The following information should be read in conjunction with the unaudited financial statements and notes thereto included in Part 1 - Item 1 of this Quarterly Report and the audited financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended June 30, 2012 (the "Form 10-K").

Factors That May Affect Operating Results

This Quarterly Report on Form 10-Q includes "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. All statements other than statements of historical fact are "forward-looking statements" for purposes of these provisions, including any statements regarding our sales to Taiwan and China, the continuation of a high level of turns orders, higher or lower levels of inventory, future gross profit and gross margin; the plans and objectives of management for future operations; our tax rate; currency fluctuations; the adequacy of allowances for returns, price protection and other concessions; the sufficiency of cash generated from operations and cash balances; our exposure to interest rate risk; expectations regarding our research and development and selling, general and administrative expenses; the impact of our new global structure on our future tax rates; and our possible future acquisitions and assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as "may," "will," "expects," "plans," "anticipates," "estimates," "potential," or "continue," or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to risks and uncertainties, including but not limited to the factors set forth (i) in Item 1A, Risk Factors, of Part II of this Form 10-Q, and (ii) in Note 1 to the Notes to Condensed Consolidated Financial Statements. All forward-looking statements and reasons why results may differ included in this Quarterly Report are made as of the date hereof, and we assume no obligation to update any such forward-looking statement or reason why actual results may differ.

Results of Operations

The following table sets forth certain statement of operations data as a
percentage of net revenues for the periods indicated.

                                          Three Months Ended                      Six Months Ended
                                   December 29,        December 31,        December 29,       December 31,
                                       2012                2011                2012               2011

Net revenues                               100.0 %             100.0 %             100.0 %            100.0 %
Cost of revenues                            63.2 %              64.0 %              62.6 %             64.3 %
   Gross profit                             36.8 %              36.0 %              37.4 %             35.7 %
Operating expenses:
   Research and development                 16.7 %              17.3 %              15.5 %             16.1 %
   Selling, general and
administrative                              24.8 %              23.2 %              22.6 %             21.9 %
     Total operating expenses               41.5 %              40.5 %              38.1 %             38.0 %
Loss from operations                        (4.7 )%             (4.5 )%             (0.7 )%            (2.3 )%
Interest and other income, net               2.6 %               2.1 %               2.1 %              2.6 %
Income (loss) before income
taxes                                       (2.1 )%             (2.4 )%              1.4 %              0.3 %
Income tax expense (benefit)                15.6 %              (1.1 )%              7.8 %              0.3 %
Net income (loss) from
consolidated companies                     (17.7 )%             (1.3 )%             (6.4 )%             0.1 %
Equity in net income of
unconsolidated affiliates                    0.2 %               0.2 %               0.2 %              0.1 %
Net income (loss)                          (17.5 )%             (1.1 )%             (6.2 )%             0.2 %

Net Revenues

The following table sets forth our revenues and the customer concentrations with
respect to such revenues for the periods indicated.

                                            Three Months Ended                                    Six Months Ended
(In thousands)               December 29,       December 31,           %           December 29,       December 31,           %
                                 2012               2011            Change             2012               2011            Change

Net revenues                $       30,433     $       30,481            -0.2 %   $       67,182     $       65,813             2.1 %
% of net sales accounted
for by top 5 direct
customers (1)                         40.7 %             44.6 %                             41.3 %             48.0 %

Number of direct
customers that each
account for more than 10%
of net sales                             2                  2                                  2                  2

% of net sales accounted
for by top 5 end
customers (2)                         29.5 %             27.7 %                             30.0 %             28.0 %

Number of end customers
that each account for
more than 10% of net
sales                                    1                  1                                  0                  0

(1) Direct customers purchase products directly from us and include distributors, contract manufacturers and original equipment manufacturers ("OEM"s).

(2) End customers are OEMs and their products are manufactured using our products. End customers may purchase directly from us or from distributors or contract manufacturers. For end customer data, we rely on information provided by our direct distribution and contract manufacturing customers.

We design, develop and market high-performance integrated circuits ("ICs" or IC products) and frequency control products ("FCPs" or FCP products) used in many of today's advanced electronic systems. Our IC products include products that support the connectivity, timing and signal conditioning of high-speed parallel and serial protocols that transfer data among a system's microprocessor, memory and various peripherals, such as displays and monitors, and between interconnected systems. Our FCPs are electronic components that provide frequency references such as crystals, oscillators, and hybrid timing generation products for computer, communication and consumer electronic products. Our analog, digital and mixed-signal ICs, together with our FCP products enable higher system bandwidth and signal quality, resulting in better operating reliability, signal integrity, and lower overall system cost in applications such as notebook computers, servers, network switches and routers, storage area networks, digital TVs, cell phones, GPS and digital media players.

Net revenues consist of product sales, which we generally recognize upon shipment, less an estimate for returns and allowances.

Net revenues decreased $48,000 or 0.2% in the second quarter of fiscal 2013 versus the second quarter of fiscal 2012. The essentially flat sales are primarily the result of continued economic softness in both domestic and international markets. Net revenue for IC and FCP products in the second quarter of fiscal 2013 versus the second quarter of fiscal 2012 reflected:

· a $953,000 decrease in sales of IC products to $18.1 million, a decrease of 5.0%, and
· an increase of $905,000 or 7.9% in sales of our FCP products to $12.3 million.

Net revenue increased $1.4 million or 2.1% in the first half of fiscal 2013 versus the first half of fiscal 2012. This increase reflects changes in IC and FCP product sales as follows:

· an $846,000 decrease in sales of IC products to $40.7 million, for a 2.0% sales decrease, and
· an increase of $2.2 million or 9.1% in sales of our FCP products to $26.5 million.

Sales of FCP products in the second quarter and first half of fiscal 2012 were suppressed by supply chain interruptions related to severe flooding during the 2011 monsoon season in Thailand which lasted from August through December in many parts of the country.

The following table sets forth net revenues by country as a percentage of total net revenues for the three and six months ended December 29, 2012 and December 31, 2011:

                                                                  Net Revenues
                                          Three Months Ended                      Six Months Ended
                                   December 29,        December 31,       December 29,         December 31,
                                       2012                2011               2012                 2011
China (including Hong Kong)                   50 %                37 %               45 %                 35 %
Taiwan                                        32 %                45 %               37 %                 46 %
United States                                  5 %                 6 %                5 %                  6 %
Other (less than 10% each)                    13 %                12 %               13 %                 13 %
Total                                        100 %               100 %              100 %                100 %

Over the past several years, sales to Taiwan and China have constituted the majority of our sales. We expect this trend will continue in the future.

Our net revenue levels have been highly dependent on the number of new orders that are received for products to be delivered to the customer within the same quarter, also called "turns" orders. Because of our lack of visibility into demand when turns orders are high, it is difficult to predict which products to build to match future demand. We believe the current high level of turns orders will continue indefinitely. The sustainability of customer demand is uncertain and our markets are highly dependent on worldwide economic conditions. The high level of turns orders together with the uncertainty of product mix and pricing makes it difficult to predict future levels of sales and may require us to carry higher levels of inventory.

Gross Profit

The following table sets forth our gross profit for the periods indicated:

                                           Three Months Ended                                     Six Months Ended
                             December 29,       December 31,           %           December 29,       December 31,           %
(In thousands)                   2012               2011            Change             2012               2011            Change

Net revenues                $       30,433     $       30,481            -0.2 %   $       67,182     $       65,813             2.1 %
Gross profit                        11,194             10,977             2.0 %           25,105             23,514             6.8 %
Gross profit as a
percentage of net

The increase in gross profit in the second quarter of fiscal 2013 as compared to the second quarter of fiscal 2012 of $217,000 is primarily the result of margins in the IC products improving from 45% to 48%, partially offset by FCP margins decreasing slightly from 21% to 20%.

The increase in gross profit in the first half of fiscal 2013 as compared to the first half of fiscal 2012 of $1.6 million is primarily the result of:

· a 2.1% increase in sales, which led to $0.5 million of increased gross profit, and
· a gross margin increase from 35.7% to 37.4%, resulting in a $1.1 million increase in gross profit.

Future gross profit and gross margin are highly dependent on the level and product mix of net revenues. This includes the mix of sales between lower margin FCP products and our higher margin integrated circuit products. Although we have been successful at favorably improving our integrated circuit product mix and penetrating new end markets, there can be no assurance that this will continue. Accordingly, we are not able to predict future gross profit levels or gross margins with certainty.

During the three and six months ended December 29, 2012, gross profit and gross margin benefited as a result of the sale of inventory of $108,000 and $148,000 respectively, that we had previously identified as excess and written down to zero value, as compared with benefits of $124,000 and $141,000, respectively, for the same periods of the prior year.

Research and Development ("R&D")

                                           Three Months Ended                                     Six Months Ended
                             December 29,       December 31,           %           December 29,       December 31,           %
(In thousands)                   2012               2011            Change             2012               2011            Change

Net revenues                $       30,433     $       30,481            -0.2 %   $       67,182     $       65,813             2.1 %
Research and development             5,097              5,277            -3.4 %           10,420             10,593            -1.6 %

R&D as a percentage of
net revenues                          16.7 %             17.3 %                             15.5 %             16.1 %

Research and development expenses consist primarily of costs related to personnel and overhead, non-recurring engineering charges, and other costs associated with the design, prototyping, testing, manufacturing process design support, and technical customer applications support of our products. The $180,000 expense reduction for the three month period ended December 29, 2012 as compared to the same period of the prior year is primarily attributable to decreases of $156,000 in depreciation and amortization and $116,000 in fabrication and assembly expenditures, partially offset by increased compensation expenditures of $103,000. The $173,000 expense reduction for the six month period ended December 29, 2012 as compared to the same period of the prior year is primarily attributable to decreases of $329,000 in depreciation and amortization and $130,000 in fabrication and assembly expenditures, partially offset by increased compensation expenditures of $304,000.

We believe that continued spending on research and development to develop new products and improve manufacturing processes is critical to our long-term success, and as a result we expect to continue to invest in research and development projects. In the short term, we intend to continue to focus on cost control as business conditions improve. If business conditions deteriorate or the rate of improvement does not meet our expectations, we may implement further cost-cutting actions.

Selling, General and Administrative ("SG&A")

                                            Three Months Ended                                     Six Months Ended
                             December 29,       December 31,           %           December 29,       December 31,           %
(In thousands)                   2012               2011            Change             2012               2011            Change

Net revenues                $       30,433     $       30,481            -0.2 %   $       67,182     $       65,813             2.1 %
Selling, general and
administrative                       7,532              7,060             6.7 %           15,171             14,399             5.4 %

SG&A as a percentage of
net revenues                          24.8 %             23.2 %                             22.6 %             21.9 %

Selling, general and administrative expenses consist primarily of personnel and related overhead costs for sales, marketing, finance, administration, human resources and general management. The expense increase of approximately $472,000 for the three month period ended December 29, 2012 as compared to the same period of the prior year is attributable primarily to increased charges of $160,000 in compensation expenses, $245,000 for facilities-related expenses and $356,000 of increased expenditures for legal, accounting and information systems services, partially offset by decreases of $304,000 in charges for receivables write-offs. The expense increase of approximately $772,000 for the six month period ended December 29, 2012 as compared to the same period of the prior year is attributable primarily to increased charges of $497,000 in compensation expenses, $227,000 for facilities-related expenses and $385,000 of increased expenditures for legal, accounting and information systems services, partially offset by decreases of $310,000 in charges for receivables write-offs.

We anticipate that selling, general and administrative expenses will increase in future periods over the long term due to increased staffing levels, particularly in sales and marketing, as well as increased commission expense to the extent we achieve higher sales levels. We intend to continue our focus on controlling costs. If business conditions deteriorate or the rate of improvement does not meet our expectations, we may implement further cost-cutting actions.

Interest and Other Income, Net

                                            Three Months Ended                              Six Months Ended
                               December 29,      December 31,         %        December 29,      December 31,         %
(In thousands)                     2012              2011          Change          2012              2011          Change

Interest income               $          892     $         648        37.7 %   $       1,745     $       1,581        10.4 %
Other income (expense)                  (110 )             (97 )                        (105 )            (155 )
Exchange gain (loss)                      13                87                          (210 )             282
  Interest and other income   $          795     $         638                 $       1,430     $       1,708

Interest and other income, net for the three month period ended December 29, 2012 increased $157,000 as compared with the same period of the prior year due primarily to a $239,000 increase in realized gains on sales and maturities of investments, partially offset by somewhat higher other expenses and reduced exchange gains. Interest and other income, net for the six month period ended December 29, 2012 decreased $278,000 as compared with the same period of the prior year due primarily to a $492,000 shift from an exchange gain last year to an exchange loss this year, partially offset by a $195,000 increase in realized gains on sales and maturities of investments.

Income Tax Expense (Benefit)

                                           Three Months Ended                      Six Months Ended
                                    December 29,         December 31,       December 29,       December 31,
(In thousands)                          2012                 2011               2012               2011

Pre-tax income (loss)              $         (640 )     $         (722 )   $          944      $         230
Income tax expense (benefit)                4,756                 (335 )            5,256                199

Effective tax rate                           -743 %                 46 %              557 %               87 %

During the quarter ended December 29, 2012, we began implementation of an operating structure to more efficiently align the Company's transaction flows with the Company's geographic business operations. We have foreign sales offices in Korea, Taiwan, Japan, Singapore and Hong Kong, manufacturing operations in Taiwan and China, and research and development centers in Hong Kong and China. Revenues from non-U.S. regions account for over 90% of all revenue. In addition, nearly all of our suppliers are located in the Asia Pacific region. Based on these factors we have formed new legal entities and begun realigning existing ones, completed the intercompany transfer of intellectual property rights, inventory and fixed assets across different tax jurisdictions, and implemented intercompany intellectual property licensing agreements between our U.S. and foreign entities. These actions resulted in a gain for tax purposes, for which we recorded a $5.0 million tax provision in the quarter.

The income tax expense for the three and six months ended December 29, 2012 included the $5.0 million tax provision discussed above. Excluding this amount, income tax expense (benefit) for the three and six months ended December 29, 2012 would have been $(231,000) and $269,000 for effective tax rates of (36)% and 28%, respectively. The decrease in the effective tax rate to 28% for the six month period ended December 29, 2012 as compared with 87% for the same period of the prior year is due primarily to changes in forecasted income and the allocation of earnings between different tax jurisdictions.

Our effective tax rate may differ from the federal statutory rate primarily due to state income taxes, research and development tax credits, share-based compensation from incentive stock options, the employee stock purchase plan and foreign non-qualified stock options, tax-exempt interest income, and differing tax rates in income-earning foreign jurisdictions.

Equity in Net Income of Unconsolidated Affiliates

Equity in net income of unconsolidated affiliates consists of our allocated portion of the net income of Jiyuan Crystal Photoelectric Frequency Technology Ltd. ("JCP"), an FCP manufacturing company located in Science Park of Jiyuan City, Henan Province, China. JCP is a key manufacturing partner of PSE-TW, and PSE-TW has acquired a 49% equity interest in JCP. For the three and six month periods ended December 29, 2012, the Company's allocated portion of JCP's results was income of $57,000 and $165,000, respectively, as compared with income of $52,000 and $79,000 for the three and six month periods ended December 31, 2011, respectively.

Liquidity and Capital Resources

As of December 29, 2012, our principal sources of liquidity included cash, cash equivalents and short-term and long-term investments of approximately $124.3 million as compared with $127.8 million on June 30, 2012.

Our investment in debt securities includes government securities, corporate debt securities and mortgage-backed and asset-backed securities. Government securities include US treasury securities, US federal agency securities, foreign government and agency securities, and US state and municipal bond obligations. Many of the municipal bonds are insured; those that are not are nearly all AAA/Aaa rated. The corporate debt securities are all investment grade and nearly all are single A-rated or better. The asset-backed securities are AAA/Aaa rated and are backed by auto loans, student loans, credit card balances and residential or commercial mortgages. Most of our mortgage-backed securities are collateralized by prime residential mortgages issued by government agencies including FNMA, FHLMC and FHLB. Those issued by banks are AAA-rated. At December 29, 2012, unrealized gains on marketable securities net of taxes were $443,000. When assessing marketable securities for other than temporary declines in value, we consider a number of factors. Our analyses of the severity and duration of price declines, portfolio manager reports, economic forecasts and the specific circumstances of issuers indicate that it is reasonable to expect marketable securities with unrealized losses at December 29, 2012 to recover in fair value up to our cost bases within a reasonable period of time. We have the ability and intent to hold investments with unrealized losses until maturity, when the obligors are required to redeem them at full face value or par, and we believe the obligors have the financial resources to redeem the debt securities. Accordingly, we do not consider our investments to be other than temporarily impaired at December 29, 2012.

As of December 29, 2012, $29.7 million was classified as cash and cash equivalents compared with $24.3 million as of June 30, 2012. The maturities of our short term investments are staggered throughout the year so that cash requirements are met. Because we are a fabless semiconductor manufacturer, we have lower capital equipment requirements than other semiconductor manufacturers who own wafer fabrication facilities. For the six month period ended December 29, 2012, we spent approximately $9.9 million on property and equipment compared to $3.5 million for the six month period ended December 31, 2011. We generated approximately $1.7 million of interest income for the six month period ended December 29, 2012, as compared with $1.6 million of interest income for the six month period ended December 31, 2011. In the longer term we may generate less interest income if our total invested balance decreases and these decreases are not offset by rising interest rates or increased cash generated from operations or other sources.

Our net cash provided by operating activities of $6.4 million for the six months ended December 29, 2012 was primarily the result of non-cash expenses of $5.6 million in depreciation and amortization, $1.7 million of share-based compensation expense, $300,000 tax benefit from stock option transactions and $217,000 write-off of property and equipment, partially offset by a net loss of $4.1 million, $548,000 gain on sale of investments in marketable securities and $165,000 equity in net income of unconsolidated affiliates. Additional contributions to cash included decreases of $5.2 million in accounts receivable, $1.2 million in prepaid expenses and other current assets and $781,000 in inventory, and an increase of $2.2 million in accrued liabilities. Such contributions were partially offset by a decrease of $6.3 million in accounts payable. Our net cash provided by operating activities was $15.8 million in the six months ended December 31, 2011.

Our cash used in investing activities of $238,000 for the six months ended December 29, 2012 was the result of additions to property and equipment of approximately $9.9 million, partially offset by sales and maturities of available for sale investments exceeding purchases of available for sale investments by approximately $9.7 million. Our cash used in investing activities was $10.6 million for the six months ended December 31, 2011.

Our cash used in financing activities for the six months ended December 29, 2012 . . .