Dialog Semiconductor
Annual Report 2004

Plain-text annual report

Dialog Semiconductor Annual Report 2004 Dialog Semiconductor Plc — Five-Year Financial Summary Selected Financial Data (in thousands of €, except per share, equity ratio and em- ployee data) 2004 2003 2002 2001 2000 Earnings data Revenues Research and development expenses Operating profit (loss) Net income (loss) Cash flow from operations 1) Balance Sheet data Cash and cash equivalents Marketable securities Liquid assets Shareholders’ equity Equity ratio in % Total assets Capital expenditures Share data Basic earnings (loss) per share Weighted average number of shares (in thousands) - basic Other data Employees (at December 31) 116,044 (29,071) (6,088) (5,743) (8,601) 13,977 17,542 31,519 121,135 85.3 141,959 12,321 (0.13) 44,025 92,893 (30,590) (13,224) (20,420) 7,588 8,109 44,900 53,009 126,843 90.3 140,471 5,901 (0.46) 43,951 77,104 (34,530) (27,406) (10,208) (7,596) 31,005 – 31,005 147,495 88.8 166,073 3,872 (0.23) 43,888 100,519 (31,256) (24,136) (41,386) 15,139 32,626 – 32,626 158,092 88.3 179,062 3,157 (0.94) 43,788 214,459 (22,898) 38,387 26,650 18,072 29,879 – 29,879 199,287 80.5 247,572 39,024 0.62 42,669 296 273 284 287 268 1) In 2000 excluding advance payments to secure silicon capacity of € 23,201. Overview of the legal group structure Overview of the legal group structure Dialog Semiconductor Plc , UK Dialog Semiconductor GmbH, Germany, Headquarters Sales, Marketing, Design & Test Dialog Semiconductor Inc., USA Sales, Marketing & Design North America Dialog Semiconductor UK Ltd., Dialog Seminconductor UK Ltd., United Kingdom United Kingdom Sales, Marketing & Design Sales, Marketing & Design Northern Europe Northern Europe Dialog Semiconductor KK Dialog Semiconductor KK Japan Japan Sales, Marketing & Design Sales, Marketing & Design Japan Japan Unaudited Quarterly Financial Information 2004 Revenues Gross margin Selling, general and administrative expenses Research and development Amortization of intangible assets Restructuring and related impairment charges Operating profit (loss) Financial income (expense), net Recovery of investment Result before income taxes Income taxes Net income (loss) Basic earnings (loss) per share 2003 Revenues Gross margin Selling, general and administrative expenses Research and development Amortization of intangible assets Restructuring and related impairment charges Operating profit (loss) Financial income (expense), net Recovery of investment Result before income taxes Income taxes Net income (loss) Basic earnings (loss) per share 2002 Revenues Gross margin Selling, general and administrative expenses Research and development Amortization of intangible assets Operating profit (loss) Financial income (expense), net Recovery of investment Result before income taxes Income taxes Net income (loss) Basic earnings (loss) per share Q1 23,000 7,974 (2,668) (7,387) (486) (59) (2,626) 248 54 (2,324) 836 (1,488) (0.03) Q1 21,015 6,221 (2,335) (8,767) (551) (1,465) (6,897) 2 166 (6,729) 1,864 (4,865) (0.11) Q1 19,063 5,516 (2,297) (7,996) (447) (5,224) 362 6,457 1,595 (588) 1,007 0.02 Q2 30,402 10,229 (2,799) (6,923) (474) - 33 161 - 194 (69) 125 0.00 Q2 21,086 6,472 (2,344) (7,455) (553) (315) (4,195) 205 - (3,990) 1,352 (2,638) (0.06) Q2 17,051 4,648 (2,603) (8,617) (444) (7,016) (1,422) 755 (7,683) 2,773 (4,910) (0.11) Q3 31,584 10,373 (2,794) (7,166) (289) - 124 210 - 334 (120) 214 0.00 Q3 23,247 8,008 (2,347) (7,296) (485) (59) (2,179) 71 149 (1,959) 457 (1,502) (0.03) Q3 17,903 4,993 (2,696) (8,574) (540) (6,817) 491 2,675 (3,651) 1,299 (2,352) (0.05) Q4 31,058 7,685 (3,438) (7,595) (271) - (3,619) (264) - (3,883) (711) (4,594) (0.10) Q4 27,545 9,818 (2,215) (7,072) (484) - 47 25 - 72 (11,487) (11,415) (0.26) Q4 23,087 4,538 (3,000) (9,343) (544) (8,349) (228) 2,082 (6,495) 2,542 (3,953) (0.09) Total 116,044 36,261 (11,699) (29,071) (1,520) (59) (6,088) 355 54 (5,679) (64) (5,743) (0.13) Total 92,893 30,519 (9,241) (30,590) (2,073) (1,839) (13,224) 303 315 (12,606) (7,814) (20,420) (0.46) Total 77,104 19,695 (10,596) (34,530) (1,975) (27,406) (797) 11,969 (16,234) 6,026 (10,208) (0.23) Meeting the silicon needs of a new digital age For the first time in the history of electron- ics, the world is experiencing very fast moving demand for everything digital. There seems to be a rapidly growing global appetite for always-connected lifestyles, with the ability to talk, take photos, listen to music, watch movies, play games and connect to the internet at any time. Many products and services enabling this lifestyle have only come to reality within the last 12 months or so – such as mobile phones with multiple megapixel resolution cameras and advanced color displays ena- bling an all-in-one device with additional video download capability; and digital music players capable of playing back hours of downloaded music. electronics equipment manufacturers are having to keep up the pace of new product development to meet consumer demand for the latest must-have gadgets. At Dialog Semiconductor, we work closely with in- dustry leaders in wireless, optics and imag- ing to deliver mixed signal semiconductor solutions that enable these sophisticated electronics products. With over 20 years experience in research, development and manufacture of power management, audio and imaging technol- ogy behind several generations of mobile handsets, our technical knowledge and expertise is also enabling solutions for automotive and industrial electronics mar- kets. As operators and service providers drive market acceptance of this new digital age, Our chip and system-level solutions address two key market areas: Wireless We provide the industry’s most highly integrated power management and audio ICs that improve standby times and there- fore extend battery life in wireless and other hand-held consumer electronics products. On top of this, our CMOS tech- nology image sensors, camera modules, and liquid crystal display drivers add sophisti- cated high-resolution imaging capabilities to these mobile and consumer gadgets. Automotive / Industrial Our application specific ICs are providing the leading automotive manufacturers with engine management and comfort electron- ics systems, based on our expertise in power management and analog and digital circuit system integration. Extending this technology to high voltages, we also pro- vide industrial lighting control system ICs for fluorescent lamps. Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Table of Contents Shareholder Information Letter to our Shareholders Management The Dialog Semiconductor Share in 2004 Corporate Profile Business Overview Our Mission and Strategy Our Solution Our Principal Products Our Principal Customers Our Product Cycle Management Report Executive Summary Operating and Financial Review Results of Operations Trend Information Liquidity and Capital Resources Critical Accounting Policies and Related Uncertainties Risk Factors Outlook Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Consolidated Statements of Operations Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Changes in Shareholders’ Equity Notes to the Consolidated Financial Statements Corporate Governance Report of the Board of Directors Accounting under International Financial Reporting Standards (IFRSs) Corporate Governance Principles Members of the Board of Directors 2 2 4 5 10 10 12 13 14 16 16 19 19 20 21 23 25 27 29 30 31 33 34 35 36 37 38 52 52 52 53 56 Annual Report 2004 | 1 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Shareholder Information Letter to our Shareholders Dear Shareholders, nine months of 2003. However, in the fourth quarter, like others in the industry we were affected by the weak US dollar exchange rate against the Euro. Combined with lower than expected uptake from key customers, this impacted our business, slowing down revenue growth for the full year to 25 percent. Overall, shipments of our ICs for wireless and automotive applications were up in value terms compared to 2003. This is a result of two developments for the Com- pany: one is the addition of new products such as our liquid crystal display (LCD) drivers for wireless handsets, and the sec- ond is continued success in winning design slots within the growing number of hand- sets and other consumer electronic products being designed and manufactured in Asia. Products & partnerships We announced new products and partner- ships in two key areas during 2004 – in display drivers and imaging, and in inte- grated power management ICs. Both are extremely important as we enter an age in which multimedia and communications are reaching unprecedented levels of conver- gence. In displays and imaging, our entry into color LCD driver ICs, announced in Febru- ary 2004, has proved to be a success. We introduced the first products in this family, the DA8912A and DA8913A, in June and started shipping in volume to customers during the second half of the year. We also announced a long-term collabora- tion with Carl Zeiss, a world leader in the optical and optoelectronics industry, to develop and market modules for high qual- ity camera phones. The combination of Carl I am able to report revenue growth of 25 percent in 2004 compared to 2003. Our 2004 revenue grew to €116 million, and we reduced operating losses for the full year by more than 50 percent. With the increased opportunities created by our new products and implementation of an operational review to manage costs appropriate to our revenue levels, we remain positive for steady growth through 2005. Key developments during the year Dialog Semiconductor had significant developments during 2004 on many fronts – new products, partnerships, and further penetration of key markets and customers. We are especially encouraged by the sig- nificant progress represented by the inclu- sion of our audio and power management products in 3G handsets. In 2004 20 mil- lion 3G handsets were shipped worldwide. This market is expected to grow to almost 50 million in 2005. During the first three quarters of 2004, revenue increased 30 percent over the first 2 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Zeiss’ optical expertise and our high quality image sensor capability promises to be exciting as we look to jointly shape the market for next generation camera phones. In power management, we launched the DA9030 in May, the first integrated power management IC (PMIC) to support the Wireless Intel SpeedStep® technology. The IC, targeted at entry-level, mid-range and premium smartphones, personal digital assistants (PDAs) and communicators with highly sophisticated multimedia and inter- net capabilities, provides significant power consumption and system cost savings com- pared to equivalent discrete solutions. Outlook During 2004, we established a very good platform from which to exploit many more opportunities in both the wireless handset market and the automotive electronic in- dustry. The ability to build on our strengths in mixed signal IC design, applications knowledge and experience in the wireless market have resulted in Dialog Semicon- ductor being able to develop and deliver a range of products and solutions to meet our customers’ needs. The Company is therefore continuing to evolve as we establish ourselves as a sup- plier of both application specific standard products (ASSPs) and solutions for wireless and automotive electronic markets, as well as application specific integrated circuits (ASICs). We expect to build further market share in imaging through partnerships with other blue-chip names in opto-mechanical and imaging. In addition, we are working with the leading mobile phone manufacturers to position ourselves as a key supplier of mixed signal devices in a number of differ- ent design sockets within the handset – not just power management or audio. Our product portfolio includes embedded cam- eras and display drivers. With these multiple component design-in prospects, we are positive about the Com- pany’s growth potential in 2005. This would not be possible without the contin- ued commitment of all our stakeholders, so I would like to once again thank all our employees, customers, partners and all others who have helped Dialog Semicon- ductor maintain a growth path in 2004. Kirchheim/Nabern, February 2005 Roland Pudelko CEO & President Annual Report 2004 | 3 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Management Roland Pudelko Chief Executive Officer and President (52) With Dialog Semiconductor since 1989 and served as Executive Director, CEO and Presi- dent from 1998. He has over 20 years experience in management, design and engineering in electronics, including with the Daimler-Benz Group, and TEMIC. Gary Duncan Vice-President, Engineering – Imaging (49) With the company since 1987 and is responsible for the design and development of imag- ing products. Prior experience includes various senior engineering and management posi- tions at Plessey and ES2. Peter Hall Vice-President, Quality and Technical Support (53) Joined in 1987 and is responsible for technical support, IT and quality. Previous manage- ment and engineering positions were at STC Semiconductors and MEM in Switzerland. Erwin Hopf Vice-President, Operations (50) Joined in 2002, after over 20 years experience in various process engineering as well as research and development and production management positions at Siemens Components and Infineon Technologies. Yoshihiko Kido Vice-President, Japan (52) Joined in 2001, after various management positions at General Electric, Act Japan and Seagate. He was also a founding employee of Nippon Ericsson, as procurement director for mobile phones and base station components. Martin Klöble Vice-President, Finance and Controlling (45) With the company since 1999 and previously a partner with KPMG. An MBA graduate and qualified tax consultant and certified public accountant in Germany (Wirtschaftsprüfer) and in the United States (CPA). Martin Sallenhag Director of Product Marketing (36) Joined Dialog Semiconductor in 2001, after roles in management and engineering at Erics- son Mobile Communications and Axis Communications. He is responsible for the technical marketing of Dialog’s product groups. Richard Schmitz Vice-President, Engineering - Mixed Signal ICs (48) Joined in 1989 and is responsible for mixed signal semiconductors for power management & audio, RF, and automotive & industrial products. Previously at Hewlett Packard's instru- ments division and the Institute for Microelectronics, Stuttgart. 4 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance The Dialog Semiconductor Share in 2004 The International Stock Markets in 2004 Following three years ending in losses from 2000 to 2002, and the bull market of 2003, the momentum of the international stock markets slowed a little in 2004. While the most important leading stock exchanges in Europe, the US and Japan were up at the end of the trading year, growth was signifi- cantly slower than in the previous year. In addition to factors such as the development of the dollar-euro exchange rate and the interest rate increase implemented by the Federal Reserve Bank in the summer, the high price of oil was a key negative impact on the continuation of the bull market. The Dow Jones Index of the most important US industrials rose by 3.6 percent over the trading year as a whole. The Nasdaq Com- posite ended 2004 up by8.7 percent. How- ever, both figures disguise the fact that the price level in the US fell considerably at times in late summer. It was not until the last quarter of 2004 that price develop- ments were again increasingly positive, being driven primarily by sustained in- creases in corporate profits and sound economic data. The DAX also shared this development. Following a relatively highly volatile per- formance in the first half-year, prices ral- lied strongly from August, allowing the DAX to rise by7.3 percent at year-end. At the very end of the year, the DAX reached its annual high of 4256 points. In contrast, the TecDAX turned in a negative perform- ance, falling3.9 percent over the year. The Dialog Semiconductor Share Performance The very strong performance of the 2003 trading year continued at the beginning of 2004. Dialog Semiconductor’s share began 2004 with a Xetra closing price of €3.55. Buoyed by, among other things, its inclu- sion in the TecDAX effective from March 22, 2004, Dialog Semiconductor's share developed positively in the opening weeks of the year, reaching its annual high of €4.49 (NASDAQ $5.66) on February 18. While maintaining stable trading volumes, the share remained at around this level until the end of the first quarter. At the start of the second quarter, the per- formance of Dialog Semiconductor's share was initially weaker, though this was in line with the performance of the TecDAX as a whole, which was also down. The share started the second quarter at €4.01 with a quarterly high of €4.09 (NASDAQ $5.00) and a quarterly low of €2.69 (NASDAQ $3.06). As at June 30 – following a tempo- rary recovery from around mid-May to mid-June – the Xetra closing price was €3.08. Largely parallel to the somewhat weaker performance of the TecDAX and interna- tional stock markets as a whole, the price of Dialog Semiconductor's share tracked largely sideways in the third quarter and subsequently also in the fourth quarter, while displaying relatively low volatility and below-average trading volumes. The quarterly high for the third quarter was €3.09 (NASDAQ $3.75) and €2.94 for the fourth quarter (NASDAQ $3.57). The share's development in the final quar- ter of 2004 was largely defined by the announcement of a negative business out- look for the fourth quarter on December 15. With the weakness of the dollar and reve- nue falling short of forecasts in the Mobile Communications sector, Dialog Semicon- ductor was forced to adjust its revenue and earnings targets for the fourth quarter and fiscal 2004 downwards. Following this announcement, the share price dropped significantly by 28 percent to its annual low of €1.63 (NASDAQ $2.29). Leading German indices mixed Annual Report 2004 | 5 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Finally, as a result of this drastic price slide in the final days of trading in 2004, Dialog Semiconductor's share fell 49.7 percent in total as against its closing price on Decem- ber 31, 2003. Looking back over the year, one highlight was the inclusion of Dialog Semiconductor in the TecDAX. Thus, since March 22, 2004, Dialog Semiconductor's share has been listed in the blue chip index for the 30 largest technology stocks in the Prime Standard. The share's listing in this index came as a result of the improved perform- ance of Dialog Semiconductor's share in 2003 and market and investor confidence in the progressive change in the company's business orientation and its impact on the trend towards profitability. As at December 31, 2004, in the TecDAX league table, Dialog Semiconductor was placed at 21 for the criterion of trading volume and at 40 for market capitalization. In the preceding Share price movement compared to TecDAX January 2, 2004 - December 30, 2004 months, the share was rated significantly below 35, the threshold used in semi- annual reviews. Against this backdrop, the possibility that Deutsche Börse will remove the share from the TecDAX in its forthcom- ing review cannot be ruled out. However, it has been made clear in the past that consis- tency is often weighted more heavily as a review factor than short-term shortfalls. Taken over the year as a whole, Dialog Semiconductor has good results in this context, which would support its remaining in the TecDAX. Capital Increase On September 24, 2004, the company is- sued 2,000,000 new ordinary shares from authorized capital at a price of £0.10 per share for the employee stock option plan, so as to have shares to serve option rights granted to employees. Dialog Semiconductor Plc TecDAX in % 150 125 100 75 50 25 First Quarter Second Quarter Third Quarter Fourth Quarter Inclusion in the TecDAX 6 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Market prices The following table shows, for the periods indicated, the highest and lowest closing Frankfurt (DLG) NASDAQ (DLGS) First Quarter Second Quarter Third Quarter Fourth Quarter First Quarter Second Quarter Third Quarter Fourth Quarter market prices for our shares on the TecDAX (Xetra) and the NASDAQ: 2004 2003 High € 4.49 € 4.09 € 3.09 € 2.94 $ 5.66 $ 5.00 $ 3.75 $ 3.57 Low € 3.48 € 2.69 € 2.46 € 1.63 $ 4.40 $ 3.06 $ 3.01 $ 2.29 High € 1.31 € 1.64 € 3.28 € 4.39 $ 1.68 $ 1.93 $ 3.80 $ 5.52 Low € 0.82 € 0.85 € 1.56 € 2.90 $ 0.95 $ 0.95 $ 1.80 $ 3.45 Average trading volume per day 237,200 253,640 Investor Relations: Successful Continuation of Dialog with the Financial Community Creating and maintaining transparency for capital market participants – this principle that all TecDAX companies are required to follow was again the maxim of Dialog Semiconductor's financial communication in fiscal 2004. On roadshows in London, Frankfurt, Co- logne and Vienna and at numerous tech- nology conferences, the Dialog Semicon- ductor management team addressed and answered questions put by investors, ana- lysts and journalists. As is traditional when publishing annual results, we held a DVFA analysts’ conference, as well as telephone conferences on the publication of our quar- terly results. Furthermore, some 30 individ- ual meetings were held with investors, analysts and the press worldwide in fiscal 2004. We continued to intensively maintain and extend our investor relations offering on our home page www.dialog- semiconductor.com. In addition to the comprehensive offering of share price overviews, financial reports and other information, of particular note here are, for example, disclosures on all Dialog Semi- conductor Plc directors' dealings in line with Section 15a of the Wertpapierhan- delsgesetz (WpHG – German Securities Trading Act) under the German Corporate Governance Code and all disclosures pub- lished as ad hoc publicity. Intensive exchange of information with investors, analysts and the press Annual Report 2004 | 7 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Investor Relations Activities in 2004 Date February 18 March 15 - 16 March 25 - 26 April 27 April 28 May 12 July 21 July 27 September 16 September 21 October 20 November 2 Location Frankfurt London Event Press and Analyst Conference of 2003 result Roadshow Kepler Equities Frankfurt/Cologne Roadshow Kepler Equities Frankfurt DZ Bank Conference Conference Call Release of first quarter results London Annual shareholders’ meeting Conference Call Release of second quarter results Frankfurt Vienna Frankfurt Roadshow Berenberg Bank Roadshow Dresdner Kleinwort Wasserstein Roadshow WestLB Conference Call Release of third quarter results London Roadshow WestLB Reporting by Financial Analysts In the past fiscal year, we continued to maintain the intensive and ongoing ex- change of opinions and information with financial analysts. The following table shows a selection of institutes and analysts that published re- ports on Dialog Semiconductor or covered our company as part of a peer group analy- sis for the semiconductor industry in 2004. Institution Areté Research Berenberg Bank BW Bank DZ Bank ING BHF-Bank Kepler Equities LBBW MM Warburg SES Research WestLB Panmure Analyst Brett Simpson Dr. Oliver Wojahn Helmut Bartsch Harald Schnitzer Manuel Deimel Ingo Queiser Stephan Wittwer Michael Bahlmann Oliver Drebing Dr. Karsten Iltgen Share Data (share prices refer to Xetra, Frankfurt Stock Exchange) Stock Exchanges and Symbols Frankfurt Stock Exchange (Prime Standard) : DLG Security Identification Number (SIN) Number of shares as of Dec. 31, 2004 Share price as of Dec. 31, 2004 (in €) 2004 High (in €) 2004 Low (in €) Performance since offering Trading volume per day (average 2004) Market capitalization (in millions of €) Basic loss per share 2004 (in €) NASDAQ, USA : DLGS 927 200 46,068,930 1.71 4.49 1.63 (82%) 237,200 79 (0.13) 8 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Principal Shareholders Information regarding entities known by the company to be beneficial owners of more than 3 percent of outstanding shares in the company is shown in the table below: Name Apax Partners Adtran, Inc. Ericsson Radio Systems AB Free float (1) Total Number 8,460,793 2,520,960 2,101,554 32,985,623 46,068,930 Percent 18.4 5.5 4.5 71.6 100.0 (1) Of which 4,688,171 shares (10.2%) are held by the Capital Group Companies Inc as notified on January 13, 2005 on behalf of discretionary clients. 2,001,559shares (4.3%) are held by the Dialog Semiconductor Plc Benefit Trust. Disclosure of Interests The provisions of the UK Companies Act of 1985 require that any person acquir- ing a direct or indirect interest of 3 percent or more of a class of shares issued by the company (including shares held in the form of ADSs) with voting rights at the company's general meetings . must inform the company of its interest within two working days. If the 3 per- cent interest is exceeded, the shareholder must inform the company of any in- crease or decrease of one percentage point in its interest. Annual Report 2004 | 9 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Corporate Profile Innovative IC solutions for wireless, automotive and industrial electron- ics Business Overview Dialog Semiconductor develops and sup- plies a range of innovative integrated cir- cuit (IC) product solutions for wireless, automotive and industrial electronics sys- tems. Our background and strengths are in specific design skills such as mixed signal circuits, image sensing and processing. Our business model is a ‘fabless’ one whereby we design ICs, outsource production of silicon wafers, and then deliver final chips to our customers. Dialog’s customers are designers and manufacturers of mobile handsets and portable electronics products, as well as automotive suppliers. Our chip solutions for their products range from comprehensive and highly integrated power management and audio functions, to image sensors, image processing and multimedia display drivers. History and Development of the Company Our roots are firmly established in the design of complex analog and digital cir- cuits. Dialog Semiconductor originated from the European activities of a US semi- conductor company, International Micro- electronic Products, Inc. ("IMP"), founded in 1981 in Silicon Valley, specializing in mixed signal CMOS semiconductor tech- nology. After being acquired by Daimler- Benz AG and becoming a part of its sub- sidiary Temic Telefunken Microelectronic, Dialog Semiconductor Plc was created as a result of a subsequent management buy- out financed by Apax Partners, Adtran and Ericsson. Then in 1999 we made an initial public offering on the Frankfurt Stock Exchange and in 2000 listed on NASDAQ. In 2002 we acquired the CMOS imaging business and associated Active Pixel Sensor (APS) patent portfolio from Sarnoff Corpo- ration. Throughout our history we have delivered several technology firsts. For example, in 1996 we introduced the first system level CMOS power management device, and four years later the first combined power man- agement and audio device for 3G. In imag- ing, we developed the first digital camera accessory module in 2001 for a leading mobile phone manufacturer, and in 2002 we launched a full VGA resolution camera module as a standard product for high quality photo imaging and video in mobile phones and personal digital assistants (PDAs). 10 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Global Presence Our corporate headquarters office is located near Stuttgart, Germany. To support our growing customer base in greater China we recently, in the first quarter of 2005, opened a new office based in Taipei, Tai- wan. We have additional offices in Ger- many as well as Austria, Japan, United Kingdom and the USA. New office opened in Taipei Our Expertise Dialog Semiconductor’s competitive advan- tage comes from a strong track record in designing, manufacturing, testing and delivering mixed signal circuits produced entirely in complimentary metal oxide semiconductor (“CMOS”) technology. Our core technology expertise is applied across different target markets, enabling maxi- mum return on investment from our re- search and development while delivering the latest technology products for each of these chosen markets. For example, the technology that helps us optimize power usage, processes audio signals, and convert analog or digital data for wireless handsets also provides us with the ability to deliver competitive solutions in automotive, industrial and imaging applications. Our Employees In the year ended December 31, 2004 our global workforce grew to 296 employees in eight locations worldwide, the majority of whom are employed in R&D functions. This represents an 8% headcount increase com- pared with 273 employees at the end of the preceding year. Annual Report 2004 | 11 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Our Mission and Strategy Dialog Semiconductor’s mission is: “To be the leading global supplier of lowest power, highest quality, mixed signal components and system level solutions to the wireless and automotive markets” Achieving this mission requires a clearly focused strategy that we have developed based on: (cid:132) Expanding relationships with key industry leaders (cid:132) Building on a common technology platform (cid:132) Marketing standard product solu- tions (cid:132) Proactively refining customers’ sys- tem architecture (cid:132) Expanding engineering expertise (cid:132) Selectively expanding global capa- bilities (cid:132) Remaining focused on our existing business model (cid:132) Delivering the highest quality prod- ucts The success of this strategy is demon- strated by the strong and growing rela- tionships developed with some of our high profile, high volume customers. They see Dialog Semiconductor as a flexible partner and integral part of their overall supply chain. We work with our customers to rapidly develop appropriate responses, both technically and commercially, to chang- ing market trends and requirements. Through our relationships with partners and manufacturers, we then ensure rapid delivery of quality-approved products to the customer. 12 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Our Solution Dialog Semiconductor’s products address the needs of original equipment manufac- turers (OEMs) requiring either standard products or customer-specific silicon. We design, develop and deliver mixed signal components and system level solutions based on our technology expertise in key areas such as power management, audio- CODECS, imaging and system-on-a-chip integration. Our solutions address two major market requirements in: (cid:132) Wireless communication electronics (cid:132) Automotive and industrial electronics In wireless applications, key factors driving the pace of development of our product solutions are the rapid evolution of smaller and more sophisticated devices packed with advanced capabilities such as wireless communications, digital camera, video and audio. This places huge demands on the power management and requires excellent imag- ing and displays. Dialog Semiconductor’s strength in developing highly integrated power management and audio chips enable optimum use of the battery to prolong usage time, and provide high performance audio playback at the same time. In addi- tion, our excellent image sensors, image processing and display drivers enhance the user experience with the camera and graphical user interface. In automotive and industrial, our products address the safety, management and con- trol of electronics systems in the car; and highly integrated smart power electronics management systems such as electronic ballasts for lighting. With all our products, our customers ac- knowledge our leadership in creating inno- vative silicon solutions in 100% CMOS technology - fully tested and delivered quickly to achieve competitive time-to- market objectives. We address two major markets: Wireless Automotive / Industrial Annual Report 2004 | 13 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Our Principal Products Dialog Semiconductor’s products utilize common technology platforms to deliver unique, highly integrated and high per- formance capabilities for selected target applications. (cid:132) Smart mirror™ LDO (low dropout volt- age) regulators – minimizing current consumption and simplifying circuit design Our main product categories are: (cid:132) High efficiency buck and boost con- (cid:132) Power management and audio ICs (cid:132) Camera modules (cid:132) Liquid crystal display drivers (cid:132) Application specific ICs Power Management and audio ICs The drive towards smaller and more sophis- ticated portable consumer electronics prod- ucts puts the challenge to designers and manufacturers to achieve maximum battery life. Effective power management is there- fore an increasingly vital part of the system – an area in which Dialog Semiconductor has considerable experience as a result of designing chips for hundreds of millions of cellular handsets. We continue to develop new power management products such as the DA9030 and DA9011 introduced during 2004. Combined with our expertise in integrating both low voltage and high voltage circuits for car electronics and lighting control systems, we also deliver custom and intelli- gent power management solutions for automotive and industrial electronics sys- tems. Our chips for cellphones take advantage of the benefits of integrating high perform- ance audio CODEC functions with power management circuits. The two are comple- mentary functions that can be designed onto a single chip, enabling one chip to both improve battery life and provide digi- tal audio playback or hi-fi quality voice. This results in unique power management and audio chips which are highly inte- grated and can contain over 30 different functions, all in a single chip. Typical func- tions include: verters – designed for efficiencies over 90% with currents up to 500mA (cid:132) Programmable multiple chemistry bat- tery chargers – handling all common battery technologies, NiMH, LiJon and polymer (cid:132) Audio CODECs with up to 24-bit capa- bility for digital audio player algo- rithms and based on Dialog’s own digi- tal signal processing (DSP) designs op- timized for minimum power consump- tion and silicon area Camera modules Since developing the first digital camera accessory module for a leading mobile handset manufacturer in 2001, and acquir- ing the CMOS imaging business and associ- ated patent portfolio from Sarnoff Corpora- tion in 2002, Dialog Semiconductor has developed a range of standalone CMOS image sensors and complete modules con- sisting of sensor, image DSP, lens, housing and connector. In 2004 we announced our collaboration with Carl Zeiss Corporation to initiate a program of camera module development utilizing the best of our image sensor and processing technology, and combining it with a high quality lens in an extremely small package using optics from Carl Zeiss. The relationship between our companies is a powerful one that we expect to shape a growing market for high quality camera phones. Our high-resolution, high performance sensors and modules are ideal for embed- ding into wireless handsets and hand-held electronics. In addition the high sensitivity of the pixels and processing capability down to each pixel makes our image sensor technology the ideal choice for automotive systems, where near real-time response is required. New power management IC: DA9030 14 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Key features of our CMOS image sensors include: (cid:132) Superior video in outdoor uncontrolled lighting (cid:132) High confidence image capture (cid:132) Fast response (cid:132) Very low power and low voltage re- quirements (cid:132) High resolution still and streaming video modes Liquid Crystal Display Drivers In 2004 we announced availability of a brand new range of color liquid crystal display (LCD) drivers providing real inno- vation for the mobile phone display market. Delivered as standard parts ready for pro- duction, the DA89xx family delivers supe- rior color performance and low power consumption, while providing mobile phone handset makers the flexibility to customize display parameters for creating differentiation. Our family of color display drivers is spe- cially developed for the growing number of wireless handsets with high-resolution color displays and also with dual displays. The color STN (super-twisted nematic) liquid crystal display (LCD) drivers provide excellent resolution of up to 65,000 colors, and address a demand for higher perform- ance full color, high speed moving images using MLA (multi-line addressing) LCD technology. This ensures faster response time compared to conventional passive matrix displays, and high-speed moving images are supported while maintaining very low power consumption. Products include the new DA8912A and DA8913A, which incorporate fully inte- grated graphic display memory with high speed interfaces and various power man- agement functions to enable a single, low power chip for managing the display in next generation mobile phone handsets and portable electronic products. The devices offer fast display graphic transfer rates, supporting moving images. Application Specific ICs (ASICs) Although we are increasingly seeing stan- dard product solutions addressing a vast majority of customer requirements in our target markets, there is still a demand from some customers for custom solutions. These ASIC solutions are based on our in- house expertise in mixed signal design, and in integrating complex analog high voltage (up to 40V) and other low voltage circuits, all produced in mainstream CMOS technol- ogy. Our expertise is based on many years of experience, proven in-house technology, and the latest CAD tools to rapidly develop leading-edge application specific ICs. This experience is gained from delivering cus- tom solutions for cellular phone handsets, in automotive electronics systems, and in industrial systems. In cellular phones for example, we have developed over 50 different power man- agement designs for the world’s leading cellphone manufacturers. Our ASICs are becoming ever more integrated with many power management functions on the chip – such as high performance LDOs (low drop out voltage regulators), high efficiency AC- DC converters, complete battery charging circuits, programmable LED drivers and USB interfaces. For sophisticated audio capability, we have also successfully inte- grated audio functions on to the same chip – exploiting the complementary nature of power and audio sub-systems. In automotive electronics, our ASICs con- trol safety, engine management, and com- fort electronics for the top automobile manufacturers. This exploits Dialog’s com- petence in power management systems and mixed signal design, together with knowl- edge of integrating high performance ana- log circuits and high-density digital logic and high voltage circuits on a single chip in a standard CMOS process. Our partner- ship with leading automotive equipment suppliers has also resulted in developing chips able to connect directly to high volt- age circuits of up to 40V. In industrial systems, our single chip solu- tions integrate high voltage low power Color LCD driver: DA8912A Annual Report 2004 | 15 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance circuits for electronic ballasts used to con- trol fluorescent lamps. Our customers are using ASICs that integrate, for example, the functionality of power factor correction circuits, lamp management circuits, and half bridge driver. Our expertise in the integration of these circuits forms the basis of highly integrated control chips for smart power electronic systems in other applica- tions such as computer and mobile com- munications systems. Dialog’s solution is ideal for instances where the chip must be highly integrated yet have the ability to control high voltages intelligently using digital circuits on the same chip. Our ASIC solutions are manufactured by leading foundry partners, with which we work in true partnership to ensure our customers can access both the latest CMOS processes, as well as foundry capacity. This enables our customers to meet both costs and time-to-market objectives for their products. We also have our own process engineers in-house to ensure our customers benefit from extracting the optimum capa- bility from a process. Our Principal Customers Our principal customers are recognized wireless communications, consumer elec- tronics, and automotive equipment manu- facturers. These customers are for both our standard products introduced over the last two years, as well as application specific (ASIC) products. The rapidly evolving technology in all our target market sectors means that a partner- ship approach with our customers is essen- tial – whether it is for standard products or for custom solutions. Hence our customers look to Dialog as an outside source of Our Product Cycle As a fabless semiconductor manufacturer, our focus is on developing the products and technology, and then delivering quality- approved products to our customers. Hence we design, develop and supply mixed sig- nal ASICs and ASSPs, outsource the actual manufacture of wafers and assembly to selected foundries and assemblers, and then test the products in-house, before final delivery to customers. The product cycle is as follows: (cid:132) Design and development (cid:132) Manufacture of wafers (cid:132) Assembly and testing (cid:132) Quality and environment control expertise, while the close working relation- ship provides us with an opportunity to continually develop and fine-tune market leading technological expertise with recog- nized industry leaders. Long-term relationships with our customers include those with Ericsson, Motorola and Siemens for wireless communications; Adtran for wireline communications appli- cations; Bosch and Conti Temic for auto- motive applications; and Tridonic for in- dustrial applications. Design and development Our customers gain significant advantage from our ability to rapidly develop mixed signal ASIC and ASSP designs, fostered through many years of design experience and a highly skilled engineering staff of over 150 professionals. Evolving designs are constantly monitored through our design library database, and we achieve rapid design cycles through our strategy of modifying and reusing previously designed building blocks. We use industry standard design tools from suppliers such as Cadence Design Systems, Inc. to increase design automation and top- level simulation to identify system design incompatibilities at an early stage. 16 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Our focus is on furthering our technology expertise in power management, audio- CODECs, image sensors and systems, and display driver technology. We also ensure that our process teams are up to date with the latest commercially available CMOS manufacturing technologies. Our total spend on research and develop- ment in 2004 was €29 million. This re- source was focused on enhancing our soft- ware development, state-of-the-art digital system design, leading edge analog design, as well as test systems. Manufacture of wafers We outsource our wafer production to selected foundries with a demonstrated ability to provide high quality products on tight deadlines. Foundries we use include Chartered Semiconductor Manufacturing Pte., Ltd. in Singapore and Taiwan Semi- conductors Manufacturing Co., Ltd. (“TSMC”). Our choice of technology is CMOS rather than bipolar, primarily because CMOS devices consume less power and permit more transistors to be integrated on a sin- gle chip, essential for the target markets we address. We always aim to ensure that all steps in the manufacturing process can be provided by at least two suppliers, in order to pre- vent shortage or loss of chip production due to market conditions or disasters such as foundry fires. Since the successful manufacture of silicon wafers is critical to our reputation and profitability, we work carefully to identify suitable foundries in order to maintain continuity and security of supply for our customers. We also place, where possible, our own process engineers directly at the fab premises to resolve any potential engi- neering issues and to ensure both the qual- ity and timely delivery of the finished product. Assembly and testing We outsource final assembly of the chips from the wafers to various sub-contractors in the Far East and Europe. Completely assembled chips are then returned to Dialog Semiconductor for final testing before delivery to the customer. All our chips are tested in-house, and no product is delivered to a customer unless it has been tested and approved. Our rigorous testing approach allows us to ensure overall quality control of our manu- factured products. The test programs devel- oped by our test engineers are based upon specifications determined by individual customers as well as our own standard product specifications, and are developed in parallel with the design. Our test equipment is regularly calibrated to ensure the accu- racy of test parameters. Quality and environment control Dialog Semiconductor’s policy is to supply products and services in full compliance with relevant specifications to ensure cus- tomer requirements are met. Hence our quality management system has been es- tablished and is maintained to provide customers with the assurance that our products and services fulfil both their con- tractual requirements as well as future needs. Our main target is to achieve ‘Zero Fails’. An uncompromising approach to quality assurance in every area of our operations, through active participation from every employee within the company, produces a highly structured quality environment that has resulted in Dialog Semiconductor being approved by all our major blue-chip cus- tomers. In addition to ensuring the highest levels of product quality and operational efficiency, we also believe in a commitment to envi- ronmentally friendly products. Responsibil- ity for nature and the environment have been an important part of our company philosophy and activities since 1999. Our aim is to minimize adverse environmental impacts by advancing environmentally compatible product design and environ- mentally friendly activities. As part of this commitment, we maintain a certified environmental management sys- tem in accordance with international stan- Annual Report 2004 | 17 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance dards (ISO14001). Awareness and knowl- edge of environmental issues is promoted throughout the organization so that it becomes a natural part of the decision making process. As a fabless semiconductor company, Dia- log Semiconductor’s business model is based on strategic outsourcing. In order to achieve the highest quality we must de- mand world-class quality standards from both our fabrication and assembly partners as well as our own internal processes to increase our customers’ confidence in our products. Dialog Semiconductor is accred- ited to QS9000/ISO9001:2000/ISO14001 and as an extension of this practice it is our policy to build partnerships with sup- pliers that are also qualified to the same international quality standards. . 18 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Management Report The following discussion of our financial condition and results of operations should be read in conjunction with the audited financial statements included in this annual report, which have been prepared in accordance with US GAAP. Executive Summary We are a global supplier of power man- agement, audio and imaging technology, delivering innovative mixed signal stan- dard products as well as application spe- cific integrated circuits for wireless, auto- motive and industrial applications. To date, we have shipped over 500 million inte- grated circuits for cellular phones. We operate in intense competitive markets and our customers select us based upon numer- ous factors including price, design cycle time, reliability and performance. Our customers purchase our products through periodic orders made throughout the year. The prices paid for each type of product or design are generally agreed with customers on an annual basis for specified volumes of each design ordered by the customer during the year. Potential price reductions in sub- sequent years are typically offset by lower production costs as a result of improved yields, lower wafer costs or smaller chip sizes. Critical success factors for us include the continued growth in the worldwide market for cellular handsets, the completion of our new designs on a timely basis, customers acceptance and implementation of our designs in large-scale production, and continued demand from our key customers for the development of new products. Part- nerships with companies at all levels of business are important for our success in a market dominated by major international semiconductor companies. We rely on our fabless business model that enables us to focus our research and development activi- ties, which are essential for us to respond to our customers’ cutting edge silicon solu- tions requirements and also maintain our competitiveness in our market. Conse- quently, it is critical for us to make signifi- cant and ongoing cash expenditures to fund our research and development activi- ties. We have also made significant invest- ments in long-lived assets, primarily for our in-house test equipment. We have a significant amount of liquid assets on hand, primarily from the remain- ing sales proceeds from the issuance of our ordinary shares in 1999 and 2000, cash generated from operations in previous years and recoveries of certain of our in- vestments and deposits. Substantially all of our near term future cash inflows are ex- pected to come from the sale of our prod- ucts. We generally collect cash from our customers within 58 days after product delivery. However, we derive a substantial portion of our revenues from a relatively small number of wireless communications manufacturers. Sales to two customers individually accounted for 65% of total revenues in 2004. Therefore, the main action we are taking to minimize the risk of this dependency is developing new prod- ucts for new customers; such new products include a range of color liquid crystal dis- play drivers, image sensors and camera modules. Material opportunities we envi- sion include growth in our main market, cellular handsets, based on the expected transition to 3G, and a further worldwide growth in semiconductor sales, especially in Asia. However, our revenues, profitabil- ity and growth could decline if the growth in these markets slows. We believe that our key performance indi- cators are revenues, gross margin and research and development costs, thereby being the main driver of our operating profit or loss. Accordingly, our Board of Directors and management use operating profit as a measure of performance. More than 500 million ICs shipped New products reduce dependency on few customers Operating profit is a key perform- ance indicator Annual Report 2004 | 19 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Operating and Financial Review Forward-looking statements. This annual report contains “forward- looking statements”. All statements regard- ing our future financial condition, results of operations and businesses, strategy, plans and objectives are forward-looking. Statements containing the words “believes”, “intends”, “expects” and words of similar meaning are also forward-looking. Such statements involve unknown risks, uncer- tainties and other factors that may cause our results, performance or achievements or conditions in the markets in which we operate to differ from those expressed or implied in such statements. These factors include, among others, product demand, the effect of economic conditions and conditions in the semiconductor and tele- communications markets, exchange rate and interest rate movements, capital and credit market developments, the timing of customer orders and manufacturing lead times, the changes in customer order and payment patterns, the financial condition and strategic plans of our major customers, insufficient, excess or obsolete inventory, and the impact of competing products and their pricing, product development, com- mercialization and technological difficul- ties, political risks in the countries in which we operate or sale and supply constraints. It is not possible to predict or identify all such factors. Consequently, any such list should not be considered to be a complete statement of all potential risks or uncer- tainties. We do not assume the obligations to update forward-looking statements. The following table sets forth historical consolidated statements of operations of Dialog for the fiscal years ended December 31, 2004, 2003 and 2002 in thousands of Euros and as a percentage of revenues: (in thousands of €) Revenues Cost of sales Gross margin Selling and marketing expenses General and administrative expenses 2004 % of 2003 revenues % of revenues 2002 % of revenues 116,044 100.0 92,893 100.0 77,104 (79,783) (68.8) (62,374) (67.2) (57,409) 36,261 (6,237) (5,462) 31.2 30,519 32.8 19,695 (5.3) (4.7) (4,197) (5,044) (4.5) (5.4) (4,149) (6,447) Research and development expenses (29,071) (25.0) (30,590) (32.9) (34,530) Amortization of intangible assets (1,520) (1.3) (2,073) (2.2) (1,975) 100.0 (74.4) 25.6 (5.4) (8.4) (44.8) (2.5) Restructuring and related impairment charges Operating loss Interest income, net Foreign currency exchange gains and losses, net Recovery of investment (59) (0.1) (1,839) (2.0) - - (6,088) (5.2) (13,224) (14.2) (27,406) (35.5) 1,081 0.9 757 0.8 1,121 1.5 (726) 54 (0.6) - (454) 315 (0.5) (1,918) 0.3 11,969 (2.5) 15.5 Result before income taxes (5,679) (4.9) (12,606) (13.6) (16,234) (21.0) Income tax (expense) benefit (64) (0.1) (7,814) (8.4) 6,026 7.8 Net loss (5,743) (5.0) (20,420) (22.0) (10,208) (13.2) 20 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Results of Operations Revenues Revenues were €116.0 million for the year ended December 31, 2004 compared with €92.9 million for year ended December 31, 2003. The increase of 25% in revenues primarily results from higher sales volumes in our wireless communication and auto- motive markets which more than offset a decline in revenues in our industrial appli- cations sector during the period. Revenues in the wireless communications sector were €90.6 million for the year ended December 31, 2004 compared with €69.9 in 2003, comprising 78% and 75% of our total revenues in the years ended December 31, 2004 and 2003, respectively. Revenues from our automotive applications sector were €11.9 million and €7.9 million, repre- senting 10% and 9% of our total revenues in 2004 and 2003, respectively. Revenues from our industrial applications sector were €13.5 million or 12% of total revenues in 2004 and €15.1 million or 16% of total revenues in 2003. Regional growth was particularly strong in Asia where revenue increased from €24.9 million (China €18.2 million, other Asian countries €6.7 million) to €42.1 million (China €19.7 million, other Asian countries €22.4 million) for year ended December 31, 2003 and 2004, respectively. Due to the shipments of new products in volume production to the market we expect revenues for the year ended December 31, 2005 to be higher than those for the year ended December 31, 2004. However, our forward visibility with respect to customer demand is limited and a successful intro- duction of new products depends on the completion of new designs on a timely basis. Our revenues for 2005 will also be highly dependent on continued growth in the worldwide market for cellular handsets. We cannot give any assurance that this growth trend will continue throughout 2005. Cost of Sales Cost of sales consists of the costs of out- sourcing production and assembly, related personnel costs and applicable overhead and depreciation of test and other equip- ment. Cost of sales increased by 28% from €62.4 million (67.2% of our total revenues) for the year ended December 31, 2003 to €79.8 million (68.8% of our total revenues) for year ended December 31, 2004, in line with increased production volumes. In addition, as a result of introducing new products to volume production in 2004, per unit production costs increased during their ramp-up phase and also increased cost of sales as a percentage of total revenues. Selling and Marketing Expenses Selling and marketing expenses consist primarily of salaries, travel expenses, sales commissions and costs associated with advertising and other marketing activities. Selling and marketing expenses increased from €4.2 million for year ended December 31, 2003 to €6.2 million for year ended December 31, 2004 due primarily to an increase in sales commissions incurred in connection with higher sales volumes. As a percentage of total revenues, selling and marketing expenses increased from 4.5% to 5.3%. General and Administrative Expenses General and administrative expenses con- sist primarily of personnel and support costs for our finance, human resources, information systems and other manage- ment departments. General and administra- tive expenses increased from €5.0 million for the year ended December 31, 2003 to €5.5 million for the year ended December 31, 2004, due primarily to legal fees and other costs incurred in connection with the filing of patent applications. General and administrative expenses decreased from 5.4% of total revenues to 4.7% of total revenues resulting from the proportionally higher revenue base. Revenues (in millions of €) 100 50 0 2002 2003 2004 Cost of Sales (in millions of €) 0 -50 -100 2002 2003 2004 Annual Report 2004 | 21 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Research and Development Expenses Research and development expenses princi- pally consist of design and engineering related costs associated with the develop- ment of new application specific integrated circuits (“ASICs”) and application specific standard products (“ASSPs”). Research and development expenses decreased 5% from €30.6 million for the year ended December 31, 2003 to €29.1 million for the year ended December 31, 2004. The decrease in research and development expenses primar- ily results from continued cost savings following the closure of our Swedish sub- sidiary. Research and development ex- penses decreased from 32.9% to 25.0% as a percentage of total revenues resulting both from the absolute decrease and the propor- tionately higher revenue base. Amortization of Intangible Assets Intangible assets subject to amortization include ASIC design software, a 16-bit microcontroller, licenses and certain imag- ing patents. Amortization expense for the year ended December 31, 2004 was €1.5 million as compared to €2.1 million for the year ended December 31, 2003, a decrease of 27%. Amortization expense decreased as certain intangible assets reached the end of their useful lives. Restructuring and Related Impairment Charges In the second quarter of 2003 we closed our Swedish subsidiary. In connection with the closure of the facility, we recorded restructuring charges of €1.5 million and impairment charges of €0.3 million, total- ing €1.8 million for the year ended Decem- ber 31, 2003. In 2004 we settled a lease obligation in connection with the closure and incurred additional costs of €0.1 million. See Note 3 to the consolidated financial statements for further informa- tion. Operating Loss We reported an operating loss of €6.1 million for the year ended December 31, 2004 and €13.2 million for the year ended December 31, 2003, a decrease of 54%. This decrease in operating loss was primarily due to a higher gross margin and lower restructuring and impairment charges in the year ended December 31, 2004. Interest Income, net Interest income, net from the Company’s investments (primarily short-term deposits and exchange-traded funds) increased from €0.8 million for the year ended December 31, 2003 to €1.1 million for the year ended December 31, 2004 reflecting higher cash equivalents and marketable securities bal- ances during 2004. Foreign Currency Exchange Gains and Losses, net Foreign currency transaction gains and losses result from amounts ultimately real- ized upon settlement of foreign currency transactions and from the period end re- measurement of foreign currency denomi- nated receivables, prepaid expenses and payables into Euro. Foreign currency ex- change losses, net were €0.7 million for the year ended December 31, 2004 and €0.5 million for the year ended December 31, 2003. Recovery of Investment In the fourth quarter of 2001, we deter- mined that our ability to recover the full amount of our investments in silicon sup- plier ESM Holding Limited (“ESM”) was impaired. Accordingly we wrote off our investments in ESM. In March 2002, Inter- national Rectifier acquired ESM. As a result we were able to recover €0.1 million and €0.3 million for the years ended December 31, 2004 and 2003, respectively. Income Taxes Income tax expense was €0.1 million for the year ended December 31, 2004 com- pared with €7.8 million income tax ex- pense for the year ended December 31, 2003. The change in income taxes mainly reflects a valuation allowance on deferred tax assets recognized in 2003 of €11.8 million primarily related to the uncertainty about the future realizability of our German tax-loss carryforwards. See Note 6 to the consolidated financial statements for fur- ther information. Research and Development Expenses (in millions of €) 0 -25 -50 2002 2003 2004 Operating Loss (in millions of €) 0 -25 -50 2002 2003 2004 22 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance manufacturers increasingly using addi- tional applications and graphics processors, and continually demanding even lower power consumption in the same form factor despite incorporating more sophisticated features. Market Trends The biggest market trend in the industry that Dialog Semiconductor addresses is the convergence of multimedia and mobile communications. This means we will see not just camera phones or smart phones, but devices such as PDAs with integrated phone and multimedia capability. There will most likely be an explosion in other mobile gaming and entertainment possibili- ties in the next three years, resulting from the rapid evolution of the mobile handset as we currently know it. Camera phones alone will build on the growth of 200% in 2004 (source: In- Stat/MDR press release, 14 December 2004, "Camera Phone Market Continues to Boom - 200% Growth in Annual Shipments"). Mobile gaming services are expected to generate significant additional revenue in future years, accounting for over 4% of total wireless data revenue in the USA by 2009 (source: In-Stat/MDR press release, 7 September 2004, "Gaming to be Key Con- tributor to Wireless Data Usage and Reve- nues"). Traditional mobile phone handsets will also continue to grow, although not at as great a rate as in the boom years leading up to 2001. Gartner predicts 763 million handsets to be shipped in 2008, compared to 629 million in 2004 (source: Gartner Market Focus Report: “Semiconductors in Mobile Phones, Worldwide, 2004-2008”, 24 De- cember 2004). Trend Information General The semiconductor industry in general is highly cyclical and has been subject to significant economic downturns which, at various times, have resulted in production overcapacity, reduced product demand and an accelerated erosion of average selling prices. Revenues from our wireless communica- tions applications accounted for 78% of our total revenues for the year ended December 31, 2004, 75% of our total revenues for the year ended December 31, 2003 and 71% of our total revenues for the year ended De- cember 31, 2002. According to the Semiconductor Industry Association (SIA), strong growth in sales of personal computers and wireless handsets were among the major drivers of record chip sales in 2004, evidenced by a 28% growth rate in 2004 for the total market for semiconductors (source: SIA press release, 31 January 2005, “Global semiconductor sales hit record $213 billion in 2004”). The wireless handset market saw its first real growth in 3G/WCDMA (Wideband code- division multiple access) phones, with 20 million shipped worldwide in 2004, repre- senting 3% of total handset sales in 2004 (source: Strategy Analytics press release, 14 February 2005,"20 Million 3G Phones Sold Worldwide in 2004”). This growth was driven by aggressive mobile operator mar- keting in Japan and Western Europe to encourage millions of early adopters to upgrade from their existing 2.5G devices. The top handset manufacturers in this space expect the market to more than dou- ble in size in 2005 as usability and styling is improved. Overall wireless handset shipment growth was up last year, as a result of technologi- cal advanced features such as color screens, cameras and clamshell designs. The markets saw more clamshell handsets with dual displays, larger main displays to display content, more sophisticated and higher resolution cameras, and high quality audio. These developments were accompanied by More than 20 million 3G phones shipped in 2004 WCDMA technology ready for commercial launch as networks improve and handsets become generally available Annual Report 2004 | 23 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance In the broader consumer electronics sector, there has also been a burst of consumer interest in devices for playing back downloaded digital music. This trend is likely to fuel interest and also significant growth in portable digital music players, even with the different music download standards such as MP3, AC3 or WMA. In automotive, complex electronics systems were in the past a feature of only the most prestigious cars. However, the growing trend among the manufacturers of lower cost cars is to add more value to their cars, making the electronics systems almost as complex as those of the top end cars. The result will be a mass market rather than niche market for complex electronics sys- tems built in to the car. One other key trend will be the growing use of imaging electronics for driver safety features such as geographic positioning, navigation systems, blind spot detection and white lane departure systems. Geographic Market Trends We allocate our revenues to countries based on the location of the shipment destination. Changes in revenues from period to period have differed among geographical regions. As our customers have continued to in- crease their production in the greater China region and by adding new Asian customers, regional growth was particularly strong in Asia in 2004, where revenue increased by 69% from €24.9 million for the year ended December 31, 2003 to €42.1 million for the year ended December 31, 2003, respec- tively. Particularly in France, we experi- enced decline in demand for our ASIC products where revenue decreased by 58% from €4.5 million for the year ended De- cember 31, 2003 to €1.9 million for the year ended December 31, 2004, due primar- ily to the fact that our contract with one customer based in France was not renewed upon expiration. In 2003, regional growth was particularly strong in Germany and China where revenue increased from €31.5 million for the year ended December 31, 2002 to €45.4 million for the year ended December 31, 2003 and from €13.0 million for the year ended December 31, 2002 to €18.2 million for the year ended December 31, 2003, respectively. In 2003, particularly in France, we experienced decline in de- mand for our ASIC products where revenue decreased from €9.3 million for the year ended December 31, 2002 to €4.5 million for the year ended December 31, 2003. Gross Margin Trends Our gross margin decreased from 32.8% of revenues for the year ended December 31, 2003 to 31.2% of revenues for the year ended December 31, 2004. The weakening of the US dollar against the Euro and the reduction in price of wireless communica- tion ICs were the primary factors contribut- ing to this decrease in our gross margin. Research and Development Expenditure Trends Research and development costs amounted to €29.1 million in 2004, €30.6 million in 2003 and €34.5 million in 2002. We expect to incur research and development costs below the current level based on certain cost savings measures. Our ability to gener- ate revenues in the long term depends on achieving technical feasibility from our research and development programs, and on customers accepting our designs and implementing them in large-scale produc- tion. Foreign Currency Exchange Rate Trends The reporting currency for our consolidated financial statements is the Euro. The func- tional currency for our operations is gener- ally the applicable local currency. Accord- ingly, the assets and liabilities, the equity accounts and the statements of income and cash flow of companies whose functional currency is not the Euro must be translated into the reporting currency (the Euro). See Note 2 to the consolidated financial state- ments for further information. Changes in exchange rates also influence our results of operations. Our sales are primarily denomi- nated in US Dollars and Euro, whereas our purchases of raw materials and manufac- turing services are primarily denominated in US Dollars. In order to hedge our foreign currency exposure, primarily the US Dollar, we at- tempt to match cash inflows and outflows in the same currency. Gross Margin (in millions of €) 50 25 0 2002 2003 2004 24 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Since its introduction on January 1, 1999, the Euro has fluctuated in value against the US Dollar. From the date of its introduction through December 31, 2001, the Euro de- clined approximately 25% against the US Dollar. Through February 04, 2005 the Euro had recovered to 110% of its original value. Changes in the exchange rate between the Euro and other non-Euro currencies, prin- cipally the US Dollar, will affect the trans- lation of our consolidated financial results into Euro, and will also affect the value of any amounts that our subsidiaries distribute to us. Exchange rate changes may also affect our balance sheet. Changes in the Euro values of our assets and liabilities resulting from exchange-rate movements may cause us to record foreign currency gains and losses. We do not currently enter into forward or other derivative transac- tions to hedge against exchange rate fluc- tuations. For the year ended December 31, 2004, 55% of our revenues were denominated in Euro and 45% were denominated in US Dollars, and 18% of our cost of sales was denominated in Euro and 82% was de- nominated in US Dollars. Due to the weak- ening of the US Dollar in the fourth quarter and a higher proportion of US Dollar- denominated revenue compared with previ- ous quarters combined with lower than expected uptake from key customers, our revenue growth was lower in the fourth quarter compared with the first three quar- ters of the year. For the year ended December 31, 2003 78% of our revenues were denominated in Euro and 22% were denominated in US Dollars, and 25% of our cost of sales was denomi- nated in Euro and 75% was denominated in US Dollars. For the year ended December 31, 2002, 76% of our revenues were de- nominated in Euro, 23% were denominated in US Dollars and 1% were denominated in Pound Sterling, and 25% of our cost of sales was denominated in Euro and 75% was denominated in US Dollars. We also have foreign currency risk with respect to our net investments in foreign subsidiaries in Japan, the United Kingdom and the United States. Foreign currency translation gains and losses with respect to these subsidiaries are included in other comprehensive income. Liquidity and Capital Resources Cash flows Cash used for operating activities was €8.6 million for year ended December 31, 2004 compared with cash provided by operating activities of €7.6 million for the year ended December 31, 2003. In the year ended December 31, 2004 we used cash mainly to increase our inventory to meet previously projected forecasts of our customers. We expect this level to be reduced in the first half 2005. In the year ended December 31, 2003, our working capital (excluding cash and cash equivalents and marketable secu- rities) had decreased primarily due to con- tractually required refunds of advance payments from a silicon supplier which resulted in a related operating cash inflow. Cash provided by investing activities was €14.5 for year ended December 31, 2004 compared with cash used for investing activities of €30.3 million for year ended December 31, 2003. Cash provided by investing activities for the year ended December 31, 2004 consisted mostly of a net sale of marketable securities of €27.4 million offset in part by the purchase of test equipment, tooling (masks), laboratory and EDP equipment of €12.3 million, and the purchase of software, licenses and patents of €0.7 million. Cash used for in- vesting activities for the year ended De- cember 31, 2003 consisted mostly of the purchase of marketable securities of €45.0 million, the purchase of test equipment, tooling (masks), laboratory and EDP equipment of €5.9 million, and the pur- chase of software, licenses and patents of €1.4 million. In October 2003, we also received an early repayment of our deposit of €21.7 million (USD 20 million) from Chartered. Annual Report 2004 | 25 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Liquidity At December 31, 2004 we had €14.0 mil- lion in cash and cash equivalents and €17.5 million in marketable securities. The work- ing capital was €67.1 million. Our primary sources of liquidity have his- torically been cash from operations, cash from the issuance of ordinary shares in 1999 and 2000, short-term borrowings, the recovery of the investment in ESM Limited and in 2003 the early repayment of a de- posit from Chartered. As of December 31, 2004 we had no long-term debt. We expect to reduce our working capital in 2005, thereby increasing our cash and cash equivalents and marketable securities in 2005. A decrease in customer demand for our products caused by unfavorable indus- try conditions or an inability to develop new products in response to technological changes could materially reduce the amount of cash generated from operations. If necessary, we have available for use a short-term credit facility of €12.5 million that bears interest at a rate of EURIBOR + 0.75% per annum. At December 31, 2004 we had no amounts outstanding under this facility. Accordingly, we believe the fund- ing available from these and other sources will be sufficient to satisfy our working capital requirements in the near to medium term. Capital Expenditures and Investments Purchases of property, plant and equipment were €12.3 million for the year ended December 31, 2004 compared to €5.9 million for the year ended December 31, 2003 and €3.9 million for the year ended December 31, 2002. Our capital expenditures in 2004, 2003 and 2002 con- sisted primarily of purchasing new or re- placement test systems, tooling equipment, handling systems and other equipment in the ordinary course of our business. Capital expenditures in 2004 increased over that of prior years as we upgraded eight test sys- tems enabling us to test four ICs in a single test step, and added certain test equipment to test color display and image sensor ICs. In 2004, 2003 and 2002 we paid install- ments of €0.3, €0.8 and €1.5 million, re- spectively, for the CMOS imaging technol- ogy and associated CMOS Active Pixel Sensor (APS) patents which we acquired in 2002. We expect capital expenditures in 2005 to be below the 2004 level. In future periods, we may make strategic investments or acquisitions in connection with our plans to expand our business internationally. Off-Balance Sheet Arrangements and Other Commitments We have no off-balance sheet arrange- ments involving variable interest entities. We lease design software, all of our office facilities, office and test equipment, and vehicles under operating leases. Future minimum lease payments under rental and lease agreements, which have initial or remaining terms in excess of one year at December 31, 2004 are as follows (€ thou- sands) (in thousands of €) 2005 2006 2007 2008 2009 Thereafter Operating leases 8,148 6,629 6,399 6,429 3,297 316 We have no long-term debt, capital lease obligations, unconditional purchase obliga- tions or any other long-term obligations that would have a material impact on our liquidity or financial condition. We have supply agreements with various suppliers and maintain an outstanding balance of advance payment of €1.2 million with one supplier, which will be refunded in propor- tion to our purchases of wafers. See Note 11 to the consolidated financial statements. Dividends We did not pay dividends in the years ended December 31, 2004, 2003 and 2002. We do not currently plan to pay dividends in the foreseeable future. 26 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Critical Accounting Policies and Related Uncertainties We have identified the following ac- counting policies and related uncertain- ties with the accounting measures used in preparing our consolidated financial statements that we believe are essential to understanding the financial reporting risks present in the current economic environment. Recoverability of Long-Lived Assets Goodwill At December 31, 2004, the carrying value of our goodwill is €11.8 million. Since 2002, goodwill is no longer amor- tized, but we have, and will continue to evaluate the recoverability of our good- will at least annually or when significant events occur or circumstances arise which indicate that the fair value of the Company may be less than its net share- holders’ equity. The fair value of the Company is determined by estimating the present value of future cash flows, which we believe is a more appropriate measure to determine fair value than the Company’s current market capitalization (which is based on the quoted market price of the Company’s ordinary shares). For purposes of performing step 1 of the impairments test, the fair value of the entire company is determined based on expected cash flows which are derived from the Company’s strategic plan and forecasts. The discount rate applied considered marketplace participant as- sumptions including a risk-free rate, market risk premium and a beta factor that is consistent with the Company’s market peers. If it becomes necessary to change assumptions used to determine the fair value of the company, we may conclude that our ability to recover the carrying value of our goodwill is im- paired. Such an impairment charge could have a material adverse impact on our future result of operations. Other Long-Lived Assets Our business is capital intensive and has required, and will continue to require, significant investments in long-lived assets, including property, plant, equip- ment and intangible assets (other than goodwill). At December 31, 2004, the carrying amount of our property, plant and equipment was €21.2 million. As discussed in Note 2 to the consolidated financial statements, recoverability of these long-lived assets that will continue to be held and used is evaluated when- ever an indication of impairment exists. Then we will compare the carrying amount of the asset or group of assets to the net undiscounted cash flows ex- pected to be generated by the asset or group of assets. If the asset or group of assets is considered impaired, the im- pairment recognized is measured as the amount by which the carrying amount of the impaired asset or group of assets exceeds its fair value. We do not believe that our ability to recover the carrying value of our other long-lived assets has been impaired and no significant impairment charges have been recognized in any of the past three years. However, a general economic downturn and, specifically, a continued downturn in the semiconductor industry would intensify competitive pricing pressure because of overcapacity in the industry, and we could be forced to decrease production and reduce capacity. Such events could adversely affect our estimates of future net cash flows ex- pected to be generated by our long-lived assets. It is reasonably possible that our future operating results could be materi- ally and adversely affected by an im- pairment charge related to the recover- ability of our long-lived assets. Realizable Value of Inventories We value inventory at the lower of cost or market. We review the recoverability of inventory based on regular monitor- ing of the size and composition of the inventory positions, market conditions, current economic events, the pricing environment and projected future de- mand. This evaluation is inherently judgmental and requires material esti- Annual Report 2004 | 27 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Germany, as well as detailed forecasts of taxable income in the foreseeable future. Although we forecasted generating future taxable income, the change in tax law increased the forecasted number of additional years we had to generate such future taxable income in order to fully realize these loss carryforward benefits. Pursuant to SFAS 109 and the inherent uncertainties in projecting future taxable income, we concluded that it is more likely than not that a portion of our tax losses could not ultimately be realized. Consequently, we recognized an addi- tional valuation allowance of €1.9 mil- lion and €11.8 million as of December 31, 2004 and 2003, respectively, to reduce the carrying value of our net deferred tax assets to an amount that we believed was more likely than not ex- pected to be ultimately realized. mates, including both forecasted product demand and pricing environment, both of which may be susceptible to signifi- cant change. Changes in estimates regarding the realizability of the carrying value of our inventory has resulted in excess inven- tory provision of €1.9 million being charged to costs of sales in 2002. No excess inventory provision was required in 2004 and 2003. At December 31, 2004, our total inventory was €29.8 million. We believe that the carrying value of our inventory will be recovered through customer consumption of goods based on their forecasts and related contractual agreements. However, the demand for our products can fluctuate significantly in response to rapid tech- nological changes in the semiconductor and wireless communications industries. It is reasonably possible that future operating results could be materially and adversely affected if any excess inven- tory charges are needed. Realization of Deferred Tax Assets Total deferred tax assets, before the recognition of valuation allowances, were €31.2 million at December 31, 2004, which include deferred tax assets of €25.2 million on tax loss carryfor- wards. While the majority of these losses may be carried forward indefinitely, their realization is dependent on gener- ating sufficient taxable income to utilize the losses. In December 2003, the Ger- man government enacted new tax legis- lation, which among other things, limits the use of German tax-loss carryfor- wards to 60% of the taxable income for fiscal years starting from 2004 and thereafter. We have evaluated our de- ferred tax asset position and the need for a valuation allowance as a result of this change in tax law. The assessment requires the exercise of judgment on the part of our management, with respect to, among other things, benefits that could be realized from available tax strategies and future taxable income, as well as other positive and negative factors. Our assessment considered the weight given to cumulative tax losses incurred in 28 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Risk Factors The market in which we compete is characterized by continuous develop- ment and technological improvement. As a result, our success depends on our ability to develop new designs and products on a cost effective, timely basis. Our future success also depends on our ability to anticipate and respond to new market trends, to rapidly implement new designs which satisfy customers' desires, and to keep abreast of techno- logical changes within the semiconduc- tor industry generally. It is not possible to predict or identify all relevant risk factors and, therefore, the following list should not be considered to be a com- plete statement of all potential risks or uncertainties. (cid:132) We have not been profitable for the last four fiscal years, and there is no guarantee that we will return to profitability (cid:132) We currently depend on a few cus- tomers for a substantial portion of our revenues, and the loss of one or more of these customers may result in a material decline in our revenues (cid:132) Our revenues, profitability and (cid:132) growth could decline if the growth of the wireless communications market slows If we are unable to adapt rapidly to changing markets and technology, we may lose customers and be un- able to develop new business (cid:132) The semiconductor industry is highly cyclical in nature and this results in periodic overcapacity (cid:132) We face intense competition, and if we are unable to compete effectively or if we are unable to adapt rapidly to changing markets and technology, we could lose customers and be un- able to develop new business (cid:132) The loss of one of our principal foundry relationships or assembly services or a delay in foundry or as- sembly production may result in a material loss of production and revenues (cid:132) Obtaining access to manufacturing capacity at semiconductor manufac- turing plants may become increas- ingly difficult and could result in higher costs and a material loss of revenues (cid:132) Perceived health risks relating to cellular handsets could lead to de- creased demand for ASICs (cid:132) Our business, financial condition and reputation may be materially ad- versely affected if our ASICs, or the electronic systems of which they are a part, contain defects that cause damage or injury (cid:132) Our products are difficult to manu- facture and manufacturing defects can adversely affect our results (cid:132) We may not be able to remain com- petitive if we lose any of our key ex- ecutives or if we cannot hire and re- tain qualified engineers and sales and marketing personnel If we are unable to protect our intel- lectual property and knowhow from being copied or used by others, our competitors may gain access to its content and technology (cid:132) (cid:132) The profitability of our business may be adversely affected by currency fluctuations and by the economic and legal developments in the coun- tries where we conduct our business (cid:132) We may become a passive foreign investment company (cid:132) US-resident shareholders may find it more difficult to protect their inter- ests than they would as shareholders of a US-based corporation (cid:132) Our future operating results could be materially affected if judgments un- derlying any of our accounting poli- cies were to significantly change Annual Report 2004 | 29 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Outlook In recent years, convergence of mobile communications and multimedia has been talked about as a key driver for growth in the electronics industry. Dialog Semicon- ductor expects 2005 to be the first year when this is expected to have a major impact on our business. Convergence will drive growth in ship- ments of our integrated circuits (ICs) for power management and color LCD displays as well as camera modules featuring ad- vanced optics for wireless and consumer electronics products. In addition, we ex- pect to see further advances in the use of image sensors in automotive and industrial electronics on top of our established market in safety and comfort electronics in cars. While mobile phone handset growth is expected to rise progressively to 763 mil- lion handsets in 2008 (from 629 million in 2004, source: Gartner Market Focus Report: “Semiconductors in Mobile Phones, World- wide, 2004-2008”, 24 December 2004), we are now supplying more than just the power management and audio IC that represented the traditional slot for Dialog Semiconductor in the handset. Expansion of our product range over the last three years not only addresses more elements of the handset and smartphone, but also ex- tends to other portable consumer electron- ics devices like PDAs (personal digital assistants) and personal audio players (such as MP3). Asia plays a strong part in this growth of wireless and consumer electronics, which is why we have also strengthened our opera- tions in the region with our new southeast Asia office for local sales, marketing and technical support to a growing customer base. In the wireless sector, some of the market indicators illustrate where greater demand is likely to emerge for our diversified range of ICs and modules for the mobile phone. Worldwide annual shipments of camera phones was up more than 200% in 2004 (source: In-Stat/MDR press release, 14 December 2004, "Camera Phone Market Continues to Boom - 200% Growth in Annual Shipments"), and CMOS image sensor shipments will grow at roughly seven times the rate of CCDs (charge cou- pled devices) through 2008 (source: In- Stat/MDR press release, 18 October 2004, "Camera Phones and Digital Still Cameras Driving Market for CMOS and CCDs"). CMOS sensors offer lower prices, lower power consumption, and the ability to integrate other functions on chips, making them ideal for camera phones. We have introduced camera modules that improve picture quality due to world-class optics from Carl Zeiss, and provide excellent image sensor performance. As operators look to increase ARPU (aver- age revenue per user), mobile gaming ser- vices are expected to generate 4.4% of total wireless data revenues of US$1.8 billion in the USA by 2009; gaming downloads will also increase 10-fold from 2003 levels (source: In-Stat/MDR press release, 7 Sep- tember 2004, "Gaming to be Key Contribu- tor to Wireless Data Usage and Revenues"). The implication in the US and worldwide is that handsets will need both advanced color graphic display capability and ex- tremely efficient power management sys- tems. In the automotive sector, we are expecting more interest in our imaging systems ad- dressing applications such as lane departure warning and blind spot detection. Overall, Dialog Semiconductor believes the prospects for growth during 2005 are posi- tive as a result of our transition to both developing more application specific stan- dard products (ASSPs) for emerging ‘con- vergence’ applications in wireless and consumer electronics, as well as addressing the needs of our application specific IC (ASIC) customers in the more traditional but advancing automotive and industrial electronics markets. 30 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Report of Independent Registered Public Accounting Firm In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial posi- tion of Dialog Semiconductor Plc and sub- sidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. Stuttgart, Germany February 21, 2005 KPMG Deutsche Treuhand-Gesellschaft Aktiengesellschaft Wirtschaftsprüfungsgesellschaft To the Board of Directors of Dialog Semi- conductor Plc: We have audited the accompanying con- solidated balance sheets of Dialog Semi- conductor Plc and subsidiaries (the “Com- pany”) as of December 31, 2004 and 2003 and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial state- ments are the responsibility of the Com- pany's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with standards established by the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and signifi- cant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. Annual Report 2004 | 31 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Consolidated Financial Statements Consolidated Financial Statements Consolidated Statements of Operations Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Changes in Shareholders’ Equity Notes to the Consolidated Financial Statements Other Disclosures to the Statements of Operation Summary of Significant Accounting Policies Restructuring and Related Impairment Charges Recovery of Investment 1. General 2. 3. 4. 5. 6. 7. Additional Cash Flow Information 8. Trade Accounts Receivable, net 9. 10. Marketable Securities 11. Deposits and Prepaid Expenses Income Taxes Inventories 12. Property, Plant and Equipment, net 13. Intangible Assets and Goodwill 14. Accrued Expenses 15. Shareholders' Equity and Comprehensive Income 16. Pension Scheme 17. Stock-based Compensation 18. Commitments 19. Financial Instruments and Hedging Activities 20. Segment Reporting 21. Transactions with Related Parties Corporate Governance Report of the Board of Directors Accounting under International Financial Reporting Standards (IFRSs) Corporate Governance Principles Members of the Board of Directors 33 34 35 36 37 38 38 39 42 42 43 43 45 45 45 45 46 46 46 47 47 47 48 49 49 50 51 52 52 52 53 56 Annual Report 2004 | 33 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Consolidated Statements of Operations (in thousands, except per share data) Revenues Cost of sales Gross margin Selling and marketing expenses General and administrative expense Research and development expenses Amortization and intangible assets Restructuring and related impairment charges Operating loss Interest income, net Foreign currency exchange gains and losses, net Recovery of investment Result before income taxes Income tax (expense) benefit Net loss Loss per share: Basic and diluted Weighted average number of shares (in thousands): Basic and diluted Notes 2004 2004 2003 2002 20 $ 157,100 € 116,044 € 92,893 € 77,104 5 (108,010) (79,783) (62,374) (57,409) 49,090 36,261 30,519 19,695 (8,444) (7,394) (6,237) (5,462) (4,197) (5,044) (4,149) (6,447) (39,356) (29,071) (30,590) (34,530) (2,058) (1,520) 3 (80) (59) (2,073) (1,839) (1,975) – (8,242) (6,088) (13,224) (27,406) 1,463 (983) 73 1,081 (726) 54 757 (454) 315 1,121 (1,918) 11,969 (7,689) (5,679) (12,606) (16,234) (86) (64) (7,814) 6,026 (7,775) (5,743) (20,420) (10,208) 4 6 (0.18) (0.13) (0.46) (0.23) 44,025 44,025 43,951 43,888 The accompanying notes are an integral part of these Consolidated Financial Statements 34 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Consolidated Balance Sheets (in thousands) ASSETS Cash and cash equivalents Trade accounts receivable, net Inventories Marketable securities Deferred taxes Prepaid expenses Other current assets Total current assets Property, plant and equipment, net Intangible assets Goodwill Deposits Deferred taxes Prepaid expenses TOTAL ASSETS LIABILITIES AND SHAREHOLDERS’ EQUITY Trade accounts payable Accrued expenses Income taxes payable Deferred taxes Other current liabilities Total current liabilities Deferred taxes Total liabilities Ordinary Shares Additional paid-in capital Accumulated deficit Accumulated other comprehensive loss Employee stock purchase plan shares Shareholders’ equity Notes Dec 31, 2004 Dec 31, 2004 Dec 31, 2003 8 9 10 6 11 12 13 13 11 6 11 14 6 6 15 $ 18,922 € 13,977 32,540 40,335 23,749 950 834 380 24,036 29,794 17,542 702 616 281 € 8,109 14,338 13,242 44,900 103 2,131 993 117,710 86,948 83,816 28,752 5,775 15,956 263 22,270 1,458 21,238 4,266 11,786 194 16,450 1,077 20,590 5,440 11,786 183 17,729 927 192,184 141,959 140,471 20,888 4,175 12 9 1,726 26,810 1,381 28,191 9,515 228,497 (72,323) (1,294) (402) 15,429 3,084 9 7 1,275 19,804 1,020 20,824 7,028 168,782 (53,422) (956) (297) 7,157 3,165 18 4 1,615 11,959 1,669 13,628 6,737 168,795 (47,679) (984) (26) 163,993 121,135 126,843 TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY 192,184 141,959 140,471 The accompanying notes are an integral part of these Consolidated Financial Statements Annual Report 2004 | 35 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Consolidated Statements of Cash Flows (in thousands) Cash flows from operating activities: Net loss Adjustments to reconcile net loss to net cash provided by (used for) operating activities: Recovery of investment Provision for excess inventory Restructuring and related impairment charges Depreciation of property, plant and equipment Amortization intangible assets Losses on disposals of fixed assets Increase in deferred tax asset valuation allowance Other changes in deferred taxes Changes in current assets and liabilities: Trade accounts receivable Inventories Prepaid expenses Trade accounts payable Accrued expenses Income taxes payable Other assets and liabilities Cash provided by (used for) operating activities Cash flows from investing activities: Recovery of investment Purchases of property, plant and equipment Purchases of intangible assets Investments and deposits received (made) Purchases of marketable securities Sale of marketable securities Cash provided by (used for) investing activities Cash flows from financing activities: Costs for issuance of shares Sale of employee stock purchase plan shares Other Cash provided by financing activities 2004 2004 2003 2002 $ (7,775) € (5,743) € (20,420) € (10,208) (73) - (444) 15,570 2,058 199 - 24 (13,128) (22,408) 1,844 11,204 (104) (12) 1,401 (11,644) (54) - (328) 11,501 1,520 147 - 18 (9,697) (16,552) 1,362 8,276 (77) (9) 1,035 (8,601) 73 54 (16,680) (12,321) (914) (27) (67,243) 104,360 19,569 (28) 40 - 12 (675) (20) (49,670) 77,087 14,455 (21) 30 - 9 (315) – 613 12,545 2,073 253 10,237 (1,984) 1,691 1,265 5,382 (2,846) (258) (107) (541) 7,588 315 (5,901) (1,410) 21,670 (44,998) – (11,969) 1,930 – 12,834 1,975 – – (4,167) 450 715 1,663 1,760 (1,381) (1,224) 26 (7,596) 11,969 (3,872) (2,101) 94 – – (30,324) 6,090 – 37 – 37 – 58 (44) 14 Cash provided by (used for) operating, investing and financing activities 7,937 5,863 (22,699) (1,492) Effect of foreign exchange rate changes on cash and cash equivalents Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period 7 7,944 10,978 18,922 5 (197) 5,868 (22,896) 8,109 13,977 31,005 8,109 (129) (1,621) 32,626 31,005 The accompanying notes are an integral part of these Consolidated Financial Statements 36 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Consolidated Statements of Changes in Shareholders’ Equity (in thousands of €) Accumulated other comprehen- sive loss Addi- tional paid-in capital Accumu- lated deficit Currency transla- tion adjust- ment Available for sale securities Derivative financial instru- ments Employee stock purchase plan shares Ordinary Shares Total Balance at December 31, 2001 6,737 168,788 (17,051) (270) Net loss Other comprehensive loss Total comprehensive loss Cost of issuance of shares in 2000 Sale of employee stock purchase plan shares – – – – – – (44) 37 (10,208) – – – – (287) – – Balance at December 31, 2002 6,737 168,781 (27,259) (557) Net loss Other comprehensive income (loss) Total comprehensive loss Sale of employee stock purchase plan shares – – – – – 14 (20,420) – – – (366) – Balance at December 31, 2003 6,737 168,795 (47,679) (923) Net loss Other comprehensive income (loss) Total comprehensive loss New issuance of shares Sale of employee stock purchase plan shares – – 291 – – – (22) 9 (5,743) – – – – (5) – – – – – – – – – (61) – (61) – 33 – – Balance at December 31, 2004 7,028 168,782 (53,422) (928) (28) (42) – (116) – – (70) 158,092 – – – 21 (10,208) (403) (10,611) (44) 58 (158) (49) 147,495 – 158 – – – – – – – – – (20,420) (269) (20,689) 23 37 (26) 126,843 – – (291) 20 (5,743) 28 (5,715) (22) 29 (297) 121,135 The accompanying notes are an integral part of these Consolidated Financial Statements. Annual Report 2004 | 37 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Notes to the Consolidated Financial Statements 1. General a) Description of Business Dialog Semiconductor Plc and subsidiaries ("Dialog" or the "Company") is a fabless semiconductor company that devel- ops and supplies power management, audio and imaging technology, delivering innovative mixed signal standard products as well as application specific IC solutions for wire- less, automotive and industrial applications. The company’s expertise in mixed signal design, with products manufactured entirely in CMOS technology, enhances the performance and features of wireless, hand-held and portable electronic prod- ucts. Its technology is also used in intelligent control circuits in automotive and industrial applications. Production of these designs is then outsourced, and the final products are returned to Dialog for approval and testing before delivery to the customers. b) Vulnerability Due to Certain Significant Concentrations The Company’s future results of operations involve a number of risks and uncertainties. Factors that could affect the Com- pany’s future operating results and cause actual results to vary materially from historical results include, but are not limited to, the highly cyclical nature of both the semiconduc- tor and wireless communications industries, dependence on certain customers and the ability to obtain adequate supply of sub-micron wafers. The Company's products are generally utilized in the cellular communications and automotive industries. The Company generates a substantial portion of its revenue from the wire- less communications market, which accounted for 78%, 75% and 71% of the Company’s total revenue for the years ended December 31, 2004, 2003 and 2002, respectively. The Company’s revenue base is diversified by geographic region and by individual customer. Changes in foreign cur- rency exchange rates influence the Company’s results of operations. The Company’s sales are primarily denominated in Euros and US dollars whereas purchases of raw materials and manufacturing services are primarily denominated in US dollars (see Note 19 for a description of the Company’s hedg- ing activities). The Company also has foreign currency ex- change risks with respect to its net investments in foreign subsidiaries in Japan, the United Kingdom and the United States. Fluctuations in these currencies could significantly impact the Company’s reported results from operations. The Company depends on a relatively small number of cus- tomers for a substantial portion of its revenues, and the loss of one or more of these customers may result in a significant decline in future revenue. During 2004 and 2002, two cus- tomers individually accounted for more than 10% of the Company's revenues. Total revenues from these two custom- ers were €75,651 and €46,746 or 65% and 61% in 2004 and 2002, respectively. Net receivables from these two customers were €15,724 at December 31, 2004. During 2003, one cus- tomer individually accounted for more than 10% of the Company’s revenue. Total revenue from this customer was €60,192 or 65%. Net receivables from this customer were €9,414 at December 31, 2003. The Company performs ongo- ing credit evaluations of its customers' financial condition and, generally, requires no collateral from its customers. c) Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("US GAAP"). All amounts herein are shown in thousands of Euro (“€”) and for the year 2004 are also presented in U.S. Dollars (“$”), the latter being unaudited and presented solely for convenience of the reader at the rate of €1 = $1.3538, the Noon Buying Rate of the Federal Reserve Bank of New York on December 31, 2004. 38 | Annual Report 2004 (in thousands of € unless otherwise stated) Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance 2. Summary of Significant Accounting Policies Principles of Consolidation and Investments in Affiliated Companies The consolidated financial statements include Dialog Semiconductor Plc and all of its owned subsidiaries: Name Registered Office Participation Dialog Semiconductor GmbH Kirchheim/Teck - Nabern, Germany Dialog Semiconductor (UK) Limited Swindon, UK Dialog Semiconductor Inc Dialog Semiconductor KK Clinton, New Jersey, USA Tokyo, Japan 100% 100% 100% 100% All intercompany accounts and transactions are eliminated in consolidation. Cash and Cash Equivalents Cash and cash equivalents include highly liquid investments with original maturity dates of three months or less. Marketable Securities Marketable securities at December 31, 2004 and 2003 consist of exchange traded funds and at December 31, 2003 also debt securities that are classified as available-for-sale and are accounted for on the basis of the settlement date and re- corded at fair value as determined by the most recently quoted market price of each security at the balance sheet date. Unrealized gains and losses, net of the related tax ef- fect, on available-for-sale securities are excluded from earn- ings and are reported as a component of other comprehen- sive income (loss) until realized. Realized gains and losses from the sale of available-for-sale securities are determined on a specific-identification basis. A decline in the market value of any available-for-sale security below cost that is deemed to be other than temporary will result in an impair- ment, which is charged to earnings. Interest income is recog- nized when earned. Any credit losses are included in the allowance for doubtful accounts through a charge to bad debt expense. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. In the profit and loss ac- count, impairment losses are included in sales and marketing expenses. Recoveries of trade receivables previously written- off are recorded when received. Reversals of impairment losses, if any, would be included in other operating income. The Company does not have any off-balance-sheet credit exposure related to its customers. Other Current Assets Other current assets include tax refunds receivable at Decem- ber 31, 2004 and 2003. It also included interest receivable at December 31, 2003. Property, Plant and Equipment Property, plant and equipment are stated at cost less accumu- lated depreciation. Depreciation is charged on a straight-line basis over the estimated useful lives of the assets as follows: Inventories Inventories are valued at the lower of cost or market. Cost, which includes direct materials, labor and overhead plus indirect overhead, is determined using the first-in, first-out (FIFO) or weighted average cost methods. Equipment Test equipment Useful life 3 to 8 years Leasehold improvements Shorter of useful life or lease term Office and other equipment 3 to 13 years Trade Accounts Receivable Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company reviews its allowance for doubtful accounts quarterly. Management, considering current infor- mation and events regarding the customers’ ability to repay their obligations, considers the collectibility of a trade ac- count receivable to be impaired when it is probable that the Company will be unable to collect all amounts due according to the sales terms. When a trade receivable is considered to be impaired, the amount of the impairment is measured based on the present value of expected future cash flows. Goodwill and other Intangible Assets Goodwill represents the excess of purchase price over fair value of net assets of businesses acquired. Purchased intan- gible assets with estimable useful lives primarily consist of licenses, software, customer lists and patents and are re- corded at acquisition cost less accumulated amortization. Intangible assets other than goodwill are amortized on a straight-line basis over the estimated useful lives of the as- sets ranging from 3 to 17 years. Goodwill is tested annually for impairment and more fre- quently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent the carrying amount exceeds the asset’s fair value. (In thousands of € unless otherwise stated) Annual Report 2004 | 39 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Prior to the adoption of SFAS 142 in 2002, goodwill and assembled workforce were amortized over their estimated useful life. Impairment of Long-Lived Assets In accordance with SFAS 144, long-lived assets, such as property, plant and equipment, and purchased intangibles subject to amortization, are evaluated for impairment when- ever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recov- erability of assets to be held and used is measured by a com- parison of the carrying amount of an asset or group of assets to future undiscounted net cash flows expected to be gener- ated by the asset or group of assets. If the carrying amount of an asset or group of asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. Foreign Currencies The functional currency for the Company's operations is generally the applicable local currency. Accordingly, the assets and liabilities of companies whose functional currency is other than the Euro are included in the consolidation by translating the assets and liabilities into the reporting cur- rency (the Euro) at the exchange rates applicable at the end of the reporting year. Equity accounts are measured at his- torical rates. The statements of income and cash flows are translated at the average exchange rates during the year. Translation gains or losses are accumulated as a separate component of shareholders' equity. Foreign currency transac- tion gains and losses are included in financial income, net at each reporting period. They result from amounts ultimately realized upon settlement of foreign currency transactions and from the period end re-measurement of foreign currency denominated monetary assets and liabilities into the func- tional currency of the respective entity. The exchange rates of the more important currencies against the Euro used in preparation of the consolidated financial state- ments were as follows: Currency Great Britain Japan United States Exchange rate at Annual average exchange rate Dec 31, 2004 Dec 31, 2003 € 1 = 0.71 139.83 1.36 € 1 = 0.70 133.68 1.25 2004 € 1 = 0.68 134.46 1.24 2003 € 1 = 0.69 130.93 1.13 2002 € 1 = 0.63 118.05 0.94 Revenue Recognition Substantially all of the Company’s revenue is derived from the sale of its products. Product revenue, net of discounts, is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the price of the transaction is fixed and determinable, and collectibility is reasonably as- sured. Product-Related Expenses Cost of sales consist of the costs of outsourcing production and assembly, personnel costs and applicable overhead and depreciation of test and other equipment. Provisions for estimated product warranty are recorded in cost of sales at the time the related sale is recognized. Expenditures for ad- vertising and sales promotion and for other sales-related expenses are charged to marketing expenses as incurred. Shipping and handling costs amounting to €313 (2003: €251; 2002: €221) are recorded within selling expenses. Income Taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences be- tween the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years, in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company records deferred tax valuation allowances, if any, to reduce the deferred tax assets to amounts, which will more likely than not be real- ized. Stock-Based Compensation The Company has a stock-based employee compensation plan that is accounted for using the intrinsic-value-based method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Under this method, no stock-based compensation cost is reflected in net income (loss), as all options granted by the plan had an 40 | Annual Report 2004 (in thousands of € unless otherwise stated) Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance exercise price equal to market value of the underlying com- mon stock on the date of grant. SFAS 123, Accounting for Stock-Based Compensation, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation. As allowed by SFAS 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure re- quirements of SFAS 123, as amended by SFAS 148, Account- ing for Stock-Based Compensation-Transition and Disclosure. The following table illustrates the effect on net loss if the fair-value-based method had been applied to all outstanding and unvested awards in each period. penses during the reporting period. Significant items subject to such estimates and judgments include the recoverability of the carrying value of goodwill and other long-lived assets, the realizability of deferred income tax assets and invento- ries, and the fair value of stock-based employee compensa- tion awards. Actual results may differ from those estimates. In the fourth quarter of 2004, the company determined that the useful life of its test equipment is eight years. Previously the useful life had been determined to be five years. The effect of this change in accounting estimates resulted in a lower depreciation of €1,349 (€842, net of tax, or €0.02 per share). Net loss, as reported: Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects Pro forma net loss Earnings (loss) per share Basic – as reported Basic – pro forma Diluted – as reported Diluted – pro forma 2004 2003 2002 (5,743) (20,420) (10,208) (847) (601) (1,166) (6,590) (21,021) (11,374) (0.13) (0.15) (0.13) (0.15) (0.46) (0.48) (0.46) (0.48) (0.23) (0.26) (0.23) (0.26) Derivative Instruments and Hedging Activities The Company operates internationally, giving rise to expo- sure to changes in foreign currency exchange rates. The Company applies SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 137, SFAS No. 138 and SFAS No. 149, which provides guid- ance on accounting for all derivative instruments, and for hedging activities. Derivative financial instruments are re- corded at their fair value and included in other current assets or other current liabilities. Earnings (Loss) per Share Earnings (loss) per share has been computed using the weighted average number of outstanding ordinary shares for each year. Because the Company reported a net loss in each of the years in the three-year period ended December 31, 2004, only basic per share amounts have been presented for those years. Had the Company reported net income in 2004, 2003 and 2002, the weighted average number of shares out- standing would have potentially been diluted by 1,309,406 and 962,184 and 2,634,382 stock options, respectively (not assuming the effects of applying the treasury stock method). Use of Estimates The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, as well as disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and ex- Recently Issued Accounting Standards In June 2004, EITF No. 03-1, The Meaning of Other-Than- Temporary Impairment and its Application to Certain Invest- ment, was issued which includes new guidance for evaluating and recording other than temporary impairment losses on debt and equity securities accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Secu- rities and cost method investments, as well as new disclosure requirements for investments that are deemed to be tempo- rarily impaired. While the disclosure requirements for speci- fied debt and equity securities and cost method investments are effective for annual periods ending after December 15, 2003, the FASB Board has directed the FASB staff to delay the effective date for the measurement and recognition guid- ance contained in EITF No. 03-1. This delay does not suspend the requirement to recognize other-than-temporary impair- ments as required by existing authoritative literature. The Company does not expect the adoption of EITF No. 03-1 to have a material impact on its consolidated financial state- ments. In November 2004, the FASB issued Statement No. 151, Inventory Costs, to amend the guidance in Chapter 4, “Inven- tory Pricing,” of FASB Accounting Research Bulletin No. 43, Restatement and Revision of Accounting Research Bulletins. Statement 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). The Statement requires that those items be recognized as current-period charges. Additionally, Statement 151 requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The company does not believe the adoption of SFAS No. 151 will have a material impact on its consolidated financial statements. In December 2004, the FASB issued SFAS No. 123(R), Share- Based Payment, which establishes standards for transactions in which an entity exchanges its equity instruments for goods or services. This standard requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date (In thousands of € unless otherwise stated) Annual Report 2004 | 41 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance fair value of the award based upon an option-pricing model and an estimate of the number of awards expected to vest. Compensation cost will be recognized as they vest, including related tax effects. SFAS No. 123(R) will be effective for interim or annual reporting periods beginning on or after June 15, 2005. The statement provides for three alternate transition methods, each having a different reporting impli- cation. The company previously accounted for its stock based compensation plan using the intrinsic-value-based method based on APB Opinion No 25. Under this method, no stock- based compensation is reflected in net income (loss) (see also “Stock based compensation” in this note 2 to the consoli- dated financial statements). The Company is in the process of determining the transition method it is going to adopt and the potential impact on the financial statements. 3. Restructuring and Related Impairment Charges Restructuring and related asset impairment charges are com- prised of €59 restructuring charges for the year ended De- cember 31, 2004 and of €1,554 restructuring charges and €285 impairment charges totaling €1,839 for the year ended December 31, 2003. Restructuring Charges In the first quarter of 2003 the Company decided to close the Swedish subsidiary. Restructuring charges incurred in 2003, include termination benefits that were paid to all employees affected by the closing of €1,076 and a provision for esti- mated costs that will continue to be incurred under an oper- ating lease for the building for its remaining term without economic benefit to the Company of €478. In the first quarter of 2004 the Company settled its building lease obligation in connection with the closure and recognized an additional charge of €59. The contractual termination benefits were accounted for in accordance with SFAS 88. The provision for the operating lease was recorded at its estimated fair value in accordance with SFAS 146. The pretax amounts for the restructuring charges are com- prised of the following: (in thousands of €) Liability balance at Janu- ary 1, 2003 Initial charges Additional charges Payments made Liability balance at December 31, 2003 Additional charges Payments made Liability balance at December 31, 2004 Employee termination costs Contract termination costs - 834 242 - 346 132 Total - 1,180 374 (1,076) (150) (1,226) - - - - 328 59 (387) 328 59 (387) - - Asset Impairment Charges As a result of the closure of the Swedish facility, certain long-lived assets with a net carrying value of €158 have been abandoned and certain prepaid expenses of €127 no longer provided any future benefit to the Company. Accord- ingly, impairment charges totaling €285 were recognized for the year ended December 31, 2003, to write-off these assets. 4. Recovery of Investment In the fourth quarter of 2001, the Company determined that its ability to recover the full amount of its investments in silicon supplier ESM was impaired. Accordingly the Company wrote off the investments in ESM. In March 2002, ESM was acquired by International Rectifier. As a result, the Company was able to subsequently recover €12.0 million, €0.3 million and €0.1 million of its total investment in ESM in 2002, 2003 and 2004. 42 | Annual Report 2004 (in thousands of € unless otherwise stated) Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance 5. Other Disclosures to the Statements of Operation Result before income taxes is stated after charging: (in thousands of €) Depreciation of property, plant and equipment Amortization of intangible assets Personnel costs Cost of sales: provision for excess inventory 6. Income Taxes 2004 11,501 1,520 21,622 - 2003 12,545 2,073 21,197 - 2002 12,834 1,975 20,193 1,930 Loss before income taxes consists of the following: Benefit (provision) for income taxes are as follows: 2002 (in thousands of €) 2004 2003 2002 (in thousands of €) Germany Foreign 2004 (3,079) (2,600) 2003 (6,323) (6,283) (11,376) (4,858) (5,679) (12,606) (16,234) Although Dialog is a UK company, its principal operations are located in Germany and all of its operating subsidiaries are owned by its German subsidiary. Accordingly, the follow- ing information is based on German corporate tax law. The Company’s statutory tax rate for its German subsidiary is 25%. Including the impact of the solidarity surcharge of 5.5%, the federal corporate tax rate amounts to 26,375%. Expected benefit for income taxes Foreign tax rate differential Amortization of non-deductible intangible assets Valuation allowance on deferred tax assets Others Actual benefit (expense) for income taxes Current taxes: Germany Foreign Deferred taxes: Germany Foreign - (38) 250 (91) 43 1,685 - (8,287) (26) (64) 314 (7,814) 3,941 357 6,026 A reconciliation of income taxes determined using the Ger- man corporate tax rate of 26,375% plus the after federal tax benefit rate for trade taxes of 11,225%, for a combined statu- tory rate of 37.6%, is as follows: 2004 2,135 (200) (41) 2003 4,740 (505) (41) (1,947) (11,804) (204) (11) (64) 2002 6,104 (387) (41) (118) 468 (7,814) 6,026 (In thousands of € unless otherwise stated) Annual Report 2004 | 43 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Deferred income tax assets and liabilities are summarized as follows: Property, plant and equipment Net operating loss and tax credit carryforwards Liabilities Other Valuation allowance Deferred tax assets Property, plant and equipment Receivables Deferred tax liabilities Net deferred tax assets Dec 31, 2004 Dec 31, 2003 374 196 25,158 5,654 12 31,198 (14,046) 17,152 (1,020) (7) (1,027) 16,125 24,284 5,640 41 30,161 (12,329) 17,832 (1,669) (4) (1,673) 16,159 Tax loss carryforwards and established valuation allowances are summarized as follows: December 31, 2004 Tax loss carryfor- wards subject to valution allowance Tax loss carryforward Valuation allo- wance Tax loss carryforward December 31, 2003 Tax loss carryfor- wards subject to valution allowance Valuation allo- wance 63,124 6,384 1,571 1,442 - 28,648 6,286 1,571 1,442 - 11,392 2,026 498 131 - 14,046 61,696 4,391 1,520 1,514 543 27,220 4,293 1,520 1,514 543 10,235 1,288 493 131 182 12,329 Germany UK US Federal State Sweden Total In assessing the realizability of deferred tax assets, manage- ment considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods, in which those temporary differences become de- ductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. In De- cember 2003, the German government enacted new tax legis- lation, which among other things, limits the use of German tax-loss carryforwards to 60% of the taxable income for fiscal years starting from 2004 and thereafter. As a result of this change in tax law, at December 31, 2003 the Company has re-evaluated its deferred tax asset position and the need for a valuation allowance for the German tax losses. The assessment requires the exercise of judgment on the part of management, with respect to, among other things, benefits that could be realized from available tax strategies and future taxable income, as well as other positive and negative fac- tors. The assessment in 2003 considered the weight given to cumulative losses incurred in Germany over the three-year period ended December 31, 2003, as well as detailed forecasts of taxable income in the foreseeable future. Although the Company forecasted generating future taxable income to approximate available tax-loss carryforwards, the change in tax law increased the forecasted number of additional years that future taxable income must be generated in order to fully realize these loss carryforward benefits. Pursuant to SFAS 109 and the inherent uncertainties in projecting future taxable income, management had concluded that it is more likely than not that a portion of our tax losses could not ultimately be realized. Consequently, in 2003 the Company recognized a valuation allowance of €10,235, to reduce the carrying value of its net deferred tax assets on tax loss carry- forwards in Germany to an amount that was more likely than not expected to be ultimately realized. Furthermore, based on management’s assessment, at December 31, 2003 the com- pany established valuation allowances of €1,288, €624 and €182 on tax losses in the UK, the US and Sweden, respec- tively, since it was more likely than not, that the deferred tax assets will not be realized through future taxable earnings. Due to losses incurred in 2004, the company has not recog- nized any additional deferred tax assets and established an additional valuation allowance of €1,947 on the tax-loss 44 | Annual Report 2004 (in thousands of € unless otherwise stated) Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance carryforwards generated mainly in Germany in 2004. How- ever, management has evaluated whether it is more likely than not that the Company can recover the carrying amount of deferred tax assets and determined that an additional valuation allowance with respect to the deferred tax assets is not required at December 31, 2004. 7. Additional Cash Flow Information The tax loss carryforwards in the US are expiring in 2005 through 2017, the other tax loss carryforwards have no expi- ration date. The following represents supplemental information with respect to cash flows: (in thousands of €) Interest paid, net Income taxes paid, net 2004 5 49 2003 14 372 2002 9 911 8. Trade Accounts Receivable, net The recorded trade accounts receivable for which an impair- ment has been recognized and the related allowance for doubtful accounts at December 31, 2004 and 2003 were €34 and €17, and €270 and €197, respectively. The allowance for doubtful accounts developed as follows: 9. Inventories Inventories are comprised of the following: (in thousands of €) 2004 2003 2002 Allowance for doubtful ac- counts at beginning of year Additions charged to bad debt expense Write-offs charged against the allowance Reductions charged to bad debt expense Allowance for doubtful accounts at end of year 197 16 397 230 439 222 (186) (210) (139) (10) (220) (125) 17 197 397 (in thousands of €) Raw materials Work-in-process Finished goods 2004 9,893 13,906 5,995 2003 2,738 5,026 5,478 29,794 13,242 10. Marketable Securities The Company has invested in “investment grade” rated debt securities with a maturity up to six months, and exchange traded funds, which invest in debt-securities. All marketable securities are classified as available for sale. The aggregate costs, fair values and unrealized losses per security class are as follows: (in thousands of €) Corporate debt securities Debt based funds Dec 31, 2004 Dec 31, 2003 Cost – 17,581 17,581 Fair value Unrealized loss Cost Fair value Unrealized loss – 17,542 17,542 – (39) (39) 43,029 1,969 44,998 42,947 1,953 44,900 (82) (16) (98) (In thousands of € unless otherwise stated) Annual Report 2004 | 45 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance 11. Deposits and Prepaid Expenses At December 31, 2002, the Company maintained deposits of $20 million with Chartered Semiconductor Manufacturing Pte., Ltd. (“Chartered”). These deposits were refunded to the Company in October 2003. In addition, the Company paid Chartered a total of $10 million in 2000 as an advance pay- ment for future wafer deliveries and $2.5 million to another supplier. Such advance payments are classified in the balance sheet line items "Prepaid expenses". In 2004 all remaining advance payments paid to Chartered were refunded to the company. The outstanding balance of the advance payments 12. Property, Plant and Equipment, net is refunded in proportion to the Company’s purchases of wafers from the other supplier, and at this time, the Company expects to have the entire advance payments refunded. The amount of advance payments classified in prepaid expenses on the consolidated balance sheet as current assets represents that amount of advance payments expected to be refunded in the next twelve months. A summary of activity for property, plant and equipment for the year ended December 31, 2004 is as follows: Cost Jan 1, 2004 Currency change Addi- tions Reclassi- fications Disposals Dec 31, 2004 Accumu- lated depre- ciation Net book value as of Dec 31, 2004 Accumu- lated depre- ciation 2003 Net book value as of Dec 31, 2003 Depre- ciation 2004 (in thousands of €) Test equipment Leasehold improvements 53.050 903 (2) (19) 8.028 158 Office and other equipment 14.303 (112) 2.412 300 - (33) (863) (145) (860) 60.513 (45.227) 15.286 (36.956) 16.094 (9.076) 897 (596) 301 (550) 353 (121) 15.710 (11.782) 3.928 (10.427) 3.876 (2.304) Advance payment relating to test equipment Property, plant and equipment 267 - 1.723 (267) - 1.723 - 1.723 - 267 - 68.523 (133) 12.321 - (1.868) 78.843 (57.605) 21.238 (47.933) 20.590 (11.501) 13. Intangible Assets and Goodwill A summary of activity for intangible assets and Goodwill for the year ended December 31, 2004 is as follows: Cost Jan 1, 2004 Currency change Addi- tions Reclassi- fications Disposals Dec 31, 2004 Accumu- lated depre- ciation Net book value as of Dec 31, 2004 Accumu- lated depre- ciation 2003 Net book value as of Dec 31, 2003 Depre- ciation 2004 10.930 3.008 13.938 15.736 (26) - (26) - 348 - 348 - - - - - (199) 11.053 (8.952) - 3.008 (843) 2.101 2.165 (7.992) (506) 2.938 2.502 (1.183) (337) (199) 14.061 (9.795) 4.266 (8.498) 5.440 (1.520) - 15.736 (3.950) 11.786 (3.950) 11.786 - (in thousands of €) Software, licenses and other Patents Intangible assets Goodwill During the year ended December 31, 2004 and 2003, the Company acquired software and licenses for a total purchase price of €348 and €618 respectively. The expected weighted average useful life of these assets is 3 years. During the year 2002, the Company acquired the CMOS imaging technology and associated CMOS Active Pixel Sensor (APS) patent port- folio from Sarnoff Corporation, a research and development institute, for a total purchase price of €3,008. The expected weighted average useful life of these patents is 9 years. In addition, Sarnoff may be paid additional contingent consid- eration which will be determined as a percentage of the revenues received from sales of imagers used for camera applications and as an agreed sum for each imager used for cellular phone applications. Such contingent consideration is 46 | Annual Report 2004 (in thousands of € unless otherwise stated) Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance limited in absolute terms and has a fixed expiration date as specified in the purchase agreement. The aggregate amortization expense for the years ended December 31, 2004, 2003 and 2002 was €1,520, €2,073 and €1,975, respectively. Amortization expense of the gross car- rying amount of intangible assets at December 31, 2004 is estimated to be €1,015 in 2005, €631 in 2006, €542 in 2007, €518 in 2008 and €483 in 2009. 14. Accrued Expenses The Company issues various types of contractual product warranties under which it guarantees the performance of products delivered for a certain period or term. The changes in the provision for those product warranties are summarized as follows: (in thousands of €) Balance at beginning of year Utilizations Additions Balance at end of year 2004 135 (8) 28 155 2003 115 (115) 135 135 15. Shareholders' Equity and Comprehensive Income At December 31, 2003, Dialog had authorized 104,311,860 ordinary shares with a par value of £0.10 per share, of which 44,068,930 were issued and outstanding. All shares are fully paid. previously been granted to employees. These shares are le- gally issued and outstanding, but are not considered issued and outstanding for accounting purposes and accordingly have been reported in the caption “employee stock purchase plan shares” as a reduction of shareholders' equity. On September 24, 2004, the Company completed an offering of 2,000,000 previously unissued ordinary shares at £0.10 per share to its employee benefit trust, to make such shares available for the exercise of stock option rights that had The related tax effects allocated to each component of other comprehensive income (loss) for the years ended December 31, 2004, 2003 and 2002 are as follows: (in thousands of €) Pretax Tax effect Net Pretax Tax effect Net Pretax Tax effect Net 2004 2003 2002 Unrealized (losses) gains on available for sale securities Unrealized (losses) gains on derivative financial instru- ments Currency translation adjust- ment Other Comprensive Income (loss) 59 (26) 33 (98) 37 (61) - - - - 12 71 - (17) (43) - (5) 28 253 (95) 158 (185) 69 (116) (508) 142 (366) (437) 150 (287) (353) 84 (269) (622) 219 (403) In 2003, realized losses of €44 (net of €27 tax benefits) on the settlement of a derivative financial instrument were reclassified into net loss (see Note 19) . 16. Pension Scheme The group operates defined contribution pension schemes. The pension cost charge for the year represents contributions payable by the group to the funds and amounted to €484 (2003: €565; 2002: €640). At December 31, 2004, contribu- tions amounting to €59 (2003: €5) were payable to the funds and are included in creditors. (In thousands of € unless otherwise stated) Annual Report 2004 | 47 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance 17. Stock-based Compensation a) Stock option plan On August 7, 1998, the Company adopted a stock option plan ("Plan") under which employees and directors may be granted from time-to-time, at the discretion of the Board, stock options to acquire up to 3,840,990 shares of the Com- pany's authorized but unissued ordinary shares. On May 16, 2002 the shareholders of the Company approved a resolution increasing the maximum amount of stock options which may be granted by the company to 15%, after issue, of the Com- pany's issued share capital. At December 31, 2004, 15%, after issue, of the Company's issued share capital amounted to 8,129,811 shares. Stock options are granted with an exercise price not less than the quoted price at the date of grant. Stock options have terms of ten years and vest over periods of one to five years from the date of grant. The fair value of all grants in the three-year period ended December 31, 2004 is estimated using the Black-Scholes option pricing model. Expectations of early exercise are accounted for within the average life of the options. The following weighted-average assumptions were used for stock option grants for the years ended December 31, 2004, 2003 and 2002. Expected dividend yield Expected volatility Risk free interest rate Expected life (in years) Weighted average share price Weighted average exercise price Weighted-average fair value of options granted (in €) 2004 0% 80% 3.4% 5.0 3.70 2003 0% 74% 3.4% 3.8 3.37 2002 0% 106% 3.7% 5.0 2.33 3.70 3.37 2.33 2.44 2.21 1.83 Stock option plan activity for the years ended December 31, 2004, 2003 and 2002 was as follows: (prices in €) Outstanding at beginning of year Granted Exercised Forfeited Cancelled Outstanding at end of year Options exercisable at year end 2004 2003 2002 Weighted average exercise price 2.32 3.70 0.44 3.48 - 2.34 1.53 Options 3,412,270 108,960 (64,648) (157,176) - 3,299,406 1,827,076 Weighted average exercise price 3.62 3.37 0.52 6.21 7.29 2.32 0.70 Options 2,634,382 2,050,180 (76,828) (204,004) (991,460) 3,412,270 1,013,356 Options 2,672,506 124,060 (79,174) (83,010) - 2,634,382 1,217,402 Weighted average exercise price 3.78 2.33 0.79 9.78 - 3.62 3.07 The weighted average share price at the date of exercise of options was €3.23 in the year ended December 31, 2004. In April 2003, the Company's board of directors approved a resolution giving employees the right to cancel their options granted in 2000, 2001 and 2002. Employees elected to cancel a total of 991,460 options with a weighted average exercise of €7.29. In November 2003, approximately 2.0 million op- tions were granted at an exercise price equal to fair value (at that date) of €3.45 per share. 48 | Annual Report 2004 (in thousands of € unless otherwise stated) Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance The following table summaries information about stock options outstanding at December 31, 2004: Options Outstanding Weighted-Average Remaining Con- tractual Life (in years) Options Exercisable Weighted-Average Exercise Price Number Exercisable at December 31, 2004 Weighted-Average Exercise Price 5.0 8.7 7.2 0.70 3.47 2.34 1,254,622 572,454 1,827,076 0.64 3.48 1.53 Number Out- standing at Decem- ber 31, 2004 1,345,086 1,954,320 3,299,406 Range of Exercise Prices €0.32 - 2.15 €3.00 - 8.00 €0.32 - 8.00 b) Employee Stock Purchase Plan On March 26, 1998, in connection with the acquisition of the Company, the Company and its then majority owner, Apax Partners, adopted a Subscription and Shareholders Agree- ment under which employees and directors were invited at the discretion of the Board, to purchase up to 3,456,890 ordinary shares of the Company from Apax Partners or an established Employee Benefit Trust. The purchase price of the shares was equal to their estimated fair value on the date the employee or director subscribes for those shares. During the first quarter of 1999, the Trust acquired the remaining 668,800 ordinary shares from Apax Partners, which had not been sold to employees or directors, for purposes of distribut- ing them to employees under the Employee Stock Purchase Plan or for distribution in connection with the exercise of employee stock options. On September 24, 2004, the Company completed an offering of 2,000,000 previously unissued ordinary shares at £0.10 per share to its employee benefit trust, to make such shares available for the exercise of stock option rights that had previously been granted to employees. At December 31, 2004, the Trust continued to hold 2,001,559 shares, equaling the remaining balance of the acquired 668,800 shares and the 2,000,000 shares acquired in 2004 (see note 15). 18. Commitments The Company leases design software, all of its office facili- ties, office and test equipment, and vehicles under operating leases. Total rentals under operating leases, charged as an expense in the statement of operations, amounted to €7,780, €7,581 and €7,229 for the years ended December 31, 2004, 2003 and 2002, respectively. Future minimum lease payments under rental and lease agreements, which have initial or remaining terms in excess of one year at December 31, 2004 are as follows: (in thousands of €) Operating leases 2005 2006 2007 2008 2009 Thereafter Total 8,148 6,629 6,399 6,429 3,297 316 31,218 At December 31, 2004, the Company had an unused short- term credit line of €12,500. There are no amounts out- standing under this credit line at December 31, 2004. 19. Financial Instruments and Hedging Activities a) Use of Derivative Financial Instruments The Company’s sales are primarily denominated in Euros and US dollars whereas purchases of raw materials, manufactur- ing services and the use of design software are primarily denominated in US dollars, whereas other costs and expenses such as salaries and other overhead costs are denominated in Euro, GBP and US dollars. In order to manage these foreign currency exchange risks, the Company attempts to match cash inflows and outflows (sales with supply costs) in the same currency, primarily the US dollar. In situations where the Company is not able to effectively match cash inflows and outflows in the same currency, management considers the use of derivative financial instruments. As a matter of policy, the Company does not engage in derivatives trading, derivatives market-making or other speculative activities. (In thousands of € unless otherwise stated) Annual Report 2004 | 49 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance To hedge existing foreign currency exposure related to a $20 million deposit (see Note 11), the Company purchased foreign currency forward contracts in 2000 to effectively change the US Dollar deposits into Euro (€21,680) upon the expected return of the deposit as of December 31, 2003. These deposits were refunded to the Company in October 2003. Upon receipt of the deposit, the Company settled its currency hedging position related to this deposit and recognized a loss of €71 in the consolidated statement of operations. In the fourth quarter of 2003, the Company entered into derivative financial arrangements with a bank (the "counter- party") that obligates the Company, if directed to do so by the counterparty, to purchase a total of $3,611 during the first half of 2004 at euro-dollar exchange rates ranging from 1.22 to 1.24. These arrangements do not qualify for hedge accounting treatment. Accordingly, the fair value of these derivative financial instruments, which are based on a Black- Scholes pricing model, are recognized on the balance sheet and the changes in fair value are recognized in earnings. At December 31, 2003, these transactions resulted in a net unre- alized loss of €78 recognized in earnings. b) Fair value of financial instruments The fair value of a financial instrument is the price at which one party would assume the rights and /or duties of another party. The carrying amounts and fair values of the Group’s financial instruments are as follows: (in thousands of €) Carrying amount Fair Value Carrying amount Fair Value Dec 31, 2004 Dec 31, 2003 Financial instruments (other than derivative instruments) Cash and cash equivalents Marketable securities Deposits Derivative instruments (currency contracts) Current liabilities 20. Segment Reporting 13,977 17,542 194 13,977 17,542 194 8,109 44,900 183 8,109 44,900 183 - - 78 78 The Company has one operating segment, which is the design and supply of semiconductor chips. The Company delivers its products to various market sectors and generates a substan- tial portion of its revenue from the wireless communications market; 78%, 75% and 71% of total revenues in the years ended December 31, 2004, 2003 and 2002, respectively. Revenues by market sector consisted of the following: Wireless communication Automotive Industrial 2004 90,617 11,898 13,529 116,044 2003 69,849 7,896 15,148 92,893 2002 54,715 6,074 16,315 77,104 50 | Annual Report 2004 (in thousands of € unless otherwise stated) Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Revenues are allocated to countries based on the location of the shipment destination: Following are the net carrying values of investments in prop- erty, plant and equipment by geographic location: Germany France Other European countries China Other Asian countries Other countries 2004 47,719 1,936 14,931 19,738 22,351 9,369 2003 45,395 4,532 10,438 18,198 6,695 7,635 2002 31,478 9,348 11,698 13,006 5,154 6,420 116,044 92,893 77,104 Property, plant and equipment Germany Japan United Kingdom USA Dec 31, 2004 Dec 31, 2003 20,675 19,634 92 189 282 176 358 422 21,238 20,590 21. Transactions with Related Parties Timothy Anderson, a member of the Company’s Board of Directors, is also a partner in the law firm Reynolds Porter Chamberlain, which frequently acts as the Company’s legal adviser. Fees to Reynolds Porter Chamberlain for legal ser- vices rendered were €212, €162 and €268 in 2004, 2003 and 2002, respectively. (In thousands of € unless otherwise stated) Annual Report 2004 | 51 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Corporate Governance Report of the Board of Directors As reported in this document, 2004 was a year of consolida- tion and preparation for new opportunities from a broaden- ing product and technology portfolio. Collaboration with partners and customers ensured that we made progress in the development of products for a more diverse customer base. During the year the Board oversaw the functioning of execu- tive management of the Company at the quarterly Board Meetings of February 4, April 21, July 13, October 13, 2004 and assured itself of the proper conduct of executive man- agement during that year. At such Board Meetings the Board received and analyzed reports from the chief executive as to the achievements of the Company as compared to budget and progress made in achieving the commercial goals for the year. The Compensation Committee, comprising Jan Tufvesson, Michael Glover and Greg Reyes met in October 2004 to dis- cuss the achievements of the Management during that year and to establish the individual objectives of the Management for 2005. The Audit Committee, comprising of Jan Tufvesson, Michael Glover and since October 1st 2004 Aidan Hughes, met on a quarterly basis. These meetings concentrated on a review of the financial information to be reported on for the relevant prior financial period and on the internationally accepted standards for fair and responsible financial report- ing and corporate governance. The Company’s audited financial statements, for the year ended December 31, 2003, and the reports from the Directors and Auditors thereon were presented to, and approved by, the shareholders at the annual general meeting of the Com- pany, held on May 12, 2004, at which KPMG, the Company’s independent auditor was reappointed until the following annual general meeting of the Company. The Board extends its thanks and appreciation to the Execu- tive Management and all employees for their hard work and considerable achievements in 2004. 52 | Annual Report 2004 Accounting under International Financial Reporting Standards (IFRSs) In compliance with the European Parliament and Council Regulation on the application of International Financial Reporting Standards (IFRSs) adopted in July 2002, all listed European Union companies, including banks and insurance companies, are required to prepare their consolidated finan- cial statements in accordance with IFRS for fiscal years commencing on or after January 1, 2005. IFRS 1, First-Time Adoption of International Financial Re- porting Standards, requires disclosures that explain how the transition from previous GAAP to IFRSs affected the entity’s reported financial position, financial performance and cash flows and to comply with each IFRS effective at the reporting date for its first IFRS financial statements. An entity shall prepare an opening IFRS balance sheet at the date of transi- tion and present at least one year of comparative information under IFRSs. Accordingly our date of transition to IFRSs is the beginning of business on 1 January 2004 (opening IFRS balance sheet date). As a UK company, Dialog has to use its UK GAAP financial statements (previous GAAP) which are filed at Companies House for purposes of conversion from previous GAAP to IFRSs. We expect to prepare and publish IFRS financial statements in the first quarter 2005. Convergence of IFRSs and U.S. GAAP Dialog strongly supports further alignments between IFRSs and U.S. GAAP to increase international comparability and transparency in financial reporting. In preparation for our adoption of IFRSs, we closely track developments and activi- ties at both standard setting bodies, the IASB and the U.S. Financial Accounting Standards Board—FASB, and ex- pressly welcome the joint initiatives that have already and will further significantly increase the speed and extent of convergence of IFRSs and U.S. GAAP. Following a formal commitment to the common goal of convergence in Septem- ber 2002, both Boards have added a joint short-term conver- gence project to their agendas, which is aimed at removing a number of individual differences in the short-term. That is in consideration of the 2005 IFRSs adoption date in Europe, usually by selecting current practice either under existing IFRSs or U.S. GAAP. A long-term objective for the IASB and the FASB is to work together to reduce or eliminate remain- ing differences on an ongoing basis, through a series of joint projects and through coordination of future work programs. In addition, the Boards have agreed to work together through Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance their respective interpretive bodies in converging interpreta- tion and application issues. Dialog expects the adoption of IFRSs to have the following impact on its Consolidated Financial Statements: Research and development costs U.S. GAAP generally requires R&D costs to be expensed as incurred. Separate rules apply to software development costs, which may qualify for capitalization under certain circum- stances. Under IFRSs, a distinction is to be made between research and development. All costs identified as research costs are to be expensed as incurred, whereas development costs are to be capitalized and amortized if specified criteria are met. Accounting for Goodwill Goodwill represents the excess of purchase price over fair value of net assets of businesses acquired. Under U.S. GAAP, beginning January1, 2002, goodwill is no longer amortized, but instead tested for impairment. In accordance with IFRS 1, we expect not to apply IFRS 3, Business Combinations, retro- spectively to past business combinations. Therefore the carry- ing amount of goodwill in the opening IFRS balance sheet shall be the carrying amount under previous GAAP at the date of transition to IFRSs. We previously have amortized goodwill over a five year period resulting in a zero balance as of December 31, 2003 in our UK GAAP financial state- ments. Accordingly, goodwill is no longer recorded as an asset in our IFRS financial statements. Corporate Governance Principles High corporate governance standards Dialog Semiconductor Plc is committed to comply with Ger- man, US and internationally accepted standards for fair and responsible corporate governance. Accordingly, Dialog Semi- conductor (as a foreign Company listed on the German stock exchange) has established and published its own Corporate Governance Principles corresponding in substance to the provision of the “German Declaration on Corporate Govern- ance”. Also, in accordance with the Sarbanes-Oxley Act of 2002, Dialog has adopted a Code of Business Conduct and Ethics and maintains an Audit Committee. Furthermore, as Dialog is listed on NASDAQ, the Code of Business Conduct and Ethics complies with NASDAQ`s corporate governance rules. Dialog has adopted and will follow these principles and codes in order to further enhance the confidence of share- holders, customers, employees and the general public in the Company. Full details of the Corporate Governance Principles and the Code of Business Conduct and Ethics are published on Dialog Semiconductor’s internet site (www.dialog- semiconductor.com). In summary the Corporate Governance Principles cover the following key areas Shareholders rights and the Annual General Meeting (AGM) Each share carries one vote, and there are no multiple voting rights or preferential voting rights (golden shares). All finan- cial and independent audit reports are presented to the AGM. The AGM is where the directors will obtain authorization to approve and pass resolutions related to Company business, such as auditor’s remuneration, and issue of new shares. The Company will also facilitate the personal exercising of share- holders’ voting rights. The company shall publish key infor- mation relating to the AGM on its web site on the day of the annual meeting. Board of Directors’ responsibilities, composition and com- pensation Dialog has seven non-executive directors and one executive director on the Board, to supervise the general management and develop the Company’s strategy. The non-executive directors do not play an active role in day-to-day operations providing an independence and objectivity in the making of key decisions. During 2004, directors received the remunera- tion listed below and their shareholdings in Dialog Semicon- ductor are as follows. Annual Report 2004 | 53 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Name Roland Pudelko Tim Anderson 1) Michael Glover Aidan Hughes Position Executive Director, CEO and President Non-executive Director Non-executive Chairman of the Audit Committee Non-executive Director (since October 1, 2004) John McMonigall Non-executive Director Gregorio Reyes Non-executive Director Michael Risman Non-executive Director Jan Tufvesson Non-executive Chairman Compensation (in €) Directors Holdings Bonus / Long- term incen- tives 33.334 Base salary 279.105 7.366 51.565 11.050 29.466 44.198 29.466 51.565 - - - - - - - 503.781 33.334 Shares 320.405 75.166 195.000 - - 35.000 1.172 175.062 801.805 Options 517.450 - - - - - - - 517.450 1) Tim Anderson is also a partner in the law firm Reynolds Porter Chamberlain, which frequently acts as our legal adviser. Fees to Reynolds Porter Chamberlain for legal services rendered during the 2004 fiscal year amounted to €212. Variable compensation of the Chief Executive Officer is measured based on the profitability of the Company as well as success in reaching specific strategic goals. Audit Committee and Compensation Committee Dialog has established an Audit Committee of the Board of Directors consisting of independent directors: Messrs. Glover (chairman of the Audit Committee), Tufvesson and Hughes. To maintain independence, members of the Committee are not to receive payment from the Company for consulting, advisory, or other services other than for board service and are not to be affiliated with the Company. The Compensation Committee determines the salaries and incentive compensa- tion of Dialog’s officers and the officers of the Company’s subsidiaries and provides recommendations for the salaries and incentive compensation of other employees and consult- ants. Our Compensation Committee consists of Messrs. Tufvesson (chairman of the Compensation Committee), Glover and Reyes. None of the members of this Committee should serve as an employee of the Company. Transparency, including director’s dealing, insider dealing and loans Dialog promptly discloses price sensitive information to the stock exchanges and then publishes the information elec- tronically. Significant shareholder interests should be re- ported to the Company according to the UK Companies Act 1985. Transactions in securities of the Company’s own shares carried out by members of the Board of Directors and of their family members will be reported and published without delay pursuant to section 15a of the German Securities Trading Act (Wertpapierhandelsgesetz). With regard to insider dealing Dialog has adopted a Code of Dealing, in which we comply with stringent guidelines to ensure against suspicion of abus- ing the possession of price sensitive information, by prohibit- ing dealing in any of the company’s financial instruments during defined periods. In addition, the Company will not provide or guarantee any loans to directors or senior execu- tives. Business conduct and ethics The Company shall comply with all governmental laws, rules and regulations that are applicable to the Company's activi- ties, and expects that all directors, officers and employees acting on behalf of the Company will obey the law. Directors, officers and employees should not be involved in any activ- ity, which creates or gives the appearance of a conflict of interest between their personal interests and the Company's interests. The Company is committed to promoting the values of honesty, integrity and fairness in the conduct of its busi- ness and sustaining a work environment that fosters mutual respect, openness and individual integrity. Directors, officers and employees are expected to deal honestly and fairly with the Company's customers, suppliers, competitors and other third parties. Auditor’s independence The aggregate fees billed for each of the last two fiscal years for professional services rendered by the principal accountant for the audit of annual financial statements or services by the principal accountant, KPMG, were as follows: (in thousands of €) 2004 2003 Audit fees Tax fees 174 110 284 169 65 234 Tax services rendered in 2004 were pre-approved by the audit committee in accordance with § 401(i) of the Sarbanes – Oxley Act of 2002. Our Auditor, KPMG, confirmed their independence at each quarterly audit committee meeting and declared the follow- ing: 54 | Annual Report 2004 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Our internal organization complies with the requirements of the “Gemeinsamen Stellungnahme der Wirtschaftsprüfer- kammer und des Instituts der Wirtschaftsprüfer in Deutsch- land: Zur Qualitätssicherung in der Wirtschaftsprüferpraxis“ (VO 1/1995). Our partners are prohibited to have any finan- cial investment in a KPMG audit client. All other professional staff is prohibited to have any financial investment in an audit client he or she delivers services to. The affected per- sons have to declare that they comply with these regulations on a regular basis.” Declaration of conformity with regard to the German cor- porate governance code “Dialog Semiconductor Plc has established and published its own corporate governance principles corresponding in sub- stance to the provisions of the German “Declaration on Cor- porate Governance” as published on November 13, 2002 thereby adopting in substance the recommendations of the Government Commission on the German Corporate Govern- ance Code”. This declaration is available on the Internet at: www.dialog- semiconductor.com/Investor Relations/Corporate Governance. London, February 2005 Jan Tufvesson, Chairman “We hereby confirm, that as of February 21, 2005, we are independent accountants with respect to the Company within in the meaning of the Securities Acts administered by the Securities and Exchange Commission of the United States and the requirements of the Independence Standards Board, Auditing Standard No. 2 of the Public Company Accounting Oversight Board (United States), German law, the German Coporate Governance Code and professional standards in Germany and the United States. In particular (cid:132) We verified that no professional relationships to the Company exist that may reasonably be thought to bear on our independence. This relates especially to board membership and employee relationships with the Com- pany. (cid:132) We verified that no financial relationships exist that may reasonably be thought to bear on our independence. This relates especially to direct investments such as stocks, bonds and similar investments. We are also independent in respect to the requirements of § 319 paragraph 2 no. 8 HGB (unamended version). For each of the last five years our annual revenues generated from services to the Com- pany and other entities for, which the Company holds more than 20% ownership amounted to less than 30% in fact, less than 1% of our total revenues. This is also ex- pected to be the case for the current fiscal year (§ 319 paragraph 3 no. 5 HGB (amended version)). (cid:132) We will also ensure that anything, which may reasonably be thought to bear on our independence with regard to the self review threat will be avoided. In particular, apart from the audit we have not taken part in the maintenance of any books or records or the preparation of financial statements and will not do so in future. (cid:132) We will comply with the requirements regarding internal rotation (§ 319 paragraph 3 no. 6 HGB). (cid:132) We are not aware of any other relationships or matters, which may reasonably be thought to bear on our inde- pendence such as close family or personal relationships with the board members or management of the Company. Annual Report 2004 | 55 Shareholder Information Corporate Profile Management Report Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Notes to the Consolidated Financial Statements Corporate Governance Members of the Board of Directors Jan Olof Ingemar Tufvesson, Chairman (66) joined the board of our then-holding company in 1990 and has served as chairman of the board since March 1998. Be- tween 1972 and 1980 he held senior appointments on the Royal Swedish Air Force Board. In 1980 he joined Ericsson where he had a number of executive roles, the last being a vice president at LM Ericsson corporate, responsible for all procurement in Ericsson and for developing relations with key suppliers. Mr. Tufvesson graduated from the Royal Uni- versity of Technology in Stockholm with a masters degree in electronic engineering in 1962. Mr. Tufvesson retired from Ericsson in 1998 and is now based in Stockholm. Roland Pudelko, Chief Executive Officer and President (52) joined us in 1989 as managing director and has served as Executive Director, CEO and President since March 1998. He has over 20 years experience in electronics and microelec- tronics, primarily in management positions within the Daim- ler-Benz Group. During that time, he was on the board of a joint venture with ACER of Taiwan, and in the TEMIC Group he was responsible for worldwide design and engineering. Mr. Pudelko has a diploma in communication technologies. He is also the managing director of Dialog Semiconductor GmbH and other consolidated subsidiaries of Dialog Semi- conductor Plc. Timothy Richard Black Anderson (43) joined the board of our then-holding company in 1990 and has served as a director since February 1998. Mr. Anderson has been a partner with the London law firm Reynolds Porter Chamberlain since 1989, where he specializes in business law for media and technology companies. He holds a law degree from Southampton University and is qualified as a solicitor in England and Wales. Michael John Glover (66) joined the board of our then-holding company in 1990 and has served as a director since March 1998. Mr. Glover was a senior executive with technology based companies in the United Kingdom, Europe, the Far East and North America prior to becoming involved in private equity fund manage- ment in 1985. He has a degree in economics from the Uni- versity of Birmingham. Mr. Glover is currently Managing Director of Aylestone Strategic Management Limited and serves as a director of other companies. Aidan Hughes (44) joined us as a director in October 2004. He qualified as a chartered accountant with Price Waterhouse in the 1980s before taking senior accountant roles at Lex Service Plc and Carlton Communications Plc. He served the Sage Group Plc as finance director from 1993 until 2000. Between December 2001 and August 2004 Hughes was a director of Communisis Plc. John McMonigall (61) has served as one of our directors since March 1998. He joined Apax Partners as a director in 1990 and is currently the director responsible for investments in telecommunica- tions, software and related fields. Between 1986 and 1990, Mr. McMonigall held a variety of senior positions at British Telecom, including managing director of the customer service division. He was also a member of the management board of British Telecom. He is currently on the board of five other public and private companies, including Crane Telecommuni- cations Ltd, Autonomy plc and Amphion Ltd. Gregorio Reyes (63) joined us as a director in December 2003, and has been a private investor and management consultant since 1994 with current board positions at companies including LSI Logic Corp., Appshop, Amphion Semiconductor, Astute Networks, Future Trade Technologies, and Nuera Communications. He has held various executive positions with National Semicon- ductor (1962-1967), Motorola (1967-1968) and Fairchild Semiconductor (1968-1978). He was also president and CEO of National Micronetics (1981-1984), and chairman and CEO of American Semiconductor Equipment Technologies (1986- 1990), and of Sunward Technologies (1990-1994). Michael Risman (36) joined us as a director in August 1999, having been closely involved with our company since March 1998. He is a direc- tor of Apax Partners where he has responsibility for their European IT investment activities and is a member of their International Approval Committee. Before joining Apax Partners in 1995, Mr. Risman worked for Cap Gemini as a consultant and for Jaguar Cars as an R&D engineer. He earned an MBA from Harvard Business School and an MA (Hons) degree in Electrical Engineering and Management from Cambridge University. He is also a director of Frontier Silicon (Holdings) Ltd, Red-M (Communications) Limited and Streamserve Inc. 56 | Annual Report 2004 Investor Information (cid:132) Annual Meeting (cid:132) Corporate Calendar The annual meeting of Dialog Semiconductor Plc will be held on May 11, 2005 9 a.m. local time 278/282 High Holborn London WC1V 7HA United Kingdom April 20, 2005 Release of first quarter results May 11, 2005 Annual shareholders’ meeting July 20, 2005 Release of second quarter results October 19, 2005 Release of third quarter results (cid:132) Corporate Counsel (cid:132) Certified Public Accountants Reynolds Porter Chamberlain London, United Kingdom KPMG Deutsche Treuhand-Gesellschaft Stuttgart, Germany (cid:132) US Listing (cid:132) ADS Administrator Our Shares are listed on Nasdaq in the form of American Depositary Shares (ADS). Each ADS represents one ordinary share. Dialog Semiconductor is subject to the regulations of the Securities and Exchange Commission (SEC) in the USA as they apply to foreign companies and files with the SEC its Annual Report on Form 20-F and other information as required. ADS holders may instruct The Bank of New York, which administers our ADS program, as to the exercise of voting rights pertaining thereto: The Bank of New York 101 Barclay Street, 22W New York, NY 10286 Telephone: +1 (888) 269-2377 Facsimile: +1 (212) 571-3050 (cid:132) Please direct inquiries to: (cid:132) www.dialog-semiconductor.com Dialog Semiconductor Birgit Hummel Neue Straße 95 D-73230 Kirchheim/Teck - Nabern Telephone Fax E-mail: birgit.hummel@diasemi.com +49-7021-805-412 +49-7021-805-200 All our recent press releases are accessible together with the latest Annual and Interim Reports. Publications of interest to current and potential investors (Form 20-F, Annual and Interim Reports) are available without charge upon request. Please order within the investor relations section of our homepage. Technical Glossary Analog A type of signal in an electronic circuit that takes on a continuous range of values rather than only a few discrete values. APS Advanced Pixel Sensor technology used in Dialog Semiconductor’s CMOS image sensors. ASIC Application Specific Integrated Circuit; an integrated chip custom designed for a specific application. ASSP Application Specific Standard Product; a semiconductor device integrated circuit (IC) dedicated to a specific application and sold to more than one user. is typically lower than the input voltage. LED Light Emitting Diode. A semiconductor device that emits light when charged with electricity, often used for LCD display backlights. Mixed signal Describes a combination of analog and digital signals being generated, controlled or modified on the same chip. MLA Multi-Line Addressing is a technology used in color LCDs to enable full color, high quality display of moving images with fast response time, high brightness, lower cost and low power consumption. Audio CODEC The interface between analog signals (such as the human voice) and the digital data processing inside a mobile phone, determining voice quality. MP3 (MPEG-1 Audio Layer-3) A standard technology format for compression of sound sequences into very small files, while preserving the original level of sound quality. CAD Computer Aided Design, usually refers to a software tool used for designing electronics hardware or software systems. CDMA (Code Division Multiple Access) An alternative to GSM technology for mobile wireless networks. Chips Electronic integrated circuits. CMOS Complimentary Metal Oxide Semiconductor, the most popular class of semiconductor manufacturing technology. DC-DC A DC-to-DC converter accepts a direct current input voltage and produces a direct current output voltage. The output is typically at a different voltage level than the input, and often the component provides power bus regulation. Digital A type of signal used to transmit information that has only discrete levels of some parameter (usually voltage). Fabless A term describing a company that designs and delivers semiconductors by outsourcing the fabrication (manufacturing) process. Foundry A manufacturing plant where silicon wafers are produced. GPS Global Positioning System. A worldwide satellite navigation system used in electronics systems for positional information. GPRS General Packet Radio Service, a step between GSM and 3G (third generation) mobile networks, offering fast data transmission via the GSM network GSM Global System for Mobile Communications, the world’s most widely used mobile system. IC Integrated Circuit; an electronic device with numerous components on a single chip. Imaging The capture and processing of images via an image sensor for use by an electronic device to send to a display for viewing by a user. Liquid Crystal Display (LCD) A display technology found in many portable electronics products, including personal organizers, cellular handsets and notebook computers. Multimedia messaging services (MMS) A standardized messaging service for the mobile environment, delivering user-created content from phone to phone, and containing any combination of graphics, images and audio. NiMH, L Ion and polymer Various battery technologies. Personal digital assistant (PDA) A hand-held computer designed for use as a personal organizer with communications capabilities. Power management The management of the power requirements of various subsystems, important in hand-held and portable electronics equipment. PMIC Power Management IC. Semiconductor A base material halfway between a conductor and an insulator, which can be physically altered by mixing in certain atoms. Semiconductors form the basis for present-day electronics. Silicon A semi-metallic element used to create a wafer, and the most common semiconductor material - in about 95% of all manufactured chips. Smart Mirror™ A technology patented by Dialog Semiconductor which simplifies circuit design and provides very low current consumption in power management circuits. STN Super-Twisted Nematic, refers to the direction of rotation of the liquid crystals in an LCD to enable excellent brightness and a wide angle at which the display can be viewed before losing much contrast. System on chip (SOC) Advanced semiconductor device embedding custom circuits and intellectual property (IP) elements into single chip solutions. USB Universal Serial Bus. A universal interface standard to connect different electronics devices VGA Video Graphics Array. A standard size/resolution of 640 pixels by 480 pixels for digital cameras, images, and displays. Wafer A slice of silicon from a 4, 5, 6 or 8 inch diameter silicon bar and used as the foundation on which to build semiconductor products. LDO Low Dropout voltage regulators are used in battery operated systems, where the output voltage WCDMA Wideband CDMA, a 3G (third generation) wireless standard, also referred to as UMTS. Financial Glossary Cash Flow The primary purpose of a statement of cash flows is to provide relevant information about the cash receipts and cash payments of an enterprise during a period. It helps to assess the enterprise's ability to generate positive future net cash flows. A statement of cash flows shall explain the change in cash and cash equivalents during the period by classifying cash receipts and payments according to whether they stem from operating, investing, or financing activities. Cash flow from operating activities Cash flow from operating activities includes all transactions and other events that are not defined as investing or financing activities in paragraphs. Operating activities generally involve producing and delivering goods and providing services. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income. Comprehensive Income The purpose of reporting comprehensive income is to report a measure of all changes in equity of an enterprise that result from recognized transactions and other economic events of the period other than transactions with owners such as capital increases or dividends. An example of items effecting comprehensive income is foreign currency translation adjustments resulting from the process of translating an entity's financial statements in a foreign currency into the reporting currency. Corporate Governance Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance. Deferred taxes Deferred tax assets or liabilities are temporary differences between the tax basis of an asset or liability and its reported amount in the financial statements that will result in taxable or deductible amounts in future years when the reported amount of the asset or liability is recovered or settled, respectively. Derivative financial instruments A financial instrument that derives its value from the price or expected price of an underlying asset (e.g. a security, currency or bond). Goodwill Goodwill is to be recorded in a purchase business combination for an excess of the cost of the acquired enterprise over the total amount assigned to the identifiable assets acquired less liabilities assumed. Gross Margin Gross Margin equals the difference between revenues and cost of sales as presented in the statement of operations. Hedging A strategy used to minimize exposure to changes in prices, interest rates or exchange rates by means of derivative financial instruments (options, swaps, forward contracts, etc.). Impairment Impairment is the condition that exists when the carrying amount of a long-lived asset exceeds its fair value (the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset). IFRS (International Financial Reporting Standards) Accounting standards generally to be used for fiscal years commencing on or after January 1, 2005 by all publicly listed European Union companies in compliance with the European Parliament and Council Regulation adopted in July 2002. Prime Standard The new segmentation of the equity market of the German Stock Exchange comprises a Prime Standard segment in addition to the General Standard segment that applies the statutory minimum requirements. The Prime Standard segment addresses companies that wish to target international investors. These companies are required to meet high international transparency criteria, over and above those set out by the General Standard. Restructuring Charges Costs associated with an exit or disposal activity, e.g. termination benefits provided to employees that are involuntarily terminated. Securities Debt securities are instruments representing a creditor relationship with an enterprise and include government securities, corporate bonds, commercial paper, and all securitized debt instruments. Available-for-sale securities are debt securities not classified as held-to-maturity or trading securities. Shareholders’ equity Shareholders’ equity reflects the investment of shareholders in a company. Shareholders’ equity is comprised of ordinary shares, additional paid-in capital, retained earnings and accumulated other comprehensive income. Stock option plans Stock option plans include all agreements by an entity to issue shares of stock or other equity instruments to employees. Stock option plans provide employees the opportunity to receive stock resulting in an additional compensation based on the future share price performance. The purpose of stock option plans is to motivate employees to increase shareholder value on a long-term basis. Total Assets Total assets include all current and non-current assets. Total assets equal total liabilities and shareholders’ equity. Working Capital Working capital is represented by the excess of current assets over current liabilities and identifies the relatively liquid portion of total enterprise capital that constitutes a margin or buffer for meeting obligations within the ordinary operating cycle of the business 

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