MONOLITHIC POWER SYSTEMS INC - Quarter Report: 2018 September (Form 10-Q)

 

 

Table of Contents

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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, 2018

 

OR

 

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

 

Commission file number: 000-51026

 

____________________________

 

Monolithic Power Systems, Inc.

(Exact name of registrant as specified in its charter)

____________________________

 

Delaware	77-0466789
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)

 

4040 Lake Washington Blvd. NE, Suite 201, Kirkland, Washington 98033

(Address of principal executive offices)(Zip code)

 

  (425) 296-9956

(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 every Interactive Data File required to be submitted 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 such files).    Yes  ☒    No  ☐

 

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

 

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

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 42,412,000 shares of the registrant’s common stock issued and outstanding as of October 29, 2018.

 

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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	24
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	31
ITEM 4.	CONTROLS AND PROCEDURES	31
PART II. OTHER INFORMATION		31
ITEM 1.	LEGAL PROCEEDINGS	31
ITEM 1A.	RISK FACTORS	32
ITEM 6.	EXHIBITS	48

 

 

 

		September 30,				December 31,
		2018				2017
ASSETS
Current assets:
Cash and cash equivalents		$	131,094			$	82,759
Short-term investments			216,754				216,331
Accounts receivable			59,887				38,037
Inventories			136,790				99,281
Other current assets			12,876				12,762
Total current assets			557,401				449,170
Property and equipment, net			147,497				144,636
Long-term investments			5,257				5,256
Goodwill			6,571				6,571
Acquisition-related intangible assets, net			308				951
Deferred tax assets, net			12,852				15,917
Other long-term assets			33,271				30,068
Total assets		$	763,157			$	652,569
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	27,603			$	22,813
Accrued compensation and related benefits			22,996				15,597
Accrued liabilities			34,908				27,507
Total current liabilities			85,507				65,917
Income tax liabilities			31,173				31,621
Other long-term liabilities			36,313				33,024
Total liabilities			152,993				130,562
Commitments and contingencies
Stockholders' equity:
Common stock and additional paid-in capital, $0.001 par value; shares authorized: 150,000; shares issued and outstanding: 42,408 and 41,614, respectively			435,085				376,586
Retained earnings			180,819				143,608
Accumulated other comprehensive income (loss)			(5,740	)			1,813
Total stockholders’ equity			610,164				522,007
Total liabilities and stockholders’ equity		$	763,157			$	652,569

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		Three Months Ended September 30,								Nine Months Ended September 30,
		2018				2017				2018				2017
Revenue		$	159,975			$	128,939			$	428,885			$	341,499
Cost of revenue			70,957				58,083				190,810				154,377
Gross profit			89,018				70,856				238,075				187,122
Operating expenses:
Research and development			25,630				21,442				70,720				60,629
Selling, general and administrative			29,552				25,255				85,431				73,219
Litigation expense			343				327				1,513				903
Total operating expenses			55,525				47,024				157,664				134,751
Income from operations			33,493				23,832				80,411				52,371
Interest and other income, net			2,714				1,255				5,387				3,873
Income before income taxes			36,207				25,087				85,798				56,244
Income tax provision			4,639				1,445				8,168				3,112
Net income		$	31,568			$	23,642			$	77,630			$	53,132
Net income per share:
Basic		$	0.75			$	0.57			$	1.84			$	1.29
Diluted		$	0.71			$	0.54			$	1.75			$	1.22
Weighted-average shares outstanding:
Basic			42,362				41,458				42,173				41,276
Diluted			44,669				43,486				44,450				43,384
Cash dividends declared per common share		$	0.30			$	0.20			$	0.90			$	0.60

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		Three Months Ended September 30,								Nine Months Ended September 30,
		2018				2017				2018				2017
Net income		$	31,568			$	23,642			$	77,630			$	53,132
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments			(4,526	)			1,500				(6,999	)			3,992
Change in unrealized gain (loss) on available-for-sale securities, net of tax of $241, $0, $241, 0, respectively			491				222				(554	)			565
Total other comprehensive income (loss), net of tax			(4,035	)			1,722				(7,553	)			4,557
Comprehensive income		$	27,533			$	25,364			$	70,077			$	57,689

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		Nine Months Ended September 30,
		2018				2017
Cash flows from operating activities:
Net income		$	77,630			$	53,132
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of intangible assets			9,058				12,092
Amortization of premium on available-for-sale securities			1,122				1,494
Gain on deferred compensation plan investments			(949	)			(1,902	)
Stock-based compensation expense			45,765				40,759
Deferred taxes, net			3,169				-
Changes in operating assets and liabilities:
Accounts receivable			(22,752	)			(16,505	)
Inventories			(37,496	)			(28,384	)
Other assets			(665	)			1,696
Accounts payable			5,978				4,999
Accrued compensation and related benefits			7,838				4,542
Accrued liabilities			4,635				7,276
Income tax liabilities			528				1,249
Net cash provided by operating activities			93,861				80,448
Cash flows from investing activities:
Property and equipment purchases			(18,057	)			(25,108	)
Purchases of short-term investments			(86,021	)			(102,274	)
Proceeds from maturities and sales of short-term investments			83,679				61,678
Contributions to deferred compensation plan, net			(1,396	)			(2,124	)
Net cash used in investing activities			(21,795	)			(67,828	)
Cash flows from financing activities:
Property and equipment purchased on extended payment terms			-				(250	)
Proceeds from exercise of stock options			59				129
Proceeds from vesting of restricted stock units			9,625				-
Proceeds from shares issued under the employee stock purchase plan			3,028				2,701
Dividends and dividend equivalents paid			(34,381	)			(25,264	)
Net cash used in financing activities			(21,669	)			(22,684	)
Effect of change in exchange rates			(2,062	)			1,790
Net increase (decrease) in cash, cash equivalents and restricted cash			48,335				(8,274	)
Cash, cash equivalents and restricted cash, beginning of period			82,874				112,813
Cash, cash equivalents and restricted cash, end of period		$	131,209			$	104,539
Supplemental disclosures:
Cash paid for taxes and interest		$	6,388			$	1,855
Non-cash investing and financing activities:
Liability accrued for property and equipment purchases		$	1,563			$	284
Liability accrued for dividends and dividend equivalents		$	15,397			$	10,131

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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 accounting principles, 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, 2017, filed with the SEC on March 1, 2018.

 

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, 2018 or for any other future periods.

 

Summary of Significant Accounting Policies

 

Except for the changes related to revenue recognition discussed in “Recently Adopted Accounting Pronouncements” and in Note 2 below, there have been no other changes to the Company’s significant accounting policies during the three and nine months ended September 30, 2018 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, 2017.

 

Recently Adopted Accounting Pronouncements

  

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606), 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. The Company adopted the standard on January 1, 2018 using the modified retrospective method applied to those contracts which were not completed as of December 31, 2017. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior-period amounts have not been retrospectively adjusted and continue to be reported in accordance with Topic 605, Revenue Recognition.

 

The Company recorded a net increase to the opening balance of retained earnings of $0.4 million, net of tax, as of January 1, 2018 due to the cumulative effect of initially applying Topic 606, primarily related to the change in revenue recognition for three U.S.-based distributors. Sales to these distributors are transacted under the terms of agreements providing price adjustment rights. Prior to the adoption of Topic 606, revenue and costs related to these sales were deferred until the Company received notification from the distributors that the products had been sold to the end customers and the amount of price adjustments was fixed and finalized. Upon adoption of Topic 606, the transaction price takes into consideration the effect of variable consideration such as price adjustments, which are estimated and recorded at the time the promised goods are transferred to the distributors. Accordingly, effective January 1, 2018, the Company recognizes revenue at the time of shipment to the distributors, adjusted for an estimate of the price adjustments based on management’s review of historical data and other information available at the time. See Note 2 for further discussion.

 

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows - Restricted Cash (Topic 230), which requires entities to show the changes in the total of cash, cash equivalents and restricted cash in the statement of cash flows. The Company adopted the standard on January 1, 2018 and applied the guidance retrospectively to all periods presented. See Note 9 for further discussion.

 

Recent Accounting Pronouncements Not Yet Adopted as of September 30, 2018

 

In August 2018, the SEC issued Final Rule Release No. 33-10532, Disclosure Update and Simplification, which amends certain disclosure requirements, including the presentation of changes in stockholders’ equity and the dividend per share for interim periods. The final rule will be effective on November 5, 2018. The Company is evaluating the impact of the adoption on its disclosures.

 

 

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement, which changes certain disclosure requirements, including those related to Level 3 fair value measurements. The standard will be effective for annual reporting periods beginning after December 15, 2019. Early adoption is permitted. The Company is evaluating the impact of the adoption on its disclosures.

 

In January 2017, the FASB issued ASU No. 2017-04, Intangibles – Goodwill and Other (Topic 350), which simplifies the accounting for goodwill impairment. The guidance removes step two of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. Entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. The standard will be applied prospectively, and will be effective for annual reporting periods beginning after December 15, 2019. Early adoption is permitted. The Company is evaluating the impact of the adoption on its annual goodwill impairment test.

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326), which introduces a model based on expected losses to estimate credit losses for most financial assets and certain other instruments. In addition, for available-for-sale debt securities with unrealized losses, the losses will be recognized as allowances rather than reductions in the amortized cost of the securities. The standard will be effective for annual reporting periods beginning after December 15, 2019, with early adoption permitted for annual reporting periods beginning after December 15, 2018. Entities will apply the standard by recording a cumulative-effect adjustment to retained earnings. The Company is evaluating the impact of the adoption on its consolidated financial position, results of operations, cash flows and disclosures.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires entities to recognize a right-of-use asset and a lease liability on the balance sheets for substantially all leases with a lease term greater than 12 months, including leases currently accounted for as operating leases. In addition, the standard applies to leases embedded in service or other arrangements. The standard requires modified retrospective adoption and will be effective for annual reporting periods beginning after December 15, 2018, with early adoption permitted. The Company will adopt the standard on January 1, 2019. The Company is evaluating the impact of the adoption on its consolidated financial statements and disclosures, and expects to elect certain available transitional practical expedients. The Company anticipates recording assets and liabilities primarily related to its real estate leases on its Consolidated Balance Sheets, with no material impact to its Consolidated Statements of Operations.

 

 

2. REVENUE RECOGNITION

 

Revenue from Product Sales

 

The following table presents the Company’s revenue disaggregated by end market (in thousands, except for percentages):

 

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(1)	2017 amounts have not been adjusted under the modified retrospective method.

 

The Company generates revenue primarily from product sales, which include assembled and tested integrated circuits, as well as dies in wafer form. The Company also generates royalty revenue from licensing arrangements and revenue from wafer testing services performed for third parties, which have not been significant in all periods presented.

 

The Company sells its products primarily through third-party distributors, value-added resellers, original equipment manufacturers, original design manufacturers and electronic manufacturing service providers. For the three months ended September 30, 2018 and 2017, approximately 87% and 88%, respectively, of the Company’s sales were made through distribution arrangements. For the nine months ended September 30, 2018 and 2017, approximately 87% and 88%, respectively, of the Company’s sales were made through distribution arrangements. These distribution arrangements contain enforceable rights and obligations specific to those distributors and not the end customers. Purchase orders, which are generally governed by sales agreements or the Company's standard terms of sale, state the final terms for unit price, quantity, shipping and payment agreed by both parties. The Company considers purchase orders to be the contracts with customers. The unit price as stated on the purchase orders is considered the observable, stand-alone selling price for the arrangements.

 

 

Under Topic 606, the Company recognizes revenue when it satisfies a performance obligation by transferring control of the promised goods or services to its customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. The Company excludes taxes assessed by government authorities, such as sales taxes, from revenue.

 

Product sales consist of a single performance obligation that the Company satisfies at a point in time. The Company recognizes product revenue from distributors and direct end customers when the following events have occurred: (a) the Company has transferred physical possession of the products, (b) the Company has a present right to payment, (c) the customer has legal title to the products, and (d) the customer bears significant risks and rewards of ownership of the products. In accordance with the shipping terms specified in the contracts, these criteria are generally met when the products are shipped from the Company’s facilities (such as the “Ex Works” shipping term) or delivered to the customers’ locations (such as the “Delivered Duty Paid” shipping term).

 

Under certain consignment agreements, revenue is not recognized when the products are held at customers’ designated locations because the Company retains ownership and the customers do not have an unconditional obligation to pay. The Company recognizes revenue when the customers pull the products from the locations or after a 60-day period lapses, at which time control transfers to the customers and the Company invoices them for payment.

 

Variable Consideration

 

The Company records variable consideration as a reduction to revenue in the same period the revenue is recognized. Three U.S.-based distributors have price adjustment rights when they sell the Company’s products to their end customers at a price that is lower than the distribution price invoiced by the Company. When the Company receives claims from the distributors that products have been sold to the end customers at the lower price, the Company issues the distributors credit memos for the price adjustments. The Company estimates the price adjustments based on analyses of historical claims, at both the distributor and product level, as well as an assessment of any known trends of product sales mix. Other U.S. distributors and non-U.S. distributors, which make up the majority of the Company’s total sales to distributors, do not have price adjustment rights.

 

In addition, certain distributors have limited stock rotation rights that permit the return of a small percentage of the previous six months’ purchases. The Company estimates the stock rotation returns based on analyses of historical returns, and the current level of inventory in the distribution channel.  The Company recognizes an asset for product returns which represents the right to recover products from the customers related to stock rotations, with a corresponding reduction to cost of goods sold.

 

Contract Balances

 

The Company records a receivable when it has an unconditional right to receive consideration after the performance obligations are satisfied. As of September 30, 2018 and December 31, 2017, accounts receivable totaled $59.9 million and $38.0 million, respectively. To manage credit risk, management performs ongoing credit evaluations of its customers’ financial condition. The Company did not recognize any impairment losses related to its receivables in any of the periods presented.

 

For certain customers located in Asia, the Company requires cash payments two weeks before the products are scheduled to be shipped to the customers. The Company records these payments received in advance of performance as customer prepayments within current accrued liabilities. As of September 30, 2018 and December 31, 2017, customer prepayments totaled $1.8 million and $4.7 million, respectively. The decrease in the customer prepayment balance for the nine months ended September 30, 2018 resulted from a decrease in unfulfilled customer orders for which the Company has received payments. For the nine months ended September 30, 2018, the Company recognized $4.7 million of revenue that was included in the customer prepayment balance as of December 31, 2017.

 

Contract Costs

The Company pays sales commissions based on the achievement of pre-determined product sales targets. As the Company recognizes product sales at a point in time, sales commissions are expensed as incurred.

 

Warranty

 

The Company generally provides one to two-year warranties against defects in materials and workmanship and will either repair the products, provide replacements at no charge to customers or issue a refund. As they are considered assurance-type warranties, the Company does not account for them as separate performance obligations. Warranty reserve requirements are generally based on a specific assessment of the products sold with warranties when a customer asserts a claim for warranty or a product defect. 

 

 

Practical Expedients

 

The Company’s standard payment terms generally require customers to pay 30 to 60 days after the Company satisfies the performance obligations. For those customers who are required to pay in advance, the Company satisfies the performance obligations typically within one quarter. The Company has elected not to determine whether contacts with customers contain significant financing components.

 

As of September 30, 2018, the Company’s unsatisfied performance obligations primarily included products held in consignment arrangements and customer purchase orders for products that the Company has not yet shipped. Because the Company expects to fulfill these performance obligations within one year, the Company has elected not to disclose the amount of these remaining performance obligations or the timing of recognition.

 

Changes to Financial Statement Line Items

 

The following tables compare the impact on the financial statement line items between the application of Topic 606 and Topic 605 as of September 30, 2018, and for the three and nine months ended September 30, 2018. The significant changes between the two standards are primarily attributable to the following:

 

	●	Under Topic 606, the Company recognizes revenue for three U.S.-based distributors upon shipment of the products to them, net of an estimated amount for price adjustments. Under Topic 605, the Company would have deferred the recognition of revenue and related costs for these U.S. distributors until the Company received notification from the distributors that the products had been sold to the end customers and the amount of price adjustments was fixed and finalized.
	●	Under Topic 606, the Company records assets for product returns within other current assets, which primarily represent the carrying value of inventory it expects to recover from customers related to stock rotation returns. Under Topic 605, such amounts would have been netted against the stock rotation reserve within current accrued liabilities.
	●	Under Topic 606, the Company recorded a cumulative effect of initially applying the standard to retained earnings. Under Topic 605, the Company would not have recorded this adjustment.

 

Condensed Consolidated Balance Sheet (in thousands):

 

 

 

Condensed Consolidated Statement of Operations (in thousands, except per-share amounts):

 

 

Condensed Consolidated Statement of Comprehensive Income (in thousands):

 

 

Condensed Consolidated Statement of Cash Flows (in thousands):

 

 

 

3. STOCK-BASED COMPENSATION

 

2014 Equity Incentive Plan (the “2014 Plan”)

 

The Board of Directors adopted 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, as amended, became effective on November 13, 2014 and provides for the issuance of up to 5.5 million shares. The 2014 Plan will expire on November 13, 2024. As of September 30, 2018, 2.7 million shares remained available for future issuance under the 2014 Plan. 

 

Stock-Based Compensation Expense

 

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

 

 

 

Restricted Stock Units

 

The Company’s restricted stock units (“RSUs”) include time-based RSUs, RSUs with only performance conditions (“PSUs”), RSUs with both market and performance conditions (“MPSUs”), and RSUs with only market conditions (“MSUs”). Vesting of all awards requires continued service for the Company. In addition, vesting of awards with performance conditions or market conditions is subject to the achievement of pre-determined performance goals. A summary of RSU activity is presented in the table below (in thousands, except per-share amounts): 

 

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(1)	Amount reflects the number of PSUs and MPSUs that may ultimately be earned based on management’s probability assessment of the achievement of performance conditions at each reporting period. In addition, MPSUs are subject to the achievement of market conditions.

 

The intrinsic value related to vested RSUs was $13.9 million and $12.5 million for the three months ended September 30, 2018 and 2017, respectively. The intrinsic value related to vested RSUs was $79.0 million and $61.3 million for the nine months ended September 30, 2018 and 2017, respectively. As of September 30, 2018, the total intrinsic value of all outstanding RSUs was $465.9 million, based on the closing stock price of $125.53. As of September 30, 2018, unamortized compensation expense related to all outstanding RSUs was $89.3 million with a weighted-average remaining recognition period of approximately three years. 

 

Cash proceeds from vested PSUs with a purchase price feature totaled $9.6 million for the nine months ended September 30, 2018. There were no proceeds for the nine months ended September 30, 2017.

 

Time-Based RSUs:

 

For the nine months ended September 30, 2018, the Compensation Committee of the Board of Directors (the "Compensation Committee") granted 93,000 RSUs with time-based vesting conditions to non-executive employees and non-employee directors. The RSUs vest over four years for employees and one year for directors, subject to continued service with the Company.

  

2018 PSUs:

 

In February 2018, the Compensation Committee granted 188,000 PSUs to the executive officers, which represent a target number of shares to be awarded based on the Company’s average two-year (2018 and 2019) revenue growth rate compared against the analog industry’s average two-year revenue growth rate as published by the Semiconductor Industry Association (“2018 Executive PSUs”). The maximum number of shares that an executive officer can earn is 300% of the target number of the 2018 Executive PSUs. 50% of the 2018 Executive PSUs will vest in the first quarter of 2020 if the pre-determined performance goals are met during the performance period and approved by the Compensation Committee. The remaining 2018 Executive PSUs will vest over the following two years on a quarterly basis. Vesting is subject to the employees’ continued employment with the Company. Assuming the achievement of the highest level of performance goals, the total stock-based compensation cost for the 2018 Executive PSUs is $46.1 million.

 

In February 2018, the Compensation Committee granted 44,000 PSUs to certain non-executive employees, which represent a target number of shares to be awarded based on the Company’s 2019 revenue goals for certain regions or product line divisions, or based on the Company’s average two-year (2018 and 2019) revenue growth rate compared against the analog industry’s average two-year revenue growth rate as published by the Semiconductor Industry Association (“2018 Non-Executive PSUs”). The maximum number of shares that an employee can earn is either 200% or 300% of the target number of the 2018 Non-Executive PSUs, depending on the job classification of the employee. 50% of the 2018 Non-Executive PSUs will vest in the first quarter of 2020 if the pre-determined performance goals are met during the performance period and approved by the Compensation Committee. The remaining 2018 Non-Executive PSUs will vest over the following two years on an annual or quarterly basis. Vesting is subject to the employees’ continued employment with the Company. Assuming the achievement of the highest level of performance goals, the total stock-based compensation cost for the 2018 Non-Executive PSUs, excluding cancelled shares, is $8.8 million.

 

 

The 2018 Executive PSUs and the 2018 Non-Executive PSUs contain a purchase price feature, which requires the employees to pay the Company $30 per share upon vesting of the shares. Shares that do not vest will not be subject to the purchase price payment. The Company determined the grant date fair value of the 2018 Executive PSUs and the 2018 Non-Executive PSUs using the Black-Scholes model with the following assumptions: stock price of $110.00, expected term of 2.6 years, expected volatility of 27.5% and risk-free interest rate of 2.3%. 

 

2015 MPSUs:

 

On December 31, 2015, the Compensation Committee granted 86,000 MPSUs to the executive officers and 41,000 MPSUs to certain non-executive employees, which represent a target number of shares to be awarded upon achievement of both market conditions and performance conditions (“2015 MPSUs”). The maximum number of shares that an employee can earn is 500% of the target number of the 2015 MPSUs. The 2015 MPSUs consist of four separate tranches with various performance periods ending on December 31, 2019. The first tranche contains market conditions only, which require the achievement of five stock price targets ranging from $71.36 to $95.57 with a performance period from January 1, 2016 to December 31, 2019. As of September 30, 2017, all five stock price targets for the first tranche have been achieved and approved by the Compensation Committee.

 

The second, third and fourth tranches contain both market conditions and performance conditions. Each tranche requires the achievement of five stock price targets measured against a base price equal to the greater of: (1) the average closing stock price during the 20 consecutive trading days immediately before the start of the performance period for that tranche, or (2) the closing stock price immediately before the start of the performance period for that tranche. The stock price targets for the second tranche range from $89.56 to $106.81 with a performance period from January 1, 2017 to December 31, 2019. As of December 31, 2017, all five stock price targets for the second tranche have been achieved and approved by the Compensation Committee. The stock price targets for the third tranche range from $120.80 to $135.48 with a performance period from January 1, 2018 to December 31, 2019. As of September 30, 2018, all five stock price targets for the third tranche have been achieved and approved by the Compensation Committee. The stock price targets for the fourth tranche will be determined on December 31, 2018 with a performance period from January 1, 2019 to December 31, 2019.

 

In addition, each of the second, third and fourth tranches requires the achievement of one of following six operating metrics:

 

	1.	Successful implementation of full digital solutions for certain power products.
	2.	Successful implementation, and adoption by a key customer, of an integrated, software-based field-oriented control with sensors to motor drivers.
	3.	Successful implementation of certain advanced power analog processes.
	4.	Successful design wins and achievement of a specific level of revenue with a global networking customer.
	5.	Achievement of a specific level of revenue with a global electronics manufacturer.
	6.	Achievement of a specific level of market share with certain core power products.

   

As of October 30, 2018, the first and the second operating metrics have been achieved and the determination of achievement was approved by the Compensation Committee.

 

Subject to the employees’ continued employment with the Company, the 2015 MPSUs will fully vest on January 1, 2020 if the pre-determined individual market and performance goals in each tranche are met during the performance periods and approved by the Compensation Committee. In addition, the 2015 MPSUs contain sales restrictions on the vested shares by employees for up to two years.

 

The Company determined the grant date fair value of the 2015 MPSUs using a Monte Carlo simulation model with the following weighted-average assumptions: stock price of $61.35, expected volatility of 33.2%, risk-free interest rate of 1.3%, and an illiquidity discount of 7.8% to account for the post-vesting sales restrictions. Assuming the achievement of all of the required market and performance goals, the total stock-based compensation cost for the 2015 MPSUs, excluding cancelled shares, is $24.6 million ($8.3 million for the first tranche, $4.5 million for the second tranche, $5.2 million for the third tranche, and $6.6 million for the fourth tranche).

 

For the first tranche, stock-based compensation expense is being recognized over the requisite service period. For the second, third and fourth tranches, stock-based compensation expense for each tranche is recognized if an operating metric has been achieved, or if management believes it is probable that an operating metric will be achieved during the performance periods in each reporting period. As of October 30, 2018, two operating metrics have been achieved, and based on management’s quarterly assessment, one additional operating metric was considered probable of being achieved during the performance periods. Accordingly, stock-based compensation expense is being recognized for the second, third and fourth tranches over the requisite service period.

 

 

Employee Stock Purchase Plan (“ESPP”)

  

For the three months ended September 30, 2018 and 2017, 15,000 and 18,000 shares, respectively, were issued under the ESPP. For the nine months ended September 30, 2018 and 2017, 33,000 and 40,000 shares, respectively, were issued under the ESPP. As of September 30, 2018, 4.6 million shares were available for future issuance.

 

The intrinsic value of the shares issued was $0.6 million and $0.5 million for the three months ended September 30, 2018 and 2017, respectively. The intrinsic value of the shares issued was $1.1 million and $1.0 million for the nine months ended September 30, 2018 and 2017, respectively. As of September 30, 2018, the unamortized expense was $0.4 million, which will be recognized through the first quarter of 2019. The Black-Scholes model was used to value the employee stock purchase rights with the following weighted-average assumptions: 

 

 

Cash proceeds from the shares issued under the ESPP were $3.0 million and $2.7 million for the nine months ended September 30, 2018 and 2017, respectively. 

  

 

4. BALANCE SHEET COMPONENTS

 

Inventories 

 

Inventories consist of the following (in thousands): 

 

 

Other Current Assets

 

Other current assets consist of the following (in thousands):

 

 

Under Topic 606, “assets for product returns” primarily represent the carrying value of inventory the Company expects to recover from customers related to stock rotation returns. Prior to the adoption of Topic 606, such amounts were netted against the stock rotation reserve within current accrued liabilities.

 

 

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 and nine months ended September 30, 2018.

 

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

 

 

 

Amortization expense is recorded in cost of revenue in the Condensed Consolidated Statements of Operations. For the three months ended September 30, 2018 and 2017, amortization expense totaled $0.2 million and $0.5 million, respectively. For the nine months ended September 30, 2018 and 2017, amortization expense totaled $0.6 million and $1.5 million, respectively.

 

As of September 30, 2018, the estimated future amortization expense was 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 shares, and calculated using the treasury stock method. Contingently issuable shares, including equity awards with performance conditions or market conditions, are considered outstanding common shares and included in the basic net income per share as of the date that all necessary conditions to earn the awards have been satisfied. Prior to the end of the contingency period, the number of contingently issuable shares included in the diluted net income per share is based on the number of shares, if any, that would be issuable under the terms of the arrangement at the end of the reporting period.

 

The Company’s outstanding RSUs contain forfeitable rights to receive cash dividend equivalents, which are accumulated and paid to the employees when the underlying RSUs vest. Dividend equivalents accumulated on the underlying RSUs are forfeited if the employees do not fulfill their service requirement and the awards do not vest. 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): 

 

 

 

 

7. SEGMENT AND GEOGRAPHIC INFORMATION

 

The Company operates in one reportable segment that includes the design, development, marketing and sale of high-performance analog solutions for the consumer, computing and storage, industrial, automotive and communications markets. The Company’s chief operating decision maker is its Chief Executive Officer, who reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. 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 and 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 equal to or greater than 10% of the Company's total revenue, or with accounts receivable balances greater than 10% of the Company’s total accounts receivable:

 

__________________

* Represents less than 10%.

 

The Company’s agreements with these third-party distributors and value-added reseller were made in the ordinary course of business and may be terminated with or without cause by these customers 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 any of these customers 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 short period following the termination of the agreement with the customer. 

 

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 is a party to actions and proceedings in the ordinary course of business, including potential litigation initiated by its shareholders, 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. As of September 30, 2018, there were no material pending legal proceedings to which the Company was a party.

  

 

9. CASH, CASH EQUIVALENTS, INVESTMENTS AND RESTRICTED CASH

 

The following is a summary of the Company’s cash, cash equivalents and 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 the unrealized gain and loss positions related to the Company’s available-for sale investments (in thousands): 

 

 

 

Restricted Cash

 

The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the Condensed Consolidated Balance Sheets to the amounts shown in the Condensed Consolidated Statements of Cash Flows:

 

 

Restricted cash includes a security deposit that is set aside in a bank account and cannot be withdrawn by the Company under the terms of a lease agreement. The restriction will end and any unused amount will be returned to the Company upon the expiration of the lease.

  

 

10. FAIR VALUE MEASUREMENTS  

 

The following tables summarize the fair value measurement of the financial assets (in thousands):

 

 

 

 

●	Level 1—includes instruments with quoted prices in active markets for identical assets.
●	Level 2—includes instruments for which the valuations are based upon quoted market prices in active markets involving similar assets or inputs other than quoted prices that are observable for the assets. The market inputs used to value these instruments generally consist of market yields, recently executed transactions, broker/dealer quotes or alternative pricing sources with reasonable levels of price transparency. Pricing sources may include industry standard data providers, security master files from large financial institutions, and other third-party sources used to determine a daily market value.
●	Level 3—includes instruments for which the valuations are based on inputs that are unobservable and significant to the overall fair value measurement.

 

The Company’s level 3 assets consist of government-backed student loan auction-rate securities, which became illiquid in 2008. The Company determined the fair value of the auction-rate securities using a discounted cash flow model with the following assumptions:

 

 

 

11. DEFERRED COMPENSATION PLAN

 

The following table summarizes the deferred compensation plan balances in the Condensed Consolidated Balance Sheets (in thousands):

 

 

 

 

12. INTEREST AND OTHER INCOME, NET

 

The components of interest and other income, net are as follows (in thousands):

 

 

 

13. INCOME TAXES

 

As of September 30, 2018, the Company has not adjusted its provisional tax estimates related to the U.S. Tax Cuts and Jobs Act enacted in December 2017 (the “2017 Tax Act”) that were recorded in the fourth quarter of 2017. These amounts remained as estimates and, as permitted by Staff Accounting Bulletin No. 118, they will be refined through December 2018 based on the Company’s ongoing analysis of data and tax positions along with new guidance from regulators and interpretation of the law.

 

The income tax provision for the three and nine months ended September 30, 2018 was $4.6 million, or 12.8% of pre-tax income, and $8.2 million, or 9.5% of pre-tax income, respectively. The effective tax rate differed from the federal statutory rate primarily because foreign income generated by the Company’s subsidiaries in Bermuda and China was taxed at lower rates, and because of certain stock-based compensation deductions. In addition, the effective tax rate was impacted by the inclusion of the global intangible low-taxed income ("GILTI") under the 2017 Tax Act.

 

For the three and nine months ended September 30, 2018, the Company’s effective tax rate included the estimated impact of $18.4 million and $46.2 million, respectively, related to the GILTI provisions that was included as additional subpart F income, which was accounted for as a period cost. In addition, during the first quarter of 2018, the Company paid the 2018 installment of $1.9 million related to the deemed repatriation transition tax liability. As of September 30, 2018, $1.9 million of the transition tax liability was recorded in current accrued liabilities and $20.1 million was recorded in long-term income tax liabilities on the Condensed Consolidated Balance Sheet.

  

The income tax provision for the three and nine months ended September 30, 2017 was $1.4 million, or 5.8% of pre-tax income, and $3.1 million, or 5.5% of pre-tax income, respectively. The effective tax rate differed from the federal statutory rate primarily because foreign income generated by the Company’s subsidiaries in Bermuda and China was taxed at lower rates. In addition, the effective tax rate was impacted by changes in the valuation allowance primarily related to stock-based compensation.

 

As of September 30, 2018, the Company had $18.1 million of unrecognized tax benefits, $11.2 million of which would affect its effective tax rate if recognized after considering the valuation allowance. At December 31, 2017, the Company had $16.3 million of unrecognized tax benefits, $9.1 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 between 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 September 30, 2018 and December 31, 2017, the Company has $0.8 million and $0.5 million, respectively, of accrued interest related to uncertain tax positions, which were recorded in long-term income tax liabilities in the Consolidated Balance Sheets.

 

In July 2018, the U.S. Ninth Circuit Court of Appeals overturned the U.S. Tax Court’s unanimous 2015 decision in Altera v. Commissioner, holding that the Internal Revenue Service ("IRS") did not violate the rule-making procedures required by the Administrative Procedures Act. In the case, the taxpayer challenged IRS regulations that required participants in qualified cost sharing arrangements to share stock based compensation costs. The Tax Court had invalidated those regulations, in part because the Treasury Department failed to adequately consider significant taxpayer comments when adopting them. In August 2018, the U.S. Ninth Circuit Court of Appeals withdrew its July 2018 opinion. The Company will continue to monitor developments related to this case and the potential impact on its financial statements.

 

 

 

14. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

 

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

 

 

 

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

   

 

15. DIVIDENDS AND DIVIDEND EQUIVALENTS

 

Cash Dividend Program

 

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. Based on the Company’s historical practice, stockholders of record as of the last business day of the quarter are entitled to receive the quarterly cash dividends when and if declared by the Board of Directors, which are payable to the stockholders in the following month. The Board of Directors declared the following cash dividends (in thousands, except per-share amounts): 

 

 

As of September 30, 2018 and December 31, 2017, accrued dividends totaled $12.7 million and $8.3 million, respectively.

 

The declaration of any future cash dividends is at the discretion of the Board of Directors and will depend on, among other things, the Company’s financial condition, results of operations, capital requirements, business conditions, statutory requirements of Delaware law, and other factors that the Board of Directors may deem relevant, as well as a determination that cash dividends are in the best interests of the stockholders.

 

The Company anticipates that cash used for future dividend payments will come from its current domestic cash and cash generated from ongoing U.S. operations, as well as cash to be repatriated from its Bermuda subsidiary. Earnings from other foreign subsidiaries will continue to be indefinitely reinvested. 

 

Cash Dividend Equivalent Rights

 

Under the Company’s stock plans, outstanding RSUs 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 accumulated and paid to the employees when the underlying RSUs vest. Dividend equivalents accumulated on the underlying RSUs are forfeited if the employees do not fulfill their service requirement and the awards do not vest. As of September 30, 2018 and December 31, 2017, accrued dividend equivalents totaled $7.8 million and $5.8 million, respectively.

 

 

 

16. SUBSEQUENT EVENTS

 

Employee Equity Awards

 

2018 MSUs:

 

In October 2018, the Compensation Committee granted 60,000 MSUs to the executive officers and 60,000 MSUs to certain non-executive employees, which represent a target number of shares to be awarded upon achievement of stock price targets (“2018 MSUs”). The maximum number of shares that an employee can earn is 500% of the target number of the 2018 MSUs if the Company achieves five stock price targets ranging from $140 to $172. The performance period for the first two stock price targets is from October 26, 2018 to December 31, 2021, and the performance period for the last three price targets is from October 26, 2018 to December 31, 2023.

 

Subject to the employees’ continued employment with the Company, the 2018 MSUs will fully vest on January 1, 2024 if the pre-determined stock price targets are met during the performance periods and approved by the Compensation Committee. In addition, the 2018 MSUs contain sales restrictions on the vested shares by employees for up to two years.

 

2019 PSUs:

 

In October 2018, the Compensation Committee granted 53,000 PSUs to certain non-executive employees, which represent a target number of shares to be awarded based on the Company’s 2020 revenue goals for certain regions or product line divisions, or based on the Company’s average two-year (2019 and 2020) revenue growth rate compared against the analog industry’s average two-year revenue growth rate as published by the Semiconductor Industry Association (“2019 Non-Executive PSUs”). The maximum number of shares that an employee can earn is either 200% or 300% of the target number of the 2019 Non-Executive PSUs, depending on the job classification of the employee. 50% of the 2019 Non-Executive PSUs will vest in the first quarter of 2021 if the pre-determined performance goals are met during the performance period and approved by the Compensation Committee. The remaining 2019 Non-Executive PSUs will vest over the following two years on an annual or quarterly basis. Vesting is subject to the employees’ continued employment with the Company.

 

 

 

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