Monolithic Power Systems, Inc.
MONOLITHIC POWER SYSTEMS INC (Form: 10-Q, Received: 05/01/2014 17:19:03)

 



 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q


 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2014

 

OR

 

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  ☒     No  ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒     No  ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  ☐       Accelerated filer  ☒       Non-accelerated filer  ☐       Smaller reporting company  ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐     No  ☒

 

There were 38,605,790 shares of the registrant’s common stock issued and outstanding as of April 25, 2014.

 



 

 
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

17

ITEM 3.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

25

ITEM 4.     CONTROLS AND PROCEDURES

25

PART II. OTHER INFORMATION

26

ITEM 1.     LEGAL PROCEEDINGS

26

ITEM 1A. RISK FACTORS

26

ITEM 2.      UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

41

ITEM 6.      EXHIBITS

42

   

 

 
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,

2014

   

December 31,

2013

 

ASSETS

               

Current assets:

               

Cash and cash equivalents

  $ 88,885     $ 101,213  

Short-term investments

    139,750       125,126  

Accounts receivable, net of allowances of $0 as of March 31, 2014 and December 31, 2013

    22,057       23,730  

Inventories

    39,829       39,737  

Deferred income tax assets, net

    292       294  

Prepaid expenses and other current assets

    2,444       1,986  

Total current assets

    293,257       292,086  

Property and equipment, net

    65,897       64,837  

Long-term investments

    9,843       9,860  

Deferred income tax assets, net

    476       481  

Other long-term assets

    5,159       1,644  

Total assets

  $ 374,632     $ 368,908  
                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

               

Current liabilities:

               

Accounts payable

  $ 11,748     $ 10,694  

Accrued compensation and related benefits

    10,332       10,419  

Accrued liabilities

    8,559       17,376  

Total current liabilities

    30,639       38,489  

Income tax liabilities

    5,652       5,542  

Other long-term liabilities

    3,674       1,478  

Total liabilities

    39,965       45,509  

Commitments and contingencies (Notes 6 and 8)

               

Stockholders' equity:

               

Common stock, $0.001 par value; shares authorized: 150,000; shares issued and outstanding: 38,672 and 38,291 as of March 31, 2014 and December 31, 2013, respectively

    237,059       234,201  

Retained earnings

    91,956       82,938  

Accumulated other comprehensive income

    5,652       6,260  

Total stockholders’ equity

    334,667       323,399  

Total liabilities and stockholders’ equity

  $ 374,632     $ 368,908  

 

 

See accompanying notes to unaudited 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,

 
   

2014

   

2013

 

Revenue

  $ 60,061     $ 51,470  

Cost of revenue

    27,964       24,085  

Gross profit

    32,097       27,385  

Operating expenses:

               

Research and development

    15,603       12,123  

Selling, general and administrative

    16,109       13,258  

Litigation benefit, net

    (8,700 )     (301 )

Total operating expenses

    23,012       25,080  

Income from operations

    9,085       2,305  

Interest and other income (expense), net

    190       (10 )

Income before income taxes

    9,275       2,295  

Income tax provision (benefit)

    257       (204 )

Net income

  $ 9,018     $ 2,499  
                 

Basic net income per share

  $ 0.23     $ 0.07  

Diluted net income per share

  $ 0.23     $ 0.07  

Weighted average common shares outstanding:

               

Basic

    38,470       36,259  

Diluted

    39,517       37,708  

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

   

 

 
4

 

 

MONOLITHIC POWER SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(Unaudited)

 

   

Three Months Ended March 31,

 
   

2014

   

2013

 

Net income

  $ 9,018     $ 2,499  

Other comprehensive income (loss), net of tax:

               

Change in unrealized losses on auction-rate securities, net of $0 tax in 2014 and 2013

    (17 )     (15 )

Change in unrealized gains on other available-for-sale securities, net of $0 tax in 2014 and 2013

    5       (7 )

Foreign currency translation adjustments

    (596 )     303  

Total other comprehensive income (loss), net of tax

    (608 )     281  

Comprehensive income

  $ 8,410     $ 2,780  

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 

 
5

 

 

MONOLITHIC POWER SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

   

Three Months Ended March 31,

 
   

2014

   

2013

 

Cash flows from operating activities:

               

Net income

  $ 9,018     $ 2,499  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Depreciation and amortization

    3,182       2,709  

Amortization and realized loss (gain) on investments

    71       98  

Excess tax benefit from stock option transactions

    -       (132 )

Stock-based compensation

    7,598       4,660  

Changes in operating assets and liabilities:

               

Accounts receivable

    1,673       (3,285 )

Inventories

    (81 )     (2,836 )

Prepaid expenses and other current assets

    (2,036 )     315  

Accounts payable

    1,058       2,135  

Accrued liabilities

    (8,473 )     1,889  

Accrued income taxes payable and noncurrent tax liabilities

    38       (526 )

Accrued compensation and related benefits

    (63 )     (822 )

Net cash provided by operating activities

    11,985       6,704  
                 

Cash flows from investing activities:

               

Property and equipment purchases

    (4,516 )     (3,435 )

Purchases of short-term investments

    (41,977 )     (17,590 )

Proceeds from sale of short-term investments

    27,252       21,250  

Proceeds from sale of long-term investments

    -       25  

Net cash provided by (used in) investing activities

    (19,241 )     250  
                 

Cash flows from financing activities:

               

Proceeds from issuance of common shares

    5,554       9,839  

Proceeds from employee stock purchase plan

    1,053       1,167  

Repurchases of common shares

    (11,358 )     -  

Excess tax benefits from stock option transactions

    -       132  

Net cash provided by (used in) financing activities

    (4,751 )     11,138  

Effect of change in exchange rates

    (321 )     91  

Net increase (decrease) in cash and cash equivalents

    (12,328 )     18,183  

Cash and cash equivalents, beginning of period

    101,213       75,104  

Cash and cash equivalents, end of period

  $ 88,885     $ 93,287  

Supplemental disclosures for cash flow information:

               

Cash paid for taxes

  $ 217     $ 324  

Supplemental disclosures of non-cash activities:

               

Liability accrued for property and equipment purchases

  $ 445     $ 4,230  

 

 

See accompanying notes to unaudited 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 the Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on March 10, 2014.

 

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, 2014 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, 2014 as compared to the significant accounting policies described in the Company’s audited consolidated financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2013.

 

Recently Adopted Accounting Pronouncement

 

In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists . The standard gives guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists, with the purpose of reducing diversity in practice. This new standard requires the netting of unrecognized tax benefits against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax positions. The Company adopted this standard in the first quarter of 2014 prospectively and the adoption did not have an impact on its consolidated financial position, results of operations, or cash flows.

 

2. Stock-Based Compensation

 

Stock Plans

 

As of March 31, 2014, approximately 2.9 million shares were available for future issuance under the 2004 Equity Incentive Plan (the “2004 Plan”). The 2004 Plan will expire on November 12, 2014. Once the 2004 Plan expires, the Company will no longer be able to grant equity awards under the 2004 Plan, and any shares otherwise remaining available for future grants under the 2004 Plan will no longer be available for issuance.

 

The Company’s Board of Directors adopted the 2014 Equity Incentive Plan (the “2014 Plan”) in April 2013, and the Company’s stockholders approved it in June 2013. The 2014 Plan will become effective on November 13, 2014, the day after the 2004 Plan expires. The 2014 Plan provides for the issuance of up to 5,500,000 shares and will expire on November 13, 2024.

 

 

 
7

 

 

Stock-Based Compensation Expense

 

The Company recognized stock-based compensation expenses as follows (in thousands):

 

   

Three Months Ended March 31,

 
   

2014

   

2013

 

Cost of revenue

  $ 205     $ 156  

Research and development

    2,005       1,373  

Selling, general and administrative

    5,388       3,131  

Tax benefit

    -       (47 )

Total

  $ 7,598     $ 4,613  

 

Restricted Stock

 

The Company’s restricted stock units (“RSUs”) include time-based RSUs, performance-based RSUs (“PSUs”) and market-based RSUs (“MSUs”). A summary of the RSUs is presented in the table below:

 

   

Time-Based

RSUs

   

Weighted-

Average Grant

Date Fair

Value Per

Share

   

PSUs

   

Weighted-

Average Grant

Date Fair

Value Per

Share

   

MSUs

   

Weighted-

Average Grant

Date Fair

Value Per

Share

   

Total

   

Weighted-

Average Gran t

Date Fair

Value Per

Share

 

Outstanding at January 1, 2014

    754,306     $ 19.41       1,027,782     $ 23.02       1,800,000     $ 23.57       3,582,088     $ 22.53  

Awards granted (1)

    120,135     $ 32.06       756,684     $ 31.58       -     $ -       876,819     $ 31.65  

Performance adjustment (2)

    -     $ -       (155,255 )   $ 29.65       -     $ -       (155,255 )   $ 29.65  

Awards released

    (145,524 )   $ 18.97       (165,136 )   $ 17.76       -     $ -       (310,660 )   $ 18.33  

Awards forfeited

    (3,892 )   $ 18.39       -     $ -       -     $ -       (3,892 )   $ 18.39  

Outstanding at March 31, 2014

    725,025     $ 21.60       1,464,075     $ 27.33       1,800,000     $ 23.57       3,989,100     $ 24.59  

 


(1)

The number of PSUs granted reflects the maximum number of shares that can ultimately be earned assuming the achievement of the highest level of performance conditions under the programs.

(2)

The performance adjustment reflects the number of PSUs that have not been earned or will not ultimately be earned based on management’s probability assessment.

 

The intrinsic value related to awards released for the three months ended March 31, 2014 and 2013 was $10.2 million and $8.7 million, respectively. As of March 31, 2014, the total intrinsic value of outstanding awards was $154.7 million, based on the closing stock price of $38.77. As of March 31, 2014, unamortized compensation expense related to outstanding awards was approximately $61.2 million with a weighted-average remaining recognition period of approximately six years.

 

2014 Time-Based RSUs and PSUs:

 

In February 2014, the Board of Directors granted 336,000 shares to the Company’s executive officers. These grants included 25% time-based RSUs which vest over two years on a quarterly basis, and 75% PSUs which represent a target number of RSUs to be awarded based on the Company achieving an average two-year (2014 and 2015) revenue growth rate compared against the analog industry’s average two-year revenue growth rate as determined by the Semiconductor Industry Association (“2014 Executive PSUs”). The maximum number of 2014 Executive PSUs that an executive officer can ultimately earn is 300% of the target shares granted. Half of the 2014 Executive PSUs will vest in February 2016 if the pre-determined performance goals are met and approved by the Compensation Committee and the executive officer is employed by the Company. The remaining shares will vest over the following two years on a quarterly basis, subject to continued employment.

 

Stock Options

 

A summary of the stock options activities 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, 2014

    1,356,446     $ 15.86       1.9     $ 25,505,753  

Options exercised

    (350,920 )   $ 15.83                  

Options forfeited and expired

    (1,167 )   $ 11.48                  

Outstanding at March 31, 2014

    1,004,359     $ 15.87       1.7     $ 22,998,787  

Options exercisable at March 31, 2014 and expected to vest

    1,002,281     $ 15.88       1.7     $ 22,942,298  

Options exercisable at March 31, 2014

    942,757     $ 16.01       1.5     $ 21,459,665  

 

 

 
8

 

 

Total intrinsic value of options exercised was $6.9 million and $5.6 million for the three months ended March 31, 2014 and 2013, respectively. The net cash proceeds from the exercise of stock options were $5.6 million and $9.8 million for the three months ended March 31, 2014 and 2013, respectively. At March 31, 2014, unamortized compensation expense related to unvested options was approximately $0.4 million with a weighted-average remaining recognition period of approximately one year.

 

Employee Stock Purchase Plan

  

For the three months ended March 31, 2014 and 2013, 43,000 and 65,000 shares, respectively, were issued under the Employee Stock Purchase Plan. As of March 31, 2014, 4.8 million shares were available for future issuance.

 

The intrinsic value of stock purchased was $0.5 million for both the three months ended March 31, 2014 and 2013. As of March 31, 2014, the unamortized expense was $0.2 million, which will be recognized over five months. The Black-Scholes model was used to value the employee stock purchase rights with the following assumptions:

 

   

Three Months Ended March 31,

 
   

2014

   

2013

 

Expected term (years)

    0.5       0.5  

Expected volatility

    33.9 %     28.5 %

Risk-free interest rate

    0.1 %     0.1 %

Dividend yield

    -       -  

 

Cash proceeds from employee stock purchases for the three months ended March 31, 2014 and 2013 were $1.1 million and $1.2 million, respectively. 

  

3. Balance Sheet Components 

 

Inventories 

 

Inventories consist of the following (in thousands):

 

   

March 31,

2014

   

December 31,

2013

 

Work in process

  $ 24,874     $ 26,605  

Finished goods

    14,955       13,132  

Total inventories

  $ 39,829     $ 39,737  

 

Other Long-Term Assets

 

Other long-term assets consist of the following (in thousands):

 

   

March 31,

2014

   

December 31,

2013

 

Deferred compensation plan assets

  $ 2,570     $ 607  

Prepaid expense

    1,632       57  

Other

    957       980  

Total other long-term assets

  $ 5,159     $ 1,644  

 

 

 
9

 

 

Accrued Liabilities

 

Accrued liabilities consist of the following (in thousands):

 

   

March 31,

2014

   

December 31,

2013

 

Proceeds from litigation (see Note 6)

  $ -     $ 9,489  

Deferred revenue and customer prepayments

    2,940       2,523  

Stock rotation reserve

    1,779       1,459  

Sales rebate

    1,072       900  

Commissions

    786       931  

Warranty

    334       451  

Other

    1,648       1,623  

Total accrued liabilities

  $ 8,559     $ 17,376  

 

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

 

   

Three Months Ended March 31,

 
   

2014

   

2013

 

Balance at beginning of period

  $ 451     $ 331  

Warranty provision for product sales

    60       103  

Settlements made

    (74 )     (93 )

Unused warranty provision

    (103 )     (66 )

Balance at end of period

  $ 334     $ 275  

 

Other Long-Term Liabilities

 

Other long-term liabilities consist of the following (in thousands):

 

   

March 31,

2014

   

December 31,

2013

 

Deferred compensation plan liabilities

  $ 2,567     $ 628  

Other

    1,107       850  

Total other long-term liabilities

  $ 3,674     $ 1,478  

   

4. Net Income per Share 

 

Basic net income per share 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 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,

 
   

2014

   

2013

 

Numerator:

               

Net income

  $ 9,018     $ 2,499  
                 

Denominator:

               

Weighted average outstanding shares used to compute basic net income per share

    38,470       36,259  

Effect of dilutive securities

    1,047       1,449  

Weighted average outstanding shares used to compute diluted net income per share

    39,517       37,708  
                 

Net income per share - basic

  $ 0.23     $ 0.07  

Net income per share - diluted

  $ 0.23     $ 0.07  

 

 

 
10

 

 

For the three months ended March 31, 2014, there were no anti-dilutive common stock equivalents. For the three months ended March 31, 2013, approximately 0.2 million common stock equivalents were excluded from the calculation of diluted net income per share because their inclusion would have been anti-dilutive.  

 

5. Segment Information

 

As defined by the requirements of ASC 280-10-55, Segment Reporting – Overall – Implementation , 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, storage and computing, consumer and industrial markets. The Company’s chief operating decision maker is its chief executive officer. The Company derives a majority of its revenue from sales to customers located outside North America, with geographic revenue based on the customers’ ship-to locations.

 

The following table summarizes those distributors with sales greater than 10% of the Company's total revenue:

 

   

Three Months Ended March 31,

 

Customer

 

2014

   

2013

 

A

    26 %     34 %

B

    10 %     *  

 

*Represents less than 10%.

 

The following table summarizes those distributors with accounts receivable balances greater than 10% of the Company’s total accounts receivable:

 

Customer

 

March 31,

2014

   

December 31,

2013

 

A

    24 %     32 %

B

    16 %     17 %

 

The following is a summary of revenue by geographic regions (in thousands):

   

   

Three Months Ended March 31,

 

Country and Region

 

2014

   

2013

 

China

  $ 36,859     $ 26,779  

Taiwan

    9,064       7,519  

Europe

    4,591       3,950  

Korea

    2,736       2,418  

United States

    2,603       1,901  

Japan

    2,141       1,521  

Southeast Asia

    2,013       7,329  

Other

    54       53  

Total

  $ 60,061     $ 51,470  

 

The following is a summary of revenue by product family (in thousands):

 

   

Three Months Ended March 31,

 

Product Family

 

2014

   

2013

 

DC to DC products

  $ 53,935     $ 46,442  

Lighting control products

    6,126       5,028  

Total

  $ 60,061     $ 51,470  

 

 

 
11

 

 

The following is a summary of long-lived assets by geographic regions (in thousands):

 

Country

 

March 31,

2014

   

December 31,

2013

 

China

  $ 39,093     $ 41,557  

United States

    31,753       24,719  

Other

    210       205  

Total

  $ 71,056     $ 66,481  

 

6. 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 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

 

In May 2012, the United States District Court for the Northern District of California (the “District Court”) 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 was in addition to the approximately $0.3 million in taxable costs that the District Court had earlier ordered O2 Micro to pay to the Company in connection with the same lawsuit.  In October 2012, O2 Micro appealed the District Court’s judgment to the United States Court of Appeals for the Federal Circuit (the “Federal Circuit”). In August 2013, the Federal Circuit affirmed O2 Micro’s liability for the full amount of the award.  In September 2013, O2 Micro filed a petition for rehearing of that ruling, but the Federal Circuit denied O2 Micro’s petition for rehearing on October 16, 2013. 

 

In November 2013, the Company received a cash payment of $9.5 million from O2 Micro. In January 2014, O2 Micro filed an appeal with the United States Supreme Court. Had O2 Micro been successful in obtaining a favorable ruling against the Company, MPS could have been liable to return a portion or all of the $9.5 million to O2 Micro. Accordingly, the Company recorded the $9.5 million as a current liability as of December 31, 2013.

 

In March 2014, the Supreme Court declined to hear the case. As O2 Micro has no further legal avenues to appeal, the Company released the current liability of $9.5 million and recorded the amount in litigation benefit, net, in the Condensed Consolidated Statement of Operations in the first quarter of 2014. In addition, the Company incurred additional legal fees of $500,000 in connection with the final resolution of the lawsuit.

 

7. Cash, Cash Equivalents and Investments 

 

The following is a summary of the Company’s cash and cash equivalents, short-term and long-term investments (in thousands):

 

   

Estimated Fair Market Value as of

 
   

March 31,

2014

   

December 31,

2013

 

Cash, cash equivalents and investments:

               

Cash

  $ 62,857     $ 62,625  

Money market funds

    26,028       35,588  

U.S. treasuries and government agency bonds

    139,750       128,126  

Auction-rate securities backed by student-loan notes

    9,843       9,860  

Total cash, cash equivalents and investments

  $ 238,478     $ 236,199  

 

 

 
12

 

 

Reported as:

 

March 31,

2014

   

December 31,

2013

 

Cash and cash equivalents

  $ 88,885     $ 101,213  

Short-term investments

    139,750       125,126  

Long-term investments

    9,843       9,860  

Total cash, cash equivalents and investments

  $ 238,478     $ 236,199  

 

For the three months ended March 31, 2014, the Company did not redeem any auction-rate securities. For the three months ended March 31, 2013, the Company redeemed $25,000 of auction-rate securities at par.

 

The contractual maturities of the Company’s short-term and long-term available-for-sale investments are as follows (in thousands):

 

   

March 31,

2014

   

December 31,

2013

 

Due in less than 1 year

  $ 89,651     $ 95,509  

Due in 1 - 5 years

    50,099       29,617  

Due in greater than 5 years

    9,843       9,860  
    $ 149,593     $ 134,986  

 

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, 2014

 
   

Adjusted Cost

   

Unrealized Gains

   

Unrealized Losses

   

Total Fair Value

   

Fair Value of

Investments in

Unrealized

Loss Position

 
                                         

Money market funds

  $ 26,028     $ -     $ -     $ 26,028     $ -  

U.S. treasuries and government agency bonds

    139,743       32       (25 )     139,750       34,000  

Auction-rate securities backed by student-loan notes

    10,220       -       (377 )     9,843       9,843  
    $ 175,991     $ 32     $ (402 )   $ 175,621     $ 43,843  

   

   

As of December 31, 2013

 
   

Adjusted Cost

   

Unrealized Gains

   

Unrealized Losses

   

Total Fair Value

   

Fair Value of

Investments in

Unrealized

Loss Position

 
                                         

Money market funds

  $ 35,588     $ -     $ -     $ 35,588     $ -  

U.S. treasuries and government agency bonds

    128,123       26       (23 )     128,126       42,880  

Auction-rate securities backed by student-loan notes

    10,220       -       (360 )     9,860       9,860  
    $ 173,931     $ 26     $ (383 )   $ 173,574     $ 52,740  

 

The following table details the fair value measurement of the financial assets (in thousands):

 

   

Fair Value Measurement at March 31, 2014

 
           

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

  $ 26,028     $ 26,028     $ -     $ -  

U.S. treasuries and government agency bonds

    139,750       -       139,750       -  

Auction-rate securities backed by student-loan notes

    9,843       -       -       9,843  
    $ 175,621     $ 26,028     $ 139,750     $ 9,843  

   

 

 
13

 

 

   

Fair Value Measurement at December 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

  $ 35,588     $ 35,588     $ -     $ -  

U.S. treasuries and government agency bonds

    128,126       -       128,126       -  

Auction-rate securities backed by student-loan notes

    9,860       -       -       9,860  
    $ 173,574     $ 35,588     $ 128,126     $ 9,860  

 

The Company's level 2 assets consist of U.S. treasuries and 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):

 

Balance at January 1, 2014

  $ 9,860  

Sales and settlement at par

    -  

Change in unrealized loss included in other comprehensive income

    (17 )

Ending balance at March 31, 2014

  $ 9,843  

  

As of March 31, 2014, the Company’s investment portfolio included $9.8 million in government-backed student loan auction-rate securities, net of impairment charges of $407,000, of which $377,000 was temporary and $30,000 was recorded as other-than-temporary. This compares to an investment balance as of December 31, 2013 of $9.9 million, net of impairment charges of $390,000, of which $360,000 was temporary and $30,000 was recorded as other-than-temporary.

  

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 with the following assumptions:

 

   

March 31,

2014

   

December 31,

2013

 

Time-to-liquidity (months)

    24         24    

Expected return

    2.7%         2.5%    

Discount rate

  3.6%  - 8.4%     3.3% - 8.1%  

 

Deferred Compensation Plan:

 

The Company has a non-qualified, unfunded deferred compensation plan, which became effective in July 2013 and provides certain key employees, including our executive management, with the ability to defer the receipt of compensation in order to accumulate funds for retirement on a tax deferred basis. The Company does not make contributions to the plan or guarantee returns on the investments. The Company is responsible for the plan’s administrative expenses. Participant deferrals and investment gains and losses remain as the Company’s liabilities and the underlying assets are subject to claims of general creditors.

 

As of March 31, 2014 and December 31, 2013, the plan assets totaled $2.6 million and $0.6 million, and the plan liabilities totaled $2.6 million and $0.6 million, respectively. For the three months ended March 31, 2014, the Company recorded an income of $36,000 in interest and other income (expense), net, related to the changes in the cash surrender value of the plan assets and an operating expense of $13,000 related to the changes in the fair value of the plan liabilities.

 

 

 
14

 

 

8.    Income Taxes

 

The income tax provision for the three months ended March 31, 2014 was $0.3 million, or 2.8% of the income before income taxes. This differs from the federal statutory rate 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 options exercises and the releases of RSUs and changes in our valuation allowance.

 

The income tax benefit for the three months ended March 31, 2013 was $(0.2) million, or (8.9)% of the income before income taxes. This differs from the federal statutory rate 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.

 

Unrecognized Tax Benefits

 

As of March 31, 2014 and December 31, 2013, the Company had unrecognized tax benefits of approximately $15.2 million and $14.9 million, respectively. As of March 31, 2014 and December 31, 2013, the Company had approximately $5.2 million and $5.0 million, respectively, of tax benefits that, if recognized, would result in an adjustment to the Company’s effective tax rate after considering the valuation allowance.  

 

Uncertain tax positions relate to the allocation of income and deductions among the Company’s global entities and to the determination of the research and development tax credit. The Company believes that it is reasonably possible that approximately $1.2 million of its unrecognized tax benefits may be released in 2014 as a result of a lapse of the statute of limitations. In addition, it is reasonably possible that over the next twelve-month period the Company may experience other increases or decreases in its unrecognized tax benefits. However, it is not possible to determine either the magnitude or the range of other increases or decreases at this time.

 

The Company recognizes interest and penalties, if any, related to uncertain tax positions in its income tax provision. As March 31, 2014 and December 31, 2013, the Company had $0.8 million of accrued interest related to uncertain tax positions.

 

Income Tax Audits

 

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 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. 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, is $10.5 million, plus interest and penalties, if any. The Company responded to the IRS Revised NOPA in May 2012. In June 2013, the IRS responded and continued to disagree with the Company’s rebuttal. The Company met with the IRS Office of Appeals in March 2014. However, no resolutions were reached in the meeting, and both parties are scheduled to meet again in May 2014. Meanwhile, the Company agreed to grant the IRS an extension of the statute of limitations for taxable years 2005 through 2007 to December 31, 2014. 

 

The IRS also audited the research and development credits carried forward into year 2005 and the credits generated in the years 2005 through 2007. The Company received a NOPA from the IRS in February 2011, proposing to reduce the research and development credits generated in year 2005 through 2007 and the carryforwards, which would then reduce the value of such credits carried forward to subsequent tax years.

 

The Company reviewed and responded to the above proposed adjustments. The Company regularly assesses the likelihood of an adverse outcome resulting from such examinations to determine the adequacy of its provision for income taxes. As of March 31, 2014, based on the technical merits of its tax return filing positions and the interactions to date with the IRS, the Company believes that it is more-likely-than-not that the resolution of the audits will not have a significant impact on the Company’s consolidated financial position, results of operations and cash flows.

 

 

 
15

 

 

9.   Accumulated Other Comprehensive Income

 

The following table summarizes the changes in accumulated other comprehensive income (in thousands):

 

   

Unrealized Losses

on Auction-Rate

Securities

   

Unrealized Gains

on Other

Available -for-Sale

Securities

   

Foreign Currency

Translation

Adjustments

   

Total

 

Balance as of January 1, 2014

  $ (360 )   $ 4     $ 6,616     $ 6,260  

Other comprehensive income (loss) before reclassifications

    (17 )     5       (596 )     (608 )

Amounts reclassified from accumulated other comprehensive income

    -       -       -       -  

Net current period other comprehensive income (loss)

    (17 )     5       (596 )     (608 )

Balance as of March 31, 2014

  $ (377 )   $ 9     $ 6,020     $ 5,652  

  

10.   Stock Repurchase Program  

 

In July 2013, the Board of Directors approved a stock repurchase program that authorizes the Company to repurchase up to $100 million in the aggregate of its common stock through June 30, 2015. All shares are retired upon repurchase. The following table summarizes the repurchase activities under the program:

 

   

Shares Repurchased

   

Average Price Per Share

   

Amount Repurchased

 
                   

(in thousands)

 

Cumulative balance at January 1, 2014

    663,802     $ 31.06     $ 20,615  

Repurchases

    323,789     $ 35.08       11,358  

Cumulative balance at March 31, 2014

    987,591     $ 32.38     $ 31,973  

 

As of March 31, 2014, $68.0 million remained available for future repurchases under the program.

 

 

 
16

 

 

  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 increase our revenue through the introduction of 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 liquidity of our investments on our capital resources,

 

  

the application of our products in the communications, storage and computing, consumer and industrial markets continuing to account for 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 2014 and beyond,

 

  

the factors that we believe will impact our ability to achieve revenue growth,

 

  

the outcome of the IRS audit of our tax returns,

 

  

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, 2014 included in this report and our audited consolidated financial statements and related notes for the year ended December 31, 2013 included in our Annual Report on Form 10-K.

 

 

 
17

 

 

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 storage and computing products, network communications products, flat panel TVs, set top boxes, lighting products and a wide variety of consumer and portable electronics products, and 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. For the three months ended March 31, 2014 and 2013, 88% and 89% of our revenue, respectively, 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, storage and 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 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, financial instruments, inventories, income taxes, warranty obligations and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making the judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Estimates and judgments used in the preparation of our financial statements are, by their nature, uncertain and unpredictable, and depend upon, among other things, many factors outside of our control, such as demand for our products and economic conditions.  Accordingly, our estimates and judgments may prove to be incorrect and actual results may differ, perhaps significantly, from these estimates.

 

We believe the following critical accounting policies reflect our more significant judgments used in the preparation of our consolidated financial statements.

 

Revenue Recognition. We recognize revenue when the following four basic criteria are met: (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 us generally recognizing revenue upon shipment (when title passes) to customers, including distributors, original equipment manufacturers and electronic manufacturing service providers. 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.

 

 

 
18

 

 

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.

 

For the three months ended March 31, 2014 and 2013, approximately 91% and 93%, respectively, of our distributor sales, including sales to our value-added resellers, 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 products purchased during the previous six months.

 

For the three months ended March 31, 2014 and 2013, approximately 9% and 7%, respectively, of our distributor sales were made through small distributors primarily based on purchase orders. These distributors typically have no stock rotation rights.

  

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 consolidated financial statements.  

 

We generally recognize revenue upon shipment of products to the distributors for the following reasons:

 

 

(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 when 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 distributors’ 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 distributors.

 

(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 distributors have sold our products to end customers. 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 revenue balance from these two distributors as of March 31, 2014 and December 31, 2013 was $1.7 million. The deferred costs as of March 31, 2014 and December 31, 2013 were $0.2 million.

 

We generally provide a one to two-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.

 

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.

 

 

 
19

 

 

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, 2014 and December 31, 2013, we had a valuation allowance of $16.7 million attributable to management’s determination that it is more likely than not that most of the deferred tax assets in the U.S. 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 our 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, we have determined that it is more likely than not that the U.S. deferred tax benefits will not be realized.

 

We incurred significant stock-based compensation expense, which related to employee 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 are a party 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, 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.

 

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 use the Black-Scholes model to estimate the fair value of our options and employee stock purchase plan. The fair value of our time-based and performance-based restricted stock units is based on the grant date share price. The fair value of our market-based restricted stock units is estimated using a Monte Carlo simulation model.

 

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 awards, unless the awards are subject to performance or market conditions, in which case we recognize compensation expense over the requisite service period of each separate vesting tranche. For our performance-based awards, we recognize compensation expense when it becomes probable that the performance criteria specified in the plan will be achieved. For our market-based awards, compensation expense is not reversed if the market condition is not satisfied. The amount of stock-based compensation that we recognize is also based on an expected forfeiture rate. If there is a difference between the forfeiture assumptions used in determining stock-based compensation expense 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.

 

 

 
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Results of Operations

 

The table below sets forth the data from our Condensed Consolidated Statement of Operations as a percentage of revenue:  

 

   

Three Months Ended March 31,

 
   

2014

   

2013

 
   

(in thousands, except percentages)

 

Revenue

  $ 60,061       100.0

%

  $ 51,470       100.0

%

Cost of revenue

    27,964       46.6       24,085       46.8  

Gross profit

    32,097       53.4       27,385       53.2  

Operating expenses:

                               

Research and development

    15,603       26.0       12,123       23.5  

Selling, general and administrative

    16,109       26.8       13,258       25.8  

Litigation benefit, net

    (8,700 )     (14.5 )     (301 )     (0.6 )

Total operating expenses

    23,012       38.3       25,080       48.7  

Income from operations

    9,085       15.1       2,305       4.5  

Interest and other income (expense), net

    190       0.3       (10 )     (0.0 )

Income before income taxes

    9,275       15.4       2,295       4.5  

Income tax provision (benefit)

    257       0.4       (204 )     (0.4 )

Net income

  $ 9,018       15.0

%

  $ 2,499       4.9

%

 

Revenue

 

The following table shows our revenue by product family:

 

   

Three Months Ended March 31,

         

Product Family

 

2014

   

% of

Revenue

   

2013

   

% of

Revenue

   

Percentage

Change

 
   

(In thousands, except percentages)

         

DC to DC products

  $ 53,935       89.8 %   $ 46,442       90.2 %     16.1 %

Lighting control products

    6,126       10.2 %     5,028       9.8 %     21.8 %

Total

  $ 60,061       100.0 %   $ 51,470       100.0 %     16.7 %

 

Revenue for the three months ended March 31, 2014 was $60.1 million, an increase of $8.6 million, or 16.7%, from $51.5 million for the three months ended March 31, 2013. This increase was due to higher sales of both DC to DC and lighting control products, as higher unit shipments were offset in part by lower average selling prices for these products. Revenue from our DC to DC products was $53.9 million for the three months ended March 31, 2014, an increase of $7.5 million, or 16.1%, from the same period in 2013. This increase was primarily due to higher sales of our DC to DC converters and battery charger products, offset in part by lower sales of our Mini-Monsters and PMIC products. Revenue from our lighting control products was $6.1 million for the three months ended March 31, 2014, an increase of $1.1 million, or 21.8%, compared with the same period in 2013. This increase was primarily due to higher sales of our WLED products, offset in part by decreased demand for our CCFLC products.

 

 

 
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Cost of Revenue and Gross Margin

 

Cost of revenue consists primarily of costs incurred to manufacture, assemble and test our products, as well as other overhead costs and stock-based compensation expenses.

 

   

Three Months Ended March 31,

         
   

2014

   

2013

   

Percentage

Change

 
   

(in thousands, except percentages)

 

Cost of revenue

  $ 27,964     $ 24,085       16.1 %

Cost of revenue as a percentage of revenue

    46.6 %     46.8 %        

Gross profit

  $ 32,097     $ 27,385       17.2 %

Gross margin

    53.4 %     53.2 %        

   

Gross profit as a percentage of revenue, or gross margin, was 53.4% for the three months ended March 31, 2014, compared to 53.2% for the three months ended March 31, 2013. The increase in gross margin year-over-year was primarily due to an improved product mix of higher margin products, offset in part by lower overhead capitalization, compared to the same period in 2013.

 

Research and Development

 

Research and development expenses consist of salary and benefit expenses and stock-based compensation expenses for design and product engineers, expenses related to new product development, and related facility costs. 

 

   

Three Months Ended March 31,

         
   

2014

   

2013

   

Percentage

Change

 
   

(in thousands, except percentages)

 

Research and development ("R&D")

  $ 15,603     $ 12,123       28.7 %

R&D as a percentage of revenue

    26.0 %     23.5 %        

 

R&D expenses were $15.6 million, or 26.0% of revenue, for the three months ended March 31, 2014 and $12.1 million, or 23.5% of revenue, for the three months ended March 31, 2013. The increase in R&D expenses was primarily due to an increase in bonus accrual and salary and benefits expenses, and an increase in stock-based compensation expenses associated with the performance-based and market-based equity awards. Our R&D headcount as of March 31, 2014 was 452 employees, compared with 398 employees as of March 31, 2013.

 

Selling, General and Administrative

 

Selling, general and administrative expenses include salary and benefit expenses and stock-based compensation expenses for sales, marketing and administrative personnel, sales commissions, travel expenses, related facilities costs, and outside legal and accounting fees.

 

   

Three Months Ended March 31,

         
   

2014

   

2013

   

Percentage

Change

 
   

(in thousands, except percentages)

 

Selling, general and administrative ("SG&A")

  $ 16,109     $ 13,258       21.5 %

SG&A as a percentage of revenue

    26.8 %     25.8 %        

 

SG&A expenses were $16.1 million, or 26.8% of revenue, for the three months ended March 31, 2014 and $13.3 million, or 25.8% of revenue, for the three months ended March 31, 2013. The increase in SG&A expenses was primarily due to an increase in stock-based compensation expenses associated with the performance-based and market-based equity awards, an increase in bonus accrual and an increase in commission expenses due to higher revenue. Our SG&A headcount was 251 employees as of March 31, 2014, compared with 253 employees as of March 31, 2013.

 

Litigation Benefit, Net

 

Litigation benefit, net, includes primarily patent litigation and other contract-related matters.

 

 

 
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Net litigation benefit was $(8.7) million for the three months ended March 31, 2014, compared to a net litigation benefit of $(0.3) million for the three months ended March 31, 2013. The increase in net litigation benefit was primarily due to the recognition of the $9.5 million settlement of the O2 Micro litigation, net of $500,000 of additional legal fees incurred in connection with the final resolution of the litigation. This increase in net litigation benefit was partially offset by higher expenses incurred in other litigation matters for the three months ended March 31, 2014 compared to the same period in 2013.

 

Interest and Other Income (Expense), Net

 

For the three months ended March 31, 2014, interest and other income, net, was $190,000, compared with a net expense of $(10,000) for the three months ended March 31, 2013.  The increase in interest and other income, net, was primarily due to lower foreign exchange losses and higher interest income.

 

Income Tax Provision

 

The income tax provision for the three months ended March 31, 2014 was $0.3 million, or 2.8% of the income before income taxes. This differs from the federal statutory rate primarily because our foreign income was taxed at lower rates and because of the benefit that we realized as a result of stock options exercises and the releases of RSUs and changes in our valuation allowance. The income tax benefit for the three months ended March 31, 2013 was $(0.2) million, or (8.9)% of the income before income taxes. This differs from the federal statutory rate 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 releases of RSUs.

 

Liquidity and Capital Resources

 

   

March 31,

2014

   

December 31,

2013

 
   

(In thousands)

 

Cash and cash equivalents

  $ 88,885     $ 101,213  

Short-term investments

    139,750       125,126  

Total cash, cash equivalents and short-term investments

  $ 228,635     $ 226,339  

Percentage of total assets

    61.0 %     61.4 %
                 

Total current assets

  $ 293,257     $ 292,086  

Total current liabilities

    (30,639 )     (38,489 )

Working capital

  $ 262,618     $ 253,597  

 

As of March 31, 2014, we had cash and cash equivalents of $88.9 million and short-term investments of $139.8 million, compared with cash and cash equivalents of $101.2 million and short-term investments of $125.1 million as of December 31, 2013. As of March 31, 2014, $64.2 million of cash and cash equivalents and $17.0 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 compensation and related benefits, deferred revenue and customer prepayments, and other current liabilities.

 

As of March 31, 2014, we had working capital of $262.6 million, compared with working capital of $253.6 million as of December 31, 2013. The $9.0 million increase in working capital was due to a $1.2 million increase in current assets and a $7.8 million decrease in current liabilities. The increase in current assets was primarily due to an increase in short-term investments, partially offset by a decrease in cash and cash equivalents and accounts receivable. The decrease in current liabilities was primarily due to a decrease in accrued liabilities as we released the liability of $9.5 million related to the O2 Micro litigation in the first quarter of 2014 and recorded it in litigation benefit, net, in the Condensed Consolidated Statement of Operations.

 

 

 
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Summary of Cash Flows 

 

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

 

   

Three Months Ended March 31,

 
   

2014

   

2013

 
   

(In thousands)

 

Cash provided by operating activities

  $ 11,985     $ 6,704  

Cash provided by (used in) investing activities

    (19,241 )     250  

Cash provided by (used in) financing activities

    (4,751 )     11,138  

Effect of exchange rate changes on cash and cash equivalents

    (321 )     91  

Net increase (decrease) in cash and cash equivalents

  $ (12,328 )   $ 18,183  

 

 

For the three months ended March 31, 2014, net cash provided by operating activities was $12.0 million, primarily due to our net income adjusted for certain non-cash items, including depreciation and amortization and stock-based compensation, and a decrease in accrued liabilities. The decrease in accrued liabilities was primarily driven by the release of the liability of $9.5 million related to the O2 Micro litigation. 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 three months ended March 31, 2014, net cash used in investing activities was $19.2 million, primarily reflecting net purchases of short-term investments of $14.7 million and purchases of property and equipment of $4.5 million. For the three months 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 .

 

As of March 31, 2014, our investment portfolio included $9.8 million in government-backed student loan auction-rate securities, net of impairment charges of $407,000, of which $377,000 was temporary and $30,000 was recorded as other-than-temporary. This compares to an investment balance as of December 31, 2013 of $9.9 million, net of impairment charges of $390,000, of which $360,000 was temporary and $30,000 was recorded as other-than-temporary. For the three months ended March 31, 2014 and 2013, we redeemed $0 and $25,000 of auction-rate securities at par.

 

For the three months ended March 31, 2014, net cash used in financing activities was $4.8 million, primarily reflecting $11.4 million used in the repurchases of our common stock, partially offset by $6.6 million of cash proceeds from stock option exercises and stock purchases through our employee stock purchase plan. For the three months ended March 31, 2013, net cash provided by financing activities was $11.1 million, primarily reflecting $11.0 million of cash received from the exercise of stock options and stock purchases through our employee stock purchase plan.

 

In July 2013, our Board of Directors approved a stock repurchase program that authorizes us to repurchase up to $100 million in the aggregate of our common stock through June 30, 2015. All shares are retired upon repurchase. For the three months ended March 31, 2014, we repurchased a total of 324,000 shares for $11.4 million, at an average price of $35.08 per share. From the inception of the program through March 31, 2014, we repurchased a total of 988,000 shares for $32.0 million, at an average price of $32.38 per share. As of March 31, 2014, $68.0 million remained available for future repurchases under the program.

 

Although cash requirements will fluctuate based on the timing and extent of many factors such as those discussed above, we believe that cash generated from operations, together with the liquidity provided by existing cash balances and short-term investments, will be sufficient to satisfy our liquidity requirements for the next 12 months. For further details regarding our operating, investing and financing activities, see the Condensed Consolidated Statements 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.

 

 

 
24

 

 

From time to time, we have engaged in discussions with third parties concerning potential acquisitions of product lines, technologies, businesses and companies, 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 or convertible debt securities, our existing stockholders may experience significant dilution.

 

Contractual Obligations

 

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.

 

Currently, we are leasing a manufacturing facility in Chengdu, China. We have an option to acquire this manufacturing facility for approximately $1.7 million, which consists 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.

 

Our outstanding purchase commitments primarily consist of wafer purchases from our foundries and assembly services. As of March 31, 2014, the outstanding balance was $14.2 million, compared with $12.4 million as of December 31, 2013.

  

Our other contractual obligations have not changed significantly from those disclosed in our annual report on Form 10-K for the year ended December 31, 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, 2013. During the three months ended March 31, 2014, there were no material changes or developments that would materially alter the market risk assessment performed as of December 31, 2013.

 

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(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934 as of the end of the period covered by this Annual Report on Form 10-K. 

 

Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of March 31, 2014, 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 the SEC’s 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 quarter ended March 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Limitations on Effectiveness of Controls and Procedures

 

In designing and evaluating our 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.

 

 
25

 

   

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

We and certain of our subsidiaries are parties to actions and proceedings in the ordinary course of business, including litigation regarding our shareholders and our intellectual property, challenges to the enforceability or validity of our intellectual property and claims that our products infringe on the intellectual property rights of others. These proceedings often involve complex questions of fact and law and may require the expenditure of significant funds and the diversion of other resources to prosecute and defend. We defend ourselves vigorously against any such claims.

 

O2 Micro

 

In May 2012, the United States District Court for the Northern District of California (the “District Court”) 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 we won in 2010.  This award was in addition to the approximately $0.3 million in taxable costs that the District Court had earlier ordered O2 Micro to pay to us in connection with the same lawsuit.  In October 2012, O2 Micro appealed the District Court’s judgment to the United States Court of Appeals for the Federal Circuit (the “Federal Circuit”). In August 2013, the Federal Circuit affirmed O2 Micro’s liability for the full amount of the award.  In September 2013, O2 Micro filed a petition for rehearing of that ruling, but the Federal Circuit denied O2 Micro’s petition for rehearing on October 16, 2013. 

 

In November 2013, we received a cash payment of $9.5 million from O2 Micro. In January 2014, O2 Micro filed an appeal with the United States Supreme Court. Had O2 Micro been successful in obtaining a favorable ruling against us, MPS could have been liable to return a portion or all of the $9.5 million to O2 Micro. Accordingly, we recorded the $9.5 million as a current liability as of December 31, 2013.

 

In March 2014, the Supreme Court declined to hear the case. As O2 Micro has no further legal avenues to appeal, we released the current liability of $9.5 million and recorded the amount in litigation benefit, net, in the Condensed Consolidated Statement of Operations in the first quarter of 2014. In addition, we incurred additional legal fees of $500,000 in connection with the final resolution of the lawsuit.

 

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 response to various factors, many of which are beyond our control, including:

 

  

our results of operations and financial performance;

 

  

general economic, industry and market conditions worldwide;

 

  

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;

 

 

 
26

 

 

  

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;

  

  

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;

 

 

 

  

any mergers, acquisitions or divestitures of assets undertaken by us;

 

 

 

  

government debt default;

 

 

 

  

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:

 

 

changes in general demand for electronic products as a result of worldwide macro-economic conditions;

 

  

changes in business conditions at our distributors, value-added resellers and/or end-customers;

 

  

changes in general economic conditions in the countries where our products are sold or used;

  

  

the timing of developments and related expenses in our litigation matters;

 

  

the possibility of lost business as a result of customer and prospective customer concerns about being litigation targets;

 

  

continued dependence on our turns business (orders received and shipped within the same fiscal quarter);

 

  

continued dependence on the Asian markets for our customer base;

 

  

increases in assembly costs due to commodity price increases, such as the price of gold;

 

 

 
27

 

 

  

the timing of new product introductions by us and our competitors;

 

  

changes in our revenue mix between OEMs, ODMs, distributors and value-added resellers;

 

 

changes in product mix and actual and potential product liability;

 

  

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 storage and computing, 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 capacity issues;

  

  

changes in manufacturing yields;

 

  

movements in exchange rates, interest rates or tax rates; and

 

  

accounting charges resulting from 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 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.

 

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. 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.

 

 

 
28

 

 

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), are difficult to accurately forecast;

 

  

our customers’ orders may be canceled or rescheduled without significant penalty to our customers;

 

  

consumer electronic sales, which have experienced a downturn as a result of the worldwide economic crisis;

  

  

changes in revenue mix between OEMs, ODMs, distributors and value-added resellers;

 

  

changes in product mix and actual and potential product liability;

 

  

changes in revenue mix between end market segments (i.e. communication, storage and computing, consumer and industrial);

 

  

our competition, which could adversely impact our selling prices and our potential sales;

 

  

our manufacturing costs, including our ability to negotiate with our vendors and our ability to efficiently run our test facility in China;

 

  

 

manufacturing capacity constraints;

 

settlements of tax audits;

 

  

stock-based compensation accounting charges; and

 

  

our operating expenses, including general and administrative expenses, selling and marketing expenses, and research and development expenses relating to products that will not be introduced and will not generate revenue until later periods, if at all.

 

We may not achieve profitability on a quarterly or annual basis in the future. Unfavorable changes in our operations, including any of the factors noted above, may have a material adverse effect on our quarterly or annual profitability.

  

We may not experience growth rates comparable to past years.

 

In the past, our revenue increased significantly in certain years due to increased sales of certain of our products. Due to various factors, including increased competition, loss of certain of our customer base, unfavorable changes in our operations, reduced global electronics demand, end-customer market downturn, market acceptance and penetration of our current and future products and ongoing litigation, we may not experience growth rates comparable to past periods, which could materially and adversely affect our stock price and results of operations.

 

We may be unsuccessful in developing and selling new products with margins similar to or better than what we have experienced in the past, which would impact our overall gross margin and financial performance.

 

Our success depends on products that are differentiated in the market, which result in gross margins that have historically been above the industry averages. Should we fail to improve our gross margin in the future, and accordingly develop and introduce sufficiently differentiated products that result in higher gross margins than industry averages, our financial condition could be materially adversely affected. 

 

The highly cyclical nature of the semiconductor industry, which has produced significant and sometimes prolonged downturns, could materially adversely affect our operating results, financial condition and cash flows.

 

Historically, the semiconductor industry has been highly cyclical and, at various times, has experienced significant downturns and wide fluctuations in supply and demand. These conditions have caused significant variances in product demand and production capacity, as well as rapid erosion of average selling prices. The industry may experience severe or prolonged downturns in the future, which could result in downward pressure on the price of our products as well as lower demand for our products. Because significant portions of our expenses are fixed in the short term or incurred in advance of anticipated sales, we may not be able to decrease our expenses in a timely manner to offset any sales shortfall. These conditions could have a material adverse effect on our operating results, financial condition and cash flows.

 

 

 
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If demand for our products declines in the major end markets that we serve, our revenue will decrease and our results of operations and financial condition would be materially and adversely affected.

 

We believe that the application of our products in the storage and computer, consumer electronics, communications and industrial markets will continue to account for the majority of our revenue. If the demand for our products declines in the major end markets that we serve, our revenue will decrease and our results of operations and financial condition would be materially and adversely affected. In addition, as technology evolves, the ability to integrate the functionalities of various components, including our discrete semiconductor products, onto a single chip and/or onto other components of systems containing our products increases. Should our customers require integrated solutions that we do not offer, demand for our products could decrease, and our business and results of operations would be materially and adversely affected.

 

We may be unsuccessful in developing and selling new products or in penetrating new markets required to maintain or expand our business.

 

Our competitiveness and future success depend on our ability to design, develop, manufacture, assemble, test, market, and support new products and enhancements on a timely and cost-effective basis. A fundamental shift in technologies in any of our product markets could have a material adverse effect on our competitive position within these markets. Our failure to timely develop new technologies or to react quickly to changes in existing technologies could materially delay our development of new products, which could result in product obsolescence, decreased revenue, and/or a loss of market share to competitors.

 

As we develop new product lines, we must adapt to market conditions that are unfamiliar to us, such as competitors and distribution channels that are different from those we have known in the past. Some of our new product lines require us to re-equip our labs to test parameters we have not tested in the past. If we are unable to adapt rapidly to these new and additional conditions, we may not be able to successfully penetrate new markets.

 

The success of a new product depends on accurate forecasts of long-term market demand and future technological developments, as well as on a variety of specific implementation factors, including:

 

  

timely and efficient completion of process design and device structure improvements;

 

  

timely and efficient implementation of manufacturing, assembly, and test processes;

 

  

the ability to secure and effectively utilize fabrication capacity in different geometries;