**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

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**FORM10-Q**

 

| **x**      | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                                                                                                    |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                  |
|       |       | **For the  quarterly period ended October 31, 2007**                                                                                                                                                                             |
|       |       |                                                                                                                                                                                                                                  |
|       |       | **OR**                                                                                                                                                                                                                                |
|       |       |                                                                                                                                                                                                                                  |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                    |
| ** ** | ** ** | ** **                                                                                                                                                                                                                            |
| ** ** | ** ** | **For the  transition period from                to                ** |

 

**Commission file number: 0-29939**

 

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**OMNIVISION TECHNOLOGIES, INC.**

(Exact name of registrantas specified in its charter)

 

| **Delaware**                       | ** ** | **77-0401990**          |
|------------------------------------|------------|-------------------------|
| (State or other  jurisdiction      |       | (I.R.S. Employer        |
| of incorporation  or organization) |       | Identification  Number) |

 

**1341 Orleans Drive, Sunnyvale,California 94089-1136**

(Address of PrincipalExecutive Offices) (Zip Code)

 

Registrant’s telephonenumber, including area code: **(408) 542-3000**

 

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Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities and Exchange Act of 1934 during thepreceding 12 months (or for shorter period that the registrant was required tofile such reports); and (2) has been subject to such filing requirements forthe past 90 days. Yes xNo o

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  xAccelerated filer  o  Non-accelerated filer  o

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theSecurities Exchange Act of 1934). Yes oNo x

 

AtNovember 30, 2007, 55,453,813 shares of common stock of theregistrant were outstanding, exclusive of 6,435,700 shares of treasury stock.

 

 

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**OMNIVISION TECHNOLOGIES, INC.**

 

**INDEX**

 
| ** **                         | ** **                                                                                                                           | ** ** | **Page**   |
|------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **                         | ** **                                                                                                                           | ** ** | ** ** |
| ** **                         | ** **                                                                                                                           | ** ** | ** ** |
| **PART I.  FINANCIAL INFORMATION** | ** **                                                                                                                           | ** ** |
| ** **                         | ** **                                                                                                                           | ** ** | ** ** |
| **Item  1.**                       | Financial  Statements:                                                                                                               |       | 3          |
|                               |                                                                                                                                 |       |       |
|                               | Condensed  Consolidated Balance Sheets (unaudited) – October 31, 2007 and  April 30, 2007                   |       | 3          |
|                               |                                                                                                                                 |       |       |
|                               | Condensed  Consolidated Statements of Income (unaudited) – Three and Six  Months Ended October 31, 2007 and 2006 |       | 4          |
|                               |                                                                                                                                 |       |       |
|                               | Condensed  Consolidated Statements of Cash Flows (unaudited) – Six Months  Ended October 31, 2007 and 2006       |       | 5          |
|                               |                                                                                                                                 |       |       |
|                               | Notes  to Condensed Consolidated Financial Statements (unaudited)                                                                    |       | 6          |
|                               |                                                                                                                                 |       |       |
| **Item 2.**                        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                          |       | 26         |
|                               |                                                                                                                                 |       |       |
| **Item 3.**                        | Quantitative  and Qualitative Disclosures About Market Risk                                                                          |       | 44         |
|                               |                                                                                                                                 |       |       |
| **Item 4.**                        | Controls and  Procedures                                                                                                             |       | 45         |
|                               |                                                                                                                                 |       |       |
|                               |                                                                                                                                 |       |       |
| **PART II. OTHER  INFORMATION**    | ** **                                                                                                                           | ** ** |
|                               |                                                                                                                                 |       |       |
| **Item 1.**                        | Legal Proceedings                                                                                                                    |       | 46         |
|                               |                                                                                                                                 |       |       |
| **Item 1A.**                       | Risk  Factors                                                                                                                        |       | 48         |
|                               |                                                                                                                                 |       |       |
| **Item 2.**                        | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                         |       | 62         |
|                               |                                                                                                                                 |       |       |
| **Item 4.**                        | Submission  of Matters to a Vote of Security Holders                                                                                 |       | 62         |
|                               |                                                                                                                                 |       |       |
| **Item  6.**                       | Exhibits                                                                                                                             |       | 63         |
|                               |                                                                                                                                 |       |       |
| Signatures                         |                                                                                                                                 | 64         |
|                               |                                                                                                                                 |       |       |
| Exhibit  Index                     |                                                                                                                                 |       |
| Exhibit 31.1                       |                                                                                                                                 |       |
| Exhibit 31.2                       |                                                                                                                                 |       |
| Exhibit 32                         |                                                                                                                                 |       |

 

2

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**PART I —FINANCIAL INFORMATION**

 

**ITEM 1.   FINANCIAL STATEMENTS**

 

**OMNIVISION TECHNOLOGIES, INC.**

 

**CONDENSEDCONSOLIDATED BALANCESHEETS**

**(in thousands, except per shareamounts)**

**(unaudited)**

 
| ** **                                                                                                                                                                                                           | ** ** | **October 31,** | ** ** | **April 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|---------------|------------|
| ** **                                                                                                                                                                                                           | ** ** | **2007**             | ** ** | **2007**      | ** ** |
| **ASSETS**                                                                                                                                                                                                           | ** ** | ** **           | ** ** | ** **    | ** ** |
| Current assets:                                                                                                                                                                                                      |       |                 |       |          |       |
| Cash and cash equivalents                                                                                                                                                                                            |       | $                    | 207,606    |          | $          | 190,878 |   |
| Short-term investments                                                                                                                                                                                               |       | 116,326              |       | 114,432       |       |
| Accounts receivable, net of allowances for doubtful  accounts and sales returns                                                                                                                                      |       | 87,720               |       | 65,666        |       |
| Inventories                                                                                                                                                                                                          |       | 133,370              |       | 119,663       |       |
| Deferred income taxes                                                                                                                                                                                                |       | 3,862                |       | 3,356         |       |
| Prepaid expenses and other current assets                                                                                                                                                                            |       | 7,016                |       | 8,717         |       |
| Recoverable insurance proceeds (Note 15)                                                                                                                                                                             |       | 13,000               |       | 13,000        |       |
| Total current assets                                                                                                                                                                                                 |       | 568,900              |       | 515,712       |       |
| Property, plant and equipment, net                                                                                                                                                                                   |       | 83,146               |       | 64,363        |       |
| Long-term investments                                                                                                                                                                                                |       | 81,460               |       | 67,281        |       |
| Goodwill                                                                                                                                                                                                             |       | 7,541                |       | 7,541         |       |
| Intangibles, net                                                                                                                                                                                                     |       | 17,212               |       | 20,493        |       |
| Other long-term assets                                                                                                                                                                                               |       | 12,909               |       | 12,669        |       |
| Total assets                                                                                                                                                                                                         |       | $                    | 771,168    |          | $          | 688,059 |   |
|                                                                                                                                                                                                                 |       |                 |       |          |       |
| **LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS’  EQUITY**                                                                                                                                                    |       |                 |       |          |       |
| Current liabilities:                                                                                                                                                                                                 |       |                 |       |          |       |
| Accounts payable                                                                                                                                                                                                     |       | $                    | 87,849     |          | $          | 56,290 |   |
| Accrued expenses and other current liabilities                                                                                                                                                                       |       | 18,877               |       | 17,524        |       |
| Litigation settlement accrual                                                                                                                                                                                        |       | 13,000               |       | 13,750        |       |
| Income taxes payable                                                                                                                                                                                                 |       | 10,859               |       | 61,617        |       |
| Deferred income                                                                                                                                                                                                      |       | 6,697                |       | 8,873         |       |
| Current portion of long-term debt                                                                                                                                                                                    |       | 654                  |       | 631           |       |
| Total current liabilities                                                                                                                                                                                            |       | 137,936              |       | 158,685       |       |
| Long-term liabilities:                                                                                                                                                                                               |       |                 |       |          |       |
| Long-term income taxes payable                                                                                                                                                                                       |       | 59,758               |       | —        |       |
| Non-current portion of long-term debt                                                                                                                                                                                |       | 27,270               |       | 27,576        |       |
| Other long-term liabilities                                                                                                                                                                                          |       | 5,824                |       | 6,998         |       |
| Total long-term liabilities                                                                                                                                                                                          |       | 92,852               |       | 34,574        |       |
| Total liabilities                                                                                                                                                                                                    |       | 230,788              |       | 193,259       |       |
|                                                                                                                                                                                                                 |       |                 |       |          |       |
| Commitments and contingencies (Note 15)                                                                                                                                                                              |       |                 |       |          |       |
|                                                                                                                                                                                                                 |       |                 |       |          |       |
| Minority interest                                                                                                                                                                                                    |       | 4,470                |       | 4,344         |       |
|                                                                                                                                                                                                                 |       |                 |       |          |       |
| Stockholders’ equity:                                                                                                                                                                                           |       |                 |       |          |       |
| Common stock, $0.001 par value; 100,000 shares  authorized; 61,709 issued and 55,273 outstanding at October 31, 2007 and  60,811 shares issued and 54,941 outstanding at April 30, 2007, respectively |       | 62                   |       | 61            |       |
| Additional paid-in capital                                                                                                                                                                                           |       | 354,605              |       | 329,012       |       |
| Accumulated other comprehensive income                                                                                                                                                                               |       | 1,163                |       | 867           |       |
| Treasury stock, 6,436 and 5,870 at October 31,  2007 and April 30, 2007, respectively                                                                                                                      |       | (89,184              | )          | (79,568       | )          |
| Retained earnings                                                                                                                                                                                                    |       | 269,264              |       | 240,084       |       |
| Total stockholders’ equity                                                                                                                                                                                      |       | 535,910              |       | 490,456       |       |
| Total liabilities, minority interest and  stockholders’ equity                                                                                                                                                  |       | $                    | 771,168    |          | $          | 688,059 |   |

 

The accompanying notesare an integral part of these Condensed Consolidated Financial Statements (unaudited).

 

3

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**OMNIVISION TECHNOLOGIES, INC.**

 

**CONDENSEDCONSOLIDATED STATEMENTSOF INCOME**

**(in thousands, except per shareamounts)**

**(unaudited)**

 
| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                       | ** ** | **October 31,**   | ** ** | **October 31,** | ** ** |
| ** **                                       | ** ** | **2007**               | ** ** | **2006**             | ** ** | **2007** | ** ** | **2006** | ** ** |
| Revenues                                         |       | $                      | 232,622    |                 | $          | 137,656 |   | $ | 405,756 |   | $ | 274,531 |   |
| Cost of revenues                                 |       | 173,998                |       | 92,101               |       | 306,524 |   | 179,256 |   |
| Gross profit                                     |       | 58,624                 |       | 45,555               |       | 99,232 |   | 95,275 |   |
|                                             |       |                   |       |                 |       |   |   |   |   |
| Operating expenses:                              |       |                   |       |                 |       |   |   |   |   |
| Research, development and related                |       | 20,178                 |       | 18,657               |       | 37,604 |   | 35,499 |   |
| Selling, general and administrative              |       | 15,787                 |       | 15,774               |       | 30,952 |   | 28,225 |   |
| Litigation settlement                            |       | —                 |       | 3,300                |       | — |   | 3,300 |   |
| Total operating expenses                         |       | 35,965                 |       | 37,731               |       | 68,556 |   | 67,024 |   |
|                                             |       |                   |       |                 |       |   |   |   |   |
| Income from operations                           |       | 22,659                 |       | 7,824                |       | 30,676 |   | 28,251 |   |
| Interest income, net                             |       | 3,325                  |       | 3,366                |       | 6,686 |   | 6,769 |   |
| Other income (expense), net                      |       | (338                   | )          | 669                  |       | (78 | ) | 1,646 |   |
| Income before income taxes and minority interest |       | 25,646                 |       | 11,859               |       | 37,284 |   | 36,666 |   |
|                                             |       |                   |       |                 |       |   |   |   |   |
| Provision for income taxes                       |       | 5,151                  |       | 3,907                |       | 3,791 |   | 10,531 |   |
| Minority interest                                |       | (15                    | )          | 2,537                |       | 6 |   | 4,839 |   |
| Net income                                       |       | $                      | 20,510     |                 | $          | 5,415 |   | $ | 33,487 |   | $ | 21,296 |   |
|                                             |       |                   |       |                 |       |   |   |   |   |
| Net income per share:                            |       |                   |       |                 |       |   |   |   |   |
| Basic                                            |       | $                      | 0.37       |                 | $          | 0.10 |   | $ | 0.61 |   | $ | 0.39 |   |
| Diluted                                          |       | $                      | 0.36       |                 | $          | 0.10 |   | $ | 0.60 |   | $ | 0.38 |   |
|                                             |       |                   |       |                 |       |   |   |   |   |
| Shares used in computing net income per share:   |       |                   |       |                 |       |   |   |   |   |
| Basic                                            |       | 54,985                 |       | 54,620               |       | 54,868 |   | 54,511 |   |
| Diluted                                          |       | 56,449                 |       | 55,624               |       | 55,503 |   | 55,689 |   |

 

The accompanying notesare an integral part of these Condensed Consolidated Financial Statements(unaudited).

 

4

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**OMNIVISION TECHNOLOGIES, INC.**

**CONDENSEDCONSOLIDATED STATEMENTSOF CASH FLOWS**

**(in thousands, unaudited)**

 
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                         | ** ** | **October 31,** | ** ** |
| ** **                                                                         | ** ** | **2007**             | ** ** | **2006** | ** ** |
| Cash flows from operating activities:                                              |       |                 |       |   |   |
| Net income                                                                         |       | $                    | 33,487     |   | $ | 21,296 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                 |       |   |   |
| Depreciation and amortization                                                      |       | 6,337                |       | 7,822 |   |
| Change in fair value of interest rate swap                                         |       | 169                  |       | — |   |
| Stock-based compensation                                                           |       | 13,986               |       | 15,277 |   |
| Minority interest in net income of consolidated  affiliates                        |       | 6                    |       | 4,839 |   |
| Equity investment gain, net                                                        |       | (4,072               | )          | (1,628 | ) |
| Affiliate stock grants                                                             |       | 56                   |       | 179 |   |
| Write-down of inventories                                                          |       | 12,422               |       | 2,354 |   |
| Loss on disposal of property, plant and equipment                                  |       | —               |       | 7 |   |
| Changes in assets and liabilities:                                                 |       |                 |       |   |   |
| Accounts receivable, net                                                           |       | (22,046              | )          | (9,384 | ) |
| Inventories                                                                        |       | (27,659              | )          | (51,173 | ) |
| Deferred income taxes                                                              |       | (314                 | )          | — |   |
| Prepaid expenses and other current assets                                          |       | 1,700                |       | (17,653 | ) |
| Accounts payable                                                                   |       | 22,922               |       | 35,349 |   |
| Accrued expenses and other current liabilities                                     |       | 3,821                |       | 14,702 |   |
| Income taxes payable                                                               |       | 4,690                |       | 11,535 |   |
| Deferred income                                                                    |       | (2,176               | )          | 520 |   |
| Deferred tax liabilities                                                           |       | (1,344               | )          | (962 | ) |
| Net cash provided by operating activities                                          |       | 41,985               |       | 33,080 |   |
| Cash flows from investing activities:                                              |       |                 |       |   |   |
| Purchases of short-term investments                                                |       | (65,241              | )          | (125,672 | ) |
| Proceeds from sales or maturities of short-term  investments                       |       | 63,961               |       | 96,800 |   |
| Purchases of property, plant and equipment, net of  sales                          |       | (16,566              | )          | (49,143 | ) |
| Purchases of long-term investments                                                 |       | (9,000               | )          | — |   |
| Purchases of intangible assets                                                     |       | —               |       | (548 | ) |
| Net cash used in investing activities                                              |       | (26,846              | )          | (78,563 | ) |
| Cash flows from financing activities:                                              |       |                 |       |   |   |
| Repayment of long-term debt                                                        |       | (283                 | )          | (74 | ) |
| Cash contribution by minority shareholder                                          |       | 49                   |       | 4,290 |   |
| Affiliate cash dividend paid to minority shareholder                               |       | (226                 | )          | (245 | ) |
| Proceeds from exercise of stock options and employee  stock purchase plan          |       | 11,607               |       | 8,345 |   |
| Payments for repurchases of common stock                                           |       | (9,616               | )          | — |   |
| Net cash provided by financing activities                                          |       | 1,531                |       | 12,316 |   |
| Effect of exchange rate changes on cash and cash  equivalents                      |       | 58                   |       | (25 | ) |
| Net (decrease) increase in cash and cash equivalents                               |       | 16,728               |       | (33,192 | ) |
| Cash and cash equivalents at beginning of period                                   |       | 190,878              |       | 240,227 |   |
| Cash and cash equivalents at end of period                                         |       | $                    | 207,606    |   | $ | 207,035 |   |
| Supplemental cash flow information:                                                |       |                 |       |   |   |
| Taxes paid, net                                                                    |       | $                    | 2,031      |   | $ | 1,764 |   |
| Interest paid                                                                      |       | $                    | 9          |   | $ | 13 |   |
| Supplemental schedule of non-cash investing and  financing activities:             |       |                 |       |   |   |
| Capital equipment financing obligation                                             |       | $                    | 8,597      |   | $ | 554 |   |
| Affiliate shares issued to affiliate employees                                     |       | $                    | 295        |   | $ | 459 |   |
| Change-of-interest benefit from minority shareholder  cash contribution            |       | $                    | —     |   | $ | 1,229 |   |
| Issuance of escrow shares to CDM selling  stockholders                             |       | $                    | —     |   | $ | 34 |   |
| Capitalized interest                                                               |       | $                    | 140        |   | $ | — |   |
| Impact of initial adoption of FIN 48 on retained  earnings                    |       | $                    | 4,307      |   | $ | — |   |

 

The accompanying notesare an integral part of these Condensed Consolidated Financial Statements(unaudited).

 

5

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**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

**Note 1 — Basis ofPresentation**

 

## ***Overview***

 

The accompanying interimunaudited condensed consolidated financial statements as of October 31,2007 and April 30, 2007 and for the three and six months endedOctober 31, 2007 and 2006 have been prepared by OmniVision Technologies,Inc., and its subsidiaries (“OmniVision” or the “Company”) in accordance withthe rules and regulations of the U.S. Securities and Exchange Commission (“SEC”).The amounts as of April 30, 2007 come from the Company’s annual auditedfinancial statements. Certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with generally acceptedaccounting principles have been condensed or omitted in accordance with suchrules and regulations. In the opinion of management, the accompanying unauditedcondensed consolidated financial statements reflect all adjustments, consistingonly of normal recurring adjustments, necessary to state fairly the financialposition of the Company and its results of operations and cash flows as of andfor the periods presented. These condensed consolidated financial statementsshould be read in conjunction with the annual audited financial statements andnotes thereto included in the Company’s Annual Report on Form 10-K for thefiscal year ended April 30, 2007 (the “Form 10-K”).

 

The results of operationsfor the three and six months ended October 31, 2007 are not necessarilyindicative of the results that may be expected for the fiscal year endingApril 30, 2008 or any other future period.

 

## ***Useof Estimates***

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities, thedisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. The Company bases its estimates and judgments on itshistorical experience, knowledge of current conditions and beliefs of whatcould occur in the future considering available information. Actual resultscould differ from these estimates.

 

**Note 2 — Summaryof Significant Accounting Policies**

 

## ***Principlesof Consolidation***

 

The condensed consolidatedfinancial statements include the accounts of the Company, its wholly-ownedsubsidiaries and its consolidated affiliate. All significant inter-companyaccounts and transactions have been eliminated.

 

## ***Change-of-InterestBenefit/Impairment***

 

Where an unrelated thirdparty invests in one of the Company’s consolidated subsidiaries or affiliates,and the per share value of the investment exceeds the Company’s average pershare carrying value in the entity, the Company will record thechange-of-interest benefit as “Additional paid-in capital.” If the per sharevalue is less than the Company’s per share carrying value, the Company will assesswhether the investment has been impaired.

 

## ***ForeignCurrency Translation***

 

For subsidiaries orconsolidated affiliates with local currencies as the functional currency, theassets and liabilities of the subsidiaries are translated into U.S. dollars atthe rates of exchange prevailing on the balance sheet date. Revenue and expenseitems are translated into U.S. dollars at the average rate of exchange for theperiod. Unrealized gains and losses from foreign currency translation areincluded in “Accumulated other comprehensive income,” a component ofstockholders’ equity. For subsidiaries with the U.S. dollar as the functionalcurrency, and with assets denominated in currencies other than the functionalcurrency, non-monetary assets are remeasured into U.S. dollars using historicalrates of exchange. Monetary assets are remeasured into U.S. dollars usingexchange rates prevailing on the balance sheet date. Remeasurement gains andlosses which are included in “Other income (expense), net,” have not beenmaterial in any of the periods presented.

 

6

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**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

## ***Cashand Cash Equivalents***

 

The Company considers allhighly liquid investments purchased with a maturity at the date of purchase ofthree months or less to be cash equivalents. Cash equivalents consistprincipally of commercial paper, government bonds, certificates of deposit andmoney market funds that are stated at cost, which approximates fair value.

 

The Company maintains itscash and cash equivalent balances with major financial institutions in theUnited States. These balances are subject to a concentration of credit risk andonly a small proportion of these balances are covered by Federal DepositInsurance Corporation (“FDIC”) insurance.

 

## ***Inventories***

 

Inventories are stated atthe lower of cost, determined on a first-in, first-out (“FIFO”) basis, ormarket.

 

The Company recordsallowances to reduce the carrying value of inventories to their net realizablevalue when the Company believes that the net realizable value is less thancost. The Company also records allowances for the cost of inventories when thenumber of units on hand exceeds the number of units that the Company forecastswill be sold over a certain period of time, generally 12 months. The recordingof these allowances establishes a new and lower cost basis for eachspecifically identified inventory item, and the Company does not restore thecost basis to its original level regardless of any subsequent changes in factsor circumstances.

 

## ***ComprehensiveIncome (Loss)***

 

Comprehensive income(loss) is defined as the change in the equity of a company during a period fromtransactions and other events and circumstances excluding transactionsresulting from investments by owners and distributions to owners. Comprehensiveincome for the three months ended October 31, 2007 was $20.7 millionand included net income, unrealized gains (losses) from available-for-salesecurities and translation gains (losses) from foreign subsidiaries. Comprehensiveincome for the six months ended October 31, 2007 was $29.5 millionand included net income, the impact of the initial adoption of FIN 48 onretained earnings, unrealized gains (losses) from available-for-sale securitiesand translation gains (losses) from foreign subsidiaries. Comprehensive incomefor the three months ended October 31, 2006 was $5.6 million andincluded net income, unrealized gains (losses) from available-for-salesecurities and translation gains (losses) from foreign subsidiaries.Comprehensive income for the six months ended October 31, 2006 was$21.7 million and included net income, unrealized gains (losses) fromavailable-for-sale securities, change-of-interest benefits and translationgains (losses) from foreign subsidiaries.

 

## ***RevenueRecognition***

 

For shipments tocustomers without agreements that allow for returns or credits, principally originalequipment manufacturers (“OEMs”) and value added resellers (“VARs”), theCompany recognizes revenue using the “sell-in” method. Under this method, theCompany recognizes revenue upon the shipment of products to the customerprovided that the Company has received a signed purchase order, the price isfixed or determinable, title and risk of loss has transferred to the customer,collection of resulting receivables is considered reasonably assured, productreturns are reasonably estimable, there are no customer acceptance requirementsand there are no remaining material obligations. At the time revenue isrecognized, the Company provides for future returns of potentially defectiveproduct based on historical experience. For cash consideration given to customersfor which the Company does not receive a separately identifiable benefit orcannot reasonably estimate fair value, the Company records the amounts asreductions of revenue.

 

For shipments todistributors under agreements allowing for returns or credits, the Companyrecognizes revenue using the “sell-through” method under which the Companydefers revenue and the related costs of sale until the distributor resells theproduct to the Company’s end-user customer and the Company is notified inwriting by the distributor of such sale. The amount billed to thesedistributors less the cost of inventory shipped to but not yet sold by thedistributors is shown net on the Condensed Consolidated Balance Sheets asdeferred income.

 

In addition, the Companyrecognizes revenue from the performance of services to a limited number ofcustomers by its wholly-owned subsidiary, CDM Optics, Inc. (“CDM”), and,through December 31, 2006, by its then consolidated

 

7

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**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

affiliate, VisEraTechnologies Company, Ltd. (“VisEra”). (See Note 5.) The Companyrecognizes the CDM-associated revenue under either the completed-contract orthe percentage-of-completion methods. The percentage-of-completion method ofaccounting is used for cost reimbursement-type contracts, where revenuesrecognized are that portion of the total contract price equal to the ratio ofcosts expended to date to the anticipated final total costs based on currentestimates of the costs to complete the projects. CDM-associated revenue has notbeen material in any of the periods presented. Until December 31, 2006,the Company recognized VisEra’s service revenue from third party customers whenthe production services provided by VisEra were complete and the product wasshipped to the customer.

 

## ***IncomeTaxes***

 

The Company accounts fordeferred income taxes using the liability method, under which the expectedfuture tax consequences of timing differences between the book and tax basis ofassets and liabilities are recognized as deferred tax assets and liabilities.Valuation allowances are established when necessary to reduce deferred taxassets when management estimates, based on available objective evidence, thatit is more likely than not that the benefit of deferred tax assets will not berealized.

 

On May 1, 2007, theCompany adopted Financial Accounting Standards Board (“FASB”) InterpretationNo. (“FIN”) 48, *“Accounting forUncertainty in Income Taxes—an interpretation of FASB Statement No. 109”*(“FIN 48”) which the FASB issued in June 2006. See Note 14 forthe impact of FIN 48 on the Company’s condensed consolidated financialstatements. FIN 48 requires that the Company recognize in its consolidatedfinancial statements the impact of a tax position that, based on the technicalmerits of the position, is more likely than not to be sustained upon examination.The evaluation of a tax position in accordance with this interpretation is atwo-step process. In the first step, recognition, the Company determineswhether it is more-likely-than-not that a tax position will be sustained uponexamination, including resolution of any related appeals or litigationprocesses, based on the technical merits of the position. The second stepaddresses measurement of a tax position that meets the more-likely-than-notcriterion. The tax position is measured at the largest amount of benefit thathas a greater than 50 percent likelihood of being realized upon ultimatesettlement. Tax positions that previously failed to meet themore-likely-than-not recognition threshold will be recognized in the firstsubsequent financial reporting period in which that threshold is met.Previously recognized tax positions that no longer meet themore-likely-than-not recognition threshold will be de-recognized in the firstsubsequent financial reporting period in which that threshold is no longer met.The differences between the amounts recognized in the condensed consolidatedfinancial statements prior to the adoption of FIN 48 and the amountsreported after adoption have been accounted for as a cumulative-effectadjustment recorded to the beginning balance of retained earnings.

 

## ***Stock-BasedCompensation***

 

Effective May 1,2006, the Company adopted the provisions of Statement of Financial AccountingStandards (“SFAS”) No. 123 (revised 2004), *“Share-Based Payment,”* (“SFAS No. 123(R)”) whichrequires all share-based payments to employees, including grants of employeestock options and of other stock-based compensation under the 2007 Equity Incentive Plan (the “2007 Plan”)which was approved by the Company’s stockholders on September 26, 2007,and employee stock purchases under the 2000 Employee Stock Purchase Plan (the “2000Purchase Plan”), to be recognized in the financial statements based on theirrespective grant date fair values. The 2007 Plan replaced the Company’s2000 Stock Plan. SFAS No. 123(R) supersedes AccountingPrinciples Board (“APB”) Opinion No. 25, *“Accountingfor Stock Issued to Employees”* (“APB 25”) and relatedinterpretations and eliminates the pro forma disclosures of SFAS No. 123, *“Accounting for Stock-Based Compensation”*(“SFAS No. 123”). In March 2005, the SEC issued SAB No. 107, *“Share-Based Payment”*(“SAB 107”),which provides guidance regarding the interaction of SFAS No. 123(R) andcertain SEC rules and regulations. The Company has applied the provisionsof SAB 107 in its adoption of SFAS No. 123(R).

 

The Company adoptedSFAS No. 123(R) using the modified prospective method. The Company’s condensedconsolidated financial statements as of and for the fiscal year endedApril 30, 2007 and all subsequent reported periods reflect the impact ofadopting SFAS No. 123(R). (See Note 11.)

 

8

----

 

**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

## ***RecentAccounting Pronouncements***

 

In September 2006,the FASB issued SFAS No. 157, “*Fair Value Measurements”*(“SFAS No. 157”),which defines fair value, establishes guidelines for measuring fair value andexpands the requisite disclosures for fair value measurements.SFAS No. 157 does not require any new fair value measurements butrather establishes a common definition of fair value to be used throughoutgenerally accepted accounting principles. SFAS No. 157 is effectivein fiscal years beginning after November 15, 2007 and the Company isrequired to adopt it in the first quarter of fiscal 2009. The Company doesnot expect its adoption of the provisions of SFAS No. 157 to have amaterial effect on its financial condition, results of operations or cashflows.

 

In December 2007,the FASB issued SFAS No. 141 (revised 2007), “*Business Combinations”*(“SFAS No. 141(R)”), whichestablishes the principles and requirements for how an acquirer:(1)  recognizes and measures in its financial statements theidentifiable assets acquired, the liabilities assumed, and any noncontrollinginterest in the acquiree; (2)  recognizes and measures the goodwillacquired in the business combination or a gain from a bargain purchase; and(3)  determines what information to disclose to enable users of thefinancial statements to evaluate the nature and financial effects of thebusiness combination. SFAS No. 141(R) replaces SFAS No. 141, “*Business Combinations.”*SFAS No. 141(R)is effective in fiscal years beginning after December 15, 2008 and the Company is required to adopt it inthe first quarter of its fiscal 2010. The Company is currently evaluatingthe impact SFAS No. 141(R) may have on its financial position,results of operations and cash flows.

 

In December 2007,the FASB also issued SFAS No. 160, “*NoncontrollingInterests in Consolidated Financial Statements”*(“SFAS No. 160”),which establishes accounting and reporting standards that require:(1)  the ownership interests in subsidiaries held by parties otherthan the parent, and income attributable to those parties, be clearlyidentified and distinguished in the parent’s consolidated financial statements;and (2)  when a subsidiary is deconsolidated, any retainednoncontrolling equity investment in the former subsidiary be initially measuredat fair value. SFAS No. 160 is an amendment of Accounting ResearchBulletin No. 51, “*Consolidated Financial Statements”*and relatedinterpretations. SFAS No. 160 is effective for fiscal years beginningon or after December 15, 2008 and the Company is required to adopt it inthe first quarter of its fiscal 2010. The Company is currently evaluatingthe impact SFAS No. 160 may have on its financial position, resultsof operations and cash flows.

 

**Note 3 — Short-TermInvestments**

 

Available-for-salesecurities at October 31, 2007 and April 30, 2007 were as follows (inthousands):

 
| ** **                                                          | ** ** | **As of October 31, 2007** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                          | ** ** | **Amortized**                   | ** ** | **Gross  Unrealized** | ** ** | **Gross  Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                                          | ** ** | **Cost**                        | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Certificates of deposit                                             |       | $                               | 7,012      |   | $ | 2 |   | $ | — |   | $ | 7,014 |   |
| U.S. government debt securities with maturities less  than one year |       | 51,567                          |       | 62 |   | (2 | ) | 51,627 |   |
| U.S. government debt securities with maturities over  one year      |       | 5,006                           |       | 4 |   | — |   | 5,010 |   |
| Municipal bonds and notes                                           |       | 11,970                          |       | 2 |   | — |   | 11,972 |   |
| Commercial paper and bond funds                                     |       | 40,671                          |       | 36 |   | (4 | ) | 40,703 |   |
|                                                                |       | $                               | 116,226    |   | $ | 106 |   | $ | (6 | ) | $ | 116,326 |   |
|                                                                |       |                            |       |   |   |   |   |   |   |
| Contractual maturity dates, less than one year                      |       |                            |       |   |   |   |   | $ | 76,546 |   |
| Contractual maturity dates, one year to two years                   |       |                            |       |   |   |   |   | 39,780 |   |
|                                                                |       |                            |       |   |   |   |   | $ | 116,326 |   |
|                                                                     |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |

 

9

----

 

**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 
| ** **                                                          | ** ** | **As of April 30, 2007** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                          | ** ** | **Amortized**            | ** ** | **Gross  Unrealized** | ** ** | **Gross  Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                                          | ** ** | **Cost**                 | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Certificates of deposit                                             |       | $                        | 3,332      |   | $ | — |   | $ | — |   | $ | 3,332 |   |
| U.S. government debt securities with maturities less  than one year |       | 3,000                    |       | — |   | — |   | 3,000 |   |
| U.S. government debt securities with maturities over  one year      |       | 10,034                   |       | — |   | (12 | ) | 10,022 |   |
| Municipal bonds and notes                                           |       | 70,521                   |       | — |   | (23 | ) | 70,498 |   |
| Commercial paper and bond funds                                     |       | 27,623                   |       | — |   | (43 | ) | 27,580 |   |
|                                                                |       | $                        | 114,510    |   | $ | — |   | $ | (78 | ) | $ | 114,432 |   |
|                                                                |       |                     |       |   |   |   |   |   |   |
| Contractual maturity dates, less than one year                      |       |                     |       |   |   |   |   | $ | 20,130 |   |
| Contractual maturity dates, one year to two years                   |       |                     |       |   |   |   |   | 46,602 |   |
| Contractual  maturity dates, two years to 39 years(1)               |       |                     |       |   |   |   |   | 47,700 |   |
|                                                                |       |                     |       |   |   |   |   | $ | 114,432 |   |
|                                                                     |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)         Representsauction rate securities with a final maturity of up to 39 years and an interestrate reset no less frequent than every 35 days.

 

10

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**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

**Note 4 — BalanceSheet Accounts (in thousands)**

 
| ** **                                      | ** **                      | **October 31,** | ** ** | **April 30,** | ** ** |
|-------------------------------------------------|---------------------------------|----------------------|------------|--------------------|------------|
| ** **                                      | ** **                      | **2007**             | ** ** | **2007**           | ** ** |
| Cash and cash equivalents:                      |                            |                 |       |               |       |
| Cash                                            |                            | $                    | 80,043     |               | $          | 18,274 |   |
| Money market funds and certificates of deposit  |                            | 40,147               |       | 89,020             |       |
| Commercial paper and government bonds           |                            | 87,416               |       | 83,584             |       |
|                                            |                            | $                    | 207,606    |               | $          | 190,878 |   |
| Accounts receivable, net:                       | ** **                      | ** **           | ** ** | ** **         | ** ** |
| Accounts receivable                             |                            | $                    | 92,854     |               | $          | 72,113 |   |
| Less:                                           | Allowance for doubtful accounts |                 | (1,262     | )                  | (980       | ) |
|                                            | Allowance for sales returns     |                 | (3,872     | )                  | (5,467     | ) |
|                                            |                            | $                    | 87,720     |               | $          | 65,666 |   |
| Inventories:                                    |                            |                 |       |               |       |
| Work in progress                                |                            | $                    | 82,102     |               | $          | 64,159 |   |
| Finished goods                                  |                            | 51,268               |       | 55,504             |       |
|                                            |                            | $                    | 133,370    |               | $          | 119,663 |   |
| Prepaid expenses and other current assets:      |                            |                 |       |               |       |
| Prepaid expenses                                |                            | $                    | 5,706      |               | $          | 2,967 |   |
| Deposits and other                              |                            | 152                  |       | 4,693              |       |
| Interest receivable                             |                            | 1,158                |       | 1,057              |       |
|                                            |                            | $                    | 7,016      |               | $          | 8,717 |   |
| Property, plant and equipment, net:             |                            |                 |       |               |       |
| Land                                            |                            | $                    | 26,074     |               | $          | 26,074 |   |
| Buildings and land use right                    |                            | 13,061               |       | 7,612              |       |
| Buildings/leasehold improvements                |                            | 5,635                |       | 4,666              |       |
| Machinery and equipment                         |                            | 38,075               |       | 19,745             |       |
| Furniture and fixtures                          |                            | 725                  |       | 718                |       |
| Software                                        |                            | 2,667                |       | 2,546              |       |
| Construction in progress                        |                            | 14,539               |       | 17,496             |       |
|                                            |                            | 100,776              |       | 78,857             |       |
| Less: Accumulated depreciation and amortization |                            | (17,630              | )          | (14,494            | )          |
|                                            |                            | $                    | 83,146     |               | $          | 64,363 |   |
| Other long-term assets:                         |                            |                 |       |               |       |
| Deferred income taxes – non-current        |                            | $                    | 7,093      |               | $          | 6,869 |   |
| Prepaid wafer credits                           |                            | 4,000                |       | 4,000              |       |
| Long-term employee loan receivable              |                            | 1,000                |       | 1,000              |       |
| Other long-term assets                          |                            | 816                  |       | 800                |       |
|                                            |                            | $                    | 12,909     |               | $          | 12,669 |   |
| Accrued expenses and other current liabilities: |                            |                 |       |               |       |
| Employee compensation                           |                            | $                    | 7,411      |               | $          | 4,713 |   |
| Third party commissions                         |                            | 1,205                |       | 1,021              |       |
| Professional services                           |                            | 2,021                |       | 1,830              |       |
| Noncancelable purchase commitments              |                            | 374                  |       | 906                |       |
| Pricing adjustments                             |                            | 5,224                |       | 4,022              |       |
| Other                                           |                            | 2,642                |       | 5,032              |       |
|                                            |                            | $                    | 18,877     |               | $          | 17,524 |   |
| Other long-term liabilities:                    |                            |                 |       |               |       |
| Deferred tax liabilities                        |                            | $                    | 5,163      |               | $          | 6,506 |   |
| Other                                           |                            | 661                  |       | 492                |       |
|                                            |                            | $                    | 5,824      |               | $          | 6,998 |   |

 

11

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**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

**Note 5 — Long-termInvestments**

 

Long-term investments asof October 31, 2007 and April 30, 2007 consisted of the following (inthousands):

 

| ** ** | ** ** | **October 31,** | ** ** | **April 30,** | ** ** |
|------------|------------|----------------------|------------|--------------------|------------|
| ** ** | ** ** | **2007**             | ** ** | **2007**           | ** ** |
| ImPac      |       | $                    | 2,149      |               | $          | 2,355 |   |
| VisEra     |       | 65,481               |       | 60,265             |       |
| WLCSP      |       | 9,169                |       | —             |       |
| XinTec     |       | 4,661                |       | 4,661              |       |
| Total      |       | $                    | 81,460     |               | $          | 67,281 |   |

 

## ***ImPacTechnology Co., Ltd.***

 

In 2003, in order toenhance its access to plastic and ceramic packaging services that were in shortsupply, the Company purchased approximately 27% of the common stock of ImPacTechnology Co., Ltd. (“ImPac”), a privately-held company based in Taiwan for atotal of $2.0 million in cash. In December 2003, the Company made anadditional cash contribution of approximately $0.8 million to maintain itsequity ownership percentage in ImPac. Unrelated third parties own the balanceof ImPac’s equity. During fiscal 2004, the Company’s equity interestdeclined to approximately 23% due to additional rounds of financing obtained byImPac in which the Company did not participate. The Company’s purchases fromImPac are at arm’s length and the Company accounts for this investment usingthe equity method. The Company recorded an equity loss of $97,000 and $206,000,respectively, in “Other income (expense), net,” as its portion of ImPac’s netloss for the three and six months ended October 31, 2007. The Companyrecorded equity income of $224,000 and $347,000, respectively, in “Other income(expense), net,” as its portion of the net income for the three and six monthsended October 31, 2006 recorded by ImPac. (See Note 16.)

 

## ***VisEraTechnologies Company, Ltd.***

## *** ***

In August 2005, theCompany entered into an Amended and Restated Shareholders’ Agreement (the “AmendedVisEra Agreement”) with Taiwan Semiconductor Manufacturing Company Limited (“TSMC”),VisEra, and VisEra Holding Company (“VisEra Cayman”). The Amended VisEraAgreement amended and restated the original Shareholders’ Agreement (the “VisEraAgreement”) that the parties entered into on October 29, 2003, pursuant towhich the Company and TSMC agreed to form VisEra, a joint venture in Taiwan,for the purposes of providing manufacturing services and automated finaltesting services related to complementary metal oxide semiconductor, or CMOS,image sensors. In November 2003, pursuant to the terms of the VisEra Agreement,the Company contributed $1.5 million in cash to VisEra and granted anon-exclusive license to certain of its manufacturing and automated finaltesting technologies and patents. In order to provide greater financial andfiscal flexibility to VisEra, in connection with the Amended VisEra Agreement,the parties formed VisEra Cayman, a company incorporated in the Cayman Islandsand VisEra became a subsidiary of VisEra Cayman.

 

Under the terms of theAmended VisEra Agreement, the parties reaffirmed their respective commitmentsto VisEra, and expanded the scope of and made certain modifications to the VisEraAgreement. The Company and TSMC have equal interests in VisEra Cayman. In thequarter ended October 31, 2005, the Company contributed $7.5 millionto VisEra and VisEra Cayman.

 

As a result of theadditional investment that the Company and TSMC made in VisEra during thequarter ended October 31, 2005, the Company’s and TSMC’s interest eachincreased from 25% to 43%, and consequently the Company re-evaluated itsaccounting for VisEra in accordance with FIN 46(R), *“Consolidationof Variable Interest Entities.”* The Company concluded that, as aresult of its step acquisition of VisEra, and because substantially all of theactivities of VisEra either involved or were conducted on behalf of theCompany, VisEra was a variable interest entity. Since the Company was thesource of virtually all of VisEra’s revenues, the Company had a decisiveinfluence over VisEra’s profitability. In the quarter ended January 2006, theCompany increased its interest in VisEra from 43% to 46% through purchases of$9.5 million of unissued shares. Accordingly, the Company considereditself to be the

 

12

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**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

primary beneficiary ofVisEra, and included VisEra’s financial results in its consolidated financialstatements through December 31, 2006.

 

In January 2006, inaccordance with the Amended VisEra Agreement, VisEra purchased color filterprocessing equipment and related assets from TSMC for an aggregate priceequivalent to $16.9 million. In connection with the purchase, VisEraentered into a three-year lease agreement with TSMC. Under this agreement,VisEra leases from TSMC approximately 14,000 square feet of factory and officespace where the assets are located at an annual cost of approximately$2.4 million.

 

In May 2006, VisErapurchased certain equipment and intellectual property from Dai Nippon PrintingCo., Ltd., or Dai Nippon, for approximately $3.1 million. Dai Nippon alsomade an investment in VisEra Cayman of approximately $4.3 million. Becausethe per share value of the Dai Nippon investment exceeded the Company’s averageper share carrying value in VisEra Cayman, the Company recorded a one-timechange-of-interest benefit of $1.2 million directly to “Additional paid-incapital,” a component of stockholders’ equity. In November 2006, theCompany invested another $6.1 million in VisEra.

 

On January 1, 2007,the Company assumed responsibility for logistics management services previouslyprovided to the Company by VisEra. As a consequence of the change, the Companyconcluded that, as of the date of the change, it would lose its status as theprimary beneficiary of the joint venture, VisEra would cease to be VIE asdefined under FIN 46(R) and, as a result, the Company deconsolidatedVisEra. Accordingly, beginning on January 1, 2007, the Company has accountedfor its investment in VisEra under the equity method. The deconsolidation ofVisEra did not have a material effect on the Company’s reported revenue orreported net income for the fiscal year ended April 30, 2007. In April 2007,pursuant to a January 2007 amendment to the Amended VisEra Agreement thatprovided for an increase in VisEra’s manufacturing capacity, the Company andTSMC each made an additional investment of $27.0 million in VisEra. Thisadditional investment is part of an ongoing capacity expansion program atVisEra. As of October 31, 2007, the Company and TSMC have agreed to commita total of $112.9 million to the joint venture, which commitments may bemade in the form of cash or asset contributions. Through October 31, 2007,the Company has contributed $51.6 million to VisEra and VisEra Cayman.

 

All other material termsof the Amended VisEra Agreement remain in effect. (See Note 16.)

 

## ***ChinaWLCSP Limited***

 

In May 2007, theCompany, through its wholly-owned subsidiary, OmniVision Trading (Hong Kong)Company Limited, consummated an Investment Agreement with China WLCSP Limited (“WLCSP”)(the “Investment Agreement”) and an Equity Interests Transfer Agreement withWLCSP and Infinity-CSVC Venture Capital Enterprise (“Infinity-CSVC”) (the “TransferAgreement”), each with an effective date of April 6, 2007. WLCSP is in thebusiness of designing, manufacturing, packaging and selling certain wafer levelchip scale packaging related services, for which the Company is currently acustomer. Pursuant to the Investment Agreement, the Company acquired 2,500,000units of WLCSP’s equity interests from WLCSP at a per unit price of $2.00 foran aggregate purchase amount of $5.0 million. Under the terms of theTransfer Agreement, the Company purchased from Infinity-CSVC 2,000,000 units ofWLCSP’s outstanding equity interests at a price per unit of $2.00 for anaggregate purchase amount of $4.0 million. Following the completion of thetwo transactions, the Company owns approximately 19.98% of WLCSP’s registeredcapital on a fully-diluted basis and has appointed a member to WLCSP’s board ofdirectors and a supervisor to monitor the actions of WLCSP’s board of directorsand officers.

 

At the date of thetransaction, the Company’s $9.0 million investment in WLCSP exceeded itsshare of the book value of WLCSP’s assets by $5.7 million. Of this$5.7 million difference, $4.1 million represents equity methodgoodwill which, in accordance with SFAS No. 142, *“Goodwill and Other Intangible Assets,”***and APB Opinion No. 18, *“The Equity Method of Accounting for Investments in Common Stock”*(“APB 18”),the Company will not amortize. The Company will amortize the remaining basisdifference of $1.6 million, which is attributable to intangible assets ofWLCSP, over an average life of approximately three years.

 

13

----

 

**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

The Company accounts forits investment in WLCSP under the equity method and, for the three and sixmonths ended October 31, 2007, recorded equity income of $0.5 millionand $169,000 in “Other income (expense), net,” consisting of its portion of thenet income recorded by WLCSP during the periods, partially offset by an equitymethod investment adjustment.

 

## ***XinTec,Inc.***

 

Between October 2005and March 2006, pursuant to the terms of the Amended VisEra Agreement (asdefined above), VisEra Cayman completed the acquisition of approximately 29.6%of the issued and outstanding shares of XinTec, Inc. (“XinTec”), a Taiwan-basedsupplier of chip-scale packaging services, in which the Company already held anapproximate 7.8% interest. Since VisEra was a consolidated entity at the time,the Company’s beneficial interest in XinTec increased to more than 20%.Consequently, beginning in the three months ended October 31, 2005 andthrough December 31, 2006, the Company accounted for its investment inXinTec under the equity method.

 

In January 2007,TSMC purchased approximately 90.5 million previously-unissued shares fromXinTec. The purchased shares represented approximately a 43.0% ownershipinterest in XinTec. Other existing shareholders, including the Company and theCompany’s affiliate, VisEra, did not purchase additional shares. As a result,the Company’s direct ownership percentage in XinTec declined to approximately4.4%. VisEra’s ownership interest declined to 16.9%, and the Company’s beneficialownership percentage in XinTec declined to 12.4%. Consequently, effectiveJanuary 1, 2007, in accordance with APB 18, the Company began toaccount for XinTec as a cost method investment. In addition, because the pershare value of the TSMC investment exceeded the Company’s average per sharecarrying value in XinTec, the Company recorded a one-time change-of-interestbenefit of $1.2 million directly to “Additional paid-in capital,” acomponent of stockholders’ equity. For the three and six months ended October 31, 2006,the Company recorded equity income of $0.5 million and $1.3 millionin “Other income (expense), net,” for its portion of the net income recorded byXinTec.

 

The following tablepresents the summary combined financial information of ImPac, VisEra and WLCSPas derived from the ImPac, VisEra and WLCSP financial statements for the threeand six months ended October 31, 2007 and 2006 (in thousands):

 

| ** **             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **             | ** ** | **October  31,**       | ** ** | **October  31,**     | ** ** |
| ** **             | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Operating data:        |       |                             |       |                           |       |   |   |   |   |
| Revenues               |       | $                                | 35,317     |                           | $          | 46,382 |   | $ | 77,129 |   | $ | 89,354 |   |
| Gross profit           |       | 12,202                           |       | 8,650                          |       | 19,483 |   | 15,688 |   |
| Income from operations |       | 7,700                            |       | 6,761                          |       | 12,035 |   | 12,127 |   |
| Net income             |       | $                                | 6,415      |                           | $          | 4,620 |   | $ | 8,070 |   | $ | 7,809 |   |

 

The summarized financialinformation for the three and six months ended October 31, 2007 and 2006was derived from financial statements prepared under accounting principles generally accepted inthe United States of America.

 

The amount ofconsolidated retained earnings that represented undistributed earnings ofinvestees accounted for by the equity method totaled $9.4 million and$6.8 million at October 31, 2007 and April 30, 2007,respectively.

 

**Note 6 — ConsolidatedAffiliate – Silicon Optronics, Inc.**

 

In May 2004, the Companyentered into an agreement with Powerchip Semiconductor Corporation (“PSC”), aTaiwan based company that produces memory chips and provides semiconductorfoundry services, to establish a joint venture in Taiwan. The purpose of thejoint venture, Silicon Optronics, Inc. (“SOI”), is to conduct manufacturing,marketing and selling of certain of the Company’s legacy products. The Companycontributed approximately $2.1 million to SOI in exchange for an ownershippercentage of 49.0%. In March 2005, the Company assumed control of theboard of directors of SOI and the Company has consolidated SOI sinceApril 30, 2005.

 

14

----

 

**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

In July 2006, SOIdeclared a cash dividend of $482,000, of which the Company received $237,000.In July 2006, SOI also issued shares to its employees with an estimatedfair value of $459,000, which caused the Company’s ownership percentage todecline from 49.0% to 46.6%.

 

In April 2007, SOIbecame listed on the Taiwan GreTai Securities Market, (“TGSM”). The TGSM is theapproximate equivalent in Taiwan of the Over-The-Counter market in the UnitedStates. In conjunction with the TGSM listing, various employees of SOIexercised their options and increased the number of shares outstanding, whichcaused the Company’s ownership percentage to decline to 44.0% as of October 31,2007.

 

During the six monthsended October 31, 2007, SOI paid a cash dividend of $409,000. InOctober 2007, SOI issued options to various of its employees exercisablefor 600,000 shares of its common stock. (See Note 16.)

 

**Note 7 — IntangibleAssets**

 

Intangible assetsas of October 31, 2007 consist of the following (in thousands):

 

| ** **                | ** ** | **Cost** | ** ** | **Accumulated   Amortization** | ** ** | **Net Book   Value** | ** ** |
|---------------------------|------------|----------|------------|-------------------------------------|------------|--------------------------------|------------|
| Core technology           |       | $        | 17,800     |                                | $          | 8,900                          |       | $ | 8,900 |   |
| Patents and licenses      |       | 13,487   |       | 5,892                               |       | 7,595                          |       |
| Trademarks and tradenames |       | 1,400    |       | 700                                 |       | 700                            |       |
| Customer relationships    |       | 100      |       | 83                                  |       | 17                             |       |
| Intangible assets, net    |       | $        | 32,787     |                                | $          | 15,575                         |       | $ | 17,212 |   |

 

Intangible assetsas of April 30, 2007 consist of the following (in thousands):

 

| ** **                | ** ** | **Cost** | ** ** | **Accumulated   Amortization** | ** ** | **Net Book   Value** | ** ** |
|---------------------------|------------|----------|------------|-------------------------------------|------------|--------------------------------|------------|
| Core technology           |       | $        | 17,800     |                                | $          | 7,120                          |       | $ | 10,680 |   |
| Patents and licenses      |       | 13,460   |       | 4,520                               |       | 8,940                          |       |
| Trademarks and tradenames |       | 1,400    |       | 560                                 |       | 840                            |       |
| Customer relationships    |       | 100      |       | 67                                  |       | 33                             |       |
| Intangible assets, net    |       | $        | 32,760     |                                | $          | 12,267                         |       | $ | 20,493 |   |

 

For the three and sixmonths ended October 31, 2007, the Company amortized $1.6 million and$3.3 million, respectively, of its intangible assets. During the three andsix months ended October 31, 2006, the Company amortized $1.8 millionand $3.5 million, respectively, of its intangible assets. The totalexpected future annual amortization of these intangible assets is as follows(in thousands):

 

| **Years Ending April 30,** | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|------------|------------|
| 2008                                      |       | $          | 3,284      |   |
| 2009                                      |       | 6,532      |       |
| 2010                                      |       | 6,386      |       |
| 2011                                      |       | 973        |       |
| 2012                                      |       | 37         |       |
| Total                                     |       | $          | 17,212     |   |

 

15

----

 

**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

**Note 8 — BorrowingArrangements**

 

The followingtable shows the Company’s debt and lease obligations (in thousands):

 

| ** **                             | ** ** | **October 31,   2007** | ** ** | **April 30,   2007** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
|                                   |       |                             |       |                           |       |
| Mortgage loan                          |       | $                                | 27,716     |                           | $          | 27,927 |   |
| Capital lease obligations              |       | 208                              |       | 280                            |       |
|                                   |       | 27,924                           |       | 28,207                         |       |
| Less: amount  due within one year |       | (654                             | )          | (631                           | )          |
| Non-current portion of long-term debt  |       | $                                | 27,270     |                           | $          | 27,576 |   |

 

AtOctober 31, 2007, aggregate debt maturities were as follows: (inthousands):

 

| **Years Ending April 30,** | ** ** | **Mortgage   Loan** | ** ** | **Capital   Lease** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|--------------------------|------------|--------------------------|------------|-----------|------------|
| 2008                                      |       | $                        | 274        |                     | $          | 74        |       | $ | 348 |   |
| 2009                                      |       | 515                      |       | 134                      |       | 649       |       |
| 2010                                      |       | 548                      |       | —                   |       | 548       |       |
| 2011                                      |       | 583                      |       | —                   |       | 583       |       |
| 2012                                      |       | 620                      |       | —                   |       | 620       |       |
| Thereafter                                |       | 25,176                   |       | —                   |       | 25,176    |       |
| Total                                     |       | $                        | 27,716     |                     | $          | 208       |       | $ | 27,924 |   |

 

## ***MortgageLoan***

 

On March 16, 2007,the Company entered into a Loan and Security Agreement with a domestic bank.The Loan and Security Agreement provides for a term mortgage loan in theprincipal amount of $27.9 million (the “Mortgage Loan”) and a secured lineof credit with an aggregate maximum principal amount of up to$12.0 million (the “Term Loan”). Borrowings under the Mortgage Loan accrueinterest at the London Interbank Borrowing Rate (“LIBOR”) rate plus90 basis points. Borrowings under the Term Loan accrue interest at theLIBOR rate plus 125 basis points. The Mortgage and Term Loans mature onMarch 31, 2017 and September 30, 2012, respectively.

 

As of October 31,2007, $27.7 million was outstanding under the Mortgage Loan. AtOctober 31, 2007, the interest rate under the Mortgage Loan was 5.6%. TheCompany was in compliance with the financial covenants of the Loan and SecurityAgreement as of October 31, 2007.

 

In conjunction with theMortgage Loan, the Company entered into an interest rate swap with the samebank to convert the variable interest rate described above to a fixed rate. Theswap is for a period of ten years, and the notional amount of the swapapproximates the principal outstanding under the Mortgage Loan. The Company isthe fixed rate payer under the swap and the rate is fixed at 5.27% per annum.The Company remeasures the swap at fair value at each balance sheet date andrecords it as either an asset or a liability, depending on whether the fairvalue represents a net gain or net loss. As of October 31, 2007, theCompany recorded $0.7 million in “Other long-term liabilities.” For thethree and six months ended October 31, 2007, the Company recorded lossesof $0.8 million and $169,000, respectively, in “Other income (expense),net.”

 

## ***Linesof Credit at SOI***

 

SOI maintains fourunsecured lines of credit with three commercial banks, which provide a total ofapproximately $3.5 million in available credit. All borrowings under thesefour lines of credit maintained by SOI bear interest at the market interestrate prevailing at the time of borrowing. There are no financial covenantrequirements for these facilities and at October 31, 2007, there were noborrowings outstanding under these facilities.

 

16

----

 

**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

## ***CapitalLease Obligations***

 

In February 2006,the Company leased telecommunications equipment under a three-year capitallease at an imputed interest rate of 7.5% per annum. Terms of the agreementrequire the Company to make monthly payments of approximately $14,000 throughFebruary 2009. Accordingly, the Company recorded a capital asset for$393,000 that is being depreciated over a five-year period in accordance withthe Company’s capitalization policy. As of October 31, 2007, $208,000 wasoutstanding under the capital lease. As of October 31, 2007, $56,000 wasclassified as a long-term obligation.

 

**Note 9 — NetIncome Per Share**

 

Basic net income pershare is computed by dividing net income by the weighted average number ofcommon shares outstanding during the period.

 

Diluted net income pershare is computed according to the treasury stock method using the weightedaverage number of common and potentially dilutive common shares outstandingduring the period. Potentially dilutive common shares represent the effect ofstock options. For the three and six months ended October 31, 2007,4,711,000 and 5,382,000 shares, respectively, of common stock subjectto outstanding options were not included in the calculation of diluted netincome per share because they were antidilutive (i.e., the per share exerciseprice for such options exceeded the average trading price of the Company’scommon stock as reported on The Nasdaq Stock Market for the periods presented).For the three and six months ended October 31, 2006, 9,820,000 and5,163,000 shares, respectively, of common stock subject to outstandingoptions were not included in the calculation of diluted net income per sharebecause they were antidilutive.

 

The Company’s earningsper share were calculated under the provisions of the Statement of FinancialAccounting Standards (or “SFAS”) No. 128, *“EarningsPer Share,”* or SFAS No. 128. SFAS No. 128 requires thatthe Company take into account the effect on consolidated earnings per share ofoptions, warrants and convertible securities issued by its subsidiaries. Theeffect on consolidated earnings per share depends on whether the securitiesissued by the subsidiary enable their holders to obtain common stock of thesubsidiary company or common stock of the parent company. Securities issued bya subsidiary that enable their holders to obtain the subsidiary’s common stockare included in computing the subsidiary’s earnings per share data. The dilutedper-share earnings of the subsidiary are included in the Company’s consolidatedearnings per share computations based on the consolidated group’s holding ofthe subsidiary’s securities. In June 2006, SOI issued options exercisablefor an additional 700,000 shares of its own common stock. Most recently,in October 2007, SOI issued options to various of its employeesexercisable for 600,000 shares of its common stock. In the calculation ofits earnings per share for the three and six months ended October 31, 2007and 2006, the Company included the effect of SOI’s options in its consolidatedearnings per share.

 

17

----

 

**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

The following table setsforth the computation of basic and diluted earnings per share attributable tocommon stockholders for the periods indicated (in thousands, except per sharedata):

 

| ** **                                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                       | ** ** | **October 31,**             | ** ** | **October 31,**           | ** ** |
| ** **                                                       | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| ***Basic:***                                                     |       |                             |       |                           |       |   |   |   |   |
| Numerator:                                                       |       |                             |       |                           |       |   |   |   |   |
| Net income                                                       |       | $                                | 20,510     |                           | $          | 5,415 |   | $ | 33,487 |   | $ | 21,296 |   |
|                                                             |       |                             |       |                           |       |   |   |   |   |
| Denominator:                                                     |       |                             |       |                           |       |   |   |   |   |
| Weighted average common shares for net income per  share         |       | 54,985                           |       | 54,620                         |       | 54,868 |   | 54,511 |   |
|                                                             |       |                             |       |                           |       |   |   |   |   |
| Basic net income per share                                       |       | $                                | 0.37       |                           | $          | 0.10 |   | $ | 0.61 |   | $ | 0.39 |   |
|                                                             |       |                             |       |                           |       |   |   |   |   |
| ***Diluted:***                                                   |       |                             |       |                           |       |   |   |   |   |
| Numerator:                                                       |       |                             |       |                           |       |   |   |   |   |
| Net income                                                       |       | $                                | 20,510     |                           | $          | 5,415 |   | $ | 33,487 |   | $ | 21,296 |   |
| Dilutive effect of SOI consolidation                             |       | —                           |       | (2                             | )          | — |   | (3 | ) |
| Net income for diluted computation                               |       | $                                | 20,510     |                           | $          | 5,413 |   | $ | 33,487 |   | $ | 21,293 |   |
|                                                             |       |                             |       |                           |       |   |   |   |   |
| Denominator:                                                     |       |                             |       |                           |       |   |   |   |   |
| Denominator for basic net income per share                       |       | 54,985                           |       | 54,620                         |       | 54,868 |   | 54,511 |   |
| Weighted average effect of dilutive securities:                  |       |                             |       |                           |       |   |   |   |   |
| Common stock options                                             |       | 1,464                            |       | 1,004                          |       | 635 |   | 1,178 |   |
| Weighted average common shares for diluted net  income per share |       | 56,449                           |       | 55,624                         |       | 55,503 |   | 55,689 |   |
|                                                             |       |                             |       |                           |       |   |   |   |   |
| Diluted net income per share                                     |       | $                                | 0.36       |                           | $          | 0.10 |   | $ | 0.60 |   | $ | 0.38 |   |

 

**Note 10 — Segmentand Geographic Information**

 

The Company identifiesits business segments based on business activities, management responsibilityand geographic location. For all periods presented, the Company operated in asingle reportable business segment.

 

The Company sells itsimage-sensor products either directly to OEMs and VARs or indirectly throughdistributors. The following table illustrates the percentage of revenues fromsales to OEMs and VARs and to distributors for the three and six months endedOctober 31, 2007 and 2006:

 

| ** **    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **    | ** ** | **October 31,**             | ** ** | **October 31,**           | ** ** |
| ** **    | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| OEMs and VARs |       | 68.5                             | %          | 62.7                           | %          | 66.8 | % | 65.4 | % |
| Distributors  |       | 31.5                             |       | 37.3                           |       | 33.2 |   | 34.6 |   |
| Total         |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |

 

18

----

 

**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

Since the Company’send-user customers market and sell their products worldwide, its revenues bygeographic location are not necessarily indicative of the geographicdistribution of end-user sales, but rather indicate where the products and/ortheir components are manufactured or sourced. The revenues by geography in thefollowing table are based on the country or region in which the Company’scustomers issue their purchase orders (in thousands):

 

| ** **    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **    | ** ** | **October 31,**             | ** ** | **October 31,**           | ** ** |
| ** **    | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| China(1)      |       | 199,598                          |       | $                              | 90,887     |   | 352,507 |   | $ | 166,961 |   |
| Taiwan        |       | 19,507                           |       | 29,081                         |       | 30,603 |   | 57,052 |   |
| United States |       | 2,496                            |       | 1,259                          |       | 3,888 |   | 3,752 |   |
| Japan         |       | 774                              |       | 4,855                          |       | 3,335 |   | 17,943 |   |
| South Korea   |       | 784                              |       | 7,287                          |       | 1,628 |   | 21,528 |   |
| All other     |       | 9,463                            |       | 4,287                          |       | 13,795 |   | 7,295 |   |
| Total         |       | $                                | 232,622    |                           | $          | 137,656 |   | $ | 405,756 |   | $ | 274,531 |   |
|               |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |

 

----

(1)  Prior yeardata reclassified to combine the results for Hong Kong and China.

 

The Company’s long-livedassets are located in the following countries (in thousands):

 

| ** **    | ** ** | **October 31,** | ** ** | **April 30,** | ** ** |
|---------------|------------|----------------------|------------|--------------------|------------|
| ** **    | ** ** | **2007**             | ** ** | **2007**           | ** ** |
| Taiwan        |       | $                    | 77,126     |               | $          | 71,953 |   |
| China         |       | 46,443               |       | 22,053             |       |
| United States |       | 45,335               |       | 41,896             |       |
| All other     |       | 518                  |       | 542                |       |
| Total         |       | $                    | 169,422    |               | $          | 136,444 |   |

 

**Note 11 — EmployeeStock Purchase and Stock Option Plans**

 

## ***Stock-BasedCompensation Award Activity***

 

The following tablesummarizes stock-based compensation award activity under the 2000 StockPlan and the 2000 Director Option Plan, and the related weighted averageexercise price, for the six months ended October 31, 2007:

 

| ** **                                           | ** ** | ** **                                         | ** ** | **Options outstanding**     | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                           | ** ** | **Options   Available   For Grant** | ** ** | **Number of   Shares** | ** ** | **Weighted   Average   Price Per   Share** | ** ** |
| ** **                                           | ** ** | **(in   thousands)**                          | ** ** | **(in   thousands)**        | ** ** | ** ** | ** ** |
| Balance at May 1, 2007                               |       | 1,743                                              |       | 12,537                           |       | $ | 18.54 |   |
| Replenished                                          |       | 3,137                                              |       | —                           |       | — |   |
| Granted                                              |       | (2,782                                             | )          | 2,782                            |       | 15.34 |   |
| Exercised                                            |       | —                                             |       | (762                             | )          | 12.81 |   |
| Expired or forfeited                                 |       | 464                                                |       | (464                             | )          | 20.82 |   |
| Balance at October 31, 2007                     |       | 2,562                                              |       | 14,093                           |       | 18.14 |   |
| Vested and expected to vest at October 31, 2007 |       |                                               |       | 13,622                           |       | $ | 18.11 |   |

 

As of October 31,2007 and April 30, 2007, options to purchase 7,025,000 and6,126,000 shares, respectively, were vested.

 

The total intrinsic valueof options exercised during the three and six months ended October 31,2007 was $6.2 millionand $7.1 million,respectively. Total cash received from employees as a result of employee stockoption

 

19

----

 

**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

exercises during the sixmonths ended October 31, 2007 and 2006 was approximately $9.8 million and $7.0 million, respectively.

 

As of October 31,2007, net of forfeitures, there was $54.0 million of unrecognized compensation expense related tounvested stock options, which the Company expects to recognize over a weightedaverage period of 2.5 years. For the 2000 Purchase Plan, as ofOctober 31, 2007, there was $2.1 million of unrecognized compensationexpense which the Company expects to recognize over a weighted average periodof 1.1 years. The Company’s current practice is to issue new shares tosettle share option exercises. As of April 30, 2007, net of forfeitures,there was $44.5 million of unrecognized compensation cost related tounvested stock options, which the Company expected to recognize over a weightedaverage period of 1.2 years. For the 2000 Purchase Plan, as of April 30,2007, there was $1.2 million of unrecognized compensation cost which theCompany expected to be recognized over a weighted average period of1.1 years. The Company’s current practice is to issue new shares to settleshare option exercises.

 

## ***ValuationAssumptions***

 

SFAS No. 123(R)requires companies to estimate the fair value of stock-based compensationawards on the grant date using an option pricing model. The value of theportion of the award that is ultimately expected to vest is recognized asexpense over the requisite service period in the Company’s CondensedConsolidated Statements of Income. The Company measures the fair value ofstock-based compensation awards using Black-Scholes consistent with theprovisions of SFAS No. 123(R), SEC SAB No. 107.Black-Scholes was developed to estimate the fair value of freely tradable,fully transferable options without vesting restrictions. These assumptionsdiffer significantly from the characteristics of the Company’s stock-basedcompensation awards. Black-Scholes also requires the use of highly subjective,complex assumptions, including expected term and the price volatility of theCompany’s stock.

 

The fair value for theseoptions was estimated using the Black-Scholes option pricing model. The pershare weighted average estimated grant date fair value for employee optionsgranted was $8.98 and $7.01 the three and six months ended October 31,2007, respectively. The per share weighted average estimated grant date fairvalue for employee options granted was $8.67 and $11.59 duringthe three and six months ended October 31, 2006, respectively.

 

The following weightedaverage assumptions are included in the estimated fair value calculations forstock options granted in the three and six months ended October 31, 2007and 2006:

 

| ** **                          | ** ** | **Employee Stock Option Plans**     | ** ** |
|-------------------------------------|------------|----------------------------------------------------|------------|
| ** **                          | ** ** | **Three Months Ended  October 31,** | ** ** | **Six Months Ended  October 31,** | ** ** |
| ** **                          | ** ** | **2007**                                           | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** |
| Risk-free interest rate             |       | 4.20                                               | %          | 4.81 | % | 4.78 | % | 4.94 | % |
| Expected term of options (in years) |       | 4.0                                                |       | 4.0 |   | 4.0 |   | 4.0 |   |
| Expected volatility                 |       | 55.0                                               | %          | 62.3 | % | 52.3 | % | 64.8 | % |
| Expected dividend yield             |       | 0                                                  | %          | 0 | % | 0 | % | 0 | % |

 

Using Black-Scholes, theper share weighted average estimated fair value of rights issued pursuant tothe Company’s 2000 Purchase Plan during the three and six months ended October 31,2007 was $5.57 and$5.61, respectively. Using Black-Scholes, the per share weighted averageestimated fair value of rights issued pursuant to the Company’s 2000 PurchasePlan during the three and six months ended October 31, 2006 was $8.25 and $8.19, respectively.

 

20

----

 

**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

The following weightedaverage assumptions are included in the estimated grant date fair valuecalculations for rights to purchase stock under the 2000 Purchase Plan:

 

| ** **                          | ** ** | **Employee Stock Purchase Plan** | ** ** |
|-------------------------------------|------------|-------------------------------------------------|------------|
| ** **                          | ** ** | **Three Months Ended**                | ** ** | **Six Months Ended** | ** ** |
| ** **                          | ** ** | **October 31,**                            | ** ** | **October 31,** | ** ** |
| ** **                          | ** ** | **2007**                                        | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** |
| Risk-free interest rate             |       | 5.07                                            | %          | 5.11 | % | 5.0 | % | 5.11 | % |
| Expected term of options (in years) |       | 0.5                                             |       | 0.5 |   | 0.5 |   | 0.5 |   |
| Expected volatility                 |       | 41.0                                            | %          | 57.2 | % | 48.3 | % | 57.2 | % |
| Expected dividend yield             |       | 0                                               | %          | 0 | % | 0 | % | 0 | % |

 

The definitions of the termsused to determine the above values are as follows:

 

•                  *Expected term:*The expected term represents the period that the Company’s stock-based awardsare expected to be outstanding and is estimated based on historical experience.

•                  *Risk-free interest rate:*The risk-free interest rate assumption is based upon observed interest ratesappropriate for the expected term of the Company’s stock-based awards.

•                  *Expected volatility:*Upon the adoption of SFAS No. 123(R), the Company determined expectedvolatility based on an average between the historical volatility of the Company’scommon stock and the implied volatility based on the Company’s traded options.Averaging two data sources may provide a better proxy to what market placeparticipants would use to value the Company’s options. Previously, the Companydetermined expected volatility based on the historical volatility of theCompany’s common stock.

•                  *Dividend yield:*The dividend yield assumption reflects the Company’s intention not to pay acash dividend under its dividend policy.

•                  *Estimated pre-vestingforfeitures:* When estimating pre-vesting forfeitures, the Companyconsiders forfeiture behavior based on actual historical information.

 

## ***2007Equity Incentive Plan***

 

In September 2007,on the recommendation of the Company’s board of directors, the stockholders ofthe Company approved the 2007 Equity Incentive Plan (the “2007 Plan”),which the Company’s board of directors had previously approved. The2007 Plan is designed to replace the Company’s 2000 Stock Plan and nonew awards will be granted under the 2000 Stock Plan. 6,000,000 shares ofcommon stock have been reserved for issuance under the 2007 Plan. The2007 Plan provides for the grant of the following types of incentiveawards: (i) stock options; (ii) stock appreciation rights;(iii) restricted stock; (iv) restricted stock units;(v) performance shares and performance units; and (vi) other stock orcash awards. In general, stock option and stock appreciation right awards underthe 2007 Plan will be granted at a price not less than 100% of the fairmarket value of the Company’s common stock on the date of grant. The 2007 Planalso allows for the grant of full value awards. Through October 31, 2007,the Company had not granted any equity incentive instruments to employees underthe 2007 Plan.

 

In November 2007, theCompany’s board of directors approved the termination of the Company’s 2000Director Option Plan. The 2007 Plan will cover all future grants ofequity-based compensation to directors.

 

21

----

 

**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

**Note 12 — AdditionalPaid-in Capital**

 

The following table showsthe amounts recorded to “Additional paid-in capital” for the six months endedOctober 31, 2007 (in thousands):

 

| ** **                                    | ** ** | **Additional** | ** ** |
|-----------------------------------------------|------------|----------------|------------|
| ** **                                    | ** ** | **Paid-in**    | ** ** |
| ** **                                    | ** ** | **Capital**    | ** ** |
| Balance at May 1, 2007                   |       | $              | 329,012    |   |
| Exercise of stock options                     |       | 9,763          |       |
| Employee stock purchase plan                  |       | 1,844          |       |
| Compensation related to stock options granted |       | 13,986         |       |
| Balance at October 31, 2007              |       | $              | 354,605    |   |

 

**Note 13 — TreasuryStock**

 

In June 2005, theCompany’s board of directors authorized the repurchase in an open-marketprogram of up to an aggregate of $100 million of the Company’s commonstock. At the time that the program expired in June 2006, and at April 30,2007, the Company had cumulatively repurchased 5,870,000 shares of itscommon stock for an aggregate cost of approximately $79.6 million.

 

In February 2007,the Company’s board of directors approved an additional stock repurchaseprogram that provides for the repurchase of up to $100 million of itsoutstanding common stock in an open-market program. Subject to applicablesecurities laws, such repurchases will be at such times and in such amounts asit deems appropriate, based on factors such as market conditions, legalrequirements and other corporate considerations. As of October 31, 2007,the Company had cumulatively repurchased 566,000 shares of its commonstock under the open-market program for an aggregate cost of approximately$9.6 million.

 

**Note 14 — IncomeTaxes**

 

The Company adopted theprovisions of FIN 48 on May 1, 2007. As a result of the adoption ofFIN 48, the Company increased its net unrecognized tax benefits by$4.3 million, and accounted for the increase as a cumulative effect of achange in accounting principle by reducing retained earnings by$4.3 million. The Company also recorded a $2.7 million increase inits liability for net unrecognized tax benefits, a $1.3 million decreasein deferred tax assets and a $0.3 million decrease in other receivables.The total amount of gross unrecognized tax benefits as of the date of adoptionwas $70.1 million.

 

Historically, the Companyclassified the liability for net unrecognized tax benefits in current incometaxes payable. As a result of the adoption of FIN 48, the Companyreclassified $64.3 million of its liability for net unrecognized taxbenefits from current to long-term income taxes payable because the Companydoes not expect to make cash payments on these liabilities within twelve monthsof the balance sheet date. The Company’s net unrecognized tax benefitsconsisted of gross unrecognized tax benefits, reduced by the associated federaltax benefits on state unrecognized tax benefits and interest.

 

The total amount of grossunrecognized tax benefits of $70.1 million as of the date of adoptionincludes $68.8 million that, if recognized, would reduce the Company’seffective income tax rate in future periods; and $1.3 million related tothe federal tax benefit on state unrecognized tax benefits and interest, ifrecognized. One or more of these unrecognized tax benefits could be subject toa valuation allowance if and when recognized in a future period, which couldimpact the timing of any related effective tax rate benefit.

 

The Company’s policy toinclude interest and penalties related to unrecognized tax benefits within theprovision for income taxes on the Condensed Consolidated Statements of Incomedid not change as a result of implementing the provisions of FIN 48. As ofthe date of adoption, the Company had accrued $5.1 million and$7.4 million for potential interest and penalties, respectively. During thethree and six months ended October 31, 2007, the Company accruedapproximately $0.7 million and $1.4 million of interest. As a resultof a change in tax law in a foreign jurisdiction

 

22

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**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

during the first quarterof fiscal 2008, the Company reduced the total amount of gross unrecognizedtax benefits, as well as its accrual for penalties, by $4.5 million.

 

The Company filesU.S. federal, U.S. state, and foreign tax returns. ForU.S. federal, U.S. state and foreign tax returns, the Company isgenerally no longer subject to tax examinations for years prior tofiscal 2003. Over the next twelve months, the Company does not anticipateany material change to the balance of gross unrecognized tax benefits.

 

**Note 15 — Commitmentsand Contingencies**

 

## ***Commitments***

 

The Company alsomaintains a subsidiary in Shanghai, SDC, which provides assistance to theCompany in various product design projects and in marketing and sales support.On January 10, 2007, SDC entered into a Land-Use-Right Purchase Agreement(the “Purchase Agreement”) with the Construction and Transportation Commissionof the Pudong New District, Shanghai. The Purchase Agreement has an effectivedate of December 31, 2006. Under the terms of the Purchase Agreement, theCompany agreed to pay an aggregate amount of approximately $0.6 million(the “Purchase Price”) in exchange for the right to use approximately 323,000square feet of land located in Shanghai for a period of 50 years. Inaddition, the Company is obligated to invest a minimum of approximately$30.0 million to develop the land and construct facilities, which amountincludes the Purchase Price. As of October 31, 2007, the Company hascontributed $8.5 million of the $30.0 million total investment.Construction of the facilities on the land must be completed by June 30,2009, pursuant to contractual agreement, subject to an additional one-yearextension under limited circumstances. The Company may use the land solely forthe purposes of industrial use and/or scientific research. The Company intendsto use SDC’s registered capital to partially fund its commitment to thisproject.

 

The Company has variouscommitments arising from the Amended VisEra Agreement, and the subsequentamendments to it. In particular, as of October 31, 2007, the Company andTSMC have agreed to commit a total of $112.9 million to the joint venture,which commitments may be made in the form of cash or asset contributions.Additional contributions may be made by additional investors, additionalcontributions by the Company and TSMC, or a combination thereof, provided thatthe Company and TSMC have and will maintain equal interests in VisEra andVisEra Cayman. Through October 31, 2007, the Company has contributed$51.6 million to VisEra and VisEra Cayman. To the extent, if any, that thevalue of assets contributed in the future exceeds the value of the Company’scommitment, the Company will receive cash from VisEra Cayman. (See Notes 5and 16.)

 

## ***Litigation***

 

From time to time, theCompany has been subject to legal proceedings and claims with respect to suchmatters as patents, product liabilities and other actions arising out of thenormal course of business.

 

On November 29,2001, a complaint captioned *McKee v. OmniVisionTechnologies, Inc., et. al., Civil Action No. 01 CV 10775*, was filedin the United States District Court for the Southern District of New Yorkagainst OmniVision, some of the Company’s directors and officers, and variousunderwriters for the Company’s initial public offering. Plaintiffs generallyallege that the named defendants violated federal securities laws because theprospectus related to the Company’s offering failed to disclose, and containedfalse and misleading statements regarding, certain commissions purported tohave been received by the underwriters, and other purported underwriterpractices in connection with their allocation of shares in the Company’soffering. The complaint seeks unspecified damages on behalf of a purportedclass of purchasers of the Company’s common stock between July 14, 2000and December 6, 2000. Substantially similar actions have been filedconcerning the initial public offerings for more than 300 differentissuers, and the cases have been coordinated as *In reInitial Public Offering Securities Litigation, 21 MC 92*. Claimsagainst the Company’s directors and officers have been dismissed withoutprejudice pursuant to a stipulation. On February 19, 2003, the Courtissued an order dismissing all claims against the Company except for a claimbrought under Section 11 of the Securities Act of 1933.

 

In June 2004, the issuerdefendants and plaintiffs negotiated a stipulation of settlement for the claimsagainst the issuer defendants, including OmniVision, that was submitted to theCourt for approval. In August 2005, the Court

 

23

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**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS — (Continued)**

**For the Three and Six MonthsEnded October 31, 2007 and 2006**

**(unaudited)**

 

preliminarily approvedthe settlement. In December 2006, the appellate court overturned thecertification of classes in the six test cases that were selected by theunderwriter defendants and plaintiffs in the coordinated proceedings. Becauseclass certification was a condition of the settlement, it was unlikely that thesettlement would receive final court approval. On June 25, 2007, the Courtentered an order terminating the proposed settlement based upon a stipulationamong the parties to the settlement. On August 14, 2007, plaintiffs filedamended master allegations and amended complaints in the six test cases, whichthe defendants in those cases have moved to dismiss. It is uncertain whetherthere will be any revised or future settlement. If the litigation proceeds, theCompany believes that it has meritorious defenses to plaintiffs’ claims andintends to defend the action vigorously.

 

On October 12, 2007,a purported OmniVision shareholder filed a complaint against certain of theCompany’s IPO underwriters. The complaint, *Vanessa Simmonds v. Bankof America Corporation, et al.*, Case No. C07-1668, filed inDistrict Court for the Western District of Washington, makes similarallegations to those made in *In re Initial PublicOffering Securities Litigation* and seeks the recovery of short-swingtrading profits under Section 16(b) of the Securities Exchange Act of1934. The Company is named as a nominal defendant. No recovery is sought fromthe Company.

 

On June 10, 2004,the first of several putative class actions was filed against the Company andcertain of its present and former directors and officers in federal court inthe Northern District of California on behalf of investors who purchased itscommon stock at various times from February 2003 through June 9,2004. Those actions were consolidated under the caption *In re OmniVision Technologies, Inc.,*No. C-04-2297-SC,and a consolidated complaint was filed. The consolidated complaint assertsclaims on behalf of purchasers of the Company’s common stock betweenJune 11, 2003 and June 9, 2004, and seeks unspecified damages. Theconsolidated complaint generally alleges that defendants violatedSections 10(b) and 20(a) of the Securities Exchange Act of 1934 byallegedly engaging in improper accounting practices that purportedly led to theCompany’s financial restatement. On July 29, 2005, the Court denied theCompany’s motion to dismiss the complaint. The parties engaged in settlementdiscussions and in November 2006, the parties reached an agreement inprinciple to settle this litigation. The total amount of the proposedsettlement is approximately $13.8 million, of which approximately$0.8 million would be contributed by the Company and the remainder wouldbe funded by insurance carriers that issued Directors and Officers LiabilityInsurance Policies to the Company. During fiscal 2007, the Company accrued$3.3 million as its share of the settlement, including unreimburseddefense costs, net of the $13.0 million in recoverable insurance proceeds.The parties have executed a Stipulation of Settlement that was filed with theCourt on May 15, 2007. On May 25, 2007, the Court issued an Orderpreliminarily approving the settlement and providing for notice of thesettlement to be provided to the purported shareholder class. The Ordergranting preliminary approval scheduled a hearing on September 7, 2007 todetermine whether the settlement is fair, reasonable and adequate to thepurported class. The hearing was held on September 7, 2007, as scheduled.On December 6, 2007, the Court issued its order granting final approval ofthe settlement and judgment was entered. Objectors to the settlement have 30days to appeal the Court’s approval of the settlement. The Company believesthat ultimate settlement is probable at the currently estimated amount. If theorder approving the settlement does not become final and litigation against itcontinues, the Company believes that it has meritorious defenses and intends todefend the case vigorously. However, if the litigation continues, the Companycannot estimate whether the result of the litigation would have a materialadverse effect on its financial condition, results of operations or cash flows.

 

On October 20, 2005,a purported shareholder derivative complaint, captioned *Hackl v.Hong*, No. 1:05-CV-050985, was filed in Santa Clara CountySuperior Court for the State of California. The parties executed a Stipulationof Settlement that was filed with the Court on June 18, 2007. OnJune 26, 2007, the Court entered an order approving the settlement,pursuant to which the Company agreed to pay a settlement fee in the amount of$200,000. The Company expensed this amount in the three months endedJuly 31, 2007.

 

**Note 16 — RelatedParty Transactions**

 

In May 2006, theCompany consummated a loan agreement with one of its employees. Under the termsof the agreement, which the board of directors approved in fiscal 2004,the Company extended to the employee a three-year $1.0 million loan withan imputed interest rate of approximately five percent per annum which matureson May 12, 2009. The loan is secured by a deed of trust.

 

24

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**OMNIVISION TECHNOLOGIES, INC.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**

**For the Three and Six Months EndedOctober 31, 2007 and 2006**

**(unaudited)**

 

In thesecond quarter of fiscal 2006, the Company entered into an agreement withImPac (see Note 5) under which ImPac agreed to provide certain managementand support services to HWSC. The Company compensates ImPac for the servicesprovided in accordance with the Company’s policy regarding related partytransactions. The Company’s board of directors approved the agreement, whichmay be cancelled by either party at any time. During the three months endedJanuary 31, 2007, the Company and ImPac agreed to phase out ImPac’smanagement and support services over a period of several months beginning onJanuary 1, 2007. During the three and six months ended October 31,2007, the Company paid ImPac approximately $45,000 and $90,000 in softwarelicensing fees. In addition, for the three and six months endedOctober 31, 2007, the Company paid ImPac approximately$3.7 million and $6.4 million for manufacturing services. During thethree and six months ended October 31, 2006, the Company paid ImPac approximately$254,000 and $465,000 as compensation for management and support services.

 

TheCompany consolidated VisEra’s operating results from August 1, 2005 toDecember 31, 2006. Subsequently, the Company has accounted for itsinvestment in VisEra under the equity method. For the three and six monthsended October 31, 2007, the Company paid $22.4 million and $56.7 millionto VisEra for color filter and other manufacturing services.

 

InMay 2007, the Company purchased a 19.98% ownership in WLCSP for$9.0 million. For the three and six months ended October 31, 2007,the Company paid $5.7 million and $8.0 million to WLCSP for chipscale packaging services.

 

Thefollowing table summarizes the transactions that the Company’s consolidatedaffiliate, SOI, and its affiliate, VisEra, engaged in with related parties inthe ordinary course of business in the three and six months endedOctober 31, 2007 and 2006 (in thousands):

 

| ** **                          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **October 31,**             | ** ** | **October 31,**           | ** ** |
| ** **                          | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| ***SOI transactions with:***        | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| ImPac:                              |       |                             |       |                           |       |   |   |   |   |
| Purchases of manufacturing services |       | $                                | 537        |                           | $          | 1,089 |   | $ | 1,100 |   | $ | 2,414 |   |
| Balance payable at period end       |       | 562                              |       | 800                            |       | 562 |   | 800 |   |
| PSC:                                |       |                             |       |                           |       |   |   |   |   |
| Purchases of wafers                 |       | 2,975                            |       | 1,295                          |       | 4,515 |   | 2,469 |   |
| Rent and other services             |       | 27                               |       | 23                             |       | 27 |   | 37 |   |
| Balance payable at period end       |       | 1,066                            |       | 757                            |       | 1,066 |   | 757 |   |
|                                |       |                             |       |                           |       |   |   |   |   |
| ***VisEra transactions with:***     |       |                             |       |                           |       |   |   |   |   |
| ImPac:                              |       |                             |       |                           |       |   |   |   |   |
| Purchases of manufacturing services |       | —                           |       | 3,660                          |       | — |   | 7,093 |   |
| Balance payable at period end       |       | —                           |       | 2,334                          |       | — |   | 2,334 |   |
| TSMC:                               |       |                             |       |                           |       |   |   |   |   |
| Sales to TSMC                       |       | 480                              |       | 531                            |       | 1,095 |   | 963 |   |
| Purchases of manufacturing services |       | 361                              |       | 182                            |       | 604 |   | 453 |   |
| Rent, utilities and other services  |       | 1,916                            |       | 974                            |       | 3,775 |   | 1,956 |   |
| Balance payable at period end       |       | 1,209                            |       | 461                            |       | 1,209 |   | 461 |   |
| WLCSP:                              |       |                             |       |                           |       |   |   |   |   |
| Purchases of manufacturing services |       | $                                | —     |                           | $          | — |   | $ | 1,531 |   | $ | — |   |

 

TheCompany purchases a substantial portion of its wafers from TSMC. The Companyalso purchases a portion of its wafers from PSC.

 

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| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|-------------|------------|-------------------------------------------------------------------------------------------------|

 

*The following information should be read in conjunction withour unaudited condensed interim financial statements and the notes theretoincluded in Item 1 of this Quarterly Report on Form 10-Q. Thefollowing discussion contains forward-looking statements, within the meaning ofSection 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934, which involve risks and uncertainties.Forward-looking statements generally include words such as “may,” “will,” “plans,”“seeks,” “expects,” “anticipates,” “outlook,” “intends,” “believes” and wordsof similar import as well as the negative of those terms. In addition, anystatements that refer to expectations, projections or other characterizationsof future events or circumstances, including any underlying assumptions, areforward-looking statements. All forward-looking statements included in thisQuarterly Report on Form 10-Q, including, but not limited to, statementsregarding the extent of future sales through distributors, future growth trendsand opportunities in certain markets, the development, introduction andcapabilities of new products, the establishment of partnerships with othercompanies, increased unit volume sales, the increase of competition in ourindustry, the continued importance of the camera cell phone market to ourbusiness, continued price competition and the consequent reduction in theaverage selling prices of our products, future expenses, our effective tax ratefor fiscal 2008, our future investments, our working capital requirementsin fiscal 2008, and the sufficiency of our available cash, cashequivalents and short-term investments are based on current expectations andare subject to important factors that could cause actual results to differmaterially from those projected in the forward-looking statements. Suchimportant factors include, but are not limited to, those set forth under thecaption “Item 1A. Risk Factors,” beginning on page 45 of thisQuarterly Report and elsewhere in this Quarterly Report and in other documentswe file with the**U.S. Securitiesand Exchange Commission**(“SEC”). All subsequent written and oral**forward-looking statements by orattributable to us or persons acting on our**behalf are expressly qualified in their entirety bysuch factors.*

 

*OmniVisionand OmniPixel are registered trademarks of OmniVision Technologies, Inc.CameraChip,  OmniPixel2, OmniPixel3,Square Graphics Array and TrueFocus are trademarks of OmniVision Technologies,Inc. Wavefront Coded is a registered trademark of CDM Optics, Inc., awholly-owned subsidiary of OmniVision Technologies, Inc. Wavefront Coding is atrademark of CDM Optics, Inc.*

 

**Overview**

 

Wedesign, develop and market high performance, highly integrated and costefficient semiconductor image sensor devices. Our main products, image-sensingdevices which we refer to by the name CameraChipTM image sensors, capture animage electronically and are used in a number of consumer and commercial mass-marketapplications. Our CameraChip image sensors are manufactured using thecomplementary metal oxide semiconductor, or CMOS, fabrication process and arepredominantly single-chip solutions that integrate several distinct functionsincluding image capture, image processing, color processing, signal conversionand output of a fully processed image or video stream. We believe that ourhighly integrated image sensors enable camera device manufacturers to buildhigh quality camera products that are smaller, less complex, more reliable,more cost effective and more power efficient than cameras using traditionalcharge-coupled devices, or CCDs.

 

## ***Technology***

## *** ***

InAugust 2004, we announced the introduction of our OmniPixel® technology.In September 2005, we announced the introduction of our OmniPixel2TMarchitecture. The OmniPixel2 architecture, which is based on a 2.2μ x 2.2μpixel and uses a 0.13μ process geometry, is less than half the size of theOmniPixel architecture introduced in 2004, but with improved performance. Withthe OmniPixel2 architecture, we significantly improved sensor performance inthree key areas: the improved fill-factor and zero-gap micro-lens structureincreased the sensor’s capacity to capture light and the sensor’s improvedquantum efficiency improved its dynamic range, that is its capacity to capturewidely differing light levels in a single image; and its capacity to rapidlyadjust to changes in light levels.

 

InFebruary 2007, we introduced our first TrueFocusTM camera with WavefrontCodingTM technology for the mobile handset market. Our patented Wavefront Codingtechnology is a method of optically encoding light using a special lens to forman intermediate image on the sensor, and decoding this intermediate image withdigital processing to create a picture that is in focus across virtually theentire image. TrueFocus technology offers true ‘point-and-shoot’ capabilitywhere the entire image is always in focus and always available for instantone-click capture in real time, with no waiting for the lens to focus.TrueFocus technology is designed to provide our customers with a product thateffectively targets the mobile handset market by being small, durable, easy tomanufacture and cost-competitive.

 

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| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)** |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------|

 

InMay 2007, we announced the introduction of the latest generation of ourOmniPixel architecture, our OmniPixel3TM architecture. The OmniPixel3architecture is based on a new 1.75μ x 1.75μ pixel and uses a0.11μ process geometry which further reduces the size of a given sensorarray without any reduction in image quality.

 

Giventhe rapidly changing nature of our technology, there can be no assurance thatwe will not encounter delays or other unexpected production or performanceissues with future products. During the early stages of production, productionyields and gross margins for products based on new technology are typicallylower than those of established products.

 

## ***New Products***

## *** ***

InFebruary 2007, in addition to the first TrueFocus camera describedearlier, we announced the details of two other new products. The first was a5.17-megapixel auto-focus camera module for mobile handsets based around theOV5623 CameraChip sensor. The new module provides the basis for highresolution cameras to enter the mainstream mobile handset market. Ourintroduction of the 5.17-megapixel camera module with auto-focus capability, afunction previously associated only with digital still cameras, or  DSCs, and expensive camera phones, bringshigh image quality and camera performance closer to the mainstream camera phonemarket. We expect that our new 5.17-megapixel camera module will enable ourhandset customers to continue to move up the ‘megapixel curve’ in order toprovide DSC-quality imaging on mass market camera phones.

 

Thesecond new product was the OV7680, a new 1/10 inch VGA CameraChip sensordesigned for entry-level camera phones, for secondary cameras in 3G handsets,and for integrated notebook PC cameras. The new sensor incorporates a uniquenon-linear lens shift technology, which permits a reduction in the height of thecamera module to just 3.17mm.

 

InMarch 2007, we introduced the OV10620, our first color High Dynamic Range,or HDR, CMOS image sensor for mass market applications. The new OV10620 has thecapacity to capture widely differing light levels in a single image and torapidly adjust to changes in light levels, much like the human eye underquickly changing light conditions. The OV10620 rapidly switches to HDR mode tohandle extreme variations of bright and dark conditions and automaticallyswitches back to non-HDR mode when condition return to normal. The newsingle-chip sensor also has a spectral light sensitivity of up to 1,000 nm,which is near infrared sensitivity.

 

InJune 2007, we introduced the OV3640, the first fully integrated3.2-megapixel CameraChip sensor in a 1⁄4-inch format. Based on the new1.75-micron OmniPixel3 architecture, the OV3640 is small enough to fit thestandard 8 x 8 mm sockets used in 2.0-megapixel camera phones, making it anideal drop-in upgrade for existing handset designs. The highly integratedOV3640 features a high-speed two-lane mobile industry processor interface, orMIPI, to enable the fast transfer of large blocks of data, which is critical tomaking effective use of increased camera resolutions. In addition, the newsensor incorporates advanced image signal processing and onboard JPEGcompression to allow existing baseband processors without MIPI to support acamera upgrade to 3.2 megapixels at 15 frames per second in fullresolution. In addition to MIPI, the OV3640 also incorporates advanced imagestabilization functionality similar to that used in DSC and camcorder products.

 

InJune 2007, we announced that we had begun volume shipments of our recentlyintroduced OV6680 high-performance Square Graphics ArrayTM, camera chip sensor.With its unique 400 x 400 array, low-light sensitivity and small form factor,the new OV6680 is intended primarily for use in secondary cameras for the 3Gvideo phone market and for entry-level, ultra-thin camera phone designs. Weanticipate significant growth in these markets during the next several years.

 

InOctober 2007, we launched the OV2650, our third generation 2-megapixelCameraChip sensor. Powered by OmniPixel3 technology, the OV2650 brings DSCperformance to camera phones in a 1/5-inch optical format, with a compact sizethat allows for an easy upgrade of existing 1.3-megapixel and VGA camera phonedesigns. The OV2650 combines our proprietary 1.75-micron OmniPixel3 technologywith advanced image signal processing, or ISP, to offer best-in-class low-lightperformance, superb color reproduction, and ultra-low noise. In addition, theOV2650 offers other advanced features, including: advanced image stabilizationfor easier picture taking; HDR for advanced video functionality; a MIPIinterface to ease picture sharing; and a high-end ISP to deliver DSC-likeperformance.

 

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| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)** |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------|

 

InOctober 2007, we announced that the smallest of our family of CMOS imagingdevices, the 1/18-inch OV6920 sensor, is a key component of Avantis MedicalSystems’ Third EyeTM RetroscopeTM auxiliary endoscopy system. The new disposableminiature video endoscope, which has already been cleared by the FDA forcommercial distribution in the United States, is smaller in diameter than aballpoint pen refill. Its distal tip diameter of just 3.5 mm allows it to fitthrough the instrument channels of standard-size endoscopes, calledcolonoscopes, used in colonoscopy. Before the development of the Third EyeRetroscope, endoscopes this small could typically be made only through the useof fiber optic bundles that relay the image to a larger sensor positionedoutside the body. Through a strategic partnership with OmniVision, Avantis hassucceeded in placing a complete imaging system, including miniaturized videosensor, signal processing circuitry and integrated lens elements, right at thetip of the catheter.

 

## ***Joint Venture with TSMC***

## *** ***

InOctober 2003, we entered into a Shareholders’ Agreement, or the VisEraAgreement, with Taiwan Semiconductor Manufacturing Company Limited, or TSMC,pursuant to which we agreed with TSMC to form VisEra Technologies Company,Ltd., or VisEra, a joint venture in Taiwan. VisEra’s mission is to provideback-end manufacturing services. In connection with the formation of VisEra,both TSMC and we entered into separate nonexclusive license agreements withVisEra pursuant to which each party licenses certain intellectual property toVisEra relating to manufacturing services. The VisEra Agreement also providedthat once VisEra had acquired the capability to deliver high qualitymanufacturing services, we would be committed to direct a substantial portionof our requirements in these areas to VisEra, subject to pricing and technologyrequirements. Both TSMC and we have also committed not to compete directly or indirectlywith VisEra in the provision of certain manufacturing services. Historically,we have relied upon TSMC to provide us with a substantial proportion of ourwafers. As a part of the VisEra Agreement, TSMC agreed to commit substantialwafer manufacturing capacity to us in exchange for our commitment to purchase asubstantial portion of our wafers from TSMC, subject to pricing and technologyrequirements.

 

InAugust 2005, we entered into an Amended and Restated Shareholders’Agreement with TSMC, or the Amended VisEra Agreement, under which the partiesreaffirmed their respective commitments to VisEra, expanded the scope of andmade certain modifications to the VisEra Agreement. Under the Amended VisEraAgreement, the parties agreed to raise the total capital committed to the jointventure from $50.0 million to $68.0 million. The $18.0 millionincrease was designated principally for the acquisition from unrelated existingshareholders of approximately 29.6% of the issued share capital of XinTec,Inc., or XinTec, of which we directly owned approximately 7.8% at that time. Infiscal 2006, VisEra invested an additional $0.5 million and weinvested an additional $130,000 in XinTec as our portion of an additionalcapital injection to enable XinTec to expand its production capacity. As aresult of the increase in our beneficial interest in XinTec due to VisEra’sinvestment in XinTec during fiscal 2006, we accounted for our investmentin XinTec under the equity method. In January 2007, TSMC through thepurchase of approximately 90.5 million previously unissued shares,acquired a controlling interest in XinTec. As a result of TSMC’s investment,our ownership percentage in XinTec declined from 7.8% to 4.4% andVisEra’s ownership percentage declined from 29.6% to 16.9%. Due to thereduction in our ownership percentage in XinTec and the deconsolidation ofVisEra described below, effective January 1, 2007, we began to account for ourinterest in XinTec under the cost method.

 

As aresult of the additional investment that TSMC and we made in VisEra under theAmended VisEra Agreement, TSMC’s and our interest each increased from 25% to43%, and consequently we re-evaluated our accounting for VisEra in accordancewith Financial Accounting Standards Board, or FASB, Interpretation No. 46(revised December 2003), or FIN 46(R), *“Consolidation of VariableInterest Entities.”* We concluded that, as a result of our stepacquisition of VisEra and because substantially all of the activities of VisEraeither involve or are conducted on our behalf, VisEra was a variable interestentity. Since we were the source of virtually all of VisEra’s revenues, we hada decisive influence over VisEra’s profitability. Accordingly, we consideredourselves to be the primary beneficiary of the joint venture, and in thequarter which ended in October 2005, we began to include VisEra’s financialresults in our consolidated financial statements. In the quarter endedJanuary 2006, we increased our interest in VisEra from 43% to 46% throughpurchases of unissued shares. In January 2006, pursuant to the AmendedVisEra Agreement, VisEra purchased from TSMC the equipment used for applyingcolor filers and micro-lenses to wafers, and VisEra is now providing therelated processing services that we previously purchased from TSMC. InNovember 2006, we invested $6.1 million in VisEra as our portion ofan additional cash or asset contribution to be made by TSMC and us under thethen current Amended VisEra Agreement.

 

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| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)** |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------|

 

EffectiveJanuary 1, 2007, by mutual agreement, we assumed responsibility forthe logistics management services previously provided to us by VisEra. As aconsequence, we concluded that we had lost our status as the primarybeneficiary of the joint venture and that VisEra had ceased to be a variableinterest entity (“VIE”) as defined under FIN 46(R). As a result, wedeconsolidated VisEra as of the date of the change. As a consequence of thedeconsolidation, effective January 1, 2007, we account for our investmentin VisEra under the equity method. The deconsolidation of VisEra did not have amaterial effect on our reported revenue or reported net income forfiscal 2007. See Note 5 – *“Long-termInvestments”*to our condensed consolidated financial statements.

 

InJanuary 2007, we and TSMC also signed an amendment to the Amended VisEraAgreement to provide for an increase in VisEra’s manufacturing capacity. Underthe amendment, we and TSMC each made an additional $27.0 millioninvestment in VisEra in April 2007. This investment is part of an ongoingcapacity expansion program at VisEra. All other material terms of the AmendedVisEra Agreement remain in effect.

 

## ***Joint Venture with PSC***

## *** ***

In May2004, we entered into an agreement with Powerchip Semiconductor Corporation, orPSC, to establish the joint venture called Silicon Optronics, Inc., or SOI. Thepurpose of SOI is to conduct manufacturing, marketing and selling of certain ofour legacy products.

 

InMarch 2005, we assumed control of the board of directors of SOI and wehave consolidated SOI since April 30, 2005. In July 2006, SOIdeclared a cash dividend of $482,000, of which we received $237,000 when the cashdividend was paid in August 2006. SOI also issued shares to its employeesin July 2006, with an estimated fair value of $459,000 which caused ourownership percentage to decline from 49.0% to 46.6%. In April 2007, SOIbecame listed on the Taiwan GreTai Securities Market, or TGSM. The TGSM is theapproximate equivalent in Taiwan of the Over-The-Counter market in the UnitedStates. In conjunction with the TGSM listing, various employees of SOIexercised their options and increased the number of shares outstanding, whichcaused our ownership percentage to decline to 44.0% as of October 31,2007.

 

Duringthe six months ended October 31, 2007, SOI paid a cash dividend of$409,000, of which we received $185,000. In October 2007, SOI issuedoptions to various of its employees exercisable for 600,000 shares of itscommon stock. (See Note 16 – *“Related PartyTransactions”*to our condensed consolidated financial statements.

 

## ***Acquisition of CDM***

## *** ***

InApril 2005, we completed the acquisition of CDM Optics, Inc., or CDM, acompany located in Boulder, Colorado. CDM is the exclusive licensee from anaffiliate of the University of Colorado of a patented technology, known asWavefront Coding technology that increases the performance of an imaging systemby substantially increasing the depth of field and/or correcting opticalaberrations within the image. We expect that it will significantly reduce thesize and complexity of the auto-focus function on future camera modulesutilizing OmniVision sensors. Because the image is always in focus, WavefrontCoding technology also eliminates the time-delay inherent in conventional autoor manually focused camera systems. The closing consideration for theacquisition consisted of $10.0 million in cash and approximately 515,000shares of our common stock. Approximately 147,000 of these shares were retainedas security for certain indemnities given by the sellers.

 

In thequarter ended October 31, 2006, we increased “Goodwill” related to ouracquisition of CDM by $2.6 million. The increase was related, in part, toa put option that expired during the quarter with respect to the 147,000 sharesheld in escrow, 145,000 of which were put to us for cash totaling$2.8 million. The other part of the increase related to the value of theinitial shares that we issued as part of the CDM acquisition. These shares werealso subject to a put option, an option that expired unexercised subsequent totheir original issuance. Both amounts should have been recorded as part of theinitial acquisition of CDM.

 

Inaddition, we are obligated to pay $10.0 million in cash upon the sale,prior to the end of April 2009, of a pre-determined number ofrevenue-producing products incorporating CDM’s technology.

 

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## ***Capital Resources***

## *** ***

As ofOctober 31, 2007, we had approximately $207.6 million in cash andcash equivalents and approximately $116.3 million in short-term investments.To mitigate market risk related to short-term investments, we have aninvestment policy designed to preserve the value of capital and to generateinterest income from these investments without material exposure to marketfluctuations. Market risk is the potential loss due to the change in value of afinancial instrument as a result of changes in interest rates or bond prices.Our policy is to invest in financial instruments with short maturities,limiting interest rate exposure, and to measure performance against comparablebenchmarks. We maintain our portfolio of cash equivalents and short-terminvestments in a variety of securities, including both government and corporateobligations with ratings of A or better and money market funds. We do notbelieve that the value of our cash and short-term investments will besignificantly affected by recent instability in global financial markets.

 

InJune 2005, our board of directors authorized us to use up to $100 millionof our available cash in an open-market program to repurchase our common stock.At the expiration of the program on June 21, 2006, we had cumulativelyrepurchased 5,870,000 shares of our common stock for an aggregate cost ofapproximately $79.6 million.

 

InFebruary 2007, our board of directors approved an additional stockrepurchase program that provides for the repurchase of up to $100 millionof our outstanding common stock in an open-market program. Subject toapplicable securities laws, such repurchases will be at such times and in suchamounts as we deem appropriate, based on factors such as market conditions,legal requirements and other corporate considerations. As of October 31,2007, we had cumulatively repurchased 566,000 shares of our common stockunder the open-market program for an aggregate cost of approximately$9.6 million. See Note 13 *– “TreasuryStock”*to our condensed consolidated financial statements.

 

## ***The Current Economic and Market Environment***

## *** ***

Weoperate in a challenging economic environment that has undergone significantchanges in technology and in patterns of global trade. We strive to remain aleader in the development and marketing of image sensing devices based on theCMOS fabrication process and have benefited from the growing market demand forand acceptance of this technology.

 

Wesell our products worldwide directly to original equipment manufacturers, orOEMs, which include branded customers and contract manufacturers, and valueadded resellers, or VARs, and indirectly through distributors. In order toensure that we address all available markets for our image sensors, we divideour marketing efforts into two separate groups. The Mainstream Productsmarketing group addresses the camera cell phone and DSC markets, and the EmergingProducts marketing group addresses the notebook and personal computer, securityand surveillance, toys and games, automotive and medical markets.

 

In thecamera cell phone market in particular, future revenues depend to a largeextent on design wins where, on the basis of an exhaustive evaluation ofavailable products, a particular hand-set maker determines which image sensorto design into one or more specific models. There is generally a time lag ofbetween six and nine months between the time of a particular design win and thefirst shipments of the designated product. Design wins are also an importantdriver in the many other markets that we address, and in some cases, such asautomotive or medical applications, the time lag between a particular designwin and first revenue can be longer than one year.

 

Theoverwhelming majority of sales of our products depend on decisions by the engineeringdesigners for manufacturers of products that incorporate image sensors tospecify one of our products rather than one made by a competitor. In mostcases, the decision to specify a particular product requires conforming otherspecifications of the product to the chosen image sensor and makes subsequentchanges both difficult and expensive. Accordingly, the ability to produce anddeliver on time reliable products in large quantities is a key competitivedifferentiator. Since our inception, we have shipped more than 770 millionimage sensors, including approximately 120 million in the second quarterof fiscal 2008. We believe that this demonstrates the capabilities of ourproduction system, including our sources of offshore fabrication.

 

Wecurrently outsource the wafer fabrication and packaging of our image-sensorproducts to third parties. We outsource the color filter and micro-lens phasesof production to a joint venture. This approach allows us to focus our

 

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resources on the design, development, marketing andtesting of our products and significantly reduces our capital requirements.

 

Toincrease and enhance our production capabilities, last year we completed aproject with TSMC, our principal wafer supplier and one of the largest wafer fabricationcompanies in the world, to increase from two to four the number of theirfabrication facilities, at which our products can be produced. VisEra, ourjoint venture with TSMC and our investments in three key back-end packagingsuppliers are part of a broad strategy to ensure that we have sufficientback-end capacity for the processing of our image sensors in the variousformats required by our customers. In January 2007, we amended our jointventure agreement with TSMC to each invest an additional $27.0 million inVisEra, and VisEra is currently expanding its capacity. Separately, TSMCpurchased 90.5 million shares from XinTec to enable XinTec to expand itscapacity.

 

InFebruary 2007, we entered into a foundry manufacturing agreement with PSC,and we currently expect to begin volume production of product at PSC in thesecond half of calendar 2008.

 

Wecurrently perform the final testing of the majority of our products at our ownfacility in China. We are currently expanding our testing capacity, as well asour overall capability to design more custom products for our customers. Asnecessary, we will make further investments to ensure that we have sufficientproduction capacity to meet the demands of our customers as part of our ongoingefforts to lower production costs to offset, at least in part, the continuingpressure we experience on prices.

 

Sinceour end-user customers market and sell their products worldwide, our revenuesby geographic location are not necessarily indicative of the geographic distributionof end-user sales, but rather indicate where the products and/or theircomponents are manufactured or sourced. The revenues we report by geography arebased on the country or region in which our customers issue their purchaseorders to us.

 

Manyof the products using our image sensors, such as camera cell phones, notebookand personal computers, digital still cameras and cameras for toys and games,are consumer electronics goods. These mass-market camera devices generally haveseasonal cycles which historically have caused the sales of our customers tofluctuate quarter-to-quarter. Historically, demand from OEMs and distributorsthat serve such consumer product markets has been stronger in the second andthird quarters of our fiscal year and weaker in the first and fourth quartersof our fiscal year. In addition,****since a verylarge number of the manufacturers who use our products are located in China,Hong Kong and Taiwan, the pattern of demand for our image sensors has beenincreasingly influenced by the timing of the extended lunar or Chinese New Yearholiday, a period in which the factories which use our image sensors generallyclose.

 

Webelieve that the market opportunity represented by camera cell phones remainsvery large. We benefited from the growth in shipments of image sensors,particularly for camera cell phones in fiscal 2007 and in the first halfof fiscal 2008. Demand increases were particularly strong for our VGA and2.0-megapixel image sensors.

 

Wealso believe that, like the digital still camera market, camera cell phone andnotebook and personal computer demand will not only continue to shift towardhigher resolutions, but also will increasingly fragment into multipleresolution categories. In addition, there is increased demand forcustomization, and several different interface standards are coming tomaturity. All of these trends will require the development of an increasingvariety of products.

 

As themarkets for image sensors have grown, we have experienced competition from manufacturersof CMOS and CCD image sensors. Our principal competitors in the market for CMOSimage sensors include MagnaChip, Micron, Samsung, Sony, ST Microelectronics andToshiba. We expect to see continued price competition in the image sensormarket for camera cell phones, notebook and personal computers and digitalcameras as those markets continue to grow. Although we believe that wecurrently compete effectively in those markets, our competitive position couldbe impaired by companies that have greater financial, technical, marketing,manufacturing and distribution resources, broader product lines, better accessto large customer bases, greater name recognition, longer operating historiesand more established strategic and financial relationships than we do. Suchcompanies may be able to adapt more quickly to new or emerging technologies andcustomer requirements or devote greater resources to the promotion and sale oftheir products. Many of thesecompetitors own and operate their own fabrication facilities, which in certaincircumstances may give them the ability to price their products moreaggressively than we can or may allow them to respond more rapidly than we canto changing market opportunities.

 

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As aresult of the increase in competition and the growth of variousconsumer-product applications for image sensors, we have experienced a shorteningin the life cycle of some image-sensor products. For example, in the securityand surveillance market we continue to sell image sensors introduced more thanfour years ago, whereas in the camera cell phone market, product life cyclescan be as short as six months. With the shortening of product life cycles, itwill be increasingly difficult to accurately forecast customer demand for ourproducts. As a result, we face the risk of being unable to fulfill customerorders if we underestimate market demand and the risks of excess inventory andproduct obsolescence if we overestimate market demand for our products. Theshortening of product life cycles also increases the importance of having shortproduct development cycles and being accurate in the prediction of markettrends in the design of new products. The reduction in product life cyclesincreases the importance of our continued investment in research anddevelopment, which we consider to be critical to our future success.

 

Incommon with many other semiconductor products and as a response to competitivepressures, the average selling prices, or ASPs, of image sensor products havedeclined steadily since their introduction, and we expect ASPs to continue todecline in the future. Accordingly, in order to maintain our gross margins, weand our suppliers have to work continuously to lower our manufacturing costsand increase our production yields, and in order to maintain or grow ourrevenues, we have to increase the number of units we sell by a large enoughamount to offset the effect of declining ASPs. In addition, if we are unable totimely introduce new products that can take advantage of smaller processgeometries or new products that incorporate more advanced technology andinclude more advanced features that can be sold at higher average sellingprices, our gross margin will decline.

 

Wehave migrated the production of our OmniPixel2 sensors to the 0.13μ processgeometries, which has enabled us to increase the resolution of our imagesensors while decreasing overall chip size. Meanwhile, we will produce ourOmniPixel3 sensors with 0.11μ process technologies. We initiated massproduction volumes at the 0.13μ process node at the end of calendar 2005.Given the rapidly changing nature of our technology, there can be no assurancethat we will not encounter delays or other unexpected yield issues with futureproducts. During the early stages of production, production yields and grossmargins for new products are typically lower than those of established products.We can encounter unexpected manufacturing issues, such as the unexpectedback-end problems that resulted in low yields on two of our products, the firstof which arose in the fourth quarter of fiscal 2005 and in the firstquarter of fiscal 2006. In addition, in preparation for new productintroductions, we gradually decrease production of established products. Due toour 12-14 week production cycle, it is extremely difficult to predictprecisely how many units of established products we will need. It is alsodifficult to accurately predict the speed of the ramp of new products. As aresult, it is possible that we could suffer from shortages for certain productsand build inventories in excess of demand for other products. We carefullyconsider the risk that our inventories may be excess to expected future demandand record appropriate reserves. If, as sometimes happens, we are subsequentlyable to sell these reserved products, the sales have little or no associatedcost and consequently they have a favorable impact on gross margins.

 

## ***Sources of Revenues***

## *** ***

Wegenerate almost all our revenue by selling our products directly to OEMs andVARs and indirectly through distributors. For accounting purposes, we treatsales to OEMs and VARs as one source of revenue, and distributors as anotherand our revenue recognition policies for the two groups are different. Ingeneral, we sell to our customers on FOB shipping point or FCA terms.

 

Forshipments to customers without agreements that allow for returns or credits, principallyOEMs and VARs, we recognize revenue using the “sell-in” method. Under thismethod, we recognize revenue when title passes to the customer provided that wehave received a signed purchase order, the price is fixed or determinable,title and risk of loss has transferred to the customer, collection of resultingreceivables is considered reasonably assured, product returns are reasonablyestimable, there are no customer acceptance requirements and there are noremaining material obligations. We provide for future returns of potentiallydefective products based on historical experience at the time we recognizerevenue. For cash consideration given to customers for which we do not receivea separately identifiable benefit or cannot reasonably estimate fair value, werecord the amounts as reductions of revenue.

 

Forshipments to distributors under agreements allowing for returns or credits, werecognize revenue using the “sell-through” method under which we defer revenueand related costs of sales until the distributor resells the product to ourend-user customer and notifies us in writing of such sale. The amount billed tothese distributors, less the cost of

 

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inventory shipped to but not yet sold by thedistributors, is shown net on the condensed consolidated balance sheets asdeferred income. Accounting for revenue on the “sell-through” method requiresthat we obtain sales and inventory information from our distributors. As partof our internal control process, we observe our distributors’ physical countsof their inventories of our products on a regular basis.

 

Inorder to determine whether collection is probable, we assess a number offactors, including our past transaction history with the customer and thecreditworthiness of the customer. If we determine that collection is notreasonably assured, we defer the recognition of revenue until collectionbecomes reasonably assured or upon receipt of payment.

 

Inaddition, we recognize revenue from the performance of services to a limitednumber of our customers by our wholly-owned subsidiary, CDM, and, throughDecember 31, 2006, by our then consolidated affiliate, VisEra. We recognize theCDM-associated revenue under either the completed-contract or thepercentage-of-completion methods. The percentage-of-completion method ofaccounting is used for cost reimbursement-type contracts, where revenues recognizedare that portion of the total contract price equal to the ratio of costsexpended to date to the anticipated final total costs based on currentestimates of the costs to complete the projects. CDM-associated revenue has notbeen material in any of the periods presented. Until December 31, 2006 werecognized VisEra’s service revenue from third-party customers when theproduction services provided by VisEra were complete and the product wasshipped to the customer.

 

## ***Critical Accounting Policies and Estimates***

## *** ***

For adiscussion of our critical accounting policies, please refer to the discussionin our Annual Report on Form 10-K for the fiscal year ended April 30,2007. Other than for policies that are related to the adoption of FinancialAccounting Standards Board, or FASB, Interpretation, or FIN, No. 48, *“Accounting for Uncertainty in Income Taxes–an interpretation of FASBStatement No. 109,”* or FIN 48, there have been no materialchanges in any of our critical accounting policies since April 30, 2007.

 

*Accountingfor Income Taxes*

 

Weadopted FIN 48 and related guidance on May 1, 2007. SeeNote 14 – *“Income Taxes”*to our condensed consolidated financial statements. Under FIN 48, we arerequired to make certain estimates and judgments in determining income taxexpense for financial statement purposes. These estimates and judgments occurin the calculation of tax credits, benefits, and deductions, and in thecalculation of certain tax assets and liabilities, which arise from differencesin the timing of recognition of revenue and expense for tax and financialstatement purposes, as well as the interest and penalties relating to theseuncertain tax positions. Significant changes to these estimates may increase ordecrease to our tax provision in a subsequent period. Similarly, for taxliabilities denominated in a currency other than the US dollars, changes in thevalue of the denominated currency will increase or decrease our tax provisionin a subsequent period.

 

Wealso have to assess the likelihood that we will be able to realize our deferredtax assets. If realization is not likely, we are required increase ourprovision for taxes by recording a valuation allowance against the deferred taxassets that we estimate we will not ultimately realize. We believe that we willultimately realize a substantial majority of the deferred tax assets recordedon our condensed consolidated balance sheets. However, should there be a changein our ability to realize our deferred tax assets, our tax provision wouldincrease in the period in which we determined that the realization is no longerprobable.

 

Inaddition, the calculation of our tax liabilities involves dealing withuncertainties in the application of complex tax regulations. As a result of theimplementation of FIN 48, we recognize liabilities for uncertain taxpositions based on the two-step process prescribed within the interpretation.The first step is to evaluate the tax position for recognition by determiningif the weight of available evidence indicates that it is more likely than notthat the position will be sustained on audit, including resolution of relatedappeals or litigation, if any. The second step requires us to estimate andmeasure the tax benefit as the largest amount that is more than 50% likely to berealized upon ultimate settlement. Because we are required to determine theprobability of various possible outcomes, such estimates are inherentlydifficult and subjective. We reevaluate these uncertain tax positions on aquarterly basis. This re-evaluation is based on factors including, but notlimited to, changes in facts or circumstances, and changes in tax law. A changein recognition or measurement would result either in the recognition of a taxbenefit or in an additional charge to the tax provision for the period.

 

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**Results of Operations**

 

Thefollowing table sets forth the results of our operations as a percentage ofrevenues. Our historical operating results are not necessarily indicative ofthe results we can expect for any future period.

 

| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                       | ** ** | **October 31,**             | ** ** | **October 31,**           | ** ** |
| ** **                                       | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Revenues                                         |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                                 |       | 74.8                             |       | 66.9                           |       | 75.5 |   | 65.3 |   |
| Gross margin                                     |       | 25.2                             |       | 33.1                           |       | 24.5 |   | 34.7 |   |
| Operating expenses:                              |       |                             |       |                           |       |   |   |   |   |
| Research, development and related                |       | 8.7                              |       | 13.5                           |       | 9.3 |   | 12.9 |   |
| Selling, general and administrative              |       | 6.8                              |       | 11.5                           |       | 7.6 |   | 10.3 |   |
| Litigation settlement                            |       | —                           |       | 2.4                            |       | — |   | 1.2 |   |
| Total operating expenses                         |       | 15.5                             |       | 27.4                           |       | 16.9 |   | 24.4 |   |
| Income from operations                           |       | 9.7                              |       | 5.7                            |       | 7.6 |   | 10.3 |   |
| Interest income, net                             |       | 1.4                              |       | 2.4                            |       | 1.6 |   | 2.5 |   |
| Other income (expense), net                      |       | (0.1                             | )          | 0.5                            |       | — |   | 0.6 |   |
| Income before income taxes and minority interest |       | 11.0                             |       | 8.6                            |       | 9.2 |   | 13.4 |   |
| Provision for income taxes                       |       | 2.2                              |       | 2.8                            |       | 0.9 |   | 3.8 |   |
| Minority interest                                |       | —                           |       | 1.9                            |       | — |   | 1.8 |   |
| Net income                                       |       | 8.8                              | %          | 3.9                            | %          | 8.3 | % | 7.8 | % |

 

*Three Months Ended October 31,2007 as Compared to Three Months Ended October 31, 2006*

 

### **Revenues**

### ** **

Wederive substantially all of our revenues from the sale of our image-sensorproducts for use in a wide variety of consumer and commercial mass-marketapplications including camera cell phones, notebooks and personal computers,security and surveillance cameras, digital still cameras, interactive video andtoy cameras and automotive products. Revenues for the three months endedOctober 31, 2007 increased by 69.0% to approximately $232.6 millionfrom $137.7 million for the three months ended October 31, 2006. Theincrease in revenues was due to an increase in unit sales of our image-sensorproducts, primarily for cell phones, notebooks and personal computers, and amore favorable product mix offset, in part, by a decline in our average sellingprices.

 

## ***Revenues from Sales to OEMs and VARs as Compared toDistributors***

## *** ***

Wesell our image-sensor products either directly to OEMs and VARs or indirectlythrough distributors. The following table shows the percentage of revenues fromsales to OEMs and VARs and distributors in the three months endedOctober 31, 2007 and 2006:

 

| ** **    | ** ** | **Three Months Ended** | ** ** |
|---------------|------------|----------------------------------|------------|
| ** **    | ** ** | **October 31,**             | ** ** |
| ** **    | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| OEMs and VARs |       | 68.5                             | %          | 62.7 | % |
| Distributors  |       | 31.5                             |       | 37.3 |   |
| Total         |       | 100.0                            | %          | 100.0 | % |

 

*OEMs andVARs.*   In the three months endedOctober 31, 2007, two OEM customers accounted for approximately 15.9% and10.4% of our revenues. In the three months ended October 31, 2006,one OEM customer accounted for approximately 17.8% of our revenues. For thethree months ended October 31, 2007 and 2006, no other OEM or VAR customeraccounted for 10% or more of our revenues.

 

*Distributors.*   Inthe three months ended October 31, 2007, one distributor customeraccounted for approximately 19.4% of our revenues. In the three months endedOctober 31, 2006, two distributor customers accounted for

 

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approximately 13.6% and 13.4% of our revenues,respectively. For the three months ended October 31, 2007 and 2006, noother distributor customer accounted for 10% or more of our revenues.

 

## ***Revenues from Domestic Sales as Compared to Foreign Sales***

## *** ***

Thefollowing table shows the percentage of our revenues derived from sales of ourimage-sensor products to domestic customers as compared to foreign customersfor the three months ended October 31, 2007 and 2006:

 

| ** **     | ** ** | **Three Months Ended** | ** ** |
|----------------|------------|----------------------------------|------------|
| ** **     | ** ** | **October 31,**             | ** ** |
| ** **     | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| Domestic sales |       | 1.1                              | %          | 0.9 | % |
| Foreign sales  |       | 98.9                             |       | 99.1 |   |
| Total          |       | 100.0                            | %          | 100.0 | % |

 

Wederive the majority of our foreign sales from customers in Asia and, to alesser extent, in Europe. Over time, our sales to Asia-Pacific customers haveincreased primarily as a result of the continuing trend of outsourcing theproduction of consumer electronics products to Asia-Pacific manufacturers andfacilities and to the increasing markets in Asia for consumer products. Becauseof the preponderance of Asia-Pacific manufacturers and the fact that virtuallyall products incorporating our image-sensor products are sold globally, webelieve that the geographic distribution of our sales does not accuratelyreflect the geographic distribution of sales into end-user markets of productswhich incorporate our image sensors.

 

### **Gross Profit**

### ** **

Ourgross margin in the three months ended October 31, 2007 was 25.2%, downfrom 33.1% for the three months ended October 31, 2006. The principal contributor to the year-over-year decline in gross margin was thedecline in our average selling prices,partially offset by reductions in our production costs. During the three months ended October 31, 2007, the average selling prices of ourproducts decreased, in large part due to an increase in the proportion of salesrepresented by lower margin VGA image sensors as compared to the three monthsended October 31, 2006. In the three-month periods endedOctober 31, 2007 and 2006, in accordance with SFAS No. 123(R),we recorded approximately $1.0 million in stock compensation expense tocost of revenues, representing 0.4% of revenues and 0.7% of revenues,respectively.

 

Revenuefrom sales of previously reserved products in the three months endedOctober 31, 2007 was $1.5 million, as compared to $4.1 millionduring the same period in the prior fiscal year. In the three months endedOctober 31, 2007, we recorded an allowance for excess and obsoleteinventory totaling $7.7 million to cost of revenues as compared to$1.5 million during the same period in the prior fiscal year.

 

**Research, Development and Related Expenses**

 

Research,development and related expenses consist primarily of compensation andpersonnel-related expenses, non-recurring engineering costs related principallyto the costs of the masks we buy when we release new product designs to themanufacturing foundry, costs for purchased materials, designs, tooling,depreciation of computers and workstations, and amortization of acquiredintangible intellectual property and computer aided design software. Becausethe number of new designs we release to the foundry can fluctuate from periodto period, research, development and related expenses may fluctuatesignificantly. Research, development and related expenses for the three monthsended October 31, 2007 increased to approximately $20.2 million fromapproximately $18.7 million for the three months ended October 31,2006. As a percentage of revenues, research and development expenses for thethree months ended October 31, 2007 and 2006 represented 8.7% and 13.5%,respectively.

 

Theincrease in research, development and related expenses of approximately$1.5 million, or 8.2%, for the three months ended October 31,2007 from the similar period in the prior year resulted primarily from a $1.3 millionincrease in salary and payroll-related expenses associated with salaryincreases and the hiring of additional personnel, a $272,000 increase inoffice and facility expenses, and a $251,000 increase in depreciation andamortization expenses of acquired intangible assets, partially offset by a$284,000 decrease in software expenses and a $219,000 reduction in stock-basedcompensation expense recognized in accordance with SFAS No. 123(R).We anticipate that our research,

 

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development and related expenses will continue toincrease as we develop and introduce new products employing our OmniPixel3 andWavefront Coding technologies and develop other new technologies related toimage sensors.

 

**Selling, General and Administrative Expenses**

 

Selling,general and administrative expenses consist primarily of compensation andpersonnel related expenses, commissions paid to distributors and manufacturers’representatives and insurance and legal expenses. Selling, general andadministrative expenses for the three months ended October 31, 2007 wasapproximately $15.8 million, which represented only a $13,000 increasefrom the three months ended October 31, 2006. As a percentage of revenues,selling, general and administrative expenses for the three months endedOctober 31, 2007 and 2006 represented 6.8% and 11.5%, respectively.

 

Theincrease in selling, general and administrative expenses of approximately$13,000, or 0.1%, for the three months ended October 31, 2007 from thesimilar period in the prior year resulted primarily from a $1.1 millionincrease in salary and payroll-related expenses associated with salaryincreases and the hiring of additional personnel, a $211,000 increase in legaland accounting expenses, a $159,000 increase in bad debt expense and a $145,000increase in other taxes, partially offset by a $0.7 million reduction instock-based compensation expense recognized in accordance withSFAS No. 123(R), a $250,000 decrease in facility expenses, a $136,000decrease in fees for outside services, and a $133,000 decrease in commissionspaid primarily to distributors. We anticipate that our selling, general andadministrative expenses will increase in the future due to the continuedexpansion of our organization and the continuing upgrade of our computersystems, including our enterprise resource planning, or ERP, and othermanagement information systems.

 

**Litigation Settlement**

 

Weaccrued $3.3 million in litigation settlement expenses for the quarterended October 31, 2006, to reflect our share of the settlement of thesecurities class action lawsuit pending in the United States District Court forthe Northern District of California. The parties to the litigation have reachedan agreement to settle the litigation, and are awaiting final Court approval ofthe settlement. Litigation settlement expenses for the three months endedOctober 31, 2006 represented 2.4% of revenue. (See *“Note 15 – Commitments andContingencies”* of the Notes to our condensed consolidated financialstatements.)

 

**Interest Income, Net**

 

Weinvest our cash, cash equivalents and short-term investments ininterest-bearing accounts consisting primarily of money market funds,commercial paper, certificates of deposit, high-grade corporate securities andgovernment bonds. Interest income remained unchanged at approximately$3.4 million for the three months ended October 31, 2007 and 2006,respectively. Interest income for the three months ended October 31, 2007as compared to the corresponding period in the prior year was the result ofhigher interest rates offset by lower balances in interest-bearing accountsresulting primarily from the deconsolidation of VisEra.

 

**OtherIncome (Expense), Net**

 

Otherincome (expense), net, for the three months ended October 31, 2007 totaled$338,000 in net expenses. The current quarter amount included a$0.8 million loss on the interest rate swap agreement and a $97,000 lossfor the three months ended October 31, 2007 as our portion of the net lossrecorded by ImPac Technology Co., Ltd., or ImPac, which we account for underthe equity method of accounting. These losses were partially offset by a $0.5 milliongain consisting of our portion of the net income recorded by China WLCSPLimited, or WLCSP, which we account for under the equity method of accounting.Other income (expense), net, for the three months ended October 31, 2006was income of $0.7 million and consisted principally of $0.5 millionas our portion of the income recorded by XinTec we accounted for under theequity method of accounting and $224,000 as our portion of the incomerecorded by ImPac.

 

**Provision for Income Taxes**

 

Wegenerated approximately $25.6 million and $11.9 million in incomebefore income taxes and minority interest for the three months endedOctober 31, 2007 and 2006, respectively. We recorded provisions for incometaxes for the three months ended October 31, 2007 and 2006 of approximately$5.2 million and $3.9 million, respectively. For the three monthsended October 31, 2007 and 2006, our effective tax rates were 20.1% and32.9%, respectively. Quarterly

 

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| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)** |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------|

 

income taxes reflect our current estimate of theeffective tax rate for the fiscal year and include, when applicable, the impactof changes from the prior estimated rate and discrete tax items. We now expectour annual effective tax rate for fiscal 2008 to be lower than wepreviously estimated primarily due to the favorable impact of the change in theexpected geographical mix of income and the tax provision for the three monthsended October 31, 2007 reflects the consequent adjustment. However, therate for the three months ended October 31, 2007 is higher than the ratereflected in the tax provision for the three months ended July 31, 2007primarily due to a benefit recorded in the three months ended July 31,2007 attributable to the release of unrecognized tax benefits includinginterest and penalties that were no longer required as a result of a change intax law in a foreign jurisdiction in which we do business. In both years, oureffective tax rates are less than the combined federal and state statutory rateof approximately 40% principally because we earn a significant portion of ourincome in jurisdictions where tax rates are lower than the combined federal andstate statutory rate. We expect that our consolidated effective tax rate infiscal 2008 will continue to be less than the combined federal and statestatutory rates. The extent of the difference is principally contingent uponthe geographic mix of our total pre-tax income. We adopted the provisions ofFIN 48 on May 1, 2007. The effect of adoption of FIN 48 on ourCondensed Consolidated Balance Sheets as of May 1, 2007 is summarized inNote 14 – *“Income Taxes”*toour condensed consolidated financial statements.

 

**Minority Interest**

 

Minorityinterest for the three months ended October 31, 2007 and 2006 was($15,000) and $2.5 million, respectively. For the three months endedOctober 31, 2007 and 2006, approximately ($15,000) and $197,000,respectively, represents the 56.0% interest that we do not own in the netincome of SOI. For the three months ended October 31, 2006, approximately$2.3 million represents the 54.4% interest that we did not own in the netincome of VisEra. Because we deconsolidated VisEra effective January 1,2007, we did not record any minority interest expense in VisEra for the threemonths ended October 31, 2007.

 

*Six Months Ended October 31,2007 as Compared to Six Months Ended October 31, 2006*

 

### **Revenues**

### ** **

Revenuesfor the six months ended October 31, 2007 increased by 47.8% toapproximately $405.8 million from $274.5 million for the six monthsended October 31, 2006. The increase in revenues was due to an increase inunit sales of our image-sensor products, primarily for cell phones, notebooksand personal computers, and a more favorable product mix offset, in part, by adecline in our average selling prices.

 

## ***Revenues from Sales to OEMs and VARs as Compared toDistributors***

## *** ***

Wesell our image-sensor products either directly to OEMs and VARs or indirectlythrough distributors. The following table shows the percentage of revenues fromsales to OEMs and VARs and distributors in the six months endedOctober 31, 2007 and 2006:

 

| ** **    | ** ** | **Six Months Ended** | ** ** |
|---------------|------------|--------------------------------|------------|
| ** **    | ** ** | **October 31,**           | ** ** |
| ** **    | ** ** | **2007**                       | ** ** | **2006** | ** ** |
| OEMs and VARs |       | 66.8                           | %          | 65.4 | % |
| Distributors  |       | 33.2                           |       | 34.6 |   |
| Total         |       | 100.0                          | %          | 100.0 | % |

 

*OEMs andVARs.*   In the six months endedOctober 31, 2007, one OEM customer accounted for approximately 16.8% ofour revenues. In the six months ended October 31, 2006, one OEM customeraccounted for approximately 15.5% of our revenues. For the six months endedOctober 31, 2007 and 2006, no other OEM or VAR customer accounted for 10%or more of our revenues.

 

*Distributors.*   Inthe six months ended October 31, 2007, one distributor customer accountedfor approximately 20.9% of our revenues. In the six months endedOctober 31, 2006, two distributor customers accounted for approximately13.2% and 10.7% of our revenues. For the six months ended October 31, 2007and 2006, no other distributor customer accounted for 10% or more of ourrevenues.

 

37

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| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)** |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------|

 

## ***Revenues from Domestic Sales as Compared to Foreign Sales***

## *** ***

Thefollowing table shows the percentage of our revenues derived from sales of ourimage-sensor products to domestic customers as compared to foreign customers forthe six months ended October 31, 2007 and 2006:

 

| ** **     | ** ** | **Six Months Ended** | ** ** |
|----------------|------------|--------------------------------|------------|
| ** **     | ** ** | **October 31,**           | ** ** |
| ** **     | ** ** | **2007**                       | ** ** | **2006** | ** ** |
| Domestic sales |       | 1.0                            | %          | 1.4 | % |
| Foreign sales  |       | 99.0                           |       | 98.6 |   |
| Total          |       | 100.0                          | %          | 100.0 | % |

 

Wederive the majority of our foreign sales from customers in Asia and, to alesser extent, in Europe. Over time, our sales to Asia-Pacific customers have increasedprimarily as a result of the continuing trend of outsourcing the production ofconsumer electronics products to Asia-Pacific manufacturers and facilities andto the increasing markets in Asia for consumer products. Because of thepreponderance of Asia-Pacific manufacturers and the fact that virtually allproducts incorporating our image-sensor products are sold globally, we believethat the geographic distribution of our sales does not accurately reflect thegeographic distribution of sales into end-user markets of products whichincorporate our image sensors.

 

### **Gross Profit**

### ** **

Ourgross margin in the six months ended October 31, 2007 was 24.5%, down from34.7% for the six months ended October 31, 2006. The principal contributor to the year-over-year decline in gross margin was thedecline in our average selling prices,partially offset by reductions in our production costs. In the six months ended October 31, 2007, in accordancewith SFAS No. 123(R), we recorded approximately $1.9 million instock-based compensation expense to cost of revenues, or 0.5% of revenues, ascompared to $2.0 million or 0.7% in the six months ended October 31,2006.

 

Revenuefrom sales of previously reserved products in the six months endedOctober 31, 2007 was $3.4 million, as compared to $7.0 millionduring the same period in the prior fiscal year. In the six months endedOctober 31, 2007, we recorded an allowance for excess and obsoleteinventory totaling $12.4 million to cost of revenues as compared to $2.4 million during the sameperiod in the prior fiscal year.

 

**Research, Development and Related Expenses**

 

Research,development and related expenses for the six months ended October 31, 2007increased to approximately $37.6 million from approximately$35.5 million for the six months ended October 31, 2006. As apercentage of revenues, research and development expenses for the six monthsended October 31, 2007 and 2006 represented 9.3% and 12.9%, respectively.

 

Theincrease in research, development and related expenses of approximately$2.1 million, or 5.9%, for the six months ended October 31, 2007from the similar period in the prior year resulted primarily from a$3.1 million increase in salary and payroll-related expenses associatedwith salary increases and the hiring of additional personnel, a $0.7 millionincrease in office and facility expenses, a $485,000 increase in depreciationand amortization expenses of acquired intangible assets and a $193,000 increasein legal expenses, partially offset by a $1.2 million decrease innon-recurring engineering expenses related to new product development, a$1.0 million reduction in stock-based compensation expense recognized inaccordance with SFAS No. 123(R) and a $282,000 decrease in softwareexpenses.

 

**Selling, General and Administrative Expenses**

 

Selling,general and administrative expenses for the six months ended October 31,2007 increased to approximately $31.0 million from $28.2 million forthe six months ended October 31, 2006. As a percentage of revenues,selling, general and administrative expenses for the six months endedOctober 31, 2007 and 2006 represented 7.6% and 10.3%, respectively.

 

Theincrease in selling, general and administrative expenses of approximately$2.7 million, or 9.7%, for the six months ended October 31, 2007 fromthe similar period in the prior year resulted primarily from a$2.3 million increase in salary and payroll-related expenses associatedwith salary increases and the hiring of additional personnel, a

 

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| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)** |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------|

 

$1.7 million increase in legal and accountingexpenses due primarily to an increase in legal fees associated with thesettlement of the 2004 class-action lawsuit and the related shareholderderivative complaint, a $354,000 increase in bad debt expense and a $243,000increase in other taxes, partially offset by a $0.5 million decrease infees for outside services, a $402,000 decrease in facility expenses, a $353,000decrease in commissions paid primarily to distributors, and a $298,000reduction in stock-based compensation expense recognized in accordance withSFAS No. 123(R).

 

**Litigation Settlement**

 

Weaccrued $3.3 million in litigation settlement expenses for the six monthsended October 31, 2006, to reflect our share of the settlement of thesecurities class action lawsuit pending in the United States District Court forthe Northern District of California. The parties to the litigation have reachedan agreement to settle the litigation, and are awaiting final Court approval ofthe settlement. Litigation settlement expenses for the six months endedOctober 31, 2006 represented 1.2% of revenue. (See *“Note 15 – Commitments andContingencies”* of the Notes to our condensed consolidated financialstatements.)

 

**Interest Income, Net**

 

Interestincome for the six months ended October 31, 2007 decreased slightly toapproximately $6.7 million from $6.8 million for the six months endedOctober 31, 2006. The reduction in interest income for the six monthsended October 31, 2007 as compared to the corresponding period in theprior year was the result of lower balances in interest-bearing accountsresulting primarily from the deconsolidation of VisEra, largely offset byhigher interest rates.

 

**OtherIncome (Expense), Net**

 

Otherincome (expense), net, for the six months ended October 31, 2007 totaled$78,000 in expenses. The amount included a $169,000 loss on the interest rateswap agreement and a $206,000 loss for the six months ended October 31,2007 as our portion of the net loss recorded by ImPac which we account forunder the equity method of accounting. These losses were partially offset by a$169,000 gain consisting of our portion of the net income recorded by WLCSP,which we account for under the equity method of accounting. Other income(expense), net, for the six months ended October 31, 2006 was income of$1.6 million and consisted of $1.3 million as our portion of theincome recorded by XinTec and $347,000 as our portion of the income recorded byImPac, both of which we account for using the equity method of accounting,combined with other income, net.

 

**Provision for Income Taxes**

 

Wegenerated approximately $37.3 million and $36.7 million in incomebefore income taxes and minority interest for the six months endedOctober 31, 2007 and 2006, respectively. We recorded provisions for incometaxes for the six months ended October 31, 2007 and 2006 of approximately$3.8 million and $10.5 million, respectively. For the six monthsended October 31, 2007 and 2006, our effective tax rates were 10.2% and28.7%, respectively. Year-to-date income taxes reflect our estimate of theeffective tax rate for the fiscal year and include, when applicable, the impactof discrete tax items. The lower effective tax rate for the six months endedOctober 31, 2007 as compared to the six months ended October 31, 2006 isprincipally due to the favorable impact of the change in the expected geographicalmix of income and the benefit recorded in the three months ended July 31,2007 attributable to the release of unrecognized tax benefits includinginterest and penalties that were no longer required as a result of a change intax law in a foreign jurisdiction in which we do business. In both years, oureffective tax rates are less than the combined federal and state statutory rateof approximately 40% principally because we earn a significant portion of ourincome in jurisdictions where tax rates are lower than the combined federal andstate statutory rate. We adopted the provisions of FIN 48 on May 1,2007. The effect of adoption of FIN 48 on our Condensed ConsolidatedBalance Sheets as of May 1, 2007 is summarized in Note 14 – *“Income Taxes”*to our condensed consolidated financialstatements.

 

**Minority Interest**

 

Minorityinterest for the six months ended October 31, 2007 and 2006 was $6,000 and$4.8 million, respectively. For the six months ended October 31, 2007and 2006, approximately $6,000 and $269,000, respectively, represents theapproximately 56.0% interest that we do not own in the net income of SOI whichwe included in our consolidated operating results. For the six months endedOctober 31, 2006, approximately $4.6 million represents the 57%interest that we did not own in the net income of VisEra. Because wedeconsolidated VisEra effective January 1, 2007, we did not record anyminority interest expense in VisEra for the six months ended October 31,2007.

 

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| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)** |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------|

 

**Liquidity and Capital Resources**

 

Ourprincipal sources of liquidity at October 31, 2007 consisted of cash, cashequivalents and short-term investments of $323.9 million.

 

## ***Liquidity***

## *** ***

Ourworking capital increased by approximately $74.0 million to $431.0 millionas of October 31, 2007 from $357.0 million as of April 30, 2007.The increase was primarily attributable to: $50.8 million decrease inincome taxes payable primarily due to the reclassification of $64.3 millionof liability for net unrecognized tax benefits from current to long-term incometaxes payable as a result of the adoption of FIN 48; a $22.1 millionincrease in accounts receivable, net, consistent with the increase in revenuesfrom prior year levels; a $16.7 million increase in cash and cashequivalents; an $13.7 million increase in inventories in anticipation ofincreased sales in the third quarter of fiscal 2008; a $2.2 milliondecrease in deferred income; a $1.9 million increase in short-terminvestments; and a $0.8 million decrease in a litigation settlementaccrual. These increases in working capital were partially offset by: a $31.6 millionincrease in accounts payable primarily resulting from increased inventorypurchases; and a $1.7 million decrease in prepaid and other expenses and a$1.4 million increase in accrued liabilities.

 

SOImaintains four unsecured lines of credit with three commercial banks, whichprovide a total of approximately $3.5 million in available credit. Allborrowings under the four lines of credit maintained by SOI bear interest atthe market interest rate prevailing at the time of borrowing. There are nofinancial covenant requirements for these facilities and at October 31,2007, there were no borrowings outstanding under these facilities.

 

## ***Cash Flows from Operating Activities***

## *** ***

Forthe six months ended October 31, 2007, net cash provided by operatingactivities totaled approximately $42.0 million as compared to$33.1 million for the corresponding period in the prior year. Theprincipal components of the current year amount were: net income ofapproximately $33.5 million for the six months ended October 31,2007, adjusted for non-cash charges of $14.0 million in stock-basedcompensation, $12.4 million in write-down of inventories, $6.3 millionin depreciation and amortization, and $4.1 million of gains in equityinvestments; a $22.9 million increase in accounts payable; a$4.7 million increase in income taxes payable; a $3.8 million increasein accrued expenses and other current liabilities and a $1.7 milliondecrease in prepaid expenses and other current assets. These increases werepartially offset by: a $27.7 million increase in inventories; a $22.0 millionincrease in accounts receivable, net; a $2.2 million decrease in deferredincome and a $1.3 million decrease in deferred tax liabilities. The $22.0 millionincrease in accounts receivable, net, reflects the higher level of revenuesduring the six months ended October 31, 2007, partially offset by adecrease in days of sales outstanding as of October 31, 2007 to 35 daysfrom 49 days as of April 30, 2007. The $27.7 million increase ininventories was in anticipation of increased sales in the third quarter offiscal 2008.The inventory balances increased concurrently with an increase in annualizedinventory turns to 5.2 as of October 31, 2007 from 3.1 as ofApril 30, 2007. The $1.7 million decrease in prepaid expenses andother current assets was principally due to the reclassification of a depositpaid for land from other current assets to property, plant and equipment upontransfer of title.

 

Forthe six months ended October 31, 2006, net cash provided by operatingactivities totaled approximately $33.1 million, primarily due to: netincome of approximately $21.3 million for the six months endedOctober 31, 2006, adjusted for non-cash charges of $15.3 million instock-based compensation, $7.8 million in depreciation and amortization,$4.8 million in the minority interest in the net income of consolidatedaffiliates and $1.6 million of gains in equity investments; a$35.3 million increase in accounts payable; a $14.7 million increasein accrued expenses and other current liabilities; an $11.5 millionincrease in accrued income taxes payable and a $0.5 million increase indeferred income. These increases were partially offset by: a $51.2 millionincrease in inventories; a $17.7 million increase in prepaid expenses andother current assets; a $9.4 million increase in accounts receivable, netand a $1.0 million decrease in deferred tax liabilities. The $17.7 millionincrease in prepaid expenses and other current assets resulted from$13.0 million in recoverable insurance proceeds associated with thesettlement of security class-action litigation. The $14.7 million increasein accrued expenses and other current liabilities resulted from a$13.8 million litigation settlement accrual associated with the settlementof security class-action litigation. The $9.4 million increase in accountsreceivable, net, reflects the higher level of revenues during the six monthsended October 31, 2006, as days of sales outstanding as ofOctober 31, 2006 increased to 50 days from 45 days as ofApril 30, 2006. The $51.2 million

 

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| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)** |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------|

 

increase in inventories resulted from an increase latein the quarter in our work-in-process to support our anticipated increase inunit volume sales in the next two quarters, to prepare for new packagingcapacity expected to come on-line at XinTec and a shift in demand towards VGA products latein the quarter, which precluded wafer production schedule adjustments.The increase in inventory balances resulted in a decline in inventory turns to3.6 as of October 31, 2006 from 6.1 as of April 30, 2006. Our accruedincome taxes payable increased as a consequence of an additional accrual forthe three and six months ended October 31, 2006.

 

## ***Cash Flows From Investing Activities***

## *** ***

Forthe six months ended October 31, 2007, our cash used in investingactivities decreased to $26.8 million as compared to approximately$78.6 million for the corresponding period in the prior year, due to: $16.6 millionin purchases of property, plant and equipment; $9.0 million in a long-terminvestment in WLCSP and $1.3 million in net purchases of short-terminvestments. For the six months ended October 31, 2006, our cash used ininvesting activities increased to $78.6 million, due to:$49.1 million in purchases of property, plant and equipment;$28.9 million in net purchases of short-term investments and$0.5 million in purchase of intangible property. Of the $49.1 millionin purchases of property, plant and equipment, $24.9 million representsinvestments in packaging equipment that will be operated by XinTec. Inaddition, $23.2 million represents capital equipment and manufacturingfacility investments at VisEra.

 

## ***Cash Flows From Financing Activities***

## *** ***

Forthe six months ended October 31, 2007, net cash provided by financingactivities totaled approximately $1.5 million as compared to$12.3 million for the corresponding period in the prior year. This changewas primarily due to $11.6 million in proceeds from the exercise of stockoptions and employee purchases through our employee stock purchase planpartially offset by $9.6 million in repurchases of shares of our commonstock under the open-market program in the six months ended October 31,2007. For the six months ended October 31, 2006, net cash provided byfinancing activities totaled approximately $12.3 million and resulted from$8.3 million in proceeds from the exercise of stock options and employeepurchases through our employee stock purchase plan and a $4.3 million cashcontribution by one of our minority interest shareholders.

 

## ***Capital Commitments and Resources***

## *** ***

Overthe next two years, we expect to invest a total of $30.0 million in oursubsidiary, the Shanghai Design Center, or SDC, of which we have alreadycontributed $8.5 million. The funding requirement arises from ourexecution of a Land-Use-Right Purchase Agreement with the Construction andTransportation Commission of the Pudong New District, Shanghai with aconcomitant commitment to spend approximately $30.0 million to develop theland. See Note 15* – “Commitmentsand Contingencies”*to our condensed consolidated financialstatements. We expect to fund our capital commitments to SDC from our availableworking capital.

 

InFebruary 2007, our board of directors approved an additional stockrepurchase program that provides for the repurchase of up to $100 millionof our outstanding common stock in an open-market program. Subject toapplicable securities laws, such repurchases will be at such times and in suchamounts as we deem appropriate, based on factors such as market conditions,legal requirements and other corporate considerations. As of October 31,2007, we had cumulatively repurchased 566,000 shares of our common stockunder the open-market program for an aggregate cost of approximately$9.6 million. See Note 13 *–“TreasuryStock”*to our condensed consolidated financial statements.

 

We areobligated to pay an additional $10.0 million in cash upon the sale of apre-determined number of revenue-producing products incorporating CDM’stechnology. CDM and the costs associated with the acquisition are included inour condensed consolidated balance sheets at October 31, 2007 andApril 30, 2007.

 

Wecurrently expect our available cash, cash equivalents and short-terminvestments, together with cash that we anticipate generating from operatingactivities, will be sufficient to satisfy our capital requirements overapproximately the next twelve months. Other than normal working capitalrequirements, we expect our capital requirements totaling approximately$70 million over approximately the next twelve months will consistprimarily of funding capital investment at HWSC, funding a portion of theacquisition and build-out costs associated with the purchase of a complex offour buildings in Santa Clara, and funding a portion of the development costsof the land we have leased in Shanghai.

 

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| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)** |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------|

 

We arenow required to disclose our unrecognized tax benefits as commitments inaccordance with FIN 48. The non-current portion of the unrecognized taxbenefits at October 31, 2007 was $59.8 million, of which the timingof the resolution is uncertain.

 

Ourability to generate cash from operations is subject to substantial risksdescribed below under the caption Part II Item 1A. *“Risk Factors.”*We encourage you to reviewthese risks carefully.

 

**Contractual Obligations and Commercial Commitments**

 

Thefollowing table summarizes our contractual obligations and commercialcommitments as of October 31, 2007 and the effect such obligations andcommitments are expected to have on our liquidity and cash flows in futureperiods (in thousands):

 
| ** **                                                | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                | ** ** | ** **                                | ** ** | **Less than** | ** ** | ** ** | ** ** | ** ** | ** ** | **More than** | ** ** |
| ** **                                                | ** ** | **Total**                                 | ** ** | **1 Year** | ** ** | **1 - 3 Years** | ** ** | **3 - 5 Years** | ** ** | **5 Years** | ** ** |
| Contractual Obligations:                                  |       |                                      |       |   |   |   |   |   |   |   |   |
| Operating leases                                          |       | $                                         | 15,286     |   | $ | 5,308 |   | $ | 7,553 |   | $ | 2,425 |   | $ | — |   |
| Capital leases                                            |       | 208                                       |       | 152 |   | 56 |   | — |   | — |   |
| Mortgage obligation                                       |       | 27,717                                    | (1)        | 500 |   | 1,097 |   | 1,240 |   | 24,880 |   |
| Noncancelable orders                                      |       | 60,188                                    |       | 60,188 |   | — |   | — |   | — |   |
| Total contractual obligations                             |       | 103,399                                   |       | 66,148 |   | 8,706 |   | 3,665 |   | 24,880 |   |
|                                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Other Commercial Commitments:                             |       |                                      |       |   |   |   |   |   |   |   |   |
| Investment in Shanghai Design Center                      |       | 21,868                                    | (2)        | — |   | 21,868 |   | — |   | — |   |
| Total commercial commitments                              |       | 21,868                                    |       | — |   |   |   | — |   | — |   |
| Total contractual obligations and commercial  commitments |       | $                                         | 125,267    |   | $ | 66,148 |   | $ | 30,574 |   | $ | 3,665 |   | $ | 24,880 |   |

 

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| (1) |   | In March 2007, we  entered into a mortgage loan with a domestic bank in the amount of  $27.9 million. See Note 8 –*“Borrowing Arrangements”*  to our condensed consolidated financial statements.                                                                                                                                                      |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Over the next two  years, we expect to invest a total of approximately $30.0 million in our  subsidiary, SDC, of which we have already invested $8.5 million. SDC  will use the funds to develop land and construct facilities for its use. See  Note 15 – *“Commitments and  Contingencies”* to our condensed consolidated financial statements. |

 

### **Off-Balance SheetArrangements**

### ** **

We didnot have any off-balance sheet arrangements during the period covered by thisQuarterly Report on Form 10-Q.

 

### **Recent AccountingPronouncements**

### ** **

InSeptember 2006, the FASB issued Statement of Financial AccountingStandards, or SFAS, No. 157, *“Fair Value Measurements,”*or SFASNo. 157, which defines fair value, establishes guidelines for measuringfair value and expands the requisite disclosures for fair value measurements.SFAS No. 157 does not require any new fair value measurements but ratherestablishes a common definition of fair value to be used throughout generallyaccepted accounting principles. SFAS No. 157 is effective in fiscal yearsbeginning after November 15, 2007 and we are required to adopt it in thefirst quarter of fiscal 2009. We do not expect our adoption of the provisionsof SFAS No. 157 to have a material effect on our financial condition,results of operations or cash flows.

 

InDecember 2007, the FASB issued SFAS No. 141 (revised 2007),“*Business Combinations”*(“SFAS No. 141(R)”),which establishes the principles and requirements for how an acquirer:(1)  recognizes and measures in its financial statements theidentifiable assets acquired, the liabilities assumed, and any noncontrollinginterest in the acquiree; (2)  recognizes and measures the goodwillacquired in the business combination or a gain from a bargain purchase; and(3)  determines what information to disclose to enable users of thefinancial statements to evaluate the nature and financial effects of thebusiness combination. SFAS No. 141(R) replaces SFAS No. 141,

 

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| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)** |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------|

 

“*Business Combinations.”*SFAS No. 141(R)is effective in fiscal years beginning after December 15, 2008 and we arerequired to adopt it in the first quarter of our fiscal 2010. We arecurrently evaluating the impact SFAS No. 141(R) may have on ourfinancial position, results of operations and cash flows.

 

InDecember 2007, the FASB also issued SFAS No. 160, “*Noncontrolling Interests in Consolidated Financial Statements”*(“SFAS No. 160”),which establishes accounting and reporting standards that require:(1)  the ownership interests in subsidiaries held by parties otherthan the parent, and income attributable to those parties, be clearlyidentified and distinguished in the parent’s consolidated financial statements;and (2)  when a subsidiary is deconsolidated, any retainednoncontrolling equity investment in the former subsidiary be initially measuredat fair value. SFAS No. 160 is an amendment of Accounting ResearchBulletin No. 51, “*Consolidated Financial Statements”*and relatedinterpretations. SFAS No. 160 is effective for fiscal years beginningon or after December 15, 2008 and we are required to adopt it in the firstquarter of our fiscal 2010. We are currently evaluating the impactSFAS No. 160 may have on our financial position, results of operationsand cash flows.

 

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**ITEM 3.   QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

## ***Foreign Currency Exchange Risk***

## *** ***

Wesell our products globally, in particular to branded customers, contractmanufacturers, VARs and distributors in China, Japan, Korea and Taiwan.

 

Thegreat majority of our transactions with our customers and vendors aredenominated in U.S. dollars. The expenses we incur in currencies other thanU.S. dollars affect gross profit, selling, general and administrative expenses,research, development and related expenses and income taxes, and are primarilyincurred in China, where the Chinese Yuan, or CNY, is the local currency and inTaiwan, where the New Taiwan dollar is the local currency. Since July 2005, theChinese central bank has benchmarked the CNY against a basket of currencies,and as of October 31, 2007 has allowed the CNY to appreciate byapproximately 9.8% against the U.S. dollar.

 

As ofOctober 31, 2007, the functional currency of our wholly-owned subsidiarieslocated in Hong Kong, OmniVision Technologies (Hong Kong) Company Limited andOmniVision Trading (Hong Kong) Company Ltd., in the Cayman Islands, OmniVisionInternational Holding, Ltd. and HuaWei Technology International, Ltd., and inChina, HWSC and SDC, is the U.S. dollar. Our other wholly-owned subsidiarieshave their respective local currencies as their functional currencies. Thefunctional currency of our consolidated affiliate, SOI, is the New Taiwandollar. Transaction gains and losses resulting from transactions denominated incurrencies other than the respective functional currencies are included in “Otherincome (expense), net” for the periods presented. The amounts of transactiongains and losses for the three months ended October 31, 2007 and 2006 werenot material.

 

Giventhat the expenses that we incur in currencies other than U.S. dollars have notbeen a significant percentage of our revenues, we do not believe that ourforeign currency exchange rate fluctuation risk is significant. Consequently,we do not believe that a 10% change in foreign currency exchange rates wouldhave a significant effect on our future net income or cash flows.

 

Becausewe do not believe that we currently have any significant direct foreigncurrency exchange rate risk, we have not hedged exposures denominated inforeign currencies or used any other derivative financial instruments. Althoughwe transact the overwhelming majority of our business in U.S. dollars, futurefluctuations in the value of the U.S. dollar may affect the competitiveness ofour products and thus may impact our results of operations.

 

## ***Market Interest Rate Risk***

## *** ***

Our cash equivalents and short-term investments are exposed tofinancial market risk due to fluctuation in interest rates, which may affectour interest income and, from time to time, the fair market value of ourinvestments. We manage our exposure to financial market risk by performingongoing evaluations of our investment portfolio. We presently invest in moneymarket funds, certificates of deposit issued by banks, commercial paper,certificates of deposit, high-grade corporate securities and government bondsmaturing approximately 18 months or less from the date of purchase. In thepast, we also invested in auction rate securities which have a final maturitydate of up to thirty years but whose interest rate is reset principally up toevery 35 days, and in variable rate demand notes, which have a finalmaturity date of up to thirty-nine years but whose interest rate is reset atvarying intervals typically between 7 and 35 days. As of October 31, 2007, wedid not hold any auction rate securities or variable rate demand notes.

 

Due tothe short maturities of our investments, the carrying value should approximatethe fair market value. In addition, we do not use our investments for tradingor other speculative purposes. Due to the short duration of our investmentportfolio, we do not expect that an immediate 10% change in interest rateswould have a material effect on the fair market value of our portfolio.Therefore, we would not expect our operating results or cash flows to beaffected to any significant degree by the effect of a sudden change in marketinterest rates. We do not believe that the recent instability in globalfinancial markets has significantly affected the value of our cash andshort-term investments.

 

Duringfiscal 2007, we financed the purchase of a four-building complex in SantaClara, California with a $27.9 million mortgage loan. The mortgage loan isa variable rate loan which bears interest at LIBOR plus 90 basis points andchanges in the interest rate affect our interest payments. However, concurrentwith the mortgage loan, we also entered into an interest rate swap with anotional amount that approximates the principal outstanding under the

 

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mortgage loan. We are the fixed rate payer under theswap with a fixed rate of 5.27%. Consequently, a hypothetical 10% change inLIBOR would not have a material effect on our annual interest expense.

 

**ITEM 4.   CONTROLS AND PROCEDURES**

 

**(a)  ****Evaluation of Disclosure Controls and Procedures.**

 

Underthe supervision and with the participation of our chief executive officer andour chief financial officer, our management conducted an evaluation of theeffectiveness of our disclosure controls and procedures, as defined in theSecurities Exchange Act of 1934, as of the end of the period covered by thisQuarterly Report on Form 10-Q. Based on this evaluation, our chiefexecutive officer and chief financial officer have concluded that, at the levelof reasonable assurance, our disclosure controls and procedures are effectiveto ensure that the information we are required to disclose in reports that wefile or submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in Securities and ExchangeCommission rules and forms and that such information is accumulated andcommunicated to our management including our principal executive and principalfinancial officers, as appropriate, to allow timely decisions regardingrequired disclosure.

 

**(b)  Changes in InternalControls.**

 

Therehave been no changes in our internal control over financial reporting duringthe period covered by this Quarterly Report on Form 10-Q that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

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** **

**PART II — OTHER INFORMATION**

 

**ITEM 1.   LEGAL PROCEEDINGS**

 

Fromtime to time, we have been subject to legal proceedings and claims with respectto such matters as patents, product liabilities and other actions arising outof the normal course of business.

 

OnNovember 29, 2001, a complaint captioned *McKee v.OmniVision Technologies, Inc., et. al., Civil Action No. 01 CV 10775*,was filed in the United States District Court for the Southern District of NewYork against us, some of our directors and officers, and various underwritersfor our initial public offering. Plaintiffs generally allege that the nameddefendants violated federal securities laws because the prospectus related toour offering failed to disclose, and contained false and misleading statementsregarding, certain commissions purported to have been received by theunderwriters, and other purported underwriter practices in connection withtheir allocation of shares in our offering. The complaint seeks unspecifieddamages on behalf of a purported class of purchasers of our common stockbetween July 14, 2000 and December 6, 2000. Substantially similaractions have been filed concerning the initial public offerings for more than300 different issuers, and the cases have been coordinated as *In re Initial Public Offering Securities Litigation, 21 MC 92*.Claims against our directors and officers have been dismissed without prejudicepursuant to a stipulation. On February 19, 2003, the Court issued an orderdismissing all claims against us except for a claim brought underSection 11 of the Securities Act of 1933.

 

InJune 2004, the issuer defendants and plaintiffs negotiated a stipulation ofsettlement for the claims against the issuer defendants, including us, that wassubmitted to the Court for approval. In August 2005, the Court preliminarilyapproved the settlement. In December 2006, the appellate court overturnedthe certification of classes in the six test cases that were selected by theunderwriter defendants and plaintiffs in the coordinated proceedings. Becauseclass certification was a condition of the settlement, it was unlikely that thesettlement would receive final court approval. On June 25, 2007, the Courtentered an order terminating the proposed settlement based upon a stipulationamong the parties to the settlement. On August 14, 2007, plaintiffs filedamended master allegations and amended complaints in the six test cases, whichthe defendants in those cases have moved to dismiss. It is uncertain whetherthere will be any revised or future settlement. If the litigation proceeds, webelieve that we have meritorious defenses to plaintiffs’ claims and intend todefend the action vigorously.

 

OnOctober 12, 2007, a purported OmniVision shareholder filed a complaintagainst certain of our IPO underwriters. The complaint, *VanessaSimmonds v. Bank of America Corporation, et al.*, CaseNo. C07-1668, filed in District Court for the Western District ofWashington, makes similar allegations to those made in *In reInitial Public Offering Securities Litigation* and seeks the recoveryof short-swing trading profits under Section 16(b) of the SecuritiesExchange Act of 1934. The complaint names us as a nominal defendant. Norecovery is sought from us.

 

OnJune 10, 2004, the first of several putative class actions was filedagainst us and certain of our present and former directors and officers infederal court in the Northern District of California on behalf of investors whopurchased our common stock at various times from February 2003 throughJune 9, 2004. Those actions were consolidated under the caption *In re OmniVision Technologies, Inc.,*No. C-04-2297-SC,and a consolidated complaint was filed. The consolidated complaint assertsclaims on behalf of purchasers of our common stock between June 11, 2003and June 9, 2004, and seeks unspecified damages. The consolidatedcomplaint generally alleges that defendants violated Sections 10(b) and20(a) of the Securities Exchange Act of 1934 by allegedly engaging inimproper accounting practices that purportedly led to our financial restatement.On July 29, 2005, the Court denied our motion to dismiss the complaint.The parties engaged in settlement discussions and in November 2006, theparties reached an agreement in principle to settle this litigation. The totalamount of the proposed settlement is approximately $13.8 million, of whichapproximately $0.8 million would be contributed by us and the remainderwould be funded by insurance carriers that issued Directors and OfficersLiability Insurance Policies to us. We accrued $3.3 million duringfiscal 2007, as our share of the settlement, including unreimburseddefense costs, net of the $13.0 million in recoverable insurance proceeds.The parties have executed a Stipulation of Settlement that was filed with theCourt on May 15, 2007. On May 25, 2007, the Court issued an Orderpreliminarily approving the settlement and providing for notice of thesettlement to be provided to the purported shareholder class. The Ordergranting preliminary approval scheduled a hearing on September 7, 2007 todetermine whether the settlement is fair, reasonable and adequate to thepurported class. The hearing was held on September 7, 2007, as scheduled.On December 6, 2007, the Court issued its order granting final approval ofthe settlement and judgment was entered. Objectors to the settlement have 30days to appeal the Court’s approval of the settlement. We believe that ultimatesettlement is probable at the currently estimated

 

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amount. If the order approving the settlement does notbecome final and litigation against us continues, we believe that we havemeritorious defenses and intend to defend the case vigorously. However, if thelitigation continues, we cannot estimate whether the result of the litigationwould have a material adverse effect on our financial condition, results ofoperations or cash flows.

 

OnOctober 20, 2005, a purported shareholder derivative complaint, captioned *Hackl v. Hong*, No. 1:05-CV-050985, was filed in SantaClara County Superior Court for the State of California. The parties executed aStipulation of Settlement that was filed with the Court on June 18, 2007.On June 26, 2007, the Court entered an order approving the settlement,pursuant to which we paid a settlement fee in the amount of $200,000.

 

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**ITEM 1A.  RISK FACTORS**

 

*This Quarterly Report on Form 10-Q, includingManagement’s Discussion and Analysis of Financial Condition and Results ofOperations, contains forward-looking statements. These forward-lookingstatements are subject to substantial risks and uncertainties that could causeour future business, financial condition or results of operations to differmaterially from our historical results or currently anticipated results,including those set forth below.*

 

*The following description of these risk factors includes anymaterial changes to and supersedes the description of the risk factorsassociated with our business previously disclosed in Item 1A of our 2007Annual Report on Form 10-K filed with the SEC on June 29, 2007. As aresult of the following risk factors, as well as of other variables affectingour operating results, past financial performance may not be a reliableindicator of future performance, and historical trends should not be used toanticipate results or trends in future periods.*

 

***Risks Related to Our Business***

 

## ***We face intense competition in our markets from moreestablished CMOS and CCD image sensor manufacturers, and if we are unable tocompete successfully we may not be able to maintain or grow our business.***

## *** ***

Theimage sensor market is intensely competitive, and we expect competition in thisindustry to continue to increase. This competition has resulted in rapidtechnological change, evolving standards, reductions in product selling pricesand rapid product obsolescence. If we are unable to successfully meet thesecompetitive challenges, we may be unable to maintain and grow our business. Anyinability on our part to compete successfully would also adversely affect ourresults of operations and impair our financial condition.

 

Our image-sensor products face competition fromother companies that sell CMOS image sensors and from companies that sell CCDimage sensors. Many of our competitors have longer operating histories, greaterpresence in key markets, greater name recognition, larger customer bases, moreestablished strategic and financial relationships and significantly greaterfinancial, sales and marketing, distribution, technical and other resourcesthan we do. Many of them also have their own manufacturing facilities which maygive them a competitive advantage. As a result, they may be able to adapt morequickly to new or emerging technologies and customer requirements or devotegreater resources to the promotion and sale of their products. Our competitorsinclude established CMOS image sensor manufacturers such as Kodak,MagnaChip, Micron, Matsushita, Samsung, Sony, STMicroelectronics and Toshiba as well as CCD image sensor manufacturerssuch as Fuji, Kodak, Matsushita,NEC, Sanyo, Sharp, Sony, Texas Instruments and Toshiba. Many of these competitors own and operate their ownfabrication facilities, which in certain circumstances may give them theability to price their products more aggressively than we can or may allow themto respond more rapidly than we can to changing market opportunities. Inaddition, we compete with a large number of smaller CMOS manufacturersincluding Foveon, PixArt andPixelplus and Pixim. Competitionwith these and other companies has required, and in the future may require, usto reduce our prices. For instance, we have seen increased competition in themarkets for VGA image sensor products with resulting pressures on productpricing. Downward pressure on pricing could result both in decreased revenuesand lower gross margins, which would adversely affect our profitability.

 

Ourcompetitors may acquire or enter into strategic or commercial agreements orarrangements with foundries or providers of color filter processing, assemblyor packaging services. These strategic arrangements between our competitors andthird party service providers could involve preferential or exclusivearrangements for our competitors. Such strategic alliances could impair ourability to secure sufficient capacity from foundries and service providers tomeet our demand for wafer manufacturing, color filter processing, assembly orpackaging services, adversely affecting our ability to meet customer demand forour products. In addition, competitors may enter into exclusive relationshipswith distributors, which could reduce available distribution channels for ourproducts and impair our ability to sell our products and grow our business.Further, some of our customers could also become developers of image sensors,and this could potentially adversely affect our results of operations, businessand prospects.

 

## ***Declines in our average selling prices may result indeclines in our revenues and may further reduce our gross margins.***

## *** ***

We have experienced and expect to continue toexperience pressure to reduce the selling prices of our products, and ouraverage selling prices have declined as a result. Competition in our productmarkets is intense and as this competition continues to intensify, weanticipate that these pricing pressures will increase. We expect that theaverage selling prices for many of our products will continue to decline overtime. Unless we can increase unit sales sufficiently

 

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to offset these declines inour average selling prices, our revenues will decline. Declines in our averageselling prices have adversely affected our gross margins, and unless we canreduce manufacturing costs to compensate, additional reductions in our averageselling prices will continue to adversely affect our gross margins and couldmaterially and adversely affect our operating results and impair our financialcondition. We have increased and intend to continue to increase our research,development and related expenses to continue the development of new imagesensor products in fiscal years 2008 and 2009 that can be sold at higherselling prices and/or manufactured at lower cost. However, if we are unable totimely introduce new products that incorporate more advanced technology andinclude more advanced features that can be sold at higher average sellingprices, or if we are unable to successfully develop more cost-effectivetechnologies, our financial results could be adversely affected.

 

## ***Sales of our image-sensor products for camera cellphones account for a large portion of our revenues, and any decline in sales tothe camera cell phone market or failure of this market to continue to grow asexpected could adversely affect our results of operations.***

## *** ***

Salesto the camera cell phone market account for a large portion of our revenues.Although we can only estimate the percentages of our products that are used inthe camera cell phone market due to the significant number of our image-sensorproducts that are sold to module makers or through distributors and VARs, webelieve that the camera cell phone market accounted for approximately 80% ofour revenues in fiscal 2007 and 70% in the six months endedOctober 31, 2007. We expect that revenues from sales of our image-sensorproducts to the camera cell phone market will continue to account for asignificant portion of our revenues during fiscal 2008 and beyond. Any factorsadversely affecting the demand for our image sensors in this market could causeour business to suffer and adversely affect our operating results. The digitalimage sensor market for camera cell phones is extremely competitive, and weexpect to face increased competition in this market in the future. In addition,we believe the market for camera cell phones is also relatively concentratedand the top five producers account for more than 80% of the annual sales ofthese products. If we do not continue to achieve design wins with key cameracell phone manufacturers, our market share or revenues could decrease. Thecamera cell phone image sensor market is also subject to rapid technologicalchange. In order to compete successfully in this market, we will have tocorrectly forecast customer demand for technological improvements and be ableto deliver such products on a timely basis at competitive prices. If we fail todo this, our results of operations, business and prospects would be materiallyand adversely affected. In the past, we have experienced problems accuratelyforecasting customer demand in other markets. If our sales to the camera cellphone market do not increase and/or the camera cell phone market does not growas expected, our results of operations, business and prospects would bematerially adversely affected.

 

## ***Our future success depends on the timely development,introduction, marketing and selling of new CMOS image sensors, which we mightnot be able to achieve.***

## *** ***

Ourfailure to successfully develop new products that achieve market acceptance ina timely fashion would adversely affect our ability to grow our business andour operating results. The development, introduction and market acceptance ofnew products is critical to our ability to sustain and grow our business. Anyfailure to successfully develop, introduce, market and sell new products couldmaterially adversely affect our business and operating results. The developmentof new products is highly complex, and we have in the past experienced delaysin completing the development and introduction of new products. From time totime, we have also encountered unexpected manufacturing problems as we increasethe production of new products. For example, in the fourth quarter of fiscal2005, and again in the first quarter of fiscal 2006, the back-end yields on twoof our advanced products were significantly below where we planned, and ourgross margins were adversely impacted. As our products integrate new and moreadvanced functions, they become more complex and increasingly difficult todesign and debug. Successful product development and introduction depends on anumber of factors, including:

 

•                  accurateprediction of market requirements and evolving standards, including pixelresolution, output interface standards, power requirements, optical lens size,input standards and operating systems for personal computers and otherplatforms;

 

•                  development ofadvanced technologies and capabilities;

 

•                  definition,timely completion and introduction of new CMOS image sensors that satisfycustomer requirements;

 

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•                  development ofproducts that maintain a technological advantage over the products of ourcompetitors, including our advantages with respect to the functionality andpixel capability of our image-sensor products and our proprietary testingprocesses; and

 

•                  marketacceptance of the new products.

 

Accomplishing all of these steps is difficult, timeconsuming and expensive. We may be unable to develop new products or productenhancements in time to capture market opportunities or achieve significant orsustainable acceptance in new and existing markets. In addition, our productscould become obsolete sooner than anticipated because of a rapid change in oneor more of the technologies related to our products or the reduced life cyclesof consumer products.

 

## ***Design wins are a key determinant of future revenues,and failure to obtain design wins has in the past, and could in the future,adversely affect our revenues and impair our ability to grow our business.***

## *** ***

Our past success has been, and our future successis, dependent upon manufacturers designing our image-sensor products into theirproducts. To achieve design wins, which are decisions by manufacturers todesign our products into their systems, we must define and deliver costeffective and innovative image-sensor solutions on a timely basis that satisfythe manufacturers’ requirements. Our ability to achieve design wins is subjectto numerous risks including competitive pressures as well as technologicalrisks. If we do not achieve a design win with a prospective customer, it may bedifficult to sell our image-sensor products to such prospective customer in thefuture because once a manufacturer has designed a supplier’s products into itssystems, the manufacturer may be reluctant to change its source of componentsdue to the significant costs, time, effort and risk associated with qualifyinga new supplier. Accordingly, if we fail to achieve design wins with key devicemanufacturers that embed image sensors in their products, our market share orrevenues could decrease. Furthermore, to the extent that our competitors securedesign wins, our ability to expand our business in the future will be impaired.

 

## ***We depend on a limited number of third party waferfoundries, which reduces our ability to control our manufacturing process.***

## *** ***

Unlike some of our larger competitors, we do not ownor operate a semiconductor fabrication facility. Instead, we rely on TSMC, PSCand other subcontract foundries to produce all of our wafers. Historically, wehave relied on TSMC to provide us with a substantial majority of our wafers. Asa part of our joint venture agreement with TSMC, TSMC has agreed to commitsubstantial wafer manufacturing capacity to us in exchange for our commitmentto purchase a substantial portion of our wafers from TSMC, subject to pricingand technology requirements.

 

In addition, we have entered into a foundrymanufacturing agreement with PSC pursuant to which we and PSC have agreed tojointly develop certain pixel-related process technology and for PSC to processcertain of our CMOS image sensors at PSC’s facilities in accordance with thescheduled development approved by both parties.

 

Under the terms of these supply agreements, wesecure manufacturing capacity in any particular period on a purchase orderbasis. The foundries have no obligation to supply products to us for any specificperiod, in any specific quantity or at any specific price, except as set forthin a particular purchase order. In general, our reliance on third partyfoundries involves a number of significant risks, including:

 

•                  reduced controlover delivery schedules, quality assurance, manufacturing yields and productioncosts;

 

•                  lack ofguaranteed production capacity or product supply;

 

•                  unavailabilityof, or delayed access to, next generation or key process technologies; and

 

•                  financialdifficulties or disruptions in the operations of third party foundries due tocauses beyond our control.

 

If TSMC, PSC, or any of our other foundries wereunable to continue manufacturing our wafers in the required quantities, atacceptable quality, yields and costs, or in a timely manner, we would have toidentify and qualify substitute foundries, which would be time consuming anddifficult, and could increase our costs or result in unforeseen manufacturingproblems. In addition, if competition for foundry capacity increases we may berequired to pay increased amounts for manufacturing services. We are alsoexposed to additional risks if we transfer our production of semiconductorsfrom one foundry to another, as such transfer could interrupt our manufacturingprocess. Further, some

 

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of our foundries may also bedevelopers of image sensor products and if one or more of our other foundrieswere to decide not to fabricate our companion DSP chips for competitive orother reasons, we would have to identify and qualify other sources for theseproducts.

 

## ***We rely on a joint venture company for color filterapplication and on third party service providers for packaging services, whichreduces our control over delivery schedules, product quality and cost, andcould adversely affect our ability to deliver products to customers.***

## *** ***

We rely on VisEra, our joint venture with TSMC, forthe color filter processing of our completed wafers. In addition, we rely onAdvanced Semiconductor Engineering, Inc. and ImPac, our equity investee, forsubstantially all of our ceramic chip packages. We also rely on ImPac for ourplastic chip packages. We rely on XinTec and WLCSP, two investee companies, forchip scale packages, which are generally used in our products designed for thesmallest form factor applications. We are currently expanding our color filterprocessing capacity at VisEra. If for any reason one or more of these serviceproviders becomes unable or unwilling to continue to provide color filter processingor packaging services of acceptable quality, at acceptable costs and in atimely manner, our ability to deliver our products to our customers could beseverely impaired. We would have to identify and qualify substitute serviceproviders, which could be time consuming and difficult and could result inunforeseen operational problems. Substitute service providers might not beavailable or, if available, might be unwilling or unable to offer services onacceptable terms.

 

In addition, if competition for color filterprocessing or packaging capacity increases, we may be required to pay or investsignificant amounts to secure access to these services, which could adverselyimpact our operating results. The number of companies that provide these servicesis limited and some of them have limited operating histories and financialresources. In the event our current providers refuse or are unable to continueto provide these services to us, we may be unable to procure services fromalternate service providers. Furthermore, if customer demand for our productsincreases, we may be unable to secure sufficient additional capacity from ourcurrent service providers on commercially reasonable terms, if at all.Moreover, our reliance on a limited number of third party service providers toprovide color filter processing services subjects us to reduced control overdelivery schedules, quality assurance and costs. This lack of control may causeunforeseen product shortages or may increase our costs of manufacturing, assemblingor testing of our products, which would adversely affect our operating results.

 

## ***Fluctuations in our quarterly operating results havecaused volatility in the market price of our common stock and make it difficultto predict our future operating results.***

## *** ***

Our quarterly operating results have variedsignificantly from quarter to quarter in the past and are likely to varysignificantly in the future based on a number of factors, many of which arebeyond our control. These factors and other industry risks, many of which aremore fully discussed in our other risk factors, include, but are not limitedto:

 

•                  the volume andmix of our product sales;

 

•                  competitivepricing pressures;

 

•                  our ability toaccurately forecast demand for our products;

 

•                  our ability toachieve acceptable wafer manufacturing or back-end processing yields;

 

•                  our gain or lossof a large customer;

 

•                  our ability tomanage our product transitions;

 

•                  the availabilityof production capacity at the suppliers that manufacture our products orprocess our products;

 

•                  the growth ofthe market for products and applications using CMOS image sensors;

 

•                  the timing andsize of orders from our customers;

 

•                  the volume ofour product returns;

 

•                  the seasonalnature of customer demand for our products;

 

•                  the deferral ofcustomer orders in anticipation of new products, product designs orenhancements;

 

•                  the announcementand introduction of products and technologies by our competitors;

 

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•                  adverse changesin global economic conditions;

 

•                  the level of ouroperating expenses; and

 

•                  the increasedvolatility of our effective tax rate as a consequence of our adoption of FASBInterpretation No. 48, or FIN 48, *“Accountingfor Uncertainty in Income Taxes—an Interpretation of FASB StatementNo. 109.”*

 

Our introduction of new products and our product mixhave affected and may continue to affect our quarterly operating results.Changes in our product mix could adversely affect our operating results,because some products provide higher margins than others. We typicallyexperience lower yields when manufacturing new products through the initialproduction phase, and consequently our gross margins on new products havehistorically been lower than our gross margins on our more establishedproducts. We also anticipate that the rate of orders from our customers mayvary significantly from quarter to quarter. Our operating expenses arerelatively fixed, and our inventory levels are based on our expectations of futurerevenues. Consequently, if we do not achieve the revenues we expect in anyquarter, expenses and inventory levels could be disproportionately high,adversely impacting our operating results for that quarter, and potentially infuture quarters.

 

All of these factors are difficult to forecast andcould result in fluctuations in our quarterly operating results. Our operatingresults in a given quarter could be substantially less than anticipated, and,if we fail to meet market analysts’ expectations, a substantial decline in ourstock price could result. Fluctuations in our quarterly operating results couldadversely affect the price of our common stock in a manner unrelated to ourlong-term operating performance.

 

## ***Our business is subject to seasonal fluctuations whichmay in turn cause fluctuations in our results of operations from period toperiod.***

## *** ***

Many of the products using our image sensors, suchas camera cell phones, notebooks and personal computers, digital still cameras and cameras for toysand games, are consumer electronics goods. These mass-market camera devicesgenerally have seasonal cycles which historically have caused the sales of ourcustomers to fluctuate quarter-to-quarter. Historically, demand from OEMs anddistributors that serve such consumer product markets has been stronger in thesecond and third quarters of our fiscal year and weaker in the first and fourthquarters of our fiscal year.

 

In addition, since a very large number of themanufacturers who use our products are located in China, Hong Kong and Taiwan,the pattern of demand for our image sensors has been increasingly influenced bythe timing of the extended lunar or Chinese New Year holiday, a period in whichthe factories which use our image sensors generally close. For example, webelieve that the decline in revenues that we experienced in the fourth quarterof fiscal 2007 is partly attributable to the fact that in 2007 Chinese New Yearoccurred in mid-February, and manufacturing did not resume in full untilsometime in March.

 

## ***Problems with wafer manufacturing and/or back-endprocessing yields could result in higher product costs and could impair ourability to meet customer demand for our products.***

## *** ***

If the foundries manufacturing the wafers used inour products cannot achieve the yields we expect, we will incur higher per unitcosts and reduced product availability. Foundries that supply our wafers haveexperienced problems in the past achieving acceptable wafer manufacturingyields. Wafer yields are a function both of our design technology and theparticular foundry’s manufacturing process technology. Certain risks areinherent in the introduction of such new products and technology. Low yieldsmay result from design errors or manufacturing failures in new or existingproducts. During the early stages of production, production yields for newproducts are typically lower than those of established products. Unlike manyother semiconductor products, optical products can be effectively tested onlywhen they are complete. Accordingly, we perform final testing of our productsonly after they are assembled. As a result, yield problems may not beidentified until our products are well into the production process. The risksassociated with low yields could be increased because we rely on third partyoffshore foundries for our wafers, which can increase the effort and timerequired to identify, communicate and resolve manufacturing yield problems. Inaddition to wafer manufacturing yields, our products are subject to yield lossin subsequent manufacturing steps, often referred to as back-end processing,such as the application of color filters and micro-lenses, dicing (cutting thewafer into individual devices, or die) and packaging. Any of these potentialproblems with wafer manufacturing and/or back-end processing yields couldresult in a reduction in our gross margins and/or our ability to timely deliverproducts to customers, which could adversely affect our customer relations andmake it more difficult to sustain and grow our business. For example,

 

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low back-end yields on twoof our products adversely impacted our gross margins for the fiscal quartersended April 30, 2005, July 31, 2005 and October 31, 2005.

 

## ***If we do not forecast customer demand correctly, ourbusiness could be impaired and our stock price may decline.***

## *** ***

Oursales are generally made on the basis of purchase orders rather than long-termpurchase commitments; however, we manufacture products and build inventorybased on our estimates of customer demand. Accordingly, we must rely onmultiple assumptions to forecast customer demand. We are continually working toimprove our sales forecasting procedures. If we overestimate customer demand,we may manufacture products that we may be unable to sell, or we may have tosell at lower prices. This could materially and adversely affect our results ofoperations and financial condition. In addition, our customers may cancel ordefer orders at any time by mutual written consent. We have experiencedproblems with accurately forecasting customer demand in the past. For example,there was a shift in the mix of product demand, in particular a shift in demand towards VGA productslate in the second quarter of fiscal 2007, and as a result our inventoriesat the end of the second and third quarters were higher than we intended themto be. We are required to accurately predict customer demand because we mustoften make commitments to have products manufactured before we receive firmpurchase orders from our customers. Conversely, if we underestimate customerdemand, we may be unable to manufacture sufficient products quickly enough tomeet actual demand, causing us to lose customers and impairing our ability togrow our business. In preparation for new product introductions, we graduallyramp down production of established products. With our 12-14 week productioncycle, it is extremely difficult to predict precisely how many units ofestablished products we will need. It is also difficult to accurately predictthe speed of the ramp of our new products and the impact on inventory levelspresented by the shorter life cycles of end-user products. The shorter productlife cycle is a result of an increase in competition and the growth of variousconsumer-product applications for image sensors. For example, although in thesecurity and surveillance market we continue to sell image-sensor productsintroduced more than four years ago, in the camera cell phone market, theproduct life cycle of image sensors can be as little as six months. Under thesecircumstances, it is possible that we could suffer from shortages for certainproducts and, if we underestimate market demand, we face the risk of beingunable to fulfill customer orders. We also face the risk of excess inventoryand product obsolescence if we overestimate market demand for our products andbuild inventories in excess of demand. Our ability to accurately forecast salesis also a critical factor in our ability to meet analyst expectations for ourquarterly and annual operating results. Any failure to meet these expectationswould likely lead to a substantial decline in our stock price.

 

## ***We depend on the increased acceptance of mass-marketimage sensor applications to grow our business and increase our revenues.***

## *** ***

Our business strategy depends in large part on thecontinued growth of various markets into which we sell our image-sensorproducts, including the markets for camera cell phones, notebook andpersonal computers, digital still andvideo cameras, commercial and security and surveillance applications, toys andgames, including interactive video games, and automotive applications. Ourability to sustain and grow our business also depends on the continueddevelopment of new markets for our products such as medical imaging devices. Ifthese current and new markets do not grow and develop as we anticipate, we maybe unable to sustain or grow the sales of our products.

 

In addition, the market price of our common stockmay be adversely affected if certain of these new markets do not emerge ordevelop as expected. Securities analysts may already factor revenue from suchnew markets into their future estimates of our financial performance and shouldsuch markets not develop as expected by such securities analysts the tradingprice of our common stock could be adversely affected.

 

## ***Our lengthy manufacturing, packaging and assemblycycle, in addition to our customers’ design cycle, may result in uncertaintyand delays in generating revenues.***

## *** ***

The production of our image sensors requires alengthy manufacturing, packaging and assembly process, typically lastingapproximately 12-14 weeks. Additional time may pass before a customer commencesvolume shipments of products that incorporate our image sensors. Even when amanufacturer decides to design our image sensors into its products, themanufacturer may never ship final products incorporating our image sensors.Given this lengthy cycle, we experience a delay between the time we incurexpenditures for research and development and sales and marketing efforts andthe time we generate revenue, if any, from these expenditures. This delay makesit more difficult to forecast customer demand, which adds uncertainty to themanufacturing planning process and could adversely affect our operatingresults. In addition, the product life cycle for certain of our image-sensorproducts designed for use in certain

 

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applications can berelatively short. If we fail to appropriately manage the manufacturing,packaging and assembly process, our products may become obsolete before theycan be incorporated into our customers’ products and we may never realize areturn on investment for the expenditures we incur in developing and producingthese products.

 

## ***Our ability to deliver products that meet customerdemand is dependent upon our ability to meet new and changing requirements forcolor filter application and sensor packaging.***

## *** ***

We expect that as we develop new products to meettechnological advances and new and changing industry and customer demands, ourcolor filter application and ceramic, plastic and chip-scale packagingrequirements will also evolve. Our ability to continue to profitably deliverproducts that meet customer demand is dependent upon our ability to obtainthird party services that meet these new requirements on a cost-effectivebasis. We have historically relied exclusively on third parties, and morerecently, on one of our joint ventures, to provide these services. There can beno assurances that any of these parties will be able to develop enhancements tothe services they provide to us to meet these new and changing industry andcustomer requirements. Furthermore, even if these service providers are able todevelop their services to meet new and evolving requirements, these servicesmay not be available at a cost that enables us to sustain our profitability.

 

## ***The high level of complexity and integration of ourproducts increases the risk of latent defects, which could damage customerrelationships and increase our costs.***

## *** ***

Our products are based upon evolving technology, andbecause we integrate many functions on a single chip, are complex. Theintegration of additional functions into already complex products could resultin a greater risk that customers or end users could discover latent defects orsubtle faults after we have already shipped significant quantities of aproduct. Although we test our products, we have in the past and may in thefuture encounter defects or errors. For example, in the third quarter of fiscal2005, we made a provision of $2.7 million related to the possiblereplacement of products that did not meet a particular customer’s standards.Delivery of products with defects or reliability, quality or compatibilityproblems may damage our reputation and ability to retain existing customers andattract new customers. In addition, product defects and errors could result inadditional development costs, diversion of technical resources, delayed productshipments, increased product returns, product warranty costs for recall andreplacement and product liability claims against us which may not be fullycovered by insurance.

 

## ***Historically, our revenues have been dependent upon afew key customers, the loss of one or more of which could significantly reduceour revenues.***

## *** ***

Historically,a relatively small number of OEMs, VARs and distributors have accounted for asignificant portion of our revenues. Any material delay, cancellation orreduction of purchase orders from one or more of our major customers ordistributors could result in our failure to achieve anticipated revenue for aparticular period. In addition, if we are unable to retain one or more of ourlargest OEM, distributor or VAR customers, or if we are unable to maintain ourcurrent level of revenues from one or more of these significant customers, ourbusiness and results of operation would be impaired and our stock price coulddecrease, potentially significantly. In the six months ended October 31, 2007,one OEM customer accounted for approximately 16.8% of our revenues, and onedistributor customer accounted for approximately 20.9% of our revenues. In thesix months ended October 31, 2006, one OEM customer accounted forapproximately 15.5% of our revenues and two distributor customers accounted forapproximately 13.2% and 10.7%  of ourrevenues. In addition, approximately 55% of our revenues have historically comefrom our top five customers. Our business, financial condition, results ofoperations and cash flows will continue to depend significantly on our abilityto retain our current key customers and attract new customers, as well as onthe financial condition and success of our OEMs, VARs and distributors.

 

## ***Changes in accounting rules for stock-based compensationhave adversely affected our reported operating results, and may adverselyaffect our stock price and our competitiveness in the employee marketplace.***

## *** ***

Sinceour founding, we have used employee stock options and other stock-basedcompensation to attract, motivate and retain our employees. In December 2004,the Financial Accounting Standards Board issued Statement of FinancialAccounting Standards, or SFAS, No. 123(R), *“Share-Based Payment,”*or SFAS No. 123(R). We adopted SFAS No. 123(R) on May 1,2006 and accordingly, we began to measure compensation costs for allstock-based compensation at fair value and recognize these costs as expenses inour Consolidated Statements of Income. The recognition of these expenses in ourConsolidated Statements of Income has had a negative effect on our earnings pershare, which could negatively impact our future stock price. In addition,reducing or altering our use of stock-based compensation to reduce

 

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these expenses, may adversely impact our ability toattract, motivate and retain qualified employees, which could put us at acompetitive disadvantage in the employee marketplace.

 

## ***We may be required to record a significant charge toearnings if our goodwill, amortizable intangible assets or long-terminvestments become impaired.***

## *** ***

Undergenerally accepted accounting principles, we are required to review ouramortizable intangible assets for impairment when events or changes incircumstances indicate the carrying value may not be recoverable. We arerequired to test goodwill for impairment at least annually. Factors that may beconsidered a change in circumstances indicating that the carrying value of ouramortizable intangible assets may not be recoverable include a decline in stockprice and market capitalization, and slower growth rates in our industry. Wemay be required to record a significant charge to earnings in our financialstatements during the period in which we determine that our goodwill,amortizable intangible assets or long-term investments have been impaired. Anysuch charge would adversely impact our results of operations. As ofOctober 31, 2007, our net goodwill and amortizable intangible assetstotaled approximately $24.8 million and our long term investments totaledapproximately $81.5 million.

 

## ***We maintain a backlog of customer orders that issubject to cancellation or delay in delivery schedules, and any cancellation ordelay may result in lower than anticipated revenues.***

## *** ***

Oursales are generally made pursuant to standard purchase orders. We include inour backlog only those customer orders for which we have accepted purchaseorders and assigned shipment dates within the upcoming 12 months. Ordersconstituting our current backlog are subject to cancellation or changes indelivery schedules, and backlog may not necessarily be an indication of futurerevenue. Any cancellation or delay in orders which constitute our current orfuture backlog may result in lower than expected revenues.

 

## ***If we are unable to maintain processes and proceduresto sustain effective internal control over our financial reporting, our abilityto provide reliable and timely financial reports could be harmed and this couldhave a material adverse effect on our stock price.***

## *** ***

We arerequired to comply with the rules promulgated under Section 404 of theSarbanes-Oxley Act of 2002. Section 404 requires that we prepare an annualmanagement report assessing the effectiveness of our internal control overfinancial reporting, and requires a report by our independent registered publicaccounting firm addressing this assessment and the effectiveness of ourinternal control over financial reporting.

 

Wehave in the past discovered, and may in the future discover, areas of ourinternal control that need improvement. For example, we restated our financialstatements for the first, second and third quarters of fiscal 2004. If these orsimilar types of issues were to arise with respect to our internal controls infuture periods, they could impair our ability to produce accurate and timelyfinancial reports.

 

As ourbusiness expands, ongoing compliance with the provisions of Section 404 ofthe Sarbanes-Oxley Act of 2002 andmaintenance of effective internal control over financial reporting will requirethat we hire additional qualified finance and accounting personnel. Becauseother businesses face similar challenges, there is significant competition forsuch personnel, and there can be no assurance that we will be able to attractand/or retain suitably qualified employees.

 

## ***Corporate governance regulations have recentlyincreased our compliance costs and could further increase our expenses ifchanges occur within our business.***

## *** ***

Changesin laws and regulations affecting public companies, including the provisions ofthe Sarbanes-Oxley Act, have imposed new requirements on us and on ourofficers, directors, attorneys and independent registered public accountingfirm. In order to comply with these new rules, we added internal resources andhave utilized additional outside legal, accounting and advisory services, whichincreased our operating expenses in fiscal 2005 and fiscal 2006 as compared toprior fiscal years. We expect to incur ongoing operating expenses as wemaintain compliance with Section 404. In addition, if we undergosignificant modifications to our structure through personnel or system changes,acquisitions, or otherwise, it may be increasingly difficult to maintaincompliance with the existing and evolving corporate governance regulations.

 

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## ***We hold a significant amount of marketable securitieswhich are managed on our behalf by third parties and are subject to generalmarket risks over which we have no control.***

## *** ***

As of October 31, 2007, we held cash and cashequivalents totaling $207.6 million, and short-term investments totaling$116.3 million. These assets are managed on our behalf by unrelated thirdparties in accordance with a cash management policy that has been approved byour board of directors and restricts our investments to a maximum maturity of18 months and to investment-grade instruments. Recent uncertainties in globalcapital markets associated with a repricing of risk have caused disruptions inthe orderly function of markets where ordinarily there is virtually unlimitedliquidity. To date, we have not realized any losses as a result of thesedisruptions, but a future requirement to liquidate a portion of our portfolioat short notice could result in losses of principal.

 

## ***There are risks associated with our operations inChina.***

## *** ***

InDecember 2000, we established Hua Wei Semiconductor (Shanghai) Co. Ltd.,or HWSC, as part of our efforts to streamline our manufacturing process andreduce the costs and working capital associated with the testing of ourimage-sensor products, and relocated our automated image testing equipment fromthe United States to China. We are currently expanding our testing capabilitieswith additional automated testing equipment, which will also be located inChina. However, there are significant administrative, legal and governmentalrisks to operating in China that could result in increased operating expensesor that could prevent us from achieving our objectives in operations. The risksfrom operating in China that could increase our operating expenses andadversely affect our operating results, financial condition and ability todeliver our products and grow our business include, without limitation:

 

•                  difficulties instaffing and managing foreign operations, particularly in attracting andretaining personnel qualified to design, sell and support CMOS image sensors;

 

•                  difficulties incoordinating our operations in China with those in California;

 

•                  diversion ofmanagement attention;

 

•                  difficulties inmaintaining uniform standards, controls, procedures and policies across ourglobal operations, including inventory management and financial consolidation;

 

•                  political andeconomic instability, which could have an adverse impact on foreign exchangerates in Asia and could impair our ability to conduct our business in China;and

 

•                  inadequacy ofthe local infrastructure to support our needs.

 

## ***We may experience integration or other problems withpotential future acquisitions, which could have an adverse effect on our businessor results of operations. New acquisitions could dilute the interests ofexisting stockholders, and the announcement of new acquisitions could result ina decline in the price of our common stock.***

## *** ***

We mayin the future make acquisitions of, or investments in, businesses that offerproducts, services and technologies that we believe would complement ourproducts, including CMOS image sensor manufacturers. We may also makeacquisitions of, or investments in, businesses that we believe could expand ourdistribution channels. Even if we were to announce an acquisition, we may notbe able to complete it. In addition, any future acquisition or substantialinvestment could present numerous risks, including:

 

•                  difficulty inrealizing the potential technological benefits of the transaction;

 

•                  difficulty inintegrating the technology, operations or work force of the acquired businesswith our existing business;

 

•                  unanticipatedexpenses related to technology integration;

 

•                  disruption ofour ongoing business;

 

•                  difficulty inrealizing the potential financial or strategic benefits of the transaction;

 

•                  difficulty inmaintaining uniform standards, controls, procedures and policies;

 

•                  possibleimpairment of relationships with employees, customers, suppliers and strategicpartners as a result of integration of new businesses and management personnel;

 

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•                  reductions inour future operating results from amortization of intangible assets;

 

•                  impairment ofresulting goodwill; and

 

•                  potentialunknown or unexpected liabilities associated with acquired businesses.

 

Weexpect that any future acquisitions could include consideration to be paid incash, shares of our common stock or a combination of cash and our common stock.If and when consideration for a transaction is paid in common stock, it willresult in dilution to our existing stockholders.

 

## ***We may never achieve all of the anticipated benefitsfrom our joint venture with TSMC.***

## *** ***

InOctober 2003, we entered into an agreement with TSMC to form VisEra, ajoint venture in Taiwan, for the purposes of providing manufacturing services.In August 2005, we amended and restated our agreement with TSMC in part toenable VisEra to acquire 29.6% of XinTec, a supplier of chip-scale packagingservices in which we originally invested in April 2003 and in which we directlyhold an approximate four percent interest. In January 2007, we entered into afurther amendment to the agreement with TSMC to expand the scope of VisEra’sactivities and provide additional funding for the expansion of VisEra.

 

InJanuary 2006, VisEra acquired certain color filter processing equipmentfrom TSMC and assumed direct responsibility for providing the color filterprocessing services that had previously been provided by TSMC. We expect thatVisEra will be able to provide us with a committed supply of high qualitymanufacturing services at competitive prices. However, there are significantlegal, governmental and relationship risks to developing VisEra, and we cannotensure that we will receive the expected benefits from the joint venture. Forexample, VisEra may not be able to provide manufacturing services that havecompetitive technology or prices, which could adversely affect our productofferings and our ability to meet customer requirements for our products. Inaddition, the existence of VisEra may also make it more difficult for us tosecure dependable services from competing merchant vendors who provide similarmanufacturing services.

 

## ***We may not achieve all of the anticipated benefits ofour alliances with, and strategic investments in, third parties.***

## *** ***

Weexpect to develop our business partly through forming alliances or jointventures with and making strategic investments in other companies, some of whichmay be companies at a relatively early stage of development. For example, inApril 2003, we made an investment in XinTec, a chip scale packagingservice company, and in June 2003 we made an investment in ImPac, aplastic packaging service company. In December 2005, VisEra, our jointventure with TSMC, completed the acquisition of a further 29.6% of the issuedand outstanding shares of XinTec. In January 2007, TSMC acquired directly a43.0% interest in XinTec, thus reducing our beneficial ownership in XinTec to12.4%

 

In May2004, we entered into an agreement with PSC under which we established SOI, ajoint venture as a company incorporated under the laws of Taiwan. The purposeof the joint venture is to conduct the business of manufacturing, marketing andselling of certain of our legacy products. In March 2005, we assumedcontrol of the board of directors of SOI and we have consolidated SOI sinceApril 30, 2005.

 

Ourinvestments in these companies may negatively impact our operating results,because, under certain circumstances, we are required to recognize our portionof any loss recorded by each of these companies or to consolidate them into ouroperating results. We expect to continue to utilize partnerships, strategicalliances and investments, particularly those that enhance our manufacturingcapacity and those that provide manufacturing services and testing capability.These investments and partnering arrangements are crucial to our ability togrow our business and meet the increasing demands of our customers. However, wecannot ensure that we will achieve the benefits we expect from these alliances.For example, we may not be able to obtain acceptable quality and/or wafermanufacturing yields from these companies, which could result in higher operatingcosts and could impair our ability to meet customer demand for our products. Inaddition, certain of these investments or partnering relationships may placerestrictions on the scope of our business, the geographic areas in which we cansell our products and the types of products that we can manufacture and sell.For example, our agreement with TSMC provides that we may not engage inbusiness that will directly compete with the business of VisEra. This type ofnon-competition provision may impact our ability to grow our business and tomeet the demands of our customers.

 

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## ***Changes in our relationships with our joint venturesand/or companies in which we hold less than a majority interest could changethe way we account for such interests in the future.***

## *** ***

Aspart of our strategy, we have formed joint ventures with two of our foundrypartners, and we hold a minority interest in two companies from which wepurchase certain manufacturing services. Under the applicable provisions ofgenerally accepted accounting principles in the United States of America, wecurrently consolidate one of these joint ventures into our consolidatedfinancial statements and results of operations, and record the equity intereststhat we do not own as minority interests. For the investments that we accountfor under the equity method, we record as part of other income or expense ourshare of the increase or decrease in the equity of the companies in which wehave invested. It is possible that, in the future, our relationships and/or ourinterests in or with these joint ventures or other investees could change. Suchchanges have in the past, and could in the future result in deconsolidation orconsolidation of such entities, as the case may be, which could result inchanges in our reported results.

 

## ***We may be unable to adequately protect ourintellectual property, and therefore we may lose some of our competitiveadvantage.***

## *** ***

Werely on a combination of patent, copyright, trademark and trade secret laws aswell as nondisclosure agreements and other methods to protect our proprietarytechnologies. We have been issued patents and have a number of pending UnitedStates and foreign patent applications. However, we cannot provide assurancethat any patent will be issued as a result of any applications or, if issued,that any claims allowed will be sufficiently broad to protect our technology.It is possible that existing or future patents may be challenged, invalidatedor circumvented. For example, in August 2002 we initiated a patent infringementaction in Taiwan, Republic of China against IC Media Corporation of San Jose,California for infringement of a Taiwanese patent that had been issued to us.In response to our patent infringement action, in October 2002,IC Media Corporation initiated a cancellation proceeding in the TaiwanIntellectual Property Office with respect to our patent. In July 2003, theTaiwan Intellectual Property Office made an initial determination to grant thecancellation of the subject patent, which decision was upheld by the TaiwanMinistry of Economic Affairs and the High Administrative Court. We decided notto appeal such decision by the May 31, 2005 deadline. Although we do notbelieve the cancellation of the Taiwanese patent at issue in the disputedescribed above has had a material adverse effect on our business or prospects,there may be other situations where our inability to adequately protect ourintellectual property rights could materially and adversely affect our competitiveposition and operating results. If a third party can copy or otherwise obtainand use our products or technology without authorization, develop correspondingtechnology independently or design around our patents, this could materiallyadversely affect our business and prospects. Effective patent, copyright,trademark and trade secret protection may be unavailable or limited in foreigncountries. Any disputes over our intellectual property rights, whatever theultimate resolution of such disputes, may result in costly and time-consuminglitigation or require the license of additional elements of intellectualproperty for a fee.

 

## ***Litigation regarding intellectual property coulddivert management attention, be costly to defend and prevent us from using orselling the challenged technology.***

## *** ***

Inrecent years, there has been significant litigation in the United Statesinvolving intellectual property rights, including in the semiconductorindustry. We have in the past been, and may in the future be, subject to legalproceedings and claims with respect to our intellectual property, includingsuch matters as trade secrets, patents, product liabilities and other actionsarising out of the normal course of business. These claims may increase as ourintellectual property portfolio becomes larger or more valuable. Intellectualproperty claims against us, and any resulting lawsuit, may cause us to incursignificant expenses, subject us to liability for damages and invalidate ourproprietary rights. In fiscal 2002, we paid $3.5 million to settle anintellectual property litigation matter. Any potential intellectual propertylitigation against us would likely be time-consuming and expensive to resolveand would divert management’s time and attention and could also force us totake actions such as:

 

•                  ceasing the saleor use of products or services that incorporate the infringed intellectualproperty;

 

•                  obtaining fromthe holder of the infringed intellectual property a license to sell or use therelevant technology, which license may not be available on acceptable terms, ifat all; or

 

•                  redesigningthose products or services that incorporate the disputed intellectual property,which could result in substantial unanticipated development expenses and delayand prevent us from selling the products until the redesign is completed, if atall.

 

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If weare subject to a successful claim of infringement and we fail to developnon-infringing intellectual property or license the infringed intellectualproperty on acceptable terms and on a timely basis, we may be unable to sellsome or all of our products, and our operating results could be adverselyaffected. We may in the future initiate claims or litigation against thirdparties for infringement of our intellectual property rights or to determinethe scope and validity of our proprietary rights or the proprietary rights ofcompetitors. These claims could also result in significant expense and thediversion of technical and management attention.

 

## ***We have been named as a defendant in certainlitigation that could have a material adverse impact on our operating resultsand financial condition.***

## *** ***

We arecurrently a defendant in ongoing litigation matters as described in Part II,Item 1 – *“Legal Proceedings”* of this QuarterlyReport. We have reached an agreement in principle to settle the shareholderclass action lawsuit pending in the United States District Court for theNorthern District of California. We accrued $3.3 million in litigationsettlement expenses during the quarter ended October 31, 2006 to reflectour share of the settlement, including unreimbursed defense costs, net of$13.0 million in recoverable insurance proceeds. The parties executed aStipulation of Settlement that was filed with the Court in May 2007.Notice of the settlement was provided to the purported shareholder class. TheOrder granting preliminary approval scheduled a hearing on September 7,2007 to determine whether the settlement is fair, reasonable and adequate tothe purported class. The hearing was held on September 7, as scheduled. OnDecember 6, 2007, the Court issued its order granting final approval ofthe settlement and judgment was entered. Objectors to the settlement have 30days to appeal the Court’s approval of the settlement. However, if the orderapproving the settlement of the matters described in Part II,Item 1 – *“Legal Proceedings”*does not become final and we fail to prevail in such matters, such failurecould have a material adverse effect on our consolidated financial position,results of operations, or cash flows in the future. In addition, the results oflitigation are uncertain, and the litigation process may utilize a portion ofour cash resources and divert management’s attention from the day-to-dayoperations of our company, all of which could harm our business.

 

## ***If we do not effectively manage our growth, ourability to increase our revenues and improve our earnings could be adverselyaffected.***

## *** ***

Ourgrowth has placed, and will continue to place, a significant strain on ourmanagement and other resources. To manage our growth effectively, we must,among other things:

 

•                  significantlyimprove our operational, financial and accounting systems;

 

•                  train and manageour existing employee base;

 

•                  attract andretain qualified personnel with relevant experience; and

 

•                  effectivelymanage accounts receivable and inventory.

 

Forexample, our failure to effectively manage our inventory levels could resulteither in excess inventories, which could adversely affect our gross marginsand operating results, or lead to an inability to fill customer orders, whichwould result in lower sales and could harm our relationships with existing andpotential customers.

 

Wemust also manage multiple relationships with customers, business partners andother third parties, such as our foundries and process and assembly vendors.Moreover, our growth may significantly overburden our management and financialsystems and other resources. We may not make adequate allowances for the costsand risks associated with our expansion. In addition, our systems, proceduresor controls may not be adequate to support our operations, and we may not be able to expand quickly enough tocapitalize on potential market opportunities. Our future operatingresults will also depend, in part, on our ability to expand sales andmarketing, research and development, accounting, finance and administrativesupport.

 

## ***Our future tax rates could be higher than weanticipate if the proportion of future operating income generated outside theU.S. by our foreign subsidiaries is less than we expect, or the mix differsfrom that which we expect.***

## *** ***

Anumber of factors will affect our future tax rate, and certain of these factorscould increase our effective tax rate in future periods, which could adverselyimpact our operating results. For example, the complex rules for accounting forthe tax effects of stock-based compensation under SFAS No. 123(R) resulted inan increase in our effective tax rate beginning in the fiscal year endedApril 30, 2007. Similarly, we anticipate that there will be greatervolatility in our future effective tax rates due to the adoption of FIN 48in the fiscal year which began on May 1, 2007. In addition, our

 

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future effective tax rates could be negativelyaffected by changes in tax laws or the interpretation of tax laws, byunanticipated decreases in the amount of revenue or earnings in countries withlow statutory tax rates, or by changes in the valuation of our deferred taxassets and liabilities.

 

Incommon with all multinational companies, we are subject to tax in multiplejurisdictions. The tax authorities in any given jurisdiction may seek toincrease the taxes being collected by, for example, asserting that the transferprices we charge between related entities are either too high or too lowdepending on which side of the transaction they are looking at. Although webelieve we have provided sufficient taxes for all prior periods, adjustmentscould be proposed that would, in some cases, result in liabilities in excess ofsuch provisions.

 

## ***Our sales through distributors increase the complexityof our business and may reduce our ability to forecast revenues.***

## *** ***

Duringfiscal 2007, approximately 40.0% of our revenues came from sales throughdistributors. For the six months ended October 31, 2007, approximately33.2% of our revenues came from sales through distributors. We expect thatrevenues from sales through distributors may continue to represent a higherproportion of our total revenues than they have in the past. Selling throughdistributors reduces our ability to accurately forecast sales and increases thecomplexity of our business, requiring us to, among other matters:

 

•                  manage a morecomplex supply chain;

 

•                  manage the levelof inventory at each distributor;

 

•                  provide forcredits, return rights and price protection;

 

•                  estimate theimpact of credits, return rights, price protection and unsold inventory atdistributors; and

 

•                  monitor thefinancial condition and creditworthiness of our distributors.

 

Anyfailure to manage these challenges could cause us to inaccurately forecastsales and carry excess or insufficient inventory, thereby adversely affectingour operating results.

 

## ***We face foreign business, political and economicrisks, because a majority of our products and those of our customers aremanufactured and sold outside of the United States.***

## *** ***

Weface difficulties in managing our third party foundries, color filterapplication service providers, ceramic and plastic packaging service providersand our foreign distributors, most of whom are located in Asia. Any politicaland economic instability in Asia might have an adverse impact on foreignexchange rates and could cause service disruptions for our vendors anddistributors and adversely affect our customers.

 

Salesoutside of the United States accounted for substantially all of our revenuesfor fiscal 2006 and 2007. We anticipate that sales outside of the UnitedStates will continue to account for nearly all of our revenues in futureperiods. Dependence on sales to foreign customers involves certain risks,including:

 

•                  longer paymentcycles;

 

•                  the adverseeffects of tariffs, duties, price controls or other restrictions that impairtrade;

 

•                  decreasedvisibility as to future demand;

 

•                  difficulties inaccounts receivable collections; and

 

•                  burdens ofcomplying with a wide variety of foreign laws and labor practices.

 

Salesof our products have to date been denominated principally in U.S. dollars. Overthe last several years, the U.S. dollar has weakened against most othercurrencies. Future increases in the value of the U.S. dollar, if any, wouldincrease the price of our products in the currency of the countries in whichour customers are located. This may result in our customers seekinglower-priced suppliers, which could adversely impact our operating results. Ifa larger portion of our international revenues were to be denominated inforeign currencies in the future, we would be subject to increased risksassociated with fluctuations in foreign exchange rates.

 

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## ***Our business could be harmed if we lose the servicesof one or more members of our senior management team, or if we are unable toattract and retain qualified personnel.***

## *** ***

Theloss of the services of one or more of our executive officers or key employees,which has occurred from time to time, or the decision of one or more of theseindividuals to join a competitor, could adversely affect our business and harmour operating results and financial condition. Our success depends to asignificant extent on the continued service of our senior management andcertain other key technical personnel. None of our senior management is boundby an employment or non-competition agreement. We do not maintain key man lifeinsurance on any of our employees.

 

Oursuccess also depends on our ability to identify, attract and retain qualifiedsales, marketing, finance, management and technical personnel, particularlyanalog or mixed signal design engineers. We have experienced, and may continueto experience, difficulty in hiring and retaining candidates with appropriatequalifications. If we do not succeed in hiring and retaining candidates withappropriate qualifications, our revenues and product development efforts couldbe harmed.

 

## ***We are in the process of upgrading our enterpriseresource planning and other management information systems.***

## *** ***

As ourbusiness grows and becomes more complex, we have to expand and upgrade ourenterprise resource planning system and other management information systemswhich are critical to the operational, accounting and financial functions ofour company. We have evaluated alternative solutions, both short-term andlong-term, to meet the operating, administrative and financial reportingrequirements of our business and are currently preparing to implement a systembased on a suite of application software developed by Oracle Corporation.Implementation of such a system requires significant management attention andresources over an extended period of time and any significant design errors inor delay in the implementation of the system could materially adversely affectour operating results and impact our ability to manage our business.

 

## ***Our operations may be impaired as a result ofdisasters, business interruptions or similar events.***

## *** ***

Disastersand business interruptions such as earthquakes, water, fire, electricalfailure, accidents and epidemics affecting our operating activities, majorfacilities, and employees’ and customers’ health could materially and adverselyaffect our operating results and financial condition. In particular, our Asianoperations and most of our third party service providers involved in the manufacturingof our products are located within relative close proximity. Therefore, anydisaster that strikes within close proximity of that geographic area could beextremely disruptive to our business and could materially and adversely affectour operating results and financial condition. We do not currently have adisaster recovery plan.

 

## ***Acts of war and terrorist acts may seriously harm ourbusiness and revenue, costs and expenses and financial condition.***

## *** ***

Actsof war or terrorist acts, wherever they occur around the world, may causedamage or disruption to our business, employees, facilities, suppliers,distributors or customers, which could significantly impact our revenue, costs,expenses and financial condition. In addition, as a company with significantoperations and major distributors and customers located in Asia, we may beadversely impacted by heightened tensions and acts of war that occur inlocations such as the Korean Peninsula, Taiwan and China. The potential forfuture terrorist attacks, the national and international responses to terroristattacks or perceived threats to national security, and other acts of war orhostility have created many economic and political uncertainties that couldadversely affect our business and results of operations in ways that cannotpresently be predicted. We are uninsured for losses and interruptions caused byterrorist acts and acts of war.

 

***Risks Related to the Securities Markets and Ownership of OurCommon Stock***

 

## ***Provisions in our charter documents and Delaware law,as well as our stockholders’ rights plan, could prevent or delay a change incontrol of our company and may reduce the market price of our common stock.***

## *** ***

Provisionsof our certificate of incorporation and bylaws may discourage, delay or preventa merger or acquisition that a stockholder may consider favorable. Theseprovisions include:

 

•                  adjusting theprice, rights, preferences, privileges and restrictions of preferred stockwithout stockholder approval;

 

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•                  providing for aclassified board of directors with staggered, three year terms;

 

•                  requiringsupermajority voting to amend some provisions in our certificate ofincorporation and bylaws;

 

•                  limiting thepersons who may call special meetings of stockholders; and

 

•                  prohibitingstockholder actions by written consent.

 

Provisionsof Delaware law also may discourage, delay or prevent another company fromacquiring or merging with us. Our board of directors adopted a preferred stockrights agreement in August 2001. Pursuant to the rights agreement, ourboard of directors declared a dividend of one right to purchase oneone-thousandth share of our Series A Participating Preferred Stock foreach outstanding share of our common stock. The dividend was paid onSeptember 28, 2001 to stockholders of record as of the close of businesson that date. Each right entitles the registered holder to purchase from us oneone-thousandth of a share of Series A Preferred at an exercise price of$176.00, subject to adjustment. The exercise of the rights could have theeffect of delaying, deferring or preventing a change of control of our company,including, without limitation, discouraginga proxy contest or making more difficult the acquisition of a substantial blockof our common stock. The rights agreement could also limit the price thatinvestors might be willing to pay in the future for our common stock.

 

## ***Our stock has been and will likely continue to besubject to substantial price and volume fluctuations due to a number offactors, many of which are beyond our control, that may prevent ourstockholders from selling our common stock at a profit.***

## *** ***

Themarket price of our common stock has fluctuated substantially, and there can beno assurance that such volatility will not continue. Since the beginning offiscal 2002 through July 31, 2007, the closing sales price of our commonstock has ranged from a high of $33.90 per share to a low of$1.26 per share. The closing sales price of our common stock on August 31,2007 was $20.87 per share. The securities markets have experiencedsignificant price and volume fluctuations in the past, and the market prices ofthe securities of semiconductor companies have been especially volatile. Thismarket volatility, as well as general economic, market or political conditions,could reduce the market price of our common stock in spite of our operatingperformance. The market price of our common stock may fluctuate significantlyin response to a number of factors, including:

 

•                  actual or anticipatedfluctuations in our operating results;

 

•                  changes inexpectations as to our future financial performance;

 

•                  changes infinancial estimates of securities analysts;

 

•                  release oflock-up or other transfer restrictions on our outstanding shares of commonstock or sales of additional shares of common stock;

 

•                  sales or theperception in the market of possible sales of shares of our common stock by ourdirectors, officers, employees or principal stockholders;

 

•                  changes inmarket valuations of other technology companies; and

 

•                  announcements byus or our competitors of significant technical innovations, design wins,contracts, standards or acquisitions.

 

Due tothese factors, the price of our stock may decline and investors may be unableto resell their shares of our stock for a profit. In addition, the stock marketexperiences extreme volatility that often is unrelated to the performance ofparticular companies. These market fluctuations may cause our stock price todecline regardless of our performance.

 

**ITEM 2.   UNREGISTERED SALESOF EQUITY SECURITIES AND USE OF PROCEEDS**

 

We didnot repurchase any shares of our common stock in the second quarter offiscal 2008.

 

**ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

Ourannual meeting of stockholders was held at our corporate headquarters at 1341Orleans Drive, Sunnyvale, California on September 26, 2007 at10:00 a.m. local time. The results of the matters voted upon were asfollows:

 

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1.     Toelect one Class I director to serve until the expiration of his three-yearterm or until his successor is duly elected and qualified.

 

| ** ** | ** ** | **Vote**   | ** ** |
|------------|------------|------------|------------|
| ** ** | ** ** | **For**    | ** ** | **Withheld** | ** ** |
| Shaw Hong  |       | 47,132,451 |       | 1,496,894 |   |

 

Theterm of office of directors Xinping (James) He, Joseph Jeng, Dwight Steffensenand Andrew Wang continued after the annual meeting.

 

2.              To approve the 2007Equity Incentive Plan (the “2007 Plan”).

 

| **For**    | ** ** | **Against** | ** ** | **Abstained** | ** ** | **No Vote** | ** ** |
|------------|------------|-------------|------------|---------------|------------|------------------|------------|
| 22,650,514 |       | 7,088,587   |       | 512,965       |       | 18,377,279       |       |

 

3.     Toratify the appointment of PricewaterhouseCoopers LLP as our independentregistered public accounting firm for the fiscal year ending April 30,2008.

 

| **For**    | ** ** | **Against** | ** ** | **Abstained** | ** ** | **No Vote** | ** ** |
|------------|------------|-------------|------------|---------------|------------|------------------|------------|
| 48,033,131 |       | 500,186     |       | 96,028        |       | —           |       |

 

**ITEM 6.   EXHIBITS**

 

| **Exhibit   Number** | ** **         | **Description** |
|---------------------------|--------------------|-----------------|
|                      |   3.2.1* |            | Certificate of  Amendment to the Bylaws of the Company effective as of November 27,  2007. |
|                      | 10.26*             |            | 2007 Equity Incentive  Plan, as amended November 27, 2007. |
|                      | 10.27*             |            | Form of Non-Employee  Director Stock Option Agreement Under 2007 Equity Incentive Plan. |
|                      | 10.28*             |            | Form of  Employee/Consultant Stock Option Agreement Under 2007 Equity Incentive Plan. |
|                      | 31.1               |            | Certification of Chief  Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002. |
|                      | 31.2               |            | Certification of Chief  Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002. |
|                      | 32                 |            | Certification of Chief  Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. |

 

----

| * |   | Incorporated by reference to the Company’s Current Report on  Form 8-K as filed with the Commission on November 30, 2007. |
|---|--------|------------------------------------------------------------------------------------------------------------------------------------------|

 

63

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**SIGNATURES**

 

Pursuantto the requirements of the Securities and Exchange Act of 1934, the registranthas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.

 

 
|   | **OMNIVISION TECHNOLOGIES, INC**. |   |   |
|--------|-----------------------------------|--------|--------|
|   | *(Registrant)*                    |   |

 

 

Dated: December 10, 2007

 
| ** ** | By:                                               | **/s/ SHAW HONG** | ** ** |
|------------|---------------------------------------------------|-------------------|------------|
|       | **Shaw Hong**                                     |              |
|       | *Chief Executive Officer, President and Director* |              |
|       | *(Principal Executive Officer)*                   |              |

 

 

Dated: December 10, 2007

** **
| ** ** | By:                                            | **/s/ PETER V. LEIGH** | ** ** |
|------------|------------------------------------------------|------------------------|------------|
|       | **Peter V. Leigh**                             |                   |
|       | *Chief Financial Officer*                      |                   |
|       | *(Principal Financial and Accounting Officer)* |                   |

 

64

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**Exhibit Index**

 

| **Exhibit   Number** | ** **         | **Description** |
|---------------------------|--------------------|-----------------|
|                      |   3.2.1* |            | Certificate of  Amendment to the Bylaws of the Company effective as of November 27,  2007. |
|                      | 10.26*             |            | 2007 Equity Incentive  Plan, as amended November 27, 2007. |
|                      | 10.27*             |            | Form of Non-Employee  Director Stock Option Agreement Under 2007 Equity Incentive Plan. |
|                      | 10.28*             |            | Form of  Employee/Consultant Stock Option Agreement Under 2007 Equity Incentive Plan. |
|                      | 31.1               |            | Certification of Chief  Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002. |
|                      | 31.2               |            | Certification of Chief  Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002. |
|                      | 32                 |            | Certification of Chief  Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. |

 

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| * |   | Incorporated by reference to the Company’s Current Report on  Form 8-K as filed with the Commission on November 30, 2007. |
|---|--------|------------------------------------------------------------------------------------------------------------------------------------------|

 

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