<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
____________________________
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended June 30, 1999
or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ______________
to ______________
Commission File Number 0-23441
____________________
POWER INTEGRATIONS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3065014
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
477 N. Mathilda Avenue, Sunnyvale, California 94086
(Address of principal executive offices) (Zip code)
(408) 523-9200
(Registrant's telephone number, including area code)
_____________________________
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [_]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at July 31, 1999
--------------------------------- ------------------------------------
Common Stock, $.001 par value 13,155,875 shares
================================================================================
<PAGE>
POWER INTEGRATIONS, INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page
<S> <C> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Operations 4
Condensed Consolidated Statements of Cash Flows 5
Notes To Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Changes in Securities and Use of Proceeds 25
Item 3. Defaults upon Senior Securities 25
Item 4. Submission of Matters to Vote of Security Holders 25
Item 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 26
SIGNATURES 27
TOPSwitch, TinySwitch and EcoSmart are trademarks of Power Integrations, Inc.
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
POWER INTEGRATIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------- --------------
<S> <C> <C>
(unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents........................................................ $ 7,882 $24,176
Short-term investments........................................................... 43,632 20,242
Accounts receivable.............................................................. 7,700 4,640
Inventories...................................................................... 8,284 8,845
Prepaid expenses and other current assets........................................ 3,953 812
------------- --------------
Total current assets....................................................... 71,451 58,715
------------- --------------
PROPERTY AND EQUIPMENT, net......................................................... 8,065 6,339
------------- --------------
$79,516 $65,054
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of capitalized lease obligations................................. $ 1,699 $ 1,950
Accounts payable................................................................. 7,245 5,866
Accrued payroll and related expenses............................................. 2,573 2,394
Taxes payable and other accrued liabilities...................................... 1,625 2,951
Deferred income on sales to distributors......................................... 2,566 2,566
------------- --------------
Total current liabilities.................................................. 15,708 15,727
------------- --------------
CAPITALIZED LEASE OBLIGATIONS, net of current portion............................... 1,944 1,963
------------- --------------
STOCKHOLDERS' EQUITY:
Common stock..................................................................... 13 12
Additional paid-in capital....................................................... 61,539 57,289
Common stock warrants............................................................ -- 12
Stockholder notes receivable..................................................... (264) (274)
Deferred compensation............................................................ (251) (321)
Cumulative translation adjustment................................................ (70) (57)
Retained earnings ( deficit)..................................................... 897 (9,297)
------------- --------------
Total stockholders' equity................................................. 61,864 47,364
------------- --------------
$79,516 $65,054
============= ==============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
balance sheets.
3
<PAGE>
POWER INTEGRATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- -----------------------------
1999 1998 1999 1998
--------------- ---------- -------------- ------------
<S> <C> <C> <C> <C>
NET REVENUES:
Product sales........................................... $22,655 $14,647 $43,101 $28,549
License fees and royalties.............................. 324 466 699 990
--------------- ---------- -------------- ------------
Total net revenues................................... 22,979 15,113 43,800 29,539
--------------- ---------- -------------- ------------
COST OF REVENUES.......................................... 10,482 8,254 19,949 16,230
--------------- ---------- -------------- ------------
GROSS PROFIT.............................................. 12,497 6,859 23,851 13,309
--------------- ---------- -------------- ------------
OPERATING EXPENSES:
Research and development................................ 2,535 1,720 4,871 3,279
Sales and marketing..................................... 2,729 1,724 5,204 3,613
General and administrative.............................. 1,427 730 2,796 1,278
--------------- ---------- -------------- ------------
Total operating expenses............................. 6,691 4,174 12,871 8,170
--------------- ---------- -------------- ------------
INCOME FROM OPERATIONS.................................... 5,806 2,685 10,980 5,139
--------------- ---------- -------------- ------------
OTHER INCOME, net......................................... 433 189 1,017 376
--------------- ---------- -------------- ------------
INCOME BEFORE PROVISION FOR
INCOME TAXES............................................. 6,239 2,874 11,997 5,515
PROVISION FOR INCOME TAXES................................ 939 721 1,803 1,384
--------------- ---------- -------------- ------------
NET INCOME................................................ $ 5,300 $ 2,153 $10,194 $ 4,131
=============== ========== ============== ============
EARNINGS PER SHARE:
Basic................................................... $0.41 $0.18 $0.80 $0.34
=============== ========== ============== ============
Diluted................................................. $0.38 $0.16 $0.73 $0.31
=============== ========== ============== ============
SHARES USED IN PER SHARE CALCULATION:
Basic................................................... 12,903 12,087 12,773 12,083
=============== ========== ============== ============
Diluted................................................. 14,092 13,119 13,908 13,123
=============== ========== ============== ============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
<PAGE>
POWER INTEGRATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(In thousands)
<TABLE>
<CAPTION>
Six Months Ended June 30,
--------------------------------
1999 1998
--------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income........................................................................ $ 10,194 $ 4,131
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization................................................... 1,559 1,468
Deferred compensation expense................................................... 70 70
Deferred income taxes........................................................... (2,957) --
Tax benefit associated with employee stock plans................................ 3,006 --
Change in operating assets and liabilities:
Accounts receivable.......................................................... (3,060) 1,146
Inventories.................................................................. 561 (3,625)
Prepaid expenses and other current assets.................................... (184) 97
Accounts payable............................................................. 1,379 (674)
Accrued liabilities.......................................................... (1,160) 1,165
Deferred income on sales to distributors..................................... -- 1,491
--------------- -------------
Net cash provided by operating activities................................. 9,408 5,269
--------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment............................................. (2,513) (595)
Purchases of short-term investments............................................. (40,072) (29,114)
Proceeds from sales and maturities of short-term investments.................... 16,682 6,392
--------------- -------------
Net cash used in operating activities..................................... (25,903) (23,317)
--------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock...................................... 1,233 (34)
Proceeds from stockholder note repayment........................................ 10 --
Principal payments under capitalized lease obligations.......................... (1,042) (990)
--------------- -------------
Net cash provided by (used in) financing activities....................... 201 (1,024)
--------------- -------------
NET DECREASE IN CASH AND CASH EQUIVALENTS......................................... (16,294) (19,072)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD.................................. 24,176 25,553
--------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD........................................ $ 7,882 $ 6,481
=============== =============
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Capitalized lease obligations incurred for property and equipment............... $ 772 $ 1,439
=============== =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest.......................................................... $ 173 $ 213
=============== =============
Cash paid for income taxes...................................................... $ 3,161 $ 449
=============== =============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE>
POWER INTEGRATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION:
The condensed consolidated financial statements include the accounts of Power
Integrations, Inc. (the Company), a Delaware corporation, and its wholly owned
subsidiaries. Significant inter-company accounts and transactions have been
eliminated.
While the financial information furnished is unaudited, the condensed
consolidated financial statements included in this report reflect all
adjustments (consisting only of normal recurring adjustments) which the Company
considers necessary for the fair presentation of the results of operations for
the interim periods covered and of the financial condition of the Company at the
date of the interim balance sheet. The results for interim periods are not
necessarily indicative of the results for the entire year. The condensed
consolidated financial statements should be read in conjunction with the Power
Integrations, Inc. consolidated financial statements for the year ended December
31, 1998 included in its Form 10-K.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Cash and Cash Equivalents and Short-Term Investments
The Company considers cash invested in highly liquid financial instruments
with an original maturity of three months or less to be cash equivalents. Cash
investments in highly liquid financial instruments with original maturities
greater than three months but not longer than fifteen months are classified as
short-term investments. As of June 30, 1999, the Company's short-term
investments consisted of U.S. Government backed securities, corporate commercial
paper and other high quality commercial and municipal securities, which were
classified as held to maturity and were valued using the amortized cost method
which approximates market.
Revenue Recognition
Product revenues consist of sales to original equipment manufacturers, or
OEMs, merchant power supply manufacturers and distributors. Revenues from
product sales to OEMs and merchant power supply manufacturers are recognized
upon shipment. Sales to distributors are made under terms allowing certain
rights of return and protection against subsequent price declines on the
Company's products held by the distributors. As a result of the Company's
distributor agreements, the Company defers recognition of revenue and the
proportionate costs of revenues derived from sales to distributors until the
distributors resell the Company's products to their customers. The margin
deferred as a result of this policy is reflected as "deferred income on sales to
distributors" in the accompanying condensed consolidated balance sheets.
Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Segment Reporting
During 1998, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 131, "Disclosures About Segments of an Enterprise and Related
Information." SFAS 131 requires a new basis of determining reportable business
segments, i.e., the management approach. This approach requires that business
segment information used by management to assess performance and manage company
resources be the source for information disclosure. On this basis, the Company
is organized and operates as one business segment, the design, development,
manufacture and marketing of proprietary, high-voltage, analog integrated
circuits for use primarily in the AC to DC power conversion markets.
6
<PAGE>
POWER INTEGRATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
New Accounting Standards
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
establishes accounting and reporting standards for derivative instruments,
hedging activities, and exposure definition. SFAS No. 133 requires companies to
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. SFAS No. 133 is
effective for all fiscal quarters of fiscal years beginning after June 15, 2000.
The Company does not expect the adoption of SFAS No. 133 to have a material
impact on its financial statements.
3. INVENTORIES:
Inventories are stated at the lower of cost (first-in, first-out) or market.
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------------------------
<S> <C> <C>
Raw materials......................................................... $1,692 $3,132
Work-in-process....................................................... 2,912 2,901
Finished goods........................................................ 3,680 2,812
------ ------
$8,284 $8,845
====== ======
</TABLE>
4. SIGNIFICANT CUSTOMERS AND EXPORT SALES:
Customer Concentration
The Company's end user base is highly concentrated and a relatively small
number of OEMs and distributors accounted for a significant portion of the
Company's net revenues. For the six months ended June 30, 1999 and 1998, ten
customers accounted for approximately 70% and 65% of total net revenues,
respectively.
The following customers accounted for more than 10% of total net revenues:
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------------------------
Customer 1999 1998
-------- --------------------------
<S> <C> <C>
A..................................................................... 17% 21%
B..................................................................... 11% 13%
C..................................................................... 11% *
</TABLE>
- ------------------
* less than 10% or no sales
7
<PAGE>
POWER INTEGRATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Export Sales
The Company markets its products in North America and in foreign countries
through its sales personnel and a worldwide network of independent sales
representatives and distributors. As a percentage of total net revenues, export
sales, which consist of domestic sales to customers in foreign countries, are
comprised of the following:
<TABLE>
<CAPTION>
Six Months Ended
June 30,
---------------------------
1999 1998
---------------------------
<S> <C> <C>
Japan...................................................................... 3% 3%
Taiwan..................................................................... 17% 26%
Hong Kong/China............................................................ 20% 23%
Korea...................................................................... 14% 7%
Western Europe............................................................. 16% 16%
Other...................................................................... 8% 6%
---- ----
Total foreign.................................................... 78% 81%
==== ====
</TABLE>
5. EARNINGS PER SHARE:
Earnings per share are calculated in accordance with SFAS No. 128 "Earnings
Per Share". SFAS No. 128 requires companies to compute earnings per share under
two different methods (basic and diluted). Basic earnings per share are
calculated by dividing net income by the weighted average shares of common stock
outstanding during the period. Diluted earnings per share are calculated by
dividing net income by the weighted average shares of outstanding common stock
and common stock equivalents during the period. Common stock equivalents
included in the diluted calculation consist of dilutive shares issuable upon the
exercise of outstanding common stock options and warrants computed using the
treasury stock method.
The following table sets forth the calculation of basic and diluted earnings
per share (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
1999 1998 1999 1998
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Basic earnings per share:
Net income................................................... $ 5,300 $ 2,153 $10,194 $ 4,131
----------- ---------- ---------- -----------
Weighted average common shares............................... 12,903 12,087 12,773 12,083
----------- ---------- ---------- -----------
Basic earnings per share.................................. $ 0.41 $ 0.18 $ 0.80 $ 0.34
----------- ---------- ---------- -----------
Diluted earnings per share:
Net income................................................... $ 5,300 $ 2,153 $10,194 $ 4,131
----------- ---------- ---------- -----------
Weighted average common shares............................... 12,903 12,087 12,773 12,083
Weighted average common share equivalents:
Options................................................... 1,070 719 985 724
Employee stock purchase plan.............................. 42 34
Warrants.................................................. 77 313 116 316
----------- ---------- ---------- -----------
Diluted weighted average common shares....................... 14,092 13,119 13,908 13,123
----------- ---------- ---------- -----------
Diluted earnings per share............................. $ 0.38 $ 0.16 $ 0.73 $ 0.31
=========== ========== ========== ===========
</TABLE>
8
<PAGE>
POWER INTEGRATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. PROVISION FOR INCOME TAXES:
Income tax expense for the six-month periods ended June 30, 1999 and 1998
includes a provision for Federal, state and foreign taxes based on the annual
estimated effective tax rate applicable to the Company and its subsidiaries for
the year. The difference between the statutory rate and the Company's effective
tax rate for the six months ended June 30, 1999 is primarily due to the
beneficial impact of deferred taxes resulting from a reduction in the valuation
allowance of $3.0 million.
7. LEGAL PROCEEDINGS:
In July 1998, the Company filed a complaint for patent infringement in the
U.S. District Court, Northern District of California, against its largest end
user, Motorola. In August 1998, the Company voluntarily dismissed the complaint,
and filed a new complaint in the U.S. District Court, District of Delaware,
alleging that Motorola has infringed and continues to infringe on two of the
Company's circuit patents. The Company seeks, among other things, an order
enjoining Motorola from infringing on the Company's patents and an award for
damages resulting from the alleged infringement. In October 1998, Motorola
asserted various counterclaims against the Company, alleging that the Company is
infringing on certain of Motorola's patents. The Company believes that
Motorola's counterclaims are without merit and intends to vigorously defend
itself against such claims. The trial is currently scheduled to commence in
October 1999.
Litigation may be necessary to resolve the claims asserted by the Company
against Motorola, and to resolve the claims Motorola has asserted against the
Company. There can be no assurance that the Company will prevail in any future
litigation. Any such litigation whether or not determined in the Company's favor
or settled by the Company, would be costly and would divert the efforts and
attention of the Company's management and technical personnel from normal
business operations, which could have a material adverse effect on the Company's
business, financial condition and operating results. Adverse determinations in
litigation could result in the loss of the Company's proprietary rights, subject
the Company to significant liabilities, require the Company to seek licenses
from third parties or prevent the Company from licensing its technology, any of
which could have a material adverse effect on the Company's business, financial
condition and operating results.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This Management's Discussion and Analysis of Financial Condition and
Operating results includes a number of forward-looking statements which reflect
our current views with respect to future events and financial performance. These
forward-looking statements are subject to certain risks and uncertainties,
including those discussed in the "Risk Factors" and elsewhere in this report,
that could cause actual results to differ materially from historical results or
those anticipated. In this report, the words "anticipates," "believes,"
"expects," "future," "intends," and similar expressions identify forward-looking
statements. We caution you not to place undue reliance on these forward-looking
statements, which speak only as of the date of this report.
The following management's discussion and analysis of financial condition and
results of operations should be read in conjunction with management's discussion
and analysis of financial condition and results of operations included in our
Form 10-K for the year ended December 31, 1998.
Overview
We design, develop, manufacture and market proprietary, high-voltage, analog
integrated circuits, or ICs, for use primarily in AC to DC power conversion
markets. We have targeted high-volume power supply markets, including the
cellular telephone, personal computer, cable and direct broadcast satellite and
various consumer and industrial electronics markets. Our initial focus is on
those markets that are sensitive to size, portability, energy efficiency, time-
to-market and benefits of integrated power supplies. We believe our patented
TOPSwitch ICs, introduced in 1994, are the first highly integrated power
conversion ICs to achieve widespread market acceptance. We introduced an
enhanced family of ICs, TOPSwitch-II, in April 1997. In September 1998, we
announced the TinySwitch family of integrated circuits that incorporates our new
EcoSmart technology. This new family of ICs is designed to enable a new class of
light, compact, energy-efficient power supplies.
Results of Operations
The following table sets forth certain operating data as a percentage of
total net revenues for the periods indicated.
<TABLE>
<CAPTION>
Percentage of Percentage of
Total Net Revenues for Total Net Revenues for
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- -----------------------------
1999 1998 1999 1998
------------- ------------ ------------- ----------
<S> <C> <C> <C> <C>
Net revenues:
Product sales........................................ 98.6% 96.9% 98.4% 96.6%
Royalties............................................ 1.4 3.1 1.6 3.4
------------- ------------ ------------- ----------
Total net revenues................................ 100.0 100.0 100.0 100.0
------------- ------------ ------------- ----------
Cost of revenues....................................... 45.6 54.6 45.5 54.9
------------- ------------ ------------- ----------
Gross profit........................................... 54.4 45.4 54.5 45.1
------------- ------------ ------------- ----------
Operating expenses:
Research and development............................. 11.0 11.4 11.1 11.1
Sales and marketing.................................. 11.9 11.4 11.9 12.2
General and administrative........................... 6.2 4.8 6.4 4.3
------------- ------------ ------------- ----------
Total operating expenses.......................... 29.1 27.6 29.4 27.6
------------- ------------ ------------- ----------
Income from operations................................. 25.3 17.8 25.1 17.5
Other income, net...................................... 1.9 1.2 2.3 1.3
------------- ------------ ------------- ----------
Income before provision for income taxes............... 27.2 19.0 27.4 18.8
------------- ------------ ------------- ----------
Provision for income taxes............................. 4.1 4.8 4.1 4.7
------------- ------------ ------------- ----------
Net income ............................................ 23.1% 14.2% 23.3% 14.1%
============= ============ ============= ==========
</TABLE>
10
<PAGE>
Comparison of the Three and Six Months Ended June 30, 1999 and 1998
Net revenues. Net revenues consist of revenues from product sales, which
are calculated net of returns and allowances, plus license fees and royalties
paid by licensees of our technology. Net revenues for the second quarter ended
June 30, 1999 were $23.0 million compared to $15.1 million for the second
quarter of 1998, an increase of $7.9 million, or 52.1%. Net revenues for the six
months ended June 30, 1999 were $43.8 million compared to $29.5 million for the
comparable period of 1998, an increase of $14.3 million, or 48.3%.
Net revenues from product sales represented $22.7 million and $14.6 million
in the second quarter of 1999 and 1998, respectively. Net revenues from product
sales represented $43.1 million and $28.5 million in the first half of 1999 and
1998, respectively. The increase in net revenues from product sales for the
three months and six months ended June 30, 1999 was due primarily to strong
demand for our products across all of our major markets and geographies. In
total, sales of our TOPSwitch and TinySwitch products accounted for 96.0% of net
product revenues both for the quarter and the six months ended June 30, 1999.
Net revenues from royalties were $324,000 for the second quarter of 1999,
compared to $466,000 for the second quarter of 1998, and $699,000 for the six
months ended June 30, 1999, compared to $990,000 for the same period in 1998.
International sales were $17.6 million in the second quarter of 1999 compared
to $12.4 million for the same period in 1998, an increase of $5.2 million, or
41.0%, which represented 76.4% of net revenues compared to 82.4% in the
comparable period of 1998. International sales were $34.3 million for the six
months ended June 30, 1999 compared to $24.0 million for the same period in
1998, an increase of $10.3 million, or 42.7%, which represented 78.3% of net
revenues compared to 81.4% in the comparable period of 1998. Although the power
supplies using our products are designed and distributed worldwide, most of
these power supplies are manufactured in Asia. As a result, sales to this region
were 59.6% and 70.7% of product sales for the three months ended June 30, 1999
and 1998, respectively, and 61.6% and 69.2% of product sales for the six months
ended June 30, 1999 and 1998, respectively. We expect international sales to
continue to account for a large portion of our net revenues.
Direct sales for the second quarter of 1999 were divided 43.0% to
distributors and 57.0% to original equipment manufacturers, or OEMs, and power
supply merchants, compared to 51.3% to distributors and 48.7% to OEMs and power
supply merchants for the same quarter in 1998. For the six months ended June 30,
1999, direct sales were divided 44.1% to distributors and 55.9% to OEMs and
power supply merchants, compared to 49.8% to distributors and 50.2% to OEMs and
power supply merchants for the same period in 1998. For the quarter ended June
30, 1999, sales to three customers accounted for 12.3%, 14.4% and 10.4% of net
revenues, and for the quarter ended June 30, 1998, two of the same customers
accounted for 24.3% and 11.5% of net revenues, and another customer accounted
for 10.3% of net revenues. For the six months ended June 30, 1999, sales to
three customers accounted for 17.1%, 11.0% and 10.9% of net revenues, and for
the six months ended June 30, 1998, two of the same customers accounted for
21.1% and 12.8% of net revenues.
The exact dollar amounts and percentages of sales to end customers are
difficult to ascertain because most of those sales occur through distributors or
indirectly through sales to merchant power supply manufacturers which, in turn,
sell power supplies to OEMs. However, we estimate that direct and indirect sales
to Motorola, who is our largest end user, accounted for approximately 23% and
13% of net revenues for the quarters ended June 30, 1999 and 1998, respectively,
and approximately 20% and 9% of net revenues for the six months ended June 30,
1999 and 1998, respectively. Direct sales to Motorola were 11.6% and 4.7% of net
revenues for the quarters ended June 30, 1999 and 1998, respectively, and 12.1%
and 4.0% of net revenues for the six months ended June 30, 1999 and 1998,
respectively.
Cost of revenues; Gross profit. Gross profit is equal to net revenues less
cost of revenues. Our cost of revenues consists primarily of costs associated
with the purchase of wafers, the assembly and packaging of our products, and
internal labor and overhead associated with the testing of both wafers and
packaged components. Gross profit for the second quarter of 1999 was $12.5
million, or 54.4%, of net revenues, compared to $6.9 million, or 45.4%, of net
revenues for the same period in 1998. Gross profit for the six months ended June
30, 1999 was $23.9 million, or 54.5%, of net revenues, compared to $13.3
million, or 45.1%, of net revenues for the same period in 1998. The increase in
gross profit for the three months and six months ended June 30, 1999 was
primarily due to
11
<PAGE>
efficiencies achieved from increased sales volume, lower prices for wafers and
better manufacturing yields due to improved test equipment. We cannot assure you
that these or other factors will have a favorable impact on our gross profit in
future periods.
Research and development expenses. Research and development expenses
consist primarily of employee-related expenses, expensed material and facility
costs associated with the development of new processes and new products. We also
expense prototype wafers and mask sets related to new products as research and
development costs until new products are released to production. Research and
development expenses for the second quarter of 1999 were $2.5 million compared
to $1.7 million for the same period in 1998, an increase of $815,000, or 47.4%,
which represented 11.0% and 11.4% of our net revenues in each period,
respectively. Research and development expenses for the first half of 1999 were
$4.9 million compared to $3.3 million for the same period in 1998, an increase
of $1.6 million, or 48.6%, which represented 11.1% of net revenues for both
periods. The increase for the three months and six months ended June 30, 1999
was primarily due to increased salaries and other costs related to the hiring of
additional engineering personnel, outside consulting fees and expensed prototype
materials caused by the transition of foundry manufacturing processes, and
bringing newly developed products into manufacturing. We expect research and
development expenses to continue to increase in absolute dollars but to
fluctuate as a percentage of our net revenues.
Sales and marketing expenses. Sales and marketing expenses consist
primarily of employee-related expenses, commissions to sales representatives and
facilities expenses, including expenses associated with our regional sales and
support offices. Sales and marketing expenses for the second quarter of 1999
were $2.7 million compared to $1.7 million for the same period in 1998, an
increase of $1.0 million, or 58.3%, which represented 11.9% and 11.4% of our net
revenues, respectively. Sales and marketing expenses for the first half of 1999
were $5.2 million compared to $3.6 million for the same period in 1998, an
increase of $1.6 million, or 44.0%, which represented 11.9% and 12.2% of our net
revenues, respectively. The increase for the three months and six months ended
June 30, 1999 was primarily a result of the addition of personnel to support
increased sales, and to increase the availability of field application
engineers. We expect sales and marketing expenses to continue to increase in
absolute dollars, but will fluctuate as a percentage of our net revenues.
General and administrative expenses. General and administrative expenses
consist primarily of employee-related expenses for administration, finance,
human resources and general management, as well as consulting, outside services,
legal and auditing expenses. For the quarters ended June 30, 1999 and 1998,
general and administrative expenses were $1.4 million and $730,000,
respectively, which represented 6.2% and 4.8% of our net revenues. For the six
months ended June 30, 1999 and 1998, general and administrative expenses were
$2.8 million and $1.3 million, respectively, which represented 6.4% and 4.3% of
our net revenues. This increase in spending was primarily attributable to
increased professional and legal expenses related to our patent infringement
lawsuit filed against Motorola. While the lawsuit against Motorola continues, we
expect general and administrative expenses to continue to increase in absolute
dollars, and as a percentage of our net revenues.
Other income, net. Other income, net, for the second quarter of 1999
increased by $244,000 over the same period in 1998, and for the six months ended
June 30, 1999, it increased by $641,000 over the same period in 1998. The
increase for the three month and six month periods ended June 30, 1999 was due
primarily to additional interest income from an increase in short-term
investments in 1999.
Provision for income taxes. Provision for income taxes represents Federal,
state and foreign taxes. The provision for income taxes was $939,000 for the
second quarter of 1999 compared to $721,000 for the same period in 1998. The
provision for income taxes was $1.8 million for the first half of 1999 compared
to $1.4 million for the same period in 1998. Our estimated effective tax rate
for 1999 is 15% compared to 25% used in the same period for 1998. The difference
between the statutory rate and our effective tax rate for 1999 is primarily due
to the beneficial impact of deferred taxes resulting from a reduction in the
valuation allowance.
Liquidity and Capital Resources
At June 30, 1999, we had approximately $51.5 million in cash, cash
equivalents and short-term investments. In addition, under a revolving line of
credit agreement with Union Bank of California, we can borrow up to $10.0
million. A portion of the credit line is used to cover advances for commercial
letters of credit and standby letters of
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credit, which we provide to Matsushita and OKI prior to the shipment of wafers
by those foundries to us. The balance of this credit line is unused and
available. The line of credit agreement contains financial covenants and
requires that we maintain profitability on a quarterly basis and not pay or
declare dividends without the bank's prior consent. We have financed a
significant portion of our machinery and equipment through capital equipment
leases. We financed additional equipment during the six months ended June 30,
1999 in the amount of $772,000. We do not expect to obtain any additional
financing for equipment purchases during the balance of 1999.
As of June 30, 1999, we had working capital, defined as current assets less
current liabilities, of approximately $55.7 million, which was an increase of
approximately $12.7 million over December 31, 1998. Our operating activities
generated cash of $9.4 million and $5.3 million in the six months ended June 30,
1999 and 1998, respectively. Cash generated in the first half of 1999 was
principally the result of net income in the amount of $10.2 million,
depreciation and amortization, tax benefits from employee stock plans and an
increase in accounts payable, partially offset by increases in accounts
receivable and deferred income taxes. Cash generated in the first half of 1998
was principally the result of net income, increases in deferred revenue and
accrued liabilities, and a decrease in accounts receivables, offset by an
increase in inventories.
Our investing activities were a net transfer from cash and cash equivalents
to short-term investments of $23.4 million and $22.7 million in the six months
ended June 30, 1999 and 1998, respectively.
We believe that cash generated from operations, together with existing
sources of liquidity, will satisfy our projected working capital and other cash
requirements for at least the next 12 months.
Year 2000 Issues
Some computers, software, and other equipment include computer code in which
calendar year data is abbreviated to only two digits. As a result of this design
decision, some of these systems could fail to operate or fail to produce correct
results if "00" is interpreted to mean 1900, rather than 2000. These problems
are widely expected to increase in frequency and severity as the year 2000
approaches, and are commonly referred to as the year 2000 problem.
Assessment. The year 2000 problem affects the computers, software and other
equipment that we use, operate or maintain for our operations. Accordingly, we
have organized a program team responsible for monitoring the assessment and
remediation status of our year 2000 projects and reporting such status to our
board of directors. This project team is currently assessing the potential
effect and costs of remediating the year 2000 problem for our internal systems.
As of June 30, 1999, our year 2000 project plan had been reviewed by an
independent consulting firm as to completeness and progress. There were no major
omissions identified. The primary recommendations focus on the importance of
expediting testing and contingency planning activities. The review
recommendations have been incorporated into the plan.
Products. We have evaluated the functionality of our past and present
products with respect to any year 2000 problems and have determined that none of
our past or present products utilize date-related functions and, therefore, have
no year 2000 problems.
Internal Infrastructure. We have completed an inventory of our computers,
software applications, and production equipment used in connection with our
internal operations and we have categorized those systems as critical or non-
critical. We expect to complete the process of modifying, upgrading, or
replacing non-compliant systems categorized as critical, which began during
1998, during the third quarter of 1999.
Systems Other than Information Technology Systems. In addition to computers
and related systems, the operation of office and facilities equipment, including
fax machines, telephone switches, security systems, and other common devices,
may be affected by the year 2000 problem. As of June 30, 1999, we had completed
remediation of critical office and facilities equipment with the exception of
our telephone equipment, which will be replaced during the third quarter of 1999
in response to corporate growth requirements.
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We estimate the total cost to us of completing any required modifications,
upgrades or replacements of our internal systems, beyond expenditures planned to
meet the needs for managing our growth, to be approximately $350,000, almost all
of which we believe will be incurred during 1999. This estimate is being
monitored and we will revise it, as additional information becomes available.
Based on the activities described above, we do not believe that the year 2000
problem will have a material adverse effect on our business or operating
results. In addition, we have not deferred any material information technology
projects as a result of our year 2000 problem activities.
Suppliers. We are in the process of contacting third-party suppliers of
components used in the manufacture of our products to identify and, to the
extent possible, resolve issues involving the year 2000 problem. We have
categorized our suppliers as critical or non-critical and we intend to verify
the status of the materials, parts or products from all critical suppliers as
well as their continued performance into the year 2000 during the third quarter
of 1999. However, we have limited or no control over the actions of these third-
party suppliers. Thus, while we expect that we will be able to resolve any
significant year 2000 problems with these third parties, we cannot assure you
that these suppliers will resolve any or all year 2000 problems before the
occurrence of a material disruption to the operation of our business. Any
failure of these third parties to resolve year 2000 problems with their systems,
on a timely basis, could have a material adverse effect on our business,
operating results and financial condition.
Customers. We are in the process of contacting our customers and, to the
extent possible, determining their year 2000 readiness and ensuring that their
inability to take delivery of planned product shipments will not substantially
impact our revenue flow. However, we have limited or no control over the actions
of these customers. Thus, while we expect that we will be able to resolve any
significant year 2000 problems with them, we cannot ensure you that these
customers will not materially reduce their purchases from us in order to resolve
their year 2000 problems. Any failure of these customers to resolve year 2000
problems with their systems on a timely basis, could have a material adverse
effect on our business, operating results and financial condition.
Most Likely Consequences of Year 2000 Problems. We expect to identify and
resolve all year 2000 problems that could materially adversely affect our
business operations prior to the times when these problems could cause
disruptions to our business. However, we believe that it is not possible to
determine with complete certainty that we have identified or corrected all year
2000 problems affecting us. The number of devices that could be affected and the
interactions among these devices are simply too numerous. In addition, no one
can accurately predict how many year 2000 problem-related failures will occur or
the severity, duration or financial consequences of these perhaps inevitable
failures. As a result, we believe that the following consequences are possible:
. a significant number of operational inconveniences and inefficiencies for
us, our contract manufacturers and our customers that will divert
management's time and attention and financial and human resources from
ordinary business activities;
. several business disputes and claims for pricing adjustments or penalties
due to year 2000 problems by our customers, which we believe will be
resolved in the ordinary course of business; and
. a few serious business disputes alleging that we failed to comply with the
terms of contracts or industry standards of performance, some of which
could result in litigation or contract termination.
Worst case year 2000 scenario. While it is impossible to evaluate every
aspect of year 2000 compliance, we believe the worst case scenario related to
year 2000 compliance issues would be the failure of a sole or limited source
supplier to be year 2000 compliant. The failure of one of these suppliers to be
year 2000 compliant could seriously interrupt the flow of materials into the
manufacturing process and therefore delay the manufacture and sale of our
products. However, due to the general uncertainty inherent in the year 2000
computer problem resulting from the uncertainty of the year 2000 readiness of
third-party suppliers, we are unable to determine at this time whether the
consequences of year 2000 failures will have a material impact on our business.
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Contingency Plans. We are currently developing contingency plans to be
implemented if our efforts to identify and correct year 2000 problems affecting
our internal systems are not effective. We expect to complete our contingency
plans during the third quarter of 1999. Depending on the systems affected, these
plans could include:
. accelerated replacement of affected equipment or software;
. short-to medium-term use of backup equipment and software;
. increased work hours for our personnel; and
. use of contract personnel on an accelerated schedule to correct any year
2000 problems that arise or to provide manual workarounds for information
systems.
Our implementation of any of these contingency plans could have a material
adverse effect on our business, operating results and financial condition.
Disclaimer. The discussion of our efforts and expectations relating to year
2000 compliance are forward-looking statements. Our ability to achieve year
2000 compliance and the level of incremental costs associated therewith could be
adversely affected by, among other things, the availability and cost of
programming and testing resources, third party suppliers' ability to modify
proprietary software, and unanticipated problems identified in the ongoing
compliance review.
New Accounting Standards
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, hedging activities, and exposure
definition. SFAS No. 133 requires companies to recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. SFAS No. 133 is effective for all fiscal
quarters of fiscal years beginning after June 15, 2000. We do not expect that
the adoption of SFAS No. 133 will have a material impact on our financial
statements.
Factors That May Affect Future Results of Operations
Our future results of operations are dependent upon a number of factors,
including those described below. For a complete description of these factors,
see our Form 10-K for the year ended December 31, 1998.
Our Operating Results Fluctuate and Are Unpredictable. Our net revenues and
operating results have varied significantly in the past, are difficult to
forecast, are subject to numerous factors both within and outside of our
control, and may fluctuate significantly in the future. As a result, our
operating results in a future quarter or quarters could fall below the
expectations of public market analysts or investors. If that occurs, the price
of our stock may decline.
Some of the reasons our operating results may fluctuate in the future include
the following:
. Our Operating Results Depend on the Volume and Timing of Orders
Received. Our net revenues and operating results are substantially
dependent upon the volume and timing of orders received from our customers.
We have historically experienced lengthy sales cycles, which limit our
visibility regarding future financial performance. We are also subject to
the risks to which the markets for our customers' or end users' products
are subject, and to technological or other changes in those markets which
may affect customer-buying patterns. In addition, the ordering patterns of
some of our existing large customers have been unpredictable in the past,
and we expect that customer-ordering patterns will continue to be
unpredictable in the future. Not only does the volume of units ordered by
particular customers vary substantially from period to period, but also
purchase orders received from particular customers often vary substantially
from early oral estimates provided by those customers for planning
purposes. Our business is
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characterized by short-term customer orders and shipment schedules, and
customer orders typically can be canceled or rescheduled without
significant penalty to the customer. We have in the past experienced
customer cancellations of substantial orders for reasons beyond our
control, and significant cancellations could occur again at any time in the
future.
. Our Operating Results Are Subject to Competitive Pressures on Selling
Prices. Our net revenues and operating results are also subject to
competitive pressures on selling prices. Historically, average selling
prices of products in the semiconductor and the high-voltage AC to DC power
supply industries have decreased over the lives of the products. If we are
unable to successfully introduce new products with higher average selling
prices or are unable to reduce manufacturing costs to offset expected
decreases in the prices of our existing products, our operating margins
will be adversely affected.
. Our Operating Results Are Dependent Upon the Volume and Timing of Our
Orders With Our Foundries. Our operating results are also substantially
dependent upon the volume and timing of orders that we place with our
foundries. Due to the absence of substantial noncancellable backlog, we
must plan our production and inventory levels based on internal forecasts
of customer demand, which is unpredictable and may fluctuate substantially.
If we underestimate the number of units required to meet customer demand
and fail to maintain adequate inventory levels, we may lose significant
revenue opportunities and market share to competitors. On the other hand,
if we overestimate the number of units required to meet customer demand,
our operating results may be materially adversely affected as a result of
costs associated with carrying excess inventory and with obsolescence.
Excess inventory and obsolescence costs could be further increased by any
unestimated returns from our distributors or customers.
. Our net revenues and operating results may also fluctuate because of
the following:
. unavailability of raw materials;
. fluctuations in manufacturing yields, whether resulting from
the transition to new foundries or from other factors;
. changes in product mix, including the impact of new product
introduction on existing products;
. our ability to develop and bring to market new products and
technologies on a timely basis;
. the introduction of products and technologies by our
competitors;
. market acceptance of our and our customers' products;
. the timing of investments in research and development and sales
and marketing; and
. fluctuations in exchange rates, particularly exchange rates
between the U.S. dollar and the Japanese yen.
We Depend on the Cellular Phone Battery Charger and Desktop PC Stand-By
Markets for a Majority of Our Net Revenues. A limited number of applications of
our products, primarily in the cellular phone battery chargers and desktop PC
stand-by markets, currently account for the majority of our net revenues. We
expect that our net revenues and operating results will continue to be
substantially dependent upon these markets for the foreseeable future. The
cellular phone and desktop PC markets can be highly cyclical and have been
subject to significant economic downturns at various times. Any significant
downturn in these markets could cause a decline in our net revenues and a
reduction in the price of our stock.
Our net revenues and operating results are subject to many of the risks to
which the cellular phone battery charger and desktop PC stand-by markets for
these applications are subject, and may also be impacted by technological or
other developments in these markets. In particular, recent advances in battery
technology which offer competitive advantages to the OEMs of cellular telephones
permit these OEMs, including our largest end user,
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Motorola, to lower, or consider lowering, the wattage level of the power
supplies used to recharge batteries. As the output power has dropped below 5
watts for some slow or trickle chargers, some OEMs have substituted older
alternative technologies for switchers. Although this has not had any
significant impact on our business to date, it could in the future if these
older technological alternatives are more cost effective than our current and
future product offerings. While we continue our efforts to enhance the cost
effectiveness of integrated switchers based on our high-voltage ICs, we cannot
guarantee we will be successful in our efforts, and, in the absence of a
successful competitive response, demand for our products would be materially
adversely affected. Similarly, if a competitor successfully and cost-effectively
combines desktop PC stand-by power supplies with the main PC desktop power
supplies before we do, demand for our products could be materially adversely
affected.
We believe that our future success will depend in part upon our ability to
penetrate additional markets for our products, and we cannot assure you that we
will be able to overcome the marketing or technological challenges necessary to
do so. To the extent that a competitor penetrates additional markets before we
do, or takes market share from us in our existing markets, our net revenues and
financial condition could be materially adversely affected.
We Are Highly Dependent on a Limited Number of Customers. Our end user base
is highly concentrated, and a relatively small number of OEMs, directly or
indirectly through merchant power supply manufacturers, account for a
significant portion of our revenue. Accordingly, if one of these OEMs
significantly reduces its purchases from us, our net revenues may decline. We
have experienced these effects in the past and we cannot assure you that our
customers will not reduce, cancel or delay orders in the future.
We expect to continue to be dependent upon a relatively limited number of
customers for a significant portion of our net revenues in future periods. Also,
no customer is presently obligated either to purchase a specified amount of
products or to provide us with binding forecasts of product purchases for any
period. Our products are typically one of many components used in a larger
product produced by our customers. Demand for our products is therefore subject
to many risks beyond our control, including, among others:
. competition faced by our customers in their particular end markets;
. market acceptance of the products of our customers;
. technical challenges which may or may not be related to the components
supplied by us; and
. the technical, sales and marketing and management capabilities of our
customers and the financial and other resources of our customers.
Motorola's Semiconductor Components Group, or SCG, has developed products
intended to compete with us. Although we have been successful in competing
against internally developed products in the past, we have been forced to reduce
IC prices and have lost sales because of SCG's sale of certain ICs that are the
subject of our patent infringement lawsuit with Motorola. Motorola's Energy
Systems Group, or ESG, informed us, in the second quarter of 1999, of their
intent to move a high volume charger program to another solution. As a result of
this decision, our direct sales to ESG over the next few quarters may be
significantly reduced.
We Are Dependent on Our Wafer Suppliers. We outsource all of our
semiconductor manufacturing and product assembly, except for testing and
finishing. We have supply arrangements for the production of wafers with
Matsushita and OKI. Although certain aspects of our relationships with
Matsushita and OKI are contractual, many important aspects of these
relationships depend on the continued cooperation of these strategic partners
and, in many instances, the parties' course of conduct deviates from the literal
provisions of the contracts. We cannot assure you that our strategic partners
and we will continue to work together successfully in the future or that either
Matsushita or OKI will not seek an early termination of its wafer supply
agreement with us. If we were unable to obtain wafers from Matsushita and OKI
and could not timely qualify another supplier, we would not be able to supply
our customers with the products they require, which would cause our net revenues
to decline.
Our wafer supply contracts with Matsushita and OKI terminate in June 2000 and
September 2003, respectively. We cannot assure you that we will be able to reach
an agreement with Matsushita to extend the term of
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its wafer supply agreement. Failure to reach, in a timely fashion, an extension
of our agreement with Matsushita or to enter into an arrangement with another
manufacturer could result in material disruptions in supply. Any disruption in
our supply of wafers would adversely impact our ability to sell our product and
would cause a decline in our net revenues.
Certain contractual provisions limit the conditions under which we can enter
into similar arrangements with other Japanese manufacturers or their
subsidiaries during the term of our agreement with Matsushita. In addition, our
products do not require leading edge device process geometries. As device
process geometries become increasingly smaller and as demand for such smaller
geometries increases, Matsushita and OKI may decide at some point to convert all
of their manufacturing processes to smaller geometries in response to these
industry trends. We estimate that it would take between 9 to 12 months from the
time we identified an alternate manufacturing source before that source could
produce wafers with acceptable manufacturing yields in sufficient quantities to
meet our needs.
We typically receive shipments from Matsushita or OKI in approximately 8 to
10 weeks after placing orders, and lead times for new products can be
substantially longer. To provide sufficient time for assembly, testing and
finishing, we typically need to receive wafers from Matsushita or OKI 4 to 6
weeks before the desired ship date to our customers. As a result of these
factors and the fact that customers' orders can be made with little advance
notice, we have only a limited ability to react to fluctuations in demand for
our products. This could cause us to have an excess or a shortage of inventory
of a particular product. From time to time in the past we have been unable to
fully satisfy customer requests as a result of these factors. Any significant
disruptions in deliveries would materially adversely affect our business and
operating results. Although we provide OKI and Matsushita with rolling forecasts
of our production requirements, the ability of Matsushita or OKI to provide
wafers to us is limited by the available capacity of the foundry in which it
manufactures wafers for us. An increased need for capacity to meet internal
demands or demands of other customers could cause Matsushita and OKI to reduce
capacity available to us. Matsushita and OKI may also require us to pay amounts
in excess of contracted or anticipated amounts for wafer deliveries or require
us to make other concessions in order to acquire the wafer supply necessary to
meet our customers' requirements. Any of these concessions could materially
adversely affect our business. We carry a substantial amount of inventory of
tested wafers to help offset these factors to better serve our markets and meet
customer demand.
We Rely on Our Contracted Foundries and Independent Subcontractors to Produce
Wafers and Assemble Finished Products at Acceptable Yields. We depend on
Matsushita and OKI to produce wafers, and independent subcontractors to assemble
finished products, at acceptable yields and to deliver them to us in a timely
manner. The failure of Matsushita or OKI to supply us wafers at acceptable
yields could prevent us from selling our products to our customers and would
likely cause a decline in our net revenues. The manufacture of our TOPSwitch
products utilizes a CMOS process with a proprietary, highly sensitive implant
process step. To the extent the wafer foundries do not achieve acceptable
manufacturing yields or they experience product shipment delays, our financial
condition and operating results would be materially adversely affected. Our IC
assembly process also requires our manufacturers to use a high-voltage molding
compound available from only one vendor, which is difficult to process. This
compound and its required processes, together with the other non-standard
materials and processes needed to assemble our products, require a more exacting
level of process control than normally required for standard packages.
Unavailability of the sole source compound or problems with the assembly process
can materially adversely affect yields and cost to manufacture. Good production
yields are particularly important to our business and financial results,
including our ability to meet our customers' demand for products and to maintain
profitability. As we continue to increase our product output, our foundries and
assemblers may experience a decrease in yields. We cannot assure you that
acceptable yields will be maintainable in the future.
Matsushita Has Licenses to Our Technology Which It May Use to Our Detriment.
Matsushita manufactures and sells its versions of our TOPSwitch families of
products under the right, exclusive during the term of the contract as to other
Japanese companies, except OKI and their subsidiaries, granted by us to
manufacture and sell products using our technology to Japanese companies
worldwide and to subsidiaries of Japanese companies located in Asia. Some of
these products are redistributed by the Japanese customers to their
manufacturing operations in other regions. Beginning in April 1997, we agreed
not to sell our products in Japan to new customers. We receive
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royalties on Matsushita's sales, although these royalties are substantially
lower than the gross profit we would receive on direct sales. In addition, the
royalties Matsushita pays are denominated in Japanese yen and are subject to
risks inherent in exchange rate fluctuations. Although we engage in sales,
marketing and support activities to encourage sales by Matsushita, our ability
to take advantage of the potentially large Japanese market for our products is
largely dependent on Matsushita and its ability to promote and deliver our
products. Should we fail to negotiate acceptable royalty-bearing extensions to
our contract with Matsushita, we would need to expend substantial effort and
expense to establish ourselves in this market directly or through a different
partner. We cannot assure you that we would not lose customers for Matsushita's
products during any transition. Furthermore, the licenses to Matsushita for many
important aspects of our technology are perpetual. We cannot assure you that
Matsushita will not use these technology rights to develop or market competing
products following any termination of its relationship with us or after
termination of Matsushita's royalty obligation to us.
Our International Sales Subject Us to Substantial Risks. Sales to customers
outside of the United States account for a large portion of our net revenues.
These sales involve a number of risks to us, including:
. imposition of government controls;
. currency exchange fluctuations;
. potential insolvency of international distributors and representatives;
. reduced protection for intellectual property rights in some countries;
. the impact of recessionary environments in economies outside the United
States;
. longer receivables collection periods;
. tariffs and other trade barriers and restrictions; and
. the burdens of complying with a variety of foreign laws.
Furthermore, because substantially all of our foreign sales are denominated
in U.S. dollars, increases in the value of the dollar would increase the price
in local currencies of our products in foreign markets and make our products
relatively more expensive and less price competitive than competitors' products
that are priced in local currencies. Our failure to adequately address these
risks could reduce our international sales, which would materially adversely
affect our operating results.
We Are Dependent on Foreign Manufacturers and Assemblers for the Manufacture
of Our Wafers. Because we depend on Matsushita and OKI, both located in Japan,
for the manufacture of all of our finished silicon wafers and on foreign
assembly subcontractors of our products, we are directly affected by the
political and economic conditions of the countries in which our wafers are or
are expected to be manufactured. To the extent that these countries experience
prolonged work stoppages or other inability to manufacture and assemble our
products, our business, financial condition or operating results could be
materially adversely affected. Our contracts with Matsushita and OKI are
denominated in Japanese yen, which exposes us to the risk of increased costs for
finished wafers. We do not believe we could readily pass this increase through
to our customers.
New Products and Technological Change May Render Our and Our Customers'
Products Out of Date. Our future success depends in significant part upon our
ability to develop new ICs for high-voltage power conversion for existing and
new markets, to introduce these products in a timely manner and to have these
products selected for design into products of leading manufacturers. If we fail
to develop and sell new products in a timely manner, our net revenues could
decline.
The development of new devices is highly complex, and from time to time we
have experienced delays in completing the development of new products.
Successful product development and introduction depends on a number of factors,
including:
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. accurate new product definition;
. timely completion and introduction of new product designs;
. availability of foundry capacity;
. achievement of acceptable manufacturing yields; and
. market acceptance of our and our customers' products.
We cannot be sure that we will be able to adjust to changing market demands
as quickly and cost-effectively as necessary to compete successfully.
Furthermore, we cannot assure you that we will be able to introduce new products
in a timely and cost-effective manner or in sufficient quantities to meet
customer demand or that such products will achieve market acceptance. Our or our
customers' failure to develop and introduce new products successfully and in a
timely manner would materially adversely affect our business, financial
condition and operating results. In addition, customers may defer or return
orders for existing products in response to the introduction of new products.
Although we maintain reserves against returns, we cannot assure you that these
reserves will be adequate.
We Have Historically Experienced a Lengthy Sales Cycle. Our products are
generally incorporated into a customer's products at the design stage. However,
customer decisions to use our products, commonly referred to as design wins,
which can often require us to expend significant resources without any assurance
of success, often precede volume sales, if any, by a year or more. If a customer
decides at the design stage not to incorporate our products into its product, we
may not have another opportunity for a design win with respect to that product
for many months or years. Because of this lengthy sales cycle, we may experience
a delay between increasing expenses for research and development and our sales
and marketing efforts and the generation of volume production revenues, if any,
from these expenditures. Moreover, the value of any design win will largely
depend upon the commercial success of the customer's product. We cannot assure
you that we will continue to achieve design wins or that any design win will
result in future revenues. Our failure to timely develop and introduce products
that are incorporated into our customers' products could significantly reduce
our net revenues and adversely affect our operating results.
Our Products Must Meet Exacting Specifications, and Undetected Defects and
Failures May Occur. The fabrication and assembly of ICs is a highly complex and
precise process. We expect that our customers will continue to establish
demanding specifications for quality, performance and reliability that our
products must meet. ICs as complex as those we sell often encounter development
delays and may contain undetected defects or failures when first introduced or
after commencement of commercial shipments. We have from time to time in the
past experienced product quality, performance or reliability problems. We cannot
guarantee that defects or failures will not occur in the future relating to our
product quality, performance and reliability that may have a material adverse
effect on our operating results. If these defects and failures occur, we could
experience lost revenue, increased costs, including warranty expense and costs
associated with customer support, delays in or cancellations or rescheduling of
orders or shipments and product returns or discounts, any of which would harm
our operating results.
The High-Voltage Power Supply Industry is Extremely Competitive and Highly
Price-Sensitive. The high-voltage power supply industry is intensely
competitive and characterized by extreme price sensitivity. Accordingly, the
most significant competitive factor in the target markets for our products is
cost effectiveness. Our products face competition from alternative technologies,
including traditional linear transformers and discrete switcher power supplies.
We believe that at current pricing, our high-voltage power conversion IC
families of products offer favorable cost-performance benefits compared to the
competition. However, there has recently been over capacity of discrete
components, which has resulted in significant price erosion for these products.
Continued significant erosion in the price of competing products, including
high-voltage Bipolar and MOSFET transistors and PWM controller ICs, could
adversely affect the cost effectiveness of our products. Also, older alternative
technologies to switchers are more cost-effective than discrete switchers and
integrated switchers that use our products in certain power ranges for some
applications. If power requirements for applications in which our products are
currently
20
<PAGE>
utilized, including battery chargers for cellular telephones, drop below certain
power levels, these older alternative technologies can be used more cost
effectively than our TOPSwitch-based switchers. We are continuing our efforts to
enhance the cost effectiveness of integrated switchers in the lower power ranges
but we cannot guarantee that we will be successful in these efforts.
Recently, our TOPSwitch product families have begun to meet additional
competition from hybrid and single high-voltage ICs similar to TOPSwitch.
Fairchild Semiconductor, Motorola, STMicroelectronics and Sanken are developing
or producing these competing products. We expect competition to increase as
companies like these see the success we have had in converting older
technologies to the integrated solutions used in our product offerings. To the
extent these competitors' products are more cost effective than our products,
our operating results could be materially adversely affected. Many of our
emerging competitors, including Fairchild Semiconductor, Motorola,
STMicroelectronics and Sanken, have significantly greater financial, technical,
manufacturing and marketing resources than we do. In a market where a high-
voltage IC is designed into a customer's product and the provider of the IC is
therefore the sole source of the IC for that product, greater manufacturing
resources may be a significant factor in the customer's choice of the IC because
of the customer's perception of greater certainty in its source of supply.
Our ability to compete in our target markets also depends on these factors:
. the timing and success of new product introductions by us and our
competitors;
. the pace at which our customers incorporate our products into their end
user products;
. the availability of wafer fabrication and finished good manufacturing
capability;
. availability of adequate sources of raw materials; and
. the protection of our products by effective utilization of intellectual
property laws.
We cannot assure you that our products will continue to compete favorably or
that we will be successful in the face of increasing competition from new
products and enhancements introduced by existing competitors or new companies
entering this market. We believe our failure to compete successfully in the
high-voltage power supply business would materially reduce our operating
results.
We Must Protect Our Intellectual Property And Have Sued, And Have Been Sued,
By Our Largest End User, Motorola, Regarding Certain Patents. Our future
success depends upon our ability to protect our intellectual property, including
patents, trade secrets, and know-how, and to continue our technological
innovation. We cannot assure you that the steps we have taken to protect our
intellectual property will be adequate to prevent misappropriation or that
others will not develop competitive technologies or products.
In July 1998, we filed a complaint for patent infringement in the U.S.
District Court, Northern District of California, against our largest end user,
Motorola. In August 1998, we voluntarily dismissed the complaint, and filed a
new complaint in the U.S. District Court, District of Delaware, alleging that
Motorola has infringed and continues to infringe on two of our circuit patents.
We seek, among other things, an order enjoining Motorola from infringing on our
patents and an award for damages resulting from the alleged infringement. In
October 1998, Motorola asserted various counterclaims against us, alleging that
we are infringing on certain of Motorola's patents. We believe that Motorola's
counterclaims are without merit and intend to vigorously defend ourselves
against these claims. The trial is currently scheduled to commence in October
1999.
Litigation may be necessary to resolve the claims we have asserted against
Motorola and to resolve the claims Motorola has asserted against us. There can
be no assurance that we will prevail in any future litigation. Any litigation,
whether or not determined in our favor or settled by us, would be costly and
would divert the efforts and attention of our management and technical personnel
from normal business operations, which could materially adversely affect our
operating results. Adverse determinations in litigation could result in the loss
of our proprietary rights, subject us to significant liabilities, require us to
seek licenses from third parties or prevent us from licensing
21
<PAGE>
our technology, any of which could have a material adverse effect on our
business, financial condition and operating results.
Moreover, the laws of some foreign countries in which our technology is or
may in the future be licensed may not protect our intellectual property rights
to the same extent as the laws of the United States, thus increasing the
possibility of infringement of our intellectual property.
We Depend on a Few Key Personnel. Our success depends to a significant
extent upon the continued service of our executive officers and other key
management and technical personnel, and on our ability to continue to attract,
retain and motivate qualified personnel, such as experienced systems
applications engineers. The competition for these employees is intense,
particularly in Silicon Valley. The loss of the services of one or more of our
engineers, executive officers or other key personnel or our inability to recruit
replacements for these individuals or to otherwise attract, retain and motivate
qualified personnel could have a material adverse effect on our business,
financial condition or operating results. We do not have long-term employment
contracts with, and we do not have in place "key person" life insurance policies
on, any of our employees.
Our Future Success Depends On Our Successful Management of Growth. We have
experienced a period of rapid growth and expansion, which has placed, and
continues to place, a significant strain on our resources. To accommodate this
growth, we will be required to implement a variety of new and upgraded
operational and financial systems, procedures and controls, including the
improvement of our internal management systems, which may require substantial
management efforts. These efforts if not accomplished successfully, could
adversely affect our business and cause our net revenues to decline. In
addition, any future periods of rapid growth or expansion could be expected to
place a significant strain on our limited managerial, financial, engineering and
other resources.
Relationships with new customers generally require significant engineering
support. As a result, any increase in the number of customers using our
technology will increase the strain on our resources, particularly our
engineers. These strains may result in delays or difficulties in our research
and development process, which could make it difficult for us to develop future
generations of our products and to remain competitive. In addition, the rapid
rate of hiring new employees could be disruptive and adversely affect the
efficiency of our research and development process.
Arrival of the Year 2000 May Create Unforeseen Difficulties. Many computer
systems were not designed to handle any dates beyond the year 1999, and
therefore, computer hardware and software for virtually all businesses will need
to be modified prior to the year 2000 in order to remain functional. We are
concerned that many enterprises will be devoting a substantial portion of their
information systems spending to resolving this upcoming year 2000 problem. This
expense may result in spending being diverted from ICs for use in AC to DC power
conversion in the near future. We are still assessing the impact of the year
2000 issue on our internal information systems and have begun, and in many cases
completed, corrective efforts in these areas. We have evaluated the
functionality of our current products with respect to any year 2000 problems and
have determined that our current products have no year 2000 problems. We do not
anticipate that addressing the year 2000 problem for our internal information
systems and future products will have a material impact on our operations or
financial results. However, we cannot assure you that these costs will not be
greater than anticipated, or that we will complete the corrective actions we
have undertaken before any year 2000 problems could occur. The year 2000 issue
could lower demand for our products while increasing our costs. These factors,
while not quantified, could have a material adverse impact on our operations and
financial results.
We have relationships with key suppliers, who are our single source or one of
a limited number of providers of certain materials used in our products. If
these suppliers fail to adequately address the year 2000 issue for the products
they provide to us, we may not be able to manufacture our ICs, which would harm
our business. We are still assessing the effect the year 2000 issue will have on
our suppliers and at this time we cannot determine the impact it will have. We
will develop contingency plans if it appears we or our key suppliers will not be
year 2000 compliant. However, we cannot assure you that any contingency plans we
develop will be adequate to resolve the year 2000 problems we may encounter.
22
<PAGE>
We Have Adopted Anti-Takeover Measures Which May Make it More Difficult for a
Third Party to Acquire Us. Our board of directors has the authority to issue up
to 3,000,000 shares of preferred stock and to determine the price, rights,
preferences and privileges of those shares without any further vote or action by
the stockholders. The rights of the holders of common stock will be subject to,
and may be adversely affected by, the rights of the holders of any preferred
stock that may be issued in the future. The issuance of shares of preferred
stock, while potentially providing flexibility in connection with possible
acquisitions and for other corporate purposes, could have the effect of making
it more difficult for a third party to acquire a majority of our outstanding
voting stock. We have no present intention to issue shares of preferred stock.
In February 1999, our board of directors adopted a preferred stock purchase
rights plan intended to guard against certain takeover tactics. The adoption of
this plan was not in response to any proposal to acquire us, and the board is
not aware of any such effort. The existence of this plan could also have the
effect of making it more difficult for a third party to acquire a majority of
our outstanding voting stock.
In addition, provisions of our certificate of incorporation may have the
effect of delaying or preventing a change of control, which could adversely
affect the market price of our common stock. These provisions provide, among
other things, that:
. stockholders may not take action by written consent;
. the ability of stockholders to call special meetings and to raise matters
at stockholders' meetings is restricted; and
. certain amendments of our certificate of incorporation, and all amendments
of our bylaws, require the approval of holders of at least two-thirds of
the voting power of all outstanding shares.
We are also subject to the anti-takeover provisions of section 203 of the
Delaware General Corporation Law, which prohibits us from engaging in a
"business combination" with an "interested stockholder" for a period of three
years after the date of the transaction in which the person became an interested
stockholder, unless the business combination is approved in a prescribed manner.
The application of section 203 also could have the effect of delaying or
preventing a change of control.
Our Stock Price Has Been Volatile. Our common stock has been, and is likely
to be, volatile. We cannot assure you that the trading price of our common stock
will remain at or near the price at which you may have purchased it. Factors
including future announcements concerning us or our competitors, quarterly
variations in operating results, announcements of technological innovations, the
introduction of new products or changes in our product pricing policies or those
of our competitors, proprietary rights or other litigation, changes in earnings
estimates by analysts and other factors could cause the market price of our
common stock to fluctuate substantially. In addition, stock prices for many
technology companies fluctuate widely for reasons, which may be unrelated to
operating results. These fluctuations, as well as general economic, market and
political conditions such as recessions or military conflicts may materially
adversely affect the market price of our common stock. Moreover, the trading
prices of many high technology stocks are at or near their historical highs and
reflect price/earning ratios substantially above historical norms.
23
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
There has not been a material change in our exposure to interest rate and
foreign currency risks since the date of the 1998 Form 10-K.
Interest Rate Risk. Our exposure to market risk for changes in interest rates
relate primarily to our investment portfolio. We do not use derivative financial
instruments in our investment portfolio. We invest in high-credit quality
issuers and, by policy, limit the amount of credit exposure to any one issuer.
As stated in our policy, we ensure the safety and preservation of our invested
principal funds by limiting default risk, market risk and reinvestment risk. We
mitigate default risk by investing in safe and high-credit quality securities
and by constantly positioning our portfolio to respond appropriately to a
significant reduction in a credit rating of any investment issuer, guarantor or
depository. The portfolio includes only marketable securities with active
secondary or resale markets to ensure portfolio liquidity.
The table below presents principal amounts and related weighted average
interest rates for our investment portfolio at June 30, 1999. All investments
mature, by policy, in 15 months or less.
(in thousands, except average interest rates)
<TABLE>
<CAPTION>
Average
Carrying Interest
Amount Rate
----------- -----------
Cash Equivalents:
<S> <C> <C>
U.S. corporate securities......................................................... $ 2,004 5.27%
Tax-exempt securities............................................................. 1,000 3.83%
----------- -----------
Total cash equivalents....................................................... 3,004 4.79%
----------- -----------
Short-term Investments:
U.S. corporate securities......................................................... 38,812 5.59%
U.S. Government securities........................................................ 959 5.16%
Foreign securities................................................................ 3,079 7.43%
----------- -----------
Total short-term investments................................................. 42,850 5.71%
----------- -----------
Total investment securities.................................................. $45,854 5.65%
=========== ===========
</TABLE>
Foreign Currency Exchange Risk. We transact business in various foreign
countries. Our primary foreign currency cash flows are in Japan and Western
Europe. Currently, we do not employ a foreign currency hedge program utilizing
foreign currency forward exchange contracts as the foreign currency transactions
and risks to date have not been significant.
24
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In July 1998, we filed a complaint for patent infringement in the U.S.
District Court, Northern District of California, against our largest end user,
Motorola. In August 1998, we voluntarily dismissed the complaint, and filed a
new complaint in the U.S. District Court, District of Delaware, alleging that
Motorola has infringed and continues to infringe on two of our circuit patents.
We seek, among other things, an order enjoining Motorola from infringing on our
patents and an award for damages resulting from the alleged infringement. In
October 1998, Motorola asserted various counterclaims against us, alleging that
we are infringing on certain of Motorola's patents. We believe that Motorola's
counterclaims are without merit and intend to vigorously defend ourselves
against these claims. The trial is currently scheduled to commence in October
1999.
Litigation may be necessary to resolve the claims we have asserted against
Motorola and to resolve the claims Motorola has asserted against us. There can
be no assurance that we will prevail in any future litigation. Any litigation,
whether or not determined in our favor or settled by us, would be costly and
would divert the efforts and attention of our management and technical personnel
from normal business operations, which could hurt our business. Adverse
determinations in litigation could result in the loss of our proprietary rights,
subject us to significant liabilities, require us to seek licenses from third
parties or prevent us from licensing our technology, any of which could have a
material adverse effect on our business, financial condition and operating
results.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
At the Annual Meeting of Stockholders of Power Integrations, Inc. held on June
3, 1999, the following proposals were adopted by the margins indicated.
Proposal I - To elect the following person as a Class II director to hold office
for a three-year term and until his successor is elected and qualified:
Voted For Withheld
--------------- ---------------
E. Floyd Kvamme 10,728,640 110,823
Proposal II - To approve an amendment to our 1997 Stock Option Plan which
provides that effective January 1, 2000, 620,000 shares which would otherwise
only be available for grant under such plan pursuant to nonstatutory stock
options may instead be granted pursuant to incentive stock options:
Voted Voted
For Against Abstain
------------- ------------- ---------
7,378,797 3,457,465 3,201
25
<PAGE>
Proposal III - To approve an increase in the number of shares reserved for
issuance under our 1997 Employee Stock Purchase Plan from 250,000 to 500,000
shares of common stock:
Voted Voted
For Against Abstain
------------- ------------- ---------
10,590,231 247,546 1,686
Proposal IV - To ratify the appointment of Arthur Andersen LLP as our
independent auditors for the fiscal year ending December 31, 1999:
Voted Voted
For Against Abstain
------------- ------------- ---------
10,825,722 4,180 9,561
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits.
The following exhibits are attached hereto and filed herewith:
27.1 Financial Data Schedule.
b. Reports on Form 8-K.
None
26
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
POWER INTEGRATIONS, INC.
/s/ Robert G. Staples
Dated: August 10, 1999 By:__________________________________
Robert G. Staples
Chief Financial Officer
27
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 7,882
<SECURITIES> 43,632
<RECEIVABLES> 8,855
<ALLOWANCES> 1,155
<INVENTORY> 8,284
<CURRENT-ASSETS> 71,451
<PP&E> 19,096
<DEPRECIATION> 11,031
<TOTAL-ASSETS> 79,516
<CURRENT-LIABILITIES> 15,708
<BONDS> 0
0
0
<COMMON> 13
<OTHER-SE> 61,851
<TOTAL-LIABILITY-AND-EQUITY> 79,516
<SALES> 43,101
<TOTAL-REVENUES> 43,800
<CGS> 19,949
<TOTAL-COSTS> 19,949
<OTHER-EXPENSES> 12,871
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 168
<INCOME-PRETAX> 11,997
<INCOME-TAX> 1,803
<INCOME-CONTINUING> 10,194
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 10,194
<EPS-BASIC> 0.80
<EPS-DILUTED> 0.73
</TABLE>
