UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 20-F
(Mark One)
[ ] Registration statement pursuant to Section 12(b) or 12(g) of the
Securities Exchange Act of 1934
or
[x] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 Forfor the fiscal year ended December 31, 20032004
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: 0-30910
O2 MICRO INTERNATIONAL LIMITED
(Exact Name of Registrant as Specified in Its Charter)
The Cayman Islands
(Jurisdiction of Incorporation or Organization)
Grand Pavilion Commercial Centre, West Bay Road
P.O. Box 32331 SMB, George Town
Grand Cayman, Cayman Islands
(Address of Principal Executive Offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Name of Each Exchange On Which
------------------------------
Title of Each Class Registered
------------------- ----------------------------------------
Ordinary Shares, par value Nasdaq National Market
$0.001 per share Nasdaq National Market Cayman Islands Stock Exchange
Securities registered or to be registered pursuant to Section 12(g) of the Act:
None
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d)
of the Act:
None
(Title of Class)
Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of the close of the period covered by the annual
report.
39,032,61639,188,062 Ordinary Shares
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [x] No [ ]
Indicate by check mark which financial statement item the registrant has elected
to follow:
Item 17 [ ] Item 18 [x]
TABLE OF CONTENTS
PART I
Item 1. Identity of Directors, Senior Management and Advisors...............3Advisors.............1
Item 2. Offer Statistics and Expected Timetable.............................3Timetable...........................1
Item 3. Key Information.....................................................3Information...................................................1
Item 4. Information on the Company.........................................12Company.......................................13
Item 5. Operating and Financial Review and Prospects.......................20Prospects.....................19
Item 6. Directors, Senior Management and Employees.........................26Employees.......................27
Item 7. Major Shareholders and Related Party Transactions..................31Transactions................32
Item 8. Financial Information..............................................32Information............................................33
Item 9. The Offer and Listing..............................................32Listing............................................33
Item 10. Additional Information.............................................33Information...........................................34
Item 11. Quantitative and Qualitative Disclosures About Market Risk.........42Risk.......43
Item 12. Description of Securities Other Than Equity Securities.............44Securities...........45
PART II
Item 13. Defaults, Dividend Arrearages and Delinquencies....................44Delinquencies..................45
Item 14. Material Modifications to the Rights of Security Holders
and Use of Proceeds.............................................44Proceeds.............................................45
PART III
Item 15. Controls and Procedures............................................44Procedures..........................................45
Item 16. Reserved...........................................................45Reserved.........................................................46
Item 16A Audit Committee Financial Expert...................................45Expert.................................46
Item 16B Code of Ethics.....................................................45Ethics...................................................46
Item 16C Principal Accountant Fees and Services.............................45Services ..........................46
Item 16D Exemption from the Listing Standards for Audit Committee...........45Committee.........47
Item 16E Purchased Equity Securities by the Issuer and Affiliated
Persons...46Purchasers......................................................47
PART IV
Item 17. Financial Statements...............................................46Statements.............................................48
Item 18. Financial Statements...............................................46Statements.............................................48
Item 19. Exhibits...........................................................46Exhibits.........................................................48
Signatures.......................................................50
Index to Consolidated Financial Statements...................................F-1
Signatures
2
Certain Definitions and Conventions
In this annual report on Form 20-F (the "Annual Report"), references to
"$" and "dollars" are to United States dollars. Percentages and certain amounts
contained herein have been rounded for ease of presentation. Any discrepancies
in any table between totals and the sums of amounts listed are due to rounding.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report contains "forward-looking statements" withinstatements of a forward-looking nature.
These statements are made under the meaning
of Section 27A"safe harbor" provisions of the U.S. Private
Securities Litigation Reform Act of 19331995. You can identify these forward-looking
statements by terminology such as "may," "will," "expects," "should," "could,"
"plans," "intends," "anticipates," "believes," "estimates," "predicts,"
"potential" or "continue" or the negative of these terms and Section 21E of the Securities
Exchange Act of 1934, includingother comparable
terminology. These forward-looking statements include, without limitation,
statements regarding our ability to develop products in a timely manner to meet
customer demands, our ability to take advantage of cost-efficiencies associated
with the "fabless" semiconductor business model, our future resultsgross profits,
continued expansion of operationsour engineering, research and business prospects.development resources, our
efforts to reduce costs and expenses, our expectations regarding outcome of
litigation matters, our expectation that our existing facilities will be
adequate to meet our needs, and our statements regarding the effect of adoption
of certain accounting policies. These forward-looking statements are based uponon
our current assumptions and beliefs in light of the information currently
available to us. Actual results, levels of activity, performance or achievements
may differ materially from those expressed or implied in these forward-looking
statements for a variety of reasons, including
thoseincluding: changes in demand for devices
that use our products; market conditions in the semiconductor industry and the
economy as a whole; the stages of our products in their life cycles, variations,
expansions or reductions in the mix of our product offerings, the timing of our
product introductions, specific product manufacturing costs, increased
competition, introduction of new competing technologies and the increase of
unexpected expenses, and such other factors discussed under "Key Information -
Risk Factors", "Operating and Financial Review and Prospects" and elsewhere in
this Annual Report. We assume no obligation to update or revise any
forward-looking information, whether as a result of new information, future
events or otherwise. You are cautioned not to place undue reliance on these
forward-looking statements which apply only as of the date of this Annual
Report. We assume no obligation to update or revise
any forward-looking statements, whether as a result of new information, future
events or otherwise.
PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
Not applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable.
ITEM 3. KEY INFORMATION
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data for the years ended December
31, 2001, 2002, 2003 and 2003,2004, and the selected consolidated financial data as of
December 31, 20022003 and 2003,2004, set forth below, are derived from our audited
consolidated financial statements included herein, and should be read in
conjunction with, and are qualified in their entirety by reference to, these
consolidated financial statements, including the notes to these consolidated
financial statements and "Item 5. Operating and Financial Review and Prospects"
included
1
elsewhere in this annual report on Form 20-F. The selected consolidated
financial data for the years ended December 31, 19992000 and 20002001 and the selected
consolidated financial data as of December 31, 1999, 2000, 2001 and 2001,2002, set forth
below, are derived from our audited consolidated financial statements and
related notes which do not appear in this annual report on Form 20-F. Our
consolidated financial statements are prepared and presented in accordance with
generally accepted accounting principles in the United States.
Year Ended December 31,
-----------------------------------------------
1999--------------------------------------------------------------
2000 2001 2002 2003 ------- ------- ------- ------- -------2004
---------- ---------- ---------- ---------- ----------
(in thousands, except per share data)
Consolidated Statement of
Operations Data:
3
Consolidated Statement of
Operations Data:
Net sales ........................ $23,728 $40,356 $45,819 $70,187 $88,599......................... $ 40,356 $ 45,819 $ 70,187 $ 88,599 $ 92,196
Cost of sales .................... 9,797..................... 15,687 16,465 28,143 38,314 ------- ------- ------- ------- -------37,403
---------- ---------- ---------- ---------- ----------
Gross profit ..................... 13,931...................... 24,669 29,354 42,044 50,285 54,793
Operating expenses:
Research and development ...... 5,521....... 9,682 14,320 18,935 19,219 20,260
Selling, general and
administrative ............. 6,973............... 8,714 9,909 12,325 17,4769,561 11,790 13,522 16,348
Patent litigation .............. 0 348 535 3,954 5,334
Stock-based compensation ...... 773....... 458 166 44 --
------- ------- ------- ------- -------- -
---------- ---------- ---------- ---------- ----------
Total operating expenses ... 13,267..... 18,854 24,395 31,304 36,695 ------- ------- ------- ------- -------41,942
---------- ---------- ---------- ---------- ----------
Income from operations ........... 664............ 5,815 4,959 10,740 13,590 12,851
Non-operating income - net ....... 187........ 1,056 1,827 1,662 1,437 ------- ------- ------- ------- -------2,705
---------- ---------- ---------- ---------- ----------
Income before income tax 851.......... 6,871 6,786 12,402 15,027 15,556
Income tax expense ............... 13................ 227 1,152 1,673 1,826 ------- ------- ------- ------- -------1,472
---------- ---------- ---------- ---------- ----------
Net income ....................... 838........................ 6,644 5,634 10,729 13,201 ======= ======= ======= ======= =======14,084
========== ========== ========== ========== ==========
Earnings per share:
Basic ...................... 0.09 0.34 0.17 0.28 0.34 0.36
Diluted .................... 0.03 0.21 0.16 0.27 0.33 0.35
Shares used to compute basic
earnings per share: ........... 9,736 19,419 34,020 38,300 38,374 ======= ======= ======= ======= =======39,156
========== ========== ========== ========== ==========
Shares used to compute diluted
earnings per share: ........... 29,723 32,260 35,576 39,591 39,736 ======= ======= ======= ======= =======40,102
========== ========== ========== ========== ==========
December 31,
--------------------------------------------------
1999--------------------------------------------------------------
2000 2001 2002 2003 ------- ------- -------- -------- --------2004
---------- ---------- ---------- ---------- ----------
(in thousands)
Consolidated Balance Sheet Data:
Cash and short term investments ........ $ 5,946 $37,448 $118,950 $112,009 $120,41237,448 $ 118,950 $ 112,009 $ 120,412 $ 120,088
Working capital ..................... 6,796................... 44,072 122,990 120,793 130,510 132,713
Total assets ........................ 12,791...................... 54,607 136,419 145,836 169,293 185,196
Long-term debt, excluding current
portion .......................... 2 13 7 -- --- - -
Net assets .......................... 8,300........................ 47,928 128,424 135,148 154,727 170,781
Ordinary shares and additional
paid-in capital ................... 55,104 130,235 126,232 137,115 139,620
CAPITALIZATION AND INDEBTEDNESS
Not applicable.
REASONS FOR THE OFFER AND USE OF PROCEEDS
Not applicable.
2
RISK FACTORS
If the markets for notebook computers, or other computing, communications or consumer electronics, industrial or communications
products do not grow substantially or even decrease, our net sales will be
harmed.
Our business focuses on designing, developing and marketing high
performance integrated circuits for manufacturers of products for the computer,
consumer electronics, industrial and communications markets. Because many of the
leading suppliers of these products have an intermediary manufacture their
products or those portions of their products containing our components, we
currently derive substantially all of our product revenues from sales to these
intermediaries. We also have targeted and are designing products for other
computer, consumer electronics, industrial and communications applications such
as internet security, mobile phones, global positioning systems, portable intelligent devicesDVD
players, liquid crystal display (LCD) monitors and portable DVD players.LCD television sets. We
cannot be certain that the
4
markets for these products will continue to grow as
rapidly as they have in the past or that a significant slowdown in these markets
will not occur. We believe that an important factor driving growth in these
markets has been the growing popularity of mobile computing, the growing
popularity of thinner displays, and the emergence and continued development of
the Internet and wireless communications networks. If mobile computing does not
continue to grow in popularity and the demand for notebook computers declines,
or does not grow as quickly as we expect, our intermediaries or original
equipment manufacturer customers will experience lower demand for notebook
computers that use our products, and our net sales will suffer. If the growth in
the use of the Internet and wireless communications networks declines, or does
not grow as quickly as we anticipate, our customers may experience lower demand
for the electronic devices that use our products, and our sales will suffer. If
demand for products using LCDs declines, or does not grow as quickly as we
anticipate, our customers may experience lower demand for those systems that use
our products, which may cause our sales to suffer.
In addition, we have experienced, and may experience in the future,
shortages of liquid crystal displaysLCDs and semiconductors caused by industry market trends or by
natural disasters, such as earthquakes, that are outside of our control. These
shortages may increase the costs of components used in mobile
devices and therefore constrainthose products containing
our products. This may cause an increase in the cost of such products, thus
constraining their more widespread market acceptance.
Finally, the semiconductor industry has historically been highly
cyclical and, at various times, has experienced significant downturns and wide
fluctuations in supply and demand. This has caused significant variances in
product demand, production capacity and rapid erosion of average selling prices.
Industry-wide fluctuations in the future could result in pricing pressure on our
products as well as lower demand for our products. If such fluctuations were to
occur, it could materially adversely affect our operating margins and net sales.
Fluctuations in our quarterly operating results due to factors such as changes
in the demand for electronic devices that can utilize our products could depress
our stock price.
We believe that quarter-to-quarter comparisons of our financial results
are not necessarily meaningful indicators of our future operating results, and
they should not be relied upon as an indication of our future performance. If
our quarterly operating results fail to meet the expectations of securities
analysts, the trading price of our ordinary shares could be negatively affected.
Our quarterly operating results have varied substantially in the past and may
vary substantially in the future depending upon a number of factors described
below and elsewhere in this Risk Factors section, including many that are beyond
our control. These factors include: changes in demand for devices that use our
products; market conditions in the semiconductor industry and the economy as a
whole; the timing and cancellation of customer orders; the level of orders
received that can be shipped in a quarter; the availability of third party
semiconductor foundry, assembly and test capacity;capacities;
3
fluctuations in manufacturing yields; delays in introductions of new products;
changes in the mix of sales of higher margin products and lower margin products;
seasonal changes in demand during the year-end holiday season for devices that
use our products; and the amount of legal and other expenses incurred in a
particular quarter. In addition, the trading price of our ordinary shares may be
affected by factors such as: significant price and volume fluctuations in the
stock and financial markets in the U.S. and other countries, as well as
relatively thin trading volume of our stock on the Nasdaq National Market. In
addition, the trading market for our stock is affected by the research and
reports that securities or industry analysts publish about us or our business.
We do not have control over such coverage. If one or more analysts were to
downgrade our stock, our stock price may decline. In addition, if one or more
analysts cease coverage of the Company or does not regularly publish reports on
us, we may lose visibility in the financial markets, which could cause our stock
price or trading volume to decline.
If orders for our products are deferred or cancelled, our quarterly net sales,
operating margins and net income could be substantially reduced.
Orders for our products can be cancelled or deferred with little notice
from and without significant penalty to our customers. A significant portion of
our net sales in any quarter depends on orders booked and shipped in that
quarter. If a large amount of orders placed is cancelled or deferred, our net
sales in that quarter could be substantially reduced. Since we do not have
significant non-cancelable backlog, we typically plan our production and
inventory expenses based on internal forecasts of customer demand, which are
highly unpredictable and can fluctuate substantially. In particular, in response
to anticipated lengthy lead times, which in the past have been as much as ten
weeks or more, to obtain inventory and materials from our suppliers, we place
orders with these suppliers in advance of anticipated customer demand, which can
result in excess inventory expenses if the expected orders fail to materialize.
We also expect to increase our expenses 5
for personnel and new product
development. It is difficult for us to reduce our production, inventory,
personnel and new product development expenses quickly in response to any
shortfalls in net sales resulting from lower than expected, cancelled or
deferred orders. As a result, any significant downturn in orders would not only
harm our net sales, it would likely have a disproportionately adverse effect on
our operating margins and net income.
A substantial portion of our net sales is generated by a small number of large
customers. If any of these customers delays or reduces its orders, our net sales
and earnings will be harmed.
Historically, a relatively small number of customers havehas accounted for a
significant portion of our net sales in any particular period. We have no
long-term volume purchase commitments from any of our significant customers. We
cannot be certain that our current customers will continue to place orders with
us, that orders by existing customers will continue at the levels of previous
periods or that we will be able to obtain orders from new customers. In
addition, some of our customers, acting as intermediary manufacturers, supply
products to end-market purchasers, and any of these end-market purchasers could
choose to reduce or eliminate orders for our customers' products. This would in
turn lower our customers' orders for our products.
In 2004, one customer accounted for 10% or more of our net revenues
(17.54%). In 2003, one customer accounted for 10% or more of our net revenues
(13.5%). In 2002, two customers accounted for 10% or more of our net revenues
(18.6% and 15.9%, respectively). In 2001, two customers accounted for 10% or
more of our net revenues (20.9% and 11.0%, respectively). The variations in sales to these customers as a
percentage of our total revenue have been caused by a number of factors, some of
which were outside our control. We anticipate that sales of our products to a
relatively small number of customers will continue to account for a significant
portion of our net sales. The reduction, delay or cancellation of orders from
one or more of our significant customers would have a disproportionately
negative impact on our results of operations.
4
If we cannot compete effectively against new and existing competitors, our net
sales and operating margins could be harmed.
Our ability to compete successfully in the market for semiconductor or
integrated circuit products depends on factors both within and outside our
control, including: our success in designing and subcontracting the manufacture
of new products that implement new technologies and satisfy our customers'
needs; the performance of our products across a variety of parameters such as
power savings, reliability and cost efficiency; the price of our products and those of our
competitors; our ability to control production costs; and the features of our
competitors' products.
We believe our principal competitors include Linear Technology, Maxim
Integrated Products Texas Instruments, Ricoh Company, Ltd. and Texas Instruments.Monolithic Power
Systems. In addition to these competitors, other integrated circuit companies
may decide to enter the market with mixed signal integrated products that
compete with ours or incorporate functions similar to those provided by our
products. We also face competition from in-house integrated circuit design and
manufacturing groups at some of our existing and potential customers, such as
Toshiba Corporation.
Many of our competitors, such as Texas Instruments, have greater name
recognition, their own manufacturing capabilities, significantly greater
financial and technical resources, and the sales, marketing and distribution
strengths that are normally associated with large multinational companies. These
competitors may also have pre-existing relationships with our customers or
potential customers. These competitors may be able to introduce new technologies
more quickly, address customer requirements more rapidly and devote greater
resources to the promotion and sale of their products than we do. Further, in
the event of a manufacturing capacity shortage, these competitors may be able to
manufacture products themselves or obtain third-party manufacturing capability
when we are unable to do so.
6
If we do not develop and introduce new products timely, our net sales and gross
margins will be harmed.
Our limitedsuccess depends upon our ability to develop and introduce new
products selected for design into products for the computer, consumer
electronics, industrial and communications markets. If we are unable to develop
new products in a timely manner, our net sales will suffer. In addition, because
our gross margins typically decline over the life cycle of our products as a
result of competitive pressures and voluntary pricing arrangements, any failure
to develop new products in a timely manner will likely cause our gross margins
to decline. The development of our new products is highly complex, and from time
to time we have experienced delays in the introduction of new products of as
much as eight to twelve weeks or more. Successful product development and
introduction of new products depend on a number of factors, including the
following: accurate new product definition; timely completion of new product
designs; achievement of manufacturing yields; timely and cost-effective
production of new products; and delays in the introduction of new third-party
supplied products used as key components in devices that incorporate our
products. We often incur significant expenditures in the development of a new
product without any assurance that it will be selected for design-in to such
products. If we incur such expenditures but fail to be selected, our operating
history makes itresults will be adversely affected, and may cause significant fluctuations from
period to period. Furthermore, even if we were selected for design-in, we cannot
be assured that these systems will be commercially successful or that we will
benefit from any associated revenue.
It is difficult to evaluate our future prospects, and we cannot assure you that
we will not incur future losses.
We were incorporated in March 1995. Accordingly, we have a limited
operating history, and ourOur past results cannot be relied upon to predict our future
performance. We incurred net losses in each year prior to the year ended
December 31, 1999. While weWe experienced significant quarter to quarter sales growth in
the years ended December 31, 2001, 2002 and 2003,2003. However, in the first quarter
ending March 31, 2004,
5
in the third quarter ending September 30, 2004 and in the first quarter ending
March 31, 2005, we experienced a decrease in sales compared to the previous
quarter. Our net sales are subject to fluctuation from quarter to quarter, our
previous overall growth may not continue, and we may not be able to sustain or
increase profitability in the future. We anticipate that our expenses will
increase substantially in the foreseeable future as we continue to develop and
protect our technology and expand our product offerings. These efforts may prove
more expensive than we currently anticipate, and we may not succeed in
increasing our net sales sufficiently to offset our increased expenses. If we
fail to increase our net sales to keep pace with our increased expenses, we may
again experience net losses in future periods, which would cause the value of
our stock to decline.
If we cannot adapt our product offerings to respond to rapid technological
changes, our net sales will be harmed.
The markets for computer, consumer electronics, industrial and
communications products, and the components used in these products, are
characterized by rapidly changing technology and very frequent new product
introductions by our direct customers and our competitors. For example, the
microprocessor, display and battery technologies with which our products
interoperate change very rapidly, and the product life cycles for products in
the computer, consumer electronics, industrial and communications markets that
use our power management and security technologies are often less than one year.
If we do not respond in a timely manner to technological changes and new product
introductions by our direct customers and competitors by developing new products
and enhancing our existing products, we will be unable to maintain and grow our
product sales. In addition, the emergence of significantly more efficient or
cost-effective battery, display or microprocessor technologies could lessen the
need for the power management functionality of our products, which would harm
our net sales.
We depend on third parties to manufacture, assemble and test our products and,
if they are unable to do so, our ability to ship products and our net sales and
gross margins will be harmed.
We do not own or operate the integrated circuit fabrication facilities
that manufacture the products we design. Three foundries, United
Microelectronics Corporation, or UMC, Taiwan Semiconductor Manufacturer Company
Limited, or TSMC, and X-FAB Semiconductor Foundries AG, or X-FAB, manufactured
most of the semiconductor devices that we sold in 2003.2004. These suppliers
manufacture integrated circuit semiconductors for us according to purchase
orders. We do not have a guaranteed level of production capacity at any of our
suppliers, and any one or more could raise prices without notice. We provide the
suppliers with rolling forecasts of our production requirements; however, the
ability of each supplier to provide wafers to us is limited by the supplier's
available capacity. Our suppliers could choose to prioritize capacity for other
customers, particularly larger customers, reduce or eliminate deliveries to us
on short notice or increase the prices they charge us. Accordingly, we cannot be
certain that our suppliers will allocate sufficient capacity, if any, to satisfy
our requirements particularly during any industry-wide capacity shortages. In
addition, if any of our suppliers were to become unable to continue
manufacturing our products in the required volumes at acceptable quality, yields
and costs or in a timely manner, our business and operating results would be
seriously harmed.
There are other significant risks associated with our reliance on
outside suppliers, including: the disruption in our ability to ship products
caused by the length of time, as much as six to twelve months, required for us
to qualify alternative suppliers for existing or new products; the reduction or
elimination of deliveries to us by our foundries caused by a sudden demand for
an increased amount of semiconductor devices or a sudden reduction or
elimination of manufacturing capacity by any existing manufacturers of
semiconductor devices; the unavailability of, or delays in obtaining access to,
key process technologies used by these suppliers; and the susceptibility of our
third-party suppliers to production interruptions resulting from natural
disasters, such as the interruptions experienced in Taiwan in the past due to
earthquake activity. Any of these events could cause our foundries to either
reduce or eliminate deliveries to us, and a disruption in our ability to ship
products to our customers could negatively affect our business and results of
operations.
6
We also rely on independent subcontractors to assemble and test
substantially all of our semiconductor products. We do not have long-term
agreements with any of these subcontractors and typically obtain services from
them on a purchase order basis. Our reliance on these subcontractors involves
risks such as reduced control over delivery schedules, quality assurance and
costs. These risks could result in product shortages or increase our costs of
manufacturing, assembling or testing our products. If these subcontractors are
unable or unwilling to continue to provide assembly and test services and
deliver products at acceptable quality, yields and costs or in a timely manner,
our business would be seriously harmed. We would also have 7
to identify and
qualify substitute subcontractors, which would be time consuming and costly and
could result in unforeseen operational difficulties.
If we do not develop and introduce new products timely, our net sales and gross
margins will be harmed.
Our success depends upon our ability to develop and introduce new products
selected for design into products for the computer, consumer electronics,
industrial and communications markets. If we are unable to develop new products
in a timely manner, our net sales will suffer. In addition, because our gross
margins typically decline over the life cycle of our products as a result of
competitive pressures and voluntary pricing arrangements, any failure to develop
new products in a timely manner will likely cause our gross margins to decline.
The development of our new products is highly complex, and from time to time we
have experienced delays in the introduction of new products of as much as eight
to twelve weeks or more. Successful product development and introduction of new
products depend on a number of factors, including the following: accurate new
product definition; timely completion of new product designs; achievement of
manufacturing yields; timely and cost-effective production of new products; and
delays in the introduction of new third-party supplied products used as key
components in devices that incorporate our products.
If we cannot adapt our product offerings to respond to rapid technological
changes, our net sales will be harmed.
The markets for computer, consumer electronics, industrial and
communications products, and the components used in these products, are
characterized by rapidly changing technology and very frequent new product
introductions by our direct customers and our competitors. For example, the
microprocessor, display and battery technologies with which our products
interoperate change very rapidly, and the product life cycles for products in
the computer, consumer electronics, industrial and communications markets that
use our power management and security technologies are often less than one year.
If we do not respond in a timely manner to technological changes and new product
introductions by our direct customers and competitors by developing new products
and enhancing our existing products, we will be unable to maintain and grow our
product sales. In addition, the emergence of significantly more efficient or
cost-effective battery, display or microprocessor technologies could lessen the
need for the power management or power saving functionality of our products,
which would harm our net sales.
Sales of our products could decline if we fail to support evolving industry
standards.
Our net sales are derived from sales of semiconductor products that are
components of electronic devices built to industry standards and widely accepted
specifications. For example, the hardware specification for the voltage of most
notebook computers is currently either 3.3 or 5.0 volts and the software used to
control the power management functions of many notebook computers conforms to
the Advanced Configuration Power Interface specification. Our products must be
designed to conform to these standards and specifications in order to achieve
market acceptance. Technology standards and specifications continually evolve,
and we may not be able to successfully design and manufacture new products in a
timely manner that conformconforms to these new standards. Additionally, new products
we develop to conform to new specifications may not be accepted in the market.
Defects in our products could result in significant costs and could impair our
ability to sell our products.
Detection of any significant defects in our products may result in,
among other things, loss of or delay in, market acceptance and sales of our
products, diversion of development resources, injury to our reputation and
increased service and warranty costs. Because our products are complex, they may
contain defects that can be detected at any point in a product's life cycle.
These defects could harm our reputation, which could result in significant costs
to us and could impair our ability to sell our products. The costs we may incur
in correcting any product defects may be substantial and could decrease our
profit margins. While we continually test our products for defects and work with
customers through our customer support services to identify and 8
correct
problems, defects in our products may be found in the future. Testing for
defects is complicated in part because it is difficult to simulate the highly
complex environments in which our customers may use our products. In the past,
we have discovered defects in our products and have experienced delays in the
shipment of our products. These delays have principally related to new product
update releases. To date, none of these delays has materially affected our
business. However, product defects or delays in the future could be material,
and could adversely affect our ability to sell our products.
We have substantial operations outside of the United States that expose us to
risks specific to our international operations that could harm our net sales and
net income.
As of December 31, 2003,2004, a substantial portion of our operations,
approximately 70%68% of our employees, and allmost of the third parties we use to
manufacture, assemble and test most of our products were located in Japan, Korea, the
People's Republic of China, Singapore and Taiwan. In addition, sales outside the
United States as a percentage of net sales were 99.9% in the year ended December
31, 2001 and almost 100% in the years ended
December 31, 2002, December 31, 2003 and December 31, 2003.2004. We expect our
non-U.S. operations to grow and non-U.S. sales to continue to account for a
substantial percentage of our net sales.
We are subject to risks specific to our international business
operations, including: the risk of supply disruption, production disruption or
other disruption arising from the outbreak of Severe Acute Respiratory Syndrome;
the risk of potential conflict and further instability in the relationship
between Taiwan and the People's Republic of China; risks related to
international political instability and to the recent global economic turbulence
and adverse economic circumstances in Asia, such as in Japan and Korea;
unpredictable
7
consequences on the economic conditions in the U.S. and the rest of the world
arising from terrorist attacks, such as the attacks of September 11, 2001 in the
U.S. and other military or security operations, particularly with regard to the
conflicts in the Middle East involving Iraq; unexpected changes in regulatory
requirements or legal uncertainties regarding tax regimes, such as the change to
the tax code of Taiwan in 2001 that resulted in a higher income tax rate on our
retained earnings; tariffs and other trade barriers, including current and
future import and export restrictions; difficulties in staffing and managing
international operations, such as Singapore, the People's Republic of China and
Taiwan; risks that changes in foreign currency exchange rates will make our
products comparatively more expensive; limited ability to enforce agreements and
other rights in foreign countries; changes in labor conditions; longer payment
cycles and greater difficulty in collecting accounts receivables; burdens and
costs of compliance with a variety of foreign laws; limitation on imports or
exports and expropriation of private enterprises; and reversal of the current
policies (including favorable tax and lending policies) encouraging foreign
investment or foreign trade by our host countries. In addition, the geographical
distances between Asia, America, the Cayman Islands and Europe also create a
number of logistical and communication challenges. Although we have not
experienced any serious harm in connection with our international operations, we
cannot assure you that such problems will not arise in the future.
Our reporting currency is the U.S. dollar. However, a significant
portion of our operating expenses is denominated in currencies other than the
U.S. dollar, primarily the New Taiwan dollar and the Chinese Renminbi. As a
result, appreciation or depreciation of other currencies in relation to the U.S.
dollar could result in material transaction or translation gains or losses that
could reduce our operating results. We do not currently engage in currency
hedging activities.
Our ability to manage growth will affect our ability to achieve and maintain
profitability.
Our ability to maintain profitability will depend in part on our ability
to implement and expand operational, customer support and financial control
systems and to train and manage our employees. We may not be able to augment or
improve existing systems and controls or implement new systems and controls in
response to future growth, if any. In addition, we will need to expand our
facilities to accommodate the growth in our personnel. Any failure to manage
growth could divert management attention from executing our business plan and
hurt our ability to expand our business successfully. Our historical growth has
placed, and any further growth is likely to continue to place, a significant
strain on our resources. In order to grow 9
successfully, we will need to maintain
close coordination among our executive, engineering, accounting, finance,
marketing, sales, operations and customer support organizations, particularly in
light of the internationally dispersed nature of our operations.
If we fail to protect our intellectual property rights, competitors may be able
to use our technology or trademarks, and this could weaken our competitive
position, increase our costs, reduce our margins and reduce our net sales.
Our success is heavily dependent upon proprietary technology. We rely
primarily on a combination of patent, copyright and trademark laws, trade
secrets, confidentiality procedures and contractual provisions to protect our
proprietary rights and prevent competitors from using our technology in their
products. These laws and procedures provide only limited protection. Our patents
may not provide sufficiently broad protection or they may not prove to be
enforceable in actions against alleged infringers.
Our ability to sell our products and prevent competitors from
misappropriating our proprietary technology and trade names is dependent upon
protecting our intellectual property. Despite precautions that we take, it may
be possible for unauthorized third parties to copy aspects of our current or
future products or to obtain and use information that we regard as proprietary.
In particular, we may provide our customers with access to our proprietary
information underlying our products. Additionally, our competitors may
independently develop similar or superior technology. Policing unauthorized use
of software, circuit design or semiconductor design is difficult and some
foreign laws do not protect our proprietary rights to the same extent as United
States laws. We have in the past and have currently initiated litigation to
protect our intellectual
8
property rights. Litigation may be necessary in the future to enforce our
intellectual property rights, to protect our trade secrets or to determine the
validity and scope of the proprietary rights of others. Litigation could result
in substantial costs and diversion of resources and could harm our business,
future operating results and financial condition. See "Information on the
Company--Business Overview--Intellectual Property".
We will need to recruit and retain qualified personnel to grow our business
successfully.
Our future success will depend on our ability to attract and retain
experienced sales, research and development, marketing, customer support and
management personnel. If we do not attract and retain these personnel, this
could harm our ability to grow our business, sell our products, enter new
markets and increase our share of existing markets. There can be no assurance
that we will be successful in hiring for these positions in the near future. Our
sales strategy requires that we hire additional direct sales persons or
independent sales representatives internationally and in the United States.
Moreover, our independent sales representatives and direct sales personnel must
market our products effectively and be qualified to provide timely and
cost-effective customer support and service. If they are unable to do so or we
are unable to expand these organizations, this could harm our ability to
increase our net sales and limit our ability to sell our products or expand our
market share. Competition for qualified personnel in digital, analog and mixed
signal semiconductor design is intense. In the past, we have experienced
difficulty in recruiting qualified personnel, especially technical and sales
personnel. Moreover, we intend to expand the scope of our international
operations, which will require us to attract experienced management, research
and development, marketing, sales and customer support personnel for our
international offices. We expect competition for qualified personnel to remain
intense, and we may not succeed in attracting or retaining such personnel. In
addition, new employees generally require substantial training in our design
methodology, design flow and technology, which in turn requires significant
resources and management attention. There is a risk that, even if we invest
significant resources in attempting to attract, train and retain qualified
personnel, we will not be successful in our efforts. In this case, our costs of
doing business would increase without the expected increase in net sales.
Our success will depend to a significant extent on the continued service
of our executive officers, including Sterling Du, our chief executive officer
and chairman of the board of directors, and other key employees, including key
sales, consulting, technical, marketing and legal personnel. If we lose the
services of one or more of our executives or key employees, our business and
ability to implement our business objectives successfully could be harmed,
particularly if one or more of our executives or key employees decided to join a
competitor or otherwise compete directly or indirectly with us.
Our transfer pricing procedures may be challenged, which may subject us to
higher taxes and adversely affect our earnings.
Transfer pricing refers to the prices that one member of a group of
related corporations charges to another member of the group for goods, services
or the use of intellectual property. If two or more affiliated corporations are
located in different countries, the laws or regulations of each country
generally will require that transfer prices be the same as those charged by
unrelated corporations dealing with each other at arm's length. If one or more
of the countries in which our affiliated corporations are located believes that
transfer prices were manipulated by our affiliate corporations in a way that
distorts the true taxable income of the corporations, the laws of countries
where our affiliated corporations are located could require us to redetermine
transfer prices and thereby reallocate the income of our affiliate corporations
in order to clearly reflect such income. Any reallocation of income from one of
our corporations in a lower tax jurisdiction to an affiliated corporation in a
higher tax jurisdiction would result in a higher overall tax liability to us.
Moreover, if the country from which the income is being reallocated does not
agree to the reallocation, the same income could be subject to taxation by both
countries.
We have adopted transfer pricing agreements with our subsidiaries
located in the United States, the People's Republic of China, Taiwan, Japan and
Singapore to regulate intercompany transfers. A transfer pricing agreement is a
contract for the transfer of goods, services or intellectual property from one
corporation
9
to a related corporation that sets forth the prices that the related parties
believe are at arm's length. We have
10
entered into these types of agreements
because a portion of our assets, such as intellectual property developed in our
U.S. and foreign subsidiaries, is transferred among our affiliated corporations.
In such agreements, we have determined transfer prices that we believe are the
same as the prices that would be charged by unrelated parties dealing with each
other at arm's length. In this regard, we are subject to risks not faced by
other companies with international operations that do not create inter-company
transfers. If the United States Internal Revenue Service or the taxing
authorities of any other jurisdiction were to successfully challenge these
agreements or require changes in our transfer pricing practices, we could become
subject to higher taxes and our earnings would be adversely affected. We believe
that we operate in compliance with all applicable transfer pricing laws in these
jurisdictions. However, there can be no assurance that we will continue to be
found to be operating in compliance with transfer pricing laws, or that such
laws will not be modified, which, as a result, may require changes to our
transfer pricing practices or operating procedures. Any determination of income
reallocation or modification of transfer pricing laws can result in an income
tax assessment of the portion of income deemed to be derived from the taxing
jurisdiction that so reallocates the income or modifies its transfer pricing
laws.
If we fail to protect our intellectual property rights, competitors may be able
to use our technology or trademarks, and this could weaken our competitive
position, increase our costs and reduce our net sales.
Our success is heavily dependent upon proprietary technology. We rely
primarily on a combination of patent, copyright and trademark laws, trade
secrets, confidentiality procedures and contractual provisions to protect our
proprietary rights and prevent competitors from using our technology in their
products. These laws and procedures provide only limited protection. Our patents
may not provide sufficiently broad protection or they may not prove to be
enforceable in actions against alleged infringers.
Our ability to sell our products and prevent competitors from
misappropriating our proprietary technology and trade names is dependent upon
protecting our intellectual property. Despite precautions that we take, it may
be possible for unauthorized third parties to copy aspects of our current or
future products or to obtain and use information that we regard as proprietary.
In particular, we may provide our customers with access to our proprietary
information underlying our products. Additionally, our competitors may
independently develop similar or superior technology. Policing unauthorized use
of software, circuit design or semiconductor design is difficult and some
foreign laws do not protect our proprietary rights to the same extent as United
States laws. Litigation may be necessary in the future to enforce our
intellectual property rights, to protect our trade secrets or to determine the
validity and scope of the proprietary rights of others. Litigation could result
in substantial costs and diversion of resources and could harm our business,
future operating results and financial condition. See "Information on the
Company--Business Overview--Intellectual Property".
Third parties have asserted and in the future could assert that our products
infringe their intellectual property rights. These claims could harm our ability
to sell our products and expose us to litigation.
As is typical in the semiconductor industry, we have from time to time
received communications from third parties asserting patents that cover certain
of our technologies or products and alleging infringement of certain
intellectual property rights. We may receive similar communications in the
future. In the event any third party were to make a valid claim against us or
our customers, we could be enjoined from selling selected products such as our
inverter power or AudioDJpower products or could be required to pay royalties to third
parties. Third-party infringement claims, with or without merit, have been and
could continue to be time consuming, result in substantial diversion of our
resources and potentially significant litigation costs, including costs related
to any damages we may owe, cause product shipment delays or require us to enter
into license agreements. Such license agreements may not be available on
acceptable terms, or at all. Any one of such events could seriously harm our
business and our operating results. We expect that semiconductor companies will
increasingly be subject to infringement claims as the number of products and
competitors in the semiconductor industry grows. See "Information on the
Company--Business Overview--Intellectual Property".
11From time to time, in the normal course of business, we indemnify third
parties with whom we enter into contractual relationships, including customers
and parties to other transactions with us, with respect to certain matters. We
have agreed, under certain conditions, to hold these third parties harmless
against specified losses, such as those arising from a breach of representations
or covenants, other third party claims that our products when used for their
intended purposes infringe the intellectual property rights of such other third
parties or other claims made against certain parties. It is not possible to
determine the maximum potential amount of liability under these indemnification
obligations due to our limited history of prior indemnification claims and the
unique facts and circumstances that are likely to be involved in each particular
claim. Historically, payments made by us under these obligations have not been
material.
Until our litigations are resolved we will continue to incur substantial
legal expenses that vary with the level of activity in the legal proceedings.
This level of activity is not entirely within our control as we may need to
respond to legal actions. Consequently, we may find it difficult to predict the
legal expenses for any given quarter, which will impair our ability to forecast
our results of operations for that quarter. It is likely that these expenses
will increase leading up to and during our trials scheduled for June 2005, for
September 2005, and for December 2005.
Monolithic Power Systems, Inc. ("MPS") has alleged that our OZ960,
OZ961, OZ969A and OZ970 products infringe on one of their patents and a
continuation of that patent. On May 28, 2004, the U.S. District Court for the
Northern District of California granted our motion for summary judgment that MPS
lacked evidence of damages. As the case currently stands, MPS will not be able
to recover damages at
10
trial but may only attempt to seek injunctive relief and attorneys' fees.
However, given the inherent uncertainties in litigation, there cannot be any
assurance that we will prevail in any particular litigation matter, and we
cannot predict the outcome of any such litigation. If any party was to prevail
in its claims against us, our operating results could be materially adversely
affected. In any litigation arising from claims that we infringe on the
intellectual property rights of others, an adverse result could involve an
injunction to prevent the sales of a material portion of our products, and a
reduction or the elimination of the value of related inventories, any of which
could have a material adverse effect on our revenues, net sales, result of
operations and financial condition. This risk factor only summarizes the legal
proceedings in which we are involved and related events. You are advised to read
the descriptions of our litigation in "Business Overview - Intellectual
Property."
We may be subject to lawsuits from third parties.
We are a defendant or plaintiff in actions that arise in the normal
course of business as well as actions that arose as counterclaims in response to
our patent infringement actions, including actions for antitrust, unfair
competition and interference. While we currently believe the amount of ultimate
liability, if any, with respect to these actions will not materially affect the
our financial position, overall trends in results of operations, or liquidity,
the ultimate outcome of any litigation or claim is uncertain, and the impact of
an unfavorable outcome could be material to us. We believe that the ultimate
disposition of these matters will not have a material adverse effect on our
business, financial condition or results of operations.
Provisions in our charter documents may discourage potential acquisition bids
for us and prevent changes in our management that our shareholders may favor.
Provisions in our charter documents could discourage potential
acquisition proposals and could delay or prevent a change in control transaction
that our shareholders favor. These provisions could have the effect of
discouraging others from making tender offers for our shares. As a result, these
provisions may prevent the market price of our ordinary shares from reflecting
the effects of actual or rumored takeover attempts and may prevent shareholders
from reselling their shares at or above the price at which they purchased their
shares. These provisions may also prevent changes in our management that our
shareholders may favor. Our charter documents do not permit shareholders to act
by written consent, do not permit shareholders to call a general meeting and
provide for a classified board of directors, which means shareholders can only
elect, or remove, a limited number of our directors in any given year.
Furthermore, our board of directors have the authority to issue up to 5,000,000
preference shares in one or more series. Our board of directors can fix the
price, rights, preferences, privileges and restrictions of such preference
shares without any further vote or action by our shareholders. The issuance of
preference shares may delay or prevent a change in control transaction without
further action by our shareholders or make removal of management more difficult.
We have and continue to incur significant costs with respect to corporate
governance and financial reporting compliance.
To comply with the requirements of the Sarbanes-Oxley Act of 2002, as
well as new rules subsequently implemented by the SEC and adopted by Nasdaq in
response to Sarbanes-Oxley, we have made changes to our financial reporting,
securities disclosure and corporate governance practices. We may incur increased
legal and financial compliance costs due to these new or revised rules,
regulations, and listing requirements and management time and resources may be
re-directed to implement our compliance initiatives. These rules may make it
more difficult for us to attract and retain qualified executive officers and
members of our board of directors, as well as make it more costly to obtain
liability coverage for our officers and directors.
11
If we fail to maintain an effective system of internal controls, we may not be
able to accurately report our financial results. As a result, current and
potential stockholders could lose confidence in our financial reporting, which
would harm our business.
Effective internal controls are necessary for us to provide reliable
financial reports. If we cannot provide reliable financial reports or prevent
fraud, our operating results could be misstated, our reputation may be harmed
and the trading price of our stock could be negatively affected. In connection
with the audit of our financial statements for the three years ended December
31, 2004, in May 2005 our independent registered public accounting firm reported
to our audit committee a matter that was a "reportable condition" in our
internal controls as defined in standards established by the American Institute
of Certified Public Accountants. In general, reportable conditions are
significant deficiencies in our internal controls that, in our auditor's
judgment, could adversely affect our ability to record, process and report
financial data consistent with the assertions of management in the financial
statements. In 2005, we devoted significant resources to remediate and improve
our internal controls. We believe that these efforts have remediated the
concerns that gave rise to the "reportable condition." However, we cannot be
certain that our controls over our financial processes and reporting will
continue to be adequate in the future. Any failure of our internal controls over
financial reporting, could cause us to fail to meet our reporting obligations.
In addition, pursuant to Section 404 of the Sarbanes-Oxley Act of 2002,
beginning with our Annual Report on Form 20-F for the fiscal year ending
December 31, 2006, we will be required to furnish a report by our management on
our internal control over financial reporting. Such a report will contain, among
other matters, an assessment of the effectiveness of our internal control over
financial reporting as of the end of our fiscal year, including a statement as
to whether or not our internal control over financial reporting is effective.
This assessment must include disclosure of any material weaknesses in our
internal control over financial reporting identified by management. Such report
must also contain a statement that our auditors have issued an attestation
report on management's assessment of such internal controls. We are still
performing the system and process documentation and evaluation needed to comply
with Section 404, which is both costly and challenging.
During this process, if our management identifies one or more material
weaknesses in our internal control over financial reporting, we will be unable
to assert such internal control is effective. If we are unable to assert that
our internal control over financial reporting is effective (or if our auditors
are unable to attest that our management's report is fairly stated or they are
unable to express an opinion on the effectiveness of our internal controls), we
could lose investor confidence in the accuracy and completeness of our financial
reports, which would have an adverse effect on our stock price.
Changes in accounting standards for stock option plans may impact our operating
results and our ability to use stock options to recruit, retain and motivate
employees.
The Financial Accounting Standards Board has published revisions to
Statement of Financial Accounting Standards No. 123 which requires all public
entities to treat the value of stock options granted to employees as an expense.
As a public entity as contemplated by SFAS 123R, we are required to record, as
of the first annual reporting period beginning after June 15, 2005, a
compensation expense equal to the value of each stock option granted. This
expense would likely be recognized over the vesting period of the stock option.
The requirement to expense stock option grants reduces the attractiveness of
granting stock options because the additional expense associated with these
grants may adversely affect our profitability. However, stock options remain an
important employee recruitment and retention tool, and we may not be able to
attract and retain key personnel if any future adverse effects on our
profitability resulting from the application of SFAS 123R compel us to reduce
the scope of our employee stock option program. Our employees are critical to
our ability to develop and design systems that advance our productivity and
technology goals, increase our sales goals and provide support to customers.
Accordingly, as a result of the requirement to adopt SFAS 123R to expense
12
stock option grants beginning with the first fiscal year after June 15, 2005,
our future profitability would be reduced, as would our ability to use stock
options to recruit, retain and motivate key employees.
Because we are a Cayman Islands company, it could be difficult for investors to
effect service of process on and recover against us or our directors and
officers and our shareholders may face difficulties in protecting their
interests.
We are a Cayman Islands company, and many of our officers and directors
are residents of various jurisdictions outside the United States. A substantial
portion of our assets and the assets of our officers and directors, at any one
time, are and may be located in jurisdictions outside the United States.
Although we have irrevocably agreed that we may be served with process in Santa
Clara, California with respect to actions arising out of or in connection with
violations of United States federal securities laws relating to offers and sales
of ordinary shares, it could be difficult for investors to effect service of
process within the United States on our directors and officers who reside
outside the United States or to recover against us or our directors and officers
on judgments of United States courts predicated upon the civil liability
provisions of the United States federal securities laws.
Our corporate affairs are governed by our charter documents, consisting
of our memorandum and articles of association, and by the Companies Law of the
Cayman Islands. The rights of our shareholders and fiduciary responsibilities of
our directors are governed by Cayman Islands law and are not as clearly
established as under statutes or judicial precedent in existence in
jurisdictions in the United States. While there is some case law in the Cayman
Islands on these matters, it is not as developed as, for example, English law
and United States law. However, we believe that English case law, although not
binding in the courts of the Cayman Islands, would be regarded as persuasive.
Due to this relative vagueness of Cayman Islands law, our public shareholders
may have more difficulty in protecting their interests in the face of actions by
our management, directors or controlling shareholders than would shareholders of
a corporation incorporated in a jurisdiction in the United States.
ITEM 4. INFORMATION ON THE COMPANY
HISTORY AND DEVELOPMENT OF THE COMPANY
Our legal name is O2 MicroO2Micro International Limited. We are incorporated in
Cayman Islands. Our registered office is located at M&C Corporate Services
Limited, P.O. Box 309, Ugland House, South Church Street, George Town, Grand
Cayman, Cayman Islands. Our principal executive offices are located at Grand
Pavilion Commercial Centre, West Bay Road, P.O. Box 32331 SMB, George Town,
Grand Cayman, Cayman Islands. Our telephone number is (345) 945-1110. We have a
subsidiary, O2Micro,O//2//Micro, Inc., which was incorporated as a California
corporation in March 1995. In March 1997, O2 Micro International Limited was
incorporated as a Cayman Islands company. In March 1997, we exchanged our
ordinary shares and preference 12
shares for common stock and preferred stock of
O2O//2// Micro, Inc. After the exchange, we held all of the outstanding capital
stock of O2O//2// Micro, Inc., our wholly owned subsidiary in the United States.
Our agent for service of process in the U.S. for the purpose of our
securities filings is our chief executive officer, Sterling Du, c/o O2Micro,O//2//Micro,
Inc., 3118 Patrick Henry Drive, Santa Clara, CA 95054.
Since January 1, 2001,2002, our principal capital expenditures were
investments in and loans to various private companies of approximately $7.4$17.2
million in the aggregate, $9.1$21.6 million in the purchase of capitalland, property and
equipment, and $12.4$12.1 million deposited for Taiwan court bonds in connection with
preliminary injunction actions in Taiwan.
In May 2004, we purchased the 37,180 square foot building in
Santa Clara, California housing our California operations. The purchase price
was approximately $4.6 million.13
BUSINESS OVERVIEW
We design, develop and market high performance integrated circuits for
power management power saving applications and computer security applications. OurWe focus on integrated circuits that
use mixed signal designs, which combine analog and digital circuits on a single
chip, reducing the number of semiconductors needed and decreasing the size,
weight, power requirements and cost of the end product. We focus our product
design efforts on integrated circuits for the markets of computer, consumer
electronics, industrial and communications products, which
typically require both digital and analog circuits.products. Products in these markets
include notebook computers, liquid crystal displays,internet security devices, mobile phones, portable
intelligent devices, global
positioning systems, and portable DVD players.players, LCD monitors and LCD television sets.
Our system-level expertise, proprietary design methodologies and extensive
experience with power management systems allow us to develop products quickly so
that our customers can achieve rapid time to market with new devices. Our
products are used in electronic devices currently sold by large computer and
consumer electronics companies.
Industry Background
The emergence of wireless communications networks and the Internet,
combined with the rapid development of technologies to enable less expensive,
smaller and more powerful electronic devices, has created large markets for
mobile products that provide electronic connectivity independent of physical
location. One of the most significant challenges in these markets remains the
efficient management of power. Moreover, as users demand smaller mobile devices
with greater functionality, the limitations of power source technology become
increasingly problematic because meeting these demands typically requires larger
and heavier power sources. Despite the importance of power source technology,
major advances in battery storage capacity have been limited. As a result,
manufacturers are turning to innovative new semiconductor technologies to manage
the available power source capacity more efficiently.
Power management requires a combination of two distinct technological
disciplines: digital integrated circuit design and analog integrated circuit
design. Digital circuits, such as microprocessor and memory semiconductors,
provide most of the functionality of fundamental computer technologies. However,
digital circuits generally cannot handle significant amounts of current or
multiple voltage levels. In contrast, analog circuits use and manipulate
continuously varying voltage and current levels. Battery power systems, which
have relatively high and continuously varying power levels, are inherently
analog systems.
Digital integrated circuit technology can be used to manage power
systems more intelligently and efficiently and to help address the need for
longer battery life in mobile applications. However, since power systems are
analog by nature, mixed signal circuits, or circuits that incorporate both
digital and analog technologies, are necessary in order to harness the
intelligence provided by digital technology. Designing mixed signal circuits
poses a number of difficulties: analog circuits are more sensitive than digital
circuits to the physical layout and electrical characteristics of the circuit;
analog circuit designers must have a very high 13
level of circuit design
expertise; and basic differences in the technologies used in digital and analog
circuit design make combining the technologies problematic.
In addition, mixed signal circuits are comprised of both digital and
analog components, and the trend toward more complex devices has increased the
number of components substantially. Integrating the functions of those
components on a single chip, known as a system-on-a-chip, can enable
manufacturers to make products smaller, lighter, simpler to produce and more
reliable. Thus, as mobile computing and communications devices grow in
complexity and functionality, there is an increasing need for higher levels of
systems integration. In addition, variances in battery designs among manufacturers make
it more difficult to design intelligent systems that are optimized for
particular power systems.
Most analog integrated circuit companies offer broad product lines of
analog and, in some cases, mixed signal integrated circuit products. Their
products are typically designed to function in a wide range of applications, and
thus are not optimized for specific power system applications. Their products
also usually must be combined with other discrete circuit components, creating
larger and heavier products that are more difficult to manufacture and can be
less reliable. In addition, many of these companies lack the digital circuit
design and system-level expertise and focus necessary to design new products
quickly to meet the rapidly changing needs of mobile computing and
communications device manufacturers. Finally, many of these companies' existing
integrated circuit products are not currently designed to take full advantage of
recently developed standards-based battery design parameters, which can enable
the use of simpler and more efficient power management systems.
Most mobile computing, communications and other consumer electronics
product manufacturers need mixed signal and analog integrated circuit products
specifically designed to optimize the power system usage in their devices so
that they can offer new devices with richer functionality and longer battery
lives. These integrated circuit products should also be highly integrated and
standards-based to help manufacturers, create
14
products that are smaller, lighter, easier to use, more reliable and more
cost-efficient to design and produce. In addition, in mobile device markets
where product life cycles can be less than one year, these solutions need to be
developed using advanced design methodologies to allow manufacturers to achieve
rapid time to market with their new products.
Products
O2Micro designs, develops, and markets innovative power management and
security components for manufacturers of products for the computer, consumer
electronics, industrial and communications markets. The company's integrated
circuit products are produced with digital, analog, and mixed signal integrated
circuit manufacturing processes.
Our products control and monitor battery charging and discharging,
select and switch between power sources, manage and provide power for lighting
of liquid crystal displays, control and provide power for notebook CD players, and link external notebook plug-in cards and smart cards used in e-commerce
transactions.provide
internet security.
O2Micro's products include:
. Battery chargers and controllers for notebook computers and
other applications. Our products control and monitor battery
charging and discharging for various battery chemistry
compositions and capacities. They incorporate a variety of
built-in features such as temperature monitors, voltage
monitors, current monitors, voltage limiting devices, current
limiting devices, and the selection and switching between power
sources.
. Intelligent Inverter for the control of backlight CCFLcold cathode
fluorescent lamps (CCFL) in LCD displays in notebook computers,
LCD monitors, LCD televisions, Global Positioning Systems (GPS),
and other mobile applications.
. Audio DJDC/DC Controllers for the playing of music on a computer using the computer CD
ROM drive.
14
use in providing power to portable
computing sub-systems and microprocessors.
. Super DJ for playing of MP3 music on a computer hard drive or CD ROM
drive.
.CardBus products, including SmartCardBus, 4-in-1 Memory CardBus,
and Standard CardBus for PCMCIA interface.
. SmartCardBus for secure on line e-commerce utilizing PCMCIA interface.
. 4-in-1 memory card businterface reader for the direct
detection and reading of standard modem cards, smart card, four standard flash memory
media cards: Memory Stick, SD Memory Card, MultiMediaCard (MMC),cards, and Smart
Media.standard modem cards.
Marketing, Sales, and Customer Support
Our marketing strategy is focused on the sale of proprietary mixed
signal products to customers in the computer, consumer electronics, industrial
and communications markets. These markets tend to be dominated by a limited
number of major brand name companies. As a result, we focus our resources on the
major suppliers in each market.
We sell primarily standard products to our customers and work with them
on new product development. We market these products through a combination of
direct sales people, independent sales representatives and distributors in Asia,
Europe and North America.
Our marketing efforts include market analysis, participation in industry
trade shows and technical conferences, sales training, publication of technical
articles, maintenance of our web site and advertising. In addition, we maintain
customer support staff in United States, Taiwan, China and Japan for post order
servicing and applications support.
15
Customers
We focus on the major suppliers of products to the mobile computing,
display, communications and other consumer electronics markets. Many of these
major suppliers use third party providers, such as electronic manufacturing
services (EMS) providers or other intermediaries, to produce their products or
portions of their products containing our components. Hence, the majority of our
sales occur with these third party service providers.
The table below sets forth, for the periods indicated, the dollar amount
of our net sales derived from Asia, United States and other regions:
Years Ended December 31
--------------------------------------------------------------
(In Thousands)
Location of customers 2001 2002 2003 - --------------------- ------- ------- -------2004
--------------------------- --------- --------- ---------
Asia $45,780 $70,149 $88,548$ 70,149 $ 88,548 $ 92,105
United States 39 31 51 53
Other regions -- 7 --
------- ------- -------
$45,819 $70,187 $88,599
======= ======= =======- 38
--------- --------- ---------
$ 70,187 $ 88,599 $ 92,196
========= ========= =========
Manufacturing
We subcontract the manufacture of our products to wafer foundries,
assembly and test companies. This "fabless" approach allows us to focus on our
product development strengths, minimize fixed costs and capital expenditures,
and access diverse manufacturing technologies.
15
We use established mainstream processes for the manufacture of our
products. The value added by our products is provided by differentiated
functionality rather than leading edge processes. This approach reduces our
technical risks and minimizes the risks related to production capacity
constraints.
Currently, the majority of our products are manufactured using 0.25 to
0.80 micron CMOS semiconductor processes. Our major wafer foundry providers
include UMC, TSMC and X-FAB. We maintain second source capacity on selected
products. We utilize several assembly and test service providers in Taiwan and
other parts of Asia on a monthly or quarterly purchase order basis.
Competition
We compete in the market for mixed signal integrated circuit products
based on such factors as product performance, power efficiency, new
technologies, functional innovation, reliability, price and availability.
We believe our principal competitors include Linear Technology, Maxim
Integrated Products, Texas Instruments, Ricoh Company, Ltd. and Texas Instruments.Monolithic Power
Systems, Inc.. There is also competition from internal integrated circuit design
and manufacturing capabilities of some of our existing and potential customers,
such as Toshiba. In addition to these competitors, other integrated circuit
companies may decide to enter the market with mixed signal integrated products
that compete with our products or incorporate functions similar to those
provided by our products.
Intellectual Property
Our success depends significantly upon our ability to protect our
intellectual property. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy aspects of our products or
16
obtain and use information that we regard as proprietary. Competitors may
recruit our employees who have access to our proprietary technologies, processes
and operations.
We rely in part on patents to protect our intellectual property. As of
December 31, 2003,2004, we had approximately 3051 patents issued in the United States
and approximately 2243 patents issued in other countries. In addition, we had
approximately 79117 patent applications pending in the United States Patent and
Trademark Office. We also had approximately 122230 patent applications pending in
various countries other than the United States. These patents may never be
issued. Even if these patents are issued, taken together with our existing
patents, they may not be sufficiently broad to protect our proprietary rights,
or they may prove to be unenforceable. To protect our proprietary rights, we
also rely on a combination of copyrights, trademarks, trade secret laws,
contractual provisions, licenses and maskwork protection under the Federal
Semiconductor Chip Protection Act of 1984. We also enter into confidentiality
agreements with our employees, consultants outsourced manufacturers and customers and seek to control
access to, and distribution of, our other proprietary information.
We may from time to time grant rights to third parties for our patents
and other intellectual property. In March 2003, we granted a limited
non-exclusive license to Ricoh Company, Ltd. for our patents entitled
"Integrated PC Card Host Controller for the Detection and Operation of a
Plurality of Expansion Cards" (U.S. Patent No. 6,470,284 and Taiwan Patent No.
155891) and their foreign counterparts.
The laws of some foreign countries do not protect our proprietary rights
to as great an extent as do the laws of the United States, and many companies
have encountered substantial infringement problems in these countries, some of
which are countries in which we have sold and continue to sell a significant
portion of our products. There is a risk that our means of protecting our
proprietary rights may not be adequate. For example, our competitors may
independently develop similar technology, duplicate our products or design
around our patents or our other intellectual property rights. If we fail to
adequately protect our intellectual property, it would be easier for our
competitors to sell competing products.
We have initiated and are pursuing certain patent infringement actions
in Taiwan. In January 2003, the Shihlin District Court in Taiwan issued a
preliminary injunction prohibiting Monolithic Power Systems, 16
Inc. or MPS from
designing, manufacturing, selling, importing or displaying its MP1011A and
MP1015 products. In March 2003, the Taipei District Court in Taiwan issued a
preliminary injunction prohibiting Beyond Innovation Technology Co., Ltd.
("Bitek") from making, selling, using, or importing for the purposes of making,
selling and using, their BIT3105, BIT3105-P & BIT3106 "high efficiency ZVS CCFL
controller" related products, irrespective of their various types of package. In
August 2003, the Taipei District Court issued a preliminary injunction
prohibiting Bitek from designing, making, selling, displaying and importing and
all other disposing acts related to its parts, which infringe on our Taiwan
Patent Number 152318, including without limitation BIT3107. As of MayDecember 31,
2004, we have deposited $12.4$13.9 million with the Taiwan courts for court bonds in
connection with those preliminary injunction actions and related provisional
attachment actions as well as other preliminary injunction actions and
provisional attachment actions. The court bonds provide security for the
enjoined party to claim damages against in the event we do not ultimately
prevail in the underlying infringement action associated with the particular
preliminary injunction action or provisional attachment action.
We have also been in litigation against MPS in the U.S. MPS has alleged
that our OZ960, OZ961, OZ969OZ969A and OZ970 products infringe on one of their
patents and a continuation of that patent. Litigation on such claim is pending
in the United States District Court in the Northern District of California. We
have answered MPS' claims, denying all of their substantive allegations. In
addition, given the results of the claims constructions adopted by the Court on
November 26, 2001 and December 27, 2002, we believe that we have meritorious
defenses against MPS' allegations. On May 28, 2004, the Court granted our motion
for summary judgment that MPS lacked evidence of damages. As the judgmentcase currently
stands, MPS will not be able to recover damages at trial but may only attempt to
seek injunctive relief and attorneys' fees. Trial on these claims is currently
scheduled for August 2004.June 2005.
17
Given the inherent uncertainties in litigation, there cannot be any
assurance that we will prevail in any of the pending litigations, and we cannot
predict the outcome of any such litigation. If any party was to prevail in its
claims against us, our operating results could be materially adversely affected.
In any litigation arising from claims that we infringe on the intellectual
property rights of others, an adverse result could involve an injunction to
prevent the sales of a material portion of our products, a reduction or the
elimination of the value of related inventories, and the assessment of a
substantial monetary award for damages related to past sales, any of which could
have a material adverse effect on our result of operations and financial
condition.
ORGANIZATIONAL STRUCTURE
We are incorporated under the laws of the Cayman Islands and we are a
holding company for the various subsidiaries that conduct our business on a
worldwide basis. Our significant subsidiaries, all of which are wholly-owned,
are:
- ------------------------------------------------------------------------------------------
Significant Subsidiary Country of Incorporation Date of Incorporation
- ------------------------------------------------------------------------------------------
O//2//Micro, Inc. U.S.A. March 1995
- ------------------------------------------------------------------------------------------
O//2//Micro Electronics, Inc. Taiwan March 1999
- ------------------------------------------------------------------------------------------
O//2//Micro International Japan Limited Japan August 1999
- ------------------------------------------------------------------------------------------
O//2//Micro PTE Limited-Singapore Singapore September 1999
- ------------------------------------------------------------------------------------------
O//2//Micro (Wuhan) Co., Ltd. People's Republic of China January 2001
- ------------------------------------------------------------------------------------------
O//2//Micro (Beijing) Co., Ltd. People's Republic of China February 2001
- ------------------------------------------------------------------------------------------
O//2//Micro (Shanghai) Co., Ltd. People's Republic of China April 2001
- ------------------------------------------------------------------------------------------
O//2//Micro (Chengdu) Co., Ltd. People's Republic of China July 2004
- ------------------------------------------------------------------------------------------
PROPERTY, PLANT AND EQUIPMENT
The table below describes our headquarters and the facilities
where the above subsidiaries are located as of December 31, 2004:
Approx. Available
Location Square Feet Lease Expiration
- -------- ----------------- -----------------
California, USA...................... 37,180 not applicable
Taipei, Taiwan....................... 20,779 2006
Hsin-Chu, Taiwan..................... 25,450 2006
Singapore............................ 7,078 2005
Shanghai, China...................... 12,276 2005
Beijing, China....................... 17,608 2007
Wuhan, China......................... 10,884 2006
Chengdu, China....................... 10,291 2005
Grand Cayman, Cayman Islands......... 1,000 2006
Tokyo, Japan......................... 1,301 2006
18
We use our Cayman Islands facility for performing invoicing and
receiving amounts payable. Research and development, marketing, applications and
administrative staff are located in California. We also have sales offices in
Pfluggerville, Texas and Houston, Texas. Marketing, sales, applications,
worldwide production support, final inspection and shipping, and general and
administrative staff are located in Hsin-Chu and Taipei, Taiwan. We have an
office in Tokyo, Japan housing marketing, sales and applications staff, and
offices in Singapore, Beijing, Shanghai, Wuhan and Chengdu primarily for
research and development activities. We believe our current leased facilities
are adequate for our needs for the foreseeable future, and that any additional
space required will be available to us on commercially reasonable terms.
In May 2004, we purchased a 37,180 square foot building in Santa
Clara, California housing our California operations. The purchase price was
approximately $4.6 million. In March 2005, we purchased a 10,350 square foot
facility in Shanghai, China for approximately $2.3 million. In May 2005, we
purchased an additional 20,559 square feet of space for the Shanghai, China
facility for approximately $4.9 million.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
Overview
We design, develop and market high performance integrated circuits for
power management and computer security applications. Our net sales have been
derived primarily from the sale of mixed signal integrated circuit products to
customers in the computer, consumer electronics, industrial and communications
products markets.
Our net sales have grown from $70.2 million in 2002 to $88.6 in 2003 and
$92.2 million in 2004. This increase in net sales was due primarily to
introduction of our new products, higher unit shipments of our existing products
and expansion of our customer base and the number of intermediaries we supply
to. We continued to diversify our customer base and market focus entering
additional market segments in the consumer electronics, industrial and
communications markets. Our overall gross margin has fluctuated in the past and
is likely to fluctuate in the future due to the stages of our products in their
life cycles, variations in our product mix, the timing of our product
introductions and specific product manufacturing costs. New products typically
have higher gross margins than products that are more mature. Gross margins on
specific products we sell will typically decline over the life of these products
due to competitive pressures and volume pricing agreements.
Operating expenses grew from $31.3 million in 2002 to $36.7 million in
2003 and $41.9 million in 2004. Our operating expenses increased as we continued
our new product development efforts, expanded our operations and hired
additional personnel. Our net income was $10.7 million in 2002, $13.2 million in
2003 and $14.1 million in 2004. We have been profitable in each quarter since
the quarter ended September 30, 1999. We believe this profitability was the
result of our strategy to make investments to develop new products and grow net
sales, while maintaining a high level of fiscal control, product quality and
customer satisfaction. Our profitability resulted in retained earnings of $31.3
million at December 31, 2004.
We utilize a fabless semiconductor business model, which means we focus
on designing, developing and marketing products, while having these products
manufactured by large independent semiconductor foundries. Because we are a
fabless semiconductor company, we do not need to invest significant capital to
manufacture semiconductor devices, and can take advantage of some of the
cost-efficiencies of third-party foundries. We place purchase orders for
specific quantities of packaged semiconductor devices or wafers at set prices.
We also use third parties to test and assemble our products, which reduces the
capital we need to invest in these activities.
19
We sell our products through a combination of direct sales offices,
sales representatives and distributors. We have sales representatives in China,
Singapore, Taiwan, and the United Kingdom, as well as one distributor in Japan.
In the year ended December 31, 2004, we continued to experience increased sales
activities in China.
Revenue from product sales to customers, other than distributors, is
recognized at the time of shipment, including revenue that has been realized and
earned. Sales through distributors are recognized when the distributors make a
sale. Under certain conditions, customers may return defective products.
Allowances for sales returns are provided on the basis of past experience; these
provisions are deducted from sales.
Critical Accounting Policies--
Revenue Recognition and Accounts Receivable Allowances
We recognize revenue to direct customers in accordance with SEC Staff
Accounting Bulletin No. 104, Revenue Recognition in Financial Statements (SAB
104). SAB 104 requires that four basic criteria must be met before revenue can
be recognized: (1) persuasive evidence of an agreement exists, (2) delivery has
occurred or services have been rendered, (3) the fee is fixed and determinable,
and (4) collectibility is reasonably assured. Determination of criteria (4) is
based on the management's judgments regarding the collectibility of those fees.
In certain limited instances, we sell products through distributors. We
have limited control over these distributors' selling of products to third
parties. Accordingly we recognize revenues on sales to distributors when the
distributors sell the products to third parties. We defer recognition of such
sales until the product is sold by the distributors to their end customers.
Products held by distributors are included in our inventory balance. Accounts
receivable from distributors are recognized and inventory is relieved upon
shipment as title to inventories generally transfers upon shipment at which
point we have a legally enforceable right to collection under normal terms.
17
We make estimates of potential future product returns and sales
allowances related to current period revenue. We analyze historical returns,
changes in current demand, and acceptance of products when evaluating the
adequacy of sales returns and allowances. Estimates may differ from actual
product returns and allowances. These differences may materially impact our
reported revenue and amounts ultimately collected on accounts receivable. In
addition, we monitor collectability of accounts receivable primarily through
review of the accounts receivable aging. When facts and circumstances indicate
the collection of specific amounts or from specific customers is at risk, we
access the impact on amounts recorded for bad debts and, if necessary, will
record a charge in the period such determination is made. To date, we have not
experienced material write-offs of accounts receivable due to uncollectability.
As of December 31, 2002, 2003 and 2004, the allowance we set aside for
product returns and sales allowances was $314,000, $315,000 and $317,000,
respectively, representing 0.4%, 0.4% and 0.3% of our revenue as of those dates.
For the years ended December 31, 2002 and 2003, we did not have to record any
additional provisions subsequent to the year ended because actual returns and
sales allowances were lower than the estimated amounts. For the year ended
December 31, 2004, we also did not have to record any additional provisions as
of May 7, 2005.
Inventories
Our inventories are stated at the lower of standard cost or market
value. Cost is determined on a currently adjusted standard basis, which
approximates actual cost on a first-in first-out basis. Because of the
cyclicality of the market, inventory levels, obsolescence of technology and the
product life cycles, we write down inventories to net realizable value based on
backlog, forecasted product demand and historical sales levels. Backlog is
subject to revisions, cancellations and rescheduling. Actual demand and market
20
conditions may be lower than those projected by us. This difference could have a
material adverse effect on our gross margin should inventory write downs beyond
those initially recorded become necessary.
As of December 31, 2002, 2003 and 2004, we recorded inventory allowances
in an aggregate amount of $1.1 million, $1.3 million and $791,000, respectively.
Our inventory valuation allowances were primarily for estimated scraps and
defects. For the years ended December 31, 2002 and 2003, we did not have to
record any additional allowances subsequent to the year ended because actual
write-offs were lower than the estimated amounts. For the year ended December
31, 2004, we also did not record any additional allowances as of May 7, 2005.
Long-Lived Assets
We evaluate the recoverability of property, plant and equipment in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets."
We perform periodic reviews to determine whether facts and circumstances exist
that would indicate that the carrying amounts of property, plant and equipment
might not be fully recoverable. If facts and circumstances indicate that the
carrying amount of property, plant and equipment might not be fully recoverable,
we compare projected undiscounted net cash flows associated with the related
assets over their estimated remaining useful life against their respective
carrying amounts. In the event that the projected undiscounted cash flows are
not sufficient to recover the carrying value of the assets, the assets are
written down to their estimated fair values based on the expected discounted
future cash flows attributable to the assets. Evaluation of impairment of
property, plant and equipment requires estimates in the forecast of future
operating results that are used in the preparation of the expected future
undiscounted cash flows. Actual future operating results and remaining economic
lives of the property, plant and equipment could differ from the estimates used
in assessing the recoverability of these assets. These differences could result
in additional impairment charges, which could have a material adverse impact on
the results of operations.
Income Taxes
Our income taxes are accounted in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 109 "Accounting for Income Taxes". The
provision for income tax represents income tax paid and payable for the current
year plus the changes in the deferred income tax assets and liabilities during
the years. Deferred income tax assets are primarily the tax effects of the
operating loss carryforwards and temporary differences. On a periodic basis we
evaluate the deferred tax assets balance for realizability. To the extent we
believe it is more likely than not that some portion of deferred tax assets will
not be recognized, we will increase the valuation allowance against the deferred
tax assets. Realization of the deferred tax assets is dependent primarily upon
future taxable income, changes in tax laws and other factors. These changes, if
any, may require possible material adjustment to the deferred tax assets,
resulting in a reduction in net income in the period when such determinations
are made.
Legal Contingencies
18
We are currently involved in various claims and legal proceedings. We
periodically assess each matter in order to determine if a contingent liability
in accordance with Statement of Financial Accounting Standards No. 5 (SFAS 5),
"Accounting for Contingencies," should be recorded. In making the determination,
we, depending on the nature of the matter, consult with external counsel and
technical experts. Based on the information obtained combined with our judgment
regarding all the facts and circumstances of each matter, we determine whether
it is probable that a contingent loss may be incurred and whether the amount of
such loss can be estimated. Should a loss be probable and estimable, we record a
contingent loss in accordance with SFAS 5. In determining the amount of a
contingent loss, we take into consideration advice received from experts in the
specific matter, current status of legal proceedings, prior case history and
other factors. Should the judgments and estimates be incorrect, we may need to
record additional contingent losses that could materially adversely impact our
results of operations.
ORGANIZATIONAL STRUCTURE
We are incorporated under the laws21
Operating Results
The following table summarizes historical results of the Cayman Islands and we areoperations as a
holding companypercentage of net sales for the various subsidiaries that conduct our business on a
worldwide basis. Our significant subsidiaries, all of which are wholly-owned,
are:
- --------------------------------------------------------------------------------------------
Significant Subsidiary Country of Incorporation Date of Incorporation
- --------------------------------------------------------------------------------------------
O//2//Micro, Inc. U.S.A. March 1995
- --------------------------------------------------------------------------------------------
O//2//Micro Electronics, Inc. Taiwan March 1999
- --------------------------------------------------------------------------------------------
O//2//Micro International Japan Limited Japan August 1999
- --------------------------------------------------------------------------------------------
O//2//Micro PTE Limited-Singapore Singapore September 1999
- --------------------------------------------------------------------------------------------
O//2//Micro (Wuhan) Co. Ltd. People's Republic of China January 2001
- --------------------------------------------------------------------------------------------
O//2//Micro (Beijing) Co. Ltd. People's Republic of China February 2001
- --------------------------------------------------------------------------------------------
O//2//Micro (Shanghai) Co., Ltd. People's Republic of China April 2001
- --------------------------------------------------------------------------------------------
PROPERTY, PLANT AND EQUIPMENT
The table below describes our headquarters and the facilities where the
above subsidiaries are located as ofperiods shown.
Year Ended December 31,
2003:
Approx. Available
Location Square Feet Lease Expiration
- --------------------------------
----------------- ----------------
California, USA................. 18,240 not applicable
Taipei, Taiwan.................. 11,3152002 2003 2004
Hsin-Chu, Taiwan................ 16,123 2005
Singapore....................... 7,078 2005
Shanghai, China................. 8,113 2004
Beijing, China.................. 7,866 2004
Wuhan, China.................... 6,348 2004
19
Grand Cayman, Cayman Islands..................................... 1,000 2004
Tokyo, Japan..................................................... 874 2004
We use our Cayman Islands facility for performing invoicing and
receiving amounts payable.------ ------ ------
Consolidated Statement of Operations Data:
Net sales.................................. 100.0% 100.0% 100.0%
Cost of sales.............................. 40.1 43.2 40.6
------ ------ ------
Gross margin............................... 59.9 56.8 59.4
Operating expenses:
Research and development, marketing, applications and
administrative staff are located in California. We also have sales offices in
Pfluggerville, Texas and Houston, Texas. Marketing, sales, applications,
worldwide production support, final inspection and shipping, anddevelopment.............. 27.0 21.7 22.0
Selling, general and administrative staff are located in Hsin-Chuadministrative... 16.8 15.3 17.7
Patent litigation .................... 0.8 4.5 5.8
Stock-based compensation.............. 0.1 - -
------ ------ ------
Total operating expenses.......... 44.6 41.4 45.5
------ ------ ------
Income from operations..................... 15.3 15.4 13.9
Non-operating income-net .................. 2.4 1.6 2.9
Income tax expenses........................ 2.4 2.1 1.6
------ ------ ------
Net income................................. 15.3% 14.9% 15.2%
====== ====== ======
Years Ended December 31, 2004 and Taipei, Taiwan. We have an
office in Tokyo, Japan housing marketing,2003
Net Sales. Net sales and applications staff, and
offices in Singapore, Beijing, Shanghai and Wuhan for research and development
activities. We believeconsisted of product revenues generated principally
by sales of our current leased facilities are adequate for our needsintegrated circuit products. Net sales for the foreseeable future, and that any additional space required will be
available to us on commercially reasonable terms.
In Mayyear ended
December 31, 2004 we purchased the 37,180 square foot building in Santa
Clara, California housing our California operations. The purchase price was
approximately $4.6 million.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
Overview
We design, develop and market high performance mixed signal integrated
circuits for power management, power saving applications and computer security
applications. Our net sales have been derived primarilywere $92.2 million, an increase of $3.6 million or 4.1% from the sale of mixed
signal integrated circuit products to customers in the mobile computing,
display, communications and other consumer electronics products markets.
Our net sales have grown from $45.8 million in 2001 to $70.2 in 2002 and
$88.6 million infor the year ended December 31, 2003. This increase in net sales
was due primarily to
introduction of our new products, higherresulted from increased unit shipments of our existing products as well as
shipments of new products and expansion of our customer base and the number of
intermediaries we supply to. In 2004, we introduced new Cardbus and CCFL
inverter controller products. We continuedalso enhanced the features of certain products
in every existing product group in 2004 (except for Audio DJ products).
Gross Profit. Gross profit represents net sales less cost of sales. Cost
of sales primarily consists of the cost of purchasing packaged integrated
circuit products manufactured and assembled for us by independent foundries and
packaging vendors and other costs associated with the procurement, storage and
shipment of these products. Gross profit for the year ended December 31, 2004
was $54.8 million, an increase of $4.5 million or 9.0% from $50.3 million for
the year ended December 31, 2003. This increase in absolute dollars was due to
diversifyincreased sales. Gross profit as a percentage of net sales for the year ended
December 31, 2004 increased to 59.4% from 56.8% for the year ended December 31,
2003 due to increased sales of higher margin products. We expect that our customer base and market focus entering
additional market segments in the consumer electronics, industrial and
communications markets. Our overall gross
margin has fluctuated in the past and
is likelyprofit as a percentage of net sales will continue to fluctuate in the future due toas
a result of the stages of our products in their life cycles, variations in our
product mix, the timing of our product introductions and specific product
manufacturing costs.
New products typically
have higher gross margins than products that are more mature. Gross marginsResearch and Development Expenses. Research and development expenses
consist primarily of salaries and related costs of employees engaged in
research, design and development activities and, to a lesser extent, expenses
for outside engineering consultants. Research and development expenses for the
year ended December 31, 2004 were $20.3 million, an increase of $1.0 million or
5.4% from $19.2 million for the year ended December 31, 2003. This increase
primarily reflected the addition of research and development personnel. As a
percentage of net sales, research and development expenses were 22.0% for the
year ended December 31, 2004, an increase from 21.7% for the year ended December
31, 2003. Research and development expenses as a percentage of net sales will
fluctuate from quarter to quarter depending on specific products we sell will typically decline over the
life22
amount of these products
due to competitive pressuresnet sales and volume pricing agreements.
Operating expenses grew from $24.4 million in 2001 to $31.3 million in 2002
and $36.7 million in 2003. Our operating expenses increased as we continued ourthe success of new product development efforts, expandedwhich we
view as critical to our operationsfuture growth. At any point in time, we have many
research and hired additional
personnel. Our net income was $5.6 million in 2001, $10.7 million in 2002development projects underway, and $13.2 million in 2003.we believe that none of these
projects is material on an individual basis. We have been profitable in each quarter sinceexpect to continue the
quarter
ended September 30, 1999. We believe this profitability was the resultdevelopment of our
strategy to make investments to developinnovative technologies and processes for new products and growwe
believe that a continued commitment to research and development is essential in
order to maintain product leadership with our existing products and to provide
innovative new product offerings. Therefore, we expect to continue to invest
significant resources into research and development in the future.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses consist primarily of employee-related expenses, sales
commissions to agents, professional fees, legal fees, travel and other
promotional expenses. Selling, general and administrative expenses for the year
ended December 31, 2004 were $16.3 million, an increase of $2.8 million or 20.9%
from $13.5 million for the year ended December 31, 2003. This increase in
absolute dollars was primarily due to additional personnel, additional traveling
and increased sales and marketing expenses. As a percentage of net sales,
while
maintaining a high level of fiscal control, product qualityselling, general and customer
satisfaction. Our profitability resulted in retained earnings of $18.1 million
atadministrative expenses were 17.7% for the year ended
December 31, 2004, an increase from 15.3% for the year ended December 31, 2003.
We utilizeexpect that selling, general and administrative expenses will continue to
increase in absolute dollars for the foreseeable future.
Patent Litigation Expenses. Patent litigation expenses consist primarily
of fees paid to outside counsel and consultants engaged by outside counsel.
Patent litigation expenses for the year ended December 31, 2004 were $5.3
million, an increase of $1.4 million or 34.9% from $4.0 million for the year
ended December 31, 2003. This increase in absolute dollars was primarily due to
increased litigation activity in existing cases and filing of additional
litigation by us. As a fabless semiconductor business model, which means we focuspercentage of net sales, patent litigation expenses were
5.8% for the year ended December 31, 2004, an increase from 4.5% for the year
ended December 31, 2003. We expect that patent litigation expenses will continue
to fluctuate for the foreseeable future. (Please see also, "Business Overview -
Intellectual Property.")
Non-operating Income-net. Non-operating income-net reflects interest
earned on designing, developingaverage cash balances, less interest on borrowings, foreign exchange
transaction gains and marketing products, while having these products
manufactured by large independent semiconductor foundries. Because we are a
fabless semiconductor company, we do not need to invest significant capital to
manufacture semiconductor devices,losses, gain on sales of long-term investments and
can take advantageimpairment loss on investment in shares of some ofstock. Non-operating income-net was
$2.7 million for the cost-efficiencies of third-party foundries. We place purchase ordersyear ended December 31, 2004 increasing from $1.4 million
for
specific quantities of packaged semiconductor devices or wafers at set prices.
We also use third parties to test and assemble our products, which reduces the
capital we need to invest in these activities.
We sell our products through a combination of direct sales offices, sales
representatives and distributors. Additionally, we have sales representatives in
China, Singapore, Taiwan, and the United
20
Kingdom, as well as one distributor in Japan. In the year ended December 31, 2003, we continued to experience increasedreflecting additional foreign exchange
transaction gains and gains on sales activity in China.
Revenue from product sales to customers, other than distributors, is
recognized at the time of shipment, including revenue that has been realized and
earned. Sales through distributors are recognized when the distributors make a
sale. Under certain conditions, customers may return defective products.
Allowances for sales returns are provided on the basis of past experience; these
provisions are deducted from sales.
Operating Results
The following table summarizes historical results of operations as a
percentage of net sales for the periods shown.
Year Ended December 31,
-----------------------
2001 2002 2003
----- ----- -----
Consolidated Statement of Operations Data:
Net sales ............................................ 100.0% 100.0% 100.0%
Cost of sales ........................................ 35.9 40.1 43.2
----- ----- -----
Gross margin ......................................... 64.1 59.9 56.8
Operating expenses:
Research and development .......................... 31.3 27.0 21.7
Selling, general and administrative ............... 21.6 17.5 19.7
Stock-based compensation .......................... 0.4 0.1 --
----- ----- -----
Total operating expenses ....................... 53.3 44.6 41.4
----- ----- -----long-term investments.
Income from operations ............................... 10.8 15.3 15.4
Non-operating income-net ............................. 4.0 2.4 1.6Taxes. Income tax expenses .................................. 2.5 2.4 2.1
----- ----- -----
Netwere $1.5 million for the year ended
December 31, 2004, compared to income ........................................... 12.3% 15.3% 14.9%
===== ===== =====tax expenses of $1.8 million for the year
ended December 31, 2003. This decrease in the amount of our income tax expenses
was primarily due to a change in the global sales mix and the reversal of
additional income tax payable for the 2000 tax year as a result of an
examination and approval of our 2000 income tax return by the local Taiwan tax
office authority. The effective tax rate was 9.5% for the year ended December
31, 2004, compared to 12.2% for the year ended December 31, 2003.
Years Ended December 31, 2003 and 2002
Net Sales. Net sales consistconsisted of product revenues generated principally
by sales of our integrated circuit products. Net sales for the year ended
December 31, 2003 were $88.6 million, an increase of $18.4 million or 26.2% from
$70.2 million for the year ended December 31, 2002. This increase in net sales
resulted from increased unit shipments of our existing products as well as
shipments of new products and expansion of our customer base and the number of
intermediaries we supply to. In 2003, we introduced Cardbus Power Switch
(OZ2216) and Cardbus Security (OZH31B) products. We also enhanced the features
of certain products in every existing product group in 2003.
Gross Profit. Gross profit represents net sales less cost of sales. Cost
of sales primarily consists of the cost of purchasing packaged integrated
circuit products manufactured and assembled for us by independent foundries and
packaging vendors and other costs associated with the procurement, storage and
shipment of
23
these products. Gross profit for the year ended December 31, 2003 was $50.3
million, an increase of $8.2 million or 19.6% from $42.0 million for the year
ended December 31, 2002. This increase in absolute dollars was due to increased
sales. Gross profit as a percentage of net sales for the year ended December 31,
2003 decreased to 56.8% from 59.9% for the year ended December 31, 2002 due to
increased sales of lower margin products. We expect that our gross profit as a
percentage of net sales will continue to fluctuate in the future as a result of
the stages of our products in their life cycles, variations in our product mix,
the timing of our product introductions and specific product manufacturing
costs.
21
Research and Development Expenses. Research and development expenses
consist primarily of salaries and related costs of employees engaged in
research, design and development activities and, to a lesser extent of, expenses
for outside engineering consultants. Research and development expenses for the
year ended December 31, 2003 were $19.2 million, an increase of $284,000 or 1.5%
from $18.9 million for the year ended December 31, 2002. This increase primarily
reflected the addition of research and development personnel. As a percentage of
net sales, research and development expenses were 21.7% for the year ended
December 31, 2003, a decrease from 27.0% for the year ended December 31, 2002.
Research and development expenses as a percentage of net sales will fluctuate
from quarter to quarter depending on the amount of net sales and the success of
new product development efforts, which we view as critical to our future growth.
At any point in time, we have many research and development projects underway,
and we believe that none of these projects is material on an individual basis.
We expect to continue the development of innovative technologies and processes
for new products and we believe that a continued commitment to research and
development is essential in order to maintain product leadership with our
existing products and to provide innovative new product offerings. Therefore, we
expect to continue to make significant research and development investments in
the future.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses consist primarily of employee-related expenses, sales
commissions to agents, professional fees, legal fees, travel and other
promotional expenses. Selling, general and administrative expenses for the year
ended December 31, 2003 were $17.5$13.5 million, an increase of $5.2$1.7 million or 41.8%14.7%
from $12.3$11.8 million for the year ended December 31, 2002. This increase in
absolute dollars was primarily due to increase of legal expenses relating to
intellectual property protection efforts, additional personnel, additional traveling
and increased sales commissions relating to higher sales. As a percentage of net
sales, selling, general and administrative expenses were 19.7%15.3% for the year
ended December 31, 2003, an increasea decrease from 17.6%16.8% for the year ended December 31,
2002. We expect that selling, general and administrative expenses and legal expenses associated with on-going patent infringement litigation
matters in particular, will continue
to increase in absolute dollars for the foreseeable future.
Patent Litigation Expenses. Patent litigation expenses consist primarily
of fees paid to outside counsel and consultants engaged by outside counsel.
Patent litigation expenses for the year ended December 31, 2003 were $4.0
million, an increase of $3.4 million or 639.1% from $535,000 for the year ended
December 31, 2002. This increase in absolute dollars was primarily due to
increased litigation activity in existing cases and filing of additional
litigation by us. As a percentage of patent litigation expenses were 4.5% for
the year ended December 31, 2003, an increase from 0.8% for the year ended
December 31, 2002. We expect that patent litigation expenses will continue to
fluctuate for the foreseeable future. (Please see also, "Business Overview -
Intellectual Property.")
Stock-based Compensation. For accounting purposes, we recognize deferred
stock-based compensation whenever we grant options or warrants to purchase our
ordinary shares to employees with exercise prices that are less than the deemed
fair market value of the underlying shares at the grant date and whenever we
grant options or warrants to consultants. Amortization of deferred stock-based
compensation recorded in the year ended December 31, 2003 was $0, a decrease of
$44,000 or 100.0% from $44,000 for the year ended December 31, 2002.
Non-operating Income-net. Non-operating income-net reflects interest
earned on average cash balances, less interest on borrowings, impairment loss on
investment in shares of stock and foreign exchange transaction gains and losses.
Non-operating income-net was $1.4 million for the year ended December 31, 2003
24
decreasing from $1.7 million for the year ended December 31, 2002, reflecting
less interest earned in our cash and short-term investment.
Income Taxes. Income tax expenses were $1.8 million for the year ended
December 31, 2003, compared to income tax expenses of $1.7 million for the year
ended December 31, 2002. This increase in the amount of our income tax expenses
was primarily due to increase in our net income. The effective tax rate was
12.2% for the year ended December 31, 2003, compared to 13.5% for the year ended
December 31, 2002.
Years Ended December 31, 2002 and 2001
Net Sales. Net sales consist of product revenues generated principally by
sales of our integrated circuit products. Net sales for the year ended December
31, 2002 were $70.2 million, an increase of $24.4 million or 53.2% from $45.8
million for the year ended December 31, 2001. This increase in net sales
resulted from increased unit shipments of our existing products as well as
shipments of new products. In 2002, we introduced our 4-in-1 MemoryCardBus
products.
22
Gross Profit. Gross profit represents net sales less cost of sales. Cost of
sales primarily consists of the cost of purchasing packaged integrated circuit
products manufactured and assembled for us by independent foundries and
packaging vendors and other costs associated with the procurement, storage and
shipment of these products. Gross profit for the year ended December 31, 2002
was $42.0 million, an increase of $12.7 million or 43.2% from $29.4 million for
the year ended December 31, 2001. This increase in absolute dollars was due to
increased sales. Gross profit as a percentage of net sales for the year ended
December 31, 2002 decreased to 59.9% from 64.1% for the year ended December 31,
2001 due to increased sales of lower margin products. We expect that our gross
profit as a percentage of net sales will continue to fluctuate in the future as
a result of the stages of our products in their life cycles, variations in our
product mix, the timing of our product introductions and specific product
manufacturing costs.
Research and Development Expenses. Research and development expenses
consist primarily of salaries and related costs of employees engaged in
research, design and development activities and, to a lesser extent of, expenses
for outside engineering consultants. Research and development expenses for the
year ended December 31, 2002 were $18.9 million, an increase of $4.6 million or
32.2% from $14.3 million for the year ended December 31, 2001. This increase
primarily reflected the addition of research and development personnel
associated with the expansion of our design activities in Singapore and the
People's Republic of China. As a percentage of net sales, research and
development expenses were 27.0% for the year ended December 31, 2002, a decrease
from 31.3% for the year ended December 31, 2001. We expect that research and
development expenses will continue to increase in absolute dollars in the
foreseeable future.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses consist primarily of employee-related expenses, sales
commissions to agents, professional fees, legal fees and trade show and other
promotional expenses. Selling, general and administrative expenses for the year
ended December 31, 2002 were $12.3 million, an increase of $2.4 million or 24.4%
from $9.9 million for the year ended December 31, 2001. This increase in
absolute dollars was primarily due to additional personnel, increased sales
commissions relating to higher sales, increased corporate insurance premiums,
increased travel costs, increased product marketing costs and increased legal
expenses relating to intellectual property protection efforts. As a percentage
of net sales, selling, general and administrative expenses were 17.5% for the
year ended December 31, 2002, a decrease from 21.6% for the year ended December
31, 2001. We expect that selling, general and administrative expenses, and legal
expenses associated with on-going patent infringement litigation matters in
particular, will continue to increase in absolute dollars for the foreseeable
future.
Stock-based Compensation. For accounting purposes, we recognize deferred
stock-based compensation whenever we grant options or warrants to purchase our
ordinary shares to employees with exercise prices that are less than the deemed
fair market value of the underlying shares at the grant date and whenever we
grant options or warrants to consultants. Amortization of deferred stock-based
compensation recorded in the year ended December 31, 2002 was $44,000, a
decrease of $122,000 or 73.5% from $166,000 for the year ended December 31,
2001.
Non-operating Income-net. Non-operating income-net reflects interest earned
on average cash balances, less interest on borrowings, impairment loss on
investment in shares of stock and foreign exchange transaction gains and losses.
Non-operating income-net was $1.7 million for the year ended December 31, 2002
decreasing from $1.8 million for the year ended December 31, 2001, reflecting
recognition of an additional impairment loss on investment in shares of stock.
Income Taxes. Income tax expenses were $1.7 million for the year ended
December 31, 2002, compared to income tax expenses of $1.2 million for the year
ended December 31, 2001. This increase in the amount of our income tax expenses
was primarily due to increase in our net income. The effective tax rate was
13.5% for the year ended December 31, 2002, compared to 17.0% for the year ended
December 31, 2001.
23
Liquidity and Capital Resources
Since our inception, we have financed our operations primarily through
private salesales of securities and through our initial public offering in August
2000 and our public offering in November 2001 as well as cash provided by
operating activities in recent years. Cash and short-term investments were
$120.1 million at December 31, 2004 as compared to $120.4 million at December
31, 2003 as compared to $112.0 million at December
31, 2002.2003. Our operating activities provided cash in the amount of $14.1 million
in the year ended December 31, 2004, $14.8 million in the year ended December
31, 2003 $9.5 million in the year ended December 31,
2002 and $9.5 million in the year ended December 31, 2001. In May 2004, we
purchased the building in Santa Clara, California housing our California
operations. The purchase price was approximately $4.6 million which we paid in
cash.2002.
Non-cash charges consist of depreciation of fixed assets, impairment of
investment in shares of stock, changes of deferred income tax assets and
amortization of stock-based compensation from stock options and warrants. The
working capital components that have a significant impact on our cash flows are
accounts receivable, inventory, notes, accounts payable, prepaid expenses and
other current assets, income tax payable and accrued liabilities.
These net cash inflows for operations resulted from net income offset by
increases in inventory and accounts receivable due to increased sales and also
resulted from increases in notes and accounts payable, income tax payable and
accrued liabilities.
Our investing activities used cash of $25.2 million in the year ended
December 31, 2004, $23.5 million in the year ended December 31, 2003 and $34.7
million in the year ended December 31, 2002 and $22.8
million2002. Investing activities in the year
ended December 31, 2001.2004 primarily represented increase in short-term
investments, acquisition of land, property and equipment and additional
long-term investments. Investing activities in the year ended December 31, 2003
primarily represented the increaseincreases of short-term investments and the increase
of restricted assets. Investing activities in the year ended December 31, 2002
primarily represented short-term investments, investment in shares of stock and
purchases of capital equipment. Investing
activities inIn the year ended December 31, 2001 primarily represented increase2004, there were
net purchases of $11.0 million in short-term investments and purchases$1.9 million
increase of capital equipment.restricted assets. In the year ended December 31, 2003, there were
net purchases of $11.0 million in short-term investments and $10.0 million
increase of restricted assets. In the year ended December 31, 2002, there were
net purchases of $22.3 million on short-term investments, $6.0$7.0 million
investment in shares of stocks and $4.3 million purchase of capital equipment.
In the year ended December 31, 2001, there were
net purchases2004, we sold 1,000,000 shares of $20.1 million in short-term investments and $2.3 million in
purchases of fixed assets. In the year ended December 31, 2003, we converted
$1.75 million in loans to preference sharesstock in 360
Degree Web andfor $1.0 million, purchased $147,000$313,000 of stock in Etrend Hightech.Hightech and
purchased $4.5 million of common stock in CSMC Technologies Corporation.
Net cash provided by financing activities was $5.9 million$946,000 in the year ended
December 31, 2003,2004, primarily due to exercise of stock options and issuance of
shares under our Employee Stock Purchase Plan and offset by repurchaserepurchases of our
stock under a share repurchase program. Net cash provided by financing
activities was $5.9 million in the year ended December 31, 2003, primarily due
to exercises of stock options and issuance of shares under our Employee Stock
Purchase Plan, offset by repurchases of our stock from shareholders under share
repurchases program. Net cash used in financing activities was $4.4 million
in the year ended December 31, 2002, primarily due to repurchaserepurchases of our stock
under ourthe Company's existing share repurchase program offset by proceeds from
the exercise of stock options, exercise of warrants and issuance of shares under
Employee Stock Purchase Plan.
Net cash provided by financing activities
was $75.0 million in the year ended December 31, 2001, primarily due to the
issuance of ordinary shares in our public offering in November 2001.25
We believe our cash balances will be sufficient to meet our capital
requirements for at least the next 12 months. Our future capital requirements
will depend on many factors, including the inventory levels we maintain, the
level of investments we make in new technology and improvements to existing
technology, the levels of promotion and advertising required to launch new
products and attain competitive position in the marketplace, and the market
acceptance of our products. Thereafter, we may need to raise additional funds
through public or private financing. No assurance can be given that additional
funds will be available or that we can obtain additional funds on terms
favorable to us.
24
Research and Development, Patents and Licenses, etc.
We believe that the continued introduction of new products in our target
markets is essential to our growth. As of December 31, 2003,2004, we had
approximately 171257 full-time employees world-wide engaged in research and
development efforts. Our total expenditures for research and development were
$20.3 million for the year ended December 31, 2004, $19.2 million for the year
ended December 31, 2003, and $18.9 million for the year ended December 31, 2002, and $14.3 million for the year ended December 31, 2001.2002.
We believe that our research and development staffing will increase in the next
12 months primarily due to the expansion of our existing design centers and the
opening of additional design centers.centers in China.
We employ designers who have the necessary engineering and systems
qualifications and are experienced in system architecture, analog, digital,
mixed signal and software design and development. We also utilize independent
contractors from time to time for specific research and development projects.
Our internal research and development personnel thoroughly review the external
development processes and the design of these products as part of our quality
assurance process. All development is carried out using ISO 9001 certified
design processes, and our design tools are continuously enhanced to improve
design, fabrication and verification of our products.
We work with our customers to monitor the performance of our product
designs and to provide support at each stage of customer product development.
Due to the complexity of our products, we maintain a significant direct
applications support staff for customer technical support in our key markets -
Japan, Taiwan, China, Korea and the United States. These direct applications
engineering personnel assist with capturing business and supporting existing
products at key customers. Additionally, we work closely with our customers to
develop highly efficient power management products for specific mobile
applications.
Trend Information
See "Risk Factors" and "Operating and Financial Review and Prospects"
above.
Off-Balance Sheet Arrangements
There are no off-balance sheet arrangements that have or are reasonably
likely to have a current or future effect on our financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that is material to investors.
Tabular Disclosure of Contractual Obligations
The table below describes our contractual obligations as of December 31,
2003:2004:
Payments due by period
-------------------------------------------------------------------------------------------------------------------
Less than More than
Contractual Obligations Total 1 year 1-3 years 3-5 years 5 years
---------------- --------- --------- --------- ---------
(in thousands)
Long-Term Debt Obligations ................ $ $ $ $ $
Capital (Finance) Lease Obligations ....... 2 2 -- -- --
Operating Lease Obligations ............... 1,575 1,359 216 -- --
Purchase Obligations ...................... -- -- -- -- --Obligations............. $ 1,340 $ 998 $ 342 $ $
Licenses, Maintenance and Support ......... 928 928 -- -- --Support........ 547 304 243 - -
Total.................................... 1,887 1,302 585 - -
2526
Other Long-Term Liabilities Reflected on
the Company's Balance Sheet under the
GAAP of the primary financial
statements ............................. -- -- -- -- --
Total ..................................... 2,505 2,289 216 -- --
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
Directors and Senior Management
Our executive officers and directors and their ages as of December 31,
2003,2004, were as follows:
Name Age Position
- ---- --- --------
Sterling Du............................ 44Du................... 45 Chief Executive Officer, Class I Director and Chairman of the
Board
Chuan Chiung "Perry" Kuo............... 44Kuo...... 45 Chief Financial Officer, Class I Director and Secretary
Ivan Chang 41................... 42 Vice-President, Finance
Johnny Chiang 46................ 47 Vice-President, Logistics and Backend
James Keim............................. 59Keim.................... 60 Class II Director and Head of Marketing and Sales
Michael Austin......................... 68Austin................ 69 Class III Director
Geok Ling Goh.......................... 62Goh................. 63 Class I Director and member of Audit Committee
Lawrence Lin........................... 53Lin.................. 54 Class II Director and member of Audit Committee
Keisuke Yawata......................... 69Yawata................ 70 Class III Director and member of Audit Committee
Sterling Du has served as our chief executive officer and chairman of
our board of directors since March 1997 and as a Class I Director since June
2001. He also served as our chief financial officer from March 1997 to March
1999. From May 1995 to March 1997, Mr. Du was president and chief executive
officer of O2Micro,O//2//Micro, Inc., our predecessor entity. From October 1993 to April
1995, Mr. Du was vice president of engineering at GreenLogic, Inc., a
semiconductor design company, which he co-founded. Mr. Du received a B.S. in
chemical engineering from National Taiwan University and an M.S. in electrical
engineering from the University of California, Santa Barbara.
Chuan Chiung "Perry" Kuo has served as our general manager of Taiwan
operations since January 1997, as chief financial officer and a director since
March 1999, as secretary since October 1999 and as a Class I director since June
2001. From February 1992 to December 1996, he was executive vice president of
Pac Net Group, a holding company with investments in chemicals, electronics and
real estate. From July 1983 to February 1992, he held various positions at
Formosan Rubber Group, a rubber manufacturer, including product design engineer,
plant manager, research and development director, and vice president. Mr. Kuo
received a B.S. in chemical engineering from National Taiwan University and an
M.B.A. from the Rotterdam School of Management, Erasmus University in The
Netherlands.
Ivan Chang has served as our Vice-President, Finance since February
2003. He also served as our Controller from July 1999 until February 2003. From
August 1996 to July 1999, he was Finance Manager at Siemens Limited in Taiwan.
Mr. Chang received a B.S. in Accounting from Soochow University and an M.S. in
Accounting Information from University of Maryland, College Park.
Johnny Chiang has served as our Vice-President, Logistics and Backend
since February 2003. He also served as our Director of Operations from March
1999 to February 2003 and our Operations Manager from November 1997 to March
1999. Mr. Chiang received a B.S. in Industrial Engineering from Chung Yung
University.
2627
James Keim has served as a director since March 1999 and as Head of
Marketing and Sales since December 2001 and a Class II director since June 2001.
He also served as our chief operating officer from June 1998 to June 2001. From
March 1995 to June 1998, Mr. Keim was a principal in Global Marketing
Associates, an international consulting firm. Prior to March 1995, he had been
vice president of sales at Alliance Semiconductor Corporation, vice president of
marketing at Performance Semiconductor Corporation and worldwide linear
marketing manager at Fairchild Semiconductor Corporation. Mr. Keim received a
B.S. in engineering from Iowa State University, an M.S. in electrical
engineering and an M.B.A. from the University of Illinois.
Michael Austin has served as a director since October 1997 and as a
Class III director since June 2001. Mr. Austin is a resident of the Cayman
Islands and is a Chartered Accountant. Mr. Austin was admitted as an Associate
of the Institute of Chartered Accountants in England and Wales in 1964 and as a
Fellow in 1969. Mr. Austin is also an Associate Member of The Chartered
Institute of Taxation, a Member of the Society of Trust and Estate
Practitioners, and a Notary Public of the Cayman Islands. Mr. Austin served as
the managing partner of the Cayman Islands office of KPMG Peat Marwick, an
international accounting firm, for 23 years. Since retiring in July 1992, Mr.
Austin has been a consultant and currently serves as a non-executive director on
several company boards, including those of a number of mutual funds, trust and
insurance companies. He serves as a director of Scottish Re, a public company.
Effective
January 1, 1997, Mr. Austin was appointedserved as a director of the Cayman Islands Monetary Authority from
January 1997, and becamewas appointed Chairman of the Board in January 2003.2003, a
position he held until his retirement on July 31, 2004. He has also served on a
variety of other government committees and government related boards, including
the Cayman Islands Agricultural and Industrial Development Board, as Chairman;
the Stock Exchange Committee; and the Government/Private Sector Consultative
Committee. In 1990 Mr. Austin was awarded an M.B.E. by Her Majesty the Queen in
recognition of services to the public and business community.
Geok Ling Goh has served as a director since January 2000, as a member
of the Audit Committee since August 2000 and as a Class I director since June
2001. From October 1998 to October 1999, he was the managing director of Micron
Semiconductor Asia Pte Ltd. From June 1970 to October 1998, he held various
positions at Texas Instruments Singapore Pte Ltd, including Vice-President of
Marketing and in 1993, the first local managing director of Texas Instruments
Singapore Pte Ltd. He serves as the Chairman of Tuas Power and as a director on
the boards of Singapore Technologies Pte Ltd., Sembcorp Industries Ltd., Plato Capital Ltd. (formerly PKTech
International Ltd, ASTI Holdings Limited,Ltd), Venture Corporation Ltd., DBS Group Holdings Ltd. and DBS
Bank Ltd. He also serves as a council member of Nanyang Technology University.
He received a bachelor of engineering degree from Sydney University.
Lawrence Lin has served as a Class II director and member of the Audit
Committee since June 2003. He is a Certified Public Accountant in Taiwan. Mr.
Lin co-founded L&C Company, Certified Public Accountants, a member firm of
Urbach Hacker Young International, in 1990. Mr. Lin has been a partner of L&C
Company since 1990 and a Director of Urbach Hacker Young International from
October 1994 to October 1998. Prior to L&C Company, he had been a partner at T N
Soong & Co. Mr. Lin serves as Corporate Supervisor for a number of Taiwan
companies including Amason Technology Corporation, Cellink Company Limited and Tex Year Industries Inc. and Uniflex Technology Inc. He
received a bachelor of science degree from Taipei Vocational Commercial School.
Keisuke Yawata has served as a director since October 1999, as a member
of the Audit Committee since August 2000 and as a Class III director since June
2001. Mr. Yawata is a partner and director of Start-up101, a venture capital
firm, since 1999 and is the Chief Executive Officer of The Future International,
a consulting firm he founded in 1997. From 1995 to 1997, he was the president
and chief executive officer of Applied Materials Japan and a senior vice
president of Applied Materials, Inc. From 1985 to 1994, he was at LSI Logic KK,
serving as president and chief executive officer from 1985 to 1992, and as
chairman of the board from 1993 to 1994. From 1958 to 1984, he was employed by
NEC Corporation and its subsidiaries
28
where he held various positions, the last position being president and chief
executive officer of NEC Electronics, Inc. from 1981 to 1984. In addition, Mr.
Yawata was a vice president of the Semiconductor Industry Association Japan
Chapter from 1989 to 1994. Mr. Yawata serves as a director on the boards of Bee
27
Technology,U10
Networks, DigiPub Japan, Sequence Design KK and NanoGeometry Research. He
received a B.S. in electrical engineering from Osaka University in Osaka, Japan
and an M.S. in electrical engineering from Syracuse University.
There are no family relationships among any of our directors or
executive officers.
Compensation
We paid an aggregate amount of compensation during 20032004 to our directors
and officers as a group equal to approximately $2,072,054.$2,713,962. All of our officers
and directors are eligible to participate in our employee benefit plans.
Share Ownership of Directors and Senior Management
As of December 31, 2003,2004, the aggregate number of ordinary shares
beneficially owned by our directors and officers was 3,172,079.2,473,717. This number
includes options to purchase an aggregate of 501,722751,184 ordinary shares under our
1997 Stock Plan and 1999 Stock Plan exerciseable within 60 days of December 31,
2003.2004.
Employee Benefit Plans
1997 Stock Plan. Our 1997 stock plan was adopted by our board of
directors and approved by our shareholders in 1997. The 1997 stock plan provides
for the granting to our employees of incentive stock options within the meaning
of Section 422 of the United States Internal Revenue Code, and for the granting
to employees and independent contractors of nonstatutory stock options and stock
purchase rights. Our board of directors and our shareholders have authorized a
total of 3,700,000 ordinary shares for issuance pursuant to the 1997 stock plan,
as amended. As of December 31, 2003,2004, options outstanding and exercisable under
the 1997 stock plan were 570,207, of which 522,554 were exercisable.478,866. No more grants have been made under this plan
after the consummation of our initial public offering.
1999 Stock Incentive Plan. Our 1999 stock plan was adopted by our board
of directors in October 1999 and was approved by our shareholders prior to the
consummation of our initial public offering in August 2000. The 1999 stock plan
provides for the granting to employees of incentive stock options within the
meaning of Section 422 of the Internal Revenue Code and the granting of
nonstatutory stock options, stock appreciation rights, dividend equivalent
rights, restricted stock, performance units, performance shares and other
equity-based rights to our employees, directors and consultants. Initially, we
have reserved 3,000,000 ordinary shares for issuance under the 1999 stock plan.
Commencing January 1, 2001, the number of ordinary shares of stock reserved for
issuance under the 1999 stock plan will be increased annually by a number equal
to 4% of the fully-diluted number of ordinary shares outstanding as of December
31 of the immediately preceding calendar year or a lesser number determined by
the administrator. However, the maximum number of ordinary shares available for
issuance as incentive stock options will be increased by the least of 4% of the
fully-diluted number of ordinary shares outstanding on December 31 of the
immediately preceding calendar year, 1,500,000 ordinary shares or a smaller
number as determined by the administrator. In the year ended December 31, 2003,2004,
the number of shares reserved under the 1999 stock plan was increased by
1,500,0001,000,000 shares. Where an award agreement permits the exercise or purchase of
the award for a specified period of time following the recipient's termination
of service with us, or the recipient's disability or death, the award will
terminate to the extent not exercised or purchased on the last day of the
specified period or the last day of the original term of the award, whichever
occurs first. As of December 31, 2003,2004, options outstanding under the 1999 stock
plan were 3,349,653,3,994,235, of which 878,0381,612,934 were exercisable.
29
1999 Employee Stock Purchase Plan. Our 1999 purchase plan was approved
by our board of directors in October 1999, was approved by our shareholders
prior to the consummation of our initial public offering in August 2000 and is
intended to qualify as an "employee stock purchase plan" under Section 423 of
the Internal 28
Revenue Code and to provide our employees with an opportunity to
purchase ordinary shares through payroll deductions. Initially, an aggregate of
1,000,000 ordinary shares arewere reserved for issuance under the 1999 purchase
plan and available for purchase thereunder, subject to adjustment in the event
of a stock split, stock dividend or other similar change in our ordinary shares
or our capital structure. Commencing on January 1, 2001, the number of shares
reserved under this plan will be increased by a number equal to the leastlesser of 2%
of the fully-diluted number of ordinary shares outstanding on that date, 800,000
shares or a smaller number determined by the administrator. All of our employees
and the employees of our subsidiaries (including officers) who have been
employed by us for at least ten days and whose customary employment is for more
than five months in any calendar year and more than 20 hours per week are
eligible to participate in the 1999 purchase plan. Employees subject to the
rules or laws of a foreign jurisdiction that prohibit or make impractical their
participation in the 1999 purchase plan are not eligible to participate in the
1999 purchase plan. As of December 31, 2003, 297,0972004, 415,576 shares had been issued
under the 1999 purchase plan.
The 1999 purchase plan designates offer periods, purchase periods and
exercise dates. Offer periods are generally overlapping periods of 24 months,
with new offering periods (other than the first offering period) commencing on
May 1 and November 1 of each year. The initial offer period commenced on
September 1, 2000 and ended on October 31, 2002. Purchase periods are generally
six-month periods, with the initial purchase period commencing on September 1,
2000 and ending on April 30, 2001. The exercise date is the last day of each
purchase period.
On the first day of each offer period, a participating employee is
granted purchase rights, which are a form of option to be automatically
exercised on the forthcoming exercise dates within the offer period during which
deductions are to be made from the pay of participants in accordance with their
authorizations and credited to their accounts under the 1999 purchase plan. When
a purchase right is exercised, the participant's withheld salary is used to
purchase ordinary shares. The price per share at which ordinary shares are to be
purchased under the 1999 purchase plan during any offer period is the lesser of
85% of the fair market value of our ordinary shares on the date of the grant of
the option or 85% of the fair market value of our ordinary shares on the
applicable exercise date. The participant's purchase right is exercised in this
manner on all four exercise dates arising in the offer period unless, on the
first day of any purchase period, the fair market value of our ordinary shares
is lower than the fair market value of the ordinary shares on the first day of
the offer period. If so, the participant's participation in the original offer
period is terminated, and the participant is automatically enrolled in the new
offer period commencing on that day.
Payroll deductions may range in whole percentage increments from 1% to
10% of a participant's regular base pay, including commissions, overtime,
bonuses, annual awards and other incentive payments. Participants may not make
direct cash payments to their accounts. An employee may purchase a maximum of
2,000 ordinary shares under the 1999 purchase plan during a purchase period.
Additional limitations on the amount of ordinary shares that may be purchased
during any calendar year are imposed by the Internal Revenue Code.
Board Practices
Duties of Directors
Under Cayman Islands law, our directors have a duty of loyalty to act
honestly in good faith with a view to promoting our best interests. Our
directors also have a duty of care to exercise the care, diligence and skills
that a reasonably prudent person would exercise in comparable circumstances. In
fulfilling their duty of care to us, our directors must ensure compliance with
our memorandum and articles of association and the class rights vested under our
memorandum and articles of association in the holders of the shares.
2930
Terms of Directors and Officers
Our memorandum and articles of association allow our shareholders by
ordinary resolution to appoint any person to be a director and in a like manner
to remove any director and appoint another person in his place. Further, our
directors have the power at any time to appoint any person to become one of our
directors, either to fill a vacancy or as an addition to the existing directors,
except that the total number of directors may not exceed the number fixed in
accordance with our memorandum and articles of association. We have currently
set the number of directors at not less than five or more than nine persons, but
a majority of our shareholders may, by ordinary resolution, increase or reduce
the limits on the number of directors. Prior to completion of our initial public
offering, our memorandum and articles of association were amended to provide for
our board of directors to be elected on a staggered basis which means
shareholders can only elect, or remove, a limited number of our directors in any
given year and can make it more difficult for a third party to acquire us
without the consent of our board of directors. At our first annual general
meeting after becoming eligible to have a classified board, our board of
directors were divided into three classes, designated Class I, Class II, and
Class III, as nearly equal in number as the then total number of directors
permits. At that annual general meeting, three Class I directors were elected
for a one-year term, two Class II directors for a two-year term and two Class
III directors for a three-year term. At each subsequent annual general meeting,
successors to the class of directors whose terms expires at that annual general
meeting will be elected for a three-year term. If the number of directors is
changed, any increase or decrease will be apportioned among the classes so as to
maintain the number of directors in each class as nearly as possible, and any
additional directors of any class elected to fill a vacancy resulting from an
increase in that class will hold office for a term that shall coincide with the
remaining term of that class, but in no case will a decrease in the number of
directors shorten the term of any incumbent director. The term of executive
officers is determined by our board of directors. There are no provisions of
Cayman Islands law which require the term of executive officers to be for a
particular period.
Committees of the Board of Directors
We have an audit committee and a compensation committee. Each of our
audit committee members qualifies as an "independent" director for purposes of
the rules and regulations of the Nasdaq National Market System. The Audit
Committee is established by the Board primarily for the purpose of overseeing
the accounting and financial reporting processes of the Company and audits of
the financial statements of the Company. The Committee's responsibilities
include (1) the appointment, retention, compensation and oversight of the work
of our independent auditors, and for review of its qualifications, and (2)
review of our system of internal controls. The Committee also maintains
procedures for the receipt, retention and treatment of complaints received by
the Company regarding accounting, internal controls, or auditing matters and for
the confidential, anonymous submission by employees of the company of concerns
regarding accounting or auditing matters. The Audit Committee meets at least
four times per year, and also meets separately with the representatives of
management at least annually. The Audit Committee held four meetings in 2003.2004.
Currently, Messrs. Yawata, Goh and Lin serve on the audit committee.
The compensation committee establishes remuneration levels for our
officers, performs the functions that are provided under our employee benefit
programs and administers the 1999 stock plan. Currently, Messrs. Lin, Austin and
Kuo serve on the compensation committee.
Compensation Committee Interlocks and Insider Participation
No member of our compensation committee serves as a member of the board
of directors or the compensation committee of any entity that has one or more
executive officers serving as a member of our board of directors or our
compensation committee.
3031
Employees
As of December 31, 2003,2004, we had 315426 full-time employees, 96104 of which
were based in the United States, 191289 in Asia, 2430 in Europe and fourthree in Cayman
Islands. Our employees are not represented by any collective bargaining
agreements, and we have never experienced a work stoppage. We believe our
employee relations are good.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
MAJOR SHAREHOLDERS
The following table sets forth information known to us with respect to
the beneficial ownership of our ordinary shares, as of December 31, 2003,2004, by
each shareholder known by us to own beneficially more than 5% of our ordinary
shares.
Shares Beneficially Owned
---------------------------------------------------
Name of Beneficial Owner Number Percent
- ------------------------------------------------------------------------------ --------- -------
Wasatch Advisors, Inc. 6,761,671 17.3%6,859,366 17.49
Fidelity Management & Research Company 5,050,690 12.9%5,881,890 15.00
Capital Research 3,640,000 9.28
RS Investment Management Co. LLC 4,309,707 11.0%2,253,088 5.75
None of the major shareholders listed above have differing voting rights
with respect to the ordinary shares of the Company.
RELATED PARTY TRANSACTIONS
Loans
In 2001, James Keim, one of our directors, accepted the assignment of
Head of Marketing and Sales in the Cayman Islands, and moved to the Cayman
Islands in December 2001. In connection with the move and to assist Mr. Keim to
purchase a residence in the Cayman Islands, we entered into a term loan
agreement with Mr. Keim in February 2002, under which we made an interest free,
unsecured loan in the amount of $400,000 to Mr. Keim. The loan is repayable in
February 2007. As of December 31, 2003,2004, approximately $18,000 had been repaid.
In February 2000, we loaned $750,000 to 360 DEG.Degree Web Ltd (360 DEG.Degree
Web). The loan accrued interest at a rate of USD-LIBOR + 1% and iswas to be paid
semiannually until the loan iswas fully repaid or until the loan iswas converted
into up to 2,083,333 shares of Series B preference shares of 360 DEG.Degree Web. The
conversion price was $0.36 per share, convertible at any time before February 1,
2005 or before 360 DEG.Degree Web offers its shares in an initial public offering.
In February 2002, we made an additional loan of $1.0 million to 360 DEG.Degree Web
on terms similar to the February 2000 loan. The February 2002 loan iswas also
convertible, into a maximum of 1,000,000 Series C preference shares of 360
DEG.Degree Web at a conversion price of $1.00 per share. On January 3, 2003, we
exercised our option to convert both the February 2000 and February 2002 loans
(aggregate principal of $1,750,000) into 2,083,333 Series B preference shares at
$0.36 per share and 1,000,000 Series B2 preference shares at $1.00 per share.
After the conversion, we owned a 35.18% interest in 360 DEG.degree Web. We did not
participate in 360 DEG.degree Web's additional financing rounds during 2003, and our
ownership was diluted to 29.33% as of December 31, 2003. In March 2004, we sold
1,000,000 shares of our stock in 360 DEG.degree Web and recognized a gain of
$340,000. Upon completion of the transaction, our ownership was reduced to
32
19.8%. As of December 31, 2003,2004, one of our directors serves as a director of 360
DEG.Degree Web. From time to time, we may make additional loans to 360 DEG.Degree Web on
similar terms.
31
ITEM 8. FINANCIAL INFORMATION
CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
Consolidated Financial Statements
Our financial statements set forth in the accompanying index to
Consolidated Financial Statements included in this Annual Report following Part
IV beginning on page F-1 are hereby incorporated in this Annual Report. Our
Consolidated Financial Statements are filed as part of this Annual Report.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our ordinary shares
or other securities and do not anticipate paying cash dividends in the
foreseeable future.
ITEM 9. THE OFFER AND LISTING
ORDINARY SHARE PRICES AND RELATED MATTERS
Our ordinary shares are listed and traded on the Nasdaq National Market
and the Cayman Islands Stock Exchange. The following table sets forth for the
periods indicated the high and low last reported sales prices per ordinary share
since trading on August 23, 2000 as furnished by the Nasdaq National Market. The
initial public offering of our ordinary shares on August 23, 2000 was at the
price of $9.00 per share.
(a) Annual high and low market prices
High Low
------ ------------- --------
August 23, 2000 through December 31, 2000 $28.63 $ 5.3826.00 $ 6.75
January 1, 2001 through December 31, 2001 $24.05$ 24.05 $ 5.50
January 1, 2002 through December 31, 2002 $25.28$ 25.28 $ 5.30
January 1, 2003 through December 31, 2003 $25.29$ 25.29 $ 8.01
January 1, 2004 through December 31, 2004 $ 24.98 $ 9.04
(b) Quarterly high and low market prices
Fourth Quarter 2001 $24.05 $11.81$ 24.05 $ 11.81
First Quarter 2002 $25.28 $15.90$ 25.28 $ 15.90
Second Quarter 2002 $18.74$ 18.74 $ 8.99
Third Quarter 2002 $13.00$ 13.00 $ 7.88
Fourth Quarter 2002 $13.60$ 13.60 $ 5.30
First Quarter 2003 $12.00$ 12.00 $ 8.01
Second Quarter 2003 $17.05 $10.45$ 17.05 $ 10.45
Third Quarter 2003 $18.25 $13.45$ 18.25 $ 13.45
Fourth Quarter 2003 $25.29 $14.56$ 25.29 $ 14.56
First Quarter 2004 $24.98 $14.10$ 24.98 $ 14.10
Second Quarter 2004 $ 18.30 $ 13.44
Third Quarter 2004 $ 16.20 $ 9.04
Fourth Quarter 2004 $ 13.16 $ 10.27
First Quarter 2005 $ 10.95 $ 8.74
33
(c) Monthly high and low market prices
October 2003 $21.31 $14.562004 $ 12.42 $ 10.49
November 2003 $25.29 $22.832004 $ 13.15 $ 12.10
December 2003 $25.05 $20.33
32
2004 $ 13.16 $ 10.27
January 2004 $24.98 $20.082005 $ 10.87 $ 8.74
February 2004 $22.15 $17.182005 $ 10.95 $ 8.78
March 2004 $18.64 $14.102005 $ 10.63 $ 9.43
April 2004 $18.30 $14.462005 $ 10.41 $ 9.35
May 2004 $17.31 $13.442005 $ 12.78 $ 10.05
ITEM 10. ADDITIONAL INFORMATION
The following are summaries of material provisions of our memorandum and
articles of association and the Companies Law (2003(2004 Revision). The summary is
qualified in its entirety by reference to our memorandum and articles of
association (see Item 19-Exhibit 1).
Registered Office
The Company has been assigned registration number CR-72204 by the
registrar of companies in the Cayman Islands. The registered office is located
at the offices of M&C Corporate Services Limited, P.O. Box 309, Ugland House,
South Church Street, George Town, Grand Cayman, Cayman Islands. The telephone
number at that location is (345) 949-8066.
Objects and Purposes
Paragraph 3 of the memorandum of association provides that the objects
and purposes of the Company are unlimited and the Company may perform all
corporate activities not prohibited by any law as provided by the Companies Law.
Directors
Article 107 of the articles of association of the Company provides that
a director will not be disqualified by his office from contracting with the
Company notwithstanding such director's interest and that such an interested
director will not be liable to the Company for any profit realized through such
contract or arrangement, provided, if the director's interest in such contract
or arrangement is material, the interested director declares such interest at
the earliest meeting of the board. Article 117 provides that directors'
compensation shall from time to time be determined by the Company in general
meeting or by the board in accordance with the articles of association. Article
126 provides that the directors may exercise all the powers of the Company to
borrow money and to mortgage or charge its undertaking, property and uncalled
capital or any part thereof and to issue debentures, debenture stock and other
securities whether outright or as security for any debt, liability or obligation
of the Company or of any third party.
Ordinary Shares
General. The Company's articles of association authorize the issuance of
95,000,000 ordinary shares with a par value of US $0.001. All the outstanding
ordinary shares are fully paid and nonassessable and accordingly no further
capital may be called for by the Company from any holder of the ordinary shares
outstanding. Certificates representing the ordinary shares are issued in
registered form. The ordinary shares are not entitled to any sinking fund or
pre-emptive or redemption rights. Under Cayman Islands Law, non-residents may
freely hold, vote and transfer ordinary shares in the same manner as Cayman
Islands residents,
34
subject to the provisions of the Companies Law and the articles of association.
No Cayman Islands laws or regulations restrict the export or import of capital
or affect the payment of dividends to non-residents holders of the ordinary
shares.
Dividends. The holders of our ordinary shares are entitled to receive
the dividends that are declared by the board of directors. Dividends may be paid
only out of profits, which include net earnings and retained
33
earnings
undistributed in prior years, and out of share premium, a concept analogous to
paid-in-surplus in the United States, subject to a statutory solvency test.
Voting Rights. Each ordinary share is entitled to one vote on all
matters upon which the ordinary shares are entitled to vote, including the
election of directors. Voting at any meeting of shareholders is by show of hands
unless a poll is demanded. A poll may be demanded by the chairman of the meeting
or any shareholder present in person or by proxy, before or on the declaration
of the result of the show of hands.
A quorum required for a meeting of shareholders consists of at least a
number of shareholders present in person or by proxy and entitled to vote
representing the holders of not less than a majority of our issued voting share
capital. Shareholders' meetings are held annually and may be convened by the
board of directors on its own initiative. Advanced notice of at least ten days
is required for the convening of shareholders' meetings.
Any ordinary resolution to be made by the shareholders requires the
affirmative vote of a simple majority of the votes attaching to the ordinary
shares and preference shares, if any, cast in a general meeting, while a special
resolution requires the affirmative vote of two-thirds of the votes cast
attaching to the ordinary shares and preference shares, if any. Holders of
ordinary shares, which are currently the only shares, carrying the right to vote
at our general meetings, have the power, among other things, to elect directors,
appoint auditors and make changes in the amount of our authorized share capital.
Material issues that require a special resolution of the shareholders
under the Companies Law include resolutions to alter the memorandum of
association with respect to any objects, powers or other matters specified
therein, any alteration of the articles of association, any reduction of
capital, any change of name, the appointment of an inspector for examining into
the affairs of the company, requiring the company to be wound up by a court, any
voluntary winding up, delegating to creditors the power of appointing
liquidators, making binding arrangements between the company and its creditors,
sanctioning the transfer of the business or property of the company being wound
up to another company whether established in the Cayman Islands or in any other
jurisdiction and sanctioning the re-registration of an ordinary non-resident
company as an exempted company.
Liquidation. If we are to be liquidated, the liquidator may, with the
approval of the shareholders, divide among the shareholders in cash or in kind
the whole or any part of our assets, in a manner proportionate to their
shareholdings, and may vest the whole or any part of those assets in trustees of
those trusts for the benefit of the shareholders that the liquidator, with the
approval of the shareholders, thinks fit, provided that a shareholder may not be
compelled to accept any shares or other assets that would subject that
shareholder to liability.
Preference Shares
The articles of association authorizes the issuance of 5,000,000
preference shares with a par value of $0.001 per share. Pursuant to our articles
of association, the board of directors has the authority, without further action
by the shareholders, to issue preference shares in one or more series. It also
has the authority to fix the designations, powers, preferences, privileges and
relative participating, optional or special rights and the qualifications,
limitations or restrictions of those shares, including dividend rights,
conversion rights, voting rights, terms of redemption and liquidation
preferences, any or all of which may be greater than the rights of the ordinary
shares. The board of directors, without shareholder approval, can issue
preference shares
35
with voting, conversion or other rights that could harm the voting power and
other rights of the holders of ordinary shares. Subject to the directors' duty
of acting in our best interest, preference shares can be issued quickly with
terms calculated to delay or prevent a change in control or make removal of
management more difficult. Additionally, the issuance of preference shares may
have the effect of decreasing the market price of the ordinary shares, and may
harm the voting and other rights of the holders of ordinary shares.
34
Anti-takeover Effects of Provisions in Our Charter Documents
Provisions in our charter documents could discourage potential
acquisition proposals and could delay or prevent a change in control transaction
that our shareholders favor. These provisions could have the effect of
discouraging others from making tender offers for our shares. As a result, these
provisions may prevent the market price of our ordinary shares from reflecting
the effects of actual or rumored takeover attempts and may prevent shareholders
from reselling their shares at or above the price at which they purchased their
shares. These provisions may also prevent changes in our management that our
shareholders may favor. Our charter documents do not permit shareholders to act
by written consent, do not permit shareholders to call a general meeting and
provide for a classified board of directors, which means shareholders can only
elect, or remove, a limited number of our directors in any given year.
Furthermore, as discussed above, our board of directors have the authority to
issue up to 5,000,000 preference shares in one or more series. Our board of
directors can fix the price, rights, preferences, privileges and restrictions of
such preference shares without any further vote or action by our shareholders.
The issuance of preference shares may delay or prevent a change in control
transaction without further action by our shareholders or make removal of
management more difficult.
Differences in Corporate Law
The Companies Law of the Cayman Islands is modeled after that of England
but does not follow recent United Kingdom statutory enactments and differs from
laws applicable to United States corporations and their shareholders. The
following paragraphs are a summary of the significant differences between the
provisions of the Companies Law applicable to us and the laws applicable to
companies incorporated in the United States and to their shareholders.
Mergers and Similar Arrangements. Cayman Islands law does not provide
for mergers as that expression is understood under United States corporate law.
However, there are statutory provisions that facilitate the reconstruction and
amalgamation of companies, provided that the arrangement in question is approved
by a majority in number of each class of shareholders and creditors with whom
the arrangement is to be made, and who must in addition represent three-fourths
in value of each class of shareholders or creditors, as the case may be, that
are present and voting either in person or by proxy at a meeting or meetings
convened for that purpose. The convening of the meetings and subsequently the
arrangement must be sanctioned by the Grand Court of the Cayman Islands. While a
dissenting shareholder would have the right to express to the court the view
that the transaction ought not to be approved, the court can be expected to
approve the arrangement if it satisfies itself that:
. the parties have complied with the statutory provisions
regarding majority vote;
. the shareholders have been fairly represented at the meeting in
question;
. the arrangement is one that a businessman would reasonably
approve; and
. the arrangement is not one that would more properly be
sanctioned under some other provision of the Companies Law.
When a take-over offer is made and accepted by holders of 90% of the
shares within four months, the offeror may, within a two-month period require
the holders of the remaining shares to transfer these shares on
36
the terms of the offer. An objection can be made to the Grand Court of the
Cayman Islands but this is unlikely to succeed unless there is evidence of
fraud, bad faith or collusion.
If the arrangement and reconstruction is approved, the dissenting
shareholder would have no rights comparable to appraisal rights, which would
otherwise ordinarily be available to dissenting shareholders of United States
corporations, providing rights to receive payment in cash for the judicially
determined value of the shares.
35
Shareholders' Suits. Maples and Calder has advised us that no
significant or major reported class action or derivative action has been brought
in a Cayman Islands court. In principle, we will normally be the proper
plaintiff and a derivative action may not be brought by a minority shareholder.
However, based on English authorities, which would in all likelihood be of
persuasive authority in the Cayman Islands, exceptions to the foregoing
principle apply in circumstances in which:
. a company is acting or proposing to act illegally or outside of
its powers;
. the act complained of, although not outside of its powers, could
be effected only if authorized by more than a simple majority
vote;
. the individual rights of the plaintiff shareholders have been
infringed or are about to be infringed; or
. those who control the company are perpetrating a "fraud on the
minority."
Indemnification
Cayman Islands law does not limit the extent to which a company's
articles of association may provide for indemnification of officers and
directors, except to the extent that a provision may be held by the Cayman
Islands courts to be contrary to public policy, such as to provide
indemnification against civil fraud or the consequences of committing a crime.
Our articles of association provide for indemnification of officers and
directors for losses, damages, costs and expenses incurred in their capacities
as such, except if they acted in a willfully negligent manner or defaulted in
any action against them.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to our directors, officers or persons controlling us
pursuant to these provisions, we have been informed that, in the opinion of the
Securities and Exchange Commission, this indemnification is against public
policy as expressed in the Securities Act and therefore is unenforceable.
Enforceability of Civil Liabilities
We are a Cayman Islands company. We incorporated in the Cayman Islands
because of the following benefits associated with being a Cayman Islands
company:
. political and economic stability;
. an effective judicial system;
. unlike some jurisdictions which impose taxes on worldwide
income, no taxation of companies based upon profits, income,
gains or appreciation;
. the absence of exchange control or currency restrictions; and
. the availability of professional and support services.
37
However, the Cayman Islands has a less developed body of securities laws
than the United States and provides less protection for investors. For example,
the remedies of shareholders and fiduciary responsibilities of our directors are
governed by Cayman Islands law and are not as clearly established as under
statutes or judicial precedent in existence in jurisdictions in the United
States. While there is some case law in the Cayman Islands on these matters, it
is not as developed as, for example, English law. However, we believe that
English case law, although not binding in the courts of the Cayman Islands,
would be regarded as persuasive. Based on English case law, we believe under
Cayman Islands law, our directors have a duty of
36
loyalty to act honestly in good
faith with a view to promoting our best interests. Our directors also have a
duty of care to exercise the care, diligence and skills that a reasonably
prudent person would exercise in comparable circumstances. In fulfilling their
duty of care to us, our directors must ensure compliance with our memorandum and
articles of association and the class rights vested under our memorandum and
articles of association in the holders of the shares.
A substantial majority of our assets are located outside the United
States. In addition, a majority of our directors and officers are nationals
and/or residents of countries other than the United States, and all or a
substantial portion of our assets and the assets of our directors and officers
are located outside the United States. As a result, it may be difficult to
effect service of process within the United States upon us or our directors and
officers or to enforce against us or against them judgments obtained in United
States courts, including judgments predicated upon the civil liability
provisions of the securities laws of the United States or any state thereof.
Maples and Calder, our counsel as to Cayman Islands law, has advised us
that there is uncertainty regarding whether the courts of the Cayman Islands
would (1) recognize or enforce judgments of United States courts obtained
against us or our officers and directors predicated upon the civil liability
provisions of the securities laws of the United States or any state thereof or
(2) be competent to hear original actions brought in their jurisdiction against
us or our officers and directors predicated upon the securities laws of the
United States or any state thereof.
There is no statutory enforcement in the Cayman Islands of judgments
obtained in the United States. Instead, such a judgment must be enforced by
action at common law. Maples and Calder have advised us that a final and
conclusive judgment in a federal or state court of the United States under which
a sum of money is payable, other than a sum payable in respect of taxes, fines,
penalties or similar charges, may be subject to enforcement proceedings as a
debt in the Courts of the Cayman Islands under the common law doctrine of
obligation.
Material Contracts
Other than the contacts listed under Item 19--Exhibits, in the past two
years we have not entered into any material contracts other than contracts
entered into in the ordinary course of business.
Exchange Control
Our articles of association authorizes us to issue an aggregate of
95,000,000 ordinary shares with a par value of $0.001 per share. Of those
95,000,000 authorized ordinary shares, 39,032,61639,188,062 shares were issued and
outstanding as of December 31, 2003,2004, all of which are fully paid or credited as
fully paid. We may not call for any further capital from any holder of ordinary
shares outstanding. Under Cayman Islands law, non-residents of the Cayman
Islands may freely hold, vote and transfer ordinary shares in the same manner as
Cayman Islands residents, subject to the provisions of the Companies Law and our
articles of association. No Cayman Islands laws or regulations restrict the
export or import of capital, or affect the payment of dividends to non-resident
holders of ordinary shares.
38
TAXATION
Cayman Islands Taxation
The Cayman Islands currently levy no taxes on individuals or
corporations based upon profits, income, gains or appreciation and there is no
taxation in the nature of inheritance tax or estate duty. There are no other
taxes likely to be material to us levied by the Government of the Cayman Islands
except for stamp duties that may be applicable on instruments executed in, or
after execution brought within, the jurisdiction of
37
the Cayman Islands. The
Cayman Islands are not party to any double tax treaties. There are no exchange
control regulations or currency restrictions in the Cayman Islands.
No stamp duties are payable on the issue or transfer of shares. An
agreement to transfer shares may be subject to stamp duty if the agreement is
executed in the Cayman Islands or, if executed outside the Cayman Islands,
subsequently brought into the Cayman Islands. The Stamp Duty Law (2003 Revision)
does not provide who is liable to pay stamp duty on any document but, in
practice, the person who seeks to rely on the document in any civil court
proceedings will be required to pay stamp duty in order to have the document
admitted in evidence.
United States Federal Income Taxation
The following discussion addresses the material United States federal
income tax consequences of the ownership of ordinary shares held as a capital
asset by a "U.S. Investor." This summary is based on the Internal Revenue Code
of 1986, as amended (the "Code"), final, temporary and proposed Treasury
Regulations thereunder, and administrative and judicial interpretations thereof,
all as in effect as of the date hereof, and all of which are subject to change
at any time (possibly on a retroactive basis) by legislative, judicial or
administrative action, and to differing interpretations. There can be no
assurance that the Internal Revenue Service (the "IRS") will not take a contrary
view. This summary does not discuss state or local tax consequences of the
ownership of ordinary shares.
A "U.S. Investor" means a person who is any of the following:
. a citizen or resident of the United States;
. a corporation or partnershipother entity treated as a corporation created
or organized in or under the laws of the United States or any
political subdivision thereof;
. an estate the income of which is subject to U.S. federal income
taxation regardless of its source;
. a trust that is subject to the primary supervision of a court
within the United States and the control of all of its substantial
decisions by one or more U.S. persons;
. a trust that has a valid election in effect under applicable
U.S. Treasury regulations to be treated as a U.S. person; or
. a person that is otherwise subject to U.S. federal income
taxation on its net income.
If a partnership (including for this purpose any entity treated as a
partnership for U.S. tax purposes) is a beneficial owner of ordinary shares, the
U.S. tax treatment of a partner in the partnership will generally depend on the
status of the partner and the activities of the partnership. A holder of
ordinary shares that is a partnership and partners in such partnership should
consult their individual tax advisors about the U.S. federal income tax
consequences of holding or disposing of the ordinary shares.
39
This summary does not address the United States federal income tax
treatment of investors having a special legal status, including without
limitation the following types of investors, who may be subject to tax rules
that differ significantly from those summarized below:
. life insurance companies;
. tax-exempt investors;
. banks and financial institutions;
. dealers in securities;
. traders in securities that elect to use a mark-to-market method
of accounting for their securities holdings;
38
. persons liable for alternative minimum tax;
. U.S. investors who or that actually or constructively hold 10%
or more of our voting shares;
. investors who hold our ordinary shares as part of straddles,
hedging or integrated or conversion transactions; or
. persons whose "functional currency" is not the U.S. dollar.
This summary is not a comprehensive description of all of the tax
considerations that may be relevant with respect to your ownership of ordinary
shares. You are advised to consult your own tax adviser with respect to your
particular circumstances and with respect to the effects of federal, state,
local or foreign tax laws to which you may be subject.
Dividends. Subject to the discussion in "Passive Foreign Investment
Company Status" below, in the event that a U.S. Investor receives a distribution
on the ordinary shares, other than a pro rata distribution of ordinary shares or
rights with respect to the ordinary shares, that U.S. Investor will be required
to include the distribution in gross income as a taxable dividend to the extent
that a distribution is paid from our current or accumulated earnings and profits
as determined for United States federal income tax purposes. Distributions in
excess of our current and accumulated earnings and profits will first be
treated, for United States federal income tax purposes, as a nontaxable return
on capital to the extent of the U.S. Investor's basis in the ordinary shares and
thereafter as gain from the sale or exchange of a capital asset. Dividends paid
by us will not be eligible for the corporate dividends received deduction. The
amount of any distribution of property other than cash will be the fair market
value of that property on the date of distribution. The Jobs and Growth Tax
Reconciliation Act of 2003 provides, for taxable years beginning after December
31, 2002 and before January 1, 2009, that "qualified dividend income" paid to an
individual shareholder will be subject to tax at the rates applicable to
long-term capital gains (which are currently taxed at the maximum rate of 15%)
if various statutory requirements, including a specified holding period, are
satisfied. In order for dividends to constitute "qualified dividend income," the
shareholder generally must have held the ordinary shares for more than 60 days
during the 120-day period beginning 60 days before the ex-dividend date;
however, because the holding period rules are intricate and because an owner's
holding period is reduced for periods during which the risk of loss is
diminished, U.S. Investors should consult their own advisors concerning the
calculation of their holding periods. Moreover, a dividend will not be treated
as a qualified dividend income to the extent that the taxpayer is under an
obligation (whether pursuant to a short sale or otherwise) to make related
payments with respect to positions in substantially similar or related property.
We believe that any dividends paid by us would generally constitute "qualified
dividend income" if the shareholder satisfies the holding period requirements
and is not subject to such an obligation to make related payments, so long as we
are not classified as a passive
40
foreign investment company for our taxable year in which the dividend is paid or
the preceding taxable year (see " -Passive Foreign Investment Company Status"
below).
Dividends will constitute foreign source income for foreign tax credit
limitation purposes. The limitation on foreign taxes eligible for credit is
calculated separately with respect to specific classes of income. For this
purpose, dividends distributed by us with respect to the ordinary shares will be
"passive income" or in certain circumstances "financial services income" to a
U.S. Investor. Special rules apply to individuals whose foreign source income
during the taxable year consists entirely of "qualified passive income" and
whose creditable foreign taxes paid or accrued during the taxable year do not
exceed $300 ($600 in the case of a joint return). Further, in particular
circumstances, a U.S. Investor that (i) has held the ordinary shares for less
than a specified minimum period during which it is not protected from risk of
loss, (ii) is obligated to make payments related to the dividends, or (iii)
holds the ordinary shares in arrangements in which the U.S. Investor's expected
economic profit, after non-U.S. taxes, is insubstantial, will not be allowed a
foreign tax credit for foreign taxes imposed on dividends paid on the ordinary
shares.
39
Distributions to a U.S. Investor of new ordinary shares or rights to
subscribe for new ordinary shares that are received as part of a pro rata
distribution to all our shareholders will not be subject to United States
federal income tax. The basis of the new ordinary shares or rights so received
will be determined by allocating the U.S. investor's basis in the old ordinary
shares between the old ordinary shares and the new ordinary shares or rights
received, based on their relative fair market values on the date of
distribution. However, the basis of the new ordinary shares or rights will be
zero if the fair market value of the new ordinary shares or rights is less than
15% of the fair market value of the old ordinary shares at the time of
distribution and the U.S. Investor does not make an election to determine the
basis of the rights by allocation as described above. A U.S. Investor's holding
period in the new ordinary shares or rights will generally include the holding
period of the old ordinary shares on which the distribution was made.
Dispositions of Shares. Subject to the discussion in "Passive Foreign
Investment Company Status" below, gain or loss realized by a U.S. Investor on
the sale or other disposition of the ordinary shares will be subject to United
States federal income tax as capital gain or loss in an amount equal to the
difference between the amount realized on the disposition and that U.S.
Investor's basis in the ordinary shares. The capital gain or loss will be
long-term capital gain or loss if the U.S. Investor has held the ordinary shares
for more than one year at the time of the sale or exchange. If you are an
individual, you will be eligible for reduced rates of taxation (currently, at a
maximum rate of 15% for sales occurring in taxable years beginning before
January 1, 2009) on long-term capital gain. You may deduct any loss resulting
from the sale or exchange of the ordinary shares only against other capital
gains, except that if you are an individual, up to $3,000 of capital loss in
excess of your capital gains may be deducted against ordinary income. Excess
losses may be carried forward. Gain or loss realized by a U.S. Investor will be
treated as U.S. source gain or loss for U.S. foreign tax credit purposes, except
that loss will be treated as foreign source loss to the extent you received
dividends that were includible in the financial services income basket during
the 24-month period prior to the sale.
Passive Foreign Investment Company Status. We believe that we are not a
passive foreign investment company and do not expect to become a passive foreign
investment company in the future. We will be classified as a passive foreign
investment company if, after the application of "look through" rules, either (a)
75% or more of the gross income of the company in a taxable year is passive
income, or (b) the average percentage of assets by value of the company in a
taxable year that produce or are held for the production of passive income
(which includes cash) is at least 50%, the income or assets test. Whether or not
we are a passive foreign investment company will be determined annually based
upon the composition of our income and assets including goodwill, from time to
time. In determining that we are not a passive foreign investment company, we
are relying on our projected expenditure plans for the current year and future
years and the current valuation of our assets, including goodwill. In
calculating goodwill, we have valued our total assets based on our total market
value determined using the then market price of our shares and have made a
number of assumptions regarding the amount of this value allocable to goodwill.
Because the determination of goodwill will be based on the price of our shares,
it is subject to change. We believe our valuation approach is
41
reasonable. However, it is possible that the Internal Revenue Service will
challenge the valuation of our goodwill, which may result in our being
classified as a passive foreign investment company. In addition, the composition
of our income and assets will be affected by the extent to which we spend the
cash we have raised, which is a passive asset for purposes of the passive
foreign investment company asset test discussed above, on acquisitions and
capital expenditures. We intend to use the cash we have raised in the past and
conduct our business activities in an effort to reduce the risk of our
classification as a passive foreign investment company. Because the passive
foreign investment company determination is made at the end of each taxable
year, we cannot determine in advance whether we will be considered a passive
foreign investment company for the 20042005 taxable year or for any future taxable
year. If we determine that we have become a passive foreign investment company,
we will notify all U.S. investors who have been record shareholders during any
period in which we determine that we are a passive foreign investment company,
within 60 days of the end of our taxable year for which we make such
determination.
Special U.S. tax rules apply to U.S. Investors of interests in a passive
foreign investment company. Subject to the discussion of the market-to-market
election and qualified electing fund election below, if we
40
were a passive
foreign investment company for any taxable year during which a U.S. Investor
held ordinary shares, that U.S. Investor would be subject to special tax rules
regardless of whether we meet the income or assets test for any other year with
respect to:
. any "excess distribution" by us to the U.S. Investor, which
means any distributions received by the U.S. Investor on the
ordinary shares in a taxable year that are greater than 125% of
the average annual distributions received by the U.S. Investor
in the three preceding taxable years, or, if shorter, the U.S.
Investor's holding period for the ordinary shares; and
. any gain realized on the sale or other disposition, including a
pledge, of ordinary shares.
Under these special tax rules:
. the excess distribution or gain would be allocated ratably over
the U.S. Investor's holding period for the ordinary shares;
. the amount allocated to the current taxable year and any taxable
year prior to the first taxable year in which we are a passive
foreign investment company would be treated as ordinary income;
. the amount allocated to each of the other years would be taxed
as ordinary income at the highest tax rate in effect for that
year; and
. the interest charge applicable to underpayments of tax would be
imposed with respect to the resulting tax attributable to each
prior year in which we were a passive foreign investment company
to recover the deemed benefit from the deferred payment of the
tax attributable to each prior year.
In addition, dividends that a U.S. Investor receives from us will not be
eligible for the special tax rates applicable to "qualified dividend income"
(see "-- United States Federal Income Taxation --- Dividends") if we are a
passive foreign investment company either in the taxable year of the
distribution or the preceding taxable year, but will instead be taxable at rates
applicable to ordinary income.
If we are a passive foreign investment company in any year, a U.S.
Investor would be required to file an annual return on Internal Revenue Service
Form 8621 regarding distributions received with respect to the ordinary shares
and any gain realized on the disposition of the ordinary shares.
A U.S. Investor in a passive foreign investment company is allowed to
make a mark-to-market election with respect to the stock of the passive foreign
investment company, provided that the passive foreign investment company,
provided that the stock of the
42
passive foreign investment company is "marketable" within the meaning of the
Code. The ordinary shares will be "marketable" as long as the underlying ordinary sharesthey remain listed on
Nasdaq. If the election is made, a U.S. Investor would be required to mark the
stock to market each taxable year and recognize ordinary gain for any increase
in market value for that taxable year and would be allowed to recognize an
ordinary loss for any decrease in that market value to the extent that prior
gains exceed prior losses. The adjusted basis in the stock of the passive
foreign investment company would be adjusted to reflect that gain or loss. The
mark-to-market election will be effective for the taxable year for which the
election is made and all subsequent taxable years, unless the ordinary shares
cease to be marketable or the Internal Revenue Service consents to the
revocation of the election.
Alternatively, for each year we meet the income or assets test, a U.S.
Investor can make an election to include in income annually its pro rata share
of our earnings and net capital gains. This election is referred to as a
qualified electing fund election. To make a qualified electing fund election,
you will need to have an annual information statement from us documenting the
earnings and capital gain for the year. If we were to become a passive foreign
investment company, we would furnish the passive foreign investment company
41
annual information statement to any shareholder or former shareholder who
requested it. In general, a U.S. Investor must make a qualified electing fund
election on or before the due date for filing its income tax return for the
first year to which the qualified electing fund election will apply. U.S.
Investors are permitted to make retroactive elections in particular
circumstances, including if the U.S. Investor had a reasonable belief that the
foreign corporation was not a passive foreign investment company and filed a
protective election. As discussed above, we will notify investors if we
determine that we have become a passive foreign investment company. This notice
will provide U.S. Investors on a calendar tax year with sufficient time to make
the qualified electing fund election. U.S. Investors (in particular those with a
tax year other than the calendar year) should consult their own tax advisors as
to the consequences of making a protective qualified electing fund election or
other consequences of the qualified electing fund election.
If we are a passive foreign investment company in any year, you should
consult with your tax adviser regarding whether to make a mark-to-market or
qualified electing fund election.
Information Report and Backup Withholding. In general, information reporting
requirements will apply to dividends in respect of our ordinary shares or the
proceeds received on the sale, exchange or redemption of our ordinary shares
paid within the United States (and, in certain cases, outside the United States)
to U.S. Investor other than certain exempt recipients, such as corporations, and
a 28% backup withholding tax may apply to such amounts if the U.S. Investor
fails to provide an accurate taxpayer identification number or to report
interest and dividends required to be shown on its U.S. federal income tax
returns. The amount of any backup withholding from a payment to a U.S. Investor
will be allowed as credit against the U.S. Investor's U.S. federal income tax
liability provided that the appropriate returns are filed.
DOCUMENTS ON DISPLAY
We file annual reportreports on Form 20-F and furnish current reports on Form
6-K with the SEC. You may read and copy this information at the SEC's Public
Reference Room at Judiciary Plaza, 450 Fifth Street N.W., Washington, D.C.
20549, and at the regional offices of the SEC located at 233 Broadway, New York,
New York 10279 and Citicorp Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661. You can also request copies of the documents, upon
payment of a duplicating fee, by writing to the Public Reference Section of the
SEC. Please call the SEC at 1-800-SEC-0330 for further information on the
operation of the Public Reference Room. Certain of our SEC filings are also
available to the public from the SEC's website at http://www.sec.gov.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss related to adverse changes in market
prices, including interest rates and foreign exchange rates, of financial
instruments. In the normal course of business, our financial
43
position is routinely subject to a variety of risks, including market risk
associated with interest rate movements and currency rate movements on non-U.S.
dollar denominated assets and liabilities, as well as collectibility of accounts
receivable.
We regularly assess these financial instruments and their ability to
address market risk and have established policies and business practices to
protect against the adverse effects of these and other potential exposures.
Interest Rate Risk
Our major market risk exposure is changing interest rates. Our exposure
to market risk for changes in interest rates relates primarily to our
investments in government and corporate bonds.
We maintain an investment portfolio consisting mainly of fixed income
securities. These securities are subject to interest rate risk and will fall in
value if market interest rates increase. If market 42
rates were to increase
immediately and uniformly by 10.0% from the levels at December 31, 2003,2004, the
fair value of the portfolio would decline by an immaterial amount. We presently
intend to treat our fixed income investments as available for sale, and
therefore we do not expect our operating results or cash flows to be affected to
any significant degree by the effect of a sudden short-term change in market
interest rate exposures. We did not purchase or hold any derivative financial
instruments for trading purposes.
The table below provides information about our financial instruments
whose maturity dates are greater than three months as of December 31, 2003.2004.
Expected Maturity Dates
------------------------------------------------------------
2008 and Fair
2004
2005 2006 2007 thereafter2008 2009 Thereafter Total Fair Value
------ ---- --------- ---- ---- ---- ---------- ----- ----------
------ ------
(in thousands)
US Treasury Bills:
Fixed rate (US$) ... 33,958 -- -- -- 33,958 33,958........ 3,963 - - - - - 3,963 3,963
Government Bonds:
Fixed rate (US$) ... 2,346 4,993 1,575 8,914 8,914........ - 4,224 6,973 - 1,667 - 12,864 13,565
Time Deposit
Fixed rate (US$) ... 11,622 3 11,625 11,625........ 11,742 - - - - - 11,742 11,742
Corporate Bonds
Fixed rate (US$) ... 8,185 -- -- -- -- 8,185 8,185........ 11,908 - - - - - 11,908 11,908
Foreign currency risk
Fluctuations in exchange rates may adversely affect our financial
results. The functional currencies for our foreign subsidiaries are the local
currency. As a result, certain of our assets and liabilities, including certain
bank accounts, accounts receivable, restricted assets, short-term investments
and accounts payable, exist in non-US dollar-denominated currencies, which are
sensitive to foreign currency exchange rate fluctuations. As of December 31,
2003,2004, we held approximately $11.9$18.8 million in government bonds, certificates of
deposits and bank demand accounts denominated in New Taiwan Dollars.foreign currencies.
We have not engaged in hedging techniques designed to mitigate foreign
currency exposures and we may experience economic losslosses as a result of foreign
currency exchange fluctuations. We will monitor the currency exchange
fluctuations periodically. For the year ended December 31, 2003,2004, we
44
experienced gains of $287,000$648,000 due to foreign currency exchange fluctuations,
which are reflected in the results of operations.
Recent Accounting Pronouncements
In January 2003,December 2004, the Financial Accounting Standards Board ("FASB") released
Interpretationissued SFAS No. 46, "Consolidation123 (R)
"Share-Based Payment". It required that companies recognize compensation expense
equal to the fair value of Variable Interest Entities"("FIN 46")
which requires that all primary beneficiariesstock options or other share based payment. As a
public entity as contemplated by SFAS No. 123 (R), we are required to record, as
of Variable Interest Entities
("VIE") consolidate that entity. FIN 46 is effective immediately for VIEs
created after January 31, 2003 and to VIEs in which an enterprise obtains an
interest after that date. It applies in the first fiscal year or interimannual reporting period beginning after June 15, 20032005. SFAS No. 123
(R) applies to VIEs in which an enterprise holds a variable
interest it acquired before February 1, 2003. In December 2003,all awards granted, and prior period's awards that are modified,
repurchased, or cancelled. The impact on our net income will include the
FASB
published a revision to FIN 46 ("FIN 46R") to clarify someremaining amortization of the provisionsfair value of existing options currently disclosed
as pro forma expense and is contingent upon the interpretation and to defernumber of future options
granted, the effective date of implementation for certain
entities. Under the guidance of FIN 46R, entities that do not have interests in
structures that are commonly referred to as special purpose entities (SPE's)
43
are required to apply the provisions of the interpretation in financials
statements for periods ending after March 14, 2004. The Company does not have
interests in special purpose entities and will apply the provisions of FIN 46R
with its first quarter 2004 financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity". The
statement establishes standards for how an issuer classifies and measures
certain financial instruments. This statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. The statement requires that certain financial instruments that, under
previous guidance, could be accounted for as equity, be classified as
liabilities, or assets in some circumstances. This statement does not apply to
features embedded in a financial instrument that is not a derivative in its
entirety. The statement also requires disclosures about alternative ways of
settling the instrumentsselected transition method and the capital structureselection of entities whose shares are
mandatorily redeemable.either the
Black-Scholes or the binominal lattice model for valuing options. The adoption
of SFAS No. 150 did notthis standard will have no impact the
Company's consolidated financial statements.on our cash flows.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
There are no defaults, dividend arrearages or delinquencies
that are required to be disclosed.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE
OF PROCEEDS.
RIGHTS OF SECURITY HOLDERS
There are no material modifications to the rights of security
holders that are required to be disclosed.
USE OF PROCEEDS
As of December 31, 2003,2004, the net proceeds from our initial
public offering in August 2000 and our public offering in November 2001 were
primarily used for general working capital and investment in interest income
producing financial instruments. None of the net proceeds from our initial
public offering were paid, directly or indirectly, to any of our directors,
officers or general partners or any of their associates, or to any person owning
ten percent or more of any class of our equity securities, or any of our
affiliates.
PART III
ITEM 15. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are
designed to ensure that information required to be disclosed in our reports
filed pursuant to the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms, and that such information is accumulated and communicated to the
management, including the Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required disclosure. In
designing and evaluating the disclosure controls and procedures, management
recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the
4445
desired control objectives. In addition, the design of any control system is
based in part upon certain assumptions about the likelihood of future events.
Due to these and other inherent limitations of any controls and procedures,
there can be no assurance that any such design will succeed in achieving its
stated goals under all potential future conditions.
Within 90 days prior to the date of this annual report on Form
20-F, we carried out an evaluation, under the supervision and with the
participation of the management, including the Chief Executive Officer and the
Chief Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures. Based on the foregoing, the Chief Executive
Officer and the Chief Financial Officer concluded that the Company's disclosure
controls and procedures were effective.
There have been no significant changes in our internal controls
or in other factors that could significantly affect the internal controls
subsequent to the date we completed our evaluation.
ITEM 16. Not applicable.
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
The Board of Directors has determined that Mr. Lawrence Lin is an "audit
committee financial expert" as defined in Item 16A of Form 20-F.
ITEM 16B. CODE OF ETHICS
We have adopted the O2 Micro International Limited Code of Business
Conduct and Ethics ("Code of Conduct"), a code of business conduct and ethics
that applies to our employees, officers and non-employee directors, including
our principal executive officer, principal financial officer, principal
accounting officer or controller and persons performing similar functions. It is
publicly available on our website at www.o2micro.com. If we make any substantive
amendments or grant any waiver from a provision of the Code of Conduct to our
directors or executive officers, we will disclose the nature of such amendment
or waiver on that website or in a report on Form 6-K or in the next annual
report on Form 20-F.
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Deloitte & Touche has served as the Company's independent auditors for
each of the fiscal years in the two-year period ended December 31, 2003.2004. The
appointment of the independent auditor is subject to approval and ratification
by the Company's shareholders at the annual general meeting of shareholders. The
following table presents the aggregate fees for professional services and other
services rendered by Deloitte & Touche in each of the years ended December 31,
20022003 and 2003.2004.
Year ended Year ended
December 31, 20022003 December 31, 20032004
----------------- -----------------
Audit Fees 258,496 272,835 $ 312,000
Audit-related Fees 19,741 26,944 12,821
Tax Fees 15,961 4,215 111,785
All Other Fees -- --- 111,126
Total $294,198 $303,994$ 303,994 $ 547,732
Audit Fees. This category includes the audit of our annual financial statements,
review of quarterly financial statements and services that are normally provided
by Deloitte & Touche in connection with statutory and regulatory filings or
engagements for those fiscal years.
46
Audit-related Fees. This category consists of assurance and related services by
Deloitte & Touche that are related to the performance of audit or review of our
financial statements and are reported above under "Audit Fees."
Tax Fees. This category consists of professional services rendered by Deloitte &
Touche for tax compliance and tax consultation. The services for fees disclosed
under this category include tax return preparation and technical tax
consultation.
All Other Fees: This category consists primarily of fees for the review and
study of financial and other information processes.
The Audit Committee pre-approves all audit and permissible non-audit services
provided by the independent registered public accounting firms. These services
may include audit services, audit-related services, tax services and other
services. During the year ended December 31, 2004, the Audit Committee
pre-approved all audit and non-audit-fees of Deloitte & Touche.
ITEM 16D. EXEMPTION FROM THE LISTING STANDARDS FOR AUDIT COMMITTEE
Not applicable.
45
ITEM 16E. PURCHASEDPURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
PERSONS
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Number of
Shares Purchased as Maximum Number of
Part of Publicly Shares that May Yet
Total Number of Average Price Paid Announced Plans or Be Purchased Under
Period Shares Purchased per Share Programs (1) the Plans or Programs
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
February 11, 2003 77,500 8.32 77,500 2,201,800
February 13, 2003April 1, 2004 10,000 $ 17.22 10,000 2,191,800
June 18, 2004 1,000 16.11 1,000 2,190,800
August 20, 2004 to 95,000 10.88 95,000 2,095,800
August 30, 2004
September 9, 2004 14,200 10.34 14,200 2,081,600
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
(1) In May 2002, we announced a share repurchase program to repurchase up to
3,000,000 shares of our Ordinary Shares. There is no expiration date for the
share repurchase program.
47
PART IV
ITEM 17. FINANCIAL STATEMENTS
The Company's Consolidated Financial Statements have been
prepared in accordance with Item 18 hereof.
ITEM 18. FINANCIAL STATEMENTS
The Company's financial statements set forth in the accompanying Index
to Consolidated Financial Statements included in this annual report on Form 20-F
following Part IV beginning on page F-1 are hereby incorporated herein by this
reference. Such consolidated financial statements are filed as part of this
annual report on Form 20-F.
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 20022003 and 20032004
Consolidated Statements of Operations and Comprehensive Income for the
years ended December 31, 2001, 2002, 2003 and 20032004
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2001, 2002, 2003 and 20032004
Consolidated Statements of Cash Flows for the years ended December 31,
2001, 2002, 2003 and 20032004
Notes to Consolidated Financial Statements
ITEM 19. EXHIBITS
1. Memorandum and Articles of Association of the registrant (incorporated
by reference from Exhibits 3.1 and 3.2 to the Registration Statement on
Form F-1 (File No. 333-12386) filed by the registrant)
46
4.1 Standard NNN Lease dated July 29, 1999 by and between Limir Realty Corp.
#17 as landlord and O2Micro, Inc. as tenant (incorporated by reference
from Exhibit 10.5 to the Registration Statement on Form F-1 (File No.
333-12386) filed by the registrant)
4.2 Lease dated October 16, 1997 by and between Hung Kuo Development Corp.
as landlord and O2Micro, Inc. as tenant (incorporated by reference from
Exhibit 10.6 to the Registration Statement on Form F-1 (File No.
333-12386) filed by the registrant)
4.3 Agreement dated October 1, 1999 by and between PSA Corporation Limited
as landlord and O2Micro, Inc. as tenant (incorporated by reference from
Exhibit 10.8 to the Registration Statement on Form F-1 (File No.
333-12386) filed by the registrant)
8.1 List of registrant's subsidiaries
10.1 Consent of Deloitte & Touche, independent registered public accounting
firm
12.1 Certification of Chief Executive Officer of the Company, pursuant to
Section 302 of the Sarbanes-Oxley Act.
12.2 Certification of Chief Financial Officer of the Company, pursuant to
Section 302 of the Sarbanes-Oxley Act.
48
13. Certification pursuant to 18U.S.C.18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act.
14.1 Consent of Deloitte & Touche, independent auditors
14.2 Consent of Deloitte & Touche, independent auditors
4749
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange
Act of 1934, the registrant hereby certifies that it meets all of the
requirements for filing on Form 20-F and that it has duly caused and authorized
the undersigned to sign this annual report on its behalf.
O2 MICRO INTERNATIONAL LIMITED
Date: June 10, 200420, 2005 By: /s/ STERLING DU
----------------------------------------------------------------
Name: Sterling Du
Title: Chief Executive Officer
50
O//2//O2 MICRO INTERNATIONAL LIMITED
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Independent Auditors' Report.................................................F-3Report.........................................F-2
Consolidated Balance Sheets..................................................F-5Sheets..........................................F-3
Consolidated Statements of Operations and Comprehensive Income...............F-6Income.......F-4
Consolidated Statements of Shareholders' Equity..............................F-8Equity......................F-6
Consolidated Statements of Cash Flows........................................F-9Flows................................F-7
Notes to Consolidated Financial Statements..................................F-11
F-1Statements...........................F-9
O//2//Micro International Limited and
Subsidiaries
Consolidated Financial Statements as of
December 31, 20022003 and 2003
Together with2004 and
Report of Independent Auditors' Report
F-2Registered Public
Accounting Firm
F-1
[LETTERHEAD OF DELOITTE & TOUCHE TAIPEI, TAIWAN]
REPORT OF INDEPENDENT AUDITORS' REPORTREGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and the Shareholders
O//2//Micro International Limited
We have audited the accompanying consolidated balance sheets of O//2//MicroO2Micro
International Limited and subsidiaries (the "Company") as of December 31, 20022003
and 20032004 and the related consolidated statements of operations and comprehensive
income, shareholders' equity, and cash flows for each of the years ended
December 31, 2002, 2003 and 20032004 (expressed in United States dollars). These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
The financial statements of the Company for the year ended December 31,
2001 were audited by other auditors whose report expressed an unqualified
opinion on those statements.
We conducted our audits in accordance with auditingthe standards generally accepted
inof the United States of America.Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includesstatements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, thesuch consolidated financial statements referred to above present fairly, in all
material respects, the financial position of O//2//MicroO2Micro International Limited and
subsidiaries as of December 31, 20022003 and 20032004 and the results of their
operations and their cash flows for each of the years ended December 31, 2002,
2003 and 2003,2004, in conformity with accounting principles generally accepted in
the United States of America.
/s/ Deloitte & Touche
Grand Cayman, Cayman Islands
January 30, 2004
F-3
Independent Auditors' Report
The Board of Directors28, 2005 (May 10, 2005 as to Note 2 "Stock-based Compensation" and the Shareholders
O//2//Micro International Limited
We have audited the accompanying consolidated balance sheet of O//2//Micro
International Limited and subsidiaries as of December 31, 2001 and the related
consolidated statements of operations and comprehensive income, shareholders'
equity, and cash flows for the year ended December 31, 2001. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of O//2//Micro
International Limited and its subsidiaries as of December 31, 2001 and the
results of their operations and their cash flows for the year ended December 31,
2001 in conformity with accounting principles generally accepted in the United
States of America.
Deloitte & Touche
(TN Soong & Co and Deloitte & Touche (Taiwan)
established Deloitte & Touche effective June 1, 2003)
January 24, 2002
F-4Note
12)
F-2
O//2//MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Thousand U.S. Dollars, Except Per Share Amounts)
- --------------------------------------------------------------------------------
December 31
--------------------
2002 2003
-------- ---------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 69,334 $ 66,489
Restricted cash 2,019 1,892
Short-term investments 42,675 53,923
Accounts receivable--net 7,595 9,794
Inventories 6,967 9,613
Prepaid expenses and other current assets 2,891 3,365
-------- --------
Total current assets 131,481 145,076
-------- --------
LONG-TERM INVESTMENTS 7,735 7,865
-------- --------
FIXED ASSETS--Net 5,611 4,880
-------- --------
OTHER ASSETS
Restricted assets--net -- 10,044
-------- --------
Others 1,009 1,428
-------- --------
TOTAL ASSETS $145,836 $169,293
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Notes and accounts payable $ 5,202 $ 6,334
Income tax payable 1,957 2,852
Accrued expenses and other current liabilities 3,529 5,380
-------- --------
Total current liabilities 10,688 14,566
-------- --------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Preference shares at $0.001 par value per share
Authorized--5,000,000 shares -- --
Ordinary shares at $0.001 par value per share
Authorized--95,000,000 shares
Issued--38,857,094 shares including 720,700 shares
of treasury stocks as of December 31, 2002 and
39,032,616 shares as of December 31, 2003 39 39
Treasury stock (6,823) --
Additional paid-in capital 133,016 137,076
Accumulated other comprehensive loss (692) (521)
Retained earnings 9,608 18,133
-------- --------
Total shareholders' equity 135,148 154,727
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $145,836 $169,293
======== ========
December 31
-------------------------
ASSETS 2003 2004
----------- -----------
CURRENT ASSETS
Cash and cash equivalents $ 66,489 $ 56,320
Restricted cash 1,892 1,887
Short-term investments 53,923 63,768
Accounts receivable, net 9,794 9,431
Inventories 9,613 11,231
Prepaid expenses and other current assets 3,365 4,491
----------- -----------
Total current assets 145,076 147,128
----------- -----------
LONG-TERM INVESTMENTS 7,865 11,781
----------- -----------
LAND, PROPERTY AND EQUIPMENT, NET 4,880 10,758
----------- -----------
RESTRICTED ASSETS 10,044 13,873
----------- -----------
OTHER ASSETS 1,428 1,656
----------- -----------
TOTAL $ 169,293 $ 185,196
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Notes and accounts payable $ 6,334 $ 3,635
Income tax payable 2,852 3,751
Accrued expenses and other current liabilities 5,380 7,029
----------- -----------
Total current liabilities 14,566 14,415
----------- -----------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Preference shares at $0.001 par value per share
Authorized - 5,000,000 shares - -
Ordinary shares at $0.001 par value per share
Authorized -- 95,000,000 shares
Issued - 39,032,616 shares and 39,188,062 shares
as of December 31, 2003 and 2004, respectively 39 39
Additional paid-in capital 137,076 139,581
Accumulated other comprehensive loss (521) (110)
Retained earnings 18,133 31,271
----------- -----------
Total shareholders' equity 154,727 170,781
----------- -----------
TOTAL $ 169,293 $ 185,196
=========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
F-5F-3
O//2//MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(In Thousand U.S. Dollars, Except Per Share Amounts)
- --------------------------------------------------------------------------------
Years Ended December 31
---------------------------
2001-------------------------------------
2002 2003 ------- ------- -------2004
----------- ----------- -----------
NET SALES $45,819 $70,187 $88,599$ 70,187 $ 88,599 $ 92,196
COST OF SALES 16,465 28,143 38,314 ------- ------- -------37,403
----------- ----------- -----------
GROSS PROFIT 29,354 42,044 50,285 ------- ------- -------54,793
----------- ----------- -----------
OPERATING EXPENSES
Research and development (exclusive of amortization of deferred stock
compensation of $91, $30, $0 and $0 in 2001, 2002, 2003 and
2003,2004, respectively) 14,320 18,935 19,219 20,260
Selling, general and administrative (exclusive of amortization of
deferred stock compensation of $75,
$14, $0 and $0 in 2001, 2002, 2003
and 2003,2004, respectively) 9,909 12,325 17,47611,790 13,522 16,348
Patent litigation 535 3,954 5,334
Stock-based compensation 166 44 --
------- ------- -------- -
----------- ----------- -----------
Total operating expenses 24,395 31,304 36,695 ------- ------- -------41,942
----------- ----------- -----------
INCOME FROM OPERATIONS 4,959 10,740 13,590 ------- ------- -------12,851
----------- ----------- -----------
NON-OPERATING INCOME(EXPENSES)INCOME (EXPENSES)
Interest income 1,814 1,802 1,283 1,455
Impairment loss on long-term investments -- (483) (17) Interest expenses (11) (4) (1)-
Gain on sale of long-term investments - - 340
Foreign exchange gain--net 59gain, net 4 287 Other--net (35) 343 (115)
------- ------- -------648
Other, net 339 (116) 262
----------- ----------- -----------
Total non-operating income 1,827 1,662 1,437 ------- ------- -------2,705
----------- ----------- -----------
INCOME BEFORE INCOME TAX 6,786 12,402 15,027 15,556
INCOME TAX EXPENSE 1,152 1,673 1,826 ------- ------- -------1,472
----------- ----------- -----------
NET INCOME 5,634 10,729 13,201 ------- ------- -------14,084
----------- ----------- -----------
OTHER COMPREHENSIVE INCOME (LOSS)
Translation adjustments on subsidiaries (489) 132 (90) 714
Unrealized gain (loss) on available-for-sale securities 15 (127) 261 ------- ------- -------(303)
----------- ----------- -----------
Total other comprehensive income (loss) (474) 5 171 ------- ------- -------411
----------- ----------- -----------
COMPREHENSIVE INCOME $ 5,160 $10,734 $13,372
======= ======= =======10,734 $ 13,372 $ 14,495
=========== =========== ===========
(Continued)
F-6F-4
Years Ended December 31
---------------------------
2001-------------------------------------
2002 2003 ------- ------- -------2004
----------- ----------- -----------
EARNINGS PER SHARE:
Basic $ 0.17 $ 0.28 $ 0.34 ======= ======= =======$ 0.36
=========== =========== ===========
Diluted $ 0.16 $ 0.27 $ 0.33 ======= ======= =======$ 0.35
=========== =========== ===========
SHARES USED IN EARNINGS PER SHARE CALCULATION:
Basic (in thousands) 34,020 38,300 38,374 ======= ======= =======39,156
=========== =========== ===========
Diluted (in thousands) 35,576 39,591 39,736 ======= ======= =======40,102
=========== =========== ===========
The accompanying notes are an integral part of the consolidated
financial statements. (Concluded)
F-7F-5
O//2//MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In Thousand U.S. Dollars, Except Per Share Amounts)
- --------------------------------------------------------------------------------
Additional Paid-in Capital
Ordinary Shares -----------------------------
----------------------------------------------------------
------------------------ Ordinary Stock Treasury
Shares Amount shares optionsShares Options Total Stock Warrants
---------- ------------------- -------- ------- -------- -------------------- --------- ------------ ---------- --------
BALANCE, JANUARY 1, 2001 32,788,238 $332002 38,134,511 $ 53,148 $1,92338 $ 55,071129,068 $ --1,129 $ 51
Issuance of:
Shares issued for exercise of stock options 656,215 1 1,780 (796) 984 -- --
Shares issued for 1999 ESPP Plan 90,058 -- 690 -- 690 -- --
Shares, net of $601 in offering costs 4,600,000 4 73,450 -- 73,450 -- --
Cancellation of stock options -- -- -- (39) (39) -- --
Options granted to nonemployees -- -- -- 41 41 -- --
Amortization of deferred stock compensation -- -- -- -- -- -- --
Net income for 2001 -- -- -- -- -- -- --
Translation adjustments on subsidiaries -- -- -- -- -- -- --
Unrealized gain on available-for-sale securities -- -- -- -- -- -- --
---------- --- -------- ------ -------- ------- ----
BALANCE, DECEMBER 31, 2001 38,134,511 38 129,068 1,129 130,197 --$ - $ 51
Issuance of:
Shares issued for exercise of
stock options 325,279 1 1,187 (275) 912 -- --- -
Shares issued for 1999 ESPP Plan 97,304 --- 737 --- 737 -- --- -
Shares issued for exercise of
warrants 300,000 --- 801 --- 801 --- (51)
Acquisition of treasury stocks--720,700stocks -
720,700 shares -- -- -- -- --- - - - - (6,823) ---
Cancellation of stock options -- -- --- - - (2) (2) -- --- -
Options granted to nonemployees -- -- --- - - 371 371 -- --- -
Amortization of deferred stock
compensation -- -- -- -- -- -- --- - - - - - -
Net income for 2002 -- -- -- -- -- -- --- - - - - - -
Translation adjustments on
subsidiaries -- -- -- -- -- -- --- - - - - - -
Unrealized loss on
available-for-sale securities -- -- -- -- -- -- --- - - - - - -
------------- -------- ------------ --------- ------------ ---------- --- -------- ------ -------- ------- ----
BALANCE, DECEMBER 31, 2002 38,857,094 39 131,793 1,223 133,016 (6,823) ---
Issuance of:
Shares issued for exercise of
stock options 863,987 1 6,135 (503) 5,632 -- --- -
Shares issued for 1999 ESPP Plan 109,735 --- 942 --- 942 -- --- -
Cancellation of stock options -- -- --- - - (23) (23) -- --- -
Acquisition of treasury stock--77,500stock -
77,500 shares -- -- -- -- --- - - - - (647) ---
Retirement of treasury stock (798,200) (1) (2,793) --- (2,793) 7,470 ---
Options granted to nonemployees -- -- --- - - 302 302 -- --- -
Net income for 2003 -- -- -- -- -- -- --- - - - - - -
Translation adjustments on
subsidiaries -- -- -- -- -- -- --- - - - - - -
Unrealized loss on
available-for-sale securities -- -- -- -- -- -- --- - - - - - -
------------- -------- ------------ --------- ------------ ---------- --- -------- ------ -------- ------- ---
BALANCE, DECEMBER 31, 2003 39,032,616 $39 $136,07739 136,077 999 137,076 - -
Issuance of:
Shares issued for exercise of
stock options 157,167 - 1,359 (77) 1,282 - -
Shares issued for 1999 ESPP Plan 118,479 - 1,032 - 1,032 - -
Acquisition and retirement of
treasury stock (120,200) - (422) - (422) - -
Options granted to nonemployees - - - 613 613 - -
Net income for 2004 - - - - - - -
Translation adjustments on
subsidiaries - - - - - - -
Unrealized gain on
available-for-sale securities - - - - - - -
------------- -------- ------------ --------- ------------ ---------- --------
BALANCE, DECEMBER 31, 2004 39,188,062 $ 999 $137,07639 $ -- $--138,046 $ 1,535 $ 139,581 $ - $ -
============= ======== ============ ========= ============ ========== === ======== ====== ======== ======= ===
Accumulated Other
Comprehensive Income (Loss)
------------------------------------------------------------------------ Retained
Unrealized Cumulative Earnings Total
Deferred investment translationInvestment Translation (Accumulated Shareholders'
Compensation gain/loss adjustmentGain (Loss) Adjustment Total Deficit) Equity
------------ ----------- ----------- --------------- ------- ------------ -------------------------
BALANCE, JANUARY 1, 2001 ($249)2002 $ -- ($223) ($223) ($6,755)(44) $ 47,928
Issuance of:
Shares issued for exercise of stock options -- -- -- -- -- 985
Shares issued for 1999 ESPP Plan -- -- -- -- -- 690
Shares, net of $601 in offering costs -- -- -- -- -- 73,454
Cancellation of stock options 6 -- -- -- -- (33)
Options granted to nonemployees -- -- -- -- -- 41
Amortization of deferred stock compensation 199 -- -- -- -- 199
Net income for 2001 -- -- -- -- 5,634 5,634
Translation adjustments on subsidiaries -- -- (489) (489) -- (489)
Unrealized gain on available-for-sale securities -- 15 -- 15 -- 15
------ ----- ----- ----- ------- --------
BALANCE, DECEMBER 31, 2001 (44) 15$ (712) $ (697) $ (1,121) $ 128,424
Issuance of:
Shares issued for exercise of
stock options -- -- -- -- --- - - - - 913
Shares issued for 1999 ESPP Plan -- -- -- -- --- - - - - 737
Shares issued for exercise of
warrants -- -- -- -- --- - - - - 750
Acquisition of treasury stocks--720,700stocks -
720,700 shares -- -- -- -- --- - - - - (6,823)
Cancellation of stock options -- -- -- -- --- - - - - (2)
Options granted to nonemployees -- -- -- -- --- - - - - 371
Amortization of deferred stock
compensation 44 -- -- -- --- - - - 44
Net income for 2002 -- -- -- --- - - - 10,729 10,729
Translation adjustments on
subsidiaries -- --- - 132 132 --- 132
Unrealized loss on
available-for-sale securities --- (127) --- (127) --- (127)
--- ----- ----- ----- ------- --------------- ------- ------- ----------- ------------
BALANCE, DECEMBER 31, 2002 --- (112) (580) (692) 9,608 135,148
Issuance of:
Shares issued for exercise of
stock options -- -- -- -- --- - - - - 5,633
Shares issued for 1999 ESPP Plan -- -- -- -- --- - - - - 942
Cancellation of stock options -- -- -- -- --- - - - - (23)
Acquisition of treasury stock--77,500stock -
77,500 shares -- -- -- -- --- - - - - (647)
Retirement of treasury stock -- -- -- --- - - - (4,676) ---
Options granted to nonemployees -- -- -- -- --- - - - - 302
Net income for 2003 -- -- -- --- - - - 13,201 13,201
Translation adjustments on
subsidiaries -- --- - (90) (90) --- (90)
Unrealized loss on
available-for-sale securities --- 261 --- 261 --- 261
------ ----- ----- ----- ------- --------------- ------- ------- ----------- ------------
BALANCE, DECEMBER 31, 2003 - 149 (670) (521) 18,133 154,727
Issuance of:
Shares issued for exercise of
stock options - - - - - 1,282
Shares issued for 1999 ESPP Plan - - - - - 1,032
Acquisition and retirement of
treasury stock - - - - (946) (1,368)
Options granted to nonemployees - - - - - 613
Net income for 2004 - - - - 14,084 14,084
Translation adjustments on
subsidiaries - - 714 714 - 714
Unrealized gain on
available-for-sale securities - (303) - (303) - (303)
------- ------- ------- ------- ----------- ------------
BALANCE, DECEMBER 31, 2004 $ --- $ 149 ($670) ($521) $18,133 $154,727
====== ===== ===== =====(154) $ 44 $ (110) $ 31,271 $ 170,781
======= =============== ======= ======= =========== ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-8F-6
O//2//MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousand U.S. Dollars)
- --------------------------------------------------------------------------------
Years Ended December 31
--------------------------------
2001------------------------------------------
2002 2003 -------- --------- ---------2004
------------ ------------ ------------
OPERATING ACTIVITIES
Net income $ 5,634 $ 10,729 $ 13,201 $ 14,084
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 1,180 1,937 2,623 2,692
Amortization of deferred stock compensation 166 44 --- -
Amortization of stock options granted for services 19 74 335 386
Gain on sale of long-term investments - - (340)
Loss (gain) on sale of short-term investments 2 (385) 5 -
Deferred income tax assets (153) 198 386 (68)
Impairment of long-term investments -- 483 17 -
Loss on sale of fixed assets -- 7 68 3
Changes in operating assets and liabilities:
Accounts receivable--net 1,720receivable, net (3,895) (2,199) 363
Inventories 111 (1,606) (2,646) (1,618)
Prepaid expenses and other current assets (571) (765) (474) (1,278)
Notes and accounts payable (197) 1,632 1,132 (2,699)
Income taxes payable 770 737 895 899
Accrued expenses and other current liabilities 831 333 1,413 -------- --------- ---------1,705
------------ ------------ ------------
Net cash provided by operating activities 9,512 9,523 14,756 -------- --------- ---------14,129
------------ ------------ ------------
INVESTING ACTIVITIES
Receivables from employee cash advance (185)employees (262) (104) 116
Acquisition of:
Fixed assets (2,295)Land, property and equipment (4,275) (1,749) Patents (122) -- --(8,354)
Long-term investments -- (6,968) (147) (4,861)
Short-term investments (21,636) (188,231) (116,138) (166,045)
(Increase) decrease in:
Restricted assets -- --- (10,044) (1,945)
Restricted cash 40 (860) 127 5
Other assets (68) (46) (612) (187)
Proceeds from:
Sale of short-term investments 1,513 165,970 105,146 155,021
Sale of fixed assets --long-term investments - - 1,020
Sale of equipment 3 1 -------- --------- ---------2
------------ ------------ ------------
Net cash used in investing activities (22,753) (34,669) (23,520) -------- --------- ---------(25,228)
------------ ------------ ------------
(Continued)
F-9F-7
Years Ended December 31
----------------------------
2001------------------------------------------
2002 2003 ------- -------- -------2004
------------ ------------ ------------
FINANCING ACTIVITIES
Acquisitions of treasury stock $ -- ($6,823) ($647)(6,823) $ (647) $ (1,368)
Proceeds from:
Exercise of stock options 985 913 5,633 Issuance of ordinary shares 73,454 -- --1,282
Issuance of shares for warrants exercised -- 750 --- -
Issuance of ordinary shares under ESPP Plan 690 737 942 1,032
Payments of principal of capital leases (42) (10) (6) Decrease in guarantee deposits (51) -- --
------- -------- --------
------------ ------------ ------------
Net cash provided by (used in) financing
activities 75,036 (4,433) 5,922 ------- -------- -------946
------------ ------------ ------------
EFFECTS OF CHANGES IN FOREIGN EXCHANGEXCHANGE RATE (429) 99 (3) ------- -------- -------(16)
------------ ------------ ------------
NET INCREASE (DECREASE)DECREASE IN CASH AND CASH EQUIVALENTS 61,366 (29,480) (2,845) (10,169)
CASH AND CASH EQUIVALENTS AT BEGINNING
OF YEAR 37,448 98,814 69,334 ------- -------- -------66,489
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $98,814 $ 69,334 $66,489
======= ======== =======$ 66,489 $ 56,320
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS
Cash paid for interest $ 11 $ 4 $ 1 $ -
Cash paid for tax 474$ 744 $ 600 $ 641
NON-CASH INVESTING AND FINANCING ACTIVITIES
Property and equipment acquired under capital leases 5 -- --Short-term investments reclassified to
restricted assets $ - $ - $ 1,144
Convertible loans converted to long-term
investments -- --$ - $ 1,750 $ -
Unrealized gain (loss) on short-term investments 15accounted
for available-for-sale $ (127) $ 261 $ (303)
The accompanying notes are an integral part of the consolidated
financial statements. (Concluded)
F-10F-8
O//2//MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States Dollars Unless Otherwise Noted)
- --------------------------------------------------------------------------------
1. GENERAL
Business
O//2//Micro, Inc. was incorporated in the state of California in the
United States of America on March 29, 1995 to design, develop, and
deliver semiconductor components primarily for mobile applications. In
March 1997, O//2//Micro, Inc. reincorporated in the Cayman Islands under
the name O//2//Micro International Limited (the "Company"). In
connection with the reincorporation, all authorized and outstanding
common stock, preferred stock and stock options of O//2//Micro, Inc.
were exchanged for the Company's ordinary shares, preference shares and
stock options with identical rights and preferences. O//2//Micro, Inc.
became the Company's subsidiary after the shares exchange.
The Company had incorporated various wholly-owned subsidiaries, namely,
O//2//Micro Electronics, Inc. (O//2//Micro-Taiwan)Micro - Taiwan), O//2//Micro
International Japan Limited (O//2//Micro-Japan)Micro - Japan), O//2//Micro PTE
Limited-SingaporeLimited - Singapore (O//2//Micro-Singapore)Micro - Singapore), and other subsidiaries.
O//2//Micro-Taiwan and O//2//Micro-JapanMicro - Japan are engaged in trading while
O//2//Micro-SingaporeMicro - Singapore and other subsidiaries are engaged in research
and development. The Company also established a Taiwanese branch office,
O//2//Micro International Limited-TaiwanLimited - Taiwan Branch (O//2//Micro-TaiwanMicro - Taiwan
Branch) to engage in marketing and customer support related services.
Due to the duplicate function of O//2//Micro-TaiwanMicro - Taiwan Branch and
O//2//Micro-Taiwan,Micro - Taiwan, the Board of Directors determined to dissolve
O//2//Micro-TaiwanMicro - Taiwan Branch on October 31, 2002. The dissolution process
of O//2//Micro-TaiwanMicro - Taiwan Branch was not completed as of December 31,
2003.2004.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of
America. The consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All intercompany accounts
and transactions have been eliminated on consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect certain
reported amounts and disclosures. Accordingly, actual results could
differ from those estimates.
F-11
Concentration of Credit Risk
Financial instruments that potentially subject the Company to a
concentration of credit risk consist of cash, cash equivalents,
short-term investments and accounts receivable. Cash is deposited with
high credit quality financial institutions. For short-term investments,
the Company invests in debt securities with credit rating of A and
better. For accounts receivable, the Company performs ongoing credit
evaluations of its customers' financial condition and the Company
maintains an allowance for doubtful accounts receivable based upon
review of the expected collectibility of individual accounts.
F-9
Fair Value of Financial Instruments
The Company's financial instruments, including cash and cash
equivalents, restricted cash, accounts receivable, and notes and
accounts payable and
capital lease obligations are carried at cost, which approximates the fair value
due to the short-term maturity of those instruments. Fair values of
short-term investments and long-term investments represent quoted market
prices, if available. If no quoted market prices are available, fair
values are estimated based on other factors. Fair value of restricted
assets, which are composed of foreign government bonds, negotiated
certificates of deposit and cash, is estimated based on combination of
fair value of each component.
Cash and Cash Equivalents
The Company considers all highly liquid investments with maturities of
not more than three months when purchased to be cash equivalents.
Restricted Assets
The Company classifies deposits made for customs, collateral for
obtaining foundry capacity, lines of credit and office leases and Taiwan court cases as
restricted assets.cash. The deposits are classified as current asset if
refundable within a twelve-month period. Restricted assets consist of
deposits made for Taiwan court cases in the form of Taiwan Government
bonds, negotiated certificates of deposit and cash.
Short-term Investments
The Company maintains its excess cash in U.S. treasury bills and notes,
government and corporate bonds issued by financial institutions with
strong ratings. The specific identification method is used to determine
the cost of securities sold, with realized gains and losses reflected in
non-operating income and expenses. As of December 31, 2003,2004, all of the
Company's investments were classified as available-for-sale securities
and are recorded at market value. Unrealized gains and losses on these
investments are included with accumulated other comprehensive income and
loss, as a separate component of shareholders' equity, net of any
related tax effect, unless unrealized losses are deemed other than
temporary. Unrealized losses are recorded as a charge to income when
deemed other than temporary.
Inventories
The Company outsources the wafer fabrication, assembly, and testing of
its products. Inventories are stated at the lower of standard cost or
market value. Cost is determined on a currently adjusted standard basis,
which approximates actual cost on a first-in first-out basis.
F-12
Long-term Investments
Long-term investments over which the Company does not exercise
significant influence are accounted for under the cost method of
accounting. Management evaluates related information in addition to
quoted market prices, if any, in determining the fair value of these
investments and whether an other than temporary decline in value exists.
Factors indicative of an other than temporary decline include recurring
operating losses, credit defaults and subsequent rounds of financings at
an amount below the cost basis of the investment. The list is not all
inclusive and management periodically weighs all quantitative and
qualitative factors in determining if any impairment loss exists.
Fixed Assets
Fixed assetsLand, Property and Equipment
Land, property and equipment are stated at cost less accumulated
depreciation. Major additions, renewals and betterments are capitalized,
while maintenance and repairs are expensed as incurred.
F-10
Depreciation is provided on the straight-line method over estimated
service lives that range as follows: equipment--3building - 35 years, equipment - 3
to 10 years, furniture and fixtures--3fixtures - 3 to 15 years, equipment under
capital lease--2lease - 3 to 5 years, leasehold improvements--2improvements - the shorter of
the estimated useful life or the lease term, which is 2 to 6 yearsyears; and
transportation equipment--5equipment - 5 years. Depreciation expense recognized
during the years ended December 31, 2001,
2002, 2003 and 20032004 was
approximately $1,129,000, $1,884,000, $2,325,000 and $2,325,000,$2,391,000, respectively.
Equipment covered by agreements qualifying as capital leases is stated
at the lower of fair market value or the present value of the minimum
lease payments at the inception of the lease, less depreciation.
Long-lived Asset Impairment
The Company evaluates the recoverability of long-lived assets whenever
events or changes in circumstances indicate the carrying value may not
be recoverable. The carrying value of a long-lived asset is considered
impaired when the anticipated undiscounted cash flows from such asset is
separately identifiable and is less than the carrying value. If
impairment occurs, a loss based on the excess of carrying value over the
fair market value of the long-lived asset is recognized. Fair market
value is determined by reference to quoted market prices, if available,
or discounted cash flows, as appropriate.
Other Assets--Others
Other assets--others consist of refundable deposits, employee cash
advances, deferred charges and patents. Costs incurred in connection with
securing patents, including attorneys' fees, are capitalized and amortized
over the estimated life of the related technology which is estimated to be
five years.
Treasury Stock
In 2003, theThe Company determined it will retireretires ordinary shares repurchased under a share repurchase
plan. Accordingly, the excess of the purchase price over par value was
allocated between additional paid--inpaid-in capital and retained earnings based
on the average issuance price of the shares repurchased. Any future
repurchases will be immediately retired.
F-13
Revenue Recognition
Revenue from product sales to customers, other than distributors, is
recognized at the time of shipment and when title and right of ownership
transfers to customers. The four criteria for revenue being realized and
earned are the existence of evidence of sale, actual shipment, fixed or
determinable selling price, and reasonable assurance of collectibility.
Allowances for sales returns and discounts are provided at the time of
the recognition of the related revenues on the basis of experience and
these provisions are deducted from sales.
In certain limited instances, the Company sells its products through
distributors. The Company has limited control over these distributors'
selling of products to third parties. Accordingly, the Company
recognizes revenue on sales to distributors when the distributors sell
the Company's products to third parties. Thus, products held by
distributors are included in the Company's inventory balance.
The Company provides its distributors with limited product rotation and
price protection rights for products held in distributors' inventory. To
date, the Company has given no price adjustments to or rotated any
products for its distributors.
Research and Development
Research and development costs consist of expenditures incurred during
the course of planned research and investigation aimed at the discovery
of new knowledge that will be useful in developing new products or
processes, or at significantly enhancing existing products or production
processes as well as expenditures incurred for the design and testing of
product alternatives or construction of prototypes. All expenditures
related to research and development activities of the Company are
charged to operating expenses when incurred.
F-11
Advertising Expenses
The Company expenses all advertising and promotional costs as incurred.
These costs were $1,464,000, $1,577,000, $795,000 and $795,000$1,108,000 in the years ended
December 31, 2001, 2002, 2003 and 2003,2004, respectively. A portion of these costs
were for advertising, which amounted to $138,000 in 2001, $138,000 in 2002,
and $153,000 in
2003.2003 and $367,000 in 2004.
Income Taxes
The Company is not subject to income or other taxes in the Cayman
Islands. However, subsidiaries are subject to taxes of the jurisdiction
where they are located.
Under current Republic of China ("ROC") tax regulations, the current
year's earnings, on a tax basis, that are not distributed in the
following year are subject to a 10% additional income tax. This 10%
additional income tax is recognized in the period during which the
related income is generated.
F-14
Income taxes are accounted for in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 109 "Accounting for Income Taxes". The
provision for income tax represents income tax paid and payable for the
current year plus the changes in the deferred income tax assets and
liabilities during the years. Deferred income tax assets are recognized
for operating loss carryforwards, research and development credits, and
temporary differences. The Company believes that uncertainty exists
regarding the realizability of certain deferred income tax assets and,
accordingly, has established a valuation allowance for those net
deferred income tax assets to the extent the realizability is not deemed
more likely than not.
Stock-based Compensation
The Company has elected to follow Accounting Principles Board Opinion
("APB") No. 25, "Accounting for Stock Issued to Employees" and complies
with the disclosure provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation" for its employee stock options. Under APB No.
25, compensation expense is measured based on the difference, if any, on
the date of the grant, between the fair value of the Company's stock and
the exercise price.
Had the compensation costexpense for the Company's stock-based compensation
plans been determined on the basis of the fair values under SFAS No.
123, the Company's fiscal 2001, 2002, 2003 and 20032004 net income and net income
per share would have been adjusted tobe the following pro forma amounts.following.
Years Ended December 31
---------------------------
2001-------------------------------------
2002 2003 ------- ------- -------2004
----------- ----------- -----------
Net income as reported (in thousands) $ 5,634 $10,729 $13,20110,729 $ 13,201 $ 14,084
Add: Stock basedStock-based compensation expense included in net
income, including tax expense of $0 for 2001, 2002, 2003 and 2003,2004,
respectively 166 44 --- -
Deduct: Stock-based compensation costsexpense determined under
SFAS No. 123 including tax expense of $0 for 2001, 2002, 2003 and
2003,2004, respectively (2,297) (5,121) (4,525)
------- ------- -------(8,643) (8,061) (6,940)
----------- ----------- -----------
Pro forma net income $ 3,5032,130 $ 5,6525,140 $ 8,676
======= ======= =======7,144
=========== =========== ===========
(Continued)
F-12
Years Ended December 31
-----------------------------------
2002 2003 2004
--------- --------- ---------
Pro forma shares used in calculation--basiccalculation - basic (in thousands) 34,020 38,300 38,374 ------- ------- -------39,156
========= ========= =========
Pro forma earnings per share--basicshare - basic $ 0.100.06 $ 0.150.13 $ 0.23
======= ======= =======0.18
========= ========= =========
Earnings per share--basicshare - basic as reported $ 0.17 $ 0.28 $ 0.34 ======= ======= =======$ 0.36
========= ========= =========
Pro forma shares used in calculation--dilutedcalculation - diluted (in thousands) 35,576 39,591 39,736 ======= ======= =======40,102
========= ========= =========
Pro forma earnings per share--dilutedshare - diluted $ 0.100.05 $ 0.140.13 $ 0.22
======= ======= =======0.18
========= ========= =========
Earnings per share--dilutedshare - diluted as reported $ 0.16 $ 0.27 $ 0.33 ======= ======= =======$ 0.35
========= ========= =========
F-15
Foreign Currency Transactions
The functional currency is the local currency of the respective
entities. Foreign currency transactions are recorded at the rate of
exchange in effect when the transaction occurs. Gains or losses,
resulting from the application of different foreign exchange rates when
cash in foreign currency is converted into the entities' functional
currency, or when foreign currency receivables and payables are settled,
are credited or charged to income in the period of conversion or
settlement. At year-end, the balances of foreign currency monetary
assets and liabilities are restated based on prevailing exchange rates
and any resulting gains or losses are credited or charged to income.
Translation of Foreign Currency Financial Statements
The reporting currency of the Company is the U.S. dollar. Accordingly,
the financial statements of the foreign subsidiaries are translated into
U.S. dollars at the following exchange rates: Assets and liabilities--currentliabilities -
current rate on balance sheet date; shareholders' equity--historicalequity - historical
rate; income and expenses--weightedexpenses - weighted average rate during the year. The
resulting translation adjustment is recorded as a separate component of
shareholders' equity.
Comprehensive Income (Loss)
Comprehensive income represents net income plus the results of certain
changes in shareholders' equity during a period from non-owner sources
that are not reflected in the consolidated statement of operations.
Legal Contingencies
The Company is currently involved in various claims and legal
proceedings. Periodically, the Company reviews the status of each
significant matter and assesses the potential financial exposure. If the
potential loss from any claim or legal proceeding is considered probable
and the amount can be estimated, the Company accrues a liability for the
estimated loss. Because of uncertainties related to these matters,
accruals are based only on the best information available at the time.
As additional information becomes available, the Company reassesses the
potential liability related to the pending claims and litigation and
revises these estimates as appropriate. Such revisions in the estimates
of the potential liabilities could have a material impact on the results
of operations and financial position.
F-13
Recent Accounting Pronouncements
Not Yet Adopted
In January 2003, the Financial Accounting Standards Board ("FASB") released
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN
46") which requires that all primary beneficiaries of Variable Interest
Entities ("VIE") consolidate that entity. FIN 46 is effective immediately
for VIEs created after January 31, 2003 and to VIEs in which an enterprise
obtains an interest after that date. It applies in the first fiscal year or
interim period beginning after June 15, 2003 to VIEs in which an enterprise
holds a variable interest it acquired before February 1, 2003. In December 2003, the FASB published a revision to FIN 46 ("FIN 46R") to clarify some
of the provisions of the interpretation and to defer the effective date of
implementation for certain entities. Under the guidance of FIN 46R,
entities that do not have interests in structures that are commonly
referred to as special purpose entities (SPE's) are required to apply the
provisions of the interpretation in financial statements for periods ending
after March 14, 2004. The Company does not have interests in special
purpose entities and will apply the provisions of FIN 46R with its first
quarter 2004, financial statements.
F-16
In May 2003, the FASB issued SFAS No. 150, "Accounting123(R) "Share-Based Payment."
SFAS No. 123(R) requires that companies recognize compensation expense
equal to the fair value of stock options or other share based payments
for Certain
Financial Instruments with Characteristics of both Liabilities and Equity".
The statement establishes standards for how an issuer classifies and
measures certain financial instruments. This statement is effective for
financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interimannual reporting period beginningthat begins after June 15, 2003.2005. SFAS
No. 123(R) applies to all awards granted after June 15, 2005, and prior
period's awards that are modified, repurchased, or cancelled after June
15, 2005. The statement requires that certain
financial instruments that, under previous guidance, could be accounted forimpact on the Company's net income will include the
remaining amortization of the fair value of existing options currently
disclosed as equity, be classified as liabilities, or assetspro forma expense in some circumstances.
This statement does not apply to features embedded in a financial
instrument thatNote 2 and is not a derivative in its entirety. The statement also
requires disclosures about alternative wayscontingent upon the
number of settlingfuture options granted, the instrumentsselected transition method and the
capital structureselection of entities whose shares are mandatorily redeemable.either the Black-Scholes or the binominal lattice model for
valuing options. The adoption of SFAS No. 150 did notthis standard will have no impact on
the Company's consolidated
financial statements.cashflows.
Reclassifications
Certain amounts reported in previous years have been reclassified to
conform to the 20032004 presentation.
3. CASH AND CASH EQUIVALENTS
December 31
-----------------
2002------------------------
2003 ------- -------2004
----------- -----------
(In Thousands)
Time deposits $31,191 $34,951
US treasury bills and corporate bonds 25,997$ 17,122 $ 21,534
Time deposits 34,951 19,383
Savings and checking accounts 12,140 14,409 15,389
Petty cash 6 7 ------- -------
$69,334 $66,489
======= =======14
----------- -----------
$ 66,489 $ 56,320
=========== ===========
4. SHORT-TERM INVESTMENTS
The following is a summary of available-for-sale securities:
December 31
-----------------
2002------------------------
2003 ------- -------2004
----------- -----------
(In Thousands)
Time deposits $ 10,611 $ 23,038
US treasury bills $26,914 $33,958
Time deposits 10,263 10,61133,958 19,967
Corporate bonds 2,247 8,185 17,014
Foreign government bonds 3,227 1,144 3,724
Others 24 25 ------- -------
$42,675 $53,923
======= =======
F-1725
----------- -----------
$ 53,923 $ 63,768
=========== ===========
F-14
Available-for-sale securities by contractual maturity are as follows:
December 31
-----------------
2002------------------------
2003 ------- -------2004
----------- -----------
(In Thousands)
Due within one year $40,606 $52,752$ 52,752 $ 61,023
Due after one year through two years 2,069 --- 1,698
Due after two years -- 1,171 ------- -------
$42,675 $53,923
======= =======1,047
----------- -----------
$ 53,923 $ 63,768
=========== ===========
The Company's gross realized gains and losses on the sale of investments
for the year ended December 31, 20022003 were $606,000$0 and $221,000,$5,000, respectively,
and for the year ended December 31, 20032004 were $0 and $5,000,
respectively.$0. Gross unrealized gains
and losses at December 31, 20022003 were $64,000$196,000 and $176,000,$47,000, respectively
and at December 31, 20032004 were $196,000$293,000 and $47,000,$182,000, respectively. The
Company did not provide the disclosure of fair value and unrealized
losses by category of investment as required by EITF No 03-1, "The
Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments" as the amount of the unrealized losses for 2003 and
2004 are deemed insignificant.
5. ACCOUNTS RECEIVABLE--NETRECEIVABLE, NET
December 31
----------------
2002------------------------
2003 ------ -------2004
----------- -----------
(In Thousands)
Accounts receivable $7,973 $10,195$ 10,195 $ 9,838
Allowances for
Doubtful receivables (64) (86) (90)
Sales returns and discounts (314) (315) ------ -------
$7,595(317)
----------- -----------
$ 9,794 ====== =======$ 9,431
=========== ===========
The changes in the allowances are summarized as follows:
2001 2002 2003 ---- ---- ----2004
----------- ----------- -----------
(In Thousands)
Allowances for doubtful receivables
Balance, beginning of year $ 38 $ 55 $ 64 $ 86
Additions 17 9 22 ---- ---- ----4
----------- ----------- -----------
Balance, end of year $ 55 $ 64 $ 86 ==== ==== ====$ 90
=========== =========== ===========
Allowances for sales returns and
discounts
Balance, beginning of the year $252 $314 $314$ 314 $ 314 $ 315
Additions 62 --- 1 ---- ---- ----2
----------- ----------- -----------
Balance, end of the year $314 $314 $315
==== ==== ====
F-18$ 314 $ 315 $ 317
=========== =========== ===========
F-15
6. INVENTORIES
December 31
---------------
2002------------------------
2003 ------ ------2004
----------- -----------
(In Thousands)
Finished goods $2,344 $2,042$ 2,042 $ 2,844
Work-in-process 2,846 3,608 4,336
Raw materials 1,777 3,963 ------ ------
$6,967 $9,613
------ ------4,051
----------- -----------
$ 9,613 $ 11,231
=========== ===========
7. LONG-TERM INVESTMENTS
December 31
---------------
2002------------------------
2003 ------ ------2004
----------- -----------
(In Thousands)
Cost method
X-FAB Semiconductor Foundries AG (X-FAB) $4,968 $4,968$ 4,968 $ 4,968
360 Degree Web Ltd. (360 Degree Web) -- 1,750 1,070
GEM Services, Inc. (GEM) 500 500
Etrend Hightech Corporation (Etrend) 500 647 Silicon Genesis960
----------- -----------
7,865 7,498
Available for sale securities - noncurrent
CSMC Technologies Corporation (SiGen) 17 --
------ ------
5,985(CSMC) - 4,283
----------- -----------
$ 7,865 Convertible loans to 360 Degree Web 1,750 --
------ ------
$7,735 $7,865
====== ======$ 11,781
=========== ===========
The Company invested in X-FAB's ordinary shares in July 2002. X-FAB is a
European-American foundry group that specializes in mixed signal
applications. As of December 31, 2003,2004, the Company acquiredheld 530,000 shares
forat the value of $4,968,000 (4,982,000 EURO), which represents a 2.03%
ownership of X-FAB.
The Company invested in GEM's preferred shares in August 2002. GEM is a
multinational semiconductor assembly and test company. As of December 31,
2003, the Company acquired 333,334 shares for $500,000, which represents a
1.26% ownership of GEM.
The Company invested in Etrend's ordinary shares in December 2002 and July
2003. Etrend is a wafer probing, packing and testing company. As of
December 31, 2003, the Company acquired 2,189,288 shares for $647,000,
which represents approximately 12.5% ownership of Etrend.
The Company invested in SiGen preferred shares in December 2000. SiGen is
an advanced nanotechnology company that develops silicon-on-insulator
"SOI", strained-silicon products and other engineered multi-layer
structures to the microelectronics and photonics industries for advanced
electronic and opto-electronic device applications. As of December 31,
2003, the Company acquired 71,840 shares for $500,000, which represents a
0.25% ownership of SiGen. In 2002 and 2003, the Company reviewed
qualitative factors of this investment and determined that the decline in
value of SiGen was other-than-temporary and recognized an impairment loss
of $483,000 and $17,000, respectively.
F-19
On January 3, 2003, the Company exercised its option to convert its
convertible loans of $1,750,000 in 360 Degree Web to 2,083,333 Series B
preference shares of capital stock at $0.36 per share and 1,000,000
Series B2 preference shares of capital stock at $1.00 per share. 360
Degree Web designs, develops and markets intelligent security software
solutions that provide secure computing environment for personal
computer mobile devices and the internet. After the conversion, the
Company had a 35.18%35.2% ownership in 360 Degree Web. The Company did not
participate in 360 Degree Web's financing during 2003 and the ownership
was diluted to 29.33%29.3% as of December 31, 2003. At December 31, 2003, oneThe Company accounts for
its investment under the cost method of the Company's directors
servesaccounting as a director of 360 Degree Web. In addition, the Companyit does not
actively participate in the decision-making process at 360 Degree Web.
Management of 360 Degree Web,
owns more than 50%holds one director seat and management of 360 Degree Web holds the
controlling interest.
In March 2004, the Company sold 1,000,000 shares of its stock in 360
Degree Web and recognized a gain of $340,000. Upon completion of the
outstanding votingtransaction, the Company's ownership was reduced to 19.8% as of December
31, 2004.
The Company invested in GEM's preferred shares in August 2002. GEM is a
multinational semiconductor assembly and 100%test company. As of December
31, 2004, the Company held 333,334 shares at the value of $500,000,
which represents a 1.07 % ownership of GEM.
F-16
The Company invested in Etrend's ordinary shares in December 2002, July
2003 and March 2004. Etrend is a wafer probing, packing and testing
company. As of December 31, 2003, the Company held 2,189,288 shares at
the value of $647,000, which represents approximately 12.5% ownership of
Etrend. The Company invested an additional $313,000 for Etrend's
financing in March 2004. As of December 31, 2004, the Company's
ownership was reduced to 11.2%.
The Company invested in Silicon Genesis Corporation (SiGen) preferred
shares in December 2000. SiGen is an advanced nanotechnology company
that develops Silicon-on-insulator "SOI", strained-silicon products and
other engineered multi-layer structures to microelectronics and
photonics industries for advanced electronic and opto-electronic device
applications.
In 2002 and 2003, the Company reviewed the qualitative factors of the
Series A voting preferredinvestment, determined that the decline in value was
other-than-temporary and recognized an impairment loss of $483,000 and
$17,000, respectively. The Company held 23,946 shares of SiGen as of
December 31, 2004 representing 0.07% ownership in SiGen with a carrying
value of zero.
In August 2004, the Company invested in CSMC's ordinary shares which has more
characteristicsare
listed in Hang Seng Stock Market in Hong Kong. CSMC is a semiconductor
foundry company. The Company held 70,200,000 shares acquired for a
purchase price of common stock than the other preferred shares. Therefore,$4,547,000, which represents approximately 2.67%
ownership of CSMC. As of December 31, 2004, the Company accounts for the investment under the cost methodrecognized
unrealized losses of accounting.$265,000.
8. FIXED ASSETS--NETLAND, PROPERTY AND EQUIPMENT, NET
December 31
-----------------
2002------------------------
2003 ------- -------2004
----------- -----------
(In Thousands)
Cost
Land $ - $ 2,510
Buildings - 2,150
Equipment $ 8,928 $10,45710,457 13,035
Furniture and fixtures 242 336 1,054
Equipment under capital lease 165 165160
Leasehold improvements 654 727 1,309
Transportation equipment 56 56
Prepayment for leasehold 239improvement 43 ------- -------
10,284179
----------- -----------
11,784 ------- -------20,453
----------- -----------
Accumulated depreciation
Buildings - 39
Equipment 3,985 6,096 8,337
Furniture and fixtures 117 131 420
Equipment under capital lease 155 162 160
Leasehold improvements 398 486 698
Transportation equipment 18 29 ------- -------
4,67341
----------- -----------
6,904 ------- -------
$ 5,6119,695
----------- -----------
$ 4,880 ------- -------$ 10,758
=========== ===========
F-17
9. OTHER ASSETS
December 31
----------------
2002------------------------
2003 ------ -------2004
----------- -----------
(In Thousands)
Restricted assetsDeferred charges, net $ -- $10,044
------ -------473 $ 789
Long-term note receivables from employees 447 551 435
Refundable deposits 404 432
----------- -----------
$ 1,428 $ 1,656
=========== ===========
Deferred charges 39 473
Refundable deposits 373 404
Patent costs--netconsist of accumulated amortizationconsultant and maintenance contracts and are
amortized over the term of $169 in
2002 and $319 in 2003 150 --
------ -------
1,009 1,428
------ -------
$1,009 $11,472
====== =======
F-20
As of December 31, 2003, restricted assets consisted of deposits made for
Taiwan court cases in the form of Taiwan Government bonds, negotiated
certificates of deposit and cash, amountingcontract which is 3 to $10,044,000.8 years.
In 2001, James Keim, one of the Company's directors, accepted the
assignment of Head of Marketing and Sales in the Cayman Islands, and
moved to the Cayman Islands in December 2001. In connection with the
move and to assist Mr. Keim to purchase a residence in the Cayman
Islands, the Company entered into a term loan agreement with Mr. Keim in
February 2002, under which the Company made an interest free, unsecured
loan in the amount of $400,000 to Mr. Keim. The loan is repayable onin
February 2007. As of December 31, 2003,2004, $18,000 had been repaid.
10. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
December 31
---------------
2002------------------------
2003 ------ ------2004
----------- -----------
(In Thousands)
Salaries, bonus and benefits $ 1,827 $ 2,150
Legal and audit fees $ 314 $1,180
Salaries and bonus 995 1,1551,180 1,917
Deferred income tax liabilities -- 444 Accrued vacation 350 371
ESPP payable 172 301388
Commissions 331 239 Others126
Other accrued expenses 1,367 1,690 ------ ------
$3,529 $5,380
====== ======2,448
----------- -----------
$ 5,380 $ 7,029
=========== ===========
11. INCOME TAXES
Income before income taxes consisted of:
Years Ended December 31
--------------------------
2001-------------------------------------
2002 2003 ------ ------- -------2004
----------- ----------- -----------
(In Thousands)
Cayman $2,635 $10,735 $12,159$ 10,735 $ 12,159 $ 15,496
Other subsidiaries 4,151 1,667 2,868 ------ ------- -------
$6,786 $12,402 $15,027
====== ======= =======60
----------- ----------- -----------
$ 12,402 $ 15,027 $ 15,556
=========== =========== ===========
F-18
Income tax expense consisted of:
Years Ended December 31
------------------------
2001-------------------------------------
2002 2003 ------ ------ ------2004
----------- ----------- -----------
(In Thousands)
Current $1,305 $1,475 $1,440$ 1,475 $ 1,440 $ 1,540
Deferred (153) 198 386 ------ ------ ------(68)
----------- ----------- -----------
Income tax expense $1,152 $1,673 $1,826
====== ====== ======
F-21
$ 1,673 $ 1,826 $ 1,472
=========== =========== ===========
The Company and its subsidiaries file separate income tax returns.
Reconciliation of the significant differences between the statutory
income tax rate and the effective income tax rate on pretax income is as
follows:
Years Ended December 31
------------------------
2001-------------------------------------
2002 2003 ------ ----- -----2004
----------- ----------- -----------
Cayman statutory rate 0% 0% 0%
Foreign in excess of statutory rate 22.40% 12.40% 10.72% 7.09%
Research and development credits (14.10%) (5.90%) (4.39%) (6.08%)
Adjustments to prior years' taxes (6.40%) 0.40% 0.09% 3.49%
Valuation allowance 10.40% 5.70% 2.55% 4.59%
Others 4.70% 0.90% 3.18% ------ ----- -----0.37%
----------- ----------- -----------
Effective tax rate 17.00% 13.50% 12.15% ====== ===== =====9.46%
=========== =========== ===========
The deferred income tax assets and liabilities as of December 31, 20022003
and 20032004 consisted of the following:
December 31
------------------
2002-------------------------
2003 ------- -------2004
----------- -----------
(In Thousands)
Deferred income tax assets
Research and development credits $ 3,409 $ 4,443
Net operating loss carryforwards $ 567 $ 390 Research and development credits 2,835 3,409254
Accrued vacation 118 117
Depreciation and amortization 93 104 Accrued vacation 122 1187
Others 43 165 ------- -------
3,660149
----------- -----------
4,186 4,970
Valuation allowance (3,440) (3,909) ------- -------(4,681)
----------- -----------
Total net deferred income tax assets 220 277 ------- -------289
----------- -----------
Deferred income tax liabilities
Withholding tax liabilities -- 359 413
Unrealized foreign exchange 9 (64)
Unrealized capital allowance -- 76 Unrealized foreign exchange 1 9
------- -------39
----------- -----------
Total deferred income tax liabilities 1 444 ------- -------388
----------- -----------
Net deferred income tax assets (liabilities)liabilities $ 219 ($167)
======= =======(167) $ (99)
=========== ===========
Balance sheet caption reported in:
Prepaid expenses and other current assets $ 219277 $ 277289
Accrued expenses and other current
liabilities -- 444 ------- -------388
----------- ------------
$ 219 ($167)
======= =======
F-22(167) $ (99)
=========== ============
F-19
The valuation allowance shown in the table above relates to net
operating loss and credit carryforwards and temporary differences for
which the Company believes that realization is uncertain. The valuation
allowance increased $772,000 and $469,000 for the years ended December
31, 2004 and 2003, respectively.
As of December 31, 2003, O//2//Micro,2004, O2Micro, Inc. had U.S. federal and California
state net operating loss carryforwards of approximately $290,000$ 0 and
$4,994,000,$4,345,000, and U.S. federal and California state research and
development credit carryforwards of approximately $2,123,000$2,651,000 and
$1,949,000,$2,716,000, respectively. The U.S. federal net
operating loss carryforwards will expire from 2011 through 2012 if not
utilized. TheCalifornia state net operating loss
carryforwards will expire in 2004 and 2005 if not utilized. The U.S.
federal research and development credit will expire from 2012 through
20232024 if not utilized, while the California state research and
development credit will never expire. Utilization of the net operating
loss carryforwards may be subject to significant annual limitation due
to the ownership change limitations provided by the U.S. Internal Revenue
Code of 1986 and similar provisions in the State of California's tax
regulations. The annual limitation may result in the expiration of net
operating losses before utilization.
The Company reversed $375,000 of income tax payable for the 2000 tax
year in September 2004 due to completion of the examination and approval
of its filed income tax return for the year ended December 31, 2000.
On May 24, 2004, O2 Micro-Taiwan applied to the Taiwan Custom's
officials for the rectification of the value of the imported goods
reported for the period from March 2003 to March 2004. The Company had
mistakenly reported a lower amount to the Taiwan Custom's Authority than
the correct amount that was reported on the Company's tax return for the
year ended December 31, 2003 and the amount that will be reported on the
Company's tax return for the year ended December 31, 2004. However,
rectification of custom's records usually cannot extend prior to the
latest six month period reported. The Company has further obtained the
opinion of Taiwan's Ministry of Finance as to accept rectification of
the value of the imported goods prior to the latest six month period.
The Company will continue to apply for the rectification to the Taiwan
Custom's Authority. If the Company's rectification application for the
period prior to the latest six months is rejected, the understated cost
of the imported goods reported to the customs officials may be deemed to
be the actual cost and thus the taxable income for the year ended
December 31, 2003 would be higher. The Company has determined the
maximum impact on income tax would be $1,680,000 (NT$52,000,000) for O2
Micro-Taiwan. The Company believes that it would be able to minimize the
maximum exposure by providing records of actual costs paid. Accordingly,
the Company has estimated the probable outcome and accrued $658,000
(NT$22,000,000) at December 31, 2004.
12. SHAREHOLDERS' EQUITY
Employee Benefit PlansEMPLOYEE BENEFIT PLANS
Savings planPlan
The Company has a savings plan that qualifies under Section 401(k) of
the U.S. Internal Revenue Code. Participating employees may defer up to
15% of pretax salary, but not more than statutory limits. The Company
may make voluntary contributions to the savings plan but has made no
contributions since the inception of the savings plan.
F-20
1999 employee stock purchase planEmployee Stock Purchase Plan ("1999 purchase plan"Purchase Plan")
In 1999, the Company's Board of Directors adopted the 1999 Purchase
Plan, which was approved by the shareholders prior to the consummation
of its initial public offering in October 1999.August 2000. A total of 1,000,000
ordinary shares have been reserved for issuance under the 1999 Purchase
Plan, plus annual increases on January 1 of each year, commencing in
2001, up to 800,000 shares as approved by the Board of Directors. The
1999 Purchase Plan is subject to adjustment in the event of a stock
split, stock dividend or other similar changes in ordinary shares or
capital structure.
The 1999 Purchase Plan permits eligible employees to purchase ordinary
shares through payroll deductions, which may range from 1% to 10% of an
employee's regular base pay at a price equal to the lesser of 85% of the
fair market value of the Company's ordinary shares on the date of grant
of the option to purchase or 85% of the fair market value of the
Company's ordinary shares on the applicable exercise date. Employees may
elect to discontinue their participation in the purchase plan at any
time during the enrollment period. Participation ends automatically on
termination of employment with the Company. If not terminated earlier,
the 1999 Purchase Plan will have a term of 10 years. During 20022003 and
2003, 97,3042004, 109,735 and 109,735118,479 ordinary shares, respectively, had been
purchased under the 1999 Purchase Plan. As of December 31, 2003, 702,9032004, 584,424
shares were available for issuance.
Stock option plansOption Plans
In 1997, the Company's Board of Directors adopted the 1997 Stock Plan,
and in 1999, adopted the 1999 Stock Incentive Plan (collectively, the
"Plans"). The Plans provide for the granting of stock options to
employees, directors and consultants of the Company. Options granted
under the Plans may be either incentive stock options ("ISO") within the
meaning of Section 422 of the United States Internal Revenue Code, or
nonstatutory stock options ("NSO"). ISOs may be granted only to Company
employees and directors. NSOs may be granted to Company employees and
consultants.
F-23
Options under the Plans may be granted for periods of up to ten years
and at prices no less than 85% of the estimated fair value of the shares
(in the case of NSOs) on the date of grant as determined by the Board of
Directors, provided, however, that (i) the exercise price of an ISO may
not be less than 100% of the estimated fair value of the shares on the
date of grant, and (ii) the exercise price of an ISO granted to a 10%
shareholder may not be less than 110% of the estimated fair value of the
shares on the date of grant. Options may be exercised following the
termination of a grantee's continuous service only to the extent
provided in the award agreement. Options generally expire no later than
ten years after grant, or five years in the case of an ISO granted to a
10% shareholder. The options generally vest over a period of four years
from the vesting commencement date. Options may be granted with
different vesting terms from time to time.
Under the 1997 Stock Plan, the Board of Directors reserved 3,700,000
ordinary shares for issuance. After the completion of an initial public
offering, no further options were granted under the 1997 Stock Plan.
Under the 1999 Stock Incentive Plan, the maximum aggregate number of
shares available for grant shall be 3,000,000 ordinary shares plus an
annual increase on January 1 of each year, commencing in 2001, equal to
the least of 1,500,000 shares (in the case of ISOs) or 4% of the
outstanding ordinary shares on the last day of the preceding fiscal year
or a smaller number determined by the administrator. As of December 31,
2003,2004, the number of options outstanding and exercisable were 570,207 and 522,554was 478,866
under the 1997 Stock Plan, respectively, and 3,349,6533,994,235 and 878,0381,612,934 under the 1999
Stock Incentive Plan, respectively.
F-21
A summary of the Company's stock option activity and related information
is as follows:
Weighted
Number of Average
Available Outstanding Exercise
for Grant Options Price
------------------- ----------- --------
Balance, January 1, 2001 3,034,006 2,323,365
Granted (1,615,000) 1,615,000 $12.04
Exercised -- (656,215) $ 1.50
Canceled 168,373 (168,373) $ 6.45
---------- ---------
Balance, December 31, 20012002 1,587,379 3,113,777
Additional shares authorized 1,500,000 ---
Granted (1,310,400) 1,310,400 $12.30$ 12.30
Exercised --- (325,113) $ 2.96
Canceled 54,894 (54,894) $10.83
---------- ---------$ 10.83
------------- ------------
Balance, December 31, 2002 1,831,873 4,044,170
Additional shares authorized 1,500,000 ---
Granted (913,300) 913,300 $13.88$ 13.88
Exercised --- (863,987) $ 6.52
Canceled 173,623 (173,623) $13.05
---------- ---------$ 13.05
------------- ------------
Balance, December 31, 2003 2,592,196 3,919,860
========== =========
F-24
Additional shares authorized 1,000,000 -
Granted (904,050) 904,050 $ 13.54
Exercised - (156,167) $ 8.15
Canceled 194,642 (194,642) $ 14.02
------------- ------------
Balance, December 31, 2004 2,882,788 4,473,101
============= ============
The following table summarizes information about the stock options
outstanding as of December 31, 2003:2004:
Options Outstanding Options Exercisable
------------------------------------ ------------------------------------------------------------------ --------------------------
Weighted
Average Weighted Weighted
Remaining Average Number Average
Number Contractual Exercise Exercisable Exercise
Range of Exercise Prices Outstanding Life Price and Vested Price
- ------------------------ --------------- ----------- --------- ----------- -------- ----------- -----------------
$0.03--$0.03-$0.09 69,292 3.4664,292 2.43 $ 0.045 69,2920.04 64,292 $ 0.05
$0.18--0.04
$0.18-$0.25 2,396 4.801,167 3.77 $ 0.245 2,3960.24 1,167 $ 0.250.24
$0.50 50,333 5.19 $ 0.500 50,33346,333 4.19 $ 0.50 $3.95--46,333 $ 0.50
$3.95-$5.88 277,560 6.23254,536 5.26 $ 4.777 234,7494.81 246,225 $ 4.58
$6.50--4.77
$6.50-$9.60 1,115,723 7.879.74 1,128,624 7.15 $ 8.460 522,2048.59 737,568 $ 8.37
$10.06--8.52
$10.06-$14.97 1,550,677 8.36 $12.900 316,156 $12.92
$15.38--1,934,366 8.05 $ 12.82 593,391 $ 12.92
$15.38-$24.18 853,879 8.68 $18.168 205,462 $17.81
--------- ---------
3,919,860 8.011,043,783 8.04 $ 11.81 1,400,59218.02 402,824 $ 9.44
========= =========17.91
-------------- --------------
4,473,101 7.54 $ 12.20 2,091,800 $ 10.69
============== ==============
For purposes of measuring compensation expense under APB No. 25, the
fair value of the shares on the date of grant was determined by the
Board of Directors for grants prior to August 23, 2000. The fair value
of subsequent option grants were based on the market price of ordinary
shares on the day of grant.
F-22
The Company calculated the minimum fair value of each option grant on the date
of grant using the Black-Scholes option pricing model as prescribed by
SFAS No. 123. The Black-Scholes option valuation model was developed for
estimating the fair value of traded options that have no vesting
restrictions and are fully transferable. In addition, option valuation
models requiremodel requires the input of highly subjective assumptions, including the
expected stock price volatility. Years Ended December 31
---------------------------
2001 2002 2003
------- ------- -------
Risk-free interest rate 4% 3% 3%The Company used the following
weighted-average assumptions in calculating the fair value of the
options granted:
Stock Options Employee Stock Purchase Plan
------------------------------------ --------------------------------------
Years Ended December 31
-----------------------------------------------------------------------------
2002 2003 2004 2002 2003 2004
--------- --------- --------- --------- --------- --------
Risk-free interest rate 2.76% 3.34% 3.54% 1.82% 1.58%-1.80% -
Expected life 5-9 years 5-9 years 5-7 years 0.50-2.03 0.51-1.53 -
years years
Volatility 75% 70% 65% 85% 65% -
Dividend - - - - - -
Expected life 5 years 5 years 5 years
Volatility 83.08% 114.18% 155.62%
Dividend -- -- --of stock options is estimated to be one year after
vesting.
The weighted average fair values under SFAS No. 123 for options granted
during the years ended December 31, 2001,2002, 2003 and 2004 was $9.83, $7.64
and $8.63, respectively. The weighted average fair values under SFAS No.
123 for purchase rights granted pursuant to the Employee Stock Purchase
Plan during the years ended December 31, 2002, and 2003 was $4.93, $3.86$5.13 and
$4.03,$5.40, respectively. There is no purchase rights granted pursuant to the
Employee Stock Purchase Plan during the year ended December 31, 2004.
Deferred compensationCompensation
In connection with stock option grants since the Company's inception,
the Company recognized accumulated deferred compensation totaling
$3,056,000 which was fully amortized as of December 31, 2002.
Amortization expense recognized during the years ended December 31,
2001, 2002, and 2003 was approximately $166,000, $44,000 and $0, respectively.
F-25
$44,000.
Ordinary Shares reservedReserved
Ordinary shares reserved for future issuance was as follows at December
31, 2003:
Shares
---------2004:
Outstanding stock options 3,919,8604,473,101
Shares reserved for future stock option grants 2,592,1962,882,788
Shares reserved for employee stock purchase plan 702,903
---------
7,214,959
=========584,424
------------
7,940,313
============
13. EARNINGS PER SHARE
Basic earnings per share is calculated by dividing net income by the
weighted average number of ordinary shares outstanding during the
period. Diluted earnings per share is calculated by dividing net income
by the weighted average number of ordinary and dilutive ordinary
equivalent shares outstanding during the period, using either the "as if
converted" method for convertible preference shares or the treasury
stock method for options and warrants.
F-23
A reconciliation of the numerator and denominator of basic and diluted
earnings per share calculations is provided as follows:
Years Ended December 31
---------------------------
2001 2002 2003
------- ------- -------
Net income (in thousands) $ 5,634 $10,729 $13,201
======= ======= =======
Weighted average thousand shares outstanding--basic 34,020 38,300 38,374
Effect of dilutive securities:
Options 1,317 1,194 1,362
Warrants 239 97 --
------- ------- -------
Weighted average thousand shares outstanding--diluted 35,576 39,591 39,736
======= ======= =======
Earnings per share--basic $ 0.17 $ 0.28 $ 0.34
======= ======= =======
Earnings per share--diluted $ 0.16 $ 0.27 $ 0.33
======= ======= =======
Years Ended December 31
-------------------------------------
2002 2003 2004
----------- ----------- -----------
Net income (in thousands) $ 10,729 $ 13,201 $ 14,084
=========== =========== ===========
Weighted average thousand shares
outstanding - basic $ 38,300 $ 38,374 $ 39,156
Effect of dilutive securities:
Options 1,194 1,362 946
Warrants 97 - -
----------- ----------- -----------
Weighted average thousand shares
outstanding - diluted $ 39,591 $ 39,736 $ 40,102
=========== =========== ===========
Earnings per share - basic $ 0.28 $ 0.34 $ 0.36
=========== =========== ===========
Earnings per share - diluted $ 0.27 $ 0.33 $ 0.35
=========== =========== ===========
Certain antidilutive outstanding options and warrants were excluded from
the computation of diluted EPS since their exercise prices exceeded the
average market price of the ordinary shares during the period. The
antidilutive stock options excluded and their associated exercise prices
per share were 1,023,100 shares and $12.54 to $24.05 as of December 31,
2001, 1,141,900 shares andat $14.10 to $24.18 as of December 31,
2002 and2002; 916,646 shares andat $15.38 to $24.18 as of December 31, 2003.
F-26
2003 and
1,227,037 shares at $ 14.97 to $ 24.18 as of December 31, 2004.
14. LEASE COMMITMENTS
The Company leases office space and certain equipment under
non-cancelable operating lease agreements that expire at various dates
through January
2006.February 2007. The Company's office lease provides for periodic
rentrental increases based on the general rate of inflation.
The Company also leases certain equipment
under a capital lease that expires in May 2004. There are provisions in the
lease that provide for a bargain purchase option upon the expiration of the
lease.
As of December 31, 2003,2004, minimum lease payments under all noncancelable
leases were as follows:
Capital Operating
Year Leases
Leases
---- ------- ---------------------
(In Thousands)
20042005 $ 2 $1,359
2005 -- 2131,113
2006 -- 3470
2007 -- --
2008 -- --
--- ------13
---------
Total minimum lease payments 2 $1,575
======
Less--amount representing interest 1
---
Present value of minimum lease payments 1
Less--current portion 1
---
Long-term obligations under capital lease $--
===
Capital lease obligations are secured by the related equipment and the
total costs of the equipment under capital lease was $165,000, $165,000 and
$165,000 for December 31, 2001, 2002 and 2003, respectively. Accumulated
depreciation was $122,000, $155,000 and $162,000 at December 31, 2001, 2002
and 2003, respectively.$ 1,596
=========
15. CONTINGENCIES
a.
Monolithic Power Systems, Inc. ("MPS"), a privately held company based in Los Gatos,
California, USA has alleged in a counterclaim that certainour OZ960, OZ961, OZ969 and OZ970
products of the Company infringe on twoone of MPS' patents.their patents and a continuation of that
patent. Litigation on such claim is pending in the United States
District Court in the Northern District of California. We have answered
MPS' claims, denying all of their substantive allegations. In addition,
given the results of the claims constructions adopted by the Court on
November 26, 2001 and December 27, 2002, we believe that we have
meritorious defenses against MPS' allegations. On May 28, 2004, the
Court granted our motion for summary judgment that MPS lacked evidence
of damages. As the judgment currently stands, MPS will not be able to
recover damages at trial but may only attempt to seek injunctive relief
and attorneys' fees. Trial on these claims is currently scheduled to
commence June 2005.
F-24
In January 2004, we filed a lawsuit in the U.S. District Court in the
Eastern District of Texas against Beyond Innovation Technology Co.,
Ltd., SPI Electronic Co., Ltd., FSP Group and Lien Chang Electronic
Enterprise Co., Ltd. The lawsuit asserts that those companies infringe
one or more claims of U.S. Patent Nos. 6,259,615 and 6,396,722 and in an
amended complaint, U.S. Patent No. 6,804,129. They have counterclaimed
for August 2004.antitrust violations and interference. Trial on these claims is
currently scheduled to commence December 2005.
In October 2004, we filed a lawsuit in the U.S. District Court in the
Eastern District of Texas against MPS alleging infringement of one or
more claims of U.S. Patent No. 6,804,129. MPS has counterclaimed for
antitrust violations and unfair competition.
While the Company cannot make any assurance regarding the eventual
resolution of this matter,these matters, the Company does not believe the final
outcome will have a material adverse effect on its consolidated results
of operations or financial condition.
The Company, as a normal course of business, is a party to various
litigation matters, legal proceedings and claims. These actions may be
in various jurisdictions, and may involve patent protection and/or
patent infringement. While the results of such litigations and claims
cannot be predicted with certainty, the final outcome of such matters is
not expected to have a material adverse effect on its consolidated
financial position or results of operations. No assurance can be given,
however, that these matters will be resolved without the Company
becoming obligated to make payments or to pay other costs to the
opposing parties, with the potential for having an adverse effect on the
Company's financial position or its results of operations.
F-27
16. FINANCIAL INSTRUMENTS
Information on the Company's financial instruments areis as follows:
December 31
---------------------------------------
2002 2003
------------------ ------------------
Carrying Fair Carrying Fair
Value Value Value Value
-------- ------- -------- -------
December 31
--------------------------------------------------
2003 2004
------------------------ ------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ----------- ----------- -----------
(In Thousands)
Assets
Cash and cash equivalents $ 66,489 $ 66,489 $ 56,320 $ 56,320
Restricted cash 1,892 1,892 1,887 1,887
Short-term investments 53,923 53,923 63,768 63,768
Long-term investment in CSMC - - 4,283 4,283
Restricted assets 10,044 10,796 13,873 13,577
The carrying amounts of cash and cash equivalents $69,334 $69,334 $66,489 $66,489
Restrictedand restricted cash
2,019 2,019 1,892 1,892
Short-termreported in the consolidated balance sheets approximate their estimated
fair values. The fair values of short-term investments 42,675 42,675 53,923 53,923
Accounts receivable--net 7,595 7,595 9,794 9,794
Restricted assets--net -- -- 10,044 10,796
Liabilities
Notes and accounts payable 5,202 5,202 6,334 6,334long-term
investment in CSMC are based on quoted market prices.
Fair values of restricted assets made in the form of Taiwan Government
bonds are based on quoted market value;price; otherwise are carried at amounts
which approximate fair value.
Long-term investments except for investment in CSMC are in
privately-held companies where there is no readily determinable market
value. The Company periodically evaluates these investments for
impairment. If it is determined that an other than
temporaryother-than-temporary decline has
occurred in the carrying value, an impairment charge is recorded in the
period of decline in value.
F-25
17. SEGMENT INFORMATION
The Company designs, develops and markets innovative power management
and security components for mobile communication, computer, information
appliance and LCD products. The Company's integrated circuit products
are produced with digital, analog, and mixed signal integrated circuit
manufacturing processes. The Company's Chief Operating Decision Maker
("CODM"), the Chief Executive Officer, reviews information on an
enterprise-wide basis to assess performance and allocate resources so
the Company has one reporting segment.
Net revenues from unaffiliated customers by geographic region are based
on the customer's bill-toship-to location and were as follows:
Years Ended December 31
---------------------------
2001-------------------------------------
2002 2003 ------- ------- -------2004
----------- ----------- -----------
(In Thousands)
Asia $45,780 $70,149 $88,548$ 70,149 $ 88,548 $ 92,105
United States 39 31 51 53
Europe -- 7 --
------- ------- -------
$45,819 $70,187 $88,599
------- ------- -------
F-28
- 38
----------- ----------- -----------
$ 70,187 $ 88,599 $ 92,196
=========== =========== ===========
Long-lived assets consist of fixed assetsland, property and equipment and are based
on the physical location of the assets at the end of each year.
Years Ended
December 31
------------------------
2001 2002 2003 ------ ------ ------2004
----------- -----------
(In Thousands)
Taiwan $1,272 $2,759 $2,354$ 2,354 $ 2,772
U.S.A. 1,190 1,422 1,251 6,551
Singapore 227 764 633 327
People's Republic of China 204 388 415 757
Others 320 278 227 ------ ------ ------
$3,213 $5,611 $4,880
====== ====== ======
During the year ended December 31, 2003, one customer accounted for 13.5%
of net revenues. During351
----------- -----------
$ 4,880 $ 10,758
=========== ===========
For the year ended December 31, 2002, two customers accounted for 18.6% and
15.9% of net revenues. DuringFor the year ended December 31, 2001, two customers2003, one customer
accounted for 20.9% and 11.0%13.5% of net revenues.
F-29
revenues and the same customer accounted for
17.54% of net revenues for the year ended December 31, 2004.
F-26