**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 
| **(Mark One)** | ** **                                                                                                                                                                                |
|----------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **     | ** **                                                                                                                                                                                |
| **x**          | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**                                                               |
| ** **     | ** **                                                                                                                                                                                |
| ** **     | **For the  quarterly period ended March 31, 2008**                                                                                                                                   | ** ** |
| ** **     | ** **                                                                                                                                                                                |
| ** **     | **OR**                                                                                                                                                                                    | ** ** |
| ** **     | ** **                                                                                                                                                                                |
| **o**          | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**                                                                   |
| ** **     | ** **                                                                                                                                                                                |
| ** **     | **For the  transition period from             to              .** | ** ** |

 

**Commission File Number 0-26944**

 

 

**SILICON STORAGETECHNOLOGY, INC.**

(Exact name ofRegistrant as Specified in its Charter)

 

| **California**(State or Other Jurisdiction of  Incorporation or Organization) | ** ** | **77-0225590**(I.R.S. Employer  Identification Number) |
|-------------------------------------------------------------------------------|------------|--------------------------------------------------------|
| ** **                                                                    | ** ** | ** **                                             |
| **1171  Sonora Court, Sunnyvale, CA**                                         | ** ** | **94086**                                              |
| (Address of  Principal Executive Offices)                                     | ** ** | (Zip Code)                                             |

 
| **(408) 735-9110**                                    |
|------------------------------------------------------------|
| (Registrant’s  Telephone Number, including Area Code) |

 

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

 

Indicate bycheck mark whether the registrant is a large accelerated filer, an acceleratedfiler, a non-accelerated filer, or a smaller reporting company. See the definitionsof “large accelerated filer,” “accelerated filer,” and “smaller reportingcompany” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer o                     |   | Accelerated filer x         |
|-----------------------------------------------|--------|----------------------------------|
|                                          |   |                             |
| Non-accelerated filer o                       |   | Smaller reporting company o |
| (Do not check if a smaller reporting company) |   |                             |

 

Indicate bycheck mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).Yes o  No x

 

Number ofshares outstanding of Common Stock, no par value, as of the latest practicabledate May 2, 2008: 102,204,557.

 

 

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**SILICON STORAGE TECHNOLOGY, INC.**

 

**FORM 10-Q: QUARTER ENDED MARCH 31, 2008**

**TABLE OF CONTENTS**

 
| **Part I—FINANCIAL INFORMATION** | ** **                                                                                  |
|--------------------------------------------|---------------------------------------------------------------------------------------------|
|                                       |                                                                                        |   |
| Item 1.                               | Condensed Consolidated Financial Statements (Unaudited):                                    |   |
|                                       | Condensed  Consolidated Statements of Operations                                            | 3 |
|                                       | Condensed  Consolidated Balance Sheets                                                      | 4 |
|                                       | Condensed Consolidated Statements of Cash Flows                                             | 5 |
|                                       | Notes to Condensed Consolidated Financial Statements                                        | 6 |
|                                       |                                                                                        |   |
| Item 2.                               | Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 17 |
|                                       |                                                                                        |   |
| Item 3.                               | Quantitative and Qualitative Disclosures  About Market Risk                                 | 25 |
|                                       |                                                                                        |   |
| Item 4.                               | Controls and Procedures                                                                     | 26 |
|                                       |                                                                                        |   |
| **Part II—OTHER INFORMATION**    | ** **                                                                                  |
| ** **                                 | ** **                                                                                  |
| Item 1.                               | Legal Proceedings                                                                           | 27 |
|                                       |                                                                                        |   |
| Item 1A.                              | Risk Factors                                                                                | 27 |
|                                       |                                                                                        |   |
| Item 2.                                    | Unregistered Sales of Equity Securities and  Use of Proceeds                                | 39 |
|                                       |                                                                                        |   |
| Item 6.                               | Exhibits                                                                                    | 40 |
|                                       |                                                                                        |   |
| Signatures                                 |                                                                                        | 41 |

 

2

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**PART I—FINANCIAL INFORMATION**

 

**Item 1. Condensed Consolidated Financial Statements**

 

**SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

**(inthousands, except per share data)**

 
| ** **                                                                                          | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                          | ** ** | **March 31,**               | ** ** |
| ** **                                                                                          | ** ** | **2007**                         | ** ** | **2008** | ** ** |
| Net revenues:                                                                                       |       |                             |       |   |   |
| Product revenues - unrelated parties                                                                |       | $                                | 39,133     |   | $ | 30,469 |   |
| Product revenues - related parties                                                                  |       | 49,078                           |       | 39,229 |   |
| Technology licensing                                                                                |       | 9,223                            |       | 11,305 |   |
| Technology licensing - related parties                                                              |       | 90                               |       | 82 |   |
| Total net revenues                                                                                  |       | 97,524                           |       | 81,085 |   |
| Cost of revenues:                                                                                   |       |                             |       |   |   |
| Cost of revenues - unrelated parties                                                                |       | 28,785                           |       | 21,299 |   |
| Cost of revenues - related parties                                                                  |       | 42,218                           |       | 34,077 |   |
| Total cost of revenues                                                                              |       | 71,003                           |       | 55,376 |   |
| Gross profit                                                                                        |       | 26,521                           |       | 25,709 |   |
|                                                                                                |       |                             |       |   |   |
| Operating expenses:                                                                                 |       |                             |       |   |   |
| Research and development                                                                            |       | 13,491                           |       | 15,612 |   |
| Sales and marketing                                                                                 |       | 6,765                            |       | 7,483 |   |
| General and administrative                                                                          |       | 7,038                            |       | 7,183 |   |
| Total operating expenses                                                                            |       | 27,294                           |       | 30,278 |   |
| Loss from operations                                                                                |       | (773                             | )          | (4,569 | ) |
| Interest income                                                                                     |       | 1,830                            |       | 1,302 |   |
| Other income (expense), net                                                                         |       | (20                              | )          | (364 | ) |
| Interest expense                                                                                    |       | (89                              | )          | (64 | ) |
|                                                                                                |       |                             |       |   |   |
| Income (loss) before provision for income  taxes and pro rata share of loss from equity investments |       | 948                              |       | (3,695 | ) |
| Provision for (benefit from) income taxes                                                           |       | 746                              |       | (7,050 | ) |
| Income before pro rata share of loss from  equity investments                                       |       | 202                              |       | 3,355 |   |
| Pro rata share of loss from equity  investments                                                     |       | 1,516                            |       | 1,896 |   |
|                                                                                                |       |                             |       |   |   |
| Net income (loss)                                                                                   |       | $                                | (1,314     | ) | $ | 1,459 |   |
|                                                                                                |       |                             |       |   |   |
| Net income (loss) per share - basic                                                                 |       | $                                | (0.01      | ) | $ | 0.01 |   |
|                                                                                                |       |                             |       |   |   |
| Shares used in per share calculation -  basic                                                       |       | 103,943                          |       | 103,602 |   |
|                                                                                                |       |                             |       |   |   |
| Net income (loss) per share - diluted                                                               |       | $                                | (0.01      | ) | $ | 0.01 |   |
|                                                                                                |       |                             |       |   |   |
| Shares used in per share calculation -  diluted                                                     |       | 103,943                          |       | 104,014 |   |

 

Theaccompanying notes are an integral part of these unaudited condensedconsolidated financial statements.

 

3

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**SILICONSTORAGE TECHNOLOGY, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

**(inthousands)**

 
| ** **                                                                                                                                            | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                                                                                                                            | ** ** | **2007**              | ** ** | **2008**           | ** ** |
| ** **                                                                                                                                            | ** ** | ** **            | ** ** | ** **         | ** ** |
| **ASSETS**                                                                                                                                            |       |                  |       |               |       |
|                                                                                                                                                  |       |                  |       |               |       |
| Current assets:                                                                                                                                       |       |                  |       |               |       |
| Cash and cash equivalents                                                                                                                             |       | $                     | 118,157    |               | $          | 88,323 |   |
| Short-term available-for-sale investments                                                                                                             |       | 44,067                |       | 58,089             |       |
| Trade accounts receivable-unrelated  parties, net of allowance for doubtful accounts of $20 at December 31,  2007 and $16 at March 31, 2008 |       | 19,301                |       | 15,040             |       |
| Trade accounts receivable-related parties                                                                                                             |       | 37,012                |       | 19,160             |       |
| Inventories                                                                                                                                           |       | 50,178                |       | 59,718             |       |
| Other current assets                                                                                                                                  |       | 6,055                 |       | 7,222              |       |
| Total current assets                                                                                                                                  |       | 274,770               |       | 247,552            |       |
|                                                                                                                                                  |       |                  |       |               |       |
| Property and equipment, net                                                                                                                           |       | 18,247                |       | 18,087             |       |
| Long-term available-for-sale investments                                                                                                              |       | 36,160                |       | 53,335             |       |
| Equity investments, GSMC                                                                                                                              |       | 23,150                |       | 23,150             |       |
| Equity investments, ACET                                                                                                                              |       | 20,756                |       | 20,574             |       |
| Equity investments, others                                                                                                                            |       | 10,645                |       | 10,561             |       |
| Goodwill                                                                                                                                              |       | 11,221                |       | 11,221             |       |
| Intangible assets, net                                                                                                                                |       | 7,391                 |       | 6,659              |       |
| Other assets                                                                                                                                          |       | 1,125                 |       | 1,755              |       |
| Total assets                                                                                                                                          |       | $                     | 403,465    |               | $          | 392,894 |   |
|                                                                                                                                                  |       |                  |       |               |       |
| **LIABILITIES**                                                                                                                                       |       |                  |       |               |       |
|                                                                                                                                                  |       |                  |       |               |       |
| Current liabilities:                                                                                                                                  |       |                  |       |               |       |
| Borrowing under line of credit facility                                                                                                               |       | $                     | 6,836      |               | $          | — |   |
| Trade accounts payable-unrelated parties                                                                                                              |       | 23,572                |       | 21,832             |       |
| Trade accounts payable-related parties                                                                                                                |       | 18,495                |       | 19,308             |       |
| Accrued expenses and other liabilities                                                                                                                |       | 21,457                |       | 18,225             |       |
| Deferred revenue                                                                                                                                      |       | 3,004                 |       | 3,312              |       |
| Total current liabilities                                                                                                                             |       | 73,364                |       | 62,677             |       |
|                                                                                                                                                  |       |                  |       |               |       |
| Taxes payable                                                                                                                                         |       | 6,194                 |       | 6,689              |       |
| Other liabilities                                                                                                                                     |       | 1,354                 |       | 1,114              |       |
| Total liabilities                                                                                                                                     |       | 80,912                |       | 70,480             |       |
|                                                                                                                                                  |       |                  |       |               |       |
| Commitments (Note 7) and Contingencies  (Note 8)                                                                                                      |       |                  |       |               |       |
|                                                                                                                                                  |       |                  |       |               |       |
| **SHAREHOLDERS’  EQUITY**                                                                                                                        |       |                  |       |               |       |
|                                                                                                                                                  |       |                  |       |               |       |
| Preferred stock, no par value:                                                                                                                        |       |                  |       |               |       |
| Authorized: 7,000 shares                                                                                                                              |       |                  |       |               |       |
| Series A Junior Participating Preferred Stock, no par value                                                                                      |       |                  |       |               |       |
| Designated: 450 shares                                                                                                                                |       |                  |       |               |       |
| Issued and outstanding: none                                                                                                                          |       |                  |       |               |       |
| Common stock, no par value:                                                                                                                           |       |                  |       |               |       |
| Authorized: 250,000 shares                                                                                                                            |       | 434,905               |       | 430,497            |       |
| Issued and outstanding: 104,198 shares at December 31, 2007 and  102,156 shares at March 31, 2008                                           |       |                  |       |               |       |
| Accumulated other comprehensive income                                                                                                                |       | 31,239                |       | 34,049             |       |
| Accumulated deficit                                                                                                                                   |       | (143,591              | )          | (142,132           | )          |
| Total shareholders’ equity                                                                                                                       |       | 322,553               |       | 322,414            |       |
| Total liabilities and shareholders’ equity                                                                                                       |       | $                     | 403,465    |               | $          | 392,894 |   |

 

The accompanying notes are an integral partof these unaudited condensed consolidated financial statements.

 

4

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**SILICONSTORAGE TECHNOLOGY, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

**(inthousands)**

** **
| ** **                                                                                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2007**                                         | ** ** | **2008** | ** ** |
| ** **                                                                                                 | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                                                      |       |                                             |       |   |   |
| Net income (loss)                                                                                          |       | $                                                | (1,314     | ) | $ | 1,459 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities:                  |       |                                             |       |   |   |
| Depreciation and amortization                                                                              |       | 2,664                                            |       | 2,749 |   |
| Stock-based compensation expense                                                                           |       | 1,574                                            |       | 1,113 |   |
| Credits from doubtful accounts receivable                                                                  |       | (46                                              | )          | (4 | ) |
| Provision for (release from) sales returns                                                                 |       | 82                                               |       | (64 | ) |
| Provision for excess and obsolete  inventories, write-down of inventories and adverse purchase commitments |       | 2,838                                            |       | 1,511 |   |
| Pro rata share of loss from equity  investments                                                            |       | 1,516                                            |       | 1,915 |   |
| Impairment of notes receivable and interest                                                                |       | —                                           |       | 216 |   |
| Gain on disposal of equipment                                                                              |       | —                                           |       | (4 | ) |
| Changes in operating assets and  liabilities:                                                              |       |                                             |       |   |   |
| Trade accounts receivable-unrelated parties                                                                |       | (379                                             | )          | 4,319 |   |
| Trade accounts receivable-related parties                                                                  |       | 15,976                                           |       | 17,862 |   |
| Inventories                                                                                                |       | 5,103                                            |       | (10,685 | ) |
| Other current and non-current assets                                                                       |       | (730                                             | )          | (1,363 | ) |
| Trade accounts payable-unrelated parties                                                                   |       | (11,116                                          | )          | (1,741 | ) |
| Trade accounts payable-related parties                                                                     |       | (14,518                                          | )          | 813 |   |
| Accrued expenses and other liabilities                                                                     |       | (923                                             | )          | (3,149 | ) |
| Deferred revenue                                                                                           |       | 534                                              |       | 307 |   |
| Net cash provided by operating activities                                                                  |       | 1,261                                            |       | 15,254 |   |
| Cash flows from investing activities:                                                                      |       |                                             |       |   |   |
| Purchase of property and equipment                                                                         |       | (1,724                                           | )          | (1,722 | ) |
| Proceeds from sale of equipment                                                                            |       | —                                           |       | 15 |   |
| Purchases of intellectual property license                                                                 |       | (225                                             | )          | — |   |
| Investments in notes receivable                                                                            |       | —                                           |       | (533 | ) |
| Purchases of available-for-sale investments                                                                |       | (17,986                                          | )          | (32,404 | ) |
| Sales and maturities of available-for-sale  investments                                                    |       | —                                           |       | 2,625 |   |
| Net cash used in investing activities                                                                      |       | (19,935                                          | )          | (32,019 | ) |
| Cash flows from financing activities:                                                                      |       |                                             |       |   |   |
| Debt repayments                                                                                            |       | —                                           |       | (6,943 | ) |
| Issuance of shares of common stock                                                                         |       | 1,236                                            |       | 337 |   |
| Repurchases of common stock                                                                                |       | —                                           |       | (6,164 | ) |
| Principal payments of capital leases                                                                       |       | (300                                             | )          | (299 | ) |
| Net cash provided by (used for) financing  activities                                                      |       | 936                                              |       | (13,069 | ) |
| Net decrease in cash and cash equivalents                                                                  |       | (17,738                                          | )          | (29,834 | ) |
| Cash and cash equivalents at beginning of  period                                                          |       | 100,973                                          |       | 118,157 |   |
| Cash and cash equivalents at end of period                                                                 |       | $                                                | 83,235     |   | $ | 88,323 |   |

 

The accompanying notes are an integral partof these unaudited condensed consolidated financial statements.

 

5

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**SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**(Unaudited)**

 

**1. Basis of Presentation**

 

In the opinion of management, theaccompanying unaudited condensed interim consolidated financial statements containall adjustments, all of which are normal and recurring in nature, necessary tofairly state our financial position, results of operations and cash flows. Theresults of operations for the interim periods presented are not necessarilyindicative of the results that may be expected for any future interim periodsor for the full fiscal year. These interim financial statements should be readin conjunction with the audited consolidated financial statements in our AnnualReport on Form 10-K for the year ended December 31, 2007.

 

The year-end balance sheet at December 31,2007 was derived from audited consolidated financial statements, but does notinclude all disclosures required by U.S. generally accepted accountingprinciples. Please refer to the audited consolidated financial statements inour Annual Report on Form 10-K for the year ended December 31, 2007.

 

The preparation of financial statements inconformity with U.S. generally accepted accounting principles requires us tomake estimates and assumptions that affect the reported amounts of assets andliabilities and the disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

 

Certain amounts previously reported have beenreclassified to conform to the current period’s presentation.

* *

*Recent Accounting Pronouncements*

 

In December 2007, Financial AccountingStandards Board, or the FASB issued Statement of Financial Accounting Standard No. 141(Revised 2007), *Business Combinations*, or SFAS No. 141R.SFAS No. 141R will change the accounting for business combinations. UnderSFAS No. 141R, an acquiring entity will be required to recognize all theassets acquired and liabilities assumed in a transaction at theacquisition-date fair value with limited exceptions. SFAS No. 141R willchange the accounting treatment and disclosure for certain specific items in abusiness combination. SFAS No. 141R applies prospectively to businesscombinations for which the acquisition date is on or after the beginning of thefirst annual reporting period beginning on or after December 15, 2008.Accordingly, any business combinations we engage in will be recorded anddisclosed following existing GAAP until January 1, 2009. We expect SFAS No. 141Rwill have an impact on accounting for business combinations once adopted butthe effect is dependent upon acquisitions at that time. We are still assessingthe impact of this pronouncement.

 

In December 2007, the FASB issued SFAS No. 160,*Noncontrolling Interests in Consolidated FinancialStatements—An Amendment of ARB No. 51*, or SFAS No. 160.SFAS No. 160 establishes new accounting and reporting standards for thenoncontrolling interest in a subsidiary and for the deconsolidation of asubsidiary. SFAS No. 160 is effective for fiscal years beginning on orafter December 15, 2008. We have not completed our evaluation of thepotential impact, if any, of the adoption of SFAS No. 160 on our consolidatedfinancial position, results of operations and cash flows.

 

In March 2008, the FASB issuedSFAS 161, *Disclosures about DerivativeInstruments and Hedging Activities, an amendment of FASB Statement 133,*or SFAS 161. SFAS 161amends and expands the disclosure requirements of SFAS 133 with the intentto provide users of financial statements with an enhanced understanding of: (i) howand why an entity uses derivative instruments; (ii) how derivativeinstruments and related hedged items are accounted for under SFAS 133 andits related interpretations and (iii) how derivative instruments andrelated hedged items affect an entity’s financial position, financialperformance and cash flows. This statement is effective for financialstatements issued for fiscal years and interim periods beginning after November 15,2008, with early application encouraged. We are still evaluating the impact ofthis standard but do not expect the adoption of SFAS 161 to have amaterial impact on our financial statements.

 

**2. Fair Value**

 

Effective January 1, 2008, we adopted SFAS No. 157, *Fair Value Measurements*, or SFAS 157.  In February 2008,the FASB issued FASB Staff Position No. FAS 157-2, *EffectiveDate of FASB Statement No. 157*, which provides a one yeardeferral of the effective date of SFAS 157 for non-financial assets andnon-financial liabilities, except those that are recognized or disclosed in thefinancial statements at fair value at least annually (fair value of reportingunits for goodwill impairment tests, non-financial assets and liabilitiesacquired in a business combination). Therefore, we adopted the provisions ofSFAS 157 with respect to its financial assets and liabilities only.  SFAS157 defines fair value, establishes a framework for measuring 

 

6

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fair value under generally accepted accounting principles and enhancesdisclosures about fair value measurements. Fair value is defined under SFAS 157as the exchange price that would be received for an asset or paid to transfer aliability (an exit price) in the principal or most advantageous market for theasset or liability in an orderly transaction between market participants on themeasurement date. Valuation techniques used to measure fair value under SFAS 157must maximize the use of observable inputs and minimize the use of unobservableinputs. The standard describes a fair value hierarchy based on three levels ofinputs, of which the first two are considered observable and the lastunobservable, that may be used to measure fair value which are the following:

 
| · | Level 1 - Quoted prices in active markets  for identical assets or liabilities.                                                                                                                                                                                                                                                                       |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| · | Level 2 - Inputs other than Level 1 that  are observable, either directly or indirectly, such as quoted prices for similar  assets or liabilities; quoted prices in markets that are not active; or other  inputs that are observable or can be corroborated by observable market data  for substantially the full term of the assets or liabilities. |
| · | Level 3 - Unobservable inputs that are  supported by little or no market activity and that are significant to the  fair value of the assets or liabilities.                                                                                                                                                                                           |

 

The adoption of this statement with respectto our financial assets and liabilities, did not impact our consolidatedresults of operations and financial condition, but required additionaldisclosure for assets and liabilities measured at fair value.

 

In accordance with SFAS 157, the followingtable represents the Company’s fair value hierarchy for its financial assets(cash equivalents and investments) measured at fair value on a recurring basisas of March 31, 2008 (in thousands):

 
| ** **                                | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|-----------|------------|
| Money market funds                        |       | $                | 10,464     |             | —     |             | —     |      | $          | 10,464 |   |
| Short term available-for-sale investments |       |             | 58,089     |             | —     |             | —     |      |       | 58,089 |   |
| Long term available-for-sale investments  |       | 53,535           |       | —           |       | —           |       | 53,535    |       |
|                                      |       |             |       |             |       |             |       |      |       |
| Total                                     |       | $                | 121,888    |             | —     |             | —     |      | $          | 121,888 |   |

 

Effective January 1, 2008, we adoptedSFAS No. 159 *The Fair Value Option for Financial Assetsand Financial Liabilities,*  orSFAS 159. SFAS 159 allows an entity the irrevocable option to elect fair valuefor the initial and subsequent measurement for specified financial assets andliabilities on a contract-by-contract basis. We did not elect to adopt the fairvalue option under this Statement.

 

**3. Computation of Net Income (Loss) Per Share**

 

We have computed and presented net income(loss) per share under two methods, basic and diluted. Basic net income (loss)per share is computed by dividing net income (loss) by the weighted average numberof common shares outstanding for the period. Diluted net income (loss) pershare is computed by dividing net income (loss) by the sum of the weightedaverage number of common shares outstanding and potential common shares (whendilutive). A reconciliation of the numerator and the denominator of basic anddiluted net income (loss) per share is as follows (in thousands, except pershare amounts):

 
| ** **                                      | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|
| ** **                                      | ** ** | **March 31,**               | ** ** |
| ** **                                      | ** ** | **2007**                         | ** ** | **2008** | ** ** |
| Numerator -basic                                |       |                             |       |   |   |
| Net income (loss)                               |       | $                                | (1,314     | ) | $ | 1,459 |   |
|                                            |       |                             |       |   |   |
| Denominator - basic                             |       |                             |       |   |   |
| Weighted average common stock outstanding       |       | 103,943                          |       | 103,602 |   |
|                                            |       |                             |       |   |   |
| Basic net income (loss) per share               |       | $                                | (0.01      | ) | $ | 0.01 |   |
|                                            |       |                             |       |   |   |
| Denominator - diluted                           |       |                             |       |   |   |
| Weighted average common stock outstanding       |       | 103,943                          |       | 103,602 |   |
| Dilutive potential of common stock  equivalents |       | —                           |       | 412 |   |
| Total                                           |       | 103,943                          |       | 104,014 |   |
|                                            |       |                             |       |   |   |
| Diluted net income (loss) per share             |       | $                                | (0.01      | ) | $ | 0.01 |   |

 

7

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Stock options to purchase 11,606,610 sharesof common stock were outstanding as of March 31, 2007 with a weightedaverage exercise price of $6.82. These stock options were not included in thecomputation of diluted net loss per share for the three months ended March 31,2007 because we had a net loss for this period. Stock options to purchase10,371,185 shares with a weighted average share price of $7.44 were outstandingand not included in the computation of diluted net income per share for thethree months ended March 31, 2008 since the exercise price of theseoptions exceeded the average fair market value of our common stock for thethree months ended March 31, 2008.

** **

**4. Stock Compensation**

*** ***

***Employee Stock Purchase Plan***

 

Our 1995 Employee Stock Purchase Plan, or thePurchase Plan, as amended, has 6.0 million shares of common stock reservedfor issuance. The Purchase Plan provides for eligible employees to purchaseshares of common stock at a price equal to 90% of the fair value of our commonstock six months after the option date by withholding up to 10% of their annualbase earnings. As of March 31, 2008, 368,000 shares were available forpurchase under the Purchase Plan. Shares issued under the Purchase Plan for thethree months ended March 31, 2008 were 118,000 for $282,000.

*** ***

***Equity Incentive Plan***

 

Our 1995 Equity Incentive Plan, or the EquityIncentive Plan, as amended, has 31.8 million shares of common stockreserved for issuance upon the exercise of stock options to our employees,consultants and affiliates. Under the Equity Incentive Plan, the Board ofDirectors has the authority to determine to whom options will be granted, thenumber of shares under option, the option term and the exercise price. Theoptions generally are exercisable beginning one year from the date of grant andgenerally thereafter over four years from the date of grant. The term of anyoptions issued may not exceed ten years from the date of grant.

*** ***

***Directors’ Stock Option Plan***

 

Each of our non-employee directors receivesstock option grants under our 1995 Non-Employee Directors’ Stock Option Plan,or the Directors’ Plan, as amended. Pursuant to the Directors’ Plan, upon eachnon-employee director’s initial election or appointment to the Board, such newnon-employee director receives an initial stock option grant for 45,000 sharesof common stock. Each initial stock option grant vests as to 25% of the sharessubject to the grant on the anniversary of the grant date. In addition, eachnon-employee director will receive a fully vested annual stock option grant for12,000 shares of common stock on the date of the annual shareholders meeting.As of March 31, 2008, the Directors’ Plan had 124,000 shares available forissuance.

*** ***

***Compensation Expense***

 

We recognize stock-based compensation on thegraded vesting method over the vesting periods of the stock options, generallyfour years. The graded vesting method provides for vesting of portions of theoverall awards at interim dates and results in accelerated vesting as comparedto the straight-line method.

 

8

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The amount of recognized compensation expensefor our stock option plans is adjusted based upon an estimated forfeiture ratewhich is derived from historical data.

 

The Purchase Plan provides for eligibleemployees to purchase shares of common stock at a price equal to 90% of thefair value of our common stock on the last day of each six-month offeringperiod. The compensation is the difference between the fair value and purchaseprice on the date of purchase.

 

The following table shows total stock-basedcompensation expense included in the condensed consolidated statement ofoperations (in thousands):

 
| ** **                                      | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                      | ** ** | **2007**                                         | ** ** | **2008** | ** ** |
| ** **                                      | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Cost of goods sold                              |       | $                                                | 131        |   | $ | 65 |   |
| Research and development                        |       | 784                                              |       | 477 |   |
| Sales and marketing                             |       | 276                                              |       | 172 |   |
| General and administrative                      |       | 383                                              |       | 399 |   |
| Tax effect of stock-based compensation  expense |       | —                                           |       | — |   |
| Effect on net income                            |       | $                                                | 1,574      |   | $ | 1,113 |   |

 

Stock-based compensation of $88,000 and$54,000 was capitalized in inventory as of March 31, 2008 and December 31,2007, respectively. The tax benefit from the exercise of options was $0 for thethree months ended March 31, 2007 and 2008, respectively.

 

As of March 31, 2008, we had unrecognizedcompensation expense from stock options of $6.8 million excluding estimatedforfeitures.

** **

**5. Investments**

 

We consider cash and all highly liquidinvestments purchased with an original or remaining maturity of less than threemonths at the date of purchase to be cash equivalents. Substantially all of ourcash and cash equivalents are in the custody of three major financialinstitutions.

 

Short and long-term investments, which arecomprised of federal, state and municipal government obligations, foreign andpublic corporate debt securities and marketable equity securities, areclassified as available-for-sale and carried at fair value, based on quotedmarket prices, with the unrealized gains or losses, net of tax, reported inshareholders’ equity as other comprehensive income. The cost of debt securitiesis adjusted for amortization of premiums and accretion of discounts tomaturity, both of which are included in interest income. Realized gains andlosses are recorded on the specific identification method.

 

Investments in privately held enterprises andcertain restricted stocks are accounted for using either the cost or equitymethod of accounting, as appropriate. Each period, we evaluate whether an eventor change in circumstances had occurred that may indicate an investment hasbeen impaired. If upon further investigation of such events we determine theinvestment has suffered a decline in value that is other than temporary, wewrite down the investment to its estimated fair value. As of March 31,2008 and December 31, 2007 the carrying value of these investments was$54.3 million and $54.6 million, respectively.

 

King Yuan Electronics Company Limited, orKYE, Insyde Software Corporation, or Insyde, Powertech Technology,Incorporated, or PTI and Professional Computer Technology Limited, or PCT, areTaiwanese companies that are listed on the Taiwan Stock Exchange. Equityinvestments in these companies have been included in “Long-termavailable-for-sale investments.” The investments that are not available forresale due to local securities regulations within one year at the balance sheetdate are recorded at cost. The investments that are available for resale withinone year at the balance sheet date are recorded at fair value, with unrealizedgains and losses, net of tax, reported in shareholders’ equity as othercomprehensive income. If a decline in value is judged to be other thantemporary, it is reported as an impairment of equity investments. Cashdividends and other distributions of earnings from the investees, if any, areincluded in other income when declared.

 

In September 2006, we invested anadditional $15.9 million in Advanced Chip EngineeringTechnology Inc., or ACET, that increased our ownership share of ACET’soutstanding capital stock from 9.4% to 46.9% and required us to change from thecost method of accounting to the equity method of accounting for thisinvestment. Under the equity method of accounting, we are required to recordour ownership interest in ACET’s reported net income or loss each reportingperiod

 

9

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as well as restate our prior period financial statements to reflect theequity method of accounting from the date of the initial investment. Ouroperating results now include a line item titled “pro rata share of loss fromequity investments” on our condensed consolidated statement of operations wherewe record these expenses. In the third quarter of 2007 we made an additionalcash investment, along with other third-party investors, of $10.3 millionin ACET’s common stock. Our total investment currently represents 38.5% of theoutstanding equity of ACET at March 31, 2008.

 

The table below presents unaudited summarizedinformation regarding ACET’s results of operation without any pro-rataadjustments for our percentage ownership of the outstanding equity of ACET (inthousands):

 
| ** ** | ** ** | **For the three months  ended March 31,** | ** ** |
|------------|------------|--------------------------------------------------------------------|------------|
| ** ** | ** ** | **2007**                                                           | ** ** | **2008** | ** ** |
| Net sales  |       | $                                                                  | 146        |   | $ | 619 |   |
| Gross loss |       | $                                                                  | (2,082     | ) | $ | (2,546 | ) |
| Net loss   |       | $                                                                  | (3,067     | ) | $ | (3,937 | ) |

 

We owned 9.8% of the equity of GraceSemiconductor Manufacturing Corporation, or GSMC as of March 31, 2008 witha carrying value of $23.2 million.

 

The fair values of available-for-saleinvestments as of March 31, 2008 were as follows (in thousands):

 
| ** **                                                      | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gain** | ** ** | **Unrealized  Loss** | ** ** | **Fair Value** | ** ** |
|-----------------------------------------------------------------|------------|---------------------|------------|----------------------|------------|----------------------|------------|---------------------|------------|
| Money market funds                                              |       | $                   | 10,464     |                 | $          | —               |       | $                   | —     |   | $ | 10,464 |   |
| Corporate bonds and notes                                       |       |                | 17,979     |                 |       | 43                   |       |                | —     |   |   | 18,022 |   |
| Government bonds and notes                                      |       | 55,798              |       | 316                  |       | —               |       | 56,114              |       |
| Foreign listed equity securities                                |       | 4,945               |       | 32,343               |       | —               |       | 37,288              |       |
| Total bonds, notes and equity securities                        |       | $                   | 89,186     |                 | $          | 32,702               |       | $                   | —     |   | $ | 121,888 |   |
| Less amounts classified as cash equivalents                     |       |                |       |                 |       |                 |       | (10,464             | )          |
| Total short and long-term  available-for-sale investments       |       |                |       |                 |       |                 |       | $                   | 111,424    |   |
| Contractual maturity dates for investments  in bonds and notes: |       |                |       |                 |       |                 |       |                |       |
| Less than one year                                              |       |                |       |                 |       |                 |       | 58,089              |       |
| One to five years                                               |       |                |       |                 |       |                 |       | 16,046              |       |
|                                                            |       |                |       |                 |       |                 |       | 74,135              |       |

 

Securities are classified as current if theyare expected to be realized in cash or sold or consumed during the normal operatingcycle of our business.

 

The unrealized gains and losses as of March 31,2008 are recorded in accumulated other comprehensive income, net of tax.

 

The fair valueof available-for-sale investments, including restricted available-for-saleinvestments, as of December 31, 2007 were as follows (in thousands):

 
| ** **                                                      | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gain** | ** ** | **Unrealized  Loss** | ** ** | **Fair  Value** | ** ** |
|-----------------------------------------------------------------|------------|---------------------|------------|----------------------|------------|----------------------|------------|-----------------|------------|
| Money market funds                                              |       | $                   | 39,996     |                 | $          | —               |       | $               | —     |   | $ | 39,996 |   |
| Corporate bonds and notes                                       |       |                | 9,955      |                 |       | —               |       |            | (5         | ) |   | 9,950 |   |
| Government bonds and notes                                      |       | 34,055              |       | 62                   |       | —               |       | 34,117          |       |
| Foreign listed equity securities                                |       | 4,999               |       | 31,215               |       | —               |       | 36,160          |       |
| Total bonds, notes and equity securities                        |       | $                   | 89,005     |                 | $          | 31,277               |       | $               | (5         | ) | $ | 120,223 |   |
| Less amounts classified as cash equivalents                     |       |                |       |                 |       |                 |       | (39,996         | )          |
| Total short and long-term  available-for-sale investments       |       |                |       |                 |       |                 |       | $               | 80,227     |   |
| Contractual maturity dates for investments  in bonds and notes: |       |                |       |                 |       |                 |       |            |       |
| Less than one year                                              |       |                |       |                 |       |                 |       | 84,063          |       |
| One to five years                                               |       |                |       |                 |       |                 |       | —          |       |
|                                                            |       |                |       |                 |       |                 |       | $               | 84,063     |   |

 

10

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The unrealized gains and losses as of December 31, 2007 arerecorded in accumulated other comprehensive income, net of tax.

We compare the carrying value of our available for sale investmentswith their quoted market prices at the end of each period. If the quoted marketprice of a marketable security has dropped significantly during a period or hasbeen below our carrying value for an extended period of time, we review theinvestment to determine whether the decline is other than temporary. In makingthis determination, we consider among other things, the investee’s recentoperating performance, cash position and revenue and earnings outlook. If wedetermine that the decline is other than temporary, the investment is writtendown to its market value as measured at the end of the period. Any resultingcharge is included in our statement of operations in the related period. Futureincreases in the quoted market value of the investment are not recognized untilthe underlying securities are sold.

 

**6. Selected Balance Sheet Detail**

 

Details of selected balance sheet accounts are as follows (inthousands):

 

Inventories comprise:

 
| ** **                                          | ** ** | **December 31,  2007** | ** ** | **March 31,  2008** | ** ** |
|-----------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| Raw materials                                       |       | $                           | 21,301     |                     | $          | 28,141 |   |
| Work in-process                                     |       | 14,742                      |       | 10,878                   |       |
| Finished goods                                      |       | 8,419                       |       | 14,812                   |       |
| Finished goods inventories held at logistics center |       | 5,716                       |       | 5,887                    |       |
|                                                |       | $                           | 50,178     |                     | $          | 59,718 |   |

 

Inventories are stated at the lower of cost, determined on a first-in,first-out basis, or market value. We typically plan our production andinventory levels based on internal forecasts of customer demand, which arehighly unpredictable and can fluctuate substantially. The value of ourinventory is dependent on our estimate of future average selling prices, and,if our projected average selling prices are over estimated, we may be requiredto adjust our inventory value. If we over estimate future market demand, we mayend up with excess inventory levels that cannot be sold within a normaloperating cycle and we may be required to record a provision for excessinventory. Our inventories include high technology parts and components thatare specialized in nature or subject to rapid technological obsolescence. Someof our customers have requested that we ship them product that has a finishedgoods date of manufacture less than one year. In the event that this becomes acommon requirement, it may be necessary for us to provide for an additionalallowance for our on-hand finished goods inventory with a date of manufactureof greater than one year, which could result in a significant adjustment andcould harm our financial results. We review on-hand inventory includinginventory held at the logistic center for potential excess, obsolescence andlower of cost or market exposure and record provisions accordingly. Due to thelarge number of units in our inventory, even a small change in average sellingprices could result in a significant adjustment and have a material impact onour financial position and results of operations.

 

Our allowance for excess and obsolete inventories includes a provisionfor finished goods inventory with a date of manufacture of greater than twoyears and for certain products with a date of manufacture of greater than oneyear. In addition, our allowance includes a provision for die, work-in-processand finished goods inventories that exceed our estimated forecast for the nexttwelve to twenty four months. For the obsolete inventory analysis, we reviewinventory items in detail and consider date code, customer base requirements,known product defects, planned or recent product revisions, end of life plansand diminished market demand. For excess inventory, we review inventory itemsin detail and consider our customer base requirements and market demand. Whilewe have programs to minimize inventories on hand and we consider technologicalobsolescence when estimating allowances for potentially excess and obsoleteinventories and those required to reduce recorded amounts to market values, itis reasonably possible that such estimates could change in the near term. Suchchanges in estimates could have a material impact on our financial position andresults of operations. For the three months ended March 31, 2008, we soldpreviously written down inventory for a total of $1.6 million. 

 

Accrued expenses and other liabilities comprise (in thousands):

 
| ** **                             | ** ** | **December 31,  2007** | ** ** | **March 31,  2008** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| Accrued compensation and related items |       | $                           | 10,223     |                     | $          | 8,247 |   |
| Accrued adverse purchase commitments   |       | 111                         |       | 443                      |       |
| Accrued commission                     |       | 1,859                       |       | 1,838                    |       |
| Accrued vendor invoices                |       | (42                         | )          | 212                      |       |
| Accrued income tax payable             |       | 180                         |       | 142                      |       |
| Accrued warranty                       |       | 358                         |       | 209                      |       |
| Accrued legal and accounting fees      |       | 6,047                       |       | 3,425                    |       |
| Other accrued liabilities              |       | 2,721                       |       | 3,709                    |       |
|                                   |       | $                           | 21,457     |                     | $          | 18,225 |   |

 

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Changes in the warranty reserves during the three months ended March 31,2007 and 2008 were as follows (in thousands):

 
| ** **                                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                   | ** ** | **2007**                                         | ** ** | **2008** | ** ** |
| Beginning balance                            |       | $                                                | 298        |   | $ | 358 |   |
| Provisions for warranty                      |       | 1,074                                            |       | 43 |   |
| Warranty returns                             |       | (677                                             | )          | (135 | ) |
| Rescreening, retesting and other settlements |       | (167                                             | )          | (57 | ) |
| Ending balance                               |       | $                                                | 528        |   | $ | 209 |   |

 

Our products are generally subject to warranty and we provide for theestimated future costs of repair, replacement or customer accommodation uponshipment of the product in our condensed consolidated statements of operations.Our warranty accrual is estimated based on historical claims compared tohistorical revenues. For new products, we use our historical percentage for theappropriate class of product.

 

**7. Commitments**

 

Our technology licenseagreements generally include an indemnification clause that indemnifies thelicensee against liability and damages (including legal defense costs) arisingfrom any claims of patent, copyright, trademark or trade secret infringement byour proprietary technology. The terms of these guarantees approximate the termsof the technology license agreements, which typically range from five to tenyears. Our current license agreements expire from 2007 through 2014. Themaximum possible amount of future payments we could be required to make, ifsuch indemnifications were required on all of these agreements, is$51.3 million. We have not recorded any liabilities as of March 31,2008 related to these indemnities as no such claims have been made or asserted.

 

During our normal course of business, we have made certain indemnities,commitments and guarantees under which we may be required to make payments inrelation to certain transactions. These include indemnities to various lessorsin connection with facility leases for certain claims arising from suchfacility or lease and indemnities to our directors and officers to the maximumextent permitted under the laws of California. In addition, we have contractualcommitments to some customers, which could require us to incur costs to repairan epidemic defect with respect to our products outside the normal warrantyperiod if such defect were to occur. The duration of these indemnities,commitments and guarantees varies. The majority of these indemnities,commitments and guarantees do not provide for any limitation of the maximumpotential future payments that we could be obligated to make. We have notrecorded any liability for these indemnities, commitments and guarantees in theaccompanying condensed consolidated balance sheets. We do, however, accrue forlosses for any known contingent liability, including those that may arise fromindemnification provisions, when future payment is probable and the amount is reasonablyestimatable.

 

**8. Contingencies**

 

In January and February 2005multiple shareholder derivative complaints were filed in California SuperiorCourt for the County of Santa Clara, purportedly on behalf of SST againstcertain of our directors and officers. The derivative complaints assertedclaims for, among other things, breach of fiduciary duty and violations of theCalifornia Corporations Code. These derivative actions were consolidated underthe caption *In Re Silicon Storage Technology, Inc. DerivativeLitigation,* Lead Case No. 1:05CV034387 (Cal. Super. Ct., SantaClara Co.). On April 28, 2005, the derivative action was stayed bycourt order. On October 19, 2007, following the dismissal with prejudiceof certain federal putative class actions, the court lifted this stay. On December 6,2007, plaintiffs filed a consolidated amended complaint reiterating some of theprevious claims and asserting claims substantially identical to those containedin the *Chuzhoy v. Yeh* (Cal. Super. Ct., SantaClara Co.) and *In re Silicon StorageTechnology, Inc., Derivative Litigation* (N.D. Cal., San JoseDiv.) putative derivative actions. We intend to continue to take allappropriate actions in response to this lawsuit. The impact related to theoutcome of this matter is undeterminable at this time.

 

12

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On July 13, 2006, ashareholder derivative complaint was filed in the United States District Courtfor the Northern District of California by Mike Brien under the caption *Brien v. Yeh, et al*., Case No. C06-04310 JF (N.D.Cal.). On July 18, 2006, a shareholder derivative complaint was filed inthe United States District Court for the Northern District of California byBehrad Bazargani under the caption *Bazargani v. Yeh, et al*.,Case No. C06-04388 HRL (N.D. Cal.). Both complaints were broughtpurportedly on behalf of SST against certain of our current directors andcertain of our current and former officers and allege among other things, thatthe named officers and directors: (a) breached their fiduciary duties asthey colluded with each other to backdate stock options, (b) violated Rule 10b-5of the Securities Exchange Act of 1934 through their alleged actions, and (c) wereunjustly enriched by their receipt and retention of such stock options. The *Brien* and *Bazargani* caseswere consolidated into one case: *In re Silicon StorageTechnology, Inc.**Derivative Litigation*,Case No. C06-04310 JF and a consolidated amended shareholder derivativecomplaint was filed on October 30, 2006. On May 9, 2008 plaintiff filedtheir second consolidated shareholder derivative complaint. Our response is dueMay 19, 2008. On October 31, 2006, a similar shareholder derivativecomplaint was filed in the Superior Court of the State of California for the Countyof Santa Clara by Alex Chuzhoy under the caption *Chuzhoy v.Yeh, et al.,* Case No. 1-06-CV-074026. This complaint wasbrought purportedly on behalf of SST against certain of our current directorsand certain of our current and former officers and alleges among other things,that the named officers and directors breached their fiduciary duties as theycolluded with each other to backdate stock options and were allegedly unjustlyenriched by their actions. The *Chuzhoy*complaint also alleges that certain of our officers and directors violatedsection 25402 of the California Corporations Code by selling shares of ourcommon stock while in possession of material non-public adverse information. Noresponse is due until after the plaintiff files an amended complaint. We intendto take all appropriate action in responding to all of the complaints.

 

On or about July 13, 2007, a patent infringement suit was broughtby OPTi Inc. in the United States District Court for the Eastern Districtof Texas alleging infringement of two United State patents related to a “CompactISA-bus Interface”. The plaintiff seeks a permanent injunction, and damages foralleged past infringement, as well as any other relief the court may grant thatis just and proper. At this time, discovery has not yet commenced, and weintend to vigorously defend the suit.

 

From time to time, we are also involved in other legal actions arisingin the ordinary course of business. We have accrued certain costs associatedwith defending these matters. There can be no assurance that the shareholderclass action complaints, the shareholder derivative complaints or other thirdparty assertions will be resolved without costly litigation, in a manner thatis not adverse to our financial position, results of operations or cash flowsor without requiring payments in the future which may adversely impact netincome. No estimate can be made of the possible loss or possible range of lossassociated with the resolution of these contingencies. As a result, no lossesassociated with these or other litigation have been accrued in our financialstatements as of March 31, 2008.

 

**9. Line of Credit**

 

OnAugust 07, 2007, SST China Limited entered into a one year facilityagreement with Bank of America, N.A. Shanghai Branch, a U.S. bank, for RMB58.40 million revolving line of credit. The line of credit will be used forworking capital but there are no restrictions in the agreement as to how thefunds may be used.  The interest rate forthe line of credit is 90% of People’s Bank of China’s base rate (6.57% at March 31,2008).  This facility line is guaranteedby the parent company, Silicon Storage Technology, Inc. SST is required tomeet certain financial covenants, including have a ratio of the funded debt toEBITA less than 2.0. If not, we have to deposit with Bank of America cashcollateral at all times in an amount equal to the outstanding principalbalance. During the period ending March 31, 2008 we repaid the balance onthis line of credit in the amount of $6.9 million and as of March 31,2008, SST China Limited has no outstanding balance against this line. We are incompliance with all terms of this facility agreement.

 

**10. Goodwill and Intangible Assets:**

 

Our goodwill and intangibleassets include $11.2 million of goodwill and $16.5 million of identifiableintangible assets acquired from acquisitions made in 2004 and 2005 and $3.0million of purchased intellectual property. The goodwill is not being amortizedbut is tested for impairment annually, as well as when an event or circumstanceoccurs indicating a possible impairment in value. In the first quarter of 2008,we reclassed approximately a net $23,000 in intellectual property intooperating expense.

 

As of March 31, 2008, our intangible assets consisted of thefollowing (in thousands):

 
| ** **             | ** ** | **Cost** | ** ** | **Accumulated  Amortization** | ** ** | **Accumulated  Impairment** | ** ** | **Net** | ** ** |
|------------------------|------------|----------|------------|-------------------------------|------------|-----------------------------|------------|---------|------------|
| Existing technology    |       | $        | 11,791     |                          | $          | (8,529                      | )          | $       | (384       | ) | $ | 2,878 |   |
| Intellectual property  |       | 3,030    |       | (128                          | )          | —                      |       | 2,902   |       |
| Trade name             |       | 1,198    |       | (852                          | )          | —                      |       | 346     |       |
| Customer relationships |       | 1,857    |       | (1,491                        | )          | —                      |       | 366     |       |
| Backlog                |       | 811      |       | (811                          | )          | —                      |       | —  |       |
| Non-Compete Agreements |       | 810      |       | (643                          | )          | —                      |       | 167     |       |
|                   |       | $        | 19,497     |                          | $          | (12,454                     | )          | $       | (384       | ) | $ | 6,659 |   |

 

13

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As of December 31,2007, our intangible assets consisted of the following (in thousands):

 
| ** **             | ** ** | **Cost** | ** ** | **Accumulated  Amortization** | ** ** | **Accumulated  Impairment** | ** ** | **Net** | ** ** |
|------------------------|------------|----------|------------|-------------------------------|------------|-----------------------------|------------|---------|------------|
| Existing technology    |       | $        | 11,791     |                          | $          | (7,996                      | )          | $       | (384       | ) | $ | 3,411 |   |
| Intellectual property  |       | 3,053    |       | (98                           | )          | —                      |       | 2,955   |       |
| Trade name             |       | 1,198    |       | (792                          | )          | —                      |       | 406     |       |
| Customer relationships |       | 1,857    |       | (1,446                        | )          | —                      |       | 411     |       |
| Backlog                |       | 811      |       | (811                          | )          | —                      |       | —  |       |
| Non-Compete Agreements |       | 810      |       | (602                          | )          | —                      |       | 208     |       |
|                   |       | $        | 19,520     |                          | $          | (11,745                     | )          | $       | (384       | ) | $ | 7,391 |   |

 

All intangible assets are being amortized on a straight-line basis overtheir estimated useful lives. Existing technologies have been assigned usefullives of between four and five years, with a weighted average life ofapproximately 4.6 years. Non-compete agreements have been assigned usefullives between two and four years, with a weighted average of 3.6 years.Intellectual property has been assigned an estimated life of three to fiveyears and will begin amortization as it is put into service. Trade names andbacklogs have been assigned useful lives of five years, and one year, respectively.Customer relationships have been assigned useful lives between three and fiveyears with a weighted average of 4.0 years. Amortization expense forintangible assets were $941,000 and $709,000 for the three months ended March 31,2007 and 2008, respectively.

 

Estimated future intangible asset amortization expense for the nextfive years is as follows (in thousands):

 
| **Fiscal Year**       | ** ** | **Amortization of  Intangible Assets** | ** ** |
|----------------------------|------------|--------------------------------------------------|------------|
| 2008 remaining nine months |       | $                                                | 2,481      |   |
| 2009                       |       | 2,572                                            |       |
| 2010                       |       | 1,040                                            |       |
| 2011                       |       | 566                                              |       |
| 2012 and thereafter        |       | —                                           |       |
|                       |       | $                                                | 6,659      |   |

 

There was no change in the carrying amount of goodwill for the threemonths ended March 31, 2008 from December 31, 2007.

 

**11. Segment Reporting**

 

Our Memory Product segment,which is comprised of NOR flash memory products, includes the Multi-PurposeFlash or MPF family, the Multi-Purpose Flash Plus or MPF+ family, theConcurrent SuperFlash or CSF family, the Firmware Hub or FWH family, the SerialFlash family, the ComboMemory family, the Many-Time Programmable or MTP family,and the Small Sector Flash or SSF family.

 

Our Non-Memory Productssegment is comprised of all other semiconductor products including flashmicrocontrollers, smartcard ICs and modules, radio frequency ICs and modules,NAND controllers and NAND-controller based modules.

 

Technology Licensingincludes both license fees and royalties generated from the licensing of ourSuperFlash technology to semiconductor manufacturers for use in embedded flashapplications.

 

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We do not allocate operating expenses, interest and otherincome/expense, interest expense, impairment of equity investments or provisionfor or benefit from income taxes to any of these segments for internalreporting purposes, as we do not believe that allocating these expenses arebeneficial in evaluating segment performance. Additionally, we do not allocateassets to segments for internal reporting purposes as we do not manage oursegments by such metrics. The following table shows our revenues and grossprofit for each segment (in thousands):

 
| ** **           | ** ** | **Three Months Ended  March 31, 2007** | ** ** | **Three Months Ended  March 31, 2008** | ** ** |
|----------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **           | ** ** | **Revenues**                                               | ** ** | **Gross  Profit**                                          | ** ** | **Revenues** | ** ** | **Gross  Profit** | ** ** |
| ** **           | ** ** | ** **                                                 | ** ** | ** **                                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Memory               |       | $                                                          | 78,616     |                                                       | $          | 15,063 |   | $ | 61,690 |   | $ | 12,675 |   |
| Non-Memory           |       | 9,595                                                      |       | 2,145                                                      |       | 8,008 |   | 1,647 |   |
| Technology Licensing |       | 9,313                                                      |       | 9,313                                                      |       | 11,387 |   | 11,387 |   |
|                 |       | $                                                          | 97,524     |                                                       | $          | 26,521 |   | $ | 81,085 |   | $ | 25,709 |   |

 

**12. Related Party Transactions and Balances**

 

The following table is a summary of our related party revenues andpurchases for the three months ended March 31, 2007 and 2008, and ourrelated party accounts receivable and accounts payable and accruals as of December 31,2007 and March 31, 2008 (in thousands):

 
| ** **                                                      | ** ** | **Revenues**       | ** ** | **Purchases**      | ** ** |
|-----------------------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                                      | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
| ** **                                                      | ** ** | **2007**           | ** ** | **2008**           | ** ** | **2007** | ** ** | **2008** | ** ** |
| Silicon Technology Co., Ltd.                          |       | $                  | 265        |               | $          | — |   | $ | — |   | $ | — |   |
| Apacer Technology, Inc. & related entities        |       | 765                |       | 724                |       | — |   | — |   |
| Advanced Chip Engineering Technology, Inc.                 |       | —             |       | —             |       | — |   | 207 |   |
| Professional Computer Technology Limited & related entities |       | 48,048             |       | 38,505             |       | — |   | — |   |
| Grace Semiconductor Manufacturing Corp.                         |       | 90                 |       | 82                 |       | 15,841 |   | 21,457 |   |
| King Yuan Electronics Company, Limited                          |       | —             |       | —             |       | 7,523 |   | 5,415 |   |
| Powertech Technology, Incorporated                              |       | —             |       | —             |       | 4,451 |   | 5,183 |   |
|                                                            |       | $                  | 49,168     |               | $          | 39,311 |   | $ | 27,815 |   | $ | 32,262 |   |

 
| ** **                                                      | ** ** | **Trade Accounts Receivable** | ** ** | **Account Payable and  Accruals** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                      | ** ** | **December 31,  2007**             | ** ** | **March 31,  2008**                    | ** ** | **December 31,  2007** | ** ** | **March 31,  2008** | ** ** |
| Silicon Technology Co., Ltd.                          |       | $                                       | —     |                                        | $          | — |   | $ | — |   | $ | — |   |
| Apacer Technology, Inc. & related entities        |       | 51                                      |       | 375                                         |       | — |   | — |   |
| Advanced Chip Engineering Technology, Inc.                 |       | —                                  |       | —                                      |       | 11 |   | 215 |   |
| Professional Computer Technology Limited & related entities |       | 36,789                                  |       | 18,644                                      |       | 624 |   | 375 |   |
| Grace Semiconductor Manufacturing Corp.                         |       | 172                                     |       | 141                                         |       | 8,490 |   | 11,201 |   |
| King Yuan Electronics Company, Limited                          |       | —                                  |       | —                                      |       | 5,509 |   | 4,068 |   |
| Powertech Technology, Incorporated                              |       | —                                  |       | —                                      |       | 3,861 |   | 3,449 |   |
|                                                            |       | $                                       | 37,012     |                                        | $          | 19,160 |   | $ | 18,495 |   | $ | 19,308 |   |

 

15

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Professional Computer Technology Limited, or PCT, earns commissions forpoint-of-sales transactions to customers. PCT’s commissions are paid at thesame rate as all of our other stocking representatives in Asia. In addition, wepay Silicon Professional Technology Ltd., or SPT, a wholly-ownedsubsidiary of PCT, a fee for providing logistics center functions. This fee isbased on a percentage of revenue for each product shipped through SPT to ourend customers. The fee paid to SPT covers the costs of warehousing and insuringinventory and processing accounts receivable, the personnel costs required tomaintain logistics and information technology functions and the costs toperform demand forecasting, billing and collection of accounts receivable.

 

**13. Income Taxes**

 

Wemaintained a full valuation allowance on our net deferred tax assets as of March 31,2008. The valuation allowance was determined in accordance with the provisionsof Statement of Financial Accounting Standards No. 109, *Accounting for Income Taxes*, or SFAS No. 109, whichrequires an assessment of both positive and negative evidence when determiningwhether it is more likely than not that deferred tax assets are recoverable;such assessment is required on a jurisdiction by jurisdiction basis. We intendto maintain a full valuation allowance on the U.S. deferred tax assets untilsufficient positive evidence exists to support reversal of the valuationallowance.

 

Ourtax provision for the first quarter of 2008 was a benefit of approximately$7.1million. This consists of a $7.9 million benefit due to a refund from anIRS settlement from an amended return, and $0.8 million charge related toforeign income and withholding taxes. The tax refund of $7.9 million included$6.1 million of tax and $1.8 million of interest.  Our tax provision for the first quarter of2007 was approximately $0.7 million. This consists primarily of foreign incomeand withholding taxes.

 

Theprovision for income tax decreased approximately $7.8 million in the firstquarter of 2008 as compared to the same period in 2007. The decrease is dueprimarily to an IRS settlement from an amended return. Since the tax positiontaken in the refund claim did not meet the more likely than not recognitionthreshold under FIN 48, thus we had not previously recognized the tax benefitof this position. Therefore, upon settlement with the IRS the entire amount ofthe refund is recorded as a benefit provision in the current quarter. Therewere no other material changes to our unrecognized tax benefits in the quarter.We do not anticipate any material changes to our uncertain tax positions overthe next 12 months. We continue to include interest and penalties, if any, intax expense.

 

**14. Stock Repurchase Program**

 

On February 6, 2008, weannounced that our Board of Directors authorized management to repurchase up to$30 million of our common stock at any time commencing February 11,2008.  The program does not obligate usto acquire shares at any particular price per share and may be suspended at anytime at our discretion. During the quarter ended March 31, 2008, wepurchased and retired 2.2 million shares for an aggregated cost of$6.2 million.

** **

**15. Subsequent Event**

 

On May 1, 2008, we completed our tender offer by which activeemployees who were option holders were offered the opportunity to amend orexchange their options to avoid the adverse tax consequences of Section 409A.  A total of 1,535,000 Section 409A shares weretendered and 4,855,000 underwater shares were tendered in exchange for a totalof 1,981,000 new options issued. The new options have an exercise price of$3.19 per share, the closing price of our common stock as reported on theNASDAQ Global Market on May 1, 2008.

 

16

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**Item 2.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations.**

 

*The following discussion may be understood more fully by reference tothe consolidated financial statements, notes to the consolidated financialstatements and management’s discussion and analysis of financial condition andresults of operations contained in our Annual Report on Form 10-K for theyear ended December 31, 2007, as filed with the Securities and ExchangeCommission.*

* *

*The following discussion contains forward-looking statements, whichinvolve risk and uncertainties. All forward-looking statements included in thisdocument are based on information available to us on the date hereof, and weassume no obligation to update any such forward-looking statements. Our actualresults could differ materially from those anticipated in these forward-lookingstatements as a result of certain factors which are difficult to forecast andcan materially affect our quarterly or annual operating results. Fluctuations inrevenues and operating results may cause volatility in our stock price. Pleasealso see Item 1A. “Risk Factors.”*

 

**Overview**

 

We are a leading supplier of NOR flash memory semiconductor devices forthe digital consumer, networking, wireless communications and Internetcomputing markets. NOR flash memory is a form of nonvolatile memory that allowselectronic systems to retain information when the system is turned off. NORflash memory is now used in hundreds of millions of consumer electronics andcomputing products annually.

 

We produce and sell many products based on our SuperFlash design andmanufacturing process technology. Our products are incorporated into productssold by many well-known companies including Apple, Asustek, Cambridge SiliconRadio, Canon, Compal, Dell, Epson, First International Computer, FIC, Foxconn,or Honhai, Fujitsu, Funai, Garmin, Gigabyte, GN Netcom, Haier, Hewlett Packard,Huawei, Infineon, Intel, IBM, Inventec, JVC, Lenovo, Lexmark, LG Electronics,Lite-On IT, Matsushita, or Panasonic, Micronas, Motorola, NEC, Nintendo,Philips, Pioneer, Quanta, Sagem, Samsung, Sanyo, Seagate, Sony, Sony Ericsson,TCL, Thomson, TiVO, Toshiba, USI, Western Digital, and ZTE.

 

We also produce and sell other semiconductor products including flashmicrocontrollers, smartcard ICs and modules, radio frequency, or RF, ICs andmodules, NAND controllers and NAND-controller based modules.

 

One of our key initiatives is the active development of our non-memorybusiness. Our objective is to transform SST from a pure play in flash memory toa multi-product line semiconductor company and a leading licensor of embeddedflash technology. We continue to execute on our plan to derive a significantportion of our revenue from non-memory products, which includes embeddedcontrollers, NAND-controller based modules, smartcard ICs and radio frequencyICs and modules. We believe non-memory products represent an area in which wehave significant competitive advantages and also an area that can yieldprofitable revenue with higher and more stable gross margins than our memoryproducts in the long run.

 

During the first quarter of 2008, we saw the first meaningful revenuefrom our NANDrive devices. While revenue from these devices was less than$100,000, it represented a substantial increase over the prior quarter and weexpect to see further increases in the second quarter of 2008. During thefirst quarter of 2008, we introduced additional products to our NANDrive lineto allow us to address industrial applications operating in harsh environments,including factory automation and in-cabin automotive electronics. We continueto work on many more design-in opportunities for this family of products. In the All-in-OneMemory area, we are also seeing strong interests fromcell phone and industrial applications. We are focused on working with severalcustomers to design in our first products. Due to the complexity of thisproduct family, the design-in and qualification cycle is expected to be long. In 2007, weintroduced an advanced wireless audio solution, MeleodyWing SP, which allowsusers to connect surround sound speakers wirelessly to their high-definitionTVs at wire-equivalent sound quality. Customerinterest continues to be favorable and the design-in activities are continuing.As wireless speaker products are a very new area in the consumer audio/visualindustry, and several AV manufacturers had bad experience of high return ratein the past due to the poor quality of existing market wireless audio products,the potential volume accounts are very cautious in adopting any new wirelessaudio solutions. As such, we believe we will gradually increase shipments tosmall accounts to establish our track-record in quality and delivery beforeshipments with high volume accounts will start to occur. We continue to believethe strategy of investing in higher ASP products such as NANDrive,All-In-OneMemory and MelodyWing, will drive our revenue and gross profit growthover time.

 

Duringthe first quarter of 2008, in addition to normal seasonality, we experiencedsoftness in our memory business due to a combinationof factors. We experienced push-outs of shipments by several of our high-volume customers, aggressivepricing due to inventory adjustments by competitors in the mobile phone market,and certain high-volume commodity customers that were turned away during thesecond half of 2007 due to product shortages did not purchase from us. Ongoing volatile macroeconomicconditions are prompting us to plan and guide conservatively for our business for thecurrent quarter 

 

17

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and the rest of the year.Overall, we expect that the near-term sluggishness in the market will continuethrough the second quarter, keeping our revenues fairly flat.

 

Inthe area of memory technologies, we are continuing to reduce manufacturingcosts through the transition to smaller process technologies that generallycarry a lower cost per die. Wafer starts are primarily now in the 180 and 250nanometer geometry. We began the120-nanometer pilot production in the first quarter at Powerchip’s 8” line andbegan engineering lots on a 12” line. We also expect to begin the 120nm pilotproduction at Grace in the second quarter. As a result, the supply situation isimproving and we expect to be able to meet the seasonal build in the secondhalf of 2008.  By gradually converting alarge portion of our products from 180 nanometer to 120 nanometer, we expectour unit output from both foundries to increase by the fourth quarter of thisyear.

 

The semiconductor industry has historically been cyclical,characterized by periodic changes in business conditions caused by productsupply and demand imbalance. When the industry experiences downturns, theyoften occur in connection with, or in anticipation of, maturing product cyclesand declines in general economic conditions. These downturns are characterizedby weak product demand, excessive inventory and accelerated decline of sellingprices.

 

***Concentrations***

 

We derived 87.7%, 88.8% and85.2% of our net product revenues during 2006, 2007 and the first three monthsof 2008, respectively, from product shipments to Asia. In addition,substantially all of our wafer suppliers and packaging and testingsubcontractors are located in Asia.

 

Shipments to our top ten endcustomers, which exclude transactions through stocking representatives anddistributors, accounted for 20.1%, 17.8% and 22.5% of our net product revenuesin 2006, 2007 and the first three months of 2008, respectively.

 

No single end customer,which we define as original equipment manufacturers, or OEMs, original designmanufacturers, or ODMs, contract electronic manufacturers, or CEMs, or endusers, represented 10.0% or more of our net product revenues during 2006, 2007and the first three months of 2008.

 

We ship products to, andhave accounts receivable from, OEMs, ODMs, CEMs, stocking representatives,distributors, and our logistics center. Our stocking representatives,distributors and logistics center reship our products to our end customers,including OEMs, ODMs, CEMs and end users. Shipments, by us or our logisticcenter, to our top three stocking representatives for reshipment accounted for48.5%, 60.3% and 51.1% of our product shipments in 2006, 2007 and the firstthree months of 2008, respectively. In addition, the same three stockingrepresentatives solicited sales, for which they received a commission, for10.3%, 9.1% and 10.2% of our product shipments to end users in 2006, 2007 andthe first three months of 2008, respectively.

 

We out-source our end customer service logistics in Asia to SiliconProfessional Technology Ltd., or SPT, which supports our customers inTaiwan, China and other Southeast Asia countries. SPT provides forecasting,planning, warehousing, delivery, billing, collection and other logisticfunctions for us in these regions. SPT is a wholly-owned subsidiary of one ofour stocking representatives in Taiwan, Professional Computer TechnologyLimited, or PCT. Please see a description of our relationship with PCT under “RelatedParty Transactions.” Products shipped to SPT are accounted for as our inventoryheld at our logistics center, and revenue is recognized when the products havebeen delivered and are considered as a sale to our end customers by SPT. Forthe years ended December 31, 2006, 2007 and the three months ended March 31,2008, SPT serviced end customer sales accounting for 59.1%, 60.1% and 55.2% ofour net product revenues recognized. As of December 31, 2006, 2007 and thethree months ended March 31, 2008, SPT represented 68.9%, 65.3% and 54.5%of our net accounts receivable, respectively.

 

Our product sales are made primarily using short-term cancelablepurchase orders. The quantities actually purchased by the customer, as well asshipment schedules, are frequently revised to reflect changes in the customer’sneeds and in our supply of product. Accordingly, our backlog of open purchaseorders at any given time is not a meaningful indicator of future sales. Changesin the amount of our backlog do not necessarily reflect a corresponding changein the level of actual or potential sales.

 

**Critical Accounting Estimates**

 

For information related to our revenue recognition and other criticalaccounting estimates, please refer to the “Critical Accounting Estimates” sectionof Item 7. “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” contained in our Annual Report on Form 10-K forthe year ended December 31, 2007.

 

18

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EffectiveJanuary 1, 2008, we adopted SFAS No. 157, *Fair ValueMeasurements*, or SFAS 157.  In February 2008, the FASBissued FASB Staff Position No. FAS 157-2, *EffectiveDate of FASB Statement No. 157*, which provides a one yeardeferral of the effective date of SFAS 157 for non-financial assets andnon-financial liabilities, except those that are recognized or disclosed in thefinancial statements at fair value at least annually (fair value of reportingunits for goodwill impairment tests, non-financial assets and liabilitiesacquired in a business combination). Therefore, we adopted the provisions ofSFAS 157 with respect to its financial assets and liabilities only.  SFAS157 defines fair value, establishes a framework for measuring fair value undergenerally accepted accounting principles and enhances disclosures about fairvalue measurements. Fair value is defined under SFAS 157 as the exchange pricethat would be received for an asset or paid to transfer a liability (an exitprice) in the principal or most advantageous market for the asset or liabilityin an orderly transaction between market participants on the measurement date.Valuation techniques used to measure fair value under SFAS 157 must maximizethe use of observable inputs and minimize the use of unobservable inputs. Thestandard describes a fair value hierarchy based on three levels of inputs, ofwhich the first two are considered observable and the last unobservable, thatmay be used to measure fair value which are the following:

 
| · |   | Level 1 - Quoted prices in active markets for identical assets or  liabilities.                                                                                                                                                                                                                                                                       |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| · |   | Level 2 - Inputs other than Level 1 that are observable, either  directly or indirectly, such as quoted prices for similar assets or  liabilities; quoted prices in markets that are not active; or other inputs  that are observable or can be corroborated by observable market data for  substantially the full term of the assets or liabilities. |
| · |   | Level 3 - Unobservable inputs that are supported by little or no  market activity and that are significant to the fair value of the assets or  liabilities.                                                                                                                                                                                           |

 

Theadoption of this statement did not impact our consolidated results ofoperations and financial condition, but required additional disclosure forassets and liabilities measured at fair value.

 

**Results of Operations: Three months ended March 31, 2008**

 

**Net Revenues (in thousands)**

 
| ** **           | ** ** | **Three Months Ended** | ** ** | ** **       | ** ** | ** **         | ** ** | ** **           | ** ** | ** **           | ** ** |
|----------------------|------------|----------------------------------|------------|------------------|------------|--------------------|------------|----------------------|------------|----------------------|------------|
| ** **           | ** ** | **March 31,**               | ** ** | **Dec 31,** | ** ** | **March 31,** | ** ** | **1Q08-Over-**       | ** ** | **1Q08-Over-**       | ** ** |
| ** **           | ** ** | **2007**                         | ** ** | **2007**         | ** ** | **2008**           | ** ** | **4Q07 Change** | ** ** | **1Q07 Change** | ** ** |
| Memory Revenue       |       | $                                | 78,616     |             | $          | 86,360             |       | $                    | 61,690     |                 | $          | (24,670 | ) | (28.6 | )% | $ | (16,926 | ) | (21.5 | )% |
| Non-Memory Revenue   |       | 9,595                            |       | 9,274            |       | 8,008              |       | (1,266               | )          | (13.7                | )%         | (1,587 | ) | (16.5 | )% |
| Product revenues     |       | 88,211                           |       | 95,634           |       | 69,698             |       | (25,936              | )          | (27.1                | )%         | (18,513 | ) | (21.0 | )% |
| Technology licensing |       | 9,313                            |       | 11,744           |       | 11,387             |       | (357                 | )          | (3.0                 | )%         | 2,074 |   | 22.3 | % |
| Total net revenues   |       | $                                | 97,524     |             | $          | 107,378            |       | $                    | 81,085     |                 | $          | (26,293 | ) | (24.5 | )% | $ | (16,439 | ) | (16.9 | )% |

 

Thefollowing discussions are based on our reportable segments described inNote 11 of our unaudited condensed consolidated financial statements.

 

*Memory Products*

 

Memory revenue decreased 21.5% in the first quarter of 2008 from thefourth quarter of 2007 primarily due to a 20.7% decrease in unit shipments.Seasonal weakness in demand across all application categories from the postholiday-build season and industry over supply led to the results. Memoryrevenue decreased in the first quarter of 2008 compared to the first quarter of2007 due to a 12.3% decrease in average selling prices and a 11.7% decrease inunit shipments. The decrease in average selling prices was primarily a resultof product mixand continuing competitive pricing pressures in the NOR flash  markets.

* *

*Non-Memory Products*

 

Non-memory revenue decreased 13.2% in the first quarter of 2008 fromthe fourth quarter of 2007 primarily due to a 26.2% decrease in unit shipments.The decrease was primarily due to lower unit shipments in first quarter of 2008from decreased demand of smartcard ICs. The decrease in unit shipments wassomewhat offset by a 21.2% increase in average selling prices due to productmix. Non-memory revenue decreased 16.5% in the first quarter of 2008 comparedto the first quarter of 2007 due to a 36.1% decrease in unit shipments.  We expect revenue to fluctuate in non-memorybusiness throughout 2008 as we expect to grow and diversify our revenue andcustomer base.

 

19

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*Technology Licensing Revenue*

 

Technology license revenue includes a combination of up-front fees androyalties. Technology licensing revenue for the first quarter of 2008 declinedfrom the fourth quarter of 2007 due to slightly lower royalties. Technologylicensing revenue for the first quarter of 2008 increased compared to the firstquarter of 2007 as a result of higher royalties received. We anticipaterevenues from technology licensing may fluctuate significantly in the future.

 

**Gross Profit (in thousands)**

 
| ** **                        | ** ** | **Three Months Ended** | ** ** | ** **       | ** ** | ** **         | ** ** | ** **           | ** ** | ** **           | ** ** |
|-----------------------------------|------------|----------------------------------|------------|------------------|------------|--------------------|------------|----------------------|------------|----------------------|------------|
| ** **                        | ** ** | **March 31,**               | ** ** | **Dec 31,** | ** ** | **March 31,** | ** ** | **1Q08-Over-**       | ** ** | **1Q08-Over-**       | ** ** |
| ** **                        | ** ** | **2007**                         | ** ** | **2007**         | ** ** | **2008**           | ** ** | **4Q07 Change** | ** ** | **1Q07 Change** | ** ** |
| Memory gross profit               |       | $                                | 15,063     |             | $          | 21,078             |       | $                    | 12,675     |                 | $          | (8,403 | ) | (39.9 | )% | $ | (2,388 | ) | (15.9 | )% |
| Memory gross margin               |       | 19.2                             | %          | 24.4             | %          | 20.5               | %          |                 |       |                 |       |   |   |   |   |
| Non-Memory gross profit           |       | $                                | 2,145      |             | $          | 1,586              |       | $                    | 1,647      |                 | $          | 61 |   | 3.8 | % | $ | (498 | ) | (23.2 | )% |
| Non-Memory gross margin           |       | 22.4                             | %          | 17.2             | %          | 20.6               | %          |                 |       |                 |       |   |   |   |   |
| Product gross profit              |       | $                                | 17,208     |             | $          | 22,664             |       | $                    | 14,322     |                 | $          | (8,342 | ) | (36.8 | )% | $ | (2,886 | ) | (16.8 | )% |
| Product gross margin              |       | 19.5                             | %          | 23.7             | %          | 20.5               | %          |                 |       |                 |       |   |   |   |   |
| Technology licensing gross profit |       | 9,313                            |       | 11,744           |       | 11,387             |       | (357                 | )          | (3.0                 | )%         | 2,074 |   | 22.3 | % |
| Technology licensing gross margin |       | 100.0                            | %          | 100.0            | %          | 100.0              | %          |                 |       |                 |       |   |   |   |   |
| Total gross profit                |       | $                                | 26,521     |             | $          | 34,408             |       | $                    | 25,709     |                 | $          | (8,699 | ) | (25.3 | )% | $ | (812 | ) | (3.1 | )% |
| Total gross margin                |       | 27.2                             | %          | 32.1             | %          | 31.7               | %          |                 |       |                 |       |   |   |   |   |

 

*Product Gross Profit*

* *

*Memory products*

 

Gross profit for memory products decreased 39.9% in the first quarterof 2008 compared to the fourth quarter of 2007 largely due to a 20.7% decreasein the number of units shipped and a 9.5% decline in the average selling pricesof these products. Serial flash devices led the declines in both units shippedand average selling prices. Compared to the first quarter of 2007, gross profitdecreased by 15.9% due to a 12.3% decrease in average selling prices fromproduct mix coupled with an 11.7% decrease in unit shipments.

* *

*Non-memory products*

 

Gross profit for non-memory products increased 3.9% in the firstquarter of 2008 compared to the fourth quarter of 2007 as average sellingprices increased 21.2% offsetting a 26.2% decrease in unit shipments. Incomparison to the first quarter of 2007, gross profit decreased 23.2% due to a36.1% decline in unit shipments led by smartcard ICs. Average selling pricesincreased 21.2% to partially offset the decline.

 

For other factors that could affect our gross profit, please also seeItem 1A. “Risk Factors—We incurred significant inventory valuation andadverse purchase commitment adjustments in 2006, 2007 and the first threemonths ended March 31, 2008 and we may incur additional significantinventory valuation adjustments in the future.”

 

**Operating Expenses (in thousands)**

* *

*Research and development*

* *
| ** **               | ** ** | **Three Months Ended** | ** ** | ** **       | ** ** | ** **         | ** ** | ** **           | ** ** | ** **           | ** ** |
|--------------------------|------------|----------------------------------|------------|------------------|------------|--------------------|------------|----------------------|------------|----------------------|------------|
| ** **               | ** ** | **March 31,**               | ** ** | **Dec 31,** | ** ** | **March 31,** | ** ** | **1Q08-Over-**       | ** ** | **1Q08-Over-**       | ** ** |
| ** **               | ** ** | **2007**                         | ** ** | **2007**         | ** ** | **2008**           | ** ** | **4Q07 Change** | ** ** | **1Q07 Change** | ** ** |
| Research and development |       | $                                | 13,491     |             | $          | 14,694             |       | $                    | 15,612     |                 | $          | 918 |   | 6.2 | % | $ | 2,121 |   | 15.7 | % |
| Percent of revenue       |       | 13.8                             | %          | 13.7             | %          | 19.3               | %          |                 |       |                 |       |   |   |   |   |
|                          |            |                                  |            |                  |            |                    |            |                      |            |                      |            |  |  |  |  |  |  |  |  |  |

 

Research and development expenses include costs associated with thedevelopment of new products, enhancements to existing products, qualityassurance activities and occupancy costs. These costs consist primarily ofemployee salaries, stock-based compensation expense and other benefit-relatedcosts and the cost of materials such as wafers and masks.

 

20

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In comparison to the fourth quarter of 2007, research and developmentspending increased primarily due to an increases in masks and reticules costsof $516,000 as well as a $380,000 increase in evaluation parts as part of theramp in new product introductions. For the three months ended March 31,2008 in comparison to the same quarter in 2007, research and developmentspending increased due to higher wafer, mask and reticle costs of $741,000,evaluation parts of $349,000 and outside services of $227,000. Salaries andwages also rose $652,000 due to increased headcount. We expect that researchand development expenses will fluctuate based on the timing of engineeringprojects for new product introductions and the development of new technologiesto support future growth.

 

*Sales and marketing*

* *
| ** **          | ** ** | **Three Months Ended** | ** ** | ** **       | ** ** | ** **         | ** ** | ** **           | ** ** | ** **           | ** ** |
|---------------------|------------|----------------------------------|------------|------------------|------------|--------------------|------------|----------------------|------------|----------------------|------------|
| ** **          | ** ** | **March 31,**               | ** ** | **Dec 31,** | ** ** | **March 31,** | ** ** | **1Q08-Over-**       | ** ** | **1Q08-Over-**       | ** ** |
| ** **          | ** ** | **2007**                         | ** ** | **2007**         | ** ** | **2008**           | ** ** | **4Q07 Change** | ** ** | **1Q07 Change** | ** ** |
| Sales and marketing |       | $                                | 6,765      |             | $          | 7,535              |       | $                    | 7,483      |                 | $          | (52 | ) | (0.7 | )% | $ | 718 |   | 10.6 | % |
| Percent of revenue  |       | 6.9                              | %          | 7.0              | %          | 9.2                | %          |                 |       |                 |       |   |   |   |   |
|                     |            |                                  |            |                  |            |                    |            |                      |            |                      |            |  |  |  |  |  |  |  |  |  |

 

Sales and marketing expenses consist primarily of commissions, employeesalaries, stock-based compensation expense and other benefit-related costs, aswell as travel and entertainment expenses.

 

Sales and marketing expense decreased in the first quarter of 2008compared to the fourth quarter of 2007 due to lower logistic center fees of$355,000. This decrease was partially offset by increased commission expense of$309,000. From the same period a year ago, sales and marketing expensesincreased $718,000 for the quarter ended March 31, 2008 due to highersalaries and wages of $441,000 and payroll taxes of $215,000. Partiallyoffsetting these were lower stock-based compensation expenses of $103,000. Weexpect that future sales and marketing expenses may increase in absolutedollars. In addition, fluctuations in revenues will cause fluctuations in salesand marketing expenses due to our commission expenses.

* *

*General and administrative*

 
| ** **                 | ** ** | **Three Months Ended** | ** ** | ** **       | ** ** | ** **         | ** ** | ** **           | ** ** | ** **           | ** ** |
|----------------------------|------------|----------------------------------|------------|------------------|------------|--------------------|------------|----------------------|------------|----------------------|------------|
| ** **                 | ** ** | **March 31,**               | ** ** | **Dec 31,** | ** ** | **March 31,** | ** ** | **1Q08-Over-**       | ** ** | **1Q08-Over-**       | ** ** |
| ** **                 | ** ** | **2007**                         | ** ** | **2007**         | ** ** | **2008**           | ** ** | **4Q07 Change** | ** ** | **1Q07 Change** | ** ** |
| General and administrative |       | $                                | 7,038      |             | $          | 6,154              |       | $                    | 7,183      |                 | $          | 1,029 |   | 16.7 | % | $ | 145 |   | 2.1 | % |
| Percent of revenue         |       | 7.2                              | %          | 5.7              | %          | 8.9                | %          |                 |       |                 |       |   |   |   |   |
|                            |            |                                  |            |                  |            |                    |            |                      |            |                      |            |  |  |  |  |  |  |  |  |  |

 

General and administrative expenses mainly consist of salaries,stock-based compensation, and other-benefit related costs for administrative,executive and finance personnel, recruiting costs, professional services andlegal fees and allowances for doubtful accounts.

 

General and administrative expenses increased in the first quarter of2008 compared to the fourth quarter of 2007 primarily due to increased legalexpenses of $237,000, a $232,000 increase in tax service fees, a $207,000increase in executive bonuses, a $192,000 increase in stock based compensationexpense and a $151,000 increase in company matching of 401k contributions.  In comparison to the first quarter of 2007,general and administrative expenses increased $145,000 for the quarter ended March 31,2008 due to increases in salaries and wages of $132,000, payroll tax expensesof $254,000 and recurring legal expenses of $208,000. Partially offsettingthese increases were decreases in outside services $213,000 and legal fees of$554,000 related to our independent stock option investigation. We anticipatethat general and administrative expenses may increase in absolute dollars as wescale our facilities, infrastructure and headcount to support our overallexpected growth.

 

*Interest and Other income and expense, net*

* *
| ** **         | ** ** | **Three Months Ended** | ** ** | ** **       | ** ** | ** **         | ** ** | ** **           | ** ** | ** **           | ** ** |
|--------------------|------------|----------------------------------|------------|------------------|------------|--------------------|------------|----------------------|------------|----------------------|------------|
| ** **         | ** ** | **March 31,**               | ** ** | **Dec 31,** | ** ** | **March 31,** | ** ** | **1Q08-Over-**       | ** ** | **1Q08-Over-**       | ** ** |
| ** **         | ** ** | **2007**                         | ** ** | **2007**         | ** ** | **2008**           | ** ** | **4Q07 Change** | ** ** | **1Q07 Change** | ** ** |
| Interest income    |       | $                                | 1,830      |             | $          | 1,824              |       | $                    | 1,302      |                 | $          | (522 | ) | (28.6 | )% | $ | (528 | ) | (28.9 | )% |
| Percent of revenue |       | 1.9                              | %          | 1.7              | %          | 1.6                | %          |                 |       |                 |       |   |   |   |   |
|                    |            |                                  |            |                  |            |                    |            |                      |            |                      |            |  |  |  |  |  |  |  |  |  |

 

21

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Interest income includesinterest from our cash and short-term cash equivalents. For the first quarterended March 31, 2008 in comparison to the fourth quarter of 2007, interestincome declined due to decreases in short-term interest rates, For the threemonths ended March 31, 2008 in comparison to the same period in 2007,interest income fell due to sharply lower average interest rates. We expectthat interest income will fluctuate due to changing economic conditions in theUnited States as well as fluctuating short-term interest rates.

 

*Other income and expense, net*

 
| ** **                  | ** ** | **Three Months Ended** | ** ** | ** **       | ** ** | ** **         | ** ** | ** **           | ** ** | ** **           | ** ** |
|-----------------------------|------------|----------------------------------|------------|------------------|------------|--------------------|------------|----------------------|------------|----------------------|------------|
| ** **                  | ** ** | **March 31,**               | ** ** | **Dec 31,** | ** ** | **March 31,** | ** ** | **1Q08-Over-**       | ** ** | **1Q08-Over-**       | ** ** |
| ** **                  | ** ** | **2007**                         | ** ** | **2007**         | ** ** | **2008**           | ** ** | **4Q07 Change** | ** ** | **1Q07 Change** | ** ** |
| Other income (expense), net |       | $                                | (20        | )                | $          | (79                | )          | $                    | (364       | )                    | $          | (285 | ) | 360.8 | % | $ | (344 | ) | 1720.0 | % |
| Percent of revenue          |       | 0.0                              | %          | 0.0              | %          | -0.3               | %          |                 |       |                 |       |   |   |   |   |
|                             |            |                                  |            |                  |            |                    |            |                      |            |                      |            |  |  |  |  |  |  |  |  |  |

 

Other income (expense) forthe periods presented includes translation gains and losses, and othermiscellaneous transactions. In the first quarter ended March 31, 2008, wefully reserved a note receivable from a third party in the amount of $216,000due to our expected inability to collect it. Also in the first quarter of 2008,we recorded a translation loss of $133,000 due to the weakness of the U.S.dollar. Other income (expense) will fluctuate significantly year to year but wedo not expect it to have material impact to our consolidated statement ofoperations.

 

*Interest expense*

 
| ** **         | ** ** | **Three Months Ended** | ** ** | ** **       | ** ** | ** **         | ** ** | ** **           | ** ** | ** **           | ** ** |
|--------------------|------------|----------------------------------|------------|------------------|------------|--------------------|------------|----------------------|------------|----------------------|------------|
| ** **         | ** ** | **March 31,**               | ** ** | **Dec 31,** | ** ** | **March 31,** | ** ** | **1Q08-Over-**       | ** ** | **1Q08-Over-**       | ** ** |
| ** **         | ** ** | **2007**                         | ** ** | **2007**         | ** ** | **2008**           | ** ** | **4Q07 Change** | ** ** | **1Q07 Change** | ** ** |
| Interest expense   |       | $                                | 89         |             | $          | 132                |       | $                    | 64         |                 | $          | (68 | ) | (51.5 | )% | $ | (25 | ) | (28.1 | )% |
| Percent of revenue |       | 0.1                              | %          | 0.1              | %          | 0.1                | %          |                 |       |                 |       |   |   |   |   |
|                    |            |                                  |            |                  |            |                    |            |                      |            |                      |            |  |  |  |  |  |  |  |  |  |

 

Interestexpense declined in the first quarter ended March 31, 2008 compared thesame period a year ago and the fourth quarter ended December 31, 2007 aswe paid down our credit line during the period and do not have any othersignificant outstanding debt. On August 7, 2007, SST China Limited enteredinto a one year facility agreement with Bank of America, N.A. Shanghai Branch,a U.S. bank, for RMB 58.40 million revolving line of credit. The line of creditwill be used for working capital but there are no restrictions in the agreementas to how the funds may be used.  Theinterest rate for the line of credit is 90% of People’s Bank of China’s baserate (6.57% at March 31, 2008). This facility line is guaranteed by the parent company, Silicon StorageTechnology, Inc. SST is required to meet certain financial covenants,including have a ratio of the funded debt to EBITA less than 2.0. If not, wehave to deposit with Bank of America cash collateral at all times in an amountequal to the outstanding principal balance. During the period ending March 31,2008 we fully repaid the balance on this line of credit in the amount of $6.9million and as of March 31, 2008, SST China Limited has no outstandingbalance under this line. We are in compliance with all terms of this facilityagreement.

 

22

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*Equity investments*

 
| ** **                                     | ** ** | **Three Months Ended** | ** ** | ** **       | ** ** | ** **         | ** ** | ** **           | ** ** | ** **           | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|------------------|------------|--------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                     | ** ** | **March 31,**               | ** ** | **Dec 31,** | ** ** | **March 31,** | ** ** | **1Q08-Over-**       | ** ** | **1Q08-Over-**       | ** ** |
| ** **                                     | ** ** | **2007**                         | ** ** | **2007**         | ** ** | **2008**           | ** ** | **4Q07 Change** | ** ** | **1Q07 Change** | ** ** |
| Pro rata share of loss from equity investments | ** ** | $                                | 1,516      |             | $          | 1,727              |       | $                    | 1,896      |                 | $          | 169 |   | 9.8 | % | $ | 380 | ** ** | 25.1 | % |
|                                                |            |                                  |            |                  |            |                    |            |                      |            |                      |            |  |  |  |  |  |  |  |  |  |

 

Forthe quarter ended March 31, 2008, our pro rata share of the loss in ACETwas $1.9 million, compared to $1.5 million for the same period in theprior year and $1.7 million for the fourth quarter ended December 31,2007.  Our total investment represents38.5% of the outstanding equity of ACET at March 31, 2008.

 

**Provision for Income Taxes**

 

Theprovision for income tax for the first quarter of 2008 was a benefit ofapproximately $7.1 million. This consists primarily of an IRS settlement froman amended return and foreign income and withholding taxes. We maintained afull valuation allowance on our net deferred tax assets as of March 31,2008. The valuation allowance was determined in accordance with the provisionsof Statement of Financial Accounting Standards No. 109, *Accounting for Income Taxes*, or SFAS No. 109, whichrequires an assessment of both positive and negative evidence when determiningwhether it is more likely than not that deferred tax assets are recoverable;such assessment is required on a jurisdiction by jurisdiction basis. We intendto maintain a full valuation allowance on the U.S. deferred tax assets until sufficientpositive evidence exists to support reversal of the valuation allowance.

 

**Liquidity and Capital Resources (in thousands)**

 
| ** **                  | ** ** | **Three Months Ended** | ** ** |
|-----------------------------|------------|----------------------------------|------------|
| ** **                  | ** ** | **March 31,  2007**         | ** ** | **March 31,  2008** | ** ** |
| ** **                  | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Cash provided by (used in): |       |                             |       |   |   |
| Operating activities        |       | $                                | 1,261      |   | $ | 15,254 |   |
| Investing activities        |       | $                                | (19,935    | ) | $ | (32,019 | ) |
| Financing Activities        |       | $                                | 936        |   | $ | (13,069 | ) |

 

*Operating activities.*  For the three months ended March 31,2008, the primary sources of operating cash flows were a $22.2 milliondecrease in trade accounts receivable due to lower revenues in the currentquarter. Offsetting these sources of cash flow was a $10.7 million increase ininventories due to decreased memory product sales  and $3.1 million decrease in accruedliabilities.

 

For the three months ended March 31, 2007, the primary sources ofoperating cash flows were a $16.0 million decrease in trade accountsreceivable from related parties due to lower sales during the quarter and a$5.1 million decrease in inventories resulting from our continued focus onmore effectively managing inventory levels and capacity constraints at one ofour major foundries, Grace Semiconductor. Offsetting these sources of cash flowwas a $25.6 million decrease in accounts payable.

* *

*Investing activities.*  For the three months ended March 31,2008, investing activities used $32.0 million in cash, primarily from thepurchase of $32.4 million in available for sales investments and$1.7 million for the purchase of equity securities, partially offset bythe $2.6 million sale of available for sale investments. For the three monthsended March 31, 2007, investing activities used $19.9 million incash, primarily from the purchase of $18.0 million in available for salesinvestments and $1.7 million for the purchase of equity securities.

* *

*Financing activities.*  For the three months ended March 31,2008, cash used by financing activities included the repurchase of common stockof $6.2 million and the repayment of our credit line of $6.9 million. Forthe three months ended March 31, 2007, cash provided by financingactivities included the issuance of common stock of $1.3 million partiallyoffset by capital lease payments of $300,000.

 

Principal sources of liquidity at March 31, 2008 consisted of$146.4 million of cash, cash equivalents and short-term available-for-saleinvestments.

 

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**CreditMarket Risk**

 

As of March 31,2008, we held corporate bonds and of notes of $50.0 million and $34.1 millionof government bonds and notes. These securities’ cash flows are funded by theprincipal and interest payments of the underlying corporate loans and federal,state and local governmental loans. The recent credit market instability mayadversely impact our disposition of these securities at or near their quotedfair market value. We evaluate these investments at each balance sheetdate. There is the risk that at future balance sheet dates we may record acharge for a decline in the fair value that is considered other than temporary anda loss would be recognized in the income statement at that time.

 

Basedon our current business plan, our cash and cash equivalents balances and ourexisting unused credit facilities are sufficient to cover our currentlyanticipated fiscal 2008 cash flow requirements.

 

As of March 31, 2008, other than as described below, there were nomaterial changes in long-term debt obligations, capital lease obligations,operating lease obligations, purchase obligations or any other long-termliabilities reflected on our condensed consolidated balance sheet as comparedto December 31, 2007.

 

*Purchase Commitments.*  As of March 31, 2008, we had outstandingpurchase commitments with our foundry vendors of $45.7 million fordelivery in 2008. We have recorded a liability of $443,000 for adverse purchasecommitments. In comparison, as of December 31, 2007, we had outstandingpurchase commitments with our foundry vendors of $42.0 million fordelivery in 2008, with a recorded liability of $111,000 for adverse purchasecommitments.

* *

*Operating Capital Requirements.*  We believe our cash balances, together withthe funds we expect to generate from operations, will be sufficient to meet ourprojected working capital and other cash requirements through at least the nexttwelve months. However, if we fail to execute to our business strategies, wecould experience declines in our cash balances. We have secured a one yearfacility agreement with Bank of America, N.A. Shanghai Branch, a U.S. bank, forRMB 58.40 million revolving line of credit. The line of credit will be used forworking capital but there are no restrictions in the agreement as to how thefunds may be used.  The interest rate forthe line of credit is 90% of People’s Bank of China’s base rate (6.57% at March 31,2008).  This facility line is guaranteedby the parent company, Silicon Storage Technology, Inc. SST is required tomeet certain financial covenants, including have a ratio of the funded debt toEBITA less than 2.0. If not, we have to deposit with Bank of America cash collateralat all times in an amount equal to the outstanding principal balance. As of March 31,2008, SST China Limited has no outstanding balance against this line. We are incompliance with all terms of this facility agreement. There can be no assurancethat future events will not require us to seek additional borrowings or capitaland, if so required, that such borrowing or capital will be available onacceptable terms. Factors that could affect our short-term and long-term cashused or generated from operations and as a result, our need to seek additionalborrowings or capital include:

 

·                  the averageselling prices of our products;

 

·                  customer demandfor our products;

 

·                  the need tosecure future wafer production capacity from our suppliers;

 

·                  the timing ofsignificant orders and of license and royalty revenue;

 

·                  the ability tomanage our inventory levels according to plan; and

 

·                  unanticipatedresearch and development expenses associated with new product introductions.

 

Please also see Item 1A. “Risk Factors—Our operating resultsfluctuate materially  and anunanticipated decline in revenues may disappoint securities analysts orinvestors and result in a decline in our stock price.”

 

In January and February 2005, multiple putative shareholderclass action complaints were filed against us and certain of our directors andofficers in the United States District Court for the Northern District ofCalifornia. Following the filing of the putative class action lawsuits,multiple shareholder derivative complaints were filed in California SuperiorCourt for the County of Santa Clara, purportedly on behalf of SST againstcertain of our directors and officers. In addition, in July and October 2006,multiple shareholder derivative complaints were filed against us and certain ofour directors and officers in the United States District Court for the NorthernDistrict of California. In the event of unfavorable outcome of the suits, wemay be required to pay damages. For more information, please also seeItem 1A. “Risk Factors—We are engaged in derivative suits, which maybecome time consuming, costly and divert management resources and could impactour stock price.”

 

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From time to time, we are also involved in other legal actions arisingin the ordinary course of business. We have accrued certain costs associatedwith defending these matters. There can be no assurance that the shareholderclass action complaints, the shareholder derivative complaints or other thirdparty assertions will be resolved without costly litigation, in a manner thatis not adverse to our financial position, results of operations or cash flowsor without requiring royalty payments in the future which may adversely impactgross margins. No estimate can be made of the possible loss or possible rangeof loss associated with the resolution of these contingencies. As a result, nolosses have been accrued in our financial statements as of March 31, 2008.

 

**Recent Accounting Pronouncements**

 

In December 2007, the FASB issued SFAS No. 141 (Revised2007), *Business Combinations*, or SFAS No. 141R.SFAS No. 141R will change the accounting for business combinations. UnderSFAS No. 141R, an acquiring entity will be required to recognize all theassets acquired and liabilities assumed in a transaction at theacquisition-date fair value with limited exceptions. SFAS No. 141R willchange the accounting treatment and disclosure for certain specific items in abusiness combination. SFAS No. 141R applies prospectively to businesscombinations for which the acquisition date is on or after the beginning of thefirst annual reporting period beginning on or after December 15, 2008.Accordingly, any business combinations we engage in will be recorded anddisclosed following existing GAAP until January 1, 2009. We expect SFAS No. 141Rwill have an impact on accounting for business combinations once adopted butthe effect is dependent upon acquisitions at that time. We are still assessingthe impact of this pronouncement.

 

In December 2007, the FASB issued SFAS No. 160, *Noncontrolling Interests in Consolidated Financial Statements—AnAmendment of ARB No. 51*, or SFAS No. 160. SFAS No. 160establishes new accounting and reporting standards for the noncontrollinginterest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160is effective for fiscal years beginning on or after December 15, 2008. Wehave not completed our evaluation of the potential impact, if any, of theadoption of SFAS No. 160 on our consolidated financial position, resultsof operations and cash flows.

 

In March 2008, the FASB issued SFAS 161, *Disclosures about Derivative Instruments and HedgingActivities, an amendment of FASB Statement 133,*or SFAS 161. SFAS 161amends and expands the disclosure requirements of SFAS 133 with the intentto provide users of financial statements with an enhanced understanding of: (i) howand why an entity uses derivative instruments; (ii) how derivativeinstruments and related hedged items are accounted for under SFAS 133 andits related interpretations and (iii) how derivative instruments andrelated hedged items affect an entity’s financial position, financialperformance and cash flows. This statement is effective for financialstatements issued for fiscal years and interim periods beginning after November 15,2008, with early application encouraged. We are still evaluating the impact ofthis standard but do not expect the adoption of SFAS 161 to have amaterial impact on our financial statements.

 

**Item 3.  Quantitative and Qualitative Disclosuresabout Market Risk**

 

We are exposed to risks associated with foreign exchange ratefluctuations due to our international manufacturing and sales activities. Theseexposures may change over time as business practices evolve and couldnegatively impact our operating results and financial condition. Currently, wedo not hedge these foreign exchange rate exposures. Substantially all of oursales are denominated in U.S. dollars. An increase in the value of the U.S.dollar relative to foreign currencies could make our products more expensiveand therefore reduce the demand for our products, a decrease in the value ofthe U.S. dollar relative to foreign currencies could raise the costs tomanufacture our products. Such a decline in the demand could reduce revenuesand/or result in operating losses. In addition, a downturn in the economies ofChina, Japan or Taiwan could impair the value of our equity investments incompanies with operations in these countries. If we consider the value of thesecompanies to be impaired, we will write off, or expense, some or all of ourinvestments.

 

At any time, fluctuations in interest rates could affect interestearnings on our cash, cash equivalents and available-for-sale investments, orthe fair value of our investment portfolio. A 10% move in interest rates as of March 31,2008 would have an immaterial effect on our financial position, results ofoperations and cash flows. Currently, we do not hedge these interest rateexposures. As of March 31, 2008, the carrying value of ouravailable-for-sale investments approximated fair value. The table belowpresents the carrying value and related weighted average interest rates for ourcash, cash equivalents and available-for-sale investments as of March 31,2008 (in thousands):

 
| ** **                                    | ** ** | **Carrying  Value** | ** ** | **Interest  Rate** | ** ** |
|-----------------------------------------------|------------|---------------------|------------|--------------------|------------|
| Cash and cash equivalents—variable rate  |       | $                   | 83,323     |               | 1.3        | % |
| Short-term available-for-sale—fixed rate |       | 58,089              |       | 4.2                | %          |
| Long-term available-for-sale—fixed rate  |       | 16,046              |       | 4.1                | %          |
|                                          |       | $                   | 162,458    |               | 2.6        | % |

 

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**Item 4.  Controls and Procedures**

 

**Disclosure Controls and Procedures**

 

We maintain disclosure controls and procedures that are designed toensure that information required to be disclosed in our reports filed or submittedpursuant to the Securities Exchange Act of 1934, as amended, or the ExchangeAct, is recorded, processed, summarized and reported within the time periodsspecified in the Securities and Exchange Commission’s rules and forms.Disclosure controls and procedures also are designed to ensure that suchinformation is accumulated and communicated to our management, including ourChief Executive Officer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure.

 

Our management, with the participation of our Chief Executive Officerand Chief Financial Officer, conducted an evaluation of the effectiveness ofour disclosure controls and procedures (as defined in the Exchange Act Rules 13a-15(e) and15d-15(e)) as of March 31, 2008. Based on their evaluation, the ChiefExecutive Officer and the Chief Financial Officer have concluded that, as of March 31,2008, our disclosure controls and procedures were not effective because of thematerial weakness described below.

 

**Material Weakness in Internal Control Over Financial Reporting**

 

A material weakness is a control deficiency, or combination of controldeficiencies, in internal control over financial reporting such that there isreasonable possibility that a material misstatement of the annual or interimannual statement will not be presented or detected on a timely basis.

 

At March 31, 2008, we did not maintain effective controls over thecompleteness, accuracy, valuation and presentation and disclosure of inventoryand the related cost of revenue accounts. Specifically, our controls over therecording of inventory adjustments resulting from physical inventoryobservations, capitalization of production variances into inventory andvaluation of inventory related reserves in accordance with generally acceptedaccounting principles in the United States, were not effective. These controldeficiencies resulted in audit adjustments to the 2006 and 2007 consolidatedannual financial statements and to 2007 consolidated interim financial statements.Additionally, these control deficiencies could result in misstatements to theinventory and the related cost of revenue accounts and disclosures that wouldresult in a material misstatement of the annual or interim consolidatedfinancial statements that would not be prevented or detected. Accordingly, wedetermined that these control deficiencies constitute a material weakness at March 31,2008.

 

**Remediation Plan for Material Weakness**

 

We had previously decided that our existing inventory tracking andmanagement system needed improvement and began planning for the implementationof a new system in 2006. In August 2007, we began implementing Oracle ShopFloor Management, or OSFM, a computerized inventory tracking and managementsystem that is integrated with our other accounting and information technologysystems. We believe OSFM once completely implemented will provide the basis forthe development of adequate controls over inventory. We continued to work onimproving our controls in the inventory area in the first quarter of 2008however, as of March 31, 2008 we have not completed our review, evaluationand remediation of the new system and the inventory controls surrounding OSFM.

 

In addition we plan to review the adequacy of our staffing and thetechnical knowledge and experience of our current staff as well as to improvethe training and education of our people in the accounting and otherdepartments that impact inventory controls.

 

**Changes in Internal Control Over Financial Reporting**

 

Except as discussed above, there have been no changes in our internalcontrol over financial reporting during the quarter ended March 31, 2008that have materially affected or are reasonably likely to materially affect ourinternal control over financial reporting, as defined in Rule 13a-15(f) underthe Exchange Act.

 

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** **

**PART II—OTHERINFORMATION**

 

**Item 1.  Legal Proceedings**

 

InJanuary and February 2005 multiple shareholder derivative complaintswere filed in California Superior Court for the County of Santa Clara,purportedly on behalf of SST against certain of our directors and officers. Thederivative complaints asserted claims for, among other things, breach offiduciary duty and violations of the California Corporations Code. Thesederivative actions were consolidated under the caption *In ReSilicon Storage Technology, Inc. Derivative Litigation,* LeadCase No. 1:05CV034387 (Cal. Super. Ct., Santa Clara Co.). On April 28,2005, the derivative action was stayed by court order. On October 19,2007, following the dismissal with prejudice of certain federal putative classactions, the court lifted this stay. On December 6, 2007, plaintiffs fileda consolidated amended complaint reiterating some of the previous claims andasserting claims substantially identical to those contained in the *Chuzhoy v. Yeh* (Cal. Super. Ct., Santa Clara Co.) and *In re Silicon Storage Technology, Inc., Derivative Litigation*(N.D. Cal., San Jose Div.) putative derivative actions. We intend to continueto take all appropriate actions in response to this lawsuit. The impact relatedto the outcome of this matter is undeterminable at this time.

 

OnJuly 13, 2006, a shareholder derivative complaint was filed in the UnitedStates District Court for the Northern District of California by Mike Brienunder the caption *Brien v. Yeh, et al*., Case No. C06-04310JF (N.D. Cal.). On July 18, 2006, a shareholder derivative complaint wasfiled in the United States District Court for the Northern District ofCalifornia by Behrad Bazargani under the caption *Bazargani v.Yeh, et al*., Case No. C06-04388 HRL (N.D. Cal.). Bothcomplaints were brought purportedly on behalf of SST against certain of ourcurrent directors and certain of our current and former officers and allegeamong other things, that the named officers and directors: (a) breachedtheir fiduciary duties as they colluded with each other to backdate stockoptions, (b) violated Rule 10b-5 of the Securities Exchange Act of1934 through their alleged actions, and (c) were unjustly enriched bytheir receipt and retention of such stock options. The *Brien*and *Bazargani* cases were consolidated intoone case: *In re Silicon Storage Technology, Inc.**Derivative Litigation*, Case No. C06-04310JF and a consolidated amended shareholder derivative complaint was filed on October 30,2006. On May 9, 2008 plaintiff filed their second consolidated shareholderderivative complaint. Our response is due May 19, 2008. On October 31,2006, a similar shareholder derivative complaint was filed in the SuperiorCourt of the State of California for the County of Santa Clara by Alex Chuzhoyunder the caption *Chuzhoy v. Yeh, et al.,* Case No. 1-06-CV-074026.This complaint was brought purportedly on behalf of SST against certain of ourcurrent directors and certain of our current and former officers and allegesamong other things, that the named officers and directors breached theirfiduciary duties as they colluded with each other to backdate stock options andwere allegedly unjustly enriched by their actions. The *Chuzhoy*complaint also alleges that certain of our officers and directors violated section 25402of the California Corporations Code by selling shares of our common stock whilein possession of material non-public adverse information. No response is dueuntil after the plaintiff files an amended complaint. We intend to take all appropriateaction in responding to all of the complaints.

 

Onor about July 13, 2007, a patent infringement suit was brought byOPTi Inc. in the United States District Court for the Eastern District ofTexas alleging infringement of two United State patents related to a “CompactISA-bus Interface”. The plaintiff seeks a permanent injunction, and damages foralleged past infringement, as well as any other relief the court may grant thatis just and proper. At this time, discovery has not yet commenced, and weintend to vigorously defend the suit.

 

Fromtime to time, we are also involved in other legal actions arising in theordinary course of business. We have accrued certain costs associated withdefending these matters. There can be no assurance that the shareholder classaction complaints, the shareholder derivative complaints or other third partyassertions will be resolved without costly litigation, in a manner that is notadverse to our financial position, results of operations or cash flows orwithout requiring payments in the future which may adversely impact net income.No estimate can be made of the possible loss or possible range of lossassociated with the resolution of these contingencies. As a result, no lossesassociated with these or other litigation have been accrued in our financialstatements as of March 31, 2008.

 

**Item 1A.  Risk Factors**

 

**RisksRelated to Our Business**

 

**Thematters relating to the review of our historical stock option grantingpractices and the restatement of our consolidated financial statements hasresulted in litigation, which could harm our financial results.**

 

InMarch 2007, our Board of Directors determined to conduct a voluntaryreview of our historical stock option grant practices covering the time fromour initial public offering in 1995 through 2007. The review was led by theChairman of the 

 

27

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Audit Committee of the Boardof Directors with the assistance of outside independent legal counsel, andbegan on or about March 15, 2007. As described further in Item 7. “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andNote 2. to our consolidated financial statements in our Annual Report on Form 10-Kfor the year ended December 31, 2006, the Chairman of the Audit Committeehas reached the conclusion that incorrect measurement dates were used forfinancial accounting purposes for stock option grants made in certain priorperiods. As a result, we have recorded additional non-cash stock-based compensationexpense, and related tax effects, related to stock option grants and haverestated our historical financial statements. The review of our historicalstock option granting practices has also required us to incur substantialexpenses for legal, accounting, tax and other professional services, totaling$12.0 million for the year ended December 31, 2007. In addition, thereview diverted management’s attention from our business, and could in thefuture harm our business, financial condition, results of operations and cashflows.

 

Ourhistorical stock option granting practices and the restatement of our priorfinancial statements have exposed us to greater risks associated withlitigation and regulatory proceedings. As described in Item 1. “LegalProceedings,” several derivative complaints have been filed against ourdirectors and certain of our executive officers pertaining to allegationsrelating to stock option grants. These or future similar complaints, or anyfuture litigation or regulatory action may not result in the same conclusionsreached by the Chairman of the Audit Committee. The conduct and resolution ofthese matters or other litigation will be time consuming, expensive and maydistract management from the conduct of our business.

 

Wealso voluntarily contacted the SEC regarding the review and, as of the date ofthe filing of this Quarterly Report on Form 10-Q, the SEC is continuing aninformal inquiry of our historical stock option grant practices. In October 2007,we met with the SEC and provided it with the status of the review, and in November 2007,we voluntarily provided the SEC with further documents. We plan to continue tocooperate with the SEC in its inquiry.

 

Whilewe believe that we have made appropriate judgments in concluding the correctmeasurement dates for option grants, the SEC may disagree with the manner inwhich we have accounted for and reported, or not reported, the financial impactof past option grant measurement date errors, and there is a risk that itsinquiry could lead to circumstances in which we may have to further restate ourprior financial statements, amend prior filings with the SEC, or otherwise takeother actions not currently contemplated. Any such circumstance could also leadto future delays in filing our subsequent SEC reports and delisting of ourcommon stock from the NASDAQ Global Market. Furthermore, if we are subject toadverse findings in any of these matters, we could be required to pay damagesor penalties or have other remedies imposed upon us which could harm ourbusiness, financial condition, results of operations and cash flows.

 

**We havenot been in compliance with SEC reporting requirements and NASDAQ listingrequirements and may continue to face compliance issues with such regulatorybodies. If we are unable to remain in compliance with SEC reportingrequirements and NASDAQ listing requirements our business will be harmed.**

 

Dueto the independent review and resulting restatement we were unable to file ourperiodic reports with the SEC on a timely basis during 2007 and face thepossibility of the delisting of our common stock from the NASDAQ Global Market.As a result of our failure to file our periodic reports on a timely basis, weare not eligible to use a registration statement on Form S-3 to registeroffers and sales of our securities until all periodic reports have been timelyfiled for at least 12 months. In addition, if the NASDAQ Listing andHearing Review Council concludes that we are not in compliance with applicablelisting requirements, then we may be unable to continue to list our stock onthe NASDAQ Global Market. Despite our filing in January 2008 of ourdelinquent periodic reports we remain in violation of NASDAQ listingrequirements due to our failure to hold an annual meeting of shareholders in2007. Although we anticipate holding an annual meeting in June 2008, if our common stock isdelisted the price of our common stock and the ability of our shareholders totrade our common stock could be adversely affected. In addition, we would besubject to a number of restrictions regarding the registration andqualification of our common stock under federal and state securities laws.

 

**We aresubject to the risks of additional lawsuits from former officers and employeesin connection with our historical stock option practices, the resultingrestatement, and the remedial measures we have taken.**

 

Formeremployees may bring lawsuits against us or engage us in arbitration relating totheir stock options and other matters. These lawsuits may be time consuming andexpensive, and cause further distraction from the operation of our business.The adverse resolution of any specific lawsuit could harm our business,financial condition and results of operations.

 

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**Ouroperating results fluctuate materially, and an unanticipated decline inrevenues may disappoint securities analysts or investors and result in adecline in our stock price.**

 

Althoughwe were profitable for the year ended December 31, 2004, we incurred netlosses for the years ended December 31, 2007, 2006, and 2005. Ouroperating results have fluctuated significantly and our past financialperformance should not be used to predict future operating results. Our recentquarterly and annual operating results have fluctuated, and may continue tofluctuate, due to the following factors, all of which are difficult to forecastand many of which are out of our control:

 
| · |   | the availability, timely  delivery and cost of wafers or other manufacturing and assembly services from  our suppliers;               |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                  |
| · |   | competitive pricing  pressures and related changes in selling prices;                                                                 |
|   |   |                                                                                                                                  |
| · |   | fluctuations in  manufacturing yields and significant yield losses;                                                                   |
|   |   |                                                                                                                                  |
| · |   | new product announcements  and introductions of competing products by us or our competitors;                                          |
|   |   |                                                                                                                                  |
| · |   | product obsolescence;                                                                                                                 |
|   |   |                                                                                                                                  |
| · |   | lower of cost or market,  obsolescence or other inventory adjustments;                                                                |
|   |   |                                                                                                                                  |
| · |   | changes in demand for, or  in the mix of, our products;                                                                               |
|   |   |                                                                                                                                  |
| · |   | the gain or loss of  significant customers;                                                                                           |
|   |   |                                                                                                                                  |
| · |   | market acceptance of  products utilizing our SuperFlash® technology;                                                             |
|   |   |                                                                                                                                  |
| · |   | changes in the channels  through which our products are distributed and the timeliness of receipt of  distributor resale information; |
|   |   |                                                                                                                                  |
| · |   | exchange rate  fluctuations;                                                                                                          |
|   |   |                                                                                                                                  |
| · |   | general economic,  political and environmental-related conditions, such as natural disasters;                                         |
|   |   |                                                                                                                                  |
| · |   | changes in our allowance  for doubtful accounts;                                                                                      |
|   |   |                                                                                                                                  |
| · |   | valuation allowances on  deferred tax assets based on changes in estimated future taxable income;                                     |
|   |   |                                                                                                                                  |
| · |   | difficulties in  forecasting, planning and management of inventory levels;                                                            |
|   |   |                                                                                                                                  |
| · |   | unanticipated research and  development expenses associated with new product introductions;                                           |
|   |   |                                                                                                                                  |
| · |   | the timing of significant  orders and of license and royalty revenue;                                                                 |
|   |   |                                                                                                                                  |
| · |   | valuation of investments  and long-term assets; and                                                                                   |
|   |   |                                                                                                                                  |
| · |   | the impact of the  sub-prime mortgage crisis on our cash and other investments.                                                       |

 

Asrecent experience confirms, a downturn in the market for goods that incorporateour products can also harm our operating results.

 

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**Ouroperating expenses are relatively fixed, and we order materials in advance ofanticipated customer demand. Therefore, we have limited ability to reduceexpenses quickly in response to any revenue shortfalls.**

 

Ouroperating expenses are relatively fixed, and we therefore have limited abilityto reduce expenses quickly in response to any revenue shortfalls. Consequently,our operating results will be harmed if our revenues do not meet ourprojections. We may experience revenue shortfalls for the following reasons:

 
| · |   | sudden drops in consumer  demand which may cause customers to cancel backlog, push out shipment  schedules, or reduce new orders, possibly due to a slowing economy or  inventory corrections among our customers;                                    |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                  |
| · |   | significant declines in  selling prices that occur because of competitive price pressure during an  over-supply market environment;                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                  |
| · |   | sudden shortages of raw  materials for fabrication, test or assembly capacity constraints that lead  our suppliers to allocate available supplies or capacity to other customers  which, in turn, harm our ability to meet our sales obligations; and |
|   |   |                                                                                                                                                                                                                                                  |
| · |   | the reduction,  rescheduling or cancellation of customer orders.                                                                                                                                                                                      |

 

Inaddition, political or economic events beyond our control can suddenly resultin increased operating costs. In addition, we are now required to recordcompensation expense on stock option grants and purchases under our employeestock purchase plan which substantially increases our operating costs andimpacts our earnings (loss) per share.

 

**Weincurred significant inventory valuation and adverse purchase commitmentadjustments in 2006, 2007 and the three months ended March 31, 2008 and wemay incur additional significant inventory valuation adjustments in the future.**

 

Wetypically plan our production and inventory levels based on internal forecastsof customer demand, which are highly unpredictable and can fluctuatematerially. The value of our inventory is dependent on our estimate of futureaverage selling prices, and, if our projected average selling prices are overestimated, we may be required to adjust our inventory value to reflect thelower of cost or market. As of March 31, 2008, we had $59.7 millionof net inventory on hand, an increase of $9.5 million, or 19.0%, from December 31,2007. Total valuation adjustments to inventory and adverse purchase commitmentswere $2.8 million and $1.5 million in the three months ended March 31,2007 and 2008, respectively. Due to the large number of units in our inventory,even a small change in average selling prices could result in a significantadjustment and could harm our financial results. Some of our customers haverequested that we ship them product that has a finished goods date ofmanufacture that is less than one year. As of March 31, 2008, ourallowance for excess and obsolete inventories includes an allowance for our onhand finished goods inventory with a date of manufacture of greater than twoyears and for certain products with a date of manufacture of greater than oneyear. In the event that this becomes a common requirement, it may be necessaryfor us to provide for an additional allowance for our on hand finished goodsinventory with a date of manufacture of greater than one year, which couldresult in a significant adjustment and could harm our financial results.

 

**Cancellationsor rescheduling of backlog may result in lower future revenue and harm ourbusiness.**

 

Dueto possible customer changes in delivery schedules and cancellations of orders,our backlog at any particular date is not necessarily indicative of actualsales for any succeeding period. A reduction of backlog during any particularperiod, or the failure of our backlog to result in future revenue, could harmour business in the future. We experienced a decrease in the average sellingprices of our products as a result of the industry-wide oversupply and excessiveinventory in the market in the second half of 2004 and the first half of 2005.Although we saw strengthening of market demand in the second half of 2005 andpricing remained relatively stable in 2006 and 2007, although there was priceerosion in selected areas in the three months ended March 31, 2008. Ourbusiness could be further harmed by industry-wide prolonged downturns in thefuture.

 

**Ourbusiness may suffer due to risks associated with international sales andoperations.**

 

During2006, 2007 and the three months ended March 31, 2008, our internationalproduct and licensing revenues accounted for 94.7%, 94.3% and 92.1% of our netrevenues, respectively. Our international business activities are subject to anumber of risks, each of which could impose unexpected costs on us that wouldharm our operating results. These risks include:

 
| · |   | difficulties in complying  with regulatory requirements and standards; |
|--------|--------|------------------------------------------------------------------------|
|   |   |                                                                   |
| · |   | tariffs and other trade  barriers;                                     |
|   |   |                                                                   |
| · |   | costs and risks of  localizing products for foreign countries;         |

 

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| · |   | reliance on third parties  to distribute our products;     |
|--------|--------|------------------------------------------------------------|
|   |   |                                                       |
| · |   | extended accounts  receivable payment cycles;              |
|   |   |                                                       |
| · |   | potentially adverse tax  consequences;                     |
|   |   |                                                       |
| · |   | limits on repatriation of  earnings; and                   |
|   |   |                                                       |
| · |   | burdens of complying with  a wide variety of foreign laws. |

 

Inaddition, we have made equity investments in companies with operations inseveral Asian countries. The value of our investments is subject to theeconomic and political conditions particular to their industries and theircountries, foreign exchange rates, and the global economy. If we determine thata change in the recorded value of an investment is other than temporary, wewill adjust the value of the investment. Such an expense could have a negativeimpact on our operating results.

 

Wederived 87.7%, 88.8% and 85.2% of our net product revenues from Asia during2006, 2007 and the three months ended March 31, 2008, respectively.Additionally, substantially all of our wafer suppliers and packaging andtesting subcontractors are located in Asia. Any kind of economic, political orenvironmental instability in this region of the world can have a severenegative impact on our operating results due to the large concentration of ourproduction and sales activities in this region. If countries where we dobusiness experience severe currency fluctuation and economic deflation, it cannegatively impact our revenues and also negatively impact our ability tocollect payments from customers. In this event, the lack of capital in thefinancial sectors of these countries may make it difficult for our customers toopen letters of credit or other financial instruments that are guaranteed byforeign banks. Finally, the economic situation can exacerbate a decline inselling prices for our products as our competitors reduce product prices togenerate needed cash.

 

Itshould also be noted that we are greatly impacted by the political, economicand military conditions in Taiwan. Taiwan and China are continuously engaged inpolitical disputes and both countries have continued to conduct militaryexercises in or near the other’s territorial waters and airspace. Such disputesmay continue and even escalate, resulting in an economic embargo, a disruptionin shipping or even military hostilities. Any of these events can delayproduction or shipment of our products. Any kind of activity of this nature oreven rumors of such activity can harm our operations, revenues, operatingresults, and stock price.

 

**Weinvest in companies for strategic reasons and may not realize a return on ourinvestments.**

 

Wemake investments in companies around the world to further our strategicobjectives and support our key business initiatives. Such investments includeinvestments in equity securities of public companies and investments innon-marketable equity securities of private companies, which range fromearly-stage companies that are often still defining their strategic directionto more mature companies whose products or technologies may directly supportour products or initiatives. The success of these companies is dependent onproduct development, market acceptance, operational efficiency, and other keybusiness success factors. The private companies in which we invest may failbecause they may not be able to secure additional funding, obtain favorable investmentterms for future financings, or take advantage of liquidity events such asinitial public offerings, mergers, and private sales. If any of these privatecompanies fail, we could lose all or part of our investment in that company. Ifwe determine that an other-than-temporary decline in the fair value exists forthe equity securities of the public and private companies in which we invest,we write down the investment to its fair value and recognize the relatedwrite-down as an investment loss. For the years ended December 31, 2006and 2007, we recorded impairments on our investments of $44.1 million and$22.4 million, respectively. Furthermore, when the strategic objectives ofan investment have been achieved, or if the investment or business divergesfrom our strategic objectives, we may decide to dispose of the investment. Ourinvestments in nonmarketable equity securities of private companies are notliquid, and we may not be able to dispose of these investments on favorableterms or at all. The occurrence of any of these events could negatively affectour results of operations.

 

**Ourinvestment portfolio may be impaired by further deterioration of the capitalmarkets.**

 

Ourcash and cash equivalents and short-term investment portfolio as of March 31,2008 consists of money market funds, federal, state and municipal governmentobligations, foreign and public corporate debt securities and listed equitysecurities. We follow an established investment policy and set of guidelines tomonitor, manage and limit our exposure to interest rate and credit risk. Thepolicy sets forth credit quality standards and limits our exposure to any oneissuer. As a result of current adverse financial market conditions, somefinancial instruments, such as structured investment vehicles, sub-primemortgage-backed securities and collateralized debt obligations, may pose risksarising from liquidity and credit 

 

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concerns. As of March 31,2008, we had no direct holdings in these categories of investments and ourexposure to these financial instruments through our indirect holdings in moneymarket mutual funds was not material to total cash, cash equivalents andshort-term investments. As of March 31, 2008, we had no impairment chargeassociated with our short-term investment portfolio. However, we cannot predictfuture market conditions or market liquidity and our investment portfolio maybe impaired by future events.

 

**Terroristattacks and threats, and government responses thereto, could harm our business.**

 

Terroristattacks in the United States or abroad against American interests or citizens,U.S. retaliation for these attacks, threats of additional terrorist activityand the war in Iraq have caused our customer base to become more cautious. Anyescalation in these events or similar future events may disrupt our operationsor those of our customers, distributors and suppliers, affect the availabilityof materials needed to manufacture our products, or affect the means to transportthose materials to manufacturing facilities and finished products to customers.In addition, these events have had and may continue to have an adverse impacton the U.S. and world economy in general and consumer spending in particular,which could harm our business.

 

**We donot typically enter into long-term contracts with our customers, and the lossof a major customer could harm our business.**

 

Wedo not typically enter into long-term contracts with our customers. Inaddition, we cannot be certain as to future order levels from our customers. Inthe past, when we have entered into a long-term contract, the contract hasgenerally been terminable at the convenience of the customer.

 

**Wedepend on stocking representatives and distributors to generate a majority ofour revenues.**

 

Werely on stocking representatives and distributors to establish and maintaincustomer relationships and to sell our products. These stocking representativesand distributors could discontinue their relationship with us or discontinue sellingour products at any time. The majority of our stocking representatives arelocated in Asia. The loss of our relationship with any stocking representativeor distributor could harm our operating results by impairing our ability tosell our products to our end customers.

 

**Wedepend on Silicon Professional Technology Ltd., or SPT, our logisticscenter, to support many of our customers in Asia.**

 

We out-source our end customer service logistics in Asia to SiliconProfessional Technology Ltd., or SPT, which supports our customers inTaiwan, China and other Southeast Asia countries. SPT provides forecasting,planning, warehousing, delivery, billing, collection and other logisticfunctions for us in these regions. SPT is a wholly-owned subsidiary of one of ourstocking representatives in Taiwan, Professional Computer Technology Limited,or PCT. Please see a description of our relationship with PCT under “RelatedParty Transactions and Balances” in our Annual Report on Form 10-K for theyear ended December 31, 2007. Products shipped to SPT are accounted for as ourinventory held at our logistics center, and revenue is recognized when theproducts have been delivered and are considered as a sale to our end customersby SPT. For the years ended December 31, 2006, 2007 and the three monthsended March 31, 2008, SPT serviced end customer sales accounting for59.1%, 60.1% and 55.2% of our net product revenues recognized. As of December 31,2006, 2007 and the three months ended March 31, 2008, SPT represented68.9%, 65.3% and 54.5% of our net accounts receivable, respectively.

 

We do not have any long-term contracts with SPT, PCT or SiliconProfessional Alliance Corporation, or SPAC, another subsidiary of PCT. SPT, PCTor SPAC may cease providing services to us at any time. If SPT, PCT or SPACwere to terminate their relationship with us we would experience a delay inreestablishing warehousing, logistics and distribution functions, and it couldimpair our ability to collect accounts receivable from SPT and may harm our business.

 

**Wedepend on a limited number of foreign foundries to manufacture our products,and these foundries may not be able to satisfy our manufacturing requirements,which could cause our revenues to decline.**

 

Weoutsource substantially all of our manufacturing and testing activities. Wecurrently buy all of our wafers and sorted die from a limited number ofsuppliers. The majority of our products are manufactured by five foundries,Grace and Shanghai Hua Hong NEC Electronic Company Limited, or HHNEC, in Chinaand TSMC in Taiwan, Seiko-Epson and Yasu in Japan. We have an equity investmentin GSMC, a Cayman Islands company, which owns a wafer foundry subsidiary,Grace, in Shanghai, China. We anticipate that these foundries, together withSanyo in Japan, Samsung in Korea and Powerchip Semiconductor Corporation, orPSC, in Taiwan will continue to manufacture substantially all of our productsin the foreseeable future. If these suppliers fail to satisfy our requirementson a timely basis at competitive prices we could 

 

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suffer manufacturing delays,a possible loss of revenues or higher than anticipated costs of revenues, anyof which could harm our operating results.

 

Ourrevenues may be impacted by our ability to obtain adequate wafer supplies fromour foundries. The foundries with which we currently have arrangements,together with any additional foundry at which capacity might be obtained, maynot be willing or able to satisfy all of our manufacturing requirements on atimely basis at favorable prices. In addition, we have encountered delays inqualifying new products and in ramping-up new product production and we couldexperience these delays in the future. During the first quarter of 2006, weexperienced fabrication issues with one of our wafer foundries and capacityconstraints for certain package types at one of our backend suppliers. We arealso subject to the risks of service disruptions, raw material shortages andprice increases by our foundries. Such disruptions, shortages and priceincreases could harm our operating results.

 

**Manufacturingcapacity has in the past been difficult to secure and if capacity constraintsarise in the future our revenues may decline.**

 

Inorder to grow, we need to increase our present manufacturing capacity. Theexisting capacity from Grace, HHNEC and TSMC available wereinsufficient during 2007. Events that we have not foreseen could arise whichwould further limit our capacity. Similar to our investment in GSMC, we may determinethat it is necessary to invest substantial capital in order to secureappropriate production capacity commitments. If we cannot secure additionalmanufacturing capacity on acceptable terms, our ability to grow will beimpaired and our operating results will be harmed.

 

**Ourcost of revenues may increase if we are required to purchase manufacturingcapacity in the future.**

 

Toobtain additional manufacturing capacity, we may be required to make deposits,equipment purchases, loans, joint ventures, equity investments or technologylicenses in or with wafer fabrication companies. These transactions couldinvolve a commitment of substantial amounts of our capital and technologylicenses in return for production capacity. We may be required to seek additionaldebt or equity financing if we need substantial capital in order to secure thiscapacity and we cannot assure you that we will be able to obtain suchfinancing.

 

**If ourfoundries fail to achieve acceptable wafer manufacturing yields, we willexperience higher costs of revenues and reduced product availability.**

 

Thefabrication of our products requires wafers to be produced in a highlycontrolled and ultra-clean environment. Semiconductor companies that supply ourwafers have, from time to time, experienced problems achieving acceptable wafermanufacturing yields. Semiconductor manufacturing yields are a function of bothour design technology and the foundry’s manufacturing process technology. Lowyields may result from marginal design or manufacturing process drift. Yieldproblems may not be identified until the wafers are well into the productionprocess, which often makes them difficult, time consuming and costly tocorrect. Furthermore, we rely on independent foundries for our wafers whichincreases the effort and time required to identify, communicate and resolvemanufacturing yield problems. If our foundries fail to achieve acceptablemanufacturing yields, we will experience higher costs of revenues and reducedproduct availability, which could harm our operating results.

 

**If ourfoundries discontinue the manufacturing processes needed to meet our demands,or fail to upgrade the technologies needed to manufacture our products, we mayface production delays and lower revenues.**

 

Ourwafer and product requirements typically represent a small portion of the totalproduction of the foundries that manufacture our products. As a result, we aresubject to the risk that a foundry will cease production on an older orlower-volume manufacturing process that it uses to produce our parts.Additionally, we cannot be certain our foundries will continue to devoteresources to advance the process technologies on which the manufacturing of ourproducts is based. Either one of these events could increase our costs and harmour ability to deliver our products on time.

 

**Ourdependence on third-party subcontractors to assemble and test our productssubjects us to a number of risks, including an inadequate supply of productsand higher costs of materials.**

 

Wedepend on independent subcontractors to assemble and test our products. Ourreliance on these subcontractors involves the following significant risks:

 
| · |   | reduced control over  delivery schedules and quality; |
|--------|--------|-------------------------------------------------------|

 

33

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| · |   | the potential lack of  adequate capacity during periods of strong demand;       |
|--------|--------|---------------------------------------------------------------------------------|
|   |   |                                                                            |
| · |   | difficulties selecting and  integrating new subcontractors;                     |
|   |   |                                                                            |
| · |   | limited warranties on the  service they provide to us;                          |
|   |   |                                                                            |
| · |   | potential increases in  prices due to capacity shortages and other factors; and |
|   |   |                                                                            |
| · |   | potential misappropriation  of our intellectual property.                       |

 

Theserisks may lead to increased costs, delayed product delivery or loss ofcompetitive advantage, which would harm our profitability and customerrelationships.

 

**Becauseour flash memory products typically have lengthy sales cycles, we mayexperience substantial delays between incurring expenses related to researchand development and the generation of revenues.**

 

Dueto the flash memory product cycle we usually require more than nine months torealize volume shipments after we first contact a customer. We first work withcustomers to achieve a design win, which may take three months or longer. Ourcustomers then complete the design, testing and evaluation process and begin toramp up production, a period which typically lasts an additional nine months orlonger. As a result, a significant period of time may elapse between ourresearch and development efforts and our realization of revenue, if any, fromvolume purchasing of our products by our customers.

 

**We faceintense competition from companies with significantly greater financial,technical and marketing resources that could harm sales of our products.**

 

Wecompete with major domestic and international semiconductor companies, many ofwhich have substantially greater financial, technical, marketing, distribution,and other resources than we do. Many of our competitors have their ownfacilities for the production of semiconductor memory components and haverecently added significant capacity for such production. Our low density memoryproducts, medium density memory products, and high density memory products, ifwe are successful in developing these products, face substantial competition.In addition, we may in the future experience direct competition from ourfoundry partners. We have licensed to our foundry partners the right tofabricate products based on our technology and circuit design, and to sell suchproducts worldwide, subject to our receipt of royalty payments. Competition mayalso come from alternative technologies such as ferroelectric random accessmemory devices, or FRAM, magneto-resistive random access memory, or MRAM, orother developing technologies.

 

**Ourmarkets are subject to rapid technological change and, therefore, our successdepends on our ability to develop and introduce new products.**

 

Themarkets for our products are characterized by:

 
| · |   | rapidly changing  technologies;                       |
|--------|--------|-------------------------------------------------------|
|   |   |                                                  |
| · |   | evolving and competing  industry standards;           |
|   |   |                                                  |
| · |   | changing customer needs;                              |
|   |   |                                                  |
| · |   | frequent new product  introductions and enhancements; |
|   |   |                                                  |
| · |   | increased integration with  other functions; and      |
|   |   |                                                  |
| · |   | rapid product  obsolescence.                          |

 

Todevelop new products for our target markets, we must develop, gain access toand use leading technologies in a cost-effective and timely manner and continueto expand our technical and design expertise. In addition, we must have ourproducts designed into our customers’ future products and maintain closeworking relationships with key customers in order to develop new products thatmeet their changing needs. In addition, products for communicationsapplications are based on continually evolving industry standards. Our abilityto compete will depend on our ability to identify and ensure compliance withthese industry standards. As a result, we could be required to investsignificant time and effort and incur significant 

 

34

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expense to redesign ourproducts and ensure compliance with relevant standards. We believe thatproducts for these applications will encounter intense competition and behighly price sensitive. While we are currently developing and introducing newproducts for these applications, we cannot assure you that these products willreach the market on time, will satisfactorily address customer needs, will besold in high volume, or will be sold at profitable margins.

 

Wecannot assure you that we will be able to identify new product opportunitiessuccessfully, develop and bring to market new products, achieve design wins orrespond effectively to new technological changes or product announcements byour competitors. In addition, we may not be successful in developing or usingnew technologies or in developing new products or product enhancements thatachieve market acceptance. Our pursuit of necessary technological advances mayrequire substantial time and expense. Failure in any of these areas could harmour operating results.

 

**Ourfuture success depends in part on the continued service of our key designengineering, sales, marketing and executive personnel and our ability toidentify, recruit and retain additional personnel.**

 

Weare highly dependent on Bing Yeh, our President and Chief Executive Officer, aswell as the other principal members of our management team and engineeringstaff. There is intense competition for qualified personnel in thesemiconductor industry, in particular the highly skilled design, applicationsand test engineers involved in the development of flash memory technology.Competition is especially intense in Silicon Valley, where our corporateheadquarters are located. We may not be able to continue to attract and retainengineers or other qualified personnel necessary for the development of ourbusiness or to replace engineers or other qualified personnel who may leave ouremploy in the future. Our anticipated growth is expected to place increaseddemands on our resources and will likely require the addition of new managementand engineering personnel and the development of additional expertise byexisting management personnel. The failure to recruit and retain key designengineers or other technical and management personnel could harm our business.

 

**Ourability to compete successfully depends, in part, on our ability to protect ourintellectual property rights.**

 

Werely on a combination of patent, trade secrets, copyrights, mask work rights,nondisclosure agreements and other contractual provisions and technicalmeasures to protect our intellectual property rights. Policing unauthorized useof our products, however, is difficult, especially in foreign countries.Litigation may continue to be necessary in the future to enforce ourintellectual property rights, to protect our trade secrets, to determine thevalidity and scope of the proprietary rights of others, or to defend againstclaims of infringement or invalidity. Litigation could result in substantialcosts and diversion of resources and could harm our business, operating resultsand financial condition regardless of the outcome of the litigation. As of March 31,2008, we held 254 patents in the United States relating to certain aspects ofour products and processes, with expiration dates ranging from 2010 to 2027 andhave filed for several more. In addition, we hold several patents in Europe,Japan, Korea, Taiwan, and China. We cannot assure you that any pending patentapplication will be granted. Our operating results could be harmed by thefailure to protect our intellectual property.

 

**We areengaged in derivative suits, which may become time consuming, costly and divertmanagement resources and could impact our stock price.**

 

Securitiesclass action law suits are often brought against companies, particularlytechnology companies, following periods of volatility in the market price oftheir securities. Irrespective of the validity or the successful assertion ofsuch claims, we could incur significant costs and management resources indefending against such claims. We are currently facing multiple shareholderderivative complaints. The complaints were brought purportedly on behalf of SSTagainst certain of our current and former officers and directors and allege,among other things, that the named officers and directors: (a) breachedtheir fiduciary duties as they colluded with each other to backdate stockoptions, (b) violated Rule 10b-5 of the Securities Exchange Act of1934 through their alleged actions, and (c) were unjustly enriched bytheir receipt and retention of such stock options.

 

Fromtime to time, we are also involved in other legal actions arising in theordinary course of business. There can be no assurance that the shareholderclass action complaints, the shareholder derivative complaints or other thirdparty assertions will be resolved without costly litigation, in a manner thatis not adverse to our financial position, results of operations or cash flowsor without requiring payments in the future which may adversely impact grossmargins. No estimate can be made of the possible loss or possible range of lossassociated with the resolution of these contingencies. As a result, no losseshave been accrued in our financial statements as of March 31, 2008.

 

Duringthe course of these lawsuits there may be public announcements of the resultsof hearings, motions, and other interim proceedings or developments in thelitigation. If securities analysts or investors perceive these results to benegative, it could harm the market price of our stock. We have incurred certaincosts associated with defending these matters, 

 

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and at any time, additionalclaims may be filed against us, which could increase the risk, expense andduration of the litigation. Further, because of the amount of discoveryrequired in connection with this type of litigation, there is a risk that someof our confidential information could be compromised by disclosure. For moreinformation with respect to our litigation, please also see Item 3. “LegalProceedings.”

 

**If weare accused of infringing the intellectual property rights of other parties wemay become subject to time consuming and costly litigation. If we lose, wecould suffer a significant impact on our business and be forced to pay damages.**

 

Thirdparties may assert that our products infringe their proprietary rights, or mayassert claims for indemnification resulting from infringement claims againstus. Any such claims may cause us to delay or cancel shipment of our products orpay damages that could harm our business, financial condition and results ofoperations. In addition, irrespective of the validity or the successfulassertion of such claims, we could incur significant costs in defending againstsuch claims.

 

Wereceive from time to time, letters or communications from other companies statingthat such companies have patent rights that involve our products. Since thedesign of most of our products is based on SuperFlash technology, any legalfinding that the use of our SuperFlash technology infringes the patent ofanother company would have a significantly negative effect on our entireproduct line and operating results. Furthermore, if such a finding were made,there can be no assurance that we could license the other company’s technologyon commercially reasonable terms or that we could successfully operate withoutsuch technology. Moreover, if we are found to infringe, we could be required topay damages to the owner of the protected technology and could be prohibitedfrom making, using, selling, offering to sell or importing into the UnitedStates any products that infringe the protected technology. In addition, themanagement attention consumed by and legal cost associated with any litigationcould harm our operating results. During the course of these lawsuits there maybe public announcements of the results of hearings, motions, and other interimproceedings or developments in the litigation. If securities analysts orinvestors perceive these results to be negative, it could harm the market priceof our stock.

 

**If anearthquake or other natural disaster strikes our manufacturing facility orthose of our suppliers, we would be unable to manufacture our products for asubstantial amount of time and we would experience lost revenues.**

 

Ourcorporate headquarters are located in California near major earthquake faults.In addition, some of our suppliers are located near fault lines. In the eventof a major earthquake or other natural disaster near our headquarters, ouroperations could be harmed. Similarly, a major earthquake or other naturaldisaster such as typhoon near one or more of our major suppliers, like theearthquakes in April 2006 and December 2006 or the typhoons in September 2001and July 2005 that occurred in Taiwan, could potentially disrupt theoperations of those suppliers, which could then limit the supply of ourproducts and harm our business.

 

**A virusor viral outbreak in Asia could harm our business.**

 

Wederive substantially all of our revenues from Asia and our logistics center islocated in Taiwan. A virus or viral outbreak in Asia, such as the SARS outbreakin early 2003 or threat of the Avian flu, could harm the operations of oursuppliers, distributors, logistics center and those of our end customers, whichcould harm our business.

 

**Prolongedelectrical power outages, energy shortages, or increased costs of energy couldharm our business.**

 

Ourdesign and process research and development facilities and our corporateoffices are located in California, which is susceptible to power outages andshortages as well as increased energy costs. To limit this exposure, allcorporate computer systems at our main California facilities are on batteryback-up. In addition, all of our engineering and back-up servers and selectedcorporate servers are on generator back-up. While the majority of ourproduction facilities are not located in California, more extensive powershortages in the state could delay our design and process research anddevelopment as well as increase our operating costs.

 

**Ourgrowth has in the past placed a significant strain on our management systemsand resources and if we fail to manage our growth, our ability to market orsell our products or develop new products may be harmed.**

 

Ourbusiness has in the past experienced rapid growth which strained our internalsystems and future growth will require us to continuously develop sophisticatedinformation management systems in order to manage our business effectively. Wehave implemented a supply-chain management system and a vendor electronic datainterface system. There is no guarantee that these measures, in themselves,will be adequate to address any growth, or that we will be able to foresee in atimely manner other infrastructure needs before they arise. Our success dependson the ability of our executive officers to 

 

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effectively manage ourgrowth. If we are unable to manage our growth effectively, our results ofoperations will be harmed. If we fail to successfully implement new managementinformation systems, our business may suffer severe inefficiencies that mayharm the results of our operations.

 

**We havedetermined that we have a material weakness in our internal control overfinancial reporting. As a result, current and potential stockholders could loseconfidence in our financial reporting, which would harm our business and thetrading price of our stock.**

 

UnderSection 404 of the Sarbanes-Oxley Act of 2002, we are required to evaluateand determine the effectiveness of our internal control over financial reporting.We have dedicated a significant amount of time and resources to ensurecompliance with this legislation for the year ended December 31, 2007 andwill continue to do so for future fiscal periods. We may encounter problems ordelays in completing the review, evaluation, and the implementation ofimprovements. Additionally, management’s assessment of our internal controlover financial reporting may identify deficiencies that need to be addressed inour internal control over financial reporting or other matters that may raiseconcerns for investors.

 

Therestatement of financial statements for the years ended December 31, 1997through December 31, 2005 in prior filings with the SEC is a strongindicator of the existence of a material weakness in the design or operation ofinternal control over financial reporting. We concluded that the controldeficiencies that resulted in the restatement of the previously issuedconsolidated financial statements were remediated, and thus concluded that thecontrol deficiencies relating to our historical stock option grant practicesthat resulted in the restatement of the previously-issued financial statementsdid not constitute a material weakness as of December 31, 2006. However,as of December 31, 2006 and 2007 and the quarter ended March 31,2008, we did not maintain effective controls over the completeness, accuracy,valuation and presentation and disclosure of inventory and the related cost ofrevenue accounts. Specifically, our controls over the recording of inventoryadjustments resulting from physical inventory observations, capitalization ofproduction variances into inventory and valuation of inventory related reservesin accordance with generally accepted accounting principles in the UnitedStates, were not effective. These control deficiencies resulted in auditadjustments to the 2006 and 2007 consolidated annual and the quarter ended March 31,2008 interim financial statements. Additionally, these control deficienciescould result in misstatements to the inventory and the related cost of revenueaccounts and disclosures that would result in a material misstatement of theannual or interim consolidated financial statements that would not be preventedor detected. Accordingly, we determined that these control deficienciesconstitute a material weakness at December 31, 2006 and 2007. Because ofthis material weakness, our management concluded that, as of December 31,2006 and 2007, we did not maintain effective internal control over financialreporting based on those criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). As a result,PricewaterhouseCoopers LLP, issued an adverse opinion with respect to theeffectiveness of our internal controls over financial reporting for the yearsended December 31, 2006 and 2007.

 

Shouldwe determine in future fiscal periods that we have additional materialweaknesses in our internal controls over financial reporting, the reliabilityof our financial reports may be impacted, and our results of operations orfinancial condition may be harmed and the price of our common stock maydecline.

 

**Futurechanges in financial accounting standards or practices or existing taxation rules orpractices may cause adverse unexpected revenue fluctuations and affect ourreported results of operations.**

 

Achange in accounting standards or practices or a change in existing taxation rules orpractices can have a significant effect on our reported results and may evenaffect reporting of transactions completed before the change is effective. Newaccounting pronouncements and taxation rules and varying interpretationsof accounting pronouncements and taxation practice have occurred and may occurin the future. Changes to existing rules or the questioning of currentpractices may adversely affect our reported financial results or the way weconduct our business. For example, we adopted SFAS No. 123(R) in thefirst quarter of 2006 which requires us to record charges to earnings for thestock options we grant and purchases of our common stock under our employeestock purchase plan.

 

**Evolvingregulation of corporate governance and public disclosure may result inadditional expenses and continuing uncertainty.**

 

Changinglaws, regulations and standards relating to corporate governance and publicdisclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations andNASDAQ Marketplace rules are creating uncertainty for public companies. Wecontinually evaluate and monitor developments with respect to new and proposed rules andcannot predict or estimate the amount of the additional costs we may incur orthe timing of such costs. These new or changed laws, regulations and standardsare subject to varying interpretations, in many cases due to their lack ofspecificity, and as a result, their 

 

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application in practice mayevolve over time as new guidance is provided by regulatory and governingbodies. This could result in continuing uncertainty regarding compliancematters and higher costs necessitated by ongoing revisions to disclosure andgovernance practices. We are committed to maintaining high standards ofcorporate governance and public disclosure. As a result, we have investedresources to comply with evolving laws, regulations and standards, and thisinvestment has resulted in increased general and administrative expenses and adiversion of management time and attention from revenue-generating activitiesto compliance activities. If our efforts to comply with new or changed laws,regulations and standards differ from the activities intended by regulatory orgoverning bodies due to ambiguities related to practice, regulatory authoritiesmay initiate legal proceedings against us and we may be harmed.

 

**Acquisitionscould result in operating difficulties, dilution and other harmfulconsequences.**

 

Inthe past four years we have acquired Emosyn, LLC a fabless semiconductormanufacturer specializing in the design and marketing of smartcard ICs for SIMapplications, G-Plus, Inc., a semiconductor manufacturer specializing inthe design and marketing of radio frequency ICs and monolithic microwave ICsand Actrans Systems Inc., a fabless semiconductor company that designsflash memory and EEPROMs. We expect to continue to evaluate and consider awide array of potential strategic transactions, including businesscombinations, acquisitions and dispositions of businesses, technologies,services, products and other assets, including interests in our existingsubsidiaries and joint ventures. At any given time we may be engaged indiscussions or negotiations with respect to one or more of such transactions.Any such transactions could be material to our financial condition and resultsof operations. There is no assurance that any such discussions or negotiationswill result in the consummation of any transaction. The process of integratingany acquired business may create unforeseen operating difficulties andexpenditures and is itself risky. The areas where we may face difficultiesinclude:

 
| · |   | diversion of management  time, as well as a shift of focus from operating the businesses to issues of  integration and future products;                                                                                                     |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                        |
| · |   | declining employee morale  and retention issues resulting from changes in compensation, reporting  relationships, future prospects, or the direction of the business;                                                                       |
|   |   |                                                                                                                                                                                                                                        |
| · |   | the need to integrate each  company’s accounting, management information, human resource and other  administrative systems to permit effective management, and the lack of  control if such integration is delayed or not implemented; |
|   |   |                                                                                                                                                                                                                                        |
| · |   | the need to implement  controls, procedures and policies appropriate for a public company at  companies that prior to acquisition had lacked such controls, procedures and  policies; and                                                   |
|   |   |                                                                                                                                                                                                                                        |
| · |   | in some cases, the need to  transition operations onto our technology platforms.                                                                                                                                                            |

 

Internationalacquisitions involve additional risks, including those related to integrationof operations across different cultures and languages, currency risks, and theparticular economic, political, and regulatory risks associated with specificcountries. Moreover, we may not realize the anticipated benefits of any or allof our acquisitions. As a result of future acquisitions or mergers, we mightneed to issue additional equity securities, spend our cash, or incur debt,contingent liabilities, or amortization expenses related to intangible assets,any of which could reduce our profitability and harm our business.

 

**RisksRelated to Our Industry**

** **

**Oursuccess is dependent on the growth and strength of the flash memory market.**

 

Substantiallyall of our products, as well as all new products currently under design, arestand-alone flash memory devices or devices embedded with flash memory. Amemory technology other than SuperFlash may be adopted as an industry standard.Our competitors are generally in a better financial and marketing position thanwe are from which to influence industry acceptance of a particular memorytechnology. In particular, a primary source of competition may come fromalternative technologies such as FRAM or MRAM devices if such technology iscommercialized for higher density applications. To the extent our competitorsare able to promote a technology other than SuperFlash as an industry standard;our business will be seriously harmed.

 

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**Theselling prices for our products are extremely volatile and have historicallydeclined during periods of over capacity or industry downturns.**

 

Thesemiconductor industry has historically been cyclical, characterized byperiodic changes in business conditions caused by product supply and demandimbalance. When the industry experiences downturns, they often occur inconnection with, or in anticipation of, maturing product cycles and declines ingeneral economic conditions. These downturns are characterized by weak productdemand, excessive inventory and accelerated decline of selling prices. Weexperienced a decrease in the average selling prices of our products as aresult of the industry-wide oversupply and excessive inventory in the market inthe second half of 2004 and the first half of 2005. Although we sawstrengthening of market demand in the second half of 2005 and pricing remainedrelatively stable in 2006 and 2007, there was price erosion in selected areas.Our business could be further harmed by industry-wide prolonged downturns inthe future.

 

**Thereis seasonality in our business and if we fail to continue to introduce newproducts this seasonality may become more pronounced.**

 

Salesof our products in the consumer electronics applications market are subject toseasonality. As a result, sales of these products are impacted by seasonalpurchasing patterns with higher sales generally occurring in the second half ofeach year. In the past we have been able to mitigate such seasonality with theintroduction of new products throughout the year. If we fail to continue tointroduce new products, our business may suffer and the seasonality of aportion of our sales may become more pronounced.

 

**Item 2. Unregistered Sales of Equity Securitiesand Use of Proceeds**

 

The following table showspurchases of our common stock and the available funds to purchase additionalcommon stock for each period in the quarter ended March 31, 2008:

 
| ** **                                      | ** ** | ** **             | ** ** | ** **                   | ** ** | **Total Number of**          | ** ** | ** **                     | ** ** |
|-------------------------------------------------|------------|------------------------|------------|------------------------------|------------|----------------------------------------|------------|--------------------------------|------------|
| ** **                                      | ** ** | **Total Number**  | ** ** | ** **                   | ** ** | **Shares Purchased**              | ** ** | **Value That May**   | ** ** |
| ** **                                      | ** ** | **of Shares**     | ** ** | **Average Price**       | ** ** | **As Part of Publicly** | ** ** | **Yet be Purchased** | ** ** |
| **Period**                                      | ** ** | **Purchased (1)** | ** ** | **Paid per Share** | ** ** | **Announced Plan**                | ** ** | **Under the Plan**   | ** ** |
| January 1, 2008 to Janauary 31, 2008       |       | —                 |       | $                            | —     |                                   | —     |                           | $          | 30,000,000 |   |
| February 1, 2008 to February 29, 2008 |       | 420,000                |       | $                            | 2.93       |                                   | 420,000    |                           | $          | 28,768,000 |   |
| March 1, 2008 to March 31, 2008       |       | 1,783,000              |       | $                            | 2.77       |                                   | 1,783,000  |                           | $          | 23,835,000 |   |
|                                            |       |                   |       |                         |       |                                   |       |                           |       |
| First Quarter Total                             |       | 2,203,000              |       | $                            | 2.80       |                                   | 2,203,000  |                           | $          | 23,835,000 |   |

 

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(1)                                  In the first quarter offiscal 2008, our Board of Directors approved a share purchase program torepurchase up to $30 million of our common stock at any time commencing February 11,2008.  The program does not obligate usto acquire shares at any particul price per share and may be suspended at anytime at our discretion.

 

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**Item 6.  Exhibits.**

 
| (a) |   | *Exhibits.* |
|-----|--------|-------------|

 
|   |   | We incorporate by  reference all exhibits filed in connection with our Annual Report on Form 10-K  for the year ended December 31, 2007.                                                                                                                            |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                          |
| 31.1   |   | Certification of President  and Chief Executive Officer required by Rule 13a- 14(a) of the  Securities Exchange Act of 1934, as amended.                                                                                                                            |
| 31.2   |   | Certification of Senior  Vice President, Finance and Chief Financial Officer required by  Rule 13a- 14(a) of the Securities Exchange Act of 1934, as amended.                                                                                                       |
| 32.1*  |   | Certification of President  and Chief Executive Officer, as required by Rule 13a-14(b) of the  Securities Exchange Act of 1934, as amended, and Section 1350 of  Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).                       |
| 32.2*  |   | Certification of Senior  Vice President, Finance and Chief Financial Officer, as required by  Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended,  and Section 1350 of Chapter 63 of Title 18 of the United States  Code (18 U.S.C. 1350). |

 

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| * |   | The certifications  attached as Exhibit 32.1 and Exhibit 32.2 accompany the Quarterly  Report on Form 10-Q, are not deemed filed with the Securities and  Exchange Commission and are not to be incorporated by reference into any  filing of Silicon Storage Technology, Inc. under the Securities Act of  1933, as amended, or the Securities Exchange Act of 1934, as amended (whether  made before or after the date of the Form 10-Q), irrespective of any  general incorporation language contained in such filing. |
|---|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hascaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized, in the City of Sunnyvale, County of Santa Clara, State ofCalifornia, on the 12th day of May, 2008.

 
|   | SILICON STORAGE  TECHNOLOGY, INC. |
|--------|----------------------------------------|
|   |                                   |
|   | By:                                    | /S/  BING YEH |
|   |                                   | Bing  Yeh |
|   |                                   | Chairman,  President and |
|   |                                   | Chief  Executive Officer |
|   |                                   | (*Principal Executive Officer*) |
|   |                                   |   |
|   |                                   |   |
|   |                                   | /S/  JAMES B. BOYD |
|   |                                   | James  B. Boyd |
|   |                                   | Senior  Vice President, Finance and |
|   |                                   | Chief  Financial Officer |
|   |                                   | (*Principal Financial and Accounting Officer*) |

 

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