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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 20-F
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
Commission file number
Galileo Technology Ltd.
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(Exact name of Registrant as specified in its charter and translation of
Registrant's name into English)
Israel
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(Jurisdiction of incorporation or organization)
Moshav Manof, D.N. Misgav 20184, Israel
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(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the
Act.
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Title of each class Name of each exchange on which registered
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N/A None
</TABLE>
Securities registered or to be registered pursuant to Sections 12(g) of the
Act.
Ordinary Shares, par value 0.01 New Israeli Shekels per share
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(Title of Class)
Securities for which there is a reporting obligation pursuant to Section
15(d) of the Act.
None
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Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of the close of the period covered by the annual
report.
Ordinary Shares, par value 0.01 New Israeli Shekels per share 41,989,908
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [_]
Indicate by check mark which financial statement item the registrant has
elected to follow.
Item 17 [_] Item 18 [X]
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PART I
Item 1. Description of Business.
Overview
Galileo Technology Ltd. defines, develops and markets advanced digital
semiconductor devices that perform critical functions for new-world converged
network systems, in which voice, video, and data are handled seamlessly using
Internet Protocol (IP) techniques. Galileo's core competencies utilized in
making converged networks a reality include various LAN technologies, WAN
technologies, and high performance CPU subsystem technologies. Time-to-market
pressures, bandwidth constraints and the need for improved network management
capabilities have forced network system vendors increasingly to transition
from internally-developed solutions to third-party semiconductor devices that
are highly-integrated, scalable, programmable and flexible and meet the
demands of more technologically sophisticated networks. Galileo's highly
integrated "communications systems on silicon" simplify the designs, reduce
development risks and costs, and substantially improve time-to-market for
manufacturers of data communications equipment.
Galileo is organized around two principal product groups: Internetworking
Products, which consists of system controllers and WAN communications
controllers, and Switching Products, which consists of switched Ethernet
controllers, switched Ethernet processors, and switched POS/ATM processors.
Galileo Technology Ltd. is an international company with its headquarters in
Moshav Manof, Israel and its business headquarters, Galileo Technology, Inc.
("GTI"), in San Jose, California.
Galileo serves 100's of customers worldwide, including all datacom and
telecom equipment leaders. Since both datacom and telecom systems leaders are
actively working in the construction of new-world converged networks, Galileo
has realized an important expansion of its customer base, which until recently
consisted predominantly of the datacom market leaders.
Galileo is a pioneer in the development of "communications systems on
silicon," providing network system vendors with high-quality, cost-effective
semiconductor devices that perform critical functions in their systems.
Galileo's semiconductor devices are characterized by high-performance features
and comply with established network standards. Accordingly, by utilizing
Galileo's semiconductor devices, network system vendors can develop their
products more rapidly than when they use their own semiconductor devices,
thereby reducing their time-to-market and development risk and costs.
Galileo's customers can also use the Company's semiconductor devices to
develop a wide range of end-to-end network systems capable of spanning the
price/performance spectrum, from entry-level sub $300 network systems to core
infrastructure network systems costing hundreds of thousands of dollars.
Galileo has developed several product families for communication system
vendors that address the important subsystems in communication systems--the
CPU subsystem, the LAN subsystem and the WAN subsystem. Furthermore, Galileo
has developed highly integrated solutions that incorporate a mix of the
technologies necessary to implement new- world converged networks, in which
the handling of voice, video, and data is unified around IP techniques.
Galileo is considered to be a world leader with some of the families that
form its Internetworking products group, namely in the area of highly
integrated system controllers that support the leading MIPS and PowerPC RISC
processors. These products are used by several communications industry
leaders, including Cabletron Systems Inc. ("Cabletron"), Cisco Systems, Inc.
("Cisco"), Ericsson LM telephone Company ("Ericsson"), and Lucent Technologies
Inc. ("Lucent").
The strong technical foundation established for the creation of the system
controller products has been used to create an important line of WAN
communications controllers, which is the other family forming the
Internetworking products group. The Company introduced in 1997 a remote access
controller co-defined with
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Intel Corporation ("Intel"), a Galileo customer for this product. This product
was augmented in 1998 to provide customers with additional CPU choices
including MIPS, PowerPC, and Motorola's Coldfire, in addition to Intel's i960
and i486. The WAN technologies developed for this product contributed the
balance of foundation technologies necessary to create the new Horizon line of
powerful WAN communications controllers in 1999. The Horizon family consists
of products that integrate most of the system blocks needed to implement
converged voice/data routers. These products utilize all of the key
technologies developed by Galileo, and when coupled with some of the leading
RISC processors in the market, a full router is implemented.
Galileo is considered to be an industry leader and pioneer in merchant
switched Ethernet controllers, providing its customers with high-performance
system solutions targeted at a wide range of cost/performance combinations.
Galileo introduced the first merchant single chip Ethernet (10Mbps) switch
controller in 1996. This was followed with the industry's first merchant Fast
Ethernet (100Mbps) switch controller later in 1996. In 1998, Galileo
introduced the first merchant solution for Gigabit Ethernet (1000Mbps)
switches building on its second generation switch architecture GalNet(TM)-II.
In 1999, Galileo introduced the state-of-the-art GalNet-3 family of switched
Ethernet processors and switched Packet-Over-SONET/ATM processors. Galileo's
Switching products can be used individually or can be cascaded using the
Company's proprietary GalNet protocol to produce scalable, flexible switching
systems. Switched Ethernet LAN controller customers include Cabletron, Cisco,
Intel, Lucent, and Nortel.
Galileo's products are supported by evaluation boards and reference designs
which help accelerate its customers' development activities and time to
market. Many of Galileo's products are based on industry standard building
blocks such as the PCI bus, LVDS signaling, SDRAM memories, etc., to
facilitate the Company's penetration of the communications market by making it
easier for network system vendors to integrate Galileo's products into their
systems. Galileo has developed close working relationships with several
leading network system vendors, enabling the Company to define products
meeting customer requirements and to achieve design wins in their new
networking systems at the time of initial product definition.
Business Strategy
Galileo's objective is to continue to develop "communications systems on
silicon" that help converged-network system vendors to get to market quickly
with high performance, cost-effective and scalable systems. Key elements of
Galileo's strategy to continue to achieve this objective include the
following:
Focus on the High-Growth, Rapidly Evolving Converged-Network Markets.
Galileo's strategy has naturally migrated to focus on one of the most
promising segments of the high-growth communications market: converged-
networks that carry voice, video, and data, across the LAN and WAN. Within
these markets, the Company aims to deliver high-performance, feature-rich
products to market segments that have achieved significant size and where the
Company's products can be widely utilized. The communications market is
characterized by rapid growth, intense time-to-market pressures and
increasingly stringent performance requirements. The Company has focused on
addressing the increasing demands of traditional network system vendors and
new market entrants for high-performance, cost-effective network subsystem
components. Galileo's product families are aimed at providing solutions to the
technically demanding problems of these network system vendors. Galileo's
strategy is to continue to focus on highly differentiated products that either
anticipate demand or address existing demand, to expand the use of Galileo
devices in a given network system by leveraging its established technology and
systems expertise for new product development, and to target additional
products across a customer's product line by taking advantage of its incumbent
position as a supplier of valuable system building blocks.
Provide System-Level Solutions to Optimize Performance.
Galileo defines and develops highly-differentiated "communications systems
on silicon" with a system perspective, combining the Company's strengths in
system architecture and semiconductor design. The Company
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believes that this strategy distinguishes it from many competitors that design
from a narrower component perspective. By designing products with
consideration of the operating environment around them and the various
hardware and software system issues that customers face, Galileo provides
comprehensive system solutions that optimize the performance of network
systems. Because Galileo's products are designed with a system perspective and
are highly integrated and flexible, network system vendors can easily
incorporate the Company's semiconductor devices into their systems, reduce
their time-to-market and decrease their development risk and costs.
Provide Flexible Semiconductor Devices that Enable Customers to Manufacture
Systems Across the Price/Performance Spectrum.
Galileo utilizes a modular approach as the foundation of its system level
architecture, resulting in highly programmable products that can be easily and
flexibly configured by system vendors. Accordingly, customers can cost-
effectively and quickly produce a suite of products with a range of
price/performance characteristics. For example, Galileo's proprietary GalNet
protocol enables its customers to cascade the Company's switched Ethernet LAN
controllers to produce a scalable product, depending upon their system
requirements and target market. In 1998, this protocol was extended to the
Company's GalNet-II switched Ethernet controllers, thereby preserving
customer's investments in management software. Once again, in 1999, the
protocol was extended to the new flagship GalNet-3 family. As a further
demonstration of flexibility, GalNet-II and GalNet-3 products can be mixed in
the same system and GalNet-II's software can be applied and expanded to the
GalNet-3 products.
The Company also believes that its modular approach provides significant
research and development leverage; for example, technology developed for a WAN
controller may become a critical building block in a subsequent LAN product.
Galileo believes that, with the advent of semiconductor device geometries in
the 0.25 and 0.18 micron ranges, a rich function library will be necessary to
compete effectively given increasing levels of integration. Building a
modular, reusable library, which can facilitate the creation of derivative or
related new products, is a key component in Galileo's strategy of providing
modular, scalable, programmable semiconductor devices to customers for maximum
flexibility and rapid time to market.
Strengthen and Expand Customer Relationships.
Galileo maintains a customer-oriented approach that stresses relationships
with leading datacom and telecom OEMs and emphasizes strong customer input in
the product definition process. Galileo has developed close working
relationships with several leading system vendors, enabling the Company to
achieve design wins in new systems at the time of initial product definition.
Beyond the design stage, Galileo's field application engineering group offers
full service technical support and training. By working with customers
throughout the entire product life-cycle, Galileo is able to gain insights
into its customers' future plans and needs, identify emerging industry trends
and consequently deliver high-performance, cost-effective products with wide
market appeal.
Maintain Technological Leadership.
Galileo has assembled a team of engineers with considerable expertise in
system architecture, product definition, semiconductor design, communications
and network engineering. This engineering team is a pioneer in the development
of "communications systems on silicon" and has developed many industry "first
movers", including the industry's first merchant single chip Ethernet switch.
An important element of the strategy is the rapid expansion of the engineering
team headcount, which is necessary to implement the many product ideas that
emanate from the Product Definition and Marketing teams. The Company intends
to continue as a leading provider of silicon components to the communications
market by leveraging its engineering resources and proprietary technology to
develop additional highly-differentiated products.
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Customers and Products
Galileo sells its products to communications OEMs around the world. A
number of the leading manufacturers of data communications equipment have
designed equipment that includes the Company's products. The Company's
communications customers include:
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Alcatel D-Link Systems Inc. Lucent Technologies Inc.
Cabletron Systems, Inc. Ericsson LM Telephone Company Northern Telecom Inc.
Accton Technology Corp. Cisco Systems Inc. Intel Corporation
</TABLE>
During 1999, sales to Cisco, D-Link and Accton, accounted for 22%, 14% and
13% of the Company's total net sales, respectively. The majority of sales to
D-Link and Accton represented designs won by Galileo at companies such as
Hewlett Packard, Nortel Networks, and Intel, which are designed and
manufactured in Taiwan under Original Design and Manufacturing (ODM)
contracts. During 1998, sales to Cisco accounted for 26% of the Company's
total net sales. The Company currently has purchase agreements with a few of
its largest customers. However, none of the Company's customer purchase
agreements contains minimum purchase requirements. Customers purchase the
Company's products pursuant to short-term purchase orders that may be canceled
without charge if notice is given within an agreed-upon period. The Company's
future success depends in significant part upon the decision of the Company's
current and prospective customers to continue to purchase products from the
Company. There is increasing consolidation within the Company's customer base.
Accordingly, there can be no assurance that the Company's current customers
will continue to place orders with the Company or that the Company will be
able to obtain orders from new customers. See "Item 1--Description of
Business--Risk Factors--Risks Relating to the Company--Customer
Concentration."
The Company's existing products--system controllers, WAN communications
controllers, switched Ethernet controllers and processors, and switched
POS/ATM processors--provide some of the key functionality of modern
communications systems. Galileo also designs evaluation boards, and develops
basic firmware and software, to provide applications support to its customers.
Internetworking Products.
System Controllers. Galileo's highly integrated system controllers can be
combined with the leading embedded RISC microprocessors to form complete CPU
subsystems. The Company's system controllers contain all the key control
blocks needed to build high-performance 32-bit and 64-bit CPU subsystems
(based on MIPS, Intel i960, or PowerPC microprocessors)--DRAM controller,
peripheral device controller, DMA (direct memory access) engines, timers, PCI
interface(s), interrupt controllers, etc. These system controllers provide
system designers with the ability to match their CPU performance to the
targeted overall system price/performance by simply changing CPUs. An
additional advantage to OEMs using Galileo system controllers over internally
developed solutions is that new products are generally software-compatible
with older generations--supporting fast development time by re-using software
which might otherwise need to be re-developed.
The overall performance of a given system is often determined by how
quickly and efficiently data is moved from place to place within a system. For
example, interface data is often moved from a PCI-bus peripheral to main
memory, followed by a CPU interrupt (to inform the CPU of the presence of new
data), and then by moving parts of the data from main memory to the CPU for
inspection and other operations. This example involves several data movements,
all of which are supported with a Galileo system controller. Galileo's system
controllers maximize the performance of this system example by providing
powerful DMA (direct memory access) engines, which allow the CPU and
peripherals to move data in and out of the main memory at high speeds with
minimal CPU involvement--allowing the CPU to concentrate its resources on
other activities while this data movement is happening. Additionally, Galileo
system controllers use a multi-bus architecture internally, which allows
multiple data movement operations to occur simultaneously between devices
controlled by the system controller.
The majority of design wins for Galileo's system controllers are in
communications applications. These applications include switches, routers
(LAN-WAN edge routers and enterprise routers) and various telecom
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applications. Other markets in which Galileo has a strong presence include
intelligent PC add-in cards, host applications (thin clients, digital set to
boxes) and Storage Area Networks (SAN). Galileo identified the PowerPC
platform as a growing market in 1998 and introduced its first system
controllers that support it in 1999. These products have been well received by
the market and have garnered multiple design wins amongst datacom and telecom
world leaders.
Galileo currently offers system controllers at typical per unit book prices
ranging from $15 to $68 for an order of 10,000 units. High volume discounts
are applied for larger quantities. There can be no assurance, however, that
these per unit prices will not decline in the future. See "Item 1--Description
of Business--Risk Factors--Risks Relating to the Company--Potential
Fluctuations in Operating Results" and "Item 9--Management's Discussion and
Analysis of Financial Condition and Results of Operations."
WAN Communication Controllers. Galileo's WAN communications controllers
integrate all the key building blocks necessary to provide access from the LAN
to the WAN, essentially creating a router subsystem when coupled with a RISC
microprocessor. These WAN communications controllers span from the value
segment GT-96010A, used today in production SOHO routers, to the recently
introduced high-performance Horizon family. In general, these products enable
data routing between Ethernet and various WAN technologies, such as ISDN,
T1/E1, T3/E3, Frame Relay and xDSL technologies. The Company intends to
continue investing in the development of WAN communications controllers, using
its state-of-the-art system controller and switching technologies as
contributed building blocks to further the sophistication and capabilities of
these products. The Company currently offers its WAN communication controllers
at a typical per unit book prices ranging from $25.00 to $120.00 for an order
of 10,000 units. There can be no assurance, however, that this per unit price
will not decline in the future. See "Item 1--Description of Business--Risk
Factors--Risks Relating to the Company--Potential Fluctuations in Operating
Results" and "Item 9--Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Switching Products.
Switched Ethernet Controllers and Processors. Galileo is considered to be
the pioneer and an industry leader in switched Ethernet controllers and
processors, in terms of established customers and breadth of product
offerings. In 1999, the Company introduced its third and fourth generation
families of switched Ethernet controllers, the latter being the award-winning
GalNet 3 family of Layer 3/4/5 switched processors, which expands Galileo's
switched technology to the areas of Packet-Over-SONET (POS) and ATM. A
chronology of Galileo's switched Ethernet families shows the depth of
architectural understanding and expertise required to be an effective
participant in this market.
GalNet(TM): Galileo's first generation of switched Ethernet controllers.
Based on the Company's proprietary GalNet architecture, this family consists
of 4 products: the GT-48001A (8-port 10Mbps), GT-48002A (2-port 10/100Mbps
Fast Ethernet), GT-48004A (4-port 10/100Mbps Fast Ethernet), and the GT-48006A
(2-port 10/100Mbps Fast Ethernet). Except for the GT-48006A, these products
may be easily combined into system applications by using the integrated
standard PCI bus as a communications I/O channel. The GalNet family did not
garner significant new designs during 1999, and mostly produced legacy revenue
from systems that were designed between 1996 and 1998. An exception to this
was the GT-48006A, which continued as a very active part. The GT-48006A is
most often found in system products known as "Dual Speed Repeaters" providing
the necessary bridge between 10Mbps and 100Mbps Ethernet LANs, and more
recently in HomePNA applications.
Galaxy(TM): The Galaxy family of switched Ethernet controllers represents
the second generation of Galileo switches. It provides highly integrated
solutions for combinations of 10Mbps Ethernet and 10/100Mbps Fast Ethernet
applications. Currently there are three products in the family, the GT-48207
(unmanaged 8-port 10Mbps + 2-port 10/100Mbps Fast Ethernet), GT-48208 (managed
8-port 10Mbps + 2-port 10/100Mbps Fast Ethernet), and the GT-48212 (managed
12-port 10Mbps + 2-port 10/100Mbps Fast Ethernet). These devices may be used
stand-alone, or combined to form combinations such as 16-port 10Mbps + 2-port
10/100Mbps or 24-port 10Mbps + 2-port 10/100Mbps systems. The devices may be
used without a system CPU (unmanaged) or with a low-cost
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external CPU (managed) to build systems supporting VLANs, RMON, IP Multicast,
and other feature-rich networking applications.
GalNet-II(TM): Introduced in 1998, GalNet-II represents the Company's third
generation of switched Ethernet controllers, and was the Company's most
successful product family in 1999. With 21-products in its portfolio, GalNet-
II supports all Ethernet network speeds from standard 10Mbps to 1000Mbps
Gigabit Ethernet, and provides unprecedented levels of end-system variations,
price/performance points, and advanced features. GalNet-II further supports
products targeting a wide variety of end markets, including small-office home-
office (SOHO), workgroup, and chassis/enterprise switching solutions. GalNet-
II Switches can range in port density from one to 32 ports of Gigabit
Ethernet, or 8 ports to 256 ports of Fast Ethernet, or combinations of Fast
and Gigabit. The product family also includes devices supporting the most
recently adopted IEEE standards for VLANs, priority queuing for multimedia
support, and switch traffic flow control.
GalNet-II products departed from Galileo's original GalNet family by
implementing a proprietary chip-to chip communications channel called
"G.Link". G.Link provides much higher communications bandwidth between switch
controllers than the PCI bus used in the GalNet family, and facilitates the
use of "G.Link Crossbar Switches" to provide switch system expansion,
management CPU interfacing, and system stacking, as well as interface to other
networking architectures and protocols. Current products in the GalNet-II
family include:
G.Link Crossbar Switches:
GT-48300: Provides 4 G.Link ports with one PCI port for interfacing with
a management CPU subsystem or other system components.
GT-48301: Similar to the GT-48300, the GT-48301 provides 4 G.Link ports
but no PCI port.
GT-48302: A higher density version of the GT-48300, the GT-48302
provides 8 G.Link ports and one PCI port.
GT-48302A: A higher speed, lower cost version of the GT-48302, provides
8 G.Link ports and one PCI port.
GT-48303A: Provides 6 G.Link ports and one PCI port.
GalNet-II Switched Ethernet Controllers:
Fast Ethernet:
GT-48310: Provides 8 Fast Ethernet ports with a high-performance switch
engine supporting an advanced suite of switch management functions,
including IP Multicast, IEEE 802.1Q VLANs, priority queuing via the IEEE
802.1p protocol, and Layer 3 protocol filtering as well as standard'
management features such as spanning tree and RMON.
GT-48310A: A higher performance version of the GT-48310, supports the
RMII standard of connectivity to physical layer devices.
GT-48310B: A lower cost version of the GT-48310A.
GT-48311: A sub-set of the GT-48310, the GT-48311 provides the same
switch functionality with a reduced management feature set, targeting cost-
sensitive managed switch applications.
GT-48310A: A higher performance version of the GT-48311, supports the
RMII standard of connectivity to physical layer devices.
GT-48310B: A lower cost version of the GT-48311A.
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GT-48312: Provides a high-performance and expandable 8-port Fast
Ethernet switch without management support for low-cost workgroup switches
with many combinations of Fast and Gigabit Ethernet ports.
GT-48312A: A higher performance version of the GT-48312, supports the
RMII standard of connectivity to physical layer devices.
GT-48312B: A lower cost version of the GT-48312A.
GT-48313: A low cost member of the GalNet-II family, the GT-48313 is not
expandable and only supports 8-ports of Fast Ethernet switching.
GT-48314: The lowest cost 8-port non-expandable member of the family,
reduces the need for external buffer memories to only one, and supports the
RMII standard of connectivity to physical layer devices.
GT-48315: A low cost 5-port non-expandable member of the family, reduces
the need for external buffer memories to only one, and provides the 5th
port with an MII interface.
Gigabit Ethernet:
GT-48320: The industry's first merchant Gigabit Ethernet Switch
controller, the GT-48320 provides a single port of Gigabit Ethernet
(1000Mbps) with a G.Link port for switch expansion and management I/O. It
supports all of the advanced management feature set found in the GT-48310.
GT-48320A: A higher performance version of the GT-48320. This device
works with both fiber optics and twisted pair copper physical layer
devices.
GT-48322A: Provides a high-performance and expandable 8-port Fast
Ethernet switch without management support for low-cost workgroup switches
with many combinations of Fast and Gigabit Ethernet ports, or for pure
Gigabit switches.
Accessories:
GT-48330: This is a low cost G.Link-to-CPU bridge device, which enables
the management of a GalNet2 or GalNet2+ system via a low cost 8- or 16-bit
microcontroller or microprocessor.
GT-48331: This device bridges communications between an original G.Link
interface and a faster G.Link+ interface, while providing CRC and
retransmission for higher reliability stacking.
GalNet-3(TM): Introduced in 1999, GalNet-3 is the most ambitious project at
Galileo to date. It represents the Company's fourth generation of switched
Ethernet controllers, and is targeted at converged networks. It consists of
Ethernet, Packet-Over-SONET (POS), and ATM products. The family uses the same
principles of modularity and flexibility that Galileo devised for the GalNet-
II family. The existing crossbar chips can be used to build GalNet-3 systems,
which means that GalNet-II and GalNet-3 products can be mixed in the same
system. This provides attractive paths for Layer 2 to Layer 3-and-above
migrations. GalNet-3 is targeted at Enterprise switches, Metropolitan Area
Networks, and Internet Core network equipment. Various new derivative members
of this family will be introduced in 2000.
GalNet-3 Switched Processors:
Ethernet
GT-48510: Provides 8 Fast Ethernet ports with support for Layer2/3/4/5,
including IP/IPX routing, one of the most advanced Flow Classifiers in the
industry, and an external hardware interface (EHI) for the customer to add
his own value-added hardware differentiation. First Layer 2/3/4/5 switched
Ethernet processor to offer guaranteed Availability of Service (AOS(TM)).
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GT-48520: Provides 1-port of Gigabit Ethernet with support for
Layer2/3/4/5, including IP/IPX routing, one of the most advanced Flow
Classifiers in the industry, and an external hardware interface (EHI) for
the customer to add his own value-added hardware differentiation. First
Layer 2/3/4/5 switched Ethernet processor to offer guaranteed Availability
of Service (AOS(TM)).
Packet-Over-SONET (POS) and ATM
GT-48540: Provides 1-port of POS of up to OC-12c or ATM 622Mbps. It
supports Layer 2/3/4/5, including IP/IPX routing, one of the most advanced
Flow Classifiers in the industry, and an external hardware interface (EHI)
for the customer to add his own value-added hardware differentiation.
Switched controllers and processors are offered at typical per unit book
prices ranging from $10 to $150 for an order of 10,000 units. There can be no
assurance, however, that these per unit prices will not decline in the future.
See "Item 1--Description of Business--Risk Factors--Risks Relating to the
Company--Potential Fluctuations in Operating Results" and "Item 9--
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Evaluation Boards. To facilitate the adoption of its semiconductor devices,
the Company designs system-level evaluation boards that closely resemble
actual end products or subsystems within them. The Company's evaluation boards
include basic hardware and firmware that enable customers to expedite their
designs by using the evaluation boards as a reference or by incorporating
portions of the firmware into their own code. These boards are used as
evaluation and development vehicles for each semiconductor device designed by
the Company. As the Company's engineering team designs and debugs these
boards, they must consider system problems similar to the ones that customers
may face in their product development. The Company also offers customers the
option of detailed design reviews of their schematics prior to fabrication,
which can reduce their time-to-market.
Technology
Galileo is a pioneer in the development of cost-effective "communications
systems on silicon." The Company offers both the core logic that resides next
to the RISC microprocessor and some of the key LAN and WAN subsystems. The
ability to implement these functions proficiently is predicated on various
proprietary core technologies and intellectual property that the Company
possesses.
Advanced Algorithms. The Company uses both proprietary and industry
standard algorithms to implement some of the most distinctive features in its
products. For example, Galileo's proprietary address recognition algorithm
permits the proper identification and handling of incoming Ethernet packets at
full-wire speed, while replacing expensive, fast SRAMs or content addressable
memories ("CAMs") with inexpensive DRAMs. This algorithm is used in all of
Galileo's switched Ethernet LAN controllers and in the Company's newer WAN
communications controllers. This algorithm enables these products to recognize
between 8,000 and 64,000 distinct Ethernet addresses--depending on the
product--and to manage the traffic for entire network segments. The Company
has also licensed proprietary algorithms from third parties and integrated
them into the Company's products to provide highly differentiated solutions.
For example, Galileo licenses the HP-EASE packet sampling technology from
Hewlett-Packard, making Galileo the only supplier of Ethernet switches with
such network monitoring and diagnostics capabilities. In addition to HP-EASE
support, many of Galileo's switched Ethernet LAN controllers include the
hardware-assist to support remote networking monitoring ("RMON").
System Architecture. Galileo's architects, designers, technical marketing
engineers and applications engineers have broad knowledge of communications
system architectures and advanced microprocessors. Using such system
expertise, the Company is able to develop semiconductor devices that address
the system requirements of modern communications equipment. Galileo's system-
level approach considers the various components in a system, enabling the
Company to anticipate and evaluate effectively the various systems issues and
tradeoffs that its customers will face when designing the end equipment. This
helps Galileo to partition its
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devices properly and to attain appropriate levels of integration. A system-
level approach also results in modular offerings: a device may operate on a
stand-alone basis as a complete basic system or various devices may be
interconnected to form a more complex system.
Internet Protocol Knowledge. Galileo's intimate knowledge and market
leadership in Ethernet and Internet Protocol (IP) technologies is an important
asset in the area of converged networks. After many years of debate as to what
technology would be most appropriate to implement new-world converged networks
that not only carry data, but also voice and video, IP technologies have been
widely selected as the core technologies for such implementations. The result
of this is that the worldwide networks that separately carry voice and data
today are being re-architected into one unified converged network that uses IP
technologies at its core. Galileo's GalNet-3 family exemplifies the
implementation of a state-of -the-art set of products that uses IP
technologies to deliver a comprehensive solution for networks where it is
critical to effectively carry multiple types of media, to guarantee Quality of
Service, to bill for services and establish service level agreements, to
provide redundancy for high reliability, and to effectively bridge to other
technologies like Packet-Over-SONET and ATM. Galileo's IP technology is
especially attractive to telecommunications customers, who traditionally have
not emphasized the development of this type of technology in-house.
Design Methodology. The Company's design methodology utilizes advanced
computer aided design ("CAD") tools for implementation, logic verification,
synthesis and layout of its semiconductor devices. Galileo designs its
products using Verilog, a high-level design language, and standard cell
libraries from its fabricators for logic synthesis. Galileo verifies its
designs at both the Verilog level and gate level, using standard and
proprietary software tools. The Company also conducts system-level simulations
in which the software model of a new device interacts with models of the
devices with which it will interface in a typical system in order to test
system-level operability. These simulations are often conducted with key
customers that provide extensive feedback to the Company's design team. As a
result, Galileo has successfully designed products highly functional on first
silicon. In many cases the products are also production worthy. Galileo uses a
technique called Formal Verification, which it believes increases customer
confidence in complex designs by reducing the probability of hard-to-find
defects. The layout of the Company's advanced semiconductor devices is
conducted in-house, using state-of-the-art tools that result in competitive
compact die sizes and high frequency operation.
Complex Function Library. Galileo has developed a rich library of complex
functional blocks that provides the Company with an intellectual property base
for new designs. The Company's design is achieved with high-level language and
in modular fashion. This modular approach facilitates the re-use of complex
blocks in new designs, reducing Galileo's product development cycles. The
Company believes that a rich library of complex functions is required to
compete effectively in the market, especially in terms of cost and development
cycles and with process geometry of 0.35 micron or less. Galileo expects that
its library of multiple CPU interfaces, memory and device controllers, high-
performance DMA controllers, PCI interfaces, switching engines, Ethernet, Fast
Ethernet, and Gigabit controllers, Packet-Over-SONET controllers, time-
division multiplexers, HDLC controllers, proprietary algorithms and other such
functions will enable it to take advantage of these state-of-the-art
semiconductor processes.
Competition
The communications market into which the Company sells its products is
intensely competitive and is subject to frequent product introductions with
improved price/performance characteristics, rapid technological change, unit
ASP erosion and continued emergence of new industry standards. The
semiconductor industry is also intensely competitive and is characterized by
rapid technological change, product obsolescence and unit ASP erosion. The
Company expects competition to increase in the future from existing
competitors and from companies that may enter the Company's existing or future
markets, including certain current customers, with similar or substitute
solutions that may be less costly or provide better performance or features
than the Company's products. To be successful in the future, Galileo must
continue to respond promptly and effectively to changing customer performance,
feature and pricing requirements, technological change and competitors'
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innovations. There can be no assurance that the Company will be able to
compete successfully against current and future competitors or that
competitive pressures faced by the Company will not materially adversely
affect the Company's business, financial condition and results of operations.
Traditionally, Galileo's customers have internally developed the key ASIC
components for their network systems or utilized programmable logic, such as
FPGAs, for system and network controllers. Recently, they have begun to
outsource these semiconductor devices as a result of intense time-to-market
pressures, the increasing technological complexity of network systems and
development costs. The Company's success depends in large part on increased
acceptance of outsourcing as an alternative to in-house development by these
companies. Many of Galileo's current and potential customers have substantial
technological capabilities and financial resources. These customers may
currently be developing, or may in the future determine to develop or acquire,
components or technologies that are similar to or may be substituted for the
Company's products and, therefore, may discontinue purchases of the Company's
products. If such customers develop or acquire technology to develop their own
components rather than purchase the Company's products, the Company's
business, financial condition and results of operations would be materially
adversely affected.
Third-party merchant competitors vary in the scope of the products and
services they offer. Many large companies develop and market network
components. In the market for system controllers, the Company's competitors
include NEC Corp. with respect to the MIPS microprocessor, and Motorola and
IBM with respect to the Power PC microprocessor. Galileo's switched Ethernet
LAN controllers compete with products from companies such as Broadcom
Corporation, MMC Networks, and Allayer Technologies Corporation. The Company's
WAN communications controllers compete directly with products from companies
such as Motorola, Inc., Siemens A.G., and PMC-Sierra Inc. In addition, the
Company expects increased competition in the future from other emerging and
established companies.
Several of Galileo's current and potential competitors have longer
operating histories, greater name recognition, access to larger customer bases
and significantly greater financial, technical, marketing and other resources
than the Company. As a result, they may be able to adapt more quickly to new
or emerging technologies and changes in customer requirements or to devote
greater resources to the promotion and sale of their products than the
Company. In addition, current and potential competitors may determine, for
strategic reasons, to consolidate, to lower the price of their products
substantially or to bundle their products with other products. Current and
potential competitors have established or may establish financial or strategic
relationships among themselves or with existing or potential customers,
resellers or other third parties. Accordingly, it is possible that new
competitors or alliances among competitors could emerge and rapidly acquire
significant market share. There can be no assurance that the Company will be
able to compete successfully against current and future competitors. Increased
competition may result in price reductions, reduced gross margins and loss of
market share, any of which would materially adversely affect the Company's
business, financial condition and results of operations. See "Item 1--
Description of Business--Risk Factors--Risks Relating to the Company--Intense
Competition" and "--Dependence on Growth of Outsourcing."
Galileo believes that its ability to compete successfully depends on a
number of factors, both within and outside of its control, including the
price, performance and quality of the Company's and its competitors' products,
the timing and success of new product and feature introductions by the
Company, its customers and its competitors, the emergence of new standards in
the communications industry, the development of technical innovations, the
ability to obtain adequate foundry capacity and sources of raw materials, the
efficiency of production, the rate at which the Company's customers design the
Company's products into their products, the number and nature of the Company's
competitors in a given market, the assertion of intellectual property rights
and general market and economic conditions. For these and other reasons, there
can be no assurance that the Company will be able to compete successfully in
the future.
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Sales, Marketing and Technical Support
Galileo markets and sells its products around the world primarily through a
selected team of manufacturers' representatives, stocking representatives and
distributors. Manufacturers' representatives service the North American
market. Insight Electronics, a national distributor, also services the North
American customer base.
Outside North America, the Company has engaged stocking representatives
that normally act as distributors but occasionally act as commissioned
representatives with respect to large volume orders. The Company's
international network includes representatives in many countries in Europe and
Asia Pacific. The Company continues to develop relationships with new
distributors and representatives and the Company is unable to predict the
extent to which some of these distributors and representatives will be
successful in marketing and selling the Company's products. Moreover, many of
its distributors also market and sell competing products. The State of Israel
is serviced directly by the Company. The Company maintains direct sales
offices in San Jose, Boston, Austin, London and Tel-Aviv. See "Item 1--
Description of Business--Risk Factors--Risks Relating to the Company--
Dependence on Third-Party Distribution."
Sales to North America represented approximately 50%, 51% and 51% of total
net sales for the years ended December 31, 1999, 1998 and 1997, respectively.
Sales to Asia represented approximately 35%, 32% and 24% of total net sales
for the years ended December 31, 1999, 1998 and 1997, respectively. Sales to
Europe and Israel, combined, represented approximately 15%, 17% and 26% of
total net sales for the years ended December 31, 1999, 1998 and 1997,
respectively.
Galileo believes that its staff of executives, managers and applications
engineers helps distinguish the Company from others in the industry through
quality of service and effective reduction of the development cycle. The
Company also provides a valuable technical resource for consulting on system
trends and implementations. Technical support to customers is provided through
field applications engineers, technical marketing and factory applications
engineers and, if necessary, product designers and architects. Local field
support is provided in person or by telephone. The Israeli engineering team
provides support principally by electronic mail or by telephone.
Galileo believes that providing network system vendors with comprehensive
product service and support is critical to maintaining a competitive position
in the data communications market. The Company works closely with its
customers to monitor the performance of its product designs and to provide
application design support and assistance. Galileo provides support at each
stage of product development. During the design phase, Galileo sells software
simulation models of each semiconductor device, in Verilog language, which
allow customers to simulate their entire system before committing it to a PC
board. The Company also offers a line of evaluation boards which contain
subsystems that are representative of a typical customer design. These boards
enable customers to evaluate a semiconductor device, as well as hardware
design and software development functions, without significant development
effort on their part, thereby facilitating decision making and eventual rapid
time-to-market. Galileo believes that close contact with these customers
allows the Company to tailor its products to the market and technical needs
defined by key OEMs. Understanding its customers' particular networking
problems enables the Company to design and develop solutions in its next
generation products.
Research and Development
Galileo's research and development expertise facilitates short product
design cycles, provides flexibility to allow better response to customer needs
and enables the Company to attract and maintain strategic customers. The
Company's research and development group focuses on developing new products
and enhancing its existing products. Extensive product development input is
obtained from customers and through the Company's participation in industry
organizations and standards-setting bodies such as the IEEE 802.3 Committee.
As of December 31, 1999, the Company's research and development staff
consisted of 194 employees, all of whom were located in Israel and most of
whom held engineering or other advanced technical degrees. The
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Company's gross research and development expenditures in 1999, 1998 and 1997
were approximately $16.6 million, $10.7 million, and $6.2 million,
respectively. The Company expects that it will continue to commit substantial
resources to research and development in the future. See "Item 9--Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Results of Operations--Research and Development Expenses."
The markets for the Company's products are characterized by rapidly
changing technologies, evolving and competing industry standards, changes in
customer needs, emerging competition, new product introductions and rapid
product obsolescence. The Company's future success will depend, in part, on
its ability to use leading technologies effectively, to continue to develop
its technical expertise, to maintain close working relationships with its key
customers in order to develop new products that meet changing customer needs,
to advertise and market its products, and to influence and respond to changing
industry standards and other technological changes on a timely and cost-
effective basis. See "Item 1--Description of Business--Risk Factors--Risks
Relating to the Company--Rapid Technological Change; Necessity to Develop and
Introduce New Products."
Manufacturing
Currently, Galileo contracts the manufacturing of its products on a turnkey
basis, in which fully assembled and tested products are purchased at
predetermined prices. This model allows the Company to focus substantially all
of its resources on the definition, development and marketing of products. The
fabless model significantly reduces the capital requirements of the Company
since it does not need to own and operate a semiconductor wafer fabrication
facility or a semiconductor assembly and test facility.
In 1999, Galileo subcontracted approximately 90% of its semiconductor
manufacturing to Taiwan Semiconductor Manufacturing Company ("TSMC"). The
balance, representing the manufacturing of one system controller product, was
subcontracted out primarily to Samsung in South Korea. During 2000, it is
expected that the Company will continue to contract out approximately 90% of
the Company's production to TSMC. All of TSMC's and Samsung's production
consists of CMOS products. During 1999, the Company discontinued purchasing an
older product from Temic. Most of the products supplied by TSMC to the Company
in 1999 were manufactured on eight-inch wafers. Galileo selects its
manufacturing vendors in large part due to their conformance with
international standards of quality and their compatibility with state-of-the-
art CAD tools used by Galileo. Primarily all of the Company's products are
expected to be single-source manufactured for the foreseeable future.
Galileo uses mainstream processes for the manufacturing of its products,
instead of depending on the latest process, which typically has both
availability and technical risks associated with it. The Company is able to
follow this "n-1" approach because its main value-added resides in the
differentiated architecture and functionality of its products. While the
Company still manufactures some older established products in 0.5 micron
geometry, most of Galileo's products are currently fabricated in 0.35 micron
geometry. The Company believes that the transitioning of its products to
increasingly smaller geometries, like 0.25 micron and 0.18 micron, will be
important for the Company to remain competitive. No assurance can be given
that future process migration will be achieved without difficulty.
Galileo's design methodology includes the use of standard cell libraries
provided by vendors of ASIC technology, rather than the use of its own
libraries. The Company is a customer of the ASIC division of TSMC, which
provides turnkey services similar to those of other leading ASIC vendors. This
strategy permits the Company to concentrate its resources on the design of
products, instead of creating and maintaining an in-house cell library.
Galileo intends to continue to rely on TSMC and its subcontractors for
substantially all of its manufacturing, assembly and testing requirements for
the foreseeable future. TSMC also manufactures products for other companies.
The Company does not have a long-term manufacturing agreement with TSMC.
Therefore, TSMC is not obligated to supply products to the Company for any
specific period, in any specific quantity or at any
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specific price, except as may be provided in a particular purchase order that
has been accepted by TSMC. See "Item 1--Description of Business--Risk
Factors--Risks Relating to the Company--Dependence on TSMC; Manufacturing
Risks."
Galileo's reliance on one independent foundry involves certain risks. The
Company has experienced delays and may in the future experience delays in
receiving supplies of products, and there can be no assurance that the Company
will be able to obtain such products within the time frames and in the volumes
required by the Company at an affordable cost or at all. Any failure to obtain
such products on a timely basis at a favorable cost could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Item 1--Description of Business--Risk Factors--Risks Relating
to the Company--Dependence on TSMC; Manufacturing Risks."
Proprietary Rights
Galileo's future success and ability to compete are dependent, in part,
upon its proprietary technology. The Company relies in part on patent, trade
secret, trademark and copyright law to protect its intellectual property.
There can be no assurance that any patents will issue pursuant to the
Company's current or future patent applications or that any issued patents
will not be invalidated, circumvented, challenged or licensed to others. In
addition, there can be no assurance that the rights granted under any such
patents will provide competitive advantages to the Company. There can be no
assurance that any patents issued to the Company will be adequate to safeguard
and maintain the Company's proprietary rights, to deter misappropriation or to
prevent an unauthorized third party from copying the Company's technology,
designing around the patents owned by the Company or otherwise obtaining and
using the Company's products, designs or other information. In addition, there
can be no assurance that others will not develop technologies that are similar
or superior to the Company's technology.
The Company also relies on confidentiality agreements to protect its
proprietary rights. It is the Company's policy to require employees and
consultants and, when possible, suppliers to execute confidentiality
agreements upon the commencement of their relationships with the Company.
There can be no assurance that the Company's efforts to protect its
proprietary rights will be adequate. Litigation may be necessary to enforce
the Company's intellectual property rights and to protect the Company's trade
secrets, and there can be no assurance that such efforts will be successful.
The Company's inability to protect its proprietary rights effectively would
have a material adverse effect on the Company's business, financial condition
and results of operations.
Many participants in the semiconductor and communications industries have a
significant number of patents and have frequently demonstrated a readiness to
commence litigation based on allegations of patent and other intellectual
property infringement. Although the Company is not aware of any claim of
infringement or misappropriation against the Company, there can be no
assurance that third parties will not assert such claims in the future with
respect to the Company's current or future products. The Company expects that
companies will increasingly be subject to infringement claims as the number of
products and competitors in the Company's industry segment grows and the
functionality of products in different industry segments overlaps. Responding
to such claims, regardless of merit, could cause product shipment delays or
require the Company to enter into royalty or licensing arrangements. Any such
claims could also lead to time-consuming, protracted and costly litigation
which would require significant expenditures of time, capital and other
resources by the Company and its management. Moreover, no assurance can be
given that any necessary royalty or licensing agreement will be available or
that, if available, such agreement could be obtained on commercially
reasonable terms. See "Item 1--Description of Business--Risk Factors--Risks
Relating to the Company--Limited Protection of Intellectual Property and
Proprietary Rights" and "Business--Technology."
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RISK FACTORS
Risks Relating to the Company
Potential Fluctuations in Operating Results. The Company's operating
results are subject to quarterly and other fluctuations due to a variety of
factors, including the gain or loss of significant customers, increased
pricing pressures, the timing of new product and feature announcements and
introductions by the Company, its competitors or its customers and market
acceptance of existing, new or enhanced versions of the Company's and its
competitors' and customers' products. Additionally, even if existing, new or
enhanced versions of the Company's products are accepted by the Company's
customers, the Company could experience fluctuations in its operating results
as a result of any delays or slowdown in the customers production ramp. Other
factors include the availability of foundry capacity, the availability of
products as a result of fluctuations in manufacturing yields and the
availability and cost of raw materials to its main supplier, TSMC in Taiwan,
the availability of advanced packaging capacity, changes in the mix of
products sold, the cyclical nature of both the data communications market and
the semiconductor industry, the timing of significant orders, order
cancellations and reschedulings, significant increases in expenses associated
with expansion of operations and changes in pricing policies of the Company,
its competitors or TSMC, including decreases in unit average selling prices
("ASPs") of the Company's products. Historically, unit ASPs in the
semiconductor industry have decreased over the life of individual products. In
the past, the Company has experienced decreases in unit ASPs on each of its
products. The Company believes that many of its current and potential
customers are volume purchasers, and will require volume discounts, and that
per unit ASPs of individual products will continue to decline in the future
due to these increased volume shipments and other pricing pressures. Such
declines in unit ASPs will lead to declines in the gross margins for these
products, absent offsetting cost reductions or high margins on new product
introductions. Furthermore, as the Company enters new markets, there can be no
assurance that gross margins will be consistent with historical levels. These
factors are difficult to forecast, and these or other factors could materially
affect the Company's quarterly or annual operating results. Therefore, there
can be no assurance as to the level of net sales or net income, if any, that
may be attained by the Company in any given period in the future. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Intense Competition. The data communications market into which the Company
sells its products is intensely competitive and is subject to frequent product
introductions with improved price/performance characteristics, rapid
technological change, unit ASP erosion and continued emergence of new industry
standards. The semiconductor industry is also intensely competitive and is
characterized by rapid technological change, product obsolescence and unit ASP
erosion. The Company expects competition to increase in the future from
existing competitors and from companies that may enter the Company's existing
or future markets, including certain current customers, with similar or
substitute solutions that may be less costly or provide better performance or
features than the Company's products. To be successful in the future, the
Company must continue to respond promptly and effectively to changing customer
performance, feature and pricing requirements, technological change and
competitors' innovations. There can be no assurance that the Company will be
able to compete successfully against current and future competitors or that
competitive pressures faced by the Company will not have a material adverse
effect on the Company's business, financial condition and results of
operations.
Third-party merchant competitors vary in the scope of the products and
services they offer. Many large companies develop and market network
components. In the market for system controllers, the Company's competitors
include NEC Corp. with respect to the MIPS microprocessor, several small
companies with respect to the Intel i960 microprocessor, and Motorola and IBM
with respect to the Power PC microprocessor. Galileo's switched Ethernet LAN
controllers compete with products from companies such as Broadcom Corporation,
MMC Networks, Allayer Technologies Corporation, I-Cube, Inc., and PMC-Sierra,
Inc. The Company's remote access WAN controller competes directly with
products from Motorola, Inc., Siemens A.G. and Temic Semiconductors ("Temic").
In addition, the Company expects increased competition in the future from
other emerging and established companies.
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Customer Concentration. To date, a small number of customers have accounted
for a majority of the Company's net sales. The Company expects that revenues
from the sale of its products to a limited number of customers will continue
to account for a significant percentage of its net sales for the foreseeable
future. In addition, a limited number of large OEMs account for a majority of
purchasers in the data communications market, and the Company's success will
be dependent upon its ability to establish and maintain relationships with
these customers. The Company currently has purchase agreements with a few of
its larger customers. None of the Company's customer purchase agreements
contains minimum purchase requirements. Customers purchase the Company's
products pursuant to short-term purchase orders that may be canceled without
charge if notice is given within an agreed-upon period. The loss of any one of
the Company's major customers would have a material adverse effect on the
Company's business, financial condition and results of operations. The
Company's future success depends in significant part upon the decision of the
Company's current and prospective customers to continue to purchase products
from the Company. There is increasing consolidation within the Company's
customer base. Accordingly, there can be no assurance that the Company's
current customers will continue to place orders with the Company or that the
Company will be able to obtain orders from new customers. If orders by current
customers are canceled, decreased or delayed or the Company fails to obtain
significant orders from new customers, the Company's business, financial
condition and results of operations would be materially adversely affected.
Product Concentration; Broad Market Acceptance of Products. The Company
currently derives substantially all of its net sales from its system
controllers and switched Ethernet LAN controllers, and the Company expects
that net sales from these products will continue to account for a substantial
portion of the Company's net sales for the foreseeable future. The Company's
future performance will also depend in part on its ability to successfully
develop, introduce and market new and enhanced products at competitive prices.
Broad market acceptance of these products is, therefore, critical to the
Company's future success. Factors that may affect the market acceptance of the
Company's products include the market acceptance of network switching
products, the price, functionality and availability of competing products and
technologies, and the success of the sales efforts of the Company and its
customers. There can be no assurance that the Company will be able to develop
products that will attain broad market acceptance. Failure of the Company's
products to achieve broad market acceptance would have a material adverse
effect on the Company's business, financial condition and results of
operations. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations".
Dependence on TSMC; Manufacturing Risks. Substantially all of the Company's
semiconductor devices are manufactured, assembled and tested by TSMC and its
subcontractors. The Company intends to continue to rely on TSMC and its
subcontractors for substantially all of its manufacturing, assembly and
testing requirements for the foreseeable future. TSMC also manufactures
products for other companies. The Company does not have a long-term
manufacturing agreement with TSMC. Therefore, TSMC is not obligated to supply
products to the Company for any specific period, in any specific quantity or
at any specific price, except as may be provided in a particular purchase
order that has been accepted by TSMC. The Company's reliance on TSMC for the
manufacture, assembly and testing of its products involves a number of risks,
including the possible absence of adequate capacity as the Company expands,
the unavailability of, or interruption in access to, certain process
technologies and reduced control over delivery schedules, quality assurance,
manufacturing yields and costs. The Company has experienced delays and may in
the future experience delays in receiving semiconductor devices from TSMC, and
there can be no assurance that the Company will be able to obtain
semiconductor devices within the time frames and in the volumes required by
the Company at an affordable cost or at all.
In the event that TSMC is unable or unwilling to continue to manufacture
the Company's key products in required volumes, the Company would be required
to qualify acceptable alternative foundries and such foundries would need time
to prepare for volume production. It could take six months or longer for
another foundry to commence volume production, and no assurance can be given
that any additional foundry would become available to the Company or that any
additional foundry would be able to provide products on a turnkey basis or
would be in a position to satisfy the Company's production requirements on a
timely basis and at acceptable
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price levels. The loss of TSMC as a supplier, the inability of the Company in
a period of increased demand for its products to obtain additional foundry
capacity from TSMC or other manufacturers, the inability of TSMC or other
manufacturers to maintain acceptable manufacturing yields, or any other
circumstances that would limit the Company's ability to obtain adequate
supplies of manufactured products, would delay shipments of the Company's
products significantly. A delay in shipments could cause cancellation of
orders, damage relationships with current and prospective customers or result
in the loss of customers. Any such event would have a material adverse effect
on the Company's business, financial condition and results of operations.
Increases in semiconductor demand may limit available foundry capacity
worldwide. The Company does not currently have a long-term manufacturing
agreement with TSMC and may not be able to obtain such an agreement on terms
favorable to the Company in the future. In the event increased worldwide
semiconductor demand limits available foundry capacity, the Company may not be
able to obtain sufficient allocation of manufacturing capacity to meet its
manufacturing needs. Allocation of a foundry's manufacturing capacity may be
influenced by a customer's size or the existence of a long-term agreement with
the foundry. To address foundry capacity constraints, other semiconductor
suppliers that rely on third-party foundries have utilized various
arrangements, including equity investments in or loans to independent
component manufacturers, in exchange for guaranteed production capacity, joint
ventures to own and operate foundries, or "take or pay" contracts that commit
a company to purchase specified quantities of components over extended
periods. While the Company is not currently a party to any such arrangements,
it may determine to enter into such arrangements in the future. There can be
no assurance, however, that such arrangements will be available to the Company
on acceptable terms or at all. Any such arrangements could require the Company
to commit substantial capital. The need to commit substantial capital could
require the Company to obtain additional debt or equity financing, which could
result in dilution to the Company's shareholders. There can be no assurance
that such additional financing, if required, would be available when needed
or, if available, could be obtained on terms acceptable to the Company.
The manufacture of the Company's products is a highly complex and precise
process, requiring production in a highly controlled environment. Changes in
TSMC's manufacturing processes or the inadvertent use of defective or
contaminated materials by TSMC could adversely affect TSMC's ability to
achieve acceptable manufacturing yields and product reliability. To the extent
that TSMC does not achieve such yields or product reliability, the Company's
customer relationships, business, financial condition and results of
operations could be adversely affected.
The Company's products are assembled and tested by third-party
subcontractors. Such assembly and testing is conducted on a purchase order
basis rather than under a long-term agreement. As a result of its reliance on
third-party subcontractors to assemble and test its products, the Company
cannot directly control product delivery schedules, which could lead to
product shortages or quality assurance problems that could increase the costs
of manufacturing or assembly of the Company's products. Qualification of
assembly and test subcontractors normally requires a significant investment of
time. If TSMC is unable to provide the Company with its products on a turnkey
basis or the Company is otherwise required to find alternative subcontractors,
product shipments could be delayed significantly. Any problems associated with
the delivery, quality or cost of the assembly and testing of the Company's
products could have a material adverse effect on the Company's business,
financial condition and results of operations. See "--Intense Competition."
Rapid Technological Change; Necessity to Develop and Introduce New
Products. The markets for the Company's products are characterized by rapidly
changing technologies, evolving and competing industry standards, changes in
customer needs, emerging competition, new product introductions and rapid
product obsolescence. The Company's future success will depend, in part, on
its ability to use leading technologies effectively, to continue to develop
its technical expertise, to maintain close working relationships with its key
customers in order to develop new products that meet changing customer needs,
to advertise and market its products and to influence and respond to changing
industry standards and other technological changes on a timely and cost-
effective basis. There can be no assurance that the Company will be successful
in effectively developing
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or using new technologies, developing new products or enhancing its existing
products on a timely basis, or that such new technologies or enhancements will
achieve market acceptance. The Company's pursuit of necessary technological
advances may require substantial time and expense, and there can be no
assurance that the Company will succeed in adapting its products or business
to alternate technologies. Failure of the Company, for technological or other
reasons, to develop and introduce new or enhanced products that are compatible
with industry standards and that satisfy customer price and performance
requirements would have a material adverse effect on the Company's business,
financial condition and results of operations.
In addition, the Company's competitors may offer enhancements to existing
products, or offer new products based on new technologies, industry standards
or customer requirements, that have the potential to replace or provide lower
cost alternatives to the Company's products. The introduction of such
enhancements or new products by the Company's competitors could render the
Company's existing and future products obsolete, unmarketable or inoperable.
There can be no assurance that the Company will be able to develop new
products to compete with new technologies on a timely basis or in a cost-
effective manner.
Product Complexity. Products as complex as those offered by the Company
frequently contain errors, defects and bugs when first introduced or as new
versions are released. The Company has experienced such errors, defects and
bugs in the past in connection with new products. Introductions by the Company
of new or enhanced products with reliability, quality or compatibility
problems could significantly delay or hinder market acceptance of such
products, which could adversely affect the Company's ability to retain its
existing customers and to attract new customers. Moreover, such errors,
defects or bugs could cause problems, interruptions, delays or cessation of
service to the Company's customers. Alleviating such problems could require
significant expenditures of capital and resources by the Company. There can be
no assurance that, despite testing by TSMC and its subcontractors, the Company
or its customers, errors, defects or bugs will not be found in new products
after commencement of commercial production, resulting in additional
development costs, loss of, or delays in, market acceptance, diversion of
technical and other resources from the Company's other development efforts,
claims by the Company's customers or others against the Company, or the loss
of credibility with the Company's current and prospective customers. Any such
event would have a material adverse effect on the Company's business,
financial condition and results of operations.
Dependence on OEMs. The Company's future success depends on OEMs' designing
the Company's products into their network systems. The Company must anticipate
market trends and the price, performance and functionality requirements of
such network system vendors and must successfully develop and manufacture
products that meet these requirements. In addition, the Company must meet the
timing requirements of such OEMs and must make products available to them in
sufficient quantities. The Company works closely with its customers to
determine customers' future product needs and receives a rolling forecast from
customers for products. The Company has incurred and expects to continue to
incur expenses based upon these sales forecasts. The Company's customer
purchase agreements contain no minimum purchase requirements. Customers
purchase the Company's products pursuant to short-term purchase orders that
may be canceled without charge if notice is given within an agreed-upon
period. Therefore, there can be no assurance that the actual net sales which
the Company will receive will be commensurate with the level of expenses that
the Company will incur based on forecasts it receives from its customers in
any future period. The Company believes that its success in broadly
penetrating markets for its products also depends on its ability to maintain
and cultivate relationships with OEMs that are leaders in the data
communications and networking markets. Accordingly, in selling to OEMs, the
Company can often incur significant expenditures prior to volume sales of new
products. The inability of the Company to develop relationships with
additional OEMs and have its products designed into new network systems
developed by existing and potential OEM customers would have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
Dependence on Third-Party Distribution. The Company sells its products to
customers primarily through distributors and manufacturers' representatives.
The Company's relationships with many of its distributors and
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manufacturers' representatives have been established within the last three
years, and the Company is unable to predict the extent to which some of these
distributors and manufacturers' representatives will be successful in
marketing and selling the Company's products. Moreover, many of its
distributors also market and sell competing products. Manufacturers'
representatives and distributors may terminate their relationships with the
Company at any time. The Company's future performance will also depend, in
part, on its ability to attract additional distributors or manufacturers'
representatives that will be able to market and support the Company's products
effectively, especially in markets in which the Company has not previously
distributed its products. There can be no assurance that the Company will
retain its current distributors or manufacturers' representatives or that it
will be able to recruit additional or replacement distributors or
manufacturers' representatives. The loss of one or more of the Company's
distributors or manufacturers' representatives could have a material adverse
effect on the Company's business, financial condition and results of
operations. The Company generally realizes a higher gross margin on direct
sales and from sales through manufacturers' representatives than on sales
through distributors. Accordingly, if the Company's distributors were to
account for an increased portion of the Company's net sales, its gross margin
would decline. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Dependence on Key Personnel. The Company's future performance depends, in
significant part, upon the continued service of key technical, sales and
management personnel. Several members of the Company's senior management have
only recently joined the Company. The Company does not have employment
agreements with or any life insurance on any of these individuals. The loss of
the services of one or more of the Company's key personnel could have a
material adverse effect on the Company's business, financial condition and
results of operations. In addition, the Company's future success depends on
its continuing ability to attract and retain highly qualified technical, sales
and management personnel. Competition for such personnel in both the United
States and Israel is intense, and there can be no assurance that the Company
will be able to attract and retain key technical, sales and management
personnel in the future. If the Company cannot retain or is unable to hire
such key personnel, the Company's business, financial condition and results of
operations could be materially adversely affected.
Limited Protection of Intellectual Property and Proprietary Rights. The
Company's future success and ability to compete are dependent, in part, upon
its proprietary technology. The Company relies in part on patent, trade
secret, trademark and copyright law to protect its intellectual property.
There can be no assurance that any patents will issue pursuant to the
Company's current or future patent applications or that any issued patents
will not be invalidated, circumvented, challenged or licensed to others. In
addition, there can be no assurance that the rights granted under any such
patents will provide competitive advantages to the Company. There can be no
assurance that any patents issued to the Company will be adequate to safeguard
and maintain the Company's proprietary rights, to deter misappropriation or to
prevent an unauthorized third party from copying the Company's technology,
designing around the patents owned by the Company or otherwise obtaining and
using the Company's products, designs or other information. In addition, there
can be no assurance that others will not develop technologies that are similar
or superior to the Company's technology.
The Company also relies on confidentiality agreements to protect its
proprietary rights. It is the Company's policy to require employees and
consultants and, when possible, suppliers to execute confidentiality
agreements upon the commencement of their relationships with the Company.
There can be no assurance that the Company's efforts to protect its
proprietary rights will be adequate. Litigation may be necessary to enforce
the Company's intellectual property rights and to protect the Company's trade
secrets, and there can be no assurance that such efforts will be successful.
The Company's inability to protect its proprietary rights effectively would
have a material adverse effect on the Company's business, financial condition
and results of operations.
Many participants in the semiconductor and data communications industries
have a significant number of patents and have frequently demonstrated a
readiness to commence litigation based on allegations of patent and other
intellectual property infringement. Although the Company is not aware of any
claim of infringement or misappropriation against the Company, there can be no
assurance that third parties will not assert such claims in
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<PAGE>
the future with respect to the Company's current or future products. The
Company expects that companies will increasingly be subject to infringement
claims as the number of products and competitors in the Company's industry
segment grows and the functionality of products in different industry segments
overlaps. Responding to such claims, regardless of merit, could cause product
shipment delays or require the Company to enter into royalty or licensing
arrangements. Any such claims could also lead to time-consuming, protracted
and costly litigation that would require significant expenditures of time,
capital and other resources by the Company and its management. Moreover, no
assurance can be given that any necessary royalty or licensing agreement will
be available or that, if available, such agreement could be obtained on
commercially reasonable terms.
Risks Relating to Operations in Israel
Operations in Israel. The Company is incorporated under the laws of, and
its principal offices are located in, the State of Israel. Thus, the Company
is directly influenced by the political, economic and military conditions
affecting Israel. Accordingly, any major hostilities involving Israel, the
interruption or curtailment of trade between Israel and its present trading
partners or a significant downturn in the economic or financial condition of
Israel could have a material adverse effect on the Company's business,
financial condition and results of operations. Despite some progress toward
peace between Israel and its Arab neighbors, there remain a number of
countries that restrict business with Israel or Israeli companies. There can
be no assurance that restrictive laws or policies toward Israel or Israeli
businesses will not have an adverse effect on the expansion of the Company's
business.
Inflation and Currency Fluctuations. Because most of the Company's net
sales are generated in U.S. dollars, and a substantial portion of the
Company's operating expenses are incurred in NIS, the Company is exposed to
risk to the extent that the rate of inflation in Israel exceeds the rate of
devaluation of the NIS in relation to the U.S. dollar or the timing of such
devaluation lags behind inflation in Israel. Likewise, the Company's
operations could be adversely affected if it is unable to guard against
currency fluctuations in the future. In the future, the Company may enter into
currency hedging transactions to decrease the risk of financial exposure from
fluctuations in the exchange rate of the dollar against the NIS; however, no
assurance can be given that such measures will adequately protect the Company
from material adverse effects due to the impact of inflation in Israel. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Dependence on Tax Benefits. The Company receives certain tax benefits
through operating in Israel, particularly as a result of the "Approved
Enterprise" status of most of the Company's existing facilities. To be
eligible for these tax benefits, the Company must continue to meet certain
conditions, including making certain investments in fixed assets in Israel.
The Company believes that it is in compliance with all applicable conditions.
If the Company fails to meet such conditions in the future, the tax benefits
could be canceled and the Company would be required to refund the tax benefits
already received with the addition of the Israeli CPI linkage adjustment and
interest. There can be no assurance that these tax benefits will be continued
in the future at their current levels or at any level. Israeli authorities
have indicated that the government may reduce or eliminate these benefits in
the future. The termination or reduction of certain tax benefits would have a
material adverse effect on the Company's business, financial condition and
results of operations. The Company may, from time to time, submit requests for
expansion of its Approved Enterprise programs or for new programs. No
assurance can be given that any such requests will be approved. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Item 2. Description of Property.
Galileo's corporate and technical headquarters are located in Moshav Manof,
Israel, and its worldwide business center is located at GTI in San Jose,
California. The facility in Moshav Manof consists of an aggregate of
approximately 10,800 square feet. The Company also leases two other facilities
as satellite design centers. One of these is on the premises of the Technion,
Israel Institute of Technology (the "Technion") and the other is in Lod, a
suburb of Tel Aviv. These centers occupy an aggregate of approximately 4,500
square feet.
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The worldwide business center in San Jose, California occupies
approximately 15,443 square feet in two adjacent buildings. Galileo Technology
Europe Limited, a wholly owned subsidiary of the Company, occupies
approximately 750 square feet in Hemel Hempstead, Hertfordshire, England. The
Company also leases two small sales offices in Brookline and Auburn,
Massachusetts. The Company believes that these facilities are adequate for its
current needs and that suitable additional or substitute space will be
available when needed.
Item 3. Legal Proceedings.
The Company is not a party to any legal proceedings which, individually or
in the aggregate, are believed to be material to the Company's business.
Item 4. Control of Registrant.
The following table sets forth certain information regarding the beneficial
ownership of the Company's ordinary shares as of March 20, 2000 by (1) each
person who is known by the Company to be the owner of more than ten percent of
its outstanding ordinary shares and (2) by the officers and directors of the
Company as a group. As of March 20, 2000, 42,410,019 of the Company's ordinary
shares were issued and outstanding.
<TABLE>
<CAPTION>
Amount Percent of
Owned Class
---------- ----------
<S> <C> <C>
Avigdor Willenz 8,806,478 20.8%
All directors and officers as a group (9 persons) 10,823,914 25.5%
</TABLE>
Item 5. Nature of Trading Market.
The Company's ordinary shares have traded publicly on The Nasdaq Stock
Market since July 29, 1997. On February 26, 1999, the Company trading symbol
on Nasdaq was changed to "GALT" from "GALTF".
The following table lists the high and low closing sales prices for the
Company's ordinary shares, for the periods indicated, as reported by The
Nasdaq Stock Market:
<TABLE>
<CAPTION>
High Low
------ ------
<S> <C> <C>
1998:
First Quarter $20.75 $14.13
Second Quarter $16.82 $ 4.94
Third Quarter $ 7.25 $ 4.75
Fourth Quarter $13.50 $ 3.50
1999:
First Quarter $14.63 $ 9.06
Second Quarter $22.81 $10.94
Third Quarter $32.88 $22.50
Fourth Quarter $29.44 $18.38
</TABLE>
On March 20, 2000 the last reported price of the Company's ordinary shares
on The Nasdaq Stock Market was $19.63 per share. On March 20, 1999, there were
approximately 14,600 holders of record of the Company's ordinary shares.
If the Company decides to distribute a cash dividend out of income that has
been exempted from tax, the income out of which the dividend is distributed
will be subject to the 25% Israeli corporate tax rate. The Company has never
declared or paid cash dividends on its ordinary shares and does not anticipate
paying any cash dividends in the foreseeable future. The Company intends to
retain future earnings to finance the development of its business.
20
<PAGE>
Item 6. Exchange Controls and Other Limitations Affecting Security Holders.
Under current Israeli regulations, any dividends or other distributions
paid in respect of ordinary shares purchased by non-residents of Israel with
certain non-Israeli currencies (including dollars) will be freely repatriable
in such non-Israeli currencies at the rate of exchange prevailing at the time
of conversion, provided that Israeli income tax has been paid on, or withheld
from, such payments.
Israeli residents, including corporations, that wish to purchase securities
outside of Israel must meet the requirements set forth in a general permit
that was issued by the Controller of Foreign Currency of the Bank of Israel.
To the extent that these requirements relate to securities, the ordinary
shares meet the requirements. Neither the Memorandum of Association or
Articles of Association of the Company nor the laws of the Sate of Israel
restrict in any way the ownership or voting of ordinary shares by non-
residents of Israel, except with respect to subjects of countries which are at
a state of war with Israel.
Item 7. Taxation.
U.S. Tax Considerations Regarding Ordinary Shares Acquired by U.S. Taxpayers
The following discussion summarizes the material U.S. federal income tax
consequences arising from the purchase, ownership and sale of ordinary shares.
This summary is based on the provisions of the Internal Revenue Code of 1986,
as amended (the "Code"), final, temporary and proposed U.S. Treasury
Regulations promulgated thereunder, and administrative and judicial
interpretations thereof, in effect as of the date of this filing, all of which
are subject to change, possibly with retroactive effect. The consequences to
any particular investor may differ from those described below by reason of
that investor's particular circumstances. This summary does not address the
considerations that may be applicable to particular classes of taxpayers,
including financial institutions, broker-dealers, tax-exempt organizations and
investors who own (directly, indirectly or through attribution) 10% or more of
the Company's outstanding voting stock (a "10 Percent Shareholder"). This
summary is addressed only to holders that are U.S. citizens, individuals
resident in the United States for purposes of U.S. federal income tax,
domestic corporations or partnerships and estates or trusts treated as "United
States persons" under Section 7701 of the Code ("U.S. Holders").
Each investor should consult with his or her own tax advisor as to the
particular tax consequences of the purchase, ownership and sale of ordinary
shares, including the effects of applicable state, local, foreign or other tax
laws and possible changes in the tax laws.
Tax Basis of Ordinary Shares
A U.S. Holder's tax basis in his or her ordinary shares will be the
purchase price paid therefor by such U.S. Holder. The holding period of each
ordinary share owned by a U.S. Holder will commence on the day following the
date of the U.S. Holder's purchase of such ordinary share and will include the
day on which the ordinary share is sold by such U.S. Holder.
Sale or Exchange of Ordinary Shares
A U.S. Holder's sale or exchange of ordinary shares will result in the
recognition of gain or loss by such U.S. Holder in an amount equal to the
difference between the amount realized and the U.S. Holder's basis in the
ordinary shares sold. Subject to the following discussion of the consequences
of the Company being treated as a Passive Foreign Investment Company or a
Foreign Investment Company, such gain or loss will be capital gain or loss if
such ordinary shares are a capital asset in the hands of the U.S. Holder. Gain
or loss realized on the sale of ordinary shares will be long-term capital gain
or loss if the ordinary shares sold had been held for more than one year at
the time of their sale. Long-term capital gains recognized by certain
taxpayers generally are subject to a reduced rate of federal tax (currently a
maximum of 20%). If the U.S. Holder's holding period on the date of the sale
or exchange was one year or less, such gain or loss will be short-term capital
gain or loss.
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<PAGE>
Short-term capital gains generally are subject to tax at the same rates as
ordinary income. In general, any capital gain recognized by a U.S. Holder upon
the sale or exchange of ordinary shares will be treated as U.S.-source income
for U.S. foreign tax credit purposes.
See discussion under "Item 7--Israeli Taxation and Foreign Exchange
Regulations--Capital Gains Tax" and "--Taxation of Non-Residents" for a
discussion of taxation by Israel of capital gains realized on sales of capital
assets.
Treatment of Dividend Distributions
For U.S. federal income tax purposes, gross dividends (including the amount
of any Israeli taxes withheld therefrom) paid to a U.S. Holder with respect to
his or her ordinary shares will be included in his or her ordinary income to
the extent made out of current or accumulated earnings and profits of the
Company, as determined based on U.S. tax principles, at the time the dividends
are received and will be treated as foreign source dividend income for
purposes of the foreign tax credit limitation described below. Such dividends
will not be eligible for the dividends received deduction allowed to U.S.
corporations under Section 243 of the Code. Dividend distributions in excess
of the Company's current and accumulated earnings and profits will be treated
first as a non-taxable return of the U.S. Holder's tax basis in his or her
ordinary shares to the extent thereof and then as a gain from the sale of
ordinary shares. Dividends paid in NIS will be includible in income in a U.S.
dollar amount based on the exchange rate at the time of their receipt, and any
gain or loss resulting from currency fluctuations during the period from the
date a dividend is paid to the date such payment is converted into U.S.
dollars generally will be treated as ordinary income or loss.
Any Israeli withholding tax imposed on dividends paid to a U.S. Holder will
be a foreign income tax eligible for credit against such U.S. Holder's U.S.
federal income tax liability subject to certain limitations under which
foreign tax credits allowable with respect to specific classes of income
cannot exceed the U.S. federal income taxes otherwise payable with respect to
each such class of income (or, alternatively, for deduction against income in
determining such tax liability). Generally, the foreign tax credit is limited
to the same proportion of U.S. tax on worldwide income that taxable income
from sources outside the U.S. bears to taxable income from both U.S. and
foreign sources. Foreign income taxes exceeding the credit limitation for the
year of payment or accrual may be carried back for two taxable years and
forward for five taxable years in order to reduce U.S. federal income taxes,
subject to the credit limitation applicable in each of such years. Other
restrictions on the foreign tax credit include a general prohibition on the
use of the credit to reduce liability for the U.S. individual and corporation
alternative minimum taxes by more than 90% and an allowance of foreign tax
credits for alternative minimum tax purposes only to the extent of foreign-
source alternative minimum taxable income. See "Item 7--Israeli Taxation and
Foreign Exchange Regulations--Taxation of Non-Residents."
Information Reporting and Backup Withholding
Any dividends paid on the ordinary shares to U.S. Holders may be subject to
U.S. information reporting requirements and the 31% U.S. backup withholding
tax. In addition, the proceeds of a U.S. Holder's sale of ordinary shares in
the U.S. through a U.S. or U.S.-related broker may be subject to the 31% U.S.
backup withholding tax, unless the broker is furnished with a duly completed
and signed Form W-9. Any amounts withheld under the U.S. backup withholding
tax rules will be allowed as a refund or a credit against the U.S. Holder's
U.S. federal income tax, provided the required information is furnished to the
U.S. Internal Revenue Service.
Tax Status of the Company for U.S. Federal Income Tax Purposes
Passive Foreign Investment Company. If the Company were deemed to be a
passive foreign investment company (a "PFIC") for U.S. federal income tax
purposes, any gain recognized by a U.S. Holder upon the sale of ordinary
shares (or the receipt of certain distributions) wo uld be treated as ordinary
income, such income would be allocated over such U.S. Holder's holding period
for such ordinary shares and an interest charge would
22
<PAGE>
be imposed on the amount of deferred tax on such income which is allocated to
prior taxable years. Generally, the Company will be treated as a PFIC for any
tax year if, in such tax year or any prior tax year, either (i) 75% or more of
its gross income is passive in nature, or (ii) on average, 50% or more of its
assets (by value) produce or are held for the production of passive income.
The Company does not believe it satisfies either of the tests for PFIC status
for any tax year to date and it expects that the majority of its assets will
continue to generate sufficient levels of income to avoid PFIC treatment for
U.S. federal income tax purposes. However, since the determination whether the
Company is a PFIC will be made annually based on facts and circumstances that,
to some extent, may be beyond the Company's control, there can be no assurance
that the Company will not become a PFIC at some time in the future. If the
Company were determined to be a PFIC, however, a U.S. Holder could elect to
treat his or her ordinary shares as an interest in a qualified electing fund
(a "QEF Election"), in which case, the U.S. Holder would be required to
include in income currently his or her proportionate share of the Company's
earnings and profits in years in which the Company is a PFIC whether or not
distributions of such earnings and profits are actually made to such U.S.
Holder, but any gain subsequently recognized upon the sale by such U.S. Holder
of his or her ordinary shares generally would be taxed as a capital gain. See
"Sale or Exchange of ordinary shares" above. The Company will notify U.S.
Holders if it believes it will be treated as a PFIC for any tax year in order
to enable U.S. Holders to consider whether to make a QEF Election. In
addition, the Company will comply with the applicable information reporting
requirements for U.S. Holders to make a QEF Election. U.S. Holders should
consult with their own tax advisers regarding the eligibility, manner and
advisability of making a QEF Election if the Company is treated as a PFIC.
Controlled Foreign Corporations. Sections 951 through 964 and Section 1248
of the Code relate to controlled foreign corporations ("CFC"). The CFC
provisions may impute some portion of such a corporation's undistributed
income to certain U.S. shareholders on a current basis and convert into
dividend income some portion of gains on dispositions of stock which would
otherwise qualify for capital gains treatment. In general, the CFC provisions
will apply to the Company only if 10 Percent Shareholders who are U.S. Holders
own in the aggregate (or are deemed to own after application of complex
attribution rules) more than 50% (measured by voting power or value) of the
outstanding stock of the Company. The Company does not believe that it is a
CFC. It is possible that the Company could become a CFC in the future. Even if
the Company were classified as a CFC in a future year, however, the CFC rules
referred to above would apply only with respect to 10 Percent Shareholders who
are U.S. persons.
Personal Holding Company/Foreign Personal Holding Company/Foreign
Investment Company. A corporation will be classified as a personal holding
company (a "PHC") if at any time during the last half of a tax year (i) five
or fewer individuals (without regard to their citizenship or residence)
directly or indirectly or by attribution own more than 50% in value of the
corporation's stock and (ii) at least 60% of its ordinary gross income, as
specially adjusted, consists of personal holding company income (defined
generally to include dividends, interest, royalties, rents and certain other
types of passive income). A PHC is subject to a United States federal income
tax of 39.6% on its undistributed personal holding company income (generally
limited, in the case of a foreign corporation, to United States source
income).
A corporation will be classified as a foreign personal holding company (a
"FPHC") and not a PHC if at any time during a tax year (i) five or fewer
individual United States citizens or residents directly or indirectly or by
attribution own more than 50% of the total combined voting power or value of
the corporation's stock and (ii) at least 60% of its gross income consists of
foreign personal holding company income (defined generally to include
dividends, interest, royalties, rents and certain other types of passive
income). Each United States shareholder in an FPHC is required to include in
gross income, as a dividend, an allocable share of the FPHC's undistributed
foreign personal holding company income (generally the taxable income of the
FPHC, as specially adjusted).
A corporation will be classified as a foreign investment company (a "FIC")
if for any taxable year it (i) is registered under the Investment Company Act
of 1940, as amended, as a management company or share investment trust or is
engaged primarily in the business of investing or trading in securities or
commodities (or any interest therein) and (ii) 50% or more of the value or the
total combined voting power of all the corporation's
23
<PAGE>
stock is owned directly or indirectly (including stock owned through the
application of attribution rules) by United States persons. In general, unless
an FIC elects to distribute 90% or more of its taxable income (determined
under United States tax principles as specially adjusted) to its shareholders,
gain on the sale or exchange of FIC stock is treated as ordinary income
(rather than capital gain) to the extent of such shareholder's ratable share
of the corporation's earnings and profits for the period during which such
stock was held.
The Company believes that it is not a PHC, FPHC, or a FIC. However, no
assurance can be given as to the Company's future status.
Israeli Taxation and Foreign Exchange Regulations
The following discussion summarizes the material Israeli tax laws affecting
the Company and its shareholders, including U.S. and other non-Israeli
shareholders. This discussion is for general information only and is not
intended to substitute for careful or specific tax planning. To the extent
that the discussion is based on legislation yet to be judicially or
administratively interpreted, there can be no assurance that the views
expressed herein will accord with any such interpretation in the future. This
discussion is not intended, and should not be construed, as legal or
professional tax advice, and does not cover all possible tax considerations.
Accordingly, each investor should consult his or her own tax advisor as to the
particular tax consequences of an investment in the ordinary shares including
the effects of applicable Israeli or foreign or other tax laws and possible
changes in the tax laws.
General Corporate Tax Structure
Israeli companies are generally subject to "Company Tax" at the rate of 36%
of taxable income, such rate having become effective on January 1, 1996.
Tax Benefits and Grants for Research and Development
Israeli tax law has allowed, under certain conditions, a tax deduction in
the year incurred for expenditures (including capital expenditures) in
scientific research and development projects, if the expenditures are approved
by the relevant Israeli Government Ministry (determined by the field of
research) and the research and development is for the promotion of the
enterprise and is carried out by, or on behalf of, the company seeking such
deduction. Expenditures not so approved or funded are deductible over a three-
year period. However, expenditures made out of proceeds of Government grants
are not deductible.
Law for the Encouragement of Capital Investments, 1959
The Company's first investment plan was granted Approved Enterprise status
on October 10, 1993 under the Law for the Encouragement of Capital
Investments, 1959, as amended (the "Investment Law"). The Company's first
investment plan of $221,000 in fixed assets was completed in April 1996 and
the Company received a final approval from the Investment Center of the
Ministry of Industry and Commerce of the State of Israel (the "Investment
Center"). The Company's second investment plan of $2,050,000 in fixed assets
was completed in December 1997. The Company's third investment plan of
$8,815,000 in fixed assets was completed in November 1999. As of December 31,
1999, the Company received approval for its fourth investment plan. Under the
fourth investment plan, the Company agreed to invest approximately
$15,000,000, of which $544,000 was invested as of December 31, 1999. See "Item
9--Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations--Provision for Income Taxes."
The Investment Law provides that a capital investment in eligible
facilities may, upon application to the Investment Center, be designated as an
Approved Enterprise. Each certificate of approval for an Approved Enterprise
relates to a specific investment program delineated both by its financial
scope, including its capital sources, and by its physical characteristics,
e.g., the equipment to be purchased and utilized pursuant to the program. The
tax benefits derived from any such certificate of approval relate only to
taxable income attributable to the specific Approved Enterprise.
24
<PAGE>
Taxable income of a company derived from an Approved Enterprise designated
as such after July 30, 1978, is subject to Company Tax at the rate of up to
25% (rather than 36% as stated above) for the "Benefits Period," a period up
to seven years commencing with the year in which the Approved Enterprise first
generated taxable income (limited to 12 years from the year of commencement of
production or 14 years from the beginning of the year of approval, whichever
is earlier) and, under certain circumstances (as further detailed below),
extending to a maximum of ten years from the commencement of the Benefit
Period. In the event that a company is operating under more than one approval
or that its capital investments are only partly approved (a "Mixed
Enterprise"), its effective Company Tax is the result of a weighted
combination of the various applicable rates.
A company owning an Approved Enterprise approved after April 1, 1986 (or
prior thereto provided no government grants or loans had previously been
granted regarding such enterprise) may elect to forego certain Government
grants extended to Approved Enterprises in return for an "alternative package"
of tax benefits (the "Alternative Package"). Under the Alternative Package
which the Company has elected, a company's undistributed income derived from
an Approved Enterprise will be exempt from Company Tax for a period of between
two and ten years, depending on the geographic location of the Approved
Enterprise within Israel, and such company will be eligible for the tax
benefits under the Investment Law for the remainder of the Benefits Period. If
such company decides to distribute a cash dividend out of its exempt income,
such distributed income would be subject to a companies tax at the rate of up
to 25%. The recipient of a cash dividend which is distributed out of income
that is entitled to such tax benefits would be subject to a reduced income tax
rate of 15%, which would be withheld from any such dividend. Whether the
Alternative Package is elected or not, an Approved Enterprise is entitled to
receive other incentives such as state guaranteed loans and accelerated
depreciation on property and equipment, subject to certain conditions and
limitations. Since January 1997, the only benefit granted is accelerated
depreciation.
Subject to certain provisions concerning income derived from the
Alternative Package, all dividends are considered to be attributable to the
entire enterprise and their effective tax rate is the result of a weighted
combination of the various applicable tax rates.
Any incentives received by a company in accordance with the Investment Law
remain subject to final ratification by the Investment Center, such
ratification being conditional upon fulfillment of all terms of the approved
program, as stipulated in the Investment Law, the rules and regulations
enacted thereby and the letter granting Approved Enterprise status, including,
among others, funding of at least 30% of the approved plan with shareholders'
equity.
In the event that these conditions are violated, in whole or in part, the
Company would be required to refund the amount of tax benefits, with the
addition of the Israeli CPI linkage adjustment and interest. The Company
believes its Approved Enterprise operates in substantial compliance with all
such conditions and criteria and is in the process of seeking written
confirmation from the Investment Center that it meets these conditions. See
"Item 1--Description of Business--Risk Factors--Risks Relating to Operations
in Israel--Dependence on Tax Benefits" and "Item 9--Management's Discussion
and Analysis of Financial Condition and Results of Operations."
Each new application for approval of an investment plan will be reviewed on
its own merits according to the criteria applicable at that time, and there is
no assurance that new applications of the Company will be approved. The
Ministry of Finance has announced that it may seek to reduce, or even cancel,
some or all of the benefits under the Investment Law.
Taxation Under Inflationary Conditions
The Income Tax Law (Inflationary Adjustments), 1985 (the "Inflationary
Adjustments Law") is intended to adjust the tax system to the rate of
inflation, i.e. to tax profits on a "real" (inflation-adjusted) basis.
25
<PAGE>
Under the Inflationary Adjustments Law, results for tax purposes are
measured in "real" terms, in accordance with the changes in the CPI. The
Company is taxed under this law. The discrepancy between the change in (i) the
CPI and (ii) the exchange rate of the NIS to the dollar, each year and
cumulatively, may result in a significant difference between taxable income
and the income denominated in dollars as reflected in the financial statements
of the Company. In addition, subject to certain limitations, depreciation of
fixed assets and losses carried forward are adjusted for inflation on the
basis of changes in the CPI.
The salient features of the Inflationary Adjustments Law can be described
generally as follows:
(a) A special tax adjustment for the preservation of equity whereby
certain corporate assets are classified broadly into Fixed (inflation
resistant) Assets and Non-Fixed (soft) Assets. Where a company's equity, as
defined in such law, exceeds the depreciated cost of Fixed Assets, a
deduction from taxable income that takes into account the effect of the
applicable annual rate of inflation on such excess is allowed (up to a
ceiling of 70% of taxable income in any single tax year, with the unused
portion permitted to be carried forward on a linked basis without limit).
If the depreciated cost of Fixed Assets exceeds a company's equity, then
such excess multiplied by the applicable annual rate of inflation is added
to taxable income.
(b) Subject to certain limitations, depreciation deductions on Fixed
Assets and losses carried forward are adjusted for inflation based on the
increase in the CPI.
(c) The allowance of a special annual deduction against taxable income,
as adjusted, at a rate of 2.5% of taxable income if the annual rate of
inflation during the tax year exceeds 25%, an additional 2.5% of taxable
income if the rate of inflation during the tax year exceeds 50%, and an
additional 2.5% of taxable income for each 100% in which the annual rate of
inflation during the tax year exceeds 50%. Since 1985, the inflation rate
in Israel has not exceeded 25% per year.
(d) Gains on the sale and the increase in value of certain traded
securities during the tax year are taxable in certain circumstances, even
if such gains have not been realized. However, dealers in securities are
subject to the regular tax rules applicable to business income in Israel.
Law for the Encouragement of Industry (Taxes), 1969
The Company currently qualifies as an "Industrial Company" within the
definition of the Law for the Encouragement of Industry (Taxes), 1969 (the
"Industry Encouragement Law"). According to the Industry Encouragement Law, an
"Industrial Company" is a company resident in Israel, at least 90% of the
income of which in any tax year, determined in Israeli currency (exclusive of
income from defense loans, capital gains, interest and dividends) is derived
from an "Industrial Enterprise" owned by it. An "Industrial Enterprise" is
defined as an enterprise whose major activity in a given tax year is
industrial production activity.
The following preferred corporate tax benefits are available to Industrial
Companies (including the Company):
(a) Deduction of purchases of know-how and patents over an eight-year
period for tax purposes.
(b) Deduction of expenses incurred in connection with a public issuance
of securities over a three-year period.
(c) An election under certain conditions to file a consolidated tax
return with additional related Israeli Industrial Companies.
(d) Accelerated depreciation rates on equipment and buildings.
Eligibility for the benefits under the Industry Encouragement Law is not
subject to receipt of prior approval from any governmental authority. No
assurance can be given that the Company will continue to qualify as an
"Industrial Company" or that the benefits described above will be available in
the future.
26
<PAGE>
Capital Gains Tax
Israeli law generally imposes a capital gains tax on the sale of capital
assets. The law distinguishes between the "Real Gain" and the "Inflationary
Surplus." The Real Gain is the excess of the total capital gain over the
Inflationary Surplus, computed on the basis of the increase in the Israeli CPI
between the date of purchase and the date of sale. The Inflationary Surplus
accumulated until December 31, 1993 is taxed at a rate of 10% for residents of
Israel (reduced to no tax for non-residents if calculated according to the
exchange rate of the foreign currency lawfully invested in shares of an
Israeli resident company, instead of the Israeli CPI), while the Real Gain is
added to ordinary income, which is taxed at ordinary rates of up to a maximum
of 50% for individuals and 36% for corporations. Inflationary Surplus
accumulated from and after December 31, 1993 is exempt from any capital gains
tax. Under current law, the ordinary shares of the Company are exempt from
Israeli capital gains so long as they are listed on the Nasdaq Stock Market or
on a stock exchange recognized by the Israeli Ministry of Treasury and the
Company qualifies as an Industrial Company. There can be no assurance that the
Company will maintain such a listing or qualification. See "--Law for the
Encouragement of Industry (Taxes), 1969." Notwithstanding the foregoing, the
exemption from capital gains tax does not apply to a shareholder whose taxable
income is determined pursuant to the Inflationary Adjustments Law, 1985, nor
to a company or an individual whose gains from selling or otherwise disposing
of ordinary shares are deemed "Business Income," in which case such gains are
subjected to corporate tax or income tax, respectively.
U.S.-Israel Tax Treaty
On September 23, 1994, the United States Senate gave its advice and consent
to the exchange by the United States of instruments of ratification of a
Convention Between the Government of the United States of America and the
Government of Israel with Respect to Taxes on Income signed November 20, 1975,
as amended by Protocols signed May 30, 1980 and January 26, 1993 (the "U.S.-
Israel Tax Treaty"). The U.S.-Israel Tax Treaty is in effect for taxable years
beginning on or after January 1, 1995, and for withholding taxes for payments
beginning February 1, 1995. Pursuant to the U.S.-Israel Tax Treaty, the sale,
exchange or disposition of ordinary shares by a person who qualifies as a
resident of the United States within the meaning of the U.S.-Israel Tax Treaty
and who is entitled to claim the benefits afforded to such resident by the
U.S.-Israel Tax Treaty ("Treaty U.S. Resident") will not be subject to the
Israeli capital gain tax unless such Treaty U.S. Resident holds, directly or
indirectly, shares representing 10% or more of the voting power of the Company
during any part of the 12-month period preceding such sale, exchange or
disposition. A sale, exchange or disposition of ordinary shares by a Treaty
U.S. Resident who holds, directly or indirectly, shares representing 10% or
more of the voting power of the Company, at any time during such preceding 12-
month period would be subject to such Israeli tax, to the extent applicable;
however, under the U.S.-Israel Tax Treaty, such Treaty U.S. Resident would be
permitted to claim a credit for such taxes against the U.S. income tax imposed
with respect to such sale, exchange or disposition, subject to the limitations
in U.S. laws applicable to foreign tax credits.
Taxation of Non-Residents
Non-residents of Israel are subject to income tax on income accrued or
derived from sources in Israel or received in Israel. Such sources of income
include passive income such as dividends, royalties and interest, as well as
non-passive income from services rendered in Israel. On distributions of
dividends other than bonus shares (stock dividends), income tax at the rate of
25% is withheld at source, unless a different rate is provided in a treaty
between Israel and the shareholder's country of residence. Under the U.S.-
Israel Tax Treaty, the maximum tax on dividends paid to a holder of ordinary
shares who is a resident of the United States will be 25% (however, under the
Investment Law, dividends generated by an Approved Enterprise are taxed at the
rate of 15%).
For information with respect to the applicability of Israeli capital gains
taxes on the sale of ordinary shares by United States residents, see "--
Capital Gains Tax."
27
<PAGE>
Foreign Exchange Regulations
Non-residents of Israel who purchase the Company's ordinary shares with
U.S. dollars or other foreign currency will be able to convert dividends (if
any) thereon, and any amounts payable upon the dissolution, liquidation or
winding up of the affairs of the Company, as well as the proceeds of any sale
in Israel of ordinary shares to an Israeli resident, into freely repatriable
dollars, at a rate of exchange prevailing at the time of conversion, pursuant
to regulations issued under the Currency Control Law, 1978, provided that
Israeli income tax has been withheld with respect to such amounts, to the
extent applicable.
Under applicable currency control regulations, the Company has obtained a
permit from the Controller of Foreign Exchange to retain the net proceeds of
its initial public offering completed in July 1997 outside of Israel.
Item 8. Selected Consolidated Financial Data.
The selected consolidated statement of operations data for each of the
three years in the period ended December 31, 1999 and the consolidated balance
sheet data at December 31, 1999 and 1998 are derived from the audited
consolidated financial statements included elsewhere in this Annual Report.
The selected consolidated statement of operations data for the years ended
December 31, 1996 and 1995 and the consolidated balance sheet data at December
31, 1997, 1996 and 1995 are derived from audited consolidated financial
statements not included in this Annual Report. The data have been derived from
financial statements that have been prepared in accordance with accounting
principles generally accepted in the United States and should be read in
conjunction with the consolidated financial statements, related notes thereto
and "Item 9--Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere herein.
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------------
1999 1998 1997 1996 1995
------- ------- ------- ------ -------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net Sales $79,717 $51,643 $36,505 $6,462 $ 843
Cost of sales 28,041 19,272 13,561 3,012 298
------- ------- ------- ------ -------
Gross profit 51,676 32,371 22,944 3,450 545
Operating expenses:
Research and development 16,633 10,656 6,234 2,828 1,391
Sales and marketing 7,849 6,006 4,427 1,134 517
General and administrative 4,374 3,653 3,345 586 297
------- ------- ------- ------ -------
Total operating expenses 28,856 20,315 14,006 4,548 2,205
------- ------- ------- ------ -------
Operating income (loss) 22,820 12,056 8,938 (1,098) (1,660)
Other income, net 4,669 4,154 1,556 164 70
------- ------- ------- ------ -------
Income (loss) before provision
for income taxes 27,489 16,210 10,494 (934) (1,590)
Provision for income taxes 1,380 760 158 14 --
------- ------- ------- ------ -------
Net income (loss) $26,109 $15,450 $10,336 $ (948) $(1,590)
======= ======= ======= ====== =======
Earnings (loss) per share:
Basic $ 0.63 $ 0.38 $ 0.32 $(0.04) $ (0.08)
======= ======= ======= ====== =======
Diluted $ 0.58 $ 0.36 $ 0.27 $(0.04) $ (0.08)
======= ======= ======= ====== =======
Shares used in computing earnings
(loss) per share:
Basic 41,233 40,698 31,896 21,132 20,648
======= ======= ======= ====== =======
Diluted 44,845 42,614 38,024 21,132 20,648
======= ======= ======= ====== =======
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
December 31,
----------------------------------------
1999 1998 1997 1996 1995
-------- -------- ------- ------- ------
(in thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash, cash equivalents and short-term
investments $105,653 $ 86,445 $71,236 $ 7,636 $3,156
Working capital 112,038 84,445 70,372 6,143 2,674
Total assets 140,738 102,921 82,492 12,712 4,209
Short-term borrowings -- 128 228 2,221 339
Long-term debt -- 6 131 250 29
Total shareholders' equity 121,305 89,799 72,998 7,366 3,155
</TABLE>
Item 9. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations contains forward-looking statements that involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including those set forth under "Item 1--Description of
Business--Risk Factors" and in the Company's other filings with the Securities
and Exchange Commission.
Overview
Galileo Technology Ltd. defines, develops and markets advanced digital
semiconductor devices that perform critical functions for new-world converged
network systems, in which voice, video and data are handled seamlessly using
Internet Protocol (IP) techniques. Galileo's core competencies utilized in
making converged networks a reality include various LAN technologies, WAN
technologies and high performance CPU subsystem technologies. Time-to-market
pressures, bandwidth constraints and the need for improved network management
capabilities have forced network system vendors increasingly to transition
from internally-developed solutions to third-party semiconductor devices that
are highly-integrated, scalable, programmable and flexible and meet the
demands of more technologically sophisticated networks. Galileo's highly
integrated "communications systems on silicon" simplify the designs, reduce
development risks and costs, and substantially improve time-to-market for
manufacturers of data communications equipment.
Galileo is organized around two principal product groups: Internetworking
Products, which consists of system controllers and WAN communications
controllers, and Switching Products, which consists of switched Ethernet
controllers, switched Ethernet processors, and switched POS/ATM processors.
Galileo Technology Ltd. is an international company with its headquarters in
Moshav Manof, Israel and its business headquarters, Galileo Technology, Inc.
("GTI"), in San Jose, California.
The Company believes that period-to-period comparisons of its financial
results are not necessarily meaningful and should not be relied upon as an
indication of future performance. See "Risk Factors--Risks Relating to the
Company--Potential Fluctuations in Operating Results." For the year ended
December 31, 1999, five customers accounted for approximately 66% of the
Company's net sales. The Company expects that it will continue to depend on a
limited number of customers to generate a significant percentage of its net
sales for the foreseeable future. See "Item 1--Description of Business--Risk
Factors--Risks Relating to the Company--Customer Concentration" and "--
Dependence on OEMs."
29
<PAGE>
Results of Operations
The table below sets forth certain statement of operations data as a
percentage of net sales for the years ended December 31, 1999, 1998 and 1997.
<TABLE>
<CAPTION>
Year ended
December 31,
-------------------
1999 1998 1997
----- ----- -----
<S> <C> <C> <C>
Net sales 100.0% 100.0% 100.0%
Cost of sales 35.2 37.3 37.1
Gross profit 64.8 62.7 62.9
Operating expenses:
Research and development 20.9 20.6 17.1
Sales and marketing 9.8 11.6 12.1
General and administrative 5.5 7.1 9.2
----- ----- -----
Total operating expenses 36.2 39.3 38.4
----- ----- -----
Operating income 28.6 23.4 24.5
Other income (expense), net 5.9 8.0 4.2
----- ----- -----
Income before provision for income taxes 34.5 31.4 28.7
Provision for income taxes 1.7 1.5 0.4
----- ----- -----
Net income 32.8% 29.9% 28.3%
===== ===== =====
</TABLE>
Net Sales. Net sales to date have been derived primarily from the sale of
system controllers and switched Ethernet LAN controllers. Net sales increased
to $79.7 million in 1999 from $51.6 million in 1998 and $36.5 million in 1997.
The key factor contributing to the growth of the Company's net sales in 1999
and 1998 was the increased demand for the Company's products, leading to
higher volume shipments of the Company's switched Ethernet LAN controllers and
system controllers partially offset by declining average selling prices. See
"Item 1--Description of Business--Risk Factors--Risks Relating to the
Company--Potential Fluctuations in Operating Results."
Net sales, other than revenues from sales to distributors, are recorded
when title transfers. Sales to distributors, which are made under agreements
allowing price protection and right of return on products unsold by the
distributor, are not recognized until the products are sold by the
distributor. The Company accrues estimated sales returns for sales made to
customers, other than distributors, and accrues warranty costs upon
recognition of product sales. The Company has not experienced significant
warranty claims to date.
Sales to five customers accounted for approximately 66% and 59% and 54% of
the Company's net sales in 1999, 1998 and 1997, respectively. The Company
expects a significant portion of its future sales to remain concentrated
within a limited number of strategic customers. There can be no assurance that
the Company will be able to retain its strategic customers, that such
customers will not cancel or reschedule orders or that, in the event they
cancel orders, such orders will be replaced by other sales. The occurrence of
any such events or the loss of a strategic customer would have a material
adverse effect on the Company's operating results. See "Item 1--Description of
Business--Risk Factors--Risks Relating to the Company--Customer Concentration"
and "--Dependence on OEMs."
Cost of Sales/Gross Profit. Cost of sales consists principally of the cost
of purchased packaged semiconductor products from third party foundries,
principally TSMC. Cost of sales increased to $28.0 million in 1999 from $19.3
million in 1998 and $13.6 million in 1997. The increases in 1999 and 1998 were
due to increased sales of system controllers and switched Ethernet LAN
controllers.
The gross profit on net sales in 1999 increased to 64.8% from 62.7% in
1998. The gross margin on net sales in 1998 decreased slightly from the gross
margin of 62.9% in 1997. The increase in the Company's gross
30
<PAGE>
margin on net sales during 1999 was primarily due to the increased percentage
of net sales comprised of new products that generated higher gross margins and
lower manufacturing costs. The Company anticipates that as these new products
mature the average selling price ("ASP") for these products will decrease.
Such declines in unit ASPs will lead to declines in the Company's overall
gross margins, absent offsetting cost reductions or higher margins on new
product introductions. During 1998, the Company experienced an overall decline
in both its products' ASPs and its products' overall manufacturing costs as
compared to 1997. The impact of these two factors were relatively
proportionate resulting in stable gross margins in 1998 and 1997.
Research and Development Expenses. Research and development expenses
primarily consist of salaries and related costs of employees engaged in
ongoing research, design and development activities, and subcontracting costs.
Research and development expenses in 1999 increased to $16.6 million from
$10.7 million in 1998 and $6.2 in 1997. As a percentage of net sales, research
and development expenses were 20.9%, 20.6% and 17.1% in 1999, 1998 and 1997,
respectively. The increase in research and development expenses in 1999, 1998
and 1997 reflects the addition of personnel, the increase in nonrecurring
engineering and product verification expenses. The Company anticipates that
research and development expenses will increase in absolute dollars.
Sales and Marketing Expenses. Sales and marketing expenses are mainly
comprised of commissions to sales representatives, employee-related expenses,
trade exhibition and product marketing expenses. Sales and marketing expenses
increased to $7.8 million in 1999 from $6.0 million in 1998 and $4.4 million
in 1997. These increases were primarily due to personnel additions, increased
sales commissions on higher sales and increased trade exhibition costs. Sales
and marketing expenses as a percentage of net sales were 9.8%, 11.6% and 12.1%
in 1999, 1998, and 1997, respectively. This decrease reflected higher levels
of net sales in 1999 and 1998. The Company anticipates that sales and
marketing expenses will increase in absolute dollars.
General and Administrative Expenses. General and administrative expenses
increased to $4.4 million from $3.7 million and $3.3 million in 1997. General
and administrative expenses increased in absolute dollars as a result of
additions in personnel, increased facility expenses and increases in legal and
accounting fees. The Company anticipates that general and administrative
expenses will increase in absolute dollars.
Other Income (Expense), Net. Other income (expense), net increased to $4.7
million in 1999 from $4.2 million in 1998 and $1.6 million in 1997. The
increases reflected higher interest income on higher average cash and short-
term investment balances as a result of cash generated from operations and the
Company's initial public offering completed in July 1997.
Deferred Compensation. In connection with the grant of certain stock
options to employees through July 1997, the Company recorded deferred
compensation of approximately $3.0 million, representing the aggregate
difference between the respective exercise prices of options at their date of
grant and the deemed fair value for accounting purposes of the ordinary shares
subject to such options. Such amount is presented as a reduction of
shareholders' equity and is amortized over the vesting periods of the
applicable options. Amortization of deferred compensation recorded for the
years ended December 31, 1999, 1998 and 1997 was $509,000, $586,000 and
$617,000, respectively.
Provision for Income Taxes. The provision for income taxes for 1999, 1998
and 1997 primarily consisted of the Company's United States income tax
expense.
The Company fully utilized its Israeli and U.S. federal net operating loss
carryforwards in 1997.
The Company's first investment plan was granted "Approved Enterprise"
status on October 10, 1993 under the Israeli Law for the Encouragement of
Capital Investments, 1959 (the "Investment Law"). The Approved Enterprise
status will allow a full tax exemption on the undistributed income derived
from the Company's investment in its Israeli facilities. The benefits of the
investment plans are expected to expire in 2006. Entitlement to the benefits
is conditional upon the Company fulfilling the conditions stipulated by the
Investment Law,
31
<PAGE>
regulations published thereunder and the instruments of approval for the
specific investments in Approved Enterprises. In the event that these
conditions are violated, in whole or in part, the Company would be required to
refund the amount of tax benefits, with the addition of the Israeli CPI
linkage adjustment and interest. The Company believes its Approved Enterprise
operates in substantial compliance with all such conditions and criteria. See
"Item 7--Taxation--Israeli Taxation and Foreign Exchange Regulations--Law for
the Encouragement of Capital Investments, 1959."
If the Company decides to distribute a cash dividend out of income that has
been exempted from tax, the income out of which the dividend is distributed
will be subject to the 25% Israeli corporate tax rate. The Company currently
has no plans to distribute dividends and intends to retain future earnings to
finance the development of its business.
The Company's pre-tax income from its U.S. operations is subject to U.S.
taxation at U.S. statutory tax rates. However, the Company anticipates that
most of its income will be generated from its Israeli operations and therefore
its overall effective tax rate will be significantly lower than the U.S.
statutory income tax rate. The pretax income from U.S. operations was
$1,659,000 in 1999, $1,103,000 in 1998 and $550,000 in 1997.
At December 31, 1999, the Company had a net deferred tax asset of $0.6
million. The Company believes the net deferred tax asset is realizable based
upon current effected levels of future taxable income. The Company will
continue to assess, on a quarterly basis, the realizability of the deferred
tax assets based on actual and forecasted operating results.
Quarterly Results
The following table presents unaudited quarterly financial information for
each of the four quarters in the years ended December 31, 1999 and 1998. Such
information has been prepared on the same basis as the Company's Consolidated
Financial Statements.
<TABLE>
<CAPTION>
Quarter Ended
---------------------------------------------
March 31, June 30, September 30, December 31,
1999 1999 1999 1999
--------- -------- ------------- ------------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Statement of Operations Data:
Net sales $15,152 $18,271 $22,024 $24,270
Gross profit 9,705 12,024 14,404 15,543
Operating income 4,009 5,374 6,311 7,108
Net income 4,965 6,130 7,059 7,936
Earnings per share:
Basic $ 0.12 $ 0.15 $ 0.17 $ 0.19
Diluted $ 0.11 $ 0.14 $ 0.16 $ 0.18
<CAPTION>
Quarter Ended
---------------------------------------------
March 31, June 30, September 30, December 31,
1998 1998 1998 1998
--------- -------- ------------- ------------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Net sales $15,139 $11,359 $11,454 $13,691
Gross profit 9,536 7,004 7,111 8,720
Operating income 4,434 2,179 2,019 3,424
Net income 5,241 3,109 2,853 4,247
Earnings per share:
Basic $ 0.13 $ 0.08 $ 0.07 $ 0.10
Diluted $ 0.12 $ 0.07 $ 0.07 $ 0.10
</TABLE>
32
<PAGE>
Liquidity and Capital Resources
Cash, cash equivalents and short-term investments were $105.7 million and
$86.4 million at December 31, 1999 and 1998, respectively. The Company
generated net cash from operations of $22.6 million, $20.4 million and $13.4
million in 1999, 1998 and 1997, respectively. Net cash generated from
operations in 1999, 1998 and 1997 consisted primarily of net income plus
increases in accounts payable and accrued liabilities offset by increases in
accounts receivable and inventories. Investing activities reflected purchases
of property and equipment of $7.4 million, $3.5 million and $2.3 million in
1999, 1998 and 1997, respectively. Continued expansion of the Company's
business may require higher levels of capital equipment purchases. Financing
activities provided cash of $4.3 million in 1999 and $52.5 million in 1997 and
used $0.4 million in 1998. In 1999, the cash generated from financing
activities was primarily generated from proceeds from the issuance of ordinary
shares under the Company's employee share option and purchase plans. In June
1998, the Company's wholly owned subsidiary, GTI, commenced a program to buy
an aggregate of up to five percent of the ordinary shares of the Company.
During 1998, GTI acquired 455,200 shares for an aggregate purchase price of
$2.2 million. During 1998, the cash used by GTI in purchasing these ordinary
shares was offset by the cash received from the issuance of ordinary shares.
The cash generated by financing operations in 1997 was primarily as a result
of raising $53.0 million in net proceeds from the Company's initial public
offering of its ordinary shares in July 1997.
The Company uses an independent foundry, TSMC, to fabricate substantially
all of its products, minimizing its need to invest in manufacturing equipment
and to develop integrated circuit fabrication processes. As a result, the
Company relies on TSMC to achieve acceptable manufacturing yields and to
allocate to the Company a sufficient portion of foundry capacity to meet the
Company's needs. See "Item 1--Business Description--Risk Factors--Risks
Relating to the Company--Dependence on TSMC; Manufacturing Risks." This model
allows the Company to avoid utilizing its capital resources for manufacturing
facilities and work-in-process inventory, and allows the Company to focus
substantially all of its resources on the definition, development and
marketing of its products. The Company to date has ordered products from TSMC
primarily based on forecasts from its customers of orders they intend to place
for the Company's products. This manufacturing arrangement requires the
Company to purchase inventory before it receives revenues from sales. Since
the Company's customers may cancel orders without charge if notice is given
within an agreed-upon period, the Company may incur expenses for inventory
purchases that are not sold to customers. In the future, the Company may need
to maintain higher levels of inventories to meet rapidly changing customer
demands, which would place additional demands on the Company's working
capital. See "Item 1--Business Description--Risk Factors--Risk Factors--Risks
Relating to the Company--Dependence on OEMs."
At December 31, 1999, the Company had $112.0 million in working capital.
The Company's principal sources of liquidity at December 31, 1999 consisted of
approximately $105.7 million in cash, cash equivalents and short-term
investments. The Company believes that its existing cash, cash equivalents and
short-term investments, together with any cash flows generated from its
operations, will be sufficient to satisfy its working capital and capital
expenditure requirements for at least the next 12 months.
Foreign Currency Transactions
Substantially all of the Company's sales and a substantial portion of its
costs are denominated in United States dollars. Since the dollar is the
primary currency in the economic environment in which the Company operates,
the dollar is its functional currency, and, accordingly, monetary accounts
maintained in currencies other than the dollar (principally cash, and
liabilities) are remeasured using the foreign exchange rate at the balance
sheet date. Operational accounts and nonmonetary balance sheet accounts are
remeasured and recorded at the rate in effect at the date of the transaction.
The effects of foreign currency remeasurement are reported in current
operations, and have been immaterial to date.
33
<PAGE>
Impact of Inflation, Devaluation and Fluctuation of Currencies on Results of
Operations and Financial Position
For many years prior to 1986, the Israeli economy was characterized by high
rates of inflation and devaluation of the Israeli currency against the U.S.
dollar and other currencies. However, since the institution of the Israeli
Economic Program in 1985, inflation, while continuing, has been reduced
significantly and the rate of devaluation has diminished substantially.
A devaluation of the NIS in relation to the U.S. dollar would have the
effect of decreasing the dollar value of assets (mostly current assets) of the
Company, to the extent the underlying value is NIS-based. Such a devaluation
would also have the effect of reducing the U.S. dollar amount of any
liabilities of the Company, which are payable in NIS (unless such payables are
linked to the U.S. dollar).
Most of the Company's sales and production costs are denominated in
dollars. The Company's expenses that are denominated in NIS are principally
payroll. Its expenses in NIS exceed its net sales received in NIS. The results
of operations of the Company are adversely affected by increases in the rate
of inflation in Israel when such increases are not offset by a corresponding
devaluation of the NIS against the U.S. dollar. If the rate of inflation in
Israel exceeds the rate of devaluation of the U.S. dollar against the NIS, the
Company may experience an increase in the cost of its operations in dollar
terms, relating primarily to the cost of salaries in Israel that are paid in
NIS partially linked to the CPI in Israel. Such increases have not materially
adversely affected the Company's results of operations in such periods,
although there can be no assurance that there will not be a material adverse
effect on the Company's business, operating results and financial condition in
the future should this pattern recur. See "Item 1--Description of Business--
Risk Factors--Risks Relating to Operations in Israel--Inflation and Currency
Fluctuations."
Item 9. Quantitative and Qualitative Disclosures About Market Risk
In the normal course of business, the financial position of the Company is
routinely subjected to a variety of risks, including market risk associated
with interest rate movements and currency rate movements on non-U.S. dollar
denominated assets and liabilities, as well as collectibility of accounts. The
Company regularly assesses these risks and has established policies and
business practices to protect against the adverse effects of these and other
potential exposures. As a result, the Company does not anticipate material
losses in these areas.
For purposes of specific risk analysis, the Company uses sensitivity
analysis to determine the impacts that market risk exposures may have on the
fair values of the Company's financial instruments. The financial instruments
included in the sensitivity analysis consist of all of the Company's cash and
cash equivalents and short-term investments.
To perform sensitivity analysis, the Company assesses the risk of loss in
fair values from the impact of hypothetical changes in interest rates and
foreign currency exchange rates on market sensitive instruments. The market
values for interest risk are computed based on the present value of future
cash flows as impacted by the changes in rates attributable to the market risk
being measured. The discount rates used for the present value computations
were selected based on market interest rates in effect at December 31, 1999
and 1998. The market values for foreign exchange risk are computed based on
spot rates in effect at December 31, 1999 and 1998. The market values that
result from these computations are compared to the market values of these
financial instruments at December 31, 1999 and 1998. The differences in this
comparison are the hypothetical gains or losses associated with each type of
risk.
The results of the sensitivity analysis are as follows:
Interest Rate Risk: A 10% decrease or a 10% increase in the levels of
interest rates with all other variables held constant would not materially
affect the earnings, cash flow and fair value of the Company's financial
instruments at December 31, 1999 and 1998.
Foreign Currency Exchange Rate Risk: A 10% movement in levels of foreign
currency exchange rates against the U.S. dollar with all other variables
held constant would not materially affect the earnings, cash flow and fair
value of the Company's financial instruments at December 31, 1999 and 1998.
34
<PAGE>
Item 10. Directors and Officers of Registrant.
The following table sets forth certain information with respect to the
directors and executive officers of the Company as of March 20, 2000:
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C> <C>
Avigdor Willenz(1) 43 Chief Executive Officer and Chairman of the Board of Directors
Manuel Alba 44 President of GTI and Director
Ed Rodriguez 42 Chief Operating Officer
George A. Hervey 52 Senior Vice President and Chief Financial Officer
David Shemla 40 Vice President of Product Definition
Eliaz Lavi 43 Vice President of Operations, Quality & Reliability
Menachem Schwartz 48 Vice President of Computer Aided Design
Matty Karp(1)(2) 50 Director
Christopher J. Director
Schaepe(1)(2) 35
</TABLE>
- --------
(1) Member of Compensation Committee.
(2) Member of Audit Committee.
Mr. Willenz founded the Company in November 1992 and has served as the
Company's Chief Executive Officer and Chairman of the Board of Directors since
that time. Between 1988 and 1992, Mr. Willenz was Corporate Product Definition
Manager/Chief Engineer for IDT. Between 1984 and 1988, Mr. Willenz worked as
design manager at Elbit Computers Ltd. ("Elbit"). Mr. Willenz holds a B.S.E.E.
from the Technion in Israel.
Mr. Alba has served as a director of the Company since March 1994. Mr. Alba
has also been President of GTI since its incorporation in April 1994. From
1989 to 1994, Mr. Alba worked as a marketing manager at IDT. From 1983 to
1989, Mr. Alba worked as a Staff Market Development Engineer at National
Semiconductor Corporation. He holds a B.S.E.E. from the National Polytechnic
Institute (Mexico City), an M.S.E.E. from the University of Southern
California and an M.B.A. from the University of Santa Clara.
Mr. Rodriguez joined the Company in May 1999 as Senior Vice President and
Chief Operating Officer. Prior to joining the Company, Mr. Rodriguez was Vice
President and General Manager of the Datacom Division of Cypress Semiconductor
Corporation from 1998 to 1999. Prior to working at Cypress Semiconductor
Corporation, Mr. Rodriguez spent 17 years at National Semiconductor
Corporation, most recently as Vice President and General Manager of the
Networking Products Division. He holds a B.S.E.E and M.S.E.E from the
University of Miami.
Mr. Hervey joined the Company in March 1997 as Senior Vice President and
Chief Financial Officer. Prior to joining the Company, Mr. Hervey was Senior
Vice President of Finance and Chief Financial Officer of S3 Incorporated from
1992 to 1997. From 1990 to 1992, Mr. Hervey was Vice President of Finance and
Chief Financial Officer of Paradigm Technology, Inc. Mr. Hervey holds a B.S.
in business administration from the University of Rhode Island.
Mr. Shemla joined the Company in September 1994 as Vice President of
Communications. Prior to joining the Company, Mr. Shemla spent 11 years at
Digital Equipment Corporation, most recently as a design team manager for FDDI
and Ethernet controllers. Mr. Shemla holds a B.S.E.E. from the Technion in
Israel.
Mr. Lavi joined the Company in June 1996 as Vice President of Operations,
Quality & Reliability. Prior to joining the Company, Mr. Lavi worked at Intel,
acquiring over 12 years of experience in VLSI back-end activities. For the
last four years, Mr. Lavi worked as a Test Engineering Manager at Intel's
Israel Development Center. Mr. Lavi holds a B.S.E.E from the Technion in
Israel.
35
<PAGE>
Mr. Schwartz joined the Company in March 1993 as Vice President of Computer
Aided Design. Prior to joining the Company, Mr. Schwartz was the manager of
Elta's VLSI design department. Mr. Schwartz holds a B.S.E.E. from the Technion
in Israel.
Mr. Karp has served as a director of the Company since August 1994. Mr.
Karp has been President of Kardan Technologies Ltd. ("Kardan") and Active
Chairman of Kardan Technology Ventures since 1994. Since April 1994, he has
also managed the Nitzanim Venture Capital Fund. Between 1979 and 1994, Mr.
Karp held several corporate management positions at Elbit, most recently the
position of Senior Executive. Mr. Karp holds a B.S.E.E. from the Technion in
Israel and is a graduate of the AMP at the Harvard Business School.
Mr. Schaepe has served as a director of the Company since November 1995.
Mr. Schaepe is a general partner of Weiss, Peck & Greer Venture Partners, a
technology focused venture capital firm which he joined in 1991. Previously,
Mr. Schaepe served in corporate finance and capital markets roles at Goldman,
Sachs & Co. after his employment as a software engineer at International
Business Machines Corporation. He is a director of several private companies
and holds B.S. and M.S. degrees in computer science from Massachusetts
Institute of Technology and an M.B.A. from Stanford Business School.
Officers are appointed by the Board of Directors. Pursuant to the Company's
Articles of Association, as amended (the "Articles of Association"), directors
are elected at the annual general meeting of shareholders of the Company by a
vote of the holders of a majority of the voting power represented at such
meeting. Each director holds office until the annual general meeting of
shareholders next following the annual general meeting at which such director
was elected or until his earlier resignation or removal. A director may be re-
elected for subsequent terms.
Item 11. Compensation of Directors and Officers.
The directors of the Company can be remunerated by the Company for their
services as directors to the extent such remuneration is approved by the
Company's shareholders at an annual general meeting. Directors currently do
not receive monetary compensation for their services as directors but are
reimbursed for their expenses for each Board of Directors meeting attended.
Nonemployee Directors are eligible to participate in the 1998 Nonemployee
Directors Stock Option Plan.
The aggregate direct remuneration paid by the Company and GTI to all
directors and executive officers (9 persons) in 1999 was approximately
$987,000. During 1999, the Company set aside an aggregate amount of
approximately $125,000 to provide for pension, retirement or similar benefits
for all directors and executive officers. As of December 31, 1999, the Company
accrued severance benefits for the same group in the aggregate amount of
approximately $218,000. As of December 31, 1999, directors and executive
officers of the Company (9 persons) held stock options to purchase an
aggregate of 2,197,692 ordinary shares.
There are no employment agreements between the Company and any of its
officers or directors.
Item 12. Options to Purchase Securities from Registrant or Subsidiaries.
At March 20, 2000, options and purchase rights to purchase a total of
7,744,291 ordinary shares were outstanding at exercise prices ranging from
$0.001 to $29.06 and with expiration dates ranging from 2003 to 2010. At March
20, 2000, an independent trustee (the "Trust Arrangement") held 997,016 of the
Company's ordinary shares. The shares under the Trust Arrangement are
restricted for use under individual share purchase agreements and share
options to employees and consultants. At March 20, 1999, the persons named in
Item 10 as a group (9 persons) held options to acquire 2,247,910 ordinary
shares. Reference is also made to the information contained in Item 4 above.
Item 13. Interest of Management in Certain Transactions.
From the inception of the Company's operations, the founder has provided
the Company with loans in the aggregate amount of $51,000. All such loans were
repaid during 1998.
36
<PAGE>
PART II
Item 14. Description of Securities to be Registered.
Not applicable.
PART III
Item 15. Defaults Upon Senior Securities.
Not applicable.
Item 16. Changes in Securities and Changes in Security for Registered
Securities.
Not applicable.
PART IV
Item 17. Financial Statements.
The Company has responded to Item 18.
Item 18. Financial Statements
Reference is made to Item 19 for a list of all financial statements filed
as part of this Annual Report on Form 20-F.
Item 19. Financial Statements and Exhibits
(a) (1) Financial Statements:
<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors 38
Consolidated Balance Sheets as of December 31, 1999 and 1998 39
Consolidated Statements of Operations for each of the three years in the
period ended December 31, 1999 40
Consolidated Statement of Shareholders' Equity for the three year period
ended December 31, 1999 41
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 1999 42
Notes to Consolidated Financial Statements 43
(a) (2) Financial Statement Schedules:
The following financial statement schedule of Galileo Technology Ltd. for
each of the three years in the period ended December 31, 1999 is filed as part
of the Annual Report and should be read in conjunction with the consolidated
financial statements of Galileo Technology Ltd.
Schedule II--Valuation and Qualifying Accounts 55
</TABLE>
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the
consolidated financial statements or notes thereto.
(b) Exhibits
<TABLE>
<S> <C>
Exhibit 4.1--Consent of Ernst & Young LLP, Independent Auditors
Exhibit 27.1--Financial Data Schedule
</TABLE>
37
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Galileo Technology Ltd.
We have audited the accompanying consolidated balance sheets of Galileo
Technology Ltd. as of December 31, 1999 and 1998, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the
three years in the period ended December 31, 1999. Our audits also included
the financial statement schedule listed in the Index at Item 19(a)(2). These
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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 consolidated financial position of Galileo
Technology Ltd. at December 31, 1999 and 1998, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
/s/ Ernst & Young LLP
Palo Alto, California
January 14, 2000
except for Note 12, as to which the date is
February 29, 2000
38
<PAGE>
GALILEO TECHNOLOGY LTD.
CONSOLIDATED BALANCE SHEETS
(U.S. dollars, in thousands, except share and per share data)
<TABLE>
<CAPTION>
December 31,
------------------
1999 1998
-------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 42,648 $ 45,607
Short-term investments 63,005 40,838
Accounts receivable, net of allowances of $203 in 1999
and $207 in 1998 12,523 5,207
Inventories 8,094 2,851
Prepaid expenses and other assets 3,049 1,745
-------- --------
Total current assets 129,319 96,248
Other assets 2,031 1,857
Property and equipment, net 9,388 4,816
-------- --------
Total assets $140,738 $102,921
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 6,495 $ 4,826
Accrued and other current liabilities 8,969 6,078
Deferred income 1,817 771
Current maturities of long-term debt -- 128
-------- --------
Total current liabilities 17,281 11,803
Accrued severance pay 500 283
Long-term debt -- 6
Other liabilities 1,652 1,030
Commitments
Shareholders' equity:
Ordinary Shares--nominal value approximately $0.003 per
share; at amounts paid in; 100,000,000 shares
authorized; 41,989,908 and 40,953,118 shares issued
and outstanding at December 31, 1999 and 1998,
respectively 74,440 70,148
Treasury shares at cost; 305,376 Ordinary Shares at
December 31, 1998 -- (1,451)
Deferred compensation (432) (941)
Accumulated other comprehensive income (loss) (124) 155
Retained earnings 47,421 21,888
-------- --------
Total shareholders' equity 121,305 89,799
-------- --------
Total liabilities and shareholders' equity $140,738 $102,921
======== ========
</TABLE>
See accompanying notes.
39
<PAGE>
GALILEO TECHNOLOGY LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
(U.S. dollars, in thousands, except per share data)
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Net sales $79,717 $51,643 $36,505
Cost of sales 28,041 19,272 13,561
------- ------- -------
Gross profit 51,676 32,371 22,944
Operating expenses:
Research and development 16,633 10,656 6,234
Sales and marketing 7,849 6,006 4,427
General and administrative 4,374 3,653 3,345
------- ------- -------
Total operating expenses 28,856 20,315 14,006
------- ------- -------
Operating income 22,820 12,056 8,938
Interest income 4,921 4,383 1,689
Interest and other expense (252) (229) (133)
------- ------- -------
Income before provision for income taxes 27,489 16,210 10,494
Provision for income taxes 1,380 760 158
------- ------- -------
Net income $26,109 $15,450 $10,336
======= ======= =======
Earnings per share:
Basic $ 0.63 $ 0.38 $ 0.32
======= ======= =======
Diluted $ 0.58 $ 0.36 $ 0.27
======= ======= =======
Shares used in computing earnings per share:
Basic 41,233 40,698 31,896
======= ======= =======
Diluted 44,845 42,614 38,024
======= ======= =======
</TABLE>
See accompanying notes.
40
<PAGE>
GALILEO TECHNOLOGY LTD.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(U.S. dollars, in thousands, except share data)
<TABLE>
<CAPTION>
Ordinary Accumulated Retained
Preferred Shares Ordinary Shares Treasury Shares Other Earnings Total
------------------ ------------------ ---------------- Deferred Comprehensive (Accumulated Shareholders'
Shares Amount Shares Amount Shares Amount Compensation Income (Loss) Deficit) Equity
---------- ------ ---------- ------- -------- ------ ------------ ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at
December 31,
1996 1,190,293 $7,723 24,518,376 $ 3,977 -- $ -- $(1,058) $ -- $(3,276) $ 7,366
Comprehensive
income:
Other
comprehensive
income--change
in net
unrealized gain
(loss) on
available-for-
sale investments -- -- -- -- -- -- -- (15) -- (15)
Net income -- -- -- -- -- -- -- -- 10,336 10,336
--------
Comprehensive
income -- -- -- -- -- -- -- -- -- 10,321
--------
Issuance of
Preferred
Shares, net of
issuance costs 270,300 1,450 -- -- -- -- -- -- -- 1,450
Conversion of
Series B and D
Preferred Shares
into Ordinary
Shares (1,460,593) (9,173) 8,763,558 9,173 -- -- -- -- -- --
Issuance of
Ordinary Shares -- -- 40,800 102 -- -- -- -- -- 102
Issuance of
Ordinary Shares,
in conjunction
with the
Company's
initial public
offering, net of
issuance costs -- -- 6,900,000 52,981 -- -- -- -- -- 52,981
Issuance of
Ordinary Shares
pursuant to
warrant exercise -- -- 30,994 -- -- -- -- -- -- --
Issuance of
Ordinary Shares
under share
option plans -- -- 229,102 29 -- -- -- -- -- 29
Tax benefit of
stock option
transactions -- -- -- 132 -- -- -- -- -- 132
Deferred
compensation
related to
certain options
granted to
employees prior
to the initial
public offering -- -- -- 1,086 -- -- (1,086) -- -- --
Amortization of
deferred
compensation -- -- -- -- -- -- 617 -- -- 617
---------- ------ ---------- ------- -------- ------ ------- ----- ------- --------
Balance at
December 31,
1997 -- -- 40,482,830 67,480 -- -- (1,527) (15) 7,060 72,998
Comprehensive
income:
Other
comprehensive
income--change
in net
unrealized gain
(loss) on
available-for-
sale investments -- -- -- -- -- -- -- 170 -- 170
Net income -- -- -- -- -- -- -- -- 15,450 15,450
--------
Comprehensive
income -- -- -- -- -- -- -- -- -- 15,620
--------
Purchase of
Treasury Shares
at cost -- -- -- -- (455,200) (2,203) -- -- -- (2,203)
Issuance of
Ordinary Shares
under share
option and
employee stock
purchase plans -- -- 472,288 1,930 149,824 752 -- -- (622) 2,060
Tax benefit of
stock option
transactions -- -- -- 738 -- -- -- -- -- 738
Amortization of
deferred
compensation -- -- -- -- -- -- 586 -- -- 586
---------- ------ ---------- ------- -------- ------ ------- ----- ------- --------
Balance at
December 31,
1998 -- -- 40,953,118 70,148 (305,376) (1,451) (941) 155 21,888 89,799
Comprehensive
income:
Other
comprehensive
income--change
in net
unrealized gain
(loss) on
available-for-
sale investments -- -- -- -- -- -- -- (279) -- (279)
Net income -- -- -- -- -- -- -- -- 26,109 26,109
--------
Comprehensive
income -- -- -- -- -- -- -- -- -- 25,830
--------
Issuance of
Ordinary Shares
under share
option and
employee stock
purchase plans -- -- 1,036,790 3,594 305,376 1,451 -- -- (576) 4,469
Tax benefit of
stock option
transactions -- -- -- 698 -- -- -- -- -- 698
Amortization of
deferred
compensation -- -- -- -- -- -- 509 -- -- 509
---------- ------ ---------- ------- -------- ------ ------- ----- ------- --------
Balance at
December 31,
1999 -- $ -- 41,989,908 $74,440 -- $ -- $ (432) $(124) $47,421 $121,305
========== ====== ========== ======= ======== ====== ======= ===== ======= ========
</TABLE>
See accompanying notes
41
<PAGE>
GALILEO TECHNOLOGY LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
(U.S. dollars, in thousands)
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities
Net income $ 26,109 $ 15,450 $ 10,336
Adjustments to reconcile net income to net
cash
provided by operating activities:
Depreciation 2,863 1,635 897
Amortization of deferred compensation 509 586 617
Change in deferred tax assets 456 (380) (642)
Changes in operating assets and liabilities:
Accounts receivable (7,316) (641) (2,743)
Inventories (5,243) (464) (1,237)
Prepaid expenses and other assets (697) (356) (174)
Accounts payable 1,669 1,894 886
Accrued and other current liabilities 2,891 1,837 4,392
Deferred income 1,046 (243) 1,014
Accrued severance pay 217 73 100
Other liabilities 83 1,030 --
-------- -------- --------
Net cash provided by operating activities 22,587 20,421 13,446
Cash flows from investing activities
Purchases of short-term investments (35,789) (57,041) (29,364)
Proceeds from sales and maturities of short-
term investments 13,343 43,722 4,304
Purchases of property and equipment (7,435) (3,484) (2,281)
Other assets -- (1,530) --
-------- -------- --------
Net cash used in investing activities (29,881) (18,333) (27,341)
Cash flows from financing activities
Proceeds from issuance of Preferred Shares -- -- 1,450
Proceeds from issuance of Ordinary Shares 4,469 2,060 131
Repurchase of Ordinary Treasury Shares -- (2,203) --
Proceeds from initial public offering -- -- 52,981
Proceeds from issuance of debt -- -- 2,264
Repayment of debt (134) (225) (4,376)
-------- -------- --------
Net cash provided by (used in) financing
activities 4,335 (368) 52,450
Net increase (decrease) in cash and cash
equivalents (2,959) 1,720 38,555
Cash and cash equivalents at beginning of year 45,607 43,887 5,332
-------- -------- --------
Cash and cash equivalents at end of year $ 42,648 $ 45,607 $ 43,887
======== ======== ========
Supplemental disclosure
Interest paid $ 4 $ 15 $ 133
======== ======== ========
Income taxes paid $ 1 $ 498 $ --
======== ======== ========
Noncash financing activities
Conversion of Preferred Shares to Ordinary
Shares $ -- $ -- $ 9,173
======== ======== ========
</TABLE>
See accompanying notes
42
<PAGE>
GALILEO TECHNOLOGY LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Business and Significant Accounting Policies
Organization and Basis of Presentation
Galileo Technology Ltd. (the "Company") was incorporated under the laws of
Israel in November 1992 and commenced operations in March 1993. The Company,
together with its United States subsidiary, Galileo Technology, Inc. ("GTI"),
a California corporation, and its United Kingdom subsidiary, Galileo
Technology Europe Ltd., defines, develops and markets advanced digital
semiconductor devices that perform critical functions for New World converged-
network systems, in which voice, video, and data are handled seamlessly using
Internet Protocol techniques.
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States and include the
accounts of the Company and its subsidiaries. Intercompany accounts and
transactions have been eliminated in consolidation.
The Company has elected to prepare its financial statements in U.S.
dollars, which is also the Company's functional currency. Substantially all of
the Company's sales are made in U.S. dollars. In addition, a substantial
portion of the Company's costs are incurred in U.S. dollars. Since the U.S.
dollar is the primary currency in the economic environment in which the
Company operates, the U.S. dollar is its functional currency.
Nature of Operations and Related Concentrations
The Company's sales are concentrated with a few customers. For 1999, five
customers represented approximately 66% of the Company's net sales. The
following provides information on sales to major customers which each
constituted more than 10% of net sales. Sales to one customer represented 22%,
26% and 12% of net sales for 1999, 1998 and 1997, respectively. Sales to two
other customers represented 13% and 12% of net sales for 1999. Sales to
another customer represented 14% and 10% of net sales for 1999 and 1997,
respectively. Sales to another customer represented 17% of net sales for 1997.
The Company uses a single independent foundry in Taiwan to fabricate and
manufacture substantially all of its semiconductor products. The Company's
reliance on a single independent foundry involves a number of risks, including
the possible absence of adequate capacity as the Company expands, the
unavailability of, or interruption in access to, certain process technologies
and reduced control over delivery schedules, quality assurance, manufacturing
yields and costs.
The loss of any of the Company's major customers or its supplier would have
a material adverse effect on the Company's business, financial condition and
results of operations.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Revenue Recognition
Net sales represent revenues derived from sales of semiconductor devices
including system controllers and switched Ethernet LAN controllers. Revenues
from product sales to customers, other than sales to distributors, are
recorded when title transfers. Sales to distributors, which are made under
agreements allowing price protection and right of return on products unsold by
the distributor, are not recognized until the products are sold by the
distributor. The Company's anticipated profit on such distribution sales are
recorded as deferred income.
43
<PAGE>
GALILEO TECHNOLOGY LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company accrues estimated sales returns for sales made to customers, other
than distributors, and accrues warranty costs upon recognition of net sales.
The Company has not experienced significant warranty claims to date.
Research and Development
Research and development costs are expensed as incurred, in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 2, "Accounting for
Research and Development Costs."
Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with a maturity of
three months or less, when purchased, to be cash equivalents.
Pursuant to SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," the Company's debt securities have been designated as
available-for-sale. Available-for-sale securities are carried at fair value,
which is determined based upon the quoted market prices of the securities,
with unrealized gains and losses reported in accumulated other comprehensive
income, a component of shareholders' equity. Realized gains and losses and
declines in value judged to be other than temporary on available-for-sale
securities are included in interest income. The Company views its available-
for-sale portfolio as available for use in its current operations.
Accordingly, the Company has classified all investments as short term, even
though the stated maturity date may be one year or more from beyond the
current balance sheet date. The cost of securities sold is based on the
specific identification method. Interest and dividends on securities
classified as available-for-sale are included in interest income.
Inventories
Inventories are stated at the lower of cost or market value. Cost is
determined by the first-in, first-out method. Substantially all of the
inventories are finished goods.
Property and Equipment
Property and equipment is recorded at cost. Depreciation of property and
equipment is recognized on the straight-line method over the estimated useful
lives of the assets (generally from three to five years).
Foreign Currency Transactions
Monetary accounts maintained in currencies other than the dollar
(principally cash and liabilities) are remeasured using the foreign exchange
rate at the balance sheet date. Operational accounts and nonmonetary balance
sheet accounts are measured and recorded at the rate in effect at the date of
the transaction. The effects of foreign currency remeasurement are reported in
current operations. The effect of foreign currency remeasurement was not
significant in 1999, 1998 or 1997.
Concentrations of Credit Risk
Financial instruments that subject the Company to credit risk consist
primarily of uninsured cash, cash equivalents and short-term investment
balances held at high-quality financial institutions and trade receivables
from its customers. The Company sells primarily to large network system
vendors. The Company extends reasonably short collection terms and performs
ongoing credit evaluations but does not require collateral. The Company
provides reserves for potential credit losses, and such losses have been
within management's expectations.
44
<PAGE>
GALILEO TECHNOLOGY LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Accounting for Stock-Based Compensation
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee share options because, as
discussed below, the alternative fair value accounting provided for under SFAS
No. 123, "Accounting for Stock-Based Compensation," ("SFAS 123") requires use
of option valuation models that were not developed for use in valuing employee
share options. Under APB 25, when the exercise price of the Company's employee
share purchase rights or options equals the market price of the underlying
ordinary shares on the date of the grant, no compensation expense is
recognized.
In connection with the grant of certain share options to employees through
July 1997, the Company recorded deferred compensation of approximately $3.0
million for the aggregate differences between the respective exercise prices
of options at their dates of grant and the deemed fair value for accounting
purposes of the ordinary shares subject to such options. Such amount is
presented as a reduction of shareholders' equity and is amortized ratably over
the vesting period of the related options.
Earnings Per Share
Earnings per share has been computed in accordance with the SFAS No. 128,
"Earnings Per Share," which requires disclosure of basic and diluted earnings
per share. Basic earnings per share has been computed using the weighted-
average number of ordinary shares outstanding during the period and the
conversion of convertible preferred stock from the original date of issuance.
Basic earnings per share excludes any dilutive effects of options, shares
subject to repurchase, warrants, and convertible securities. Diluted earnings
per share includes the impact of potentially dilutive securities. Following
the guidance given by the Securities and Exchange Commission ("SEC") in Staff
Accounting Bulletin ("SAB") No. 98, ordinary shares and preferred shares that
had been issued or granted for nominal consideration prior to the Company's
initial public offering would be included in the calculation of basic and
diluted earnings per share as if these shares had been outstanding for all
periods presented. No such issuances or grants have been made.
On June 12, 1997, the Company's shareholders approved a 3-for-1 ordinary
share split in the form of a share dividend which was effected on June 24,
1997. On September 8, 1999, the Company's shareholders approved a 2-for-1
ordinary share split in the form of a share dividend which was effected on
September 17, 1999. All share and per share amounts have been retroactively
adjusted to reflect these splits.
The following table sets forth the computation of basic and diluted
earnings per share (in thousands, except per share data):
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Numerator used for both basic and diluted earnings per
share $26,109 $15,450 $10,336
======= ======= =======
Denominator for basic earnings per share--
Weighted average shares outstanding 41,233 40,698 31,896
======= ======= =======
Denominator for diluted earnings per share:
Denominator for basic earnings per share 41,233 40,698 31,896
Effect of dilutive securities:
Employee share options 3,612 1,916 2,700
Warrants -- -- 6
Convertible preferred shares -- -- 3,422
------- ------- -------
44,845 42,614 38,024
======= ======= =======
Basic earnings per share $ 0.63 $ 0.38 $ 0.32
======= ======= =======
Diluted earnings per share $ 0.58 $ 0.36 $ 0.27
======= ======= =======
</TABLE>
45
<PAGE>
GALILEO TECHNOLOGY LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Recent Accounting Standards
In June 1999, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities--
Deferral of the Effective Date of FASB Statement No. 133." This Statement
defers for one year the effective date of Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"). The rule will now
apply for years beginning after June 15, 2000. Because of the Company's
minimal use of derivatives, the Company does not anticipate that the adoption
of SFAS 133 will have a significant effect on the Company's consolidated
results of operations or financial position.
In December 1999, the SEC issued SAB No. 101 ("SAB 101"), "Revenue
Recognition in Financial Statements." SAB 101 summarizes certain areas of the
Staff's views in applying generally accepted accounting principles to revenue
recognition in financial statements. The Company believes that its current
revenue recognition policies comply with SAB 101.
2. Available-for-Sale-Securities
The fair value and the amortized cost of available-for-sale securities at
December 31, 1999 and 1998 are presented in the following tables (in
thousands):
<TABLE>
<CAPTION>
December 31, 1999
-----------------------------------------
Unrealized Unrealized Estimated
Amortized Holding Holding Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Corporate debt securities $ 35,854 $ -- $(285) $ 35,569
Debt securities of states of the
United States and political
subdivisions of the states 23,342 -- (79) 23,263
Israel government securities 24,700 328 (88) 24,940
-------- ----- ----- --------
$ 83,896 $ 328 $(452) $ 83,772
======== ===== ===== ========
Reported as:
Cash equivalents $ 20,767 $ -- $ -- $ 20,767
Short-term investments 63,129 328 (452) 63,005
-------- ----- ----- --------
$ 83,896 $ 328 $(452) $ 83,772
======== ===== ===== ========
<CAPTION>
December 31, 1998
-----------------------------------------
Unrealized Unrealized Estimated
Amortized Holding Holding Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Corporate debt securities $ 37,907 $ 83 $ (8) $ 37,982
Debt securities of states of the
United States and political
subdivisions of the states 15,524 34 -- 15,558
Israel government securities 11,942 88 (42) 11,988
-------- ----- ----- --------
$ 65,373 $ 205 $ (50) $ 65,528
======== ===== ===== ========
Reported as:
Cash equivalents $ 24,690 $ -- $ -- $ 24,690
Short-term investments 40,683 205 (50) 40,838
-------- ----- ----- --------
$ 65,373 $ 205 $ (50) $ 65,528
======== ===== ===== ========
</TABLE>
46
<PAGE>
The contractual maturities of available-for-sales debt securities
classified as short-term investments at December 31, 1999 are as follows (in
thousands):
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
--------- -------
<S> <C> <C>
Due in one year or less $ 22,129 $22,049
Due after one year through three years 20,446 20,179
Due after three years through five years 20,554 20,777
-------- -------
$ 63,129 $63,005
======== =======
</TABLE>
Proceeds from the sale of available-for-sale securities were approximately
$4,974,000 and $1,934,000 for 1999 and 1998. The Company realized a net gain
of approximately $59,000 and $11,000 from the sale of available-for-sale
securities for 1999 and 1998. The Company had no sales of available-for-sale
securities in 1997.
3. Property and Equipment
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
----------------
1999 1998
------- -------
<S> <C> <C>
Computer equipment $12,035 $ 5,728
Furniture, fixtures and other 3,223 2,095
------- -------
15,258 7,823
Accumulated depreciation (5,870) (3,007)
------- -------
$ 9,388 $ 4,816
======= =======
</TABLE>
4. Long-Term Debt
The Company had no outstanding long-term debt as of December 31, 1999. As
of December 31, 1998, the Company had $134,000 of long-term debt. The fair
market value of the Company's long-term debt approximated the carrying value.
The fair value was estimated using a discounted cash flow analysis, based on
the Company's incremental borrowing rate for similar types of borrowing
arrangements.
5. Accrued and Other Current Liabilities
Accrued and other current liabilities consists of the following (in
thousands):
<TABLE>
<CAPTION>
December 31,
--------------
1999 1998
------- ------
<S> <C> <C>
Compensation and benefits $ 3,415 $2,710
Income and other tax authorities 3,120 901
Other 2,434 2,467
------- ------
$ 8,969 $6,078
======= ======
</TABLE>
47
<PAGE>
6. Accrued Severance Liabilities
The Company's liability for severance pay pursuant to Israeli law is fully
provided for through insurance contracts and by accrual. The net accrued
severance pay liability reported in the balance sheet reflects the following
(in thousands):
<TABLE>
<CAPTION>
December
31,
-----------
1999 1998
------ ----
<S> <C> <C>
Accrued severance pay $1,431 $832
Less amount funded 931 549
------ ----
Unfunded portion, net accrued severance pay $ 500 $283
====== ====
</TABLE>
Severance expenses for 1999, 1998 and 1997 amounted to approximately
$599,000, $324,000 and $257,000, respectively.
7. Commitments
Lease Commitments
The Company leases its facilities and other equipment under operating lease
agreements which expire through 2025. Aggregate future minimum annual payments
under noncancelable operating leases as of December 31, 1999 were as follows
(in thousands):
<TABLE>
<S> <C>
2000 $ 656
2001 455
2002 256
2003 149
2004 96
Thereafter 2,016
-------
$ 3,628
=======
</TABLE>
Total rent expense for 1999, 1998 and 1997 was $657,000, $384,000 and
$297,000, respectively.
8. Shareholders' Equity
Initial Public Offering
In July 1997, the Company completed an initial public offering of 6,900,000
ordinary shares at a price of $8.50 per share. Net proceeds from the initial
public offering were approximately $53.0 million. Warrants to purchase 225,000
Series B convertible preferred shares were exercised prior to the initial
public offering resulting in net proceeds to the Company of $1,050,000.
Concurrent with the initial public offering, each of the 860,593 shares of
Series B convertible preferred shares and each of the 600,000 shares of Series
D convertible preferred shares outstanding were converted into 8,763,558
shares of the Company's ordinary shares. Net proceeds of the initial public
offering were approximately $53.0 million.
Share Repurchase Program
In June 1998, the Company's wholly-owned subsidiary, GTI, commenced a
program to buy an aggregate of up to five percent of the ordinary shares of
the Company. During 1998, GTI acquired 455,200 ordinary shares for an
aggregate purchase price of $2,203,000. No additional ordinary shares were
repurchased during 1999. Such repurchased ordinary shares were accounted for
as treasury shares and resulted in a reduction of shareholders' equity. When
treasury shares were reissued, the Company used a last-in, first-out method
and the excess of the repurchase cost over the reissuance price was treated as
a reduction of retained earnings. As of December 31, 1999, all of the
Company's treasury shares have been reissued.
48
<PAGE>
Options and Share Purchase Rights
In 1993, the Company issued 3,000,000 ordinary shares to an independent
trustee (the "Trust Arrangement"). The shares under the Trust Arrangement are
restricted for use under individual share purchase agreements and share
options to employees and consultants. No purchase rights or options have been
granted subsequent to 1997. The shares under the Trust Arrangement cannot be
returned to the Company, have voting and dividend rights, and are considered
issued and outstanding. The shares remain in trust until paid for pursuant to
the exercise of a purchase right or option grant.
In June 1997, the Company's shareholders approved the Galileo Technology
Ltd. 1997 Employees' Stock Option Plan (the "GTL Plan") under which the
Company is authorized to issue options to purchase ordinary shares to its
Israeli employees. Options granted under the GTL Plan expire eight years from
the date of grant and are subject to earlier termination upon termination of
the optionee's employment or other relationship with the Company. Unless
otherwise determined by the Board of Directors, one half of the optioned
shares vest two years from the date of grant and an additional 1/48th of the
optioned shares vest each month thereafter. ordinary shares subject to
outstanding options that expire or terminate prior to exercise will be
available for future issuance under the GTL Plan. Subject to applicable laws,
the Board of Directors may amend or modify the GTL Plan at any time. The GTL
Plan will terminate in June 2005, unless sooner terminated by the Board of
Directors.
The Galileo Technology Ltd. 1997 GTI Stock Option Plan amended and restated
the GTI Stock Option Plan (together, the "GTI Plan") under which the Company
is authorized to issue options to purchase shares to its U.S. employees. The
GTI Plan was approved by the Company's shareholders in June 1997. ordinary
shares subject to outstanding options that expire or terminate prior to
exercise will be available for future issuance under the GTI Plan.
Under the GTI Plan, employees (including officers and directors) of GTI
may, at the discretion of the Board of Directors, be granted incentive stock
options to purchase ordinary shares at an exercise price not less than 100% of
the fair market value of such shares on the date of grant. The exercise price
for options to a 10% shareholder must not be less than 110% of the fair market
value of such shares on the grant date. Non-statutory stock options granted
pursuant to the GTI Plan must have an exercise price of not less than 85% of
the fair market value of such shares on the date of grant. The Board of
Directors has complete discretion to determine which eligible individuals are
to receive stock option grants, the number of shares subject to each such
grant, the status of any option as either an incentive option or a non-
statutory option, the vesting schedule for each option and the maximum term
for which each option is to remain outstanding. Unless otherwise determined by
the Board of Directors, one quarter of the optioned shares vest one year from
the date of the grant and an additional 1/48th of the optioned shares vest
each month thereafter as long as the holder continues to be an employee or
consultant of GTI or the Company.
In August 1998, the Company's shareholders approved the Galileo Technology
Ltd. 1998 Nonemployee Directors' Stock Option Plan (the "Directors Plan")
under which the Company is authorized to issue options to purchase ordinary
shares to its nonemployee directors. Options granted under the Directors Plan
expire ten years from the date of grant and are subject to earlier termination
if the optionee ceases to be a director of the Company. ordinary shares
subject to outstanding options that expire or terminate prior to exercise will
be available for future issuance under the Directors Plan. The Directors Plan
will terminate in June 2008.
During 1998, the Company adopted two separate Option Exchange Programs to
allow employees to exchange their out-of-the-money options for new options
with an exercise price equal to the fair value of the Company's ordinary
shares on the date of the exchange. The first program resulted in a total of
approximately 1,328,000 options with a weighted average exercise price of
$14.57 being exchanged for new options with an exercise price of $6.50. The
second, subsequent program resulted in a total of approximately 2,374,000
options with a weighted average exercise price of $8.40 being exchanged for
new options with an exercise price of $3.50. The new options will continue to
vest in accordance with the original options' vesting schedules and cannot be
exercised prior to one year from the date of the exchange. These programs are
reflected in the following table as cancellations and grants.
49
<PAGE>
As of December 31, 1999, 15,557,436 ordinary shares have been authorized
for issuance pursuant to options and purchase rights under the above terms. Of
these shares, 1,019,136 shares were available for future grant. The Board of
Directors has appointed officers of the Company to determine the allocation of
the shares between the plans.
As of December 31, 1999, 200,000 ordinary shares have been authorized for
issuance under the Directors Plan. Of these shares, 75,000 shares were
available for future grant.
A summary of option and purchase right activity is as follows:
<TABLE>
<CAPTION>
Activity Outstanding
----------------------- -----------------------------
Weighted Average
Share Trust Number of Purchase/Exercise
Options Arrangement Shares Price
---------- ----------- ---------- -----------------
<S> <C> <C> <C> <C>
Balance, January 1, 1997 1,111,200 3,446,262 4,557,462 $ 0.068
Grant of purchase rights
or options 2,148,222 82,278 2,230,500 $ 8.755
Exercise of purchase
rights or options (229,102) (460,492) (689,594) $ 0.046
Forfeited and cancelled (57,000) -- (57,000) $ 2.523
---------- ---------- ----------
Balance, December 31,
1997 2,973,320 3,068,048 6,041,368 $ 3.255
Grant of options 6,413,302 -- 6,413,302 $ 6.034
Exercise of purchase
rights or options (563,724) (877,830) (1,441,554) $ 1.218
Forfeited and cancelled (3,783,028) -- (3,783,028) $10.540
---------- ---------- ----------
Balance, December 31,
1998 5,039,870 2,190,218 7,230,088 $ 2.435
Grant of options 3,163,113 -- 3,163,113 $17.542
Exercise of purchase
rights or options (1,259,697) (1,144,897) (2,404,594) $ 2.553
Forfeited and cancelled (391,813) -- (391,813) $ 3.807
---------- ---------- ----------
Balance, December 31,
1999 6,551,473 1,045,321 7,596,794 $ 8.797
========== ========== ========== =======
Exercisable at:
December 31, 1999 2,124,238 $ 3.099
========== =======
December 31, 1998 1,880,954 $ 0.270
========== =======
December 31, 1997 2,114,636 $ 0.068
========== =======
</TABLE>
The options and purchase rights outstanding at December 31, 1999 have been
segregated into ranges of exercise prices as follows:
<TABLE>
<CAPTION>
Outstanding Exercisable
--------------------------------------------------- ----------------------------------
Number of Weighted-Average Weighted-Average Number of
Range of Options/Purchase Remaining Purchase/Exercise Options/ Purchase Weighted-Average
Exercise Prices Rights Contractual Life Price Rights Exercise Price
- --------------- ---------------- ---------------- ----------------- ----------------- ----------------
<S> <C> <C> <C> <C> <C>
$ 0.001--$ 2.500 1,447,236 6.7 $ 0.358 801,825 $ 0.230
$ 3.500 1,978,936 8.1 $ 3.500 830,921 $ 3.500
$ 4.125--$ 9.688 1,520,591 8.8 $ 6.209 438,943 $ 6.574
$10.250--$20.500 1,035,070 9.4 $13.941 52,549 $11.500
$21.063--$29.063 1,614,961 9.7 $21.996 -- $ --
--------- ---------
$ 0.001--$29.063 7,596,794 8.8 $ 8.797 2,124,238 $ 3.099
========= === ======= ========= =======
</TABLE>
The weighted average fair value of purchase rights and options granted
during 1999, 1998 and 1997 was $12.37, $3.30 and $4.58, respectively. In 1997,
the Company granted 797,400 purchase rights or options at below deemed fair
value with a weighted average exercise price of $1.15 and a weighted average
fair value of $2.20. Deferred compensation of approximately $1,086,000 was
recorded in connection with these grants.
50
<PAGE>
Pro forma Disclosures
Pro forma information regarding net income and earnings per share is
required by SFAS 123, which also requires that the information be determined
as if the Company had accounted for its employee share options granted
subsequent to December 31, 1994 under the fair value method of that statement.
The fair value for these options was estimated at the date of grant using the
Black-Scholes option pricing model using a graded vesting approach with the
following assumptions for 1999, 1998 and 1997: risk-free interest rates of 5%
to 6.25%; no dividend yield; weighted-average expected term of the option of
approximately three years for options granted in 1999 and 1998, respectively
and approximately four years for options granted in 1997; and volatility of
0.83, 0.85 and 0.71, respectively.
The Black-Scholes option pricing model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected share price volatility.
Because the Company's employee share options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee share
options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma information follows (in thousands, except for per share
information):
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Net income as reported $26,109 $15,450 $10,336
Pro forma net income $11,995 $ 9,907 $ 8,291
Pro forma earnings per share:
Basic $ 0.29 $ 0.24 $ 0.26
Diluted $ 0.28 $ 0.24 $ 0.22
Shares used in calculating pro forma earnings per
share:
Basic 41,233 40,698 31,896
Diluted 43,565 41,528 37,728
</TABLE>
Employee Stock Purchase Plan
On January 6, 1998, the shareholder's approved the Galileo Technology Ltd.
1997 Employee Stock Purchase Plan (the "ESPP"). The ESPP permits eligible
employees to purchase shares at a price equal to 85% of the lower of the fair
market value at the beginning or end of each offering period. As of December
31, 1999, a total of 103,043 shares have been reserved for further issuance
under the ESPP. During 1999 and 1998, respectively, there were 83,189 and
56,388 shares issued under the ESPP. The number of shares reserved for
issuance under the ESPP automatically increases by 105 percent of the number
of shares purchased under the ESPP in the previous calendar year. The increase
is effected each year on January 1.
Ordinary Shares Reserved for Future Issuance
As of December 31, 1999, approximately 7,748,652 ordinary shares are
reserved for future issuance under the Company's share option plans and the
ESPP.
9. Nonqualified Deferred Compensation Plan
During 1998, the Company adopted a nonqualified deferred compensation plan.
This plan allows officers and certain other employees of the Company to defer
all or part of their compensation, to be paid to the participants or their
designated beneficiaries upon retirement, death or separation from the
Company. The amount
51
<PAGE>
of compensation deferred and related investment earnings are held in an
irrevocable rabbi trust and is included in other assets in the Company's
balance sheet. The offsetting liability is included in other liabilities
reflecting the amounts due employees.
10. Income Taxes
The tax provision consists of the following (in thousands):
<TABLE>
<CAPTION>
Year ended
December 31,
----------------------
1999 1998 1997
------- ------- -----
<S> <C> <C> <C>
Current:
United States $ 924 $ 1,140 $ 800
Israel -- -- --
------- ------- -----
924 1,140 800
Deferred:
United States 456 (380) (642)
Israel -- -- --
------- ------- -----
456 (380) (642)
======= ======= =====
$ 1,380 $ 760 $ 158
======= ======= =====
</TABLE>
Tax benefits resulting from the exercise of nonqualified share options and
the disqualifying dispositions of shares acquired under the Company's employee
share option plans reduced United States taxes currently payable as shown
above by approximately $698,000, $738,000 and $132,000 for 1999, 1998 and 1997
respectively. Such benefit was credited to shareholders' equity.
The Company has been granted "Approved Enterprise" status by the Israeli
Government under the Law for the Encouragement of Capital Investments, 1959
(the "Investment Law"). The Approved Enterprise status will allow the Company
a tax holiday on undistributed Israeli income. The benefits under these
investment plans are scheduled to fully expire in 2006.
In the event of distribution of cash dividends from income which is tax
exempt due to the above, the Company would have to pay tax at the rate of 20%
on an amount equal to the amount distributed. The Company currently has no
plans to distribute dividends and intends to retain future earnings to finance
the development of its business. The tax exempt income attributable to the
Approved Enterprise can be distributed to shareholders without subjecting the
Company to taxes only upon the complete liquidation of the Company. All of the
Company's retained earnings are attributable to the Company's "approved
enterprises" and are not available for distribution without the payment of
tax. Should all of the earnings be distributed, the Company would be required
to pay $10.7 million in taxes.
The entitlement to the above tax holiday is conditional upon the Company's
fulfilling the conditions stipulated by the Investment Law, regulations
published thereunder and the instruments of approval for the specific
investments in Approved Enterprises. In the event of a failure to comply with
these conditions, the benefits may be canceled and the Company may be required
to refund the amount of the benefits, in whole or in part, with the addition
of CPI-adjustment differences and interest. The Company's management believes
that the Company is in compliance with all of the required terms.
Israeli taxable income not eligible for "Approved Enterprise" benefits
mentioned above is taxed at the regular corporate tax rate of 36% in 1999,
1998 and 1997.
Pretax income from foreign (U.S.) operations was $1,659,000 in 1999,
$1,103,000 in 1998 and $550,000 in 1997.
52
<PAGE>
A reconciliation between the Company's effective tax rate and the Israeli
statutory rate is as follows (in thousands):
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Income before provision for income taxes $27,489 $16,210 $10,494
Statutory Israeli rate 36% 36% 36%
Expected tax (benefit) $ 9,896 $ 5,836 $ 3,778
"Approved Enterprise" benefit (9,896) (5,836) (3,778)
United States tax on foreign (U.S.)
operations, net 1,380 760 158
------- ------- -------
$ 1,380 $ 760 $ 158
======= ======= =======
</TABLE>
The per share basic and diluted benefit of the Israeli "Approved
Enterprise" benefit is $0.24 and $0.22, respectively, for 1999, $0.14 for
1998, and $0.12 and $0.10, respectively, for 1997.
Significant components of the Company's deferred tax assets are as follows
(in thousands):
<TABLE>
<CAPTION>
December
31,
------------
1999 1998
---- ------
<S> <C> <C>
Deferred tax assets:
Certain accrued expenses and reserves that are not
currently
deductible for income tax purposes $506 $ 731
Compensation expense not currently deductible 70 394
Other, net (9) (46)
---- ------
Total deferred assets 567 1,079
Valuation allowance -- (56)
---- ------
Net deferred tax assets $567 $1,023
==== ======
</TABLE>
The valuation allowance decreased by $94,000 and $100,000 during 1998 and
1997, respectively.
11. Geographic Information and Major Customers
The Company and its subsidiaries operate in one segment, principally the
definition, development and marketing of semiconductor devices for the data
communication market. Operations in Israel include research and development
and production contracting. Operations in the U.S. include marketing and
sales. The following is a summary of operations within geographic areas (in
thousands). Revenue is attributed to the geographic area in which the sale
originates. Long-lived assets primarily represent property and equipment, net.
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------
1999 1998 1997
------- -------- --------
<S> <C> <C> <C>
Revenues from external customers:
United States $79,654 $ 51,589 $ 36,505
Israel 63 54 --
------- -------- --------
$79,717 $ 51,643 $ 36,505
======= ======== ========
Long-lived assets:
United States $ 602 $ 543
Israel 9,091 4,773
------- --------
$ 9,693 $ 5,316
======= ========
</TABLE>
53
<PAGE>
12. Subsequent Events
On February 29, 2000, the Company announced that it expects to record non-
recurring charges of approximately $2.5 million in the quarter ended March 31,
2000. These charges will reflect increased inventory reserve requirements and
the write off of investments and intellectual property for discontinued
projects that no longer fit with the Company's business strategies.
54
<PAGE>
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Additions
-------------------
Balance at Charged to Charged Balance at
Beginning Costs and to Other End of
Description of Period Expenses Accounts Deductions Period
----------- ---------- ---------- -------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Year ended December 31,
1999:
Product return reserve $ 766 $ 200 $ -- $(438)(2) $ 528
Accrued warranty costs 307 60 -- -- 367
Allowance for doubtful
accounts 207 -- -- (4)(1) 203
------ ------ ----- ----- ------
Total $1,280 $ 260 $ -- $(442) $1,098
====== ====== ===== ===== ======
Year ended December 31,
1998:
Product return reserve $ 770 $ 200 $ -- $(204)(2) $ 766
Accrued warranty costs 232 75 -- -- 307
Allowance for doubtful
accounts 177 50 -- (20)(1) 207
------ ------ ----- ----- ------
Total $1,179 $ 325 $ -- $(224) $1,280
====== ====== ===== ===== ======
Year ended December 31,
1997:
Product return reserve $ 75 $ 695 $ -- $ -- $ 770
Accrued warranty costs -- 232 -- -- 232
Allowance for doubtful
accounts 18 159 -- -- 177
------ ------ ----- ----- ------
Total $ 93 $1,086 $ -- $ -- $1,179
====== ====== ===== ===== ======
</TABLE>
- --------
(1) Uncollectible accounts written off, net of recoveries.
(2) Product returns charged to the product return reserve.
55
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act of
1934, the registrant certifies that it meets all of the requirements for filing
on Form 20-F and has duly caused this registration statement annual report to
be signed on its behalf by the undersigned, thereunto duly authorized.
Galileo Technology ltd.
/s/ Michael T. Tate
By: _________________________________
Michael T. Tate,
Vice President of Finance
May 16, 2000
56
<PAGE>
EXHIBIT 4.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 333-30072) pertaining to the Galileo Technology Ltd. 1997 Employees'
Stock Option Plan and Galileo Technology Ltd. 1997 GTI Stock Option Plan, in the
Registration Statement (Form S-8 No. 333-30078) pertaining to the Galileo
Technology Ltd. 1997 Employee Stock Purchase Plan, and in the Registration
Statement (Form S-8 333-63205) pertaining to the Galileo Technology Ltd. 1998
Nonemployee Directors' Stock Option Plan of our report dated January 14, 2000,
except for note 12 as to which the date is February 29, 2000, with respect to
the consolidated financial statements and schedule of Galileo Technology Ltd.
included in the Annual Report (Form 20-F) for the year ended December 31, 1999.
/s/ Ernst & Young LLP
Palo Alto, California
May 16, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS IN THE ANNUAL REPORT ON FORM 20-F OF GALILEO TECHNOLOGY
LTD. FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1999 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 42,648
<SECURITIES> 63,005
<RECEIVABLES> 12,726
<ALLOWANCES> 203
<INVENTORY> 8,094
<CURRENT-ASSETS> 129,319
<PP&E> 15,258
<DEPRECIATION> 5,870
<TOTAL-ASSETS> 140,738
<CURRENT-LIABILITIES> 17,281
<BONDS> 0
0
0
<COMMON> 74,440
<OTHER-SE> 46,865
<TOTAL-LIABILITY-AND-EQUITY> 140,738
<SALES> 79,717
<TOTAL-REVENUES> 79,717
<CGS> 28,041
<TOTAL-COSTS> 28,041
<OTHER-EXPENSES> 16,633
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4
<INCOME-PRETAX> 27,489
<INCOME-TAX> 1,380
<INCOME-CONTINUING> 26,109
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 26,109
<EPS-BASIC> 0.63
<EPS-DILUTED> 0.58
</TABLE>
