Summary of INTEGRATED SILICON SOLUTION INC

Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
We are a fabless semiconductor company that designs and markets high performance integrated circuits for the following key markets: (i) automotive,
(ii) communications, (iii) industrial, medical and military, and (iv) digital consumer. Our primary products are low and medium density DRAM in both package and Known Good Die (KGD) form and high speed and low power SRAM. In fiscal 2012, approximately 96% of our revenue was derived from our DRAM and SRAM products. Sales of our DRAM products have represented a majority of our net sales in each year since fiscal 2003. On September 14, 2012, we acquired approximately 94.1% of Chingis Technology Corporation (Chingis) for approximately $32 million, or $13 million net of the approximately $19 million in cash and cash equivalents on Chingis' balance sheet at closing. Founded in 1995, Chingis provides a variety of NOR flash memory technologies used in standalone and embedded applications. Chingis is headquartered in HsinChu, Taiwan and has offices in Taiwan, Korea, China and the United States. Our financial results reflect accounting for Chingis on a consolidated basis beginning September 14, 2012. On January 31, 2011, we acquired Si En Integration Holdings Limited (Si En), a privately held fabless provider of high performance analog and mixed signal integrated circuits headquartered in Xiamen, China. Si En targets the mobile communications, digital consumer, networking, and automotive markets with high quality analog products. Si En's current products include audio power amplifiers, LED drivers, voltage converters and temperature sensors. In January 2010, we formed a separate business unit, Giantec Semiconductor, Inc. (Giantec) which designs and markets application specific standard products (ASSP) primarily EEPROMs and SmartCards. As part of this formation, Giantec raised approximately $3.8 million from an outside investor. On December 30, 2010, Giantec received an additional investment of $4.0 million from outside investors, and as a result our ownership interest was reduced to approximately 44% and we were required to deconsolidate Giantec. In August 2011, we sold approximately 37% of our shares in Giantec and on August 31, 2011, Giantec merged with Maxllent Corp. thereby reducing our ownership interest in Giantec to approximately 19.85%. Our consolidated financial statements reflect accounting for Giantec on a consolidated basis from January 1, 2010 through December 30, 2010. For the period from December 31, 2010 through August 31, 2011, we accounted for Giantec on the equity method and our results included our percentage share of Giantec's results of operations. Effective September 1, 2011, we account for Giantec on the cost basis. In order to control our operating expenses, for the past several years we have limited our headcount in the U.S. and maintained much of our operations in Taiwan and China. We believe this strategy has enabled us to limit our operating expenses while simultaneously locating these operations closer to our manufacturing partners and our customers. As a result of these efforts, we currently have significantly more employees in Asia than we do in the U.S. We intend to continue these strategies going forward. As a fabless semiconductor company, our business model is less capital intensive because we rely on third parties to manufacture, assemble and test our products. Because of our dependence on third-party wafer foundries, our ability to increase our unit sales volumes depends on our ability to increase our wafer capacity allocation from current foundries, add additional foundries and improve yields of good die per wafer. In recent years, it has become more difficult for us to secure long-term foundry capacity (particularly for our DRAM products) due to industry consolidation affecting foundries and adverse financial conditions at foundries. In addition, certain of our foundries have decided not to produce the type of wafers that we need (especially certain types of DRAM wafers) so we have been forced to rely on alternative sources of supply and to place large last time buy orders which expose us to the risk of inventory obsolescence. Once a product is in production at a particular foundry, it is time consuming and costly to have such product manufactured at a different foundry. Although such matters have not had a material adverse impact on our business or financial results in recent periods, there can be no assurance as to the future impact that such matters will have on our business, customer relationships or results of operations. The average selling prices of our DRAM and SRAM products are sensitive to supply and demand conditions in our target markets and have generally declined over time. We experienced declines in the average selling prices for many of our products in fiscal 2012 and in fiscal 2011. We expect average selling prices for our products to decline in the future, principally due to market demand, market competition and the supply of competitive products in the market. Any future decreases in our average selling prices could have an adverse impact on our revenue growth rate, gross margins and operating margins. Our ability to maintain or increase revenues will be highly dependent upon our ability to increase unit sales volumes of existing products and to introduce and sell new products in quantities sufficient to compensate for the anticipated declines in average selling prices of existing products. Declining average selling prices will adversely affect our gross margins unless we are able to offset such declines with commensurate reductions in per unit costs or changes in product mix in favor of higher margin products. Revenue from product sales to our direct customers is recognized upon shipment provided that persuasive evidence of a sales arrangement exists, the price is fixed or determinable, title has transferred, collection of resulting receivables is reasonably

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assured, there are no customer acceptance requirements and there are no remaining significant obligations. A portion of our sales is made to distributors under agreements that provide for the possibility of certain sales price rebates and limited product return privileges. Given the uncertainties associated with credits that will be issued to these distributors, we defer recognition of such sales until our products are sold by the distributors to their end customers. Revenue from sales to distributors who do not have sales price rebates or product return privileges is recognized at the time our products are sold by us to the distributors.
We market and sell our products in Asia, the U.S., Europe and other locations through our direct sales force, distributors and sales representatives. The percentage of our sales shipped outside the U.S. was approximately 84%, 85% and 85% in fiscal 2012, 2011 and 2010, respectively. We measure sales location by the shipping destination. We anticipate that sales to international customers will continue to represent a significant percentage of our net sales. The percentages of our net sales by region are set forth in the following table:

          Fiscal Years Ended
             September 30,
        2012       2011    2010
Asia     62 %       64 %    66 %
Europe   21         20      18
U.S.     16         15      15
Other     1          1       1
Total   100 %      100 %   100 %

Our sales are generally made by purchase orders. Because industry practice allows customers to reschedule or cancel orders on relatively short notice, backlog may not be a good indicator of our future sales. Cancellations of customer orders or changes in product specifications could result in the loss of anticipated sales without allowing us sufficient time to reduce our inventory and operating expenses.
Due to the complex nature of the markets we serve and the broad fluctuations in economic conditions in the U.S. and other countries, it is difficult for us to assess the impact of seasonal factors on our business.
We are subject to the risks of conducting business internationally, including economic conditions in Asia, particularly Taiwan and China, changes in trade policy and regulatory requirements, duties, tariffs and other trade barriers and restrictions, the burdens of complying with foreign laws and, possibly, political instability. Most of our foundries and all of our assembly and test subcontractors are located in Asia. Although our international sales are largely denominated in U.S. dollars, we do have sales transactions in New Taiwan dollars, in Hong Kong dollars and in Chinese renminbi. In addition, we have foreign operations where expenses are generally denominated in the local currency. Such transactions expose us to the risk of exchange rate fluctuations. We monitor our exposure to foreign currency fluctuations, but have not adopted any hedging strategies to date. There can be no assurance that exchange rate fluctuations will not harm our business and operating results in the future.

Fiscal Year Ended September 30, 2012 Compared to Fiscal Year Ended September 30, 2011
Net Sales. Net sales consist principally of total product sales less estimated sales returns. Net sales decreased by 2% to $266.0 million in fiscal 2012 from $270.5 million in fiscal 2011. The decrease in net sales of $4.5 million was principally due to a decrease in ASSP, analog and SRAM revenue partially offset by an increase in DRAM revenue in fiscal 2012 compared to fiscal 2011. Our DRAM revenue increased by 8% in fiscal 2012 compared to fiscal 2011 principally as a result of a favorable shift in product mix whereas our SRAM revenue decreased by 8% in fiscal 2012 compared to fiscal 2011 as a result of a decrease in unit shipments and average selling prices. Fiscal 2012 included $8.9 million of analog revenue compared to $13.6 million in fiscal 2011. The decrease in analog revenue was the result of a decrease in unit shipments as the China feature phone market weakened due to the shift toward smart phones. As a result of our deconsolidation of Giantec, our ASSP revenue decreased $7.0 million in fiscal 2012 compared to fiscal 2011. Fiscal 2012 includes $1.2 million of flash revenue from our acquisition of Chingis which closed on September 14, 2012. We anticipate that the average selling prices of our existing products will generally decline over time, although the rate of decline may fluctuate for certain products. There can be no assurance that any future price declines will be offset by higher volumes or by higher prices on newer products. In fiscal 2012, revenue from our largest distributor accounted for 14% of net sales and revenue from our second largest distributor accounted for 13% of our net sales. In fiscal 2011, revenue from our largest distributor accounted for 15% of net sales and revenue from our second largest distributor accounted for 12% of our net sales.

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Gross profit. Cost of sales includes die cost from the wafers acquired from foundries, subcontracted package, assembly and test costs, costs associated with in-house product testing, quality assurance and import duties. Gross profit decreased by $7.4 million to $83.0 million in fiscal 2012 from $90.4 million in fiscal 2011. Our gross margin was 31.2% in fiscal 2012 compared to 33.4% in fiscal 2011. Our gross profit for fiscal 2012 included $5.4 million for the write-off of certain intangible assets acquired with our acquisition of Si En which unfavorably impacted our gross margin by 2.0%. Fiscal 2012 included a $5.7 million charge for inventory write-downs which unfavorably impacted our gross margin by 2.2% compared to a $3.5 million charge for inventory write-downs which unfavorably impacted our gross margin by 1.3% in fiscal 2011. Excluding the impact of the impairment charge and inventory write-downs, our gross margin increased in fiscal 2012 compared to fiscal 2011 due to the favorable impact in the current period of a change in product mix as well as a decrease in product costs for certain products. We believe that the average selling prices of our products will decline over time and, unless we are able to reduce our cost per unit or improve our product mix to higher gross margin products to the extent necessary to offset such declines, the decline in average selling prices will result in a material decline in our gross margin. In addition, our product costs could increase if our suppliers raise prices, which could result in a material decline in our gross margin. When demand for end products has increased, foundries have tended to raise wafer prices. Although we have product cost reduction programs in place that involve efforts to reduce internal costs and supplier costs, there can be no assurance that product costs will be reduced or that such reductions will be sufficient to offset the expected declines in average selling prices. We do not believe that such cost reduction efforts are likely to have a material adverse impact on the quality of our products or the level of service provided by us.
Research and development. Research and development expenses increased by 12% to $30.9 million in fiscal 2012 from $27.6 million in fiscal 2011. As a percentage of net sales, research and development expenses increased to 11.6% in fiscal 2012 from 10.2% in fiscal 2011. The increase in research and development expenses of $3.3 million can be partially attributed to a $1.8 million impairment charge in fiscal 2012 for certain intangible and tangible assets acquired with our acquisition of Si En. In addition, $1.1 million of the increase in our research and development expenses is the result of consolidating Si En for all of fiscal 2012 and additional analog product development expenses. Our acquisition of Chingis in September 2012 resulted in an increase of $0.5 million in research and development expenses. Also, headcount related expenses increased in fiscal 2012 compared to fiscal 2011. The foregoing increases were partially offset by a $0.9 million decrease in research and development expenses as a result of our deconsolidation of Giantec. We expect the dollar amount of our research and development expenses to increase in fiscal 2013 and expect such expenses to fluctuate as a percentage of net sales depending on our overall level of sales.
Selling, general and administrative. Selling, general and administrative expenses increased by 15% to $42.2 million in fiscal 2012 from $36.6 million in fiscal 2011. As a percentage of net sales, selling, general and administrative expenses increased to 15.9% in fiscal 2012 from 13.5% in fiscal 2011. The increase in selling, general and administrative expenses of $5.6 million can be partially attributed to a $2.9 million impairment charge in fiscal 2012 for certain intangible assets acquired with our acquisition of Si En. In addition, $0.9 million of the increase in our selling, general and administrative expenses is the result of consolidating Si En for all of fiscal 2012. Our acquisition of Chingis in September 2012 resulted in an increase of $1.0 million in selling, general and administrative expenses. Also, headcount related expenses and accounting and legal fees increased in fiscal 2012 compared to fiscal 2011. The foregoing increases were partially offset by a $0.7 million decrease in selling, general and administrative expenses as a result of our deconsolidation of Giantec. We expect the dollar amount of our selling, general and administrative expenses to increase in fiscal 2013 and expect such expenses to fluctuate as a percentage of net sales depending on our overall level of sales.
Impairment of goodwill. During the fourth quarter of fiscal 2012, we completed the first step of our annual goodwill impairment test, which included examining the impact of current general economic conditions on our future prospects and the current level of our market capitalization. Based on this analysis, we concluded that goodwill related to our analog reporting unit was impaired. Our analog reporting unit's goodwill was originally recorded in connection with our acquisition of Si En. Therefore, we performed the second step of the impairment test to determine the implied fair value of goodwill. Specifically, we hypothetically allocated the estimated fair value of our equity as determined in the first step to recognized and unrecognized net assets, including allocations to intangible assets. The analysis indicated that there would be approximately $3.9 million remaining implied value attributable to goodwill and accordingly, we wrote off $4.3 million of our goodwill.
Interest and other income (expense), net. Interest and other income (expense), net was expense of $1.7 million in fiscal 2012 compared to income of $2.1 million in fiscal 2011. The $1.7 million of interest of other income (expense) in fiscal 2012 was comprised of a $2.3 million charge to write-down our investment in Semiconductor Manufacturing International Corporation (SMIC) due to the decline in fair market value being considered other than temporary, foreign exchange losses of approximately $0.6 million, other expenses of approximately $0.3 million offset in part by $1.3 million in rental income from the lease of excess space in our Taiwan facility and $0.2 million of interest income. The $2.1 million of interest and other income in fiscal 2011 was comprised of $1.4 million in rental income from the lease of excess space in our Taiwan facility, foreign exchange gains of approximately $0.4 million, $0.2 million from our equity interest in Giantec and interest income of $0.2 million offset in part by other items.

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Gain on sale of investments. The gain on the sale of investments was $0.6 million in fiscal 2011 as we sold an investment and recorded a pre-tax gain of approximately $0.6 million.
Provision (benefit) for income taxes. We recorded income tax expense of $6.5 million for fiscal 2012 that is principally comprised of U.S. federal, state and foreign income taxes. The difference between the $6.5 million tax expense and the tax on income based on the federal statutory rate of 35% is principally due to the impact of non-deductible foreign impairment charges, foreign losses for which no tax benefit has been recorded, non-deductible stock based compensation charges and other valuation allowance adjustments. For fiscal 2012, we continued to record a valuation allowance on certain U.S. and foreign deferred tax assets where the estimated realization is not certain.
We recorded an income tax benefit of $27.3 million for fiscal 2011. The income tax benefit was due to the release of valuation allowances for federal, state and foreign deferred tax assets of approximately $28.3 million offset by the income tax provision of $1.0 million of foreign taxes on certain income earned by our foreign entities and some miscellaneous state income taxes. The release of the valuation allowance in fiscal 2011 was based on our evaluation of historical evidence, trends in profitability and expectations of future taxable income. As such, we determined that a valuation allowance was no longer necessary for the majority of our U.S. and for certain foreign deferred tax assets because, based on the available evidence, realization of these net deferred tax assets was more likely than not. A valuation allowance remained on certain U.S and foreign deferred tax assets to reduce our deferred tax assets to an amount that is more likely than not to be realized.
Net income attributable to noncontrolling interests. The net income attributable to noncontrolling interests was $0.1 million in fiscal 2012 compared to $0.2 million in fiscal 2011.

Fiscal Year Ended September 30, 2011 Compared to Fiscal Year Ended September 30, 2010
Net Sales. Net sales increased by 7% to $270.5 million in fiscal 2011 from $252.5 million in fiscal 2010. The increase in net sales of $18.0 million was principally due to an increase in unit shipments and an increase in average selling prices for certain of our DRAM products in fiscal 2011 compared to fiscal 2010. In addition, SRAM revenue increased in fiscal 2011 compared to fiscal 2010 as a result of a change in product mix. The fiscal year ended September 30, 2011 included $13.6 million of analog revenue from our acquisition of Si En which was completed on January 31, 2011. As a result of our deconsolidation of Giantec, our ASSP revenue decreased $17.5 million in fiscal 2011 compared to fiscal 2010.
In fiscal 2011, revenue from our largest distributor accounted for 15% of net sales and revenue from our second largest distributor accounted for 12% of our net sales. In fiscal 2010, revenue from our largest distributor accounted for 15% of net sales and revenue from our second largest distributor accounted for 10% of our net sales.
Gross profit. Gross profit decreased by $6.1 million to $90.4 million in fiscal 2011 from $96.5 million in fiscal 2010. Our gross margin was 33.4% in fiscal 2011 compared to 38.2% in fiscal 2010. The decrease in gross margin in fiscal 2011 compared to fiscal 2010 can be attributed to the unfavorable impact in fiscal 2011 from increased product costs for certain products partially as result of the impact of changes in the value of the New Taiwan dollar relative to the U.S. dollar which was partially offset by an increase in average selling prices for certain of our DRAM products. Our gross margin for fiscal 2011 and fiscal 2010 benefited from the sale of $1.5 million and $3.4 million, respectively, of products previously written down to zero carrying value. The decrease in our gross profit in fiscal 2011 compared to fiscal 2010 can be attributed to a decrease in gross profit dollars for our ASSP products as a result of our deconsolidation of Giantec offset by gross profit dollars contributed by our analog products as a result of our acquisition of Si En. Research and development. Research and development expenses increased by 15% to $27.6 million in fiscal 2011 from $24.1 million in fiscal 2010. As a percentage of net sales, research and development expenses increased to 10.2% in fiscal 2011 from 9.5% in fiscal 2010. The increase in research and development expenses of $3.5 million can be attributed to a $1.7 million increase in research and development expenses for our analog products as a result of our acquisition of Si En partially offset by a $0.8 million decrease in research and development expenses as a result of our deconsolidation of Giantec. In addition, approximately $1.5 million of the increase in research and development expenses in fiscal 2011 compared to fiscal 2010 can be attributed to the impact of changes in the value of the New Taiwan dollar relative to the U.S. dollar as a majority of our research and development expenses are incurred in Taiwan. In addition, testing fees and other product development costs increased in fiscal 2011 compared to fiscal 2010.
Selling, general and administrative. Selling, general and administrative expenses increased by 13% to $36.6 million in fiscal 2011 from $32.5 million in fiscal 2010. As a percentage of net sales, selling, general and administrative expenses increased to 13.5% in fiscal 2011 from 12.9% in fiscal 2010. The increase in selling, general and administrative expenses of $4.1 million can be attributed to an increase of $1.3 million in stock-based compensation expense, an increase in sales commissions of $0.6 million as a result of higher commissionable revenue in fiscal 2011 compared to fiscal 2010 and an increase of $1.9 million as a result of our acquisition of Si En in fiscal 2011 partially offset by a $1.4 million decrease in expenses as a result of our deconsolidation

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of Giantec in fiscal 2011. In addition, approximately $0.6 million of the increase in our selling, general and administrative expenses in fiscal 2011 compared to fiscal 2010 can be attributed to the impact of changes in the value of the New Taiwan dollar relative to the U.S. dollar. Selling, general and administrative expenses for fiscal 2011 includes approximately $0.3 million in legal expenses in connection with our acquisition of Si En.
Interest and other income, net. Interest and other income, net was $2.1 million in fiscal 2011 compared to $1.2 million in fiscal 2010. The $2.1 million of interest and other income in fiscal 2011 was comprised of $1.4 million in rental income from the lease of excess space in our Taiwan facility, foreign exchange gains of approximately $0.4 million, $0.2 million from our equity interest in Giantec and interest income of $0.2 million offset in part by other items. The $1.2 million of interest and other income in fiscal 2010 was comprised of $1.1 million in rental income from the lease of excess space in our Taiwan facility, foreign exchange gains of approximately $0.1 million and interest income of $0.3 million offset in part by other items.
Gain on sale of investments. The gain on the sale of investments was $0.6 million in fiscal 2011 compared to $2.8 million in fiscal 2010. In fiscal 2011, we sold an investment and recorded a pre-tax gain of approximately $0.6 million. In fiscal 2010, we sold all of our shares of Ralink for approximately $3.2 million and recorded a pre-tax gain of approximately $2.8 million.
Provision (benefit) for income taxes. We recorded an income tax benefit of $27.3 million for fiscal 2011. The income tax benefit was due to the release of valuation allowances for federal, state and foreign deferred tax assets of approximately $28.3 million offset by the income tax provision of $1.0 million of foreign taxes on certain income earned by our foreign entities and some miscellaneous state income taxes. The release of the valuation allowance in fiscal 2011 was based on our evaluation of historical evidence, trends in profitability and expectations of future taxable income. As such, we determined that a valuation allowance was no longer necessary for the majority of our U.S. and for certain foreign deferred tax assets because, based on the available evidence, realization of these net deferred tax assets was more likely than not. A valuation allowance remained on certain U.S and foreign deferred tax assets where the estimated realization was not as certain.
For fiscal 2010, we recorded an income tax expense of $1.2 million that was principally comprised of foreign taxes on certain income earned by our foreign entities, state income taxes reduced by a refund of previously paid federal alternative minimum taxes and a reversal of previously recorded unrecognized tax benefits. On November 6, 2009, the Worker, Homeownership, and Business Assistance Act of 2009 was signed into law. One of the provisions in such Act allows a taxpayer, at the taxpayer's election, to carryback either its 2008, 2009 or 2010 net operating losses 3, 4, or 5 years whereas, generally, net operating losses can only be carried back up to 2 years. These net operating loss carryback provisions allow for the recovery of previously paid federal alternative minimum taxes.
Net income attributable to noncontrolling interests. The net income attributable to noncontrolling interests was $0.2 million in fiscal 2011 compared to $0.6 million in fiscal 2010.

Liquidity and Capital Resources
As of September 30, 2012, our principal sources of liquidity included cash, cash equivalents and short-term investments of approximately $82.0 million. During fiscal 2012, operating activities provided cash of approximately $32.3 million compared to $30.6 million provided in fiscal 2011. The cash provided by operations in fiscal 2012 was primarily due to our net loss of $2.6 million adjusted for non-cash items of $34.9 million and increases in accounts payable of $2.4 million and increases in accrued and other liabilities of $2.0 million. This was partially offset by increases in inventories of $2.7 million, increases in accounts receivable of $1.3 million and increases in other assets of $0.3 million. The cash provided by operations in fiscal 2011 was primarily due to our net income of $56.1 million adjusted for non-cash items of $18.2 million and decreases in accounts receivable of $0.7 million. This was partially offset by decreases in accounts payable of $2.9 million, decreases in accrued liabilities . . .