O2Micro International Limited
Annual Report 2014

Plain-text annual report

 CONTENTS CORPORATE INFORMATION CHAIRMAN’S STATEMENT REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FINANCIAL HIGHLIGHTS 1 2 4 7 - i - CORPORATE INFORMATION Independent Auditor Deloitte & Touche Legal counsel Board of Directors Morrison & Foerster LLP Palo Alto office 755 Page Mill Road Palo Alto, California 94304 USA Maples and Calder PO Box 309 Ugland House Grand Cayman KY1-1104 Cayman Islands Executive Directors Sterling Du (Chairman, Chief Executive Officer) Chuan Chiung “Perry” Kuo (Chief Financial Officer) James Elvin Keim (Head of Marketing and Sales) Independent Non-executive Directors Michael Austin Teik Seng Tan Shoji Akutsu Lawrence Lai-Fu Lin Zhuoping Yu Ji Liu The Bank of New York Mellon Corporation ADR Division One Wall Street, 29th Floor New York, New York 10286 USA Maples Fund Services (Cayman) Limited PO Box 1093 Boundary Hall, Cricket Square Grand Cayman KY1-1102 Cayman Islands Grand Pavilion Commercial Centre, West Bay Road PO Box 32331 SMB, George Town Grand Cayman KY1-1209 Cayman Islands Phone: (345) 945-1110 Fax: (345) 945-1113 3118 Patrick Henry Drive Santa Clara, CA 95054 USA Phone: (408) 987-5920 Fax: (408) 987-5929 3rd Floor, 1, Sec 4 Nanjing East Road Taipei, Taiwan 105 Phone: (886) 2-2545-9095 Fax: (886) 2-2547-1721 Maples Corporate Services Limited Ugland House, P.O. Box 309 Grand Cayman KY1-1104, Cayman Islands Depositary for American Depositary Receipts Share Registrar Corporate Headquarters Other Addresses Registered office - 1 - CHAIRMAN’S STATEMENT TO OUR SHAREHOLDERS As we enter our 20th year as an innovation leader, 2014 represented a transition period for O2Micro when we reinvigorated the Company to return to growth and profitability. Through a combination of operational expense reductions and the implementation of certain initiatives to monetize assets of the Company, we believe we have transitioned the Company to benefit from our next growth phase. Our high-priority initiatives to deliver superior customer solutions resulted in design-win momentum in our new tablet and smartphone products and the expansion of our customer base in our backlighting, battery management, power management and general lighting markets. We view 2015 as the potential “turn around” point for the Company. We believe in this development for a number of significant reasons including: Due to ongoing customer product ramps and cyclicality of the business, we believe our reported first quarter 2015 revenue level will represent a trough level and we anticipate quarterly revenue growth going forward. Second, we do not believe that we will face additional declines in our power management business for notebook computers, as we believe this business has stabilized. Next, our shipments of products to our Chinese customers are increasing as a percentage of total product shipments. O2Micro shipped over 45 million parts to Chinese customers in 2014, an increase of 85% from 2013 levels. As the trend of the electronics market moves toward China, we are better able to compete with Chinese competitors by our improved cost structure and efficient distribution channels in the Chinese Marketplace. Fourth, we believe our higher growth drivers including products for the tablet and smartphone markets, general lighting and battery management products will represent an increasing portion of total revenue as we proceed throughout 2015 and into 2016. Finally, we have reduced operational expenses by over forty percent from first quarter 2010 levels and we believe that we have achieved the necessary expense structure to return to profitability in the near future. In 2014, we dedicated approximately 70% of our R&D spending to developing new innovative products. As a result, customer design activity with our new products has been robust, and should continue into 2015. In fact, revenue from new products accounted for approximately 40% of total revenue in 2014. As this trend continues, new design revenue will continue to gain momentum in diverse markets and expanding our customer base for our LED general lighting, backlighting, battery management and power management products. In our backlighting business, we are projecting renewed growth in this product area as we move into 2015, based on increasing design activity in TV, tablet, and smartphone markets. We continue to be a worldwide leader in LED backlighting for TVs and monitors, and our expanding customer base in our backlighting business includes such market leaders as Sony, Toshiba, HP, Dell, Lenovo, Skyworth, TCL, Hisense, among others. After fully assessing the landscape in 2014, we felt that another emphasis of the Company should be, among other things, to address and penetrate the tablet and smartphone markets with our advanced and unique solutions. I am pleased to report that our efforts are paying off and we achieved multiple significant design wins with several platform providers who are integrating O2Micro products into high-volume tablet and smartphone products. We expect to recognize significant revenue from these customers throughout 2015 and into 2016. These design wins are a direct result of our strategic decision to pursue the tablet and smartphone market, and we expect to announce additional design wins in these markets in throughout 2015 and beyond. We have also developed additional products in our product pipeline that include a wide spectrum of integrated circuits utilizing our proprietary technology to support additional existing and new market segments. Our LED general lighting business continues to grow rapidly in this competitive market. Our strategy of targeting leading LED manufacturers in China, the U.S. and Japan is working. We are very pleased an increasing number of market leaders are using our general lighting product technologies. This customer list includes GE, Panasonic, Samsung, Toshiba, Osram, IKEA, IRIS Japan, Lights of America, and TCP, and we continue to see a broader-based acceptance of our proprietary Free Dimming and two- color dimming products in more applications, thereby expanding our international customer base. We have also successfully introduced our TRIAC controller lighting products for legacy dimmable fixtures and see these products gaining revenue momentum in 2015. This segment of the market continues to evolve, and feel we are our products and technologies are well positioned to serve this market for years to come. O2Micro’s proprietary, analog power management technology in our battery management segment supports a variety of end markets and continues to grow with our rapidly expanding customer base. Our battery management products continue to achieve many new design wins, and we continue to be very optimistic for continued growth in power tool, e-bike, e-vehicle, appliances and vacuum cleaner markets. We are also seeing increasing design activity for products in - 2 - uninterrupted power supply applications. Major manufacturers using our products include Black & Decker, Electrolux, LG, Panasonic, and TTI, to name a few. At the end of 2014, we continued to make difficult, yet necessary, cost saving measures to better align the Company financials with current and anticipated revenue levels. We also focused our efforts to take full advantage of our technological and business strengths. As we highlighted at the end of 2014, we have shifted some of our resources to design win activity in the China based tablet and smartphone markets. This concentrated effort to exploit our market strengths will allow us to better support our customers with a high level of satisfaction that our customers have come to expect from O2Micro, and we will continue to garner additional design wins in our target markets. Finally, we are also in the process of monetizing some of our real-estate assets and long-term investments. The company began this monetization process in the second half of 2014 and we expect to continue to evaluate these assets going forward and share additional information with our Shareholders throughout 2015. In 2015, O2Micro is well positioned with a more cost-efficient business model, strong secular growth drivers and proven strategies in place to return to profitability in the near future. Revenue from previous generation technologies now represents a minimal portion of our overall business, which, in turn, allows us to dedicate more resources to new and emerging technologies. We are already witnessing revenue from our new products exceeding the declines that we faced from legacy technologies in 2014. In fact, we expect that revenue from general lighting and battery management will represent approximately 25% of our total revenue by the middle of 2015. Our Management Team is diversified and experienced. We strongly believe we have one of the strongest international infrastructure support organizations in the industry, which will enable us to foster future growth and sustainability in the years to come. We thank you for your support and we look forward to reporting our progress to you throughout the year. Sterling Du Chairman of the Board and Chief Executive Officer - 3 - O2Micro International Limited and Subsidiaries Consolidated Financial Statements as of December 31, 2014 and 2013 and for the Three Years Ended December 31, 2014, 2013 and 2012, and Report of Independent Registered Public Accounting Firm - 4 - REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and the Shareholders of O2Micro International Limited: We have audited the accompanying consolidated balance sheets of O2Micro International Limited and subsidiaries (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of operations and comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2014 (expressed in United States dollars). These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of O2Micro International Limited and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2014, based on the criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated April 23, 2015 expressed an unqualified opinion on the Company’s internal control over financial reporting. /s/ Deloitte & Touche Taipei, Taiwan Republic of China April 23, 2015 - 5 - REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and the Shareholders of O2Micro International Limited: We have audited the internal control over financial reporting of O2Micro International Limited and subsidiaries (the “Company”) as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2014, of the Company and our report dated April 23, 2015 expressed an unqualified opinion on those financial statements. /s/ Deloitte & Touche Taipei, Taiwan Republic of China April 23, 2015 - 6 - FINANCIAL HIGHLIGHTS O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Thousand US Dollars, Except Per Share Amounts and Share Data) ASSETS CURRENT ASSETS Cash and cash equivalents (notes 4 and 5) Restricted cash Short-term investments (notes 4 and 6) Accounts receivable, net Inventories (note 7) Prepaid expenses and other current assets (note 8) Total current assets LONG-TERM INVESTMENTS (notes 4 and 9) PROPERTY AND EQUIPMENT, NET (note 10) OTHER ASSETS Intangible assets, net (note 11) Other assets (note 12) Total other assets TOTAL ASSETS LIABILITIES AND SHAREHOLDERS’ EQUITY CURRENT LIABILITIES Notes and accounts payable Income tax payable Accrued expenses and other current liabilities (note 13) Total current liabilities OTHER LONG-TERM LIABILITIES Accrued pension liabilities (note 15) Other liabilities (note 10) Total long-term liabilities Total liabilities COMMITMENTS AND CONTINGENCIES (notes 18 and 19) SHAREHOLDERS’ EQUITY Preference shares at $0.00002 par value per share; Authorized – 250,000,000 shares; Ordinary shares at $0.00002 par value per share; Authorized – 4,750,000,000 shares; Issued – 1,660,786,600 shares Outstanding – 1,327,260,450 and 1,391,744,250 shares as of December 31, 2014 and 2013, respectively Additional paid-in capital Accumulated deficits Accumulated other comprehensive income Treasury stock – 333,526,150 and 269,042,350 shares as of December 31, 2014 and 2013, respectively Total shareholders’ equity $ December 31 2014 2013 $ 41,069 164 21,481 6,789 8,642 1,308 79,453 42,293 173 33,606 10,024 7,217 1,437 94,750 14,754 16,121 19,363 23,039 - 3,168 3,168 - 3,509 3,509 $ 116,738 $ 137,419 $ $ 2,131 650 6,049 8,830 293 349 642 4,169 238 5,353 9,760 391 658 1,049 9,472 10,809 - - 33 141,229 (17,291) 6,768 33 140,198 (2,234) 8,512 (23,473) (19,899) 107,266 126,610 TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 116,738 $ 137,419 The accompanying notes are an integral part of the consolidated financial statements. - 7 - O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (In Thousand US Dollars, Except Per Share Amounts and Share Data) Years Ended December 31 2013 2014 2012 NET SALES COST OF SALES GROSS PROFIT OPERATING EXPENSES Research and development (a) Selling, general and administrative (a) Costs associated with exit activities (note 3) Provision for litigation (note19) Litigation income (note 19) $ 63,591 $ 73,785 $ 97,666 30,856 36,411 44,067 32,735 37,374 53,599 21,885 24,721 3,027 - (75) 27,017 30,898 - - - 34,310 34,594 3,343 9,422 (100) Total operating expenses 49,558 57,915 81,569 LOSS FROM OPERATIONS (16,823) (20,541) (27,970) NON-OPERATING INCOME Interest income Foreign exchange gain (loss), net Gain on sale of long-term investments (note 9) Gain on sale of real estate (note 10) Other, net Total non-operating income LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAX 1,035 589 436 458 432 2,950 1,303 491 - - 646 1,706 (217) 23 - 873 2,440 2,385 (13,873) (18,101) (25,585) INCOME TAX EXPENSE (note 14) 1,184 992 1,103 NET LOSS FROM CONTINUING OPERATIONS (15,057) (19,093) (26,688) INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF TAX - (6) 895 NET LOSS (15,057) (19,099) (25,793) OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX EFFECT OF NIL Foreign currency translation adjustments Unrealized (loss) gain on available-for-sale securities (note 9) Unrealized pension gain (loss) Total other comprehensive (loss) income (1,416) (398) 70 (1,744) 11 342 294 647 COMPREHENSIVE LOSS $ (16,801) $ (18,452) $ 846 185 (65) 966 (24,827) (Continued) - 8 - O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (In Thousand US Dollars, Except Per Share Amounts and Share Data) Years Ended December 31 2013 2014 2012 BASIC AND DILUTED LOSS PER SHARE (note 17) Continuing operations Discontinued operations $ $ (0.01) - (0.01) $ $ (0.01) $ - $ (0.01) (0.02) - (0.02) NUMBER OF SHARES USED IN LOSS PER SHARE CALCULATION: Basic and Diluted (in thousands) (a) INCLUDES STOCK-BASED COMPENSATION CHARGE AS FOLLOWS: Research and development Selling, general and administrative 1,362,465 1,435,778 1,552,190 $ $ 489 1,631 $ $ 700 1,909 $ $ 930 2,137 The accompanying notes are an integral part of the consolidated financial statements. (Concluded) - 9 - O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (In Thousand US Dollars, Except Share Data) BALANCE, JANUARY 1, 2012 Issuance of: Shares for exercise of stock options Shares for Employee Stock Purchase Plan Shares vested under restricted share units Acquisition of treasury stock –130,927,000 shares Treasury stock reissued for : Exercise of stock options Employee Stock Purchase Plan Restricted share units Stock-based compensation Net loss for 2012 Pension loss Foreign currency translation adjustments Unrealized gain on available-for-sale securities BALANCE, DECEMBER 31, 2012 Issuance of: Shares for exercise of stock options Shares for Employee Stock Purchase Plan Shares vested under restricted share units Acquisition of treasury stock – 126,856,850 shares Treasury stock reissued for : Exercise of stock options Employee Stock Purchase Plan Restricted share units Stock-based compensation Net loss for 2013 Pension gain Foreign currency translation adjustments Unrealized gain on available-for-sale securities Ordinary Shares Shares Amount Additional Paid – in Capital Retained Earnings (Accumulated Deficits) Accumulated Other Comprehensive Income Unrealized Investment Gain (Loss) Cumulative Unrealized Translation Adjustment Gain (Loss) Pension Treasury Shareholders’ Total Stock Equity 1,653,265,600 $ 33 $ 136,625 $ 42,658 $ (129) $ 7,445 $ (417) $ 6,899 $ (4,111) $ 182,104 1,566,650 7,553,950 15,245,000 - (1,217,700) (5,611,550) (10,015,350) - - - - - - - - - - - - - - - - - 80 532 - - - - - - (109) (505) (897) 3,067 - - - - - (25,793) - - - - - - - - - - - - - - - - - 185 - - - - - - - - - - 846 - - - - - - - - - - (65) - - - - - - - - - - - (65) 846 185 - - - (10,584) 109 505 897 - - - - - 80 532 - (10,584) - - - 3,067 (25,793) (65) 846 185 1,660,786,600 33 138,793 16,865 56 8,291 (482) 7,865 (13,184) 150,372 543,100 6,046,050 13,297,850 - (543,100) (6,046,050) (13,297,850) - - - - - - - - - - - - - - - - - 25 335 - - - - - - (42) (467) (1,055) 2,609 - - - - - (19,099) - - - - - - - - - - - - - - - - - 342 - - - - - - - - - - 11 - - - - - - - - - - 294 - - - - - - - - - - - 294 11 342 - - - (8,279) 42 467 1,055 - - - - - 25 335 - (8,279) - - - 2,609 (19,099) 294 11 342 BALANCE, DECEMBER 31, 2013 1,660,786,600 33 140,198 (2,234) 398 8,302 (188) 8,512 (19,899) 126,610 Issuance of: Shares for exercise of stock options Shares for Employee Stock Purchase Plan Shares vested under restricted share units Acquisition of treasury stock – 83,468,900 shares Treasury stock reissued for : Exercise of stock options Employee Stock Purchase Plan Restricted share units Stock-based compensation Net loss for 2014 Pension gain Foreign currency translation adjustments Unrealized gain on available-for-sale securities Reclassification adjustments for gain on available-for-sale securities included in net loss 796,900 5,284,800 12,903,400 - (796,900) (5,284,800) (12,903,400) - - - - - - - - - - - - - - - - - - - 44 258 - - - - - - (59) (383) (949) 2,120 - - - - - (15,057) - - - - - - - - - - - - - - - - - 74 - - - - - - - - - - (1,416) - - - - - - - - - - - - - - 70 - - - - - - - 70 (1,416) 74 - - (472) - - (472) - - - (4,965) 59 383 949 - - - - - - 44 258 - (4,965) - - - 2,120 (15,057) 70 (1,416) 74 (472) 1,660,786,600 BALANCE, DECEMBER 31, 2014 The accompanying notes are an integral part of the consolidated financial statements. $ 33 $ 141,229 $(17,291) $ - $ 6,886 $ (118) $ 6,768 $ (23,473) $ 107,266 - 10 - O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousand US Dollars) Years Ended December 31 2013 2012 2014 OPERATING ACTIVITIES Net loss Adjustments to reconcile net loss to net cash used in operating activities: $ (15,057) $ (19,099) $ (25,793) Depreciation and amortization Stock-based compensation Loss on asset write-off Inventory write-downs Gain on sale of long-term investments Impairment loss on long-term investments Gain on disposal of property and equipment, net Deferred income taxes Other, net Changes in operating assets and liabilities: Accounts receivable, net Inventories Prepaid expenses and other current assets Deferred charges Notes and accounts payable Income tax payable Accrued expenses and other current liabilities Accrued pension liabilities Long-term income tax payable Other liabilities 3,718 2,120 82 1,538 (436) 83 (428) 78 (36) 3,235 (2,963) 130 (985) (2,038) 412 577 (12) - (346) 4,685 2,609 - 900 - - (106) 41 (1) (1,251) (200) 510 (1,366) 413 (124) (1,083) (25) - (8,893) 5,372 3,067 2,320 1,220 (23) - (85) 101 80 3,289 (1,211) 213 (790) (2,885) (244) (1,025) 53 (66) 9,422 Net cash used in operating activities (10,328) (22,990) (6,985) INVESTING ACTIVITIES Acquisition of: Short-term investments Long-term investments Property and equipment Decrease (increase) in: Restricted assets Restricted cash Other assets Proceeds from: Sale of short-term investments Sale of long-term investments Disposal of property and equipment (22,346) - (1,004) (15,496) (250) (743) - (1) 116 34,333 1,304 1,982 10,000 1 108 52,131 - 166 (24,722) - (2,151) (10,000) (1) (83) 48,381 583 296 Net cash provided by investing activities 14,384 45,917 12,303 FINANCING ACTIVITIES Acquisition of treasury stock Proceeds from: (4,965) (8,279) (10,916) Exercise of stock options Issuance of ordinary shares under the Employee Stock Purchase Plan 44 258 25 335 80 532 Net cash used in financing activities (4,663) (7,919) (10,304) (Continued) - 11 - O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousand US Dollars) Years Ended December 31 2013 2012 2014 EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATE $ (617) $ (613) $ 322 NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,224) 14,395 (4,664) CASH AND CASH EQUIVALENTS AT BEGINNING OF THE YEAR 42,293 27,898 32,562 CASH AND CASH EQUIVALENTS AT END OF THE YEAR $ 41,069 $ 42,293 $ 27,898 SUPPLEMENTAL DISCLOSURES OF CASH FLOWS Cash paid for interest Cash paid for tax $ $ - 697 $ $ - 1,064 $ $ - 1,307 The accompanying notes are an integral part of the consolidated financial statements. (Concluded) - 12 - O2MICRO INTERNATIONAL LIMITED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Expressed in United States Dollars Unless Otherwise Noted) 1. GENERAL Business O2Micro, Inc. was incorporated in the state of California in the United States of America on March 29, 1995. In March 1997, O2Micro International Limited (the “Company”) was formed in the Cayman Islands and all authorized and outstanding common stock, preferred stock, and stock options of O2Micro, Inc. were exchanged for the Company’s ordinary shares, preference shares, and stock options with identical rights and preferences. O2Micro, Inc. became the Company’s subsidiary after the share exchange. The Company designs, develops and markets innovative power management components for the Computer, Consumer, Industrial, Automotive and Communications markets. The Company’s ordinary shares (“Shares”) were initially listed on The NASDAQ National Market (“NASDAQ”) on August 23, 2000, and on the Cayman Islands Stock Exchange on February 1, 2001. At the Extraordinary General Meeting of Shareholders (“EGM”) held on November 14, 2005, the shareholders approved a public global offering of the Company’s Shares and the proposed listing of the Company's Shares on the Main Board of The Stock Exchange of Hong Kong Limited (“SEHK”) and various matters related to the proposed listing and offering. Following the approval of these matters, the Company ceased trading its Shares on the NASDAQ, effected a 50-for-1 share split of Shares, created an American depositary share (“ADS”) program for the ADSs to be quoted on the NASDAQ, and delisted the Shares from the NASDAQ on November 25, 2005. The Company commenced trading of ADSs on the NASDAQ on November 28, 2005, and subsequently listed the Shares on the SEHK on March 2, 2006, by way of introduction. On February 27, 2009, the Company submitted an application for the voluntary withdrawal of the listing of Shares on the Main Board of SEHK (collectively referred to as “Proposed Withdrawal”) for reasons of cost and utility. The Company retained its existing primary listing of ADSs on the NASDAQ following the Proposed Withdrawal and for the foreseeable future. The Proposed Withdrawal was approved at the EGM held on May 30, 2009, and the listing of the Shares on SEHK was withdrawn on September 9, 2009. The Company has incorporated various wholly-owned subsidiaries in the past, including, among others, O2Micro Electronics, Inc. (“O2Micro-Taiwan”), O2Micro International Japan Ltd. (“O2Micro-Japan”), O2Micro Pte Limited-Singapore (“O2Micro-Singapore”), O2Micro (China) Co., Ltd. (“O2Micro-China”), and O2Security Limited (“O2Security”). O2Micro-Taiwan is engaged in operations and sales support services. O2Micro-Japan is engaged in sales support services. O2Micro-Singapore, O2Micro-China, and other subsidiaries are mostly engaged in research and development services. O2Security was primarily engaged in operations and sales of Network Security products (“Network Security Group”). In November 2010, the Company commenced a plan to terminate its Network Security business and initiated shutdown activities associated with the Network Security Group, and in 2011, the Company formally dissolved all business entities related to O2Security Limited. The Company has reflected the operating results of this business group as discontinued operations in the accompanying consolidated statements of operations and comprehensive income. Please also see discussions in note 3. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated on consolidation. - 13 - Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates. Significant accounting estimates reflected in the Company’s consolidated financial statements include valuation allowance for deferred income tax assets, allowance for doubtful accounts, inventory valuation, useful lives for property and equipment, impairment of long-lived assets and identified intangible assets, allowances for sales adjustments, pension and uncertain tax liabilities, contingencies and stock-based compensation. Concentration of Credit Risk Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash, cash equivalents, short-term investments and accounts receivable. Cash is deposited with high credit quality financial institutions. For cash equivalents and short-term investments, the Company invests primarily in time deposits and debt securities with high credit quality. For accounts receivable, the Company performs ongoing credit evaluations of its customers’ financial condition and the Company maintains an allowance for doubtful accounts based upon a review of the expected collectability of individual accounts. Fair Value of Financial Instruments The Company’s financial instruments include cash and cash equivalents, restricted cash, accounts receivable, and notes and accounts payable. The carrying amounts approximate the fair value due to the short-term maturity of those instruments. Fair value of available-for-sale investments including short-term investments and long-term investments is based on quoted market prices. Long-term investments in private company equity securities are accounted for under the cost method because the Company does not exercise significant influence over the entities. The Company evaluates related information including operating performance, subsequent rounds of financing, advanced product development and related business plan in determining the fair value of these investments and whether an other-than-temporary decline in value exists. Cash and Cash Equivalents The Company considers all highly liquid investments with maturities of not more than three months when purchased to be cash equivalents. Investments with maturities of more than three months are classified as short-term investments. Restricted Cash The Company classifies deposits made for customs and cash pledged to a bank for the issuance of letters of credit as restricted cash. The deposits are classified as current assets if refundable within a twelve-month period from the balance sheet date. Short-term Investments The Company maintains its excess cash in time deposits, government, corporate, or other agency bonds issued with high credit ratings. The specific identification method is used to determine the cost of securities sold, with realized gains and losses reflected in non-operating income and expenses. As of December 31, 2013, all the above-mentioned investments except for time deposits were classified as available-for-sale securities and were recorded at fair value. Unrealized gains and losses on these investments are included in accumulated other comprehensive income and loss as a separate component of losses are deemed shareholders’ equity, net of any other-than-temporary. income when deemed other-than-temporary. There were no available-for-sale securities as of December 31, 2014. losses are recorded as a charge tax effect, unless unrealized Unrealized related to Investment transactions are recorded on the trade date. - 14 - Inventories Inventories are stated at the lower of standard cost or market value. The cost of inventories comprises cost of purchasing raw materials and where applicable, those overheads that have been incurred in bringing the inventories to their present location and condition. Cost is determined on a currently adjusted standard basis, which approximates actual cost on a first-in, first-out basis. The Company assesses its inventory for estimated obsolescence or unmarketable inventory based upon management’s assumptions about future demand and market conditions and writes down inventory as needed. Long-term Investments Long-term investments in private companies over which the Company does not exercise significant influence are accounted for under the cost method. Management evaluates related information in determining whether an other-than-temporary decline in value exists. Factors indicative of an other-than-temporary decline include recurring operating losses, credit defaults and subsequent rounds of financing at an amount below the cost basis of the investment. The list is not all-inclusive and management periodically weighs all quantitative and qualitative factors in determining if any impairment loss exists. Long-term investments in listed companies are classified as available-for-sale securities and are recorded at fair value. Unrealized gains and losses on these investments are included in accumulated other comprehensive income and loss as a separate component of shareholders’ equity, net of any related tax effect, unless unrealized losses are deemed other-than-temporary. Unrealized losses are recorded as a charge to income when deemed other-than-temporary. Property and Equipment Property and equipment are stated at cost less accumulated depreciation. Major additions and betterments are capitalized, while maintenance and repairs are expensed as incurred. Depreciation is computed on a straight-line basis over estimated service lives that range as follows: buildings - 35 to 49.7 years, equipment - 3 to 10 years, furniture and fixtures - 3 to 9 years, leasehold improvements - the shorter of the estimated useful life or the lease term, which is 2 to 6 years, and transportation equipment - 5 years. Long-lived Asset Impairment The Company evaluates the recoverability of long-lived assets whenever events or changes in circumstances indicate the carrying value may not be recoverable. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flows from the asset is separately identifiable and is less than the carrying value. If impairment occurs, a loss based on the excess of the carrying value over the fair value of the long-lived asset is recognized. Fair value is determined by reference to quoted market prices, if available, or discounted cash flows, as appropriate. Identified Intangible Assets Intellectual property assets primarily represent customer relationship, tradename, and developed technologies acquired, and are recorded based on a purchase price allocation analysis on the fair value of the assets acquired. The Company amortizes acquired intangible assets using straight-line method over the estimated life ranging from 3 to 10 years. The intangible assets, subject to amortization, are reviewed for impairment whenever circumstances indicate that the useful life is shorter than the Company had originally estimated or that the carrying amount of assets may not be recoverable. If such facts and circumstances exist, the Company assesses the recoverability of identified intangible assets by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives against their respective carrying amounts. Impairments, if any, are based on the excess of the carrying amount over the fair value of those assets. The Company determines the fair value using the income approach which includes the discounted cash flow and other economic factors as inputs. - 15 - Treasury Stock The Company may retire ordinary shares repurchased under a share repurchase plan. Accordingly, upon retirement the excess of the purchase price over par value is allocated between additional paid-in capital and retained earnings based on the average issuance price of the shares repurchased. The Company may also determine not to retire ordinary shares repurchased for the purpose of reissuing them upon exercise of stock option, Employee Stock Purchase Plan, and release of restricted stock units (“RSUs”). The reissue cost of shares repurchased is determined by the moving average method. A repurchase of ADS is recorded as treasury stock until the Company completes the withdrawal of the underlying ordinary shares from the ADS program. Revenue Recognition Revenue from product sales to customers, other than distributors, is recognized at the time of shipment and when title and right of ownership transfers to customers. The four criteria for revenue being realized and earned are the existence of evidence of sale, actual shipment, fixed or determinable selling price, and reasonable assurance of collectability. Allowances for sales returns and discounts are provided at the time of the recognition of the related revenues on the basis of experience and these provisions are deducted from sales. In certain limited instances, the Company sells its products through distributors. The Company has limited control over these distributors’ selling of products to third parties. Accordingly, the Company recognizes revenue on sales to distributors when the distributors sell the Company’s products to third parties. Thus, products held by distributors are included in the Company’s inventory balance. Freight Costs Costs of shipping and handling for delivery of the Company’s products that are reimbursed by customers are recorded as revenue in the consolidated statements of operations and comprehensive income. Shipping and handling costs are charged to cost of sales as incurred. Research and Development Research and development costs consist of expenditures incurred during the course of planned research and investigation aimed at the discovery of new knowledge and intellectual property that will be useful in developing new products or processes, or at significantly enhancing existing products or production processes as well as expenditures incurred for the design and testing of product alternatives or construction of prototypes. All expenditures related to research and development activities of the Company are charged to operating expenses when incurred. Advertising Expenses The Company expenses all advertising and promotional costs as incurred. These costs were approximately $948,000, $1,349,000, and $1,203,000 in 2014, 2013, and 2012, respectively. A portion of these costs was for advertising, which approximately amounted to $205,000, $297,000, and $272,000 in 2014, 2013, and 2012, respectively. Pension Costs For employees under defined contribution pension plans, pension costs are recorded based on the actual contributions made to employees’ pension accounts. For employees under defined benefit pension plans, pension costs are recorded based on the actuarial calculation. Government Grants Government grants received by the Company to assist with specific research and development activities are recognized as non-operating income. If the Company has an obligation to repay any of the funds provided by government grants regardless of the outcome of the research and development, the Company will estimate that obligation and recognize the amount as a liability. - 16 - Income Tax The provision for income tax represents income tax paid and payable for the current year plus the changes in the deferred income tax assets and liabilities during the relevant years. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases, and operating loss and tax credit carryforwards. The Company believes that uncertainty exists regarding the realization of certain deferred income tax assets and, accordingly, has established a valuation allowance for those deferred income tax assets to the extent the realization is not deemed to be more likely than not. Deferred income tax assets and liabilities are measured using enacted tax rates. The Company utilizes a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained in a dispute with taxing authorities, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. Stock-based Compensation The Company grants stock options to its employees and certain non-employees and estimates the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense ratably over the requisite service periods. The Company has elected to use the Black-Scholes option pricing model to determine the fair value of stock options on the date of grant. The Company also grants RSUs to its employees and the RSUs are measured based on the fair market value of the underlying stock on the date of grant. Foreign Currency Transactions The functional currency is the local currency of the respective entities. Foreign currency transactions are recorded at the rate of exchange in effect when the transaction occurs. Gains or losses, resulting from the application of different foreign exchange rates when cash in foreign currency is converted into the entities’ functional currency, or when foreign currency receivable and payable are settled, are credited or charged to income in the period of conversion or settlement. At year-end, the balances of foreign currency monetary assets and liabilities are recorded based on prevailing exchange rates and any resulting gains or losses are credited or charged to income. Translation of Foreign Currency Financial Statements The reporting currency of the Company is the US dollar. Accordingly, the financial statements of the foreign subsidiaries are translated into US dollars at the following exchange rates: assets and liabilities - current rate on balance sheet date; shareholders’ equity - historical rate; income and expenses - weighted average rate during the year. The resulting translation adjustment is recorded as a separate component of shareholders’ equity. Comprehensive Income (Loss) Comprehensive income (loss) represents net income (loss) plus the results of certain changes in shareholders’ equity during a period from non-owner sources. Legal Contingencies The Company is currently involved in various claims and legal proceedings. Periodically, the Company reviews the status of each significant matter and assesses the potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be estimated, the Company accrues a liability for the estimated loss. In view of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, the Company reassesses the potential liability related to the pending claims and litigation and revises these estimates as appropriate. Such revisions in the estimates of the potential liabilities could have a material impact on the results of operations and financial position. - 17 - As part of its standard terms and conditions, the Company offers limited indemnification to third parties with whom it enters into contractual relationships, including customers; however, it is not possible to determine the range of the amount of potential liability under these indemnification obligations due to the lack of prior indemnification claims. These indemnifications typically hold third parties harmless against specified losses, such as those arising from a breach of representation or covenant, or other third party claims that the Company’s products, when used for their intended purposes, infringe the intellectual property rights of such other third parties. These indemnifications are triggered by any claim of infringement of intellectual property rights brought by a third party with respect to the Company’s products. The terms of these indemnifications may not be waived or amended except by written notice signed by both parties, and may only be terminated with respect to the Company’s products. Recent Accounting Pronouncements In February 2013, the Financial Accounting Standard Board (“FASB”) issued an accounting update, which provides guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date. The guidance requires an entity to measure such obligations as the sum of the amount that the reporting entity agreed to pay on the basis of its arrangement among its co-obligors plus additional amounts the reporting entity expects to pay on behalf of its co-obligors. The new guidance is effective for fiscal years beginning after December 15, 2013. The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or cash flows. In March 2013, the FASB issued an accounting update that amended guidance on a parent’s accounting for the cumulative translation adjustment upon derecognition of a subsidiary or group of assets within a foreign entity. This guidance requires that the parent release any related cumulative translation adjustment into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. The guidance is effective for fiscal years beginning after December 15, 2013. The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or cash flows. In July 2013, the FASB issued an accounting update, which creates new guidance regarding the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. Under certain circumstances, unrecognized tax benefits should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. The guidance is effective for fiscal years beginning after December 15, 2013 and early adoption is permitted. The adoption of this guidance did not have a material impact on the Company’s financial statement disclosures since the Company did not have any unrecognized tax benefits. In April 2014, the FASB issued an accounting update, which changes the criteria for reporting discontinued operations for all public and nonpublic entities. The guidance requires only disposals that represent a strategic shift that has (or will have) a major effect on the entity’s results and operations would qualify as discontinued operations. The guidance also requires entities 1) to expand their disclosures about discontinued operations to include more information about assets, liabilities, income, and expenses and 2) to disclose the pre-tax income attributable to a disposal of “of an individually significant component of an entity that does not qualify for discontinued operations presentation in the financial statements.” The guidance is effective for fiscal years beginning after December 15, 2014 and early adoption is prohibited. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or cash flow. In May 2014, the FASB issued a new standard related to revenue recognition. Under the new standard, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, the new standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new standard is effective for fiscal years beginning after December 15, 2016 and early adoption is prohibited. The new guidance is required to be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying it recognized at the date of initial application. The Company has not yet selected a transition method nor has it determined the impact of the new standard on the Company’s consolidated financial statements. - 18 - In June 2014, the FASB issued an accounting update, which clarifies the accounting for share-based payments. The guidance requires that a performance target that affects vesting and that could be achieved after the requisite service period is treated as a performance condition. The guidance is effective for fiscal years beginning after December 15, 2015 and early adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or cash flow. In August 2014, the FASB issued new standard related to the presentation of financial statements when there may be conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern. This standard sets forth management’s responsibility to evaluate, each reporting period, whether there is substantial doubt about our ability to continue as a going concern, and if so, to provide related footnote disclosures. The standard is effective for fiscal years beginning after December 15, 2016 and early adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or cash flow. In February 2015, the FASB issued an accounting update to amend the consolidation analysis. All legal entities are subject to reevaluation under the revised consolidation model. The amendment is effective for fiscal years beginning after December 15, 2015 and early adoption is permitted. The adoption of this amendment is not expected to have a material impact on the Company’s results of operations, financial position or cash flow. 3. DISCONTINUED OPERATIONS AND EXIT ACTIVITIES Discontinued Operations As part of the Company’s strategy to evaluate its business segments periodically, management noted that the Network Security Group has incurred significant operating losses and its business had not grown as projected. In light of the downturn of business in Network Security products the Company determined that a triggering event had occurred and initiated an impairment loss analysis on the Network Security Group’s long-lived assets using a discounted cash flow approach in estimating fair value as market values could not be readily determined. In November 2010, the Board of Directors (the “Board”) resolved to discontinue the operations of Network Security Group and to liquidate the assets of the Network Security Group in due course. The Company has ceased the segment’s operation and has commenced the related shutdown activities, most of which were completed in 2011. The Company did not have any revenue and expense from the operations of this business segment in 2014. The Company determined that the Network Security Group meets the definition of a separate component and the results of the Network Security Group are reported as discontinued operations in the accompanying statements of operations and comprehensive income. Exit Activities In November 2012, the Company determined to dissolve the Intelligent E-Commerce Group, one of the product lines of the Company’s Integrated Circuit Group, which comprised of the IC products such as Smart Card ICs, connectivity ICs, and power switches ICs. The actions taken to dissolve the Intelligent E-Commerce Group resulted in significantly reducing the operating activities of the Intelligent E-Commerce products, terminating the related workforce, and licensing the related intellectual property and technology to one of the Company’s authorized sales representatives, Axland Corporation Limited (“Axland”). Axland provides certain support services to the existing customers of the Intelligent E-Commerce products. For the year ended December 31, 2012, the Company recorded costs associated with exit activities of $3,343,000, of which $2,320,000 and $1,023,000 were related to a loss on asset write-off and one-time employee termination benefits, respectively. The Company determined that those assets directly held/carried by the Intelligent E-Commerce Group provided no future benefit and recognized a loss on asset write-off, including property and equipment of $462,000, intangible assets of $1,198,000, and deferred charges of $660,000. As of December 31, 2012, one-time employee termination benefits of $1,023,000 were accrued and recorded as accrued expenses and other current liabilities on the balance sheet, which had been settled in 2013. - 19 - In December 2014, the Company determined to dissolve the Intelligent Power Group, one of the product lines of the Company’s Integrated Circuit Group, which comprised of the IC products such as DC/DC controller ICs, battery charger controllers ICs, charger ICs, and LDO Regulator ICs. The actions taken to dissolve the Intelligent Power Group resulted in significantly reducing the developing activities of the Intelligent Power products, and terminating the related workforce. For the year ended December 31, 2014, the Company recorded costs associated with exit activities of $3,027,000, of which $82,000 and $2,945,000 were related to a loss on asset write-off and one-time employee termination benefits, respectively. The Company determined that those assets directly held/carried by the Intelligent Power Group provided no future benefit and recognized a loss on asset write-off, including property and equipment of $24,000, and deferred charges of $58,000. As of December 31, 2014, one-time employee termination benefits of $2,945,000 were accrued and recorded as accrued expenses and other current liabilities on the balance sheet, which had been settled in 2015. 4. FAIR VALUE MEASUREMENTS The Company measures its cash equivalents and marketable securities at fair value. The Company also determines the fair value of long-term investments and long-lived assets whenever events or changes in circumstances indicate the carrying value may not be recoverable. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. A three-tier fair value hierarchy is established as a basis for considering such assumptions and for inputs used in the valuation methodologies in measuring fair value: Level 1 – Observable inputs such as quoted prices for identical instruments in active markets; Level 2 – Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; Level 3 – Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. Assets and liabilities measured at fair value on recurring and nonrecurring bases were as follows: Items measured at fair value on a recurring basis at December 31, 2014 Cash and cash equivalents Money market mutual funds Items measured at fair value on a recurring basis at December 31, 2013 Cash and cash equivalents Money market mutual funds Short-term investments Government bonds Corporate bonds Agency bonds Long-term investments Fair Value Measurements at the End of the Reporting Period Level 2 Level 1 Level 3 (In Thousands) Total $ - $ 162 $ - $ 162 $ - $ 1,764 $ - $ 1,764 - - - 1,613 1,517 5,448 - - - - 1,613 1,517 5,448 1,284 Available-for-sale securities (note 9) 1,284 - Total recurring fair value measurements $ 1,284 $ 10,342 $ - $ 11,626 - 20 - Items measured at fair value on a nonrecurring basis at December 31, Total Losses 2014 Level 1 Level 2 Level 3 Total Long-term investments Cost method securities (note 9) $ - $ - $ 167 $ 167 $ (83) Long-lived assets held and used related to the exit activities Property and equipment (note 3) Other assets (note 3) - - - - - - - - (24) (58) Total nonrecurring fair value measurements $ - $ - $ 167 $ 167 $ (165) As described in note 3, in connection with the dissolution of the Intelligent Power Group, property and equipment and deferred charges with a carrying amount of $24,000, and $58,000, respectively, were written down to their fair value of zero, resulting in an exit activities charge of $82,000, which was included in earnings for the year ended December 31, 2014. There were no items measured at fair value on a nonrecurring basis at December 31, 2013. The Company utilized a pricing service to estimate fair value measurements for the money market mutual funds, government bonds, corporate bonds and agency bonds. The pricing service utilized market quotations for fixed maturity securities that had quoted prices in active markets. Fixed maturity securities generally traded daily on dealer bids rather than bids recorded on exchanges. The pricing service prepared estimates of fair value measurements for these securities using its proprietary pricing applications which included available relevant market information, benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Since most of the fixed maturity securities had maturities of one year or less, the Company believed that the fair value would not be materially different from the original purchased cost. The Company’s fair value processes included controls that were designed to ensure appropriate fair values were recorded. The fair value estimates provided by the pricing service for the Company’s investments were based on observable market information rather than market quotes. Accordingly, the estimates of fair value for short-term investments were determined based on Level 2 inputs at December 31, 2014 and 2013, respectively. The fair value measurement in cost method securities was determined based on a recent round financing in August, 2014. Please also see discussions in note 9. 5. CASH AND CASH EQUIVALENTS Time deposits Savings and checking accounts Money market mutual funds Petty cash (In Thousands) December 31 2014 2013 $ 17,679 23,214 162 14 $ 24,015 16,499 1,764 15 $ 41,069 $ 42,293 - 21 - 6. SHORT-TERM INVESTMENTS (In Thousands) December 31, 2014 Gross Gross Cost Unrealized Unrealized Gains Losses Fair Value Time deposits $ 21,481 $ - $ - $ 21,481 (In Thousands) December 31, 2013 Gross Gross Cost Unrealized Unrealized Gains Losses Fair Value Time deposits $ 25,028 $ - $ - $ 25,028 Available-for-sale securities Government bonds Corporate bonds Agency bonds 1,610 1,519 5,448 $ 33,605 $ 3 - 2 5 - (2) (2) 1,613 1,517 5,448 $ (4) $ 33,606 Short-term investments by contractual maturity were as follows: Time deposits Due within one year Due after one year through two years Time deposits Due within one year Due after two years Available-for-sale securities Due within one year (In Thousands) December 31, 2014 Fair Value Cost $ 21,477 4 $ 21,481 $ 21,477 4 $ 21,481 (In Thousands) December 31, 2013 Fair Value Cost $ 25,024 4 25,028 $ 25,024 4 25,028 8,577 8,578 $ 33,605 $ 33,606 The Company’s gross realized gains and losses on the sale of investments for the year ended December 31, 2014 were $38,000 and $2,000, respectively. Please also see discussions in note 9. The Company’s gross realized gains and losses on the sale of investments for the year ended December 31, 2013, were $1,000 and $0, respectively. The Company’s gross realized gains and losses on the sale of investments for the year ended December 31, 2012, were $1,000 and $0, respectively. - 22 - The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses that were not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2013 (nil at December 31, 2014). (In Thousands) December 31, 2013 Less Than 12 Months_ 12 Months or Greater_ Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses $ $ 500 1,517 2,830 $ 4,847 $ - 2 2 4 $ $ - - - - $ $ - - - - $ 500 $ 1,517 2,830 $ 4,847 $ - 2 2 4 Government bonds Corporate bonds Agency bonds 7. INVENTORIES Finished goods Work-in-process Raw materials (In Thousands) December 31 2014 2013 $ 2,686 1,405 4,551 $ 2,153 1,725 3,339 $ 8,642 $ 7,217 (In Thousands) December 31 2014 2013 $ $ 674 293 26 19 17 279 592 338 29 56 16 406 $ 1,308 $ 1,437 8. PREPAID EXPENSES AND OTHER CURRENT ASSETS Prepaid expenses Interest receivable Other receivable Value-added-tax recoverable Deferred income tax assets Other - 23 - 9. LONG-TERM INVESTMENTS Cost method Sigurd Microelectronics (Cayman) Co., Ltd. (“Sigurd Cayman”) X-FAB Silicon Foundries SE (“X-FAB”) Philip Ventures Enterprise Fund (“PVEF”) GEM Services, Inc. (“GEM”) Excelliance MOS Co., Ltd (“EMC”) Verticil Electronics Corp. (“Verticil”) Asia Sinomos Semiconductor Inc. (“Sinomos”) Silicon Genesis Corporation (“SiGen”) Available-for-sale securities – noncurrent Etrend Hightech Corp. (“Etrend”) (In Thousands) December 31 2014 2013 $ 7,200 4,968 497 78 1,844 167 - - 14,754 $ 7,200 4,968 497 78 1,844 250 - - 14,837 - 1,284 $ 14,754 $ 16,121 The following table shows the movement of gross unrealized gains and losses of the Company’s available-for-sale securities. (In Thousands) Years Ended December 31 2013 2014 2012 Balance at beginning of period Other comprehensive income before reclassification adjustment Reclassification adjustment Balance at end of period $ 398 $ 56 $ (129) 74 (472) 342 - 185 - $ - $ 398 $ 56 The following table shows the gross unrealized gains and losses and fair value of the Company’s available-for-sale securities at December 31, 2013 (nil at December 31, 2014). (In Thousands) December 31, 2013 Gross Gross Cost Unrealized Unrealized Gains Losses Fair Value Etrend $ 920 $ 364 $ - $ 1,284 In July 2008, the Company invested in preferred shares of Sigurd Cayman for $5,700,000 to become a strategic partner of Sigurd Microelectronics Corporation (“Sigurd”). Upon completion of the transaction, the Company obtained a 19.54% ownership of Sigurd Cayman. The Company accounts for the investment under the cost method as the Company does not exercise significant influence over operating and financial policies of Sigurd Cayman and management of Sigurd holds the controlling interests. In April 2010, the Company participated in another round of preferred shares issued by Sigurd Cayman amounting to $1,500,000. As of December 31, 2014, the Company held 9,690,445 shares, which represented an 18.88% ownership of Sigurd Cayman. The Company invested in X-FAB’s ordinary shares in July 2002. X-FAB (formerly known as X-FAB Semiconductor Foundries AG) in analog/mixed-signal application. As of December 31, 2014, the Company held 530,000 shares at the cost of $4,968,000 (4,982,000 EURO), which represented a 1.60% ownership of X-FAB. is a European-American that specializes foundry group - 24 - In November 2005, the Company invested in PVEF, a fund management company in Singapore, with an investment amount of $585,000 (SG$1,000,000) for 20 units in the placement at SG$50,000 per unit. The Company further invested $357,000 (SG$500,000) in June 2010 to obtain 30 units. A portion of the shares were redeemed by PVEF in November 2012 at the cost of $445,000 and the carrying cost of the Company reduced to $497,000 accordingly. The Company held a 5% interest in the fund as of December 31, 2014. The Company invested in GEM’s preference shares in August 2002. GEM is a multinational semiconductor assembly and test company. On April 16, 2012, GEM signed a share purchase agreement with a listed company in Taiwan which will purchase GEM’s preference share at a price of $0.235 per share to obtain approximately 58.4% ownership of GEM. In respect to this subsequent event, the Company considered this a Type I subsequent event and the investment to be other-than-temporarily impaired. Therefore, the Company recognized an impairment loss of $422,000 as of December 31, 2011. As of December 31, 2014, the Company held 333,334 shares at the cost of $78,000, which represented a 0.36% ownership of GEM. The Company invested $1,960,000 (NT$62,900,000) in EMC’s 3,468,000 ordinary shares in June 2010. EMC is a fabless power device design company in Taiwan, specialized in power semiconductor process development, and the design of high efficiency power device and system. In December 2012, the Company sold 200,000 shares in the amount of $138,000 in the process of EMC’s getting listed on the Emerging Stock GreTai Security Market of Taiwan. As of December 31, 2014, the Company held 3,474,854 shares at the cost of $1,844,000, which represented a 10.86% ownership of EMC. In July 2013, the Company invested $250,000 (NT$7,500,000) in Verticil, a privately-owned manufacturer of LED power modules and integrated lighting solutions provider in Taiwan. Based on the recent operating status and a round of financing of Verticil in August 2014, the Company considered the investment to be other-than-temporarily impaired. Therefore, the Company recognized an impairment loss of $83,000 (NT$2,500,000) in the third quarter of 2014. As of December 31, 2014, the Company held 500,000 shares of Verticil, represented a 3.33% ownership. The Company invested in Etrend’s ordinary shares in December 2002, July 2003, and March 2004, respectively. Etrend is a wafer probing, packing and testing company. In August 2007, Etrend’s shares were listed on the Emerging Stock GreTai Security Market of Taiwan and the Company reclassified the investment in Etrend to available-for-sale securities. Etrend was successfully listed on the GreTai Securities Market of Taiwan in November 2010. The Company sold the entire Etrend shares in the stock exchange market during the second half year of 2014 and a gain of $436,000 was recorded for the year ended December 31, 2014. In January 2005, the Company invested in ordinary shares of Sinomos, a privately owned foundry company, at a total amount of $5,000,000. In May and December 2006, the Company further invested in preferred shares of $3,288,000 and $4,785,000, respectively. In September 2008, in view of Sinomos’ operating status and recurring financial losses, the Company determined that the decline in fair value of the investment in Sinomos was other-than-temporary and recognized an impairment charge of $13,073,000. Along with the recognition of impairment charge, the Company also wrote-off the outstanding prepayments in relation to Sinomos’ foundry service of $2,942,000. As of December 31, 2014, the Company held 30,101,353 of ordinary and preference shares, representing an 18.41% ownership of Sinomos. The Company invested in SiGen preferred shares in December 2000. SiGen is an advanced nanotechnology company that develops Silicon-on-insulator, stained-silicon products and other engineered multi-layer structures to microelectronics and photonic for advanced electronic and opto-electronic device applications. In 2002 and 2003, the Company reviewed qualitative factors related to the investment, determined that the decline in value was other-than-temporary and the carrying value was decreased to zero. The Company held 23,946 shares of SiGen as of December 31, 2014, representing a 0.06% ownership of SiGen. - 25 - 10. PROPERTY AND EQUIPMENT, NET Cost Land Buildings Equipment Furniture and fixtures Leasehold improvements Transportation equipment Property leased to others Prepayment for property and equipment Accumulated depreciation Buildings Equipment Furniture and fixtures Leasehold improvements Transportation equipment Property leased to others (In Thousands) December 31 2014 2013 $ 2,510 8,055 22,751 1,030 2,052 668 3,766 4,397 45,229 1,757 20,887 886 1,701 619 16 25,866 $ 2,510 8,055 26,052 1,148 3,150 673 - 9,929 51,517 1,577 22,649 935 2,724 593 - 28,478 $ 19,363 $ 23,039 Depreciation expense recognized during the years ended December 31, 2014, 2013, and 2012 was approximately $2,548,000, $3,464,000, and $3,707,000, respectively. As a result of dissolution activities of the Intelligent Power Group and the Intelligent E-commence Group, losses on asset write-off of $24,000 and $462,000, respectively, on property and equipment were incurred for the years ended December 31, 2014 and 2012. Please see discussions in note 3. In August 2009, the Company sold its land, located in Hsinchu, Taiwan, to a real estate developer in exchange for a portion of the real estate after it is developed, which includes a portion of an office building and a portion of a parking lot, with a carrying value of approximately $8,918,000. The Company consummated this transaction to acquire office building space and parking lot space for the purpose of future operations and business growth. The Company deferred the transaction gain of $129,000 during the construction period. In the fourth quarter of 2014, some units of the building were completed and the Company recorded realized gain of $72,000 accordingly. Considering the Company’s current operating scale and capital requirements, the Company leased out three units to a third party in December 2014. The Company also sold two building units to third parties in the fourth quarter of 2014. As a result of the sale of building units, a net gain of $458,000 was recorded for the year ended December 31, 2014. - 26 - 11. INTANGIBLE ASSETS, NET Intangible assets consisted of the following as of December 31, 2013 (nil as of December 31, 2014): (In Thousands) Gross Carrying Accumulated Amount Amortization Write-off Asset Net Developed technologies Other $ 2,564 317 $ (1,366) (317) $ (1,198) - $ $ 2,881 $ (1,683) $ (1,198) $ - - - As a result of dissolution activities of the Intelligent E-Commerce Group, a loss on asset write-off of $1,198,000 on intangible assets was incurred for the year ended December 31, 2012. Please see discussions in note 3. Amortization expense of the intangible assets acquired was approximately $31,000 for the year ended December 31, 2013. The intangible assets were fully amortized in the year ended December 31, 2013. 12. OTHER ASSETS Deferred charges Land use rights Refundable deposits Deferred income tax assets - noncurrent (In Thousands) December 31 2014 2013 $ 1,338 1,151 565 114 $ 1,554 1,179 681 95 $ 3,168 $ 3,509 Deferred charges are advanced payments for consulting, maintenance, and engineering license contracts and are amortized over the terms of the contracts from 2 to 5 years. Amortization expense of the deferred charges for the years ended December 31, 2014, 2013, and 2012, was approximately $1,142,000, $1,162,000, and $1,299,000, respectively. As a result of dissolution activities of the Intelligent Power Group and the Intelligent E-Commerce Group, losses on asset write-off of $58,000 and $660,000, respectively, on deferred charges incurred for the years ended December 31, 2014 and 2012. Please see discussions in note 3. All land within municipal zones in China is owned by the government. Limited liability companies, joint stock companies, foreign-invested enterprises, privately held companies and individual natural persons must pay fees for granting of rights to use land within municipal zones. Legal use of land is evidenced and sanctioned by land use certificates issued by the local municipal administration of land resources. Land use rights granted for industrial purposes are limited to a term of no more than 50 years. Land use rights are recorded at cost less accumulated amortization. Amortization is provided on a straight-line basis over the term of the land use rights agreement which is 49.7 years. Amortization expense of the land use rights for the years ended December 31, 2014, 2013, and 2012, was approximately $28,000, $28,000, and $29,000, respectively. - 27 - 13. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES Salaries, bonus and benefits Engineering related expenses Legal and audit fees Value-added tax payable Consulting fees Withholding tax payable Deferred income tax liabilities Shipping expenses Promotional expenses Other accrued expenses 14. INCOME TAX (In Thousands) December 31 2014 2013 $ 3,094 1,030 258 158 150 138 119 92 56 954 $ 2,697 645 456 81 150 151 21 120 155 877 $ 6,049 $ 5,353 The Company is not subject to income or other taxes in the Cayman Islands. However, subsidiaries are subject to taxes of the jurisdiction where they are located. Loss before income taxes from continuing operations consisted of: (In Thousands) Years Ended December 31 2013 2014 2012 Cayman Islands Foreign Income tax expense from continuing operations consisted of: $(18,943) 5,070 $(22,116) 4,015 $(31,218) 5,633 $(13,873) $(18,101) $(25,585) (In Thousands) Years Ended December 31 2013 2014 2012 Current Deferred $ 1,106 78 $ 951 41 $ 1,002 101 Income tax expense $ 1,184 $ 992 $ 1,103 Income tax expenses (benefit) from discontinued operations were $0, $0, and $(1,000) for the years ended December 31, 2014, 2013, and 2012, respectively. The Company and its subsidiaries file separate income tax returns. The applicable statutory income tax rate in the Cayman Islands was zero for the Company for the years being reported. The reconciliation between the provision for income taxes at the statutory rate and the provision for income taxes at the effective tax rate is as follows: - 28 - (In Thousands) Years Ended December 31 2013 2014 2012 Tax expense at statutory rate Increase (decrease) in tax resulting from: Differences between Cayman and foreign tax rates Changes in deferred income tax assets Adjustments to prior years’ taxes Changes in valuation allowances for deferred income tax assets Other $ - $ - $ - 989 (72) 23 150 94 808 (474) 20 515 123 1,048 156 (2) (55) (44) $ 1,184 $ 992 $ 1,103 The deferred income tax assets and liabilities as of December 31, 2014 and 2013 consisted of the following: Deferred income tax assets Research and development credits Net operating loss carryforwards Depreciation and amortization Accrued vacation and other expenses Valuation allowance Total net deferred income tax assets Deferred income tax liabilities Unrealized capital allowance Unrealized foreign exchanges (In Thousands) December 31 2014 2013 $ 5,858 101 293 98 6,350 (6,219) $ 5,634 71 301 174 6,180 (6,069) $ 131 $ 111 $ $ 10 109 $ 119 $ 16 5 21 The valuation allowance shown in the table above relates to net operating losses, credit carryforwards and temporary differences for which the Company believes that realization is not more than likely. The valuation allowance increased by $150,000 and $515,000 and decreased by $55,000 for the years ended December 31, 2014, 2013, and 2012, respectively. The changes in the valuation allowance in 2014, 2013, and 2012 were primary due to the fluctuations in R&D credits from O2Micro Inc. that could not be utilized. As of December 31, 2014, O2Micro, Inc. had U.S. federal and state research and development credit carryforwards of approximately $5,349,000 and $6,590,000, respectively. The US federal research and development credit will expire from 2022 through 2034 if not utilized, while the state research and development credit will never expire. Utilization of the research and development credits may be subject to significant annual limitation due to the ownership change limitations provided by the U.S. Internal Revenue Code of 1986 and similar provisions in the State of California’s tax regulations. The annual limitation may result in the expiration of federal research and development credits before utilization. The Company files income tax returns in various foreign jurisdictions. The Company is generally no longer subject to income tax examinations by tax authorities for years prior to 2009 because of the statute of limitations. 15. RETIREMENT AND PENSION PLANS The Company has a savings plan that qualifies under Section 401(k) of the US Internal Revenue Code. Participating employees may defer up to the US Internal Revenue Service statutory limit amounts of pretax - 29 - salary. The Company may make voluntary contributions to the savings plan but has made no contributions since the inception of the savings plan in 1997. The Company also participates in mandatory pension funds and social insurance schemes, if applicable, for employees in jurisdictions in which other subsidiaries or offices are located to comply with local statutes and practices. For the years ended December 31, 2014, 2013, and 2012, pension costs charged to income in relation to the contributions to these schemes were $1,328,000, $1,586,000, and $1,837,000, respectively. The Company adopted a defined benefit pension plan and established an employee pension fund committee for certain employees of O2Micro-Taiwan who are subject to the Taiwan Labor Standards Law (“Labor Law”) to comply with local requirements. This benefit pension plan provides benefits based on years of service and average salary computed based on the final six months of employment. The Labor Law requires the Company to contribute between 2% to 15% of employee salaries to a government specified plan, which the Company currently makes monthly contributions equal to 2% of employee salaries. Contributions are required to be deposited in the name of the employee pension fund committee with the Bank of Taiwan. The government is responsible for the administration of all the defined benefit plans for the companies in Taiwan under the Labor Standards Law. The government also sets investment policies and strategies, determines investment allocation and selects investment managers. As of December 31, 2014 and 2013, the asset allocation was primarily in cash, equity securities and debt securities. Furthermore, under the Labor Standards Law, the rate of return on assets shall not be less than the average interest rate on a two-year time deposit published by the local banks and the government is responsible for any shortfall in the event that the rate of return is less than the required rate of return. However, information on how investment allocation decisions are made, inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period and significant concentrations of risk within plan assets is not fully made available to the companies by the government. Therefore, the Company is unable to provide the required fair value disclosures related to pension plan assets. The percentage of major category of plan assets as of December 2014 and 2013 were as follows: Cash Debt securities Equity securities December 31 2014 2013 19% 31% 50% 23% 32% 45% Changes in projected benefit obligation and plan assets for the years ended December 31, 2014 and 2013 were as follows: (In Thousands) Years Ended December 31 2013 2014 2012 Projected benefit obligation, beginning of the year Service cost Interest cost Benefits paid Actuarial (gain) loss Effect of changes in foreign exchange rate $ 933 3 17 - (61) (54) $ 1,220 3 18 - (277) (31) $ 1,074 5 20 - 76 45 Projected benefit obligation, end of the year $ 838 $ 933 $ 1,220 Fair value of plan assets, beginning of the year Employer contributions Actual return on plan assets Effect of changes in foreign exchange rate $ $ $ 542 24 12 (33) 512 36 7 (13) 446 42 5 19 Fair value of plan assets, end of the year $ 545 $ 542 $ 512 - 30 - The component of net periodic benefit cost was as follows: (In Thousands) Years Ended December 31 2013 2014 2012 Service cost Interest cost Expected return on plan assets Amortization of net pension loss $ $ 3 17 (9) 6 $ 3 18 (9) 20 5 20 (10) 17 Net periodic benefit cost $ 17 $ 32 $ 32 The funded status of the plan was as follows: Accumulated benefit obligation Project benefit obligation Plan assets at fair value Funded status of the plan (In Thousands) December 31 2014 2013 $ (653) $ (711) (838) 545 (933) 542 $ (293) $ (391) The actuarial assumptions to determine the benefit obligations were as follows: Discount rate Rate of compensation increases December 31 2014 2013 2.0% 2.0% 2.0% 2.0% The actuarial assumptions to determine the net periodic benefit cost were as follows: Years Ended December 31 2013 2014 2012 Discount rate Rate of compensation increases Expected long-term rate of return on plan assets 2.0% 2.0% 1.8% 2.0% 2.0% 1.8% 1.5% 2.0% 1.8% The expected long-term rate of return shown for the plan assets was weighted to reflect a two-year deposit interest rate of local banking institutions. - 31 - Estimated future benefit payments are as follows: Year 2015 2016 2017 2018 2019 and thereafter 16. STOCK-BASED COMPENSATION Employee Stock Purchase Plan (In Thousands) $ 5 5 14 36 284 In October 1999, the Board adopted the 1999 Employee Stock Purchase Plan (“1999 Purchase Plan”), which was approved by the shareholders prior to the consummation of its initial public offering in August 2000. A total of 50,000,000 ordinary shares were reserved for issuance under the 1999 Purchase Plan, plus annual increases on January 1 of each year, commencing in 2001, up to 40,000,000 shares as approved by the Board. In June 2008, an additional 20,000,000 shares were reserved for issuance as also approved by the Board. The 1999 Purchase Plan was subject to adjustment in the event of a stock split, stock dividend or other similar changes in ordinary shares or capital structure. The 1999 Purchase Plan permitted eligible employees to purchase ordinary shares through payroll deductions, which may range from 1% to 10% of an employee’s regular base pay. Beginning November 1, 2005, the 1999 Purchase Plan was implemented through consecutive offer periods of 3 months’ duration commencing on the first day of February, May, August and November. Under the 1999 Purchase Plan, ordinary shares may be purchased at a price equal to the lesser of 90% of the fair market value of the Company’s ordinary shares on the date of grant of the option to purchase (which is the first day of the offer period) or 90% of the fair market value of the Company’s ordinary shares on the applicable exercise date (which is the last day of the offer period). Employees may have elected to discontinue their participation in the purchase plan at any time; however, all of the employee’s payroll deductions previously credited to the employee’s account will be applied to the exercise of the employee’s option on the next exercise date. Participation ends automatically on termination of employment with the Company. If not terminated earlier, the 1999 Purchase Plan had a term of 10 years. By 2009, 10,685,400 ordinary shares had been purchased under the 1999 Purchase Plan. As approved by the EGM held on May 30, 2009, the Company adopted the 2009 Employee Stock Purchase Plan (“2009 Purchase Plan”) along with the Company delisting from SEHK in September 2009. The 2009 Purchase Plan succeeded the 1999 Purchas Plan, and the terms and provisions of 2009 Purchase Plan are generally the same as the 1999 Purchase Plan. The 2009 Purchase Plan has a term of 10 years, if not terminated earlier. A total of 25,000,000 ordinary shares were reserved for issuance under the 2009 Purchase Plan starting November 2009. As approved by the Annual General Meeting of Shareholders (“AGM”) held on June 22, 2012, additional 15,000,000 ordinary shares were reserved for issuance under the 2009 Purchase Plan. From 2012 to 2014, 18,884,800 ordinary shares had been purchased under the 2009 Purchase Plan. Stock Option Plans In 1997, the Board adopted the 1997 Stock Plan, and in 1999, adopted the 1999 Stock Incentive Plan. The plans provide for the granting of stock options to employees, directors and consultants of the Company. Under the 1997 Stock Plan, the Board reserved 185,000,000 ordinary shares for issuance. After the completion of an initial public offering, no further options were granted under the 1997 Stock Plan. Under the 1999 Stock Incentive Plan, the maximum aggregate number of shares available for grant was 150,000,000 ordinary shares plus an annual increase on January 1 of each year, which commenced in 2001, equal to the lesser of 75,000,000 shares or 4% of the outstanding ordinary shares on the last day of the preceding fiscal year or a smaller number determined by the plan administrator. As of December 31, 2014, the number of options outstanding and exercisable was 67,115,600 and 67,115,600, respectively, under the 1999 Stock Incentive Plan. - 32 - The Board adopted the 2005 Share Option Plan (“2005 SOP”), which was effective on March 2, 2006, the date the Company completed the listing on the SEHK. The adoption of the 2005 SOP also resulted in the Board terminating the 1997 Stock Plan and 1999 Stock Incentive Plan. The Company began issuing stock options solely under the 2005 SOP for up to 100,000,000 ordinary shares. As approved by the EGM held on May 30, 2009, the number of shares available for issue was increased from 100,000,000 to 175,000,000 shares. The references to Hong Kong and Hong Kong related rules and regulations were also removed along with the completion of the Company’s delisting from the SEHK in 2009. As approved by the AGM held on June 22, 2012, additional 50,000,000 ordinary shares were reserved for issuance under the 2005 SOP. Under the terms of the 2005 SOP, stock options are generally granted at fair market value of the Company’s ordinary shares. The stock options have a contractual term of 8 years from the date of grant and vest over a requisite service period of 4 years. As of December 31, 2014, the number of options outstanding and exercisable was 161,551,000 and 126,393,300, respectively, under the 2005 SOP. A summary of the Company’s stock option activity under the plans as of December 31, 2014, and changes during the year then ended is presented as follows: Number of Options Shares Weighted Weighted Average Average Remaining Exercise Contract Life Price Aggregate Intrinsic Value Outstanding Options, January 1, 2014 Granted Exercised Forfeited or expired 247,157,450 19,840,000 (796,900) (37,533,950) $ 0.1482 $ 0.0706 $ 0.0549 $ 0.1921 Outstanding Options, December 31, 2014 228,666,600 $ 0.1345 2.88 $ 48,000 Vested and Expected to Vest Options at December 31, 2014 226,113,220 $ 0.1352 2.84 $ 48,000 Exercisable Options at December 31, 2014 193,508,900 $ 0.1452 2.26 $ 48,000 The total intrinsic value of options exercised during the years ended December 31, 2014, 2013, and 2012 was $13,000, $9,000, and $74,000, respectively. The following table summarizes information about outstanding and vested stock options: Options Outstanding Options Exercisable Range of Exercise Prices $0.0460 - $0.0612 $0.0620 - $0.0940 $0.0948 - $0.1594 $0.1636 - $0.1774 $0.2036- $0.3432 Number Outstanding 35,580,950 45,194,650 43,649,800 34,053,100 70,188,100 Life 2.73 6.08 3.84 1.65 0.89 Weighted Average Weighted Remaining Average Contractual Exercise Price Number Exercisable and Vested Weighted Average Exercise Price $ 0.0491 32,393,000 $ 0.0718 19,464,100 $ 0.1178 38,021,800 $ 0.1664 33,441,900 $ 0.2132 70,188,100 $ 0.0479 $ 0.0759 $ 0.1194 $ 0.1664 $ 0.2132 Balance, December 31, 2014 228,666,600 2.88 $ 0.1345 193,508,900 $ 0.1452 - 33 - The Company calculated the fair value of each option grant on the date of grant using the Black-Scholes option pricing model that use the assumptions in the following table. Risk-free interest rate is based on the US Treasury yield curve in effect at the time of grant. The Company uses the simplified method to estimate the expected life because the options are considered as plain vanilla share-based payment awards. Expected volatilities are based on historical volatility of stock prices for a period equal to the options’ expected term. The dividend yield is zero as the Company has never declared or paid dividends on the ordinary shares or other securities and does not anticipate paying dividends in the foreseeable future. Stock Options Years Ended December 31 2013 2014 2012 Employee Stock Purchase Plan Years Ended December 31 2013 2012 2014 Risk-free interest rate Expected life Volatility Dividend 1.49%-1.76% 0.68%-1.75% 0.59%-1.04% 0.02%-0.05% 0.04%-0.06% 0.06%-0.10% 5 Years 34%-37% - 5 Years 40%-48% - 5 Years 48%-50% - 0.25-0.26 Years 30%-45% - 0.25-0.26 Years 24%-40% - 0.25-0.26 Years 27%-45% - The weighted-average grant-date fair value of options granted during the years ended December 31, 2014, 2013, and 2012 was $0.0245, $0.0263, and $0.0438, respectively. The weighted-average fair value of options granted under the 2009 Purchase Plan during the years ended December 31, 2014, 2013, and 2012 was $0.0104, $0.0106, and $0.0140, respectively. Share Incentive Plan The Board adopted the 2005 Share Incentive Plan (“2005 SIP”), which was effective on March 2, 2006, the date the Company completed the SEHK listing. The 2005 SIP provides for the grant of restricted shares, RSU, share appreciation rights and dividend equivalent rights (collectively referred to as “Awards”) up to 75,000,000 ordinary shares. As approved by the EGM held on May 30, 2009, the number of shares available for issue was increased from 75,000,000 to 125,000,000 shares. The references to Hong Kong and Hong Kong related rules and regulations were also removed along with the completion of the Company’s delisting from the SEHK. As approved by the AGM held on June 22, 2012, an additional 62,500,000 ordinary shares were reserved for issuance under the 2005 SIP. Awards may be granted to employees, directors and consultants. The RSUs vest over a requisite service period of 4 years. A summary of the status of the Company’s RSUs as of December 31, 2014, and changes during the year ended December 31, 2014, is presented as follows: Nonvested at January 1, 2014 Granted Vested Forfeited and expired Number of Outstanding Awards Weighted Average Grant-Date Fair Value 36,215,100 29,222,650 (12,903,400) (5,710,500) $ 0.0824 $ 0.0691 $ 0.0921 $ 0.0705 Nonvested at December 31, 2014 46,823,850 $ 0.0710 As of December 31, 2014, there was $2,908,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the plans including stock options and RSUs. The cost is expected to be recognized over a weighted-average period of 2.34 years. The total fair value of RSUs vested during the years ended December 31, 2014, 2013, and 2012was $1,189,000, $1,321,000, and $1,474,000, respectively. Cash received from option exercise under all share-based payment arrangements for the years ended December 31, 2014, 2013, and 2012 was $302,000, $360,000, and $612,000, respectively. Ordinary Shares Reserved - 34 - As of December 31, 2014, ordinary shares reserved for future issuance were as follows: Outstanding stock options Outstanding RSUs Shares reserved for future stock option grants Shares reserved for Employee Stock Purchase Plan Shares reserved for Awards 228,666,600 46,823,850 54,697,550 10,335,100 55,569,900 396,093,000 Shares issued for the exercise of stock options, Employee Stock Purchase Plan and shares vested under restricted stock units are from the treasury shares. 17. EARNINGS (LOSS) PER SHARE Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of ordinary shares outstanding during the period. Diluted earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of ordinary and dilutive ordinary equivalent shares outstanding during the period, using the treasury stock method for options. A reconciliation of the numerator and denominator of basic and diluted earnings (loss) per share calculations was as follows: Years Ended December 31 2013 2014 2012 Net loss from continuing operations (in thousands) Income (loss) from discontinued operations (in thousands) $ (15,057) - $ (19,093) (6) $ (26,688) 895 Net loss (in thousands) $ (15,057) $ (19,099) $ (25,793) Weighted average shares outstanding (in thousands) – basic 1,362,465 1,435,778 1,552,190 Effect of dilutive securities: Options and RSUs (in thousands) - - - Weighted average shares outstanding (in thousands) – diluted 1,362,465 1,435,778 1,552,190 Loss per share – basic and diluted Continuing operations Discontinued operations $ (0.01) $ (0.01) $ - (0.01) $ - (0.01) $ $ (0.02) - (0.02) Certain outstanding options and RSUs were excluded from the computation of diluted EPS since their effect would have been anti-dilutive. The anti-dilutive stock options excluded and their associated exercise prices per share were 228,666,600 shares at $0.0460 to $0.3462 as of December 31, 2014, 247,157,450 shares at $0.0558 to $0.4792 as of December 31, 2013, and 261,321,450 shares at $0.0460 to $0.4792 as of December 31, 2012. The anti-dilutive RSUs excluded were 46,823,850 shares, 36,215,100 shares, and 32,838,550 shares as of December 31, 2014, 2013, and 2012, respectively. - 35 - 18. COMMITMENTS Lease Commitments The Company leases office space and certain equipment under non-cancelable operating lease agreements that expire at various dates through December 2019. For the years ended December 31, 2014, 2013, and 2012, leasing costs charged to income in relation to these agreements were $2,415,000, $2,661,000, and $2,918,000, respectively. The Company’s office lease provides for periodic rental increases based on the general inflation rate. As of December 31, 2014, future minimum lease payments under all non-cancelable operating lease agreements were as follows: Year 2015 2016 2017 2018 2019 Total minimum lease payments (In Thousands) Operating Leases $ 1,542 659 291 177 67 $ 2,736 Purchase obligations and commitments include payments due under various types of license, maintenance and support agreements with contractual terms within one year. As of December 31, 2014, those purchase commitments amounted to $997,000. 19. CONTINGENCIES Legal Proceedings The Company is involved in several litigation matters relating to its intellectual property, as detailed below. While the Company cannot make any assurances regarding the eventual resolution of these matters, the Company does not believe at this time that the final outcomes will have a material adverse effect on its consolidated results of operations or financial condition. Monolithic Power Systems, Inc. v. O2Micro International Limited, Case No. C 08-4567 CW. On October 1, 2008, Monolithic Power Systems, Inc. (“MPS”) filed a complaint in the United States District Court in the Northern District of California for declaratory judgment that certain claims of the Company’s patents are invalid and not infringed. The Company filed counterclaims for patent infringement. The matter was scheduled for trial in July 2010; however the Company dismissed the case in June 2010, and agreed not to assert the patent in dispute for this matter against MPS. MPS moved for costs and attorneys fees. On May 3, 2012, the Court approved MPS’ revised motion and set the final award of $8,419,429 in attorneys’ fees, and two orders of costs for $663,151 and $339,315 and accordingly, the Company recorded approximately $9.4 million of provision for litigation as of December 31, 2012. The Company filed an appeal with the United States Court of Appeals for the Federal Circuit (Case No. 12-1221), and filed a supersedeas bond to secure the judgment. The matter was affirmed on appeal on August 13, 2013, by the United States Court of Appeals, Federal Circuit, and the supersedeas bond was released and a Satisfaction of Judgment was filed on November 21, 2013, in the amount of $9,488,926 and the restricted assets were subsequently released in December 2013. The Company appealed the matter before the United States Supreme Court, which was denied on March 24, 2014, and the matter is now closed. O2Micro, Inc. v. Texas Instruments Japan Limited. In November 2013, the Company filed a patent infringement suit against Texas Instruments Japan Limited (“Texas Instrument”) in the Civil Division of the Tokyo District Court. The complaint alleges, inter alia, that Texas Instruments’ charging products infringe on the Company’s related Japanese patents. The matter is currently pending. O2 Holdings Limited v. O2Micro International Ltd., Germany, District of Hamburg. On August 20, 2008, the Regional Court of Hamburg issued a temporary restraining order prohibiting the Company from using the trademark “O2Micro” and “O2Micro Breathing Life into Mobility” in Germany. A hearing was held, - 36 - and on November 4, 2009, the initial order was upheld, and the Appellate Court upheld the initial ruling in August 2012. The parties settled the case, and the case has been dismissed. retailer. With O2Micro (Wuhan) Co Ltd. v. Protek (Shanghai) Ltd., et al., Wuhan Intermediate Court, China. On February 10, 2011, the Company filed a patent infringement action in Wuhan Intermediate Court against ASUS Notebook manufacturer “Protek (Shanghai) Ltd.” and Wuhan Heyonghaoyu Co Ltd., the infringing the Company added ChiMei-Innolux Corporation product (“ChiMei-Innolux”), Richtek Technology Corporation (“Richtek”) et al. as defendants. The objection to the jurisdiction made by ChiMei-Innolux and Richtek has been rejected by court. The Company and Richtek submitted their respective test scheme in November 2012 and tested respectively in the court on March 16, 2013. The first hearing was held on May 21. 2013. The Company dismissed the case in April 2014. further evidence, O2Micro(China) v. Legendsec Information Technology (Beijing) Inc., et al., Chengdu Intermediate Court, China. The Company filed a trade secret infringement suit against Yunfeng Li, Feitong and Legendsec Information Technology (Beijing) Inc. (“Legendsec”) in Chengdu Intermediate Court on August 18, 2014, requesting the three defendants to stop the infringement actions and claim for compensatory damages. The first hearing was held on October 30, 2014. The matter is currently pending. O2Micro(China) v. Legendsec Information Technology (Beijing) Inc., Beijing Haidian District People's Court, China. The Company filed a copyright infringement suit against Legendsec in Beijing Haidian District People's Court on November 19, 2014, requesting the defendant to stop the infringement actions and claimed for compensatory damages. The first hearing was held on March 16, 2015. The matter is currently pending. The Company received $75,000, $0, and $100,000 litigation income in relation to patent litigation cases in the United States for the years ended December 31, 2014, 2013, and 2012, respectively. The Company, as a normal course of business, is a party to litigation matters, legal proceedings, and claims. These actions may be in various jurisdictions and may involve patent protection and/or infringement. While the results of such litigations and claims cannot be predicted with certainty, the final outcome of such matters is not expected to have a material adverse effect on its consolidated financial position or results of operations. No assurance can be given, however, that these matters will be resolved without the Company becoming obligated to make payments or to pay other costs to the opposing parties, with the potential for having an adverse effect on the Company’s financial position or its results of operations. Except for the litigation provision stated above, no other provision for any litigation has been provided as of December 31, 2014 and 2013. 20. FINANCIAL INSTRUMENTS Information on the Company’s financial instruments was as follows: (In Thousands) December 31 2014 2013 Carrying Amount Fair Value Carrying Amount Fair Value $ 41,069 164 21,481 $ 41,069 164 21,481 $ 42,293 173 33,606 $ 42,293 173 33,606 Assets Cash and cash equivalents Restricted cash Short-term investments Long-term investments in available-for-sale securities - - 1,284 1,284 The carrying amounts of cash and cash equivalents and restricted cash reported in the consolidated balance sheets approximate their estimated fair values. The fair values of short-term investments and long-term investments in available-for-sale securities are based on quoted market prices. - 37 - Long-term investments, except for investments in available-for-sale securities, are in privately-held companies where there is no readily determinable market value and are recorded using the cost method. Since they entail an unreasonable high cost to obtain verifiable fair values, fair value is not presented. The Company periodically evaluates these investments for impairment. If it is determined that an other-than-temporary decline has occurred in the carrying value, an impairment loss is recorded in the period of decline in value. 21. SEGMENT INFORMATION In September 2008, the Board approved a plan to transfer Network Security business to O2Security along with its Series A preference shares financing. In anticipation of the business transfer, management identified two reportable segments, including Integrated Circuit Group and Network Security Group. The Integrated Circuit Group’s core products and principal source of revenue are its power management semiconductors. These semiconductor products are produced with digital, analog, and mixed signal integrated circuit (“IC”) manufacturing processes. The Network Security Group’s system security solution products include support for VPN and firewalls, which provide security functions between computer systems and networks, including the transmission of data across the Internet. In November 2010, the Company determined to discontinue the Network Security Group. Please see discussions in note 3. The Company does not identify or allocate assets by operating segment, nor does the chief operating decision maker (“CODM”) evaluate operating segments using discrete asset information. The Company does not have inter-segment revenue, and, accordingly, there is none to be reported. The Company does not allocate gains and losses from interest and other income, or income taxes to operating segments. The accounting policies for segment reporting are the same as for the Company as a whole. Operating segment net sales and operating loss, including the discontinued Network Security Group, were as follows: (In Thousands) Net sales Integrated Circuit Group Network Security Group Loss from operations Integrated Circuit Group Network Security Group Years Ended December 31 2013 2014 2012 $ 63,591 - $ 73,785 - $ 97,666 825 $ 63,591 $ 73,785 $ 98,491 $ (16,823) - $ (20,541) (6) $ (27,970) 767 $ (16,823) $ (20,547) $ (27,203) Net sales to unaffiliated customers (including the discontinued Network Security Group) by geographic region are based on the customer’s ship-to location and were as follows: China Japan Taiwan Korea Other (In Thousands) Years Ended December 31 2013 2014 2012 $ $ $ 55,133 4,490 2,022 288 1,658 65,602 4,677 1,892 500 1,114 78,709 6,502 2,271 7,965 3,044 $ 63,591 $ 73,785 $ 98,491 For the years ended December 31, 2014 and 2013, two customers accounted for 10% or more of net sales. For the year ended December 31, 2012, only one customer accounted for 10% or more of net sales. Sales - 38 - to these major customers were generated from the Integrated Circuit Group. The percentage of net sales to these customers was as follows: Customer A Customer B Customer C Years Ended December 31 2013 2012 2014 12% 10% 4% 15% 7% 10% 9% 10% 5% Long-lived assets consisted of property and equipment and were as follows based on the physical location of the assets at the end of each year: (In Thousands) Taiwan China U.S.A. Singapore Other 2014 December 31 2013 2012 $ 8,689 $ 6,363 4,188 59 64 10,576 $ 7,872 4,388 98 105 11,608 9,500 4,718 155 161 $ 19,363 $ 23,039 $ 26,142 - 39 -   

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