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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 phone battery chargers and desktop PC stand-
by markets, currently account for the majority of our revenues. The exact dollar
amounts and percentages of sales for use in particular markets are difficult to
ascertain because such sales occur through distributors or indirectly through
sales to power supply manufacturers. During 1998 we estimate that approximately
26% of our revenues were attributable to use of our products in power supplies
for cellular phone battery chargers and approximately 28% of our revenues were
attributable to the use of our products in desktop PC stand-by power supplies.
We expect that our revenues and operating results will continue to be
substantially dependent upon these markets for the foreseeable future. The
cellular phone and desktop PC markets can be highly cyclical and have been
subject to significant economic downturns at various times.
We may experience substantial period-to-period fluctuations in future
operating results due to general conditions of these markets. Our revenues and
operating results are subject to many of the risks to which the markets for
these applications are subject, and may also be impacted by technological or
other developments in these markets. In particular, recent advances in battery
technology which offer competitive advantages to the OEMs of cellular telephones
permit such OEMs, including our largest end user, Motorola, to lower, or
consider lowering, the wattage level of the power supplies used to recharge
batteries. As the output power has dropped below 5 watts for some slow or
trickle chargers, older alternative technologies have been substituted for
switchers by some OEMs. Although this has not had any significant impact on our
business to date, it could in the future if these older technological
alternatives are more cost effective than our current and future product
offerings. While we continue our efforts to enhance the cost effectiveness of
integrated switchers based on our high-voltage ICs, we cannot guarantee we will
be successful in our efforts, and, in the absence of a successful competitive
response, demand for our products would be materially adversely affected.
Similarly, if a competitor successfully and cost-effectively combines desktop PC
stand-by power supplies with the main PC desktop power supplies before we do,
demand for our products could be materially adversely affected.
We believe that our future success will depend in part upon our ability to
penetrate additional markets for our products, and we cannot assure you that we
will be able to overcome the marketing or technological challenges necessary to
do so. To the extent that a competitor penetrates additional markets before we
do, or takes market share from us in our existing markets, our revenues,
financial condition and operating results would be materially adversely
affected.
We Are Highly Dependent on a Limited Number of Customers. 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 1996, 1997 and 1998. Motorola is presently
our largest end user. The exact dollar amounts and percentages of sales to
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 10 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.
We expect to continue to be dependent upon a relatively limited number of
customers for a significant portion of our net revenues in future periods. Also,
no customer is presently obligated either to purchase a specified amount of
products or to provide us with binding forecasts of product purchases for any
period. Our products are typically one of many components used in a larger
product produced by our customers. Demand for our products is therefore subject
to many risks beyond our control, including, among others:
. competition faced by our customers in their particular end markets;
. market acceptance of the products of our customers;
. technical challenges which may or may not be related to the components
supplied by us; and
28
. the technical, sales and marketing and management capabilities of our
customers and the financial and other resources of our customers.
Certain divisions within Motorola have developed products intended to compete
with us, as has Samsung, another customer of our products. We believe that we
have been successful in competing against such internally developed products to
date, but in the future we may lose sales as a result of such competing
products. The reduction, delay or cancellation of orders from Motorola or one of
our other significant customers, or the discontinuance of our products by our
end users, could materially adversely affect our business, financial conditions
and operating results. We have experienced such effects in the past and we
cannot assure you that any of our customers will not reduce, cancel or delay
orders in the future.
We Are Dependent on Our Wafer Suppliers. We outsource all of our
semiconductor manufacturing and product assembly, except for testing and
finishing. We have supply arrangements for the production of wafers with
Matsushita and OKI. Although certain aspects of our relationships with
Matsushita and OKI are contractual, many important aspects of these
relationships depend on the continued cooperation of these strategic partners
and, in many instances, the parties' course of conduct deviates from the literal
provisions of the contracts. We cannot assure you that our strategic partners
and we will continue to work together successfully in the future or that either
Matsushita or OKI will not seek an early termination of its wafer supply
agreement with us.
Our wafer supply contracts with Matsushita and OKI terminate in June 2000 and
September 2003, respectively. 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 our agreement
with Matsushita. In addition, our products do not require leading edge device
process geometries. As device process geometries become increasingly smaller and
as demand for such smaller geometries increases, Matsushita and OKI may decide
at some point to convert all of their manufacturing processes to smaller
geometries in response to these industry trends. In the event of a supply
disruption with OKI or Matsushita, if 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 estimate that it would take between 9 to 12 months from
the time an alternate manufacturing source is identified for that source to
produce wafers with acceptable manufacturing yields in sufficient quantities to
meet our needs.
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 or 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 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. Although
we provide OKI and Matsushita with rolling forecasts of our production
requirements, the ability of Matsushita or OKI to provide wafers to us is
limited by the available capacity of the foundry in which it manufactures wafers
for us. An increased need for capacity to meet internal demands or demands of
other customers could cause Matsushita and OKI to reduce capacity available to
us. Matsushita and OKI may also require us to pay amounts in excess of
contracted or anticipated amounts for wafer deliveries or require us to make
other concessions in order to acquire the wafer supply necessary to meet our
customers' requirements. Any of these concessions could materially adversely
affect our business, financial condition or 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.
We Rely on Our Contracted Foundries and Independent Subcontractors to Produce
Wafers and Assemble Finished Products at Acceptable Yields. We depend on
Matsushita and OKI to produce wafers, and independent
29
subcontractors to assemble finished products, at acceptable yields and to
deliver them to us in a timely manner. The manufacture of our TOPSwitch products
utilizes a CMOS process with a proprietary, highly sensitive implant process
step. To the extent the wafer foundries do not achieve acceptable manufacturing
yields or they experience product shipment delays, our financial condition or
operating results would be materially adversely affected. Our IC assembly
process also requires our manufacturers to use a high-voltage molding compound
available from only one vendor, which 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. Unavailability of
the sole source compound or problems with the assembly process can materially
adversely affect yields and cost to manufacture. Good production yields are
particularly important to our business and financial results, including our
ability to meet customers' demand for products and to maintain profitability. As
we continue to increase our product output, our foundries and assemblers may
experience a decrease in yields. We cannot assure you that acceptable yields
will be maintainable in the future.
Matsushita and OKI Have Certain Licenses to Our Technology Which They May Use
to Our Detriment. Matsushita currently manufactures and sells its versions of
our TOPSwitch families of products under the right, exclusive during the term of
the contract as to other Japanese companies, except OKI and their subsidiaries,
granted by us to manufacture and sell products using our technology to Japanese
companies worldwide and to subsidiaries of Japanese companies located in Asia.
In certain circumstances, these products are redistributed by the Japanese
customers to their manufacturing operations in other regions. Beginning in April
1997, we agreed not to sell our products in Japan to new customers. We receive
royalties on sales by Matsushita, although such royalties are substantially
lower than the gross profit we would receive on direct sales. In addition, the
royalties paid by Matsushita are denominated in Japanese yen and are subject to
risks inherent in exchange rate fluctuations. Although we engage in sales,
marketing and support activities to encourage sales by Matsushita, should
Matsushita fail to adequately promote and deliver our products, our ability to
take advantage of the potentially large Japanese market for our products could
be severely limited. Should we fail to negotiate acceptable royalty-bearing
extensions to our contract with Matsushita, we would need to expend substantial
effort and expense to establish ourselves in this market directly or through a
different partner. There can be no assurance that we would not lose customers
for Matsushita's products during such a transition. In addition, the licenses to
Matsushita and OKI for many important aspects of our technology are perpetual.
We cannot assure you that Matsushita or OKI will not use these technology rights
to develop or market competing products following any termination of their
relationships with us or after termination of Matsushita's royalty obligation to
us.
Our International Sales Subject Us to Substantial Risks. Sales to customers
outside of the United States were $16.8 million, $36.0 million and $58.1 million
in 1996, 1997 and 1998, respectively, which represented 72%, 81% and 83% of our
net revenues for such periods. These sales involve a number of inherent risks,
including:
. imposition of government controls;
. currency exchange fluctuations;
. potential insolvency of international distributors and representatives;
. reduced protection for intellectual property rights in some countries;
. the impact of recessionary environments in economies outside the United
States;
. political instability;
. generally longer receivables collection periods;
. tariffs and other trade barriers and restrictions; and
. the burdens of complying with a variety of foreign laws.
30
Furthermore, because substantially all of our foreign sales are denominated in
U.S. dollars, increase in the value of the dollar would increase the price in
local currencies of our products in foreign markets and make our products
relatively more expensive and less price competitive than competitors' products
that are priced in local currencies. We are exposed to additional risks to the
extent that the products of our customers are subject to foreign currency or
other international risks. These factors may have a material adverse effect on
our future international sales and, consequently, on our business, financial
condition or operating results.
We Are Dependent on Foreign Manufacturers and Assemblers for the Manufacture
of Our Wafers. Because we depend on Matsushita and OKI, both located in Japan,
for the manufacture of all of our finished silicon wafers and on foreign
assembly subcontractors of our products, we are directly affected by the
political and economic conditions of the countries in which our wafers are or
are expected to be manufactured. To the extent that these conditions result in
any prolonged work stoppages or other inability to manufacture and assemble our
products, our business, financial condition or operating results could be
materially adversely affected. Our contracts with Matsushita and OKI are
denominated in Japanese yen, exposing us to the risk of increased costs for
finished wafers, which increase we could not readily pass through to our
customers.
New Products and Technological Change May Render Our and Our Customers'
Products Out of Date. Our future success depends in significant part upon our
ability to develop new ICs for high-voltage power conversion for existing and
new markets, to introduce these products in a timely manner and to have these
products selected for design into products of leading manufacturers. The
development of these new devices is highly complex, and from time to time we
have experienced delays in completing the development of new products.
Successful product development and introduction depends on a number of factors,
including:
. accurate new product definition;
. timely completion and introduction of new product designs;
. availability of foundry capacity;
. achievement of acceptable manufacturing yields; and
. market acceptance of our and our customers' products.
We cannot be sure that we will be able to adjust to changing market demands as
quickly and cost-effectively as necessary to compete successfully. Furthermore,
we cannot assure you that we will be able to introduce new products in a timely
and cost-effective manner or in sufficient quantities to meet customer demand or
that such products will achieve market acceptance. Our or our customers' failure
to develop and introduce new products successfully and in a timely manner would
materially adversely affect our business, financial condition and operating
results. Certain customers may defer or return orders for existing products in
response to the introduction of new products. Although we maintain reserves
against any such returns, there can be no assurance that these reserves will be
adequate.
We Have Historically Experienced a Lengthy Sales Cycle. Our products are
generally incorporated into a customer's products at the design stage. However,
customer decisions to use our products, commonly referred to as design wins,
which can often require us to expend significant resources without any assurance
of success, often precede volume sales, if any, by a year or more. If a customer
decides at the design stage not to incorporate our products into its product, we
may not have another opportunity for a design win with respect to that product
for many months or years. Because of such a lengthy sales cycle, we may
experience a delay between increasing expenses for research and development and
our sales and marketing efforts and the generation of volume production
revenues, if any, from such expenditures. Moreover, the value of any design win
will largely depend upon the commercial success of the customer's product. We
cannot assure you that we will continue to achieve design wins or that any
design win will result in future revenues. Our failure to timely develop and
introduce products that are incorporated into our customers' products could
materially adversely affect our business, financial condition and operating
results.
31
Our Products Must Meet Exacting Specifications, and Undetected Defects and
Failures May Occur. The fabrication and assembly of ICs is a highly complex and
precise process. We expect that our customers will continue to establish
demanding specifications for quality, performance and reliability that our
products must meet. ICs as complex as those we sell often encounter development
delays and may contain undetected defects or failures when first introduced or
after commencement of commercial shipments. We have from time to time in the
past experienced product quality, performance or reliability problems. We cannot
guarantee that defects or failures will not occur in the future relating to our
product quality, performance and reliability that may have a material adverse
effect on our operating results. If such defects and failures occur, we could
experience lost revenue, increased costs, including warranty expense and costs
associated with customer support, delays in or cancellations or reschedulings of
orders or shipments and product returns or discounts, any of which would
materially adversely affect our business, financial condition or operating
results.
The High-Voltage Power Supply Industry is Extremely Competitive and Highly
Price-Sensitive. 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 high-voltage power conversion IC
families of products offer favorable cost-performance benefits compared to the
competition. However, there has been sizeable over capacity of discrete
components, which resulted in significant price erosion for these products
during 1998. Continued significant erosion in the price of competing products,
such as high-voltage Bipolar and MOSFET transistors and PWM controller ICs,
could adversely affect the cost effectiveness of our products. Also, older
alternative technologies to switchers are more cost-effective than discrete
switchers and integrated switchers that use our products 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 TOPSwitch-based switchers.
We are continuing our efforts to enhance the cost effectiveness of integrated
switchers in the lower power ranges but we cannot guarantee that we will be
successful in these efforts.
Recently, our TOPSwitch product families have begun to meet additional
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.
We expect competition to increase as companies like these see the success we
have had in converting older technologies to the integrated solutions used in
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 we do. 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
32
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.
We Must Protect Our Intellectual Property And Have Sued, And Have Been Sued,
By Our Largest End User, Motorola, Regarding Certain Patents. Our future
success depends upon our ability to protect our intellectual property, including
patents, trade secrets, and know-how, and to continue our technological
innovation. We cannot assure you that the steps we have taken to protect our
intellectual property will be adequate to prevent misappropriation or that
others will not develop competitive technologies or products.
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.
We Depend on a Few Key Personnel. Our success depends to a significant extent
upon the continued service of our executive officers and other key management
and technical personnel, and on our ability to continue to attract, retain and
motivate qualified personnel, such as experienced systems applications
engineers. The competition for these employees is intense, particularly in
Silicon Valley. The loss of the services of one or more of our engineers,
executive officers or other key personnel or our inability to recruit
replacements for such personnel or to otherwise attract, retain and motivate
qualified personnel could have a material adverse effect on our business,
financial condition or operating results. We do not have long-term employment
contracts with, and we do not have in place "key person" life insurance policies
on, any of our employees.
Our Future Success Depends On Our Successful Management of Growth. We have
experienced a period of rapid growth and expansion which has placed, and
continues to place, a significant strain on our resources. To accommodate this
growth, we will be required to implement a variety of new and upgraded
operational and financial systems, procedures and controls, including the
improvement of our internal management systems, which may require substantial
management efforts. Such efforts may not be accomplished successfully. In
addition, any future periods of rapid growth or expansion could be expected to
place a significant strain on our limited managerial, financial, engineering and
other resources. Relationships with new customers generally require significant
engineering support. As a result, any increase in the number of customers using
our technology will increase the strain on our resources, particularly our
engineers. Any delays or difficulties in our research and development process
caused by these factors or others could make it difficult for us to develop
future generations of our products and to remain competitive. In addition, the
rapid rate of hiring new employees could be disruptive and adversely affect the
efficiency of our research and development process. Any failure to improve our
operational, financial and management systems, or to hire, train, motivate or
manage our employees, could have a material adverse effect on our business,
financial condition and operating results.
33
Arrival of the Year 2000 May Create Unforeseen Difficulties. Many computer
systems were not designed to handle any dates beyond the year 1999, and
therefore, computer hardware and software for virtually all businesses will need
to be modified prior to the year 2000 in order to remain functional. We are
concerned that many enterprises will be devoting a substantial portion of their
information systems spending to resolving this upcoming year 2000 problem. This
expense may result in spending being diverted from ICs for use in AC to DC power
conversion in the near future. We are still assessing the impact of the year
2000 issue on our internal information systems and have begun, and in many cases
completed, corrective efforts in these areas. We have evaluated the
functionality of our current products with respect to any year 2000 problems and
have determined that our current products have no year 2000 problems. We do not
anticipate that addressing the year 2000 problem for our internal information
systems and future products will have a material impact on our operations or
financial results. However, we cannot assure you that these costs will not be
greater than anticipated, or that we will complete the corrective actions we
have undertaken before any year 2000 problems could occur. The year 2000 issue
could lower demand for our products while increasing our costs. These combining
factors, while not quantified, could have a material adverse impact on our
operations and financial results.
We have certain relationships with key suppliers. If these suppliers fail to
adequately address the year 2000 issue for the products they provide to us, this
could have a material adverse impact on our operations and financial results. We
are still assessing the effect the year 2000 issue will have on our suppliers
and at this time we cannot determine the impact it will have. Contingency plans
will be developed if it appears we or our key suppliers will not be year 2000
compliant. Any such noncompliance could have a material adverse impact on our
operations.
We Have Adopted Certain Anti-Takeover Measures Which May Make it More
Difficult for a Third Party to Acquire Us. Our board of directors has the
authority to issue up to 3,000,000 shares of preferred stock and to determine
the price, rights, preferences and privileges of those shares without any
further vote or action by the stockholders. The rights of the holders of common
stock will be subject to, and may be adversely affected by, the rights of the
holders of any preferred stock that may be issued in the future. The issuance of
shares of preferred stock, while potentially providing desirable flexibility in
connection with possible acquisitions and for other corporate purposes, could
have the effect of making it more difficult for a third party to acquire a
majority of our outstanding voting stock. We have no present intention to issue
shares of preferred stock. In addition, certain provisions of our certificate of
incorporation may have the effect of delaying or preventing a change of control,
which could adversely affect the market price of our common stock. These
provisions provide, among other things, that:
. stockholders may not take action by written consent;
. the ability of stockholders to call special meetings and to raise matters
at stockholders' meetings is restricted; and
. certain amendments of our certificate of incorporation, and all amendments
of our bylaws, require the approval of holders of at least two-thirds of
the voting power of all outstanding shares.
In addition, we are subject to the anti-takeover provisions of section 203 of
the Delaware General Corporation Law, which prohibits us from engaging in a
"business combination" with an "interested stockholder" for a period of three
years after the date of the transaction in which the person became an interested
stockholder, unless the business combination is approved in a prescribed manner.
The application of section 203 also could have the effect of delaying or
preventing a change of control.
Our Stock Price Has Been Volatile. Our common stock has been, and is likely
to be, volatile. Factors such as future announcements concerning us or our
competitors, quarterly variations in operating results, announcements of
technological innovations, the introduction of new products or changes in our
product pricing policies or those of our competitors, proprietary rights or
other litigation, changes in earnings estimates by analysts or other factors
could cause the market price of our common stock to fluctuate substantially. In
addition, stock prices for many technology companies fluctuate widely for
reasons which may be unrelated to operating results. These fluctuations, as well
as general economic, market and political conditions such as recessions or
34
military conflicts, may materially adversely affect the market price of our
common stock. Moreover, the trading prices of many high technology stocks are at
or near their historical highs and reflect price/earning ratios substantially
above historical norms. We cannot assure you that the trading price of our
common stock will remain at or near the price at which you may have purchased
it.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
Interest Rate Risk. Our exposure to market risk for changes in interest rates
relate primarily to our investment portfolio. We do not use derivative financial
instruments in our investment portfolio. We invest in high-credit quality
issuers and, by policy, limit the amount of credit exposure to any one issuer.
As stated in our policy, we ensure the safety and preservation of our invested
principal funds by limiting default risk, market risk and reinvestment risk. We
mitigate default risk by investing in safe and high-credit quality securities
and by constantly positioning our portfolio to respond appropriately to a
significant reduction in a credit rating of any investment issuer, guarantor or
depository. The portfolio includes only marketable securities with active
secondary or resale markets to ensure portfolio liquidity.
The table below presents principal amounts and related weighted average
interest rates for our investment portfolio at December 31, 1998. All
investments mature, by policy, in 15 months or less.
(in thousands, except average interest rates)
AVERAGE
CARRYING INTEREST
AMOUNT RATE
----------- ------------
Cash Equivalents:
U.S. corporate securities......................................................... $15,596 5.32%
------- ----
Total cash equivalents....................................................... 15,596 5.32%
------- ----
Short-term Investments:
U.S. corporate securities......................................................... 14,881 5.72%
U.S. Government securities........................................................ 959 5.16%
Foreign securities................................................................ 3,922 6.60%
------- ----
Total short-term investments................................................. 19,762 5.87%
------- ----
Total investment securities.................................................. $35,358 5.63%
======= ====
Foreign Currency Exchange Risk. We transact business in various foreign
countries. Our primary foreign currency cash flows are in Japan and Western
Europe. Currently, we do not employ a foreign currency hedge program utilizing
foreign currency forward exchange contracts as the foreign currency transactions
and risks to date have not been significant.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Financial Statements and Supplementary Data required by this item are set
forth at the pages indicated at Item 14(a).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
35
PART III
The SEC allows us to include information required in this report by referring
to other documents or reports we have already or will soon be filing. This is
called "Incorporation by Reference." We intend to file our definitive proxy
statement pursuant to Regulation 14A not later than 120 days after the end of
the fiscal year covered by this report, and certain information therein is
incorporated in this report by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item is incorporated by reference to
information set forth in our definitive proxy statement under the heading
"Proposal No. 1--Election of Directors" and in Part I of this report under the
heading "Executive Officers of the Registrant."
The information required by this Item with respect to compliance with Section
16(a) of the Securities Exchange Act of 1934 is incorporated by reference to
information set forth in the definitive Proxy Statement under the heading
"Executive Compensation and Other Matters."
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item is incorporated by reference to
information set forth in our definitive proxy statement under the heading
"Executive Compensation and Other Matters."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated by reference to
information set forth in our definitive proxy statement under the heading "Stock
Ownership of Certain Beneficial Owners and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference to
information set forth in our definitive proxy statement under the heading
"Certain Relationships and Related Transactions."
36
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this Form:
1. Financial Statements
Page
-----
Report of Independent Public Accountants........................................................... 38
Consolidated Balance Sheets........................................................................ 39
Consolidated Statements of Operations.............................................................. 40
Consolidated Statements of Stockholders' Equity.................................................... 41
Consolidated Statements of Cash Flows.............................................................. 42
Notes to Consolidated Financial Statements......................................................... 43
2. Financial Statement Schedules
All schedules have been omitted because the required information is not
present or not present in amounts sufficient to require submission of the
schedules or because the information required is included in the
Consolidated Financial Statements or Notes thereto.
3. Exhibits
See Index to Exhibits. The Exhibits listed in the accompanying Index to
Exhibits are filed as part of this report.
(b) Reports on Form 8-K
None.
37
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Power Integrations, Inc.:
We have audited the accompanying consolidated balance sheets of Power
Integrations, Inc. (a Delaware corporation) and subsidiaries as of December 31,
1998 and 1997, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Power Integrations, Inc. and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
San Jose, California
January 18, 1999
38
POWER INTEGRATIONS, INC.
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1997
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
1998 1997
------------ -----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.......................................................... $24,176 $ 25,553
Short-term investments............................................................. 20,242 3,455
Accounts receivable, net of allowances of $1,293 and $1,269, respectively.......... 4,640 6,243
Inventories........................................................................ 8,845 7,328
Prepaid expenses and other current assets.......................................... 812 349
------- --------
Total current assets............................................................ 58,715 42,928
------- --------
PROPERTY AND EQUIPMENT, AT COST:
Machinery and equipment............................................................ 14,716 11,914
Leasehold improvements............................................................. 1,158 711
------- --------
15,874 12,625
Less: Accumulated depreciation and amortization.................................... (9,535) (6,994)
------- --------
6,339 5,631
------- --------
$65,054 $ 48,559
======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of capitalized lease obligations................................... $ 1,950 $ 1,787
Accounts payable................................................................... 5,866 6,903
Accrued payroll and related expenses............................................... 2,394 1,685
Taxes payable and other accrued liabilities........................................ 2,951 1,042
Deferred income on sales to distributors........................................... 2,566 1,380
------- --------
Total current liabilities....................................................... 15,727 12,797
------- --------
CAPITALIZED LEASE OBLIGATIONS, net of current portion................................ 1,963 2,435
COMMITMENTS (NOTE 5)
STOCKHOLDERS' EQUITY:
Convertible Preferred Stock, $0.001 par value
Authorized--3,000,000 shares
Outstanding--none -- --
Common Stock, $0.001 par value
Authorized-- 40,000,000 shares
Outstanding--12,497,064 shares in 1998 and 12,073,904 shares in 1997............ 12 12
Additional paid-in capital......................................................... 57,289 56,220
Common stock warrants.............................................................. 12 12
Stockholder notes receivable....................................................... (274) (405)
Deferred compensation.............................................................. (321) (461)
Cumulative translation adjustment.................................................. (57) (76)
Accumulated deficit................................................................ (9,297) (21,975)
------- --------
Total stockholders' equity...................................................... 47,364 33,327
------- --------
$65,054 $ 48,559
======= ========
The accompanying notes are an integral part of these consolidated balance
sheets.
39
POWER INTEGRATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1998 1997 1996
------------- ------------ ------------
NET REVENUES:
Product sales........................................................... $68,206 $44,827 $23,324
License fees and royalties.............................................. 1,802 1,162 619
------- ------- -------
Total net revenues................................................... 70,008 45,989 23,943
------- ------- -------
COST OF REVENUES.......................................................... 36,638 26,291 15,546
------- ------- -------
GROSS PROFIT.............................................................. 33,370 19,698 8,397
------ ------ -------
OPERATING EXPENSES:
Research and development................................................ 7,231 5,253 3,519
Sales and marketing..................................................... 8,468 6,417 3,905
General and administrative.............................................. 3,641 2,053 1,558
------- ------- -------
Total operating expenses............................................. 19,340 13,723 8,982
------- ------- -------
INCOME (LOSS) FROM OPERATIONS............................................. 14,030 5,975 (585)
------- ------- -------
OTHER INCOME (EXPENSE):
Interest income......................................................... 1,801 359 204
Interest expense........................................................ (432) (832) (780)
Other, net.............................................................. (121) (210) (150)
------- ------- -------
Total other income (expense)......................................... 1,248 (683) (726)
------- ------- -------
INCOME (LOSS) BEFORE PROVISION FOR
INCOME TAXES.......................................................... 15,278 5,292 (1,311)
PROVISION FOR INCOME TAXES................................................ 2,600 530 30
------- ------- -------
NET INCOME (LOSS)......................................................... $12,678 $ 4,762 $(1,341)
======= ======= =======
EARNINGS (LOSS) PER SHARE:
Basic................................................................... $ 1.04 $ 2.52 $ (1.57)
======= ======= =======
Diluted................................................................. $ 0.96 $ 0.51 $ (1.57)
======= ======= =======
SHARES USED IN PER SHARE CALCULATION:
Basic................................................................... 12,213 1,888 856
======= ======= =======
Diluted................................................................. 13,226 9,339 856
======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
40
POWER INTEGRATIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS)
CONVERTIBLE ADDITIONAL STOCKHOLDER
PREFERRED STOCK COMMON STOCK PAID-IN NOTES DEFERRED
-----------------------------------------
Shares AMOUNT SHARES AMOUNT CAPITAL Warrants RECEIVABLE COMPENSATION
-------- --------- ------ -------- ----------- -------- ------------ -------------
BALANCE AT
DECEMBER 31, 1995................. 45,059 $ 34,478 831 $ 438 $ -- $ -- $ -- $ --
Issuance of Series C
Preferred Stock upon
exercise of warrants............. 805 793 -- -- -- -- -- --
Issuance of Common
Stock under employee
stock option plan, net
of repurchases................... -- -- 28 27 -- -- -- --
Issuance of Common
Stock upon exercise of
warrants......................... -- -- 17 100 -- -- -- --
Issuance of warrants to
purchase Common
Stock............................ -- -- -- -- -- 12 -- --
Translation adjustment............ -- -- -- -- -- -- -- --
Net loss.......................... -- -- -- -- -- -- -- --
------- -------- ------ ------- ------- -------- ----------- ------------
BALANCE AT
DECEMBER 31, 1996................. 45,864 35,271 876 565 -- 12 -- --
Issuance of Common
Stock under employee
stock option plan................ -- -- 1,050 982 3 -- (405) --
Issuance of Common
Stock in connection
with Public Offering............. -- -- 2,700 3 18,842 -- -- --
Conversion of Preferred
Stock to
Common Stock..................... (45,864) (35,271) 7,448 7 35,264 -- -- --
Change in par value............... -- -- -- (2,111) 2,111 -- -- --
Deferred compensation............. -- -- -- 566 -- -- -- (566)
Amortization of deferred
compensation..................... -- -- -- -- -- -- -- 105
Translation adjustment............ -- -- -- -- -- -- -- --
Net income........................ -- -- -- -- -- -- -- --
------- -------- ------ ------- ------- -------- ----------- ------------
BALANCE AT
DECEMBER 31, 1997................. -- -- 12,074 12 56,220 12 (405) (461)
Issuance of Common
Stock under employee
stock option plan, net of
repurchases.............. -- -- 137 -- 247 -- -- --
Issuance of Common
Stock under employee
stock purchase plan.............. -- -- 92 -- 627 -- -- --
Exercise of warrants, net......... -- -- 194 -- 46 -- -- --
Proceeds of stockholder
note repayment................... -- -- -- -- -- -- 131 --
Income tax benefit from
Employee stock option plan....... -- -- -- -- 240 -- -- --
Additional IPO costs.............. -- -- -- -- (91) -- -- --
Amortization of deferred
compensation..................... -- -- -- -- -- -- -- 140
Translation adjustment............ -- -- -- -- -- -- -- --
Net income........................ -- -- -- -- -- -- -- --
------- -------- ------ ------- ------- -------- ----------- ------------
BALANCE AT DECEMBER 31, 1998....... -- $ -- 12,497 $ 12 $57,289 $ 12 $ (274) $ (321)
======= ======== ====== ======= ======= ======== =========== ============
CUMULATIVE TOTAL
TRANSLATION ACCUMULATED STOCKHOLDERS'
ADJUSTMENT DEFICIT EQUITY
------------ ------------ -------------
BALANCE AT
DECEMBER 31, 1995................. $ (8) $(25,396) $ 9,512
Issuance of Series C
Preferred Stock upon
exercise of warrants............. -- -- 793
Issuance of Common
Stock under employee
stock option plan, net
of repurchases................... -- -- 27
Issuance of Common
Stock upon exercise of
warrants......................... -- -- 100
Issuance of warrants to
purchase Common
Stock............................ -- -- 12
Translation adjustment............ (5) -- (5)
Net loss.......................... -- (1,341) (1,341)
------- -------- -------
BALANCE AT
DECEMBER 31, 1996................. (13) (26,737) 9,098
Issuance of Common
Stock under employee
stock option plan................ -- -- 580
Issuance of Common
Stock in connection
with Public Offering............. -- -- 18,845
Conversion of Preferred
Stock to
Common Stock..................... -- -- --
Change in par value............... -- -- --
Deferred compensation............. -- -- --
Amortization of deferred
compensation..................... -- -- 105
Translation adjustment............ (63) -- (63)
Net income........................ -- 4,762 4,762
------- -------- -------
BALANCE AT
DECEMBER 31, 1997................. (76) (21,975) 33,327
Issuance of Common
Stock under employee
stock option plan, net of
repurchases.............. -- -- 247
Issuance of Common
Stock under employee
stock purchase plan.............. -- -- 627
Exercise of warrants, net......... -- -- 46
Proceeds of stockholder
note repayment................... -- -- 131
Income tax benefit from
Employee stock option plan....... -- -- 240
Additional IPO costs.............. -- -- (91)
Amortization of deferred
compensation..................... -- -- 140
Translation adjustment............ 19 -- 19
Net income........................ -- 12,678 12,678
------- -------- -------
BALANCE AT DECEMBER 31, 1998...... $(57) $ (9,297) $47,364
======= ======== =======
The accompanying notes are an integral part of these consolidated financial
statements.
41
POWER INTEGRATIONS, INC.
CONSOLIDATED STATEMENTS OF C ASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS)
1998 1997 1996
------------- -------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................................... $ 12,678 $ 4,762 $(1,341)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization............................................. 3,034 2,265 1,887
Deferred compensation expense............................................. 140 105 --
Provision for accounts receivable and other allowances.................... 24 984 143
Change in operating assets and liabilities:
Accounts receivable.................................................... 1,579 (4,450) 166
Inventories............................................................ (1,517) (3,390) 443
Prepaid expenses and other current assets.............................. (463) (49) (134)
Accounts payable....................................................... (1,036) 5,427 (504)
Accrued liabilities.................................................... 2,877 1,754 285
Deferred income on sales to distributors............................... 1,186 646 142
-------- -------- -------
Net cash provided by operating activities........................... 18,502 8,054 1,087
-------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment....................................... (1,956) (1,439) (537)
Purchases of short-term investments....................................... (47,904) (13,402) (9,406)
Proceeds from sales and maturities of short-term investments.............. 31,117 14,357 5,793
-------- -------- -------
Net cash used in investing activities............................... (18,743) (484) (4,150)
-------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of preferred stock............................. -- -- 793
Net proceeds from issuance of common stock................................ 828 19,425 127
Proceeds from stockholder note repayment.................................. 131 -- --
Net proceeds from issuance of warrants to purchase common stock........... -- -- 12
Principal payments under capitalized lease obligations.................... (2,095) (1,724) (590)
Proceeds (repayment) related to note payable to a stockholder............. -- (3,000) 3,000
-------- -------- -------
Net cash provided by (used in) financing activities................. (1,136) 14,701 3,342
-------- -------- -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........................ (1,377) 22,271 279
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD............................ 25,553 3,282 3,003
-------- -------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................................. $ 24,176 $ 25,553 $ 3,282
======== ======== =======
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES:
Capitalized lease obligations incurred for property and equipment......... $ 1,786 $ 1,630 $ 1,883
======== ======== =======
Conversion of preferred stock to common stock............................. $ -- $ 35,271 $ --
======== ======== =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest.................................................... $ 445 $ 832 $ 780
======== ======== =======
Cash paid for income taxes................................................ $ 714 $ 164 $ 45
======== ======== =======
The accompanying notes are an integral part of these consolidated financial
statements.
42
POWER INTEGRATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. THE COMPANY:
Power Integrations, Inc. (the "Company"), which was incorporated in
California on March 25, 1988 and reincorporated in Delaware in December 1997
(see Note 6), designs, develops, manufactures and markets proprietary, high-
voltage, analog integrated circuits for use in AC to DC power conversion
primarily for the cellular telephone, personal computer and various consumer
electronics markets.
The Company is subject to a number of risks including, among others, the
volume and timing of orders received by the Company from its customers;
competitive pressures on selling prices; the volume and timing of orders placed
by the Company with its foundries; the 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 introductions on existing products; the Company's ability
to develop and bring to market new products and technologies on a timely basis;
the introduction of products and technologies by the Company's competitors;
market acceptance of the Company's and its 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; and changes in the
international business climate and economic conditions.
All of the wafers are manufactured by two offshore independent foundries.
Although there are a number of other suppliers that could provide similar
services, a change in suppliers could cause a delay in manufacturing and
possible loss of sales, which could adversely affect operating results.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation and Foreign Currency Translation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries after elimination of intercompany transactions
and balances. The functional currencies of the Company's subsidiaries are the
local currencies. Accordingly, all assets and liabilities are translated into
U.S. dollars at the current exchange rates as of the applicable balance sheet
date. Revenues and expenses are translated at the average exchange rate
prevailing during the period. Cumulative gains and losses from the translation
of the foreign subsidiaries' financial statements have been included in
stockholders' equity.
Cash and Cash Equivalents and Short-Term Investments
The Company considers cash invested in highly liquid financial instruments
with an original maturity of three months or less to be cash equivalents. Cash
investments in highly liquid financial instruments with original maturities
greater than three months but less than one year are classified as short-term
investments. As of December 31, 1998 and 1997, the Company's short-term
investments consist of U.S. Government backed securities, corporate commercial
paper and other high quality commercial and municipal securities, which are
classified as held to maturity and are valued using the amortized cost method
which approximates market.
Inventories
Inventories (which consist of costs associated with the purchases of wafers
from offshore foundries and of packaged components from several offshore
assembly manufacturers, as well as internal labor and overhead associated with
the testing of both wafers and packaged components) are stated at the lower of
cost (first-in, first-
43
POWER INTEGRATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
out) or market. Provisions, when required, are made to reduce excess and
obsolete inventories to their estimated net realizable values. Inventories
consist of the following (in thousands):
DECEMBER 31,
-------------------------
1998 1997
---------- ----------
Raw materials............................................................ $3,132 $3,323
Work-in-process.......................................................... 2,901 2,977
Finished goods........................................................... 2,812 1,028
------ ------
$8,845 $7,328
====== ======
Property and Equipment
Depreciation and amortization of property and equipment are provided using
the straight-line method over the shorter of the estimated useful lives of the
assets over a period of one to four years or over the applicable lease term.
Included in property and equipment are assets acquired under capital lease
obligations with an original cost of approximately $8.2 million and $7.8
million, as of December 31, 1998 and 1997, respectively. Related accumulated
amortization on these leased assets was approximately $4.7 million and $4.0
million, as of December 31, 1998 and 1997, respectively.
Earnings (Loss) Per Share
In December 1997, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 128 "Earnings per Share." SFAS No. 128 requires companies
to compute earnings per share under two different methods (basic and diluted).
Basic earnings per share is calculated by dividing net income (loss) by the
weighted average shares of common stock outstanding during the period. Diluted
earnings per share is calculated by dividing net income (loss) by the weighted
average shares of outstanding common stock and common stock equivalents during
the period. Common stock equivalents included in the diluted calculation consist
of dilutive shares issuable upon the exercise of outstanding common stock
options and warrants computed using the treasury stock method.
A summary of the earnings per share calculation for each of the three years
ended December 31, 1998, 1997 and 1996 is as follows (in thousands, except per
share amounts):
1998 1997 1996
---------- ---------- -----------
Basic earnings (loss) per share:
Net income (loss)........................................................ $ 12,678 $4,762 $(1,341)
------- ------ -------
Weighted average common shares........................................... 12,213 1,888 856
------- ------ -------
Basic earnings (loss) per share..................................... $ 1.04 $ 2.52 $ (1.57)
======= ====== =======
Diluted earnings (loss) per share:
Net income (loss)........................................................ $ 12,678 $4,762 $(1,341)
------- ------ -------
Weighted average common shares........................................... 12,213 1,888 856
Weighted average common share equivalents:
Preferred stock..................................................... -- 7,039 --
Options............................................................. 723 289 --
Employee stock purchase plan........................................ 5 -- --
Warrants............................................................ 285 123 --
------- ------ -------
Diluted weighted average common shares...................................... 13,226 9,339 856
------- ------ -------
Diluted earnings (loss) per share................................... $ 0.96 $ 0.51 $ (1.57)
======= ====== =======
44
POWER INTEGRATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
New Accounting Standards
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," which establishes standards for reporting
and presentation of comprehensive income. SFAS No. 130, which was adopted by the
Company in the first quarter of 1998, requires companies to report a new measure
of income. "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 the Company's financial statements.
During 1998, the Company 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, the Company
is organized and operates 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 the Company's disclosures or financial statements.
Revenue Recognition, Significant Customers
Product revenues consist of sales to OEMs and merchant power supply
manufacturers and to distributors. Revenues from product sales to OEM and
merchant power supply manufacturers are recognized upon shipment. The Company
provides for estimated sales returns and allowances related to such sales at the
time of shipment. During 1998, 1997 and 1996, sales to distributors of the
Company's products accounted for approximately 48%, 45% and 52% of net revenues,
respectively. Sales to distributors are made under terms allowing certain rights
of return and protection against subsequent price declines of the Company's
products held by the distributors. Pursuant to the Company's distributor
agreements, the Company protects its distributors' exposures related to the
impact of price reductions as well as products at distributors that are slow
moving or have been discontinued. These agreements, which may be canceled by
either party on a specified notice, generally contain a provision for the return
of the Company's product in the event the agreement with the distributor is
terminated. Accordingly, the Company defers recognition of revenue and the
proportionate costs of revenues derived from sales to distributors until such
distributors resell the Company's products to their customers. The margin
deferred as a result of this policy is reflected as "deferred income on sales
to distributors" in the accompanying consolidated balance sheets.
The Company has entered into separate wafer supply and technology license
agreements with two separate unaffiliated wafer foundries. The wafer supply
agreements, which expire in June 2000 and September 2003, are renewable. In
connection with the technology license agreements, the Company is entitled to
receive a royalty on sales of products by the foundries, which incorporate the
Company's technology into their own products. Initial license fees received
under the agreements were non-refundable. As of December 31, 1998, only one
foundry has sold products to third parties under its license rights. For the
years ended December 31, 1998, 1997 and 1996, revenue recognized under these
agreements was approximately $1.8 million, $1.2 million and $619,000,
respectively.
45
POWER INTEGRATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company's 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 the Company's revenue. For
the years ended December 31, 1998, 1997 and 1996, ten customers accounted for
approximately 67%, 67% and 64% of net revenues, respectively.
The following customers accounted for more than 10% of total net revenues:
YEAR ENDED DECEMBER 31,
------------------------------------------
Customer 1998 1997 1996
-------- ---------- ---------- ----------
A..................................................... 22% 21% *
B..................................................... * 15% *
C..................................................... 13% * *
- ----------------
* less than 10% or no sales to the customer
Export Sales
The Company markets its products in North America and in foreign countries
through its sales personnel and a worldwide network of independent sales
representatives and distributors. Export sales, which consist of domestic sales
to customers in foreign countries are comprised of the following:
YEAR ENDED DECEMBER 31,
------------------------------------------
1998 1997 1996
---------- ---------- ----------
Japan................................................. 3% 5% 16%
Taiwan................................................ 26% 28% 13%
Hong Kong............................................. 26% 25% 12%
Western Europe........................................ 15% 12% 19%
Other................................................. 13% 11% 12%
---- ---- ----
Total foreign..................................... 83% 81% 72%
==== ==== ====
Foreign Currency Risk
During 1995, the Company opened a Japanese yen bank account with a U.S.
bank for payments to suppliers and for cash receipts from Japanese suppliers and
customers denominated in yen. For the years ended December 31, 1997 and 1996,
the Company realized foreign exchange transaction losses of approximately
$86,000 and $77,000, respectively. For the year ended December 31, 1998, the
Company realized a foreign exchange transaction gain of approximately $35,000.
These amounts are included in "other income (expense)," in the accompanying
consolidated statements of operations.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
46
POWER INTEGRATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Concentration of Credit Risk
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash investments and trade
receivables. The Company has cash investment policies that limit cash
investments to short-term, low risk investments. With respect to trade
receivables, the Company performs ongoing credit evaluations of its customers'
financial condition and requires letters of credit whenever deemed necessary.
Additionally, the Company establishes an allowance for doubtful accounts based
upon factors surrounding the credit risk of specific customers, historical
trends related to past losses and other relevant information. As of December 31,
1998 and 1997, approximately 67% and 71% of accounts receivable, respectively,
were concentrated with ten customers.
3. BANK LINE OF CREDIT:
The Company entered into a $10.0 million revolving line of credit agreement
with a bank in October 1998. Advances under the agreement bear interest at a
fixed rate of the bank's LIBOR rate plus 1.5% per annum or at the bank's
variable interest rate. The Company has the option to choose between the two
rates. The agreement covers advances for commercial letters of credit and
standby letters of credit, provided that at no time will the aggregate sum of
all advances exceed $10.0 million. As of December 31, 1998, there were
outstanding letters of credit totaling 382,478,000 Japanese yen (approximately
$3.4 million). The agreement, which expires on November 30, 2000, restricts the
Company from entering into certain transactions and contains certain financial
covenants. As of December 31, 1998, there were no borrowings outstanding under
the agreement. The Company previously had an $8.0 million revolving line of
credit agreement with another bank, which expired on October 10, 1998.
4. NOTE PAYABLE TO A STOCKHOLDER:
In May 1996, the Company issued a $3.0 million note payable to a holder of
Series C Preferred Stock, with an original maturity date of October 1999 and an
interest rate of 12%. The note, which was subordinated in rights of payment to
all existing and future indebtedness of the Company, was repaid to the holder in
December 1997.
5. COMMITMENTS:
The Company leases its facilities under noncancellable operating leases,
which expire at various dates through October 2003. The lease for the Company's
main corporate facilities expires in October 2003 and contains a conditional
five-year option at fair market value to the year 2008. The Company is currently
exploring the possibility of leasing additional space to accommodate near term
and future requirements. Rent expense under all operating leases was
approximately $500,000, $291,000 and $223,000 in 1998, 1997 and 1996,
respectively.
A significant portion of the Company's machinery and equipment is leased
under agreements accounted for as capital leases. The Company leased
approximately $1.8 million and $1.6 million of equipment during 1998 and 1997,
respectively, under various capital leasing arrangements. In 1998, the Company
entered into a new capital lease line of credit agreement, which allows for
combined borrowings of up to $4.4 million to finance the acquisition of property
and equipment. The capital leasing agreement, which expires on June 30, 1999,
bears interest at a fixed rate established at the time of borrowing, which
ranged from approximately 6.3% to 7.1% as of December 31, 1998. Approximately
$2.6 million was available under this capital leasing agreement as of December
31, 1998.
47
POWER INTEGRATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Future minimum lease payments under all noncancellable operating and
capital lease agreements as of December 31, 1998 are as follows (dollars in
thousands):
FISCAL YEAR OPERATING CAPITAL
----------- --------- -------
1999 $ 882 $ 2,235
2000 812 1,215
2001 769 571
2002 755 291
Thereafter 626 68
------ -------
Total minimum lease payments................................................... $3,844 4,380
======
Less: Amounts representing interest on capital leases (6.3% to 14.9%).......... (467)
-------
3,913
Less: Current portion.......................................................... (1,950)
-------
Long-term portion.............................................................. $ 1,963
=======
6. STOCKHOLDERS' EQUITY:
Reincorporation and Reverse Stock Split
In September 1997, the board of directors approved the reincorporation of
the Company in Delaware, which became effective in connection with the Company's
initial public offering ("IPO"). Upon completion of the IPO in December 1997,
the Company was authorized to issue 40,000,000 shares of $0.001 par value common
stock.
In September 1997, the Company's board of directors approved a one-for-6.8
reverse split of its common stock. All common and per share amounts in the
accompanying consolidated financial statements have been adjusted retroactively
to give effect to this reverse stock split.
Preferred Stock
With the closing of the Company's IPO in December 1997, all of the
outstanding convertible preferred stock automatically converted into 7,447,558
shares of common stock. Upon conversion of the outstanding preferred stock to
common stock, such preferred stock was retired. As of December 31, 1998, the
Company was authorized to issue 3,000,000 shares of new $0.001 par value
preferred stock, of which none was outstanding as of December 31, 1998.
1988 Stock Option Plan
In June 1988, the board of directors approved the 1988 Stock Option Plan
(the "1988 Plan"), whereby the board of directors may grant options to key
employees, directors and consultants to purchase the Company's common stock at
exercise prices of not less than 85% of the fair value of the shares at the date
of grant. Options expire ten years after the date of grant (five years if the
option is granted to a ten percent owner optionee) and generally vest over 50
months. Options granted under the 1988 Plan will remain outstanding in
accordance with their terms, but effective July 1997, the board of directors had
determined that no further options would be granted under the 1988 Plan.
48
POWER INTEGRATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1997 Stock Option Plan
In June 1997, the board of directors approved the 1997 Stock Option Plan
(the "1997 Plan"), whereby the board of directors may grant options to key
employees, directors and consultants to purchase the Company's common stock at
exercise prices of not less than 85% of the fair value of the shares at the date
of grant. As of December 31, 1998, the 1997 Plan's maximum share reserve is
2,132,227 shares, which is comprised of the sum of (i) 660,745 shares (new
shares allocated to the 1997 Plan) and (ii) 1,471,482 shares granted pursuant to
the 1988 Plan (the "1988 Plan Options"). The number of shares available for
issuance under the 1997 Plan, at any time, is reduced by the number of shares
remaining subject to the 1988 Plan Options. Options expire ten years after the
date of grant (five years if the option is granted to a ten percent owner
optionee) and generally vest over 48 months.
1997 Outside Directors Stock Option Plan
In September 1997, the board of directors approved an Outside Director
Stock Option Plan (the "Directors Plan"). A total of 200,000 shares of common
stock have been reserved for issuance under the Directors Plan. The Directors
Plan provides for the grant of nonstatutory stock options to nonemployee
directors of the Company. The Directors Plan is designed to work automatically
without administration; however, to the extent administration is necessary, it
will be performed by the board of directors. The Directors Plan provides that
each current and future nonemployee director of the Company will be granted an
option to purchase 15,000 shares of common stock on the effective date or the
date on which the optionee first becomes a nonemployee director of the Company
after the effective date as the case may be (the "Initial Grant"). Thereafter,
each nonemployee director who has served on the board of directors continuously
for 6 months will be granted an additional option to purchase 5,000 shares of
common stock (an "Annual Grant"). Subject to an optionee's continuous service
with the Company, approximately 1/3rd of an Initial Grant will become
exercisable one year after the date of grant and 1/36th of the Initial Grant
will become exercisable monthly thereafter. Each Annual Grant will become
exercisable in twelve monthly installments beginning in the 25th month after the
date of grant, subject to the optionee's continuous service. The exercise price
per share of all options granted under the Directors Plan will equal the fair
market value of a share of common stock on the date of grant. Options granted
under the Directors Plan have a term of ten years and are non-transferable. In
the event of certain changes in control of the Company, options outstanding
under the Directors Plan will become immediately exercisable and vested in full.
1998 Nonstatutory Stock Option Plan
In July 1998, the board of directors approved the 1998 Nonstatutory Stock
Option Plan (the "1998 Plan"), whereby the board of directors may grant
nonstatutory options to employees and consultants to purchase the Company's
common stock at exercise prices of not less than 85% of the fair value of the
shares at the date of grant. As of December 31, 1998, the maximum share reserve
under this plan was 500,000 shares. Options expire ten years after the date of
grant (five years if the option is granted to a ten percent owner optionee) and
generally vest over 48 months.
49
POWER INTEGRATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table summarizes option activity under the 1988, 1997, 1998
and Directors Plans:
(prices are weighted average prices)
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------------
1998 1997 1996
--------------------------- --------------------------- ---------------------------
SHARES PRICE SHARES PRICE SHARES PRICE
------------- ------------ ------------- ------------ ------------- ------------
Options outstanding,
beginning of year........... 874,756 $ 2.76 1,296,426 $0.80 1,132,257 $0.70
Granted................... 658,650 10.15 662,432 2.69 323,970 1.36
Exercised................. (137,738) 1.77 (1,049,602) .55 (27,847) .94
Cancelled................. (62,457) 6.56 (34,500) 1.42 (131,954) 1.16
--------- ------ ---------- ----- --------- -----
Options outstanding,
end of year................. 1,333,211 $ 6.21 874,756 $2.76 1,296,426 $0.80
========= ====== ========== ===== ========= =====
Exercisable, end of year........ 363,674 $ 2.21 237,629 $0.97 527,782 $0.75
========= ====== ========== ===== ========= =====
Options issued under the 1988, 1997 and 1998 Plans may be exercised at any
time prior to their expiration. Options issued under the Directors Plan are
exercisable upon vesting. In addition, the Company has the right, upon
termination of an optionholder's employment or service with the Company, at its
discretion, to repurchase any unvested shares issued under the 1988, 1997 and
1998 Plans at the original purchase price. Under the terms of the Plans, an
option holder may not sell shares obtained upon the exercise of an option until
the option has vested as to those shares. As of December 31, 1998, an aggregate
of 275,579 shares of common stock issued under the 1988, 1997 and 1998 Plans are
subject to repurchase by the Company at $.51 to $1.70 per share and a weighted
average repurchase price of $1.45 per share.
The Company accounts for its Plans under APB Opinion No. 25, "Accounting
for Stock Issued to Employees." Had compensation expense for the Plans been
determined under a fair value method consistent with SFAS No. 123, "Accounting
for Stock Based Compensation," the Company's net income (loss) would have been
decreased (increased) to the following pro forma amounts (in thousands, except
per share information):
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
--------- --------- ----------
Net income (loss):
As reported................................................................ $12,678 $4,762 $(1,341)
Pro forma.................................................................. $11,599 $4,427 $(1,401)
Basic earnings (loss) per share:
As reported................................................................ $ 1.04 $ 2.52 $ (1.57)
Pro forma.................................................................. $ 0.95 $ 2.34 $ (1.64)
Diluted earnings (loss) per share:
As reported................................................................ $ 0.96 $ 0.51 $ (1.57)
Pro forma.................................................................. $ 0.88 $ 0.47 $ (1.64)
50
POWER INTEGRATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The weighted-average grant date fair value of options granted during fiscal
years 1998, 1997 and 1996 was $10.15, $1.68 and $0.27, respectively. The fair
value of each option grant is estimated on the date of grant using the Black-
Scholes option pricing model with the following weighted average assumptions
used for grants in 1998, 1997 and 1996: risk-free interest rates of 5.25, 6.2
and 6.2 percent, respectively; expected dividend yields of zero percent;
expected lives of 1.5 years for 1998 and 4 years for 1997 and 1996; expected
volatility of 73%, 70% and zero percent for 1998, 1997 and 1996, respectively.
The following table summarizes the stock options outstanding at December
31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- --------------------------------------------------------------------------- ---------------------------------------
NUMBER WEIGHTED WEIGHTED NUMBER WEIGHTED
OUTSTANDING AT AVERAGE AVERAGE EXERCISABLE AT AVERAGE
EXERCISE DECEMBER 31, REMAINING EXERCISE DECEMBER 31, EXERCISE
PRICE 1998 LIFE PRICE 1998 PRICE
- -------------------- ----------------- ----------------- --------------- -------------------- -----------------
$ .51--$1.36 407,725 6.08 $ 0.94 265,973 $0.83
$1.70--$8.50 220,015 8.59 $ 3.89 64,648 $4.02
$8.75 503,400 9.50 $ 8.75 -- --
$8.84--$25.06 202,071 9.28 $13.08 33,053 $9.76
--------- ---- ------ ------- -----
$ .51--$25.06 1,333,211 8.27 $ 6.21 363,674 $2.21
========= ==== ====== ======= =====
1997 Employee Stock Purchase Plan
Under the 1997 Employee Stock Purchase Plan (the "Purchase Plan"), 250,000
shares of common stock are reserved for issuance to eligible employees. The
Purchase Plan permits employees to purchase common stock through payroll
deductions, which may not exceed 15 percent of an employee's compensation, at
85% of the lower of the fair market value of the Company's common stock on the
first or the last day of each offering period. As of December 31, 1998, 92,127
shares had been purchased and 157,873 shares were reserved for future issuance
under the Purchase Plan.
Stockholder Notes Receivable
In July 1997, in connection with the purchase of common stock upon exercise
of stock options granted to certain officers and employees of the Company, the
Company loaned to these officers and employees an aggregate of $405,000, at an
interest rate of 6.65% pursuant to Promissory Note and Pledge Agreements. These
loans, which are secured by 238,231 shares of common stock, are full recourse
notes, and are due in full without regard to the value of the Company's common
stock in July 2002, or at the Company's option upon (i) termination of
employment with the Company, (ii) a default in the payment of any installment or
principal and/or interest when due, (iii) a sale of the pledged stock or (iv)
acceleration being reasonably necessary for the Company to comply with any
regulations promulgated by the Board of Governors of the Federal Reserve System
affecting the extension of credit in connection with the Company's securities.
As of December 31, 1998, the unpaid principal portion of these loans was
$274,000.
Deferred Compensation
In connection with the issuance of stock options to employees and
consultants prior to December 1997, the Company recorded deferred compensation
in the aggregate amount of approximately $566,000, representing the difference
between the fair market value of the Company's common stock and the exercise
price of the stock options at the date of grant. The Company is amortizing the
deferred compensation expense over the shorter of the period in which the
employee, director or consultant provides services or the applicable vesting
period, which is typically over 48 months. For the year ended December 31, 1998
and 1997, amortization expense was
51
POWER INTEGRATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
approximately $140,000 and $105,000, respectively. Compensation expense is
decreased in the period of forfeiture for any accrued, but unvested compensation
arising from the early termination of an option holder's services. No
compensation expense related to any other periods presented has been recorded.
Warrants
In connection with the issuance of Series E Preferred Stock in 1994, the
Company issued warrants for the purchase of Series E Preferred Stock, which upon
the completion of the IPO and the reincorporation in Delaware, were
automatically converted to purchase 20,728 shares of common stock at $5.74 per
share. These warrants were exercised in 1998.
In connection with an equipment lease agreement entered into during 1993
with a leasing company, the Company issued a warrant for the purchase of
preferred stock. Upon the completion of the IPO and the reincorporation in
Delaware, the warrant was automatically converted to purchase 16,303 shares of
common stock at $3.68 per share. This same warrant provides for the purchase of
additional preferred stock, which, upon the completion of the IPO and the
reincorporation in Delaware, was automatically converted to purchase 12,551
shares of common stock at $4.78 per share. This warrant is currently exercisable
and expires on December 29, 2003. The Company leased additional equipment during
1994 from the same company and, as part of this lease, the Company issued a
warrant for the purchase of preferred stock. Upon the completion of the IPO and
the reincorporation in Delaware, the warrant automatically converted into a
warrant to purchase 12,551 shares of common stock at $4.78 per share. This
warrant is currently exercisable and expires on December 27, 2004. In 1995, the
Company leased additional equipment from the same company and issued a warrant
to purchase preferred stock, which upon the completion of the IPO and the
reincorporation in Delaware, automatically converted into a warrant to purchase
24,509 shares of common stock at $3.67 per share. The warrant is currently
exercisable and expires on December 27, 2005.
In connection with an equipment leasing agreement entered into during 1995
with a leasing company, the Company issued a warrant to purchase 41,165 shares
of the Company's common stock at $6.34 per share. This warrant was exercised in
1998.
In connection with obtaining the revolving line of credit agreement with a
bank in 1995 (see Note 3), the Company issued the bank warrants to purchase
preferred stock. Upon the completion of the IPO and the reincorporation in
Delaware, the preferred stock was automatically converted to purchase 146,786
shares of common stock at $3.67 per share. These warrants were exercised in
1998. In connection with the renewal of the line of credit agreement in 1996,
the Company issued the bank a warrant to purchase 23,149 shares of common stock
at $6.34 per share. This warrant was exercised in 1998.
In connection with the issuance of a note payable to a stockholder in 1996
(see Note 4), the Company issued a warrant to purchase 176,470 shares of the
Company's common stock at $1.36 per share. The warrant may be exercised at any
time and expires on May 22, 2002. This warrant was deemed to have an immaterial
value at the issuance date, and accordingly, is carried at the amount paid for
the warrant in the accompanying consolidated financial statements.
Shares Reserved
As of December 31, 1998, the Company had shares of common stock reserved
for future issuance as follows:
Stock Option and Stock Purchase Plans.................................................. 1,804,436
Warrants to Purchase Common Stock...................................................... 185,914
---------
1,990,350
=========
52
POWER INTEGRATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. INCOME TAXES:
The Company accounts for income taxes under SFAS No. 109 "Accounting for
Income Taxes." SFAS No. 109 provides for a liability approach to accounting for
income taxes under which deferred income taxes are provided based upon enacted
tax laws and rates applicable to the periods in which taxes become payable.
The components of the provision for income taxes are as follows (in
thousands):
YEAR ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
----------- ----------- -----------
Current provision:
Federal......................................................... $ 1,886 $ 262 $ 5
State........................................................... 694 55 3
Foreign......................................................... 20 16 22
------- ------- -----
2,600 333 30
------- ------- -----
Deferred provision (benefit):
Federal......................................................... 4,136 1,946 (422)
State........................................................... (103) (404) (68)
Foreign......................................................... -- -- --
------- ------- -----
4,033 1,542 (490)
------- ------- -----
Net increase (decrease) in valuation allowance..................... (4,033) (1,345) 490
------- ------- -----
$ 2,600 $ 530 $ 30
======= ======= =====
The provision for income taxes differs from the amount, which would result
by applying the applicable Federal income tax rate to income (loss) before
provision for income taxes as follows:
YEAR ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
Provision (benefit) computed at Federal statutory rate............... 35.0% 34.0% (34.0)%
Change in valuation allowance........................................ (23.0) (25.4) 34.0
Alternative minimum tax.............................................. -- 1.1 0.6
Non deductible expenses and other.................................... 4.9 -- --
Foreign tax.......................................................... 0.1 0.3 1.7
----- ----- ------
17.0% 10.0% 2.3%
===== ===== ======
The components of the net deferred income tax asset were as follows
(in thousands):
DECEMBER 31,
--------------------------
1998 1997
------------- -----------
Net operating loss carryforwards.................................................. $ -- $ 5,013
Tax credit carryforwards.......................................................... 1,128 1,651
Inventory reserves................................................................ 2,283 1,543
Accounts receivable allowances.................................................... 527 509
Accrued vacation.................................................................. 132 112
Other cumulative temporary differences............................................ 1,072 347
------- -------
5,142 9,175
Valuation allowance............................................................... (5,142) (9,175)
------- -------
$ -- $ --
======= =======
53
POWER INTEGRATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A valuation allowance has been recorded for the entire deferred tax asset
as a result of uncertainties regarding the realization of the asset balance, the
variability of operating results and taxable income.
As of December 31, 1998, the Company had research and development tax
credit carryforwards of approximately $1.0 million. These carryforwards expire
in various periods from 2007 to 2018. The United States Tax Reform Act of 1986
contains provisions that limit research and development credits available to be
used in any given year upon the occurrence of certain events.
8. LEGAL PROCEEDINGS:
In July 1998, the Company filed a complaint for patent infringement in the
U.S. District Court, Northern District of California, against its largest end
user, Motorola. In August 1998, the Company 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 the
Company's circuit patents. The Company seeks, among other things, an order
enjoining Motorola from infringing on the Company's patents and an award for
damages resulting from the alleged infringement. In October 1998, Motorola
asserted various counterclaims against the Company alleging that the Company is
infringing on certain of Motorola's patents. The Company believes that
Motorola's counterclaims are without merit and intends to vigorously defend
itself against such claims.
Litigation may be necessary to resolve the claims asserted by the Company
against Motorola, and to resolve the claims Motorola has asserted against the
Company. There can be no assurance that the Company would prevail in any future
litigation. Any such litigation, whether or not determined in the Company's
favor or settled by the Company, would be costly and would divert the efforts
and attention of the Company's management and technical personnel from normal
business operations, which would have a material adverse effect on the Company's
business, financial condition and operating results. Adverse determinations in
litigation could result in the loss of the Company's proprietary rights, subject
the Company to significant liabilities, require the Company to seek licenses
from third parties or prevent the Company from licensing its technology, any of
which could have a material adverse effect on the Company's business, financial
condition and operating results. Moreover, the laws of certain foreign countries
in which the Company's technology is or may in the future be licensed may not
protect its intellectual property rights to the same extent as the laws of the
United States, thus increasing the possibility of infringement of the Company's
intellectual property.
54
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
POWER INTEGRATIONS, INC.
Dated: March 16, 1999 By: /s/ Robert G. Staples
-------------------------------------
Robert G. Staples
Chief Financial Officer
55
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Howard F. Earhart and Robert G. Staples
his true and lawful attorney-in-fact and agent, with full power of substitution
and, for him and in his name, place and stead, in any and all capacities to sign
any and all amendments to this Report on Form 10-K, and to file the same, with
all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorney-in-fact and
agent full power and authority to do and perform each and every act and thing
requisite and necessary to be done in connection therewith, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorney-in-fact and agent, or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT
HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE
CAPACITIES AND ON THE DATES INDICATED.
/s/ HOWARD F. EARHART
Dated: March 16, 1999 By:-------------------------------
Howard F. Earhart
President, Chief Executive Officer
and Director (Principal Executive
Officer)
/s/ ROBERT G. STAPLES
Dated: March 16, 1999 By:-------------------------------
Robert G. Staples
Chief Financial Officer
(Principal Financial and Principal
Accounting Officer)
/s/ Dr. EDWARD C. ROSS
Dated: March 16, 1999 By:-------------------------------
Dr. Edward C. Ross
Director
/s/ DR. WILLIAM DAVIDOW
Dated: March 16, 1999 By:-------------------------------
Dr. William Davidow
Director
/s/ E. FLOYD KVAMME
Dated: March 16, 1999 By:-------------------------------
E. Floyd Kvamme
Director
/s/ STEVEN J. SHARP
Dated: March 16, 1999 By:-------------------------------
Steven J. Sharp
Director
56
POWER INTEGRATIONS, INC
EXHIBITS
TO
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED
DECEMBER 31, 1998
EXHIBIT NUMBER DESCRIPTION
- -------------- -----------
3.1 Restated Certificate of Incorporation (we also filed in
our Current Report on Form 8-K filed with the SEC on March
12, 1999, a Certificate of Designation which amends this
Restated Certificate).
3.2*++ By-Laws, as amended February 24, 1999.
4.1* Fifth Amended and Restated Rights Agreement dated April 27,
1995, as amended, by and among us and certain of our
investors.
4.2* Investors' Rights Agreement dated as of May 22, 1996 between
us and Hambrecht & Quist Transition Capital, LLC.
10.1* Form of Indemnification Agreement for directors and
officers.
10.2* 1988 Stock Option Plan and forms of agreements thereunder.
10.3* 1997 Stock Option Plan and forms of agreements thereunder.
10.4* 1997 Outside Directors Stock Option Plan and forms of
agreements thereunder.
10.5* 1997 Employee Stock Purchase Plan and forms of agreements
thereunder.
10.6* Amended Technology License Agreement dated as of June 29,
1995, as amended on April 1, 1997 between us and Matsushita.
10.7* Amended Wafer Foundry Agreement dated as of June 29, 1997,
between us and Matsushita.
10.9* Master Equipment Lease Agreement dated as of February 11,
1997 among us and Finova Technology Finance, Inc.
10.10* Master Lease Agreement dated as of September 3, 1996 between
us and Leasing Technologies International, Inc.
10.11* Master Equipment Lease Agreement dated as of November 17,
1995 between us and Lighthouse Capital Partners, L.P.
10.12* Master Equipment Lease Agreement dated as of December 29,
1993, as amended, between us and MMC/GATX Partnership No. 1.
10.14* Founder Stock Purchase Agreement between us and Steven J.
Sharp dated as of April 13, 1988.
10.15* Founder Stock Purchase Agreement between us and Klas H.
Eklund dated as of April 13, 1988.
10.16* Founder Stock Purchase Agreement between us and Arthur E.
Fury dated as of April 13, 1988.
10.18** Industrial Building Lease between us and Mathilda
Development, a California limited partnership, dated as of
June 3, 1998.
10.21+ Wafer Supply Agreement between us and OKI, dated as of
October 1, 1998.
10.22+ Master Equipment Lease Agreement between us and Metlife
Capital Limited Partnership, dated as of July 31, 1998.
10.23 Loan Agreement between us and Union Bank of California,
N.A., dated as of October 16, 1998.
11.1 Statements of Computation of Pro Forma Common Shares and
Equivalents (see footnote 2 to our consolidated financial
statements).
21.1* List of subsidiaries.
23.1 Consent of Independent Public Accountants.
24.1 Power of Attorney (See signature page).
27.1 Financial Data Schedule.
_____________
* As filed with the SEC in our Registration Statement on Form S-1 on
September 11, 1997.
** As filed with the SEC in our quarterly report on Form 10-Q on August
12, 1998.
+ As filed with the SEC in our quarterly report on Form 10-Q on November
10, 1998.
++ We filed an amendment to the Bylaws with the SEC in our Current Report
on Form 8-K on March 12, 1999.