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FORM 10-K

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(MARK ONE)

[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
     SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2004

OR

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

FOR THE TRANSITION PERIOD FROM ___________ TO  _____________

Commission file number 0-26944

Silicon Storage Technology, Inc.(Exact name of Registrant as Specified in its Charter)



|California                                                     | 77-0225590                             
|-------------------------------------------------------------- | ---------------------------------------
|(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification Number)

1171 Sonora CourtSunnyvale, California     94086(Address of Principal Executive Offices including Zip Code)

(408) 735-9110(Registrant's Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:
                          Common Stock, no par value.

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

Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act).  Yes [X]       No  [     ]


Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K, or any amendment to
this Form 10-K.   Yes [X]          No  [     ]Aggregate market value of the voting stock held by non-affiliates of
SST as of June 30, 2004: $856,986,924  based on the closing price of SST's
Common Stock as reported on the Nasdaq National Market. Number of shares
outstanding of SST's Common Stock, no par value, as of the latest practicable
date, February 28, 2005: 97,840,923.Documents incorporated by reference: Exhibits previously filed as noted
on page 40. Part III - A portion of the Registrant's definitive proxy statement
for the Registrant's Annual Meeting of Shareholders, to be held on June 2, 2005, which will be filed with
the Securities and Exchange Commission.1
Silicon Storage Technology, Inc.

                                    Form 10-K

                      For the Year Ended December 31, 2004

                                TABLE OF CONTENTS

Part I.

PageItem 1.
Business
3Item 2.
Properties
10Item 3.
Legal Proceedings
10Item 4.
Submission of Matters to a Vote of Security Holders
11Part II.Item 5.
Market for the Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities
12Item 6.
Selected Consolidated Financial Data
14Item 7.
Management's Discussion and Analysis of Financial Condition and
Results of Operations
15Item 7A.
Quantitative and Qualitative Disclosures About Market
Risk
40Item 8.
Consolidated Financial Statements and Supplementary
Data
41Item 9.
Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
42Item 9A.
Controls and Procedures
42Item 9B.
Other Information
43Part III.Item 10.
Directors and Executive Officers of the Registrant
44Item 11.
Executive Compensation
44Item 12.
Security Ownership of Certain Beneficial Owners and Management and
Related Shareholder Matters
44Item 13.
Certain Relationships and Related Transactions
44Item 14.
Principal Accountant Fees and Services
44Part IV.Item 15.
Exhibits and Financial Statement Schedule
45Index to Exhibits
45Signatures
48Index to Consolidated Financial
Statements
492PART I

Item 1. Business
Overview
Silicon Storage Technology, Inc., or SST or us or we, is a leading supplier of flash
memory semiconductor devices for the digital consumer, networking, wireless communications and
Internet computing markets.
We offer over 90 products based on our SuperFlash design and manufacturing process technology.
Our customers include: 3Com, Apple, Asustek, BenQ, Cisco, Dell, First International Computer, or
FIC, Gigabyte, Huawei, Hyundai, Infineon, Intel, IBM, Inventec, Legend, LG Electronics, or LG,
Motorola, National Semiconductor, NEC, Nintendo, Nortel, Panasonic, Philips, Quanta, Samsung, Sanyo,
Seagate, Siemens, Sony, Sony Ericsson, Texas Instruments and VTech.
We also license our SuperFlash technology to leading semiconductor companies including
1st Silicon (Malaysia) Sdn. Bhd., Analog Devices, IBM, Motorola Inc., National
Semiconductor Corporation, NEC Corporation, Oki Electric Industry Co., Samsung Electronics Co. Ltd.,
SANYO Electric Co., Ltd., Seiko Epson Corporation, Shanghai Huahong NEC Electronics Co., Ltd.,
Taiwan Semiconductor Manufacturing Co., Ltd., or TSMC, Toshiba Corporation and Winbond Electronics
Corporation for applications in semiconductor devices that integrate flash memory with other
functions on a single chip.
Our products are manufactured at leading wafer foundries and semiconductor manufacturers
including Global Communication Semiconductor, Shanghai Grace Semiconductor Manufacturing
Corporation, or Grace, Samsung Electronics Co., Ltd., SANYO Electric Co., Ltd., Seiko Epson
Corporation, Shanghai Hua Hong NEC Electronics Co. Ltd., TSMC and Yasu Semiconductor Corporation, or
Yasu. We also work with Grace, Powerchip Semiconductor Corporation, and TSMC to develop new
technology for manufacturing our products.
The semiconductor industry has historically been cyclical, characterized by periodic changes in
business conditions caused by product supply and demand imbalance. When the industry experiences
downturns, they often occur in connection with, or in anticipation of, maturing product cycles and
declines in general economic conditions. These downturns are characterized by weak product demand,
excessive inventory and accelerated declines of selling prices. In some cases, downturns, such as
the one we have experienced from late 2000 through 2002, have lasted for more than a year. We began
to experience a slow recovery during 2002 through the first half of 2003. During the second half of
2003 and the first half of 2004, demand for our products increased sharply and we began to see
improvements in the average selling prices of our products. However, we experienced a decrease in
the average selling prices of our products as a result of the industry-wide oversupply and excessive
inventory in the market in the second half of 2004. Our business could be further harmed by
industry-wide prolonged downturns in the future.
We derived 88.5%, 90.0% and 86.0% of our net product revenues during 2002, 2003 and 2004,
respectively, from product shipments to Asia. Additionally, substantially all of our wafer suppliers
and packaging and testing subcontractors are located in Asia.
Industry Background
Semiconductor integrated circuits are critical components used in an increasingly wide
variety of applications, such as computers and computer systems, communications equipment, consumer
products and industrial automation and control systems. As integrated circuit performance has
increased and size and cost have decreased, the use of semiconductors in these applications has
grown significantly.
Historically, the demand for semiconductors has been driven by the PC market. In recent years,
growth in demand for semiconductors relating to PCs has been outpaced by growth in demand for
semiconductors that are used in digital electronic devices for communication and consumer
applications. Communications applications include digital subscriber line modems, cable modems,
networking equipment, wireless local area network, or WLAN, devices, cellular phones and Global
Positioning Systems, or GPS. Consumer-oriented digital electronic devices include digital cameras,
DVD players, MP3 players, personal data assistants, or PDAs, set-top boxes, Digital TVs and video
games.

3In order to function correctly, PCs and other digital electronic devices require program code.
The program code defines how devices function and affects how they are configured. In PCs, this
program code, called BIOS, initiates the loading of the PC's operating system, which is then read
from the disk drive. In the case of other digital electronic devices, the program code is stored in
its entirety in nonvolatile memory, mostly in flash memory. As a result, virtually all digital
electronic systems that use a processor or controller for computing, consumer, communications, and
industrial applications require nonvolatile memory.
System manufacturers generally prefer nonvolatile memory devices that can be reprogrammed
efficiently in the system in order to achieve several important advantages. With re-programmable
memory, manufacturers can cost effectively change program codes in response to faster product cycles
and changing market specifications. This in turn greatly simplifies inventory management and
manufacturing processes. Re-programmable memory also allows the manufacturer to reconfigure or
update a system either locally or through a network connection. In addition, in-system
re-programmable devices can be used for data storage functions, such as storage of phone numbers for
speed dialing in a cellular phone or captured images in a digital camera.
Flash memory is the predominant re-programmable nonvolatile memory device used to store program
code and data. Flash memory can electrically erase select blocks of data on the device much faster
and more simply than with alternative solutions, such as Erasable Programmable Read-Only Memory, or
EPROM. Moreover, flash memory is significantly less expensive than other re-programmable solutions,
such as Electrically Erasable Programmable Read-Only Memory, or EEPROMs. As a result, the demand for
flash memory has grown dramatically. This growth has been fueled by the need for code sharing and
other storage functions in a wide array of digital devices. According to a March 2005 Webfeet
Research report, worldwide flash memory revenue was $17.3 billion in 2004 and is expected to grow to
$19.8 billion in 2005 and $32.3 billion in 2009.
Our Solution
We are a leading supplier of flash memory semiconductor devices addressing the needs of
high volume applications. We believe our proprietary flash memory technology, SuperFlash, offers
superior performance to other flash memory solutions. In addition, we believe SuperFlash has
benefits that include high reliability, fast, fixed erase time, the ability to be scaled to a
smaller size and a low-cost manufacturing process. We offer over 90 products based on our
proprietary SuperFlash design and manufacturing process technology. These products are produced to
meet the needs of a wide range of digital consumer, networking, wireless communications and Internet
computing markets. Our product offerings include standard flash products, application specific
memory products, embedded controllers and mass data storage products. Our memory devices have
densities ranging from 256 Kbit to 32 Mbit and are generally used for the storage of program code.
Our flash embedded microcontrollers support concurrent flash read-while-write operations using
In-Application Programming, or IAP. Our mass data storage products are used for storing images, music
and other data in devices such as digital cameras and MP3 players.

Our Strategy
Our objective is to be the leading worldwide supplier of flash memory devices and the
leading licensor of embedded flash technology for program code storage applications. In addition, we
intend to leverage our SuperFlash technology to penetrate the high-density mass data storage
markets. We intend to achieve our objectives by:
Maintaining a leading position in the program code storage market. We believe that program
code storage is an attractive segment of the flash memory market for a number of reasons. While
experiencing continued growth in all densities, solutions for program code storage applications
benefit from the increasing number and variety of digital electronic applications, longer product
lives and lower density requirements relative to mass data storage applications. We believe that our
proprietary SuperFlash technology is a superior product for program code storage applications
because we believe it offers superior reliability and performance at a lower cost of manufacture
than competing solutions.
Continuing to enhance our leading flash memory technology. We believe that our proprietary
SuperFlash technology is less complicated, more reliable, more scalable and more cost-effective than
competing flash memory technologies. Our ongoing research and development efforts are focused on
enhancing our leading flash memory technology by working closely with technology partners who own
wafer fabrication facilities with advanced lithographic and other manufacturing equipment.

4Introducing new products based on SuperFlash. We intend to introduce new standard memory
and various application specific products. We continue to develop and expand our ComboMemory family.
ComboMemory is a new class of devices for wireless and portable applications that combine volatile
and nonvolatile memory on a single monolithic device or multiple die in a common package with
optimized performance. We also continue to expand our flash microcontroller family and Advanced
Technology Architecture, or ATA, controller products. In 2004, we continued to expand our family of
serial flash products which now includes densities of 512kbit, 1Mbit, 2Mbit 4Mbit and 8Mbit. For PC
BIOS applications, we are expanding our LPC Firmware Flash product offering to match all the
densities offered in our Firmware Hub, or FWH, products.
Maintaining a leading position in licensing embedded flash technology. We believe that
SuperFlash technology is well-suited for embedded memory applications, which integrate flash memory
and other functions onto a monolithic chip. We intend to continue to license SuperFlash technology
to semiconductor manufacturers for embedded flash applications, to enhance our technology and to
facilitate integration at higher densities and higher levels of complexity.
Penetrating the high-density mass data storage market. Many digital electronic devices
currently being introduced, such as MP3 players, digital cameras and PDAs, require high-density
flash memory for storing music, pictures and other data that require mass data storage capacities.
We believe that the market for high-density flash memory is attractive based on its potential size
and growth. We further believe that SuperFlash technology can readily scale to address this market's
needs as they change. We intend to leverage our leading technology and strong manufacturing
partnerships to introduce high-density mass data storage flash products and to compete effectively
in this market.

Leveraging our leading SuperFlash technology to become a premier provider of wireless memory
solutions. We intend to leverage our leading SuperFlash technology to provide products for
wireless applications such as cellular phones, GPS, WLAN, Bluetooth, data pagers and cordless
telephones. We have designed low-density flash products for wireless modems, WLANs, data pagers,
Bluetooth modules and cordless telephones, and we are currently designing higher density products
for the cellular phone market. We intend to continue to develop our products to take advantage of
the significant growth opportunities in the wireless applications market with specific focus on
cellular phone, GPS, WLAN and Bluetooth applications.

Our Flash Products
Currently, we offer low and medium density devices (256 Kbit to 32 Mbit) that target a
broad range of existing and emerging applications in the digital consumer, networking, wireless
communications and Internet computing markets. Our products are segmented largely based upon
attributes such as density, voltage, access speed, package and target application. We divide our
flash products into three distinct reportable segments: the Standard Memory Product Group, or SMPG,
the Application Specific Product Group, or ASPG, and the Special Product Group, or SPG.
SMPG. SMPG includes the Multi-Purpose Flash, or MPF, family, the Multi-Purpose Flash Plus,
or MPF+, family and the Many-Time Programmable, or MTP, family. These product families allow us to
produce products optimized for cost and functionality to support a broad range of mainstream
applications that use nonvolatile memory products. Effective January 1, 2003, we transferred certain
MTP products from SMPG to SPG. Effective July 1, 2003, we transferred the Small Sector Flash, or
SSF, family from SMPG to SPG. Effective January 1, 2004, we transferred the last MTP series of
products from SMPG to SPG. Accordingly, our segment revenues and gross profit information have been
reclassified for presentation purposes as if transfers occurred as of January 1, 2002.
ASPG. ASPG includes Concurrent SuperFlash, Serial Flash, Firmware Hub, or FWH and Low Pin
Count, or LPC, flash products. These products are designed to address specific applications such as
cellular phones, hard disk drives, optical drives and PCs. ASPG also includes flash embedded
controllers such as the ATA flash disk controller. Effective January 1, 2003, we transferred
FlashFlex51 microcontroller products from ASPG to SPG. Accordingly, our segment revenues and gross
profit information have been reclassified for presentation purposes as if the transfer occurred as
of January 1, 2002.

SPG. SPG includesComboMemory,
ROM/RAM Combos, SSF, MTP, FlashFlex51 microcontroller and other special flash products. These
products are used in applications requiring low power and a small form factor such as cellular
phones, wireless modems, MP3 systems, pagers and digital organizers. Effective January 1, 2003, we
transferred certain MTP products from SMPG to SPG and certain flash microcontroller products from
ASPG to SPG. Effective July 1, 2003, we transferred the SSF family from SMPG to SPG. Effective
January 1, 2004, we transferred the last MTP series of products from SMPG to SPG. Accordingly, our
segment revenues and gross profit information have been reclassified for presentation purposes as if
the transfer occurred as of January 1, 2002.

5Our Newly Acquired Businesses
During the second half of 2004, we acquired a majority ownership of Emosyn LLC and
substantially all the assets of G-Plus, Inc., to help with our strategic growth.
Emosyn.Emosyn products include flash memory based smart
card IC chips. The Theseus Platinum product family specifically targets the smart card market
through the sales of products with optimized embedded flash memory densities and cost structure for
various applications. These products are used primarily in cell phone subscriber identification
module, or SIM, applications, and include such benefits of use as user configurable, lower power
consumption, long term data retention and high endurance of data access. We acquired a majority
ownership of Emosyn on September 10, 2004. The segment data is reflected from this date through the
end of the year.

SST Communications Corporation or SCC.

Financial information by reportable segment is contained in Note 15 of the Notes to Consolidated
Financial Statements and is incorporated herein by reference.

Technology Licensing

We license our SuperFlash technology to semiconductor manufacturers for use in embedded
flash applications. We intend to increase our market share by entering into additional license
agreements for our SuperFlash process and memory cell technology with leading wafer foundries and
semiconductor manufacturers. We expect to continue to receive licensing fees and royalties from
these agreements. We design our products using our patented memory cell technology and fabricate
them using our patented process technology. As of December 31, 2004, we held 116 patents in the
United States relating to certain aspects of our products and processes, with expiration dates
ranging from 2010 to 2023, and have filed for several more. In addition, we hold several patents in
Europe, Japan, Korea, Taiwan and Canada and have filed several foreign patent applications in
Europe, Japan, Korea, Taiwan and Canada.

Customers

We provide high-performance flash memory solutions and other products to customers in
four major markets: digital consumer, networking, wireless communications and Internet computing.
Our customers benefit by obtaining products that we believe are highly reliable, technologically
advanced and have attractive cost structures. As a result of these highly desirable benefits, we
have developed relationships with many of the industry's leading companies. In digital consumer
products, we provide products for consumer companies including Funai, Orion, Apple, Inventec,
Reingncom, Telechips, Orient Power, Sagem, Bang & Olufsen, BenQ, Creative Technologies, Hitachi,
JVC, LG, Lite-On, Teac, Premier, Teraoptix, ALCO, BBK, Innowave, Coship, Kaon Media, Sandmartin,
Nintendo, Panasonic, Philips, Samsung, Sanyo, Sharp, Sony, Toshiba, Thomson Multimedia, TiVo, and
Micronas. In networking, we provide products for Broadcom, Atheros, Conexant, Askey, Gemtech, Cisco,
Sagem, Samsung, Tecom, Huawei, ZTE, Alpha Networks, Cybertan, Global Sun, Adtran, Dare, Free Box,
Avocent and Linksys. In wireless communications, we provide products for companies including
Cambridge Silicon Radio, Sagem, Mitsumi, Alps, Bang & Olufsen, LG, Maxon, RTX, Vtech and
Wistron. In Internet computing, we provide a wide array of products for companies including Asustek,
Compal, Dell, FIC, Gigabyte, HP, IBM, Inventec, LG, Mitac, Quanta, Samsung, HonHai (Foxconn),
Fujitsu Siemans, Seagate, Western Digital Maxtor, Matrox and Wistron.

6

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The following tables illustrate the geographic regions in which our customers or licensees
operate based on the country to which the product is shipped by us or the logistics center or
license revenue is generated.

`Year ended December 31,
                                                  ---------------------------------------------
                                                      2002             2003            2004
                                                  ------------  ------------------  -----------
United States................................... $     21,871  $           19,600  $    32,833
Europe..........................................       10,599               9,957       28,863
Japan...........................................       28,465              27,575       35,233
Korea...........................................       30,321              25,214       36,715
Taiwan..........................................       91,219             109,254      125,491
China (including Hong Kong).....................       70,609              76,107      148,100
Other Asian countries...........................       21,574              27,334       41,963
                                                  ------------  ------------------  -----------
                                                 $    274,658  $          295,041  $   449,198
                                                  ============  ==================  ===========`

Sales and Distribution

We sell a majority of our products to customers in Asia through our representatives. We
distribute a majority of our products through our logistics center. We also sell and distribute our
products in North America and Europe through manufacturers' representatives and distributors. Our
manufacturer representative and distributor relationships are generally cancelable, with reasonable
notice, by either party.

Applications

As the Digital Consumer, Networking, Wireless Communications and Internet Computing
industries continue to expand and diversify, new applications are likely to be developed. We believe
our products are designed to address this expanding set of applications:

`Wireless                  Internet
         Digital Consumer                      Networking         Communications              Computing
----------------------------------------- -------------------- -------------------- ------------------------------
TV Replayer          Set-top Box          VoIP                 Cellular Phone       Information Appliance
Digital TV           CD-ROM Drive         DSL Modem            Data Pager           Notebook PC
Digital Camera       CD-RW Drive          Cable Modem          Cordless             Desktop PC
Digital Camcorder    DVD-ROM Drive        V.90/56K Modem          Telephone         Hard Disk Drive
DVD Player           DVD-RAM Drive        Wireless LAN         GPS on Cellular      LCD Monitor
DVD Recorder         DVD-RW Drive         Network                 Phone             Palm PC
VCD Player           Web Browser             Interface Card    Bluetooth            X-PC
MP3 Player           Hand-held GPS        Router/Switch           Applications      Server
Video Game           Electronic Toys                           Wireless Modems      Graphics Card
PDA                  Smart Cards                                                    Printer
Electronic Book      Memory Cards                                                   Copier/Scanner
Remote Controller    Electronic                                                     Bar Code Scanner
                        Organizer                                                   Thin Client System`

Manufacturing

We purchase wafers and sorted die from semiconductor manufacturing foundries, have this
product shipped directly to subcontractors for packaging, testing, and finishing, and then ship the
final product to our customers. Virtually all of our subcontractors are located in Asia.

Wafer and Sorted Die. During 2004, our major wafer fabrication foundries were TSMC, Grace,
Sanyo, Samsung and Seiko-Epson. In 2004, wafer sort, which is the process of testing individual die
on silicon wafer, was performed at King Yuan Electronics Company, Limited, or KYE, Lingsen, Samsung,
Sanyo, Seiko-Epson and TSMC. Although capacity is not guaranteed, under these arrangements, we
generally receive preferential treatment regarding wafer pricing and capacity. In order to obtain,
on an ongoing basis, an adequate supply of wafers, we have considered and will continue to consider
various possible options, including equity investments in foundries in exchange for guaranteed
production volumes, the formation of joint ventures to own and operate foundries and the licensing
of our proprietary technology. In 2001, we invested $50.0 million in Grace Semiconductor
Manufacturing Corporation, or GSMC, a Cayman Islands company, which has been funded mostly by
investors who reside outside of China. In March 2004 we invested an additional $33.2 million in
GSMC. Grace is a subsidiary of GSMC and is located in Shanghai, People's Republic of China. Grace
has been manufacturing our products since late 2003.

7

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Packaging, Testing and Finishing. In the assembly process, the individual die are
separated and assembled into packages. Following assembly, the packaged devices require testing and
finishing to segregate conforming from nonconforming devices and to identify devices by performance
levels. Currently, all devices are tested and inspected pursuant to our quality assurance program at
our domestic or international subcontracted test facilities or at our test facilities in Sunnyvale,
California before shipment to customers. Certain facilities currently perform consolidated assembly,
packaging, test and finishing operations all at the same location. During 2004, most subcontracted
facilities performing the substantial majority of our operations were in Taiwan. The subcontractors
with the largest amount of our activity are KYE, Lingsen, and Powertech Technology, Incorporated, or
PTI. We hold equity investments in three subcontractors: Apacer Technology, Inc., or Apacer, KYE and
PTI. For newly released products, the initial test and finishing activities are performed at our
Sunnyvale facility.

Research and Development

We believe that our future success will depend in part on the development of next
generation technologies with reduced feature size. During 2002, 2003 and 2004, we spent $47.1
million, $43.1 million and $46.9 million, respectively, on research and development. Our research
efforts are focused on process development and product development. Our research strategy is to
collaborate with our partners to advance our technologies. We work simultaneously with several
partners on the development of multiple generations of technologies. In addition, we allocate our
resources and personnel into category-specific teams to focus on new product development. From time
to time we invest in, jointly develop with, license or acquire technology from other companies in
the course of developing products.

Competition

The semiconductor industry is intensely competitive and has been characterized by price
erosion, rapid technological change and product obsolescence. We compete with major domestic and
international semiconductor companies, many of whom have substantially greater financial, technical,
marketing, distribution, manufacturing and other resources than us. Our low density memory products,
sales of which presently account for substantially all of our revenues, compete against products
offered by Spansion (AMD/Fujitsu), Atmel, Intel, Macronix, STMicroelectronics, PMC and Winbond. Our
medium-density memory products compete with products offered by Spansion, Intel, ST
Microelectronics, Mitsubishi, Samsung, Sharp Electronics and Toshiba. If we are successful in
developing our high-density products, these products will compete principally with products offered
by Spansion (AMD/Fujitsu), Atmel, Fujitsu, Hitachi, Intel, Mitsubishi, Samsung, SanDisk, Sharp
Electronics, STMicroelectronics and Toshiba, as well as any new entrants to the market. In addition,
competition may come from alternative technologies such as ferroelectric random access memory
device, or FRAM, technology.

The competition in the existing markets for some of our product families, such as the FlashFlex51
microcontroller product family, is extremely intense. We compete principally with major companies
such as Atmel, Microchip Technology, Motorola Philips and Winbond in the microcontroller market. We
may, in the future, also experience direct competition from our foundry partners. We have licensed
to our foundry partners the right to fabricate certain products based on our proprietary technology
and circuit design, and to sell such products worldwide, subject to royalty payments back to us. The
Emosyn products compete with Masked ROM and flash or EEPROM offerings primarily from Infineon,
Renesas, Samsung and STMicroelectronics. For the SCC products, the competition in the existing
markets is also extremely intense. SCC competes primarily with Microsemi, SiGe, Micromobio, Anadigic
and Maxim especially in the WLAN (WiFi 802) markets.

We compete principally on price, reliability, functionality and the ability to offer timely
delivery to customers. While we believe that our low density products currently compete favorably on
the basis of cost, reliability and functionality, it is important to note that some of our principal
competitors have a significant advantage over us in terms of greater financial, technical and
marketing resources. Our long-term ability to compete successfully in the evolving flash memory
market will depend on factors both within and beyond our control, including access to advanced
process technologies at competitive prices, successful and timely product development, wafer supply,
product pricing, actions of our competitors and general economic conditions.

8

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Employees

As of December 31, 2004, we employed 600 individuals on a full-time basis, all but 206 of
whom reside in the United States. Of these 600 employees, 90 were employed in manufacturing support,
254 in engineering, 125 in sales and marketing and 131 in administration, finance and information
technology. Our employees are not represented by a collective bargaining agreement, nor have we ever
experienced any work stoppage related to strike activity. We believe that our relationship with our
employees is good.

Executive Officers

The following table lists the names, ages and positions of our executive officers as of
December 31, 2004. There are no family relationships between any executive officer of SST. Executive
officers serve at the discretion of our board of directors.

|Name                                                                                      | Age                     | Position                                                                                                                                                                                                                                                                                                                                                                                                              
|----------------------------------------------------------------------------------------- | ----------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Bing Yeh 
Yaw Wen Hu
Derek Best
Michael Briner
Chen Tsai
Isao Nojima
Paul Lui
Jack K. Lai | 54
55
54
57
53
60
54
50 | President and Chief Executive Officer 
Executive Vice President and Chief Operating Officer
Senior Vice President, Sales and Marketing
Senior Vice President, Application Specific Product Group
Senior Vice President, Worldwide Backend Operations
Senior Vice President, Standard Memory Product Group
Vice President, Special Product Group
Vice President, Finance and Administration and
Chief Financial Officer

__________

Bing Yeh, one of our co-founders, has served as our President and Chief Executive Officer and
has been a member of our board of directors since our inception in 1989. Prior to that, Mr. Yeh
served as a senior research and development manager of Xicor, Inc., a nonvolatile memory
semiconductor company. From 1981 to 1984, Mr. Yeh held program manager and other positions at
Honeywell Inc. From 1979 to 1981, Mr. Yeh was a senior development engineer of EEPROM technology of
Intel Corporation. He was a Ph.D. candidate in Applied Physics and earned an Engineer degree at
Stanford University. Mr. Yeh holds a M.S. and a B.S. in Physics from National Taiwan University.

Yaw Wen Hu, Ph.D., joined us in July 1993 as Vice President, Technology Development. In
1997, he was given the additional responsibility of wafer manufacturing and, in August 1999, he
became Vice President, Operations and Process Development. In January 2000, he was promoted to
Senior Vice President, Operations and Process Development. In April 2004, he was promoted to
Executive Vice President and Chief Operating Officer. Dr. Hu has been a member of our board of
directors since September 1995. From 1990 to 1993, Dr. Hu served as deputy general manager of
technology development of Vitelic Taiwan Corporation. From 1988 to 1990, he served as FAB
engineering manager of Integrated Device Technology, Inc. From 1985 to 1988, he was the director of
technology development at Vitelic Corporation. From 1978 to 1985, he worked as a senior development
engineer in Intel Corporation's Technology Development Group. Dr. Hu holds a B.S. in Physics from
National Taiwan University and a M.S. in Computer Engineering and a Ph.D. in Applied Physics from
Stanford University.

Derek Best joined us in June 1997 as Vice President of Sales and Marketing. In June 2000
he was promoted to Senior Vice President, Sales & Marketing. Prior to joining SST he worked for
Micromodule Systems, a manufacturer of high-density interconnect technology, as vice president
marketing and sales world wide from 1992 to 1996. From 1987 to 1992 he was a co-founder and owner of
Mosaic Semiconductor, a SRAM and module semiconductor company. Mr. Best holds an Electrical
Engineering degree from Portsmouth University in England.

Michael Briner joined us as Vice President, Design Engineering in November 1997, and
became Vice President, Products during 1999. He was promoted to Senior Vice President of Application
Specific Product Group in February 2001. From 1993 to 1997, he served as vice president of design
engineering for Micron Quantum Devices, Inc., a subsidiary of Micron Technology, Inc., chartered to
develop and manufacture flash memory products. From 1986 through 1992, he served as director of
design engineering for the Nonvolatile Division of Advanced Micro Devices, Inc. In this position, he
was instrumental in helping AMD become a major nonvolatile memory manufacturer. Mr. Briner holds a
B.S. in Electrical Engineering from the University of Cincinnati.

9

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Chen Tsai joined us in August 1996 as Senior Manager, Yield Enhancement and became
Director, Product and Test Engineering the same year. In 1999, he became Director of Worldwide
Backend Operations and in 2000 he was promoted to Vice President of Worldwide Backend Operations. In
October 2004, Mr. Tsai was appointed Senior Vice President of Worldwide Backend Operations. From
1992 to 1996, Mr. Tsai was Manager of Process Development at Atmel Corporation, a manufacturer of
semiconductors, where he was also a Staff Engineer of E2PROM from 1989 to 1992. From 1988 to 1989,
he was Vice President of Technology at Tristar Technology, Inc., a wireless systems company. From
1980 to 1988 he held various positions at Xicor, Inc. and Teledyne Semiconductor. Mr. Tsai holds a
B.S. in Physics from Show Chu University and a M.S. in both Physics and Electrical Engineering from
Florida Institute of Technology.

Isao Nojima joined us as Vice President, Memory Design and Product Engineering in March
1993 and became Vice President, Advanced Development in July 1997. He became Vice President of
Standard Memory Product Group in July 2000. In April 2004, he was promoted to Senior Vice President
of Standard Memory Product Group. From 1990 to 1993, Mr. Nojima served as director of design
engineering of Pioneer Semiconductor Corporation, now called Pericom, a manufacturer of
semiconductors. From 1980 to 1990, he served as design manager of Xicor Inc., a nonvolatile
semiconductor company. From 1977 to 1980, he served as a senior design engineer for Intel
Corporation. From 1969 to 1976, he was a senior researcher at Toshiba's R&D Center in Japan. Mr.
Nojima holds a B.S. and a M.S. in Electrical Engineering from Osaka University in Japan.

Paul Lui joined us as Vice President and General Manager of the Linvex Product Line in
June 1999 and became Vice President, Special Product Group in June 2001. From 1994 to 1999, he was
the president and founder of Linvex Technology Corporation. From 1987 to 1994, he was the president
and chief executive officer of Macronix, Inc. From 1981 to 1985, he served as group general manager
at VLSI Technology, Inc. where he was responsible for transferring that company's technology to
Korea. In addition, Mr. Lui has held senior engineering positions at the Synertek Division of
Honeywell and McDonnell Douglas. Mr. Lui holds a M.S.E.E. degree from University of California,
Berkeley and a B.S. degree in Electrical Engineering and Mathematics from California Polytechnic
State University, San Luis Obispo.

Jack Lai joined us as Chief Financial Officer and Vice President, Finance and
Administration and Secretary in November 2003. Before joining SST, he was vice president and chief
financial officer of Aplus Flash Technology, a memory design and manufacturing company, from 2001 to
2003. Prior to this, Mr. Lai had served as vice president of operations and finance and chief
financial officer at WireX Communications, Inc., a software system developer, from 2000 to 2001 and
vice president and chief financial officer at Genoa Electronics Corp., a manufacturer of computer
and related systems, from 1998 to 1999. Mr. Lai holds M.B.A.'s from San Jose State University in San
Jose, CA and Culture University in Taipei, Taiwan. He also holds a B.A. in Business Administration
from Tamkang University in Taipei, Taiwan.

Available Information

We were incorporated in California in 1989. We make available free of charge on or
through our Internet website,

Item 2. Properties

As of December 31, 2004, we occupied three major facilities totaling 131 thousand square feet
in Sunnyvale, California which our executive offices, research and development, principal
manufacturing engineering and testing facilities are located. Of the three major facilities
occupied, we own one facility totaling 20 thousand square feet and we lease 2 facilities totaling
111 thousand square feet. The leases on the two facilities expire in 2010. In addition, we leased 4
facilities totaling 77 thousand square feet in Sunnyvale, California that were all unoccupied by the
end of 2004. The leases on all four of these facilities expire in 2005. We also have 54 thousand
square feet of office space in various domestic and international sites with expiration ranging from
2005 to 2012. We believe these facilities are adequate to meet our needs for at least the next 12
months.

10

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Item 3. Legal Proceedings

In January 1996, Atmel Corporation filed suit against SST alleging that we infringed six U.S.
patents. We successfully moved for summary judgment on two of the six asserted patents in September
1997. In January 2001, Atmel withdrew its allegation that we infringed another patent. On May 7,
2002, a judgment was entered against us in the amount of $36.5 million based on a jury's finding
that we infringed two of the three remaining patents. We appealed the judgment on July 16, 2002. On
September 12, 2003 the Court of Appeals upheld the jury's verdict. On November 18, 2003 the Court of
Appeals denied our request for a rehearing, and in December 2003 we paid Atmel $37.8 million to
satisfy the judgment plus statutory interest accrued during the appeals. The payment was recorded as
other operating expense in the year ending December 31, 2003. In addition, on June 28, 2004 we paid
$247 thousand of legal related expenses incurred by Atmel pursuant to the court order.

The third patent remaining in the case, the `903 patent, expired in September 2001. The trial
court has held that, if it is found to be valid, certain of our products infringed that patent. A
trial to determine whether the `903 patent is invalid began on July 29, 2002. On August 5, 2002 the
jury announced that it was unable to reach a verdict on our invalidity defense, and a mistrial was
declared. Atmel requested a new trial, but the Court stayed the matter until after our appeal of the
earlier judgment is resolved. At Atmel's request, the Court directed the parties to conduct a
settlement conference before a Magistrate Judge. That settlement conference was scheduled for April
14, 2004 and was subsequently rescheduled for September 7, 2004. No conclusion was reached during
the settlement conference on September 7, 2004. A new trial date on the invalidity of the `903
patent has been scheduled for June 27, 2005. The impact related to the outcome of the remaining
patent is undeterminable at this time.

In January and February 2005, multiple punative shareholder class action complaints were filed
against SST and certain directors and officers, in the United States District Court for the Northern
District of California, following our announcement of anticipated financial results for the fourth
quarter of 2004. The complaints are captioned: Hunt v. Silicon Storage Technology, Inc., et
al., Case No. C 05 00408 WHA (N.D. Cal.); Baker v. Silicon Storage Technology, Inc., et
al., Case No. C 05 00295 PJH (N.D. Cal.); Grobler v. Silicon Storage Technology, Inc., et
al., Case No. C 05 00376 MHP (N.D. Cal.); Talmo v. Silicon Storage Technology, Inc., et
al., Case No. C 05 00390 MMC (N.D. Cal.); and DiCintio v. Silicon Storage Technology, Inc.,
et al., Case No. C 05 0708 MMC (N.D. Cal.). The complaints seek unspecified damages on alleged
violations of federal securities laws during the period from March 22, 2004 to December 20, 2004.
Consolidation and the appointment of lead plaintiff are currently pending in these purported class
actions. We intend to take all appropriate action in response to these lawsuits. The impact related
to the outcome of these matters is undeterminable at this time.

In January and February 2005, following the filing of the putative class actions, multiple
shareholder derivative complaints were filed in California Superior Court for the County of Santa
Clara, purportedly on behalf of SST against certain directors and officers. The factual allegations
of these complaints are substantially identical to those contained in the putative shareholder class
actions filed in federal court. The derivative complaints assert claims for, among other things,
breach of fiduciary duty and violations of the California Corporations Code. These derivative
actions have been consolidated under the caption In Re Silicon Storage Technology, Inc.
Derivative Litigation, Lead Case No. 1:05CV034387 (Cal. Super. Ct., Santa Clara Co.). We intend
to take all appropriate action in response to these lawsuits. The impact related to the outcome of
these matters is undeterminable at this time.

From time to time, we are also involved in other legal actions arising in the ordinary course of
business. We have incurred certain costs while defending these matters. There can be no assurance
the remaining Atmel complaint, the shareholder class action complaints, the shareholder derivative
complaints or other third party assertions will be resolved without costly litigation, in a manner
that is not adverse to our financial position, results of operations or cash flows or without
requiring royalty payments in the future which may adversely impact gross margins. No estimate can
be made of the possible loss or possible range of loss associated with the resolution of these
contingencies. As a result, no losses have been accrued in our financial statements as of December
31, 2004.

Item 4. Submission of Matters to a Vote of Security Holders

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

11

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PART II

Item 5. Market for Registrant's Common Stock, Related
Stockholder Matters and Issuer Purchases of Equity Securities

Price Range of Common Stock

The principal U.S. market for our Common Stock is the Nasdaq National Market. The only
class of our securities that is traded is our Common Stock. Our Common Stock has traded on the
Nasdaq National Market since November 21, 1995, under the symbol SSTI. The following table sets
forth the quarterly high and low closing sales prices of the Common Stock for the period indicated
as reported by the Nasdaq National Market. These prices do not include retail mark-ups, markdowns,
or commissions. The closing sales price of our Common Stock on December 31, 2004, the last trading
day in 2004, was $5.95.



|2003                                                          |                                                                                                              | High Close              | Low Close            
|------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------ | ----------------------- | ---------------------
|First Quarter:
Second Quarter:
Third Quarter:
Fourth Quarter: | January 1 - March 31, 2003
April 1 - June 30, 2003
July 1 - September 30, 2003
October 1 - December 31, 2003 | $ 4.78
4.80
10.00
14.11 | $ 2.25
2.31
4.19
9.32
|2004                                                          |                                                                                                              | High Close              | Low Close            
|First Quarter:
Second Quarter:
Third Quarter:
Fourth Quarter: | January 1 - March 31, 2004
April 1 - June 30, 2004
July 1 - September 30, 2004
October 1 - December 31, 2004 | $13.46
16.77
9.52
7.77  | $10.64
9.55
5.42
5.72
|2005                                                          |                                                                                                              | High Close              | Low Close            
|First Quarter:                                                | January 1 - February 28, 2005                                                                                | $ 5.72                  | $ 4.30               

Approximate Number of Equity Security Holders

As of December 31, 2004, there were approximately 301 record holders of
our Common Stock.

Dividends

We have never paid a cash dividend on our Common Stock and we intend to continue to
retain earnings, if any, to finance future growth. Accordingly, we do not anticipate the payment of
cash dividends to holders of Common Stock in the foreseeable future.

Equity Compensation Plan Information

Information regarding our equity compensation plans will be contained in our definitive
Proxy Statement with respect to our Annual Meeting of Shareholders under the caption "Compensation -
Equity Compensation Plan Information," and is incorporated by reference into this report. All of our
equity compensation plans have been approved by our shareholders.

12

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Stock Purchase Program

|Period                                 | (a) Total Number of Shares Purchased | (b) Average Price Paid per Share | (c) Total Number of Shares Purchased as Part of Publicly Announced Plans or
Programs | (d) Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased
Under the Plans or Programs (1)
|-------------------------------------- | ------------------------------------ | -------------------------------- | ------------------------------------------------------------------------------------ | --------------------------------------------------------------------------------------------------------------------
|July 1 through July 31, 2004           | --                                   | --                               | --                                                                                   | $15,000,000                                                                                                         
|August 1 through August 31, 2004       | 2,229,773                            | $5.77                            | 2,229,773                                                                            | $2,134,210                                                                                                          
|September 1 through September 30, 2004 | 344,700                              | $5.79                            | 344,700                                                                              | $138,397                                                                                                            
|Total                                  | 2,574,473                            | $5.77(2)                         | 2,574,473                                                                            |                                                                                                                     

1. On July 29, 2004, we announced the approval by our board of directors of the
purchase of an aggregate of up to $15 million of our common stock.
The stock purchase program ended on December 31, 2004. Approximately 2,574,000 shares were
repurchased under this program all during August and September 2004 for an aggregate purchase price
of $14.9 million. The purchase prices ranged from $5.48 to $6.12 per share. We
did not repurchase any shares during the fourth quarter of 2004.
2. Represents weighted average purchase price during the repurchase period.

13

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Item 6. Selected Consolidated Financial Data

The following selected consolidated financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of Operations" and the
Consolidated Financial Statements and the notes thereto included elsewhere in this report. Certain
amounts in our prior years' consolidated financial statements have been reclassified to conform to
the current year presentation. These reclassifications have no impact on our previously reported net
income (loss).

`Year ended December 31,
                                                    -----------------------------------------------------
                                                      2000       2001       2002       2003       2004
                                                    ---------  ---------  ---------  ---------  ---------
                                                           (in thousands, except per share data)

Consolidated Statements of Operations Data:
Net revenues:
    Product revenues - unrelated parties.......... $ 408,708  $ 168,593  $ 100,620  $  86,549  $ 180,234
    Product revenues - related parties............    66,608     90,025    143,401    169,980    224,497
    License revenues - unrelated parties..........    14,945     35,412     30,637     38,512     44,311
    License revenues - related parties............        --         --         --         --        156
                                                    ---------  ---------  ---------  ---------  ---------
      Total net revenues..........................   490,261    294,030    274,658    295,041    449,198
Cost of revenues..................................   264,139    248,161    206,246    218,775    322,093
                                                    ---------  ---------  ---------  ---------  ---------
Gross profit......................................   226,122     45,869     68,412     76,266    127,105
                                                    ---------  ---------  ---------  ---------  ---------
Operating expenses:
    Research and development......................    41,535     50,380     47,069     43,144     46,904
    Sales and marketing...........................    27,968     26,794     25,498     22,272     28,295
    General and administrative....................    14,966     17,855     17,097     14,398     18,292
    Other.........................................     3,911      1,346         --     37,849      7,375
                                                    ---------  ---------  ---------  ---------  ---------
      Total operating expenses....................    88,380     96,375     89,664    117,663    100,866
                                                    ---------  ---------  ---------  ---------  ---------
Income (loss) from operations.....................   137,742    (50,506)   (21,252)   (41,397)    26,239
Interest and other income.........................    10,510      7,449      3,225      2,996      2,295
Interest and other expense........................      (691)      (437)      (242)      (350)      (281)
Impairment of equity investments..................        --     (3,274)    (7,757)        --       (509)
                                                    ---------  ---------  ---------  ---------  ---------
Income (loss) before provision for (benefit from)
    income taxes and minority interest............   147,561    (46,768)   (26,026)   (38,751)    27,744
Provision for (benefit from) income taxes.........    41,813    (17,772)   (10,931)    26,416      3,906
Minority interest.................................        --         --         --         --        (91)
                                                    ---------  ---------  ---------  ---------  ---------
Net income (loss)................................. $ 105,748  $ (28,996) $ (15,095) $ (65,167) $  23,929
                                                    =========  =========  =========  =========  =========
Net income (loss) per share - basic............... $    1.23  $   (0.32) $   (0.16) $   (0.69) $    0.25
                                                    =========  =========  =========  =========  =========
Net income (loss) per share - diluted............. $    1.13  $   (0.32) $   (0.16) $   (0.69) $    0.24
                                                    =========  =========  =========  =========  =========

Consolidated Balance Sheet Data:
Total assets...................................... $ 512,590  $ 446,760  $ 440,606  $ 396,361  $ 502,331
                                                    =========  =========  =========  =========  =========
Long-term obligations............................. $     279  $   1,793  $   1,873  $   1,423  $   1,307
                                                    =========  =========  =========  =========  =========
Shareholders' equity.............................. $ 416,635  $ 391,411  $ 381,851  $ 331,497  $ 375,984
                                                    =========  =========  =========  =========  =========`

14

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Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations

Except for the historical information contained herein, the following discussion contains
forward-looking statements that involve risks and uncertainties. All forward-looking statements
included in this document are based on information available to us on the date hereof, and we assume
no obligation to update any such forward-looking statements. Our actual results could differ
materially from those discussed. Factors that could cause or contribute to such differences include,
but are not limited to, those discussed below under the heading "Business Risks", as well as those
discussed elsewhere in this report.

Overview

We are a leading supplier of flash memory semiconductor devices for the digital consumer,
networking, wireless communication and Internet computing markets.

The semiconductor industry has historically been cyclical, characterized by periodic changes in
business conditions caused by product supply and demand imbalance. When the industry experiences
downturns, they often occur in connection with, or in anticipation of, maturing product cycles and
declines in general economic conditions. These downturns are characterized by weak product demand,
excessive inventory and accelerated declines of selling prices. In some cases, downturns, such as
the one we experienced from late 2000 through 2002, have lasted for more than a year. We began to
experience a slow recovery during 2002 through the first half of 2003. During the second half of
2003 and the first half of 2004, demand for our products increased sharply and we began to see
improvements in the average selling prices of our products. However, we experienced a decrease in
the average selling prices of our products as a result of the slow-down in the demand for some of
our products in the second half of 2004 and our business could be further harmed again by prolonged
industry-wide downturns in the future.

Our product sales are made primarily using short-term cancelable purchase orders. The quantities
actually purchased by the customer, as well as shipment schedules are frequently revised to reflect
changes in the customer's needs and in our supply of products. Accordingly, our backlog of open
purchase orders at any given time is not a meaningful indicator of future sales. Changes in the
amount of our backlog do not necessarily reflect a corresponding change in the level of actual or
potential sales.

We derived 88.5%, 90.0% and 86.0% of our net product revenues during 2002, 2003 and 2004,
respectively, from product shipments to Asia. Additionally, substantially all of our wafer suppliers
and packaging and testing subcontractors are located in Asia.

Shipments to our top ten end customers, which excludes transactions through stocking
representatives and distributors, accounted for 31.5%, 37.7% and 29.1% of our net product revenues
in 2002, 2003 and 2004, respectively.

No single end customer, which we define as original equipment manufacturers, or OEMs, original
design manufacturers, or ODMs, contract electronic manufacturers, or CEMs, or end users, represented
10.0% or more of our net product revenues during 2002, 2003 and 2004.

Since 2001, we have been increasing our out-sourcing activities for our customer service
logistics to support our customers. Silicon Professional Technology Ltd., or SPT, supports our
customers in Taiwan, China and other Southeast Asia countries. SPT provides planning, warehousing,
delivery, billing, collection and other logistic functions for us in these regions. SPT is a
wholly-owned subsidiary of one of our stocking representatives in Taiwan, Professional Computer Technology
Limited, or PCT. Please see a description of our relationship with PCT under "Related Party
Transactions." Products shipped to SPT are accounted for as our inventory held at our logistics
center, and revenue is recognized when the products have been delivered and are considered as a sale
to our end customers by SPT. For the years ended December 31, 2002, 2003 and 2004, SPT serviced end
customer sales accounting for 57.4%, 64.2% and 52.9% of our net product revenues recognized. As of
December 31, 2002, 2003 and 2004, SPT represented 68.5%, 73.4% and 55.1% of our net accounts
receivable, respectively.

15

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We ship products to, and have 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 logistic center, to our top three stocking representatives for
reshipment accounted for 16.9%, 29.9% and 34.0% of our product shipments in 2002, 2003 and 2004,
respectively. In addition, the same three stocking representatives solicited sales, for which they
received a commission, for 41.3%, 32.8% and 25.1% of our product shipments to end users in 2002,
2003 and 2004, respectively.

16

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Results of Operations: Years Ended December 31, 2002, 2003 and 2004

Net Revenues

Net revenues were $449.2 million in 2004, $295.0 million in 2003 and $274.7 million in 2002.
Net revenues for 2004 increased compared to 2003 due to increased unit shipments and average selling
prices, increased license and royalty revenues and sales from companies acquired during 2004. Net
revenues for 2003 increased compared to 2002 due to increased unit shipments and increased license
and royalty revenues, offset by decreased average selling prices. Average selling prices fluctuate
due to a number of factors including the overall supply and demand for our products in the
marketplace, maturing product cycles and changes in general economic conditions.

Product Revenues. Product revenues were $404.7 million in 2004, $256.5 million in 2003 and
$244.0 million in 2002. Product revenues for 2004 increased compared to 2003 primarily due to
increased unit shipments by 35.32%, and increased average selling prices by 16.2%. Product revenues
for 2003 increased compared to 2002 primarily due to increased unit shipments by 23.5%, partially
offset by decreased average selling prices by 15.7%. The decrease from 2001 to 2002 was primarily
due to decreased average selling prices by 36.5%, partially offset by increased unit shipments of
our products by 31.6%. Shipping volumes fluctuate due to overall industry supply and demand.

License Revenues. Revenues from license fees and royalties were $44.5 million in 2004,
$38.5 million in 2003 and $30.6 million in 2002. The increase from 2003 to 2004 is due to increased
license fees of $6.0 million from our new licensees. The increase from 2002 to 2003 related
primarily to increased royalty payments from our existing licensees and up-front license fees from
our new licensees. We anticipate that license revenues may fluctuate significantly in the
future.

Gross Profit

Gross profit was $127.1 million, or 28.3% of net revenues, in 2004, $76.3 million, or 25.8%
of net revenues, in 2003, and $68.4 million, or 24.9% of net revenues, in 2002. The increase in
gross profit in 2004 when compared to 2003 is primarily due to improved manufacturing costs achieved
by transitioning manufacturing technology to smaller geometries, the sale of previously reserved
inventory, increases in average selling prices and unit shipments by 16.2% and 35.3%, respectively,
as well as increased revenues from technology licensing by $6.0 million, offset by a net increase of
$28.5 million in our provision for inventory and adverse purchase commitments over the 2003
provision. The increase in gross profit in 2003 when compared to 2002 is primarily due to increased
unit shipments of 23.5%, increased technology licensing revenues of $7.9 million and improved
manufacturing costs as a result of transitions to more advanced process technologies, offset by
decreased average selling prices by 15.7%. Product gross margin was 20.4% in 2004, compared to 14.7%
in 2003 and 15.5% in 2002. The increase in product gross margin in 2004 when compared to 2003 is
primarily due to improved manufacturing costs, increases in average selling prices and unit
shipments by 16.2% and 35.3%, respectively, offset by an increase in our provision for inventory and
adverse purchase commitments of $28.5 million over the 2003 provision. The decrease in product gross
margin in 2003 when compared to 2002 was primarily due to decreased average selling prices of 15.7%,
offset by improved manufacturing costs as a result of transitions to more advanced process
technologies. For other factors affecting our gross profit, please also see "Business Risks - We
incurred significant inventory valuation adjustments in 2002, 2003 and 2004 and we may incur
additional significant inventory valuation adjustments in the future."

Operating Expenses

Operating expenses consist of research and development, sales and marketing, general and
administrative and other expenses. Operating expenses were $100.9 million, or 22.5% of net revenues,
in 2004, $117.7 million or 39.9% of net revenues, in 2003, and $89.7 million, or 32.6% of net
revenues, in 2002. The decrease in 2004 from 2003 was primarily due to the Atmel judgement of $37.8
million in 2003 and $1.0 million decrease in depreciation expense, offset by the $5.9 million write
off of in process research and development related to our newly acquired businesses, increases of
$5.9 million in headcount related expenses, $2.0 million in mask, wafer and evaluation parts, $2.0
million in general and administrative related to outside services and $1.6 million in commission
expense and $1.5 million in operating lease impairment. The increase in 2003 from 2002 was primarily
due to the Atmel judgement of $37.8 million, offset by decreases of $2.8 million in bad debt
expense, $1.7 million in mask, wafer and evaluation part expenses, $1.5 million in legal fees, $1.1
million in commission expense and $1.1 million in depreciation expense. We anticipate that we will
continue to devote substantial resources to research and development, sales and marketing and to
general and administrative activities, and that these expenses will increase in absolute
dollars.

17

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Research and development. Research and development expenses include costs associated with
the development of new products, enhancements to existing products, quality assurance activities and
occupancy costs. These costs consist primarily of employee salaries and benefits and the cost of
materials such as wafers and masks. Research and development expenses were $46.9 million, or 10.4%
of net revenues, in 2004, $43.1 million, or 14.6% of net revenues, in 2003, and $47.1 million, or
17.1% of net revenues, in 2002. Research and development expenses increased by 8.7% from 2003
primarily due to increases in wafer, mask and evaluation part expenses of $2.0 million due to the
completion of certain technology projects during 2004, headcount related expenses of $2.2 million
due to profit sharing payments and increased headcount, offset by reduced depreciation expense of
$797 thousand. Research and development expenses decreased by 8.3% from 2002 primarily due to
decreases in wafer, mask and evaluation part expenses of $1.7 million due to cost reduction measures
and the completion of certain technology projects during 2003, headcount related expenses of $1.4
million due to a reduction in headcount and depreciation expense of $761 thousand. We expect
research and development expenses will increase in absolute dollars.

Sales and marketing. Sales and marketing expenses consist of commissions, headcount and
related costs, as well as travel, entertainment and promotional expenses. Sales and marketing
expenses were $28.3 million, or 6.3% of net revenues, in 2004, $22.3 million, or 7.5% of net
revenues, in 2003, and $25.5 million, or 9.3% of net revenues, in 2002. The increase in sales and
marketing expenses from 2003 to 2004 by 27.1% was primarily due to increases in headcount related
costs of $2.4 million due to bonus and profit sharing payments and increased headcount, an increase
in commission expense of $1.6 million due to increased sales, an increase in logistic center fees of
$742 thousand due to increased activity through the logistic center, and increased marketing
expenses of $395 thousand. The decrease in sales and marketing expenses from 2002 to 2003 by 12.7%
was primarily due to decreases in headcount related costs of $1.7 million due to the transfer of
some sales personnel to Asia and decreased facility and information technology related expenses, a
decrease in commission expense of $1.1 million due to reduced commission rates and decreased
marketing expenses of $849 thousand, offset by increased logistic center fees of $652 thousand due
to increased activity through the logistic center. We expect sales and marketing expenses will
increase in absolute dollars as we continue to expand our sales and marketing efforts. In addition,
fluctuations in revenues will cause fluctuations in sales and marketing expenses as it impacts our
commission expense.

General and administrative. General and administrative expenses consist of salaries and
related costs for administrative, executive and finance personnel, recruiting costs, professional
services and legal fees and allowances for doubtful accounts. General and administrative expenses
were $18.3 million, or 4.1% of net revenues, in 2004, $14.4 million, or 4.9% of net revenues, in
2003, and $17.1 million, or 6.2% of net revenues, in 2002. The increase in general and
administrative expenses from 2003 to 2004 by 27.0% was primarily due to increases in accounting and
outside consulting fees of $2.0 million due to the increase costs of complying with Sarbanes-Oxley
reporting, headcount related expenses of $1.3 million due to profit sharing payments and increased
headcount, and bad debt expenses of $597 thousand due to a charge taken in 2004. The decrease in
general and administrative expenses from 2002 to 2003 by 15.8% was primarily due to decreases in bad
debt expenses of $2.8 million due to a charge taken in 2002 related to one specific customer, a
decrease in legal fees of $1.5 million due to decreased Atmel defense activity, and lower
depreciation and amortization expense of $876 thousand, offset by increases in headcount related
costs of $2.4 million due to changes in allocations for facility, IT and insurance expenses. We
anticipate that general and administrative expenses will increase in absolute dollars as we scale
our facilities, infrastructure, and headcount to support our overall expected growth. We may also
incur additional expenses in connection with the Atmel, shareholder class action and shareholder
derivative litigation. For further information on this litigation see "Legal Proceedings."

Other operating expenses. In 2004, other operating expenses of $7.4 million, or 1.6% of
net revenues, were comprised of $5.9 million related to the write off of in-process research and
development relating to the acquisition of Emosyn and G-Plus and a $1.5 million period charge
related to an operating lease for an abandoned building. At the time of the Emosyn acquisition, we
estimated that the acquired IP R&D was approximately 30% complete and would be completed over
the next nine months at an estimated cost of approximately $484 thousand, and at the time of the
G-Plus acquisition, we estimated that the acquired IP R&D projects were between 20% to 80%
complete and would be completed over the next fourteen months at an estimated cost of approximately
$1.2 million. The charge related to an operating lease results from our purchase of a new building
with the intent to vacate the leased property and represents the estimated difference between the
total discounted future sublease income and our discounted lease commitments relating to this
building. In 2003, other operating expenses were $37.8 million, or 12.8% of net revenues, which
related entirely to the Atmel litigation settlement. The $37.8 million of settlement fees and
interest was paid in December 2003. There were no other operating expenses recorded in 2002.

18

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Interest and other income. Interest and other income was $2.3 million, or 0.5% of net
revenues, during 2004, $3.0 million, or 1.0% of net revenues, during 2003, and $3.2 million, or 1.2%
of net revenues, during 2002. Interest and other income decreased from 2003 to 2004 primarily due to
decreased realized gains from the sale of some of our investments by $649 thousand. Interest income
decreased from 2002 to 2003 primarily due to decreased interest rates on invested cash, offset by
realized gains of $649 thousand on the sale of some of our investments.

Interest and other expense. Interest and other expense was $281 thousand during 2004 as
compared to $350 thousand during 2003 and $242 thousand during 2002. Interest and other expenses in
2003 included a loss on sale of assets of $118 thousand. Interest expense relates to interest on our
notes payable and interest and fees under a line of credit that we terminated in July 2002.

Impairment of equity investments. During 2003, Insyde, a company in which we have
an investment, completed an initial public offering on the Taiwan Stock Exchange. Since the initial
public offering there had been a significant decline in the market value of the investment. During
2004, we recognized a $509 thousand loss from the impairment of our equity investment because
Insyde's stock price had declined below the acquisition cost for more than six months. The
impairment was considered to be "other-than-temporary" in nature, thus the investment value was
permanently written down to reflect the fair value. As of December 31, 2004 the recorded value of
our investment in Insyde was $456 thousand.

In 2000, we acquired a 10.0% interest in Apacer, a privately held company located in
Taiwan that designs, manufactures and markets memory modules, for $9.9 million in cash. Our
investment in Apacer was valued at cost. Bing Yeh, our President, CEO and Chairman of our Board of
Directors, is a member of Apacer's Board of Directors. In 2001, we invested an additional $2.1
million in Apacer. In August 2002, we made an additional investment of $181 thousand. At the end of
the third quarter of 2002, we determined that a continued and significant decline in Apacer's price
per share was other than temporary, and accordingly, in the third quarter of 2002, we recorded a
period charge to impairment of equity investments of $7.8 million to write down our investment in
Apacer to $4.4 million which was determined using the price per share paid for the additional
investment in August 2002. As of December 31, 2004 the recorded value of our investment in Apacer
was $4.4 million.

Provision for (Benefit from) Income Taxes

In 2004, our income tax expense was $3.9 million on a net income before tax of $27.8
million.  During the year of 2004, we maintained a full valuation allowance on our net deferred tax
assets. The valuation allowance was determined in accordance with the provisions of Statement of
Financial Accounting Standards No. 109, or SFAS No. 109, "Accounting for Income Taxes," which
requires an assessment of both positive and negative evidence when determining whether it is more
likely than not that deferred tax assets are recoverable; such assessment is required on a
jurisdiction by jurisdiction basis. Cumulative losses incurred in the U.S. in recent years
represented sufficient negative evidence under SFAS No. 109 and accordingly, a full valuation
allowance was recorded against U.S. deferred tax assets. We intend to maintain a full valuation
allowance on the U.S. deferred tax assets until sufficient positive evidence exists to support
reversal of the valuation allowance.  Our income tax benefit of $10.9 million in 2002 consisted of a
42.0% tax rate on our loss before income taxes.  In 2003, we implemented an international tax
structure, which in conjunction with the full valuation allowance, will mean that going forward we
will record a tax expense as a result of foreign tax withholding and alternative minimum tax until
such time that the valuation allowance against the deferred tax asset is no longer required.

Segment Reporting

Our operations involve the design, development, manufacturing, marketing and technical
support of our nonvolatile memory technology and products. We offer low to medium density devices
that target a broad range of existing and emerging applications in the digital consumer, networking,
wireless communications and Internet computing markets. Our products are differentiated based upon
attributes such as density, voltage, access speed, package and predicted endurance. We also license
our technology for use in non-competing applications. Our reportable segments are: the Standard
Memory Product Group, or SMPG, the Application Specific Product Group, or ASPG, the Special Product
Group, or SPG, the Emosyn Products, the SST Communications Corporation Products, or SCC, and
Technology Licensing. Refer to Note 15 to the Consolidated Financial Statements for revenue and
gross profit information by reportable segment. Our analysis of the changes for each segment is
discussed below.

19

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SMPG includes our three standard flash memory product families: the MPF family, the MPF+ family
and the MTP family. Effective January 1, 2003, we transferred certain MTP products from SMPG to SPG.
Effective July 1, 2003, we transferred the Small Sector Flash, or SSF, family from SMPG to SPG.
Effective January 1, 2004, we transferred the last MTP series of products from SMPG to SPG.
Accordingly, our segment revenues and gross profit information have been reclassified for
presentation purposes as if the transfer occurred as of January 1, 2002. SMPG revenues were $269.4
million in 2004, $166.8 million in 2003 and $143.2 million in 2002. The increase in revenue in 2004
compared to 2003 was the result of both an increase in unit shipments of 26.9% and an increase in
average selling prices of 28.7%. The increase in revenues in 2003 compared to 2002 was primarily due
to increases in unit shipments of our products by 23.4%, offset by decreases in average selling
prices of 7.6%. Gross margin was 18.0% in 2004, 12.8% in 2003 and 3.8% in 2002. The increase in
gross margin in 2004 from 2003 was due to improvements in the market price during the first three
quarters as well as lower manufacturing costs achieved by transitioning manufacturing technology to
lower geometries. The increase in gross margin in 2003 from 2002 was primarily due to higher
inventory valuation adjustments in 2002, the sale of previously reserved inventory in 2003 and
product mix.

ASPG includes Concurrent SuperFlash, Serial Flash, Firmware Hub, or FWH, and Low Pin Count, or
LPC flash products. ASPG also includes flash embedded controllers such as the ATA controller.
Effective January 1, 2003, we transferred FlashFlex51 microcontroller products from ASPG to SPG.
Accordingly, our segment revenues and gross profit information have been reclassified for
presentation purposes as if the transfer occurred as of January 1, 2002. ASPG revenues were $73.2
million in 2004, $60.5 million in 2003 and $67.8 million in 2002. The increase in revenues in 2004
compared to 2003 was primarily due to an increase in unit shipments of 29.4%, offset by decreases in
average selling prices of 7.7%. The decrease in revenues in 2003 compared to 2002 was primarily due
to decreases in average selling prices of 31.8%, offset by increases in unit shipments of our
products of 32.9%. Gross margin was 26.5% in 2004, 19.1% in 2003 and 36.2% in 2002. The increase in
gross margin in 2004 from 2003 was due to lower manufacturing costs achieved by transitioning
manufacturing technology to lower geometries and product mix. The decrease in gross margin in 2003
from 2002 was primarily due to decreases in average selling prices and product mix.

SPG includes ComboMemory, ROM/RAM Combos, SSF, MTP, FlashFlex51 microcontrollers and other
special flash products. Effective January 1, 2003, we transferred certain MTP products from SMPG to
SPG and FlashFlex51 microcontroller products from ASPG to SPG. Effective July 1, 2003, we
transferred the SSF family from SMPG to SPG. Effective January 1, 2004, we transferred the last MTP
series of products from SMPG to SPG. Accordingly, our segment revenue and gross margin information
have been reclassified for presentation purposes as if the transfer occurred as of January 1, 2002.
SPG revenues were $44.6 million in 2004, $29.3 million in 2003 and $33.0 million in 2002. The
increase in revenues in 2004 compared to 2003 was the result of both an increase in unit shipments
of 5.8% and an increase in average selling prices of 34.3%. The decrease in revenues in 2003
compared to 2002 was primarily due to decreases in average selling prices of 19.5% offset by an
increase in unit shipments of our products by 12.3%. Gross margin was 28.5% in 2004, 16.3% in 2003
and 23.6% in 2002. The increase in gross margin in 2004 from 2003 was due to lower manufacturing
costs achieved by transitioning manufacturing technology to lower geometries. The increase in gross
margin in 2004 from 2003 was due to improvements in the market price during the first three quarters
as well as lower manufacturing costs achieved by transitioning manufacturing technology to lower
geometries. The decrease in gross margin in 2003 from 2002 was primarily due to decreases in average
selling prices and product mix.

Emosyn Products include the Theseus Platinum product family and
other flash memory based microprocessor chips. We acquired a majority ownership of Emosyn on
September 10, 2004. The segment revenue of $16.9 million for 2004 is from the date of acquisition
through the end of the year. Gross margin for 2004 was 14.0%.

SCC includes RF transceiver, synthesizer, power amplifier and switch
products. We formed SST Communications Corporation and acquired substantially all of the assets of
G-Plus, Inc. on November 5, 2004. The segment revenue of $593 thousand for 2004 is from the date of
acquisition through the end of the year. Gross margin for 2004 was negative 35.8%.

Revenue and gross profit related to Technology Licensing was $44.5 million for 2004, $38.5
million for 2003 and $30.6 million for 2002. The increase from 2003 to 2004 is due to increased
up-front license fees from our new licensees. The increase from 2002 to 2003 related primarily to
increase royalty payments from our existing licensees and up-front license fees from our new
licensees.

20

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Related Party Transactions

The following table is a summary of our related party revenues and purchases (in thousands):

`Year Ended
                                                         December 31, 2004
                                                  --------------------------------
                                                    Revenues         Purchases
                                                  ------------  ------------------
Silicon Technology Co., Ltd..................... $      7,943  $               --
Apacer Technology, Inc and related entities.....        2,359                 707
Silicon Professional Technology Ltd.............      214,195                  --
Grace Semiconductor Manufacturing Corporation...          156              59,278
King Yuan Electronics Company, Limited..........           --              38,248
Powertech Technology, Incorporated..............           --              14,718
                                                  ------------  ------------------
                                                 $    224,653  $          112,951
                                                  ============  ==================

                                                             Year Ended
                                                         December 31, 2003
                                                  --------------------------------
                                                    Revenues         Purchases
                                                  ------------  ------------------
Silicon Technology Co., Ltd..................... $      3,615  $               --
Apacer Technology, Inc and related entities.....        1,555               2,361
Silicon Professional Technology Ltd.............      164,810                  --
Grace Semiconductor Manufacturing Corporation...           --                  12
King Yuan Electronics Company, Limited..........           --              19,659
Powertech Technology, Incorporated..............           --               9,280
                                                  ------------  ------------------
                                                 $    169,980  $           31,312
                                                  ============  ==================

                                                             Year Ended
                                                         December 31, 2002
                                                  --------------------------------
                                                    Revenues         Purchases
                                                  ------------  ------------------
Silicon Technology Co., Ltd..................... $      2,089  $               --
Acer and related entities (1)...................          269                  --
Apacer Technology, Inc and related entities.....          899                 588
Professional Computer Technology Limited........          141                  --
Silicon Professional Technology Ltd.............      140,003                  --
King Yuan Electronics Company, Limited..........           --              18,163
Powertech Technology, Incorporated..............           --               8,378
                                                  ------------  ------------------
                                                 $    143,401  $           27,129
                                                  ============  ==================`

(1) Excludes Apacer Technology, Inc. balances.

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The following table is a summary of our related party accounts receivable and accounts payable and
accruals (in thousands):

`December 31, 2003            December 31, 2004
                                                  --------------------------------  -----------------------
                                                                     Accounts                     Accounts
                                                    Accounts       Payable and       Accounts    Payable and
                                                   Receivable        Accruals       Receivable    Accruals
                                                  ------------  ------------------  -----------  ----------
Silicon Technology Co., Ltd..................... $        232  $               --  $       322  $       --

Apacer Technology, Inc and related entities.....          400                 736          458         320
Professional Computer Technology Limited........           --                  15           --          72
Silicon Professional Technology Ltd.............       40,588                 550       32,037         694
Grace Semiconductor Manufacturing Corporation...           --                  --          156      17,227
King Yuan Electronics Company, Limited..........           --               6,896           --      13,702
Powertech Technology, Incorporated..............           --               2,533           --       3,867
Other...........................................           --                   4           --          --
                                                  ------------  ------------------  -----------  ----------
                                                 $     41,220  $           10,734  $    32,973  $   35,882
                                                  ============  ==================  ===========  ==========`

In 1996, we acquired a 14% interest in Silicon Technology Co., Ltd., or Silicon
Technology, a privately held Japanese company, for $939 thousand in cash. Bing Yeh, our President,
CEO and Chairman of our Board of Directors, is also a member of Silicon Technology's board of
directors. We acquired the interest in Silicon Technology in order to provide a presence for our
products in Japan. We now have our own office in Japan, although Silicon Technology continues to
sell our products. At December 31, 2004, our investment, which is carried at cost, represented 9% of
the outstanding equity of Silicon Technology. Our sales to Silicon Technology were made at
prevailing market prices and the payment terms are consistent with the payment terms extended to our
other customers. We are not obligated to provide Silicon Technology with any additional
financing.

In 2000, we acquired a 10% interest in Apacer Technology Inc, or Apacer, for $9.9 million in
cash. Apacer, a privately held Taiwanese company and a related entity of Acer, is a memory module
manufacturer. Bing Yeh, our President, CEO and Chairman of our Board of Directors, is also a member
of Apacer's board of directors. In 2001, we invested an additional $2.1 million in Apacer. In August
2002, we made an additional investment of $181 thousand. The investment was written down to $4.4
million during 2002, please refer to Note 13 of the Notes to the Consolidated Financial Statements.
At December 31, 2004, our investment represented 10% of the outstanding equity of Apacer. Our sales
to the related Acer entities were made at prevailing market prices and the payment terms are
consistent with the payment terms extended to our other customers. Our purchases from Apacer are
made pursuant to purchase orders at prevailing market prices. We do not have a long-term contract
with Apacer to supply us with products. If Apacer were to terminate its relationship with us, we
believe that we would be able to procure the necessary products from other production
subcontractors. We are not obligated to provide Apacer with any additional financing.

In 2000, we acquired a 15% interest in Professional Computer Technology Limited, or PCT, a
privately held Taiwanese company, for $1.5 million in cash. Bing Yeh, our President, CEO and
Chairman of our Board of Directors, is also a member of PCT's board of directors. PCT is one of our
stocking representatives. In May 2002, we made an additional investment of $179 thousand in PCT.
During 2003, PCT completed an initial public offering on the Taiwan Stock Exchange and we sold a
portion of our holdings. Under Taiwan security regulations, a certain number of shares must be held
in a central custody and are restricted from sale for a period of time. The shares available for
sale within one year are carried at the quoted market price and included in long-term
available-for-sale investments in the balance sheet as of December 31, 2004. Shares required to be held in custody
for greater than a one year period are carried at cost and included in equity investments. In
February 2004, we purchased $1.7 million of PCT's European convertible bonds. As of December 31,
2004, the value of the stock and convertible bond investment recorded as long-term
available-for-sale is valued at $6.4 million and the restricted portion of the investment carried at cost is
recorded at $675 thousand. At December 31, 2004 our investment represented 13% of the outstanding
equity and 13% of the European convertible bonds of PCT.

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PCT and it subsidiary, Silicon Professional Alliance Corporation, or SPAC, earn commissions for
point-of-sales transactions to its customers. Commissions to PCT and SPAC are paid at the same rate
as all of our other stocking representatives in Asia. In 2002, 2003 and 2004 we paid sales
commissions of $2.5 million, $1.2 million and $579 thousand, respectively, to PCT and SPAC.
Shipments, by us or our logistics center, to PCT and SPAC for reshipment accounted for 10.3%, 27.3%
and 31.3% of our product shipments in 2002, 2003 and 2004. In addition, PCT and SPAC solicited
sales, for which they earned a commission, for 19.5%, 12.0% and 3.3% of our shipments to end users
in 2002, 2003 and 2004, respectively.

In 2001, PCT established a separate company and wholly-owned subsidiary, Silicon Professional
Technology, Ltd., or SPT, to provide planning, warehousing, delivery, billing, collection and other
logistic functions for us in Taiwan. SPT now services substantially all of our end customers based
in Taiwan, China and other Southeast Asia countries. Products shipped to SPT are accounted for as
our inventory held at our logistics center, and revenue is recognized when the products have been
delivered and are considered as a sale to our end customers by SPT. We pay SPT a fee based on a
percentage of revenue for each product sold through SPT to our end customers. The fee paid to SPT
covers the cost of warehousing and insuring inventory and accounts receivable, personnel costs
required to maintain logistics and information technology functions and the costs to perform billing
and collection of accounts receivable. SPT receives extended payment terms and is obligated to pay
us whether or not they have collected the accounts receivable.

We do not have any long-term contracts with SPT, PCT or SPAC, and SPT, PCT or SPAC may cease
providing services to us at any time. If SPT, PCT or SPAC were to terminate their relationship with
us we would experience a delay in reestablishing warehousing, logistics and distribution functions
which would harm our business. We are not obligated to provide SPT, PCT or SPAC with any additional
financing.

In 2000, we acquired a 1% interest in King Yuan Electronics Company, Limited, or KYE, a publicly
held Taiwanese company, which is a production subcontractor, for $4.6 million in cash. A member of
our management team holds a supervisor position at KYE. The role and responsibilities of a
supervisor are defined and governed by Corporate Law in Taiwan. The investment was made in KYE in
order to strengthen the relationship between us and KYE. During 2001, KYE completed an initial
public offering on the Taiwan Stock Exchange. Accordingly, the investment has been included in
long-term available-for-sale investments in the balance sheet as of December 31, 2003 and 2004. The
investment was written down to $1.3 million during 2001 and is valued at $2.3 million as of December
31, 2004 based on the quoted market price. At December 31, 2004, our investment represented 0.5% of
the outstanding equity of KYE. Our purchases from KYE are made pursuant to purchase orders at
prevailing market prices. We do not have a long-term contract with KYE to supply us with services.
If KYE were to terminate its relationship with us, we believe that we would be able to procure the
necessary services from other production subcontractors. We are not obligated to provide KYE with
any additional financing.

In 2000, we acquired a 3% interest in Powertech Technology, Incorporated, or PTI, a privately
held Taiwanese company, which is a production subcontractor, for $2.5 million in cash.
Bing Yeh, our President, CEO and Chairman of the Board of Directors,
is also a member of PTI's board of
directors. The investment was made in PTI in order to strengthen the relationship between us and
PTI. During 2003, PTI completed an initial public offering on the Taiwan Stock Exchange and we sold
a portion of our holdings. Under Taiwan security regulations, a certain number of shares must be
held in a central custody and are restricted from sale for a period of time. The shares available
for sale within one year are carried at the quoted market price and included in long-term
available-for-sale investments in the balance sheet as of December 31, 2003 and 2004. Shares required to be
held in custody for greater than a one year period are carried at cost and included in equity
investments. In August 2004, we invested $723 thousand cash in PTI shares available for sale. As of
December 31, 2004, the value of the investment recorded as long-term available-for-sale is valued at
$14.1 million and the restricted portion of the investment carried at cost is recorded at $767
thousand. At December 31, 2004, our investment represented 2% of the outstanding equity of PTI. Our
purchases from PTI are made pursuant to purchase orders at prevailing market prices. We do not have
a long-term contract with PTI to supply us with services. If PTI were to terminate its relationship
with us, we believe that we would be able to procure the necessary services from other production
subcontractors. We are not obligated to provide PTI with any additional financing.

In 2001, we acquired a 9% interest in Grace Semiconductor Manufacturing Corporation, or GSMC, a
privately held Cayman Islands company for $50.0 million in cash. In March 2004, we invested an
additional $33.2 million in GSMC. Bing Yeh, our President, CEO and Chairman of our Board of
Directors, is also a member of GSMC's board of directors. In addition, a member of our management
team holds one supervisor position at GSMC. The role and responsibilities of a supervisor are
defined and governed by Corporate Law in the Cayman Islands. This investment is carried at cost.
GSMC has a wholly owned subsidiary, Shanghai Grace Semiconductor Manufacturing Corporation, or
Grace, which is a wafer foundry company with operations in China. Grace began to manufacture our
products since late 2003. We do not have a long-term contract with Grace to supply us with products.
At December 31, 2004, our investment represented 10% of the outstanding equity of GSMC.

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In 2002, we acquired a 6% interest in Insyde Software Corporation, or Insyde, a privately held
Taiwanese company, for $964 thousand in cash. Bing Yeh, our President, CEO and Chairman of our Board
of Directors, is also a member of Insyde's board of directors. During 2003, Insyde completed an
initial public offering on the Taiwan Stock Exchange. Under Taiwan security regulations, a certain
number of shares must be held in a central custody and are restricted from sale for a period of
time. The shares available for sale within one year are carried at the quoted market price and
included in long-term available-for-sale investments in the balance sheet as of December 31, 2003
and 2004. Shares required to be held in custody for greater than a one year period are carried at
cost and included in equity investments. In January 2004, we invested an additional $133 thousand
cash in Insyde's convertible bonds. The stock investment was written down $509 thousand during 2004,
refer to Note 13 of these Notes to the Consolidated Financial Statements. At December 31, 2004, our
investment represented 6% of the outstanding equity and 6% of the convertible bonds of Insyde.

In June 2004, we acquired a 9% interest in Advanced Chip Engineering Technology, or ACET, a
privately held Taiwanese company for $4.0 million cash. ACET, a related entity of KYE, is a
production subcontractor. Chen Tsai, our Senior Vice President of Worldwide Backend Operations, is
also a member of ACET's board of directors. At December 31, 2004 our investment, which is carried at
cost, represented 9% of the outstanding equity of ACET.

In November 2004, we acquired a 30% interest in Nanotech
Corporation, or Nanotech, a privately held Cayman Island company, for $3.8 million cash. Nanotech, a
development stage company, has a wholly owned subsidiary which is in the process of establishing
foundry operations in China. Bing Yeh, our President, CEO and Chairman of our Board of Directors, is
also a member of Nanotech's board of directors. Tsuyoshi Taira, a member of our Board of Directors,
also invested in this round of financing.

24

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Critical Accounting Estimates

Our critical accounting estimates are as follows:

- Revenue recognition;
- Allowance for sales returns;
- Allowance for doubtful accounts;
- Allowance for excess and obsolete inventory and lower of cost or market;
- Warranty accrual;
- Litigation costs;
- Valuation of equity investments;
- Provision for adverse purchase commitments; and
- Accounting for income taxes.

Revenue recognition. Sales to direct customers and foreign stocking representatives are
recognized net of an allowance for estimated returns. When product is shipped to direct customers or
stocking representatives, or by our distributors or SPT to end users, prior to recognizing revenue,
we also require that evidence of the arrangement exists, the price is fixed or determinable and
collection is reasonably assured. Our shipping terms are generally freight on board, or FOB,
shipping point and payment terms typically range from 30 to 75 days. Sales to distributors are made
primarily under arrangements allowing price protection and the right of stock rotation on
merchandise unsold. Because of the uncertainty associated with pricing concessions and future
returns, we defer recognition of such revenues, related costs of revenues and related gross profit
until the merchandise is sold by the distributor. Products shipped to SPT are accounted for as our
inventory held at our logistics center, and revenue is recognized when the products have been
delivered and are considered as a sale to our end customers by SPT.

Most of our technology licenses provide for the payment of up-front license fees and continuing
royalties based on product sales. For license and other arrangements for technology that we are
continuing to enhance and refine, and under which we are obligated to provide unspecified
enhancements, revenue is recognized over the lesser of the estimated period that we have
historically enhanced and developed refinements to the technology, approximately two to three years
(the upgrade period), or the remaining portion of the upgrade period from the date of delivery,
provided all specified technology and documentation has been delivered, the fee is fixed or
determinable and collection of the fee is reasonably assured. From time to time, we reexamine the
estimated upgrade period relating to licensed technology to determine if a change in the estimated
upgrade period is needed. Revenue from license or other technology arrangements where we are not
continuing to enhance and refine technology or are not obligated to provide unspecified enhancements
is recognized upon delivery, if the fee is fixed or determinable and collection of the fee is
reasonably assured.

Royalties received under these arrangements during the upgrade period are recognized as revenue
based on the ratio of the elapsed portion of the upgrade period to the estimated upgrade period. The
remaining portions of the royalties are recognized ratably over the remaining portion of the upgrade
period. Royalties received after the upgrade period has elapsed are recognized when reported to
us.

If we make different judgments or utilize different estimates in relation to the estimated period
of technology enhancement and development, the amount and timing of our license and royalty revenues
could be materially different.

Allowance for sales returns. We maintain allowances for sales returns for estimated
product returns by our customers. We estimate our allowance for sales returns based on our
historical return experience, current economic trends, changes in customer demand, known returns we
have not received and other assumptions. The allowance for sales returns was $1.8 million, $1.3
million and $2.0 million as of December 31, 2002, 2003 and 2004, respectively. If we make different
judgments or utilize different estimates, the amount and timing of our revenue could be materially
different.

Allowance for doubtful accounts. We maintain allowance for doubtful accounts for estimated
losses from the inability of our customers to make required payments. We evaluate our allowance for
doubtful accounts based on the aging of our accounts receivable, the financial condition of our
customers and their payment history, our historical write-off experience and other assumptions. If
we were to make different judgments of the financial condition of our customers or the financial
condition of our customers were to deteriorate, resulting in an impairment of their ability to make
payments, additional allowances may be required. The allowance for doubtful accounts was $4.4
million, $1.1 million and $1.2 million as of December 31, 2002, 2003 and 2004, respectively.

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Allowance for excess and obsolete inventory and lower of cost or market. Our inventories
are stated at the lower of cost (determined on a first-in, first-out basis) or market value. We
typically plan our production and inventory levels based on internal forecasts of customer demand,
which are highly unpredictable and can fluctuate substantially. The value of our inventory is
dependent on our estimate of future average selling prices, and, if our projected average selling
prices are over estimated, we may be required to adjust our inventory value to reflect the lower of
cost or market. Our inventories include high technology parts and components that are specialized in
nature or subject to rapid technological obsolescence. We maintain allowance for inventory for
potentially excess and obsolete inventories and those inventories carried at costs that are higher
than their market values. We review on-hand inventory including inventory held at the logistic
center for potential excess, obsolete and lower of cost or market exposure and adjust the level of
inventory reserve accordingly. Some of our customers have requested that we ship them product that
has a finished goods date of manufacture that is less than one year old. In the event that this
becomes a common requirement, it may be necessary for us to provide for an additional allowance for
our on hand finished goods inventory with a date of manufacture of greater than one year old, which
could result in additional inventory write-downs.

Warranty accrual. Our products are generally subject to warranty and we provide for the
estimated future costs of repair, replacement or customer accommodation upon shipment of the product
in the accompanying statements of operations. Our warranty accrual is estimated based on historical
claims compared to historical revenues and assumes that we have to replace products subject to a
claim. For new products, we use our historical percentage for the appropriate class of product.
Should actual product failure rates differ from our estimates, revisions to the estimated warranty
liability would be required. The recorded value of our warranty accrual was $492 thousand, $187
thousand and $3.8 million as of December 31, 2002, 2003 and 2004, respectively.

Litigation costs. From time to time, we are also involved in other legal actions arising
in the ordinary course of business. We have incurred certain costs associated with defending these
matters. There can be no assurance the Atmel complaint, shareholder class action complaints,
shareholder derivative complaints or other third party assertions will be resolved without costly
litigation, in a manner that is not adverse to our financial position, results of operations or cash
flows or without requiring royalty payments in the future which may adversely impact gross margins.
As of December 31, 2004, no estimate can be made of the possible loss or possible range of loss
associated with the resolution of these contingencies. If additional information becomes available
such that we estimate that there is a possible loss or possible range of loss associated with these
contingencies, then we would record the minimum estimated liability, which could materially impact
our results of operations and financial position.

Valuation of equity investments. We hold minority interests in companies having operations
in the semiconductor industry. We record an investment impairment charge when we believe an
investment has experienced a decline in value that is other than temporary. Future adverse changes
in market conditions or poor operating results of underlying investments could result in losses or
an inability to recover the carrying value of the investments, thereby possibly requiring an
impairment charge in the future. The recorded value of our equity investments was $62.3 million,
$70.1 million and $121.7 million as of December 31, 2002, 2003 and 2004, respectively.

Provision for adverse purchase commitments. We maintain a provision for adverse purchase
commitments for in process orders at our vendors when there is a lower of cost or market valuation
against our on hand inventory. Once production has begun against our purchase orders, we are
committed to purchasing the inventory or, if we cancel the order, we are liable for all costs
incurred up to the time of cancellation. If we have written down our on-hand inventory of the
ordered product for lower of cost or market valuations, we must consider the impact to in process
inventory at our vendor. We evaluate our in process orders to determine the impact of canceling the
order and the impact of purchasing the inventory at a cost higher than the estimated current market
value. If we determine that market conditions become less favorable than those currently projected
by management, such as an unanticipated decline in average selling prices or demand not meeting our
expectations, additional inventory write-downs may be required when the inventory is purchased into
inventory. The recorded provision for adverse purchase commitments was $1.3 million, $538 thousand
and $8.3 million as of December 31, 2002, 2003 and 2004, respectively.

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Accounting for income taxes. During the third quarter of 2003 we recorded a charge to
establish a full valuation allowance against our deferred tax assets offset by a reduction in income
tax payable as a result of a reassessment of expected liabilities for 2003 and certain exposures.
Accordingly, for 2003 we recorded an income tax expense of $26.4 million. During the fourth quarter
of 2003, we maintained a full valuation allowance on our net deferred tax assets. The valuation
allowance was determined in accordance with the provisions of Statement of Financial Accounting
Standards No. 109, or SFAS No. 109, "Accounting for Income Taxes," which requires an assessment of
both positive and negative evidence when determining whether it is more likely than not that
deferred tax assets are recoverable; such assessment is required on a jurisdiction by jurisdiction
basis. Cumulative losses incurred in the U.S. in recent years represented sufficient negative
evidence under SFAS No. 109 and accordingly, a full valuation allowance was recorded against U.S.
deferred tax assets. We intend to maintain a full valuation allowance on the U.S. deferred tax
assets until sufficient positive evidence exists to support reversal of the valuation allowance.
During 2004, we maintained a full valuation allowance on our
deferred tax assets.

Liquidity and Capital Resources

Operating activities. Our operating activities used cash of $14.0 million in 2004 and
$7.6 million in 2003. For 2004, our primary use of cash was for inventory purchases. Cash used in
operating activities included an increase in inventory of $133.6 million to support increased sales
activities and forecast customer demands, a $7.1 million increase in trade receivables from
unrelated parties due to increased revenues and increases in other assets and deferred revenues of
$4.3 million. Cash generated from operating activities included a net income of $23.9 million, a
decrease in trade receivables from related parties of $8.1million due mainly to decreased payment
terms with our logistic center, SPT, an increase in related and unrelated trade accounts payable of
$37.8 million due to increased purchases of products and business activities, and an increase in
accrued expenses and other liabilities of $7.5 million. Non-cash adjustments related to a provision
for excess and obsolete inventories, write down of inventory to market and adverse purchase
commitments of $35.9 million, depreciation and amortization expense of $7.4 million, in-process
research and development of $5.9 million, a provision for sales returns and doubtful accounts of
$2.2 million and a $1.5 million operating lease impairment charge. For 2003, our primary source of
operating cash flow was the timing of inventory purchases and payments to our vendors and service
providers, offset by the payment of $37.8 million to Atmel. Cash generated from operating activities
included decreases in inventories of $29.5 million due to increased sales, which reduced the amount
of inventory held, and other current and non-current assets of $18.3 million, increases in trade
accounts payable from related and unrelated parties of $12.4 million due to increased strategic
purchasing of certain products, increases in deferred revenue of $1.0 million and non-cash related
adjustments of $37.9 million. Non-cash adjustments related to $7.7 million of depreciation and
amortization, $6.7 million of inventory valuation adjustments, $22.3 million decrease in net
deferred tax assets and $1.3 million of tax benefit from employee stock plans, offset by a $228
thousand charge to expense for provision for doubtful accounts. Working capital uses of cash
included a net loss of $65.2 million, increases in trade accounts receivable from related and
non-related parties of $19.9 million due to increased revenue at the end of 2003 compared to 2002 and
increased activity through our logistic center which has extended payment terms and decreases in
accrued expenses and other liabilities of $6.5 million.

Investing activities. Our investing activities used cash of $26.0 million during 2004
primarily due to investments in equity securities of GSMC, ACET, Nanotech, PCT, PTI and Insyde of
$33.2 million, $4.0 million, $3.8 million, $1.7 million, $723 thousand and $133 thousand,
respectively, and the acquisitions of Emosyn and G-Plus which used cash of $16.0 million and $4.6
million, respectively. Investing activities also used cash for purchases of available for sale
investments and restricted cash of $47.6 million and purchases of property and equipment of $8.0
million. Sales and maturities of available for sale investments provided cash from investing
activities of $91.9 million. Our investing activities provided cash of $10.2 million during 2003,
primarily due to a total of $12.0 million cash from the excess sales and maturities of
available-for-sale investments and restricted cash over the purchases of such investments, offset by $1.8
million invested in capital expenditures.

Financing activities. Our financing activities used cash of $8.9 million in 2004 and
provided cash of $4.3 million in 2003. During 2004, the repurchase of our common stock used cash of
$14.9 million and the issuance of shares of common stock issued under our employee stock purchase
plan and the exercise of employee stock options provided cash of $5.5 million. Repayment of loans
used cash of $393 thousand and minority interest capital contributions provided cash of $820
thousand. During 2003, the cash provided was primarily from $4.5 million of common stock issued
under our employee stock purchase plan and the exercise of employee stock options, offset by $250
thousand in loan repayments.

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Principal sources of liquidity at December 31, 2004 consisted of $104.0 million of cash, cash
equivalents, and short-term and long-term available-for-sale investments.

Purchase Commitments. As of December 31, 2004, we had outstanding purchase commitments
with our foundry vendors of $100.7 million for delivery in 2005. We have recorded a liability of
$8.3 million for adverse purchase commitments.

Lease Commitments. We have long-term, non-cancelable building lease commitments. In 2001
and the second quarter of 2004, we recorded charges to other operating expense of $756 thousand and
$1.5 million, respectively, relating to operating leases for two unoccupied buildings. These charges
represent the estimated difference between the total discounted future sublease income and our
discounted lease commitments relating to these buildings. Payments made on the lease have reduced
the recorded combined liability to $270 thousand and $976 thousand at December 31, 2003 and 2004,
respectively.

Future payments due under building lease, purchase commitments and other contractual obligations
as of December 31, 2004 (in thousands):

`Less than                                More than
Contractual obligations                              Total            1 year         1-3 years   3-5 years    5 years
------------------------------------------------  ------------  ------------------  -----------  ----------  ---------
Notes payable................................... $        744  $              705  $        39  $       --  $      --
Operating leases................................       16,602               4,182        5,797       5,727        896
Purchase commitments............................      100,694             100,694           --          --         --
Other long-term liability.......................          480                  --          480          --         --
                                                  ------------  ------------------  -----------  ----------  ---------
Total........................................... $    118,520  $          105,581  $     6,316  $    5,727  $     896
                                                  ============  ==================  ===========  ==========  =========`

Operating Capital Requirements. We believe that our cash balances, together with funds we
expect to generate from operations, will be sufficient to meet our projected working capital and
other cash requirements through at least the next twelve months. However, there can be no assurance
that future events will not require us to seek additional borrowings or capital and, if so required,
that such borrowing or capital will be available on acceptable terms. Factors that could affect our
short-term and long-term cash used or generated from operations and as a result, our need to seek
additional borrowings or capital include:

- the average selling prices of our products;
- customer demand for our products;
- the need to secure future wafer production capacity from our suppliers;
- the timing of significant orders and of license and royalty revenue;
- merger, acquisition or joint venture projects;
- unanticipated research and development expenses associated with new product
introductions; and
- the outcome of ongoing litigation.

Please also see "Business Risks - Our operating results fluctuate significantly, and an
unanticipated decline in revenues may disappoint securities analysts or investors and result in a
decline in our stock price."

Recent Accounting Pronouncements

In March 2004, the Financial Accounting Standards Board, or FASB, issued EITF
Issue No. 03-01, or EITF 03-1, "The Meaning of Other-Than-Temporary Impairment and
Its Application to Certain Investments" which provided new guidance for assessing impairment losses
on investments. Additionally, EITF 03-1 includes new disclosure requirements for investments
that are deemed to be temporarily impaired. In September 2004, the FASB delayed the accounting
provisions of EITF 03-1; however the disclosure requirements remain effective for annual
periods ending after June 15, 2004. We will evaluate the impact of EITF 03-1 once final
guidance is issued.

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In October 2004, the FASB approved EITF Issue 04-10 "Determining Whether to
Aggregate Operating Segments That Do Not Meet the Quantitative Thresholds" which addresses an issue
in the application of paragraph 19 of SFAS No. 131, Disclosures about Segments of an Enterprise and
related information.  In November 2004, the FASB delayed until further notice the effective date of
this issue.  We are currently assessing the impact of the disclosure requirements of EITF Issue
04-10 on our consolidated financial statements.

In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an Amendment of ARB No. 43,
Chapter 4."  The amendments made by SFAS No.151 are intended to improve financial reporting by
clarifying that abnormal amounts of idle facility expense, freight, handling costs, and wasted
materials (spoilage) should be recognized as current-period charges and by requiring the allocation
of fixed production overheads to inventory based on the normal capacity of the production
facilities.  The guidance is effective for inventory costs incurred beginning after June 15, 2005.
We are currently reviewing the impact of SFAS No. 151 on the carrying amounts of our inventory.  We
do not expect the adoption of SFAS No. 151 will have a material impact on our consolidated financial
statements.

In December 2004, the FASB issued SFAS 123R (revised 2004), "Share Based
Payment." SFAS 123R is a revision of FASB 123 and supersedes APB No. 25. SFAS 123R establishes
standards for the accounting for transactions in which an entity exchanges its equity instruments
for good or services or incurs liabilities in exchange for goods or services that are based on the
fair value of the entity's equity instruments. SFAS 123R focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment transactions. SFAS
123R requires an entity to measure the cost of employee services received in exchange for an award
of equity instruments based on the grant-date fair value of the award over the period during which
an employee is required to provide service for the award. The grant-date fair value of employee
share options and similar instruments must be estimated using option-pricing models adjusted for the
unique characteristics of those instruments unless observable market prices for the same or similar
instruments are available. In addition, SFAS 123R requires a public entity measure the cost of
employee services received in exchange for an award of liability instruments based on its current
fair value and that the fair value of that award will be remeasured subsequently at each reporting
date through the settlement date. The effective date of SFAS 123R for SST is for the first interim
or annual period after June 15, 2005. Although we have not yet determined whether the adoption
of SFAS 123R will result in amounts that are similar to the current pro forma disclosures under
SFAS123, we are evaluating the requirements under SFAS 123R and expect the adoption to have a
significant adverse impact on our consolidated operating expenses.

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Business Risks

Risks Related to Our Business

Our operating results fluctuate materially, and an unanticipated decline in revenues may
disappoint securities analysts or investors and result in a decline in our stock price.

Although we were profitable for the first three quarters of 2004, we incurred net losses for
2002 and 2003 and the fourth quarter of 2004. Our operating results have fluctuated significantly
and our past financial performance should not be used to predict future operating results. Our
recent quarterly and annual operating results have fluctuated, and may continue to fluctuate, due to
the following factors, all of which are difficult to forecast and 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

As recent experience confirms, a downturn in the market for products such as personal computers
and cellular telephones that incorporate our products can also harm our operating results.

Our operating expenses are relatively fixed, and we order materials in advance of anticipated
customer demand. Therefore, we have limited ability to reduce expenses quickly in response to any
revenue shortfalls.

Our operating expenses are relatively fixed, and we therefore have limited ability to reduce
expenses quickly in response to any revenue shortfalls. Consequently, our operating results will be
harmed if our revenues do not meet our projections. 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.

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In addition, political or economic events beyond our control can suddenly result
in increased operating costs. For example, the terrorist attacks of September 11, 2001 have resulted
in a substantial increase to our business insurance costs. In addition, under a current proposed
standard, we would be required to record compensation expense on stock option grants and on shares
purchased under our employee stock purchase program, which would substantially increase our
operating costs and impact our earnings (loss) per share.

We incurred significant inventory valuation and adverse purchase commitment adjustments in
2002, 2003 and 2004 and we may incur additional significant inventory valuation adjustments in the
future.

We typically plan our production and inventory levels based on internal forecasts of customer
demand, which are highly unpredictable and can fluctuate materially. The value of our inventory is
dependent on our estimate of future average selling prices, and, if our projected average selling
prices are over estimated, we may be required to adjust our inventory value to reflect the lower of
cost or market. As of December 31, 2004, we had $156.6 million of inventory on hand, an increase of
$110.5 million, or 240%, from December 31, 2003. Total valuation adjustments to inventory and
adverse purchase commitments were $10.4 million in 2002, $6.7 million in 2003 and $35.9 million in
2004. Due to the large number of units in our inventory, even a small change in average selling
prices could result in a significant adjustment and could harm our financial results. Some of our
customers have requested that we ship them product that has a finished goods date of manufacture
that is less than one year old. As of December 31, 2004, our allowance for excess and obsolete
inventories includes an allowance for our on hand finished goods inventory with a date of
manufacture of greater than two years old and for certain products with a date of manufacture of
greater than one year old. In the event that this becomes a common requirement, it may be necessary
for us to provide for an additional allowance for our on hand finished goods inventory with a date
of manufacture of greater than one year old, which could result in a significant adjustment and
could harm our financial results.

Cancellations or rescheduling of backlog may result in lower future revenue and harm our
business.

Due to possible customer changes in delivery schedules and cancellations of orders, our
backlog at any particular date is not necessarily indicative of actual sales for any succeeding
period. A reduction of backlog during any particular period, or the failure of our backlog to result
in future revenue, could harm our business in the future. We experienced a sharp downturn in several
of our markets late in the fourth quarter of 2000 through 2002, as our customers reacted to
weakening demand for their products. We began to experience a slow recovery during 2002 through the
first half of 2003. During the second half of 2003 and the first half of 2004, demand for our
products increased sharply and we had improvements in the average selling prices of our products.
However, during the second half of 2004, we experienced a demand slow-down for our products. Our
business could be harmed by industry-wide fluctuations in the future.

Our business may suffer due to risks associated with international sales and operations.

During 2002, 2003 and 2004, our export product and licensing revenues accounted for 92.0%,
92.9% and 92.7% of our net revenues, respectively. Our international business activities are subject
to a number of risks, each of which could impose unexpected costs on us that would harm 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;
- 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.

In addition, we have made equity investments in companies with operations in China, Japan and
Taiwan. The value of our investments is subject to the economic and political conditions particular
to their industry, their countries and to foreign exchange rates and to the global economy. If we
determine that a change in the recorded value of an investment is other than temporary, we will
adjust the value of the investment. Such an expense could have a negative impact on our operating
results.

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We derived 88.5%, 90.0% and 86.0% of our net product revenues from Asia during 2002, 2003 and
2004, respectively. Additionally, substantially all of our wafer suppliers and packaging and testing
subcontractors are located in Asia. Any kind of economic, political or environmental instability in
this region of the world can have a severe negative impact on our operating results due to the large
concentration of our production and sales activities in this region. For example, during 1997 and
1998, several Asian countries where we do business, such as Japan, Taiwan and Korea, experienced
severe currency fluctuation and economic deflation, which negatively impacted our revenues and also
negatively impacted our ability to collect payments from customers. During this period, the lack of
capital in the financial sectors of these countries made it difficult for our customers to open
letters of credit or other financial instruments that are guaranteed by foreign banks. Finally, the
economic situation during this period exacerbated a decline in selling prices for our products as
our competitors reduced product prices to generate needed cash.

It should also be noted that we are greatly impacted by the political, economic and military
conditions in Taiwan. Taiwan and China are continuously engaged in political disputes and both
countries have continued to conduct military exercises in or near the other's territorial waters and
airspace. Such disputes may continue and even escalate, resulting in an economic embargo, a
disruption in shipping or even military hostilities. Any of these events could delay production or
shipment of our products. Any kind of activity of this nature or even rumors of such activity could
harm our operations, revenues, operating results, and stock price.

Terrorist attacks and threats, and government responses thereto, could harm our business.

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

We do not typically enter into long-term contracts with our customers, and the loss of a major
customer could harm our business.

We do not typically enter into long-term contracts with our customers. In addition, we cannot
be certain as to future order levels from our customers. In the past, when we have entered into a
long-term contract, the contract has generally been terminable at the convenience of the customer.

We depend on stocking representatives and distributors to generate a majority of our revenues.

We rely on stocking representatives and distributors to establish and maintain customer
relationships and to sell our products. These stocking representatives and distributors could
discontinue their relationship with us or discontinue selling our products at any time. The majority
of our stocking representatives are located in Asia. The loss of our relationship with any stocking
representative or distributor could harm our operating results by impairing our ability to sell our
products to our end customers.

We depend on SPT, our logistics center, to support many of our customers in Asia.

Since March 2001, we have been increasing our out-sourcing activities with our customer service
logistics to support our customers. Currently SPT supports our customers in Taiwan, China and other
Southeast Asia countries. SPT provides planning, warehousing, delivery, billing, collection and
other logistic functions for us in these regions. SPT is a wholly owned subsidiary of one of our
stocking representatives in Taiwan, PCT. During 2002, 2003 and 2004, SPT serviced end customer
shipments accounted for 57.4%, 64.2% and 52.9% of our net product revenues recognized, respectively.
As of December 31, 2002, 2003, and 2004, SPT accounted for 68.5%, 73.4% and 55.1%, respectively, of
our net accounts receivable. For further description of our relationships with PCT and SPT, please
refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operation - Related Party Transactions."

We do not have any long-term contracts with SPT, PCT or SPAC, and SPT, PCT or SPAC may cease
providing services to us at any time. If SPT, PCT or SPAC were to terminate their relationship with
us we would experience a delay in reestablishing warehousing, logistics and distribution functions,
which could impair our ability to collect accounts receivable from SPT and may harm our
business.

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We depend 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.

We outsource substantially all of our manufacturing and testing activities. We currently buy
all of our wafers and sorted die from a limited number of suppliers. Substantially all of our
products are manufactured by six foundries, TSMC in Taiwan, Sanyo, Seiko-Epson and Yasu in Japan,
Grace in China, and Samsung in Korea. In March 2001, we invested $50.0 million in GSMC, a Cayman
Islands company, for a wafer foundry project located in Shanghai, China. In March 2004, we invested
an additional $33.2 million in GSMC. Grace, a wholly owned subsidiary of GSMC, began manufacturing
some of our products early in the fourth quarter of 2003. We anticipate that these foundries,
together with Shanghai Hua Hong NEC Electronic Company Limited, or HHNEC, and Vanguard in Taiwan
will manufacture substantially all of our products in 2005. If these suppliers fail to satisfy our
requirements on a timely basis at competitive prices we could suffer manufacturing delays, a
possible loss of revenues or higher than anticipated costs of revenues, any of which could harm our
operating results.

Our revenues may be impacted by our ability to obtain adequate wafer supplies from our foundries.
The foundries with which we currently have arrangements, together with any additional foundry at
which capacity might be obtained, may not be willing or able to satisfy all of our manufacturing
requirements on a timely basis at favorable prices. In addition, we have encountered delays in
qualifying new products and in ramping-up new product production and we could experience these
delays in the future. We are also subject to the risks of service disruptions, raw material
shortages and priceincreases by our foundries. Such disruptions, shortages and price
increases could harm our operating results.

Manufacturing capacity has in the past been difficult to secure and if capacity constraints
arise in the future our revenues may decline.

In order to grow, we need to increase our present manufacturing capacity. We currently
believe that the existing capacity plus additional future capacity from Grace, HHNEC and Vanguard
available to us will be sufficient through 2005. However, events that we have not foreseen could
arise which would limit our capacity. Similar to our $83.2 million investment in GSMC, we may
determine that it is necessary to invest substantial capital in order to secure appropriate
production capacity commitments. If we cannot secure additional manufacturing capacity on acceptable
terms, our ability to grow will be impaired and our operating results will be harmed.

Our cost of revenues may increase if we are required to purchase manufacturing capacity in
the future.

To obtain additional manufacturing capacity, we may be required to make deposits, equipment
purchases, loans, joint ventures, equity investments or technology licenses in or with wafer
fabrication companies. These transactions could involve a commitment of substantial amounts of our
capital and technology licenses in return for production capacity. We may be required to seek
additional debt or equity financing if we need substantial capital in order to secure this capacity
and we cannot assure you that we will be able to obtain such financing.

If our foundries fail to achieve acceptable wafer manufacturing yields, we will experience
higher costs of revenues and reduced product availability.

The fabrication of our products requires wafers to be produced in a highly controlled and
ultra-clean environment. Semiconductor companies that supply our wafers have, from time to time,
experienced problems achieving acceptable wafer manufacturing yields. Semiconductor manufacturing
yields are a function of both our design technology and the foundry's manufacturing process
technology. Low yields may result from marginal design or manufacturing process drift. Yield
problems may not be identified until the wafers are well into the production process, which often
makes them difficult, time consuming and costly to correct. Furthermore, we rely on independent
foundries for our wafers which increases the effort and time required to identify, communicate and
resolve manufacturing yield problems. If our foundries fail to achieve acceptable manufacturing
yields, we will experience higher costs of revenues and reduced product availability, which could
harm our operating results.

If our foundries discontinue the manufacturing processes needed to meet our demands, or
failto upgrade the technologies needed to manufacture our products, we may face production
delays and lower revenues.

Our wafer and product requirements typically represent a small portion of the total
production of the foundries that manufacture our products. As a result, we are subject to the risk
that a foundry will cease production on an older or lower-volume manufacturing process that it uses
to produce our parts. Additionally, we cannot be certain our foundries will continue to devote
resources to advance the process technologies on which the manufacturing of our products is based.
Either one of these events could increase our costs and harm our ability to deliver our products on
time.

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Our dependence on third-party subcontractors to assemble and test our products subjects us to
a number of risks, including an inadequate supply of products and higher costs of materials.

We depend on independent subcontractors to assemble and test our products. Our reliance on
these subcontractors involves the following significant risks:

- reduced control over delivery schedules and quality;
- the potential lack of adequate capacity during periods of strong demand;
- difficulties selecting and integrating new subcontractors;
- limited warranties on products supplied to us;
- potential increases in prices due to capacity shortages and other factors; and
- potential misappropriation of our intellectual property.

These risks may lead to increased costs, delayed product delivery or loss of competitive
advantage, which would harm our profitability and customer relationships.

Because our flash memory products typically have lengthy sales cycles, we may experience
substantial delays between incurring expenses related to research and development and the generation
of revenues.

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

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

We compete with major domestic and international semiconductor companies, many of which have
substantially greater financial, technical, marketing, distribution, and other resources than we do.
Many of our competitors have their own facilities for the production of semiconductor memory
components and have recently added significant capacity for such production. Our low density memory
products, sales of which presently account for substantially all of our revenues, compete against
products offered by Spansion (AMD/Fujitsu), Atmel, Intel, Macronix, STMicroelectronics, PMC and
Winbond. Our medium-density memory products compete with products offered by Spansion, Intel, ST
Microelectronics, Mitsubishi, Samsung, Sharp Electronics and Toshiba. If we are successful in
developing our high-density products, these products will compete principally with products offered
by Spansion (AMD/Fujitsu), Atmel, Fujitsu, Hitachi, Intel, Mitsubishi, Samsung, SanDisk, Sharp
Electronics, STMicroelectronics and Toshiba, as well as any new entrants to the market.

In addition, we may in the future experience direct competition from our foundry partners. We
have licensed to our foundry partners the right to fabricate products based on our technology and
circuit design, and to sell such products worldwide, subject to our receipt of royalty payments.

Competition may also come from alternative technologies such as ferroelectric random access
memory devices, or FRAM, or other developing technologies.

Our markets are subject to rapid technological change and, therefore, our success depends on
our ability to develop and introduce new products.

The markets 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.

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To develop new products for our target markets, we must develop, gain access to and use leading
technologies in a cost-effective and timely manner and continue to expand our technical and design
expertise. In addition, we must have our products designed into our customers' future products and
maintain close working relationships with key customers in order to develop new products that meet
their changing needs.

In addition, products for communications applications are based on continually evolving industry
standards. Our ability to compete will depend on our ability to identify and ensure compliance with
these industry standards. As a result, we could be required to invest significant time and effort
and incur significant expense to redesign our products and ensure compliance with relevant
standards. We believe that products for these applications will encounter intense competition and be
highly price sensitive. While we are currently developing and introducing new products for these
applications, we cannot assure you that these products will reach the market on time, will
satisfactorily address customer needs, will be sold in high volume, or will be sold at profitable
margins.

We cannot assure you that we will be able to identify new product opportunities successfully,
develop and bring to market new products, achieve design wins or respond effectively to new
technological changes or product announcements by our competitors. In addition, we may not be
successful in developing or using new technologies or in developing new products or product
enhancements that achieve market acceptance. Our pursuit of necessary technological advances may
require substantial time and expense. Failure in any of these areas could harm our operating
results.

Our future success depends in part on the continued service of our key design engineering,
sales, marketing and executive personnel and our ability to identify, recruit and retain additional
personnel.

We are highly dependent on Bing Yeh, our President and Chief Executive Officer, as well as
the other principal members of our management team and engineering staff. There is intense
competition for qualified personnel in the semiconductor industry, in particular the highly skilled
design, applications and test engineers involved in the development of flash memory technology.
Competition is especially intense in Silicon Valley, where our corporate headquarters is located. We
may not be able to continue to attract and retain engineers or other qualified personnel necessary
for the development of our business or to replace engineers or other qualified personnel who may
leave our employ in the future. Our anticipated growth is expected to place increased demands on our
resources and will likely require the addition of new management and engineering personnel and the
development of additional expertise by existing management personnel. The failure to recruit and
retain key design engineers or other technical and management personnel could harm our business.

Our ability to compete successfully depends, in part, on our ability to protect our
intellectual property rights.

We rely on a combination of patent, trade secrets, copyrights, mask work rights,
nondisclosure agreements and other contractual provisions and technical measures to protect our
intellectual property rights. Policing unauthorized use of our products, however, is difficult,
especially in foreign countries. Litigation may continue to be necessary in the future to enforce
our intellectual property rights, to protect our trade secrets, to determine the validity and scope
of the proprietary rights of others, or to defend against claims of infringement or invalidity.
Litigation could result in substantial costs and diversion of resources and could harm our business,
operating results and financial condition regardless of the outcome of the litigation. We own 114
patents in the United States relating to our products and processes, with expiration dates ranging
from 2010 to 2023, and have filed for several more. In addition, we hold several patents in Europe
and Canada, and have filed several foreign patent applications in Europe, Japan, Korea, Taiwan and
Canada. We cannot assure you that any pending patent application will be granted. Our operating
results could be harmed by the failure to protect our intellectual property.

If we become engaged in securities class action suits and derivative suits, we may become
subject to consuming and costly litigation and divert management resources and could impact our
stock price.

Securities class action law suits are often brought against companies, particularly
technology companies, following periods of volatility in the market price of their securities.
Irrespective of the validity or the successful assertion of such claims, we could incur significant
costs and management resources in defending against such claims.

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In January and February 2005, multiple putative shareholder class action complaints were filed
against us and certain directors and officers in the United States District Court for the Northern
District of California, following our announcement of anticipated financial results for the fourth
quarter of 2004. The complaints seek unspecified damages on alleged violations of federal securities
laws during the period from March 22, 2004 to December 20, 2004. Consolidation and the appointment
of a lead plaintiff are currently pending in these purported class actions.

In January and February 2005, following the filing of the putative class action lawsuits,
multiple shareholder derivative complaints were filed in California Superior Court for the County of
Santa Clara, purportedly on behalf of SST against certain directors and officers. The factual
allegations of these complaints are substantially identical to those contained in the putative
shareholder class actions filed in federal court. The derivative complaints assert claims for, among
other things, breach of fiduciary duty and violations of the California Corporations Code.

Public announcements may hurt our stock price. During the course of lawsuits there may be
public announcements of the results of hearings, motions, and other interim proceedings or
developments in the litigation. If securities analysts or investors perceive these results to be
negative, it could harm the market price of our stock.

Our litigation may be expensive, may be protracted and confidential information may be
compromised. We have incurred certain costs associated with defending these matters, and at any
time, additional claims may be filed against us, which could increase the risk, expense and duration
of the litigation. Further, because of the amount of discovery required in connection with this type
of litigation, there is a risk that some of our confidential information could be compromised by
disclosure. For more information with respect to our litigation, please also see "Part I, Item 3 - Legal Proceedings."

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

Third parties may assert that our products infringe their proprietary rights, or may assert
claims for indemnification resulting from infringement claims against us. Any such claims may cause
us to delay or cancel shipment of our products or pay damages that could harm our business,
financial condition and results of operations. In addition, irrespective of the validity or the
successful assertion of such claims, we could incur significant costs in defending against such
claims.

In the past we were sued both by Atmel Corporation and Intel Corporation regarding patent
infringement issues and sued Winbond Electronics Corporation regarding our contractual relationship
with them. Significant management time and financial resources have been devoted to defending these
lawsuits. We settled with Intel in May 1999, with Winbond in October 2000, and the Atmel litigation
is ongoing.

In addition to the Atmel, Intel and Winbond actions, we receive from time to time, letters or
communications from other companies stating that such companies have patent rights that involve our
products. Since the design of all of our products is based on SuperFlash technology, any legal
finding that the use of our SuperFlash technology infringes the patent of another company would have
a significantly negative effect on our entire product line and operating results. Furthermore, if
such a finding were made, there can be no assurance that we could license the other company's
technology on commercially reasonable terms or that we could successfully operate without such
technology. Moreover, if we are found to infringe, we could be required to pay damages to the owner
of the protected technology and could be prohibited from making, using, selling, or importing into
the United States any products that infringe the protected technology. In addition, the management
attention consumed by and legal cost associated with any litigation could harm our operating
results.

Public announcements may hurt our stock price. During the course of lawsuits there may be
public announcements of the results of hearings, motions, and other interim proceedings or
developments in the litigation. If securities analysts or investors perceive these results to be
negative, it could harm the market price of our stock.

Our litigation may be expensive, may be protracted and confidential information may be
compromised. On April 8, 2002, a jury found that we willfully infringed Atmel's '811 and '829
patents, and awarded Atmel $20.0 million in actual damages. On May 7, 2002, the court entered
judgment in the total amount of $36.5 million, which includes the original $20.0 million. The '811
and '829 patents expired in February 2002. Therefore, we are not precluded from selling any of our
products. On December 12, 2003, we paid Atmel $37.8 million to satisfy the judgement plus statutory
interest accrued during the appeal. The `903 patent case still remains open. The court found that we

36

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infringed the `903 patent but the jury was unable to unanimously decide whether the `903 is valid
and a mistrial was declared. A settlement conference scheduled for April 14, 2004 was rescheduled
for September 7, 2004. No conclusion was reached during the settlement conference on September 7,
2004. A new trial date on the invalidity of the `903 patent has been scheduled for June 27, 2005. If
we are not successful in reaching a settlement, litigation may continue to consume substantial
amounts of our financial and managerial resources. We have incurred certain costs associated with
defending this matter, and at any time Atmel may file additional claims against us, which could
increase the risk, expense and duration of the litigation. Further, because of the substantial
amount of discovery required in connection with this type of litigation, there is a risk that some
of our confidential information could be compromised by disclosure. For more information with
respect to our litigation, please also see "Part I, Item 3- Legal Proceedings."

If an earthquake or other natural disaster strikes our manufacturing facility or those of our
suppliers, we would be unable to manufacture our products for a substantial amount of time and we
would experience lost revenues.

Our corporate headquarters are located in California near major earthquake faults.
In addition, some of our suppliers are located near fault lines.  In the event of a major earthquake
or other natural disaster near our headquarters, our operations could be harmed.  Similarly, a major
earthquake or other natural disaster such as typhoon near one or more of our major suppliers, like
the earthquakes in September 1999 and March 2002 or the typhoon in September 2001 that occurred in
Taiwan, could potentially disrupt the operations of those suppliers, which could then limit the
supply of our products and harm our business.

A virus or viral outbreak in Asia could harm our business.

We derive substantially all of our revenues from Asia and our logistics center is
located in Taiwan.  A virus or viral outbreak in Asia, such as the recent SARS outbreak in early
2003, could harm the operations of our suppliers, distributors, logistics center and those of our
end customer, which could harm our business.

Prolonged electrical power outages, energy shortages, or increased costs of
energy could harm our business.

Our design and process research and development facilities and our corporate offices are
located in California, which is susceptible to power outages and shortages as well as increased
energy costs. To limit this exposure, all corporate computer systems at our main California
facilities are on battery back-up. In addition, all of our engineering and back-up servers
and selected corporate servers are on generator back-up. While the majority of our
production facilities are not located in California, more extensive power shortages in the state
could delay our design and process research and development as well as increase our operating costs.

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

Our business has in the past experienced rapid growth which strained our internal systems and
future growth will require us to continuously develop sophisticated information management systems
in order to manage our business effectively. We recently implemented a supply-chain management
system and a vendor electronic data interface 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 a timely
manner other infrastructure needs before they arise. Our success depends on the ability of our
executive officers to effectively manage our growth. If we are unable to manage our growth
effectively, our results of operations will be harmed. If we fail to successfully implement new
management information systems, our business may suffer severe inefficiencies that may harm the
results of our operations.

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

A change in accounting standards or practices or a change in existing taxation rules
or practices can have a significant effect on our reported results and may even affect reporting of
transactions completed before the change is effective. New accounting pronouncements and taxation
rules and varying interpretations of accounting pronouncements and taxation practice have occurred
and may occur in the future. Changes to existing rules or the questioning of current practices may
adversely affect our reported financial results or the way we conduct our business.

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For example, changes requiring that we record compensation expense in
the statement of operations for stock options using the fair value method or any changes in existing
taxation rules related to stock options could have a significant negative effect on our reported
results. The FASB has issued changes to generally accepted accounting principles in the United
States that, when implemented the third quarter of 2005, will require us to record charges to
earnings for the stock options we grant.

Evolving regulation of corporate governance and public disclosure may result in additional
expenses and continuing uncertainty

Changing laws, regulations and standard relating to corporate governance and public
disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq National Market
rules are creating uncertainty for public companies. We continually evaluate and monitor
developments with respect to new and proposed rules and cannot predict or estimate the amount of the
additional costs we may incur or the timing of such costs. These new or changed laws, regulations
and standards are subject to varying interpretations, in many cases due to their lack of
specificity, and as a result, their application in practice may evolve over time as new guidance is
provided by regulatory and governing bodies. This could result in continuing uncertainty regarding
compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance
practices. We are committed to maintaining high standards of corporate governance and public
disclosure. As a result, we have invested resources to comply with evolving laws, regulations and
standards, and this investment may result in increased general and administrative expenses and a
diversion of management time and attention from revenue-generating activities to compliance
activities. If our efforts to comply with new or changed laws, regulations and standards differ from
the activities intended by regulatory or governing bodies due to ambiguities related to practice,
regulatory authorities may initiate legal proceedings against us and we may be harmed.

We, and our independent registered public accounting firm, have determined
that we have a material weakness in our internal controls over financial reporting. As a result,
current and potential stockholders could lose confidence in our financial reporting, which would
harm our business and the trading price of our stock.

Under Section 404 of the Sarbanes-Oxley Act of 2002, we are required to evaluate and
determine the effectiveness of our internal controls over financial reporting. We have dedicated a
significant amount of time and resources to ensure compliance with this legislation for the year
ended December 31, 2004 and will continue to do so for future fiscal periods. We may encounter
problems or delays in completing the review and evaluation, the implementation of improvements and
the receipt of a positive attestation, or any attestation at all, by our independent auditors.
Additionally, management's assessment of our internal controls over financial reporting may identify
deficiencies that need to be addressed in our internal controls over financial reporting or other
matters that may raise concerns for investors.

As of December 31, 2004, we did not maintain effective control over accounting for and
review of the valuation of inventory, the income tax provision and related balance sheet accounts
and licensing revenue because the company lacked a sufficient complement of personnel with a level
of accounting expertise that is commensurate with our financial reporting requirements.
Specifically, we lacked sufficient controls over the write down of inventory to its lower
of cost or market, accounting for complex licensing contracts with multiple elements, and processes
and procedures related to the determination and review of the quarterly and annual tax provisions in
accordance with generally accepted accounting principles in the United States. This control
deficiency resulted in an audit adjustment to the 2004 consolidated financial statements related to
the write-down of inventory to the lower of cost or market. Additionally, this deficiency could
result in a material misstatement to the annual or interim consolidated financial statements that
would not be prevented or detected. Accordingly, management has determined that this control
deficiency constitutes a material weakness. Because of this material weakness,
our management concluded that, as of December 31, 2004, we did not maintain effective internal
control over financial reporting based on those criteria. As a result, PricewaterhouseCoopers LLP,
has issued an adverse opinion with respect to our internal controls over financial reporting and
their report is included in this Form 10-K.

Should we, or our independent registered public accounting firm, determine in future fiscal
periods that we have additional material weaknesses in our internal controls over financial
reporting, the reliability of our financial reports may be impacted, and our results of operations
or financial condition may be harmed and the price of our common stock may decline.

Acquisitions could result in operating difficulties, dilution
and other harmful consequences.

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In September 2004 we acquired majority ownership in Emosyn and in November 2004 we acquired
substantially all of the assets of G-Plus. We expect to continue to evaluate and consider a wide
array of potential strategic transactions, including business combinations, acquisitions and
dispositions of businesses, technologies, services, products and other assets, including interests
in our existing subsidiaries and joint ventures. At any given time we may be engaged in discussions
or negotiations with respect to one or more of such transactions. Any of such transactions could be
material to our financial condition and results of operations. There is no assurance that any such
discussions or negotiations will result in the consummation of any transaction. The process of
integrating any acquired business may create unforeseen operating difficulties and expenditures and
is itself risky. The areas where we may face difficulties include:

- 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 platforms.

International acquisitions involve additional risks, including those related to integration of
operations across different cultures and languages, currency risks, and the particular economic,
political, and regulatory risks associated with specific countries. Moreover, we may not realize the
anticipated benefits of any or all of our acquisitions. As a result of future acquisitions or
mergers, we might need 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.

Risks Related to Our Industry

Our success is dependent on the growth and strength of the flash memory market.

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

The selling prices for our products are extremely volatile and have historically declined
during periods of over capacity or industry downturns.

The semiconductor industry has historically been cyclical, characterized by periodic changes
in business conditions caused by product supply and demand imbalance. When the industry experiences
downturns, they often occur in connection with, or in anticipation of, maturing product cycles and
declines in general economic conditions. These downturns are characterized by weak product demand,
excessive inventory and accelerated declines of average selling prices. In some cases, downturns,
such as the one we experienced from late 2000 through 2002, have lasted for more than a year. Our
business could be further harmed by industry-wide prolonged downturns in the future. The flash
memory products portion of the semiconductor industry, from which we derive substantially all of our
revenues, suffered from excess capacity in 2001, 2002, 2003 and in late 2004, which resulted in
greater than normal declines in our markets, which unfavorably impacted our revenues, gross margins
and profitability. While these conditions began to improve during the third quarter of 2003,
deteriorating market conditions at the end of 2000 through the first part 2003 and again in the
fourth quarter of 2004 have resulted in the decline of our selling prices and harmed our operating
results.

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There is seasonality in our business and if we fail to continue to introduce new products this
seasonality may become more pronounced.

Sales of our products in the consumer electronics applications market are subject to
seasonality. As a result, sales of these products are impacted by seasonal purchasing patterns with
higher sales generally occurring in the second half of each year. In the past we have been able to
mitigate such seasonality with the introduction of new products throughout the year. If we fail to
continue to introduce new products, our business may suffer and the seasonality of a portion of our
sales may become more pronounced.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to risks associated with foreign exchange rate fluctuations due to our
international manufacturing and sales activities. These exposures may change over time as business
practices evolve and could negatively impact our operating results and financial condition.
Currently, we do not hedge these foreign exchange rate exposures. All of our sales 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 expensive and therefore reduce the demand for our products. Such a decline in
the demand could reduce revenues and/or result in operating losses. In addition, a downturn in the
economies of China, Japan or Taiwan could impair the value of our equity investments in companies
with operations in these countries. If we consider the value of these companies to be impaired, we
will write off, or expense, some or all of our investments. In 2001, we wrote down our investment in
KYE by $3.3 million to $1.3 million due to an other than temporary decline in its market value. As
of December 31, 2004, the recorded value of our KYE investment was $2.3 million based on the quoted
market price. In the third quarter of 2002, we wrote down our investment in Apacer, a privately held
memory module manufacturer located in Taiwan, by $7.8 million due to an other than temporary decline
in its value. As of December 31, 2004, the recorded value of our Apacer investment was $4.4
million. During 2004, we wrote down our
investment in Insyde by $509 thousand because Insyde's stock price had declined below the
acquisition cost for more than six months. The impairment was considered to be "other-than-temporary"
in nature. In addition, we have equity investments in companies with operations in China,
Japan, Taiwan and United States with recorded values at December 31, 2004 of $86.9 million, $0.9
million, $16.6 million and $0.6 million, respectively.

At any time, fluctuations in interest rates could affect interest earnings on our cash, cash
equivalents and short-term investments, or the fair value of our investment portfolio. A 10% move in
interest rates as of December 31, 2004 would have an immaterial effect on our financial position,
results of operations and cash flows. Currently, we do not hedge these interest rate exposures. As
of December 31, 2004, the carrying value of our available-for-sale investments approximated fair
value. The table below presents the carrying value and related weighted average interest rates for
our unrestricted and restricted cash, cash equivalents and available-for-sale investments as of
December 31, 2004 (in thousands):

`Carrying     Interest
                                                                               Value        Rate
                                                                            -----------  -----------
Short-term available-for-sale investments - fixed rate.................... $    68,628          2.2%
Cash and cash equivalents - variable rate.................................      35,365          0.4%
                                                                            -----------
                                                                           $   103,993          1.6%
                                                                            ===========`

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Item 8. Consolidated Financial Statements and Supplementary Data

The consolidated financial statements are included in a separate section of this Annual
Report.

Supplementary Data: Selected Consolidated Quarterly Data

The following table presents our unaudited consolidated statements of operations data for
each of the eight quarters in the period ended December 31, 2004. In our opinion, this information
has been presented on the same basis as the audited consolidated financial statements included in a
separate section of this report, and all necessary adjustments, consisting only of normal recurring
adjustments, have been included in the amounts below to present fairly the unaudited quarterly
results when read in conjunction with the audited consolidated financial statements and related
notes. The operating results for any quarter should not be relied upon as necessarily indicative of
results for any future period. We expect our quarterly operating results to fluctuate in future
periods due to a variety of reasons, including those discussed in "Business Risks."

`Quarter Ended
                                        ------------------------------------------------------
                                         March 31,      June 30,    September 30, December 31,
                                            2004          2004          2004          2004
                                        ------------  ------------  ------------  ------------
                                                (in thousands, except per share data)
Net revenues:
    Product revenues.................. $     91,370  $    115,571  $    101,260  $     96,530
    License revenues..................       13,063        12,958        10,912         7,534
                                        ------------  ------------  ------------  ------------
      Total net revenues.............. $    104,433  $    128,529  $    112,172  $    104,064
Gross profit.......................... $     38,151  $     48,767  $     39,584  $        603
Income (loss) from operations......... $     15,421  $     23,396  $     14,752  $    (27,330)
Net income (loss)..................... $     14,233  $     22,099  $     14,522  $    (26,925)
Net income (loss) per share-basic..... $       0.15  $       0.23  $       0.15  $      (0.28)
Net income (loss) per share-diluted... $       0.14  $       0.22  $       0.15  $      (0.28)


                                                            Quarter Ended
                                        ------------------------------------------------------
                                         March 31,      June 30,    September 30, December 31,
                                            2003          2003          2003          2003
                                        ------------  ------------  ------------  ------------
                                                (in thousands, except per share data)
Net revenues:
    Product revenues.................. $     53,921  $     54,860  $     65,397  $     82,351
    License revenues..................        7,788         9,320         8,538        12,866
                                        ------------  ------------  ------------  ------------
      Total net revenues.............. $     61,709  $     64,180  $     73,935  $     95,217
Gross profit.......................... $      9,208  $     16,247  $     18,341  $     32,470
Income (loss) from operations......... $    (11,083) $     (3,739) $    (37,390) $     10,815
Net income (loss)..................... $    (10,665) $     (4,589) $    (59,018) $      9,105
Net income (loss) per share-basic..... $      (0.11) $      (0.05) $      (0.62) $       0.10
Net income (loss) per share-diluted... $      (0.11) $      (0.05) $      (0.62) $       0.09`

We recorded settlement fees of $36.5 million and interest of $1.3 million related to the Atmel
lawsuit in the third and fourth quarter of 2003, respectively. In the third quarter of 2003, we
recorded a full valuation of our deferred tax assets and associated adjustments to income tax
payable, resulting in a tax expense of $22.9 million.

We recorded an operating lease impairment of $1.5 million relating to an operating lease for an
abandoned building in the second quarter of 2004. We expensed the in-process research and
development resulting from the acquisitions of Emosyn and G-Plus in the amount of $1.7 million and
$4.2 million in the third and fourth quarters of 2004, respectively. We recorded a provision of
adverse purchase commitments of $2.6 million and $5.4 million in the third and fourth quarter,
respectively. In the fourth quarter of 2004, we recorded an $18.3 million valuation adjustment
against inventory for potentially excess and obsolete inventories and those inventories carried at
costs that are higher than their market values.

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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure

Not applicable.

Item 9A. Controls and Procedures

Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our reports filed or submitted pursuant to the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange Commission's rules and
forms. Disclosure controls and procedures also are designed to ensure that such information is
accumulated and communicated to our management, including our Chief Executive Officer and
Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. A
control system, no matter how well designed and operated, can provide only reasonable, not absolute,
assurance that the control system's objectives will be met.

Our management, including the Chief Executive Officer and Chief Financial Officer,
conducted an evaluation of the effectiveness of our disclosure controls and procedures (as
defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of December 31, 2004. Based upon the evaluation, the
Chief Executive Officer and the Chief Financial Officer concluded that due to the material weakness
described below, our disclosure controls and procedures were not effective at the
reasonable assurance level as of December 31, 2004.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal
controls over financial reporting during our fourth quarter that materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.

Management's Report in Internal Control over Financial Reporting

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

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

Our management has assessed the effectiveness of our internal control over
financial reporting as of December 31, 2004. In making its assessment of internal control over
financial reporting, our management used the criteria described in "Internal Control-Integrated
Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO).

A material weakness is a control deficiency or combination of control deficiencies, that results
in more than a remote likelihood that a material misstatement of the annual or interim financial
statements will not be prevented or detected. As of December 31, 2004, we did not maintain
effective control over accounting for and review of the valuation of inventory, the income tax
provision and related balance sheet accounts and licensing revenue because we lacked a
sufficient complement of personnel with a level of accounting expertise that is commensurate with
our financial reporting requirements. Specifically, we lacked sufficient controls
over the write down of inventory to its lower of cost or market, accounting for complex licensing
contracts with multiple elements, and processes and procedures related to the determination and
review of the quarterly and annual tax provisions in accordance with generally accepted accounting
principles in the United States. This control deficiency resulted in an audit adjustment to the 2004
consolidated financial statements related to the write-down of inventory to the lower of cost or
market. Additionally, this deficiency could result in a material misstatement to the annual or
interim consolidated financial statements that would not be prevented or detected. Accordingly,
management has determined that this control deficiency constitutes a material weakness. Because of
this material weakness, we have concluded that the Company did not maintain effective internal
control over financial reporting as of December 31, 2004 based on criteria in Internal
Control-Integrated Framework.

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Management has excluded Emosyn LLC ("Emosyn"), and SST Communications Corporation ("SCC"), from
its assessment of internal control over financial reporting as of December 31, 2004, because these
companies were acquired by us in purchase business combinations during 2004. Emosyn and SCC
are consolidated subsidiaries whose combined total assets and revenues represent 6.4% and 6.4%,
respectively, of the related consolidated financial statement amount as of and for the year ended
December 31, 2004.

Management's assessment of the effectiveness of the Company's internal control over financial
reporting as of December 31, 2004 has been audited by PricewaterhouseCoopers LLP, and independent
registered public accounting firm, as stated in their report which appears herein.

Remediation of Material Weakness

In response to the material weakness described above, we have recently hired new
senior accounting personnel and is in the process of hiring additional accounting and finance staff.
In addition, we intend to enhance its training programs for accounting and finance
personnel.

Item 9B. Other Information

On December 21, 2004, were notified by the Enforcement Office of the Securities and Exchange
Commission that it is conducting an informal inquiry regarding trading of shares of our common stock
prior to our December 20, 2004 announcement of updated guidance for our financial results for the
fourth quarter of 2004. The inquiry involves trading in shares of our common stock by an executive
officer, a director of SST and three employees. We are cooperating with the Enforcement Office.

43

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PART III

Item 10. Directors and Executive Officers of the Registrant

The information required by this item will be contained in our definitive Proxy Statement
with respect to our Annual Meeting of Shareholders under the captions "Election of Directors,"
"Security Ownership of Certain Beneficial Owners and Management - Compliance with the Reporting
Requirement of Section 16(a)," "Audit Committee," "Nominating and Corporate Governance Committee,"
and "Code of Conduct," and are incorporated by reference into this report. The information relating
to our executive officers is contained in Part I, Item 1 of this report.

Item 11. Executive Compensation

The information required by this item will be contained in our definitive Proxy Statement
with respect to our Annual Meeting of Shareholders under the caption "Compensation - Compensation of
Officers," and is incorporated by reference into this report.

Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Shareholder Matters

The information required by this item will be contained in our definitive Proxy Statement
with respect to our Annual Meeting of Shareholders under the captions "Security Ownership of Certain
Beneficial Owners and Management" and "Compensation - Equity Compensation Plan Information," and are
incorporated by reference into this report.

Item 13. Certain Relationships and Related Transactions

The information required by this item will be contained in our definitive Proxy Statement
with respect to our Annual Meeting of Shareholders under the caption "Certain Transactions," and is
incorporated by reference into this report. Please also see "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Related Party Transactions."

Item 14. Principal Accountant Fees and Services

The information required by this item will be contained in our definitive Proxy Statement
with respect to our Annual Meeting of Shareholders under the caption "Ratification of Selection of
Independent Registered Public Accounting Firm" and is incorporated by reference into this report.

44

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PART IV

Item 15. Exhibits and Financial Statement Schedule

(a) (1) Consolidated Financial Statements. The index to the consolidated financial statements
is found on page 49 of this Report.

(2) Financial Statement Schedule. Financial
statement schedule Number II is included.

(3) Exhibits. See Exhibit Index in part (b), below.

(b) Index to Exhibits.

|Exhibit Number | Description of Document                                                                                                                                                                                                
|-------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1 (1)        | Bylaws of Silicon Storage Technology, Inc., as amended.                                                                                                                                                                
|3.2 (2)        | Restated Articles of Incorporation of SST, dated November 3, 1995.                                                                                                                                                     
|3.3 (3)        | Certificate of Amendment of the Restated Articles of Incorporation
of SST, dated June 30, 2000.                                                                                                                        
|3.4 (4)        | Certificate of Designation of Series A Junior Participating
Preferred Stock.                                                                                                                                           
|4.1            | Reference is made to Exhibits 3.1 to 3.4.                                                                                                                                                                              
|4.2 (5)        | Specimen Stock Certificate of SST.                                                                                                                                                                                     
|4.3 (6)        | Rights Agreement between SST and American Stock Transfer and Trust
Co., dated May 4, 1999.                                                                                                                             
|4.4 (7)        | Amendment No. 1 to Rights Agreement between SST and American Stock
Transfer and Trust Co., dated October 28, 2000.                                                                                                     
|10.1 (8)       | Equity Incentive Plan and related agreements.                                                                                                                                                                          
|10.2 (9)       | Employee Stock Purchase Plan.                                                                                                                                                                                          
|10.3 (10)      | 1995 Non-Employee Director's Stock Option Plan.                                                                                                                                                                        
|10.4 (11)      | Profit Sharing Plan.                                                                                                                                                                                                   
|10.5 (12)      | Lease Agreement between SST and Sonora Court Properties, dated May
4, 1993, as amended.                                                                                                                                
|10.6 (13)      | Lease Agreement between SST and Coast Properties, dated May 4, 1995,
as amended.                                                                                                                                       
|10.8 (14)      | Lease amendment, dated March 4, 1998, between SST and Sonora Court
Properties.                                                                                                                                         
|10.9 (15)      | Lease Amendment, dated March 4, 1998, between SST and Coast
Properties.                                                                                                                                                
|10.11 (16)     | Second Amendment to Lease, dated September 13, 1999, between SST and
Coast Properties.                                                                                                                                 
|10.12 (17)     | Lease Agreement between SST and Bhupinder S. Lehga and Rupinder K.
Lehga, dated November 15, 1999.                                                                                                                     
|10.13 (18)     | Lease Agreement between SST and The Irvine Company, dated November
22, 1999.                                                                                                                                           
|10.14 (19)     | Sunnyvale Industrials Net Lease Agreement, dated June 26, 2000.                                                                                                                                                        
|21.1           | Subsidiaries of SST.                                                                                                                                                                                                   
|23.1           | Consent of PricewaterhouseCoopers LLP, Independent Registered Public
Accounting Firm.                                                                                                                                  
|24.1           | Power of Attorney is contained on the signature page.                                                                                                                                                                  
|31.1           | Certification required by Rule 13a-14(a).                                                                                                                                                                              
|31.2           | Certification required by Rule 13a-4(a).                                                                                                                                                                               
|32.1           | Certification of President and Chief Executive Officer, as required
by Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C.
1350).*                                          
|32.2           | Certification of Vice President Finance & Administration, Chief
Financial Officer and Secretary, as required by Rule 13a- 14(b) and Section 1350 of Chapter 63 of
Title 18 of the United States Code (18 U.S.C. 1350).*

* The certifications attached as Exhibit 32.1 and Exhibit 32.2
accompany the Annual Report on Form 10-K, are not deemed filed with the Securities and Exchange
Commission and are not to be incorporated by reference into any filing of the Company 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-K), irrespective of any general incorporation language
contained in such filing.

________

1. Filed as Exhibit 3.1 to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2004,
filed August 5, 2004 and incorporated by reference herein.
2. Filed as Exhibit 3.4 to our Registration Statement on Form S-1, as amended, File No. 33-97802,
filed on October 5, 1995, and incorporated by reference herein.
3. Filed as Exhibit 3.5 to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2000,
filed on August 7, 2000, and incorporated by reference herein.
4. Filed as Exhibit 99.3 to our Current Report on Form 8-K filed on May 18, 1999, and incorporated
by reference herein.
5. Filed as Exhibit 4.2 to our Registration Statement on Form S-1, as amended, File No. 33-97802,
filed on November 3, 1995, and incorporated by reference herein.
6. Filed as Exhibit 99.2 to our Current Report on Form 8-K filed on May 18, 1999, and incorporated
by reference herein.
7. Filed as Exhibit 3.6 to our Annual Report on Form 10-K for the year ended December 31, 2000, as
amended, filed on March 30, 2001, and incorporated by reference herein.
8. Filed as amended as Exhibit 99.1 to our Registration Statement on Form S-8, File No. 333-98135,
filed on August 15, 2002, and incorporated by reference herein.
9. Filed as amended as Exhibit 99.2 to our Registration Statement on Form S-8, File No. 33-33130,
filed on March 23, 2000, and incorporated by reference herein.
10. Filed as amended as Exhibit 99.2 to our Registration Statement on Form S-8 File No. 33-98135,
filed on August 15, 2002, and incorporated by reference herein.
11. Filed as Exhibit 10.5 to our Registration Statement on Form S-1, as amended, File No. 33-97802,
filed on October 5, 1995, and incorporated by reference herein.
12. Filed as Exhibit 10.6 to our Registration Statement on Form S-1, as amended, File No. 33-97802,
filed on October 5, 1995, and incorporated by reference herein.
13. Filed as Exhibit 10.7 to our Registration Statement on Form S-1, as amended, File No. 33-97802,
filed on October 5, 1995, and incorporated by reference herein.
14. Filed as Exhibit 10.17 to our Quarterly Report on Form 10-Q for the quarter ended June 30, 1998,
filed on August 14, 1998, and incorporated by reference herein.
15. Filed as Exhibit 10.18 to our Quarterly Report on Form 10-Q for the quarter ended June 30, 1998,
filed on August 14, 1998, and incorporated by reference herein.
16. Filed as Exhibit 10.23 to our Annual Report on Form 10-K for the year ended December 31, 1999,
as amended, filed on February 24, 2000, and incorporated by reference herein.
17. Filed as Exhibit 10.24 to our Annual Report on Form 10-K for the year ended December 31, 1999,
as amended, filed on February 24, 2000, and incorporated by reference herein.
18. Filed as Exhibit 10.25 to our Annual Report on Form 10-K for the year ended December 31, 1999,
as amended, filed on February 24, 2000, and incorporated by reference herein.
19. Filed as Exhibit 10.28 to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2000,
filed on August 7, 2000, and incorporated by reference herein.

47

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Sunnyvale, County of Santa Clara, State of California, on the 31st
day of March, 2005.

| |                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------
| | SILICON STORAGE TECHNOLOGY, INC.
By: /s/ BING YEH 
Bing Yeh
President and Chief Executive Officer
(Principal Executive Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the Registrant and in the capacities and on
the dates indicated.

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints Bing Yeh and Jack K. Lai, and each or any one of them, his true and lawful
attorney-in-fact and agent, with full power of substitution and re-substitution, for him and in his
name, place and stead, in any and all capacities, to sign any and all amendments to this report, and
to file the same, with all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of
them, full power and authority to do and perform each and every act and thing requisite and
necessary to be done in connection therewith, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or
any of them, or their or his substitutes or substitute, may lawfully do or cause to be done by
virtue hereof.

|Signature                               | Title                                                                                                                       | Date          
|--------------------------------------- | --------------------------------------------------------------------------------------------------------------------------- | --------------
|/s/ BING YEH
Bing Yeh                   | President, Chief Executive Officer and Director (Principal Executive Officer)                                               | March 31, 2005
|/s/ JACK K. LAI
Jack K. Lai             | Vice President Finance & Administration, Chief Financial Officer and Secretary
(Principal Financial and Accounting Officer) | March 31, 2005
|/s/ YAW WEN HU
Yaw Wen Hu               | Director                                                                                                                    | March 31, 2005
|/s/ TSUYOSHI TAIRA
Tsuyoshi Taira       | Director                                                                                                                    | March 31, 2005
|/s/ RONALD CHWANG
Ronald Chwang         | Director                                                                                                                    | March 31, 2005
|/s/ YASUSHI CHIKAGAMI
Yasushi Chikagami | Director                                                                                                                    | March 31, 2005

48

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SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|Item                                                                            | Page
|------------------------------------------------------------------------------- | ----
|Report of Independent Registered Public Accounting
Firm                         | 50  
|Consolidated Balance Sheets                                                     | 52  
|Consolidated Statements of Operations                                           | 53  
|Consolidated Statements of Shareholders' Equity
and Comprehensive Income (Loss) | 54  
|Consolidated Statements of Cash
Flows                                           | 55  
|Notes to Consolidated Financial
Statements                                      | 56  
|Schedule II                                                                     | 82  

49

---



Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of
Silicon Storage Technology, Inc.

We have completed an integrated audit of Silicon Storage
Technology, Inc.'s 2004 consolidated financial statements and of its internal control over financial
reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated financial
statements in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Our opinions, based on our audits, are presented below.

Consolidated financial statements and financial statement schedule

In our opinion, the consolidated financial statements listed in
the index appearing under Item 15 (a) (1) present fairly, in all material respects, the
financial position of Silicon Storage Technology, Inc. and its subsidiaries at December 31,
2004 and 2003, and the results of their operations and their cash flows for each of the three years
in the period ended December 31, 2004 in conformity with accounting principles generally
accepted in the United States of America. In addition, in our opinion, the financial statement
schedule listed in the index appearing under Item 15 (a) (2) presents fairly, in all
material respects, the information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial statement schedule are
the responsibility of the Company's management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits. We conducted our audits
of these statements in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit of financial statements includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.

Internal control over financial reporting

Also, we have audited management's assessment, included in
Management's Report on Internal Control over Financial Reporting appearing under Item 9A, that
Silicon Storage Technology, Inc. did not maintain effective internal control over financial
reporting as of December 31, 2004, because

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

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

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

A material weakness is a control deficiency, or combination of
control deficiencies, that results in more than a remote likelihood that a material misstatement of
the annual or interim financial statements will not be prevented or detected.

As described in Management's Report on Internal Control over Financial Reporting , management has
excluded Emosyn LLC ("Emosyn") and SST Communications Corporation ("SCC") from its assessment of
internal control over financial reporting as of December 31, 2004 because these companies were
acquired by the Company in purchase business combinations during 2004. We have also excluded Emosyn
and SCC from our audit of internal control over financial reporting. Emosyn and SCC are consolidated
subsidiaries whose combined total assets and revenues represent 6.4% and 6.4%, respectively, of the
related consolidated financial statement amount as of and for the year ended December 31, 2004.

In our opinion, management's assessment that Silicon Storage
Technology, Inc. did not maintain effective internal control over financial reporting as of
December 31, 2004, is fairly stated, in all material respects, based on criteria established in
Internal Control - Integrated Framework issued by the COSO. Also, in our opinion, because of
the effect of the material weakness described above on the achievement of the objectives of the
control criteria, Silicon Storage Technology, Inc. has not maintained effective internal control
over financial reporting as of December 31, 2004, based on criteria established in Internal
Control - Integrated Framework issued by the COSO.

/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
San Jose, California
March 31, 2005

51

---



SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS

                                 (in thousands)

`December 31,
                                                                      --------------------
                                                                        2003       2004
                                                                      ---------  ---------
                               ASSETS
Current assets:
    Cash and cash equivalents....................................... $  84,250  $  35,365
    Short-term available-for-sale investments.......................   100,944     68,628
    Trade accounts receivable-unrelated parties, net of allowance
      for doubtful accounts of $1,118 as of December 31, 2003 and
      $1,189 as of December 31, 2004................................    14,110     25,206
    Trade accounts receivable-related parties.......................    41,220     32,973
    Inventories, net................................................    46,120    156,618
    Other current assets............................................    13,232     16,049
                                                                      ---------  ---------
       Total current assets.........................................   299,876    334,839
Property and equipment, net.........................................    11,325     16,620
Equity investment, GSMC.............................................    50,000     83,150
Equity investments, other...........................................     8,077     15,413
Long-term available-for-sale investments............................    24,969     23,094
Goodwill............................................................        --     15,600
Intangible assets, net..............................................        --      9,767
Other assets........................................................     2,114      3,848
                                                                      ---------  ---------
           Total assets............................................. $ 396,361  $ 502,331
                                                                      =========  =========

                            LIABILITIES
Current liabilities:
    Notes payable, current portion.................................. $     393  $     705
    Trade accounts payable-unrelated parties........................    36,773     53,273
    Trade accounts payable-related parties..........................    10,734     35,882
    Accrued expenses and other liabilities..........................    11,911     30,593
    Deferred revenue................................................     3,630      2,388
                                                                      ---------  ---------
       Total current liabilities....................................    63,441    122,841
Other liabilities...................................................     1,423      1,307
Minority interest...................................................        --      2,199
                                                                      ---------  ---------
       Total liabilities............................................    64,864    126,347
                                                                      ---------  ---------
Commitments (Note 4) and Contingencies (Note 5).

                        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
    Issued and outstanding: 95,328 shares in 2003
    and 97,358 shares in 2004.......................................   345,384    358,578
Accumulated other comprehensive income..............................     9,178     16,542
Retained earnings (accumulated deficit).............................   (23,065)       864
                                                                      ---------  ---------
       Total shareholders' equity...................................   331,497    375,984
                                                                      ---------  ---------
           Total liabilities and shareholders' equity............... $ 396,361  $ 502,331
                                                                      =========  =========`

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

52

---



SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                      (in thousands, except per share data)

`Year Ended December 31,
                                                                 -------------------------------
                                                                   2002       2003       2004
                                                                 ---------  ---------  ---------
Net revenues:
    Product revenues - unrelated parties....................... $ 100,620  $  86,549  $ 180,234
    Product revenues - related parties.........................   143,401    169,980    224,497
    License revenues - unrelated parties.......................    30,637     38,512     44,311
    License revenues - related parties.........................        --         --        156
                                                                 ---------  ---------  ---------
         Total net revenues....................................   274,658    295,041    449,198
Cost of revenues:
    Cost of revenues - unrelated parties.......................    85,707     73,398    135,331
    Cost of revenues - related parties.........................   120,539    145,377    186,762
                                                                 ---------  ---------  ---------
         Total cost of revenues................................   206,246    218,775    322,093
                                                                 ---------  ---------  ---------
Gross profit...................................................    68,412     76,266    127,105
                                                                 ---------  ---------  ---------
Operating expenses:
    Research and development...................................    47,069     43,144     46,904
    Sales and marketing........................................    25,498     22,272     28,295
    General and administrative.................................    17,097     14,398     18,292
    Other (Note 5 and Note 12).................................        --     37,849      7,375
                                                                 ---------  ---------  ---------
         Total operating expenses..............................    89,664    117,663    100,866
                                                                 ---------  ---------  ---------
Income (loss) from operations..................................   (21,252)   (41,397)    26,239
Interest and other income......................................     3,225      2,996      2,295
Interest and other expense.....................................      (242)      (350)      (281)
Impairment of equity investments...............................    (7,757)        --       (509)
                                                                 ---------  ---------  ---------
Income (loss) before provision for (benefit from)
    income taxes and minority interest.........................   (26,026)   (38,751)    27,744
Provision for (benefit from) income taxes......................   (10,931)    26,416      3,906
Minority interest..............................................        --         --        (91)
                                                                 ---------  ---------  ---------
         Net income (loss)..................................... $ (15,095) $ (65,167) $  23,929
                                                                 =========  =========  =========

Net income (loss) per share - basic............................ $   (0.16) $   (0.69) $    0.25
                                                                 =========  =========  =========

Shares used in per share calculation - basic...................    92,667     94,723     95,756
                                                                 =========  =========  =========

Net income (loss) per share - diluted.......................... $   (0.16) $   (0.69) $    0.24
                                                                 =========  =========  =========

Shares used in per share calculation - diluted.................    92,667     94,723     99,143
                                                                 =========  =========  =========`

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

53

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SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES

 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)
                                 (in thousands)

`Retained     Accumulated
                                       Common Stock        Earnings        Other
                                   --------------------  (Accumulated  Comprehensive
                                    Shares     Amount      Deficit)        Income        Total
                                   ---------  ---------  ------------  --------------  ---------
Balances, December 31, 2001.......   91,585  $ 333,989  $     57,197  $          225  $ 391,411
    Issuance of shares of
       common stock under
       employee stock
       purchase and
       option plans...............    1,710      4,076            --              --      4,076
    Tax benefit from exercise
       of stock options...........       --      1,533            --              --      1,533
    Net loss......................       --         --       (15,095)             --
    Unrealized loss on
       available for sale
       securities, net of tax.....       --         --            --             (74)
    Comprehensive loss............       --         --            --              --    (15,169)
                                   ---------  ---------  ------------  --------------  ---------
Balances, December 31, 2002.......   93,295    339,598        42,102             151    381,851
    Issuance of shares of
       common stock under
       employee stock
       purchase and
       option plans...............    2,033      4,535            --              --      4,535
    Tax benefit from exercise
       of stock options...........       --      1,251            --              --      1,251
    Net loss......................       --         --       (65,167)             --
    Unrealized gain on
       available for sale
       securities.................       --         --            --           9,027
    Comprehensive loss............       --         --            --              --    (56,140)
                                   ---------  ---------  ------------  --------------  ---------
Balances, December 31, 2003.......   95,328    345,384       (23,065)          9,178    331,497
    Repurchase of shares of
       common stock...............   (2,574)   (14,853)                                 (14,853)
    Issuance of shares of
       common stock for
       acquisition of G-Plus, Inc.    3,030     22,074                                   22,074
    Issuance of shares of
       common stock under
       employee stock
       purchase and
       option plans...............    1,574      5,545            --              --      5,545
    Tax benefit from exercise
       of stock options...........       --        428            --              --        428
    Net income....................       --         --        23,929              --
    Unrealized gain on
       available for sale
       securities.................       --         --            --           7,337
    Cumulative translation adjustm       --         --            --              27
    Comprehensive income..........       --         --            --              --     31,293
                                   ---------  ---------  ------------  --------------  ---------
Balances, December 31, 2004.......   97,358  $ 358,578  $        864  $       16,542  $ 375,984
                                   =========  =========  ============  ==============  =========`

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

54

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SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)

`Year Ended December 31,
                                                                    -------------------------------
                                                                      2002       2003       2004
                                                                    ---------  ---------  ---------
Cash flows from operating activities:
      Net income (loss)........................................... $ (15,095) $ (65,167) $  23,929
      Adjustments to reconcile net income (loss) to net cash
         provided by (used in) operating activities:
      Depreciation and amortization...............................     9,847      7,696      7,445
      Purchased in-process research and development...............        --         --      5,896
      Operating lease impairment..................................        --         --      1,479
      Provision for doubtful accounts receivable..................     3,046        228        825
      Provision for sales returns ................................     2,842        316      1,347
      Provision for excess and obsolete inventories, write down
         of inventory to market and adverse purchase commitments..    10,441      6,670     35,883
      Deferred income taxes.......................................     7,036     22,318         --
      (Gain) loss on disposition of equipment.....................       (92)       114        (33)
      Gain on sale of equity investments..........................        --       (649)        --
      Loss in equity interest.....................................        --         --         93
      Impairment of equity investments............................     7,757         --        509
      Tax benefit from employee stock plans.......................     1,533      1,251        428
      Minority interest...........................................        --         --        (91)
      Changes in operating assets and liabilities:
           Trade accounts receivable from unrelated parties.......     3,263     (3,931)    (7,113)
           Trade accounts receivable from related parties.........    (4,452)   (15,972)     8,080
           Inventories............................................    16,024     29,507   (133,622)
           Other current and noncurrent assets....................   (21,269)    18,318     (3,045)
           Trade accounts payable to unrelated parties............     4,310      8,365     12,422
           Trade accounts payable to related parties..............      (564)     4,045     25,354
           Accrued expenses and other liabilities.................     1,588     (6,535)     7,464
           Deferred revenue.......................................    (2,849)       980     (1,242)
                                                                    ---------  ---------  ---------
            Net cash provided by (used in) operating activities...    23,366      7,554    (13,992)
                                                                    ---------  ---------  ---------
Cash flows from investing activities:
      Acquisitions, net of cash...................................        --         --    (18,443)
      Acquisition of property and equipment.......................    (4,315)    (1,806)    (8,042)
      Proceeds from sale of equipment.............................       118         --         33
      Purchases of available-for-sale investments and
         restricted cash..........................................   (81,262)   (72,659)   (47,590)
      Sales and maturities of available-for-sale investments......    28,626     84,645     91,869
      Investment in equity securities.............................    (1,660)        --    (43,839)
                                                                    ---------  ---------  ---------
            Net cash provided by (used in) investing activities...   (58,493)    10,180    (26,012)
                                                                    ---------  ---------  ---------
Cash flows from financing activities:
      Repayments of notes payable.................................      (316)      (250)      (393)
      Issuance of shares of common stock..........................     4,076      4,535      5,545
      Repurchase of common stock..................................        --         --    (14,853)
      Minority interest: capital contrinution.....................        --         --        820
                                                                    ---------  ---------  ---------
            Net cash provided by (used in) financing activities...     3,760      4,285     (8,881)
                                                                    ---------  ---------  ---------
Net increase (decrease) in cash and cash equivalents..............   (31,367)    22,019    (48,885)
Cash and cash equivalents at beginning of year....................    93,598     62,231     84,250
                                                                    ---------  ---------  ---------
Cash and cash equivalents at end of year.......................... $  62,231  $  84,250  $  35,365
                                                                    =========  =========  =========
Supplemental disclosure of cash flow information:
Cash received for interest........................................ $   3,449  $   2,813  $   2,146
Cash paid for interest............................................ $     221  $     127  $      82
Net cash paid for (received from) income taxes.................... $  (3,189) $  (8,224) $   2,798
Common stock issued in connection with acquisitions............... $      --  $      --  $  22,074

During the year ended December 31, 2004, we issued approximately 3.0 million shares of common stock
with the acquisition of G-Plus.  No shares of common stock were issued in connection with the acquistion of Emosys.`

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

55

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SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES
                                NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

1. Nature of Operations and Summary of Significant Accounting Policies:

Nature of Operations:

Silicon Storage Technology, Inc. ("SST" or "us" or "we") supplies flash memory
semiconductor devices for digital consumer, networking, wireless communications and Internet
computing markets. Flash memory is nonvolatile memory that does not lose data when the power source
is removed and is capable of electronically erasing selected blocks of data. We license our
SuperFlash technology to other companies for non-competing applications. Our products are used in
personal computers, personal computer peripheral devices, consumer electronics and communications
devices. Our products are sold to manufacturers located primarily in Asia.

Use of Estimates in Preparation of the Financial Statements:

The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires us to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those estimates.

Risks, Uncertainties and Concentrations:

Our sales are concentrated in the nonvolatile memory class of the semiconductor memory
industry, which is highly competitive and rapidly changing. Significant technological changes in the
industry, changes in customer requirements, changes in product costs and selling prices, or the
emergence of competitor products with new capabilities or technologies could affect our operating
results adversely. We currently buy all wafers and die, an integral component of our products, from
outside suppliers and we are dependent on third party subcontractors to assemble and test our
products. Failure by these suppliers to satisfy our requirements on a timely basis at competitive
prices could cause us to suffer manufacturing delays, a possible loss of revenues, or higher than
anticipated costs of revenues, any of which could severely adversely affect operating results.

We have been increasing our out-sourcing activities for our end customer service logistics to
support our customers. Currently Silicon Professional Technology Ltd., or SPT, supports our
customers in Taiwan, China and other Southeast Asia countries. SPT provides planning, warehousing,
delivery, billing, collection and other logistic functions for us in these regions. SPT is a
wholly-owned subsidiary of one of our stocking representatives in Taiwan, Professional Computer Technology
Limited, or PCT. Products shipped to SPT are accounted for as our inventory held at our logistics
center, and revenue is recognized when the products have been delivered and are considered as a sale
to our end customers by SPT. For the years ended December 31, 2002, 2003 and 2004, SPT serviced end
customer sales accounting for 57.4%, 64.2% and 52.9%, respectively, of our net product revenues
recognized. Further description of our relationships with PCT and SPT are in Note 16 of these Notes
to the Consolidated Financial Statements.

We ship products to, and have accounts receivable from, original equipment manufacturers, or
OEMs, original design manufacturers, or ODMs, contract electronic manufacturers, or 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 logistics center, to our top three stocking representatives for
reshipment accounted for 16.9%, 29.9% and 34.0% of our product shipments in 2002, 2003 and 2004,
respectively. In addition, the same three stocking representatives solicited sales, for which they
received a commission, for 41.3%, 32.8% and 25.1% of our shipments to end users in 2002, 2003 and
2004, respectively. Our stocking representatives and distributors could discontinue their
relationship with us or discontinue selling our products at any time. The loss of our relationship
with any of our stocking representatives or distributors could harm our operating results by
impairing our ability to sell our products to our end customers. Our logistics center, SPT, may
cease providing services to us at any time. If SPT were to terminate their relationship with us we
would experience a delay in reestablishing warehousing, logistics and distribution functions, which
could impair our ability to collect accounts receivable from SPT and may harm our business.

We derived 88.5%, 90.0% and 86.0% of our net product revenues from Asia during 2002, 2003 and
2004, respectively.

56

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In addition, substantially all of our wafer suppliers and packaging and testing subcontractors
are located in Asia. Any kind of economic, political or environmental instability in this region of
the world can have a severe negative impact on our operating results due to the large concentration
of our production and sales activities in this region.

Our revenues may be impacted by our ability to obtain adequate wafer supplies from our foundries.
The foundries with which we currently have arrangements, together with any additional foundry at
which capacity might be obtained, may not be willing or able to satisfy all of our manufacturing
requirements on a timely basis at favorable prices. In addition, we have encountered delays in
qualifying new products and in ramping-up new product production and we could experience these
delays in the future. We are also subject to the risks of service disruptions, raw material
shortages and priceincreases by our foundries. Such disruptions, shortages and price
increases could harm our operating results.

We depend on independent subcontractors to assemble and test our products. Our reliance on these
subcontractors involves the following significant risks:

- reduced control over delivery schedules and quality;
- the potential lack of adequate capacity during periods of strong demand;
- difficulties selecting and integrating new subcontractors;
- limited warranties on products supplied to us;
- potential increases in prices due to capacity shortages and other factors; and
- potential misappropriation of our intellectual property.

These risks may lead to increased costs, delayed product delivery or loss of competitive
advantage, which would harm our profitability and customer relationships.

It should be noted that we may be greatly impacted by the political, economic and military
conditions in Taiwan. Taiwan and China are continuously engaged in political disputes and both
countries continue to conduct military exercises in or near the other's territorial waters and
airspace. Such disputes may continue and even escalate, resulting in an economic embargo, a
disruption in shipping or even military hostilities. This could severely harm our business by
interrupting or delaying production or shipment of our product. Any kind of activity of this nature
or even rumors of such activity could severely and negatively impact our operations, revenues,
operating results, and stock price.

Our corporate headquarters are located in California near major earthquake faults. In addition,
some of our suppliers are located near fault lines. In the event of a major earthquake or other
natural disaster near our headquarters, our operations could be harmed. Similarly, a major
earthquake or other natural disaster, such as a typhoon, near one or more of our major suppliers,
like the earthquakes in September 1999 and March 2002 or the typhoon in September 2001 that occurred
in Taiwan, could potentially disrupt the operations of those suppliers, which could then limit the
supply of our products and harm our business.

Basis of Consolidation:

The consolidated financial statements include the accounts of SST and our wholly-owned
and majority-owned subsidiaries after elimination of inter-company balances and transactions. The
functional currency of SST and all its subsidiaries, except SST China, is the United States dollar.
The functional currency of SST China is the Chinese Yuan.

Foreign Currency Transactions:

Monetary accounts maintained in currencies other than the United States dollar are
re-measured using the foreign exchange rate at the balance sheet date. Operational accounts and
non-monetary balance sheet accounts are measured and recorded at the rate in effect at the date of the
transactions. The effects of foreign currency re-measurement are reported in current operations. The
effect of foreign currency re-measurement was not significant in fiscal years 2002, 2003 or
2004.

57

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Financial Instruments:

Cash equivalents are highly liquid investments with original or remaining maturities of
three months or less as of the dates of purchase. Highly liquid investments included in cash
equivalents are classified as available-for-sale and are carried at cost, which approximates fair
value. Cash equivalents present insignificant risk of changes in value because of interest rate
changes. We maintain substantially all of our cash balances with three major financial and/or
brokerage institutions domiciled in the United States and we have not experienced any material
losses relating to these investment instruments.

Short and long-term investments, which are comprised of federal, state and municipal government
obligations, foreign and public corporate debt securities and listed equity securities, are
classified as available-for-sale and carried at fair value, based on quoted market prices, with the
unrealized gains or losses, net of tax, reported in Shareholders' Equity as Other Comprehensive
Income. The cost of debt securities is adjusted for amortization of premiums and accretion of
discounts to maturity, both of which are included in interest income. Realized gains and losses are
recorded on the specific identification method. Realized gains in 2003 were $649 thousand. Realized
gains and losses were not material in 2002 and 2004.

The carrying amounts reported for cash and cash equivalents, accounts receivable, accounts
payable and accrued expenses are considered to approximate fair values based upon the short
maturities of those financial instruments. The fair value of available-for-sale investments is in
Note 2 of these Notes to the Consolidated Financial Statements.

Financial instruments that potentially subject us to concentrations of credit risks comprise,
principally, cash, cash equivalents, investments and trade accounts receivable. We invest our excess
cash in accordance with our investment policy, which has been approved by our Board of Directors and
reviewed periodically. We perform credit evaluations of new customers and require those without
positive, established histories to pay in advance, upon delivery or through letters of credit.
Otherwise, we do not require collateral of our customers, and maintain allowances for potential
credit losses. As of December 31, 2003 and 2004, SPT represented 73.4% and 55.1% of our net accounts
receivable, respectively.

We have acquired interests in Japanese and Taiwanese companies and a Cayman Islands company
operating in China. See Note 16 of these Notes to the Consolidated Financial Statements. Some of
these companies are privately held and it was not practicable to estimate the fair value of the
investments in the issued and untraded common stock. Investments in privately held companies are
included in "Equity investments" in the balance sheet and are carried at cost. When a decline in
value is other than temporary the cost basis of the securities are reduced to their estimated fair
value. Some of the Taiwanese companies are public companies and their stock is traded on the Taiwan
Stock Exchange. Three of these companies completed initial public offerings in Taiwan during 2003.
Under Taiwan security regulations, a certain number of shares must be held in central custody
subsequent to an initial public offering and are restricted from sale for a period of time. Shares
required to be held in custody for greater than a one year period are carried at cost and recorded
as equity investments. The unrestricted shares and the shares available for sale within one year
from the balance sheet date are carried at quoted market price and included in long-term available
for sale investments, with unrealized gains and losses reported as a separate component of
shareholders' equity. If a loss is other than temporary, it is reported as an "Impairment of equity
investments." See Note 13 of these Notes to the Consolidated Financial Statements. Cash dividends
and other distributions of earnings from the investees, if any, are included in other income when
declared.

Accounts Receivable

The allowance for doubtful accounts is based on an assessment of the collectibility of
customer accounts. We review the allowance by considering factors such as historical experience,
credit quality, age of the accounts receivable balances, and current economic conditions that may
affect a customer's ability to pay.

Inventories:

Inventories are stated at the lower of cost (determined on a first-in, first-out basis)
or market value. We typically plan our production and inventory levels based on internal forecasts
of customer demand, which are highly unpredictable and can fluctuate substantially. The value of our
inventory is dependent on our estimate of future average selling prices, and, if our projected
average selling prices are not realized, we may be required to adjust our inventory value to reflect
the lower of cost or market. Due to the large number of units in our inventory, even a small change
in average selling prices could result in a significant adjustment and have a significant impact on
our financial position and results of operations. Our inventories include high technology parts and
components that are specialized in nature or subject to rapid technological obsolescence. Some of
our customers have requested that we ship them product that has a finished goods date of manufacture
that is less than one year old. In the event that this becomes a common requirement, it may be
necessary for us to provide for an additional allowance for our on hand finished goods inventory

58

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with a date of manufacture of greater than one year old, which could result in a significant
adjustment and could harm our financial results. We review on-hand inventory including inventory
held at the logistic center for potential excess, obsolete and lower of cost or market exposure and
adjust the level of inventory reserve accordingly. Our allowance for excess and obsolete inventories
includes an allowance for our on hand finished goods inventory with a date of manufacture of greater
than two years old and for certain products with a date of manufacture of greater than one year old.
For the obsolete inventory analysis, we review inventory items in detail and consider date code,
customer base requirements, known product defects, planned or recent product revisions, end of life
plans and diminished market demand. While we have programs to minimize the required inventories on
hand and we consider technological obsolescence when estimating allowances for potentially excess
and obsolete inventories and those required to reduce recorded amounts to market values, it is
reasonably possible that such estimates could change in the near term. Such changes in estimates
could have a significant impact on our financial position and results of operations.

Inventory valuation adjustments to cost of sales and adverse purchase commitments amounted to
$10.4 million in 2002, $6.7 million in 2003 and $35.9 million in 2004. In 2002, 2003 and 2004, $5.9
million, $3.3 million and $29.2 million, respectively, of the adjustment related to lower of cost or
market with the balance due to excess or obsolete inventory.

Property and Equipment:

Property and equipment are stated at cost and depreciated using the straight-line method
over estimated useful lives of three to seven years, except for building for which the useful life
is forty years. See Note 3 of these Notes to the Consolidated Financial Statements.

Goodwill and Intangible Assets:

Goodwill and intangibles were acquired in acquisitions in 2004. Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets", or SFAS 142, requires goodwill
to be tested for impairment on an annual basis and between annual tests in certain circumstances,
and written down when impaired. No impairment of goodwill has been identified since the date of
acquisition. Furthermore, SFAS 142 requires purchased intangible assets other than goodwill to be
amortized over their useful lives unless these lives are determined to be indefinite. Purchased
intangible assets are carried at cost less accumulated amortization. Amortization is computed using
the straight-line method over the estimated useful lives of one to five years. No impairment of
intangibles has been identified since the date of acquisition.

Long-Lived Assets:

Long-lived assets include property and equipment, equity investments and intangible
assets. Whenever events or changes in circumstances indicate that the carrying amounts of long-lived
assets may not be recoverable, we estimate the future cash flows, undiscounted and without interest
charges, expected to result from the use of those assets and their eventual disposition. If the sum
of the expected future cash flows is less than the carrying amount of those assets, we recognize an
impairment loss based on the excess of the carrying amount over the fair value of the assets.

Revenue Recognition:

Sales to direct customers and foreign stocking representatives are recognized net of an
allowance for estimated returns. When product is shipped to direct customers or stocking
representatives, or by our distributors or SPT to end users, prior to recognizing revenue, we
require that evidence of the arrangement exists, the price is fixed or determinable and collection
is reasonably assured. Sales to distributors are made primarily under arrangements allowing price
protection and the right of stock rotation on unsold merchandise. Because of the uncertainty
associated with pricing concessions and future returns, we defer recognition of such revenues,
related costs of revenues and related gross profit until the merchandise is sold by the distributor.
Products shipped to SPT are accounted for as our inventory held at our logistics center and revenue
is recognized when the products have been delivered and are considered as a sale to our end
customers by SPT.

For license and other arrangements for technology that we are continuing to enhance and refine
and under which we are obligated to provide unspecified enhancements, revenue is recognized over the
lesser of the estimated period that we have historically enhanced and developed refinements to the
technology, approximately two to three years (the upgrade period), or the remaining portion of the
upgrade period from the date of delivery, provided all specified technology and documentation has
been delivered, the fee is fixed or determinable and collection of the fee is reasonably assured.

59

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From time to time, we re-examine the estimated upgrade period relating to licensed technology to
determine if a change in the estimated upgrade period is needed. Revenue from license or other
technology arrangements where we are not continuing to enhance and refine technology or are not
obligated to provide unspecified enhancements is recognized upon delivery, if the fee is fixed or
determinable and collection of the fee is reasonably assured.

Royalties received under these arrangements during the upgrade period are recognized as revenue
based on the ratio of the elapsed portion of the upgrade period to the estimated upgrade period. The
remaining portions of the royalties are recognized ratably over the remaining portion of the upgrade
period. Royalties received after the upgrade period has elapsed are recognized when reported to us,
which generally coincides with the receipt of payment.

Research and Development:

Research and development expenses are charged to operations as incurred.

Income Taxes:

Deferred tax assets and liabilities are determined based on the difference between the
financial statement and tax bases of assets and liabilities using enacted tax rates in effect for
the year in which the differences are expected to affect taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to the amounts expected to be realized.

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 number of common shares outstanding for the period. Diluted net income (loss) per share is
computed adjusting the net income (loss) by the potential minority interests and dividing by the sum
of the weighted average number of common shares outstanding and potential common shares. The
calculation of diluted net income (loss) per share excludes potential common stock if the effect is
antidilutive. Potential common stock shares consist of common stock options, computed using the
treasury stock method based on the average stock price for the period.

Stock-based Compensation:

We have employee stock benefit plans, which are described more fully in Note 9, "Stock-based
Compensation." We account for stock-based compensation using the intrinsic value method. No
compensation cost has been recognized for the stock option plans or the employee stock purchase
plan. Had compensation cost for these plans been determined based on the fair value at the grant
date of the awards, our net income (loss) and net income (loss) per share for 2002, 2003 and 2004
would have been as follows (in thousands, except per share amounts):

`Year Ended December 31,
                                                        -------------------------------
                                                          2002       2003       2004
                                                        ---------  ---------  ---------
Net income (loss) as reported......................... $ (15,095) $ (65,167) $  23,929
Deduct: total stock-based employee compensation
   expense determined under fair value based method
   for all awards, net of related tax effects.........   (12,112)    (7,601)    (9,036)
                                                        ---------  ---------  ---------
Pro forma net income (loss)........................... $ (27,207) $ (72,768) $  14,893
                                                        =========  =========  =========
Basic income (loss) per share.........................
   As reported:....................................... $   (0.16) $   (0.69) $    0.25
   Pro forma:......................................... $   (0.29) $   (0.77) $    0.16
Diluted net income (loss) per share...................
   As reported:....................................... $   (0.16) $   (0.69) $    0.24
   Pro forma:......................................... $   (0.29) $   (0.77) $    0.15`

The weighted average fair value of options granted under the Equity Incentive Plan and the
Directors' Plan during 2002, 2003 and 2004 was $4.01, $6.45 and $8.15, respectively, per share. The
weighted average fair values of the Emosyn International Limited option grants was $0.48 for
2004.

60

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The weighted average valuation of right grants under the Purchase Plan during 2002, 2003 and 2004
was $3.81, $1.82 and $6.54, respectively, per share.

Comprehensive Income (Loss):

Comprehensive income (loss) is defined as the change in equity of a business enterprise
during a period from transactions and other events and circumstances from non-owner sources.
Comprehensive income (loss) includes unrealized gains and losses on available-for-sale investments,
net of tax, and cumulative translation adjustments. Other comprehensive income (loss) is presented
in the Statement of Shareholders' Equity and Comprehensive Income (Loss).

Reclassifications:

Certain amounts in fiscal 2003 and 2002 consolidated financial statements have been
reclassified to conform to the current year presentation. These reclassifications have no impact on
our previously reported net losses. Specifically, we reclassified certain auction rate securities
from cash equivalents to short-term investments where interest rates reset in less than 90 days but
have a maturity date longer than 90 days. This resulted in a reclassification from cash and cash
equivalents to short-term investments of $40.4 million at December 31, 2003. Further, the
reclassifications had the effect of increasing net cash used in investing activities by $41.5
million the year ended December 31, 2002 and increasing net cash provided by investing activities by
$1.1 million for the year ended December 31, 2003.

Recent Accounting Pronouncements:

In March 2004, the FASB issued EITF Issue No. 03-01, or EITF 
03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" which
provided new guidance for assessing impairment losses on investments. Additionally, EITF 03-1
includes new disclosure requirements for investments that are deemed to be temporarily impaired. In
September 2004, the FASB delayed the accounting provisions of EITF 03-1; however the disclosure
requirements remain effective for annual periods ending after June 15, 2004. We will evaluate
the impact of EITF 03-1 once final guidance is issued.
In October 2004, the FASB approved EITF Issue 04-10 "Determining Whether to
Aggregate Operating Segments That Do Not Meet the Quantitative Thresholds" which addresses an issue
in the application of paragraph 19 of SFAS No. 131, Disclosures about Segments of an Enterprise and
related information.  In November 2004, the FASB delayed until further notice the effective date of
this issue.  We are currently assessing the impact of the disclosure requirements of EITF Issue
04-10 on our consolidated financial statements.

In November 2004, the FASB, issued SFAS No. 151, "Inventory Costs, an Amendment of ARB No.
43, Chapter 4."  The amendments made by SFAS No.151 are intended to improve financial reporting by
clarifying that abnormal amounts of idle facility expense, freight, handling costs, and wasted
materials (spoilage) should be recognized as current-period charges and by requiring the allocation
of fixed production overheads to inventory based on the normal capacity of the production
facilities.  The guidance is effective for inventory costs incurred beginning after June 15, 2005.
We are currently reviewing the impact of SFAS No. 151 on the carrying amounts of our inventory.  We
do not expect the adoption of SFAS No. 151 will have a material impact on our consolidated financial
statements.In December 2004, the FASB issued SFAS 123R (revised 2004), "Share Based Payment."  SFAS 123R
is a revision of FASB 123 and supersedes APB No. 25.  SFAS 123R establishes standards for the
accounting for transactions in which an entity exchanges its equity instruments for good or services
or incurs liabilities in exchange for goods or services that are based on the fair value of the
entity's equity instruments.  SFAS 123R focuses primarily on accounting for transactions in which an
entity obtains employee services in share-based payment transactions.  SFAS 123R requires an entity
to measure the cost of employee services received in exchange for an award of equity instruments
based on the grant-date fair value of the award over the period during which an employee is required
to provide service for the award.  The grant-date fair value of employee share options and similar
instruments must be estimated using option-pricing models adjusted for the unique characteristics of
those instruments unless observable market prices for the same or similar instruments are available.
In addition, SFAS 123R requires a public entity measure the cost of employee services received in
exchange for an award of liability instruments based on its current fair value and that the fair
value of that award will be remeasured subsequently at each reporting date through the settlement
date.  The effective date of SFAS 123R for SST is for the first interim or annual period after61June 15, 2005. While we have not determined the impact of SFAS 123R on our financial statements
at this time, we expect that the adoption of this statement will have a significant adverse impact
on our consolidated financial position and results of operations.  Although we have not yet
determined whether the adoption of SFAS 123R will result in amounts that are similar to the current
pro forma disclosures under SFAS123, we are evaluating the requirements under SFAS 123R and expect
the adoption to have a significant adverse impact on our consolidated operating expenses.

2. Available-for-Sale Investments:The fair value of available-for-sale investments, including restricted available-for-sale
investments, as of December 31, 2004 were as follows (in thousands):

Amortized  Unrealized   Unrealized     Fair
                                                                   Cost        Gain         Loss        Value
                                                                 ---------  -----------  -----------  ---------
Corporate bonds and notes...................................... $     106  $        --  $        --  $     106
Government bonds and notes.....................................    78,625           --          (69)    78,556
Foreign listed equity securities...............................     6,509       16,977         (393)    23,093
                                                                 ---------  -----------  -----------  ---------
Total bonds, notes and equity securities....................... $  85,240  $    16,977  $      (462)   101,755
                                                                 =========  ===========  ===========
Less amounts classified as cash equivalents.............................................               (10,033)
                                                                                                      ---------
     Total short and long-term available-for-sale investments...........................             $  91,722
                                                                                                      =========
Contractual maturity dates for investments in bonds and notes:
     Less than 1 year...................................................................             $  68,628
                                                                                                      =========

The unrealized gain as of December 31, 2004 is recorded in accumulated other comprehensive
income, net of tax of zero.

Market values were determined for each individual security in our investment portfolio. The
declines in value of the government bonds and notes primarily relate to changes in the interest
rates and are considered temporary in nature. With respect to our foreign listed equity securities,
our policy is to review our equity holdings on a regular basis to evaluate whether or not such
securities have experienced an other than temporary decline in fair value. Our policy includes, but
is not limited to, reviewing each company's cash position, earnings and revenue outlook, stock price
performance over the past six months, liquidity, management and ownership. If we believe that an
other-than-temporary decline in value exists, it is our policy to write down these investments to
the market value and record the related write-down in our consolidated statement of operations. At
December 31, 2004, the foreign listed equity securities having a fair value of $1.3 million have
been in a continuous loss position for less than twelve months.

The fair value of available-for-sale investments as of December 31, 2003 were as follows (in
thousands):

Amortized  Unrealized   Unrealized     Fair
                                                                   Cost        Gain         Loss        Value
                                                                 ---------  -----------  -----------  ---------
Corporate bonds and notes...................................... $     184  $        --  $        --  $     184
Government bonds and notes.....................................   158,382           14           --    158,396
Foreign listed equity securities...............................     3,759        9,265         (101)    12,923
                                                                 ---------  -----------  -----------  ---------
Total bonds, notes and equity securities....................... $ 162,325  $     9,279  $      (101)   171,503
                                                                 =========  ===========  ===========
Less amounts classified as cash equivalents.............................................               (45,590)
                                                                                                      ---------
     Total short and long-term available-for-sale investments...........................             $ 125,913
                                                                                                      =========
Contractual maturity dates for investments in bonds and notes:
     Less than 1 year...................................................................             $ 100,944
     Greater than 1 year................................................................                12,046
                                                                                                      ---------
                                                                                                     $ 112,990
                                                                                                      =========

The unrealized gain as of December 31, 2003 is recorded in accumulated other
comprehensive income, net of tax of zero.

623. Balance Sheet Detail (in thousands):
Trade accounts receivable comprise:

December 31,
                                                                 ----------------------
                                                                   2003        2004
                                                                 ---------  -----------
Trade Accounts Receivable...................................... $  57,749  $    61,377
Allowance for sales returns....................................    (1,301)      (2,009)
Allowance for doubtful accounts................................    (1,118)      (1,189)
                                                                 ---------  -----------
                                                                $  55,330  $    58,179
                                                                 =========  ===========

Inventories, net, comprise:

December 31,
                                                                 ----------------------
                                                                   2003        2004
                                                                 ---------  -----------
Raw materials.................................................. $  20,735  $    86,355
Work in process................................................    11,265        4,151
Finished goods.................................................     9,579       60,520
Inventory held at logistic center..............................     4,541        5,592
                                                                 ---------  -----------
                                                                $  46,120  $   156,618
                                                                 =========  ===========

Other current assets comprise:

December 31,
                                                                 ----------------------
                                                                   2003        2004
                                                                 ---------  -----------
Refundable income tax.......................................... $   5,533  $     6,035
Other current assets...........................................     7,699       10,014
                                                                 ---------  -----------
                                                                $  13,232  $    16,049
                                                                 =========  ===========

Property and Equipment comprise:

December 31,        Estimated
                                                                 ----------------------    Useful
                                                                   2003        2004         Lives
                                                                 ---------  -----------  -----------
Land........................................................... $      --  $       959
Building.......................................................        --        1,532   Forty years
Equipment......................................................    13,533       17,662   Four years
Computer and design hardware...................................    11,900       13,684   Three years
Software.......................................................     9,768       13,254   Three years
Vehicles.......................................................        12           29   Five years
Furniture and fixtures.........................................     1,958        2,072   Seven years
Leasehold improvements.........................................     7,255        8,695   (1)
                                                                 ---------  -----------
                                                                   44,426       57,887
Less accumulated depreciation..................................    33,392       41,461
                                                                 ---------  -----------
                                                                   11,034       16,426
Construction in progress.......................................       291          194
                                                                 ---------  -----------
                                                                $  11,325  $    16,620
                                                                 =========  ===========

(1) Seven years or remaining lease term, whichever is lessDepreciation expense was $9.3 million, $7.7 million and $6.6 million for 2002, 2003 and 2004,
respectively.

63Accrued liabilities comprise:

December 31,
                                                                 ----------------------
                                                                   2003        2004
                                                                 ---------  -----------
Accrued compensation and related costs......................... $   4,911  $     6,829
Accrued adverse puchase commitment.............................       537        8,330
Accrued commission.............................................     1,333        2,198
Impairment lease liability.....................................       215          976
Accrued yield commitment.......................................       201        1,167
Accrued income tax payable.....................................       659        2,038
Accrued warranty...............................................       187        3,826
Other accrued liabilities......................................     3,868        5,229
                                                                 ---------  -----------
                                                                $  11,911  $    30,593
                                                                 =========  ===========

Our technology license agreements generally include an indemnification clause that indemnifies
the licensee against liability and damages (including legal defense costs) arising from any claims
of patent, copyright, trademark or trade secret infringement by our proprietary technology. The
terms of these guarantees approximate the terms of the technology license agreements, which
typically range from five to ten years. Our current license agreements expire from 2005 through
2014. The maximum possible amount of future payments we could be required to make, if such
indemnifications were required on all of these agreements, is $39.7 million. We have not recorded
any liabilities as of December 31, 2004 related to these indemnities as no such claims have been
made or asserted.

Accrued warranty:

Year Ended December 31,
                                                                 ----------------------
                                                                   2003        2004
                                                                 ---------  -----------
Balance at beginning of year................................... $     492  $       187
Accruals for warranties issued during the period...............       485        4,834
Settlements made...............................................      (790)      (1,195)
                                                                 ---------  -----------
Balance at end of year......................................... $     187  $     3,826
                                                                 =========  ===========

Our products are generally subject to warranty and we provide for the estimated future costs of
repair, replacement or customer accommodation upon shipment of the product in the accompanying
statements of operations. Our warranty accrual is based on specific known open warranty issues and
an estimate of unknown claims. The unknown estimated accrual is based on historical claims compared
to historical revenues and assumes that we have to replace products subject to a claim. For new
products, we use our historical percentage for the appropriate class of product. Warranty expense
has increased from 2003 to 2004 due to rescreening work related to two specific customers and higher
shipment volume and return rates.

4. Commitments:
We lease our corporate facilities under non-cancelable operating leases that expire in 2005
through 2012. The leases require escalating monthly payments over their terms and, therefore,
periodic rent expense is being recognized on a straight-line basis. Under the terms of the leases,
we are responsible for maintenance costs, including real property taxes, utilities and other costs.
Rent expense was $5.4 million, $5.5 million and $5.0 million in 2002, 2003 and 2004, respectively.During 2001 and the second quarter of 2004, we recorded charges
to other operating expense of $756 thousand and $1.5 million, respectively, relating to operating
leases for two unoccupied buildings. These charges represent the fair value of the liability
determined by reducing the remaining lease commitment by the estimated sublease income relating to
these two buildings. The estimated liability may be adjusted subsequently depending on the actual
sublease income we may receive. At December 31, 2002, 2003 and 2004, payments made have reduced the
recorded liability to $473 thousand, $270 thousand and $976 thousand, respectively.


64Future minimum rental payments at December 31, 2004 are as follows (in thousands):

2005........................................................... $   4,182
2006...........................................................     2,941
2007...........................................................     2,856
2008...........................................................     2,822
2009...........................................................     2,905
Thereafter.....................................................       896
                                                                 ---------
                                                                $  16,602
                                                                 =========

5. Contingencies:
In January 1996, Atmel Corporation filed suit against SST alleging that we infringed six U.S.
patents. We successfully moved for summary judgment on two of the six asserted patents in September
1997. In January 2001, Atmel withdrew its allegation that we infringed another patent. On May 7,
2002, a judgment was entered against the us in the amount of $36.5 million based on a jury's finding
that we infringed two of the three remaining patents. We appealed the judgment on July 16, 2002. On
September 12, 2003 the Court of Appeals upheld the jury's verdict. On November 18, 2003 the Court of
Appeals denied our request for a rehearing, and in December 2003 we paid Atmel $37.8 million to
satisfy the judgment plus statutory interest accrued during the appeals. The payment was recorded as
other operating expense in the year ending December 31, 2003. In addition, on June 28, 2004 we paid
$247 thousand of legal related expenses incurred by Atmel pursuant to the court order.
The third patent remaining in the case, the `903 patent, expired in September 2001. The trial
court has held that, if it is found to be valid, certain of our products infringed that patent. The
trial to determine whether the `903 patent is invalid began on July 29, 2002. On August 5, 2002the jury announced that it was unable to reach a verdict on our
invalidity defense, and a mistrial was declared. Atmel requested a newtrial,
but the Court stayed the matter until after our appeal of the earlier judgment is resolved. At
Atmel's request, the Court has directed the parties to conduct a settlement conference before a
Magistrate Judge. That settlement conference was scheduled for April 14, 2004 and was subsequently
rescheduled for September 7, 2004. No conclusion was reached during the settlement conference on
September 7, 2004. A new trial date on the invalidity of the `903 patent has been scheduled for June
27, 2005. The impact related to the outcome of the remaining patent is undeterminable at this
time.

In January and February 2005, multiple putative shareholder class action complaints were filed
against the Company and certain directors and officers, in the United States District Court for the
Northern District of California, following the Company's announcement of anticipated financial
results for the fourth quarter of 2004. The complaints are captioned: Hunt v. Silicon Storage
Technology, Inc., et al., Case No. C 05 00408 WHA (N.D. Cal.); Baker v. Silicon Storage
Technology, Inc., et al., Case No. C 05 00295 PJH (N.D. Cal.); Grobler v. Silicon Storage
Technology, Inc., et al., Case No. C 05 00376 MHP (N.D. Cal.); Talmo v. Silicon Storage
Technology, Inc., et al., Case No. C 05 00390 MMC (N.D. Cal.); and DiCintio v. Silicon
Storage Technology, Inc., et al., Case No. C 05 0708 MMC (N.D. Cal.). The complaints seek
unspecified damages on alleged violations of federal securities laws during the period from March
22, 2004 to December 20, 2004. Consolidation and the appointment of lead plaintiff are currently
pending in these purported class actions. The Company intends to take all appropriate action in
response to these lawsuits. The impact related to the outcome of these matters is undeterminable at
this time.

In January and February 2005, following the filing of the putative class actions, multiple
shareholder derivative complaints were filed in California Superior Court for the County of Santa
Clara, purportedly on behalf of the Company against certain directors and officers. The factual
allegations of these complaints are substantially identical to those contained in the putative
shareholder class actions filed in federal court. The derivative complaints assert claims for, among
other things, breach of fiduciary duty and violations of the California Corporations Code. These
derivative actions have been consolidated under the caption In Re Silicon Storage Technology,
Inc. Derivative Litigation, Lead Case No. 1:05CV034387 (Cal. Super. Ct., Santa Clara Co.). The
Company intends to take all appropriate action in response to these lawsuits. The impact related to
the outcome of these matters is undeterminable at this time.

From time to time, we are also involved in other legal actions arising in the ordinary course of
business. We have accrued certain costs associated with defending these matters. There can be no
assurance the remaining Atmel complaint or other third party assertions will be resolved without

65

---



costly litigation, in a manner that is not adverse to our financial position, results of operations
or cash flows or without requiring royalty payments in the future which may adversely impact gross
margins. No estimate can be made of the possible loss or possible range of loss associated with the
resolution of these contingencies. As a result, no losses have been accrued in our financial
statements as of December 31, 2004.

6. Line of Credit

On July 16, 2004 we entered into a 2-year loan agreement with Cathay Bank, a U.S. bank,
for a $3.0 million revolving line of credit.  The interest rate for the line of credit is 3.475% per
annum.  The line of credit is collateralized by a $3.0 million certificate of deposit which is
included in non-current other assets.  The certificate of deposit matures in July 2006 and carries
an interest rate of 2.6% per annum.  As of December 31, 2004, we had no borrowings under our line of
credit.

7. Acquisitions

Emosyn LLC.

In connection with the Emosyn acquisition, we issued the minority stockholder
a put option. On the fourth anniversary date of the closing of the acquisition or if there is an
earlier material change in business, the minority stockholder shall have the right to require SST to
purchase all of its interest at the then current fair market value of the minority interest fair
market value stock price.

The total purchase price was allocated to the estimated fair value of the assets
acquired and liabilities assumed as follows (in thousands):

`Fair value of tangible net assets acquired................... $   9,252
Existing technology..........................................     6,029
In-process research and development..........................     1,988
Trade name...................................................     1,093
Customer relationships.......................................       549
Backlog......................................................       712
Trade accounts payable, accrued expenses and other liabilitie    (3,621)
                                                               ---------
  Total purchase price....................................... $  16,002
                                                               =========`

We valued the existing technology and in-process research and development, or IP R&D, utilizing
a discounted cash flow model which uses forecasts of future revenues and expenses related to the
intangible asset.  We utilized a discount rate of 30% for existing technology, trade name and
customer relationships, 50% for in-process research and development, and 18% for backlog,
respectively.  The existing technology and trade name are amortized to cost of revenues over their
estimated lives of five years.  The customer relationships and backlog are amortized to cost of
revenues over their estimated lives of one to three years.  As of December 31, 2004, existing
technology, trade name, customer relationships and backlog are all included in intangible
assets.

In-process research and development acquired of $2.0 million was expensed and
included in other operating expenses as of the date of the acquisition. At the time of the Emosyn
acquisition, we estimated that the acquired IP R&D was approximately 30% complete and would be
completed over the next nine months at an estimated cost of approximately $484 thousand.

66

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G-Plus, Inc.  On November 5, 2004, we purchased substantially all the assets of
G-Plus Inc., or G-Plus, a privately held company located in Santa Monica, California.  The
acquisition was accounted for under the purchase method of accounting, and accordingly, the net
assets and results of G-Plus' operations have been included in the consolidated financial statements
since that date.  G-Plus is a semiconductor manufacturer specializing in the design and marketing of
radio frequency ICs and monolithic microwave ICs for a wide range of wireless and multimedia
applications.  The acquisition provides us the opportunity to make SuperFlash the embedded memory of
choice for wireless applications.  We also believe that the acquisition will help G-Plus leverage
our foundry relationships and manufacturing operation infrastructure in order to meet the rising
demand for G-Plus wireless products.

The aggregate purchase price was $26.9 million, including $4.6 million of cash, common stock valued
at $22.1 million and costs related to the acquisition of $200 thousand.  The fair value of the
3,030,082 shares of our common stock issued to the former stockholders of G-Plus was determined
based on the average closing price of the Company's common stock over a two-day trading period prior
to the closing date.  Below is a summary of the total preliminary purchase price (in thousands):

`Cash......................................................... $   4,600
Common stock.................................................    22,074
Acquisition direct costs.....................................       194
                                                               ---------
  Total purchase price....................................... $  26,868
                                                               =========`

The total purchase price was allocated to the estimated fair value of the assets acquired and
liabilities assumed as follows (in thousands):

`Fair value of tangible net assets acquired........................ $   5,983
Existing technology...............................................     1,814
In-process research and development...............................     3,908
Customer relationships............................................       355
Backlog...........................................................        11
Goodwill..........................................................    15,600
Trade accounts payable, accrued expenses and other liabilities....      (803)
                                                                    ---------
  Total purchase price............................................ $  26,868
                                                                    =========`

We valued the existing technology and in-process research and development, or IP
R&D, utilizing a discounted cash flow model which uses forecasts of future revenues and expenses
related to the intangible asset.  We utilized a discount rate of 28% for existing technology and
customer relationships, 30-35% for in-process research and development projects, and 26% for
backlog, respectively.  The existing technology is amortized to cost of revenues over its estimated
life of four years.  The customer relationships and backlog are amortized to cost of revenues over
their estimated lives of one to three years.  As of December 31, 2004, existing technology, customer
relationships and backlog are all included in intangible assets.

In-process research and development acquired of $3.9 million was expensed and
included in other operating expenses as of the date of the acquisition.

At the time of the G-Plus acquisition, we estimated that the acquired IP R&D
projects were between 20% to 80% complete and would be completed over the next fourteen months at an
estimated cost of approximately $1.2 million.

The following unaudited pro forma financial information presents the combined results of
operations of Emosyn and G-Plus as if the acquisitions had occurred as of the beginning of 2004 and
2003.  The pro forma financial information does not necessarily reflect the results of operations
that would have occurred had the combined companies constituted a single entity during such periods,
and is not necessarily indicative of results which may be obtained in the future.

67

---



`December 31,
                                                  ---------------------------
                                                        2003          2004
                                                  ----------------  ---------
Revenue......................................... $        303,791  $ 470,956
Net income (loss)............................... $        (75,308) $  18,550
Net income (loss) per share - basic............. $          (0.80) $    0.19
Net income (loss) per share - diluted........... $          (0.80) $    0.19`

8. Goodwill and Intangible Assets:

As discussed in note 7, our acquisitions of Emosyn and G-Plus included the acquisition of
$10.6 million of finite-lived intangible assets. The acquisition of G-Plus also included the
acquisition of $15.6 million of goodwill. The goodwill is not being amortized, but is tested for
impairment annually, as well as when an event or circumstance occurs indicating a possible
impairment in value.

As of December 31, 2004, our intangible assets consisted of the following (in thousands):

`Accumulated
                                   Cost    Amortization   Net
                                 ---------  ---------  ---------
Existing technology.............$   7,843  $     437  $   7,406
Trade name......................    1,093         67      1,026
Customer relationships..........      904         73        831
Backlog.........................      723        219        504
                                 ---------  ---------  ---------
Balance at December 31, 2004....$  10,563  $     796  $   9,767
                                 =========  =========  =========`

All intangible assets are being amortized on a straight-line method over their estimated useful
lives. Existing technologies have been assigned useful live of between four and five years (with a
weighted average life of approximately 4.8 years). Trade names, customer relationships and backlogs
have been assigned useful lives of five years, three years and one year, respectively. Amortization
expense was $796 thousand and $496 thousand in 2004 and 2002, respectively. There was no
amortization expense in 2003.

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

`Amortization of
                                            Intangible Assets
                                            ---------
                                   2005    $   2,684
                                   2006        2,179
                                   2007        2,105
                                   2008        1,809
                                   2009          990
                                            ---------
                                           $   9,767
                                            =========`

9. Stock-based Compensation:

Employee Stock Purchase Plan:

Our 1995 Employee Stock Purchase Plan, or the Purchase Plan, as amended, has 6.0 million
shares reserved for issuance. The Purchase Plan provides for eligible employees to purchase shares
of common stock at a price equal to 85% of the fair market value of our common stock on the date of
the option grant, or, if lower, 85% of the fair market value of our common stock six months after
the option grant, by withholding up to 10 percent of their annual base earnings. At December 31,
2004, 1.9 million shares were available for purchase under the Purchase Plan. Shares issued under
the Purchase Plan in 2002, 2003 and 2004 were 517 thousand, 931 thousand and 507 thousand,
respectively.

68

---

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

Directors' Option Plan:

Our 1995 Non-Employee Directors' Stock Option Plan, or the Directors' Plan, as
amended, provides for the automatic initial grant of options to purchase 45 thousand shares of our
common stock to our non-employee directors. The Directors' Plan also provides for the grant of
options to purchase up to an additional 18 thousand shares annually thereafter. Options under the
Directors' Plan become exercisable immediately upon date of grant, and the exercise price of options
granted must equal or exceed the fair market value of our common stock on the date of grant. The
options expire ten years after the date of grant. As of December 31, 2004, we have reserved 950
thousand shares of common stock for issuance upon the exercise of stock options under the Directors'
Plan.

Activity under the Equity Incentive Plan and Directors' Plan are as follows (in thousands, except
per share data):

`Available            Options Outstanding          Weighted
                                  for    --------------------------------------   Average
                                 Grant    Shares    Price Per Share    Amount      Price
                               --------- --------- -----------------  ---------  ---------
Balances, December 31, 2001...    3,814    10,887 $  0.05 - $ 29.44  $  77,642  $    7.13
     Granted..................   (1,377)    1,377    3.65 -   10.80      7,133       5.16
     Exercised................       --    (1,193)   0.05 -    8.63     (1,227)      1.03
     Terminated...............      417      (417)   0.68 -   29.44     (4,038)      9.68
     Authorized...............    2,200        --         -                 --         --
                               --------- ---------                    ---------
Balances, December 31, 2002...    5,054    10,654    0.05 -   29.44     79,510       7.46
     Granted..................   (1,337)    1,337    2.30 -   13.57     11,460       8.57
     Exercised................       --    (1,102)   0.05 -   10.29     (2,305)      2.09
     Terminated...............      742      (742)   0.95 -   26.02     (9,595)     12.98
     Authorized...............    1,650        --         -                 --         --
                               --------- ---------                    ---------
Balances, December 31, 2003...    6,109    10,147    0.07 -   29.44     79,070       7.79
     Granted..................   (2,395)    2,395    5.77 -   16.34     19,531       8.15
     Exercised................       --    (1,067)   0.07 -   11.81     (2,786)      2.61
     Terminated...............      444      (444)   2.83 -   26.02     (4,998)     11.25
     Authorized...............       --        --         -                 --         --
                               --------- ---------                    ---------
Balances, December 31, 2004...    4,158    11,031 $  0.08 - $ 29.44  $  90,817  $    8.23
                               ========= =========                    =========`

At December 31, 2002, 2003 and 2004, 6.6 million, 6.9 million and 6.9 million
options were exercisable at a weighted-average exercise price per share of $6.62, $7.96 and $8.59,
respectively.

The options outstanding and currently exercisable by exercise price under the Equity
Incentive Plan and the Directors' Plan at December 31, 2004 are as follows (in thousands, except per
exercise price data):

69

---



`Options Outstanding            Options Exercisable
                         ------------------------------------- --------------------------
                                        Weighted-
                                         Average    Weighted-                  Weighted-
                                        Remaining    Average                    Average
    Range of                 Number     Contractual  Exercise      Number       Exercise
 Exercise Prices          Outstanding      Life       Price     Outstanding      Price
------------------------ -------------- ----------  ---------- --------------  ----------
$     0.08 - $     1.04          1,175       3.06  $     0.94          1,175  $     0.94
$     1.08 - $     3.65          1,671       5.65  $     2.69          1,108  $     2.26
$     3.81 - $     4.71          1,117       6.54  $     4.45            905  $     4.47
$     4.72 - $     6.48          1,299       8.51  $     6.03            348  $     5.25
$     6.66 - $     8.16          1,111       9.50  $     7.47             99  $     7.92
$     8.28 - $     9.32          1,256       7.73  $     9.00            484  $     8.63
$     9.64 - $    11.81          1,466       5.10  $    10.76          1,260  $    10.77
$    11.85 - $    18.60          1,283       6.45  $    16.55            854  $    17.99
$    19.96 - $    28.35            636       5.45  $    24.08            636  $    24.08
$    29.44 - $    29.44             17       5.50  $    29.44             17  $    29.44
                         --------------                        --------------
$     0.08 - $    29.44         11,031       6.43  $     8.23          6,886  $     8.59
                         ==============                        ==============`

The fair value of each option grant for both of the SST stock option plans are estimated on the date
of grant using the Black-Scholes multiple options pricing model with the following weighted average
assumptions by year:

`Year Ended December 31,
                                                        -------------------------------
                                                          2002       2003       2004
                                                        ---------  ---------  ---------
Risk-free interest rate...............................   2.8-4.9%   2.4-3.1%   2.7-3.9%
Expected term of option...............................    6 years    5 years    5 years
Expected volatility...................................        99%        99%        94%
Expected dividend yield...............................         0%         0%         0%`

The fair value of each stock purchase right is estimated using the Black-Scholes model with the
following weighted average assumptions by year:

`Year Ended December 31,
                                                        -------------------------------
                                                          2002       2003       2004
                                                        ---------  ---------  ---------
Risk-free interest rate...............................   2.1-2.3%   1.0-1.4%   1.2-2.1%
Expected term of right................................   1/2 year   1/2 year   1/2 year
Expected volatility...................................       102%        86%        74%
Expected dividend yield...............................         0%         0%         0%`

Option grants and Purchase Plan rights are priced at the date of grant. The
risk-free interest rate range represents the low and high end of the range used at different points
during the year.

Stock Options in Emosyn International Limited:

In 2004, Emosyn International Limited, a majority-owned
subsidiary of SST, adopted a stock option plan to grant nonstatutory andincentive stock options to purchase common stock of Emosyn to employees, directors and consultants.
Emosyn stock options do not create a right to purchase the common stock of SST.
As of December 31, 2004, 8.8 million shares of its common stock were reserved for issuance upon the
exercise of stock options. Stock options are granted at prices determined by the Board of Directors.
Nonstatutory and incentive stock options may be granted at prices not less than 85% of the fair
market value and at not less than fair market value, respectively, at the date of grant. Options
generally become exercisable one year after the date of grant and vest over a maximum period of five
years following the date of grant. Emosyn has not granted stock options to non-employees.

The following table summarizes Emosyn International Limited's option activities for 2004 (in
thousands, except per share data):

`Weighted
                                 Available            Options Outs Average
                                 for Grant   Shares     Amount      Price
                                 ---------  ---------  ---------  ---------
Shares authorized...............    8,824
Options granted.................   (5,289)     5,289  $   2,539  $    0.48
Options canceled................       --         --
                                 ---------  ---------  ---------  ---------
Balance at December 31, 2004....    3,535      5,289  $   2,539  $    0.48
                                 =========  =========  =========  =========`

70

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As of December 31, 2004, no options were vested. The weighted average remaining life of the options
outstanding is 4.7 years.  The fair value of each option grant for Emosyn's stock option plan is
estimated on the date of grant using the Black-Scholes multiple options pricing model with the
following weighted average assumptions for 2004: risk-free interest rate of 3.3-3.9%, expected term
of right of 5 years, expected volatility of 0% and expected dividend yield of 0%.  Option grants are
priced at the date of grant. The risk-free interest rate range represents the low and high end of
the range used at different points during the year.

10. Shareholders' Equity:

Authorized Capital Shares:

Our authorized capital shares consist of 250.0 million shares of common stock and 7.0
million shares of preferred stock. Of the preferred stock, 450 thousand shares have been designated
as series A junior participating preferred stock. All of our capital shares have no par value.

Share Purchase Rights Plan:

We have a Share Purchase Rights Plan, adopted in May 1999 and subsequently amended, in
which preferred stock rights were distributed as a rights dividend at a rate of one right for each
share of common stock held as of the close of business on May 27, 1999. Preferred stock rights will
also be issued with any new issuance of common shares. Each right entitles the registered holder
under certain circumstances to purchase from us one three-hundredth (one-third of one one-hundredth)
of a share of series A junior participating preferred stock. Until the occurrence of certain events
the preferred stock rights will be transferable with and only with the Common Shares. The effect
will be to discourage acquisitions of more than 15 percent of our common stock without negotiations
with our Board of Directors. The rights expire May 3, 2009.

Stock Repurchase Program:

On July 28, 2004, our board of directors authorized the
purchase of an aggregate of up to $15.0 million of our common stock. The purchases were made in the
open market at prevailing market prices, subject to compliance with applicable provisions of the
California Corporation Code and in accordance with applicable federal and state securities laws and
regulations. The stock purchase program ended on December 31, 2004. Approximately 2,574,000 shares
were repurchased under this program during August and September 2004 for an aggregate purchase price
of $14.9 million. The purchase prices ranged from $5.48 to $6.12 per share.

11. Net Income (Loss) Per Share:

A reconciliation of the numerator and the denominator of basic and diluted net loss
per share are as follows (in thousands except for per share data):

71

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`Year Ended December 31,
                                                                 -----------------------------------
                                                                   2002        2003         2004
                                                                 ---------  -----------  -----------
Numerator - Basic and diluted
  Net income (loss)............................................ $ (15,095) $   (65,167) $    23,929
                                                                 =========  ===========  ===========
Denominator - Basic
  Weighted average common stock outstanding....................    92,667       94,723       95,756
                                                                 =========  ===========  ===========

Basic net income (loss) per share.............................. $   (0.16) $     (0.69) $      0.25
                                                                 =========  ===========  ===========
Numerator - Diluted:
  Net income (loss)............................................ $ (15,095) $   (65,167) $    23,929
                                                                 =========  ===========  ===========
Denominator - Diluted:
  Weighted average common stock outstanding....................    92,667       94,723       95,756
  Dilutive potential of common stock equivalents:
    Options....................................................        --           --        3,387
                                                                 ---------  -----------  -----------
                                                                   92,667       94,723       99,143
                                                                 =========  ===========  ===========

Diluted net income (loss) per share............................ $   (0.16) $     (0.69) $      0.24
                                                                 =========  ===========  ===========`

Anti-dilutive stock options to purchase approximately 5,363,000 shares of common stock with a
weighted average price of $13.03 were excluded from the computation of diluted net income per share
for 2004 because the exercise price of the options exceeded the average fair market value of the
stock for 2004. Stock options to purchase 10.7 million and 10.1 million shares of common stock with
weighted average price of $7.46 and $7.79 were outstanding at December 31, 2002 and 2003,
respectively, but were not included in the computation of diluted net loss per share because we had
a net loss in 2002 and 2003.

12. Other Operating Expenses:

Other operating expenses comprised (in thousands):

`Year ended December 31,
                                                  ---------------------------------------------
                                                      2002             2003            2004
                                                  ------------  ------------------  -----------
Operating lease impairment...................... $         --  $               --  $     1,479
In-process research and development.............           --                  --        5,896
Atmel Settlement................................           --              37,849           --
                                                  ------------  ------------------  -----------
                                                 $         --  $           37,849  $     7,375
                                                  ============  ==================  ===========`

Operating lease impairment. During the second quarter of 2004, we recorded a period
charge to other operating expense of $1.5 million relating to an operating lease for an abandoned
building. This charge represents the estimated difference between the total discounted future
sublease income and our discounted lease commitments relating to this building. At December 31,
2002, 2003 and 2004, payments made have reduced the recorded liability to $473 thousand, $270
thousand and $976 thousand, respectively.

In-process research and development. In September 2004, we acquired a majority of
the outstanding shares of Emosyn LLC, or Emosyn, and in November 2004 we acquired substantially all
of the assets of G-Plus, Inc, or G-Plus. As discussed in note 7, a portion of the purchase price of
each acquisition was allocated to in-process research and development and immediately expensed. The
amount of in-process research and development included in other operating expenses from the Emosyn
and G-Plus was $2.0 million and $3.9 million, respectively.

Atmel Settlement. In September 2003, the Federal Circuit Court issued a decision
upholding the trial court verdict that we infringed on the `811 and `829 patents in our lawsuit with
Atmel. As a result of that decision, we accrued the judgement of $36.5 million. In October 2003, the
court denied our petition to reconsider its decision. In December 2003, we recorded an additional
$1.3 million in settlement fees related to the interest on the judgement from the time the judgement
was entered in May 2002 to the payment date of the judgement in December 2003. The total judgement
and interest of $37.8 million was paid to Atmel in December 2003.

72

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13. Impairment of Equity Investments:

In 2000, we acquired a 10.0% interest in Apacer Technology, Inc., or Apacer, a privately held
company located in Taiwan that designs, manufactures and markets memory modules, for $9.9 million in
cash. Our investment in Apacer was valued at cost. Bing Yeh, our President, CEO and Chairman of our
Board of Directors, is also a member of Apacer's Board of Directors. In 2001, we invested an
additional $2.1 million in Apacer. In August 2002, we made an additional investment of $181
thousand. At the end of the third quarter of 2002, we determined that a continued and significant
decline in Apacer's price per share was other than temporary, and accordingly, in the third quarter
of 2002, we recorded a period charge to other expense of $7.8 million to write down our investment
in Apacer to $4.4 million which was determined using the price per share paid for the additional
investment in August 2002.

During 2003, Insyde, a company in which we have an investment, completed an initial
public offering on the Taiwan Stock Exchange. Since the initial public offering there had been a
significant decline in the market value of the investment. During 2004, we recognized a $509
thousand loss from the impairment of our equity investment because Insyde's stock price had declined
below the acquisition cost for more than six months. We could not conclude that the value of our
investment would be recovered in the foreseeable future. The impairment was, therefore, considered
to be "other-than-temporary" in nature, thus the investment value was permanently written down to
reflect the fair value.

14. Income Taxes:

The provision for income taxes reflected in the Statements of Operations for the
years ended December 31, 2002, 2003 and 2004 are as follows (in thousands):

`Year Ended December 31,
                                       --------------------------------------
                                         2002           2003          2004
                                       ---------  ----------------  ---------
Current:
      Federal                         $  (3,912) $          2,516  $     736
      State..........................         1                 2          2
      Foreign........................        16             1,580      3,168
                                       ---------  ----------------  ---------
                                         (3,895)            4,098      3,906
                                       ---------  ----------------  ---------
Deferred:
      Federal........................    (5,874)           16,818         --
      State..........................    (1,162)            5,500         --
                                       ---------  ----------------  ---------
                                         (7,036)           22,318         --
                                       ---------  ----------------  ---------
                                      $ (10,931) $         26,416  $   3,906
                                       =========  ================  =========`

Our effective tax rate (benefit)/provision differs from the statutory federal income tax
rate as shown in the following schedule:

`Year Ended December 31,
                                       ---------------------------------------
                                         2002           2003          2004
                                       ---------- ----------------- ----------
United States statutory rate.........     (35.0)%           (35.0)%     35.0 %
State taxes, net of federal benefit..      (4.5)               --         --
Foreign taxes, net...................        --               4.0       12.9
Research and development credit......      (5.9)             (4.8)      (4.0)
Tax exempt interest..................      (2.5)             (2.0)      (2.6)
Capital loss carried forward and not
   benefitted........................      10.4                --         --
Change in estimated tax contingency..      (4.3)               --       (1.5)
Change in valuation allowance........        --             106.1      (30.5)
Write offs...........................        --                --        4.9
Other................................      (0.2)             (0.1)      (0.2)-
                                       ---------- ----------------- ----------
                                          (42.0)%            68.2 %     14.0 %
                                       ========== ================= ==========`

As of December 31, 2003 and 2004 our deferred tax assets and liabilities consisted
of (in thousands):

73

---



`December 31,
                                                  ---------------------------
                                                        2003          2004
                                                  ----------------  ---------
Allowance for excess and obsolete inventory..... $          2,552  $     237
Allowance for sales returns.....................              457         27
Allowance for doubtful accounts.................              419         48
Other...........................................            2,803      2,500
Capitalized research and development............            2,052      1,591
Net operating loss carry-forwards...............           10,516      1,456
Depreciation....................................              803      1,902
Tax credits.....................................           21,512     20,213
                                                  ----------------  ---------
Total deferred tax asset........................ $         41,114  $  27,974
Valuation allowance.............................          (41,114)   (27,191)
Acquired intangibles............................               --       (783)
                                                  ----------------  ---------
Net deferred tax asset                           $             --  $      --
                                                  ================  =========`

Our provision for taxes included a charge recorded during the third quarter of
2003 to establish a full valuation allowance against our deferred tax assets offset by a reduction
in income tax payable as a result of a reassessment of expected liabilities for 2003 and certain
exposures.  During the year of 2004, we maintained a full valuation allowance on our net deferred
tax assets. The valuation allowance was determined in accordance with the provisions of Statement of
Financial Accounting Standards No. 109, or SFAS No. 109, "Accounting for Income Taxes," which
requires an assessment of both positive and negative evidence when determining whether it is more
likely than not that deferred tax assets are recoverable; such assessment is required on a
jurisdiction by jurisdiction basis. Cumulative losses incurred in the U.S. in recent years
represented sufficient negative evidence under SFAS No. 109 and accordingly, a full valuation
allowance was recorded against U.S. deferred tax assets. We intend to maintain a full valuation
allowance on the U.S. deferred tax assets until sufficient positive evidence exists to support
reversal of the valuation allowance.

At December 31, 2004, we had $4.2M of federal net operating loss
carryforward and had no state net operating loss carry forwards. At December 31, 2004, we had
available research and development credit carryforwards for federal and state income tax purposes of
$12.8 million and $7.1 million, respectively. The federal carryforwards expire between 2009 and
2024. The state carryforwards has no expiration dates.

Undistributed earnings of the Company's foreign subsidiaries of
approximately $6.4 million at December 31, 2004, are considered to be indefinitely reinvested
and, accordingly, no provision for federal and state income taxes have been provided thereon. Upon
distribution of those earnings in the form of dividends or otherwise, the Company would be
subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding
taxes payable to various foreign countries.

On October 22, 2004, the President signed the American Jobs Creation Act of 2004, or the
Job Act.  Among other provisions, the Job Act includes a temporary incentive for U.S. corporations
to repatriate accumulated income earned abroad.  We currently do not intend to repatriate foreign
earnings under the Job Act.  It is not anticipated that the other provisions of the Job Act will
have a material impact on our effective tax rate.

15. Segment Reporting:

Our operations involve the design, development, manufacturing, marketing and technical
support of our nonvolatile memory products. We offer low to medium density devices that target a
broad range of existing and emerging applications in the digital consumer, networking, wireless
communications and Internet computing markets. Our products are differentiated based upon attributes
such as density, voltage, access speed, package and predicted endurance. We also license our
technology for use in non-competing applications.

We manage our business in six reportable segments: the Standard Memory Product Group, or SMPG,
the Application Specific Product Group, or ASPG, the Special Product Group, or SPG, the Emosyn
Products, or Emosyn, the SST Communications Corporation Products, or SCC, and Technology Licensing.
We do not allocate operating expenses, interest and other income, interest expense, impairment of
equity investments and provision for or benefit from income taxes to any of these segments for
internal reporting purposes, as we do not believe that allocating these expenses are material in
evaluating a business unit's performance.

74

---



SMPG includes our three standard flash memory product families: the Multi-Purpose Flash, or MPF,
family, the Multi-Purpose Flash Plus, or MPF+, family and the Many-Time Programmable, or MTP,
family. These families allow us to produce products optimized for cost, functionality and quality to
support a broad range of mainstream applications that use nonvolatile memory products. Effective
January 1, 2003, we transferred certain MTP products from SMPG to SPG. Effective July 1, 2003, we
transferred the Small Sector Flash, or SSF, family from SMPG to SPG. Effective January 1, 2004, we
transferred the last MTP series of products from SMPG to SPG. Accordingly, our segment revenues and
gross profit information have been reclassified for presentation purposes as if the transfer
occurred as of January 1, 2002.

ASPG includes Concurrent SuperFlash, Serial Flash, Firmware Hub, or FWH, and Low Pin Count, or
LPC, flash products. These products are designed to address specific applications such as cellular
phones, hard disk drives and PCs. ASPG also includes flash embedded controllers such the ATA flash
disk controller to consumer, industrial and mass data storage applications. Effective January 1,
2003, we transferred FlashFlex51 microcontroller products from ASPG to SPG. Accordingly, our segment
revenue and gross margin information have been reclassified for presentation purposes as if the
transfer occurred as of January 1, 2002.

SPG includes ComboMemory, ROM/RAM Combos, the Small Sector Flash, or SSF, family, certain
Multi-Time Programmable, or MTP, family, FlashFlex51 microcontrollers and other special flash products.
These products are used in applications requiring low power and a small form factor such as cellular
phones, wireless modems, MP3 players, pagers and digital organizers. Effective January 1, 2003, we
transferred certain MTP products from SMPG to SPG and FlashFlex51 microcontroller products from ASPG
to SPG. Effective July 1, 2003, we transferred the SSF family from SMPG to SPG. Effective January 1,
2004, we transferred the last MTP series of products from SMPG to SPG. Accordingly, our segment
revenue and gross margin information have been reclassified for presentation purposes as if the
transfer occurred as of January 1, 2002.

Emosyn includes flash memory based microprocessor chips. The
Theseus Platinum product family specifically targets the smart card market through the sales of the
TP-40, TP-62, TP-100 and TP-130 products. These products are used primarily in cell phone
applications, and include such benefits of use as lower power consumption, long term data retention
and high endurance of data access. We acquired a majority ownership of Emosyn on September 10, 2004.
The segment data is reflected from this date through the end of the year.

SSC includes RF transmitter, receiver, synthesizer, power amplifier and
switch products. These products provide end-to-end RF solutions to enable wireless multimedia and
broadband networking applications. We formed SST Communications Corporation and acquired the
operations of G-Plus, Inc. on November 5, 2004. The segment data is reflected from this date through
the end of the year.

Technology licensing includes both up front license fees and royalties.

75

---



The following table shows our product revenues and gross profit (loss) for each segment (in
thousands):

`Year Ended December 31, 2004
                                          --------------------------
                                                           Gross
                                            Revenues    Profit (Loss)
                                          ------------  ------------
SMPG.................................... $    269,376  $     48,352
ASPG....................................       73,221        19,429
SPG.....................................       44,636        12,706
Emosyn..................................       16,905         2,363
SCC.....................................          593          (212)
Technology Licensing....................       44,467        44,467
                                          ------------  ------------
                                         $    449,198  $    127,105
                                          ============  ============


                                         Year Ended December 31, 2003
                                          --------------------------

                                            Revenues    Gross Profit
                                          ------------  ------------
SMPG.................................... $    166,776  $     21,428
ASPG....................................       60,481        11,544
SPG.....................................       29,272         4,782
Technology Licensing....................       38,512        38,512
                                          ------------  ------------
                                         $    295,041  $     76,266
                                          ============  ============


                                         Year Ended December 31, 2002
                                          --------------------------

                                            Revenues    Gross Profit
                                          ------------  ------------
SMPG.................................... $    143,194  $      5,451
ASPG....................................       67,791        24,534
SPG.....................................       33,036         7,790
Technology Licensing....................       30,637        30,637
                                          ------------  ------------
                                         $    274,658  $     68,412
                                          ============  ============`

Our net revenues are all denominated in U.S. dollars and are summarized as follows (in
thousands):

`Year ended December 31,
                                                  ---------------------------------------------
                                                      2002             2003            2004
                                                  ------------  ------------------  -----------
United States................................... $     21,871  $           19,600  $    32,833
Europe..........................................       10,599               9,957       28,863
Japan...........................................       28,465              27,575       35,233
Korea...........................................       30,321              25,214       36,715
Taiwan..........................................       91,219             109,254      125,491
China (including Hong Kong).....................       70,609              76,107      148,100
Other Asian countries...........................       21,574              27,334       41,963
                                                  ------------  ------------------  -----------
                                                 $    274,658  $          295,041  $   449,198
                                                  ============  ==================  ===========`

Foreign revenue is based on the country to which the product is shipped by us or
our logistics center.

76

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The locations and net book value of long-lived assets follows:

`December 31,
                                                  --------------------------------
                                                      2003             2004
                                                  ------------  ------------------
United States................................... $     10,052  $           13,443
China...........................................          855               1,035
Taiwan..........................................          299                 898
Other...........................................          119               1,244
                                                  ------------  ------------------
                                                 $     11,325  $           16,620
                                                  ============  ==================`

16. Equity Investments and Related Party Reporting:

Equity investments comprise (in thousands):

`Equity Investments comprise (in thousands):
                                                              December 31, 2004
                                                  ---------------------------------------------
                                                                    Long-term          Total
                                                     Equity     Available for Sale    Equity
                                                  Investments      Investments      Investment
                                                  ------------  ------------------  -----------
Advanced Chip Engineering Technology ........... $      4,012  $               --  $     4,012
Apacer Technology, Inc .........................        4,357                  --        4,357
Grace Semiconductor Manufacturing Corporation ..       83,150                  --       83,150
Insyde Software Corporation (1).................          322                 266          588
King Yuan Electronics Company, Limited..........           --               2,318        2,318
Nanotech Corporation ...........................        3,767                  --        3,767
Powertech Technology, Incorporated .............          767              14,076       14,843
Professional Computer Technology Limited (2)....          675               6,434        7,109
Silicon Technology Co., Ltd ....................          939                  --          939
Other...........................................          574                  --          574
                                                  ------------  ------------------  -----------
                                                 $     98,563  $           23,094  $   121,657
                                                  ============  ==================  ===========

                                                              December 31, 2003
                                                  ---------------------------------------------
                                                                    Long-term          Total
                                                     Equity     Available for Sale    Equity
                                                  Investments      Investments      Investment
                                                  ------------  ------------------  -----------
Apacer Technology, Inc ......................... $      4,358  $               --  $     4,358
Grace Semiconductor Manufacturing Corporation ..       50,000                  --       50,000
Insyde Software Corporation.....................          466                 397          863
King Yuan Electronics Company, Limited..........           --               3,218        3,218
Powertech Technology, Incorporated .............        1,206               5,498        6,704
Professional Computer Technology Limited........          775               3,810        4,585
Silicon Technology Co., Ltd ....................          939                  --          939
Other...........................................          333                  --          333
                                                  ------------  ------------------  -----------
                                                 $     58,077  $           12,923  $    71,000
                                                  ============  ==================  ===========`

(1) Includes $133 thousand in convertible bonds.
(2) Includes $1.3 million in convertible bonds.

77

---

The following table is a summary of our related party revenues and purchases (in thousands):

Year Ended
                                                               December 31, 2004
                                                  --------------------------------
                                                    Revenues         Purchases
                                                  ------------  ------------------
Silicon Technology Co., Ltd..................... $      7,943  $               --
Apacer Technology, Inc and related entities.....        2,359                 707
Silicon Professional Technology Ltd.............      214,195                  --
Grace Semiconductor Manufacturing Corporation...          156              59,278
King Yuan Electronics Company, Limited..........           --              38,248
Powertech Technology, Incorporated..............           --              14,718
                                                  ------------  ------------------
                                                 $    224,653  $          112,951
                                                  ============  ==================

                                                               Year Ended
                                                               December 31, 2003
                                                  --------------------------------
                                                    Revenues         Purchases
                                                  ------------  ------------------
Silicon Technology Co., Ltd..................... $      3,615  $               --
Apacer Technology, Inc and related entities.....        1,555               2,361
Silicon Professional Technology Ltd.............      164,810                  --
Grace Semiconductor Manufacturing Corporation...           --                  12
King Yuan Electronics Company, Limited..........           --              19,659
Powertech Technology, Incorporated..............           --               9,280
                                                  ------------  ------------------
                                                 $    169,980  $           31,312
                                                  ============  ==================

                                                               Year Ended
                                                               December 31, 2002
                                                  --------------------------------
                                                    Revenues         Purchases
                                                  ------------  ------------------
Silicon Technology Co., Ltd..................... $      2,089  $               --
Acer and related entities (1)...................          269                  --
Apacer Technology, Inc and related entities.....          899                 588
Professional Computer Technology Limited........          141                  --
Silicon Professional Technology Ltd.............      140,003                  --
King Yuan Electronics Company, Limited..........           --              18,163
Powertech Technology, Incorporated..............           --               8,378
                                                  ------------  ------------------
                                                 $    143,401  $           27,129
                                                  ============  ==================

(1) Excludes Apacer Technology, Inc. balances.


78The following table is a summary of our related party accounts receivable and accounts payable
and accruals (in thousands):

December 31, 2003             December 31, 2004
                                                  --------------------------------  -----------------------
                                                                     Accounts                     Accounts
                                                    Accounts       Payable and       Accounts    Payable and
                                                   Receivable        Accruals       Receivable    Accruals
                                                  ------------  ------------------  -----------  ----------
Silicon Technology Co., Ltd..................... $        232  $               --  $       322  $       --

Apacer Technology, Inc and related entities.....          400                 736          458         320
Professional Computer Technology Limited........           --                  15           --          72
Silicon Professional Technology Ltd.............       40,588                 550       32,037         694
Grace Semiconductor Manufacturing Corporation...           --                  --          156      17,227
King Yuan Electronics Company, Limited..........           --               6,896           --      13,702
Powertech Technology, Incorporated..............           --               2,533           --       3,867
Other...........................................           --                   4           --          --
                                                  ------------  ------------------  -----------  ----------
                                                 $     41,220  $           10,734  $    32,973  $   35,882
                                                  ============  ==================  ===========  ==========

In 1996, we acquired a 14% interest in Silicon Technology Co., Ltd., or Silicon Technology, a
privately held Japanese company, for $939 thousand in cash. Bing Yeh, our President, CEO and
Chairman of our Board of Directors, is also a member of Silicon Technology's board of directors. We
acquired the interest in Silicon Technology in order to provide a presence for our products in
Japan. We now have our own office in Japan, although Silicon Technology continues to sell our
products to smaller customers. At December 31, 2004 our investment, which is carried at cost,
represented 9% of the outstanding equity of Silicon Technology. Our sales to Silicon Technology were
made at prevailing market prices and the payment terms are consistent with the payment terms
extended to our other customers. We are not obligated to provide Silicon Technology with any
additional financing.
In 2000, we acquired a 10% interest in Apacer Technology, Inc, or Apacer, for $9.9 million in
cash. Apacer, a privately held Taiwanese company and a related entity of Acer, is a memory module
manufacturer. Bing Yeh, our President, CEO and Chairman of our Board of Directors, is also a member
of Apacer's board of directors. In 2001, we invested an additional $2.1 million in Apacer. In August
2002, we made an additional investment of $181 thousand. The investment was written down to $4.4
million during 2002, refer to Note 13 of these Notes to the Consolidated Financial Statements. At
December 31, 2004, our investment represented 10% of the outstanding equity of Apacer.
In 2000, we acquired a 15% interest in Professional Computer Technology Limited, or PCT, a
privately held Taiwanese company, for $1.5 million in cash. Bing Yeh, our President, CEO and
Chairman of our Board of Directors, is also a member of PCT's board of directors. PCT is one of our
stocking representatives. In May 2002, we made an additional investment of $179 thousand in PCT.
During 2003, PCT completed an initial public offering on the Taiwan Stock Exchange and we sold a
portion of our holdings. Under Taiwan security regulations, a certain number of shares must be held
in a central custody and are restricted from sale for a period of time. The shares available for
sale within one year are carried at the quoted market price and included in long-term
available-for-sale investments in the balance sheet as of December 31, 2003 and 2004. Shares required to be held
in custody for greater than a one year period are carried at cost and included in equity
investments. In February 2004, we invested an additional $1.7 million cash in PCT's European
convertible bonds which are included in long-term available-for-sale investments in the balance
sheet as of December 31, 2004. At December 31, 2004 our investment represented 13% of the
outstanding equity and 13% of the European convertible bonds of PCT.

PCT and its subsidiary, Silicon Professional Alliance Corporation, or SPAC, earn
commissions for point-of-sales transactions to its customers.  Commissions to PCT and SPAC are paid
at the same rate as all of our other stocking representatives in Asia.  In 2002, 2003 and 2004 we
paid sales commissions of $2.5 million, $1.2 million and $579 thousand, respectively, to PCT and
SPAC.  Shipments, by us or our logistics center, to PCT and SPAC for reshipment accounted for 10.3%,
27.3% and 31.3% of our product shipments in 2002, 2003 and 2004.  In addition, PCT and SPAC
solicited sales, for which they earned a commission, for 19.5%, 12.0% and 3.3% of our shipments to
end users in 2002, 2003 and 2004, respectively.

79In 2001, PCT established a separate company and wholly-owned subsidiary, Silicon
Professional Technology Ltd., or SPT, to provide planning, warehousing, delivery, billing,
collection and other logistic functions for us in Taiwan. SPT now services substantially all of our
end customers based in Taiwan, China and other Southeast Asia countries. Product shipped to SPT is
accounted for as our inventory held at our logistics center, and revenue is recognized when the
products have been delivered and are considered as a sale to our end customers by SPT. We pay SPT a
fee based on a percentage of revenue for each product sold through SPT to our end customers. The fee
paid to SPT covers the cost of warehousing and insuring inventory and accounts receivable, personnel
costs required to maintain logistics and information technology functions and the costs to perform
billing and collection of accounts receivable. SPT receives extended payment terms and must pay us
whether or not they have collected the accounts receivable.
In 2000, we acquired a 1% interest in King Yuan Electronics Company Limited, or KYE, a publicly
held Taiwanese company, which is a production subcontractor, for $4.6 million in cash. A member of
our management team holds a supervisor position at KYE. The role and responsibilities of a
supervisor are defined and governed by Corporate Law in Taiwan. The investment was made in KYE in
order to strengthen the relationship between us and KYE. During 2001, KYE completed an initial
public offering on the Taiwan Stock Exchange. Accordingly, the investment has been included in
long-term available-for-sale investments in the balance sheet as of December 31, 2003 and 2004. From the
date of the initial public offering to December 31, 2001, there had been a significant decline in
the market value of the investment. We concluded that the decline in value was "other-than-temporary"
and a write down of $3.3 million was necessary in 2001. The investment was written down
to $1.3 million based on the quoted market price as of December 31, 2001. The investment is valued
at $2.3 million as of December 31, 2004 based on the quoted market price. At December 31, 2004, our
investment represented 0.5% of the outstanding equity of KYE.

In 2000, we acquired a 3% interest in Powertech Technology, Inc., or PTI, a privately held
Taiwanese company, which is a production subcontractor, for $2.5 million in cash.
Bing Yeh, our President, CEO and Chairman of the Board of Directors,
is also a member of PTI's board of directors.
During 2003, PTI completed an initial public offering on the Taiwan Stock Exchange and we sold a
portion of our holdings. Under Taiwan security regulations, a certain number of shares must be held
in a central custody and are restricted from sale for a period of time. The shares available for
sale within one year are carried at the quoted market price and included in long-term
available-for-sale investments in the balance sheet as of December 31, 2003 and 2004. Shares required to be held
in custody for greater than a one year period are carried at cost and included in equity
investments. In August 2004, we invested an additional $723 thousand cash in PTI shares available
for sale. At December 31, 2004, our investment represented 2% of the outstanding equity of PTI.

In 2001, we acquired a 9% interest in Grace Semiconductor Manufacturing Corporation, or GSMC, a
privately held Cayman Islands company for $50.0 million cash. In March 2004, we invested an
additional $33.2 million cash in GSMC. Bing Yeh, our president, CEO and Chairman of our Board of
Directors, is also a member of GSMC's board of directors. In addition, a member of our management
team holds one supervisor position at GSMC. The role and responsibilities of a supervisor are
defined and governed by Corporate Law in the Cayman Islands. This investment is carried at cost.
GSMC has a wholly owned subsidiary, Shanghai Grace Semiconductor Manufacturing Corporation, or
Grace, which is a wafer foundry company with operations in China. At December 31, 2004, our
investment represented 10% of the outstanding equity of GSMC.
In 2002, we acquired a 6% interest in Insyde Software Corporation, or Insyde, a privately held
Taiwanese company, for $964 thousand in cash. Bing Yeh, our President, CEO and Chairman of our Board
of Directors, is also a member of Insyde's board of directors. During 2003, Insyde completed an
initial public offering on the Taiwan Stock Exchange. Under Taiwan security regulations, certain
numbers of shares must be held in a central custody and are restricted from sale for a period of
time. The shares available for sale within one year are carried at the quoted market price and
included in long-term available-for-sale investments in the balance sheet as of December 31, 2003
and 2004. Shares required to be held in custody for greater than a one year period are carried at
cost and included in equity investments. In January 2004, we invested an additional $133 thousand
cash in Insyde's convertible bonds. The stock investment was written down $509 thousand during 2004,
refer to Note 12 of these Notes to the Consolidated Financial Statements. At December 31, 2004, our
investment represented 6% of the outstanding equity and 6% of the convertible bonds of Insyde.
In June 2004, we acquired a 9% interest in Advanced Chip Engineering Technology, or ACET, for
$4.0 million cash. ACET, a privately held Taiwanese company and a related entity of KYE, is a
production subcontractor. Chen Tsai, our Senior Vice President of Worldwide Backend Operations, is
also a member of ACET's board of directors. At December 31, 2004 our investment, which is carried at
cost, represented 9% of the outstanding equity of ACET.


80In November 2004, we acquired a 30% interest in Nanotech
Corporation, or Nanotech, a privately held Cayman Island company, for $3.8 million cash. Nanotech, a
development stage company, has a wholly owned subsidiary which is in the process of starting up
foundry operations in China. Bing Yeh, our President, CEO and Chairman of our Board of Directors, is
also a member of Nanotech's board of directors. Tsuyoshi Taira, a member of our Board of Directors,
also invested in this round of financing. The investment was part of a second round of
financing.We are not obligated to provide Nanotech with any additional
financing. At December 31, 2004 our investment, which is accounted for under the equity
method, represented 30% of the outstanding equity of Nanotech.


17. Employee Benefit Plans:
Profit Sharing Plan:We have a Profit Sharing Plan under which employees may collectively earn up to 10% of
our operating profit, provided that both net earnings before interest income (expense), net
provision for (benefit from) income taxes and operating profit are greater than 10% of sales. For
purposes of the Profit Sharing Plan, "operating profit" is net revenues less cost of revenues and
less operating expenses. The sum paid to any particular employee as profit sharing is a function of
the employee's length of service, performance and salary. We plan to pay profit sharing sums, when
available, to employees twice a year. During 2004, profiting sharing expenses of $3.7 million were
recorded. No profit sharing was paid in relation to 2002 or 2003.
401(k) Plan:

We have adopted the SST 401(k) Tax Sheltered Savings Plan and Trust, or the
401(k) Plan, as amended, which is intended to qualify under Section 401 of the Internal Revenue Code
of 1986.  The 401(k) Plan covers essentially all employees.  Each eligible employee may elect to
contribute to the 401(k) Plan, through payroll deductions, up to 15% of their compensation, subject
to certain limitations.  At our discretion, we may make additional contributions on behalf of
employees.  All employee contributions are 100% vested.  During 2002, 2003 and 2004, we matched the
first $1,000 of each employees' contribution, for a total of $405 thousand, $384 thousand and $379
thousand, respectively.

18. Subsequent Events:

On February 7, 2004, we entered into a Memorandum of Understanding, or MoU, to acquire a company. There would be
significant penalties if either party were to terminate the MoU. The termination penalties range from
$1 million and $2 million.

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SCHEDULE II

SILICON STORAGE TECHNOLOGY, INC.

                        VALUATION AND QUALIFYING ACCOUNTS

                                 (in thousands)

`Balance at  Charged to    Write-off   Balance at
                                                                Beginning    Costs and   of Accounts    End of
Description                                                     of Period    Expenses      /Other       Period
--------------------------------------------------------------  ----------  -----------  -----------  ----------
Year ended December 31, 2002
  Allowance for doubtful accounts............................. $    2,814  $     3,046  $     1,440  $    4,420
  Allowance for sales returns................................. $    4,498  $     2,842  $     5,553  $    1,787
  Allowance for excess and obsolete inventories and adverse
     purchase commitments..................................... $   47,747  $    10,441  $    29,466  $   28,722
  Valuation allowance on deferred tax assets.................. $       --  $        --  $        --  $       --

Year ended December 31, 2003
  Allowance for doubtful accounts............................. $    4,420  $       228  $     3,530  $    1,118
  Allowance for sales returns................................. $    1,787  $       316  $       802  $    1,301
  Allowance for excess and obsolete inventories and adverse
     purchase commitments..................................... $   28,722  $     6,670  $    23,638  $   11,754
  Valuation allowance on deferred tax assets.................. $       --  $    41,114  $        --  $   41,114

Year ended December 31, 2004
  Allowance for doubtful accounts............................. $    1,118  $       825  $       754  $    1,189
  Allowance for sales returns................................. $    1,301  $     1,347  $       639  $    2,009
  Allowance for excess and obsolete inventories and adverse
     purchase commitments..................................... $   11,754  $    35,883  $     7,155  $   40,482
  Valuation allowance on deferred tax assets.................. $   41,114  $        --  $    13,923  $   27,191`

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