Monolithic Power Systems, Inc.
MONOLITHIC POWER SYSTEMS INC (Form: 10-Q, Received: 04/28/2011 16:08:21)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-Q

 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2011
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission file number: 000-51026
 

Monolithic Power Systems, Inc.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 
Delaware
77-0466789
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
 
6409 Guadalupe Mines Road, San Jose, CA 95120 (408) 826-0600
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE AND TELEPHONE NUMBER)
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   o     No   o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large
accelerated filer   o     Accelerated filer   x     Non-accelerated filer   o     Smaller reporting company   o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   o     No   x
 
There were 34,270,683 shares of the registrant’s common stock issued and outstanding as of April 19, 2011.
 
 
1

 
 
MONOLITHIC POWER SYSTEMS, INC.
 
TABLE OF CONTENTS
 
 
 
 
PAGE
PART I. FINANCIAL INFORMATION
3
    ITEM 1.
FINANCIAL STATEMENTS
3
 
CONDENSED CONSOLIDATED BALANCE SHEETS
3
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
4
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
5
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
6
    ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
16
    ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
26
    ITEM 4.
CONTROLS AND PROCEDURES
26
PART II. OTHER INFORMATION
26
    ITEM 1.
LEGAL PROCEEDINGS
26
    ITEM 1A.
RISK FACTORS
26
    ITEM 6.
EXHIBITS
38
 
 
2

 

 PART I. FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
MONOLITHIC POWER SYSTEMS, INC.
 
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value and share amounts)
(Unaudited)
 
   
March 31,
   
December 31,
 
   
2011
   
2010
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 74,062     $ 48,010  
Short-term investments
    101,957       129,709  
Accounts receivable, net of allowances of $0 in
     both 2011 and 2010
    17,642       18,347  
Inventories
    23,117       25,789  
Deferred income tax assets, net - current
    205       204  
Prepaid expenses and other current assets
    2,686       2,314  
Total current assets
    219,669       224,373  
Property and equipment, net
    37,326       37,262  
Long-term investments
    17,270       19,180  
Deferred income tax assets, net - long-term
    39       39  
Other assets
    706       749  
Total assets
  $ 275,010     $ 281,603  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
  $ 10,505     $ 8,979  
Accrued compensation and related benefits
    5,723       8,792  
Accrued liabilities
    10,512       11,199  
Total current liabilities
    26,740       28,970  
                 
Non-current income tax liability
    5,018       5,015  
Other long-term liabilities
    3       723  
      Total liabilities
    31,761       34,708  
Stockholders' equity:
               
Common stock, $0.001 par value, $35 and $35 in 2011
     and 2010, respectively; shares authorized: 150,000,000;
     shares issued and outstanding: 34,882,333 and 35,063,033
     in 2011 and 2010, respectively
    172,443       178,269  
Retained earnings
    68,540       66,647  
Accumulated other comprehensive income
    2,266       1,979  
Total stockholders’ equity
    243,249       246,895  
Total liabilities and stockholders’ equity
  $ 275,010     $ 281,603  
 
 
See accompanying notes to condensed consolidated financial statements.
 
 
3

 
 
MONOLITHIC POWER SYSTEMS, INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)

   
Three months ended March 31,
 
   
2011
   
2010
 
             
             
Revenue
  $ 44,468     $ 50,250  
Cost of revenue
    22,163       20,954  
                 
Gross profit
    22,305       29,296  
Operating expenses:
               
Research and development
    10,086       11,040  
Selling, general and administrative
    9,490       10,393  
Litigation expense
    813       1,567  
                 
Total operating expenses
    20,389       23,000  
                 
Income from operations
    1,916       6,296  
Other income (expense):
               
Interest and other income
    271       347  
Interest and other expense
    (88 )     -  
                 
Total other income, net
    183       347  
                 
Income before income taxes
    2,099       6,643  
Income tax provision
    206       287  
                 
Net income
  $ 1,893     $ 6,356  
Basic net income per share
  $ 0.05     $ 0.18  
Diluted net income per share
  $ 0.05     $ 0.17  
Weighted average common shares outstanding:
               
Basic
    35,024       35,421  
Diluted
    36,105       37,783  
 
 
See accompanying notes to condensed consolidated financial statements.
 
 
4

 
 
MONOLITHIC POWER SYSTEMS, INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
 
   
Three months ended March 31,
 
   
2011
   
2010
 
             
Cash flows from operating activities:
           
Net income
  $ 1,893     $ 6,356  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    2,270       1,723  
Amortization and realized loss on debt instruments
    183       127  
Tax benefit from stock option transactions
    1,472       567  
Excess tax benefit from stock option transactions
    (435 )     (215 )
Stock-based compensation
    2,987       4,024  
Changes in operating assets and liabilities:
               
Accounts receivable
    705       (9,019 )
Inventories
    2,679       5,066  
Prepaid expenses and other assets
    (345 )     238  
Accounts payable
    1,299       2,032  
Accrued and long-term liabilities
    (347 )     (357 )
Accrued income taxes payable and noncurrent tax liabilities
    (1,037 )     (353 )
Accrued compensation and related benefits
    (3,094 )     (1,956 )
Net cash provided by operating activities
    8,230       8,233  
                 
Cash flows from investing activities:
               
Property and equipment purchases
    (3,056 )     (3,570 )
Purchase of short-term investments
    (15,968 )     (46,037 )
Proceeds from sale of short-term investments
    43,530       38,148  
Proceeds from sale of long-term investments
    2,050       75  
Net cash provided by (used in) investing activities
    26,556       (11,384 )
                 
Cash flows from financing activities:
               
Proceeds from issuance of common stock
    3,527       4,047  
Proceeds from employee stock purchase plan
    928       1,054  
Repurchase of common stock
    (13,710 )     -  
Excess tax benefits from stock option transactions
    435       215  
Net cash provided by (used in) financing activities
    (8,820 )     5,316  
                 
Effect of change in exchange rates
    86       (17 )
Net increase in cash and cash equivalents
    26,052       2,148  
Cash and cash equivalents, beginning of period
    48,010       46,717  
Cash and cash equivalents, end of period
  $ 74,062     $ 48,865  
                 
Supplemental disclosures for cash flow information:
               
Cash paid for taxes
  $ 100     $ 159  
Supplemental disclosures of non-cash investing and financing activities:
               
Liability accrued for equipment purchases
  $ 3,464     $ 2,526  
Temporary impairment (reversal) of auction-rate securities
  $ (140 )   $ (185 )
 
See accompanying notes to condensed consolidated financial statements.
 
 
5

 
 
MONOLITHIC POWER SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
1. Basis of Presentation — The accompanying unaudited condensed consolidated financial statements have been prepared by Monolithic Power Systems, Inc. (the “Company” or “MPS”) in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted in accordance with these rules and regulations. The information in this report should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in its Form 10-K filed with the SEC on March 4, 2011.
 
In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the Company’s financial position, results of operations and cash flows for the interim periods presented. The financial statements contained in this Form 10-Q are not necessarily indicative of the results that may be expected for the year ending December 31, 2011 or for any other future period.

Recent Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") No. 2009-13, " Multiple-Deliverable Revenue Arrangements " ("ASU 2009-13"). The new standard changes the requirements for establishing separate units of accounting in a multiple element arrangement and requires the allocation of arrangement consideration to each deliverable to be based on the relative selling price. ASU 2009-13 is effective for fiscal years beginning on or after June 15, 2010. We have adopted the provisions of ASU 2009-13 and the impact was not material to our results of operations or financial position.
 
2. Stock-Based Compensation — The Company has two stock option plans and an employee stock purchase plan—the 1998 Stock Option Plan, the 2004 Equity Incentive Plan and the 2004 Employee Stock Purchase Plan. The Company recognized stock-based compensation expenses for the three months ended March 31, 2011 and 2010, as follows (in thousands):
 
   
Three months ended March 31,
 
   
2011
   
2010
 
Non-Employee
  $ 4     $ 1  
ESPP
    152       227  
Restricted Stock
    1,163       1,610  
Stock Options
    1,668       2,186  
TOTAL
  $ 2,987     $ 4,024  
 
 
6

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)
 
2004 Equity Incentive Plan
 
The Company’s Board of Directors adopted the Company’s 2004 Equity Incentive Plan in March 2004, and the Company’s stockholders approved it in November 2004. Options granted under the 2004 Plan have a maximum term of ten years. New hire grants generally vest over four years at the rate of 25 percent one year from the date of grant and 1/48 th monthly thereafter. Refresh grants generally vest over four years at the rate of 50 percent two years from the date of grant and 1/48 th monthly thereafter. There were 800,000 shares initially reserved for issuance under the 2004 Plan. The 2004 Plan provides for annual increases in the number of shares available for issuance beginning on January 1, 2005 equal to the least of: 5% of the outstanding shares of common stock on the first day of the year, 2,400,000 shares, or a number of shares determined by the Board of Directors. The following is a summary of the 2004 Plan, which includes stock options and restricted stock awards and units:
 
Available for Grant as of December 31, 2010
    2,954,607  
2011 Additions to Plan
    1,753,151  
2011 Grants
    (700,480 )
2011 Cancellations
    150,033  
Available for Grant as of March 31, 2011
    4,157,311  
 
A summary of the status of the Company’s stock option plans at March 31, 2011 and changes during the three months then ended is presented in the table below: 
 
   
Stock Options
   
Weighted Average Exercise Price
   
Weighted Average Remaining Contractual Term (Years)
   
Aggregate Intrinsic Value
 
Outstanding at December 31, 2010 (5,584,241 options exercisable at a weighted-average exercise price of $14.46 per share)
    5,835,118     $ 14.61       4.30     $ 19,035,591  
    Options granted (weighted-average fair value of $8.95 per share)
    10,000     $ 15.53                  
    Options exercised
    (532,411 )   $ 6.63                  
    Options forfeited and expired
    (119,107 )   $ 17.70                  
Outstanding at March 31, 2011
    5,193,600     $ 15.35       4.14     $ 8,129,368  
Options exercisable at March 31, 2011 and expected to become exercisable
    4,992,943     $ 15.26       4.11     $ 8,079,711  
Options vested and exercisable at March 31, 2011
    4,027,776     $ 14.61       3.94     $ 7,854,438  
 
 
7

 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)
 
The total fair value of options that vested during the three months ended March 31, 2011 and 2010 was $1.7 million and $2.2 million, respectively. The total intrinsic value of options exercised during the three months ended March 31, 2011 and 2010 was $4.7 million and $6.3 million, respectively. Net cash proceeds from the exercise of stock options were $3.5 million for the three months ended March 31, 2011 and $4.0 million for the three months ended March 31, 2010. At March 31, 2011, unamortized compensation expense related to unvested options was approximately $7.9 million, net of estimated forfeitures. The weighted average period over which compensation expense related to these options will be recognized is approximately 1.8 years.

The employee stock-based compensation expense recognized under ASC 718-10-30 Compensation – Stock Compensation –Overall - Initial Measurement, was determined using the Black-Scholes option pricing model. Option pricing models require the input of subjective assumptions and these assumptions can vary over time. The Company used the following weighted-average assumptions to determine the fair values of stock option awards granted during the three months ended March 31, 2011 and 2010: 
 
   
Three months ended March 31
 
   
2011
   
2010
 
Expected term (years)
    4.1       4.1  
Expected volatility
    52.9 %     56.3 %
Risk-free interest rate
    1.7 %     1.9 %
Dividend yield
    -       -  
 
In estimating the expected term, the Company considers its historical stock option exercise experience, post vesting cancellations and remaining contractual term of the options outstanding. In estimating the expected volatility, the Company uses its own historical data to determine its estimated expected volatility. The Company uses the U.S. Treasury yield for its risk-free interest rate and a dividend yield of zero as it does not issue dividends. The Company applies a forfeiture rate that is based on options that have been forfeited historically.
 
Restricted Stock

The Company grants restricted stock units, which vest generally over four years as determined by the Company’s Compensation Committee, and are issued upon vesting. Before vesting, these restricted stock units are not eligible for dividends, if and when declared. A summary of the restricted stock units is presented in the table below:
 
   
Restricted
Stock Units
   
Weighted Average Grant Date Fair Value Per Share
   
Weighted Average Remaining Recognition Period (Years)
 
Outstanding at December 31, 2010
    960,174     $ 19.88       2.91  
    Awards granted
    690,480       14.84          
    Awards released
    (108,704 )     17.93          
    Awards forfeited
    (30,926 )     20.58          
Outstanding at March 31, 2011
    1,511,024     $ 17.70       3.23  

The total fair value of restricted stock units that vested was $2.5 million for the three months ended March 31, 2011 and $1.0 million for the three months ended March 31, 2010, respectively. The intrinsic value related to restricted stock units released for the three months ended March 31, 2011 and 2010 was $1.6 million and $1.2 million, respectively. The intrinsic value related to restricted stock units outstanding at March 31, 2011 and 2010 was $26.8 million and $20.2 million, respectively. At March 31, 2011, the unamortized compensation expense related to unvested restricted stock units was approximately $19.3 million, net of estimated forfeitures, with a weighted average remaining recognition period of 3.2 years.
 
 
8

 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)
 
On February 25, 2010, the Board granted 416,000 performance units to the Company’s executive officers. These performance units generally vest over four years, with a graded acceleration feature that allows all or a portion of these awards to be accelerated if certain performance conditions are satisfied. The amount of shares to be accelerated is based on achieving certain performance targets, with the minimal acceleration occurring if performance exceeds at least 110% of non-GAAP earnings per share as set forth in the Company’s annual operating plan approved by the Board, as determined by the Compensation Committee in its sole discretion. The Compensation Committee has the discretion not to accelerate any shares, if it so chooses, even if the performance targets are met. To date, none of the shares have been accelerated and it is too early in the year to ascertain whether certain of the shares will be accelerated in 2011.
 
2004 Employee Stock Purchase Plan
 
Under the 2004 Employee Stock Purchase Plan (the Purchase Plan), eligible employees may purchase common stock through payroll deductions. Participants may not purchase more than 2,000 shares in a six-month offering period or stock having a value greater than $25,000 in any calendar year as measured at the beginning of the offering period in accordance with the Internal Revenue Code and applicable Treasury Regulations. A total of 200,000 shares of common stock were reserved for issuance under the Purchase Plan.  The Purchase Plan provides for an automatic annual increase beginning on January 1, 2005 by an amount equal to the least of: 1,000,000 shares, 2% of the outstanding shares of common stock on the first day of the year, or a number of shares as determined by the Board of Directors. For the three months ended March 31, 2011 and 2010, 70,685 shares and 57,240 shares, respectively, were issued under the Purchase Plan. The following is a summary of the Purchase Plan and changes during the three months ended March 31, 2011:
 
 Available Shares as of December 31, 2010
    3,141,931  
 2011 Additions to Plan
    701,260  
 2011 Purchases
    (70,685 )
 Available Shares as of March 31, 2011
    3,772,506  
 
The Purchase Plan is considered compensatory under ASC 718-50-25-2, Compensation – Stock Compensation - Employee Share Purchase Plans - Recognition, and is accounted for in accordance with ASC 718-50-30-2 Compensation – Stock Compensation - Employee Share Purchase Plans - Initial Measurement - Look-Back Plans . The intrinsic value for stock purchased was $0.2 and $0.2 million for the three months ended March 31, 2011 and 2010, respectively. The unamortized expense as of March 31, 2011 was $0.2 million, which will be recognized over 0.4 years. The Black-Scholes option pricing model was used to value the employee stock purchase rights. For the three months ended March 31, 2011 and 2010, the following weighted average assumptions were used in the valuation of the stock purchase rights:
 
   
Three months ended March 31
 
   
2011
   
2010
 
Expected term (years)
    0.5       0.5  
Expected volatility
    37.5 %     41.3 %
Risk-free interest rate
    0.2 %     0.2 %
Dividend yield
    -       -  
                 

Cash proceeds from employee stock purchases for the three months ended March 31, 2011 and 2010 was $0.9 million and $1.1 million, respectively.
 
 
9

 
 
  NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)
 
3. Inventories - Inventories consist of the following (in thousands):
 
   
March 31, 2011
   
December 31, 2010
 
Work in progress
  $ 13,364     $ 11,559  
Finished goods
    9,753       14,230  
Total inventories
  $ 23,117     $ 25,789  
 
4. Accrued Liabilities - Accrued liabilities consist of the following (in thousands):
 
   
March 31, 2011
   
December 31, 2010
 
Deferred revenue and customer prepayments
  $ 3,102     $ 3,200  
Chengdu building construction cost
    2,578       3,633  
Stock rotation reserve
    1,264       811  
Legal expenses and settlement costs
    983       844  
Warranty
    463       764  
Other
    2,122       1,947  
Total accrued liabilities
  $ 10,512     $ 11,199  
 
A roll-forward of the warranty reserve for the three months ended March 31, 2011 and 2010 is as follows:
 
   
Three months ended March 31,
 
   
2011
   
2010
 
Balance at beginning of year
  $ 764     $  294  
Warranty costs
    (296 )     -  
Unused warranty provision
    (121 )      (26 )
Warranty provision for product sales
    116       121  
Balance at end of period
  $ 463     $  389  
 
5. Net Income per Share and Comprehensive Income   — Basic net income per share excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted net income per share is calculated using the treasury stock method and reflects the potential dilution that would occur if outstanding securities or other contracts to issue common stock were exercised or converted into common stock. The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):
 
 
10

 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)
 
   
Three months ended March 31,
 
   
2011
   
2010
 
Numerator:
           
   Net income
  $ 1,893     $ 6,356  
                 
Denominator:
               
   Weighted average oustanding shares used to compute basic net income per share
    35,024       35,421  
   Effect of dilutive securities
    1,081       2,362  
   Weighted average oustanding shares used to compute diluted net income per share
    36,105       37,783  
                 
Net income (loss) per share - basic
  $ 0.05     $ 0.18  
Net income (loss) per share - diluted
  $ 0.05     $ 0.17  
 
For the three months ended March 31, 2011 and 2010, approximately 4.7 million and 1.5 million weighted common stock equivalents, respectively, were excluded from the calculation of diluted net income per share because their inclusion would have been anti-dilutive.
 
The following table sets forth the components of other comprehensive income, net of income tax effect (in thousands):
 
   
Three months ended March 31,
 
   
2011
   
2010
 
Net income
  $ 1,893     $ 6,356  
Other comprehensive income (loss):
               
   Change in value of temporary impairment of auction-rate securities
    140       185  
   Unrealized gain (loss) on available-for-sale securities
    (7 )     48  
   Foreign currency translation adjustments
    154       1  
                 
Comprehensive income
  $ 2,180     $ 6,590  
 
6. Segment Information
 
As defined by the requirements of ASC 280-10-50 Segment Reporting – Overall - Disclosure , the Company operates in one reportable segment: the design, development, marketing and sale of high-performance, mixed-signal analog semiconductors for the communications, computing, consumer, and industrial markets. Geographic revenue is based on the location to which customer shipments are delivered. For the three months ended March, 31, 2011 and 2010, the Company derived substantially all of its revenue from sales to customers located outside North America. The following is a list of customers whose sales exceeded 10% of revenue for the three months ended March 31, 2011 and 2010.
 
     
Revenue
 
     
Three months ended March 31,
 
Customers
   
2011
   
2010
 
               
A       16 %     10 %
B       *       14 %
C       *       11 %
 
(*) represents less than 10%
 
 
11

 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)
 

 
 
The following is a summary of revenue by geographic region based on customer ship-to location (in thousands):
 
   
Three months ended March 31,
 
Country
 
2011
   
2010
 
China
  $ 23,677     $ 22,565  
Taiwan
    5,129       5,515  
Korea
    4,427       8,511  
Europe
    3,475       5,460  
Japan
    2,978       2,880  
USA
    1,106       2,843  
Other
    3,676       2,476  
                 
Total
  $ 44,468     $ 50,250  
 
The following is a summary of revenue by product family (in thousands):
 
   
For the three months ended March 31,
 
Product Family  
2011
   
2010
 
DC to DC Converters
  $ 37,093     $ 40,301  
Lighting Control Products
    5,888       7,434  
Audio Amplifiers
    1,487       2,515  
                 
Total   $ 44,468     $ 50,250  
 
The following is a summary of long-lived assets by geographic region (in thousands):
 
   
March 31, 2011
   
December 31, 2010
 
China
  $ 34,437     $ 34,468  
United States
    2,811       2,719  
Taiwan
    117       134  
Japan
    79       85  
Other
    60       58  
 TOTAL
  $ 37,504     $ 37,464  
 
7. Litigation
 
The Company and certain of its subsidiaries are parties to other actions and proceedings incident to the Company's business in the ordinary course of business, including litigation regarding its intellectual property, challenges to the enforceability or validity of its intellectual property and claims that the Company’s products infringe on the intellectual property rights of others. The pending proceedings involve complex questions of fact and law and will require the expenditure of significant funds and the diversion of other resources to prosecute and defend. The results of legal proceedings are inherently uncertain, and material adverse outcomes are possible.   
 
 
12

 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)

 
 
8. Fair Value Measurements
 
The Company follows the provisions of ASC 820-10 Fair Value Measurements and Disclosures – Overall, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles in the United States of America, and requires that assets and liabilities carried at fair value be classified and disclosed in one of the three categories noted in the table below. The Company also adopted the provisions of ASC 820-10-35-51 Fair Value Measurement and Disclosure – Overall – Subsequent Measurement – Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly , effective April 1, 2009 , which provides additional guidance for estimating fair value in accordance with ASC 820-10 Fair Value Measurements and Disclosures – Overall , when the volume and level of activity for the asset or liability have significantly decreased. Effective January 1, 2010, the Company adopted the provisions of ASU 2010-06, “ Disclosures About Fair Value Measurements ”, which adds new requirements for disclosures about transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements. For the quarter ended March 31, 2011, there were no such transfers.
 
The following table details the fair value measurements as of March 31, 2011 within the fair value hierarchy of the financial assets that are required to be recorded at fair value (in thousands):
 
   
Fair Value Measurements at March 31, 2011 Using
 
         
Quoted Prices in Active Markets for Identical Assets
   
Significant Other Observable Inputs
   
Significant Unobservable Inputs
 
   
Total
   
Level 1
   
Level 2
   
Level 3
 
US Treasuries and US Government Agency Bonds
  $ 92,631     $ 92,631     $ -     $ -  
Money Market Funds      35,762        35,762                  
Commercial Paper / Corporates
    11,325       -       11,325       -  
Long-term available-for-sale auction-rate securities
    17,270       -       -       17,270  
    $ 156,988     $ 128,393     $ 11,325     $ 17,270  
 
At March 31, 2011, fixed income available-for-sales securities included $92.6 million in US government agencies and treasuries and $11.3 million in corporate notes and commercial paper, $2.0 million of which was classified as cash equivalents and the remainder of which was classified as short-term investments. From these investments, there was $15,500 in unrealized losses. The impact of gross unrealized gains and losses was not material. At March 31, 2011, the Company also had $18.1 million in face value of auction-rate securities, all of which are classified as long-term available-for-sale investments and $35.8 million in money market securities.
 
The Company adopted the provisions of ASC 320-10-35 Investments – Debt and Equity Securities – Overall – Subsequent Measurement and ASC 320-10-50 Investments – Debt and Equity Securities – Overall – Disclosure, effective April 1, 2009 and used the guidelines therein to determine whether the impairment on its available-for-sale securities is temporary or other-than-temporary. Temporary impairment charges are recorded in accumulated other comprehensive income (loss) within stockholders’ equity and have no impact on net income. Other-than-temporary impairment exists when the entity has the intent to sell the security or it will more likely than not be required to sell the security before anticipated recovery or it does not expect to recover the entire amortized cost basis of the security. Other-than-temporary impairment charges are recorded in other income (expense) in the Consolidated Statement of Operations.
 
 
13

 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)
 
The following table provides a reconciliation of the beginning and ending balances for the assets measured at fair value using significant unobservable inputs (Level 3) (in thousands):
 
   
Auction-Rate
Securities
 
Ending balances at December 31, 2010
  $ 19,180  
Sales and Settlement at Par
    (2,050 )
Unrealized Gain
    140  
Ending balances at March 31, 2011
  $ 17,270  
 
The Company’s Level 3 assets consist of government-backed student loan auction-rate securities, with interest rates that reset through a Dutch auction every 7 to 35 days and which became illiquid in 2008. At March 31, 2011, the Company’s investment portfolio included $18.1 million, net of impairment charges of $0.8 million, in government-backed student loan auction-rate securities. The underlying maturity of these auction-rate securities is up to 37 years. Although it is unclear as to when these investments will regain their liquidity, management has concluded that as of March 31, 2011 and December 31, 2010, the cumulative impairment of $0.8 million and $1.0 million, respectively, was temporary based on the following analysis:
 
·  
The decline in the fair value of these securities is not largely attributable to adverse conditions specifically related to these securities or to specific conditions in an industry or in a geographic area;
·  
Management possesses both the intent and ability to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value;
·  
Management believes that it is more likely than not that the Company will not have to sell these securities before recovery of its cost basis;
·  
Except for the credit loss of $70,000 recognized during the year ended December 31, 2009 for the Company’s holdings in auction rate securities described below, the Company does not believe that there is any additional credit loss associated with other auction-rate securities because the Company expects to recover the entire amortized cost basis;
·  
The majority of the securities remain AAA rated, with $6.5 million of the auction rate securities having been downgraded by Moody’s to A3-Baa3, during the year ended December 31, 2009 and there have been no downgrades since; and
·  
All scheduled interest payments have been made pursuant to the reset terms and conditions.

Based on the guidance of ASC 320-10-35 and ASC 320-10-50, the Company evaluated the potential credit loss of each of the auction-rate securities that are currently held by the Company. Based on such analysis, the Company determined that those securities that are not 100% FFELPS guaranteed are potentially subject to credit risks based on the extent to which the underlying debt is collateralized and the security-specific student-loan default rates. The Company’s portfolio includes three such securities, one of which has a senior parity ratio of approximately 126%, which is substantially above the expected student-loan default rate for that security. Conversely, the senior parity ratio for the other two securities is approximately 106%. If, therefore, the student-loan default rate and borrowing rate for these issuers increases, the remaining balance in these trusts may not be sufficient to cover the senior debt. The Company therefore concluded that there is potential credit risk for these two securities and as such, used the discounted cash flow model to determine the amount of credit loss to be recorded. In valuing the potential credit loss, the following parameters were used: 20 year expected term, cash flows based on the 90-day t-bill rates for 20 year forwards and a risk premium of 5.9%, the amount of interest that the Company was receiving on these securities when the market was last active. As of March 31, 2011 and December 31, 2010, the potential credit loss associated with these securities was $70,000, which the Company deemed other-than-temporary and had recorded in other expense in its Condensed Consolidated Statement of Operations during 2009.
 
Unless a rights offering or other similar offer is made to redeem at par and accepted by the Company, the Company intends to hold the balance of these investments through successful auctions at par, which the Company believes could take approximately 2.0 years.
 
 
14

 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)
 
The valuation of the auction-rate securities is subject to fluctuations in the future, which will depend on many factors, including the collateral quality, potential to be called or restructured, underlying final maturity, insurance guaranty, liquidity and market conditions, among others. To determine the fair value of the auction-rate securities at December 31, 2010 and March 31, 2011, the Company used a discounted cash flow model, for which there are three valuation parameters, including time-to-liquidity, discount rate and expected return. The following are the values used in the discounted cash flow model:
 
 
December 31, 2010
March 31, 2011
Time-to-Liquidity
24 months
24 months
Expected Return (Based on the 2-year
treasury rate, plus a contractual penalty
rate)
2.9%
3.3%
Discount Rate (Based on the 2-year
LIBOR, the cost of debt and a liquidity
risk premium)
4.1% - 8.9%, depending on the credit-rating
of the security
4.5% - 9.3%, depending on the credit-rating
of the security
 
The gross accumulated impairment charge was $0.8 million as of March 31, 2011, of which $0.7 million was recorded as temporary and $0.1 million was previously recorded as other-than-temporary. The gross accumulated impairment charge was $1.0 million as of December 31, 2010, of which $0.9 million was recorded as temporary and the remaining $0.1 million was recorded as other-than-temporary.
 
If the auctions continue to fail, the liquidity of the Company’s investment portfolio may be negatively impacted and the value of its investment portfolio could decline. 
 
9. Income Taxes
 
The income tax provision for the three months ended March 31, 2011 was $0.2 million or 9.8% of the Company’s income before income taxes. This differs from the federal statutory rate of 34% primarily because the Company’s foreign income was taxed at lower rates and because of the benefit that the Company realized as a result of the disqualifying disposition of incentive stock options and employee stock plan purchases. The income tax provision for the three months ended March 31, 2010 was $0.3 million or 4.3% of the pre-tax income, respectively. This differed from the federal statutory rate of 34% primarily because the Company’s foreign income was taxed at lower rates.
 
We are subject to examination of our income tax returns by the IRS and other tax authorities.  Our U.S. federal income tax returns for the years ended December 31, 2000 through December 31, 2007 are under examination by the IRS.  In April 2011, we received from the IRS a Notice of Proposed Adjustment, or “NOPA,” relating to a cost-sharing agreement entered into by the Company and its international subsidiaries in 2004.  In the NOPA, the IRS objected to the Company's allocation of certain litigation expenses between the Company and our international subsidiaries and the amount of "buy-in payments" made by our international subsidiaries to the Company in connection with the cost-sharing agreement, and proposed to increase our U.S. taxable income according to a few alternative methodologies.  The methodology resulting in the largest potential adjustment could, if the IRS were to prevail on all matters in dispute, increase our potential federal and state income tax liabilities by up to $37.0 million, plus interest and penalties, if any.  We believe that the IRS's position in the NOPA is incorrect and that our tax returns for those years were correct as filed.  We expect to contest these proposed adjustments vigorously.     The IRS also audited the research and development credits generated in the years 2000 through 2007, and the carryforward of these credits to subsequent years.  We received a NOPA from the IRS in February 2011, proposing to reduce the research and development credits generated in years 2000 through 2007, which would also reduce the value of such credits carried forward to subsequent tax years.  We are currently reviewing these proposed adjustments as well. We regularly assess the likelihood of an adverse outcome resulting from such examinations to determine the adequacy of our provision for income taxes. Based on the technical merits of our tax return filing positions, we believe that it is more-likely-than-not that the benefit of such positions will be sustained upon the resolution of our audits resulting in no significant impact on our consolidated financial position and the results of operations and cash flows.
 
 
15

 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)

10.           Stock Repurchase Program

On July 27, 2010, the Board of Directors approved a stock repurchase program that authorizes MPS to repurchase up to $50.0 million in the aggregate of its common stock between August 2, 2010 and December 31, 2011. In February 2011, the Board of Directors approved an increase from $50.0 million to $70.0 million. As of December 31, 2010, the Company repurchased 1,899,789 shares for a total of $31.5 million. In 2011, the following shares have been repurchased through the open market and subsequently retired:
 
2011 Calendar Year
 
Shares Repurchased
   
Average Price per Share
   
Value (in thousands)
 
 February
    817,500     $ 15.47     $ 12,648  
 March
    75,000     $ 14.17     $ 1,062  
 Total Shares Repurchased
    892,500             $ 13,710  
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
This quarterly report on Form 10-Q contains forward-looking statements that involve many risks and uncertainties. These statements relate to future events and our future performance and are based on current expectations, estimates, forecasts and projections about the industries in which we operate and the beliefs and assumptions of our management. These include statements concerning, among others:
 
 
the above-average industry growth of product and market areas that we have targeted,
 
 
our plan to introduce additional new products within our existing product families as well as in new product categories and families,
 
 
our belief that we will continue to incur significant legal expenses that vary with the level of activity in each of our legal proceedings,
 
 
the impact of our outstanding litigation and changing market conditions on the revenue we derive from our CCFL product line,
 
 
the effect of auction-rate securities on our liquidity and capital resources,
 
 
the application of our products in the computer, consumer electronics, and communications markets continuing to account for a majority of our revenue,
 
 
estimates of our future liquidity requirements,
 
 
the cyclical nature of the semiconductor industry,
 
 
protection of our proprietary technology,
 
 
near term business outlook for 2011,
 
 
the factors that we believe will impact our ability to achieve revenue growth,
 
 
the outcome of the IRS audit of our tax return for the tax years ended December 31, 2006 and 2007,
 
 
the percentage of our total revenue from various market segments, and
 
 
the factors that differentiate us from our competitors.
 
You can identify forward-looking statements by terms such as “would,” “could,” “may,” “will,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “targets,” “seek,” or “continue,” the negative of these terms or other variations of such terms. These statements are only predictions based upon assumptions that we believe to be reasonable at the time made, and are subject to risks and uncertainties. Therefore, actual events or results may differ materially and adversely from those expressed in any forward-looking statement. In evaluating these statements, you should specifically consider the risks described below in the section entitled “Risk Factors.” These factors may cause our actual results to differ materially from any forward-looking statements. Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The following discussion and analysis should be read in connection with the information presented in our unaudited condensed consolidated financial statements and related notes for the quarter ended March 31, 2011 included in this report and our audited consolidated financial statements and related notes for the year ended December 31, 2010 included in our Annual Report on Form 10-K filed on March 4, 2011 with the Securities and Exchange Commission.
 
 
16

 
 
Overview
 
We are a fabless semiconductor company that designs, develops, and markets proprietary, advanced analog and mixed-signal semiconductors. We currently offer products that serve multiple markets, including flat panel televisions, wireless communications, telecommunications equipment, general consumer products, notebook computers, and set top boxes, among others. We believe that we differentiate ourselves by offering solutions that are more highly integrated, smaller in size, more energy efficient, more accurate with respect to performance specifications and, consequently, more cost-effective than many competing solutions. We plan to continue to introduce additional new products within our existing product families, as well as in new product categories.

We operate in the cyclical semiconductor industry where there is seasonal demand for certain of our products. We are not and will not be immune from current and future industry downturns, but we have targeted product and market areas that we believe have the ability to offer above average industry performance over the long term.
 
We work with third parties to manufacture and assemble our integrated circuits (“ICs”). This has enabled us to limit our capital expenditures and fixed costs, while focusing our engineering and design resources on our core strengths.
 
Generally, it is difficult for us to forecast revenue for the following reasons:
 
·  
Orders in the semiconductor industry can be cancelled or rescheduled without significant penalty to the customer. This is mitigated to a certain extent, as the typical lead times for our orders are fewer than 90 days.
 
·  
We are not able to predict, with certainty, the sales cycle for new products to gain traction in the market. Generally, it takes six to twelve months to achieve revenue, with volume production achieved three to six months after we receive an initial customer order for a new product.
 
We derive most of our revenue from sales through distribution arrangements or direct sales to customers in Asia, where the components we produce are incorporated into an end-user product. 89% of our revenue for the quarter ended March 31, 2011 and 83% of our revenue for the quarter ended March 31, 2010 was attributable to direct or indirect sales to customers in Asia. We derive a majority of our revenue from the sales of our DC to DC converter product family which services the consumer electronics, communications and computing markets. We believe our ability to achieve revenue growth will depend, in part, on our ability to develop new products, enter new market segments, gain market share, manage litigation risk, diversify our customer base and successfully secure manufacturing capacity.
 
Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an on-going basis, including those related to revenue recognition, stock-based compensation, long-term investments, short-term investments, inventories, income taxes, warranty obligations and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making the judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Estimates and judgments used in the preparation of our financial statements are, by their nature, uncertain and unpredictable, and depend upon, among other things, many factors outside of our control, such as demand for our products and economic conditions.  Accordingly, our estimates and judgments may prove to be incorrect and actual results may differ, perhaps significantly, from these estimates.
 
We believe the following critical accounting policies reflect our more significant judgments used in the preparation of our consolidated financial statements.
 
Revenue Recognition.  We recognize revenue in accordance with Financial Accounting Standards Board (“FASB”) – Accounting Standards Codification (“ASC”) 605-10-S25 Revenue Recognition – Overall – Recognition . ASC 605-10-S25 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed and determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgment regarding the fixed nature of the fee charged for products delivered and the collectibility of those fees. The application of these criteria has resulted in our generally recognizing revenue upon shipment (when title passes) to customers. Should changes in conditions cause management to determine these criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely impacted.
 
 
17

 
 
Approximately 90% of our distributor sales, including sales to our value-added resellers, are made through distribution arrangements with third parties. These arrangements do not include any special payment terms (our normal payment terms are 30-45 days for our distributors, with value-added resellers having payment terms up to 90 days), price protection or exchange rights. Returns are limited to our standard product warranty. Certain of our large distributors have contracts that include limited stock rotation rights that permit the return of a small percentage of the previous six months’ purchases in return for a compensating new order of equal or greater dollar value.

Our revenue consists primarily of assembled and tested finished goods. We also sell die in wafer form to our customers and value-added resellers and receive royalty revenue from third parties and value-added resellers.

We maintain a sales reserve for stock rotation rights, which is based on historical experience of actual stock rotation returns on a per distributor basis, where available, and information related to products in the distribution channel. This reserve is recorded at the time of sale. In the future, if we are unable to estimate our stock rotation returns accurately, we may not be able to recognize revenue from sales to our distributors based on when we sell inventory to our distributors. Instead, we may have to recognize revenue when the distributor sells through such inventory to an end-customer.

We generally recognize revenue upon shipment of products to the distributor for the following reasons (based on ASC 605-15-25-1 Revenue Recognition – Products – Recognition – Sales of Products When Right of Return Exists ):

(1)  
Our price is fixed and determinable at the date of sale. We do not offer special payment terms, price protection or price adjustments to distributors where we recognize revenue upon shipment
(2)  
Our distributors are obligated to pay us and this obligation is not contingent on the resale of our products
(3)  
The distributor’s obligation is unchanged in the event of theft or physical destruction or damage to the products
(4)  
Our distributors have stand-alone economic substance apart from our relationship
(5)  
We do not have any obligations for future performance to directly bring about the resale of our products by the distributor
(6)  
The amount of future returns can be reasonably estimated. We have the ability and the information necessary to track inventory sold to and held at our distributors. We maintain a history of returns and have the ability to estimate the stock rotation returns on a quarterly basis.

If we enter into arrangements that have rights of return that are not estimable, we recognize revenue under such arrangements only after the distributor has sold our products to an end customer.

Approximately 10% of our distributor sales are made through small distributors based on purchase orders rather than formal distribution arrangements.  These distributors do not receive any stock rotation rights and, as such, hold very little inventory, if any.  We do not have a history of accepting returns from these distributors.

The terms in a majority of our distribution agreements include the non-exclusive right to sell, and the agreement to use best efforts to promote and develop a market for, our products in certain regions of the world and the ability to terminate the distribution agreement by either party with up to three months notice. We provide a one year warranty against defects in materials and workmanship. Under this warranty, we will repair the goods, provide replacements at no charge, or, under certain circumstances, provide a refund to the customer for defective products. Estimated warranty returns and warranty costs are based on historical experience and are recorded at the time product revenue is recognized.
 
In 2006, we signed a distribution agreement with a U.S. distributor. Revenue from this distributor is recognized upon sale by the distributor to the end customer because the distributor has certain rights of return which management believes are not estimable. The deferred revenue balance from this distributor as of March 31, 2011 and December 31, 2010 was $1.1 million and $1.0 million, respectively.
 
Warranty Reserves.  We currently provide a 12-month warranty against defects in materials and workmanship and will either repair the goods or provide replacement products at no charge to the customer for defective products. We record estimated warranty costs by product, which are based on historical experience over the preceding 12 months, at the time we recognize product revenue. Reserve requirements are recorded in the period of sale and are based on an assessment of the products sold with warranty and historical warranty costs incurred. As the complexity of our products increases, we could experience higher warranty claims relative to sales than we have previously experienced, and we may need to increase these estimated warranty reserves.
 
 
18

 
 
Inventory Valuation.  We value our inventory at the lower of the standard cost (which approximates actual cost on a first-in, first-out basis) or its current estimated market value.  We write down inventory for obsolescence or lack of demand, based on assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. On the contrary, if market conditions are more favorable, we may be able to sell inventory that was previously reserved.

Accounting for Income Taxes . ASC 740-10 Income Taxes – Overall prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. In accordance with ASC 740-10, we recognize federal, state and foreign current tax liabilities or assets based on our estimate of taxes payable or refundable in the current fiscal year by tax jurisdiction. We also recognize federal, state and foreign deferred tax assets or liabilities for our estimate of future tax effects attributable to temporary differences and carryforwards. We record a valuation allowance to reduce any deferred tax assets by the amount of any tax benefits that, based on available evidence and judgment, are not expected to be realized.
 
Our calculation of current and deferred tax assets and liabilities is based on certain estimates and judgments and involves dealing with uncertainties in the application of complex tax laws. Our estimates of current and deferred tax assets and liabilities may change based, in part, on added certainty or finality or uncertainty to an anticipated outcome, changes in accounting or tax laws in the U.S., or foreign jurisdictions where we operate, or changes in other facts or circumstances. In addition, we recognize liabilities for potential U.S. and foreign income tax for uncertain income tax positions taken on our tax returns if it has less than a 50% likelihood of being sustained. If we determine that payment of these amounts is unnecessary or if the recorded tax liability is less than our current assessment, we may be required to recognize an income tax benefit or additional income tax expense in our financial statements in the period such determination is made. We have calculated our uncertain tax positions which were attributable to certain estimates and judgments primarily related to transfer pricing, cost sharing and our international tax structure exposure.
 
As of March 31, 2011 and December 31, 2010, we had a valuation allowance of $16.9 million and $16.8 million, respectively, attributable to management’s determination that it is more likely than not that none of the deferred tax assets in the United States will be realized, except for certain deferred tax assets related to uncertain income tax positions. Should it be determined that all or part of the net deferred tax asset will not be realized in the future, an adjustment to increase the deferred tax asset valuation allowance will be charged to income in the period such determination is made. Likewise, in the event we were to determine that it is more likely than not that we would be able to realize our deferred tax assets in the future in excess of our net recorded amount, an adjustment to the valuation allowance for the deferred tax asset would increase income in the period such determination was made.
 
Contingencies .  We and certain of our subsidiaries are parties to other actions and proceedings incident to our business in the ordinary course of business, including litigation regarding our intellectual property, challenges to the enforceability or validity of our intellectual property and claims that our products infringe on the intellectual property rights of others. The pending proceedings involve complex questions of fact and law and will require the expenditure of significant funds and the diversion of other resources to prosecute and defend. In addition, from time to time, we become aware that we are subject to other contingent liabilities.  When this occurs, we will evaluate the appropriate accounting for the potential contingent liabilities using ASC 450-20-25-2 Contingencies – Loss Contingencies - Recognition to determine whether a contingent liability should be recorded. In making this determination, management may, depending on the nature of the matter, consult with internal and external legal counsel and technical experts. Based on the facts and circumstances in each matter, we use our judgment to determine whether it is probable that a contingent loss has occurred and whether the amount of such loss can be estimated. If we determine a loss is probable and estimable, we record a contingent loss in accordance with ASC 450-20-25-2. In determining the amount of a contingent loss, we take into account advice received from experts for each specific matter regarding the status of legal proceedings, settlement negotiations (which may be ongoing), prior case history and other factors. Should the judgments and estimates made by management need to be adjusted as additional information becomes available, we may need to record additional contingent losses that could materially and adversely impact our results of operations. Alternatively, if the judgments and estimates made by management are adjusted, for example, if a particular contingent loss does not occur, the contingent loss recorded would be reversed which could result in a favorable impact on our results of operations.
 
 
19

 
 
Accounting for Stock-Based Compensation.  We account for stock-based compensation under the provisions of ASC 718-10-30 Compensation – Stock Compensation – Overall – Initial Measurement , using the modified prospective method. ASC 718-10-30 eliminates the alternative of applying the intrinsic value measurement to stock compensation awards issued to employees. Rather, the standard requires us to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period) .   We currently use the Black-Scholes option-pricing model to estimate the fair value of our share-based payments. The Black-Scholes option-pricing model is based on a number of assumptions, including historical volatility, expected life, risk-free interest rate and expected dividends.   If these assumptions change, stock-based compensation may differ significantly from what we have recorded in the past. The amount of stock-based compensation that we recognize is also based on an expected forfeiture rate. If there is a difference between the forfeiture assumptions used in determining stock-based compensation costs and the actual forfeitures which become known over time, we may change the forfeiture rate, which could have a significant impact on our stock-based compensation expense.
 
Fair Value Instruments. ASC 820-10 Fair Value Measurements and Disclosures – Overall defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles in the United States of America, and requires that assets and liabilities carried at fair value be classified and disclosed in one of the three categories, as follows:

a.  
Level 1: Quoted prices in active markets for identical assets;
b.  
Level 2: Significant other observable inputs; and
c.  
Level 3: Significant unobservable inputs.
 
ASC 820-10-35-51 Fair Value Measurement and Disclosure – Overall – Subsequent Measurement – Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly provides additional guidance for estimating fair value in accordance with ASC 820-10 Fair Value Measurements and Disclosures – Overall , when the volume and level of activity for the asset or liability have significantly decreased.
 
Our financial instruments include cash and cash equivalents and short-term and long-term investments. Cash equivalents are stated at cost, which approximates fair market value based on quoted market prices. Short-term and long-term investments are stated at their fair market value.
 
The face value of our holdings in auction rate securities is $18.1 million, all of which is classified as long-term available-for-sale investments. Investments in available-for-sale securities are recorded at fair value, and unrealized gains or losses (that are deemed to be temporary) are recognized through shareholders' equity, as a component of accumulated other comprehensive income in our consolidated balance sheet. We record an impairment charge to earnings when an available-for-sale investment has experienced a decline in value that is deemed to be other-than-temporary. Investments in trading securities are recorded at fair value and unrealized gains and losses are recognized in other income (expense) in our condensed consolidated statement of operations.
 
We adopted the provisions of ASC 320-10-35 Investments – Debt and Equity Securities – Overall – Subsequent Measurement and ASC 320-10-50 Investments – Debt and Equity Securities – Overall - Disclosure, effective April 1, 2009 and used the guidelines therein to determine whether the impairment is temporary or other-than temporary. Other-than-temporary impairment charges exist when the entity has the intent to sell the security or it will more likely than not be required to sell the security before anticipated recovery. During the year ended December 31, 2009, we recognized a credit loss of $70,000, which was deemed to be other-than-temporary in other income (expense) in our Condensed Consolidated Statement of Operations. There have been no such losses since.
 
 
20

 

Based on certain assumptions described in Note 8, “Fair Value Measurements”, to our condensed consolidated financial statements and the Liquidity and Capital Resources section of “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this quarterly report on Form 10-Q, we recorded impairment charges on our holdings in auction-rate securities. The valuation of these securities is subject to fluctuations in the future, which will depend on many factors, including the collateral quality, potential to be called or restructured, underlying final maturity, insurance guaranty, liquidity and market conditions, among others.

Results of Operations
 
The table below sets forth the data from our Condensed Consolidated Statement of Operations as a percentage of revenue for the periods indicated:
  
   
Three months ended March 31,
 
   
2011
   
2010
 
Revenue
    100.0 %     100.0 %
Cost of revenue
    49.8 %     41.7 %
                 
Gross profit
    50.2 %     58.3 %
Operating expenses:
               
Research and development
    22.7 %     22.0 %
Selling, general and administrative
    21.4 %     20.7 %
Litigation expense
    1.8 %     3.1 %
                 
Total operating expenses
    45.9 %     45.8 %
                 
Income from operations
    4.3 %     12.5 %
Other income (expense):
               
Interest and other income
    0.6 %     0.7 %
Interest and other expense
    (0.2 %)     0.0 %
                 
Total other income, net
    0.4 %     0.7 %
                 
Income before income taxes
    4.7 %     13.2 %
Income tax provision
    0.4 %     0.6 %
                 
Net income
    4.3 %     12.6 %
 
Revenue.
 
   
For the three months ended March 31,
 
   
2011
   
2010
   
 
 
   
(in thousands)
    Change  
Revenue
  $ 44,468     $ 50,250       (11.5 )%
 
Revenue for the three months ended March 31, 2011 was $44.5 million, a decrease of $5.8 million, or 11.5%, from $50.3 million for the three months ended March 31, 2010. The decrease in revenue was largely attributable to a decrease in the sales of our DC to DC products, primarily from having lost certain customers in Korea as a result of lack of production capacity and resulting product shortages in 2010. In addition, sales of our lighting control products also decreased because of a reduction in the demand for our CCFL products, which was partially offset by increased sales of our WLED products. Audio sales were down year over year due to a change in product mix and a decline in the average selling price for certain of our audio products.
 
The following table illustrates changes in our revenue by product family
:
 
21

 
 
   
For the three months ended March 31,
       
   
2011
         
2010
         
 
 
   
(in thousands)
   
% of
   
(in thousands)
   
% of
       
    Amount    
Revenue
    Amount    
Revenue
    Change  
DC to DC Converters
  $ 37,093       83.4 %   $ 40,301       80.2 %     (8.0 )%
Lighting Control Products
    5,888       13.2 %     7,434       14.8 %     (20.8 )%
Audio Amplifiers
    1,487       3.3 %     2,515       5.0 %     (40.9 )%
                                         
    $ 44,468       100.0 %   $ 50,250       100.0 %     (11.5 )%
 
Gross Profit.  Gross profit as a percentage of revenue, or gross margin, was 50.2% for the three months ended March 31, 2011and 58.3% for the three months ended March 31, 2010. For the three months ended March 31, 2011, gross margin declined year-over-year as a result of declining average selling prices for certain of our products, changes in product mix, higher product costs and an increase in inventory reserves.

Research and Development.
 
   
For the three months ended March 31,
 
   
2011
   
2010
   
 
 
   
(in thousands)
   
Change
 
Revenue
  $ 44,468     $ 50,250       (11.5 )%
Research and development (“R&D”) (including stock-based
compensation of $1,427 and $1,735 for the three months ended
March 31, 2011 and 2010, respectively)
    10,086       11,040       (8.6 )%
                         
R&D as a percentage of revenue
    22.7 %     22.0 %        
 
R&D expenses were $10.1 million, or 22.7% of revenue, for the three months ended March 31, 2011 and $11.0 million, or 22.0% of revenue, for the three months ended March 31, 2010. The year-over-year decrease was primarily due to a decrease in variable compensation, certain new product development expenses and stock-based compensation expenses.
 
Selling, General and Administrative.
 
   
For the three months ended March 31,
 
   
2011
   
2010
   
 
 
   
(in thousands)
    Change  
Revenue
  $ 44,468     $ 50,250       (11.5 )%
Selling, general and administrative (“SG&A”) (including stock-based
compensation of $1,497 and $2,210 for the three months ended
March 31, 2011 and 2010, respectively)
    9,490       10,393       (8.7 )%
                         
SG&A as a percentage of revenue
    21.4 %     20.7 %        
 
SG&A expenses were $9.5 million, or 21.4% of revenue, for the three months ended March 31, 2011 and $10.4 million, or 20.7% of revenue, for the three months ended March 31, 2010. For the three months ended March 31, 2011, SG&A expenses decreased year over year due to lower stock-based compensation expenses, variable compensation expenses and sales commissions.
 
 
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Litigation Expense.
 
   
For the three months ended March 31,
 
   
2011
   
2010
   
 
 
   
(in thousands)
    Change  
Revenue
  $ 44,468     $ 50,250       (11.5 )%
Litigation expense
    813       1,567       (48.1 )%
                         
Litigation expense as a percentage of revenue
    1.8 %     3.1 %        
 
Litigation expenses were $0.8 million, or 1.8% of revenue, for the three months ended March 31, 2011 as compared to $1.6 million, or 3.1% of revenue, for the three months ended March 31, 2010. During the three months ended March 31, 2011, we incurred legal expenses to recover attorneys’ fees from O2Micro. During the three months ended March 31, 2010, we incurred legal expenses primarily for the defense of our lawsuits involving O2Micro, which were resolved in the second quarter of 2010.
 
Income Tax Provision.  The income tax provision for the three months ended March 31, 2011 was $0.2 million or 9.8% of our income before income taxes. This differs from the federal statutory rate of 34% primarily because our foreign income was taxed at lower rates and because of the benefit that we realized as a result of the disqualifying disposition of incentive stock options and employee stock plan purchases. The income tax provision for the three months ended March 31, 2010 was $0.3 million or 4.3% of the pre-tax income, respectively. This differed from the federal statutory rate of 34% primarily because our foreign income was taxed at lower rates.
 
Liquidity and Capital Resources.

As of March 31, 2011, we had working capital of $192.9 million, including cash and cash equivalents of $74.1 million and short-term investments of $102.0 million compared to working capital of $195.4 million, including cash and cash equivalents of $48.0 million and short-term investments of $129.7 million as of December 31, 2010. We have financed our growth primarily with proceeds from cash generated from operating activities, proceeds from the exercise of stock options and proceeds from the issuance of shares through the Company’s employee stock purchase plan.
 
For the three months ended March 31, 2011, net cash provided by operating activities was $8.2 million. Net cash increased primarily due to strong operating results and an increase in accounts payable for inventory purchases. This was partially offset by an increase in inventory to meet the anticipated second quarter demand and an increase in accounts receivable resulting from shipments at the end of the quarter for which the collections have not been received. For the three months ended March 31, 2010, net cash provided by operating activities was $8.2 million. Net cash increased primarily due to strong operating results and a reduction in inventory during the first quarter of 2010. This was partially offset by an increase in accounts receivable, primarily from increased shipments at the end of the quarter for which the collections have not been made.
 
For the three months ended March 31, 2011, net cash used in investing activities was $26.6 million, primarily related to the redemption of short-term investments to fund our stock repurchase efforts. For the three months ended March 31, 2010, net cash used in investing activities was $11.4 million, primarily related to equipment purchases for our Chengdu facility and the purchase of short-term investments.
 
We use professional investment management firms to manage the majority of our invested cash. Our fixed income portfolio is primarily invested in government securities, auction-rate securities and highly rated corporate notes and commercial paper. The balance of the fixed income portfolio is managed internally and invested primarily in money market securities for working capital purposes.
 
 
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We adopted the provisions of ASC 320-10-35 Investments – Debt and Equity Securities – Overall – Subsequent Measurement and ASC 320-10-50 Investments – Debt and Equity Securities – Overall - Disclosure, effective April 1, 2009 and used the guidelines therein to determine whether the impairment is temporary or other-than temporary. Temporary impairment charges are recorded in accumulated other comprehensive income (loss) within equity and have no impact on net income. Other-than-temporary impairment charges exist when the entity has the intent to sell the security or it will more likely than not be required to sell the security before anticipated recovery. Other-than-temporary impairment charges are recorded in other income (expenses) in the Consolidated Statement of Operations.

At March 31, 2011, the Company’s investment portfolio included $18.1 million, net of impairment charges of $0.8 million, in government-backed student loan auction-rate securities. The underlying maturity of these auction-rate securities is up to 37 years. Although it is unclear as to when these investments will regain their liquidity, management has concluded that as of March 31, 2011 and December 31, 2010, the cumulative impairment of $0.8 million and $1.0 million, respectively, was temporary based on the following analysis:

1.  
The decline in the fair value of these securities is not attributable to adverse conditions specifically related to these securities or to specific conditions in an industry or in a geographic area;
2.  
Management possesses both the intent and ability to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value;
3.  
Management believes that it is more likely than not that the Company will not have to sell these securities before recovery of its cost basis;
4.  
Except for the credit loss of $70,000 recognized in year ended December 31, 2009 for the Company’s holdings in auction rate securities described below, the Company does not believe that there is any additional credit loss associated with other auction-rate securities because the Company expects to recover the entire amortized cost basis;
5.  
The majority of the securities remain AAA rated, with $6.5 million of the auction rate securities having been downgraded by Moody’s to A3-Baa3 during the year ended December 31, 2009, and there have been no downgrades since; and
6.  
All scheduled interest payments have been made pursuant to the reset terms and conditions.

Based on the guidance of ASC 320-10-35 and ASC 320-10-50, the Company evaluated the potential credit loss of each of the auction-rate securities that are currently held by the Company. Based on such analysis, the Company determined that those securities that are not 100% FFELPS guaranteed are potentially subject to credit risks based on the extent to which the underlying debt is collateralized and the security-specific student-loan default rates. The Company’s portfolio includes three such securities, one of which has a senior parity ratio of approximately 126%, which is substantially above the expected student-loan default rate for that security. Conversely, the senior parity ratio for the other two securities is approximately 106%. If, therefore, the student-loan default rate and borrowing rate increases for these issuers, the remaining balance in these trusts may not be sufficient to cover the senior debt. The Company therefore concluded that there is potential credit risk for these two securities and as such, used the discounted cash flow model to determine the amount of credit loss to be recorded. In valuing the potential credit loss, the following parameters were used: 20 year expected term, cash flows based on the 90-day t-bill rates for 20 year forwards and a risk premium of 5.9%, the amount of interest that the Company was receiving on these securities when the market was last active. During the year ended December 31, 2009, the potential credit loss associated with these securities was $70,000, which the Company deemed other-than-temporary and recorded in other expense in its Consolidated Statement of Operations during 2009. There have been no such losses since.
 
Unless a rights offering or other similar offer is made to redeem at par and accepted by us, we intend to hold the balance of these investments through successful auctions at par, which we believe could take approximately 2.0 years.
 
The valuation of the auction-rate securities is subject to fluctuations in the future, which will depend on many factors, including the collateral quality, potential to be called or restructured, underlying final maturity, insurance guaranty, liquidity and market conditions, among others. To determine the fair value of the auction-rate securities at December 31, 2010 and March 31, 2011, we used a discounted cash flow model, for which there are three valuation parameters, including time-to-liquidity, discount rate and expected return. The following are the values used in the discounted cash flow model:
 
 
December 31, 2010
March 31, 2011
Time-to-Liquidity
24 months
24 months
Expected Return (Based on the requisite treasury
rate, plus a contractual penalty rate)
2.9%
3.3%
Discount Rate (Based on the requisite LIBOR, the
cost of debt and a liquidity risk premium)
4.1% - 8.9%, depending on the credit-rating
of the security
4.5% - 9.3%, depending on the credit-rating
of the security
 
 
24

 
 
From the fourth quarter of 2010 to the first quarter of 2011, we kept the time-to-liquidity constant at 2.0 years. We sold $2.1 million in auction-rate securities at par and reversed the impairment related to these securities in the amount of $0.2 million. This reduced the overall impairment from $1.0 million at December 31, 2010 to $0.8 million at March 31, 2011.
 
Net cash used in financing activities for the three months ended March 31, 2011 was $8.8 million, primarily from stock repurchases in the amount of $13.7 million, which was partially offset by the proceeds from the exercise of stock options in the amount of $3.5 million and proceeds from the employee stock purchase plan of $0.9 million. Net cash provided by financing activities for the three months ended March 31, 2010 was $5.3 million, primarily from the exercise of stock options in the amount of $4.0 million and proceeds from the employee stock purchase plan of $1.1 million.
 
On July 27, 2010, we announced that our Board of Directors approved a stock repurchase program that authorizes the Company to repurchase up to $50.0 million of its common stock between August 2, 2010 and December 31, 2011. In February 2011, the Board of Directors approved an increase from $50.0 million to $70.0 million. As of December 31, 2010, the Company repurchased 1,899,789 shares for a total of $31.5 million. In 2011, the following shares have been repurchased through the open market and subsequently retired:
 
2011 Calendar Year
 
Shares Repurchased
   
Average Price per Share
   
Value (in thousands)
 
 February
    817,500     $ 15.47     $ 12,648  
 March
    75,000     $ 14.17     $ 1,062  
 Total Shares Repurchased
    892,500             $ 13,710  
 
Although cash requirements will fluctuate based on the timing and extent of many factors such as those discussed above, we believe that cash generated from operations, together with the liquidity provided by existing cash and cash equivalents and short-term investments, will be sufficient to satisfy our liquidity requirements for at least the next 12 months. For further details regarding our operating, investing and financing activities, see our Condensed Consolidated Statements of Cash Flows.
 
Contractual Obligations and Off Balance Sheet Arrangements.

We lease our headquarters and sales offices in San Jose, California. The building that we are leasing was sold and the new landlord has exercised the right to terminate the lease, effective April 18, 2012. Certain of our facility leases provide for periodic rent increases. In September 2004, we signed an agreement with the Chinese local authority to construct a facility in Chengdu, China. We have the option to acquire this facility in Chengdu after a five-year lease term, which option became exercisable in March 2011. We will likely enter into a purchase agreement for this facility at a date to be determined and as the opportunity necessitates. We constructed a 150,000 square foot research and development facility in Chengdu, China which was put into operation in October 2010, and for which we are in the process of negotiating the final payment to the building contractor for changes made during the construction. We have accrued $2.5 million, which is our best estimate at this time.

We also lease our sales offices in Japan, China, Taiwan and Korea.
 
As of March 31, 2011, our total outstanding purchase commitments with vendors were $17.5 million, which includes wafer purchases from our two foundries and the purchase of assembly services primarily from multiple contractors in Asia. This compares to purchase commitments of $14.4 million as of December 31, 2010.
 
Our other contractual obligations have not changed significantly from that disclosed in our annual report on Form 10-K filed with the SEC on March 4, 2011.
 
 
25

 
 
As of March 31, 2011, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of the Securities and Exchange Commission’s Regulation S-K.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
For a discussion of market risks at December 31, 2010, refer to Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” in our annual report on Form 10-K for the fiscal year ended December 31, 2010 filed with the SEC on March 4, 2011. During the three months ended March 31, 2011, there were no material changes or developments that would materially alter the market risk assessment performed as of December 31, 2010.
 
ITEM 4. CONTROLS AND PROCEDURES
 
Evaluation of disclosure controls and procedures.
 
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 as of the end of the period covered by this quarterly report on Form 10-Q.  In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.  In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
 
Based on our evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.
 
Changes in internal control over financial reporting.
 
There were no changes in our internal control over financial reporting that occurred during the period covered by this quarterly report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
We and certain of our subsidiaries are parties to other actions and proceedings incident to our business in the ordinary course of business, including litigation regarding our intellectual property, challenges to the enforceability or validity of our intellectual property and claims that our products infringe on the intellectual property rights of others. The pending proceedings involve complex questions of fact and law and will require the expenditure of significant funds and the diversion of other resources to prosecute and defend. The results of legal proceedings are inherently uncertain, and material adverse outcomes are possible.   
 
ITEM 1A. RISK FACTORS
 
Our business involves risks and uncertainties. You should carefully consider the risks described below, together with all of the other information in this Form 10-Q and other filings with the Securities and Exchange Commission in evaluating our business. If any of the following risks actually occur, our business, financial condition, operating results and growth prospects would likely be materially and adversely affected. In such an event, the trading price of our common stock could decline, and you could lose all or part of your investment in our common stock. Our past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.  These risks, which have been updated from the risk factors previously disclosed in our Annual Report on Form 10-K involve forward-looking statements and our actual results may differ substantially from those discussed in these forward-looking statements.
 
 
26

 

The future trading price of our common stock could be subject to wide fluctuations in response to a variety of factors.
 
The future trading price of our common stock is likely to be highly volatile and could be subject to wide fluctuations in price in response to various factors, many of which are beyond our control, including:
 
 
our results of operations and financial performance;
 
 
general economic, industry and global market conditions;
 
 
whether our forward guidance meets the expectations of our investors;
 
 
the depth and liquidity of the market for our common stock;
 
 
developments generally affecting the semiconductor industry;
 
 
commencement of or developments relating to our involvement in litigation;
 
 
investor perceptions of us and our business strategies;
 
 
changes in securities analysts’ expectations or our failure to meet those expectations;
 
 
actions by institutional or other large stockholders;
 
 
terrorist acts or acts of war;
 
 
actual or anticipated fluctuations in our results of operations;
 
 
developments with respect to intellectual property rights;
 
 
announcements of technological innovations or significant contracts by us or our competitors;
 
 
introduction of new products by us or our competitors;
 
 
our sale of common stock or other securities in the future;
 
 
conditions and trends in technology industries;
 
 
changes in market valuation or earnings of our competitors;
 
 
our ability to develop new products, enter new market segments, gain market share, manage litigation risk, diversify our customer base and successfully secure manufacturing capacity;
 
 
our ability to increase our gross margins; and
 
 
changes in the estimation of the future size and growth rate of our markets.
 
In addition, the stock market in general often experiences substantial volatility that is seemingly unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our common stock.
 
We expect our operating results to fluctuate from quarter to quarter and year to year, which may make it difficult to predict our future performance and could cause our stock price to decline and be volatile.
 
Our revenue, expenses, and results of operations are difficult to predict, have varied significantly in the past and will continue to fluctuate significantly in the future due to a number of factors, many of which are beyond our control. We expect fluctuations to continue for a number of reasons, including:
 
 
a deterioration in general demand for electronic products as a result of worldwide financial crises and associated macro-economic slowdowns;
 
 
a deterioration in business conditions at our distributors, value-added resellers and/or end-customers;
 
 
adverse general economic conditions in the countries where our products are sold or used;
 
 
the timing of developments and related expenses in our litigation matters;
 
 
the possibility of additional lost business as a result of customer and prospective customer concerns about adverse outcomes in our litigations or about being litigation targets;
 
 
continued dependence on our turns business (orders received and shipped within the same fiscal quarter);

 
increases in assembly costs due to commodity price increases, such as the price of gold;
 
 
the timing of new product introductions by us and our competitors;
 
 
the acceptance of our new products in the marketplace;
 
 
27

 
 
 
our ability to develop new process technologies and achieve volume production;
 
 
our ability to meet customer product demand in a timely manner;
 
 
the scheduling, rescheduling, or cancellation of orders by our customers;
 
 
the cyclical nature of demand for our customers’ products;
 
 
an increase in stock rotation reserves;
 
 
our ability to manage our inventory levels, including the levels of inventory held by our distributors;
 
 
inventory levels and product obsolescence;
 
 
seasonality and variability in the computer, consumer electronics, and communications markets;
 
 
the availability of adequate manufacturing capacity from our outside suppliers;
 
 
increases in prices for finished wafers due to general capacity shortages;
 
 
the potential loss of future business resulting from current capacity issues;
 
 
changes in manufacturing yields; and
 
 
movements in exchange rates, interest rates or tax rates.
 
Due to the factors noted above and other risks described in this section, many of which are beyond our control, you should not rely on quarter-to-quarter or year-over-year comparisons to predict our future financial performance. Unfavorable changes in any of the above factors may seriously harm our business and cause our stock price to decline and be volatile.
 
We may not be profitable on a quarterly or annual basis.
 
Our profitability is dependent on many factors, including:
 
·  
our sales, which because of our turns business (i.e., orders received and shipped within the same fiscal quarter), is difficult to accurately forecast;
 
·  
consumer electronic sales, which has experienced and may continue to experience a downturn as a result of the worldwide economic crisis;
 
·  
our competition, which could adversely impact our selling prices and our potential sales;
 
·  
our manufacturing costs, including our ability to negotiate with our vendors and our ability to efficiently run our test facility in China;
 
·  
manufacturing capacity constraints; and
 
·  
our operating expenses, including general and administrative expenses, selling and marketing expenses, stock-based compensation expenses, litigation expenses, and research and development expenses relating to products that will not be introduced and will not generate revenue until later periods, if at all.
 
We may not achieve profitability on a quarterly or annual basis in the future. Unfavorable changes in our operations, including any of the factors noted above, may have a material adverse effect on our quarterly or annual profitability.
 
We may not experience growth rates comparable to past years.
 
In the past, our revenues increased significantly in certain years due to increased sales of certain of our products. Due to various factors, including increased competition, loss of certain of our customer install base, unfavorable changes in our operations, reduced global electronics demand, end-customer market downturn, market acceptance and penetration of our current and future products and ongoing litigation, we may not experience growth rates comparable to past periods, which could materially and adversely affect our stock price and results of operations.
 
Due to product shortages early in 2010, several major customers in Korea sought alternative suppliers, which impacted our revenue in the first quarter of 2011 and may continue to impact our revenue in future periods. If we are unable to fill this revenue gap, our growth rate may be impacted, which could materially and adversely affect our stock price and results of operations.
 
We may be unsuccessful in developing and selling new products with margins similar to or better than what we have experienced in the past, which would impact our overall gross margin and financial performance.
 
 
28

 
 
Our success depends on products that are differentiated in the market, which result in gross margins that have historically been above the industry averages. During the first quarter of 2011, our gross margins decreased materially as compared to the first quarter of 2010. Should we fail to improve our gross margin in the future, and accordingly develop and introduce sufficiently differentiated products that result in higher gross margins than industry averages, our financial condition could be materially adversely affected.
 
The highly cyclical nature of the semiconductor industry, which has produced significant and sometimes prolonged downturns, could materially adversely affect our operating results, financial condition and cash flows.
 
Historically, the semiconductor industry has been highly cyclical and, at various times, has experienced significant downturns and wide fluctuations in supply and demand. These conditions have caused significant variances in product demand and production capacity, as well as rapid erosion of average selling prices. The industry may experience severe or prolonged downturns in the future, which could result in downward pressure on the price of our products as well as lower demand for our products. Because significant portions of our expenses are fixed in the short term or incurred in advance of anticipated sales, we may not be able to decrease our expenses in a timely manner to offset any sales shortfall. These conditions could have a material adverse effect on our operating results, financial condition and cash flows.
 
If demand for our products declines in the major end markets that we serve, our revenue will decrease and our results of operations and financial condition would be materially and adversely affected.
 
We believe that the application of our products in the computer, consumer electronics and communications markets will continue to account for the majority of our revenue. If the demand for our products declines in the major end markets that we serve, our revenue will decrease and our results of operations and financial condition would be materially and adversely affected. In addition, as technology evolves, the ability to integrate the functionalities of various components, including our discrete semiconductor products, onto a single chip and/or onto other components of systems containing our products increases. Should our customers require integrated solutions that we do not offer, demand for our products could decrease, and our business and results of operations would be materially and adversely affected.
 
We derive most of our revenue from direct or indirect sales to customers in Asia and have significant operations in Asia, which may expose us to political, cultural, regulatory, economic, foreign exchange, and operational risks.
 
We derive most of our revenue from customers located in Asia through direct or indirect sales through distribution arrangements with parties located in Asia. As a result, we are subject to increased risks due to this geographic concentration of business and operations. For the quarter ended March 31, 2011, approximately 89% of our revenue was from customers in Asia. There are risks inherent in doing business in Asia, and internationally in general, including:
 
 
changes in, or impositions of, legislative or regulatory requirements, including tax laws in the United States and in the countries in which we manufacture or sell our products;
 
 
trade restrictions, including restrictions imposed by the United States government on trading with parties in foreign countries;
 
 
currency exchange rate fluctuations impacting intra-company transactions;
 
 
transportation delays;
 
 
changes in tax regulations in China that may impact our tax status in Chengdu;
 
 
multi-tiered distribution channels that lack visibility to end customer pricing and purchase patterns;
 
 
international political relationships and threats of war;
 
 
terrorism and threats of terrorism;
 
 
epidemics and illnesses;
 
 
work stoppages and infrastructure problems due to adverse weather conditions or natural disasters;
 
 
work stoppages related to employee dissatisfaction;
 
 
economic and political instability;
 
 
changes in import/export regulations, tariffs, and freight rates;
 
 
longer accounts receivable collection cycles and difficulties in collecting accounts receivables;
 
 
enforcing contracts generally; and
 
 
less effective protection of intellectual property and contractual arrangements.
 
 
29

 
 
If we fail to expand our customer base and significantly reduce the geographical concentration of our customers, we will continue to be subject to the foregoing risks, which could materially and adversely affect our revenue and financial condition.
 
We receive a significant portion of our revenue from distribution arrangements, value-added resellers and direct customers, and the loss of any one of these distributors or value-added resellers or failure to collect a receivable from them could adversely affect our operations and financial position.
 
We market our products through distribution arrangements and value-added resellers and through our direct sales and applications support organization to customers that include OEMs, ODMs and electronic manufacturing service providers. Receivables from our customers are generally not secured by any type of collateral and are subject to the risk of being uncollectible. For the quarter ended March 31, 2011, sales to our largest distributor accounted for approximately 16% of our total revenue. Significant deterioration in the liquidity or financial condition of any of our major customers or any group of our customers could have a material adverse impact on the collectability of our accounts receivable and our future operating results. We primarily conduct our sales on a purchase order basis, and we do not have any long-term supply contracts.
 
Moreover, we believe a high percentage of our products are eventually sold to a number of OEMs. Although we communicate with OEMs in an attempt to achieve “design wins,” which are decisions by OEMs and/or ODMs to incorporate our products, we do not have purchase commitments from these end users. Therefore, there can be no assurance that the OEMs and/or ODMs will continue to incorporate our ICs into their products. OEM technical specifications and requirements can change rapidly, and we may not have products that fit new specifications from an end-customer for whom we have had previous design wins. We cannot be certain that we will continue to achieve design wins from large OEMs, that our direct customers will continue to be successful in selling to the OEMs, or that the OEMs will be successful in selling products which incorporate our ICs. The loss of any significant customer, any material reduction in orders by any of our significant customers or by their OEM customers, the cancellation of a significant customer order, or the cancellation or delay of a customer’s or OEM’s significant program or product could reduce our revenue and adversely affect our operations and financial condition.
 
Due to the nature of our business as a component supplier, we may have difficulty both in accurately predicting our future revenue and appropriately managing our expenses.
 
Because we provide components for end products and systems, demand for our products is influenced by our customers’ end product demand. As a result, we may have difficulty in accurately forecasting our revenue and expenses. Our revenue depends on the timing, size, and speed of commercial introductions of end products and systems that incorporate our products, all of which are inherently difficult to forecast, as well as the ongoing demand for previously introduced end products and systems. In addition, demand for our products is influenced by our customers’ ability to manage their inventory. Our sales to distributors are subject to higher volatility because they service demand from multiple levels of the supply chain which, in itself, is inherently difficult to forecast. Specifically, in the fourth quarter of 2010, demand was lower because distributors used up inventory that was shipped in the third quarter. If our customers, including distributors, do not manage their inventory correctly or misjudge their customers’ demand, our shipments to and orders from our customers may vary significantly on a quarterly basis.

Our ability to increase product sales and revenues is currently constrained by the manufacturing capacity of our suppliers.
 
Although we provide our suppliers with rolling forecasts of our production requirements, their ability to provide wafers to us is limited by the available capacity, particularly capacity in the geometries we require, at the facilities in which they manufacture wafers for us .   As a result, this lack of capacity has constrained our product sales and revenue growth.  In addition, an increased need for capacity to meet internal demands or demands of other customers could cause our suppliers to reduce capacity available to us. Our suppliers may also require us to pay amounts in excess of contracted or anticipated amounts for wafer deliveries or require us to make other concessions in order to acquire the wafer supply necessary to meet our customer requirements. If our suppliers extend lead times, limit supplies or the types of capacity we require, or increase prices due to capacity constraints or other factors, our revenue and gross margin may materially decline.  In addition, if we experience supply delays or limitations, our customers may reduce their purchase levels with us and/or seek alternative solutions to meet their demand, which could materially and adversely impact our business and results of operations.
 
Due to lack of capacity, which resulted in product shortages in early 2010, several major customers in Korea sought alternative suppliers, which impacted our revenue in the first quarter of 2011 and may continue to impact our revenue in future periods. If we are faced with capacity issues similar to what we experienced in 2010, our product sales and revenue may be further impacted, which could materially and adversely affect our business and results of operations.
 
 
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We currently depend on two third-party suppliers to provide us with wafers for our products. If any of our wafer suppliers become insolvent or capacity constrained and are unable and/or fail to provide us sufficient wafers at acceptable yields and at anticipated costs, our revenue and gross margin may decline or we may not be able to fulfill our customer orders.

We have a supply arrangement with two suppliers for the production of wafers. Should any of our suppliers become insolvent or capacity constrained, we many not be able to fulfill our customer orders, which would likely cause a decline in our revenue.

While certain aspects of our relationship with these suppliers are contractual, many important aspects of this relationship depend on our suppliers’ continued cooperation and our management relationships. In addition, the fabrication of ICs is a highly complex and precise process. Problems in the fabrication process can cause a substantial percentage of wafers to be rejected or numerous ICs on each wafer to be non-functional. This could potentially reduce yields. The failure of our suppliers to supply us wafers at acceptable yields could prevent us from fulfilling our customer orders for our products and would likely cause a decline in our revenue.
 
Further, as is common in the semiconductor industry, our customers may reschedule or cancel orders on relatively short notice. Under our agreement with our suppliers, we have an option to order wafers based on a committed forecast that can cover a period of one to six months. If our customers cancel orders after we submit a committed forecast to our suppliers for the corresponding wafers, we may be required to purchase wafers that we may not be able to resell, which would adversely affect our operating results, financial condition, and cash flows.
 
We might not be able to deliver our products on a timely basis if our relationships with our assembly and test subcontractors are disrupted or terminated.
 
All of our products are assembled by third-party subcontractors and a portion of our testing is currently performed by third-party subcontractors. We do not have any long-term agreements with these subcontractors. As a result, we may not have direct control over product delivery schedules or product quality. Also, due to the amount of time typically required to qualify assembly and test subcontractors, we could experience delays in the shipment of our products if we were forced to find alternate third parties to assemble or test our products.  In addition, events such as the recent global economic crisis may materially impact our assembly supplier’s ability to operate. Any future product delivery delays or disruptions in our relationships with our subcontractors could have a material adverse effect on our operating results, financial condition, and cash flows.
 
There may be unanticipated costs associated with adding to or supplementing our third-party supplier’s manufacturing capacity.
 
We anticipate that future growth of our business will require increased manufacturing capacity on the part of third-party supply foundries, assembly shops, or testing facilities for our products.  In order to facilitate such growth, we may need to enter into strategic transactions, investments and other activities. Such activities are subject to a number of risks, including:
 
§  
the costs and expense associated with such activities;
 
§  
the availability of modern foundries to be developed, acquired, leased or otherwise made available to us or our third-party suppliers;
 
§  
the ability of foundries and our third-party suppliers to obtain the advanced equipment used in the production of our products;
 
§  
delays in bringing new foundry operations online to meet increased product demand; and
 
§  
unforeseen environmental, engineering or manufacturing qualification problems relating to existing or new foundry facilities.
 
These and other risks may affect the ultimate cost and timing of any expansion of our third-party supplier’s capacity.
 
We purchase inventory in advance based on expected demand for our products, and if demand is not as expected, we may have insufficient or excess inventory, which could adversely impact our financial position.
 
As a fabless semiconductor company, we purchase our inventory from a third party manufacturer in advance of selling our product. We place orders with our manufacturer based on existing and expected orders from our customers for particular products. While our contracts with our customers and distributors include lead time requirements and cancellation penalties that are designed to protect us from misalignment between customer orders and inventory levels, we must nonetheless make some predictions when we place orders with our manufacturer. In the event that our predictions are inaccurate due to unexpected increases in orders or unavailability of product within the time frame that is required, we may have insufficient inventory to meet our customer demands. In the event that we order products that we are unable to sell due to a decrease in orders, unexpected order cancellations, injunctions due to patent litigations, or product returns, we may have excess inventory which, if not sold, may need to be disposed of or would result in a decrease in our revenues in future periods as the excess inventory at our distributors is sold. If any of these situations were to arise, it could have a material impact on our business and financial position.
 
 
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The outcome of currently ongoing and future examinations of our income tax returns by the IRS could have a material adverse effect on our results of operations.
 
We are subject to examination of our income tax returns by the IRS and other tax authorities.  Our U.S. federal income tax returns for the years ended December 31, 2000 through December 31, 2007 are under examination by the IRS.  In April 2011, we received from the IRS a Notice of Proposed Adjustment, or “NOPA,” relating to a cost-sharing agreement entered into by the Company and its international subsidiaries in 2004.  In the NOPA, the IRS objected to the Company's allocation of certain litigation expenses between the Company and our international subsidiaries and the amount of "buy-in payments" made by our international subsidiaries to the Company in connection with the cost-sharing agreement, and proposed to increase our U.S. taxable income according to a few alternative methodologies.  The methodology resulting in the largest potential adjustment could, if the IRS were to prevail on all matters in dispute, increase our potential federal and state income tax liabilities by up to $37.0 million, plus interest and penalties, if any.  We believe that the IRS's position in the NOPA is incorrect and that our tax returns for those years were correct as filed.  We expect to contest these proposed adjustments vigorously.     The IRS also audited the research and development credits generated in the years 2000 through 2007, and the carryforward of these credits to subsequent years.  We received a NOPA from the IRS in February 2011, proposing to reduce the research and development credits generated in years 2000 through 2007, which would also reduce the value of such credits carried forward to subsequent tax years.  We are currently reviewing these proposed adjustments as well. We regularly assess the likelihood of an adverse outcome resulting from such examinations to determine the adequacy of our provision for income taxes.   Based on the technical merits of our tax return filing positions, we believe that it is more-likely-than-not that the benefit of such positions will be sustained upon the resolution of our audits resulting in no significant impact on our consolidated financial position and the results of operations and cash flows. However, t here can be no assurance that the outcomes from these IRS examinations will not have a material adverse effect on our future operating results.
 
If we are unsuccessful in any of the legal proceedings involving us and any of our competitors, we could be prevented from selling many of our products and/or be required to pay substantial damages. An unfavorable outcome or an additional award of damages, attorneys’ fees or an injunction could cause our revenue to decline significantly and could severely harm our business and operating results.

If we are not successful in litigation that could be brought against us or our customers, we could be ordered to pay monetary fines and/or damages. If we are found liable for willful patent infringement, damages could be doubled or tripled. We and/or our customers could also be prevented from selling some or all of our products. Moreover, our customers and end-users could decide not to use our products or our products or our customers’ accounts payable to us could be seized. Finally, interim developments in these proceedings could increase the volatility in our stock price as the market assesses the impact of such developments on the likelihood that we will or will not ultimately prevail in these proceedings.
 
Given our inability to control the timing and nature of significant events in our legal proceedings that either have arisen or may arise, our legal expenses are difficult to forecast and may vary substantially from our publicly-disclosed forecasts with respect to any given quarter, which could contribute to increased volatility in our stock price and financial condition.
 
Historically, we have incurred significant expenses in connection with various legal proceedings that vary with the level of activity in the proceeding. It is difficult for us to forecast our legal expenses for any given quarter, which adversely affects our ability to forecast our expected results of operations in general. We may also be subject to unanticipated legal proceedings, which would result in our incurrence of unexpected legal expenses. If we fail to meet the expectations of securities or industry analysts as a result of unexpected changes in our legal expenses, our stock price could be impacted.
 
Our ongoing legal proceedings and the potential for additional legal proceedings have diverted, and may continue to divert, financial and management resources.
 
The semiconductor industry is characterized by frequent claims of infringement and litigation regarding patent and other intellectual property rights. Patent infringement is an ongoing risk, in part because other companies in our industry could have patent rights that may not be identifiable when we initiate development efforts. Litigation may be necessary to enforce our intellectual property rights, and we may have to defend ourselves against additional infringement claims. Such litigation is very costly. In the event any third party makes a new infringement claim against us or our customers, we could incur additional ongoing legal expenses. In addition, in connection with these legal proceedings, we may be required to post bonds to defend our intellectual property rights in certain countries for an indefinite period of time, until such dispute is resolved. If our legal expenses materially increase or exceed anticipated amounts, our capital resources and financial condition could be adversely affected. Further, if we are not successful in any of our intellectual property defenses, our financial condition cold be adversely affected and our business could be harmed. In addition, our management team may also be required to devote a great deal of time, effort and energy to these legal proceedings, which could distract management’s focus on our operations and adversely affect our business.
 
 
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We will continue to vigorously defend and enforce our intellectual property rights around the world, especially as it relates to patent litigation. We will take the appropriate action in various courts throughout the world and may be required to post bonds to defend such intellectual property in certain countries for an indefinite period of time, until such dispute is resolved. If we are not successful in defending our intellectual property, we could lose revenue and the business could be harmed.

From time to time, we are faced with having to defend our intellectual property rights throughout the world. Should we become engaged in such proceedings, it could divert management’s attention from focusing on and implementing the business strategy. Further, should we not be successful in any of our intellectual property defenses, the revenue may be affected and the business could be harmed.
 
Failure to protect our proprietary technologies or maintain the right to certain technologies may negatively affect our ability to compete.
 
We rely heavily on our proprietary technologies. Our future success and competitive position depend in part upon our ability to obtain and maintain protection of certain proprietary technologies used in our products. We pursue patents for some of our new products and unique technologies, and we also rely on a combination of nondisclosure agreements and other contractual provisions, as well as our employees’ commitment to confidentiality and loyalty, to protect our technology, know-how, and processes. Despite the precautions we take, it may be possible for unauthorized third parties to copy aspects of our current or future technology or products or to obtain and use information that we regard as proprietary. We intend to continue to protect our proprietary technology, including through patents. However, there can be no assurance that the steps we take will be adequate to protect our proprietary rights, that our patent applications will lead to issued patents, that others will not develop or patent similar or superior products or technologies, or that our patents will not be challenged, invalidated, or circumvented by others. Furthermore, the laws of the countries in which our products are or may be developed, manufactured, or sold may not protect our products and intellectual property rights to the same extent as laws in the United States. Our failure to adequately protect our proprietary technologies could harm our business.
 
The market for government-backed student loan auction-rate securities has suffered a decline in liquidity which may impact the liquidity and potential value of our investment portfolio.
 
The market for government-backed student loan auction-rate securities with interest rates that reset through a Dutch auction every 7 to 35 days, became illiquid in 2008. At March 31, 2011, the Company’s investment portfolio included $17.2 million, net of impairment charges of $0.8 million, in government-backed student loan auction-rate securities. As of that date, $18.1 million, the face value of our auction-rate security investments, have failed to reset through successful auctions and it is unclear as to when these investments will regain their liquidity. The underlying maturity of these auction-rate securities is up to 37 years. 
 
Based on certain assumptions described in Note 8, “Fair Value Measurements”, to our condensed consolidated financial statements and the Liquidity and Capital Resources section of “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this quarterly report on Form 10-Q, we recorded temporary and other-than-temporary impairment charges on these investments. The valuation is subject to fluctuations in the future, which will depend on many factors, including the collateral quality, potential to be called or restructured, underlying final maturity, insurance guaranty, liquidity and market conditions, among others. We experienced our first failed auction in mid-February 2008.
 
Should there be further deterioration in the market for auction-rate securities or if the accounting rules for these securities change, the value of our portfolio may decline, which may have an adverse impact on our cash position and our earnings. In addition, it is unlikely that we will be able to liquidate our auction-rate securities in the short term.
 
We may be unsuccessful in developing and selling new products or in penetrating new markets required to maintain or expand our business.
 
Our competitiveness and future success depend on our ability to design, develop, manufacture, assemble, test, market, and support new products and enhancements on a timely and cost-effective basis. A fundamental shift in technologies in any of our product markets could have a material adverse effect on our competitive position within these markets. Our failure to timely develop new technologies or to react quickly to changes in existing technologies could materially delay our development of new products, which could result in product obsolescence, decreased revenue, and/or a loss of market share to competitors.
 
 
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As we develop new product lines, we must adapt to market conditions that are unfamiliar to us, such as competitors and distribution channels that are different from those we have known in the past. Some of our new product lines require us to re-equip our labs to test parameters we have not tested in the past. If we are unable to adapt rapidly to these new and additional conditions, we may not be able to successfully penetrate new markets.
 
The success of a new product depends on accurate forecasts of long-term market demand and future technological developments, as well as on a variety of specific implementation factors, including:
 
 
timely and efficient completion of process design and device structure improvements;
 
 
timely and efficient implementation of manufacturing, assembly, and test processes;
 
 
the ability to secure and effectively utilize fabrication capacity in different geometries;
 
 
product performance;
 
 
product availability;
 
 
the quality and reliability of the product; and
 
 
effective marketing, sales and service.
 
To the extent that we fail to timely introduce new products or to quickly penetrate new markets, our revenue and financial condition could be materially adversely affected.
 
Certain of our CCFL products are used to drive fluorescent lighting products which contain small amount of mercury.
 
Our CCFL products are used to drive fluorescent lighting products which contain small amount of mercury. This is the subject of environmental concerns, particularly in Europe. Should environmental issues impair the widespread use of our CCFL-based products, and should we be unable to produce replacement products based on LED lighting fast enough to compensate for the loss of our CCFL-related business, our business and results of operations could be adversely affected.

The complexity of calculating our tax provision may result in errors that could result in restatements of our financial statements.

Due to the complexity associated with the calculation of our tax provision, we have hired independent tax advisors to assist us in the calculation. If we or our independent tax advisors fail to resolve or fully understand certain issues that we may have had in the past and issues that may arise in the future, we could be subject to errors, which would result in us having to restate our financial statements. Restatements are generally costly and could adversely impact our results of operations and/or have a negative impact on the trading price of our common stock.

We face risks in connection with our internal control over financial reporting related to income taxes.

Because of the complexity of our tax structure, we have had errors in our financial statements in the calculation of our tax provision that previously resulted in restatements of our prior year financial results. Although we believe that we have implemented appropriate internal control over financial reporting related to the computation of our income tax provision, we cannot be certain that any measures we have taken or may take in the future will ensure that we implement and maintain adequate internal control over financial reporting and that we will avoid any material weakness in the future. In addition, we cannot assure you that we will not in the future identify further material weaknesses in our internal control over financial reporting related to the calculation of our income tax provision that we have not discovered to date, which may impact the reliability of our financial reporting and financial statements.

Changes in effective tax rates or adverse outcomes resulting from examination of our income tax returns could adversely affect our results

Our future effective tax rates could be adversely affected by earnings being lower than anticipated in countries where we have lower statutory rates and higher than anticipated in countries where we have higher statutory rates, by changes in the valuation of our deferred tax assets and liabilities, or by changes in tax laws, regulations, accounting principles or interpretations thereof. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from these continuous examinations will not have an adverse effect on our operating results and financial condition.
 
 
34

 

Our products must meet exacting specifications, and undetected defects and failures may occur, which may cause customers to return or stop buying our products and may expose us to product liability risk.
 
Our customers generally establish demanding specifications for quality, performance, and reliability that our products must meet. Integrated circuits as complex as ours often encounter development delays and may contain undetected defects or failures when first introduced or after commencement of commercial shipments, which might require product replacement or recall. Further, our third-party manufacturing processes or changes thereof, or raw material used in the manufacturing processes may cause our products to fail. We have from time to time in the past experienced product quality, performance or reliability problems. Our standard warranty period is one year, which exposes the company to significant risks of claims for defects and failures. If defects and failures occur in our products, we could experience lost revenue, increased costs, including warranty expense and costs associated with customer support, delays in, cancellations or rescheduling of orders or shipments, and product returns or discounts, any of which would harm our operating results.
 
In addition, product liability claims may be asserted with respect to our technology or products. Although we currently have insurance, there can be no assurance that we have obtained a sufficient amount of insurance coverage, that asserted claims will be within the scope of coverage of the insurance, or that we will have sufficient resources to satisfy any asserted claims.
 
The price and availability of commodities (e.g., gold, platinum, copper and silicon) may adversely impact our ability to deliver our products in a timely and cost-effective manner and may affect our business and results of operations.
 
Our products incorporate commodities such as gold, platinum, copper and silicon. The price and availability of these commodities and other like commodities that we use could negatively impact our business and results of operations.
 
Devaluation of the U.S. Dollar relative to other foreign currencies, including the Chinese Yuan, may adversely affect results of operations.
 
Our manufacturing and packaging suppliers are and will continue to be primarily located in China for the foreseeable future. Should the value of the Chinese Yuan continue to rise against the U.S. Dollar, there could be an increase in our manufacturing costs relative to competitors who have manufacturing facilities located in the U.S., which could adversely affect our operations. In addition, because we collect payments from all customers in U.S. dollars, fluctuations in the value of foreign currencies could have an adverse impact on our customers’ business, which could negatively impact our business and results of operations.
 
We and our manufacturing partners are or will be subject to extensive Chinese government regulation, and the benefit of various incentives from Chinese governments that we and our manufacturing partners receive may be reduced or eliminated, which could increase our costs or limit our ability to sell products and conduct activities in China.
 
Most of our manufacturing partners are located in China. In addition, we have established a facility in China, initially for the testing of our ICs. The Chinese government has broad discretion and authority to regulate the technology industry in China. China’s government has implemented policies from time to time to regulate economic expansion in China. It also exercises significant control over China’s economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. New regulations or the readjustment of previously implemented regulations could require us and our manufacturing partners to change our business plans, increase our costs, or limit our ability to sell products and conduct activities in China, which could adversely affect our business and operating results.
 
In addition, the Chinese government and provincial and local governments have provided, and continue to provide, various incentives to encourage the development of the semiconductor industry in China. Such incentives include tax rebates, reduced tax rates, favorable lending policies, and other measures, some or all of which may be available to our manufacturing partners and to us with respect to our facility in China. Any of these incentives could be reduced or eliminated by governmental authorities at any time. Any such reduction or elimination of incentives currently provided to our manufacturing partners could adversely affect our business and operating results.
 
There are inherent risks associated with the operation of our testing facility in China, which could increase product costs or cause a delay in product shipments.
 
 
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We have a testing facility in China that began operations in 2006. In addition to the risks discussed elsewhere in this quarterly report on Form 10-Q, we face the following risks, among others:
 
 
inability to maintain appropriate and acceptable manufacturing controls; and
 
 
higher than anticipated overhead and other costs of operation.
 
If we are unable to continue a fully operational status with appropriate controls, we may incur higher costs than our current expense levels, which would affect our gross margins. In addition, if capacity restraints result in significant delays in product shipments, our business and results of operations would be adversely affected.
 
The average selling prices of products in our markets have historically decreased over time and will likely do so in the future, which could harm our revenues and gross profits.
 
Average selling prices of semiconductor products in the markets we serve have historically decreased over time. Our gross profits and financial results will suffer if we are unable to offset any reductions in our average selling prices by reducing our costs, developing new or enhanced products on a timely basis with higher selling prices or gross profits, or increasing our sales volumes. Additionally, because we do not operate our own manufacturing or assembly facilities, we may not be able to reduce our costs as rapidly as companies that operate their own facilities, and our costs may even increase, which could also reduce our margins.
 
Because of the lengthy sales cycles for our products and the fixed nature of a significant portion of our expenses, we may incur substantial expenses before we earn associated revenue and may not ultimately achieve our forecasted sales for our products.
 
The introduction of new products presents significant business challenges because product development plans and expenditures must be made up to two years or more in advance of any sales. It takes us up to 12 months or more to design and manufacture a new product prototype. Only after we have a prototype do we introduce the product to the market and begin selling efforts in an attempt to achieve design wins. This sales process, which averages six to twelve months, requires us to expend significant sales and marketing resources without any assurance of success. Volume production of products that use our ICs, if any, may not be achieved for an additional three to six months after an initial sale. Sales cycles for our products are lengthy for a number of reasons:
 
 
our customers usually complete an in-depth technical evaluation of our products before they place a purchase order;
 
 
the commercial adoption of our products by OEMs and ODMs is typically limited during the initial release of their product to evaluate product performance and consumer demand;
 
 
our products must be designed into a customer’s product or system; and
 
 
the development and commercial introduction of our customers’ products incorporating new technologies frequently are delayed.
 
As a result of our lengthy sales cycles, we may incur substantial expenses before we earn associated revenue because a significant portion of our operating expenses is relatively fixed and based on expected revenue. The lengthy sales cycles of our products also make forecasting the volume and timing of orders difficult. In addition, the delays inherent in lengthy sales cycles raise additional risks that customers may cancel or change their orders. Our sales are made by purchase orders. Because industry practice allows customers to reschedule or cancel orders on relatively short notice, backlog is not always a good indicator of our future sales. If customer cancellations or product changes occur, we could lose anticipated sales and not have sufficient time to reduce our inventory and operating expenses.
 
The loss of any of our key personnel or the failure to attract or retain specialized technical and management personnel could impair our ability to grow our business.
 
Our future success depends upon our ability to attract and retain highly qualified technical and managerial personnel. We are particularly dependent on the continued services of our key executives, including Michael Hsing, our President and Chief Executive Officer, who founded our company and developed our proprietary process technology. In addition, personnel with highly skilled analog and mixed-signal design engineering expertise are scarce and competition for personnel with these skills is intense. There can be no assurance that we will be able to retain existing key employees or that we will be successful in attracting, integrating or retaining other highly qualified personnel with critical capabilities in the future. If we are unable to retain the services of existing key employees or are unsuccessful in attracting new highly qualified employees quickly enough to meet the demands or our business, including design cycles, our business could be harmed.
 
 
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If we fail to retain key employees in sales, applications, finance and legal or to make continued improvements to our internal systems, particularly in the accounting and finance area, our business may suffer.
 
If we fail to continue to adequately staff our sales, applications, financial and legal staff, maintain or upgrade our business systems and maintain internal controls that meet the demands of our business, our ability to operate effectively will suffer. The operation of our business also depends upon our ability to retain these employees, as these employees hold a significant amount of institutional knowledge about us and our products, and, if they were to terminate their employment, our sales and internal control over financial reporting could be adversely affected.
 
We intend to continue to expand our operations, which may strain our resources and increase our operating expenses.
 
We plan to continue to expand our domestic and foreign operations through internal growth, strategic relationships, and/or acquisitions. We expect that any such expansion will strain our systems and operational and financial controls. In addition, we are likely to incur significantly higher operating costs. To manage our growth effectively, we must continue to improve and expand our systems and controls, as well as hire experienced administrative and financial personnel. If we fail to do so, our growth will be limited. If we fail to effectively manage our planned expansion of operations, our business and operating results may be harmed.
 
We may engage in future acquisitions that dilute the ownership interests of our stockholders and cause us to incur debt or to assume contingent liabilities, and we may be unable to successfully integrate these companies into our operations, which would adversely affect our business.
 
As a part of our business strategy, from time to time we review acquisition prospects that would complement our current product offerings, enhance our design capability or offer other competitive opportunities. In the event of future acquisitions, we could use a significant portion of our available cash, cash equivalents and short-term investments, issue equity securities which would dilute current stockholders’ percentage ownership, incur substantial debt or contingent liabilities, and/or incur impairment charges related to goodwill or other intangibles. Such actions by us could impact our operating results and/or the price of our common stock.
 
In addition, we may be unable to identify or complete prospective acquisition for various reasons, including competition from other companies in the semiconductor industry, the valuation expectations of acquisition candidates and applicable antitrust laws or related regulations.  If we are unable to identify and complete acquisitions, we may not be able to successfully expand our business and product offerings.
 
To the extent we are successful in completing strategic acquisitions, if we are unsuccessful in integrating any acquired company into our operations or if integration is more difficult than anticipated, we may experience disruptions that could harm our business and not realize the anticipated benefits of the acquisitions. Some of the risks that may adversely affect our ability to integrate or realize any anticipated benefits from the acquired companies, businesses or assets include those associated with:
 
§  
unexpected losses of key employees or customers of the acquired companies or businesses;
 
§  
conforming the acquired company’s standards, processes, procedures and controls with our operations;
 
§  
coordinating new product and process development;
 
§  
hiring additional management and other critical personnel;
 
§  
increasing the scope, geographic diversity and complexity of our operations;
 
§  
difficulties in consolidating facilities and transferring processes and know-how;
 
§  
other difficulties in the assimilation of acquired operations, technologies or products;
 
§  
diversion of management’s attention from other business concerns; and
 
§  
adverse effects on existing business relationships with customers.
 
 
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We compete against many companies with substantially greater financing and other resources, and our market share may be reduced if we are unable to respond to our competitors effectively.
 
The analog and mixed-signal semiconductor industry is highly competitive, and we expect competitive pressures to continue. Our ability to compete effectively and to expand our business will depend on our ability to continue to recruit applications and design talent, our ability to introduce new products, and our ability to maintain the rate at which we introduce these new products. We compete with domestic and non-domestic semiconductor companies, many of which have substantially greater financial and other resources with which to pursue engineering, manufacturing, marketing, and distribution of their products. We are in direct and active competition, with respect to one or more of our product lines, with at least 10 manufacturers of such products, of varying size and financial strength. The number of our competitors has grown due to the expansion of the market segments in which we participate. We consider our competitors to include, but not be limited to: Fairchild Semiconductor, Intersil, Linear, Maxim Integrated Products, Micrel, Microsemi, National Semiconductor, O2Micro, RichTek, Rohm, Semtech, STMicroelectronic, Texas Instruments and Volterra. We expect continued competition from existing competitors as well as competition from new entrants in the semiconductor market.
 
We cannot assure you that our products will continue to compete favorably or that we will be successful in the face of increasing competition from new products and enhancements introduced by existing competitors or new companies entering this market, which would materially and adversely affect our results of operations and our financial condition.
 
If securities or industry analysts downgrade our stock or do not continue to publish research or reports about our business, our stock price and trading volume could decline.
 
The trading market for our common stock will depend on the research and reports that industry or securities analysts publish about us or our business. We do not have any control over these analysts. If one or more of the analysts who cover us downgrade our stock, our stock price would likely decline. If one or more of these analysts cease coverage of us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.
 
Because of their significant stock ownership, our officers and directors will be able to exert significant influence over our future direction.
 
Executive officers, directors, and affiliated entities beneficially owned in aggregate, approximately 18% of our outstanding common stock as of March 31, 2011. These stockholders, if acting together, would be able to significantly influence all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions.
 
Major earthquakes or other natural disasters and resulting systems outages may cause us significant losses.
 
Our corporate headquarters, the production facilities of our third-party wafer supplier, our IC testing facility, a portion of our assembly and research and development activities, and certain other critical business operations are located in or near seismically active regions and are subject to periodic earthquakes. We do not maintain earthquake insurance and could be materially and adversely affected in the event of a major earthquake. Much of our revenue, as well as our manufacturers and assemblers, are concentrated in Asia. Such concentration increases the risk that other natural disasters, labor strikes, terrorism, war, political unrest, epidemics, and/or health advisories could disrupt our operations. In addition, we rely heavily on our internal information and communications systems and on systems or support services from third parties to manage our operations efficiently and effectively. Any of these are subject to failure due to a natural disaster or other disruption. System-wide or local failures that affect our information processing could have material adverse effects on our business, financial condition, operating results, and cash flows.
 
Our facilities in Chengdu, China are located in a seismically active area, as evidenced by the May 2008 earthquake that was centered in the Sichuan Province of China. Although there was no damage to our facilities as a result of that earthquake, should there be additional earthquakes in the area, we may incur losses and our business, financial condition and/or operating results may suffer.
 
We have a sales facility in Japan, which is located in a seismically active area, as evidenced by the March 2011 earthquake that was centered off the coast of Japan’s Miyagi Prefecture. While there was no damage to our facilities as a result of the earthquake, our customers may have experienced disruptions in their supply chains that may impact our revenue in future quarters. Additional earthquakes in the region may have a more significant impact longer term, which could affect our results of operations and financial conditions.
 
 
38

 

ITEM 6. EXHIBITS
 
3.1(1)
Amended and Restated Certificate of Incorporation
3.2(2)
Amended and Restated Bylaws
31.1
Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
______________________
* This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that Section, nor shall it be deemed incorporated by reference in any filings under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any filings.
 
(1) Incorporated by reference to Exhibit 3.2 of the Registrant’s Form S-1 Registration Statement (Registration No. 333-117327), declared effective by the Securities and Exchange Commission on November 18, 2004.
(2) Incorporated by reference to Exhibit 3.4 of the Registrant’s Form S-1 Registration Statement (Registration No. 333-117327), declared effective by the Securities and Exchange Commission on November 18, 2004.
 
 
39

 

MONOLITHIC POWER SYSTEMS, INC
 
SIGNATURE
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
MONOLITHIC POWER SYSTEMS, INC.
   
Dated: April 28, 2011
 
 
/s/ MEERA RAO
 
Meera Rao
 
Chief Financial Officer
 
(Principal Financial and Accounting Officer)
 
 
40

 
 
EXHIBIT INDEX
 
3.1(1)
Amended and Restated Certificate of Incorporation
3.2(2)
Amended and Restated Bylaws
31.1
Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
__________________
*
This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that Section, nor shall it be deemed incorporated by reference in any filings under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any filings.
(1) Incorporated by reference to Exhibit 3.2 of the Registrant’s Form S-1 Registration Statement (Registration No. 333-117327), declared effective by the Securities and Exchange Commission on November 18, 2004.
(2) Incorporated by reference to Exhibit 3.4 of the Registrant’s Form S-1 Registration Statement (Registration No. 333-117327), declared effective by the Securities and Exchange Commission on November 18, 2004.

 
Exhibit 31.1
 
CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO
SECURITIES EXCHANGE ACT RULES 13a-14(a) and 15d-14(a), AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
 
I, Michael R. Hsing, certify that:
 
1. I have reviewed this quarterly report on Form 10-Q of Monolithic Power Systems, Inc.;
 
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
  Date: April 28, 2011
 
/s/ MICHAEL R. HSING
Michael R. Hsing
Chief Executive Officer
Exhibit 31.2
 
CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO
SECURITIES EXCHANGE ACT RULES 13a-14(a) and 15d-14(a), AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
 
I, Meera Rao, certify that:
 
1. I have reviewed this quarterly report on Form 10-Q of Monolithic Power Systems, Inc.;
 
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
Date: April 28, 2011
 
/s/ MEERA RAO
Meera Rao
Chief Financial Officer
Exhibit 32.1
 
The following certification shall not be deemed “filed” for purposes of section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any filings.
 
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND
CHIEF FINANCIAL OFFICER PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
 
In connection with the quarterly report on Form 10-Q of Monolithic Power Systems, Inc., a Delaware corporation, for the period ended September 30, 2010, as filed with the Securities and Exchange Commission, each of the undersigned officers of Monolithic Power Systems, Inc. certifies pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
 
(1) the accompanying report on Form 10-Q of the Company for the period ended September 30, 2010, as filed with the Securities and Exchange Commission (the “Report”), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
 
(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Monolithic Power Systems, Inc. for the periods presented therein.
 
Date: April 28, 2011
 
/s/ MICHAEL R. HSING
Michael R. Hsing
Chief Executive Officer
 
Date: April 28, 2011
 
 
/s/ MEERA RAO
Meera Rao
Chief Financial Officer
 
A signed original of the above certification has been provided to Monolithic Power Systems, Inc. and will be retained by Monolithic Power Systems, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.