Monolithic Power Systems, Inc.
MONOLITHIC POWER SYSTEMS INC (Form: 10-Q, Received: 05/02/2013 16:43:04)

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


FORM 10-Q
 

 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2013
 
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)
 
79 Great Oaks Boulevard, San Jose, CA 95119 (408) 826-0600
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE AND TELEPHONE NUMBER)
 

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   x     No   o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer   o     Accelerated filer   x     Non-accelerated filer   o     Smaller reporting company   o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   o     No   x
 
There were 3 6,775,880 shares of the registrant’s common stock issued and outstanding as of April 25, 2013.
 


 
1

 
 
MONOLITHIC POWER SYSTEMS, INC.
 
TABLE OF CONTENTS
 
PAGE
 
PART I. FINANCIAL INFORMATION
  3  
ITEM 1.
FINANCIAL STATEMENTS (Unaudited)
  3  
 
CONDENSED CONSOLIDATED BALANCE SHEETS
  3  
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
  4  
 
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
  5  
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
  6  
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  7  
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  18  
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  27  
ITEM 4.
CONTROLS AND PROCEDURES
  28  
PART II. OTHER INFORMATION
  28  
ITEM 1.
LEGAL PROCEEDINGS
  28  
ITEM 1A.
RISK FACTORS
  28  
ITEM 4.
MINE SAFETY DISCLOSURES
  43  
ITEM 6.
EXHIBITS
  44  
 
 
2

 
 
 PART I. FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS

 
MONOLITHIC POWER SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
(Unaudited)
 
   
March 31,
2013
   
December 31,
2012
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 93,287     $ 75,104  
Short-term investments
    81,756       85,521  
Accounts receivable, net of allowances of $7 as of March 31, 2013 and $20 as of December 31, 2012
    22,669       19,383  
Inventories
    34,949       32,115  
Deferred income tax assets, net - current
    6       1  
Prepaid expenses and other current assets
    1,764       2,177  
Total current assets
    234,431       214,301  
Property and equipment, net
    62,871       59,412  
Long-term investments
    11,715       11,755  
Deferred income tax assets, net - long-term
    669       669  
Other assets
    1,105       1,025  
Total assets
  $ 310,791     $ 287,162  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
  $ 13,256     $ 9,859  
Accrued compensation and related benefits
    6,875       7,686  
Accrued liabilities
    7,679       5,915  
Total current liabilities
    27,810       23,460  
                 
Long-term liabilities
    1,250          
Non-current income tax liabilities
    5,420       5,408  
Total liabilities
    34,480       28,868  
Stockholders' equity:
               
Common stock, $0.001 par value; shares authorized: 150,000; shares issued and outstanding: 36,733 and 35,673 as of March 31, 2013 and December 31, 2012, respectively
    209,316       194,079  
Retained earnings
    62,539       60,040  
Accumulated other comprehensive income
    4,456       4,175  
Total stockholders’ equity
    276,311       258,294  
Total liabilities and stockholders’ equity
  $ 310,791     $ 287,162  
 
See accompanying notes to condensed consolidated financial statements.

 
3

 
 
MONOLITHIC POWER SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)
 
   
Three months ended March 31,
 
   
2013
   
2012
 
             
             
Revenue
  $ 51,470     $ 50,484  
Cost of revenue (1)
    24,085       24,074  
Gross profit
    27,385       26,410  
Operating expenses:
               
Research and development (1)
    12,123       11,118  
Selling, general and administrative (1)
    13,258       11,966  
Litigation expense (benefit)
    (301 )     128  
Total operating expenses
    25,080       23,212  
Income from operations
    2,305       3,198  
Interest income (expense) and other, net
    (10 )     106  
Income before income taxes
    2,295       3,304  
Income tax provision (benefit)
    (204 )     309  
Net income
  $ 2,499     $ 2,995  
Basic net income per share
  $ 0.07     $ 0.09  
Diluted net income per share
  $ 0.07     $ 0.08  
Weighted average common shares outstanding:
               
Basic
    36,259       34,105  
Diluted
    37,708       35,538  
                 
  (1) Includes stock-based compensation as follows:                
Cost of revenue   $ 156     $ 95  
Research and development     1,373       1,266  
Selling, general and administrative     3,131       1,954  
Total stock-based compensation expense
  $ 4,660     $ 3,315  
 
See accompanying notes to condensed consolidated financial statements.

 
4

 
 
MONOLITHIC POWER SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(Unaudited)
 
   
Three months ended March 31,
 
   
2013
   
2012
 
Net income
  $ 2,499     $ 2,995  
Other comprehensive income (loss), net of tax:
               
Auction-rate securities valuation reserve adjustments, net of $0 tax in 2013 and 2012
    (15 )     90  
Unrealized loss on available-for-sale securities, net of $0 tax in 2013 and 2012
    (7 )     (16 )
Foreign currency translation adjustments, net of $0 tax in 2013 and 2012
    303       398  
                 
Comprehensive income
  $ 2,780     $ 3,467  
 
See accompanying notes to condensed consolidated financial statements.

 
5

 

MONOLITHIC POWER SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
 
   
Three months ended March 31,
 
             
   
2013
   
2012
 
             
Cash flows from operating activities:
           
Net income
  $ 2,499     $ 2,995  
Adjustments to reconcile net income to net cash provided by operating activities:
         
Depreciation and amortization
    2,709       2,184  
Loss on disposal of property and equipment
    -       74  
Amortization and realized gain on available-for-sale securities
    98       28  
Deferred income tax assets
    -       (2 )
Tax benefit from stock option transactions
    2,914       649  
Excess tax benefit from stock option transactions
    (132 )     (100 )
Stock-based compensation
    4,660       3,315  
Changes in operating assets and liabilities:
               
Accounts receivable
    (3,285 )     (4,849 )
Inventories
    (2,836 )     (1,443 )
Prepaid expenses and other current assets
    315       97  
Accounts payable
    2,135       4,098  
Accrued liabilities
    1,889       2,207  
Accrued income taxes payable and noncurrent tax liabilities
    (3,440 )     (432 )
Accrued compensation and related benefits
    (822 )     (2,602 )
Net cash provided by operating activities
    6,704       6,219  
                 
Cash flows from investing activities:
               
Property and equipment purchases
    (3,435 )     (4,875 )
Purchases of short-term investments
    (17,590 )     (49,415 )
Proceeds from sale of short-term investments
    21,250       25,000  
Proceeds from sale of long-term investments
    25       100  
Net cash provided by (used in) investing activities
    250       (29,190 )
                 
Cash flows from financing activities:
               
Proceeds from issuance of common stock
    9,839       3,985  
Proceeds from employee stock purchase plan
    1,167       1,036  
Excess tax benefits from stock option transactions
    132       100  
Net cash provided by financing activities
    11,138       5,121  
Effect of change in exchange rates
    91       210  
Net increase (decrease) in cash and cash equivalents
    18,183       (17,640 )
Cash and cash equivalents, beginning of period
    75,104       96,371  
Cash and cash equivalents, end of period
  $ 93,287     $ 78,731  
                 
Supplemental disclosures for cash flow information:
               
Cash paid for taxes
  $ 324     $ 125  
Supplemental disclosures of non-cash investing and financing activities:
         
Liability accrued for property and equipment purchases
  $ 4,230     $ 3,099  
Temporary impairment of auction-rate securities
  $ 15     $ (90 )
 
See accompanying notes to condensed consolidated financial statements.
 
 
6

 
 
MONOLITHIC POWER SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
1. Basis of Presentation — The accompanying unaudited condensed consolidated financial statements have been prepared by Monolithic Power Systems, Inc. (the “Company” or “MPS”) in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted in accordance with these rules and regulations. The information in this report should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in its Form 10-K filed with the SEC on March 5, 2013.
 
In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the Company’s financial position, results of operations and cash flows for the interim periods presented. The financial statements contained in this Form 10-Q are not necessarily indicative of the results that may be expected for the year ending December 31, 2013 or for any other future period.

Summary of Significant Accounting Policies

There have been no changes to the Company’s significant accounting policies during the three months ended March 31, 2013 as compared to the significant accounting policies described in the Company’s audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

Recently Adopted Accounting Pronouncements
 
In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This ASU adds new disclosure requirements for items reclassified out of accumulated other comprehensive income (“AOCI”). The ASU is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2012 and must be applied prospectively. The Company adopted this standard effective January 1, 2013 (see Note 10).
 

2. Stock-Based Compensation — The Company recognized stock-based compensation expenses as follows (in thousands):

   
Three months ended March 31,
 
   
2013
   
2012
 
Non-employee
  $ -     $ 5  
ESPP
    192       211  
Restricted stock
    4,134       2,180  
Stock options
    334       919  
    $ 4,660     $ 3,315  
 

The income tax benefit for stock-based compensation expenses was $47,000 and $102,000 for the three months ended March 31, 2013 and 2012, respectively.

2004 Equity Incentive Plan

The following is a summary of the 2004 Equity Incentive Plan, which includes stock options, restricted stock units ( “RSUs ”) and performance share units ( “PSUs ”) :
 
Available for grant as of January 1, 2013
    4,957,244  
Additions to plan
    1,783,664  
Grants
    (550,928 )
Performance awards adjustment
    (49,972 )
Cancellations
    261,755  
Available for grant as of March 31, 2013
    6,401,763  
 
 
7

 
 
A summary of the status of the Company’s stock option plans during the three months ended March 31, 2013 is presented in the table below: 
 
 
 
Stock Options
   
Weighted Average
Exercise Price
   
Weighted Average Remaining
Contractual Term
(Years)
   
Aggregate Intrinsic
Value
 
Outstanding at January 1, 2013 (3,603,762 options exercisable at a weighted-average exercise price of $15.59 per share)
    3,813,361     $ 15.62       2.56     $ 25,379,573  
Options granted
    -       -                  
Options exercised
    (626,970 )     15.69                  
Options forfeited and expired
    (169,325 )     15.18                  
Outstanding at March 31, 2013
    3,017,066     $ 15.63       2.31     $ 26,390,327  
Options exercisable at March 31, 2013 and expected to become exercisable
    3,006,437     $ 15.63       2.30     $ 26,290,048  
Options vested and exercisable at March 31, 2013
    2,848,738     $ 15.61       2.17     $ 24,966,361  
 
Total intrinsic value of options exercised was $5.6 million and $2.8 million, respectively, for the three months ended March 31, 2013 and 2012. The net cash proceeds from the exercise of stock options were $9.8 million and $4.0 million, respectively, for the three months ended March 31, 2013 and 2012. At March 31, 2013, unamortized compensation expense related to unvested options was approximately $1.2 million. The weighted average period over which compensation expense related to these unvested options will be recognized is approximately 1.8 years.
 
The Company used the following weighted-average assumptions to determine the fair value of the options awards:
 
   
Three months ended March 31,
 
   
2013
   
2012
 
Expected term (years)
    3.9       4.1  
Expected volatility
    50.5 %     53.4 %
Risk-free interest rate
    0.6 %     0.6 %
Dividend yield
    -       -  
 
In estimating the expected term, the Company considers its historical stock option exercise experience, post vesting cancellations and remaining contractual term of the options outstanding. In estimating the expected volatility, the Company uses its own historical data to determine its estimated expected volatility. The Company uses the U.S. Treasury yield for its risk-free interest rate and a dividend yield of zero as generally it does not issue dividends. The cash dividend paid in December 2012 was a special dividend and the Company currently does not expect to pay dividends in the future. The Company applies a forfeiture rate that is based on options that have been forfeited historically.
 
  Restricted Stock

A summary of the RSUs and PSUs is presented in the table below:
 
    RSUs    
Weighted
Average Grant
Date Fair
Value Per
Share
   
PSUs
   
Weighted
Average Grant
Date Fair
Value Per
Share
   
Total
   
Weighted
Average Grant
Date Fair
Value Per
Share
   
Weighted
Average
Remaining Recognition
Period (Years)
 
Outstanding at January 1, 2013
    1,098,563     $ 16.96       531,185     $ 18.49       1,629,748     $ 17.46       2.18  
Awards granted
    239,388       23.84       311,540       24.35       550,928       24.13          
Performance awards adjustment (1)
    -       -       49,972       17.55       49,972       17.55          
Awards released
    (161,078 )     16.51       (206,409 )     18.90       (367,487 )     17.85          
Awards forfeited
    (65,374 )     16.52       (27,056 )     17.91       (92,430 )     16.93          
Outstanding at March 31, 2013
    1,111,499     $ 18.53       659,232     $ 21.09       1,770,731     $ 19.48       2.31  
 
 
(1)
The performance awards adjustment reflects the change in management s probability assessment as of March 31, 2013 of the number of PSUs that will ultimately vest.

The intrinsic value related to restricted stock released for the three months ended March 31, 2013 and 2012 was $8.7 million and $2.0 million, respectively. The total intrinsic value of restricted stock outstanding at March 31, 2013 and December 31, 2012, was $43.2 million and $36.3 million, respectively. At March 31, 2013, unamortized compensation expense related to unvested restricted stock was approximately $25.4 million with a weighted-average remaining recognition period of 2.3 years. However, if the highest pre-determined performance targets related to the PSUs are met, unamortized compensation expense will increase by approximately $19.8 million. 

 
8

 
 
2010 PSU Awards: 

On February 25, 2010, the Board granted 416,000 PSUs to the Company’s executive officers (“2010 Executive PSUs”). These performance units generally vested over four years, with a graded acceleration feature that allowed all or a portion of these awards to be accelerated if certain performance conditions were satisfied. The number of shares to be accelerated was based on achieving certain performance targets as set forth in the Company’s annual operating plan approved by the Board, as determined by the Compensation Committee in its sole discretion.  In February 2013, the Compensation Committee determined that the pre-determined performance goals for the 2010 Executive PSUs were met and therefore accelerated the vesting of the remaining awards in February 2013.  As of March 31, 2013, there were no unvested or unreleased 2010 Executive PSUs.
 
2011 CEO Awards:

The Company granted 153,000 time-based RSUs to its CEO on February 8, 2011. In the fourth quarter of 2011, the Compensation Committee proposed modifying half of the time-based RSUs to PSUs and on February 7, 2012, the Board approved the performance goals based on the Company’s 2012 revenue (“2012 Modification”). The time-based RSUs that were not modified vested over two years on a quarterly basis from February 2011 to February 2013. The PSUs vested upon achievement of the pre-determined performance goals and the CEO’s continued employment through the date that the Compensation Committee approves the release of the shares. The maximum number of PSUs the CEO may receive was 100% of the RSUs originally granted. In February 2013, the Compensation Committee determined that the pre-determined performance goals for the 2012 Modification were met and therefore the PSUs were released in February 2013.  As of March 31, 2013, there were no unvested or unreleased 2011 CEO Awards.

2012 RSU and PSU Awards:

On February 14, 2012, the Board granted 413,000 awards to the Company’s executive officers. 50% of the RSUs granted to Company’s executive officers vest over two years on a quarterly basis (“2012 Time-based RSUs”) and 50% of the units represents a target number of RSUs awarded upon achievement of certain  goals (“2012 Executive PSUs”) for the Company’s revenue in 2013. Half of the 2012 Executive PSUs will vest if the pre-determined performance goals are met and the employee is employed by the Company when the Compensation Committee approves the release of the shares. The remainder vests over the following two years on a quarterly basis. The maximum number of 2012 Executive PSUs that can be released to an executive employee is 300% of the PSUs originally granted. The PSUs earned will be reduced by a maximum of 15% in the event that the Company’s total shareholder return (“TSR”), defined as the cumulative change in share price plus dividends, as compared to the Company’s compensation peer group, is below a specified percentile for calendar years 2012 and 2013.

Based on the Company’s revenue forecast as of March 31, 2013, the Company has determined that it is probable that it will be able to exceed the pre-determined performance goals. Stock-based compensation for the PSUs expected to meet the pre-determined goals is determined based on grant date fair value adjusted for expected forfeiture rate and is being amortized over the requisite service period of each separate vesting tranche. The Company continues to evaluate expected performance against the pre-determined goals and will adjust stock-based compensation expense accordingly.
 
On April 24, 2012, the Company granted 344,650 awards to its existing non-executive employees. These grants include 219,317 time-based RSUs, which generally vest over two years on a quarterly basis, and 125,333 PSUs. The PSUs will be a target number of shares awarded upon achievement of a pre-determined revenue target for the Company as a whole, certain regions or product-line divisions in 2013 (“2012 Non-Executive PSUs”). Half of the 2012 Non-Executive PSUs will vest if the pre-determined performance goals are met and the employee is employed by the Company when the Compensation Committee approves the release of the shares.  The remainder vests over the following two years on a quarterly basis. The maximum number of shares an employee may receive is 300% of the PSUs originally granted.

Based on the Company’s revenue forecast as of March 31, 2013, the Company has determined that it is probable that it will be able to achieve the pre-determined performance goals such that the majority of the PSUs granted will vest for the 2012 Non-Executive PSUs. Stock-based compensation for the PSUs expected to meet the pre-determined goals is determined based on grant date fair value adjusted for expected forfeiture rate and is being amortized over the requisite service period of each separate vesting tranche. The Company continues to evaluate expected performance against the pre-determined goals and will adjust stock-based compensation expense accordingly.
 
 
9

 
 
2013 RSU and PSU Awards:

On February 5, 2013, the Board granted 293,760 awards to the Company’s executive officers. 25% of the RSUs granted to Company’s executive officers vest over two years on a quarterly basis (“2013 Time-based RSUs”) and 75% of the units represents a target number of RSUs awarded upon achievement of certain  goals (“2013 Executive PSUs”) for the Company’s revenue in 2014. Half of the 2013 Executive PSUs will vest if the pre-determined performance goals are met and the employee is employed by the Company when the Compensation Committee approves the release of the shares. The remainder vests over the following two years on a quarterly basis. The maximum number of 2013 Executive PSUs that can be released to an executive employee is 300% of the PSUs originally granted.

On February 5, 2013, the Company granted 215,433 awards to its existing non-executive employees. These grants include 124,211 time-based RSUs, which generally vest over two years on a quarterly basis, and 91,222 PSUs. The PSUs will be a target number of shares awarded upon achievement of a pre-determined revenue target for the Company as a whole, certain regions or product-line divisions in 2014 (“2013 Non-Executive PSUs”). Half of the 2013 Non-Executive PSUs will vest if the pre-determined performance goals are met and the employee is employed by the Company when the Compensation Committee approves the release of the shares.  The remainder vests over the following two years on a quarterly basis. The maximum number of shares an employee may receive is 300% of the PSUs originally granted.

Based on the Company’s revenue forecast as of March 31, 2013, the Company has determined that it is probable that it will be able to achieve the pre-determined performance goals such that 100% of the PSUs granted will vest for the 2013 Executive PSUs and the 2013 Non-Executive PSUs. Stock-based compensation for the PSUs expected to meet the pre-determined goals is determined based on grant date fair value adjusted for expected forfeiture rate and is being amortized over the requisite service period of each separate vesting tranche. T he Company continues to evaluate expected performance against the pre-determined goals and will adjust stock-based compensation expense accordingly.

2004 Employee Stock Purchase Plan
  
For the three months ended March 31, 2013 and 2012, 65,247 and 97,247 shares, respectively, were issued under the 2004 Employee Stock Purchase Plan. The following is a summary of the Purchase Plan and changes during the three months ended March 31, 2013:
 
Available shares as of January 1, 2013
   
4,217,960
 
Additions to plan
   
713,466
 
Purchases
   
(65,247
)
Available shares as of March 31, 2013
   
4,866,179
 
 
The intrinsic value for stock purchased was $0.5 million and $0.7 million for the three months ended March 31, 2013 and 2012, respectively. The unamortized expense as of March 31, 2013 was $198,000, which will be recognized over 0.4 year. The Black-Scholes option pricing model was used to value the employee stock purchase rights. For three months ended March 31, 2013 and 2012, the following assumptions were used in the valuation:
 
   
Three months ended March 31,
 
   
2013
   
2012
 
Expected term (years)
    0.5       0.5  
Expected volatility
    28.5 %     50.7 %
Risk-free interest rate
    0.1 %     0.1 %
Dividend yield
    -       -  
 
Cash proceeds from employee stock purchases for the three months ended March 31, 2013 and 2012 were $1.2 million and $1.0 million, respectively.
  
3. Inventories - Inventories consist of the following (in thousands):

   
March 31,
2013
   
December 31,
2012
 
Work in progress
  $ 24,963     $ 20,992  
Finished goods
    9,986       11,123  
Total inventories
  $ 34,949     $ 32,115  
 
 
10

 
 
4. Accrued Liabilities - Accrued liabilities consist of the following (in thousands):
 
   
March 31,
2013
   
December 31,
2012
 
Deferred revenue and customer prepayments
  $ 2,885     $ 2,198  
Stock rotation reserve
    1,554       961  
Legal expenses and settlement costs
    599       402  
Warranty
    275       331  
Other
    2,366       2,023  
Total accrued liabilities
  $ 7,679     $ 5,915  

A roll-forward of the warranty reserve is as follows (in thousands):

   
Three months ended March 31,
 
   
2013
   
2012
 
Balance at beginning of year
  $ 331     $ 561  
Warranty provision for product sales
    103       101  
Settlements made during the period
    (93 )     (6 )
Unused warranty provision
    (66 )     (83 )
Balance at end of period
  $ 275     $ 573  
 
5. Net Income per Share  — Basic net income per share excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted net income per share reflects the potential dilution that would occur if outstanding securities or other contracts to issue common stock were exercised or converted into common stock, and calculated using the treasury stock method.  The Company has securities outstanding, which could potentially dilute basic net income per share in the future, but were excluded from the computation of diluted net income per share in the periods presented, as their effect would have been anti-dilutive. The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):
 
   
Three months ended March 31,
 
   
2013
   
2012
 
Numerator:
           
Net income
  $ 2,499     $ 2,995  
                 
Denominator:
               
Weighted average outstanding shares used to compute basic net income per share
    36,259       34,105  
Effect of dilutive securities
    1,449       1,433  
Weighted average outstanding shares used to compute diluted net income per share
    37,708       35,538  
                 
Net income per share - basic
  $ 0.07     $ 0.09  
Net income per share - diluted
  $ 0.07     $ 0.08  

 
For the three months ended March 31, 2013 and 2012, approximately 0.2 million and 2.1 million weighted common stock equivalents, respectively, were excluded from the calculation of diluted net income per share because their inclusion would have been anti-dilutive.

6. Segment Information
 
As defined by the requirements of ASC 280-10-55, Segment Reporting – Overall – Implementation Guidance and Illustrations , the Company operates in one reportable segment that includes the design, development, marketing and sale of high-performance, mixed-signal analog semiconductors for the communications, computing, consumer and industrial markets. The Company’s chief operating decision maker is its chief executive officer. The Company does not specifically allocate any of its resources to or measure the performance of, individual product families. The Company derives a substantial majority of its revenue from sales to customers located outside North America, with geographic revenue based on the customers’ ship-to location.

The following is a list of customers whose sales exceeded 10% of revenue for the three months ended March 31, 2013 and 2012:
 
 
11

 

     
Three months ended March 31,
 
Customers
   
2013
   
2012
 
               
  A       34 %     29 %
 
Reflecting consolidations in recent years among distributors, the Company corrected the 2012 amount reported in the table above from the amounts previously reported to disclose a group of entities under common control as a single customer, rather than as separate customers. Under the corrected disclosure, Customer A is reported as representing 29% of the Company's total revenue for the three months ended March 31, 2012 (rather than as two separate customers representing 15% and 14% of revenue as previously reported). This correction had no impact on the Company's condensed consolidated balance sheet, condensed consolidated statements of operations, condensed consolidated statements of cash flows or condensed consolidated statements of comprehensive income.

The following is a summary of revenue by geographic region based on customers’ ship-to location (in thousands):
 
   
Three months ended March 31,
 
Country
 
2013
   
2012
 
China
  $ 26,779     $ 29,093  
Taiwan
    7,519       6,415  
Europe
    3,950       4,190  
Japan
    1,521       2,306  
Korea
    2,418       1,959  
USA
    1,901       1,112  
Rest of Asia
    7,329       5,054  
Other
    53       355  
Total
  $ 51,470     $ 50,484  
 
The following is a summary of revenue by product family (in thousands):
 
   
Three months ended March 31,
 
Product Family
 
2013
   
2012
 
DC to DC converters
  $ 46,442     $ 44,342  
Lighting control products
    5,028       6,142  
Total
  $ 51,470     $ 50,484  
 
The following is a summary of long-lived assets by geographic region (in thousands):

   
March 31,
2013
   
December 31,
2012
 
China
  $ 38,694     $ 37,071  
USA
    25,085       23,163  
Taiwan
    83       90  
Japan
    49       57  
Other
    65       55  
Total
  $ 63,976     $ 60,436  
 
7. Litigation
 
The Company and certain of its subsidiaries are parties to actions and proceedings in the ordinary course of business, including litigation regarding its shareholders, a former employee and its intellectual property, challenges to the enforceability or validity of its intellectual property and claims that the Company’s products infringe on the intellectual property rights of others. These proceedings often involve complex questions of fact and law and may require the expenditure of significant funds and the diversion of other resources to prosecute and defend. The Company defends itself vigorously against any such claims.

O2 Micro
 
On May 3, 2012, the United States District Court for the Northern District of California issued an order finding O2 Micro International, Ltd. (“O2 Micro”) liable for approximately $9.1 million in attorneys’ fees and non-taxable costs, plus interest, in connection with the patent litigation that the Company won in 2010.  This award is in addition to the approximately $0.3 million in taxable costs that the Court had earlier ordered O2 Micro to pay to the Company in connection with the same lawsuit. The Court then entered judgment for the Company. In October 2012, O2 Micro filed an appeal against this judgment. As of March 31, 2013, the Company did not record the award as income as payment has not been received.
 
 
12

 
 
Silergy

In December 2011, the Company entered into a settlement and license agreement with Silergy Corp and Silergy Technologies for infringement of the Company’s patent whereby the Company will receive a total of $2.0 million.  The first $1.2 million was paid in equal installments of $300,000 in each quarter of 2012 and the remainder will be paid in two equal installments in first two quarters of 2013. For the three months ended March 31, 2013 and 2012, the Company received payments totaling $400,000 and $300,000, respectively, which were recorded as credits to litigation expense (benefit) in the Condensed Consolidated Statements of Operations.
 
8. Fair Value Measurements
 
The following is a schedule of Company’s cash and cash equivalents, short-term investments and long-term investments (in thousands):

   
Estimated Fair Market Value as of
 
   
March 31,
2013
   
December 31,
2012
 
Cash, cash equivalents and investments
           
Cash in banks
  $ 73,486     $ 59,145  
Money market funds
    19,801       15,959  
Government agencies / treasuries
    81,756       85,521  
Auction-rate securities backed by student-loan notes
    11,715       11,755  
Total cash, cash equivalents and investments
  $ 186,758     $ 172,380  
 
Reported as:
 
March 31,
2013
   
December 31,
2012
 
Cash and cash equivalents
  $ 93,287     $ 75,104  
Short-term investments
    81,756       85,521  
Long-term investments
    11,715       11,755  
Total cash, cash equivalents and investments
  $ 186,758     $ 172,380  
 
The contractual maturities of the Company’s investments classified as available-for-sale is as follows (in thousands):
 
   
March 31,
2013
   
December 31,
2012
 
Due in less than 1 year
  $ 60,794     $ 52,880  
Due in 1 - 5 years
    20,962       32,641  
Due in greater than 5 years
    11,715       11,755  
    $ 93,471     $ 97,276  
 
ASC 820-10 Fair Value Measurements and Disclosures – Overall defines fair value, establishes a framework for measuring fair value and requires that assets and liabilities carried at fair value be classified and disclosed in one of 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.
 
The following table details the fair value measurements within the fair value hierarchy of the financial assets that are required to be recorded at fair value (in thousands):
 
   
Fair Value Measurements at March 31, 2013
 
         
 
Quoted Prices in
Active Markets for
Identical Assets
   
Significant Other Observable Inputs
   
Significant
Unobservable Inputs
 
   
Total
   
Level 1
   
Level 2
   
Level 3
 
Money market funds
  $ 19,801     $ 19,801     $ -     $ -  
US treasuries and US government agency bonds
    81,756       -       81,756       -  
Long-term available-for-sale auction-rate securities
    11,715       -       -       11,715  
    $ 113,272     $ 19,801     $ 81,756     $ 11,715  
 
 
13

 
 
   
Fair Value Measurements at December 31, 2012
 
         
 
Quoted Prices in
Active Markets for
Identical Assets
   
Significant Other Observable Inputs
   
Significant
Unobservable
Inputs
 
   
Total
   
Level 1
   
Level 2
   
Level 3
 
Money market funds
  $ 15,959     $ 15,959     $ -     $ -  
US treasuries and US government agency bonds
    85,521       -       85,521       -  
Long-term available-for-sale auction-rate securities
    11,755       -       -       11,755  
    $ 113,235     $ 15,959     $ 85,521     $ 11,755  
 
 
The following tables summarize unrealized gains and losses related to our investments in marketable securities designated as available-for sale (in thousands):

   
As of March 31, 2013
 
   
Adjusted Cost
   
Unrealized Gains
   
Unrealized Losses
   
Total Fair Value
   
Fair Value of
Investments in
Unrealized
Loss Position
 
                               
Money market funds
  $ 19,801     $ -     $ -     $ 19,801     $ -  
US treasuries and US government agency bonds
    81,724       38       (6 )     81,756       15,363  
Auction-rate securities backed by student-loan notes
    12,220       -       (505 )     11,715       11,715  
    $ 113,745     $ 38     $ (511 )   $ 113,272     $ 27,078  
 
 
   
As of December 31, 2012
 
   
Adjusted Cost
   
Unrealized Gains
   
Unrealized Losses
   
Total Fair Value
   
Fair Value of
Investments in
Unrealized
Loss Position
 
                               
Money market funds
  $ 15,959     $ -     $ -     $ 15,959     $ -  
US treasuries and US government agency bonds
    85,483       45       (7 )     85,521       14,121  
Auction-rate securities backed by student-loan notes
    12,245       -       (490 )     11,755       11,755  
    $ 113,687     $ 45     $ (497 )   $ 113,235     $ 25,876  
 
At March 31, 2013, fixed income available-for-sale securities included $81.8 million securities issued by government agencies and treasuries which are classified as short-term investments on the Condensed Consolidated Balance Sheet. The Company also had $19.8 million invested in money market funds. At March 31, 2013, there was $6,000 in unrealized losses from these investments. The impact of gross unrealized gains and losses was not material.  At March 31, 2013, the Company also had $11.7 million of auction-rate securities, all of which are classified as long-term available-for-sale investments.

At December 31, 2012, fixed income available-for-sale securities included $85.5 million securities issued by government agencies and treasuries which are classified as short-term investments on the Condensed Consolidated Balance Sheet. The Company also had $16.0 million invested in money market funds. At December 31, 2012, there was $7,000 in unrealized losses from these investments. The impact of gross unrealized gains and losses was not material.  At December 31, 2012, the Company also had $11.8 million of auction-rate securities, all of which are classified as long-term available-for-sale investments.
   
Temporary impairment charges are recorded in accumulated other comprehensive income (loss) within stockholders’ equity and have no impact on net income. Other-than-temporary impairment exists when the Company either 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 interest income and other, net in the Condensed Consolidated Statement of Operations.
 
The Company's level 2 assets consist of U.S. treasuries and U.S. government agency bonds. These securities generally have market prices available from multiple sources, which are used as inputs into a distribution-curve based algorithm to determine fair value.
 
The Company’s level 3 assets consist of government-backed student loan auction-rate securities, with interest rates that reset through a Dutch auction every 7 to 35 days and which became illiquid in 2008. The following table provides a reconciliation of the Company’s level 3 assets (in thousands):

 
14

 
 
   
Auction-Rate Securities
 
Beginning balances at January 1, 2013
  $ 11,755  
Sales and settlement at par
    (25 )
Total realized and unrealized gains (losses):
       
Included in interest income and other, net
    -  
Included in other comprehensive income
    (15 )
Ending balance at March 31, 2013
  $ 11,715  
 
 
The Company’s investment portfolio as of March 31, 2013 included $11.7 million in government-backed student loan auction-rate securities, net of impairment charges of $535,000, of which $505,000 was temporary and $30,000 was recorded as other-than-temporary. This compares to an investment balance for auction-rate securities as of December 31, 2012 of $11.8 million in government-backed student loan auction-rate securities, net of impairment charges of $520,000, of which $490,000 was temporary and $30,000 was recorded as other-than-temporary.

The underlying maturities of these auction-rate securities are up to 35 years. As of March 31, 2013 and December 31, 2012, 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 largely 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.
$6.3 million of auction-rate securities were downgraded by Moody’s to A3-Baa3 during the year ended December 31, 2009;
 
6.
All scheduled interest payments have been made pursuant to the reset terms and conditions; and
 
7.
All redemptions of auction-rate securities representing 72% of the original portfolio have been at par.
 
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: 2.0 year expected term, cash flows based on the 90-day t-bill rates for 2.0 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, 2012, the Company was able to redeem a security at face value for which an other-than-temporary impairment of $40,000 had previously been recorded for and therefore, recognized a gain of $40,000 in interest income and other, net, in our Condensed Consolidated Statement of Operations.
 
  Unless a rights offering or other similar offer is made to redeem at par and accepted by the Company, the Company intends to hold the balance of these investments through successful auctions at par, which the Company believes could take approximately 2.0 years.
 
Determining the fair value of the auction-rate securities requires significant management judgment regarding projected future cash flows which will depend on many factors, including the quality of the underlying collateral, estimated time for liquidity including potential to be called or restructured, underlying final maturity, insurance guaranty and market conditions, among others. To determine the fair value of the auction-rate securities, the Company used a discounted cash flow model, for which there are four unobservable inputs: estimated time-to-liquidity, discount rate, credit quality of the issuer and expected interest receipts. A significant increase in the time-to liquidity or the discount rate inputs or a significant decrease in the credit quality of the issuer or the expected interest receipts inputs in isolation would result in a significantly lower fair value measurement.

 
15

 
 
The following are the values used in the discounted cash flow model:
 
    March 31, 2013     December 31, 2012  
Time-to-liquidity (months)
  24     24  
Expected return (based on the requisite treasury rate, plus a contractual penalty rate)
  1.7%     1.8%  
Discount rate (based on the requisite LIBOR, the cost of debt and a liquidity risk premium)
  2.5% -
7.3%, depending on the credit-rating of the security
    2.5% -
7.3% depending on the credit-rating of the security
 
 
If the auctions continue to fail, the liquidity of the Company’s investment portfolio may be negatively impacted and the value of its investment portfolio could decline. 
 
9.    Income Taxes
 
The income tax benefit for the three months ended March 31, 2013 was ($204,000), or (8.9)% of the Company’s profit before income taxes. This differs from the federal statutory rate of 34% primarily because the Company’s foreign income was taxed at lower rates and because of the benefit that the Company realized as a result of stock option exercises and releases of RSUs. The income tax provision for the three months ended March 31, 2012 was $309,000, or 9.4% of the income before income taxes. This differs from the federal statutory rate of 34% primarily because the Company’s foreign income was taxed at lower rates and because of the benefit the Company realized as a result of stock option exercises and the releases of RSUs.

The Company is subject to examination of its income tax returns by the IRS and other tax authorities. The Company’s U.S. Federal income tax returns for the years ended December 31, 2005 through December 31, 2007 are under examination by the IRS. In April 2011, the Company received from the IRS a Notice of Proposed Adjustment (“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 its international subsidiaries and the amount of “buy-in payments” made by the Company’s international subsidiaries to the Company in connection with the cost-sharing agreement, and proposed to increase the Company’s 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. The Company believes that the IRS's position in the NOPA is incorrect and that its tax returns for those years were correct as filed. The Company is contesting these proposed adjustments vigorously. In February 2012, the Company received a revised NOPA from the IRS (Revised NOPA).  In this Revised NOPA, the IRS raised the same issues as in the NOPA issued in April 2011 but under a different methodology.  Under the Revised NOPA, the largest potential federal income tax adjustment, if the IRS were to prevail on all matters in dispute, has decreased to $10.5 million, plus interest and penalties, if any. The Company responded to the IRS Revised NOPA in May 2012, but has not yet received a response from the IRS. As of March 2013, the Company agreed to grant the IRS an extension of the statute of limitations for taxable years 2005 through 2007 to October 31, 2013.

Our French entity is currently under audit for taxable year 2009 and 2010 for which the Company is in the process of responding to questions raised.   Aside from the U.S. and France, there are no other material income tax audits.

The Company regularly assesses the likelihood of an adverse outcome resulting from such examinations to determine the adequacy of its provision for income taxes. Based on the technical merits of its tax return filing positions, the Company believes that it is more-likely-than-not the tax positions it has taken will be sustained upon the resolution of its audits resulting in no material impact on its consolidated financial position and the results of operations and cash flows.

As of March 31, 2013, the Company had unrecognized tax benefits of approximately $13.7 million. Included in this balance is approximately $4.9 million of tax benefits that, if recognized, would result in an adjustment to the Company’s effective tax rate after considering the valuation allowance.  It is reasonably possible that the total amount of unrecognized tax benefits will increase or decrease in the next 12 months. Such changes could occur based on the normal expiration of statutes of limitations or the possible conclusion of ongoing tax audits. However, as of March 31, 2013 the Company does not expect to significantly change its unrecognized tax benefits within the next twelve months.

The Company classifies interest and penalties related to uncertain tax positions as a component of its provision for income taxes. The Company has accrued an insignificant amount of interest and penalties relating to the income tax on the unrecognized tax benefits as of March 31, 2013 and March 31, 2012.
 
 
16

 
 
10.   Accumulated Other Comprehensive Income
 
The following table summarizes the changes in accumulated balances of other comprehensive income for the three months ended March 31, 2013 (in thousands):
 
   
Auction Rate Securities Valuation Reserve Adjustment
   
Unrealized Gain on Available-for-Sale Securities
   
Foreign Currency Translation
   
Tax
   
Total
 
                               
Beginning balance
  $ (490 )   $ 40     $ 4,625     $ -     $ 4,175  
Other comprehensive income (loss) before reclassifications
    (15 )     (6 )     303       -       282  
Amounts reclassified from accumulated other comprehensive income
    -       (1 )     -       -       (1 )
Net current period other comprehensive income (loss)
    (15 )     (7 )     303       -       281  
Ending balance
  $ (505 )   $ 33     $ 4,928     $ -     $ 4,456  
 
The following table provides details about reclassifications out of accumulated other comprehensive income for the three months ended March 31, 2013 (in thousands):

Details about Accumulated Other Comprehensive Income Components
 
Amount Reclassified from Accumulated Other Comprehensive Income
 
Affected Line Items in the Consolidated Statement of Operations
         
Unrealized gains on available-for-sale securities
  $ 1  
Interest income (expense) and other, net
      -  
Income tax provision
      1  
Total, net of tax
           
Total reclassifications for the period
  $ 1  
Total, net of tax
 
 
17

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
This quarterly report on Form 10-Q contains forward-looking statements that involve many risks and uncertainties. These statements relate to future events and our future performance and are based on current expectations, estimates, forecasts and projections about the industries in which we operate and the beliefs and assumptions of our management. These include statements concerning, among others:
 
 
the above-average industry growth of product and market areas that we have targeted,
 
 
our plan to introduce additional new products within our existing product families as well as in new product categories and families,
 
 
our intention to exercise our purchase option with respect to our manufacturing facility in Chengdu, China,
 
 
our belief that we will continue to incur significant legal expenses that vary with the level of activity in each of our legal proceedings,
 
 
the effect of auction-rate securities on our liquidity and capital resources,
 
 
the application of our products in the Communications, Computing, Consumer and Industrial 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 2013,
 
 
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, 2005 through 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 quarterly report on Form 10-Q and, in particular, in the section entitled “Part II. Other Information, 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 quarterly report on Form 10-Q. Readers should carefully review future reports and documents that we file from time to time with the Securities and Exchange Commission, such as our annual reports on Form 10-K, quarterly reports on Form 10-Q and any current reports on Form 8-K.

The following management’s discussion and analysis should be read in connection with the information presented in our unaudited condensed consolidated financial statements and related notes for the three months ended March 31, 2013 included in this report and our audited consolidated financial statements and related notes for the year ended December 31, 2012 included in our Annual Report on Form 10-K filed on March 5, 2013 with the Securities and Exchange Commission.
 
 
18

 
 
Overview
 
We are a fabless semiconductor company that designs, develops, and markets proprietary, advanced analog and mixed-signal semiconductors. 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, automotive and industrial markets. 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 new products within our existing product families, as well as in new innovative product categories.

We operate in the cyclical semiconductor industry where there is seasonal demand for certain 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.
 
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 after we receive an initial customer order for a new product to ramp up. Typical lead time for orders is 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 and direct sales to customers in Asia, where the products we produce are incorporated into end-user products. 89% of our revenue for each of the quarters ended March 31, 2013 and 2012, 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 Communications, Computing, Consumer and Industrial markets. We believe our ability to achieve revenue growth will depend, in part, on our ability to develop new products, enter new market segments, gain market share, manage litigation risk, diversify our customer base and successfully secure manufacturing capacity.

Critical Accounting Policies and Estimates
 
Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an on-going basis, including those related to revenue recognition, stock-based compensation, long-term investments, short-term investments, inventories, income taxes, warranty obligations and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making the judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Estimates and judgments used in the preparation of our financial statements are, by their nature, uncertain and unpredictable, and depend upon, among other things, many factors outside of our control, such as demand for our products and economic conditions.  Accordingly, our estimates and judgments may prove to be incorrect and actual results may differ, perhaps significantly, from these estimates.
 
We believe the following critical accounting policies reflect our more significant judgments used in the preparation of our condensed 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 or 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. Should changes in conditions cause management to determine these criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely impacted.
 
Approximately 93% of our distributor sales, including sales to our value-added resellers, for the three months ended March 31, 2013 were 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), 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.
 
 
19

 
 
Approximately 7% of our distributor sales for the three months ended March 31, 2013 were made through small distributors primarily based on purchase orders. These distributors also have limited or no stock rotation rights.

Our revenue consists primarily of sales of assembled and tested finished goods. We also sell die in wafer form to our customers and value-added resellers, and we 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. Historically, these returns were not material to our condensed consolidated financial statements.  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 or 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.

The terms in a majority of our distribution agreements include the non-exclusive right to promote, develop a market for, and sell our products in certain regions of the world and the ability to terminate the distribution agreement by either party with up to three months’ notice. We provide a one year warranty against defects in materials and workmanship. Under this warranty, we will repair the goods, provide replacements at no charge, or, under certain circumstances, provide a refund to the customer for defective products. Estimated warranty returns and warranty costs are based on historical experience and are recorded at the time product revenue is recognized.
 
Two of our 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 income balance from these two distributors as of March 31, 2013 and December 31, 2012 was $1.6 million and $1.4 million, respectively.
 
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. Conversely, if market conditions are more favorable, inventory may be sold 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 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.

 
20

 
 
Our calculation of current and deferred tax assets and liabilities is based on certain estimates and judgments and involves dealing with uncertainties in the application of complex tax laws. Our estimates of current and deferred tax assets and liabilities may change based, in part, on added certainty or finality or uncertainty to an anticipated outcome, changes in accounting or tax laws in the U.S., or foreign jurisdictions where we operate, or changes in other facts or circumstances. In addition, we recognize liabilities for potential U.S. and foreign income tax for uncertain income tax positions taken on our tax returns if it has less than a 50% likelihood of being sustained. If we determine that payment of these amounts is unnecessary or if the recorded tax liability is less than our current assessment, we may be required to recognize an income tax benefit or additional income tax expense in our financial statements in the period such determination is made. We have calculated our uncertain tax positions which were attributable to certain estimates and judgments primarily related to transfer pricing, cost sharing and our international tax structure exposure.
 
  As of March 31, 2013 and December 31, 2012, we had a valuation allowance for each period of $12.5 million, 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 additional amounts 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.

As a result of the cost sharing arrangements with the Company’s international subsidiaries (cost share arrangements), relatively small changes in costs that are not subject to sharing under the cost share arrangements can significantly impact the overall profitability of the U.S. entity. Because of the U.S. entity’s inconsistent earnings history and uncertainty of future earnings, the Company has determined that it is more likely than not that the U.S. deferred tax benefits will not be realized.

The Company incurred significant stock-based compensation expense, some of which related to incentive stock options and employees stock purchase plans for which no corresponding tax benefit will be recognized unless a disqualifying disposition occurs. Disqualifying dispositions result in a reduction of income tax expense in the period when the disqualifying disposition occurs. Tax benefits related to realized tax deductions in excess of previously expensed stock compensation are recorded as an addition to paid-in-capital.
 
Contingencies . We and certain of our subsidiaries are parties to actions and proceedings incidental 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. 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 fair value for time-based stock awards and stock awards that are contingent upon the achievement of financial performance metrics is based on the grant date share price.
 
  We recognize compensation expense equal to the grant-date fair value for all share-based payment awards that are expected to vest. This expense is recorded on a straight-line basis over the requisite service period of the entire award, unless the awards are subject to market or performance conditions, in which case we recognize compensation expense over the requisite service period of each separate vesting tranche. We recognize compensation expense for our performance share units when it becomes probable that the performance criteria specified in the plan will be achieved. The amount of stock-based compensation that the Company recognizes 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.

 
21

 
 
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.
 
Investments in available-for-sale securities are recorded at fair value, and unrealized gains or losses (that are deemed to be temporary) are recognized through shareholders' equity, as a component of accumulated other comprehensive income in our condensed consolidated balance sheet and in our condensed consolidated statement of comprehensive income. 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.
  
Based on certain assumptions described in Note 8, “Fair Value Measurements” to our condensed consolidated financial statements and the Liquidity and Capital Resources section of Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this quarterly report on Form 10-Q, we recorded impairment charges on our holdings in auction-rate securities. The valuation of these securities is subject to fluctuations in the future, which will depend on many factors, including the collateral quality, potential to be called or restructured, underlying final maturity, insurance guaranty, liquidity and market conditions, among others.

Results of Operations
 
The table below sets forth the data from our Condensed Consolidated Statement of Operations as a percentage of revenue for the periods indicated:  
 
   
Three months ended March 31,
 
   
2013
   
2012
 
   
(in thousands, except percentages)
 
                         
Revenue
  $ 51,470       100.0 %   $ 50,484       100.0 %
Cost of revenue
    24,085       46.8       24,074       47.7  
Gross profit
    27,385       53.2       26,410       52.3  
                                 
Operating expenses:
                               
Research and development
    12,123       23.5       11,118       22.0  
Selling, general and administrative
    13,258       25.8       11,966       23.7  
Litigation expense (benefit), net
    (301 )     (0.6 )     128       0.3  
Total operating expenses
    25,080       48.7       23,212       46.0  
                                 
Income from operations
    2,305       4.5       3,198       6.3  
Interest income and other, net
    (10 )     (0.0 )     106       0.2  
                                 
Income before income taxes
    2,295       4.5       3,304       6.5  
Income tax provision
    (204 )     (0.4 )     309       0.6  
                                 
Net income
  $ 2,499       4.9 %   $ 2,995       5.9 %
 
 
22

 
 
Revenue
 
The following table shows our revenue by product family:
 
   
Three months ended March 31,
       
Product Family
 
2013
   
% of
Revenue
 
2012
   
% of
Revenue
   
Percent
Change
 
   
(In thousands, except percentages)
             
DC to DC converters
  $ 46,442       90.2 %   $ 44,342       87.8 %     4.7 %
Lighting control products
    5,028       9.8 %     6,142       12.2 %     (18.1 %)
Total
  $ 51,470       100.0 %   $ 50,484       100.0 %     2.0 %
 
Revenue for the three months ended March 31, 2013 was $51.5 million, an increase of $1.0 million, or 2%, from $50.5 million for the three months ended March 31, 2012. This increase was primarily due to increased demand for our DC to DC converters which was partially offset by decreased demand for our lighting control products. Revenue from our DC to DC converters was $46.4 million, an increase of $2.1 million, or 5%, over the same period in 2012 primarily due to increased demand for our Mini-Monster products. Revenue from our lighting control products for the three months ended March 31, 2013 was $5.0 million, a decrease of $1.1 million or 18% compared with the same period in 2012 primarily due to reductions in demand for our CCFL and WLED products for backlighting applications.

Cost of Revenue and Gross Margin
 
   
Three months ended March 31,
       
   
2013
   
2012
   
Percent
Change
 
   
(in thousands, except percentages)
 
Cost of revenue (1)
  $ 24,085     $ 24,074       0 %
Cost of revenue as a percentage of revenue
    46.8 %     47.7 %        
Gross profit
  $ 27,385     $ 26,410       4 %
Gross margin
    53.2 %     52.3 %        
(1) Includes stock-based compensation expense
  $ 156     $ 95          
 
Cost of revenue consists primarily of costs incurred to manufacture, assemble and test our products, as well as other overhead costs relating to the aforementioned costs including stock-based compensation expense. Gross profit as a percentage of revenue, or gross margin, was 53.2% for the three months ended March 31, 2013, compared to 52.3% for the three months ended March 31, 2012. The increase in gross profit margin year-over-year was primarily due to an improved product mix offset in part by lower overhead capitalization compared to the same period in 2012.

Research and Development
 
Research and development expenses consist of salary and benefit expenses for design and product engineers, expenses related to new product development, and related facility costs. 
 
   
Three months ended March 31,
       
   
2013
   
2012
   
Percent
Change
 
   
(in thousands, except percentages)
 
Research and development ("R&D") (1)
  $ 12,123     $ 11,118       9 %
R&D as a percentage of revenue
    23.5 %     22.0 %        
(1) Includes stock-based compensation expense
  $ 1,373     $ 1,266          
 
R&D expenses were $12.1 million, or 23.5% of revenue, for the three months ended March 31, 2013 and $11.1 million, or 22.0% of revenue, for the three months ended March 31, 2012. R&D expenses increased year-over-year primarily due to an increase in expenses associated with new product development partially offset by lower bonus accrual. Our R&D headcount as of March 31, 2013 was 398 employees, compared with 387 employees as of March 31, 2012.
 
 
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Selling, General and Administrative

Selling, general and administrative 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.
 
   
Three months ended March 31,
       
   
2013
   
2012
   
Percent
Change
 
   
(in thousands, except percentages)
 
Selling, general and administrative ("SG&A") (1)
  $ 13,258     $ 11,966       11 %
SG&A as a percentage of revenue
    25.8 %     23.7 %        
(1) Includes stock-based compensation expense
  $ 3,131     $ 1,954          
 
SG&A expenses were $13.3 million, or 25.8% of revenue, for the three months ended March 31, 2013 and $12.0 million, or 23.7% of revenue, for the three months ended March 31, 2012. SG&A expenses increased year-over-year primarily due to an increase in stock-based compensation expenses compared to the same period in 2012. Our SG&A headcount was 253 employees as of March 31, 2013, compared with 242 employees as of March 31, 2012.
 
Litigation Expense (Benefit), net

   
Three months ended March 31,
       
   
2013
   
2012
   
Percent
Change
 
   
(in thousands, except percentages)
 
Litigation expense (benefit)
  $ (301 )   $ 128       -335 %
Litigation expense as a percentage of revenue
    -0.6 %     0.3 %        
 
Litigation benefit, net, was $0.3 million, or (0.6)% of revenue, for the three months ended March 31, 2013, compared to an expense of $0.1 million, or 0.3% of revenue, for the three months ended March 31, 2012. The year-over-year decrease in litigation expense was primarily due to $0.4 million received in connection with a settlement reached with Silergy. This payment was recorded as a credit to litigation expense (benefit), net, in the Condensed Consolidated Statements of Operations.
 
Interest Income (Expense) and Other, Net

For the three months ended March 31, interest income (expense) and other, net, was an expense of ($10,000) in 2013 and income of $106,000 in 2012.  Interest income and other fell year-over-year primarily due to a higher foreign exchange loss.

Income Tax Provision

The income tax benefit for the three months ended March 31, 2013 was ($204,000), or (8.9%) of our profit 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 stock option exercises and the releases of RSUs. The income tax provision for the three months ended March 31, 2012 was $309,000, or 9.4% of the income before income taxes. This differs from the federal statutory rate of 34% primarily because the Company’s foreign income was taxed at lower rates and because of the benefit the Company realized as a result of stock option exercises and the releases of RSUs.

 
24

 
 
Liquidity and Capital Resources
 
   
March 31,
2013
   
December 31,
2012
 
   
(In thousands)
       
Cash and cash equivalents
  $ 93,287     $ 75,104  
Short-term investments
    81,756       85,521  
Total cash, cash equivalents and short-term investments
  $ 175,043     $ 160,625  
Percentage of total assets
    56.3 %     55.9 %
                 
Total current assets
  $ 234,431     $ 214,301  
Total current liabilities
    (27,810 )     (23,460 )
Working capital
  $ 206,621     $ 190,841  
 
As of March 31, 2013, we had cash and cash equivalents of $93.3 million and short-term investments of $81.8 million, compared with cash and cash equivalents of $75.1 million and short-term investments of $85.5 million as of December 31, 2012. The increase of $18.2 million in cash and cash equivalents was primarily due to net proceeds from short-term investments, cash generated from operating activites, proceeds from the exercise of stock options, and stock sold through our Employee Stock Purchase Plan (ESPP) offset in part by investment in equipment. As of March 31, 2013, $47.6 million of the $93.3 million of cash and cash equivalents and $17.0 million of the $81.8 million of short-term investments were held by our international subsidiaries. If these funds are needed for our operations in the U.S., we may be required to accrue and pay U.S. taxes to repatriate these funds. However, our intent is to indefinitely reinvest these funds outside of the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations.

The significant components of our working capital are cash and cash equivalents, short-term investments, accounts receivable, inventories, deferred income taxes and prepaid expenses and other current assets, reduced by accounts payable, accrued and other current liabilities, deferred revenue and customer prepayments.

As of March 31, 2013, we had working capital of $206.6 million, compared with working capital of $190.8 million as of December 31, 2012. The $15.8 million increase in working capital was due to a $20.1 million net increase in current assets net of a $4.3 million increase in current liabilities. The increase in current assets was primarily due to increase in cash and cash equivalents, accounts receivable and inventories, which were partially offset by reduction in short- term investments and prepaid expenses. The increase in cash and cash equivalents was primarily due to cash generated from operating activities and proceeds from exercises of stock options and ESPP purchase. In addition, accounts receivable increased primarily reflecting an increase in shipments. The increase in current liabilities was primarily due to increases in accounts payable and accrued liabilities.

Summary of Cash Flows

The table below summarizes the cash and cash equivalents provided by (used in) our operating, investing and financing activities for the periods presented:

   
Three months ended March 31,
 
   
2013
   
2012
 
   
(In thousands)
 
Cash provided by operating activities
  $ 6,704     $ 6,219  
Cash provided by (used in) investing activities
    250       (29,190 )
Cash provided by financing activities
    11,138       5,121  
Effect of exchange rate changes on cash and cash equivalents
    91       210  
Net increase (decrease) in cash and cash equivalents
  $ 18,183     $ (17,640 )
 
For the three months ended March 31, 2013, net cash provided by operating activities was $6.7 million, primarily due to cash contributed from our operating results during the year, which was partially offset by increases in both accounts receivable and inventories. The increase in accounts receivable resulted primarily from an increase in shipments in the first quarter of 2013 and the timing of those shipments. The increase in inventories was primarily due to an increase in strategic wafer and die bank inventories as well as an increase in finished goods necessary to meet anticipated future demand.
 
For the quarter ended March 31, 2013, net cash provided by investing activities was $0.3 million reflecting net proceeds of $3.7 million from short-term investments, which was offset by $3.4 million of equipment and software purchases.
 
We use professional investment management firms to manage the majority of our invested cash. Our fixed income portfolio is primarily invested in US government securities and auction-rate securities. The balance of the fixed income portfolio is managed internally and invested primarily in money market securities for working capital purposes.
 
 
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As of March 31, 2013 our investment portfolio included $11.7 million, in government-backed student loan auction-rate securities, net of impairment charges of $535,000, of which $505,000 was temporary and $30,000 was other-than-temporary. This compares to an investment balance of auction-rate securities as of December 31, 2012 of $11.8 million, net of impairment charges of $520,000, of which $490,000 was temporary and $30,000 was other-than-temporary.
 
The underlying maturities of these auction-rate securities are up to 35 years. As of March 31, 2013 and December 31, 2012, 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 we 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 our holdings in auction rate securities described below, we do not believe that there is any additional credit loss associated with other auction-rate securities because we expect to recover the entire amortized cost basis;
 
5.
$6.3 million of the auction-rate securities were downgraded by Moody’s to A3-Baa3 during the year ended December 31, 2009.;
 
6.
All scheduled interest payments have been made pursuant to the reset terms and conditions; and
 
7.
All redemptions of auction-rate securities representing 72% of the original portfolio have been at par.
 
Based on the guidance of ASC 320-10-35 and ASC 320-10-50, we evaluated the potential credit loss of each of the auction-rate securities that are currently held by us. Based on such analysis, we determined that those securities that are not 100% Federal Family Education Loan Program (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 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. We 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: 2.0 year expected term, cash flows based on the 90-day t-bill rates for 2.0 year forwards and a risk premium of 5.9%, the amount of interest that we were 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 we deemed other-than-temporary and recorded in other expense in its Condensed Consolidated Statement of Operations during 2009. There have been no such losses since. During the year ended December 31, 2012, we were able to redeem one of these two securities at par and therefore, recognized a gain of $40,000 in interest income and other, net, in our Condensed Consolidated Statement of Operations.
 
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.
 
Determining the fair value of the auction-rate securities requires significant management judgment regarding projected future cash flows which will depend on many factors, including the quality of the underlying collateral, estimated time for liquidity including potential to be called or restructured, underlying final maturity, insurance guaranty and market conditions, among others. To determine the fair value of the auction-rate securities at March 31, 2013 and December 31, 2012, we used a discounted cash flow model, for which there are four unobservable inputs: estimated time-to-liquidity, discount rate, credit quality of the issuer and expected interest receipts. A significant increase in the time-to-liquidity or the discount rate inputs or a significant decrease in the credit quality of the issuer or the expected interest receipts inputs in isolation would result in a significantly lower fair value measurement.

The following are the values used in the discounted cash flow model:

    March 31, 2013     December 31, 2012  
Time-to-liquidity (months)
  24     24  
Expected return (based on the requisite treasury rate, plus a contractual penalty rate)
  1.7%     1.8%  
Discount rate (based on the requisite LIBOR, the cost of debt and a liquidity risk premium)
  2.5% -
7.3%, depending on the credit-rating of the security
    2.5% -
7.3% depending on the credit-rating of the security
 

 
26

 

Net cash provided by financing activities for the quarter ended March 31, 2013 was $11.1 million primarily reflecting a combined $9.8 million of cash received from the exercise of stock options and $1.2 million cash received from stock sold through our ESPP. Net cash provided by financing activities for the three months ended March 31, 2012 was $5.1 million, primarily from the proceeds from the exercise of stock options in the amount of $4.0 million and proceeds of $1.0 million in cash received from stock sold through our ESPP.
 
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 our 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 Condensed 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, issuing debt or convertible debt securities, incurring indebtedness secured by our assets, or selling 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 and debt securities or incurring indebtedness secured by our assets. 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 and Off Balance Sheet Arrangements
 
We lease our research and development and sales offices in the United States, Japan, China, Taiwan and Korea. Certain of our facility leases provide for periodic rent increases.

In September 2004, we signed an agreement with the Chinese local authority to construct a facility in Chengdu, China. 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. Following the five-year lease term, we now have an option to acquire this facility in Chengdu for approximately $1.8 million which consist of total construction cost incurred minus total rent paid by us during the lease term.  This option became exercisable in March 2011 and does not expire. 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.

As of March 31, 2013, our total outstanding purchase commitments were $16.4 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 $15.5 million as of December 31, 2012.
  
Our other contractual obligations have not changed significantly from that disclosed in our annual report on Form 10-K filed with the SEC on March 5, 2013.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
For a discussion of market risks, refer to Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” in our annual report on Form 10-K for the year ended December 31, 2012 filed with the SEC on March 5, 2013. During the three months ended March 31, 2013, there were no material changes or developments that would materially alter the market risk assessment performed as of December 31, 2012.
 
 
 
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ITEM 4. CONTROLS AND PROCEDURES
 
Evaluation of disclosure controls and procedures
 
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 as of the end of the period covered by this quarterly report on Form 10-Q.  In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.  In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
 
Based on our evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.
 
Changes in internal control over financial reporting
 
There were no changes in our internal control over financial reporting that occurred during the period covered by this quarterly report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS

 The Company and certain of its subsidiaries are parties to actions and proceedings in the ordinary course of business, including litigation regarding its shareholders, a former employee and its intellectual property, challenges to the enforceability or validity of its intellectual property and claims that the Company’s products infringe on the intellectual property rights of others. These proceedings often involve complex questions of fact and law and may require the expenditure of significant funds and the diversion of other resources to prosecute and defend. The Company defends itself vigorously against any such claims. As of March 31, 2013, the Company did not record the award as income as payment has not been received.
 
O2 Micro
 
On May 3, 2012, the United States District Court for the Northern District of California issued an order finding O2 Micro International, Ltd. (“O2 Micro”) liable for approximately $9.1 million in attorneys’ fees and non-taxable costs, plus interest, in connection with the patent litigation that the Company won in 2010.  This award is in addition to the approximately $300,000 in taxable costs that the Court had earlier ordered O2 Micro to pay to the Company in connection with the same lawsuit. The Court then entered judgment for the Company. In October 2012, O2 Micro filed an appeal against this judgment. 
 
Silergy

In December 2011, the Company entered into a settlement and license agreement with Silergy Corp and Silergy Technologies for infringement of the Company’s patent whereby the Company will receive a total of $2.0 million.  The first $1.2 million was paid in equal installments of $300,000 in each quarter of 2012 and the remainder will be paid in two equal installments in first two quarters of 2013. For the three months ended March 31, 2013 and 2012, the Company received payments totaling $400,000 and $300,000, respectively, which were recorded as credits to litigation expense (benefit) in the Condensed Consolidated Statements of Operations.

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 quarterly report on Form 10-Q and other filings with the Securities and Exchange Commission in evaluating our business.  If any of the following risks actually occur, our business, financial condition, operating results, and growth prospects would likely be 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.
 
  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:
 
 
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our results of operations and financial performance;
 
 
general economic, industry and global market conditions;
 
 
our ability to outperform the market, and outperform at a level that meets or exceeds our investors’ expectations;
 
 
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;
 
 
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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;
 
 
changes in our revenue mix between OEM’s, ODM’s, distributors and value-added resellers;
 
 
changes in product mix;
 
 
the acceptance of our new products in the marketplace;

 
our ability to develop new process technologies and achieve volume production;
 
 
our ability to meet customer product demand in a timely manner;
 
 
the scheduling, rescheduling, or cancellation of orders by our customers;
 
 
the cyclical nature of demand for our customers’ products;
 
 
the fluctuations in our estimate for 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.

Our business has been and may continue to be significantly impacted by the deterioration in worldwide economic conditions and uncertainty in the outlook for the global economy makes it more likely that our actual results will differ materially from expectations.

 
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Global credit and financial markets have experienced disruptions, and may continue to experience disruptions in the future, including diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment rates, and continued uncertainty about economic stability. These economic uncertainties affect businesses such as ours in a number of ways, making it difficult to accurately forecast and plan our future business activities. The continued or further tightening of credit in financial markets may lead consumers and businesses to postpone spending, which may cause our customers to cancel, decrease or delay their existing and future orders with us. In addition, financial difficulties experienced by our suppliers or distributors could result in product delays, increased accounts receivable defaults and inventory challenges. The volatility in the credit markets has severely diminished liquidity and capital availability. Demand for consumer electronics is a function of the health of the economies in the United States, Japan and around the world. As a result of the recent global recession experienced by the U.S. and other economies around the world, as well as the European sovereign debt crisis, the overall demand for electronics has been and may continue to be adversely affected. We cannot predict the timing, strength or duration of any economic disruption or subsequent economic recovery, worldwide, in the United States, in our industry, or in the consumer electronics market. These and other economic factors have had and may continue to have a material adverse effect on demand for our products and on our financial condition and operating results.
 
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;

 
changes in revenue mix between OEM’s, ODM’s, distributors and value-added resellers;
 
 
changes in product mix;