MONOLITHIC POWER SYSTEMS INC - Quarter Report: 2022 March (Form 10-Q)

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 STOCKHOLDERS’ EQUITY

(in thousands, except per-share amounts)

(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 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, 2021, filed with the SEC on  February 25, 2022.

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 Quarterly Report on Form 10-Q are not necessarily indicative of the results that  may be expected for the year ending  December 31, 2022 or for any other future periods.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenue and expenses during the reporting period. Significant estimates and assumptions used in these condensed consolidated financial statements primarily include those related to revenue recognition, inventory valuation, valuation of share-based awards, contingencies and income tax valuation allowances. Actual results could differ from these estimates and assumptions, and any such differences may be material to the Company’s condensed consolidated financial statements.

Neither the COVID-19 pandemic nor the conflict between Ukraine and Russia materially and adversely impacted the Company's overall operating results or business operations for the three months ended March 31, 2022. As of the date of issuance of these condensed consolidated financial statements, the Company is not aware of any specific event or circumstance related to the pandemic or the conflict between Ukraine and Russia that would require management to update the significant estimates and assumptions used in the preparation of the condensed consolidated financial statements. As new events continue to evolve and additional information becomes available, any changes to these estimates and assumptions will be recognized in the condensed consolidated financial statements as soon as they become known.

2. REVENUE RECOGNITION

Revenue from Product Sales

The Company generates revenue primarily from product sales, which include assembled and tested integrated circuits (“ICs”), as well as dies in wafer form. These product sales accounted for 98% and 97% of the Company’s total revenue for the three months ended March 31, 2022 and 2021, respectively. The remaining revenue primarily includes royalty revenue from licensing arrangements and revenue from wafer testing services performed for third parties, which have not been significant for the periods presented. See Note 7 for the disaggregation of the Company’s revenue by geographic region and by product family.

The Company sells its products primarily through third-party distributors, value-added resellers, original equipment manufacturers (“OEMs”), original design manufacturers (“ODMs”) and electronic manufacturing service (“EMS”) providers. For the three months ended March 31, 2022 and 2021, 82% and 89%, respectively, of the Company’s product 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, set 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.

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 shipped and delivered to be held at customers’ designated locations because the Company continues to control the products and retain ownership, and the customers do not have an unconditional obligation to pay. The Company recognizes revenue when the customers consume the products from the consigned inventory locations or, in some cases, after a 60-day period from the delivery date has passed, at which time control transfers to the customers and the Company invoices them for payment.

Variable Consideration

The Company accounts for price adjustment and stock rotation rights as variable consideration that reduces the transaction price and recognizes that reduction in the same period the associated revenue is recognized. Four 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 using the expected value method based on an analysis 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 do not have price adjustment rights. The Company records a credit against accounts receivable for the estimated price adjustments, with a corresponding reduction to revenue.

Certain distributors have limited stock rotation rights that permit the return of a small percentage of the previous six months’ purchases in accordance with the contract terms. The Company estimates the stock rotation returns using the expected value method based on an analysis of historical returns, and the current level of inventory in the distribution channel. The Company records a liability for the stock rotation reserve, with a corresponding reduction to revenue. In addition, the Company recognizes an asset for product returns which represents the right to recover products from the customers in connection with stock rotations, with a corresponding reduction to cost of revenue.

Contract Balances

Accounts Receivable:

The Company records a receivable when it has an unconditional right to receive consideration after the performance obligations are satisfied. As of March 31, 2022 and December 31, 2021, accounts receivable totaled $120.3 million and $104.8 million, respectively. The Company's accounts receivable are short-term, with standard payment terms generally ranging from 30 to 90 days. The Company does not require its customers to provide collateral to support accounts receivable. The Company assesses the collectability by reviewing accounts receivable on a customer-by-customer basis. To manage credit risk, management performs ongoing credit evaluations of the customers’ financial condition, monitors payment performance, and assesses current economic conditions, as well as reasonable and supportable forecasts of future economic conditions, that may affect collectability of the outstanding receivables. For certain high-risk customers, the Company requires standby letters of credit or advance payment prior to shipments of goods. The Company did not recognize any write-offs of accounts receivable or record any allowance for credit losses for the periods presented.

Contract Liabilities:

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 March 31, 2022 and December 31, 2021, customer prepayments totaled $7.0 million and $4.3 million, respectively. The increase in the customer prepayment balance for the three months ended March 31, 2022 resulted from an increase in unfulfilled customer orders for which the Company had received payments. For the three months ended March 31, 2022, the Company recognized $3.8 million of revenue that was included in the customer prepayment balance as of December 31, 2021.

Practical Expedients

The Company has elected the practical expedient to expense sales commissions as incurred because the amortization period would have been one year or less. 

The Company’s standard payment terms generally require customers to pay 30 to 90 days after the Company satisfies the performance obligations. For those customers who are required to pay in advance, the Company satisfies the performance obligations generally within a quarter. The Company has elected not to determine whether contracts with customers contain significant financing components.

The Company’s unsatisfied performance obligations primarily include 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.

3. STOCK-BASED COMPENSATION

2014 Equity Incentive Plan

In  April 2013, the Board of Directors adopted the 2014 Equity Incentive Plan (the “2014 Plan”), which the Company's stockholders approved in  June 2013. In  October 2014, the Board of Directors approved certain amendments to the 2014 Plan. The amended 2014 Plan became effective on  November 13, 2014 and provided for the issuance of up to 5.5 million shares. In  April 2020, the Board of Directors further amended and restated the amended 2014 Plan (the “Amended and Restated 2014 Plan”), which the Company's stockholders approved in  June 2020. The Amended and Restated 2014 Plan became effective on  June 11, 2020 and provides for the issuance of up to 10.5 million shares. The Amended and Restated 2014 Plan will expire on  June 11, 2030. As of March 31, 2022, 5.0 million shares remained available for future issuance under the Amended and Restated 2014 Plan.  

Stock-Based Compensation Expense

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

Restricted Stock Units (“RSUs”)

The Company’s RSUs include time-based RSUs, RSUs with performance conditions (“PSUs”), RSUs with market conditions (“MSUs”), and RSUs with both market and performance conditions (“MPSUs”). Vesting of awards with performance conditions or market conditions is subject to the achievement of pre-determined performance goals and the approval of such achievement by the Compensation Committee of the Board of Directors (the “Compensation Committee”). All awards include service conditions which require continued employment with the Company. A summary of RSU activity is presented in the table below (in thousands, except per-share amounts):

The intrinsic value related to vested RSUs was $151.7 million and $159.3 million for the three months ended  March 31, 2022 and 2021, respectively. As of  March 31, 2022, the total intrinsic value of all outstanding RSUs was $1.3 billion, based on the closing stock price of $485.68. As of  March 31, 2022, unamortized compensation expense related to all outstanding RSUs was $337.4 million with a weighted-average remaining recognition period of approximately two years.

Cash proceeds from vested PSUs with a purchase price requirement totaled $2.3 million and $10.7 million for the three months ended March 31, 2022 and 2021, respectively. 

Time-Based RSUs:

For the three months ended  March 31, 2022, the Compensation Committee granted 27,000 RSUs with service conditions to non-executive employees and non-employee directors. The RSUs generally vest over four years for employees and one year for directors, subject to continued service with the Company.

2022 PSUs:

In February 2022, the Compensation Committee granted 81,000 PSUs to the executive officers, which represent a target number of shares that can be earned subject to the achievement of two sets of performance goals (“2022 Executive PSUs”). For the first goal, the executive officers can earn up to 300% of the target number of the 2022 Executive PSUs based on the achievement of the Company’s average two-year (2022 and 2023) revenue growth rate compared against the analog industry’s average two-year revenue growth rate as published by the Semiconductor Industry Association. 50% of the 2022 Executive PSUs will vest in the first quarter of 2024 if the pre-determined revenue goal is met during the performance period. The remaining 2022 Executive PSUs will vest over the following two years on a quarterly basis. For the second goal, the executive officers can earn up to an additional 200% of the target number of the 2022 Executive PSUs if the Company secures additional wafer capacity during a three-year performance period. The 2022 Executive PSUs related to the second goal will fully vest in the first quarter of 2025 if the pre-determined goal is met during the performance period. In addition, all vested shares related to the second goal will be subject to a post-vesting sales restriction period of one year. Assuming the achievement of the highest level of the performance goals, the total stock-based compensation cost for the 2022 Executive PSUs is $163.1 million.

In February 2022, the Compensation Committee granted 14,000 PSUs to certain non-executive employees, which represent a target number of shares that can be earned subject to the achievement of the Company’s 2023 revenue goals for certain regions or product line divisions, or based on the achievement of the Company’s average two-year (2022 and 2023) revenue growth rate compared against the analog industry’s average two-year revenue growth rate as published by the Semiconductor Industry Association (“2022 Non-Executive PSUs”). The maximum number of shares that an employee can earn is either 200% or 300% of the target number of the 2022 Non-Executive PSUs, depending on the job classification of the employee. 50% of the 2022 Non-Executive PSUs will vest in the first quarter of 2024 if the pre-determined goals are met during the performance period. The remaining 2022 Non-Executive PSUs will vest over the following two years on an annual or quarterly basis. Assuming the achievement of the highest level of performance goals, the total stock-based compensation cost for the 2022 Non-Executive PSUs is $13.7 million.

The 2022 Executive PSUs and the 2022 Non-Executive PSUs contain a purchase price feature, which requires the employees to pay the Company $30 per share upon vesting of the shares. The $30 purchase price requirement is deemed satisfied and waived if the average stock price for 20 consecutive trading days at any time during 2022 and 2023 is $30 higher than the grant date stock price of $393.16. This market condition was achieved in the first quarter of 2022. The Company determined the grant date fair value of the 2022 Executive PSUs and the 2022 Non-Executive PSUs using a Monte Carlo simulation model with the following assumptions: stock price of $393.16, simulation term of four years, expected volatility of 44.6%, risk-free interest rate of 1.5%, and expected dividend yield of 0.8%. In addition, the 2022 Executive PSUs subject to the second goal included an illiquidity discount of 10.3% to account for the post-vesting sales restrictions.

2022 MSUs:

In February 2022, the Compensation Committee granted 24,000 MSUs to certain non-executive employees, which represent a target number of shares that can be earned upon achievement of stock price targets (“2022 MSUs”). The maximum number of shares that an employee can earn is 500% of the target number of the 2022 MSUs if the Company achieves five stock price targets ranging from $472 to $590 during a performance period from February 3, 2022 to February 3, 2025. The 2022 MSUs will vest in equal amounts on each of the first, second and third anniversaries of February 3, 2025. The total stock-based compensation cost for the 2022 MSUs is $32.4 million.

The Company determined the grant date fair value of the 2022 MSUs using a Monte Carlo simulation model with the following assumptions: stock price of $393.16, simulation term of six years, expected volatility of 39.0%, risk-free interest rate of 1.7%, and expected dividend yield of 0.8%.

2004 Employee Stock Purchase Plan (“ESPP”)

For the three months ended March 31, 2022 and 2021, 7,000 and 10,000 shares, respectively, were issued under the ESPP. As of March 31, 2022, 4.5 million shares were available for future issuance under the ESPP.

The intrinsic value of the shares issued was $0.7 million and $1.4 million for the three months ended March 31, 2022 and 2021, respectively. As of March 31, 2022, the unamortized expense was $0.7 million, which will be recognized through the third quarter of 2022. 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 $2.8 million and $2.3 million for the three months ended March 31, 2022 and 2021, 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):

Other Long-Term Assets

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

Other Accrued Liabilities

Other accrued liabilities consist of the following (in thousands): 

Other Long-Term Liabilities

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

5. LEASES

Lessee

The Company has operating leases primarily for administrative and sales and marketing offices, manufacturing operations and research and development facilities, employee housing units and certain equipment. These leases have remaining lease terms from less than a year to four years. Some of these leases include options to renew the lease term for up to two years or on a month-to-month basis. The Company does not have finance lease arrangements.

The following table summarizes the balances of operating lease right-of-use (“ROU”) assets and liabilities (in thousands):

The following tables summarize certain information related to the leases (in thousands, except percentages):

As of March 31, 2022, the maturities of the lease liabilities were as follows (in thousands):

As of March 31, 2022, the Company had no operating leases that had not yet commenced.

Lessor 

The Company owns certain office buildings and leases a portion of these properties to third parties under arrangements that are classified as operating leases. These leases have remaining lease terms ranging from less than one year to four years. Some of these leases include options to renew the lease term for up to five years.

For the three months ended March 31, 2022 and 2021, income related to lease payments was $0.6 million and $0.3 million, respectively. As of  March 31, 2022, future income related to lease payments 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 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 the requisite service requirement and, as a result, 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): 

Anti-dilutive common stock equivalents were not material in any of the periods presented.

7. SEGMENT, SIGNIFICANT CUSTOMERS AND GEOGRAPHIC INFORMATION

The Company operates in one reportable segment that includes the design, development, marketing and sale of high-performance, semiconductor-based power electronics solutions for the storage and computing, enterprise data, automotive, industrial, communications and consumer 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 OEMs, ODMs and EMS providers. The following table summarizes those customers with sales equal to 10% or more of the Company's total revenue:  

* Represents less than 10%.

The Company’s agreements with these third-party customers 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 the 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 short period following the termination of the agreement with the distributor.

The following table summarizes those customers with accounts receivable equal to 10% or more of the Company’s total accounts receivable:  

* Represents less than 10%.

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

8. COMMITMENTS AND CONTINGENCIES

Product Warranties

The Company generally provides one to two-year warranties against defects in materials and workmanship and will 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.

The changes in warranty reserves are as follows (in thousands):

For the three months ended March 31, 2022, the warranty provision for product sales included net adjustments to pre-existing claims of $4.2 million. For the three months ended March 31, 2021, net adjustments to pre-existing claims were not material.

Purchase Commitments

The Company has outstanding purchase obligations with its suppliers and other parties that require the future purchases of goods or services, which primarily consist of wafer and other inventory purchases, assembly and other manufacturing services, construction of manufacturing and research and development facilities, purchases of production and other equipment, and license arrangements. As of March 31, 2022, the Company’s outstanding purchase obligations totaled approximately $204.1 million. 

Litigation

The Company is a party to actions and proceedings in the ordinary course of business, including potential litigation initiated by its stockholders, 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 intends to defend itself vigorously against any such claims. As of March 31, 2022, 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 debt investments (in thousands): 

The following table summarizes the contractual maturities of the short-term and long-term available-for-sale investments as of March 31, 2022 (in thousands):  

Gross realized gains and losses recognized on the sales of available-for-sale investments were not material for the periods presented. 

The following tables summarize the unrealized gain and loss positions related to the available-for sale investments (in thousands):  

The following tables present information about the available-for-sale investments that had been in a continuous unrealized loss position for less than 12 months and for greater than 12 months (in thousands): 

An impairment exists when the fair value of an investment is less than its amortized cost basis. As of March 31, 2022 and December 31, 2021, the Company did not consider the impairment of its investments to be a result of credit losses. The Company typically invests in highly rated securities, with the primary objective of minimizing the potential risk of principal loss. The Company’s investment policy generally requires securities to be investment grade and limits the amount of credit exposure to any one issuer. When evaluating a debt security for impairment, management reviews factors such as the Company’s intent to sell, or whether it will more likely than not be required to sell, the security before recovery of its amortized cost basis, the extent to which the fair value of the security is less than its cost, the financial condition of the issuer and the credit quality of the investment.

The Company’s auction-rate securities are backed by pools of student loans supported by guarantees by the U.S. Department of Education. The underlying maturities of these securities are up to 24 years. The Company has received all scheduled interest payments on a timely basis pursuant to the terms and conditions of the securities. The Company does not intend to sell these securities, and it is more likely than not that the Company will not be required to sell these securities, before recovery of its amortized cost basis. To date, the Company has redeemed $40.8 million, or 94% of the original portfolio in these auction-rate securities, at par without any realized losses.

Non-Marketable Equity Investment

In  November 2020, the Company made an equity investment in a privately held Swiss company (the “Investee”) that is accounted for under the measurement alternative. One member of the Company’s Board of Directors is an executive officer of a company that has a commercial relationship with the Investee. In addition, the Company’s Chief Executive Officer has a personal investment in the Investee and currently serves on the Investee's board of directors. As of both March 31, 2022 and December 31, 2021, the Company’s investment in the Investee, which is denominated in CHF, had a carrying value of $3.3 million. The Company did not record any impairment or adjustments resulting from observable price changes for the three months ended March 31, 2022.

Restricted Cash

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

As of March 31, 2022 and December 31, 2021, restricted cash included 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 upon the expiration of the lease.

10. FAIR VALUE MEASUREMENTS

The following tables summarize the fair value of the financial assets measured on a recurring basis (in thousands): 

Redemptions and changes in the fair value of the auction-rate securities classified as Level 3 assets were not material for the periods presented.

11. DEFERRED COMPENSATION PLAN

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

12. OTHER INCOME (EXPENSE), NET

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

13. INCOME TAXES

The income tax provision or benefit for interim periods is generally determined using an estimate of the Company’s annual effective tax rate and adjusted for discrete items, if any, in the relevant period. Each quarter the estimate of the annual effective tax rate is updated, and if the Company’s estimated tax rate changes, a cumulative adjustment is made.

The income tax expense for the three months ended  March 31, 2022 was $15.9 million, or 16.7% of pre-tax income. The effective tax rate was lower than the federal statutory rate primarily due to foreign income from the Company’s subsidiaries in Bermuda and China being taxed at lower statutory tax rates, and excess tax benefits from stock-based compensation. The decrease in the effective tax rate relative to the federal statutory rate was partially offset by the inclusion of the global intangible low-taxed income (“GILTI”) tax.

The income tax expense for the three months ended March 31, 2021 was $3.3 million, or 6.7% of pre-tax income. The effective tax rate was lower than the federal statutory rate primarily due to foreign income from the Company’s subsidiaries in Bermuda and China being taxed at lower statutory tax rates, and excess tax benefits from stock-based compensation. The decrease in the effective tax rate relative to the federal statutory rate was partially offset by the inclusion of the GILTI tax.

The Company’s uncertain tax positions relate to the allocation of income and deductions among its global entities and to the determination of the research and development tax credit. It is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. However, it is not possible to determine either the magnitude or the range of increases or decreases at this time.

14. 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 other income (expense), net, on the Condensed Consolidated Statements of Operations.

15. DIVIDENDS AND DIVIDEND EQUIVALENTS

Cash Dividend Program

The Company has a dividend program approved by the Board of Directors, 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  March 31, 2022 and December 31, 2021, accrued dividends totaled $34.9 million and $27.7 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, 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 domestic cash, cash generated from ongoing U.S. operations, and cash repatriated from its Bermuda subsidiary. The Company also anticipates that earnings from other foreign subsidiaries will continue to be indefinitely reinvested.

Cash Dividend Equivalent Rights

The Company's 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 the requisite service requirement and, as a result, the awards do not vest. As of March 31, 2022 and December 31, 2021, accrued dividend equivalents totaled $13.7 million and $13.1 million, respectively.    

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 others, 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, our industry and the global economy, including our expectations regarding the potential impacts of the COVID-19 pandemic and the conflict in Ukraine on our business, industry and the global economy. 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 our Annual Report on Form 10-K and, in particular, in the section entitled “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 SEC, such as our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K. 

Overview

We are a global company that provides high-performance, semiconductor-based power electronics solutions. Incorporated in 1997, our three core strengths include deep system-level knowledge, strong semiconductor design expertise, and innovative proprietary semiconductor process and system integration technologies. These combined strengths enable us to deliver highly integrated monolithic products that offer energy-efficient, cost-effective, easy-to-use solutions for systems found in storage and computing, enterprise data, automotive, industrial, communications and consumer applications. Our mission is to reduce total energy and material consumption in our customers’ systems with green, practical and compact solutions. 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 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 over the long term.

We work with third parties to manufacture and assemble our 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 times for orders are generally 16 to 26 weeks. Recently, we have experienced high customer demand, which has resulted in longer than usual lead times. 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 our products are incorporated into end-user products. Our revenue from direct and indirect sales to customers in Asia was 90% and 89% for the three months ended March 31, 2022 and 2021, respectively. We derive a majority of our revenue from the sales of our DC to DC converter products which serve the storage and computing, enterprise data, automotive, industrial, communications and consumer 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 continue to secure manufacturing capacity.

Impact of COVID-19 on Our Business

The COVID-19 pandemic has had, and continues to have, a significant impact around the world. Our primary focus is to continue to execute our business plan and mitigate the effect of the COVID-19 pandemic on our financial position and operations, while actively taking all necessary precautions to ensure the safety of our employees, our suppliers and our customers. The pandemic did not materially and adversely impact our overall operating results or business operations for the three months ended March 31, 2022.

In recent months, China has experienced an increase in outbreaks, specifically in Shanghai where we have business operations and where many of our customers and suppliers are located. Local governments have implemented strict measures including quarantines, shutdowns and other business restrictions, which resulted in logistics challenges across the region and throughout China. While the disruptions did not have a material adverse impact on our operations or financial condition for the three months ended March 31, 2022, we will continue to monitor and evaluate future developments. However, we cannot reasonably estimate the duration and severity of the increased regulatory requirements in Shanghai and throughout China or the potential effect of these measures on the global economy, the semiconductor industry and our business.

We have worked, and are continuing to actively work, with our stakeholders, including customers, suppliers and employees, to address the impact of the pandemic. We will continue to monitor the situation, to assess further possible implications to our business, supply chain and customers, and to take actions in an effort to mitigate adverse consequences to the extent feasible. A prolonged economic slowdown as a result of the pandemic, or otherwise, could materially and adversely impact our business, results of operations and financial condition for the remainder of 2022 and beyond.

Conflict between Ukraine and Russia

As the conflict between Ukraine and Russia continues to evolve, we are closely monitoring the impact of future developments on our business, supply chain, employees, customers and other business partners. Our total revenues in Russia have not been material and we have changed our payment terms to require payment in advance from our customers in Russia. In addition, all outstanding accounts receivable balances from our customers in Russia have been paid. 

Cybersecurity Risk Management

We are committed to protecting our information technology (“IT”) assets, including computers, systems, corporate networks and sensitive data, from unauthorized access or attack. We have established an internal global IT policy handbook as well as IT security management control procedures designed to:

We require all new employees to attend an IT security training orientation. In addition, on an as-needed basis, our IT team provides trainings and updates to employees related to our policies and procedures.

Our IT Steering Committee, which consists of our senior management and IT team, meets on a regular basis to review initiatives and projects to improve IT security, as well as resources and budgets for our cybersecurity compliance and education efforts. We completed the ISO 27001 certification, a globally recognized information security standard, in 2021.

Our Audit Committee of the Board of Directors, which consists of three independent members, is responsible for the oversight of our cybersecurity risk program. On a regular basis, the Audit Committee reviews reports and updates from our Chief Financial Officer and IT senior management about major risk exposures, their potential impact on our business operations, and management’s strategies to assess, monitor and mitigate those risks. The Audit Committee also provides updates of their oversight and findings to the Board of Directors.  

We believe we have adequate resources and sufficient policies, procedures and oversight in place to identify and manage our IT security risks to our business operations. To date, we do not believe we have experienced any material information security breaches and have not incurred significant operating expenses related to information security breaches.

Critical Accounting Policies and Estimates

In preparing our condensed consolidated financial statements in accordance with GAAP, we are required to make estimates, assumptions and judgments that affect the amounts reported in our financial statements and the accompanying disclosures. Estimates and judgments used in the preparation of our condensed consolidated financial statements are, by their nature, uncertain and unpredictable, and depend upon, among other things, many factors outside of our control, including demand for our products, economic conditions and other current and future events, such as the impact of the COVID-19 pandemic and the conflict between Ukraine and Russia. Actual results could differ from these estimates and assumptions, and any such differences may be material to our condensed consolidated financial statements. 

As of the date of issuance of these condensed consolidated financial statements, we are not aware of any specific event or circumstance that would require our management to update the significant estimates and assumptions used in the preparation of the condensed consolidated financial statements, as compared to those disclosed in the Annual Report on Form 10-K for the year ended December 31, 2021. As new events continue to evolve and additional information becomes available, any changes to these estimates and assumptions will be recognized in the condensed consolidated financial statements as soon as they become known.  

Results of Operations

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

Revenue

In the first quarter of 2022, we reorganized our end markets and broke out Computing and Storage into two new end markets: (1) Storage and Computing, and (2) Enterprise Data. All prior-period amounts have been restated to reflect the changes. The following table summarizes our revenue by end market:

Revenue for the three months ended March 31, 2022 was $377.7 million, an increase of $123.3 million, or 48.4%, from $254.5 million for the three months ended March 31, 2021. Overall unit shipments increased by 20% and average sales prices increased by approximately 23% compared to the same period in 2021. The increase in average sales prices was primarily driven by favorable changes in product mix with more sales coming from products with higher unit prices. 

For the three months ended March 31, 2022, revenue from the storage and computing market increased $45.3 million, or 88.2%, from the same period in 2021. This increase was primarily due to higher storage and commercial notebook sales. Revenue from the enterprise data market increased $26.3 million, or 162.7%, from the same period in 2021. This increase was primarily driven by continuing strength in data center and workstation computing sales. Revenue from the automotive market increased $9.7 million, or 21.6%, from the same period in 2021. This increase was primarily driven by sales growth for highly integrated applications supporting the digital cockpit, advanced driver assistance systems and connectivity. Revenue from the industrial market increased $8.8 million, or 22.0%, from the same period in 2021. This increase was primarily driven by higher sales in power sources and industrial meters. Revenue from the communications market increased $19.5 million, or 54.1%, from the same period in 2021. This increase primarily reflected higher revenue related to 5G infrastructure and satellite communication applications. Revenue from the consumer market increased $13.7 million, or 20.7%, from the same period in 2021. This increase was primarily driven by increased sales for smart TVs, gaming, and home appliances, which was partially offset by decreased sales for mobile devices.  

Cost of Revenue and Gross Margin

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

Cost of revenue was $158.8 million, or 42.1% of revenue, for the three months ended March 31, 2022, and $113.4 million, or 44.6% of revenue, for the three months ended March 31, 2021. The $45.4 million increase in cost of revenue was primarily due to a 20% increase in overall unit shipments and a 22% increase in the average direct cost of units shipped. The increase in cost of revenue was also driven by an increase in manufacturing overhead costs, which was partially offset by a decrease in inventory write-downs.

Gross margin was 57.9% for the three months ended March 31, 2022, compared with 55.4% for the three months ended March 31, 2021. The increase in gross margin was mainly driven by a favorable product mix and lower inventory write-downs as a percentage of revenue.

Research and Development (“R&D”)

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

R&D expenses were $54.1 million, or 14.3% of revenue, for the three months ended March 31, 2022, and $41.9 million, or 16.5% of revenue, for the three months ended March 31, 2021. The $12.2 million increase in R&D expenses was primarily due to an increase of $9.8 million in cash compensation expenses, which include salary, benefits and bonuses, and an increase of $2.2 million in stock-based compensation expenses, which were mainly associated with performance-based equity awards. This was partially offset by a credit of $1.2 million related to changes in the value of the deferred compensation plan liabilities. Our R&D headcount was 1,103 employees as of March 31, 2022, compared with 909 employees as of March 31, 2021. 

Selling, General and Administrative (“SG&A”)

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

SG&A expenses were $67.2 million, or 17.8% of revenue, for the three months ended March 31, 2022, and $51.5 million, or 20.2% of revenue, for the three months ended March 31, 2021. The $15.7 million increase in SG&A expenses was primarily due to an increase of $8.5 million in stock-based compensation expenses, which were mainly associated with performance-based equity awards, and an increase of $7.8 million in cash compensation expenses, which include salary, benefits and bonuses. The increase was partially offset by a credit of $2.1 million related to changes in the value of the deferred compensation plan liabilities. Our SG&A headcount was 696 employees as of March 31, 2022, compared with 585 employees as of March 31, 2021. 

Litigation Expense

Litigation expense was $1.5 million for the three months ended March 31, 2022, compared with $1.6 million for the three months ended March 31, 2021. The expenses for both periods were attributable to litigation activity related to ongoing patent infringement and other matters.

Other Income (Expense), Net

Other expense, net, was $0.6 million for the three months ended March 31, 2022, compared with other income, net, of $2.6 million for the three months ended March 31, 2021. The decrease in income was primarily due to an increase of $3.4 million in expense related to changes in the value of the deferred compensation plan investments, which was partially offset by an increase of $0.6 million in net interest income.

Income Tax Expense

The income tax provision or benefit for interim periods is generally determined using an estimate of our annual effective tax rate and adjusted for discrete items, if any, in the relevant period. Each quarter the estimate of the annual effective tax rate is updated, and if our estimated tax rate changes, a cumulative adjustment is made.

The income tax expense for the three months ended March 31, 2022 was $15.9 million, or 16.7% of pre-tax income. The effective tax rate was lower than the federal statutory rate primarily due to foreign income from our subsidiaries in Bermuda and China being taxed at lower statutory tax rates, and excess tax benefits from stock-based compensation. The decrease in the effective tax rate relative to the federal statutory rate was partially offset by the inclusion of the GILTI tax.

The income tax expense for the three months ended March 31, 2021 was $3.3 million, or 6.7% of pre-tax income. The effective tax rate was lower than the federal statutory rate primarily due to foreign income from our subsidiaries in Bermuda and China being taxed at lower statutory tax rates, and excess tax benefits from stock-based compensation. The decrease in the effective tax rate relative to the federal statutory rate was partially offset by the inclusion of the GILTI tax.

The increase in the effective tax rate for the three months ended March 31, 2022 compared to the three months ended March 31, 2021 was mainly due to a decrease in excess tax benefits from stock-based compensation, and an increase in GILTI primarily driven by the capitalization of R&D costs as mandated by the U.S. Tax Cut and Jobs Act enacted in December 2017 (the “2017 Tax Act”) and an increase in foreign income.

Liquidity and Capital Resources