**UNITED
                STATES****SECURITIES
                AND EXCHANGE COMMISSION****Washington,
                D.C. 20549****FORM
                10-K**(Mark
                One)x          
                Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
                Act of 1934For
                the fiscal year ended: January 28, 2006ORo          
                Transition Report pursuant to Section 13 or 15(d) of the Securities
                Exchange Act of 1934For
                the transition period from ____________ to ____________Commission
                File Number000-15116**SIGMA
                DESIGNS, INC.***(Exact
                name of Registrant as specified in its
                charter)*




California
            
            94-2848099(State
                or other jurisdiction of incorporation or organization)
            
            (I.R.S.
                Employer Identification Number)1221
                California Circle Milpitas, California
            
            95035(Address
                of principal executive offices)
            
            (Zip
                code)




Registrant’s
                telephone number, including area code:(408)
                262-9003**Securities
                registered pursuant to Section 12(b) of the Act:**None**Securities
                registered pursuant to Section 12(g) of the Act:**Common Stock****
              (Title
                of Class)







Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.




Yes
      [   ]   No [X]




Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act.




Yes
        [   ]   No [X]




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
        [X]   No [   ]




Indicate
      by check mark if disclosure of delinquent filers pursuant to item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the best
      of registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-K. [ ]




Indicate
      by check mark whether the registrant is a large accelerated filer, or an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule12b-2 of the Exchange Act. (Check
      one):




Large
      accelerated filer [  
]  Accelerated
      filer [X]  Non-accelerated
      filer  [   ]




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Act).




Yes
        [   ]   No [X]




As
      of
      July 30, 2005, the last business day of the Registrant’s most recently completed
      second fiscal quarter, there were 21,318,567 shares of the Registrant’s common
      stock outstanding, and the aggregate market value of such shares held by
      non-affiliates of the Registrant (based on the closing sale price of such shares
      on the Nasdaq National Market on July 29, 2005) was approximately $155,906,164.
      Shares of the Registrant’s outstanding common stock held by each executive
      officer and director and by each entity known to the Registrant to own 5% or
      more of the Registrant’s outstanding common stock have been excluded in that
      such persons may be deemed to be affiliates. This determination of affiliate
      status is not necessarily a conclusive determination for other purposes.









There
      were 22,045,875 shares of the Registrant’s Common Stock issued and outstanding
      on March 30, 2006.




DOCUMENTS
      INCORPORATED BY REFERENCE




Certain
      sections of Sigma Designs, Inc.’s definitive Proxy Statement for the 2006 Annual
      Meeting of Shareholders to be held on June 16, 2006 are incorporated by
      reference in Part III of this Form 10-K to the extent stated herein. The Proxy
      Statement will be filed within 120 days of the Registrant’s fiscal year ended
      January 28, 2006.




Exhibit
      Index is on Page E-1




Total
      number of pages is 93





















**Sigma
      Designs, Inc.**


**2006
      ANNUAL REPORT ON FORM 10-K**


**TABLE
      OF CONTENTS**




**PART
                I**
            **Page
                No**Item
                1. Business
            2Item
                1A. Certain Factors Affecting Business, Operating Results, and Financial
                Condition
            11Item
                1B. Unresolved Staff Comments
            20Item
                2. Properties
            20Item
                3. Legal Proceedings
            20Item
                4. Submission of Matters to a Vote of Security Holders
            21**PART
                II**Item
                5. Market for the Registrant's Common Equity and Related Stockholder
                Matters
            22Item
                6. Selected Financial Data
            22Item
                7. Management's Discussion and Analysis of Financial Condition and
                Results
                of Operations
            23Item
                7A. Quantitative and Qualitative Disclosures About Market Risk
            40Item
                8. Consolidated Financial Statements and Supplementary Data
            40Item
                9. Changes in and Disagreements with Accountants on Accounting and
                Financial Disclosure
            40Item
                9A. Controls and Procedures
            40Item
                9B. Other Matters
            45**PART
                III**Item
                10. Directors and Executive Officers of the Registrant
            45Item
                11. Executive Compensation
            45Item
                12. Security Ownership of Certain Beneficial Owners and Management
                and
                Related Stockholder Matters
            45Item
                13. Certain Relationships and Related Transactions
            46Item
                14. Principal Accounting Fees and Services
            46**PART
                IV**Item
                15. Exhibits, Financial Statement Schedules
            46Signatures
            47







**FORWARD-LOOKING
      INFORMATION**




Throughout
      this report, we refer to Sigma Designs, Inc., together with its subsidiaries,
      as
“we,” “us,” “our company,” “Sigma” or “the Company.”




*THIS
      FORM 10-K FOR THE YEAR ENDED JANUARY 28, 2006, CONTAINS FORWARD-LOOKING
      STATEMENTS, INCLUDING STATEMENTS ABOUT THE CONTINUED STRENGTH OF OUR BUSINESS
      AND OPPORTUNITIES FOR FUTURE GROWTH, EXPECTED RESULTS OF OPERATIONS, ANTICIPATED
      REVENUES, GROSS MARGINS AND EXPENSES, OUR ABILITY TO REMEDIATE OUR INTERNAL
      CONTROLS AND OUR AVAILABLE CASH RESOURCES. IN SOME CASES, YOU CAN IDENTIFY
      FORWARD-LOOKING STATEMENTS BY TERMINOLOGY SUCH AS “MAY”, “WILL”, “SHOULD”,
“EXPECT”, “PLAN”, “INTEND”, “ANTICIPATE”, “BELIEVE”, “ESTIMATE”, “PREDICT”,
“POTENTIAL”, OR “CONTINUE”, THE NEGATIVE OF SUCH TERMS OR OTHER COMPARABLE
      TERMINOLOGY. WE BELIEVE THAT OUR EXPECTATIONS ARE REASONABLE AND ARE BASED
      ON
      REASONABLE ASSUMPTIONS. HOWEVER, SUCH FORWARD-LOOKING STATEMENTS BY THEIR NATURE
      INVOLVE RISKS AND UNCERTAINTIES.*




*WE
      CAUTION THAT A VARIETY OF FACTORS, INCLUDING BUT NOT LIMITED TO THE FOLLOWING,
      COULD CAUSE OUR BUSINESS AND FINANCIAL RESULTS TO DIFFER MATERIALLY FROM THOSE
      EXPRESSED OR IMPLIED IN FORWARD-LOOKING STATEMENTS: OUR DEPENDENCE ON THE
      EXPANSION OF EVOLVING SEGMENTS OF THE COMSUMER ELECTRONICS MARKET; FLUCTUATING
      OPERATING RESULTS; PRICING PRESSURES; OUR ABILITY TO ATTRACT AND RETAIN
      QUALIFIED PROFESSIONALS; INDUSTRY COMPETITION; CHANGES IN INTERNATIONAL
      REGULATIONS; MONETARY AND FISCAL POLICIES; AND OTHER FACTORS DISCUSSED MORE
      FULLY IN MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
      OF OPERATIONS AND RISK FACTORS BELOW, AS WELL AS IN OTHER REPORTS SUBSEQUENTLY
      FILED FROM TIME TO TIME WITH THE SECURITIES AND EXCHANGE COMMISSION. WE ASSUME
      NO OBLIGATION TO UPDATE ANY FORWARD-LOOKING STATEMENTS.*






**PART
      I**




**ITEM
      1. BUSINESS**




We
      specialize in silicon-based digital media processors for consumer products.
      Our
      highly-integrated chipsets provide high-quality decoding of H.264, MPEG-4,
      MPEG-2, MPEG-1 and Windows® Media Video 9 (WMV9) content. MPEG or Moving Picture
      Experts Group, is an international standards body.




Complementing
      our core technology, we have developed chip and software solutions for emerging
      convergence products, including DVD playback, digital TV (DTV) reception, video
      over IP, personal video recording (PVR) and video-on-demand (VOD). We sell
      our
      products into consumer electronic devices and products. Our products are sold
      worldwide through a direct sales force and distributors. Our common stock,
      publicly traded since 1986, is listed on the NASDAQ National Market under the
      symbol SIGM. Our corporate headquarters are located in Milpitas, California,
      and
      we also have a research and development center in France as well as sales
      offices in China, Europe, Hong Kong, Japan and Taiwan.




2


We
      were
      founded in 1982, and became a pioneer in the MPEG hardware decoder market in
      1993 with the introduction of our REALmagic card, a MPEG playback card for
      personal computers, or PCs. In April 1997, we announced our entry into the
      DVD
      market. During the past few years, we have expanded well beyond our PC card
      beginnings and work with consumer electronics manufacturers and network service
      providers to deploy Internet Protocol Television (IPTV) services, digital media
      adapters, next generation high-definition DVD players, and high definition
      television. These opportunities have led to technology investments in media
      processor chips, streaming video software, digital rights management, and a
      number of other technologies.




At
      the
      end of 2001, we introduced a DVD resolution MPEG-4 decoder chip for set-top
      appliances, establishing a unique position to contribute to the deployment
      of
      next generation capabilities. Since then, we have secured numerous design wins
      and are shipping this product for applications including IP-based set-top boxes
      for video over DSL, fiber to the home, and next generation high-definition
      DVD
      players.




In
      January 2003 we launched our first high definition television (HDTV) decoder
      chips with MPEG-4. In January 2004 we announced the EM8620L, the first media
      processor to support WMV9, an advanced video compression technology from
      Microsoft Corp. In January 2005, we announced the SMP8630, the one of first
      media processor to integrate H.264, WMV9 and MPEG decoding in one
      chip.




In
      February 2006, we acquired Blue7 Communications (“Blue7”) (see Note 17
“Subsequent Event”) which was a privately-held California corporation. Our
      subsidiary, Blue7, will focus on the development of advanced wireless
      technologies and Ultra-Wideband (UWB) semiconductor products.




We
      were
      incorporated in California in January 1982. Our principal executive office
      is
      located at 1221 California Circle, Milpitas, California 95035. Our telephone
      number is (408) 262-9003, and our Internet website address is
      www.sigmadesigns.com; however, the information in, or that can be accessed
      through, our website is not part of this report. Our annual reports on Form
      10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and
      amendments to such reports are available, free of charge, on our website under
      “Investors,” as soon as reasonably practicable after we have electronically
      filed such material with, or have furnished it to, the United States Securities
      and Exchange Commission, or SEC. The public may also read and copy any materials
      we filed with the SEC at the SEC’s Public Reference Room at 450 Fifth Street,
      N.W., Washington D.C. 20549. The public may obtain information on the operation
      of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC
      also
      maintains an Internet site (www.sec.gov) that contains reports, proxy and
      information statements and other information regarding us that we filed
      electronically with the SEC.






3


**Principal
      Markets**




Our
      primary focus is to develop and market media processor chipsets for four general
      types of consumer appliances, which are IP video technology, connected media
      players, high-definition television and PC add-in and other markets. Many of
      our
      chipset products are designed to be used in a wide range of applications within
      these appliances.




***IP
      Video Technology***




Video
      delivered and distributed over Internet Protocol (IP) is emerging as an
      important product category for a growing number of consumer equipment makers.
      This technology can be further divided into two primary sub-segments, IPTV
      over
      DSL and digital media adapters (DMAs).




We
      believe broadband Internet connectivity, highly compressed digital media, and
      a
      fundamental demand for entertainment alternatives are paving the way for IPTV
      delivered over DSL. New set-top boxes, many based on advanced codecs such as
      H.264 or WMV9 and advanced digital rights management (DRM), are being developed
      by telecommunications companies around the world to tap into the potential
      revenues streams that may be created by these products. Many international
      regions currently lack the cable infrastructure that exists in the U.S., thus
      creating demand for reliable high quality video delivery. We attempt to meet
      this demand by offering a chip with a set of features including high performance
      silicon and streaming video software.




DMAs
      are
      a new consumer product category which supports distribution of video/audio
      content to television sets throughout the home using wired or wireless
      connectivity. DMAs typically work in conjunction with a centralized media center
      or gateway to offer ubiquitous digital media in home. We provide chipset
      solutions for DMAs, utilizing the same feature set, and streaming video software
      developed for the IPTV market.




Companies
      such as D-Link, Pinnacle, Sharp, I/O Data and LG Electronics, are preparing
      and
      providing IP video appliances for the consumer market using our silicon
      solutions. In addition, the new Microsoft TV platforms being planned for
      shipment by AT&T and British Telecom are currently being designed around our
      SMP8634 media processor chips.




***Connected
      Media Players***




Connected
      media players are a range of devices such as high-definition DVD players
      (Blu-ray, HD-DVD, and others), portable media devices, and multi-function media
      centers.




We
      believe high-definition DVD players with advanced video codecs have been a
      product of choice for entertainment enthusiasts for over two years. We
      introduced the first DVD decoder chips supporting playback of MPEG-4 and DivX
      video, and have followed up with the support for WMV9, an important new feature
      for downloading content. We are a supplier in this segment and provide chips
      with the latest codecs (H.264 and VC-1), support for networking and local hard
      drives, and high-definition video output. We are engaged in readying Blu-ray
      product launches with five consumer electronics manufacturers and a sixth one
      for HD-DVD.




4




We
      also
      sell our chipsets for use in portable media devices. With ongoing technology
      improvements in media compression, wireless communications, and small
      form-factor storage, portable media players have quickly become the
      media-on-the-go equivalent of the cell phone. The trend toward hand-held players
      has already moved to the mainstream for audio, while new advanced video
      compression schemes are enabling the addition of movies, personal video and
      photos, for use on the road and within the home. We serve this market by selling
      media processors that offer the latest codecs in a highly integrated package
      along with low power consumption.




***High
      Definition Television***




HDTV
      sets
      represent a substantial and growing product category, currently selling in
      the
      millions of units, led by the U.S. market and moving overseas. New widescreen
      HDTV sets are being offered in an increasing array of forms using three primary
      technologies, which are liquid crystal display (LCD), plasma and projection,
      each providing its own set of advantages. We offer a growing line of
      high-definition media processors designed for flat panel displays and offer
      advanced display-processing features.




Our
      EM8620 series of digital media processor has been selected for use in
      high-definition plasma television sets from such customers as LG Electronics.




***PC
      add-in and other markets*** ****




The
      PC
      add-in and other markets consists of PC add-in board and chipset products,
      engineering support services for both hardware and software, engineering
      development for customization of chipsets and other accessories.




**Industry
      Alliances**




To
      meet
      customer needs for a complete system solution, we have developed strong
      relationships with leading suppliers of chipsets, system software and video
      servers/encoders. Companies that provide live encoders and server systems enable
      original equipment manufacturers to deliver complete solutions for IP video
      streaming applications. Our set-top appliance reference designs, in some cases,
      depend on vendors of processors, graphics controllers, video encoders, wireless
      controllers, and DTV tuners. Furthermore, stand-alone consumer appliances
      require a substantial amount of software and middleware, from vendors such
      as
      Digital 5, Syabas, or Microsoft, with which we also have strong working
      relationships.




**Sigma
      Business Strategy**




Our
      objective is to provide digital media processing chipsets that offer advanced
      features, high video quality, and rapid time-to-market for our target
      applications. We continue to invest in technology development as well as utilize
      our fundamental advantages.




5


We
      believe that our field-proven, decoder technology, now in our fourth generation
      of silicon and equivalent evolution of software, represents one of our
      competitive advantages. We continue to invest and build on six primary
      technology foundations to provide the highest quality digital video/audio
      solutions possible:




·
            Digital
                video decoding including MPEG-1, -2 and -4 H.264 and
                WMV9;




·
            Digital
                audio decoding including MPEG-1, -2 and proprietary formats, including
                Dolby® Digital and Windows® Media Audio (WMA);




·
            Advanced
                scene composition including advanced video scaling, adaptive
                deinterlacing, adaptive flicker filtering and prioritized alpha mixing;




·
            Secure
                media processing for effectively protecting content and processing
                DRM
                algorithms, transport handling and conditional
                access;




·
            Software
                clients for VOD and IP multicast and navigation software for DVD-video,
                DVD-audio, SVCD, VCD, CD and HDD playback;
                and




·
            Standard-definition
                (SD) and high-definition (HD) solutions that share a common hardware
                and
                software architecture.




*Recent
      Acquisition:*




On
      February 16, 2006, we acquired Blue7 Communications (“Blue7”), which was a
      privately-held California corporation. Our subsidiary, Blue7, will focus on
      the
      development of advanced wireless technologies and Ultra-Wideband (UWB)
      semiconductor products.




We
      believe demand for wireless communication solutions continues to increase and
      escalate, and encompasses an increasing portion of the consumer electronics
      environment. While WiFi (802.11) solutions have largely satisfied the need
      for
      medium bandwidth data communications, it has failed to address the needs of
      an
      audio/video entertainment network which requires, enough bandwidth to handle
      multiple high-definition video streams while remaining within the price range
      of
      mainstream adoption. Ultra-Wideband (UWB) technology may offer such a solution,
      supporting a maximum data rate of 480 Mbps with high QoS, low power consumption
      and competitive pricing. We believe that our focus on IP video and networked
      consumer products, the addition of wireless communication products and
      technologies from Blue7 will enable us to address broader solutions and increase
      our value-add in each product.




**Sigma
      Products**




We
      offer
      chip-level products that enable digital media processing solutions for consumer
      appliances. We believe our line of digital media processing chips features
      high
      video quality. We complement our silicon technology with embedded software,
      portable to a wide range of operating environments. Featuring VOD and media
      navigation clients, our software is available under Windows, Linux and WinCE
      operating systems. In addition, we develop and sell reference platforms designed
      around our silicon and software as application examples for customer
      development.




6


The
      following chipset products are sold primarily into the consumer appliance
      market:




·
            The
                EM8400 series provides MPEG-4, -2 and -1 video and audio decoding
                for
                broadband interactive set-top boxes, including companies such as
                Fujitsu-Siemens, Acer and Samsung. The EM8400 Series represents one
                of the
                first MPEG-4 silicon solutions for the set-top box
                market.




·
            The
                EM8500 series is the first solution for DVD players, portable media
                players and video endpoints to support MPEG-4 and DivXTM. It is also the
                first to feature high-quality scaling to HDTV resolutions and support
                for
                DVI/HDCP. The unique features of the EM8500 series enabled the
                availability of networked DVD players and low-cost video endpoints,
                such
                as digital media adaptors and broadband network devices.




·
            The
                EM8610 series represents the first HDTV decoder silicon solutions
                to also
                support MPEG-4 and IP video streaming. Designed for HDTVs and advanced
                set-top boxes, it also offers advanced audio and video processing
                and
                progressive DVD playback. The software-compatible EM8610L series
                addresses
                the more cost-sensitive SDTV and video endpoint markets.




·
            The
                EM8620L series represents the first HD WMV9 decoder silicon solution
                and
                also supports DVD and HD MPEG-4/-2 decoding. Designed for video endpoints,
                such as digital media adaptors and broadband IP video set-top boxes,
                DVD
                receivers and advanced DVD players, the EM8620L series offers advanced
                audio and video processing.




·
            The
                SMP8630 series is one of the first chips to offer integrated support
                for
                H.264, WMV9, and MPEG decoding in a single system-on-chip solution.
                It is
                designed for IPTV set-top boxes, high-definition DVD players, HDTV
                television, and DMAs.




We
      also
      offer a series of PC-based solutions, under the NetStream and REALmagic Xcard
      brand names, that are sold into the commercial streaming market and PC add-in
      market respectively:




·
            The
                NetStream 4000 and 2000TV are PC add-in cards featuring high-performance
                MPEG-4 and -2 decoding, bringing streaming video to most PC-based
                systems.




·
            The
                REALmagic XcardTM is a desktop PC add-in solution that plugs into a
                standard PCI slot, providing high quality DVD, MPEG-4 and DivXTM Video
                playback onto a standard TV or HDTV.




**Marketing
      and Sales**




We
      currently sell most of our products through our direct sales force. We augment
      these sales through a select set of distributors and manufacturer
      representatives operating in different regions of the world. Our U.S.
      distributor is Ingram Micro, Inc. Our original equipment manufacturers, or
      OEMs,
      have included Fujitsu-Siemens, Cisco-Linksys, LG Electronics, Lite-On and
      Samsung. Our international distributors are strategically located in many
      countries around the world.




7


We
      generally maintain products for distribution through corporate markets based
      on
      forecasts rather than firm purchase orders. Purchase orders for delivery after
      30 days are typically cancelable without substantial penalty from such OEM
      customers. We currently place non-cancelable orders to purchase semiconductor
      products from our suppliers on an eight to twelve week lead-time basis.
      Consequently, if, as a result of inaccurate forecasts or canceled purchase
      orders, anticipated sales and shipments in any quarter do not occur when
      expected, expenses and inventory levels could be disproportionately high,
      requiring more working capital and resulting in more pressure on our operating
      results.




International
      customers accounted for 89%, 86% and 86% of our total net revenues in fiscal
      2006, 2005 and 2004, respectively. Revenues from our customers in Asia accounted
      for 82%, 65% and 65% of our total net revenues in fiscal 2006, 2005 and 2004,
      respectively.




Sales
      to
      distributors are typically subject to contractual rights of inventory rotation
      and price protection. Regardless of particular contractual rights, the failure
      of one or more distributors or OEMs to achieve sustained sell-through products
      could result in product returns or delayed or uncollectable receivables,
      contributing to significant fluctuations in our operating results.




**Research
      and Development**




As
      of
      January 28, 2006, we had a staff of 89 research and development personnel.
      These
      research and development personnel conduct all of our product development with
      the assistance of a number of independent contractors and consultants. We focus
      our development efforts primarily on three aspects: decoder technologies,
      including all forms of MPEG, H.264, VC-1, and a wide range of audio codecs;
      secure media processing, including DRM, conditional access, and secure data
      path; and fully integrated system-on-chip (SOC) solutions.




To
      achieve and maintain technological leadership, we must continue to make
      technological advancements in the areas of video and audio compression and
      decompression. These advancements include maintaining compatibility with
      emerging standards and multiple platforms, and making improvements to the
      current architecture.




During
      fiscal 2006, 2005, and 2004, our research and development expenses were
      approximately $14.0 million, $11.6 million, and $10.0 million, respectively.
      We
      plan to continue to devote substantial resources to research and development
      of
      future generations of MPEG and other multimedia products.




**Competition**




The
      market for digital media processors is highly competitive. Rival companies
      include Analog Devices, ATI Technologies, Broadcom, Conexant Systems, ESS
      Technology, LSI Logic, Mediatek, Philips, Pixelworks, STMicroelectronics, Texas
      Instruments and Zoran Corporation. Many of these companies have higher profiles,
      larger financial resources, and greater marketing resources than we do and
      may
      develop a competitive product that may inhibit the wide acceptance of our
      products’ technology. We believe that other manufacturers are developing MPEG
      products that will compete directly with our products in the near
      future.




We
      believe that the principal competitive factors in the market for digital media
      processors include time to market for new product introductions, product
      performance, industry standards compatibility, price, and marketing and
      distribution resources. We believe that we compete favorably with respect to
      time to market, product performance and industry standards compatibility, and
      we
      may not be able to compete favorably with respect to price and marketing and
      distribution resources.




8


**Licenses,
      Patents and Trademarks**




We
      continually seek patent protection for certain software and hardware features
      and intend to do so for future versions. We currently have seven pending patent
      applications for our technology. Twenty-seven patents have been issued to us.
      The termination dates of these patents range from 6 to 15 years. We cannot
      assure you that more patents will be issued or that such patents, even if
      issued, or our existing patents will provide adequate protection for our
      competitive position. We also attempt to protect our trade secrets and other
      proprietary information through agreements with customers, suppliers and
      employees and other security measures. Although we intend to protect our rights
      vigorously, we cannot assure you that these measures will be
      successful.




**Manufacturing**




To
      reduce
      overhead expenses, along with capital and staffing requirements, we currently
      use third-party contract manufacturers to fulfill all of our manufacturing
      needs, including chipset manufacturing and board-level assembly. All of the
      chips used by us to develop our decoding products are manufactured by outside
      suppliers and foundries. Each of these suppliers is our sole source of supply
      for the respective chips produced by such supplier and we do not have guaranteed
      price or quantity commitments.




Our
      reliance on independent suppliers involves several risks, including the
      potential absence of adequate capacity and reduced control over delivery
      schedules, manufacturing yields and costs. Any delay or interruption in the
      supply of any of the components required for the production of products could
      seriously harm our sales of products and, thus, our operating
      results.




**Backlog**




Since
      our
      customers typically expect quick deliveries, we seek to ship products within
      a
      few weeks of receipt of a purchase order. However, the customer may reschedule
      delivery of products or cancel the purchase order entirely without significant
      penalty. Historically, our backlog has not been reflective of future sales,
      because of the short period of time between customer order and delivery of
      product.




**Employees**




As
      of
      January 28, 2006, we had 160 full-time employees worldwide, including 89 in
      research and development, 42 in marketing, sales and support, 9 in operations,
      and 20 in finance and administration. As a result of our acquisition of Blue7
      on
      February 16, 2006, we have an additional 21 full-time employees.




Our
      future success will depend, in part, on our ability to continue to attract,
      retain and motivate highly qualified technical, marketing, engineering and
      management personnel, who are in great demand. Our employees are not represented
      by any collective bargaining unit, and we have never experienced a work
      stoppage. We believe that our employee relations are satisfactory.




9




**Executive
      Officers of the Registrant**




The
      following table sets forth certain information concerning our executive officers
      as of April 1, 2006:




**Name**
            **Age**
            **Position**Thinh
                Q. Tran
            53
            Chairman
                of the Board, President, and Chief Executive OfficerSilvio
                Perich
            58
            Senior
                Vice President, Worldwide SalesJacques
                Martinella
            50
            Vice
                President, EngineeringKenneth
                Lowe
            50
            Vice
                President, Strategic MarketingKit
                Tsui
            57
            Chief
                Financial Officer, and Secretary




**Mr.
      Tran** ,
      a
      founder of Sigma, has served as President, Chief Executive Officer, and Chairman
      of the Board of Directors since February 1982. Prior to joining Sigma, Mr.
      Tran
      was employed by Amdahl Corporation and Trilogy Systems Corporation, both of
      which were involved in the IBM-compatible mainframe computer
      market.




**Mr.
      Perich** joined
      Sigma in September 1985 as Director, Sales. In September 1992, Mr. Perich became
      Senior Vice President, Worldwide Sales. Mr. Perich was a co-founder of Costar
      Incorporated, a manufacturers’ representative organization for high technology
      products, where he served as partner from October 1979 to September 1985. From
      September 1972 until September 1979, Mr. Perich served in several sales
      management roles at Siliconix Inc, a specialty semiconductor
      manufacturer.




**Mr.
      Martinella** joined
      Sigma in May 1994 as Director, VLSI Engineering. In December 1995, Mr.
      Martinella became Vice President, Engineering. From June 1990 to April 1994,
      Mr.
      Martinella served in engineering and management positions at Weitek, a microchip
      manufacturer. In addition, Mr. Martinella was an engineer at National
      Semiconductor, a semiconductor manufacturer, from June 1982 to June
      1990.




**Mr.
      Lowe** joined
      Sigma in May 2000 as Vice President, Marketing. In December 2000, Mr. Lowe
      became Vice President, Strategic Marketing. Prior to joining Sigma, Mr. Lowe
      served as the Director of Multimedia Marketing for Cadence Design Systems.
      From
      1996 to 1998, Mr. Lowe served as the Vice President of Marketing for Chrontel.
      Prior to 1996, Mr. Lowe held various marketing management positions at Sierra
      Semiconductor, Datquest, Personal CAD Systems, Performix and Gould-Biomation.
      In
      the late 1980’s, Mr. Lowe served as Product Marketing Director of
      Sigma.




**Ms.
      Tsui** joined
      Sigma in November 1982 as its Accounting Manager. Ms. Tsui was promoted to
      Director of Finance in February 1990, acting Chief Financial Officer and
      Secretary in December 1996, Chief Accounting Officer in January 2000 and Chief
      Financial Officer in January 2001.




There
      is
      no family relationship among any of our directors and executive
      officers.




10




**ITEM
      1A. CERTAIN FACTORS AFFECTING BUSINESS, OPERATING RESULTS, AND FINANCIAL
      CONDITION**




You
      should carefully consider the risks described below before making an investment
      decision. The risks and uncertainties described below are not the only ones
      facing Sigma Designs. Additional risks and uncertainties not presently known
      to
      us or that we currently deem immaterial may also impair our business
      operations.




If
      any of
      the following risks actually occur, our business, financial condition and
      results of operations could be materially adversely affected. In such case,
      the
      trading price of our common stock could decline, and you could lose all or
      part
      of your investment.




***The
      average selling prices of our products have historically decreased rapidly
      and
      will likely do so in the future, which could harm our revenues and gross
      margins.***




Some
      of
      our markets, especially the DVD segments, are characterized by intense price
      competition. The willingness of customers to design our chips into their
      products depends to a significant extent upon our ability to sell our products
      at competitive prices. We expect the average selling price of our existing
      products to decline significantly over the life of each product as the markets
      for our products mature, new technologies emerge, and competition increases.
      If
      we are unable to reduce our costs sufficiently to offset declines in product
      prices or are unable to introduce more advanced products with higher margins
      in
      a timely manner, we could see declines in our market share or gross
      margins.




***Our
      business is highly dependent on the expansion of young and rapidly evolving
      segments of the consumer electronics market.***




Our
      business is highly dependent on the sale of IP video set-top boxes, connected
      media players, and high definition televisions, all of which are developing
      segments of the consumer electronics market. We expect the majority of our
      revenues for the foreseeable future to come from the sale of chipsets for use
      in
      these emerging consumer applications. Our ability to sustain and increase
      revenues is in large part dependent on the continued growth of these young
      and
      rapidly evolving market segments, whose future is largely uncertain. Many
      factors could impede or interfere with the expansion of these consumer market
      segments, including general economic conditions, other competing consumer
      electronic products, delays in the deployment of telecommunications video
      services and insufficient interest in new technology innovations. In addition,
      even if these consumer market segments expand, manufacturers of products in
      these segments may not choose to utilize our products in their products, but
      rather the products of our competitors. Moreover, market acceptance of the
      products of manufacturers that do utilize our products may not occur as
      expected. In any such case, our business would likely be harmed.




11


***We
      have a history of operating losses and we could sustain future losses. We cannot
      assure you that we will continue to be profitable and if we lose money, our
      business may not be financially viable.***




We
      incurred significant operating losses in fiscal 1995, 1996, 1998, 2001, 2002
      and
      2003 and had negative cash flow in fiscal 1995, 1998, 2002 and 2003. Since
      our
      introduction of the REALmagic® MPEG product line in November 1993, we have made
      significant investments in marketing and technological innovation for our
      REALmagic products. As a result of our investments, we experienced significant
      losses through fiscal 1996. Fiscal 1995, 1996 and 1998 also included significant
      losses associated with products other than those related to our REALmagic
      technology. Fiscal 2001, 2002 and 2003 included significant losses associated
      with a decline in demand for our REALmagic products. In recent years, we made
      significant investments in our development efforts primarily on three aspects:
      decoder technologies, including all forms of MPEG, H.264, VC-1, and a wide
      range
      of audio codecs; secure media processing, including DRM, conditional access,
      and
      secure data path; and fully integrated system-on-chip (SOC) solutions. We may
      not recognize the benefits of these investments. We turned profitable for the
      fiscal year ended January 31, 2004. However, we cannot assure that we will
      continue to be profitable. Since our inception through January 28, 2006, our
      total accumulated deficit is $57.2 million. We may incur operating losses in
      future periods or fiscal years, which in turn could cause the price of our
      common stock to decline.




***Our
      operating results are subject to significant fluctuations due to many factors
      and any of these factors could adversely affect our stock
      price***




Our
      operating results have fluctuated in the past and may continue to fluctuate
      in
      the future due to a number of factors, including but not limited
      to:




·
            new
                product introductions by us and our competitors;




·
            changes
                in our pricing models and product sales mix;




·
            unexpected
                reductions in unit sales, average selling prices and gross margins,
                particularly if they occur
                precipitously;




·
            expenses
                related to compliance with Section 404 of the Sarbanes-Oxley Act
                of
                2002;




·
            market
                acceptance of the technology embodied in our products generally and
                our
                products in particular;




·
            the
                level of acceptance of our products by our OEM customers, and acceptance
                of our OEM customers’ products by their end user
                customers;




·
            shifts
                in demand for the technology embodied in our products generally and
                our
                products in particular and those of our
                competitors;




·
            the
                loss of one or more significant
                customers;




·
            the
                timing of, and potential unexpected delays in, our customer orders
                and
                product shipments;




·
            inventory
                obsolescence;




·
            write-downs
                of accounts receivable;




·
            an
                interrupted or inadequate supply of semiconductor chips or other
                materials
                included in our products;




·
            technical
                problems in the development, ramp up, and manufacturing of products
                which
                could cause shipping delays;




·
            availability
                of third-party manufacturing capacity for production of certain products;
                and




·
            the
                impact of potential economic instability in the Asia-Pacific
                region.






12


***Our
      industry is highly competitive and we cannot assure you that we will be able
      to
      effectively compete. If we fail to compete effectively, our growth could be
      substantially affected.***




The
      market for digital media processors is highly competitive and includes embedded
      processors provided by multiple companies. Processors have, in recent years,
      included increased graphics functionality. Other companies with more experience
      and financial resources may develop a competitive product that could inhibit
      future growth in sales of our products. Increased competition may be generated
      from several major computer product manufacturers that have developed products
      and technologies that could compete directly with our products. These
      competitors include:




·
            Analog
                Devices;




·
            ATI
                Technologies;




·
            Broadcom;




·
            Conexant
                Systems;




·
            ESS
                Technology;




·
            LSI
                Logic/C-Cube;




·
            Mediatek;




·
            Philips;




·
            Pixelworks;




·
            STMicroelectronics;




·
            Texas
                Instruments; and




·
            Zoran
                Corporation.




Most
      of
      our competitors have substantial experience and expertise in audio, video and
      multimedia technology and in producing and selling consumer products through
      retail distribution and OEM channels. These companies also have substantially
      greater engineering, marketing and financial resources than we have. Our
      competitors could form cooperative relationships that could present formidable
      competition to us. We cannot assure you that our technology will continue to
      achieve commercial success or that it will compete effectively against other
      interactive multimedia products, services and technologies that currently exist,
      are under development, or may be announced by competitors. Also, we anticipate
      that our competitors will, over time, introduce features that have historically
      been unique to Sigma Designs, such as WMV9 decoding. We cannot assure you that
      we will not lose market share or suffer price erosion in each of our market
      segments as a result of the introduction of competitive products with similar
      features.




***The
      requirements of Section 404 of the Sarbanes-Oxley Act will increase our
      operating expenses, and the identification of material weaknesses in our
      internal controls as reported in our management assessment could adversely
      affect the market price of our stock.***




13




Pursuant
      to Section 404 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”), we are
      required to include a report of management's assessment of the design and
      effectiveness of our internal controls as part of our Annual Report on Form
      10-K. Our independent registered public accounting firm is required to attest
      to, and report on, our management's assessment. In order for management to
      evaluate, conclude, and report their assessment of effectiveness of internal
      control over financial reporting, we documented both the design and testing
      of
      our internal controls in extensive detail. This includes a material weakness,
      which resulted in an adverse opinion on the effectiveness of our internal
      controls, related to inadequate controls to ensure that financial information
      is
      adequately analyzed to detect misstatements including the lack of understanding
      of generally accepted accounting principles, or GAAP, and Securities Exchange
      Commission, or SEC, reporting matters. We are evaluating and taking additional
      steps and actions needed to improve our financial infrastructure and to
      eliminate the significant deficiencies and weaknesses identified. If we fail
      to
      remediate our existing material weakness or identify any new material
      weaknesses, we may be unable to prevent a material misstatement in our reported
      financial information and investors may lose confidence in our reported
      financial information, which could have a negative effect on the trading price
      of our common stock.




***Sales
      risks and volatility of OEM customer sales and resale distribution may harm
      our
      business.***




Our
      ability to increase sales and achieve continued profitability depends
      substantially on our ability to achieve a sustained high level of sales to
      our
      OEM customers. Our customers are not under any obligation to purchase any
      minimum quantity of our products. Also, even if we achieve new design wins,
      we
      cannot assure you that these manufacturers will purchase our products in
      substantial volumes. Sales to any particular OEM customer fluctuate
      significantly from quarter to quarter and are subject to severe price pressures
      by competitors. Any reductions in those sales could seriously harm our business.
      We expect that our sales to OEM customers will continue to experience
      significant fluctuations, which will cause our operation results to fluctuate
      as
      well.




***We
      may engage in investments in and acquisitions of other businesses and
      technologies, which could divert management’s attention and prove difficult to
      integrate with our existing business and technology.***




We
      continue to consider investments in and acquisitions of other businesses,
      technologies or products, to improve our market position, broaden our
      technological capabilities and expand our product offerings. For example, we
      recently completed the acquisition of Blue7 Communications in February 2006.
      However, we may not be able to acquire, or successfully identify, the companies,
      products or technologies that would enhance our business. Once we identify
      a
      strategic opportunity, the process to consummate a transaction could divert
      management’s attention from the operation of our business causing our financial
      results to decline.




In
      addition, if we are able to acquire companies, products or technologies, we
      could experience difficulties in integrating them. Integrating acquired
      businesses involves a number of risks, including but not limited
      to:




·
            the
                potential disruption of our ongoing
                business,






14


·
            unexpected
                costs or incurring unknown
                liabilities,




·
            the
                diversion of management resources from other business concerns while
                involved in integrating new businesses, technologies or
                products,




·
            the
                inability to retain the employees of the acquired
                businesses,




·
            difficulties
                relating to integrating the operations and personnel of the acquired
                businesses,




·
            adverse
                effects on the existing customer relationships of acquired
                companies,




·
            adverse
                effects associated with entering into markets and acquiring technologies
                in areas in which we have little experience,
                and




·
            acquired
                intangible assets becoming impaired as a result of technological
                advancements, or worse-than-expected performance of the acquired
                company.




If
      we are
      unable to successfully integrate the business we acquire, our operating results
      could be harmed.




***Because
      we depend on a limited number of major customers, the reduction, delay or
      cancellation of orders from these customers or the loss of these customers
      may
      adversely affect our business.***




In
      fiscal
      2006, no domestic customer accounted for more than 10% of our total net
      revenues, however, one customer in Asia accounted for 25% of our total net
      revenues. In fiscal 2005, no domestic customer accounted for more than 10%
      of
      our total net revenues but one customer in Asia accounted for 15% and one
      customer in Europe accounted for 14% of our total net revenues. In fiscal 2004,
      no customer in any regions accounted for more than 10% of our total net
      revenues. Our dependence on a few major customers will likely continue despite
      other changes in the composition of our customer base. The reduction, delay
      or
      cancellations of orders from major customers or the loss of major customers
      could materially and adversely affect our business, financial condition and
      results of operations. In addition, any difficulty in collection from key
      customers could harm our business.




***Our
      business depends on international customers, suppliers and operations, and
      as a
      result we are subject to regulatory, operational, financial and political risk,
      which could adversely affect our financial results.***




Our
      international sales represented 89%, 86% and 86% of total net revenues for
      fiscal 2006, 2005 and 2004, respectively. We anticipate that sales to
      international customers will continue to constitute a substantial percentage
      of
      our net revenues. Also, one of the foundries that manufactures our products
      and
      components is located in Asia.




Due
      to
      the concentration of international sales and the manufacturing capacity in
      Europe and Asia, we are subject to the risks of conducting business
      internationally. These risks include unexpected changes in regulatory
      requirements and fluctuations in the U.S. dollar that could increase the sales
      price in local currencies of our products in international markets, or make
      it
      difficult for us to obtain price reductions from our foundries. Overseas sales
      and purchases to date have been denominated in U.S. dollars. We do not currently
      engage in any hedging activities to reduce our exposure to exchange rate risks.
      Our results of operations could be adversely affected by exchange rate
      fluctuations.




15


We
      derive
      a substantial portion of our revenues from sales to the Asia Pacific region.
      This region of the world is subject to increased levels of economic instability,
      and this instability could seriously harm our results of operations.




***The
      timing of our customer orders and product shipments can adversely affect our
      operating results and stock price***




Our
      quarterly revenues and operating results depend upon the volume and timing
      of
      customer orders received during a given quarter and the percentage of each
      order
      that we are able to ship and recognize as revenues during each quarter, each
      of
      which is extremely difficult to forecast. The majority of our orders in a given
      quarter historically have been shipped in the last months of that quarter.
      This
      trend is likely to continue, and any failure or delay in the closing of orders
      during the last part of a quarter would adversely affect our operating results.
      Further, to the extent we receive orders late in any given quarter, we may
      be
      unable to ship products to fill those orders during the same quarter in which
      we
      received the corresponding order, which would have an adverse impact on our
      operating results for that quarter.




***If
      we fail to comply with or obtain waivers for covenants under our loan
      obligations, our financial condition could be harmed.***




We
      have
      two lines of credit at a bank, expiring in August 2007, which allow for
      borrowings of up to $15.0 million. During August 2005, we also entered into
      a
      30-month term loan for $0.5 million, which was used to purchase equipment for
      research and development. We are subject to certain financial covenants under
      the lines of credit and the term loan. We have on occasion, including the
      quarter ended April 30, 2005, been in violation of some of the covenants and
      in
      all cases, we have obtained waivers releasing us from our obligations to meet
      those covenants as of previous dates. It is possible that we may need such
      a
      waiver for future non-compliance and we cannot assure you that our bank will
      grant these waivers. If we do not meet these covenants and cannot obtain
      waivers, the lender could accelerate payments of any amounts due under the
      lines
      of credit and the term loan. To the extent we had borrowed amounts under these
      lines of credit and term loan and were required to repay them on an accelerated
      basis, it could substantially weaken our financial condition. If we do not
      have
      sufficient funds available to make full payment on the lines of credit and
      the
      term loan when required, the bank could foreclose on our accounts receivable,
      inventories, general intangibles such as patents and trademarks, equipment
      and
      tangible assets that collateralize the notes, which would harm our business.
      As
      of January 28, 2006, the total outstanding balance under the term loan was
      $444,000. We had no amounts outstanding under these two lines of credit but
      had
      availability to draw drown approximately $7.6 million. On February 8, 2006,
      we
      utilized approximately $2.4 million from one of two lines of credit for issuance
      of a standby letter of credit to a supplier.






16


***Our
      failure to keep pace with technological changes would seriously harm our
      business.***




Our
      success depends, among other things, on our ability to achieve and maintain
      technological leadership and to remain competitive in terms of price and product
      performance.




Our
      technological leadership depends on our continued technological advancements,
      as
      well as research and development investments in the area of MPEG video and
      audio
      decoding. These advancements include the following:




·
            compatibility
                with emerging standards and multiple platforms;
                and




·
            improvements
                to our silicon architecture.




We
      cannot
      assure you that we will be able to make these advancements to our technology.
      Even if we do make these advances, we cannot assure you that we will be able
      to
      achieve and maintain technological leadership. Any material failure by us or
      OEMs and software developers to develop or incorporate any required improvement
      could adversely affect the continued acceptance of our technology and the
      introduction and sale of future products based on our technology. We cannot
      assure you that products or technologies developed by others will not render
      our
      technology and the products based on our technology obsolete.




To
      be
      competitive, we must anticipate the needs of the market and successfully develop
      and introduce innovative new products in a timely fashion. We cannot assure
      you
      that we will be able to successfully complete the design of our new products,
      have these products manufactured at acceptable manufacturing yields, or obtain
      significant purchase orders for these products. The introduction of new products
      may adversely affect sales of existing products and contribute to fluctuations
      in operating results from quarter to quarter. Our introduction of new products
      also requires that we carefully manage our inventory to avoid inventory surplus
      and obsolescence. Our failure to do so could adversely impact our results of
      operations. In addition, new products, as opposed to more mature products,
      typically have higher initial component costs. These higher costs could result
      in downward pressures on our gross margins.




***We
      rely heavily on a limited number of manufacturers and suppliers and the failure
      of any of these third-party vendors to deliver products or otherwise perform
      as
      requested could damage our relationships without our customers, decrease our
      sales and limit our growth.***




Our
      products and components are presently manufactured entirely by outside suppliers
      or foundries. We do not have long-term contracts with these suppliers. We
      conduct business with our suppliers on a written purchase order basis. Our
      reliance on independent suppliers subjects us to several risks. These risks
      include:




·
            the
                absence of adequate capacity;




·
            the
                unavailability of, or interruptions in access to, certain process
                technologies; and




·
            reduced
                control over delivery schedules, manufacturing yields and
                costs.






17


We
      obtain
      some of our components from a single source. Any delay or interruption in the
      supply of any of the components required for the production of our silicon
      or
      our multimedia cards currently obtained from a single source, including delays
      resulting from a recurrence of SARS (or similar epidemics), earthquakes or
      other
      business interruptions could have a material adverse impact on our sales of
      products, and on our business.




We
      must
      provide our suppliers with sufficient lead-time to meet our forecasted
      manufacturing objectives. Any failure to properly forecast such quantities
      could
      materially and adversely affect our ability to produce products in sufficient
      quantities. We cannot assure you that our forecasts regarding new product demand
      will be accurate, particularly because we sell our products on a purchase order
      basis. Manufacturing chipsets is a complex process, and we may experience
      short-term difficulties in obtaining timely deliveries. This could affect our
      ability to meet customer demand for our products. Any such delay in delivering
      products in the future could materially and adversely affect our operating
      results. Also, should any of our major suppliers become unable or unwilling
      to
      continue to manufacture our key components in required volumes, we will have
      to
      identify and qualify acceptable additional suppliers. This qualification process
      could take up to three months or longer and additional sources of supply may
      not
      be in a position to satisfy our requirements on a timely basis.




In
      the
      past, we have experienced production delays and other difficulties, and we
      could
      experience similar problems in the future. In addition, product defects may
      occur and they may escape identification at the factory. This could result
      in
      unanticipated costs, cancellations, deferrals of purchase orders, or costly
      recall of products from customer sites.




***Loss
      of key personnel could cause our business to suffer.***




Our
      future success depends in large part on the continued service of our key
      technical, marketing, sales and management personnel. Given the complexity
      of
      our technology, we are dependent on our ability to retain and motivate highly
      skilled engineers involved in the ongoing hardware and software development
      of
      our products. These engineers are required to refine the existing hardware
      system and application-programming interface and to introduce enhancements
      in
      future applications. Despite incentives we provide, our current employees may
      not continue to work for us, and if additional personnel were required for
      our
      operations, we may not be able to obtain the services of additional personnel
      necessary for our growth.




***We
      rely upon patents, trademarks, copyrights and trade secrets to protect our
      proprietary rights and if these rights are not sufficiently protected, it could
      harm our ability to compete and to generate revenues.***




Our
      ability to compete may be affected by our ability to protect our proprietary
      information. We currently hold twenty-seven patents and these patents will
      expire within the next 6 to 15 years. These patents cover the technology
      underlying the products. We have filed certain patent applications and are
      in
      the process of preparing others. We cannot assure you that any additional
      patents for which we have applied will be issued or that any issued patents
      will
      provide meaningful protection of our product innovations. Like other emerging
      multimedia companies, we rely primarily on trade secrets and technological
      know-how in the conduct of our business. We also rely, in part, on copyright
      law
      to protect our proprietary rights with respect to our REALmagic® technology. We
      use measures such as confidentiality agreements to protect our intellectual
      property. These methods of protecting our intellectual property may not be
      sufficient.






18


***We
      may face intellectual property claims that could be costly to defend and result
      in our loss of significant rights.***




The
      semiconductor and electronics industry is characterized by frequent litigation
      regarding patent and intellectual property rights. Any such litigation could
      result in significant expense to us and divert the efforts of our technical
      and
      management personnel. In the event of an adverse result in any such litigation,
      we could be required to expend significant resources to develop non-infringing
      technology or to obtain licenses to the technology that is the subject of the
      litigation, and we may not be successful in such development or in obtaining
      such licenses on acceptable terms, if at all. In addition, patent disputes
      in
      the electronics industry have often been settled through cross-licensing
      arrangements. Because we do not yet have a large portfolio of issued patents,
      we
      may not be able to settle an alleged patent infringement claim through a cross
      licensing arrangement.




***We
      will be required to expense options granted under our employee stock plan as
      compensation, and our net income and earnings per share could be significantly
      reduced and we may be forced to change our business practices to attract and
      retain employees.***




Historically,
      we have used stock options as a key component of our employee compensation
      packages. We believe that stock options provide an incentive to our employees
      to
      maximize long-term stockholder value and, through the use of vesting, encourage
      valued employees to remain with us. In December 2004, the FASB issued SFAS
      No.
      123 (revised 2004) “Share-Based Payment” (“SFAS 123R”), which requires all
      share-based payments to employees, including grants of employee stock options,
      to be recognized in the financial statements based on their fair values. We
      are
      required to adopt SFAS 123R in our first fiscal quarter of 2007. When such
      adoption is implemented on January 29, 2006, our net income and earnings per
      share will be negatively impacted. As a result, we may decide in the future
      to
      reduce the number of employees who receive stock options or grant fewer options
      to particular employees. This could adversely affect our ability to retain
      existing employees and attract qualified candidates, and also could increase
      the
      cash compensation we would have to pay to them.




***Changes
      in financial accounting standards or practices or existing taxation rules or
      practices may cause adverse unexpected fluctuations and affect our reported
      results of operations.***




Financial
      accounting standards in the U.S. are constantly under review and may be changed
      from time to time. We are required to apply these changes when adopted. Once
      implemented, these changes could result in material fluctuations in our
      financial results of operations and the way in which such results of operations
      are reported. Similarly, we are subject to taxation in the U.S. and a number
      of
      foreign jurisdictions. Rates of taxation, definitions of income, exclusions
      from
      income, and other tax policies are subject to change over time. Changes in
      tax
      laws in a jurisdiction in which we have reporting obligations could have a
      material impact on our results of operations.




19




***Our
      stock price has demonstrated volatility and overall declines, and continued
      volatility in the stock market may cause further fluctuations or decline in
      our
      stock price.***




The
      market for our common stock has been subject to significant volatility, which
      is
      expected to continue. For example, during fiscal 2006, the closing sale price
      of
      our common stock on the Nasdaq National Market ranged from $6.31 to $17.05.
      The
      following factors, among others, may have a significant impact on the market
      price of our common stock:




·
            our
                announcement of the introduction of new
                products;




·
            our
                competitors’ announcements of the introduction of new products;
                and




·
            market
                conditions in the technology, entertainment and emerging growth company
                sectors.




In
      addition, the stock market, in general, has experienced, and is currently
      experiencing, volatility that particularly affects the market prices of equity
      securities of many high technology companies, such as those in the electronics
      and semiconductor industries. This volatility is often unrelated or
      disproportionate to the operating performance of such companies. These
      fluctuations, as well as general economic and market conditions, could decrease
      the price of our common stock.




**ITEM
      1B. UNRESOLVED STAFF COMMENTS**




None.




**ITEM
      2. PROPERTIES**




We
      currently lease a 40,000 square foot facility in Milpitas, California that
      is
      used as our headquarters. The lease on our Milpitas, California facility will
      expire in September 2007. We also lease facilities for a sales office and
      warehouse in Hong Kong, a representative office in Shenzhen China, and research
      and development near Paris, France. For the facility in California, we are
      currently evaluating all options to ensure that our facility will accommodate
      our future growth. We believe existing facilities are both suitable and adequate
      for our near-term needs.




**ITEM
      3. LEGAL PROCEEDINGS**




From
      time
      to time, we are involved in claims and legal proceedings that arise in the
      ordinary course of business. We expect that the number and significance of
      these
      matters will increase as our business expands. In particular, we could face
      an
      increasing number of patent and other intellectual property claims as the number
      of products and competitors in our industry grows. Any claims or proceedings
      against us, whether meritorious or not, could be time consuming, result in
      costly litigation, require significant amounts of management time, result in
      the
      diversion of significant operational resources, or require us to enter into
      royalty or licensing agreements which, if required, may not be available on
      terms favorable to us or at all. Were an unfavorable outcome to occur against
      us, there exists the possibility of a material adverse impact on our financial
      position and results of operations for the period in which the unfavorable
      outcome occurs, and potentially in future periods. We are not currently a party
      to any material legal proceedings.






20


**ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**




No
      matters were submitted to a vote of security holders during the fourth quarter
      of fiscal 2006.













21


**PART
      II**




**ITEM
      5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**




Our
      common stock trades on The Nasdaq National Market under the trading symbol
      “SIGM”. The following table sets forth the high and low sales prices per share
      of our common stock for each quarter in the last two fiscal years.




**Fiscal
                2006**
            
            **Fiscal
                2005****High**
            **Low**
            
            
            **High**
            **Low**First
                fiscal quarter
            
            $12.45
            $7.49
            
            
            $8.95
            $5.77Second
                fiscal quarter
            
            8.94
            6.31
            
            
            9.57
            4.75Third
                fiscal quarter
            
            12.50
            7.70
            
            
            9.84
            5.35Fourth
                fiscal quarter
            
            17.05
            10.74
            
            
            10.30
            6.81




**Shareholders**




As
      of
      April 17, 2006, we had approximately 8,000 shareholders of record.




**Dividends**




We
      have
      never paid cash dividends on our common stock and we do not plan to pay cash
      dividends to our common shareholders in the foreseeable future.




**ITEM
      6. SELECTED FINANCIAL DATA**




The
      following selected financial data is derived from our consolidated financial
      statements. This data should be read in conjunction with our consolidated
      financial statements, the notes related thereto, and Management’s Discussion and
      Analysis of Financial Condition and Results of Operations, which are included
      elsewhere in this Annual Report on Form 10-K.






22




**Fiscal
                Year ended****January
                28,**
            
            **January
                29,**
            
            **January
                31,**
            
            **February
                01,**
            
            **February
                02,****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002****(In
                thousands, except per share data)**Net
                Revenues
            $33,320
            
            
            $31,437
            
            
            $30,520
            
            
            $18,139
            
            
            $13,437Net
                income (loss)
            1,884
            
            
            1,840
            
            
            1,543
            
            
            (6,057)
            
            
            (10,392)Diluted
                net income (loss) per share
            0.08
            
            
            0.08
            
            
            0.07
            
            
            (0.37)
            
            
            (0.64)Working
                capital
            31,325
            
            
            23,998
            
            
            23,868
            
            
            4,459
            
            
            10,475Total
                assets
            39,959
            
            
            34,937
            
            
            29,792
            
            
            21,417
            
            
            26,274Shareholders’
                equity
            33,915
            
            
            29,112
            
            
            26,022
            
            
            5,802
            
            
            11,466






**ITEM
      7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS**




*You
      should read the following discussion in conjunction with our condensed
      consolidated financial statements and related notes. Except for historical
      information, the following discussion contains forward-looking statements within
      the meaning of Section 27A of the Securities Exchange Act of 1933 and Section
      21E of the Securities Exchange Act of 1934. These forward-looking statements,
      which include, among other things, statements regarding our capital resources
      and needs (including the adequacy of our current cash reserves and access to
      our
      lines of credit) and statements regarding our anticipated revenues from sales
      of
      our board, chipset and other products in general and more particularly to
      customers in the internet protocol (IP) video application market, connected
      media player market, high definition television (HDTV) market and personal
      computer (PC) add-in and other markets; statements regarding our long-term
      investments; gross margins; sales and marketing expenses; research and
      development expenses and general and administrative expenses, and statements
      involving our expected future receipt of incentive payments, involve risks
      and
      uncertainties. Our actual results may differ significantly from those projected
      in the forward-looking statements. Factors that might cause future results
      to
      differ materially from those discussed in the forward-looking statements
      include, but are not limited to, those discussed in “Certain Factors Affecting
      Business, Operating Results, and Financial Condition* ”




**Overview**




We
      specialize in silicon-based digital media processors for consumer products.
      Our
      highly-integrated chipsets provide high-quality decoding of H.264, MPEG-4,
      MPEG-2, MPEG-1 and Windows® Media Video 9 (WMV9) content.




23




Complementing
      our core technology, we have developed chip and software solutions for emerging
      convergence products, including DVD playback, digital TV (DTV) reception, video
      over IP, personal video recording (PVR) and video-on-demand (VOD). We sell
      our
      products to manufacturers of consumer electronic devices and products. Our
      products are sold worldwide through a direct sales force and distributors.
      Our
      common stock, publicly traded since 1986, is listed on the NASDAQ National
      Market under the symbol SIGM. Our corporate headquarters are located in
      Milpitas, California, and we also have a research and development center in
      France as well as sales offices in China, Europe, Hong Kong, Japan and
      Taiwan.




We
      were
      founded in 1982, and became a pioneer in the MPEG hardware decoder market in
      1993 with the introduction of our REALmagic card, a MPEG playback card for
      personal computers, or PCs. In April 1997, we announced our entry into the
      DVD
      market. During the past few years, we have expanded well beyond our PC card
      beginnings and work with consumer electronics manufacturers and network service
      providers to deploy Internet Protocol Television (IPTV) services, digital media
      adapters, networked DVD players, and high definition television. These
      opportunities have led to technology investments in media processor chips,
      streaming video software, digital rights management, and a number of other
      technologies.




Our
      primary product groups include boards, chipsets and a variety of other products
      which we refer to as our “other” product group. Our board products consist
      primarily of a series of PC based solutions using the NetStream and Xcard brand
      names, as well as certain customized development boards that are sold into
      the
      Internet Protocol (IP) video technology market, connected media player market
      and PC add-in market. Our chipset products consist primarily of video and audio
      decoding chips under the names of EM8400 series, EM8500 series, EM8610 series,
      EM8620L series and SMP8630 series for the IP video technology market, connected
      media player market as well as the PC add-in market. Products in the “other
      product” group consist primarily of development kits, engineering support
      services, and engineering development for customization of
      chipsets.




Our
      primary market segments are the IP video technology market, connected media
      player market, HDTV product market and PC add-in and other markets. The IP
      video
      technology market consists primarily of a range of consumer and commercial
      products that perform the distribution and receiving of streaming video using
      IP. The connected media player market consists primarily of a range of set-top
      and portable products that perform playback of local digital media stored on
      optical or hard disk formats. The HDTV product market consists primarily of
      a
      range of digital television sets offering high definition capability. The PC
      add-in and other markets consist primarily of a range of decoding solutions
      for
      PC-based DVD playback and streaming video.




We
      derive
      substantially all of our revenues from sales of our board products and chipsets
      to corporate customers and original equipment manufacturers, or OEMs, who in
      turn incorporate our products into technologies that are sold into the consumer
      electronics market. We do not enter into long-term commitment contracts with
      our
      OEMs and receive substantially all of our revenues based on purchase orders.
      We
      work with both OEMs and end users of our products to better understand the
      market demands and the necessary specifications for our technologies.






24




**Critical
      Accounting Policies**




Management’s
      Discussion and Analysis of Financial Condition and Results of Operations are
      based upon our consolidated financial statements, which have been prepared
      in
      accordance with accounting principles generally accepted in the United States
      of
      America. The preparation of these financial statements requires management
      to
      make estimates and assumptions that affect the reported amounts of assets and
      liabilities and the disclosure of contingent assets and liabilities at the
      date
      of the financial statements and the reported amounts of revenues and expense
      during the reporting period. On an on-going basis, management evaluates its
      estimates and judgments, including those related to revenue recognition,
      accounts receivable, and inventories. Management bases its estimates and
      judgments on historical experience and on various other factors that are
      believed 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.




***Revenue
      Recognition*** - We
      recognize revenues in accordance with Staff Accounting Bulletin (“SAB”) No. 104,
“Revenue Recognition”. Revenue is recognized when persuasive evidence of an
      arrangement exists, delivery has occurred or service has been rendered, the
      fee
      is fixed and determinable, and collectibility is probable. We derive revenues
      from three principal sources: product sales, product development contracts
      and
      service contracts.




Revenues
      from product sales to OEMs, distributors and end users are generally recognized
      upon shipment, as our shipping terms are FOB shipping point, except that
      revenues are deferred when management cannot reasonably estimate the amount
      of
      returns or where collectibility is not assured. In those situations, revenue
      is
      recognized when collection subsequently becomes probable and returns are
      estimable (generally upon resale by customers or “Sell-through Basis”).
      Allowances for sales returns, price protection and warranty costs are recorded
      at the time that revenues are recognized.




In
      fiscal
      2001, we began recognizing revenues from our primary U.S. distributor on a
      Sell-through Basis. This practice resulted from significant sales returns,
      which
      we accepted from the distributor outside of the terms of the distribution
      agreement. Under terms of a distribution agreement entered into with the
      distributor in fiscal 2002, we granted the distributor the right of return
      and
      price protection, which allows the distributor to return any product, which
      is
      in the original packaging, for full credit up to 180 days after the earlier
      of
      the agreement expiration or early termination. The price protection provision
      allows the distributor to receive a credit for the difference between the
      original price and the reduced price of our products within their inventory.
      Although the returns are not frequent in nature, returns from this distributor
      cannot be reasonably estimated. Consequently, pursuant to the above policy,
      revenue from this distributor is recognized upon resale to the distributor’s
      end-customers.




Revenues
      from product development agreements were recognized in fiscal 2006, 2005 and
      2004 when billed, earned, and collection was assured. During fiscal 2006, the
      Company classified development costs related to such agreements as cost of
      revenues. During fiscal 2005 and 2004, the Company classified development costs
      related to such agreements as research and development expenses as the
      associated effort expended in providing development revenue was resident in
      the
      R&D function. Development revenues were approximately $1.2 million, $981,000
      and $792,000, for fiscal 2006, 2005, and 2004, respectively.




25


Revenues
      from service contracts consist of fees for providing engineering support
      services, which are recognized ratably over the contract term. Expenses related
      to support service revenues were included in sales and marketing expenses,
      as
      the engineering support associated with service contract revenue is resident
      in
      the sales and marketing function. Support service revenues were $150,000,
      $308,000 and $269,000 for fiscal 2006, 2005 and 2004 respectively.




***Accounts
      Receivable*** - During
      industry downturns, certain of our customers have difficulty with their cash
      flows. Certain customers, typically those with whom we have long-term
      relationships, may delay their payments by 40-60 days beyond the original terms.
      We review the ability of our customers to pay the indebtedness they incur with
      us. We defer recognition of revenue and the related receivable when we cannot
      reasonably estimate whether collectibility is assured at the time products
      and
      services are delivered to our customer. We provide an allowance for doubtful
      accounts for estimated losses resulting from the inability of our customers
      to
      make required payments. These estimated allowances are periodically reviewed,
      analyzing the customer’s payment history and information regarding credit
      worthiness. I n
      establishing our sales return allowance, we must make estimates of potential
      future product returns related to current period product revenue, including
      analyzing historical returns, current economic trends, and changes in customer
      demand and acceptance of our products. In
      fiscal 2006, 2005 and 2004, we recorded a provision (reversal) for bad debt
      allowance and sales return in the total amount of $184,000, $595,000 and
      $(186,000), respectively. If the financial condition of our customers were
      to
      deteriorate, resulting in an impairment of their ability to make payments,
      or
      future product returns increased, additional allowances may be required.




***Inventories*** - We
      continue to monitor our inventory levels in light of product development changes
      and expectations of an eventual market upturn. We may be required to take
      additional charges for excess and obsolete inventories if the current industry
      recovery falls below our expectation or we make changes in our current product
      development plans. We estimate inventory reserves for excess and obsolete
      inventories based on our assessments of future product sales giving
      consideration for factors such as the cyclical nature of our industry. These
      forecasts require us to estimate our ability to see demand for current and
      future products and compare those estimates with our current inventory levels.
      If these forecasts or estimates change adversely, or our product roadmaps
      change, then we would need to further write down inventory.




***Deferred
      Tax Assets*** - We
      record a valuation allowance to reduce our deferred tax assets to the amount
      that is more likely than not to be realized. In the event we were to determine
      that we would be able to realize deferred tax assets in the future in excess
      of
      the net recorded amount, an adjustment to the deferred tax asset would increase
      income in the period such determination was made.




**Recent
      Accounting Pronouncements**




In
      November 2005, the FASB issued Staff Position ("FSP") FAS115-1/124-1, The
      Meaning of Other-Than-Temporary Impairment and Its Application to Certain
      Investments, which addresses the determination as to when an investment is
      considered impaired, whether that impairment is other than temporary, and the
      measurement of an impairment loss. This FSP also includes accounting
      considerations subsequent to the recognition of an other-than-temporary
      impairment and requires certain disclosures about unrealized losses that have
      not been recognized as other-than-temporary impairments. The guidance in this
      FSP amends FASB Statements No. 115, Accounting for Certain Investments in Debt
      and Equity Securities, and No. 124, Accounting for Certain Investments Held
      by
      Not-for-Profit Organizations, and APB Opinion No. 18, The Equity Method of
      Accounting for Investments in Common Stock. This FSP is effective for reporting
      periods beginning after December 15, 2005. We do not believe the adoption of
      this FSP will have a material impact on our financial statements.




26


In
      November 2005, the FASB issued FSP FAS123(R)-3, Transition Election to
      Accounting for the Tax Effects of Share-Based Payment Awards. This FSP requires
      an entity to follow either the transition guidance for the
      additional-paid-in-capital pool as prescribed in SFAS No. 123(R), Share-Based
      Payment, or the alternative transition method as described in the FSP. An entity
      that adopts SFAS No. 123(R) using the modified prospective application may
      make
      a one-time election to adopt the transition method described in this FSP. An
      entity may take up to one year from the later of its initial adoption of SFAS
      No. 123(R) or the effective date of this FSP to evaluate its available
      transition alternatives and make its one-time election. This FSP became
      effective in November 2005.




We
      account for stock-based compensation awards issued to employees using the
      intrinsic value measurement provisions of APB Opinion No. 25, “Accounting for
      Stock Issued to Employees” (“Opinion 25”). Accordingly, no compensation expense
      has been recorded for stock options granted with exercise prices greater than
      or
      equal to the fair value of the underlying common stock at the option grant
      date.
      On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued
      SFAS No. 123 (“SFAS 123”) (revised 2004), “Share-Based Payment” (“SFAS 123R”).
      SFAS 123R eliminates the alternative of applying the intrinsic value measurement
      provisions of Opinion 25 to stock compensation awards issued to employees.
      Rather, the new standard requires enterprises to measure the cost of employee
      services received in exchange for an award of equity instruments based on the
      grant-date fair value of the award. That cost will be recognized over the period
      during which an employee is required to provide services in exchange for the
      award, known as the requisite service period (usually the vesting
      period).




In
      March
      2005, the Securities and Exchange Commission issued Staff Accounting Bulletin
      No. 107 (“SAB 107”) to provide implementation guidance on SFAS 123R. SAB 107 was
      issued to assist registrants in implementing SFAS 123R while enhancing the
      information that investors receive.




We
      expect
      that the implementation of SFAS 123R will result in a non-cash charge of
      approximately $2.0 million in fiscal 2007. The actual effects of adopting SFAS
      123R will be dependent on numerous factors including, but not limited to, the
      valuation model we choose to value stock-based awards; the assumed award
      forfeiture rate; the accounting policies we adopt concerning the method of
      recognizing the fair value of awards over the requisite service period; and
      the
      transition method (as described below) we choose for adopting SFAS 123R.




We
      adopted SFAS 123R at the beginning of the first quarter of fiscal year 2007
      using the Modified Prospective Application Method. Under the Modified
      Prospective Application Method SFAS 123R is applied to new awards and to awards
      modified, repurchased, or cancelled after the effective date. Additionally,
      compensation cost for the portion of awards for which the requisite service
      has
      not been rendered (such as unvested options) that is outstanding as of the
      date
      of adoption shall be recognized as the remaining requisite services are
      rendered. The compensation cost relating to unvested awards at the date of
      adoption shall be based on the grant-date fair value of those awards as
      calculated for pro forma disclosures under the original SFAS 123, adjusted
      for
      estimated forfeitures.




27




In
      November 2004, the FASB issued SFAS No. 151, “Inventory Costs - an amendment of
      Accounting Research Bulletin (“ARB”) No. 43, Chapter 4” (“Statement”). This
      Statement amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing,"
      to
      clarify the accounting for abnormal amounts of idle facility expense, freight,
      handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter
      4, previously stated "under some circumstances, items such as idle facility
      expense, excessive spoilage, double freight, and handling costs may be so
      abnormal as to require treatment as current period charges." This Statement
      requires that those items be recognized as current-period charges regardless
      of
      whether they meet the criterion of "so abnormal." In addition, this Statement
      requires that allocation of fixed production overheads to the costs of
      conversion be based on the normal capacity of the production facilities. This
      Statement is effective for inventory costs incurred during fiscal years
      beginning after June 15, 2005. We do not believe the adoption of this Statement
      will have any immediate material impact on us.




In
      December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets”
(“SFAS 153”), which amends APB Opinion No. 29, “Accounting for Nonmonetary
      Transactions.” SFAS 153 requires prospective application for eliminating the
      exception from fair value measurement for nonmonetary exchanges of similar
      productive assets and replaces it with an exception for exchanges that do not
      have commercial substance. SFAS 153 specifies that a nonmonetary exchange has
      commercial substance if the future cash flows of the entity are expected to
      change significantly as a result of the exchange. SFAS 153 is effective for
      exchanges of nonmonetary assets occurring in fiscal periods beginning after
      June
      15, 2005. We do not believe the adoption of this Statement will have any
      immediate material impact on us.




In
      May
      2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”
(“SFAS 154”), which replaces APB Opinion No. 20, “Accounting Changes,” and SFAS
      No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS 154
      requires retroactive application of a change in accounting principle to prior
      period financial statements unless it is impracticable. SFAS 154 also requires
      that a change in method of depreciation, amortization or depletion for
      long-lived, non-financial assets be accounted for as a change in accounting
      estimate resulting from a change in accounting principle. It is effective for
      accounting changes and corrections of errors made in fiscal years beginning
      after December 15, 2005. Depending on the type of accounting change, the
      adoption of SFAS 154 may have a material impact on our consolidated financial
      statements.




In
      March 2004, the FASB Emerging Issues Task Force (“EITF”) released Issue
      03-01, “Meaning of Other Than Temporary Impairment,” which addressed
      other-than-temporary impairment for certain debt and equity investments. The
      recognition and measurement requirements of Issue 03-01, and other disclosure
      requirements not already implemented, were effective for periods after
      June 15, 2004.  In September 2004, the FASB staff issued FASB
      Staff Position (“FSP”) EITF 03-1-1, which delayed the effective date for certain
      measurement and recognition guidance during the period of delay until a final
      consensus is reached.   In June 2005, the FASB staff issued an
      FSP that supersedes EITF 03-01 and effectively reverts the guidance for
      other-than-temporary impairments to previously established literature. We do
      not
      expect 03-01 to have a material effect to our consolidated financial
      statements.






28


In
      December 2004 the FASB issued two Staff Positions (“FSP”)-FSP FAS 109-1,
      Application of FASB Statement 109 "Accounting for Income Taxes" to the Tax
      Deduction of Qualified Production Activities Provided by the American Jobs
      Creation Act of 2004, and FSP FAS 109-2 "Accounting and Disclosure Guidance
      for
      the Foreign Earnings Repatriation Provision within the American Jobs Creation
      Act of 2004." We believe that neither of these have a material impact on our
      consolidated financial statements.




On
      May
      31, 2005, the FASB issued FSP EITF 00-19-1, “Application of EITF Issue No. 00-19
      to Freestanding Financial Instruments Originally Issued as Employee
      Compensation”. FAS 123(R) indicates that a freestanding financial instrument
      issued to an employee (such as a stock option) ceases being subject to FAS
      123(R) and becomes subject to other applicable accounting standards when the
      rights conveyed by the instrument are no longer dependent on the holder being
      an
      employee. The FSP clarifies that freestanding financial instruments originally
      issued as employee compensation that can be settled only by delivering
      registered shares should not be assumed to require cash settlement (which would
      require liability accounting) when applying the provisions of Issue 00-19.
      We do
      not expect No. 00-19 to have a material effect on our consolidated financial
      statements.




**Results
      of Operations**




The
      following table sets forth our historical operating results for the periods
      indicated (in thousands):




**Fiscal
                2006**
            
            **Fiscal
                2005**
            
            **Fiscal
                2004**Net
                Revenues
            
            $
            33,320
            
            $
            31,437
            
            $
            30,520Cost
                of revenues
            
            
            (11,552
            )
            
            (9,527
            )
            
            (11,705
            )Gross
                margin
            
            
            21,768
            
            
            21,910
            
            
            18,815Operating
                expenses
            
            
            (23,248
            )
            
            (20,661
            )
            
            (17,301
            )Income
                (loss) from operations
            
            
            (1,480
            )
            
            1,249
            
            
            1,514Gain
                on sales of long-term investment
            
            
            2,549
            
            
            -
            
            
            -Interest
                income and other income, net
            
            
            823
            
            
            595
            
            
            38Provision
                for income taxes
            
            
            (8
            )
            
            (4
            )
            
            (9
            )Net
                income
            
            $
            1,884
            
            $
            1,840
            
            $
            1,543




*Revenues* :
      Our net
      revenues increased $1.9 million, or 6%, in fiscal 2006 compared to fiscal 2005.
      This increase in revenues was primarily attributable to the general increase
      in
      volume orders from large original equipment manufacturers partially offset
      by
      discounts given on these orders. Our net revenues increased $917,000, or 3%,
      in
      fiscal 2005 compared to fiscal 2004. This slight increase in revenues was
      primarily attributable to the increased non-recurring engineering revenues
      and
      sales of our new EM8620 Windows Media 9 media processors in the IP video
      technology and connected media player markets which was partially offset by
      the
      decreased sales of other MPEG chipset products in the same markets.






29


Revenues
      from sales of our products in the IP video technology and connected media player
      market was 92% of our total revenues in fiscal 2006 compared to 91% for fiscal
      2005 and 88% for fiscal 2004, while revenues from sales of our products in
      the
      PC add-in market was 6% in fiscal 2006 as compared to 8% in fiscal 2005 and
      12%
      for fiscal 2004. Revenues from our HDTV products was immaterial for fiscal
      2006
      2005 and 2004. We expect the percentage of revenues in IP video technology
      and
      connected media player markets will continue to increase while revenues from
      the
      PC add-in market declines.




*Net
      income* .
      Net
      income was $1.9 million in fiscal 2006 as compared to $1.8 million in fiscal
      2005 and $1.5 million in fiscal 2004. The slight increase in fiscal 2006 from
      fiscal 2005 was primarily attributable to $2.5 million of investment gain and
      an
      increase of $228,000 in interest and other incomes, which were partially offset
      by $1.5 million of operating loss incurred in fiscal 2006 as a result of an
      increase of $2.6 million in operating expenses and 5% decrease in the gross
      margin due to lower average selling price given to volume orders. The increase
      in fiscal 2005 from fiscal 2004 was primarily attributable to an increased
      gross
      margin of $3.1 million and an incentive of $400,000 received from the French
      tax
      authorities offset by an increase of $3.4 million of operating expenses. The
      incentive recovered qualifying research and development expenditures incurred
      by
      our French subsidiary.




The
      following table shows certain items as a percentage of net revenues, which
      are
      included in our Consolidated Statements of Operations:




**Fiscal
                2006**
            
            **Fiscal
                2005**
            
            **Fiscal
                2004**Net
                revenues
            
            
            100%
            
            
            100%
            
            
            100%Cost
                of revenue
            
            
            (35)%
            
            
            (30)%
            
            
            (38)%Gross
                profit
            
            
            65%
            
            
            70%
            
            
            62%Operating
                expenses:Research
                and development
            
            
            (42)%
            
            
            (37)%
            
            
            (33)%Sales
                and marketing
            
            
            (15)%
            
            
            (15)%
            
            
            (16)%General
                and administrative
            
            
            (12)%
            
            
            (14)%
            
            
            (8)%Gain on
              sales of
              long-term investment
            
            
            8%
            
            
            -
            
            
            -Interest
                income (expense) and other income (loss), net
            
            
            2%
            
            
            2%
            
            
            -NET
                INCOME
            
            
            6%
            
            
            6%
            
            
            5%




**Net
      Revenues**




Net
      Revenues by Product Group:




We
      have
      three main product groups: chipsets, board and “other” products. The following
      table sets forth our net revenues in each of our major product group and the
      percentage of total net revenues represented by each product group, for the
      last
      three years (in thousands):




30




**Fiscal
                2006**
            
            **Fiscal
                2005**
            
            **Fiscal
                2004**Chipsets
            
            $
            28,198
            
            
            85%
            
            $
            26,380
            
            
            84%
            
            $
            25,880
            
            
            85%Boards
            
            
            3,514
            
            
            10%
            
            
            3,280
            
            
            10%
            
            
            3,231
            
            
            10%Other
            
            
            1,608
            
            
            5%
            
            
            1,777
            
            
            6%
            
            
            1,409
            
            
            5%TOTAL
                NET REVENUES
            
            $
            33,320
            
            
            
            
            $
            31,437
            
            
            
            
            $
            30,520




*Chipsets* .
      Our
      chipsets are targeted toward manufacturers and large volume OEM customers
      building products for the digital media processor market. The increase of $1.8
      million, or 7%, in net revenues from chipsets in fiscal 2006 as compared to
      fiscal 2005 was due primarily to increased unit sales of our chipsets into
      the
      IP video technology market and connected media player market offset by the
      lower
      average selling price given to large original equipment manufacturers for volume
      orders. The increase of $500,000, or 2%, in net revenues from chipsets in fiscal
      2005 as compared to fiscal 2004 was attributable to the continuing growth of
      demand for our chipset products from the IP video technology and connected
      media
      player markets, leading to increased unit sales and higher introduction selling
      prices of our new advanced DVD player and IP video set-top box chipsets. We
      expect that net revenues from chipset products will continue to fluctuate,
      primarily due to changes in demand from our customers and volume discounts
      given
      to large original equipment manufacturers. If demand of our chipset products
      does not continue, our revenues and profitability would decline.




*Boards* .
      Our
      board level product lines target OEM customers to address the DVD upgrade
      market, system integrators to address the computer-based training, kiosks,
      and
      corporate video-on-demand markets and consumer markets for upgraded multimedia
      products. The increase of $234,000, or 7%, in net revenues from board products
      in fiscal 2006 as compared to fiscal 2005 was mainly attributable to increased
      unit sales of development reference boards to the various markets partially
      offset by decreased unit sales of project-based board products for IP video
      applications. The net revenues from MPEG-based board products for fiscal 2005
      was relatively constant as compared to fiscal 2004. We anticipate our revenues
      from board products to be relatively flat or decrease in future periods due
      to
      decreasing demand in board products, in general and our decision to focus on
      our
      chipset products in the IP video technology market and connected media player
      market instead of board products in these markets.




*Other* .
      The
“Other” category primarily includes revenue from development kits, engineering
      support services for both hardware and software, engineering development for
      customization of chipsets, freight fees and other accessories. The costs related
      to support service revenues and certain small development contracts were
      included in sales and marketing expenses, and research and development expenses,
      respectively. The decrease in net revenues from other products in fiscal 2006
      as
      compared to fiscal 2005 was primarily attributable to the decreased revenues
      from engineering support services and other accessories. We expect that net
      revenues from “other” products will continue to fluctuate due mainly to the
      timing and complexity of engineering development required by our
      customers.






31


Net
      Revenues by Market Segment:




We
      sell
      our products primarily into four market segments which consist of the IP video
      technology market, the connected media player market, the HDTV product market
      and the PC add-in and other market. The following table sets forth our net
      revenues by market and the percentage of total net revenues represented by
      our
      product sales to each market segment for each of the last three fiscal years
      (in
      thousands):




**Fiscal
                2006**
            
            **Fiscal
                2005**
            
            **Fiscal
                2004**IP
                video technology market
            
            $
            19,170
            
            
            58%
            
            $
            18,063
            
            
            58%
            
            $
            15,068
            
            
            50%Connected
                media player market
            
            
            11,227
            
            
            34%
            
            
            10,379
            
            
            33%
            
            
            11,690
            
            
            38%HDTV
                product market
            
            
            797
            
            
            2%
            
            
            362
            
            
            1%
            
            
            94
            
            
            0%PC
                add-in and other markets
            
            
            2,126
            
            
            6%
            
            
            2,633
            
            
            8%
            
            
            3,668
            
            
            12%TOTAL
                NET REVENUES
            
            $
            33,320
            
            
            
            
            $
            31,437
            
            
            
            
            $
            30,520




*IP
      video technology market* .
      For
      fiscal 2006, revenues from sales of our chipset products to the IP video
      technology market increased $1.1 million, or 6%, from fiscal 2005 and increased
      $3.0 million, or 20%, for fiscal 2005 compared to fiscal 2004. The increase
      in
      revenues in the IP video technology market for fiscal 2006 as compared to fiscal
      2005 and 2004 was mainly attributable to increased unit sales of our chipset
      products into IPTV set-top box and digital media adapter markets offset by
      lower
      average selling prices. We expect our revenues from the IP video technology
      market to fluctuate in future periods due to the uneven pace of IPTV service
      deployments, the market development of IPTV, in general, and volume discounts
      given to large original equipment manufacturers to capture the market
      share.




*Connected
      media player market* .
      For
      fiscal 2006, revenues from sales of our products to the connected media player
      market increased $848,000, or 8%, from fiscal 2005 and decreased $1.3 million,
      or 11%, for fiscal 2005 compared to fiscal 2004. The increase in revenues from
      sales of our products to the connected media player market in fiscal 2006 as
      compared to fiscal 2005 was attributable to the increased unit sales of our
      chipset products into portable media players market offset by lower average
      selling prices. The decrease in revenues from sales of our products to the
      connected media player market in fiscal 2005 as compared to fiscal 2004 was
      primarily attributable to the lower average selling prices of our MPEG chipsets.
      We expect that revenues from sales of our products to the connected media player
      market will continue to fluctuate, primarily due to changes in demand from
      our
      customers and decisions regarding pricing strategy on volume orders.




If,
      however, our pricing strategy failed and these declines in average selling
      prices for our products being sold into the IP video technology and connected
      media player markets were to continue, it could harm our revenues and
      profitability.




*HDTV
      Product Market* .
      We
      began shipment of HDTV applications during the second quarter of fiscal 2004
      and
      experienced an increase in demand through fiscal 2006. We expect revenues in
      the
      HDTV product market to increase slowly over the near term.




32




*PC
      add-in and other markets* .
      The PC
      add-in and other markets consists of PC add-in board and chipset products,
      engineering support services for both hardware and software, engineering
      development for customization of chipsets, freight fees and other accessories.
      For fiscal 2006, revenues from the PC add-in and other markets decreased
      $507,000, or 19%, as compared to fiscal 2005 and decreased $1.0 million, or
      28%,
      for fiscal 2005 compared to fiscal 2004. The decrease in revenues from sales
      of
      our products to the PC add-in and other markets in fiscal 2006 was due to the
      decreased engineering development revenues, support services and other
      accessories as compared to fiscal 2005. The decrease in revenues for fiscal
      2005
      was due primarily to the decreased unit sales of our chipsets to the PC add-in
      market, partially offset by increased revenues in engineering development
      projects as compared to fiscal 2004. We expect our revenues from sales to the
      PC
      add-in and other markets to continue to decline due to declining demand in
      the
      general market and we expect our revenues from engineering development to
      fluctuate in future periods due to the timing and complexity of the projects
      required by our customers.




Net
      Revenues by Geographic Region: **




The
      following table sets forth our net revenues by geographic region, and the
      percentage of total net revenues represented by each geographic region, for
      each
      of the last three fiscal years (in thousands):




**Fiscal
                2006**
            
            **Fiscal
                2005**
            
            **Fiscal
                2004**Asia
            
            $
            27,293
            
            
            82%
            
            $
            20,571
            
            
            65%
            
            $
            19,816
            
            
            65%North
                America
            
            
            3,944
            
            
            12%
            
            
            4,401
            
            
            14%
            
            
            4,190
            
            
            14%Europe
            
            
            2,081
            
            
            6%
            
            
            6,462
            
            
            21%
            
            
            6,502
            
            
            21%Other
                regions
            
            
            2
            
            
            -%
            
            
            3
            
            
            -%
            
            
            12
            
            
            -%TOTAL
                NET REVENUES
            
            $
            33,320
            
            
            
            
            $
            31,437
            
            
            
            
            $
            30,520




*Asia* .
      The
      revenues from Asia (which consists primarily of Korea, China and Taiwan)
      increased $6.7 million, or 33%, in fiscal 2006 as compared to fiscal 2005.
      The
      increase in revenues from Asia region was due primarily to the increased unit
      sales of our chipset products to the connected media player market and IP video
      technology market because of the shift of orders from customers in North America
      and Europe regions to Asia region and volume orders received from local original
      equipment manufacturers which was partially offset by lower average selling
      prices given to these orders. The revenues from Asia region (which consists
      primarily of Korea, China and Taiwan) in fiscal 2005 remained relatively flat
      as
      compared to fiscal 2004. Our customers for chipset products in the IP video
      technology market and the connected media player market are concentrated in
      Asia. We expect that our revenues from Asia will continue to increase due to
      increasing orders previously placed by our customers in the North America and
      Europe regions who now manufacture their products in Asia.






33




In
      fiscal
      2006, revenues from Asia region which were over 10% of total net revenues are
      as
      follows:




**Fiscal
                2006**
            
            **Fiscal
                2005**
            
            **Fiscal
                2004**Korea
            26%
            
            16%
            
            11%China
            21%
            
            21%
            
            12%Taiwan
            14%
            
            17%
            
            22%




*North
      America* .
      North
      American revenues decreased $457,000, or 10%, for fiscal 2006 as compared to
      fiscal 2005. The decrease was largely due to the decreased unit sales of our
      board products to the IP video technology market which was partially offset
      by
      the increased unit sales of our chipset products. This was due primarily to
      customers increasingly incorporating our chipsets into their final products.
      In
      addition, there was a shift of chipset orders from our customers in the North
      American region to our customers in the Asia region. North American revenues
      in
      fiscal 2005 remained relatively flat as compared to fiscal 2004. We expect
      that
      our revenues from North America will continue to decline due to our customers
      gradually switching their orders to us from the higher value board products
      to
      the lower value chipset products. In addition, our customers may place orders
      with other overseas manufacturers who incorporate our products into their final
      products. As a result, our sales are moved from our North American customers
      to
      our overseas OEMs.




*Europe.* Revenues
      from Europe for fiscal 2006 decreased $4.4 million, or 68%, as compared to
      fiscal 2005. The decrease in revenues from Europe was primarily attributable
      to
      decreases in unit sales of our chipset products. This was due primarily to
      customers increasingly incorporating our chipsets into their final products,
      which were manufactured in the Asia countries. As a result, there was a shift
      of
      chipset orders from our customers in the Europe region to our customers in
      the
      Asia region. Revenues from Europe for fiscal 2005 remained flat as compared
      to
      fiscal 2004. We anticipate revenues in Europe will fluctuate due to the fact
      that our customers may place orders with other manufacturers in other regions,
      who incorporate our products into their final products. As a result, our sales
      will move from our European customers to our customers in other
      regions.




For
      fiscal 2006, we did not have sales in excess of 10% of net revenues from a
      single European country. For fiscal 2005 and 2004, sales in Denmark were 15%
      and
      12% of net revenues, respectively. No other European country accounted for
      more
      than 10% of our net revenues in fiscal 2005 or 2004.




In
      fiscal
      2006, our international revenues were 89% of our total net revenues as compared
      to approximately 86% in both fiscal 2005 and 2004. We expect that international
      sales will continue to account for a significant portion of revenues, due in
      part to the significant overseas manufacturing of consumer appliances by our
      chipset customers.






34




Major
      Customers:




Major
      customers that accounted for over 10% of our total net revenues are as follows:




**Customers**
            **Regions**
            **Fiscal
                2006**
            **Fiscal
                2005**
            **Fiscal
                2004**A
            Asia
            25%
            15%
            *B
            Europe
            Less
                than 1% **
            14%
            *







*
            No
                single customer accounted more than 10% of our total net
                revenues




**
            Customer
                B was acquired by a U.S. Corporation and undergoing the acquisition
                process in fiscal 2006. We believe we will continue to receive orders
                from
                the U.S. Corporation after the acquisition completed.




**Gross
      Margin**




Our
      gross
      margin as a percentage of net revenues was approximately 65% in fiscal 2006,
      70%
      in fiscal 2005 and 62% in fiscal 2004. The decrease of our gross margin in
      fiscal 2006 as compared to fiscal 2005 was due primarily to lower average
      selling prices provided to original equipment manufacturers for volume
      orders . The
      increase of our gross margin in fiscal 2005 as compared to fiscal 2004 was
      due
      to our continuing efforts to reduce the cost of our original MPEG board and
      chipset products, and the introduction and sales of our new higher-margin
      chipset and board products as well as increased service and development revenues
      which have lower associated costs. In addition, the costs related to service
      revenues and certain small development contracts were included in sales and
      marketing expenses and research and development expenses (see reference to
      Critical Accounting Policies - Revenue Recognition), while our expense for
      inventory obsolescence included in cost of revenues increased $29,000, $230,000
      and $647,000 in fiscal 2005 and 2004, respectively. In addition, cost of
      revenues included $130,000 of accelerated depreciation expense due to reduction
      of estimated useful live for certain testing equipment. We expect our gross
      margins will vary from period to period due to changes in the mix of product
      sales, average selling prices, volume order discounts, our costs, the extent
      of
      development fees, changes in estimated useful lives of production testing
      equipment and provisions for inventory obsolescence. Because average selling
      prices of our products typically decline over the life of a product, if we
      are
      unable to reduce costs faster than the rate of such decline or introduce new
      products with higher average selling prices, our gross margins will decline.




**Operating
      Expenses**




**Fiscal
                2006**
            
            **Change**
            
            **Fiscal
                2005**
            
            **Change**
            
            **Fiscal
                2004**(in
                thousands)Research
                & development expense
            
            $
            14,041
            
            
            21%
            
            $
            11,648
            
            
            16%
            
            $
            10,000Sales
                and marketing expenses
            
            
            5,076
            
            
            6%
            
            
            4,804
            
            
            0%
            
            
            4,802General
                & administrative expenses
            
            
            4,131
            
            
            (2)%
            
            
            4,209
            
            
            68%
            
            
            2,499




35


*Research
      and development expenses* .
      Research and development expenses increased by approximately $2.4 million,
      or
      21%, in fiscal 2006 compared to fiscal 2005. Research and development expenses
      increased by approximately $1.6 million, or 16%, in fiscal 2005 compared to
      fiscal 2004. The year-over-year increases were primarily attributable to the
      additions of engineering staff at our headquarters, Hong Kong office and
      development center in France, independent contractors and consultants, prototype
      costs of new products, and various licensing fees. As a result of our continuing
      efforts in the development of our proprietary MPEG and WMV9 based products
      and
      the addition of research and development personnel as a result of our
      acquisition of Blue7 on February 16, 2006, research and development expenses
      will continue to increase in absolute dollars in the near term.




*Sales
      and marketing expenses* .
      Sales
      and marketing expenses increased by $272,000, or 6%, in fiscal 2006 as compared
      to fiscal 2005. The increase was due primarily to increased staff for
      engineering support and an increase in tradeshow related expenditures. In fiscal
      2005, sales and marketing expenses were comparable to fiscal 2004. As a result
      of increased headcount in our product marketing and sales development areas
      from
      our acquisition of Blue7 on February 16, 2006, we expect our sales and marketing
      expenses will increase in absolute dollars over next fiscal year.




*General
      and administrative expenses.* General
      and administrative expenses in fiscal 2006 remained relatively flat as compared
      to fiscal 2005. General and administrative expenses increased by approximately
      $1.7 million, or 68%, in fiscal 2005 compared to fiscal year 2004. The increase
      was due primarily to an increase of $200,000 in legal, $500,000 in professional
      services primarily related to Sarbanes Oxley compliance and $600,000 of bad
      debt
      expense compared to a $200,000 recovery in 2004. We expect our general and
      administrative expenses will increase in absolute dollar terms in future periods
      due to the increasing cost of insurance and professional services related to
      remediation efforts with Sarbanes Oxley compliance.




**Gain
      on sale of long-term investment**




We
      recognized a total gain of approximately $2.5 million on sales of long-term
      investments in fiscal 2006 and recorded no investment gain in fiscal 2005.
      During fiscal 2006, we sold our investment in Series B Preferred Stock of a
      local MPEG-4 system provider for approximately $1.1 million. We had no carrying
      amount in this investment at the date of sale, as it had been fully written
      off
      in fiscal 2003. The entire sales proceeds of approximately $1.1 million was
      recognized as a gain on sales of investment during the year. In addition, we
      sold another investment in an original equipment manufacturer with a carrying
      cost of approximately $2.0 million for $3.5 million and recognized a gain of
      $1.5 million. We do not expect that we will sell any of our remaining
      investments in the near future.




**Other
      income and Expense**




Other
      income and expenses mainly consisted of interest income from short-term
      investment, interest expenses from our lines of credit and term loan, loss
      on
      disposal of fixed assets and gain or loss on sales of short-term investments.
      The increase of $228,000, or 38% in fiscal 2006 as compared to fiscal 2005
      was
      due primarily to an increase of $473,000 in interest income from cash and
      short-term investments, offset by a decrease of $165,000 in the incentive
      received from the French tax authorities. The increase of $500,000 in fiscal
      2005 as compared to fiscal 2004 was due primarily to an increase of $100,000
      in
      interest income from short-term investments and the receipt of an incentive
      of
      $400,000 received from the French tax authorities. During fiscal 2006, we
      received a second incentive payment of $235,000 as compared to $400,000 received
      in 2005 from the French tax authorities for the recovery of qualifying research
      and development expenditures incurred by our French subsidiary. We will continue
      to apply for similar incentives each year. However, there is no assurance that
      we will receive such incentives in future periods.




36


**Liquidity
      and Capital Resources**




As
      of
      January 28, 2006, our principal sources of liquidity consisted of cash and
      cash
      equivalents and short-term investments of approximately $26.4 million, an
      increase of approximately $7.6 million compared with approximately $18.8 million
      at January 29, 2005. This increase resulted from the sale of long-term
      investments for aggregate proceeds of approximately $4.6 million, net borrowings
      of $444,000 from a loan agreement with a bank for financing research and
      development equipment, net cash provided by operating activities of
      approximately $1.3 million and the exercise of stock options and purchases
      of
      common stock by employees resulting in cash proceeds of approximately $2.9
      million, which was partially offset by capital equipment expenditures of
      $699,000 and short-term loans of $900,000 to Blue7 Communications in which
      we
      had an investment of $1.0 million. We subsequently acquired Blue7 on February
      16, 2006. Blue7 is currently one of our subsidiaries.




The
      total
      $750,000 of short-term loans to Blue7 with accrued interest would be deducted
      from the total purchase price. The remaining loan balance of $150,000 was
      pending for approval from the Board of Directors to be included as part of
      the
      acquisition cost for the Blue7 merger.




Net
      cash
      provided by operating activities was approximately $1.3 million for fiscal
      2006
      compared with $2.0 million in fiscal 2005 and $987,000 in fiscal 2004. Cash
      will
      continue to fluctuate based upon our ability to grow revenue while limiting
      the
      timing of payments to us from customers and to vendors from us, the timing
      of
      inventory purchases and subsequent manufacture and sale of our
      products.




Our
      primary sources of funds to date have been proceeds from preferred and common
      stock issuances, and borrowings under bank lines of credit. In certain periods,
      cash generated from operations has also been a source of funds. While we
      generated cash from operations for the year ended January 28, 2006 and 2005,
      it
      is possible that our operations will consume cash in future periods. Based
      on
      our currently anticipated cash needs, we believe that our current reserve of
      cash and cash equivalents will be sufficient to meet our primary uses of cash,
      which include our anticipated working capital requirements, obligations, capital
      expenditures, strategic investments, and other cash needs for at least the
      next
      twelve months. In addition, we believe that we will be able to comply with
      or
      make modifications to the current covenants under our existing asset-based
      banking agreements, and to renew those lines of credit upon their expiration,
      in
      order to maintain the availability of funds under these agreements.




37


Net
      cash
      provided by investing activities was approximately $2.0 million for fiscal
      2006
      compared with cash used in investing activities of $11.8 million for 2005 and
      cash used in investing activities of $1.3 million for 2004. The $2.0 million
      of
      cash provided in fiscal 2006 was generated from approximately $4.5 million
      of
      proceeds from sales of long-term investments offset by $699,000 of capital
      expenditures, a $900,000 promissory note and $991,000 of short-term investments.
      The $11.8 million of cash used in fiscal 2005 was primarily $1.2 million for
      capital expenditures, $8.6 million for short-term investments and $2.0 million
      for long-term investments. The $1.3 million of cash used in fiscal 2004 was
      mainly $265,000 for capital expenditures and $1.3 million for long-term
      investments offset by a refund of $243,000 of rental deposit.




On
      February 16, 2006, Sigma successfully acquired Blue7 Communications which was
      a
      privately-held California corporation. Sigma purchased Blue7’s shares for
      approximately $14.0 million in stock. Blue7 focuses on the development of
      advanced wireless technologies and Ultra-Wideband (UWB) semiconductor
      products.




Net
      cash
      provided by financing activities was approximately $3.3 million in fiscal 2006
      versus $1.1 million in fiscal 2005 and $18.5 in fiscal 2004. The financing
      activities consisted of bank lines of credit and term loan, sales of company
      stock through the Company’s employee stock option plan, employee stock purchase
      plan and public offering. As of January 28, 2006, the outstanding balance of
      our
      bank term loan was $444,000. The net proceeds from sale of common stock were
      $2.9 million, $1.3 million and $18.7 million in fiscal 2006, 2005 and 2004,
      respectively.




On
      January 27, 2005, the Company filed a shelf registration statement on Form
      S-3
      with the Securities and Exchange Commission covering the sale of the Company’s
      common stock in one or more offerings with a total offering price of up to
      $40
      million from time to time in amounts, at prices and on terms to be determined
      at
      the time of the applicable offering.




*Line
      of Credit and Term Loan*




On
      August
      12, 2005, we entered into a Loan and Security Agreement (the “Loan Agreement”)
      with United Commercial Bank (the “Bank”). The Loan Agreement provides for a
      maximum borrowing amount of approximately $15.5 million across three credit
      facilities consisting of two 2-year Lines of Credit and a 30-month Term Loan
      of
      $500,000.




Our
      Lines
      of Credit are used to fund daily operating cash needs. During the ordinary
      course of business, the use of the Lines of Credit is driven by collection
      and
      disbursement activities. Our daily cash needs generally follow a predictable
      pattern that parallels our payroll cycles, which drive, as necessary, our short
      term borrowing requirements.




The
      first
      2-year Lines of Credit allows us to borrow up to 80% of our accounts receivable,
      but in no event greater than $15 million, has a floating interest rate of the
      Wall Street Journal Prime Rate plus 0.25% per annum. The second 2-year Lines
      of
      Credit allows us to borrow up to $5 million as long as (1) our unrestricted
      cash
      at the Bank exceeds $10 million, (2) the credit limit of the first 2-year Line
      of Credit is utilized and (3) the total outstanding balances under both 2-year
      Lines of Credit cannot exceed $15 million at any one time. The second 2-year
      Line of Credit has a floating interest rate of the Wall Street Journal Prime
      Rate plus 0.25% per annum. Our obligations under the Loan Agreement are secured
      by substantially all of the Company’s assets, including our intellectual
      property. Both Lines of Credit expire and are payable in full on August 12,
      2007. At our option, we can repay the loans under the Loan Agreement without
      premium or penalty. As of January 28, 2006, we had no amounts outstanding under
      these two Lines of Credit but had availability to draw down approximately $7.6
      million. On February 8, 2006, we have utilized $2.4 million of the first 2-year
      Line of Credit for issuance of a standby letter of credit to a supplier.




38




Principal
      amounts under the Term Loan will become due and payable on a monthly basis
      such
      that the Term Loan will be fully repaid in February 2008. The Term Loan has
      a
      floating interest rate of the Wall Street Journal Prime Rate plus 0.5% per
      annum. The effective average interest rate paid on the Term Loan from August
      12,
      2005, through January 28, 2006, was approximately 7.4%. As of January 28, 2006,
      we had $444,000 outstanding under the Term Loan.




Under
      the
      Loan Agreement, we are subject to certain financial covenants. As of January
      28,
      2006, we are in compliance with all of the covenants contained in the Loan
      Agreement.




*Contractual
      Obligations and Commitments:*




We
      do not
      have guaranteed price or quantity commitments from any of our suppliers. We
      generally maintain products for distribution through corporate markets based
      on
      forecasts rather than firm purchase orders. Additionally, we generally acquire
      products for sale to our OEM customers only after receiving purchase orders
      from
      such customers, which purchase orders are typically cancelable without
      substantial penalty from such OEM customers. We currently place non-cancelable
      orders to purchase semiconductor products from our suppliers on an eight to
      twelve week lead-time basis.






The
      following table sets forth the amounts (in thousands) of payments due under
      specified contractual obligations as of January 28, 2006.




**Contractual
                Obligations:**
            
            **Payments
                Due by Period****1
                year or less**
            
            **1
                - 3 years**
            
            **3
                - 5 years**
            
            **5
                years or more**
            
            **Total**Operating
                Leases
            
            $
            798
            
            $
            654
            
            $
            144
            
            $
            156
            
            $
            1,752Term
                Loan
            
            
            211
            
            
            233
            
            
            -
            
            
            -
            
            
            444Non-cancelable
                purchase orders
            
            
            4,277
            
            
            -
            
            
            -
            
            
            -
            
            
            4,277$
            5,286
            
            $
            887
            
            $
            144
            
            $
            156
            
            $
            6,473




On
      April
      10, 2006, we entered into a sublease agreement to rent approximately 2,500
      square feet of a facility from a start-up company founded by a member of our
      board of directors. This is a month-to-month operating lease with base rent
      of
      $4,000 plus proportionate share of operating costs commencing April 1, 2006.




39


**ITEM
      7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK**




The
      following discussion about our market risk disclosures involves forward-looking
      statements. Actual results could differ materially from those projected in
      the
      forward-looking statements. We face exposure to market risk from adverse
      movements in interest rates and foreign currency exchange rates, which could
      affect our operations and financial condition. We do not use derivative
      financial instruments for speculative purposes.




***Interest
      Rate Sensitivity*** - As of
      January 28, 2006, we held approximately $9.5 million of short-term investments
      generally consisting of the U.S. government and corporate debt securities with
      an average original maturity of less than one year. If short-term interest
      rates
      were to decrease 10%, the decreased interest income associated with these
      short-term investments would not have a material impact on our net income (loss)
      and cash flows.




In
      additions, we had borrowings outstanding of $444,000 under a term loan agreement
      for financing equipment for research and development, and no borrowings
      outstanding under our two variable interest rate bank lines of credit. If
      short-term interest rates were to increase 10%, the increased interest expense
      associated with these arrangements would not have a material impact on our
      net
      income (loss) and cash flows.




***Foreign
      Currency Exchange Rate Sensitivity*** - The
      Hong Kong dollar and Euro are the financial currencies of our subsidiaries
      in
      Hong Kong and France, respectively. We do not currently enter into foreign
      exchange forward contracts to hedge certain balance sheet exposures and
      intercompany balances against future movements in foreign exchange rates.
      However, we do maintain cash balances denominated in the Hong Kong dollar and
      Euro. If foreign exchange rates were to weaken against the U.S. dollar
      immediately and uniformly by 10% from the exchange rate at January 28, 2006,
      the
      fair value of these foreign currency amounts would decline by an immaterial
      amount.




**ITEM
      8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**




The
      financial statements required by this item, the notes related thereto, and
      the
      independent auditors’ report appear on pages F-1 through F-31 and S-1 of this
      Annual Report on Form 10-K.




**ITEM
      9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE**




Not
      applicable.




**ITEM
      9A. CONTROLS AND PROCEDURES**




**Disclosure
      Controls and Procedures**




We
      maintain “disclosure controls and procedures,” as such term is defined in Rule
      13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that
      are designed to ensure that information required to be disclosed by us in
      reports that we file or submit under the Exchange Act is recorded, processed,
      summarized, and reported within the time periods specified in Securities and
      Exchange Commission rules and forms, and that such information is accumulated
      and communicated to our management, including our Chief Executive Officer and
      Chief Financial Officer, as appropriate, to allow timely decisions regarding
      required disclosure. In designing and evaluating our disclosure controls and
      procedures, management recognized that disclosure controls and procedures,
      no
      matter how well conceived and operated, can provide only reasonable, not
      absolute, assurance that the objectives of the disclosure controls and
      procedures are met. Our disclosure controls and procedures have been designed
      to
      meet reasonable assurance standards. Additionally, in designing disclosure
      controls and procedures, our management necessarily was required to apply its
      judgment in evaluating the cost-benefit relationship of possible disclosure
      controls and procedures. The design of any disclosure controls and procedures
      also is based in part upon certain assumptions about the likelihood of future
      events, and there can be no assurance that any design will succeed in achieving
      its stated goals under all potential future conditions.




40




As
      previously reported in the Company’s Annual Report on Form 10-K, as of January
      29, 2005, we noted two material weaknesses in our internal control over
      financial reporting. One of these material weaknesses related to the inadequate
      supervision and review controls over the recording of stock options had been
      fully remediated as of January 28, 2006. We remediated this material weakness
      by
      implementing additional controls surrounding the review of stock option
      transactions, such as adding additional staff to review and verify the records
      of all option transactions and input data into the Black-Scholes option-pricing
      model for the calculation of stock-based compensation. The remaining material
      weakness related to the inadequate controls to ensure that financial information
      is adequately analyzed to detect misstatements including the lack of
      understanding of generally accepted accounting principles, or GAAP, and
      Securities Exchange Commission, or SEC, reporting matters had not been
      remediated as of January 28, 2006. Therefore, our Chief Executive Officer and
      Chief Financial Officer concluded that our disclosure controls and procedures
      were ineffective as of January 28, 2006.




**Management’s
      Annual Report on Internal Controls Over Financial
      Reporting.**




Our
      management is responsible for establishing and maintaining adequate internal
      control over financial reporting, as such term is defined in Exchange Act Rules
      13a-15(f). The Company’s internal control system is designed to provide
      reasonable assurance to the Company’s management and Board of Directors
      regarding the preparation and fair presentation of published financial
      statements. All internal control systems, no matter how well designed, have
      inherent limitations. Therefore, even those systems determined to be effective
      can provide only reasonable assurance with respect to financial statement
      preparation and presentation and may not prevent or detect misstatements. Also,
      projections of any evaluation of effectiveness to future periods are subject
      to
      the risk that controls may become inadequate because of changes in conditions,
      or that the degree of compliance with the policies or procedures may
      deteriorate. ****




Under
      the
      supervision and with the participation of our management, including our Chief
      Executive Officer and Chief Financial Officer, we conducted an evaluation of
      the
      effectiveness of our internal control over financial reporting based on the
      framework in *Internal Control - Integrated Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission. As
      part
      of this evaluation, management established an internal control project team,
      engaged outside consultants and adopted a project work plan to document and
      assess the adequacy of our internal control over financial reporting, address
      any control deficiencies that were identified, and to validate through testing
      that the controls are functioning as documented.




41


There
      were two material weaknesses in internal control over financial reporting as
      of
      January 29, 2005 that we previously reported. One of these material weaknesses
      related to the inadequate supervision and review controls over the recording
      of
      stock options had been fully remediated as of January 28, 2006. The other
      material weakness was that we had inadequate controls in place to ensure that
      financial information is adequately analyzed to detect misstatements including
      the lack of understanding of generally accepted accounting principles, or GAAP,
      and Securities Exchange Commission, or SEC, reporting matters. We had not
      remediated this material weakness as of January 28, 2006. The following is
      a
      more detailed description of the material weakness.




·
            The
                Company’s personnel who are responsible for performing and overseeing the
                period-end financial closing and reporting process lack the understanding
                of generally accepted accounting principles (GAAP) and SEC reporting
                matters for their assigned duties, and consequently the Company’s process
                to determine and monitor compliance with GAAP and SEC reporting matters
                is
                not operating effectively. In addition, the Company has not designed
                and
                implemented appropriate controls to ensure that financial information
                (both routine and non-routine) is adequately analyzed and reviewed
                to
                detect misstatements. For example, the Company did not adequately analyze
                all incurred direct costs totaling approximately $276,000 associated
                with
                the acquisition of Blue7 Communications. The Company recorded an
                audit
                adjustment of approximately $276,000 reclassifying the direct costs
                from
                expense as part of the acquisition cost.




The
      Company has instituted remediating actions to address this weakness. The Company
      hired a certified public accountant in January 2006 with a strong background
      in
      GAAP and in SEC reporting and intends to hire additional personnel with similar
      expertise. In addition, we will continue to provide training to accounting
      personnel and engage outside consultants in areas related to GAAP and SEC
      reporting as needed. In making its assessment of internal control over financial
      reporting, management used the criteria issued by the Committee of Sponsoring
      Organizations of the Treadway Commission (COSO) in Internal Control-Integrated
      Framework. Because of the material weakness described above, management believes
      that, as of January 28, 2006, the Company did not maintain effective internal
      control over financial reporting based on those criteria. The Company’s
      independent registered public accountants have issued an attestation report
      on
      management’s assessment of the Company’s internal control over financial
      reporting. That report appears below.




**Changes
      in Internal Control Over Financial Reporting**




While
      we
      established additional controls to further improve our internal control over
      financial reporting as described below under the caption “Report of Management
      on Internal Control over Financial Reporting,” there was no other significant
      change in our internal control over financial reporting that occurred during
      the
      fourth quarter of fiscal 2006 that has materially affected, or is reasonably
      likely to materially affect, our internal control over financial reporting.






42




**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**


**ON
      INTERNAL CONTROL OVER FINANCIAL REPORTING**






Board
      of
      Directors and Stockholders of


Sigma
      Designs, Inc.




We
      have
      audited management’s assessment, included in the accompanying Management’s
      Report on Internal Control Over Financial Reporting as of January 28, 2006,
      that
      Sigma Designs, Inc. and subsidiaries (the “Company”) did not maintain effective
      internal control over financial reporting as of January 28, 2006, because of
      the
      effect of the material weakness identified in management’s assessment and
      described below, based on criteria established in Internal Control—Integrated
      Framework issued by the Committee of Sponsoring Organizations of the Treadway
      Commission (COSO). The Company’s management is responsible for maintaining
      effective internal control over financial reporting, and for its assessment
      of
      the effectiveness of internal control over financial reporting. Our
      responsibility is to express an opinion on management’s assessment, and an
      opinion on the effectiveness of the Company’s internal control over financial
      reporting based on our audit.




We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether effective
      internal control over financial reporting was maintained in all material
      respects. Our audit of internal control included obtaining an understanding
      of
      internal control over financial reporting, evaluating management’s assessment,
      testing and evaluating the design and operating effectiveness of internal
      control, and performing such other procedures as we considered necessary in
      the
      circumstances. We believe that our audit provides a reasonable basis for our
      opinion.




A
      company’s internal control over financial reporting is a process designed to
      provide reasonable assurance regarding the reliability of financial reporting
      and the preparation of financial statements for external purposes in accordance
      with generally accepted accounting principles. A company’s internal control over
      financial reporting includes those policies and procedures that (1) pertain
      to
      the maintenance of records that, in reasonable detail, accurately and fairly
      reflect the transactions and dispositions of the assets of the company; (2)
      provide reasonable assurance that transactions are recorded as necessary to
      permit preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the company are
      being made only in accordance with authorizations of management and directors
      of
      the company; and (3) provide reasonable assurance regarding prevention or timely
      detection of unauthorized acquisition, use, or disposition of the company’s
      assets that could have a material effect on the financial statements.




Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Also, projections of any evaluation of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with the policies or procedures may deteriorate.




A
      material weakness is a significant deficiency, or combination of significant
      deficiencies, that results in more than a remote likelihood that a material
      misstatement of the annual or interim financial statements will not be prevented
      or detected. The following material weakness has been identified and is included
      in management’s assessment as of January 28, 2006.




43


·
            The
                Company’s personnel who are responsible for performing and overseeing the
                period-end financial closing and reporting process lack the understanding
                of generally accepted accounting principles (GAAP) and SEC reporting
                matters for their assigned duties, and consequently the Company’s process
                to determine and monitor compliance with GAAP and SEC reporting matters
                is
                not operating effectively. In addition, the Company has not designed
                and
                implemented appropriate controls to ensure that financial information
                (both routine and non-routine) is adequately analyzed and reviewed
                to
                detect misstatements. For example, the Company did not appropriately
                account for the direct costs incurred in connection with the acquisition
                of Blue7 Communications totaling approximately
                $276,000.




This
      material weakness was considered in determining the nature, timing, and extent
      of the audit tests applied in our audit of the consolidated financial statements
      and financial statement schedule as of and for the year ended January 28, 2006,
      and this report does not affect our report dated April 24, 2006, on those
      financial statements and financial statement schedule.




In
      our
      opinion, management’s assessment that the Company did not maintain effective
      internal controls over financial reporting as of January 28, 2006, is fairly
      stated in all material respects, based on criteria established in Internal
      Control - Integrated Framework issued by the Committee of Sponsoring
      Organizations of the Treadway Commission. Also in our opinion, because of the
      effect of the material weakness described above on the achievement of the
      objectives of the control criteria, the Company has not maintained effective
      internal control over financial reporting as of January 28, 2006, based on
      criteria established in Internal Control - Integrated Framework issued by the
      Committee of Sponsoring Organizations of the Treadway Commission.




We
      do not
      express an opinion or any other form of assurance on management's statement
      referring to actions taken in remediation of the material weakness in internal
      controls subsequent to January 28, 2006.




We
      have
      also audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the consolidated balance sheet of Sigma
      Designs, Inc. as of January 28, 2006, and the related consolidated statements
      of
      operations, shareholders’ equity and comprehensive income, and cash flows for
      the year ended January 28, 2006 and our report dated April 24, 2006 expressed
      an
      unqualified opinion on those financial statements.






/s/
      GRANT
      THORNTON LLP




San
      Jose,
      CA


April
      24,
      2006






44


**ITEM
      9B. OTHER MATTERS**




None.




**PART
      III**




**ITEM
      10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**




The
      information required by this item concerning our directors is incorporated
      by
      reference from the information set forth in the section entitled “Proposal
      One—Election of Directors” contained in our Proxy Statement relating to the 2006
      Annual Meeting of Shareholders to be filed with the Securities and Exchange
      Commission within 120 days after the end of our fiscal year pursuant to General
      Instruction G(3) of Form 10-K (the “Proxy Statement”). The information required
      by this item concerning our executive officers is incorporated by reference
      to
      the information set forth at the end of Part I of this Annual Report on Form
      10-K.




The
      information regarding compliance with Section 16(a) of the Exchange Act is
      set
      forth in the section entitled “Section 16(a) Beneficial Ownership Reporting
      Compliance” in the Proxy Statement and is incorporated herein by reference.




The
      information regarding our audit committee and audit committee financial expert
      is set forth in the Proxy Statement and is incorporated herein by
      reference.




The
      information regarding our code of ethics that applies to our principal executive
      officer, principal financial officer and principal accounting officer is
      incorporated by reference from the information set forth in the section entitled
      “Management—Code of Ethics” contained in the Proxy Statement.




**ITEM
      11. EXECUTIVE COMPENSATION**




The
      information required by this item regarding executive compensation is
      incorporated by reference from the information set forth in the sections
      entitled “Election of Directors—Compensation of Directors” and “Other
      Information—Executive Compensation” contained in the Proxy Statement.




**ITEM
      12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS**




The
      information required by this item regarding security ownership of certain
      beneficial owners and management is incorporated by reference from the
      information set forth in the section entitled “Other Information—Security
      Ownership of Certain Beneficial Owners and Management” contained in the Proxy
      Statement.




The
      information regarding securities authorized for issuance under equity
      compensation plans is set forth in the Proxy Statement and is incorporated
      herein by reference.




45


**ITEM
      13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**




The
      information required by this item regarding certain relationships and related
      transactions is set forth in the section entitled “Transactions with Management”
contained in the Proxy Statement and is incorporated herein by reference.




**ITEM
      14. PRINCIPAL ACCOUNTING FEES AND SERVICES**




The
      information required by this item regarding principal accounting fees and
      services is incorporated by reference from the information set forth in the
      section entitled “Ratification of Independent Auditors - Principal Accounting
      Fees and Services” contained in the Proxy Statement.




**PART
      IV**




**ITEM
      15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**




(a)
            The
                following documents are filed as part of this Annual Report on Form
                10-K:




1.
            Consolidated
                Financial Statements




**Financial
                Statement**
            **Page**Report
                of Independent Registered Public Accounting Firm (Grant Thornton
                LLP)
            F-1Report
                of Independent Registered Public Accounting Firm (Deloitte & Touche
                LLP)
            F-2Consolidated
                Balance Sheets
            F-3Consolidated
                Statements of Operations
            F-4Consolidated
                Statements of Shareholders’ Equity and Comprehensive Income
            F-5Consolidated
                Statements of Cash Flows
            F-6Notes
                to Consolidated Financial Statements
            F-8




2.
            Consolidated
                Financial Statements Schedules




Schedule
                II—Valuation and Qualifying Accounts and Reserves
            S-1




All
      other
      schedules have been omitted as they are not required, not applicable, or the
      required information is otherwise included.




(b)
            Exhibits




The
      exhibits listed on the accompanying index to exhibits immediately following
      the
      financial statement schedules are incorporated by reference into this Annual
      Report on Form 10-K.




46




SIGNATURES




Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the
      Registrant has duly caused this report to be signed on its behalf by the
      undersigned, thereunto duly authorized, in the city of Milpitas, State of
      California, on the 8th day of May 2006.




SIGMA
      DESIGNS, INC.





By: /s/
      Thinh Q. Tran


Thinh
      Q.
      Tran


Chairman
      of the Board,


President
      and Chief Executive Officer




**POWER
      OF ATTORNEY**




KNOW
      ALL
      PERSONS BY THESE PRESENTS, that each person whose signature appears below
      constitutes and appoints Thinh Q. Tran and Kit Tsui, and each of them, jointly
      and severally, his true and lawful attorneys-in-fact, each with full power
      of
      substitution and resubstitution, for him in any and all capacities, to sign
      any
      or all amendments to this Annual Report on Form 10-K, with all exhibits thereto
      and other documents in connection therewith, with the Securities and Exchange
      Commission, granting unto said attorneys-in-fact and agents, and each of them,
      full power and authority to do and perform each and every act and thing
      requisite and necessary to be done in connection therewith, as fully to all
      intents and purposes as he or she might or could do if personally present,
      hereby ratifying and confirming all that each said attorney-in-fact and agent,
      or his or her substitute or substitutes or any of them, may lawfully do or
      cause
      to be done by virtue hereof.




PURSUANT
      TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1934, THIS ANNUAL REPORT ON FORM
      10
      K HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON BEHALF OF THE OF THE REGISTRANT
      AND IN THE CAPACITIES AND ON THE DATES INDICATED:




**Signature**
            
            **Title**
            
            **Date**/s/
                Thinh Q. Tran
            
            Chairman
                of the Board, President, and Chief Executive
            
            May
                8, 2006**Thinh
                Q. Tran**
            
            Officer (Principal Executive
              Officer)/s/
                Kit Tsui
            
            Chief
                Financial Officer and Secretary (Principal Financial
            
            May
                8, 2006**Kit
                Tsui**
            
            and
                Accounting Officer)/s/
                William J. Almon
            
            Director
            
            May
                8, 2006**William
                J. Almon**/s/
                Julien Nguyen
            
            Director
            
            May
                8, 2006**Julien
                Nguyen**/s/
                Lung C. Tsai
            
            Director
            
            May
                8, 2006**Lung
                C. Tsai**







47


**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**







Board
      of
      Directors and Stockholders


Sigma
      Designs, Inc.




We
      have
      audited the consolidated balance sheet of Sigma Designs, Inc. and subsidiaries
      as of January 28, 2006, and the related consolidated statements of operations,
      shareholders’ equity and comprehensive income and cash flows for the year ended
      January 28, 2006. These financial statements are the responsibility of
      management. Our responsibility is to express an opinion on these financial
      statements based on our audit.




We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audit provide a reasonable
      basis for our opinion.




In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the consolidated financial position of Sigma Designs, Inc.
      as
      of January 28, 2006, and the consolidated results of their operations and their
      consolidated cash flows for the year ended January 28, 2006, in conformity
      with
      accounting principles generally accepted in the United States of America.




Our
      audit
      was conducted for the purpose of forming an opinion on the basic financial
      statements taken as a whole. Schedule II is presented for purposes of
      additional analysis and is not a required part of the basic financial
      statements. This schedule has been subjected to the auditing procedures applied
      in the audit of the basic financial statements and, in our opinion, is fairly
      stated in all material respects in relation to the basic financial statements
      taken as a whole.




We
      also
      have audited, in accordance with standards of the Public Company Accounting
      Oversight Board (United States), the effectiveness of Sigma Designs Inc.’s
      internal control over financial reporting as of January 28, 2006, based on
      criteria established in Internal Control—Integrated Framework issued by the
      Committee of Sponsoring Organizations of the Treadway Commission, and our report
      dated April 24, 2006, expressed an unqualified opinion on management’s
      assessment of, and an adverse opinion on the effective operation of, internal
      control over financial reporting.







/s/
      Grant
      Thornton LLP





San
      Jose,
      California


April
      24,
      2006




F-1


**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**






To
      the
      Board of Directors and Shareholders of


Sigma
      Designs, Inc.:




We
      have
      audited the accompanying consolidated balance sheet of Sigma Designs, Inc.
      and
      subsidiaries as of January 29, 2005, and the related consolidated statements
      of
      operations, shareholders’ equity and comprehensive income (loss) and cash flows
      for each of the two years in the period ended January 29, 2005. Our audits
      also
      included the financial statement schedule listed in Item 15(a)2 for each of
      the
      two years in the period ended January 29, 2005. These financial statements
      and
      financial statement schedule are the responsibility of the Company’s management.
      Our responsibility is to express an opinion on the financial statements and
      financial statement schedule based on our audits.




We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audits provide a
      reasonable basis for our opinion.




In
      our
      opinion, such consolidated financial statements present fairly, in all material
      respects, the financial position of Sigma Designs, Inc. and subsidiaries at
      January 29, 2005, and the results of their operations and their cash flows
      for
      each of the two years in the period ended January 29, 2005 in conformity with
      accounting principles generally accepted in the United States of America. Also,
      in our opinion, such financial statement schedule for each of the two years
      in
      the period ended January 29, 2005, when considered in relation to the basic
      consolidated financial statements taken as a whole, presents fairly, in all
      material respects, the information set forth therein.






/s/
      Deloitte & Touche LLP




San
      Jose,
      California


April
      12,
      2005




F-2


**SIGMA
      DESIGNS, INC.**


**CONSOLIDATED
      BALANCE SHEETS**


**(In
      thousands, except share data)**







**ASSETS**
            
            **January
                28, 2006**
            
            **January
                29, 2005**CURRENT
                ASSETS:Cash
                and cash equivalents
            
            $
            16,827
            
            $
            10,250Short-term
                investments
            
            
            9,525
            
            
            8,529Accounts
                receivable (net of allowances of $1,491 in 2006, and $1,460 in
                2005)
            
            
            4,951
            
            
            6,417Note
                receivable - related party (note 14)
            
            
            900
            
            
            -Inventories
            
            
            3,830
            
            
            3,675Prepaid
                expenses and other current assets
            
            
            1,001
            
            
            764Total
                current assets
            
            
            37,034
            
            
            29,635EQUIPMENT
                AND LEASEHOLD IMPROVEMENTS - net
            
            
            1,474
            
            
            1,756LONG-TERM
                INVESTMENTS
            
            
            1,282
            
            
            3,313OTHER
                NON- CURRENT ASSETS
            
            
            169
            
            
            233TOTAL
                ASSETS
            
            $
            39,959
            
            $
            34,937**LIABILITIES
                AND SHAREHOLDERS’ EQUITY**CURRENT
                LIABILITIES:Accounts
                payable
            
            $
            3,467
            
            $
            3,540Accrued
                liabilities and other
            
            
            2,031
            
            
            2,097Current
                portion of bank term loan
            
            
            211
            
            
            -Total
                current liabilities
            
            
            5,709
            
            
            5,637BANK
                TERM LOAN
            
            
            233
            
            
            -OTHER
                LONG - TERM LIABILITIES
            
            
            102
            
            
            188Total
                Liabilities
            
            
            6,044
            
            
            5,825COMMITMENTS
                AND CONTINGENCIES (Note 7)SHAREHOLDERS’
                EQUITY:Common
                stock - no par value: 35,000,000 shares authorized;shares
                outstanding: 2006, 21,945,874; 2005, 21,038,962
            
            
            91,131
            
            
            88,207Accumulated
                other comprehensive income
            
            
            23
            
            
            28Accumulated
                deficit
            
            
            (57,239
            )
            
            (59,123
            )Total
                shareholders’ equity
            
            
            33,915
            
            
            29,112TOTAL
                LIABILITIES AND SHAREHOLDERS’ EQUITY
            
            $
            39,959
            
            $
            34,937






**The
                accompanying notes are an integral part of these financial
                statements**




F-3


**SIGMA
      DESIGNS, INC.**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


**(In
      thousands, except per share data)**







**Year
                Ended****January
                28, 2006**
            
            **January
                29, 2005**
            
            **January
                31, 2004**NET
                REVENUES
            
            $
            33,320
            
            $
            31,437
            
            $
            30,520COST
                OF REVENUES
            
            
            11,552
            
            
            9,527
            
            
            11,705GROSS
                PROFIT
            
            
            21,768
            
            
            21,910
            
            
            18,815OPERATING
                EXPENSES:Research
                and development
            
            
            14,041
            
            
            11,648
            
            
            10,000Sales
                and marketing
            
            
            5,076
            
            
            4,804
            
            
            4,802General
                and administrative
            
            
            4,131
            
            
            4,209
            
            
            2,499Operating
                expenses
            
            
            23,248
            
            
            20,661
            
            
            17,301INCOME
                (LOSS) FROM OPERATIONS
            
            
            (1,480
            )
            
            1,249
            
            
            1,514Gain
                on sales of long-term investments
            
            
            2,549
            
            
            -
            
            
            -Interest
                income and other income, net
            
            
            823
            
            
            595
            
            
            38INCOME
                BEFORE INCOME TAXES
            
            
            1,892
            
            
            1,844
            
            
            1,552PROVISION
                FOR INCOME TAXES
            
            
            8
            
            
            4
            
            
            9NET
                INCOME
            
            $
            1,884
            
            $
            1,840
            
            $
            1,543NET
                INCOME PER SHARE:Basic
            
            $
            0.09
            
            $
            0.09
            
            $
            0.08Diluted
            
            $
            0.08
            
            $
            0.08
            
            $
            0.07SHARES
                USED IN COMPUTATION:Basic
            
            
            21,412
            
            
            20,809
            
            
            19,437Diluted
            
            
            23,667
            
            
            23,529
            
            
            22,390






**The
                accompanying notes are an integral part of these financial
                statements**




F-4


**SIGMA
      DESIGNS, INC.**


**CONSOLIDATED
      STATEMENT OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME**


**(In
      thousands, except share data)**







**Common
                Stock**
            
            **Accumulated
                Other Comprehensive**
            
            **Accumulated**
            
            
            
            **Total
                Comprehensive****Shares**
            
            **Amount**
            
            **Income**
            
            **Deficit**
            
            **Total**
            
            **Income**Balances,
                February 1, 2003
            
            
            16,642,571
            
            $
            68,295
            
            $
            13
            
            $
            (62,506
            )
            $
            5,802Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            1,543
            
            
            1,543
            
            $
            1,543Accumulated
                translation adjustment
            
            
            -
            
            
            -
            
            
            24
            
            
            -
            
            
            24
            
            
            24Comprehensive
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            1,567Issuance
                of common stocknet
                of issuance cost of $666
            
            
            3,056,644
            
            
            16,301
            
            
            -
            
            
            -
            
            
            16,301Common
                stock issued under stock plans
            
            
            938,780
            
            
            2,352
            
            
            -
            
            
            -
            
            
            2,352Balance,
                January 31, 2004
            
            
            20,637,995
            
            
            86,948
            
            
            37
            
            
            (60,963
            )
            
            26,022Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            1,840
            
            
            1,840
            
            $
            1,840Unrealized
                loss on investments
            
            
            -
            
            
            -
            
            
            (24
            )
            
            -
            
            
            (24
            )
            
            (24
            )Accumulated
                translation adjustment
            
            
            -
            
            
            -
            
            
            15
            
            
            -
            
            
            15
            
            
            15Comprehensive
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            1,831Common
                stock issued under stock plans
            
            
            400,967
            
            
            1,259
            
            
            -
            
            
            -
            
            
            1,259Balance,
                January 29, 2005
            
            
            21,038,962
            
            
            88,207
            
            
            28
            
            
            (59,123
            )
            
            29,112Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            1,884
            
            
            1,884
            
            $
            1,884Unrealized
                gain on investments
            
            
            -
            
            
            -
            
            
            4
            
            
            -
            
            
            4
            
            
            4Accumulated
                translation adjustment
            
            
            -
            
            
            -
            
            
            (9
            )
            
            -
            
            
            (9
            )
            
            (9
            )Comprehensive
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            1,879Common
                stock issued under stock plans
            
            
            906,912
            
            
            2,924
            
            
            -
            
            
            -
            
            
            2,924Balance,
                January 28, 2006
            
            
            21,945,874
            
            $
            91,131
            
            $
            23
            
            $
            (57,239
            )
            $
            33,915






**The
                accompanying notes are an integral part of these financial
                statements**




F-5


**SIGMA
      DESIGNS, INC.**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(In
      thousands)**







**Year
                Ended****January
                28,**
              **2006**
            
            **January
                29,**
              **2005**
            
            **January
                31,**
              **2004**CASH
                FLOWS FROM OPERATING ACTIVITIES:Net
                income
            
            $
            1,884
            
            $
            1,840
            
            $
            1,543Adjustments
                to reconcile net income to net cash provided by operating
                activities:Depreciation
                and amortization
            
            
            938
            
            
            492
            
            
            572Provision
                for inventory valuation
            
            
            29
            
            
            230
            
            
            647Provision
                (reversal) for bad debts and sales returns
            
            
            31
            
            
            595
            
            
            (186
            )Gain
                on sales of long-term investments
            
            
            (2,580
            )
            
            -
            
            
            -Loss
                on disposal of assets
            
            
            43
            
            
            7
            
            
            8Investment
                impairment charge
            
            
            31
            
            
            -
            
            
            -Accretion
                of contributed leasehold improvements
            
            
            (81
            )
            
            (85
            )
            
            (83
            )Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            1,435
            
            
            (1,729
            )
            
            (731
            )Inventories
            
            
            (184
            )
            
            (1,291
            )
            
            (789
            )Prepaid
                expenses and other current assets
            
            
            (175
            )
            
            (246
            )
            
            (342
            )Other
                non-current assets
            
            
            64
            
            
            -
            
            
            -Accounts
                payable
            
            
            (73
            )
            
            1,874
            
            
            164Accrued
                liabilities and other
            
            
            (66
            )
            
            270
            
            
            184Net
                cash provided by operating activities
            
            
            1,296
            
            
            1,957
            
            
            987CASH
                FLOWS FROM INVESTING ACTIVITIES:Purchase
                of equipment
            
            
            (699
            )
            
            (1,226
            )
            
            (265
            )Purchases
                of short-term investments
            
            
            (42,221
            )
            
            (20,153
            )
            
            -Maturity
                of short-term investments
            
            
            41,225
            
            
            11,600
            
            
            -Net
                proceeds (purchases of) from long-term investments
            
            
            4,580
            
            
            (2,000
            )
            
            (1,313
            )Issuance
                of short-term promissory notes
            
            
            (900
            )
            
            -
            
            
            -Other
                non-current assets
            
            
            -
            
            
            (29
            )
            
            243Net
                cash provided by (used in) investing activities
            
            
            1,985
            
            
            (11,808
            )
            
            (1,335
            )CASH
                FLOWS FROM FINANCING ACTIVITIES:Bank
                borrowings
            
            
            600
            
            
            -
            
            
            -Repayment
                of bank borrowings
            
            
            (156
            )
            
            -
            
            
            -Net
                proceeds from sale of common stock
            
            
            2,924
            
            
            1,259
            
            
            18,653Costs
                related to registration of private offering of common stock
            
            
            (63
            )
            
            (130
            )
            
            -Repayment
                of capital lease obligations
            
            
            -
            
            
            (5
            )
            
            (122
            )Net
                cash provided by financing activities
            
            
            3,305
            
            
            1,124
            
            
            18,531Effect
                of exchange rates changes on cash
            
            
            (9
            )
            
            15
            
            
            24INCREASE
                (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            
            6,577
            
            
            (8,712
            )
            
            18,207CASH
                AND CASH EQUIVALENTS:Beginning
                of year
            
            
            10,250
            
            
            18,962
            
            
            755End
                of year
            
            $
            16,827
            
            $
            10,250
            
            $
            18,962




***(Continued)***




F-6


**SIGMA
      DESIGNS, INC.**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(In
      thousands)**







SUPPLEMENTAL
                DISCLOSURE OF CASH FLOW INFORMATION:CASH
                PAID FOR INTEREST
            
            $
            45
            
            $
            4
            
            $
            131CASH
                PAID FOR INCOME TAXES
            
            $
            9
            
            $
            15
            
            $
            3NONCASH
                INVESTING AND FINANCING ACTIVITIES:Restricted
                cash balance offset against line of credit borrowings
            
            
            -
            
            
            -
            
            $
            12,000




**The
                accompanying notes are an integral part of these financial
                statements*****.***







F-7


**SIGMA
      DESIGNS, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**







**1.**
            **NATURE
                OF OPERATIONS AND SIGNIFICANT ACCOUNTING
                POLICIES**




***Nature
      of Operations*** - Sigma
      Designs, Inc. (the Company) specializes in silicon-based digital media
      processors for IP video technology, connected media players, high-definition
      television and PC add-in and other markets. The Company’s award-winning
      REALmagic ® Video
      Streaming Technology is used in a variety of consumer applications providing
      highly integrated solutions for high-quality decoding of H.264, MPEG-4, MPEG-2,
      MPEG-1 and Windows ® Media
      Video 9 (WMV9). The Company sells its products to consumer equipment
      manufacturers, distributors, value-added resellers and corporate
      customers.




***Principle
      of Consolidation*** - The
      consolidated financial statements include Sigma Designs, Inc. and subsidiaries.
      Intercompany balances and transactions are eliminated.




***Accounting
      Period*** - The
      Company’s fiscal year ends on the Saturday closest to January 31. Fiscal 2006
      ended on January 28, 2006. Fiscal 2005 ended on January 29, 2005. Fiscal 2004
      ended on January 31, 2004. Fiscal 2006, 2005, and 2004 each included 52 weeks.
      The Company has a subsidiary in France and its annual accounting period ends
      on
      January 31.




***Pervasiveness
      of Estimates*** - The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and disclosure of contingent assets and liabilities at the date
      of
      the financial statements and the reported amounts of revenues and expenses
      during the reporting period. Actual results could differ from those estimates.
      Significant estimates used in preparing these financial statements are related
      primarily to estimates to determine the collectability of accounts receivable
      to
      determine the allowances against the accounts receivable balances, estimate
      of
      the market value used in calculating the value of inventory on a lower of cost
      or market basis, estimates of expected future cash flows and useful lives used
      in the review for impairment of investments and long-lived assets, and estimates
      of the Company’s ability to realize its deferred tax asset which are also used
      to establish whether valuation allowances are needed on those assets. It is
      at
      least reasonably possible that the estimates will change within the next
      year.




***Change
      in accounting estimate*** - During
      fiscal year 2006, the Company revised its estimate of the useful lives of
      certain production test equipment due to technology changes. Those lives were
      shortened to 2 years. Previously, all production test equipment was depreciated
      over 5 years. These changes were made to better reflect the estimated periods
      during which such equipment will remain in service. The change had the effect
      of
      increasing depreciation expense which was record as cost of revenues and
      decreasing net income by approximately $130,000 (less than $0.01 per basic
      and
      diluted share).




F-8


***Concentration
      of Credit Risk*** -
      Financial instruments which potentially subject the Company to concentrations
      of
      credit risk consist primarily of cash and cash equivalents, short-term
      investments and accounts receivable. The majority of the Company’s cash and cash
      equivalents and short-term investments are on deposit with two financial
      institutions. The Company performs ongoing credit evaluations of its customers
      and generally does not require collateral for sales on credit. The
      Company reviews accounts receivable on a monthly basis to determine if any
      receivables will potentially be uncollectible. The Company includes any accounts
      receivable balances that are determined to be uncollectible, along with a
      general reserve, in its overall allowance for doubtful accounts. The general
      reserve in the allowance for doubtful accounts is a calculation based upon
      the
      accounts receivable balance and the historical effectiveness of the Company’s
      collection of those receivables .
      The
      Company will continue to maintain reserves for potential credit
      losses.




***Cash
      and Cash Equivalents*** - The
      Company considers all highly liquid debt instruments purchased with a remaining
      maturity of three months or less to be cash equivalents.




***Short
      Term Investments*** -
      Short-term investments represent highly liquid debt instruments with a remaining
      maturity date at purchase of greater than 90 days and are stated at fair value.
      The differences between amortized cost (cost adjusted for amortization of
      premiums and accretion of discounts which are recognized as adjustments to
      interest income) and fair value representing unrealized holding gains or losses,
      are recorded separately as accumulated other comprehensive income (loss) within
      shareholders’ equity. While the Company’s intent is to hold debt securities to
      maturity, they are classified as available-for-sale because the sale of such
      securities may be required prior to maturity. Any gains and losses on the sale
      of debt securities are determined on a specific identification
      basis.




***Inventories*** *-* - ** *Inventories* are
      stated at the lower of standard cost (which approximates first-in, first-out
      basis) or market. The Company periodically reviews its inventories for excess
      and obsolete inventory items and adjusts carrying costs to estimated net
      realizable values when they are determined to be less than cost. As a result
      of
      this inventory review, the Company charged approximately $29,000, $230,000
      and
      $647,000 to cost of revenues for fiscal 2006, 2005 and 2004,
      respectively.




***Long-Term
      Investments*** ** - *Investments* in
      private equity securities of less than 20% owned companies are accounted for
      using the cost method unless the Company can exercise significant influence
      or
      the investee is economically dependent upon the Company, in which case the
      equity method is used. The Company evaluates the long-term investments for
      impairment annually according to EITF Issue No. 03-01, The Meaning of
      Other-Than-Temporary Impairment and Its Application to Certain Investments
      (“EITF 03-01). EITF
      03-01 provided guidance for evaluating whether an investment is
      other-than-temporarily impaired and requires certain disclosures with respect
      to
      these investments. The guidance also included accounting considerations
      subsequent to the recognition of an other-than-temporary impairment and
      requirements for disclosures about unrealized losses that have not been
      recognized as other-than-temporary impairments.




F-9


***Equipment
      and Leasehold Improvements*** *-* ****** Equipment
      and leasehold improvements are
      stated at cost and categorized into computer and test equipment, software,
      furniture and fixtures and other. Depreciation and amortization are computed
      using the straight-line method based on the useful lives of the assets (three
      to
      five years) or the lease term if shorter, except for certain production test
      equipment (two to five years). The contributed leasehold improvements provided
      by the landlord for the Company’s current facility is amortized using the
      straight-line method over lesser of the remaining lease term or useful life
      of
      leasehold improvements.




***Long
      Lived Assets*** - The
      Company evaluates long-lived assets for impairment whenever events or changes
      in
      circumstances such as a change in technology indicate that the carrying amount
      of an asset may not be recoverable. An impairment loss would be recognized
      when
      the sum of the undiscounted future net cash flows expected to result from the
      use of the asset and its eventual disposal is less than its carrying
      amount.




***Revenue
      Recognition*** - The
      Company recognizes revenues in accordance with Staff Accounting Bulletin (“SAB”)
      No. 104, “Revenue Recognition”. Revenue is recognized when persuasive evidence
      of an arrangement exists, delivery has occurred or service has been rendered,
      the fee is fixed and determinable, and collectibility is probable. The Company
      derives its revenues from three principal sources: product sales, product
      development contracts and service contracts.




Revenues
      from product sales to OEMs, distributors and end users are generally recognized
      upon shipment, as the Company’s shipping terms are FOB shipping point, except
      that revenues are deferred when management cannot reasonably estimate the amount
      of returns or where collectibility is not reasonably assured. In those
      situations, revenue is recognized when collection subsequently becomes probable
      and returns are estimable (generally upon resale by customers or “Sell-through
      Basis”). Allowances for sales returns, price protection and warranty costs are
      recorded at the time that revenues are recognized.




In
      fiscal
      2001, the Company began recognizing revenues from its primary U.S. distributor
      on a Sell-through Basis. This practice resulted from significant sales returns,
      which the Company accepted from the distributor outside of the terms of the
      distribution agreement. Under terms of a distribution agreement entered into
      with the distributor in fiscal 2002, the Company granted the distributor the
      right of return and price protection, which allows the distributor to return
      any
      product, which is in the original packaging, for full credit up to 180 days
      after the earlier of the agreement expiration or early termination. The price
      protection provision allows the distributor to receive a credit for the
      difference between the original price and the reduced price of the Company’s
      products within their inventory. Although the returns are not frequent in
      nature, returns from this distributor could not be reasonably estimated.
      Consequently, pursuant to the above policy, revenue from this distributor is
      recognized upon resale to the distributor’s end-customers.




Revenues
      from product development agreements were recognized in fiscal 2006, 2005 and
      2004 when billed, earned, and collection was assured. During fiscal 2006, the
      Company classified development costs related to such agreements as cost of
      revenues. During fiscal 2005 and 2004, the Company classified development costs
      related to such agreements as research and development expenses. Development
      revenues were approximately $1.2 million, $981,000 and $792,000 for fiscal
      2006,
      2005 and 2004 respectively.




F-10


Revenues
      from service contracts consist of fees for providing engineering support
      services, which are recognized ratably over the contract term. Expenses related
      to support service revenues were included in sales and marketing expenses.
      Support service revenues were $150,000, $308,000 and $269,000 for fiscal 2006,
      2005 and 2004 respectively.




***Research
      and Development expenses*** *-* Research
      and Development ** expenses
      include costs and expenses associated with the design and development of new
      products. To the extent that such costs include the development of computer
      software, they are generally incurred prior to the establishment of the
      technological feasibility of the related product that is under development
      and
      are therefore expensed as incurred. Software cost incurred after the
      establishment of technological feasibility, where the technology is well
      developed and can be immediately incorporated into the Company’s research
      endeavors is capitalized. All other research and development expense is expensed
      as incurred. Research and development expense was approximately $14.0 million,
      $11.6 million and $10.0 million for fiscal 2006, 2005 and 2004,
      respectively.




***Income
      Taxes*** -
      Deferred income taxes reflect the net tax effects of (a) temporary differences
      between the carrying amounts of assets and liabilities for financial reporting
      purposes and the amounts used for income tax purposes, and (b) operating losses
      and tax credit carryforwards. Income taxes are accounted for under an asset
      and
      liability approach in accordance with Statement of Financial Accounting
      Standards (“SFAS”) No. 109. Deferred tax liabilities are recognized for future
      taxable amounts and deferred tax assets are recognized for future deductions
      net
      of a valuation allowance to reduce deferred tax assets to amounts that are
      more
      likely than not to be realized.




***Stock-Based
      Compensation*** - The
      Company accounts for stock-based awards to employees using the intrinsic value
      method in accordance with Accounting Principles Board Opinion ("APB") No. 25,
      "Accounting for Stock Issued to Employees", and related interpretations.
      Accordingly, no compensation expense has been recognized in the financial
      statements as the Company grants options for employee stock arrangements at
      fair
      market value.




The
      Company accounts for equity instruments issued to non-employees in accordance
      with the provisions of SFAS No. 123 “Accounting for Stock-Based Compensation,”
which requires that the fair value of such instruments be recognized as an
      expense over the period in which the related services are received. For the
      year
      ended January 28, 2006, 2005 and 2004, no equity instruments were issued to
      non-employees.




SFAS
      No.
      123 also requires the disclosure of pro forma net income (loss) and earnings
      (loss) per share had the Company adopted the fair value method. Under SFAS
      No.
      123, the fair value of stock-based awards to employees is calculated through
      the
      use of option pricing models, even though such models were developed to estimate
      the fair value of freely tradable, fully transferable options without vesting
      restrictions, which significantly differ from the Company’s stock option awards.
      The Company’s stock option awards are not publicly traded and have vesting
      restrictions. These models also require subjective assumptions, including future
      stock price volatility and expected time to exercise, which greatly affect
      the
      calculated values. The Company’s pro forma calculations were made using the
      Black-Scholes option-pricing model with the following weighted average
      assumptions:




F-11


**Years
                Ended****January
                28,**
              **2006**
            **January
                29,**
              **2005**
            **January
                31,**
              **2004**Stock
                Option Plans:Risk
                free interest rate
            4.31%
            2.61%
            3.00%Expected
                volatility
            60%
            76%
            103%Expected
                life after vesting (in years)
            1.4
            1.4
            1.7Expected
                dividends
            -
            -
            -Employee
                Stock Purchase Plans:Risk
                free interest rate
            3.56%
            1.37%
            0.95%Expected
                volatility
            58%
            68%
            103%Expected
                life (in years)
            0.5
            0.5
            0.5Expected
                dividends
            -
            -
            -




The
      Company’s calculations are based on a multiple option valuation approach and
      forfeitures are recognized as they occur. If the computed fair values of awards
      had been amortized to expense over the vesting period of the awards, pro forma
      net income (loss) attributable to common shareholders would have been as follows
      (in thousands, except per share amounts):




**Years
                Ended****January
                28,**
              **2006**
            
            **January
                29,**
              **2005**
            
            **January
                31,**
              **2004**Net
                income as reported
            
            $
            1,884
            
            $
            1,840
            
            $
            1,543Deduct:
                stock-based employee compensation expensedetermined
                under fair value based method , net of tax
            
            
            (2,123
            )
            
            (1,869
            )
            
            (1,469
            )Pro
                forma net income (loss)
            
            $
            (239
            )
            $
            (29
            )
            $
            74Basic
                net income (loss) per share:As
                reported
            
            $
            0.09
            
            $
            0.09
            
            $
            0.08Pro
                forma
            
            $
            (0.01
            )
            $
            0.00
            
            $
            0.00Diluted
                net income (loss) per share:As
                reported
            
            $
            0.08
            
            $
            0.08
            
            $
            0.07Pro
                forma
            
            $
            (0.01
            )
            $
            0.00
            
            $
            0.00




Effective
      January 29, 2006, the Company adopted Statement No. 123 (revised 2004) using
      the
      modified prospective method. Under the modified prospective method, the
      compensation cost for all new awards and awards modified, repurchased or
      cancelled after the date of adoption of this Statement, as well as the
      unrecognized compensation cost of unvested awards as of the date of adoption
      will be recognized in earnings based on the grant-date fair value of those
      awards.




F-12




***Foreign
      Currency*** - The
      functional currency of the Company’s foreign subsidiaries is the local currency
      of each country. Accordingly, gains and losses from the translation of the
      financial statements of the foreign subsidiaries are included in shareholders’
equity. Transaction gains and losses, which are included in the other expenses,
      net, in the accompanying consolidated statements of operations, have not been
      significant for all years presented.




***Net
      Income (Loss) per Share*** - Basic
      earnings per share (EPS) excludes dilution and is computed by dividing net
      income (loss) by the weighted average number of common shares outstanding for
      the period. Diluted EPS reflects the potential dilution that would occur if
      securities or other contracts to issue common stock were exercised or converted
      into common stock (see Note 10).




***Fair
      Value of Financial Instruments*** - For
      certain of the Company’s financial instruments, including cash and cash
      equivalents, accounts receivable, short-term investments, note receivable,
      accounts payable and other current liabilities, the carrying amounts approximate
      their fair value due to the relatively short maturity of these items.




***Geographic
      Operating Information*** - SFAS
      No. 131, “Disclosures About Segments of an Enterprise and Related Information,”
provides annual and interim reporting standards for an enterprise’s business
      segments and related disclosures about its products, services, geographical
      areas and major customers. The Company operates in one reportable segment (Note
      14).




***Recent
      Accounting Pronouncements***




In
      November 2005, the FASB issued Staff Position ("FSP") FAS115-1/124-1, The
      Meaning of Other-Than-Temporary Impairment and Its Application to Certain
      Investments, which addresses the determination as to when an investment is
      considered impaired, whether that impairment is other than temporary, and the
      measurement of an impairment loss. This FSP also includes accounting
      considerations subsequent to the recognition of an other-than-temporary
      impairment and requires certain disclosures about unrealized losses that have
      not been recognized as other-than-temporary impairments. The guidance in this
      FSP amends FASB Statements No. 115, Accounting for Certain Investments in Debt
      and Equity Securities, and No. 124, Accounting for Certain Investments Held
      by
      Not-for-Profit Organizations, and APB Opinion No. 18, The Equity Method of
      Accounting for Investments in Common Stock. This FSP is effective for reporting
      periods beginning after December 15, 2005. We do not believe the adoption of
      this FSP will have a material impact on our financial statements.




In
      November 2005, the FASB issued FSP FAS123(R)-3, Transition Election to
      Accounting for the Tax Effects of Share-Based Payment Awards. This FSP requires
      an entity to follow either the transition guidance for the
      additional-paid-in-capital pool as prescribed in SFAS No. 123(R), Share-Based
      Payment, or the alternative transition method as described in the FSP. An entity
      that adopts SFAS No. 123(R) using the modified prospective application may
      make
      a one-time election to adopt the transition method described in this FSP. An
      entity may take up to one year from the later of its initial adoption of SFAS
      No. 123(R) or the effective date of this FSP to evaluate its available
      transition alternatives and make its one-time election. This FSP became
      effective in November 2005. We continue to evaluate the impact of the adoption
      of this FSP could have on our financial statements.




F-13


The
      Company accounts for stock-based compensation awards issued to employees using
      the intrinsic value measurement provisions of APB Opinion No. 25, “Accounting
      for Stock Issued to Employees” (“Opinion 25”). Accordingly, no compensation
      expense has been recorded for stock options granted with exercise prices greater
      than or equal to the fair value of the underlying common stock at the option
      grant date. On December 16, 2004, the Financial Accounting Standards Board
      (“FASB”) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS
      123R”). SFAS 123R eliminates the alternative of applying the intrinsic value
      measurement provisions of Opinion 25 to stock compensation awards issued to
      employees. Rather, the new standard requires enterprises to measure the cost
      of
      employee services received in exchange for an award of equity instruments based
      on the grant-date fair value of the award. That cost will be recognized over
      the
      period during which an employee is required to provide services in exchange
      for
      the award, known as the requisite service period (usually the vesting
      period).




In
      March
      2005, the Securities and Exchange Commission issued Staff Accounting Bulletin
      No. 107 (“SAB 107”) to provide implementation guidance on SFAS 123R. SAB 107 was
      issued to assist registrants in implementing SFAS 123R while enhancing the
      information that investors receive.




The
      Company expects that the implementation of SFAS 123R will result in a non-cash
      charge of approximately $2.0 million in fiscal 2007. The actual effects of
      adopting SFAS 123R will be dependent on numerous factors including, but not
      limited to, the valuation model chosen by the Company to value stock-based
      awards; the assumed award forfeiture rate; the accounting policies adopted
      concerning the method of recognizing the fair value of awards over the requisite
      service period; and the transition method (as described below) chosen for
      adopting SFAS 123R.




The
      Company adopted SFAS 123R at the beginning of the first quarter of fiscal year
      2007 using the Modified Prospective Application Method. Under the Modified
      Prospective Application Method SFAS 123R is applied to new awards and to awards
      modified, repurchased, or cancelled after the effective date. Additionally,
      compensation cost for the portion of awards for which the requisite service
      has
      not been rendered (such as unvested options) that is outstanding as of the
      date
      of adoption shall be recognized as the remaining requisite services are
      rendered. The compensation cost relating to unvested awards at the date of
      adoption shall be based on the grant-date fair value of those awards as
      calculated for pro forma disclosures under the original SFAS 123.




In
      November 2004, the FASB issued SFAS No. 151, “Inventory Costs - an amendment of
      Accounting Research Bulletin (“ARB”) No. 43, Chapter 4” (“Statement”). This
      Statement amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing,"
      to
      clarify the accounting for abnormal amounts of idle facility expense, freight,
      handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter
      4, previously stated "under some circumstances, items such as idle facility
      expense, excessive spoilage, double freight, and handling costs may be so
      abnormal as to require treatment as current period charges." This Statement
      requires that those items be recognized as current-period charges regardless
      of
      whether they meet the criterion of "so abnormal." In addition, this Statement
      requires that allocation of fixed production overheads to the costs of
      conversion be based on the normal capacity of the production facilities. This
      Statement is effective for inventory costs incurred during fiscal years
      beginning after June 15, 2005. Management does not believe the adoption of
      this
      Statement will have any immediate material impact on the Company.




F-14


In
      December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets”
(“SFAS 153”), which amends APB Opinion No. 29, “Accounting for Nonmonetary
      Transactions.” SFAS 153 requires prospective application for eliminating the
      exception from fair value measurement for nonmonetary exchanges of similar
      productive assets and replaces it with an exception for exchanges that do not
      have commercial substance. SFAS 153 specifies that a nonmonetary exchange has
      commercial substance if the future cash flows of the entity are expected to
      change significantly as a result of the exchange. SFAS 153 is effective for
      exchanges of nonmonetary assets occurring in fiscal periods beginning after
      June
      15, 2005. Depending on the type of nonmonetary exchange, the adoption of SFAS
      153 may have a material impact on the Company’s consolidated financial
      statements.




In
      May
      2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”
(“SFAS 154”), which replaces APB Opinion No. 20, “Accounting Changes,” and SFAS
      No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS 154
      requires retroactive application of a change in accounting principle to prior
      period financial statements unless it is impracticable. SFAS 154 also requires
      that a change in method of depreciation, amortization or depletion for
      long-lived, non-financial assets be accounted for as a change in accounting
      estimate resulting from a change in accounting principle. It is effective for
      accounting changes and corrections of errors made in fiscal years beginning
      after December 15, 2005. Depending on the type of accounting change, the
      adoption of SFAS 154 may have a material impact on the Company’s consolidated
      financial statements.




In
      March 2004, the FASB Emerging Issues Task Force (“EITF”) released Issue
      03-01, “Meaning of Other Than Temporary Impairment,” which addressed
      other-than-temporary impairment for certain debt and equity investments. The
      recognition and measurement requirements of Issue 03-01, and other disclosure
      requirements not already implemented, were effective for periods after
      June 15, 2004.  In September 2004, the FASB staff issued FASB
      Staff Position (“FSP”) EITF 03-1-1, which delayed the effective date for certain
      measurement and recognition guidance during the period of delay until a final
      consensus is reached.   In June 2005, the FASB staff issued an
      FSP that supersedes EITF 03-01 and effectively reverts the guidance for
      other-than-temporary impairments to previously established literature. 03-01
      is
      not expected to have a material effect to the Company’s consolidated financial
      statements.




In
      December 2004 the FASB issued two Staff Positions (“FSP”)-FSP FAS 109-1,
      Application of FASB Statement 109 "Accounting for Income Taxes" to the Tax
      Deduction of Qualified Production Activities Provided by the American Jobs
      Creation Act of 2004, and FSP FAS 109-2 "Accounting and Disclosure Guidance
      for
      the Foreign Earnings Repatriation Provision within the American Jobs Creation
      Act of 2004." Management believes that neither of these have a material impact
      on the Company’s consolidated financial statements.




F-15


On
      May
      31, 2005, the FASB issued FSP EITF 00-19-1, “Application of EITF Issue No. 00-19
      to Freestanding Financial Instruments Originally Issued as Employee
      Compensation”. FAS 123(R) indicates that a freestanding financial instrument
      issued to an employee (such as a stock option) ceases being subject to FAS
      123(R) and becomes subject to other applicable accounting standards when the
      rights conveyed by the instrument are no longer dependent on the holder being
      an
      employee. The FSP clarifies that freestanding financial instruments originally
      issued as employee compensation that can be settled only by delivering
      registered shares should not be assumed to require cash settlement (which would
      require liability accounting) when applying the provisions of Issue 00-19.
      No.
      00-19 is not expected to have a material effect on the Company’s consolidated
      financial statements.




**2.**
            **CASH,
                CASH EQUIVALENTS AND SHORT-TERM
                INVESTMENTS**




Cash,
      cash equivalents and short-term investments consisted of the following (in
      thousands):




**January
                28, 2006**
            
            **January
                29, 2005****Adjusted**
              **Cost**
            
            **Unrealized**
              **loss**
            
            **Fair
                market**
              **value**
            
            **Adjusted**
              **Cost**
            
            **Unrealized**
              **loss**
            
            **Fair
                market**
              **value**Money
                market funds
            
            $
            586
            
            $
            -
            
            $
            586
            
            $
            177
            
            $
            -
            
            $
            177Certificate
                of Deposits
            
            
            399
            
            
            (1
            )
            
            398
            
            
            -
            
            
            -
            
            
            -Corporate
                commercial paper
            
            
            4,095
            
            
            (1
            )
            
            4,094
            
            
            4,883
            
            
            (2
            )
            
            4,882Corporate
                bonds
            
            
            4,300
            
            
            (11
            )
            
            4,289
            
            
            1,305
            
            
            (9
            )
            
            1,296US
                agency discount notes
            
            
            565
            
            
            (1
            )
            
            564
            
            
            4,481
            
            
            (3
            )
            
            4,478US
                agency non callable
            
            
            2,426
            
            
            (6
            )
            
            2,420
            
            
            1,228
            
            
            (10
            )
            
            1,217Total
                cash equivalents and short-term investments
            
            $
            12,371
            
            $
            (20
            )
            
            12,351
            
            $
            12,074
            
            $
            (24
            )
            
            12,050Cash
                on hand held in the United States
            
            
            
            
            
            
            
            
            13,199
            
            
            
            
            
            
            
            
            6,194Cash
                on hand held overseas
            
            
            
            
            
            
            
            
            802
            
            
            
            
            
            
            
            
            535Total
                cash on hand
            
            
            
            
            
            
            
            
            14,001
            
            
            
            
            
            
            
            
            6,729$
            26,352
            
            
            
            
            
            
            
            $
            18,779Reported
                as:Cash
                and cash equivalents
            
            
            
            
            
            
            
            $
            16,827
            
            
            
            
            
            
            
            $
            10,250Short-term
                investments
            
            
            
            
            
            
            
            
            9,525
            
            
            
            
            
            
            
            
            8,529$
            26,352
            
            
            
            
            
            
            
            $
            18,779




F-16


The
      amortized cost and estimated market value of investments, by contractual
      maturity, are shown below (in thousands). Actual maturities may differ from
      contractual maturities.




**January
                28, 2006**
            
            **January
                29, 2005****Amortized**
              **cost**
            
            **Estimated**
              **market
                value**
            
            **Amortized**
              **cost**
            
            **Estimated**
              **market
                value**Due
                in 1 year or less
            
            $
            12,371
            
            $
            12,351
            
            $
            9,851
            
            $
            9,844Due
                in greater than 1 year
            
            
            -
            
            
            -
            
            
            2,223
            
            
            2,206TOTAL
            
            $
            12,371
            
            $
            12,351
            
            $
            12,074
            
            $
            12,050




**3.**
            **INVENTORIES**




Inventories
      consist of (in thousands):




**January
                28,**
              **2006**
            
            **January
                29,**
              **2005**Raw
                materials
            
            $
            817
            
            $
            1,264Work
                in process
            
            
            552
            
            
            251Finished
                goods
            
            
            2,461
            
            
            2,160TOTAL
            
            $
            3,830
            
            $
            3,675




The
      Company periodically reviews its inventory for excess and obsolete inventory
      items and adjusts carrying costs to estimated net realizable values when they
      are determined to be less than cost. As a result of this inventory review,
      the
      Company increased cost of revenues by $29,000 and $230,000 in fiscal 2006 and
      2005.




**4.**
            **EQUIPMENT
                AND LEASEHOLD IMPROVEMENTS -
                NET**




Equipment
      and leasehold improvements consist of (in thousands):




**January
                28,**
              **2006**
            
            **January
                29,**
              **2005**Computers
                and test equipment
            
            $
            2,262
            
            $
            2,799Software
            
            
            1,109
            
            
            1,788Furniture
                and fixtures
            
            
            1,177
            
            
            947Other
            
            
            122
            
            
            108Total
            
            
            4,670
            
            
            5,642Accumulated
                depreciation and amortization
            
            
            (3,196
            )
            
            (3,886
            )TOTAL
            
            $
            1,474
            
            $
            1,756




F-17


Furniture
      and fixtures at cost included $725,000 and $716,000 of leasehold improvements
      as
      of January 28, 2006 and January 29, 2005, respectively. Depreciation and
      leasehold amortization expense for fiscal 2006, 2005 and 2004 was $938,000,
      $492,000 and $572,000, respectively. The increased depreciation expense in
      fiscal 2006 included $130,000 of accelerated depreciation of certain test
      equipment due to reduction of their estimated useful lives.




**5.**
            **LONG-TERM
                INVESTMENTS**




Long-term
      investments consist of (in thousands):




**January
                28,**
              **2006**
            
            **January
                29,**
              **2005**OEM
                headquartered in Europe
            
            $
            -
            
            $
            2,000Local
                early-stage technology company
            
            
            1,000
            
            
            1,000Local
                MPEG-4 system provider
            
            
            263
            
            
            263Early-stage
                technology company, headquartered in China
            
            
            19
            
            
            50TOTAL
            
            $
            1,282
            
            $
            3,313




During
      the fiscal 2006, the Company sold Series B Preferred Stock of a local MPEG-4
      system provider for $1.1 million. The Company had no carrying cost for the
      preferred stock at the date of sale, as it had been fully written off as of
      February 1, 2003. Consequently, the entire sales proceeds were recorded as
      a
      gain on sale of investment. In addition, the Company sold its ownership interest
      with a carrying cost of $2.0 million in an original equipment manufacturer
      (the
“OEM”) headquartered in Europe for $3.5 million, resulting a gain on sale of
      investment of $1.5 million (see note 14). In fiscal 2006, the Company recorded
      $31,000 of impairment loss related to its investment in a start-up company
      located in China. This was due primarily to the dissolution of this start-up
      company. The Company believes that the remaining $19,000 of investment cost
      is
      recoverable. The Company did not purchase any long-term investments during
      fiscal 2006.




In
      fiscal
      2005, the Company invested an additional $1.0 million in an OEM manufacturer
      headquartered in Europe, which the Company sold for $3.5 million in fiscal
      2006.
      The Company also invested $1.0 million in an early-stage technology company
      (Blue7) located in the US, which the Company acquired on February 16, 2006
      (see
      Note 16).




F-18


**6.**
            **ACCRUED
                LIABILITIES**




Accrued
      liabilities consist of (in thousands):




**January
                28,**
              **2006**
            
            **January
                29,**
              **2005**Accrued
                salaries and benefits
            
            $
            888
            
            $
            851Accrued
                royalties
            
            
            147
            
            
            153Accrued
                professional services
            
            
            82
            
            
            412Customer
                deposits
            
            
            77
            
            
            47Other
                accrued liabilities
            
            
            837
            
            
            634TOTAL
            
            $
            2,031
            
            $
            2,097




**7.**
            **PRODUCT
                WARRANTY**




In
      general, the Company sells products with a one-year limited warranty that the
      Company’s products will be free from defects in materials and workmanship.
      Warranty cost is estimated at the time revenue is recognized, based on
      historical activity. Accrued warranty cost includes both hardware and software
      support costs and is included in accrued liabilities and other on the balance
      sheet.




Details
      of the change in accrued warranty for fiscal years 2006, 2005 and 2004 are
      as
      follows (in thousands):




**Balance
                Beginning****of
                Period**
            
            **Additions**
            
            **Change
                in preexisting****warranty**
            
            **Deductions**
            
            **Balance
                End of****Period****Fiscal
                Years**2006
            
            $
            191
            
            $
            155
            
            $
            (15
            )
            $
            (42
            )
            $
            2892005
            
            
            134
            
            
            112
            
            
            (20
            )
            
            (35
            )
            
            1912004
            
            
            66
            
            
            117
            
            
            (26
            )
            
            (23
            )
            
            134




**8.**
            **COMMITMENTS
                AND CONTINGENCIES**




The
      Company's standard terms and conditions of sale include a patent infringement
      indemnification provision for claims from third parties related to the Company's
      intellectual property. The terms and conditions of sale generally limit the
      scope of the available remedies to a variety of industry-standard methods
      including, but not limited to, a right to control the defense or settlement
      of
      any claim, procure the right for continued usage, and a right to replace or
      modify the infringing products to make them non-infringing. Such indemnification
      provisions are accounted for in accordance with SFAS No. 5 Accounting for
      Contingencies. To date, the Company has not incurred or accrued any costs
      related to any claims under such indemnification provisions.




F-19


***Leases*** - The
      Company’s primary facilities are leased under a non-cancelable lease which
      expires in September 2007. Future minimum annual payments under operating leases
      are as follows (in thousands):




**Fiscal
                Years**
            
            **Operating****Leases**2007
            
            $
            7982008
            
            
            5822009
            
            
            722010
            
            
            722011
            
            
            72Thereafter
            
            
            156TOTAL
                MINIMUM LEASE PAYMENTS
            
            $
            1,752




Rent
      expense was $736,000, $698,000 and $720,000 for fiscal 2006, 2005 and 2004,
      respectively, net of sublease income of approximately $39,000, $41,000 and
      $37,000 for fiscal 2006, 2005 and 2004, respectively.




The
      Company currently places non-cancelable orders to purchase semiconductor
      products from its suppliers on an eight to twelve week lead-time basis. As
      of
      January 28, 2006, the total amount of outstanding non-cancelable purchase orders
      was approximately $4.3 million.




***Royalties*** - The
      Company pays royalties for the right to sell certain products under various
      license agreements. During fiscal 2006, 2005 and 2004, the Company recorded
      royalty expense of $490,000 $270,000 and $578,000, respectively.




***Benefit
      Plan*** - The
      Company sponsors a 401(k) savings plan in which most employees are eligible
      to
      participate. The plan commenced in fiscal 1994. The Company is not obligated
      to
      make contributions to the plan and no contributions have been made by the
      Company.




**9.**
            **CURRENT
                AND LONG-TERM DEBT**




*New
      Credit Facilities*




On
      August
      12, 2005, the Company entered into a Loan and Security Agreement (the “Loan
      Agreement”) with United Commercial Bank (the “Bank”). The Loan Agreement
      provides for a maximum borrowing amount of approximately $15.5 million across
      three credit facilities consisting of two 2-year Lines of Credit and a 30-month
      Term Loan of $0.5 million.




The
      Company’s Lines of Credit are used to fund daily operating cash needs. During
      the ordinary course of business, the use of the Lines of Credit is driven by
      collection and disbursement activities. The Company’s daily cash needs generally
      follow a predictable pattern that parallels its payroll cycles, which drive,
      as
      necessary, short term borrowing requirements.




F-20


The
      first
      2-year Line of Credit allows the Company to borrow up to 80% of its accounts
      receivable to a maximum of $15 million and, has a floating interest rate of
      the
      Wall Street Journal Prime Rate plus 0.25% per annum. The second 2-year Line
      of
      Credit allows the Company to borrow up to $5 million as long as (1) unrestricted
      cash at the Bank exceeds $10 million, (2) the credit limit of the first 2-year
      Line of Credit is utilized and (3) the total outstanding balances under both
      2-year Lines of Credit cannot exceed $15 million at any one time. The second
      2-year Line of Credit has a floating interest rate of the Wall Street Journal
      Prime Rate plus 0.25% per annum. The Company’s obligations under the Loan
      Agreement are secured by substantially all of the Company’s assets, including
      its intellectual property. Both Lines of Credit expire and are payable in full
      on August 12, 2007. At the Company’s option, the loans under the Loan Agreement
      can be repaid without premium or penalty. As of January 28, 2006, the Company
      had no amounts outstanding under these two Lines of Credit but had availability
      to draw drown approximately $7.6 million. On February 8, 2006, the Company
      utilized $2.4 million of the first 2-year Line of Credit for a standby letter
      of
      credit to a supplier.




Principal
      amounts under the Term Loan will become due and payable on a monthly basis
      such
      that the Term Loan will be fully repaid in February 2008. The monthly payment
      including interest of the Term Loan is approximately $18,000. The Term Loan
      has
      a floating interest rate of the Wall Street Journal Prime Rate plus 0.5% per
      annum. The effective average interest rate paid on the Term Loan from August
      12,
      2005, through January 28, 2006, was approximately 7.4%. As of January 28, 2006,
      the Company had $444,000 outstanding under the Term Loan. The amounts of the
      Term Loan that mature in the next five years and thereafter are as follows
      (in
      thousands):




**Maturities**
            
            **Loan
                Payment**Less
                than one year
            
            $
            211Second
                year
            
            
            233Total
            
            $
            444




Under
      the
      Loan Agreement, the Company is subject to certain financial covenants. As of
      January 28, 2006, the Company was in compliance with all of the covenants
      contained in the Loan Agreement.




**10.**
            **NET
                INCOME PER SHARE******




Net
      income per share - basic and diluted for the periods presented is computed
      by
      dividing net income by the weighted average number of common shares outstanding
      (excluding shares subject to repurchase). Net income per share - diluted
      reflects the potential dilution that could occur if securities or other
      contracts to issue common stock were exercised or converted into common
      stock.




The
      reconciliation of the denominators of the basic and diluted net income per
      share
      computations for the fiscal 2006, 2005 and 2004 is shown in the following table
      (in thousands, except per-share data):




F-21


**Fiscal
                Year****2006**
            
            **2005**
            
            **2004**Numerator:Net
                income available to common shareholders,Basic
                and diluted
            
            $
            1,884
            
            $
            1,840
            
            $
            1,543Denominator:Weighted
                average common shares outstanding
            
            
            21,412
            
            
            20,809
            
            
            19,437Shares
                used in computation, basic
            
            
            21,412
            
            
            20,809
            
            
            19,437Effect
                of dilutive securities:Stock
                options
            
            
            2,255
            
            
            2,720
            
            
            2,953Shares
                used in computation, diluted
            
            
            23,667
            
            
            23,529
            
            
            22,390Net
                income per share:Basic
            
            $
            0.09
            
            $
            0.09
            
            $
            0.08Diluted
            
            $
            0.08
            
            $
            0.08
            
            $
            0.07




A
      summary
      of the excluded potential dilutive securities as of the end of each fiscal
      year
      follows (in thousands):




**Years
                Ended****January
                28****,**
              **2006**
            
            **January
                29****,**
              **2005**
            
            **January
                31****,**
              **2004**Stock
                options
            
            
            2
            
            
            20
            
            
            65




**11.**
            **STOCKHOLDERS’
                EQUITY**




**Stock
      Option Plan**




*2003
      Director Stock Option Plan (the “2003 Director Plan”):* During
      fiscal 2004, the Company adopted the 2003 Director Stock Option Plan to replace
      the predecessor 1994 Director Stock Option Plan which expired in fiscal 2005.
      A
      total of 200,000 shares of common stock are currently reserved for issuance
      under the 2003 Director Plan of which 50,000 have been granted as of January
      28,
      2006.




F-22


*2001
      Employee Stock Option Plan (the”2001 Option Plan”):* During
      fiscal 2002, the Company adopted the 2001 Employee Stock Option Plan (the “2001
      Option Plan”) and reserved 500,000 shares of the Company’s common stock for
      issuance under the plan, with automatic annual increases on the first day of
      the
      Company’s fiscal year equal to the lesser of (i) 1,000,000 shares, (ii) 4% of
      the Company’s outstanding common stock on such date or (iii) a lesser number of
      shares as determined by the Board of Directors, commencing February 1, 2002.
      On
      February 1, 2005, an additional 841,506 shares resulting from the automatic
      annual increase of 4% of the Company’s outstanding common stock were added to
      the shares available for issuance under the 2001 Employee Stock Option Plan.
      As
      of January 28, 2006, the Company reserved total 3.5 million shares of common
      stock for issuance under this plan. Generally, the plan provides for the
      granting of options to purchase shares of common stock at the fair market value
      on the date of grant. Options granted under the plan become exercisable over
      a
      five-year period and expire no more than ten years from the date of grant (all
      options outstanding at January 28, 2006 expire ten years from date of grant).
      The 2001 plan replaced the predecessor 1994 Option Plan which expired in fiscal
      2005.




The
      total
      stock option activities and balances of the Company’s stock option plans are
      summarized as follows:




**Number
                of Shares**
            
            **Weighted
                Average Exercise Prices Per Share**Balance,
                February 1, 2003 (2,824,354 exercisable at a weighted-average price
                of
                $2.62)
            
            
            4,605,681
            
            
            $2.43Granted
                (weighted-average fair value of $3.51)
            
            
            588,500
            
            
            $4.77Cancelled
            
            
            (62,792
            )
            
            $2.72Exercised
            
            
            (869,453
            )
            
            $2.35Balance,
                January 31, 2004 (2,551,665 exercisable at a weighted-average price
                of
                $2.65)
            
            
            4,261,936
            
            
            $2.77Granted
                (weighted-average fair value of $2.98)
            
            
            933,500
            
            
            $5.55Cancelled
            
            
            (28,428
            )
            
            $2.58Exercised
            
            
            (334,169
            )
            
            $2.46Balance,
                January 29, 2005(2,853,801 exercisable at a weighted-average price
                of
                $2.79)
            
            
            4,832,839
            
            
            $3.33Granted
                (weighted-average fair value of $5.26)
            
            
            967,900
            
            
            $10.36Cancelled
            
            
            (92,679
            )
            
            $5.89Exercised
            
            
            (825,343
            )
            
            $2.89BALANCE,
                JANUARY 28, 2006
            
            
            4,882,717
            
            
            $4.75




F-23


At
      January 28, 2006, options to purchase 195,468 shares were available for future
      grant.




**Options
                Outstanding**
            
            **Options
                Exercisable****Range
                of Exercise Prices**
            **Number
                Outstanding at January 28, 2006**
            **Weighted
                Average Remaining Life**
            **Weighted
                Average Exercise Price**
            
            **Number
                Exercisable at January 28, 2006**
            **Weighted
                Average Exercise Price**$1.00
                - $1.25
            
            471,398
            
            5.37
            $1.22
            
            366,233
            
            $1.21$1.26
                - $1.69
            
            441,029
            
            6.70
            $1.69
            
            248,281
            
            $1.69$1.70
                - $2.53
            
            831,527
            
            1.98
            $2.32
            
            812,026
            
            $2.32$2.54
                - $3.50
            
            874,203
            
            4.40
            $3.25
            
            751,277
            
            $3.22$3.51
                - $4.44
            
            160,175
            
            4.26
            $4.26
            
            160,175
            
            $4.26$4.45
                - $6.60
            
            1,067,785
            
            7.99
            $5.54
            
            369,186
            
            $5.60$6.61
                - $9.89
            
            926,600
            
            9.54
            $9.46
            
            37,923
            
            $7.75$14.81-
                $15.91
            
            110,000
            
            10.00
            $15.91
            
            -
            
            $    
                -$1.00
                - $15.91
            
            4,882,717
            
            6.17
            $4.75
            
            2,745,101
            
            $2.99




***Preferred
      Stock Rights Plan***




On
      May
      28, 2004, the Company’s Board of Directors adopted a Preferred Stock Rights
      Plan. Under the plan, the Company declared a dividend of one Preferred Share
      Purchase Right (“the Rights”) for each share of Common Share held by
      stockholders of record as of the close of business on June 18, 2004. Each Right
      initially entitles stockholders to purchase a fractional share of the Company’s
      Preferred Stock at $58 per share. However, the rights are not immediately
      exercisable and will become exercisable only upon the occurrence of certain
      events. If a person or group acquires or announces a tender or exchange offer
      that would result in the acquisition of 15 percent or more of the Company’s
      common stock while the stockholder rights plan remains in place, then, unless
      the rights are redeemed by the Company for $0.001 per right, the rights
      will become exercisable by all rights holders except the acquiring person or
      group for shares of the Company or the third party acquirer having a value
      of
      twice the right’s then-current exercise price. Absent of the aforementioned
      triggering events, the Rights will expire on June 18, 2014. The
      rights may have the effect of deterring or delaying a change in control of
      the
      Company.




***Employee
      Stock Purchase Plan***




During
      fiscal 2002, the Company adopted the 2001 Employee Stock Purchase Plan (the
      “2001” Purchase Plan”) and reserved 100,000 shares of the Company’s common stock
      for issuance under the plan, with an automatic annual increase on the first
      day
      of the Company’s fiscal year equal to the lesser of (i) 500,000 shares, (ii) 2%
      of the Company’s outstanding common stock on such date or (iii) a lesser number
      of shares as determined by the Board of Directors. Under this plan, eligible
      employees may authorize payroll deductions of up to 10% of their regular base
      salaries to purchase common stock at 85% of the fair market value at the
      beginning or end of each six-month offering period. During fiscal 2006, 2005
      and
      2004, 81,569, 66,798 and 69,327 shares of the Company’s common stock were
      purchased at an average price of $6.59, $6.58 and $4.51 per share, respectively.
      On February 1, 2005, Board of Directors approved an additional 25,000 shares
      be
      reserved under the 2001 Purchase Plan for future purchases by employees. At
      January 28, 2006, 237,569 shares under the 2001 Purchase Plan remain available
      for future purchase.




F-24




**12.**
            **INCOME
                TAXES**




Income
      before provision for income taxes consisted of the following (in
      thousands):




**Year
                ended****January
                28,**
              **2006**
            
            **January
                29,**
              **2005**
            
            **January
                31,**
              **2004**United
                States
            
            $
            1,486
            
            $
            259
            
            $
            483International
            
            
            406
            
            
            1,585
            
            
            1,069Total
            
            $
            1,892
            
            $
            1,844
            
            $
            1,552




The
      federal and state income tax provision (benefit) is summarized as follows (in
      thousands):




**Year
                ended****January
                28,**
              **2006**
            
            **January
                29,**
              **2005**
            
            **January
                31,**
              **2004**CurrentFederal
            
            $
            -
            
            $
            -
            
            $
            6State
            
            
            6
            
            
            2
            
            
            3Foreign
            
            
            2
            
            
            2
            
            
            -Total
                Current
            
            
            8
            
            
            4
            
            
            9DeferredFederal
            
            
            -
            
            
            -
            
            
            -State
            
            
            -
            
            
            -
            
            
            -Foreign
            
            
            -
            
            
            -
            
            
            -Total
                Deferred
            
            
            -
            
            
            -
            
            
            -Total
                Provision
            
            $
            8
            
            $
            4
            
            $
            9






F-25


The
      tax
      effects of significant items comprising the Company’s deferred tax assets and
      liabilities are as follows (in thousands):




**Year
                ended****January
                28,**
              **2006**
            
            **January
                29,**
              **2005**Deferred
                tax assets:Net
                operating losses and tax credit carry forwards
            
            $
            32,612
            
            $
            30,284Reserves
                not currently deductible
            
            
            2,664
            
            
            3,483Capitalized
                research and development expenditures
            
            
            456
            
            
            672Other
            
            
            692
            
            
            7936,424
            
            
            34,518Valuation
                allowance
            
            
            (36,424
            )
            
            (34,518
            )$
            -
            
            $
            -




At
      January 28, 2006, undistributed earnings of the Company’s French operations
      totaling $847,000 were considered to be permanently reinvested. No deferred
      tax
      liability has been recognized for the remittance of such earnings to the U.S.
      since it is management’s intention to utilize those earnings in the foreign
      operations. Generally, such earnings become subject to U.S. tax upon the
      remittance of dividends and under certain other circumstances. It is not
      practicable to estimate the amount of deferred tax liability on such
      undistributed earnings.




SFAS
      No.
      109 requires that the tax benefit of net operating losses, temporary differences
      and credit carryforwards be recorded as an asset to the extent that management
      assesses that realization is “more likely than not.” Realization of the future
      tax benefits is dependent on the Company’s ability to generate sufficient
      taxable income within the carryforward period. Because of the Company’s recent
      history of operating losses, risks associated with its new product introduction
      including the dependence on rapid acceptance of new technology, the dependence
      on development of complimentary software by third parties and other risks,
      such
      as technological change in the industry, short product life cycles and reliance
      on a limited number of suppliers and manufacturing contractors, management
      believes that recognition of the deferred tax assets arising from the
      above-mentioned future tax benefits is currently not likely to be realized
      and,
      accordingly, has provided a full valuation allowance. The valuation allowance
      increased by approximately $1.9 million during fiscal 2006, $429,000 during
      fiscal 2005, and approximately $2.6 million during fiscal 2004. The amount
      of
      the valuation allowance for deferred tax assets associated with excess tax
      deduction from stock based compensation arrangement that is allocated to
      contributed capital if the future tax benefits are subsequently recognized
      is
      approximately $4.8 million.




Net
      operating losses and tax credit carry forwards as of January 28, 2006 are as
      follows (in thousands):




F-26


**Amount**
            
            **Expiration
                Years**Net
                operating losses, federal
            $64,960
            
            2009-2026Net
                operating losses, state
            7,667
            
            2013-2016Tax
                credits, federal
            5,700
            
            2009-2026Tax
                credits, state
            4,415
            
            2007-IndefiniteNet
                operating losses, foreign
            3,793
            
            IndefiniteTax
                credits, foreign
            258
            
            Indefinite




Current
      federal and California tax laws include substantial restrictions on the
      utilization of net operating losses and tax credits in the event of an
“ownership change” of a corporation. Accordingly, the Company’s ability to
      utilize net operating loss and tax credit carryforwards may be limited as a
      result of such ownership changes. Such a limitation could result in the
      expiration of carryforwards before they are utilized.




The
      effective tax rate of the Company’s provision (benefit) for income taxes differs
      from the federal statutory rate as follows (in thousands):




**2006**
            
            **2005**
            
            **2004**Computed
                at 35%
            
            $
            662
            
            $
            645
            
            $
            543State
                taxes
            
            
            (169
            )
            
            8
            
            
            2Valuation
                allowance
            
            
            1,905
            
            
            429
            
            
            2,642Foreign
                tax benefits
            
            
            175
            
            
            (980
            )
            
            (325
            )Domestic
                tax credits
            
            
            (1,043
            )
            
            (776
            )
            
            (1,086
            )Tax
                deductible stock compensation
            
            
            (1,508
            )
            
            (512
            )
            
            (1,625
            )Reduction
                in deferred tax assets due to decrease ineffective
                state tax rate
            
            
            -
            
            
            1,157
            
            
            -Other
            
            
            (14
            )
            
            33
            
            
            (142
            )TOTAL
            
            $
            8
            
            $
            4
            
            $
            9




**13.**
            **MAJOR
                CUSTOMERS**




No
      domestic customer accounted for more than 10% of total net revenues in fiscal
      2006, 2005 and 2004. One international customer accounted for 25% of total
      net
      revenue in fiscal 2006. Two international customers accounted for 15% and 14%
      (a
      related party - Note 14) respectively, of total net revenue in fiscal 2005.
      No
      international customer accounted for more than 10% of total net revenues in
      fiscal year 2004.




F-27




No
      domestic customers accounted for more than 10% of total accounts receivable
      at
      January 28, 2006 and 2005. Two international customers accounted for 30% and
      12%
      of total accounts receivables at January 28, 2006. Three international customers
      accounted for 39% (Note 14), 13% and 11% of total accounts receivable at January
      29, 2005.




**14.**
            **RELATED
                PARTY TRANSACTIONS**




The
      Company had an ownership interest of less than 10% in an original equipment
      manufacturer (the “OEM”) headquartered in Europe which was accounted for using
      the cost method. The Company sold its ownership interest with a carrying cost
      of
      $2.0 million in this OEM for approximately $3.5 million in September 2005,
      resulting a gain on sale of investment of approximately $1.5 million. During
      fiscal 2006, 2005, 2004, the Company had product revenues of $123,000, $4.5
      million and $1.4 million, respectively, from this OEM.




During
      the third quarter of fiscal 2003, the Company executed an agreement to sublease
      approximately 2,600 square feet of its headquarters’ facility to a start-up
      company founded by a member of the Company’s board of directors. The term of the
      sublease is one year at the same rate as the Company’s operating lease
      arrangement for the facility. The agreement was amended during the fourth
      quarter of fiscal 2004 to extend the lease term for an additional year, and
      again in the fourth quarter of 2005 to put the lease term on a month-to-month
      basis on the same terms. The lease was terminated on August 31,
      2005.




During
      June 2005, the Company loaned $500,000 to Blue7, a California corporation,
      in
      which the Company had invested $1.0 million, for a 17% ownership interest.
      One
      of the Company’s Board member had invested $200,000 for a 2% ownership interest
      during fiscal 2005. In
      November 2005 and January 2006, the Company loaned an additional $250,000 and
      $150,000 to this company .
      As of
      January 28, 2006, the total outstanding loan balance was $900,000. On February
      16, 2006, the Company acquired Blue7 for approximately $14.0 million, increasing
      its ownership to 100%.




**15.**
            **SEGMENT
                AND GEOGRAPHICAL
                INFORMATION**




As
      discussed in Note 1, the Company follows the requirements of SFAS No. 131,
      “Disclosures About Segments of an Enterprise and Related Information.” The
      Company’s operating segments consist of its geographically based entities in the
      United States, Hong Kong and France.




All
      such
      operating entities segments have similar economic characteristics, as defined
      in
      SFAS No. 131. Accordingly, the Company operates in one reportable segment:
      the
      development, manufacturing and marketing of multimedia computer devices and
      products. The Company’s chief operating decision-maker is its Chief Executive
      Officer.




For
      fiscal 2006, 2005 and 2004, the Company recorded sales to customers throughout
      the United States and Canada, Denmark, Japan, China, Taiwan, Hong Kong and
      Korea; Germany, Belgium, Finland, The Netherlands, Norway, Sweden, the United
      Kingdom, France, Italy, Spain, Hungary, Portugal, Scotland, and Norway
      (collectively referred to as “Rest of Europe”); Singapore, Thailand, New
      Zealand, Turkey, Israel, Australia, South American and South Africa
      (collectively “Rest of Asia/New Zealand/Other Region”).




F-28


The
      following table summaries total net revenues attributed to each product group
      (in thousands):




**Year
                ended****January
                28,**
              **2006**
            
            **January
                29,**
              **2005**
            
            **January
                31,**
              **2004**Chipsets
            
            $
            28,198
            
            $
            26,380
            
            $
            25,880Boards
            
            
            3,514
            
            
            3,280
            
            
            3,231Other
            
            
            1,608
            
            
            1,777
            
            
            1,409TOTAL
                NET REVENUES
            
            $
            33,320
            
            $
            31,437
            
            $
            30,520




The
      following table summarizes total net revenues attributable to each market
      segment (in thousands):




**Year
                ended****January
                28,**
              **2006**
            
            **January
                29,**
              **2005**
            
            **January
                31,**
              **2004**IP
                video technology market
            
            $
            19,170
            
            $
            18,063
            
            $
            15,068Connected
                media player market
            
            
            11,227
            
            
            10,379
            
            
            11,690HDTV
                product market
            
            
            797
            
            
            362
            
            
            94PC
                add-in and other markets
            
            
            2,126
            
            
            2,633
            
            
            3,668TOTAL
                NET REVENUES
            
            $
            33,320
            
            $
            31,437
            
            $
            30,520




The
      following table summarizes total net revenues and long-lived assets attributable
      to significant countries (in thousands):




**Year
                ended****January
                28,**
              **2006**
            
            **January
                29****,**
              **2005**
            
            **January
                31,**
              **2004****Net
                revenues:**Korea
            
            $
            8,548
            
            $
            5,024
            
            $
            3,375China
            
            
            7,125
            
            
            6,695
            
            
            3,566Taiwan
            
            
            4,823
            
            
            5,376
            
            
            6,741United
                States
            
            
            3,816
            
            
            4,345
            
            
            4,168Hong
                Kong
            
            
            3,206
            
            
            1,056
            
            
            4,404Japan
            
            
            2,859
            
            
            1,954
            
            
            889Rest
                of Europe
            
            
            1,958
            
            
            1,685
            
            
            2,717Rest
                of Asia/New Zealand/Other Region
            
            
            734
            
            
            469
            
            
            853Canada
            
            
            128
            
            
            56
            
            
            22Denmark
            
            
            123
            
            
            4,777
            
            
            3,785TOTAL
                NET REVENUES*
            
            $
            33,320
            
            $
            31,437
            
            $
            30,520




F-29


**Year
                ended****January
                28,**
              **2006**
            
            **January
                29****,**
              **2005**
            
            **January
                31,**
              **2004****Long-lived
                assets:**United
                States
            
            $
            1,318
            
            $
            1,656
            
            $
            907France
            
            
            152
            
            
            87
            
            
            113Hong
                Kong
            
            
            4
            
            
            13
            
            
            8TOTAL
                LONG-LIVED ASSETS
            
            $
            1,474
            
            $
            1,756
            
            $
            1,028




*Net
      revenues are attributable to countries based on invoicing location of
      customer.




**16.**
            **QUARTERLY
                FINANCIAL INFORMATION**




The
      following table presents unaudited quarterly financial information for each
      of
      the Company’s last eight quarters (unaudited, in thousands, except per share
      data):




**First**
              **Quarter**
            
            **Second**
              **Quarter**
            
            **Third**
              **Quarter**
            
            **Fourth**
              **Quarter**Year
                ended January 28, 2006:Net
                revenues
            
            
            $6,375
            
            
            $7,961
            
            
            $
                8,497
            
            
            $10,487Income
                (loss) from operations
            
            
            (1,899
            )
            
            38
            
            
            79
            
            
            302Net
                income (loss)
            
            
            (717
            )
            
            163
            
            
            1,948
            
            
            490Net
                income (loss) per share:Basic
            
            
            $(0.03
            )
            
            $0
            
            
            $0.09
            
            
            $0.02Diluted
            
            
            $(0.03
            )
            
            $0
            
            
            $0.08
            
            
            $0.02




F-30


Year
                ended January 29, 2005:Net
                revenues
            
            
            $7,784
            
            
            $8,088
            
            
            $
                7,677
            
            
            $7,888Income
                (loss) from operations
            
            
            127
            
            
            783
            
            
            458
            
            
            (119
            )Net
                income (loss)
            
            
            163
            
            
            1,169
            
            
            525
            
            
            (17
            )Net
                income (loss) per share:Basic
            
            
            $0.01
            
            
            $0.05
            
            
            $0.03
            
            
            $0.00Diluted
            
            
            $0.01
            
            
            $0.05
            
            
            $0.02
            
            
            $0.00




During
      the fourth quarter of fiscal 2005, the Company reversed a $221,000 bonus expense
      which was accrued in the second and third quarter of fiscal 2005 due to profit
      projections not being met at the end of the year. The Company also recorded
      an
      additional bad debt allowance of $360,000 due to an outstanding past-due
      receivable that was determined uncollectible.




During
      the first and third quarter of fiscal 2006, the Company recorded approximately
      $1.0 million and $1.5 million of long-term investment gains,
      respectively.




**17.**
            **SUBSEQUENT
                EVENTS**




*Letter
      of credit:*




On
      February 8, 2006, the Company utilized $2.4 million of the first 2-year Line
      of
      Credit for issuance of a standby letter of credit to a supplier.




*Blue7
      Acquisition:*




On
      February 16, 2006, Sigma successfully acquired Blue7 which was a privately-held
      California corporation. Sigma purchased Blue7’s shares for approximately $14.0
      million in stock. Blue7 focuses on the development of advanced wireless
      technologies and Ultra-Wideband (UWB) semiconductor products. In exchange for
      all of the outstanding capital stock of Blue7, Sigma issued or reserved for
      issuance at the closing to holders of Blue7 capital stock other than Sigma
      an
      aggregate of 815,034 shares of Sigma Common Stock, of which 98,470 shares will
      be held in escrow to satisfy any obligations of Blue7 to indemnify Sigma against
      any claims against Blue7 for any breaches of its representations or warranties
      contained in or made pursuant to the Merger Agreement and certain other matters
      set forth in the Merger Agreement. The shares of Sigma Common Stock were issued
      pursuant to an exemption under Section 3(a)(10) of the Securities Act of 1933,
      as amended. An aggregate of 231,164 shares of the 815,034 shares of Sigma Common
      Stock issuable under the Merger Agreement are reserved for future issuance
      upon
      the exercise of options to purchase Common Stock, which options were assumed
      by
      Sigma under the terms of the Merger Agreement. Prior to the acquisition, Sigma
      held approximately 17% of the outstanding shares of Blue7 and provided loans
      totaling $900,000 to Blue7.




Sigma
      will consolidate the results of operations of Blue7 beginning the first quarter
      of fiscal 2007.




F-31




*Sublease
      Agreement* :




On
      April
      10, 2006, the Company entered into a sublease agreement to rent approximately
      2,500 square feet of a facility from a start-up company founded by a member
      of
      the Company’s board of directors. This is a month-to-month operating lease with
      base rent of $4,000 plus proportionate share of operating costs commencing
      April
      1, 2006.











F-32


**SCHEDULE
      II—VALUATION AND QUALIFYING ACCOUNTS AND RESERVES**




**Classification**
            
            **Balance
                at Beginning of Year**
            
            **Additions:
                Provision for (Reversal of) Bad Debts**
            
            **Deductions:
                Write-Offs (Recoveries) of Accounts**
            
            **Balance
                at**
              **End
                of Year****(in
                thousands)**Allowance
                for returns and doubtful accounts
              and
                price protection:
              Year
                ended2006
            
            $
            1,460
            
            $
            31
            
            $
            -
            
            $
            1,4912005
            
            
            935
            
            
            595
            
            
            70
            
            
            1,4602004
            
            
            922
            
            
            (186
            )
            
            (199
            )
            
            935









S-1


**INDEX
      TO EXHIBITS**


**Exhibit**
                **Number**
              **Description**
              
              **Filed
                  Herewith or Incorporated**
                **Herein
                  by Reference to**3.1
              Second
                  Restated Articles of Incorporation.
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Registration Statement
                  on Form S-1 (No. 33-17789) filed October 8, 1987, Amendment No.
                  1 thereto
                  filed June 9, 1988 and Amendment No. 2 thereto filed June 14, 1988,
                  which
                  Registration Statement became effective June 14, 1988.3.2
              Certificate
                  of Amendment to the Second Restated Articles of Incorporation dated
                  June
                  22, 2001.
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Registrant's
                  Registration Statement on Form S-8 (No. 333-64234) filed on June
                  29,
                  2001.3.6
              Bylaws
                  of Registrant, as amended.
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Annual Report on Form
                  10-K for the fiscal year ended February 1, 2003.4.1
              Preferred
                  Stock Rights Agreement, dated as of June 7, 2004, between the Company
                  and
                  Mellon Investor Services LLC, as Rights Agent, including the Certificate
                  of Designation, the form of Rights Certificate and the Summary
                  of Rights
                  attached thereto as Exhibit A, B and C, respectively.
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Current Report on Form
                  8-K filed on June 7, 2004.4.2
              Registration
                  Rights Agreement dated June 24, 2003, between the Company and the
                  investors named therein.
              
              Incorporated
                  by reference to exhibit 4.1 filed with the Registrant’s Form S-3 filed on
                  July 16, 2003.4.3
              Amendment
                  No.1 to Registration Rights Agreement dated July 2, 2003 between
                  the
                  Company and the investors named therein.
              
              Incorporated
                  by reference to exhibit 4.2 filed with the Registrant’s Form S-3 filed on
                  July 16, 2003.10.1
              Distribution
                  Agreement dated September 10, 1985.
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Registration Statement
                  on Form S-1 (No. 33-4131) filed on March 19, 1986, Amendment No.
                  1 thereto
                  filed April 28, 1986 and Amendment No. 2 thereto filed May 15,
                  1986, Which
                  Registration Statement became effective May 15,
                  1986.
  E-1
 10.2*
              Registrant’s
                  1986 Employee Stock Purchase Plan, as amended, and form of Subscription
                  Agreement.
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Registration Statement
                  on Form S-8 (No. 333-61549) filed on August 14, 1998.10.4*
              Registrant’s
                  Amended and Restated 1994 Stock Plan and form of Stock Option
                  Agreement.
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Registration Statement
                  on Form S-8 (No. 333-86875) filed on September 10,
                  1999.10.5*
              Registrant’s
                  1994 Director Stock Option Plan and form of Director Option
                  Agreement.
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Registration Statement
                  on Form S-3 (No. 33-74308) filed on January 28, 1994, Amendment
                  No. 1
                  thereto filed February 24, 1994, Amendment No. 2 thereto filed
                  March 3,
                  1994, Amendment No. 3 thereto filed March 4, 1994 and Amendment
                  No. 4
                  thereto filed March 8, 1994.10.6*
              Registrant’s
                  2001 Employee Stock Option Plan.
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Registrant's
                  Registration Statement on Form S-8 (333-64234) filed on June 29,
                  2001.10.7*
              Registrant’s
                  2001 Employee Stock Purchase Plan and Form of Subscription
                  Agreement.
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Registrant's
                  Registration Statement on Form S-8 (333-64234) filed on June 29,
                  2001.10.8
              Registrant’s
                  2001 Loan and Security Agreement with Silicon Valley Bank, as
                  amended.
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Annual Report on Form
                  10-K for the fiscal year ended February 2, 2002.10.9
              Lease
                  between the Registrant and EOP-Industrial Portfolio,
                  L.L.C.
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Annual Report on Form
                  10-K for the fiscal year ended February 1, 2003.10.10
              Amendment
                  to Registrant’s 2001 Loan and Security Agreement with Silicon Valley Bank.
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Annual Report on Form
                  10-K for the fiscal year ended January 31,
                  2004.
  E-2
 10.11
              Amended
                  and Restated Schedule to Loan and Security Agreement with Silicon
                  Valley
                  Bank
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Annual Report on Form
                  10-K for the fiscal year ended January 31, 2004.10.12
              Purchase
                  of Series B Preferred Stock in Envivio from Sigma Designs,
                  Inc.
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Annual Report on Form
                  10-K for the fiscal year ended January 29, 2005.10.13
              Agreement
                  and Plan of Merger dated December 13, 2005 by and among the Company,
                  Blue7
                  Communications and the other parties named therein.
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Current Report on Form
                  8-K filed on December 16, 2005.10.14
              Amendment
                  No.1 to Agreement and Plan of Merger dated January 9, 2006 by and
                  among
                  the Company, Blue7 Communications and the other parties named
                  therein.
              
              Incorporated
                  by reference to exhibit 2.1 filed with the Registrant’s Current Report on
                  Form 8-K filed on January 12, 2006.21.1
              Subsidiaries
                  of the Registrant.
              
              Incorporated
                  by reference to exhibit filed with the Registrant’s Annual Report on Form
                  10-K for the fiscal year ended January 31, 2004.23.1
              Consent
                  of Independent Registered Public Accounting Firm (Grant Thornton
                  LLP)
              
              Filed
                  herewith as page E-523.2
              Consent
                  of Independent Registered Public Accounting Firm (Deloitte & Touche
                  LLP)
              
              Filed
                  herewith as page E-624.1
              Power
                  of Attorney (contained in the signature page to this Annual Report
                  on Form
                  10-K).
              
              Filed
                  herewith as page 4731.1
              Certification
                  of the President and Chief Executive Officer pursuant to Securities
                  Exchange Act Rules 13a-14(c) and 15d-14(a).
              
              Filed
                  herewith as page E-731.2
              Certification
                  of the Chief Financial Officer and Secretary pursuant to Securities
                  Exchange Act Rules 13a-14(c) and 15d-14(a).
              
              Filed
                  herewith as page E-832.1
              Certificate
                  of Chief Executive Officer pursuant to 18 U.S.C. Section 1350,
                  as adopted
                  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
              
              Filed
                  herewith as page E-9
  E-3
 32.2
              Certificate
                  of Chief Financial Officer pursuant to 18 U.S.C. Section 1350,
                  as adopted
                  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
              
              Filed
                  herewith as page E-10




*
      Indicates management contract or compensatory plan or arrangement.






E-4