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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
 
                            ------------------------
 
                                  FORM 10-K/A
                            ------------------------
 
                 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 second 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 -- Our revenues are unpredictable and subject to
rapid decline because they depend significantly 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 -- If we are not adequately prepared for the transition to
the Year 2000, our operations will be harmed."
 
  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.
 
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     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 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 -- Our customers are highly concentrated and our revenues could
be adversely affected by the loss of key customers."
 
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 North America 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
 
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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 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 -- We have less control over the distribution of our products
because we depend significantly 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
 
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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 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 -- Operating the Australia semiconductor fabrication
facility is capital intensive and complex."
 
     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 -- We have
limited control over the fabrication, assembly and testing of our products
because we depend on third parties for these functions."
 
  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.
 
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  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 product testing. See "Factors That May Affect Future Results -- We
have limited control over the fabrication, assembly and testing of our products
because we depend on third parties for these functions."
 
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 -- We must successfully develop and introduce new products
to stay competitive."
 
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. trademark. 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.
 
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     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 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 -- Our revenues and operating results can be adversely affected by
litigation involving 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.
 
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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 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.
 
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     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.
 
     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 (including interest charges) in January 1998. These redeemable
preference shares were categorized as debt on
 
                                       13
<PAGE>   14
 
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 to countries in Asia constituted 26%, 34% and 34% of net
revenues for fiscal 1998, 1997 and 1996, respectively while sales to countries
in Europe constituted 9%, 8% and 5% in those same fiscal years. 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 of $3.5
million and $2.2 million in the third and fourth quarters, respectively, of
fiscal 1998 mainly relating to networking products. The Company considers its
current backlog and forecast of six to twelve months when calculating the demand
against inventory levels to determine excess inventory. In addition the
inventory is compared to the current product portfolio to determine products
which have been obsoleted. 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. The Company's networking
products contain analog and digital circuitry, generally referred to as mixed
signal technology. Many circuit design software tools have the capability to
generate test vectors from the data that is created in the process of designing
a circuit. Generally if the circuit doesn't contain mixed signals, that is if it
is all digital circuitry, the software design tool can generate the vectors.
However, if the circuit contains mixed signals then the vectors must be
generated by a Test Engineer. All test programs are generated by a Test Engineer
based on the vectors. Therefore, it requires a significantly more human
programming to develop a text for mixed signal devices than digital devices
which can be used in a production environment. It is also very difficult to
estimate the amount of effort which will ultimately be needed to develop the
test program.
 
     The test costs were higher than expected because parts which were tested
with an early test program would have to be retested when an improved test
program was subsequently developed. This retesting occurred throughout the
development of the networking test program development resulting in test costs
which were higher than expected. As these test programs are improved, they
generally fail more products in the retesting than an earlier test program
resulting in lower yields than previously expected with the earlier test
program. 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
 
                                       15
<PAGE>   16
 
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.
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 expenses of
approximately $386,000 and design related expenses of approximately $442,000.
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 of approximately $855,000, and increased payroll
related expenses of approximately $419,000. 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
 
                                       16
<PAGE>   17
 
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 of approximately $440,000 and marketing communications expenses
of approximately $170,000 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 of
approximately $483,000 and marketing programs to support the launch of new
products at a cost of approximately $27,000.
 
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 of approximately $521,000 and $328,000, respectively.
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.
 
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 has not recognized any tax benefit for its fiscal 1998 losses
and fully reserved its deferred tax assets because of its recent loss and
volatility of the semiconductor industry. Due to the period over which these tax
benefits are expected to be realized, sufficient uncertainty exists regarding
the realizability of a portion of these assets to warrant a valuation allowance.
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
                                       17
<PAGE>   18
 
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
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.
 
                                       18
<PAGE>   19
 
  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. However, in the most reasonably
likely worst case scenario, failure of our manufacturing, order processing or
accounting systems or equipment to achieve Year 2000 compliance or of our third
party suppliers or customers to achieve Year 2000 readiness could result in
delays in the production or shipment of products to our customers or delays in
our ability to collect accounts receivable from our customers. In the aggregate
these delays could adversely affect our results of operations, liquidity or
supplier and customer relations. 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.
 
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.
 
  Our quarterly and annual operating results are difficult to predict because
  they can fluctuate dramatically for a variety of reasons, many of which we
  cannot control.
 
     Our quarterly and annual operating results can fluctuate dramatically. For
example, in fiscal 1997, we had net earnings per share of $0.03 per share, while
in fiscal 1996, we lost $0.24 per share and in fiscal 1998, we lost $2.06 per
share. This net loss of $2.06 per share in 1998 exceeded our cumulative net
income for fiscal years 1994, 1995 and 1997 by $0.35 per share and the fiscal
combined losses for the years 1994 through 1998 exceed the cumulative income for
such years by $0.59 per share. Many of the factors affecting our results are
beyond our control. Some of these factors include:
 
     - market demand for our new and existing products;
 
     - the ability of our competitors to offer better products or to offer
       similar products at lower prices; and
 
     - the cyclicality of the semiconductor industry in general.
 
                                       19
<PAGE>   20
 
     In addition, the factors affecting our quarterly and annual results over
which we have some control include:
 
     - our ability to accurately forecast demand for our existing products;
 
     - our ability to introduce successful new products on a timely basis;
 
     - our ability to control our expenses; and
 
     - our ability to effectively manage our semiconductor fabrication facility
       in Australia.
 
     Each of the above factors is described in more detail below.
 
  Our revenues are unpredictable and subject to rapid decline because they
  depend significantly on two existing product lines.
 
     Logic and logic related products and networking products account for
substantially all of our revenue.
 
     Logic and Logic Related Products. Logic and logic related products
accounted for approximately 64%, 69% and 93% of our revenues for the fiscal
years 1998, 1997 and 1996. Demand for our 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 our ability to sell our logic products.
In addition, the market for logic products is highly competitive. As a result,
if our competitors offer similar products at lower prices we may be forced to
reduce our sales prices to maintain market share or to clear inventory. This
would adversely affect our gross margin and, consequently, our operating and
financial results. Finally, if the designers of microprocessors incorporate the
logic functions that our products perform into their microprocessors, the demand
for our logic products could diminish significantly, which would adversely
affect our revenues, margins, operating results and financial condition.
 
     Networking Products. In early winter 1997 we introduced our 10 Base T and
100 Base Tx products. These networking products accounted for 31% of our revenue
in fiscal year 1998 and 26% in fiscal year 1997. 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, we derived significant revenue
from the sale of these networking chips, although quarterly revenues from these
products declined continually from the first quarter to the fourth quarter of
fiscal year 1998. In late fiscal 1998, our competitors introduced similar chips
with either better performance or lower prices. As a result of declines in
demand and increased competition, sales for these chips have not met our
forecasts and we have had to reduce our sales prices and, in some cases, reduce
our inventory valuation to reflect the reduced sales prices. We have taken
reserves to account for expected future declines in sales prices, but there can
be no assurance that our reserves are adequate. Any further declines in sales
prices will adversely affect our revenues, gross margins, operating results and
financial condition. Although we are developing new products for this market,
which we believe we will be able to sell at higher prices and margins, there can
be no assurance that we will successfully develop such products in time, that
the demand for these products will meet expectations, that our customers will
like these new products or that we will not face similar price competition for
these products as well.
 
  We must successfully develop and introduce new products to stay competitive.
 
     For QSI to be successful, we must continually introduce new products at
better price/performance levels than are currently available. Such development
and introduction involves a significant use of cash and if we are unable to
generate sufficient cash to invest in developing and introducing new products,
or to introduce new products that are successful, our results of operations and
financial condition will be adversely affected. New product development and
introduction requires us to invest significantly in:
 
     - research and development;
 
     - prototype testing;
 
                                       20
<PAGE>   21
 
     - the production of high precision quartz plates, known as "photomasks,"
       which are used to transfer circuit patterns onto semiconductor wafers;
       and
 
     - initial inventory build.
 
     In addition, we have 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, we have an ongoing need for liquid assets to fund new product
development and introduction. This requires cash, which we must generate from
operations, divert from other uses or obtain from external financing. In
addition, even if we successfully develop and introduce new products, there can
be no assurance that the products will be successful. Our new products must be
timely, must perform to specifications and must offer a better price/performance
level than existing products.
 
  Business of QSI could suffer due to announcement of the merger.
 
     The announcement of the merger may increase the likelihood of a number of
changes to our business, any of which could have a material adverse effect. Such
changes include but are not limited to:
 
     - loss of our key management, development or other personnel;
 
     - deterioration of our distributor relationships;
 
     - returns of our products;
 
     - decreases or cessation of orders for our products;
 
     - cancellation of agreements by distributors of our product line; and
 
     - delays in product development.
 
     Even if the merger is not completed, we could be harmed by the expectation
of these changes and restoring our business to its pre-announcement value could
take a long time and be costly. As a result of the factors described above, the
failure to consummate the merger could have a material adverse effect on our
business, operating results, financial condition and stock trading price.
 
  The semiconductor industry is characterized by price erosion, declining gross
  margins, product obsolescence and heightened international competition in many
  markets.
 
     As a result, we must continually develop new products with higher average
selling prices and manage our costs in order to compete. We cannot assure you
that we will be able to do this successfully, and any failure on our part to
reduce costs or introduce new products in response to competitive pressures will
have a material adverse effect on our business. Our competitors include large
semiconductor companies like Integrated Device Technology, Inc., 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 we do. 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 we compete.
 
  Operating the Australia semiconductor fabrication facility is capital
intensive and complex.
 
     We rely on the Australian fabrication facility for most of the wafer
requirements of our logic product family. Although the facility is currently
fully operational, any disruption in production or failure to maintain
acceptable yields would adversely affect us because:
 
     - we could be unable to meet the demand for our products;
 
     - we would need to seek another source for our wafers, which would probably
       raise our cost per wafer; and
 
                                       21
<PAGE>   22
 
     - we would continue to incur the fixed expenses associated with maintaining
       the facility even though it wasn't producing wafers for us.
 
     To date, we have invested more than $14.0 million in equipment and other
capital improvements since we purchased the facility in February 1996.
 
     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. In addition, we rely on external sources for the raw
materials used in the wafer fabrication process. Although we have tried to
qualify multiple vendors, any shortage of raw materials or increase in the cost
of raw materials would adversely impact our ability to produce enough wafers to
meet our demands and would raise our cost per wafer.
 
  We store, use and dispose of hazardous materials in our fabrication process
  and we could incur substantial fines or remediation costs associated with any
  violation of the laws or regulations or any environmental damage attributed to
  our use, storage or disposal of these materials.
 
     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. As a result, we 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 our
Australian fabrication facility.
 
  We have limited control over the fabrication, assembly and testing of our
  products because we depend on third parties for these functions.
 
     Fabrication. Although we fabricate a majority of our wafers in our
Australia facility, we still rely on Taiwan Semiconductor Manufacturing Company,
Ltd., for a substantial number of wafers for small geometry networking products.
Under the terms of our agreements with TSMC, they can terminate the relationship
at any time, and we would need to find an alternative source for these wafers,
which could be a time-consuming and expensive process, and could cause us to
miss order deadlines, experience reduced revenues and incur higher costs of
goods sold. In addition, there are other risks involved in relying on TSMC as a
supplier of wafers which include:
 
     - we have less control over delivery schedules;
 
     - we can't be assured that TSMC will always have the capacity available to
       meet our needs;
 
     - we have less control over quality assurance processes;
 
     - TSMC may experience technical and/or production problems that would
       prevent them from being able to fill our orders; and
 
     - there is an increased risk that our 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 we have little control over whether TSMC
continues to improve its processes, such as fabrication in finer geometries, our
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 our products.
 
     Assembly and Testing. Substantially all of our assembly is performed by
Digital Testing Services. In addition, we rely on SPIC Electronics Laboratory in
India. We also rely on SPIC and Digital Testing to perform substantially all of
our testing for our networking products. Consequently, we have less control over
the quality and availability of the services that they provide. If the quality
or reliability of these vendors degrades, or if we have 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 our revenues and other adverse effects
on our operating results.
                                       22
<PAGE>   23
 
  Our operating results are subject to significant fluctuations because we
  depend on foreign suppliers and foreign buyers.
 
     We purchase a significant amount of our wafers and substantially all of our
assembly services from foreign suppliers, primarily in Taiwan and India and we
sell a significant amount of our products to foreign buyers. Export sales to
Asia constituted 26% of our net revenues in fiscal 1998 and 34% of our net
revenues in fiscal 1997, while export sales to Europe accounted for 9% of our
net revenue in fiscal 1998 and 8% of our net revenue in fiscal 1997. As a
result, we are 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;
 
     - currency fluctuation; and
 
     - greater risk of disruptions or delays in shipments due to political
       unrest, or economic instability.
 
     For example, our revenues from our Asian customers declined by 49% 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 we make yen-denominated purchases of wafers
from our Japanese suppliers, we 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, we would have underestimated
the cost of such wafers.
 
  Our revenues and operating results can be adversely affected by litigation
  involving patents and proprietary rights.
 
     The semiconductor industry is characterized by substantial litigation
regarding patent and other intellectual property rights. Intellectual property
litigation can be expensive and can divert the energy of our management and
engineers. In addition, if any of our products are found to infringe a third
party's valid patent, then we might be subject to injunctions and significant
damages. Furthermore, we would have to either design around such patents or
obtain a license. If we are unable to successfully design around the patents or
obtain a license, then we might be unable to offer the product and our revenues
and operating results could be materially adversely affected. In the past we
have received correspondence from Cypress Semiconductor, Inc., the Lemelson
Medical, Education & Research Foundation, International Business Machines
Corporation and MUSIC Semiconductor, Inc., claiming that we may have infringed
certain patents. Our patent counsel is reviewing these claims. Although we
believe that we have valid defenses against such claims, we cannot assure you
that we will not have to litigate such claims or enter into a settlement or
license agreement to dismiss the claims. However, because the patents others are
asserting primarily involve manufacturing processes, revenues from substantially
all of our products could be subject to the alleged infringement claims.
 
  We depend on certain key personnel to manage our operations and develop new
  products.
 
     Our success depends on our ability to recruit and retain highly skilled
engineers, marketing personnel and managers. In particular, we have a strong
need for highly skilled design, process and test engineers, for whom competition
is intense. We cannot assure you that we will be successful in hiring or
retaining such key personnel or that any of our key personnel will remain
employed with us.
 
  Our customers are highly concentrated and our revenues could be adversely
  affected by the loss of key customers.
 
     Most of our revenue typically comes from a relatively small number of
customers. For example, in fiscal year 1998, our top seven customers accounted
for 53% of our total revenue. If we were to lose any of these customers, our
revenues and operating results would be materially adversely affected. In
addition, we typically have to provide volume pricing discounts to these
customers, which reduces our gross margin.
 
                                       23
<PAGE>   24
 
  We have less control over the distribution of our products because we depend
  significantly on manufacturing representatives and distributors.
 
     We market and distribute our products primarily through manufacturers'
representatives and independent distributors. If our distributors or
representatives were to reduce the number of our products they carry or to
terminate their relationships with us, we could experience reduced revenues and
would incur additional sales expenses associated with finding a replacement. In
addition, if we don't respond to rapid changes in the channel due to factors
such as consolidation or distributor financial difficulties, our revenues may be
materially adversely affected.
 
  If we are not adequately prepared for the transition to the Year 2000, our
operations will be harmed.
 
     If our company-wide Year 2000 readiness program does not successfully
address the issue of computer programs and embedded computer chips being unable
to distinguish between the Year 1900 and the Year 2000, we may suffer an
interruption in or failure of our normal business activities and operations. In
addition, even if we successfully identify and correct any products or internal
systems that are not Year 2000 compliant, the third parties on whom we rely for
such things as telephones, banking, manufacturing, supplies and shipping may not
have systems that are Year 2000 compliant. Although we cannot determine the full
extent of effects of a Year 2000 failure by us or by our key suppliers and
customers, the most reasonably likely worst case scenario could result in delays
in the production or shipment of products to our customers or delays in our
ability to collect accounts receivable from our customers. In the aggregate,
these delays could adversely affect our results of operations, liquidity or
supplier and customer relations.
 
     Through December 1998, we had spent approximately $230,000 on our Year 2000
readiness program. We estimate that we may spend up to an additional $300,000
for other repairs, replacements or upgrades and for coordinating our Year 2000
compliance efforts with key suppliers and customers. However, we may have to
spend significantly more money to ensure that our products and internal systems
are Year 2000 compliant or to remedy any situations caused by a Year 2000
failure. We do not have a contingency plan to address the Year 2000 problem, in
the event that our current program is unsuccessful, but we expect to create one
by June 1999.
 
  Our operating results and financial condition are difficult to predict because
  the semiconductor industry is cyclical and subject to rapid change.
 
     We may experience substantial period-to-period fluctuations in future
operating results due to general semiconductor industry conditions, overall
economic conditions or other factors. 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 average selling prices and overcapacity. In addition, the
end-markets for systems that incorporate our products are characterized by
rapidly changing technology and evolving industry standards.
 
  Our stock price is volatile.
 
     Our earnings and stock price have been, and may be, subject to significant
volatility, particularly on a quarterly basis due to changes in our operating
results and financial conditions as well as to conditions that generally affect
technology companies. Any shortfall in revenue, gross margins or earnings from
expected levels could have an immediate and significant adverse effect on the
trading price of our stock in any given period. We 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
our revenue in a quarter typically is shipped in the last few weeks of that
quarter. In addition, future announcements concerning us or our competitors,
including technological innovations, new product introductions, governmental
regulations, litigation, or changes in earnings estimates by analysts, may cause
the market price of our 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.
Because of the typically low daily trading volumes of our stock, our stock price
is particularly volatile and you may find it difficult to buy or sell a large
quantity of our stock.
 
                                       24
<PAGE>   25
 
  We are evaluating the issues raised by the introduction of Euro.
 
     We are in the process of addressing the issues raised by the introduction
of the Single European Currency, or "Euro," for initial implementation as of
January 1, 1999, and through the transition period to January 1, 2002. We do not
expect the cost of any system modification to be material and do not currently
expect that introduction and use of the Euro will materially affect our foreign
exchange and hedging activities or will result in any material increase in
transaction costs. We will continue to evaluate the impact over time of the
introduction of the Euro; however, based currently available information we do
not believe that the introduction of the Euro will have a material adverse
impact on our 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 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    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      38,000       $5,234(1)
  Chief Technical Officer                      1996    $202,736    $17,600      49,000       $5,522(1)
Albert R. Enamait...........................   1998    $175,694    $ 5,734(2)   10,000           --
  Vice President of Sales & Marketing          1997    $168,569    $13,238(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                                   PRICE APPRECIATION
                             UNDERLYING      GRANTED TO    EXERCISE OR                 FOR OPTIONS TERM(1)
                              OPTIONS       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 to its employees for the
    fiscal year ended September 27,1998 is 1,597,136 shares. The Company did not
    grant SARs in fiscal year ended September 27, 1998.
 
(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 AT              IN-THE-MONEY OPTIONS AT
                              ACQUIRED ON    REALIZED     SEPTEMBER 27, 1998(#)*       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...........      --           --              16,875/ 35,625                   --/--
David Sear..................      --           --                   0/150,000                   --/--
Edward J. Bradley, Jr.......      --           --              11,290/ 23,209                   --/--
</TABLE>
 
---------------
*   There were no SAR exercises in fiscal year ended September 27, 1998 and
    there were no outstanding SARs at the end of fiscal year ended September 27,
    1998.
 
(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
 
                                       27
<PAGE>   28
 
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 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 Officer, 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...........................................    330,150(6)    4.36%
  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)..................................................  1,112,414(11)   14.12%
</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 Corporation and 79,400 shares owned by Tech Gains as to which
     Mr. Kang disclaims beneficial ownership except to the extent of his
     pecuniary interest therein. Mr. Kang is a director of Technology Associates
     Corporation and is the Managing Director of Technology Associates
     Management Company which controls TechGains.
 
 (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.
 
                                       29
<PAGE>   30
 
 (9) Includes 13,521 shares subject to outstanding stock options exercisable on
     or before January 9, 1999.
 
(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 314,151 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.............................................  38
         Notes to Consolidated Financial Statements.............  39
    (2) Financial Statement Schedule
         The following financial statement schedule is included
         herein:
         Schedule II -- Valuation and Qualifying Accounts.......  54
         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: March 22, 1999                     By:       /s/ R. PAUL GUPTA
                                            ------------------------------------
                                                       R. Paul Gupta
                                                  Chief Executive Officer
 
     Pursuant to the requirements of the Exchange Act of 1934, this report has
been signed by the following persons on behalf of the Registrant and 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 Board    March 22, 1999
------------------------------------------------
Chun P. Chiu
 
/s/ R. PAUL GUPTA                                 Director, President and Chief         March 22, 1999
------------------------------------------------  Executive Officer
R. Paul Gupta
 
/s/ STEPHEN H. VONDERACH*                         Vice President of Finance, Chief      March 22, 1999
------------------------------------------------  Financial Officer and Chief
Stephen H. Vonderach                              Accounting Officer
 
/s/ ANDREW J. S. KANG*                            Director                              March 22, 1999
------------------------------------------------
Andrew J. S. Kang
 
/s/ ROBERT L. PUETTE*                             Director                              March 22, 1999
------------------------------------------------
Robert L. Puette
 
/s/ MASAHARU SHINYA*                              Director                              March 22, 1999
------------------------------------------------
Masaharu Shinya
 
/s/ DAVID D. TSANG*                               Director                              March 22, 1999
------------------------------------------------
David D. Tsang
 
             *By: /s/ R. PAUL GUPTA
    ---------------------------------------
                 R. Paul Gupta
               (Attorney-in-Fact)
</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)...................  (12,956)     2,378
  Cumulative translation adjustment.........................   (2,582)      (157)
  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
                                                              ========    =======    =======
</TABLE>
 
                                       36
<PAGE>   37
 
<TABLE>
<CAPTION>
                                                                YEARS ENDED SEPTEMBER 30,
                                                              ------------------------------
                                                                1998       1997       1996
                                                              --------    -------    -------
<S>                                                           <C>         <C>        <C>
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during this period for:
  Interest..................................................  $    965    $ 1,091    $   107
  Taxes (refunded), net.....................................  $ (1,700)   $ 2,234    $   724
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING
  ACTIVITIES
Redeemable preference shares of a subsidiary issued as
  partial consideration for certain assets of AWAM..........  $     --    $    --    $ 6,300
Conversion of promissory notes into common stock............  $     --    $ 3,000    $    --
Acquisition of property and equipment through issuance of
  long term debt to related party...........................  $     --    $ 6,603    $ 3,668
Acquisition of property and equipment
  under capital lease obligations...........................  $  1,475
</TABLE>
 
                            See accompanying notes.
                                       37
<PAGE>   38
 
                          QUALITY SEMICONDUCTOR, INC.
 
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                  RETAINED
                                  COMMON STOCK     ADDITIONAL     EARNINGS     CUMULATIVE
                                 ---------------    PAID-IN     (ACCUMULATED   TRANSLATION     DEFERRED
                                 SHARES   AMOUNT    CAPITAL       DEFICIT)     ADJUSTMENT    COMPENSATION    TOTAL
                                 ------   ------   ----------   ------------   -----------   ------------   --------
<S>                              <C>      <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
  Cumulative translation
    adjustment.................     --      --           --                           244            --          244
  Net loss.....................     --      --           --         (1,310)                          --       (1,310)
                                 -----     ---      -------       --------      ---------      --------     --------
BALANCE AT SEPTEMBER 30,
  1996.........................  5,536       5       28,348          2,168            244          (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
  Cumulative translation
    adjustment.................     --      --           --                          (401)           --         (401)
  Net income...................     --      --           --            210                           --          210
                                 -----     ---      -------       --------      ---------      --------     --------
BALANCE AT SEPTEMBER 30,
  1997.........................  7,393       7       41,600          2,378           (157)         (191)      43,637
  Sale of common stock.........    140       1          377             --                           --          378
  Repurchase of common stock...    (30)     --         (157)            --                           --         (157)
  Amortization of deferred
    compensation...............     --      --           --             --                          191          191
  Cumulative translation
    adjustment.................     --      --           --                        (2,425)           --       (2,425)
  Net loss.....................     --      --           --        (15,334)            --)           --      (15,334)
                                 -----     ---      -------       --------      ---------      --------     --------
BALANCE AT SEPTEMBER 30,
  1998.........................  7,503     $ 8      $41,820       $(12,956)     $  (2,582)     $ 26,290
                                 =====     ===      =======       ========      =========      ========     ========
</TABLE>
 
                            See accompanying notes.
                                       38
<PAGE>   39
 
                          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.
 
                                       39
<PAGE>   40
                          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. The Company wrote-down $3.5 million and $2.2 million in inventory in
the third and fourth quarters, respectively, of fiscal 1998. 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
                                       40
<PAGE>   41
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
indicators exist. If impairment indicators are present, and the undiscounted
cash flows estimated to be generated by the assets are less than the carrying
amount of the assets, the Company considers the need to write-down long-lived
assets to estimated fair 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
 
                                       41
<PAGE>   42
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
 
     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>
 
                                       42
<PAGE>   43
                          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.
Borrowings under these agreements are secured by equipment financed under the
agreements.
 
                                       43
<PAGE>   44
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 6. LONG-TERM OBLIGATIONS TO RELATED PARTY AND CAPITAL LEASE OBLIGATIONS
(CONTINUED)
     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.
 
     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.
 
                                       44
<PAGE>   45
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 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 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.
 
CONVERTIBLE PROMISSORY NOTES
 
     In November 1996, the Company negotiated a private placement of unsecured,
convertible promissory notes in the principal amount of $5.0 million, of QSA.
The notes are convertible at the option of the investors of the Company into
either 732,931 shares of the Company's common stock or 732,931 shares of
non-voting Series B Preference shares of QSA. The Company received $3.0 million
of the total financing by December 1996, which were converted into 439,758
shares of common stock. Of the remaining amount, the Company decided not to
sell, and one of the investors agreed not to buy $2.0 million of the notes.
 
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.
 
                                       45
<PAGE>   46
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 8. SHAREHOLDERS' EQUITY (CONTINUED)
     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>
 
     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
 
                                       46
<PAGE>   47
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 8. SHAREHOLDERS' EQUITY (CONTINUED)
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
(10,000, 10,000 and 17,500 in 1998, 1997 and 1996, respectively) 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 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>
 
                                       47
<PAGE>   48
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 8. SHAREHOLDERS' EQUITY (CONTINUED)
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>
 
     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
 
                                       48
<PAGE>   49
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 8. SHAREHOLDERS' EQUITY (CONTINUED)
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.
 
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.
 
                                       49
<PAGE>   50
                          QUALITY SEMICONDUCTOR, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
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>
 
                                       50
<PAGE>   51
                          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.
 
                                       51
<PAGE>   52
                          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>
 
                                       52
<PAGE>   53
                          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.
 
                                       53
<PAGE>   54
 
                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.
 
                                       54
<PAGE>   55
 
                               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>   56
 
<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).............................
  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)..............................................
</TABLE>
<PAGE>   57
 
<TABLE>
<CAPTION>
  EXHIBIT                                                                  PAGE
  NUMBER                    EXHIBIT DOCUMENT DESCRIPTION                  NUMBER
  -------                   ----------------------------                  ------
  <C>       <S>                                                           <C>
  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.