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MICREL INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The statements contained in this quarterly report on Form 10-Q that are not purely historical may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), including statements regarding the Company's expectations, hopes, intentions or strategies regarding the future. Forward-looking statements include, but are not limited to statements regarding: future revenues and dependence on standard products sales and international sales; the levels of international sales; the effect of global market conditions on revenue levels, profitability and results of operations; future products or product development; statements regarding fluctuations in the Company's results of operations; future returns and price adjustments and allowance; future uncollectible amounts and doubtful accounts allowance; future products or product development; future research and development spending and the Company's product development strategy; the Company's markets, product features and performance; product demand and inventory to service such demand; competitive threats and pricing pressure; the effect of dependence on third parties; the Company's future use and protection of its intellectual property; future expansion or utilization of manufacturing capacity; future expenditures; current or future acquisitions; the ability to meet anticipated short-term and long-term cash requirements and the sources of funds to meet such requirements; effect of changes in market interest rates on investments; the Company's ability to recover the cost basis on its investments; the Company's need and ability to attract and retain certain personnel; the cost and outcome of litigation and its effect on the Company; the impact of changes in laws and regulations; the future realization of tax benefits; the amount of future taxable income levels and the resolution of uncertain tax positions; and share-based incentive awards and expectations regarding future stock based compensation expense. In some cases, forward-looking statements can be identified by the use of forward-looking terminology such as, but not limited to, "believe," "estimate," "may," "can," "will," "could," "would," "should," "continue," "intend," "objective," "plan," "expect," "likely," "potential," "possible" or "anticipate" or the negative of these terms or other comparable terminology. All forward-looking statements included in this report are based on information available to the Company on the date of this report, and, except as required by law, the Company assumes no obligation to update any such forward-looking statements. These statements are subject to risks and uncertainties, including those risks discussed under "Risks Factors" and elsewhere in this report, which could cause actual results and events to differ materially from those expressed or implied by such forward-looking statements. Additional factors that may affect operating results are contained within the Company's Form 10-K for the year ended December 31, 2012. Overview Micrel designs, develops, manufactures and markets a range of high-performance analog integrated circuits ("ICs"), mixed-signal ICs and digital ICs. The Company currently ships approximately 3,100 standard products. These products address a wide range of end markets including cellular handsets, portable computing, enterprise and home networking, wide area and metropolitan area networks, digital televisions and industrial equipment. The Company also manufactures custom analog and mixed-signal circuits and provides wafer foundry services for customers that produce electronic systems for communications, consumer and military applications. The Company's high performance linear and power products are characterized by high power density and small form factor. The demand for high performance linear and power circuits has been fueled by the growth of portable communications and computing devices, including for example, cellular handsets, tablet devices and notebook computers. The Company also has an extensive linear and power management offering for the networking and communications infrastructure markets including cloud and enterprise servers, network switches and routers, storage area networks and wireless base stations. In addition, the Company offers products that serve the solid state drive market and is seeing strength in the emergence of solid state drives and analog switches, including USB switches. The Company's timing and communications circuits are used primarily for enterprise networks, storage area networks, access networks and metropolitan area networks. This product portfolio consists of timing, clock management and high speed Physical Media Devices ("PMD") products. With form factor, size reductions and ease of use critical for system designs, Micrel utilizes innovative packaging and proprietary process technology to address these challenges. In 2012, the Company acquired PhaseLink Company Limited ("PhaseLink"), a private company based in Taiwan and in San Jose, California. The objective of the acquisition is to complement Micrel's high performance clock generation and distribution products for the communication market and to expand its product offerings into the consumer and industrial markets. PhaseLink provides high performance integrated timing solutions to system and oscillator manufacturers. 16 -------------------------------------------------------------------------------- Table of Contents ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company's family of LAN solutions products target the digital home, enterprise, industrial and automotive markets. This product portfolio consists of physical layer transceivers ("PHY"), Media Access Controllers ("MAC"), switches and System-On-Chip ("SoC") devices that support various LAN protocols supporting communication transmission speeds from 10 Megabits per second to a Gigabit per second. The following table presents the Company's revenues by product group, as a percentage of total net revenues, for the periods presented. Three Months Ended Net Revenues by Product Group March 31, 2013 2012 As a Percentage of Total Net Revenues Linear and Power 56 % 61 % Timing and Communications 20 17 LAN Solutions 21 18 Total standard products 97 96 Foundry, custom and other products 3 4 100 % 100 % The Company's products address a wide range of end markets. The following table presents the Company's revenues by end market as a percentage of total net revenues, for the periods presented. Three Months Ended Net Revenues by End Market March 31, 2013 2012 As a Percentage of Total Net Revenues Industrial 53 % 49 % Communications 16 17 Wireless handsets 13 17 Computing 14 14 Consumer and other 4 3 Total net revenues 100 % 100 % To enhance the readers' understanding of the Company's performance, the following is a chronological overview of the Company's results for the quarterly periods from January 1, 2012 through March 31, 2013. During the first quarter of 2012, revenues increased 4.0% to $61.2 million from $58.8 million in the fourth quarter of 2011. This increase in revenue from the fourth quarter of 2011 was principally driven by overall demand from customers in most geographies and end markets. As compared to the same period last year, first quarter 2012 revenues decreased by $6.3 million. First quarter 2012 book-to-bill ratio was one, and showed improvement compared to the fourth quarter of 2011. First quarter 2012 gross margin was 54.3%, as compared to 50.5% in the fourth quarter of 2011. With the higher revenues compared to the fourth quarter of 2011, first quarter 2012 gross margin increased from the previous quarter primarily due to a higher percentage of distribution sales which carry higher margins, an increase in factory utilization, and lower inventory reserve charges. Net income for the first quarter of 2012 was $5.9 million, or $0.10 per basic and diluted share, as compared to net income of $4.9 million, or $0.08 per basic and diluted share, for the fourth quarter of 2011, and net income of $9.1 million, or $0.15 per basic share and $0.14 per diluted share, for the first quarter of 2011. During the first quarter of 2012, cash flows from operations were $8.7 million. During the first quarter of 2012, cash and short-term investments decreased by $0.6 million to $137.3 million. In addition to maintaining its quarterly $0.04 per share cash dividend, during the first quarter of 2012 the Company repurchased $6.0 million of its common stock. 17-------------------------------------------------------------------------------- Table of Contents ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Revenues of $63.7 million in the second quarter of 2012 increased 4.2% from $61.2 million in the first quarter of 2012. The increase primarily resulted from stronger sales of the Company's timing and communications products, including contributions from the acquisition of PhaseLink. This growth was in part offset by weaker than expected demand from the Company's sell-through distributors primarily in Europe. The book-to-bill ratio in the second quarter of 2012 was above one. Second quarter 2012 gross margin increased to 55.2% as compared to 54.3% in the first quarter of 2012. The increase was principally due to a richer mix of higher-margin products and improved factory utilization. Net income attributable to Micrel, Incorporated shareholders for the second quarter of 2012 was $6.0 million, or $0.10 per basic and diluted share, as compared to net income of $5.9 million, or $0.10 per basic and diluted share, for the first quarter of 2012, and net income of $10.7 million, or $0.17 per basic and diluted share, for the second quarter of 2011. During the second quarter of 2012, cash flows from operations were $11.5 million. Cash and short term investments were $119.4 million at June 30, 2012 as compared to $137.3 million at March 31, 2012 which reflects a cash payment of $16.4 million (net of acquired cash) made on April 2, 2012 related to the PhaseLink acquisition. During the second quarter of 2012, the Company repurchased $8.7 million of its common stock. In addition, the Company maintained and paid its quarterly $0.04 per share cash dividend totaling approximately $2.5 million in the second quarter of 2012. Third quarter 2012 revenues decreased 1.2% to $62.9 million from $63.7 million in the second quarter of 2012. The decrease was principally due to lower sales of the Company's timing and communications products partially offset by gathering momentum in LAN solutions product sales. The third quarter 2012 book-to-bill ratio was above one. Third quarter 2012 gross margin decreased to 52.9% as compared to 55.2 % in the second quarter of 2012 primarily due to a mix shift to lower margin consumer-related products and lower factory capacity utilization. The lower factory utilization was due to reducing production in an attempt to minimize building inventory. Net income attributable to the Company' shareholders for the third quarter of 2012 was $4.9 million, or $0.8 per basic and diluted share, as compared to net income of $6.0 million, or $0.10 per basic and diluted share, for the second quarter of 2012, and net income of $9.2 million, or $0.15 per basic and diluted share, for the third quarter of 2011. During the third quarter of 2012, cash flows from operations were $6.4 million. Cash and short term investments were $108.7 million at September 30, 2012 as compared to $119.4 million at June 30, 2012. During the third quarter of 2012, the Company spent $13.7 million repurchasing its common stock. Additionally, the Company maintained its quarterly $0.04 per share cash dividend for a total of approximately $2.2 million. During the fourth quarter of 2012, revenues decreased slightly by 1.0 % to $62.3 million from $62.9 million in the third quarter of 2012. The decrease reflects lower sales in a difficult macroeconomic and industry environment. The fourth quarter 2012 book-to-bill ratio seasonally declined from the third quarter 2012 and was below one. Compared to the fourth quarter of 2011, revenues increased by $3.6 million, or 6.1%, primarily due to added revenues from the acquisition of PhaseLink. Fourth quarter 2012 gross margin declined sequentially to 50.3% from 52.9% in the third quarter of 2012 principally due to lower factory capacity utilization and increased inventory reserves. The lower factory utilization resulted from attempting to minimize building inventory. Net loss for the fourth quarter of 2012 was $4.5 million, or a loss of $0.08 per basic and diluted share, as compared to net income of $4.9 million, or $0.08 per basic and diluted share, for the third quarter of 2012, and net income of $4.9 million, or $0.08 per basic and diluted share, for the fourth quarter of 2011. Net loss for the fourth quarter of 2012 included a write-off of deferred tax assets totaling $7.6 million due to a change of California tax laws. During the fourth quarter of 2012, cash flows from operations were $6.0 million. Cash and short term investments were $103.6 million at December 31, 2012 as compared to $108.7 million at September 30, 2012. In the fourth quarter of 2012, the Company spent $6.1 million repurchasing its common stock and increased its quarterly cash dividend to $0.0425 per share for a total of approximately $2.5 million which was paid in November 2012. In addition, during December 2012, the Company declared an accelerated cash dividend of $0.0425 per share of common stock totaling $2.5 million paid on December 27, 2012 to shareholders of record as of December 18, 2012. The accelerated dividend was in lieu of the quarterly dividend that the Company would have otherwise announced with its quarterly financial results for the fourth quarter of 2012, and that would have been paid in the first quarter of 2013. For the year ended December 31, 2012, revenues decreased 3.4% to $250.1 million from $259.0 million for the year ended December 31, 2011. The decrease was primarily due to the continued global downturn which impacted Europe to a greater degree resulting in less demand of the Company's products, partially offset by an increase of revenues from Asia due to added revenues from the acquisition of PhaseLink since the second quarter of 2012. The book-to-bill ratio was approximately one for the full year of 2012. Gross margin for 2012 decreased to 53.1% from 55.3% for 2011. The decrease was primarily due to lower factory utilization and increased inventory reserve charges. Operating margin for 2012 decreased to 11.1% from 18.1% for 2011 principally due to lower sales and increased spending in research and development. Net income was $12.3 million, or $0.20 per diluted share, compared with $33.9 million, or $0.54 per diluted share, in 2011. During 2012, cash, cash equivalents and short term investments decreased by $34.2 million from $137.9 million primarily due to repurchases of the Company's common stock totaling $34.6 million and $12.1 million paid in dividends to shareholders. Additionally, during 2012, the Company paid a total of $17.4 million net of cash acquired for the acquisition of PhaseLink. 18-------------------------------------------------------------------------------- Table of Contents ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS During the first quarter of 2013, revenues decreased 4.2% to $59.7 million from $62.3 million in the fourth quarter of 2012. With continued global macro-economic challenges, this decrease resulted primarily from lower demand in the computing and communications end markets, partially offset by an increase in revenues from the consumer end market. As compared to the same period last year, first quarter 2013 revenues decreased by $1.4 million, or 2.3%. First quarter 2013 book-to-bill ratio was 1:1 driven by strength in the industrial end market. First quarter 2013 gross margin was 52.0%, as compared to 50.3% in the fourth quarter of 2012. This increase in gross margin from the previous quarter was primarily due to a higher percentage of distribution sales which carry higher margins. Net income for the first quarter of 2013 was $5.2 million, or $0.09 per basic and diluted share, as compared to net loss of $4.5 million, or a loss of $0.08 per basic and diluted share, for the fourth quarter of 2012, and net income of $5.9 million, or $0.10 per basic and diluted share, for the first quarter of 2012. During the first quarter of 2013, cash flows from operations were $7.7 million. During the first quarter of 2013, cash and short-term investments increased by $8.1 million to $111.7 million. The increase was partly due to the cash dividend of $0.0425 per share of common stock totaling $2.5 million, which would have been paid in the first quarter of 2013, was accelerated and paid on December 27, 2012 to shareholders of record as of December 18, 2012. In addition, the Company did not repurchase any shares of its common stock. The Company derives a substantial portion of its net revenues from standard products. For the three months ended March 31, 2013 and 2012, the Company's standard products sales accounted for 97% and 96%, respectively, of the Company's net revenues. The Company believes that a substantial portion of its net revenues in the future will depend upon standard products sales, although such sales as a proportion of net revenues may vary as the Company adjusts product output levels to correspond with varying economic conditions and demand levels in the markets which it serves. The standard products business is characterized by short-term orders and shipment schedules, and customer orders typically can be canceled or rescheduled without significant penalty to the customer. Since most standard products backlog is cancelable without significant penalty, the Company typically plans its production and inventory levels based on forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. In addition, the Company is limited in its ability to reduce costs quickly in response to any revenue shortfalls. The Company may experience significant fluctuations in its results of operations. Factors that affect the Company's results of operations include the volume and timing of orders received, changes in the mix of products sold, the utilization level of manufacturing capacity, competitive pricing pressures and the successful development and customer acceptance of new products. These and other factors are described in further detail later in this discussion and in Part II Item 1A of this Quarterly Report on Form 10-Q titled "Risk Factors." As a result of the foregoing or other factors, there can be no assurance that the Company will not experience material fluctuations in future operating results on a quarterly or annual basis, which could materially and adversely affect the Company's business, financial condition, results of operations and cash flows. Critical Accounting Policies and Estimates The financial statements included in this Quarterly Report on Form 10-Q and discussed within this Management's Discussion and Analysis of Financial Condition and Results of Operations have been prepared in accordance with accounting principles generally accepted in the United States of America. Preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments. Management bases its estimates and judgments on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company considers certain accounting policies related to revenue recognition and receivables, inventory valuation, share-based compensation, and income taxes to be critical to the fair presentation of its financial statements. For a detailed discussion of the Company's significant accounting policies, see Note 1 to Condensed Consolidated Financial Statements in this report and Note 1 of Notes to Consolidated Financial Statements in Item 8 of the Company's Annual Report on Form 10-K for the year ended December 31, 2012. Revenue Recognition and Receivables. The Company generates revenue by selling products to original equipment manufacturer ("OEM") customers, sell-through distributors and sell-in distributors. Sell-in distributors may buy and stock the Company's products for resale or may act as the Company's sales representative in arranging for direct sales from the Company to an OEM customer. The Company's policy is to recognize revenue from sales to customers when the rights and risks of ownership have passed to the customer, when persuasive evidence of an arrangement exists, the product has been delivered, the price is fixed or determinable and collection of the resulting receivable isreasonably assured. 19-------------------------------------------------------------------------------- Table of Contents ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company allows certain sell-through distributors located in North America and Europe, and in certain countries in Asia, to have price protection and pricing adjustments subsequent to the initial product shipment. As these price concessions have historically been significant, and price concessions are difficult to reliably estimate, the Company defers recognition of revenue and related cost of sales (in the balance sheet line item "deferred income on shipments to distributors") derived from sales to these sell-through distributors until they have resold the Company's products to their customers. Although revenue and related cost of sales are not recognized, the Company records an accounts receivable and relieves inventory at the time of initial product shipment. As standard terms are FOB shipping point, payment terms are enforced from shipment date and legal title and risk of inventory loss passes to the sell-through distributor upon shipment. In addition, where revenue is deferred upon shipment and recognized on a sell-through basis, the Company may offer price adjustments to its sell-through distributors to allow the distributor to price the Company's products competitively for specific resale opportunities. The Company estimates and records an allowance for distributor price adjustments for which the specific resale transaction has been completed, but the price adjustment claim has not yet been received by the Company. Sales to OEM customers and sell-in distributors are recognized based upon the shipment terms of the sale transaction when all other revenue recognition criteria have been met. The Company does not grant return rights, price protection or pricing adjustments to OEM customers. The Company offers limited contractual stock rotation rights to sell-in distributors. In addition, the Company is not contractually obligated to offer, but may infrequently grant, price adjustments or price protection to certain sell-in distributors on an exception basis. At the time of shipment to OEMs and sell-in distributors, an allowance for returns is established based upon historical return rates, and an allowance for price adjustments is established based on an estimate of price adjustments to be granted. Actual future returns and price adjustments could be different than the allowance established. The Company also maintains an allowance for doubtful accounts for estimated uncollectible accounts receivable. This estimate is based on an analysis of specific customer creditworthiness and historical bad debts experience. Actual future uncollectible amounts could exceed the doubtful accounts allowance established. Inventory Valuation. Inventories are stated at the lower of cost (first-in, first-out method) or market. The Company records adjustments to write down the cost of obsolete and excess inventory to the estimated market value based on historical and forecasted demand for its products. If actual future demand for the Company's products is less than currently forecasted, additional inventory adjustments may be required. Once an inventory write-down provision is established, it is maintained until the product to which it relates is sold or otherwise disposed of. Share-Based Compensation. Share-based compensation is measured at the grant date based on the fair value of the award and is recognized as expense in the statement of operations. To determine fair value, the Company uses the Black-Scholes valuation model which requires input factors such as expected term, stock price volatility, dividend yield and risk free interest rate. In addition, the Company estimates expected forfeiture rates of stock grants and share-based compensation expense is only recognized for those shares expected to vest. Determining the input factors, such as expected term, expected volatility and estimated forfeiture rates, requires significant judgment based on subjective future expectations. Income Taxes. Deferred tax assets and liabilities result primarily from temporary timing differences between book and tax valuation of assets and liabilities, and state research and development credit carryforwards. The Company must regularly assess the likelihood that future taxable income levels will be sufficient to ultimately realize the tax benefits of these deferred tax assets. As of March 31, 2013, the Company believes that future taxable income levels will be sufficient to realize the tax benefits of these deferred tax assets and has not established a valuation allowance except for a valuation allowance was established against deferred assets due to California tax law changes in 2012 which require mandatory single sales factor apportionment in California for most multi-state taxpayers for tax years beginning on or after January 1, 2013. Should the Company determine that future realization of these tax benefits is not more likely than not, additional valuation allowance would be established, which would increase the Company's tax provision in the period of such determination. The Company uses a two-step approach to recognize and measure uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. The Company considers many factors when evaluating and estimating its tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes. 20-------------------------------------------------------------------------------- Table of Contents ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations The following table sets forth certain operating data as a percentage of total net revenues for the periods indicated: Three Months Ended March 31, 2013 2012 Net revenues 100.0 % 100.0 % Cost of revenues 48.0 45.7 Gross profit 52.0 54.3 Operating expenses: Research and development 23.0 21.8 Selling, general and administrative 19.9 18.2 Total operating expenses 42.9 40.0 Income from operations 9.1 14.3 Other income (expense): Interest income 0.2 0.3 Interest expense - - Other income (expense), net (0.1 ) - Total other income, net 0.1 0.3 Income before income taxes 9.2 14.6 Provision for income taxes 0.4 4.9 Net income 8.8 % 9.7 % Net Revenues. For the three months ended March 31, 2013, net revenues decreased 2% to $59.7 million from $61.2 million for the same period in the prior year. The decrease was due to decreased revenues from both the Company's standard and other products. For the three months ended March 31, 2013, standard products revenues decreased 1% to $58.0 million from $58.8 million for the same period in the prior year primarily as a result of lower demand for the Company's products serving the computing and communications end markets, partially offset by revenues from the acquisition of PhaseLink and higher demand in consumer end markets. For the three months ended March 31, 2013, other products revenues decreased 25% to $1.8 million from $2.4 million for the same period of last year primarily due to lower demand for the Company's foundry products. Customer demand for semiconductors can change quickly and unexpectedly. Historically, the Company's revenue levels have been highly dependent on the amount of new orders for products to be delivered to the customer within the same quarter. Within the semiconductor industry, orders that are booked and shipped within the same quarter are called "turns fill" orders. When the turns fill level exceeds approximately 35% of quarterly revenues, it can be very difficult to predict near term revenues and income. The resulting lack of visibility into demand also makes it difficult to match product build with future demand as the Company's lead times to build its products may be substantially longer than order lead times. As noted in Part II, Item 1A "Risk Factors," customers in the semiconductor supply chain have worked to minimize the amount of inventory of semiconductors they hold. As a consequence, customers are generally providing less order backlog to the Company and other semiconductor suppliers, and relying on short lead times to buffer their build schedules. Shorter lead times reduce visibility into end demand and increase the reliance on turns fill orders. The reluctance of customers to provide order backlog together with short lead times and the uncertain growth rate of the world economy, make it difficult to precisely predict future levels of sales and profitability. 21-------------------------------------------------------------------------------- Table of Contents ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS International sales represented 69% and 72% of net revenues for the three months ended March 31, 2013 and 2012, respectively. Sales to customers in Asia represented 56% and 60% of net revenues for the three months ended March 31, 2013 and 2012 respectively. The trend for the Company's customers to move their electronics manufacturing to Asian countries has resulted in increased pricing pressure for the Company and other semiconductor manufacturers as Asia-based manufacturers are typically more concerned about cost. This can make it more difficult for U.S.-based companies to differentiate themselves in any meaningful manner other than by lowering prices. The increased concentration of electronics procurement and manufacturing in the Asia Pacific region has led, and may continue to lead, to continued price pressure for the Company's products in the future. Gross Profit. Gross profit is affected by a variety of factors including the volume of product sales, product mix, manufacturing capacity utilization, product yields and average selling prices. The Company's gross margin decreased to 52.0% for the three months ended March 31, 2013 from 54.3% for the comparable period in 2012. This decrease was primarily due to lower factory capacity utilization, increased inventory reserve charges partially offset by a higher percentage of distribution sales which carry higher margins. Research and Development Expenses. Research and development expenses as a percentage of net revenues represented 23.0% for the three months ended March 31, 2013 as compared to 21.8% for the three months ended March 31, 2012. On a dollar basis, research and development expenses increased $447,000, or 3.4%, to $13.8 million for the three months ended March 31, 2013 from $13.3 million for the comparable period in 2012. The increase was primarily due to increased headcount, consulting services and mask expenses for research and development activities as well as additional headcount from the acquisition of PhaseLink. The Company believes that the development and introduction of new products is critical to its future success and expects to continue its investment in research and development activities in the future. Selling, General and Administrative Expenses. As a percentage of net revenues, selling, general and administrative expenses represented 19.9% for the three months ended March 31, 2013 and 18.2% for the three months ended March 31, 2012. On a dollar basis, selling, general and administrative expenses increased $701,000, or 6.3%, to $11.9 million for the three months ended March 31, 2013 from $11.2 million for the comparable period in 2012. The increase primarily resulted from additional headcount expenses from the acquisition of PhaseLink and related amortization expenses of acquired intangible assets as well as increased selling expenses, which were offset in part by less spending on product marketing activities. Share-Based Compensation. The Company's results of operations for the three month periods ended March 31, 2013 and 2012 included $1.6 million and $1.8 million, respectively, of non-cash expense related to the fair value of share-based compensation awards. Share-based compensation expense is included in the statement of operations in cost of revenues, research and development expenses and selling, general and administrative expenses (see Note 3 of Notes to Condensed Consolidated Financial Statements). Other Income (Expense). Other income, net reflects interest income from investments in short-term and long-term investment securities and money market funds and other non-operating income or expense related primarily to foreign currency gain or loss, offset by interest expense incurred. Provision for Income Taxes. The income tax provision for the three months ended March 31, 2013, as a percentage of income before taxes was 4.3%. The income tax provision for this period included a $1.4 million benefit for 2012 research tax credits as a tax law was enacted on January 2, 2013 to retroactively reinstate the federal research and development tax credit to January 1, 2012. Excluding this benefit, the effective tax rate for the three months ended March 31, 2013 was 29.7%. The income tax provision for the three months ended March 31, 2012, as a percentage of income before taxes was 33.5%. The income tax provision for the prior period excluded the benefits from the federal research and development credit which expired on December 31, 2011 and had not been reinstated as of March 31, 2012. The income tax provision for these interim periods differs from taxes computed at the federal statutory rate primarily due to the tax effects of share-based compensation, state income taxes, federal and state research and development credits and federal qualified production activity deductions. 22-------------------------------------------------------------------------------- Table of Contents ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity and Capital Resources Since inception, the Company's principal sources of funding have been its cash from operations, bank borrowings and sales of common stock. Principal sources of liquidity at March 31, 2013 consisted of cash, cash equivalents and short-term investments of $111.7 million and a $5.0 million revolving line of credit from a commercial bank. The Company generated $7.7 million in cash from operating activities during the three months ended March 31, 2013. Significant cash flows included cash provided by net income of $5.2 million plus additions for non-cash activities of $4.1 million (consisting primarily of $3.4 million in depreciation and amortization, $1.5 million in share-based compensation expense and related tax effects, partially offset by a $833,000 increase in deferred income taxes) combined with a $2.5 million increase in deferred income on shipments to distributors, a $1.7 million increase in other current liabilities and a $1.2 million decrease in income taxes receivable which were offset in part by a $3.8 million decrease in accounts payable and a $3.8 million increase in accounts receivable. The Company generated $8.7 million in cash from operating activities during the three months ended March 31, 2012. Significant cash flows included cash provided by net income of $5.9 million plus additions for non-cash activities of $4.0 million (consisting primarily of $2.7 million in depreciation and amortization and $1.7 million in share-based compensation expense and related tax effects, partially offset by a $438,000 increase in deferred income taxes) combined with a $2.7 million decrease in income taxes receivable which was offset in part by a $2.3 million decrease in deferred income on shipments to distributors, a $1.6 million decrease in accounts payable and a $1.0 million increase in accounts receivable. The Company provided $19.0 million of cash in investing activities during the three months ended March 31, 2013, primarily comprised of $29.5 million in proceeds from the sales and maturities of investments, which was offset by $9.0 million in purchases of investments and $1.6 million of purchases of property, plant and equipment. The Company used $7.2 million of cash in investing activities during the three months ended March 31, 2012, comprised of $14.4 million in purchases of investments and $1.9 million of purchases of property, plant and equipment, which were offset by $9.1 million in proceeds from the sales of investments. The Company provided $1.5 million of cash in financing activities during the three months ended March 31, 2013 primarily comprised of $1.5 million in proceeds from employee stock transactions. The Company used $7.4 million of cash in financing activities during the three months ended March 31, 2012 primarily for the repurchases of $6.0 million of the Company's common stock and $2.5 million for the payment of cash dividends, which were partially offset by $1.1 million in proceeds from employee stock transactions. The Company currently intends to spend approximately $4 million to purchase capital equipment and make facility improvements during the next twelve months primarily for manufacturing equipment and additional research and development related software and equipment. On April 25, 2013, the Company's Board of Directors declared a cash dividend of $0.0425 per outstanding share of common stock payable on May 22, 2013 to shareholders of record at the close of business on May 8, 2013. This dividend will be recorded in the second quarter of 2013 and is expected to be approximately $2.5 million. Under the Company's stock repurchase program, as of March 31, 2013, the Company was authorized to repurchase an additional $19.1 million of its common stock. The Company believes that its cash from operations, existing cash balances, short-term investments and its credit facility will be sufficient to meet its cash requirements for at least the next twelve months. In the longer term, the Company believes future cash requirements will continue to be met by its cash from operations, credit arrangements and future debt or equity financings as required. 23-------------------------------------------------------------------------------- Table of Contents ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Recently Issued Accounting Standards Please refer to Note 2 of Notes to Condensed Consolidated Financial Statements for a discussion of the expected impact of recently issued accounting standards. Contractual Obligations and Commitments As of March 31, 2013 the Company had the following contractual obligations and commitments (in thousands): Payments Due By Period Less than 1-3 4-5 After 5 Total 1 Year Years Years Years Operating leases $ 2,345 $ 1,045 $ 1,101 $ 199 $ - Open purchase orders 21,851 21,851 - - - Total $ 24,196 $ 22,896 $ 1,101 $ 199 $ - Open purchase orders are defined as agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable pricing provisions; and the approximate timing of the transactions. Borrowing agreements consisted of an unsecured credit facility with Bank of the West. The credit facility includes a $5.0 million line of credit available for general working capital needs, a $5.0 million letter of credit sub-facility and a $2.0 million foreign exchange sub-facility. As of March 31, 2013, the Company had no borrowings under the line of credit. As of March 31, 2013, the Company had $8.8 million of unrecognized tax benefits. Included in the $8.8 million is $5.3 million which has not yet reduced income tax payments, and therefore, has been netted against non-current deferred tax assets. The remaining $3.5 million liability consisted of $3.3 million included in long-term income taxes payable and $270,000 netted against short-term income taxes receivable. The Company does not anticipate a significant change to the $3.3 million long-term uncertain income tax positions within the next 12 months. Off-Balance Sheet Arrangements As of March 31, 2013, the Company had no off-balance sheet arrangements and has not entered into any transactions involving unconsolidated, limited purpose entities or commodity contracts. 24-------------------------------------------------------------------------------- Table of Contents |