Forward-Looking Statements and Factors That May Affect Results

You should read the following discussion and analysis in conjunction with our unaudited condensed consolidated financial statements and notes in Item 1 and with our audited consolidated financial statements and notes included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2012.

In addition to the historical information contained in this report, this report may contain forward-looking statements, including those related to our operating model and strategies; our market penetration and market share in the PC and mobile product markets; competitive factors in the PC and mobile product markets; revenue from the PC and mobile product markets; industry estimates of growth rates of these markets; average selling prices; product design mix; manufacturing costs; gross margins; new product solution introductions; customer relationships; research and development expenses; selling, general, and administrative expenses; liquidity and anticipated cash requirements; our ability to provide local sales, operational, and engineering support to customers; our assessment of the combination of the added value we bring to our OEM customers' products in meeting their custom design requirements and the impact of our ongoing cost-improvement programs; our expectations regarding the timing of the conclusion of an ongoing appeal of a tax audit; and our expectations regarding tax benefits for the federal research credit. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially.

We caution that these statements are qualified by various factors that may affect future results, including the following: economic conditions; changes in the market for our products and the success of our customers' products; our success in moving products from the design phase into the manufacturing phase; changes in the competitive environment; infringement claims; warranty obligations related to product failures; the failure of key technologies to deliver commercially acceptable performance; our dependence on certain key markets; penetration into new markets; the absence of both long-term purchase and supply commitments; and our lengthy development and product acceptance cycles. This report should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended June 30, 2012, including particularly Item 1A-Risk Factors.

Overview

We are a leading worldwide developer and supplier of custom-designed human interface solutions that enable people to interact more easily and intuitively with a wide variety of mobile computing, communications, entertainment, and other electronic devices. We believe our results to date reflect the combination of our customer focus, the strength of our intellectual property, and our engineering know-how, which allow us to develop or engineer products that meet the demanding design specifications of OEMs.

Many of our customers have manufacturing operations in China, and many of our OEM customers have established design centers in that region. With our expanded global presence, including offices in China, Finland, Hong Kong, Japan, Korea, Switzerland, Taiwan, and the United States, we are well positioned to provide local sales, operational, and engineering support services to our existing customers, as well as potential new customers, on a global basis.

Our manufacturing operations are based on a variable cost model in which we outsource all of our production requirements and generally drop ship our products directly to our customers from our contract manufacturers' facilities, reducing the need for significant capital expenditures and allowing us to minimize our investment in inventories. This approach requires us to work closely with our contract manufacturers and semiconductor fabricators to ensure adequate production capacity to meet our forecasted volume requirements. We provide our contract manufacturers with six-month rolling forecasts and issue purchase orders based on our anticipated requirements for the next 90 days. However, we do not have any long-term supply contracts with any of our contract manufacturers. We use three third-party wafer manufacturers to supply wafers and two third-party packaging manufacturer to package our proprietary ASICs. In certain cases, we rely on a single source or a limited number of suppliers to provide other key components of our products. Our cost of revenue includes all costs associated with the production of our products, including materials, logistics, manufacturing, assembly, and test costs paid to third-party manufacturers and related overhead costs associated with our indirect manufacturing operations personnel. Additionally, we charge all warranty costs, yield losses, and any inventory provisions or write-downs to cost of revenue.

Our gross margin generally reflects the combination of the added value we bring to our OEM customers' products in meeting their custom design requirements and the impact of our ongoing cost-improvement programs. These cost-improvement programs include reducing materials and component costs and implementing design and process improvements.

Our research and development expenses include costs for supplies and materials related to product development as well as the engineering costs incurred to design human interface solutions for OEM customers prior to and after their commitment to incorporate those solutions into their products. These expenses have generally increased, reflecting our continuing commitment to the technological and design innovation required to maintain our position in our existing markets and to adapt our existing technologies or develop new technologies for new markets.

Selling, general, and administrative expenses include expenses related to sales, marketing, and administrative personnel; internal sales and outside sales representatives' commissions; market and usability research; outside legal, accounting, and consulting costs; and other marketing and sales activities. These expenses have generally increased, primarily reflecting incremental staffing and related support costs associated with our business acquisitions, increased business levels, growth in our existing markets, and penetration into new markets.

Critical Accounting Policies and Estimates

There have been no significant changes in our critical accounting policies and estimates during the six months ended December 31, 2012 compared with our critical accounting policies and estimates disclosed in Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2012.

Results of Operations

Certain of our condensed consolidated statements of income data for the periods
indicated, together with comparative absolute and percentage changes in these
amounts, were as follows (in thousands, except percentages):



                                                            Three Months Ended December 31,                                Six Months Ended December 31,
                                                   2012           2011         $ Change       % Change           2012           2011         $ Change       % Change
PC product applications                          $  61,451      $  67,067      $  (5,616 )         (8.4 %)     $ 123,876      $ 135,898      $ (12,022 )         (8.8 %)
Mobile product applications                         81,589         78,403          3,186            4.1 %        146,205        143,018          3,187            2.2 %

Net revenue                                        143,040        145,470         (2,430 )         (1.7 %)       270,081        278,916         (8,835 )         (3.2 %)

Gross margin                                        69,030         68,723            307            0.4 %        129,600        129,983           (383 )         (0.3 %)

Operating expenses:
Research and development                            34,257         29,837          4,420           14.8 %         67,059         58,063          8,996           15.5 %
Selling, general, and administrative                19,008         17,721          1,287            7.3 %         37,916         34,430          3,486           10.1 %
Amortization of acquired intangibles                   261             -             261            n/m (1)          501             -             501            n/m (1)
Change in contingent consideration                     576             -             576            n/m (1)          863             -             863            n/m (1)

Operating income                                    14,928         21,165         (6,237 )        (29.5 %)        23,261         37,490        (14,229 )        (38.0 %)

Interest income                                        225            251            (26 )        (10.4 %)           443            451             (8 )         (1.8 %)
Interest expense                                        (5 )           (5 )           -             0.0 %             (9 )           (9 )           -              -
Impairment (loss)/recovery on investments, net          -              (7 )            7         (100.0 %)            -              13            (13 )       (100.0 %)

Income before provision for income taxes            15,148         21,404         (6,256 )        (29.2 %)        23,695         37,945        (14,250 )        (37.6 %)
Provision for income taxes                           4,034          4,021             13            0.3 %          6,528          7,547         (1,019 )        (13.5 %)

Net income                                       $  11,114      $  17,383      $  (6,269 )        (36.1 %)     $  17,167      $  30,398      $ (13,231 )        (43.5 %)

(1) not meaningful

Certain of our condensed consolidated statements of income data as a percentage of net revenue for the periods indicated were as follows:

                                                                        Percentage                                    Percentage
                                             Three Months Ended            Point             Six Months Ended            Point
                                                December 31,             Increase/             December 31,            Increase/
                                             2012           2011        (Decrease)           2012         2011        (Decrease)
PC product applications                         43.0 %        46.1 %           (3.1 %)         45.9 %       48.7 %           (2.8 %)
Mobile product applications                     57.0 %        53.9 %            3.1 %          54.1 %       51.3 %            2.8 %

Net revenue                                    100.0 %       100.0 %                          100.0 %      100.0 %

Gross margin                                    48.3 %        47.2 %            1.1 %          48.0 %       46.6 %            1.4 %

Operating expenses:
Research and development                        23.9 %        20.5 %            3.4 %          24.8 %       20.8 %            4.0 %
Selling, general, and administrative            13.3 %        12.2 %            1.1 %          14.0 %       12.3 %            1.7 %
Amortization of acquired intangibles             0.2 %          -               n/m (1)         0.2 %         -               n/m (1)
Change in contingent consideration               0.4 %          -               n/m (1)         0.3 %         -               n/m (1)

Operating income                                10.4 %        14.5 %           (4.1 %)          8.6 %       13.4 %           (4.8 %)

Income before provision for income taxes        10.6 %        14.7 %           (4.1 %)          8.8 %       13.6 %           (4.8 %)

Provision for income taxes                       2.8 %         2.8 %            0.0 %           2.4 %        2.7 %           (0.3 %)

Net income                                       7.8 %        11.9 %           (4.1 %)          6.4 %       10.9 %           (4.5 %)

(1) not meaningful

Net Revenue.

Net revenue was $143.0 million for the quarter ended December 31, 2012 compared with $145.5 million for the quarter ended December 31, 2011, a decrease of $2.5 million, or 1.7%. Of our second quarter fiscal 2013 net revenue, $61.4 million, or 43.0%, was from PC product applications and $81.6 million, or 57.0%, was from mobile product applications. The decrease in net revenue for the quarter ended December 31, 2012 was attributable to a decrease in net revenue from PC product applications. Net revenue from PC product applications decreased primarily as a result of lower unit sales in the quarter, reflecting the slowdown in the PC market.

Net revenue was $270.1 million for the six months ended December 31, 2012 compared with $278.9 million for the six months ended December 31, 2011, a decrease of $8.8 million, or 3.2%. Of our first half fiscal 2013 net revenue, $123.9 million, or 45.9%, was from PC product applications and $146.2 million, or 54.1%, was from mobile product applications. The decrease in net revenue for the six months ended December 31, 2012 was attributable to a decrease in net revenue from PC product applications. Net revenue from PC product applications decreased primarily as a result of lower unit sales in the first half of the fiscal year, reflecting the slowdown in the PC market.

Based on industry estimates of unit shipments, the notebook market is anticipated to increase approximately 6%, and the mobile smartphone market is anticipated to increase approximately 27% in calendar year 2013 compared with calendar year 2012.

Gross Margin.

Gross margin as a percentage of net revenue was 48.3%, or $69.0 million, for the quarter ended December 31, 2012 compared with 47.2%, or $68.7 million, for the quarter ended December 31, 2011. The 110 basis point improvement in gross margin was primarily attributable to favorable mix of higher margin mobile product application revenue driven in part by the continued shift in mobile product revenue from lower margin full sensor module and tail solutions to higher margin chip solutions.

Gross margin as a percentage of net revenue was 48.0%, or $129.6 million, for the six months ended December 31, 2012 compared with 46.6%, or $130.0 million, for the six months ended December 31, 2011. The 140 basis point improvement in gross margin was primarily attributable to favorable mix of higher margin mobile product application revenue driven in part by the continued shift in mobile product revenue from lower margin full sensor module and tail solutions to higher margin chip solutions.

We continuously introduce new product solutions, many of which have life cycles of less than a year. Further, as we sell our capacitive sensing technology in designs that are generally unique or specific to an OEM customer's application, gross margin varies on a product-by-product basis, making our cumulative gross margin a blend of our product specific designs and independent of the vertical markets that our products serve. As a virtual manufacturer, our gross margin percentage is generally not impacted materially by our shipment volume. We charge write-downs to reduce the carrying value of obsolete, slow moving, and non-usable inventory to net realizable value, including warranty costs, to cost of revenue.

Operating Expenses.

Research and Development Expenses. Research and development expenses increased $4.4 million to $34.3 million for the quarter ended December 31, 2012 compared with the quarter ended December 31, 2011. The increase in research and development expenses primarily reflected a $2.8 million increase in employee-related costs, which included our annual merit increase and additional headcount associated with our recent acquisitions, a $908,000 increase in temporary employee expenses, and a $729,000 increase in infrastructure-related costs.

Research and development expenses increased $9.0 million to $67.1 million for the six months ended December 31, 2012 compared with the six months ended December 31, 2011. The increase in research and development expenses primarily reflected a $5.4 million increase in employee-related costs, which included our annual merit increase and additional headcount associated with our recent acquisitions, a $1.4 million increase in temporary employee expenses, and a $1.3 million increase in infrastructure-related costs.

Selling, General, and Administrative Expenses. Selling, general, and administrative expenses increased $1.3 million to $19.0 million for the quarter ended December 31, 2012 compared with the quarter ended December 31, 2011. The increase in selling, general, and administrative expenses primarily reflected an $899,000 increase in support costs, a $414,000 increase in professional fees, and a $214,000 increase in employee-related costs, which included our annual merit increase and additional headcount associated with our recent acquisitions.

Selling, general, and administrative expenses increased $3.5 million to $37.9 million for the six months ended December 31, 2012 compared with the six months ended December 31, 2011. The increase in selling, general, and administrative expenses primarily reflected a $1.6 million increase in support costs, a $1.2 million increase in employee-related costs, which included our annual merit increase and additional headcount associated with our recent acquisitions, a $591,000 increase in professional fees, and a $375,000 increase in temporary employee expenses.

Provision for Income Taxes.

We account for income taxes under the asset and liability method. We consider the operating earnings of our foreign subsidiaries to be indefinitely invested outside the United States. Accordingly, no provision has been made for the U.S. federal, state, or foreign taxes that may result from future remittances of undistributed earnings of our foreign subsidiaries.

The provision for income taxes of $4.0 million for each of the three months ended December 31, 2012 and 2011, represented estimated federal, foreign, and state income taxes. The effective tax rate for the three months ended December 31, 2012 was 26.6% and diverged from the combined federal and state statutory rate primarily because of foreign income taxed at lower tax rates and the release of unrecognized tax benefits, partially offset by foreign withholding taxes, net unrecognized tax benefits associated with qualified stock options, and a net decrease to the liability for uncertain tax positions. The effective tax rate for the three months ended December 31, 2011 was 18.8% and diverged from the combined federal and state statutory rate primarily because of foreign income taxed at lower tax rates, the retroactive reinstatement of the federal research credit, and the state research credit, partially offset by foreign withholding taxes and net unrecognized tax benefit associated with qualified stock options. The provision for income taxes for the three months ended December 31, 2012 included a release of unrecognized tax benefits of $920,000 for the lapse of a statute that should have been recorded in the third quarter of fiscal 2012. The impact of this adjustment was not material to the consolidated financial statements for fiscal 2012 or to the estimated consolidated financial statements for fiscal 2013.

The provision for income taxes of $6.5 million and $7.5 million for the six months ended December 31, 2012 and 2011, respectively, represented estimated federal, foreign, and state income taxes. The effective tax rate for the six months ended December 31, 2012 was 27.6% and diverged from the combined federal and state statutory rate primarily because of foreign income taxed at lower tax rates and the release of unrecognized tax benefits, partially offset by foreign withholding taxes, net unrecognized tax benefits associated with qualified stock options, and a net decrease to the liability for uncertain tax positions. The effective tax rate for the six months ended December 31, 2011 was 19.9% and diverged from the combined federal and state statutory rate primarily because of foreign income taxed at lower tax rates and the federal and state research credit, partially offset by foreign withholding taxes and net unrecognized tax benefits associated with qualified stock options.

Tax benefit associated with share-based compensation was $2.2 million and $2.9 million for the three months ended December 31, 2012 and 2011, respectively. Excluding the impact of share-based compensation and the related tax benefit, the effective tax rate for the three months ended December 31, 2012 and 2011 would have been 26.8% and 23.0%, respectively.

Tax benefit associated with share-based compensation was $4.4 million and $4.9 million for the six months ended December 31, 2012 and 2011, respectively. Excluding the impact of share-based compensation and the related tax benefit, the effective tax rate for the six months ended December 31, 2012 and 2011 would have been 27.2% and 22.8%, respectively.

In May 2011, we were notified by the Service that our fiscal 2003 through 2006 and fiscal 2008 through 2010 would be subject to an audit. The early periods are being audited in connection with a mandatory review of tax refunds in excess of $2.0 million when we carried back our fiscal 2008 net operating loss. In October 2012, we received a final examination report with a total proposed tax deficiency of $2.0 million over the examination periods, excluding interest and penalties. We filed a protest in October 2012 to contest the proposed adjustments through the appeals process. While we believe our unrecognized tax benefits associated with the years and issues under audit are adequate, we can make no assurances that an assessment, if any, will not exceed our accrued unrecognized tax benefits.

Currently we anticipate resolving our protest with the Service during our fiscal 2013; otherwise, the appeal process will likely extend into our fiscal 2014 and could result in a change to our unrecognized tax benefits. Any prospective adjustments to our unrecognized tax benefits will be recorded as an increase or decrease to income tax expense and cause a corresponding change to our effective tax rate. Accordingly, our effective tax rate could fluctuate materially from period to period.

On January 2, 2013 President Barack Obama signed into law the Act. The Act extends the federal research credit for two years retroactively from January 1, 2012 through December 31, 2013. As such, we will recognize approximately $2.5 million of tax benefits in our third fiscal quarter, the financial period that includes the enactment date.

Liquidity and Capital Resources

Our cash and cash equivalents were $292.5 million as of December 31, 2012 compared with $305.0 million as of June 30, 2012, a decrease of $12.5 million. The decrease reflects the combination of $44.9 million provided from operating cash flows and $2.2 million of proceeds from the sales and maturities of non-current investments, offset by $20.9 million used for the purchase of property and equipment, $5.0 million used for the acquisition of a business, $4.6 million used for the payment of contingent consideration, and $31.3 million used to repurchase 1,240,440 shares of our common stock. We consider earnings of our foreign subsidiaries indefinitely invested overseas and have made no provision for income or withholding taxes that may result from a future repatriation of those earnings. As of December 31, 2012, $268.0 million of cash and cash equivalents was held by our foreign subsidiaries. If these funds are needed for our operations in the United States, we would be required to accrue and pay U.S. federal, foreign, and state taxes to repatriate these funds.

Cash Flows from Operating Activities. Operating activities during the six months ended December 31, 2012 generated net cash of $44.9 million compared with $60.2 million of net cash generated during the six months ended December 31, 2011. For the six months ended December 31, 2012, net cash provided by operating activities was primarily attributable to net income of $17.2 million plus adjustments for non-cash charges of $20.2 million, and a $7.6 million net change in operating assets and liabilities. The net change in operating assets and liabilities was primarily attributable to a $5.1 million decrease in accounts receivable, a $7.0 million increase in other accrued liabilities, partially offset by a $6.4 million decrease in income taxes payable and a $3.1 million decrease in accounts payable. From June 30, 2012 to December 31, 2012, our days sales outstanding decreased from 68 to 62 days and our inventory turns remained unchanged at 9.

Cash Flows from Investing Activities. Our investing activities primarily relate to purchases of property and equipment and business purchases. Investing activities during the six months ended December 31, 2012 used net cash of $23.7 million compared with $3.8 million during the six months ended December 31, 2011. During the six months ended December 31, 2012, net cash used in investing activities consisted of $20.9 million used for the purchase of property and equipment (which included $11.9 million for the purchase of buildings and land), $5.0 million used for the acquisition of a business, partially offset by proceeds of $2.2 million from the sale and redemption of non-current investments.

Cash Flows from Financing Activities. Net cash used in financing activities for the six months ended December 31, 2012 was $33.6 million compared with $21.1 million for the six months ended December 31, 2011. Net cash used in financing activities for the six months ended December 31, 2012 included $31.3 million used to repurchase 1,240,440 shares of our common stock as well as $4.6 million used for the portion of the payment of contingent consideration identified as a financing activity.

Common Stock Repurchase Program. Our Board of Directors has cumulatively authorized $520.0 million for our stock repurchase program, expiring in October 2013. The program authorizes us to purchase our common stock in the open market or in privately negotiated transactions, depending upon market conditions and other factors. The number of shares purchased and the timing of purchases is based on the level of our cash balances, general business and market conditions, and other factors, including alternative investment opportunities. Common stock purchased under this program is held as treasury stock. From April 2005 through December 31, 2012, we purchased 17,024,532 shares of our common stock in the open market for an aggregate cost of $445.2 million. Treasury shares purchased prior to August 28, 2008 were not subject to the stock split on that date. As of December 31, 2012, we had $74.8 million remaining under our common stock repurchase program.

Bank Credit Facility. We maintain a $50.0 million working capital line of credit with Wells Fargo Bank. The Wells Fargo Bank revolving line of credit, which expires on September 1, 2013, provides for an interest rate equal to the prime lending rate or 250 basis points above LIBOR, depending on whether we choose a variable or fixed rate, respectively. We had not borrowed any amounts under the line of credit as of December 31, 2012.

$100 Million Shelf Registration. We have registered an aggregate of $100.0 million of common stock and preferred stock for issuance in connection with acquisitions, which shares generally will be freely tradable after their issuance under Rule 145 of the Securities Act unless held by an affiliate of the acquired company, in which case such shares will be subject to the volume and . . .