**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

----

 

**FORM 10-Q**

 

**x****        ****QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**                       ****For the quarterly period ended January 31,2008**

 

**OR**

 

**o**           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

** **

**                       ****For the transition period from                           to                                     **

 

**Commissionfile number: 0-29939**

 

----

 

**OMNIVISIONTECHNOLOGIES, INC.**

(Exact name ofregistrant as specified in its charter)

** **

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

 

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

(Address ofPrincipal Executive Offices) (Zip Code)

 

Registrant’stelephone number, including area code:**(408) 542-3000**

 

----

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securitiesand Exchange Act of 1934 during the preceding 12 months (or for shorter periodthat the registrant was required to file such reports); and (2) has beensubject to such filing requirements for the past 90 days. Yes x No £

 

Indicate by check mark whether the registrant is a large accelerated filer,an accelerated filer, a non-accelerated filer, or a smaller reporting company.See the definitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 

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

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes o No x

 

At February 29, 2008, 55,357,016 shares of common stock ofthe registrant were outstanding, exclusive of 6,540,900 shares of treasurystock.

 

 

 

----

 

**OMNIVISIONTECHNOLOGIES, INC.**

 

**INDEX**

 
| ** **         | ** **                                                                                                                           | ** ** | **Page**   |
|--------------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **         | ** **                                                                                                                           | ** ** | ** ** |
|               | **PART I.  FINANCIAL INFORMATION**                                                                                              |       |       |
| ** **         | ** **                                                                                                                           | ** ** | ** ** |
| **Item  1.**       | Financial  Statements:                                                                                                               |       | 3          |
|               |                                                                                                                                 |       |       |
|               | Condensed Consolidated Balance Sheets  (unaudited) — January 31, 2008 and April 30, 2007                    |       | 3          |
|               |                                                                                                                                 |       |       |
|               | Condensed Consolidated Statements of Income (unaudited) — Three  and Nine Months Ended January 31, 2008 and 2007 |       | 4          |
|               |                                                                                                                                 |       |       |
|               | Condensed Consolidated Statements of Cash Flows  (unaudited) — Nine Months Ended January 31, 2008 and 2007       |       | 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                                                                          |       | 45         |
| ** **         | ** **                                                                                                                           | ** ** | ** ** |
| **Item  4.**       | Controls  and Procedures                                                                                                             |       | 46         |
|               |                                                                                                                                 |       |       |
|               | **PART II.  OTHER INFORMATION**                                                                                                 |       |       |
|               |                                                                                                                                 |       |       |
| **Item  1.**       | Legal Proceedings                                                                                                                    |       | 47         |
| ** **         | ** **                                                                                                                           | ** ** | ** ** |
| **Item 1A.**       | Risk Factors                                                                                                                         |       | 49         |
| ** **         | ** **                                                                                                                           | ** ** | ** ** |
| **Item 2.**        | Unregistered Sales of Equity Securities and Use of  Proceeds                                                                         |       | 63         |
| ** **         | ** **                                                                                                                           | ** ** | ** ** |
| **Item 6.**        | Exhibits                                                                                                                             |       | 64         |
| ** **         | ** **                                                                                                                           | ** ** | ** ** |
| Signatures         |                                                                                                                                 |       | 65         |
| ** **         | ** **                                                                                                                           | ** ** | ** ** |
| Exhibit Index |                                                                                                                                 |       |
| Exhibit 31.1       |                                                                                                                                 |       |
| Exhibit 31.2       |                                                                                                                                 |       |
| Exhibit 32         |                                                                                                                                 |       |

 

2

----

**PART I— FINANCIAL INFORMATION**

 

**ITEM 1.    FINANCIAL STATEMENTS**

 

**OMNIVISIONTECHNOLOGIES, INC.**

 

**CONDENSED****CONSOLIDATED****BALANCE SHEETS**

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

**(unaudited)**

** **
| ** **                                                                                                                                                                                                                 | ** ** | **January 31,** | ** ** | **April 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                                                                 | ** ** | **2008**             | ** ** | **2007**           | ** ** |
| **ASSETS**                                                                                                                                                                                                                 | ** ** | ** **           | ** ** | ** **         | ** ** |
| Current assets:                                                                                                                                                                                                            |       |                 |       |               |       |
| Cash and cash equivalents                                                                                                                                                                                                  |       | $                    | 275,508    |               | $          | 190,878 |   |
| Short-term investments                                                                                                                                                                                                     |       | 87,794               |       | 114,432            |       |
| Accounts receivable, net of allowances for doubtful  accounts and sales returns                                                                                                                                            |       | 91,586               |       | 65,666             |       |
| Inventories                                                                                                                                                                                                                |       | 121,669              |       | 119,663            |       |
| Deferred income taxes                                                                                                                                                                                                      |       | 3,419                |       | 3,356              |       |
| Prepaid expenses and other current assets                                                                                                                                                                                  |       | 7,548                |       | 8,717              |       |
| Recoverable insurance proceeds (Note 15)                                                                                                                                                                                   |       | —               |       | 13,000             |       |
| Total current assets                                                                                                                                                                                                       |       | 587,524              |       | 515,712            |       |
| Property, plant and  equipment, net                                                                                                                                                                                        |       | 85,537               |       | 64,363             |       |
| Long-term investments                                                                                                                                                                                                      |       | 83,587               |       | 67,281             |       |
| Goodwill                                                                                                                                                                                                                   |       | 7,541                |       | 7,541              |       |
| Intangibles, net                                                                                                                                                                                                           |       | 15,569               |       | 20,493             |       |
| Other long-term assets                                                                                                                                                                                                     |       | 14,107               |       | 12,669             |       |
| Total assets                                                                                                                                                                                                               |       | $                    | 793,865    |               | $          | 688,059 |   |
|                                                                                                                                                                                                                       |       |                 |       |               |       |
| **LIABILITIES,  MINORITY INTEREST AND STOCKHOLDERS’ EQUITY**                                                                                                                                                          |       |                 |       |               |       |
| Current liabilities:                                                                                                                                                                                                       |       |                 |       |               |       |
| Accounts payable                                                                                                                                                                                                           |       | $                    | 85,052     |               | $          | 56,290 |   |
| Accrued expenses and other current liabilities                                                                                                                                                                             |       | 15,326               |       | 17,524             |       |
| Litigation settlement accrual                                                                                                                                                                                              |       | —               |       | 13,750             |       |
| Income taxes payable                                                                                                                                                                                                       |       | 5,624                |       | 61,617             |       |
| Deferred income                                                                                                                                                                                                            |       | 10,211               |       | 8,873              |       |
| Current portion of long-term debt                                                                                                                                                                                          |       | 665                  |       | 631                |       |
| Total current liabilities                                                                                                                                                                                                  |       | 116,878              |       | 158,685            |       |
| Long-term liabilities:                                                                                                                                                                                                     |       |                 |       |               |       |
| Long-term income taxes payable                                                                                                                                                                                             |       | 69,300               |       | —             |       |
| Non-current portion of long-term debt                                                                                                                                                                                      |       | 27,083               |       | 27,576             |       |
| Other long-term liabilities                                                                                                                                                                                                |       | 7,125                |       | 6,998              |       |
| Total long-term liabilities                                                                                                                                                                                                |       | 103,508              |       | 34,574             |       |
| Total liabilities                                                                                                                                                                                                          |       | 220,386              |       | 193,259            |       |
|                                                                                                                                                                                                                       |       |                 |       |               |       |
| Commitments and  contingencies (Note 15)                                                                                                                                                                                   |       |                 |       |               |       |
|                                                                                                                                                                                                                       |       |                 |       |               |       |
| Minority interest                                                                                                                                                                                                          |       | 4,520                |       | 4,344              |       |
|                                                                                                                                                                                                                       |       |                 |       |               |       |
| Stockholders’ equity:                                                                                                                                                                                                 |       |                 |       |               |       |
| Common stock, $0.001 par value; 100,000 shares  authorized; 61,893 issued and 55,352 outstanding at January 31,  2008 and 60,811 shares issued and 54,941 outstanding at April 30,  2007, respectively |       | 62                   |       | 61                 |       |
| Additional paid-in capital                                                                                                                                                                                                 |       | 366,852              |       | 329,012            |       |
| Accumulated other comprehensive income                                                                                                                                                                                     |       | 1,344                |       | 867                |       |
| Treasury stock, 6,541 and 5,870 at January 31,  2008 and April 30, 2007, respectively                                                                                                                            |       | (91,026              | )          | (79,568            | )          |
| Retained earnings                                                                                                                                                                                                          |       | 291,727              |       | 240,084            |       |
| Total stockholders’ equity                                                                                                                                                                                            |       | 568,959              |       | 490,456            |       |
| Total liabilities, minority interest and  stockholders’ equity                                                                                                                                                        |       | $                    | 793,865    |               | $          | 688,059 |   |

 

Theaccompanying notes are an integral part of these Condensed ConsolidatedFinancial Statements (unaudited).

 

3

----

 

**OMNIVISIONTECHNOLOGIES, INC.**

 

**CONDENSED****CONSOLIDATED****STATEMENTS OF INCOME**

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

**(unaudited)**

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | **January 31,**   | ** ** | **January 31,**  | ** ** |
| ** **                                        | ** ** | **2008**               | ** ** | **2007**              | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenues                                          |       | $                      | 224,921    |                  | $          | 134,381 |   | $ | 630,677 |   | $ | 408,912 |   |
| Cost of revenues                                  |       | 163,937                |       | 100,892               |       | 470,461 |   | 280,148 |   |
| Gross profit                                      |       | 60,984                 |       | 33,489                |       | 160,216 |   | 128,764 |   |
|                                              |       |                   |       |                  |       |   |   |   |   |
| Operating expenses:                               |       |                   |       |                  |       |   |   |   |   |
| Research, development and related                 |       | 20,124                 |       | 16,521                |       | 57,728 |   | 52,020 |   |
| Selling, general and administrative               |       | 15,566                 |       | 16,627                |       | 46,518 |   | 44,852 |   |
| Litigation settlement                             |       | —                 |       | —                |       | — |   | 3,300 |   |
| Total operating expenses                          |       | 35,690                 |       | 33,148                |       | 104,246 |   | 100,172 |   |
|                                              |       |                   |       |                  |       |   |   |   |   |
| Income from operations                            |       | 25,294                 |       | 341                   |       | 55,970 |   | 28,592 |   |
| Interest income, net                              |       | 3,397                  |       | 4,195                 |       | 10,083 |   | 10,964 |   |
| Other income (expense),  net                      |       | (1,040                 | )          | (756                  | )          | (1,118 | ) | 890 |   |
| Income before income  taxes and minority interest |       | 27,651                 |       | 3,780                 |       | 64,935 |   | 40,446 |   |
|                                              |       |                   |       |                  |       |   |   |   |   |
| Provision for (benefit  from) income taxes        |       | 5,138                  |       | (1,338                | )          | 8,929 |   | 9,193 |   |
| Minority interest                                 |       | 50                     |       | 988                   |       | 56 |   | 5,827 |   |
| Net income                                        |       | $                      | 22,463     |                  | $          | 4,130 |   | $ | 55,950 |   | $ | 25,426 |   |
|                                              |       |                   |       |                  |       |   |   |   |   |
| Net income per share:                             |       |                   |       |                  |       |   |   |   |   |
| Basic                                             |       | $                      | 0.41       |                  | $          | 0.08 |   | $ | 1.02 |   | $ | 0.47 |   |
| Diluted                                           |       | $                      | 0.40       |                  | $          | 0.07 |   | $ | 1.01 |   | $ | 0.46 |   |
|                                              |       |                   |       |                  |       |   |   |   |   |
| Shares used in  computing net income per share:   |       |                   |       |                  |       |   |   |   |   |
| Basic                                             |       | 55,386                 |       | 54,872                |       | 55,041 |   | 54,631 |   |
| Diluted                                           |       | 55,827                 |       | 55,885                |       | 55,583 |   | 55,509 |   |

 

The accompanyingnotes are an integral part of these Condensed Consolidated Financial Statements(unaudited).

 

4

----

** **

**OMNIVISIONTECHNOLOGIES, INC.**

**CONDENSED****CONSOLIDATED****STATEMENTS OF CASH FLOWS**

**(inthousands, unaudited)**

** **
| ** **                                                                         | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                         | ** ** | **January 31,**  | ** ** |
| ** **                                                                         | ** ** | **2008**              | ** ** | **2007** | ** ** |
| Cash flows from  operating activities:                                             |       |                  |       |   |   |
| Net income                                                                         |       | $                     | 55,950     |   | $ | 25,426 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                  |       |   |   |
| Depreciation and amortization                                                      |       | 9,841                 |       | 10,462 |   |
| Change in fair value of interest rate swap                                         |       | 1,972                 |       | — |   |
| Stock-based compensation                                                           |       | 21,628                |       | 22,880 |   |
| Tax effect from stock-based compensation                                           |       | 2,000                 |       | 365 |   |
| Minority interest in net income of consolidated  affiliates                        |       | 56                    |       | 5,827 |   |
| Equity investment gain, net                                                        |       | (6,693                | )          | (3,172 | ) |
| Affiliate stock grants                                                             |       | 56                    |       | 179 |   |
| Write-down of inventories                                                          |       | 17,928                |       | 5,753 |   |
| Excess tax benefits from stock-based compensation                                  |       | (900                  | )          | (365 | ) |
| (Gain) loss on disposal of property, plant and  equipment                          |       | (22                   | )          | 7 |   |
| Changes in assets and liabilities:                                                 |       |                  |       |   |   |
| Accounts receivable, net                                                           |       | (25,911               | )          | (7,572 | ) |
| Inventories                                                                        |       | (20,708               | )          | (56,655 | ) |
| Deferred income taxes                                                              |       | (1,195                | )          | (8,969 | ) |
| Prepaid expenses and other current assets                                          |       | 14,083                |       | (14,739 | ) |
| Accounts payable                                                                   |       | 20,474                |       | 29,864 |   |
| Accrued expenses and other current liabilities                                     |       | (12,690               | )          | 13,818 |   |
| Income taxes payable                                                               |       | 8,996                 |       | 12,298 |   |
| Deferred income                                                                    |       | 1,338                 |       | 814 |   |
| Deferred tax liabilities                                                           |       | (1,968                | )          | 2,735 |   |
| Net cash provided by operating activities                                          |       | 84,235                |       | 38,956 |   |
| Cash flows from  investing activities:                                             |       |                  |       |   |   |
| Purchases of short-term investments                                                |       | (77,055               | )          | (243,100 | ) |
| Proceeds from sales or maturities of short-term  investments                       |       | 104,926               |       | 214,741 |   |
| Purchases of property, plant and equipment, net of  sales                          |       | (21,486               | )          | (41,038 | ) |
| Deconsolidation of VisEra                                                          |       | —                |       | (20,646 | ) |
| Purchases of long-term investments                                                 |       | (9,000                | )          | — |   |
| Purchases of intangible assets                                                     |       | —                |       | (548 | ) |
| Net cash used in investing activities                                              |       | (2,615                | )          | (90,591 | ) |
| Cash flows from  financing activities:                                             |       |                  |       |   |   |
| Repayment of long-term debt                                                        |       | (459                  | )          | (107 | ) |
| Cash contribution by minority shareholder                                          |       | 49                    |       | 10,359 |   |
| Affiliate cash dividend paid to minority shareholder                               |       | (226                  | )          | (245 | ) |
| Proceeds from exercise of stock options and employee  stock purchase plan          |       | 14,213                |       | 10,445 |   |
| Excess tax benefits from stock-based compensation                                  |       | 900                   |       | 365 |   |
| Payments for repurchases of common stock                                           |       | (11,457               | )          | — |   |
| Net cash provided by financing activities                                          |       | 3,020                 |       | 20,817 |   |
| Effect of exchange rate  changes on cash and cash equivalents                      |       | (10                   | )          | 54 |   |
| Net increase (decrease)  in cash and cash equivalents                              |       | 84,630                |       | (30,764 | ) |
| Cash and cash  equivalents at beginning of period                                  |       | 190,878               |       | 240,227 |   |
| Cash and cash  equivalents at end of period                                        |       | $                     | 275,508    |   | $ | 209,463 |   |
| Supplemental cash flow  information:                                               |       |                  |       |   |   |
| Taxes paid, net                                                                    |       | $                     | 3,131      |   | $ | 1,972 |   |
| Interest paid                                                                      |       | $                     | 13         |   | $ | 20 |   |
| Supplemental schedule  of non-cash investing and financing activities:             |       |                  |       |   |   |
| Capital equipment financing obligation                                             |       | $                     | 8,238      |   | $ | 1,354 |   |
| Affiliate shares issued to affiliate employees                                     |       | $                     | 295        |   | $ | 459 |   |
| Change-of-interest benefit from minority shareholder  cash contribution            |       | $                     | —     |   | $ | 2,413 |   |
| Issuance of escrow shares to CDM selling  stockholders                             |       | $                     | —     |   | $ | 34 |   |
| Capitalized interest                                                               |       | $                     | 146        |   | $ | — |   |
| Impact of initial adoption of FIN 48 on  retained earnings                    |       | $                     | 4,307      |   | $ | — |   |

 

The accompanyingnotes are an integral part of these Condensed Consolidated Financial Statements(unaudited).

 

5

----

 

**OMNIVISIONTECHNOLOGIES, INC.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

**Note 1 — Basisof Presentation**

 

## ***Overview***

## *** ***

The accompanyinginterim unaudited condensed consolidated financial statements as of January 31,2008 and April 30, 2007 and for the three and nine months ended January 31,2008 and 2007 have been prepared by OmniVision Technologies, Inc., and itssubsidiaries (“OmniVision” or the “Company”) in accordance with the rules andregulations of the U.S. Securities and Exchange Commission (“SEC”). The amountsas of April 30, 2007 come from the Company’s audited annual financialstatements. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with generally accepted accountingprinciples have been condensed or omitted in accordance with such rules andregulations. In the opinion of management, the accompanying unaudited condensedconsolidated financial statements reflect all adjustments, consisting only ofnormal recurring adjustments, necessary to state fairly the financial positionof the Company and its results of operations and cash flows as of and for theperiods presented. These condensed consolidated financial statements should beread in conjunction with the audited annual financial statements and notesthereto included in the Company’s Annual Report on Form 10-K for thefiscal year ended April 30, 2007 (the “Form 10-K”).

 

The results ofoperations for the three and nine months ended January 31, 2008 are notnecessarily indicative of the results that may be expected for the fiscal yearending April 30, 2008 or any other future period.

 

## ***Use of 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**

 

## ***Principles of Consolidation***

## *** ***

The condensedconsolidated financial statements include the accounts of the Company, itswholly-owned subsidiaries and its consolidated affiliate. All significantinter-company accounts and transactions have been eliminated.

 

## ***Change-of-Interest Benefit/Impairment***

## *** ***

Where an unrelatedthird party invests in one of the Company’s consolidated subsidiaries oraffiliates, and the per share value of the investment exceeds the Company’saverage per share 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 willassess whether the investment has been impaired.

 

## ***Foreign Currency Translation***

## *** ***

The functionalcurrency of the Company is the U.S. dollar. For subsidiaries or consolidatedaffiliates with a functional currency other than the U.S. dollar, the assetsand liabilities of the subsidiaries are translated into U.S. dollars at therates 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 functional currency,and with assets or liabilities denominated in currencies other than the U.S.dollar, 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

----

 

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

## ***Cash and Cash Equivalents***

## *** ***

The Companyconsiders all highly liquid investments purchased with a maturity at the dateof purchase of three months or less to be cash equivalents. Cash equivalentsconsist principally of commercial paper, government bonds, certificates ofdeposit and money market funds that are stated at cost, which approximates fairvalue.

 

The Companymaintains its cash and cash equivalent balances with major financialinstitutions in the United States. These balances are subject to aconcentration of credit risk and only a small proportion of these balances arecovered by Federal Deposit Insurance Corporation (“FDIC”) insurance.

 

The Companyreviews its investments to identify and evaluate investments that may have anindication of possible impairment. Factors the Company considers in determiningwhether a loss is temporary include the length of time and extent to which fairvalue has been less than the cost basis, the financial condition and near-termprospects of the investee, and the Company’s intent and ability to hold theinvestment for a period of time sufficient to allow for any anticipated recoveryin market value. The Company places its cash investments in instruments thatmeet high credit quality standards, as specified in the Company’s investmentpolicy guidelines.

 

## ***Inventories***

## *** ***

Inventories arestated at the lower of cost, determined on a first-in, first-out (“FIFO”)basis, or market.

 

The Companyrecords allowances to reduce the carrying value of inventories to their netrealizable value when the Company believes that the net realizable value isless than cost. The Company also records allowances for the cost of inventorieswhen the number of units on hand exceeds the number of units that the Companyforecasts will be sold over a certain period of time, generally 12 months. Therecording of 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.

 

## ***Comprehensive Income (Loss)***

## *** ***

Comprehensiveincome (loss) is defined as the change in the equity of a company during aperiod from transactions and other events and circumstances excludingtransactions resulting from investments by owners and distributions to owners.Comprehensive income for the three months ended January 31, 2008 was$22.6 million and included net income, unrealized gains (losses) fromavailable-for-sale securities and foreign currency translation gains (losses)from foreign subsidiaries. Comprehensive income for the nine months ended January 31,2008 was $52.1 million and included net income, the impact of the initialadoption of FIN 48 on retained earnings, unrealized gains (losses) fromavailable-for-sale securities and foreign currency translation gains (losses)from foreign subsidiaries. Comprehensive income for the three months ended January 31,2007 was $3.7 million and included net income, unrealized gains (losses)from available-for-sale securities and translation gains (losses) from foreignsubsidiaries. Comprehensive income for the nine months ended January 31,2007 was $25.3 million and included net income, unrealized gains (losses)from available-for-sale securities, change-of-interest benefits and translationgains (losses) from foreign subsidiaries.

 

## ***Revenue Recognition***

## *** ***

For shipments tocustomers without agreements that allow for returns or credits, principallyoriginal equipment manufacturers (“OEMs”) and value added resellers (“VARs”),the Company recognizes revenue using the “sell-in” method. Under this method,the Company 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 defective productbased on historical experience. For cash consideration given to customers forwhich the Company does not receive a separately identifiable benefit or cannotreasonably estimate fair value, the Company records the amounts as reductionsof revenue.

 

7

----

 

**OMNIVISIONTECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

For shipment ofproducts sold to distributors under agreements allowing for returns or credits,title and the risk of ownership to the products transfer to the distributorupon shipment: however, prices are not fixed or determinable until thedistributor resells the products to the Company’s end-user customer and thedistributor notifies the Company in writing of the details of such salestransactions. Accordingly, the Company recognizes revenue using the “sell-through”method under which the Company defers the revenue and the related costs of saleuntil the final resale of such products to end customers. The amounts billed tothese distributors less the cost of inventory shipped to, but not yet sold by,the distributors is shown net on the Condensed Consolidated Balance Sheets as “Deferredincome.”

 

In addition, theCompany recognizes revenue from the performance of services to a limited numberof customers by its wholly-owned subsidiary, OmniVision CDM Optics, Inc. (“CDM”),formerly CDM Optics, Inc., and, through December 31, 2006, by its thenconsolidated affiliate, VisEra Technologies Company, Ltd. (“VisEra”). (SeeNote 5.) The Company recognizes the CDM-associated revenue under eitherthe completed-contract or the percentage-of-completion methods. Thepercentage-of-completion method of accounting is used for costreimbursement-type contracts, where revenues recognized are that portion of thetotal contract price equal to the ratio of costs expended to date to theanticipated final total costs based on current estimates of the costs to completethe projects. CDM-associated revenue has not been material in any of theperiods presented. Until December 31, 2006, the Company recognized VisEra’sservice revenue from third party customers when the production servicesprovided by VisEra were complete and the product was shipped to the customer.

 

## ***Income Taxes***

## *** ***

The Companyaccounts for deferred income taxes using the liability method, under which itrecognizes as deferred tax assets and liabilities the expected future taxconsequences of timing differences between the book and tax basis of assets andliabilities. The Company establishes valuation allowances to reduce deferredtax assets as necessary when management estimates, based on available objectiveevidence, that it is more likely than not that the Company will not realize thebenefit of its deferred tax assets.

 

On May 1,2007, the Company adopted Financial Accounting Standards Board (“FASB”)Interpretation No. (“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 uponexamination. The evaluation of a tax position in accordance with thisinterpretation is a two-step process. In the first step, recognition, theCompany determines whether it is more-likely-than-not that a tax position willbe sustained upon examination, including resolution of any related appeals orlitigation processes, based on the technical merits of the position. The secondstep addresses measurement of a tax position that meets themore-likely-than-not criterion. The tax position is measured at the largestamount of benefit that has a greater than 50 percent likelihood of beingrealized upon ultimate settlement. Tax positions that previously failed to meetthe more-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-Based Compensation***

## *** ***

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,

 

8

----

 

**OMNIVISIONTECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

*“Accounting for 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 Companyadopted SFAS No. 123(R) using the modified prospective method.The Company’s condensed consolidated financial statements as of and for thefiscal year ended April 30, 2007 and all subsequent reported periodsreflect the impact of adopting SFAS No. 123(R). (See Note 11.)

 

## ***Recent Accounting Pronouncements***

## *** ***

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)  recognizesand measures in its financial statements the identifiable assets acquired, theliabilities assumed, and any noncontrolling interest in the acquiree; (2)  recognizesand measures the goodwill acquired in the business combination or a gain from abargain purchase; and (3)  determines what information to disclose toenable users of the financial statements to evaluate the nature and financialeffects of the business combination. SFAS No. 141(R) replaces SFAS No. 141, *“Business Combinations.”*SFAS No. 141(R) iseffective in fiscal years beginning after December 15, 2008 and the Company is required toadopt it in the first quarter of its fiscal 2010. The Company is currentlyevaluating the impact SFAS No. 141(R) may have on its financialposition, 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)  theownership interests in subsidiaries held by parties other than the parent, andincome attributable to those parties, be clearly identified and distinguishedin the parent’s consolidated financial statements; and (2)  when asubsidiary is deconsolidated, any retained noncontrolling equity investment inthe former subsidiary be initially measured at fair value. SFAS No. 160is an amendment of Accounting Research Bulletin No. 51, *“**Consolidated Financial Statements”*and related interpretations. SFAS No. 160is effective for fiscal years beginning on or after December 15, 2008 andthe Company is required to adopt it in the first quarter of itsfiscal 2010. Other than re-classifying noncontrolling interests as acomponent of consolidated stockholders’ equity and identifying earningsattributable to noncontrolling interests as part of consolidated earnings, asrequired by SFAS No. 160, the Company does not expect the adoption of thestandard to have any other material impact on its financial position, resultsof operations and cash flows.

 

In September 2006,the FASB finalized SFAS No. 157 which will become effective in 2008 exceptas amended by FASB Staff Position (“FSP”) FAS 157-1 and FSP FAS 157-2 asdescribed below. This Statement defines fair value, establishes a framework formeasuring fair value and expands disclosures about fair value measurements;however, it does not require any new fair value measurements. The provisions ofSFAS No. 157 will be applied prospectively to fair value measurements anddisclosures for financial assets and financial liabilities and nonfinancialassets and nonfinancial liabilities recognized or disclosed at fair value inthe financial statements on at least an annual basis beginning in the firstquarter of 2008. The Company does not expect its adoption of the provisions ofSFAS No. 157 will have a material effect on its financial condition,results of operations or cash flows.

 

In February 2008,the FASB issued FASB Staff Position (“FSP”) SFAS No. 157-1, *“Application of FASB Statement No. 157 to FASB Statement No. 13and Its Related Interpretive Accounting Pronouncements That Address LeasingTransactions,”* and FSP SFAS No. 157-2, *“EffectiveDate of FASB Statement No. 157.”* FSP SFAS No. 157-1removes leasing from the scope of SFAS No. 157, *“Fair ValueMeasurements.”* FSP SFAS No. 157-2 delays the effective date ofSFAS No. 157 from 2008 to 2009 for all nonfinancial assets andnonfinancial liabilities, except those that are recognized or disclosed at fairvalue in the financial statements on a recurring basis (at least annually). TheCompany does not expect its adoption of the provisions of FSP SFAS No. 157-1and FSP SFAS No. 157-2 will have a material effect on its financialcondition, results of operations or cash flows.

 

9

----

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

**Note 3 — Short-TermInvestments**

 

Available-for-salesecurities at January 31, 2008 and April 30, 2007 were as follows (inthousands):

 

| ** **                                                          | ** ** | **As of January 31, 2008** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                          | ** ** | **Amortized**                   | ** ** | **Gross  Unrealized** | ** ** | **Gross  Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                                          | ** ** | **Cost**                        | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Certificates of deposit                                             |       | $                               | 8,333      |   | $ | 1 |   | $ | — |   | $ | 8,334 |   |
| U.S. government debt  securities with maturities less than one year |       | 44,087                          |       | 220 |   | (1 | ) | 44,306 |   |
| U.S. government debt  securities with maturities over one year      |       | 5,139                           |       | — |   | — |   | 5,139 |   |
| Municipal bonds and  notes                                          |       | 4,005                           |       | 4 |   | — |   | 4,009 |   |
| Commercial paper and  bond funds                                    |       | 25,905                          |       | 101 |   | — |   | 26,006 |   |
|                                                                |       | $                               | 87,469     |   | $ | 326 |   | $ | (1 | ) | $ | 87,794 |   |
|                                                                |       |                            |       |   |   |   |   |   |   |
| Contractual maturity  dates, less than one year                     |       |                            |       |   |   |   |   | $ | 59,626 |   |
| Contractual maturity  dates, one year to two years                  |       |                            |       |   |   |   |   | 28,168 |   |
|                                                                |       |                            |       |   |   |   |   | $ | 87,794 |   |

 
| ** **                                                          | ** ** | **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)                  Represents auction rate securities with a finalmaturity of up to 39 years and an interest rate reset no less frequent thanevery 35 days.

 

10

----

 

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

** **

**Note 4 — Balance Sheet Accounts (inthousands)**

 
| ** **                                       | ** ** | **January 31,** | ** ** | **April 30,** | ** ** |
|--------------------------------------------------|------------|----------------------|------------|--------------------|------------|
| ** **                                       | ** ** | **2008**             | ** ** | **2007**           | ** ** |
| Cash and cash  equivalents:                      |       |                 |       |               |       |
| Cash                                             |       | $                    | 18,445     |               | $          | 18,274 |   |
| Money market funds and certificates of deposit   |       | 257,063              |       | 89,020             |       |
| Commercial paper and government bonds            |       | —               |       | 83,584             |       |
|                                             |       | $                    | 275,508    |               | $          | 190,878 |   |
| Accounts receivable,  net:                       |       |                 |       |               |       |
| Accounts receivable                              |       | $                    | 95,237     |               | $          | 72,113 |   |
| Less: Allowance for doubtful accounts            |       | (1,058               | )          | (980               | )          |
| Allowance for sales returns                      |       | (2,593               | )          | (5,467             | )          |
|                                             |       | $                    | 91,586     |               | $          | 65,666 |   |
| Inventories:                                     |       |                 |       |               |       |
| Work in progress                                 |       | $                    | 58,861     |               | $          | 64,159 |   |
| Finished goods                                   |       | 62,808               |       | 55,504             |       |
|                                             |       | $                    | 121,669    |               | $          | 119,663 |   |
| Prepaid expenses and  other current assets:      |       |                 |       |               |       |
| Prepaid expenses                                 |       | $                    | 6,562      |               | $          | 2,967 |   |
| Deposits and other                               |       | 161                  |       | 4,693              |       |
| Interest receivable                              |       | 825                  |       | 1,057              |       |
|                                             |       | $                    | 7,548      |               | $          | 8,717 |   |
| Property, plant and  equipment, net:             |       |                 |       |               |       |
| Land                                             |       | $                    | 26,074     |               | $          | 26,074 |   |
| Buildings and land use right                     |       | 13,061               |       | 7,612              |       |
| Buildings/leasehold improvements                 |       | 5,685                |       | 4,666              |       |
| Machinery and equipment                          |       | 38,823               |       | 19,745             |       |
| Furniture and fixtures                           |       | 775                  |       | 718                |       |
| Software                                         |       | 2,738                |       | 2,546              |       |
| Construction in progress                         |       | 18,168               |       | 17,496             |       |
|                                             |       | 105,324              |       | 78,857             |       |
| Less: Accumulated depreciation and amortization  |       | (19,787              | )          | (14,494            | )          |
|                                             |       | $                    | 85,537     |               | $          | 64,363 |   |
| Other long-term assets:                          |       |                 |       |               |       |
| Deferred income taxes — non-current         |       | $                    | 8,207      |               | $          | 6,869 |   |
| Prepaid wafer credits                            |       | 4,000                |       | 4,000              |       |
| Long-term employee loan receivable               |       | 1,000                |       | 1,000              |       |
| Other long-term assets                           |       | 900                  |       | 800                |       |
|                                             |       | $                    | 14,107     |               | $          | 12,669 |   |
| Accrued expenses and  other current liabilities: |       |                 |       |               |       |
| Employee compensation                            |       | $                    | 5,582      |               | $          | 4,713 |   |
| Third party commissions                          |       | 1,283                |       | 1,021              |       |
| Professional services                            |       | 2,123                |       | 1,830              |       |
| Noncancelable purchase commitments               |       | 347                  |       | 906                |       |
| Pricing adjustments                              |       | 4,004                |       | 4,022              |       |
| Other                                            |       | 1,987                |       | 5,032              |       |
|                                             |       | $                    | 15,326     |               | $          | 17,524 |   |
| Other long-term  liabilities:                    |       |                 |       |               |       |
| Deferred tax liabilities                         |       | $                    | 4,661      |               | $          | 6,506 |   |
| Other                                            |       | 2,464                |       | 492                |       |
|                                             |       | $                    | 7,125      |               | $          | 6,998 |   |

 

11

----

 

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

**Note 5 — Long-termInvestments**

 

Long-terminvestments as of January 31, 2008 and April 30, 2007 consisted ofthe following (in thousands):

 

| ** ** | ** ** | **January 31,** | ** ** | **April 30,** | ** ** |
|------------|------------|----------------------|------------|--------------------|------------|
| ** ** | ** ** | **2008**             | ** ** | **2007**           | ** ** |
| ImPac      |       | $                    | 2,111      |               | $          | 2,355 |   |
| VisEra     |       | 66,879               |       | 60,265             |       |
| WLCSP      |       | 9,936                |       | —             |       |
| XinTec     |       | 4,661                |       | 4,661              |       |
| Total      |       | $                    | 83,587     |               | $          | 67,281 |   |

 

## ***ImPac Technology Co., Ltd.***

## *** ***

In 2003, in orderto enhance its access to plastic and ceramic packaging services that were inshort supply, the Company purchased approximately 27% of the common stock ofImPac Technology Co., Ltd. (“ImPac”), a privately-held company based in Taiwanfor a total of $2.0 million in cash. In December 2003, the Companymade an additional cash contribution of approximately $0.8 million tomaintain its equity ownership percentage in ImPac. Unrelated third parties ownthe balance of ImPac’s equity. During fiscal 2004, the Company’s equityinterest declined to approximately 23% due to additional rounds of financingobtained by ImPac in which the Company did not participate. The Company’spurchases from ImPac are at arm’s length and the Company accounts for thisinvestment using the equity method. The Company recorded an equity loss of$38,000 and $244,000, respectively, in “Other income (expense), net,” as itsportion of ImPac’s net loss for the three and nine months ended January 31,2008. The Company recorded equity income of $32,000 and $379,000, respectively,in “Other income (expense), net,” as its portion of the net income for thethree and nine months ended January 31, 2007 recorded by ImPac. (SeeNote 16.)

 

## ***VisEra Technologies Company, Ltd.***

## *** ***

In August 2005,the Company 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 ofthe Amended VisEra Agreement, the parties reaffirmed their respectivecommitments to VisEra, and expanded the scope of and made certain modificationsto the VisEra Agreement. The Company and TSMC have equal interests in VisEraCayman. In the quarter ended October 31, 2005, the Company contributed$7.5 million to 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,the Company increased its interest in VisEra from 43% to 46% through purchasesof $9.5 million of unissued shares. Accordingly, the Company considereditself to be the

 

12

----

 

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

primarybeneficiary of VisEra, and included VisEra’s financial results in itsconsolidated financial statements through December 31, 2006.

 

In January 2006,in accordance 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,VisEra purchased certain equipment and intellectual property from Dai NipponPrinting Co., Ltd. (“Dai Nippon”) for approximately $3.1 million. DaiNippon also made an investment in VisEra Cayman of approximately$4.3 million. Because the per share value of the Dai Nippon investmentexceeded the Company’s average per share carrying value in VisEra Cayman, theCompany recorded a one-time change-of-interest benefit of $1.2 milliondirectly to “Additional paid-in capital,” a component of stockholders’ equity.In November 2006, the Company invested another $6.1 million inVisEra.

 

On January 1,2007, the Company assumed responsibility for logistics management servicespreviously provided to the Company by VisEra. As a consequence of the change,the Company concluded that, as of the date of the change, it would lose itsstatus as the primary beneficiary of the joint venture, VisEra would cease tobe VIE as defined under FIN 46(R) and, as a result, the Companydeconsolidated VisEra. Accordingly, beginning on January 1, 2007, theCompany has accounted for its investment in VisEra under the equity method. Thedeconsolidation of VisEra did not have a material effect on the Company’sreported revenue or reported net income for the fiscal year ended April 30,2007. In April 2007, pursuant to a January 2007 amendment to theAmended VisEra Agreement that provided for an increase in VisEra’smanufacturing capacity, the Company and TSMC each made an additional investmentof $27.0 million in VisEra. This additional investment is part of anongoing capacity expansion program at VisEra. As of January 31, 2008, theCompany and TSMC have agreed to commit a total of $112.9 million to thejoint venture, which commitments may be made in the form of cash or assetcontributions. Through January 31, 2008, the Company has contributed$51.6 million to VisEra and VisEra Cayman and, as of January 31,2008, the Company has effectively met its commitment under the terms of thisagreement.

 

All other materialterms of the Amended VisEra Agreement remain in effect. (See Note 16.)

 

## ***China WLCSP Limited***

## *** ***

China WLCSPLimited (“WLCSP”) is in the business of designing, manufacturing, packaging andselling certain wafer level chip scale packaging related services, for whichthe Company is currently a customer. In May 2007, the Company acquired2,500,000 units of WLCSP’s equity interests from WLCSP at a per unit price of$2.00 for an aggregate purchase amount of $5.0 million. Concurrently, theCompany purchased from Infinity-CSVC Venture Capital Enterprise 2,000,000 unitsof WLCSP’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.

 

The Companyaccounts for its investment in WLCSP under the equity method and, for the threeand nine months ended January 31, 2008, recorded equity income of$0.8 million and $0.9 million in “Other income (expense), net,”

 

13

----

 

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

consistingof its portion of the net income recorded by WLCSP during the periods,partially offset by an equity method 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”), aTaiwan-based supplier of chip-scale packaging services, in which the Companyalready held an approximate 7.8% interest. Since VisEra was a consolidatedentity at the time, the Company’s beneficial interest in XinTec increased tomore than 20%. Consequently, beginning in the three months ended October 31,2005 and through December 31, 2006, the Company accounted for itsinvestment in XinTec 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’sbeneficial ownership percentage in XinTec declined to 12.4%. Consequently,effective January 1, 2007, in accordance with APB 18, theCompany began to account for XinTec as a cost method investment. In addition,because the per share value of the TSMC investment exceeded the Company’saverage per share carrying value in XinTec, the Company recorded a one-timechange-of-interest benefit of $1.2 million directly to “Additional paid-incapital,” a component of stockholders’ equity. For the three and nine monthsended January 31, 2007, the Company recorded equity income of$412,000 and $1.7 million, respectively, in “Other income (expense), net,”for its portion of the net income recorded by XinTec.

 

The followingtable presents the summary combined financial information of ImPac, VisEra andWLCSP as derived from their financial statements for the three and nine monthsended January 31, 2008 and 2007 prepared under accounting principlesgenerally accepted in the United States of America (in thousands):

 
| ** **             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **             | ** ** | **January 31,**   | ** ** | **January 31,**  | ** ** |
| ** **             | ** ** | **2008**               | ** ** | **2007**              | ** ** | **2008** | ** ** | **2007** | ** ** |
| Operating data:        |       |                   |       |                  |       |   |   |   |   |
| Revenues               |       | $                      | 36,934     |                  | $          | 53,576 |   | $ | 114,063 |   | $ | 142,930 |   |
| Gross profit           |       | 13,373                 |       | 9,624                 |       | 32,856 |   | 25,312 |   |
| Income from operations |       | 10,036                 |       | 7,336                 |       | 22,071 |   | 19,463 |   |
| Net income             |       | $                      | 7,327      |                  | $          | 3,982 |   | $ | 15,397 |   | $ | 11,791 |   |

 

The amount ofconsolidated retained earnings that represented undistributed earnings ofinvestees accounted for by the equity method totaled $11.8 million and$6.8 million at January 31, 2008 and April 30, 2007,respectively.

 

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

 

In May 2004,the Company entered into an agreement with Powerchip Semiconductor Corporation(“PSC”), a Taiwan based company that produces memory chips and providessemiconductor foundry services, to establish a joint venture in Taiwan. Thepurpose of the joint venture, Silicon Optronics, Inc. (“SOI”), is toconduct manufacturing, marketing and selling of certain of the Company’s legacyproducts. The Company contributed approximately $2.1 million to SOI inexchange for an ownership percentage of 49.0%. In March 2005, the Companyassumed control of the board of directors of SOI and the Company hasconsolidated SOI since April 30, 2005.

 

In July 2006,SOI declared a cash dividend of $482,000, of which the Company received$237,000. In July 2006, SOI also issued shares to its employees with anestimated fair value of $459,000, which caused the Company’s ownershippercentage to decline from 49.0% to 46.6%.

 

In April 2007,SOI became listed on the Taiwan GreTai Securities Market, (“TGSM”). The TGSM isthe approximate equivalent in Taiwan of the Over-The-Counter market in theUnited States. In conjunction with the TGSM

 

14

----

 

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

listing,various employees of SOI exercised their options and increased the number ofshares outstanding, which caused the Company’s ownership percentage to declineto 44.0% as of January 31, 2008.

 

During the ninemonths ended January 31, 2008, SOI paid a cash dividend of $409,000,of which the Company received $184,000. In October 2007, SOI issuedoptions to various of its employees exercisable for 600,000 shares of itscommon stock. (See Note 16.)

 

**Note 7 — IntangibleAssets**

 

Intangible assetsas of January 31, 2008 consist of the following (in thousands):

 

| ** **                 | ** ** | **Cost** | ** ** | **Accumulated Amortization** | ** ** | **Net Book  Value** | ** ** |
|----------------------------|------------|----------|------------|------------------------------|------------|---------------------|------------|
| Core technology            |       | $        | 17,800     |                         | $          | 9,790               |       | $ | 8,010 |   |
| Patents and licenses       |       | 13,486   |       | 6,565                        |       | 6,921               |       |
| Trademarks and  tradenames |       | 1,400    |       | 770                          |       | 630                 |       |
| Customer relationships     |       | 100      |       | 92                           |       | 8                   |       |
| Intangible assets, net     |       | $        | 32,786     |                         | $          | 17,217              |       | $ | 15,569 |   |

 

Intangibleassets as 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 andnine months ended January 31, 2008, the Company amortized$1.6 million and $4.9 million, respectively, of its intangibleassets. During the three and nine months ended January 31, 2007, theCompany amortized $1.7 million and $5.2 million, respectively, of itsintangible assets. The total expected future annual amortization of theseintangible assets is as follows (in thousands): 

 

| **Years  Ending April 30,** | ** ** | ** ** | ** ** |
|----------------------------------|------------|------------|------------|
| 2008                             |       | $          | 1,641      |   |
| 2009                             |       | 6,532      |       |
| 2010                             |       | 6,386      |       |
| 2011                             |       | 973        |       |
| 2012                             |       | 37         |       |
| Total                            |       | $          | 15,569     |   |

 

**Note 8 — BorrowingArrangements**

 

Thefollowing table shows the Company’s debt and lease obligations (in thousands):

 

| ** **                             | ** ** | **January 31,  2008** | ** ** | **April 30,  2007** | ** ** |
|----------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| Mortgage loan                          |       | $                          | 27,577     |                     | $          | 27,927 |   |
| Capital lease  obligations             |       | 171                        |       | 280                      |       |
|                                   |       | 27,748                     |       | 28,207                   |       |
| Less: amount  due within one year |       | (665                       | )          | (631                     | )          |
| Non-current portion of long-term debt  |       | $                          | 27,083     |                     | $          | 27,576 |   |

 

15

----

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

At January 31,2008, aggregate debt maturities were as follows: (in thousands):

 

| **Years  Ending April 30,** | ** ** | **Mortgage  Loan** | ** ** | **Capital  Lease** | ** ** | **Total** | ** ** |
|----------------------------------|------------|--------------------|------------|--------------------|------------|-----------|------------|
| 2008                             |       | $                  | 135        |               | $          | 37        |       | $ | 172 |   |
| 2009                             |       | 515                |       | 134                |       | 649       |       |
| 2010                             |       | 548                |       | —             |       | 548       |       |
| 2011                             |       | 583                |       | —             |       | 583       |       |
| 2012                             |       | 620                |       | —             |       | 620       |       |
| Thereafter                       |       | 25,176             |       | —             |       | 25,176    |       |
| Total                            |       | $                  | 27,577     |               | $          | 171       |       | $ | 27,748 |   |

 

## ***Mortgage Loan***

## *** ***

On March 16,2007, the Company entered into a Loan and Security Agreement with a domesticbank. 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 on March 31,2017 and September 30, 2012, respectively.

 

As of January 31,2008, $27.6 million was outstanding under the Mortgage Loan. At January 31,2008, the interest rate under the Mortgage Loan was 4.0%. The Company was incompliance with the financial covenants of the Loan and Security Agreement asof January 31, 2008.

 

In conjunctionwith the Mortgage Loan, the Company entered into an interest rate swap with thesame bank to convert the variable interest rate described above to a fixedrate. The swap is for a period of ten years, and the notional amount of theswap approximates the principal outstanding under the Mortgage Loan. TheCompany is the 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 sheetdate and records it as either an asset or a liability, depending on whether thefair value represents a net gain or net loss. As of January 31, 2008, theCompany recorded $2.5 million in “Other long-term liabilities.” For thethree and nine months ended January 31, 2008, the Company recorded lossesof $1.8 million and $2.0 million, respectively, in “Other income(expense), net.”

 

## ***Lines of 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 interest rateprevailing at the time of borrowing. There are no financial covenantrequirements for these facilities and at January 31, 2008, there were noborrowings outstanding under these facilities.

 

## ***Capital Lease 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 through February 2009.Accordingly, the Company recorded a capital asset for $393,000 that is beingdepreciated over a five-year period in accordance with the Company’scapitalization policy. As of January 31, 2008, $171,000 was outstandingunder the capital lease. As of January 31, 2008, $16,000 was classified asa long-term obligation.

 

**Note 9 — NetIncome Per Share**

 

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

 

16

----

 

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

Diluted net incomeper share 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 nine months ended January 31, 2008,7,839,000 and 5,459,000 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 nine months ended January 31, 2007, 10,723,000 and5,538,000 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’searnings per share were calculated under the provisions of the Statement ofFinancial Accounting Standards (or “SFAS”) No. 128, *“Earnings Per Share,”* or SFAS No. 128.SFAS No. 128 requires that the Company take into account the effect onconsolidated earnings per share of options, warrants and convertible securitiesissued by its subsidiaries. The effect on consolidated earnings per share dependson whether the securities issued by the subsidiary enable their holders toobtain common stock of the subsidiary company or common stock of the parentcompany. Securities issued by a subsidiary that enable their holders to obtainthe subsidiary’s common stock are included in computing the subsidiary’searnings per share data. The diluted per-share earnings of the subsidiary areincluded in the Company’s consolidated earnings per share computations based onthe consolidated group’s holding of the subsidiary’s securities. In June 2006,SOI issued options exercisable for an additional 700,000 shares of its owncommon stock. Most recently, in October 2007, SOI issued options tovarious of its employees exercisable for 600,000 shares of its commonstock. In the calculation of its earnings per share for the three and ninemonths ended January 31, 2008 and 2007, the Company included the effect ofSOI’s options in its consolidated earnings per share.

 

The followingtable sets forth the computation of basic and diluted earnings per shareattributable to common stockholders for the periods indicated (in thousands,except per share data):

 
| ** **                                                       | ** **   | **Three Months Ended** | ** **   | **Nine Months Ended** | ** **   |
|------------------------------------------------------------------|--------------|------------------------|--------------|-----------------------|--------------|
| ** **                                                       | ** **   | **January 31,**   | ** **   | **January 31,**  | ** **   |
| ** **                                                       | ** **   | **2008**               | ** **   | **2007**              | ** **   | **2008** | ** ** | **2007** | ** ** |
| ***Basic:***                                                     | *** *** | *** ***           | *** *** | *** ***          | *** *** | *** *** | *** *** | *** *** | *** *** |
| Numerator:                                                       |         |                   |         |                  |         |   |   |   |   |
| Net income                                                       |         | $                      | 22,463       |                  | $            | 4,130 |   | $ | 55,950 |   | $ | 25,426 |   |
|                                                             |         |                   |         |                  |         |   |   |   |   |
| Denominator:                                                     |         |                   |         |                  |         |   |   |   |   |
| Weighted average common shares for net income per  share         |         | 55,386                 |         | 54,872                |         | 55,041 |   | 54,631 |   |
|                                                             |         |                   |         |                  |         |   |   |   |   |
| Basic net income per share                                       |         | $                      | 0.41         |                  | $            | 0.08 |   | $ | 1.02 |   | $ | 0.47 |   |
|                                                             |         |                   |         |                  |         |   |   |   |   |
| ***Diluted:***                                                   |         |                   |         |                  |         |   |   |   |   |
| Numerator:                                                       |         |                   |         |                  |         |   |   |   |   |
| Net income                                                       |         | $                      | 22,463       |                  | $            | 4,130 |   | $ | 55,950 |   | $ | 25,426 |   |
| Dilutive effect of SOI consolidation                             |         | (1                     | )            | (1                    | )            | — |   | (3 | ) |
| Net income for diluted computation                               |         | $                      | 22,462       |                  | $            | 4,129 |   | $ | 55,950 |   | $ | 25,423 |   |
|                                                             |         |                   |         |                  |         |   |   |   |   |
| Denominator:                                                     |         |                   |         |                  |         |   |   |   |   |
| Denominator for basic net income per share                       |         | 55,386                 |         | 54,872                |         | 55,041 |   | 54,631 |   |
| Weighted average effect of dilutive securities:                  |         |                   |         |                  |         |   |   |   |   |
| Common stock options                                             |         | 441                    |         | 1,013                 |         | 542 |   | 878 |   |
| Weighted average common shares for diluted net  income per share |         | 55,827                 |         | 55,885                |         | 55,583 |   | 55,509 |   |
|                                                             |         |                   |         |                  |         |   |   |   |   |
| Diluted net income per share                                     |         | $                      | 0.40         |                  | $            | 0.07 |   | $ | 1.01 |   | $ | 0.46 |   |

 

17

----

 

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

**Note 10 — Segmentand Geographic Information**

 

The Companyidentifies its business segments based on business activities, managementresponsibility and geographic location. For all periods presented, the Companyoperated in a single reportable business segment.

 

The Company sellsits image-sensor products either directly to OEMs and VARs or indirectlythrough distributors. The following table illustrates the percentage of revenuesfrom sales to OEMs and VARs and to distributors for the three and nine monthsended January 31, 2008 and 2007:

 

| ** **    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------|------------|------------------------|------------|-----------------------|------------|
| ** **    | ** ** | **January 31,**   | ** ** | **January 31,**  | ** ** |
| ** **    | ** ** | **2008**               | ** ** | **2007**              | ** ** | **2008** | ** ** | **2007** | ** ** |
| OEMs and VARs |       | 69.1                   | %          | 51.1                  | %          | 67.6 | % | 60.7 | % |
| Distributors  |       | 30.9                   |       | 48.9                  |       | 32.4 |   | 39.3 |   |
| Total         |       | 100.0                  | %          | 100.0                 | %          | 100.0 | % | 100.0 | % |

 

Since the Company’send-user customers market and sell their products worldwide, its revenues bygeographic 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 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** | ** ** | **Nine Months Ended** | ** ** |
|---------------|------------|------------------------|------------|-----------------------|------------|
| ** **    | ** ** | **January 31,**   | ** ** | **January 31,**  | ** ** |
| ** **    | ** ** | **2008**               | ** ** | **2007**              | ** ** | **2008** | ** ** | **2007** | ** ** |
| China         |       | $                      | 192,683    |                  | $          | 104,351 |   | $ | 545,191 |   | $ | 271,312 |   |
| Taiwan        |       | 11,542                 |       | 9,923                 |       | 42,145 |   | 66,975 |   |
| United States |       | 3,282                  |       | 309                   |       | 7,170 |   | 4,061 |   |
| All other     |       | 17,414                 |       | 19,798                |       | 36,171 |   | 66,564 |   |
| Total         |       | $                      | 224,921    |                  | $          | 134,381 |   | $ | 630,677 |   | $ | 408,912 |   |

 

The Company’slong-lived assets are located in the following countries (in thousands):

 

| ** **    | ** ** | **January 31,** | ** ** | **April 30,** | ** ** |
|---------------|------------|----------------------|------------|--------------------|------------|
| ** **    | ** ** | **2008**             | ** ** | **2007**           | ** ** |
| Taiwan        |       | $                    | 78,591     |               | $          | 71,953 |   |
| China         |       | 46,193               |       | 22,053             |       |
| United States |       | 48,735               |       | 41,896             |       |
| All other     |       | 505                  |       | 542                |       |
| Total         |       | $                    | 174,024    |               | $          | 136,444 |   |

 

**Note 11 — EmployeeStock Purchase, Equity Incentive and Stock Option Plans**

 

## ***2007 Equity 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”).The 2007 Plan replaced the Company’s 2000 Stock Plan. The Company hasreserved 6,000,000 shares of common stock for issuance under the2007 Plan. The 2007 Plan provides for the grant of the followingtypes of incentive awards: (i) stock options; (ii) stock appreciationrights; (iii) restricted stock; (iv) restricted stock units; (v) performanceshares and performance units; and (vi) other stock or cash awards. Ingeneral, stock option and stock appreciation right awards under the2007 Plan will be granted at a price not less than 100% of the fair marketvalue of the Company’s common stock on the date of grant. The 2007 Planalso allows for the grant of full value awards. Through January 31, 2008,the Company had granted stock options for 108,000 shares to employees under the2007 Plan.

 

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

 

18

----

 

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

The Company’sequity incentive and stock-based compensation plans as of January 31, 2008are summarized as follows (in thousands):

 

| ** **                      | ** ** | ** **     | ** ** | **Shares**    | ** ** | ** **      | ** ** |
|---------------------------------|------------|----------------|------------|---------------|------------|-----------------|------------|
| ** **                      | ** ** | **Shares**     | ** ** | **Available** | ** ** | **Options**     | ** ** |
| **Name  of Plan**               | ** ** | **Authorized** | ** ** | **for Grant** | ** ** | **Outstanding** | ** ** |
| 1995 Stock Plan            |       | —         |       | —        |       | 79              |       |
| 2000 Stock Plan            |       | —         |       | —        |       | 13,630          |       |
| 2000 Director  Option Plan |       | —         |       | —        |       | 287             |       |
| 2007 Plan                       |       | 6,000          |       | 5,892         |       | 108             |       |
| Total                           |       | 6,000          |       | 5,892         |       | 14,104          |       |

 

## ***Stock-Based Compensation Award Activity***

## *** ***

The followingtable summarizes stock-based compensation award activity under the2000 Stock Plan, the 2000 Director Option Plan and the2007 Plan, and the related weighted average exercise price, for the ninemonths ended January 31, 2008:

 

| ** **                                            | ** ** | ** **                       | ** ** | **Options outstanding** | ** ** |
|-------------------------------------------------------|------------|----------------------------------|------------|-------------------------|------------|
| ** **                                            | ** ** | **Shares  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                            |       | —                  |       | — |   |
| Cancellation of 2000  Stock Plan                      |       | (1,766                           | )          |                    |       |   |   |
| Cancellation of 2000  Director Option Plan            |       | (803                             | )          |                    |       |   |   |
| Adoption of 2007 Plan                                 |       | 6,000                            |       |                    |       |   |   |
| Stock options granted                                 |       | (2,891                           | )          | 2,891                   |       | 15.49 |   |
| Stock options exercised                               |       | —                           |       | (801                    | )          | 12.93 |   |
| Stock options expired  or forfeited                   |       | 472                              |       | (523                    | )          | 20.77 |   |
| Balance at  January 31, 2008                     |       | 5,892                            |       | 14,104                  |       | 18.15 |   |
| Vested and expected to  vest at January 31, 2008 |       |                             |       | 13,681                  |       | $ | 18.13 |   |

 

As of January 31,2008 and April 30, 2007, options to purchase 7,659,000 and 6,126,000 shares, respectively,were vested.

 

The totalintrinsic value of options exercised during the three and nine months ended January 31,2008 was $216,000 and $7.1 million, respectively. Total cash received fromemployees as a result of employee stock option exercises during the nine monthsended January 31, 2008 and 2007 was approximately $10.4 million and$7.6 million, respectively.

 

As of January 31,2008, net of forfeitures, there was $48.5 million of unrecognizedcompensation expense related to unvested stock options, which the Companyexpects to recognize over a weighted average period of 2.4 years. For the2000 Purchase Plan, as of January 31, 2008, there was$1.8 million of unrecognized compensation expense which the Companyexpects to recognize over a weighted average period of 1.0 years. As of April 30,2007, net of forfeitures, there was $44.5 million of unrecognizedcompensation cost related to unvested stock options, which the Company expectedto recognize over a weighted average period of 1.2 years. For the2000 Purchase Plan, as of April 30, 2007, there was $1.2 millionof unrecognized compensation cost which the Company expected to be recognizedover a weighted average period of 1.1 years. The Company’s currentpractice is to issue new shares to settle share option exercises.

 

19

----

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

## *** ***

## ***Valuation Assumptions***

## *** ***

SFAS No. 123(R) requirescompanies to estimate the fair value of stock-based compensation awards on thegrant date using an option pricing model. The value of the portion of the awardthat is ultimately expected to vest is recognized as expense over the requisiteservice period in the Company’s Condensed Consolidated Statements of Income.The Company measures the fair value of stock-based compensation awards usingBlack-Scholes consistent with the provisions of SFAS No. 123(R) andSEC SAB No. 107. Black-Scholes was developed to estimate the fairvalue of freely tradable, fully transferable options without vestingrestrictions. These assumptions differ significantly from the characteristicsof the Company’s stock-based compensation awards. Black-Scholes also requiresthe use of highly subjective, complex assumptions, including expected term andthe price volatility of the Company’s stock.

 

The fair value forthese options was estimated using the Black-Scholes option pricing model. Theper share weighted average estimated grant date fair value for employee optionsgranted was $9.01 and $7.11 during the three and nine months ended January 31,2008, respectively. The per share weighted average estimated grant date fairvalue for employee options granted was $8.32 and $11.44 during the three andnine months ended January 31, 2007, respectively.

 

The followingweighted average assumptions are included in the estimated fair valuecalculations for stock options granted in the three and nine months ended January 31,2008 and 2007:

 

 

| ** **                               | ** ** | **Employee Stock Option Plans** | ** ** |
|------------------------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | **Three Months Ended**          | ** ** | **Nine Months Ended** | ** ** |
| ** **                               | ** ** | **January 31,**            | ** ** | **January 31,** | ** ** |
| ** **                               | ** ** | **2008**                        | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Risk-free interest rate                  |       | 3.08                            | %          | 4.53 | % | 4.77 | % | 4.92 | % |
| Expected term of options (in years) |       | 4.0                             |       | 4.2 |   | 4.0 |   | 4.1 |   |
| Expected volatility                      |       | 57.0                            | %          | 55.0 | % | 52.5 | % | 64.3 | % |
| Expected dividend yield                  |       | 0                               | %          | 0 | % | 0 | % | 0 | % |

 

UsingBlack-Scholes, the per share weighted average estimated fair value of rightsissued pursuant to the Company’s 2000 Purchase Plan during the three and ninemonths ended January 31, 2008 was $5.62 for both periods. UsingBlack-Scholes, the per share weighted average estimated fair value of rightsissued pursuant to the Company’s 2000 Purchase Plan during the three and ninemonths ended January 31, 2007 was $6.54and $7.41, respectively.

 

The followingweighted average assumptions are included in the estimated grant date fairvalue calculations for rights to purchase stock under the 2000 Purchase Plan:

 

| ** **                               | ** ** | **Employee Stock Purchase Plan** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **Three Months Ended**           | ** ** | **Nine Months Ended** | ** ** |
| ** **                               | ** ** | **January 31,**             | ** ** | **January 31,** | ** ** |
| ** **                               | ** ** | **2008**                         | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Risk-free interest rate                  |       | 4.74                             | %          | 4.95 | % | 4.89 | % | 5.03 | % |
| Expected term of options (in years) |       | 0.5                              |       | 0.5 |   | 0.5 |   | 0.5 |   |
| Expected volatility                      |       | 39.5                             | %          | 46.8 | % | 45.7 | % | 52.0 | % |
| Expected dividend yield                  |       | 0                                | %          | 0 | % | 0 | % | 0 | % |

 

The definitions ofthe terms used to determine the above values are as follows:

 

·                  *Expected term:* The expected term represents the period that the Company’s stock-basedawards are expected to be outstanding and is estimated based on historicalexperience.

·                  *Risk-free interest rate:* The risk-free interest rate assumption is based uponobserved interest rates appropriate for the expected term of the Company’sstock-based awards.

·                  *Expected volatility:* Upon the adoption of SFAS No. 123(R), theCompany determined expected volatility based on an average between thehistorical volatility of the Company’s common stock and the implied volatilitybased on the Company’s traded options with lives of six months or more.Averaging two data sources

 

20

----

 

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

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 topay a cash dividend under its dividend policy.

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

 

**Note 12 — AdditionalPaid-in Capital**

 

The followingtable shows the amounts recorded to “Additional paid-in capital” for the ninemonths ended January 31, 2008 (in thousands):

 

| ** **                                | ** ** | **Additional  Paid-in  Capital** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|
| Balance at May 1,  2007              |       | $                                | 329,012    |   |
| Exercise of stock options                 |       | 10,360                           |       |
| Employee stock purchase plan              |       | 3,852                            |       |
| Compensation related to stock options     |       | 21,628                           |       |
| Tax benefits of disqualified dispositions |       | 2,000                            |       |
| Balance at  January 31, 2008         |       | $                                | 366,852    |   |

 

**Note 13 — TreasuryStock**

 

In June 2005,the Company’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 January 31, 2008,the Company had cumulatively repurchased 671,000 shares of its commonstock under the open-market program for an aggregate cost of approximately$11.4 million.

 

**Note 14 — IncomeTaxes**

 

The Companyadopted the provisions of FIN 48 on May 1, 2007. As a result of theadoption of FIN 48, the Company increased its net unrecognized taxbenefits by $4.3 million, and accounted for the increase as a cumulativeeffect of a change 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 amountof gross unrecognized tax benefits of $70.1 million as of the date ofadoption includes $68.8 million that, if recognized, would reduce theCompany’s effective income tax rate in future periods; and

 

21

----

 

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

$1.3 millionrelated to the federal tax benefit on state unrecognized tax benefits andinterest, if recognized. One or more of these unrecognized tax benefits couldbe subject to a valuation allowance if and when recognized in a future period,which could impact the timing of any related effective tax rate benefit.

 

The Company’spolicy to include interest, penalties and foreign exchange gain or loss relatedto unrecognized tax benefits within the provision for income taxes on theCondensed Consolidated Statements of Income did not change as a result ofimplementing the provisions of FIN 48. As of the date of adoption, theCompany had accrued $5.1 million and $7.4 million for potentialinterest and penalties, respectively. During the three and nine months ended January 31,2008, the Company accrued approximately $0.6 million and $2.0 millionof interest. As a result of a change in tax law in a foreign jurisdictionduring the first quarter of fiscal 2008, the Company reduced the totalamount of gross unrecognized tax benefits, as well as its accrual forpenalties, 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 Companymaintains a wholly-owned subsidiary in Shanghai, Shanghai OmniVision IC DesignCo. Ltd. (“SDC”), which provides assistance to the Company in various productdesign 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 Commission of the Pudong New District,Shanghai. The Purchase Agreement has an effective date of December 31,2006. Under the terms of the Purchase Agreement, the Company agreed to pay anaggregate amount of approximately $0.6 million (the “Purchase Price”) inexchange for the right to use approximately 323,000 square feet of land locatedin Shanghai for a period of 50 years. In addition, the Company isobligated to invest a minimum of approximately $30.0 million to developthe land and construct facilities, which amount includes the Purchase Price. Asof January 31, 2008, the Company has contributed $8.5 million of the$30.0 million total investment. Construction of the facilities on the landmust be completed by June 30, 2009, pursuant to contractual agreement,subject to an additional one-year extension under limited circumstances. TheCompany may use the land solely for the purposes of industrial use and/orscientific research. The Company intends to use SDC’s registered capital topartially fund its commitment to this project.

 

The Company hasvarious commitments arising from the Amended VisEra Agreement, and thesubsequent amendments to it. In particular, as of January 31, 2008, theCompany and TSMC have agreed to commit a total of $112.9 million to thejoint venture, which commitments may be made in the form of cash or assetcontributions. Through January 31, 2008, the Company has contributed$51.6 million to VisEra and VisEra Cayman and, as of January 31,2008, the Company has effectively met its commitment under the terms of thisagreement. Additional contributions may be made by additional investors,additional contributions by the Company and TSMC, or a combination thereof,provided that the Company and TSMC have and will maintain equal interests inVisEra and VisEra Cayman. To the extent, if any, that the value of assetscontributed in the future exceeds the value of the Company’s commitment, theCompany will receive cash from VisEra Cayman. (See Notes 5 and 16.)

 

## ***Litigation***

## *** ***

From time to time,the Company has been subject to legal proceedings and claims with respect tosuch matters as patents, product liabilities and other actions arising out ofthe normal course of business.

 

On November 29,2001, a complaint captioned *McKee v. OmniVisionTechnologies, Inc., et. al., Civil Action No. 01 CV 10775*,was filed in the United States District Court for the Southern District of NewYork against OmniVision, some of the Company’s directors and officers, andvarious underwriters for the Company’s initial public offering. Plaintiffsgenerally allege that the named defendants violated federal securities lawsbecause the prospectus related to the Company’s offering failed to disclose, andcontained false and misleading statements regarding, certain

 

22

----

 

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

commissionspurported to have been received by the underwriters, and other purportedunderwriter practices in connection with their allocation of shares in theCompany’s offering. The complaint seeks unspecified damages on behalf of apurported class of purchasers of the Company’s common stock between July 14,2000 and 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 issuer defendants and plaintiffs negotiated a stipulation of settlement forthe claims against the issuer defendants, including OmniVision, that wassubmitted to the Court for approval. In August 2005, the Courtpreliminarily approved the settlement. In December 2006, the appellatecourt overturned the certification of classes in the six test cases that wereselected by the underwriter defendants and plaintiffs in the coordinatedproceedings. Because class certification was a condition of the settlement, itwas unlikely that the settlement would receive final court approval. On June 25,2007, the Court entered an order terminating the proposed settlement based upona stipulation among the parties to the settlement. On August 14, 2007,plaintiffs filed amended master allegations and amended complaints in the sixtest cases, which the defendants in those cases have moved to dismiss.Plaintiffs have also moved for class certification in the six test cases, whichthe defendants in those cases have opposed. It is uncertain whether there willbe any revised or future settlement. If the litigation proceeds, the Companybelieves that it has meritorious defenses to plaintiffs’ claims and intends todefend the action vigorously.

 

On October 12,2007, a purported OmniVision shareholder filed a complaint against certain ofthe Company’s IPO underwriters. The complaint, *VanessaSimmonds v. Bank of America Corporation, et al.*, Case No. C07-1668,filed in District 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 Companyand certain of its present and former directors and officers in federal courtin the 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 OmniVisionTechnologies, Inc., No. C-04-2297-SC, and a consolidated complaintwas filed. The consolidated complaint asserted claims on behalf of purchasersof the Company’s common stock between June 11, 2003 and June 9, 2004,and sought unspecified damages. The consolidated complaint generally allegedthat defendants violated Sections 10(b) and 20(a) of theSecurities Exchange Act of 1934 by allegedly engaging in improperaccounting practices that purportedly led to the Company’s financialrestatement. On July 29, 2005, the Court denied the Company’s motion todismiss the complaint. The parties engaged in settlement discussions and, in November 2006,reached an agreement in principle to settle the litigation. The total amount ofthe settlement was approximately $13.8 million, of which the Companyagreed to contribute approximately $0.8 million and the remainder was tobe 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 executed a Stipulation of Settlement that was filed with the Courton May 15, 2007. On May 25, 2007, the Court issued an Orderpreliminarily approving the settlement and at a hearing on September 7,2007, the Court determined that the settlement was fair, reasonable andadequate to the purported class. On December 6, 2007, the Court issued itsorder granting final approval of the settlement and entered the judgment. Thesettlement and Court Order are now final and the litigation is concluded.

 

On February 21,2008, the Company filed a lawsuit against Qualcomm Incorporated in the UnitedStates District Court for the Northern District of California alleging claimsof trademark infringement arising from Qualcomm’s use of, and attempt toregister, the mark OMNIVISION for a computer hardware system and relatedservices. The Company seeks an injunction and unspecified damages. The Companyhad previously filed opposition proceedings before the Trademark Trial andAppeal Board of the United States Patent and Trademark office against Qualcomm’sapplications to register the OMNIVISION mark, and the Company has now moved tosuspend those proceedings based upon the

 

23

----

 

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

newparallel federal litigation. The Company has not yet served Qualcomm and theCompany does not yet know how Qualcomm will respond to the litigation.

 

**Note 16 — RelatedParty Transactions**

 

In May 2006,the Company consummated a loan agreement with one of its employees. Under theterms of the agreement, which the board of directors approved infiscal 2004, the Company extended to the employee a three-year$1.0 million loan with an imputed interest rate of approximately fivepercent per annum which matures on May 12, 2009. The loan is secured by adeed of trust.

 

In the secondquarter of fiscal 2006, the Company entered into an agreement with ImPac(see Note 5) under which ImPac agreed to provide certain management andsupport services to Hua Wei Semiconductor (Shanghai) Co. Ltd. (“HWSC”). TheCompany compensates ImPac for the services provided in accordance with theCompany’s policy regarding related party transactions. The Company’s board ofdirectors approved the agreement, which may be cancelled by either party at anytime. During the three months ended January 31, 2007, the Company andImPac agreed to terminate ImPac’s management and support services and toinitiate payment of licensing fees for HWSC’s use of certain software developedby ImPac. During the three and nine months ended January 31, 2008, theCompany paid ImPac approximately $29,000 and $119,000 in softwarelicensing fees. In addition, for the three and nine months ended January 31,2008, the Company paid ImPac approximately $3.8 million and$10.2 million for manufacturing services. During the three and nine monthsended January 31, 2007, the Company paid ImPac approximately$182,000 and $647,000 as compensation for management and support servicesand approximately $33,000 for both periods in software licensing fees.

 

TheCompany consolidated VisEra’s operating results from August 1, 2005 to December 31,2006. Subsequently, the Company has accounted for its investment in VisEra underthe equity method. For the three and nine months ended January 31, 2008,the Company paid $21.6 million and $78.3 million to VisEra forcolor filter and other manufacturing services. For the three and nine monthsended January 31, 2007, the Company paid $13.2 million to VisErafor color filter and other manufacturing services.

 

In May 2007,the Company purchased a 19.98% ownership in WLCSP for $9.0 million. Forthe three and nine months ended January 31, 2008, the Company paid$6.2 million and $14.2 million to WLCSP for chip scale packagingservices.

 

24

----

**OMNIVISION TECHNOLOGIES, INC.**

 

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

**For the Three and Nine Months Ended January 31,2008 and 2007**

**(unaudited)**

 

The followingtable summarizes the transactions that the Company’s consolidated affiliate,SOI, and its affiliate, VisEra, engaged in with related parties in the ordinarycourse of business in the three and nine months ended January 31, 2008 and2007 (in thousands):

 

| ** **                          | ** **   | **Three Months Ended** | ** **   | **Nine Months Ended** | ** **   |
|-------------------------------------|--------------|------------------------|--------------|-----------------------|--------------|
| ** **                          | ** **   | **January 31,**   | ** **   | **January 31,**  | ** **   |
| ** **                          | ** **   | **2008**               | ** **   | **2007**              | ** **   | **2008** | ** ** | **2007** | ** ** |
| ***SOI  transactions with:***       | *** *** | *** ***           | *** *** | *** ***          | *** *** | *** *** | *** *** | *** *** | *** *** |
| ImPac:                              |         |                   |         |                  |         |   |   |   |   |
| Purchases of manufacturing services |         | $                      | 290          |                  | $            | 945 |   | $ | 1,390 |   | $ | 3,359 |   |
| Balance payable at period end       |         | 222                    |         | 549                   |         | 222 |   | 549 |   |
| PSC:                                |         |                   |         |                  |         |   |   |   |   |
| Purchases of wafers                 |         | 762                    |         | 2,250                 |         | 5,277 |   | 4,719 |   |
| Rent and other services             |         | 14                     |         | 4                     |         | 41 |   | 41 |   |
| Balance payable at period end       |         | 413                    |         | 330                   |         | 413 |   | 330 |   |
| VisEra:                             |         |                   |         |                  |         |   |   |   |   |
| Purchases of manufacturing services |         | 5                      |         | —                |         | 5 |   | — |   |
| Balance payable at period end       |         | 5                      |         | —                |         | 5 |   | — |   |
|                                |         |                   |         |                  |         |   |   |   |   |
| ***VisEra  transactions with:***    |         |                   |         |                  |         |   |   |   |   |
| ImPac:                              |         |                   |         |                  |         |   |   |   |   |
| Purchases of manufacturing services |         | —                 |         | 3,805                 |         | — |   | 10,899 |   |
| Balance payable at period end       |         | —                 |         | 2,586                 |         | — |   | 2,586 |   |
| TSMC:                               |         |                   |         |                  |         |   |   |   |   |
| Sales to TSMC                       |         | 579                    |         | 416                   |         | 1,674 |   | 1,378 |   |
| Purchases of manufacturing services |         | 287                    |         | 223                   |         | 891 |   | 676 |   |
| Rent, utilities and other services  |         | 1,500                  |         | 1,556                 |         | 5,275 |   | 3,513 |   |
| Balance payable at period end       |         | 822                    |         | 621                   |         | 822 |   | 621 |   |
| WLCSP:                              |         |                   |         |                  |         |   |   |   |   |
| Purchases of manufacturing services |         | —                 |         | —                |         | 1,531 |   | — |   |
| SOI:                                |         |                   |         |                  |         |   |   |   |   |
| Sales to SOI                        |         | 5                      |         | —                |         | 5 |   | — |   |
| Balance receivable at period end    |         | $                      | 5            |                  | $            | — |   | $ | 5 |   | $ | — |   |

 

The Companypurchases a substantial portion of its wafers from TSMC. The Company alsopurchases a portion of its wafers from PSC.

 

25

----

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

 

*Thefollowing information should be read in conjunction with our unauditedcondensed interim financial statements and the notes thereto included inItem 1 of this Quarterly Report on Form 10-Q. The following discussioncontains forward-looking statements, within the meaning of Section 27A ofthe Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934, which involve risks and uncertainties. Forward-lookingstatements generally include words such as “may,” “will,” “plans,” “seeks,” “expects,”“anticipates,” “outlook,” “intends,” “believes” and words of similar import aswell as the negative of those terms. In addition, any statements that refer toexpectations, projections or other characterizations of future events orcircumstances, including any underlying assumptions, are forward-lookingstatements. All forward-looking statements included in this Quarterly Report onForm 10-Q, including, but not limited to, statements regarding the extentof future sales through distributors, future growth trends and opportunities incertain markets, the development, introduction and capabilities of newproducts, the establishment of partnerships with other companies, increasedunit volume sales, the increase of competition in our industry, the continuedimportance of the camera cell phone market to our business, continued pricecompetition and the consequent reduction in the average selling prices of ourproducts, future expenses, our effective tax rate for fiscal 2008, ourfuture investments, our working capital requirements in fiscal 2008 andthereafter, the effect of a change in foreign currency rates, and thesufficiency of our available cash, cash equivalents and short-term investmentsare based on current expectations and are subject to important factors thatcould cause actual results to differ materially from those projected in theforward-looking statements. Such important factors include, but are not limitedto, those set forth under the caption “Item 1A. Risk Factors,” beginningon page 49 of this Quarterly Report and elsewhere in this Quarterly Reportand in other documents we file with the U.S. Securities and ExchangeCommission, or the SEC. All subsequent written and oral forward-lookingstatements by or attributable to us or persons acting on our behalf areexpressly qualified in their entirety by such factors.*

 

*OmniVisionand OmniPixel are registered trademarks of OmniVision Technologies, Inc.CameraChip, OmniPixel2, OmniPixel3, OmniPixel3-HS, Square Graphics Array andTrueFocus are trademarks of OmniVision Technologies, Inc. Wavefront Codedis a registered trademark of OmniVision CDM Optics, Inc., a wholly-ownedsubsidiary of OmniVision Technologies, Inc. Wavefront Coding is atrademark of OmniVision CDM Optics, Inc.*

 

**Overview**

 

We design, developand market high performance, highly integrated and cost efficient semiconductorimage sensor devices. Our main products, image-sensing devices which we referto by the name CameraChipTM image sensors, capture an image electronically andare used in a number of consumer and commercial mass-market applications. OurCameraChip image sensors are manufactured using the complementary metal oxidesemiconductor, or CMOS, fabrication process and are predominantly single-chipsolutions that integrate several distinct functions including image capture,image processing, color processing, signal conversion and output of a fullyprocessed image or video stream. We believe that our highly integrated imagesensors enable camera device manufacturers to build high quality cameraproducts that are smaller, less complex, more reliable, more cost effective andmore power efficient than cameras using traditional charge-coupled devices, orCCDs.

 

## ***Technology***

## *** ***

In August 2004,we announced the introduction of our OmniPixel® technology. In September 2005,we announced the introduction of our OmniPixel2TM architecture. The OmniPixel2architecture, which is based on a 2.2μ x 2.2μ pixel and uses a 0.13μ processgeometry, is less than half the size of the OmniPixel architecture introducedin 2004, but with improved performance.

 

In February 2007,we introduced our first TrueFocusTM camera with Wavefront CodingTM technology forthe mobile handset market. Our patented Wavefront Coding technology is a methodof optically encoding light using a special lens to form an intermediate imageon the sensor, and decoding this intermediate image with digital processing tocreate a picture that is in focus across virtually the entire image. TrueFocustechnology offers true ‘point-and-shoot’ capability where the entire image isalways in focus and always available for instant one-click capture in realtime, with no waiting for the lens to focus. TrueFocus technology is designedto provide our customers with a product that effectively targets the mobilehandset market by being small, durable, easy to manufacture andcost-competitive.

 

In May 2007,we announced the introduction of the latest generation of our OmniPixelarchitecture, our OmniPixel3TM architecture. The OmniPixel3 architecture isbased on a 1.75μ x 1.75μ pixel and uses a 0.11μ process geometrywhich further reduces the size of a given sensor array without any reduction inimage quality.

 

26

----

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

 

In February 2008,we announced our new OmniPixel3-HSTM architecture, which incorporates a newpixel design that doubles the sensitivity of our 1.75μm OmniPixel3architecture. The performance of the new OmniPixel3-HS architecturesignificantly enhances image capture under very low lighting conditions, andthereby, we believe, allows for a new generation of compact camera solutionsfor mobile handsets, notebook computers and other applications that requireexceptional low-light performance without the need for flash.

 

Given the rapidlychanging nature of our technology, there can be no assurance that we will notencounter delays or other unexpected production or performance issues withfuture products. During the early stages of production, production yields andgross margins for products based on new technology are typically lower thanthose of established products.

 

## ***New Products***

## *** ***

In February 2007,we announced the details of the OV7680, a 1/10 inch VGA CameraChip sensordesigned for entry-level camera phones, for secondary cameras in 3G handsets,and for integrated notebook PC cameras. The OV7680 sensor incorporates a uniquenon-linear lens shift technology, which permits a reduction in the height ofthe camera module to just 3.17mm.

 

In March 2007,we introduced the OV10620, our first color High Dynamic Range, or HDR, CMOSimage sensor for mass market applications. The OV10620 has the capacity tocapture widely differing light levels in a single image and to rapidly adjustto changes in light levels, much like the human eye under quickly changinglight conditions. The OV10620 rapidly switches to HDR mode to handle extremevariations of bright and dark conditions and automatically switches back tonon-HDR mode when conditions return to normal. The single-chip sensor also hasa spectral light sensitivity of up to 1,000 nm, which is near infraredsensitivity.

 

In June 2007,we introduced the OV3640, the first fully integrated 3.2-megapixel CameraChipsensor in a 1/4-inch format. Based on the original 1.75-micronOmniPixel3 architecture, the OV3640 is small enough to fit the standard 8 x 8mmsockets used in 2.0-megapixel camera phones, making it an ideal drop-in upgradefor existing handset designs. The highly integrated OV3640 features ahigh-speed two-lane mobile industry processor interface, or MIPI, to enable thefast transfer of large blocks of data, which is critical to making effectiveuse of increased camera resolutions. In addition, the sensor incorporatesadvanced image signal processing and onboard JPEG compression to allow existingbaseband processors without MIPI to support a camera upgrade to 3.2 megapixelsat 15 frames per second in full resolution. In addition to MIPI, theOV3640 also incorporates advanced image stabilization functionality similar tothat used in digital still camera, or DSC, and camcorder products. The OV3640entered volume production in January 2008.

 

In June 2007,we announced that we had begun volume shipments of our OV6680 high-performanceSquare Graphics ArrayTM, camera chip sensor. With its unique 400 x 400 array,low-light sensitivity and small form factor, the OV6680 is intended primarilyfor use in secondary cameras for the 3G video phone market and for entry-level,ultra-thin camera phone designs. We anticipate significant growth in thesemarkets during the next several years.

 

In October 2007,we launched the OV2650, our third generation 2-megapixel CameraChip sensor.Powered by OmniPixel3 technology, the OV2650 brings DSC performance to cameraphones in a 1/5-inch optical format, with a compact size that allows for aneasy upgrade of existing 1.3-megapixel and VGA camera phone designs. The OV2650combines our proprietary 1.75-micron OmniPixel3 technology with advanced imagesignal processing, or ISP, to offer best-in-class low-light performance, superbcolor reproduction, and ultra-low noise. In addition, the OV2650 offers otheradvanced features, including: advanced image stabilization for easier picturetaking; HDR for advanced video functionality; a MIPI interface to ease picturesharing; and a high-end ISP to deliver DSC-like performance.

 

In October 2007,we announced that the smallest of our family of CMOS imaging devices, the1/18-inch OV6920 sensor, is a key component of Avantis Medical Systems, Inc.Third EyeTM RetroscopeTM auxiliary endoscopy system. The disposable miniaturevideo endoscope has already been cleared by the FDA for commercial distributionin the United States. 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

 

27

----

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

 

placinga complete imaging system, including miniaturized video sensor, signalprocessing circuitry and integrated lens elements, right at the tip of thecatheter.

 

In January 2008,we introduced two new products. The first, the OV9710, is OmniVision’s firsttrue high-definition, or HD, video CameraChip sensor for mobile handset andnotebook PC markets. The OV9710 is a 1-megapixel CMOS sensor built withOmniVision’s proprietary OmniPixel3 architecture and a 3x3 micron pixel for optimallow-light sensitivity and high-quality HD video performance at 30 frames persecond, or FPS. We designed the OV9710 specifically to meet all camera cellphone (1280 x 720) and PC multimedia (1280 x 800) market requirements in termsof performance, quality, reliability and power consumption.

 

The second newproduct is the OV7725. The 1/4-inch OV7725 is built with a 6x6 micronpixel to deliver the ultra-high light sensitivity required for the low lightconditions in which most consumers use their notebook computers. The OV7725 isa highly integrated CMOS CameraChip sensor that provides the full functionalityof a VGA camera and image processor on a single chip. A unique feature of theOV7725 is its high chief ray angle which allows for a reduction in moduleheight, a critical element in building cameras that can fit in today’s thinnotebook computers. A second highlight of the OV7725 is its ability to operateat 60 FPS, in VGA mode, or 120 FPS in quarter VGA, or QVGA, for optimalperformance in PC multimedia and gaming applications.

 

In February 2008,we introduced two new products. The first, the OV3642, is a 1/4-inch, 3-megapixel CameraChip sensor with TrueFocustechnology embedded on-chip. The fully integrated OV3642 is built with our newOmniPixel3-HS technology and offers best-in-class low light performance.

 

The second newproduct is the OV7690, a VGA CameraChip sensor with a 1/13-inch form factor.The OV7690’s new 1.75-micron OmniPixel3-HS architecture combined with a unique,non-linear micro lens shift technology allows for a significant reduction indistance between the sensor and the lens, and thus enables OmniVision tosignificantly reduce the module height while maintaining the highest levels ofimage quality and camera performance. The result is an ultra-thin camera moduleof just 4.5 x 4.5 and a height of only 2.8 mm, a critical dimension both forslim camera phones and for notebook applications where the camera module can beno thicker than the LCD housing.

 

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

## *** ***

In October 2003,we entered into a Shareholders’ Agreement, or the VisEra Agreement, with TaiwanSemiconductor Manufacturing Company Limited, or TSMC, pursuant to which weagreed with TSMC to form VisEra Technologies Company, Ltd., or VisEra, a jointventure in Taiwan. VisEra’s mission is to provide back-end manufacturingservices. In connection with the formation of VisEra, both TSMC and we enteredinto separate nonexclusive license agreements with VisEra pursuant to whicheach party licenses certain intellectual property to VisEra relating tomanufacturing services. The VisEra Agreement also provided that once VisEra hadacquired the capability to deliver high quality manufacturing services, wewould be committed to direct a substantial portion of our requirements in theseareas to VisEra, subject to pricing and technology requirements. Both TSMC andwe have also committed not to compete directly or indirectly with VisEra in theprovision of certain manufacturing services. Historically, we have relied uponTSMC to provide us with a substantial proportion of our wafers. As a part ofthe VisEra Agreement, TSMC agreed to commit substantial wafer manufacturingcapacity to us in exchange for our commitment to purchase a substantial portionof our wafers from TSMC, subject to pricing and technology requirements.

 

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

 

28

----

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

 

percentage in XinTec declined from 7.8% to4.4% and VisEra’s ownership percentage declined from 29.6% to 16.9%. Dueto the reduction in our ownership percentage in XinTec and the deconsolidationof VisEra described below, effective January 1, 2007, we began to accountfor our interest in XinTec under the cost method.

 

Asa result 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), *“Consolidationof Variable Interest Entities.”* We concluded that, as a result ofour step acquisition of VisEra and because substantially all of the activities ofVisEra either involve or are conducted on our behalf, VisEra was a variableinterest entity. Since we were the source of virtually all of VisEra’srevenues, we had a decisive influence over VisEra’s profitability. Accordingly,we considered ourselves to be the primary beneficiary of the joint venture, andin the quarter which ended in October 2005, we began to include VisEra’sfinancial results in our consolidated financial statements. In the quarterended January 2006, we increased our interest in VisEra from 43% to 46%through purchases of unissued shares. In January 2006, pursuant to theAmended VisEra Agreement, VisEra purchased from TSMC the equipment used forapplying color filers and micro-lenses to wafers, and VisEra is now providingthe related processing services that we previously purchased from TSMC. In November 2006,we invested $6.1 million in VisEra as our portion of an additional cash orasset contribution to be made by TSMC and us under the then current AmendedVisEra Agreement.

 

Effective January 1, 2007,by mutual agreement, we assumed responsibility for the logistics managementservices previously provided to us by VisEra. As a consequence, we concludedthat we had lost our status as the primary beneficiary of the joint venture andthat VisEra had ceased to be a variable interest entity, or VIE, as definedunder FIN 46(R). As a result, we deconsolidated VisEra as of the date ofthe change. As a consequence of the deconsolidation, effective January 1,2007, we account for our investment in VisEra under the equity method. Thedeconsolidation of VisEra did not have a material effect on our reportedrevenue or reported net income for fiscal 2007. See Note 5 — *“Long-term Investments”*to our condensed consolidatedfinancial 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 May 2004,we entered into an agreement with Powerchip Semiconductor Corporation, or PSC,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.

 

In March 2005,we assumed control of the board of directors of SOI and we have consolidatedSOI since April 30, 2005. In July 2006, SOI declared a cash dividendof $482,000, of which we received $237,000 when the cash dividend was paid in August 2006.SOI also issued shares to its employees in July 2006, with an estimatedfair value of $459,000 which caused our ownership percentage to decline from49.0% to 46.6%. In April 2007, SOI became listed on the Taiwan GreTaiSecurities Market, or TGSM. The TGSM is the approximate equivalent in Taiwan ofthe Over-The-Counter market in the United States. In conjunction with the TGSMlisting, various employees of SOI exercised their options and increased thenumber of shares outstanding, which caused our ownership percentage to declineto 44.0% as of January 31, 2008.

 

During the ninemonths ended January 31, 2008, SOI paid a cash dividend of $409,000, ofwhich we received $184,000. In October 2007, SOI issued options to variousof its employees exercisable for 600,000 shares of its common stock. SeeNote 6 — *“ConsolidatedAffiliate — Silicon Optronics, Inc.”*to our condensedconsolidated financial statements.

 

## ***Acquisition of CDM***

## *** ***

In April 2005,we completed the acquisition of OmniVision CDM Optics, Inc., or CDM,formerly CDM Optics, Inc., a company located in Boulder, Colorado. CDM isthe exclusive licensee from an affiliate of the University of Colorado of apatented technology, known as Wavefront Coding technology that increases theperformance of an

 

29

----

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

 

imagingsystem by 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 the threemonths 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.

 

In addition, weare obligated to pay $10.0 million in cash upon the sale, prior to the endof April 2009, of a pre-determined number of revenue-producing productsincorporating CDM’s technology.

 

## ***Capital Resources***

## *** ***

As of January 31,2008, we held approximately $275.5 million in cash and cash equivalentsand approximately $87.8 million in short-term investments. To mitigatemarket risk related to short-term investments, we have an investment policydesigned to preserve the value of capital and to generate interest income fromthese investments without material exposure to market fluctuations. Market riskis the potential loss due to the change in value of a financial instrument as aresult of changes in interest rates or bond prices. Our policy is to invest infinancial instruments with short maturities, limiting interest rate exposure,and to measure performance against comparable benchmarks. We maintain ourportfolio of cash equivalents and short-term investments in a variety ofsecurities, including both government and corporate obligations with ratings ofA or better and money market funds. We do not believe that the value of ourcash and short-term investments will be significantly affected by recentinstability in global financial markets.

 

In June 2005,our board of directors authorized us to use up to $100 million of ouravailable cash in an open-market program to repurchase our common stock. At theexpiration of the program in June 2006, we had cumulatively repurchased5,870,000 shares of our common stock for an aggregate cost ofapproximately $79.6 million.

 

In February 2007,our board of directors approved an additional stock repurchase program thatprovides for the repurchase of up to $100 million of our outstandingcommon stock in an open-market program. Subject to applicable securities laws,such repurchases will be at such times and in such amounts as we deemappropriate, based on factors such as market conditions, legal requirements andother corporate considerations. As of January 31, 2008, we hadcumulatively repurchased 671,000 shares of our common stock under theopen-market program for an aggregate cost of approximately $11.4 million.See Note 13 *— “TreasuryStock”*to our condensed consolidated financial statements.

 

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

## *** ***

We operate in achallenging economic environment that has undergone significant changes intechnology and in patterns of global trade. We strive to remain a leader in thedevelopment and marketing of image sensing devices based on the CMOSfabrication process and have benefited from the growing market demand for andacceptance of this technology.

 

We sell ourproducts worldwide directly to original equipment manufacturers, or OEMs, whichinclude branded customers and contract manufacturers, and value addedresellers, or VARs, and indirectly through distributors. In order to ensurethat we address all available markets for our image sensors, we divide ourmarketing efforts into two separate groups. The Mainstream Products marketinggroup 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 the camera cellphone market in particular, future revenues depend to a large extent on designwins where, on the basis of an exhaustive evaluation of available products, aparticular hand-set maker determines which image sensor

 

30

----

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

 

todesign 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 theengineering designers for manufacturers of products that incorporate imagesensors to specify one of our products rather than one made by a competitor. Inmost cases, the decision to specify a particular product requires conformingother specifications of the product to the chosen image sensor and makessubsequent changes both difficult and expensive. Accordingly, the ability toproduce and deliver on time reliable products in large quantities is a keycompetitive differentiator. Since our inception, we have shipped more than900 million image sensors, including approximately 130 million in thethird quarter of fiscal 2008. We believe that this demonstrates thecapabilities of our production system, including our sources of offshorefabrication.

 

We currentlyoutsource the wafer fabrication and packaging of our image-sensor products tothird parties. We outsource the color filter and micro-lens phases ofproduction to a joint venture. This approach allows us to focus our resourceson the design, development, marketing and testing of our products and significantlyreduces our capital requirements.

 

To increase andenhance our production capabilities, last year we completed a project withTSMC, our principal wafer supplier and one of the largest wafer fabricationcompanies in the world, to increase from two to four the number of itsfabrication 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 sufficient back-endcapacity for the processing of our image sensors in the various formatsrequired by our customers. In January 2007, we amended our joint ventureagreement with TSMC to each invest an additional $27.0 million in VisEra,and VisEra is currently expanding its capacity. Separately, TSMC purchased90.5 million shares from XinTec to enable XinTec to expand its capacity.In February 2007, we also entered into a foundry manufacturing agreementwith PSC.

 

We currentlyperform the final testing of the majority of our products at our own facilityin China. We are currently expanding our testing capacity, as well as ouroverall 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.

 

Since our end-usercustomers market and sell their products worldwide, our revenues by geographiclocation are not necessarily indicative of the geographic distribution ofend-user sales, but rather indicate where the products and/or their componentsare manufactured or sourced. The revenues we report by geography are based onthe country or region in which our customers issue their purchase orders to us.

 

Many of theproducts using our image sensors, such as camera cell phones, notebook andpersonal computers, digital still cameras and cameras for toys and games, areconsumer 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, HongKong 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.

 

We believe thatthe market opportunity represented by camera cell phones remains very large. Webenefited from the growth in shipments of image sensors, for camera cell phonesin fiscal 2007 and in the first nine months of fiscal 2008. Demandincreases were particularly strong for our VGA and 2.0-megapixel image sensors.

 

We also believethat, like the digital still camera market, camera cell phone and notebook andpersonal computer demand will not only continue to shift toward higherresolutions, but also will increasingly fragment into multiple

 

31

----

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

 

resolutioncategories. In addition, there is increased demand for customization, andseveral different interface standards are coming to maturity. All of thesetrends will require the development of an increasing variety of products.

 

As the markets forimage sensors have grown, we have experienced competition from manufacturers ofCMOS 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.

 

As a result of theincrease in competition and the growth of various consumer-product applicationsfor image sensors, we have experienced a shortening in the life cycle of someimage-sensor products. For example, in the security and surveillance market wecontinue to sell image sensors introduced more than four years ago, whereas inthe camera cell phone market, product life cycles can be as short as sixmonths. With the shortening of product life cycles, it will be increasinglydifficult to accurately forecast customer demand for our products. As a result,we face the risk of being unable to fulfill customer orders if we underestimatemarket demand and the risks of excess inventory and product obsolescence if weoverestimate market demand for our products. The shortening of product lifecycles also increases the importance of having short product development cyclesand being accurate in the prediction of market trends in the design of newproducts. The reduction in product life cycles increases the importance of ourcontinued investment in research and development, which we consider to becritical to our future success.

 

In common withmany other semiconductor products and as a response to competitive pressures,the average selling prices, or ASPs, of image sensor products have declinedsteadily since their introduction, and we expect ASPs to continue to decline inthe future. Accordingly, in order to maintain our gross margins, we and oursuppliers have to work continuously to lower our manufacturing costs andincrease our production yields, and in order to maintain or grow our revenues,we have to increase the number of units we sell by a large enough amount tooffset the effect of declining ASPs. In addition, if we are unable to timelyintroduce new products that can take advantage of smaller process geometries ornew products that incorporate more advanced technology and include moreadvanced features that can be sold at higher average selling prices, our grossmargin will decline.

 

We have migratedthe production of our OmniPixel2 sensors to 0.13μ process geometries, which hasenabled us to increase the resolution of our image sensors while decreasingoverall chip size. As part of our ongoing efforts to achieve both higherresolutions and smaller chip sizes, we initiated mass production volumes of ourOmniPixel3 sensors with 0.11μ process technologies in January 2008. Giventhe rapidly changing nature of our technology, there can be no assurance thatwe 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 establishedproducts. We can encounter unexpected manufacturing issues, such as theunexpected back-end problems that resulted in low yields on two of our products,the first of which arose in the fourth quarter of fiscal 2005 and in thefirst quarter 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 subsequently ableto sell these reserved products, the sales have little or no associated costand consequently they have a favorable impact on gross margins.

 

32

----

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

## *** ***

## ***Sources of Revenues***

## *** ***

We generate almostall our revenue by selling our products directly to OEMs and VARs andindirectly through distributors. For accounting purposes, we treat sales toOEMs and VARs as one source of revenue, and sales to 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.

 

For shipments tocustomers 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.

 

For shipment ofproducts sold to distributors under agreements allowing for returns or credits,title and the risk of ownership to the products transfer to the distributorupon shipment; however, prices are not fixed or determinable until thedistributor resells the products to our end-user customer and the distributornotifies us in writing of the details of such sales transactions. Accordingly,we recognize revenue using the “sell-through” method under which we defer therevenue and the related costs of sale until the final resale of such productsto end customers. The amounts billed to these distributors less the cost ofinventory shipped to, but not yet sold by, the distributors is shown net on theCondensed Consolidated Balance Sheets as “Deferred income.” Accounting forrevenue on the “sell-through” method requires that we obtain sales andinventory information from our distributors. As part of our internal controlprocess, we observe our distributors’ physical counts of their inventories ofour products on a regular basis.

 

In order todetermine whether collection is probable, we assess a number of factors,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.

 

In addition, werecognize revenue from the performance of services to a limited number of ourcustomers by our wholly-owned subsidiary, CDM, and, through December 31,2006, by our then consolidated affiliate, VisEra. We recognize theCDM-associated revenue under either the completed-contract or the percentage-of-completionmethods. The percentage-of-completion method of accounting is used for costreimbursement-type contracts, where revenues recognized are that portion of thetotal contract price equal to the ratio of costs expended to date to the anticipatedfinal total costs based on current estimates of the costs to complete theprojects. CDM-associated revenue has not been material in any of the periodspresented. Until December 31, 2006 we recognized VisEra’s service revenuefrom third-party customers when the production services provided by VisEra werecomplete and the product was shipped to the customer.

 

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

## *** ***

For a discussionof our critical accounting policies, please refer to the discussion in ourAnnual Report on Form 10-K for the fiscal year ended April 30, 2007.Other than for policies that are related to the adoption of FASBInterpretation, or FIN, No. 48, *“Accounting forUncertainty in Income Taxes—an interpretation of FASB Statement No. 109,”*or FIN 48, there have been no material changes in any of our criticalaccounting policies since April 30, 2007.

 

*Accountingfor Income Taxes*

 

We adoptedFIN 48 and related guidance on May 1, 2007. See Note 14 — *“Income Taxes”* to our condensed consolidated financialstatements. Under FIN 48, we are required to make certain estimates andjudgments in determining income tax expense for financial statement purposes.These estimates and judgments occur in the calculation of tax credits,benefits, and deductions, and in the calculation of certain tax assets andliabilities, which arise from differences in the timing of recognition ofrevenue and expense for tax and financial statement purposes, as well as theinterest and penalties relating to these uncertain tax positions. Significantchanges to these estimates may increase or decrease our tax provision in asubsequent period. Similarly, for tax liabilities denominated in a currencyother than the

 

33

----

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

 

USdollars, changes in the value of the denominated currency will increase ordecrease our tax provision in a subsequent period.

 

We also have toassess the likelihood that we will be able to realize our deferred tax assets.If realization is not likely, we are required to increase our provision fortaxes by recording a valuation allowance against the deferred tax assets thatwe estimate we will not ultimately realize. We believe that we will ultimatelyrealize a substantial majority of the deferred tax assets recorded on ourcondensed consolidated balance sheets. However, should there be a change in ourability to realize our deferred tax assets, our tax provision would increase inthe period in which we determined that it is more likely than not that thebenefit of our deferred tax assets will not be realized.

 

In addition, thecalculation of our tax liabilities involves dealing with uncertainties in theapplication of complex tax regulations. As a result of the implementation ofFIN 48, we recognize liabilities for uncertain tax positions based on thetwo-step process prescribed within the interpretation. In the first step,recognition, we determine whether it is more-likely-than-not that a taxposition will be sustained upon examination, including resolution of anyrelated appeals or litigation processes, based on the technical merits of theposition. The second step addresses measurement of a tax position that meets themore-likely-than-not criterion. The tax position is measured at the largestamount of benefit that has a greater than 50 percent likelihood of beingrealized 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 addition to the tax provision for the period.

 

**Resultsof Operations**

 

The followingtable sets forth the results of our operations as a percentage of revenues. Ourhistorical operating results are not necessarily indicative of the results wecan expect for any future period.

 

| ** **                                        | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | **January 31,**   | ** ** | **January  31,** | ** ** |
| ** **                                        | ** ** | **2008**               | ** ** | **2007**              | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenues                                          |       | 100.0                  | %          | 100.0                 | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                                  |       | 72.9                   |       | 75.1                  |       | 74.6 |   | 68.5 |   |
| Gross margin                                      |       | 27.1                   |       | 24.9                  |       | 25.4 |   | 31.5 |   |
| Operating expenses:                               |       |                   |       |                  |       |   |   |   |   |
| Research, development and related                 |       | 9.0                    |       | 12.3                  |       | 9.1 |   | 12.7 |   |
| Selling, general and administrative               |       | 6.9                    |       | 12.4                  |       | 7.4 |   | 11.0 |   |
| Litigation settlement                             |       | —                 |       | —                |       | — |   | 0.8 |   |
| Total operating expenses                          |       | 15.9                   |       | 24.7                  |       | 16.5 |   | 24.5 |   |
| Income from operations                            |       | 11.2                   |       | 0.2                   |       | 8.9 |   | 7.0 |   |
| Interest income, net                              |       | 1.5                    |       | 3.1                   |       | 1.6 |   | 2.7 |   |
| Other income (expense),  net                      |       | (0.4                   | )          | (0.5                  | )          | (0.2 | ) | 0.2 |   |
| Income before income  taxes and minority interest |       | 12.3                   |       | 2.8                   |       | 10.3 |   | 9.9 |   |
| Provision for (benefit  from) income taxes        |       | 2.3                    |       | (1.0                  | )          | 1.4 |   | 2.3 |   |
| Minority interest                                 |       | —                 |       | 0.7                   |       | — |   | 1.4 |   |
| Net income                                        |       | 10.0                   | %          | 3.1                   | %          | 8.9 | % | 6.2 | % |

 

*Three Months Ended January 31, 2008 as Compared to Three MonthsEnded January 31, 2007*

 

### **Revenues**

### ** **

We derivesubstantially all of our revenues from the sale of our image-sensor productsfor use in a wide variety of consumer and commercial mass-market applicationsincluding camera cell phones, notebooks and personal computers, security andsurveillance cameras, digital still cameras, interactive video and toy camerasand automotive products. Revenues for the three months ended January 31,2008 increased by 67.4% to approximately $224.9 million from$134.4 million for the three months ended January 31, 2007. Theincrease in revenues was due to an increase in unit sales of our image-sensorproducts, primarily for cell phones, notebooks and personal computers,partially offset by a decline in our average selling prices and a lessfavorable product mix.

 

34

----

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

 

## ***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 ended January 31,2008 and 2007:

 

| ** **    | ** ** | **Three Months Ended** | ** ** |
|---------------|------------|------------------------|------------|
| ** **    | ** ** | **January 31,**   | ** ** |
| ** **    | ** ** | **2008**               | ** ** | **2007** | ** ** |
| OEMs and VARs |       | 69.1                   | %          | 51.1 | % |
| Distributors  |       | 30.9                   |       | 48.9 |   |
| Total         |       | 100.0                  | %          | 100.0 | % |

 

*OEMs andVARs.*   Inthe three months ended January 31, 2008, one OEM customer accounted forapproximately 13.1% of our revenues. For the three months ended January 31,2008 and 2007, no other OEM or VAR customer accounted for 10% or more of ourrevenues.

 

*Distributors.*   In the three monthsended January 31, 2008, one distributor customer accounted forapproximately 19.8% of our revenues. In the three months ended January 31,2007, two distributor customers accounted for approximately 18.4% and 15.9%,respectively, of our revenues. For the three months ended January 31, 2008and 2007, no other distributor customer accounted for 10% or more of ourrevenues.

 

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

## *** ***

The followingtable 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 January 31, 2008 and 2007:

 

| ** **     | ** ** | **Three Months Ended**   | ** ** |
|----------------|------------|--------------------------|------------|
| ** **     | ** ** | **January ****31,** | ** ** |
| ** **     | ** ** | **2008**                 | ** ** | **2007** | ** ** |
| Domestic sales |       | 1.5                      | %          | 0.2 | % |
| Foreign sales  |       | 98.5                     |       | 99.8 |   |
| Total          |       | 100.0                    | %          | 100.0 | % |

 

We derive themajority of our foreign sales from customers in Asia and, to a lesser 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 the preponderanceof Asia-Pacific manufacturers and the fact that virtually all productsincorporating our image-sensor products are sold globally, we believe that thegeographic distribution of our sales does not accurately reflect the geographicdistribution of sales into end-user markets of products which incorporate ourimage sensors.

 

### **GrossProfit**

### ** **

Our gross marginin the three months ended January 31, 2008 was 27.1%, up from 24.9% forthe three months ended January 31, 2007. The principal contributor tothe year-over-year increase ingross margin was reductionsin our production costs, partially offset by the decline in our average selling prices. During thethree months ended January 31,2008, the average selling prices of our products were lower than they werein the year-earlier period.  In additionto the price declines which are standard in our industry, the decline inaverage selling prices was due in part to an increase in the proportion ofsales represented by VGA image sensors, and in part also to an increase in the proportion of salesrepresented by bare die rather than packaged products. We were able topartially offset the decline in average selling prices by reducing ourmanufacturing costs. In the three-month periods ended January 31, 2008 and2007, in accordance with SFAS No. 123(R), we recorded approximately$0.9 million and $1.0 million in stock compensation expense to costof revenues, representing approximately 0.4% and 0.7% of revenues,respectively.

 

Revenue from salesof previously reserved products in the three months ended January 31, 2008was $1.9 million, as compared to $3.8 million during the same periodin the prior fiscal year. In the three months ended January 31, 2008,

 

35

----

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

 

werecorded an allowance for excess and obsolete inventory totaling$5.5 million to cost of revenues as compared to $3.4 million duringthe 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 January 31, 2008 increased to approximately $20.1 million fromapproximately $16.5 million for the three months ended January 31,2007. As a percentage of revenues, research, development and related expensesfor the three months ended January 31, 2008 and 2007 represented 9.0% and12.3%, respectively.

 

The increase inresearch, development and related expenses of approximately $3.6 million,or 21.8%, for the three months ended January 31, 2008 from thesimilar period in the prior year resulted primarily from a $1.8 millionincrease in salary and payroll-related expenses associated with salaryincreases and the hiring of additional personnel, a$0.6 million increase in stock-based compensation expense recognizedin accordance with SFAS No. 123(R), a $0.6 million increasein legal expense primarily related to patent registration activities, a$453,000 increase in office and facility expenses and a $259,000 increasein depreciation and amortization expenses of acquired intangible assets,partially offset by a $74,000 reduction in non-recurring engineering expensesrelated to new product development. We anticipate that our research,development and related expenses will continue to increase as we develop andintroduce new products employing our OmniPixel3, OmniPixel3-HS and WavefrontCoding technologies and develop other new technologies related to imagesensors.

 

**Selling,General and Administrative****Expenses**

 

Selling, generaland administrative expenses consist primarily of compensation and personnelrelated expenses, commissions paid to distributors and manufacturers’representatives and insurance and legal expenses. Selling, general andadministrative expenses for the three months ended January 31, 2008decreased to approximately $15.6 million from $16.6 million the threemonths ended January 31, 2007. As a percentage of revenues, selling,general and administrative expenses for the three months ended January 31,2008 and 2007 represented 6.9% and 12.4%, respectively.

 

The decrease inselling, general and administrative expenses of approximately$1.1 million, or 6.4%, for the three months ended January 31, 2008from the similar period in the prior year resulted primarily from a$0.5 million reduction in stock-based compensation expense recognized inaccordance with SFAS No. 123(R), a $447,000 decrease in legal andaccounting expenses, a $252,000 decrease in provisions for bad debts, a$201,000 decrease in commissions paid primarily to distributors and salesrepresentatives, a $176,000 decrease in facility expenses, a $175,000 decreasein marketing expenses and a $151,000 decrease in fees for outside services,partially offset by a $0.8 million increase in salary and payroll-relatedexpenses associated with salary increases and the hiring of additionalpersonnel. We anticipate that our selling, general and administrative expenseswill increase in the future due to the continued expansion of our organizationand the continuing upgrade of our computer systems, including our enterpriseresource planning, or ERP, and other management information systems.

 

**InterestIncome, Net**

 

We invest ourcash, cash equivalents and short-term investments in interest-bearing accountsconsisting primarily of money market funds, commercial paper, certificates ofdeposit, high-grade corporate securities and government bonds. Interest incomedeclined to approximately $3.4 million for the three months ended January 31,2008 from $4.2 million for the three months ended January 31, 2007.The reduction in interest income for the three months ended January 31, 2008as compared to the corresponding period in the prior year was the result oflower interest rates.

 

**OtherIncome (Expense), Net**

 

Other income(expense), net, for the three months ended January 31, 2008 totaled$1.0 million in net expenses. The current quarter amount included a$1.8 million non-cash charge arising from the revaluation of the interestrate

 

36

----

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

 

swaprelated to the mortgage on our Santa Clara property and a $38,000 loss thatrepresented our portion of the net loss recorded by ImPac Technology Co., Ltd.,or ImPac, which we account for under the equity method of accounting. Theselosses were partially offset by a $0.8 million gain consisting of ourportion of the net income recorded by China WLCSP Limited, or WLCSP, which wealso account for under the equity method of accounting. Other income (expense),net, for the three months ended January 31, 2007 was expense of$0.8 million. This amount included a gain of $412,000, which representedour portion of the income recorded by XinTec in the months of November andDecember 2006, the final months for which we accounted for XinTec underthe equity method of accounting prior to our reversion to the cost methodbeginning on January 1, 2007. In addition, other income (expense), net,for the three months ended January 31, 2007 included a gain of $32,000 asour portion of the income recorded by ImPac, which we account for under theequity method of accounting. Offsetting these items during the three monthsended January 31, 2007 was a $1.3 million contra-income item, whichreflected residual income attributable to the 54.6% interest in VisEra that we donot own. Prior to the deconsolidation, income attributable to the equityinterest that we do not own was recorded to minority interest expense. Theincome was earned through our sale of inventory purchased from VisEra prior to January 1,2007, the effective date of the deconsolidation.

 

**Provisionfor Income Taxes**

 

We generatedapproximately $27.7 million and $3.8 million in income before incometaxes and minority interest for the three months ended January 31, 2008and 2007, respectively. We recorded a provision for income taxes for the threemonths ended January 31, 2008 of approximately $5.1 million and anincome tax benefit of approximately $1.3 million for the three monthsended January 31, 2007. For the three months ended January 31, 2008and 2007, our effective tax rates were 18.6% and (35.4)%, respectively. In bothyears, our effective tax rates are less than the combined federal and statestatutory rate of approximately 40% principally because we earn a significantportion of our income in jurisdictions where tax rates are lower than thecombined federal and state statutory rate. We expect that our consolidatedeffective tax rate in fiscal 2008 will continue to be less than thecombined federal and state statutory rates. The extent of the difference isprincipally contingent upon the geographic mix of our total pre-tax income. Weadopted the provisions of FIN 48 on May 1, 2007. The effect ofadoption of FIN 48 on our Condensed Consolidated Balance Sheets as of May 1,2007 is summarized in Note 14 — *“Income Taxes”*toour condensed consolidated financial statements.

 

**MinorityInterest**

 

Minority interestfor the three months ended January 31, 2008 and 2007 was $50,000 and$1.0 million, respectively. For the three months ended January 31,2008 and 2007, $50,000 and $73,000, respectively, represents the 56.0%interest that we do not own in the net income of SOI. For the three monthsended January 31, 2007, approximately $0.9 million represents the54.4% 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 three months ended January 31,2008.

 

*Nine Months Ended January 31, 2008 as Compared to Nine MonthsEnded January 31, 2007*

 

### **Revenues**

### ** **

Revenues for thenine months ended January 31, 2008 increased by 54.2% to approximately$630.7 million from $408.9 million for the nine months ended January 31,2007. The increase in revenues was due to an increase in unit sales of ourimage-sensor products, primarily for cell phones, notebooks and personalcomputers, and a more favorable product mix offset, in part, by a decline inour average selling prices.

 

37

----

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

 

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

## *** ***

We sell ourimage-sensor products either directly to OEMs and VARs or indirectly throughdistributors. The following table shows the percentage of revenues from salesto OEMs and VARs and distributors in the nine months ended January 31,2008 and 2007:

 

| ** **    | ** ** | **Nine Months Ended**        | ** ** |
|---------------|------------|------------------------------|------------|
| ** **    | ** ** | **January ****31****,** | ** ** |
| ** **    | ** ** | **2008**                     | ** ** | **2007** | ** ** |
| OEMs and VARs |       | 67.6                         | %          | 60.7 | % |
| Distributors  |       | 32.4                         |       | 39.3 |   |
| Total         |       | 100.0                        | %          | 100.0 | % |

 

*OEMs andVARs.*   Inthe nine months ended January 31, 2008, one OEM customer accounted forapproximately 15.5% of our revenues. In the nine months ended January 31,2007, one OEM customer accounted for approximately 13.6% of our revenues. Forthe nine months ended January 31, 2008 and 2007, no other OEM or VARcustomer accounted for 10% or more of our revenues.

 

*Distributors.*   In the nine monthsended January 31, 2008, one distributor customer accounted forapproximately 20.5% of our revenues. In the nine months ended January 31,2007, two distributor customers accounted for approximately 14.6% and 12.4% ofour revenues, respectively. For the nine months ended January 31, 2008 and2007, no other distributor customer accounted for 10% or more of our revenues.

 

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

## *** ***

The followingtable shows the percentage of our revenues derived from sales of ourimage-sensor products to domestic customers as compared to foreign customersfor the nine months ended January 31, 2008 and 2007:

 

| ** **     | ** ** | **Nine Months Ended**    | ** ** |
|----------------|------------|--------------------------|------------|
| ** **     | ** ** | **January ****31,** | ** ** |
| ** **     | ** ** | **2008**                 | ** ** | **2007** | ** ** |
| Domestic sales |       | 1.1                      | %          | 1.0 | % |
| Foreign sales  |       | 98.9                     |       | 99.0 |   |
| Total          |       | 100.0                    | %          | 100.0 | % |

 

We derive themajority of our foreign sales from customers in Asia and, to a lesser 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.

 

### **GrossProfit**

### ** **

Our gross marginin the nine months ended January 31, 2008 was 25.4%, down from 31.5% forthe nine months ended January 31, 2007. The principal contributor tothe year-over-year decline ingross margin was thedecline in our average selling prices, together with an increase in the proportion of oursales represented by VGA image sensors, partially offset by reductions in ourproduction costs.In both the nine months ended January 31, 2008 and 2007, inaccordance with SFAS No. 123(R), we recorded approximately$2.9 million in stock-based compensation expense to cost of revenues, or0.5% and 0.7% of revenues, respectively.

 

Revenue from salesof previously reserved products in the nine months ended January 31, 2008was $5.3 million, as compared to $10.8 million during the same periodin the prior fiscal year. In the nine months ended January 31, 2008, werecorded an allowance for excess and obsolete inventory totaling$17.9 million to cost of revenues as compared to $5.8 million during the same period inthe prior fiscal year.

 

38

----

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

 

**Research,Development and Related Expenses**

 

Research,development and related expenses for the nine months ended January 31,2008 increased to approximately $57.7 million from approximately$52.0 million for the nine months ended January 31, 2007. As apercentage of revenues, research and development expenses for the nine monthsended January 31, 2008 and 2007 represented 9.1% and 12.7%, respectively.

 

The increase inresearch, development and related expenses of approximately $5.7 million,or 11.0%, for the nine months ended January 31, 2008 from the similarperiod in the prior year resulted primarily from a $4.9 million increasein salary and payroll-related expenses associated with salary increases and thehiring of additional personnel, a $1.1 million increase in office andfacility expenses, a $0.7 million increase in depreciation andamortization expenses of acquired intangible assets and a $0.7 millionincrease in legal expenses, partially offset by a $1.3 million decrease innon-recurring engineering expenses related to new product development, a$379,000 reduction in stock-based compensation expense recognized in accordancewith SFAS No. 123(R) and a $342,000 decrease in softwareexpenses.

 

**Selling,General and Administrative****Expenses**

 

Selling, generaland administrative expenses for the nine months ended January 31, 2008increased to approximately $46.5 million from $44.9 million for thenine months ended January 31, 2007. As a percentage of revenues, selling,general and administrative expenses for the nine months ended January 31,2008 and 2007 represented 7.4% and 11.0%, respectively.

 

The increase inselling, general and administrative expenses of approximately $1.7 million,or 3.7%, for the nine months ended January 31, 2008 from the similarperiod in the prior year resulted primarily from a $3.1 million increasein salary and payroll-related expenses associated with salary increases and thehiring of additional personnel, a $1.2 million increase in legal andaccounting expenses due primarily to an increase in legal fees, a $479,000increase in property and other taxes and a $211,000 increase in insuranceexpense, partially offset by a $0.8 million reduction in stock-basedcompensation expense recognized in accordance with SFAS No. 123(R), a$0.7 million decrease in fees for outside services, a $0.6 milliondecrease in facility expenses, and a $0.6 million decrease in commissionspaid primarily to distributors and sales representatives.

 

**LitigationSettlement**

 

We accrued$3.3 million in litigation settlement expenses for the nine months ended January 31,2007, to reflect our share of the settlement of the securities class actionlawsuit filed in the United States District Court for the Northern District ofCalifornia. Litigation settlement expenses for the nine months ended January 31,2007 represented 0.8% of revenue, and the litigation is now concluded. (See *“Note 15 — Commitments andContingencies”* of the Notes to our condensed consolidated financialstatements.)

 

**InterestIncome, Net**

 

Interest incomefor the nine months ended January 31, 2008 decreased slightly toapproximately $10.1 million from $11.0 million for the nine monthsended January 31, 2007. The reduction in interest income for the ninemonths ended January 31, 2008 as compared to the corresponding period inthe prior year was the result of lower interest rates.

 

**OtherIncome (Expense), Net**

 

Other income(expense), net, for the nine months ended January 31, 2008 totaled$1.1 million in expenses. The amount included a non-cash $2.0 millioncharge arising from the revaluation of the interest rate swap related to themortgage on our Santa Clara property and a $244,000 loss for the nine monthsended January 31, 2008 as our portion of the net loss recorded by ImPacwhich we account for under the equity method of accounting. These losses werepartially offset by a $0.9 million gain consisting of our portion of thenet income recorded by WLCSP, which we also account for under the equity methodof accounting. Other income (expense), net, for the nine months ended January 31,2007 was income of $0.9 million and consisted of $1.7 millionrepresenting our portion of the income recorded by XinTec and $379,000representing our portion of the income recorded by ImPac.

 

39

----

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

 

**Provisionfor Income Taxes**

 

We generatedapproximately $64.9 million and $40.4 million in income before incometaxes and minority interest for the nine months ended January 31, 2008 and2007, respectively. We recorded provisions for income taxes for the nine monthsended January 31, 2008 and 2007 of approximately $8.9 million and$9.2 million, respectively. For the nine months ended January 31,2008 and 2007, our effective tax rates were 13.8% and 22.7%, respectively.Year-to-date income taxes reflect our estimate of the effective tax rate forthe fiscal year and include, when applicable, the impact of discrete tax items.The lower effective tax rate for the nine months ended January 31, 2008 ascompared to the nine months ended January 31, 2007 is principally due tothe favorable impact of the change in the expected geographical mix of incomeand the benefit recorded in the three months ended July 31, 2007attributable to the release of unrecognized tax benefits including interest andpenalties that were no longer required as a result of a change in tax law in aforeign jurisdiction in which we do business. In both years, our effective taxrates are less than the combined federal and state statutory rate ofapproximately 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.

 

**MinorityInterest**

 

Minority interestfor the nine months ended January 31, 2008 and 2007 was $56,000 and$5.8 million, respectively. For the nine months ended January 31,2008 and 2007, approximately $56,000 and $342,000, respectively,represents the approximately 56.0% interest that we do not own in the netincome of SOI which we included in our consolidated operating results. For thenine months ended January 31, 2007, approximately $5.5 million representsthe 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 nine months ended January 31,2008.

 

**Liquidityand Capital Resources**

 

Our principalsources of liquidity at January 31, 2008 consisted of cash, cashequivalents and short-term investments of $363.3 million.

 

## ***Liquidity***

## *** ***

Our workingcapital increased by approximately $113.6 million to $470.6 millionas of January 31, 2008 from $357.0 million as of April 30, 2007.The increase was primarily attributable to: an $84.6 million increase incash and cash equivalents primarily due to cash provided by operatingactivities; a $56.0 million decrease in income taxes payable primarily dueto the reclassification of $64.3 million of liability for net unrecognizedtax benefits from current to long-term income taxes payable as a result of theadoption of FIN 48; a $25.9 million increase in accounts receivable, net,consistent with the increase in revenues from prior year levels; a$13.8 million decrease in a litigation settlement accrual and a$2.0 million increase in inventories. These increases in working capitalwere partially offset by: a $28.8 million increase in accounts payableprimarily resulting from increased inventory purchases; a $26.6 milliondecrease in short-term investments; and a $13.0 million decrease inrecoverable insurance proceeds.

 

SOI maintains fourunsecured lines of credit with three commercial banks, which provide a total ofapproximately $3.5 million in available credit. All borrowings under thefour lines of credit maintained by SOI bear interest at the market interestrate prevailing at the time of borrowing. There are no financial covenant requirementsfor these facilities and at January 31, 2008, there were no borrowingsoutstanding under these facilities.

 

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

## *** ***

For the ninemonths ended January 31, 2008, net cash provided by operating activitiestotaled approximately $84.2 million as compared to $39.0 million forthe corresponding period in the prior year. The principal components of thecurrent year amount were: net income of approximately $56.0 million forthe nine months ended January 31, 2008, adjusted for non-cash charges of$21.6 million in stock-based compensation, $17.9 million inwrite-down of inventories, $9.8 million in depreciation and amortizationand $6.7 million of gains in equity investments; a $20.5 millionincrease in accounts payable; a $14.1 million decrease in prepaid expensesand other current assets; a $9.0 million increase in income taxes payableand a $1.3 million increase in deferred income. These increases werepartially offset by: a $25.9 million increase in accounts receivable, net;a $20.7 million increase in inventories; a

 

40

----

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

 

$12.7 milliondecrease in accrued expenses and other current liabilities; and a$2.0 million decrease in deferred tax liabilities. The $25.9 millionincrease in accounts receivable, net, reflects the higher level of revenuesduring the nine months ended January 31, 2008, partially offset by animprovement in days of sales outstanding as of January 31, 2008 to37 days from 49 days as of April 30, 2007. The$20.7 million increase in inventories was a reflection of increased salesin fiscal 2008. The inventory balances increased concurrently with an improvement in annualizedinventory turns to 5.4 as of January 31, 2008 from 3.1 as of April 30,2007. The $14.1 million decrease in prepaid expenses and other currentassets was principally due to the final settlement of the class actionlitigation and the consequent removal of the associated recoverable insuranceproceeds from the balance sheet and the reclassification of a deposit paid forland from other current assets to property, plant and equipment upon transferof title.

 

For the ninemonths ended January 31, 2007, net cash provided by operating activitiestotaled approximately $39.0 million. The principal components of thecurrent year amount were: net income of approximately $25.4 million forthe nine months ended January 31, 2007, adjusted for non-cash charges of$22.9 million in stock-based compensation, $10.5 million indepreciation and amortization, $5.8 million in the minority interest inthe net income of consolidated affiliates, $5.8 million in write-down ofinventories and $3.2 million of gains in equity investments; a$29.9 million increase in accounts payable; a $13.8 million increasein accrued expenses and other current liabilities; an $12.3 millionincrease in accrued income taxes payable and a $2.7 million increase indeferred tax liabilities. These increases were partially offset by: a$56.7 million increase in inventories; a $14.7 million increase inprepaid expenses and other current assets; a $7.6 million increase inaccounts receivable, net and a $9.0 million increase in refundable anddeferred income taxes. The $14.7 million increase in prepaid expenses andother current assets principally reflect $13.0 million in recoverableinsurance proceeds associated with the settlement of security class-actionlitigation. The $13.8 million increase in accrued expenses and othercurrent liabilities resulted from a litigation settlement accrual associatedwith the settlement of security class-action litigation. The $7.6 millionincrease in accounts receivable, net, reflects the higher level of revenues duringthe nine months ended January 31, 2007, and the increase in days of salesoutstanding as of January 31, 2007 to 50 days from 45 days as ofApril 30, 2006. The $56.7 million increase in inventories wasprincipally the result of a change in the mix of product demand late in thesecond quarter which precluded wafer production schedule adjustments. The increase in inventory balancesresulted in a decline in annualized inventory turns to 3.8 as of January 31,2007. Our accrued income taxes payable increased as a consequence of additionalprovisions for the three and nine months ended January 31, 2007.

 

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

## *** ***

For the ninemonths ended January 31, 2008, our cash used in investing activitiesdecreased to $2.6 million as compared to approximately $90.6 millionfor the corresponding period in the prior year, due primarily to:$21.5 million in purchases of property, plant and equipment and$9.0 million in a long-term investment in WLCSP, partially offset by$27.9 million in net sales of short-term investments. For the nine monthsended January 31, 2007, our cash used in investing activities totaled$90.6 million due to: $41.0 million in purchases of property, plantand equipment; $28.4 million in net purchases of short-term investments;$20.6 million resulting from the deconsolidation of VisEra and$0.5 million in purchase of intangible property.

 

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

## *** ***

For the ninemonths ended January 31, 2008, net cash provided by financing activitiestotaled approximately $3.0 million as compared to $20.8 million forthe corresponding period in the prior year. This change was primarily due to$14.2 million in proceeds from the exercise of stock options and employeepurchases through our employee stock purchase plan partially offset by$11.5 million in repurchases of shares of our common stock under theopen-market program in the nine months ended January 31, 2008. For thenine months ended January 31, 2007, net cash provided by financingactivities totaled approximately $20.8 million due principally to$10.5 million in proceeds from the exercise of stock options and employeepurchases through our employee stock purchase plan and a $10.4 millioncash contribution by two of our minority interest shareholders.

 

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

## *** ***

Over the next twoyears, we expect to invest a total of $30.0 million in our wholly-ownedsubsidiary in Shanghai, Shanghai OmniVision IC Design Co. Ltd., or SDC, ofwhich we have already contributed $8.5 million. The funding requirement arisesfrom our execution of a Land-Use-Right Purchase Agreement with the Constructionand Transportation Commission of the Pudong New District, Shanghai with aconcomitant commitment to spend

 

41

----

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

 

approximately$30.0 million to develop the land. See Note 15* — “Commitmentsand Contingencies”*to our condensed consolidated financialstatements. We expect to fund our capital commitments to SDC from our availableworking capital.

 

In February 2007,our board of directors approved an additional stock repurchase program thatprovides for the repurchase of up to $100 million of our outstandingcommon stock in an open-market program. Subject to applicable securities laws,such repurchases will be at such times and in such amounts as we deemappropriate, based on factors such as market conditions, legal requirements andother corporate considerations. As of January 31, 2008, we hadcumulatively repurchased 671,000 shares of our common stock under theopen-market program for an aggregate cost of approximately $11.4 million.See Note 13 *— “TreasuryStock”*to our condensed consolidated financial statements.

 

We are obligatedto 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 January 31, 2008 and April 30,2007.

 

We currentlyexpect our available cash, cash equivalents and short-term investments,together with cash that we anticipate generating from operating activities,will be sufficient to satisfy our capital requirements over approximately thenext twelve months. Other than normal working capital requirements, we expectour capital requirements totaling approximately $70 million overapproximately the next twelve months will consist primarily of funding capitalinvestment at Hua Wei Semiconductor (Shanghai) Co. Ltd., or HWSC, funding aportion of the acquisition and build-out costs associated with the purchase ofa complex of four buildings in Santa Clara, and funding a portion of thedevelopment costs of the land we have leased in Shanghai.

 

We are nowrequired to disclose our unrecognized tax benefits as commitments in accordancewith FIN 48. The non-current portion of our unrecognized tax benefits at January 31,2008 was $69.3 million, of which the timing of the resolution isuncertain.

 

Our ability togenerate cash from operations is subject to substantial risks described belowunder the caption Part II Item 1A. *“RiskFactors.”*We encourage you to review these risks carefully.

 

42

----

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

 

**ContractualObligations and Commercial Commitments**

 

The followingtable summarizes our contractual obligations and commercial commitments as of January 31,2008 and the effect such obligations and commitments are expected to have onour liquidity and cash flows in future periods (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                                          |       | $                          | 14,381     |   | $ | 5,678 |   | $ | 6,839 |   | $ | 1,864 |   | $ | — |   |
| Capital leases                                            |       | 171                        |       | 155 |   | 16 |   | — |   | — |   |
| Mortgage obligation                                       |       | 27,577                     | (1)        | 507 |   | 1,114 |   | 1,260 |   | 24,696 |   |
| Noncancelable orders                                      |       | 59,400                     |       | 59,400 |   | — |   | — |   | — |   |
| Total contractual obligations                             |       | 101,529                    |       | 65,740 |   | 7,969 |   | 3,124 |   | 24,696 |   |
|                                                      |       |                       |       |   |   |   |   |   |   |   |   |
| Other Commercial  Commitments:                            |       |                       |       |   |   |   |   |   |   |   |   |
| Investment in Shanghai Design Center                      |       | 23,510                     | (2)        | 3,500 |   | 20,010 |   | — |   | — |   |
| Total commercial commitments                              |       | 23,510                     |       | 3,500 |   | 20,010 |   | — |   | — |   |
| Total contractual obligations and commercial  commitments |       | $                          | 125,039    |   | $ | 69,240 |   | $ | 27,979 |   | $ | 3,124 |   | $ | 24,696 |   |

----

| (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. |

 

As of January 31,2008, the long-term income taxes payable under FIN 48 was$69.3 million. We are unable to make a reasonably reliable estimate of thetiming of payments in individual years beyond twelve months due touncertainties in the timing of tax audit outcomes. Accordingly, we haveexcluded this obligation from the schedule summarizing our significantobligations to make future payments under contractual obligations as of January 31,2008 presented above.

 

### **Off-Balance SheetArrangements**

### ** **

We did not haveany off-balance sheet arrangements during the period covered by this QuarterlyReport on Form 10-Q.

 

### **Recent Accounting Pronouncements**

### ** **

In December 2007,the FASB issued SFAS No. 141 (revised 2007), *“Business Combinations,”* or**SFAS No. 141(R),which establishes the principles and requirements for how an acquirer: (1)  recognizesand measures in its financial statements the identifiable assets acquired, theliabilities assumed, and any noncontrolling interest in the acquiree; (2)  recognizesand measures the goodwill acquired in the business combination or a gain from abargain purchase; and (3)  determines what information to disclose toenable users of the financial statements to evaluate the nature and financialeffects of the business combination. SFAS No. 141(R) replaces SFAS No. 141, *“Business Combinations.”*SFAS No. 141(R) iseffective in fiscal years beginning after December 15, 2008 and we are required to adopt itin the first quarter of our fiscal 2010. We are currently evaluating theimpact SFAS No. 141(R) may have on our financial position,results of operations and cash flows.

 

In December 2007,the FASB also issued SFAS No. 160, *“NoncontrollingInterests in Consolidated Financial Statements,”*or SFAS No. 160,which establishes accounting and reporting standards that require: (1)  theownership interests in subsidiaries held by parties other than the parent, andincome attributable to those parties, be clearly identified and distinguishedin the parent’s consolidated financial statements; and (2)  when asubsidiary is

 

43

----

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

 

deconsolidated,any retained noncontrolling equity investment in the former subsidiary beinitially measured at fair value. SFAS No. 160 is an amendment ofAccounting Research Bulletin No. 51, *“**ConsolidatedFinancial Statements”*and related interpretations. SFAS No. 160 is effective forfiscal years beginning on or after December 15, 2008 and we are requiredto adopt it in the first quarter of our fiscal 2010. Other thanre-classifying noncontrolling interests as a component of consolidatedstockholders’ equity and identifying earnings attributable to noncontrollinginterests as part of consolidated earnings, as required by SFAS No. 160,we do not expect the adoption of the standard to have any other material impacton the our financial position, results of operations and cash flows.

 

In September 2006,the FASB finalized SFAS No. 157 which will become effective in 2008 exceptas amended by FASB Staff Position, or FSP, FAS 157-1 and FSP FAS 157-2 asdescribed below. This Statement defines fair value, establishes a framework formeasuring fair value and expands disclosures about fair value measurements;however, it does not require any new fair value measurements. The provisions ofSFAS No. 157 will be applied prospectively to fair value measurements anddisclosures for financial assets and financial liabilities and nonfinancialassets and nonfinancial liabilities recognized or disclosed at fair value inthe financial statements on at least an annual basis beginning in the firstquarter of 2008. We do not expect our adoption of the provisions of SFAS No. 157will have a material effect on our financial condition, results of operationsor cash flows.

 

In February 2008,the FASB issued FASB Staff Position, or FSP, SFAS 157-1, *“Application of FASB Statement No. 157 to FASB Statement No. 13and Its Related Interpretive Accounting Pronouncements That Address LeasingTransactions,”* and FSP SFAS 157-2, *“EffectiveDate of FASB Statement No. 157.”* FSP SFAS 157-1 removesleasing from the scope of SFAS No. 157, *“Fair ValueMeasurements.”* FSP SFAS 157-2 delays the effective date of SFASNo. 157 from 2008 to 2009 for all nonfinancial assets and nonfinancialliabilities, except those that are recognized or disclosed at fair value in thefinancial statements on a recurring basis (at least annually). We do not expectour adoption of the provisions of FSP SFAS No. 157-1 and FSP SFAS No. 157-2will have a material effect on our financial condition, results of operationsor cash flows.

 

44

----

 

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

 

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

## *** ***

We sell ourproducts globally, in particular to branded customers, contract manufacturers,VARs and distributors in China, Japan, Korea and Taiwan.

 

The great majorityof our transactions with our customers and vendors are denominated in U.S.dollars. The expenses we incur in currencies other than U.S. dollars affectgross profit, selling, general and administrative expenses, research,development and related expenses and income taxes, and are primarily incurredin China, where the Chinese Yuan, or CNY, is the local currency and in Taiwan,where the New Taiwan dollar is the local currency.

 

Asof January 31, 2008, the functional currency of our wholly-ownedsubsidiaries located in Hong Kong, OmniVision Technologies (Hong Kong) CompanyLimited and OmniVision Trading (Hong Kong) Company Ltd., in the Cayman Islands,OmniVision International Holding, Ltd. and OmniVision Technology InternationalLtd. (formerly HuaWei Technology International, Ltd.), and in China, Hua WeiSemiconductor (Shanghai) Co. Ltd., or HWSC, and SDC, is the U.S. dollar. Ourother wholly-owned subsidiaries have their respective local currencies as theirfunctional currencies. The functional currency of our consolidated affiliate,SOI, is the New Taiwan dollar. Transaction gains and losses resulting fromtransactions denominated in currencies other than the respective functional currenciesare included in “Other income (expense), net” for the periods presented. Theamounts of transaction gains and losses for the three months ended January 31,2008 and 2007 were not material.

 

Given that theexpenses that we incur in currencies other than U.S. dollars have not been asignificant percentage of our revenues, we do not believe that our foreigncurrency exchange rate fluctuation risk is significant. Consequently, we do notbelieve that a 10% change in foreign currency exchange rates would have asignificant effect on our future net income or cash flows.

 

Because we do notbelieve that we currently have any significant direct foreign currency exchangerate risk, we have not hedged exposures denominated in foreign currencies orused any other derivative financial instruments. Although we transact theoverwhelming majority of our business in U.S. dollars, future fluctuations inthe value of the U.S. dollar may affect the competitiveness of our products andthus may impact our results of operations.

 

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

## *** ***

Our cashequivalents and short-term investments are exposed to financial market risk dueto fluctuation in interest rates, which may affect our interest income and,from time to time, the fair market value of our investments. We manage ourexposure to financial market risk by performing ongoing evaluations of ourinvestment portfolio. We presently invest in money market funds, certificatesof deposit issued by banks, commercial paper, certificates of deposit,high-grade corporate securities and government bonds maturing approximately 18months or less from the date of purchase. In the past, we also invested inauction rate securities which have a final maturity date of up to thirty yearsbut whose interest rate is reset principally up to every 35 days, and invariable rate demand notes, which have a final maturity date of up tothirty-nine years but whose interest rate is reset at varying intervalstypically between seven and 35 days. As of January 31, 2008, we didnot hold any auction rate securities or variable rate demand notes.

 

Due to the shortmaturities of our investments, the carrying value should approximate the fairmarket value. In addition, we do not use our investments for trading or otherspeculative purposes. Due to the short duration of our investment portfolio, wedo not expect that an immediate 10% change in interest rates would have amaterial effect on the fair market value of our portfolio. Therefore, we wouldnot expect our operating results or cash flows to be affected to anysignificant degree by the effect of a sudden change in market interest rates.We do not believe that the recent instability in global financial markets hassignificantly affected the value of our cash and short-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 mortgageloan. We are the fixed rate payer under the swap with a fixed rate of 5.27%.Consequently, although we are required to mark the value of the swap to marketat each balance sheet date and record the associated non-cash cost or 

 

45

----

 

benefit as part of Other income (expense), net, ahypothetical 10% change in LIBOR would not have a material effect on our annualinterest expense.

 

**ITEM 4.   CONTROLS AND PROCEDURES**

 

**(a)  ****Evaluation of Disclosure Controlsand Procedures****.**

 

Under thesupervision and with the participation of our chief executive officer and ourchief 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.**

 

There have been nochanges in our internal control over financial reporting during the periodcovered by this Quarterly Report on Form 10-Q that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

46

----

**PART II — OTHERINFORMATION**

 

**ITEM 1.   LEGAL PROCEEDINGS**

 

From time to time,we have 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 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 under Section 11of the Securities Act of 1933.

 

In June 2004,the issuer defendants and plaintiffs negotiated a stipulation of settlement forthe claims against the issuer defendants, including us, that was submitted tothe Court for approval. In August 2005, the Court 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. Plaintiffs have also movedfor class certification in the six test cases, which the defendants in thosecases have opposed. It is uncertain whether there will be any revised or futuresettlement. If the litigation proceeds, we believe that we have meritoriousdefenses to plaintiffs’ claims and intend to defend the action vigorously.

 

On October 12,2007, a purported OmniVision shareholder filed a complaint against certain ofour 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 complaint names us as a nominal defendant. No recovery is sought fromus.

 

On June 10,2004, the first of several putative class actions was filed against us andcertain of our present and former directors and officers in federal court inthe Northern District of California on behalf of investors who purchased ourcommon 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 assertedclaims on behalf of purchasers of our common stock between June 11, 2003and June 9, 2004, and sought unspecified damages. The consolidatedcomplaint generally alleged 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 financialrestatement. On July 29, 2005, the Court denied our motion to dismiss thecomplaint. The parties engaged in settlement discussions and in November 2006,the parties reached an agreement in principle to settle the litigation. Thetotal amount of the settlement was approximately $13.8 million, of whichwe agreed to contribute approximately $0.8 million and the remainder wasto be funded by insurance carriers that issued Directors and Officers LiabilityInsurance Policies to us. We accrued $3.3 million during fiscal 2007,as our share of the settlement, including unreimbursed defense costs, net ofthe $13.0 million in recoverable insurance proceeds. The parties executeda Stipulation of Settlement that was filed with the Court on May 15, 2007.On May 25, 2007, the Court issued an Order preliminarily approving thesettlement and at a hearing on September 7, 2007, the Court determinedthat the settlement was fair, reasonable and adequate to the purported class.On December 6, 2007, the Court issued its order granting final approval ofthe settlement and entered the judgment. The settlement and Court Order are nowfinal and the litigation is concluded.

 

47

----

 

On February 21,2008, we filed a lawsuit against Qualcomm Incorporated in the United StatesDistrict Court for the Northern District of California alleging claims oftrademark infringement arising from Qualcomm’s use of, and attempt to register,the mark OMNIVISION for a computer hardware system and related services. Weseek an injunction and unspecified damages. We had previously filed oppositionproceedings before the Trademark Trial and Appeal Board of the United StatesPatent and Trademark office against Qualcomm’s applications to register theOMNIVISION mark, and we have now moved to suspend those proceedings based uponthe new parallel federal litigation. We have not yet served Qualcomm and we donot yet know how Qualcomm will respond to the litigation.

 

 

48

----

 

**ITEM 1A.  RISK FACTORS**

 

*ThisQuarterly Report on Form 10-Q, including Management’s Discussion andAnalysis of Financial Condition and Results of Operations, containsforward-looking statements. These forward-looking statements are subject tosubstantial risks and uncertainties that could cause our future business,financial condition or results of operations to differ materially from ourhistorical results or currently anticipated results, including those set forthbelow.*

 

*Thefollowing description of these risk factors includes any material changes toand supersedes the description of the risk factors associated with our businesspreviously disclosed in Item 1A of our 2007 Annual Report on Form 10-Kfiled with the SEC on June 29, 2007. As a result of the following riskfactors, as well as of other variables affecting our operating results, pastfinancial performance may not be a reliable indicator of future performance,and historical trends should not be used to anticipate results or trends infuture 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.***

## *** ***

The image sensormarket is intensely competitive, and we expect competition in this industry tocontinue to increase. This competition has resulted in rapid technologicalchange, evolving standards, reductions in product selling prices and rapidproduct obsolescence. If we are unable to successfully meet these competitivechallenges, we may be unable to maintain and grow our business. Any inabilityon our part to compete successfully would also adversely affect our results ofoperations and impair our financial condition.

 

Our image-sensor products face competition from other companies that sellCMOS image sensors and from companies that sell CCD image sensors. Many of ourcompetitors have longer operating histories, greater presence in key markets,greater name recognition, larger customer bases, more established strategic andfinancial relationships and significantly greater financial, sales andmarketing, distribution, technical and other resources than we do. Many of themalso have their own manufacturing facilities which may give them a competitiveadvantage. As a result, they may be able to adapt more quickly to new oremerging technologies and customer requirements or devote greater resources tothe promotion and sale of their products. Our competitors include establishedCMOS image sensor manufacturers such as Kodak, MagnaChip, Micron, Matsushita, Samsung, Sony,STMicroelectronics and Toshiba as wellas CCD image sensor manufacturers such as Fuji, Kodak, Matsushita, NEC, Sanyo, Sharp, Sony, TexasInstruments and Toshiba. 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. In addition, we compete with a large numberof smaller CMOS manufacturers including Foveon, PixArt, Pixelplus, Pixim, SET and Silicon File. Competition with these and other companieshas required, and in the future may require, us to reduce our prices. Forinstance, we have seen increased competition in the markets for VGA imagesensor products with resulting pressures on product pricing. Downward pressureon pricing could result both in decreased revenues and lower gross margins,which would adversely affect our profitability.

 

Our competitorsmay acquire or enter into strategic or commercial agreements or arrangementswith foundries or providers of color filter processing, assembly or packagingservices. These strategic arrangements between our competitors and third partyservice providers could involve preferential or exclusive arrangements for ourcompetitors. Such strategic alliances could impair our ability to securesufficient capacity from foundries and service providers to meet our demand forwafer manufacturing, color filter processing, assembly or packaging services,adversely affecting our ability to meet customer demand for our products. Inaddition, competitors may enter into exclusive relationships with distributors,which could reduce available distribution channels for our products and impairour ability to sell our products and grow our business. Further, some of ourcustomers could also become developers of image sensors, and this couldpotentially adversely affect our results of operations, business and prospects.

 

## ***Reductions in our average selling prices may lower ourrevenues and, as a result, may reduce our gross margins.***

## *** ***

We have experienced and expect to continue to experience pressure toreduce the selling prices of our products, and our average selling prices havedeclined as a result. Competition in our product markets is intense and as thiscompetition continues to intensify, we anticipate that these pricing pressureswill increase. We expect that the average selling prices for many of ourproducts will continue to decline over time. Unless we can increase unit salessufficiently 

 

49

----

 

to offset these declines in our average sellingprices, our revenues will decline. Reductions in our average selling priceshave adversely affected our gross margins, and unless we can reduce manufacturingcosts to compensate, additional reductions in our average selling prices willcontinue to adversely affect our gross margins and could materially andadversely affect our operating results and impair our financial condition. Wehave increased and intend to continue to increase our research, development andrelated expenses to continue the development of new image sensor products infiscal years 2008 and 2009 that can be sold at higher selling prices and/ormanufactured at lower cost. However, if we are unable to timely introduce newproducts that incorporate more advanced technology and include more advancedfeatures that can be sold at higher average selling prices, or if we are unableto successfully develop more cost-effective technologies, our financial resultscould 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.***

## *** ***

Sales to thecamera cell phone market account for a large portion of our revenues. Althoughwe can only estimate the percentages of our products that are used in thecamera 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 approximately 70% in the nine months endedJanuary 31, 2008. 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.***

## *** ***

Our failure tosuccessfully develop new products that achieve market acceptance in a timelyfashion would adversely affect our ability to grow our business and ouroperating results. The development, introduction and market acceptance of newproducts 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:

 

·                  accurate prediction of marketrequirements and evolving standards, including pixel resolution, outputinterface standards, power requirements, optical lens size, input standards andoperating systems for personal computers and other platforms;

 

·                  development of advanced technologies andcapabilities;

 

·                  definition, timely completion andintroduction of new CMOS image sensors that satisfy customer requirements;

 

50

----

 

·                  development of products that maintain a technologicaladvantage over the products of our competitors, including our advantages withrespect to the functionality and pixel capability of our image-sensor productsand our proprietary testing processes; and

 

·                  market acceptance of the new products.

 

Accomplishing all of these steps is difficult, time consuming andexpensive. We may be unable to develop new products or product enhancements intime to capture market opportunities or achieve significant or sustainableacceptance in new and existing markets. In addition, our products could becomeobsolete sooner than anticipated because of a rapid change in one or more ofthe technologies related to our products or the reduced life cycles of consumerproducts.

 

## ***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 success is, dependent uponmanufacturers designing our image-sensor products into their products. Toachieve design wins, which are decisions by manufacturers to design ourproducts into their systems, we must define and deliver cost effective andinnovative image-sensor solutions on a timely basis that satisfy themanufacturers’ requirements. Our ability to achieve design wins is subject tonumerous risks including competitive pressures as well as technological risks.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 and modifying its design platforms. Accordingly, if we fail toachieve design wins with key device manufacturers that embed image sensors intheir products, our market share or revenues could decrease. Furthermore, tothe extent that our competitors secure design wins, our ability to expand ourbusiness 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 own or operate asemiconductor fabrication facility. Instead, we rely on TSMC, PSC and othersubcontract foundries to produce all of our wafers. Historically, we haverelied on TSMC to provide us with a substantial majority of our wafers. As apart 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 foundry manufacturing agreement withPSC pursuant to which we and PSC have agreed to jointly develop certainpixel-related process technology and for PSC to process certain of our CMOSimage sensors at PSC’s facilities in accordance with the scheduled developmentapproved by both parties.

 

Under the terms of these supply agreements, we secure manufacturingcapacity in any particular period on a purchase order basis. The foundries haveno obligation to supply products to us for any specific period, in any specificquantity or at any specific price, except as set forth in a particular purchaseorder. In general, our reliance on third party foundries involves a number ofsignificant risks, including:

 

·                  reduced control over delivery schedules,quality assurance, manufacturing yields and production costs;

 

·                  lack of guaranteed production capacity orproduct supply;

 

·                  unavailability of, or delayed access to,next generation or key process technologies; and

 

·                  financial difficulties or disruptions inthe operations of third party foundries due to causes beyond our control.

 

If TSMC, PSC, or any of our other foundries were unable to continuemanufacturing our wafers in the required quantities, at acceptable quality,yields and costs, or in a timely manner, we would have to identify and qualifysubstitute foundries, which would be time consuming and difficult, and couldincrease our costs or result in unforeseen manufacturing problems. In addition,if competition for foundry capacity increases we may be required to payincreased amounts for manufacturing services. We are also exposed to additionalrisks if we transfer our production of semiconductors from one foundry toanother, as such transfer could interrupt our manufacturing process. Further,some 

 

51

----

 

of our foundries may also be developers of imagesensor products and if one or more of our other foundries were to decide not tofabricate our companion DSP chips for competitive or other reasons, we wouldhave to identify and qualify other sources for these products.

 

## ***We rely on a joint venture company for color filterapplication and on third party service providers for packaging and otherback-end services, which reduces our control over delivery schedules, productquality and cost, and could adversely affect our ability to deliver products tocustomers.***

## *** ***

We rely on VisEra, our joint venture with TSMC, for the color filterprocessing of our completed wafers. In addition, we rely on AdvancedSemiconductor 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 rely on several specialized serviceproviders, one of which is ImPac, to perform the necessary wafer probe testsand prepare good die for use in a form called chip-on-board, a process calledreconstructing wafers. If for any reason one or more of these service providersbecomes unable or unwilling to continue to provide color filter processing orpackaging services of acceptable quality, at acceptable costs and in a timelymanner, our ability to deliver our products to our customers could be severelyimpaired. We would have to identify and qualify substitute service providers,which could be time consuming and difficult and could result in unforeseenoperational problems. Substitute service providers might not be available or,if available, might be unwilling or unable to offer services on acceptableterms.

 

In addition, if competition for color filter processing, packaging,capacity or other back end services increases, we may be required to pay orinvest significant amounts to secure access to these services, which couldadversely impact our operating results. The number of companies that providethese services is limited and some of them have limited operating histories andfinancial resources. In the event our current providers refuse or are unable tocontinue to provide these services to us, we may be unable to procure servicesfrom alternate service providers. Furthermore, if customer demand for ourproducts increases, we may be unable to secure sufficient additional capacityfrom our current 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,assembling or testing of our products, which would adversely affect ouroperating 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 varied significantly from quarter toquarter in the past and are likely to vary significantly in the future based ona number of factors, many of which are beyond our control. These factors andother industry risks, many of which are more fully discussed in our other riskfactors, include, but are not limited to:

 

·                  the volume and mix of our product sales;

 

·                  competitive pricing pressures;

 

·                  our ability to accurately forecast demandfor our products;

 

·                  our ability to achieve acceptable wafermanufacturing or back-end processing yields;

 

·                  our gain or loss of a large customer;

 

·                  our ability to manage our producttransitions;

 

·                  the availability of production capacityat the suppliers that manufacture our products or process our products;

 

·                  the growth of the market for products andapplications using CMOS image sensors;

 

·                  the timing and size of orders from ourcustomers;

 

·                  the volume of our product returns;

 

·                  the seasonal nature of customer demandfor our products;

 

·                  the deferral of customer orders inanticipation of new products, product designs or enhancements;

 

52

----

 

·                  the announcement and introduction ofproducts and technologies by our competitors;

 

·                  adverse changes in global economic conditions;

 

·                  the level of our operating expenses; and

 

·                  the increased volatility of our effectivetax rate as a consequence of our adoption of FASB Interpretation No. 48,or FIN 48, *“Accounting for Uncertaintyin Income Taxes—an Interpretation of FASB Statement No. 109.”*

 

Our introduction of new products and our product mix have affected andmay continue to affect our quarterly operating results. Changes in our productmix could adversely affect our operating results, because some products providehigher margins than others. We typically experience lower yields whenmanufacturing new products through the initial production phase, andconsequently our gross margins on new products have historically been lowerthan our gross margins on our more established products. We also anticipatethat the rate of orders from our customers may vary significantly from quarterto quarter. Our operating expenses are relatively fixed, and our inventorylevels are based on our expectations of future revenues. Consequently, if we donot achieve the revenues we expect in any quarter, expenses and inventorylevels could be disproportionately high, adversely impacting our operatingresults for that quarter, and potentially in future quarters.

 

All of these factors are difficult to forecast and could result influctuations in our quarterly operating results. Our operating results in agiven quarter could be substantially less than anticipated, and, if we fail tomeet market analysts’ expectations, a substantial decline in our stock pricecould result. Fluctuations in our quarterly operating results could adverselyaffect the price of our common stock in a manner unrelated to our long-termoperating 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, such as camera cell phones,notebooks andpersonal computers, digital stillcameras and cameras for toys and games, are consumer electronics goods. Thesemass-market camera devices generally have seasonal cycles which historicallyhave caused the sales of our customers to fluctuate quarter-to-quarter.Historically, demand from OEMs and distributors that serve such consumerproduct markets has been stronger in the second and third quarters of ourfiscal year and weaker in the first and fourth quarters of our fiscal year.

 

In addition, since a very large number of the manufacturers who use ourproducts are located in China and Taiwan, the pattern of demand for our imagesensors has been increasingly influenced by the timing of the extended lunar orChinese New Year holiday, a period in which the factories which use our imagesensors generally close. For example, we believe that the decline in revenues thatwe experienced in the fourth quarter of fiscal 2007 is partly attributable tothe fact that in 2007 Chinese New Year occurred in mid-February, andmanufacturing did not resume in full until sometime 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 in our products cannotachieve the yields we expect, we will incur higher per unit costs and reducedproduct availability. Foundries that supply our wafers have experiencedproblems in the past achieving acceptable wafer manufacturing yields. Waferyields are a function both of our design technology and the particular foundry’smanufacturing process technology. Certain risks are inherent in theintroduction of such new products and technology. Low yields may result fromdesign errors or manufacturing failures in new or existing products. During theearly stages of production, production yields for new products are typicallylower than those of established products. Unlike many other semiconductorproducts, optical products can be effectively tested only when they arecomplete. Accordingly, we perform final testing of our products only after theyare assembled. As a result, yield problems may not be identified until ourproducts are well into the production process. The risks associated with lowyields could be increased because we rely on third party offshore foundries forour wafers, which can increase the effort and time required to identify,communicate and resolve manufacturing yield problems. In addition to wafermanufacturing yields, our products are subject to yield loss in subsequentmanufacturing steps, often referred to as back-end processing, such as theapplication of color filters and micro-lenses, dicing (cutting the wafer intoindividual devices, or die) and packaging. Any of these potential problems withwafer manufacturing and/or back-end processing yields could result in areduction in our gross margins and/or our ability to timely deliver products tocustomers, which 

 

53

----

 

could adversely affect our customer relations andmake it more difficult to sustain and grow our business. For example, lowback-end yields on two of our products adversely impacted our gross margins forthe fiscal quarters ended 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.***

## *** ***

Our sales aregenerally made on the basis of purchase orders rather than long-term purchasecommitments; however, we manufacture products and build inventory based on ourestimates of customer demand. Accordingly, we must rely on multiple assumptionsto forecast customer demand. We are continually working to improve our salesforecasting procedures. If we overestimate customer demand, we may manufactureproducts that we may be unable to sell, or we may have to sell at lower prices.This could materially and adversely affect our results of operations andfinancial condition. In addition, our customers may cancel or defer orders atany time by mutual written consent. We have experienced problems withaccurately forecasting customer demand in the past. For example, there was ashift in the mix of product demand, in particular a shift in demand towardsVGA products late inthe second quarter of fiscal 2007, and as a result our inventories at theend of the second and third quarters of fiscal 2007 were higher than weintended them to be. We need to accurately predict customer demand because wemust often make commitments to have products manufactured before we receivefirm purchase orders from our customers. Conversely, if we underestimatecustomer demand, we may be unable to manufacture sufficient products quicklyenough to meet actual demand, causing us to lose customers and impairing ourability to grow our business. In preparation for new product introductions, wegradually ramp down production of established products. With our 12-14 weekproduction cycle, it is extremely difficult to predict precisely how many unitsof established products we will need. It is also difficult to accuratelypredict the speed of the ramp of our new products and the impact on inventorylevels presented by the shorter life cycles of end-user products. The shorterproduct life cycle is a result of an increase in competition and the growth ofvarious consumer-product applications for image sensors. For example, althoughin the security and surveillance market we continue to sell image-sensorproducts introduced more than four years ago, in the camera cell phone market,the product life cycle of image sensors can be as little as six months. Underthese circumstances, it is possible that we could suffer from shortages forcertain products and, if we underestimate market demand, we face the risk ofbeing unable to fulfill customer orders. We also face the risk of excessinventory and product obsolescence if we overestimate market demand for ourproducts and build inventories in excess of demand. Our ability to accuratelyforecast sales is also a critical factor in our ability to meet analystexpectations for our quarterly and annual operating results. Any failure tomeet these expectations would likely lead to a substantial decline in our stockprice.

 

## ***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 the continued growth ofvarious markets into which we sell our image-sensor products, including themarkets for camera cell phones, notebook and personal computers, digital still and video cameras, commercialand security and surveillance applications, toys and games, includinginteractive video games, automotive and medical applications. If these marketsdo not grow and develop as we anticipate, we may be unable to sustain or growthe sales of our products.

 

In addition, the market price of our common stock may be adverselyaffected if certain of these new markets do not emerge or develop as expected.Securities analysts may already factor revenue from such new markets into theirfuture estimates of our financial performance and should such markets notdevelop as expected by such securities analysts the trading price of our commonstock 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 a lengthy manufacturing,packaging and assembly process, typically lasting approximately 12-14 weeks.Additional time may pass before a customer commences volume shipments ofproducts that incorporate our image sensors. Even when a manufacturer decidesto design our image sensors into its products, the manufacturer may never shipfinal products incorporating our image sensors. Given this lengthy cycle, weexperience a delay between the time we incur expenditures for research anddevelopment and sales and marketing efforts and the time we generate revenue,if any, from these expenditures. This delay makes it more difficult to forecastcustomer demand, which adds uncertainty to the manufacturing planning processand could adversely affect our operating results. In addition, the product lifecycle for certain of our image-sensor products designed for use in certain 

 

54

----

 

applications can be relatively short. If we fail toappropriately manage the manufacturing, packaging and assembly process, ourproducts may become obsolete before they can be incorporated into our customers’products and we may never realize a return on investment for the expenditureswe incur in developing and producing these 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 meet technological advancesand new and changing industry and customer demands, our color filterapplication and ceramic, plastic and chip-scale packaging requirements willalso evolve. Our ability to continue to profitably deliver products that meetcustomer demand is dependent upon our ability to obtain third party servicesthat meet these new requirements on a cost-effective basis. We havehistorically relied exclusively on third parties, and more recently, on one ofour joint ventures, to provide these services. There can be no assurances thatany of these parties will be able to develop enhancements to the services theyprovide to us to meet these new and changing industry and customerrequirements. Furthermore, even if these service providers are able to developtheir services to meet new and evolving requirements, these services may not beavailable at a cost that enables us to sustain our profitability.

 

## ***The high level of complexity and integration of our productsincreases the risk of latent defects, which could damage customer relationshipsand increase our costs.***

## *** ***

Our products are based upon evolving technology, and because we integratemany functions on a single chip, are complex. The integration of additionalfunctions into already complex products could result in a greater risk thatcustomers or end users could discover latent defects or subtle faults after wehave already shipped significant quantities of a product. Although we test ourproducts, we have in the past and may in the future encounter defects orerrors. For example, in the third quarter of fiscal 2005, we made a provisionof $2.7 million related to the possible replacement of products that didnot meet a particular customer’s standards. Delivery of products with defectsor reliability, quality or compatibility problems may damage our reputation andability to retain existing customers and attract new customers. In addition,product defects and errors could result in additional development costs,diversion of technical resources, delayed product shipments, increased productreturns, product warranty costs for recall and replacement and productliability claims against us which may not be fully covered 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, arelatively 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 nine months ended January 31,2008, one OEM customer accounted for approximately 15.5% of our revenues, andone distributor customer accounted for approximately 20.5% of our revenues. Inthe nine months ended January 31, 2007, one OEM customer accounted forapproximately 13.6% of our revenues, and two distributor customers accountedfor approximately 14.6% and 12.4%, respectively, of our revenues. In addition,approximately 55% of our revenues have historically come from our top fivecustomers. Our business, financial condition, results of operations and cashflows will continue to depend significantly on our ability to retain ourcurrent key customers and attract new customers, as well as on the financialcondition and success of our OEMs, VARs and distributors.

 

## ***Changes in accounting rules for stock-basedcompensation have adversely affected our reported operating results, and mayadversely affect our stock price and our competitiveness in the employeemarketplace.***

## *** ***

Since our founding,we have used employee stock options and other stock-based compensation toattract, motivate and retain our employees. In December 2004, the FASBissued Statement of Financial Accounting Standards  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 theseexpenses, 

 

55

----

 

mayadversely impact our ability to attract, motivate and retain qualifiedemployees, which could put us at a competitive disadvantage in the employeemarketplace.

 

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

## *** ***

Under generallyaccepted accounting principles, we are required to review our amortizableintangible assets for impairment when events or changes in circumstancesindicate the carrying value may not be recoverable. We are required to testgoodwill for impairment at least annually. Factors that may be considered achange in circumstances indicating that the carrying value of our amortizableintangible assets may not be recoverable include a decline in stock price andmarket capitalization, and slower growth rates in our industry. We may berequired to record a significant charge to earnings in our financial statementsduring the period in which we determine that our goodwill, amortizableintangible assets or long-term investments have been impaired. Any such chargewould adversely impact our results of operations. As of January 31, 2008,our net goodwill and amortizable intangible assets totaled approximately$23.1 million and our long term investments totaled approximately$83.6 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.***

## *** ***

Our sales aregenerally made pursuant to standard purchase orders. We include in our backlogonly those customer orders for which we have accepted purchase orders andassigned shipment dates within the upcoming 12 months. Orders constitutingour current backlog are subject to cancellation or changes in deliveryschedules, and backlog may not necessarily be an indication of future revenue.Any cancellation or delay in orders which constitute our current or futurebacklog 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 are required tocomply 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.

 

We have in thepast discovered, and may in the future discover, areas of our internal controlthat need improvement. For example, we restated our financial statements forthe first, second and third quarters of fiscal 2004. If these or similar typesof issues were to arise with respect to our internal controls in futureperiods, they could impair our ability to produce accurate and timely financialreports.

 

As our businessexpands, ongoing compliance with the provisions of Section 404 of theSarbanes-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.***

## *** ***

Changes in lawsand regulations affecting public companies, including the provisions of theSarbanes-Oxley Act, have imposed new requirements on us and on our officers,directors, attorneys and independent registered public accounting firm. Inorder to comply with these new rules, we added internal resources and haveutilized 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.

 

56

----

 

## *** ***

## ***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 January 31,2008, we held cash and cash equivalents totaling $275.5 million, andshort-term investments totaling $87.8 million. These assets are managed onour behalf by unrelated third parties in accordance with a cash managementpolicy that has been approved by our board of directors and restricts ourinvestments to a maximum maturity of 18 months and to investment-gradeinstruments. Recent uncertainties in global capital markets associated with arepricing of risk have caused disruptions in the orderly function of marketswhere ordinarily there is virtually unlimited liquidity. To date, we have notrealized any losses as a result of these disruptions, but a future requirementto liquidate a portion of our portfolio at short notice could result in lossesof principal.

 

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

## *** ***

In December 2000,we established Hua Wei Semiconductor (Shanghai) Co. Ltd., or HWSC, as part ofour efforts to streamline our manufacturing process and reduce the costs andworking capital associated with the testing of our image-sensor products, andrelocated our automated image testing equipment from the United States toChina. We are currently expanding our testing capabilities with additionalautomated testing equipment, which will also be located in China. However,there are significant administrative, legal and governmental risks to operatingin China that could result in increased operating expenses or that couldprevent us from achieving our objectives in operations. The risks fromoperating in China that could increase our operating expenses and adverselyaffect our operating results, financial condition and ability to deliver ourproducts and grow our business include, without limitation:

 

·                  difficulties in staffing and managingforeign operations, particularly in attracting and retaining personnelqualified to design, sell and support CMOS image sensors;

 

·                  difficulties in coordinating ouroperations in China with those in California;

 

·                  diversion of management attention;

 

·                  difficulties in maintaining uniformstandards, controls, procedures and policies across our global operations,including inventory management and financial consolidation;

 

·                  political and economic instability, whichcould have an adverse impact on foreign exchange rates in Asia and could impairour ability to conduct our business in China; and

 

·                  inadequacy of the local infrastructure tosupport our needs.

 

## ***We may experience integration or other problems withpotential future acquisitions, which could have an adverse effect on ourbusiness or results of operations. New acquisitions could dilute the interestsof existing stockholders, and the announcement of new acquisitions could resultin a decline in the price of our common stock.***

## *** ***

We may in thefuture make acquisitions of, or investments in, businesses that offer products,services and technologies that we believe would complement our products,including CMOS image sensor manufacturers. We may also make acquisitions of, orinvestments in, businesses that we believe could expand our distributionchannels. Even if we were to announce an acquisition, we may not be able tocomplete it. In addition, any future acquisition or substantial investmentcould present numerous risks, including:

 

·                  difficulty in realizing the potentialtechnological benefits of the transaction;

 

·                  difficulty in integrating the technology,operations or work force of the acquired business with our existing business;

 

·                  unanticipated expenses related totechnology integration;

 

·                  disruption of our ongoing business;

 

·                  difficulty in realizing the potentialfinancial or strategic benefits of the transaction;

 

·                  difficulty in maintaining uniformstandards, controls, procedures and policies;

 

·                  possible impairment of relationships withemployees, customers, suppliers and strategic partners as a result ofintegration of new businesses and management personnel;

 

·                  reductions in our future operatingresults from amortization of intangible assets;

 

57

----

 

·                  impairment of resulting goodwill; and

 

·                  potential unknown or unexpectedliabilities associated with acquired businesses.

 

We expect that anyfuture acquisitions could include consideration to be paid in cash, shares ofour common stock or a combination of cash and our common stock. If and whenconsideration for a transaction is paid in common stock, it will result indilution to our existing stockholders.

 

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

## *** ***

In October 2003,we entered into an agreement with TSMC to form VisEra, a joint venture inTaiwan, for the purposes of providing manufacturing services. In August 2005,we amended and restated our agreement with TSMC in part to enable VisEra toacquire 29.6% of XinTec, a supplier of chip-scale packaging services in whichwe originally invested in April 2003 and in which we directly hold anapproximate 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.

 

In January 2006,VisEra acquired certain color filter processing equipment from TSMC and assumeddirect responsibility for providing the color filter processing services thathad previously been provided by TSMC. We expect that VisEra will be able toprovide us with a committed supply of high quality manufacturing services atcompetitive prices. However, there are significant legal, governmental andrelationship risks to developing VisEra, and we cannot ensure that we willreceive the expected benefits from the joint venture. For example, VisEra maynot be able to provide manufacturing services that have competitive technologyor prices, which could adversely affect our product offerings and our abilityto meet customer requirements for our products. In addition, the existence ofVisEra may also make it more difficult for us to secure dependable servicesfrom competing merchant vendors who provide similar manufacturing services.

 

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

## *** ***

We expect todevelop our business partly through forming alliances or joint ventures withand making strategic investments in other companies, some of which may becompanies at a relatively early stage of development. For example, in April 2003,we made an investment in XinTec, a company that provides chip scale packagingservices, and in June 2003 we made an investment in ImPac, a plasticpackaging service company. In December 2005, VisEra, our joint venturewith TSMC, completed the acquisition of a further 29.6% of the issued andoutstanding shares of XinTec. In January 2007, TSMC acquired directly a 43.0%interest in XinTec, thus reducing our beneficial ownership in XinTec to 12.4%.In May 2007, we acquired approximately 20% of the registered capital ofWLCSP, a company that also provides chip scale packaging services.

 

In May 2004,we entered into an agreement with PSC under which we established SOI, a jointventure as a company incorporated under the laws of Taiwan. The purpose of thejoint 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 since April 30,2005.

 

Our investments inthese and other companies may negatively impact our operating results, because,under certain circumstances, we are required to recognize our portion of anyloss 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 higheroperating costs and could impair our ability to meet customer demand for ourproducts. In addition, certain of these investments or partnering relationshipsmay place restrictions on the scope of our business, the geographic areas inwhich we can sell our products and the types of products that we canmanufacture and sell. For example, our agreement with TSMC provides that we maynot engage in business that will directly compete with the business of VisEra.This type of non-competition provision may impact our ability to grow ourbusiness and to meet the demands of our customers.

 

58

----

 

## ***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.***

## *** ***

As part of ourstrategy, we have formed joint ventures with two of our foundry partners, andwe hold a minority interest in three companies from which we purchase certainmanufacturing services. Under the applicable provisions of generally acceptedaccounting principles in the United States of America, we currently consolidateone of these joint ventures into our consolidated financial statements andresults of operations, and record the equity interests that we do not own asminority interests. For the investments that we account for under the equitymethod, we record as part of other income or expense our share of the increaseor decrease in the equity of the companies in which we have invested. It ispossible that, in the future, our relationships and/or our interests in or withthese joint ventures or other investees could change. Such changes have in thepast, and could in the future result in deconsolidation or consolidation ofsuch entities, as the case may be, which could result in changes in ourreported results.

 

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

## *** ***

We rely on acombination of patent, copyright, trademark and trade secret laws as well asnondisclosure 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 patentinfringement action in Taiwan, Republic of China against IC Media Corporationof San Jose, California for infringement of a Taiwanese patent that had beenissued 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 dispute describedabove has had a material adverse effect on our business or prospects, there maybe other situations where our inability to adequately protect our intellectualproperty rights could materially and adversely affect our competitive positionand operating results. If a third party can copy or otherwise obtain and useour 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.***

## *** ***

In recent years,there has been significant litigation in the United States involvingintellectual property rights, including in the semiconductor industry. We havein the past been, and may in the future be, subject to legal proceedings andclaims with respect to our intellectual property, including such matters astrade secrets, patents, product liabilities and other actions arising out ofthe normal course of business. These claims may increase as our intellectualproperty portfolio becomes larger or more valuable. Intellectual propertyclaims against us, and any resulting lawsuit, may cause us to incur significantexpenses, subject us to liability for damages and invalidate our proprietaryrights. 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 sale or use of products orservices that incorporate the infringed intellectual property;

 

·                  obtaining from the holder of theinfringed intellectual property a license to sell or use the relevanttechnology, which license may not be available on acceptable terms, if at all;or

 

·                  redesigning those products or servicesthat incorporate the disputed intellectual property, which could result insubstantial unanticipated development expenses and delay and prevent us fromselling the products until the redesign is completed, if at all.

 

59

----

 

If we are subjectto a successful claim of infringement and we fail to develop non-infringingintellectual property or license the infringed intellectual property onacceptable terms and on a timely basis, we may be unable to sell some or all ofour products, and our operating results could be adversely affected. We may inthe future initiate claims or litigation against third parties for infringementof our intellectual property rights or to determine the scope and validity ofour proprietary rights or the proprietary rights of competitors. These claimscould also result in significant expense and the diversion of technical andmanagement attention.

 

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

## *** ***

We are currently adefendant in certain of the ongoing litigation matters as described in Part II,Item 1 — *“Legal Proceedings”* of this QuarterlyReport. The results of litigation are uncertain, and the litigation process mayutilize a portion of our cash resources and divert management’s attention fromthe day-to-day operations 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.***

## *** ***

Our growth hasplaced, and will continue to place, a significant strain on our management andother resources. To manage our growth effectively, we must, among other things:

 

·                  significantly improve our operational,financial and accounting systems;

 

·                  train and manage our existing employeebase;

 

·                  attract and retain qualified personnelwith relevant experience; and

 

·                  effectively manage accounts receivableand inventory.

 

For example, ourfailure to effectively manage our inventory levels could result either inexcess inventories, which could adversely affect our gross margins andoperating results, or lead to an inability to fill customer orders, which wouldresult in lower sales and could harm our relationships with existing andpotential customers.

 

We must alsomanage multiple relationships with customers, business partners and other thirdparties, such as our foundries and process and assembly vendors. Moreover, ourgrowth may significantly overburden our management and financial systems andother resources. We may not make adequate allowances for the costs and risksassociated with our expansion. In addition, our systems, procedures or controlsmay not be adequate to support ouroperations, and we may not be able to expand quickly enough to capitalize onpotential market opportunities. Our future operating results will alsodepend, in part, on our ability to expand sales and marketing, research anddevelopment, accounting, finance and administrative support.

 

## ***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.***

## *** ***

A number offactors will affect our future tax rate, and certain of these factors couldincrease our effective tax rate in future periods, which could adversely impactour operating results. For example, the complex rules for accounting forthe tax effects of stock-based compensation under SFAS No. 123(R) resultedin an increase in our effective tax rate beginning in the fiscal year ended April 30,2007. Similarly, we anticipate that there will be greater volatility in ourfuture effective tax rates due to the adoption of FIN 48 in the fiscalyear which began on May 1, 2007. In addition, our future effective taxrates could be negatively affected by changes in tax laws or the interpretationof tax laws, by unanticipated decreases in the amount of revenue or earnings incountries with low statutory tax rates, or by changes in the valuation of ourdeferred tax assets and liabilities.

 

In common with allmultinational companies, we are subject to tax in multiple jurisdictions. Thetax authorities in any given jurisdiction may seek to increase the taxes beingcollected by, for example, asserting that the transfer prices we charge betweenrelated entities are either too high or too low depending on which side of thetransaction they are looking at. Although we believe we have providedsufficient taxes for all prior periods, adjustments could be proposed thatwould, in some cases, result in liabilities in excess of such provisions.

 

60

----

 

## ***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 nine months ended January 31, 2008, approximately32.4% of our revenues came from sales through distributors. We expect thatrevenues from sales through distributors will continue to represent asignificant proportion of our total revenues. Selling through distributorsreduces our ability to accurately forecast sales and increases the complexityof our business, requiring us to, among other matters:

 

·                  manage a more complex supply chain;

 

·                  manage the level of inventory at eachdistributor;

 

·                  provide for credits, return rights andprice protection;

 

·                  estimate the impact of credits, returnrights, price protection and unsold inventory at distributors; and

 

·                  monitor the financial condition andcreditworthiness of our distributors.

 

Any failure tomanage these challenges could cause us to inaccurately forecast sales and carryexcess or insufficient inventory, thereby adversely affecting our operatingresults.

 

## ***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.***

## *** ***

We facedifficulties in managing our third party foundries, color filter applicationservice providers, ceramic and plastic packaging and other manufacturingservice providers and our foreign distributors, most of whom are located inAsia. Any political and economic instability in Asia might have an adverseimpact on foreign exchange rates and could cause service disruptions for ourvendors and distributors and adversely affect our customers.

 

Sales outside ofthe United States accounted for substantially all of our revenues forfiscal 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 payment cycles;

 

·                  the adverse effects of tariffs, duties,price controls or other restrictions that impair trade;

 

·                  decreased visibility as to future demand;

 

·                  difficulties in accounts receivablecollections; and

 

·                  burdens of complying with a wide varietyof foreign laws and labor practices.

 

Sales of ourproducts have to date been denominated principally in U.S. dollars. Over thelast several years, the U.S. dollar has weakened against most other currencies.Future increases in the value of the U.S. dollar, if any, would increase theprice of our products in the currency of the countries in which our customersare located. This may result in our customers seeking lower-priced suppliers,which could adversely impact our operating results. If a larger portion of ourinternational revenues were to be denominated in foreign currencies in thefuture, we would be subject to increased risks associated with fluctuations inforeign exchange rates.

 

## ***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.***

## *** ***

The loss of theservices of one or more of our executive officers or key employees, which hasoccurred from time to time, or the decision of one or more of these individualsto join a competitor, could adversely affect our business and harm ouroperating results and financial condition. Our success depends to a significantextent on the continued service of our senior management and certain other keytechnical personnel. None of our senior management is bound by an employment ornon-competition agreement. We do not maintain key man life insurance on any ofour employees.

 

Our success alsodepends on our ability to identify, attract and retain qualified sales,marketing, finance, management and technical personnel, particularly analog ormixed signal design engineers. We have experienced, and may continue toexperience, difficulty in hiring and retaining candidates with appropriatequalifications. If we do not 

 

61

----

 

succeedin hiring and retaining candidates with appropriate qualifications, ourrevenues and product development efforts could be harmed.

 

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

## *** ***

Asour business 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 of disasters,business interruptions or similar events.***

## *** ***

Disasters andbusiness interruptions such as earthquakes, water, fire, electrical failure,accidents and epidemics affecting our operating activities, major facilities,and employees’ and customers’ health could materially and adversely affect ouroperating results and financial condition. In particular, our Asian operationsand most of our third party service providers involved in the manufacturing ofour 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 a disasterrecovery plan.

 

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

## *** ***

Acts of war orterrorist acts, wherever they occur around the world, may cause damage ordisruption to our business, employees, facilities, suppliers, distributors orcustomers, which could significantly impact our revenue, costs, expenses andfinancial condition. In addition, as a company with significant operations andmajor distributors and customers located in Asia, we may be adversely impactedby heightened tensions and acts of war that occur in locations such as theKorean Peninsula, Taiwan and China. The potential for future terrorist attacks,the national and international responses to terrorist attacks or perceivedthreats to national security, and other acts of war or hostility have createdmany economic and political uncertainties that could adversely affect ourbusiness and results of operations in ways that cannot presently be predicted.We are uninsured for losses and interruptions caused by terrorist acts and actsof 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.***

## *** ***

Provisions of ourcertificate of incorporation and bylaws may discourage, delay or prevent amerger or acquisition that a stockholder may consider favorable. Theseprovisions include:

 

·                  adjusting the price, rights, preferences,privileges and restrictions of preferred stock without stockholder approval;

 

·                  providing for a classified board ofdirectors with staggered, three year terms;

 

·                  requiring supermajority voting to amendsome provisions in our certificate of incorporation and bylaws;

 

·                  limiting the persons who may call specialmeetings of stockholders; and

 

·                  prohibiting stockholder actions bywritten consent.

 

Provisions ofDelaware 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 on September 28,2001 to stockholders of record as of the close of business on that date. Eachright entitles the registered holder to 

 

62

----

 

purchasefrom us one one-thousandth of a share of Series A Preferred at an exerciseprice of $176.00, subject to adjustment. The exercise of the rights could havethe effect of delaying, deferring or preventing a change of control of ourcompany, 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.***

## *** ***

The market priceof our common stock has fluctuated substantially, and there can be no assurancethat such volatility will not continue. Since the beginning of fiscal 2002through January 31, 2008, the closing sales price of our common stock hasranged 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 February 29, 2008 was$15.86 per share. The securities markets have experienced significantprice and volume fluctuations in the past, and the market prices of thesecurities 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 anticipated fluctuations in ouroperating results;

 

·                  changes in expectations as to our futurefinancial performance;

 

·                  changes in financial estimates ofsecurities analysts;

 

·                  release of lock-up or other transferrestrictions on our outstanding shares of common stock or sales of additionalshares of common stock;

 

·                  sales or the perception in the market ofpossible sales of shares of our common stock by our directors, officers,employees or principal stockholders;

 

·                  changes in market valuations of othertechnology companies; and

 

·                  announcements by us or our competitors ofsignificant technical innovations, design wins, contracts, standards oracquisitions.

 

Due to thesefactors, the price of our stock may decline and investors may be unable toresell 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**

 

        The following table sets forth, for theperiods indicated, our purchases of our common stock in the third quarter offiscal 2008 (in thousands, except per share data):

 

| **Period**                                         | ** ** | **Total Number of Shares Purchased** | ** ** | **Average Price Paid per Share** | ** ** | **Total Number of Shares Purchased as Part of a Publicly Announced  Plan** | ** ** | **Approximate Dollar Value of Shares that May Yet Be Purchased  Under the Plan(1)** | ** ** |
|----------------------------------------------------|------------|--------------------------------------|------------|----------------------------------|------------|---------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------|------------|
| November 1,  2007—November 30, 2007 |       | —                               |       | —                           |       | —                                                                          |       | $                                                                                        | 90,385     |   |
| December 1,  2007—December 31, 2007 |       | 105                                  |       | $                                | 17.51      |                                                                            | 105        |                                                                                     | $          | 88,543 |   |
| January 1,  2008—January 31, 2008   |       | —                               |       | —                           |       | —                                                                          |       | $                                                                                        | 88,543     |   |
| Total                                              |       | 105                                  |       | $                                | 17.51      |                                                                            | 105        |                                                                                     |       |   |

----

(1)          On February 27, 2007, our board of directorsapproved a stock repurchase program that provides for the repurchase of up to$100 million of our outstanding common stock. Subject to applicablesecurities laws, such repurchases will be at times and in amounts as we deemappropriate, based on factors such as market conditions, legal requirements andother corporate considerations. See the section entitled *“Liquidity and Capital Resources”* inItem 2 of this Quarterly Report on Form 10-Q for further informationon this program.

 

63

----

 

**ITEM 6.   EXHIBITS**

 

| **Exhibit Number** | ** ** | **Description**                                                                                                                                                                         |
|-------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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. |

 

64

----

 

**SIGNATURES**

 

Pursuant to therequirements of the Securities and Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                       | ** ** | **OMNIVISION TECHNOLOGIES, INC**.                 |
|----------------------------|------------|---------------------------------------------------|
|                       | * *   | *(Registrant)*                                    |
|                       |       |                                              |
| Dated: March 10, 2008 |       |                                              |
|                       |       |                                              |
|                       | By:        | **/s/ SHAW HONG**                                 |
|                       |       | **Shaw Hong**                                     |
|                       |       | *Chief Executive Officer, President and Director* |
| ** **                 | ** ** | *(Principal Executive Officer)*                   |
| ** **                 | ** ** | * *                                          |
| Dated: March 10, 2008 |       |                                              |
| ** **                 | ** ** | ** **                                        |
|                       | By:        | **/s/ PETER V. LEIGH**                            |
|                       |       | **Peter V. Leigh**                                |
|                       |       | *Chief Financial Officer*                         |
| ** **                 | ** ** | *(Principal Financial and Accounting Officer)*    |
|                       |       |                                              |

** **

**65**

----

** **

**Exhibit Index**

** **

| **Exhibit Number** | ** ** | **Description**                                                                                                                                                                         |
|-------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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. |

 

----