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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
_____________
FORM 10-K
(MarK One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 1998
or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from _________ to _________
Commission File Number 0-23441
_____________
POWER INTEGRATIONS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3065014
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
477 N. MATHILDA AVENUE, CALIFORNIA 94086
(Address of principal executive offices) (Zip code)
(408) 523-9200
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of Exchange on which registered
------------------- ------------------------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
(Title of Class)
_____________
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [_]
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 registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
The aggregate market value of registrant's voting and non-voting common
equity held by nonaffiliates of registrant, based upon the closing sale price of
the common stock on February 26, 1999, as reported on the Nasdaq National
Market, was approximately $241,292,267. Shares of common stock held by each
officer, director and holder of 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.
Outstanding shares of registrant's common stock, $.001 par value, as of
February 26, 1999: 12,747,252
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the definitive Proxy Statement for registrant's 1999 Annual
Meeting of Stockholders to be filed with the Commission pursuant to Regulation
14A not later than 120 days after the end of the fiscal year covered by this
Form are incorporated by reference into Part III of this Form 10-K Report.
================================================================================
PART I
This report includes a number of forward-looking statements. Such
statements reflect our current views with respect to future events and our
potential financial performance and are subject to risks and uncertainties that
could cause our actual results and financial position to differ materially from
what we say in this report. These factors include, but are not limited to, our
ability to maintain and establish strategic partnerships; the risks inherent in
the development and delivery of complex technologies; our ability to attract,
retain and motivate qualified personnel; the emergence of new markets for our
products and services, and our ability to compete in those markets based on
timeliness, cost and market demand; and our limited financial resources. We more
fully discuss these and other risk factors in "Item 7--Management's Discussion
and Analysis of Financial Condition and Operating results--Risk Factors" and
elsewhere in this report.
ITEM 1. BUSINESS
OVERVIEW
We design, develop, manufacture and market proprietary, high-voltage,
analog integrated circuits, commonly referred to as ICs, for use in alternating
current to direct current (AC to DC) power conversion. We have targeted high-
volume power supply markets. Our primary markets include:
. the cellular telephone market;
. the personal computer market; and
. various consumer and industrial electronics markets.
Our ICs cost-effectively bring the benefits of high levels of integration
to AC to DC switching supplies. We believe that the products in our TOPSwitch
family of high-voltage ICs, introduced in 1994, are the first highly integrated
power conversion ICs to achieve widespread market acceptance. We introduced
TOPSwitch II, an enhanced family of our ICs, in April 1997 and TinySwitch, a
family of more energy-efficient power conversion ICs, in September 1998.
INDUSTRY BACKGROUND
Virtually every electronic device that plugs into a wall socket requires
some type of power supply. These power supplies convert incoming high-voltage,
alternating current, or AC, provided by electric utilities into low-voltage
direct current, or DC, that can be used by electronic devices. Additionally,
rechargeable, portable products, such as cellular phones and laptop computers,
also need an AC to DC power supply to recharge their batteries.
Historically, AC to DC power supplies have used large, inefficient
transformers which operate at low frequencies to transform high-voltage current
to low-voltage current. In the 1970s, the invention of high-voltage discrete
semiconductors enabled the development of a new generation of AC to DC power
supplies. These new AC to DC "switching" power supplies, also known as
switchers, used a high-voltage discrete semiconductor along with other
components to generate high frequency pulses of power enabling the use of
smaller, more efficient transformers to lower the voltage. Although these
discrete switchers offered advantages over older technologies, over the years
they have not kept pace with the technological advances made in the electronic
devices they power.
Recent market trends in electronics have created new requirements for power
supplies. The proliferation of portable electronic devices, particularly in
wireless communications such as cellular phones and mobile computing, has
created a global market where consumers demand that new generations of
electronic devices become smaller and lighter. This expectation of increasingly
compact systems has driven end user demand for smaller, lighter power supplies.
Another major trend affecting power supplies is the increased awareness of the
financial and environmental costs of excess energy consumption. Growing
environmental concerns have resulted
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in government guidelines, such as the voluntary "Energy Star" rating in the
United States, as well as in many foreign countries, which encourage the use of
more energy efficient electronic devices from home appliances to personal
computers. In addition, manufacturers are aggressively seeking to reduce
manufacturing costs and time-to-market by decreasing component count and
simplifying system design.
As the pressures from these market forces have increased, the limitations
of discrete switchers have become more pronounced. Discrete switchers require
numerous components which limit the power supply designers' ability to reduce
the size, increase the functionality and improve the efficiency of switchers
while at the same time meeting stringent market cost and energy efficiency
requirements. In addition, discrete switchers involve a high level of system
complexity, which limits the scalability of designs and increases time-to-market
and development risks for new products.
Despite these shortcomings, discrete switchers remain in widespread use in
the large market for high-voltage switchers within the 0.5 to 150-watt power
range. This market includes switchers for cellular phone chargers, personal
computers, televisions, VCRs, cable and direct broadcast satellite decoder boxes
and many other consumer and industrial electronic devices. Attempts to address
the shortcomings of discrete switchers by replacing discrete switchers with
integrated switchers through the use of high-voltage analog ICs did not achieve
widespread acceptance in the marketplace because they were not cost-effective.
Consequently, we believe that a substantial market opportunity exists for high-
voltage ICs that are cost effective, and combine the benefits of integration
that existing solutions lack.
OUR HIGHLY INTEGRATED SOLUTION
We have developed a family of high-voltage ICs, which we believe are the
first highly integrated power conversion ICs to achieve widespread market
acceptance. Since introducing our TOPSwitch products in 1994, we have shipped
approximately 175 million TOPSwitch ICs, 89 million of which were shipped in
1998 alone. These patented ICs achieve a high level of system integration by
combining a number of electronic components into a single IC. Our TOPSwitch
products enable many power supplies in the 0.5 to 150-watt power range to have a
total cost equal to or lower than discrete switchers. Our TOPSwitch products
offer the following key benefits to power supplies:
. Fewer Components, Reduced Size and Enhanced Functionality
Our highly integrated TOPSwitch ICs enable the design and production
of cost-effective switchers that use up to 50% fewer components and
have enhanced functionality compared to discrete-based solutions. For
example, our ICs provide thermal and short circuit protection without
increasing system cost while discrete switchers must add additional
components and cost to provide these functions.
. Improved Efficiency
Our integrated circuit also improves electrical efficiency, which
reduces power consumption and excess heat generation. Our patented
low-loss, high-voltage device, combined with its control circuitry,
improves overall electrical efficiency during both full operation and
stand-by mode.
. Reduced Time-to-Market
Our integrated circuit makes power supply design simpler and once
customers have created designs using our ICs, they can apply that
design to new products, resulting in a shorter time-to-market and
reduced product development risk.
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. Wide Power Range and Scalability
Products in our current TOPSwitch families can address a power range
of 0.5 to 150 watts. The scalable architecture of these ICs allows
switcher designers to adapt their existing TOPSwitch-based designs
to a wide range of products to address many different power supply
markets.
STRATEGY
Our objective is to be the leading provider of high-voltage power
conversion ICs. We intend to pursue the following strategies to accelerate
adoption of our products:
. Target High-Volume Markets
Because of our products' scalability and ability to address a wide
power range, a small number of products address a wide variety of
customer needs, allowing us to take advantage of economies of scale
and making us more competitive.
. Focus on Markets that Can Derive Significant Benefits from
Integration
We are initially focusing our efforts on those markets that are
particularly sensitive to size, portability, energy efficiency and
time to market issues. We achieved early success in the cellular
phone fast charger market, as cellular phone customers demanded more
portable travel chargers instead of stand-alone desktop chargers. We
have also achieved some success in the desktop PC market due to the
market's recent demand for stand-by power capability. As other
markets emerge as significant opportunities for our TOPSwitch
products, we intend to focus our resources on the development and
penetration of those markets.
. Deliver Systems Solution and Provide Applications Expertise
To help potential customers decide to purchase our TOPSwitch
products, we offer comprehensive application design support. We
provide extensive application notes and production-ready reference
design boards. We also provide application-engineering support out
of our headquarters and through field application engineering labs
located in England, India, Japan, Korea, Singapore and Taiwan. We
have committed substantial resources to system support by dedicating
approximately 15% of our workforce to applications engineering. We
believe our power supply systems expertise and investment in field
applications engineering provide us significant competitive
advantages.
. Extend Technological Leadership in High-Voltage Analog ICs
Our proprietary device structures and fabrication processes as well
as analog circuit designs have resulted in 22 U.S. patents and 33
foreign patents. These patents, in combination with our other
intellectual property, form the basis of our TOPSwitch product
families. We recently introduced an enhanced TOPSwitch product
family that provides improved power capability and system cost
advantages while preserving the design simplicity of our original
TOPSwitch products. We continue to improve our device structures,
wafer fabrication processes and analog circuit designs and seek to
obtain additional patents to protect our intellectual property.
. Leverage Patented Technology in Strategic Partnerships
We have established relationships with Matsushita Electronics
Corporation, and with OKI Electric Industry in order to take
advantage of these companies' high volume manufacturing resources,
achieve broader market penetration and in the case of Matsushita
generate royalty revenues. Our wafer manufacturing relationships
with Matsushita and OKI enable us to focus on fundamental high-
voltage silicon technology, product design and marketing while
minimizing fixed costs and
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capital expenditures. Matsushita also has licensed the right to
manufacture our products for sale in certain geographic regions and
for use in its own products.
PRODUCTS
Below is a brief description of our products:
. The TOPSwitch Product Families
Our TOPSwitch high-voltage analog IC products are able to meet the
power conversion needs of a wide range of applications within high
volume markets. Sales of TOPSwitch products accounted for 93% and
95% of our net revenues in 1997 and 1998, respectively.
* TOPSwitch
The TOPSwitch family consists of 13 products, the first of
which was introduced in 1994. The key benefits of the
TOPSwitch family compared to discrete switchers include
fewer components, reduced size, enhanced functionality and
lower cost in many applications. Our TOPSwitch products
integrate a PWM controller, a high-voltage MOSFET and a
number of other electronic components into a single 3-pin
IC. These products are produced in two high-voltage
versions--a 350-volt version for the 115VAC-switcher
markets, including the United States and Japan, and a 700-
volt version for the 230VAC-switcher markets, including
Europe.
* TOPSwitch II
The TOPSwitch II family currently consists of 11 products,
the first of which was introduced in April 1997. The
TOPSwitch II products further lower the switcher costs by
improving the performance of TOPSwitch and addressing low
power applications. The TOPSwitch II family uses the same
proprietary architecture as the original TOPSwitch family,
enabling switcher designers experienced with TOPSwitch to
take advantage of the TOPSwitch II benefits without
implementing a new architecture.
* TinySwitch
The TinySwitch family currently consists of 5 products, the
first of which was introduced in September 1998. The
TinySwitch family of high voltage ICs is the first of our
new generation chips based on our new EcoSmart technology.
We developed our EcoSmart technology to enable a new class
of light, compact, energy-efficient power supplies to
address the growing global demand to reduce energy waste in
a wide range of electronic products. The TinySwitch product
line topology was specifically designed to address low power
applications (less than 10 watts).
. Other Products
Our products also include our SMP family, our INT family and a
limited number of custom products. Sales of these products accounted
for 7% and 5% of our net revenues in 1997 and 1998, respectively. We
expect revenue from these products to continue to decline as a
percentage of net revenues.
* SMP
The SMP family is the original line of power conversion
products, which we developed for the AC to DC power supply
market. These products are used in applications where
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switcher designers are willing to pay a premium price for
additional features such as variable frequency.
* INT
The INT products are interface drivers for motor control
applications, which utilize our high-voltage process
technology.
* Custom Products
We also manufacture a limited number of custom products,
including a hook switch for telephones.
MARKETS AND CUSTOMERS
Our strategy is to target high-volume power supply markets and to initially
focus on markets that can benefit the most from our highly integrated power
conversion ICs. The following chart shows representative customers, who in some
cases are also end users of our products in power supplies in several major
market segments.
MARKET SEGMENT CUSTOMERS
- ------------------------------------------------ ------------------------------
. Cellular Phones
Battery Chargers ICC, Motorola and its
subsidiaries, Nokia, Phihong
Enterprises, Samsung
Electronics
. Desktop Computers
Stand-by Power Acbel (API), Astec, Compac,
Delta Electronics, Hipro,
Intertek, Liteon, Minebia,
Magnetek, SPI
. Cable and Direct Broadcast
Satellite
Set-top Decoders Acbel (API), Amstrad, General
Instruments, Grundig, Hughes,
Nokia, Pace, Scientific
Atlanta
. PC Peripherals
Multi-media Monitor & Audio Logitech, Lucky Goldstar, Sony
Universal Serial Bus Nokia, Philips, Samsung, Sony
Removable Mass Storage Anam Instr. (End User:
Iomega), Electronique D2,
Imation
. Consumer
TV Philips, Samsung, Sony,
Tatung, Vestel, Zenith
VCR Daewoo, Sony
DVD Sony, General Instruments
. Industrial
Utility Meters Landis & Gyr, MTC,
Schlumberger, Siemens
Uninterrupted Power Supply APC, Exide Electronics, HTM
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Description of Our Primary Markets
. Cellular Phone Chargers
In the cellular phone market, size, portability and more recently,
energy efficiency are key market drivers for these products. We
believe a substantial market opportunity exists for small, energy
efficient power supplies for battery chargers. We estimate the
total available annual market for cell phone chargers was
approximately 170 million units in 1998.
. Desktop Computer Standby Power Supplies
Desktop computers use energy while idle and turned on to wait for
communication functions such as receiving a fax. As the level of
communication functions performed by the computer increases, the
computer's power consumption during idle is becoming a significant
cost for both users and the economy. Therefore, computer
manufacturers and governmental authorities are promoting the use of
stand-by power features in new PCs to reduce the PCs' power
consumption when idle. Our TOPSwitch products are currently being
used in computers to reduce the power consumed when idle and meet
the market demand for more energy-efficient computers. We estimate
that the annual market for standby power supplies for desktop PCs
was approximately 60 million units in 1998.
. Other Markets
Although we currently focus on the above key markets, we also sell
products into a wide variety of other markets, which include PC
peripherals, televisions, VCRs, industrial meters and kitchen
appliances. As these and other markets emerge as significant
opportunities for our TOPSwitch products, we intend to focus our
resources on the development and penetration of these markets.
SALES, DISTRIBUTION AND MARKETING
We sell our products to OEMs and merchant power supply manufacturers
through a direct sales staff and through a worldwide network of independent
sales representatives and distributors. We use sales representatives throughout
Asia and Europe. Our international sales representatives also act as
distributors. In the United States, we use one national distributor and a number
of regional sales representatives. We have sales offices in Marietta, Georgia
and Laguna Beach, California, as well as in England, India, Korea and Taiwan.
For 1998, direct sales to OEMs and merchant power supply manufacturers
represented approximately 50 percent of our net revenues while sales through
distributors accounted for the remaining 50 percent. All distributors are
entitled to certain return privileges based on sales revenue and are protected
from price reductions affecting their inventories. Our distributors are not
subject to minimum purchase requirements and the sales representatives and
distributors can discontinue marketing any of our products at any time.
Our products are generally incorporated into a customer's power supply at
the design stage. Our sales and marketing efforts are focused on facilitating
the customer's use of our products in the design of new power supplies for
specific applications. An important competitive factor in determining whether a
customer decides to use our products in its designs is our commitment to provide
comprehensive application design support. We publish comprehensive databooks and
design guides and provide to our current and prospective customers extensive
application notes and production-ready reference design boards. In addition, we
provide application-engineering support out of our headquarters, and our field
application engineering labs provide local resources to support customers in key
geographies. We focus particular efforts on building relationships with, and
providing support to, industry-leading OEMs and merchant power supply
manufacturers. We have committed substantial resources to system support by
dedicating approximately 15% of our workforce to applications engineering.
Our end user base is highly concentrated, and a relatively small number of
OEMs, directly or indirectly through merchant power supply manufacturers,
accounted for a significant portion of our revenue in 1997 and 1998. Motorola is
presently our largest end user. Although the exact dollar amounts and
percentages of sales to
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Motorola are difficult to ascertain because most of such sales occur through
distributors or indirectly through sales to merchant power supply manufacturers
which, in turn, sell power supplies to Motorola, we estimate that direct and
indirect sales to Motorola accounted for approximately 14% of our net revenues
for 1998. We estimate that our top ten customers, including distributors which
resell to Motorola and other large OEMs and merchant power supply manufacturers,
accounted for 64%, 67% and 67% of our net revenues for 1996, 1997 and 1998,
respectively. For 1996, no individual customer accounted for more than 10% of
our net revenues. For 1997, Maxisum (Insight), a distributor, and Phihong
Enterprise, a merchant, accounted for 21% and 15% of our net revenues,
respectively. For 1998, Maxisum (Insight) and Synnex Technologies, a
distributor, accounted for 22% and 13% of our net revenues, respectively. No
other customers accounted for more than 10% of net revenues during 1997 and
1998. In 1996, 1997 and 1998, international sales comprised 72%, 81% and 83%,
respectively, of our net revenues.
Sales of our products are generally made pursuant to standard purchase
orders, which are frequently revised to reflect changes in the customer's
requirements. Product deliveries are scheduled upon our receipt of purchase
orders. Generally, these orders allow customers to reschedule delivery dates and
cancel purchase orders without significant penalties. For these reasons, we
believe that purchase orders received, while useful for scheduling production,
are not necessarily reliable indicators of future revenues.
In the Japanese market, we have a license agreement with Matsushita under
which Matsushita sells its versions of our products. While we continue to sell
products to our existing Japanese customers, in April 1997, we agreed not to
pursue new business in Japan until after June 2000. We believe that this
arrangement will better meet our market penetration and financial objectives in
Japan. We support Matsushita's sales efforts and our existing Japanese customers
through our office in Japan.
TECHNOLOGY
. High-Voltage Transistor Structure and Process Technology
We have developed a proprietary high-voltage, power IC technology,
which uses our MOS transistor structure and proprietary process and
has resulted in 7 U.S. patents. The technology enables us to
integrate cost effectively on the same monolithic IC, high-voltage
n-channel transistors with industry standard CMOS and bipolar
components. The IC device structure and the wafer fabrication
process both contribute to the cost effectiveness of our high-
voltage technology. The device structure results in a transistor
conduction capability that is significantly higher than that of
competing technologies. The IC device structure can be implemented
on low cost silicon wafers using a 3 micron CMOS process when
combined with our proprietary implant process step.
. IC Design and System Technology
Our proprietary IC designs combine complex control circuits and
high-voltage transistors on the same monolithic IC and have
resulted in 15 U.S. patents. Our IC design technology takes
advantage of our high-voltage process to minimize the die size of
both the high-voltage device and control circuits and improve the
performance of our ICs versus alternative integration technologies.
The combination of our IC design technology and our system level
expertise in switchers has enabled us to develop the highly
integrated TOPSwitch ICs and scalable architecture for integrated
switchers.
RESEARCH AND DEVELOPMENT
Our research and development efforts are focused on improving our high-
voltage device structures, wafer fabrication processes, analog circuit designs
and system level architecture. By these efforts, we seek to further reduce the
costs of our products, and improve the cost effectiveness and enhance the
functionality of our customers' power supplies. We have assembled a
multidisciplined team of highly skilled engineers to meet our research and
development goals. These engineers bring expertise in high-voltage structure and
process technology, analog design and power supply systems architecture.
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In 1996, 1997 and 1998, we spent $3.5 million, $5.3 million and $7.2
million, respectively, on research and development efforts. We expect to
continue to invest substantial funds in research and development activities. The
development of high-voltage analog ICs is highly complex. We cannot guarantee
that we will develop and introduce new products in a timely and cost-effective
manner or that our development efforts will successfully permit our products to
meet changing market demands.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
We use a combination of patents, trademarks, copyrights, trade secrets and
confidentiality procedures to protect our intellectual property rights. We hold
22 U.S. patents and have generally filed for or received foreign patent
protection on these patents resulting in 33 foreign patents and 15 foreign
patent applications. The U.S. patents have expiration dates ranging from 2006 to
2016. Seven of the U.S. patents are related to the device structure of the high-
voltage transistor, 10 are circuit patents that have been used in our products
and 3 are circuit patents that provide the foundation for our TOPSwitch
products. Two of the U.S. patents cover specific system applications using
TOPSwitch. We are currently pursuing additional U.S. patent applications
relating to improvements and extensions of our products. We cannot guarantee
that our pending United States or foreign patent applications or any future
United States or foreign patent applications will be approved, that any issued
patents will protect our intellectual property or will not be challenged by
third parties, or that the patents of others will not have an adverse effect on
our ability to do business. Furthermore, we cannot guarantee that others will
not independently develop similar or competing technology or design around any
of our patents. We also hold nine trademarks, five in the U.S., two in
California and two in Japan.
We regard as proprietary certain equipment, processes, information and
knowledge that we have developed and used in the design and manufacture of our
products. Our trade secrets include a proprietary high volume production process
that produces our patented high-voltage ICs. We attempt to protect our trade
secrets and other proprietary information through non-disclosure agreements,
proprietary information agreements with employees and consultants and other
security measures. Despite these efforts, we cannot guarantee that others will
not gain access to our trade secrets, or that we can meaningfully protect our
intellectual property. In addition, effective trade secret protection may be
unavailable or limited in certain foreign countries. Although we intend to
protect our rights vigorously, we cannot assure that such measures will be
completely successful.
We have granted a perpetual non-transferable license to Matsushita to use
our semiconductor patents and other intellectual property for our current high-
voltage technology, including our TOPSwitch technology, and improvements on the
existing technology to manufacture and design products for internal use and for
sale or other distribution to Japanese companies and to subsidiaries of Japanese
companies in Asia. To the extent products are not based on the TOPSwitch
technology, Matsushita may make sales or other distribution to Asian companies
in Asia. Matsushita has granted us perpetual cross licenses to the technology
developed by them under their license rights. We have agreed not to license the
technology licensed to Matsushita to other Japanese companies or their
subsidiaries prior to June 2000. We have also agreed not to sell our products in
Japan to new customers. In exchange for its license rights, Matsushita has paid
and will continue to pay to us licensing fees for a fixed period and has paid or
will pay royalties on products using the licensed technology during fixed
periods. In April 1997, we amended our license agreement with Matsushita to
explicitly include high-voltage device technology being developed by us in
return for an improved royalty structure from Matsushita.
We have also granted a perpetual, non-transferable license to AT&T
Microelectronics to use certain of our IC processes and device technologies in
the products AT&T sells. In addition, pursuant to an agreement with MagneTek,
Inc., we have granted MagneTek an exclusive, perpetual royalty-free license to
manufacture lighting products that incorporate certain of our technology.
In July 1998, we filed a complaint for patent infringement in the U.S.
District Court, Northern District of California, against our largest end user,
Motorola. In August 1998, we voluntarily dismissed the complaint, and filed a
new complaint in the U.S. District Court, District of Delaware, alleging that
Motorola has infringed and continues to infringe on two of our circuit patents.
We seek, among other things, an order enjoining Motorola from infringing on our
patents and an award for damages resulting from the alleged infringement. In
October
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1998, Motorola asserted various counterclaims against us alleging that we are
infringing on certain of Motorola's patents. We believe that Motorola's
counterclaims are without merit and intend to vigorously defend ourselves
against these claims. Litigation may be necessary to resolve the claims we have
asserted against Motorola and to resolve the claims Motorola has asserted
against us. There can be no assurance that we would prevail in any future
litigation. Any litigation, whether or not determined in our favor or settled by
us, would be costly and would divert the efforts and attention of our management
and technical personnel from normal business operations, which would have a
material adverse effect on our business, financial condition and operating
results. Adverse determinations in litigation could result in the loss of our
proprietary rights, subject us to significant liabilities, require us to seek
licenses from third parties or prevent us from licensing our technology, any of
which could have a material adverse effect on our business, financial condition
and operating results. Moreover, the laws of certain foreign countries in which
our technology is or may in the future be licensed may not protect our
intellectual property rights to the same extent as the laws of the United
States, thus increasing the possibility of infringement of our intellectual
property.
MANUFACTURING
We contract with Matsushita and OKI to manufacture our wafers in foundries
located in Japan. Our semiconductor products are assembled and packaged by
independent subcontractors in China, Malaysia and the Philippines. We perform
testing, finishing and shipping at our facility in Sunnyvale, California. This
fabless manufacturing model enables us to focus on our engineering and design
strengths, minimize fixed costs on capital expenditures, and still have access
to high-volume manufacturing capacity. Our products do not require leading edge
process geometries for them to be cost-effective, and thus we can use
Matsushita's and OKI's older, low-cost facilities for wafer manufacturing. We
use a proprietary and sensitive implant process and must interact closely with
Matsushita and OKI to achieve satisfactory yields. Although we generally utilize
standard IC packages for assembly, some materials and aspects of assembly are
specific to our products. We require our manufacturers to use a high-voltage
molding compound available from only one supplier, that is difficult to process.
This compound and its required processes, together with the other non-standard
materials and processes needed to assemble our products, require a more exacting
level of process control than normally required for standard packages. As a
result we must be involved with our contractors on an active engineering basis
to maintain and improve the process. We have developed process monitoring
equipment to support this effort and must provide adequate engineering resources
to provide similar support in the future.
Our wafer supply agreements with Matsushita and OKI expire in June 2000 and
September 2003, respectively. Under the terms of our agreement with Matsushita,
we establish minimum annual and monthly purchase and sale commitments annually
with the mutual agreement of Matsushita. We also establish pricing by good faith
agreement, subject to our right to most favored pricing. Under the terms of the
OKI agreement, OKI has agreed to reserve a specified amount of production
capacity and to sell wafers to us at fixed prices. Our agreements with both
Matsushita and OKI provide for the purchase of wafers in Japanese yen.
We cannot assure you that we will be able to reach an agreement with
Matsushita to extend the term of its wafer supply agreement. Failure to reach,
in a timely fashion, an extension of our agreement with Matsushita or to enter
into an arrangement with another manufacturer could result in material
disruptions in supply. Certain contractual provisions limit the conditions under
which we can enter into such arrangements with other Japanese manufacturers or
their subsidiaries during the term of the agreement with Matsushita. In the
event of a supply disruption with OKI or Matsushita, and we were unable to
quickly qualify alternative manufacturing sources for existing or new products
or if such sources were unable to produce wafers with acceptable manufacturing
yields, our business, financial condition and operating results would be
materially adversely affected.
We typically receive shipments from Matsushita or OKI in approximately 8 to
10 weeks after placing orders, and lead times for new products can be
substantially longer. To provide sufficient time for assembly, testing and
finishing, we typically need to receive wafers from Matsushita and OKI 4 to 6
weeks before the desired ship date to our customers. As a result of these
factors and the fact that customers' orders can be made with little advance
notice, we have only a limited ability to react to fluctuations in demand for
our products. This could cause us to have an excess or a shortage of inventory
of a particular product. From time to time in the past
10
we have been unable to fully satisfy customer requests as a result of these
factors. Any significant disruptions in deliveries would materially adversely
affect our business and operating results. We carry a substantial amount of
inventory of tested wafers to help offset these factors to better serve our
markets and meet customer demand.
COMPETITION
The high-voltage power supply industry is intensely competitive and
characterized by extreme price sensitivity. Accordingly, the most significant
competitive factor in the target markets for our products is cost effectiveness.
Our products face competition from alternative technologies, including
traditional linear transformers and discrete switcher power supplies. We believe
that at current pricing, our families of high-voltage power conversion ICs offer
favorable cost-performance benefits compared to linear and discrete switcher
supplies in many high-volume applications. However, there has been sizeable over
capacity of discrete components, which resulted in significant price erosion for
these products during 1998. A continuation of the price decline of discrete
components, such as high-voltage Bipolar and MOSFET transistors and PWM
controller ICs, could adversely affect the cost effectiveness of the TOPSwitch
products. Also older alternative technologies like linear transformers are more
cost-effective than discrete switchers and integrated switchers that use our ICs
in certain power ranges for certain applications. If power requirements for
certain applications in which our products are currently utilized, such as
battery chargers for cellular telephones, drop below certain power levels, these
older alternative technologies can be used more cost effectively than switchers.
Our newly introduced TinySwitch IC family was specifically designed to enhance
the cost effectiveness of our integrated switcher solutions in the low power
range. However, we cannot guarantee that our efforts in this area will be
successful.
Recently, our TOPSwitch product families have begun to meet increased
competition from hybrid and single high-voltage ICs similar to TOPSwitch. These
competing products are being developed or have been developed and are being
produced by companies such as Motorola, STMicroelectronics, Samsung and Sanken
Electric Company. We expect competition to increase as companies like these see
the success we have had in converting older technologies to the integrated
solutions enabled by our product offerings. To the extent these competitors'
products are more cost effective than our products, our business, financial
condition and operating results could be materially adversely affected. Many of
our emerging competitors, including Motorola, STMicroelectronics, Samsung and
Sanken, have significantly greater financial, technical, manufacturing and
marketing resources than do we. In the context of a market where a high-voltage
IC is designed into a customer's product and the provider of such ICs is
therefore the sole source of the IC for that product, greater manufacturing
resources may be a significant factor in the customer's choice of the IC because
of the customer's perception of greater certainty in its source of supply.
Our ability to compete in our target markets also depends on such factors
as:
. timing and success of new product introductions by us and our
competitors;
. the pace at which our customers incorporate our products into their
end user products;
. availability of wafer fabrication and finished good manufacturing
capability;
. availability of adequate sources of raw materials;
. protection of our products by effective utilization of intellectual
property laws; and
. general economic conditions.
We cannot assure you that our products will continue to compete favorably
or that we will be successful in the face of increasing competition from new
products and enhancements introduced by existing competitors or new companies
entering this market. Our failure to compete successfully in the high-voltage
power supply business would materially adversely affect our business, financial
condition and operating results.
11
EMPLOYEES
As of December 31, 1998, we employed 178 full time personnel, consisting of
78 in manufacturing, 41 in research and development, 47 in sales and marketing
and 12 in finance and administration.
EXECUTIVE OFFICERS OF POWER INTEGRATIONS
As of February 26, 1999, our executive officers, which are elected by and
serve at the discretion of the board of directors, were as follows:
NAME POSITION WITH POWER INTEGRATIONS AGE
- -------------------------------------- ----------------------------------------------------------------- --------
Howard F. Earhart President, Chief Executive Officer and Director 59
Balu Balakrishnan Vice President, Engineering and New Business Development 44
Joyce Engberg Vice President, Information Technology 49
Clements Edward Pausa Vice President, Operations 68
Vladimir Rumennik Vice President, Technology Development 53
Daniel M. Selleck Vice President, Worldwide Sales 52
Robert G. Staples Chief Financial Officer, Vice President, Finance and 51
Administration and Secretary
Clifford J. Walker Vice President, Corporate Development 47
Dr. Edward C. Ross(1)(2) Chairman of the Board of Directors 57
Dr. William Davidow(1) Director 63
E. Floyd Kvamme(1)(2) Director 61
Steven J. Sharp Director 57
_____________
(1) Member of the Compensation Committee
(2) Member of the Audit Committee
Howard F. Earhart has served as our President, Chief Executive Officer and
as a Director since January 1995. From 1990 to 1995 Mr. Earhart served as an
interim Chief Executive Officer for various high technology companies including
those discussed below. From July 1994 to March 1995, Mr. Earhart served as Chief
Executive Officer of Co-Active Computing, a personal computer peer-to-peer
network adapter company. From July 1994 to January 1995, Mr. Earhart served as
Chief Executive Officer of Reach Software, a software company. From December
1993 to April 1994, Mr. Earhart served as Chief Executive Officer of Quorum
Software, a software company. From August 1993 to September 1994, Mr. Earhart
served as acting Chief Executive Officer of Digital-F/X, a hardware and software
company. From September 1992 to April 1993, Mr. Earhart served as an advisor to
the Chief Executive Officer of Raster Graphics, an electrostatic plotter
company. Mr. Earhart also served as President of the Consumer Products Group of
Memorex Corporation.
Balu Balakrishnan has served as our Vice President, Engineering and New
Business Development since September 1997. From September 1994 to September
1997, Mr. Balakrishnan served as our Vice President, Engineering and Marketing.
Mr. Balakrishnan served as Vice President, Design Engineering from April 1989 to
September 1994.
Joyce Engberg has served as our Vice President, Information Technology
since February 1999. From January 1996 to January 1999, Ms. Engberg served as
Chief Information Officer of Spectrian, a manufacturer of RF power amplifiers.
From January 1993 to January 1996, Ms. Engberg served as Director of Technical
Services of Consilium, a software company.
12
Clements Edward Pausa has served as our Vice President, Operations since
June 1997. From October 1994 to June 1997, Mr. Pausa served as a Vice President
of Alphatec Group, a semiconductor manufacturing services company. From October
1990 to June 1997, Mr. Pausa served as a director of consulting at Coopers &
Lybrand LLP. Mr. Pausa has served as a director of Coopers & Lybrand LLP, since
October 1990.
Vladimir Rumennik has served as our Vice President, Technology Development
since April 1991. From February 1990 to March 1991, Mr. Rumennik was our
Director of Technology Development. Prior to January 1990, Mr. Rumennik was a
manager at Signetics, a semiconductor company and a subsidiary of Philips
Semiconductor.
Daniel M. Selleck has served as our Vice President, Worldwide Sales since
May 1993. From February 1984 to May 1993, Mr. Selleck held various sales
management positions with Philips Semiconductor including European Regional
Sales Manager and Western Area Sales Manager in the United States.
Robert G. Staples has served as our Chief Financial Officer, Vice
President, Finance and Administration and Secretary since June 1995. From
October 1994 to June 1995, Mr. Staples served as Chief Financial Officer of MIS,
a software development company. From October 1993 to October 1994, Mr. Staples
served as Chief Financial Officer of Simtec Corporation, a semiconductor
company. From April 1988 to October 1993, Mr. Staples served as Chief Financial
Officer and Vice President, Finance and Administration of Codar Technology, a
defense contracting company.
Clifford J. Walker has served as our Vice President, Corporate Development
since June 1995. From September 1994 to June 1995, Mr. Walker served as Vice
President of Reach Software, a software company. From December 1993 to September
1994, Mr. Walker served as President of Morgan Walker, a consulting company.
From July 1992 to December 1993, Mr. Walker served as Vice President of Extended
Length Flex, a PCB company.
Dr. Edward C. Ross has served as a member of the board of directors since
January 1989 and has served as the Chairman of the Board of Directors since
January 1995. From January 1989 to January 1995, Dr. Ross served as our
President and Chief Executive Officer. From September 1995 to July 1998, Dr.
Ross served as President, Technology and Manufacturing Group of Cirrus Logic, a
semiconductor company. Dr. Ross has served as Senior Vice President and General
Manager, Professional Services Group of Synopsys, Inc., an electronic design
automation company, since July 1998.
Dr. William Davidow has served as a member of the board of directors since
its inception. Dr. Davidow has been a general partner of Mohr, Davidow Ventures,
a venture capital company since 1985. Dr. Davidow also serves as a director of
two public companies, Rambus Inc. and The Vantive Corporation.
E. Floyd Kvamme has served as a member of the board of directors since
September 1989. Mr. Kvamme has been a general partner of Kleiner Perkins
Caufield & Byers, a venture capital company, since 1984. Mr. Kvamme also serves
as a director of four public companies, TriQuint Semiconductor, Harmonic
Lightwaves, Photon Dynamics and Prism Solutions.
Steven J. Sharp is one of our founders and has served as a member of the
board of directors since our inception. Mr. Sharp has served as President, Chief
Executive Officer and Chairman of the Board of TriQuint since September 1991.
ITEM 2. PROPERTIES.
Our main executive, administrative, manufacturing and technical offices are
located in a 30,000 square foot facility in Sunnyvale, California under a lease
which expires in October 2003 with a conditional five-year option at fair market
value to the year 2008. Our manufacturing operations at this facility consist of
testing wafers and ICs. We are exploring the possibility of leasing additional
space to accommodate near term and future requirements.
13
ITEM 3. LEGAL PROCEEDINGS.
In July 1998, we filed a complaint for patent infringement in the U.S.
District Court, Northern District of California, against our largest end user,
Motorola. In August 1998, we voluntarily dismissed the complaint, and filed a
new complaint in the U.S. District Court, District of Delaware, alleging that
Motorola has infringed and continues to infringe on two of our circuit patents.
We seek, among other things, an order enjoining Motorola from infringing on our
patents and an award for damages resulting from the alleged infringement. In
October 1998, Motorola asserted various counterclaims against us alleging that
we are infringing on certain of Motorola's patents. We believe that Motorola's
counterclaims are without merit and intend to vigorously defend ourselves
against these claims.
Litigation may be necessary to resolve the claims we have asserted against
Motorola and to resolve the claims Motorola has asserted against us. There can
be no assurance that we would prevail in any future litigation. Any litigation,
whether or not determined in our favor or settled by us, would be costly and
would divert the efforts and attention of our management and technical personnel
from normal business operations, which would have a material adverse effect on
our business, financial condition and operating results. Adverse determinations
in litigation could result in the loss of our proprietary rights, subject us to
significant liabilities, require us to seek licenses from third parties or
prevent us from licensing our technology, any of which could have a material
adverse effect on our business, financial condition and operating results.
Moreover, the laws of certain foreign countries in which our technology is or
may in the future be licensed may not protect our intellectual property rights
to the same extent as the laws of the United States, thus increasing the
possibility of infringement of our intellectual property.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
14
PART II
ITEM 5. MARKET FOR POWER INTEGRATION'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
We consummated our initial public offering, or "IPO," on December 12, 1997.
Our common stock trades on the Nasdaq National Market under the symbol "POWI."
As of February 26, 1999, there were approximately 172 stockholders of record.
Because brokers and other institutions on behalf of stockholders hold many of
such shares, we are unable to estimate the total number of stockholders
represented by these record holders. The following table sets forth, for the
quarter indicated, the high and low sales price per share of our common stock as
reported on the Nasdaq National Market:
PRICE RANGE
-----------------
Year Ended December 31, 1998 HIGH LOW
---------------------------- -------- -------
Fourth quarter $27.125 $11.250
Third quarter $13.563 $ 8.500
Second quarter $14.375 $ 8.125
First quarter $14.250 $ 9.375
Year Ended December 31, 1997 HIGH LOW
---------------------------- -------- -------
Fourth quarter $ 9.375 $ 8.000
*We consummated our IPO on December 12, 1997.
We have not paid any cash dividends on our capital stock. We currently
intend to retain our earnings for use in the operation and expansion of our
business and, therefore, do not anticipate paying any cash dividends in the
foreseeable future.
15
ITEM 6. SELECTED FINANCIAL DATA.
The following selected consolidated financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and the
Notes thereto included elsewhere in this Form 10-K.
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------
1998 1997 1996 1995 1994
--------- ---------- ---------- ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net revenues:
Product sales........................................ $68,206 $44,827 $23,324 $17,406 $ 5,027
License fees and royalties........................... 1,802 1,162 619 1,009 2,099
------- ------- ------- ------- -------
Total net revenues.............................. 70,008 45,989 23,943 18,415 7,126
------- ------- ------- ------- -------
Cost of revenues.......................................... 36,638 26,291 15,546 12,371 4,324
------- ------- ------- ------- -------
Gross profit.............................................. 33,370 19,698 8,397 6,044 2,802
------- ------- ------- ------- -------
Operating expenses:
Research and development............................. 7,231 5,253 3,519 2,044 2,366
Sales and marketing.................................. 8,468 6,417 3,905 2,744 2,098
General and administrative........................... 3,641 2,053 1,558 1,619 1,061
------- ------- ------- ------- -------
Total operating expenses........................ 19,340 13,723 8,982 6,407 5,525
------- ------- ------- ------- -------
Income (loss) from operations............................. 14,030 5,975 (585) (363) (2,723)
Interest and other income (expense), net.................. 1,248 (683) (726) (406) (23)
------- ------- ------- ------- -------
Income (loss) before provision for income taxes........... 15,278 5,292 (1,311) (769) (2,746)
------- ------- ------- ------- -------
Provision for income taxes................................ 2,600 530 30 34 6
------- ------- ------- ------- -------
Net income (loss)......................................... $12,678 $ 4,762 $(1,341) $ (803) $(2,752)
======= ======= ======= ======= =======
Earnings (loss) per share:
Basic................................................ $ 1.04 $ 2.52 $ (1.57) $ (1.37) $ (7.67)
------- ------- ------- ------- -------
Diluted.............................................. $ 0.96 $ 0.51 $ (1.57) $ (1.37) $ (7.67)
======= ======= ======= ======= =======
Shares used in per share calculation:
Basic................................................ 12,213 1,888 856 585 359
------- ------- ------- ------- -------
Diluted.............................................. 13,226 9,339 856 585 359
======= ======= ======= ======= =======
DECEMBER 31,
--------------------------------------------------------------
1998 1997 1996 1995 1994
--------- ---------- ---------- ---------- -----------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments......... $44,418 $29,008 $ 7,692 $ 3,800 $ 1,551
Working capital........................................... 42,988 30,131 9,769 7,435 2,580
Total assets.............................................. 65,054 48,559 19,535 15,279 5,371
Long-term debt and capitalized lease obligations, net of
current portion......................................... 1,963 2,435 5,499 2,219 508
Stockholders' equity...................................... 47,364 33,327 9,098 9,512 3,306
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
OPERATING RESULTS.
This Management's Discussion and Analysis of Financial Condition and
Operating results includes a number of forward-looking statements which reflect
our current views with respect to future events and financial performance. These
forward-looking statements are subject to certain risks and uncertainties,
including those discussed in the "Risk Factors" and elsewhere in this report
that could cause actual results to differ materially from historical results or
those anticipated. In this report, the words "anticipates," "believes,"
"expects," "future," "intends," and similar expressions identify forward-looking
statements. We caution you not to place undue reliance on these forward-looking
statements, which speak only as of the date of this report.
OVERVIEW
We design, develop, manufacture and market proprietary, high-voltage,
analog ICs for use in AC to DC power conversion primarily for the cellular
telephone, personal computer, cable and direct broadcast satellite and various
consumer electronics markets. From our inception in March 1988 through 1993, we
developed numerous standard and custom products incorporating high levels of
features and functionality, each intended to address the needs of various
markets. Although we succeeded in developing the core of our patented technology
during this period, market penetration of our products was low because these
products were not as cost-effective as alternative products. Limited product
revenue and the high costs associated with developing and marketing numerous
solutions to numerous target markets resulted in our being unprofitable.
In 1993, we changed our strategy to focus on bringing cost-effective,
integrated products to the high-voltage AC to DC power supply markets. As a
result, in 1994, we completed development of TOPSwitch, the first in our family
of cost effective, high voltage, power conversion ICs. The TOPSwitch family of
products, with its proprietary integrated architecture, is designed to address
with relatively few products broad applications in a number of high-volume,
high-voltage AC to DC power supply markets. The initial target markets served by
TOPSwitch are particularly sensitive to size, portability, energy efficiency and
time-to-market. The TOPSwitch products and the solutions enabled by them are
significantly lower in cost than our previous products and the solutions enabled
by those products. Commercial shipments of TOPSwitch began in May 1994.
Primarily as a result of the increasing sales of TOPSwitch products, our net
revenues from product sales more than tripled between 1994 and 1995, increasing
from $5.0 million to $17.4 million. Net revenues from product sales increased
sequentially by 34% in 1996, 92% in 1997 and 52% in 1998.
By focusing on the TOPSwitch family of products, we were able to more
effectively utilize our resources and limit the growth of operating expenses in
1994 and 1995. Because of this and the growth in net revenues, operating
expenses were reduced from 77.5% of net revenues in 1994 to 34.8% of net
revenues in 1995. In response to increasing market acceptance of our TOPSwitch
products and faster revenue growth in 1996, we accelerated our investment in
research and development and sales and marketing, including technical customer
support. As a result, operating expenses were $9.0 million in 1996, $13.7
million in 1997 and $19.3 million in 1998. We expect that operating expenses
will continue to increase in absolute dollars, but will fluctuate as a
percentage of net revenues, as we continue to add resources to research and
development, sales and marketing and general and administrative activities.
We have experienced increased net revenues in each of the last eight
quarters when compared to the same quarters of the prior year, achieved a
positive income from operations in each of those quarters, and achieved positive
net income in each of the quarters since June 30, 1997. However, the prediction
of future operating results is difficult. Our future operating results will
depend on many factors, including:
. the volume and timing of orders received from customers;
. competitive pressures on selling prices;
. the volume and timing of orders placed by us with our foundries;
. the availability of raw materials;
17
. fluctuations in manufacturing yields, whether resulting from the
transition to new foundries or from other factors;
. changes in product mix including the impact of new product
introduction on existing products;
. our ability to develop and bring to market new products and
technologies on a timely basis;
. the introduction of products and technologies by our competitors;
. market acceptance of ours and our customers' products;
. the timing of investments in research and development and sales and
marketing;
. cyclical semiconductor industry conditions;
. fluctuations in exchange rates, particularly the exchange rates
between the U.S. dollar and the Japanese yen;
. changes in the international business climate; and
. economic conditions generally.
We cannot assure you that we will be able to sustain profitability on a
quarterly or annual basis.
We license certain technologies and grant limited product manufacturing and
marketing rights to strategic partners in return for foundry relationships,
license fees and product royalty arrangements. Prior to the introduction of
TOPSwitch in 1994, our analog ICs generated limited product sales while license
fees and prepaid royalties accounted for a significant percentage of our total
revenues. In future periods, we expect license fees and royalties to consist
primarily of royalties on products shipped by licensees incorporating licensed
technology, and anticipate that license fees and royalties will account for a
small percentage of net revenues. We do not expect significant prepaid license
fees from future license agreements.
A portion of our cost of revenues consists of the cost of wafers. The
contract prices to purchase wafers from Matsushita and OKI are denominated in
Japanese yen. Changes in the exchange rate between the U.S. dollar and the
Japanese yen subject our gross profit and operating results to the potential for
material fluctuations. From time to time, as our strategic partners close old
production lines and move to new fabrication facilities, we must absorb a
portion of the costs of physically moving the manufacturing of our products to
new production lines, including the costs of installation of new process
technologies.
Product revenues consist of sales to OEMs and merchant power supply
manufacturers and to distributors. Revenues from product sales to OEMs and
merchant power supply manufacturers are recognized upon shipment. At that time,
we provide for estimated sales returns and other allowances related to those
sales. Approximately half of our sales are made to distributors under terms
allowing certain rights of return and price protection for our products held in
the distributors' inventories. Therefore, we defer recognition of revenue and
the proportionate cost of revenues derived from sales to distributors until such
distributors resell our products to their customers. The gross profit deferred
as a result of this policy is reflected as "deferred income on sales to
distributors" on our consolidated balance sheet. See note 2 of notes to
consolidated financial statements.
18
RESULTS OF OPERATIONS
The following table sets forth certain operating data as a percentage of
total net revenues for the periods indicated.
PERCENTAGE OF
TOTAL NET REVENUES
YEAR ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
----------- ----------- -----------
Net revenues:
Product sales........................................................... 97.4% 97.5% 97.4%
License fees and royalties.............................................. 2.6 2.5 2.6
----- ----- -----
Total net revenues................................................. 100.0 100.0 100.0
----- ----- -----
Cost of revenues............................................................. 52.3 57.2 64.9
----- ----- -----
Gross profit................................................................. 47.7 42.8 35.1
----- ----- -----
Operating expenses:
Research and development................................................ 10.3 11.4 14.7
Sales and marketing..................................................... 12.1 14.0 16.3
General and administrative.............................................. 5.2 4.4 6.5
----- ----- -----
Total operating expenses........................................... 27.6 29.8 37.5
----- ----- -----
Income (loss) from operations................................................ 20.1 13.0 (2.4)
Interest and other income (expense), net..................................... 1.8 (1.5) (3.1)
----- ----- -----
Income (loss) before provision for income taxes.............................. 21.9 11.5 (5.5)
----- ----- -----
Provision for income taxes................................................... 3.7 1.1 .1
----- ----- -----
Net income (loss)............................................................ 18.2% 10.4% (5.6)%
===== ===== =====
COMPARISON OF YEARS ENDED DECEMBER 31, 1997 AND 1998
Net revenues. Net revenues consist of revenues from product sales, which
are calculated net of returns and allowances, plus license fees and royalties
paid by licensees of our technology. Net revenues increased 52.2% from $46.0
million in 1997 to $70.0 million in 1998. Net revenues from product sales
represented $44.8 million and $68.2 million of net revenues in 1997 and 1998,
respectively. The increase in net revenues from product sales was due primarily
to increased sales of our TOPSwitch family of products, which represented 95% of
product sales in 1998. The migration from TOPSwitch to TOPSwitch II continued
with TOPSwitch II accounting for 45% of product revenue in 1998 compared to 15%
for 1997. We began commercial shipment of TOPSwitch II in April 1997. Net
revenues also grew because of an increase in royalty revenues, from $1.2 million
to $1.8 million in the two periods, respectively.
International sales increased by $20.9 million in 1998 compared to 1997,
growing from approximately 81% of net revenues in 1997 to approximately 83% of
net revenues in 1998. Although the power supplies using our products are
designed and distributed worldwide, most of such power supplies are manufactured
in Asia. As a result, the largest portion of our net revenues is derived from
sales to this region. We expect international sales to continue to account for a
large portion of our net revenues.
In 1998, two separate customers accounted for approximately 22% and 13% of
net revenues. In 1997, one of the same customers and one different customer
accounted for approximately 21% and 15% of net revenues, respectively. See note
2 of notes to consolidated financial statements.
Gross profit. Gross profit is equal to net revenues less cost of revenues.
Our cost of revenues consists primarily of costs associated with the purchase of
wafers from Matsushita and OKI, the assembly and packaging of our products, and
internal labor and overhead associated with the testing of both wafers and
packaged components. These costs include expenses incurred in connection with
the physical move of the manufacturing
19
of our products between wafer production lines at both of our foundry suppliers
and with the installation of new process technologies at these foundries. This
may recur from time to time and adversely affect our cost of revenues.
Gross profit increased from $19.7 million, or 42.8% of net revenues, to
$33.4 million, or 47.7% of net revenues, in 1997 and 1998, respectively.
Efficiencies realized from higher volumes, reductions in both wafers and
packaging costs, improved test yields, and a favorable foreign exchange rate
between the U.S. dollar and the Japanese yen through most of the year
contributed to the improvement in gross profit. Gross profit in future periods
may be influenced by fluctuations in the exchange rate between the U.S. dollar
and the Japanese yen.
Research and development expenses. Research and development expenses
consist primarily of employee-related expenses, and expensed material and
facility costs associated with the development of new processes and new
products. We also expense prototype wafers and mask sets related to new products
as research and development costs until new products are released to production.
Research and development expenses increased by approximately 37.7%, from $5.3
million in 1997 to $7.2 million in 1998. The increase was primarily the result
of increased salaries and other costs related to the hiring of additional
engineering personnel, outside consulting fees and expensed prototype materials
resulting from the transition of foundry manufacturing processes with Matsushita
and OKI. These expenses decreased as a percentage of net revenues from 11.4% in
1997 to 10.3% in 1998 due to increased sales. We expect that research and
development expenses will continue to increase in absolute dollars but will
fluctuate as a percentage of net revenues.
Sales and marketing expenses. Sales and marketing expenses consist
primarily of employee-related expenses, commissions to sales representatives and
facilities expenses, including expenses associated with our regional sales and
support offices. Sales and marketing expenses increased approximately 32%, from
$6.4 million in 1997 to $8.5 million in 1998, which represented 14.0% and 12.1%
of net revenues, respectively. This increase represents the addition of
personnel to support international sales and field application engineers. We
expect that sales and marketing expenses will continue to increase in absolute
dollars but will fluctuate as a percentage of net revenues.
General and administrative expenses. General and administrative expenses
consist primarily of employee-related expenses for administration, finance,
human resources and general management, and legal and auditing expenses. In 1997
and 1998, general and administrative expenses were $2.1 million and $3.6
million, respectively, which represented 4.4% and 5.2% of net revenues,
respectively. This increase in absolute dollars is primarily attributable to
increased professional and legal expenses related to our patent infringement
lawsuit filed against Motorola. We expect general and administrative expenses to
continue to increase in absolute dollars, and may increase as a percentage of
net revenues while our patent infringement lawsuit against Motorola continues.
Interest and other income (expense), net. Interest and other income
(expense), net, was $683,000 net expense in 1997 and $1.2 million net income in
1998. The net expense in 1997 reflects interest incurred on capital equipment
lease obligations and on $3.0 million of subordinated debt, which originated in
the second quarter of 1996, partially offset by interest income earned on cash
and short-term investments. The net income in 1998 reflects an increase in
interest income due to the increase in cash and short-term investments from 1997
to 1998, and the reduction in interest expense due to the repayment of the
subordinated debt in 1997.
Provision for income taxes. Provision for income taxes for 1997 and 1998
represents Federal, state and foreign taxes. The effective tax rate was 10% for
1997 and 17% for 1998 reflecting the profitable results for both years. The
difference between the statutory rate and our effective tax rate for 1997 and
1998 is due to the impact of benefiting net operating loss carryforwards, offset
by a change in the deferred tax valuation allowance. See note 7 of notes to
consolidated financial statements.
COMPARISON OF YEARS ENDED DECEMBER 31, 1996 AND 1997
Net revenues. Net revenues increased 92.1% from $23.9 million in 1996 to
$46.0 million in 1997. Net revenues from product sales represented $23.3 million
and $44.8 million of net revenues in 1996 and 1997,
20
respectively. The increase in net revenues from product sales was due primarily
to increased sales of our TOPSwitch family of products and, to a lesser extent,
initial sales of the TOPSwitch II family of products, which began commercial
shipment in April 1997. Net revenues also grew because of an increase in royalty
revenues, from $619,000 to $1.2 million in the two periods, respectively.
International sales increased by $19.4 million in 1997 compared to 1996,
growing from approximately 72% of net revenues in 1996 to approximately 81% of
net revenues in 1997. Although the power supplies using our products are
designed and distributed worldwide, most of such power supplies are manufactured
in Asia. As a result, the largest portion of our revenues is derived from sales
to this region.
In 1997, net revenues from two different customers accounted for
approximately 15% and 21% of net revenues. For the year ended December 31, 1996,
no individual customers accounted for more than 10% of net revenues. See note 2
of notes to consolidated financial statements.
Gross profit. Gross profit increased from $8.4 million, or 35.1% of net
revenues, to $19.7 million, or 42.8% of net revenues, in 1996 and 1997,
respectively, due to the combined effects of the absorption of certain fixed
costs over the increased sales volume, lower prices for wafers, partially as a
result of favorable foreign exchange rates, and improved packaging costs. During
this period we experienced an improved foreign exchange rate between the U.S.
dollar and the Japanese yen, contributing approximately $895,000, or
approximately 4.6 percentage points, of the gross profit.
Research and development expenses. Research and development expenses
increased by 49.3%, from $3.5 million in 1996 to $5.3 million in 1997. The
increase was primarily the result of increased salaries and other costs related
to the hiring of additional engineering personnel, outside consulting fees and
expensed prototype materials resulting from the transition of foundry
manufacturing processes with Matsushita and OKI. These expenses decreased as a
percentage of net revenues from 14.7% in 1996 to 11.4% in 1997 due to increased
sales.
Sales and marketing expenses. Sales and marketing expenses increased 64.3%,
from $3.9 million in 1996 to $6.4 million in 1997, which represented 16.3% and
14.0% of net revenues, respectively. This increase represents the addition of
personnel to support international sales and field application engineers. We
expect that sales and marketing expenses will continue to increase in absolute
dollars but will fluctuate as a percentage of net revenues.
General and administrative expenses. In 1996 and 1997, general and
administrative expenses were $1.6 million and $2.1 million, respectively, which
represented 6.5% and 4.4% of net revenues, respectively. This increase in
absolute dollars is attributable to additional headcount to support the growth
in the volume of sales.
Interest and other expense, net. Interest and other expense, net, of
$726,000 and $683,000 in 1996 and 1997, respectively, reflects interest incurred
on capital equipment lease obligations and on the $3.0 million of subordinated
debt originated in the second quarter of 1996, partially offset by interest
income earned on cash and short-term investments. We repaid the subordinated
debt with proceeds from our initial public offering and expect to continue to
utilize term debt to finance capital equipment needs.
Provision for income taxes. Provision for income taxes for 1996 and 1997
represents Federal, state and foreign taxes. The increase in the effective rate
from 2.3% for 1996 to 10.0% for 1997 reflects the profitable results for the
1997 period. The difference between the statutory rate and our effective tax
rate for 1997 is due to the impact of benefiting net operating loss
carryforwards, offset by a change in the deferred tax valuation allowance. As of
December 31, 1997, we had net operating loss carryforwards for Federal and state
income tax reporting purposes of approximately $14.3 million and $2.5 million,
respectively, which expire at various dates through 2011. See note 7 of notes to
consolidated financial statements.
21
SELECTED QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain consolidated statement of operations
data for each of the quarters in the years ended December 31, 1997 and 1998 as
well as the percentage of our net revenues represented by each item. This
information has been derived from our unaudited consolidated financial
statements. The unaudited consolidated financial statements have been prepared
on the same basis as the audited consolidated financial statements contained
herein and include all adjustments, consisting only of normal recurring
adjustments, that we consider necessary for a fair presentation of such
information when read in conjunction with our annual audited consolidated
financial statements and notes thereto appearing elsewhere in this report. The
operating results for any quarter are not necessarily indicative of the results
for any subsequent period or for the entire fiscal year.
QUARTER ENDED
------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1997 1997 1997 1997 1998 1998 1998 1998
--------- --------- ---------- --------- -------- -------- --------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net revenues:
Product sales............................... $6,831 $ 9,878 $12,959 $15,159 $13,902 $14,647 $19,907 $19,750
License fees and royalties.................. 235 171 384 372 524 466 410 402
------ ------- ------- ------- ------- ------- ------- -------
Total net revenues........................ 7,066 10,049 13,343 15,531 14,426 15,113 20,317 20,152
------ ------- ------- ------- ------- ------- ------- -------
Cost of revenues............................. 4,321 5,789 7,492 8,689 7,976 8,254 10,635 9,773
------ ------- ------- ------- ------- ------- ------- -------
Gross profit................................. 2,745 4,260 5,851 6,842 6,450 6,859 9,682 10,379
------ ------- ------- ------- ------- ------- ------- -------
Operating expenses:
Research and development.................... 1,077 1,215 1,404 1,557 1,559 1,720 1,947 2,005
Sales and marketing......................... 1,105 1,464 1,839 2,009 1,889 1,724 2,376 2,479
General and administrative.................. 410 430 620 593 548 730 1,067 1,296
------ ------- ------- ------- ------- ------- ------- -------
Total operating expenses.................. 2,592 3,109 3,863 4,159 3,996 4,174 5,390 5,780
------ ------- ------- ------- ------- ------- ------- -------
Income from operations...................... 153 1,151 1,988 2,683 2,454 2,685 4,292 4,599
Interest and other income (expense), net..... (214) (139) (196) (134) 187 189 399 473
------ ------- ------- ------- ------- ------- ------- -------
Income (loss) before provision for
income taxes................................ (61) 1,012 1,792 2,549 2,641 2,874 4,691 5,072
Provision for income taxes................... 10 57 306 157 663 721 351 865
------ ------- ------- ------- ------- ------- ------- -------
Net income (loss)............................ $ (71) $ 955 $ 1,486 $ 2,392 $ 1,978 $ 2,153 $ 4,340 $ 4,207
====== ======= ======= ======= ======= ======= ======= =======
Earnings (loss) per share
Basic....................................... $(0.08) $ 1.08 $ 0.91 $ 0.58 $ 0.16 $ 0.18 $ 0.35 $ 0.34
Diluted..................................... $(0.08) $ 0.11 $ 0.15 $ 0.22 $ 0.15 $ 0.16 $ 0.33 $ 0.31
Shares used in per share calculation
Basic....................................... 876 886 1,632 4,126 12,080 12,087 12,229 12,452
Diluted..................................... 876 9,042 9,875 10,840 13,130 13,119 13,128 13,537
PERCENTAGE OF TOTAL NET REVENUES
-------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1997 1997 1997 1997 1998 1998 1998 1998
-------- -------- --------- -------- -------- -------- --------- --------
Net revenues:
Product sales............................... 96.7% 98.3% 97.1% 97.6% 96.4% 96.9% 98.0% 98.0%
License fees and royalties.................. 3.3 1.7 2.9 2.4 3.6 3.1 2.0 2.0
----- ----- ----- ----- ----- ----- ----- -----
Total net revenues........................ 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
----- ----- ----- ----- ----- ----- ----- -----
Cost of revenues............................. 61.2 57.6 56.1 56.0 55.2 54.6 52.3 48.5
----- ----- ----- ----- ----- ----- ----- -----
Gross profit................................. 38.8 42.4 43.9 44.0 44.8 45.4 47.7 51.5
----- ----- ----- ----- ----- ----- ----- -----
Operating expenses:
Research and development.................... 15.2 12.1 10.5 10.0 10.8 11.4 9.6 9.9
Sales and marketing......................... 15.6 14.6 13.8 12.9 13.1 11.4 11.7 12.3
General and administrative.................. 5.9 4.2 4.7 3.8 3.8 4.8 5.3 6.4
----- ----- ----- ----- ----- ----- ----- -----
Total operating expenses.................. 36.7 30.9 29.0 26.7 27.7 27.6 26.6 28.6
----- ----- ----- ----- ----- ----- ----- -----
Income from operations....................... 2.1 11.5 14.9 17.3 17.1 17.8 21.1 22.9
Interest and other income (expense), net..... (3.0) (1.4) (1.5) (0.9) 1.3 1.2 1.9 2.4
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) before provision for income
taxes....................................... (0.9) 10.1 13.4 16.4 18.4 19.0 23.0 25.3
Provision for income taxes................... 0.1 0.6 2.3 1.0 4.6 4.8 1.7 4.3
----- ----- ----- ----- ----- ----- ----- -----
Net income (loss)............................ (1.0)% 9.5% 11.1% 15.4% 13.8% 14.2% 21.3% 21.0%
===== ===== ===== ===== ===== ===== ===== =====
22
Net revenues increased in each of the four consecutive quarters through the
quarter ended December 31, 1997 and were up sequentially in the second and third
quarters of 1998, primarily due to increased shipments of our TOPSwitch family
of products. Sequential net revenues were down in the first and fourth quarters
of 1998 due, we believe, to the seasonal nature of some of our markets.
Increased shipments were due to growth in the volume of sales from existing
customers, the addition of new customers and, in the second quarter of 1997, the
introduction of the TOPSwitch II product family.
Our gross profit increased as a percentage of net revenues during each of
the eight quarters ended December 31, 1998. The gross profit improvements
generally were due to efficiencies realized from higher volumes, reductions in
material costs, improved test yields and a favorable yen exchange rate.
Research and development expenses increased in absolute terms during the
eight quarters presented, primarily due to increased staffing in the areas of
new product design and technology development. Research and development expenses
fluctuated as a percentage of net revenues, but primarily trended downward due
to increases in net revenues.
Sales and marketing expenses generally increased in absolute dollars over
the eight quarters presented, primarily due to the additional staffing in sales
and application engineering and increased sales commissions due to the increased
revenues from product sales. Sales expenses were down in the first and second
quarters of 1998 due to reduced commissions because of lower seasonal net
revenues.
General and administrative expenses increased only slightly during the
first six quarters presented and increased more in the third and fourth quarters
of 1998 primarily due to increased legal expense related to our patent
infringement lawsuit filed against Motorola.
Interest and other income (expense), net, was a net expense in the four
quarters of 1997 primarily due to interest expense resulting from increased
borrowings under our capital lease lines, and from the $3.0 million subordinated
debt incurred in May 1996. In the four quarters of 1998, interest and other
income (expense), net, was a net income primarily from increased interest income
from higher cash balances created by a net positive cash flow as well as cash
proceeds from our initial public offering in December 1997. In addition, the
repayment of the subordinated debt in December 1997 reduced interest expense.
LIQUIDITY AND CAPITAL RESOURCES
In December 1997, we completed the initial public offering of our common
stock. We sold 2,700,000 shares of common stock raising approximately $20.1
million in gross proceeds. Prior to this public offering, we financed our
operations from revenues from product sales and proceeds from the private sales
of preferred and common stock. We have also funded operations through the sales
of technology licenses and engineering design services, and various capital
equipment lease lines with terms extending from thirty-six to forty-eight
months, and an $8.0 million revolving line of credit with Imperial Bank. The
line of credit with Imperial Bank has since expired. In October 1998, we
established a new revolving line of credit with Union Bank of California in the
amount of $10.0 million. A portion of the credit line is used to cover advances
for commercial letters of credit and standby letters of credit, which we provide
to Matsushita and OKI prior to the shipment of wafers by the foundries to us.
The balance of this credit line is unused and available. The line of credit
agreement contains financial covenants and requires that we maintain
profitability on a quarterly basis and not pay or declare dividends without the
bank's prior consent.
We have financed a significant portion of our machinery and equipment
through capital equipment leases. In 1998, we entered into a new capital
equipment lease line of credit with GE Capital Corporation which allows for
combined borrowings of up to $4.4 million to finance the acquisition of property
and equipment. Approximately $2.6 million was available at December 31, 1998
under this line of credit. At December 31, 1998, we owed approximately $3.9
million on our various capital equipment leases. See note 5 of notes to
consolidated financial statements.
23
As of December 31, 1998, we had working capital, defined as current assets
less current liabilities, of $43 million, which was an increase of approximately
$12.9 million over December 31, 1997. The increase was primarily due to net
income of $12.7 million in 1998.
At December 31, 1998, we had cash, cash equivalents and short-term investments
of $44.4 million and no borrowings outstanding on our bank line of credit. Our
operating activities generated cash of $8.1 million and $18.5 million in 1997
and 1998, respectively. Cash generated in 1997 was principally the result of
net income, depreciation and amortization, and an increase in accounts payable
and accrued liabilities, partially offset by increases in accounts receivable
and inventories. Cash generated in 1998 was principally the result of net
income, depreciation and amortization, increases in deferred income and accrued
liabilities and a decrease in accounts receivable, partially offset by an
increase in inventories.
Our investing activities were a net transfer from cash to short-term
investments of $484,000 and $18.7 million in 1997 and 1998, respectively.
Financing activities provided $14.7 million of net cash during 1997 and used
$1.1 million in 1998. The cash provided from financing activities in 1997 was
primarily due to the issuance of common stock and the cash used in 1998 was
primarily for payments on capital lease obligations.
We believe that cash generated from operations, together with existing sources
of liquidity, will satisfy our projected working capital and other cash
requirements for at least the next 12 months.
YEAR 2000 ISSUES
Some computers, software, and other equipment include computer code in which
calendar year data is abbreviated to only two digits. As a result of this design
decision, some of these systems could fail to operate or fail to produce correct
results if "00" is interpreted to mean 1900, rather than 2000. These problems
are widely expected to increase in frequency and severity as the year 2000
approaches, and are commonly referred to as the "year 2000 problem."
Assessment. The year 2000 problem affects the computers, software and other
equipment that we use, operate or maintain for our operations. Accordingly, we
have organized a program team responsible for monitoring the assessment and
remediation status of our year 2000 projects and reporting such status to our
board of directors. This project team is currently assessing the potential
effect and costs of remediating the year 2000 problem for our internal systems.
To date, we have not obtained verification or validation from any independent
third parties of our processes to assess and correct any of our year 2000
problems or the costs associated with these activities.
Internal Infrastructure. We believe that we have identified most of the major
computers, software applications, and related equipment used in connection with
our internal operations that will need to be evaluated to determine if they must
be modified, upgraded or replaced to minimize the possibility of a material
disruption to our business. Upon completion of this evaluation, which we expect
to occur by the end of March 1999, we will complete the process of modifying,
upgrading, and replacing major systems that have been assessed as adversely
affected. We expect to complete this process, which began in 1998, before the
occurrence of any material disruption of our business.
Systems Other than Information Technology Systems. In addition to computers
and related systems, the operation of office and facilities equipment, such as
fax machines, telephone switches, security systems, and other common devices may
be affected by the year 2000 problem. We are currently assessing the potential
effect and costs of remediating the year 2000 problem on our office, equipment
and our facilities in Sunnyvale, California.
We estimate the total cost to us of completing any required modifications,
upgrades or replacements of our internal systems, beyond expenditures planned to
meet the needs for managing our growth, to be approximately $250,000, almost all
of which we believe will be incurred during 1999. This estimate is being
monitored and we will revise it, as additional information becomes available.
24
Based on the activities described above, we do not believe that the year 2000
problem will have a material adverse effect on our business or operating
results. In addition, we have not deferred any material information technology
projects as a result of our year 2000 problem activities.
Suppliers. We are in the process of contacting third-party suppliers of
components used in the manufacture of our products to identify and, to the
extent possible, resolve issues involving the year 2000 problem. However, we
have limited or no control over the actions of these third-party suppliers.
Thus, while we expect that we will be able to resolve any significant year 2000
problems with these third parties, there can be no assurance that these
suppliers will resolve any or all year 2000 problems before the occurrence of a
material disruption to the operation of our business. Any failure of these third
parties to resolve year 2000 problems with their systems, on a timely basis,
could have a material adverse effect on our business, operating results and
financial condition.
Customers. We are in the process of contacting our customers and, to the
extent possible, determining their year 2000 readiness and to ensure that our
revenue flow will not be substantially impacted by their inability to take
delivery of planned product shipments. However, we have limited or no control
over the actions of these customers. Thus, while we expect that we will be able
to resolve any significant year 2000 problems with them, there can be no
assurance that these customers will resolve any or all year 2000 problems before
the occurrence of a material reduction in the sale of our products. Any failure
of these customers to resolve year 2000 problems with their systems, on a timely
basis, could have a material adverse effect on our business, operating results
and financial condition.
Most Likely Consequences of Year 2000 Problems. We expect to identify and
resolve all year 2000 problems that could materially adversely affect our
business operations. However, we believe that it is not possible to determine
with complete certainty that all year 2000 problems affecting us have been
identified or corrected. The number of devices that could be affected and the
interactions among these devices are simply too numerous. In addition, no one
can accurately predict how many year 2000 problem-related failures will occur or
the severity, duration, or financial consequences of these perhaps inevitable
failures. As a result, we believe that the following consequences are possible:
. a significant number of operational inconveniences and inefficiencies
for us, our contract manufacturers and our customers that will divert
management's time and attention and financial and human resources from
ordinary business activities;
. several business disputes and claims for pricing adjustments or
penalties due to year 2000 problems by our customers, which we believe
will be resolved in the ordinary course of business; and
. a few serious business disputes alleging that we failed to comply with
the terms of contracts or industry standards of performance, some of
which could result in litigation or contract termination.
Contingency Plans. We are currently developing contingency plans to be
implemented if our efforts to identify and correct year 2000 problems affecting
our internal systems are not effective. We expect to complete our contingency
plans by the end of June 1999. Depending on the systems affected, these plans
could include:
. accelerated replacement of affected equipment or software;
. short- to medium-term use of backup equipment and software;
. increased work hours for our personnel; and
. use of contract personnel on an accelerated schedule to correct any year
2000 problems that arise or to provide manual workarounds for
information systems.
Our implementation of any of these contingency plans could have a material
adverse effect on our business, operating results and financial condition.
25
Disclaimer. The discussion of our efforts and expectations relating to year
2000 compliance are forward-looking statements. Our ability to achieve year
2000 compliance and the level of incremental costs associated therewith, could
be adversely affected by, among other things, the availability and cost of
programming and testing resources, third party suppliers' ability to modify
proprietary software, and unanticipated problems identified in the ongoing
compliance review.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income,"
which establishes standards for reporting and presentation of comprehensive
income. We adopted SFAS No. 130, which requires companies to report a new
measure of income, in the first quarter of 1998. Comprehensive income is to
include foreign currency translation gains and losses and other unrealized gains
and losses that have historically been excluded from net income and reflected
instead in equity. SFAS No. 130 did not have a material impact on our financial
statements.
During 1998, we adopted Statement of Financial Accounting Standards SFAS No.
131, "Disclosures About Segments of an Enterprise and Related Information." SFAS
131 requires a new basis of determining reportable business segments, i.e., the
management approach. This approach requires that business segment information
used by management to assess performance and manage company resources be the
source for information disclosure. On this basis, we are organized and operate
as one business segment, the design, development, manufacture and marketing of
proprietary, high-voltage, analog circuits used for the AC to DC power
conversion market. As a result, the adoption of SFAS 131 had no impact on our
disclosures or financial statements.
RISK FACTORS
In addition to the other information in this Report, the following factors
should be considered carefully in evaluating our business before purchasing
shares of our stock.
Our Operating Results Fluctuate and Are Unpredictable. Our quarterly and
annual revenues and operating results have varied significantly in the past, are
difficult to forecast, are subject to numerous factors both within and outside
of our control, and may fluctuate significantly in the future. Although we were
profitable in each of the last eight quarters, there can be no assurance that we
will continue to be profitable in future periods. We believe that period-to-
period comparisons are not necessarily meaningful and should not be relied upon
as indicative of future operating results. We believe that the growth in
revenues and operating income in 1998 compared to 1997 resulted in large part
from a combination of factors, including increased market acceptance of our
TOPSwitch product and customer ordering patterns. We cannot assure you of
similar growth rates in future periods.
. Our Operating Results Depend on the Volume and Timing of Orders
Received. Our revenues and operating results are substantially dependent
upon the volume and timing of orders received from our customers. We have
historically experienced lengthy sales cycles which limit our visibility
regarding future financial performance. We are also subject to the risks to
which the markets for our customers' or end users' products are subject,
and to technological or other changes in those markets which may affect
customer-buying patterns. In addition, the ordering patterns of some of our
existing large customers have been unpredictable in the past, and we expect
that customer-ordering patterns will continue to be unpredictable in the
future. Not only does the volume of units ordered by particular customers
vary substantially from period to period, but also purchase orders received
from particular customers often vary substantially from early oral
estimates provided by those customers for planning purposes. Our business
is characterized by short-term customer orders and shipment schedules, and
customer orders typically can be canceled or rescheduled without
significant penalty to the customer. We have in the past experienced
customer cancellations of substantial orders for reasons beyond our
control, and significant cancellations could occur again at any time in the
future.
26
. Our Operating Results Are Subject to Competitive Pressures on Selling
Prices. Our revenues and operating results are also subject to competitive
pressures on selling prices. Historically, average selling prices of
products in the semiconductor and the high-voltage AC to DC power supply
industries have decreased over the lives of the products. If we are unable
to successfully introduce new products with higher average selling prices
or are unable to reduce manufacturing costs to offset expected decreases in
the prices of our existing products, our operating margins will be
adversely affected.
. Our Operating Results Are Dependent Upon the Volume and Timing of Our
Orders With Our Foundries. Our operating results are also substantially
dependent upon the volume and timing of orders that we place with our
foundries. Due to the absence of substantial noncancellable backlog, we
must plan our production and inventory levels based on internal forecasts
of customer demand, which is unpredictable and may fluctuate substantially.
If we underestimate the number of units required to meet customer demand
and fail to maintain adequate inventory levels, we may lose significant
revenue opportunities and market share to competitors. On the other hand,
if we overestimate the number of units required to meet customer demand,
our operating results may be materially adversely affected as a result of
costs associated with carrying excess inventory and with obsolescence.
Excess inventory and obsolescence costs could be further increased by any
unestimated returns from our distributors or customers.
. Other Factors Which May Affect Our Operating Results. Other factors
which may affect our revenues and operating results include the following:
. availability of raw materials;
. fluctuations in manufacturing yields, whether resulting from the
transition to new foundries or from other factors;
. changes in product mix, including the impact of new product
introduction on existing products;
. our ability to develop and bring to market new products and
technologies on a timely basis;
. the introduction of products and technologies by our competitors;
. market acceptance of our and our customers' products;
. the timing of investments in research and development and sales
and marketing;
. cyclical semiconductor industry conditions;
. fluctuations in exchange rates, particularly exchange rates
between the U.S. dollar and the Japanese yen;
. changes in the international business climate; and
. economic conditions generally.
Our operating results in a future quarter or quarters are likely to fall below
the expectations of public market analysts or investors. In such an event, the
price of our common stock will likely be materially adversely affected. See
"Management's Discussion and Analysis of Financial Condition and Operating
Results."
We Have A Limited History of Profitability and an Accumulated Deficit. Since
our inception we have incurred significant losses and negative cash flow. At
December 31, 1998, we had cumulative net losses of $9.3 million, with a net loss
of $1.3 million for 1996 and net profits of $4.8 million and $12.7 million for
1997 and 1998, respectively. Although we achieved positive net incomes for 1997
and 1998, we cannot assure you that we will achieve profitability in any future
quarterly or annual periods, and recent operating results should not be
considered indicative of future financial performance.
27
We Depend on the Cellular Phone Battery Charger and Desktop PC Stand-By
Markets for a Majority of Our Revenues. A limited number of applications of our
products, primarily in the cellular p