SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business

Monolithic Power Systems, Inc. was incorporated in the State of California on

August 22, 1997.

November 17, 2004,

the Company was reincorporated in the State of Delaware. MPS designs, develops and markets integrated power semiconductor solutions and power delivery architectures. MPS's mission is to provide innovative power solutions in the computing and storage, automotive, industrial, communications and consumer markets.

Basis of Presentation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenue and expenses during the reporting period. Significant estimates and assumptions used in these consolidated financial statements primarily include those related to revenue recognition, inventory valuation, valuation of share-based awards, valuation of goodwill and acquisition-related intangible assets, contingencies and tax valuation allowances. Actual results could differ from those estimates.

Certain Significant Risks and Uncertainties

Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, short-term and long-term investments and accounts receivable. The Company’s cash consists of checking and savings accounts. The Company’s cash equivalents include short-term, highly liquid investments purchased with remaining maturities at the date of purchase of

three

months or less. The Company’s short-term investments consist of corporate debt securities, certificates of deposit and government agency bonds and treasuries, and the long-term investments consist of government-backed student loan auction-rate securities. The Company generally does

not

require its customers to provide collateral or other security to support accounts receivable. To manage credit risk, management performs ongoing credit evaluations of its customers’ financial condition. The Company requires cash in advance for certain customers in addition to ongoing credit evaluations. See Note

for further discussion.

The Company participates in the dynamic high technology industry and believes that changes in any of the following areas could have a material adverse effect on its future financial position, results of operations or cash flows: advances and trends in new technologies and industry standards; competitive pressures in the form of new products or price reductions on current products; changes in product mix; changes in the overall demand for products offered by the Company; changes in

third

-party manufacturers; changes in key suppliers; changes in certain strategic relationships or customer relationships; litigation or claims against the Company based on intellectual property, patent, product, regulatory or other factors; fluctuations in foreign currency exchange rates; risk associated with changes in government policies and regulations on trade restrictions and corporate taxes; availability of necessary components or sub-assemblies; availability of foundry capacity; ability to integrate acquired companies; and the Company’s ability to attract and retain employees necessary to support its growth.

Foreign Currency

In general, the functional currency of the Company’s international subsidiaries is the local currency. The primary subsidiaries are located in China, Taiwan and Europe, which utilize the Renminbi, the New Taiwan Dollar and the Euro as their currencies, respectively. Accordingly, assets and liabilities of the foreign subsidiaries are translated using exchange rates in effect at the end of the period. Revenue and costs are translated using average exchange rates for the period. The resulting translation adjustments are presented as a separate component of accumulated other comprehensive income (loss) in stockholders’ equity in the Consolidated Balance Sheets. In addition, the Company incurs foreign currency exchange gain or loss related to certain intercompany transactions between the U.S. and its foreign subsidiaries that are denominated in a currency other than the functional currency. In connection with the settlement and remeasurement of the balances, the Company recorded foreign currency exchange gain (loss) of

$1.0

million, $(

0.6

) million and

$0.1

million for the years ended

December 31, 2018,

2017

and

2016,

respectively, which were reported in interest and other income, net, in the Consolidated Statements of Operations.

Cash and Cash Equivalents

The Company classifies all highly liquid investments with stated maturities of

three

months or less from date of purchase as cash equivalents.

Fair Value of Financial Instruments

Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into

three

levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:

Level

Quoted prices (unadjusted) for identical assets or liabilities in active markets

Level

Inputs other than the quoted prices in active markets that are observable either directly or indirectly

Level

Significant unobservable inputs

The Company’s financial instruments include cash and cash equivalents, and short-term and long-term investments. Cash equivalents are stated at cost, which approximates fair market value. The Company’s short-term and long-term investments are classified as available-for-sale securities and are stated at their fair market value. Premiums and discounts are generally amortized or accreted over the life of the related available-for-sale securities. Interest income is recognized when earned.

The Company determines whether an impairment is temporary or other-than temporary. Unrealized gains or losses that are deemed to be temporary are recorded as a component of accumulated other comprehensive income (loss) in stockholders’ equity in the Consolidated Balance Sheets, and changes in unrealized gains or losses are recorded in the Consolidated Statements of Comprehensive Income. The Company records an impairment charge in interest and other income, net, in the Consolidated Statements of Operations when an available-for-sale investment has experienced a decline in value that is deemed to be other-than-temporary. Other-than-temporary impairment exists when the Company either has the intent to sell the security, it will more likely than

not

be required to sell the security before anticipated recovery, or it does

not

expect to recover the entire amortized cost basis of the security.

As of

December 31, 2018

and

2017,

the fair value of the Company’s holdings in auction-rate securities was

$3.2

million and

$5.3

million, respectively, all of which was classified as long-term available-for-sale investments. The valuation of the auction-rate securities is subject to fluctuations in the future, which will depend on many factors, including the quality of the underlying collateral, estimated time to liquidity including potential to be called or restructured, underlying final maturity, insurance guaranty and market conditions, among others.

Inventories

Inventories are stated at the lower of standard cost (which approximates actual cost determined on a

first

-in

first

-out basis) and estimated net realizable value. The Company writes down excess and obsolete inventory based on its age and forecasted demand, which includes estimates taking into consideration the Company’s outlook on market and economic conditions, technology changes, new product introductions and changes in strategic direction. Actual demand

may

differ from forecasted demand, and such differences

may

have a material effect on recorded inventory values. When the Company records a write-down on inventory, it establishes a new, lower cost basis for that inventory, and subsequent changes in facts and circumstances will

not

result in the restoration or increase in that newly established cost basis.

Property and Equipment

Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Buildings and building improvements have estimated useful lives of

years. Leasehold improvements are amortized over the shorter of the estimated useful lives or the lease period. Production equipment and software have estimated useful lives of

three

eight

years. Transportation equipment has estimated useful lives of

years. Furniture and fixtures have estimated useful lives of

three

five

years. Land is

not

depreciated.

Goodwill and Acquisition-Related Intangible Assets

Goodwill represents the excess of the fair value of purchase consideration over the fair value of net tangible and identified intangible assets as of the date of acquisition. Goodwill is

not

amortized. Acquisition-related intangible assets with finite lives consist of know-how and developed technologies. These assets are amortized on a straight-line basis over the estimated useful lives of

three

five

years and the amortization expense is recorded in cost of revenue in the Consolidated Statements of Operations.

Impairment of Long-Lived Assets

The Company evaluates its long-lived assets other than goodwill for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset

may

not

be recoverable. An impairment loss would be recognized when the sum of the undiscounted future net cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. Such impairment loss would be measured as the difference between the carrying amount of the asset and its fair value based on the present value of estimated future cash flows.

The Company tests goodwill for impairment at least annually in the

fourth

quarter of the year, or whenever events or changes in circumstances indicate that goodwill

may

be impaired. The Company has elected to

first

assess the qualitative factors to determine whether it is more likely than

not

that the fair value of the reporting unit is less than its carrying amount. If the Company determines that it is more likely than

not

that its fair value is less than the carrying amount, then the

two

-step goodwill impairment test is performed. The

first

step compares the fair value of the reporting unit with its carrying amount. If the carrying amount exceeds its fair value, the

second

step measures the impairment loss by comparing the implied fair value of the goodwill with the carrying amount.

impairment of goodwill has been identified in any of the periods presented.

Deferred Compensation Plan

The Company has a non-qualified, unfunded deferred compensation plan, which provides certain key employees, including executive officers, with the ability to defer the receipt of compensation in order to accumulate funds for retirement on a tax deferred basis. The Company does

not

make contributions to the plan or guarantee returns on the investments. The Company is responsible for the plan’s administrative expenses. Participants’ deferrals and investment gains and losses remain as the Company’s liabilities and the underlying assets are subject to claims of general creditors.

The liabilities for compensation deferred under the plan are recorded at fair value in each reporting period. Changes in the fair value of the liabilities are included in operating expense in the Consolidated Statements of Operations. The Company manages the risk of changes in the fair value of the liabilities by electing to match the liabilities with investments in corporate-owned life insurance policies, mutual funds and money market funds that offset a substantial portion of the exposure. The investments are recorded at the cash surrender value of the corporate-owned life insurance policies, and at the fair value of the mutual funds and money market funds, which are classified as trading securities. Changes in the cash surrender value of the corporate-owned life insurance policies and the fair value of mutual fund and money market fund investments are included in interest and other income, net in the Consolidated Statements of Operations. The following table summarizes the deferred compensation plan balances in the Consolidated Balance Sheets (in thousands):

	December 31,
	2018		2017
Deferred compensation plan asset components:
Cash surrender value of corporate-owned life insurance policies	$	13,103	$	11,455
Fair value of mutual funds and money market funds		18,867		16,625
Total	$	31,970	$	28,080

Deferred compensation plan assets reported in:
Other long-term assets	$	31,970	$	28,080

Deferred compensation plan liabilities reported in:
Accrued compensation and related benefits (short-term)	$	447	$	356
Other long-term liabilities		32,283		28,087
Total	$	32,730	$	28,443

Revenue Recognition

The Company recognizes revenue when it transfers control of promised goods or services to its customers in an amount that reflects the consideration to which it expects to be entitled to in exchange for those goods or services. See Note

for further discussion.

Research and Development

Costs incurred in research and development are expensed as incurred.

Warranty Reserve

The Company generally provides

one

two

-year warranties against defects in materials and workmanship and will either repair the products, provide replacements at

charge to customers or issue a refund. As they are considered assurance-type warranties, the Company does

not

account for them as separate performance obligations. Warranty reserve requirements are generally based on a specific assessment of the products sold with warranties when a customer asserts a claim for warranty or a product defect. See Note

for the changes in warranty reserves for the periods presented.

Stock-Based Compensation

The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award.

The fair value of restricted stock units (“RSUs”) with service conditions or performance conditions is based on the grant date share price. The fair value of shares issued under the employee stock purchase plan and RSUs with a purchase price feature is estimated using the Black-Scholes model. The fair value of RSUs with market conditions, as well as RSUs containing both market and performance conditions, is estimated using a Monte Carlo simulation model.

Compensation expense related to awards with service conditions is recorded on a straight-line basis over the requisite service period. Compensation expense related to awards subject to market or performance conditions is recognized over the requisite service period for each separately vesting tranche. For awards with only market conditions, compensation expense is

not

reversed if the market conditions are

not

satisfied. For awards with performance conditions, as well as awards containing both market and performance conditions, the Company recognizes compensation expense when the performance goals are achieved, or when it becomes probable that the performance goals will be achieved. Management performs the probability assessment on a quarterly basis by reviewing external factors, such as macroeconomic conditions and the analog industry revenue forecasts, and internal factors, such as the Company’s business and operational objectives and revenue forecasts. Changes in the probability assessment of achievement of the performance conditions are accounted for in the period of change by recording a cumulative catch-up adjustment as if the new estimate had been applied since the service inception date. Any previously recognized compensation expense is reversed if the performance conditions are

not

expected to be satisfied as a result of management’s assessment.

Prior to

January 1, 2017,

the Company recognized stock-based compensation expense less an estimate for forfeitures. Upon the adoption of Accounting Standards Update (“ASU”)

No.

2016

09,

Compensation—Stock Compensation (Topic

718

): Improvements to Employee Share-Based Payment Accounting,

January 1, 2017,

the Company elected to account for forfeitures when they occur.

Accounting for Income Taxes

The Company recognizes federal, state and foreign current tax liabilities or assets based on its estimate of taxes payable or refundable in the current fiscal year by tax jurisdiction. The Company also recognizes federal, state and foreign deferred tax assets or liabilities for its estimate of future tax effects attributable to temporary differences and carryforwards. The Company records a valuation allowance to reduce any deferred tax assets by the amount of any tax benefits that, based on available evidence and judgment, are

not

expected to be realized.

The Company’s calculation of current and deferred tax assets and liabilities is based on certain estimates and judgments and involves dealing with uncertainties in the application of complex tax laws. The Company’s estimates of current and deferred tax assets and liabilities

may

change based, in part, on added certainty, finality or uncertainty to an anticipated outcome, changes in accounting or tax laws in the U.S. or foreign jurisdictions where the Company operates, or changes in other facts or circumstances. In addition, the Company recognizes liabilities for potential U.S. and foreign income tax for uncertain income tax positions taken on its tax returns if it has less than a

50%

likelihood of being sustained. If the Company determines that payment of these amounts is unnecessary or if the recorded tax liability is less than its current assessment, the Company

may

be required to recognize an income tax benefit or additional income tax expense in its financial statements in the period such determination is made. The Company has calculated its uncertain tax positions which were attributable to certain estimates and judgments primarily related to transfer pricing, cost sharing and its international tax structure exposure.

December 22, 2017,

the

2017

Tax Act was enacted, which significantly changed U.S. corporate income tax law. The

2017

Tax Act made the following material changes:

(

) reduction of the corporate income tax rate effective

January 1, 2018; (

) replacement of the worldwide tax system with a territorial tax regime, with a

one

-time mandatory tax on previously deferred foreign earnings; (

) amendment on the deductibility of executive performance-based compensation, and (

) creation of new taxes on certain foreign-sourced earnings. Income tax effects resulting from changes in tax laws are accounted for by the Company in the period in which the law is enacted. See Note

for further discussion.

Litigation and Contingencies

The Company is a party to actions and proceedings in the ordinary course of business, including potential litigation regarding its shareholders and its intellectual property, challenges to the enforceability or validity of its intellectual property, claims that the Company’s products infringe on the intellectual property rights of others, and employment matters. The pending proceedings involve complex questions of fact and law and will require the expenditure of significant funds and the diversion of other resources to prosecute and defend. In addition, from time to time, the Company becomes aware that it is subject to other contingent liabilities. When this occurs, the Company will evaluate the appropriate accounting for the potential contingent liabilities to determine whether a contingent liability should be recorded. In making this determination, management

may,

depending on the nature of the matter, consult with internal and external legal counsel and technical experts. Based on the facts and circumstances in each matter, the Company uses its judgment to determine whether it is probable that a contingent loss has occurred and whether the amount of such loss can be estimated. If the Company determines a loss is probable and estimable, the Company records a contingent loss. In determining the amount of a contingent loss, the Company takes into account advice received from experts for each specific matter regarding the status of legal proceedings, settlement negotiations, prior case history and other factors. Should the judgments and estimates made by management need to be adjusted as additional information becomes available, the Company

may

need to record additional contingent losses. Alternatively, if the judgments and estimates made by management are adjusted, for example, if a particular contingent loss does

not

occur, the contingent loss recorded would be reversed.

Litigation expense (benefit), net recorded in the Consolidated Statements of Operations includes primarily patent infringement litigation and other business matters. The Company records litigation costs in the period in which they are incurred. Proceeds resulting from settlement of litigation or favorable judgments are recorded as a reduction against litigation expense.

Net Income per Share

Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted net income per share reflects the potential dilution that would occur if outstanding securities or other contracts to issue common stock were exercised or converted into common shares, and calculated using the treasury stock method. Contingently issuable shares, including equity awards with performance conditions or market conditions, are considered outstanding common shares and included in the basic net income per share as of the date that all necessary conditions to earn the awards have been satisfied. Prior to the end of the contingency period, the number of contingently issuable shares included in the diluted net income per share is based on the number of shares, if any, that would be issuable under the terms of the arrangement at the end of the reporting period.

The Company’s outstanding RSUs contain forfeitable rights to receive cash dividend equivalents, which are accumulated and paid to the employees when the underlying RSUs vest. Dividend equivalents accumulated on the underlying RSUs are forfeited if the employees do

not

fulfill their service requirement and the awards do

not

vest. Accordingly, these awards are

not

treated as participating securities in the net income per share calculation.

Comprehensive Income

Comprehensive income represents the change in the Company’s net assets during the period from non-owner sources. Accumulated other comprehensive income (loss) presented in the Consolidated Balance Sheets primarily consists of unrealized gains or losses related to available-for-sale investments and foreign currency translation adjustments.

Recently Adopted Accounting Pronouncement

Revenue Recognition:

May 2014,

the FASB issued ASU

No.

2014

09,

Revenue from Contracts with Customers (Topic

606

which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. The standard’s core principle is that an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company adopted the standard on

January 1, 2018

using the modified retrospective method applied to those contracts which were

not

completed as of

December 31, 2017.

Results for reporting periods beginning after

January

2018

are presented under Topic

606,

while prior-period amounts have

not

been retrospectively adjusted and continue to be reported in accordance with Topic

605,

Revenue Recognition

The Company recorded a net increase to the opening balance of retained earnings of

$0.4

million, net of tax, as of

January

2018

due to the cumulative effect of initially applying Topic

606,

primarily related to the change in revenue recognition for

three

U.S.-based distributors. Sales to these distributors are transacted under the terms of agreements providing price adjustment rights. Prior to the adoption of Topic

606,

revenue and costs related to these sales were deferred until the Company received notification from the distributors that the products had been sold to the end customers and the amount of price adjustments was fixed and finalized. Upon adoption of Topic

606,

the transaction price takes into consideration the effect of variable consideration such as price adjustments, which are estimated and recorded at the time the promised goods are transferred to the distributors. Accordingly, effective

January 1, 2018,

the Company recognizes revenue at the time of shipment to these distributors when all revenue recognition criteria have been met, adjusted for an estimate of the price adjustments based on management’s review of historical data and other information available at the time. See Note

for further discussion.

Other:

August 2018,

the SEC issued Final Rule Release

No.

10532,

Disclosure Update and Simplification,

which amends certain disclosure requirements, including the presentation of changes in stockholders’ equity and the dividend per share for interim periods, as well as the elimination of certain disclosures for annual periods. The Company adopted the provisions of the release on

November 5, 2018.

November 2016,

the FASB issued ASU

No.

2016

18,

Statement of Cash Flows - Restricted Cash (Topic

230

which requires entities to show the changes in the total of cash, cash equivalents and restricted cash in the Consolidated Statements of Cash Flows. The Company adopted the standard on

January 1, 2018

and applied the guidance retrospectively to all periods presented. See Note

for further discussion.

Recent Accounting Pronouncements

Not

Yet Adopted as of

December

31,

2018

Leases:

February 2016,

the FASB issued ASU

No.

2016

02,

Leases (Topic

842

which requires entities to recognize right-of-use (“ROU”) assets and lease liabilities on the balance sheets for leases with terms greater than

months. In addition, the standard applies to leases embedded in service or other arrangements. The Company will adopt the standard on

January 1, 2019

using the modified retrospective method and will

not

restate comparative periods, as permitted by the standard. In addition, the Company will elect the transition practical expedients to

not

reassess whether its existing contracts contain or are leases, classification of its existing leases and lease terms.

Upon adoption, the Company will record ROU assets and lease liabilities of approximately

2.0

million to

3.0

million, which represent the present value of the remaining minimum rental payments for its outstanding leases as of

January 1, 2019,

primarily related to real estate. The adoption will

not

have a material impact on the Consolidated Statements of Operations, as the Company will continue to recognize lease expenses on a straight-line basis over the lease terms.

Other:

August 2018,

the FASB issued ASU

No.

2018

13,

Fair Value Measurement (Topic

820

): Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement,

which changes certain disclosure requirements, including those related to Level

fair value measurements. The standard will be effective for annual reporting periods beginning after

December 15, 2019.

Early adoption is permitted. The Company is evaluating the impact of the adoption on its disclosures.

January 2017,

the FASB issued ASU

No.

2017

04,

Intangibles – Goodwill and Other (Topic

350

which simplifies the accounting for goodwill impairment. The guidance removes step

two

of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value,

not

to exceed the carrying amount of goodwill. Entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. The standard will be applied prospectively, and will be effective for annual reporting periods beginning after

December 15, 2019.

Early adoption is permitted. The Company is evaluating the impact of the adoption on its annual goodwill impairment test.

June 2016,

the FASB issued ASU

No.

2016

13,

Financial Instruments – Credit Losses (Topic

326

which introduces a model based on expected losses to estimate credit losses for most financial assets and certain other instruments. In addition, for available-for-sale debt securities with unrealized losses, the losses will be recognized as allowances rather than reductions in the amortized cost of the securities. The standard will be effective for annual reporting periods beginning after

December 15, 2019,

with early adoption permitted for annual reporting periods beginning after

December 15, 2018.

Entities will apply the standard by recording a cumulative-effect adjustment to retained earnings. The Company is evaluating the impact of the adoption on its consolidated financial position, results of operations, cash flows and disclosures.