**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

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

 

**Commission file number: 0-29939**

 

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**OMNIVISION TECHNOLOGIES, INC.**

(Exact name of registrant as specified in its charter)

** **

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

 

**4275 Burton Drive, Santa Clara, California  95054**

(Address of Principal Executive Offices) (Zip Code)

 

Registrant’s telephone number, including area code:**(408)567-3000**

 

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Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities and Exchange Act of1934 during the preceding 12 months (or for shorter period that the registrantwas required to file such reports); and (2) has been subject to suchfiling requirements for the past 90 days. Yes x No o

 

Indicateby check mark whether the registrant is a large accelerated filer, an acceleratedfiler, a non-accelerated filer, or a smaller reporting company. See thedefinitions 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 |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Securities Exchange Act of 1934). Yes oNo x

 

At August 31,2008, 51,278,744 shares of common stock of the registrant wereoutstanding, exclusive of 10,963,500 shares of treasury stock.

 

 

 

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**OMNIVISIONTECHNOLOGIES, INC.**

** **

**INDEX**

 
| ** **         | ** **                                                                                                                      | **Page**   |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **         | ** **                                                                                                                      | ** ** |
| ** **         | **PART I. FINANCIAL INFORMATION**                                                                                          | ** ** |
| ** **         | ** **                                                                                                                      | ** ** |
| **Item 1.**        | Financial Statements:                                                                                                           | 3          |
|               |                                                                                                                            |       |
|               | Condensed  Consolidated Balance Sheets (unaudited) – July 31, 2008 and  April 30, 2008                 | 3          |
|               |                                                                                                                            |       |
|               | Condensed  Consolidated Statements of Income (unaudited) – Three Months Ended  July 31, 2008 and 2007       | 4          |
|               |                                                                                                                            |       |
|               | Condensed  Consolidated Statements of Cash Flows (unaudited) – Three Months  Ended July 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                                     | 25         |
|               |                                                                                                                            |       |
| **Item 3.**        | Quantitative  and Qualitative Disclosures About Market Risk                                                                     | 40         |
|               |                                                                                                                            |       |
| **Item 4.**        | Controls and  Procedures                                                                                                        | 41         |
|               |                                                                                                                            |       |
|               | **PART II. OTHER  INFORMATION**                                                                                            | ** ** |
|               |                                                                                                                            |       |
| **Item 1.**        | Legal Proceedings                                                                                                               | 42         |
|               |                                                                                                                            |       |
| **Item 1A.**       | Risk  Factors                                                                                                                   | 43         |
|               |                                                                                                                            |       |
| **Item 2.**        | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                    | 57         |
|               |                                                                                                                            |       |
| **Item 6.**        | Exhibits                                                                                                                        | 57         |
|               |                                                                                                                            |       |
| Signatures         |                                                                                                                            | 58         |
|               |                                                                                                                            |       |
| Exhibit Index |                                                                                                                            |       |
| Exhibit 31.1       |                                                                                                                            |       |
| Exhibit 31.2       |                                                                                                                            |       |
| Exhibit 32         |                                                                                                                            |       |

 

2

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**PART I— FINANCIAL INFORMATION**

 

**ITEM 1.   FINANCIAL STATEMENTS**

 

**OMNIVISION TECHNOLOGIES, INC.**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(in thousands, except per share amounts)**

**(unaudited)**

 
| ** **                                                                                                                                                                                                                   | ** ** | **July 31,** | ** ** | **April 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                                                                   | ** ** | **2008**          | ** ** | **2008**           | ** ** |
| **ASSETS**                                                                                                                                                                                                                   |       |              |       |               |       |
| Current  assets:                                                                                                                                                                                                             |       |              |       |               |       |
| Cash  and cash equivalents                                                                                                                                                                                                   |       | $                 | 251,021    |               | $          | 217,340 |   |
| Short-term  investments                                                                                                                                                                                                      |       | 28,398            |       | 51,993             |       |
| Accounts  receivable, net of allowances for doubtful accounts and sales returns                                                                                                                                              |       | 121,979           |       | 105,338            |       |
| Inventories                                                                                                                                                                                                                  |       | 110,118           |       | 115,127            |       |
| Deferred  income taxes                                                                                                                                                                                                       |       | 2,737             |       | 2,823              |       |
| Prepaid  expenses and other current assets                                                                                                                                                                                   |       | 6,723             |       | 7,430              |       |
| Total  current assets                                                                                                                                                                                                        |       | 520,976           |       | 500,051            |       |
| Property,  plant and equipment, net                                                                                                                                                                                          |       | 109,034           |       | 92,451             |       |
| Long-term  investments                                                                                                                                                                                                       |       | 87,138            |       | 85,419             |       |
| Goodwill                                                                                                                                                                                                                     |       | 7,541             |       | 7,541              |       |
| Intangibles,  net                                                                                                                                                                                                            |       | 12,287            |       | 13,928             |       |
| Other  long-term assets                                                                                                                                                                                                      |       | 19,696            |       | 18,956             |       |
| Total  assets                                                                                                                                                                                                                |       | $                 | 756,672    |               | $          | 718,346 |   |
|                                                                                                                                                                                                                         |       |              |       |               |       |
| **LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS’  EQUITY**                                                                                                                                                            |       |              |       |               |       |
| Current  liabilities:                                                                                                                                                                                                        |       |              |       |               |       |
| Accounts  payable                                                                                                                                                                                                            |       | $                 | 73,540     |               | $          | 57,760 |   |
| Accrued  expenses and other current liabilities                                                                                                                                                                              |       | 16,072            |       | 17,069             |       |
| Income  taxes payable                                                                                                                                                                                                        |       | 2,290             |       | 2,637              |       |
| Deferred  revenues, less cost of revenues                                                                                                                                                                                    |       | 11,244            |       | 8,238              |       |
| Current  portion of long-term debt                                                                                                                                                                                           |       | 4,135             |       | 651                |       |
| Total  current liabilities                                                                                                                                                                                                   |       | 107,281           |       | 86,355             |       |
| Long-term  liabilities:                                                                                                                                                                                                      |       |              |       |               |       |
| Long-term  income taxes payable                                                                                                                                                                                              |       | 78,744            |       | 78,031             |       |
| Non-current  portion of long-term debt                                                                                                                                                                                       |       | 35,005            |       | 32,830             |       |
| Other  long-term liabilities                                                                                                                                                                                                 |       | 6,038             |       | 6,955              |       |
| Total  long-term liabilities                                                                                                                                                                                                 |       | 119,787           |       | 117,816            |       |
| Total  liabilities                                                                                                                                                                                                           |       | 227,068           |       | 204,171            |       |
|                                                                                                                                                                                                                         |       |              |       |               |       |
| Commitments  and contingencies (Note 16)                                                                                                                                                                                     |       |              |       |               |       |
|                                                                                                                                                                                                                         |       |              |       |               |       |
| Minority  interest                                                                                                                                                                                                           |       | 4,138             |       | 4,444              |       |
|                                                                                                                                                                                                                         |       |              |       |               |       |
| Stockholders’  equity:                                                                                                                                                                                                  |       |              |       |               |       |
| Common  stock, $0.001 par value; 100,000 shares authorized; 62,232 issued and  51,268 outstanding at July 31, 2008 and 62,010 shares issued  and 51,046 outstanding at April 30, 2008, respectively |       | 62                |       | 62                 |       |
| Additional  paid-in capital                                                                                                                                                                                                  |       | 382,648           |       | 373,024            |       |
| Accumulated  other comprehensive income                                                                                                                                                                                      |       | 1,444             |       | 1,561              |       |
| Treasury  stock, 10,964 at July 31, 2008 and April 30, 2008, respectively                                                                                                                                          |       | (165,768          | )          | (165,768           | )          |
| Retained  earnings                                                                                                                                                                                                           |       | 307,080           |       | 300,852            |       |
| Total  stockholders’ equity                                                                                                                                                                                             |       | 525,466           |       | 509,731            |       |
| Total  liabilities, minority interest and stockholders’ equity                                                                                                                                                          |       | $                 | 756,672    |               | $          | 718,346 |   |

 

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

 

3

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**OMNIVISION TECHNOLOGIES, INC.**

 

**CONDENSED CONSOLIDATED STATEMENTS OF INCOME**

**(in thousands, except per share amounts)**

**(unaudited)**

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | **July 31,**                | ** ** |
| ** **                                        | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Revenues                                          |       | $                                | 174,279    |   | $ | 173,134 |   |
| Cost  of revenues                                 |       | 130,386                          |       | 132,526 |   |
| Gross  profit                                     |       | 43,893                           |       | 40,608 |   |
|                                              |       |                             |       |   |   |
| Operating  expenses:                              |       |                             |       |   |   |
| Research,  development and related                |       | 20,300                           |       | 17,426 |   |
| Selling,  general and administrative              |       | 17,382                           |       | 15,165 |   |
| Total  operating expenses                         |       | 37,682                           |       | 32,591 |   |
|                                              |       |                             |       |   |   |
| Income  from operations                           |       | 6,211                            |       | 8,017 |   |
| Interest  income, net                             |       | 1,276                            |       | 3,361 |   |
| Other  income, net                                |       | 49                               |       | 260 |   |
| Income  before income taxes and minority interest |       | 7,536                            |       | 11,638 |   |
|                                              |       |                             |       |   |   |
| Provision  for (benefit from) income taxes        |       | 1,413                            |       | (1,360 | ) |
| Minority  interest                                |       | (105                             | )          | 21 |   |
| Net  income                                       |       | $                                | 6,228      |   | $ | 12,977 |   |
|                                              |       |                             |       |   |   |
| Net  income per share:                            |       |                             |       |   |   |
| Basic                                             |       | $                                | 0.12       |   | $ | 0.24 |   |
| Diluted                                           |       | $                                | 0.12       |   | $ | 0.23 |   |
|                                              |       |                             |       |   |   |
| Shares  used in computing net income per share:   |       |                             |       |   |   |
| Basic                                             |       | 51,257                           |       | 54,751 |   |
| Diluted                                           |       | 51,878                           |       | 55,294 |   |

 

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

 

4

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**OMNIVISIONTECHNOLOGIES, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands, unaudited)**

** **
| ** **                                                                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                         | ** ** | **July 31,**                | ** ** |
| ** **                                                                         | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Cash  flows from operating activities:                                             |       |                             |       |   |   |
| Net  income                                                                        |       | $                                | 6,228      |   | $ | 12,977 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                             |       |   |   |
| Depreciation  and amortization                                                     |       | 4,019                            |       | 2,982 |   |
| Change  in fair value of interest rate swap                                        |       | (433                             | )          | (628 | ) |
| Stock-based  compensation                                                          |       | 6,945                            |       | 6,152 |   |
| Minority  interest in net income (loss) of consolidated affiliates                 |       | (105                             | )          | 21 |   |
| Gain  on equity investments, net                                                   |       | (1,728                           | )          | (1,461 | ) |
| Affiliate  stock grants                                                            |       | —                           |       | 56 |   |
| Write-down  of inventories                                                         |       | 2,478                            |       | 4,690 |   |
| (Gain)  loss on disposal of property, plant and equipment                          |       | 504                              |       | — |   |
| Changes  in assets and liabilities:                                                |       |                             |       |   |   |
| Accounts  receivable, net                                                          |       | (16,643                          | )          | (6,133 | ) |
| Inventories                                                                        |       | 4,010                            |       | (24,631 | ) |
| Deferred  income taxes                                                             |       | (751                             | )          | 582 |   |
| Prepaid  expenses and other current assets                                         |       | 701                              |       | 4,263 |   |
| Accounts  payable                                                                  |       | 6,778                            |       | 25,006 |   |
| Accrued  expenses and other current liabilities                                    |       | (1,177                           | )          | (29 | ) |
| Income  taxes payable                                                              |       | 368                              |       | (1,482 | ) |
| Deferred  revenues, less cost of revenues                                          |       | 3,007                            |       | (1,648 | ) |
| Deferred  tax liabilities                                                          |       | (485                             | )          | (890 | ) |
| Net  cash provided by operating activities                                         |       | 13,716                           |       | 19,827 |   |
| Cash  flows from investing activities:                                             |       |                             |       |   |   |
| Purchases  of short-term investments                                               |       | (10,113                          | )          | (11,310 | ) |
| Proceeds  from sales or maturities of short-term investments                       |       | 33,605                           |       | 7,950 |   |
| Purchases  of property, plant and equipment, net of sales                          |       | (10,495                          | )          | (14,659 | ) |
| Purchases  of long-term investments                                                |       | (1,376                           | )          | (9,000 | ) |
| Net  cash provided by (used in) investing activities                               |       | 11,621                           |       | (27,019 | ) |
| Cash  flows from financing activities:                                             |       |                             |       |   |   |
| Proceeds  from long-term borrowings                                                |       | 6,000                            |       | — |   |
| Repayment  of long-term borrowings                                                 |       | (341                             | )          | (154 | ) |
| Cash  contribution by minority shareholder                                         |       | —                           |       | 49 |   |
| Proceeds  from exercise of stock options and employee stock purchase plan          |       | 2,679                            |       | 2,916 |   |
| Payments  for repurchases of common stock                                          |       | —                           |       | (9,616 | ) |
| Net  cash provided by (used in) financing activities                               |       | 8,338                            |       | (6,805 | ) |
| Effect  of exchange rate changes on cash and cash equivalents                      |       | 6                                |       | 55 |   |
| Net  increase (decrease) in cash and cash equivalents                              |       | 33,681                           |       | (13,942 | ) |
| Cash  and cash equivalents at beginning of period                                  |       | 217,340                          |       | 190,878 |   |
| Cash  and cash equivalents at end of period                                        |       | $                                | 251,021    |   | $ | 176,936 |   |
| Supplemental  cash flow information:                                               |       |                             |       |   |   |
| Taxes  paid, net                                                                   |       | $                                | 2,285      |   | $ | 118 |   |
| Interest  paid                                                                     |       | $                                | 2          |   | $ | 5 |   |
| Supplemental  schedule of non-cash investing and financing activities:             |       |                             |       |   |   |
| Capital  equipment financing obligation                                            |       | $                                | 9,010      |   | $ | 4,687 |   |
| Affiliate  shares issued to affiliate employees                                    |       | $                                | —     |   | $ | 295 |   |
| Affiliate  cash dividend payable to minority shareholder                           |       | $                                | 201        |   | $ | 224 |   |
| Capitalized  interest                                                              |       | $                                | 183        |   | $ | 141 |   |
| 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

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**OMNIVISION TECHNOLOGIES, INC.**

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**For the Three Months Ended July 31, 2008 and2007**

**(unaudited)**

 

**Note 1 — Basisof Presentation**

 

***Overview***

## *** ***

The accompanying interimunaudited condensed consolidated financial statements as of July 31, 2008and April 30, 2008 and for the three months ended July 31, 2008 and2007 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, 2008 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, 2008 (the “Form 10-K”).

 

The results of operationsfor the three months ended July 31, 2008 are not necessarily indicative ofthe results that may be expected for the fiscal year ending April 30, 2009or any other future period.

 

***Useof Estimates***

## *** ***

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America (“GAAP”) requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. The Company bases its estimates and judgments on itshistorical experience, knowledge of current conditions and beliefs of whatcould occur in the future considering available information. Actual resultscould differ from these estimates.

 

**Note 2 — Summaryof Significant Accounting Policies**

 

***Principlesof Consolidation***

 

The 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-InterestBenefit/Impairment***

 

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

 

***ForeignCurrency Translation***

 

The functional currencyof the Company is the U.S. dollar. For subsidiaries or consolidated affiliateswith a functional currency other than the U.S. dollar, the assets andliabilities of the subsidiaries are translated into U.S. dollars at the ratesof exchange prevailing on the balance sheet date. Revenue and expense items aretranslated into U.S. dollars at the average rate of exchange for the period.Unrealized gains and losses from foreign currency translation are included in “Accumulatedother comprehensive income,” a component of stockholders’ equity. Forsubsidiaries with the U.S. dollar as the functional currency, and with assetsor liabilities denominated in currencies other than the U.S. dollar,non-monetary assets are remeasured into U.S. dollars using historical rates ofexchange. Monetary assets are remeasured into U.S. dollars using exchange ratesprevailing on the balance sheet date. Remeasurement gains and losses which areincluded in “Other income (expense), net,” have not been material in any of theperiods presented.

 

6

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**OMNIVISIONTECHNOLOGIES, INC.**

** **

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

**For theThree Months Ended July 31, 2008 and 2007**

**(unaudited)**

 

***Cashand Cash Equivalents***

 

The Company considers allhighly liquid investments purchased with a maturity at the date of purchase ofthree months or less to be cash equivalents. Cash equivalents consistprincipally of commercial paper, government bonds, certificates of deposit and moneymarket funds. (See Note 10.)

 

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

 

The Company places itscash investments in instruments that meet high credit quality standards, asspecified in the Company’s investment policy guidelines and reviews itsinvestments regularly to identify and evaluate investments for risk of possibleimpairment. Factors the Company considers in determining whether a loss istemporary include the length of time and extent to which fair value has beenless than the cost basis, the financial condition and near-term prospects ofthe investee, and the Company’s intent and ability to hold the investment for aperiod of time sufficient to allow for any anticipated recovery in marketvalue.

 

***Inventories***

 

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

 

The Company recordsprovisions to reduce the carrying value of inventories to their net realizablevalue when the Company believes that the net realizable value is less thancost. The Company also records provisions for the cost of inventories when thenumber of units on hand exceeds the number of units that the Company forecastswill be sold over a certain period of time, generally 12 months. Wherenecessary, these provisions take into account the inventories owned and not yetsold by certain of the Company’s distributors. The recording of theseallowances establishes a new and lower cost basis for each specificallyidentified inventory item, and the Company does not restore the cost basis toits original level regardless of any subsequent changes in facts orcircumstances.

 

***ComprehensiveIncome (Loss)***

 

Comprehensive income(loss) is defined as the change in the equity of a company during a period fromtransactions and other events and circumstances excluding transactionsresulting from investments by owners and distributions to owners. Comprehensiveincome for the three months ended July 31, 2008 and 2007 was$6.1 million and $8.8 million, respectively, and included net income,unrealized gains (losses) from available-for-sale securities and translationgains (losses) from foreign subsidiaries.

 

***RevenueRecognition***

 

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 defectiveproduct based on historical experience. For cash consideration given tocustomers for which the Company does not receive a separately identifiablebenefit or cannot reasonably estimate fair value, the Company records theamounts as reductions of revenue.

 

For shipment of productssold to distributors under agreements allowing for returns or credits, title andthe risk of ownership to the products transfer to the distributor uponshipment, and the distributor is obligated to pay for the products whether ornot the distributor has sold them at the time payment is due. Under the termsof the Company’s agreements with such distributors and subject to the Company’sprior approval, distributors are entitled to reclaim from the Company as priceadjustments the difference, if any, between the prices at which the Companysold the product to the distributors and the prices at which the product issubsequently sold by the distributor. In addition, distributors have 

 

7

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**OMNIVISIONTECHNOLOGIES, INC.**

** **

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

**For theThree Months Ended July 31, 2008 and 2007**

**(unaudited)**

 

limited rights to returninventory that they determine is in excess of their requirements, andaccordingly, in determining the appropriate level of allowances for excess andobsolete inventory, the Company takes into account the inventories held by itsdistributors. For these reasons, prices and revenues are not fixed ordeterminable until the distributor resells the products to the Company’send-user customers and the distributor notifies the Company in writing of thedetails of such sales transactions. Accordingly, the Company recognizes revenueusing the “sell-through” method. Under the “sell-through” method, the Companydefers the revenue, adjustments to revenue and the related costs of revenue untilthe final resale of such products to end customers. The amounts billed to thesedistributors and adjustments to revenue and the cost of inventory shipped to,but not yet sold by, the distributors are shown net on the CondensedConsolidated Balance Sheets as “Deferred revenues, less cost of revenues.”

 

In addition, the Companyrecognizes revenue from the performance of services to a limited number ofcustomers by its wholly-owned subsidiary, OmniVision CDM Optics, Inc. (“CDM”),formerly CDM Optics, Inc. The Company recognizes the CDM-associatedrevenue 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 theanticipated final total costs based on current estimates of the costs tocomplete the projects. CDM-associated revenue has not been material in any ofthe periods presented.

 

***RecentAccounting Pronouncements***

 

In September 2006,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 157, *“Fair Value Measurements”*(“SFAS No. 157”) which became effective for the Company in itsfiscal 2009. This Statement defines fair value, establishes a frameworkfor measuring fair value and expands disclosures about fair value measurements;however, it does not require any new fair value measurements. In February 2008,the FASB issued Financial Staff Position (“FSP”) SFAS No. 157-2, *“Effective Date of FASB Statement No. 157”*(“FSP SFAS No. 157-2”).FSP SFAS No. 157-2 delays the effective date of SFAS No. 157 for theCompany from its fiscal 2009 to 2010 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).Effective May 1, 2008, the Company adopted SFAS No. 157, as itapplies to the Company’s financial assets and liabilities. The adoption of theprovision of SFAS No. 157 did not have any material effect on the Company’sfinancial condition, results of operations or cash flows. (See Note 10.)

 

In February 2007,FASB issued SFAS No. 159, “*The Fair Value Option forFinancial Assets and Financial Liabilities*” (“SFAS No. 159”).Under SFAS No. 159, a company may elect to measure at fair value variouseligible items that are not currently required to be so measured. Eligibleitems include, but are not limited to, accounts receivable, available-for-salesecurities, equity method investments, accounts payable and firm commitments.SFAS No. 159 is effective in fiscal years beginning after November 15,2007 and is required to be adopted by the Company in the first quarter of itsfiscal 2009. Currently, the Company has not elected to adopt the fairvalue option, under SFAS No. 159, for any of its eligible items.

 

In May 2008,the FASB issued SFAS No. 162, “*TheHierarchy of Generally Accepted Accounting Principles*,” (“SFAS No. 162”).This standard reorganizes the GAAP hierarchy in order to improve financialreporting by providing a consistent framework for determining what accountingprinciples should be used when preparing U.S. GAAP financial statements. SFAS162 will be effective 60 days after the SEC’s approval of the Public CompanyAccounting Oversight Board’s amendments to Interim Auditing Standard, AU Section 411,“*The Meaning of Present Fairly in Conformitywith Generally Accepted Accounting Principles*.” The Company iscurrently evaluating the impact SFAS No. 162 will have on its consolidatedfinancial statements.

 

8

----

 

**OMNIVISIONTECHNOLOGIES, INC.**

** **

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

**For theThree Months Ended July 31, 2008 and 2007**

**(unaudited)**

 

**Note 3 — Short-TermInvestments**

 

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

 
| ** **                                                          | ** ** | **As of July 31, 2008** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                          | ** ** | **Amortized**                               | ** ** | **Gross  Unrealized** | ** ** | **Gross  Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                                          | ** ** | **Cost**                                    | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Certificates  of deposit                                            |       | $                                           | 5,424      |   | $ | — |   | $ | — |   | $ | 5,424 |   |
| U.S.  government debt securities with maturities less than one year |       | 15,907                                      |       | 5 |   | — |   | 15,912 |   |
| U.S.  government debt securities with maturities over one year      |       | 5,069                                       |       | — |   | (2 | ) | 5,067 |   |
| Commercial  paper and bond funds                                    |       | 1,992                                       |       | 3 |   | — |   | 1,995 |   |
|                                                                |       | $                                           | 28,392     |   | $ | 8 |   | $ | (2 | ) | $ | 28,398 |   |
|                                                                |       |                                        |       |   |   |   |   |   |   |
| Contractual  maturity dates, less than one year                     |       |                                        |       |   |   |   |   | $ | 21,335 |   |
| Contractual  maturity dates, one year to two years                  |       |                                        |       |   |   |   |   | 7,063 |   |
|                                                                |       |                                        |       |   |   |   |   | $ | 28,398 |   |

 
| ** **                                                          | ** ** | **As of April 30, 2008** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                          | ** ** | **Amortized**                                | ** ** | **Gross  Unrealized** | ** ** | **Gross  Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                                          | ** ** | **Cost**                                     | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Certificates  of deposit                                            |       | $                                            | 9,455      |   | $ | 1 |   | $ | — |   | $ | 9,456 |   |
| U.S.  government debt securities with maturities less than one year |       | 24,037                                       |       | 69 |   | — |   | 24,106 |   |
| U.S.  government debt securities with maturities over one year      |       | 5,104                                        |       | — |   | — |   | 5,104 |   |
| Commercial  paper and bond funds                                    |       | 13,298                                       |       | 29 |   | — |   | 13,327 |   |
|                                                                |       | $                                            | 51,894     |   | $ | 99 |   | $ | — |   | $ | 51,993 |   |
|                                                                |       |                                         |       |   |   |   |   |   |   |
| Contractual  maturity dates, less than one year                     |       |                                         |       |   |   |   |   | $ | 38,558 |   |
| Contractual  maturity dates, one year to two years                  |       |                                         |       |   |   |   |   | 13,435 |   |
|                                                                |       |                                         |       |   |   |   |   | $ | 51,993 |   |

 

9

----

 

**OMNIVISIONTECHNOLOGIES, INC.**

** **

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

**For theThree Months Ended July 31, 2008 and 2007**

**(unaudited)**

 

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

 
| ** **                                                    | ** ** | **July 31,** | ** ** | **April 30,** | ** ** |
|---------------------------------------------------------------|------------|-------------------|------------|--------------------|------------|
| ** **                                                    | ** ** | **2008**          | ** ** | **2008**           | ** ** |
| Cash  and cash equivalents:                                   |       |              |       |               |       |
| Cash                                                          |       | $                 | 133,175    |               | $          | 23,453 |   |
| Money  market funds and certificates of deposit               |       | 117,846           |       | 193,887            |       |
|                                                          |       | $                 | 251,021    |               | $          | 217,340 |   |
| Accounts  receivable, net:                                    | ** ** | ** **        | ** ** | ** **         | ** ** |
| Accounts  receivable                                          |       | $                 | 126,665    |               | $          | 109,452 |   |
| Less:  Allowance  for doubtful accounts             |       | (1,059            | )          | (1,080             | )          |
|    Allowance  for sales returns                |       | (3,627            | )          | (3,034             | )          |
|                                                          |       | $                 | 121,979    |               | $          | 105,338 |   |
| Inventories:                                                  |       |              |       |               |       |
| Work  in progress                                             |       | $                 | 71,019     |               | $          | 52,614 |   |
| Finished  goods                                               |       | 39,099            |       | 62,513             |       |
|                                                          |       | $                 | 110,118    |               | $          | 115,127 |   |
| Prepaid  expenses and other current assets:                   |       |              |       |               |       |
| Prepaid  expenses                                             |       | $                 | 4,885      |               | $          | 5,091 |   |
| Deposits  and other                                           |       | 1,673             |       | 1,604              |       |
| Interest  receivable                                          |       | 165               |       | 735                |       |
|                                                          |       | $                 | 6,723      |               | $          | 7,430 |   |
| Property,  plant and equipment, net:                          |       |              |       |               |       |
| Land  (1)                                                     |       | $                 | 13,000     |               | $          | 13,000 |   |
| Buildings  and land use right (1)                             |       | 39,829            |       | 26,135             |       |
| Buildings/leasehold  improvements                             |       | 16,562            |       | 5,745              |       |
| Machinery  and equipment                                      |       | 44,154            |       | 39,913             |       |
| Furniture  and fixtures                                       |       | 4,281             |       | 794                |       |
| Software                                                      |       | 7,045             |       | 2,780              |       |
| Construction  in progress                                     |       | 7,526             |       | 25,977             |       |
|                                                          |       | 132,397           |       | 114,344            |       |
| Less:  Accumulated depreciation and amortization              |       | (23,363           | )          | (21,893            | )          |
|                                                          |       | $                 | 109,034    |               | $          | 92,451 |   |
| Other  long-term assets:                                      |       |              |       |               |       |
| Deferred  income tax assets – non-current      |       | $                 | 13,794     |               | $          | 13,058 |   |
| Prepaid  wafer credits                                        |       | 4,000             |       | 4,000              |       |
| Long-term  employee loan receivable                           |       | 1,000             |       | 1,000              |       |
| Other  long-term assets                                       |       | 902               |       | 898                |       |
|                                                          |       | $                 | 19,696     |               | $          | 18,956 |   |
| Accrued  expenses and other current liabilities:              |       |              |       |               |       |
| Employee  compensation                                        |       | $                 | 5,354      |               | $          | 6,726 |   |
| Third  party commissions                                      |       | 2,243             |       | 1,970              |       |
| Professional  services                                        |       | 2,283             |       | 2,523              |       |
| Noncancelable  purchase commitments                           |       | 298               |       | 283                |       |
| Pricing  adjustments                                          |       | 4,138             |       | 3,416              |       |
| Deferred  income tax liabilities – current     |       | 3                 |       | 38                 |       |
| Other                                                         |       | 1,753             |       | 2,113              |       |
|                                                          |       | $                 | 16,072     |               | $          | 17,069 |   |
| Other  long-term liabilities:                                 |       |              |       |               |       |
| Deferred  income tax liabilities – non-current |       | $                 | 4,242      |               | $          | 4,726 |   |
| Other                                                         |       | 1,796             |       | 2,229              |       |
|                                                          |       | $                 | 6,038      |               | $          | 6,955 |   |

 

----

| (1) |   | Prior year balances have been reclassified  to conform to current year presentations. These reclassifications had no  impact on the previously reported asset balances, results of operations or  cash flows. |
|-----|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

10

----

 

**OMNIVISIONTECHNOLOGIES, INC.**

** **

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

**For theThree Months Ended July 31, 2008 and 2007**

**(unaudited)**

 

**Note 5 — Long-termInvestments**

 

Long-terminvestments as of July 31, 2008 and April 30, 2008 consisted of thefollowing (in thousands):

 
| ** ** | ** ** | **July 31,** | ** ** | **April 30,** | ** ** |
|------------|------------|-------------------|------------|--------------------|------------|
| ** ** | ** ** | **2008**          | ** ** | **2008**           | ** ** |
| VisEra     |       | $                 | 69,324     |               | $          | 68,593 |   |
| WLCSP      |       | 10,300            |       | 10,293             |       |
| XinTec     |       | 4,661             |       | 4,661              |       |
| ImPac      |       | 2,853             |       | 1,872              |       |
| Total      |       | $                 | 87,138     |               | $          | 85,419 |   |

 

***VisEraTechnologies Company, Ltd.***

 

In August 2005, theCompany entered into an Amended and Restated Shareholders’ Agreement (the “AmendedVisEra Agreement”) with Taiwan Semiconductor Manufacturing Company Limited (“TSMC”),VisEra Technologies Company, Ltd. (“VisEra”), and VisEra Holding Company (“VisEraCayman”). The Amended VisEra Agreement amended and restated the originalShareholders’ Agreement (the “VisEra Agreement”) that the parties entered intoon October 29, 2003, pursuant to which the Company and TSMC agreed to formVisEra, a joint venture in Taiwan, for the purposes of providing certainmanufacturing and automated final testing services related to complementarymetal 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 a non-exclusive license tocertain of its manufacturing and automated final testing technologies andpatents. In order to provide greater financial and fiscal flexibility toVisEra, in connection with the Amended VisEra Agreement, the parties formedVisEra Cayman, a company incorporated in the Cayman Islands and VisEra became asubsidiary of VisEra Cayman.

 

Under the terms of theAmended VisEra Agreement, the parties reaffirmed their respective commitmentsto VisEra, and expanded the scope of and made certain modifications to theVisEra Agreement. The Company and TSMC have equal interests in VisEra Cayman.In the quarter ended October 31, 2005, the Company and TSMC eachcontributed $7.5 million to VisEra and VisEra Cayman. As a result of thisadditional investment, the Company’s and TSMC’s interest each increased from25% to 43%, and consequently the Company re-evaluated its accounting for VisErain accordance with FIN 46(R), *“Consolidation of VariableInterest Entities.”* Since the Company was the source of virtuallyall of VisEra’s revenues, the Company had a decisive influence over VisEra’sprofitability. The Company concluded that, as a result of its step acquisitionof VisEra, and because substantially all of the activities of VisEra eitherinvolved or were conducted on behalf of the Company, VisEra was a variableinterest entity (“VIE”). Accordingly, the Company considered itself to be theprimary beneficiary of VisEra, and included VisEra’s financial results in itsconsolidated financial statements through December 31, 2006. In thequarter ended January 31, 2006, the Company increased its interest inVisEra from 43% to 46% through purchases of $9.5 million of unissuedshares.

 

In January 2006, inaccordance with the Amended VisEra Agreement, VisEra purchased color filter processingequipment and related assets from TSMC for an aggregate price equivalent to$16.9 million. In connection with the purchase, VisEra entered into athree-year lease agreement with TSMC. Under this agreement, VisEra leases fromTSMC approximately 14,000 square feet of factory and office space wherethe assets are located at an annual cost of approximately $2.4 million.

 

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

 

On January 1, 2007,the Company assumed responsibility for logistics management services previouslyprovided to the Company by VisEra. As a consequence of the change, the Companyconcluded that, as of the date of the change, it would lose its status as theprimary beneficiary of the joint venture, VisEra would cease to be VIE asdefined under 

 

11

----

 

**OMNIVISIONTECHNOLOGIES, INC.**

** **

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

**For theThree Months Ended July 31, 2008 and 2007**

**(unaudited)**

 

FIN 46(R) and,as a result, the Company deconsolidated VisEra. Accordingly, beginning on January 1,2007, the Company has accounted for its investment in VisEra under the equitymethod. The deconsolidation of VisEra did not have a material effect on theCompany’s reported 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 was part of anongoing capacity expansion program at VisEra. The Company’s contribution toVisEra and VisEra Cayman thus totaled $51.6 million, effectively meeting itscommitment under the terms of the January 2007 amendment to the AmendedVisEra Agreement, in which the Company and TSMC have agreed to commit a totalof $112.9 million to the joint venture. The Company has not made any additionalcontributions into VisEra since.

 

All other material termsof the original Shareholders’ Agreement remain in effect. (See Notes 16and 17.)

 

***ChinaWLCSP Limited***

 

China WLCSP Limited (“WLCSP”)is in the business of designing, manufacturing, packaging and selling certainwafer level chip scale packaging related services, for which the Company iscurrently a customer. In May 2007, the Company acquired 2,500,000 units ofWLCSP’s equity interests from WLCSP at a per unit price of $2.00 for anaggregate purchase amount of $5.0 million. Concurrently, the Companypurchased from Infinity-CSVC Venture Capital Enterprise 2,000,000 units ofWLCSP’s outstanding equity interests at a price per unit of $2.00 for anaggregate purchase amount of $4.0 million. Following the completion of thetwo transactions, the Company owns approximately 20.0% 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 various periods up to a maximum of five years.

 

The Company accounts for its investment in WLCSP underthe equity method. For the three months ended July 31, 2008 and 2007, theCompany recorded equity income of $7,000 and an equity loss of $351,000,respectively, in “Other income, net,” consisting of its portion of the netincome (loss) recorded by WLCSP during the periods, partially offset by equitymethod investment adjustments. (See Note 17.)

 

***XinTec, Inc.***

 

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

 

In January 2007,TSMC purchased approximately 90,526,000 previously-unissued shares from XinTec.The purchased shares represented approximately a 43.0% ownership interest inXinTec. Other existing shareholders, including the Company and the Company’saffiliate, VisEra, did not purchase additional shares. As a result, the Company’sdirect ownership percentage in XinTec declined to approximately 4.4%. VisEra’sownership interest declined to 16.9%, and the Company’s beneficial ownershippercentage in XinTec declined to 12.4%. Consequently, effective January 1, 2007,in accordance with APB 18, the Company began to account for XinTec as acost method investment. In addition, because the per share value of the TSMCinvestment exceeded the Company’s average per share carrying value in XinTec,the Company recorded a one-time change-of-interest benefit of $1.2 milliondirectly to “Additional paid-in capital,” a component of stockholders’ equity.(See Note 17.)

 

12

----

 

**OMNIVISIONTECHNOLOGIES, INC.**

** **

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

**For theThree Months Ended July 31, 2008 and 2007**

**(unaudited)**

 

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

 

In 2003, in order toenhance its access to plastic and ceramic packaging services that were in shortsupply, the Company purchased approximately 27% of the common stock of ImPacTechnology Co., Ltd. (“ImPac”), a privately-held company based in Taiwan for atotal of $2.0 million in cash. In December 2003, the Company made anadditional cash contribution of approximately $0.8 million to maintain itsequity ownership percentage in ImPac. Unrelated third parties own the balanceof ImPac’s equity. During fiscal 2004, the Company’s equity interestdeclined to approximately 23% due to additional rounds of financing obtained byImPac in which the Company did not participate. In July 2008, the Companypurchased additional shares in ImPac for $1.4 million. This increased theCompany’s ownership in ImPac to 25.7%. The Company’s purchases from ImPac areat arm’s length and the Company accounts for this investment using the equitymethod. The Company recorded an equity loss of $395,000 and $109,000,respectively, in “Other income, net,” as its portion of ImPac’s net loss forthe three months ended July 31, 2008 and 2007. (See Note 17.)

 

The following tablepresents the summary combined financial information of ImPac, VisEra and WLCSP,as derived from the ImPac, VisEra and WLCSP financial statements for the threemonths ended July 31, 2008 and 2007 and prepared under accountingprinciples generally accepted in the United States of America (in thousands):

 
| ** **              | ** ** | **Three Months Ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | **July 31,  2008**          | ** ** | **July 31,  2007** | ** ** |
| ***Operating data:***   |       |                             |       |   |   |
| Revenues                |       | $                                | 26,336     |   | $ | 41,812 |   |
| Gross  profit           |       | 6,100                            |       | 7,281 |   |
| Income  from operations |       | 2,784                            |       | 4,335 |   |
| Net  income             |       | $                                | 1,230      |   | $ | 1,655 |   |

 

The amount of consolidatedretained earnings that represent undistributed earnings of the investeesaccounted for by the equity method totaled $15.3 million and $14.8 million at July 31,2008 and April 30, 2008, respectively.

 

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

 

In May 2004, theCompany entered into an agreement with Powerchip Semiconductor Corporation (“PSC”),a Taiwan based company that produces memory chips and provides semiconductorfoundry services, to establish a joint venture in Taiwan. The purpose of thejoint venture, Silicon Optronics, Inc. (“SOI”), is to conductmanufacturing, 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 April 2007, SOIbecame listed on the Taiwan GreTai Securities Market, (“TGSM”). The TGSM is theapproximate equivalent in Taiwan of the Over-The-Counter market in the UnitedStates. In conjunction with the TGSM listing, various employees of SOIexercised their options and increased the number of shares outstanding. Fromtime to time, SOI also issues shares to its employees as a bonus, which dilutesthe Company’s ownership percentage. The Company’s ownership percentage in SOIwas 43.9% as of both July 31, 2008 and April 30, 2008.

 

In June 2008, SOIdeclared a cash dividend of approximately $359,000, of which $201,000 would bepayable to minority shareholders. (See Note 17.)

 

13

----

 

**OMNIVISIONTECHNOLOGIES, INC.**

** **

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

**For theThree Months Ended July 31, 2008 and 2007**

**(unaudited)**

 

**Note 7 — IntangibleAssets**

 

Intangible assets as of July 31,2008 consist of the following (in thousands):

 
| ** **                 | ** ** | **Cost** | ** ** | **Accumulated  Amortization** | ** ** | **Net Book  Value** | ** ** |
|----------------------------|------------|----------|------------|-------------------------------|------------|--------------------------|------------|
| Core  technology           |       | $        | 17,800     |                          | $          | 11,578                   |       | $ | 6,222 |   |
| Patents  and licenses      |       | 13,487   |       | 7,912                         |       | 5,575                    |       |
| Trademarks  and tradenames |       | 1,400    |       | 910                           |       | 490                      |       |
| Customer  relationships    |       | 100      |       | 100                           |       | —                   |       |
| Intangible  assets, net    |       | $        | 32,787     |                          | $          | 20,500                   |       | $ | 12,287 |   |

 

Intangible assets as of April 30,2008 consist of the following (in thousands):

 
| ** **                 | ** ** | **Cost** | ** ** | **Accumulated  Amortization** | ** ** | **Net Book  Value** | ** ** |
|----------------------------|------------|----------|------------|-------------------------------|------------|--------------------------|------------|
| Core  technology           |       | $        | 17,800     |                          | $          | 10,680                   |       | $ | 7,120 |   |
| Patents  and licenses      |       | 13,487   |       | 7,239                         |       | 6,248                    |       |
| Trademarks  and tradenames |       | 1,400    |       | 840                           |       | 560                      |       |
| Customer  relationships    |       | 100      |       | 100                           |       | —                   |       |
| Intangible  assets, net    |       | $        | 32,787     |                          | $          | 18,859                   |       | $ | 13,928 |   |

 

For the three monthsended July 31, 2008 and 2007, the Company amortized $1.6 million,respectively, of its intangible assets. The total expected future annualamortization of these intangible assets is as follows (in thousands):

 
| **Years Ending April 30,** | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|------------|------------|
| 2009                                      |       | $          | 4,891      |   |
| 2010                                      |       | 6,386      |       |
| 2011                                      |       | 973        |       |
| 2012                                      |       | 37         |       |
| Total                                     |       | $          | 12,287     |   |

 

**Note 8 — BorrowingArrangements**

 

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

 
| ** **                             | ** ** | **July 31,  2008** | ** ** | **April 30,  2008** | ** ** |
|----------------------------------------|------------|-------------------------|------------|--------------------------|------------|
|                                   |       |                    |       |                     |       |
| Mortgage  loan                         |       | $                       | 27,045     |                     | $          | 27,347 |   |
| Term  loan                             |       | 12,000                  |       | 6,000                    |       |
| Capital  lease obligations             |       | 95                      |       | 134                      |       |
|                                   |       | 39,140                  |       | 33,481                   |       |
| Less: amount due  within one year |       | (4,135                  | )          | (651                     | )          |
| Non-current  portion of long-term debt |       | $                       | 35,005     |                     | $          | 32,830 |   |

 

14

----

 

**OMNIVISIONTECHNOLOGIES, INC.**

** **

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

**For theThree Months Ended July 31, 2008 and 2007**

**(unaudited)**

 

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

 
| **Years Ending April 30,** | ** ** | **Mortgage  and Term  Loan** | ** ** | **Capital  Lease** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|--------------------|------------|-----------|------------|
| 2009                                      |       | $                                 | 2,963      |               | $          | 95        |       | $ | 3,058 |   |
| 2010                                      |       | 4,323                             |       | —             |       | 4,323     |       |
| 2011                                      |       | 4,369                             |       | —             |       | 4,369     |       |
| 2012                                      |       | 4,415                             |       | —             |       | 4,415     |       |
| 2013                                      |       | 2,466                             |       | —             |       | 2,466     |       |
| Thereafter                                |       | 20,509                            |       | —             |       | 20,509    |       |
| Total                                     |       | $                                 | 39,045     |               | $          | 95        |       | $ | 39,140 |   |

 

## ***MortgageLoan***

 

On March 16, 2007,the Company entered into a Loan and Security Agreement with a domestic bank forthe purchase of a complex of four buildings located in Santa Clara, California(the “Santa Clara Property”). The Loan and Security Agreement provides for amortgage loan in the principal amount of $27.9 million (the “Mortgage Loan”)and a secured line of credit with an aggregate maximum principal amount of upto $12.0 million (the “Term Loan”). In March 2008, the Companyborrowed $6.0 million under the Term Loan to finance improvements to theSanta Clara Property. The Company drew down the remaining $6.0 millionunder the Term Loan in July 2008. Borrowings under the Mortgage Loanaccrue interest 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 July 31, 2012, respectively.

 

Interest rates under theMortgage Loan were 3.4% and 3.6% at July 31, 2008 and April 30, 2008,respectively. The interest rate under the Term Loan was 3.7% and 4.0% at July 31,2008 and April 30, 2008, respectively. The Company was in compliance with thefinancial covenants of the Loan and Security Agreement as of July 31,2008.

 

In conjunction with theMortgage Loan, the Company entered into an interest rate swap with the samebank to effectively convert the variable interest rate described above to afixed rate. The swap is for a period of ten years, and the notional amount ofthe swap approximates the principal outstanding under the Mortgage Loan. TheCompany is the fixed rate payer under the swap and the rate is fixed at 5.3%per annum and the effective rate on the Mortgage Loan is fixed at approximately6.2%. In July 2008, in connection with the Term Loan, the Company enteredinto a second interest rate swap with the bank to effectively convert thevariable interest rate described above to a fixed rate. This second swap is fora period of four years. The Company is the fixed rate payer and the rate isfixed at 4.3% per annum and the effective rate on the Term Loan is fixed atapproximately 5.5%. The Company remeasures both swaps at fair values at eachbalance sheet date and records them as either assets or liabilities, dependingon whether the fair value represents net gains or net losses. As of July 31,2008 and April 30, 2008, the Company recorded $1.8 million and$2.2 million, respectively, in “Other long-term liabilities.” For thethree months ended July 31, 2008 and 2007, the Company recorded income of$433,000 and $0.6 million, respectively, in “Other income, net.”

 

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

 

SOI maintains fourunsecured lines of credit with three commercial banks, which provide a total ofapproximately $3.6 million in available credit. All borrowings under theselines of credit that are maintained by SOI bear interest at the market interestrate prevailing at the time of borrowing. There are no financial covenantrequirements for these facilities and at July 31, 2008, there were noborrowings outstanding under these facilities.

 

## ***CapitalLease Obligations***

 

In February 2006,the Company leased telecommunications equipment under a three-year capital leaseat an imputed interest rate of 7.5% per annum. Terms of the agreement requirethe Company to make monthly payments of approximately $14,000 through May 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 July 31, 2008, 

 

15

----

 

**OMNIVISIONTECHNOLOGIES, INC.**

** **

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

**For the ThreeMonths Ended July 31, 2008 and 2007**

**(unaudited)**

 

$95,000 was outstandingunder the capital lease and was classified as a short-term obligation. As of April 30,2008, $134,000 was outstanding under the capital lease and $133,000 wasclassified as a short-term obligation.

 

**Note 9 — NetIncome Per Share**

 

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

 

Diluted net income pershare is computed according to the treasury stock method using the weightedaverage number of common and potentially dilutive common shares outstandingduring the period. Potentially dilutive common shares represent the effect ofstock options, restricted stock units and employee stock purchase plan shares.For the three months ended July 31, 2008 and 2007, 12,179,000 and7,793,000 shares, respectively, of common stock subject to outstanding optionswere not included in the calculation of diluted net income per share becausethey were antidilutive. All restricted stock units outstanding as of July 31,2008 were included in the treasury stock method calculation.

 

The Company’s earningsper share were calculated under the provisions of the Statement of FinancialAccounting Standards (or “SFAS”) No. 128, *“EarningsPer Share,”* or SFAS No. 128. SFAS No. 128 requires thatthe Company take into account the effect on consolidated earnings per share ofoptions, warrants and convertible securities issued by its subsidiaries. Theeffect on consolidated earnings per share depends on whether the securitiesissued by the subsidiary enable their holders to obtain common stock of thesubsidiary company or common stock of the parent company. Securities issued bya subsidiary that enable their holders to obtain the subsidiary’s common stockare included in computing the subsidiary’s earnings per share data. The dilutedper-share earnings of the subsidiary are included in the Company’s consolidatedearnings per share computations based on the consolidated group’s holding ofthe subsidiary’s securities. Through July 31, 2008, SOI issued options tovarious of its employees exercisable for 2,700,000 shares of its commonstock. In the calculation of its earnings per share for the three months ended July 31,2008 and 2007, the Company included the effect of SOI’s options in itsconsolidated earnings per share.

 

The following table setsforth the computation of basic and diluted earnings per share for the periodsindicated (in thousands, except per share data):

 
| ** **                                                                      | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                      | ** ** | **July 31,**                | ** ** |
| ** **                                                                      | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| ***Basic:***                                                                    |       |                             |       |   |   |
| Numerator:                                                                      |       |                             |       |   |   |
| Net  income                                                                     |       | $                                | 6,228      |   | $ | 12,977 |   |
|                                                                            |       |                             |       |   |   |
| Denominator:                                                                    |       |                             |       |   |   |
| Weighted  average common shares for net income per share                        |       | 51,257                           |       | 54,751 |   |
|                                                                            |       |                             |       |   |   |
| Basic  net income per share                                                     |       | $                                | 0.12       |   | $ | 0.24 |   |
|                                                                            |       |                             |       |   |   |
| ***Diluted:***                                                                  |       |                             |       |   |   |
| Numerator:                                                                      |       |                             |       |   |   |
| Net  income                                                                     |       | $                                | 6,228      |   | $ | 12,977 |   |
|                                                                            |       |                             |       |   |   |
| Denominator:                                                                    |       |                             |       |   |   |
| Denominator  for basic net income per share                                     |       | 51,257                           |       | 54,751 |   |
| Weighted  average effect of dilutive securities:                                |       |                             |       |   |   |
| Stock  options, restricted stock units, and employee stock purchase plan shares |       | 621                              |       | 543 |   |
| Weighted  average common shares for diluted net income per share                |       | 51,878                           |       | 55,294 |   |
|                                                                            |       |                             |       |   |   |
| Diluted  net income per share                                                   |       | $                                | 0.12       |   | $ | 0.23 |   |

 

16

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**OMNIVISIONTECHNOLOGIES, INC.**

** **

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

**For theThree Months Ended July 31, 2008 and 2007**

**(unaudited)**

 

**Note 10 — Fair Value Measurements**

 

Effective May 1,2008, the Company adopted the provisions of SFAS No. 157, as amended. Theadoption of this standard was limited to financial assets and liabilities anddid not have a material effect on the Company’s financial condition or resultsof operations.

 

SFAS No. 157specifies a hierarchy of valuation techniques based upon whether the inputs tothose valuation techniques reflect assumptions other market participants woulduse based upon market data obtained from independent sources (observableinputs) or reflect the Company’s own assumption of market participant valuation(unobservable inputs). The fair value hierarchy consists of the following threelevels:

 

·                  *Level 1* – Inputs are quoted prices in activemarkets for identical assets or liabilities.

·                  *Level 2* – Inputs are quoted prices for similarassets or liabilities in an active market, quoted prices for identical orsimilar assets or liabilities in markets that are not active, inputs other thanquoted prices that are observable and market-corroborated inputs which arederived principally from or corroborated by observable market data.

·                  *Level 3* – Inputs are derived from valuationtechniques in which one or more significant inputs or value drivers areunobservable.

 

The following tablepresents the Company’s financial assets and liabilities that are measured atfair value on a recurring basis which were comprised of the following types ofinstruments as of July 31, 2008 (in thousands):

 
| ** **                                           | ** ** | **Total** | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|------------------------------------------------------|------------|-----------|------------|-------------|------------|-------------|------------|-------------|------------|
| Money market  funds                                  |       | $         | 51,936     |        | $          | 51,936      |       | $           | —     |   | $ | — |   |
| Bank time  deposits                                  |       | 5,996     |       | —      |       | 5,996       |       | —      |       |
| Debit securities  issued by U.S. government agencies |       | 86,317    |       | —      |       | 86,317      |       | —      |       |
| Corporate debt  securities                           |       | 1,995     |       | —      |       | 1,995       |       | —      |       |
| Total assets                                         |       | $         | 146,244    |        | $          | 51,936      |       | $           | 94,308     |   | $ | — |   |
| Interest rate  swaps                                 |       | $         | 1,796      |        | $          | —      |       | $           | 1,796      |   | $ | — |   |
| Total  liabilities                                   |       | $         | 1,796      |        | $          | —      |       | $           | 1,796      |   | $ | — |   |

 

The following tablepresents the Company’s financial assets and liabilities that are measured atfair value on a recurring basis which were presented on the Company’s CondensedConsolidated Balance Sheets as of July 31, 2008, (in thousands):

 
| ** **              | ** ** | **Total** | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|-------------------------|------------|-----------|------------|------------------|------------|------------------|------------|------------------|------------|
| *** ***            |       |      |       |             |       |             |       |             |       |
| Cash  equivalents       |       | $         | 117,846    |             | $          | 51,936           |       | $                | 65,910     |   | $ | — |   |
| Short-term  investments |       | 28,398    |       | —           |       | 28,398           |       | —           |       |
| Total Assets            |       | $         | 146,244    |             | $          | 51,936           |       | $                | 94,308     |   | $ | — |   |
| *** ***            |       |      |       |             |       |             |       |             |       |
| Interest rate swaps     |       | $         | 1,796      |             | $          | —           |       | $                | 1,796      |   | $ | — |   |
| Total Liabilities       |       | $         | 1,796      |             | $          | —           |       | $                | 1,796      |   | $ | — |   |

 

**Note 11 — Segmentand Geographic Information**

 

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

 

The Company sells itsimage-sensor products either directly to OEMs and VARs or indirectly throughdistributors. The following table illustrates the percentage of revenues fromsales to OEMs and VARs and to distributors for the three months ended July 31,2008 and 2007, respectively:

 
| ** **     | ** ** | **Three Months Ended** | ** ** |
|----------------|------------|----------------------------------|------------|
| ** **     | ** ** | **July 31,**                | ** ** |
| ** **     | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| OEMs  and VARs |       | 58.3                             | %          | 64.5 | % |
| Distributors   |       | 41.7                             |       | 35.5 |   |
| Total          |       | 100.0                            | %          | 100.0 | % |

 

17

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**OMNIVISIONTECHNOLOGIES, INC.**

** **

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

**For theThree Months Ended July 31, 2008 and 2007**

**(unaudited)**

 

Since the Company’send-user customers market and sell their products worldwide, its revenues bygeographic location are not necessarily indicative of the geographicdistribution of end-user sales, but rather indicate where their components aresourced. The revenues by geography in the following table are based on the countryor region in which the Company’s customers issue their purchase orders (inthousands):

 
| ** **     | ** ** | **Three Months Ended** | ** ** |
|----------------|------------|----------------------------------|------------|
| ** **     | ** ** | **July 31,**                | ** ** |
| ** **     | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| China          |       | $                                | 128,026    |   | $ | 152,910 |   |
| Malaysia       |       | 18,534                           |       | 3,957 |   |
| Taiwan         |       | 14,338                           |       | 11,095 |   |
| United  States |       | 10,244                           |       | 1,392 |   |
| All  other     |       | 3,137                            |       | 3,780 |   |
| Total          |       | $                                | 174,279    |   | $ | 173,134 |   |

 

The Company’s long-livedassets, including its equity method investments, are located in the followingcountries (in thousands):

 
| ** **     | ** ** | **July 31,** | ** ** | **April 30,** | ** ** |
|----------------|------------|-------------------|------------|--------------------|------------|
| ** **     | ** ** | **2008**          | ** ** | **2008**           | ** ** |
| Taiwan         |       | $                 | 87,408     |               | $          | 83,829 |   |
| United  States |       | 67,262            |       | 56,899             |       |
| China          |       | 45,927            |       | 41,550             |       |
| All  other     |       | 477               |       | 489                |       |
| Total          |       | $                 | 201,074    |               | $          | 182,767 |   |

 

**Note 12 — EmployeeStock Purchase, Equity Incentive and Stock Option Plans**

 

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

 

In September 2007, onthe recommendation of the Company’s board of directors, the stockholders of theCompany 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. Through July 31,2008, the Company had granted stock options for approximately436,000 shares and 484,000 restricted stock units to employees under the2007 Plan. In general, the Company’s stock option awards have a maximumcontractual term of ten years and vest over four years. Restricted stock unitsgranted under the 2007 Plan generally vest over three years. In July 2008,the Company also granted approximately 196,000 performance shares to certainemployees. These 196,000 shares represent the “target” number of shares ofcommon stock that will be issued if certain performance goals are achieved. Theactual number of shares to be issued will be determined at the end of aone-year performance period, and can range from 0% to 175% of the targetnumber, depending on the degree of achievement then of the performance goals.After determining the final share count, the awards will vest over two years.

 

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 Months Ended July 31, 2008 and2007**

**(unaudited)**

 

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

 
| ** **                     | ** ** | ** **     | ** ** | **Shares**         | ** ** | ** **      | ** ** | **Restricted**       | ** ** | **Performance**        | ** ** |
|--------------------------------|------------|----------------|------------|--------------------|------------|-----------------|------------|----------------------|------------|------------------------|------------|
| ** **                     | ** ** | **Shares**     | ** ** | **Available**      | ** ** | **Options**     | ** ** | **Stock Units** | ** ** | **Shares**             | ** ** |
| **Name of Plan**     | ** ** | **Authorized** | ** ** | **for Grant** | ** ** | **Outstanding** | ** ** | **Outstanding**      | ** ** | **Outstanding****(1)** | ** ** |
| 1995 Stock Plan           |       | —         |       | —             |       | 38              |       | —               |       | —                 |       |
| 2000 Stock Plan           |       | —         |       | —             |       | 13,152          |       | —               |       | —                 |       |
| 2000 Director Option Plan |       | —         |       | —             |       | 287             |       | —               |       | —                 |       |
| 2007 Plan                      |       | 6,000          |       | 4,057              |       | 585             |       | 483                  |       | 196                    |       |
| Total                          |       | 6,000          |       | 4,057              |       | 14,062          |       | 483                  |       | 196                    |       |

 

----

(1)   Represents targeted issuance. The actual number of shares ofcommon stock that will be issued in connection with the performance shares willbe determined at the end of a one-year performance period.

 

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

 

The following table summarizes the equity awardactivities under the 2000 Stock Plan, the 2000 Director Option Planand the 2007 Plan, for the three months ended July 31, 2008:

 
| ** **                                        | ** ** | **Options Outstanding**      | ** ** | **Restricted  Stock Units  Outstanding** | ** ** | **Performance  Shares  Outstanding**                   | ** ** | **Restricted  Stock units  and  Performance  Shares** | ** ** |
|---------------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                        | ** ** | **Shares  Available  For  Grant** | ** ** | **Number  of Shares**                    | ** ** | **Weighted  Average  Exercise  Price Per  Share** | ** ** | **Number of  Shares**                                 | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Grant Date  Fair Market  Value Per  Share** | ** ** |
| ** **                                        | ** ** | **(in  thousands)**               | ** ** | **(in  thousands)**                           | ** ** | ** **                                             | ** ** | **(in  thousands)**                                        | ** ** | **(in  thousands)** | ** ** | ** ** | ** ** |
| Balance at May 1, 2008                       |       |                              |       | 13,807                                        |       | $                                                      | 18.18      |                                                       | —     |   | — |   | $ | — |   |
| Shares available for grant at May 1, 2008    |       | 5,846                             |       |                                          |       |                                                   |       |                                                       |       |   |   |   |   |
| Stock options granted                             |       | (436                              | )          | 436                                           |       | 12.79                                                  |       |                                                       |       |   |   |   |   |
| Stock options exercised                           |       | —                            |       | (45                                           | )          | 5.43                                                   |       |                                                       |       |   |   |   |   |
| Stock options expired or forfeited                |       | 5                                 |       | (136                                          | )          | 19.37                                                  |       |                                                       |       |   |   |   |   |
| Restricted stock units granted (1)                |       | (968                              | )          |                                          |       |                                                   |       | 484                                                        |       |   |   | 11.95 |   |
| Restricted stock units expired or forfeited (1)   |       | 2                                 |       |                                          |       |                                                   |       | (1                                                         | )          |   |   | 11.95 |   |
| Performance shares granted (1) (2)           |       | (392                              | )          |                                          |       |                                                   |       |                                                       |       | 196 |   | 11.95 |   |
| Balance at July 31, 2008                     |       | 4,057                             |       | 14,062                                        |       | 18.04                                                  |       | 483                                                        |       | 196 |   | 11.95 |   |
| Exercisable at July 31, 2008                 |       |                              |       | 9,129                                         |       | 17.93                                                  |       |                                                       |       |   |   |   |   |
| Vested and expected to vest at July 31, 2008 |       |                              |       | 13,152                                        |       | $                                                      | 18.03      |                                                       | 358        |   | 138 |   | $ | 11.95 |   |

 

----

(1)   Shares subject to awards granted for less thanfair market value on the date of grant count against the share reserve as twoshares for every one share subject to such an award. When a share is returnedto the plan, two shares will be credited back to the reserve.

 

(2)   Represents targeted issuance. Theactual number of shares of common stock that will be issued in connection withthe performance shares will be determined at the end of a one-year performanceperiod.

 

Thetotal intrinsic value of options exercised during the three months ended July 31,2008 was $416,000. Total cash received from employees as a result of employeestock option exercises during the three months ended July 31, 2008 wasapproximately $242,000.

 

19

----

 

**OMNIVISION TECHNOLOGIES, INC.**

** **

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

**For the Three Months Ended July 31, 2008 and2007**

**(unaudited)**

 

As of July 31,2008, net of forfeitures, there was $39.4 million of unrecognizedcompensation expense related to unvested stock options, which the Companyexpects to recognize over a weighted average period of 2.2 years. As of July 31,2008, net of forfeitures, there was $8.4 million of unrecognizedcompensation expense related to unvested restricted stock units, which theCompany expects to recognize over a weighted average period of 2.9 years.For the 2000 Purchase Plan, as of July 31, 2008, there was$4.2 million of unrecognized compensation expense which the Companyexpects to recognize over a weighted average period of 1.2 years. As of April 30,2008, net of forfeitures, there was $43.0 million of unrecognizedcompensation cost related to unvested stock options, which the Company expectsto recognize over a weighted average period of 2.3 years. For the2000 Purchase Plan, as of April 30, 2008, there was $1.2 millionof unrecognized compensation cost which the Company expected to be recognizedover a weighted average period of 0.9 years. The Company’s current policyis to issue new shares to settle the exercise of stock options and prospectively,the vesting of restricted stock units.

 

## ***ValuationAssumptions***

 

SFAS No. 123(R) requirescompanies to estimate the fair value of stock-based compensation awards on thegrant date. The value of the portion of the award that is ultimately expectedto vest is recognized as expense over the requisite service period in theCompany’s Condensed Consolidated Statements of Income.

 

For restrictedstock unit awards, the per-share fair value is the closing market price of theCompany’s common stock as reported on the NASDAQ Global Market on the grantdate. For performance share awards, the per share fair value is also theclosing market price of the Company’s common stock as reported on NASDAQ.However, the related stock-based compensation is adjusted by the estimatedprobable outcome of the predetermined performance conditions. The compensationwill be adjusted for subsequent changes in the estimated and actual outcome.For stock option awards and rights issued under the 2000 Purchase Plan, theCompany measures the fair value using the Black-Scholes option pricing model.Black-Scholes was developed to estimate the fair value of freely tradable,fully transferable options without vesting restrictions. These assumptionsdiffer significantly from the characteristics of the Company’s stock-basedcompensation awards. Black-Scholes also requires the use of highly subjective,complex assumptions, including expected term and the price volatility of theCompany’s stock.

 

The fair value for these options was estimated usingthe Black-Scholes option pricing model. The per share weighted averageestimated grant date fair value for employee options granted was $5.27 and$6.81 during the three months ended July 31, 2008 and 2007, respectively.The following weighted average assumptions are included in the estimated fairvalue calculations for stock options granted in the three months ended July 31,2008 and 2007:

 
| ** **                          | ** ** | **Employee Stock Option Plans** | ** ** |
|-------------------------------------|------------|------------------------------------------------|------------|
| ** **                          | ** ** | **Three Months Ended**               | ** ** |
| ** **                          | ** ** | **July 31,**                              | ** ** |
| ** **                          | ** ** | **2008**                                       | ** ** | **2007** | ** ** |
| Risk-free interest rate             |       | 3.11                                           | %          | 4.84 | % |
| Expected term of options (in years) |       | 4.0                                            |       | 4.0 |   |
| Expected volatility                 |       | 48.2                                           | %          | 52.0 | % |
| Expected dividend yield             |       | 0                                              | %          | 0 | % |

 

UsingBlack-Scholes, the per share weighted average estimated fair value of rightsissued pursuant to the Company’s 2000 Purchase Plan during both of the threemonths ended July 31, 2008 and 2007 was $5.65.

 

20

----

 

**OMNIVISION TECHNOLOGIES, INC.**

** **

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

**For the Three Months Ended July 31, 2008 and2007**

**(unaudited)**

 

The following weighted average assumptions areincluded in the estimated grant date fair value calculations for rights topurchase stock under the 2000 Purchase Plan:

 
| ** **                          | ** ** | **Employee Stock Purchase Plan** | ** ** |
|-------------------------------------|------------|-------------------------------------------------|------------|
| ** **                          | ** ** | **Three Months Ended**                | ** ** |
| ** **                          | ** ** | **July 31,**                               | ** ** |
| ** **                          | ** ** | **2008**                                        | ** ** | **2007** | ** ** |
| Risk-free interest rate             |       | 3.90                                            | %          | 5.04 | % |
| Expected term of options (in years) |       | 0.5                                             |       | 0.5 |   |
| Expected volatility                 |       | 42.8                                            | %          | 48.3 | % |
| Expected dividend yield             |       | 0                                               | %          | 0 | % |

 

The definitions of the terms used to determine theabove values are as follows:

 

·      *Expected term:* The expected term represents the period thatthe Company’s stock-based awards are expected to be outstanding and isestimated based on historical experience.

·      *Risk-free interest rate:* The risk-free interest rateassumption is based upon observed interest rates appropriate for the expectedterm of the Company’s stock-based awards.

·      *Expected volatility:* Upon the adoption of SFAS No. 123(R),the Company 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 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 theCompany’s intention not to pay a cash dividend under its dividend policy.

·      *Estimated pre-vesting forfeitures:* When estimatingpre-vesting forfeitures, the Company considers forfeiture behavior based onactual historical information.

 

**Note 13 — Additional Paid-inCapital**

 

The following table shows the amounts recorded to “Additionalpaid-in capital” for the three months ended July 31, 2008 (in thousands):

 
| ** **                        | ** ** | **Additional** | ** ** |
|-----------------------------------|------------|----------------|------------|
| ** **                        | ** ** | **Paid-in**    | ** ** |
| ** **                        | ** ** | **Capital**    | ** ** |
| Balance at May 1, 2008       |       | $              | 373,024    |   |
| Exercise of stock options         |       | 242            |       |
| Employee stock purchase plan      |       | 2,437          |       |
| Employee stock-based compensation |       | 6,945          |       |
| Balance at July 31, 2008     |       | $              | 382,648    |   |

 

**Note 14 — Treasury Stock**

 

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 July 31, 2008, the 

 

21

----

 

**OMNIVISION TECHNOLOGIES, INC.**

** **

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

**For the Three Months Ended July 31, 2008 and2007**

**(unaudited)**

 

Companyhad cumulatively repurchased 5,093,500 shares of its common stock underthe open-market program for an aggregate cost of approximately$86.2 million.

 

**Note 15 — Income Taxes**

 

The Company’seffective tax rates for the three months ended July 31, 2008 and 2007 were18.8% and (11.7)%, respectively. Quarterly income taxes reflect an estimate ofthe effective tax rate for the fiscal year and include, when applicable, theimpact of discrete tax items. The Company’s effective tax benefit for the threemonths ended July 31, 2007 was principally the result of the income taxbenefit from discrete tax items, in particular the release during the threemonths of unrecognized tax benefits including interest and penalties that wereno longer required as a result of a change in tax law in a foreign jurisdictionwhere the Company does business. Without regard to discrete tax items, theCompany’s effective tax rates for the three months ended July 31, 2008 and2007 were less than the combined federal and state statutory rate of approximately40% principally because the Company earns a significant portion of its incomein jurisdictions where tax rates are lower than the combined federal and statestatutory rate.

 

**Note 16 — Commitments andContingencies**

 

## ***Commitments***

 

The Company maintainsa wholly-owned subsidiary in Shanghai, OmniVision Technologies (Shanghai) Co.Ltd. (“OTC”) which provides assistance to the Company in various product designprojects and in marketing and sales support. On January 10, 2007, OTCentered 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 landlocated in Shanghai for a period of 50 years. In addition, the Company isobligated to invest a minimum of approximately $33.6 million to developthe land and construct facilities, which amount includes the Purchase Price. Asof July 31, 2008, the Company has already contributed $12.0* *millionof the $33.6 million total investment. Construction of the facilities onthe land must commence and be completed during the time period beginning on June 30,2007 and ending on June 30, 2009, subject to an additional one-yearextension under limited circumstances. The Company may use the land solely forthe purposes of industrial use and/or scientific research. The Company intendsto use OTC’s registered capital to partially fund its commitment to thisproject.

 

The Company hasvarious commitments arising from the Amended VisEra Agreement, and the subsequentamendments to it. In particular, as of July 31, 2008, the Company and TSMChave agreed to commit a total of $112.9 millionto the joint venture, which commitments may be made in the form of cash orasset contributions. Through July 31, 2008, the Company hascontributed $51.6 millionto VisEra and VisEra Cayman and, as of July 31, 2008, the Company haseffectively met its commitment under the terms of this agreement. Additionalcontributions may be made by additional investors, additional contributions bythe Company and TSMC, or a combination thereof, provided that the Company andTSMC have and will maintain equal interests in VisEra and VisEra Cayman. To theextent, if any that the value of assets contributed in the future exceeds thevalue of the Company’s commitment, the Company will receive cash from VisEraCayman. (See Notes 5 and 17.)

 

## ***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,and contained false and misleading statements regarding, certain 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 

 

22

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**OMNIVISION TECHNOLOGIES, INC.**

** **

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

**For the Three Months Ended July 31, 2008 and2007**

**(unaudited)**

 

behalfof a purported 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 (the action involving OmniVision is not one of the six test cases).Because class certification was a condition of the settlement, it is unlikelythat the current settlement will 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. Plaintiffs have filedamended master allegations and amended complaints and moved for classcertification in the six test cases, which the defendants in those cases haveopposed. On March 26, 2008, the Court largely denied the test casedefendants’ motion to dismiss the amended complaints. It is uncertain whetherthere will be any revised or future settlement. If the litigation proceeds, theCompany believes that it has meritorious defenses to plaintiffs’ claims andintends to defend the action vigorously.

 

On October 12,2007, a purported OmniVision stockholder filed a complaint against certain ofthe Company’s underwriters for its initial public offering. The complaint, *Vanessa Simmonds v. Bank of America Corporation, et al.*,Case No. C07-1668, filed in District Court for the Western District ofWashington, makes similar allegations to those made in *In reInitial Public Offering Securities Litigation* and seeks the recoveryof short-swing trading profits under Section 16(b) of the SecuritiesExchange Act of 1934. The Company is named as a nominal defendant. No recoveryis sought from the Company.

 

On February 21,2008, the Company filed a lawsuit against Qualcomm Incorporated in the UnitedStates District Court for the Northern District of California (the “NorthernDistrict Action”) alleging claims of trademark infringement arising fromQualcomm’s use of, and attempt to register, the mark OMNIVISION for a computerhardware system and related services. The Company seeks an injunction andunspecified damages. The Company had previously filed opposition proceedingsbefore the Trademark Trial and Appeal Board of the United States Patent andTrademark office against Qualcomm’s applications to register the OMNIVISIONmark, and the Company successfully moved to suspend those proceedings basedupon the new parallel federal litigation. Qualcomm has filed its Answer denyingthe allegations of infringement. Trial is currently set for November 30,2009.

 

**Note 17 — Related PartyTransactions**

 

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 and may be extended, subject to mutual consent of the parties.

 

During the threemonths ended January 31, 2007, the Company and ImPac agreed to initiatepayment of licensing fees for the use of certain software developed by ImPac atOmniVision Semiconductor (Shanghai) co. Ltd., the Company’s wholly-ownedsubsidiary in China. During the three months ended July 31, 2008 and 2007,the Company paid ImPac zero and $45,000, respectively, in softwarelicensing fees. In addition, the Company paid ImPac approximately$2.7 million for manufacturing services for the three months ended July 31,2008 and 2007, respectively. During fiscal 2008, the Company loaned$1.3 million to ImPac for the purpose of expanding its manufacturingcapacities for a term of one year, but can be extended upon mutual consent ofthe parties for one year. The loan is fully collateralized by assets held byImPac. (See Note 5.) In August, 2008, the Company entered into anadditional agreement with ImPac under which the Company agreed to place certainmanufacturing equipment with ImPac on a consignment basis for a period of up tofive years.

 

23

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**OMNIVISION TECHNOLOGIES, INC.**

** **

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS— (Continued)**

**For the Three Months Ended July 31, 2008 and2007**

**(unaudited)**

 

TheCompany consolidated VisEra’s operating results from August 1, 2005 to December 31,2006. Subsequently, the Company has accounted for its investment in VisEraunder the equity method. For the three months ended July 31, 2008, theCompany paid $17.1 million to VisEra for color filter and othermanufacturing services. For the three months ended July 31, 2007, theCompany paid $34.3 million to VisEra for color filter and othermanufacturing services.

 

In May 2007,the Company purchased a 19.98% ownership in WLCSP for $9.0 million. Forthe three months ended July 31, 2008 and 2007, the Company paid$0.4 million and $2.3 million, respectively, to WLCSP for chipscale packaging services.

 

The following table summarizes the transactions thatthe Company’s consolidated affiliate, SOI, and its affiliate, VisEra, engagedin with related parties in the ordinary course of business in the three monthsended July 31, 2008 and 2007 (in thousands):

 
| ** **                            | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|
| ** **                            | ** ** | **July 31,**                | ** ** |
| ** **                            | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| ***SOI transactions with:***          | ** ** | ** **                       | ** ** | ** ** | ** ** |
| ImPac:                                |       |                             |       |   |   |
| Purchases of manufacturing services   |       | $                                | 297        |   | $ | 563 |   |
| Balance payable at period end, net    |       | 238                              |       | 422 |   |
| PSC:                                  |       |                             |       |   |   |
| Purchases of wafers                   |       | 1,035                            |       | 1,540 |   |
| Rent and other services               |       | 16                               |       | — |   |
| Balance payable at period end, net    |       | 300                              |       | 478 |   |
|                                  |       |                             |       |   |   |
| ***VisEra transactions with:***       |       |                             |       |   |   |
| TSMC:                                 |       |                             |       |   |   |
| Sales to TSMC                         |       | 658                              |       | 615 |   |
| Purchases of manufacturing services   |       | —                           |       | 243 |   |
| Rent, utilities and other services    |       | —                           |       | 1,859 |   |
| Balance receivable at period end, net |       | 473                              |       | 1,917 |   |
| WLCSP:                                |       |                             |       |   |   |
| Purchases of manufacturing services   |       | $                                | —     |   | $ | 1,531 |   |

 

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

 

24

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| **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 followingdiscussion contains forward-looking statements, within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the SecuritiesExchange Act of 1934, which involve risks and uncertainties.Forward-looking statements generally include words such as “anticipates,” “believes,”“expects,” “intends,” “may,” “outlook,” “plans,” “seeks,” “will”  and words of similar import as well as thenegative 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-lookingstatements included in this Quarterly Report on Form 10-Q, including, butnot limited to, statements regarding the extent of future sales throughdistributors, future growth trends and opportunities in certain markets, thedevelopment, introduction and capabilities of new products, future sales of ourproducts outside the United States, the increasing competition in our industry,the continued importance of the mobile phone market to our business, continuedprice competition and the consequent reduction in the average selling prices ofour products, future expenses we expect to incur, our effective tax rate forfiscal 2009, our future investments, our working capital requirements infiscal 2009 and thereafter, the effect of a change in foreign currencyrates, and the sufficiency of our available cash, cash equivalents andshort-term investments are based on current expectations and are subject toimportant factors that could cause actual results to differ materially fromthose projected in the forward-looking statements. Such important factors include, but are not limited to, thoseset forth under the caption “Item 1A. Risk Factors,” beginning on page 43of this Quarterly Report and elsewhere in this Quarterly Report and in otherdocuments we file with the U.S. Securities and Exchange Commission, orSEC. All subsequent written and oral forward-looking statements by orattributable to us or persons acting on our behalf are expressly qualified intheir entirety by such factors.*

* *

*OmniVision and OmniPixel are registered trademarks ofOmniVision Technologies, Inc. CameraChip, OmniPixel2,**OmniPixel3, OmniPixel3-HS, OmniQSP, OmniBSI, SquareGA**and TrueFocus aretrademarks of OmniVision Technologies, Inc. Wavefront Coded is aregistered trademark of**OmniVision CDM Optics, Inc.,a wholly-owned subsidiary of OmniVision Technologies, Inc. WavefrontCoding is a trademark 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 OmniPixel2 architecture,which is based on a 2.2 μm x 2.2 μm pixel and uses a 0.13 μmprocess geometry, is less than half the size of the OmniPixel architectureintroduced in 2004, but with improved performance.

 

In February 2007,we introduced our first TrueFocusTM camera with Wavefront CodingTM technology forthe mobile phone market. Our patented Wavefront Coding technology is a methodof optically encoding light using a special lens to form an intermediate imageon the image sensor, and decoding this intermediate image with digitalprocessing to create a picture that is in focus across virtually the entireimage. TrueFocus technology is designed to provide ‘point-and-shoot’ capabilityto our customers with a product that effectively targets the mobile phonemarket by being small, durable, easy to manufacture and cost-competitive.

 

In May 2007,we announced the introduction of our OmniPixel3TM architecture. The OmniPixel3architecture is based on a 1.75 μm x 1.75 μm pixel and a 0.11 μmprocess geometry which further reduced the size of a given image sensor arraywithout any reduction in image quality.

 

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| **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 1.75 μm 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 phones, notebook computers and other applications that requireexceptional low-light performance.

 

In May 2008, we announced a new approach to CMOS image sensordesign we call OmniBSITM technology. OmniBSI technology is based on an idea called back sideillumination, or BSI. Our first OmniBSI product, an 8-megapixel image sensor isbuilt using an advanced 1.4 μm pixel, and we believe we are the firstimage sensor company to announce a viable process for the mass production ofBSI sensors.

 

All current CMOS image sensors capture light on the front side of thechip, so the photo-sensitive portion has to share the surface of the imagesensor with the metal wiring of the transistors in the pixel and the metalwiring acts to limit the amount of image light that reaches the photo-sensitiveportion of the image sensor. With our new OmniBSI architecture, the image sensorreceives light through the back side of the chip. As a result, there is nometal wiring to block the image light, and the entire backside of the imagesensor can be photo-sensitive. Not only does this enable us to produce asuperior image, it also permits the front of the chip surface area to bedevoted entirely to processing, and permits an increase in the number of metallayers, both of which result in greater functionality.

 

In addition to increasing the amount of light the image sensor cancollect, our OmniBSI architecture significantly increases the quantumefficiency and reduces the cross talk of the sensor. Increasing the quantumefficiency increases the quality of the sensor’s color reproduction. Reducingcross talk reduces electrical noise, which produces sharper images and bettercolor.

 

Capturing light onthe back side of the image sensor also allows us to reduce the distance thelight has to travel to the pixels, and thus provide a wider angle of lightacceptance. Widening the angle of acceptance in turn makes it possible toreduce the height of the camera module, and thus the height of the device whichincorporates the camera.

 

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 January 2008,we introduced two new products. The first, the OV9710, is our first truehigh-definition, or HD, video CameraChip image sensor for mobile phone andnotebook computer markets. The OV9710 is a 1-megapixel CMOS image sensor builtwith our proprietary OmniPixel3 architecture and a 3 μm x 3 μm pixelfor optimal low-light sensitivity and high-quality HD video performance at30 frames per second, or FPS. We designed the OV9710 specifically to meetall mobile phone (1280 x 720 pixels) and notebook and personal computer (1280 x800 pixels) market requirements in terms of performance, quality, reliabilityand power consumption.

 

The second newproduct is the OV7725. The 1⁄4-inch OV7725 is built with a 6 μm x 6 μm pixelto deliver the ultra-high light sensitivity required for the low lightconditions in which most consumers use their notebook computers. The OV7725 isa highly integrated CameraChip image sensor that provides the fullfunctionality of a VGA camera and image processor on a single chip. A unique featureof the OV7725 is its high chief ray angle which allows for a reduction inmodule height, a critical element in building cameras that can fit in today’sthin notebook computers. A second highlight of the OV7725 is its ability tooperate at 60 FPS, in VGA mode, or 120 FPS in quarter VGA, or QVGA,for optimal performance in notebook and personal computer and gamingapplications.

 

In February 2008,we introduced two additional new products. The first, the OV3642, is a 1⁄4-inch,3-megapixel CameraChip image sensor with extended depth of field technologyembedded on-chip. The fully integrated OV3642 is built with our newOmniPixel3-HS technology and offers best-in-class low light performance.Additionally, the OV3642 incorporates our most advanced ISP technologyresulting in increased picture clarity and sharpness.

 

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

 

The second newproduct is the OV7690, a VGA CameraChip image sensor with a 1/13-inch formfactor. The OV7690’s new 1.75 μm OmniPixel3-HS architecture combined witha unique, non-linear micro lens shift technology allows for a significantreduction in distance between the image sensor and the lens, and thus enablesus to significantly reduce the module height while maintaining high levels ofimage quality and camera performance. The result is an ultra-thin camera moduleof just 4.5 mm x 4.5 mm and a height of only 2.8 mm, a criticaldimension both for slim mobile phones and for notebook computer applicationswhere the camera module can be no thicker than the LCD housing.

 

In May 2008,we introduced three new products. The first, the OV5630, is a 1/3-inch,5-megapixel CameraChip image sensor targeted at the mobile phone market. TheOV5630 is based on the OmniPixel3-HS architecture, enabling quality low-lightimage capture with low-light sensitivity of 960 mV/(Lux-sec). The OV5630 alsooutputs data in full 5-megapixel resolution at 15 FPS, and records 720p HDvideo at 60 FPS, or 1080p at 30 FPS. In QVGA resolution, the OV5630can output data at 120 FPS, ideal for slow motion preview. For the fasttransfer of image data, the OV5630 is outfitted with a two-lane, high-speedMIPI interface. This enables mobile phone makers to use the OV5630’s parallelinterface as input for a secondary camera, while alternately providing outputvia the MIPI interface.

 

In May 2008,we also introduced the OV5633, another 1/3-inch 5-megapixel CameraChip imagesensor. This image sensor has all of the same functionality as the OV5630, butemploys a different chief ray angle to suit the specific lens requirements ofthe DSC market.

 

Our third newproduct introduction in May 2008 was the OV3647, a 1/4-inch3-megapixel image sensor that supports the mobile display digital interface, orMDDI. The OV3647 is also equipped with a standard parallel interface which hasthe unique ability to act as an input for a secondary camera, so it can sharethe MDDI interface while also functioning as an MDDI hub. Sharing the MDDIreduces the number of interconnects to the Baseband processor, which increasesreliability, reduces power consumption and enables rapid two-way data transfer.Sharing the MDDI also eliminates high frequency electro-magnetic interference,or EMI, issues, which often have adverse effects on system performance. TheOV3647 is small enough to enable 7 x 7 x 5 mm camera modules with a very shortoptical track, and thus is versatile enough to work well both with fixed focusand auto-focus modules. The OV3647’s embedded, one-time programmable memory isdesigned for part recognition and simplification of module designs usingdifferent lenses. In addition to targeting the mobile phone market, the OV3647is well-suited to applications in the DSC, notebook and personal computer andtoy sectors.

 

## ***Joint Venture withTSMC***

## *** ***

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 onTSMC 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, a Taiwan-based provider of chip scale packaging services, of whichwe directly owned approximately 7.8% at that time. In fiscal 2006, VisErainvested an additional $0.5 million and we invested an additional $130,000in XinTec as our portion of an additional capital injection to enable XinTec toexpand its production capacity. As a result of the increase in our beneficialinterest in XinTec due to VisEra’s investment in XinTec duringfiscal 2006, we accounted for our investment in XinTec under the equitymethod. In January 2007, 

 

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

 

TSMC, through the purchase of approximately90.5 million previously unissued shares, acquired a controlling interestin XinTec. As a result of TSMC’s investment, our direct ownership percentage inXinTec declined from 7.8% to 4.4% and VisEra’s ownership percentagedeclined from 29.6% to 16.9%. Due to the reduction in our ownership percentagein XinTec and the deconsolidation of VisEra described below, effective January 1,2007, we began to account for 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 25.0% to43.0%, 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 activitiesof VisEra either involved or were conducted on our behalf, VisEra was avariable interest entity, or VIE. Since we were the source of virtually all ofVisEra’s revenues, we had a decisive influence over VisEra’s profitability.Accordingly, we considered ourselves to be the primary beneficiary of the jointventure, and in the quarter which ended in October 2005, we began toinclude VisEra’s financial results in our consolidated financial statements. Inthe quarter ended January 2006, we increased our interest in VisEra from43.0% to 46.0% through purchases of unissued shares. In January 2006, pursuantto the Amended VisEra Agreement, VisEra purchased from TSMC the equipment usedfor applying color filters and micro-lenses to wafers, and VisEra is nowproviding the related processing services that we previously purchased fromTSMC. In November 2006, we invested $6.1 million in VisEra as ourportion of an additional cash or asset contribution to be made by TSMC and usunder the then current Amended VisEra 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 were no longer the primary beneficiary of the joint venture and thatVisEra had ceased to be a VIE, as defined under FIN 46(R). As a result, wedeconsolidated VisEra as of the date of the change. As a consequence of thedeconsolidation, effective January 1, 2007, we account for our investmentin VisEra under the equity method. The deconsolidation of VisEra did not have amaterial effect on our reported revenue or reported net income forfiscal 2007 or 2008. See Note 5 – “*Long-termInvestments”*to our consolidated financial statements.

 

InJanuary 2007, we and TSMC also signed an amendment to the Amended VisEraAgreement to provide for an increase in VisEra’s manufacturing capacity. Underthe amendment, we and TSMC each made an additional $27.0 millioninvestment in VisEra in April 2007. In April 2008, VisErasubstantially completed the relocation and expansion of its capacity at a newlyconstructed manufacturing facility in Taiwan.

 

## ***Joint Venture withPowerchip Semiconductor Corporation***

 

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. SOI also issued shares to its employees in July 2006,with an estimated fair value of $459,000 which caused our ownership percentageto decline from 49.0% to 46.6%. In April 2007, SOI became listed on theTaiwan GreTai Securities Market, or TGSM. The TGSM is the approximateequivalent in Taiwan of the Over-The-Counter market in the United States. Inconjunction with the TGSM listing, various employees of SOI exercised theiroptions and increased the number of shares outstanding. From time to time, SOIalso issues shares to its employees as a bonus which further dilutes theCompany’s ownership percentage. As of July 31, 2008, we owned 43.9% ofSOI. See Note 6 – “*ConsolidatedAffiliate – Silicon Optronics, Inc.”*andNote 17 – “*Related Party Transactions”*to our condensed consolidated financial statements.

 

## ***Acquisition of CDM***

 

In April 2005,we completed the acquisition of OmniVision CDM Optics, Inc., or CDM,formerly CDM Optics, Inc. CDM is the exclusive licensee from an affiliateof the University of Colorado of a patented technology, known as WavefrontCoding technology that increases the performance of an imaging system bysubstantially 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 our image sensors. Because the image is 

 

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

 

alwaysin focus, Wavefront Coding technology also eliminates the time-delay inherentin conventional auto or manually focused camera systems. The closingconsideration for the acquisition consisted of $10.0 million in cash andapproximately 515,000 shares of our common stock. In addition, we areobligated to pay $10.0 million in cash upon the sale, prior to the end of April 2009,of a pre-determined number of revenue-producing products incorporating CDM’stechnology.

 

In the threemonths ended October 31, 2006, we adjusted “Goodwill” related to ouracquisition of CDM by $2.6 million. The adjustment was related, in part,to a put option that expired during the quarter with respect to the147,000 shares held 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.

 

## ***Capital Resources***

 

As of July 31,2008, we held approximately $251.0 millionin cash and cash equivalents and approximately $28.4 million in short-term investments. To mitigate marketrisk related to short-term investments, we have an investment policy designedto preserve the value of capital and to generate interest income from theseinvestments without material exposure to market fluctuations. Market risk isthe potential loss due to the change in value of a financial instrument as aresult of changes in interest rates or bond prices, and changes in marketliquidity and in the pricing of risk. Our policy is to invest in financialinstruments with short maturities, limiting interest rate exposure, and tomeasure performance against comparable benchmarks. We maintain our portfolio ofcash equivalents and short-term investments in a variety of securities,including both government and corporate obligations with ratings of “A” orbetter and money market funds. We do not believe that the value of our cash andshort-term investments will be significantly affected by recent instability inthe global financial markets.

 

In June 2005,our board of directors authorized us to use up to $100 million of ouravailable cash under an open-market program to repurchase our common stock. Atthe expiration of the program in June 2006, we had cumulativelyrepurchased 5,870,000 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. Subject to applicable securities laws, such repurchases will beat times and in amounts as we deem appropriate, based on factors such as marketconditions, legal requirements and other corporate considerations. As of July 31,2008, we had cumulatively repurchased 5,093,500 shares of our common stockunder this open-market program for an aggregate cost of approximately$86.2 million. As of July 31, 2008, we had approximately$13.8 million remaining available for further repurchases under theexisting authorization. See Note 14 *– “Treasury Stock”*to ourcondensed consolidated financial statements.

 

## ***The CurrentEconomic and Market Environment***

 

We operate in achallenging economic environment that has undergone significant changes intechnology and in patterns of global trade. We 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 organize ourmarketing efforts into end-use market groups, each of which concentrates on aparticular product or, in some cases, customer within a product group. Thus wehave marketing teams that address the mobile phone market, the notebook andpersonal computer market, the digital still camera, or DSC, market, thesecurity and surveillance market, the toys and games market, and the automotiveand medical markets.

 

In the mobilephone market in particular, future revenues depend to a large extent on designwins where, on the basis of an exhaustive evaluation of available products, aparticular mobile phone maker determines which image sensor to design into oneor more specific models. The time lag between design win and volume shipmentsvaries from as little as three months to as much as twelve months, which couldcause an unexpected delay in generating revenues, especially during periods ofproduct transitions. Design wins are also an important driver in the many othermarkets that we 

 

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address,and in some cases, such as automotive or medical applications, the time lagbetween a particular design win 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 image sensor requiresconforming other specifications of the product to the chosen image sensor andmakes subsequent changes both difficult and expensive. Accordingly, the abilityto timely produce and deliver reliable products in large quantities is a keycompetitive differentiator. Since our inception, we have shipped more than onebillion CameraChip image sensors, including approximately 117 million inthe three months ended July 31, 2008. We believe that these quantities demonstratethe capabilities 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 an investee joint venture company. This approach allows us tofocus our resources on the design, development, marketing and testing of ourproducts and significantly reduces our capital requirements.

 

To increase andenhance our production capabilities, we work closely with TSMC, our principalwafer supplier and one of the largest wafer fabrication companies in the world,to increase, as necessary, the number of its fabrication facilities, at whichour products can be produced. VisEra, our joint venture with TSMC, and ourinvestments in three key back-end packaging suppliers are part of a broadstrategy to ensure that we have sufficient back-end capacity for the processingof our image sensors in the various formats required by our customers. In January 2007,we and TSMC each invested an additional $27.0 million in VisEra for itsmanufacturing capacity expansion. In April 2008, VisEra substantiallycompleted the relocation and expansion of its capacity at a newly constructedmanufacturing facility in Taiwan. Separately, TSMC purchased90,526,000 shares from XinTec to enable XinTec to expand its capacity. In February 2007,we also entered into a foundry manufacturing agreement with 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.

 

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 mobile phones, notebook and personalcomputers, DSCs and cameras for toys and games, are consumer electronics goods.These mass-market camera devices generally have seasonal cycles whichhistorically have caused the sales of our customers to fluctuatequarter-to-quarter. Historically, demand from OEMs and distributors that servesuch consumer product markets has been stronger in the second and thirdquarters of our fiscal year and weaker in the first and fourth quarters of ourfiscal year. In addition,****since a verylarge number of the manufacturers who use our products are located in China,Hong Kong and Taiwan, the pattern of demand for our image sensors has beenincreasingly influenced by the timing of the extended lunar or Chinese New Yearholiday, a period in which the factories which use our image sensors generallyclose.

 

We believe thatthe market opportunity represented by mobile phones remains very large. Webenefited from the growth in shipments of image sensors for mobile phones infiscal 2008. In the threemonths ended July 31, 2009, demandincreases were particularly strong for our VGA and 1.0-megapixel image sensors.

 

We also believethat, like the DSC market, mobile phone and notebook and personal computerdemand will not only continue to shift toward higher resolutions, but also willincreasingly fragment into multiple resolution categories. In addition, thereis increased demand for customization, and several different interfacestandards are coming to maturity. All of these trends will require thedevelopment of an increasing variety of products.

 

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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 Hynix, Kodak, Micron, Samsung, Sharp, Sony, STMicroelectronics and Toshiba. We expect to see continued price competition inthe image-sensor market for mobile phones, notebook and personal computers anddigital cameras 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.

 

In addition, fromtime to time, other companies enter the CMOS image sensor market by usingobsolete and available manufacturing equipment. While these efforts have rarelyhad any long-term success, the new entrants do sometimes manage to gain marketshare in the short term by pricing their products significantly below currentmarket levels which puts additional downward pressure on the prices we canobtain for our products.

 

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 ASPs, our gross margin willdecline.

 

As part of ourongoing efforts to achieve both higher resolutions and smaller chip sizes, weinitiated mass production volumes of our OmniPixel3 sensors with 0.11 μmprocess technologies in January 2008. Given the rapidly changing nature ofour technology, there can be no assurance that we will not encounter delays orother unexpected yield issues with future products. During the early stages ofproduction, production yields and gross margins for new products are typicallylower than those of established products. We can encounter unexpectedmanufacturing issues, such as unexpected back-end yield problems. In addition,in preparation for new product introductions, we gradually decrease productionof established products. Due to our 12-14 week production cycle, it isextremely difficult to predict precisely how many units of established productswe will need. It is also difficult to accurately predict the speed of the rampof new products. As a result, it is possible that we could suffer fromshortages for certain products and build inventories in excess of demand forother products. We carefully consider the risk that our inventories may beexcess to expected future demand and record appropriate reserves. If, assometimes happens, we are subsequently able to sell these reserved products,the sales have little or no associated cost and consequently they have afavorable impact on gross margins.

 

## ***Sources ofRevenues***

## *** ***

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.

 

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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, and the distributor is obligated to pay for the products whetheror not the distributor has sold them at the time payment is due. Under theterms of our agreements with such distributors and subject to our priorapproval, distributors are entitled to reclaim from us as price adjustments thedifference, if any, between the prices at which we sold the product to thedistributors and the prices at which the product is subsequently sold by thedistributor. In addition, distributors have limited rights to return inventorythat they determine is in excess of their requirements, and accordingly, indetermining the appropriate level of allowances for excess and obsoleteinventory, we take into account the inventories held by our distributors. Forthese reasons, prices and revenues are not fixed or determinable until thedistributor resells the products to our end-user customers and the distributornotifies us in writing of the details of such sales transactions. Accordingly,we recognize revenue using the “sell-through” method. Under the “sell-through”method, we defer the revenue, adjustments to revenue and the related costs ofrevenue until the final resale of such products to end customers. The amountsbilled to these distributors and adjustments to revenue and the cost ofinventory shipped to, but not yet sold by, the distributors are shown net onthe Consolidated Balance Sheets as “Deferred revenues, less cost of revenues.”

 

In order todetermine whether collection is probable, we assess a number of factors,including our past transaction history with the customer and the creditworthinessof the customer. If we determine that collection is not reasonably assured, wedefer the recognition of revenue until collection becomes reasonably assured orupon receipt of payment.

 

In addition, werecognize revenue from the performance of services to a limited number of ourcustomers by our wholly-owned subsidiary, CDM. We recognize the CDM-associatedrevenue 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 theanticipated final total costs based on current estimates of the costs tocomplete the projects. CDM-associated revenue has not been material in any ofthe periods presented.

 

## ***CriticalAccounting 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, 2008.Other than for policies that are related to the issuance of performance sharesunder SFAS No. 123(R), there have been no material changes in any of ourcritical accounting policies since April 30, 2008.

 

*Stock-BasedCompensation Expense for Performance Shares*

* *

In September 2007,our stockholders approved the 2007 Equity Incentive Plan, or the2007 Plan. See Note 12 – “*EmployeeStock Purchase, Equity Incentive and Stock Option Plans”* to ourcondensed consolidated financial statements. In July 2008, as allowed bythe 2007 Plan, we granted performance share awards to certain employees. Thenumber of shares that an employee actually earns under the awards is based onOmniVision’s achievement of certain corporate performance goals at the end of aone-year performance period. The number of earned performance shares that anemployee is eligible to receive may be reduced depending on such employee’sindividual performance. As required by SFAS No. 123(R), when we record thestock-based compensation expense for such awards that carry performancecontingencies, we have to estimate the probable outcome at the end of theperformance period. Furthermore, we have to adjust the cumulative compensationexpense recorded when probable outcome for the performance-based shares issubsequently updated for changes in facts and circumstances.

 

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**Resultsof Operations**

 

The following table sets forth the results of ouroperations as a percentage of revenues. Our historical operating results arenot necessarily indicative of the results we can expect for any future period.

 
| ** **                                       | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|
| ** **                                       | ** ** | **July 31,**                | ** ** |
| ** **                                       | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Revenues                                         |       | 100.0                            | %          | 100.0 | % |
| Cost of revenues                                 |       | 74.8                             |       | 76.6 |   |
| Gross margin                                     |       | 25.2                             |       | 23.4 |   |
| Operating expenses:                              |       |                             |       |   |   |
| Research, development and related                |       | 11.6                             |       | 10.1 |   |
| Selling, general and administrative              |       | 10.0                             |       | 8.7 |   |
| Total operating expenses                         |       | 21.6                             |       | 18.8 |   |
| Income from operations                           |       | 3.6                              |       | 4.6 |   |
| Interest income, net                             |       | 0.7                              |       | 1.9 |   |
| Other income, net                                |       | —                           |       | 0.2 |   |
| Income before income taxes and minority interest |       | 4.3                              |       | 6.7 |   |
| Provision for (benefit from) income taxes        |       | 0.8                              |       | (0.8 | ) |
| Minority interest                                |       | (0.1                             | )          | — |   |
| Net income                                       |       | 3.6                              | %          | 7.5 | % |

 

*Three Months Ended July 31,2008 as Compared to Three Months Ended July 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 mobile phones, notebooks and personal computers, security andsurveillance cameras, DSCs, interactive video and toy cameras, and automotiveand medical products. Revenues for the three months ended July 31, 2008increased by 0.7% to approximately $174.3 million from $173.1 millionfor the three months ended July 31, 2007. The increase in revenues was dueto an increase in unit sales of our image-sensor products, primarily for mobilephones, and notebooks and personal computers, partially offset by a decline inour ASPs.

 

## ***Revenues fromSales to OEMs and VARs as Compared to Distributors***

 

We sell our image-sensor products either directly toOEMs and VARs or indirectly through distributors. The percentage of revenuesfrom sales to OEMs and VARs was lower in the three months ended July 31, 2008than in the prior-year period. We expect that the percentage of revenues fromsales through OEMs and VARs will vary from year to year in response to changesin the make-up of our customer list, but that it will continue to represent amajority of our revenues. The gross margin that we earn on sales to OEMs andVARs or through distributors is not significantly different. The followingtable shows the percentage of revenues from sales to OEMs and VARs anddistributors in the three months ended July 31, 2008 and 2007:

 
| ** **    | ** ** | **Three Months Ended** | ** ** |
|---------------|------------|----------------------------------|------------|
| ** **    | ** ** | **July 31,**                | ** ** |
| ** **    | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| OEMs and VARs |       | 58.3                             | %          | 64.5 | % |
| Distributors  |       | 41.7                             |       | 35.5 |   |
| Total         |       | 100.0                            | %          | 100.0 | % |

 

*OEMs andVARs.*   In the three months ended July 31,2008, two OEM customers accounted for approximately 12.3% and 10.2% of ourrevenues. In the three months ended July 31, 2007, one OEM customeraccounted for approximately 18.1% of our revenues. For the three months ended July 31,2008 and 2007, no other OEM or VAR customer accounted for 10% or more of ourrevenues.

 

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*Distributors.*   Inthe three months ended July 31, 2008, one distributor customer accountedfor approximately 22.2% of our revenues. In the three months ended July 31,2007, one distributor customer accounted for approximately 22.9% of ourrevenues. For the three months ended July 31, 2008 and 2007, no otherdistributor customer accounted for 10% or more of our revenues.

 

## ***Revenues fromDomestic Sales as Compared to Foreign Sales***

## *** ***

The followingtable shows the percentage of our revenues derived from sales of our image-sensorproducts to domestic customers as compared to foreign customers for the threemonths ended July 31, 2008 and 2007:

 
| ** **     | ** ** | **Three Months Ended** | ** ** |
|----------------|------------|----------------------------------|------------|
| ** **     | ** ** | **July ****31,**            | ** ** |
| ** **     | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Domestic sales |       | 5.9                              | %          | 0.8 | % |
| Foreign sales  |       | 94.1                             |       | 99.2 |   |
| 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.

 

### **Gross Profit**

### ** **

Our gross marginin the three months ended July 31, 2008 was 25.2%, up from 23.4% for thethree months ended July 31, 2007. The principal contributor to the year-over-year increase in gross margin was reductionsin our production costs, partiallyoffset by the decline in our ASPs.The write-down of inventories totaled approximately $2.5 million duringthe three months ended July 31, 2008, as compared to $4.7 million inthe similar prior year period. During the three months ended July 31,2008, the ASPs of our products werelower than they were in the year-earlier period. The decline in ASPs was due,in part, to a general price decline due to competition, an increase in the proportion of salesrepresented by VGA image sensors, and, in part, also to an increase inthe proportion of sales represented by bare die, often referred to aschip-on-board, or COB, products, rather than packaged products. We were able topartially offset the decline in ASPs by reducing our manufacturing costs. Werecorded approximately $0.9 millionin stock-based compensation expense to cost of revenues during the three-monthperiods ended July 31, 2008, in accordance with SFAS No. 123(R),as compared to approximately $1.0 million in the prior fiscal year.

 

Revenue from salesof previously reserved products in the three months ended July 31, 2008was $2.5 million, as compared to $1.9 million during the same periodin the prior fiscal year. In the three months ended July 31, 2008, werecorded an allowance for excess and obsolete inventory totaling $2.5 millionto cost of revenues as compared to $4.7 million during the same period inthe prior fiscal year.

 

**Research, Development and RelatedExpenses**

** **

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 fluctuate significantly.Research, development and related expenses for the three months ended July 31,2008 increased to approximately $20.3 million from approximately$17.4 million for the three months ended July 31, 2007. As apercentage of revenues, research, development and related expenses for thethree months ended July 31, 2008 and 2007 represented 11.6% and 10.1%,respectively.

 

The increase inresearch, development and related expenses of approximately $2.9 million,or 16.5%, for the three months ended July 31, 2008 from the similarperiod in the prior year resulted primarily from a $0.6 million increasein 

 

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salaryand payroll-related expenses associated with salary increases and the hiring ofadditional personnel, a $0.6 million increase in stock-basedcompensation expense recognized in accordance with SFAS No. 123(R), a$0.6 million increase in non-recurring engineering expenses relatedto new product development, a $221,000 increase in office and facilityexpenses, $346,000 increase in depreciation and amortization expenses ofacquired intangible assets and a $252,000 increase in patent-relatedexpenses. We anticipate that our research, development and related expenseswill continue to increase as we develop and introduce new products, includingthose employing our OmniBSI technologies and as we develop other newtechnologies related to image sensors.

 

**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 July 31, 2008 increasedto approximately $17.4 million from $15.2 million the three monthsended July 31, 2007. As a percentage of revenues, selling, general andadministrative expenses for the three months ended July 31, 2008 and 2007represented 10.0% and 8.7%, respectively.

 

The increase inselling, general and administrative expenses of approximately$2.2 million, or 14.6%, for the three months ended July 31, 2008 fromthe similar period in the prior year resulted primarily from a$1.1 million increase in salary and payroll-related expenses associatedwith salary increases and the hiring of additional personnel, a$0.5 million increase in commissions paid primarily to distributorsand sales representatives, a $0.5 million increase in fees for outsideservices, a $241,000 increase in stock-based compensation expenserecognized in accordance with SFAS No. 123(R), a $179,000 increase infacility expenses, partially offset by a $461,000 decrease in legal andaccounting expenses and a $199,000 decrease in provisions for bad debts.We anticipate that our selling, general and administrative expenses willincrease in the future due to the continued expansion of our organization,addition of our new corporate facilities and the continuing upgrade of ourcomputer systems, including our enterprise resource planning, or ERP, and othermanagement information systems.

 

**Interest Income, 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 $1.3 million for the three months ended July 31,2008 from $3.4 million for the three months ended July 31, 2007. Thereduction in interest income for the three months ended July 31, 2008 ascompared to the corresponding period in the prior year was the result of lowerinterest rates.

 

**Other Income, Net**

 

Other income, net,for the three months ended July 31, 2008 totaled $49,000. The currentquarter amount included a $433,000 gain on the interest rate swap agreements relatedto the mortgage on our complex of four buildings located in Santa Clara, California,or Santa Clara Property, partially offset by a $395,000 loss that representedour portion of the net loss recorded by ImPac Technology Co., Ltd., or ImPac,which we account for under the equity method of accounting. Other income, net,for the three months ended July 31, 2007 totaled $260,000. The amount forthe three months ended July 31, 2007 included a $0.6 million gain onthe interest rate swap agreement, partially offset by a $109,000 loss as ourportion of the net loss recorded by ImPac, which we account for under theequity method of accounting. In addition, Other income, net, included a$351,000 loss consisting of an equity method investment adjustment, partiallyoffset by our portion of the net income recorded by WLCSP, which we account forunder the equity method of accounting.

 

**Provision for Income Taxes**

** **

We generatedapproximately $7.5 million and $11.6 million in income before incometaxes and minority interest for the three months ended July 31, 2008 and2007, respectively. We recorded a provision for income taxes for the threemonths ended July 31, 2008 of approximately $1.4 million and anincome tax benefit of approximately $1.4 million for the three monthsended July 31, 2007. For the three months ended July 31, 2008 and2007, our effective tax rates were 18.8% and (11.7)%, respectively. Quarterlyincome taxes reflect an estimate of the effective tax rate for the fiscal yearand include, when applicable, the impact of discrete tax items. The effectivetax benefit for the three months ended July 31, 2007 was principally theresult of the income tax benefits from discrete tax items, in particular therelease of unrecognized tax benefits including interest and penalties that wereno longer required as a result of a change in tax law during that 

 

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quarterin a foreign jurisdiction in which we do business. Without regard to discretetax items, in both years, our effective tax rates were less than the combinedfederal and state statutory rate of approximately 40% principally because weearn a significant portion of our income in jurisdictions where tax rates arelower than the combined federal and state statutory rate. We expect that ourconsolidated effective tax rate in fiscal 2009 will continue to be lessthan the combined federal and state statutory rates. The extent to which oureffective tax rate in fiscal 2009 is less than the combined federal andstate statutory rates is principally contingent upon the proportion andgeographic mix of our total pre-tax income.

 

**Minority Interest**

 

Minority interestfor the three months ended July 31, 2008 and 2007 was $(105,000) and$21,000, respectively, which represents the 56.1% and 55.0% interest that wedid not own in the net income (loss) of SOI.

 

**Liquidity and Capital Resources**

** **

Our principalsources of liquidity at July 31, 2008 consisted of cash, cash equivalentsand short-term investments of $279.4 million.

 

## ***Liquidity***

 

Our workingcapital remained unchanged at $413.7 million as of July 31, 2008 and April 30,2008. The components of our working capital changed as follows: a$33.7 million increase in cash and cash equivalents primarily due to cashprovided by operating activities and a $16.6 million increase in accountsreceivable, net, resulting from an increase in product shipments late in thethree months ended July 31, 2008. These increases in working capital werepartially offset by: a $23.6 million decrease in short-term investments; a$15.8 million increase in accounts payable primarily resulting from thetiming of the ERP implementation; a $5.0 million decrease in inventories;a $3.5 million increase in the current portion of long-term debt and a$3.0 million increase in deferred revenues, less cost of revenues.

 

SOI maintains fourunsecured lines of credit with three commercial banks, which provide a total ofapproximately $3.6 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 covenantrequirements for these facilities and at July 31, 2008, there were noborrowings outstanding under these facilities.

 

## ***Cash Flows fromOperating Activities***

 

For the threemonths ended July 31, 2008, net cash provided by operating activitiestotaled approximately $13.7 million as compared to $19.8 million forthe corresponding period in the prior year. The principal components of thecurrent year amount were: net income of approximately $6.2 million for thethree months ended July 31, 2008, adjusted for non-cash charges of$6.9 million in stock-based compensation, $4.0 million indepreciation and amortization; $2.5 million in write-down of inventories,$1.7 million of gains in equity investments and a $6.8 millionincrease in accounts payable; a $4.0 million decrease in inventories; a$3.0 million increase in deferred income; a $0.7 million decrease inprepaid expenses and other current assets; and a $368,000 increase in incometaxes payable. These increases were partially offset by: a $16.6 millionincrease in accounts receivable, net; a $1.2 million decrease in accruedexpenses and other current liabilities; and a $485,000 decrease in deferred taxliabilities. The $16.6 million increase in accounts receivable, net,reflects the higher level of revenues during the three months ended July 31,2008, combined with an increase in days of sales outstanding as of July 31,2008 to 64 days from 56 days as of April 30, 2008. The$4.0 million decrease in inventories was a reflection of an improvement inannualized inventory turns to 4.7 as of July 31, 2008 from 4.3 as of April 30,2008.

 

For the threemonths ended July 31, 2007, net cash provided by operating activitiestotaled approximately $19.8 million. The principal components of thecurrent year amount were: net income of approximately $13.0 million forthe three months ended July 31, 2007, adjusted for non-cash charges of$6.2 million in stock-based compensation; $4.7 million in write-downof inventories; $3.0 million in depreciation and amortization;$1.5 million of gains in equity investments; a $25.0 million increasein accounts payable; $4.3 million decrease in prepaid expenses and othercurrent assets and a $0.6 million decrease in refundable and deferredincome taxes. These increases were partially offset by: a $24.6 millionincrease in inventories; a $6.1 million increase in accounts receivable,net; a $1.5 million decrease in income taxes payable and a$0.9 million decrease in deferred tax liabilities. The $6.1 millionincrease in accounts receivable, net, reflects the higher level of revenuesduring the three months ended July 31, 2007, partially offset by adecrease in days of sales outstanding as of July 31, 2007 to 38 daysfrom 49 days as of April 30, 2007. The 

 

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

 

$24.6 millionincrease in inventories was in anticipation of increased sales in the secondquarter of fiscal 2008.The inventory balances increased concurrently with an increase in annualizedinventory turns to 3.8 as of July 31, 2007 from 3.1 as of April 30,2007. The $4.3 million decrease in prepaid expenses and other currentassets was principally due to the reclassification of a deposit paid for landfrom other current assets to property, plant and equipment upon transfer oftitle. Our income taxes payable decreased as a consequence of the adoption ofFIN 48 as of May 1, 2007.

 

## ***Cash Flows FromInvesting Activities***

## *** ***

For the threemonths ended July 31, 2008, our cash provided by investing activitiestotaled $11.6 million as compared to approximately $27.0 million usedin investing activities for the corresponding period in the prior year, dueprimarily to: $23.5 million in net sales of short-term investments,partially offset by $10.5 million in purchases of property, plant andequipment and $1.4 million in a long-term investment in ImPac. For thethree months ended July 31, 2007, our cash used in investing activitiestotaled approximately $27.0 million, and was due to: $14.7 million inpurchases of property, plant and equipment; $9.0 million in a long-terminvestment in WLCSP and $3.4 million in net purchases of short-terminvestments.

 

## ***Cash Flows FromFinancing Activities***

## *** ***

For the threemonths ended July 31, 2008, net cash provided by financing activitiestotaled approximately $8.3 million as compared to a use of$6.8 million during the corresponding period in the prior year. Thischange was primarily due to $6.0 million in proceeds from long-termborrowings and $2.7 million in proceeds from the exercise of stock optionsand employee purchases through our employee stock purchase plan. For the threemonths ended July 31, 2007, net cash used in financing activities totaledapproximately $6.8 million. This cash used in financing activities wasprimarily due to $9.6 million in repurchases of shares of our common stockunder the open-market program in the three months ended July 31, 2007partially offset by $2.9 million in proceeds from the exercise of stockoptions and employee purchases through our employee stock purchase plan.

 

## ***CapitalCommitments and Resources***

## *** ***

Over the next twoyears, we expect to invest a total of approximately $33.6 million in ourwholly-owned subsidiary in Shanghai, OmniVision Technologies (Shanghai) Co. Ltd., or OTC, of which we havealready contributed $12.0 million. The funding requirement arises from ourexecution of a Land-Use-Right Purchase Agreement with the Construction andTransportation Commission of the Pudong New District, Shanghai with aconcomitant commitment to spend approximately $33.6 million to develop theland. See Note 16* – “Commitmentsand Contingencies”*to our condensed consolidated financialstatements. We expect to fund our capital commitments to OTC 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 July 31, 2008, we had cumulativelyrepurchased 5,093,500 shares of our common stock under the open-marketprogram for an aggregate cost of approximately $86.2 million. See Note 14 –* “Treasury Stock”*toour condensed consolidated financial statements.

 

We are obligatedto pay an additional $10.0 million in cash upon the sale, prior to the endof April 2009, of a pre-determined number of revenue-producing products incorporatingCDM’s technology. CDM and the costs associated with the acquisition areincluded in our condensed consolidated balance sheets at July 31, 2008 andApril 30, 2008.

 

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 $50 million overapproximately the next twelve months will consist primarily of funding capitalinvestments at OmniVision Semiconductor (Shanghai) Co. Ltd., or OSC, and OTC.

 

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 July 31,2008 was $78.7 million, of which the timing of the resolution isuncertain.

 

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

 

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.

 

**Contractual Obligations and Commercial Commitments**

 

The following table summarizes our contractualobligations and commercial commitments as of July 31, 2008 and the effectsuch obligations and commitments are expected to have on our liquidity and cashflows 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                                          |       | $                                         | 15,782     |   | $ | 6,934 |   | $ | 6,254 |   | $ | 2,594 |   | $ | — |   |
| Capital leases                                            |       | 95                                        |       | 95 |   | — |   | — |   | — |   |
| Mortgage obligation                                       |       | 39,045                                    | (1)        | 4,040 |   | 8,716 |   | 6,155 |   | 20,134 |   |
| Noncancelable orders                                      |       | 55,551                                    |       | 55,551 |   | — |   | — |   | — |   |
| Total contractual obligations                             |       | 110,473                                   |       | 66,620 |   | 14,970 |   | 8,749 |   | 20,134 |   |
|                                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Other Commercial Commitments:                             |       |                                      |       |   |   |   |   |   |   |   |   |
| OTC                                                       |       | 21,631                                    | (2)        | 15,142 |   | 6,489 |   | — |   | — |   |
| Total commercial commitments                              |       | 21,631                                    |       | 15,142 |   | 6,489 |   | — |   | — |   |
| Total contractual obligations and commercial  commitments |       | $                                         | 132,104    |   | $ | 81,762 |   | $ | 21,459 |   | $ | 8,749 |   | $ | 20,134 |   |

 

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| (1)    |   | In  March 2007, we entered into the Mortgage Loan with a domestic bank in  the amount of $27.9 million.  In March 2008, we borrowed $6.0 million under the Term Loan for  building improvement of the Santa Clara Property. We drew down the remaining  $6.0 million under the Term Loan in July 2008. 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  $33.6 million in our subsidiary, OTC, of which we have already invested  $12.0 million. OTC will use the funds to develop land and construct  facilities for its use. See Note 16 – “*Commitments  and Contingencies”* to our condensed consolidated financial  statements.                                                                |

 

As of July 31,2008, the long-term income taxes payable under FIN 48 was$78.7 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, if any, or their outcomes.Accordingly, we have excluded this obligation from the schedule summarizing oursignificant obligations to make future payments under contractual obligationsas of July 31, 2008 presented above.

 

### **Off-BalanceSheet Arrangements**

### ** **

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

 

### **RecentAccounting Pronouncements**

### ** **

In September 2006,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) SFAS No. 157, *“Fair ValueMeasurements”* (“SFAS No. 157”) became effective for the Companyin its fiscal 2009. This Statement defines fair value, establishes aframework for measuring fair value and expands disclosures about fair valuemeasurements; however, it does not require any new fair value measurements. In February 2008,the FASB issued Financial Staff Position (“FSP”) SFAS No. 157-2, *“Effective Date of FASB Statement No. 157.”* FSP SFAS No. 157-2delays the effective date of SFAS No. 157 for the Company from itsfiscal 2009 to 2010 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). Effective May 1,2008, we adopted SFAS No. 157, as it 

 

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

 

appliesto our financial assets and liabilities. The adoption of the provision of SFAS No. 157did not have any material effect on our financial condition, results ofoperations or cash flows.

 

In February 2007,FASB issued SFAS No. 159, “*The Fair Value Option forFinancial Assets and Financial Liabilities*” (“SFAS No. 159”).Under SFAS No. 159, a company may elect to measure at fair value variouseligible items that are not currently required to be so measured. Eligibleitems include, but are not limited to, accounts receivable, available-for-salesecurities, equity method investments, accounts payable and firm commitments.SFAS No. 159 is effective in fiscal years beginning after November 15,2007 and is required to be adopted by us in the first quarter of ourfiscal 2009. Currently, we have not elected to adopt the fair valueoption, under SFAS No. 159, for any of our eligible items.

 

In May 2008,the FASB issued SFAS No. 162, “*TheHierarchy of Generally Accepted Accounting Principles*,”  or SFAS No. 162. This standardreorganizes the GAAP hierarchy in order to improve financial reporting byproviding a consistent framework for determining what accounting principlesshould be used when preparing U.S. GAAP financial statements. SFAS 162 shall beeffective 60 days after the SEC’s approval of the Public Company AccountingOversight Board’s amendments to Interim Auditing Standard, AU Section 411,“*The Meaning of Present Fairly in Conformitywith Generally Accepted Accounting Principles*.” We are currentlyevaluating the impact SFAS No. 162 will have on our consolidated financialstatements.

 

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

** **

## ***Foreign CurrencyExchange 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 July 31, 2008, the functional currency of our wholly-owned subsidiarieslocated in Hong Kong, OmniVision Technologies (Hong Kong) Company Limited andOmniVision Trading (Hong Kong) Company Ltd., and OmniVision Holding (Hong Kong)Co., Ltd.; in the Cayman Islands, OmniVision International Holding, Ltd. andOmniVision Technology International Ltd. (formerly HuaWei TechnologyInternational, Ltd.); in China, OSC and OTC, and in Taiwan,  Taiwan OmniVision Technologies Co., Ltd. andTaiwan OmniVision International Technologies Co., Ltd. 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 functionalcurrencies are included in “Other income, net” for the periods presented. Theamounts of transaction gains and losses for the three months ended July 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 InterestRate 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 and in variable rate demand notes, which have a finalmaturity date of up to thirty-nine years but whose interest rate is reset atvarying intervals typically between seven and 35 days. As of July 31,2008, we did not hold any auction rate securities or variable rate demandnotes.

 

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%. Inboth March and July 2008, we drew down $6.0 million under a termloan. Concurrent with the term loan, we also entered into an interest rate swap

 

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with anotional amount that approximates the principal outstanding under the termloan. We are the fixed rate payer under the swap with a fixed rate of 4.26%. InJuly 2008, in connection with the Term Loan we entered into a secondinterest rate swap with the bank to effectively convert the variable interestrate described above to a fixed rate. This second swap is for a period of fouryears. We are the fixed rate payer and the rate is fixed at 4.3% per annum andthe effective rate on the Term Loan is fixed at approximately 5.5%.Consequently,although we are required to mark the value of the swaps to market at eachbalance sheet date and record the associated non-cash cost or benefit as partof Other income (expense), net, a hypothetical 10% change in LIBOR would nothave a material effect on our annual interest expense.

 

**ITEM4.   CONTROLS AND PROCEDURES**

 

**(a)  ****Evaluationof Disclosure Controls and 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 chief executiveofficer and chief financial officer have concluded that, at the level ofreasonable assurance, our disclosure controls and procedures are effective toensure that the information we are required to disclose in reports that we fileor submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in SEC rules and forms and thatsuch information is accumulated and communicated to our management includingour principal executive and principal financial officers, as appropriate, toallow timely decisions regarding required disclosure.

 

**(b)  Changesin Internal Controls.**

** **

During the threemonths ended July 31, 2008, we substantially completed the implementationof the first phase of a new enterprise resource planning system, or ERP, basedon a suite of application software developed by Oracle Corporation. As part ofthe implementation, we migrated our legacy financial and supply chainmanagement systems to the new platform. The implementation of the ERP systemrepresents a material change in our internal controls over financial reportingin our first quarter of fiscal 2009. Post-implementation reviews are beingconducted by management to ensure that internal controls surrounding the systemimplementation process, key applications, and the financial close process wereproperly designed and are operating effectively to prevent material financialstatement errors. There have been no other changes in our internal control overfinancial reporting during the period covered by this Quarterly Report on Form 10-Qthat have materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

 

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**PART II — OTHERINFORMATION**

 

**ITEM 1.   LEGALPROCEEDINGS**

 

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 (theaction involving OmniVision is not one of the six test cases). Because classcertification was a condition of the settlement, it is unlikely that thecurrent settlement will receive final court approval. On June 25, 2007,the Court entered an order terminating the proposed settlement based upon astipulation among the parties to the settlement. Plaintiffs have filed amendedmaster allegations and amended complaints and moved for class certification inthe six test cases, which the defendants in those cases have opposed. On March 26,2008, the Court largely denied the test case defendants’ motion to dismiss theamended complaints. 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 stockholder filed a complaint against certain ofour underwriters for our initial public offering. The complaint, *Vanessa Simmonds v. Bank of America Corporation, et al.*,Case No. C07-1668, filed in District Court for the Western District ofWashington, makes similar allegations to those made in *In reInitial Public Offering Securities Litigation* and seeks the recoveryof short-swing trading profits under Section 16(b) of the SecuritiesExchange Act of 1934. The complaint names us as a nominal defendant. Norecovery is sought from us.

 

On February 21,2008, we filed a lawsuit against Qualcomm Incorporated in the United StatesDistrict Court for the Northern District of California, or the NorthernDistrict Action, alleging claims of trademark infringement arising fromQualcomm’s use of, and attempt to register, the mark OMNIVISION for a computerhardware system and related services. We seek an injunction and unspecifieddamages. We had previously filed opposition proceedings before the TrademarkTrial and Appeal Board of the United States Patent and Trademark office againstQualcomm’s applications to register the OMNIVISION mark, and we successfullymoved to suspend those proceedings based upon the new parallel federallitigation. Qualcomm has filed its Answer denying the allegations ofinfringement. Trial is currently set for November 30, 2009.

 

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**ITEM 1A.   RISKFACTORS**

 

*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 2008 Annual Report on Form 10-Kfiled with the SEC on June 30, 2008. 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 toOur Business***

 

## ***We face intensecompetition in our markets from CMOS and CCD image sensor manufacturers, and ifwe are unable to compete successfully we may not be able to maintain or growour 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 Hynix, Kodak, Micron, Samsung,Sharp, Sony, STMicroelectronics and Toshiba as well as CCD image sensor manufacturers such as Fuji, Kodak, NEC, Panasonic, Sanyo, Sharp, Sony 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, MagnaChip, PixArt, Pixelplus, Pixim, SETi andSiliconFile. Competition with these andother companies has required, and in the future may require, us to reduce our prices.For instance, 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. From time to time, othercompanies enter the CMOS image sensor market by using obsolete and availablemanufacturing equipment. These new entrants gain market share in the short termby pricing their products significantly below current market levels, which putsadditional downward pressure on the prices we can obtain for our products.

 

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 ouraverage selling prices may lower our revenues and, as a result, may reduce ourgross 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 this

 

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competition continues to intensify, we anticipatethat these pricing pressures will increase. We expect that the average sellingprices for many of our products will continue to decline over time. Unless wecan increase unit sales sufficiently to offset these declines in our averageselling prices, our revenues will decline. Reductions in our average sellingprices have adversely affected our gross margins, and unless we can reducemanufacturing costs to compensate, additional reductions in our average sellingprices will continue to adversely affect our gross margins and could materiallyand adversely affect our operating results and impair our financial condition.We have increased and intend to continue to increase our research, developmentand related expenses to continue the development of new image sensor productsin fiscal years 2009 and 2010 that can be sold at higher selling pricesand/or manufactured at lower cost. However, if we are unable to timelyintroduce new products that incorporate more advanced technology and includemore advanced features that can be sold at higher average selling prices, or ifwe are unable to successfully develop more cost-effective technologies, ourfinancial results could be adversely affected.

 

## ***Sales of our image-sensor products for mobile phonesaccount for a large portion of our revenues, and any decline in sales to themobile phone market or failure of this market to continue to grow as expectedcould adversely affect our results of operations.***

## *** ***

Sales to themobile phone market account for a large portion of our revenues. Although wecan only estimate the percentages of our products that are used in the mobilephone market due to the significant number of our image-sensor products thatare sold to module makers or through distributors and VARs, we believe that themobile phone market accounted for approximately 70% of our revenues infiscal 2008 and 65% in the three months ended July 31, 2008,respectively. We expect that revenues from sales of our image-sensor productsto the mobile phone market will continue to account for a significant portionof our revenues during fiscal 2009 and beyond. Any factors adverselyaffecting the demand for our image sensors in this market could cause ourbusiness to suffer and adversely affect our operating results. The digitalimage sensor market for mobile phones is extremely competitive, and we expectto face increased competition in this market in the future. In addition, webelieve the market for mobile phones is also relatively concentrated and thetop five producers account for more than 80% of the annual sales of theseproducts. If we do not continue to achieve design wins with key mobile phonemanufacturers, our market share or revenues could decrease. The mobile phoneimage-sensor market is also subject to rapid technological change. In order tocompete successfully in this market, we will have to correctly forecastcustomer demand for technological improvements and be able to deliver suchproducts on a timely basis at competitive prices. If we fail to do this, ourresults of operations, business and prospects would be materially and adverselyaffected. In the past, we have experienced problems accurately forecastingcustomer demand in other markets. If our sales to the mobile phone market donot increase and/or the mobile phone market does not grow as expected, ourresults of operations, business and prospects would be materially 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. As our products integrate new and more advancedtechnologies and functions, they become more complex and increasingly difficultto design, debug and produce. Successful product development and introduction dependson a number of factors, including:

 

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

 

·                  development ofadvanced technologies and capabilities, including our new OmniBSI technology;

 

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

 

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

 

·                  marketacceptance of the new products.

 

Accomplishing all of these steps is difficult, 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 akey determinant of future revenues, and failure to obtain design wins adverselyaffects our revenues and impairs 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 alimited number of third party wafer foundries, which reduces our ability tocontrol 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 controlover delivery schedules, quality assurance, manufacturing yields and productioncosts;

 

·                  lack ofguaranteed production capacity or product supply;

 

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

 

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

 

If TSMC, PSC, or any of our other foundries 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 

 

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of our foundries may also develop their own ofimage-sensor products and if one or more of our other foundries were to decidenot to fabricate our companion DSP chips for competitive or other reasons, wewould have to identify and qualify other sources for these products.

 

## ***We rely on a jointventure company for color filter application and on third party serviceproviders for packaging and other back-end services, which reduces our controlover delivery schedules, product quality and cost, and could adversely affectour ability to deliver products to customers.***

 

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 on ImPac, our equity investee, forsubstantially all of our ceramic chip packages. We rely on XinTec and WLCSP,two investee companies, for chip scale packages, which are generally used inour products designed for the smallest form factor applications. We rely onseveral specialized service providers, one of which is ImPac, to perform thenecessary wafer probe tests and prepare good die for use in a form calledchip-on-board, a process called reconstructing wafers. If for any reason one ormore of these service providers were to become unable or unwilling to continueto provide services of acceptable quality, at acceptable costs or 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 unforeseen operationalproblems. Substitute service providers might not be available or, if available,might be unwilling or unable to offer services on acceptable terms.

 

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.These factors may cause unforeseen product shortages or may increase our costsof manufacturing, assembling or testing of our products, which would adverselyaffect our operating results.

 

## ***Fluctuations inour quarterly operating results have caused volatility in the market price ofour common stock and also make it difficult to predict our future operatingresults.***

## *** ***

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 andmix of our product sales;

 

·                  competitivepricing pressures;

 

·                  our ability toaccurately forecast demand for our products;

 

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

 

·                  our gain or lossof a large customer;

 

·                  our ability tomanage our product transitions;

 

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

 

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

 

·                  the timing andsize of orders from our customers;

 

·                  the volume ofour product returns;

 

·                  the seasonalnature of customer demand for our products;

 

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

 

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

 

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·                  adverse changesin global economic conditions;

 

·                  the level of ouroperating expenses; and

 

·                  fluctuations inour effective tax rate from quarter to quarter.

 

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 in the short-term, andour inventory levels are based on our expectations of future revenues.Consequently, if we do not achieve the revenues we expect in any quarter,expenses and inventory levels could be disproportionately high, adverselyimpacting our operating results 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 issubject to seasonal fluctuations which may in turn cause fluctuations in ourresults of operations from period to period.***

## *** ***

Many of the products using our image sensors, such as mobile phones, notebooksand personal computers, DSCs andcameras for toys and games, are consumer electronics goods. These mass-marketcamera devices generally have seasonal cycles which historically have causedthe sales of our customers to fluctuate quarter-to-quarter. Historically,demand from OEMs and distributors that serve such consumer product markets hasbeen stronger in the second and third quarters of our fiscal year and weaker inthe 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 revenuesthat we experienced in the fourth quarters of fiscal 2007 and 2008 is partlyattributable to the fact that in 2007 and 2008 Chinese New Year occurred inmid-February, and manufacturing did not resume in full for several weeks.

 

## ***Problems withwafer manufacturing and/or back-end processing yields could result in higherproduct costs and could impair our ability to meet customer demand for ourproducts.***

## *** ***

If the foundries manufacturing the wafers used in our products cannotachieve the yields we expect, we will incur higher 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 new products and technology. Low yields may result from designerrors or manufacturing failures in new or existing products. During the earlystages of production, production yields for new products are typically lowerthan those of established products. Unlike many other semiconductor products,optical products can be effectively tested only when they are complete.Accordingly, we perform final testing of our products only after they areassembled. As a result, yield problems may not be identified until our productsare well into the production process. The risks associated with low yieldscould be increased because we rely on third party offshore foundries for ourwafers, 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 could adversely affect our customer relations and make it moredifficult to sustain and grow our business.

 

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## ***If we do notforecast customer demand correctly, our business could be impaired and ourstock 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 towards VGA productslate in the second quarter of fiscal 2007, and as a result our inventoriesat the end of the second and third quarters of fiscal 2007 were higherthan we intended them to be. We need to accurately predict customer demandbecause we must often make commitments to have products manufactured before wereceive firm purchase orders from our customers. Conversely, if weunderestimate customer demand, we may be unable to manufacture sufficientproducts quickly enough to meet actual demand, causing us to lose customers andimpairing our ability to grow our business. In preparation for new productintroductions, we gradually ramp down production of established products. Withour 12-14 week production cycle, it is extremely difficult to predict preciselyhow many units of established products we will need. It is also difficult toaccurately predict the speed of the ramp of our new products and the impact oninventory levels presented by the shorter life cycles of end-user products. Theshorter product life cycle is a result of an increase in competition and thegrowth of various consumer-product applications for image sensors. For example,although in the security and surveillance market we continue to sellimage-sensor products introduced more than four years ago, in the mobile phonemarket, the product life cycle of image sensors can be as little as six months.Under these circumstances, it is possible that we could suffer from shortagesfor certain 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 theincreased acceptance of mass-market image-sensor applications to grow ourbusiness 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 mobile 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 lengthymanufacturing, packaging and assembly cycle, in addition to our customers’design cycle, may result in uncertainty and 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 taking 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 certainapplications can be relatively short. If we fail to appropriately manage themanufacturing, packaging and assembly process, our products may become obsoletebefore they can be incorporated into our customers’ products and we may neverrealize a return on investment for the expenditures we incur in developing andproducing these products.

 

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## ***Our ability todeliver products that meet customer demand is dependent upon our ability tomeet new and changing requirements for color filter application andimage-sensor packaging.***

## *** ***

We expect that as we develop new products to meet technological advancesand new and changing industry and customer demands, our color filter applicationand ceramic, plastic and chip scale packaging requirements will also evolve.Our ability to continue to profitably deliver products that meet customerdemand is dependent upon our ability to obtain third party services that meetthese new requirements on a cost-effective basis. There can be no assurancesthat any of these parties will be able to develop enhancements to the servicesthey provide 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 ofcomplexity and integration of our products increases the risk of latentdefects, which could damage customer relationships and increase our costs.***

## *** ***

Our products are based upon evolving technology, and because we integratemany functions on a single chip, are highly complex. The integration ofadditional functions into already complex products could result in a greaterrisk that customers or end users could discover latent defects or subtle faultsafter we have already shipped significant quantities of a product. Although wetest our products, we have in the past and may in the future encounter defectsor errors. For example, in the third quarter of fiscal 2005, we recorded aprovision of $2.7 million related to the possible replacement of productsthat did not meet a particular customer’s standards. Delivery of products withdefects or reliability, quality or compatibility problems may damage ourreputation and ability to retain existing customers and attract new customers.In addition, product defects and errors could result in additional developmentcosts, diversion of technical resources, delayed product shipments, increasedproduct returns, product warranty costs for recall and replacement and productliability claims against us which may not be fully covered by insurance.

 

## ***We depend for themajority of our revenues on a few key customers and, the loss of one or more ofour key customers could significantly reduce our revenues.***

## *** ***

A relatively smallnumber of OEMs, VARs and distributors account for a significant portion of ourrevenues. Any material delay, cancellation or reduction of purchase orders fromone or more of our major customers or distributors could result in our failureto achieve anticipated revenue for a particular period. In addition, if we areunable to retain one or more of our largest OEM, distributor or VAR customers,or if we are unable to maintain our current level of revenues from one or moreof these significant customers, our business and results of operation would beimpaired and our stock price could decrease, potentially significantly. In thethree months ended July 31, 2008, two OEM customers accounted forapproximately 12.3% and 10.2% of our revenues, and one distributor customeraccounted for approximately 22.2% of our revenues. In the three months ended July 31,2007, one OEM customer accounted for approximately 18.1% of our revenues, andone distributor customer accounted for approximately 22.9% of our revenues. Inaddition, in fiscal 2008, approximately 55.0% of our revenues came fromsales to our top five customers. Our business, financial condition, results ofoperations and cash flows will continue to depend significantly on our abilityto retain our current key customers and to attract new customers, as well as onthe financial condition and success of our OEMs, VARs and distributors.

 

## ***We may be requiredto record a significant charge to earnings if our goodwill, amortizableintangible assets or long-term investments 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 July 31, 2008, ournet goodwill and amortizable intangible assets totaled approximately$19.8 million and our long term investments totaled approximately$87.1 million.

 

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## ***We maintain abacklog of customer orders that is subject to cancellation or delay in deliveryschedules, and any cancellation or delay may result in lower than anticipatedrevenues.***

## *** ***

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 unableto maintain processes and procedures to sustain effective internal control overour financial reporting, our ability to provide reliable and timely financialreports could be harmed and this could have a material adverse effect on ourstock 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 the effectiveness of our internal control over financialreporting.

 

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.

 

## ***Corporategovernance regulations have increased our compliance costs and could furtherincrease our expenses if changes occur within our business.***

## *** ***

We are subject tocorporate governance laws and regulations affecting public companies, includingthe provisions of the Sarbanes-Oxley Act, that impose certain requirements onus and on our officers, directors, attorneys and independent registered publicaccounting firm. In order to comply with these rules, we added internalresources and have utilized additional outside legal, accounting and advisoryservices, which increased our operating expenses. We expect to incur ongoing operatingexpenses as we maintain compliance with Section 404. In addition, if weundergo significant modifications to our structure through personnel or systemchanges, acquisitions, or otherwise, it may be increasingly difficult tomaintain compliance with the existing and evolving corporate governanceregulations.

*** ***

## ***We hold asignificant amount of marketable securities which are subject to general marketrisks over which we have no control.***

## *** ***

As of July 31,2008, we held cash and cash equivalents totaling $251.0 million, andshort-term investments totaling $28.4 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 our investmentsto a maximum maturity of 18 months and to investment-grade instruments.Recent uncertainties in global capital markets associated with a repricing ofrisk have caused disruptions in the orderly function of markets whereordinarily 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 risksassociated with our operations in China.***

## *** ***

In December 2000,we established OmniVision Semiconductor (Shanghai) Co. Ltd., or OSC, formerlyHua Wei Semiconductor (Shanghai) Co. Ltd., as part of our efforts to streamlineour manufacturing process and reduce the costs and working capital associatedwith the testing of our image-sensor products, and relocated our automatedimage testing equipment from the United States to China. We are currentlyexpanding our testing capabilities with additional automated testing equipment,which will also be located in China. Through our wholly-owned subsidiary,OmniVision Technologies (Shanghai) Co. Ltd., or OTC, we are also developingland and constructing research facilities in Shanghai. 

 

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Thereare certain administrative, legal and governmental risks to operating in Chinathat could result in increased operating expenses or could hamper us in thedevelopment of our operations in China. More recently we invested in a companyin China that is providing a portion of our CSP packaging requirements. Therisks from operating in China that could increase our operating expenses andadversely affect our operating results, financial condition and ability todeliver our products and grow our business include, without limitation:

 

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

 

·                  increases in thevalue of the Chinese Yuan, or CNY;

 

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

 

·                  difficulties inenforcing contracts in China;

 

·                  difficulties inprotecting intellectual property;

 

·                  diversion ofmanagement attention;

 

·                  imposition ofburdensome governmental regulations;

 

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

 

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

 

·                  inadequacy ofthe local infrastructure to support our operations.

 

## ***We may experienceintegration or other problems with potential future acquisitions, which couldhave an adverse effect on our business or results of operations. Newacquisitions could dilute the interests of existing stockholders, and theannouncement of new acquisitions could result in a decline in the price of ourcommon stock.***

## *** ***

We may in the futuremake 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 inrealizing the potential technological benefits of the transaction;

 

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

 

·                  unanticipatedexpenses related to technology integration;

 

·                  disruption ofour ongoing business;

 

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

 

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

 

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

 

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

 

·                  impairment ofresulting goodwill; and

 

·                  potentialunknown or unexpected liabilities 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 when considerationfor a transaction is paid in common stock, it will result in dilution to ourexisting stockholders.

 

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## ***We may not achievecontinued benefits from our joint venture with TSMC.***

 

In October 2003, we entered into an agreementwith TSMC to form VisEra, a joint venture in Taiwan, for the purposes ofproviding manufacturing services. In August 2005 and again in January 2007,we entered into amendments to the agreement with TSMC to expand the scope ofVisEra’s activities and provide additional funding for the expansion of VisEra.

 

In January 2006, VisEra acquired certain colorfilter processing equipment from TSMC and assumed direct responsibility forproviding the color filter processing services that had previously beenprovided to us by TSMC. We expect that VisEra will be able to provide us with acommitted supply of high quality manufacturing services at competitive prices.However, there are significant legal, governmental and relationship risks todeveloping VisEra, and we cannot ensure that we will continue to receive theexpected benefits from the joint venture. For example, VisEra may not be ableto provide manufacturing services that have competitive technology or prices,which could adversely affect our product offerings and our ability to meetcustomer requirements for our products. In addition, the existence of VisEramay also make it more difficult for us to secure dependable services fromcompeting merchant vendors who provide similar manufacturing services.

 

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

 

We expect to develop our business partly throughforming alliances or joint ventures with and making strategic investments inother companies, some of which may be companies at a relatively early stage ofdevelopment. For example, in April 2003, we made an investment in XinTec,a company that provides chip scale packaging services, and in June 2003 wemade an investment in ImPac, a packaging service company. In December 2005,VisEra, our joint venture with TSMC, completed the acquisition of a further29.6% of the issued and outstanding shares of XinTec. In January 2007,TSMC acquired directly a 43.0% interest in XinTec, thus reducing our beneficialownership in XinTec to 12.4%. In May 2007, we acquired approximately 20.0%of the registered capital of WLCSP, a company that also provides chip scalepackaging services.

 

In May 2004, we entered into an agreement withPSC under which we established SOI, a joint venture as a company incorporatedunder the laws of Taiwan. The purpose of the joint venture is to conduct thebusiness of manufacturing, marketing and selling of certain of our legacyproducts. In March 2005, we assumed control of the board of directors ofSOI and we have consolidated SOI since April 30, 2005.

 

Our investments in these and other companies maynegatively impact our operating results, because, under certain circumstances,we are required to recognize our portion of any loss recorded by each of thesecompanies or to consolidate them into our operating results. We expect tocontinue to utilize partnerships, strategic alliances and investments,particularly those that enhance our manufacturing capacity and those thatprovide manufacturing services and testing capability. These investments andpartnering arrangements are crucial to our ability to grow our business andmeet the increasing demands of our customers. However, we cannot ensure that wewill achieve the benefits we expect from these alliances. For example, we maynot be able to obtain acceptable quality and/or wafer manufacturing yields fromthese companies, which could result in higher operating costs and could impairour ability to meet customer demand for our products. In addition, certain ofthese investments or partnering relationships may place restrictions on thescope of our business, the geographic areas in which we can sell our productsand the types of products that we can manufacture and sell. For example, ouragreement with TSMC provides that we may not engage in business that willdirectly compete with the business of VisEra. This type of non-competitionprovision may impact our ability to grow our business and to meet the demandsof our customers.

 

## ***Changes in ourrelationships with our joint ventures and/or companies in which we hold lessthan a majority interest could change the way we account for such interests inthe future.***

 

As part of our strategy, we have formed joint ventureswith two of our foundry partners, and we hold a minority interest in threecompanies from which we purchase certain manufacturing services. Under theapplicable provisions of generally accepted accounting principles in the UnitedStates of America, we currently consolidate one of these joint ventures intoour consolidated financial statements and results of operations, and record theequity interests that we do not own as minority interests. For the investmentsthat we account for under the equity method, we record as part of other incomeor expense our share of the increase or decrease in the equity of the companiesin which we have invested. 

 

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It is possible that, inthe future, our relationships and/or our interests in or with these jointventures or other investees could change. Such changes have in the past, andcould in the future result in deconsolidation or consolidation of suchentities, as the case may be, which could result in changes in our reportedresults.

 

## ***We may be unable toadequately protect our intellectual property, and therefore we may lose some ofour competitive advantage.***

 

We rely on a combination of patent, copyright,trademark and trade secret laws as well as nondisclosure agreements and othermethods to protect our proprietary technologies. We have been issued patentsand have a number of pending United States and foreign patent applications.However, we cannot provide assurance that any patent will be issued as a resultof any applications or, if issued, that any claims allowed will be sufficientlybroad to protect our technology. It is possible that existing or future patentsmay be challenged, invalidated or circumvented. For example, in August 2002,we initiated a patent infringement action in Taiwan, Republic of China againstIC Media Corporation of San Jose, California for infringement of a Taiwanesepatent that had been issued to us. In response to our patent infringementaction, in October 2002, IC Media Corporation initiated acancellation proceeding in the Taiwan Intellectual Property Office with respectto our patent. In July 2003, the Taiwan Intellectual Property Office madean initial determination to grant the cancellation of the subject patent, whichdecision was upheld by the Taiwan Ministry of Economic Affairs and the HighAdministrative Court. We decided not to appeal such decision by the May 31,2005 deadline. Although we do not believe the cancellation of the Taiwanesepatent at issue in the dispute described above has had a material adverseeffect on our business or prospects, there may be other situations where ourinability to adequately protect our intellectual property rights couldmaterially and adversely affect our competitive position and operating results.If a third party can copy or otherwise obtain and use our products ortechnology without authorization, develop corresponding technologyindependently or design around our patents, this could materially adverselyaffect our business and prospects. Effective patent, copyright, trademark andtrade secret protection may be unavailable or limited in foreign countries. Anydisputes over our intellectual property rights, whatever the ultimateresolution of such disputes, may result in costly and time-consuming litigationor require the license of additional elements of intellectual property for afee.

 

## ***Litigation regardingintellectual property could divert management attention, be costly to defendand prevent us from using or selling the challenged technology.***

## *** ***

In recent years, there has been significant litigationin the United States involving intellectual property rights, including in thesemiconductor industry. We have in the past been, and may in the future be,subject to legal proceedings and claims with respect to our intellectualproperty, including such matters as trade secrets, patents, product liabilitiesand other actions arising out of the normal course of business. These claimsmay increase as our intellectual property portfolio becomes larger or morevaluable. Intellectual property claims against us, and any resulting lawsuit,may cause us to incur significant expenses, subject us to liability for damagesand invalidate our proprietary rights. 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:

 

·                  ceasingthe sale or use of products or services that incorporate the infringedintellectual property;

 

·                  obtainingfrom the holder of the infringed intellectual property a license to sell or usethe relevant technology, which license may not be available on acceptable terms,if at all; or

 

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

 

If we are subject to a successful claim ofinfringement and we fail to develop non-infringing intellectual property orlicense the infringed intellectual property on acceptable terms and on a timelybasis, we may be unable to sell some or all of our products, and our operatingresults could be adversely affected. We may in the future initiate claims orlitigation against third parties for infringement of our intellectual propertyrights or to determine the scope and validity of our proprietary rights or theproprietary rights of competitors. These claims could also result insignificant expense and the diversion of technical and management attention.

 

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## ***If we do not effectivelymanage our growth, our ability to increase our revenues and improve ourearnings could be adversely affected.***

 

Our growth has placed, and will continue to place, asignificant strain on our management and other resources. To manage our growtheffectively, we must, among other things:

 

·                  continuouslyimprove our operational, financial and accounting systems;

 

·                  trainand manage our existing employee base;

 

·                  attractand retain qualified personnel with relevant experience; and

 

·                  effectivelymanage accounts receivable and inventory.

 

For example, our failure to effectively manage ourinventory levels could result either in excess inventories, which couldadversely affect our gross margins and operating results, or lead to aninability to fill customer orders, which would result in lower sales and couldharm our relationships with existing and potential customers.

 

We must also manage multiple relationships withcustomers, business partners and other third parties, such as our foundries andprocess and assembly vendors. Moreover, future growth could significantlyoverburden our management and financial systems and other resources. We may notmake adequate allowances for the costs and risks associated with our expansion.In addition, our systems, procedures or controls may not be adequate to supportour operations, and we may not be ableto expand quickly enough to capitalize on potential market opportunities.Our future operating results will also depend, in part, on our ability toexpand sales and marketing, research and development, accounting, finance andadministrative support.

 

## ***Our future tax ratescould be higher than we anticipate and may harm our results of operations***

 

As a multinational corporation, we conduct ourbusiness in many countries and are subject to taxation in many jurisdictions.The taxation of our business is subject to the application of multiple andsometimes conflicting tax laws and regulations as well as multinational taxconventions. The application of tax law is subject to legal and factual interpretation,judgment and uncertainty, and tax laws themselves are subject to change.Consequently, taxing authorities may impose tax assessments or judgmentsagainst us that could result in a significant charge to our earnings.

 

A number of other factors will also affect our futuretax rate, and certain of these factors could increase our effective tax rate infuture periods, which could adversely impact our operating results. Thesefactors include changes in non-deductible share-based compensation, changes intax laws or the interpretation of tax laws, changes in the proportion andgeographic mix of our revenue or income, changes in the valuation of ourdeferred tax assets and liabilities, changes in available tax credits and therepatriation of non-U.S. earnings for which we have not previously provided forU.S. taxes.

 

## ***Our sales throughdistributors increase the complexity of our business and may reduce our abilityto forecast revenues.***

 

During fiscal 2007 and 2008, approximately 40.0%and 33.2%, respectively, of our revenues came from sales through distributors.We expect that revenues from sales through distributors will continue torepresent a significant proportion of our total revenues. Selling throughdistributors reduces our ability to accurately forecast sales and increases thecomplexity of our business, requiring us to, among other matters:

 

·                  managea more complex supply chain;

 

·                  managethe level of inventory at each distributor;

 

·                  providefor credits, return rights and price protection;

 

·                  estimatethe impact of credits, return rights, price protection and unsold inventory atdistributors; and

 

·                  monitorthe financial condition and creditworthiness of our distributors.

 

Any failure to manage these challenges could cause usto inaccurately forecast sales and carry excess or insufficient inventory,thereby adversely affecting our operating results.

 

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## ***We face foreign business,political and economic risks, because a majority of our products and those ofour customers are manufactured and sold outside of the United States.***

 

We face difficulties in managing our third partyfoundries, color filter application service providers, packaging and othermanufacturing service providers and our foreign distributors, most of whom arelocated in Asia. Any political and economic instability in Asia might have anadverse impact on foreign exchange rates and could cause service disruptionsfor our vendors and distributors and adversely affect our customers.

 

Sales outside of the United States accounted forsubstantially all of our revenues for fiscal 2008 and the three monthsended July 31, 2008. We anticipate that sales outside of the United Stateswill continue to account for a substantial portion of our revenues in futureperiods. Dependence on sales to foreign customers involves certain risks,including:

 

·                  longerpayment cycles;

 

·                  theadverse effects of tariffs, duties, price controls or other restrictions thatimpair trade;

 

·                  decreasedvisibility as to future demand;

 

·                  difficultiesin accounts receivable collections; and

 

·                  burdensof complying with a wide variety of foreign laws and labor practices.

 

Sales of our products have to date been denominatedprincipally in U.S. dollars. Over the last several years, the U.S. dollar hasweakened against most other currencies. Future increases in the value of theU.S. dollar, if any, would increase the price of our products in the currencyof the countries in which our customers are located. This may result in ourcustomers seeking lower-priced suppliers, which could adversely impact ouroperating results. If a larger portion of our international revenues were to bedenominated in foreign currencies in the future, we would be subject toincreased risks associated with fluctuations in foreign currency exchangerates.

 

## ***Our business could beharmed if we lose the services of one or more members of our senior managementteam, or if we are unable to attract and retain qualified personnel.***

 

The loss of the services of one or more of ourexecutive officers or key employees, which has occurred from time to time, orthe decision of one or more of these individuals to join a competitor, couldadversely affect our business and harm our operating results and financialcondition. Our success depends to a significant extent on the continued serviceof our senior management and certain other key technical personnel. None of oursenior management is bound by an employment or non-competition agreement. We donot maintain key man life insurance on any of our employees.

 

Our success also depends on our ability to identify,attract and retain qualified sales, marketing, finance, management andtechnical personnel. We have experienced, and may continue to experience,difficulty in hiring and retaining candidates with appropriate qualifications.If we do not succeed in hiring and retaining candidates with appropriatequalifications, our revenues, operations and product development efforts couldbe harmed.

 

## ***We recently substantiallycompleted the implementation of the first phase of a new enterprise resourceplanning system, a process which presents a number of significant operationalrisks.***

 

As our business grows andbecomes more complex, it is necessary that we expand and upgrade our enterpriseresource planning system, or ERP, and other management information systemswhich are critical to the operational, accounting and financial functions ofour company. We evaluated alternative solutions, both short-term and long-term,to meet the operating, administrative and financial reporting requirements ofour business. During the three months ended July 31, 2008, wesubstantially completed the implementation of the first phase of a new ERPbased on a suite of application software developed by Oracle Corporation. Wewill continue to make further enhancements and upgrades to the ERP, asnecessary. Significant management attention and resources have been used andextensive planning has occurred to support effective implementation of the newERP system, however, such implementation carries certain risks, including therisk of significant design errors that could materially and adversely affectour operating results and impact our ability to manage our business. We alsomade certain changes to our internal control over financial reporting, which webelieve are material. As a result, there is a risk that deficiencies may existin the future and that they could constitute significant deficiencies, or, inthe aggregate, a material weakness in internal control over financialreporting.

 

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## ***Our operations may be impairedas a result of disasters, business interruptions or similar events.***

 

Disasters and business interruptions such asearthquakes, water, fire, electrical failure, accidents and epidemics affectingour operating activities, major facilities, and employees’ and customers’health could materially and adversely affect our operating results andfinancial condition. In particular, our Asian operations and most of our thirdparty service providers involved in the manufacturing of our products arelocated within relative close proximity. Therefore, any disaster that strikeswithin or close to that geographic area, such as the recent earthquake andflooding that occurred in China, could be extremely disruptive to our businessand could materially and adversely affect our operating results and financialcondition. We  have recently developedand are currently implementing a disaster recovery plan.

 

## ***Acts of war and terroristacts may seriously harm our business and revenue, costs and expenses andfinancial condition.***

 

Acts of war or terrorist acts, wherever they occuraround the world, may cause damage or disruption to our business, employees,facilities, suppliers, distributors or customers, which could significantlyimpact our revenue, costs, expenses and financial condition. In addition, as acompany with significant operations and major distributors and customerslocated in Asia, we may be adversely impacted by heightened tensions and actsof war that occur in locations such as the Korean Peninsula, Taiwan and China.The potential for future terrorist attacks, the national and internationalresponses to terrorist attacks or perceived threats to national security, andother acts of war or hostility have created many economic and politicaluncertainties that could adversely affect our business and results ofoperations in ways that cannot presently be predicted. We are uninsured forlosses and interruptions caused by terrorist acts and acts of war.

 

***Risks Related tothe Securities Markets and Ownership of Our Common Stock***

 

## ***Provisions in our charterdocuments and Delaware law, as well as our stockholders’ rights plan, couldprevent or delay a change in control of our company and may reduce the marketprice of our common stock.***

 

Provisions of our certificate of incorporation andbylaws may discourage, delay or prevent a merger or acquisition that astockholder may consider favorable. These provisions include:

 

·                  adjustingthe price, rights, preferences, privileges and restrictions of preferred stockwithout stockholder approval;

 

·                  providingfor a classified board of directors with staggered, three year terms;

 

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

 

·                  limitingthe persons who may call special meetings of stockholders; and

 

·                  prohibitingstockholder actions by written consent.

 

Provisions of Delaware law also may discourage, delayor prevent another company from acquiring or merging with us. Our board ofdirectors adopted a preferred stock rights agreement in August 2001.Pursuant to the rights agreement, our board of directors declared a dividend ofone right to purchase one one-thousandth share of our Series AParticipating Preferred Stock for each outstanding share of our common stock.The dividend was paid on September 28, 2001 to stockholders of record asof the close of business on that date. Each right entitles the registeredholder to purchase from us one one-thousandth of a share of Series APreferred at an exercise price of $176.00, subject to adjustment. The exerciseof the rights could have the effect of delaying, deferring or preventing achange of control of our company, including, without limitation, discouraging a proxy contest or makingmore difficult the acquisition of a substantial block of our common stock. Therights agreement could also limit the price that investors might be willing topay in the future for our common stock.

 

## ***Our stock has been andwill likely continue to be subject to substantial price and volume fluctuationsdue to a number of factors, many of which are beyond our control that mayprevent our stockholders from selling our common stock at a profit.***

 

The market price of our common stock has fluctuatedsubstantially, and there can be no assurance that such volatility will notcontinue. Since the beginning of fiscal 2002 through July 31, 2008, theclosing sales price of our common stock has ranged from a high of $33.90 pershare to a low of $1.26 per share. The closing sales price of our commonstock on August 31, 2008 was $11.68 per share. The securities marketshave experienced significant price and 

 

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volume fluctuations inthe past, and the market prices of the securities of semiconductor companieshave been especially volatile. This market volatility, as well as generaleconomic, market or political conditions, could reduce the market price of ourcommon stock in spite of our operating performance. The market price of ourcommon stock may fluctuate significantly in response to a number of factors,including:

 

·                  actualor anticipated fluctuations in our operating results;

 

·                  changesin expectations as to our future financial performance;

 

·                  changesin financial estimates of securities analysts;

 

·                  releaseof lock-up or other transfer restrictions on our outstanding shares of commonstock or sales of additional shares of common stock;

 

·                  salesor the perception in the market of possible sales of shares of our common stockby our directors, officers, employees or principal stockholders;

 

·                  changesin market valuations of other technology companies; and

 

·                  announcementsby us or our competitors of significant technical innovations, design wins,contracts, standards or acquisitions.

 

Due to these factors, the price of our stock maydecline and investors may be unable to resell their shares of our stock for aprofit. In addition, the stock market experiences extreme volatility that oftenis unrelated to the performance of particular companies. These marketfluctuations may cause our stock price to decline regardless of ourperformance.

 

**ITEM 2.   UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

We did not repurchase any shares of our common stockin the first quarter of fiscal 2009.

 

**ITEM 6.   EXHIBITS**

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                                                                        |
|--------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.33(1)           |       | Consulting Agreement between OmniVision  Technologies, Inc. and Peter V. Leigh effective September 30, 2008.                                                                 |
| 31.1               |       | Certification of Chief Executive Officer pursuant to  Section 302 of Sarbanes-Oxley Act of 2002.                                                                                  |
| 31.2               |       | Certification of Chief Financial Officer pursuant to  Section 302 of Sarbanes-Oxley Act of 2002.                                                                                  |
| 32                 |       | Certification of Chief Executive Officer and Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of Sarbanes-Oxley Act of 2002. |

 

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(1)          Incorporated by reference to exhibits filedwith Registrant’s Current Report on Form 8-K filed with the Securities andExchange Commission on August 28, 2008.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities andExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
| ** **                     |      | **OMNIVISION  TECHNOLOGIES, INC**.                                                |
|--------------------------------|-----------|-----------------------------------------------------------------------------------|
| * *                       | * *  | *(Registrant)*                                                                    |
|                           |      |                                                                              |
|                           |      |                                                                              |
| Dated:  September 9, 2008 |      |                                                                              |
|                           |      |                                                                              |
|                           | By:  | **/s/  SHAW HONG**                                                                |
| ** **                     |      | **Shaw  Hong**                                                                    |
| * *                       | * *  | *Chief  Executive Officer, President and Director**(Principal Executive Officer)* |
| ** **                     |      | ** **                                                                        |
| ** **                     |      | ** **                                                                        |
| Dated:  September 9, 2008 |      |                                                                              |
| ** **                     |      | ** **                                                                        |
|                           | By:  | **/s/ PETER V. LEIGH**                                                            |
| ** **                     |      | **Peter V. Leigh**                                                                |
| * *                       | * *  | *Chief Financial Officer*                                                         |
| * *                       | * *  | *(Principal Financial and Accounting Officer)*                                    |

 

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**Exhibit Index**

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                                                                        |
|--------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.33(1)           |       | Consulting Agreement between OmniVision  Technologies, Inc. and Peter V. Leigh effective September 30, 2008.                                                                 |
| 31.1               |       | Certification of Chief Executive Officer pursuant to  Section 302 of Sarbanes-Oxley Act of 2002.                                                                                  |
| 31.2               |       | Certification of Chief Financial Officer pursuant to  Section 302 of Sarbanes-Oxley Act of 2002.                                                                                  |
| 32                 |       | Certification of Chief Executive Officer and Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of Sarbanes-Oxley Act of 2002. |

 

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(1)          Incorporated by reference to exhibits filedwith Registrant’s Current Report on Form 8-K filed with the Securities andExchange Commission on August 28, 2008.

 

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