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EX-21.1 - EXHIBIT 21.1 - MONOLITHIC POWER SYSTEMS INCex21-1.htm

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

 
FORM 10-Q
 

 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2012
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission file number: 000-51026
 

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

 
Delaware
77-0466789
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
 
79 Great Oaks Boulevard, San Jose, CA 95119 (408) 826-0600
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE AND TELEPHONE NUMBER)
 

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large
accelerated filer  o    Accelerated filer  x    Non-accelerated filer  o    Smaller reporting company  o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
 
There were 34,556,346 shares of the registrant’s common stock issued and outstanding as of April 30, 2012.
 

 
 
1

 
 
MONOLITHIC POWER SYSTEMS, INC.
 
 
 
PAGE
PART I. FINANCIAL INFORMATION
 
3
    ITEM 1.
 
3
   
3
   
4
   
5
6
   
7
    ITEM 2.
 
18
    ITEM 3.
 
 29
    ITEM 4.
 
29
PART II. OTHER INFORMATION
 
 29
    ITEM 1.
 
 29
    ITEM 1A.
 
 30
    ITEM 4.
 
 43
    ITEM 6.
 
 44
 
 
 PART I. FINANCIAL INFORMATION
 

 
MONOLITHIC POWER SYSTEMS, INC.
(in thousands, except par value and share amounts)
(Unaudited)
 
 
   
March 31,
2012
   
December 31,
2011
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 78,731     $ 96,371  
Short-term investments
    102,197       77,827  
Accounts receivable, net of allowances of $5 in 2012 and 2011
    19,947       15,097  
Inventories
    21,547       20,104  
Deferred income tax assets, net - current
    646       421  
Prepaid expenses and other current assets
    2,352       1,685  
Total current assets
    225,420       211,505  
Property and equipment, net
    51,437       47,794  
Long-term investments
    13,665       13,675  
Deferred income tax assets, net - long-term
    19       239  
Other assets
    639       654  
Total assets
  $ 291,180     $ 273,867  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
         
Current liabilities:
               
Accounts payable
  $ 14,573     $ 8,904  
Accrued compensation and related benefits
    6,746       9,321  
Accrued liabilities
    10,150       7,845  
Total current liabilities
    31,469       26,070  
                 
Non-current income tax liabilities
    4,930       4,920  
Total liabilities
    36,399       30,990  
Stockholders' equity:
               
Common stock, $0.001 par value, $34 in 2012 and 2011; shares authorized: 150,000,000; shares issued and outstanding: 34,410,896 and 33,826,032 in 2012 and 2011, respectively
    167,773       159,336  
Retained earnings
    82,943       79,948  
Accumulated other comprehensive income
    4,065       3,593  
Total stockholders’ equity
    254,781       242,877  
Total liabilities and stockholders’ equity
  $ 291,180     $ 273,867  
 
See accompanying notes to condensed consolidated financial statements. 
 
 
MONOLITHIC POWER SYSTEMS, INC.
(in thousands, except per share amounts)
(Unaudited)
 
 
   
Three months ended March 31,
 
   
2012
   
2011
 
             
Revenue
  $ 50,484     $ 44,468  
Cost of revenue (1)
    24,074       22,163  
Gross profit
    26,410       22,305  
Operating expenses:
               
Research and development (2)
    11,118       10,086  
Selling, general and administrative (3)
    11,966       9,490  
Litigation expense
    128       813  
Total operating expenses
    23,212       20,389  
                 
Income from operations
    3,198       1,916  
Other income (expense):
         
Interest and other income
    157       271  
Interest and other expense
    (51 )     (88 )
Total other income, net
    106       183  
                 
Income before income taxes
    3,304       2,099  
Income tax provision
    309       206  
Net income
  $ 2,995     $ 1,893  
Basic net income per share
  $ 0.09     $ 0.05  
Diluted net income per share
  $ 0.08     $ 0.05  
Weighted average common shares outstanding:
 
Basic
    34,105       35,024  
Diluted
    35,538       36,105  
 
                 
(1) Includes stock-based compensation expense
  $ 95     $ 63  
(2) Includes stock-based compensation expense
    1,266       1,427  
(3) Includes stock-based compensation expense
    1,954       1,497  
Total stock-based compensation expense
  $ 3,315     $ 2,987  
 
See accompanying notes to condensed consolidated financial statements. 
 
 
MONOLITHIC POWER SYSTEMS, INC.
(in thousands)
(Unaudited)
 
 
   
Three months ended March 31,
 
   
2012
   
2011
 
Net income
  $ 2,995     $ 1,893  
Other comprehensive income (loss):
               
Auction-rate securities valuation reserve adjustment
    90       140  
Unrealized gain/ (loss) on available-for-sale securities
    (16 )     (7 )
Foreign currency translation adjustments
    398       154  
Comprehensive income
  $ 3,467     $ 2,180  
 
See accompanying notes to condensed consolidated financial statements.
 
 
MONOLITHIC POWER SYSTEMS, INC.
(in thousands)
(Unaudited)
 
   
Three months ended March 31,
 
   
2012
   
2011
 
             
Cash flows from operating activities:
           
Net income
  $ 2,995     $ 1,893  
Adjustments to reconcile net income to net cash provided by operating activities:
 
Depreciation and amortization
    2,184       2,270  
Loss on disposal of property and equipment
    74       -  
Amortization and realized gain on debt instruments
    28       183  
Deferred income tax assets
    (2 )     -  
Tax benefit from stock option transactions
    649       1,472  
Excess tax benefit from stock option transactions
    (100 )     (435 )
Stock-based compensation
    3,315       2,987  
Changes in operating assets and liabilities:
               
Accounts receivable
    (4,849 )     705  
Inventories
    (1,443 )     2,679  
Prepaid expenses and other current assets
    97       (345 )
Accounts payable
    4,098       1,299  
Accrued and other long-term liabilities
    2,207       (347 )
Accrued income taxes payable and noncurrent tax liabilities
    (432 )     (1,037 )
Accrued compensation and related benefits
    (2,602 )     (3,094 )
Net cash provided by operating activities
    6,219       8,230  
                 
Cash flows from investing activities:
               
Property and equipment purchases
    (4,875 )     (3,056 )
Purchases of short-term investments
    (49,415 )     (15,968 )
Proceeds from sale of short-term investments
    25,000       43,530  
Proceeds from sale of long-term investments
    100       2,050  
Net cash provided by (used in) investing activities
    (29,190 )     26,556  
                 
Cash flows from financing activities:
               
Proceeds from issuance of common stock
    3,985       3,527  
Proceeds from employee stock purchase plan
    1,036       928  
Repurchase of common stock
    -       (13,710 )
Excess tax benefits from stock option transactions
    100       435  
Net cash provided by (used in) financing activities
    5,121       (8,820 )
                 
Effect of change in exchange rates
    210       86  
Net increase (decrease) in cash and cash equivalents
    (17,640 )     26,052  
Cash and cash equivalents, beginning of period
    96,371       48,010  
Cash and cash equivalents, end of period
  $ 78,731     $ 74,062  
                 
Supplemental disclosures for cash flow information:
         
Cash paid for taxes
  $ 125     $ 100  
Supplemental disclosures of non-cash investing and financing activities:
 
Liability accrued for equipment purchases
  $ 3,099     $ 3,464  
Temporary impairment reversal of auction-rate securities
  $ (90 )   $ (140 )
 
See accompanying notes to condensed consolidated financial statements.
 
 
MONOLITHIC POWER SYSTEMS, INC.
(Unaudited)
 
1. Basis of Presentation — The accompanying unaudited condensed consolidated financial statements have been prepared by Monolithic Power Systems, Inc. (the “Company” or “MPS”) in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted in accordance with these rules and regulations. The information in this report should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in its Form 10-K filed with the SEC on March 12, 2012.
 
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, 2012 or for any other future period.

Recently Adopted Accounting Pronouncements
 
In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update  (“ASU”) No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (Topic 820) – Fair Value Measurement (ASU 2011-04), to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for level 3 fair value measurements. The ASU is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2011 and should be applied prospectively. The Company adopted this standard effective January 1, 2012.
 
In June 2011, the FASB issued ASU No. 2011-05 relating to Comprehensive Income (Topic 220) – Presentation of Comprehensive Income (ASU 2011-05), which requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The ASU is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2011 and must be applied retrospectively. The Company adopted this standard effective January 1, 2012.
 
2. Stock-Based Compensation — The Company has two stock option plans and an employee stock purchase plan—the 1998 Stock Option Plan, the 2004 Equity Incentive Plan and the 2004 Employee Stock Purchase Plan. The Company recognized stock-based compensation expenses for the three months ended March 31, 2012 and 2011, as follows (in thousands):
 
   
Three months ended March 31,
 
   
2012
   
2011
 
Non-Employee
  $ 5     $ 4  
ESPP
    211       152  
Restricted Stock
    2,180       1,163  
Stock Options
    919       1,668  
TOTAL
  $ 3,315     $ 2,987  
 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)
 
2004 Equity Incentive Plan
 
The Company’s Board of Directors adopted the Company’s 2004 Equity Incentive Plan in March 2004, and the Company’s stockholders approved it in November 2004. Options granted under the 2004 Plan have a maximum term of ten years. New hire grants generally vest over four years at the rate of 25 percent one year from the date of grant and 1/48th monthly thereafter. Refresh grants generally vest over four years at the rate of 50 percent two years from the date of grant and 1/48th monthly thereafter. There were 800,000 shares initially reserved for issuance under the 2004 Plan. The 2004 Plan provides for annual increases in the number of shares available for issuance beginning on January 1, 2005 equal to the least of: 5% of the outstanding shares of common stock on the first day of the year, 2,400,000 shares, or a number of shares determined by the Board of Directors. The following is a summary of the 2004 Plan, which includes stock options and restricted stock awards and units:
 
Available for Grant as of December 31, 2011
    4,291,737  
2012 Additions to Plan
    1,641,301  
2012 Grants
    (462,781 )
2012 Cancellations
    31,210  
Available for Grant as of March 31, 2012
    5,501,467  
 
A summary of the status of the Company’s stock option plans at March 31, 2012 and changes during the three months then ended is presented in the table below: 
 
   
Stock Options
   
Weighted
Average
Exercise Price
   
Weighted
Average
Remaining
Contractual
Term (Years)
   
Aggregate
Intrinsic Value
 
Outstanding at December 31, 2011 (4,202,786 options exercisable at a weighted-average exercise price of $15.05 per share)
    4,863,239     $ 15.31       3.44     $ 8,817,049  
Options granted (weighted-average fair value of $6.69 per share)
    7,000       15.96                  
Options exercised
    (367,100 )     10.86                  
Options forfeited and expired
    (10,435 )     19.75                  
Outstanding at March 31, 2012
    4,492,704       15.67       3.24       20,443,562  
Options exercisable at March 31, 2012 and expected to become exercisable
    4,457,906       15.66       3.22       20,307,960  
Options vested and exercisable at March 31, 2012
    3,979,612     $ 15.53       3.04     $ 18,590,366  
 
 
The total fair value of options that vested during the three months ended March 31, 2012 and 2011 was $0.9 million and $1.7 million, respectively.  The total intrinsic value of options exercised during the three months ended March 31, 2012 and 2011 was $2.8 million and $4.7 million, respectively. Net cash proceeds from the exercise of stock options were $4.0 million for the three months ended March 31, 2012 and $3.5 million for the three months ended March 31, 2011. At March 31, 2012, unamortized compensation expense related to unvested options was approximately $3.3 million, net of estimated forfeitures. The weighted average period over which compensation expense related to these options will be recognized is approximately 1.8 years.
 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)

The employee stock-based compensation expense recognized under Accounting Standards Codification (“ASC”) 718-10-30 Compensation – Stock Compensation –Overall - Initial Measurement, was determined using the Black-Scholes option pricing model. Option pricing models require the input of subjective assumptions and these assumptions can vary over time. The Company used the following weighted-average assumptions to determine the fair values of stock option awards granted during the three months ended March 31, 2012 and 2011: 
 
   
Three months ended March 31,
 
   
2012
   
2011
 
Expected term (years)
    4.1       4.1  
Expected volatility
    53.4 %     52.9 %
Risk-free interest rate
    0.6 %     1.7 %
Dividend yield
    -       -  
 
In estimating the expected term, the Company considers its historical stock option exercise experience, post vesting cancellations and remaining contractual term of the options outstanding. In estimating the expected volatility, the Company uses its own historical data to determine its estimated expected volatility. The Company uses the U.S. Treasury constant maturity yield based on the expected term for its risk-free interest rate and a dividend yield of zero as it does not issue dividends. The Company applies a forfeiture rate that is based on options that have been forfeited historically.
 
Restricted Stock

The Company grants restricted stock units, which vest generally over four years as determined by the Company’s Compensation Committee, and are issued upon vesting. Before vesting, these restricted stock units are not eligible for dividends, if and when declared. A summary of the restricted stock units is presented in the table below:
 
   
Restricted Stock Units
   
Weighted Average Grant Date Fair Value Per Share
   
Weighted Average Remaining Recognition Period (Years)
 
Outstanding at December 31, 2011
    1,299,556     $ 16.87       2.71  
Awards granted
    455,781       17.53          
Awards released
    (120,517 )     17.38          
Awards forfeited
    (20,775 )     18.17          
Outstanding at March 31, 2012
    1,614,045     $ 17.00       2.45  
 
The total fair value of restricted stock units that vested was $2.2 million for the three months ended March 31, 2012 and $2.5 million for the three months ended March 31, 2011. The intrinsic value related to restricted stock units released for the three months ended March 31, 2012 and 2011 was $2.0 million and $1.6 million, respectively. The intrinsic value related to restricted stock units outstanding at March 31, 2012 and 2011 was $31.7 million and $26.8 million, respectively. At March 31, 2012, the unamortized compensation expense related to unvested restricted stock units was approximately $18.9 million, net of estimated forfeitures, with a weighted average remaining recognition period of 2.5 years.

On February 25, 2010, the Board granted 416,000 performance units to the Company’s executive officers. These performance units generally vest over four years, with a graded acceleration feature that allows all or a portion of these awards to be accelerated if certain performance conditions are satisfied. The amount of shares to be accelerated is based on achieving certain performance targets, with the minimal acceleration occurring if performance exceeds at least 110% of non-GAAP earnings per share as set forth in the Company’s annual operating plan approved by the Board, as determined by the Compensation Committee in its sole discretion. The Compensation Committee has the discretion not to accelerate any shares, if it so chooses, even if the performance targets are met. To date, none of the shares have been accelerated.
 
 
On February 14, 2012, the Board granted 413,000 Restricted Stock Units (“RSUs) to the Company’s executive officers. Fifty percent of RSUs granted to Company’s executive officers will vest over two years on a quarterly basis (“Time-based RSUs”) and 50% of their units will be a target number of RSUs awarded upon achievement of a pre-determined target for the Company’s revenue in 2013 (“Performance-based RSUs”). Half of Performance-based RSUs will vest when earned with the remainder vesting during the following two years on a quarterly basis. The Performance-based RSUs earned will be reduced in the event that the Company’s total shareholder return (“TSR”), defined as the cumulative change in share price plus dividends, as compared to the Company’s compensation peer group is below a specified percentile for calendar years 2012 and 2013.
 
2004 Employee Stock Purchase Plan
 
Under the 2004 Employee Stock Purchase Plan (the Purchase Plan), eligible employees may purchase common stock through payroll deductions. Participants may not purchase more than 2,000 shares in a six-month offering period or stock having a value greater than $25,000 in any calendar year as measured at the beginning of the offering period in accordance with the Internal Revenue Code and applicable Treasury Regulations. A total of 200,000 shares of common stock were reserved for issuance under the Purchase Plan.  The Purchase Plan provides for an automatic annual increase beginning on January 1, 2005 by an amount equal to the least of: 1,000,000 shares, 2% of the outstanding shares of common stock on the first day of the year, or a number of shares as determined by the Board of Directors. For the three months ended March 31, 2012 and 2011, 97,247 shares and 70,685 shares, respectively, were issued under the Purchase Plan. The following is a summary of the Purchase Plan and changes during the three months ended March 31, 2012:
 
Available Shares as of December 31, 2011
    3,693,210  
2012 Additions to Plan
    676,520  
2012 Purchases
    (97,247 )
Available Shares as of March 31, 2012
    4,272,483  
 
The Purchase Plan is considered compensatory under ASC 718-50-25, Compensation – Stock Compensation - Employee Share Purchase Plans - Recognition, and is accounted for in accordance with ASC 718-50-30 Compensation – Stock Compensation - Employee Share Purchase Plans - Initial Measurement - Look-Back Plans. The intrinsic value for stock purchased was $0.7 million and $0.2 million for each of the three months ended March 31, 2012 and 2011, respectively. The unamortized expense as of March 31, 2012 was $0.3 million, which will be recognized over 0.4 years. The Black-Scholes option pricing model was used to value the employee stock purchase rights. For the three months ended March 31, 2012 and 2011, the following weighted average assumptions were used in the valuation of the stock purchase rights:
 
   
Three months ended March 31,
 
   
2012
   
2011
 
Expected term (years)
    0.5       0.5  
Expected volatility
    50.7 %     37.5 %
Risk-free interest rate
    0.1 %     0.2 %
Dividend yield
    -       -  
 
Cash proceeds from employee stock purchases for each of the three months ended March 31, 2012 and 2011 was $1.0 million and $0.9 million, respectively.
 
3. Inventories - Inventories consist of the following (in thousands):
 
   
March 31, 2012
   
December 31, 2011
 
Work in progress
  $ 14,595     $ 11,596  
Finished goods
    6,952       8,508  
Total inventories
  $ 21,547     $ 20,104  
 
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)
 
4. Accrued Liabilities- Accrued liabilities consist of the following (in thousands):
 
   
March 31, 2012
   
December 31, 2011
 
Deferred revenue and customer prepayments
  $ 5,625     $ 3,603  
Stock rotation reserve
    1,573       1,086  
Legal expenses and settlement costs
    723       911  
Warranty
    573       561  
Other
    1,656       1,684  
Total accrued liabilities
  $ 10,150     $ 7,845  
 
A roll-forward of the warranty reserve for the three months ended March 31, 2012 and 2011 is as follows (in thousands):
 
   
Three months ended March 31,
 
   
2012
   
2011
 
Balance at beginning of year
  $ 561     $ 764  
Warranty costs
    (6 )     (296 )
Unused warranty provision
    (83 )     (121 )
Warranty provision for product sales
    101       116  
Balance at end of period
  $ 573     $ 463  
 
 
5. Net Income per Share — Basic net income per share excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted net income per share is calculated using the treasury stock method and reflects the potential dilution that would occur if outstanding securities or other contracts to issue common stock were exercised or converted into common stock.  For the three months ended March 31, 2012 and 2011, the Company had securities outstanding, which could potentially dilute basic net income per share in the future, but were excluded from the computation of diluted net income per share in the periods presented, as their effect would have been anti-dilutive. The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):
 
   
Three months ended March 31,
 
   
2012
   
2011
 
Numerator:
           
Net income
  $ 2,995     $ 1,893  
                 
Denominator:
               
Weighted average oustanding shares used to compute basic net income per share
    34,105       35,024  
Effect of dilutive securities
    1,433       1,081  
Weighted average oustanding shares used to compute diluted net income per share
    35,538       36,105  
                 
Net income per share - basic
  $ 0.09     $ 0.05  
Net income per share - diluted
  $ 0.08     $ 0.05  
 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)
 
For the three months ended March 31, 2012 and 2011, approximately 2.1 million and 4.7 million common stock equivalents, respectively, were excluded from the calculation of diluted net income per share because their inclusion would have been anti-dilutive.

6. Segment Information
 
As defined by the requirements of ASC 280-10-50 Segment Reporting – Overall - Disclosure, the Company operates in one reportable segment that includes the design, development, marketing and sale of high-performance, mixed-signal analog semiconductors for the communications, computing, consumer, and industrial markets. Geographic revenue is based on the location to which customer shipments are delivered. For the three months ended March 31, 2012 and 2011, the Company derived substantially all of its revenue from sales to customers located outside North America. The following is a list of customers whose sales exceeded 10% of revenue for the three months ended March 31, 2012 and 2011.
 
   
Three months ended March 31,
 
Customers
 
2012
   
2011
 
             
A
    15 %     16 %
B
    14 %     *  
 
 (*) represents less than 10%
 
The following is a summary of revenue by geographic region based on customer ship-to location (in thousands):
 
   
Three months ended March 31,
 
Country
 
2012
   
2011
 
China
  $ 29,093     $ 23,677  
Taiwan
    6,415       5,129  
Korea
    1,959       4,427  
Europe
    4,190       3,475  
Japan
    2,306       2,978  
USA
    1,112       1,106  
Other
    5,409       3,676  
Total
  $ 50,484     $ 44,468  
 
The following is a summary of revenue by product family (in thousands):
 
   
Three months ended March 31,
 
Product Family
 
2012
   
2011
 
DC to DC Converters
  $ 44,342     $ 38,580  
Lighting Control Products
    6,142       5,888  
Total
  $ 50,484     $ 44,468  
 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)
 
The following is a summary of long-lived assets by geographic region (in thousands):
 
   
March 31, 2012
   
December 31, 2011
 
China
  $ 32,333     $ 32,566  
United States
    19,533       15,662  
Taiwan
    98       98  
Japan
    64       70  
Other
    48       51  
TOTAL
  $ 52,076     $ 48,447  
 
On July 8, 2011, the Company purchased the property located at 79 Great Oaks Boulevard in San Jose, California, to be used as its new headquarters and sales offices. The property consists of an approximately 106,262 square foot office building and approximately 5.5 acres of land. The $11.0 million purchase price for the property was allocated based on an independent third party valuation with $5.0 million attributable to the building and $6.0 million attributable to the land. The Company will begin to depreciate the building when it takes occupancy in May 2012. The increase of $3.9 million in the long-lived assets for the three months ended March 31, 2012 for the United States was primarily related to the building improvements at this new location. Buildings and building improvements have a depreciation life of up to 40 years.
 
7. Litigation
 
On September 16, 2011 and September 29, 2011, two nearly identical shareholder derivative actions were filed in the United States District Court for the Northern District of California and the California Superior Court for Santa Clara County, naming as defendants certain of the Company’s current and former directors and officers and the Company’s compensation advisory firm.  The complaints assert claims for, among other things, breach of fiduciary duty in connection with the directors' approval of compensation for the Company's executive officers during 2010.  The complaints each seek an award of damages in favor of the Company, equitable relief, costs and attorney's fees. On March 2, 2012, the parties in the state court action stipulated to the dismissal without prejudice of that action. On April 3, 2012, a hearing was held in the United States District Court on the defendants’ motions to dismiss the case. The court has not yet ruled on the motions. The matters are at a preliminary stage at the United States District Court; the defendants have not yet responded to the complaint and no discovery has taken place. In management’s opinion, the resolution of the derivative action filed in the United States District Court is uncertain and estimate of its effect cannot be made on our consolidated financial condition, results of operations or liquidity.
  
The Company and certain of its subsidiaries are parties to actions and proceedings incident to the Company's business in the ordinary course of business, including litigation regarding its intellectual property, challenges to the enforceability or validity of its intellectual property and claims that the Company’s products infringe on the intellectual property rights of others. These proceedings often involve complex questions of fact and law and 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. In December 2011, the Company entered into a settlement and license agreement with a third-party company for infringement of the Company’s patent whereby the Company will receive $2 million which will be paid in equal installments of $300,000 in each quarter of 2012 and the remainder will be paid in two equal installments in first two quarters of 2013. For the three months ended March 31, 2012, the Company received the first $300,000 payment which was recorded as a credit to the litigation expenses in the Condensed Consolidated Statements of Operations.
 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued) (Unaudited)
 
8. Fair Value Measurements
 
The following is a schedule of Company’s cash and cash equivalents, short-term investments and long-term investments as of March 31, 2012 and December 31, 2011 (in thousands):
 
   
Estimated Fair Market Value as of
 
   
March 31, 2012
   
December 31, 2011
 
   
(In thousands)
 
Cash, Cash Equivalents and Investments
           
Cash in Banks
  $ 49,899     $ 43,305  
Money Market Funds
    28,832       51,066  
Government Agencies/ Treasuries
    102,197       79,827  
Auction-Rate Securities backed by Student-Loan Notes
    13,665       13,675  
Total Cash, Cash Equivalents and Investments
  $ 194,593     $ 187,873  
 
 
Reported as:
           
Cash and Cash Equivalents
  $ 78,731     $ 96,371  
Short-term Investments
    102,197       77,827  
Long-term Investments
    13,665       13,675  
Total Cash, Cash Equivalents and Investments
  $ 194,593     $ 187,873  
 
The contractual maturities of the Company’s investments classified as available-for-sale as of March 31, 2012 and December 31, 2011 is as follows (in thousands):
 
   
March 31, 2012
   
December 31, 2011
 
             
Less than 1 year
  $ 21,510     $ 45,133  
1 - 5 years
    80,687       32,694  
Greater than 5 years
    13,665       13,675  
    $ 115,862     $ 91,502  
 
The following table details the fair value measurements as of March 31, 2012 and December 31, 2011 within the fair value hierarchy of the financial assets that are required to be recorded at fair value (in thousands):
 
   
Fair Value Measurements at March 31, 2012 Using
 
         
Quoted Prices in Active Markets for Identical Assets
   
Significant Other Observable Inputs
   
Significant Unobservable Inputs
 
   
Total
   
Level 1
   
Level 2
   
Level 3
 
Money Market Funds
  $ 28,832     $ 28,832     $ -     $ -  
US Treasuries and US Government Agency Bonds
    102,197       -       102,197       -  
Auction-rate securities backed by students loan
    13,665       -       -       13,665  
    $ 144,694     $ 28,832     $ 102,197     $ 13,665  
 
 
   
Fair Value Measurements at December 31, 2011 Using
 
         
Quoted Prices in Active Markets for Identical Assets
   
Significant Other Observable Inputs
   
Significant Unobservable Inputs
 
   
Total
   
Level 1
   
Level 2
   
Level 3
 
Money Market Funds
  $ 51,066     $ 51,066     $ -     $ -  
US Treasuries and US Government Agency Bonds
    79,827       -       79,827       -  
Long-term available-for-sale auction-rate securities
    13,675       -       -       13,675  
    $ 144,568     $ 51,066     $ 79,827     $ 13,675  
 
At March 31, 2012, fixed income available-for-sale securities included $102.2 million in US government agencies and treasuries, all of which was classified as short-term investments. The Company also had $28.8 million invested in money market funds. From these investments, there was $27,000 in unrealized losses. The impact of gross unrealized gains and losses was not material. At March 31, 2012, the Company also had $14.3 million in face value of auction-rate securities, all of which are classified as long-term available-for-sale investments.

At December 31, 2011, fixed income available-for-sale securities include securities issued by government agencies and treasuries, $77.8 million of which are classified as short-term investments and $2.0 million which are classified as cash equivalents. The Company also had $51.1 million invested in money market funds. At December 31, 2011, there was $17,000 in unrealized losses from these investments. The impact of gross unrealized gains and losses was not material. At December 31, 2011, the Company also had $14.4 million in face value of auction-rate securities, all of which are classified as long-term available-for-sale investments.
 
Temporary impairment charges are recorded in accumulated other comprehensive income (loss) within stockholders’ equity and has no impact on net income. Other-than-temporary impairment exists when the entity has the intent to sell the security or it will more likely than not be required to sell the security before anticipated recovery or it does not expect to recover the entire amortized cost basis of the security. Other-than-temporary impairment charges are recorded in other income (expense) in the Condensed Consolidated Statement of Operations.
 
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, 2012
 
   
Adjusted Cost
   
Unrealized Gains or Losses
   
Total Fair Value
   
Fair Value of Investments in  Unrealized Loss Position
 
                         
Money Market Funds
  $ 28,832     $ -     $ 28,832     $ -  
US Treasuries and US Government Agency Bonds
    102,216       (19 )     102,197       59,808  
Auction-rate securities backed by Student-Loan Notes
    14,205       (540 )     13,665       13,665  
    $ 145,253     $ (559 )   $ 144,694     $ 73,473  
 
 
   
As of December 31, 2011
 
   
Adjusted Cost
   
Unrealized Gains or Losses
   
Total Fair Value
   
Fair Value of Investments in Unrealized Loss Position
 
                         
Money Market Funds
  $ 51,066     $ -     $ 51,066     $ -  
US Treasuries and US Government Agency Bonds
    79,830       (3 )     79,827       25,281  
Auction-rate securities backed by Student-Loan Notes
    14,305       (630 )     13,675       13,675  
    $ 145,201     $ (633 )   $ 144,568     $ 38,956  
 
The Company's level 2 assets consist of U.S. treasuries, U.S. government agency bonds, corporate notes and commercial paper. 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 beginning and ending balances for the assets measured at fair value using significant unobservable inputs (Level 3) (in thousands):
 
   
Auction-Rate Securities
 
Ending balances at December 31, 2011
  $ 13,675  
Sales and Settlement at Par
    (100 )
Unrealized Gain
    90  
Ending balances at March 31, 2012
  $ 13,665  
 
At March 31, 2012, the Company’s investment portfolio included $13.7 million in government-backed student loan auction-rate securities, net of impairment charges of $0.6 million; of which, $0.5 million was temporary and $0.1 million was recorded other-than-temporary. This compares to an investment balance of auction-rate securities as of December 31, 2011 of $13.7 million net of impairment charges of $0.7 million; of which, $0.6 million was temporary and $0.1 million was recorded as other-than-temporary. The underlying maturity of these auction-rate securities is up to 36 years. As of March 31, 2012 and December 31, 2011 the portion of the impairment classified as temporary was based on the following analysis:
 
 
The decline in the fair value of these securities is not largely attributable to adverse conditions specifically related to these securities or to specific conditions in an industry or in a geographic area;
 
Management possesses both the intent and ability to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value;
 
Management believes that it is more likely than not that the Company will not have to sell these securities before recovery of its cost basis;
 
Except for the credit loss of $70,000 recognized during the year ended December 31, 2009 for the Company’s holdings in auction rate securities described below, the Company does not believe that there is any additional credit loss associated with other auction-rate securities because the Company expects to recover the entire amortized cost basis;
 
The majority of the securities remain AAA rated, with $6.3 million of the auction rate securities having been downgraded by Moody’s to A3-Baa3, during the year ended December 31, 2009 and there have been no downgrades since;
 
All scheduled interest payments have been made pursuant to the reset terms and conditions; and
 
All redemptions of auction-rate securities representing 63% of the original portfolio purchased by the Company in February 2008 have been at par.
 
 
Based on the guidance of ASC 320-10-35 and ASC 320-10-50, the Company evaluated the potential credit loss of each of the auction-rate securities that are currently held by the Company. Based on such analysis, the Company determined that those securities that are not 100% Federal Family Education Loan Programs (“FFELPS”) guaranteed are potentially subject to credit risks based on the extent to which the underlying debt is collateralized and the security-specific student-loan default rates. The Company’s portfolio includes two such securities. The senior parity ratio for the two securities is approximately 106%. If, therefore, the student-loan default rate and borrowing rate for these issuers increases, the remaining balance in these trusts may not be sufficient to cover the senior debt. The Company therefore concluded that there is potential credit risk for these two securities and as such, used the discounted cash flow model to determine the amount of credit loss to be recorded. In valuing the potential credit loss, the following parameters were used: 20 year expected term, cash flows based on the 90 day t-bill rates for 20 year forwards and a risk premium of 5.9%, the amount of interest that the Company was receiving on these securities when the market was last active. As of March 31, 2012 and December 31, 2011, the potential credit loss associated with these securities was $70,000, which the Company deemed other-than-temporary and had recorded in other expense in its Condensed Consolidated Statement of Operations during 2009. There have been no such losses since.
 
Unless a rights offering or other similar offer is made to redeem at par and accepted by the Company, the Company intends to hold the balance of these investments through successful auctions at par, which the Company believes could take approximately 2.0 years.
 
Determining the fair value of the auction-rate securities requires significant management judgment regarding projected future cash flows which will depend on many factors, including the quality of the underlying collateral, estimated time for liquidity including potential to be called or restructured, underlying final maturity, insurance guaranty and market conditions, among others. To determine the fair value of the auction-rate securities at December 31, 2011 and March 31, 2012, the Company used a discounted cash flow model, for which there are four unobservable inputs: estimated time-to-liquidity, discount rate, credit quality of the issuer and expected interest receipts. A significant increase in the time-to-liquidity or the discount rate inputs or a significant decrease in the credit quality of the issuer or the expected interest receipts inputs in isolation would result in a significantly lower fair value measurement.

The following are the values used in the discounted cash flow model:
 
   March 31, 2012
December 31, 2011
Time-to-Liquidity
24 months
24 months
Expected Return (Based on the requisite treasury rate, plus a contractual penalty rate)
1.8%
1.8%
Discount Rate (Based on the requisite LIBOR, the cost of debt and a liquidity risk premium)
2.8% - 7.6%, depending on the credit-rating of the security
3.1% - 7.9%, depending on the credit-rating of the security
 
If the auctions continue to fail, the liquidity of the Company’s investment portfolio may be negatively impacted and the value of its investment portfolio could decline. 
 
9.           Income Taxes
 
The income tax provision for the three months ended March 31, 2012 was $0.3 million or 9.4% of the Company’s income before income taxes. This differs from the federal statutory rate of 34% primarily because the Company’s foreign income was taxed at lower rates and because of the benefit that the Company realized as a result of stock option exercises and restricted units vested.

The income tax provision for the three months ended March 31, 2011 was $0.2 million or 9.8% of the Company’s income before income taxes.  This differs from the federal statutory rate of 34% primarily because the Company’s foreign income was taxed at lower rates and because of the benefit that the Company realized as a result of the disqualifying disposition of incentive stock options and employee stock plan purchases.
 
 
We are subject to examination of our income tax returns by the Internal Revenue Service (“IRS”) and other tax authorities.  Our U.S. Federal income tax returns for the years ended December 31, 2000 through December 31, 2007 are under examination by the IRS. In April 2011, we received from the IRS a Notice of Proposed Adjustment, or “NOPA”, relating to a cost-sharing agreement entered into by the Company and its international subsidiaries in 2004. In the NOPA, the IRS objected to the Company’s allocation of certain litigation expenses between the Company and our international subsidiaries and the amount of “buy-in payments” made by our international subsidiaries to the Company in connection with the cost-sharing agreement, and proposed to increase our U.S. taxable income according to a few alternative methodologies. The methodology resulting in the largest potential adjustment could, if the IRS were to prevail on all matters in dispute, increase our potential federal and state income tax liabilities by up to $37.0 million, plus interest and penalties, if any. In February 2012, the Company received a revised NOPA from the IRS (Revised NOPA). In this revised NOPA, the largest potential adjustment, if the IRS were to prevail on all matters in dispute, has decreased to $10.5 million, plus interest and penalties, if any. On March 20, 2012, the Company received an examination report from IRS, commonly referred to as a “30-day letter”, formally proposing adjustments to the taxable years 2005, 2006 and 2007. After receiving 30-day extension, the Company has until May 19, 2012, to respond to the 30-day letter. The IRS also audited the research and development credits generated in the years 2000 through 2007, and the carry forward of these credits to subsequent years. We received a NOPA from the IRS in February 2011, proposing to reduce the research and development credits generated in years 2000 through 2007, which would also reduce the value of such credits carried forward to subsequent tax years. We are currently reviewing these proposed adjustments as well. We regularly assess the likelihood of an adverse outcome resulting from such examinations to determine the adequacy of our provision for income taxes. We believe that the IRS's position in the NOPA is incorrect and that our tax returns for those years were correct as filed. We expect to contest these proposed adjustments vigorously. As of March 31, 2012, based on the technical merits of our tax return filing positions, we believe that it is more-likely-than-not that the benefit of such positions will be sustained upon the resolution of our audits resulting in no significant impact on our consolidated financial position and the results of operations and cash flows.
 
10.           Stock Repurchase Program

On July 27, 2010, the Board of Directors approved a stock repurchase program that authorized MPS to repurchase up to $50.0 million in the aggregate of its common stock between August 2, 2010 and December 31, 2011. In February 2011, the Board of Directors approved an increase from $50.0 million to $70.0 million. From August 2010 through June 2011, the Company repurchased 4,385,289 shares for a total of $70.0 million. During the three months ended March 31, 2011, the following shares have been repurchased through the open market and subsequently retired:
 
    Three months ended March 31, 2011  
 
 
Shares Repurchased
   
Average Price per Share
   
Value (in thousands)
 
February 2011
   
817,500
   
$
15.47
   
$
12,648
 
March 2011
   
75,000
   
$
14.17
   
$
1,062
 
                         
     
892,500
           
$
13,710
 
 
11.    Subsequent Events
 
On May 3, 2012, the United States District Court for the Northern District of California issued an order finding O2 Micro International, Ltd. ("O2 Micro") liable for approximately $9.1 million in attorneys' fees and non-taxable costs, plus interest, in connection with the patent litigation that the Company won in 2010. This award is in addition to the approximately $340,000 in taxable costs that the Court had earlier ordered O2 Micro to pay to the Company in connection with the same lawsuit.
 
O2 Micro filed complaints against the Company in both the United States International Trade Commission (“ITC”) and and the Northern District of California, alleging that the Company infringed four O2 Micro patents but then voluntarily dismissed three patents. In June 2010, the ITC found that the Company's products did not infringe O2 Micro's patent. Subsequently, O2 Micro unilaterally dismissed its infringement claims with prejudice, and granted the Company and its customers broad covenants not to sue in the district court case.
 
On March 3, 2011, the Court ordered O2 Micro to pay the Company $339,315.13 in costs. The Court also found that "O2 Micro engaged in a vexatious litigation strategy and litigation misconduct," entitling the Company to its reasonable attorneys' fees. O2 Micro's vexatious litigation strategy consisted of filing lawsuits against the Company and its customers; only to dismiss them after substantial litigation had taken place. This allowed O2 Micro to damage the Company's business while avoiding trials at which the validity of its patents would be challenged.
 
Since that time, the Company submitted the documentation for its attorneys' fees and non-taxable costs. O2 Micro challenged those fees on various grounds. On May 3, 2012, the Court accepted the Company's figures and entered an order awarding $8,419,429 in attorneys' fees, and $663,151 in non-taxable costs, plus interest. The Court then entered judgment for the Company.
 
The Company anticipates that O2 Micro will appeal the Court's orders and the final judgment.  These amounts will be recognized in the Consolidated Financial Statements of the company when all related appeals have been exhausted and collectibility is probable.
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
This quarterly report on Form 10-Q contains forward-looking statements that involve many risks and uncertainties. These statements relate to future events and our future performance and are based on current expectations, estimates, forecasts and projections about the industries in which we operate and the beliefs and assumptions of our management. These include statements concerning, among others:
 
 
the above-average industry growth of product and market areas that we have targeted,
 
 
our plan to introduce additional new products within our existing product families as well as in new product categories and families,
 
  our intention to exercise our purchase option with respect to our manufacturing facility in Chengdu, China.
 
 
our belief that we will continue to incur significant legal expenses that vary with the level of activity in each of our legal proceedings,
 
 
the effect of auction-rate securities on our liquidity and capital resources,
 
 
the application of our products in the Communications, Computing, Consumer and Industrial markets continuing to account for a majority of our revenue,
 
 
estimates of our future liquidity requirements,
 
 
the cyclical nature of the semiconductor industry,
 
 
protection of our proprietary technology,
 
 
near term business outlook for 2012,
 
 
the factors that we believe will impact our ability to achieve revenue growth,
 
 
the outcome of the IRS audit of our tax return for the tax years ended December 31, 2000 through 2007,
 
 
the percentage of our total revenue from various market segments, and
 
 
the factors that differentiate us from our competitors.
 

In some cases, words such as "would," "could," "may," "should," "predict," "potential," "targets," "continue," "anticipate," "expect," "intend," "plan," "believe," "seek," "estimate," "project," "forecast," "will," the negative of these terms or other variations of such terms and similar expressions relating to the future identify forward-looking statements. All forward-looking statements are based on our current outlook, expectations, estimates, projections, beliefs and plans or objectives about our business and our industry. These statements are not guarantees of future performance and are subject to risks and uncertainties. Actual events or results could differ materially and adversely from those expressed in any such forward-looking statements. Risks and uncertainties that could cause actual results to differ materially include those set forth throughout this quarterly report on Form 10-Q and, in particular, in the section entitled “Part II. Other Information; item 1A. Risk Factors". Except as required by law, we disclaim any duty to and undertake no obligation to update any forward-looking statements, whether as a result of new information relating to existing conditions, future events or otherwise or to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Readers are cautioned not to place undue reliance on such statements, which speak only as of the date of this quarterly report on Form 10-Q. Readers should carefully review future reports and documents that we file from time to time with the Securities and Exchange Commission, such as our annual reports on Form 10-K 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, 2012 included in this report and our audited consolidated financial statements and related notes for the year ended December 31, 2011 included in our Annual Report on Form 10-K filed on March 12, 2012 with the Securities and Exchange Commission.
 
Overview
 
We are a fabless semiconductor company that designs, develops, and markets proprietary, advanced analog and mixed-signal semiconductors. We offer products that serve multiple markets, including flat panel televisions, wireless communications, telecommunications equipment, general consumer products, notebook computers, and set top boxes, among others. We believe that we differentiate ourselves by offering solutions that are more highly integrated, smaller in size, more energy efficient, more accurate with respect to performance specifications and, consequently, more cost-effective than many competing solutions. We plan to continue to introduce 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 to achieve revenue and volume production is usually achieved several months after we receive an initial customer order for a new product. Typical lead time for orders 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, or direct sales to customers in Asia, where the components we produce are incorporated into end-user product. Out of our total revenue, 89% of our revenue for both the quarters ended March 31, 2012 and 2011 was attributable to direct or indirect sales to customers in Asia. We derive a majority of our revenue from the sales of our DC to DC converter product family which services the Communications, Computing, Consumer and Industrial markets. We believe our ability to achieve revenue growth will depend, in part, on our ability to develop new products, enter new market segments, gain market share, manage litigation risk, diversify our customer base and successfully secure manufacturing capacity.
 
Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an on-going basis, including those related to revenue recognition, stock-based compensation, long-term investments, short-term investments, inventories, income taxes, warranty obligations and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making the judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Estimates and judgments used in the preparation of our financial statements are, by their nature, uncertain and unpredictable, and depend upon, among other things, many factors outside of our control, such as demand for our products and economic conditions.  Accordingly, our estimates and judgments may prove to be incorrect and actual results may differ, perhaps significantly, from these estimates.
 
We believe the following critical accounting policies reflect our more significant judgments used in the preparation of our consolidated financial statements.
 
Revenue Recognition. We recognize revenue in accordance with Financial Accounting Standards Board (“FASB”) – Accounting Standards Codification (“ASC”) 605-10-S25 Revenue Recognition – Overall – Recognition. ASC 605-10-S25 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed and determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgment regarding the fixed nature of the fee charged for products delivered and the collectability of those fees. The application of these criteria has resulted in our generally recognizing revenue upon shipment (when title passes) to customers. Should changes in conditions cause management to determine these criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely impacted.
 
Approximately 80% of our sales for the three months ended March 31, 2012 are made through distributors with formal distribution agreements. These arrangements do not include any special payment terms (our normal payment terms are 30-45 days for our distributors), price protection or exchange rights. Returns are limited to our standard product warranty. Certain of our large distributors have contracts that include limited stock rotation rights that permit the return of a small percentage of the previous six months’ purchases in return for a compensating new order of equal or greater dollar value.

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

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

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

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

Approximately 8% of our sales for the three months ended March 31, 2012 are made through value-added resellers based on purchase orders rather than formal distribution arrangements.  These value-added resellers do not receive any stock rotation rights and, as such, hold very little inventory, if any.  We do not have a history of accepting returns from these value-added resellers.

The terms in a majority of our distribution agreements include the non-exclusive right to sell, and the agreement to use best efforts to promote and develop a market for, our products in certain regions of the world and the ability to terminate the distribution agreement by either party with up to three months notice. We provide a one year warranty against defects in materials and workmanship. Under this warranty, we will repair the goods, provide replacements at no charge, or, under certain circumstances, provide a refund to the customer for defective products. Estimated warranty returns and warranty costs are based on historical experience and are recorded at the time product revenue is recognized.
 
Two of the Company's U.S. distributors have distribution agreements where revenue is recognized upon sale by these distributors to their end customers because these distributors have certain rights of return which management believes are not estimable. The deferred revenue balance from these two distributors as of March 31, 2012 and December 31, 2011 was $1.5 million and $1.0 million, respectively.
 
Warranty Reserves. We currently provide a 12-month warranty against defects in materials and workmanship and will either repair the goods or provide replacement products at no charge to the customer for defective products. We record estimated warranty costs by product, which are based on historical experience over the preceding 12 months, at the time we recognize product revenue. Reserve requirements are recorded in the period of sale and are based on an assessment of the products sold with warranty and historical warranty costs incurred. As the complexity of our products increases, we could experience higher warranty claims relative to sales than we have previously experienced, and we may need to increase these estimated warranty reserves.

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

Accounting for Income Taxes.  ASC 740-10 Income Taxes – Overall prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods and disclosure. In accordance with ASC 740-10, we recognize federal, state and foreign current tax liabilities or assets based on our estimate of taxes payable or refundable in the current fiscal year by tax jurisdiction. We also recognize federal, state and foreign deferred tax assets or liabilities for our estimate of future tax effects attributable to temporary differences and carryforwards. We record a valuation allowance to reduce any deferred tax assets by the amount of any tax benefits that, based on available evidence and judgment, are not expected to be realized.
 
Our calculation of current and deferred tax assets and liabilities is based on certain estimates and judgments and involves dealing with uncertainties in the application of complex tax laws. Our estimates of current and deferred tax assets and liabilities may change based, in part, on added certainty or finality or uncertainty to an anticipated outcome, changes in accounting or tax laws in the U.S., or foreign jurisdictions where we operate, or changes in other facts or circumstances. In addition, we recognize liabilities for potential U.S. and foreign income tax for uncertain income tax positions taken on our tax returns if it has less than a 50% likelihood of being sustained. If we determine that payment of these amounts is unnecessary or if the recorded tax liability is less than our current assessment, we may be required to recognize an income tax benefit or additional income tax expense in our financial statements in the period such determination is made. We have calculated our uncertain tax positions which were attributable to certain estimates and judgments primarily related to transfer pricing, cost sharing and our international tax structure exposure.
 
As of both March 31, 2012 and December 31, 2011, we had a valuation allowance of $14.6 million attributable to management’s determination that it is more likely than not that none of the deferred tax assets in the United States will be realized, except for certain deferred tax assets related to uncertain income tax positions. Should it be determined that all or part of the net deferred tax asset will not be realized in the future, an adjustment to increase the deferred tax asset valuation allowance will be charged to income in the period such determination is made. Likewise, in the event we were to determine that it is more likely than not that we would be able to realize our deferred tax assets in the future in excess of our net recorded amount, an adjustment to the valuation allowance for the deferred tax asset would increase income in the period such determination was made.
 
 
Contingencies. We and certain of our subsidiaries are parties to actions and proceedings incident to our business in the ordinary course of business, including litigation regarding our intellectual property, challenges to the enforceability or validity of our intellectual property and claims that our products infringe on the intellectual property rights of others. The pending proceedings involve complex questions of fact and law and will require the expenditure of significant funds and the diversion of other resources to prosecute and defend. In addition, from time to time, we become aware that we are subject to other contingent liabilities.  When this occurs, we will evaluate the appropriate accounting for the potential contingent liabilities using ASC 450-20-25-2 Contingencies – Loss Contingencies - Recognition to determine whether a contingent liability should be recorded. In making this determination, management may, depending on the nature of the matter, consult with internal and external legal counsel and technical experts. Based on the facts and circumstances in each matter, we use our judgment to determine whether it is probable that a contingent loss has occurred and whether the amount of such loss can be estimated. If we determine a loss is probable and estimable, we record a contingent loss in accordance with ASC 450-20-25-2. In determining the amount of a contingent loss, we take into account advice received from experts for each specific matter regarding the status of legal proceedings, settlement negotiations (which may be ongoing), prior case history and other factors. Should the judgments and estimates made by management need to be adjusted as additional information becomes available, we may need to record additional contingent losses that could materially and adversely impact our results of operations. Alternatively, if the judgments and estimates made by management are adjusted, for example, if a particular contingent loss does not occur, the contingent loss recorded would be reversed which could result in a favorable impact on our results of operations.
  
Accounting for Stock-Based Compensation. We account for stock-based compensation under the provisions of ASC 718-10-30 Compensation – Stock Compensation – Overall – Initial Measurement. This standard requires us to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period). We currently use the Black-Scholes option-pricing model to estimate the fair value of our share-based payments. The Black-Scholes option-pricing model is based on a number of assumptions, including historical volatility, expected life, risk-free interest rate and expected dividends. The amount of stock-based compensation that we recognize is also based on an expected forfeiture rate. If there is a difference between the forfeiture assumptions used in determining stock-based compensation costs and the actual forfeitures which become known over time, we may change the forfeiture rate, which could have a significant impact on our stock-based compensation expense.
 
Fair Value Instruments. ASC 820-10 Fair Value Measurements and Disclosures – Overall defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles in the United States of America, and requires that assets and liabilities carried at fair value be classified and disclosed in one of the three categories, as follows:
 
 
a.
Level 1: Quoted prices in active markets for identical assets;
 
b.
Level 2: Significant other observable inputs; and
 
c.
Level 3: Significant unobservable inputs.
 
ASC 820-10-35-51 Fair Value Measurement and Disclosure – Overall – Subsequent Measurement – Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly provides additional guidance for estimating fair value in accordance with ASC 820-10 Fair Value Measurements and Disclosures – Overall, when the volume and level of activity for the asset or liability have significantly decreased.
 
Our financial instruments include cash and cash equivalents and short-term and long-term investments. Cash equivalents are stated at cost, which approximates fair market value. Short-term and long-term investments are stated at their fair market value.
 
The face value of our holdings in auction rate securities is $14.3 million, all of which is classified as long-term available-for-sale investments.

Investments in available-for-sale securities are recorded at fair value, and unrealized gains or losses (that are deemed to be temporary) are recognized through shareholders' equity, as a component of accumulated other comprehensive income in our condensed consolidated balance sheet. We record an impairment charge to earnings when an available-for-sale investment has experienced a decline in value that is deemed to be other-than-temporary. Investments in trading securities are recorded at fair value and unrealized gains and losses are recognized in other income (expense) in our condensed consolidated statement of operations.
 
We adopted the provisions of ASC 320-10-35 Investments – Debt and Equity Securities – Overall – Subsequent Measurement and ASC 320-10-50 Investments – Debt and Equity Securities – Overall - Disclosure, effective April 1, 2009 and used the guidelines therein to determine whether the impairment is temporary or other-than temporary. Other-than-temporary impairment charges exist when the entity has the intent to sell the security or it will more likely than not be required to sell the security before anticipated recovery. During the year ended December 31, 2009, we recognized a credit loss of $70,000, which was deemed to be other-than-temporary in other income (expense) in our Condensed Consolidated Statement of Operations. There have been no such losses since.
 
Based on certain assumptions described in Note 8, “Fair Value Measurements”, to our condensed consolidated financial statements and the Liquidity and Capital Resources section of “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this quarterly report on Form 10-Q, we recorded impairment charges on our holdings in auction-rate securities. The valuation of these securities is subject to fluctuations in the future, which will depend on many factors, including the collateral quality, potential to be called or restructured, underlying final maturity, insurance guaranty, liquidity and market conditions, among others.
 
 
Results of Operations
 
The table below sets forth the data from our Condensed Consolidated Statement of Operations as a percentage of revenue for the periods indicated:
 
   
Three months ended March 31,
 
   
2012
   
2011
 
Revenue
    100.0 %     100.0 %
Cost of revenue
    47.7 %     49.8 %
                 
Gross profit
    52.3 %     50.2 %
Operating expenses:
               
Research and development
    22.0 %     22.7 %
Selling, general and administrative
    23.7 %     21.4 %
Litigation expense
    0.3 %     1.8 %
Total operating expenses
    46.0 %     45.9 %
                 
Income from operations
    6.3 %     4.3 %
Other income (expense):
               
Interest and other income
    0.3 %     0.6 %
Interest and other expense
    (0.1 %)     (0.2 %)
Total other income, net
    0.2 %     0.4 %
                 
Income before income taxes
    6.5 %     4.7 %
Income tax provision / (benefit)
    0.6 %     0.4 %
Net income
    5.9 %     4.3 %
 
 
Revenue.
 
   
Three months ended March 31,
 
   
2012
   
2011
       
   
(in thousands)
  Change  
Revenue
  $ 50,484     $ 44,468       13.5 %
 
 
Revenue for the three months ended March 31, 2012 was $50.5 million, an increase of $6.0 million, or 13.5%, from $44.5 million for the three months ended March 31, 2011. This increase was primarily due to increased demand for our DC to DC converters. The revenue from our DC to DC converters was $44.3 million, an increase of $5.8 million, or 14.9% compared to the same period in 2011 primarily due to the increase in unit product shipment. The higher unit shipments in our DC to DC converter product line were primarily driven by an increase in demand for our DCDC and MNSTR products. Sales of our lighting control products were up 4% period over period. The following table illustrates changes in our revenue by product family:
 
    Three months ended March 31,        
   
2012
   
2011
       
   
(in thousands) Amount
   
% of
Revenue
   
(in thousands) Amount
   
% of
Revenue
  Change  
DC to DC Converters
  $ 44,342       87.8 %   $ 38,580       86.8 %     14.9 %
Lighting Control Products
    6,142       12.2 %     5,888       13.2 %     4.3 %
    $ 50,484       100.0 %   $ 44,468       100.0 %     13.5 %
 
Cost of Revenue and Gross Margin.
 
   
Three months ended March 31,
 
   
2012
   
2011
       
   
(in thousands)
  Change  
Cost of Revenue (1)
  $ 24,074     $ 22,163       8.6 %
Cost of revenue as a percentage of revenue
    47.7 %     49.8 %        
Gross Profit
  $ 26,410     $ 22,305       18.4 %
Gross Profit Margin
    52.3 %     50.2 %        
(1) Includes stock-based compensation expense
  $ 95     $ 63          
 
 
Cost of revenue consists primarily of costs incurred to manufacture, assemble and test our products, as well as other overhead costs relating to the aforementioned costs including stock-based compensation expense. Gross Profit as a percentage of revenue, or gross profit margin, was 52.3% for the three months ended March 31, 2012 and 50.2% for the three months ended March 31, 2011. The 2.1 percentage point increase in gross profit margin was primarily due to higher absorption of in-house test manufacturing overhead on higher revenue in the three months ended March 31, 2012 as compared to the same period in 2011.
 
Research and Development.
 
   
Three months ended March 31,
 
   
2012
   
2011
       
   
(in thousands)
  Change  
Research and development (“R&D”) (1)
  $ 11,118     $ 10,086       10.2 %
                         
R&D as a percentage of revenue
    22.0 %     22.7 %        
                         
(1) Includes stock-based compensation expense
  $ 1,266     $ 1,427          
 
 
Research and development (R&D) expenses consist of salary and benefit expenses for design and product engineers, expenses related to new product development, and related facility costs. R&D expenses for the three months ended March 31, 2012 increased by $1.0 million, or 10.2% compared to the R&D expenses incurred during the same period in 2011. This increase was primarily attributable to an increase in compensation related expenses. Our R&D head count as of March 31, 2012 was 387 employees as compared to 350 employees as of March 31, 2011.
 
 
Selling, General and Administrative.
 
   
Three months ended March 31,
 
   
2012
   
2011
       
   
(in thousands)
  Change  
Selling, general and administrative (“SG&A”) (1)
  $ 11,966     $ 9,490       26.1 %
                         
SG&A as a percentage of revenue
    23.7 %     21.4 %        
                         
(1) Includes stock-based compensation expense
  $ 1,954     $ 1,497          
 
Selling, general and administrative (SG&A) expenses include salary and benefit expenses for sales, marketing and administrative personnel, sales commissions, travel expenses, related facilities costs, outside legal and accounting fees, and fees associated with Sarbanes-Oxley compliance requirements. SG&A expense for the three months ended March 31, 2012 increased by $2.5 million or 26.1% compared to the SG&A expense incurred during the same period in 2011. This increase was primarily attributable to the increased compensation related expenses including stock-based compensation expense, higher professional fees and increased sales commissions as a result of increase in revenue during three months ended March 31, 2012 as compared to the same period in 2011. Our SG&A head count as of March 31, 2012 was 242 employees as compared to 231 employees as of March 31, 2011.
 
Litigation Expense.
 
   
Three months ended March 31,
 
   
2012
   
2011
       
   
(in thousands)
  Change  
Litigation expense
  $ 128     $ 813       (84.3 )%
                         
Litigation expense as a percentage of revenue
    0.3 %     1.8 %        
 
 
Litigation expenses decreased by $0.7 million for the three months ended March 31, 2012, compared to the same period in 2011. This decrease was primarily due to lower litigation spending in the quarter plus the benefit of a $0.3 million payment received under a settlement and license agreement. In December 2011, the Company entered into a settlement and license agreement with a third-party company for infringement of the Company’s patent whereby the Company will receive $2 million which will be paid in equal installments of $300,000 in each quarter of 2012 and the remainder will be paid in two equal installments in the first two quarters of 2013. For the three months ended March 31, 2012, the Company received the first $300,000 payment which was recorded as a credit to the litigation expenses in the Condensed Consolidated Statements of Operations. During the three months ended March 31, 2011, we incurred legal expenses primarily to recover attorneys’ fees from O2Micro. Overall, our litigation expense has decreased as a result of us being party to fewer material litigations.
 
Income Tax Provision. The income tax provision for the three months ended March 31, 2012 was $0.3 million or 9.4% of the Company’s income before income taxes. This differs from the federal statutory rate of 34% primarily because the Company’s foreign income was taxed at lower rates and because of the benefit that the Company realized as a result of stock option exercises and restricted units vested.

The income tax provision for the three months ended March 31, 2011 was $0.2 million or 9.8% of the Company’s income before income taxes. This differs from the federal statutory rate of 34% primarily because the Company’s foreign income was taxed at lower rates and because of the benefit that the Company realized as a result of the disqualifying disposition of incentive stock options and employee stock plan purchases.
 
 
Liquidity and Capital Resources.
 
   
March 31,
2012
   
December 31,
2011
 
    (in thousands)  
             
Cash and cash equivalents
  $ 78,731     $ 96,371  
Short-term investments
    102,197       77,827  
Total cash, cash equivalents and short-term investments
  $ 180,928     $ 174,198  
Percentage of total assets
    62.1 %     63.6 %
                 
Total current assets
  $ 225,420     $ 211,505  
Total current liabilities
    31,469       26,070  
Working Capital
  $ 193,951     $ 185,435  
 
As of March 31, 2012, we had working capital of $194.0 million, including cash and cash equivalents of $78.7 million and short-term investments of $102.2 million, compared to working capital of $185.4 million, including cash and cash equivalents of $96.4 million and short-term investments of $77.8 million as of December 31, 2011. For the three months ended March 31, 2012, cash and cash equivalents decreased by $17.6 million primarily due to investment in short-term securities and due to building improvements at our new headquarters located in San Jose, California. We have financed our operations primarily with proceeds from cash generated from operating activities, proceeds from the exercise of stock options and proceeds from the issuance of shares through the Company’s employee stock purchase plan.
 
The significant components of our working capital are cash and cash equivalents, short-term investments, accounts receivable, inventories, deferred income taxes and prepaid expenses and other current assets, reduced by accounts payable, accrued and other current liabilities, deferred revenue and customer prepayments.

The working capital at March 31, 2012, increased by $8.5 million compared to the working capital at December 31, 2011 primarily due to a $13.9 million net increase in current assets offset by a $5.4 million net increase in current liabilities. The increase in current assets was primarily due to investment in short-term securities. In addition, accounts receivable increased reflecting a change in the timing of shipments during the quarter relative to the fourth quarter of 2011. The increase in current liabilities was primarily due to an increase in accounts payable.

Summary of Cash Flows. The table below summarizes the cash and cash equivalents provided by (used in) in our operating, investing and financing activities (in thousands) for the periods presented:
 
   
Three months ended March 31,
 
   
2012
   
2011
 
   
(in thousands)
 
Cash provided by operating activities
  $ 6,219     $ 8,230  
Cash provided by (used in) investing activities
    (29,190 )     26,556  
Cash provided by (used in) financing activities
    5,121       (8,820 )
Effect of exchange rate changes on cash and cash equivalents
    210       86  
Net increase (decrease) in cash and cash equivalents
  $ (17,640 )   $ 26,052  
 
For the three months ended March 31, 2012, net cash provided by operating activities was $6.2 million, primarily due to strong operating results and an increase in accounts payable related to building improvements for our new headquarters and for inventory purchases to meet customer demands. This was partially offset by an increase in accounts receivable, primarily from the timing of shipments relative to the fourth quarter of 2011 for which the collections have not been made. For the three months ended March 31, 2011, net cash provided by operating activities was $8.2 million primarily due to strong operating results and an increase in accounts payable for inventory purchases. This was partially offset by an increase in inventory to meet the anticipated second quarter demand and an increase in accounts receivable resulting from shipments at the end of the quarter for which the collections have not been made. As of March 31, 2012, $46.9 million of the $78.7 million of cash and cash equivalents was held by our foreign 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.
 
For the three months ended March 31, 2012, net cash used by investing activities was $29.2 million, primarily related to the investment in short-term securities and investment in building improvements at our new headquarters located in San Jose, California. For the three months ended March 31, 2011, net cash provided by investing activities was $26.6 million, primarily related to the redemption of short-term investments to fund our stock repurchase program.
 
 
We use professional investment management firms to manage the majority of our invested cash. Our fixed income portfolio is primarily invested in US government securities, auction-rate securities and highly rated corporate notes and commercial paper. The balance of the fixed income portfolio is managed internally and invested primarily in money market securities for working capital purposes.
 
We adopted the provisions of ASC 320-10-35 Investments – Debt and Equity Securities – Overall – Subsequent Measurement and ASC 320-10-50 Investments – Debt and Equity Securities – Overall - Disclosure, effective April 1, 2009 and used the guidelines therein to determine whether the impairment is temporary or other-than temporary. Temporary impairment charges are recorded in accumulated other comprehensive income (loss) within equity and have no impact on net income. Other-than-temporary impairment charges exist when the entity has the intent to sell the security, it will more likely than not be required to sell the security before anticipated recovery, or it does not expect to recover the entire amortized cost basis of the security. Other-than-temporary impairment charges are recorded in other income (expenses) in the Condensed Consolidated Statement of Operations.

At March 31, 2012, the Company’s investment portfolio included $13.7 million in government-backed student loan auction-rate securities, net of impairment charges of $0.6 million; of which, $0.5 million was temporary and $0.1 million was recorded other-than-temporary. This compares to an investment balance of auction-rate securities as of December 31, 2011 of $13.7 million, net of impairment charges of $0.7 million; of which, $0.6 million was temporary and $0.1 million was recorded as other-than-temporary. The underlying maturity of these auction-rate securities is up to 36 years. As of March 31, 2012 and December 31, 2011 the portion of the impairment classified as temporary was based on the following analysis:   
 
1.
The decline in the fair value of these securities is not attributable to adverse conditions specifically related to these securities or to specific conditions in an industry or in a geographic area;
 
2.
Management possesses both the intent and ability to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value;
 
3.
Management believes that it is more likely than not that the Company will not have to sell these securities before recovery of its cost basis;
 
4.
Except for the credit loss of $70,000 recognized in year ended December 31, 2009 for the Company’s holdings in auction rate securities described below, the Company does not believe that there is any additional credit loss associated with other auction-rate securities because the Company expects to recover the entire amortized cost basis;
 
5.
The majority of the securities remain AAA rated, with $6.3 million of the auction rate securities having been downgraded by Moody’s to A3-Baa3 during the year ended December 31, 2009, and there have been no downgrades since; and
 
6.
All scheduled interest payments have been made pursuant to the reset terms and conditions; and
 
7.
All redemptions of auction-rate securities representing 63% of the original portfolio purchased by the Company in February 2008 have been at par.

Based on the guidance of ASC 320-10-35 and ASC 320-10-50, the Company evaluated the potential credit loss of each of the auction-rate securities that are currently held by the Company. Based on such analysis, the Company determined that those securities that are not 100% FFELPS guaranteed are potentially subject to credit risks based on the extent to which the underlying debt is collateralized and the security-specific student-loan default rates. The Company’s portfolio includes two such securities. The senior parity ratio for the two securities is approximately 106%. If, therefore, the student-loan default rate and borrowing rate increases for these issuers, the remaining balance in these trusts may not be sufficient to cover the senior debt. The Company therefore concluded that there is potential credit risk for these two securities and as such, used the discounted cash flow model to determine the amount of credit loss to be recorded. In valuing the potential credit loss, the following parameters were used: 20 year expected term, cash flows based on the 90-day t-bill rates for 20 year forwards and a risk premium of 5.9%, the amount of interest that the Company was receiving on these securities when the market was last active. During the year ended December 31, 2009, the potential credit loss associated with these securities was $70,000, which the Company deemed other-than-temporary and recorded in other expense in its Consolidated Statement of Operations during 2009. There have been no such losses since.
 
Unless a rights offering or other similar offer is made to redeem at par and accepted by us, we intend to hold the balance of these investments through successful auctions at par, which we believe could take approximately 2.0 years.
 
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 fma1 maturity, insurance guaranty and market conditions, among others. To determine the fair value of the auction-rate securities at December 31,2011 and March 31,2012, the Company used a discounted cash flow model, for which there are four unobservable inputs: estimated time-to-1iquidity, discount rate, credit quality of the issuer and expected interest receipts. A significant increase in the tirne-to-liquidity or the discount rate inputs or a significant decrease in the credit quality of the issuer or the expected interest receipts inputs in isolation would result in a significantly lower fair value measurement. The following are the values used in the discounted cash flow model:
 
 
March 31, 2012
December 31, 2011
Time-to-Liquidity
24 months
24 months
Expected Return (Based on the requisite treasury rate, plus a contractual penalty rate)
1.8%
1.8%
Discount Rate (Based on the requisite LIBOR, the cost of debt and a liquidity risk premium)
2.8% - 7.6%, depending on the credit-rating of the security
3.1% - 7.9%, depending on the credit-rating of the security
 
 
From the fourth quarter of 2011 to the first quarter of 2012, we kept the time-to-liquidity constant at 2.0 years. We sold $0.1 million in auction-rate securities at par and reversed the impairment related to these securities in the amount of $0.1 million. This reduced the overall impairment from $0.7 million at December 31, 2011 to $0.6 million at March 31, 2012.
 
Net cash provided by financing activities for the three months ended March 31, 2012 was $5.1 million, primarily from the proceeds from the exercise of stock options in the amount of $4.0 million and proceeds from the employee stock purchase plan of $1.0 million. Net cash used in financing activities for the three months ended March 31, 2011 was $8.8 million, primarily from stock repurchases in the amount of 13.7 million, which was partially offset by the proceeds from the exercise of stock options in the amount of $3.5 million and proceeds from the employee stock purchase plan of $0.9 million.
 
On July 27, 2010, we announced that our Board of Directors approved a stock repurchase program that authorized the Company to repurchase up to $50.0 million of its common stock between August 2, 2010 and December 31, 2011. From August 2010 through June 2011, we repurchased 4,385,289 shares for a total of $70.0 million. In February 2011, our Board of Directors approved an increase from $50.0 million to $70.0 million. During the three months ended March 31, 2011, the following shares have been repurchased through the open market and subsequently retired:
 
    Three months ended March 31, 2011  
   
Shares Repurchased
   
Average Price per Share
   
Value (in thousands)
 
February 2011
   
817,500
   
$
15.47
   
$
12,648
 
March 2011
   
75,000
   
$
14.17
   
$
1,062
 
                         
     
892,500
           
$
13,710
 
 
Although cash requirements will fluctuate based on the timing and extent of many factors such as those discussed above, we believe that cash generated from operations, together with the liquidity provided by existing cash and cash equivalents and short-term investments, will be sufficient to satisfy our liquidity requirements for at least the next 12 months. For further details regarding our operating, investing and financing activities, see our Condensed Consolidated Statements of Cash Flows.
 
Contractual Obligations and Off Balance Sheet Arrangements.
 
As of March 31, 2012 we continued to lease our headquarters and sales offices in San Jose, California. We moved to our Company-owned headquarters also located in San Jose, California in May 2012.

Certain of our facility leases provide for periodic rent increases. In September 2004, we signed an agreement with the Chinese local authority to construct a facility in Chengdu, China. We have the option to acquire this facility in Chengdu after a five-year lease term, which option became exercisable in March 2011. We will likely exercise our purchase option and enter into a purchase agreement for this facility in the future. We constructed a 150,000 square foot research and development facility in Chengdu, China which was put into operation in October 2010.
 
We also lease our sales offices in Japan, China, Taiwan, Singapore and Korea and our research and development facilities in Finland.
 
 
As of March 31, 2012, our total outstanding purchase commitments with vendors were $25.5 million, which includes wafer purchases from our three foundries and the purchase of assembly services primarily from multiple contractors in Asia. This compares to purchase commitments of $18.6 million as of December 31, 2011.
 
Our other contractual obligations have not changed significantly from that disclosed in our annual report on Form 10-K filed with the SEC on March 12, 2012.
 
As of March 31, 2012, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of the Securities and Exchange Commission’s Regulation S-K.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
For a discussion of market risks at December 31, 2011, refer to Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” in our annual report on Form 10-K for the fiscal year ended December 31, 2011 filed with the SEC on March 12, 2012. During the three months ended March 31, 2012, there were no material changes or developments that would materially alter the market risk assessment performed as of December 31, 2011.
 
During the quarter ended September 30, 2011, S&P downgraded the credit rating for U.S. long-term sovereign debt. We will continue to monitor the situation and potentially rebalance our investment portfolio, as needed. Currently, we do not believe that there is any impairment, temporary or otherwise, related to our investments in U.S. Treasuries and U.S. Agencies and as such, we have not recorded any such impairment.
 
ITEM 4. CONTROLS AND PROCEDURES
 
Evaluation of disclosure controls and procedures.
 
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 as of the end of the period covered by this quarterly report on Form 10-Q.  In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.  In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
 
Based on our evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.
 
Changes in internal control over financial reporting.
 
There were no changes in our internal control over financial reporting that occurred during the period covered by this quarterly report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
On September 16, 2011 and September 29, 2011, two nearly identical shareholder derivative actions were filed in the United States District Court for the Northern District of California and the California Superior Court for Santa Clara County, naming as defendants certain of our current and former directors and officers and our compensation advisory firm.  The complaints assert claims for, among other things, breach of fiduciary duty in connection with the directors' approval of compensation for our executive officers during 2010.  The complaints each seek an award of damages in favor of the Company, equitable relief, costs and attorney's fees. On March 2, 2012, the parties in the state court action stipulated to the dismissal without prejudice of that action. On April 3, 2012, a hearing was held in the United States District Court on the defendants’ motions to dismiss the case. The court has not yet ruled on the motions. The matters are at a preliminary stage at the United States District Court; the defendants have not yet responded to the complaint and no discovery has taken place. In management’s opinion, the resolution of the derivative action filed in the United States District Court is uncertain and estimate of its effect cannot be made on our consolidated financial condition, results of operations or liquidity.
 
On May 3, 2012, the United States District Court for the Northern District of California issued an order finding O2 Micro International, Ltd. ("O2 Micro") liable for approximately $9.1 million in attorneys' fees and non-taxable costs, plus interest, in connection with the patent litigation that the Company won in 2010. This award is in addition to the approximately $340,000 in taxable costs that the Court had earlier ordered O2 Micro to pay to the Company in connection with the same lawsuit.
 
O2 Micro filed complaints against the Company in both the United States International Trade Commission (“ITC”) and and the Northern District of California, alleging that the Company infringed four O2 Micro patents but then voluntarily dismissed three patents. In June 2010, the ITC found that the Company's products did not infringe O2 Micro's patent. Subsequently, O2 Micro unilaterally dismissed its infringement claims with prejudice, and granted the Company and its customers broad covenants not to sue in the district court case.
 
 
On March 3, 2011, the Court ordered O2 Micro to pay the Company $339,315.13 in costs. The Court also found that "O2 Micro engaged in a vexatious litigation strategy and litigation misconduct," entitling the Company to its reasonable attorneys' fees. O2 Micro's vexatious litigation strategy consisted of filing lawsuits against the Company and its customers; only to dismiss them after substantial litigation had taken place. This allowed O2 Micro to damage the Company's business while avoiding trials at which the validity of its patents would be challenged.
 
Since that time, the Company submitted the documentation for its attorneys' fees and non-taxable costs. O2 Micro challenged those fees on various grounds. On May 3, 2012, the Court accepted the Company's figures and entered an order awarding $8,419,429 in attorneys' fees, and $663,151 in non-taxable costs, plus interest. The Court then entered judgment for the Company.
 
The Company anticipates that O2 Micro will appeal the Court's orders and the final judgment.  These amounts will be recognized in the Consolidated Financial Statements of the company when all related appeals have been exhausted and collectibility is probable.
  
We and certain of our subsidiaries are parties to actions and proceedings incident to our business in the ordinary course of business, including litigation regarding our intellectual property, challenges to the enforceability or validity of our intellectual property and claims that our products infringe on the intellectual property rights of others. These proceedings often involve complex questions of fact and law and will require the expenditure of significant funds and the diversion of other resources to prosecute and defend. We defend ourselves vigorously against any such claims. In December 2011, the Company entered into a settlement and license agreement with a third-party company for infringement of the Company’s patent whereby the Company will receive $2 million which will be paid in equal installments of $300,000 in each quarter of 2012 and the remainder will be paid in two equal installments in the first two quarters of 2013. For the three months ended March 31, 2012, the Company received the first $300,000 payment which was recorded as a credit to the litigation expenses in the Condensed Consolidated Statement of Operations.
 
 
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 our 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, which have been updated from the risk factors previously disclosed in our Annual Report on Form 10-K involve forward-looking statements and our actual results may differ substantially from those discussed in these forward-looking statements.

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

 
increases in assembly costs due to commodity price increases, such as the price of gold;
 
 
the timing of new product introductions by us and our competitors;
 
 
the acceptance of our new products in the marketplace;
 
 
our ability to develop new process technologies and achieve volume production;
 
 
our ability to meet customer product demand in a timely manner;
 
 
the scheduling, rescheduling, or cancellation of orders by our customers;
 
 
the cyclical nature of demand for our customers’ products;
 
 
an increase in stock rotation reserves;
 
 
our ability to manage our inventory levels, including the levels of inventory held by our distributors;
 
 
inventory levels and product obsolescence;
 
 
seasonality and variability in the computer, consumer electronics, and communications markets;
 
 
the availability of adequate manufacturing capacity from our outside suppliers;
 
 
increases in prices for finished wafers due to general capacity shortages;
 
 
 
the potential loss of future business resulting from current capacity issues;
 
 
changes in manufacturing yields;
 
 
movements in exchange rates, interest rates or tax rates; and
 
· determining the probability of accounting charges associated with performance-based equity awards granted to our employees.
 
Due to the factors noted above and other risks described in this section, many of which are beyond our control, you should not rely on quarter-to-quarter or year-over-year comparisons to predict our future financial performance. Unfavorable changes in any of the above factors may seriously harm our business and cause our stock price to decline and be volatile.
 
We may not be profitable on a quarterly or annual basis.
 
Our profitability is dependent on many factors, including:
 
 
our sales, which because of our turns business (i.e., orders received and shipped within the same fiscal quarter), is difficult to accurately forecast;
 
 
consumer electronic sales, which have experienced and may continue to experience a downturn as a result of the worldwide economic crisis;
 
 
our competition, which could adversely impact our selling prices and our potential sales;
 
 
our manufacturing costs, including our ability to negotiate with our vendors and our ability to efficiently run our test facility in China;
                        
 
manufacturing capacity constraints;
 
· determining the probability and magnitude of stock compensation accounting charges; and
 
 
our operating expenses, including general and administrative expenses, selling and marketing expenses, stock-based compensation expenses, litigation expenses, and research and development expenses relating to products that will not be introduced and will not generate revenue until later periods, if at all.
 
We may not achieve profitability on a quarterly or annual basis in the future. Unfavorable changes in our operations, including any of the factors noted above, may have a material adverse effect on our quarterly or annual profitability.
 
Due to product shortages early in 2010, several major customers in Korea sought alternative suppliers, which impacted our full year revenue in 2011, our year to date revenue in 2012 and may continue to impact our revenue in future periods. If we are unable to find alternative sources of revenue to offset this source of lost revenue, our profitability may be impacted, which could materially and adversely affect our stock price and results of operations.
 
We may not experience growth rates comparable to past years.
 
In the past, our revenues increased significantly in certain years due to increased sales of certain of our products. Due to various factors, including increased competition, loss of certain of our customer install base, unfavorable changes in our operations, reduced global electronics demand, end-customer market downturn, market acceptance and penetration of our current and future products and ongoing litigation, we may not experience growth rates comparable to past periods, which could materially and adversely affect our stock price and results of operations.
 
We may be unsuccessful in developing and selling new products with margins similar to or better than what we have experienced in the past, which would impact our overall gross margin and financial performance.
 
Our success depends on products that are differentiated in the market, which result in gross margins that have historically been above the industry averages. Should we fail to improve our gross margin in the future, and accordingly develop and introduce sufficiently differentiated products that result in higher gross margins than industry averages, our financial condition could be materially adversely affected.
 
 
The highly cyclical nature of the semiconductor industry, which has produced significant and sometimes prolonged downturns, could materially adversely affect our operating results, financial condition and cash flows.
 
Historically, the semiconductor industry has been highly cyclical and, at various times, has experienced significant downturns and wide fluctuations in supply and demand. These conditions have caused significant variances in product demand and production capacity, as well as rapid erosion of average selling prices. The industry may experience severe or prolonged downturns in the future, which could result in downward pressure on the price of our products as well as lower demand for our products. Because significant portions of our expenses are fixed in the short term or incurred in advance of anticipated sales, we may not be able to decrease our expenses in a timely manner to offset any sales shortfall. These conditions could have a material adverse effect on our operating results, financial condition and cash flows.
 
If demand for our products declines in the major end markets that we serve, our revenue will decrease and our results of operations and financial condition would be materially and adversely affected.
 
We believe that the application of our products in the computer, consumer electronics and communications markets will continue to account for the majority of our revenue. If the demand for our products declines in the major end markets that we serve, our revenue will decrease and our results of operations and financial condition would be materially and adversely affected. In addition, as technology evolves, the ability to integrate the functionalities of various components, including our discrete semiconductor products, onto a single chip and/or onto other components of systems containing our products increases. Should our customers require integrated solutions that we do not offer, demand for our products could decrease, and our business and results of operations would be materially and adversely affected.
 
We may be unsuccessful in developing and selling new products or in penetrating new markets required to maintain or expand our business.
 
Our competitiveness and future success depend on our ability to design, develop, manufacture, assemble, test, market, and support new products and enhancements on a timely and cost-effective basis. A fundamental shift in technologies in any of our product markets could have a material adverse effect on our competitive position within these markets. Our failure to timely develop new technologies or to react quickly to changes in existing technologies could materially delay our development of new products, which could result in product obsolescence, decreased revenue, and/or a loss of market share to competitors.
 
As we develop new product lines, we must adapt to market conditions that are unfamiliar to us, such as competitors and distribution channels that are different from those we have known in the past. Some of our new product lines require us to re-equip our labs to test parameters we have not tested in the past. If we are unable to adapt rapidly to these new and additional conditions, we may not be able to successfully penetrate new markets.
 
The success of a new product depends on accurate forecasts of long-term market demand and future technological developments, as well as on a variety of specific implementation factors, including:
 
 
timely and efficient completion of process design and device structure improvements;
 
 
timely and efficient implementation of manufacturing, assembly, and test processes;
 
 
the ability to secure and effectively utilize fabrication capacity in different geometries;
 
 
product performance;
 
 
product availability;
 
 
the quality and reliability of the product; and
 
 
effective marketing, sales and service.
 
To the extent that we fail to timely introduce new products or to quickly penetrate new markets, our revenue and financial condition could be materially adversely affected.
 
 
We derive most of our revenue from direct or indirect sales to customers in Asia and have significant operations in Asia, which may expose us to political, cultural, regulatory, economic, foreign exchange, and operational risks.
 
We derive most of our revenue from customers located in Asia through direct or indirect sales through distribution arrangements with parties located in Asia. As a result, we are subject to increased risks due to this geographic concentration of business and operations. For the quarter ended March 31, 2012, approximately 89% of our revenue was from customers in Asia. There are risks inherent in doing business in Asia, and internationally in general, including:
 
 
changes in, or impositions of, legislative or regulatory requirements, including tax laws in the United States and in the countries in which we manufacture or sell our products;
 
 
trade restrictions, including restrictions imposed by the United States government on trading with parties in foreign countries;
 
 
currency exchange rate fluctuations impacting intra-company transactions;
 
 
transportation delays;
 
 
changes in tax regulations in China that may impact our tax status in Chengdu;
 
 
multi-tiered distribution channels that lack visibility to end customer pricing and purchase patterns;
 
 
international political relationships and threats of war;
 
 
terrorism and threats of terrorism;
 
 
epidemics and illnesses;
 
 
work stoppages and infrastructure problems due to adverse weather conditions or natural disasters;
 
 
work stoppages related to employee dissatisfaction;
 
 
economic and political instability;
 
 
changes in import/export regulations, tariffs, and freight rates;
 
 
longer accounts receivable collection cycles and difficulties in collecting accounts receivables;
 
 
enforcing contracts generally; and
 
 
less effective protection of intellectual property and contractual arrangements.
 
If we fail to expand our customer base and significantly reduce the geographical concentration of our customers, we will continue to be subject to the foregoing risks, which could materially and adversely affect our revenue and financial condition.
 
We are subject to anti-corruption laws in the jurisdictions in which we operate, including the U.S. Foreign Corrupt Practices Act, or the FCPA. Our failure to comply with these laws could result in penalties which could harm our reputation and have a material adverse effect on our business, results of operations and financial condition.
 
We are subject to the FCPA, which generally prohibits companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or keeping business and/or other benefits, along with various other anticorruption laws. Although we have implemented policies and procedures designed to ensure that we, our employees and other intermediaries comply with the FCPA and other anticorruption laws to which we are subject, there is no assurance that such policies or procedures will work effectively all of the time or protect us against liability under the FCPA or other laws for actions taken by our employees and other intermediaries with respect to our business or any businesses that we may acquire. We have significant operations in Asia, which places us in frequent contact with persons who may be considered “foreign officials” under the FCPA, resulting in an elevated risk of potential FCPA violations. If we are not in compliance with the FCPA and other laws governing the conduct of business with government entities (including local laws), we may be subject to criminal and civil penalties and other remedial measures, which could have an adverse impact on our business, financial condition, results of operations and liquidity. Any investigation of any potential violations of the FCPA or other anticorruption laws by U.S. or foreign authorities could harm our reputation and have an adverse impact on our business, financial condition and results of operations.
 
 
We receive a significant portion of our revenue from distribution arrangements, value-added resellers and direct customers, and the loss of any one of these distributors or value-added resellers or failure to collect a receivable from them could adversely affect our operations and financial position.
 
We market our products through distribution arrangements and value-added resellers and through our direct sales and applications support organization to customers that include OEMs, ODMs and electronic manufacturing service providers. Receivables from our customers are generally not secured by any type of collateral and are subject to the risk of being uncollectible. For the quarter ended March 31, 2012, sales to our largest two distributors accounted for approximately 29% of our total revenue. Significant deterioration in the liquidity or financial condition of any of our major customers or any group of our customers could have a material adverse impact on the collectability of our accounts receivable and our future operating results. We primarily conduct our sales on a purchase order basis, and we do not have any long-term supply contracts.
 
Moreover, we believe a high percentage of our products are eventually sold to a number of OEMs. Although we communicate with OEMs in an attempt to achieve “design wins,” which are decisions by OEMs and/or ODMs to incorporate our products, we do not have purchase commitments from these end users. Therefore, there can be no assurance that the OEMs and/or ODMs will continue to incorporate our ICs into their products. OEM technical specifications and requirements can change rapidly, and we may not have products that fit new specifications from an end-customer for whom we have had previous design wins. We cannot be certain that we will continue to achieve design wins from large OEMs, that our direct customers will continue to be successful in selling to the OEMs, or that the OEMs will be successful in selling products which incorporate our ICs. The loss of any significant customer, any material reduction in orders by any of our significant customers or by their OEM customers, the cancellation of a significant customer order, or the cancellation or delay of a customer’s or OEM’s significant program or product could reduce our revenue and adversely affect our operations and financial condition.
 
Due to the nature of our business as a component supplier, we may have difficulty both in accurately predicting our future revenue and appropriately managing our expenses.
 
Because we provide components for end products and systems, demand for our products is influenced by our customers’ end product demand. As a result, we may have difficulty in accurately forecasting our revenue and expenses. Our revenue depends on the timing, size, and speed of commercial introductions of end products and systems that incorporate our products, all of which are inherently difficult to forecast, as well as the ongoing demand for previously introduced end products and systems. In addition, demand for our products is influenced by our customers’ ability to manage their inventory. Our sales to distributors are subject to higher volatility because they service demand from multiple levels of the supply chain which, in itself, is inherently difficult to forecast. Specifically, in the fourth quarter of 2010, demand was lower because distributors used up inventory that was shipped in the third quarter. If our customers, including distributors, do not manage their inventory correctly or misjudge their customers’ demand, our shipments to and orders from our customers may vary significantly on a quarterly basis.

Our ability to increase product sales and revenues may be constrained by the manufacturing capacity of our suppliers.
 
Although we provide our suppliers with rolling forecasts of our production requirements, their ability to provide wafers to us is limited by the available capacity, particularly capacity in the geometries we require, at the facilities in which they manufacture wafers for us.  As a result, this lack of capacity has constrained our product sales and revenue growth.  In addition, an increased need for capacity to meet internal demands or demands of other customers could cause our suppliers to reduce capacity available to us. Our suppliers may also require us to pay amounts in excess of contracted or anticipated amounts for wafer deliveries or require us to make other concessions in order to acquire the wafer supply necessary to meet our customer requirements. If our suppliers extend lead times, limit supplies or the types of capacity we require, or increase prices due to capacity constraints or other factors, our revenue and gross margin may materially decline.  In addition, if we experience supply delays or limitations, our customers may reduce their purchase levels with us and/or seek alternative solutions to meet their demand, which could materially and adversely impact our business and results of operations.
 
Due to lack of capacity, which resulted in product shortages in early 2010, several major customers in Korea sought alternative suppliers, which impacted our full year revenue in 2011, our year-to-date revenue in 2012 and may continue to impact our revenue in future periods. If we are faced with capacity issues similar to what we experienced in 2010, our product sales and revenue may be further impacted, which could materially and adversely affect our business and results of operations.

We currently depend on three third-party suppliers to provide us with wafers for our products. If any of our wafer suppliers become insolvent or capacity constrained and are unable and/or fail to provide us sufficient wafers at acceptable yields and at anticipated costs, our revenue and gross margin may decline or we may not be able to fulfill our customer orders.

We have a supply arrangement with three suppliers for the production of wafers. Should any of our suppliers become insolvent or capacity constrained, we many not be able to fulfill our customer orders, which would likely cause a decline in our revenue.
 
 
While certain aspects of our relationship with these suppliers are contractual, many important aspects of this relationship depend on our suppliers’ continued cooperation and our management relationships. In addition, the fabrication of ICs is a highly complex and precise process. Problems in the fabrication process can cause a substantial percentage of wafers to be rejected or numerous ICs on each wafer to be non-functional. This could potentially reduce yields. The failure of our suppliers to supply us wafers at acceptable yields could prevent us from fulfilling our customer orders for our products and would likely cause a decline in our revenue.
 
Further, as is common in the semiconductor industry, our customers may reschedule or cancel orders on relatively short notice. Under our agreement with our suppliers, we have an option to order wafers based on a committed forecast that can cover a period of one to six months. If our customers cancel orders after we submit a committed forecast to our suppliers for the corresponding wafers, we may be required to purchase wafers that we may not be able to resell, which would adversely affect our operating results, financial condition, and cash flows.
 
We might not be able to deliver our products on a timely basis if our relationships with our assembly and test subcontractors are disrupted or terminated.
 
All of our products are assembled by third-party subcontractors and a portion of our testing is currently performed by third-party subcontractors. We do not have any long-term agreements with these subcontractors. As a result, we may not have direct control over product delivery schedules or product quality. Also, due to the amount of time typically required to qualify assembly and test subcontractors, we could experience delays in the shipment of our products if we were forced to find alternate third parties to assemble or test our products.  In addition, events such as the recent global economic crisis may materially impact our assembly supplier’s ability to operate. Any future product delivery delays or disruptions in our relationships with our subcontractors could have a material adverse effect on our operating results, financial condition, and cash flows.
 
There may be unanticipated costs associated with adding to or supplementing our third-party supplier’s manufacturing capacity.
 
We anticipate that future growth of our business will require increased manufacturing capacity on the part of third-party supply foundries, assembly shops, or testing facilities for our products.  In order to facilitate such growth, we may need to enter into strategic transactions, investments and other activities. Such activities are subject to a number of risks, including:
 
 
the costs and expense associated with such activities;
 
 
the availability of modern foundries to be developed, acquired, leased or otherwise made available to us or our third-party suppliers;
  
 
the ability of foundries and our third-party suppliers to obtain the advanced equipment used in the production of our products;
 
 
delays in bringing new foundry operations online to meet increased product demand; and
 
 
unforeseen environmental, engineering or manufacturing qualification problems relating to existing or new foundry facilities.
 
These and other risks may affect the ultimate cost and timing of any expansion of our third-party supplier’s capacity.
 
We purchase inventory in advance based on expected demand for our products, and if demand is not as expected, we may have insufficient or excess inventory, which could adversely impact our financial position.
 
As a fabless semiconductor company, we purchase our inventory from a third party manufacturer in advance of selling our product. We place orders with our manufacturer based on existing and expected orders from our customers for particular products. While our contracts with our customers and distributors include lead time requirements and cancellation penalties that are designed to protect us from misalignment between customer orders and inventory levels, we must nonetheless make some predictions when we place orders with our manufacturer. In the event that our predictions are inaccurate due to unexpected increases in orders or unavailability of product within the time frame that is required, we may have insufficient inventory to meet our customer demands. In the event that we order products that we are unable to sell due to a decrease in orders, unexpected order cancellations, injunctions due to patent litigations, or product returns, we may have excess inventory which, if not sold, may need to be disposed of or would result in a decrease in our revenues in future periods as the excess inventory at our distributors is sold. If any of these situations were to arise, it could have a material impact on our business and financial position.
 
 
The outcome of currently ongoing and future examinations of our income tax returns by the IRS could have a material adverse effect on our results of operations.
 
We are subject to examination of our income tax returns by the IRS and other tax authorities.  Our U.S. Federal income tax returns for the years ended December 31, 2000 through December 31, 2007 are under examination by the IRS. In April 2011, we received from the IRS a Notice of Proposed Adjustment, or “NOPA”, relating to a cost-sharing agreement entered into by the Company and its international subsidiaries on January 1, 2004. In the NOPA, the IRS objected to the Company’s allocation of certain litigation expenses between the Company and our international subsidiaries and the amount of “buy-in payments” made by our international subsidiaries to the Company in connection with the cost-sharing agreement, and proposed to increase our U.S. taxable income according to a few alternative methodologies. The methodology resulting in the largest potential adjustment , if the IRS were to prevail on all matters in dispute, would result in potential federal and state income tax liabilities of up to $37.0 million, plus interest and penalties, if any. We believe that the IRS’s position in the NOPA is incorrect and that our tax returns for those years were correct as filed. We expect to contest these proposed adjustments vigorously. In February 2012, we received a revised NOPA from the IRS (Revised NOPA). In this Revised NOPA, the IRS is raising the same issues as in the NOPA issued in April 2011 but under a different methodology. Under the Revised NOPA, the largest potential adjustment, if the IRS were to prevail on all matters in dispute, has decreased to $10.5 million, plus interest and penalties, if any. On March 20, 2012, the Company received an examination report from IRS, commonly referred to as a “30-day letter”, formally proposing adjustments to the taxable years 2005, 2006 and 2007. After receiving 30-day extension, the Company has until May 19th, 2012, to respond to the 30-day letter.  The IRS also audited the research and development credits generated in the years 2000 through 2007, and the carryforward of these credits to subsequent years.  We received a NOPA from the IRS in February 2011, proposing to reduce the research and development credits generated in years 2000 through 2007, which would also reduce the value of such credits carried forward to subsequent tax years.  We are currently reviewing these proposed adjustments. We regularly access the likelihood of an adverse outcome resulting from such examinations to determine the adequacy of our provision for income taxes.  As of March 31, 2012, based on the technical merits of our tax return filing positions, we believe that it is more-likely-than-not that the benefit of such positions will be sustained upon the resolution of our audits resulting in no significant impact on our consolidated financial position and the results of operations and cash flows

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

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

If we are not successful in litigation that could be brought against us or our customers, we could be ordered to pay monetary fines and/or damages. If we are found liable for willful patent infringement, damages could be doubled or tripled. We and/or our customers could also be prevented from selling some or all of our products. Moreover, our customers and end-users could decide not to use our products or our products or our customers’ accounts payable to us could be seized. Finally, interim developments in these proceedings could increase the volatility in our stock price as the market assesses the impact of such developments on the likelihood that we will or will not ultimately prevail in these proceedings.
 
 
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