Monolithic Power Systems, Inc.
MONOLITHIC POWER SYSTEMS INC (Form: 10-Q, Received: 08/09/2011 13:01:12)

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 June 30, 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 33,466,364 shares of the registrant’s common stock issued and outstanding as of July 22, 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 5. OTHER INFORMATION   38
   ITEM 6. EXHIBITS    40
 
 
 
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)

   
June 30, 2011
   
December 31, 2010
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 97,685     $ 48,010  
Short-term investments
    65,641       129,709  
Accounts receivable, net of allowances of $0 in both 2011 and 2010
    17,589       18,347  
Inventories
    24,715       25,789  
Deferred income tax assets, net - current
    452       204  
Prepaid expenses and other current assets
    1,692       2,314  
Total current assets
    207,774       224,373  
Property and equipment, net
    37,433       37,262  
Long-term investments
    17,220       19,180  
Deferred income tax assets, net - long-term
    39       39  
Other assets
    694       749  
Total assets
  $ 263,160     $ 281,603  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
  $ 10,929     $ 8,979  
Accrued compensation and related benefits
    8,042       8,792  
Accrued liabilities
    12,038       11,199  
Total current liabilities
    31,009       28,970  
                 
Non-current income tax liability
    5,021       5,015  
Other long-term liabilities
    -       723  
Total liabilities
    36,030       34,708  
Stockholders' equity:
               
Common stock, $0.001 par value, $33 and $35 in 2011 and 2010, respectively; shares authorized: 150,000,000; shares issued and outstanding: 33,466,052 and 35,063,033 in 2011 and 2010, respectively
    152,129       178,269  
Retained earnings
    72,022       66,647  
Accumulated other comprehensive income
    2,979       1,979  
Total stockholders’ equity
    227,130       246,895  
Total liabilities and stockholders’ equity
  $ 263,160     $ 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 June 30,      S ix months ended June 30,  
   
2011
   
2010
   
2011
   
2010
 
                         
Revenue
  $ 51,628     $ 55,690     $ 96,096     $ 105,940  
Cost of revenue
    25,070       23,256       47,233       44,210  
                                 
Gross profit
    26,558       32,434       48,863       61,730  
Operating expenses:
                               
Research and development
    11,237       11,785       21,323       22,825  
Selling, general and administrative
    10,343       11,615       19,833       22,008  
Litigation expense
    939       2,228       1,752       3,795  
                                 
Total operating expenses
    22,519       25,628       42,908       48,628  
                                 
Income from operations
    4,039       6,806       5,955       13,102  
Other income (expense):
                               
Interest and other income
    160       338       431       685  
Interest and other expense
    (136 )     (4 )     (224 )     (4 )
                                 
Total other income, net
    24       334       207       681  
                                 
Income before income taxes
    4,063       7,140       6,162       13,783  
Income tax provision
    581       733       787       1,020  
                                 
Net income
  $ 3,482     $ 6,407     $ 5,375     $ 12,763  
Basic net income per share
  $ 0.10     $ 0.18     $ 0.16     $ 0.36  
Diluted net income per share
  $ 0.10     $ 0.17     $ 0.15     $ 0.33  
Weighted average common shares outstanding:
 
Basic
    33,846       36,291       34,432       35,858  
Diluted
    34,903       38,355       35,598       38,151  
 
See accompanying notes to condensed consolidated financial statements.
 
 
4

 
MONOLITHIC POWER SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
 
   
Six months ended June 30,
 
   
2011
   
2010
 
Cash flows from operating activities:
           
Net income
  $ 5,375     $ 12,763  
Adjustments to reconcile net income to net cash provided by operating activities:
 
Depreciation and amortization
    4,375       3,604  
Amortization and realized gain on debt instruments
    308       275  
Tax benefit from stock option transactions
    1,845       2,838  
Excess tax benefit from stock option transactions
    (474 )     (1,396 )
Stock-based compensation
    6,662       9,563  
Changes in operating assets and liabilities:
 
Accounts receivable
    758       (14,800 )
Inventories
    1,082       5,178  
Prepaid expenses and other assets
    661       (102 )
Accounts payable
    2,062       3,202  
Accrued and long-term liabilities
    1,295       2,010  
Accrued income taxes payable and noncurrent tax liabilities
    (1,612 )     (1,443 )
Accrued compensation and related benefits
    (818 )     998  
Deferred rent
    (5 )     61  
Net cash provided by operating activities
    21,514       22,751  
                 
Cash flows from investing activities:
               
Property and equipment purchases
    (5,271 )     (12,753 )
Purchase of short-term investments
    (22,957 )     (117,030 )
Proceeds from sale of short-term investments
    86,719       94,998  
Proceeds from sale of long-term investments
    2,100       125  
Changes in restricted assets
    -       (19 )
Net cash provided by (used in) investing activities
    60,591       (34,679 )
                 
Cash flows from financing activities:
               
Proceeds from issuance of common stock
    4,262       11,777  
Proceeds from employee stock purchase plan
    928       1,054  
Repurchase of common stock
    (38,472 )     -  
Excess tax benefits from stock option transactions
    474       1,396  
Net cash provided by (used in) financing activities
    (32,808 )     14,227  
                 
Effect of change in exchange rates
    378       (54 )
Net increase in cash and cash equivalents
    49,675       2,245  
Cash and cash equivalents, beginning of period
    48,010       46,717  
Cash and cash equivalents, end of period
  $ 97,685     $ 48,962  
                 
Supplemental disclosures for cash flow information:
 
Cash paid (received) for taxes
  $ 381     $ (76 )
Supplemental disclosures of non-cash investing and financing activities:
 
Liability accrued for equipment purchases
  $ 527     $ 672  
Temporary impairment (reversal) of auction-rate securities
  $ (140 )   $ (175 )
 
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 and six months ended June 30, 2011 and 2010, as follows (in thousands):
 
   
Three months ended June 30,
   
Six months ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Non-Employee
  $ 4     $ (11 )   $ 8     $ (10 )
ESPP
    150       167       302       394  
Restricted Stock
    2,057       3,511       3,220       5,121  
Stock Options
    1,464       1,872       3,132       4,058  
TOTAL
  $ 3,675     $ 5,539     $ 6,662     $ 9,563  
 
 
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
  (784,980 )
2011 Cancellations
  285,276  
Available for Grant as of June 30, 2011  
4,208,054
 

A summary of the status of the Company’s stock option plans at June 30, 2011 and changes during the six 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 $6.22 per share)
    87,000     $ 14.76                  
    Options exercised
    (621,529 )   $ 6.86                  
    Options forfeited and expired
    (235,506 )   $ 18.38                  
Outstanding at June 30, 2011
    5,065,083     $ 15.38       3.87     $ 9,962,928  
Options exercisable at June 30, 2011 and expected to become exercisable
    4,846,018     $ 15.28       3.83     $ 9,843,665  
Options vested and exercisable at June 30, 2011
    4,073,950     $ 14.83       3.63     $ 9,441,111  
 
The total fair value of options that vested during the three months ended June 30, 2011 and 2010 was $1.5 million and $1.9 million, respectively, and the total fair value of options that vested during the six months ended June 30, 2011 and 2010 was $3.1 million and $4.1 million, respectively.  The total intrinsic value of options exercised during the three months ended June 30, 2011 and 2010 was $0.7 million and $9.5 million, respectively. The total intrinsic value of options exercised during the six months ended June 30, 2011 and 2010 was $5.5 million and $15.8 million, respectively. Net cash proceeds from the exercise of stock options was $0.7 million for the three months ended June 30, 2011 and $3.1 million for the three months ended June 30, 2010. Net cash proceeds from the exercise of stock options was $4.3 million for the six months ended June 30, 2011 and $11.8 million for the six months ended June 30, 2010. At June 30, 2011, unamortized compensation expense related to unvested options was approximately $6.3 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.
 
 
7

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

The employee stock-based compensation expense recognized under Accounting Standards Codification (“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 and six months ended June 30, 2011 and 2010: 
 
   
Three months ended June 30,
   
Six months ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Expected term (years)
    4.0       4.1       4.0       4.1  
Expected volatility
    53.0 %     56.9 %     52.9 %     56.5 %
Risk-free interest rate
    1.3 %     1.8 %     1.4 %     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
    697,980       15.98          
    Awards released
    (196,305 )     17.93          
    Awards forfeited
    (49,770 )     19.82          
Outstanding at June 30, 2011
    1,412,079     $ 17.67       2.99  

The total fair value of restricted stock units that vested was $2.1 million for the three months ended June 30, 2011 and $1.3 million for the three months ended June 30, 2010, respectively. The total fair value of restricted stock units that vested was $4.6 million for the six months ended June 30, 2011 and $2.7 million for the six months ended June 30, 2010, respectively. The intrinsic value related to restricted stock units released for the three months ended June 30, 2011 and 2010 was $1.4 million and $1.3 million, respectively, and the intrinsic value related to restricted stock units released for the six months ended June 30, 2011 and 2010 was $3.1 million and $2.5 million, respectively. The intrinsic value related to restricted stock units outstanding at June 30, 2011 and 2010 was $21.8 million and $14.9 million, respectively. At June 30, 2011, the unamortized compensation expense related to unvested restricted stock units was approximately $16.5 million, net of estimated forfeitures, with a weighted average remaining recognition period of 3.0 years.

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.
 
 
8

 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)
 
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 six months ended June 30, 2011 and 2010, 70,685 shares and 57,240 shares, respectively, were issued under the Purchase Plan. There were no shares issued under the Purchase Plan during the three months ended June 30, 2011 and 2010. The following is a summary of the Purchase Plan and changes during the six months ended June 30, 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 June 30, 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 million for each of the six months ended June 30, 2011 and 2010, respectively. The unamortized expense as of June 30, 2011 was $0.1 million, which will be recognized over 0.1 years. The Black-Scholes option pricing model was used to value the employee stock purchase rights. For the six months ended June 30, 2011 and 2010, the following weighted average assumptions were used in the valuation of the stock purchase rights:
 
   
Six months ended June 30,
 
   
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 six months ended June 30, 2011 and 2010 was $0.9 million and $1.1 million, respectively.
 
3. Inventories - Inventories consist of the following (in thousands):

   
June 30, 2011
   
December 31, 2010
 
Work in progress
  $ 13,050     $ 11,559  
Finished goods
    11,665       14,230  
Total inventories
  $ 24,715     $ 25,789  
 
 
 
9

 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)
 
 
4. Accrued Liabilities - Accrued liabilities consist of the following (in thousands):
 
   
June 30, 2011
   
December 31, 2010
 
Deferred revenue and customer prepayments
  $ 4,812     $ 3,200  
Chengdu building construction cost
    2,459       3,633  
Legal expenses and settlement costs
    1,389       844  
Stock rotation reserve
    790       811  
Warranty
    726       764  
Other
    1,862       1,947  
Total accrued liabilities
  $ 12,038     $ 11,199  
 
A roll-forward of the warranty reserve for the six months ended June 30, 2011 and 2010 is as follows:

   
Six months ended June 30,
 
   
2011
   
2010
 
Balance at beginning of year
  $ 764     $ 294  
Warranty costs
    (333 )     -  
Unused warranty provision
    (220 )     (196 )
Warranty provision for product sales
    515       255  
Balance at end of period
  $ 726     $ 353  
 
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.  For the three and six months ended June 30, 2011 and 2010, the Company had securities outstanding, which could potentially dilute basic net income per share in the future, but were excluded from the computation of diluted net income per share in the periods presented, as their effect would have been anti-dilutive. The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):
 
   
Three months ended June 30,
   
Six months ended June 30,
 
   
2011
   
2010
   
2 011
   
2 010
 
Numerator:
                       
   Net income
  $ 3,482     $ 6,407     $ 5,375     $ 12,763  
                                 
Denominator:
                               
   Weighted average oustanding shares used to compute basic net income per share
    33,846       36,291       34,432       35,858  
   Effect of dilutive securities
    1,057       2,064       1,166       2,293  
   Weighted average oustanding shares used to compute diluted net income per share
    34,903       38,355       35,598       38,151  
                                 
Net income per share - basic
  $ 0.10     $ 0.18     $ 0.16     $ 0.36  
Net income per share - diluted
  $ 0.10     $ 0.17     $ 0.15     $ 0.33  
 
 
 
10

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

For the three months ended June 30, 2011 and 2010, approximately 4.1 million and 1.6 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. For the six months ended June 30, 2011 and 2010, approximately 4.3 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 effects (in thousands):
 
      Three months ended June 30,    
Six months ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Net income
  $ 3,482     $ 6,407     $ 5,375     $ 12,763  
Other comprehensive income:
                               
   Change in value of temporary impairment of auction-rate securities
    -       (10 )     140       175  
   Unrealized gain on available-for-sale securities
    9       110       2       158  
   Foreign currency translation adjustments
    704       104       858       105  
                                 
Comprehensive income
  $ 4,195     $ 6,611     $ 6,375     $ 13,201  
 
Foreign currency translation adjustments for the quarter and six months ended June 30, 2011 were primarily from fluctuations in the renminbi.
 
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 and six months ended June 30, 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 and six months ended June 30, 2011 and 2010.
 
   
Three months ended June 30,
   
Six months ended June 30,
 
Customers
 
2011
   
2010
   
2011
   
2010
 
                         
A
    16 %     11 %     16 %     11 %
B
    *       15 %     *       14 %
C
    *       10 %     *       10 %
 
(*) 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 June 30,
   
Six months ended June 30,
 
Country
 
2011
   
2010
   
2011
   
2010
 
China
  $ 31,203     $ 28,580     $ 54,880     $ 51,145  
Taiwan
    5,156       5,381       10,285       10,896  
Korea
    4,417       10,393       8,844       18,904  
Europe
    3,567       4,620       7,042       10,080  
Japan
    2,740       2,427       5,718       5,307  
USA
    860       2,417       1,966       5,260  
Other
    3,685       1,872       7,361       4,348  
                                 
Total
  $ 51,628     $ 55,690     $ 96,096     $ 105,940  
 
The following is a summary of revenue by product family (in thousands):
 
   
Three months ended June 30,
   
Six months ended June 30,
 
Product Family
 
2011
   
2010
   
2011
   
2010
 
DC to DC Converters
  $ 42,786     $ 45,551     $ 79,879     $ 85,852  
Lighting Control Products
    6,857       7,510       12,745       14,944  
Audio Amplifiers
    1,985       2,629       3,472       5,144  
                                 
Total
  $ 51,628     $ 55,690     $ 96,096     $ 105,940  
 
The following is a summary of  long-lived assets by geographic region (in thousands):
 
   
June 30, 2011
   
December 31, 2010
 
China
  $ 34,350     $ 34,468  
United States
    3,011       2,719  
Taiwan
    114       134  
Japan
    78       85  
Other
    59       58  
 TOTAL
  $ 37,612     $ 37,464  
 
7. Litigation
 
The Company and certain of its subsidiaries are parties to 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. These proceedings often 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.   
 
 
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 and six months ended June 30, 2011, there were no such transfers.
 
The following table details the fair value measurements as of June 30, 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 June 30, 2011 Using
 
         
Quoted Prices in Active Markets for Identical Assets
     
Significant Other Observable Inputs
     
Significant Unobservable Inputs
 
 
Total
   
Level 1
   
Level 2
   
Level 3
 
Money Market Funds
$ 48,312     $ 48,312     $ -     $ -  
US Treasuries and US Government Agency Bonds
  56,786       56,786       -       -  
Commercial Paper / Corporates
  8,856       -       8,856       -  
Long-term available-for-sale auction-rate securities
  17,220       -       -       17,220  
  $ 131,174     $ 105,098     $ 8,856     $ 17,220  
 
At June 30, 2011, fixed income available-for-sale securities included $56.8 million in US government agencies and treasuries and $8.9 million in corporate notes and commercial paper, all of which was classified as short-term investments. From these investments, there was $8,800 in unrealized losses. The impact of gross unrealized gains and losses was not material. At June 30, 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 $48.3 million in money market securities, which are classified as cash and cash equivalents.
 
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  
Sales and Settlement at Par
    (50 )
Ending balances at June 30, 2011
  $ 17,220  
 
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 June 30, 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 36 years. Although it is unclear as to when these investments will regain their liquidity, management has concluded that as of June 30, 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 127%, 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 June 30, 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, March 31, 2011 and June 30, 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
   
June 30, 2011
 
Time-to-Liquidity
 
24 months
   
24 months
   
24 months
 
Expected Return (Based on the 2-year treasury rate, plus a contractual penalty rate)
  2.9%     3.3%     2.5%  
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
   
3.8% - 8.6%, depending on the credit-rating of the security
 
 
The gross accumulated impairment charge was $0.8 million as of June 30, 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 and six months ended June 30, 2011 was $0.6 million or 14.3% of the Company’s income before income taxes and $0.8 million or 12.8% of the pre-tax income, respectively. 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 restricted units released. The income tax provision for the three and six months ended June 30, 2010 was $0.7 million or 10.3% of our income before income taxes and $1.0 million or 7.4% 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 and because of the benefit that we realized as a result of stock option exercises and restricted units released.
 
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.
 
 
 

 
 
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  
 April
  917,200   $ 14.82   $ 13,617  
 May
  657,800   $ 16.48   $ 10,843  
 June
  18,000   $ 16.79   $ 302  
    2,485,500         $ 38,472  
 
From August 2010 through June 2011, the Company repurchased 4,385,289 shares for a total of $70.0 million.
 
 
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 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 and six months  ended June 30, 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. 91% of our revenue for the quarter ended June 30, 2011 and 87% of our revenue for the quarter ended June 30, 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.
 
 
17

 
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.
 
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 June 30, 2011 and December 31, 2010 was $1.3 million and $1.0 million, respectively.
 
 
18

 
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.
 
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 June 30, 2011 and December 31, 2010, we had a valuation allowance of $16.7 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 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.

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.
 
 
20

 
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 June 30,
   
Six months ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Revenue
    100.0 %     100.0 %     100.0 %     100.0 %
Cost of revenue
    48.6 %     41.8 %     49.2 %     41.7 %
                                 
Gross profit
    51.4 %     58.2 %     50.8 %     58.3 %
Operating expenses:
                               
Research and development
    21.8 %     21.1 %     22.2 %     21.5 %
Selling, general and administrative
    20.0 %     20.9 %     20.6 %     20.8 %
Litigation expense
    1.8 %     4.0 %     1.8 %     3.6 %
                                 
Total operating expenses
    43.6 %     46.0 %     44.6 %     45.9 %
                                 
Income from operations
    7.8 %     12.2 %     6.2 %     12.4 %
Other income (expense):
                               
Interest and other income
    0.3 %     0.6 %     0.4 %     0.6 %
Interest and other expense
    (0.2 %)     (0.0 %)     (0.2 %)     (0.0 %)
                                 
Total other income, net
    0.1 %     0.6 %     0.2 %     0.6 %
                                 
Income before income taxes
    7.9 %     12.8 %     6.4 %     13.0 %
Income tax provision
    1.2 %     1.3 %     0.8 %     1.0 %
                                 
Net income
    6.7 %     11.5 %     5.6 %     12.0 %

Revenue.
 
             
    For the three months ended June 30,           For the six months ended June 30,        
   
2011
   
2010
         
2011
   
2010
       
   
(in thousands)
    Change    
(in thousands)
      Change  
Revenue
  $ 51,628     $ 55,690       (7.3 )%   $ 96,096     $ 105,940       (9.3 )%
 
Revenue for the three months ended June 30, 2011 was $51.6 million, a decrease of $4.1 million, or 7.3%, from $55.7 million for the three months ended June 30, 2010. Revenue for the six months ended June 30, 2011 was $96.1 million, a decrease of $9.8 million, or 9.3%, from $105.9 million for the six months ended June 30, 2010. For the quarter and six months ended June 30, 2011, the decrease in revenue over the same periods last year 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. Audio sales were down for the three and six months ended June 30, 2011 over the same periods in 2010 due to a change in product mix and a decline in the average selling price for certain of our audio products. The sales of our lighting control products remained flat for the quarter ended June 30, 2011 over the quarter ended June 30, 2010. For the six months ended June 30, 2011, the sales of our lighting control products decreased over the same period in 2010 because of a reduction in the demand for our CCFL products, which was partially offset by increased sales of our WLED products. The following table illustrates changes in our revenue by product family:
 
 
For the three months ended June 30,
         
For the six months ended June 30,
       
 
2011
   
2010
         
2011
   
2010
       
 
(in thousands)
   
% of
   
(in thousands)
   
% of
         
(in thousands)
   
% of
   
(in thousands)
   
% of
       
  Amount    
Revenue
    Amount    
Revenue
    Change     Amount    
Revenue
    Amount    
Revenue
    Change  
DC to DC Converters
$ 42,786       82.9 %   $ 45,551       81.8 %     (6.1 )%   $ 79,879       83.1 %   $ 85,852       81.0 %     (7.0 )%
Lighting Control Products
  6,857       13.3 %     7,510       13.5 %     (8.7 )%     12,745       13.3 %     14,944       14.1 %     (14.7 )%
Audio Amplifiers
  1,985       3.8 %     2,629       4.7 %     (24.5 )%     3,472       3.6 %     5,144       4.9 %     (32.5 )%
                                                                               
  $ 51,628       100.0 %   $ 55,690       100.0 %     (7.3 )%   $ 96,096       100.0 %   $ 105,940       100.0 %     (9.3 )%
 
Gross Profit.  Gross profit as a percentage of revenue, or gross margin, was 51.4% for the three months ended June 30, 2011and 58.2% for the three months ended June 30, 2010. Gross profit as a percentage of revenue, or gross margin, was 50.8% for the six months ended June 30, 2011 and 58.3% for the six months ended June 30, 2010. For the three and six months ended June 30, 2011, gross margin declined year-over-year as a result of declining average selling prices for certain of our products, changes in product mix, an increase in inventory reserves and higher product costs.
 
 
21

 
Research and Development.
 
    For the three months ended June 30,         For the six months ended June 30,      
   
2011
 
2010
       
2011
 
2010
     
   
(in thousands)
  Change    
(in thousands)
  Change  
Revenue
  $ 51,628     $ 55,690       (7.3 )%   $ 96,096     $ 105,940       (9.3 )%
Research and development (“R&D”) (including stock-based compensation of $1,550 and $1,995 for the three months ended June 30, 2011 and 2010, respectively, and $2,977 and $3,730 for the six months ended June 30, 2011 and 2010, respectively)
    11,237       11,785       (4.6 )%     21,323       22,825       (6.6 )%
                                                 
R&D as a percentage of revenue
    21.8 %     21.2 %             22.2 %     21.5 %        
 
R&D expenses were $11.2 million, or 21.8% of revenue, for the three months ended June 30, 2011 and $11.8 million, or 21.2% of revenue, for the three months ended June 30, 2010. R&D expenses were $21.3 million, or 22.2% of revenue, for the six months ended June 30, 2011 and $22.8 million, or 21.5% of revenue, for the six months ended June 30, 2010. For the three and six months ended June 30, 2011, R&D expenses decreased year-over-year due to lower variable compensation and stock-based compensation expenses.
 
Selling, General and Administrative.
 
   
For the three months ended June 30,
         
For the six months ended June 30,
       
   
2011
   
2010
         
2011
   
2010
       
   
(in thousands)
    Change    
(in thousands)
    Change  
Revenue
  $ 51,628     $ 55,690       (7.3 )%   $ 96,096     $ 105,940       (9.3 )%
Selling, general and administrative (“SG&A”) (including stock-based compensation of $2,036 and $3,428 for the three months ended June 30, 2011 and 2010, respectively, and $3,533 and $5,638 for the six months ended June 30, 2011 and 2010, respectively)
    10,343       11,615       (11.0 )%     19,833       22,008       (9.9 )%
                                                 
SG&A as a percentage of revenue
    20.0 %     20.9 %             20.6 %     20.8 %        
 
SG&A expenses were $10.3 million, or 20.0% of revenue, for the three months ended June 30, 2011 and $11.6 million, or 20.9% of revenue, for the three months ended June 30, 2010. SG&A expenses were $19.8 million, or 20.6% of revenue, for the six months ended June 30, 2011 and $22.0 million, or 20.8% of revenue, for the six months ended June 30, 2010. For the three and six months ended June 30, 2011, SG&A expenses decreased year over year due to lower stock-based compensation expenses, variable compensation expenses and rep commissions. These were partially offset by an increase in salary and wages and an increase in professional service fees.
 
Litigation Expense.
 
             
   
For the three months ended June 30,
         
For the six months ended June 30,
       
   
2011
   
2010
         
2011
   
2010
       
   
(in thousands)
    Change    
(in thousands)
    Change  
Revenue
  $ 51,628     $ 55,690       (7.3 )%   $ 96,096     $ 105,940       (9.3 )%
Litigation expense
    939       2,228       (57.9 )%     1,752       3,795       (53.8 )%
                                                 
Litigation expense as a percentage of revenue
    1.8 %     4.0 %             1.8 %     3.6 %        

Litigation expenses were $0.9 million, or 1.8% of revenue, for the three months ended June 30, 2011, compared to $2.2 million, or 4.0% of revenue, for the three months ended June 30, 2010. Litigation expenses were $1.8 million, or 1.8% of revenue, for the six months ended June 30, 2011, compared to $3.8 million, or 3.6% of revenue, for the six months ended June 30, 2010. During the three and six months ended June 30, 2011, we incurred legal expenses primarily to recover attorneys’ fees from O2Micro relating to our lawsuits involving O2Micro, which were resolved in the second quarter of 2010. During the three and six months ended June 30, 2010, we incurred legal expenses primarily for the defense of those lawsuits.
 
Income Tax Provision.  The income tax provision for the three and six months ended June 30, 2011 was $0.6 million or 14.3% of our income before income taxes and $0.8 million or 12.8% of the pre-tax income, respectively. 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 restricted units released. The income tax provision for the three and six months ended June 30, 2010 was $0.7 million or 10.3% of our income before income taxes and $1.0 million or 7.4% 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 and because of the benefit that we realized as a result of stock option exercises and restricted stock units released.
 
 
22

 

Liquidity and Capital Resources.

As of June 30, 2011, we had working capital of $176.8 million, including cash and cash equivalents of $97.7 million and short-term investments of $65.6 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 six months ended June 30, 2011, net cash provided by operating activities was $21.5 million, primarily due to strong operating results and an increase in accounts payable for inventory purchases. For the six months ended June 30, 2010, net cash provided by operating activities was $22.8 million, primarily due to strong operating results and a reduction in inventory during the first half 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 received.
 
For the six months ended June 30, 2011, net cash provided by investing activities was $60.6 million, primarily related to the redemption of short-term investments to fund our stock repurchase program. For the six months ended June 30, 2010, net cash used in investing activities was $34.7 million, primarily related to the purchase of short-term investments and equipment purchases for our Chengdu facility.
 
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.
 
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 June 30, 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 36 years. Although it is unclear as to when these investments will regain their liquidity, management has concluded that as of June 30, 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.
 
 
23

 
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 127%, 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, March 31, 2011 and June 30, 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
June 30, 2011
Time-to-Liquidity
24 months
24 months
24 months
Expected Return (Based on the requisite treasury rate, plus a contractual penalty rate)
2.9%
3.3%
2.5%
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
3.8% - 8.6%, depending on the credit-rating of the security
 
From the first quarter of 2011 to the second quarter of 2011, we kept the time-to-liquidity constant at 2.0 years. In addition, the FFELPs student-loan spread remained constant and the spread between the expected return and labor forwards changed very little. As a result, there was no change in the impairment of $0.8 million from the first quarter to the second quarter of 2011.
 
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 six months ended June 30, 2011 was $32.8 million, primarily from stock repurchases in the amount of $38.5 million, which was partially offset by the proceeds from the exercise of stock options in the amount of $4.3 million and proceeds from the employee stock purchase plan of $0.9 million. Net cash provided by financing activities for the six months ended June 30, 2010 was $14.2 million, primarily for the issuance of common stock in the amount of $11.8 million.
 
 
24

 
 
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  
 April
    917,200     $ 14.82     $ 13,617  
 May
    657,800     $ 16.48     $ 10,843  
 June
    18,000     $ 16.79     $ 302  
      2,485,500             $ 38,472  
 
From August 2010 through June 2011, the Company repurchased 4,385,289 shares for a total of $70.0 million.

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.
 
On July 8, 2011, we entered into a Standard Offer, Agreement and Escrow Instruction for Purchase of Real Estate ("the Agreement") with Pepper Land-Great Oaks, LLC, a California limited liability company ("Pepper Land") to purchase the property located at 79 Great Oaks Boulevard in San Jose, CA to be used as our new headquarters and sales offices. Such property consists of an approximately 106,262 square foot office building and approximately 5.5 acres of land. The purchase price for the property is $11,000,000, which was funded on August 4, 2011 and for which the deed was recorded on August 5, 2011. The purchase amount was paid with cash from operations.
 
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 for this payment, which is our best estimate at this time.

We also lease our sales offices in Japan, China, Taiwan and Korea.
 
As of June 30, 2011, our total outstanding purchase commitments with vendors were $6.9 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.
 
As of June 30, 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.
 
 
25

 
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 and six months ended June 30, 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 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. These proceedings often 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.   
 
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.

 
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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;
 
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;
 
 
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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 half 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.
 
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 and second quarters of 2011, our gross margin decreased materially as compared to the same periods in 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.
 
 
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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 June 30, 2011, approximately 91% 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.
 
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.
 
 
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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 June 30, 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 half 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.

We currently depend on two third-party suppliers to provide us with wafers for our products. If either 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.

 
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