Monolithic Power Systems, Inc.
MONOLITHIC POWER SYSTEMS INC (Form: 10-K, Received: 03/12/2012 06:34:31)

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-K

(Mark One)
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2011
 
or
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission file number: 000-51026
 

 
Monolithic Power Systems, Inc.
(Exact name of registrant as specified in its charter)
 

   
Delaware
77-0466789
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
 
6409 Guadalupe Mines Road, San Jose, CA 95120 (408) 826-0600
(Address of principal executive offices, including zip code and telephone number)

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

Title of each class
Name of each exchange on which registered
Common Stock, $0.001 Par Value
The NASDAQ Global Select Market

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


 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933. £   Yes   x  No
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”). £   Yes   x No
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x      No   £
 
Indicate by check mark 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   x    No   £

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x
 
 
1

 
 
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   £          Accelerated filer   x          Non-accelerated filer   £           Smaller reporting company   £
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). £   Yes    x  No
 
The number of shares of the registrant’s stock outstanding as of June 30, 2011 was 33,466,052.  The closing price of the registrant’s common stock on the Nasdaq Global Select Market as of June 30, 2011 was $15.42.  The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant based upon the closing price of the Common Stock on the Nasdaq Global Select Market on June 30, 2011 was $351,889,196.*
 
There were 34,185,705 shares of the registrant’s common stock issued and outstanding as of February 22, 2012.
 


DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the registrant’s Proxy Statement for the registrant’s 2011 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K to the extent stated herein.  The Proxy Statement will be filed within 120 days of the registrant’s fiscal year ended December 31, 2011.  

 
*
Excludes 10,645,741 shares of the registrant’s common stock held by executive officers, directors and stockholders whose ownership exceeds 5% (“affiliates”) of the Common Stock outstanding at June 30, 2011.  Exclusion of such shares should not be construed to indicate that any such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the registrant or that such person is controlled by or under common control with the registrant.
 
 
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MONOLITHIC POWER SYSTEMS, INC.
TABLE OF CONTENTS
 
   
Page
     
 
PART I
 
Item 1.
Business
5
 
Executive Officers of the Registrant
10
Item 1A
Risk Factors
10
Item 1B
Unresolved Staff Comments
22
Item 2.
Properties
22
Item 3.
Legal Proceedings
22
Item 4.
Mine Safety Disclosures
23
     
 
PART II
 
Item 5.
Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
23
Item 6.
Selected Financial Data
24
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
25
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
36
Item 8.
Financial Statements and Supplementary Data
37
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
68
Item 9A.
Controls and Procedures
68
Item 9B.
Other Information
69
     
 
PART III
 
Item 10.
Directors, Executive Officers and Corporate Governance
69
Item 11.
Executive Compensation
69
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
69
Item 13.
Certain Relationships and Related Transactions, and Director Independence
69
Item 14.
Principal Accounting Fees and Services
69
     
 
PART IV
 
Item 15.
Exhibits, Financial Statement Schedules
70
 
Signatures
74

Except as the context otherwise requires, the terms “Monolithic Power Systems”, “MPS”, “Registrant”, “Company”, “we”, “us”, or “our” as used herein are references to Monolithic Power Systems, Inc. and its consolidated subsidiaries.
 
 
3

 

FORWARD-LOOKING STATEMENTS
 
This annual report on Form 10-K and the documents incorporated herein by reference contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that have been made pursuant to and in reliance on the provisions of the Private Securities Litigation Reform Act of 1995. These statements include among other things, statements concerning:
 
 
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 intention to exercise our purchase option with respect to our manufacturing facility in Chengdu, China.
 
 
our belief that we will incur significant legal expenses that vary with the level of activity in any of our future 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 2012 ,
 
 
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.

In some cases, words such as “would,” “could,” “may,” “should,” “predict,” “potential,” “targets,” “continue,” “anticipate,” “expect,” “intend,” “plan,” “believe,” “seek,” “estimate,” “project,” “forecast,” “will,” the negative of these terms or other variations of such terms and similar expressions relating to the future identify forward-looking statements.

All forward-looking statements are based on our current outlook, expectations, estimates, projections, beliefs and plans or objectives about our business and our industry. These statements are not guarantees of future performance and are subject to risks and uncertainties. Actual events or results could differ materially and adversely from those expressed in any such forward-looking statements.
 
Risks and uncertainties that could cause actual results to differ materially include those set forth throughout this annual report on Form 10-K and, in particular, in the section entitled “Item 1A. Risk Factors”.
 
Except as required by law, we disclaim any duty to and undertake no obligation to update any forward-looking statements, whether as a result of new information relating to existing conditions, future events or otherwise or to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Readers are cautioned not to place undue reliance on such statements, which speak only as of the date of this annual report on Form 10-K. Readers should carefully review future reports and documents that we file from time to time with the Securities and Exchange Commission, such as our quarterly reports on Form 10-Q and any current reports on Form 8-K.
 
 
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PART I
 
ITEM 1.    BUSINESS
 
General
 
Monolithic Power Systems is a fabless semiconductor company that designs, develops and markets proprietary, advanced analog and mixed-signal semiconductors. We combine advanced process technology with our highly experienced analog designers to produce high-performance power management integrated circuits (ICs) for DC to DC converters, LED drivers, Cold Cathode Fluorescent Lamp (CCFL) backlight controllers, Class-D audio amplifiers, and other Linear ICs. Our products are used extensively in computing and network communications products, flat panel TVs, set top boxes and a wide variety of consumer and portable electronics products. We partner with world-class manufacturing organizations to deliver top quality, ultra-compact, high-performance solutions through productive, cost-efficient channels. Founded in 1997 and headquartered in San Jose, California, we have expanded our global presence with offices in Taiwan, China, Korea, Japan, and Europe, which operate under MPS International, Ltd.
 
Industry Overview
 
Semiconductors comprise the basic building blocks of electronic systems and equipment. Within the semiconductor industry, components can be classified either as discrete devices, such as individual transistors, or as ICs, in which a number of transistors and other elements are combined to form a more complicated electronic circuit. ICs can be further divided into three primary categories: digital, analog, and mixed-signal. Digital ICs, such as memory devices and microprocessors, can store or perform arithmetic functions on data that is represented by a series of ones and zeroes. Analog ICs, in contrast, handle real world signals such as temperature, pressure, light, sound, or speed. In addition, analog ICs also perform power management functions, such as regulating or converting voltages, for electronic devices. Mixed-signal ICs combine digital and analog functions onto a single chip and play an important role in bridging real world phenomena to digital systems.
 
Analog and Mixed-Signal Markets.    We focus on the market for ‘high performance’ analog and mixed-signal ICs. ‘High performance’ products generally are differentiated by functionality and performance factors which include integration of higher levels of functionality onto a single chip, greater precision, higher speed and lower heat and noise. There are several key factors that distinguish analog and mixed-signal IC markets from digital IC markets and in particular the high performance portion of the analog and mixed signal IC market. These factors include longer product life cycles,   numerous market segments, technology   that is difficult to replicate, relative complexity of design and process technology, importance of experienced design engineers, lower capital requirements and diversity of end markets.  We have, however, targeted product and market areas that we believe have the ability to offer above average industry growth over the long term.
 
Products and Applications
 
We currently have three primary product families that address multiple applications within the computing, consumer electronics, communications, and industrial/automotive markets. Our products are differentiated with respect to their high degree of integration and strong levels of accuracy and efficiency, making them cost-effective relative to many competing solutions. These product families include:
 
Direct Current (DC) to DC Converters. DC to DC converter ICs are used to convert and control voltages within a broad range of electronic systems, such as portable electronic devices, wireless LAN access points, computers, set top boxes, TVs and monitors, automobiles and medical equipment. We believe that our DC to DC converters are differentiated in the market, particularly with respect to their high degree of integration, high voltage operation, high load current, high switching speed and small footprint. These features are important to our customers as they result in fewer components, a smaller form factor, more accurate regulation of voltages, and, ultimately, lower system cost and increased reliability through the elimination of many discrete components and power devices.

Lighting Control Products and AC/DC Offline Solutions.    Lighting control ICs are used in backlighting and general illumination products. Lighting control ICs for backlighting are used in systems that provide the light source for LCD panels typically found in notebook computers, LCD monitors, car navigational systems, and LCD televisions. Backlighting solutions are typically either white light emitting diode (“WLED”) lighting sources or cold cathode fluorescent lamps (CCFL). WLED lighting control ICs step-up or step-down a DC voltage, or convert from an AC line voltage supplied by the utility company (also called AC/DC Offline) and provide efficient precision power and protection to a LED string or to multiple LED strings. The CCFL ICs function by converting low-voltage direct current (DC) or battery voltage to high-voltage alternating current (AC). We believe our CCFL ICs were the first to utilize a full bridge resonant topology that allows for high efficiency, extended lifetimes for cold cathode fluorescent lamps (CCFLs), and lower signal interference with adjacent components. The full bridge topology is now the industry standard for these products.

In addition to AC/DC offline solutions for lighting illumination applications, MPS also offers AC/DC power conversion solutions for a diverse number of end products that plug into a wall outlet.
 
 
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Audio Amplifiers.    Audio amplifier ICs are used to amplify sound produced by audio processors. We currently offer Class-D audio amplifiers, which are well-suited for applications that require both a small form factor and high power efficiency, such as plasma televisions, LCD televisions and DVD players. With today’s systems becoming smaller and utilizing larger amounts of power, solution sizes and the management of heat dissipation are becoming increasingly important to the overall system design. The high degree of power efficiency and small form factor provided by our Class-D audio amplifiers allows system vendors to significantly reduce heat dissipation, eliminating the costly and sizable fans and heat sinks traditionally required by audio amplifier ICs. These features enable our customers to achieve their design and cost objectives without sacrificing sound quality.  
 
We currently target our products at the consumer electronics, communications and computing markets, with the consumer market representing the largest portion of our revenue.
 
The following is a brief summary of our product family solutions for various applications. For each of these applications, we are currently shipping product or have design wins, which are decisions by original equipment manufacturers, or OEMs, or original design manufacturers, or ODMs, to use our ICs:
 
Application
WLED Lighting Illumination (non-backlight)
LCD Backlight (Inverters or WLED)
DC to DC Converters
(Buck & Boost)
µP Reset & Supervisory
Audio Amplifiers
AC/DC Offline
Chargers
(Switching & Linear)
Current Limit Switches
Computing
               
Computers and PDA devices
 
X
X
X
X
X
X
X
LCD Monitors
 
X
X
X
X
     
Disk Drives/ Storage Networks
   
X
       
X
Consumer Electronics
               
LCD TV Displays
 
X
X
X
X
   
X
Plasma TV Displays
 
X
X
X
X
   
X
Set Top Boxes
   
X
X
X
X
 
X
Blu-Ray & DVD Players
 
X
X
X
X
     
Digital Still Cameras
   
X
X
X
 
X
 
Commercial & Industrial Bulb & CFL Replacement
X
       
X
   
GPS and Infotainment systems
 
X
X
X
X
   
X
Communications                
Cellular Handsets
   
X
 
X
X
X
 
Networking Infrastructure
   
X
X
 
X
   
VOIP
   
X
X
       
Wireless Access Points
   
X
X
       

We derive a majority of our revenue from the sales of our DC to DC converter IC product family to the computing, consumer electronics and communications markets.  In the future, we will continue to introduce additional new products within our existing product families, such as high current, high voltage, small form factor switching voltage regulators, as well as expand our newer product families in battery chargers, voltage references and low dropout regulators. Our ability to achieve revenue growth will depend in part upon our ability to enter new market segments, gain market share, grow in regions outside of Greater China, expand our customer base and successfully secure manufacturing capacity.

Please refer to the table showing our revenue by product family in the section entitled “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations”.
 
 
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Customers, Sales, and Marketing
 
We sell our products through third party distributors, value-added resellers and directly to OEMs, ODMs, and electronic manufacturing service (EMS) providers. Our third party distributors are subject to distribution agreements with us which allow the distributor to sell our products to end customers and other resellers.  Distributors may distribute our products to end customers which include OEMs, ODMs or EMS providers.  Our value-added resellers may second source our products and provide other services to customers. ODMs typically design and manufacture electronic products on behalf of OEMs, and EMS providers typically provide manufacturing services for OEMs and other electronic product suppliers. The following is a summary for the years ended December 31, 2011, 2010 and 2009 of those customers that accounted for more than 10% of our total revenue in one or more of these years:
 
   
Revenue
 
   
Year ended December 31,
 
Customers
 
2011
   
2010
   
2009
 
                   
A
    17 %     14 %     13 %
B
    10 %     *       10 %
C
    *       *       10 %
D
    *       *       *  
 
 
*
Represents less than 10%
 
Current distribution agreements with several of our major distributors provide that each distributor shall have the non-exclusive right to sell and use its best efforts to promote and develop a market for our products in several countries in Asia. These agreements may be terminated by either us or the distributor on up to three months’ notice.  These agreements provide that payment for purchases from us will generally occur within 30 to 45 days from the date of invoice.  In addition, we allow for limited stock rotation in certain agreements.
 
We have sales offices located in the United States, Taiwan, China, Korea, Singapore and Japan and have marketing representatives in Europe. Our products typically require a highly technical sales and applications engineering effort where we assist our customers in the design and use of our products in their application.  We maintain a staff of applications engineers who work directly with our customers’ engineers in the development of their systems electronics containing our products.
 
Because our sales are billed and payable in United States dollars, our sales are not directly subject to fluctuating currency exchange rates. However, because 90% of our revenue in 2011 was attributable to direct or indirect sales to customers in Asia, changes in the relative value of the dollar may create pricing pressures for our products.
 
Our sales are made primarily pursuant to standard individual purchase orders. Our backlog consists of orders that we have received from customers which have not yet shipped. Our manufacturing lead times are generally 4 to 12 weeks and we often build inventory in advance of customer orders based on our forecast of future customer orders. This subjects us to certain risks, most notably the possibility that sales will not meet our forecast, which could lead to inventories in excess of demand. If excess inventory exists, it may be necessary for us to sell it at a substantial discount or dispose of it altogether, either of which would negatively affect our profit margins.

We operate in the cyclical semiconductor industry where there is seasonal demand for certain of our products. While we are not and will not be immune from current and future industry downturns, we have targeted product and market areas that we believe have the ability to offer above average industry performance over the long term.
  
Research and Development
 
We have assembled a qualified team of engineers in the United States, China and Europe with core competencies in analog and mixed-signal design. Through our research and development efforts, we have developed a collection of intellectual property and know-how that we are able to leverage across our products and markets. These include the development of high efficiency power devices, the design of precision analog circuits, expertise in mixed-signal integration and the development of proprietary semiconductor process technologies.
 
Our research and development efforts are generally targeted at three areas: systems architecture, circuit design and implementation, and process technology. In the area of systems architecture, we are exploring new ways of solving our customers’ system design challenges and are investing in the development of systems expertise in new markets and applications that align well with our core capabilities. In the area of circuit design and implementation, our initiatives include expanding our portfolio of products and adding new features to our products.

Please refer to the discussion of the amount spent on research and development during each of the last three fiscal years in the section entitled “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Research and Development”. In the area of process technology, we are investing research and development resources to provide leading-edge analog power processes for our next generation of integrated circuits. Process technology is a key strategic component to our future growth.
 
 
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Patents and Intellectual Property Matters
 
We rely on our proprietary technologies, which include both our proprietary circuit designs for our products and our proprietary manufacturing process technologies. Our future success and competitive position depend in part upon our ability to obtain and maintain protection of our proprietary technologies.
 
In general, we have elected to pursue patent protection for aspects of our circuit designs that we believe are patentable and to protect our manufacturing process technologies by maintaining those process technologies as trade secrets. As of January 9, 2012 we had approximately 646 patents issued and pending, of which 101 have been issued in the United States. Our U.S. issued patents are scheduled to expire at various times through December 2030 and our other issued patents are scheduled to expire at various times through September 2029. Our patents are material to our business, but we do not rely on any one particular patent for our success. We also rely on a combination of nondisclosure agreements and other contractual provisions, as well as our employees’ commitment to confidentiality and loyalty, to protect our technology, know-how, and processes. In April 2008, we entered into a patent license agreement with another integrated circuit company, which is a value-added reseller, pursuant to which we have granted this company a license (with certain limited sublicense rights) under certain of our patents to make, use, and sell certain of this company’s own integrated circuit products for a period of two years , with an automatic renewal for successive one year periods, unless either party terminates, and for which this company is obligated to pay us royalties based on sales of those products. We also seek to register certain of our trademarks as we deem appropriate. We have not registered any of our copyrights and do not believe registration of copyrights is material to our business. Despite precautions that we take, it may be possible for unauthorized third parties to copy aspects of our current or future technology or products or to obtain and use information that we regard as proprietary. There can be no assurance that the steps we take will be adequate to protect our proprietary rights, that our patent applications will lead to issued patents, that others will not develop or patent similar or superior products or technologies, or that our patents will not be challenged, invalidated, or circumvented by others. Furthermore, the laws of the countries in which our products are or may be developed, manufactured or sold may not protect our products and intellectual property rights to the same extent as laws in the United States. Our failure to adequately protect our proprietary technologies could harm our business.
 
The semiconductor industry is characterized by frequent claims of infringement and litigation regarding patent and other intellectual property rights. For a more complete description of our legal matters, please read the section entitled Item 3. Legal Proceedings and Note 10 to our consolidated financial statements. Patent infringement is an ongoing risk, in part because other companies in our industry could have patent rights that may not be identifiable when we initiate development efforts. Litigation may be necessary to enforce our intellectual property rights, and we may have to defend ourselves against infringement claims. Any such litigation could be very costly and may divert our management resources. Further, we have agreed to indemnify certain of our customers and a supplier in some circumstances against liability from infringement by our products. In the event any third party were to make an infringement claim against us or our customers, we could be enjoined from selling selected products or could be required to indemnify our customers or supplier or pay royalties or other damages to third parties. If any of our products is found to infringe and we are unable to obtain necessary licenses or other rights on acceptable terms, we would either have to change our product so that it does not infringe or stop making the infringing product, which could have a material adverse effect on our operating results, financial condition, and cash flows.
 
Manufacturing
 
We utilize a fabless business model, working with third parties to manufacture and assemble our integrated circuits. This fabless approach allows us to focus our engineering and design resources on our strengths and to reduce our fixed costs and capital expenditures. In contrast to many fabless semiconductor companies, who utilize standard process technologies and design rules established by their foundry partners, we have developed our own proprietary process technology and collaborate with our foundry partners to install our technology on their equipment in their facilities for use solely on our behalf. This close collaboration and control over the manufacturing process has historically resulted in favorable yields and product performance for our integrated circuits.
 
We currently contract with three suppliers to manufacture our wafers in foundries located in China. Once our silicon wafers have been produced, they are shipped to our facility in Chengdu, China for wafer sort. Our semiconductor products are then assembled and packaged by independent subcontractors in Malaysia and China. The assembled ICs are then sent for final testing at our Chengdu facility prior to shipping to our customers.
 
In September 2004, we signed an agreement with a Chinese local authority to construct a facility in Chengdu, China, initially for the testing of our ICs. Pursuant to this agreement, we agreed to contribute capital in the form of cash, in-kind assets, and/or intellectual property, of at least $5.0 million to our wholly-owned Chinese subsidiary as the registered capital for the subsidiary and have exercised the option to purchase land use rights for the facility for approximately $0.2 million. We also have the option, which became exercisable in March 2011, to acquire the facility after a five-year lease term for the original construction cost less rents paid, which is currently estimated at $1.9 million. We will likely exercise our purchase option and enter into a purchase agreement for this facility in the future. The facility has been fully operational since 2006 and we have benefitted from shorter manufacturing cycle times and lower labor and overhead costs. Furthermore, we are continuing to expand our product testing capabilities in our China facility and are able to take advantage of the rich pool of local engineering talent to expand our manufacturing support and engineering operations.
 
 
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Key Personnel and Employees
 
Our performance is substantially dependent on the performance of our executive officers and key employees. Due to the relative complexity of the design of our analog and mixed-signal ICs, our engineers generally have more years of experience and greater circuit design aptitude than the more prevalent digital circuit design engineer.  Analog engineers with advanced skills are limited in number and difficult to replace. The loss of the services of key officers, managers, engineers and other technical personnel would harm our business. Our future success will depend, in part, on our ability to attract, train, retain, and motivate highly qualified technical and managerial personnel.  We may not be successful in attracting and retaining such personnel. Our employees are not represented by a collective bargaining organization, and we have never experienced a work stoppage or strike. Our management considers employee relations to be good. As of December 31, 2011, we employed 922 employees located in the United States, Taiwan, China, Japan, Korea, Europe and Singapore.
 
Competition
 
The analog and mixed-signal semiconductor industry is highly competitive, and we expect competitive pressures to continue. Our ability to compete effectively and to expand our business will depend on our ability to continue to recruit both applications engineering and design engineering personnel, our ability to introduce new products, and our ability to maintain the rate at which we introduce these new products. Our industry is characterized by decreasing unit selling prices over the life of a product. We compete with domestic and international semiconductor companies, many of which have substantially greater financial and other resources with which to pursue engineering, manufacturing, marketing, and distribution of their products. We are in direct and active competition, with respect to one or more of our product lines, with at least 10 manufacturers of such products, of varying size and financial strength. The number of our competitors has grown due to expansion of the market segments in which we participate. We consider our primary competitors to include Analog Devices, Fairchild Semiconductor International, International Rectifier, Intersil Corporation, Linear Technology, Maxim Integrated Products, Micrel Inc., Microchip Technology, Microsemi Corporation, O2Micro International, ON Semiconductor, Richtek Technology Corporation, Rohm Co., Ltd., Semtech Corporation, STMicroelectronics N.V., Texas Instruments Incorporated and Volterra.
 
We expect continued competition from existing competitors as well as competition from new entrants into the semiconductor market. We believe that we are competitive with respect to these factors, particularly because our ICs typically are smaller in size, are highly integrated, possess higher levels of power management functionalities and achieve high performance specifications at lower price points than most of our competition. However, we cannot assure you that our products will continue to compete favorably or that we will be successful in the face of increasing competition from new products and enhancements introduced by existing competitors or new companies entering this market.

Geographical and Segment Information

Please refer to the geographical and segment information for each of the last three fiscal years in Note 13 to our consolidated financial statements.

Please refer to the discussion of risks attendant to our foreign operations in the section entitled “Item 1A: Risk Factors”.

Available Information
 
We were incorporated in California in 1997 and reincorporated in Delaware in November 2004. Our executive offices are located at 6409 Guadalupe Mines Road, San Jose, CA 95120. Our telephone number is (408) 826-0600. Our e-mail address is investors@monolithicpower.com, and our website is www.monolithicpower.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those filed or furnished pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge. These may be obtained from our website, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission, or at the SEC website at www.sec.gov. Information contained on our website is not a part of this Form 10-K.
 
9

 
 
Executive Officers of the Registrant
 
The executive officers of the Company, and their ages as of March 12, 2012 are as follows:
 
Name
Age
Position
Michael R. Hsing
52
President, Chief Executive Officer, and Director
Meera P. Rao
51
CFO and Principal Financial and Accounting Officer
Deming Xiao
49
President of MPS Asia Operations
Maurice Sciammas
52
Senior Vice President of Worldwide Sales and Marketing
Paul Ueunten
57
Senior Vice President of Engineering
Saria Tseng
41
Vice President, Strategic Corporate Development, General Counsel and Corporate Secretary

Michael R. Hsing has served on our board of directors and has served as our President and Chief Executive Officer since founding Monolithic Power Systems in August 1997. Before founding our company, Mr. Hsing held senior technical positions at companies such as Supertex, Inc. and Micrel, Inc. Mr. Hsing is an inventor on numerous patents related to the process development of bipolar mixed-signal semiconductor manufacturing. Mr. Hsing holds a B.S.E.E. from the University of Florida.

Meera P. Rao has served as our Chief Financial Officer since January 2011. Ms. Rao joined us in January 2009 and served as our Vice President of Finance and Corporate Controller. Prior to joining MPS, she was the principal in her own consulting practice, working with various semiconductor companies, including MPS, where she set up our business operations in Chengdu, China in 2006.  Ms. Rao has more than 20 years of experience with semiconductor and high technology companies and has held various senior executive positions, including the CFO of Integration Associates, Vice President of Finance and Interim CFO at Atrica, Vice President of Finance at Raza Foundries, Corporate Controller and Interim CFO at nVIDIA, as well as various positions at Advanced Micro Devices (AMD).  Ms. Rao is a CPA and holds an MBA from the University of Rochester.

Maurice Sciammas currently serves as our Senior Vice President of Worldwide Sales and Marketing, a position he has had since 2007. Mr. Sciammas joined the Company in July 1999 and served as Vice President of Products and Vice President of Sales (excluding greater China) until he was appointed to his current position.  Before joining the Company, he was Director of IC Products at Supertex from 1990 to 1999. He has also held positions at Micrel, Inc. He holds a B.S.E.E. degree from San Jose State University.

Deming Xiao has served as our President of our Asia Operations since January 2008. Since joining us in May 2001, Mr. Xiao has held several executive positions, including Foundry Manager and Senior Vice President of Operations. Before joining us, from June 2000 to May 2001, Mr. Xiao was Engineering Account Manager at Chartered Semiconductor Manufacturing, Inc. Prior to that, Mr. Xiao spent 6 years as the Manager of Process Integration Engineering at Fairchild Imaging Sensors. Mr. Xiao holds a B.S. in Semiconductor Physics from Sichuan University, Chengdu, China and a M.S.E.E. from Wayne State University.
 
Paul Ueunten has served as our Senior Vice President of Design Engineering since October 2007.  Mr. Ueunten joined us in May 1998 and held several senior level positions, including Vice President of Design Engineering, prior to his appointment as our Senior Vice President of Design Engineering.  Before joining us, Mr. Ueunten held positions at National Semiconductor, Signetics Corporation and Sperry Flight Systems. Mr. Ueunten holds a MS in Electrical Engineering from the University of Santa Clara, a BS in Electrical Engineering from the University of Washington and a BS in Engineering-Physics from Pacific Lutheran University. Mr. Ueunten is credited with a number of patents and is a Member of the Institute of Electrical and Electronics Engineers.

Saria Tseng has served as our Vice President and General Counsel since November 2004. Ms. Tseng joined the Company from MaXXan Systems, Inc., a privately held provider of intelligent storage networking solutions, where she was also Vice President and General Counsel from January 2001 to November 2004. Prior to her corporate experience, Ms. Tseng was an attorney at Gray Cary Ware & Freidenrich, LLP from July 1999 to January 2001. Previously, she practiced law at Wang & Wang and Jones Day, Reavis & Pogue. Ms. Tseng is a member of the state bar in both California and New York and is a member of the bar association of the Republic of China (Taiwan). She holds Masters of Law degrees from Boalt Hall, University of California at Berkeley and the Chinese Culture University in Taipei.

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 annual report on Form 10-K 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 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 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;
 
 
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the cyclical nature of demand for our customers’ products;
 
 
an increase in stock rotation reserves;
 
 
our ability to manage our inventory levels, including the levels of inventory held by our distributors;
 
 
inventory levels and product obsolescence;
 
 
seasonality and variability in the computer, consumer electronics, and communications markets;
 
 
the availability of adequate manufacturing capacity from our outside suppliers;
 
 
increases in prices for finished wafers due to general capacity shortages;
 
 
the potential loss of future business resulting from current capacity issues;
 
 
changes in manufacturing yields;
 
 
movements in exchange rates, interest rates or tax rates; and
 
 
determining the probability of accounting charges associated with performance based equity awards granted to our employees.
 
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;
 
 
·
determining the probability and magnitude of stock compensation accounting charges; 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.
 
Due to product shortages early in 2010, several major customers in Korea sought alternative suppliers, which impacted our full year revenue in 2011 and may continue to impact our revenue in future periods. If we are unable to find alternative sources of revenue to offset this source of lost revenue, our profitability may be impacted, which could materially and adversely affect our stock price and results of operations.
 
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.
 
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 year ended December 31, 2011, our gross margin decreased materially as compared to the same period 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 may be unsuccessful in developing and selling new products or in penetrating new markets required to maintain or expand our business.
 
Our competitiveness and future success depend on our ability to design, develop, manufacture, assemble, test, market, and support new products and enhancements on a timely and cost-effective basis. A fundamental shift in technologies in any of our product markets could have a material adverse effect on our competitive position within these markets. Our failure to timely develop new technologies or to react quickly to changes in existing technologies could materially delay our development of new products, which could result in product obsolescence, decreased revenue, and/or a loss of market share to competitors.

As we develop new product lines, we must adapt to market conditions that are unfamiliar to us, such as competitors and distribution channels that are different from those we have known in the past. Some of our new product lines require us to re-equip our labs to test parameters we have not tested in the past. If we are unable to adapt rapidly to these new and additional conditions, we may not be able to successfully penetrate new markets.
 
The success of a new product depends on accurate forecasts of long-term market demand and future technological developments, as well as on a variety of specific implementation factors, including:
 
 
timely and efficient completion of process design and device structure improvements;
 
 
timely and efficient implementation of manufacturing, assembly, and test processes;
 
 
the ability to secure and effectively utilize fabrication capacity in different geometries;
 
 
product performance;
 
 
product availability;
 
 
the quality and reliability of the product; and
 
 
effective marketing, sales and service.
 
To the extent that we fail to timely introduce new products or to quickly penetrate new markets, our revenue and financial condition could be materially adversely affected.
 
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 year ended December 31, 2011, approximately 90% 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;
 
 
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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.
 
We are subject to anti-corruption laws in the jurisdictions in which we operate, including the U.S. Foreign Corrupt Practices Act, or the FCPA. Our failure to comply with these laws could result in penalties which could harm our reputation and have a material adverse effect on our business, results of operations and financial condition.
 
We are subject to the FCPA, which generally prohibits companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or keeping business and/or other benefits, along with various other anticorruption laws. Although we have implemented policies and procedures designed to ensure that we, our employees and other intermediaries comply with the FCPA and other anticorruption laws to which we are subject, there is no assurance that such policies or procedures will work effectively all of the time or protect us against liability under the FCPA or other laws for actions taken by our employees and other intermediaries with respect to our business or any businesses that we may acquire. We have significant operations in Asia, which places us in frequent contact with persons who may be considered “foreign officials” under the FCPA, resulting in an elevated risk of potential FCPA violations. If we are not in compliance with the FCPA and other laws governing the conduct of business with government entities (including local laws), we may be subject to criminal and civil penalties and other remedial measures, which could have an adverse impact on our business, financial condition, results of operations and liquidity. Any investigation of any potential violations of the FCPA or other anticorruption laws by U.S. or foreign authorities could harm our reputation and have an adverse impact on our business, financial condition and results of operations.
 
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 year ended December 31, 2011, sales to our largest two distributors accounted for approximately 27% 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.
 
 
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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 may be 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 full year revenue in 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 three third-party suppliers to provide us with wafers for our products. If any of our wafer suppliers become insolvent or capacity constrained and are unable and/or fail to provide us sufficient wafers at acceptable yields and at anticipated costs, our revenue and gross margin may decline or we may not be able to fulfill our customer orders.

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

While certain aspects of our relationship with these suppliers are contractual, many important aspects of this relationship depend on our suppliers’ continued cooperation and our management relationships. In addition, the fabrication of ICs is a highly complex and precise process. Problems in the fabrication process can cause a substantial percentage of wafers to be rejected or numerous ICs on each wafer to be non-functional. This could potentially reduce yields. The failure of our suppliers to supply us wafers at acceptable yields could prevent us from fulfilling our customer orders for our products and would likely cause a decline in our revenue.
 
Further, as is common in the semiconductor industry, our customers may reschedule or cancel orders on relatively short notice. Under our agreement with our suppliers, we have an option to order wafers based on a committed forecast that can cover a period of one to six months. If our customers cancel orders after we submit a committed forecast to our suppliers for the corresponding wafers, we may be required to purchase wafers that we may not be able to resell, which would adversely affect our operating results, financial condition, and cash flows.
 
We might not be able to deliver our products on a timely basis if our relationships with our assembly and test subcontractors are disrupted or terminated.
 
All of our products are assembled by third-party subcontractors and a portion of our testing is currently performed by third-party subcontractors. We do not have any long-term agreements with these subcontractors. As a result, we may not have direct control over product delivery schedules or product quality. Also, due to the amount of time typically required to qualify assembly and test subcontractors, we could experience delays in the shipment of our products if we were forced to find alternate third parties to assemble or test our products.  In addition, events such as the recent global economic crisis may materially impact our assembly supplier’s ability to operate. Any future product delivery delays or disruptions in our relationships with our subcontractors could have a material adverse effect on our operating results, financial condition, and cash flows.
 
 
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There may be unanticipated costs associated with adding to or supplementing our third-party supplier’s manufacturing capacity.
 
We anticipate that future growth of our business will require increased manufacturing capacity on the part of third-party supply foundries, assembly shops, or testing facilities for our products.  In order to facilitate such growth, we may need to enter into strategic transactions, investments and other activities. Such activities are subject to a number of risks, including:
 
 
§
the costs and expense associated with such activities;
 
 
§
the availability of modern foundries to be developed, acquired, leased or otherwise made available to us or our third-party suppliers on January 1;
 
 
§
the ability of foundries and our third-party suppliers to obtain the advanced equipment used in the production of our products;
 
 
§
delays in bringing new foundry operations online to meet increased product demand; and
 
 
§
unforeseen environmental, engineering or manufacturing qualification problems relating to existing or new foundry facilities.
 
These and other risks may affect the ultimate cost and timing of any expansion of our third-party supplier’s capacity.
 
We purchase inventory in advance based on expected demand for our products, and if demand is not as expected, we may have insufficient or excess inventory, which could adversely impact our financial position.
 
As a fabless semiconductor company, we purchase our inventory from a third party manufacturer in advance of selling our product. We place orders with our manufacturer based on existing and expected orders from our customers for particular products. While our contracts with our customers and distributors include lead time requirements and cancellation penalties that are designed to protect us from misalignment between customer orders and inventory levels, we must nonetheless make some predictions when we place orders with our manufacturer. In the event that our predictions are inaccurate due to unexpected increases in orders or unavailability of product within the time frame that is required, we may have insufficient inventory to meet our customer demands. In the event that we order products that we are unable to sell due to a decrease in orders, unexpected order cancellations, injunctions due to patent litigations, or product returns, we may have excess inventory which, if not sold, may need to be disposed of or would result in a decrease in our revenues in future periods as the excess inventory at our distributors is sold. If any of these situations were to arise, it could have a material impact on our business and financial position.
 
The outcome of currently ongoing and future examinations of our income tax returns by the IRS could have a material adverse effect on our results of operations.
 
We are subject to examination of our income tax returns by the IRS and other tax authorities.  Our U.S. Federal income tax returns for the years ended December 31, 2000 through December 31, 2007 are under examination by the IRS. In April 2011, we received from the IRS a Notice of Proposed Adjustment, or “NOPA”, relating to a cost-sharing agreement entered into by the Company and its international subsidiaries on January 1, 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, if the IRS were to prevail on all matters in dispute, would result in  potential federal and state income tax liabilities of 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. In February 2012, we received a revised NOPA from the IRS (Revised NOPA).  In this Revised NOPA, the IRS is raising the same issues as in the NOPA issued in April 2011 but under a different methodology.  Under the Revised NOPA, the largest potential adjustment, if the IRS were to prevail on all matters in dispute, has decreased to $10.5 million, plus interest and penalties, if any. This is considered to be a subsequent event to our balance sheet date and we are currently reviewing the Revised NOPA.  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. We regularly assess the likelihood of an adverse outcome resulting from such examinations to determine the adequacy of our provision for income taxes. As of December 31, 2011, 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.
 
Changes in effective tax rates or adverse outcomes resulting from examination of our income tax returns could adversely affect our results.
 
Our future effective tax rates could be adversely affected by earnings being lower than anticipated in countries where we have lower statutory rates and higher than anticipated in countries where we have higher statutory rates, by changes in the valuation of our deferred tax assets and liabilities, or by changes in tax laws, regulations, accounting principles or interpretations thereof. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from these continuous examinations will not have an adverse effect on our operating results and financial condition.

The complexity of calculating our tax provision may result in errors that could result in restatements of our financial statements.
 
Due to the complexity associated with the calculation of our tax provision, we have hired independent tax advisors to assist us in the calculation. If we or our independent tax advisors fail to resolve or fully understand certain issues that we may have had in the past and issues that may arise in the future, we could be subject to errors, which would result in us having to restate our financial statements. For example, because of the complexity of our tax structure, we have had errors in our financial statements in the calculation of our tax provision that previously resulted in restatements of our prior year financial results.  Restatements are generally costly and could adversely impact our results of operations and/or have a negative impact on the trading price of our common stock.
 
 
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If we are unsuccessful in legal proceedings brought against us or any of our competitors, we could be prevented from selling many of our products and/or be required to pay substantial damages. An unfavorable outcome or an additional award of damages, attorneys’ fees or an injunction could cause our revenue to decline significantly and could severely harm our business and operating results.

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

We will continue to vigorously defend and enforce our intellectual property rights around the world, especially as it relates to patent litigation.

From time to time, we are faced with having to defend our intellectual property rights throughout the world. Should we become engaged in such proceedings, it could divert management’s attention from focusing on and implementing our business strategy. Further, should we not be successful in any of our intellectual property enforcement actions, our revenue may be affected and our business could be harmed.
 
Failure to protect our proprietary technologies or maintain the right to certain technologies may negatively affect our ability to compete.
 
We rely heavily on our proprietary technologies. Our future success and competitive position depend in part upon our ability to obtain and maintain protection of certain proprietary technologies used in our products. We pursue patents for some of our new products and unique technologies, and we also rely on a combination of nondisclosure agreements and other contractual provisions, as well as our employees’ commitment to confidentiality and loyalty, to protect our technology, know-how, and processes. Despite the precautions we take, it may be possible for unauthorized third parties to copy aspects of our current or future technology or products or to obtain and use information that we regard as proprietary. We intend to continue to protect our proprietary technology, including through patents. However, there can be no assurance that the steps we take will be adequate to protect our proprietary rights, that our patent applications will lead to issued patents, that others will not develop or patent similar or superior products or technologies, or that our patents will not be challenged, invalidated, or circumvented by others. Furthermore, the laws of the countries in which our products are or may be developed, manufactured, or sold may not protect our products and intellectual property rights to the same extent as laws in the United States. Our failure to adequately protect our proprietary technologies could harm our business.
 
 
17

 
 
S&P’s downgraded credit rating for U.S. long-term sovereign debt and that of certain Eurozone countries could affect global and domestic financial markets, which may affect our business, financial condition and liquidity.
 
S&P’s downgraded credit rating for U.S. long-term sovereign debt and that of certain Eurozone countries could materially affect global and domestic financial markets and economic conditions. Although a downgrade of long-term sovereign credit ratings is not unprecedented, a downgrade of the U.S. credit rating is, and the potential impact is uncertain. Management will continue to monitor the situation and there could be future changes in capital requirements or a rebalancing of investment portfolios in response to management’s assessment of the related risk weightings. At this time, however, U.S. treasuries continue to trade in active markets, and the yield curve on U.S. treasuries remains an appropriate basis for determining risk-free rates.
 
Should there be a deterioration of the global and financial markets as a result of the downgraded credit rating for U.S. long-term sovereign debt, our business, financial condition and liquidity could be adversely affected.
 
The market for government-backed student loan auction-rate securities has suffered a decline in liquidity which may impact the liquidity and potential value of our investment portfolio.
 
The market for government-backed student loan auction-rate securities with interest rates that reset through a Dutch auction every 7 to 35 days, became illiquid in 2008. At December 31, 2011, the Company’s investment portfolio included $13.7 million, net of impairment charges of $0.7 million, in government-backed student loan auction-rate securities. As of that date, $14.4 million, the face value of our auction-rate security investments, have failed to reset through successful auctions and it is unclear as to when these investments will regain their liquidity. The underlying maturity of these auction-rate securities is up to 36 years. 
 
Based on certain assumptions described in Note 2, “Fair Value Measurements”, to our consolidated financial statements and the Liquidity and Capital Resources section of “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this annual report on Form 10-K, we recorded temporary and other-than-temporary impairment charges on these investments. The valuation is subject to fluctuations in the future, which will depend on many factors, including the collateral quality, potential to be called or restructured, underlying final maturity, insurance guaranty, liquidity and market conditions, among others. We experienced our first failed auction in mid-February 2008.
 
Should there be further deterioration in the market for auction-rate securities, the value of our portfolio may decline, which may have an adverse impact on our cash position and our earnings.  If the accounting rules for these securities change , there may be an adverse impact on our earnings.  It is unlikely that we will be able to liquidate our auction-rate securities in the short term.
 
We face risks in connection with our internal control over financial reporting.

Effective internal controls over financial reporting are necessary for us to provide reliable and accurate financial reports. If we cannot provide reliable financial reports or prevent fraud or other financial misconduct, our business and operating results could be harmed. Our failure to implement and maintain effective internal control over financial reporting could result in a material misstatement of our financial statements or otherwise cause us to fail to meet our financial reporting obligations. This, in turn, could result in a loss of investor confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our results of operations and/or have a negative impact on the trading price of our common stock, and could subject us to stockholder litigation. For example, because of the complexity of our tax structure, we have had errors in our financial statements in the calculation of our tax provision that previously resulted in restatements of our prior year financial results. Although we believe that we have implemented appropriate internal control over financial reporting related to the computation of our income tax provision, we cannot be certain that any measures we have taken or may take in the future will ensure that we implement and maintain adequate internal control over financial reporting and that we will avoid any material weakness in the future. In addition, we cannot assure you that we will not in the future identify further material weaknesses in our internal control over financial reporting that we have not discovered to date, which may impact the reliability of our financial reporting and financial statements. In addition, we grant performance-based equity awards to certain of our employees. It is difficult to predict if or when an accounting charge associated with these grants will occur. As a result, we may be unable to accurately anticipate the magnitude and timing of any such accounting charge, which could materially and adversely impact our results of operations in future periods.

Our products must meet exacting specifications, and undetected defects and failures may occur, which may cause customers to return or stop buying our products and may expose us to product liability risk.
 
Our customers generally establish demanding specifications for quality, performance, and reliability that our products must meet. Integrated circuits as complex as ours often encounter development delays and may contain undetected defects or failures when first introduced or after commencement of commercial shipments, which might require product replacement or recall. Further, our third-party manufacturing processes or changes thereof, or raw material used in the manufacturing processes may cause our products to fail. We have from time to time in the past experienced product quality, performance or reliability problems. Our standard warranty period is one year, which exposes the company to significant risks of claims for defects and failures. If defects and failures occur in our products, we could experience lost revenue, increased costs, including warranty expense and costs associated with customer support, delays in, cancellations or rescheduling of orders or shipments, and product returns or discounts, any of which would harm our operating results.
 
 
18

 
 
In addition, product liability claims may be asserted with respect to our technology or products. Although we currently have insurance, there can be no assurance that we have obtained a sufficient amount of insurance coverage, that asserted claims will be within the scope of coverage of the insurance, or that we will have sufficient resources to satisfy any asserted claims.
 
The price and availability of commodities (e.g., gold, platinum, copper and silicon) may adversely impact our ability to deliver our products in a timely and cost-effective manner and may affect our business and results of operations.
 
Our products incorporate commodities such as gold, platinum, copper and silicon. The price and availability of these commodities and other like commodities that we use could negatively impact our business and results of operations.
 
Devaluation of the U.S. Dollar relative to other foreign currencies, including the renminbi, may adversely affect results of operations.
 
Our manufacturing and packaging suppliers are and will continue to be primarily located in China for the foreseeable future. Should the value of the renminbi continue to rise against the U.S. Dollar, there could be an increase in our manufacturing costs relative to competitors who have manufacturing facilities located in the U.S., which could adversely affect our operations. In addition, because we collect payments from all customers in U.S. dollars, fluctuations in the value of foreign currencies could have an adverse impact on our customers’ business, which could negatively impact our business and results of operations.
 
We and our manufacturing partners are or will be subject to extensive Chinese government regulation, and the benefit of various incentives from Chinese governments that we and our manufacturing partners receive may be reduced or eliminated, which could increase our costs or limit our ability to sell products and conduct activities in China.
 
Most of our manufacturing partners are located in China. In addition, we have established a facility in China, initially for the testing of our ICs. The Chinese government has broad discretion and authority to regulate the technology industry in China. China’s government has implemented policies from time to time to regulate economic expansion in China. It also exercises significant control over China’s economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. New regulations or the readjustment of previously implemented regulations could require us and our manufacturing partners to change our business plans, increase our costs, or limit our ability to sell products and conduct activities in China, which could adversely affect our business and operating results.
 
In addition, the Chinese government and provincial and local governments have provided, and continue to provide, various incentives to encourage the development of the semiconductor industry in China. Such incentives include tax rebates, reduced tax rates, favorable lending policies, and other measures, some or all of which may be available to our manufacturing partners and to us with respect to our facility in China. Any of these incentives could be reduced or eliminated by governmental authorities at any time. Any such reduction or elimination of incentives currently provided to our manufacturing partners could adversely affect our business and operating results.
 
There are inherent risks associated with the operation of our testing facility in China, which could increase product costs or cause a delay in product shipments.
 
We have a testing facility in China that began operations in 2006. In addition to the risks discussed elsewhere in this annual report on Form 10-K, we face the following risks, among others:
 
 
inability to maintain appropriate and acceptable manufacturing controls; and
 
 
higher than anticipated overhead and other costs of operation.
 
If we are unable to maintain our testing facility in China at fully operational status with appropriate manufacturing controls and cost levels, we may incur higher costs than our current expense levels, which would affect our gross margins. In addition, if capacity restraints result in significant delays in product shipments, our business and results of operations would be adversely affected.
 
The average selling prices of products in our markets have historically decreased over time and will likely do so in the future, which could harm our revenues and gross profits.
 
Average selling prices of semiconductor products in the markets we serve have historically decreased over time. Our gross profits and financial results will suffer if we are unable to offset any reductions in our average selling prices by reducing our costs, developing new or enhanced products on a timely basis with higher selling prices or gross profits, or increasing our sales volumes. Additionally, because we do not operate our own manufacturing or assembly facilities, we may not be able to reduce our costs as rapidly as companies that operate their own facilities, and our costs may even increase, which could also reduce our margins.
 
 
19

 
 
Because of the lengthy sales cycles for our products and the fixed nature of a significant portion of our expenses, we may incur substantial expenses before we earn associated revenue and may not ultimately achieve our forecasted sales for our products.
 
The introduction of new products presents significant business challenges because product development plans and expenditures must be made up to two years or more in advance of any sales. It takes us up to 12 months or more to design and manufacture a new product prototype. Only after we have a prototype do we introduce the product to the market and begin selling efforts in an attempt to achieve design wins. This sales process requires us to expend significant sales and marketing resources without any assurance of success. Volume production of products that use our ICs, if any, may not be achieved for an additional period of time after an initial sale. Sales cycles for our products are lengthy for a number of reasons, including:
 
 
our customers usually complete an in-depth technical evaluation of our products before they place a purchase order;
 
 
the commercial adoption of our products by OEMs and ODMs is typically limited during the initial release of their product to evaluate product performance and consumer demand;
 
 
our products must be designed into a customer’s product or system; and
 
 
the development and commercial introduction of our customers’ products incorporating new technologies frequently are delayed.
 
As a result of our lengthy sales cycles, we may incur substantial expenses before we earn associated revenue because a significant portion of our operating expenses is relatively fixed and based on expected revenue. The lengthy sales cycles of our products also make forecasting the volume and timing of orders difficult. In addition, the delays inherent in lengthy sales cycles raise additional risks that customers may cancel or change their orders. Our sales are made by purchase orders. Because industry practice allows customers to reschedule or cancel orders on relatively short notice, backlog is not always a good indicator of our future sales. If customer cancellations or product changes occur, we could lose anticipated sales and not have sufficient time to reduce our inventory and operating expenses.
 
The loss of any of our key personnel or the failure to attract or retain specialized technical and management personnel could impair our ability to grow our business.
 
Our future success depends upon our ability to attract and retain highly qualified technical and managerial personnel. We are particularly dependent on the continued services of our key executives, including Michael Hsing, our President and Chief Executive Officer, who founded our company and developed our proprietary process technology. In addition, personnel with highly skilled analog and mixed-signal design engineering expertise are scarce and competition for personnel with these skills is intense. There can be no assurance that we will be able to retain existing key employees or that we will be successful in attracting, integrating or retaining other highly qualified personnel with critical capabilities in the future. If we are unable to retain the services of existing key employees or are unsuccessful in attracting new highly qualified employees quickly enough to meet the demands or our business, including design cycles, our business could be harmed.

If we fail to retain key employees in sales, applications, finance and legal or to make continued improvements to our internal systems, particularly in the accounting and finance area, our business may suffer.
 
If we fail to continue to adequately staff our sales, applications, financial and legal staff, maintain or upgrade our business systems and maintain internal controls that meet the demands of our business, our ability to operate effectively will suffer. The operation of our business also depends upon our ability to retain these employees, as these employees hold a significant amount of institutional knowledge about us and our products, and, if they were to terminate their employment, our sales and internal control over financial reporting could be adversely affected.
 
We intend to continue to expand our operations, which may strain our resources and increase our operating expenses.
 
We plan to continue to expand our domestic and foreign operations through internal growth, strategic relationships, and/or acquisitions. We expect that any such expansion will strain our systems and operational and financial controls. In addition, we are likely to incur significantly higher operating costs. To manage our growth effectively, we must continue to improve and expand our systems and controls, as well as hire experienced administrative and financial personnel. If we fail to do so, our growth will be limited. If we fail to effectively manage our planned expansion of operations, our business and operating results may be harmed.
 
We may engage in future acquisitions that dilute the ownership interests of our stockholders and cause us to incur debt or to assume contingent liabilities, and we may be unable to successfully integrate these companies into our operations, which would adversely affect our business.
 
As a part of our business strategy, from time to time we review acquisition prospects that would complement our current product offerings, enhance our design capability or offer other competitive opportunities. In the event of future acquisitions, we could use a significant portion of our available cash, cash equivalents and short-term investments, issue equity securities which would dilute current stockholders’ percentage ownership, incur substantial debt or contingent liabilities, and/or incur impairment charges related to goodwill or other intangibles. Such actions by us could impact our operating results and/or the price of our common stock.
 
 
20

 
 
In addition, we may be unable to identify or complete prospective acquisition for various reasons, including competition from other companies in the semiconductor industry, the valuation expectations of acquisition candidates and applicable antitrust laws or related regulations.  If we are unable to identify and complete acquisitions, we may not be able to successfully expand our business and product offerings.
 
To the extent we are successful in completing strategic acquisitions, if we are unsuccessful in integrating any acquired company into our operations or if integration is more difficult than anticipated, we may experience disruptions that could harm our business and not realize the anticipated benefits of the acquisitions. Some of the risks that may adversely affect our ability to integrate or realize any anticipated benefits from the acquired companies, businesses or assets include those associated with:
 
 
§
unexpected losses of key employees or customers of the acquired companies or businesses;
 
 
§
conforming the acquired company’s standards, processes, procedures and controls with our operations;
 
 
§
coordinating new product and process development;
 
 
§
hiring additional management and other critical personnel;
 
 
§
increasing the scope, geographic diversity and complexity of our operations;
 
 
§
difficulties in consolidating facilities and transferring processes and know-how;
 
 
§
other difficulties in the assimilation of acquired operations, technologies or products;
 
 
§
diversion of management’s attention from other business concerns; and
 
 
§
adverse effects on existing business relationships with customers.
 
We compete against many companies with substantially greater financial and other resources, and our market share may be reduced if we are unable to respond to our competitors effectively.
 
The analog and mixed-signal semiconductor industry is highly competitive, and we expect competitive pressures to continue. Our ability to compete effectively and to expand our business will depend on our ability to continue to recruit applications and design talent, our ability to introduce new products, and our ability to maintain the rate at which we introduce these new products. We compete with domestic and non-domestic semiconductor companies, many of which have substantially greater financial and other resources with which to pursue engineering, manufacturing, marketing, and distribution of their products. We are in direct and active competition, with respect to one or more of our product lines, with at least 10 manufacturers of such products, of varying size and financial strength. The number of our competitors has grown due to the expansion of the market segments in which we participate. We consider our competitors to include, but not be limited to: Fairchild Semiconductor, Intersil, Linear, Maxim Integrated Products, Micrel, Microsemi, National Semiconductor, O2Micro, RichTek, Rohm, Semtech, STMicroelectronic, Texas Instruments and Volterra. We expect continued competition from existing competitors as well as competition from new entrants in the semiconductor market.
 
We cannot assure you that our products will continue to compete favorably or that we will be successful in the face of increasing competition from new products and enhancements introduced by existing competitors or new companies entering this market, which would materially and adversely affect our results of operations and our financial condition.
 
If securities or industry analysts downgrade our stock or do not continue to publish research or reports about our business, our stock price and trading volume could decline.
 
The trading market for our common stock will depend, in part, on the research and reports that industry or securities analysts publish about us or our business. We do not have any control over these analysts. If one or more of the analysts who cover us downgrade our stock, our stock price would likely decline. If one or more of these analysts cease coverage of us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.
 
Because of their significant stock ownership, our officers and directors will be able to exert significant influence over our future direction.
 
Executive officers, directors, and affiliated entities beneficially owned in aggregate, approximately 18% of our outstanding common stock as of December 31, 2011. These stockholders, if acting together, would be able to significantly influence all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions.
 
 
21

 
 
Major earthquakes or other natural disasters and resulting systems outages may cause us significant losses.
 
Our corporate headquarters, the production facilities of our third-party wafer supplier, our IC testing facility, a portion of our assembly and research and development activities, and certain other critical business operations are located in or near seismically active regions and are subject to periodic earthquakes. We do not maintain earthquake insurance and could be materially and adversely affected in the event of a major earthquake. Much of our revenue, as well as our manufacturers and assemblers, are concentrated in Asia. Such concentration increases the risk that other natural disasters, labor strikes, terrorism, war, political unrest, epidemics, and/or health advisories could disrupt our operations. In addition, we rely heavily on our internal information and communications systems and on systems or support services from third parties to manage our operations efficiently and effectively. Any of these are subject to failure due to a natural disaster or other disruption. System-wide or local failures that affect our information processing could have material adverse effects on our business, financial condition, operating results, and cash flows.
 
Our facilities in Chengdu, China are located in a seismically active area, as evidenced by the May 2008 earthquake that was centered in the Sichuan Province of China. Although there was no damage to our facilities as a result of that earthquake, should there be additional earthquakes in the area, we may incur losses and our business, financial condition and/or operating results may suffer.
 
We have a sales facility in Japan, which is located in a seismically active area, as evidenced by the March 2011 earthquake that was centered off the coast of Japan’s Miyagi Prefecture. While there was no damage to our facilities as a result of the earthquake, our customers may have experienced disruptions in their supply chains that may impact our revenue in future quarters. Additional earthquakes in the region may have a more significant impact longer term, which could affect our results of operations and financial conditions.
 
ITEM 1B.    UNRESOLVED STAFF COMMENTS

None.

ITEM 2.    PROPERTIES
 
Our primary operating locations are currently in San Jose, California and Chengdu, Sichuan, China. We currently lease approximately 55,110 square feet in San Jose, which serves as our corporate headquarters, sales and research and development center. Certain test procedures and manufacturing also take place in our San Jose facility. The San Jose facility was sold and the new landlord has exercised their 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 with Pepper Land-Great Oaks, LLC, a California limited liability company 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.

We lease approximately 56,000 square feet in Chengdu which serves as our test facility and manufacturing hub and we constructed a 150,000 square foot research and development facility in Chengdu, which was put into operation in October 2010.

We also lease sales and research and development offices in the United States, Japan, China, Taiwan, Finland and Korea. We believe that our existing facilities are adequate for our current operations.
 
ITEM 3.    LEGAL PROCEEDINGS
 
On September 16, 2011 and September 29, 2011, two nearly identical shareholder derivative actions were filed in the United States District Court for the Northern District of California and the California Superior Court for Santa Clara County, naming as defendants certain of our current and former directors and officers and our compensation advisory firm.  The complaints assert claims for, among other things, breach of fiduciary duty in connection with the directors' approval of compensation for our executive officers during 2010.  The complaints each seek an award of damages in favor of the Company, equitable relief, costs and attorney’s fees.  On February 29, 2012, the plaintiff in the action filed in California Superior Court for Santa Clara County had voluntarily dismissed the action.  The matters are at a preliminary stage at the United States District Court; the defendants have moved to dismiss the complaints in the court.  In management’s opinion, the resolution of the derivative action filed in the United States District Court is uncertain and we are not able to assess whether it will have a material adverse effect on our consolidated financial condition, results of operations, or liquidity.
 
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. We defend ourselves vigorously against any such claims.
 
 
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ITEM 4 .     MINE SAFETY DISCLOSURES

Not applicable.
 
PART II
 
ITEM 5.     Market for the Registrant’s Common Equity, Related Stockholders Matters, and Issuer Purchases of Equity Securities.

Market Price of Our Common Stock

Our common stock is traded on the Nasdaq Global Select Market under the symbol “MPWR”. The following table sets forth, for the periods indicated, the high and low sales price per share of our common stock on the Nasdaq Global Select Market. These prices represent quotations among dealers without adjustments for retail mark-ups, markdowns or commissions, and may not represent prices of actual transactions.

2011
 
High
   
Low
 
Fourth Quarter ended December 31, 2011
  $ 15.61     $ 9.49  
Third Quarter ended September 30, 2011
  $ 15.64     $ 10.16  
Second Quarter ended June 30, 2011
  $ 18.56     $ 13.41  
First Quarter ended March 31, 2011
  $ 17.12     $ 12.95  
                 
2010
               
Fourth Quarter ended December 31, 2010
  $ 18.52     $ 14.75  
Third Quarter ended September 30, 2010
  $ 19.90     $ 15.46  
Second Quarter ended June 30, 2010
  $ 25.34     $ 17.34  
First Quarter ended March 31, 2010
  $ 24.50     $ 18.40  

Holders of Our Common Stock
 
As of February 16, 2012, we had approximately 21 stockholders of record and the closing price of common stock was $18.48 per share as reported by The Nasdaq Global Select Market.  Many of our shares of common stock are held by brokers and other institutions on behalf of stockholders. Based on several factors, including our proxy mailing from 2011, we estimate the total number of stockholders represented by these record holders to be at least 1,409 .

Dividend Policy

We have not paid cash dividends on our common stock since our inception. We currently expect to retain earnings for use in the operation and expansion of our business, and therefore do not anticipate paying any cash dividends for the next several years.

Performance of Our Common Stock

The following graph compares the cumulative 60-month total return provided shareholders on our common stock relative to the cumulative total returns of the Nasdaq Composite Index, the S & P 500 Index and the Philadelphia Semiconductor Index. An investment of $100 (with reinvestment of all dividends) is assumed to have been made in our common stock on 1/1/2007 and its relative performance is tracked through 12/31/2011.
 
 
23

 
 

The information contained in the Stock Performance Graph section shall not be deemed to be “soliciting material” or “filed” or incorporated by reference in future filings with the SEC, or subject to the liabilities of Section 18 of the Exchange Act, except to the extent that the Company specifically incorporates it by reference into a document filed under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.

Recent Sales of Unregistered Securities

There were no sales of unregistered securities during the year ended December 31, 2011.

ITEM 6.    SELECTED FINANCIAL DATA
 
The following financial data is derived from our audited annual consolidated financial statements as of and for the years ended December 31, 2011, 2010, 2009, 2008 and 2007. You should read the following table in conjunction with the consolidated financial statements and the related notes contained elsewhere in this report on Form 10-K. Operating results for any year are not necessarily indicative of results to be expected for any future periods.
 
 
24

 

Consolidated Statement of Operations Data:

   
Year ended December 31,
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
         
(in thousands, except per share amounts)
       
                               
Revenue
  $ 196,519     $ 218,840     $ 165,008     $ 160,511     $ 134,004  
Cost of revenue, including stock-based compensation*
    94,925       97,383       67,330       61,184       48,781  
Gross profit
    101,594       121,457       97,678       99,327       85,223  
                                         
Operating expenses:
                                       
Research and development, including stock-based compensation*
    44,518       44,372       38,295       34,850       27,342  
Selling, general and administrative, including stock-based compensation*
    40,280       41,169       36,752       35,256       29,537  
Lease abandonment
    -       -       -       -       (496 )
Litigation
    3,379       5,418       9,457       6,714       9,370  
Patent litigation settlement (provision reversal)
    -       -       (6,356 )     -       9,800  
Total operating expenses
    88,177       90,959       78,148       76,820       75,553  
                                         
Income from operations
    13,417       30,498       19,530       22,507       9,670  
                                         
Other income (expense):
                                       
Interest and other income
    671       1,156       1,047       3,587       4,741  
Other expense
    (362 )     (234 )     (429 )     (652 )     (139 )
Total other income, net
    309       922       618       2,935       4,602  
                                         
Income before income taxes
    13,726       31,420       20,148       25,442       14,272  
Income tax provision
    425       1,857       474       1,216       2,692  
                                         
Net income
  $ 13,301     $ 29,563     $ 19,674     $ 24,226     $ 11,580  
                                         
Basic income per share
  $ 0.39     $ 0.83     $ 0.57     $ 0.72     $ 0.37  
Diluted income per share
  $ 0.38     $ 0.78     $ 0.54     $ 0.67     $ 0.33  
                                         
Weighted-average common shares outstanding
    34,050       35,830       34,310       33,509       31,703  
Stock options, restricted stock and warrants
    1,110       1,996       2,324       2,611       3,387  
Diluted weighted-average common equivalent shares outstanding
    35,160       37,826       36,634       36,120       35,090  
                                         
* Stock-based compensation has been included in the following line items:
                                 
Cost of revenue
  $ 312     $ 393     $ 246     $ 344     $ 539  
Research and development
    5,909       6,742       6,408       5,821       4,625  
Selling, general and administrative
    6,905       9,675       7,957       6,993       6,064  
Total
  $ 13,126     $ 16,810     $ 14,611     $ 13,158     $ 11,228  

Consolidated Balance Sheet Data:

   
As of December 31,
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
    (in thousands)  
                               
Cash and cash equivalents
  $ 96,371     $ 48,010     $ 46,717     $ 83,266     $ 83,114  
Short-term investments
    77,827       129,709       118,914       21,922       27,765  
Long-term investments
    13,675       19,180       19,445       37,425       -  
Restricted cash
    -       -       -       7,360       7,350  
Working capital
    185,435       195,403       179,577       117,365       119,348  
Restricted assets
    -       -       -       7       8,340  
Total assets
    273,867       281,603       241,821       195,299       172,590  
Common stock
    159,336       178,269       175,518       147,298       143,890  
Total stockholders' equity
    242,877       246,895       212,957       164,645       137,537  
 
ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion should be read in conjunction with the consolidated financial statements and related notes which appear elsewhere in this annual report on Form 10-K.
 
 
25

 

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.
 
Following the introduction of a product, our sales cycle generally takes a number of quarters to achieve revenue and volume production is usually achieved several months after we receive an initial customer order for a new product. Typical lead time for orders are fewer than 90 days. These factors, combined with the fact that orders in the semiconductor industry can typically be cancelled or rescheduled without significant penalty to the customer, make the forecasting of our orders and revenue difficult.
 
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. 90% of our revenue for the year ended December 31, 2011 and 87% of our revenue for the year ended December 31, 2010 was attributable to direct or indirect sales to customers in Asia. We derive a majority of our revenue from the sales of our DC to DC converter product family which services the consumer electronics, communications and computing markets. We believe our ability to achieve revenue growth will depend, in part, on our ability to develop new products, enter new market segments, gain market share, manage litigation risk, diversify our customer base and successfully secure manufacturing capacity.

Critical Accounting Policies and Estimates
 
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an on-going basis, including those related to revenue recognition, stock-based compensation, long-term investments, short-term investments, inventories, income taxes, warranty obligations and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making the judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Estimates and judgments used in the preparation of our financial statements are, by their nature, uncertain and unpredictable, and depend upon, among other things, many factors outside of our control, such as demand for our products and economic conditions.  Accordingly, our estimates and judgments may prove to be incorrect and actual results may differ, perhaps significantly, from these estimates.
 
We believe the following critical accounting policies reflect our more significant judgments used in the preparation of our consolidated financial statements.
 
Revenue Recognition. We recognize revenue in accordance with Financial Accounting Standards Board (“FASB”) – Accounting Standards Codification (“ASC”) 605-10-S25 Revenue Recognition – Overall – Recognition . ASC 605-10-S25 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed and determinable; and (4) collectability 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 collectability of those fees. The application of these criteria has resulted in our generally recognizing revenue upon shipment (when title passes) to customers.
 
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.
 
 
26

 

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 and they are generally required to pay in advance of shipment.

The terms in a majority of the Company's distribution agreements include the non-exclusive right to sell, and the agreement to use best efforts to promote and develop a market for, the Company's products in certain regions of the world and the ability to terminate the distribution agreement by either party with up to three months notice. The Company provides a one year warranty against defects in materials and workmanship. Under this warranty, the Company will either repair the goods or provide replacements at no charge 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.
 
Two of the Company's U.S. distributors have distribution agreements where revenue is recognized upon sale by these distributors to their end customers because these distributors have certain rights of return which management believes are not estimable. The deferred revenue balance from these distributors for each of the years ended December 31, 2011 and 2010 was $1.0 million.
 
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.
 
 
27

 
 
As of December 31, 2011 and 2010, we had a valuation allowance of $14.6 million and $16.8 million, respectively, attributable to management’s determination that it is more likely than not that most of the deferred tax assets in the United States will not be realized. 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.
 
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 . This 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. 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.

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.
 
 
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Fair Value of Financial 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:
 
 
·
Level 1: Quoted prices in active markets for identical assets;
 
 
·
Level 2: Significant other observable inputs; and
 
 
·
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. Short-term and long-term investments are stated at their fair market value.
 
At December 31, 2011, the face value of our holdings in auction rate securities is $14.4 million, all of which is classified as long-term available-for-sale investments.
 
All of the Company's investments are classified as available-for-sale securities which 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 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 Consolidated Statement of Operations. There have been no such losses since.
 
Based on certain assumptions described in Note 2 to our consolidated financial statements and the Liquidity and Capital Resources section of Part II, Item 7 of this annual report on Form 10-K, 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.
 
Recent Accounting Pronouncements
 
 
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In June 2011, the FASB issued ASU No. 2011-05 relating to Comprehensive Income (Topic 220) – Presentation of Comprehensive Income (ASU 2011-05), which requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The ASU is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2011 and must be applied retrospectively. The Company is evaluating the impact ASU 2011-05 will have on its consolidated financial statements.
 
In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. Generally Accepted Accounting Principles (“GAAP”) and International Financial Reporting Standards (Topic 820) – Fair Value Measurement (ASU 2011-04), to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for level 3 fair value measurements. The ASU is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2011 and should be applied prospectively.
 
Results of Operations
 
The table below shows the Consolidated Statements of Operations amounts (in thousands) and shows each as a percentage of revenue.

   
Year ended December 31,
 
   
2011
   
2010
   
2009
 
   
(in thousands, except percentages)
 
                                     
Revenue
  $ 196,519       100.0 %   $ 218,840       100.0 %   $ 165,008       100.0 %
Cost of revenue
    94,925       48.3       97,383       44.5       67,330       40.8  
Gross profit
    101,594       51.7       121,457       55.5       97,678       59.2  
                                                 
Operating expenses:
                                               
Research and development
    44,518       22.7       44,372       20.3       38,295       23.3  
Selling, general and administrative
    40,280       20.5       41,169       18.8       36,752       22.3  
Litigation
    3,379       1.7       5,418       2.5       9,457       5.7  
Patent litigation settlement (provision reversal)
    -       -       -       -       (6,356 )     (3.9 )
Total operating expenses
    88,177       44.9       90,959       41.6       78,148       47.4  
                                                 
Income from operations
    13,417       6.8       30,498       13.9       19,530       11.8  
                                                 
Interest and other income
    671       0.3       1,156       0.6       1,047       0.6  
Other expense
    (362 )     (0.1 )     (234 )     (0.1 )     (429 )     (0.2 )
Total other income, net
    309       0.2       922       0.5       618       0.4  
                                                 
Income before income taxes
    13,726       7.0       31,420       14.4       20,148       12.2  
Income tax provision
    425       0.2       1,857       0.9       474       0.3  
                                                 
Net income
  $ 13,301       6.8 %   $ 29,563       13.5 %   $ 19,674       11.9 %
 
The following table shows our revenue by product family (amounts in thousands, except percentages):

   
Year ended December 31,
   
Percent Change
 
                                       
2011 to 2010
   
2010 to 2009
 
Product Family
 
2011
   
% of Revenue
   
2010
   
% of Revenue
   
2009
   
% of Revenue
   
Change
   
Change
 
DC to DC Converters
  $ 165,608       84.2 %   $ 183,051       83.7 %   $ 123,581       74.9 %     (9.5 %)     48.1 %
Lighting Control Products
    26,487       13.5 %     28,554       13.0 %     27,836       16.9 %     (7.2 %)     2.6 %
Audio Amplifiers
    4,424       2.3 %     7,235       3.3 %     13,591       8.2 %     (38.9 %)     (46.8 %)
                                                                 
Total
  $ 196,519       100.0 %   $ 218,840       100.0 %   $ 165,008       100.0 %                
 
Revenue. Revenue for the year ended December 31, 2011 was $196.5 million, a decrease of $22.3 million, or 10.2%, from $218.8 million for the year ended December 31, 2010. For the year ended December 31, 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 a lack of production capacity and resulting product shortages in 2010. Audio sales were down for the year ended December 31, 2011 over the same period in 2010 due to a change in product mix. The sales of our lighting control products were down for the year ended December 31, 2011 over the similar 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.
 
 
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Revenue for the year ended December 31, 2010 was $218.8 million, an increase of $53.8 million, or 32.6%, from $165.0 million for the year ended December 31, 2009. Sales during the first three quarters of 2010 were strong for MPS and the semiconductor industry in general. However, due to product shortages early in 2010, several major customers in Korea sought alternative suppliers, which impacted our revenue in the fourth quarter. In addition, in the fourth quarter of 2010, sales were lower because distributors used up inventory that was shipped in the third quarter and the general demand for consumer products declined more than seasonally. Sales during 2009 were generally weak, primarily from the deterioration in the general demand for electronic products as a result of a worldwide financial crisis and associated macro-economic slowdowns.
 
In 2010, we saw an increase in demand for our DC to DC products, with sales having increased by $59.5 million or 48.1% over sales in 2009. The increase was primarily because of higher demand for electronic products in the consumer and communications markets. Sales of our lighting control products increased slightly as a result of greater demand for our WLED solution for consumer electronics products. This was partially offset by a reduction in the demand for our CCFL products. Audio sales were down year over year due to lower demand and a decline in the average selling price for certain of our audio products.

Gross Profit.   Gross profit as a percentage of revenue, or gross margin, was 51.7% for the year ended December 31, 2011 and 55.5% for the year ended December 31, 2010. For the year ended December 31, 2011, gross margin declined year-over-year as a result of declining average selling prices for certain of our products, unabsorbed test manufacturing costs and an increase in inventory reserves.

Gross profit as a percentage of revenue, or gross margin, was 55.5% for the year ended December 31, 2010 and 59.2% for the year ended December 31, 2009. Gross margin declined year-over-year as a result of a change in the product mix, higher product costs from increased wafer and gold costs, underutilized capacity towards the end of 2010 and an increase in inventory reserves.
 
Research and Development.   Research and development (R&D) expenses consist of salary and benefit expenses for design and product engineers, expenses related to new product development, and related facility costs. 
 
   
Year ended December 31,
   
Percentage Change
 
   
2011
   
2010
   
2009
   
2011 to 2010
   
2010 to 2009
 
   
(in thousands, except percentages)
             
Revenue
  $ 196,519     $ 218,840     $ 165,008       (10.2 %)     32.6 %
Research and development ("R&D"), excluding stock-based compensation
    38,609       37,630       31,887       2.6 %     18.0 %
R&D stock-based compensation
    5,909       6,742       6,408       (12.4 %)     5.2 %
Total R&D
  $ 44,518     $ 44,372     $ 38,295       0.3 %     15.9 %
R&D as a percentage of net revenue
    22.7 %     20.3 %     23.2 %                
 
R&D expenses were $44.5 million, or 22.7% of revenue, for the year ended December 31, 2011 and $44.4 million, or 20.3% of revenue, for the year ended December 31, 2010. For the year ended December 31, 2011, R&D expenses remained flat over the same period in 2010 due to lower cash-based compensation and stock-based compensation expenses. These were partially offset by an increase in personnel-related and new product development expenses.
 
R&D expenses were $44.4 million, or 20.3% of revenue, for the year ended December 31, 2010 and $38.3 million, or 23.2% of revenue, for the year ended December 31, 2009. The year-over-year increase was primarily due to an increase in variable compensation, facilities costs and costs associated with new product development.
 
Selling, General and Administrative. Selling, general and administrative (SG&A) expenses include salary and benefit expenses for sales, marketing and administrative personnel, sales commissions, travel expenses, related facilities costs, outside legal and accounting fees, and fees associated with Sarbanes-Oxley compliance requirements.
 
   
Year ended December 31,
   
Percentage Change
 
   
2011
   
2010
   
2009
   
2011 to 2010
   
2010 to 2009
 
   
(in thousands, except percentages)
             
Revenue
  $ 196,519     $ 218,840     $ 165,008       (10.2 %)     32.6 %
Selling, general and administrative ("SG&A"), excluding stock-based compensation
    33,375       31,494       28,795       6.0 %     9.4 %
SG&A stock-based compensation
    6,905       9,675       7,957       (28.6 %)     21.6 %
Total SG&A
  $ 40,280     $ 41,169     $ 36,752       (2.2 %)     12.0 %
SG&A as a percentage of net revenue
    20.5 %     18.8 %     22.3 %                
 
SG&A expenses were $40.3 million, or 20.5% of revenue, for the year ended December 31, 2011 and $41.2 million, or 18.8% of revenue, for the year ended December 31, 2010. For the year ended December 31, 2011, SG&A expenses decreased over the same period in 2010 due to lower variable compensation and stock-based compensation expenses. These were partially offset by an increase in personnel-related expenses.
 
 
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SG&A expenses were $41.2 million, or 18.8% of revenue, for the year ended December 31, 2010 and $36.8 million, or 22.3% of revenue, for the year ended December 31, 2009. SG&A as a percentage of revenue declined compared to the corresponding period in the prior year due to the efficiencies of greater scale from increased revenues. Total SG&A expenses increased year over year due to higher stock-based compensation expenses and an increase in sales commissions and other variable compensation as a result of increased revenue in 2010.
 
Litigation.
 
   
Year ended December 31,
   
Percentage Change
 
   
2011
   
2010
   
2009
   
2011 to 2010
   
2010 to 2009
 
   
(in thousands, except percentages)
             
Revenue
  $ 196,519     $ 218,840     $ 165,008       (10.2 %)     32.6 %
Litigation expense
    3,379       5,418       9,457       (37.6 %)     (42.7 %)
Litigation expense as a percentage of net revenue
    1.7 %     2.5 %     5.7 %                

Litigation expenses were $3.4 million, or 1.7% of revenue, for the year ended December 31, 2011, compared to $5.4 million, or 2.5% of revenue, for the year ended December 31, 2010. During the year ended December 31, 2011, we incurred legal expenses primarily to recover attorneys’ fees from O2Micro relating to our lawsuits with them, which were resolved in the second quarter of 2010. During the year ended December 31, 2010, we incurred legal expenses primarily for the defense of those lawsuits. Overall, our litigation expense decreased as a result of us being party to fewer material litigations.

Litigation expenses, excluding patent litigation settlements and provision reversals were $5.4 million, or 2.5% of revenue, for the year ended December 31, 2010 as compared to $9.5 million, or 5.7% of revenue, for the year ended December 31, 2009. As a result of settling our lawsuits involving O2Micro in the second quarter of 2010, our legal expenses were significantly lower in 2010 compared to 2009.

For a more complete description of our current material litigation matters, please see Part I, Item 3 “Legal Proceedings” and Note 10 “Litigation” of Notes to Consolidated Financial Statements.
 
Patent Litigation Settlement (Provision Reversal).
 
   
Year ended December 31,
   
Percentage Change
 
   
2011
   
2010
   
2009
   
2011 to 2010
   
2010 to 2009
 
   
(in thousands, except percentages)
             
Revenue
  $ 196,519     $ 218,840     $ 165,008       (10.2 %)     32.6 %
Patent litigation settlement (provision reversal)
    -       -       (6,356 )                
Patent litigation settlement (provision reversal) as a percentage of net revenue
    0.0 %     0.0 %     (3.9 %)                
 
There were no patent litigation settlements or provision reversals in 2011 and 2010. Patent litigation provision reversal was $6.4 million for the year ended December 31, 2009. In 2009, we completed the litigation process with respect to the lawsuit related to TSE, a customer.  The conclusion of this lawsuit resulted in recording a reversal of a patent litigation provision of approximately $7.4 million. This provision was recorded as a patent litigation provision in the second quarter of 2007 and the reversal of this provision in 2009 is reflected in the Patent Litigation Settlement and Provision Reversal item in the Consolidated Statement of Operations.  In connection with the completion of this lawsuit, the Company also jointly terminated an escrow agreement with TSE and retrieved the deposit of $7.4 million. This recovery was reduced by certain litigation stipulations for other parties involved in the case in the amount of $1.0 million.
  
Interest and Other Income.   For the years ended December 31, 2011, 2010 and 2009, interest and other income was $0.7 million, $1.2 million and $1.0 million, respectively. Interest income decreased from 2010 to 2011 due to lower cash and investment balances in 2011, which resulted from stock repurchase activity and the purchase of our San Jose headquarters as well as interest rate declines year-over-year. Interest income increased from 2009 to 2010 due to higher cash and investment balances in 201 0 , partially offset by declining interest rates year-over-year.

Other Expense.   Other expense, comprised mainly of foreign exchange losses, was $0.4 million, $0.2 million and $0.4 million for the years ended December 31, 2011, 2010 and 2009, respectively.
 
Income Tax Provision.   The income tax provision for year ended December 31, 2011 was $0.4 million or 3.1% of our income before income taxes. This differs from the federal statutory rate of 34% primarily because our foreign income was taxed at lower rates and because of the benefit that we realized as a result of restricted units released.
 
The income tax provision for the year ended December 31, 2010 was $1.9 million or 5.9% of our income before income taxes. This was lower than 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 options exercised and restricted units released.
 
 
32

 
 
The income tax provision for the year ended December 31, 2009 was $0.5 million or 2.4% of the pre-tax income, respectively. This differs from the U.S. federal statutory rate of 34% primarily because our foreign income is taxed at lower rates and because of the benefit that we realized as a result of stock options exercised and restricted units released.
 
For additional information, see Note 8 “Income Taxes” of the Notes to Consolidated Financial Statements.

Liquidity and Capital Resources
 
As of December 31, 2011, we had working capital of $185.4 million, including cash and cash equivalents of $96.4 million and short-term investments of $77.8 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. At December 31, 2011, $42.1 million of our cash and $15.0 million of our short-term investments were held by our international subsidiaries and are therefore not immediately available to fund domestic operations. Our working capital decreased year-over-year primarily due to the cash requirements of our share repurchase program and 2011 capital expenditures, which included the purchase of our new San Jose headquarters, more than offset the cash generated from operating activities and the proceeds received from the exercise of options and from purchases of common stock pursuant to our employee stock purchase program.

For the year ended December 31, 2011, net cash provided by operating activities was $43.7 million, primarily from strong operating results during the year. For the year ended December 31, 2010, net cash provided by operating activities was $48.5 million, primarily due to strong operating results, partially offset by an increase in inventory to support the deliveries in the first quarter of 2011. For the year ended December 31, 2009, net cash provided by operating activities was $31.8 million, primarily due to strong operating results during the year. This was offset by an increase in accounts receivable , as a result of increased shipments at the end of the quarter ended December 31, 2009 for which collections had not yet been made , and a decrease in accrued and long-term liabilities.
 
For the year ended December 31, 2011, net cash provided by investing activities was $36.2 million, primarily from the sale of short-term investments to fund our stock repurchase program and to purchase our corporate headquarters in San Jose, California. For the year ended December 31, 2010, net cash used in investing activities was $33.8 million, primarily related to the Chengdu building construction and equipment purchases for our Chengdu facility and the net purchase of short-term investments. For the year ended December 31, 2009, net cash used in investing activities was $82.1 million, primarily related to the net purchase of short-term investments.
 
We use professional investment management firms to manage the majority of our invested cash. Our fixed income portfolio is primarily invested in municipal bonds, government securities, auction-rate securities and highly rated corporate notes. The balance of the fixed income portfolio is managed internally and invested primarily in money market funds 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 has no impact on net income. Other-than-temporary impairment charges exist when the entity has the intent to sell the security, 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 (expenses) in the Consolidated Statement of Operations.

Our investment portfolio as of December 31, 2011 included $13.7 million, in government- backed student loan auction-rate securities, net of impairment charges of $0.7 million; of which, $0.6 million was temporary and $0.1 million was recorded as other-than-temporary. This compares to an investment balance for auction-rate securities as of December 31, 2010 of $19.2 million, net of impairment charges of $1.0 million; of which, $0.9 million was temporary and $0.1 million was recorded as other-than-temporary. In both 2011 and 2010, the portion of the impairment classified as temporary was 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 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;
 
5.
While the majority of the securities in the Company's entire portfolio remain AAA rated, $6.4 million of auction rate securities were downgraded by Moody’s to A3-Baa3 during the year ended December 31, 2009. There have been no further downgrades since;
 
6.
All scheduled interest payments have been made pursuant to the reset terms and conditions; and
 
7.
All redemptions of auction-rate securities representing 67% of the original portfolio purchased by us in February 2008 have been at par.

 
33

 

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 two such securities. The senior parity ratio for the 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, June 30, 2011, September 30, 2011 and December 31, 2011, we used a discounted cash flow model, for which there are three valuation parameters, including time-to-liquidity, discount rate and expected return. The following are the values used in the discounted cash flow model:
 
 
December 31, 2010
March 31, 2011
June 30, 2011
September 30, 2011
December 31, 2011
Time-to-Liquidity
24 months
24 months
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%
1.8%
1.8%
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
2.9% - 7.7%, depending on the credit-rating of the security
3.1% - 7.9%, depending on the credit-rating of the security
 
From the third quarter of 2011 to the fourth quarter of 2011, the impairment increased slightly because of an increase in the FFELPs student-loan spread and an increase in the cost of capital. This was partially offset by $2.0 million in auction-rate securities having been called at par.
 
From the second quarter of 2011 to the third quarter of 2011, the impairment decreased, primarily due to $1.7 million in auction-rate securities having been called at par. This was slightly offset by an increase in the FFELPS student-loan spread.
 
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 year ended December 31, 2011 was $32.0 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 $4.7 million and proceeds from the employee stock purchase plan of $1.8 million. Net cash used in financing activities for the year ended December 31, 2010 was $14.0 million, primarily related to the repurchase of our common stock in the amount of $31.5 million, which was partially offset by the exercise of options and proceeds from our Employee Stock Purchase Plan in the amount of $16.2 million. Net cash provided by financing activities for the year ended December 31, 2009 was $13.6 million, primarily from the exercise of stock options and the sale of our common stock pursuant to proceeds from our Employee Stock Purchase Plan in the amount of $13.0 million.
 
 
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On July 27, 2010, the Board of Directors approved a stock repurchase program that authorized 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. The repurchase is now complete and 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  
 
2010 Calendar Year
 
Shares Repurchased
   
Average Price per Share
   
Value (in thousands)
 
 August
    983,189     $ 17.29     $ 16,998  
 November
    916,600     $ 15.85     $ 14,529  
      1,899,789             $ 31,527  
 
There were no shares repurchased in 2009.
 
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 balances and short term investments, will be sufficient to satisfy our liquidity requirements for the next 12 months. For further details regarding our operating, investing and financing activities, see the Consolidated Statement of Cash Flows.
 
In the future, in order to strengthen our financial position, in the event of unforeseen circumstances, or in the event we need to fund our growth in future financial periods, we may need to raise additional funds by any one or a combination of the following: issuing equity securities, debt or convertible debt or the sale of certain product lines and/or portions of our business. There can be no guarantee that we will be able to raise additional funds on terms acceptable to us, or at all.

From time to time, we have engaged in discussions with third parties concerning potential acquisitions of product lines, technologies and businesses, and we continue to consider potential acquisition candidates. Any such transactions could involve the issuance of a significant number of new equity securities, debt, and/or cash consideration.  We may also be required to raise additional funds to complete any such acquisition, through either the issuance of equity securities or borrowings. If we raise additional funds or acquire businesses or technologies through the issuance of equity securities, our existing stockholders may experience significant dilution.

Contractual Obligations
 
We lease our headquarters and sales offices in San Jose, California. The San Jose facility was sold and the new landlord has exercised their 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 with  Land-Great Oaks, LLC, a California limited liability company 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 was $11.0 million, which was paid on August 4, 2011 and for which the deed was recorded on August 5, 2011.

In September 2004, we signed an agreement with the Chinese local authority to construct a facility in Chengdu, China. Pursuant to this agreement, we agreed to contribute capital in the form of cash, in-kind assets, and/or intellectual property, of at least $5.0 million to our wholly-owned Chinese subsidiary as the registered capital for the subsidiary and exercised the option to purchase land use rights for the facility of approximately $0.2 million. We also have the option to acquire the facility after a five-year lease term for the original construction cost less rents paid, which is currently estimated at $1.9 million and which option became exercisable in March 2011. We will likely exercise our purchase option and enter into a purchase agreement for this facility in the future. We constructed a 150,000 square foot research and development facility in Chengdu, China which was put into operation in October 2010.
 
 
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As of December 31, 2011, our total outstanding purchase commitments were $18.6 million, which includes wafer purchases from our three 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.
 
The following table summarizes our contractual obligations at December 31, 2011, and the effect such obligations are expected to have on our liquidity and cash flow over the next five years (in thousands).

   
Payments by Period
 
   
Total
   
2012
   
2013
   
2014
   
2015
   
2016
   
Thereafter
 
Operating leases
  $ 2,138     $ 1,222     $ 784     $ 132     $ -     $ -     $ -  
Outstanding purchase commitments
    18,574       18,574       -       -       -       -       -  
    $ 20,712     $ 19,796     $ 784     $ 132     $ -     $ -     $ -  
 
Because of the uncertainty as to the timing of payments related to our liabilities for unrecognized tax benefits, we have excluded estimated obligations of $4.5 million from the table above.

Off Balance Sheet Arrangements

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

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Interest Rate Risk

Our cash equivalents and investments are subject to market risk, primarily interest rate and credit risk. Our investments are managed by outside professional managers within investment guidelines set by us. Such guidelines include security type, credit quality and maturity and are intended to limit market risk by restricting our investments to high quality debt instruments with relatively short-term maturities.

We do not use derivative financial instruments in our investment portfolio. Investments in debt securities are classified as available-for-sale or trading. For available-for-sale investments, no gains or losses are recognized by us in our results of operations due to changes in interest rates unless such securities are sold prior to maturity or are determined to be other-than-temporarily impaired. Available-for-sale investments are reported at fair value with the related unrealized gains or losses being included in accumulated other comprehensive income, a component of stockholders’ equity. Trading securities are reported at fair value with unrealized gains and losses included in earnings.

Fluctuations in interest rates of +/- 10% could impact our annual results of operations by approximately $0.1 million. The calculation is based on a 10% deviation from interest rates of 3 bps and takes into account, the ending cash and investment balances for 2011, with assumed increases similar to that in 2011.

Foreign Currency Exchange Risk

Our sales outside the United States are transacted in U.S. dollars. Accordingly, our sales are not generally impacted by foreign currency rate changes. In 2011, the primary functional currency of the Company’s offshore operations was the local currency, primarily the New Taiwan Dollar and the Chinese Yuan. To date, fluctuations in foreign currency exchange rates have not had a material impact on our results of operations. However, fluctuations of +/- 10% on intercompany transactions of $43.8 million in such local currencies could impact our annual results of operations by approximately $4.4 million .

Value Change to Long-Term Investments

As of December 31, 2011, all of our holdings in auction rate securities, which have a face value of $14.4 million, have failed to reset as a result of current market conditions. Should these auctions continue to fail and if the credit rating for these securities decline, a 10% decline in the fair value could impact our results of operations by approximately $1.4 million.

In valuing the auction-rate securities using the discounted cash flow model, a change in either the liquidity risk premium or time-to-liquidity by 10% would result in less than a $0.1 million change in the value of our auction-rate securities portfolio.
 
 
36

 
 
ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
MONOLITHIC POWER SYSTEMS, INC.
 
CONSOLIDATED FINANCIAL STATEMENTS
 
Contents
 
 
Page
Reports of Independent Registered Public Accounting Firm
38
Consolidated Balance Sheets
40
Consolidated Statements of Operations
41
Consolidated Statements of Stockholders’ Equity
42
Consolidated Statements of Cash Flows
43
Notes to Consolidated Financial Statements
44
 
 
37

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCCOUNTING FIRM

To the Board of Directors and Stockholders of
Monolithic Power Systems, Inc.
San Jose, California


We have audited the accompanying consolidated balance sheets of Monolithic Power Systems, Inc. and subsidiaries (collectively, the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on the financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Monolithic Power Systems, Inc. and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 12, 2012 expressed an unqualified opinion on the Company’s internal control over financial reporting.

/s/ Deloitte & Touche LLP

San Jose, California
March 12, 2012
 
 
38

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCCOUNTING FIRM

To the Board of Directors and Stockholders of
Monolithic Power Systems, Inc.
San Jose, California
 
 
We have audited the internal control over financial reporting of Monolithic Power Systems, Inc. and subsidiaries (collectively, the “Company”) as of December 31, 2011, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting.  Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances.  We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis.  Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2011, of the Company and our report dated March 12, 2012 expressed an unqualified opinion on those consolidated financial statements.

/s/ Deloitte & Touche LLP

San Jose, California
March 12, 2012
 
 
39

 
 
MONOLITHIC POWER SYSTEMS, INC.
 
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)

   
December 31,
 
   
2011
   
2010
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
    $96,371       $48,010  
Short-term investments
    77,827       129,709  
Accounts receivable, net of allowances of $5 in 2011 and $0 in 2010
    15,097       18,347  
Inventories
    20,104       25,789  
Deferred income tax assets, net - current
    421       204  
Prepaid expenses and other current assets
    1,685       2,314  
Total current assets
    211,505       224,373  
Property and equipment, net
    47,794       37,262  
Long-term investments
    13,675       19,180  
Deferred income tax assets, net - long-term
    239       39  
Other assets
    654       749  
Total assets
    $273,867       $281,603  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
    $8,904       $8,979  
Accrued compensation and related benefits
    9,321       8,792  
Accrued liabilities
    7,845       11,199  
Total current liabilities
    26,070       28,970  
                 
Non-current income tax liabilities
    4,920       5,015  
Other long-term liabilities
    -       723  
Total liabilities
    30,990       34,708  
Stockholders' equity:
               
Common stock, $0.001 par value, $34 and $35 in 2011 and 2010, respectively; shares authorized: 150,000,000; shares issued and outstanding: 33,826,032 and 35,063,033 in 2011 and 2010, respectively
    159,336       178,269  
Retained earnings
    79,948       66,647  
Accumulated other comprehensive income
    3,593       1,979  
Total stockholders’ equity
    242,877       246,895  
Total liabilities and stockholders’ equity
    $273,867       $281,603  
 
See accompanying notes to consolidated financial statements.
 
 
40

 
 
MONOLITHIC POWER SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)

   
Year Ended December 31,
 
   
2011
   
2010
   
2009
 
                   
Revenue
  $ 196,519     $ 218,840     $ 165,008  
Cost of revenue
    94,925       97,383       67,330  
Gross profit
    101,594       121,457       97,678  
Operating expenses:
                       
Research and development
    44,518       44,372       38,295  
Selling, general and administrative
    40,280       41,169       36,752  
Litigation
    3,379       5,418       9,457  
Litigation provision reversal, net
    -       -       (6,356 )
Total operating expenses
    88,177       90,959       78,148  
                         
Income from operations
    13,417       30,498       19,530  
Other income (expense):
                       
Interest and other income
    671       1,156       1,047  
Other expense
    (362 )     (234 )     (429 )
Total other income, net
    309       922       618  
                         
Income before income taxes
    13,726       31,420       20,148  
Income tax provision
    425       1,857       474  
Net income
  $ 13,301     $