UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x                               ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2005

or

o                                  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                to                

Commission File No. 0-29454

POWER-ONE, INC.

(Exact name of registrant as specified in its charter)

 

Registrant’s telephone number, including area code (805) 987-8741

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.001 par value

(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No x

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 o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or non-accelerated filer. See definition of “accelerated file and large accelerated filer” in Rule 12b-2 of Exchange Act. (Check one):

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x

Aggregate market value of registrant’s common stock held by non-affiliates of the registrant, based upon the closing price of a share of the registrant’s common stock on July 3, 2005, as reported by the National Market System of the National Association of Securities Dealers Automated Quotation (“NASDAQ”) System on that date was approximately $407,038,000

As of March 6, 2006, 85,470,339 shares of the registrant’s $0.001 par value common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A and relating to the registrant’s Annual Meeting of Stockholders For Fiscal Year 2005, to be held on April 25, 2006, are incorporated by reference into Parts II and III of this Annual Report on Form 10-K.

TABLE OF CONTENTS

 

Unless the context indicates otherwise, all references herein to “Power-One,” “the Company,” “we,” “us,” and “our” refer collectively to Power-One, Inc. and its subsidiaries.

This Annual Report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that can be identified by the use of forward-looking terminology such as “may,” “will,” “can,” “believe,” “expect,” “anticipate,” “estimate,” “plan,” “intend” or “continue” or the negative or other variations of such terms or comparable terminology. We caution that the matters set forth under “Risk Factors,” constitute cautionary statements identifying important factors with respect to such forward-looking statements, including certain risks and uncertainties that could cause actual results to differ materially from those in such forward-looking statements.

PART I

ITEM 1—BUSINESS

Overview

We are a leading designer and manufacturer of power conversion and power management products, most of which are sold into the high technology and communications infrastructure markets. Our products are used to convert, process and manage electrical energy to the high levels of quality, reliability and precise levels of direct current (“DC”) voltage required by communications infrastructure and other equipment. With hundreds of different products, we have one of the most comprehensive product lines in the power conversion and power management industry and are one of just a few companies that can power virtually every segment of an infrastructure network.

Our products include:

·       AC/DC power supplies that power communications and networking equipment, as well as industrial, automatic/semiconductor test, transportation, medical and other electronic equipment;

·       DC power systems that are used by communications and Internet service providers;

·       DC/DC “Brick” converters, including high-density and low-density products, that are generally used to control power on communications printed circuit boards;

·       DC/DC Point-of-Load (“POL”) converters for powering Intermediate Bus Architecture (IBA) POL and other board-level applications; and

·       A digital power management architecture (Z-One ™ system) and related digital products that integrate conversion, communications, and control for a digital board-level power solution.

We design our products primarily for the high-end markets, rather than for use in personal computers, mobile phones or other consumer products.

AC/DC power supplies convert alternating current (“AC”) from a primary power source, such as a wall outlet, into a precisely controlled DC voltage. Virtually every electronic device that plugs into an AC wall outlet requires some type of AC/DC power supply. DC/DC converters modify an existing DC voltage level to other DC voltage levels to meet the power needs of various subsystems and components within electronic equipment. DC power systems are integrated or external racks, or cabinet power systems used to power and back-up large communications infrastructure equipment. During 2004, we introduced our Z-One digital power management architecture and related products, which manage DC power in a significantly enhanced manner over traditional power supplies and also can save customers significant board space, design time and cost.

We design our power conversion and power management products primarily to meet the needs of manufacturers of infrastructure equipment. For these manufacturers, a fluctuation of power may cause severe damage to sensitive systems, resulting in data loss, file corruption and significantly reduced productivity. We design our products to take low-quality power from the electrical grid and purify it to meet the higher quality demanded by digital communications networks, providing significantly greater protection against power disturbances, such as fluctuations and outages. In addition, our products’ compact designs are critical to our customers who need to minimize the space allocated to power conversion products in order to maximize the space available for other components. We continually strive to stay ahead of the technology curve to develop innovative products that meet and exceed our customers’ needs.

While approximately 36.2% of our sales were to our top ten customers in 2005, we sell our products to hundreds of customers worldwide. Our largest customer in 2005 was Cisco Systems and its contract manufacturers, which accounted for 15.1% of our sales both in 2005 and in 2004, and 15.4% of our sales in

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2003. Other key communications infrastructure customers include Nokia, Lucent, Alcatel, Nortel and Motorola. Key customers in other industries include Siemens, Hitachi, Teradyne, and Xyratex.

We were originally incorporated in 1973 as a California corporation, and re-incorporated in the State of Delaware in January 1, 1996.

Industry Background

The power conversion and power management industry is highly fragmented and diverse. Sales of power conversion and power management products are generally divided into two broad categories: those sold to third-party customers (merchant) and those for use in-house or sold to other divisions within a manufacturer’s own company (captive). Power-One is a merchant power supply manufacturer whose products are sold to third parties.

The communications industry experienced rapid change in the late 1990s through 2000 as deregulation and privatization fueled competition and fostered the entry of new competitors. In addition, advances in technology allowed communications service providers to offer a more varied range of services. Increases in Internet usage and demand for broadband and wireless services contributed to the growth of the communications industry. Because these technological advances required significantly greater and more reliable power, the demand for power conversion and power management products also grew. In 2001, however, the communications infrastructure industry entered into a severe downturn, which was characterized by delayed network deployments by service providers due to excess capacity and by a significant inventory correction. This downturn continued into 2002, and resulted in significant industry contraction. Since this downturn we experienced decreasing sales, price erosion, cancellation of orders, write-offs of excess inventory, restructuring charges and asset impairment charges. We experienced modest sales growth in 2003 and 2004 and a decrease in 2005. We believe our customers are now ordering at levels that reflect current estimated demand.

Long term, we believe the following key trends will continue to drive demand for power conversion:

Increasing Amounts of Power Required by the Communications Infrastructure Industry.   With the development and proliferation of the Internet, wireless communications, broadband applications and other new technologies, recent years have witnessed unprecedented growth in the volume of information being transmitted around the world at any given moment. We believe that this increasing volume will drive demand for larger data processing capabilities among communications infrastructure companies and that increased data processing needs in turn will require increases in power and more demand for power conversion and power management products. Industry sources project that the amount of power required by communications infrastructure equipment will grow significantly faster than the demand by other traditional users of power.

Increasing Demand for High Reliability Power.   The nature of power demanded by the digital economy is significantly different from the power provided by the electric utility grid. The electric utility grid supplies acceptable power quality, or power that is free from surges, spikes, or sags, 99.9% of the time, resulting in the equivalent of nine hours per year of interrupted, or unavailable, power. These nine hours of downtime often occur in many isolated interruptions of very short duration. In traditional industries, a brief interruption of power only interrupts operations for the time that the power is actually unavailable. For a modern communications network, however, even a minor power disturbance or brief interruption could cause equipment to crash and significantly shorten the life-span of electrical components. A network crash could result in several hours of downtime, including the time necessary for complex microprocessor-based equipment to reboot and regain power. This downtime could lead to significant lost revenue and customer dissatisfaction. To reduce these risks, power conversion products convert this low-quality power to power that is much more reliable than that provided by the electric utility grid.

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Proliferation of Distributed Power Architecture and Intermediate Bus Architecture, as well as the Trend Toward Power Management Rather than Simple Power Conversion.   Traditional power supply architecture uses a single, centralized power supply, which distributes the power through a cable of wires to the various individual components dispersed throughout a system. Newer communications systems demand increasing amounts of power for semiconductors located throughout their communications equipment. At the same time, newer-generation communications technologies being developed are requiring semiconductors that use lower voltages than previous-generation technologies. In many sophisticated systems, the traditional architecture distributes power too inefficiently to accomplish these goals because as power increases and voltage decreases the cable thickness increases to an unacceptable size, due to the corresponding increase in current.

Distributed Power Architecture, or DPA, is a technology that has been developed to address this technical issue. DPA uses a front-end power supply that converts AC voltage into a high-level DC voltage, typically 48 volts, thus allowing a smaller cable to be used within a system to distribute power. DC/DC Brick converters are located throughout the system and placed close to the devices that actually use power. These Brick converters reduce the voltage to the precise amount needed at the point it is to be used. Furthermore, DPA helps to diversify the risk within a large communications system. While the failure of a traditional centralized power supply could jeopardize the entire system, the failure of a single DC/DC Brick converter in a DPA system may only affect those few individual components that it serves. Finally, because there are many converters within the system, DPA allows for greater flexibility by permitting a part of the system to be reconfigured or upgraded without requiring a major change to the overall system.

More recently, a modified version of DPA called Intermediate Bus Architecture, or IBA, has emerged, which addresses the number of different and lower voltages required by different systems. Instead of using multiple DC/DC Brick converters that have a typical input of 48 volts and low output voltages of less than 3V, the IBA uses a single Brick converter with an intermediate voltage (typically between 12 volts and 3 volts). The intermediate voltage from the one converter is then transmitted to multiple Point of Load (POL) DC/DC converters, each of which converts the intermediate voltage to the required lower voltages, which are typically 3 volts or less. During 2003 we announced a new division within the Company, Silicon Power Systems (SPS), which designs highly innovative and efficient silicon-based solutions for next generation DC/DC power management products in the IBA market. We developed our maXyz product line specifically for the IBA market. In 2004 we introduced our Z-One digital power management architecture and related products as part of the maXyz product line. We have spent and anticipate spending significant capital on R&D related to this developing area of power conversion technology.

Our Competitive Advantages

We believe that we have key advantages that helped us to establish a leading brand for our products. The factors that we believe contribute to this leading position are as follows:

Broad Product Line.   We offer hundreds of products, in power ranging from one watt to a half-megawatt. Our smaller products are no larger than a fingernail, while our larger DC power systems could fill an entire cabinet. With millions of potential current and voltage configurations, our broad product line offers our customers a one-stop-shop opportunity, allowing them to purchase nearly all of their power conversion and power management products from a single supplier. As a result, we are one of the few companies that can power virtually every segment of an infrastructure network.

Leading Design and Development Capabilities.   There are a limited number of highly-skilled power engineers in the world, and we believe that we have assembled some of the most capable and innovative teams in the industry. In addition to maintaining a high retention rate among our technical staff, we also added top scientists to our ranks through each of our past strategic acquisitions. This pool of engineering talent has allowed us to consistently upgrade to new generations of power conversion products, each of

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which has outperformed prior products with higher power density and smaller size. It has also allowed us to become a leader in the implementation of DPA technology, and we expect to achieve a similar leading position in IBA technology. We believe that our Z-One digital power management architecture has created a first-to-market competitive advantage for us, although certain competitors have announced a strategic alliance to develop similar or competing products. We have been diligent in seeking to establish intellectual property rights (i.e. via securing patents) for the intellectual property we have developed and implemented in our Z-One digital power management architecture and products. We have also been diligent in protecting those rights. To date, we have initiated patent infringement litigation against two companies that have announced and introduced products which we believe infringe upon certain of our intellectual property rights as secured in certain U.S. patents issued to us.

Reputation for Quality and Reliability.   We have been in the power conversion industry since 1973. By establishing rigorous internal quality control programs, we believe that we have been able to provide our customers with products that are highly reliable. This is particularly important for manufacturers of infrastructure equipment. As a result, we established a strong customer base that includes many of the largest manufacturers in the communications infrastructure industry. Although power conversion products typically represent only 2% to 5% of the cost of an entire network, their failure can cripple the entire system in which they are installed. Consequently, we believe most customers are not willing to risk buying from an unproven supplier in an effort to cut costs in this area.

Changing Customer Needs.   Manufacturers and service providers are facing greater competition to accelerate the time-to-market for their new products, and are increasingly expected to produce newer generations of products in a shorter period of time. As a result, they are more likely to purchase from suppliers who can offer a broad range of standardized power conversion products, rather than highly customized products that take more time to design and manufacture. Manufacturers of communications infrastructure equipment are also focusing more on their core competencies, and therefore increasingly outsourcing the manufacture of power conversion products to more efficient suppliers. Consequently, these customers are moving towards sourcing from the limited number of suppliers who can meet all of these needs.

Our Strategy: Powering the High Technology and Communications Markets

Our primary objective is to become one of the worldwide leaders in power conversion equipment for the global communications and high technology equipment markets. To achieve this objective, we plan to do the following:

Expand Product Lines, Including DPA and IBA Products.   We provide one of the most comprehensive lines of power conversion and power management products, including DPA and IBA products, which are increasingly being designed into infrastructure equipment. Our Z-One digital power management products play a key role in our strategy. Once a power supply has been designed into a customer’s product, it is generally difficult for the customer to change suppliers during that product’s life cycle. We also work with our customers to understand their changing product needs in order to proactively develop leading technology products. We intend to continue our extensive research and development program to improve our products’ performance and expand the breadth of our product offerings.

Continue to Cross-Sell Products on a Global Basis.   We expanded the geographic reach of our business through a series of strategic acquisitions in 1998 through 2003, which provided market penetration for our AC/DC and DC/DC products throughout Europe and opened access for our telecom DC power systems products to Europe and Asia. We believe we have substantial opportunities to market products developed in one region to customers located in other regions. We intend to capitalize on our increased access to global markets by attempting to sell our complete product line to customers who had previously purchased only those products offered by the companies we acquired.

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Continue to Acquire and Invest in Strategic Businesses and Technologies.   We plan to selectively acquire and invest in businesses and technologies that can extend our geographic reach, increase the breadth of our product line, enhance the performance of our products, lower our manufacturing costs or expand our customer base in the communications infrastructure equipment market. We believe the fragmentation of the power conversion industry presents opportunities for further consolidation. In addition, we are investing aggressively in internal research and development initiatives to create next-generation power conversion products and continuing to invest in advanced technologies for our DC/DC power converter products to enable significantly smaller power converters, higher efficiencies, and better performance in controlling and managing power on communications-oriented printed circuit boards. We continue to earmark a significant portion of our overall research and development budget to develop this technology.

In 2004 we introduced our Z-One digital power management architecture and related products, which integrate conversion, communications, and control for a digital board-level solution. Features of this architecture and the related Z-7000 product line include the ability to fully manage up to 32 POL DC/DC converters with a single-wire digital bus. It also provides a significant reduction in Printed Circuit Board (PCB) space, cost savings, and a decrease in components, number of PCB traces, and power-system development time. In 2005, we introduced our Z-1000 product line, which are power conversion and management products that contain many, but not all, of the same features as the Z-7000 products, which we plan to market for customers’ mid-range applications.

Utilize Contract Manufacturers to Minimize Risk and Remain Cost Competitive.   We have shifted our manufacturing model toward increased use of low-cost contract manufacturers around the world, especially in Asia. We have made strategic investments in or formed joint ventures with certain contract manufacturers in order to ensure adequate access to their capacity. Although we currently manufacture many of our products in low-cost locations such as the Dominican Republic and Slovakia, the increased use of contract manufacturers has enabled us to lower our overall costs and allowed us to more efficiently scale production without significant capital investments in production capacity.

Our Products

The majority of our products are standard and modified standard products that are designed to accelerate customers’ time to market, as well as reduce the cost of customers’ new product introductions. Power supplies are generally classified as standard, modified standard and custom. Standard products refer to products that are standard to a particular manufacturer, as opposed to an industry standard. Modified standard products are a specific company’s standard products modified to fit a particular customer application. Because they have already been designed and manufactured, standard and modified standard products allow end customers to reduce their time-to-market and minimize costs for new product introductions. Custom products are usually designed from “scratch” to meet the specifications of a unique customer application. Standard and modified standard products tend to have higher margins than custom products, which require significant tool and die costs and four-to six-month lead-times from conception through production. In addition, users with high-volume production requirements typically operate in more price-sensitive industries. We also have developed modular product architectures, which are meant to achieve the flexibility of a custom power supply without the long lead-times and significant tool and die costs.

We operate in an industry where quantity discounts, price erosion, and product obsolescence due to technological improvements, all of which result in decreased revenues in a static environment, are normal. While we see price erosion on most of the products we sell, we also see price erosion (i.e. cost reduction) on many of the components we purchase for inclusion in our products. Product obsolescence refers to the tendency of small and less expensive products to replace larger and more expensive products. In DC/DC bricks, for example, the functions of a full-brick were replaced by half-brick, which was replaced by a quarter brick, which was replaced by a 1/8th-brick, which will eventually be replaced by a 1/16th-brick or smaller product. Each successive product is smaller and somewhat less costly than its predecessor, but has

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usually retained or expanded the functionality of its predecessor. Sales of each successor product typically replace sales of the predecessor product. These phenomena are normal in our industry, and we have experienced price erosion in line with industry trends. Price erosion on our products may negatively impact gross margins. Price erosion may also mask increases in unit sales of certain products.

All of our products are designed to convert, regulate, purify, store, manage or distribute electrical power for electronic equipment. Our products can be classified into three main groups: AC/DC power supplies, DC/DC converters and DC power systems. Our Z-One silicon board power management products fall into the DC/DC converter category. These categories can be distinguished based on their location, size and functions within the system.

AC/DC power supplies:

·       are typically embedded within the equipment;

·       range in equivalent size from a small paperback book to a desktop computer;

·       convert AC voltage, from a primary power source such as a wall outlet, into DC voltage(s); and

·       are used primarily in networking systems, large scale data processors and industrial equipment.

DC/DC converters (“Bricks”) and POLs:

·       are embedded within the equipment, and are generally mounted directly on the printed circuit boards;

·       bricks range in equivalent size from an AA battery to a portable CD player;

·       POLs may be silicon-based, and range in equivalent size from a fingernail to a small matchbox;

·       modify DC voltage into other levels of DC voltage(s) and are the cornerstone of DPA and IBA technology; and

·       are used by our customers primarily to power communications infrastructure equipment, although their usage is expanding to other markets, including server and storage.

DC power systems:

·       can be either stand-alone units that are external to the equipment or sub-systems (racks) that are integrated into an OEM’s system;

·       range in size from a shelf of integrated modules to large-scale systems that can fill entire cabinets;

·       convert AC voltage into DC voltage and, together with a generator or an array of batteries, provide several hours of additional power capacity in the event of an AC input disturbance; and

·       are used primarily to power communications networks and cellular communications systems.

Division Structure

Prior to 2005, the Company consisted of four divisions: the Compact Advanced Power Systems (“CAPS”) division, the Energy Solutions (“ES”) division, the Silicon Power Systems (“SPS”) division and di/dt. In 2005, we restructured and integrated most of our operations into one division. The most significant components of the restructuring involved the elimination of most DC power systems operations in Norway and their integration into our other existing locations, as well as the elimination of certain manufacturing operations in North America and subsequent transfer of the manufacturing to our other existing locations or to contract manufacturers. SPS is focused on developing next-generation silicon-based

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digital power management products for the recently introduced Z-One digital power management architecture.

Customers

We sell our power conversion products to a diversified group of hundreds of equipment manufacturers, including contract manufacturers. Cisco Systems and its contract manufacturers accounted for 15.1% of our sales in both 2005 and 2004, and 15.4% of our sales in 2003. Cisco Systems and its contract manufacturers collectively were the only customers to account for more than 10% of our sales during these periods.

Our top 10 customers accounted for approximately 36.2% of net sales in 2005, 38.4% of net sales in 2004 and 36.3% of net sales in 2003. Although our sales are diversified across many end markets, our strategy has been to focus our sales efforts on the communications infrastructure equipment market due to the suitability of our products for this market and because of the higher level of long-term growth we believe this market will experience. The following table illustrates the percentage of our net sales in our primary markets:

 

We have manufacturing and/or research and development operations in the United States, Dominican Republic, Switzerland, Slovakia, Ireland and China. We have two product lines, referred to as “embedded products” and “power systems.” Embedded products include AC/DC power supplies, DC/DC converters (“Bricks”) and POLs, and power management products, while the power systems product line is comprised of DC power systems. The following table summarizes our revenues and long lived assets in different geographic locations (in millions):

 

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(a)           Revenues are attributable to countries based on location of customer.

Sales and Marketing

We market our products through a global sales force. We have direct sales offices in Europe, North America, Asia and Australia. These direct sales offices are augmented by an extensive network of manufacturers’ representatives and distributors.

Our direct sales force is typically oriented towards customers that have the potential to purchase large volumes of our products, generally several million dollars or more on an annual basis. Our direct sales force works closely with our existing and potential customers to determine their long-term technology requirements for power conversion products. This close collaboration allows us to design products that best fit our customers’ expected applications. We expect that our direct sales to strategic accounts will increase in the future as we increasingly focus on sales to these customers.

Research, Development and Engineering

Worldwide we have 294 employees in our research and development departments of which 158 are engineers. We spent approximately $22.0 million on research and development in 2005, $29.4 million in 2004 and $28.5 million in 2003. During 2005, we shifted our research and development operations toward lower-cost locations, thereby significantly reducing research and development costs with only a modest decrease in research and development resources. We have four engineering and design centers in the United States: Andover, Massachusetts; and Camarillo, Carlsbad, and Morgan Hill, California. We also have engineering and design centers in Santo Domingo, Dominican Republic; Uster, Switzerland; Dubnica, Slovakia; Shenzhen, China; and Limerick, Ireland. Additionally, we have engineering staff on site in each of our manufacturing facilities. Finally, we have engineering teams at each of our power plant system integration facilities to enable more efficient customization of our system configurations for our customers. Our goal has been to establish research centers in areas that are strategically located for servicing our customers and in which we have strong access to technical talent.

Manufacturing Process and Quality Control

Production of most of our products typically entails subassembly of sophisticated printed circuit boards that are in turn combined with structural hardware to produce a final product. In response to market demands for increased quality and reliability, design complexity, and sophisticated technology, we continue to invest in state-of-the-art processes and have automated many electronic assembly and testing processes that we previously performed manually. We have also standardized many of our manufacturing processes and much of our equipment worldwide to increase efficiency and optimize flexibility between facilities.

Our manufacturing processes are designed to rapidly produce a wide variety of quality products at a low cost. The use of surface mount technology, or SMT, permits us to reduce board size by eliminating the need for holes in the printed circuit boards and by allowing us to use smaller components. Our investment

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in SMT has significantly increased our product development processes and production capacity, and we believe it has also improved our product quality. In addition, we made an equity investment in and have manufacturing outsourcing arrangements with a contract manufacturer in Asia and we have outsourcing arrangements with other contract manufacturers.

Product quality and responsiveness to our customers’ needs are of critical importance in our efforts to compete successfully. We emphasize quality and reliability in both the design and manufacturing of our products. In addition to testing throughout the design and manufacturing process, we test and /or burn-in our products using automated equipment and customer-approved processes. We also perform out-of-box test or pre-ship audit on randomly selected units before delivery. We require the same levels of quality from our contract manufacturers.

As their operations expand internationally, our customers increasingly require that their power products meet or exceed established international safety and quality standards. In response to this need, we design and manufacture our power conversion products in accordance with the certification requirements of many international agencies. These agencies include Underwriters Laboratories in the U.S., the CSA International in Canada, and TUV Product Service for the European market; additionally, various equipment may be tested to Network Equipment-Building System requirements for the U.S. telecom market, and to European Telecom Standard Institute requirements for the European Union telecom market.

We manufacture and assemble approximately 50% of our products at our facilities in the Dominican Republic, Asia, and Slovakia. We have smaller system integration facilities throughout Europe, Asia, and North America for our DC power system products. Production of our silicon-based POLs is outsourced to contract manufacturers in North America and in Asia. All of our manufacturing facilities are ISO certified or, in the case of the newest facilities, are in the process of receiving their certification. In our global manufacturing operations, we currently have an aggregate of approximately 350,000 square feet of manufacturing space. Most of our subcontractors are located in Asia.

In addition to our own facilities, we utilize low-cost contract manufacturing in several locations around the world. Although we currently manufacture many of our own products, we have shifted toward increased use of contract manufacturers to minimize costs and capital requirements, while providing greater flexibility. Approximately 50% of our products are produced by contract manufacturers. We tend to shift high-volume, low-mix products to the contract manufacturers while retaining low-volume, high-mix products at our own manufacturing facilities. Although decisions to use and/or expand contract manufacturing will depend on a number of factors, including customer needs, we expect that the overall trend toward increased use of contract manufacturers will continue in the future.

Suppliers

We maintain a network of suppliers for components and other materials used in the manufacture of our power conversion products. We typically design products using components readily available from several sources and attempt to minimize our use of components that we can only obtain through a single source. We procure components based upon our enterprise resource planning system and use a combination of forecasts, customer purchase orders and formal purchase agreements to create our materials requirements plan.

We occasionally use components or other materials for which a single supplier is the only source of supply. We may seek to establish long-term relationships with such suppliers. We have a number of volume purchase agreements with certain suppliers of key items. This practice enables us to maintain a more constant source for required supplies and produce cost savings through volume purchase discounts.

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Backlog

We generally sell our products pursuant to purchase orders rather than long-term contracts. Backlog consists of purchase orders on-hand having delivery dates scheduled within the next six months. Customers may cancel or reschedule most deliveries without penalty. Our backlog is not necessarily a reliable indicator of future revenue because a significant portion of customer orders is turns business (orders booked and shipped within the same reporting period that never appear as period-end backlog). We believe that our lead-times are substantially lower than our competition, which allows us to turn around product to customers more quickly than our competitors. Therefore, a higher proportion of our business is turns business. In addition, customers on Vendor Managed Inventory (“VMI”) programs exercise discretion as to the timing of inventory consumption. When VMI programs are initiated by customers, bookings and backlog are canceled and replaced by a product-use forecast. We then manufacture product for the customer per the forecast, and the customer uses the inventory as needed. Under a VMI program, the booking and billing occur simultaneously upon use of the product, and therefore there is always a book-to-bill ratio of 1.0 for these programs. We may bring additional VMI programs on-line in the future, which would result in higher turns business, lower backlog, and higher finished goods inventory.

Competition

The power conversion industry is highly fragmented and characterized by intense competition. No single company dominates the overall market, and our competitors vary depending upon the specific type of products they produce. We believe that the principal bases of competition in our targeted markets are breadth of product line, competitive prices, quality, reliability, technical knowledge, flexibility, readily available products and financial strength. Our competition includes companies located throughout the world, including Artesyn Technologies which recently announced that it was to be acquired by Emerson Electric, C&D Technologies, Delta Electronics, Eltek, Lite-On, Phihong, Vicor, and divisions of Emerson Electric and Tyco International.

Intellectual Property Matters

We regard certain equipment, processes, information and knowledge that we developed and use to design and manufacture our products as proprietary. We rely on a combination of patent, trade secret and other intellectual property laws, confidentiality agreements executed by most of our employees and other measures to protect our proprietary rights. We consider our intellectual property to be very important and valuable, particularly the patents we have secured and are continuing to seek in the area of digital power management and control. Those particular patents have all been very recently issued, (i.e. during 2004 or later), and have patent terms extending for approximately 20 years from date of grant. We have made intellectual property protection a key element of our overall research and development in the area of digital power management and control. We consider these digital power management and control patents to be key intellectual property assets that we will rely upon to protect our Z-One family of products and technologies well into the future. We currently maintain 80 active U.S. patents, many of which are protected by corresponding foreign patents in selected jurisdictions. Additional U.S. and foreign patent applications are pending. Trademarks are also an element of our overall intellectual property holdings. The trademarks associated with our digital power management and control technologies are considered the more important marks, along with those marks associated with our corporate name. We hold 10 U.S. registered trademarks with additional applications pending, and claim common law trademark rights to certain additional marks.

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Employees

At December 31, 2005, we employed 2,513 employees at our facilities in the following functions:

 

We believe that our continued success depends, in part, on our ability to attract and retain qualified personnel. We consider our relations with our employees to be good. None of our employees are represented by a union.

Company Website, Corporate Governance Website and Access to Company Filings

The Company posts all periodic reports on Form 10-K and 10-Q, current reports on Form 8-K, and amendments to these reports filed or furnished pursuant to the Securities Exchange Act of 1934 on its website at www.power-one.com, as soon as reasonably practicable after the reports are filed with or furnished to the Securities and Exchange Commission. Access to these reports is free of charge. In addition, the Company maintains a Corporate Governance section on its Website to provide easy access for the investor community to relevant information about our corporate governance. The public may read and copy any materials the Company files with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549, and the public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.  In addition, the SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov.

EXECUTIVE OFFICERS OF THE REGISTRANT

Set forth below is certain information concerning our executive officers.

(1)          As of March 9, 2006

Steven J. Goldman.   Mr. Goldman, our Chairman of the Board, joined Power-One in 1982 and has held several positions in the Company, including Vice President of Engineering, Senior Vice President and Chief Financial Officer. In July, 1990, Mr. Goldman was selected by the Board of Directors to lead Power-One as President and CEO. He was named Chairman of the Board in 1997. Mr. Goldman received his B.S. Degree in Electrical Engineering from the University of Bridgeport in 1979. He is a 1989 graduate of the Pepperdine University Presidential and Key Executive MBA Program, and in 1999 he was recognized by Pepperdine as a Distinguished Alumnus of the Graziado School. Mr. Goldman is a contributing member of the San Fernando Valley Chapter of the Young Presidents’ Organization.

William T. Yeates.   Mr. Yeates joined us in January, 2000 as President and Chief Operating Officer and served as President and Chief Operating Officer until February, 2006 when he was appointed our

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Chief Executive Officer. Before joining us, Mr. Yeates held various positions of increasing responsibility at Lucent Technologies, including Vice President and General Manager of the Titania Power Division. He received his B.S. degree in Electrical Engineering and his M.B.A degree in Finance from Louisiana Tech University.

Brad W. Godfrey.   Mr. Godfrey, who joined us in 1988, was appointed President and Chief Operating Officer in February, 2006. During his tenure with us, he has held a variety of positions of increasing responsibility and scope within the Company, including Senior Vice President—Global Operations. He served as the CAPS Division President from July, 2003 until February, 2006.

Paul E. Ross.   Mr. Ross, who joined us in April, 2001, was appointed Treasurer and Chief Financial Officer in May, 2005. He has served the Company as Assistant Secretary since May, 2004 and served as Assistant Treasurer from May, 2004 until May, 2005. He has served as Vice President, Finance since January, 2005.  Prior to joining the Company, Mr. Ross was employed with British Petroleum, Los Angeles. Mr. Ross is a CPA and holds a B.A. degree from the University of California, Los Angeles, and an M.B.A. degree from the University of Southern California.

Veronica O. Tarrant.   Ms. Tarrant, who joined us in June, 2000, was appointed Chief Accounting Officer in May 2005. She has served the Company as Vice President, Finance since January, 2003. She was previously employed by the Company as Controller, CAPS Division, from June, 2000 until January, 2003. Prior to joining the Company, Ms. Tarrant was employed by Schlumberger, Los Angeles.  Ms. Tarrant holds a B.A., Economics, from Pomona College, and an M.B.A. from Pepperdine University.

Randall H. Holliday.   Mr. Holliday joined us in 2000 as General Counsel, and was appointed Secretary in 2001. Before joining us, Mr. Holliday served as Secretary and General Counsel of Xircom, Inc. He has held a variety of in-house legal positions in diverse industries since 1981. Mr. Holliday received his J.D. degree in 1974 from Florida State University, Tallahassee, FL.

Our officers serve at the discretion of the Board.

ITEM 1A—RISK FACTORS

A significant percentage of our revenue is generated from customers in the volatile communications infrastructure industry. If our customers in this industry do not maintain their level of purchases from us, our operating results may be materially adversely affected.

Our sales to the communications infrastructure industry has been in the range of 59% to 73% of our total sales during the five years ended December 31, 2005, and we expect this concentration of customers in the communications infrastructure industry to continue. The communications industry steadily grew in the late 1990s through 2000, driven primarily by the expansion of the Internet, broadband and wireless networks. The subsequent downturn in the industry in 2001and 2002 caused a sharp decrease in demand for our products as a result of a decrease in capital spending by our customers. The industry downturn caused some of our customers, including our largest customers, to restructure into smaller operations and hampered their ability to forecast accurately. Our future revenue growth depends in large part on the resumed growth of these services as widely used media for commerce and communication. However, if the communications infrastructure industry experiences further volatility, it could have a material adverse effect on our operating results.

Price erosion may have a material adverse effect on our margins and profitability.

The power supply manufacturing industry is generally characterized by intense competition. We believe that the principal bases of competition in our targeted markets are breadth of product line, cost, quality, reliability, technical knowledge, flexibility, readily available products, and stability and reputation of the provider. We saw pricing pressure from some of our key customers during 2005, 2004 and 2003 and have factored additional price erosion into our forecast for 2006. Downward pricing pressure could have a material adverse effect on our operating results.

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Failure to anticipate trends in the type of power conversion products our customers will demand may adversely affect our business.

Because we have many customers in the communications infrastructure industry, the factors and economic trends that affect these companies also affect our business. The communications infrastructure industry has experienced rapid change in recent years. With advances in technology, communications service providers offer a more varied range of services. Increasing usage of the Internet, demand for broadband services and wireless services all contributed to the growth of the communications infrastructure industry. Because resulting technological advances required significantly greater and more reliable power, the demand for newer generation power conversion products has also grown. To respond to the needs of our customers in the communications infrastructure industry, we must continuously develop new and more advanced products at lower prices. We have made and will continue to make significant investments in next generation technologies, but there can be no assurance that the resulting products will be successful or that we will recoup our research and developments costs through increased sales.

During 2003, we announced the creation of a new division within the Company dedicated to developing next-generation DC/DC products, and this division launched its first major digital power management products during 2004. Many of these new products are based on silicon technology, which may expose us to new and unfamiliar competitors. We also have limited experience in the semiconductor industry. While we believe that our technology is ahead of our competitors, and is protected by adequate intellectual property rights, some of our traditional competitors have formed a consortium with other semiconductor technology companies to address the same market as we are seeking to address. This consortium has created doubt about our technology and products in the marketplace. In addition, although we have licensed our technology to another company in order to address customers’ second source concerns, there can be no assurance that sufficient quantities of our products will be available. The market may not accept our technology or adoption rates may be slower than expected. Our inability to properly assess developments in the communications infrastructure industry or to anticipate the needs of our customers could cause us to lose some or all of these customers, prevent us from obtaining new customers, or cause us to record substantial write-offs.

We may not be able to procure necessary key components for our products.

The electronics manufacturing industry is cyclical. During periods of growth, key components we require to build our products may become unavailable in the timeframe required for us to meet our customers’ demands. Our inability to secure sufficient components to build products for our customers could negatively impact our sales and operating results. We may choose to mitigate this risk by increasing the levels of our inventory. With increased inventory comes increased excess and obsolescence risk should our forecasts fail to materialize or if there are negative factors impacting our customers’ end markets. If we purchase too much inventory or the wrong inventory, we may have to write-off the inventory, thereby negatively impacting our gross margins and operating results.

Vendor managed inventory programs give rise to variability in our revenue and operating results.

Certain significant customers are on vendor managed inventory, or VMI, programs. For VMI programs, we build product to the customers’ forecast and the inventory is physically located at a site controlled by the customer. The customer uses the inventory as needed, and the sale occurs at that time. We experienced and expect to continue to experience variability as to the timing of customers’ use of VMI, which results in variability in our net sales and operating results.

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Cancellations, reductions or delays in purchases could cause our quarterly results to fluctuate.

We do not obtain long-term purchase orders or commitments from our customers and customers may generally cancel, reduce or postpone orders without penalty. Cancellations, reductions and delays in orders could reduce our backlog and adversely affect our net sales, gross profit and operating results. Our expense levels are based, in part, on expected future revenues and are relatively fixed once set. Our expectations for net sales beyond 90 days are based partially on our own estimate of future demand and partially on firm customer orders. Because a substantial portion of our quarterly net sales is made during the last month of a quarter, we are limited in our ability to reduce expenses quickly if for any reason net sales do not meet our expectations in a particular period. Therefore, fluctuations in net sales, particularly if customers cancel, postpone or delay orders, may adversely impact our operating results.

Fluctuations in customer needs may also affect our mix of products and volume of orders, which in turn affect our gross margin and operating results. High-volume orders, if cancelled, may substantially increase the risk of inventory obsolescence and asset write-offs due to excess capacity.

We rely on a few major customers for a material portion of our business and the loss of any of those customers could reduce our net income and operating results.

A few customers account for a material portion of our net sales each year. Cisco Systems and its contract manufacturers represented approximately 15% of our net sales in 2005 and 2004. For 2005 and 2004, our top five original equipment manufacturers (“OEM”) customers accounted for approximately 28% and 31% of our net sales, respectively. In addition, some of our products sell for significantly higher gross margins than others. If we lose any of these key customers, if any of them reduces or cancels a significant order, or if our product mix changes significantly, our net sales and operating results could decrease significantly.

Environmental, health and safety laws may restrict our operations.

We are subject to local laws and regulations in various regions in which we operate, including the European Union (“EU”). In particular, two current EU directives may have a material impact on our business. The first is the Restriction of Certain Hazardous Substances Directive (“RoHS”), which restricts the distribution of certain substances, including lead, within the EU and is effective July 1, 2006. In addition to eliminating and/or reducing the level of specified hazardous materials from our products, we will also be required to maintain and publish a detailed list of all chemical substances in our products. We are starting to see requests from our customers, including some of our major customers, for RoHS-compliant products. We are in the process of compiling RoHS-compliant information on our products as well as procuring RoHS-compliant material and information from our suppliers.

The second directive is the Waste Electrical and Electronic Equipment Directive (“WEEE”), which was effective August 13, 2005 in certain jurisdictions and requires covered manufacturers or importers to recycle or dispose of all products manufactured or imported into the EU by a party which is subject to the directive at its own expense at the end of the products’ useful lives. It is our current position and interpretation of the WEEE directive that our products are not directly covered by or such as to require to our direct compliance with the directive. We believe our end customers bear the responsibility for WEEE directive compliance for the products and/or systems in which our products are components.

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There are certain risks we face in complying with, or seeking to conduct our business in connection with, the RoHS and WEEE directives, which include but are not limited to the following:

·       For RoHS

·        We may be unable to procure appropriate RoHS-compliant material in sufficient quantity and quality and/or may be unable to incorporate it into our manufacturing processes without compromising quality and/or impacting our cost structure;

·        We may not be able to sell non-compliant product into the EU or to any customer whose end product will be sold into the EU, which may result in reduced sales;

·        We may face additional excess and obsolete inventory risk related to non-compliant inventory that we may continue to hold for which there is reduced demand and that we may need to write down.

·       For WEEE

·        We may be determined by applicable national regulatory agencies which implement the WEEE directive that certain of our products are directly covered under the WEEE directive, making us directly responsible for WEEE compliance for such products.

·        Our customers may refuse to agree to contractual language which allocates and assigns WEEE responsibility, or demand that we undertake WEEE responsibilities independent of regulatory interpretation.

We are unable to estimate at this time the cost of compliance, if any, with either EU directive. Compliance and non-compliance with these laws may have a material adverse impact on our net sales and operating results.

We are subject to credit risks.

Some of our customers have experienced and may continue to experience financial difficulties and/or have failed to meet their financial obligations to us. As a result, we have incurred charges for bad debt provisions related to certain trade receivables. In certain cases where our end-customers utilize contract manufacturers or distributors, our accounts receivable risk may lie with the contract manufacturer or distributor and may not be guaranteed by the end-customer. If there are additional failures of our customers to meet their receivables obligations to us, or if the assumptions underlying our recorded bad debt provisions with respect to receivables obligations do not materially reflect our customers’ financial conditions and payment levels, we could incur additional write-offs of receivables in excess of our provisions, which could have a material adverse effect on our cash flow and operating results.

We face, and might in the future face, intellectual property infringement claims that might be costly to resolve.

We have from time to time received, and may in the future receive, communications from third parties asserting patent or other intellectual property rights that are alleged to cover our products. At least one such claim has resulted in litigation in the past that was resolved favorably for us. If we do not prevail in any such litigation, our business may be adversely affected.

In addition, our industry is characterized by uncertain and conflicting intellectual property claims and vigorous protection and pursuit of intellectual property rights or positions, which have on occasion resulted in significant and often protracted and expensive litigation. We cannot assure that intellectual property claims will not be made against us in the future or that we will not be prohibited from using our technologies subject to any such claims or that we will not be required to obtain licenses and make

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corresponding royalty payments. In addition, the necessary management attention diverted to litigation, along with the associated legal costs, could have a significant adverse effect on operating results.

Any failure to protect our intellectual property could have a material adverse effect on our business; costs associated with enforcing our rights could adversely affect our results.

We rely upon a combination of patents, trademarks, contractual provisions and trade secret laws to protect our proprietary rights in certain of our products. Our competitors may, however, misappropriate our technology or independently develop technologies that are as good as, or better than, ours. Additionally, the laws of some foreign countries do not protect our proprietary rights as much as U.S. laws do. We currently own patents and continue to apply for additional patents, but the U.S. Patent and Trademark Office may reject some or all of our patent applications. The patents that the U.S. government issues to us may not provide us with a competitive advantage or create a sufficiently broad claim to protect the technology that we develop.

Our competitors may challenge or circumvent our patents, and some of our patents may be invalidated. Litigation may be necessary to enforce our patents and other intellectual property rights, to protect our trade secrets, to determine the validity of and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. Litigation could result in substantial costs and diversion of resources and could have a significant adverse effect on operating results.

During 2005 we initiated legal proceedings against two companies whom we believe have infringed on some of our patents in the area of digital power management. While we believe our cases are strong, there can be no assurance that the judicial system will uphold our patents, or will find that our patent(s) have been infringed.   We may incur significant costs in these current proceedings protecting our technology though the judicial system, which costs may not be recouped through damages awards, settlements, royalties or other payments.

Additionally, we may bring suit against additional companies in the future whom we believe violate our intellectual property, further increasing our costs. In addition, competitors  (either individually, or via alliance-type arrangements) may release infringing product(s) prior to any court ruling or other judicial action which upholds or supports our intellectual property rights,  with the goal of securing market share with competing product. Significant costs associated with litigation, slower-than-expected adoption rates of our new product, and competitor introductions of competing product could individually or in combination have a material adverse impact on our operating results.

We are subject to risks associated with future company and technology acquisitions, divestitures, joint ventures and strategic investments.

We may continue to pursue acquisitions and disposals of businesses, products and technologies, or enter into joint ventures and equity investment arrangements, that could complement or otherwise enhance our business. The negotiation of potential acquisitions, divestitures, joint ventures or investments as well as the integration of an acquired business, product or technology could require us to incur significant costs and cause diversion of management’s time and resources for which economic and opportunity costs cannot be recouped if the transactions do not occur. Future transactions by us could result in the following consequences:

·       dilutive issuances of equity securities;

·       incurrence of debt and contingent liabilities;

·       impairment of tangible and intangible assets;

·       research and development write-offs; and

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·       other acquisition-related expenses.

We may also encounter difficulties in integrating acquired assets with our operations. Furthermore, we may not realize the benefits we anticipated when entering into these transactions. In addition, after we complete an acquisition, our management must be able to assume significantly greater responsibilities, and this in turn may cause them to divert their attention from our existing operations. Any of the foregoing could have a material adverse effect on our financial position and results of operations.

Our success depends on our ability to retain our senior management and to attract and retain key technical personnel.

If we lose one or more members of our senior management, or if we cannot attract and retain qualified management or highly technical personnel, our operating results could be adversely affected. Our capacity to develop and implement new technologies depends on our ability to employ personnel with highly technical skills. Competition for such qualified technical personnel is intense due to the relatively limited number of power supply engineers worldwide. We believe that this supply will remain constrained because of the limited number of engineering students concentrating on power conversion.

Much of our business is subject to risks associated with operations in foreign countries.

Many of our operations are located outside of the United States and we expect to build or move additional operations overseas. Depending on location, our operations may be affected by:

·       imposition of tariffs, quotas, taxes and other market barriers;

·       restrictions on the export or import of technology;

·       greater difficulty in accounts receivable collection and longer collection periods;

·       inconsistent regulations and unexpected changes in legislation or regulatory requirements;

·       political and economic instability;

·       work stoppages and difficulties in staffing and managing international operations; and

·       fluctuations in the value of the U.S. dollar relative to foreign currencies.

Historically, we have not hedged against any currency exchange rate risks. The occurrence of any of these factors may adversely affect our operating results.

We may fail to capture customers in the new markets that we are pursuing.

We are pursuing customers in new markets, most notably for our digital power management products and in the server/storage industry. The server/storage industry has been historically volatile. Any downturn or disruption in this industry could impact our sales and operating results. While we have secured design wins from significant players in this industry in the past, there can be no assurance that these design wins will turn into revenue in the quantity or timeframe projected. We have made investments in our infrastructure, increased our operating costs and have forgone other business opportunities in order to service these new potentially significant customers.  Failure of these design wins to translate into revenue in the quantities or timeline projected could have a materially adverse impact on our revenue and operating results.

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Our charter contains provisions that may hinder or prevent a change in control of our company.

Certain provisions of our Certificate of Incorporation could make it difficult for a third party to obtain control of us, even if such a change in control would benefit our stockholders. As currently adopted, our Certificate of Incorporation provides for election of all directors annually. Stockholders must inform our corporate secretary before a stockholders’ meeting of any business they wish to discuss and any directors they wish to nominate. Our Certificate of Incorporation also requires approval of 75% of our voting stock to amend certain provisions. Our Board of Directors can issue preferred stock without stockholder approval. Stockholder rights could be adversely affected by the rights of holders of preferred stock that we issue in the future. Finally, we have a stockholder rights plan that allows our stockholders to purchase preferred stock at a reduced price if certain parties attempt to acquire a substantial interest in us without the approval of our Board of Directors. Any one of the provisions discussed above could discourage third parties from obtaining control of us. Such provisions may also impede a transaction in which our stockholders could receive a premium over then-current market prices and our stockholders’ ability to approve transactions that they consider in their best interests.

ITEM 1B—UNRESOLVED STAFF COMMENTS

None.

ITEM 2—PROPERTIES

The table below lists our principal facilities currently in operation.

 

We believe that the facilities we now use are adequate for our current and anticipated operating needs. We own our facilities in Slovakia and Switzerland. We lease the remainder of our facilities pursuant to lease agreements with expiration dates through 2014 in North America and 2011 in Europe and 2010 in Asia. We believe that we will be able to renew these leases with similar terms upon expiration. If we cannot renew, we believe that we could find other suitable premises without any material adverse impact on our operations.

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ITEM 3—LEGAL PROCEEDINGS

The Company is involved in certain claims and legal proceedings which have arisen in the normal course of business. Management does not believe that the outcome of any currently pending claims or legal proceedings in which the Company is currently involved will have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flow.

Power-One, Inc. v. Artesyn Technologies, Inc. and Silicon Laboratories, Inc.   United States District Court, Eastern District of Texas, Civil Action No. 2-05-CV-463 (LED). This combined action initiated by the Company against Artesyn Technologies on September 30, 2005, and against Silicon Laboratories on December 14, 2005, alleges that certain products of the named defendants infringe certain patents held by the Company which focus on technologies relating to digital power management and control. The Complaint seeks certain injunctive relief against and compensatory damages from each defendant.  Trial proceedings are in the very initial stages of discovery and related procedural matters.

ITEM 4—SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended December 31, 2005.

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PART II

ITEM 5—MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our Common Stock is listed on the NASDAQ and is traded under the symbol “PWER.” The following table sets forth, for the quarterly periods indicated, the range of high and low closing sale prices for our common stock.

 

As of March 9, 2006, there were 489 holders of record of our common stock.

We have not paid any cash dividends on our common stock and do not anticipate paying cash dividends in the foreseeable future.

In May 2005, the Company announced that it had received authorization from its Board of Directors to purchase up to $20 million of its outstanding common stock in open-market transactions. At December 31, 2005, $15.7 million remains available for purchase in accordance with this authorization. This authorization expires on December 31, 2006.

The following is a table summarizing the issuer’s purchases of its own equity securities during the three months ended December 31, 2005:

 

Securities Authorized for Issuance Under Equity Compensation Plans

The information required by this item will be contained under the caption “Equity Compensation Plan Information as of December 31, 2005” in our definitive Proxy Statement related to our Annual Meeting of Stockholders for Fiscal Year 2005, to be held on April 25, 2006, and such information is incorporated herein by reference.

ITEM 6—SELECTED FINANCIAL DATA

In the table below, we provide selected consolidated historical financial and operating data. We prepared this information using audited financial statements for the fiscal years ended December 31, 2005, 2004, 2003, 2002 and 2001. When reading this selected historical consolidated financial and operating data, it is important to read it along with “Item 7—Management’s Discussion and Analysis of Financial

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Condition and Operating Results” included in this Form 10-K. Historical results are not necessarily indicative of future results.

(1)          Our fiscal year is the 52- or 53-week ending on the Sunday nearest to December 31. For clarity of presentation we described year-ends presented as if the year ended on December 31. As such, the year ended December 31, 2004 represents a 53-week year and the years ended December 31, 2005, 2003, 2002 and 2001 each represent a 52-week year.

(2)          The year ended December 31, 2001 includes pre-tax charges that consist of the following: restructuring charge of $25.1 million, goodwill and asset impairment charge of $33.8 million, inventory charge of $110.3 million, technology write-off of $7.5 million, write-off of capitalized bank fees of $1.1 million, a $58.8 million deferred tax valuation allowance and $1.3 million in stock compensation charges primarily related to the employer match of our 2001 Deferred Compensation Plan.

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(3)          The year ended December 31, 2002 includes pre-tax charges that consist of the following: restructuring charge of $10.7 million, goodwill and other asset impairment charge of $110.2 million, inventory charge of $73.0 million, a $39.9 million deferred tax valuation allowance and $6.5 million in stock compensation charges and related payroll taxes primarily related to the employer match of our 2001 Deferred Compensation Plan.

(4)          The year ended December 31, 2003 includes a write-down of approximately $5.7 million, included in other expense, to reduce the book value of an investment held in a privately-owned enterprise and a restructuring charge of $3.1 million for a reduction in force and accruals related to an excess facility.

(5)          On February 14, 2003, we acquired di/dt Inc. The purchase price for di/dt was approximately $17.5 million, which consisted of the following: a $2.0 million note receivable from, as well as a $3.1 million cost basis investment in, di/dt prior to the acquisition; 1.4 million shares of the Company’s common stock valued at $6.3 million at acquisition; $1.0 million in cash and acquisition costs; and 0.5 million shares of the Company’s common stock paid as earn-out to the former shareholders of di/dt during 2003 and 2004 valued at $5.1 million. Earn-out payments have been recorded as additional goodwill, and no earn-out provisions extended beyond December 31, 2004. In addition to the purchase price, the Company granted a cash bonus of approximately $1.0 million to the original founders of di/dt upon acquisition, which was recorded as compensation expense in 2003.

(6)          During 2004, we performed an impairment test in accordance with SFAS 144. The results of these tests indicated that the manufacturing equipment at one of our European facilities was impaired and we recorded non-cash impairment charges of $0.7 million. In addition, we wrote down our Mexico building to fair value based on current market activity resulting in non-cash impairment charges of $1.3 million. We also recorded a $1.1 million write-off of an investment we own in a privately-held technology company, which was recorded in other expense. The year ended December 31, 2004 also includes pre-tax restructuring charges of $0.7 million related to severance and benefit payments, consolidation of excess facilities, contract termination costs, and other shutdown costs, in accordance with SFAS 146 and $0.4 million of restructuring charges for settlement payments and legal fees related to additional personnel and legal costs resulting from the closure of the Boston, Massachusetts facility during 2001.

(7)          During 2005, we announced a restructuring plan which was accounted for in accordance with SFAS 146. We recorded pre-tax charges of $11.1 million for restructuring costs which included a workforce reduction in Europe and North America, and the charges were comprised of severance and related benefits, consolidation of excess facilities and continuing lease obligations thereon, contract termination costs, and other shutdown costs. During 2005, we also performed impairment reviews in accordance with SFAS 144. As a result, we identified certain long-lived assets associated with the 2005 restructuring whose carrying value would not be recoverable from future cash flows, and recorded an impairment charge of $5.1 million for these assets for the year ended December 31, 2005. These assets consisted of an owned building in Norway that was held for use and which was written down to fair market value and then sold in 2005; leasehold improvements for leased facilities whose operations were closed during the year; and miscellaneous other long-lived assets that will no longer be used. We also determined that an investment in a foreign enterprise, recorded in other assets on the balance sheet, was impaired. The impairment charge of $2.0 million was recorded in other expense and primarily resulted from a forecast reduction for the enterprise and the related cash flow.

(8)          Consists of purchase orders having delivery dates scheduled within the following six months, and does not include turns business that is ordered, produced, and shipped in the same period.

(9)          Includes current and long-term portions of long-term debt and capital leases.

(10)   Includes items in footnote (9) above and short-term debt.

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ITEM 7—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

Certain statements contained in this Management’s Discussion and Analysis (MD&A), including, without limitation, statements containing the words “may,” “will,” “can,” “anticipate,” “believe,” “plan,” “estimate,” “continue,” and similar expressions constitute “forward-looking statements.” These forward-looking statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including risks described in the Risk Factors sections and elsewhere in this filing. Except for our ongoing obligation to disclose material information as required by federal securities laws, we do not intend to update you concerning any future revisions to any forward-looking statements to reflect events or circumstances occurring after the date of this report. The following discussion should be read in conjunction with the Risk Factors as well as our financial statements and the related notes.

Introduction

We are a worldwide organization and leading designer and manufacturer of hundreds of high-quality brand name AC/DC and DC/DC power supplies and converters and power management products. We sell our products to original equipment manufacturers, distributors and service providers who value quality, reliability, technology and service. We have hundreds of customers in the communications, industrial, transportation, automatic/semiconductor test equipment, medical equipment and other electronic equipment industries.

Our AC/DC power supplies are typically embedded in our customers’ products and convert alternating current to direct current. Our board-mounted DC/DC products provide precise levels of DC power to sensitive electronic components embedded in our customers’ equipment. Our power management products also provide precise levels of DC power to sensitive electronic components, but include elements of communications and control. In addition, our power management products are programmable via a graphical user interface and offer our customers significant cost and time savings over traditional DC/DC converters. Our DC power systems, which provide back-up power, are sold to telecommunications and Internet service providers worldwide.

In February 2005, we announced a restructuring plan in which we consolidated our division structure. The most significant components of this plan involved the elimination of most DC power systems operations in Norway and their integration into our other existing locations, as well as the elimination of certain manufacturing operations in North America and subsequent transfer of the manufacturing to our other existing locations or to contract manufacturers. In addition, we implemented cost reductions in other areas of the Company. We have seen an increasing portion of the $30 million in targeted annual cost savings each quarter during 2005. We incurred $16.2 million of restructuring and asset impairment charges during 2005, of which approximately $5.1 million were non-cash in nature and primarily related to asset impairment charges for long-lived assets. The balance of the charges related to severance and continuing lease obligations for closed facilities, the longest of which continues into 2011.

All products are sold under the Power-One brand name by our sales force. We have two product lines, referred to as “embedded products” and “power systems.” Embedded products include AC/DC power supplies, DC/DC converters (“Bricks”) and POLs, and power management products, while the power systems product line is comprised of the DC power systems.

Our Silicon Power Systems (“SPS”) group is strategically significant to the Company and is engaged in the design and production of highly innovative and efficient silicon-based digital power management

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solutions for next generation DC/DC power conversion products in the Intermediate Bus Architecture (IBA) market. SPS’ maXyz™ product line was introduced in 2003 and was developed specifically for the IBA market. In 2004, we introduced our new Z-One™ digital power management architecture and our new Z-series product line which included a digital controller. We began full production of these products near the end of the third quarter of 2004, and signed on C&D Technologies as a second-source licensing partner for these products. We have continued to strengthen our Z-One Alliance by announcing the addition of Atmel to the partnership during the third quarter of 2005, and by establishing a Z-Alliance™ website at www.Z-Alliance.org. During the first quarter of 2005, we introduced the Z-1000 No-Bus™ family of digital point-of-load converters, which provides customers with digital power conversion without requiring a change in architecture. In response to our new technology, certain of our competitors have formed a consortium in an attempt to develop competing technologies. We filed a lawsuit on September 30, 2005 against Artesyn Technologies, Inc. and against Silicon Laboratories, Inc. on December 14, 2005 for infringement of patents held by the Company related to this technology. The lawsuits seek compensatory damages and a permanent injunction to prohibit these companies from making, using, selling or offering to sell infringing products, and are in the earliest stages.

We have spent and anticipate spending significant capital on R&D related to this developing area of power management technology, but there can be no assurance that the market will accept the resulting technology or that we will recover our investment in this technology through sales of new products. The costs related to defending our patents and intellectual property may be material to our results of operations.

In May 2005, the Board of Directors authorized the purchase of up to $20 million in shares of our common stock with the intent to retire the shares. This authorization expires on December 31, 2006. During 2005, we repurchased and retired 0.8 million shares of our common stock for approximately $4.3 million.

We generate a significant percentage of our revenue internationally through sales offices located throughout Europe and Asia. In addition, manufacturing is performed in our own facilities in the Dominican Republic, China, and Slovakia, and at contract manufacturers in Asia. Approximately 50% of our products are manufactured by our contract manufacturers. We believe that the increased use of contract manufacturers will provide us with greater flexibility and a better ability to respond to changes in the market and will be less capital intensive. We are significantly increasing our presence in Asia to take advantage of its lower cost structure and closer proximity to certain major customers. However, we recognize that there are inherent risks to our international operations that may impact our business, which include but are not limited to the following:

·  Currency risk, since we will increasingly receive payments and purchase components in foreign currencies and we have historically not engaged in foreign currency hedging activities;

·  Risk associated with expanding sales or manufacturing operations into economies and markets that may experience financial or political instability;

·  Differing degrees of intellectual property protection outside of the United States;

·  Frequent changes in laws and policies affecting trade, investment and taxes, including laws and policies relating to repatriation of funds and to withholding taxes, that are administered under very different judicial systems;

·  Increased reliance on overseas contract manufacturers that may not be able to manufacture and deliver products in the quantity, quality and timeline required; and

·  Additional time constraints on management associated with overseeing an increased number of small operations that are geographically dispersed across Asia.

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We are subject to local laws and regulations in various regions in which we operate, including the European Union (“EU”). In particular, two current EU directives may have a material impact on our business. The first is the Restriction of Certain Hazardous Substances Directive (“RoHS”), which restricts the distribution of certain substances, including lead, within the EU and is effective July 1, 2006. In addition to eliminating and/or reducing the level of specified hazardous materials from our products, we will also be required to maintain and publish a detailed list of all chemical substances in our products. We are starting to see requests from our customers, including some of our major customers, for RoHS-compliant products. We are in the process of compiling RoHS-compliant information on our products as well as procuring RoHS-compliant material and information from our suppliers.

The second directive is the Waste Electrical and Electronic Equipment Directive (“WEEE”), which was effective August 13, 2005 in certain jurisdictions and requires covered manufacturers or importers to recycle or dispose of all products manufactured or imported into the EU by a party which is subject to the directive at its own expense at the end of the products’ useful lives. It is our current position and interpretation of the WEEE directive that our products are not directly covered by or such as to require to our direct compliance with the directive. We believe our end customers bear the responsibility for WEEE directive compliance for the products and/or systems in which our products are components.

There are certain risks we face in complying with, or seeking to conduct our business in connection with, the RoHS and WEEE directives, which include but are not limited to the following:

·  For RoHS

·   We may be unable to procure appropriate RoHS-compliant material in sufficient quantity and quality and/or may be unable to incorporate it into our manufacturing processes without compromising quality and/or impacting our cost structure;

·   We may not be able to sell non-compliant product into the EU or to any customer whose end product will be sold into the EU, which may result in reduced sales;

·   We may face additional excess and obsolete inventory risk related to non-compliant inventory that we may continue to hold for which there is reduced demand and that we may need to write down.

·  For WEEE

·   We may be determined by applicable national regulatory agencies which implement the WEEE directive that certain of our products are directly covered under the WEEE directive, making us directly responsible for WEEE compliance for such products.

·   Our customers may refuse to agree to contractual language which allocates and assigns WEEE responsibility, or demand that we undertake WEEE responsibilities independent of regulatory interpretation.

We are unable to estimate at this time the cost of compliance, if any, with either EU directive. Compliance and non-compliance with these laws may have a material adverse impact on our net sales and operating results.

We operate in an industry where quantity discounts, price erosion, and product obsolescence due to technological improvements, all of which result in decreased revenues in a static environment, are normal. While we see price erosion on most of the products we sell, we also see price erosion (i.e. cost reduction) on many of the components we purchase for inclusion in our products. Product obsolescence refers to the tendency of small and less expensive products to replace larger and more expensive products. In DC/DC bricks, for example, the functions of a full-brick were replaced by half-brick, which was replaced by a quarter brick, which was replaced by a 1/8th-brick, which will eventually be replaced by a 1/16th-brick or

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smaller product. Each successive product is smaller and somewhat less costly than its predecessor, but has usually retained or expanded the functionality of its predecessor. Sales of each successor product typically replace sales of the predecessor product. These phenomena are normal in our industry, and we have experienced price erosion in line with industry trends. Price erosion on our products may negatively impact gross margins. Price erosion may also mask increases in unit sales of certain products.

Critical Accounting Policies

Application of our accounting policies requires management to make judgments and estimates about the amounts reflected in the financial statements. Management uses historical experience and all available information to make these estimates and judgments, although differing amounts may be reported if there are changes in the assumptions and estimates. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts, inventory allowances, restructuring costs, impairment charges, depreciation and amortization, sales returns, warranty costs, taxes and contingencies. Management has identified the following accounting policies as critical to an understanding of our financial statements and as areas most dependent on management’s judgment and estimates.

Revenue Recognition—We recognize revenue when persuasive evidence of an arrangement exists, title transfer has occurred, the price is fixed or readily determinable, and collectibility is probable. We recognize revenue in accordance with Staff Accounting Bulletin No. 104, “Revenue Recognition.” Sales are recorded net of sales returns and discounts, which are estimated at the time of shipment based upon historical data.

We generally recognize revenue at the time of shipment (or at the time of inventory consumption for customers on Vendor Managed Inventory (“VMI”) programs) because this is the point at which revenue is earned and realizable and the earnings process is complete. For most shipments, title to shipped goods transfers at the shipping point, so the risks and rewards of ownership transfer once the product leaves our warehouse. For shipments in which title transfers at a later date, revenue recognition is delayed. Revenue is only recognized when collectibility is reasonably assured. We may charge shipping and handling costs to customers, which are included in revenue and cost of goods sold.

We offer our distributors a standard agreement which includes payment terms, description of rights to return or exchange product, and price discounts. In general, payment is due within 30 days of shipment of the product to the distributors. The distributor has a right to return only if we discontinue a product that the distributor has on hand. The distributor has a right to exchange up to 5% of the dollar value of products purchased within the prior six-month period, so long as the distributor is currently purchasing at least the equivalent dollar value in new product. Estimated product exchanges or returns are accrued for at the time of the sale based on historical information in accordance with Statement of Financial Accounting Standards (SFAS) 48, “Revenue Recognition When Right of Return Exists.” Finally, we may give price discounts to a distributor at the time a purchase order is received from the distributor for product that they will sell to a specific customer. The price discount is available for one year following issuance of the purchase order for items listed on the purchase order. We accrue for the estimated price discount at the time revenue is recognized.

We have a joint venture in Asia which, along with certain of our contract manufacturers, may purchase raw components and other goods from Power-One, and sell finished goods back to Power-One as well as to other third parties. We record revenue on sales to the joint venture and contract manufacturer only when the components and goods are for sales to third parties. When the joint venture or contract manufacturer purchases components that will be assembled and sold back to us, no revenue is recorded because the earnings process has not been completed.

Impairment of Long-Lived Assets and Goodwill—We review the recoverability of the carrying value of long-lived assets using the methodology prescribed in SFAS 144, “Accounting for the Impairment and

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Disposal of Long-Lived Assets.” We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Upon such an occurrence, recoverability of these assets is determined by comparing the forecasted undiscounted net cash flows to which the assets relate, to the carrying amount. If the asset is determined to be unable to recover its carrying value, it is written down to fair value. Fair value is determined based on discounted cash flows, appraised values or other information available in the market, depending on the nature of the assets. Methodologies for determining fair value are inherently based on estimates that may change, such as the useful lives of assets and our cash flow forecasts associated with certain assets. A change in these estimates may result in impairment charges, which would impact our operating results.

We review the carrying value of goodwill and non-amortizable intangible assets using the methodology prescribed in SFAS 142, “Goodwill and Other Intangible Assets.” SFAS 142 requires that we not amortize goodwill, but instead subject it to impairment tests on at least an annual basis and whenever circumstances suggest that goodwill may be impaired. These impairment tests are also dependent on management’s forecasts, which frequently change. A change in our forecasts may result in impairment charges.

Restructuring Costs—Effective January 1, 2003, we adopted and recorded restructuring charges in accordance with SFAS 146, “Accounting for Costs Associated with Disposal Activities,” which requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, in contrast to the date of an entity’s commitment to an exit plan. Restructuring costs were related to the downsizing of our operations and primarily consisted of specific charges that had been incurred or were to be incurred with no future economic benefit. These charges included costs related to personnel severance, continuing lease obligations for vacant facilities and write-off of leasehold improvements and equipment therein, and certain contract termination penalties and other shutdown costs. Calculation of the restructuring reserves includes management’s judgment regarding closed facilities, which include assumptions about the length of time it will take for facilities to be subleased as well as the likely sublease income amount. Changes in these estimates may impact our operating results.

Deferred Income Tax Asset Valuation Allowance—We record a deferred income tax asset in jurisdictions where the Company generates a loss. We also record a valuation allowance against these deferred income tax assets in accordance with SFAS 109, “Accounting for Income Taxes,” when, in management’s judgment, it is more likely than not that the deferred income tax assets will not be realized in the foreseeable future.

Inventories—Inventories are stated at the lower of cost (first-in, first-out method) or market. Slow moving and obsolete inventory are written down quarterly based on a comparison of on-hand quantities to historical and projected usages. Additionally, reserves for non-cancelable open purchase orders for components we are obligated to purchase in excess of projected usage, or for open purchase orders where the market price is lower than the purchase order price, are recorded as other accrued expenses on the balance sheet. Calculation of inventory write-downs is based on management’s assumptions regarding projected usage of each component, which are subject to changes in market demand.

Accounts Receivable and Allowance for Doubtful Accounts—We establish the allowance for doubtful accounts using the specific identification method and also provide a reserve in the aggregate. Our estimates for calculating the aggregate reserve are based on historical information. Any changes to our assumptions or estimates may impact our operating results.

Recent Pronouncements and Accounting Changes—In November 2004, the FASB issued SFAS No. 151, “Inventory Costs an amendment of ARB No. 43, Chapter 4” (SFAS No. 151). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, handling costs and wasted material (spoilage). Among other provisions, the new rule requires that such items be recognized as current-period charges, regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. SFAS No. 151 is effective for fiscal years beginning

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after June 15, 2005. We do not expect that adoption of SFAS 151 will have a material effect on the Company’s financial position, results of operations, or liquidity.

In December 2004, the FASB issued SFAS 123(R), “Share-Based Payment,” which revises SFAS 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” We adopted SFAS 123(R) in the first quarter of fiscal 2006 using the modified prospective method and will continue to evaluate the impact of SFAS 123(R) on our operating results and financial condition. Valuing a stock option is a complex calculation that can be performed by a number of valuation methods, such as the Black-Scholes or lattice binomial methods. Each valuation method, however, may utilize a number of management judgments as calculation inputs, including but not limited to the expected life of the option, expected forfeitures, and future volatility. We will recognize the compensation cost for stock-based awards issued after December 31, 2005 on a straight-line basis over the requisite service period for the entire award. Changes in the our estimates of the valuation assumptions may materially impact the valuation of any options granted and therefore impact operating results if a substantial number of options are granted in the future.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3” (SFAS 154). This Statement replaces APB Opinion No. 20, “Accounting Changes,” and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements,” and changes the requirements for the accounting for and reporting of a change in accounting principle by requiring retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impractical to determine either the period-specific effects or the cumulative effect of the change. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. In addition, the Statement requires that a change in depreciation or amortization for long-lived assets be accounted for as a change in accounting estimate effected by a change in accounting principle. When a pronouncement includes specific transition provisions, those provisions should be followed. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Consequently, we will adopt provisions of SFAS 154 for the fiscal year beginning January 1, 2006. Management currently believes the adoption of the provisions of SFAS 154 will not have a material impact on the Company’s financial position or results of operations.

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Results of Operations

The years ended December 31, 2005 and 2003 represent 52-week years and the year ended December 31, 2004 represents a 53-week year. The following table represents our consolidated statements of operations as a percentage of net sales for the periods presented:

 

Comparison of Fiscal Year Ended December 31, 2005 with Fiscal Year Ended December 31, 2004

Net Sales.   Net sales decreased $18.7 million, or 7%, to $261.6 million for the year ended December 31, 2005 from $280.3 million for the year ended December 31, 2004. Sales decreases for the year ended December 31, 2005 were attributable to volume decreases in sales to certain communications and semiconductor automatic test equipment industry customers. The industry experienced a softening across all market segments during 2005 as compared to the moderate growth seen in the industry during 2004.

Net sales for our two product lines are as follows, in millions:

 

Net sales by customer category are as follows, in millions:

 

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Cisco Systems and its contract manufacturers collectively were the only customer to exceed 10% of net sales in either years ended December 31, 2005 or 2004 with $39.6 million, or 15% of net sales, and $42.3 million, or 15% of net sales, in each respective year.

Net sales by end-markets were as follows:

 

Our combined 180-day and 90-day backlog are summarized as follows:

 

Our combined 180-day backlog on December 31, 2005 was $34.7 million, a decrease of 9% compared to backlog of $38.0 million on December 31, 2004. The decrease in backlog primarily reflects the shorter lead times and a temporary build-up of inventory at our customers during the fourth quarter of 2005. Our bookings were not significantly impacted by any new Vendor Managed Inventory (“VMI”) programs during 2005. When VMI programs are initiated by customers, bookings are canceled (or never placed) and replaced by a forecast. We then supply product to the customer per an agreed-upon electronic “signal” or an order placed to ship the goods, and the customer uses the inventory as needed. Under a VMI program, the booking and billing occur simultaneously upon use of the product, and therefore there is always a book-to-bill ratio of 1.0 for these programs. We may bring additional VMI programs on-line in the future, which could result in higher turns business and a lower backlog. As such, we believe that backlog may not necessarily be a reliable indicator of future results over time.

Gross Profit (Loss).   Gross profit for the year ended December 31, 2005 was $76.7 million compared with a gross profit of $97.9 million for 2004. As a percentage of net sales, gross profit percentage decreased to 29.3% for the year ended December 31, 2005 from a gross profit percentage of 34.9% for the same period in 2004. The decrease in gross margin during the year ended December 31, 2005 was primarily due to two factors. First, the decrease of $18.7 million in sales related to the volume sold during 2005 compared to 2004 negatively impacted our margin by approximately 4%. Second, the gross margin was negatively impacted by approximately 1 point by a write-off of excess inventory resulting from a shift in our forecasted product mix as well as from product rationalization in our telecom power systems division in Europe. We recorded $6.0 million in cost of goods sold related to the write off of the excess inventory and other inventory adjustments during the year ended December 31, 2005 compared to $3.1 million related to write-offs of excess and obsolete inventory recorded during the year ended December 31, 2004.

Selling, General and Administrative Expense.   Selling, general and administrative expense decreased $9.2 million, or 14%, to $58.6 million for the year ended December 31, 2005 from $67.8 million for 2004. As a percentage of net sales, selling, general and administrative expense decreased to 22% for the year ended December 31, 2005 from 24% for the same period in 2004.

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Selling expense decreased $5.2 million, or 18%, to $24.3 million for the year ended December 31, 2005 from $29.5 million for 2004. The decrease in selling expenses during the year ended December 31, 2005 was primarily due to the decrease in product revenue during 2005, lower commission expense, reduced bonus expense, and due to personnel reductions as a result of the restructuring plan implemented during 2005.

Administrative expense decreased $4.0 million, or 11%, to $34.3 million for the year ended December 31, 2005 from $38.3 million for 2004. The decrease was primarily due to cost savings resulting from the restructuring of our North American and European operations during 2005.

Engineering and Quality Assurance Expense.   Engineering and quality assurance expense decreased $5.3 million, or 12% to $36.9 million for the year ended December 31, 2005 from $42.2 million for 2004. As a percentage of net sales, engineering and quality assurance expense decreased to 14% for the year ended December 31, 2005 from 15% for the same period in 2004.

Engineering expense decreased $5.5 million, or 15%, to $30.9 million for the year ended December 31, 2005 from $36.4 million for the same period in 2004. The decreases in engineering expense were primarily due to cost savings resulting from the restructuring of our North American and European operations during 2005.

Quality assurance expense increased $0.2 million, or 4%, to $6.0 million for the year ended December 31, 2005 from $5.8 million for the same period in 2004. Quality assurance expense for the year ended December 31, 2005 included support costs related to the transfer of production, both internally and externally to contract manufacturers, which resulted from the restructuring of our operations in Norway and North America, as well as expense related to the RoHS initiative.

Amortization of Intangible Assets.   Amortization of intangible assets remained constant at $3.9 million for both years ended December 31, 2005 and 2004.

Other changes in intangible asset balances from period to period relate primarily to the translation of the intangible asset balances from our subsidiaries’ functional currencies into U.S. dollars.

Restructuring Charge during Fiscal Year Ended December 31, 2005.   Effective January 1, 2003, we adopted SFAS 146. During 2005, we recorded pre-tax cash restructuring charges of $11.1 million in accordance with SFAS 146, of which $4.7 million related to severance payments for a reduction in headcount and $6.2 million related to consolidation of excess facilities. The charges were a result of our plan to restructure our organization and to realign and consolidate our telecom power systems business, as well as consolidate our domestic facilities. We estimate that overall we will save approximately $30 million annually as a result of the restructuring initiatives implemented and have seen an increasing portion of these savings during the latter half of 2005. A summary of the restructuring activity recorded under SFAS 146 during the year ended December 31, 2005 is as follows, in millions:

 

Asset Impairment.   As a result of the restructuring, during 2005 we recorded $5.1 million in asset impairment non-cash charges, in accordance with SFAS 144, for our building in Norway that was sold during the fourth quarter of 2005, for leasehold improvements for leased facilities whose operations are being closed, and for other long-lived assets that will no longer be used.

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Loss from Operations.   As a result of the items above, loss from operations increased $19.8 million to a loss of $38.9 million for the year ended December 31, 2005 from an operating loss of $19.1 million for the same period in 2004.

Interest Income (Expense), Net.   Net interest income was $2.2 million for the year ended December 31, 2005 compared to net interest income of $1.2 million for the same period in 2004. The increase in net interest income between periods is largely attributable to changes in our cash management plan as well as to the decrease in interest expense resulting from the repayment of our long-term debt during the quarter ended March 31, 2004.

Other Income (Expense), Net.   Net other income was $0.3 million for the year ended December 31, 2005, compared with net other expense of $0.2 million for 2004. Net other income during 2005 included $1.7 million net gains related to foreign currency fluctuations, and $0.6 million of proceeds from the settlement of a lawsuit, offset by $2.0 million related to the impairment of certain foreign investments resulting from a forecast reduction for those enterprises and the related cash flow. Components of other expense during 2004 include the write-down of $1.1 million related to an investment we hold in a privately-held technology company and foreign currency losses, offset by income related to our joint venture and a VAT tax refund in Europe.

Provision for Income Taxes.   The provision for income taxes was $1.8 million for the year ended December 31, 2005 at our profitable international locations, compared to the provision for income taxes of $3.1 million for 2004. For the year ended December 31, 2005, we recorded a deferred income tax asset valuation allowance of approximately $14.3 million compared to $10.1 million recorded during the same period in 2004.

We record a deferred income tax asset in jurisdictions where we generate a loss. We also record a valuation allowance against these deferred tax assets in accordance with SFAS 109, “Accounting for Income Taxes,” when, in management’s judgment, it is more likely than not that the deferred income tax assets will not be realized in the foreseeable future.

Comparison of Fiscal Year Ended December 31, 2004 with Fiscal Year Ended December 31, 2003

Net Sales.   Net sales increased $24.0 million, or 9%, to $280.3 million for the year ended December 31, 2004 from $256.3 million for the year ended December 31, 2003. We continued to see moderate growth within our industry during 2004 as customers ordered product at levels that reflected their current needs. Sales increases were attributable to volume growth in sales to certain communications and semiconductor automatic test equipment industry customers, and distributors. In addition, we estimate that approximately $8 to $10 million of the increase in net sales related to sales in foreign currencies as the US dollar experienced significant weakening during 2004.

Net sales for our two product lines were as follows, in millions:

 

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Net sales by customer category were as follows, in millions:

 

Cisco Systems and its contract manufacturers collectively were the only customer to exceed 10% of net sales in both years ended December 31, 2004 and 2003 at $42.3 million, or 15% of net sales, and $39.4 million, or 15% of net sales, in each respective year.

Net sales by end-markets were as follows:

 

Our combined 180-day and 90-day backlog are summarized as follows:

 

Our combined 180-day backlog on December 31, 2004 was $38.0 million, a decrease of 4% compared to backlog of $39.6 million on December 31, 2003. The slight decrease in backlog primarily reflects the shorter lead times within the industry. Our bookings were not significantly impacted by any new Vendor Managed Inventory (“VMI”) programs during 2004. When VMI programs are initiated by customers, bookings are canceled (or never placed) and replaced by a forecast. We then supply product to the customer per an agreed-upon electronic “signal” or an order placed to ship the goods, and the customer uses the inventory as needed. Under a VMI program, the booking and billing occur simultaneously upon use of the product, and therefore there is always a book-to-bill ratio of 1.0 for these programs. We may bring additional VMI programs on-line in the future, which could result in higher turns business and a lower backlog. As such, we believe that backlog may not necessarily be a reliable indicator of future results over time.

Gross Profit (Loss).   Gross profit for the year ended December 31, 2004 was $97.9 million compared with a gross profit of $94.7 million for 2003. As a percentage of net sales, gross profit percentage decreased to 34.9% for the year ended December 31, 2004 from a gross profit percentage of 36.9% for the same period in 2003. Two factors contributed to the decrease in gross margin during the year ended December 31, 2004. First, we recorded $3.1 million, or approximately 1 point, in cost of goods sold related to write-offs for excess and obsolete inventory, the majority of which was related to some of our power

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systems products which are being discontinued. Second, during 2004 our product mix was unfavorable due to a decrease in sales of high-power products which carry an above-average gross margin, as well as significantly higher sales of telecom power systems to one of our largest telecom customers and of other embedded products, which have lower gross margins. We estimate that the product mix and volume sold in 2004 compared to 2003 negatively impacted our gross margin by approximately $1.5 million, or nearly one percent.

Selling, General and Administrative Expense.   Selling, general and administrative expense increased $5.4 million, or 9%, to $67.8 million for the year ended December 31, 2004 from $62.4 million for 2003. As a percentage of net sales, selling, general and administrative expense remained constant at 24% for the years ended December 31, 2004 and 2003.

Selling expense increased $4.2 million, or 16%, to $29.5 million for the year ended December 31, 2004 from $25.3 million for 2003. Increases were primarily due to $1.5 million higher commissions expense during 2004 related to increased sales, increases in our sales force of $0.8 million, as well as foreign currency fluctuations related to the weakening US dollar.

Administrative expense increased $1.2 million, or 3%, to $38.3 million for the year ended December 31, 2004 from $37.1 million for 2003. The increase in administrative expense was primarily due to costs associated with audit fees related to Sarbanes-Oxley legislation, legal work associated with patent filings related to new products, various corporate projects, as well as foreign currency fluctuations. These increases were partially offset by cost savings resulting from the restructuring of our European operations.

Engineering and Quality Assurance Expense.   Engineering and quality assurance expense increased $1.4 million, or 4% to $42.2 million for the year ended December 31, 2004 from $40.8 million for 2003. As a percentage of net sales, engineering and quality assurance expense decreased to 15% for the year ended December 31, 2004 from 16% for the same period in 2003. The increases in engineering and quality assurance expenses were primarily due to foreign currency movements.

Amortization of Intangible Assets and Goodwill Impairment.   Amortization of intangible assets increased $0.3 million, or 8%, to $3.9 million for the year ended December 31, 2004 from $3.6 million for the same period in 2003. The increase in amortization expense was associated with the acquisition of di/dt in February 2003, which resulted in twelve months of amortization expense recorded during the year ended December 31, 2004 compared to ten months of amortization expense recorded during the same period in 2003.

Other changes in intangible asset balances from period to period relate primarily to the translation of the intangible asset balances from our subsidiaries’ functional currencies into U.S. dollars.

Restructuring Charge during Fiscal Year Ended December 31, 2004.   Effective January 1, 2003, we adopted SFAS 146. During 2004, we recorded pre-tax cash restructuring charges of $1.1 million primarily related to severance payments for a reduction in headcount in our European operations and other costs related to our restructuring of the Boston, Massachusetts facility in 2001. A summary of the restructuring activity recorded under SFAS 146 during the year ended December 31, 2004 is as follows, in millions:

 

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