Restatement of Previously issued Financial Statements

Background on the Restatement

Audit Committee's Investigation

In January 2013, following receipt of information concerning potential revenue recognition issues, the Audit Committee of the Board of Directors engaged independent legal counsel and forensic accountants to conduct an investigation concerning the potential issues and to work with management to determine the potential impact on accounting for revenue. In February 2013, as a result of the findings of the Audit Committee's investigation to date, the Company determined that certain of its employees had engaged in conduct which resulted in revenue being recorded in periods prior to the criteria for revenue recognition under U.S. generally accepted accounting principles being satisfied.

The investigation revealed arrangements with three of the Company's distributors regarding extended payment terms, which allowed these distributors to pay the Company after they received payment from their customer, and with one of the Company's distributors regarding return rights and profit margin protection, for sales to such distributors with respect to certain transactions. In addition, arrangements were revealed with one non-distributor customer to honor transfer of title at a date later than the customer's purchase orders indicated. Based on the results of its investigation, the Audit Committee determined that these arrangements had not been communicated to the Company's finance and accounting department, or to the Company's CEO, and therefore, had not been considered when revenue was originally recorded. Based on the terms of the agreements with these customers as they were known to the Company's finance and accounting department, it had been the Company's policy to record revenue related to shipments as title passed at either shipment from the Company's facilities or receipt at the customer's facility, assuming all other revenue recognition criteria had been achieved. In addition to the arrangements noted above, the investigation uncovered an error on an individual transaction where a customer was given extended payment terms, which allowed them to pay the Company after they received payment from their customer, but those terms were not considered when revenue was originally recognized.

As a result of the arrangements discovered during the investigation, the Company does not believe that a fixed or determinable sales price existed at the time of shipment, nor was collection reasonably assured, at least with respect to certain transactions. In addition, revenue related to certain shipments to the one non-distributor customer was recorded before the actual transfer of title and the satisfaction of the Company's obligation to deliver the products. Therefore, revenue from these sales should not have been recognized at the time of shipment.

Based on the arrangements with customers revealed in the investigation that were not considered when revenue was originally recognized, the Company determined the following:

•

Beginning in the period in which the investigation revealed arrangements regarding extended payment terms for certain sales to three distributors, the Company determined it is appropriate to defer revenue recognition on all sales to these distributors from the period of shipment to the period in which payment is received. For these distributors, revenue recognition in the period in which payment is received was determined to be appropriate beginning in the fourth quarter of 2011.

•

Beginning in the period in which the investigation revealed return rights and profit margin protection for one distributor, the Company determined it appropriate to defer revenue recognition on all sales to this distributor until the distributor confirms with the Company that they are not entitled to any further returns or credits. For this distributor, the deferral of revenue on this basis was determined to be appropriate beginning in the fourth quarter of 2011. At such time as the distributor confirms with the Company that they are not entitled to any further returns or credits, which is currently anticipated to occur in the second half of the fiscal year 2013, previous sales for which revenue has been deferred, net of any credits or returns that may be made by the distributor, will be recognized as revenue.


•	For the arrangements with the non-distributor customer to honor transfer of title at a date later than the customer's purchase order indicated, the Company determined it appropriate to defer revenue recognition to the period in which the Company agreed to honor transfer of title.


•	For the individual transaction where a customer was given extended payment terms which were not considered when revenue was originally recognized in the first quarter of 2011, revenue recognition in the period in which payment was received, which was in the second quarter of 2011, was determined to be appropriate.

Management's Subsequent Internal Review

Once the audit committee investigation was complete, management of the Company conducted a review beginning with the first quarter of 2009 through the first quarter of 2013 to ensure that all sales arrangements had been detected and accounted for appropriately. During this review, the Company noted that there were a number of quarter end revenue cut-off errors wherein revenue was recorded prior to the transfer of title to the customer and the satisfaction of the Company's obligation to deliver the products. The Company has corrected these errors occurring in the first quarter of 2011 through the third quarter of 2012 by moving the revenue recognition for these items to the period in which delivery actually occurred.

Results of the Audit Committee's Investigation and Management's Internal Review

Based on the findings of the investigation, as previously reported in the Company's current report on Form 8-K dated March 7, 2013, the Audit Committee, in consultation with management and the Board of Directors, concluded that the Company's previously issued financial statements contained in its annual report on Form 10-K for the year ended December 31, 2011, and the quarterly reports on Form 10-Q for the quarters ended March 31, 2011, June 30, 2011, September 30, 2011, March 31, 2012, June 30, 2012 and September 30, 2012, should no longer be relied upon. Accordingly, the consolidated financial statements for the first three quarters of the fiscal year ended December 31, 2012, for the fiscal year ended December 31, 2011, and for each of the interim periods within the fiscal year ended December 31, 2011, have been restated in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2012. See Note 15, in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2012, for the effects of the restatement adjustments on our 2012 and 2011 unaudited quarterly financial information.

As a result of the Audit Committee's investigation, certain employees were terminated and the Company's Sr. Vice President of Sales and Marketing resigned as reported in the Company's current report on Form 8-K dated March 7, 2013.

In connection with the errors identified during the investigation resulting in the restatement of previously reported financial statements, the Company identified control deficiencies in its internal control over financial reporting that constitute material weaknesses. For a discussion of our disclosure controls and procedures and the material weaknesses identified, see Part I, Item 4, Controls and Procedures, of this Quarterly Report on Form 10-Q.

The Company's previously filed annual report on Form 10-K for the fiscal year ended December 31, 2011, and its quarterly reports on Form 10-Q for the periods affected by the restatements, have not been amended. Accordingly, investors should no longer rely upon the Company's previously released financial statements for any quarterly or annual periods after and including March 31, 2011, and any earnings releases or other communications relating to these periods. See Note 2, Restatement of Previously Issued Financial Statements and Financial Information, and Note 15, Unaudited Quarterly Financial Information, of the Notes to the Consolidated Financial Statements, in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2012, for the impact of these adjustments for the full fiscal year ended December 31, 2011, and the first three quarters of the fiscal year ended December 31, 2012 and each of the quarterly periods in the fiscal year ended December 31, 2011, respectively.

Restatement Adjustments

Restatement Adjustments Related to Sales Arrangements

Several adjustments were made to the Company's previously filed consolidated financial statements as a result of the restatement in order to reflect revenue recognition in the appropriate periods as discussed above. Accordingly, for the subject sales transactions, revenue and accounts receivable balances were reduced by an equivalent amount in the period that the sale was originally recorded as revenue, and revenue was increased in the subsequent period in which the criteria for revenue recognition were met. Further, for the subject sales transactions, cost of revenue was reduced, and inventory was increased, in the period that the sale was originally recorded as revenue, and cost of revenue was increased, and inventory was reduced, in the period the sale was ultimately recorded as revenue. However, for sales to one distributor in which revenue is being deferred until the Company determines that the distributor is not entitled to any further returns or credits, as discussed above, the increase to revenue, and the related reduction to inventory and increase to cost of revenue, will be recorded in a future period when this determination is made.

The adjustments also reflect the impacts of adjusting the Company's returns reserves for certain stock rotation rights of the distributors, and adjusting the Company's reserves for allowances for doubtful accounts, as well as commissions expense, although these changes were not material.

In addition to the adjustments to revenue, accounts receivable, inventory and cost of revenue, inventory reserves balances and cost of revenue were adjusted in relation to the adjustments to inventory discussed above, in order to reflect inventory ultimately recorded on our balance sheets at its lower of cost or market value.

Other Restatement Adjustments

Since the Company's determination to restate its previously issued financial statements constituted an event of default under the terms of its credit facility, the bank had the right to require immediate payment of the outstanding borrowings. As a result restatement adjustments were recorded to reclassify the amounts outstanding under the credit facility from long-term debt to current liabilities as of each respective balance sheet date. In addition, an insignificant amount of debt issuance costs were reclassified from a long-term asset to a short-term asset, consistent with the classification of the related debt. In June 2013, the Company entered into a forbearance agreement with the bank wherein the bank agreed to forbear from further exercise of its rights and remedies to call our outstanding debt under the credit facility in connection with the events of default for a period terminating on the earlier of September 30, 2013 or the occurrence of any additional events of default.

Further, a restatement adjustment was made to reclassify a legal settlement with a customer from selling, general and administrative expense to contra-revenue in the second quarter of 2011 in the amount of for $2.6 million. Certain other immaterial adjustments were made in connection with the restatement.

The restatement adjustments did not impact the Company's previously reported tax provision or benefit in any of the affected periods, other than a $54,000 decrease in the income tax provision for the quarter ended September 30, 2012, as all of the restatement adjustments were related to our U.S. operations, for which the Company has significant net operating loss carryforwards and has not recorded an income tax expense or benefit in any period to date. However, the restatement adjustments did impact the composition of the Company's deferred tax assets and liabilities as of December 31, 2011 as presented in Note 10, Income Taxes, of the Notes to the Consolidated Financial Statements included in the Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

The restated quarterly condensed consolidated statement of operations for the first quarter of fiscal year 2012 is presented below (in thousands, except per share data):



	Three Months Ended March 31, 2012
	As previously reported			Restatement Adjustments			Restated
Revenue	$	39,230		$	(3,426	)	$	35,804
Cost of revenue	23,093			(2,446		)	20,647
Gross profit	16,137			(980		)	15,157
Operating expenses:
Selling, general and administrative	9,286			502			9,788
Research and development	5,596			(26		)	5,570
Total operating expenses	14,882			476			15,358
Income (loss) from operations	1,255			(1,456		)	(201		)
Interest expense, net	(26		)	—			(26		)
Amortization of debt discount and prepaid debt costs	(11		)	—			(11		)
Income (loss) from operations before income taxes	1,218			(1,456		)	(238		)
Income tax provision	714			—			714
Net income (loss)	$	504		$	(1,456	)	$	(952	)
Net income (loss) per share:
Basic	$	0.02		$	(0.05	)	$	(0.03	)
Diluted	$	0.02		$	(0.05	)	$	(0.03	)
Weighted average common shares outstanding:
Basic	28,122						28,122
Diluted	28,559						28,122

The restated quarterly condensed consolidated statement of cash flows for the first quarter of fiscal year 2012 is presented below (in thousands):



	Three Months Ended March 31, 2012
	As previously reported			Restatement Adjustments		Restated
OPERATING ACTIVITIES:
Net income (loss)	$	504		(1,456	)	$	(952	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation	1,768			—		1,768
Amortization of intangible assets	134			—		134
Amortization of debt discount and prepaid debt costs	11			—		11
Pension cost	46			—		46
Stock-based compensation expense	1,286			—		1,286
Recovery of losses on accounts receivable	(103		)	(69	)	(172		)
Changes in operating assets and liabilities:				—
Trade and other accounts receivable	(6,568		)	2,535		(4,033		)
Inventories	(3,211		)	(2,571	)	(5,782		)
Prepaid expenses and other assets	229			(113	)	116
Accounts payable and accrued liabilities and deferred revenue	(3,217		)	1,773		(1,444		)
Accrued employee compensation	(434		)	(99	)	(533		)
Deferred income taxes	11			—		11
Other long-term liabilities	(2,263		)	—		(2,263		)
Net cash used in operating activities	(11,807		)	—		(11,807		)
INVESTING ACTIVITIES:
Purchases of property and equipment	(4,057		)	—		(4,057		)
Net cash used in investing activities	(4,057		)	—		(4,057		)
FINANCING ACTIVITIES:
Principal payments on long-term debt and short-term borrowings	(3,183		)	—		(3,183		)
Proceeds from long-term and short-term borrowings	8,161			—		8,161
Proceeds from sale of common stock, net of offering costs	10,283			—		10,283
Repurchase of shares	(286		)	—		(286		)
Proceeds from issuance of common stock under equity compensation plans	1,319			—		1,319
Net cash provided by financing activities	16,294			—		16,294
Increase in cash and cash equivalents from operations	430			—		430
Effect of exchange rate changes on cash and cash equivalents	909			—		909
Increase in cash and cash equivalents	1,339			—		1,339
Cash and cash equivalents, beginning of period	29,289			—		29,289
Cash and cash equivalents, end of period	$	30,628		—		$	30,628