** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

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**FORM10-Q**

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

 

**Commission file number: 0-29939**

 

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**OMNIVISION TECHNOLOGIES, INC.**

**(Exact name of registrant asspecified in its charter)**

** **

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

 

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

**(Address of Principal ExecutiveOffices) (Zip Code)**

 

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

 

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Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities and Exchange Act of 1934 during thepreceding 12 months (or for shorter period that the registrant was required tofile such reports); and (2) has been subject to such filing requirements forthe past 90 days. Yes  x No  o

 

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

 

Large accelerated filer  x Acceleratedfiler  o  Non-acceleratedfiler  o

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theSecurities Exchange Act of 1934). Yes  o No  x

 

At August 31, 2007,54,738,646 shares of common stock of the registrant were outstanding,exclusive of 6,435,700 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, 2007 and  April 30, 2007               |       | 3          |
|              |       |                                                                                                                          |       |       |
|              |       | Condensed  Consolidated Statements of Income (unaudited) — Three Months Ended  July 31, 2007 and 2006     |       | 4          |
|              |       |                                                                                                                          |       |       |
|              |       | Condensed  Consolidated Statements of Cash Flows (unaudited) — Three Months  Ended July 31, 2007 and 2006 |       | 5          |
|              |       |                                                                                                                          |       |       |
|              |       | Notes to  Condensed Consolidated Financial Statements (unaudited)                                                             |       | 6          |
|              |       |                                                                                                                          |       |       |
| **Item 2.**       |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                   |       | 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                                                                                                                 |       | 44         |
| ** **        |       |                                                                                                                          |       |       |
| **Item 2.**       |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                  |       | 58         |
| ** **        |       |                                                                                                                          |       |       |
| **Item  6.**      |       | Exhibits                                                                                                                      |       | 58         |
| ** **        |       |                                                                                                                          |       |       |
| Signatures        |       |                                                                                                                          |       | 59         |
| ** **        |       |                                                                                                                          |       |       |
| Exhibit  Index    |       |                                                                                                                          |       |       |
| Exhibit 31.1 |       |                                                                                                                          |
| Exhibit 31.2 |       |                                                                                                                          |
| Exhibit 32   |       |                                                                                                                          |

 

2

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**PART I —FINANCIAL INFORMATION**

**ITEM 1.   FINANCIAL STATEMENTS**

**OMNIVISION TECHNOLOGIES, INC.**

 

**CONDENSEDCONSOLIDATED BALANCESHEETS**

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

**(unaudited)**

** **
| ** **                                                                                                                                                                                                         | ** ** | **July 31,  2007** | ** ** | **April 30,  2007** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| **ASSETS**                                                                                                                                                                                                         |       |                    |       |                     |       |
| Current assets:                                                                                                                                                                                                    |       |                    |       |                     |       |
| Cash and cash  equivalents                                                                                                                                                                                         |       | $                       | 176,936    |                     | $          | 190,878 |   |
| Short-term  investments                                                                                                                                                                                            |       | 117,898                 |       | 114,432                  |       |
| Accounts  receivable, net of allowances for doubtful accounts and sales returns                                                                                                                                    |       | 71,803                  |       | 65,666                   |       |
| Inventories                                                                                                                                                                                                        |       | 138,334                 |       | 119,663                  |       |
| Refundable and  deferred income taxes                                                                                                                                                                              |       | 3,751                   |       | 3,356                    |       |
| Prepaid expenses  and other current assets                                                                                                                                                                         |       | 4,462                   |       | 8,717                    |       |
| Recoverable  insurance proceeds (Note 15)                                                                                                                                                                          |       | 13,000                  |       | 13,000                   |       |
| Total current  assets                                                                                                                                                                                              |       | 526,184                 |       | 515,712                  |       |
|                                                                                                                                                                                                               |       |                    |       |                     |       |
| Property, plant and  equipment, net                                                                                                                                                                                |       | 79,305                  |       | 64,363                   |       |
| Long-term investments                                                                                                                                                                                              |       | 78,661                  |       | 67,281                   |       |
| Goodwill                                                                                                                                                                                                           |       | 7,541                   |       | 7,541                    |       |
| Intangibles, net                                                                                                                                                                                                   |       | 18,856                  |       | 20,493                   |       |
| Other long-term assets                                                                                                                                                                                             |       | 12,206                  |       | 12,669                   |       |
| Total assets                                                                                                                                                                                                       |       | $                       | 722,753    |                     | $          | 688,059 |   |
|                                                                                                                                                                                                               |       |                    |       |                     |       |
| **LIABILITIES,  MINORITY INTEREST AND STOCKHOLDERS’ EQUITY**                                                                                                                                                  |       |                    |       |                     |       |
| ** **                                                                                                                                                                                                         |       |                    |       |                     |       |
| Current liabilities:                                                                                                                                                                                               |       |                    |       |                     |       |
| Accounts payable                                                                                                                                                                                                   |       | $                       | 85,999     |                     | $          | 56,290 |   |
| Accrued expenses  and other current liabilities                                                                                                                                                                    |       | 15,238                  |       | 17,524                   |       |
| Litigation  settlement accrual                                                                                                                                                                                     |       | 13,000                  |       | 13,750                   |       |
| Income taxes  payable                                                                                                                                                                                              |       | 4,686                   |       | 61,617                   |       |
| Deferred income                                                                                                                                                                                                    |       | 7,225                   |       | 8,873                    |       |
| Current portion  of long-term debt                                                                                                                                                                                 |       | 641                     |       | 631                      |       |
| Total current  liabilities                                                                                                                                                                                         |       | 126,789                 |       | 158,685                  |       |
|                                                                                                                                                                                                               |       |                    |       |                     |       |
| Long-term liabilities:                                                                                                                                                                                             |       |                    |       |                     |       |
| Long-term income  taxes payable                                                                                                                                                                                    |       | 59,758                  |       | —                   |       |
| Non-current  portion of long-term debt                                                                                                                                                                             |       | 27,412                  |       | 27,576                   |       |
| Other long-term  liabilities                                                                                                                                                                                       |       | 5,616                   |       | 6,998                    |       |
| Total long-term  liabilities                                                                                                                                                                                       |       | 92,786                  |       | 34,574                   |       |
| Total  liabilities                                                                                                                                                                                                 |       | 219,575                 |       | 193,259                  |       |
|                                                                                                                                                                                                               |       |                    |       |                     |       |
| Commitments and  contingencies (Note 15)                                                                                                                                                                           |       |                    |       |                     |       |
|                                                                                                                                                                                                               |       |                    |       |                     |       |
| Minority interest                                                                                                                                                                                                  |       | 4,485                   |       | 4,344                    |       |
|                                                                                                                                                                                                               |       |                    |       |                     |       |
| Stockholders’ equity:                                                                                                                                                                                         |       |                    |       |                     |       |
| Common stock,  $0.001 par value; 100,000 shares authorized; 61,037 issued and 54,601  outstanding at July 31, 2007 and 60,811 shares issued and 54,941  outstanding at April 30, 2007, respectively |       | 61                      |       | 61                       |       |
| Additional  paid-in capital                                                                                                                                                                                        |       | 338,080                 |       | 329,012                  |       |
| Accumulated  other comprehensive income                                                                                                                                                                            |       | 982                     |       | 867                      |       |
| Treasury stock,  6,436 and 5,870 at July 31, 2007 and April 30, 2007, respectively                                                                                                                       |       | (89,184                 | )          | (79,568                  | )          |
| Retained  earnings                                                                                                                                                                                                 |       | 248,754                 |       | 240,084                  |       |
| Total  stockholders’ equity                                                                                                                                                                                   |       | 498,693                 |       | 490,456                  |       |
| Total liabilities,  minority interest and stockholders’ equity                                                                                                                                                |       | $                       | 722,753    |                     | $          | 688,059 |   |

 

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

 

3

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**OMNIVISION TECHNOLOGIES, INC.**

 

**CONDENSEDCONSOLIDATED STATEMENTSOF INCOME**

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

**(unaudited)**

 
| ** **                                        | ** ** | **Three Months Ended  July 31,** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                        | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| Revenues                                          |       | $                                               | 173,134    |   | $ | 136,875 |   |
| Cost of revenues                                  |       | 132,526                                         |       | 87,155 |   |
| Gross profit                                      |       | 40,608                                          |       | 49,720 |   |
|                                              |       |                                            |       |   |   |
| Operating expenses:                               |       |                                            |       |   |   |
| Research,  development and related                |       | 17,426                                          |       | 16,842 |   |
| Selling, general  and administrative              |       | 15,165                                          |       | 12,451 |   |
| Total operating  expenses                         |       | 32,591                                          |       | 29,293 |   |
|                                              |       |                                            |       |   |   |
| Income from operations                            |       | 8,017                                           |       | 20,427 |   |
| Interest income, net                              |       | 3,361                                           |       | 3,403 |   |
| Other income, net                                 |       | 260                                             |       | 977 |   |
| Income before income  taxes and minority interest |       | 11,638                                          |       | 24,807 |   |
|                                              |       |                                            |       |   |   |
| Provision for (benefit  from) income taxes        |       | (1,360                                          | )          | 6,624 |   |
| Minority interest                                 |       | 21                                              |       | 2,302 |   |
| Net income                                        |       | $                                               | 12,977     |   | $ | 15,881 |   |
|                                              |       |                                            |       |   |   |
| Net income per share:                             |       |                                            |       |   |   |
| Basic                                             |       | $                                               | 0.24       |   | $ | 0.29 |   |
| Diluted                                           |       | $                                               | 0.23       |   | $ | 0.28 |   |
|                                              |       |                                            |       |   |   |
| Shares used in  computing net income per share:   |       |                                            |       |   |   |
| Basic                                             |       | 54,751                                          |       | 54,401 |   |
| Diluted                                           |       | 55,294                                          |       | 56,704 |   |

 

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

 

4

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**OMNIVISION TECHNOLOGIES, INC.**

**CONDENSEDCONSOLIDATED STATEMENTSOF CASH FLOWS**

**(in thousands, unaudited)**

** **
| ** **                                                                         | ** ** | **Three Months Ended  July 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| Cash flows from  operating activities:                                             |       |                                            |       |   |   |
| Net income                                                                         |       | $                                               | 12,977     |   | $ | 15,881 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                            |       |   |   |
| Depreciation and  amortization                                                     |       | 2,982                                           |       | 3,788 |   |
| Change in fair  value of interest rate swap                                        |       | (628                                            | )          | — |   |
| Stock-based  compensation                                                          |       | 6,152                                           |       | 6,455 |   |
| Minority  interest in net income of consolidated affiliates                        |       | 21                                              |       | 2,302 |   |
| Equity  investment gain, net                                                       |       | (1,461                                          | )          | (876 | ) |
| Affiliate stock  grants                                                            |       | 56                                              |       | 179 |   |
| Write-down of  inventories                                                         |       | 4,690                                           |       | 883 |   |
| Loss on disposal  of property, plant and equipment                                 |       | —                                          |       | 8 |   |
| Changes in  assets and liabilities:                                                |       |                                            |       |   |   |
| Accounts  receivable, net                                                          |       | (6,133                                          | )          | (6,117 | ) |
| Inventories                                                                        |       | (24,631                                         | )          | (14,451 | ) |
| Refundable and  deferred income taxes                                              |       | 582                                             |       | — |   |
| Prepaid expenses  and other current assets                                         |       | 4,263                                           |       | (3,108 | ) |
| Accounts payable                                                                   |       | 25,006                                          |       | 7,047 |   |
| Accrued expenses  and other current liabilities                                    |       | (29                                             | )          | 106 |   |
| Income taxes  payable                                                              |       | (1,482                                          | )          | 6,252 |   |
| Deferred income                                                                    |       | (1,648                                          | )          | 939 |   |
| Deferred tax  liabilities                                                          |       | (890                                            | )          | (485 | ) |
| Net cash  provided by operating activities                                         |       | 19,827                                          |       | 18,803 |   |
| Cash flows from  investing activities:                                             |       |                                            |       |   |   |
| Purchases of  short-term investments                                               |       | (11,310                                         | )          | (58,122 | ) |
| Proceeds from  sales or maturities of short-term investments                       |       | 7,950                                           |       | 51,528 |   |
| Purchases of  property, plant and equipment, net of sales                          |       | (14,659                                         | )          | (6,137 | ) |
| Purchases of  long-term investments                                                |       | (9,000                                          | )          | — |   |
| Purchases of  intangible assets                                                    |       | —                                          |       | (548 | ) |
| Net cash used in  investing activities                                             |       | (27,019                                         | )          | (13,279 | ) |
| Cash flows from  financing activities:                                             |       |                                            |       |   |   |
| Repayment of  long-term debt                                                       |       | (154                                            | )          | (39 | ) |
| Cash  contribution by minority shareholder                                         |       | 49                                              |       | 4,290 |   |
| Proceeds from  exercise of stock options and employee stock purchase plan          |       | 2,916                                           |       | 6,748 |   |
| Payments for  repurchases of common stock                                          |       | (9,616                                          | )          | — |   |
| Net cash  provided by (used in) financing activities                               |       | (6,805                                          | )          | 10,999 |   |
| Effect of exchange rate  changes on cash and cash equivalents                      |       | 55                                              |       | (32 | ) |
| Net (decrease) increase  in cash and cash equivalents                              |       | (13,942                                         | )          | 16,491 |   |
| Cash and cash  equivalents at beginning of period                                  |       | 190,878                                         |       | 240,227 |   |
| Cash and cash  equivalents at end of period                                        |       | $                                               | 176,936    |   | $ | 256,718 |   |
| Supplemental cash flow  information:                                               |       |                                            |       |   |   |
| Taxes paid, net                                                                    |       | $                                               | 118        |   | $ | 1,580 |   |
| Interest paid                                                                      |       | $                                               | 5          |   | $ | 7 |   |
| Supplemental schedule  of non-cash investing and financing activities:             |       |                                            |       |   |   |
| Capital  equipment financing obligation                                            |       | $                                               | 4,687      |   | $ | 44 |   |
| Affiliate shares  issued to affiliate employees                                    |       | $                                               | 295        |   | $ | 459 |   |
| Affiliate cash  dividend payable to minority shareholder                           |       | $                                               | 224        |   | $ | 245 |   |
| Change-of-interest  benefit from minority shareholder cash contribution            |       | $                                               | —     |   | $ | 1,229 |   |
| Capitalized interest  and other costs                                              |       | $                                               | 141        |   | $ | — |   |

 

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

 

5

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**OMNIVISIONTECHNOLOGIES, INC.**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**For theThree Months Ended July 31, 2007 and 2006**

**(unaudited)**

**Note 1 — Basisof Presentation**

## ***Overview***

The accompanying interim unaudited condensedconsolidated financial statements as of July 31, 2007 and April 30,2007 and for the three months ended July 31, 2007 and 2006 have beenprepared by OmniVision Technologies, Inc., and its subsidiaries (“OmniVision”or the “Company”) in accordance with the rules and regulations of the U.S.Securities and Exchange Commission (“SEC”). The amounts as of April 30,2007 come from the Company’s annual audited financial statements. Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with generally accepted accounting principles have beencondensed or omitted in accordance with such rules and regulations. In theopinion of management, the accompanying unaudited condensed consolidatedfinancial statements reflect all adjustments, consisting only of normalrecurring adjustments, necessary to state fairly the financial position of theCompany and its results of operations and cash flows as of and for the periodspresented. These condensed consolidated financial statements should be read inconjunction with the annual audited financial statements and notes theretoincluded in the Company’s Annual Report on Form 10-K for the fiscal yearended April 30, 2007 (the “Form 10-K”).

The results of operations for the three months endedJuly 31, 2007 are not necessarily indicative of the results that may beexpected for the fiscal year ending April 30, 2008 or any other futureperiod.

## ***Useof Estimates***

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities, the disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. The Company bases itsestimates and judgments on its historical experience, knowledge of currentconditions and beliefs of what could occur in the future considering availableinformation. Actual results could differ from these estimates.

**Note 2 — Summaryof Significant Accounting Policies**

## ***Principlesof Consolidation***

The consolidated financial statements include theaccounts of the Company, its wholly-owned subsidiaries and its consolidatedaffiliate. All significant inter-company accounts and transactions have beeneliminated.

## ***Change-of-InterestBenefit***

Where an unrelated third party invests in one of theCompany’s consolidated subsidiaries or affiliates, and the per share value ofthe investment exceeds the Company’s average per share carrying value in theentity, the Company will record the change-of-interest benefit as “Additionalpaid-in capital.” If the per share value is less than the Company’s per sharecarrying value, the Company will assess whether the investment has beenimpaired.

## ***ForeignCurrency Translation***

For subsidiaries or consolidated affiliates with localcurrencies as the functional currencies, the assets and liabilities of thesubsidiaries are translated into U.S. dollars at the rates of exchangeprevailing on the balance sheet date. Revenue and expense items are translated intoU.S. dollars at the average rate of exchange for the period. Unrealized gainsand losses from foreign currency translation are included in “Accumulated othercomprehensive income,” a component of stockholders’ equity. For subsidiarieswith the U.S. dollar as the functional currency, and with assets denominated incurrencies other than the functional currency, non-monetary assets areremeasured into U.S. dollars using historical rates of exchange. Monetaryassets are remeasured into U.S. dollars using exchange rates prevailing on thebalance sheet date. Remeasurement gains and losses are included in “Otherincome, net” and have not been material in any of the periods presented.

6

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**OMNIVISIONTECHNOLOGIES, INC.**

** **

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

**For theThree Months Ended July 31, 2007 and 2006**

## **(unaudited)**

## ***Cashand Cash Equivalents***

The Company considers all highly liquid investmentspurchased with a maturity at the date of purchase of three months or less to becash equivalents. Cash equivalents consist principally of commercial paper,government bonds, certificates of deposit and money market funds that arestated at cost, which approximates fair value.

The Company’s cash and cash equivalents amount issubject to concentration of credit risk. The Company maintains some cash andcash equivalent balances with financial institutions that are in excess ofFederal Deposit Insurance Corporation (“FDIC”) insurance limits.

## ***Inventories***

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

The Company records allowances to reduce the carryingvalue of inventories to their net realizable value when the Company believesthat the net realizable value is less than cost. The Company also recordsallowances for the cost of inventories when the number of units on hand exceedsthe number of units that the Company forecasts will be sold over a certainperiod of time, generally 12 months. The recording of these allowancesestablishes a new and lower cost basis for each specifically identifiedinventory item, and the Company does not restore the cost basis to its originallevel regardless of any subsequent changes in facts or circumstances.

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

Comprehensive income (loss) is defined as the changein the equity of a company during a period from transactions and other eventsand circumstances excluding transactions resulting from investments by ownersand distributions to owners. Comprehensive income for the three months endedJuly 31, 2007 and 2006 was $8.8 million and $16.1 million,respectively, and included net income, unrealized losses fromavailable-for-sale securities, change-of-interest benefits and translationgains (losses) from foreign subsidiaries.

## ***RevenueRecognition***

For shipments to customers without agreements thatallow for returns or credits, principally original 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 ofproducts to the customer provided that the Company has received a signedpurchase order, the price is fixed or determinable, title and risk of loss hastransferred to the customer, collection of resulting receivables is consideredreasonably assured, product returns are reasonably estimable, there are nocustomer acceptance requirements and there are no remaining materialobligations. At the time revenue is recognized, the Company provides for futurereturns of potentially defective product based on historical experience. Forcash consideration given to customers for which the Company does not receive aseparately identifiable benefit or cannot reasonably estimate fair value, theCompany records the amounts as reductions of revenue.

For shipments to distributors under agreementsallowing for returns or credits, the Company recognizes revenue using the “sell-through”method under which the Company defers revenue and the related costs of saleuntil the distributor resells the product to the Company’s end-user customerand the Company is notified in writing by the distributor of such sale. Theamount billed to these distributors less the cost of inventory shipped to butnot yet sold by the distributors is shown net on the consolidated balancesheets as deferred income.

In addition, the Company recognizes revenue from theperformance of services to a limited number of customers by its wholly-ownedsubsidiary, CDM Optics, Inc. (“CDM”), and, through December 31, 2006, byits then consolidated affiliate, VisEra Technologies Company, Ltd. (“VisEra”).(See Note 5.) The Company recognizes the CDM-associated revenue undereither the completed-contract or the percentage-of-completion methods. Thepercentage-of-completion method of accounting is used for costreimbursement-type contracts, where revenues recognized are that portion of thetotal contract price equal to the ratio of costs expended to date to theanticipated final total costs based on current estimates of the costs tocomplete the projects. CDM-associated revenue has not been material in any ofthe periods presented. Until December 31, 2006, the Company recognized VisEra’sservice revenue from third party customers when the production servicesprovided by VisEra were complete and the product was shipped to the customer.

7

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**OMNIVISIONTECHNOLOGIES, INC.**

** **

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

**For theThree Months Ended July 31, 2007 and 2006**

## **(unaudited)**

## ***IncomeTaxes***

The Company accounts for deferred income taxes usingthe liability method, under which the expected future tax consequences oftiming differences between the book and tax basis of assets and liabilities arerecognized as deferred tax assets and liabilities. Valuation allowances areestablished when necessary to reduce deferred tax assets when managementestimates, based on available objective evidence, that it is more likely thannot that the benefit of deferred tax assets will not be realized.

On May 1, 2007, the Company adopted FinancialAccounting Standards Board (“FASB”) Interpretation, (“FIN”) No. 48, *“Accounting for Uncertainty in Income Taxes—an interpretation of FASBStatement No. 109”* (“FIN 48”) which the FASB issued inJune 2006. See Note 14 for the impact of FIN 48 on the Company’sconsolidated financial statements. FIN 48 requires that the Companyrecognize in its consolidated financial statements the impact of a tax positionthat, based on the technical merits of the position, is more likely than not tobe sustained upon examination. The evaluation of a tax position in accordancewith this interpretation is a two-step process. In the first step, recognition,the Company determines whether it is more-likely-than-not that a tax positionwill be sustained upon examination, including resolution of any related appealsor litigation processes, based on the technical merits of the position. Thesecond step addresses measurement of a tax position that meets themore-likely-than-not criterion. The tax position is measured at the largestamount of benefit that has a greater than 50 percent likelihood of beingrealized upon ultimate settlement. Tax positions that previously failed to meetthe more-likely-than-not recognition threshold will be recognized in the firstsubsequent financial reporting period in which that threshold is met.Previously recognized tax positions that no longer meet themore-likely-than-not recognition threshold will be de-recognized in the firstsubsequent financial reporting period in which that threshold is no longer met.The differences between the amounts recognized in the consolidated financialstatements prior to the adoption of FIN 48 and the amounts reported afteradoption have been accounted for as a cumulative-effect adjustment recorded tothe beginning balance of retained earnings.

## ***Stock-BasedCompensation***

Effective May 1, 2006, the Company adopted theprovisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(revised 2004), *“Share-Based Payment,”*(“SFAS No. 123(R)”) which requires all share-based payments toemployees, including grants of employee stock options and employee stockpurchases under the 2000 Employee Stock Purchase Plan (the “2000 Purchase Plan”),to be recognized in the financial statements based on their respective grantdate fair values. SFAS No. 123(R) supersedes Accounting PrinciplesBoard (“APB”) Opinion No. 25, *“Accountingfor Stock Issued to Employees”* (“APB 25”) and relatedinterpretations and eliminates the pro forma disclosures of SFAS No. 123, *“Accounting for Stock-Based Compensation”*(“SFAS No. 123”). In March 2005, the SEC issued SAB No. 107, *“Share-Based Payment”*(“SAB 107”),which provides guidance regarding the interaction of SFAS No. 123(R) andcertain SEC rules and regulations. The Company has applied the provisionsof SAB 107 in its adoption of SFAS No. 123(R).

The Company adopted SFAS No. 123(R) usingthe modified prospective method. The Company’s consolidated financialstatements as of and for the fiscal year ended April 30, 2007 reflectthe impact of adopting SFAS No. 123(R). (See Note 11.)

## ***RecentAccounting Pronouncements***

In September 2006, the FASB issued Statement ofFinancial Accounting Standards No. 157, “*FairValue Measurements’’*(“SFAS No. 157”), which defines fairvalue, establishes guidelines for measuring fair value and expands therequisite disclosures for fair value measurements. SFAS No. 157 doesnot require any new fair value measurements but rather establishes a commondefinition of fair value to be used throughout generally accepted accountingprinciples. SFAS No. 157 is effective in fiscal years beginning afterNovember 15, 2007 and the Company is required to adopt it in the first quarterof fiscal 2009. The Company does not expect its adoption of the provisionsof SFAS No. 157 to have a material effect on its financial condition,results of operations or cash flows.

In February 2007,the FASB issued SFAS No. 159, *“The Fair Value Option forFinancial Assets and Financial Liabilities,”* (“SFAS No. 159”)which permits entities to choose to measure many financial instruments andcertain other items at fair value that are not currently required to bemeasured at fair value. The objective is to improve

8

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**OMNIVISIONTECHNOLOGIES, INC.**

** **

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

**For theThree Months Ended July 31, 2007 and 2006**

## **(unaudited)**

financial reporting by providing entities with theopportunity to mitigate volatility in reported earnings caused by measuringrelated assets and liabilities differently without having to apply complexhedge accounting provisions. SFAS No. 159 also establishespresentation and disclosure requirements designed to facilitate comparisonsbetween entities that choose different measurement attributes for similar typesof assets and liabilities. SFAS No. 159 does not affect any existingaccounting literature that requires certain assets and liabilities to becarried at fair value. The Company does not expect its adoption of theprovisions of SFAS No. 157 to have a material effect on its financialcondition, results of operations or cash flows.

In June 2007, theFASB ratified Emerging Issues Task Force (EITF) Issue No. 07-3, *“Accounting for Nonrefundable Advance Payments for Goods or Services toBe Used in Future Research and Development Activities”* (EITF 07-3).EITF 07-3 requires non-refundable advance payments for goods and services to beused in future research and development activities to be recorded as an assetand expensing the payments when the research and development activities areperformed. EITF 07-3 applies prospectively for new contractual arrangementsentered into in fiscal years beginning after December 15, 2007. TheCompany currently recognizes these non-refundable advanced payments as anexpense upon payment. The  Company doesnot expect its adoption of EITF 07-3 to have a significant impact on itsfinancial condition, results of operations or cash flows.

**Note 3 — Short-Term Investments**

Available-for-sale securities at July 31, 2007and April 30, 2007 were as follows (in thousands):

 
| ** **                                                          | ** ** | **As of July 31, 2007** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                          | ** ** | **Amortized  Cost**                         | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| Certificates of  deposit                                            |       | $                                           | 6,411      |   | $ | 3 |   | $ | — |   | $ | 6,414 |   |
| U.S. government  debt securities with maturities less than one year |       | 3,000                                       |       | — |   | (1 | ) | 2,999 |   |
| U.S. government  debt securities with maturities over one year      |       | 10,022                                      |       | — |   | (13 | ) | 10,009 |   |
| Municipal bonds  and notes                                          |       | 62,988                                      |       | — |   | (13 | ) | 62,975 |   |
| Commercial paper  and bond funds                                    |       | 35,558                                      |       | — |   | (57 | ) | 35,501 |   |
|                                                                |       | $                                           | 117,979    |   | $ | 3 |   | $ | (84 | ) | $ | 117,898 |   |
| Contractual  maturity dates, less than one year                     |       |                                        |       |   |   |   |   | $ | 25,248 |   |
| Contractual  maturity dates, one year to two years                  |       |                                        |       |   |   |   |   | 49,650 |   |
| Contractual  maturity dates, two years to 39 years(1)               |       |                                        |       |   |   |   |   | 43,000 |   |
|                                                                |       |                                        |       |   |   |   |   | $ | 117,898 |   |

 

9

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**OMNIVISIONTECHNOLOGIES, INC.**

** **

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

**For theThree Months Ended July 31, 2007 and 2006**

## **(unaudited)**

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

----

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

 

10

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**OMNIVISIONTECHNOLOGIES, INC.**

 

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

**For theThree Months Ended July 31, 2007 and 2006**

**(unaudited)**

 

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

** **
| ** **                                       | ** ** | **July 31,  2007** | ** ** | **April 30,  2007** | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| Cash and cash  equivalents:                      |       |                    |       |                     |       |
| Cash                                             |       | $                       | 58,457     |                     | $          | 18,274 |   |
| Money market  funds and certificates of deposit  |       | 35,684                  |       | 89,020                   |       |
| Commercial paper  and government bonds           |       | 82,795                  |       | 83,584                   |       |
|                                             |       | $                       | 176,936    |                     | $          | 190,878 |   |
| Accounts receivable,  net:                       | ** ** | ** **              | ** ** | ** **               | ** ** |
| Accounts  receivable                             |       | $                       | 77,315     |                     | $          | 72,113 |   |
| Less:Allowance  for doubtful accounts            |       | (1,159                  | )          | (980                     | )          |
| Allowance for  sales returns                     |       | (4,353                  | )          | (5,467                   | )          |
|                                             |       | $                       | 71,803     |                     | $          | 65,666 |   |
| Inventories:                                     |       |                    |       |                     |       |
| Work in progress                                 |       | $                       | 81,044     |                     | $          | 64,159 |   |
| Finished goods                                   |       | 57,290                  |       | 55,504                   |       |
|                                             |       | $                       | 138,334    |                     | $          | 119,663 |   |
| Prepaid expenses and  other current assets:      |       |                    |       |                     |       |
| Prepaid expenses                                 |       | $                       | 3,433      |                     | $          | 2,967 |   |
| Deposits and  other                              |       | 81                      |       | 4,693                    |       |
| Interest  receivable                             |       | 948                     |       | 1,057                    |       |
|                                             |       | $                       | 4,462      |                     | $          | 8,717 |   |
| Property, plant and  equipment, net:             |       |                    |       |                     |       |
| Land                                             |       | $                       | 26,074     |                     | $          | 26,074 |   |
| Buildings and  land use right                    |       | 13,061                  |       | 7,612                    |       |
| Buildings/leasehold  improvements                |       | 5,117                   |       | 4,666                    |       |
| Machinery and  equipment                         |       | 33,364                  |       | 19,745                   |       |
| Furniture and  fixtures                          |       | 724                     |       | 718                      |       |
| Software                                         |       | 2,680                   |       | 2,546                    |       |
| Construction in  progress                        |       | 13,928                  |       | 17,496                   |       |
|                                             |       | 94,948                  |       | 78,857                   |       |
| Less: Accumulated  depreciation and amortization |       | (15,643                 | )          | (14,494                  | )          |
|                                             |       | $                       | 79,305     |                     | $          | 64,363 |   |
| Other long-term assets:                          |       |                    |       |                     |       |
| Deferred income  taxes — noncurrent         |       | $                       | 6,268      |                     | $          | 6,869 |   |
| Prepaid wafer  credits                           |       | 4,000                   |       | 4,000                    |       |
| Long-term  employee loan receivable              |       | 1,000                   |       | 1,000                    |       |
| Other long-term  assets                          |       | 938                     |       | 800                      |       |
|                                             |       | $                       | 12,206     |                     | $          | 12,669 |   |
| Accrued expenses and  other current liabilities: |       |                    |       |                     |       |
| Employee  compensation                           |       | $                       | 5,644      |                     | $          | 4,713 |   |
| Third party  commissions                         |       | 795                     |       | 1,021                    |       |
| Professional  services                           |       | 1,903                   |       | 1,830                    |       |
| Noncancelable  purchase commitments              |       | 1,056                   |       | 906                      |       |
| Pricing  adjustments                             |       | 3,698                   |       | 4,022                    |       |
| Other                                            |       | 2,142                   |       | 5,032                    |       |
|                                             |       | $                       | 15,238     |                     | $          | 17,524 |   |
| Other long-term  liabilities:                    |       |                    |       |                     |       |
| Deferred tax  liabilities                        |       | $                       | 5,616      |                     | $          | 6,506 |   |
| Other                                            |       | —                  |       | 492                      |       |
|                                             |       | $                       | 5,616      |                     | $          | 6,998 |   |

 

11

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**OMNIVISIONTECHNOLOGIES, INC.**

 

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

**For theThree Months Ended July 31, 2007 and 2006**

**(unaudited)**

** **

**Note 5 — Long-termInvestments**

** **

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

|        | ** ** | **July 31,  2007** | ** ** | **April 30,  2007** | ** ** |
|--------|------------|-------------------------|------------|--------------------------|------------|
| ImPac  |       | $                       | 2,246      |                     | $          | 2,355 |   |
| VisEra |       | 63,105                  |       | 60,265                   |       |
| WLCSP  |       | 8,649                   |       | —                   |       |
| XinTec |       | 4,661                   |       | 4,661                    |       |
| Total  |       | $                       | 78,661     |                     | $          | 67,281 |   |

 

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

In 2003, in order to enhance its access to plastic andceramic packaging services that were in short supply, the Company purchasedapproximately 27% of the common stock of ImPac Technology Co., Ltd. (“ImPac”),a privately-held company based in Taiwan for a total of $2.0 million incash. In December 2003, the Company made an additional cash contributionof approximately $0.8 million to maintain its equity ownership percentagein ImPac. Unrelated third parties own the balance of ImPac’s equity. Duringfiscal 2004, the Company’s equity interest declined to approximately 23%due to additional rounds of financing obtained by ImPac in which the Companydid not participate. The Company’s purchases from ImPac are at arm’s length andthe Company accounts for this investment using the equity method. The Companyrecorded an equity loss of $109,000 in “Other income, net,” for its portion ofthe net loss recorded by ImPac in the three months ended July 31, 2007 andincome of $123,000 as its portion of the net income of ImPac in the threemonths ended July 31, 2006. (See Note 16.)

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

In August 2005, the Company entered into anAmended and Restated Shareholders’ Agreement (the “Amended VisEra Agreement”)with Taiwan Semiconductor Manufacturing Company Limited (“TSMC”), VisEra, andVisEra Holding Company (“VisEra Cayman”). The Amended VisEra Agreement amendedand restated the original Shareholders’ Agreement (the “VisEra Agreement”) thatthe parties entered into on October 29, 2003, pursuant to which theCompany and TSMC agreed to form VisEra, a joint venture in Taiwan, for thepurposes of providing manufacturing services and automated final testingservices related to complementary metal oxide semiconductor, or CMOS, imagesensors. In November 2003, pursuant to the terms of the original Shareholders’Agreement, the Company contributed $1.5 million in cash to VisEra andgranted a non-exclusive license to certain of its manufacturing and automatedfinal testing technologies and patents. In order to provide greater financialand fiscal flexibility to VisEra, in connection with the Amended VisEraAgreement, the parties formed VisEra Cayman, a company incorporated in theCayman Islands and VisEra became a subsidiary of VisEra Cayman.

Under the terms of the Amended VisEra Agreement, theparties reaffirmed their respective commitments to VisEra, and expanded thescope of and made certain modifications to the original Shareholders’Agreement. The Company and TSMC have equal interests in VisEra Cayman. In thequarter ended October 31, 2005, the Company contributed $7.5 millionto VisEra and VisEra Cayman.

As a result of the additional investment that theCompany and TSMC made in VisEra during the quarter ended October 31, 2005,the Company’s and TSMC’s interest each increased from 25% to 43%, and consequentlythe Company re-evaluated its accounting for VisEra in accordance with FIN46(R), *“Consolidation of Variable Interest Entities.”*The Company concluded that, as a result of its step acquisition of VisEra, andbecause substantially all of the activities of VisEra either involved or wereconducted on behalf of the Company, VisEra was a variable interest entity.Since the Company was the source of virtually all of VisEra’s revenues, theCompany had a decisive influence over VisEra’s profitability. In the quarterended January 2006, the Company increased its interest in VisEra from 43%to 46% through purchases of $9.5 million of unissued shares. Accordingly,the Company considered itself to be the primary beneficiary of VisEra, andincluded VisEra’s financial results in its consolidated financial statementsthrough December 31, 2006.

12

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**OMNIVISIONTECHNOLOGIES, INC.**

 

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

**For theThree Months Ended July 31, 2007 and 2006**

**(unaudited)**

 

In January 2006, in accordance with the Amended VisEraAgreement, VisEra purchased color filter processing equipment and relatedassets from TSMC for an aggregate price equivalent to $16.9 million. Inconnection with the purchase, VisEra entered into a three-year lease agreementwith TSMC. Under this agreement, VisEra leases from TSMC approximately 14,000square feet of factory and office space where the assets are located at anannual cost of approximately $2.4 million.

In May 2006, VisEra purchased certain equipment andintellectual property from Dai Nippon Printing Co., Ltd., or Dai Nippon, forapproximately $3.1 million. Dai Nippon also made an investment in VisEraCayman of approximately $4.3 million. Because the per share value of theDai Nippon investment exceeded the Company’s average per share carrying valuein VisEra Cayman, the Company recorded a one-time change-of-interest benefit of$1.2 million directly to “Additional paid-in capital,” a component ofstockholders’ equity. In November 2006, the Company invested another$6.1 million in VisEra.

On January 1, 2007, the Company assumedresponsibility for logistics management services previously provided to theCompany by VisEra. As a consequence of the change, the Company concluded that,as of the date of the change, it would lose its status as the primarybeneficiary of the joint venture, VisEra would cease to be VIE as defined underFIN 46(R) and, as a result, the Company deconsolidated VisEra.Accordingly, beginning on January 1, 2007, the Company accounted for itsinvestment in VisEra under the equity method. The deconsolidation of VisEra didnot have a material effect on the Company’s reported revenue or reported netincome for the fiscal year ended April 30, 2007. In April 2007,pursuant to a January 2007 amendment to the Amended VisEra Agreement thatprovided for an increase in VisEra’s manufacturing capacity, the Company andTSMC each made an additional investment of $27.0 million in VisEra. Thisadditional investment is part of an ongoing capacity expansion program atVisEra. As of July 31, 2007, the Company and TSMC have agreed to commit atotal of $112.9 million to the joint venture, which commitments may bemade in the form of cash or asset contributions. Through July 31, 2007,the Company has contributed $51.6 million to VisEra and VisEra Cayman.

All other material terms of the Amended VisEraAgreement remain in effect. (See Note 16.)

## ***ChinaWLCSP Limited***

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

At the date of the transaction, the Company’s $9.0 millioninvestment in WLCSP exceeded its share of the book value of WLCSP’s assets by$5.7 million. Of this difference, $4.1 million represents equitymethod goodwill which the Company will not amortize, in accordance with SFASNo. 142, *“Goodwill and Other Intangible Assets,”*and APB Opinion No. 18, *“The Equity Method ofAccounting for Investments in Common Stock”*(“APB 18”). TheCompany will amortize the remaining basis difference of $1.6 million,which is attributable to intangible assets of WLCSP,  over an average life of approximately threeyears.

The Company accounts for its investment in WLCSP underthe equity method and, in the three months ended July 31, 2007, recordedan equity loss of $351,000 in “Other income, net,” consisting of an equitymethod investment adjustment partially offset by its portion of the net incomerecorded by WLCSP during the period.

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

Between October 2005 and March 2006,pursuant to the terms of the Amended VisEra Agreement (as defined above),VisEra Cayman completed the acquisition of approximately 29.6% of the issuedand outstanding shares of XinTec, Inc. (“XinTec”), a Taiwan-based supplier ofchip-scale packaging services, in which the Company already held

13

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**OMNIVISIONTECHNOLOGIES, INC.**

 

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

**For theThree Months Ended July 31, 2007 and 2006**

**(unaudited)**

 

an approximate 7.8% interest. Since VisEra was aconsolidated entity at the time, the Company’s beneficial interest in XinTecincreased to more than 20%. Consequently, beginning in the three months endedOctober 31, 2005 and through December 31, 2006, the Company accountedfor its investment in XinTec under the equity method.

In January 2007, TSMC purchased approximately90.5 million previously-unissued shares from XinTec. The purchased sharesrepresented approximately a 43.0% ownership interest in XinTec. Other existingshareholders, including the Company and the Company’s affiliate, VisEra, didnot purchase additional shares. Consequently, the Company’s direct ownershippercentage in XinTec declined to approximately 4.4%. VisEra’s ownershipinterest declined to 16.9%, and the Company’s beneficial ownership percentagein XinTec declined to 12.4%. Consequently, in accordance with APB 18, theCompany began to account for XinTec as a cost method investment effectiveJanuary 1, 2007. 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.For the three months ended July 31, 2006, the Company recorded equityincome of $0.8 million in “Other income, net,” for its portion of the netincome recorded by XinTec.

The following table presents the summary combinedfinancial information of ImPac, VisEra and WLCSP as derived from the ImPac,VisEra and WLCSP financial statements for the three months ended July 31,2007 and 2006 (in thousands):

 
| ** **             | ** ** | **Three Months Ended** | ** ** |
|------------------------|------------|----------------------------------|------------|
|                        | ** ** | **July 31,  2007**          | ** ** | **July 31,  2006** | ** ** |
| ***Operating  data:*** |       |                             |       |   |   |
| Revenues               |       | $                                | 41,812     |   | $ | 42,971 |   |
| Gross profit           |       | 7,281                            |       | 7,038 |   |
| Income from operations |       | 4,335                            |       | 5,367 |   |
| Net income             |       | $                                | 1,655      |   | $ | 3,190 |   |

 

The summarized financial information for the threemonths ended July 31, 2007 and 2006 was derived from financial statementsprepared under accountingprinciples generally accepted in the United States of America.

The amount of consolidated retained earnings thatrepresented undistributed earnings of investees accounted for by the equitymethod totaled $7.1 million and $6.8 million at July 31, 2007and April 30, 2007, respectively.

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

In May 2004, the Company entered into an agreementwith Powerchip Semiconductor Corporation (“PSC”), a Taiwan based company thatproduces memory chips and also provides semiconductor foundry services, toestablish a joint venture in Taiwan. The purpose of the joint venture, SiliconOptronics, Inc. (“SOI”), is to conduct manufacturing, marketing and selling ofcertain of the Company’s legacy products. The Company contributed approximately$2.1 million to SOI in exchange for an ownership percentage of 49.0%. InMarch 2005, the Company assumed control of the board of directors of SOIand the Company has consolidated SOI since April 30, 2005.

In July 2006, SOI declared a cash dividend of$482,000, of which the Company received $237,000. In July 2006, SOI alsoissued shares to its employees with an estimated fair value of $459,000 whichcaused the Company’s ownership percentage to decline from 49.0% to 46.6%.

In April 2007, SOI became listed on the TaiwanGreTai Securities Market, (“TGSM”). The TGSM is the approximate equivalent inTaiwan of the Over-The-Counter market in the United States. In conjunction withthe TGSM listing, various employees of SOI exercised their options andincreased the number of shares outstanding, which caused the Company’sownership percentage to decline to 45.0% as of July 31, 2007. InJune 2007, SOI declared a cash dividend of $409,000. (See Note 16.)

14

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**OMNIVISIONTECHNOLOGIES, INC.**

 

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

**For theThree Months Ended July 31, 2007 and 2006**

**(unaudited)**

 

**Note 7 — Intangible Assets andGoodwill**

Intangible assets as of July 31, 2007 consist ofthe following (in thousands):

|                            | ** ** | **Cost** | ** ** | **Accumulated  Amortization** | ** ** | **Net Book  Value** | ** ** |
|----------------------------|------------|----------|------------|-------------------------------|------------|--------------------------|------------|
| Core technology            |       | $        | 17,800     |                          | $          | 8,010                    |       | $ | 9,790 |   |
| Patents and  licenses      |       | 13,490   |       | 5,218                         |       | 8,272                    |       |
| Trademarks and  tradenames |       | 1,400    |       | 630                           |       | 770                      |       |
| Customer  relationships    |       | 100      |       | 76                            |       | 24                       |       |
| Intangible  assets, net    |       | $        | 32,790     |                          | $          | 13,934                   |       | $ | 18,856 |   |

 

Intangible assets as ofApril 30, 2007 consist of the following (in thousands):

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

 

During the three months ended July 31, 2007 and2006, the Company recorded $1.6 million and $1.7 million,respectively, in total amortization expense of intangible assets. The totalexpected future annual amortization of these intangible assets is as follows(in thousands):

| Years Ending April 30, | ** ** | ** ** | ** ** |
|---------------------------------------|------------|------------|------------|
| 2008                                  |       | $          | 4,928      |   |
| 2009                                  |       | 6,532      |       |
| 2010                                  |       | 6,386      |       |
| 2011                                  |       | 973        |       |
| 2012                                  |       | 37         |       |
| Total                                 |       | $          | 18,856     |   |

 

**Note 8 — BorrowingArrangements**

The following table showsthe Company’s debt and lease obligations (in thousands):

|                                        | ** ** | **July 31,  2007** | ** ** | **April 30,  2007** | ** ** |
|----------------------------------------|------------|-------------------------|------------|--------------------------|------------|
|                                   |       |                    |       |                     |       |
| Mortgage loan                          |       | $                       | 27,809     |                     | $          | 27,927 |   |
| Capital lease  obligations             |       | 244                     |       | 280                      |       |
|                                   |       | 28,053                  |       | 28,207                   |       |
| Less: amount due  within one year      |       | (641                    | )          | (631                     | )          |
| Non-current portion of  long-term debt |       | $                       | 27,412     |                     | $          | 27,576 |   |

 

At July 31, 2007,aggregate debt maturities were as follows: (in thousands):

| Years Ending April 30, | ** ** | **Mortgage  Loan** | ** ** | **Capital  Lease** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|--------------------|------------|--------------------|------------|-----------|------------|
| 2008                                  |       | $                  | 367        |               | $          | 110       |       | $ | 477 |   |
| 2009                                  |       | 515                |       | 134                |       | 649       |       |
| 2010                                  |       | 548                |       | —             |       | 548       |       |
| 2011                                  |       | 583                |       | —             |       | 583       |       |
| 2012                                  |       | 620                |       | —             |       | 620       |       |
| Thereafter                            |       | 25,176             |       | —             |       | 25,176    |       |
| Total                                 |       | $                  | 27,809     |               | $          | 244       |       | $ | 28,053 |   |

 

15

----

**OMNIVISIONTECHNOLOGIES, INC.**

 

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

**For theThree Months Ended July 31, 2007 and 2006**

**(unaudited)**

 

## ***MortgageLoan***

On March 16, 2007, the Company entered into aLoan and Security Agreement with a domestic bank. The Loan and SecurityAgreement provides for a term mortgage loan in the principal amount of$27.9 million (the “Mortgage Loan”) and a secured line of credit with anaggregate maximum principal amount of up to $12.0 million (the “Term Loan”).Borrowings under the Mortgage Loan accrue interest at the London InterbankBorrowing Rate (“LIBOR”) rate plus 90 basis points. Borrowings under theTerm Loan accrue interest at the LIBOR rate plus 125 basis points. TheMortgage and Term Loans mature on March 31, 2017 and September 30,2012, respectively.

As of July 31, 2007, $27.8 million wasoutstanding under the Mortgage Loan. At July 31, 2007, the interest rateunder the Mortgage Loan was 6.2%. The Company was in compliance with thefinancial covenants of the Loan and Security Agreement as of July 31,2007.

In conjunction with the Mortgage Loan, the Companyentered into an interest rate swap with the same bank to convert the variableinterest rate described above to a fixed rate. The swap is for a period of tenyears, and the notional amount of the swap approximates the principaloutstanding under the Mortgage Loan. The Company is the fixed rate payer underthe swap and the rate is fixed at 5.27% per annum. The Company measures theswap at fair value and records it as either an asset or a liability, dependingon whether the fair value represents a net gain or net loss. As ofJuly 31, 2007, the Company recorded $136,000 in “Other long-term assets”and, for the three months ended July 31, 2007, income of $0.6 millionin “Other income, net.”

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

SOI maintains four unsecured lines of credit withthree commercial banks, which provide a total of approximately$3.4 million in available credit. All borrowings under the four lines ofcredit maintained by SOI bear interest at the market interest rate prevailingat the time of borrowing. There are no financial covenant requirements forthese facilities and at July 31, 2007, there were no borrowingsoutstanding under these facilities.

## ***CapitalLease Obligations***

In February 2006, the Company leasedtelecommunications equipment under a three-year capital lease at an imputedinterest rate of 7.5% per annum. Terms of the agreement require the Company tomake monthly payments of approximately $14,000 through February 2009.Accordingly, the Company recorded a capital asset for $393,000 that is beingdepreciated over a five-year period in accordance with the Company’scapitalization policy. As of July 31, 2007, $244,000 was outstanding underthe capital lease. As of July 31, 2007, $95,000 was classified as along-term obligation.

**Note 9 — NetIncome Per Share**

Basic net income per share is computed by dividing netincome by the weighted average number of common shares outstanding during theperiod.

Diluted net income per share is computed according tothe treasury stock method using the weighted average number of common andpotentially dilutive common shares outstanding during the period. Potentiallydilutive common shares represent the effect of stock options. For the threemonths ended July 31, 2007 and 2006, 7,793,000 and3,350,000  shares, respectively, of common stock subject tooutstanding options were not included in the calculation of diluted net incomeper share because they were antidilutive (i.e., the per share exercise pricefor such options exceeded the average trading price of the Company’s commonstock as reported on The Nasdaq Stock Market for the periods presented).

The Company’s earnings per share were calculated underthe provisions of the Statement of Financial Accounting Standards (or “SFAS”)No. 128, *“Earnings Per Share,”*or SFAS No. 128. SFAS No. 128 requires that the Company take intoaccount the effect on consolidated earnings per share of options, warrants andconvertible securities issued by its subsidiaries. The effect on consolidatedearnings per share depends on whether the securities issued by the subsidiaryenable their holders to obtain common stock of the subsidiary company or commonstock of the parent company. Securities issued by a subsidiary that enabletheir holders to obtain the subsidiary’s common stock are included in computingthe subsidiary’s earnings per share data. The diluted per-share earnings of thesubsidiary are included in the

16

----

**OMNIVISIONTECHNOLOGIES, INC.**

 

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

**For theThree Months Ended July 31, 2007 and 2006**

**(unaudited)**

 

Company’s consolidated earnings per share computationsbased on the consolidated group’s holding of the subsidiary’s securities. InFebruary 2005, SOI issued options exercisable for 1,400,000 shares of itsown common stock. Subsequently, in June 2006, SOI issued optionsexercisable for an additional 700,000 shares of its own common stock. In thecalculation of its earnings per share for the three months ended July 31,2007 and 2006, the Company included the effect of SOI’s options in itsconsolidated earnings per share.

The following table sets forth the computation ofbasic and diluted earnings per share attributable to common stockholders forthe periods indicated (in thousands, except per share data):

|                                                                  | ** **   | **Three Months Ended  July 31,** | ** **   |
|------------------------------------------------------------------|--------------|-------------------------------------------------|--------------|
| ** **                                                       | ** **   | **2007**                                        | ** **   | **2006** | ** ** |
| ***Basic:***                                                     | *** *** | *** ***                                    | *** *** | *** *** | *** *** |
| Numerator:                                                       |         |                                            |         |   |   |
| Net income                                                       |         | $                                               | 12,977       |   | $ | 15,881 |   |
|                                                             |         |                                            |         |   |   |
| Denominator:                                                     |         |                                            |         |   |   |
| Weighted average common shares for net income per  share         |         | 54,751                                          |         | 54,401 |   |
|                                                             |         |                                            |         |   |   |
| Basic net income per share                                       |         | $                                               | 0.24         |   | $ | 0.29 |   |
|                                                             |         |                                            |         |   |   |
| ***Diluted:***                                                   |         |                                            |         |   |   |
| Numerator:                                                       |         |                                            |         |   |   |
| Net income                                                       |         | $                                               | 12,977       |   | $ | 15,881 |   |
| Dilutive effect of SOI consolidation                             |         | —                                          |         | (1 | ) |
| Net income for diluted computation                               |         | $                                               | 12,977       |   | $ | 15,880 |   |
|                                                             |         |                                            |         |   |   |
| Denominator:                                                     |         |                                            |         |   |   |
| Denominator for basic net income per share                       |         | 54,751                                          |         | 54,401 |   |
| Weighted average effect of dilutive securities:                  |         |                                            |         |   |   |
| Common stock options                                             |         | 543                                             |         | 2,303 |   |
| Weighted average common shares for diluted net  income per share |         | 55,294                                          |         | 56,704 |   |
|                                                             |         |                                            |         |   |   |
| Diluted net  income per share                                    |         | $                                               | 0.23         |   | $ | 0.28 |   |

 

**Note 10 — Segmentand Geographic Information**

The Company identifies its business segments based onbusiness activities, management responsibility and geographic location. For allperiods presented, the Company operated in a single reportable businesssegment.

The Company sells its image-sensor products eitherdirectly to OEMs and VARs or indirectly through distributors. The followingtable illustrates the percentage of revenues from sales to OEMs and VARs and todistributors for the three months ended July 31, 2007 and 2006:

|               | ** ** | **Three Months Ended  July 31,** | ** ** |
|---------------|------------|-------------------------------------------------|------------|
| ** **    | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| OEMs and VARs |       | 64.5                                            | %          | 68.1 | % |
| Distributors  |       | 35.5                                            |       | 31.9 |   |
| Total         |       | 100.0                                           | %          | 100.0 | % |

 

17

----

**OMNIVISIONTECHNOLOGIES, INC.**

 

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

**For theThree Months Ended July 31, 2007 and 2006**

**(unaudited)**

Since the Company’s end-user customers market and selltheir products worldwide, its revenues by geographic location are notnecessarily indicative of the geographic distribution of end-user sales, butrather indicate where the products and/or their components are manufactured orsourced. The revenues by geography in the following table are based on thecountry or region in which the Company’s customers issue their purchase orders(in thousands):

|               | ** ** | **Three Months Ended  July 31,** | ** ** |
|---------------|------------|-------------------------------------------------|------------|
| ** **    | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| China(1)      |       | $                                               | 152,910    |   | $ | 76,074 |   |
| Taiwan        |       | 11,095                                          |       | 27,970 |   |
| Japan         |       | 2,561                                           |       | 13,088 |   |
| United States |       | 1,392                                           |       | 2,493 |   |
| South Korea   |       | 844                                             |       | 14,242 |   |
| All other     |       | 4,332                                           |       | 3,008 |   |
| Total         |       | $                                               | 173,134    |   | $ | 136,875 |   |

----

(1)    Prioryear data reclassified to combine the results for Hong Kong and China.

 

The Company’s long-lived assets are located in thefollowing countries (in thousands):

|               | ** ** | **July 31,  2007** | ** ** | **April 30,  2007** | ** ** |
|---------------|------------|-------------------------|------------|--------------------------|------------|
| Taiwan        |       | $                       | 74,891     |                     | $          | 71,953 |   |
| United States |       | 44,256                  |       | 41,896                   |       |
| China         |       | 43,275                  |       | 22,053                   |       |
| All other     |       | 482                     |       | 542                      |       |
| Total         |       | $                       | 162,904    |                     | $          | 136,444 |   |

 

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

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

The following table summarizes stock-basedcompensation award activity under the 2000 Stock Plan and the2000 Director Option Plan, and the related weighted average exerciseprice, for the three months ended July 31, 2007:

|                                                   | ** ** | ** **                             | ** ** | **Options outstanding**    | ** ** |
|---------------------------------------------------|------------|----------------------------------------|------------|----------------------------|------------|
| ** **                                        | ** ** | **Options  Available  For Grant** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Price Per  Share** | ** ** |
|                                              | ** ** | **(in thousands)**                     | ** ** | **(in thousands)**         |       |   |   |
| Balance at May 1, 2007                            |       | 1,743                                  |       | 12,537                     |       | $ | 18.54 |   |
| Replenished                                       |       | 3,137                                  |       | —                     |       | — |   |
| Granted                                           |       | (2,527                                 | )          | 2,527                      |       | 14.93 |   |
| Exercised                                         |       | —                                 |       | (90                        | )          | 11.82 |   |
| Expired or  forfeited                             |       | 257                                    |       | (257                       | )          | 20.09 |   |
| Balance at  July 31, 2007                    |       | 2,610                                  |       | 14,717                     |       | 17.93 |   |
| Vested and expected to vest at July 31, 2007 |       |                                   |       | 14,213                     |       | $ | 17.89 |   |

 

As of July 31, 2007 and April 30, 2007,options to purchase 7,238,000and 6,126,000 shares,respectively, were vested.

The total intrinsic value of options exercised duringthe three months ended July 31, 2007 and 2006 was $485,000 and$4.6 million, respectively. Total cash received from employees as a resultof employee stock option exercises during the three months ended July 31,2007 and 2006 was approximately $1.1 million and $5.4 million, respectively.

18

----

**OMNIVISIONTECHNOLOGIES, INC.**

 

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

**For theThree Months Ended July 31, 2007 and 2006**

**(unaudited)**

As of July 31, 2007, net of forfeitures, therewas $59.0 millionof unrecognized compensation expense related to unvested stock options, whichis expected to be recognized over a weighted average period of 2.6 years.For the 2000 Purchase Plan, as of July 31, 2007, there was$3.0 million of unrecognized compensation expense which is expected to berecognized over a weighted average period of 1.2 years. The Company’scurrent practice is to issue new shares to settle share option exercises. As ofApril 30, 2007, net of forfeitures, there was $44.5 million ofunrecognized compensation cost related to unvested stock options, which isexpected to be recognized over a weighted average period of 1.2 years. Forthe 2000 Purchase Plan, as of April 30, 2007, there was$1.2 million of unrecognized compensation cost which is expected to berecognized over a weighted average period of 1.1 years. The Company’scurrent practice is to issue new shares to settle share option exercises.

## ***ValuationAssumptions***

SFAS No. 123(R) requires companies toestimate the fair value of stock-based compensation awards on the grant dateusing an option pricing model. The value of the portion of the award that isultimately expected to vest is recognized as expense over the requisite serviceperiod in the Company’s Condensed Consolidated Statements of Income. TheCompany measures the fair value of stock-based compensation awards usingBlack-Scholes consistent with the provisions of SFAS No. 123(R),SEC SAB No. 107. Black-Scholes was developed to estimate the fairvalue of freely tradable, fully transferable options without vestingrestrictions. These assumptions differ significantly from the characteristicsof the Company’s stock-based compensation awards. Black-Scholes also requiresthe use of highly subjective, complex assumptions, including expected term andthe price volatility of the Company’s stock.

The fair value 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 $6.81 and$13.93 during the three months ended July 31, 2007 and 2006, respectively.

The following weighted average assumptions areincluded in the estimated fair value calculations for stock options granted inthe three months ended July 31, 2007 and 2006:

|                                      | ** ** | **Employee Stock Option Plans**               | ** ** |
|--------------------------------------|------------|-----------------------------------------------|------------|
| ** **                           | ** ** | **Three Months Ended**July 31, | ** ** |
| ** **                           | ** ** | **2007**                                      | ** ** | **2006** | ** ** |
| Risk-free interest rate              |       | 4.84                                          | %          | 5.05 | % |
| Expected term of  options (in years) |       | 4.0                                           |       | 4.0 |   |
| Expected volatility                  |       | 52.0                                          | %          | 66.8 | % |
| Expected dividend yield              |       | 0                                             | %          | 0 | % |

 

Using Black-Scholes, the per share weighted averageestimated fair value of rights issued pursuant to the Company’s 2000 PurchasePlan during the three months ended July 31, 2007 and 2006 was $5.65 and $8.13, respectively.

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, | ** ** |
| ** **                           | ** ** | **2007**                                      | ** ** | **2006** | ** ** |
| Risk-free interest rate              |       | 5.04                                          | %          | 5.11 | % |
| Expected term of  options (in years) |       | 0.5                                           |       | 0.5 |   |
| Expected volatility                  |       | 48.3                                          | %          | 57.2 | % |
| Expected dividend yield              |       | 0                                             | %          | 0 | % |

 

19

----

**OMNIVISIONTECHNOLOGIES, INC.**

 

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

**For theThree Months Ended July 31, 2007 and 2006**

**(unaudited)**

The definitions of the terms used to determine the abovevalues 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 ofSFAS No. 123(R), the Company determined expected volatility based onan average between the historical volatility of the Company’s common stock andthe implied volatility based on the Company’s traded options. Averaging twodata sources may provide a better proxy to what market place participants woulduse to value the Company’s options. Previously, the Company determined expectedvolatility based on the historical volatility of the Company’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 12 — Additional Paid-inCapital**

The following table shows the amounts recorded to “Additionalpaid-in capital” for the three months ended July 31, 2007 (in thousands):

|                                                | ** ** | **Additional  Paid-in  Capital** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|
| Balance at May 1,  2007                   |       | $                                | 329,012    |   |
| Exercise of  stock options                     |       | 1,072                            |       |
| Employee stock  purchase plan                  |       | 1,844                            |       |
| Compensation  related to stock options granted |       | 6,152                            |       |
| Balance at July 31, 2007                  |       | $                                | 338,080    |   |

 

**Note 13 — TreasuryStock**

In June 2005, the Company’s board of directorsauthorized the repurchase in an open-market program of up to an aggregate of$100 million of the Company’s common stock. At the time that the programexpired in June 2006, and at April 30, 2007, the Company had cumulativelyrepurchased 5,870,000 shares of its common stock for an aggregate cost ofapproximately $79.6 million.

In February 2007, the Company’s board ofdirectors approved an additional stock repurchase program that provides for therepurchase of up to $100 million of its outstanding common stock in anopen-market program. Subject to applicable securities laws, such repurchaseswill be at such times and in such amounts as it deems appropriate, based onfactors such as market conditions, legal requirements and other corporateconsiderations. As of July 31, 2007, the Company had cumulativelyrepurchased 566,000 shares of its common stock under the open-marketprogram for an aggregate cost of approximately $9.6 million.

**Note 14 — IncomeTaxes**

The Company adopted the provisions of FIN 48 onMay 1, 2007. As a result of the adoption of FIN 48, the Companyincreased its net unrecognized tax benefits by $4.3 million, and accountedfor the increase as a cumulative effect of a change in accounting principle byreducing retained earnings by $4.3 million. The Company also recorded a$2.7 million increase in its liability for net unrecognized tax benefits,a $1.3 million decrease in deferred tax assets and a $0.3 milliondecrease in other receivables. The total amount of gross unrecognized taxbenefits as of the date of adoption was $70.1 million.

Historically, the Company classified the liability fornet unrecognized tax benefits in current income taxes payable. As a result ofthe adoption of FIN 48, the Company reclassified $64.3 million of itsliability for net unrecognized tax benefits from current to long-term incometaxes payable because payment of cash is not anticipated

20

----

**OMNIVISIONTECHNOLOGIES, INC.**

 

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

**For theThree Months Ended July 31, 2007 and 2006**

**(unaudited)**

within one year of the balance sheet date. The Company’snet unrecognized tax benefits consisted of gross unrecognized tax benefits,reduced by the associated federal tax benefits on state unrecognized tax benefits and interest.

The total amount of gross unrecognized tax benefits of$70.1 million as of the date of adoption includes $68.8 million that,if recognized, would reduce the Company’s effective income tax rate in futureperiods; and $1.3 million related to the federal tax benefit on stateunrecognized tax benefits and interest, if recognized. One or more of theseunrecognized tax benefits could be subject to a valuation allowance if and whenrecognized in a future period, which could impact the timing of any relatedeffective tax rate benefit.

The Company’s policy to include interest and penaltiesrelated to unrecognized tax benefits within the provision for income taxes onthe Condensed Consolidated Statements of Income did not change as a result ofimplementing the provisions of FIN 48. As of the date of adoption, theCompany had accrued $5.1 million and $7.4 million for the potentialpayment of interest and penalties, respectively. During the quarter endedJuly 31, 2007, the Company accrued approximately $0.7 million ofinterest. As a result of a change in tax law in a foreign jurisdiction duringthe first quarter of fiscal 2008, the Company reduced the total amount ofgross unrecognized tax benefits, as well as its accrual for penalties, by$4.5 million.

The Company files U.S. federal, U.S. state,and foreign tax returns. For U.S. federal, U.S. state and foreign taxreturns, the Company is generally no longer subject to tax examinations foryears prior to fiscal 2003. Over the next twelve months, the Company doesnot anticipate any material change to the balance of gross unrecognized taxbenefits.

**Note 15 — Commitmentsand Contingencies**

## ***Commitments***

In December 2000, the Company formed asubsidiary, Hua Wei Semiconductor (Shanghai) Co. Ltd., or HWSC, to conducttesting operations and other processes associated with the manufacturing of itsproducts in China. The registered capital of HWSC is $30.0 million and, asof July 31, 2007, the Company had fully funded the registered capitalcommitment. The funds were used primarily for payment to building contractorsfor the construction of facilities and for the purchase of equipment.

The Company also maintains a subsidiary in Shanghai,SDC, which provides assistance to the Company in various product designprojects and in marketing and sales support. On January 10, 2007, SDCentered into a Land-Use-Right Purchase Agreement (the “Purchase Agreement”)with the Construction and Transportation Commission of the Pudong New District,Shanghai. The Purchase Agreement has an effective date of December 31,2006. Under the terms of the Purchase Agreement, the Company agreed to pay anaggregate amount of approximately $0.6 million (the “Purchase Price”) inexchange for the right to use approximately 323,000 square feet of land locatedin Shanghai for a period of 50 years. In addition, the Company isobligated to invest a minimum of approximately $30 million to develop theland and construct facilities, which amount includes the Purchase Price. As ofJuly 31, 2007, the Company has contributed $7.5 million of the$30 million total investment. Construction of the facilities on the landmust be completed by June 30, 2009, pursuant to contractual agreement,subject to an additional one-year extension under limited circumstances. TheCompany may use the land solely for the purposes of industrial use and/orscientific research. The Company intends to use SDC’s registered capital topartially fund its commitment to this project.

The Company has various commitments arising from the AmendedVisEra Agreement, and the subsequent amendments to it. In particular, as ofJuly 31, 2007, the Company and TSMC have agreed to commit a total of$112.9 million to the joint venture, which commitments may be made in theform of cash or asset contributions. Additional contributions may be made byadditional investors, additional contributions by the Company and TSMC, or acombination thereof, provided that the Company and TSMC have and will maintainequal interests in VisEra and VisEra Cayman.

Through July 31, 2007, the Company hascontributed $51.6 million to VisEra and VisEra Cayman. To the extent, ifany, that the value of assets contributed in the future exceeds the value ofthe Company’s commitment, the Company will receive cash from VisEra Cayman.(See Notes 5 and 16.)

21

----

**OMNIVISIONTECHNOLOGIES, INC.**

 

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

**For theThree Months Ended July 31, 2007 and 2006**

**(unaudited)**

## ***Litigation***

From time to time, the Company has been subject tolegal proceedings and claims with respect to such matters as patents, productliabilities and other actions arising out of the normal course of business.

On November 29, 2001, a complaint captioned *McKee v. OmniVision Technologies, Inc., et. al., Civil Action No. 01 CV10775*, was filed in the United States District Court for theSouthern District of New York against OmniVision, some of the Company’s directorsand officers, and various underwriters for the Company’s initial publicoffering. Plaintiffs generally allege that the named defendants violatedfederal securities laws because the prospectus related to the Company’soffering 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 the Company’s offering. The complaint seeksunspecified damages on behalf of a purported class of purchasers of the Company’scommon stock between July 14, 2000 and December 6, 2000.Substantially similar actions have been filed concerning the initial publicofferings for more than 300 different issuers, and the cases have beencoordinated as *In re Initial Public Offering SecuritiesLitigation, 21 MC 92*. Claims against the Company’s directorsand officers have been dismissed without prejudice pursuant to a stipulation.On February 19, 2003, the Court issued an order dismissing all claimsagainst the Company except for a claim brought under Section 11 of theSecurities Act of 1933.

In June 2004, the issuer defendants and plaintiffsnegotiated a stipulation of settlement for the claims against the issuerdefendants, including OmniVision, that was submitted to the Court for approval.In August 2005, the Court preliminarily approved the settlement. InDecember 2006, the appellate court overturned the certification of classesin the six test cases that were selected by the underwriter defendants andplaintiffs in the coordinated proceedings. Because class certification was acondition of the settlement, it was unlikely that the settlement would receivefinal court approval. On June 25, 2007, the Court entered an order terminatingthe proposed settlement based upon a stipulation among the parties to thesettlement.  Plaintiffs have indicatedthat they will seek to amend their allegations and file amended complaints.  It is uncertain whether there will be anyrevised or future settlement. If the litigation proceeds, the Company believesthat it has meritorious defenses to plaintiffs’ claims and intends to defendthe action vigorously.

On June 10, 2004, the first of several putativeclass actions was filed against the Company and certain of its present andformer directors and officers in federal court in the Northern District ofCalifornia on behalf of investors who purchased its common stock at varioustimes from February 2003 through June 9, 2004. Those actions wereconsolidated under the caption *In reOmniVision Technologies, Inc.,*No. C-04-2297-SC, and aconsolidated complaint was filed. The consolidated complaint asserts claims onbehalf of purchasers of the Company’s common stock between June 11, 2003and June 9, 2004, and seeks unspecified damages. The consolidatedcomplaint generally alleges that defendants violated Sections 10(b) and20(a) of the Securities Exchange Act of 1934 by allegedly engaging inimproper accounting practices that purportedly led to the Company’s financialrestatement. On July 29, 2005, the Court denied the Company’s motion todismiss the complaint. The parties engaged in settlement discussions and inNovember 2006, the parties reached an agreement in principle to settlethis litigation. The total amount of the proposed settlement is approximately$13.8 million, of which approximately $0.8 million would becontributed by the Company and the remainder would be funded by insurancecarriers that issued Directors and Officers Liability Insurance Policies to theCompany. During fiscal 2007, the Company accrued $3.3 million as itsshare of the settlement, including unreimbursed defense costs, net of the$13.0 million in recoverable insurance proceeds. The parties have executeda Stipulation of Settlement that was filed with the Court on May 15, 2007.On May 25, 2007, the Court issued an Order preliminarily approving thesettlement and providing for notice of the settlement to be provided to thepurported shareholder class. The Order granting preliminary approval scheduleda hearing on September 7, 2007 to determine whether the settlement isfair, reasonable and adequate to the purported class. The hearing was heldon  September 7, as scheduled, butthe Court had not issued a ruling on the matter as of the date of this filing.As a part of the Stipulation of Settlement, the parties agreed to staydiscovery and other proceedings. The Company believes that ultimate settlementis probable at the currently estimated amount. If the settlement does not  becomefinal and litigation against it continues, the Company believes that it hasmeritorious defenses and intends to defend the case vigorously. If thelitigation continues, the Company cannot estimate whether the result of thelitigation would have a material adverse effect on its financial condition,results of operations or cash flows.

22

----

**OMNIVISIONTECHNOLOGIES, INC.**

 

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

**For theThree Months Ended July 31, 2007 and 2006**

**(unaudited)**

On October 20, 2005, a purported shareholderderivative complaint, captioned *Hackl v. Hong*,No. 1:05-CV-050985, was filed in Santa Clara County Superior Court for theState of California. This derivative action contains allegations that werevirtually identical to the prior state court derivative actions that werevoluntarily dismissed, and which were based on the allegations contained in thesecurities class actions. The complaint generally sought unspecified damagesand equitable relief based on causes of action against various of the Company’spresent and former directors and officers for purported breach of fiduciaryduty, abuse of control, gross mismanagement, waste of corporate assets, unjustenrichment and violations of California Corporations Code. The Company wasnamed solely as a nominal defendant against whom no monetary recovery wassought. Pursuant to a January 20, 2006 Court Order, plaintiff furnished abond for reasonable expenses in order to proceed with his derivative action. OnMay 15, 2006, the Court sustained the Company’s demurrer to the complaintwith leave to amend on the grounds that the plaintiff failed to make apre-litigation demand on the Company’s board of directors and fails tosufficiently plead that demand is futile. On October 4, 2006, the Courtsustained the Company’s demurrer to the complaint as well and again grantedplaintiff leave to amend. On May 10, 2007, the Court sustained the Company’sdemurrer contending that plaintiff’s complaint failed to allege adequately whyno pre-litigation demand had been made on the Company’s board of directors, but granted plaintiff leave to furtheramend the complaint. Simultaneously, the parties advised the Court that theyhad reached a settlement in principle. The parties executed a Stipulation ofSettlement that was filed with the Court on June 18, 2007. On June 26,2007, the Court entered an order approving the settlement, pursuant to whichthe Company agreed to pay a settlement fee in the amount of $200,000. TheCompany expensed this amount in the quarter ended July 31, 2007.

**Note 16 — RelatedParty Transactions**

In May 2006, the Company consummated a loanagreement with one of its employees. Under the terms of the agreement, whichthe board of directors approved in fiscal 2004, the Company extended tothe employee a three-year $1.0 million loan with an imputed interest rateof approximately five percent per annum which matures on May 12, 2009. Theloan is secured by a deed of trust.

In the second quarter of fiscal 2006, the Companyentered into an agreement with ImPac (see Note 5) under which ImPac agreedto provide certain management and support services to HWSC. The Companycompensates ImPac for the services provided in accordance with the Company’spolicy regarding related party transactions. The Company’s board of directorsapproved the agreement, which may be cancelled by either party at any time.During the three months ended January 31, 2007, the Company and ImPacagreed to phase out ImPac’s management and support services over a period ofseveral months beginning on January 1, 2007. During the three months endedJuly 31, 2006, the Company paid ImPac approximately $211,000 ascompensation for management and support services. During the three months endedJuly 31, 2007, the Company paid ImPac approximately $45,000 as softwarelicensing fees.

The Company consolidated VisEra’s operating resultsfrom August 1, 2005 to December 31, 2006. Subsequently, the Companyaccounted for its investment in VisEra under the equity method. For thethree-month period ended July 31, 2007, the Company paid$34.3 million to VisEra for color filter and other manufacturing services.

In May 2007, the Company purchased a 19.98%ownership in WLCSP for $9.0 million. For the three-month period endedJuly 31, 2007, the Company paid $2.3 million to WLCSP for chip scalepackaging services.

23

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**OMNIVISIONTECHNOLOGIES, INC.**

 

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

**For theThree Months Ended July 31, 2007 and 2006**

**(unaudited)**

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, 2007 and 2006 (in thousands):
| ** **                           | ** ** | **Three Months Ended  July 31,** | ** ** |
|--------------------------------------|------------|-------------------------------------------------|------------|
| ** **                           | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ***SOI  transactions with:***        | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| ImPac:                               |       |                                            |       |   |   |
| Purchases of  manufacturing services |       | $                                               | 563        |   | $ | 1,325 |   |
| Balance payable  at period end       |       | 422                                             |       | 958 |   |
| PSC:                                 |       |                                            |       |   |   |
| Purchases of  wafers                 |       | 1,540                                           |       | 1,174 |   |
| Rent and other  services             |       | —                                          |       | 14 |   |
| Balance payable  at period end       |       | 478                                             |       | 254 |   |
|                                 |       |                                            |       |   |   |
| ***VisEra  transactions with:***     |       |                                            |       |   |   |
| ImPac:                               |       |                                            |       |   |   |
| Purchases of  manufacturing services |       | —                                          |       | 3,433 |   |
| Balance payable  at period end       |       | —                                          |       | 3,235 |   |
| TSMC:                                |       |                                            |       |   |   |
| Sales to TSMC                        |       | 615                                             |       | 432 |   |
| Purchases of  manufacturing services |       | 243                                             |       | 271 |   |
| Rent, utilities  and other services  |       | 1,859                                           |       | 982 |   |
| Balance payable  at period end       |       | 1,917                                           |       | 509 |   |
| WLCSP:                               |       |                                            |       |   |   |
| Purchases of  manufacturing services |       | $                                               | 1,531      |   | $ | — |   |

 

The Company purchases a substantial portion of itswafers from TSMC. The Company also purchases a portion of its wafers from PSC.

 

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**ITEM 2.****                MANAGEMENT’SDISCUSSION 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 ofSection 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934, which involve risks and uncertainties.Forward-looking statements generally include words such as “may,” “will,” “plans,”“seeks,” “expects,” “anticipates,” “outlook,” “intends,” “believes” and wordsof similar import as well as the negative of those terms. In addition, anystatements that refer to expectations, projections or other characterizationsof future events or circumstances, including any underlying assumptions, areforward-looking statements. All forward-looking statements included in thisQuarterly Report on Form 10-Q, including, but not limited to, statementsregarding the extent of future sales through distributors, future trends andopportunities in certain markets, the development, introduction andcapabilities of new products, the establishment of partnerships with othercompanies, increased unit volume sales, the increase of competition in ourindustry, the continued importance of the camera cell phone market to ourbusiness, continued price competition and the consequent reduction in theaverage selling prices of our products, future gross margins and futureexpenses, our effective tax rate for fiscal 2008, our future investments,our working capital requirements in fiscal 2008, and the sufficiency ofour available cash, cash equivalents and short-term investments are based oncurrent expectations and are subject to important factors that could causeactual results to differ materially from those projected in the forward-lookingstatements. Such important factors include, but are not limited to, those setforth under the caption “Item 1A. Risk Factors,” beginning on page 44of this Quarterly Report and elsewhere in this Quarterly Report and in otherdocuments we file with the**U.S. Securitiesand Exchange Commission**(“SEC”). All subsequent written and oral**forward-looking statements by orattributable to us or persons acting on our**behalf are expressly qualified in their entirety bysuch factors.*

*OmniVision and OmniPixel are registered trademarks ofOmniVision Technologies, Inc. CameraChip, OmniPixel2, OmniPixel3, Square Graphics Array and TrueFocus aretrademarks of OmniVision Technologies, Inc. Wavefront Coded is a registeredtrademark of CDM Optics, Inc., a wholly-owned subsidiary of OmniVisionTechnologies, Inc. Wavefront Coding is a trademark of CDM Optics, Inc.*

**Overview**

We design, develop and market high performance, highlyintegrated and cost efficient semiconductor image sensor devices. Our mainproducts, image-sensing devices which we refer to by the name CameraChipTM imagesensors, capture an image electronically and are used in a number of consumerand commercial mass-market applications. Our CameraChip image sensors aremanufactured using the complementary metal oxide semiconductor, or CMOS,fabrication process and are predominantly single-chip solutions that integrateseveral distinct functions including image capture, image processing, colorprocessing, signal conversion and output of a fully processed image or videostream. We believe that our highly integrated image sensors enable cameradevice manufacturers to build high quality camera products that are smaller,less complex, more reliable, more cost effective and more power efficient thancameras using traditional charge-coupled devices, or CCDs.

## ***Technology***

In August 2004, we announced the introduction ofour OmniPixel® technology. In September 2005, we announcedthe introduction of our OmniPixel2TM architecture. The OmniPixel2  architecture, which is based on a 2.2μ x 2.2μpixel and uses a 0.13μ process geometry, is less than half the size of theOmniPixel architecture introduced in 2004, but with improved performance. Withthe OmniPixel2 architecture, we significantly improved sensor performance inthree key areas: the improved fill-factor and zero-gap micro-lens structureincreased the sensor’s capacity to capture light and the sensor’s improvedquantum efficiency improved its dynamic range, that is its capacity to capturewidely differing light levels in a single image; and its capacity to rapidlyadjust to changes in light levels.

In February 2007, we introduced our firstTrueFocusTM camera with Wavefront CodingTM technology for the mobile handsetmarket. Our patented Wavefront Coding technology is a method of opticallyencoding light using a special lens to form an intermediate image on thesensor, and decoding this intermediate image with digital processing to createa picture that is in focus across virtually the entire image. TrueFocus technologyoffers true ‘point-and-shoot’ capability where the entire image is always infocus and always available for instant one-click capture in real time, with nowaiting for the lens to focus. TrueFocus technology is designed to provide ourcustomers with a product that effectively targets the mobile handset market bybeing small, durable, easy to manufacture and cost-competitive.

25

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**ITEM 2.****                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS —(Continued)**

In May 2007, we announced the introduction of thelatest generation of our OmniPixel architecture, our OmniPixel3TM architecture.The OmniPixel3 architecture is based on a new 1.75μ x 1.75μ pixel anduses a 0.11μ process geometry which further reduces the size of a givensensor array without any reduction in image quality.

Given the rapidly changing nature of our technology,there can be no assurance that we will not encounter delays or other unexpectedproduction or performance issues with future products. During the early stagesof production, production yields and gross margins for products based on newtechnology are typically lower than those of established products.

## ***NewProducts***

In September 2006, we introduced the OV7720, ahigh sensitivity digital video graphics array, or VGA, CameraChip sensordesigned specifically for security and surveillance applications. Unlike thesensors used in conventional analog security cameras, the new sensor produceshigh quality digital output and eliminates the need for A/D converters whilesimplifying post processing. The OV7720 is one of the first high performancesensors capable of running at 60 frames per second and delivers, webelieve, exceptional low-light sensitivity and performance without sacrificingthe speed required for advanced security applications. In September 2006,we also unveiled the new OV7949 advanced CMOS CameraChip sensor designedspecifically for commercial closed-circuit television/video monitoring securitysystems. The highly integrated, single-chip OV7949 video camera chip sensor isbased on our proprietary OmniPixel architecture. The OV7949 combines a highlevel of functionality with a brand new design that we specifically engineeredto operate extremely well in low-light conditions, a feature especiallycritical to indoor and night security monitoring systems.

In October 2006, we announced the availability ofour new all digital OV7710 CameraChip advanced CMOS image sensor developedspecifically for automotive applications. The OV7710 is a highly integratedCMOS video camera that combines a high level of functionality with all digitaloutput. Digital output is a key requirement for automotive machine-visionapplications such as airbag deployment, lane departure warning, collisionavoidance/pedestrian detection, windshield wiper control, and drowsinessdetection. The OV7710 features a dual dynamic overlay function, which permitstext or graphics within the image.

In February 2007, in addition to the firstTrueFocus camera described earlier, we announced the details of two other newproducts. The first was a 5.17-megapixel auto-focus camera module for mobilehandsets based around the OV5623 CameraChip sensor. The new moduleprovides the basis for high resolution cameras to enter the mainstream mobilehandset market. Our introduction of the 5.17-megapixel camera module with auto-focuscapability, a function previously associated only with digital still cameras,or  DSCs, and expensive camera phones,brings high image quality and camera performance closer to the mainstreamcamera phone market. We expect that our new 5.17-megapixel camera module willenable our handset customers to continue to move up the ‘megapixel curve’ inorder to provide DSC-quality imaging on mass market camera phones.

The second new product was the OV7680, a new 1/10 inchVGA CameraChip sensor designed for entry-level camera phones, for secondarycameras in 3G handsets, and for integrated notebook PC cameras. The new sensorincorporates a unique non-linear lens shift technology, which permits areduction in the height of the camera module to just 3.17mm.

In March 2007, we introduced the OV10620, ourfirst color High Dynamic Range, or HDR, CMOS image sensor for mass marketapplications. The new OV10620 has the capacity to capture widely differinglight levels in a single image and to rapidly adjust to changes in lightlevels, much like the human eye under quickly changing light conditions. TheOV10620 rapidly switches to HDR mode to handle extreme variations of bright anddark conditions and automatically switches back to non-HDR mode when conditionreturn to normal. The new single-chip sensor also has a spectral lightsensitivity of up to 1,000 nm, which is near infrared sensitivity.

In June 2007, we introduced the OV3640, the firstfully integrated 3.2-megapixel CameraChip sensor in a 1⁄4-inch format. Based onthe new 1.75-micron OmniPixel3 architecture, the OV3640 is small enough to fitthe standard 8 x 8 mm sockets used in 2.0-megapixel camera phones, making it anideal drop-in upgrade for existing handset designs. The highly integratedOV3640 features a high-speed two-lane mobile industry processor interface, orMIPI, to enable the fast transfer of large blocks of data, which is critical tomaking effective use of increased camera resolutions. In addition, the newsensor incorporates advanced image signal processing and onboard JPEGcompression to allow existing baseband processors without MIPI to support acamera upgrade to 3.2 megapixels at 15 frames per second in

26

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**ITEM 2.****                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (Continued)**

full resolution. In addition to MIPI, the OV3640 alsoincorporates advanced image stabilization functionality similar to that used inDSC and camcorder products.

In June 2007, we announced that we had begunvolume shipments of our recently introduced OV6680 high-performance SquareGraphics ArrayTM, camera chip sensor. With its unique 400 x 400 array, low-lightsensitivity and small form factor, the new OV6680 is intended primarily for usein secondary cameras for the 3G video phone market and for entry-level,ultra-thin camera phone designs. We anticipate significant growth in thesemarkets during the next several years.

## ***JointVenture with TSMC***

In October 2003, we entered into a Shareholders’Agreement, or the VisEra Agreement, with Taiwan Semiconductor ManufacturingCompany Limited, or TSMC, pursuant to which we agreed with TSMC to form VisEraTechnologies Company, Ltd., or VisEra, a joint venture in Taiwan. VisEra’smission is to provide back-end manufacturing services. In connection with theformation of VisEra, both TSMC and we entered into separate nonexclusivelicense agreements with VisEra pursuant to which each party licenses certainintellectual property to VisEra relating to manufacturing services. The VisEraAgreement also provided that once VisEra had acquired the capability to deliverhigh quality manufacturing services, we would be committed to direct asubstantial portion of our requirements in these areas to VisEra, subject topricing and technology requirements. Both TSMC and we have also committed notto compete directly or indirectly with VisEra in the provision of certainmanufacturing services. Historically, we have relied upon TSMC to provide uswith a substantial proportion of our wafers. As a part of the VisEra Agreement,TSMC agreed to commit substantial wafer manufacturing capacity to us inexchange for our commitment to purchase a substantial portion of our wafersfrom TSMC, subject to pricing and technology requirements.

In August 2005, weentered into an Amended and Restated Shareholders’ Agreement with TSMC, or theAmended VisEra Agreement, under which the parties reaffirmed their respectivecommitments to VisEra, expanded the scope of and made minor modifications tothe VisEra Agreement. Under the Amended VisEra Agreement, the parties agreed toraise the total capital committed to the joint venture from $50.0 millionto $68.0 million. The $18.0 million increase was designatedprincipally for the acquisition from unrelated existing shareholders ofapproximately 29.6% of the issued share capital of XinTec, Inc., or XinTec, ofwhich we directly owned approximately 7.8% at that time. In fiscal 2006,VisEra invested an additional $0.5 million and we invested an additional$130,000 in XinTec as our portion of an additional capital injection to enableXinTec to expand its production capacity. As a result of the increase in ourbeneficial interest in XinTec due to VisEra’s investment in XinTec duringfiscal 2006, we accounted for our investment in XinTec under the equitymethod. In January 2007, TSMC through the purchase of approximately90.5 million previously unissued shares, acquired a controlling interestin XinTec. As a result of TSMC’s investment, our ownership percentage in XinTecdeclined from 7.8% to 4.4% and VisEra’s ownership percentage declinedfrom 29.6% to 16.9%. Due to the reduction in our ownership percentage in XinTecand the deconsolidation of VisEra described below, effective January 1, 2007,we began to account for our interest in XinTec under the cost method.

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

Effective January 1, 2007, by mutualagreement, we assumed responsibility for the logistics management servicespreviously provided to us by VisEra. As a consequence, we concluded that we hadlost our status as the primary beneficiary of the joint venture and that VisErahad ceased to be a variable interest entity (“VIE”) as defined under

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**ITEM 2.****                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS —(Continued)**

FIN 46(R). As a result, we deconsolidated VisEraas of the date of the change. As a consequence of the deconsolidation,effective January 1, 2007, we account for our investment in VisEra underthe equity method. The deconsolidation of VisEra did not have a material effecton our reported revenue or reported net income for fiscal 2007. SeeNote 5 — *“Long-term Investments”*toour condensed consolidated financial statements.

In January 2007, weand TSMC also signed an amendment to the Amended VisEra Agreement to providefor an increase in VisEra’s manufacturing capacity. Under the amendment, we andTSMC each made an additional $27.0 million investment in VisEra inApril 2007. This investment is part of an ongoing capacity expansionprogram at VisEra. All other material terms of the Amended VisEra Agreementremain in effect.

## ***JointVenture with PSC***

In May 2004, we entered into an agreement withPowerchip Semiconductor Corporation, or PSC, to establish the joint venturecalled Silicon Optronics, Inc., or SOI. The purpose of SOI is to conductmanufacturing, marketing and selling of certain of our legacy products.

In March 2005, we assumed control of the board ofdirectors of SOI and we have consolidated SOI since April 30, 2005. InJuly 2006, SOI declared a cash dividend of $482,000, of which we received$237,000 when the cash dividend was paid in August 2006. SOI also issuedshares to its employees in July 2006, with an estimated fair value of$459,000 which caused our ownership percentage to decline from 49.0% to 46.6%.In April 2007, SOI became listed on the Taiwan GreTai Securities Market,or TGSM. The TGSM is the approximate equivalent in Taiwan of theOver-The-Counter market in the United States. In conjunction with the TGSMlisting, various employees of SOI exercised their options and increased thenumber of shares outstanding, which caused our ownership percentage to declineto 45.0% as of July 31, 2007.

In June 2007, SOI declared a cash dividend of$409,000. The dividend will be paid in September 2007.

## ***Acquisitionof CDM***

In April 2005, we completed the acquisition ofCDM Optics, Inc., or CDM, a company located in Boulder, Colorado. CDM is theexclusive licensee from an affiliate of the University of Colorado of apatented technology, known as Wavefront Coding technology that increases theperformance of an imaging system by substantially increasing the depth of fieldand/or correcting optical aberrations within the image. We expect that it willsignificantly reduce the size and complexity of the auto-focus function onfuture camera modules utilizing OmniVision sensors. Because the image is 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. Approximately 147,000 ofthese shares were retained as security for certain indemnities given by thesellers.

In the quarter ended October 31, 2006, weincreased “Goodwill” related to our acquisition of CDM by $2.6 million.The increase was related, in part, to a put option that expired during thequarter with respect to the 147,000 shares held in escrow, 145,000 of whichwere put to us for cash totaling $2.8 million. The other part of theincrease related to the value of the initial shares that we issued as part ofthe CDM acquisition. These shares were also subject to a put option, an optionthat expired unexercised subsequent to their original issuance. Both amountsshould have been recorded as part of the initial acquisition of CDM.

In addition, we are obligated to pay$10.0 million in cash upon the sale, prior to the end of April 2009,of a pre-determined number of revenue-producing products incorporating CDM’stechnology.

## ***CapitalResources***

As of July 31, 2007, we had approximately $176.9 millionin cash and cash equivalents and approximately $117.9 million inshort-term investments. To mitigate market risk related to short-terminvestments, we have an investment policy designed to preserve the value ofcapital and to generate interest income from these investments without materialexposure to market fluctuations. Market risk is the potential loss due to thechange in value of a financial instrument as a result of changes in interestrates or bond prices. Our policy is to invest in financial instruments withshort maturities, limiting interest rate exposure, and to measure performanceagainst comparable benchmarks. We maintain our portfolio of cash equivalentsand short-term investments in a variety of securities, including both governmentand corporate obligations with ratings of A or better and money market funds.We do not believe that the

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**ITEM 2.****                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS —(Continued)**

value of our cash and short-term investments will besignificantly affected by recent instability in global financial markets.

In June 2005, our board of directors authorized us touse up to $100 million of our available cash in an open-market program torepurchase our common stock. At the expiration of the program on June 21,2006, we had cumulatively repurchased 5,870,000 shares of our common stockfor an aggregate cost of approximately $79.6 million.

In February 2007, our board of directors approvedan additional stock repurchase program that provides for the repurchase of upto $100 million of our outstanding common stock in an open-market program.Subject to applicable securities laws, such repurchases will be at such timesand in such amounts as we deem appropriate, based on factors such as marketconditions, legal requirements and other corporate considerations. As ofJuly 31, 2007, we had cumulatively repurchased 566,000 shares of ourcommon stock under the open-market program for an aggregate cost ofapproximately $9.6 million. See Note 13 *— “Treasury Stock”*to our condensedconsolidated financial statements.

## ***TheCurrent Economic and Market Environment***

We operate in a challenging economic environment thathas undergone significant changes in technology and in patterns of globaltrade. We strive to remain a leader in the development and marketing of imagesensing devices based on the CMOS fabrication process and have benefited fromthe growing market demand for and acceptance of this technology.

We sell our products worldwide directly to originalequipment manufacturers, or OEMs, which include branded customers and contractmanufacturers, and value added resellers, or VARs, and indirectly throughdistributors. In order to ensure that we address all available markets for ourimage sensors, we divide our marketing efforts into two separate departments.The Mainstream Products marketing department addresses the camera cell phoneand DSC markets, and the Advanced Products marketing department addresses thenotebook and personal computer, security and surveillance, toys and games,automotive and medical markets.

In the camera cell phone market in particular, futurerevenues depend to a large extent on design wins where, on the basis of anexhaustive evaluation of available products, a particular hand-set makerdetermines which image sensor to design into one or more specific models. Thereis generally a time lag of between six and nine months between the time of aparticular design win and the first shipments of the designated product. Designwins are also an important driver in the many other markets that we address,and in some cases, such as automotive applications, the time lag between aparticular design win and first revenue can be longer than one year.

The overwhelming majorityof sales of our products depend on decisions by engineering designers andmanufacturers of products that incorporate image sensors to specify one of ourproducts rather than one made by a competitor. In most cases, the decision tospecify a particular product requires conforming other specifications of theproduct to the chosen image sensor and makes subsequent changes both difficultand expensive. Accordingly, the ability to produce and deliver on time reliableproducts in large quantities is a key competitive differentiator. Since ourinception, we have shipped more than 650 million image sensors, includingapproximately 86 million in the first quarter of fiscal 2008. Webelieve that this demonstrates the capabilities of our production system,including our sources of offshore fabrication.

We currently outsource the wafer fabrication andpackaging of our image-sensor products to third parties.  We outsource the color filter and micro-lensphases of production to a joint venture. This approach allows us to focus ourresources on the design, development, marketing and testing of our products andsignificantly reduces our capital requirements.

To increase and enhance our production capabilities,last year we completed a project with TSMC, our principal wafer supplier andone of the largest wafer fabrication companies in the world, to increase fromtwo to four the number of their fabrication facilities, at which our productscan be produced. VisEra, our joint venture with TSMC and our investments inthree key back-end packaging suppliers are part of a broad strategy to ensurethat we have sufficient back-end capacity for the processing of our imagesensors in the various formats required by our customers. In January 2007,we amended our joint venture agreement with TSMC to each invest an additional$27 million in VisEra, and VisEra is currently expanding its capacity.Separately, TSMC purchased 90.5 million shares from XinTec to enableXinTec to expand its capacity.

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**ITEM 2.****                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS —(Continued)**

In February 2007, we entered into a foundrymanufacturing agreement with PSC, and we currently expect to begin volumeproduction of product at PSC in the second half of calendar 2008.

We currently perform the final testing of the majorityof our products at our own facility in China. We are currently expanding ourtesting capacity, as well as our overall capability to design more customproducts for our customers. As necessary, we will make further investments toensure that we have sufficient production capacity to meet the demands of ourcustomers as part of our ongoing efforts to lower production costs to offset,at least in part, the continuing pressure we experience on prices.

Since our end-user customers market and sell theirproducts worldwide, our revenues by geographic location are not necessarilyindicative of the geographic distribution of end-user sales, but ratherindicate where the products and/or their components are manufactured orsourced. The revenues we report by geography are based on the country or regionin which our customers issue their purchase orders to us.

Many of the products using our image sensors, such ascamera cell phones, notebook and personal computers, digital still cameras 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, Hong Kong and Taiwan, the pattern of demand forour image sensors has been increasingly influenced by the timing of theextended lunar or Chinese New Year holiday, a period in which the factorieswhich use our image sensors generally close.

We believe that the market opportunity represented bycamera cell phones remains very large. We benefited from the growth inshipments of image sensors, particularly for camera cell phones infiscal 2007 and in the first quarter of 2008. Demand increases wereparticularly strong for our VGA and 2.0-megapixel image sensors.

We also believe that, like the digital still cameramarket, camera cell phone and notebook and personal computer demand will notonly continue to shift toward higher resolutions, but also will increasinglyfragment into multiple resolution categories. In addition, there is increaseddemand for customization, and several different interface standards are comingto maturity. All of these trends will require the development of an increasingvariety of products.

As the markets for image sensors have grown, we haveexperienced competition from manufacturers of CMOS and CCD image sensors. Ourprincipal competitors in the market for CMOS image sensors include MagnaChip,Micron, Samsung, Sony, ST Microelectronics and Toshiba. We expect to seecontinued price competition in the image sensor market for camera cell phones,notebook and personal computers and digital cameras as those markets continueto grow. Although we believe that we currently compete effectively in thosemarkets, our competitive position could be impaired by companies that havegreater financial, technical, marketing, manufacturing and distributionresources, broader product lines, better access to large customer bases, greatername recognition, longer operating histories and more established strategic andfinancial relationships than we do. Such companies may be able to adapt morequickly to new or emerging technologies and customer requirements or devotegreater resources to the promotion and sale of their products. Many of these competitors own and operatetheir own fabrication facilities, which in certain circumstances may give themthe ability to price their products more aggressively than we can or may allowthem to respond more rapidly than we can to changing market opportunities.

As a result of the increase in competition and thegrowth of various consumer-product applications for image sensors, we haveexperienced a shortening in the life cycle of some image-sensor products. Forexample, although in the security and surveillance market we continue to sellimage sensors introduced more than four years ago, in the camera cell phonemarket, product life cycles can be as short as six months. With the shorteningof product life cycles, it will be increasingly difficult to accuratelyforecast customer demand for our products. As a result, we face the risk ofbeing unable to fulfill customer orders if we underestimate market demand andthe risks of excess inventory and product obsolescence if we overestimatemarket demand for our products. The shortening of product life cycles alsoincreases the importance of having short product development cycles and beingaccurate in the prediction of market trends in the design of new products. Thereduction in product life cycles increases the importance of our continuedinvestment in research and development, which we consider to be critical to ourfuture success.

In common with many other semiconductor products andas a response to competitive pressures, the average selling prices, or ASPs, ofimage sensor products have declined steadily since their introduction, and weexpect ASPs to

30

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**ITEM 2.****                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS —(Continued)**

continue to decline in the future. Accordingly, inorder to maintain our gross margins, we and our suppliers have to workcontinuously to lower our manufacturing costs and increase our productionyields, and in order to maintain or grow our revenues, we have to increase thenumber of units we sell by a large enough amount to offset the effect ofdeclining ASPs. In addition, if we are unable to timely introduce new productsthat can take advantage of smaller process geometries or new products that incorporatemore advanced technology and include more advanced features that can be sold athigher average selling prices, our gross margin will decline.

We have migrated the production of our new sensors tothe 0.13μ process geometries, which has enabled us to increase the resolutionof our image sensors while decreasing overall chip size. We initiated massproduction volumes at the 0.13μ process node at the end of calendar 2005.Given the rapidly changing nature of our technology, there can be no assurancethat we will not encounter delays or other unexpected yield issues with futureproducts. During the early stages of production, production yields and grossmargins for new products are typically lower than those of establishedproducts. We can encounter unexpected manufacturing issues, such as theunexpected back-end problems that resulted in low yields on two of ourproducts, the first of which arose in the fourth quarter of fiscal 2005and in the first quarter of fiscal 2006. In addition, in preparation for newproduct introductions, we gradually decrease production of establishedproducts. Due to our 12-14 week production cycle, it is extremelydifficult to predict precisely how many units of established products we willneed. It is also difficult to accurately predict the speed of the ramp of newproducts. As a result, it is possible that we could suffer from shortages forcertain products and build inventories in excess of demand for other products.We carefully consider the risk that our inventories may be excess to expectedfuture demand and record appropriate reserves. If, as sometimes happens, we aresubsequently able to sell these reserved products, the sales have little or noassociated cost and consequently they have a favorable impact on gross margins.

## ***Sourcesof Revenues***

We generate almost all our revenue by selling ourproducts directly to OEMs and VARs and indirectly through distributors. Foraccounting purposes, we treat sales to OEMs and VARs as one source of revenue,and distributors as another and our revenue recognition policies for the twogroups are different. In general, we sell to our customers on FOB shippingpoint or FCA terms.

For shipments to customers without agreements thatallow for returns or credits, principally OEMs and VARs, we recognize revenueusing the “sell-in” method. Under this method, we recognize revenue when titlepasses to the customer provided that we have received a signed purchase order,the price is fixed or determinable, title and risk of loss has transferred tothe customer, collection of resulting receivables is considered reasonablyassured, product returns are reasonably estimable, there are no customeracceptance requirements and there are no remaining material obligations. Weprovide for future returns of potentially defective products based onhistorical experience at the time we recognize revenue. For cash considerationgiven to customers for which we do not receive a separately identifiablebenefit or cannot reasonably estimate fair value, we record the amounts asreductions of revenue.

For shipments to distributors under agreementsallowing for returns or credits, we recognize revenue using the “sell-through”method under which we defer revenue and related costs of sales until thedistributor resells the product to our end-user customer and notifies us inwriting of such sale. The amount billed to these distributors, less the cost ofinventory shipped to but not yet sold by the distributors, is shown net on theconsolidated balance sheets as deferred income. Accounting for revenue on the “sell-through”method requires that we obtain sales and inventory information from ourdistributors. As part of our internal control process, we observe ourdistributors’ physical counts of their inventories of our products on a regularbasis.

In order to determine whether collection is probable,we assess a number of factors, including our past transaction history with thecustomer and the creditworthiness of the customer. If we determine thatcollection is not reasonably assured, we defer the recognition of revenue untilcollection becomes reasonably assured or upon receipt of payment.

In addition, we recognize revenue from the performanceof services to a limited number of our customers by our wholly-ownedsubsidiary, CDM, and, through December 31, 2006, by our then consolidatedaffiliate, VisEra. We recognize the CDM-associated revenue under either thecompleted-contract or the percentage-of-completion methods. Thepercentage-of-completion method of accounting is used for costreimbursement-type contracts, where revenues recognized are that portion of thetotal contract price equal to the ratio of costs expended to date to theanticipated final total costs based on current estimates of the costs tocomplete the projects. CDM-associated revenue has not been material in any ofthe periods presented. Until December 31, 2006 we recognized VisEra’sservice revenue from third-party customers when the production servicesprovided by VisEra were complete and the product was shipped to the customer.

31

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**ITEM 2.****                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS —(Continued)**

## ***CriticalAccounting Policies and Estimates***

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

*Accounting for Income Taxes*

We adopted FIN 48 and related guidance onMay 1, 2007. See Note 14 — “*Income Taxes”*to our condensed consolidated financial statements.

We are required to make certain estimates andjudgments in determining income tax expense for financial statement purposes.These estimates and judgments occur in the calculation of tax credits,benefits, and deductions, and in the calculation of certain tax assets andliabilities, which arise from differences in the timing of recognition ofrevenue and expense for tax and financial statement purposes, as well as theinterest and penalties relating to these uncertain tax positions. Significantchanges to these estimates may result in an increase or decrease to our taxprovision in a subsequent period.

We also have to assess the likelihood that we will beable to recover our deferred tax assets. If recovery is not likely, we arerequired increase our provision for taxes by recording a valuation allowanceagainst the deferred tax assets that we estimate will not ultimately berecoverable. We believe that we will ultimately recover a substantial majorityof the deferred tax assets recorded on our consolidated condensed balancesheets. However, should there be a change in our ability to recover ourdeferred tax assets, our tax provision would increase in the period in which wedetermined that the recovery is not probable.

In addition, the calculation of our tax liabilitiesinvolves dealing with uncertainties in the application of complex taxregulations. As a result of the implementation of FIN 48, we recognizeliabilities for uncertain tax positions based on the two-step processprescribed within the interpretation. The first step is to evaluate the taxposition for recognition by determining if the weight of available evidenceindicates that it is more likely than not that the position will be sustainedon audit, including resolution of related appeals or litigation processes, ifany. The second step requires us to estimate and measure the tax benefit as thelargest amount that is more than 50% likely to be realized upon ultimatesettlement. Because we are required to determine the probability of variouspossible outcomes, such estimates are inherently difficult and subjective. Wereevaluate these uncertain tax positions on a quarterly basis. Thisre-evaluation is based on factors including, but not limited to, changes infacts or circumstances, and changes in tax law. A change in recognition ormeasurement would result in the recognition of a tax benefit or an additional chargeto the tax provision in the period.

 

32

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**ITEM 2.****                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS —(Continued)**

**Results of 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,** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                        | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| Revenues                                          |       | 100.0                                           | %          | 100.0 | % |
| Cost of revenues                                  |       | 76.6                                            |       | 63.7 |   |
| Gross margin                                      |       | 23.4                                            |       | 36.3 |   |
| Operating expenses:                               |       |                                            |       |   |   |
| Research,  development and related                |       | 10.1                                            |       | 12.3 |   |
| Selling, general  and administrative              |       | 8.7                                             |       | 9.1 |   |
| Total operating  expenses                         |       | 18.8                                            |       | 21.4 |   |
| Income from operations                            |       | 4.6                                             |       | 14.9 |   |
| Interest income, net                              |       | 1.9                                             |       | 2.5 |   |
| Other income, net                                 |       | 0.2                                             |       | 0.7 |   |
| Income before income  taxes and minority interest |       | 6.7                                             |       | 18.1 |   |
| Provision for (benefit  from) income taxes        |       | (0.8                                            | )          | 4.8 |   |
| Minority interest                                 |       | —                                          |       | 1.7 |   |
| Net income                                        |       | 7.5                                             | %          | 11.6 | % |

 

*Three Months Ended July 31, 2007 as Compared to Three Months EndedJuly 31, 2006*

### **Revenues**

We derive substantially all of our revenues from thesale of our image-sensor products for use in a wide variety of consumer andcommercial mass-market applications including camera cell phones, notebooks andpersonal computers, security and surveillance cameras, digital still cameras, interactivevideo and toy cameras and automotive products. Revenues for the three monthsended July 31, 2007 increased by 26.5% to approximately$173.1 million from $136.9 million for the three months endedJuly 31, 2006. The increased revenues were due to an increase in unitsales of our image-sensor products, primarily for cell phones, and a morefavorable product mix offset, in part, by a decline in our average sellingprices.

## ***Revenuesfrom Sales to OEMs and VARs as Compared to Distributors***

We sell our image-sensor products either directly toOEMs and VARs or indirectly through distributors. The following table shows thepercentage of revenues from sales to OEMs and VARs and distributors in thethree months ended July 31, 2007 and 2006:

|               | ** ** | **Three Months Ended  July 31,** | ** ** |
|---------------|------------|-------------------------------------------------|------------|
| ** **    | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| OEMs and VARs |       | 64.5                                            | %          | 68.1 | % |
| Distributors  |       | 35.5                                            |       | 31.9 |   |
| Total         |       | 100.0                                           | %          | 100.0 | % |

 

*OEMs and VARs.*   Inthe three months ended July 31, 2007, one OEM customer accounted forapproximately 18.1% of our revenues. In the three months ended July 31,2006, one OEM customer accounted for approximately 13.2% of our revenues. Forthe three months ended July 31, 2007 and 2006, no other OEM or VARcustomer accounted for 10% or more of our revenues.

*Distributors.*   Inthe three months ended July 31, 2007, one distributor customer accountedfor approximately 22.9% of our revenues. In the three months endedJuly 31, 2006, one distributor customer accounted for approximately 12.9%of our revenues. For the three months ended July 31, 2007 and 2006, noother distributor customer accounted for 10% or more of our revenues.

33

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**ITEM 2.****                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS —(Continued)**

## ***Revenuesfrom Domestic Sales as Compared to Foreign Sales***

The following table shows the percentage of ourrevenues derived from sales of our image-sensor products to domestic customersas compared to foreign customers for the three months ended July 31, 2007and 2006:

|                | ** ** | **Three Months Ended  July 31,** | ** ** |
|----------------|------------|-------------------------------------------------|------------|
| ** **     | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| Domestic sales |       | 0.8                                             | %          | 1.8 | % |
| Foreign sales  |       | 99.2                                            |       | 98.2 |   |
| Total          |       | 100.0                                           | %          | 100.0 | % |

 

We derive the majority of our foreign sales fromcustomers in Asia and, to a lesser extent, in Europe. Over time, our sales toAsia-Pacific customers have increased primarily as a result of the continuingtrend of outsourcing the production of consumer electronics products toAsia-Pacific manufacturers and facilities and to the increasing markets in Asiafor consumer products. Because of the preponderance of Asia-Pacificmanufacturers and the fact that virtually all products incorporating ourimage-sensor products are sold globally, we believe that the geographicdistribution of our sales does not accurately reflect the geographic distributionof sales into end-user markets of products which incorporate our image sensors.

### **Gross Profit**

Our gross margin in the three months endedJuly 31, 2007 was 23.4%, down from 36.3% for the three months endedJuly 31, 2006. Theprincipal contributor to the year-over-year decline in gross margin was the year-over-year decline in ouraverage selling prices,partially offset by reductions in our production costs. However, during the three months ended July 31, 2007, the averageselling prices of our products increased, in large part due to an increase inthe proportion of sales represented by higher resolution image sensors ascompared to the fourth quarter of fiscal 2007. In the three monthsended July 31, 2007, in accordance with SFAS No. 123(R), werecorded approximately $1.0 million in stock compensation expense to costof revenues, or 0.6% of revenues, as compared to $0.9 million or 0.7% inthe three months ended July 31, 2006.

Revenue from sales of previously reserved products inthe three months ended July 31, 2007 was $1.9 million, as compared to$2.9 million during the same period in the prior fiscal year. In the threemonths ended July 31, 2007, we recorded an allowance for excess andobsolete inventory totaling $4.7 million to cost of revenues as comparedto $0.9 million during the same period in the prior fiscal year.

**Research,Development and Related Expenses**

Research, development and related expenses consistprimarily of compensation and personnel-related expenses, non-recurringengineering costs related principally to the costs of the masks we buy when werelease new product designs to the manufacturing foundry, and costs forpurchased materials, designs, tooling, depreciation of computers andworkstations, and amortization of acquired intangible intellectual property andcomputer aided design software. Because the number of new designs we release tothe foundry can fluctuate from period to period, research, development andrelated expenses may fluctuate significantly. Research, development and relatedexpenses for the three months ended July 31, 2007 increased toapproximately $17.4 million from approximately $16.8 million for thethree months ended July 31, 2006. As a percentage of revenues, researchand development expenses for the three months ended July 31, 2007 and 2006represented 10.1% and 12.3%, respectively.

The increase in research, development and relatedexpenses of approximately $0.6 million, or 3.5%, for the three monthsended July 31, 2007 from the similar period in the prior year resultedprimarily from a $1.8 million increase in salary and payroll-relatedexpenses associated with the hiring of additional personnel, a$400,000 increase in office and facility expenses, a $234,000 increase indepreciation and amortization expenses of acquired intangible assets, partiallyoffset by a $1.2 million decrease in non-recurring engineering expensesrelated to new product development and a $0.7 million reduction instock-based compensation expense recognized in accordance with SFAS No. 123(R).We anticipate that our research, development and related expenses will continueto increase as we develop and introduce new products employing our OmniPixel3and Wavefront Coding technologies and develop other new technologies related toimage sensors.

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**ITEM 2.****                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS —(Continued)**

**Selling,General and AdministrativeExpenses**

Selling, general and administrative expenses consistprimarily of compensation and personnel related expenses, commissions paid todistributors and manufacturers’ representatives and insurance and legalexpenses. Selling, general and administrative expenses for the three monthsended July 31, 2007 increased to approximately $15.2 million from$12.5 million for the three months ended July 31, 2006. As apercentage of revenues, selling, general and administrative expenses for thethree months ended July 31, 2007 and 2006 represented 8.7% and 9.1%,respectively.

The increase in selling, general and administrativeexpenses of approximately $2.7 million, or 21.8%, for the three monthsended July 31, 2007 from the similar period in the prior year resultedprimarily from a $1.5 million increase in legal and accounting expensesdue primarily to an increase in legal fees associated with the settlement of ashareholder derivative complaint and related lawsuits, a $1.3 millionincrease in salary and payroll-related expenses associated with salaryincreases and the hiring of additional personnel, the recognition of an additional$0.4 million in stock-based compensation expense recognized in accordancewith SFAS No. 123(R), partially offset by a $0.4 milliondecrease in fees for outside services, a $0.2 million decrease incommissions paid primarily to distributors and a $0.2 million decrease infacility expenses. We anticipate that our selling, general and administrativeexpenses will increase in the future due to the continued expansion of ourorganization and the continuing upgrade of our computer systems, including ourenterprise resource planning, or ERP, and other management information systems.

**Interest Income, Net**

We invest our cash, cash equivalents and short-terminvestments in interest-bearing accounts consisting primarily of money marketfunds, commercial paper, certificates of deposit, high-grade corporatesecurities and government bonds. Interest income remained unchanged at$3.4 million for the three months ended July 31, 2007 as compared tothe corresponding period in the prior year. Interest income for the three monthsended July 31, 2007 as compared to the corresponding period in the prioryear was the result of higher interest rates offset by lower balances ininterest-bearing accounts resulting primarily from the deconsolidation ofVisEra.

**OtherIncome, Net**

Other income, net, for the three months endedJuly 31, 2007 totaled $260,000. The current quarter amount included a$0.6 million gain on the interest rate swap agreement, partially offset bya $109,000 loss for the three months ended July 31, 2007 as our portion ofthe net loss recorded by ImPac Technology Co., Ltd., or ImPac, which we accountfor under the equity method of accounting. In addition, Other income, net,included a $351,000 loss consisting of an equity method investment adjustment,partially offset by our portion of the net income recorded by WLCSP Limited, orWLCSP, which we account for under the equity method of accounting.

Other income, net, for the three months endedJuly 31, 2006 was income of $1.0 million and consisted principally of$0.8 million as our portion of the income recorded by XinTec we accountedfor under the equity method of accounting and $123,000 as our portion of theincome recorded by ImPac.

**Provision for Income Taxes**

We generated approximately $11.6 million and$24.8 million in income before income taxes and minority interest for thethree months ended July 31, 2007 and 2006, respectively. We recorded anincome tax benefit of approximately $1.4 million and a provision forincome taxes of approximately $6.6 million for the three months endedJuly 31, 2007 and 2006, respectively. For the three months endedJuly 31, 2007 and 2006, our effective tax rates were (11.7)% and 26.7%,respectively. Quarterly income taxes reflect an estimate of the effective taxrate for the fiscal year and include, when applicable, the impact of discretetax items. The current quarter rate is reduced by the income tax benefit fromdiscrete tax items, in particular the release of unrecognized tax benefitsincluding interest and penalties that were no longer required as a result of achange in tax law during the current quarter in a foreign jurisdiction in whichwe do business. In both years, our effective tax rates are less than thecombined federal and state statutory rate of approximately 40% principally becausewe earn a portion of our income in jurisdictions where tax rates are lower thanthe combined federal and state statutory rate. We expect that our consolidatedeffective tax rate in fiscal 2008 will continue to be less than thecombined federal and state statutory rates. The extent to which our effectivetax rate in fiscal 2008 is less than the combined federal and statestatutory rates is principally contingent upon the proportion and geographicmix of our total pre-tax income. We adopted the provisions of FIN 48 onMay 1, 2007. The effect of adoption of FIN 48 on our CondensedConsolidated Balance Sheets as of May 1, 2007 is summarized in Note14 —*“Income Taxes”*to our condensedconsolidated financial statements.

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**ITEM 2.****                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS —(Continued)**

**Minority Interest**

Minority interest for the three months endedJuly 31, 2007 and 2006 was $21,000 and $2.3 million, respectively.For the three months ended July 31, 2007 and 2006, approximately $21,000and $72,000, respectively, represents the 55.0% interest that we do not own inthe net income of SOI. For the three months ended July 31, 2006,approximately $2.2 million represents the 54.4% interest that we did notown in the net income of VisEra. Because we deconsolidated VisEra effectiveJanuary 1, 2007, we did not record any minority interest expense in VisErafor the three months ended July 31, 2007.

**Liquidity and Capital Resources**

Our principal sources of liquidity at July 31,2007 consisted of cash, cash equivalents and short-term investments of$294.8 million.

## ***Liquidity***

Our working capital increased by approximately$42.4 million to $399.4 million as of July 31, 2007 from$357.0 million as of April 30, 2007. The increase was primarilyattributable to: $56.9 million decrease in income taxes payable primarilydue to the reclassification of $64.3 million of liability for netunrecognized tax benefits from current to long-term income taxes payable as aresult of the adoption of FIN 48; an $18.7 million increase ininventories in anticipation of increased sales in the second quarter offiscal 2008; a $6.1 million increase in accounts receivable, net,consistent with the increase in revenues from prior year levels;  a $3.5 million increase in short-terminvestments; a $2.3 million decrease in accrued liabilities; a$1.6 million decrease in deferred income and a $0.8 million decreasein a litigation settlement accrual. These increases in working capital werepartially offset by: a $29.7 million increase in accounts payableprimarily resulting from increased inventory purchases; a $13.9 milliondecrease in cash and cash equivalents and a $4.3 million decrease inprepaid and other expenses.

SOI maintains four unsecured lines of credit withthree commercial banks, which provide a total of approximately$3.4 million in available credit. All borrowings under the four lines ofcredit maintained by SOI bear interest at the market interest rate prevailingat the time of borrowing. There are no financial covenant requirements forthese facilities and at July 31, 2007, there were no borrowingsoutstanding under these facilities.

## ***CashFlows from Operating Activities***

For the three months ended July 31, 2007, netcash provided by operating activities totaled approximately $19.8 millionas compared to $18.8 million for the corresponding period in the prioryear. The principal components of the current year amount were: net income ofapproximately $13.0 million for the three months ended July 31, 2007,adjusted for non-cash charges of $6.2 million in stock-based compensation;$4.7 million in write-down of inventories; $3.0 million indepreciation and amortization; $1.5 million of gains in equityinvestments; a $25.0 million increase in accounts payable; $4.3 milliondecrease in prepaid expenses and other current assets and a $0.6 milliondecrease in refundable and deferred income taxes. These increases werepartially offset by: a $24.6 million increase in inventories; a$6.1 million increase in accounts receivable, net; an $1.5 milliondecrease in income taxes payable and a $0.9 million decrease in deferredtax liabilities. The $6.1 million increase in accounts receivable, net,reflects the higher level of revenues during the three months ended July 31,2007, partially offset by a decrease in days of sales outstanding as ofJuly 31, 2007 to 38 days from 49 days as of April 30, 2007.The $24.6 million increase in inventories was in anticipation of increasedsales in the second quarter of fiscal 2008. The inventory balances increasedconcurrently with an increase in annualized inventory turns to 3.8 as of July 31,2007 from 3.1 as of April 30, 2007. The $4.3 million decrease inprepaid expenses and other current assets was principally due to thereclassification of a deposit paid for land from other current assets toproperty, plant and equipment upon transfer of title.  Our income taxes payable decreased as aconsequence of the adoption of FIN 48 as of May 1, 2007.

For the three months ended July 31, 2006, netcash provided by operating activities totaled approximately $18.8 million,primarily due to: net income of approximately $15.9 million for the threemonths ended July 31, 2006, adjusted for non-cash charges of$6.5 million in stock-based compensation, $3.8 million indepreciation and amortization and $2.3 million in the minority interest inthe net income of consolidated affiliates and $0.9 million in write-downof inventories; a $7.0 million increase in accounts payable; a$6.3 million increase in income taxes payable and a $0.9 millionincrease in deferred income. These increases were partially offset by: a $14.5 millionincrease in inventories; a $6.1 million increase in accounts receivable,net; a $3.1 million increase in prepaid expenses and other current assets.The $6.1 million increase in accounts receivable, net, reflects the higherlevel of revenues during the three months ended July 31, 2006, as days of salesoutstanding as of July 31, 2006 increased slightly to 48 days from45 days as of April 30, 2006. The $14.5 million

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**ITEM 2.****                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS —(Continued)**

increase in inventories was driven by our 12 to14 week production cycle and reflects our increased sales activitycombined with a decline in inventory turns to 5.1 as of July 31, 2006 from6.1 as of April 30, 2006. Our income taxes payable increased as aconsequence of an additional accrual for the three months ended July 31,2006.

## ***CashFlows From Investing Activities***

For the three months ended July 31, 2007, our cashused in investing activities increased to $27.0 million as compared toapproximately $13.3 million for the corresponding period in the prioryear, due to: $14.7 million in purchases of property, plant and equipment;$9.0 million in a long-term investment in WLCSP and $3.4 million innet purchases of short-term investments. For the three months endedJuly 31, 2006, our cash used in investing activities decreased to$13.3 million, due to: $6.6 million in net purchases of short-terminvestments; $6.1 million in purchases of property, plant and equipmentand $0.5 million in purchase of intangible property.

## ***CashFlows From Financing Activities***

For the three months ended July 31, 2007, netcash used in financing activities totaled approximately $6.8 million ascompared to net cash provided by financing activities of $11.0 million forthe corresponding period in the prior year. This change was primarily due to$9.6 million in repurchases of shares of our common stock under the open-marketprogram in the three months ended July 31, 2007 partially offset by$2.9 million in proceeds from the exercise of stock options and employeepurchases through our employee stock purchase plan. For the three months endedJuly 31, 2006, net cash provided by financing activities totaledapproximately $11.0 million resulted from $6.7 million in proceedsfrom the exercise of stock options and employee purchases through our employeestock purchase plan and a $4.3 million cash contribution by one of our minorityinterest shareholders.

## ***CapitalCommitments and Resources***

In December 2000, we formed a subsidiary, Hua WeiSemiconductor (Shanghai) Co. Ltd. (“HWSC”) in China, to conduct testingoperations and other processes associated with the manufacturing of ourproducts. The registered capital of HWSC is $30.0 million which we hadfully funded as of July 31, 2007. These funds were used primarily for paymentto building contractors for the construction of facilities and the purchase ofequipment.

Over the next two years, we expect to invest a totalof $30.0 million in our subsidiary, the Shanghai Design Center, or SDC, ofwhich we have already contributed $7.5 million. The funding isnecessitated by our execution of a land-lease agreement with the Construction andTransportation Commission of the Pudong New District, Shanghai with acommitment to spend approximately $30.0 million to develop the land. SeeNote 15* — “Commitments and Contingencies”*toour condensed consolidated financial statements. We expect to fund our capitalcommitments to SDC from our available working capital.

In February 2007, our board of directors approvedan additional stock repurchase program that provides for the repurchase of upto $100 million of our outstanding common stock in an open-market program.Subject to applicable securities laws, such repurchases will be at such timesand in such amounts as we deem appropriate, based on factors such as marketconditions, legal requirements and other corporate considerations. As ofJuly 31, 2007, we had cumulatively repurchased 566,000 shares of ourcommon stock under the open-market program for an aggregate cost ofapproximately $9.6 million. See Note 13 *— “Treasury Stock”*to our condensedconsolidated financial statements.

We are obligated to pay an additional$10.0 million in cash upon the sale of a pre-determined number ofrevenue-producing products incorporating CDM’s technology. CDM and the costsassociated with the acquisition are included in our condensed consolidatedbalance sheets at July 31, 2007 and April 30, 2007.

We currently expect our available cash, cashequivalents and short-term investments, together with cash that we anticipateto generate from operating activities, will be sufficient to satisfy ourcapital requirements over approximately the next twelve months. Other thannormal working capital requirements, we expect our capital requirementstotaling approximately $70 million over approximately the next twelvemonths will consist primarily of funding capital investment at HWSC, funding aportion of the acquisition and build-out costs associated with the purchase ofa complex of four buildings in Santa Clara, and funding a portion of thedevelopment costs of the land we have leased in Shanghai.

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**ITEM 2.****                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS —(Continued)**

We are now required to disclose our unrecognized taxbenefits as commitments in accordance with FIN 48. The non-current portionof the unrecognized tax benefits at July 31, 2007 was $59.8 million,of which the timing of the resolution is uncertain.

Our ability to generate cash from operations issubject to substantial risks described below under the caption Part IIItem 1A. *“Risk Factors.”*Weencourage you to review these risks carefully.

**Contractual Obligations and Commercial Commitments**

The following table summarizes our contractualobligations and commercial commitments as of July 31, 2007 and the effectsuch obligations and commitments are expected to have on our liquidity and cashflows in future periods (in thousands):
| ** **                                                | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                | ** ** | **Total**                  | ** ** | **Less than1 Year** | ** ** | **1 - 3 Years** | ** ** | **3 - 5 Years** | ** ** | **More than5 Years** | ** ** |
| **Contractual  Obligations:**                             |       |                       |       |   |   |   |   |   |   |   |   |
| Operating leases                                          |       | $                          | 13,894     |   | $ | 4,779 |   | $ | 7,549 |   | $ | 1,517 |   | $ | 49 |   |
| Capital leases                                            |       | 244                        |       | 149 |   | 95 |   | — |   | — |   |
| Mortgage obligation                                       |       | 27,809                     | 1          | 492 |   | 1,080 |   | 1,222 |   | 25,015 |   |
| Noncancelable orders                                      |       | 79,051                     |       | 79,051 |   | — |   | — |   | — |   |
| Total contractual obligations                             |       | 120,998                    |       | 84,471 |   | 8,724 |   | 2,739 |   | 25,064 |   |
|                                                      |       |                       |       |   |   |   |   |   |   |   |   |
| **Other  Commercial Commitments:**                        |       |                       |       |   |   |   |   |   |   |   |   |
| Investment in Shanghai Design Center                      |       | 22,868                     | 2          | — |   | 22,868 |   | — |   | — |   |
| Total commercial commitments                              |       | 22,868                     |       | — |   | 22,868 |   | — |   | — | ­ |
| Total  contractual obligations and commercial commitments |       | $                          | 143,866    |   | $ | 84,471 |   | $ | 31,592 |   | $ | 2,739 |   | $ | 25,064 |   |

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(1)                InMarch 2007, we entered into a mortgage loan with a domestic bank in theamount of $27.9 million. See Note 8 — “*BorrowingArrangements”* to our condensed consolidated financial statements.

(2)                Overthe next two years, we expect to invest a total of approximately$30.0 million in our subsidiary, SDC, of which we have already invested$7.5 million. SDC will use the funds to develop land and constructfacilities for its use. See Note 15 — “*Commitmentsand Contingencies”* to our condensed consolidated financialstatements.

### **Off-Balance Sheet Arrangements**

We did not have any off-balance sheet arrangementsduring the period covered by this Quarterly Report on Form 10-Q.

### **Recent Accounting Pronouncements**

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

In February 2007, the FASB issuedSFAS No. 159, *“The Fair Value Option forFinancial Assets and Financial Liabilities,”* orSFAS No. 159, which permits entities to choose to measure at fairvalue many financial instruments and certain other items that are not currentlyrequired to be measured at fair value. The objective is to improve financialreporting by providing entities with the opportunity to mitigate volatility inreported earnings caused by measuring related assets and liabilitiesdifferently without having to apply complex hedge accounting provisions.SFAS No. 159 also establishes presentation and disclosurerequirements designed to facilitate comparisons between entities that choosedifferent measurement attributes for similar types of assets and liabilities.SFAS No. 159 does not affect any existing

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**ITEM 2.****                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS —(Continued)**

accounting literature that requires certain assets andliabilities to be carried at fair value. SFAS No. 159 does notestablish requirements for recognizing and measuring dividend income, interestincome, or interest expense. This Statement does not eliminate disclosurerequirements included in other accounting standards.**SFAS No. 159 is effective in fiscal yearsbeginning after November 15, 2007 and we are required to adopt it in thefirst quarter of fiscal 2009. We are currently evaluating the impactSFAS No. 159 may have on our financial position, results ofoperations or cash flows.

In June 2007, the FASB ratified Emerging IssuesTask Force (EITF) Issue No. 07-3, *“Accounting forNonrefundable Advance Payments for Goods or Services to Be Used in FutureResearch and Development Activities”* (EITF 07-3). EITF 07-3 requiresnon-refundable advance payments for goods and services to be used in futureresearch and development activities to be recorded as an asset and expensingthe payments when the research and development activities are performed. EITF07-3 applies prospectively for new contractual arrangements entered into infiscal years beginning after December 15, 2007. We currently recognizethese non-refundable advanced payments as an expense upon payment. We do notexpect our adoption of EITF 07-3 to have a significant impact on our financialcondition, results of operations or cash flows.

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**ITEM 3.****                QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

## ***ForeignCurrency Exchange Risk***

We sell our products globally, in particular tobranded customers, contract manufacturers, VARs and distributors in China,Japan, Korea and Taiwan.

The great majority of our transactions with our customersand vendors are denominated in U.S. dollars. The expenses we incur incurrencies other than U.S. dollars affect gross profit, selling, general andadministrative and research, development and related expenses, and areprimarily incurred in China, where the Chinese Yuan, or CNY, is the localcurrency and in Taiwan, where the New Taiwan dollar is the local currency.Since July 2005, the Chinese central bank has benchmarked the CNY against abasket of currencies, and as of July 31, 2007 has allowed the CNY toappreciate by approximately 8.5% against the U.S. dollar.

As of July 31, 2007,the functional currency of our wholly-owned subsidiaries located in Hong Kong,OmniVision Technologies (Hong Kong) Company Limited and OmniVision Trading(Hong Kong) Company Ltd., in the Cayman Islands, OmniVision InternationalHolding, Ltd. and HuaWei Technology International, Ltd., and in China, HWSC andSDC, is the U.S. dollar. Our other wholly-owned subsidiaries have theirrespective local currencies as their functional currencies. The functionalcurrency of our consolidated affiliate, SOI, is the New Taiwan dollar.Transaction gains and losses resulting from transactions denominated incurrencies other than the respective functional currencies are included in “Otherincome, net” for the periods presented. The amounts of transaction gains andlosses for the three months ended July 31, 2007 and 2006 were notmaterial.

Given that the expenses that we incur in currenciesother than U.S. dollars have not been a significant percentage of our revenues,we do not believe that our foreign currency exchange rate fluctuation risk issignificant. Consequently, we do not believe that a 10% change in foreigncurrency exchange rates would have a significant effect on our future net incomeor cash flows.

Because we do not believe that we currently have anysignificant direct foreign currency exchange rate risk, we have not hedgedexposures denominated in foreign currencies or used any other derivativefinancial instruments. Although we transact the overwhelming majority of ourbusiness in U.S. dollars, future fluctuations in the value of the U.S. dollarmay affect the competitiveness of our products and thus may impact our resultsof operations.

## ***MarketInterest Rate Risk***

Our cash equivalents and short-term investments areexposed to financial market risk due to fluctuation in interest rates, whichmay affect our interest income and, in the future, the fair market value of ourinvestments. We manage our exposure to financial market risk by performingongoing evaluations of our investment portfolio. We presently invest in moneymarket funds, certificates of deposit issued by banks, commercial paper,certificates of deposit, high-grade corporate securities and government bondsmaturing approximately 18 months or less from the date of purchase. We alsoinvest in auction rate securities which have a final maturity date of up tothirty years but whose interest rate is reset principally up to every35 days, and in variable rate demand notes, which have a final maturitydate of up to thirty-nine years but whose interest rate is reset at varyingintervals typically between 7 and 35 days. Due to the short maturities of ourinvestments, the carrying value should approximate the fair market value. In addition,we do not use our investments for trading or other speculative purposes. Due tothe short duration of our investment portfolio, we do not expect that animmediate 10% change in interest rates would have a material effect on the fairmarket value of our portfolio. Therefore, we would not expect our operatingresults or cash flows to be affected to any significant degree by the effect ofa sudden change in market interest rates. We do not believe that the value ofour cash and short-term investments will be significantly affected by recentinstability in global financial markets.

During fiscal 2007, we financed the purchase of afour-building complex in Santa Clara, California with an $27.9 millionmortgage loan. The mortgage loan is a variable rate loan which bears interestat LIBOR plus 90 basis points and changes in the interest rate will affect ourinterest payments. Concurrent with the mortgage loan, we also entered into aninterest rate swap with a notional amount that approximates the principal outstandingunder the mortgage loan. We are the fixed rate payer under the swap with afixed rate of 5.27%. Consequently, we do not believe that a hypothetical 10%change in LIBOR would have a material effect on our annual interest expense.

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**ITEM 4.****                CONTROLSAND PROCEDURES**

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

Under the supervision and with the participation ofour chief executive officer and our chief financial officer, our managementconducted an evaluation of the effectiveness of our disclosure controls andprocedures, as defined in the Securities Exchange Act of 1934, as of the end ofthe period covered by this Quarterly Report on Form 10-Q. Based on thisevaluation, our chief executive officer and chief financial officer have concludedthat, at the level of reasonable assurance, our disclosure controls andprocedures are effective to ensure that the information we are required todisclose in reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified inSecurities and Exchange Commission rules and forms and that such information isaccumulated and communicated to our management including our principalexecutive and principal financial officers, as appropriate, to allow timelydecisions regarding required disclosure.

**(b)  Changes in Internal Controls.**

There have been no changes in our internal controlover financial reporting during the period covered by this Quarterly Report onForm 10-Q that have materially affected, or are reasonably likely tomaterially 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 legalproceedings and claims with respect to such matters as patents, productliabilities and other actions arising out of the normal course of business.

On November 29, 2001, a complaint captioned *McKee v. OmniVision Technologies, Inc., et. al., Civil Action No. 01 CV10775*, was filed in the United States District Court for theSouthern District of New York against us, some of our directors and officers,and various underwriters for our initial public offering. Plaintiffs generallyallege that the named defendants violated federal securities laws because theprospectus related to our offering failed to disclose, and contained false andmisleading statements regarding, certain commissions purported to have beenreceived by the underwriters, and other purported underwriter practices inconnection with their allocation of shares in our offering. The complaint seeksunspecified damages on behalf of a purported class of purchasers of our commonstock between July 14, 2000 and December 6, 2000. Substantiallysimilar actions have been filed concerning the initial public offerings formore than 300 different issuers, and the cases have been coordinated as *In re Initial Public Offering Securities Litigation, 21 MC 92*.Claims against our directors and officers have been dismissed without prejudicepursuant to a stipulation. On February 19, 2003, the Court issued an orderdismissing all claims against us except for a claim brought underSection 11 of the Securities Act of 1933.

In June 2004, the issuer defendants and plaintiffsnegotiated a stipulation of settlement for the claims against the issuerdefendants, including us, that was submitted to the Court for approval. In August 2005,the Court preliminarily approved the settlement. In December 2006, theappellate court overturned the certification of classes in the six test casesthat were selected by the underwriter defendants and plaintiffs in thecoordinated proceedings. Because class certification was a condition of thesettlement, it was unlikely that the settlement will receive final courtapproval. On June 25, 2007, the Court entered an order terminating theproposed settlement based upon a stipulation among the parties to thesettlement. Plaintiffs have indicated that they will seek to amend theirallegations and file amended complaints. It is uncertain whether there will beany revised or future settlement. If the litigation proceeds, we believe thatwe have meritorious defenses to plaintiffs’ claims and intend to defend theaction vigorously.

On June 10, 2004, the first of several putativeclass actions was filed against us and certain of our present and formerdirectors and officers in federal court in the Northern District of Californiaon behalf of investors who purchased our common stock at various times fromFebruary 2003 through June 9, 2004. Those actions were consolidatedunder the caption *In re OmniVisionTechnologies, Inc.,*No. C-04-2297-SC, and a consolidatedcomplaint was filed. The consolidated complaint asserts claims on behalf ofpurchasers of our common stock between June 11, 2003 and June 9,2004, and seeks unspecified damages. The consolidated complaint generallyalleges that defendants violated Sections 10(b) and 20(a) of theSecurities Exchange Act of 1934 by allegedly engaging in improperaccounting practices that purportedly led to our financial restatement. OnJuly 29, 2005, the Court denied our motion to dismiss the complaint. Theparties engaged in settlement discussions and in November 2006, theparties reached an agreement in principle to settle this litigation. The totalamount of the proposed settlement is approximately $13.8 million, of whichapproximately $0.8 million would be contributed by us and the remainderwould be funded by insurance carriers that issued Directors and OfficersLiability Insurance Policies to us. We accrued $3.3 million duringfiscal 2007, as our share of the settlement, including unreimburseddefense costs, net of the $13.0 million in recoverable insurance proceeds.The parties have executed a Stipulation of Settlement that was filed with theCourt on May 15, 2007. On May 25, 2007, the Court issued an Orderpreliminarily approving the settlement and providing for notice of thesettlement to be provided to the purported shareholder class. The Ordergranting preliminary approval scheduled a hearing on September 7, 2007 todetermine whether the settlement is fair, reasonable and adequate to thepurported class. The hearing was held on September 7, as scheduled, butthe Court had not issued a ruling on the matter as of the date of this filing.As a part of the Stipulation of Settlement, the parties agreed to staydiscovery and other proceedings. We believe that ultimate settlement isprobable at the currently estimated amount. If the settlement does not  become final and litigation against uscontinues, we believe that we have meritorious defenses and intend to defendthe case vigorously. If the litigation continues, we cannot estimate whetherthe result of the litigation would have a material adverse effect on ourfinancial condition, results of operations or cash flows.

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On October 20, 2005,a purported shareholder derivative complaint, captioned *Hackl v.Hong*, No. 1:05-CV-050985, was filed in Santa Clara CountySuperior Court for the State of California. This derivative action containsallegations that were virtually identical to the prior state court derivativeactions that were voluntarily dismissed, and which were based on theallegations contained in the securities class actions. The complaint generallysought unspecified damages and equitable relief based on causes of actionagainst various of our present and former directors and officers for purportedbreach of fiduciary duty, abuse of control, gross mismanagement, waste ofcorporate assets, unjust enrichment and violations of California CorporationsCode. We were named solely as a nominal defendant against whom no monetaryrecovery was sought. Pursuant to a January 20, 2006 Court Order, plaintifffurnished a bond for reasonable expenses in order to proceed with hisderivative action. On May 15, 2006, the Court sustained our demurrer tothe complaint with leave to amend on the grounds that the plaintiff failed tomake a pre-litigation demand on our board of directors and fails tosufficiently plead that demand is futile. On October 4, 2006, the Courtsustained our demurrer to the amended complaint as well and again grantedplaintiff leave to amend. On May 10, 2007, the Court sustained ourdemurrer contending that plaintiff’s amended complaint failed to allegeadequately why no pre-litigation demand had been made on the OmniVision board ofdirectors, but granted plaintiff leave to further amend the complaint.Simultaneously, the parties advised the Court that they had reached asettlement in principle. The parties executed a Stipulation of Settlement thatwas filed with the Court on June 18, 2007. On June 26, 2007, theCourt entered an order approving the settlement, pursuant to which the Companypaid a settlement fee in the amount of $200,000.

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**ITEM1A.  RISK FACTORS**

*This Quarterly Report onForm 10-Q, including Management’s Discussion and Analysis of FinancialCondition and Results of Operations, contains forward-looking statements. Theseforward-looking statements are subject to substantial risks and uncertaintiesthat could cause our future business, financial condition or results of operationsto differ materially from our historical results or currently anticipatedresults, including those set forth below.*

*Thefollowing description of these risk factors includes any material changes toand supersedes the description of the risk factors associated with our businesspreviously disclosed in Item 1A of our 2007 Annual Report onForm 10-K filed with the SEC on June 29, 2007. As a result of thefollowing risk factors, as well as of other variables affecting our operatingresults, past financial performance may not be a reliable indicator of futureperformance, and historical trends should not be used to anticipate results ortrends in future periods.*

***Risks Related to Our Business***

## ***Weface intense competition in our markets from more established CMOS and CCDimage sensor manufacturers, and if we are unable to compete successfully we maynot be able to maintain or grow our business.***

The image sensor market is intensely competitive, andwe expect competition in this industry to continue to increase. Thiscompetition has resulted in rapid technological change, evolving standards,reductions in product selling prices and rapid product obsolescence. If we areunable to successfully meet these competitive challenges, we may be unable tomaintain and grow our business. Any inability on our part to competesuccessfully would also adversely affect our results of operations and impairour financial condition.

Our image-sensor productsface competition from other companies that sell CMOS image sensors and fromcompanies that sell CCD image sensors. Many of our competitors have longeroperating histories, greater presence in key markets, greater name recognition,larger customer bases, more established strategic and financial relationshipsand significantly greater financial, sales and marketing, distribution,technical and other resources than we do. Many of them also have their ownmanufacturing facilities which may give them a competitive advantage. As aresult, they may be able to adapt more quickly to new or emerging technologiesand customer requirements or devote greater resources to the promotion and saleof their products. Our competitors include established CMOS image sensormanufacturers such as Kodak, MagnaChip, Micron, Matsushita, Samsung,Sony, STMicroelectronics and Toshiba aswell as CCD image sensor manufacturers such as Fuji, Kodak, Matsushita, NEC, Sanyo, Sharp, Sony, TexasInstruments and Toshiba. Many of thesecompetitors own and operate their own fabrication facilities, which in certaincircumstances may give them the ability to price their products moreaggressively than we can or may allow them to respond more rapidly than we canto changing market opportunities. In addition, we compete with a large numberof smaller CMOS manufacturers including Foveon, PixArt and Pixelplus and Pixim. Competition with these and other companies has required, and in thefuture may require, us to reduce our prices. For instance, we have seenincreased competition in the markets for VGA image sensor products with resultingpressures on product pricing. Downward pressure on pricing could result both indecreased revenues and lower gross margins, which would adversely affect ourprofitability.

Our competitors may acquire or enter into strategic orcommercial agreements or arrangements with foundries or providers of colorfilter processing, assembly or packaging services. These strategic arrangementsbetween our competitors and third party service providers could involvepreferential or exclusive arrangements for our competitors. Such strategicalliances could impair our ability to secure sufficient capacity from foundriesand service providers to meet our demand for wafer manufacturing, color filterprocessing, assembly or packaging services, adversely affecting our ability tomeet customer demand for our products. In addition, competitors may enter intoexclusive relationships with distributors, which could reduce availabledistribution channels for our products and impair our ability to sell ourproducts and grow our business. Further, some of our customers could alsobecome developers of image sensors, and this could potentially adversely affectour results of operations, business and prospects.

## ***Declinesin our average selling prices may result in declines in our revenues and mayfurther reduce our gross margins.***

We have experienced andexpect to continue to experience pressure to reduce the selling prices of ourproducts, and our average selling prices have declined as a result. Competitionin our product markets is intense and as this competition continues tointensify, we anticipate that these pricing pressures will increase. We expectthat the average selling prices for many of our products will continue todecline over time. Unless we can increase unit sales sufficiently to offsetthese declines in our average selling prices, our revenues will decline. Ourlow average selling prices have adversely affected our gross margins, andunless we can reduce manufacturing costs to compensate, additional reductionsin our average selling prices will continue to adversely affect our grossmargins and could materially and 

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adversely affect our operating results and impair ourfinancial condition. We have increased and intend to continue to increase ourresearch, development and related expenses to continue the development of newimage sensor products in fiscal years 2008 and 2009 that can be sold at higherselling prices and/or manufactured at lower cost. However, if we are unable totimely introduce new products that incorporate more advanced technology andinclude more advanced features that can be sold at higher average sellingprices, or if we are unable to successfully develop more cost-effectivetechnologies, our financial results could be adversely affected.

## ***Salesof our image-sensor products for camera cell phones account for a large portionof our revenues, and any decline in sales to the camera cell phone market orfailure of this market to continue to grow as expected could adversely affectour results of operations.***

Sales to the camera cell phone market account for alarge portion of our revenues. Although we can only estimate the percentages ofour products that are used in the camera cell phone market due to thesignificant number of our image-sensor products that are sold to module makersor through distributors and VARs, we believe that the camera cell phone marketaccounted for approximately 80% of our revenues in fiscal 2007 and 70% inthe three months ended July 31, 2007. We expect that revenues from salesof our image-sensor products to the camera cell phone market will continue toaccount for a significant portion of our revenues during fiscal 2008 andbeyond. Any factors adversely affecting the demand for our image sensors inthis market could cause our business to suffer and adversely affect ouroperating results. The digital image sensor market for camera cell phones isextremely competitive, and we expect to face increased competition in thismarket in the future. In addition, we believe the market for camera cell phonesis also relatively concentrated and the top five producers account for morethan 80% of the annual sales of these products. If we do not continue toachieve design wins with key camera cell phone manufacturers, our market shareor revenues could decrease. The camera cell phone image sensor market is alsosubject to rapid technological change. In order to compete successfully in thismarket, we will have to correctly forecast customer demand for technologicalimprovements and be able to deliver such products on a timely basis atcompetitive prices. If we fail to do this, our results of operations, businessand prospects would be materially and adversely affected. In the past, we haveexperienced problems accurately forecasting customer demand in other markets.If our sales to the camera cell phone market do not increase and/or the cameracell phone market does not grow as expected, our results of operations,business and prospects would be materially adversely affected.

## ***Ourfuture success depends on the timely development, introduction, marketing andselling of new CMOS image sensors, which we might not be able to achieve.***

Our failure to successfully develop new products thatachieve market acceptance in a timely fashion would adversely affect our abilityto grow our business and our operating results. The development, introductionand market acceptance of new products is critical to our ability to sustain andgrow our business. Any failure to successfully develop, introduce, market andsell new products could materially adversely affect our business and operatingresults. The development of new products is highly complex, and we have in thepast experienced delays in completing the development and introduction of newproducts. From time to time, we have also encountered unexpected manufacturingproblems as we increase the production of new products. For example, in thefourth quarter of fiscal 2005, and again in the first quarter of fiscal 2006,the back-end yields on two of our advanced products were significantly belowwhere we planned, and our gross margins were adversely impacted. As ourproducts integrate new and more advanced functions, they become more complexand increasingly difficult to design and debug. Successful product developmentand introduction depends on 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;

·                  developmentof advanced technologies and capabilities;

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

·                  developmentof products 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 thesesteps is difficult, time consuming and expensive. We may be unable to developnew products or product enhancements in time to capture market opportunities orachieve significant or sustainable acceptance in new and existing markets. Inaddition, our products could become obsolete sooner than anticipated 

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because of a rapid change in one or more of thetechnologies related to our products or the reduced life cycles of consumerproducts.

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

Our past success has been,and our future success is, dependent upon manufacturers designing our image-sensorproducts into their products. To achieve design wins, which are decisions bymanufacturers to design our products into their systems, we must define anddeliver cost effective and innovative image-sensor solutions on a timely basisthat satisfy the manufacturers’ requirements. Our ability to achieve designwins is subject to numerous risks including competitive pressures as well astechnological risks. If we do not achieve a design win with a prospectivecustomer, it may be difficult to sell our image-sensor products to suchprospective customer in the future because once a manufacturer has designed asupplier’s products into its systems, the manufacturer may be reluctant tochange its source of components due to the significant costs, time, effort andrisk associated with qualifying a new supplier. 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.

## ***Wedepend on a limited number of third party wafer foundries, which reduces ourability to control our manufacturing process.***

Unlike some of our largercompetitors, we do not own or operate a semiconductor fabrication facility.Instead, we rely on TSMC, PSC and other subcontract foundries to produce all ofour wafers. Historically, we have relied on TSMC to provide us with asubstantial majority of our wafers. As a part of our joint venture agreementwith TSMC, TSMC has agreed to commit substantial wafer manufacturing capacityto us in exchange for our commitment to purchase a substantial portion of ourwafers from TSMC, subject to pricing and technology requirements.

In addition, we have enteredinto a foundry manufacturing agreement with PSC pursuant to which we and PSChave agreed to jointly develop certain pixel-related process technology and forPSC to process certain of our CMOS image sensors at PSC’s facilities inaccordance with the scheduled development approved by both parties.

Under the terms of thesesupply agreements, we secure manufacturing capacity in any particular period ona purchase order basis. The foundries have no obligation to supply products tous for any specific period, in any specific quantity or at any specific price,except as set forth in a particular purchase order. In general, our reliance onthird party foundries involves a number of significant risks, including:

·                  reducedcontrol over delivery schedules, quality assurance, manufacturing yields andproduction costs;

·                  lackof guaranteed 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 ourother foundries were unable to continue manufacturing our wafers in therequired volumes, at acceptable quality, yields and costs, or in a timelymanner, we would have to identify and qualify substitute foundries, which wouldbe time consuming and difficult, and could increase our costs or result inunforeseen manufacturing problems. In addition, if competition for foundrycapacity increases we may be required to pay increased amounts formanufacturing services. We are also exposed to additional risks if we transferour production of semiconductors from one foundry to another, as such transfercould interrupt our manufacturing process. Further, some of our foundries mayalso be developers of image sensor products and if one or more of our otherfoundries were to decide not to fabricate our companion DSP chips forcompetitive or other reasons, we would have to identify and qualify othersources for these products.

## ***Werely on a joint venture company for color filter application and on third partyservice providers for packaging services, which reduces our control overdelivery schedules, product quality and cost, and could adversely affect ourability to deliver products to customers.***

We rely on VisEra, our jointventure with TSMC, for the color filter processing of our completed wafers. Inaddition, we rely on Advanced Semiconductor Engineering, Inc. and ImPac forsubstantially all of our ceramic chip packages. We also rely on ImPac, ourequity investee, for our plastic 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 

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form factor applications. We are currently expandingour color filter processing capacity at VisEra and with these serviceproviders. If for any reason one or more of these service providers becomesunable or unwilling to continue to provide color filter processing or packagingservices of acceptable quality, at acceptable costs and in a timely manner, ourability to deliver our products to our customers could be severely impaired. Wewould have to identify and qualify substitute service providers, which could betime 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 competitionfor color filter processing or packaging capacity increases, we may be requiredto pay or invest significant amounts to secure access to these services, whichcould adversely impact our operating results. The number of companies thatprovide these services is limited and some of them have limited operatinghistories and financial resources. In the event our current providers refuse orare unable to continue to provide these services to us, we may be unable toprocure services from alternate service providers. Furthermore, if customerdemand for our products increases, we may be unable to secure sufficientadditional capacity from our current service providers on commerciallyreasonable terms, if at all. Moreover, our reliance on a limited number ofthird party service providers to provide color filter processing servicessubjects us to reduced control over delivery schedules, quality assurance andcosts. This lack of control may cause unforeseen product shortages or mayincrease our costs of manufacturing, assembling or testing of our products,which would adversely affect our operating results.

## ***Fluctuationsin our quarterly operating results have caused volatility in the market priceof our common stock and make it difficult to predict our future operatingresults.***

Our quarterly operatingresults have varied significantly from quarter-to-quarter in the past and arelikely to vary significantly in the future based on a number of factors, manyof which are beyond our control. These factors and other industry risks, many ofwhich are more fully discussed in our other risk factors, include, but are notlimited to:

·                  thevolume and mix of our product sales;

·                  competitivepricing pressures;

·                  ourability to accurately forecast demand for our products;

·                  ourability to achieve acceptable wafer manufacturing or back-end processingyields;

·                  ourgain or loss of a large customer;

·                  ourability to manage our product transitions;

·                  theavailability of production capacity at the suppliers that manufacture ourproducts or components of our products;

·                  thegrowth of the market for products and applications using CMOS image sensors;

·                  thetiming and size of orders from our customers;

·                  thevolume of our product returns;

·                  theseasonal nature of customer demand for our products;

·                  thedeferral of customer orders in anticipation of new products, product designs orenhancements;

·                  theannouncement and introduction of products and technologies by our competitors;

·                  thelevel of our operating expenses; and

·                  theincreased volatility of our effective tax rate as a consequence of our adoptionof FASB Interpretation No. 48, or FIN 48, *“Accounting for Uncertainty in Income Taxes—an Interpretation of FASBStatement No. 109.”*

Our introduction of newproducts and our product mix have affected and may continue to affect ourquarterly operating results. Changes in our product mix could adversely affectour operating results, because some products provide higher margins thanothers. We typically experience lower yields when manufacturing new products throughthe initial production phase, and consequently our gross margins on newproducts have historically been lower than our gross margins on our moreestablished products. We also anticipate that the rate of orders from ourcustomers may vary significantly from quarter to quarter. Our operatingexpenses are relatively fixed, and our inventory levels are based on ourexpectations of future revenues. Consequently, if we do not achieve therevenues we expect in any quarter, expenses 

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and inventory levels could be disproportionately high,and our operating results for that quarter, and potentially future quarters,may be harmed.

All of these factors aredifficult to forecast and could result in fluctuations in our quarterlyoperating results. Our operating results in a given quarter could besubstantially less than anticipated, and, if we fail to meet market analysts’expectations, a substantial decline in our stock price could result.Fluctuations in our quarterly operating results could adversely affect the priceof our common stock in a manner unrelated to our long-term operatingperformance.

## ***Ourbusiness is subject to seasonal fluctuations which may in turn causefluctuations in our results of operations from period to period.***

Many of the products usingour image sensors, such as camera cell phones, notebooks and personalcomputers, digital still cameras andcameras for toys and games, are consumer electronics goods. These mass-marketcamera devices generally have seasonal cycles which historically have caused thesales of our customers to fluctuate quarter-to-quarter. Historically, demandfrom OEMs and distributors that serve such consumer product markets has beenstronger in the second and third quarters of our fiscal year and weaker in thefirst and fourth quarters of our fiscal year.

In addition, since a verylarge number of the manufacturers who use our products are located in China,Hong Kong and Taiwan, the pattern of demand for our image sensors has beenincreasingly influenced by the timing of the extended lunar or Chinese New Yearholiday, a period in which the factories which use our image sensors generallyclose. For example, we believe that the decline in revenues that we experiencedin the fourth quarter of fiscal 2007 is partly attributable to the fact thatChinese New Year occurred this year in mid-February, and manufacturing did notresume in full until sometime in March.

## ***Problemswith wafer manufacturing and/or back-end processing yields could result inhigher product costs and could impair our ability to meet customer demand forour products.***

If the foundriesmanufacturing the wafers used in our products cannot achieve the yields weexpect, we will incur higher per unit costs and reduced product availability.Foundries that supply our wafers have experienced problems in the pastachieving acceptable wafer manufacturing yields. Wafer yields are a functionboth of our design technology and the particular foundry’s manufacturingprocess technology. Certain risks are inherent in the introduction of such newproducts and technology. Low yields may result from design errors ormanufacturing failures in new or existing products. During the early stages ofproduction, production yields for new products are typically lower than thoseof established products. Unlike many other semiconductor products, opticalproducts can be effectively tested only when they are complete. Accordingly, weperform final testing of our products only after they are assembled. As aresult, yield problems may not be identified until our products are well intothe production process. The risks associated with low yields could be increasedbecause we rely on third party offshore foundries for our wafers, which canincrease the effort and time required to identify, communicate and resolvemanufacturing yield problems. In addition to wafer manufacturing yields, ourproducts are subject to yield loss in subsequent manufacturing steps, oftenreferred to as back-end processing, such as the application of color filtersand micro-lenses, dicing (cutting the wafer into individual devices, or die)and packaging. Any of these potential problems with wafer manufacturing and/orback-end processing yields could result in a reduction in our gross marginsand/or our ability to timely deliver products to customers, which couldadversely affect our customer relations and make it more difficult to sustainand grow our business. For example, low back-end yields on two of our productsadversely impacted our gross margins for the fiscal quarters ended April 30,2005, July 31, 2005 and October 31, 2005.

## ***Ifwe do not forecast customer demand correctly, our business could be impairedand our stock price may decline.***

Our sales are generally made on the basis of purchaseorders rather than long-term purchase commitments; however, we manufactureproducts and build inventory based on our estimates of customer demand.Accordingly, we must rely on multiple assumptions to forecast customer demand.We are continually working to improve our sales forecasting procedures. If weoverestimate customer demand, we may manufacture products that we may be unableto sell, or we may have to sell to other customers at lower prices. This couldmaterially and adversely affect our results of operations and financialcondition. In addition, our customers may cancel or defer orders at any time bymutual written consent. We have experienced problems with accuratelyforecasting customer demand in the past. For example, there was a shift in themix of product demand, in particular a shift in demand towards VGA products late in the secondquarter of fiscal 2007, and as a result our inventories at the end of thesecond and third quarters were higher than we intended them to be. We arerequired to accurately predict customer demand because we must often makecommitments to have products manufactured before we receive firm purchaseorders from our customers. Conversely, if we underestimate customer demand, wemay be unable to manufacture sufficient products quickly enough to meet actual 

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demand, causing us to lose customers and impairing ourability to grow our business. In preparation for new product introductions, wegradually ramp down production of established products. With our 12-14 weekproduction cycle, it is extremely difficult to predict precisely how many unitsof established products we will need. It is also difficult to accuratelypredict the speed of the ramp of our new products and the impact on inventorylevels presented by the shorter life cycles of end-user products. The shorterproduct life cycle is a result of an increase in competition and the growth ofvarious consumer-product applications for image sensors. For example, althoughin the security and surveillance market we continue to sell image-sensorproducts introduced more than four years ago, in the camera cell phone market,the product life cycle of image sensors can be as little as six months. Underthese circumstances, it is possible that we could suffer from shortages forcertain products and, if we underestimate market demand, we face the risk ofbeing unable to fulfill customer orders. We also face the risk of excessinventory and product obsolescence if we overestimate market demand for ourproducts and build inventories in excess of demand. Our ability to accuratelyforecast sales is also a critical factor in our ability to meet analystexpectations for our quarterly and annual operating results. Any failure tomeet these expectations would likely lead to a substantial decline in our stockprice.

## ***Wedepend on the increased acceptance of mass-market image sensor applications togrow our business and increase our revenues.***

Our business strategydepends in large part on the continued growth of various markets into which wesell our image-sensor products, including the markets for camera cell phones, notebookand personal computers, digital stilland video cameras, commercial and security and surveillance applications, toysand games, including interactive video games, and automotive applications. Ourability to sustain and grow our business also depends on the continueddevelopment of new markets for our products such as medical imaging devices. Ifthese current and new markets do not grow and develop as anticipated, we may beunable to sustain or grow the sales of our products.

In addition, the marketprice of our common stock may be adversely affected if certain of these newmarkets do not emerge or develop as expected. Securities analysts may alreadyfactor revenue from such new markets into their future estimates of our financialperformance and should such markets not develop as expected by such securitiesanalysts the trading price of our common stock could be adversely affected.

## ***Ourlengthy manufacturing, packaging and assembly cycle, in addition to ourcustomers’ design cycle, may result in uncertainty and delays in generatingrevenues.***

The production of our imagesensors requires a lengthy manufacturing, packaging and assembly process,typically lasting approximately 12-14 weeks. Additional time may pass before acustomer commences volume shipments of products that incorporate our imagesensors. Even when a manufacturer decides to design our image sensors into itsproducts, the manufacturer may never ship final products incorporating ourimage sensors. Given this lengthy cycle, we experience a delay between the timewe incur expenditures for research and development and sales and marketingefforts and the time we generate revenue, if any, from these expenditures. Thisdelay makes it more difficult to forecast customer demand, which addsuncertainty to the manufacturing planning process and could adversely affectour operating results. In addition, the product life cycle for certain of ourimage-sensor products designed for use in certain applications can berelatively short. If we fail to appropriately manage the manufacturing,packaging and assembly process, our products may become obsolete before theycan be incorporated into our customers’ products and we may never realize areturn on investment for the expenditures we incur in developing and producingthese products.

## ***Ourability to deliver products that meet customer demand is dependent upon ourability to meet new and changing requirements for color filter application andsensor packaging.***

We expect that as we developnew products to meet technological advances and new and changing industry andcustomer demands, our color filter application and ceramic, plastic andchip-scale packaging requirements will also evolve. Our ability to continue toprofitably deliver products that meet customer demand is dependent upon ourability to obtain third party services that meet these new requirements on acost-effective basis. We have historically relied exclusively on third parties,and more recently, on one of our joint ventures, to provide these services.There can be no assurances that any of these parties will be able to developenhancements to the services they provide to us to meet these new and changingindustry and customer requirements. Furthermore, even if these service providersare able to develop their services to meet new and evolving requirements, theseservices may not be available at a cost that enables us to sustain ourprofitability.

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## ***Thehigh level of complexity and integration of our products increases the risk oflatent defects, which could damage customer relationships and increase ourcosts.***

Because we integrate manyfunctions on a single chip, our products are complex and are based uponevolving technology. The integration of additional functions into the complex operationsof our products could result in a greater risk that customers or end userscould discover latent defects or subtle faults after volumes of product havealready been shipped. Although we test our products, we have in the past andmay in the future encounter defects or errors. For example, in the thirdquarter of fiscal 2005, we made a provision of $2.7 million related to thepossible replacement of products that did not meet a particular customer’sstandards. Delivery of products with defects or reliability, quality orcompatibility problems may damage our reputation and ability to retain existingcustomers and attract new customers. In addition, product defects and errorscould result in additional development costs, diversion of technical resources,delayed product shipments, increased product returns, product warranty costsfor recall and replacement and product liability claims against us which maynot be fully covered by insurance.

## ***Historically,our revenues have been dependent upon a few key customers, the loss of one ormore of which could significantly reduce our revenues.***

Historically, a relatively small number of OEMs, VARsand distributors have accounted for a significant portion of our revenues. Anymaterial delay, cancellation or reduction of purchase orders from one or moreof our major customers or distributors could result in our failure to achieveanticipated revenue for a particular period. In addition, if we are unable toretain one or more of our largest OEM, distributor or VAR customers, or if weare unable to maintain our current level of revenues from one or more of thesesignificant customers, our business and results of operation would be impairedand our stock price could decrease, potentially significantly.  In the three months ended July 31, 2007,one OEM customer accounted for approximately 18.1% of our revenues, and onedistributor customer accounted for approximately 22.9% of our revenues. In thethree months ended July 31, 2006, one OEM customer accounted for approximately13.2% of our revenues and one distributor customer accounted for approximately12.9% of our revenues. In addition, approximately 50% of our revenues havehistorically come from our top five customers. Our business, financialcondition, results of operations and cash flows will continue to dependsignificantly on our ability to retain our current key customers and attractnew customers, as well as on the financial condition and success of our OEMs,VARs and distributors.

## ***Changesin accounting rules for stock-based compensation have adversely affected ourreported operating results, and may adversely affect our stock price and ourcompetitiveness in the employee marketplace.***

Since our founding, we have used employee stockoptions and other stock-based compensation to attract, motivate and retain ouremployees. In December 2004, the Financial Accounting Standards Board issuedStatement of Financial Accounting Standards, or SFAS, No. 123(R), *“Share-Based Payment,”* or SFAS No. 123(R). We adoptedSFAS No. 123(R) on May 1, 2006 and accordingly, we began to measurecompensation costs for all stock-based compensation at fair value and recognizethese costs as expenses in our Consolidated Statements of Income. Therecognition of these expenses in our Consolidated Statements of Income has hada negative effect on our earnings per share, which could negatively impact ourfuture stock price. In addition, if we reduce or alter our use of stock-basedcompensation to minimize these expenses, our ability to attract, motivate andretain qualified employees may be impaired, which could put us at a competitivedisadvantage in the employee marketplace.

## ***Wemay be required to record a significant charge to earnings if our goodwill,amortizable intangible assets or long-term investments become impaired.***

Under generally accepted accounting principles, we arerequired to review our amortizable intangible assets for impairment when eventsor changes in circumstances indicate the carrying value may not be recoverable.We are required to test goodwill for impairment at least annually. Factors thatmay be considered a change in circumstances indicating that the carrying valueof our amortizable intangible assets may not be recoverable include a declinein stock price and market capitalization, and slower growth rates in ourindustry. We may be required to record a significant charge to earnings in ourfinancial statements during the period in which we determine that our goodwill,amortizable intangible assets or long-term investments have been impaired. Anysuch charge would adversely impact our results of operations. As ofJuly 31, 2007, our net goodwill and amortizable intangible assets totaledapproximately $26.4 million and our long term investments totaledapproximately $78.7 million.

 

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## ***Wemaintain a backlog of customer orders that is subject to cancellation or delayin delivery schedules, and any cancellation or delay may result in lower thananticipated revenues.***

Our sales are generally made pursuant to standardpurchase orders. We include in our backlog only those customer orders for whichwe have accepted purchase orders and assigned shipment dates within theupcoming 12 months. Orders constituting our current backlog are subject tocancellation or changes in delivery schedules, and backlog may not necessarilybe an indication of future revenue. Any cancellation or delay in orders whichconstitute our current or future backlog may result in lower than expectedrevenues.

## ***Ifwe are unable to maintain processes and procedures to sustain effectiveinternal control over our financial reporting, our ability to provide reliableand timely financial reports could be harmed and this could have a materialadverse effect on our stock price.***

We are required to comply with the rules promulgatedunder Section 404 of the Sarbanes-Oxley Act of 2002. Section 404requires that we prepare an annual management report assessing theeffectiveness of our internal control over financial reporting, and requires areport by our independent registered public accounting firm addressing thisassessment and the effectiveness of our internal control over financialreporting.

We have in the past discovered, and may in the futurediscover, areas of our internal control that need improvement. For example, werestated our financial statements for the first, second and third quarters offiscal 2004. If these or similar types of issues were to arise with respect toour internal controls in future periods, they could impair our ability toproduce accurate and timely financial reports.

As our business expands, ongoing compliance with theprovisions of Section 404 of the Sarbanes-Oxley Act of 2002 and maintenance of effectiveinternal control over financial reporting will require that we hire additionalqualified finance and accounting personnel. Because other businesses facesimilar challenges, there is significant competition for such personnel, andthere can be no assurance that we will be able to attract and/or retainsuitably qualified employees.

## ***Corporategovernance regulations have recently increased our compliance costs and couldfurther increase our expenses if changes occur within our business.***

Changes in laws and regulations affecting publiccompanies, including the provisions of the Sarbanes-Oxley Act, have imposed newrequirements on us and on our officers, directors, attorneys and independentregistered public accounting firm. In order to comply with these new rules, weadded internal resources and have utilized additional outside legal, accountingand advisory services, which increased our operating expenses in fiscal 2005and fiscal 2006 as compared to prior fiscal years. We expect to incur ongoingoperating expenses as we maintain compliance with Section 404. Inaddition, if we undergo significant modifications to our structure throughpersonnel or system changes, acquisitions, or otherwise, it may be increasinglydifficult to maintain compliance with the existing and evolving corporategovernance regulations.

## ***Wehold a significant amount of marketable securities which are managed on ourbehalf by third parties and are subject to general market risks over which wehave no control.***

As of July 31, 2007, we held cash and cashequivalents totaling $176.9 million, and short-term investments totaling$117.9 million.  These assets aremanaged on our behalf by unrelated third parties in accordance with a cashmanagement policy that has been approved by our board of directors andrestricts our investments to a maximum maturity of 18 months and toinvestment-grade instruments.  Recentuncertainties in global capital markets associated with a repricing of riskhave caused disruptions in the orderly function of markets where ordinarilythere is virtually unlimited liquidity. To date, we have not realized any losses as a result of thesedisruptions, but a future requirement to liquidate a portion of our portfolioat short notice could result in losses of principal.

## ***Thereare risks associated with our operations in China.***

In December 2000, we established Hua WeiSemiconductor (Shanghai) Co. Ltd., or HWSC, as part of our efforts tostreamline our manufacturing process and reduce the costs and working capitalassociated with the testing of our image-sensor products, and relocated ourautomated image testing equipment from the United States to China. In addition,we also expect to expand testing capabilities with additional automated testingequipment, which will also be located in China. However, there are significantadministrative, legal and governmental risks to operating in China that couldresult in increased operating expenses or that could prevent us from achievingour objectives in operations. The risks from operating in China that couldincrease our operating expenses and adversely affect our operating results,financial condition and ability to deliver our products and grow our businessinclude, without limitation:

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

·                  difficultiesin coordinating our operations in China with those in California;

·                  diversionof management attention;

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

·                  politicaland economic instability, which could have an adverse impact on foreignexchange rates in Asia and could impair our ability to conduct our business inChina; and

·                  inadequacyof the local infrastructure to support our needs.

## ***Wemay experience integration or other problems with potential futureacquisitions, which could have an adverse effect on our business or results ofoperations. New acquisitions could dilute the interests of existingstockholders, and the announcement of new acquisitions could result in adecline in the price of our common stock.***

We may in the future make acquisitions of, orinvestments in, businesses that offer products, services and technologies thatwe believe would complement our products, including CMOS image sensormanufacturers. We may also make acquisitions of, or investments in, businessesthat we believe could expand our distribution channels. Even if we were toannounce an acquisition, we may not be able to complete it. In addition, anyfuture acquisition or substantial investment could present numerous risks,including:

·                  difficultyin realizing the potential technological benefits of the transaction;

·                  difficultyin integrating the technology, operations or work force of the acquiredbusiness with our existing business;

·                  unanticipatedexpenses related to technology integration;

·                  disruptionof our ongoing business;

·                  difficultyin realizing the potential financial or strategic benefits of the transaction;

·                  difficultyin maintaining 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;

·                  reductionsin our future operating results from amortization of intangible assets;

·                  impairmentof resulting goodwill; and

·                  potentialunknown or unexpected liabilities associated with acquired businesses.

We expect that any future acquisitions could includeconsideration to be paid in cash, shares of our common stock or a combinationof cash and our common stock. If and when consideration for a transaction ispaid in common stock, it will result in dilution to our existing stockholders.

## ***Wemay never achieve all of the anticipated benefits from our joint venture withTSMC.***

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, we amended and restated ouragreement with TSMC in part to enable VisEra to acquire 29.6% of XinTec, asupplier of chip-scale packaging services in which we originally invested inApril 2003 and in which we directly hold an approximate four percent interest.In January 2007, we entered into a further amendment to the agreement with TSMCto expand the scope of VisEra’s activities and provide additional funding forthe 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 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 receive the expectedbenefits from the joint venture. For example, VisEra may not be able to providemanufacturing services that have competitive technology or prices, which couldadversely affect our product offerings and our ability to meet customerrequirements for our products. In addition, the existence of VisEra may alsomake it 

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more difficult for us to secure dependable servicesfrom competing merchant vendors who provide similar manufacturing services.

## ***Wemay not achieve all of the anticipated benefits of our alliances with, andstrategic 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 chip scale packaging service company, and in June 2003 we made aninvestment in ImPac, a plastic packaging service company. InDecember 2005, VisEra, our joint venture with TSMC, completed theacquisition of a further 29.6% of the issued and outstanding shares of XinTec.In January 2007, TSMC acquired directly a 43.0% interest in XinTec, thusreducing our beneficial ownership in XinTec to 12.4%

In May 2004, we entered into an agreement with PSCunder which we established SOI, a joint venture as a company incorporated underthe laws of Taiwan. The purpose of the joint venture is to conduct the businessof manufacturing, marketing and selling of certain of our legacy products. InMarch 2005, we assumed control of the board of directors of SOI and wehave consolidated SOI since April 30, 2005.

Our investments in these companies may negativelyimpact our operating results, because, under certain circumstances, we arerequired to recognize our portion of any loss recorded by each of thesecompanies or to consolidate them into our operating results. We expect to continueto utilize partnerships, strategic alliances and investments, particularlythose that enhance our manufacturing capacity and those that providemanufacturing services and testing capability. These investments and partneringarrangements are crucial to our ability to grow our business and meet theincreasing demands of our customers. However, we cannot ensure that we willachieve the benefits expected as a result of these alliances. For example, wemay not be able to obtain acceptable quality and/or wafer manufacturing yieldsfrom these companies, which could result in higher operating costs and couldimpair our ability to meet customer demand for our products. In addition,certain of these investments or partnering relationships may place restrictionson the scope of our business, the geographic areas in which we can sell ourproducts and the types of products that we can manufacture and sell. Forexample, our agreement with TSMC provides that we may not engage in businessthat will directly compete with the business of VisEra. This type ofnon-competition provision may impact our ability to grow our business and tomeet the demands of our customers.

## ***Changesin our relationships with our joint ventures and/or companies in which we holdless than a majority interest could change the way we account for suchinterests in the future.***

As part of our strategy, we have formed joint ventureswith two of our foundry partners, and we hold a minority interest in twocompanies 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. It is possible that, in the future, ourrelationships and/or our interests in or with these joint ventures or otherinvestees could change. Such changes have in the past, and could in the futureresult in deconsolidation or consolidation of such entities, as the case maybe, which could result in changes in our reported results.

## ***Wemay be unable to adequately protect our intellectual property, and therefore wemay lose some of our 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 weinitiated a patent infringement action in Taiwan, Republic of China against ICMedia 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 theMay 31, 2005 

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deadline. Although we do not believe the cancellationof the Taiwanese patent at issue in the dispute described above has had amaterial adverse effect on our business or prospects, there may be othersituations where our inability to adequately protect our intellectual propertyrights could materially and adversely affect our competitive position andoperating results. If a third party can copy or otherwise obtain and use ourproducts or technology 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.

## ***Litigationregarding intellectual property could divert management attention, be costly todefend and 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 claims mayincrease 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. In fiscal 2002, we paid$3.5 million to settle an intellectual property litigation matter. Anypotential intellectual property litigation against us would likely betime-consuming and expensive to resolve and would divert management’s time andattention and could also force us to take 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 acceptableterms, 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.

## ***Wehave been named as a defendant in certain litigation that could have a materialadverse impact on our operating results and financial condition.***

We are currently a defendant in ongoing litigationmatters as described in Part II, Item 1 — *“Legal Proceedings”*of this Quarterly Report. We have reached an agreement in principle to settlethe shareholder class action lawsuit pending in the United States DistrictCourt for the Northern District of California. We accrued $3.3 million inlitigation settlement expenses during the quarter ended October 31, 2006to reflect our share of the settlement, including unreimbursed defense costs,net of $13.0 million in recoverable insurance proceeds. The partiesexecuted a Stipulation of Settlement that was filed with the Court in May 2007.Notice of the settlement was provided to the purported shareholder class. TheOrder granting preliminary approval scheduled a hearing on September 7,2007 to determine whether the settlement is fair, reasonable and adequate tothe purported class. The hearing was held on September 7, as scheduled,but the Court had not issued a ruling on the matter as of the date of thisfiling. As a part of the Stipulation of Settlement, the parties agreed to staydiscovery and other proceedings. If there is no final settlement of the mattersdescribed in Part II, Item 1 — “*Legal Proceedings,”*and we fail to prevail in such matters, such failure could have a materialadverse effect on our consolidated financial position, results of operations,or cash flows in the future. In addition, the results of litigation areuncertain, and the litigation process may utilize a portion of our cashresources and divert management’s attention from the day-to-day operations ofour company, all of which could harm our business.

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## ***Ifwe do not effectively manage our growth, our ability to increase our revenuesand improve our earnings 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:

·                  significantlyimprove 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 an inabilityto fill customer orders, which would result in lower sales and could harm ourrelationships 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, our growth may significantly overburdenour management and financial systems and other resources. We may not makeadequate allowances for the costs and risks associated with our expansion. Inaddition, our systems, procedures or controls may not be adequate to support our operations, and we may not be able toexpand 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.

## ***Ourfuture tax rates could be higher than we anticipate if the proportion of futureoperating income generated outside the U.S. by our foreign subsidiaries is lessthan we expect, or the mix differs from that which we expect.***

A number of factors will affect our future tax rate,and certain of these factors could increase our effective tax rate in futureperiods, which could adversely impact our operating results. For example, thecomplex rules for accounting for the tax effects of stock-based compensationunder SFAS No. 123(R) resulted in an increase in our effective tax rate in thefiscal year ended April 30, 2007. Similarly, we anticipate that there willbe greater volatility in our future effective tax rates due to the adoption ofFIN 48 in the fiscal year which began on May 1, 2007. In addition,our future effective tax rates could be negatively affected by changes in taxlaws or the interpretation of tax laws, by unanticipated decreases in theamount of revenue or earnings in countries with low statutory tax rates, or bychanges in the valuation of our deferred tax assets and liabilities.

In common with all multinational companies, we aresubject to tax in multiple jurisdictions. The tax authorities in any givenjurisdiction may seek to increase the taxes being collected by, for example,asserting that the transfer prices we charge between related entities areeither too high or too low depending on which side of the transaction they arelooking at. Although we believe we have provided sufficient taxes for all priorperiods, adjustments could be proposed that would, in some cases, result inliabilities in excess of such provisions.

## ***Oursales through distributors increase the complexity of our business and mayreduce our ability to forecast revenues.***

During fiscal 2007, approximately 40.0% of ourrevenues came from sales through distributors. For the three months endedJuly 31, 2007, approximately 35.5% of our revenues came from sales throughdistributors. We expect that revenues from sales through distributors willcontinue to represent higher proportion of our total revenues than they have inthe past. Selling through distributors reduces our ability to accurately forecastsales and increases the complexity of our business, requiring us to, amongother 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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## ***Weface foreign business, political and economic risks, because a majority of ourproducts and those of our customers are manufactured and sold outside of theUnited States.***

We face difficulties in managing our third partyfoundries, color filter application service providers, ceramic and plasticpackaging 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 2006 and 2007. We anticipatethat sales outside of the United States will continue to account for nearly allof our revenues in future periods. Dependence on sales to foreign customersinvolves 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. A larger portion of our international revenues may bedenominated in foreign currencies in the future, which would subject us toincreased risks associated with fluctuations in foreign exchange rates.

## ***Ourbusiness could be harmed if we lose the services of one or more members of oursenior management team, or if we are unable to attract and retain qualifiedpersonnel.***

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, particularly analog or mixed signal design engineers. Wehave experienced, and may continue to experience, difficulty in hiring andretaining candidates with appropriate qualifications. If we do not succeed in hiringand retaining candidates with appropriate qualifications, our revenues andproduct development efforts could be harmed.

## ***Weare in the process of upgrading our enterprise resource planning and othermanagement information systems.***

As our business grows andbecomes more complex, we have to expand and upgrade our enterprise resourceplanning system and other management information systems which are critical tothe operational, accounting and financial functions of our company. We haveevaluated alternative solutions, both short-term and long-term, to meet theoperating, administrative and financial reporting requirements of our businessare in the beginning stages of implementing a system based on a suite ofapplication software developed by Oracle Corporation.  Implementation of such a system requiressignificant management attention and resources over an extended period of timeand any significant design errors in or delay in the implementation of thesystem could materially adversely affect our operating results and impact ourability to manage our business.

## ***Ouroperations may be impaired as a result of disasters, business interruptions orsimilar 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 close proximity of that geographic area could be extremely disruptive toour business and 

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could materially and adversely affect our operatingresults and financial condition. We do not currently have a disaster recoveryplan.

## ***Actsof war and terrorist acts may seriously harm our business and revenue, costsand expenses and financial 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 to the Securities Markets and Ownership of OurCommon Stock***

## ***Provisionsin our charter documents and Delaware law, as well as our stockholders’ rightsplan, could prevent or delay a change in control of our company and may reducethe market price 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.

## ***Ourstock has been and will likely continue to be subject to substantial price andvolume fluctuations due to a number of factors, many of which are beyond ourcontrol, that may prevent our stockholders from selling our common stock at aprofit.***

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, 2007, theclosing sales price of our common stock has ranged from a high of$33.90 per share to a low of $1.26 per share. The closing sales priceof our common stock on August 31, 2007 was $20.87 per share. Thesecurities markets have experienced significant price and volume fluctuationsin the 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;

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·                  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**

The following table sets forth, for the periodsindicated, our purchases of our common stock in the first quarter offiscal 2008 (in thousands, except per share data):
| **Period**                                 | ** ** | **Total Number  of Shares  Purchased** | ** ** | **Average Price  Paid per  Share** | ** ** | **Total Number of  Shares  Purchased as  Part of a Publicly  Announced Plan** | ** ** | **Approximate  Dollar Value of  Shares that May  Yet Be Purchased  Under the Plan**(1) | ** ** |
|--------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------|------------|
| May 1,  2007—May 31, 2007   |       | —                                           |       | $                                            | —     |                                                                                                             | —     |                                                                                                                           | $          | 100,000 |   |
| June 1,  2007—June 30, 2007 |       | 566                                              |       | 17.00                                        |       | 566                                                                                                              |       | $                                                                                                                              | 90,385     |   |
| July 1,  2007—July 31, 2007 |       | —                                           |       | —                                       |       | —                                                                                                           |       | $                                                                                                                              | 90,385     |   |
| Total                                      |       | 566                                              |       | $                                            | 17.00      |                                                                                                             | 566        |                                                                                                                           |       |   |

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(1)                OnFebruary 27, 2007, our board of directors approved a stock repurchaseprogram that provides for the repurchase of up to $100 million of ouroutstanding common stock. Subject to applicable securities laws, suchrepurchases will be at times and in amounts as we deem appropriate, based onfactors such as market conditions, legal requirements and other corporateconsiderations. See the section entitled *“CapitalResources”* in Item 2 of this Quarterly Report on Form 10-Qfor further information on this program.

**ITEM 6.   EXHIBITS**

| Exhibit  Number | ** ** | **Description** |
|-----------------|------------|-----------------|
|            | 31.1       |            |   | Certification of Chief Executive Officer pursuant to  Section 302 of Sarbanes-Oxley Act of 2002. |
|            | 31.2       |            |   | Certification of Chief Financial Officer pursuant to  Section 302 of Sarbanes-Oxley Act of 2002. |
|            | 32         |            |   | Certification of Chief Executive Officer and Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of Sarbanes-Oxley Act of 2002. |

 

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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  10, 2007 |                               |   |
|                       | By:                                | **/s/****SHAW HONG** |
| ** **                 | ** **                         | **Shaw  Hong** |
| * *                   | * *                           | *Chief  Executive Officer, President and Director* |
| * *                   | * *                           | *(Principal  Executive Officer)* |
|                       |                               |   |
| Dated: September  10, 2007 |                               |   |
|                       | 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** |
|-----------------|------------|-----------------|
|            | 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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