UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2013

or

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from     to   

Commission File No. 001-33813

MEMSIC, Inc.
(Exact name of registrant as specified in its charter)

Delaware	04-3457049
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)
One Tech Drive, Suite 325 Andover, Massachusetts	01810
(Address of principal executive offices)	(Zip Code)

(978) 738-0900
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  ☒No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ☒ No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐     Accelerated filer ☐     Non-accelerated filer ☐     Smaller reporting company ☒

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes  ☐ No  ☒

The number of shares of common stock, par value $0.00001 per share, of the registrant outstanding as of August 9, 2013 was 24,449,824.

MEMSIC, Inc.

FORM 10-Q, March 31, 2013

TABLE OF CONTENTS

		PAGE NO.
PART I.	FINANCIAL INFORMATION
ITEM 1.	Financial Statements
	Unaudited Consolidated Balance Sheets as of June 30, 2013 and December 31, 2012	1
	Unaudited Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2013 and 2012	2
	Unaudited Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2013 and 2012	3
	Unaudited Consolidated Statement of Stockholders’ Equity as of June 30, 2013	4
	Unaudited Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2013 and 2012	5
	Notes to Unaudited Consolidated Financial Statements	6
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
ITEM 4.	Controls and Procedures	32
PART II.	OTHER INFORMATION
ITEM 1.	Legal Proceedings	33
ITEM 1A.	Risk Factors	33
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33
ITEM 6.	Exhibits	34
Signatures

PART I.   FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

MEMSIC, Inc.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

	June 30,			December 31,
	2013			2012
ASSETS
Current assets:
Cash and cash equivalents	$	38,583,630		$	27,306,202
Restricted cash		2,743,062			2,867,896
Short-term investments		20,000,000			34,640,188
Accounts receivable, net of allowance for doubtful accounts of $8,356 and $18,774, respectively, as of June 30, 2013 and December 31, 2012		4,472,242			4,821,867
Inventories		8,619,887			9,840,659
Other current assets		2,078,356			2,285,923
Total current assets		76,497,177			81,762,735
Property and equipment, net		30,980,960			29,002,825
Long-term investments		2,500,000			2,500,000
Intangible assets, net		9,413,499			9,918,305
Other assets		137,182			144,106
Total assets	$	119,528,818		$	123,327,971
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	5,754,949		$	3,778,672
Accrued expenses		2,913,365			3,934,975
Advance research funding		2,743,062			2,867,896
Current portion of note payable to bank		2,500,000			1,000,000
Total current liabilities		13,911,376			11,581,543
Note payable to bank, net of current portion		13,930,000			16,430,000
Building liability		8,257,988			8,135,115
Other liabilities		100,237			86,420
Total other liabilities		22,288,225			24,651,535
Stockholders’ equity:
Common stock, $0.00001 par value; authorized, 45,000,000 shares; 24,312,704 and 24,219,685 shares issued and outstanding at June 30, 2013 and December 31, 2012, respectively		243			242
Additional paid-in capital		103,537,903			102,813,203
Accumulated other comprehensive income		4,898,004			4,477,071
Accumulated deficit		(25,636,990	)		(20,896,074	)
MEMSIC, Inc. stockholders' equity		82,799,160			86,394,442
Non-controlling interest related to joint ventures		530,057			700,451
Total stockholders' equity		83,329,217			87,094,893
Total liabilities and stockholders’ equity	$	119,528,818		$	123,327,971

See notes to consolidated financial statements (unaudited)

1

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three months ended June 30,						Six months ended June 30,
	2013			2012			2013			2012
Net sales	$	13,179,094		$	14,415,237		$	24,607,377		$	34,432,290
Cost of goods sold		8,225,181			8,630,850			15,494,839			21,230,804
Gross profit		4,953,913			5,784,387			9,112,538			13,201,486
Operating expenses:
Research and development		1,917,807			1,769,201			3,863,179			3,472,360
Sales and marketing		872,237			1,228,408			2,014,303			2,660,707
General and administrative		4,075,952			2,399,923			7,019,341			4,635,995
Depreciation		342,644			378,354			668,815			817,295
Amortization		307,079			413,886			758,023			810,008
Total operating expenses		7,515,719			6,189,772			14,323,661			12,396,365
Operating (loss) income		(2,561,806	)		(405,385	)		(5,211,123	)		805,121
Other income:
Interest and dividend income		7,580			125,259			40,615			233,034
Foreign exchange gain (loss)		237,559			(193,190	)		318,062			(225,453	)
Other, net		12,374			25,468			80,365			38,641
Total other income (loss)		257,513			(42,463	)		439,042			46,222
Loss before income taxes		(2,304,293	)		(447,848	)		(4,772,081	)		851,343
Provision for income taxes		6,098			29,355			36,405			97,938
Net (loss) income		(2,310,391	)		(477,203	)		(4,808,486	)		753,405
Less: net (loss) income attributable to noncontrolling interests		(33,393	)		(15,789	)		(67,570	)		14,315
Net (loss) income attributable to MEMSIC, Inc.	$	(2,276,998	)	$	(461,414	)	$	(4,740,916	)	$	739,090
Net (loss) income per common share attributable to MEMSIC, Inc.:
Basic	$	(0.09	)	$	(0.02	)	$	(0.20	)	$	0.03
Diluted	$	(0.09	)	$	(0.02	)	$	(0.20	)	$	0.03
Weighted average shares outstanding used in calculating net (loss) income per common share:
Basic		24,236,445			23,986,332			24,215,415			23,919,650
Diluted		24,236,445			23,986,332			24,215,415			24,404,777

See notes to consolidated financial statements (unaudited)

2

MEMSIC, Inc.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

	Three months ended June 30,						Six months ended June 30,
	2013			2012			2013			2012
Net (loss) income	$	(2,310,391	)	$	(477,203	)	$	(4,808,486	)	$	753,405
Other comprehensive (loss) income:
Unrealized gain on investments		(124	)		(1,054	)		-			(1,057	)
Foreign currency translation adjustments		344,975			(251,473	)		420,933			(327,656	)
Comprehensive (loss) income		(1,965,540	)		(729,730	)		(4,387,553	)		424,692
Less: (loss) income attributable to noncontrolling interest		(33,393	)		(15,789	)		(67,570	)		14,315
Comprehensive (loss) income attributable to MEMSIC, Inc.	$	(1,932,147	)	$	(713,941	)	$	(4,319,983	)	$	410,377

See notes to consolidated financial statements (unaudited)

3

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

(Unaudited)

										Accumulated
							Additional			Other					MEMSIC, Inc.			Non-
	Common Stock						Paid-In			Comprehensive		Accumulated			Stockholders’			controlling			Total
	Shares			Par Value			Capital			Income		Deficit			Equity			Interest			Equity
Balance at December 31, 2012		24,219,685		$	242		$	102,813,203		$	4,477,071	$	(20,896,074	)	$	86,394,442		$	700,451		$	87,094,893
Net loss											-		(4,740,916	)		(4,740,916	)		(67,570	)		(4,808,486	)
Foreign currency translation adjustment											420,809		-			420,809			-			420,809
Unrealized loss on investment											124		-			124			-			124
Exercise of options to purchase common stock		36,051			0			77,624								77,625						77,625
Issuance of restricted stock award		61,968			1			(12,924	)							(12,924	)					(12,924	)
Stock compensation expense								660,000								660,000						660,000
Retirement of common stock		(5,000	)		(0	)										(0	)					(0	)
Dividend paid to non-controlling interest																-			(102,824	)		(102,824	)
Balance at June 30, 2013		24,312,704		$	243		$	103,537,903		$	4,898,004	$	(25,636,990	)	$	82,799,160		$	530,057		$	83,329,217

See notes to consolidated financial statements (unaudited)

4

MEMSIC, Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Six months ended June 30,
	2013			2012
Cash flows from operating activities:
Net (loss) income	$	(4,808,486	)	$	753,405
Adjustments to reconcile net (loss) income to cash provided by operating activities:
Depreciation		1,400,475			1,808,654
Amortization		824,722			805,093
Stock compensation expense		660,000			751,001
Deferred rent		13,817			(17,837	)
Deferred income taxes		18,976			(3,725	)
Changes in operating assets and liabilities:
Restricted cash		168,151			833,490
Accounts receivable		238,297			1,946,748
Inventories		1,313,455			451,014
Other assets		148,300			(523,387	)
Advance research funding		(168,151	)		(833,490	)
Accounts payable and accrued expenses		1,005,551			(4,304,093	)
Net cash provided by operating activities		815,107			1,666,873
Cash flows from investing activities:
Purchase of short-term investments		(20,000,000	)		(28,075,075	)
Proceeds from sale of short-term investments		34,640,000			-
Purchase of property and equipment		(2,956,171	)		(1,075,088	)
Net cash provided by (used in) investing activities		11,683,829			(29,150,163	)
Cash flows from financing activities:
Cash dividend paid to non-controlling interest		(102,824	)		(59,129	)
Proceeds from exercise of options to purchase common stock		64,701			193,538
Payment on note payable to bank		(1,000,000	)		(500,000	)
Net cash used in financing activities		(1,038,123	)		(365,591	)
Effect of exchange rate changes on cash and cash equivalents		(183,385	)		(48,580	)
Net increase (decrease) in cash and cash equivalents		11,277,428			(27,897,461	)
Cash and cash equivalents —beginning of period		27,306,202			51,914,128
Cash and cash equivalents —end of period	$	38,583,630		$	24,016,667

See notes to consolidated financial statements (unaudited)

5

MEMSIC, Inc.

Notes to Unaudited Consolidated Financial Statements

1. NATURE OF THE BUSINESS AND OPERATIONS

MEMSIC, Inc. (the Company) was incorporated on March 3, 1999 as a Delaware corporation. The Company is a leading provider of semiconductor sensor systems solutions based on micro electromechanical systems (MEMS) technology and advanced integrated circuit design. The Company’s sensor and solution products have a wide range of applications for consumer electronics, mobile phones, automotive (airbags, rollover detection, electronic stability control and navigation systems), as well as business, industrial and medical applications.

MEMSIC, Inc. maintains its corporate headquarters in Massachusetts. All manufacturing operations are provided by its wholly-owned subsidiary, MEMSIC Semiconductor (Wuxi) Company Limited (MEMSIC Semiconductor) and its indirect wholly owned subsidiary, MEMSIC Transducer Systems Company Limited (MTS), which are located in the People’s Republic of China (PRC). The Company also has a majority (51%) owned and controlled joint venture, Crossbow Japan Limited (Crossbow Japan) and an indirect majority (67%) owned and controlled joint venture, MEMSIC Wuxi Wireless Sensor Network Technology Company Limited (Wuxi WSN) in the PRC.

Crossbow Japan

On February 5, 2013, the board of directors of Crossbow Japan voted to dissolve the joint venture as of March 31, 2013. On March 29, 2013, the Company, the other partner of the joint venture, Sumitomo Precision Products Co. Ltd. (“SPP”) and Crossbow Japan signed a Termination Agreement to dissolve and liquidate the joint venture as of March 31, 2013. The Company expects that the liquidation and distribution of the net assets will be finalized during the year ending December 31, 2013.  The Company and SPP also signed a Distributor Agreement to appoint SPP as the exclusive distributor of the Company’s system solution products in Japan effective on April 1, 2013. The Company concluded that the dissolution will not represent a discontinued operation due to the significant continuing involvement as a result of the Distributor Agreement.

IDG Acquisition

On April 22, 2013, the Company entered into an Agreement and Plan of Merger to be acquired by IDG-Accel China Capital II, L.P. and its affiliates MZ Investment Holdings Limited and MZ Investment Holdings Merger Sub Limited (collectively, “IDG”), for $4.225 per share in cash. Affiliates of IDG currently hold approximately 19.5% of the company’s outstanding common stock. IDG and its affiliates will acquire all the outstanding shares of common stock of MEMSIC that are not currently owned by them, including shares underlying outstanding in-the-money equity awards, for approximately $88.5 million. The merger agreement is subject to customary conditions, including a vote of the Company’s stockholders, which is scheduled on September 16, 2013. The transaction is expected to close during the third quarter of 2013.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICES

Principles of Consolidation

The accompanying unaudited consolidated financial statements include the accounts of the Company, MEMSIC Semiconductor, MTS, Crossbow Japan and Wuxi WSN. The Company presents all of Crossbow Japan’s and Wuxi WSN’s assets, liabilities, revenue and expenses, as well as the non-controlling interests in joint ventures in its consolidated financial statements. All significant intercompany balances and transactions have been eliminated in consolidation.

6

Unaudited Interim Financial Information

The accompanying interim consolidated financial statements are unaudited. These financial statements and notes should be read in conjunction with the audited consolidated financial statements and related notes, together with management’s discussion and analysis of financial condition and results of operations, contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, which is on file with the Securities and Exchange Commission (SEC).

The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the SEC. Certain information and footnote disclosures normally included in financial statements that have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) have been condensed or omitted pursuant to such SEC rules and regulations. In the opinion of management, the unaudited interim consolidated financial statements and notes have been prepared on the same basis as the audited consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, and include all adjustments (consisting of normal, recurring adjustments) necessary for the fair presentation of the Company’s financial position at June 30, 2013, results of operations for the three and six months ended June 30, 2013 and 2012 and cash flows for the six months ended June 30, 2013 and 2012. The interim periods are not necessarily indicative of results to be expected for any other interim periods or for the full year.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect at the date of the financial statements the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses. Actual results could differ from these estimates.

Cash Equivalents

The Company considers all highly liquid instruments with an original maturity of three months or less to be cash equivalents.

Restricted Cash

The Company has presented cash on hand associated with advance research funding received from the Chinese government as restricted cash since the cash must be maintained in a separate bank account and used only for specified research projects.

Advance Research Funding

Advance research funding represents research funding granted by the Chinese government for specific research and development projects the Company is taking on. The amount received is initially recorded as a liability and subsequently recognized as a credit to research and development expenses in the statements of operations or to the carrying value of equipment purchased for the projects as the Company performs the projects and has complied with the conditions or performance obligations attached to the related government grants. There are no conditions under which amounts utilized are required to be refunded under the terms of the grants.

7

Advance research funding activities for the six months ended June 30, 2013 are as follows:

	Advanced Research Funding
Balance at January 1, 2013	$	2,867,896
Funds received		456,219
Research and development activities		(161,470	)
Property and equipment expenditures		(462,900	)
Foreign exchange rate impact		43,317
Balance at June 30, 2013	$	2,743,062

Short-term Investments

Short-term investments consist primarily of bank certificate deposits, government and municipal bonds with maturities of one year or less. The Company classifies its short-term investments as “held-to-maturity”, which are carried at amortized cost.

Foreign Currency

The Company’s manufacturing operations and certain other operations are conducted by MEMSIC Semiconductor, MTS and Wuxi WSN. The functional currency of MEMSIC Semiconductor, MTS and Wuxi WSN is the Renminbi. Financial transactions between the Company and MEMSIC Semiconductor and MTS are conducted in United States dollars. At June 30, 2013 and December 31, 2012, the underlying currency for approximately 55.3% and 54.4% of consolidated assets, respectively, was the Renminbi. The functional currency of Crossbow Japan is the Japanese Yen. At June 30, 2013 and December 31, 2012, the underlying currency for approximately 0.4% and 1.4% of consolidated assets, respectively, was the Japanese Yen. The Company does not believe that it is subject to significant foreign exchange risk and, accordingly, has not utilized hedging strategies with respect to such foreign exchange exposure.

The financial statements of MEMSIC Semiconductor, MTS, Wuxi WSN and Crossbow Japan are translated into United States dollars in accordance with GAAP, utilizing the following method: assets and liabilities are translated at the exchange rate in effect at the end of the period, and revenues and expenses are translated at the weighted average exchange rate during the year. Cumulative translation gains and losses are included as a separate component of stockholders’ equity and reported as a part of comprehensive income. Transaction gains and losses are included in the consolidated statements of operations as incurred.

Net Income (Loss) per Common Share

Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted-average common shares outstanding during the period. Diluted net income (loss) per share is calculated by dividing net income (loss) by the weighted-average common shares and potentially dilutive securities outstanding during the period using the treasury stock method.

Income Taxes

Deferred tax assets and liabilities relate to temporary differences between the financial reporting basis and the tax basis of assets and liabilities, the carryforward tax losses and available tax credits. Such assets and liabilities are measured using tax rates and laws expected to be in effect at the time of their reversal or utilization. Valuation allowances are established, when necessary, to reduce the net deferred tax asset to an amount more likely than not to be realized. For interim reporting periods, the Company uses the estimated annual effective tax rate except with respect to discrete items, whose impact is recognized in the interim period in which the discrete item occurred.

8

Inventories

Inventories are stated at the lower of cost (weighted average FIFO) or market. The Company evaluates its inventory for potential excess and obsolete inventories based on forecasted demands and records a provision for such amounts as necessary.

Revenue Recognition 

The Company recognizes revenue from the sale of its products to its customers when all of the following conditions have been met: (i) evidence exists of an arrangement with the customer, typically consisting of a purchase order or contract; (ii) the Company’s products have been shipped and risk of loss has passed to the customer; (iii) the Company has completed all of the necessary terms of the purchase order or contract; (iv) the amount of revenue to which the Company is entitled is fixed or determinable; and (v) the Company believes it is probable that it will be able to collect the amount due from the customer based upon an evaluation of the customer’s creditworthiness. To the extent that one or more of these conditions has not been satisfied, the Company defers recognition of revenue. An allowance for estimated future product returns and sales price allowances is established at the date of revenue recognition. An allowance for uncollectible receivables is established by a charge to operations when, in the opinion of the Company, it is probable that the amount due to the Company will not be collected.

The Company sells its products to distributors as well as to end customers. Sales to distributors are made pursuant to distributor agreements, which allow for the return of goods under certain limited circumstances. Accordingly, the Company follows the following criteria for recognition of sales to distributors: (i) the selling price to the distributor is fixed or determinable at the date of shipment; (ii) the distributor’s obligation to pay the selling price is not contingent on resale of the product; (iii) the Company’s product has been shipped and risk of loss has passed to the distributor; (iv) it is probable that the amount due from the distributor will be collected; (v) the Company does not have significant future obligations to directly assist in the distributor’s resale of the product; and (vi) the amount of future returns can be reasonably estimated. Once these criteria are met, the Company recognizes revenue upon shipment to the distributor and estimates returns based on historical sales returns.

Stock-Based Compensation

   The Company accounts for share-based payments to employees based on requirements that all share-based payments to employees, including grants of employee stock options, shall be recognized in the financial statements based on their fair values. The cost of equity-based service awards is based on the grant-date fair value of the award and is recognized over the period during which the employee is required to provide service in exchange for the award (vesting period). Stock-based compensation arrangements with non-employees are accounted for utilizing the fair value method or, if a more reliable measurement, the value of the services or consideration received. The resulting compensation expense is recognized for financial reporting purposes over the term of performance or vesting.

3. LONG-TERM INVESTMENTS

Investments held by the Company at June 30, 2013 and December 31, 2012 consisted primarily of auction rate securities, or ARS, and are considered available for sale. These securities reset the interest or dividend rates by auctions held at intervals of 7, 28, 35 or 49 days, and at such dates the Company has the option to sell such securities. The auction rate securities held by the Company have a contractual maturity of greater than 10 years.

These investments are carried at fair value, with the unrealized gains and losses, if any, net of tax, reported in other comprehensive income. The cost of securities sold is based on the specific identification method. Interest and dividends on securities are included in interest and dividend income. Quarterly, management reviews the valuation of investments and considers whether any decline in value is deemed to be other than a temporary decline.

9

At June 30, 2013, the Company held one ARS investment: Illinois Educational Facilities Authority Select Auction Variable Rate Securities having a value at par of $3.0 million with a maturity date in 2028. The carrying value of this investment at June 30, 2013 was $2.5 million, net of a $0.5 million temporary unrealized impairment loss. The Company has classified this investment as a long-term asset due to liquidity issues experienced in global credit and capital markets as well as failed auctions since the first quarter of 2008. A failed auction means that the amount of securities submitted for sale at auction exceeded the amount of purchase orders. If an auction fails, the issuer becomes obligated to pay interest at penalty rates, and all of the auction rate securities the Company holds continue to pay interest in accordance with their stated terms. However, the failed auctions create uncertainty as to the liquidity of these securities.

Based on the Company’s expected operating cash flows, and other sources of cash, the Company does not expect the potential lack of liquidity in these investments to affect its ability to execute its current business plan in the near term.

4. FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company’s financial instruments consist primarily of cash equivalents, restricted cash, short-term investments, accounts receivable, long-term investments, accounts payable, notes payable, accrued expenses and long-term debt. The carrying amounts of the Company’s financial instruments, which include cash equivalents, restricted cash, short-term investments, accounts receivable, accounts payable, notes payable and accrued expenses, approximate their fair values due to the short-term nature of the instruments. Long-term investments are measured at fair value on a recurring basis. The Company’s long-term debt consists of a five-year project loan from Agricultural Bank of China and reflects currently available terms and conditions. Consequently, the carrying value of the Company’s long-term debt approximates fair value.

5. FAIR VALUE MEASUREMENT

Recurring Fair Value Measurement

The Company accounts for assets and liabilities recognized or disclosed in the financial statements at fair value on a recurring basis in accordance with the provisions of ASC Topic 820.

ASC Topic 820 provides that fair value is an exit price, representing the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants based on the highest and best use of the asset or liability. 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. ASC Topic 820 requires the Company to use valuation techniques to measure fair value that maximize the use of observable inputs and minimize the use of unobservable inputs. These inputs are prioritized as follows:

Level 1: Observable inputs such as quoted prices for identical assets or liabilities in active markets

Level 2: Other inputs that are observable directly or indirectly, such as quoted prices for similar assets or liabilities or market-corroborated inputs

Level 3: Unobservable inputs for which there is little or no market data and which require the Company to develop its own assumptions about how market participants would price the assets or liabilities

The valuation techniques that may be used to measure fair value are as follows:

A. Market approach - Uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities

B. Income approach - Uses valuation techniques to convert future amounts to a single present amount based on current market expectations about those future amounts, including present value techniques, option-pricing models and excess earnings method

C. Cost approach - Based on the amount that currently would be required to replace the service capacity of an asset (replacement cost)

10

The following table sets forth the Company’s financial instruments that are measured at fair value on a recurring basis and presents them within the fair value hierarchy using the lowest level of input that is significant to the fair value measurement at June 30, 2013 (in thousands):

 

	Carrying amount as of		Quoted prices  in active markets available		Significant other observable inputs		Significant unobservable inputs		Valuation
	June 30, 2013		(Level 1)		(Level 2)		(Level 3)		Technique
Cash equivalents	$	38,584	$	38,584	$	-	$	-	(A)
Restricted cash		2,743		2,743		-		-	(A)
Short-term investments		20,000		20,000		-		-	(A)
Long-term investments		2,500		-		-		2,500	(B)
Total assets recorded at fair value	$	63,827	$	61,327	$	-	$	2,500

The reconciliation of the Company’s long-term investments, consist of auction rate securities measured at fair value on a recurring basis using unobservable inputs (Level 3) is as follows (in thousands):

	Auction Rate Securities
Balance at January 1, 2013	$	2,500
Redemptions		-
Transfers to Level 3		-
Gains and losses:
Reported in earnings		-
Reported in other comprehensive loss		-
Balance at June 30, 2013	$	2,500

The Company historically accounted for the ARS held in its portfolio as available-for-sale investments. The carrying value of these ARS approximated fair value due to the frequent resetting of the interest rate. While the Company continues to earn interest at the specified contractual rate on this investment, due to the illiquidity of these securities under current market conditions, the Company has considered whether par value continues to be a reasonable basis for estimating the fair value of these ARS at June 30, 2013 and December 31, 2012. The Company estimated the fair value of these securities at June 30, 2013 and December 31, 2012 using broker valuations and internally-developed models of the expected future cash flows related to the securities as well as referencing a third party specialist’s valuation. One of the more significant assumptions made in the Company’s internally-developed models was the term of expected cash flows of the underlying auction rate securities and the discount related to the illiquidity of the investment. The Company developed several scenarios for the liquidation of the auction rate securities over periods that ranged from 3 to 7 years and applied discount rates of 2.18% to 4.23% for the respective period to calculate the discounted fair value. In estimating the fair value of this investment, the Company also considered the financial condition and near-term prospects of the issuers, the magnitude of the losses compared to the investment' cost, the length of time the investment have been in an unrealized loss position, the low probability that the Company will be unable to collect all amounts due according to the contractual terms of the security, whether the security has been downgraded by a rating agency, and the Company’s ability and intent to hold the investment until the anticipated recovery in market value occurs. Based on its estimated operating cash flows and other sources of cash, the Company intends to hold these auction rate securities for the foreseeable future, if necessary.

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The Company’s valuation analysis in the second quarter of 2013 did not result in a change to the unrealized impairment loss on record at December 31, 2012. As of June 30, 2013, the unrealized impairment loss is $500,000. The Company continues to monitor the market for auction rate securities and to assess its impact on the fair value of the Company’s investments. If current market conditions deteriorate further, the Company may be required to record additional temporary unrealized losses in other comprehensive loss or, if the decline in fair value is judged to be other-than-temporary, the cost basis of the individual security may be written down to fair value as a new cost basis and the amount of the write-down would be reflected as a charge to earnings.

6. INVENTORIES

Inventories consist of the following:

	June 30,		December 31,
	2013		2012
Raw materials	$	4,319,189	$	4,533,002
Work in process		2,952,282		3,083,008
Finished goods		1,348,416		2,224,649
Total	$	8,619,887	$	9,840,659

7. INTANGIBLE ASSETS

Intangible assets relate to issued and applied-for patents on the Company’s core technology and gas meter processing know-how purchased in May 2008, as well as trademarks, customer relationships and developed technology acquired from Crossbow Technology, Inc. on January 15, 2010.

As of June 30, 2013, intangible assets consisted of the following:

 

	Gross carrying amount		Accumulated amortization			Net carrying amount		Expected life (Years)
June 30, 2013
Patents	$	1,647,212	$	(448,078	)	$	1,199,134			15
Know-how		563,336		(563,336	)		-			5
Trademarks		408,000		(408,000	)		-			2
Customer relationships		5,040,013		(1,952,485	)		3,087,528	8	-	10
Developed technology		7,796,364		(2,669,527	)		5,126,837	8	-	10
	$	15,454,925	$	(6,041,426	)	$	9,413,499

Amortization expense expected over the next five years is approximately $1.5 million per year. Amortization expense amounted to $0.3 million and $0.4 million respectively for each of the three months ended June 30, 2013 and 2012.

The Company has considered the cash flows associated with the valuation of the definite-lived intangible assets and concluded that the straight line method best approximates the economic pattern of usefulness of those assets.

8. NOTE PAYABLE TO BANK

On June 30, 2010, MTS, a wholly owned subsidiary of MEMSIC Semiconductor, entered into a five-year project loan agreement with Agricultural Bank of China. The total loan available was $20 million, of which $15 million was used by the Company for the purchase of substantially all the assets acquired from Crossbow Technology, Inc., $3 million was available for working capital purposes and $2 million was available for the purchase of equipment to be used in the manufacture of the Company’s system solution products.

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The loan is collateralized by the buildings and land owned by MEMSIC Semiconductor as well as the land and intellectual property owned by MTS. The interest rate of the loan is a variable rate, adjusted semi-annually based on the LIBOR rate plus 4.00%. MTS has obtained agreement from the local government in Wuxi, China to fully subsidize the interest expense on a quarterly basis. There are no financial covenants required for this loan. As of June 30, 2013, $17.9 million has been withdrawn, $1.5 million has been repaid and $16.4 million is outstanding and $2.1 million is available for borrowing. Interest expense of approximately $0.2 million is paid on a quarterly basis and is fully subsidized by the Wuxi government. Based on the terms of the agreement, there are no circumstances in which amounts previously subsidized by the Wuxi government are repayable by the Company. In the remote event the Wuxi government is unable to fulfill its obligation, the Company would recognize the interest expense in its income statement. The repayment schedule of the principal amount is as follows:

 

Date	Payment Amount
June 29, 2014	$	2,500,000
June 29, 2015		13,930,000
	$	16,430,000

9. BUILDING LIABILITY

In June 2010, the Company purchased a piece of land in Wuxi for approximately $4.0 million to build the MTS manufacturing facility. In August 2011, the Company completed construction of the MTS manufacturing facility with 14,000 square meters of total space to host the manufacturing of its system solution products. The construction cost of approximately $8.3 million was financed by the local Chinese government. In the third quarter of 2012, the Company was notified by the local Chinese government that the Company would be expected to make payments on the building beginning in February 2013. As of June 30, 2013, the Company is renegotiating with the local Chinese government the payment terms of the construction cost of the building and has not made any payments. However, since the third quarter of 2012, the Company has accrued a financing charge of $116,000 per quarter using the effective interest rate method at an annual rate of 8% on the construction cost of the building based on a 2009 memorandum with the local Chinese government. The $8.3 million construction cost of the building is reflected as a long-term liability and the accrued finance charge of $116,000 per quarter is net of the interest income in the accompanying consolidated financial statements.

10. STOCK BASED COMPENSATION

Description of Plan 

On March 29, 2000, the Company’s stockholders and board of directors approved the 2000 Omnibus Stock Plan (the “2000 Plan”), as amended, under which 2,969,000 shares of the Company’s common stock were reserved for issuance to directors, officers, employees, and consultants. With the adoption of the 2007 Plan discussed below, the Company no longer grants awards under the 2000 Plan.

On August 22, 2007, the Company’s board of directors approved the 2007 Stock Incentive Plan (the “2007 Plan”), under which up to 3,000,000 shares of the Company’s common stock may become available for issuance. At the adoption date, 1,526,425 shares were reserved for issuance. The reserved amount increases by 300,000 shares at each of the five anniversaries of the adoption date, for a maximum of 3,000,000 shares issuable under the 2007 Plan.

Options granted under the 2000 Plan and the 2007 Plan may be incentive stock options or nonqualified stock options. Both the 2000 Plan and the 2007 Plan provide that the exercise price of incentive stock options must be at least equal to the market value of the Company’s common stock at the date such option is granted. For incentive stock option grants to an employee who owns more than 10% of the outstanding shares of common stock of the Company, the exercise price on the incentive stock option must be 110% of market value at the time of grant. Granted options expire in ten years or less from the date of grant and vest based on the terms of the awards, generally ratably over four years.

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On December 9, 2009, the Company’s board of directors approved the 2009 Nonqualified Inducement Stock Option Plan (the “2009 Plan”) with an effective date on January 15, 2010, the closing date of the acquisition of Crossbow assets. Under the 2009 Plan, up to 1,250,000 shares of the Company’s common stock may become available for issuance. On December 23, 2010, the Company’s board of directors approved an Amended and Restated 2009 Nonqualified Inducement Stock Option Plan (the “Amended and Restated Plan”) and an increase in shares of the Company’s common stock available for issuance under the Amended and Restated Plan from 1,250,000 to 2,500,000. Except as otherwise determined by the Compensation Committee of the Company’s board of directors, the form of option to be employed under the Amended and Restated Plan shall be substantially identical to the form of nonqualified option customarily used under the Company’s 2007 Stock Incentive Plan.

On June 29, 2011 at its Annual Meeting of Stockholders, the Company’s stockholders and board of directors approved the amendment and restatement of the Company’s 2007 Plan. The Amended and Restated 2007 Plan

● permits the granting of restricted stock units (“RSU”), performance-based stock awards and stock appreciation rights;

● eliminates the ability to reprice options;

● extends the expiration date of the plan to June 29, 2021;

● provides that awards may qualify as “performance-based compensation” under Section 162(m) of the Internal Revenue Code of 1986, as amended; and

● incorporates certain other administrative provisions.

The approval of the amendment and restatement of the 2007 Plan does not change the number of shares available for awards under the 2007 Plan.

On June 28, 2012, the Company’s shareholders voted to approve an amendment to the Company’s amended and restated 2007 stock incentive plan, including increasing the number of shares of common stock issuable under the 2007 Plan by 1,500,000 shares. The maximum shares issuable under the 2007 Plan thus increased to 4,500,000 shares.

Valuation of Stock Options

The Company uses the Black-Scholes option pricing model to calculate the grant-date fair value of an option award. The key input assumptions used in the Black-Scholes option pricing model include: (i) the risk-free interest rate, which is based on the yield available on U.S. Treasury zero-coupon bonds at the date of grant with maturity dates approximately equal to the expected life at the grant date, (ii) the expected life of the options, which is based on evaluations of historical and expected future employee exercise behavior; (iii) volatility, which is based on the implied volatility of the Company’s common stock, which the Company believes results in the best estimate of the grant-date fair value of employee stock options because it reflects the market’s current expectations of future volatility; and (iv) dividend yield of zero, as the Company has not paid dividends in the past and it does not expect to in the foreseeable future. Prior to January 1, 2010, due to limited historical information on the volatility of the Company’s common stock, the Company determined the volatility for options based on an analysis of reported data for a peer group of companies that issued options with substantially similar terms. The Company utilizes historical data to estimate pre-vesting forfeitures and records stock-based compensation expense only for those awards that are expected to vest.

No options were granted during the three and six months ended June 30, 2013. The weighted-average fair value per share of the options granted during the three and six months ended June 30, 2012 was $2.23, utilizing the following assumptions:

	Three months ended June 30,							Six months ended June 30,
	2013		2012					2013		2012
Volatility	NA		67	%	-	71	%	NA		67	%	-	71	%
Expected dividend yield	0	%				0	%	0	%				0	%
Expected life (years)	NA		6.3		-	8.5		NA		6.3		-	8.5
Risk free interest rate	NA		1.15	%	-	1.44	%	NA		1.15	%	-	1.44	%
Forfeitures	33	%	33	%	-	36	%	33	%	33	%	-	36	%

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The Company accounts for stock options granted to consultants using the fair value method for the calculation of compensation cost. For the three months ended June 30, 2013 and 2012, the Company recorded compensation expense for stock option grants to consultants in the amount of approximately $4,800 and $1,000, respectively. At June 30, 2013, total unrecognized stock-based compensation expense for stock options granted to consultants was $28,000.

At June 30, 2013, total unrecognized stock-based compensation expense for stock options granted to the Company’s employees and directors was approximately $1.2 million.

The stock option activity under the 2000, 2007 and 2009 Stock Plan is as follows:

 

				Weighted		Remaining
	Options			Average		Contractual	Aggregrate
	Outstanding			Exercise Price		Term in Years	Intrinsic Value
Options outstanding at January 1, 2013		2,635,500		$	4.59	6.3	$	2,014,390
Granted		-			-	-		-
Exercised		(36,051	)		2.15			-
Cancelled		(69,825	)		3.65	-		-
Options outstanding at June 30, 2013		2,529,624		$	4.60	5.9	$	3,264,912
Options vested at June 30, 2013		1,463,692		$	4.56	4.7	$	1,954,567
Available for grant at June 30, 2013		4,229,462

The intrinsic values (aggregate market value minus aggregate exercise price) of stock options exercised during the three months ended June 30, 2013 and 2012 were $28,000 and $269,500, respectively. The total fair value of options vested during the three and six months ended June 30, 2013 was approximately $224,000 and $278,000, respectively. The total fair value of options vested during the three and six months ended June 30, 2012 was approximately $189,000 and $504,000, respectively.

Stock-based compensation expenses related to stock options, restricted stock awards (“RSAs”) and RSUs were charged to the following expenses:

	Three months ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
Research and development	$	30,464	$	42,616	$	104,369	$	86,869
Sales and marketing		18,802		22,437		52,935		90,158
General and administrative		291,598		363,021		502,696		573,974
Total	$	340,864	$	428,074	$	660,000	$	751,001

The Company accounted for RSAs and RSUs using the fair value at the date of the grant for the calculation of compensation cost. For the three and six months ended June 30, 2013, the Company recorded compensation expense for RSAs and RSUs in the amount of $152,000 and $334,000 respectively. For the three and six months ended June 30, 2012, the Company recorded compensation expense for RSAs and RSUs in the amount of $207,000 and $344,000, respectively.

As of June 30, 2013, total unrecognized compensation expenses related to non-vested RSAs and RSUs were $95,000 and $751,000, respectively. These expenses are expected to be recognized over a weighted average period of 1.8 years for RSAs and 2.5 years for RSUs.

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A summary of RSA activity for the six months ended June 30, 2013 is as follows:

 

				Weighted
				Average
				Market Value
	Shares			at Grant Date
Nonvested at January 1, 2013		52,500		$	3.41
Awarded		-			-
Vested		(17,500	)		-
Forfeited		-			-
Nonvested at June 30, 2013		35,000		$	3.41

A summary of RSU activity for the six months ended June 30, 2013 is as follows:

 

				Weighted
				Average
				Market Value
	Shares			at Grant Date
Nonvested at January 1, 2013		640,917		$	3.08
Awarded		-			-
Vested		(113,833	)		-
Forfeited		(66,000	)		-
Nonvested at June 30, 2013		461,084		$	3.02

11. COMMON STOCK

The Company reserved 7,255,170 and 7,194,229 shares at June 30, 2013 and 2012, respectively for issuance upon exercise of options to purchase common stock and upon vesting of RSUs.

12. NET INCOME (LOSS) PER COMMON SHARE

         The calculation of the numerator and denominator for basic and diluted net income (loss) per common share is as follows:

 

	For the three months ended June 30,						For the six months ended June 30,
	2013			2012			2013			2012
Numerator:
Net (loss) income attributable to MEMSIC, Inc.	$	(2,276,998	)	$	(461,414	)	$	(4,740,916	)	$	739,090
Denominator:
Basic weighted average shares		24,236,445			23,986,332			24,215,415			23,919,650
Dilutive effect of common stock equivalents		-			-			-			485,127
Diluted weighted average shares		24,236,445			23,986,332			24,215,415			24,404,777
Net (loss) income per common share to MEMSIC, Inc.
Basic	$	(0.09	)	$	(0.02	)	$	(0.20	)	$	0.03
Diluted	$	(0.09	)	$	(0.02	)	$	(0.20	)	$	0.03

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During the six months ended June 30, 2013 and 2012, the Company had 0.7 million and 1.5 million, respectively, potential common shares in the form of stock options and RSUs which were not included in the computation of net income (loss) per diluted share because these stock options and RSUs would be anti-dilutive.

13. SEGMENT INFORMATION

The Company conducts its operations and manages its business in two reporting segments. The Company develops, designs, manufactures and markets (i) semiconductor sensor products (“sensor products”) based on micro-electromechanical systems (MEMS) technology and advanced integrated circuit design and (ii) sensor system solution products (“system solution products”) which incorporate sensors with on-board computing, wireless communications and systems and application software solutions. In making operating decisions, the Company’s chief executive officer, who is the chief operating decision maker, considers the gross profit results of the sensor product reporting unit and the system solution product reporting unit separately, but utilizes enterprise wide operating expense and earning results. As the management resources and certain assets are shared between the reporting segments, it is not practical to report the earnings and assets separately.

Revenues by product application

The categorization of revenue by product application is determined using a variety of data points including the technical characteristics of the product, the end customer product and application into which the Company’s product will be incorporated, and requires substantial judgment. Set forth below are the Company’s revenues by product application for the periods presented.

 

	Three months ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
Mobile phone	$	7,194,949	$	5,890,070	$	12,714,831	$	17,636,794
Consumer		1,393,151		2,394,135		2,322,089		3,818,912
Automotive		3,366,067		3,376,209		6,549,404		7,069,912
Industrial/other		1,224,927		2,754,824		3,021,053		5,906,672
Total	$	13,179,094	$	14,415,237	$	24,607,377	$	34,432,290

Revenues and gross profit by product type

The following table summarizes revenue and gross profit by product categories.

 

	Three months ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
Revenue
Sensor products	$	12,351,420	$	12,004,181	$	22,362,323	$	29,212,198
System solution products		827,673		2,411,056		2,245,053		5,220,092
Total	$	13,179,094	$	14,415,237	$	24,607,377	$	34,432,290

	Three months ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
Gross Profit
Sensor products	$	4,590,462	$	4,462,567	$	8,206,125	$	10,467,274
System solution products		363,451		1,321,820		906,413		2,734,212
Total	$	4,953,913	$	5,784,387	$	9,112,538	$	13,201,486

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Revenues by geographical region

Revenue by geographic region, based upon customer location, for the three and six months ended June 30, 2013 and 2012 was as follows:

 

	Three months ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
Asia (excluding Japan)	$	8,150,366	$	7,106,611	$	14,522,007	$	19,831,847
Europe		818,397		954,874		1,580,701		1,981,968
Japan		559,305		2,848,416		1,779,238		5,086,233
North America		3,629,496		3,484,788		6,680,550		7,491,786
Other		21,530		20,548		44,881		40,456
Total	$	13,179,094	$	14,415,237	$	24,607,377	$	34,432,290

Total Assets by geographical region

Total assets by geographical region are as follows:

 

	June 30,		December 31,
	2013		2012
United States	$	52,995,947	$	54,509,508
China		66,067,051		67,146,027
Japan		465,820		1,672,436
Total	$	119,528,818	$	123,327,971

Total long-lived assets by geographical region are as follows:

	June 30,		December 31,
	2013		2012
United States	$	629,899	$	517,960
China		30,351,061		28,484,568
Japan		-		297
Total	$	30,980,960	$	29,002,825

 

Total net assets by geographical region are as follows:

 

	June 30,		December 31,
	2013		2012
United States	$	55,417,208	$	58,775,602
China		27,888,977		27,994,626
Japan		23,032		324,665
Total	$	83,329,217	$	87,094,893

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14. CONTINGENCIES

On September 11, 2011, Trilogy Marketing, Inc. (Trilogy) commenced an action in the United States District Court for the Eastern District of Michigan, in which it alleges that MEMSIC has failed to pay sales representative commissions to Trilogy. The Company has not concluded that a loss of any magnitude in this matter is probable, and is unable to estimate the range of potential loss, if any, that might arise from this matter.

On April 22, 2013, the Company entered into an Agreement and Plan of Merger, referred to herein as the “merger agreement,” pursuant to which the Company will be acquired by IDG Accel China Capital II, L.P. and its affiliates MZ Investment Holdings Limited, referred to herein and in the merger agreement as “Parent,” and MZ Investment Holdings Merger Sub Limited (collectively, “IDG”), for $4.225 per share in cash. The merger agreement is filed as Exhibit 2.1 to this Report. Affiliates of IDG currently hold approximately 19.5% of the company’s outstanding common stock. IDG and its affiliates will acquire all the outstanding shares of common stock of MEMSIC that are not currently owned by them, including shares underlying outstanding in-the-money equity awards, for approximately $88.5 million. The merger agreement is subject to customary conditions, including a vote of the Company’s stockholders. The transaction is expected to close during the third quarter of 2013.

Under the merger agreement, the Company is obliged to pay Parent a termination fee of up to $1.77 million in the event the merger agreement is terminated:

● by Parent, if the Company’s board of directors changes its recommendation in favor of the merger, or if the Company materially breaches its non-solicitation obligations in the merger agreement;

● by either Parent or the Company, if the merger has not been consummated by April 22, 2014, or by Parent, if a material breach by the Company of its representations, warranties or covenants in the merger agreement results in the inability to comply with closing conditions set forth in the merger agreement by such date, and assuming, in each case that:

o a Competing Transaction (as such term is defined for this purpose in the merger agreement) is announced and not withdrawn; and

o the Company consummates a Competing Transaction within 12 months of the termination of the merger agreement;

● by either Parent or the Company, if the Company’s stockholders do not adopt the merger agreement and a Competing Transaction has been publicly announced or made known, and not withdrawn; and

● by the Company, if the Company’s board of directors approves, and the Company enters into, a definitive agreement with respect to a Superior Proposal (as such term is defined in the merger agreement).

In general, neither Parent nor the Company may terminate the merger agreement if such party is in breach of its obligations under the agreement, or if such breach causes or contributes to the failure of a condition to the consummation of the merger.

On May 14, 2013, a putative class action captioned Spencer v. Zhao et al., C.A. No. 13-1771-BLS, was filed in Massachusetts Superior Court in Suffolk County against the Company, its directors and certain other parties. The amended complaint alleges, among other things, that the directors breached their fiduciary duties in connection with their consideration and approval of the merger agreement and seeks an award of monetary damages in an unspecified amount and injunctive relief to prevent the consummation of the merger. While the Company and the other defendants believe that the allegations made in the lawsuit are without merit, to minimize the expense and uncertainty of litigation the Company and the other defendants have entered into a memorandum of understanding with the plaintiff dated July 29, 2013 (the ““MOU’’). In the MOU, the parties agreed to settle the lawsuit subject to certain conditions and without admitting any liability. The MOU includes an agreement in principle to negotiate and execute a final settlement agreement which would provide for the release and settlement by the Company’s stockholders of all claims against the Company and the other defendants, in exchange for which the Company would supplement the proxy statement for the merger with certain additional disclosures. The settlement will not affect the amount of the merger consideration that the Company’s stockholders are entitled to receive in the merger. The settlement is contingent upon plaintiff’s completion of confirmatory discovery and is subject to the approval of the Massachusetts Superior Court. The Company expects that plaintiff’s counsel will seek an award of attorneys’ fees and expenses as part of the settlement. No demand for such fees and expenses has been made at this time and the Company is unable to estimate the range of potential loss, if any, that might arise from this matter.

The Company may be subject to claims that arise out of the ordinary course of business in legal disputes. In management’s opinion, these matters will not have a material adverse effect on the financial position of the Company.

15. SUBSEQUENT EVENTS

The Company evaluated subsequent events occurring after June 30, 2013 through the date of filing of the Quarterly Report on Form 10-Q in which these financial statements are included, and concluded that except noted above, there was no event of which management was aware that occurred after the balance sheet date that would require any adjustment to the accompanying consolidated financial statements.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

This information should be read in conjunction with the unaudited condensed consolidated financial statements and related notes included in Item 1 of Quarterly Report on Form 10-Q and the audited consolidated financial statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

This quarterly report on Form 10-Q contains “forward-looking statements” that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements include any expectation of earnings, revenues,or other financial items; any statements of the plans, strategies and objectives of management for future operations; factors that may affect our operating results; statements concerning new products or services; statements related to future capital expenditures; statements related to future economic conditions or performance; statements as to industry trends and other matters that do not relate strictly to historical facts or statements of assumptions underlying any of the foregoing. These statements are often identified by the use of words such as, but not limited to, “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “will,” “plan,” “target,” “continue,” and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included elsewhere in this Form 10-Q and in our other filings with the SEC. Furthermore, such forward-looking statements speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Overview

We provide advanced semiconductor sensor and system solutions based on integrated micro-electromechanical systems, or MEMS, technology and mixed signal circuit design. We operate and manage our business in two reporting segments. We develop, design, manufacture and market:

●     semiconductor sensor products, which we refer to as sensor products, based on MEMS technology and advanced integrated circuit design; and

●     sensor system solution products, which we refer to as system solution products, which incorporate sensors with on-board computing, wireless communications and systems and application software solutions.

In making operating decisions, our chief executive officer, who is the chief operating decision maker, considers the gross profit results of the sensor product segment and the system solution product segment separately, but utilizes enterprise wide operating expense and earning results.

Our sensor products combine proprietary thermal-based MEMS technology and advanced analog mixed signal processing circuitry design into a single chip using a standard CMOS process. This approach allows us to provide sensor solutions at a lower cost, with higher performance and greater functionality than our competitors. Our magnetic sensor product is based on AMR technology which provides higher accuracy, better sensitivity across temperature and lower power as compared to hall-effect based magnetic sensors. In addition, our technology platform allows us to easily integrate additional functions or create new sensors to expand into touch and flow sensors and related applications. Our sensor products have a wide range of applications such as mobile phones, automotive safety systems and video projectors.

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Our system solution products consist primarily of wireless sensors that connect the physical environment with enterprise management and information systems to provide advanced monitoring, automation and control solutions for a range of industries, as well as inertial systems that provide end-users and systems integrators with MEMS-based solutions for measurement of static and dynamic motion in a wide variety of challenging environments, including avionics, remotely operated vehicles, agricultural and construction vehicles, automotive test and wind power turbines.

Our system solution products consisted primarily of the product lines we acquired from Crossbow Technology in January 2010, including the non-military portion of Crossbow’s inertial navigation systems business and its wireless sensor network Mote and eKo environmental monitoring business.

We manufacture our sensor products utilizing a “semi-fabless” model by outsourcing the production of CMOS wafers and completing the post-CMOS MEMS process in-house. By outsourcing the standard CMOS manufacturing process, we are able to more efficiently manage our capital expenditures and cost of goods sold.

We manufacture our wireless system solution products and partial inertial system solution products through outsourcing most of the assembly process to third-party contract assembly vendors and performing final testing and programming functions in-house at our facility in Wuxi. Certain of our inertial system solution products, including FAA certified products, were manufactured by Crossbow Technology under a manufacturing agreement that expired on December 31, 2012. We are currently seeking new contract manufacturers for our FAA certified products.

We sell our products either to distributors, which then resell to OEMs and ODMs, or to OEM and ODM customers directly. Historically, a small number of our customers have accounted for a substantial portion of our revenue, and sales to our largest distributor customers and OEM and ODM customers have varied significantly. This significant variation is in part due to the fact that our sales are made on the basis of purchase orders rather than long-term contracts. Although our distributors generally provide us with non-binding rolling forecasts, our distributors generally have up to 30 days prior to delivery to cancel or reschedule shipments pursuant to our distribution agreements. This arrangement has added to the fluctuation and unpredictability of our sales. Because our products are a component of our customers’ products, our sales performance is significantly affected by the sales performance of our customers’ products. It is difficult for us to accurately forecast our product demand because in the case where we sell our products to distributors, we may not know the identity of the distributor’s OEM and ODM customers and information regarding their demand.

OEM and ODM customers’ products are complex and require significant time to define, design and ramp to volume production. Our sales cycle begins with our marketing and sales staff and application engineers engaging with our OEM and ODM customers’ system designers and management, which is typically a multi-month, or even multi-year, process. If this process is successful, an OEM and ODM customer will decide to incorporate our solution in its product, which we refer to as a design-win. Because the sales cycles for our products are long, we incur expenses to develop and sell our products, regardless of whether we achieve the design-win and well in advance of generating revenue, if any, from those expenditures. Although we do not have long-term purchase commitments from any of our distributor customers or OEM and ODM customers, once one of our products is incorporated into an OEM’s or ODM’s design, it is likely to remain a part of the design for the life cycle of its product. We believe this to be the case because a redesign would generally be time consuming and expensive.

IDG Acquisition

On April 22, 2013, we entered into an Agreement and Plan of Merger to be acquired by IDG-Accel China Capital II, L.P. and its affiliates MZ Investment Holdings Limited and MZ Investment Holdings Merger Sub Limited (collectively, “IDG”), for $4.225 per share in cash. Affiliates of IDG currently hold approximately 19.5% of our outstanding common stock. IDG and its affiliates will acquire all the outstanding shares of common stock of MEMSIC that are not currently owned by them, including shares underlying outstanding in-the-money equity awards, for approximately $88.5 million. The merger agreement is subject to customary conditions, including a vote of our stockholders, which is scheduled on September 16, 2013. The transaction is expected to close during the third quarter of 2013.

Description of Certain Line Items

Net Sales

Net sales represent gross revenue net of an allowance for the estimated amount of product returns and sales rebates from our customers. Sales to distributors are made pursuant to distributor agreements, which allow for the return of goods under certain circumstances. We recognize revenue in accordance with ASC Topic 605-15, Revenue Recognition.

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Our revenue has been derived from shipments of our sensor products and system solution products. The primary factors that affect our revenue are the sales volumes and average selling prices of our products. Growth in our net sales has generally been attributable to the increase in the unit volumes of our products, as the average selling prices of our sensor products have tended to decline due to the following factors, among others:

• the semiconductor component market is highly competitive, and as a result, the average selling prices of particular components generally experience rapid declines over the course of their respective product and technology life cycles. This trend has been particularly evident recently in the market for mobile phone applications. We seek to mitigate the impact of this trend on our business by continuing to rapidly design, develop and sell new generations of products with additional functionalities to replace older generation products;

• we may also elect to reduce our product prices as we are able to improve our manufacturing efficiency or to reduce our manufacturing costs. We may also reduce prices in order to increase market adoption of our products in certain markets;

• changes in our product mix may affect the average selling prices of our products. For example, our products for consumer and mobile phone markets generally have lower average selling prices than products for the automotive market; and

• we may grant discounts to our large customers or OEM and ODM customers for high volume purchases.

Net Sales by Reportable Segment

Our sales consist of two reportable segments: sensor products that are used as components in our customers’ products and system solution products that incorporate sensors with on-board computing, wireless communications and systems and application software solutions and offer a complete system solution to our customers. The following table sets forth our net sales by reportable segment for the periods indicated by amount and as a percentage of our net sales (dollar amounts in thousands).

 

	Three months ended June 30,										Six months ended June 30,
	2013					2012					2013					2012
	Amount		% of Sales			Amount		% of Sales			Amount		% of Sales			Amount		% of Sales
Sensor products	$	12,351		93.7	%	$	12,004		83.3	%	$	22,362		90.9	%	$	29,212		84.8	%
System solution products		828		6.3			2,411		16.7			2,245		9.1			5,220		15.2
Total	$	13,179		100.0	%	$	14,415		100.0	%	$	24,607		100.0	%	$	34,432		100.0	%

Net Sales by Application

In the first six months of 2013, net sales from mobile phone applications were the largest component of our total sales. The net sales from mobile phone applications as a percentage of total net sales increased to 51.7% from 51.2% for the corresponding period in 2012. However, the dollar amount of net sales from mobile phone applications decreased to $12.7 million from $17.6 million for the corresponding period of 2012. The decrease was mainly due to the decrease of our magnetic sensor sales to a major mobile phone manufacturer, which declined to $2.7 million in the first six months of 2013, compared to $12.0 million in the corresponding period of 2012. Our sales to this major mobile phone manufacturer are expected to continue to decrease due to the winding down in sales volume of the phone models that our sensor is designed in. However, we expect sales from mobile phone applications in the China market to increase and the mobile phone applications to continue to be the largest component of our total sales for the remainder of 2013.   

Net sales from automotive applications for the first six months of 2013 were the second largest component of our total sales, representing 26.6% of total net sales, compared with 20.5% of total net sales for the corresponding period in 2012. The percentage increase was mainly due to lower total sales in 2013. To increase sales from the automotive market, we will continue to seek to increase sales from new automotive applications and to expand our customer base. However, revenue increases, if any, from the automotive market will require significant time, as the development lead time in this market is generally longer than other markets in which we participate.

Net sales from industrial and other applications decreased in the first six months of 2013 to $3.0 million, representing 12.3% of total net sales, compared to $5.9 million, or 17.2% of total net sales in the corresponding period of 2012. This decrease was mainly due to lower sales from our system solution products which have undergone product upgrading and the loss of consolidated sales from Crossbow Japan as a result of the dissolution of Crossbow Japan.

Net sales from consumer applications decreased in the first six months of 2013 to $2.3 million, or 9.4% of total net sales, compared to $3.8 million, or 11.1% of total net sales in the corresponding period of 2012. This decrease was primarily due to a decrease in sales of our accelerometer product in a digital camera application in the Japan market.

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The following table sets forth our net sales by application for the periods indicated by amount and as a percentage of our net sales (dollar amounts in thousands).

 

	Three months ended June 30,										Six months ended June 30,
	2013					2012					2013					2012
	Amount		% of Sales			Amount		% of Sales			Amount		% of Sales			Amount		% of Sales
Mobile phone	$	7,195		54.6	%	$	5,890		40.9	%	$	12,715		51.7	%	$	17,637		51.2	%
Consumer		1,393		10.6			2,394		16.6			2,322		9.4			3,819		11.1
Automotive		3,366		25.5			3,376		23.4			6,549		26.6			7,070		20.5
Industrial/other		1,225		9.3			2,755		19.1			3,021		12.3			5,906		17.2
Total	$	13,179		100.0	%	$	14,415		100.0	%	$	24,607		100.0	%	$	34,432		100.0	%

Net Sales by Customer Base

Our customers primarily consist of distributors, OEMs and ODMs. Historically, a small number of our customers have accounted for a substantial portion of our net sales. We have three customers (one ODM and two distributors) representing 10% or more of our net sales, which accounted in the aggregate for approximately 60.0% of our net sales in the second quarter of 2013, compared with three customers (two ODMs and one distributor) representing 58.3% in the corresponding period of 2012.

We have experienced and will continue to experience fluctuations in demand from a significant number of customers. It is difficult for us to accurately forecast our product demand, particularly in the case of sales to our distributors, as we may not know the identity of the distributor’s OEM and ODM customers and lack information regarding their demand, and recent adverse macro-economic changes have increased the difficulty of accurately forecasting product demand and revenue. Occasionally, design changes in the products of our OEM and ODM customers have resulted in the loss of sales.

Net Sales by Geography

Our products are shipped to OEM and ODM customers worldwide. However, we focus on different application markets among geographical regions. In Asia (excluding Japan), our revenue is primarily derived from products for mobile phone applications. We are also seeking to expand the consumer and industrial applications markets in that region. In Japan, our revenue has primarily been derived from products for consumer applications, particularly projectors and digital cameras. We are also seeking to penetrate the automotive market in Japan. In North America, our revenue has primarily been derived from products for automotive applications. In Europe, our revenue has primarily been derived from industrial applications.

The following table sets forth our net sales by geographical region for the periods indicated by amount and as a percentage of our net sales (dollar amounts in thousands).

 

	Three months ended June 30,										Six months ended June 30,
	2013					2012					2013					2012
	Amount		% of Sales			Amount		% of Sales			Amount		% of Sales			Amount		% of Sales
Asia (excluding Japan)	$	8,150		61.8	%	$	7,107		49.3	%	$	14,522		59.0	%	$	19,832		57.6	%
Europe		818		6.2			955		6.6			1,580		6.4			1,982		5.8
Japan		559		4.2			2,848		19.8			1,779		7.2			5,086		14.8
North America		3,630		27.5			3,485		24.2			6,681		27.2			7,492		21.7
Other		22		0.2			20		0.1			45		0.2			40		0.1
Total	$	13,179		100.0	%	$	14,415		100.0	%	$	24,607		100.0	%	$	34,432		100.0	%

Cost of Goods Sold

We are a semi-fabless company. We outsource wafer production for our accelerometer products and for a portion of the wafers used in our magnetic sensor products to third-party foundries and complete the post-CMOS MEMS and most of the packaging, assembly and testing functions in-house. We also purchase our ceramic packaging materials from third-party suppliers.

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Our wireless system solution products and some of our inertial system solution products were manufactured by our indirect subsidiary in Wuxi, China through outsourcing most of the assembly process to third-party contract assembly vendors and performing final testing and programming functions in-house at our facility in Wuxi.

Cost of goods sold consists of: (i) cost of wafer, ceramic and other materials purchased from third parties; (ii) manufacturing overhead, primarily consisting of salaries and wages of our quality control employees and manufacturing-related management employees, depreciation, and equipment and parts; (iii) direct labor, primarily consisting of salaries and wages of our manufacturing operators; and (iv) outsourced processing fees paid to third-party packaging service providers and assembly vendors.

Our relationships with third-party foundry and packaging service providers do not provide for guaranteed levels of production capacity at pre-determined prices. As a result, our outsourcing costs relating to wafer production, and to a lesser extent, packaging services, are susceptible to sudden changes based on conditions in the global semiconductor market and our service providers’ available capacity.

Gross Profit and Gross Margin

Our gross profit and gross margin from our sensor products have historically declined over time, due to a variety of factors, including average selling prices of our products, our product application mix, prices of wafers, excess and obsolete inventory, pricing by competitors, changes in production yields, and percentage of sales conducted through distributors. Our products for mobile phone applications have historically had lower margins than our products for automotive products. We have continuously worked to stabilize and improve our gross margin through engineering redesign of our sensor products and by seeking to improve the manufacturing process to increase manufacturing efficiency. Notwithstanding the relatively low margins in the mobile phone applications market, we will seek to increase our market share in that market by introducing products with more functionalities and at a competitive cost, in the goal of capitalizing on the significant potential for revenue growth in that market.

The gross margin from systems solution products has fluctuated based on the mix of the product sales. Gross margins from wireless sensor network products are generally lower than those of inertial products.

Research and Development Expenses

Research and development expenses are recognized as they are incurred and primarily consist of salaries and wages of research and development employees; research costs, primarily consisting of mask costs and prototype wafers and consulting fees paid for outside design services; travel and other expenses; and stock-based compensation attributable to our research and development employees.

Sales and Marketing Expenses

Sales and marketing expenses primarily consist of wages, salaries and commissions for our sales and marketing personnel; consulting expenses, primarily consisting of sales consulting services and software application consulting services; travel expenses; independent sales representatives’ commissions; office rental; market promotion and other expenses and stock-based compensation.

General and Administrative Expenses

General and administrative expenses primarily consist of salaries and wages for administrative personnel; costs for professional services, including legal, tax and accounting services; depreciation and amortization expenses for non-manufacturing equipment; travel and entertainment expenses; office supply and other office-related expenses; office rental expenses; other expenses, such as utilities, insurance and provision for accounts receivable; and stock-based compensation.

Other Income (Expense)

Other income (expense) primarily consists of interest income earned on our investments of cash and cash equivalents, and interest expense incurred on our borrowings and net foreign currency exchange gains and losses.

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Provision for Income Taxes

We conduct sales through our headquarters in Andover, Massachusetts. Our Wuxi subsidiary is primarily engaged in manufacturing and engineering activities and does not conduct direct sales to customers. For internal accounting and PRC tax purposes, we account for the transfers of goods from our Wuxi subsidiary to our U.S. headquarters as sales, and calculate the transfer price of such sales based on a markup of manufacturing and operating costs. We believe the prices of these sales were consistent with the prevailing market prices.

U.S. Tax

In the United States, we are subject to the federal income tax and the Massachusetts state income tax, which are approximately at the rates of 34.0% and 8.0%, respectively. At December 31, 2012, the Company had gross U.S. net operating loss carryforwards of $10.3 million, which expire in various amounts beginning in 2028. Included within this amount is approximately $367,000 of excess tax deductions associated with non-qualified stock options that have been exercised. When these excess tax benefits actually result in a reduction to currently payable income taxes, the tax benefit will be recorded as an increase to additional paid-in capital. The Company’s operating losses may be subject to limitations under provisions of the Internal Revenue Code.

PRC tax

Our PRC taxes primarily consist of enterprise income tax, value-added tax, and certain other miscellaneous taxes.

Enterprise Income Tax

Under the “Enterprise Income Tax Law” of China, which took effect on January 1, 2008, Foreign Invested Enterprises (FIEs) and domestic companies are subject to a uniform tax rate of 25%. In addition, preferential tax treatment would continue to be given to companies (FIEs or domestic) in certain encouraged sectors and to entities classified as “high-technology companies especially supported by the PRC government”. The company needs to meet certain qualification requirements to be eligible for this preferential tax treatment. The qualification will be reviewed every three years.

MEMSIC Semiconductor has been qualified as a “high-technology company especially supported by the PRC government” since 2008 and passed the “high-technology Company especially supported by the PRC government” review in 2011. Therefore, a preferential enterprise income tax rate of 15% under the new tax law will apply to MEMSIC Semiconductor from 2012 to 2014.

The new tax law and its implementing rules provide that dividends paid by a PRC entity to a non-resident enterprise for tax purposes is subject to PRC withholding tax at a rate of 10% subject to reduction by an applicable tax treaty with the PRC. We expect that a 10% withholding tax will apply to dividends paid to us by our Wuxi subsidiary, but this treatment will depend on our status as a non-resident enterprise of China. For detailed discussion of PRC tax issues related to resident enterprise status, see “Risk Factors -Risks Related to Doing Business in China - We may be treated as a resident enterprise for PRC tax purposes under the Enterprise Income Tax Law effective as of January 1, 2008, which may subject us to PRC income tax for any dividends we pay to our non-PRC stockholders”.

Our indirect Wuxi subsidiary and MEMSIC Semiconductor’s wholly owned subsidiary MEMSIC Transducer Systems Company Limited (“MTS”) is subject to the enterprise income tax rate of 25%. In 2013, MTS will apply for “high-technology Company especially supported by the PRC government”. Once approved, a preferential enterprise income tax rate of 15% will apply to MTS.

See “Risk Factors—Risks Related to Doing Business in China—The discontinuation of any of the preferential tax treatments currently available to us in China could materially and adversely affect our business, financial condition and results of operations.” included in our Annual Report on Form 10-K for the period ended December 31, 2012.

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Other PRC taxes

Other miscellaneous PRC taxes primarily consist of property tax, land-use tax and stamp tax which are accounted for in our general and administrative expenses, and education surcharge and City maintenance and construction tax, which is recorded as part of our cost of goods sold.

Crossbow Japan Taxes

Our majority owned joint venture in Japan is subject to Japan taxes including enterprise income tax, value-added tax, and certain other miscellaneous taxes. The effective income tax rate for Crossbow Japan is 40%.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements and related notes requires us to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, net sales and expenses, and related disclosure of contingent assets and liabilities. We have based our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We consider an accounting policy to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements. For a discussion of the critical accounting policies that we consider to be the most sensitive and that require the most significant estimates and assumptions used in the preparation of our consolidated financial statements, see our Annual Report on Form 10-K for the year ended December 31, 2012, under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations--Critical Accounting Policies.” There has been no change in our critical accounting policies and estimates from those described in our Annual Report on Form 10-K for the year ended December 31, 2012.

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Results of Operations

The following tables set forth a summary of our unaudited statements of operations data for the periods described by amount and as a percentage of our total net sales. This information should be read together with our unaudited consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. The operating results in any period are not necessarily indicative of the results that may be expected for any future period:

 

	For the three months ended June 30,												For the six months ended June 30,
	2013						2012						2013						2012
	Amount			% of net sales			Amount			% of net sales			Amount			% of net sales			Amount			% of net sales
	(dollar amounts in thousands)												(dollar amounts in thousands)
Net sales	$	13,179			100.0	%	$	14,415			100.0	%	$	24,607			100.0	%	$	34,432			100.0	%
Cost of goods sold		8,225			62.4			8,631			59.9			15,495			63.0			21,231			61.7
Gross profit		4,954			37.6			5,784			40.1			9,112			37.0			13,201			38.3
Operating expenses:
Research and development		1,918			14.6			1,769			12.3			3,863			15.7			3,472			10.1
Sales and marketing		872			6.6			1,228			8.5			2,014			8.2			2,661			7.7
General and administrative		4,076			30.9			2,400			16.6			7,019			28.5			4,636			13.5
Depreciation		343			2.6			378			2.6			669			2.7			817			2.4
Amortization		307			2.3			414			2.9			758			3.1			810			2.3
Total operating expenses		7,516			57.0			6,189			42.9			14,323			58.2			12,396			35.9
Operating (loss) income		(2,562	)		(19.4	)		(405	)		(2.8	)		(5,211	)		(21.2	)		805			2.4
Other income:
Interest and dividend income		8			0.1			125			0.9			41			0.2			233			0.7
Foreign exchange gain		238			1.8			(193	)		(1.4	)		318			1.3			(225	)		(0.7	)
Other, net		12			0.1			25			0.2			80			0.3			39			0.1
Total other income		258			2.0			(43	)		(0.3	)		439			1.8			47			0.1
(Loss) income before income taxes		(2,304	)		(17.4	)		(448	)		(3.1	)		(4,772	)		(19.4	)		852			2.5
Provision for income taxes		6			0.1			29			0.2			36			0.1			98			0.3
Net (loss) income		(2,310	)		(17.5	)		(477	)		(3.3	)		(4,808	)		(19.5	)		754			2.2
Less: net (loss) income attributable to noncontrolling interests		(33	)		(0.3	)		(16	)		(0.1	)		(68	)		(0.3	)		14			0.0
Net (loss) income attributable to MEMSIC, Inc.	$	(2,277	)		(17.2	)%	$	(461	)		(3.2	)%	$	(4,740	)		(19.2	)%	$	740			2.2	%

Quarter Ended June 30, 2013 Compared to Quarter Ended June 30, 2012

Net sales.    Our net sales decreased by 8.6% to $13.2 million for the three months ended June 30, 2013 from $14.4 million in the corresponding period of 2012. This decrease was primarily due to a 78.5% decrease in net sales of our magnetic sensor product to a major mobile phone manufacturer, whose smart phone models in which our sensor is included are winding down in the market and a 79.2% decrease in net sales of sensors for a digital camera application in Japan due to inventory correction. This decrease was partially offset by a 186.0% increase in sales from mobile phone applications in China.

Cost of goods sold.    Our cost of goods sold decreased by 4.7% to $8.2 million for the three months ended June 30, 2013 from $8.6 million for the corresponding period of 2012. This decrease was primarily due to the change in product mix. For the second quarter of 2013, the highest volume of products sold was the newly introduced low-cost wafer level packaged and LCC packaged accelerometer product, as compared to the magnetic sensor product in the second quarter of 2012.

Gross profit and gross margin.   Our gross profit decreased by 14.3% to $5.0 million for the three months ended June 30, 2013 from $5.8 million in the corresponding period of 2012. Our gross margin percentage also decreased by approximately 2.5 percentage points to 37.6% for the three months ended June 30, 2013 from 40.1% in the corresponding period of 2012, due to the change in product mix.

Our gross profit and gross margin by reportable segment are shown in the following table (dollars in thousands):

	Three months ended June 30,
	2013					2012
	Gross Profit		Margin %			Gross Profit		Margin %
Sensor products	$	4,591		37.2	%	$	4,462		37.2	%
System solution products		363		43.9			1,322		54.8
Total	$	4,954		37.6	%	$	5,784		40.1	%

 

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Gross profit from our sensor products increased to $4.6 million for the three months ended June 30, 2013 from $4.5 million in the corresponding period of 2012. This increase was primarily due to an increase in volume sold from the lower cost digital orientation sensor product. Gross margin of our sensor products for the three months ended June 30, 2013 stayed the same at 37.2% as in the corresponding period of 2012.

Gross profit of our system solution products decreased to $0.4 million for the three months ended June 30, 2013 from $1.3 million in the corresponding period of 2012. This decrease was primarily due to the decrease in the total consolidated sales of our system solution products as a result of the dissolution of Crossbow Japan. Gross margin of our system solution products decreased to 43.9% for the three months ended June 30, 2013 from 54.8% in the corresponding period of 2012. The decrease in the gross margin of our system solution products were mainly due to a decrease in sales of inertial products as a result of the product transition as well as an increased manufacturing unit cost due to lower sales volume.

Research and development.    Our research and development expenses increased by 8.4% to $1.9 million for the three months ended June 30, 2013 from $1.8 million in the corresponding period of 2012. This increase was primarily due to the addition of engineering headcount and tape-out cost related to new product development. Research and development expenses as a percentage of total net sales also increased to 14.6% for the three months ended June 30, 2013 from 12.3% for the corresponding period of 2012 due to higher engineering cost and lower net sales. We expect our research and development expenses will continue to increase for the remainder of 2013 as we intend to invest in engineering resources to develop new products and system solutions.

Sales and marketing.    Our sales and marketing expenses decreased by 29.0% to $0.9 million for the three months ended June 30, 2013 from $1.2 million for the corresponding period of 2012. The decrease was primarily due to a reduced commission expense as a result of lower sales as well as a temporary reduction of our sales and marketing headcount. Sales and marketing expenses, as a percentage of total net sales, decreased to 6.6% for the three months ended June 30, 2013 from 8.5% for the corresponding period of 2012 due to lower total sales and marketing expense in the second quarter of 2013. We expect sales and marketing expense to increase for the remainder of 2013 as we plan to add additional technical sales in the U.S. market.

General and administrative.    Our general and administrative expenses increased by 69.8% to $4.1 million for the three months ended June 30, 2013 from $2.4 million in the corresponding period of 2012. This increase was primarily due to legal and Special Committee fees related to the IDG merger transaction. General and administrative expenses, as a percentage of total net sales also increased to 30.9% for the three months ended June 30, 2013 from 16.6% for the corresponding period in 2012.

Depreciation expense. Depreciation expense related to office equipment, computers, software, leasehold improvements and building spaces that are not used in the course of manufacturing our products. Depreciation expense for the three months ended June 30, 2013 decreased to $343,000 from $378,000 in the corresponding period of 2012 due to the transfer of certain research and development equipment into manufacturing.

Amortization expense. Amortization expense was at $0.3 million for the three months ended June 30, 2013, compared to $0.4 million in the corresponding period of 2012. The decrease was due to the full amortization of certain patents and knowhow during the second quarter of 2013.

Other income.    Our other income was $258,000 for the three months ended June 30, 2013 compared to other expense of $43,000 in the corresponding period of 2012. The increase was primarily attributable to foreign exchange gain, partially offset by lower net interest income resulted from an accrued interest expense of $116,000 booked in the second quarter of 2013 related to the construction cost of the MTS building that was financed by the local Chinese government.

Provision for income taxes.    Our income tax provision was $6,000 for the three months ended June 30, 2013 compared to an income tax provision of $29,400 in the corresponding period of 2012. Our income tax provision for the second quarter of 2013 reflected a tax provision of $2,000 and $4,000 related to changes in certain deferred tax assets MEMSIC Semiconductor in China and Crossbow Japan, respectively.

Our income tax provision for the second quarter of 2012 reflected tax provision of $11,700 related to income in Crossbow Japan and a tax provision of $17,700 related to income in MEMSIC Semiconductor in China.

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Six Months Ended June 30, 2013 Compared to Six Months Ended June 30, 2012

Net sales.    Our net sales decreased by 28.5% to $24.6 million for the six months ended June 30, 2013 from $34.4 million in the corresponding period of 2012. This decrease was primarily due to a 77.2% decrease in net sales of our magnetic sensor product to a major mobile phone manufacturer, whose smart phone models in which our sensor is included are winding down in the market and a 76.7% decrease in net sales of sensors for a digital camera application in Japan due to inventory correction. This decrease was partially offset by a 76.3% increase in net sales from mobile phone applications in China.

Cost of goods sold.    Our cost of goods sold decreased by 27.0% to $15.5 million for the six months ended June 30, 2013 from $21.2 million for the corresponding period in 2012. This decrease was primarily due to the decrease in the volume of units sold in our higher cost sensor products and an increase in volume of units sold in our lower cost digital thermal orientation sensor products.

Gross profit and gross margin.   Our gross profit decreased by 31.0% to $9.1 million for the six months ended June 30, 2013 from $13.2 million in the corresponding period of 2012. Our gross margin percentage decreased by approximately 1.3 percentage points to 37.0% for the six months ended June 30, 2013 from 38.3% in the corresponding period of 2012.

Our gross profits and gross margins by reportable segment for the six months ended June 30, 2013 and 2012 are shown in the following table (dollars in thousands):

	Six months ended June 30,
	2013					2012
	Gross Profit		Margin %			Gross Profit		Margin %
Sensor products	$	8,206		36.7	%	$	10,467		35.9	%
System solution products		906		40.4			2,734		52.4
Total	$	9,112		37.0	%	$	13,201		38.3	%

Gross profit from our sensor products decreased to $8.2 million for the six months ended June 30, 2013 from $10.5 million for the corresponding period of 2012, primarily due to the decrease of net sales of our magnetic sensor product to a major mobile phone manufacturer and of our accelerometer product for the Japanese digital camera application. Gross margin of our sensor products increased to 36.7% for the six months ended June 30, 2013 from 35.9% for the corresponding period of 2012 as a result of an increase in volume units sold of our lower cost digital thermal orientation sensor.

Gross profit of our system solution products decreased to $0.9 million for the six months ended June 30, 2013 from $2.7 million for the corresponding period of 2012. This decrease was primarily due to the decrease in the total consolidated sales of our system solution products as a result of the dissolution of Crossbow Japan. Gross margin of our system solution products decreased to 40.4% for the six months ended June 30, 2013 from 52.4% for the corresponding period in 2012. The decrease in the gross margin of our system solution products was mainly due to a decrease in sales of inertial products as a result of the product transition as well as an increased manufacturing unit cost due to lower sales volume.

Research and development.    Our research and development expenses increased by 11.3% to $3.9 million for the six months ended June 30, 2013 from $3.5 million in the corresponding period of 2012. This increase was primarily due to the addition of engineering headcount and tape-out cost related to new product development. Research and development expenses as a percentage of total net sales also increased to 15.7% for the six months ended June 30, 2013 from 10.1% for the corresponding period of 2012 due to higher engineering cost and lower net sales in 2013. We expect our research and development expenses will continue to increase for the remainder of 2013 as we intend to invest in engineering resources to develop new products and system solutions.

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Sales and marketing.    Our sales and marketing expenses decreased by 24.3% to $2.0 million for the six months ended June 30, 2013 from $2.7 million for the corresponding period of 2012. The decrease was primarily due to a reduced commission expense as a result of lower sales to the major mobile phone manufacturer as well as a temporary reduction of our sales and marketing headcount. Sales and marketing expenses, as a percentage of total net sales, increased to 8.2% for the six months ended June 30, 2013 from 7.7% for the corresponding period of 2012 due to lower total sales in 2013. We expect sales and marketing expense to increase for the remainder of 2013 as we plan to add additional technical sales in the U.S. market.

General and administrative.    Our general and administrative expenses increased by 51.4% to $7.0 million for the six months ended June 30, 2013 from $4.6 million in the corresponding period of 2012. This increase was primarily due to legal and Special Committee fees related to the IDG merger transaction. General and administrative expenses, as a percentage of total net sales also increased to 28.5% for the six months ended June 30, 2013 from 13.5% for the corresponding period in 2012, due to higher legal expenses and lower total sales in 2013.

Depreciation expense. Depreciation expense related to office equipment, computers, software, leasehold improvements and building spaces that are not used in the course of manufacturing our products. Depreciation expense for the six months ended June 30, 2013 decreased to $669,000 from $817,000 in the corresponding period of 2012 due to the transfer of certain research and development equipment into manufacturing.

Amortization expense. Amortization expense remained flat at $0.8 million for the first six months of 2013 and 2012.

Other income.    Our other income was $439,000 for the six months ended June 30, 2013 compared to $47,000 in the corresponding period of 2012. The increase was primarily attributable to a foreign exchange gain of $318,000 in the first six months of 2013 as compared to a foreign exchange loss of $225,000 in the corresponding period of 2012, partially offset by lower net interest income resulted from an accrued interest expense of $232,000 booked in 2013 related to construction cost of the MTS building that was financed by the local Chinese government.

Provision for income taxes.    Our income tax provision was $36,000 for the six months ended June 30, 2013 compared to an income tax provision of $98,000 in the corresponding period of 2012. Our income tax provision for the first six month of 2013 reflected a tax provision of $36,000 related to income in Crossbow Japan.

Our income tax provision for the first six month of 2012 reflected a tax provision of $81,000 related to income in Crossbow Japan and a provision of $16,000 related to income in MEMSIC Semiconductor.

Liquidity and Capital Resources

As of June 30, 2013, our principal sources of liquidity consisted of cash, cash equivalents and restricted cash of $41.3 million. In addition, our investments included $20.0 million of short-term investments and $2.5 million of auction rate securities that are classified as long-term investments on our balance sheet. The principal represented by the auction rate security will not be accessible to us until one of the following occurs: a successful auction occurs, the issuer redeems the issue, a buyer is found outside of the auction process or the underlying securities have matured. Based on our expected operating cash flows, and our other sources of cash, we do not expect the potential lack of liquidity in these investments to affect our ability to execute our current business plan in the near term. There can be no assurance that we would be able in the near term to liquidate these securities on favorable terms, or at all, and if we should require access to these funds sooner than we currently expect, our inability to sell these auction rate securities could adversely affect our liquidity and our financial flexibility.

We outsource certain steps of the manufacturing process to third parties while conducting the remaining steps in-house. As a result, our principal uses of cash historically have consisted of payments to our suppliers for the costs related to the outsourcing of wafer fabrication and outsourced processing fees paid to and materials purchased from third parties, as well as payments for our manufacturing overhead and equipment purchases. Other significant cash outlays consist of capital expenditures, including the construction of our buildings in China. We also have used cash to fund salaries, wages and commissions for our non-manufacturing related employees.

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On June 30, 2010, our indirect Wuxi subsidiary, MEMSIC Transducer Systems Company Limited, or MTS, obtained a $20 million, five-year project loan from Agricultural Bank of China. Of this amount, $15 million was used by MTS to purchase from us substantially all the assets that we purchased from Crossbow Technology, Inc., $3 million was available for working capital purposes and $2 million was available for the purchase of equipment to build the manufacturing capacity for the system solution products. This loan is collateralized by the buildings and land owned by our Wuxi subsidiaries as well as the intellectual property purchased by MTS from us. The interest rate of the loan is a variable rate, adjusted semi-annually based on the LIBOR rate plus 4.00%. MTS has obtained agreement from the local Wuxi government to fully subsidize the interest expense on a quarterly basis. As of June 30, 2013, $17,930,000 has been withdrawn, $1,500,000 has been repaid and $16,430,000 is outstanding. The repayment schedule of the principal amount is as follows:

 

Date	Payment Amount
June 29, 2014	$	2,500,000
June 29, 2015		13,930,000
	$	16,430,000

We believe that our current cash, proceeds of our project loan from the Agricultural Bank of China and cash flow from operations will be sufficient to meet our anticipated cash needs, including working capital requirements and capital expenditures for at least the next twelve months. Our future cash requirements will depend on many factors, including our operating income, the timing of our new product introductions, the costs of maintaining adequate manufacturing capacity, the continuing market acceptance of our products, or other changing business conditions and future developments, including any investments or acquisitions we may decide to pursue. If our existing cash is insufficient to meet our requirements, we may seek to sell additional equity securities, debt securities or borrow from banks. We cannot assure you that financing will be available in the amounts we need or on terms acceptable to us, if at all. The sale of additional equity securities, including convertible debt securities, would be dilutive to our stockholders. The incurrence of indebtedness would divert cash for working capital requirements and capital expenditures to service debt and could result in operating and financial covenants that restrict our operations and our ability to pay dividends to our stockholders. If we are unable to obtain additional equity or debt financing, our business, operations and prospects may suffer.

Operating Activities

Net cash used in operating activities for the six months ended June 30, 2013 was $0.8 million, which was derived from net loss of $4.8 million, adjusted to reflect a net increase related to non-cash items, and a net decrease relating to changes in balances of operating assets and liabilities. The adjustment related to non-cash items, an increase of $2.9 million, was mainly attributable to depreciation and amortization expense of $2.2 million, stock compensation expense of $0.7 million and an increase in deferred rent of $14,000 and deferred income tax of $19,000. The adjustment related to changes in the balances of operating assets and liabilities, a net increase in cash of $2.7 million, was primarily the result of decreases of $1.3 million in inventory, $0.2 million in accounts receivable, $0.1 million in other assets, and an increase of $1.0 million in accounts payable and accrued expenses.

Net cash provided by operating activities for the six months ended June 30, 2012 was $1.7 million, which was derived from a net income of $0.8 million, adjusted to reflect a net increase related to non-cash items, and a net decrease relating to changes in balances of operating assets and liabilities. The adjustment related to non-cash items, an increase of $3.3 million, was mainly attributable to depreciation and amortization expense of $2.6 million, stock-based compensation of $0.8 million, offset by a decrease in deferred rent and income tax of $22,000. The adjustment related to changes in the balances of operating assets and liabilities, a net decrease in cash of $2.4 million, was primarily the result of a decrease of $4.3 million in accounts payable and accrued expenses and an increase of $0.5 million in other assets, offset by decreases of $1.9 million in accounts receivables due to decreased sales and $0.5 million decrease in inventory.

Investing Activities

Net cash provided by investing activities for the six months ended June 30, 2013 was $11.7 million, primarily consisting of $34.6 million of proceeds from sale of short-term investments, offset by $20.0 million used for the purchase of short term investments and $3.0 million used for the purchase of property and equipment, mainly attributable to expansion of our sensor manufacturing capacity in China.

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Net cash used in investing activities for the six months ended June 30, 2012 was $29.2 million, primarily consisting of $28.1 million used to purchase short term investments and $1.1 million used for the purchase of property and equipment mainly attributable to expansion of our sensor manufacturing capacity in China.

Financing Activities

Net cash used in financing activities for the six months ended June 30, 2013 was $1.0 million, consisting $1.0 million repayment of bank loan by MTS and cash dividend of $103,000 paid to the minority owner of Crossbow Japan, offset by proceeds of $65,000 from exercise of options to purchase common stock.

Net cash used in financing activities for the six months ended June 30, 2012 was $0.4 million, consisting $0.5 million repayment of bank loan by MTS and cash dividend of $59,000 paid to the minority owner of Crossbow Japan, offset by proceeds of $0.2 million from exercise of options to purchase common stock.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet financing arrangements, other than property and equipment operating leases, nor do we have any transactions, arrangements or other relationships with any special purpose entities established by us, at our direction or for our benefit.

Item 4. Controls and Procedures

A. Evaluation of Disclosure Controls and Procedures

Based on the evaluation of our disclosure controls and procedures (as defined in the Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) required by Exchange Act Rules 13a15(b) or 15d-15(b), our chief executive officer and our principal financial and accounting officer have concluded that as of June 30, 2013, the end of the period covered by this report, our disclosure controls and procedures were effective.

B. Changes in Internal Controls

There were no changes in our internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f), that occurred during the quarter ended June 30, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II - OTHER INFORMATION

Item 1. Legal Proceedings

On September 11, 2011, Trilogy Marketing, Inc. (Trilogy) commenced an action in the United States District Court for the Eastern District of Michigan, in which it alleges that MEMSIC has failed to pay sales representative commissions to Trilogy. We have not concluded that a loss of any magnitude in this matter is probable, and are unable to estimate the range of potential loss, if any, that might arise from this matter.

On May 14, 2013, a putative class action captioned Spencer v. Zhao et al., C.A. No. 13-1771-BLS, was filed in Massachusetts Superior Court in Suffolk County against us, our directors and certain other parties. The amended complaint alleges, among other things, that our directors breached their fiduciary duties in connection with their consideration and approval of our April 22, 2013 agreement to be acquired by IDG-Accel China Capital II and its affiliates and seeks an award of monetary damages in an unspecified amount and injunctive relief to prevent the consummation of the merger. While we and the other defendants believe that the allegations made in the lawsuit are without merit, to minimize the expense and uncertainty of litigation we and the other defendants have entered into a memorandum of understanding with the plaintiff dated July 29, 2013 (the ““MOU’’). In the MOU, the parties agreed to settle the lawsuit subject to certain conditions and without admitting any liability. The MOU includes an agreement in principle to negotiate and execute a final settlement agreement which would provide for the release and settlement by our stockholders of all claims against us and the other defendants, in exchange for which we would supplement the proxy statement for the merger with certain additional disclosures. The settlement will not affect the amount of the merger consideration that our stockholders are entitled to receive in the merger. The settlement is contingent upon plaintiff’s completion of confirmatory discovery and is subject to the approval of the Massachusetts Superior Court. We expect that plaintiff’s counsel will seek an award of attorneys’ fees and expenses as part of the settlement. No demand for such fees and expenses has been made at this time and we are unable to estimate the range of potential loss, if any, that might arise from this matter.

Item 1A. Risk Factors

There has been no material change in the risk factors disclosed under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2012, as supplemented by our Quarterly Report or Form 10-Q for the three months ended march 31, 2013.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The net proceeds to us of our initial public offering in 2007, including the net proceeds from exercise of underwriters’ over-allotment option were approximately $60.2 million. Through June 30, 2013, we have applied approximately $13.6 million of the net proceeds to fund capital expenditures for the expansion of our manufacturing facility in Wuxi, $7.3 million to the construction of two new buildings adjacent to that facility and $4.0 million to the purchase of a piece of land to build the MTS manufacturing facility and manufacturing equipment, and $18.0 million to the Crossbow acquisition. We invested the balance of $17.3 million of the net proceeds from our initial public offering in money market funds and auction rate securities, pending other uses.

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Item 6. Exhibits

			Incorporated by Reference
Exhibit No.	Description	Filed with This Form 10- Q	Form	Filing Date	Exhibit No.
2.1	Agreement and plan of Merger dated as of April 22, 2013 among MZ Investment Holdings Limited, MZ Investment Holdings Merger Sub Limited and MEMSIC, Inc.		8-K	April 25, 2013	2.1
3.1	Second Amended and Restated Certificate of Incorporation of MEMSIC, Inc.		8-K	December 19, 2007	3.1
3.2	Amended and Restated By-Laws of MEMSIC, Inc.		S-1/A	November 30, 2007	3.4
4.1	Form of common stock certificate.		S-1/A	December 7, 2007	4.2
4.2	Fifth Amended and Restated Investor Rights Agreement.		S-1	September 28, 2007	4.3
4.4	2009 Nonqualified Inducement Stock Plan		10Q	November 14, 2011	4.4
10.1	Voting Agreement dated as of April 22, 2013 among MEMSIC, Inc., MZ Investment Holdings Limited and certain stockholders of MEMSIC, Inc.		8-K	April 25, 2013	10.1
31.1	Chief Executive Officer certification required by Rule 13a-14(a)	X
31.2	Principal Accounting Officer certification required by Rule 13a-14(a)	X
32.1	Chief Executive Officer certification pursuant to 18 U.S.C. Section 1350	X
32.2	Principal Financial and Accounting Officer certification pursuant to 18 U.S.C. Section 1350	X
101.***	The following materials from MEMSIC, Inc.’s Quarterly Report on Form 10-Q for the three and six months ended June 30, 2013, formatted in XBRL (eXtensible Business Reporting Language): (i) the Unaudited Consolidated Balance Sheets; (ii) the Unaudited Consolidated Statements of Operations; (iii) the Unaudited Consolidated Statements of Comprehensive Income (Loss); (iv) the Unaudited Consolidated Statements of Cash Flows and (v) the Notes to Consolidated Financial Statements, tagged as blocks of text.	X

Attached as Exhibit 101 to this report are the following formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Balance Sheets as of June 30, 2013 (Unaudited) and December 31, 2012; (ii) Unaudited Consolidated Statements of Operations for the three and six months ended June 30, 2013 and 2012; (iii) Unaudited Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2013 and 2012, (iv) Unaudited Consolidated Statements of Cash Flows for the six months ended June 30, 2013 and 2012 and (v) Notes to Unaudited Consolidated Financial Statements.

In accordance with Rule 406T of Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act, is deemed not filed for purposes of Section 18 of the Exchange Act, and otherwise is not subject to liability under these sections.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	MEMSIC, Inc.
Dated: August 14, 2013	By:	/S/ YANG ZHAO
		Yang Zhao
		Chief Executive Officer and President
		Principal Executive Officer
Dated: August 14, 2013	By:	/S/ PATRICIA NIU
		Patricia Niu
		Principal Financial and Accounting Officer