
customers. The Company recently increased its reliance on overseas testing
houses for
 
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product testing. See "Factors That May Affect Future Results -- Dependence on
Fabrication, Assembly and Test Subcontractors."
 
RESEARCH AND DEVELOPMENT
 
     The Company's research and development efforts are focused on the design of
new networking, interface logic and clock management devices, improvements in
the Company's process and design technologies, improvement of existing device
performance, cost reductions in the manufacturing and assembly process and
improvements in device packaging. As of September 27, 1998, the Company had 57
employees involved in research and product development activities.
 
     The Company's research, development and engineering expenses in the fiscal
years 1998, 1997 and 1996 were approximately $10.5 million, $9.3 million and
$7.0 million, respectively. The Company expects that it will continue to spend
substantial funds on research and development in order to maintain its
competitiveness in new product and process technology development.
 
     The Company's future success is highly dependent upon the timely completion
and introduction of new products at competitive price/performance levels. The
success of new products depends on a variety of factors, including product
selection, successful and timely completion of product development, the
Company's ability to secure sufficient wafer fabrication capacity, achievement
of acceptable wafer fabrication yields (the proportion of good die on a silicon
wafer) by the Company and independent wafer suppliers, and the Company's ability
to offer such new products at competitive prices. There can be no assurance that
the Company will be able to successfully identify new product opportunities and
develop and bring to market such new products or that the Company will be able
to respond effectively to new technological changes or new product announcements
by others. In addition, the Company may experience delays, difficulty in
procuring adequate fabrication capacity for the development and manufacture of
such new products or other difficulties in achieving volume production of these
new products. The failure of the Company to complete and introduce new products
in a timely manner and at competitive price/performance levels would materially
and adversely affect the Company's operating results. See "Factors That May
Affect Future Results -- Dependence on New Products."
 
LICENSES, PATENTS AND TRADEMARKS
 
     The Company aggressively seeks the issuance of patents to protect
inventions and technology which are important to its business. The Company has
been awarded seven United States patents in the area of circuit design and wafer
processing, with various expiration dates, none earlier than 2010. In addition,
the Company has three United States patent applications pending. The Company
also has six current foreign patent applications pending. The Company has one
registered U.S. trademarks. The Company has also routinely protected its
numerous original mask sets under the U.S. Semiconductor Chip Protection Act.
There can be no assurance that the Company's pending patent applications will be
allowed or that the issued or pending patents will not be challenged or
circumvented by competitors.
 
     Notwithstanding the Company's pursuit of patent protection, the Company
believes that its future success will depend primarily upon the technical
expertise, creative skills and management abilities of its officers and key
employees rather than on patent ownership. The Company also relies substantially
on trade secrets and proprietary technology to protect its technology and
manufacturing know-how, and works actively to foster continuing technological
innovation to maintain and protect its competitive position. There can be no
assurance that the Company's competitors will not independently develop or
patent substantially equivalent or superior technologies.
 
     The semiconductor industry is characterized by substantial litigation
regarding patent and other intellectual property rights. In the past the Company
has received correspondence from Cypress Semiconductor, Inc., the Lemelson
Medical, Education and Research Foundation, International Business Machine
Corporation and Music Semiconductor, Inc. claiming that certain of the Company's
products have infringed certain patents. The Company's patent counsel is
reviewing the claims. There can be no assurance that such claims will not result
in litigation or that other third parties will not assert claims against the
Company that
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result in litigation. Any such litigation, whether or not determined in favor of
the Company, could result in significant expense and divert the Company's
attention from other matters. If any of the Company's products were found to
infringe any third party patent, and such patent were determined to be valid,
the third party would be entitled to injunctive relief, which would prevent the
Company from selling any such infringing products. In addition, depending on the
number of infringing products and the extent of sales of such products, the
Company could suffer significant monetary damages, which could include treble
damages for any infringement that is determined to be willful. Although QSI
could seek a license to sell products determined to infringe any third party
patent, there can be no assurance that a license would be available on terms
acceptable to the Company, if at all. The Company could also attempt to redesign
any infringing products so as to avoid infringement, although any effort to do
so could be expensive and time consuming, and there is no assurance the effort
would be successful. See "Factors That May Affect Future Results -- Patents and
Proprietary Rights."
 
SUBSIDIARY
 
     The Company has one wholly-owned subsidiary Quality Semiconductor
Australia, Pty. Ltd. ("QSA") in Sydney, Australia. QSA has a fully operational
wafer foundry business and product design center.
 
EMPLOYEES
 
     At September 27, 1998, the Company had approximately 193 full-time
employees, including 25 in sales, marketing and customer support, 79 in
manufacturing, assembly and testing, 57 in research and product development, and
32 in finance and administration.
 
     The Company's future success will depend to a large extent on the continued
contributions of Chun P. Chiu and R. Paul Gupta, who would be difficult to
replace. The future success of the Company also will depend on its ability to
attract and retain qualified marketing, technical and management personnel,
particularly highly skilled design, process and test engineers, for whom
competition is intense. The loss of or failure to attract and retain any such
persons could delay product development cycles or otherwise have a material
adverse effect on the Company's business. The Company has never had a work
stoppage and certain employees of the Company's wafer fab facility are
represented by a labor organization. The Company considers its employees
relations to be good.
 
OFFICERS AND DIRECTORS OF THE REGISTRANT
 
     The officers and directors of the Company and their ages as of September
27, 1998 are as follows:
 
<TABLE>
<CAPTION>
             NAME                AGE                             POSITION
             ----                ---                             --------
<S>                              <C>  <C>
Chun P. Chiu...................  56   Chairman of the Board of Directors and Chief Technical Officer
R. Paul Gupta..................  60   President and Chief Executive Officer
David Sear.....................  53   Executive Vice President and Chief Operating Officer
Albert Enamait.................  59   Vice President of Sales and Marketing
Edward J. Bradley, Jr..........  55   Vice President of Manufacturing Operations
Stephen H. Vonderach...........  64   Vice President of Finance, Chief Financial Officer,
                                      Chief Accounting Officer and Secretary
Andrew J. S. Kang..............  47   Director
Robert L. Puette...............  56   Director
Masaharu Shinya................  55   Director
David D. Tsang.................  56   Director
</TABLE>
 
     Mr. Chiu, one of the Company's founders, has served as the Company's
Chairman of the Board since its inception in 1988, Chief Executive Officer from
inception until March 1996 and President from inception until June 1994. In
March of 1996 he also became the Company's Chief Technical Officer. In 1980, Mr.
Chiu co-founded Integrated Device Technology, Inc. ("IDT"), a semiconductor
manufacturer, and served in various management positions at IDT through 1988,
most recently as Director, Business Development for
 
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Japan and Far East. Mr. Chiu also has served as a director of several privately
owned companies, including Capella Micro Systems. Mr. Chiu holds an MSEE degree
from Oregon State University and a BSEE degree from Waseda University, Tokyo,
Japan.
 
     Mr. Gupta has served as Chief Executive Officer since March 1996, Chief
Operating Officer from February 1993 to March 1996 and as a director of the
Company since August 1995. He served as Vice President of Operations from August
1992 until June 1994. Since May 1995, Mr. Gupta has served as a director of
YieldUp International Corp. From 1988 to 1992, Mr. Gupta served as President of
Blackship Computers, a system integration company. Mr. Gupta holds a BSEE degree
from California State University -- San Luis Obispo.
 
     Dr. Sear has served as Executive Vice President and Chief Operating Officer
since January 1998. From January 1994 to February 1997, Dr. Sear served as
President and Chief Executive Officer of Integrated Circuit Systems Inc. Dr.
Sear served as President and Chief Operating Officer of Catalyst Semiconductor
from December 1990 to January 1994. Dr. Sear holds a BSEE and Ph.D. degrees from
the University of London, England.
 
     Mr. Enamait has served as the Company's Vice President of Sales and
Marketing since July 1, 1996. From 1991 until 1996 Mr. Enamait was a consultant
with BJE Associates, an executive training and consulting firm. From 1989 to
1991, Mr. Enamait was Director, Worldwide Sales and Standard Product Marketing
for Raytheon Semiconductor, a semiconductor manufacturer.
 
     Mr. Bradley, Jr. joined the Company in January 1993. Before his appointment
to Vice President of Operations in February 1996, Mr. Bradley served as
Director, Manufacturing Operations. Prior to joining the Company, Mr. Bradley
was employed with Harris Semiconductor (formerly GE/Intersil), a semiconductor
manufacturer, where he held various positions in manufacturing management
including Operations Manager, Plant Manager and Director of Production Control
and Test Operations.
 
     Mr. Vonderach has served as Vice President of Finance, Chief Financial
Officer, Chief Accounting Officer and Secretary of the Company since April 1998.
From March 1997 to March 1998 Mr. Vonderach served as Vice President and Chief
Financial Officer of Ixmicro Corporation. From July 1993 to February 1997 Mr.
Vonderach served as Vice President and Chief Financial Officer of the Company.
Mr. Vonderach holds a BBA degree from University of Pittsburgh and an MBA from
Pepperdine University.
 
     Mr. Kang has served as a director of the Company since 1992. In 1990, Mr.
Kang founded Technology Associates Corp., a Taiwanese venture capital company
and was its President until October, 1997. Since October, 1997 Mr. Kang has been
the Managing Director of Technology Associates Management Co., Ltd., which
manages Techgains venture fund. Mr. Kang also is serving as the president of
Natural Polymer International Corp., a Dallas based biodegradable material
research manufacturing company. Mr. Kang holds a MA degree from Soochow
University, Taiwan, and MSM from ADL Management Education Institute, Cambridge,
MA.
 
     Mr. Puette has served as a director of the Company since 1992. Mr. Puette
is the President and director of Centigram Corporation, a communications
company. Mr. Puette was the Chairman, President and Chief Executive Officer of
NetFRAME Systems, Inc., a computer company from 1995 to 1997. From 1990 to 1993,
Mr. Puette served as President of Apple USA, a computer manufacturer. Prior to
1990, Mr. Puette served as a group general manager of Hewlett-Packard Company,
an electronics and systems company. Mr. Puette also serves as a director of
Cisco Systems, Inc., a networking company. Mr. Puette holds a BSEE degree from
Northwestern University and a MSOR degree from Stanford University.
 
     Mr. Shinya has served as a director of the Company since its inception in
1988. Mr. Shinya has served as President of Kanematsu Semiconductor Corporation,
a distributor of electronics products in Tokyo, Japan, since 1990 and from 1988
to 1990, as Senior Managing Director. Kanematsu Semiconductor Corporation is a
subsidiary of Kanematsu Corporation, a large Japanese trading house. Mr. Shinya
also serves on the Board of Directors of several privately held companies.
 
                                        9
<PAGE>   10
 
     Mr. Tsang has been President and Chief Executive Officer of Oak Technology,
Inc. ("Oak") since he founded the company in July 1987 and a director of Oak
since October 1987. He has also served as Chairman of the Board of Directors of
Oak since January 1991. Mr. Tsang has also held the position of Chief Financial
Officer and Secretary of Oak. Since January 1997, he has also been a director of
ASE Test Ltd. Mr. Tsang holds a BSEE degree in electrical engineering from
Brigham Young University and an MS degree in electrical engineering from the
University of Santa Clara.
 
ITEM 2. PROPERTIES
 
     The Company's headquarters and research and development activities are
located in Santa Clara, California, in a 50,000 square foot facility which
includes approximately 3,000 square feet of facilities for the Company's test
operations. In July 1997, the Company extended its current lease agreement
through March 2001. The Company also leases a 41,000 square foot facility in
Sydney, Australia as a result of its acquisition of the wafer fabrication
facility in February 1996. Included in this facility is a class 10 wafer
fabrication area of approximately 5,000 square feet, an assembly area of
approximately 4,000 square feet and a test area of approximately 3,000 square
feet. In addition, the Company has short-term leases for its sales offices
located in Irvine, California and Framingham, Massachusetts. The Company
believes that its existing facilities are adequate to meet its currently
foreseeable requirements.
 
ITEM 3. LEGAL PROCEEDINGS
 
     Not applicable.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
 
                                       10
<PAGE>   11
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
MARKET FOR COMMON STOCK
 
     Quality Semiconductor, Inc.'s common stock is listed on the Nasdaq National
Market and is traded under the symbol "QUAL." The following table represents the
high and low sales prices for the Company's common stock for each quarter of
fiscal 1998 and 1997.
 
<TABLE>
<CAPTION>
                                                              HIGH      LOW
                                                             ------    ------
<S>                                                          <C>       <C>
1998
First Quarter..............................................  $14.75    $ 3.88
Second Quarter.............................................  $ 5.69    $ 3.75
Third Quarter..............................................  $ 4.25    $ 2.13
Fourth Quarter.............................................  $ 2.38    $ 1.50
 
1997
First Quarter..............................................  $ 9.25    $ 6.13
Second Quarter.............................................  $10.13    $ 7.00
Third Quarter..............................................  $11.75    $ 7.25
Fourth Quarter.............................................  $16.75    $10.38
</TABLE>
 
     The Company has never paid cash dividends and has no present intention to
pay cash dividends.
 
  Holders of Record
 
     As of September 30, 1998, there were 130 shareholders of record of the
Company's Common Stock. Since many holders are listed under their brokerage
firms' names, the actual number of shareholders is higher.
 
ITEM 6. SELECTED FINANCIAL DATA
 
<TABLE>
<CAPTION>
                                                       YEARS ENDED SEPTEMBER 30,
                                          ----------------------------------------------------
                                            1998       1997       1996       1995       1994
                                          --------    -------    -------    -------    -------
                                                 (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                       <C>         <C>        <C>        <C>        <C>
REVENUES:
Total revenues..........................  $ 60,818    $62,691    $44,688    $46,189    $36,966
Operating income (loss).................  $(12,308)   $   720    $(3,530)   $ 6,386    $ 5,189
Interest, net...........................  $   (642)   $  (398)   $    77    $   520    $  (192)
Income (loss) before provision (benefit)
  for taxes.............................  $(12,950)   $   322    $(2,015)   $ 6,906    $ 4,997
Net income (loss).......................  $(15,334)   $   210    $(1,310)   $ 4,766    $ 3,243
Basic net income (loss) per share.......  $  (2.06)   $  0.03    $ (0.24)   $  1.00    $  2.51
Diluted net income (loss) per share.....  $  (2.06)   $  0.03    $ (0.24)   $  0.85    $  0.83
Weighted average shares outstanding
  (Basic)...............................     7,428      6,361      5,524      4,750      1,294
Weighted average shares outstanding
  (Diluted).............................     7,428      7,053      5,524      5,589      3,900
Working capital.........................  $  9,211    $27,775    $14,103    $27,379    $ 8,460
Total assets............................  $ 46,313    $69,832    $52,521    $42,779    $23,146
Long-term obligations (less current
  portion)..............................  $  5,146    $ 7,202    $ 2,840    $     5    $   493
Shareholders' equity....................  $ 26,290    $43,637    $30,345    $31,221    $11,888
Dividends...............................  $     --    $    --    $    --    $    --    $    --
</TABLE>
 
                                       11
<PAGE>   12
 
<TABLE>
<CAPTION>
                                                   FOR THE YEARS ENDED SEPTEMBER 30,
                                          ----------------------------------------------------
                                            1998       1997       1996       1995       1994
                                          --------    -------    -------    -------    -------
                                                 (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                       <C>         <C>        <C>        <C>        <C>
BASIC NET INCOME (LOSS) PER SHARE
  COMPUTATION
Numerator:
  Net income (loss).....................  $(15,334)   $   210    $(1,310)   $ 4,766    $ 3,243
                                          ========    =======    =======    =======    =======
Denominator:
  Weighted average number of shares
     outstanding during the period......     7,428      6,361      5,524      4,750      1,294
                                          ========    =======    =======    =======    =======
Basic net income (loss) per share.......  $  (2.06)   $  0.03    $ (0.24)   $  1.00    $  2.51
                                          ========    =======    =======    =======    =======
DILUTED NET INCOME (LOSS) PER SHARE
  COMPUTATION
Numerator:
  Net income (loss).....................  $(15,334)   $   210    $(1,310)   $ 4,766    $ 3,243
                                          ========    =======    =======    =======    =======
Denominator:
  Weighted average number of shares
     outstanding during the period......     7,428      6,361      5,524      4,750      1,294
Effect of dilutive securities:
  Stock options.........................        --        676         --        556        430
  Warrants..............................        --         16         --          3         --
  Convertible preferred stock...........        --         --         --        280      2,176
                                          --------    -------    -------    -------    -------
  Total.................................     7,428      7,053      5,524      5,589      3,900
                                          ========    =======    =======    =======    =======
Dilutive net income (loss) per share....  $  (2.06)   $  0.03    $ (0.24)   $  0.85    $  0.83
                                          ========    =======    =======    =======    =======
</TABLE>
 
     See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Notes to Consolidated Financial Statements."
 
                                       12
<PAGE>   13
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 
RESULTS OF OPERATIONS
 
     This discussion summarizes the significant factors affecting the Company's
consolidated operating results, financial condition, liquidity and cash flows
during the three year period ended September 30, 1998. The following discussion
should be read in conjunction with the five year summary of selected financial
data and the Company's consolidated financial statements and notes thereto.
 
     The following table sets forth certain financial data from the Consolidated
Statements of Operations as a percentage of net revenues for the periods
indicated.
 
<TABLE>
<CAPTION>
                                                              YEARS ENDING SEPTEMBER 30,
                                                              --------------------------
                                                               1998      1997      1996
                                                              ------     -----     -----
<S>                                                           <C>        <C>       <C>
Net revenues................................................    100%      100%      100%
Cost of revenues............................................   79.5      63.9      67.6
Gross margin................................................   20.5      36.1      32.4
Operating expenses..........................................   40.8      34.9      40.3
Research and development....................................   17.2      14.8      15.7
Sales and marketing.........................................   15.3      13.3      15.6
General and administrative..................................    8.3       6.9       9.0
Total operating expenses....................................   40.8      35.0      40.3
Operating income (loss).....................................  (20.2)      1.1      (7.9)
Other income................................................     --        --       3.2
Interest, net...............................................   (1.1)     (0.6)      0.2
Income (loss) before provision (benefit) for taxes..........  (21.3)      0.5      (4.5)
Provision (benefit) for taxes...............................    3.9       0.2      (1.6)
Net income (loss)...........................................  (25.2)%     0.3%     (2.9)%
</TABLE>
 
PROPOSED MERGER WITH INTEGRATED DEVICE TECHNOLOGY, INC.
 
     On November 1, 1998, the Company signed a definitive agreement to merge
with Integrated Device Technology, Inc. ("IDT"). Under the terms of the
agreement, each issued and outstanding share of the Company's Common Stock will
be exchanged for 0.6875 shares of Common Stock of IDT. The merger is planned to
close during the first calendar quarter of 1999.
 
ACQUISITION OF BUSINESS
 
     On February 16, 1996 the Company acquired certain assets of AWA
MicroElectronics Pty. Ltd. ("AWAM"), a subsidiary of AWA Limited, based in
Sydney, Australia. The AWAM assets that were acquired by a new subsidiary of the
Company, Quality Semiconductor Australia, Pty. Ltd. ("QSA"), included a fully
operational wafer foundry business and product design center. In a separate
agreement, the Company has also signed a strategic alliance agreement with AWA
Limited, to jointly develop new products and technologies. The acquisition was
accounted for using the purchase method.
 
     The net purchase price of the AWAM facility was $11.8 million, consisting
of $5.0 million cash, $6.3 million present value of redeemable preference shares
of QSA, fair value of warrants of $65,000, and acquisition costs of
approximately $400,000. The allocation of the purchase price, based upon an
independent valuation, consisted of $8.8 million of net tangible assets and $3.0
million of intangible assets which were related to assembled workforce, customer
base, and goodwill, which are being amortized over five years. The Company had
incurred approximately $505,000 of amortization expense in fiscal 1998 ($610,000
in fiscal 1997) related to the acquisition. AWA Limited was issued 1,000
redeemable preference shares of QSA at an issue price of $1,125 per share. In
July 1997, the Company redeemed 426 preference shares for approximately $3.0
million. The Company redeemed the final 574 preference shares for approximately
$4.0 million
 
                                       13
<PAGE>   14
 
(including interest charges) in January 1998. These redeemable preference shares
were categorized as debt on the balance sheet and discounted to their present
value. QSA's results of operations have been included in the consolidated
results of operations since the date of acquisition. See Note 5 of Notes to
Consolidated Financial Statements.
 
NET REVENUES
 
     Fourth quarter fiscal year 1998 revenues declined $8.3 million compared to
the same period of fiscal year 1997. The decline in fourth quarter revenues was
substantially attributable to poor market conditions, particularly in the Far
East, intense competition and decreasing average selling prices. This quarterly
decline resulted in a decline in revenues for the twelve months ended September
30, 1998 compared to the twelve months ended September 30, 1997.
 
     Net revenues for fiscal 1998 were $60.8 million, a decrease of 3% from net
revenues in fiscal 1997. This compares with an increase of net revenues of 40%
in fiscal 1997 compared to fiscal 1996. The decline in revenues from year to
year was mainly the result of lower volume shipments of logic products and lower
average selling prices for both logic and QuickSwitch products. These declines
in revenues were partially offset by increases in revenues from year to year for
networking and clock management products whose increased volumes were also
adversely affected by lower average selling prices. Although networking revenues
increased in fiscal year 1998 over fiscal year 1997, quarterly revenues in
fiscal year 1998 declined continually from the first quarter to the fourth
quarter. The increase in net revenues from fiscal 1996 to fiscal 1997 was mainly
due to shipments of proprietary networking and clock management products which
began shipping in fiscal 1997 and accounted for over 30% of fiscal 1997
revenues, and increased unit shipments in logic products, partially offset by
lower average selling prices due mainly to intense competition, lower demand and
declining ASPs. The Company expects that the average selling prices of its
products generally will continue to decline over the lives of such products.
Sales of networking, clock management and interface logic devices are expected
to continue to account for a significant majority of revenues in the foreseeable
future. To increase net revenues, the Company seeks to increase unit sales of
existing products, principally by reducing prices in conjunction with cost
reduction programs, and to introduce and sell new products. No assurance can be
given that these efforts will be successful.
 
     As is common in the semiconductor industry, the Company sells a significant
portion of its products through distributors. Domestic distributors accounted
for approximately, 21%, 19% and 26% of the Company's net revenues during fiscal
1998, 1997 and 1996, respectively. The decrease in percentage of net revenues
through distribution from fiscal 1996 to fiscal 1998 and 1997 was mainly due to
a majority of the networking products being shipped direct from QSI to end
users. Sales by Arrow Electronics Inc. ("Arrow") accounted for approximately
15%, 12% and 19% of net revenues during fiscal 1998, 1997 and 1996,
respectively, and the remainder of domestic distributor sales were made
primarily through Bell Industries and NuHorizons Electronics Corp. Recognition
of sales to these distributors and the related cost of sales is deferred until
such distributors resell the products to their customers. There can be no
assurance that future sales by distributors will continue at the present levels.
The loss of one or more distributors could have a material adverse effect on the
Company's operating results.
 
     In fiscal 1998, sales to Arrow and Kanematsu USA, Inc. accounted for 15%
and 12% of net revenues, respectively. In fiscal 1997, sales to Arrow and
Kanematsu USA, Inc. accounted for 12% and 17% of net revenues, respectively, and
in fiscal 1996, sales to Arrow, Kanematsu USA, Inc. and Solectron accounted for
19%, 11% and 10%, of net revenues, respectively.
 
     Export sales, primarily consisting of sales to countries in Europe and the
Far East, constituted 35%, 42% and 38% of net revenues for fiscal 1998, 1997 and
1996, respectively. The decline in export sales to Asia from fiscal 1997 to
fiscal 1998 was the result of poor market conditions in those various countries.
 
                                       14
<PAGE>   15
 
GROSS MARGIN
 
     The following table sets forth the Company's net revenues and gross margin:
 
<TABLE>
<CAPTION>
                                                              YEARS ENDED SEPTEMBER 30,
                                                        --------------------------------------
                                                           1998          1997          1996
                                                        ----------    ----------    ----------
                                                        (IN THOUSANDS, EXCEPT PERCENTAGE DATA)
<S>                                                     <C>           <C>           <C>
Net revenues..........................................   $60,818       $62,691       $44,688
Cost of revenues......................................   $48,324       $40,073       $30,226
Gross margin..........................................   $12,494       $22,618       $14,462
Gross margin as a percentage of net revenues..........      20.5%         36.1%         32.4%
</TABLE>
 
     The Company's cost of revenues includes the cost of wafer fabrication,
assembly performed by third party vendors, testing by third party vendors and
direct and indirect costs associated with the testing, procurement, scheduling,
quality assurance functions performed by the Company, and writedowns of
inventory.
 
     Gross margin in fiscal 1998 was 21% of net revenues, compared with 36% of
net revenues in fiscal 1997 and 32% of net revenues in fiscal 1996. The lower
margins in fiscal 1998 were principally due to inventory write-downs, mainly
relating to networking products. The write-down of networking products was
primarily the result of intense competition and a shifting of the market from
single PHY to quad PHY, which the Company does not currently offer. This shift
began in fiscal 1997 when the Company was shipping its single PHY product at
record levels and had to make commitments for wafers to its wafer foundry. These
factors combined to create the excess inventory. In addition, higher than
expected testing costs and related lower than expected yields for the Company's
networking products contributed to the lower margins. Also contributing to the
lower margins was the decrease in average selling prices across all product
lines. Gross margin in fiscal 1997 was 36% of net revenues, compared with 32% of
net revenues in fiscal 1996. The increase in gross margin from fiscal 1996 to
1997 resulted from changes in product mix, specifically, the sale of higher
margin networking and clock management products and the Company's cost reduction
programs.
 
     The markets for the Company's products are subject to severe price
competition and price declines. There can be no assurance that the Company will
succeed in reducing its product costs rapidly enough to maintain or increase its
gross margin level.
 
     The Company's quarterly revenues and operating results have varied
significantly in the past and are likely to vary substantially from quarter to
quarter in the future. The Company's operating results are affected by a wide
variety of factors, many of which are outside of the Company's control,
including but not limited to, economic conditions and overall market demand in
the United States and worldwide, the Company's ability to introduce new products
and technologies on a timely basis, changes in product mix, fluctuations in
manufacturing costs which affect the Company's gross margins, declines in market
demand for the Company's and its customers' products, sales timing, the level of
orders which are received and can be shipped in a quarter, the cyclical nature
of both the semiconductor industry and the markets addressed by the Company's
products, product obsolescence, price erosion, and competitive factors. The
Company's operating results in fiscal 1999 are likely to be affected by these
factors as well as others.
 
     The Company must order wafers and build inventory well in advance of
product shipments. Because the Company's markets are volatile and subject to
rapid technology and price changes, there is a risk that the Company will
forecast incorrectly and produce excess or insufficient inventories of
particular products. This inventory risk is heightened because many of the
Company's customers place orders with short lead times. These factors increase
not only the inventory risk but also the difficulty of forecasting quarterly
operating results. Moreover, as is common in the semiconductor industry, the
Company frequently ships more product in the third month of each quarter than in
either of the first two months of the quarter, and shipments in the third month
are higher at the end of that month. The concentration of sales in the last
month of the quarter contributes to the difficulty in predicting the Company's
quarterly revenues and results of operations.
 
     The Company's products are in various stages of their product life cycles.
The Company's success is highly dependent upon its ability to develop complex
new products, to introduce them to the marketplace ahead of the competition, and
to have them selected for design into products of leading system manufacturers.
 
                                       15
<PAGE>   16
 
These factors have become increasingly important to the Company's results of
operations because the rate of change in the markets served by the Company
continues to accelerate. Since product life cycles are continually becoming
shorter, revenues may be affected quickly if new product introductions are
delayed or if the Company's products are not designed into successive
generations of products of the Company's customers.
 
     The Company's gross margins also will depend on the Company's success at
introducing and ramping production of new products quickly and effectively
because the gross margins of semiconductor products decline as competitive
products are introduced. Also, the Company must deliver product to customers
according to customer schedules. Any delay in new product introductions could
affect revenues and gross margins for current and follow-on products if
customers shift to competitors to meet their requirements.
 
     As a result of the above factors, gross margin fluctuations are difficult
to predict, and there can be no assurance that the Company will maintain gross
margins at current levels in future periods. To offset this margin pressure, the
Company seeks to reduce costs by improving wafer yields, negotiating price
reductions with suppliers, and achieving economies of scale by means of higher
production levels. The Company also seeks to offset margin erosion by selling a
higher percentage of new products, which tend to have higher margins than more
mature products. No assurance can be given that these efforts will be
successful.
 
RESEARCH AND DEVELOPMENT
 
     The Company's research and development activities include process
development and new product development. Research and development expenditures
in fiscal 1998 were $10.5 million, or 17% of net revenues, compared to $9.3
million, or 15% of net revenues in fiscal 1997, and $7.0 million, or 16% of net
revenues in fiscal 1996. The increase in spending for fiscal 1998 reflected
mainly an increase for product development including payroll and design related
expenses. The increase in spending for fiscal 1997 was mainly due to increased
spending on new product development and process technology. These costs included
higher material and testing charges, and increased payroll related expenses. The
Company believes that the continued development of its new products is essential
to its success and is committed to continue its investment in research and
development to maintain a strong technological position in the industry. All the
Company's research and development costs are expensed as incurred.
 
     The Company believes that future revenue growth will depend in substantial
part on the success of new products and the continued success and sales of
existing products. New products are generally incorporated into a customer's
product or system at the design stage. However, design wins, which can often
require significant expenditures by the Company, may precede the generation of
volume sales, if any, by a year or more. No assurance can be given that the
Company will achieve design wins or that any design win will result in
significant future net revenues.
 
SALES AND MARKETING
 
     Sales and marketing expenditures in fiscal 1998 were $9.3 million, or 15%
of net revenue compared with $8.3 million, or 13% of net revenues in fiscal 1997
and $7.0 million, or 16% of net revenues in fiscal 1996. Sales and marketing
expenses for fiscal 1998 increased from fiscal 1997 primarily due to payroll
related expenses and marketing communications expenses for new product data
books. Sales and marketing expenses in fiscal 1997 increased from fiscal 1996
mainly due to increased sales commissions due to higher revenues, increased
payroll related expenses and marketing programs to support the launch of new
products.
 
GENERAL AND ADMINISTRATIVE
 
     General and administrative expenditures in fiscal 1998 were $5.0 million,
or 8% of net revenues, compared with $4.3 million, or 7% of net revenues in
fiscal 1997, and $4.0 million, or 9% of net revenues in fiscal 1996. General and
administrative expenses increased 17% over fiscal 1997 mainly due to higher
payroll and legal expenses. General and administrative expenditures in fiscal
1997 remained flat compared to fiscal 1996. The percentage decrease from 1996 to
1997 and 1998 reflects management's continued efforts to control spending.
 
                                       16
<PAGE>   17
 
OTHER INCOME
 
     Other income of $1.4 million in fiscal 1996 was earned as a result of
engineering and marketing services provided by the Company pursuant to an
agreement with AWA Limited. The Company has completed the services under the
agreement with AWA Limited and does not expect similar income to continue in
future periods.
 
INTEREST, NET
 
     Net interest expense for fiscal 1998 was $642,000 compared to $398,000 for
fiscal 1997 and net interest income of $77,000 in fiscal 1996. The increase in
net interest expense in fiscal 1998 from fiscal 1997 was the result of financing
capital equipment additions and earning less interest on lower cash balances.
The change from net interest income in fiscal 1996 to net interest expense in
fiscal 1997 was due to increased interest expense associated with an increase in
notes payable used to purchase property and equipment.
 
PROVISION (BENEFIT) FOR TAXES
 
     The Company incurred a provision for income taxes of $2.4 million in fiscal
1998, primarily as a result of write-offs of deferred tax assets and the Company
not benefitting its pre-tax loss of $13.0 million due to limitations imposed
under Statement of Financial Accounting Standards No. 109 (SFAS 109),
"Accounting for Income Taxes." The Company's effective tax rate was 35% for each
of fiscal 1997 and fiscal 1996. Significant items impacting the 1997 effective
tax rate include state income taxes, research and development credits and
nondeductible amortization of interest. The Company recorded a tax benefit for
fiscal 1996 based on available carryback potential.
 
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
 
     Since its inception, the Company has financed its operations and investment
in property, plant and equipment primarily through the sale of debt and equity
securities. During the twelve months ended September 30, 1998 net cash provided
by operations totaled $7.3 million, primarily as a result of efforts to reduce
operating costs and working capital requirements. Depreciation and amortization
contributed $7.4 million, while changes in operating assets and liabilities
added $12.6 million to the cash provided by operations, mainly due to decreases
of $8.9 million in inventories, and $2.8 million in accounts receivable and more
than offset the net loss of $15.3 million for the year. Investment in capital
equipment of $6.3 million was partially offset by sales of short term
investments net of purchases, which provided $1.8 million primarily resulting in
$4.6 million of cash used in investing activities.
 
     The reduction of long term debt of $6.4 million, including approximately
$4.0 million for the final installment for the purchase of the wafer fabrication
facility in Australia represented a substantial majority of the Company's
financing activities.
 
     The combined effect of the investing and financing activities partially
offset by the cash provided by operating activities resulted in a decrease of
$3.5 million in cash from, $9.4 million at the beginning of fiscal 1998 to $5.9
million in cash at the year end of fiscal 1998.
 
     The Company believes that current available cash, short-term investments
and cash generated from operations will be sufficient to finance the Company's
working capital and capital equipment requirements through at least the next
twelve months. The Company anticipates a reduction in capital expenditures in
fiscal 1999.
 
YEAR 2000 ISSUES
 
  General
 
     The Company is currently conducting a company-wide Year 2000 readiness
program ("Y2K Program"). The Y2K Program is addressing the issue of computer
programs and embedded computer chips being unable to distinguish between the
year 1900 and the year 2000. Therefore, some computer hardware and software will
 
                                       17
<PAGE>   18
 
need to be modified prior to the year 2000 in order to remain functional. The
Company anticipates that Year 2000 compliance will be substantially complete by
June, 1999.
 
  Year 2000 Program
 
     The Company's Y2K Program is divided into four major sections -- QSI
manufactured products, internal information ("IT") system, non-IT system (e.g.,
testing equipment), and third-party suppliers and customers. The general phases
common to all sections are: (1) inventorying Year 2000 items; (2) assessing the
Year 2000 compliance of items determined to be material to the company; and (3)
repairing or replacing material items that are determined not to be Year 2000
compliant.
 
     The Company has completed the review of QSI manufactured products for Year
2000 compliance purposes. It did not find any Year 2000 related issues in
products which it sells to customers.
 
     With respect to its internal IT computer systems, the Company has completed
the inventory and review phases of the Y2K Program. The Company expects to
complete the repair and replacement phase by not later than June 1999.
 
     The Company has completed the inventory phase of its non-IT systems. It is
currently reviewing the Year 2000 compatibility of its non-IT systems. It is
expected to complete the review by December, 1998. To date, about 30 percent of
its non-IT systems are Year 2000 compliant. Those that are not yet Year 2000
compliant will be repaired or replaced by June, 1999.
 
     The Company has been working with its key suppliers and contract
manufacturers to assess the possible effects of their Year 2000 readiness on the
Company's operations. The Company's reliance on suppliers and contract
manufacturers and, therefore, on the proper functioning of their information
systems and software, means that failure to address Year 2000 issues could have
a material impact on the Company's operations and financial results; however,
the potential impact and related costs are not known at this time.
 
  Costs
 
     The Company does not have a separate budget for its Y2K Program. It has
paid for the cost related to the Y2K Program out of its budget allocated for
annual maintenance. The total cost associated with required modifications to
become Year 2000 compliant is not expected to be material to the Company's
financial position. The Company estimates that it may spend up to an additional
$300,000 for other repairs, replacements or upgrades and for communicating with
key suppliers and customers.
 
  Risks
 
     The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Year 2000 problem resulting in part from the
uncertainty of the Year 2000 readiness of third-party suppliers and customers,
the Company is unable to determine at this time whether the consequences of Year
2000 failures will have a material impact on the Company's results of
operations, liquidity or financial condition. The Y2K Program is expected to
significantly reduce the Company's level of uncertainty about the Year 2000
problem and, in particular, about the Year 2000 compliance and readiness of its
material key suppliers and customers. The Company believes that, with the
completion of the Y2K Program as scheduled, the possibility of significant
interruptions of normal operations should be reduced.
 
     The Company does not yet have a contingency plan to address the Year 2000
problem, but it is expected to complete one by June 1999.
 
                                       18
<PAGE>   19
 
FACTORS THAT MAY AFFECT FUTURE RESULTS
 
  Cautionary Statement Concerning Forward Looking Statements
 
     This report contains certain forward-looking statements that are subject to
risks and uncertainties. For such statements the Company claims the protection
of the safe harbor for forward-looking statements contained in Section 21E of
and Rule 3b-6 under the Securities Exchange Act of 1934. Such forward-looking
statements include, without limitations, statements regarding the Company's
expectations, intentions or future strategies and involve known and unknown
risks, uncertainties and other factors. The following factors, in addition to
those discussed elsewhere in the report, could cause the results to differ
materially from those expressed in such forward looking statements. All forward
looking statements included in this document are based on information available
to the Company on the date hereof, and the Company assumes no obligations to
update any such forward-looking statements. Actual results could differ
materially from those projected in the forward-looking statements as a result of
the risk factors set forth below. In evaluating the Company's business,
prospective investors should carefully consider the following risk factors in
addition to the other information set forth herein or incorporated herein by
reference.
 
  Potential Declines in Operating Results
 
     QSI's quarterly and annual operating results can fluctuate dramatically.
For example, in fiscal 1997, it had basic and diluted net income per share of
$0.03, while in fiscal 1998, it had a basic and diluted net loss per share of
$2.06. Many of the factors affecting the Company's results are beyond its
control. Some of these factors include:
 
     - market demand for the Company's new and existing products;
 
     - the ability of its competitors to offer better products or to offer
       similar products at lower prices; and
 
     - the cyclicality of the semiconductor industry in general.
 
     In addition, the factors affecting the Company's quarterly and annual
results include:
 
     - the Company's ability to accurately forecast demand for the Company's
       existing products;
 
     - the Company's ability to introduce successful new products on a timely
       basis;
 
     - the Company's ability to control the Company's expenses; and
 
     - the Company's ability to effectively manage the Company's semiconductor
       fabrication facility in Australia.
 
Each of the above factors is described in more detail below.
 
  Dependence On Two Existing Product Lines
 
     Logic products and networking products account for substantially all of the
Company's revenue.
 
     Logic Products. Demand for the Company's logic products depends heavily on
the market for personal computers. As a result, any adverse change in the demand
for personal computers will adversely affect the Company's ability to sell the
Company's logic products. In addition, the market for logic products is highly
competitive. As a result, if the Company's competitors offer similar products at
lower prices, the Company may be forced to reduce the Company's sales prices to
maintain market share or to clear inventory. This would adversely affect the
Company's gross margin and, consequently, the Company's operating and financial
results. Finally, if the designers of microprocessors incorporate the logic
functions that the Company's products perform into their microprocessors, the
demand for the Company's logic products could diminish significantly, which
would adversely affect the Company's revenues, margins, operating results and
financial condition.
 
     Networking Products. In early winter 1997, the Company introduced its 10
Base T and 100 Base Tx products. These products are CMOS transceiver chips that
are used in adapters, repeaters, switches and bus cards in Fast Ethernet
networks. They are also used for multiplexers and demultiplexers and switches in
Asynchronous Transmission Mode networks. During the remainder of fiscal 1997 and
fiscal 1998, the
 
                                       19
<PAGE>   20
 
Company derived significant revenue from the sale of these networking chips.
However, in late fiscal 1998, the Company's competitors introduced similar chips
with either better performance or lower prices. As a result, sales for these
chips have not met the Company's forecasts and the Company has had to reduce its
sales prices and, in some cases, reduce its inventory valuation to reflect the
reduced sales prices. The Company has taken reserves to account for expected
future declines in sales prices, but there can be no assurance that the
Company's reserves are adequate. Any further declines in sales prices will
adversely affect the Company's revenues, gross margins, operating results and
financial condition. Although the Company is developing new products for this
market, which the Company believes it will be able to sell at higher prices and
margins, there can be no assurance that the Company will successfully develop
such products in time, that the demand for these products will meet
expectations, that the Company's customers will like these new products or that
the Company will not face similar price competition for these products as well.
 
  Dependence on New Products
 
     For QSI to be successful, the Company must continually introduce new
products at better price/ performance levels than are currently available. To do
this, the Company must invest significantly in (i) research and development;
(ii) prototype testing; (iii) mask making; and (iv) initial inventory build. In
addition, the Company has to invest in obtaining "design wins." However, it can
be more than a year before a design win results in significant revenues. For
these reasons, the Company has an ongoing need for liquid assets to fund new
product development and introduction. This requires cash, which the Company must
generate from operations, divert from other uses or obtain from external
financing. In addition, even if the Company successfully develops and introduces
new products, there can be no assurance that the products will be successful.
The Company's new products must be timely, must perform to specifications and
must offer a better price/performance level than existing products. If the
Company is unable to generate sufficient cash to invest in developing and
introducing new products, or to introduce new products that are successful, the
Company's results of operations and financial condition will be materially
adversely affected.
 
  Competitiveness of the Semiconductor Industry
 
     The Company competes in an industry characterized by price erosion,
declining gross margins, product obsolescence and heightened international
competition in many markets. The Company's competitors include large
semiconductor companies like IDT, Texas Instruments Incorporated, National
Semiconductor Corporation, Level One and Cypress Semiconductor Corporation.
These larger companies have greater financial, technical, marketing and
distribution and other resources and offer broader product lines than the
Company does. In addition, they have longer standing relationships with their
customers and suppliers. Therefore, these companies may be better able to
withstand a downturn in the market for QSI's products or sustained price
reductions in the markets in which the Company competes.
 
     Historically, the ASPs in the semiconductor industry decrease over the life
of a particular product. If the Company is to remain profitable, the Company has
to reduce its costs as ASPs decline, and the Company must introduce new products
with higher ASPs. No assurance can be given that the Company will be able to do
this successfully, and any failure on the Company's part to reduce costs or
introduce new products in response to competitive pressures will have a material
adverse effect on the Company's operating results and financial condition.
 
  Risks Associated with Operating the Australian Semiconductor Fabrication
Facility
 
     The Company relies on the Australian fabrication facility for most of the
wafer requirements of its logic product family. The Company purchased the
facility in February 1996 and has been upgrading the facility since then. To
date, the Company has invested more than $14 million in equipment and other
capital improvements. Although the facility is currently fully operational, any
disruption in production would adversely affect the Company because
 
     - the Company would need to seek another source for its, which would
       probably raise its cost per wafer, and
 
                                       20
<PAGE>   21
 
     - the Company would continue to incur the fixed expenses associated with
       maintaining the facility even though it wasn't producing wafers for the
       Company.
 
     The manufacture of semiconductor wafers is complex and yields are highly
dependent on maintaining a clean environment. Although the fabrication process
is highly controlled, the equipment may not perform flawlessly. A substantial
percentage of wafers could be rejected or individual dies on a wafer could be
nonfunctional due to minor impurities, difficulties in the production process or
defects in the masks. If the Company is unable to maintain acceptable yields
from its wafer fabrication facility, then the Company's operating results and
financial condition would be materially adversely affected. In addition, the
Company relies on external sources for the raw materials used in the wafer
fabrication process. Although the Company has tried to qualify multiple vendors,
any shortage of raw materials or increase in the cost of raw materials would
adversely impact the Company's ability to produce enough wafers to meet its
demands and would raise its cost per wafer, which would adversely affect its
revenues and operating margins.
 
     The wafer fabrication process also requires us to store, use and dispose of
chemicals and gases that may be toxic, volatile or otherwise hazardous. The
improper storage, use or disposal of these chemicals and gases could have
materially adverse effects on humans, animals and the environment. In addition,
the storage, use and disposal of these chemicals and gases are subject to laws
and regulations at the national, state and local level. Because the public is
focusing more on environmental issues and the safety hazards associated with
handling hazardous and toxic material, the laws and regulations governing them
may become more stringent. Although the Company diligently try to comply with
the laws and regulations governing the handling of these materials, the Company
cannot guarantee that the Company will always be in compliance or that the
Company will not have to incur substantial fines or remediation costs associated
with any violation of the laws or regulations or any environmental damage
attributed to the Company's use, storage or disposal of these materials. In
addition, the Company may have to incur additional expenses in the future in
order to comply with more stringent rules or regulations governing the handling
of the chemicals and gases used in the Company's Australian fabrication
facility.
 
  Dependence On Fabrication, Assembly and Test Subcontractors
 
     Fabrication. Although the Company fabricates a majority of the Company's
wafers in the Company's Australian facility, the Company still relies on Taiwan
Semiconductor Manufacturing Company, Ltd. ("TSMC"), for a substantial number of
wafers for small geometry networking products. The risks involved in relying on
TSMC as a supplier of wafers include
 
     - the Company has less control over delivery schedules;
 
     - the Company can't be assured that TSMC will always have the capacity
       available to meet the Company's needs;
 
     - the Company has less control over quality assurance processes;
 
     - TSMC may experience technical and/or production problems that would
       prevent them from being able to fill the Company's orders; and
 
     - there is an increased risk that the Company's intellectual property may
       be misappropriated.
 
     In addition, the dependence on a third party wafer supplier tends to slow
the product development cycle because of the need to coordinate design activity
and qualify processes. Because the Company has little control over whether TSMC
continues to improve its processes, such as fabrication in finer geometries, the
Company's competitors who do not rely on third party wafer fabrication may be
better able to transition to improved processes and, as a consequence, offer
products at a better price/performance level than the Company's products.
 
     Assembly and Testing. Substantially all of the Company's assembly is
performed by Digital Testing Services ("DTS") and SPIC Electronics Laboratory
("SPEL") in India. In addition, the Company relies on SPEL and DTS to perform
substantially all of the Company's testing for the Company's networking
products. Consequently, the Company has less control over the quality and
availability of the services that they provide.
                                       21
<PAGE>   22
 
If the quality or reliability of these vendors degrades, or if the Company has
to find alternate sources of assembly and testing, the process of qualifying
alternate vendors could delay product development and product shipment and could
result in loss of customers, limitations or reductions in the Company's revenues
and other adverse effects on the Company's operating results.
 
  Risks Associated With International Purchases and Sales.
 
     The Company purchases a significant amount of the Company's wafers and
substantially all of the Company's assembly services from foreign suppliers. In
addition, the Company sells a significant amount of the Company's products to
foreign buyers. As a result, the Company is subject to the risks generally
associated with doing business abroad. These risks include, but are not limited
to:
 
     - the need to comply with foreign government regulations;
 
     - less protection for the Company's intellectual property rights;
 
     - currency fluctuation; and
 
     - greater risk of disruptions or delays in shipments due to political
       unrest, or economic instability.
 
     For example, the Company's revenues from the Company's Asian customers
declined during the fourth quarter of fiscal 1998 from the same period in fiscal
1997 as the result of uncertainties in the Asian capital markets.
 
     In addition, to the extent that the Company makes yen-denominated purchases
of wafers from its Japanese suppliers, the Company may be exposed to the risk
that the exchange rate of yen for dollars may decrease from the date that the
purchases are agreed upon and the wafers are delivered and, therefore, the
Company would have underestimated the cost of such wafers.
 
  Patents and Proprietary Rights
 
     The semiconductor industry is characterized by substantial litigation
regarding patent and other intellectual property rights. In the past the Company
has received correspondence from Cypress Semiconductor, Inc., the Lemelson
Medical, Education & Research Foundation ("Lemelson"), International Business
Machines Corporation ("IBM") and MUSIC Semiconductor, Inc., claiming that the
Company may have infringed certain patents. The Company's patent counsel is
reviewing these claims. In addition, the Company has in the past filed claims
against other companies alleging that they have misappropriated the Company's
trade secrets. Intellectual property litigation can be expensive and can divert
the energy of the Company's management and engineers. In addition, if any of the
Company's products are found to infringe a third party's valid patent, then the
Company might be subject to injunctions and significant damages. In addition,
the Company would have to either design around such patents or obtain a license.
If the Company are unable to successfully design around the patents or obtain a
license, then the Company might not be able to offer the product and the
Company's revenues and operating results could be materially adversely affected.
 
  Dependence on Key Personnel
 
     The Company's success depends on the Company's ability to recruit and
retain highly skilled engineers, marketing personnel and managers. In
particular, the Company has a strong need for highly skilled design, process and
test engineers, for whom competition is intense. The Company cannot make an
assurance that the Company will be successful in hiring or retaining such key
personnel or that any of the Company's key personnel will remain employed with
QSI.
 
  Customer Concentration
 
     Most of the Company's revenue typically comes from a relatively small
number of customers. For example, in fiscal year 1998, the Company's top seven
customers accounted for 53% of the Company's total revenue. If the Company were
to lose any of these customers, the Company's revenues and operating results
 
                                       22
<PAGE>   23
 
would be materially adversely affected. In addition, the Company typically have
to provide volume pricing discounts to these customers, which reduces the
Company's gross margin.
 
  Dependence on Manufacturer Representatives and Distributors
 
     The Company market and distribute the Company's products primarily through
manufacturers' representatives and independent distributors. This reduces the
Company's ability to control the channels of distribution for the Company's
products and requires us to respond to rapid changes in the channel due to
factors such as consolidation or distributor financial difficulties. For
example, many of the Company's distributors typically offer competing products.
If the Company's distributors or representatives were to reduce the number of
the Company's products that it carries or to terminate its relationship with us,
the Company could experience reduced revenues and would incur additional sales
expenses associated with finding a replacement.
 
  Year 2000 Compliance
 
     The dates on which the Company believes that the programs (the "Y2K
Program") initiated to address problems associated with issue of computer
programs and embedded computer chips being unable to distinguish between the
Year 1900 and the Year 2000 (the "Year 2000 Problem") will be completed are
based on the best estimates of the Company's management, which were derived
utilizing numerous assumptions of future events, including the continued
availability of certain resources, third-party modification plans and other
factors. However, the Company cannot guarantee that these estimates will be
achieved, or that there will not be a delay in, or increased costs associated
with, the implementation of the Y2K Program. Specific factors that might cause
differences between the estimates and actual results include, but are not
limited to, the availability and cost of personnel trained in these areas, the
ability to locate and correct all relevant computer code, timely responses to
and corrections by third-parties and suppliers, the ability to implement
interfaces between the new systems and the systems not being replaced, and
similar uncertainties. Due to the general uncertainty inherent in the Year 2000
Problem, resulting in part from the uncertainty of the Year 2000 readiness of
third-parties and the interconnection of global businesses, the Company cannot
guarantee that the Company will be able to timely and cost-effectively resolve
problems associated with the Year 2000 issue. Any failure to adequately address
this Year 2000 Problem could have a material adverse effect on the Company's
operations and business, or expose us to third-party liability.
 
  Cyclical Nature of Semiconductor Industry
 
     The semiconductor industry has historically been cyclical and subject to
significant economic downturns at various times and has been characterized by
diminished product demand, accelerated erosion of ASPs and overcapacity. In
addition, the end-markets for systems that incorporate the Company's products
are characterized by rapidly changing technology and evolving industry
standards. The Company may experience substantial period-to-period fluctuations
in future operating results due to general semiconductor industry conditions,
overall economic conditions or other factors.
 
  Volatility of Company's Stock Price
 
     The Company's earnings and stock price have been, and may be, subject to
significant volatility, particularly on a quarterly basis. Any shortfall in
revenue, gross margins or earnings from expected levels could have an immediate
and significant adverse effect on the trading price of the Company's stock in
any given period. The Company may not learn of, or be able to confirm, revenue,
gross margin or earnings shortfalls until late in the quarter, or following the
end of the quarter, because a significant portion of the Company's revenue in a
quarter typically is shipped in the last few weeks of that quarter. In addition,
future announcements concerning us or the Company's competitors, including
technological innovations, new product introductions, governmental regulations,
litigation, or changes in earnings estimates by analysts, may cause the market
price of the Company's stock to fluctuate substantially. Stock prices for many
technology companies fluctuate widely for reasons that may be unrelated to
operating results, such as general economic, political and market conditions.
The Company's stock price is also subject to potentially large volatility due to
the very low trading
                                       23
<PAGE>   24
 
volumes of the Company's stock on most days since the initial public offering of
the Company's stock on November 17,1994. In addition, this low trading volume
may continue and could affect the ability of shareholders to sell their shares.
 
  Requirements Associated with the Introduction of the Euro
 
     The Company is in the process of addressing the issues raised by the
introduction of the Single European Currency ("Euro") for initial implementation
as of January 1, 1999, and through the transition period to January 1, 2002. The
Company expects to be able to meet related legal requirements by January 1,
1999, and through the transition period. The Company does not expect the cost of
any system modifications to be material and does not currently expect that
introduction and use of the Euro will materially affect the Company's foreign
exchange and hedging activities or will result in any material increase in
transaction costs. The Company will continue to evaluate the impact over time of
the introduction of the Euro; however, based on currently available information
management does not believe that the introduction of the Euro will have a
material adverse impact on the Company's financial condition or the overall
trends in results of operations.
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
     The Company's exposure to market risk for changes in interest rates relates
primarily to the investment portfolio and long-term debt obligations. The
Company maintains an investment policy which ensures the safety and preservation
of its invested funds by limiting default risk, market risk, and reinvestment
risk. The table below presents principal cash flows amounts and related
weighted-average interest rates by year of maturity for the Company's investment
portfolio and long-term debt obligations.
 
<TABLE>
<CAPTION>
                                       1999      2000      2001     TOTAL     FAIR VALUE
                                      ------    ------    ------    ------    ----------
<S>                                   <C>       <C>       <C>       <C>       <C>
Cash equivalents
  Fixed rate........................  $2,664        --        --    $2,664      $2,664
  Average rate......................    3.70%       --        --      3.70%
Short-term investments
  Fixed rate........................  $1,100        --        --    $1,100      $1,100
  Average rate......................    4.70%       --        --      4.70%
Auction rate preferred
  Variable rate.....................  $  800        --        --    $  800      $  800
  Average rate......................    3.80%       --        --      3.80%
                                      ------                        ------      ------
          Total Investment
            Securities..............  $4,564        --        --    $4,564      $4,564
                                      ------                        ------      ------
  Average rate......................    3.96%       --        --      3.96%
Long-Term Debt
  Fixed rate........................  $2,488    $2,713    $1,453    $6,654      $6,654
  Average rate......................    8.70%     8.70%     8.70%     8.70%
</TABLE>
 
     The Company mitigates default risk by attempting to invest in high credit
quality securities and by constantly positioning its portfolio to respond
appropriately to a significant reduction in a credit rating of any investment
issuer or guarantor. The portfolio includes only marketable securities with
active secondary or resale markets to ensure portfolio liquidity and maintains a
prudent amount of diversification.
 
     The Company has no cash flow exposure due to rate changes for long-term
debt obligations. The Company primarily enters into debt obligation to support
general corporate purposes including capital expenditures and working capital
needs.
 
     The Company conducts business on a global basis. As such, it is exposed to
adverse or beneficial movements in foreign currency exchange rates. The Company
may enter into foreign currency forward contracts to minimize the impact of
exchange rate fluctuations on certain foreign currency commitments and balance
sheet positions. The realized gains and losses on these contracts are deferred
and offset against
 
                                       24
<PAGE>   25
 
realized and unrealized gains and losses when the transaction occurs. At
September 30, 1998 there were no outstanding foreign currency exchange
contracts.
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
     Refer to the Index at Item 14 included herein.
 
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
       DISCLOSURE
 
     Not Applicable.
 
                                       25
<PAGE>   26
 
                                    PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
     The information concerning the registrant's executive officers is included
under the caption "Officers and Directors of the Registrant" following Part I,
Item 1 of this report.
 
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT
 
     Section 16(a) of the Securities Exchange Act of 1934 (the "Exchange Act")
requires the Company's directors and executive officers, and persons who own
more than ten percent of a registered class of the Company's equity securities
to file with the Securities and Exchange Commission (the "SEC") initial reports
of ownership and reports of changes in ownership of Common Stock and other
equity securities of the Company. Officers, directors and greater than ten
percent shareholders are required by SEC regulation to furnish the Company with
copies of all Section 16(a) forms they file.
 
     To the Company's knowledge, based solely upon review of the copies of such
reports furnished to the Company and written representations that no other
reports were required, during the fiscal year ended September 27, 1998 all
Section 16(a) filing requirements applicable to its officers, directors and
greater than ten percent beneficial owners were complied with except that (1)
Dr. Sear filed his Form 3 late, and (2) David Tsang, a director of the Company,
filed a Form 5 late.
 
ITEM 11. EXECUTIVE COMPENSATION
 
SUMMARY COMPENSATION TABLE
 
     The following table shows the compensation earned by the Company's Chief
Executive Officer and the four other most highly compensated executive officers
of the Company whose salary and bonus for fiscal year 1998 were in excess of
$100,000 (collectively, the "Named Executive Officers").
 
<TABLE>
<CAPTION>
                                                                                     LONG-TERM
      NAME AND PRINCIPAL POSITION             ANNUAL COMPENSATION               COMPENSATION AWARDS
      ---------------------------        -----------------------------   ---------------------------------
                                         FISCAL                                               ALL OTHER
                                          YEAR    SALARY($)   BONUS($)   OPTIONS/SARS(#)   COMPENSATION($)
                                         ------   ---------   --------   ---------------   ---------------
<S>                                      <C>      <C>         <C>        <C>               <C>
R. Paul Gupta..........................   1998    $290,309    $82,940         70,000           $3,780(1)
  President and Chief Executive Officer   1997    $297,303    $79,866         40,000           $3,780(1)
                                          1996    $272,025    $22,880        132,500           $3,780(1)
Chun P. Chiu...........................   1998    $198,194    $48,720         40,000           $5,234(1)
  Chairman of the Board and               1997    $209,999    $50,232         20,000           $5,234(1)
  Chief Technical Officer                 1996    $202,736    $17,600         49,000           $5,522(1)
Albert R. Enamait......................   1998    $175,694    $ 5,774(2)      10,000               --
  Vice President of Sales & Marketing     1997    $168,569    $13,327(2)      20,000               --
                                          1996    $ 49,002    $ 9,500(2)      30,000               --
David Sear.............................   1998    $138,461    $31,200        150,000(3)            --
  Executive Vice President and Chief
  Operating Officer
Edward J. Bradley, Jr..................   1998    $135,310    $15,000         10,000               --
  Vice President of Manufacturing         1997    $122,192    $20,000         10,000               --
                                          1996    $111,770    $20,000         17,000               --
</TABLE>
 
---------------
(1) Represents premiums paid on life insurance policy.
 
(2) Represents amounts paid for sales incentive.
 
(3) Represents the options granted in connection with Dr. Sear's acceptance of
    employment with the Company.
 
                                       26
<PAGE>   27
 
     The following tables set forth information for the Named Executive Officers
with respect to grants of options to purchase Common Stock of the Company made
in the fiscal year ended September 27, 1998 and the value of all options held by
such executive officers on September 27, 1998.
 
STOCK OPTION/SAR GRANTS IN FISCAL YEAR 1998
 
<TABLE>
<CAPTION>
                                               INDIVIDUAL GRANTS                       POTENTIAL REALIZABLE
                            -------------------------------------------------------      VALUE AT ASSUMED
                             NUMBER OF       % OF TOTAL                               ANNUAL RATES OF STOCK
                             SECURITIES     OPTIONS/SARS                                PRICE APPRECIATION
                             UNDERLYING      GRANTED TO    EXERCISE OR                 FOR OPTIONS TERM(1)
                            OPTIONS/SARS    EMPLOYEES IN   BASE PRICE    EXPIRATION   ----------------------
           NAME               GRANTED       FISCAL YEAR*     ($/SH)         DATE        5%($)       10%($)
           ----             ------------    ------------   -----------   ----------   ---------    ---------
<S>                         <C>             <C>            <C>           <C>          <C>          <C>
R. Paul Gupta.............      70,000(2)       4.4%         $ 5.00      2/27/2008     220,113      557,818
Chun P. Chiu..............      40,000(2)       2.5%         $ 5.00      2/27/2008     125,779      318,748
Albert R. Enamait.........      10,000(2)       0.6%         $3.938      4/24/2008      24,768       62,762
David Sear................     150,000(3)       9.4%         $ 4.00      1/12/2008     377,337      956,245
Edward J. Bradley, Jr.....      10,000(2)       0.6%         $3.938      4/24/2008      24,768       62,762
</TABLE>
 
---------------
 *  Total number of options granted by the Company for the fiscal year ended
    September 27,1998 is 1,597,136 shares.
 
(1) The 5% and 10% assumed rates of appreciation are suggested by the rules of
    the Securities and Exchange Commission and do not represent the Company's
    estimate or projection of the future Common Stock price. There can be no
    assurance that any of the values reflected in the table will be achieved.
    Actual gains, if any, on stock option exercises and Common Stock holdings
    are dependent upon a number of factors, including the future performance of
    the Common Stock, overall market conditions and the timing of option
    exercises, if any.
 
(2) Stock options were granted pursuant to the 1989 Option Plan or the 1995
    Option Plan and are exercisable in 2.08% increments monthly commencing 30
    days from the date of the grant, becoming fully vested on the fourth
    anniversary of the date of the grant.
 
(3) Includes 50,000 shares of the options granted pursuant to the 1995 Option
    Plan. The options are exercisable as to 25% of the options on January 12,
    1999 and in 2.778% increments monthly thereafter.
 
AGGREGATED OPTION/SAR EXERCISES IN FISCAL YEAR 1998 AND OPTION/SAR VALUES AT END
OF FISCAL YEAR 1998
 
<TABLE>
<CAPTION>
                                                           NUMBER OF SECURITIES
                                                          UNDERLYING UNEXERCISED         VALUE OF UNEXERCISED
                                SHARES        VALUE           OPTIONS/SARS AT           IN-THE-MONEY OPTIONS AT
                              ACQUIRED ON    REALIZED      SEPTEMBER 28, 1997(#)       SEPTEMBER 27, 1998($)(2)
            NAME              BALANCE(#)      ($)(1)    (EXERCISABLE/UNEXERCISABLE)   (EXERCISABLE/UNEXERCISABLE)
            ----              -----------    --------   ---------------------------   ---------------------------
<S>                           <C>            <C>        <C>                           <C>
R. Paul Gupta...............      --           --             170,779/131,721                   --/--
Chun P. Chiu................      --           --              53,241/ 73,759                   --/--
Albert R. Enamait...........      --           --              35,625/ 52,500                   --/--
David Sear..................      --           --                   0/150,000                   --/--
Edward J. Bradley, Jr.......      --           --              11,290/ 23,209                   --/--
</TABLE>
 
---------------
(1) Calculated on the basis of the fair value of the underlying securities at
    exercise, minus the exercise price.
 
(2) Calculated on the basis of the fair value of the underlying securities at
    year-end minus the exercise price.
 
DIRECTOR COMPENSATION
 
     Each non-employee director of the Company receives a fee of $500 ($1000 if
traveling from outside California and $2,000 if traveling from outside from the
United States) for each meeting of the Board of Directors or Board committees
attended by such director, and is reimbursed for out-of-pocket expenses incurred
in connection with attendance at meetings of the Board of Directors and
committees. During the fiscal year ended September 27, 1998, Messrs. Kang,
Puette, Shinya and Tsang received aggregate fees of $6,000, $12,500, $6,500, and
$3,500 respectively, for their services as directors. In addition, non-employee
 
                                       27
<PAGE>   28
 
directors are eligible to receive stock option grants pursuant to the Company's
1993 Directors' Stock Option Plan. During the fiscal year ended September 27,
1998, Messrs. Kang, Puette, Shinya and Tsang each received a stock option to
purchase 2,500 shares of Common Stock under the 1993 Directors' Stock Option
Plan. On April 24, 1998, the Board of Directors of the Company approved an
amendment to the 1993 Directors' Stock Option Plan. The amendment, which took
effect on November 17, 1998, increases from 2,500 to 5,000 the number of option
granted on each anniversary of the Company's initial public offering to each
non-employee director who has served on the Board for at least six months as of
such anniversary date. In addition, Mr. Puette received aggregate fees of
$10,000 for consulting services performed during the fiscal year 1998.
 
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT OR CHANGE-IN-CONTROL
AGREEMENTS.
 
     The Company does not have employment contracts with its employees except
for the change of control agreements (described below) entered into with certain
key employees, including all the executive officers and directors. The
agreements provide for the acceleration of vesting for each unvested share of
Common Stock or option to purchase Common Stock by two years and for severance
payments (discussed below) in the event of involuntary termination within one
year following a change of control of the Company. The agreements were approved
by the Board of Directors.
 
     If a key employee is involuntarily terminated within one year for any
reason other than cause after a change of control, the Company will provide for
a lump sum severance payment consisting of (i) six months (in the case of the
Chairman of the Board and vice presidents, twelve months; in the case of the
Chief Executive Office, eighteen months) (the "Severance Period") of the monthly
salary which the employee was receiving immediately prior to the change of
control and (ii) the target bonus which would have been paid over the Severance
Period; and (iii) a prorated amount of the employee's target bonus for the
fiscal year in which the termination occurs. The Company also will continue to
provide all benefits through the end of the Severance Period substantially
identical to those to which the employee was entitled immediately prior to the
change of control, as well as outplacement services with a total value not to
exceed $15,000.
 
     In the event of a change of control, regardless of whether a director is
terminated in connection with the change of control, the vesting schedule for
each of unvested share of common stock or option to purchase common stock held
by a director will be accelerated by two years.
 
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
 
     For fiscal year 1998, Messrs. Puette and Tsang served on the Compensation
Committee of the Company's Board of Directors. Both of them are non-employee
directors.
 
                                       28
<PAGE>   29
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     The following table sets forth the beneficial ownership of the Company's
Common Stock as of November 10, 1998 as to (i) each person who is known by QSI
to beneficially own more than five percent of QSI's Common Stock, (ii) each of
QSI's directors, (iii) each of the CEO and the four other most highly
compensated executive officers for the fiscal year ended September 27, 1998 (the
"Named Executive Officers"), and (iv) all directors and executive officers as a
group.
 
<TABLE>
<CAPTION>
                                                                SHARES BENEFICIALLY
                5% SHAREHOLDERS, DIRECTORS,                          OWNED(1)
                 NAMED EXECUTIVE OFFICERS,                    -----------------------
      AND DIRECTORS AND EXECUTIVE OFFICERS AS A GROUP          NUMBER      PERCENT(2)
      -----------------------------------------------         ---------    ----------
<S>                                                           <C>          <C>
Chun P. Chiu................................................    364,315(3)    4.82%
  Chairman of the Board & Chief Technical Officer
R. Paul Gupta...............................................    300,959(4)    3.91%
  Director, President & Chief Executive Officer
Masaharu Shinya.............................................     68,333(5)       *
  Director
Andrew J. S. Kang...........................................    250,750(6)    3.34%
  Director
Robert L. Puette............................................      5,000(7)       *
  Director
David D. Tsang..............................................      5,000(8)       *
  Director
David Sear..................................................          0          *
  Executive Vice President & Chief Operating Officer
Edward J. Bradley, Jr.......................................     18,032(9)       *
  Vice President of Manufacturing
Albert R. Enamait...........................................     20,625(10)       *
  Vice President of Sales and Marketing
All current officers and directors as a group (10
  persons)..................................................  1,033,014(11)   13.22%
</TABLE>
 
---------------
* Less than 1%
 
 (1) Except as indicated in the footnotes to this table and pursuant to
     applicable community property laws, the persons named in the table have
     sole voting and investment power with respect to all shares of Common
     Stock.
 
 (2) As of November 10, 1998, 7,502,690 shares were issued and outstanding.
 
 (3) Includes 61,601 shares subject to outstanding stock options exercisable on
     or before January 9, 1999. Also includes 4,500 shares held by Mr. Chiu's
     children as to which Mr. Chiu disclaims beneficial ownership.
 
 (4) Includes 185,437 shares subject to outstanding stock options exercisable on
     or before January 9, 1999.
 
 (5) Includes 10,000 shares subject to outstanding stock options exercisable on
     or before January 9, 1999. Also includes 50,000 shares held by Kanematsu
     Semiconductor Corporation as to which Mr. Shinya disclaims beneficial
     ownership. Mr. Shinya is the president of Kanematsu Semiconductor
     Corporation.
 
 (6) Includes 10,000 shares subject to outstanding stock options exercisable on
     or before January 9, 1999. Also includes 234,751 shares owned by Technology
     Associates Management Company Ltd. as to which Mr. Kang disclaims
     beneficial ownership except to the extent of his pecuniary interest
     therein. Mr. Kang is the Managing Director of Technology Associates
     Management Company.
 
 (7) Represents 5,000 shares subject to outstanding stock options exercisable on
     or before January 9, 1999.
 
 (8) Represents 5,000 shares subject to outstanding stock options exercisable on
     or before January 9, 1999.
 
 (9) Includes 13,521 shares subject to outstanding stock options exercisable on
     or before January 9, 1999.
 
                                       29
<PAGE>   30
 
(10) Represents 20,625 shares subject to outstanding stock options exercisable
     on or before January 9, 1999.
 
(11) Includes an aggregate of 311,184 shares subject to outstanding stock
     options and warrants exercisable on or before January 9, 1999. Includes
     50,000 shares described in footnote 5 above owned by an affiliate of Mr.
     Shinya, a director of QSI, as to which such director may have disclaimed
     beneficial ownership. Also includes 234,751 shares described in footnote 6
     above owned by an affiliate of Mr. Kang, a director of QSI, as to which Mr.
     Kang may have disclaimed beneficial ownership.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     The Company has entered into certain transactions with Kanematsu
Semiconductor Corporation and its subsidiaries (Kanematsu), a shareholder of the
Company, whose president, serves on the Company's Board of Directors. The
Company entered into an agreement pursuant to which Kanematsu acts as an
intermediary in the purchase of wafers from other suppliers. The Company
purchased approximately $300,000, $1,400,000 and $6,800,000 of wafers through
Kanematsu in fiscal 1998, 1997 and 1996, respectively.
 
     Kanematsu also acts as a distribution representative to sell products of
the Company. Sales by the Company to Kanematsu approximated $7,116,000,
$10,520,000 and $4,898,000 in fiscal 1998, 1997 and 1996, respectively.
 
     In addition, Kanematsu acts as a sales agent for the Company in Japan for
which the Company makes commission payments to Kanematsu. Commissions paid by
the Company to Kanematsu approximated $53,000, $56,000 and $278,000 in fiscal
1998, 1997 and 1996, respectively.
 
     During fiscal 1992 and 1993, the Company issued promissory notes to finance
approximately $1,104,000 and $365,000, respectively, of capital equipment, at
annual interest rates ranging from twelve to fourteen percent. The Company paid
the balance due on these notes during fiscal year 1996. On March 28, 1996, the
Company entered into an agreement (the "Agreement") with Kanematsu to finance
approximately $8.0 million of wafer fabrication equipment for installation at
Quality Semiconductor Australia Pty. Limited ("QSA"), a subsidiary of the
Company. The Agreement expires March 31, 2001 and the borrowings bear interest
at a rate of 8.5%. In March 1997, Company agreed to enter into a second finance
arrangement with Kanematsu to finance an additional $2.5 million. As of
September 28, 1998, out of a total borrowing of $10.3 million, $6.7 million was
outstanding under the Agreement.
 
                                       30
<PAGE>   31
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
 
(a) The following documents are filed as part of this report:
 
<TABLE>
    <S>                                                           <C>
    (1) Financial Statements and Report of Ernst & Young LLP,
        Independent Auditors
         Report of Ernst & Young LLP, Independent Auditors......  33
         Consolidated Balance Sheets at September 30, 1998 and
         1997...................................................  34
         Consolidated Statements of Operations -- Years Ended
          September 30, 1998, 1997
           and 1996.............................................  35
         Consolidated Statements of Cash Flows -- Years Ended
          September 30, 1998, 1997
           and 1996.............................................  36
         Consolidated Statements of Shareholders' Equity --Years
          Ended September 30, 1998, 1997
           and 1996.............................................  37
         Notes to Consolidated Financial Statements.............  38
    (2) Financial Statement Schedule
         The following financial statement schedule is included
         herein:
         Schedule II -- Valuation and Qualifying Accounts.......  52
         All other schedules are omitted because they are not
          required or the required information is included in
          the financial statements or notes thereto.
    (3) Exhibits
         The exhibits listed in the accompanying index to
          exhibits are filed or incorporated by reference as
          part of this annual report.
</TABLE>
 
(b) Reports on Form 8-K.
 
     A report on From 8-K was filed after the end of fiscal year 1998 on
November 4, 1998, to announce that the Company and Integrated Device Technology,
Inc. entered into an Agreement and Plan of Merger.
 
                                       31
<PAGE>   32
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) 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.
 
                                                         QUALITY SEMICONDUCTOR,
INC.
 
Dated: December 4, 1998                   By:       /s/ R. PAUL GUPTA
                                            ------------------------------------
                                                       R. Paul Gupta
                                                  Chief Executive Officer
 
                               POWER OF ATTORNEY
 
     KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below hereby constitutes and appoints, jointly and severally, R. Paul
Gupta and Stephen H. Vonderach, and each of them, as his attorney-in-fact, with
full power of substitution, for him in any and all capacities, to sign any and
all amendments to this Report on Form 10-K, and to file the same, with exhibits
thereto and other documents in connection therewith with the Securities and
Exchange Commission, hereby ratifying and confirming our signatures as they may
be signed by the Company's said attorney to any and all amendments to said
Report on Form 10-K.
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons in the capacities and on
the dates indicated.
 
<TABLE>
<CAPTION>
                   SIGNATURE                                    TITLE                      DATE
                   ---------                                    -----                      ----
<S>                                               <C>                                <C>
 
/s/ CHUN P. CHIU                                  Director and Chairman of the       December 4, 1998
------------------------------------------------  Board
Chun P. Chiu
 
/s/ R. PAUL GUPTA                                 Director, President and Chief      December 4, 1998
------------------------------------------------  Executive Officer
R. Paul Gupta
 
/s/ STEPHEN H. VONDERACH                          Vice President of Finance, Chief   December 4, 1998
------------------------------------------------  Financial Officer and Chief
Stephen H. Vonderach                              Accounting Officer
 
/s/ ANDREW J. S. KANG                             Director                           December 4, 1998
------------------------------------------------
Andrew J. S. Kang
 
/s/ ROBERT L. PUETTE                              Director                           December 4, 1998
------------------------------------------------
Robert L. Puette
 
/s/ MASAHARU SHINYA                               Director                           December 4, 1998
------------------------------------------------
Masaharu Shinya
 
/s/ DAVID D. TSANG                                Director                           December 4, 1998
------------------------------------------------
David D. Tsang
</TABLE>
 
                                       32
<PAGE>   33
 
                         REPORT OF INDEPENDENT AUDITORS
 
The Board of Directors and Shareholders
Quality Semiconductor, Inc.
 
     We have audited the accompanying consolidated balance sheets of Quality
Semiconductor, Inc. as of September 30, 1998 and 1997, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the three years in the period ended September 30, 1998. Our audits also
included the financial statement schedule listed in the index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Quality Semiconductor, Inc. at September 30, 1998 and 1997, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended September 30, 1998, in conformity with generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements as a
whole, presents fairly in all material respects the information set forth
therein.
 
                                                           /s/ Ernst & Young LLP
 
San Jose, California
October 28, 1998
 
                                       33
<PAGE>   34
 
                          QUALITY SEMICONDUCTOR, INC.
 
                          CONSOLIDATED BALANCE SHEETS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                                SEPTEMBER 30,
                                                              ------------------
                                                               1998       1997
                                                              -------    -------
<S>                                                           <C>        <C>
Current assets:
  Cash and cash equivalents.................................  $ 5,938    $ 9,403
  Short-term investments....................................    1,900      3,656
  Accounts receivable, net of allowances of $462 and $856 at
     September 30, 1998 and 1997, respectively..............    5,346      6,939
  Accounts receivable from related parties..................      506        773
  Other receivables.........................................       --      1,036
  Inventories...............................................    8,210     17,689
  Prepaid expenses..........................................    1,190      1,963
  Deferred income taxes.....................................      166      3,364
                                                              -------    -------
Total current assets........................................   23,256     44,823
Property and equipment, net.................................   21,787     22,859
Other assets................................................    1,270      2,150
                                                              -------    -------
Total assets................................................  $46,313    $69,832
                                                              =======    =======
 
                      LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Accounts payable..........................................  $ 4,184    $ 5,489
  Accounts payable to related parties.......................      248        222
  Accrued compensation......................................    1,608      1,925
  Other accrued liabilities.................................    2,167        751
  Deferred income on shipments to distributors..............    2,972      2,995
  Long-term obligations to related party due within one
     year...................................................    2,488      1,684
  Current portion -- capital lease obligations..............      378         --
  Redeemable preference shares of subsidiary................       --      3,982
                                                              -------    -------
Total current liabilities...................................   14,045     17,048
Long-term obligations to related party......................    4,166      7,202
Long-term portion -- capital lease obligations..............      980         --
Deferred income taxes.......................................      832      1,945
Commitments and contingencies
Shareholders' equity:
  Preferred stock, $.001 par value; Authorized
     shares -- 1,000,000
     Issued and outstanding shares -- none                         --         --
  Common stock, $.001 par value;
     Authorized shares -- 30,000,000
     Issued and outstanding shares -- 7,502,690 in 1998 and
      7,393,076 in 1997.....................................        8          7
  Additional paid-in capital................................   41,820     41,600
  Retained earnings (accumulated deficit)...................  (15,538)     2,221
  Deferred compensation.....................................       --       (191)
                                                              -------    -------
Total shareholders' equity..................................   26,290     43,637
                                                              -------    -------
Total liabilities and shareholders' equity..................  $46,313    $69,832
                                                              =======    =======
</TABLE>
 
                            See accompanying notes.
                                       34
<PAGE>   35
 
                          QUALITY SEMICONDUCTOR, INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                                YEARS ENDED SEPTEMBER 30,
                                                              ------------------------------
                                                                1998       1997       1996
                                                              --------    -------    -------
<S>                                                           <C>         <C>        <C>
Net revenues................................................  $ 60,818    $62,691    $44,688
Cost of revenues............................................    48,324     40,073     30,226
                                                              --------    -------    -------
Gross margin................................................    12,494     22,618     14,462
Operating expenses:
  Research and development..................................    10,462      9,281      6,982
  Sales and marketing.......................................     9,295      8,323      6,986
  General and administrative................................     5,045      4,294      4,024
                                                              --------    -------    -------
Total operating expenses....................................    24,802     21,898     17,992
                                                              --------    -------    -------
Operating income (loss).....................................   (12,308)       720     (3,530)
Other income................................................        --         --      1,438
Interest income.............................................       260        724        510
Interest expense............................................      (902)    (1,122)      (433)
                                                              --------    -------    -------
Income (loss) before provision (benefit) for taxes..........   (12,950)       322     (2,015)
Provision (benefit) for taxes...............................     2,384        112       (705)
                                                              --------    -------    -------
Net income (loss)...........................................  $(15,334)   $   210    $(1,310)
                                                              ========    =======    =======
Net income (loss) per share -- Basic........................  $  (2.06)   $  0.03    $ (0.24)
                                                              ========    =======    =======
Net income (loss) per share -- Diluted......................  $  (2.06)   $  0.03    $ (0.24)
                                                              ========    =======    =======
Weighted shares outstanding -- Basic........................     7,428      6,361      5,524
                                                              ========    =======    =======
Weighted shares outstanding -- Diluted......................     7,428      7,053      5,524
                                                              ========    =======    =======
</TABLE>
 
                            See accompanying notes.
                                       35
<PAGE>   36
 
                          QUALITY SEMICONDUCTOR, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                YEARS ENDED SEPTEMBER 30,
                                                              ------------------------------
                                                                1998       1997       1996
                                                              --------    -------    -------
<S>                                                           <C>         <C>        <C>
OPERATING ACTIVITIES
Net income (loss)...........................................  $(15,334)   $   210    $(1,310)
Adjustments to reconcile net income (loss) to net cash
  provided by (used in) operating activities:
  Depreciation and amortization.............................     7,416      5,372      3,977
  Deferred income taxes.....................................     2,433     (1,183)    (1,021)
  Deferred compensation amortization........................       191        229        228
  Changes in operating assets and liabilities:
     Accounts and related parties receivables, net..........     1,717     (1,083)      (778)
     Other receivables......................................     1,036       (317)       277
     Inventories............................................     8,931     (3,705)      (510)
     Prepaid expenses.......................................       734     (1,431)       (66)
     Accounts payable, including related parties............    (1,107)     2,215     (1,407)
     Income taxes payable...................................        --     (1,707)      (282)
     Accrued compensation...................................      (135)       713       (536)
     Other accrued liabilities..............................     1,416       (489)       806
     Deferred income on shipments to distributors...........       (23)       977        120
                                                              --------    -------    -------
Total adjustments...........................................    22,609       (409)       808
                                                              --------    -------    -------
Net cash provided by (used in) operating activities.........     7,275       (199)      (502)
INVESTING ACTIVITIES
Purchase of certain assets of AWAM..........................        --         --     (5,005)
Capital expenditures, net...................................    (6,341)    (3,340)    (3,296)
Purchase of short-term investments..........................    (3,654)    (5,686)    (5,935)
Sales and maturities of short-term investments..............     5,410      4,433     13,012
Deposits and other assets...................................       (45)       246       (126)
                                                              --------    -------    -------
Net cash used in investing activities.......................    (4,630)    (4,347)    (1,350)
FINANCING ACTIVITIES
Principal payments on long-term debt and preference
  shares....................................................    (6,448)    (4,235)      (472)
Net proceeds from promissory notes..........................        --      2,850         --
Net proceeds from issuance of common stock..................       378     10,633        635
Repurchase of common stock..................................      (157)      (229)      (819)
Principal payments on capital lease obligations.............       117         --       (199)
                                                              --------    -------    -------
Net cash provided by (used in) financing activities.........    (6,110)     9,019       (855)
                                                              --------    -------    -------
Net increase (decrease) in cash and cash equivalents........    (3,465)     4,473     (2,707)
Cash and cash equivalents at beginning of period............     9,403      4,930      7,637
                                                              --------    -------    -------
Cash and cash equivalents at end of period..................  $  5,938    $ 9,403    $ 4,930
                                                              ========    =======    =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
  Interest..................................................  $    965    $ 1,091    $   107
  Taxes (refunded), net.....................................  $ (1,700)   $ 2,234    $   724
</TABLE>
 
                            See accompanying notes.
                                       36
<PAGE>   37
 
                          QUALITY SEMICONDUCTOR, INC.
 
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                       RETAINED
                                       COMMON STOCK     ADDITIONAL     EARNINGS
                                      ---------------    PAID-IN     (ACCUMULATED     DEFERRED
                                      SHARES   AMOUNT    CAPITAL       DEFICIT)     COMPENSATION    TOTAL
                                      ------   ------   ----------   ------------   ------------   --------
<S>                                   <C>      <C>      <C>          <C>            <C>            <C>
BALANCE AT SEPTEMBER 30, 1995.......  5,475     $ 5      $28,386       $  3,478        $(648)      $ 31,221
  Sale of common stock..............    196       1          634             --           --            635
  Tax benefit from stock option
     exercises......................     --      --           81             --           --             81
  Repurchase of common stock........   (135)     (1)        (818)            --           --           (819)
  Issuance of warrants..............     --      --           65             --           --             65
  Amortization of deferred
     compensation...................     --      --           --             --          228            228
  Translation adjustment............     --      --           --            244           --            244
  Net loss..........................     --      --           --         (1,310)          --         (1,310)
                                      -----     ---      -------       --------        -----       --------
BALANCE AT SEPTEMBER 30, 1996.......  5,536       5       28,348          2,412         (420)        30,345
  Sale of common stock, conversion
     of promissory notes, and
     issuance of warrants...........  1,890       2       13,296             --           --         13,298
  Tax benefit from stock option
     exercises......................     --      --          185             --           --            185
  Repurchase of common stock........    (33)     --         (229)            --           --           (229)
  Amortization of deferred
     compensation...................     --      --           --             --          229            229
  Translation adjustment............     --      --           --           (401)          --           (401)
  Net income........................     --      --           --            210           --            210
                                      -----     ---      -------       --------        -----       --------
BALANCE AT SEPTEMBER 30, 1997.......  7,393       7       41,600          2,221         (191)        43,637
  Sale of common stock..............    140       1          377             --           --            378
  Repurchase of common stock........    (30)     --         (157)            --           --           (157)
  Amortization of deferred
     compensation...................     --      --           --             --          191            191
  Translation adjustment............     --      --           --         (2,425)          --         (2,425)
  Net loss..........................     --      --           --        (15,334)          --        (15,334)
                                      -----     ---      -------       --------        -----       --------
BALANCE AT SEPTEMBER 30, 1998.......  7,503     $ 8      $41,820       $(15,538)       $  --       $ 26,290
                                      =====     ===      =======       ========        =====       ========
</TABLE>
 
                            See accompanying notes.
                                       37
<PAGE>   38
 
                          QUALITY SEMICONDUCTOR, INC.
 
                         NOTES TO FINANCIAL STATEMENTS
 
 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
     Quality Semiconductor, Inc. (the Company), a California corporation,
designs, develops and markets high-performance logic, clock management and
advanced networking semiconductor products. The Company targets systems
manufacturers principally in networking, computer, workstation, and
telecommunications markets.
 
     The Company's operating results are subject to a variety of risks
characteristic of the semiconductor industry, including booking and shipment
uncertainties, wafer yield fluctuations, and price erosion, as well as general
economic conditions.
 
BASIS OF PRESENTATION
 
     The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiary, Quality Semiconductor Australia, Pty. Ltd.
(QSA). All significant intercompany accounts and transactions have been
eliminated in consolidation.
 
FOREIGN CURRENCY TRANSLATION
 
     The Company uses the local currency as its functional currency for QSA.
Translation adjustments, which result from the process of translating foreign
currency financial statements into U.S. dollars, are included as a component of
shareholders' equity.
 
FISCAL YEAR
 
     The Company's fiscal year ends on the last Sunday in September. Fiscal
years 1998, 1997, and 1996 ended on September 27, 28, and 29, respectively. The
Company's fiscal quarters end on the last Sunday of each calendar quarter. For
convenience, the accompanying consolidated financial statements have been shown
as ending on the last day of the calendar month.
 
USE OF ESTIMATES
 
     The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ materially from those estimates.
 
CASH, CASH EQUIVALENTS, AND SHORT-TERM INVESTMENTS
 
     The Company considers all highly liquid investments with an original
maturity of ninety days or less to be cash equivalents. Cash equivalents are
carried at fair value, which approximates costs. The Company's short-term
investments primarily comprise readily marketable debt securities.
 
     The Company has classified its entire investment portfolio as
available-for-sale. Available-for-sale securities are classified as cash
equivalents or short-term investments and are stated at fair value with
unrealized gains and losses included in shareholders' equity. The amortized cost
of debt securities is adjusted for amortization of premiums and accretion of
discounts to maturity. Such amortization and accretion are included in interest
income. Realized gains and losses are included in interest income. The cost of
securities sold is based on the specific identification method.
 
                                       38
<PAGE>   39
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATION OF RISK
 
     The Company uses financial instruments that potentially subject it to
concentrations of credit risk. Such instruments include cash equivalents,
short-term investments, accounts receivable, and financial instruments used in
hedging activities. The Company invests its cash in cash deposits, money market
funds, commercial paper, or readily marketable debt securities. The Company
places its investments with high-credit quality financial institutions and
limits the credit exposure to any one financial institution or instrument. To
date, the Company has not experienced losses on these investments. The Company
primarily sells its products to original equipment manufacturers and
distributors. The Company performs ongoing credit evaluations of its customers'
financial positions and generally requires no collateral. The Company maintains
reserves for potential credit losses, and such losses have been within
management's expectations.
 
     The Company operates a wafer fabrication facility, which involves
significant risks inherent in any manufacturing endeavor, including production
yields, technical difficulties with process control, and other events.
 
     Sales and marketing risks include such factors as the loss of a significant
distributor, concentration of customers, and volume discounts that may be
granted to significant customers.
 
INVENTORIES
 
     Inventories are stated at the lower of standard cost, which approximates
actual (first-in, first-out method) or market (estimated net realizable value).
 
     The Company's inventory valuation process is done on a part-by-part basis.
Lower of cost to market adjustments, specifically identified on a part-by-part
basis, reduce the carrying value of the related inventory and take into
consideration reduction of sales prices, excess inventory levels, and obsolete
inventory. Once established, these adjustments are considered permanent and are
not reversed until the related inventory is sold or disposed.
 
     The Company produces inventory based on orders received and forecasted
demand. The Company must order wafers and build inventory well in advance of
product shipments. Because the Company's markets are volatile and subject to
rapid technology and price changes, there is a risk that the Company will
forecast incorrectly and produce excess or insufficient inventories of
particular products. This inventory risk is heightened because many of the
Company's customers place orders with short lead times. Demand will differ from
forecasts, and such a difference may have a material effect on actual results of
operations.
 
     Given the volatility of the market for the Company's products, the Company
makes inventory provisions for potentially excess and obsolete inventory based
on backlog and forecast demand. However, such backlog demand is subject to
revisions, cancellations, and rescheduling. Actual demand will inevitability
differ from such backlog and forecast demand, and such differences may be
material to the financial statements. Excess inventory increases the risk of
obsolescence, is a nonproductive use of capital resources, increases inventory
handling costs, and delays realization of the price and performance benefits
associated with more advanced manufacturing processes.
 
PROPERTY AND EQUIPMENT
 
     Property and equipment are stated at cost. Depreciation and amortization
are computed using the straight-line method over the assets estimated useful
lives of two to ten years. Capitalized leases and leasehold improvements are
amortized using the straight-line method over the shorter of the useful lives of
the assets or the terms of the lease. The Company performs reviews to determine
if property and equipment impairment
 
                                       39
<PAGE>   40
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
indicators exist. If impairment indicators are present, the Company considers
the need to write-down property and equipment to its estimated net realizable
value.
 
REVENUE RECOGNITION AND DEFERRED REVENUE
 
     Revenue from product sales to customers other than sales to domestic
distributors are recorded when products are shipped. Sales made to domestic
distributors under agreements allowing price protection and right of return on
merchandise unsold by the distributors are deferred until the merchandise is
sold by the distributors.
 
ADVERTISING AND PROMOTION COSTS
 
     The Company's policy is to expense advertising and promotion costs as they
are incurred. The Company's advertising and promotion expenses were
approximately $752,000, $577,000, and $511,000 in fiscal 1998, 1997, and 1996,
respectively.
 
FOREIGN EXCHANGE FORWARD CONTRACTS
 
     The Company may enter into foreign currency forward exchange contracts to
manage exposure related to certain foreign currency commitments and balance
sheet positions. The Company does not enter into derivative financial
instruments for trading purposes. Foreign currency forward exchange contracts
designated as effective hedges of firm commitments are treated as hedges for
accounting purposes. Gains and losses related to qualified accounting hedges of
firm commitments are deferred and are recognized in income when the underlying
hedged transaction is settled.
 
     The Company remains subject to the transaction exposures that arise from
foreign exchange movements between the dates of when foreign currency purchase
transactions are recorded and the dates cash payments are made in foreign
currencies. At September 30, 1998 and 1997, there were no contracts outstanding.
 
STOCK BASED COMPENSATION
 
     The Company accounts for employee stock based compensation in accordance
with the provisions of the Accounting Principles Board Opinion No. 25
"Accounting For Stock Issued to Employees" (APP Opinion 25). In October 1995,
the Financial Accounting Standards Board released Statement of Financial
Accounting Standard No. 123, "Accounting For Stock-Based Compensation" (SFAS
123), which provides an alternative to APB Opinion No. 25. As allowed under SFAS
123, the Company continues to account for its employee stock plans in accordance
with the provisions of APB Opinion No. 25 (see Note 8).
 
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
 
     In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" (SFAS 130), which establishes
standards for reporting and display of comprehensive income and its components
(revenue, expenses, gains, and losses) in a full set of general-purpose
financial statements. SFAS 130 will be adopted by the Company in fiscal 1999.
 
     In June 1997, the FASB issued Statement of Financial Accounting Standard
No. 131, "Disclosure about Segments of an Enterprise and Related Information"
(SFAS 131), which changes the way public companies report information about
operating segments. SFAS 131, which is based on the management approach to
segment reporting, establishes requirements to report selected segment
information quarterly and to report entitywide disclosures about products and
services, major customers, and the material countries in which the entity holds
assets and reports revenue. SFAS 131 will be adopted by the Company in fiscal
1999.
 
                                       40
<PAGE>   41
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
     In June 1998, the FASB released Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS
133). SFAS 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for derivatives used for hedging activities. It requires that all
derivatives be recognized either as an asset or liability and measured at fair
value. SFAS 133 is effective for all fiscal quarters for fiscal years beginning
after June 15, 1999 and will be adopted by the Company in fiscal 2000. Adoption
of this pronouncement is not expected to have a material impact on the Company's
financial statements.
 
 2. FINANCIAL INSTRUMENTS
 
     The following is a summary of the fair value of available-for-sale
securities at September 30, 1998 and 1997:
 
<TABLE>
<CAPTION>
                                                              SEPTEMBER 30,
                                                            -----------------
                                                             1998      1997
                                                            ------    -------
                                                             (IN THOUSANDS)
<S>                                                         <C>       <C>
Municipal bonds...........................................  $3,700    $ 6,966
Auction rate preferreds...................................     800      1,450
Commercial paper and other................................      64      2,705
                                                            ------    -------
                                                            $4,564    $11,121
                                                            ======    =======
Included in short-term investments........................  $1,900    $ 3,656
Included in cash and cash equivalents.....................   2,664      7,465
                                                            ------    -------
                                                            $4,564    $11,121
                                                            ======    =======
</TABLE>
 
     The fair value of all available-for-sale securities approximates amortized
cost. Gross realized and unrealized gains and losses on the sale of
available-for-sale securities has not been material.
 
     The fair value of the Company's investments in debt securities, by
contractual maturity, is as follows:
 
<TABLE>
<CAPTION>
                                                              SEPTEMBER 30,
                                                             ----------------
                                                              1998      1997
                                                             ------    ------
                                                              (IN THOUSANDS)
<S>                                                          <C>       <C>
Due in less than one year..................................  $3,764    $9,671
                                                             ------    ------
                                                             $3,764    $9,671
                                                             ======    ======
</TABLE>
 
 3. INVENTORIES
 
     Inventories consist of the following at September 30:
 
<TABLE>
<CAPTION>
                                                             1998      1997
                                                            ------    -------
                                                             (IN THOUSANDS)
<S>                                                         <C>       <C>
Inventories:
  Raw materials...........................................  $1,078    $ 5,421
  Work-in-process.........................................   4,270      3,770
  Finished goods..........................................   2,862      8,498
                                                            ------    -------
                                                            $8,210    $17,689
                                                            ======    =======
</TABLE>
 
                                       41
<PAGE>   42
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 4. PROPERTY, EQUIPMENT, AND LEASEHOLD IMPROVEMENTS
 
     Property, equipment, and leasehold improvements consist of the following at
September 30:
 
<TABLE>
<CAPTION>
                                                            1998       1997
                                                           -------    -------
                                                             (IN THOUSANDS)
<S>                                                        <C>        <C>
Property and equipment:
  Equipment and software.................................  $41,830    $36,631
  Furniture and fixtures.................................      908        795
  Leasehold improvements.................................    1,470      1,608
                                                           -------    -------
                                                            44,208     39,034
  Less accumulated depreciation and amortization.........   22,421     16,175
                                                           -------    -------
                                                           $21,787    $22,859
                                                           =======    =======
</TABLE>
 
     Equipment includes $1,475,000 of equipment under capital leases at
September 30, 1998. Accumulated depreciation for such equipment was $117,000 at
September 30, 1998.
 
 5. PURCHASE OF BUSINESS
 
     On February 16, 1996, the Company acquired certain assets of AWA
MicroElectronics Pty. Ltd. (AWAM), a subsidiary of AWA Limited, based in Sydney,
Australia. The AWAM assets that were acquired by a new subsidiary of the
Company, QSA, included a fully operational wafer foundry business and product
design center. The acquisition was accounted for using the purchase method.
QSA's results of operations have been included in the consolidated results of
operations since the date of acquisition.
 
     The net purchase price of the AWAM facility was $11.8 million, consisting
of $5.0 million cash, $6.3 million present value of redeemable preference shares
of QSA, fair value of warrants of $65,000, and acquisition costs of
approximately $400,000. The allocation of the purchase price, based upon an
independent valuation, consisted of $8.8 million of net tangible assets and $3.0
million of intangible assets that were related to assembled workforce, customer
base, and goodwill, which are being amortized over five years. The Company
incurred approximately $505,000 of amortization expense in fiscal 1998 ($610,000
and $375,000 in fiscal 1997 and 1996, respectively). AWA Limited was issued
1,000 redeemable preference shares of QSA at an issue price of $1,125 per share.
In July 1997, the Company redeemed 426 preference shares for approximately $3.0
million dollars. The Company redeemed the final 574 preference shares for
approximately $4.0 million (including interest charges) in January 1998.
 
     Other income of $1.4 million in fiscal 1996 was earned as a result of
engineering and marketing services provided by the Company pursuant to an
agreement with AWA Limited.
 
 6. LONG-TERM OBLIGATIONS TO RELATED PARTY AND CAPITAL LEASE OBLIGATIONS
 
     On March 28, 1996, the Company entered into an agreement with Kanematsu
USA, Inc., a subsidiary of Kanematsu Semiconductor Corporation (Kanematsu),
whose president is a director of the Company, to finance approximately $8.0
million of wafer fabrication equipment for installation at QSA. In March 1997,
the Company agreed to enter into a second finance arrangement with Kanematsu USA
Inc. to finance an additional $2.5 million. These agreements expire March 31,
2001, and the borrowings bear interest of 8.5% and 9.25% respectively. There
were borrowings of approximately $10.3 million against these agreements, of
which approximately $6.7 million was outstanding at September 30, 1998.
 
     In fiscal 1998, the Company leased a portion of its equipment under capital
lease agreements, which required the Company to maintain certain financial
ratios and a minimum cash balance. As of September 30, 1998, the Company was in
compliance with the covenant requirements contained in the lease.
 
                                       42
<PAGE>   43
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 6. LONG-TERM OBLIGATIONS TO RELATED PARTY AND CAPITAL LEASE OBLIGATIONS
(CONTINUED)
     Future maturities of long-term obligations to Kanematsu and minimum
payments for capital lease obligations are as follows:
 
<TABLE>
<CAPTION>
                                                   CAPITAL LEASE      LONG-TERM
            YEAR ENDING SEPTEMBER 30,               OBLIGATIONS      OBLIGATIONS
            -------------------------              -------------    --------------
                                                           (IN THOUSANDS)
<S>                                                <C>              <C>
1999.............................................     $  474            $2,488
2000.............................................        474             2,713
2001.............................................        569             1,453
Less amounts representing interest...............       (159)               --
                                                      ------            ------
                                                      $1,358            $6,654
                                                      ======            ======
</TABLE>
 
 7. NET INCOME (LOSS) PER SHARE
 
     The following table sets forth the computation of basic and diluted net
income (loss) per share:
 
<TABLE>
<CAPTION>
                                                          FOR THE YEARS ENDED SEPTEMBER 30,
                                                        --------------------------------------
                                                           1998          1997          1996
                                                        -----------    ---------    ----------
                                                        (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                     <C>            <C>          <C>
BASIC NET INCOME (LOSS) PER SHARE COMPUTATION
  Numerator:
     Net income (loss)..............................     $(15,334)      $  210       $(1,310)
                                                         ========       ======       =======
  Denominator:
     Weighted average number of common shares
       outstanding during the period................        7,428        6,361         5,524
                                                         ========       ======       =======
  Basic net income (loss) per share.................     $  (2.06)      $ 0.03       $ (0.24)
                                                         ========       ======       =======
DILUTED NET INCOME (LOSS) PER SHARE COMPUTATION
  Numerator:
     Net income (loss)..............................     $(15,334)      $  210       $(1,310)
                                                         ========       ======       =======
  Denominator:
     Weighted average number of common shares
       outstanding during the period................        7,428        6,361         5,524
  Effect of dilutive securities:
     Stock options..................................           --          676            --
     Warrants.......................................           --           16            --
                                                         ========       ======       =======
          Total.....................................        7,428        7,053         5,524
                                                         ========       ======       =======
  Dilutive net income (loss) per share..............     $  (2.06)      $ 0.03       $ (0.24)
                                                         ========       ======       =======
</TABLE>
 
     Options and warrants outstanding during 1998 and 1996 were excluded from
the computation of diluted net loss per common share because the effect in years
with a net loss would be antidilutive.
 
 8. SHAREHOLDERS' EQUITY
 
WARRANTS
 
     As partial consideration for the purchase of QSA, the Company issued 50,000
warrants with an exercise price of $13.00 per share, valued at $65,000, which
expire in February 1999. In May 1997, the Company
 
                                       43
<PAGE>   44
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 8. SHAREHOLDERS' EQUITY (CONTINUED)
issued 108,000 warrants with an exercise price of $8.50 in conjunction with the
completed private placement of 1,080,000 shares of common stock. The warrants
expired in May 1998.
 
PREFERRED STOCK
 
     The Board of Directors has the authority, without any further vote or
action by the shareholders, to provide for the issuance of 1,000,000 shares of
preferred stock from time to time in one or more series with such designations,
rights, preferences, and limitations as the Board of Directors may determine,
including the consideration received, the number of shares comprising each
series, dividend rates, redemption provisions, liquidation preferences,
redemption fund provisions, conversion rights, and voting rights, all without
the approval of the holders of common stock.
 
STOCK OPTION PLANS
 
     The Company's 1989 and 1995 Stock Option Plans (the Plans) provide for the
grant of incentive stock options and nonstatutory stock options to employees,
directors, and consultants of the Company at prices ranging from 85% to 110%
(depending on the type of grant) of the fair market value of the common stock on
the date of grant as determined by the Board of Directors. The options generally
vest at a rate of 25% one year after the date of the grant and additionally
every six months or monthly thereafter. The vesting and exercise provisions of
the option grants are determined by the Board of Directors.
 
     The following is a summary of option activities for the plans (in
thousands, except per share amounts):
 
<TABLE>
<CAPTION>
                                                               OPTIONS OUTSTANDING
                                                  ---------------------------------------------
                                     AVAILABLE                                      WEIGHTED
                                        FOR        NUMBER          PRICE            AVERAGE
                                       GRANT      OF SHARES      PER SHARE       EXERCISE PRICE
                                     ---------    ---------    --------------    --------------
<S>                                  <C>          <C>          <C>               <C>
BALANCE AT SEPTEMBER 30, 1995......      105          928      $0.75 - $15.00        $6.23
  Authorized.......................      410           --            --                 --
  Granted..........................   (1,347)       1,347      $4.25 - $ 8.00        $5.25
  Exercised........................       --         (116)     $0.75 - $ 8.00        $2.09
  Canceled.........................      920         (920)     $0.75 - $15.00        $8.59
                                      ------       ------
BALANCE AT SEPTEMBER 30, 1996......       88        1,239      $1.20 - $ 7.92        $3.79
  Authorized.......................      533           --            --                 --
  Granted..........................     (572)         572      $7.00 - $14.00        $8.36
  Exercised........................       --         (312)     $0.75 - $ 9.00        $3.39
  Canceled.........................      271         (271)     $1.20 - $ 8.25        $4.94
                                      ------       ------
BALANCE AT SEPTEMBER 30, 1997......      320        1,228      $1.20 - $14.00        $5.79
  Authorized.......................      340           --            --                 --
  Granted..........................   (1,497)       1,497      $2.03 - $ 6.50        $3.42
  Exercised........................       --          (31)     $1.20 - $ 8.25        $4.09
  Canceled.........................    1,258       (1,258)     $1.20 - $14.00        $5.67
                                      ------       ------
BALANCE AT SEPTEMBER 30, 1998......      421        1,436      $1.20 - $ 9.00        $3.63
                                      ======       ======
</TABLE>
 
                                       44
<PAGE>   45
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 8. SHAREHOLDERS' EQUITY (CONTINUED)
     Outstanding and exercisable options presented by price range as of
September 30, 1998 are as follows:
 
<TABLE>
<CAPTION>
                                   OPTIONS OUTSTANDING                             OPTIONS EXERCISABLE
                 -------------------------------------------------------   ------------------------------------
                                     WEIGHTED AVERAGE
                 NUMBER OF OPTIONS      REMAINING                          NUMBER OF OPTIONS
   RANGE OF      OUTSTANDING AS OF   CONTRACTUAL LIFE   WEIGHTED AVERAGE   EXERCISABLE AS OF   WEIGHTED AVERAGE
EXERCISE PRICES       9/30/98            (YEARS)         EXERCISE PRICE         9/30/98         EXERCISE PRICE
---------------  -----------------   ----------------   ----------------   -----------------   ----------------
<S>              <C>                 <C>                <C>                <C>                 <C>
$1.20 - $2.03..         38,166             9.57              $1.99                1,666             $1.20
$2.25 - $2.25..        749,391             8.51              $2.25                   --             $  --
$2.70 - $3.93..        163,882             4.44              $3.25               95,966             $2.76
$4.00 - $4.00..        150,000             9.29              $4.00                   --             $  --
$4.25 - $4.25..        201,061             7.81              $4.25              109,499             $4.25
$5.00 - $8.00..        162,557             8.48              $5.75               48,095             $6.35
$8.25 - $8.25..         90,875             8.56              $8.25               32,751             $8.25
$8.37 - $8.37..         10,000             6.88              $8.37                   --             $  --
$8.75 - $8.75..          7,500             7.14              $8.75                   --             $  --
$9.00 - $9.00..         25,000             6.14              $9.00               17,500             $9.00
                     ---------                                                  -------
$1.20 - $9.00..      1,598,432             8.05              $3.63              305,477             $4.80
                     =========                                                  =======
</TABLE>
 
     Options to purchase approximately 305,000 and 360,000 shares were
exercisable at September 30, 1998 and 1997, respectively. Agreements covering a
majority of the outstanding options provide for acceleration of vesting upon a
change in control of the Company.
 
     In January 1994, the shareholders approved the adoption of the 1993
Employee Stock Purchase Plan (the 1993 Purchase Plan) covering 200,000 shares of
common stock for issuance under the plan and the adoption of the 1993 Directors'
Stock Option Plan (the Directors' Plan) covering 100,000 shares of common stock
for issuance under that plan. In February 1998, the shareholders approved an
increase to the number of shares of common stock reserved for issuance under the
1993 Purchase Plan by 100,000 shares to an aggregate total of 300,000 shares.
Under the 1993 Purchase Plan, employees may be granted the opportunity to
purchase common stock at 85% of market value on the first or last day of the
offering period (as defined by the plan), whichever is lower. The Directors'
Plan provides for the issuance of stock options to directors of the Company.
There were 107,368, 52,762 and 79,770 shares issued under the 1993 Purchase Plan
in 1998, 1997, and 1996 respectively, and 16,735 shares remained available for
issuance as of September 30, 1998. The Company has granted 77,500 options under
the Directors' Plan at exercise prices between $6.19 to $9.00; 5,000 options
were exercised, and 10,000 options were canceled as of September 30, 1998.
 
     In February 1998, the Board of Directors granted stock options for an
additional 100,000 common shares outside of any Company stock option plan at an
exercise price of $4.00. At September 30, 1998, all of these stock options
remain outstanding.
 
     In February 1996, the Board of Directors approved a plan for the Company to
repurchase up to 200,000 shares of its outstanding common stock in the open
market from time to time, limited to the total purchase price of $1.3 million
per the loan agreement. During fiscal 1996, the Company repurchased 135,000
shares at an average price of $6.07. During fiscal 1997, the Company repurchased
an additional 32,500 shares at an average price of $7.06. During fiscal 1998,
the Company repurchased an additional 30,000 shares at an average price of
$5.19. In November 1998, the Board of Directors cancelled the common stock
repurchase plan.
 
     In July 1996, the Company offered all optionees holding outstanding options
the opportunity to exchange such options for similar options with exercise
prices equal to the then fair market value. Under the July 1996
 
                                       45
<PAGE>   46
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 8. SHAREHOLDERS' EQUITY (CONTINUED)
offer, options to purchase 564,375 shares with exercise prices exceeding $4.25
per share were exchanged for similar options exercisable at $4.25 per share.
Except for officers, each option retained the original option's four-year
vesting period. The 196,500 options exchanged by officers have vesting beginning
with the new grant date. The effect of these exchanges has been included in the
table in 1996 activity for options granted and canceled.
 
     In July 1998, the Company offered all optionees, excluding officers,
holding outstanding options the opportunity to exchange such options for similar
options with exercise prices equal to the then fair market value. Under the July
1998 offer, options to purchase 775,000 shares with exercise prices exceeding
$2.25 per share were exchanged for similar options exercisable at $2.25 per
share. Each option retained the original four-year vesting period. However, the
options are not exercisable for six months. The effect of the exchange has been
included in the table in 1998 activity for options granted and canceled.
 
     Common stock was reserved for issuance as follows (in thousands of shares):
 
<TABLE>
<CAPTION>
                                                              SEPTEMBER 30,
                                                              --------------
                                                              1998     1997
                                                              -----    -----
<S>                                                           <C>      <C>
1989 and 1995 Stock Option Plans............................  1,857    1,548
1993 Purchase Plan, Directors' Plan, and other..............    212      119
Warrants....................................................     50      158
                                                              -----    -----
                                                              2,119    1,825
                                                              =====    =====
</TABLE>
 
SHAREHOLDER RIGHTS PLAN
 
     In September 1997, the Company adopted a shareholder rights plan and
declared a dividend distribution of one common stock purchase right for each
outstanding share of common stock. The rights became exercisable based upon the
occurrence of certain conditions, including acquisitions of the Company stock,
tender or exchange offers, and certain business combination transactions of the
Company. In the event one of the conditions is triggered, each right entitles
the registered holder to purchase a number of shares of common stock of the
Company or, under limited circumstances, of the acquirer. The rights are
redeemable at the Company's option, under certain conditions, for $0.01 per
right and expire September 17, 2007.
 
ACCOUNTING FOR STOCK-BASED COMPENSATION
 
     The Company applies APB Opinion No. 25 and related interpretations in
accounting for stock-based awards to employees and directors. If compensation
cost for the Company's stock-based compensation plans had been determined
consistent with SFAS 123, the Company's net income (loss) and net income (loss)
per share would have been adjusted to the pro forma amounts indicated below:
 
<TABLE>
<CAPTION>
                                                                    SEPTEMBER 30,
                                                       ---------------------------------------
                                                          1998           1997          1996
                                                       -----------    ----------    ----------
                                                        (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                    <C>            <C>           <C>
Net income (loss)
  As reported........................................   $(15,334)      $   210       $(1,310)
  Pro forma..........................................   $(17,048)      $(1,155)      $(2,259)
Basic and diluted net income (loss) per share
  As reported........................................   $  (2.06)      $ (0.03)      $ (0.24)
  Pro forma..........................................   $  (2.30)      $ (0.18)      $ (0.41)
</TABLE>
 
                                       46
<PAGE>   47
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 8. SHAREHOLDERS' EQUITY (CONTINUED)
     The effects on pro forma disclosures of applying SFAS 123 are not likely to
be representative of the effects on pro forma disclosures of future years.
Because SFAS 123 is applicable only to options granted subsequent to September
30, 1995, the pro forma effect will not be fully reflected until 1999.
 
     The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model. The Black-Scholes option valuation model
was developed for use in estimating the fair value of traded options that have
no vesting restrictions and are fully transferable. In addition, the
Black-Scholes model requires the input of highly subjective assumptions,
including the expected stock price volatility. Because the Company's stock-based
awards to employees have characteristics significantly different from those of
traded options and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its stock-based awards to employees. The following weighted average assumptions
were used to calculate the fair value for grants during the years ended
September 30, 1998, 1997 and 1996: risk-free interest rates of 5.36%, 6.35% and
6.18% for 1998, 1997 and 1996, respectively; a dividend yield of 0% for all
years; a weighted average expected life of 4.32 years for both 1998 and 1997 and
4.28 years for 1996, and a volatility factor of the expected market price of the
Company's common stock of .83, .84, and .84, for 1998, 1997 and 1996,
respectively. The weighted average grant date fair value of options granted
during 1998, 1997 and 1996 was $2.23, $5.56 and $3.44, respectively.
 
     Compensation cost is estimated for the fair value of the employees'
purchase rights using the Black-Scholes model with the following assumptions for
these rights granted in 1998, 1997 and 1996: a dividend yield of 0% for all
years; an expected life of six months for all years; an expected volatility of
 .83, .69 and .69 for 1998, 1997 and 1996, respectively; and a risk-free interest
rate of 5.05%, 5.45% and 5.25% for 1998, 1997 and 1996, respectively. The
weighted average fair market value of the purchase rights granted in 1998, 1997
and 1996 was $1.10, $3.40 and $3.23 respectively.
 
 9. COMMITMENTS AND CONTINGENCIES
 
COMMITMENTS
 
     The Company leases its manufacturing and office facilities and certain
equipment under noncancelable operating leases expiring through 2010. The
Company is generally responsible for taxes, insurance, and utilities under these
leases. The Company's office facilities lease contains scheduled rent increases
over the term of the lease. Rental expense is charged to operations on a
straight-line basis over the lease term. The office facilities lease is secured
by a deposit of $47,500 included in deposits and other assets.
 
     Future minimum lease payments under noncancelable operating leases are as
follows:
 
<TABLE>
<CAPTION>
                                                         SEPTEMBER 30,
                                                              1998
                                                         --------------
                                                         (IN THOUSANDS)
<S>                                                      <C>
1999.................................................        $1,414
2000.................................................         1,428
2001.................................................           847
2002.................................................           340
2003.................................................           364
Thereafter...........................................         3,489
                                                             ------
                                                             $7,882
                                                             ======
</TABLE>
 
     Total rent expense for fiscal 1998, 1997 and 1996 was approximately
$1,418,000, $1,343,000, and $952,000, respectively.
                                       47
<PAGE>   48
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
CONTINGENCIES
 
     The Company has from time to time received communications from third
parties asserting that the Company is infringing certain patents and other
intellectual property rights of others or seeking indemnifications against such
alleged infringements. The Company is unable to determine at this time the
extent to which these matters will be pursued by claimants or to predict with
certainty the eventual outcome. However, the Company believes that the ultimate
resolution of these matters will not have a material adverse effect on its
financial position, results of operations, or cash flows.
 
10. PROVISION (BENEFIT) FOR TAXES
 
     The provision (benefit) for income taxes consists of the following:
 
<TABLE>
<CAPTION>
                                                                 SEPTEMBER 30,
                                                            ------------------------
                                                             1998     1997     1996
                                                            ------    -----    -----
                                                                 (IN THOUSANDS)
<S>                                                         <C>       <C>      <C>
Federal:
  Current.................................................  $ (466)   $ 956    $ 282
  Deferred................................................   2,360     (689)    (700)
                                                            ------    -----    -----
                                                             1,894      267     (418)
State:
  Current.................................................      --       --     (122)
  Deferred................................................     622     (155)    (112)
                                                            ------    -----    -----
                                                               622     (155)    (234)
Foreign:
  Current.................................................     417      339      267
  Deferred................................................    (549)    (339)    (320)
                                                            ------    -----    -----
                                                              (132)      --      (53)
                                                            ------    -----    -----
                                                            $2,384    $ 112    $(705)
                                                            ======    =====    =====
</TABLE>
 
     A reconciliation of the income tax provision (benefit) at the federal
statutory rate (35%) to the income tax provision (benefit) at the effective tax
rate is as follows:
 
<TABLE>
<CAPTION>
                                                                 SEPTEMBER 30,
                                                            ------------------------
                                                             1998      1997    1996
                                                            -------    ----    -----
                                                                 (IN THOUSANDS)
<S>                                                         <C>        <C>     <C>
Income tax computed at the federal statutory rate.........  $(4,533)   $112    $(705)
State taxes (net of federal effect).......................       --    (101)    (152)
Research and development credits..........................       --    (278)     (53)
Goodwill amortization.....................................      123     220      101
Nondeductible interest....................................       --     184      145
Tax exempt interest.......................................       --     (70)    (140)
Operating losses not benefited............................    6,794      --       --
Other individually immaterial items.......................       --      45       99
                                                            -------    ----    -----
                                                            $ 2,384    $112    $(705)
                                                            =======    ====    =====
</TABLE>
 
                                       48
<PAGE>   49
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
10. PROVISION (BENEFIT) FOR TAXES (CONTINUED)
     Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax liabilities and assets as of September 30, 1998 and
1997 are as follows:
 
<TABLE>
<CAPTION>
                                                                SEPTEMBER 30,
                                                              ------------------
                                                               1998       1997
                                                              -------    -------
                                                                (IN THOUSANDS)
<S>                                                           <C>        <C>
Deferred tax assets:
  Net operating loss carryforwards..........................  $ 4,873    $    --
  Research and development tax credit carryforwards.........      770        184
  Inventory.................................................      881      1,673
  Deferred income...........................................    1,096      1,121
  Other individually immaterial items.......................      637        386
                                                              -------    -------
          Total deferred tax assets.........................    8,257      3,364
Valuation allowance.........................................   (8,091)        --
                                                              -------    -------
Net deferred tax assets.....................................  $   166    $ 3,364
                                                              =======    =======
Deferred tax liabilities:
  Fixed and intangible assets with no tax basis.............  $  (832)   $(1,563)
  Depreciation..............................................       --       (382)
                                                              -------    -------
          Total deferred tax liabilities....................  $  (832)   $(1,945)
                                                              =======    =======
</TABLE>
 
     As of September 30, 1998, the Company had federal and state net operating
loss carryforwards of approximately $12,000,000 and $10,000,000, respectively,
which will expire in the years 2002 through 2018, if not utilized. In addition,
the Company had federal and state tax credit carryforwards of approximately
$300,000 and $600,000, respectively, which will expire in the years 2002 through
2013, if not utilized.
 
     The components of the Company's income (loss) before provision (benefit)
for taxes are as follows:
 
<TABLE>
<CAPTION>
                                                         YEARS ENDED SEPTEMBER 30,
                                                       ------------------------------
                                                         1998       1997       1996
                                                       --------    -------    -------
                                                               (IN THOUSANDS)
<S>                                                    <C>         <C>        <C>
Domestic.............................................  $(11,812)   $(1,480)   $(1,453)
Foreign..............................................      (768)    (1,158)      (562)
Eliminations.........................................      (370)        --         --
                                                       --------    -------    -------
                                                       $(12,950)   $   322    $(2,015)
                                                       ========    =======    =======
</TABLE>
 
11. RELATED PARTY TRANSACTIONS
 
     Kanematsu acts as an intermediary in the purchase of wafers from other
suppliers. The Company purchased $300,000, $1,400,000 and $6,800,000 of wafers
through Kanematsu in fiscal 1998, 1997 and 1996, respectively.
 
     Kanematsu also acts as a distribution representative to sell products of
the Company. Sales by the Company to Kanematsu were $7,116,000, $10,520,000 and
$4,898,000 in fiscal 1998, 1997 and 1996, respectively.
 
                                       49
<PAGE>   50
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
11. RELATED PARTY TRANSACTIONS (CONTINUED)
     In addition, Kanematsu acts as a sales agent for the Company in Japan for
which the Company makes commission payments to Kanematsu. Commissions paid by
the Company to Kanematsu were $53,000, $56,000 and $278,000 in fiscal 1998, 1997
and 1996, respectively.
 
12. INDUSTRY AND GEOGRAPHIC INFORMATION
 
     The Company operates in a single industry segment. The Company markets its
products in the United States and in foreign countries through its sales
personnel, independent sales representatives and distributors. The following
table summarizes the Company's operations in different geographic areas for
1998, 1997 and 1996:
 
<TABLE>
<CAPTION>
                                              UNITED                  ADJUSTMENTS AND
                                              STATES     AUSTRALIA     ELIMINATIONS      CONSOLIDATED
                                             --------    ---------    ---------------    ------------
                                                                  (IN THOUSANDS)
<S>                                          <C>         <C>          <C>                <C>
YEAR ENDED SEPTEMBER 30, 1998
Sales to unaffiliated customers............  $ 58,409     $ 2,409        $     --          $ 60,818
Transfers between geographic areas.........  $     --     $ 9,595        $ (9,595)         $     --
                                             --------     -------        --------          --------
          Total Revenue....................  $ 58,409     $12,004        $ (9,595)         $ 60,818
                                             ========     =======        ========          ========
Income (loss) from operations..............  $(11,177)    $  (761)       $   (370)         $(12,308)
Other Income (expense), net................  $   (635)    $    (7)       $     --          $   (642)
                                             --------     -------        --------          --------
Income (loss) before income taxes..........  $(11,812)    $  (768)       $   (370)         $(12,950)
                                             ========     =======        ========          ========
Identifiable assets........................  $ 37,048     $ 9,635        $   (370)         $ 46,313
                                             ========     =======        ========          ========
 
YEAR ENDED SEPTEMBER 30, 1997
Sales to unaffiliated customers............  $ 59,271     $ 3,420        $     --          $ 62,691
Transfers between geographic areas.........  $     --     $10,909        $(10,909)         $     --
                                             --------     -------        --------          --------
          Total Revenue....................  $ 59,271     $14,329        $(10,909)         $ 62,691
                                             ========     =======        ========          ========
Income (loss) from operations..............  $ (1,298)    $  (578)       $     --          $    720
Other Income (expense), net................  $   (154)    $  (244)       $     --          $   (398)
Income (loss) before income taxes..........  $ (1,144)    $  (822)       $     --          $    322
                                             ========     =======        ========          ========
Identifiable assets........................  $ 47,249     $22,583        $     --          $ 69,832
                                             ========     =======        ========          ========
 
YEAR ENDED SEPTEMBER 30, 1996
Sales to unaffiliated customers............  $ 40,814     $ 3,874        $     --          $ 44,688
Transfers between geographic areas.........  $     --     $   420        $   (420)         $     --
                                             --------     -------        --------          --------
          Total Revenue....................  $ 40,814     $ 4,294        $   (420)         $ 44,688
                                             ========     =======        ========          ========
Income (loss) from operations..............  $ (1,813)    $(1,717)       $     --          $ (3,530)
Other Income (expense), net................  $    360     $ 1,155        $     --          $  1,515
Income (loss) before income taxes..........  $ (1,453)    $  (562)       $     --          $ (2,015)
                                             ========     =======        ========          ========
Identifiable assets........................  $ 35,279     $17,242        $     --          $ 52,521
                                             ========     =======        ========          ========
</TABLE>
 
                                       50
<PAGE>   51
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
12. INDUSTRY AND GEOGRAPHIC INFORMATION (CONTINUED)
     Total export revenues consisting of sales from the Company's U.S. operating
subsidiaries to non-affiliated customers by geographic region for the three
years ended September 30, 1998, are as follows:
 
<TABLE>
<CAPTION>
                                                  YEARS ENDED SEPTEMBER 30,
                                                -----------------------------
                                                 1998       1997       1996
                                                -------    -------    -------
                                                       (IN THOUSANDS)
<S>                                             <C>        <C>        <C>
Far East......................................   15,718     21,064     15,073
Europe........................................    5,377      5,015      2,105
                                                -------    -------    -------
                                                $21,095    $26,079    $17,178
                                                =======    =======    =======
</TABLE>
 
     One customer accounted for 15%, 12% and 19% of net revenues in fiscal 1998,
1997 and 1996, respectively. In fiscal 1998, 1997, and 1996 one additional
customer accounted for 12%, 17%, and 11% of net revenues, respectively. In
fiscal 1996, one additional customer accounted for 10% of total product
revenues.
 
13. SUBSEQUENT EVENTS (UNAUDITED)
 
     On November 1, 1998, the Company signed a definitive agreement and plan of
merger with Integrated Device Technology, Inc. (IDT). Under the terms of the
agreement, each issued and outstanding share of the Company, at the effective
time of the merger, will be exchanged for 0.6875 shares of IDT common stock. The
merger is planned to close during the second quarter of the Company's fiscal
1999.
 
                                       51
<PAGE>   52
 
                SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
 
<TABLE>
<CAPTION>
                                                                 CHARGED TO
                                                     BEGINNING   COSTS AND       (1)        ENDING
                                                      BALANCE     EXPENSES    DEDUCTIONS   BALANCE
                                                     ---------   ----------   ----------   --------
<S>                                                  <C>         <C>          <C>          <C>
Year ended September 30, 1998
  Allowance for Doubtful Accounts..................  $197,000     $130,000     $161,000    $166,000
  Allowance for Sales Returns......................   659,000           --      363,000     296,000
                                                     --------     --------     --------    --------
                                                     $856,000     $130,000     $524,000    $462,000
                                                     ========     ========     ========    ========
Year ended September 30, 1997
  Allowance for Doubtful Accounts..................  $123,000     $ 74,000     $     --    $197,000
  Allowance for Sales Returns......................    50,000      609,000           --     659,000
                                                     --------     --------     --------    --------
                                                     $173,000     $683,000     $     --    $856,000
                                                     ========     ========     ========    ========
Year ended September 30, 1996
  Allowance for Doubtful Accounts..................  $123,000     $     --     $     --    $123,000
  Allowance for Sales Returns......................        --       50,000           --      50,000
                                                     --------     --------     --------    --------
                                                     $123,000     $ 50,000     $     --    $173,000
                                                     ========     ========     ========    ========
</TABLE>
 
---------------
(1) Primarily deductions represent write-offs of accounts receivable and sales
    returns.
 
                                       52
<PAGE>   53
 
                               INDEX TO EXHIBITS
 
<TABLE>
<CAPTION>
  EXHIBIT                                                                  PAGE
  NUMBER                    EXHIBIT DOCUMENT DESCRIPTION                  NUMBER
  -------                   ----------------------------                  ------
  <C>       <S>                                                           <C>
   2.1      Asset Purchase Agreement dated January 2, 1996 between
            Quality Semiconductor Australia Pty. Ltd. and AWA
            Microelectronics Pty. Ltd. (incorporated by reference to
            Exhibit 2.1 of the Company's Form 8-K filed on March 4,
            1996).......................................................
   3.1      Amended and Restated Articles of Incorporation of the
            Company (incorporated by reference to Exhibit 3.1 of the
            Company's Registration Statement on Form S-1 (File No.
            33-72884), which became effective on November 16, 1994).....
   3.2      Bylaws of the Company, as amended(1)........................
   4.1      Subscription Agreement dated January 12, 1996 between AWA
            Limited and Quality Semiconductor Australia Pty. Ltd
            (incorporated by reference to Exhibit 4.1 of the Company's
            Form 8-K filed on March 4, 1996)............................
   4.2      Put Option dated January 12, 1996 between Quality
            Semiconductor, Inc. and AWA Limited (incorporated by
            reference to Exhibit 4.2 of the Company's Form 8-K filed on
            March 4, 1996)..............................................
   4.3      Common Stock Purchase Warrant dated February 16, 1996 issued
            by Quality Semiconductor, Inc. to AWA Limited (incorporated
            by reference to Exhibit 4.3 of the Company's Form 8-K filed
            on March 4, 1996)...........................................
   4.4      Form of QSA Convertible/Redeemable Note Issuance Agreement
            dated November 21, 1996 between Quality Semiconductor
            Australia, Pty. Limited, Quality Semiconductor, Inc. and
            Technology Associates (Note No. 1) (incorporated by
            reference to Exhibit 4.1 of the Company's Form 8-K filed on
            December 11, 1996)..........................................
   4.5      Form of QSA Convertible/Redeemable Note Issuance Agreement,
            dated November 21, 1996 between Quality Semiconductor
            Australia Pty. Limited, Quality Semiconductor, Inc. and Win
            Win Venture Capital Corporation (Note No. 3) (incorporated
            by reference to Exhibit 4.2 of the Company's Form 8-K filed
            on December 11, 1996).......................................
   4.6      Form of QSA Convertible/Redeemable Note Issuance Agreement,
            dated November 21, 1996, between Quality Semiconductor
            Australia, Pty. Limited, Quality Semiconductor, Inc. and Win
            Win Venture Capital Corporation (Note No. 4) (incorporated
            by reference to Exhibit 4.3 of the Company's Form 8-K filed
            on December 11, 1996).......................................
   4.7      Form of QSA Convertible/Redeemable Note Issuance Agreement,
            dated November 21, 1996, between Quality Semiconductor
            Australia, Pty. Limited, Quality Semiconductor, Inc. and Win
            Win Venture Capital Corporation (Note No. 5) (incorporated
            by reference to Exhibit 4.4 of the Company's Form 8-K filed
            on December 11, 1996).......................................
   4.8      Form of Unsecured Convertible Promissory Note of Quality
            Semiconductor Australia, Pty. Limited (incorporated by
            reference to Exhibit 4.5 of the Company's Form 8-K filed on
            December 11, 1996)..........................................
   4.9      Unit Purchase Agreement (including Warrant), dated May 22,
            1997 between Quality Semiconductor, Inc. and the Purchasers
            (incorporated by reference to Exhibit 4.1(1) of S-3 filed on
            June 27, 1997)..............................................
</TABLE>
<PAGE>   54
 
<TABLE>
<CAPTION>
  EXHIBIT                                                                  PAGE
  NUMBER                    EXHIBIT DOCUMENT DESCRIPTION                  NUMBER
  -------                   ----------------------------                  ------
  <C>       <S>                                                           <C>
   4.13     Preferred Shares Rights Agreement, dated August 29, 1997
            between Quality Semiconductor, Inc. and BankBoston N.A.,
            including the Certificate of Designation of Rights,
            Preferences and Privileges of Series Participating Preferred
            Stock, the Form of Rights Certificate and the Summary of
            Rights attached thereto as Exhibit A, B, and C, respectively
            (incorporated by reference to Exhibit 4.1 of the Company's
            Form 8-K filed on September 16, 1997).......................
  10.1      Form of Indemnification Agreement for directors and officers
            (incorporated by reference to Exhibit 10.1 of the Company's
            Registration Statement on Form S-1 (File No. 33-72884),
            which became effective on November 16, 1994)................
  10.2      Amended and Restated 1989 Stock Option Plan and forms of
            agreements thereunder (incorporated by reference to Exhibit
            10.2 of the Company's Registration Statement on Form S-1
            (File No. 33-72884), which became effective on November 16,
            1994).......................................................
  10.3      1993 Employee Stock Option Plan and forms of agreements
            thereunder (incorporated by reference to Exhibit 10.3 of the
            Company's Registration Statement on Form S-1 (File No.
            33-72884), which became effective November 16, 1994)........
  10.4      Amended and Restated 1993 Directors' Stock Option Plan and
            forms of subscription agreement(1)..........................
  10.5      Amended and Restated 1995 Stock Option Plan and form of
            agreement thereunder (incorporated by reference to Exhibit
            4.3 of the Company's Form S-8 filed April 25, 1997).........
  10.6      Technology/Product Development & Licensee Agreement between
            the Company and Seiko Instruments, Inc., dated as of October
            17, 1988 (incorporated by reference to Exhibit 10.13 of the
            Company's Registration Statement on Form S-1 (File No.
            33-72884), which became effective on November 16, 1994).....
  10.7      Technology/Product Development & License Agreement between
            the Company and Yamaha Corporation, dated as of September
            23, 1989 (incorporated by reference to Exhibit 10.14 of the
            Company's Registration Statement on Form S-1 (File No.
            33-72884), which became effective on November 16, 1994).....
  10.8      Distribution Agreement between the Company and Kanematsu
            Semiconductor Corporation, dated as of November 7, 1991
            (incorporated by reference to Exhibit 10.15 of the Company's
            registration Statement on Form S-1 (File No. 33-72884),
            which became effective on November 16, 1994)................
  10.9      Sales Agreement between the Company and Kanematsu
            Semiconductor Corporation, dated as of June 1, 1990
            (incorporated by reference to Exhibit 10.16 of the Company's
            Registration Statement on Form S-1 (File No. 33-72884),
            which became effective on November 16, 1994)................
  10.10     Lease Agreement dated December 12, 1990 between the Company
            and the Prudential Insurance Company of America
            (incorporated by reference to Exhibit 10.19 of the Company's
            Registration Statement on Form S-1 (File No. 33-72884),
            which became effective on November 16, 1994)................
  10.11     Master Lease Agreement dated November 1, 1993 between the
            Company and Comdisco Inc., as amended (incorporated by
            reference to Exhibit 10.20 of the Company's Registration
            Statement on Form S-1 (File No. 33-72884), which became
            effective on November 16, 1994).............................
</TABLE>
<PAGE>   55
 
<TABLE>
<CAPTION>
  EXHIBIT                                                                  PAGE
  NUMBER                    EXHIBIT DOCUMENT DESCRIPTION                  NUMBER
  -------                   ----------------------------                  ------
  <C>       <S>                                                           <C>
  10.12     Guaranty and Indemnification Agreement dated January 12,
            1996 among AWA Limited, Quality Semiconductor Australia Pty.
            Ltd. and Quality Semiconductor, Inc. (incorporated by
            reference to Exhibit 2.2 of the Company's Form 8-K filed on
            March 4, 1996)..............................................
  10.13     Technology Services Agreement dated February 16, 1996 among
            AWA Limited, AWA MicroElectronics Pty. Ltd. and Quality
            Semiconductor, Australia Pty. Ltd. (incorporated by
            reference to Exhibit 2.3 of the Company's Form 8-K filed on
            March 4, 1996)..............................................
  10.14     Building Lease Agreement, as amended, dated July 22, 1997
            between the Company and James S. Lindsay (incorporated by
            reference to Exhibit 10.14 of the Company's Form 10-K (File
            No. 2-23128) filed on December 19, 1997)....................
  10.15     Credit Agreement amendment, dated June 25, 1997 between the
            Company and Bank of America (incorporated by reference to
            Exhibit 10.15 of the Company's Form 10-K (File No. 2-23128)
            filed on December 19, 1997).................................
  10.16     Change of Control Agreement, effective August 28, 1997
            between the Company and Directors (incorporated by reference
            to Exhibit 10.16 of the Company's Form 10-K (File No.
            2-23128) filed on December 19, 1997)........................
  10.17     Change of Control Agreement effective August 28, 1997
            between the Company and R. Paul Gupta (incorporated by
            reference to Exhibit 10.17 of the Company's Form 10-K (File
            No. 2-23128) filed on December 19, 1997)....................
  10.18     Change of Control Agreement effective August 28, 1997
            between the Company and employees (incorporated by reference
            to Exhibit 10.18 of the Company's Form 10-K (File No.
            2-23128) filed on December 19, 1997)........................
  10.19     Change of Control Agreement effective August 28, 1997
            between the Company and employees(2)........................
  10.20     Agreement and Plan of Merger by and among Integrated Device
            Technology, Inc., Penguin Acquisition, Inc., and Quality
            Semiconductor, Inc., dated November 1, 1998(3)..............
  22.1      Subsidiaries of the Registrant (incorporated by reference to
            Exhibit 22.1 of the Company's Form 10-K (File No. 2-23128)
            filed on December 19, 1997).................................
  23.1      Consent of Ernst & Young LLP, Independent Auditors..........
  24.1      Power of Attorney included on the signature page of this
            Annual Report on Form 10-K..................................
  27.1      Financial Data Schedule.....................................
</TABLE>
 
---------------
(1) Filed herewith.
 
(2) Incorporated by reference to the identically numbered exhibit filed with the
    Registrant's Form 8-K dated January 20, 1998.
 
(3) Incorporated by reference to the identically numbered exhibit filed with the
    Registrant's Form 8-K dated November 4, 1998.