| MONOLITHIC POWER SYSTEMS INC particular, in the section entitled “Item 1A Risk Factors” |
| The Company disclaims any duty to and undertakes no obligation to update any forward-looking statements, whether as a result of new information relating to existing conditions, future events or otherwise or to release publicly the results of any future revisions it may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events |
| Readers are cautioned not to place undue reliance on such statements, which speak only as of the date of this annual report on Form 10-K Readers should carefully review future reports and documents that the Company files from time to time with the Securities and Exchange Commission, such as its quarterly reports on Form 10-Q and any current reports on Form 8-K PART I ITEM 1 |
| (together with its consolidated subsidiaries, “MPS” or the “Company”) is a high performance analog and mixed-signal semiconductor company |
| We design, develop, and market proprietary, advanced analog and mixed-signal semiconductors for large and high growth markets |
| Our semiconductors, or integrated circuits (ICs), are used in a variety of electronic products, such as notebook computers, flat panel displays, cellular handsets, digital cameras, wireless local area network (LAN) access points, home entertainment systems, and personal digital assistants |
| 3 ______________________________________________________________________ [30]Table of Contents We compete on our ability to offer deep system-level and applications knowledge, strong analog and mixed-signal design expertise, and low cost and high performance products through our proprietary process technology for the design and manufacture of our ICs |
| Industry Overview We operate in the cyclical semiconductor industry |
| Although the semiconductor industry experienced increased demand in 2005, the industry may experience downturns in the future |
| While we will not be immune from future industry downturns, we have targeted product and market areas that we believe have the ability to offer above average industry growth over the long term |
| Semiconductors comprise the basic building blocks of electronic systems and equipment |
| Within the semiconductor industry, components can be classified either as discrete devices, such as individual transistors, or as ICs, in which a number of transistors and other elements are combined to form a more complicated electronic circuit |
| ICs can be further divided into three primary categories: digital, analog, and mixed-signal |
| Digital ICs, such as memory devices and microprocessors, can store or perform arithmetic functions on data that is represented by a series of ones and zeroes |
| Analog ICs, in contrast, handle real world signals such as temperature, pressure, light, sound, or speed |
| In addition, analog ICs also perform power management functions, such as regulating or converting voltages, for electronic devices |
| Mixed-signal ICs combine digital and analog functions onto a single chip and play an important role in bridging real world phenomena to digital systems |
| Analog and Mixed-Signal Markets |
| ‘High performance’ products generally are differentiated by functionality and performance factors which include integration of higher levels of functionality onto a single chip, greater precision, higher speed and lower heat and noise |
| There are several key factors that distinguish analog and mixed-signal IC markets from digital IC markets and in particular the high performance portion of the analog and mixed signal IC market |
| These factors include longer product life cycles, numerous market segments, technology that is difficult to replicate, relative complexity of design and process technology, importance of experienced design engineers, lower capital requirements, and diversity of end markets |
| Products and Applications We currently have three primary product families that address multiple applications within the computing, consumer, and communications markets |
| Our products are differentiated with respect to their high degree of integration and strong levels of accuracy and efficiency, making them cost-effective relative to many competing solutions |
| These product families include: Liquid Crystal Display (LCD) Backlight Inverters |
| LCD backlight inverter ICs are used in systems that provide the light source for LCD panels typically found in notebook computers, LCD monitors, car navigational systems, and, more recently, LCD televisions |
| These ICs function by converting low voltage direct current (DC) or battery voltage to high voltage alternating current (AC) |
| We believe our LCD backlight inverter ICs were the first to utilize a full bridge resonant topology that allows for high efficiency, extended lifetimes for cold cathode fluorescent lamps (CCFLs), and lower signal interference with adjacent components |
| The full bridge topology is now industry standard for these products |
| We also believe that our LCD backlight inverter ICs are the semiconductor industry’s only backlight inverter ICs with four fully-integrated power devices |
| This integration reduces the overall size, total solution part count, and cost for our customers |
| Our LCD product family encompasses all of the products that we formerly referred to as our CCFL product family, as well as other non-CCFL solutions for LCD backlight inverters |
| Direct Current (DC) to DC Converters |
| DC to DC converter ICs are used to convert and control voltages within a broad range of electronic systems, such as portable electronic devices, 4 ______________________________________________________________________ [31]Table of Contents wireless LAN access points, home appliances, automobiles, and medical equipment |
| We believe that our DC to DC converters are differentiated particularly with respect to their high degree of integration and rapid switching speeds |
| These features are important to our customers as they result in fewer components, smaller form factors, more accurate regulation of voltages, and, ultimately, lower system costs through the elimination of discrete power devices |
| We also include Light Emitting Diode (LED) driver ICs in our DC to DC product family |
| LED driver ICs are used in lighting displays in small, portable devices, such as color cellular handsets, personal digital assistants, global positioning systems, and electronic gaming systems, as well as in emerging applications such as traffic lights and automobile signal lights |
| We were one of the first companies to offer LED driver ICs with a protection feature that limits damage to a system in the event of a poor power connection |
| We believe that our LED driver ICs are differentiated in the market with respect to their small size, power efficiency, and cost-effectiveness |
| Audio Amplifiers |
| Audio amplifier ICs are used to amplify sound produced by audio processors |
| We currently offer Class D audio amplifiers, which are well-suited for applications that require both small size and high power efficiency, such as plasma televisions, LCD televisions, and DVD players |
| With today’s systems becoming smaller and utilizing larger amounts of power, solution sizes and the management of heat dissipation are becoming increasingly important to overall system design |
| The high degree of power efficiency and small form factor provided by our Class D audio amplifiers allows system vendors to significantly reduce heat dissipation, eliminating the costly and sizable fans and heat sinks traditionally required by audio amplifier ICs |
| These features enable our customers to achieve their design and cost objectives without sacrificing sound quality |
| We currently target our products at the computing, consumer electronics, and wireless markets |
| Of these three markets, the computing market represents the largest portion of our revenue |
| As we continue to expand our product portfolio and addressable markets, and as other end markets in which we participate continue to grow, we expect that our revenue from the computing market may decline as a percentage of our total revenue over time |
| The following chart is a brief summary of our product family solutions for various applications |
| For each of these applications, we either are currently shipping product or have design wins, which are decisions by OEMs or ODMs to use our ICs: Application _________________________________________________________________ LCD Backlight Inverters _________________________________________________________________ DC to DC Converters _________________________________________________________________ Audio Amplifiers _________________________________________________________________ Computing Computers and PDA devices X X LCD Monitors X X X Disk Drives/ Storage Networks X Consumer Electronics LCD TV Displays X X X Plasma TV Displays X X Set Top Boxes X DVD Players X X X GPS and Infotainment systems X Wireless Cellular Handsets X X Wireless Access Points X We derive a majority of our revenue from sales of our LCD backlight inverter product family to the computing and consumer electronics markets and from sales of our DC to DC converter IC product 5 ______________________________________________________________________ [32]Table of Contents family to the computing, consumer electronics and wireless markets |
| In the future, we expect to introduce additional new products within our existing product families and other products that include voltage references and low dropout regulators |
| Our ability to achieve revenue growth will depend in part upon our ability to enter new market segments, gain market share, expand our customer base, and successfully secure manufacturing capacity |
| Customers, Sales, and Marketing We sell our products through third party distributors and directly to OEMs, ODMs, and electronic manufacturing service providers |
| Our third party distributors are subject to distribution agreements with MPS which allow the distributor to sell our products to end customers |
| Distributors may distribute our products to end customers which include OEMs, ODMs or electronic manufacturing service providers |
| ODMs typically design and manufacture electronic products on behalf of OEMs, and electronic manufacturing service providers typically provide manufacturing services for OEMs and other electronic product suppliers |
| For the year ended December 31, 2005, sales to our largest customers, each comprising greater than 10prca of our revenue, accounted for 54prca of our total revenue |
| Each of our three largest customers is a distributor |
| The following is a summary of the percentage of total revenue for the years ended December 31, 2005, 2004 and 2003 from these customers: Year Ended December 31, _________________________________________________________________ 2005 _________________________________________________________________ 2004 _________________________________________________________________ 2003 _________________________________________________________________ A 23 % 28 % 0 % B 20 % 21 % 0 % C 11 % 9 % 16 % Our current distribution agreements with several of our major distributors provide that each distributor shall have the non-exclusive right to sell and use its best efforts to promote and develop a market for, our products in several countries in Asia |
| These agreements may be terminated by either us or the distributor on up to three months’ notice |
| These agreements provide that payment for purchases from us will occur within 30 days from the date of invoice |
| In addition, we allow for limited stock rotation in certain agreements |
| We have sales offices located in the United States, Taiwan, China, Korea and Japan and have marketing representatives in Europe |
| For the year ended December 31, 2005, 95prca of our sales were to customers located in Asia |
| Our products typically require a highly technical sales and applications engineering effort where we assist our customers in the design and use of our products in their application |
| We maintain a staff of applications engineers who work directly with our customers’ engineers in the development of their systems electronics containing our products |
| Because our sales are billed and payable in United States dollars, our sales are not directly subject to fluctuating currency exchange rates |
| However, because 95prca of our revenue in 2005 was attributable to direct or indirect sales to customers who manufacture their products in Asia, changes in the relative value of the dollar may create pricing pressures for our products |
| Beginning August 1, 2005 we increased our standard product warranty period from 90 days to one year |
| We provide a warranty against defects in materials and workmanship on all our products and will either repair the goods, provide replacements at no charge to the customer, or under certain circumstances, refund amounts to the customer for defective products |
| Estimated sales returns and warranty costs, based on historical experience by product, are recorded at the time product revenue is recognized |
| Historical warranty expense as a percentage of revenue has been negligible |
| Our sales are made primarily pursuant to standard individual purchase orders |
| Our backlog consists of orders that we have received from customers which have not yet shipped |
| Our backlog at 6 ______________________________________________________________________ [33]Table of Contents December 31, 2005 was dlra17dtta1 million |
| We believe that backlog is not necessarily a good indicator of future sales |
| Order lead times may vary, and, as is common within our industry, customers are allowed to reschedule or cancel orders on relatively short notice |
| Our quarterly revenue is also influenced by orders booked and shipped within that quarter which are not reflected by backlog at the end of any preceding quarter |
| Our manufacturing lead times are generally 6 to 14 weeks and we often must build inventory in advance of customer orders based on our forecast of future customer orders |
| This subjects us to certain risks, most notably the possibility that sales will not meet our forecast, which could lead to inventories in excess of demand |
| If we have excess inventory, we may need to either sell it at a substantial discount or dispose of it altogether, either of which would negatively affect our profit margins |
| The markets in which we sell our products are subject to seasonality |
| Our revenue generally tends to increase in the third and fourth quarters of each calendar year, when customers place orders to meet year-end holiday production and demand, and our revenue tends to decrease in the first quarter of each calendar year |
| However, our rapid revenue growth and the use of distributors for the majority of our sales makes it difficult for us to separate seasonal changes in customer order patterns from absolute changes in customer demand |
| This difficulty is partly attributable to the increasing breadth of our product mix and to the differing rates of growth among our various products |
| Information regarding financial data by segment is set forth in Part II Item 8 of this Form 10-K in the Notes to Consolidated Financial Statements of Note 15, “Segment Information |
| ” Research and Development We have assembled a qualified team of engineers with core competencies in analog and mixed-signal design |
| Through our research and development efforts, we have developed a collection of intellectual property and know-how that we are able to leverage across our products and markets |
| Examples of our intellectual property and know-how include the development of high efficiency power devices, the design of precision analog circuits, expertise in mixed-signal integration and development of proprietary semiconductor process technologies |
| Our research and development efforts are generally targeted at three areas: system architectures, circuit design and implementation, and process technology |
| In the area of system architectures, we are exploring new ways of solving our customers’ system design challenges and are investing in the development of systems expertise in new markets and applications that align well with our core capabilities |
| In the area of circuit design and implementation, our initiatives include expanding our portfolio of products, developing more standard cells and libraries, improving our device structures, and adding new features to our products |
| For example, we are currently working to expand our product portfolio into new products areas such as operational amplifiers |
| We have developed a proprietary process technology that is applicable across a wide range of analog and mixed-signal products |
| We intend to continue to invest in our process technology to further refine this technology with respect to overall chip size and power handling capabilities |
| As appropriate, in the future we may also expand our base of process technologies, but only if these technologies are cost-effective and enable us to further expand our product offerings beyond what is currently achievable |
| Research and development expenses were approximately dlra14dtta8 million, dlra12dtta9 million, and dlra6dtta6 million in fiscal years 2005, 2004, and 2003, respectively, which includes stock-based compensation of dlra2dtta6 million, dlra5dtta2 million and dlra1dtta1 million, respectively |
| 7 ______________________________________________________________________ [34]Table of Contents Patents and Intellectual Property Matters We rely on our proprietary technologies, which include both our proprietary circuit designs for our products and our proprietary manufacturing process technologies for manufacturing our products |
| Our future success and competitive position depend in part upon our ability to obtain and maintain protection of our proprietary technologies |
| In general, we have elected to pursue patent protection for aspects of our circuit designs that we believe are patentable and to protect our manufacturing process technologies by maintaining those process technologies as trade secrets |
| As of March 1, 2006, we have 18 issued United States and foreign patents and 112 United States and foreign applications on file |
| We also rely on a combination of nondisclosure agreements and other contractual provisions, as well as our employees’ commitment to confidentiality and loyalty, to protect our technology, know-how, and processes |
| We have entered into a patent license agreement with another integrated circuit company, pursuant to which we have granted this company a license (with certain limited sublicense rights) under certain of our patents to make, use, and sell certain of this company’s own integrated circuit products for a period of two years, and for which this company is obligated to pay us royalties based on sales of those products |
| We also seek to register certain of our trademarks as we deem appropriate |
| We have not registered any of our copyrights and do not believe registration of copyrights is material to our business |
| Despite precautions that we take, it may be possible for unauthorized third parties to copy aspects of our current or future technology or products or to obtain and use information that we regard as proprietary |
| There can be no assurance that the steps we take will be adequate to protect our proprietary rights, that our patent applications will lead to issued patents, that others will not develop or patent similar or superior products or technologies, or that our patents will not be challenged, invalidated, or circumvented by others |
| Furthermore, the laws of the countries in which our products are or may be developed, manufactured or sold may not protect our products and intellectual property rights to the same extent as laws in the United States |
| Our failure to adequately protect our proprietary technologies could harm our business |
| The semiconductor industry is characterized by frequent claims of infringement and litigation regarding patent and other intellectual property rights, such as our litigation with O2 Micro International Limited, Linear Technology Corporation, Microsemi Corporation and Micrel Corporation |
| For a ITEM 1A RISK FACTORS Our business involves risks and uncertainties |
| You should carefully consider the risks described below, together with all of the other information in this annual report on Form 10-K and other filings with the Securities and Exchange Commission in evaluating our business |
| If any of the following risks actually occur, our business, financial condition, operating results, and growth prospects would likely be adversely affected |
| In such an event, the trading price of our common stock could decline, and you could lose all or part of your investment in our common stock |
| If we are unsuccessful in any of the legal proceedings between us and O2 Micro, Micrel or Taiwan Sumida Electronics, we could be prevented from selling many of our products and/or be required to pay substantial damages or fines |
| An unfavorable outcome or an additional award of damages, attorney’s fees or an injunction could cause our revenue to decline significantly and could severely harm our business and operating results |
| We are engaged in various legal proceedings with O2 Micro and Micrel |
| These proceedings involve various claims and counterclaims in the United States and Taiwan alleging, among other things, patent and trade secret infringement, misappropriation of trade secrets, and unfair competition |
| O2 Micro has also taken legal action against our wafer manufacturer and various customers and users 11 ______________________________________________________________________ [38]Table of Contents of our products in Taiwan and the United States, some of which we are |