================================================================================ 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 March 31, 2000 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 April 28, 2000 - ----------------------------------- ---------------------------------- Common Stock, $.001 par value 27,230,555 shares ================================================================================
POWER INTEGRATIONS, INC. TABLE OF CONTENTS <TABLE> <CAPTION> Page <S> <C> PART I. FINANCIAL INFORMATION 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 19 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 </TABLE> TOPSwitch, TinySwitch and EcoSmart are trademarks of Power Integrations, Inc. 2
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS POWER INTEGRATIONS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands) <TABLE> <CAPTION> March 31, December 31, 2000 1999 --------- ----------- (unaudited) <S> <C> <C> ASSETS CURRENT ASSETS: Cash and cash equivalents........................................................ $ 33,398 $27,883 Short-term investments........................................................... 29,997 33,789 Accounts receivable.............................................................. 8,760 9,682 Inventories...................................................................... 16,207 11,406 Prepaid expenses and other current assets........................................ 5,239 5,339 -------- ------- Total current assets........................................................... 93,601 88,099 -------- ------- PROPERTY AND EQUIPMENT, net......................................................... 12,023 10,472 -------- ------- $105,624 $98,571 ======== ======= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of capitalized lease obligations................................. $ 1,023 $ 1,228 Accounts payable................................................................. 6,585 6,524 Accrued payroll and related expenses............................................. 2,403 3,994 Taxes payable and other accrued liabilities...................................... 1,403 1,818 Deferred income on sales to distributors......................................... 3,266 3,366 -------- ------- Total current liabilities...................................................... 14,680 16,930 -------- ------- CAPITALIZED LEASE OBLIGATIONS, net of current portion............................... 1,188 1,393 -------- ------- STOCKHOLDERS' EQUITY: Common stock..................................................................... 27 26 Additional paid-in capital....................................................... 70,075 65,553 Stockholder notes receivable..................................................... (76) (201) Deferred compensation............................................................ (146) (181) Cumulative translation adjustment................................................ (165) (129) Retained earnings................................................................ 20,041 15,180 -------- ------- Total stockholders' equity..................................................... 89,756 80,248 -------- ------- $105,624 $98,571 ======== ======= </TABLE> 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 March 31, --------------------- 2000 1999 ------- ------- <S> <C> <C> NET REVENUES: Product sales......................................................................... $27,587 $20,446 License fees and royalties............................................................ 423 375 ------- ------- Total net revenues................................................................. 28,010 20,821 COST OF REVENUES........................................................................ 13,442 9,467 ------- ------- GROSS PROFIT............................................................................ 14,568 11,354 ------- ------- OPERATING EXPENSES: Research and development.............................................................. 3,055 2,336 Sales and marketing................................................................... 3,408 2,475 General and administrative............................................................ 1,917 1,369 ------- ------- Total operating expenses........................................................... 8,380 6,180 ------- ------- INCOME FROM OPERATIONS.................................................................. 6,188 5,174 OTHER INCOME, net....................................................................... 755 584 ------- ------- INCOME BEFORE PROVISION FOR INCOME TAXES........................................................................... 6,943 5,758 PROVISION FOR INCOME TAXES.............................................................. 2,082 864 ------- ------- NET INCOME.............................................................................. $ 4,861 $ 4,894 ======= ======= EARNINGS PER SHARE: Basic................................................................................. $ 0.18 $ 0.19 ======= ======= Diluted............................................................................... $ 0.17 $ 0.18 ======= ======= SHARES USED IN PER SHARE CALCULATION: Basic................................................................................. 26,756 25,289 ======= ======= Diluted............................................................................... 28,877 27,425 ======= ======= </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> Three Months Ended March 31, ---------------------------- 2000 1999 ---------- ---------- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income......................................................................... $ 4,861 $ 4,894 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization.................................................... 861 751 Deferred compensation expense.................................................... 35 35 Provision for (reduction in) accounts receivable and other allowances............ (281) 107 Deferred income taxes............................................................ -- (1,440) Change in operating assets and liabilities: Accounts receivable........................................................... 1,201 (1,488) Inventories................................................................... (4,801) 603 Prepaid expenses and other current assets..................................... 100 30 Accounts payable.............................................................. 63 752 Accrued liabilities........................................................... (187) 1,538 Deferred income on sales to distributors...................................... (100) (300) ------- -------- Net cash provided by operating activities.................................. 1,752 5,482 ------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment.............................................. (2,412) (1,360) Purchases of short-term investments.............................................. (9,925) (23,843) Proceeds from sales and maturities of short-term investments..................... 13,717 6,666 ------- -------- Net cash provided by (used in) operating activities........................ 1,380 (18,537) ------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from issuance of common stock....................................... 2,668 767 Proceeds from stockholder note repayment......................................... 125 5 Principal payments under capitalized lease obligations........................... (410) (457) ------- -------- Net cash provided by financing activities.................................. 2,383 315 ------- -------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............................... 5,515 (12,740) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD................................... 27,883 24,176 ------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD......................................... $33,398 $ 11,436 ======= ======== SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Capitalized lease obligations incurred for property and equipment................ $ -- $ 1,786 ======= ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest........................................................... $ 52 $ 85 ======= ======== Cash paid for income taxes....................................................... $ 625 $ 282 ======= ======== </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, 1999 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 March 31, 2000, 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 No.131 requires a new basis of determining reportable business segments, i.e., the management approach. This approach requires that business segment information used by management to assess performance and manage company resources be the source for information disclosure. On this basis, the Company is organized and operates as one business segment, the design, development, manufacture and marketing of proprietary, high-voltage, analog circuits for use in the AC to DC power conversion market. 6
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 consolidated results of operations and financial position. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 provides guidance on applying generally accepted accounting principles to revenue recognition issues in financial statements. The Company will adopt SAB 101 as required in the second quarter of 2000 and does not expect such adoption to have a material impact on its consolidated results of operations and financial position. 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> March 31, December 31, 2000 1999 ------------------------ <S> <C> <C> Raw materials................................. $ 4,314 $ 4,039 Work-in-process............................... 5,702 4,059 Finished goods................................ 6,191 3,308 ------- ------- $16,207 $11,406 ======= ======= </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 three months ended March 31, 2000 and 1999, ten customers accounted for approximately 69% and 70% of total net revenues, respectively. The following customers accounted for more than 10% of total net revenues: <TABLE> <CAPTION> Three Months Ended March 31, Customer 2000 1999 -------- -------------------- <S> <C> <C> A.............................................. 20% 23% B.............................................. * 12% </TABLE> _______________ * less than 10% or no sales 7
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> Three Months Ended March 31, 2000 1999 ------------------ <S> <C> <C> Western Europe..................................... 21% 16% Hong Kong/China.................................... 20% 25% Taiwan............................................. 17% 12% Korea.............................................. 12% 17% Japan.............................................. 2% 3% Other.............................................. 9% 8% ---- ---- Total foreign................................. 81% 81% ==== ==== </TABLE> Product Sales For the three months ended March 31, 2000 and 1999, sales of TOPSwitch products accounted for 98% and 96% of total net revenues, respectively. TOPSwitch products include TOPSwitch, TOPSwitch II and TinySwitch. 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 March 31, -------------------- 2000 1999 --------- ------- <S> <C> <C> Basic earnings per share: Net income.............................................. $ 4,861 $ 4,894 ------- ------- Weighted average common shares.......................... 26,756 25,289 ------- ------- Basic earnings per share............................. $ 0.18 $ 0.19 ======= ======= Diluted earnings per share: Net income.............................................. $ 4,861 $ 4,894 ------- ------- Weighted average common shares.......................... 26,756 25,289 Weighted average common share equivalents: Options.............................................. 2,066 1,841 Warrants............................................. -- 249 Employee stock purchase plan......................... 55 46 ------- ------- Diluted weighted average common shares.................. 28,877 27,425 ------- ------- Diluted earnings per share........................ $ 0.17 $ 0.18 ======= ======= </TABLE> 8
POWER INTEGRATIONS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 6. PROVISION FOR INCOME TAXES: Income tax expense for the three-month periods ended March 31, 2000 and 1999 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 quarter ended March 31, 2000 is primarily due to the beneficial impact of international sales, research and development credits and Federal tax exempt investments. 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 two of the Company's circuit patents. In October 1998, Motorola asserted various counterclaims against the Company, alleging that the Company is infringing certain of Motorola's patents. Trial of this action was held in October 1999. On October 15, 1999, the jury returned a unanimous verdict in favor of the Company. The jury determined that Motorola had willfully infringed one of the Company's patents and awarded the Company $32.3 million in compensatory damages. The jury also found that the Company had not infringed any of the asserted Motorola patents and that two of the Motorola patents were invalid. In March 2000, the Company and Motorola entered into a settlement agreement. Pursuant to the settlement agreement, the court has issued a permanent injunction prohibiting Motorola from selling the ICs that were the subject of the lawsuit. Additionally, the Company will not collect the money judgment from Motorola and will continue for a two-year term as a preferred supplier of high-voltage power conversion ICs for cellular phone chargers that Motorola manufacturers. The companies will work more closely together to develop future generations of cellular phone chargers for Motorola. 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 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, 1999. Overview We design, develop, manufacture and market proprietary, high-voltage, analog integrated circuits, or ICs, for use 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 and time-to-market. 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 for power supplies used in a broad range of electronic products. TinySwitch ICs - incorporating our 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. In March 2000, we introduced the TOPSwitch-FX family of products, which also incorporates our EcoSmart technology to help engineers meet the growing need for environmentally friendly power solutions. We believe this new family of ICs gives power supply design engineers the ability to cost effectively integrate additional functionality into the power supplies they design. 10
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 Total Net Revenues for Three Months Ended March 31, ---------------------- 2000 1999 -------- --------- <S> <C> <C> Net revenues: Product sales......................................... 98.5% 98.2% Royalties............................................. 1.5 1.8 ----- ----- Total net revenues................................. 100.0 100.0 Cost of revenues........................................ 48.0 45.5 ----- ----- Gross profit............................................ 52.0 54.5 ----- ----- Operating expenses: Research and development.............................. 10.9 11.2 Sales and marketing................................... 12.2 11.9 General and administrative............................ 6.8 6.6 Total operating expenses........................... 29.9 29.7 ----- ----- Income from operations.................................. 22.1 24.8 Other income, net....................................... 2.7 2.8 ----- ----- Income before provision for income taxes................ 24.8 27.6 Provision for income taxes.............................. 7.4 4.1 ----- ----- Net income.............................................. 17.4% 23.5% ===== ===== </TABLE> Comparison of the Three Months Ended March 31, 2000 and 1999 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 first quarter ended March 31, 2000 were $28.0 million compared to $20.8 million for the first quarter of 1999, an increase of $7.2 million, or 35%. Net revenues from product sales represented $27.6 million and $20.4 million in the first quarter of 2000 and 1999, respectively. The increase in net revenues from product sales for the three months ended March 31, 2000 was due primarily to strong demand for our products in the cellular phone charger and set top box decoder charger markets, which together accounted for approximately 60% of the increase. Higher sales volume of the TOPSwitch family of products across a larger customer base also contributed to the increase. In total, sales of our TOPSwitch and TinySwitch products accounted for approximately 98% of net product revenues in the quarter ended March 31, 2000. Revenue from royalties was $423,000 for the first quarter of 2000, compared to $375,000 for the first quarter of 1999. International sales were $22.8 million in the first quarter of 2000 compared to $16.8 million for the same period in 1999, an increase of $6.0 million, or 36%, which represented 81% of our net revenues in both quarters. 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 60% and 64% of product sales for the three months ended March 31, 2000 and 1999, respectively. We expect international sales to continue to account for a large portion of our net revenues. Direct sales for the first quarter of 2000 were divided approximately 47% to distributors and 53% to OEMs and power supply merchants, compared to approximately 45% to distributors and 55% to OEMs and power supply 11
merchants for the same quarter in 1999. For the quarter ended March 31, 2000, sales to one customer accounted for 20% of net revenues, and for the quarter ended March 31, 1999, that same customer accounted for 23% of net revenues and another customer accounted for 12% 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 15% and 17% of net revenues for the quarters ended March 31, 2000 and 1999, respectively. Direct sales to Motorola were approximately 8% and 12% of our net revenues for the quarters ended March 31, 2000 and 1999, 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 first quarter of 2000 was $14.6 million, or 52%, of net revenues, compared to $11.4 million, or 54.5%, of net revenues for the same period in 1999. The decrease in gross profit percentage for the three months ended March 31, 2000 was primarily due to the adverse impact of increased customer pricing pressure and the increase in wafer costs from a stronger yen, partially offset by improved manufacturing productivity, reduced material pricing, 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 first quarter of 2000 were $3.1 million compared to $2.3 million for the same period in 1999, an increase of $719,000, or 31%, which represented 10.9% and 11.2% of our net revenues, respectively. The increase in absolute dollars for the three months ended March 31, 2000 was primarily due to increased salaries and other costs related to the hiring of additional engineering personnel. 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 first quarter of 2000 were $3.4 million compared to $2.5 million for the same period in 1999, an increase of $933, 000, or 38%, which represented 12.2% and 11.9% of our net revenues, respectively. The increase in absolute dollars for the three months ended March 31, 2000 was primarily a result of the addition of personnel to support increased sales, and to increase the availability of field application engineers. There was also an increase in sales commissions as a result of increased sales. We expect that sales and marketing expenses will 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, and consulting, outside services, legal and auditing expenses. For the quarters ended March 31, 2000 and 1999, general and administrative expenses were $1.9 million and $1.4 million, respectively, which represented 6.8% and 6.6% of our net revenues, respectively. This increase in spending is primarily attributable to increased professional and legal expenses related to the settlement of our patent infringement lawsuit filed against Motorola. We expect general and administrative expenses to decline in the second quarter reflecting lower professional and legal expenses following the settlement of the lawsuit. Subsequent to the second quarter, we expect general and administrative expenses to continue to increase in absolute dollars, but to fluctuate as a percentage of our net revenues. Other income, net. Other income, net, for the first quarter of 2000 increased by $171,000 over the same period in 1999. The increase for the three months ended March 31, 2000 was due primarily to additional interest income from an increase in cash, cash equivalents and short-term investments in 2000. Provision for income taxes. Provision for income taxes represents Federal, state and foreign taxes. The provision for income taxes was $2.1 million for the first quarter of 2000 compared to $864,000 for the same period 12
in 1999. The estimated effective tax rate for 2000 is 30% compared to 15% used in the first quarter of 1999. The lower tax rate in 1999 reflected the benefit of net operating loss carryforwards, all of which were used by December 31, 1999. The difference between the statutory rate and our effective tax rate for 2000 is primarily due to the beneficial impact of international sales, research and development credits and Federal tax exempt investments. Liquidity and Capital Resources At March 31, 2000, we had approximately $63.4 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 credit, which we provide to Matsushita and OKI prior to the shipment of wafers by the foundries to us. The balance of this credit line is unused and available. The line of credit agreement contains financial covenants and requires that we maintain profitability on a quarterly basis and not pay or declare dividends without the bank's prior consent. We have financed a significant portion of our machinery and equipment through capital equipment leases. There was no additional equipment financing during the three months ended March 31, 2000. As of March 31, 2000, we had working capital, defined as current assets less current liabilities, of approximately $78.4 million, which was an increase of approximately $7.8 million over December 31, 1999. Our operating activities generated cash of $1.8 million and $5.5 million in the quarters ended March 31, 2000 and 1999, respectively. Cash generated in the first quarter of 2000 was principally the result of net income in the amount of $4.9 million, depreciation and amortization, and a decrease in accounts receivable, partially offset by an increase in inventory. Cash generated in the first quarter of 1999 was principally the result of net income of $4.9 million and an increase in accrued liabilities; offset by increases in accounts receivable and deferred taxes. Our investing activities were a net transfer from short-term investments to cash and cash equivalents of $3.8 million in the quarter ended March 31, 2000 and a net transfer from cash and cash equivalents to short-term investments of $17.2 million in the quarter ended March 31, 1999. Purchases of property and equipment were $2.4 million and $1.4 million in the quarters ended March 31, 2000 and 1999, 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. 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 consolidated results of operations and financial position. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 provides guidance on applying generally accepted accounting principles to revenue recognition issues in financial statements. We will adopt SAB 101 as required in the second quarter of 2000 and do not expect such adoption to have a material impact on our consolidated results of operations and financial position. Factors That May Affect Future Results of Operations In addition to the other information in this Report, the following factors should be considered carefully in evaluating our business before purchasing shares of our stock. Our quarterly operating results are volatile and difficult to predict. If we fail to meet the expectations of public market analysts or investors, the market price of our common stock may decrease significantly. Our net 13
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 quarterly operating results will likely fall below the expectations of public market analysts or investors. If that occurs, the price of our stock may decline. Some of the factors that could affect our operating results include the following: . the volume and timing of orders received from customers; . the volume and timing of orders placed by us with our foundries; . 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 timing of investments in research and development and sales and marketing; . cyclical semiconductor industry conditions; and . fluctuations in exchange rates, particularly the exchange rates between the U.S. dollar and the Japanese yen. Our quarterly results may be subject to seasonality. Historically, our revenues are strongest in our third and fourth quarters, due to what we believe are seasonal factors attributed to the high volume consumer markets for the end products into which our ICs are sold. Our revenues have then followed a pattern of being sequentially linear or somewhat down in the first and second quarters of the next year. We do not have long-term contracts with any of our customers and if they fail to place, or if they cancel or reschedule orders for our products, our operating results and business may suffer. Our business is characterized by short-term customer orders and shipment schedules. 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. In addition, customer orders can be canceled or rescheduled without significant penalty to the customer. In the past we have experienced customer cancellations of substantial orders for reasons beyond our control, and significant cancellations could occur again at any time. We depend on Motorola for a significant portion of our net revenues and if we lose Motorola as a customer, our operating results will suffer. For the quarter ended March 31, 2000, direct sales to Motorola accounted for approximately 8% of our net revenues. Indirect sales, through power supply merchants, which incorporate our ICs into the products they produce for Motorola, accounted for approximately 7% of our net revenues. For the quarter ended March 31, 1999, direct sales and indirect sales to Motorola accounted for approximately 12% and 5% of our net revenues, respectively. We expect that our operating results, in part, will depend on our direct and indirect sales to Motorola for the foreseeable future. In addition if Motorola continues to shift from higher end to lower end cellular phones that use older technology chargers which do not use our ICs, our direct and indirect sales to Motorola will be adversely impacted. Intense competition in the high-voltage power supply industry may lead to a decrease in the average selling price and reduced sales volume of our products, which may harm our business. The high-voltage power supply industry is intensely competitive and characterized by significant price erosion. Our products face competition from alternative technologies, including traditional linear transformers and discrete switcher power supplies. If the price of competing products decreases significantly, the cost effectiveness of our products will be adversely affected. If power requirements for applications in which our products are currently utilized, including battery chargers for cellular telephones, drop below current power levels, these older alternative technologies can be used more cost effectively than our TOPSwitch-based switchers. 14
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, including our ability to introduce new products with higher average selling prices, would materially harm our operating results. If demand for our products declines in the cellular phone battery charger and desktop personal computer stand-by markets, our net revenues will decrease. Applications of our products in the cellular phone battery chargers and desktop personal computer, or PC, stand-by markets have and should continue to account for a significant portion 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 our net revenues to decline and the price of our stock to fall. In addition, technological advances in these markets may reduce demand for our products. Because the sales cycle for our products can be lengthy, we may incur substantial expenses before we generate significant revenues, if any. 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 research and development and sales and marketing resources without any assurance of success, often precede volume sales, if any, by a year or more. 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. 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. Our products must meet exacting specifications, and undetected defects and failures may occur which may cause customers to return or stop buying our products. Our customers generally 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. If defects and failures occur in our products, 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. We depend on third-party suppliers to provide us with wafers for our products and if they fail to provide us sufficient wafers, our business will suffer. 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 their continued cooperation and, in many instances, their course of conduct deviates from the literal provisions of the contracts. We cannot assure you that we will continue to work successfully with Matsushita or OKI in the future, that they will continue to provide us with sufficient capacity at their foundries to meet our needs, or that either of them will not seek an early termination of its wafer supply agreement with us. We are currently in negotiations on a new agreement with Matsushita, but we cannot assure you that we will be able to agree on a new contract with Matsushita. Our current agreement expires in June 2000, and if we cannot extend our agreement with Matsushita, our net revenues may decline. We estimate that it would take 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. Although we provide Matsushita and OKI with rolling forecasts of our production requirements, their ability to provide wafers to us is limited by the available capacity of the foundry in which they manufacture 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 harm our business. 15
If our third-party suppliers and independent subcontractors do not produce our wafers and assemble our finished products at acceptable yields, our net revenues may decline. 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. In addition, our IC assembly process 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. 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. 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. Pursuant to our agreement with Matsushita, Matsushita has the right to manufacture and sell products using our technology to Japanese companies worldwide and to subsidiaries of Japanese companies located in Asia. In addition, we have agreed not to sell our products in Japan to new customers. Although we receive royalties on Matsushita's sales, these royalties are substantially lower than the gross profit we would receive on direct sales. We cannot assure you that Matsushita will not use the technology rights we have granted it 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 activities 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: . 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; . tariffs and other trade barriers and restrictions; and . the burdens of complying with a variety of foreign laws. Our failure to adequately address these risks could reduce our international sales, which would materially adversely affect our operating results. Furthermore, because substantially all of our foreign sales are denominated in U.S. dollars, increases in the value of the dollar 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. If our efforts to enhance existing products and introduce new products are not successful, we may not be able to generate demand for our products. Our 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. 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 these products will achieve market acceptance. Our or our customers' failure to develop and introduce new products successfully and in a timely manner would harm our business and may cause the price of our common stock to fall. 16
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. If our products do not penetrate additional markets, our business will not grow as we predict. We believe that our future success depends in part upon our ability to penetrate additional markets for our products. 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. If we are unable to adequately protect or enforce our intellectual property rights, we could lose market share, incur costly litigation expenses or lose valuable assets. Our 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. From time to time we have received, and we may receive in the future, communications alleging possible infringement of patents or other intellectual property rights of others. Litigation, which could result in substantial cost to us, may be necessary to enforce our patents or other intellectual property rights or to defend us against claimed infringement of the rights of others. The failure to obtain necessary licenses or other rights or litigation arising out of infringement claims could cause us to lose market share and harm our business. 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 must attract and retain qualified personnel to be successful and competition for qualified personnel is intense in our market. 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 harm our business. 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 recent growth has strained our resources and if we fail to successfully manage this growth, we may lose customers. We have experienced a period of rapid growth and expansion, which has placed, and continues to place, a significant strain on our resources. Relationships with our customers generally require significant engineering support. A significant 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 impede our ability to develop future generations of our products and to remain competitive. In addition, any future periods of rapid growth or expansion could be expected to place a significant strain on our limited managerial, financial and engineering resources. 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 hostile takeover tactics. The adoption of this plan was not in response to any proposal to acquire us, and the 17
board is not aware of any such effort. The existence of this plan could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. The future trading price of our common stock could be subject to wide fluctuations in response to a variety of factors. The price of our common stock has been, and is likely to be, volatile. 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, may harm the market price of our common stock. 18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS. There has not been a material change in our exposure to interest rate and foreign currency risks since the date of our 1999 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 March 31, 2000. All investments mature, by policy, in 15 months or less. (in thousands, except average interest rates) <TABLE> <CAPTION> Average Carrying Interest Amount Rate -------- -------- <S> <C> <C> Cash Equivalents: Tax-exempt securities..................................... $25,200 4.03% ------- ---- Total cash equivalents............................... 25,200 4.03% ------- ---- Short-term Investments: U.S. corporate securities................................. 7,069 5.26% Foreign securities........................................ 2,063 5.03% Tax-exempt securities..................................... 19,924 3.87% ------- ---- Total short-term investments......................... 29,056 4.28% ------- ---- Total investment securities.......................... $54,256 4.17% ======= ==== </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. 19
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 two of our circuit patents. In October 1998, Motorola asserted various counterclaims against us, alleging that we are infringing certain of Motorola's patents. Trial of this action was held in October 1999. On October 15, 1999, the jury returned a unanimous verdict in our favor. The jury determined that Motorola had willfully infringed one of our patents and awarded us $32.3 million in compensatory damages. The jury also found that we had not infringed any of the asserted Motorola patents and that two of the Motorola patents were invalid. In March 2000, we entered into a settlement agreement with Motorola. Pursuant to the settlement agreement, the court has issued a permanent injunction prohibiting Motorola from selling the ICs that were the subject of the lawsuit. Additionally, we will not collect the money judgment from Motorola and will continue for a two-year term as a preferred supplier of high- voltage power conversion ICs for cellular phone chargers that Motorola manufacturers. The companies will work more closely together to develop future generations of cellular phone chargers for Motorola. 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: 27.1 Financial Data Schedule. b. Reports on Form 8-K. None. 20
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. POWER INTEGRATIONS, INC. Dated: May 10, 2000 By: /s/ Robert G. Staples --------------------------------- Robert G. Staples Chief Financial Officer 21