MONOLITHIC POWER SYSTEMS INC - Quarter Report: 2015 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2015

OR

Commission file number: 000-51026

Monolithic Power Systems, Inc.

(Exact name of registrant as specified in its charter)

79 Great Oaks Boulevard, San Jose, CA 95119

(Address of principal executive offices)(Zip code)

  (408) 826-0600

(Registrant’s telephone number, including area code)

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.

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 39,529,690 shares of the registrant’s common stock issued and outstanding as of May 1, 2015.

MONOLITHIC POWER SYSTEMS, INC.

 PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

MONOLITHIC POWER SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

(Unaudited)

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)

See accompanying notes to unaudited condensed consolidated financial statements.

MONOLITHIC POWER SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(Unaudited)

See accompanying notes to unaudited condensed consolidated financial statements.

MONOLITHIC POWER SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

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, 2014, filed with the SEC on March 2, 2015.

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, 2015 or for any other future periods.

Summary of Significant Accounting Policies

There have been no changes to the Company’s significant accounting policies during the three months ended March 31, 2015 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, 2014.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers, which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. The standard’s core principle is that an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Under the new standard, entities will apply the following five-step model when evaluating revenue contracts with customers:

The standard as currently issued will be effective for the Company starting in the first quarter of fiscal 2017. In April 2015, the FASB voted to propose a one-year deferral to the effective date, but to permit entities to adopt one year earlier if they choose (i.e., the original effective date). The proposal is subject to the FASB’s due process requirement, which includes a period for public comments. Entities have the option of using either a full retrospective or a modified retrospective application in the adoption of this standard. The Company is evaluating the transition method and the impact of the adoption on its consolidated financial position, results of operations and cash flows.

2. STOCK-BASED COMPENSATION

Stock Plan

The Board of Directors adopted the 2014 Equity Incentive Plan (the “2014 Plan”) in April 2013, and the stockholders approved it in June 2013. In October 2014, the Board of Directors approved certain amendments to the 2014 Plan. The 2014 Plan became effective on November 13, 2014. The 2014 Plan provides for the issuance of up to 5.5 million shares and will expire on November 13, 2024. As of March 31, 2015, 5.4 million shares remained available for future issuance. 

Stock-Based Compensation Expense

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

Restricted Stock

The Company’s restricted stock units (“RSUs”) include time-based RSUs, performance-based RSUs (“PSUs”) and market-based RSUs (“MSUs”). Time-based RSUs generally vest over one to four years, subject to continued employment with the Company. PSUs vest over four years and MSUs vest over ten years, subject to the achievement of pre-determined performance goals and continued employment with the Company. A summary of the RSUs is presented in the table below:

The intrinsic value related to awards released for the three months ended March 31, 2015 and 2014 was $25.6 million and $10.2 million, respectively. As of March 31, 2015, the total intrinsic value of outstanding awards, including RSUs, PSUs and MSUs, was $220.4 million, based on the closing stock price of $52.65. As of March 31, 2015, unamortized compensation expense related to outstanding awards, including RSUs, PSUs and MSUs, was approximately $95.6 million with a weighted-average remaining recognition period of approximately five years. 

2015 PSUs:

In February 2015, the Board of Directors granted 172,000 shares of PSUs which represent a target number of RSUs to be awarded based on the Company’s average two-year (2015 and 2016) revenue growth rate compared against the analog industry’s average two-year revenue growth rate as determined by the Semiconductor Industry Association (“2015 Executive PSUs”). The maximum number of 2015 Executive PSUs that an executive officer can ultimately earn is 300% of the target shares. Half of the 2015 Executive PSUs will vest in February 2017 if the pre-determined performance goals are met and approved by the Compensation Committee. The remaining shares will vest over the following two years on a quarterly basis. The vesting is subject to the employees’ continued employment with the Company.

In February 2015, the Board of Directors granted 58,000 shares of PSUs which represent a target number of RSUs to be awarded based on the Company’s 2016 revenue goals for certain regions or product line divisions, or the Company’s average two-year (2015 and 2016) revenue growth rate compared against the analog industry’s average two-year revenue growth rate as determined by the Semiconductor Industry Association (“2015 Non-Executive PSUs”). The maximum number of 2015 Non-Executive PSUs that an employee can ultimately earn is either 200% or 300% of the target shares, depending on the job classifications of the employees. Half of the 2015 Non-Executive PSUs will vest in the first quarter of 2017 if the pre-determined performance goals are met and approved by the Compensation Committee. The remaining shares will vest over the following two years on an annual or quarterly basis. The vesting is subject to the employees’ continued employment with the Company.

Stock Options

A summary of the stock options activities is presented in the table below:

Total intrinsic value of options exercised was $2.5 million and $6.9 million for the three months ended March 31, 2015 and 2014, respectively. The net cash proceeds from the exercise of stock options were $1.3 million and $5.6 million for the three months ended March 31, 2015 and 2014, respectively. As of March 31, 2015, unamortized compensation expense related to unvested options was approximately $0.1 million with a weighted-average remaining recognition period of less than one year.

Employee Stock Purchase Plan (“ESPP”)

For the three months ended March 31, 2015 and 2014, 30,000 and 43,000 shares, respectively, were issued under the ESPP. As of March 31, 2015, 4.7 million shares were available for future issuance.

The intrinsic value of stock purchased was $0.4 million and $0.5 million for the three months ended March 31, 2015 and 2014, respectively. As of March 31, 2015, the unamortized expense was $0.2 million, which will be recognized through the third quarter of 2015. The Black-Scholes model was used to value the employee stock purchase rights with the following weighted-average assumptions:

Cash proceeds from stock purchases were $1.1 million for both the three months ended March 31, 2015 and 2014. 

3. ACQUISITION

On July 22, 2014 (the “Acquisition Date”), the Company acquired 100% of the outstanding capital stock of Sensima Technology SA (“Sensima”), a company based in Switzerland that develops magnetic sensor technologies for angle measurements as well as three-dimensional magnetic field sensing. The acquisition is expected to create new opportunities with customers by offering enhanced solutions in power management for key industries such as automotive, industrial and cloud computing. As a result of the acquisition, Sensima became a subsidiary of the Company and its results of operations have been included in the Company’s consolidated financial statements subsequent to the acquisition.

Purchase Consideration

The fair value of the purchase consideration consists of the following (in thousands):

Cash paid at the Acquisition Date included $1.2 million that is being held in an escrow account for a one-year period, which is subject to Sensima’s satisfaction of certain representations and warranties.

The contingent consideration arrangement requires the Company to pay up to an additional $8.9 million to former Sensima shareholders if Sensima achieves a new product introduction as well as certain product revenue and direct margin targets in 2016. The fair value of the contingent consideration at the Acquisition Date was $2.5 million, which was estimated based on a probability-weighted analysis of possible future cash flow outcomes. The fair value of the contingent consideration is recorded in other long-term liabilities in the Condensed Consolidated Balance Sheets and is remeasured at the end of each reporting period, with any changes in fair value recorded in operating expense in the Condensed Consolidated Statements of Operations. Actual amounts that will ultimately be paid may differ from the obligations recorded.

The Company incurred $0.6 million of transaction costs that were expensed as incurred.

Preliminary Purchase Consideration Allocation

The estimated fair value of assets acquired and liabilities assumed is as follows (in thousands):

Intangible assets with finite lives include know-how and developed technologies with estimated useful lives of three to five years. The fair value of know-how was determined using the relief from royalty method, and the fair value of the developed technologies was determined using the income approach. Intangible assets with indefinite lives include IPR&D, which consists of incomplete R&D projects that had not reached technological feasibility as of the Acquisition Date. The fair value of the IPR&D assets was determined using the income approach.

The goodwill arising from the acquisition was primarily attributed to synergies which will enable the Company to develop advanced solutions in power management by combining with Sensima’s magnetic sensor technologies. The goodwill is not expected to be deductible for tax purposes.

The purchase price allocation is considered preliminary and dependent upon the finalization of the valuation of assets acquired and liabilities assumed, primarily related to deferred taxes. The Company is currently determining if the acquisition qualifies as a tax-free reorganization within the meaning of Swiss tax rules pursuant to the tax holiday granted to Sensima by the Swiss tax authorities. Final determination of the valuation could result in an adjustment to the preliminary purchase price allocation, with an offsetting adjustment to goodwill.

Equity Awards

On the Acquisition Date, the Board of Directors granted $1.7 million of time-based RSUs (or 40,000 shares) to key Sensima employees who became employees of the Company. These awards vest over four years. In addition, the Board of Directors granted $2.0 million of PSUs (or 47,000 shares) to these employees, with the right to earn up to a maximum of $8.0 million based on the achievement of certain cumulative Sensima product revenue targets during the performance period from the Acquisition Date to July 22, 2019. One half of the awards subject to each revenue goal will vest immediately when the pre-determined revenue goal is met and approved by the Compensation Committee, and the remaining 50% will vest over the following two years. The vesting is subject to the employees’ continued employment with the Company. These equity awards are considered arrangements for post-acquisition services and the related compensation expense is being recognized over the requisite service period.

Pro Forma Information (Unaudited)

Supplemental information of the Company’s results of operations on a pro forma basis, as if the Sensima acquisition had been consummated on January 1, 2014, is presented as follows (in thousands, except per-share amounts):

These pro forma results are not necessarily indicative of the Company’s consolidated results of operations in future periods or the results that would have been realized had the Company acquired Sensima during the periods presented. The pro forma results include adjustments primarily related to Sensima’s results of operations, amortization of intangible assets, stock-based compensation expense and the related tax effects.

4. BALANCE SHEET COMPONENTS

Inventories 

Inventories consist of the following (in thousands):

Other Long-Term Assets

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

Accrued Liabilities

Accrued liabilities consist of the following (in thousands): 

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

Other Long-Term Liabilities

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

5. GOODWILL AND ACQUISITION-RELATED INTANGIBLE ASSETS, NET

There have been no changes in the balance of goodwill during the three months ended March 31, 2015.

Acquisition-related intangible assets consist of the following (in thousands):

Amortization expense was recorded in cost of revenue in the Condensed Consolidated Statements of Operations and totaled $0.4 million for the three months ended March 31, 2015. No amortization expense was recorded for the three months ended March 31, 2014.

Management currently expects the IPR&D will be completed in the first half of 2016. Upon completion, the intangible assets will be subject to amortization over its useful life.

As of March 31, 2015, the estimated future amortization expense of intangible assets subject to amortization is as follows (in thousands):

6. NET INCOME PER SHARE

Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted net income per share reflects the potential dilution that would occur if outstanding securities or other contracts to issue common stock were exercised or converted into common stock, and calculated using the treasury stock method. 

The Company’s outstanding RSUs contain forfeitable rights to receive dividend equivalents, which are accrued quarterly during the vesting periods of the RSUs and are payable to the employees when the awards vest. Dividend equivalents accrued on the RSUs are forfeited if the employees do not fulfill their service requirement during the vesting periods. Accordingly, these awards are not treated as participating securities in the net income per share calculation. 

The following table sets forth the computation of basic and diluted net income per share (in thousands, except per-share amounts):

For the three months ended March 31, 2015, approximately 24,000 common stock equivalents were excluded from the calculation of diluted net income per share because their inclusion would have been anti-dilutive.  For the three months ended March 31, 2014, there were no anti-dilutive common stock equivalents.

7. SEGMENT AND GEOGRAPHIC INFORMATION

The Company operates in one reportable segment that includes the design, development, marketing and sale of high-performance, mixed-signal analog semiconductors for the communications, storage and computing, consumer and industrial markets. The Company’s chief operating decision maker is its chief executive officer, who reviews financial information presented on a consolidated basis. The Company derives a majority of its revenue from sales to customers located outside North America, with geographic revenue based on the customers’ ship-to locations.

The Company sells its products primarily through third-party distributors, value-added resellers and directly to original equipment manufacturers, original design manufacturers, and electronic manufacturing service providers. The following table summarizes those customers with sales greater than 10% of the Company's total revenue or accounts receivable balances greater than 10% of the Company’s total accounts receivable:

___________

* Represents less than 10%. 

Both of the customers are third-party distributors. The Company’s agreements with these distributors were made in the ordinary course of business and may be terminated with or without cause by these distributors with advance notice. Although the Company may experience a short-term disruption in the distribution of its products and a short-term decline in revenue if its agreement with either of these distributors was terminated, the Company believes that such termination would not have a material adverse effect on its financial statements because it would be able to engage alternative distributors, resellers and other distribution channels to deliver its products to end customers within a few quarters following the termination of an agreement with a distributor.

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

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

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

8. 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, claims that the Company’s products infringe on the intellectual property rights of others, and employment matters. 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 in October 2013. 

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

In March 2014, the Supreme Court declined to hear the case. As O2 Micro had no further legal avenues to appeal, the Company released the current liability of $9.5 million and recorded the award as a litigation benefit in the Condensed Consolidated Statements of Operations in the first quarter of 2014. In addition, the Company incurred additional legal fees of $0.5 million in connection with the final resolution of the lawsuit.

9. CASH, CASH EQUIVALENTS AND INVESTMENTS

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

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

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

10. FAIR VALUE MEASUREMENT

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

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 rollforward of the fair value of the auction-rate securities (in thousands):

The Company determined the fair value of the auction-rate securities using a discounted cash flow model with the following assumptions:

The Company’s level 3 liabilities consist of the contingent consideration related to the acquisition of Sensima in July 2014. The arrangement requires the Company to pay up to $8.9 million to Sensima’s former shareholders if Sensima achieves a new product introduction as well as certain product revenue and direct margin targets in 2016. The fair value of the contingent consideration at the Acquisition Date was $2.5 million, which was estimated based on a probability-weighted analysis of possible future cash flow outcomes. There were no changes in the fair value of the contingent consideration for the three months ended March 31, 2015.

11. DEFERRED COMPENSATION PLAN

The Company has a non-qualified, unfunded deferred compensation plan, which provides certain key employees, including executive management, with the ability to defer the receipt of compensation in order to accumulate funds for retirement on a tax deferred basis. The Company does not make contributions to the plan or guarantee returns on the investments. The Company is responsible for the plan’s administrative expenses. Participants’ deferrals and investment gains and losses remain as the Company’s liabilities and the underlying assets are subject to claims of general creditors. As of March 31, 2015 and December 31, 2014, the plan assets totaled $8.4 million and $6.1 million, and the plan liabilities totaled $8.4 million and $6.2 million, respectively.

12. INCOME TAXES

The income tax provision for the three months ended March 31, 2015 was $0.5 million, or 8.2% of the income before income taxes. This differs from the federal statutory rate primarily because the Company’s foreign income was taxed at lower rates, and because of the benefit that the Company realized as a result of stock option exercises, the release of RSUs and changes in the valuation allowance.

The income tax provision for the three months ended March 31, 2014 was $0.3 million, or 2.8% of the income before income taxes. This differs from the federal statutory rate primarily because the Company’s foreign income was taxed at lower rates, and because of the benefit that the Company realized as a result of stock option exercises, the release of RSUs and changes in the valuation allowance.

Unrecognized Tax Benefits

As of March 31, 2015, the Company had $16.7 million of unrecognized tax benefits, $5.0 million of which would affect its effective tax rate if recognized after considering the valuation allowance. As of December 31, 2014, the Company had $16.4 million of unrecognized tax benefits, $4.8 million of which would affect its effective tax rate if recognized after considering the valuation allowance.

Uncertain tax positions relate to the allocation of income and deductions among the Company’s global entities and to the determination of the research and development tax credit. It is reasonably possible that over the next twelve-month period, the Company may experience increases or decreases in its unrecognized tax benefits. However, it is not possible to determine either the magnitude or the range of increases or decreases at this time.

The Company recognizes interest and penalties, if any, related to uncertain tax positions in its income tax provision. As of March 31, 2015 and December 31, 2014, the Company has approximately $0.5 million of accrued interest related to uncertain tax positions, which were recorded in long-term tax liabilities in the Condensed Consolidated Balance Sheets.

Income Tax Audits

The Company is subject to examination of its income tax returns by the IRS and other tax authorities. The Company’s U.S. Federal income tax returns for the years ended December 31, 2005 through December 31, 2007 are under examination by the IRS. In April 2011, the Company received from the IRS a Notice of Proposed Adjustment ("NOPA") relating to a cost-sharing agreement entered into by the Company and its international subsidiaries on January 1, 2004. In the NOPA, the IRS objected to the Company’s allocation of certain litigation expenses between the Company and its international subsidiaries and the amount of "buy-in payments" made by the international subsidiaries to the Company in connection with the cost-sharing agreement, and proposed to increase the Company’s U.S. taxable income according to a few alternative methodologies. In February 2012, the Company received a revised NOPA from the IRS (“Revised NOPA”). In this Revised NOPA, the IRS raised the same issues as in the NOPA issued in April 2011 but under a different methodology. Under the Revised NOPA, the largest potential federal income tax payment, if the IRS were to prevail on all matters in dispute, is $10.5 million, plus interest and penalties, if any. The Company responded to the IRS Revised NOPA in May 2012. In June 2013, the IRS responded and continued to disagree with the Company’s rebuttal. The Company met with the IRS Office of Appeals in 2014, had additional discussions again in 2015, and both parties have been in continuous discussions for a resolution of the matter. However, there is no guarantee these discussions will be conclusive. Meanwhile, the Company agreed to grant the IRS an extension of the statute of limitations for taxable years 2005 through 2007 to September 30, 2015. 

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

Subsequent to March 31, 2015, the Company reached a final resolution with the IRS in connection with the income tax audits. See Note 16 for further discussion of the subsequent event.

13. ACCUMULATED OTHER COMPREHENSIVE INCOME

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

The amounts reclassified from accumulated other comprehensive income were recorded in interest and other income, net, in the Condensed Consolidated Statement of Operations.

14. STOCK REPURCHASE PROGRAM

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

As of March 31, 2015, $27.8 million remained available for future repurchases under the program.

15. DIVIDENDS AND DIVIDEND EQUIVALENTS

In June 2014, the Board of Directors approved a dividend program pursuant to which the Company intends to pay quarterly cash dividends on its common stock. Stockholders of record as of the last day of the quarter are entitled to receive the quarterly cash dividends when and if declared by the Board of Directors, which are generally payable on the 15th of the following month. For the first quarter of 2015, the Board of Directors declared a dividend of $0.20 per share for a total of $7.9 million, which was accrued as of March 31, 2015 and will be paid to the stockholders on April 15, 2015.

The declaration of any future cash dividends is at the discretion of the Board of Directors and will depend on the Company's financial condition, results of operations, capital requirements, business conditions and other factors, as well as a determination that cash dividends are in the best interests of the Company's stockholders. The Company anticipates that the cash used for future dividends will come from its current domestic cash and cash generated from ongoing U.S. operations. If cash held by the Company’s international subsidiaries is needed for the payment of dividends, the Company may be required to accrue and pay U.S. taxes to repatriate the funds. 

Under the Company’s stock plans, outstanding RSU awards contain rights to receive cash dividend equivalents, which entitle employees who hold RSUs to the same dividend value per share as holders of common stock. The dividend equivalents are accrued quarterly during the vesting periods of the RSUs and are payable to the employees when the awards vest. Dividend equivalents accrued on the outstanding RSUs are forfeited if the employees do not fulfill their service requirement during the vesting periods. As of March 31, 2015 and December 31, 2014, accrued dividend equivalents totaled $1.4 million and $0.8 million, respectively.

16. SUBSEQUENT EVENTS

Stock Repurchase Program

In April 2015, the Board of Directors approved an extension of the stock repurchase program to December 31, 2015. No other terms were amended under the program.

Income Tax Audits

In April 2015, the Company reached a final resolution with the IRS in connection with the income tax audits for the years 2005 through 2007. Under the agreement, the Company made a one-time buy-in payment of $1.2 million for taxes related primarily to the revaluation of a license for certain intellectual property rights of the Company to one of its international subsidiaries.  This buy-in payment is final and no additional payment will be required with respect to the intellectual property license for the years under examination or for a previous or subsequent tax year. In addition, the Company expects to make a $1.1 million related interest payment in the next few months as well as a $0.2 million tax payment for the years 2008 to 2013.  There were no penalties assessed on the Company as a result of the audits.

For the second quarter of 2015, the Company's income tax provision will include a one-time net charge of approximately $2.3 million, reflecting the taxes and interest to be paid partially offset by the reversal of previously accrued tax liabilities and valuation allowances. Of the $2.3 million charge, approximately $1.6 million relates to taxes and $0.7 million to interest.

 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 within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that have been made pursuant to and in reliance on the provisions of the Private Securities Litigation Reform Act of 1995. These statements include among other things, statements concerning:

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, Part II. Other Information, “Item 1A. Risk Factors.” Except as required by law, we disclaim any duty to and undertake no obligation to update any forward-looking statements, whether as a result of new information relating to existing conditions, future events or otherwise or to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Readers are cautioned not to place undue reliance on such statements, which speak only as of the date of this Quarterly Report on Form 10-Q.

Readers should carefully review future reports and documents that we file from time to time with the Securities and Exchange Commission, such as our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K 

The following management’s discussion and analysis should be read in connection with the information presented in our unaudited condensed consolidated financial statements and related notes for the three months ended March 31, 2015 included in this report and our audited consolidated financial statements and related notes for the year ended December 31, 2014 included in our Annual Report on Form 10-K.

Overview

We are a leading company in high performance power solutions. Founded in 1997, we pioneered integrated power semiconductor solutions and power delivery architectures. Our mission is to provide innovative power solutions in cloud computing, telecommunications, industrial and automotive, and consumer market segments. 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. Our revenue from direct or indirect sales to customers in Asia was 91% and 88% for the three months ended March 31, 2015 and 2014, respectively. 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

There have been no significant changes in our critical accounting policies and estimates used in the preparation of our financial statements during the three months ended March 31, 2015, as compared to those disclosed in the Annual Report on Form 10-K for the year ended December 31, 2014.

Results of Operations

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

Revenue

The following table shows our revenue by product family:

Revenue for the three months ended March 31, 2015 was $73.5 million, an increase of $13.4 million, or 22.4%, from $60.1 million for the three months ended March 31, 2014. This increase was due to higher sales of both DC to DC and lighting control products, as unit shipments increased 29% due to higher market demand with current customers and additional design wins with new customers, which were offset in part by a 5% decrease in average sales prices. Revenue from our DC to DC products was $66.3 million for the three months ended March 31, 2015, an increase of $12.4 million, or 22.9%, from the same period in 2014. This increase was primarily due to higher sales of our DC to DC converters, which were offset in part by lower sales of our Mini-Monsters products. Revenue from our lighting control products was $7.2 million for the three months ended March 31, 2015, an increase of $1.1 million, or 18.2%, compared with the same period in 2014.  

Cost of Revenue and Gross Margin

Cost of revenue consists primarily of costs incurred to manufacture, assemble and test our products, as well as warranty costs, inventory-related expenses and other overhead costs and stock-based compensation expenses. In addition, cost of revenue includes amortization of intangible assets from the Sensima acquisition beginning in the third quarter of 2014.

Cost of revenue was $33.9 million, or 46.0% of revenue, for the three months ended March 31, 2015, and $28.0 million, or 46.6% of revenue, for the three months ended March 31, 2014. The $5.9 million increase in cost of revenue was primarily due to a 29% increase in unit shipments, which was partially offset by a 3% decrease in the average direct cost of units shipped. In addition, the increase in cost of revenue was driven by the amortization of intangible assets of $0.4 million from the Sensima acquisition in July 2014.

Gross profit as a percentage of revenue, or gross margin, was 54.0% for the three months ended March 31, 2015, compared to 53.4% for the three months ended March 31, 2014. The increase in gross margin was primarily due to higher absorption of in-house test manufacturing overhead, compared to the same period in 2014. This increase was partially offset by higher sales of lower margin products and the amortization of intangible assets from the Sensima acquisition in July 2014.

Research and Development

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

R&D expenses were $16.0 million, or 21.8% of revenue, for the three months ended March 31, 2015 and $15.6 million, or 26.0% of revenue, for the three months ended March 31, 2014. The $0.4 million increase in R&D expenses was primarily due to an increase of $0.7 million in new product development expenses, an increase of $0.6 million in stock-based compensation expenses primarily associated with the performance-based equity awards, an increase of $0.2 million in manufacturing and laboratory supplies, and an increase of $0.1 million in depreciation. These increases were partially offset by a decrease of $1.3 million in cash compensation expenses, which include salary, benefits and bonuses. Our R&D headcount was 482 employees as of March 31, 2015, compared with 452 employees as of March 31, 2014. 

Selling, General and Administrative

Selling, general and administrative expenses primarily include salary and benefit expenses, bonuses and stock-based compensation expenses for sales, marketing and administrative personnel, sales commissions, travel expenses, facilities costs, and professional service fees. 

SG&A expenses were $17.5 million, or 23.8% of revenue, for the three months ended March 31, 2015 and $16.1 million, or 26.8% of revenue, for the three months ended March 31, 2014. The $1.4 million increase in SG&A expenses was primarily due to an increase of $1.0 million in stock-based compensation expenses primarily associated with the performance-based equity awards, an increase of $0.2 million in commission expenses due to higher revenue, an increase of $0.1 million related to the changes in the values of the employee deferred compensation plan liabilities, and an increase of $0.1 million in depreciation. These increases were partially offset by a decrease of $0.4 million in cash compensation expenses, which include salary, benefits and bonuses. Our SG&A headcount was 276 employees as of March 31, 2015, compared with 251 employees as of March 31, 2014.

Litigation Expense (Benefit), Net

For the three months ended March 31, 2015, litigation expense was $0.3 million, compared with a net litigation benefit of $(8.7) million for the three months ended March 31, 2014. Net litigation benefit for the three months ended March 31, 2014 included the recognition of a $9.5 million award from the O2 Micro litigation, partially offset by $0.5 million of additional legal fees incurred in connection with the final resolution of the litigation. See Note 8 to our Condensed Consolidated Financial Statements for further discussion of this litigation.

Interest and Other Income, Net

For the three months ended March 31, 2015, interest and other income, net, was $0.6 million, compared with $0.2 million for the three months ended March 31, 2014.  The increase in interest and other income, net, was primarily due to higher foreign currency exchange gains and an increase in interest income.

 Income Tax Provision

The income tax provision for the three months ended March 31, 2015 was $0.5 million, or 8.2% of the income before income taxes. This differs from the federal statutory rate primarily because our foreign income was taxed at lower rates, and because of the benefit that we realized as a result of stock option exercises, the release of RSUs and changes in the valuation allowance.

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

Liquidity and Capital Resources

As of March 31, 2015, we had cash and cash equivalents of $96.0 million and short-term investments of $137.8 million, compared with cash and cash equivalents of $126.3 million and short-term investments of $112.5 million as of December 31, 2014. As of March 31, 2015, $51.5 million of cash and cash equivalents and $46.2 million of short-term investments were held by our international subsidiaries. If these funds are needed for our operations in the U.S., we may be required to accrue and pay U.S. taxes to repatriate these funds. However, our intent is to indefinitely reinvest these funds outside of the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations.

The significant components of our working capital are cash and cash equivalents, short-term investments, accounts receivable, inventories, prepaid expenses and other current assets, reduced by accounts payable, accrued compensation and related benefits, and other accrued liabilities. As of March 31, 2015, we had working capital of $269.3 million, compared with working capital of $271.3 million as of December 31, 2014. The $2.0 million decrease in working capital was due to a $9.1 million increase in current liabilities, partially offset by a $7.1 million increase in current assets. The increase in current liabilities was primarily due to an increase in accounts payable and other accrued liabilities, partially offset by a decrease in accrued compensation and related benefits. The increase in current assets was primarily due to an increase in short-term investments and inventories, partially offset by a decrease in cash and cash equivalents.

Summary of Cash Flows 

The following table summarizes our cash flow activities:

For the three months ended March 31, 2015, net cash provided by operating activities was $15.7 million, primarily due to our net income adjusted for certain non-cash items, including depreciation and amortization and stock-based compensation, and a net decrease of $3.0 million from the changes in our operating assets and liabilities. The increase in inventories was primarily due to an increase in strategic wafer and die bank inventories as well as an increase in finished goods necessary to meet anticipated future demand. The increase in accounts payable was primarily driven by increased inventory and capital asset purchases to meet anticipated future demand. For the three months ended March 31, 2014, net cash provided by operating activities was $12.0 million, primarily due to our net income adjusted for certain non-cash items, including depreciation and amortization and stock-based compensation, and a decrease in accrued liabilities. The decrease in accrued liabilities was primarily driven by the release of the liability of $9.5 million related to the O2 Micro litigation.

For the three months ended March 31, 2015, net cash used in investing activities was $32.1 million, primarily due to net purchases of investments of $27.4 million and purchases of property and equipment of $4.7 million. For the three months ended March 31, 2014, net cash used in investing activities was $19.2 million, primarily reflecting net purchases of short-term investments of $14.7 million and purchases of property and equipment of $4.5 million. 

For the three months ended March 31, 2015, net cash used in financing activities was $13.9 million, primarily reflecting $10.4 million used in repurchases of our common stock pursuant to our stock repurchase program and $5.9 million used to pay dividends to our stockholders and dividend equivalents to our employees who hold RSUs, partially offset by $2.4 million of cash proceeds from stock option exercises and issuance of shares through our employee stock purchase plan. For the three months ended March 31, 2014, net cash used in financing activities was $4.8 million, primarily reflecting $11.4 million used in the repurchases of our common stock pursuant to our stock repurchase program, partially offset by $6.6 million of cash proceeds from stock option exercises and issuance of shares through our employee stock purchase plan.

In July 2013, our Board of Directors approved a stock repurchase program that authorizes us to repurchase up to $100 million in the aggregate of our common stock through June 30, 2015. All shares are retired upon repurchase. For the three months ended March 31, 2015, we repurchased a total of 0.2 million shares for $10.4 million, at an average price of $51.33 per share. For the three months ended March 31, 2014, we repurchased a total of 0.3 million shares for $11.4 million, at an average price of $35.08 per share. As of March 31, 2015, $27.8 million remained available for future repurchases under the program.

In June 2014, our Board of Directors approved a dividend program pursuant to which we intend to pay quarterly cash dividends on our common stock. In addition, RSU awards contain rights to receive dividend equivalents, which entitle employees who hold RSUs to the same dividend value per share as holders of common stock. The dividend equivalents are accrued quarterly during the vesting periods of the RSUs and are payable to the employees when the awards vest. Dividend equivalents accrued on the RSUs are forfeited if the employees do not fulfill their service requirement during the vesting periods. For the three months ended March 31, 2015, we paid dividends and dividend equivalents totaling $5.9 million.

Although cash requirements will fluctuate based on the timing and extent of many factors such as those discussed above, we believe that cash generated from operations, together with the liquidity provided by existing cash balances and short-term investments, will be sufficient to satisfy our liquidity requirements for the next 12 months. We anticipate the cash used for future dividends, dividend equivalents and the stock repurchase program will come from our current domestic cash and cash generated from ongoing U.S. operations. If cash held by our international subsidiaries is needed for these payments, we may be required to accrue and pay U.S. taxes to repatriate these funds.

In the future, in order to strengthen our financial position, in the event of unforeseen circumstances, or in the event we need to fund our growth in future financial periods, we may need to raise additional funds by any one or a combination of the following: issuing equity securities, issuing debt or convertible debt securities, incurring indebtedness secured by our assets, or selling certain product lines and/or portions of our business. There can be no guarantee that we will be able to raise additional funds on terms acceptable to us, or at all.

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

Contractual Obligations 

We lease our research and development and sales offices in the United States, Europe, Japan, China, Taiwan and Korea. Certain of our facility leases provide for periodic rent increases. Currently, we are leasing a manufacturing facility in Chengdu, China. We have an option to acquire this manufacturing facility for approximately $1.6 million, which consists of total construction cost incurred minus total rent paid by us during the lease term.  This option became exercisable in March 2011. We may exercise the purchase option and enter into a purchase agreement for this facility in the future.

Our outstanding purchase commitments primarily consist of wafer purchases from our foundries and assembly services. As of March 31, 2015, the outstanding balance was $39.6 million, compared with $44.2 million as of December 31, 2014.

Our other contractual obligations have not changed significantly from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014.