Edgar Filing: MONOLITHIC POWER SYSTEMS INC

mpwr20131020_10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2013

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

Commission file number: 000-51026

Monolithic Power Systems, Inc.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

Delaware

77-0466789

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification Number)

79 Great Oaks Boulevard, San Jose, CA 95119 (408) 826-0600

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE AND TELEPHONE NUMBER)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

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

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

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

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

There were 38,206,635 shares of the registrant’s common stock issued and outstanding as of October 21, 2013.

MONOLITHIC POWER SYSTEMS, INC.

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

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

MONOLITHIC POWER SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

(Unaudited)

	September 30, 2013		December 31, 2012
ASSETS
Current assets:
Cash and cash equivalents	$	110,446	$	75,104
Short-term investments		93,902		85,521
Accounts receivable, net of allowances of $10 as of September 30, 2013 and $20 as of December 31, 2012		21,957		19,383
Inventories		42,975		32,115
Deferred income tax assets, net - current		19		1
Prepaid expenses and other current assets		1,651		2,177
Total current assets		270,950		214,301
Property and equipment, net		67,221		59,412
Long-term investments		9,847		11,755
Deferred income tax assets, net - long-term		669		669
Other assets		1,353		1,025
Total assets	$	350,040	$	287,162

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	10,406	$	9,859
Accrued compensation and related benefits		6,708		7,686
Accrued liabilities		9,245		5,915
Total current liabilities		26,359		23,460

Long-term liabilities		1,311		-
Non-current income tax liabilities		5,039		5,408
Total liabilities		32,709		28,868
Stockholders' equity:
Common stock, $0.001 par value; shares authorized: 150,000; shares issued and outstanding: 38,227 and 35,673 as of September 30, 2013 and December 31, 2012, respectively		235,993		194,079
Retained earnings		75,439		60,040
Accumulated other comprehensive income		5,899		4,175
Total stockholders’ equity		317,331		258,294
Total liabilities and stockholders’ equity	$	350,040	$	287,162

See accompanying notes to unaudited condensed consolidated financial statements.

MONOLITHIC POWER SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(Unaudited)

	Three months ended September 30,						Nine months ended September 30,
	2013			2012			2013			2012

Revenue	$	65,347		$	56,508		$	174,531		$	165,599
Cost of revenue (1)		30,053			26,495			80,924			78,004
Gross profit		35,294			30,013			93,607			87,595
Operating expenses:
Research and development (1)		12,643			11,967			37,246			35,553
Selling, general and administrative (1)		13,891			11,955			40,941			36,088
Litigation expense (benefit)		104			(229	)		(455	)		(345	)
Total operating expenses		26,638			23,693			77,732			71,296

Income from operations		8,656			6,320			15,875			16,299
Interest and other income (expense), net		(59	)		156			149			621
Income before income taxes		8,597			6,476			16,024			16,920
Income tax provision		1,187			555			625			1,412
Net income	$	7,410		$	5,921		$	15,399		$	15,508

Basic net income per share	$	0.20		$	0.17		$	0.42		$	0.45
Diluted net income per share	$	0.19		$	0.16		$	0.40		$	0.43
Weighted average common shares outstanding:
Basic		37,910			35,145			37,079			34,677
Diluted		39,009			36,438			38,419			36,008

(1) Includes stock-based compensation expense as follows:
Cost of revenue	$	163		$	112		$	465		$	325
Research and development		1,491			1,465			4,557			4,255
Selling, general and administrative		3,577			2,605			10,059			6,746
Total stock-based compensation expense	$	5,231		$	4,182		$	15,081		$	11,326

See accompanying notes to unaudited condensed consolidated financial statements.

MONOLITHIC POWER SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(Unaudited)

	Three months ended September 30,					Nine months ended September 30,
	2013		2012			2013		2012
Net income	$	7,410	$	5,921		$	15,399	$	15,508
Other comprehensive income (loss), net of tax:
Auction-rate securities valuation adjustments, net of $0 tax for the three and nine months ended September 30, 2013 and 2012		149		42			117		141
Unrealized gains on available-for-sale securities, net of $0 tax for the three and nine months ended September 30, 2013 and 2012		34		42			12		36
Foreign currency translation adjustments, net of $0 tax for the three and nine months ended September 30, 2013 and 2012		431		(141	)		1,595		255
Total other comprehensive income (loss), net of tax		614		(57	)		1,724		432
Comprehensive income	$	8,024	$	5,864		$	17,123	$	15,940

See accompanying notes to unaudited condensed consolidated financial statements.

MONOLITHIC POWER SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

	Nine months ended September 30,
	2013			2012

Cash flows from operating activities:
Net income	$	15,399		$	15,508
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		8,960			6,866
Loss on disposal of property and equipment		-			79
Amortization and loss on investments		320			145
Gain on auction-rate securities		-			(40	)
Excess tax benefit from stock option transactions		-			(835	)
Stock-based compensation		15,081			11,326
Changes in operating assets and liabilities:
Accounts receivable		(2,573	)		(6,464	)
Inventories		(10,851	)		(12,519	)
Prepaid expenses and other current assets		463			(490	)
Accounts payable		1,164			2,345
Accrued liabilities		3,492			(345	)
Accrued income taxes payable and noncurrent tax liabilities		(215	)		1,254
Accrued compensation and related benefits		(1,002	)		(3,380	)
Net cash provided by operating activities		30,238			13,450

Cash flows from investing activities:
Property and equipment purchases		(15,424	)		(18,735	)
Proceeds from sale of property and equipment		-			13
Purchases of intangible assets		-			(459	)
Premiums paid on deferred compensation plan		(309	)		-
Purchases of short-term investments		(62,374	)		(115,709	)
Proceeds from sale of short-term investments		55,700			86,168
Proceeds from sale of long-term investments		25			2,100
Net cash used in investing activities		(22,382	)		(46,622	)

Cash flows from financing activities:
Proceeds from issuance of common stock		32,654			12,233
Proceeds from employee stock purchase plan		2,145			1,852
Repurchases of common stock		(7,973	)		-
Excess tax benefits from stock option transactions		-			835
Net cash provided by financing activities		26,826			14,920
Effect of change in exchange rates		660			128
Net increase (decrease) in cash and cash equivalents		35,342			(18,124	)
Cash and cash equivalents, beginning of period		75,104			96,371
Cash and cash equivalents, end of period	$	110,446		$	78,247
Supplemental disclosures for cash flow information:
Cash paid for taxes	$	847		$	732
Supplemental disclosures of non-cash investing and financing activities:
Liability accrued for property and equipment purchases	$	2,081		$	1,687
Temporary impairment of auction-rate securities	$	(117	)	$	(141	)

See accompanying notes to unaudited condensed consolidated financial statements.

MONOLITHIC POWER SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared by Monolithic Power Systems, Inc. (the “Company” or “MPS”) in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted in accordance with these rules and regulations. The information in this report should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 5, 2013.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the Company’s financial position, results of operations and cash flows for the interim periods presented. The financial statements contained in this Form 10-Q are not necessarily indicative of the results that may be expected for the year ending December 31, 2013 or for any other future period.

Summary of Significant Accounting Policies

There have been no changes to the Company’s significant accounting policies during the three and nine months ended September 30, 2013 as compared to the significant accounting policies described in the Company’s audited consolidated financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 5, 2013.

Recently Adopted Accounting Pronouncement

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

2. Stock-Based Compensation

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

	Three months ended September 30,						Nine months ended September 30,
	2013			2012			2013			2012
Non-employee	$	-		$	6		$	-		$	17
Employee stock purchase plan		129			88			460			478
Restricted stock		4,894			3,447			13,800			8,508
Stock options		208			641			821			2,323
Tax benefit		(80	)		(59	)		(175	)		(172	)
	$	5,151		$	4,123		$	14,906		$	11,154

2014 Equity Incentive Plan

The Company’s Board of Directors adopted the 2014 Equity Incentive Plan (the “2014 Plan”) in April 2013, and the Company’s stockholders approved the 2014 Plan at the Company’s Annual Meeting of Stockholders in June 2013. The 2014 Plan will become effective on November 13, 2014, the day after the 2004 Equity Incentive Plan (the “2004 Plan”) expires. Once the 2004 Plan expires, the Company will no longer be able to grant equity awards under the 2004 Plan, and any shares otherwise remaining available for future grants under the 2004 Plan will no longer be available for issuance. The 2014 Plan provides for the issuance of up to 5,500,000 shares and will expire on November 13, 2024.

2004 Equity Incentive Plan

The following is a summary of the 2004 Plan, which includes stock options, time-based restricted stock units (“RSUs”) and performance share units (“PSUs”):

Available for grants as of January 1, 2013	4,957,244
Additions to plan	1,783,664
Grants	(563,930	)
Performance awards adjustment (1)	(375,509	)
Cancellations	161,747
Available for grant as of September 30, 2013	5,963,216

(1) The performance awards adjustment reflects the change in management’s probability assessment as of September 30, 2013 of the number of PSUs that will ultimately vest. See “Restricted Stock” section for details.

Restricted Stock

A summary of the time-based RSUs and PSUs is presented in the table below:

	RSUs			Weighted Average Grant Date Fair Value Per Share		PSUs			Weighted Average Grant Date Fair Value Per Share		Total			Weighted Average Grant Date Fair Value Per Share		Weighted Average Remaining Recognition Period (Years)
Outstanding at January 1, 2013		1,098,563		$	16.96		531,185		$	18.49		1,629,748		$	17.46		2.18
Awards granted		252,388			23.74		311,542			24.35		563,930			24.08
Performance awards adjustment (1)		-			-		375,509			21.73		375,509			21.73
Awards released		(397,209	)		17.42		(206,409	)		18.90		(603,618	)		17.93
Awards forfeited		(109,822	)		17.03		(42,757	)		18.91		(152,579	)		17.55
Outstanding at September 30, 2013		843,920			18.76		969,070			21.52		1,812,990			20.24		1.88

(1) The performance awards adjustment reflects the change in management’s probability assessment as of September 30, 2013 of the number of PSUs that will ultimately vest.

The intrinsic value related to restricted stock released for the three months ended September 30, 2013 and 2012 was $3.2 million and $3.3 million, respectively. The intrinsic value related to restricted stock released for the nine months ended September 30, 2013 and 2012 was $14.8 million and $7.7 million, respectively. The total intrinsic value of restricted stock outstanding at September 30, 2013 and December 31, 2012 was $54.9 million and $36.3 million, respectively. At September 30, 2013, unamortized compensation expense related to restricted stock was approximately $24.1 million, with a weighted-average remaining recognition period of 1.9 years.

2010 PSUs:

On February 25, 2010, the Board granted 416,000 PSUs to the Company’s executive officers (“2010 Executive PSUs”). These performance units generally vested over four years, with a graded acceleration feature that allowed all or a portion of these awards to be accelerated if certain performance conditions were satisfied. The number of shares to be accelerated was based on achieving certain performance targets as set forth in the Company’s annual operating plan approved by the Board, as determined by the Compensation Committee in its sole discretion. In February 2013, the Compensation Committee determined that the pre-determined performance goals for the 2010 Executive PSUs were met and therefore accelerated the vesting of the remaining awards in February 2013.

2011 CEO Awards:

The Company granted 153,000 time-based RSUs to its CEO on February 8, 2011. In the fourth quarter of 2011, the Compensation Committee proposed modifying half of the time-based RSUs to PSUs and on February 7, 2012, the Board approved the performance goals based on the Company’s 2012 revenue (“2012 Modification”). The time-based RSUs that were not modified vested over two years on a quarterly basis from February 2011 to February 2013. The PSUs vested upon achievement of the pre-determined performance goals and the CEO’s continued employment. The maximum number of PSUs the CEO could receive was 100% of the RSUs originally granted. In February 2013, the Compensation Committee determined that the pre-determined performance goals for the 2012 Modification were met and therefore the PSUs were released in February 2013.

2012 Time-Based RSUs and PSUs:

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

Based on the Company’s revenue forecast as of September 30, 2013, the Company has determined that it is probable that it will be able to exceed the pre-determined performance goals. The Company continues to evaluate expected performance against the pre-determined goals and will adjust stock-based compensation expense accordingly.

On April 24, 2012, the Company granted 344,650 awards to its existing non-executive employees. These grants include 219,317 time-based RSUs, which generally vest over four years on a quarterly basis, and 125,333 PSUs. The PSUs will be a target number of shares awarded upon achievement of a pre-determined revenue target for the Company as a whole, certain regions or product-line divisions in 2013 (“2012 Non-Executive PSUs”). Half of the 2012 Non-Executive PSUs will vest if the pre-determined performance goals are met and the employee is employed by the Company when the Compensation Committee approves the release of the shares. The remainder vests over the following two years on a quarterly basis. The maximum number of shares an employee may receive is 300% of the PSUs originally granted.

Based on the Company’s revenue forecast as of September 30, 2013, the Company has determined that it is probable that it will be able to achieve or exceed the pre-determined performance goals. The Company continues to evaluate expected performance against the pre-determined goals and will adjust stock-based compensation expense accordingly.

2013 Time-Based RSUs and PSUs:

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

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

Based on the Company’s 2014 revenue forecast as of September 30, 2013, the Company has determined that it is probable that it will be able to achieve or exceed the pre-determined performance goals. The Company continues to evaluate expected performance against the pre-determined goals and will adjust stock-based compensation expense accordingly.

Stock Options

A summary of the stock option activities during the nine months ended September 30, 2013 is presented in the table below:

	Stock Options			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)		Aggregate Intrinsic Value
Outstanding at January 1, 2013 (3,603,762 options exercisable at a weighted-average exercise price of $15.59 per share)		3,813,361		$	15.62		2.56	$	25,379,573
Options granted		-			-
Options exercised		(2,106,632	)		15.50
Options forfeited and expired		(9,168	)		16.87
Outstanding at September 30, 2013		1,697,561			15.76		2.01		24,670,713
Options exercisable at September 30, 2013 and expected to become exercisable		1,693,071			15.77		2.00		24,594,612
Options vested and exercisable at September 30, 2013		1,592,588			15.82		1.85		23,044,939

Total intrinsic value of options exercised was $11.3 million and $3.6 million for the three months ended September 30, 2013 and 2012, respectively. Total intrinsic value of options exercised was $22.2 million and $9.1 million for the nine months ended September 30, 2013 and 2012, respectively. The net cash proceeds from the exercise of stock options were $16.5 million and $4.9 million for the three months ended September 30, 2013 and 2012, respectively. The net cash proceeds from the exercise of stock options were $32.7 million and $12.2 million for the nine months ended September 30, 2013 and 2012, respectively. At September 30, 2013, unamortized compensation expense related to unvested options was approximately $0.7 million. The weighted average period over which compensation expense related to these unvested options will be recognized is approximately 1.5 years.

In estimating the expected term, the Company considers its historical stock option exercise experience, post vesting cancellations and remaining contractual term of the options outstanding. In estimating the expected volatility, the Company uses its own historical data to determine its estimated expected volatility. The Company uses the U.S. Treasury yield for its risk-free interest rate and a dividend yield of zero as the Company generally has not paid dividends. The cash dividend paid in December 2012 was a special dividend. The Company applies a forfeiture rate that is based on options that have been forfeited historically.

Employee Stock Purchase Plan

For the three months ended September 30, 2013 and 2012, 46,000 and 55,000 shares, respectively, were issued under the Employee Stock Purchase Plan (“ESPP”). For the nine months ended September 30, 2013 and 2012, 111,000 and 152,000 shares, respectively, were issued under the ESPP. The following is a summary of the ESPP and changes during the nine months ended September 30, 2013:

Available shares as of January 1, 2013	4,217,960
Additions to plan	713,466
Purchases	(111,002	)
Available shares as of September 30, 2013	4,820,424

The intrinsic value of stock purchased was $0.3 million and $0.3 million for the three months ended September 30, 2013 and 2012, respectively. The intrinsic value of stock purchased was $0.8 million and $1.0 million for the nine months ended September 30, 2013 and 2012, respectively. The unamortized expense as of September 30, 2013 was $0.2 million, which will be recognized over five months. The Black-Scholes option pricing model was used to value the employee stock purchase rights. The following assumptions were used in the valuation:

	Three months ended September 30,						Nine months ended September 30,
	2013			2012			2013			2012
Expected term (years)		0.5			0.5			0.5			0.5
Expected volatility		27.5	%		39.6	%		28.0	%		45.8	%
Risk-free interest rate		0.1	%		0.1	%		0.1	%		0.1	%
Dividend yield		-			-			-			-

Cash proceeds from employee stock purchases for the nine months ended September 30, 2013 and 2012 were $2.1 million and $1.9 million, respectively.

3. Inventories

Inventories consist of the following (in thousands):

	September 30, 2013		December 31, 2012
Work in progress	$	28,312	$	20,992
Finished goods		14,663		11,123
Total inventories	$	42,975	$	32,115

4. Accrued Liabilities

Accrued liabilities consist of the following (in thousands):

	September 30, 2013		December 31, 2012
Deferred revenue and customer prepayments	$	2,736	$	2,198
Stock rotation reserve		1,851		961
Sales rebate		1,480		575
Commissions		629		464
Legal expenses and settlement costs		565		402
Warranty		383		331
Other		1,601		984
Total accrued liabilities	$	9,245	$	5,915

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

	Three months ended September 30,						Nine months ended September 30,
	2013			2012			2013			2012
Balance at beginning of period	$	334		$	443		$	331		$	561
Warranty provision for product sales		130			583			349			802
Settlements made		(3	)		(29	)		(98	)		(154	)
Unused warranty provision		(78	)		(138	)		(199	)		(350	)
Balance at end of period	$	383		$	859		$	383		$	859

5. Net Income per Share

Basic net income per share excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted net income per share reflects the potential dilution that would occur if outstanding securities or other contracts to issue common stock were exercised or converted into common stock, and calculated using the treasury stock method. The Company has securities outstanding, which could potentially dilute 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 September 30,				Nine months ended September 30,
	2013		2012		2013		2012
Numerator:
Net income	$	7,410	$	5,921	$	15,399	$	15,508

Denominator:
Weighted average outstanding shares used to compute basic net income per share		37,910		35,145		37,079		34,677
Effect of dilutive securities		1,099		1,293		1,340		1,331
Weighted average outstanding shares used to compute diluted net income per share		39,009		36,438		38,419		36,008

Net income per share - basic	$	0.20	$	0.17	$	0.42	$	0.45
Net income per share - diluted	$	0.19	$	0.16	$	0.40	$	0.43

For the three months ended September 30, 2013 and 2012, approximately 1,000 and 1.0 million common stock equivalents, respectively, were excluded from the calculation of diluted net income per share because their inclusion would have been anti-dilutive. For the nine months ended September 30, 2013 and 2012, approximately 7,000 and 1.3 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 280-10-55, Segment Reporting – Overall – Implementation Guidance and Illustrations, the Company operates in one reportable segment that includes the design, development, marketing and sale of high-performance, mixed-signal analog semiconductors for the communications, computing, consumer and industrial markets. The Company’s chief operating decision maker is its chief executive officer. The Company does not specifically allocate any of its resources to, or measure the performance of, individual product families. The Company derives a majority of its revenue from sales to customers located outside North America, with geographic revenue based on the customers’ ship-to location.

The following is a list of customers whose sales exceeded 10% of the Company’s total revenue:

	Three months ended September 30,						Nine months ended September 30,
Customers	2013			2012			2013			2012

A		33	%		36	%		32	%		32	%

Reflecting consolidations in recent years among distributors, the Company corrected the 2012 amounts reported in the table above from the amounts previously reported to disclose a group of entities under common control as a single customer, rather than as separate customers. Under the corrected disclosure, Customer A is reported as representing 36% of the Company's total revenue for the three months ended September 30, 2012 (rather than as three separate customers representing 18%, 17% and 1% of revenue), and 32% of the Company’s total revenue for the nine months ended September 30, 2012 (rather than as three separate customers representing 16%, 15% and 1% of revenue). This correction had no impact on the Company's consolidated financial statements.

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

	Three months ended September 30,				Nine months ended September 30,
Country and Region	2013		2012		2013		2012
China	$	40,577	$	31,023	$	102,099	$	95,207
Taiwan		8,886		7,579		24,726		21,814
Europe		3,949		5,004		11,226		12,987
Korea		2,599		3,022		7,425		7,581
Japan		2,285		2,029		5,446		6,690
USA		1,812		1,437		5,552		4,150
Rest of Asia		5,103		6,309		17,817		16,658
Other		136		105		240		512
Total	$	65,347	$	56,508	$	174,531	$	165,599

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

	Three months ended September 30,				Nine months ended September 30,
Product Family	2013		2012		2013		2012
DC to DC converters	$	57,823	$	49,710	$	154,801	$	145,217
Lighting control products		7,524		6,798		19,730		20,382
Total	$	65,347	$	56,508	$	174,531	$	165,599

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

	September 30, 2013		December 31, 2012
China	$	43,628	$	37,071
USA		24,738		23,163
Taiwan		80		90
Japan		40		57
Other		88		55
Total	$	68,574	$	60,436

7. Litigation

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

O2 Micro

In May 2012, the United States District Court for the Northern District of California (the “District Court”) issued an order finding O2 Micro International, Ltd. (“O2 Micro”) liable for approximately $9.1 million in attorneys’ fees and non-taxable costs, plus interest, in connection with the patent litigation that the Company won in 2010. This award was in addition to the approximately $0.3 million in taxable costs that the District Court had earlier ordered O2 Micro to pay to the Company in connection with the same lawsuit. In October 2012, O2 Micro appealed the District Court’s judgment to the United States Court of Appeals for the Federal Circuit (the “Federal Circuit”). In August 2013, the Federal Circuit affirmed O2 Micro’s liability for the full amount of the award. In September 2013, O2 Micro filed a petition for rehearing of that ruling, but the Federal Circuit denied O2 Micro’s petition for rehearing on October 16, 2013. O2 Micro has not indicated whether it will seek review by the United States Supreme Court. As of September 30, 2013, the Company did not record the award as income in the Condensed Consolidated Statements of Operations since payment has not been received.

Silergy

In December 2011, the Company entered into a settlement and license agreement with Silergy Corp and Silergy Technologies for infringement of the Company’s patent whereby the Company would receive a total of $2.0 million. The first $1.2 million was paid in equal installments of $300,000 in each quarter of 2012 and the remainder was paid in two equal installments in the first two quarters of 2013. No further amount was due to the Company as of September 30, 2013. All amounts were recorded as credits to litigation benefit (expense) in the Condensed Consolidated Statements of Operations in the periods the proceeds were received.

8. Investments

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

	Estimated Fair Market Value as of
	September 30, 2013		December 31, 2012
Cash, cash equivalents and investments:
Cash in banks	$	100,660	$	59,145
Money market funds		9,786		15,959
US treasuries and US government agency bonds		91,902		85,521
Auction-rate securities backed by student-loan notes		11,847		11,755
Total cash, cash equivalents and investments	$	214,195	$	172,380

Reported as:	September 30, 2013		December 31, 2012
Cash and cash equivalents	$	110,446	$	75,104
Short-term investments		93,902		85,521
Long-term investments		9,847		11,755
Total cash, cash equivalents and investments	$	214,195	$	172,380

In September, 2013, one auction-rate security of $2.0 million was called at par by the issuer and redeemed in October 2013. The Company classified the auction-rate security as a short-term investment as of September 30, 2013. In addition, as of September 30, 2013, the Company classified the auction-rate security in the “due in greater than 5 years” category in the table below as the contractual maturity date of the investment is 2042.

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

	September 30, 2013		December 31, 2012
Due in less than 1 year	$	66,468	$	52,880
Due in 1 - 5 years		25,434		32,641
Due in greater than 5 years		11,847		11,755
	$	103,749	$	97,276

ASC 820-10 Fair Value Measurements and Disclosures – Overall defines fair value, establishes a framework for measuring fair value and requires that assets and liabilities carried at fair value be classified and disclosed in one of three categories, as follows:

Level 1: Quoted prices in active markets for identical assets;

Level 2: Significant other observable inputs; and

Level 3: Significant unobservable inputs.

The following table details the fair value measurements within the fair value hierarchy of the financial assets (in thousands):

	Fair Value Measurements at September 30, 2013
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Total		Level 1		Level 2		Level 3
Money market funds	$	9,786	$	9,786	$	-	$	-
US treasuries and US government agency bonds		91,902		-		91,902		-
Auction-rate securities backed by student-loan notes		11,847		-		-		11,847
	$	113,535	$	9,786	$	91,902	$	11,847

	Fair Value Measurements at December 31, 2012
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Total		Level 1		Level 2		Level 3
Money market funds	$	15,959	$	15,959	$	-	$	-
US treasuries and US government agency bonds		85,521		-		85,521		-
Auction-rate securities backed by student-loan notes		11,755		-		-		11,755
	$	113,235	$	15,959	$	85,521	$	11,755

The following tables summarize unrealized gains and losses related to our investments in marketable securities designated as available-for sale (in thousands):

	As of September 30, 2013
	Adjusted Cost		Unrealized Gains		Unrealized Losses			Total Fair Value		Fair Value of Investments in Unrealized Loss Position

Money market funds	$	9,786	$	-	$	-		$	9,786	$	-
US treasuries and US government agency bonds		91,852		53		(3	)		91,902		4,503
Auction-rate securities backed by student-loan notes		12,220		-		(373	)		11,847		9,847
	$	113,858	$	53	$	(376	)	$	113,535	$	14,350

`	As of December 31, 2012
	Adjusted Cost		Unrealized Gains		Unrealized Losses			Total Fair Value		Fair Value of Investments in Unrealized Loss Position

Money market funds	$	15,959	$	-	$	-		$	15,959	$	-
US treasuries and US government agency bonds		85,483		45		(7	)		85,521		14,121
Auction-rate securities backed by student-loan notes		12,245		-		(490	)		11,755		11,755
	$	113,687	$	45	$	(497	)	$	113,235	$	25,876

At September 30, 2013, available-for-sale securities included $91.9 million securities issued by government agencies and treasuries which are classified as short-term investments on the Condensed Consolidated Balance Sheet. The Company also had $9.8 million invested in money market funds. At September 30, 2013, there was $3,000 in unrealized losses from these investments. At September 30, 2013, the Company also had $11.8 million of auction-rate securities.

At December 31, 2012, available-for-sale securities included $85.5 million securities issued by government agencies and treasuries which are classified as short-term investments on the Condensed Consolidated Balance Sheet. The Company also had $16.0 million invested in money market funds. At December 31, 2012, there was $7,000 in unrealized losses from these investments. At December 31, 2012, the Company also had $11.8 million of auction-rate securities, all of which are classified as long-term available-for-sale investments.

Temporary impairment charges are recorded in accumulated other comprehensive income within stockholders’ equity and have no impact on net income. Other-than-temporary impairment exists when the Company either has the intent to sell the security, it will more likely than not be required to sell the security before anticipated recovery or it does not expect to recover the entire amortized cost basis of the security. Other-than-temporary impairment charges are recorded in interest and other income (expense), net, in the Condensed Consolidated Statement of Operations.

Auction-Rate Securities:

The Company’s level 3 assets consist of government-backed student loan auction-rate securities, with interest rates that reset through a Dutch auction every 7 to 35 days and which became illiquid in 2008. The following table provides a reconciliation of the Company’s level 3 assets (in thousands):

Beginning balance at January 1, 2013	$	11,755
Sales and settlement at par		(25	)
Unrealized loss included in other comprehensive income		(15	)
Ending balance at March 31, 2013		11,715
Unrealized loss included in other comprehensive income		(17	)
Ending balance at June 30, 2013		11,698
Unrealized gain included in other comprehensive income		149
Ending balance at September 30, 2013	$	11,847

The Company’s investment portfolio as of September 30, 2013 included $11.8 million in government-backed student loan auction-rate securities, net of impairment charges of $403,000, of which $373,000 was temporary and $30,000 was recorded as other-than-temporary. This compares to an investment balance for auction-rate securities as of December 31, 2012 of $11.8 million in government-backed student loan auction-rate securities, net of impairment charges of $520,000, of which $490,000 was temporary and $30,000 was recorded as other-than-temporary. In September 2013, one auction-rate security of $2.0 million was called at par by the issuer and redeemed in October 2013. The Company classified the auction-rate security as a short-term investment as of September 30, 2013.

The underlying maturities of these auction-rate securities are up to 35 years. As of September 30, 2013 and December 31, 2012, the portion of the impairment classified as temporary was based on the following analysis:

	1.	The decline in the fair value of these securities is not largely attributable to adverse conditions specifically related to these securities or to specific conditions in an industry or in a geographic area;
	2.	Management possesses both the intent and ability to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value;
	3.	Management believes that it is more likely than not that the Company will not have to sell these securities before recovery of its cost basis;
	4.	Except for the credit loss of $70,000 recognized in the year ended December 31, 2009 for the Company’s holdings in auction-rate securities, the Company does not believe that there is any additional credit loss associated with other auction-rate securities because the Company expects to recover the entire amortized cost basis;
	5.	$6.3 million of auction-rate securities were downgraded by Moody’s to A3-Baa3 during the year ended December 31, 2009. There have been no further downgrades since. One auction-rate security of $2.0 million was called at par by the issuer and redeemed in October 2013;
	6.	All scheduled interest payments have been made pursuant to the reset terms and conditions; and
	7.	All redemptions of auction-rate securities, representing 72% of the original portfolio, have been at par.

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.

Determining the fair value of the auction-rate securities requires significant management judgment regarding projected future cash flows which will depend on many factors, including the quality of the underlying collateral, estimated time for liquidity including potential to be called or restructured, underlying final maturity, insurance guaranty and market conditions, among others. To determine the fair value of the auction-rate securities, the Company used a discounted cash flow model, for which there are four unobservable inputs: estimated time-to-liquidity, discount rate, credit quality of the issuer and expected interest receipts. A significant increase in the time-to liquidity or the discount rate inputs or a significant decrease in the credit quality of the issuer or the expected interest receipts inputs in isolation would result in a significantly lower fair value measurement. The following are the values used in the discounted cash flow model:

	At September 30, 2013	At December 31, 2012
Time-to-liquidity (months)	24	24
Expected return (based on the requisite treasury rate, plus a contractual penalty rate)	2.3%	1.8%
Discount rate (based on the requisite LIBOR, the cost of debt and a liquidity risk premium)	3.1%-7.9%, depending on the credit-rating of the security	2.5%-7.3%, depending on the credit-rating of the security

During the nine months ended September 30, 2012, the Company redeemed a security at face value for which an other-than-temporary impairment of $40,000 had previously been recorded and therefore, recognized a gain of $40,000 in interest and other income (expense), net, in the Condensed Consolidated Statement of Operations.

Deferred Compensation Plan:

In the second quarter of 2013, the Company adopted a deferred compensation plan, which provides certain key employees, including our executive management, with the ability to defer the receipt of compensation in order to accumulate funds for retirement on a tax-deferred basis, beginning July 1, 2013. The Company does not make contributions to the plan or guarantee returns on the investments. The Company is responsible for the plan’s administrative expenses. Participant deferrals and investment gains and losses remain as the Company’s liabilities and the underlying assets are subject to claims of general creditors.

The Company’s plan assets include corporate-owned life insurance policies, which are recorded at the cash surrender value in each reporting period and are included in other long-term assets. Changes in the cash surrender value are recorded in interest and other income (expense), net. The liabilities of the plan are recorded at fair value in each reporting period and are included in other long-term liabilities. Changes in fair value are recorded as an operating expense (credit). As of September 30, 2013, the plan assets totaled $302,000 and the plan liabilities totaled $311,000. For the three months ended September 30, 2013, the Company recorded an expense of $6,000 in interest and other income (expense), net, and an operating expense of $3,000.

9. Income Taxes

The income tax expense for the three and nine months ended September 30, 2013 was $1.2 million, or 13.8% of the pre-tax income, and $625,000, or 3.9% of the pre-tax income, respectively. This differs from the federal statutory rate of 34% primarily because the Company’s foreign income was taxed at lower rates and because of the benefit that the Company realized from the release of a reserve where the statute of limitations expired. The income tax provision for the three and nine months ended September 30, 2012 was $555,000, or 8.6% of the pre-tax income, and $1.4 million, or 8.3% of the pre-tax income, respectively. This differs from the federal statutory rate of 34% primarily because the Company’s foreign income was taxed at lower rates and because of the benefit that the Company realized as a result of stock option exercises and releases of restricted stock.

The Company is subject to examination of its income tax returns by the IRS and other tax authorities. The Company’s U.S. Federal income tax returns for the years ended December 31, 2005 through December 31, 2007 are under examination by the IRS. In April 2011, the Company received from the IRS a Notice of Proposed Adjustment (“NOPA”) relating to a cost-sharing agreement entered into by the Company and its international subsidiaries on January 1, 2004. In the NOPA, the IRS objected to the Company’s allocation of certain litigation expenses between the Company and its international subsidiaries and the amount of “buy-in payments” made by the Company’s international subsidiaries to the Company in connection with the cost-sharing agreement, and proposed to increase the Company’s U.S. taxable income according to a few alternative methodologies. In February 2012, the Company received a revised NOPA from the IRS (Revised NOPA). In this Revised NOPA, the IRS raised the same issues as in the NOPA issued in April 2011 but under a different methodology. Under the Revised NOPA, the largest potential federal income tax adjustment, if the IRS were to prevail on all matters in dispute, is $10.5 million, plus interest and penalties, if any. The Company responded to the Revised NOPA in May 2012. As of June 2013, the IRS has responded and continues to disagree with the Company’s rebuttal. The Company is taking the issue to the IRS Office of Appeals and is waiting for an appointed date. Meanwhile, the Company agreed to grant the IRS an extension of the statute of limitations for taxable years 2005 through 2007 to June 30, 2014. The Company believes that the IRS's position in the NOPA is incorrect and that the Company's tax returns for those years were correct as filed. The Company is contesting these proposed adjustments vigorously.

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

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

As of September 30, 2013, the Company had unrecognized tax benefits of approximately $14.3 million. Included in this balance is approximately $4.8 million of tax benefits that, if recognized, would result in an adjustment to the Company’s effective tax rate after considering the valuation allowance. It is reasonably possible that the total amount of unrecognized tax benefits will increase or decrease in the next twelve months. Such changes could occur based on the normal expiration of statutes of limitations or the possible conclusion of ongoing tax audits. As of September 30, 2013, the Company does not expect to significantly change its unrecognized tax benefits within the next twelve months.

The Company classifies interest and penalties related to uncertain tax positions as a component of its provision for income taxes. The Company has accrued an insignificant amount of interest and penalties relating to income taxes on the unrecognized tax benefits as of September 30, 2013 and December 31, 2012.

10. Accumulated Other Comprehensive Income

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

	Auction Rate Securities Valuation Adjustments			Unrealized Gains on Available-for-Sale Securities			Foreign Currency Translation Adjustments		Tax		Total

Balance as of January 1, 2013	$	(490	)	$	40		$	4,625	$	-	$	4,175
Other comprehensive income before reclassifications		117			15			1,595		-		1,727
Amounts reclassified from accumulated other comprehensive income		-			(3	)		-		-		(3	)
Net current period other comprehensive income		117			12			1,595		-		1,724
Balance as of September 30, 2013	$	(373	)	$	52		$	6,220	$	-	$	5,899

The following table provides details about reclassifications of the amount from accumulated other comprehensive income (in thousands):

Details about Accumulated Other Comprehensive Income Components	Three months ended September 30, 2013		Nine months ended September 30, 2013		Affected Line Items in the Consolidated Statement of Operations

Unrealized gains on available-for-sale securities	$	1	$	3	Interest and other income (expense), net
		-		-	Income tax provision
Total amount reclassified, net of tax	$	1	$	3

11. Stock Repurchase Program

In July 2013, the Board of Directors approved a stock repurchase program that authorizes the Company to repurchase up to $100.0 million in the aggregate of its common stock from August 9, 2013 to June 30, 2015. All shares are retired upon repurchase. For the three months ended September 30, 2013, the Company repurchased 268,000 shares for $8.0 million, at an average price of $29.75 per share. As of September 30, 2013, $92.0 million remained available for future repurchases under the program.

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, as well as the liquidity of our other investments such as US treasuries;

•

the application of our products in the Communications, Storage and Computing, Consumer and Industrial markets continuing to account for our revenue,

•

estimates of our future liquidity requirements,

•

the cyclical nature of the semiconductor industry,

•

protection of our proprietary technology,

•

near term business outlook for 2013 and 2014,

•

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

•

the outcome of the IRS audit of our tax returns for the tax years ended December 31, 2005 through 2007, and the audit of our French entity’s tax returns for the tax years ended December 31, 2009 and 2010,

•

the percentage of our total revenue from various market segments, and

•

the factors that differentiate us from our competitors.

In some cases, words such as “would,” “could,” “may,” “should,” “predict,” “potential,” “targets,” “continue,” “anticipate,” “expect,” “intend,” “plan,” “believe,” “seek,” “estimate,” “project,” “forecast,” “will,” the negative of these terms or other variations of such terms and similar expressions relating to the future identify forward-looking statements. All forward-looking statements are based on our current outlook, expectations, estimates, projections, beliefs and plans or objectives about our business and our industry. These statements are not guarantees of future performance and are subject to risks and uncertainties. Actual events or results could differ materially and adversely from those expressed in any such forward-looking statements. Risks and uncertainties that could cause actual results to differ materially include those set forth throughout this Quarterly Report on Form 10-Q and, in particular, in the section entitled “Part II. Other Information, Item 1A. Risk Factors”. Except as required by law, we disclaim any duty to and undertake no obligation to update any forward-looking statements, whether as a result of new information relating to existing conditions, future events or otherwise or to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Readers are cautioned not to place undue reliance on such statements, which speak only as of the date of this Quarterly Report on Form 10-Q. Readers should carefully review future reports and documents that we file from time to time with the Securities and Exchange Commission, such as our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.

The following management’s discussion and analysis should be read in connection with the information presented in our unaudited condensed consolidated financial statements and related notes for the three and nine months ended September 30, 2013 included in this report and our audited consolidated financial statements and related notes for the year ended December 31, 2012 included in our Annual Report on Form 10-K filed on March 5, 2013 with the Securities and Exchange Commission.

Overview

We are a fabless semiconductor company that designs, develops, and markets proprietary, advanced analog and mixed-signal semiconductors. Our products are used extensively in computing and network communications products, flat panel TVs, set top boxes and a wide variety of consumer and portable electronics products, automotive and industrial markets. We believe that we differentiate ourselves by offering solutions that are more highly integrated, smaller in size, more energy efficient, more accurate with respect to performance specifications and, consequently, more cost-effective than many competing solutions. We plan to continue to introduce new products within our existing product families, as well as in new innovative product categories.

We operate in the cyclical semiconductor industry where there is seasonal demand for certain products. We are not and will not be immune from current and future industry downturns, but we have targeted product and market areas that we believe have the ability to offer above average industry performance.

We work with third parties to manufacture and assemble our integrated circuits (“ICs”). This has enabled us to limit our capital expenditures and fixed costs, while focusing our engineering and design resources on our core strengths.

Following the introduction of a product, our sales cycle generally takes a number of quarters after we receive an initial customer order for a new product to ramp up. Typical lead time for orders is fewer than 90 days. These factors, combined with the fact that orders in the semiconductor industry can typically be cancelled or rescheduled without significant penalty to the customer, make the forecasting of our orders and revenue difficult.

We derive most of our revenue from sales through distribution arrangements and direct sales to customers in Asia, where the products we produce are incorporated into end-user products. For the three and nine months ended September 30, 2013, 91% and 90% of our revenue, respectively, was attributable to direct or indirect sales to customers in Asia. We derive a majority of our revenue from the sales of our DC to DC converter product family which services the Communications, Storage and Computing, Consumer and Industrial markets. We believe our ability to achieve revenue growth will depend, in part, on our ability to develop new products, enter new market segments, gain market share, manage litigation risk, diversify our customer base and successfully secure manufacturing capacity.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an on-going basis, including those related to revenue recognition, stock-based compensation, long-term investments, short-term investments, inventories, income taxes, warranty obligations and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making the judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Estimates and judgments used in the preparation of our financial statements are, by their nature, uncertain and unpredictable, and depend upon, among other things, many factors outside of our control, such as demand for our products and economic conditions. Accordingly, our estimates and judgments may prove to be incorrect and actual results may differ, perhaps significantly, from these estimates.

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

Revenue Recognition. We recognize revenue when the following four basic criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgment regarding the fixed nature of the fee charged for products delivered and the collectability of those fees. The application of these criteria has resulted in 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 91% and 92% of our distributor sales, including sales to our value-added resellers, for the three and nine months ended September 30, 2013, respectively, were made through distribution arrangements with third parties. These arrangements do not include any special payment terms (our normal payment terms are 30-45 days for our distributors), price protection or exchange rights. Returns are limited to our standard product warranty. Certain of our large distributors have contracts that include limited stock rotation rights that permit the return of a small percentage of the previous six months’ purchases.

Approximately 9% and 8% of our distributor sales for the three and nine months ended September 30, 2013, respectively, were made through small distributors primarily based on purchase orders. These distributors also have no stock rotation rights.

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

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

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

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

If we enter into arrangements that have rights of return that are not estimable, we recognize revenue under such arrangements only after the distributor has sold our products to an end customer.

The terms in a majority of our distribution agreements include the non-exclusive right to promote, develop a market for, and sell our products in certain regions of the world and the ability to terminate the distribution agreement by either party with up to three months’ notice. We generally provide a one to two-year warranty against defects in materials and workmanship. Under this warranty, we will repair the goods, provide replacements at no charge, or, under certain circumstances, provide a refund to the customer for defective products. Estimated warranty returns and warranty costs are based on historical experience and are recorded at the time product revenue is recognized.

Two of our U.S. distributors have distribution agreements where revenue is recognized upon sale by these distributors to their end customers because these distributors have certain rights of return which management believes are not estimable. The deferred income balance from these two distributors as of September 30, 2013 and December 31, 2012 was $1.7 million and $1.4 million, respectively.

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

Accounting for Income Taxes. ASC 740-10 Income Taxes – Overall prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on classification, interest and penalties, accounting in interim periods and disclosure. In accordance with ASC 740-10, we recognize federal, state and foreign current tax liabilities or assets based on our estimate of taxes payable or refundable in the current fiscal year by tax jurisdiction. We also recognize federal, state and foreign deferred tax assets or liabilities for our estimate of future tax effects attributable to temporary differences and carryforwards. We record a valuation allowance to reduce any deferred tax assets by the amount of any tax benefits that, based on available evidence and judgment, are not expected to be realized.

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 September 30, 2013 and December 31, 2012, we had a valuation allowance of $12.5 million and $12.5 million, respectively, attributable to management’s determination that it is more likely than not that most of the deferred tax assets in the United States will not be realized. Should it be determined that additional amounts of the net deferred tax asset will not be realized in the future, an adjustment to increase the deferred tax asset valuation allowance will be charged to income in the period such determination is made. Likewise, in the event we were to determine that it is more likely than not that we would be able to realize our deferred tax assets in the future in excess of our net recorded amount, an adjustment to the valuation allowance for the deferred tax asset would increase income in the period such determination was made.

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

We incurred significant stock-based compensation expense, some of which related to incentive stock options and employee stock purchase plans for which no corresponding tax benefit will be recognized unless a disqualifying disposition occurs. Disqualifying dispositions result in a reduction of income tax expense in the period when the disqualifying disposition occurs. Tax benefits related to realized tax deductions in excess of previously expensed stock compensation are recorded as an addition to paid-in-capital.

Contingencies. We and certain of our subsidiaries are parties to actions and proceedings incidental to our business in the ordinary course of business, including litigation regarding our intellectual property, challenges to the enforceability or validity of our intellectual property and claims that our products infringe on the intellectual property rights of others. The pending proceedings involve complex questions of fact and law and will require the expenditure of significant funds and the diversion of other resources to prosecute and defend. In addition, from time to time, we become aware that we are subject to other contingent liabilities. When this occurs, we will evaluate the appropriate accounting for the potential contingent liabilities using ASC 450-20-25-2 Contingencies – Loss Contingencies - Recognition to determine whether a contingent liability should be recorded. In making this determination, management may, depending on the nature of the matter, consult with internal and external legal counsel and technical experts. Based on the facts and circumstances in each matter, we use our judgment to determine whether it is probable that a contingent loss has occurred and whether the amount of such loss can be estimated. If we determine a loss is probable and estimable, we record a contingent loss in accordance with ASC 450-20-25-2. In determining the amount of a contingent loss, we take into account advice received from experts for each specific matter regarding the status of legal proceedings, settlement negotiations (which may be ongoing), prior case history and other factors. Should the judgments and estimates made by management need to be adjusted as additional information becomes available, we may need to record additional contingent losses that could materially and adversely impact our results of operations. Alternatively, if the judgments and estimates made by management are adjusted, for example, if a particular contingent loss does not occur, the contingent loss recorded would be reversed which could result in a favorable impact on our results of operations.

Accounting for Stock-Based Compensation. We account for stock-based compensation under the provisions of ASC 718-10-30 Compensation – Stock Compensation – Overall – Initial Measurement. This standard requires us to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. We currently use the Black-Scholes option-pricing model to estimate the fair value of our share-based payments. The Black-Scholes option-pricing model is based on a number of assumptions, including historical volatility, expected life, risk-free interest rate and expected dividends. The fair value for time-based stock awards and stock awards that are contingent upon the achievement of financial performance metrics is based on the grant date share price.

We recognize compensation expense equal to the grant-date fair value for all share-based payment awards that are expected to vest. This expense is recorded on a straight-line basis over the requisite service period of the entire award, unless the awards are subject to market or performance conditions, in which case we recognize compensation expense over the requisite service period of each separate vesting tranche. We recognize compensation expense for our performance share units when it becomes probable that the performance criteria specified in the plan will be achieved. The amount of stock-based compensation that the Company recognizes is also based on an expected forfeiture rate. If there is a difference between the forfeiture assumptions used in determining stock-based compensation costs and the actual forfeitures which become known over time, we may change the forfeiture rate, which could have a significant impact on our stock-based compensation expense.

Fair Value of Financial Instruments. ASC 820-10 Fair Value Measurements and Disclosures – Overall defines fair value, establishes a framework for measuring fair value, and requires that assets and liabilities carried at fair value be classified and disclosed in one of the three categories as follows:

Level 1: Quoted prices in active markets for identical assets;

Level 2: Significant other observable inputs; and

Level 3: Significant unobservable inputs.

Our financial instruments include cash and cash equivalents and short-term and long-term investments. Cash equivalents are stated at cost, which approximates fair market value. Short-term and long-term investments are stated at their fair market value.

Investments in available-for-sale securities are recorded at fair value, and unrealized gains or losses (that are deemed to be temporary) are recognized through stockholders' equity, as a component of accumulated other comprehensive income in our condensed consolidated balance sheet and in our condensed consolidated statement of comprehensive income. We record an impairment charge to earnings when an available-for-sale investment has experienced a decline in value that is deemed to be other-than-temporary.

Based on certain assumptions described in Note 8, “Investments” 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:

	Three months ended September 30,										Nine months ended September 30,
	2013					2012					2013					2012
	(in thousands, except percentages)										(in thousands, except percentages)

Revenue	$	65,347		100.0	%	$	56,508		100.0	%	$	174,531		100.0	%	$	165,599		100.0	%
Cost of revenue		30,053		46.0			26,495		46.9			80,924		46.4			78,004		47.1
Gross profit		35,294		54.0			30,013		53.1			93,607		53.6			87,595		52.9

Operating expenses:
Research and development		12,643		19.3			11,967		21.2			37,246		21.3			35,553		21.5
Selling, general and administrative		13,891		21.3			11,955		21.1			40,941		23.5			36,088		21.8
Litigation expense (benefit)		104		0.2			(229	)	(0.4	)		(455	)	(0.3	)		(345	)	(0.2	)
Total operating expenses		26,638		40.8			23,693		41.9			77,732		44.5			71,296		43.1

Income from operations		8,656		13.2			6,320		11.2			15,875		9.1			16,299		9.8
Interest and other income (expense), net		(59	)	(0.1	)		156		0.3			149		0.1			621		0.4
Income before income taxes		8,597		13.1			6,476		11.5			16,024		9.2			16,920		10.2
Income tax provision		1,187		1.8			555		1.0			625		0.4			1,412		0.8

Net income	$	7,410		11.3	%	$	5,921		10.5	%	$	15,399		8.8	%	$	15,508		9.4	%

Revenue

The following table shows our revenue by product family:

	Three months ended September 30,													Nine months ended September 30,
Product Family	2013		% of Revenue			2012		% of Revenue			Percent Change			2013		% of Revenue			2012		% of Revenue			Percent Change
	(In thousands, except percentages)													(In thousands, except percentages)
DC to DC converters	$	57,823		88.5	%	$	49,710		88.0	%		16.3	%	$	154,801		88.7	%	$	145,217		87.7	%		6.6%
Lighting control products		7,524