Power Integrations
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Power Integrations - 10-Q quarterly report FY


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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 September 30, 1998
or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ______________ to
______________

Commission File Number 0-23441
____________________
POWER INTEGRATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 94-3065014
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

477 N. MATHILDA AVENUE, SUNNYVALE, CALIFORNIA 94086
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(408) 523-9200
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

TITLE OF EACH CLASS NAME OF EXCHANGE ON WHICH REGISTERED
------------------- ------------------------------------
NONE NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

COMMON STOCK, $.001 PAR VALUE
(TITLE OF CLASS)
_____________________________

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [_]

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.

Class Outstanding at October 30, 1998

------------------------------- ---------------------------------
Common Stock, $.001 par value 12,444,608 shares

================================================================================
POWER INTEGRATIONS, INC.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION Page

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


PART II. OTHER INFORMATION

Item 1. Legal Proceedings 20

Item 2. Changes in Securities and Use of Proceeds 20

Item 3. Defaults upon Senior Securities 20

Item 4. Submission of Matters to Vote of Security Holders 20

Item 5. Other Information 20

Item 6. Exhibits and Reports on Form 8-K 20

SIGNATURES 21

2
PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

POWER INTEGRATIONS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS)

SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(unaudited)
ASSETS

CURRENT ASSETS:
Cash and cash equivalents.................. $ 10,708 $ 25,553
Short-term investments..................... 27,493 3,455
Accounts receivable........................ 5,578 6,243
Inventories................................ 9,017 7,328
Prepaid expenses and other current assets.. 440 349
------------- ------------
Total current assets.................. 53,236 42,928
------------- ------------

PROPERTY AND EQUIPMENT, net................... 6,577 5,631
------------- ------------
$ 59,813 $ 48,559
============= ============

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
Current portion of capitalized lease
obligations.............................. $ 1,977 $ 1,787
Accounts payable........................... 5,611 6,903
Accrued payroll and related expenses....... 1,935 1,685
Taxes payable and other accrued
liabilities.............................. 2,850 1,042
Deferred income on sales to distributors... 2,746 1,380
------------- ------------
Total current liabilities............. 15,119 12,797
------------- ------------
CAPITALIZED LEASE OBLIGATIONS, net of
current portion.......................... 2,141 2,435
------------- ------------

STOCKHOLDERS' EQUITY:
Common stock............................... 12 12
Additional paid-in capital................. 56,878 56,220
Common stock warrants...................... 12 12
Stockholder notes receivable............... (405) (405)
Deferred compensation...................... (356) (461)
Cumulative translation adjustment.......... (84) (76)
Accumulated deficit........................ (13,504) (21,975)
------------- ------------
Total stockholders' equity............ 42,553 33,327
------------- ------------
$ 59,813 $ 48,559
============= ============

The accompanying notes are an integral part of these condensed consolidated
balance sheets.

3
POWER INTEGRATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------- -----------------------------------
1998 1997 1998 1997
----------------- --------------- ----------------- ----------------
<S> <C> <C> <C> <C>
NET REVENUES:
Product sales............................... $19,907 $12,959 $48,456 $29,668
Royalties................................... 410 384 1,400 790
----------------- --------------- ----------------- ----------------
Total net revenues....................... 20,317 13,343 49,856 30,458
----------------- --------------- ----------------- ----------------
COST OF REVENUES.............................. 10,635 7,492 26,865 17,602
----------------- --------------- ----------------- ----------------
GROSS PROFIT.................................. 9,682 5,851 22,991 12,856
----------------- --------------- ----------------- ----------------
OPERATING EXPENSES:
Research and development.................... 1,947 1,404 5,226 3,696
Sales and marketing......................... 2,376 1,839 5,989 4,408
General and administrative.................. 1,067 620 2,345 1,460
----------------- --------------- ----------------- ----------------
Total operating expenses................. 5,390 3,863 13,560 9,564
----------------- --------------- ----------------- ----------------
INCOME FROM OPERATIONS........................ 4,292 1,988 9,431 3,292
----------------- --------------- ----------------- ----------------
OTHER INCOME (EXPENSE), net................... 399 (196) 775 (549)
----------------- --------------- ----------------- ----------------
INCOME BEFORE PROVISION FOR
INCOME TAXES................................. 4,691 1,792 10,206 2,743

PROVISION FOR INCOME TAXES.................... 351 306 1,735 373
----------------- --------------- ----------------- ----------------
NET INCOME.................................... $ 4,340 $ 1,486 $ 8,471 $ 2,370
----------------- --------------- ----------------- ----------------
EARNINGS PER SHARE:
Basic....................................... $0.35 $0.91 $0.70 $2.09
----------------- --------------- ----------------- ----------------
Diluted..................................... $0.33 $0.15 $0.65 $0.26
----------------- --------------- ----------------- ----------------
SHARES USED IN PER SHARE CALCULATION:
Basic....................................... 12,229 1,632 12,133 1,134
----------------- --------------- ----------------- ----------------
Diluted..................................... 13,128 9,875 13,110 9,082
================= =============== ================= ================
</TABLE>

The accompanying notes are an integral part of these condensed consolidated
financial statements.

4
POWER INTEGRATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

(IN THOUSANDS)

<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------
1998 1997
------------------- -----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................................... $ 8,471 $ 2,370
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................................... 2,278 1,613
Provision for accounts receivable and other allowances...................... (26) 709
Deferred compensation expense............................................... 105 71
Change in operating assets and liabilities:
Accounts receivable...................................................... 691 (4,844)
Inventories.............................................................. (1,689) (662)
Prepaid expenses and other current assets................................ (91) (83)
Accounts payable......................................................... (1,292) 2,846
Accrued liabilities...................................................... 2,050 1,103
Deferred income on sales to distributors................................. 1,366 827
------------------- -----------------
Net cash provided by operating activities............................. 11,863 3,950
------------------- -----------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment......................................... (1,785) (712)
Purchases of short-term investments......................................... (38,071) (9,947)
Proceeds from sales and maturities of short-term investments................ 14,033 9,895
------------------- -----------------
Net cash used in investing activities................................. (25,823) (764)
------------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock.................................. 658 577
Principal payments under capitalized lease obligations...................... (1,543) (1,232)
------------------- -----------------
Net cash used in financing activities................................. (885) (655)
------------------- -----------------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.......................... (14,845) 2,531
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD.............................. 25,553 3,282
------------------- -----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................................... $ 10,708 $ 5,813
=================== =================
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Capitalized lease obligations incurred for property and equipment........... $ 1,439 $ 1,253
=================== =================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest...................................................... $ 388 $ 626
=================== =================
Cash paid for income taxes.................................................. $ 475 $ 7
=================== =================
</TABLE>

The accompanying notes are an integral part of these condensed consolidated
financial statements.

5
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, 1997 included in its Form 10-K/A.

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 less than one year are classified as short-term
investments. As of September 30, 1998, the Company's short-term investments
consist of U.S. Government backed securities and commercial paper, which are
classified as held-to-maturity and are valued using the amortized cost method
which approximates market.

Revenue Recognition

Product revenues consist of sales to OEMs and merchant power supply
manufacturers and to distributors. Revenues from product sales to OEMs and
merchant power supply manufacturers are recognized upon shipment. 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 such distributors resell the Company's
products to their customers. The margin deferred as a result of this policy is
reflected as "deferred income on sales to distributors" in the accompanying
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.

New Accounting Standards

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting and presentation of
comprehensive income. SFAS No. 130 requires companies to report a new measure of
income. The Company adopted SFAS No. 130 in the first quarter of 1998.
"Comprehensive Income" is to include foreign currency translation gains and
losses and other unrealized gains and losses that have historically been
excluded from net income and reflected instead in equity. The adoption of SFAS
No. 130 did not have a material impact on the Company's financial statements.

6
POWER INTEGRATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information," which
requires companies to report financial and descriptive information about its
reportable operating segments. SFAS No. 131 will be adopted by the Company in
its 1998 annual consolidated financial statements. The Company anticipates that
SFAS No. 131 will not 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>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------------------------
<S> <C> <C>
Raw materials.............................................................. $4,064 $3,323
Work-in-process............................................................ 2,997 2,977
Finished goods............................................................. 1,956 1,028
------ ------
$9,017 $7,328
====== ======
</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 nine months ended September 30, 1998 and 1997,
ten customers accounted for approximately 67% of total net revenues in each such
period.

The following customers accounted for more than 10% of total net revenues:

<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------
Customer 1998 1997
-------- ------------ -----------
<S> <C> <C>
A.......................................................................... 22% 23%
B.......................................................................... 13% *
C.......................................................................... * 16%
</TABLE>
- ------------------------
* less than 10% or no sales

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>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------
1998 1997
------------ -----------
<S> <C> <C>
Japan...................................................................... 3% 5%
Taiwan..................................................................... 28% 29%
Hong Kong.................................................................. 23% 27%
Western Europe............................................................. 16% 11%
Other...................................................................... 12% 9%
----- -----
Total foreign.............................................. 82% 81%
===== =====
</TABLE>

7
POWER INTEGRATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

5. EARNINGS PER SHARE:

In December 1997, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 128 "Earnings per Share." SFAS No. 128 requires companies
to compute earnings per share under two different methods (basic and diluted).
Basic earnings per share is calculated by dividing net income by the weighted
average shares of common stock outstanding during the period. Diluted earnings
per share is 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -----------------------
1998 1997 1998 1997
------------ ----------- ----------- ----------
<S> <C> <C> <C> <C>
Basic earnings per share:
Net income................................................... $ 4,340 $1,486 $ 8,471 $2,370
------------ ----------- ----------- ----------
Weighted average common shares............................... 12,229 1,632 12,133 1,134
------------ ----------- ----------- ----------
Basic earnings per share.................................. $ 0.35 $ 0.91 $ 0.70 $ 2.09
============ =========== =========== ==========

Diluted earnings per share:
Net income................................................... $ 4,340 $1,486 $ 8,471 $2,370
------------ ----------- ----------- ----------
Weighted average common shares............................... 12,229 1,632 12,133 1,134
Weighted average common share equivalents:
Convertible preferred stock............................... -- 7,447 -- 7,447
Options................................................... 647 574 672 398
Warrants.................................................. 252 222 305 103
------------ ----------- ----------- ----------
Diluted weighted average common shares....................... 13,128 9,875 13,110 9,082
------------ ----------- ----------- ----------
Diluted earnings per share............................. $ 0.33 $ 0.15 $ 0.65 $ 0.26
============ =========== =========== ==========
</TABLE>

6. PROVISION FOR INCOME TAXES:

Income tax expense for the nine month periods ended September 30, 1998 and
1997 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.

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, Inc. ("Motorola"). In August 1998, the Company voluntarily
dismissed that complaint, and filed a new complaint in the U.S. District Court,
District of Delaware, alleging that Motorola has infringed and continues to
infringe on two of the Company's circuit patents. The Company seeks, among
other things, an order enjoining Motorola from infringing on the Company's
patents and an award for damages resulting from the alleged infringement. In
October 1998, Motorola asserted various counterclaims against the Company
alleging that the Company is infringing on certain of Motorola's patents. The
Company believes that Motorola's counterclaims are without merit and intends
to vigorously defend itself against such claims.

Litigation may be necessary to resolve the claims asserted by the Company
against Motorola, and any claims which Motorola may assert in the future against
the Company, and to defend, enforce and protect the Company's

8
POWER INTEGRATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

intellectual property rights. There can be no assurance that the Company will
prevail in any litigation with Motorola, or any other party. 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 results of operations. In addition, any litigation between the
Company and Motorola could delay the Company's ability to have its products
incorporated into a customer's products at the design stage. Delays in
customers' decisions to use the Company's products could have a material adverse
effect on the Company's business, financial condition and results of operations.
Adverse determinations in any litigation could result in the loss of certain 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 manufacturing and selling certain of its products or licensing
its technology, any of which could have a material adverse effect on the
Company's business, financial condition and results of operations.

9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

This Management's Discussion and Analysis of Financial Condition and Results
of Operations includes a number of forward-looking statements which reflect the
Company's 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 "Factors That May Affect Future Results of
Operations" and elsewhere in this Form 10-Q 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. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date hereof.

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 the
Company's Form 10-K/A for the year ended December 31, 1997.

OVERVIEW

Power Integrations, Inc. (the "Company") designs, develops and markets
proprietary, high-voltage analog integrated circuits ("ICs") for use in AC to DC
power conversion. The Company has targeted high-volume power supply markets,
including the cellular telephone, personal computer, cable and direct broadcast
satellite and various consumer and industrial electronics markets. The Company
initially focuses on those markets that are sensitive to size, portability,
energy efficiency and time-to-market. The Company believes its patented
TOPSwitch ICs, introduced in 1994, are the first highly integrated power
conversion ICs to achieve widespread market acceptance. The Company introduced
an enhanced family of ICs, TOPSwitch-II, in April 1997. In September 1998, the
Company announced the TinySwitch family of integrated circuits for power
supplies in a broad range of electronic products. TinySwitch ICs incorporating
the Company's new EcoSmart technology enable a new class of light, compact,
energy-efficient power supplies. This new family of ICs is designed to reduce
energy leakage from 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- ----------------------------
1998 1997 1998 1997
----------- ----------- ------------- -------------
<S> <C> <C> <C> <C>
Net revenues:
Product sales........................................ 98.0% 97.1% 97.2% 97.4%
Royalties............................................ 2.0 2.9 2.8 2.6
----------- ----------- ------------- -------------
Total net revenues................................ 100.0 100.0 100.0 100.0
----------- ----------- ------------- -------------
Cost of revenues....................................... 52.3 56.1 53.8 57.8
----------- ----------- ------------- -------------
Gross profit........................................... 47.7 43.9 46.2 42.2
----------- ----------- ------------- -------------
Operating expenses:
Research and development............................. 9.6 10.5 10.5 12.1
Sales and marketing.................................. 11.7 13.8 12.0 14.5
General and administrative........................... 5.3 4.7 4.7 4.8
----------- ----------- ------------- -------------
Total operating expenses.......................... 26.6 29.0 27.2 31.4
----------- ----------- ------------- -------------
Income from operations................................. 21.1 14.9 19.0 10.8
Other income (expense), net............................ 1.9 (1.5) 1.5 (1.8)
----------- ----------- ------------- -------------
Income before provision for income taxes............... 23.0 13.4 20.5 9.0
----------- ----------- ------------- -------------
Provision for income taxes............................. 1.7 2.3 3.5 1.2
----------- ----------- ------------- -------------
Net income............................................. 21.3% 11.1% 17.0% 7.8%
=========== =========== ============= =============
</TABLE>

10
COMPARISON OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997


Net revenues. Net revenues consist of revenues from product sales, which
are calculated net of returns and allowances, plus royalties paid by licensees
of the Company's technology. Net revenues for the third quarter ended September
30, 1998 were $20.3 million compared to $13.3 million for the third quarter of
1997, an increase of $7.0 million, or 53%. Net revenues for the nine months
ended September 30, 1998 were $49.9 million compared to $30.5 million for the
comparable period of 1997, an increase of $19.4 million, or 64%.

Net revenues from product sales represented $19.9 million and $13.0 million
in the third quarter of 1998 and 1997, respectively. Net revenues from product
sales represented $48.5 million and $29.7 million in the first nine months of
1998 and 1997, respectively. The increase in net revenues from product sales for
the three months and nine months ended September 30, 1998 was due primarily to
higher sales volume of the Company's TOPSwitch family of products across a
larger customer base. Net revenues also grew because of an increase in royalty
revenues. Royalties were $410,000 for the third quarter of 1998, an increase of
$26,000, or 7%, from the third quarter of 1997. Royalties were $1.4 million for
the nine months ended September 30, 1998, an increase of $610,000, or 77%, from
the nine months ended September 30, 1997.

International sales were $16.7 million in the third quarter of 1998 compared
to $10.8 million for the same period in 1997, an increase of $5.9 million, or
55%, representing 82% of net revenues compared to 81% in the comparable period
of 1997. International sales were $40.7 million for the nine months ended
September 30, 1998 compared to $23.9 million for the same period in 1997, an
increase of $16.8 million, or 70%, representing 82% of net revenues compared to
81% in the comparable period of 1997. Although the power supplies using the
Company's products are designed and distributed worldwide, most of such power
supplies are manufactured in Asia. As a result, sales to this region were 66%
and 70% of product sales for the three months ended September 30, 1998 and 1997,
respectively, and 65% and 64% of product sales for the nine months ended
September 30, 1998 and 1997, respectively. The Company expects international
sales to continue to account for a large portion of the Company's net revenues.

The Company's direct sales are divided approximately 50% to distributors and
50% to OEMs and merchants. For the quarter ended September 30, 1998, sales to
two customers accounted for 24% and 13% of net revenues, and for the quarter
ended September 30, 1997, one of those same customers accounted for 28% of net
revenues and another customer accounted for 16% of net revenues. For the nine
months ended September 30, 1998, sales to two customers accounted for 22% and
13% of net revenues, and for the comparable period ended September 30, 1997, one
of those same customers accounted for 22% of net revenues and another customer
accounted for 15% of net revenues.

The exact dollar amounts and percentages of sales to end customers are
difficult to ascertain because most of such sales occur through distributors or
indirectly through sales to merchant power supply manufacturers which, in turn,
sell power supplies to OEMs. However, the Company estimates that direct and
indirect sales to Motorola, who is the Company's largest end user, accounted for
approximately 15% and 22% of the Company's net revenues for the quarters ended
September 30, 1998 and 1997, respectively, and approximately 12% and 21% of the
Company's net revenues for the nine months ended September 30, 1998 and 1997,
respectively. Direct sales to Motorola were approximately 6% and 3% of the
Company's net revenues for the quarters ended September 30, 1998 and 1997,
respectively, and approximately 5% and 4% of the Company's net revenues for the
nine months ended September 30, 1998 and 1997, respectively.

Cost of revenues; Gross profit. Gross profit is equal to net revenues less
cost of revenues. The Company's cost of revenues consists primarily of costs
associated with the purchase of wafers, the assembly and packaging of its
products, and internal labor and overhead associated with the testing of both
wafers and packaged components. Gross profit for the third quarter of 1998 was
$9.7 million, or 47.7%, of net revenues, compared to $5.9 million, or 43.9%, of
net revenues for the same period in 1997. Gross profit for the nine months ended
September 30, 1998 was $23.0 million, or 46.2%, of net revenues, compared to
$12.9 million, or 42.2%, of net revenues for the same period

11
in 1997. The increase in gross profit for the three months and nine months ended
September 30, 1998 was primarily due to the combined effects of the absorption
of certain fixed costs over the increased sales volume, lower prices for wafers,
favorable Japanese Yen exchange rates and better manufacturing yields due to
improved test equipment. There can be no assurance that these or other factors
will have a favorable impact on 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. The
Company also expenses 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 third quarter of 1998 were $1.9
million compared to $1.4 million for the same period in 1997, an increase of
$500,000, or 36%, representing 9.6% and 10.5% of net revenues, respectively.
Research and development expenses for the first nine months of 1998 were $5.2
million compared to $3.7 million for the same period in 1997, an increase of
$1.5 million, or 40%, representing 10.5% and 12.1% of net revenues,
respectively. The increase for the three months and nine months ended September
30, 1998 was primarily due to increased salaries and other costs related to the
hiring of additional engineering personnel, outside consulting fees and expensed
prototype materials resulting from the transition of foundry manufacturing
processes. The Company expects that research and development expenses will
continue to increase in absolute dollars but will fluctuate as a percentage of
net revenues.

Sales and marketing expenses. Sales and marketing expenses consist
primarily of employee-related expenses, commissions to sales representatives and
facilities expenses, including expenses associated with the Company's regional
sales and support offices. Sales and marketing expenses for the third quarter of
1998 were $2.4 million compared to $1.8 million for the same period in 1997, an
increase of $600,000, or 33%, representing 11.7% and 13.8% of net revenues,
respectively. Sales and marketing expenses for the first nine months of 1998
were $6.0 million compared to $4.4 million for the same period in 1997, an
increase of $1.6 million, or 36%, representing 12.0% and 14.5% of net revenues,
respectively. The increase for the three months and nine months ended September
30, 1998 was primarily a result of the addition of personnel to support
international sales and field application engineers and to staff two new sales
offices in Asia which opened in June 1997. The Company expects that sales and
marketing expenses will continue to increase in absolute dollars but will
fluctuate as a percentage of net revenues.

General and administrative expenses. General and administrative expenses
consist primarily of employee-related expenses for administration, finance,
human resources, general management and facilities, and consulting, outside
services, legal and auditing expenses. For the quarters ended September 30, 1998
and 1997, general and administrative expenses were $1.1 million and $620,000,
respectively, which represented 5.3% and 4.7% of net revenues, respectively. For
the nine month periods ended September 30, 1998 and 1997, general and
administrative expenses were $2.3 million and $1.5 million, respectively, which
represented 4.7% and 4.8% of net revenues, respectively. This increase in
absolute dollars was attributable to additional headcount to support the
Company's growth and additional professional and outside services required by
the Company as a result of its public reporting obligations. The Company
expects that general and administrative expenses will continue to increase in
absolute dollars and may increase as a percentage of net revenues, particularly
in light of the Company's recently filed patent infringement claim against
Motorola.

Other income (expense), net. Other income (expense), net, for the third
quarter of 1998 increased by $595,000 over the same period in 1997, and for the
nine months ended September 30, 1998 increased by $1.3 million over the same
period in 1997. The increase for the three months and nine months ended
September 30, 1998 was due primarily to additional interest income from an
increase in short-term investments in 1998 and a reduction in interest expense
as a result of the repayment of $3.0 million of subordinated debt in the fourth
quarter of 1997. The Company expects to continue to utilize term debt to finance
its capital equipment needs.

Provision for income taxes. Provision for income taxes represents Federal,
state and foreign taxes. The provision for income taxes was $351,000 for the
third quarter of 1998 compared to $306,000 for the same period in 1997. The
provision for income taxes was $1.7 million for the first nine months of 1998
compared to $373,000 for the same period in 1997. The Company is using an
effective tax rate of 17% reflecting the profitable results for the 1998 period,
while the provision for 1997 represented minimum tax. The difference between the
statutory rate and the Company's effective tax rate for 1998 is primarily due to
the beneficial impact of net operating loss carryforwards.

12
LIQUIDITY AND CAPITAL RESOURCES

At September 30, 1998, the Company had approximately $38.2 million in cash,
cash equivalents and short-term investments. In addition, under a working
capital line of credit agreement with a bank, the Company can borrow up to $8.0
million conditional upon meeting certain financial covenants, including
maintaining quarterly profitability and specific financial covenants. As of
September 30, 1998, there were no borrowings outstanding under the line of
credit agreement. The Company has financed a significant portion of its
machinery and equipment through capital equipment leases including an additional
equipment financing in the amount of $1.4 million during the nine months ended
September 30, 1998. At September 30, 1998, approximately $4.1 million was
outstanding under various capital equipment leasing agreements.

As of September 30, 1998, the Company had working capital, defined as current
assets less current liabilities, of approximately $38.1 million, which was an
increase of approximately $8.0 million over December 31, 1997. The Company
generated $11.9 million from operating activities during the nine months ended
September 30, 1998, reflecting net income of $8.5 million, depreciation of $2.3
million and $1.1 million provided by the net change in working capital items.
The net change in working capital items primarily reflects an increase in
inventory of $1.7 million as part of the Company's program to provide shorter
lead times to its customers, a decrease in accounts payable of $1.3 million, an
increase in other liabilities of $2.0 million, and an increase of $1.4 million
in deferred revenue.

The nature of the semiconductor industry, combined with the current economic
environment, make it very difficult for the Company to predict future liquidity
requirements with certainty. However, the Company believes that its existing
cash, cash equivalents and short-term investments, cash generated from
operations and other existing sources of working capital will be adequate to
finance its operations through the next twelve months.

NEW ACCOUNTING STANDARDS

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting and presentation of
comprehensive income. SFAS No. 130 requires companies to report a new measure of
income. The Company adopted SFAS No. 130 in the first quarter of 1998.
"Comprehensive Income" is to include foreign currency translation gains and
losses and other unrealized gains and losses that have historically been
excluded from net income and reflected instead in equity. The adoption of SFAS
No. 130 did not have a material impact on the Company's financial statements.

In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information," which
requires companies to report financial and descriptive information about its
reportable operating segments. SFAS No. 131 will be adopted by the Company in
its 1998 annual consolidated financial statements. The Company anticipates that
SFAS No. 131 will not have a material impact on its financial statements.

13
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS

The Company's future results of operations are dependent upon a number of
factors, including those described below. For a complete description of such
factors, see the Company's Form 10-K/A for the year ended December 31, 1997.

Unpredictable and Fluctuating Operating Results. The Company's quarterly
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 the Company's control, and may fluctuate significantly in the future.
Although the Company was profitable in the third quarter of 1998, there can be
no assurance that the Company will continue to be profitable in future periods.
The Company believes that period-to-period comparisons are not necessarily
meaningful and should not be relied upon as indicative of future operating
results.

Factors which may affect the Company's net revenues and operating results
include the timing and volume of orders received by the Company; competitive
pressures on selling prices; the volume and timing of orders placed by the
Company with its foundries; the availability of raw materials; fluctuations in
manufacturing yields, whether resulting from the transition to new foundries or
from other factors; changes in product mix including the impact of new product
introduction, such as the Tiny Switch ICs, on existing products; the Company's
ability to develop and bring to market new products and technologies on a timely
basis; introduction of products and technologies by the Company's competitors;
market acceptance of the Company's and its customers' products; the timing of
investments in research and development and sales and marketing; the Company's
patent infringement claim against Motorola; cyclical semiconductor industry
conditions; fluctuations in exchange rates, particularly exchange rates between
the U.S. dollar and the Japanese yen; changes in the international business
climate; and economic conditions generally.

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.
The Company is 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. The Company is still
assessing the impact of the Year 2000 issue on its internal information systems
and has begun, and in many cases completed, corrective efforts in these areas.
The Company has evaluated the functionality of its current products with respect
to any Year 2000 problems and has determined that its current products have no
Year 2000 problems. The Company does not anticipate that addressing the Year
2000 problem for its internal information systems and future products will have
a material impact on its operations or financial results. However, there can be
no assurance that these costs will not be greater than anticipated, or that
corrective actions undertaken will be completed before any Year 2000 problems
could occur. The Year 2000 issue could lower demand for the Company's products
while increasing the Company's costs. These combining factors, while not
quantified, could have a material adverse impact on the Company's financial
results.

The Company has certain key relationships with suppliers. If these suppliers
fail to adequately address the Year 2000 issue for the products they provide to
the Company, this could have a material adverse impact on the Company's
operations and financial results. The Company is still assessing the effect the
Year 2000 issue will have on its suppliers and at this time, cannot determine
the impact it will have. Contingency plans will be developed if it appears the
Company or its key suppliers will not be Year 2000 compliant, and such
noncompliance is expected to have a material adverse impact on the Company's
operations.

The Company's operating results in a future quarter or quarters are likely to
fall below the expectations of public market analysts or investors. In such an
event, the price of the Company's common stock will likely be materially and
adversely affected. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

Concentration of Applications. A limited number of applications of the
Company's products, primarily in the cellular phone battery chargers and desktop
PC stand-by markets, currently account for approximately one-half of the
Company's net revenues. The Company expects that its 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

14
can be highly cyclical and have been subject to significant economic downturns
at various times, characterized by diminished product demand, accelerated
erosion of average selling prices and production over capacity. The Company may
experience substantial period-to-period fluctuations in future operating results
due to general conditions of these markets. The Company's net revenues and
operating results are subject to many of the risks to which the markets for
these applications are subject, and may also be impacted by technological or
other developments in these markets. While the Company continues its efforts to
enhance the cost effectiveness of TOPSwitch-based switchers, there can be no
assurance that the Company will be successful in its efforts, and, in the
absence of a successful competitive response by the Company, demand for the
Company's products would be materially adversely affected. Similarly, if a
competitor of the Company successfully and cost effectively combines desktop PC
stand-by power supplies with the main PC desktop power supplies prior to such
combination by the Company, demand for the Company's products could be
materially adversely affected.

Customer Concentration and Competing Products from Customers. The Company's
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 the Company's net revenues. The Company estimates that
its top ten customers, including distributors which resell to large OEMs and
merchant power supply manufacturers, accounted for approximately 67% of the
Company's net revenues for both of the nine month periods ended September 30,
1998 and 1997. The Company expects that it will continue to be dependent upon a
relatively limited number of customers for a significant portion of its net
revenues in future periods, although no customer is presently obligated either
to purchase a specified amount of products or to provide the Company with
binding forecasts of product purchases for any period. The reduction, delay or
cancellation of orders from one or more of the Company's significant customers,
or the discontinuance of the Company's products by the Company's end users,
could materially and adversely affect the Company's business, financial
conditions and results of operations. The Company has experienced such effects
in the past and there can be no assurance that any of the Company's customers
will not reduce, cancel or delay orders in the future.

Dependence on Wafer Suppliers. The Company outsources all of its
semiconductor manufacturing and product assembly except for testing and
finishing. The Company has supply arrangements for the production of wafers with
Matsushita Electronics Corporation and an affiliate of Matsushita ("MEC"), and
OKI Electric Industry Co., Ltd. ("OKI"). Although certain aspects of the
Company's relationships with MEC 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. There can be no assurance that the
Company and its strategic partners will continue to work together successfully
in the future or that either MEC or OKI will not seek an early termination of
its wafer supply agreement with the Company.

The Company's wafer supply contract with OKI was renewed on October 1, 1998.
The term of this contract is for five years, expiring in September 2003. There
can be no assurance that the Company at that time will be able to reach an
agreement with OKI to extend the term of its wafer supply agreement. The
Company's wafer supply contract with MEC terminates in June 2000. There can be
no assurance that the Company will be able to reach an agreement with MEC to
extend the term of its wafer supply agreement. The Company's failure to reach,
in a timely fashion, an extension of either agreement or to enter into an
arrangement with another manufacturer, could result in material disruptions in
supply. Certain contractual provisions limit the conditions under which the
Company can enter into such arrangements with other Japanese manufacturers or
their subsidiaries during the term of the agreement with MEC. In the event of a
supply disruption with OKI or MEC, if the Company were unable to qualify
alternative manufacturing sources for existing or new products in a timely
manner or if such sources were unable to produce wafers with acceptable
manufacturing yields, the Company's business, financial condition and operating
results would be materially and adversely affected.

From time to time in the past, the Company has been unable to fully satisfy
customer requests for its products. Any significant disruptions in deliveries of
the Company's products to its customers would materially and adversely affect
the Company's business and operating results.

Risks of Outside Manufacturing and Assembly; Sole Source Risks. The Company
depends on MEC and OKI to produce wafers, and independent subcontractors to
assemble finished products, at acceptable yields and to deliver them to the
Company in a timely manner. To the extent the wafer foundries do not achieve
acceptable manufacturing yields or they experience product shipment delays, the
Company's financial condition or results of

15
operations would be materially adversely affected. The Company's IC assembly
process requires a sole source high-voltage molding compound that is difficult
to process. This compound and its required processes, together with the other
non-standard materials and processes needed to assemble the Company's 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 the Company's
business and financial results, including its ability to meet customers' demand
for products and to maintain profitability. As the Company continues to increase
its product output, there can be no assurance that the Company's foundries and
assemblers will not experience a decrease in yields. Moreover, there can be no
assurance that acceptable yields will be maintainable in the future.

Risks of International Sales. Sales to customers outside of the United
States represented 82% and 81% for the nine months ended September 30, 1998 and
1997, respectively. These sales involve a number of inherent risks, including
imposition of government controls, currency exchange fluctuations, potential
insolvency of international distributors and representatives, reduced protection
for intellectual property rights in some countries, the impact of recessionary
environments in economies outside the United States, political instability,
generally longer receivables collection periods, tariffs and other trade
barriers and restrictions, and the burdens of complying with a variety of
foreign laws. Furthermore, because substantially all of the Company's foreign
sales are denominated in U.S. dollars, increase in the value of the dollar would
increase the price in local currencies of the Company's products in foreign
markets and make the Company's products relatively more expensive and less price
competitive than competitors' products that are priced in local currencies. The
Company is exposed to additional risks to the extent that the products of its
customers are subject to foreign currency or other international risks. There
can be no assurance that these factors will not have an adverse effect on the
Company's future international sales and, consequently, on the Company's
business, financial condition or operating results.

New Products and Technological Change. The Company's future success depends
in significant part upon its ability to develop new ICs for high-voltage power
conversion for existing and new markets, to introduce such products in a timely
manner and to have such products selected for design into products of leading
manufacturers. The development of these new devices is highly complex, and from
time to time the Company has experienced delays in completing the development of
new products. There can be no assurance that the Company will be able to adjust
to changing market demands as quickly and cost-effectively as necessary to
compete successfully. Furthermore, there can be no assurance that the Company
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. The Company's or its customers' failure to develop
and introduce new products successfully and in a timely manner would materially
adversely affect the Company's business, financial condition or operating
results.

Lengthy Sales Cycle. The Company's products are generally incorporated into
a customer's products at the design stage. However, customer decisions to use
the Company's products (design wins), which can often require significant
expenditures by the Company 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 the Company's products into its product, the Company
will not have another opportunity for a design win with respect to that product
for many months or years. Because of such a lengthy sales cycle, the Company may
experience a delay between increasing expenses for research and development and
its sales and marketing efforts and the generation of volume production
revenues, if any, from such expenditures. Failure by the Company to timely
develop and introduce products that are incorporated into its customers'
products could have a material adverse effect on the Company's business,
financial condition or results of operations.

Product Quality, Performance and Reliability. The fabrication and assembly
of ICs is a highly complex and precise process. The Company expects that its
customers will continue to establish demanding specifications for quality,
performance and reliability that must be met by the Company's products. ICs as
complex as those offered by the Company often encounter development delays and
may contain undetected defects or failures when first introduced or after
commencement of commercial shipments. The Company has from time to time in the
past experienced product quality, performance or reliability problems. There can
be no assurance that defects or failures relating to the Company's product
quality, performance and reliability will not occur in the future or that such
defects or failures will not have a material adverse effect on the Company's
operating results.

16
Competition.   The high-voltage power supply industry is intensely
competitive and characterized by extreme price sensitivity. Accordingly, the
most significant competitive factor in the target markets for the Company's
products is cost effectiveness. The Company's products face competition from
alternative technologies, primarily discrete switchers. The Company believes
that at current pricing, the TOPSwitch families of products offer favorable cost
performance benefits compared to discrete switchers in many high-volume
applications. However, any significant erosion in the price of discrete
components, such as high voltage Bipolar and MOSFET transistors and PWM
controller ICs, could adversely affect the cost effectiveness of the TOPSwitch
products. Also, older alternative technologies to switchers are more cost-
effective than switchers that use the Company's TOPSwitch products in certain
power ranges for certain applications. In the Company's continuing efforts to
enhance the cost effectiveness of its solutions in the lower power range for
power supplies, it announced the TinySwitch family of ICs in September 1998.
TinySwitch ICs are primarily targeted at the sub 10 watt power range and
incorporate the Company's new EcoSmart technology which is designed to reduce
energy leakage from power supplies. There can be no assurance that the Company
will be successful in these efforts.

In addition, the Company faces competition from MEC, which currently
manufactures and sells its versions of the Company's 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 the Company
to manufacture and sell products using the Company's technology to Japanese
companies worldwide and to subsidiaries of Japanese companies located in Asia.
Beginning in April 1997, the Company agreed not to sell its products to new
customers in Japan. The Company's TOPSwitch product families have also begun to
meet additional competition from hybrid and single high-voltage ICs similar to
TOPSwitch. These competing products are being developed or have been developed
and are being produced by companies such as Motorola, STMicroelectronics,
Samsung and Sanken. The Company expects competition to increase as Motorola,
STMicroelectronics, Samsung, Sanken and possibly other companies develop and
introduce new products.

The Company's ability to compete in its target markets also depends on such
factors as the timing and success of new product introductions by the Company
and its competitors, the pace at which the Company's customers incorporate the
Company's products into their end user products, availability of wafer
fabrication and finished good manufacturing capability, availability of adequate
sources of raw materials, protection of Company products by effective
utilization of intellectual property laws and general economic conditions. There
can be no assurance that the Company's products will continue to compete
favorably or that the Company will be successful in the face of increasing
competition from new products and enhancements introduced by existing
competitors or new companies entering this market. Failure of the Company to
compete successfully in the high-voltage power supply business would materially
and adversely affect the Company's business, financial condition and results of
operations.

Dependence on Proprietary Technology. The Company's future success depends
in part upon its ability to protect its intellectual property, including
patents, trade secrets, and know-how, and to continue its technological
innovation. There can be no assurance that the steps taken by the Company to
protect its intellectual property will be adequate to prevent misappropriation
or that others will not develop competitive technologies or products.

The semiconductor industry is characterized by frequent litigation regarding
patent and other intellectual property rights. While the Company has not
received formal notice of any infringement of the right of any third party,
questions of infringement in the semiconductor field involve highly technical
and subjective analyses. Litigation may be necessary in the future to enforce
the Company's patents and other intellectual property rights, to protect the
Company's trade secrets, to determine the validity and scope of the proprietary
rights of others, or to defend against claims of infringement or invalidity, and
there can be no assurance that the Company would prevail in any future
litigation. In addition, the laws of certain foreign countries in which the
Company's technology is or may in the future be licensed may not protect the
Company's intellectual property rights to the same extent as the laws of the
United States, thus increasing the possibility of infringement of the Company's
intellectual property.

Motorola Litigation. 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 that 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

17
counterclaims against the Company alleging that the Company is infringing on
certain of Motorola's patents. The Company believes that Motorola's
counterclaims are without merit and intends to vigorously defend itself against
such claims.

Litigation may be necessary to resolve the claims asserted by the Company
against Motorola, and any claims which Motorola may assert in the future against
the Company, and to defend, enforce and protect the Company's intellectual
property rights. There can be no assurance that the Company will prevail in any
litigation with Motorola, or any other party. 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 results of
operations. In addition, any litigation between the Company and Motorola could
delay the Company's ability to have its products incorporated into a customer's
products at the design stage. Delays in customers' decisions to use the
Company's products could have a material adverse effect on the Company's
business, financial condition and results of operations. Adverse determinations
in any litigation could result in the loss of certain 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
manufacturing and selling certain of its products or licensing its technology,
any of which could have a material adverse effect on the Company's business,
financial condition and results of operations.

Dependence on Key Personnel. The Company's success depends to a significant
extent upon the continued service of its executive officers and other key
management and technical personnel, and on its ability to continue to attract,
retain and motivate qualified personnel, such as experienced systems
applications engineers. The loss of the services of one or more of the Company's
engineers, executive officers or other key personnel or the Company's inability
to recruit replacements for such personnel or to otherwise attract, retain and
motivate qualified personnel could have a material adverse effect on the
Company's business, financial condition or operating results. The Company does
not have long-term employment contracts with any of its employees.

Management of Growth. The Company has experienced a period of rapid growth
and expansion which has placed, and continues to place, a significant strain on
its resources. To accommodate this growth, the Company will be required to
implement a variety of new and upgraded operational and financial systems,
procedures and controls, including the improvement of its accounting and other
internal management systems, all of which may require substantial management
efforts. There can be no assurance that such efforts can be accomplished
successfully.

Year 2000 Compliance. The Company is aware of the issues associated with
the programming code in existing computer systems and software products as the
year 2000 approaches. Computer programs that are written using two digits rather
than four digits to define the applicable year, may have date-sensitive software
and, for instance, may recognize a date using 00 as the year 1900 rather than
the year 2000 ("Date Code Dependency"). Systems that do not properly recognize
such information could generate erroneous data or cause a system to fail. The
Company is in the process of defining costs, issues and uncertainties associated
with making the Company's internal-use software applications compliant with the
Year 2000. In general, the Company expects to resolve the Year 2000 issues
through planned replacement upgrades of its software applications.

The Company has evaluated the functionality of its products with respect to
Year 2000 Date Code Dependencies and has determined that its products have no
Date Code Dependencies. The Company's ICs are installed by third party
manufacturers in their products. Accordingly, if any of those products have Date
Code Dependencies, there could be unforeseen Year 2000 compliance problems with
some of the Company's customers products, which could result in such customers
ordering less products from the Company. Any such decrease in customers' orders
would have a material adverse effect on the Company's operating results and
financial condition. In addition, some of the Company's customers may experience
Date Code Dependency problems that result in disruption of their internal
operations, which could delay their purchases of the Company's products, and
result in a material adverse effect on the Company's operating results and
financial condition.

The Company also is subject to risks to the extent that suppliers of
products, services and systems to the Company have business systems or products
that have Date Code Dependencies. Where practicable, the Company will attempt to
mitigate its risks with respect to the failure of suppliers to be Year 2000
compliant. In the event that suppliers are not Year 2000 compliant, the Company
will seek to qualify alternative sources of supplies. In the event the Company's
current suppliers are not Year 2000 compliant, or the Company is unable to
qualify in a timely

18
manner suppliers that are Year 2000 compliant, the Company's
results of operations and financial condition could be materially adversely
affected. Additionally, litigation may arise from situations in which the
Company has minimum purchase commitment contracts with suppliers that are not
Year 2000 compliant. If any such third party suppliers are unable to provide the
Company with products, services or systems that meet Year 2000 requirements in a
timely manner, the Company's operating results and financial condition could be
materially adversely affected.

Management does not expect the Year 2000 issues to have a material impact on
the Company's business or future results of operations. Management also believes
that the total costs to become Year 2000 compliant will be immaterial to the
Company's financial condition or results of operations. However, if the planned
replacement upgrades to its software applications are not made, or are not
completed on a timely basis, the Year 2000 issues could have a material impact
on the operations of the Company. The Company currently expects that its
internal-use software applications will be Year 2000 compliant by no later than
June 1999, before any Date Code Dependencies within the Company's internal
systems would have a material adverse impact on the Company's operations. The
cost of the project and the date on which the Company believes it will complete
the Year 2000 upgrades are based on management's best estimates, which were
derived utilizing numerous assumptions of future events, including the
availability of certain resources and other factors. However, there can be no
guarantee that these estimates will be achieved and actual results could differ
materially from those anticipated. Specific factors that might cause such
material differences include, but are not limited to, the availability and cost
of personnel trained in this area, the ability to locate and correct all
relevant computer codes, and similar uncertainties.

Year 2000 compliance is an issue for virtually all businesses, whose computer
systems and applications may require significant hardware and software upgrades
or modifications. Companies owning and operating such systems may plan to devote
a substantial portion of their information systems spending to fund such
upgrades and modifications and divert spending away from ICs for use in AC to DC
power conversion. Such changes in customers' spending patterns could have a
material adverse impact on the Company's sales, operating results and financial
condition.

Possible Volatility of Stock. The stock market has from time to time
experienced significant price and volume fluctuations which have particularly
affected the market prices of the stock of high technology companies, and which
may be unrelated to the operating performance of particular companies. Since its
initial public offering in December 1997, the market price of the Company's
common stock has ranged from a high of $18.50 to a low of $7.75 per share.
Factors such as technology and product announcements by the Company or by
competitors, disputes relating to patents and proprietary rights, and failures
or delays in the Company's development program may have a significant effect on
the market price of the Company's common stock.

19
PART II.  OTHER INFORMATION

ITEM 1. 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 that
complaint, and filed a new complaint in the U.S. District Court, District of
Delaware, alleging that Motorola has infringed and continues to infringe on two
of the Company's circuit patents. The Company seeks, among other things, an
order enjoining Motorola from infringing on the Company's patents and an award
for damages resulting from the alleged infringement. In October 1998, Motorola
asserted various counterclaims against the Company alleging that the Company
is infringing on certain of Motorola's patents. The Company believes that
Motorola's counterclaims are without merit and intends to vigorously defend
itself against such claims.

Litigation may be necessary to resolve the claims asserted by the Company
against Motorola, and any claims which Motorola may assert in the future against
the Company, and to defend, enforce and protect the Company's intellectual
property rights. There can be no assurance that the Company will prevail in any
litigation with Motorola, or any other party. 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 results of
operations. In addition, any litigation between the Company and Motorola could
delay the Company's ability to have its products incorporated into a customer's
products at the design stage. Delays in customers' decisions to use the
Company's products could have a material adverse effect on the Company's
business, financial condition and results of operations. Adverse determinations
in any litigation could result in the loss of certain 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
manufacturing and selling certain of its products or licensing its technology,
any of which could have a material adverse effect on the Company's business,
financial condition and results of operations.

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

None

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:

10.21* Wafer Supply Agreement between the Company and OKI, dated
October 1, 1998.

10.22 Master Equipment Lease Agreement between the Company and
Metlife Capital Limited Partnership, dated July 31, 1998.

27.1 Financial Data Schedule.

* This Exhibit has been filed separately with the Commission
pursuant to an application for confidential teatment. The
confidential portions of this Exhibit have been omitted and
are marked by an asterisk.

b. Reports on Form 8-K.

None.

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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: November 10, 1998 By: ____________________________________
Robert G. Staples
Chief Financial Officer

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