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**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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###### **FORM 10-Q**

######  

**(Mark One)**

 

| **x**      | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE  ACT OF 1934**                                                                                                                                                                               |
|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | **For the Quarterly Period Ended September 28,  2008**                                                                                                                                                                                                                           |
| ** ** | ** **                                                                                                                                                                                                                                                                            |
| ** ** | **OR**                                                                                                                                                                                                                                                                                |
| ** ** | ** **                                                                                                                                                                                                                                                                            |
| **o**      | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE  ACT OF 1934**                                                                                                                                                                              |
| ** ** | **For the  Transition Period From                     To                   ** |

 

**COMMISSIONFILE NUMBER: 000-22671**

** **

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**QUICKLOGIC CORPORATION**

(Exact name ofregistrant as specified in its charter)

 

| **DELAWARE**                                                    | ** ** | **77-0188504**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State  or other jurisdiction ofincorporation  or organization) |       | (I.R.S.  Employer Identification No.) |

 

**1277 ORLEANSDRIVE SUNNYVALE, CA 94089**

(Address ofprincipal executive offices, including Zip Code)

 

**(408) 990-4000**

(Registrant’stelephone number, including area code)

 

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

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company. See definition of “large accelerated filer,” “acceleratedfiler” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.(Check one):

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

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Securities Exchange Act).Yes o No x

 

As of November 3, 2008, 29,782,785 shares ofthe registrant’s common stock were outstanding.

 

 

 

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** **

**QUICKLOGICCORPORATION**

**FORM 10-Q**

**September 28,2008**

 
| ** **        | ** **                                                                                                                                                  | **Page**   |
|-------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|              |                                                                                                                                                        |       |
| **Part I.**  | **Financial  Information**                                                                                                                                  |       | 3 |
| ** **        | ** **                                                                                                                                                  | ** ** | ** ** |
| **Item 1.**       | Financial Statements                                                                                                                                        |       | 3 |
|              | Condensed  Unaudited Consolidated Statements of Operations for the three and nine months  ended September 28, 2008 and September 30, 2007         |       | 3 |
|              | Condensed  Unaudited Consolidated Balance Sheets as of September 28, 2008 and  December 30, 2007                                                  |       | 4 |
|              | Condensed  Unaudited Consolidated Statements of Cash Flows for the nine months ended  September 28, 2008 and September 30, 2007                   |       | 5 |
|              | Condensed  Unaudited Consolidated Statements of Comprehensive Loss for the three and  nine months ended September 28, 2008 and September 30, 2007 |       | 6 |
|              | Notes to Condensed Unaudited Consolidated Financial  Statements                                                                                             |       | 7 |
|              |                                                                                                                                                        |       |   |
| **Item 2.**       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                 |       | 22 |
| ** **        | ** **                                                                                                                                                  | ** ** | ** ** |
| **Item 3.**       | Quantitative  and Qualitative Disclosures about Market Risk                                                                                                 |       | 35 |
| ** **        | ** **                                                                                                                                                  | ** ** | ** ** |
| **Item 4.**       | Controls  and Procedures                                                                                                                                    |       | 35 |
|              |                                                                                                                                                        |       |   |
| **Part II.** | **Other Information**                                                                                                                                       |       | 36 |
| ** **        | ** **                                                                                                                                                  | ** ** | ** ** |
| **Item 1.**       | Legal  Proceedings                                                                                                                                          |       | 36 |
| ** **        | ** **                                                                                                                                                  | ** ** | ** ** |
| **Item  1A.**     | Risk Factors                                                                                                                                                |       | 37 |
| ** **        | ** **                                                                                                                                                  | ** ** | ** ** |
| **Item  6.**      | Exhibits                                                                                                                                                    |       | 50 |
| ** **        | ** **                                                                                                                                                  | ** ** | ** ** |
| Signatures        |                                                                                                                                                        | 51         |

 

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**PART I. Financial Information**

 

**Item 1. Financial Statements**

 

**QUICKLOGICCORPORATION**

**CONDENSEDUNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
| ** **                                            | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                            | ** ** | **September 28,  2008**     | ** ** | **September 30,  2007**    | ** ** | **September 28,  2008** | ** ** | **September 30,  2007** | ** ** |
|                                                  |       |                             |       |                            |       |   |   |   |   |
| Revenue                                               |       | $                                | 6,230      |                            | $          | 9,025 |   | $ | 25,996 |   | $ | 23,672 |   |
| Cost of revenue                                       |       | 2,778                            |       | 4,314                           |       | 12,018 |   | 13,690 |   |
| Long-lived asset impairment                           |       | —                           |       | —                          |       | 1,545 |   | — |   |
| Gross profit                                          |       | 3,452                            |       | 4,711                           |       | 12,433 |   | 9,982 |   |
| Operating expenses:                                   |       |                             |       |                            |       |   |   |   |   |
| Research and development                              |       | 1,354                            |       | 2,342                           |       | 6,785 |   | 6,968 |   |
| Selling, general and administrative                   |       | 2,666                            |       | 3,953                           |       | 10,956 |   | 12,933 |   |
| Long-lived asset impairment                           |       | —                           |       | —                          |       | 468 |   | — |   |
| Restructuring costs                                   |       | —                           |       | —                          |       | 452 |   | — |   |
| Loss from operations                                  |       | (568                             | )          | (1,584                          | )          | (6,228 | ) | (9,919 | ) |
| Write-down of investment in Tower  Semiconductor Ltd. |       | —                           |       | —                          |       | (417 | ) | — |   |
| Interest expense                                      |       | (59                              | )          | (69                             | )          | (202 | ) | (226 | ) |
| Interest income and other, net                        |       | (46                              | )          | 189                             |       | 88 |   | 752 |   |
| Loss before income taxes                              |       | (673                             | )          | (1,464                          | )          | (6,759 | ) | (9,393 | ) |
| Provision for (benefit from) income taxes             |       | (58                              | )          | 29                              |       | (24 | ) | 71 |   |
| Net loss                                              |       | $                                | (615       | )                               | $          | (1,493 | ) | $ | (6,735 | ) | $ | (9,464 | ) |
|                                                  |       |                             |       |                            |       |   |   |   |   |
| Net loss per share:                                   |       |                             |       |                            |       |   |   |   |   |
| Basic                                                 |       | $                                | (0.02      | )                               | $          | (0.05 | ) | $ | (0.23 | ) | $ | (0.33 | ) |
| Diluted                                               |       | $                                | (0.02      | )                               | $          | (0.05 | ) | $ | (0.23 | ) | $ | (0.33 | ) |
|                                                  |       |                             |       |                            |       |   |   |   |   |
| Weighted average shares:                              |       |                             |       |                            |       |   |   |   |   |
| Basic and diluted                                     |       | 29,772                           |       | 29,116                          |       | 29,589 |   | 28,966 |   |

 

See accompanying Notes to Condensed UnauditedConsolidated Financial Statements.

 

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**QUICKLOGICCORPORATION**

**CONDENSEDUNAUDITED CONSOLIDATED BALANCE SHEETS**

**(inthousands, except par value amount)**

 
| ** **                                                                                                                 | ** ** | **September 28,  2008** | ** ** | **December 30,  2007** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                 |       |                         |       |                        |       |
|                                                                                                                       |       |                         |       |                        |       |
| Current assets:                                                                                                            |       |                         |       |                        |       |
| Cash and cash equivalents                                                                                                  |       | $                            | 18,833     |                        | $          | 20,868 |   |
| Short-term investment in Tower  Semiconductor Ltd.                                                                         |       | 519                          |       | 1,279                       |       |
| Accounts receivable, net                                                                                                   |       | 2,279                        |       | 2,634                       |       |
| Inventories                                                                                                                |       | 2,457                        |       | 5,770                       |       |
| Other current assets                                                                                                       |       | 919                          |       | 1,607                       |       |
| Total current assets                                                                                                       |       | 25,007                       |       | 32,158                      |       |
| Property and equipment, net                                                                                                |       | 4,013                        |       | 5,877                       |       |
| Investment in Tower Semiconductor Ltd.                                                                                     |       | 261                          |       | 644                         |       |
| Other assets                                                                                                               |       | 1,027                        |       | 2,745                       |       |
| TOTAL ASSETS                                                                                                               |       | $                            | 30,308     |                        | $          | 41,424 |   |
|                                                                                                                       |       |                         |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                             |       |                         |       |                        |       |
|                                                                                                                       |       |                         |       |                        |       |
| Current liabilities:                                                                                                       |       |                         |       |                        |       |
| Revolving line of credit                                                                                                   |       | $                            | 2,000      |                        | $          | — |   |
| Trade payables                                                                                                             |       | 1,453                        |       | 4,207                       |       |
| Accrued liabilities                                                                                                        |       | 2,009                        |       | 2,228                       |       |
| Deferred revenue less cost of revenue                                                                                      |       | 239                          |       | 516                         |       |
| Deferred royalty revenue                                                                                                   |       | —                       |       | 431                         |       |
| Current portion of debt and capital lease  obligations                                                                     |       | 764                          |       | 2,497                       |       |
| Total current liabilities                                                                                                  |       | 6,465                        |       | 9,879                       |       |
|                                                                                                                       |       |                         |       |                        |       |
| Long-term liabilities:                                                                                                     |       |                         |       |                        |       |
| Debt and capital lease obligations, less  current portion                                                                  |       | 186                          |       | 2,527                       |       |
| Total liabilities                                                                                                          |       | 6,651                        |       | 12,406                      |       |
|                                                                                                                       |       |                         |       |                        |       |
| Commitments and contingencies (see  Note 15) and litigation (see Note 16)                                             |       |                         |       |                        |       |
|                                                                                                                       |       |                         |       |                        |       |
| Stockholders’ equity:                                                                                                 |       |                         |       |                        |       |
| Common stock, $0.001 par value; 100,000  shares authorized; 29,783 and 29,390 shares issued and outstanding,  respectively |       | 30                           |       | 29                          |       |
| Additional paid-in capital                                                                                                 |       | 169,397                      |       | 167,298                     |       |
| Accumulated other comprehensive income  (loss)                                                                             |       | (376                         | )          | 350                         |       |
| Accumulated deficit                                                                                                        |       | (145,394                     | )          | (138,659                    | )          |
| Total stockholders’ equity                                                                                            |       | 23,657                       |       | 29,018                      |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                            |       | $                            | 30,308     |                        | $          | 41,424 |   |

 

See accompanying Notes to Condensed UnauditedConsolidated Financial Statements.

 

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**QUICKLOGICCORPORATION**

**CONDENSEDUNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(inthousands)**

 
| ** **                                                                                  | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                  | ** ** | **September 28,  2008**    | ** ** | **September 30,  2007** | ** ** |
| ** **                                                                                  | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                                       |       |                            |       |   |   |
| Net loss                                                                                    |       | $                               | (6,735     | ) | $ | (9,464 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used for) operating activities: |       |                            |       |   |   |
| Depreciation and amortization                                                               |       | 1,717                           |       | 2,292 |   |
| Gain on sale of equipment                                                                   |       | —                          |       | (95 | ) |
| Write-off of long-lived assets                                                              |       | 45                              |       | 7 |   |
| Stock-based compensation                                                                    |       | 1,971                           |       | 1,261 |   |
| Decrease in wafer credits from Tower  Semiconductor Ltd.                                    |       | 254                             |       | 681 |   |
| Write-down of inventories                                                                   |       | 1,331                           |       | 3,533 |   |
| Long-lived asset impairment                                                                 |       | 2,013                           |       | — |   |
| Write-down of marketable securities                                                         |       | 417                             |       | — |   |
| Bad debt expense                                                                            |       | 44                              |       | 163 |   |
| Changes in assets and liabilities:                                                          |       |                            |       |   |   |
| Accounts receivable                                                                         |       | 311                             |       | 93 |   |
| Inventories                                                                                 |       | 1,982                           |       | 693 |   |
| Other assets                                                                                |       | 725                             |       | 714 |   |
| Trade payables                                                                              |       | (2,697                          | )          | (1,965 | ) |
| Accrued liabilities                                                                         |       | (219                            | )          | 182 |   |
| Deferred income and royalty revenue                                                         |       | (708                            | )          | (405 | ) |
| Net cash provided by (used for) operating  activities                                       |       | 451                             |       | (2,310 | ) |
|                                                                                        |       |                            |       |   |   |
| Cash flows from investing activities:                                                       |       |                            |       |   |   |
| Capital expenditures for property and  equipment                                            |       | (541                            | )          | (1,021 | ) |
| Proceeds from sale of equipment                                                             |       | —                          |       | 95 |   |
| Net cash used for investing activities                                                      |       | (541                            | )          | (926 | ) |
|                                                                                        |       |                            |       |   |   |
| Cash flows from financing activities:                                                       |       |                            |       |   |   |
| Payment of debt and capital lease  obligations                                              |       | (4,074                          | )          | (1,896 | ) |
| Proceeds from debt obligations                                                              |       | —                          |       | 442 |   |
| Proceeds from issuance of common stock                                                      |       | 129                             |       | 915 |   |
| Proceeds from revolving line of credit                                                      |       | 2,000                           |       | — |   |
| Net cash used for financing activities                                                      |       | (1,945                          | )          | (539 | ) |
|                                                                                        |       |                            |       |   |   |
| Net decrease in cash and cash equivalents                                                   |       | (2,035                          | )          | (3,775 | ) |
| Cash and cash equivalents at beginning of  period                                           |       | 20,868                          |       | 24,621 |   |
| Cash and cash equivalents at end of period                                                  |       | $                               | 18,833     |   | $ | 20,846 |   |
|                                                                                        |       |                            |       |   |   |
| Supplemental disclosures of cash flow  information:                                         |       |                            |       |   |   |
| Interest paid                                                                               |       | $                               | 210        |   | $ | 245 |   |
| Income taxes paid                                                                           |       | $                               | 9          |   | $ | 132 |   |

 

See accompanying Notes to Condensed UnauditedConsolidated Financial Statements.

 

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**QUICKLOGICCORPORATION**

**CONDENSEDUNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS**

**(inthousands)**

 
| ** **                                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                | ** ** | **September 28,  2008**     | ** ** | **September 30,  2007**    | ** ** | **September 28,  2008** | ** ** | **September 30,  2007** | ** ** |
|                                                      |       |                             |       |                            |       |   |   |   |   |
| Net loss                                                  |       | $                                | (615       | )                               | $          | (1,493 | ) | $ | (6,735 | ) | $ | (9,464 | ) |
| Other comprehensive loss, net of tax:                     |       |                             |       |                            |       |   |   |   |   |
| Unrealized gain (loss) on  available-for-sale investments |       | (376                             | )          | 484                             |       | (726 | ) | 108 |   |
| Total comprehensive loss                                  |       | $                                | (991       | )                               | $          | (1,009 | ) | $ | (7,461 | ) | $ | (9,356 | ) |

 

See accompanying Notes to Condensed UnauditedConsolidated Financial Statements.

 

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**QUICKLOGIC CORPORATION**

**NOTES TO CONDENSED UNAUDITEDCONSOLIDATED FINANCIAL STATEMENTS**

 

**Note1—The Company and Basis of Presentation**

 

QuickLogic Corporation (“QuickLogic”or the “Company”) was founded in 1988 and reincorporated in Delaware in 1999.The Company develops and markets low power programmable solutions that enablecustomers to add features to their mobile, consumer and industrial products.The Company is a fabless semiconductor company that operates in a singleindustry segment where it designs, markets and supports Customer SpecificStandard Products (“CSSPs”), Field Programmable Gate Arrays (“FPGAs”),application solutions, associated design software and programming hardware.

 

Theaccompanying interim consolidated financial statements are unaudited. In theopinion of management, these statements have been prepared in accordance withgenerally accepted accounting principles (“GAAP”) and include all adjustments,consisting only of normal recurring adjustments, necessary to provide a fairstatement of results for the interim periods presented. The Company recommendsthat these consolidated financial statements be read in conjunction with theCompany’s Annual Report on Form 10-K for the year ended December 30,2007. Operating results for the three and nine months ended September 28,2008 are not necessarily indicative of the results that may be expected for thefull year.

 

QuickLogic’sfiscal year ends on the Sunday closest to December 31.  QuickLogic’sfiscal third quarter for 2008 and 2007 ended Sunday, September 28, 2008and September 30, 2007, respectively.

 

*Liquidity*

 

The Company anticipatesthat its existing cash resources will fund operations, finance purchases ofcapital equipment and provide adequate working capital for the next twelvemonths. The Company’s liquidity is affected by many factors including, amongothers, the level of revenue and gross profit, the conversion of designopportunities into revenue, market acceptance of existing and new productsincluding CSSPs based on our ArcticLinkTM and PolarPro® solutionplatforms, fluctuations in revenue as a result of product end-of-life,fluctuations in revenue as a result of the stage in the product life cycle ofits customers’ products, costs of securing access to and availability ofadequate manufacturing capacity, levels of inventories, wafer purchasecommitments, customer credit terms, the amount and timing of research anddevelopment expenditures, the timing of new product introductions, productionvolumes, product quality, sales and marketing efforts, the value and liquidityof its investment portfolio, the amount and financing arrangements forpurchases of capital equipment, changes in operating assets and liabilities,the ability to obtain or renew debt financing and to remain in compliance withthe terms of existing credit facilities, the ability to raise funds from thesale of shares of Tower Semiconductor Ltd. (“Tower”) and equity in the Company,the issuance and exercise of stock options and participation in the Company’semployee stock purchase plan, and other factors related to the uncertainties ofthe industry and global economics. Accordingly, there can be no assurance thatevents in the future will not require the Company to seek additional capitalor, if so required, that such capital will be available on terms acceptable tothe Company.

 

*Principlesof Consolidation*

 

The consolidatedfinancial statements include the accounts of QuickLogic Corporation and itswholly owned subsidiaries, QuickLogic International, Inc., QuickLogicCanada Company, QuickLogic Kabushiki Kaisha and QuickLogic Software (India)Private Ltd. The Company and its subsidiaries use the U.S. dollar as itsfunctional currency. All intercompany accounts and transactions are eliminatedin consolidation.

 

*Usesof Estimates*

 

The preparation of theseconsolidated financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities, the disclosures of contingent assets and liabilities and thereported amounts of revenue and expenses during the period. Actual resultscould differ from those estimates, particularly in relation to revenue recognition,the allowance for doubtful accounts, sales returns, valuation of investments,valuation of long-lived assets, valuation of inventories includingidentification of excess quantities, market value and obsolescence, measurementof stock-based compensation awards, fair value measurements of financial assetsand liabilities, accounting for income taxes and estimating accruedliabilities.

 

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**QUICKLOGIC CORPORATION**

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

 

**Note 2—SignificantAccounting Policies**

 

There have been nomaterial changes in the Company’s significant accounting policies for the ninemonths ended September 28, 2008 from its disclosure in the Annual Reporton Form 10-K for the year ended December 30, 2007, except asdescribed below. For a discussion of the significant accounting policies,please see the Annual Report on Form 10-K for the fiscal year ended December 30,2007 filed with the Securities Exchange Commission (“SEC”) on March 11,2008.

 

*Long-LivedAssets*

 

The Company reviews therecoverability of its long-lived assets, such as property and equipment,prepaid wafer credits and investments, annually and when events or changes incircumstances occur that indicate that the carrying value of the asset or assetgroup may not be recoverable. The assessment of possible impairment is based onthe Company’s ability to recover the carrying value of the asset or asset groupfrom the expected future pre-tax cash flows, undiscounted and without interestcharges, of the related operations. If these cash flows are less than thecarrying value of the asset or asset group, an impairment loss is recognizedfor the difference between the estimated fair value and the carrying value, andthe carrying value of the related assets is reduced by this difference. Themeasurement of impairment requires management to estimate future cash flows andthe fair value of long-lived assets. The Company recorded $2.0 million oflong-lived asset impairment charges in the second quarter of 2008. See Note 12.

 

*Fair Value*

 

Effective December 31,2007, the Company adopted the provisions of SFAS No. 157, “*Fair Value Measurements*,” (“SFAS 157”) andSFAS No. 159, “*The Fair Value Optionfor Financial Assets and Financial Liabilities*,” (“SFAS 159”). SFAS157 establishes a framework for measuring fair value and expands disclosuresabout fair value measurements. SFAS 159 permits companies to choose to measurecertain financial instruments and certain other items at fair value. See Note8.

 

*RecentlyIssued Accounting Pronouncements*

 

In October 2008, theFinancial Accounting Standards Board (“FASB”) issued FSP No. 157-3, “*Determining the Fair Value of a Financial Asset Whenthe Market for That Asset is Not Active”,*FSP No. 157-3clarifies the application of SFAS No. 157, which the Company adopted as ofDecember 31, 2007, in cases where a market is not active. The Company hasconsidered FSB No. 157-3 in its determination of estimated fair values asof September 28, 2008, and the impact was not significant.

 

In May 2008,FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 162, “*The Hierarchy of Generally Accepted AccountingPrinciples*,” (“SFAS 162”). This standard reorganizes the GAAPhierarchy in order to improve financial reporting by providing a consistentframework for determining what accounting principles should be used whenpreparing U.S. GAAP financial statements. SFAS 162 shall be effective 60 daysafter the SEC’s approval of the Public Company Accounting Oversight Board’samendments to Interim Auditing Standard, AU Section 411, “*The Meaning of Present Fairly in Conformity withGenerally Accepted Accounting Principles*.” The Company is currentlyevaluating the impact SFAS 162 will have on its consolidated financialstatements.

 

In April 2008,FASB issued FASB Staff Position (“FSP”) SFAS No. 142-3, “*Determination of the Useful Life of Intangible Assets*,”(“FSP FAS 142-3”). FSP FAS 142-3 amends the list of factors an entity shouldconsider in developing renewal or extension assumptions used in determining theuseful life of recognized intangible assets under SFAS No. 142, “*Goodwill and Other Intangible Assets*,” (“SFAS142”). The intent of FSP FAS 142-3 is to improve the consistency between theuseful life of a recognized intangible asset under SFAS 142 and the period ofexpected cash flows used to measure the fair value of the asset under SFAS No. 141,“*Business Combinations*.” FSP FAS142-3 is effective for fiscal years beginning after December 15, 2008 andinterim periods within those fiscal years. The Company is currently evaluatingthe impact FSP FAS 142-3 will have on its consolidated financial statements.

 

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**QUICKLOGIC CORPORATION**

**NOTESTO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

 

**Note 3—NetLoss Per Share**

 

Basic net loss per shareis computed by dividing net loss available to common stockholders by theweighted average number of common shares outstanding during the period. Dilutednet loss per share is computed using the weighted average number of commonshares outstanding during the period plus potentially dilutive common sharesoutstanding during the period under the treasury stock method. In computingdiluted net loss per share, the average stock price for the period is used indetermining the number of shares assumed to be purchased from the exercise ofstock options.

 

Forthe third quarter and first nine months of 2008 and 2007, approximately 7.3million and 7.8 million shares, respectively, associated with stock-basedawards outstanding and the estimated number of shares to be purchased under theoffering period of the ESPP were not included in the calculation of diluted netloss per share, as they were considered antidilutive due to the net loss theCompany experienced during this period.

 

**Note4—Investment in Tower Semiconductor Ltd.**

 

On December 12,2000, the Company entered into several agreements with Tower, as amended, underwhich the Company agreed to make a strategic investment in Tower of up to$25 million as part of Tower’s plan to build and equip a new waferfabrication facility. During 2001 and 2002, the Company paid a total of$21.3 million to Tower to fulfill its investment requirements under theagreement. In partial consideration for the investment, the Company received 1,757,368Tower ordinary shares with an original cost of $16.6 million. The Companysold a portion of the Tower ordinary shares in fiscal year 2003.

 

During the second quarterof 2008, the Company wrote down the value of its investment in Tower shares by$417,000 due to an “other than temporary” decline in market value, to acarrying value of $0.86 per share. This determination included factors such asmarket value and the period of time that the market value had been below thecarrying value. The Company also wrote down the Tower shares in periods priorto 2006 as a result of “other than temporary” declines in their market value.During the third quarter of 2008, the market value of Tower ordinary sharesdeclined to $0.58 per share, and the resulting $376,000 reduction in value ofthe Company’s investment in Tower was reflected in accumulated othercomprehensive loss on the unaudited consolidated balance sheet. The marketvalue of Tower ordinary shares was $0.22 per share on October 31, 2008. Ifthe value per share remains below $0.86 at the end of our fiscal fourthquarter, we may incur a charge for the “other than temporary” decline in marketvalue since June 28, 2008.

 

Pursuant to SFAS 157, thefair value of the Company’s marketable securities as of September 28, 2008was determined based on “Level 1” inputs as described in Note 8. As of September 28,2008, the Company held 1,344,543 available-for-sale Tower ordinary shares. TheCompany plans to continue to hold 450,000 of the Tower ordinary shares in orderto receive preferred product pricing under the agreements with Tower and hasrecorded these shares as a long-term investment on the unaudited consolidated balancesheets. The remaining 894,543 shares are classified as a short-term investmenton the unaudited consolidated balance sheets.

 

The Company also received$4.7 million in prepaid wafer credits in partial consideration for theinvestment. As of September 28, 2008, the prepaid wafer credit balance was$951,000 and these credits were recorded within long-term other assets on theunaudited consolidated balance sheets. Tower has guaranteed the Companycapacity at Tower through at least 2010 and the credits can be applied towardwafer purchases from Tower at 15% of the value of purchases made through 2010.

 

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**QUICKLOGIC CORPORATION**

**NOTESTO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

 

**Note 5—BalanceSheet Components**

 
| ** **                                | ** ** | **September 28,  2008** | ** ** | **December 30,  2007** | ** ** |
|-------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **(in thousands)**      | ** ** |
| Inventories:                              |       |                         |       |                        |       |
| Raw materials                             |       | $                            | 75         |                        | $          | 199 |   |
| Work-in-process                           |       | 2,052                        |       | 4,714                       |       |
| Finished goods                            |       | 330                          |       | 857                         |       |
|                                      |       | $                            | 2,457      |                        | $          | 5,770 |   |
|                                      |       |                         |       |                        |       |
| Other current assets:                     |       |                         |       |                        |       |
| Prepaid expenses                          |       | $                            | 747        |                        | $          | 1,371 |   |
| Other                                     |       | 172                          |       | 236                         |       |
|                                      |       | $                            | 919        |                        | $          | 1,607 |   |
|                                      |       |                         |       |                        |       |
| Property and equipment:                   |       |                         |       |                        |       |
| Equipment                                 |       | $                            | 13,893     |                        | $          | 14,979 |   |
| Software                                  |       | 8,072                        |       | 9,303                       |       |
| Furniture and fixtures                    |       | 840                          |       | 823                         |       |
| Leasehold improvements                    |       | 800                          |       | 803                         |       |
|                                      |       | 23,605                       |       | 25,908                      |       |
| Accumulated depreciation and amortization |       | (19,592                      | )          | (20,031                     | )          |
|                                      |       | $                            | 4,013      |                        | $          | 5,877 |   |
|                                      |       |                         |       |                        |       |
| Other assets:                             |       |                         |       |                        |       |
| Prepaid wafer credits                     |       | $                            | 951        |                        | $          | 2,551 |   |
| Other                                     |       | 76                           |       | 194                         |       |
|                                      |       | $                            | 1,027      |                        | $          | 2,745 |   |
|                                      |       |                         |       |                        |       |
| Accrued liabilities:                      |       |                         |       |                        |       |
| Employee related accruals                 |       | $                            | 1,284      |                        | $          | 1,452 |   |
| Other                                     |       | 725                          |       | 776                         |       |
|                                      |       | $                            | 2,009      |                        | $          | 2,228 |   |

 

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**QUICKLOGIC CORPORATION**

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

 

**Note 6—Obligations**

** **
| ** **                                            | ** ** | **September 28,  2008** | ** ** | **December 30,  2007** | ** ** |
|-------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                            | ** ** | **(in thousands)**      | ** ** |
|                                                  |       |                         |       |                        |       |
| Debt and capital lease obligations:                   |       |                         |       |                        |       |
| Revolving line of credit                              |       | $                            | 2,000      |                        | $          | — |   |
| Notes payable to bank                                 |       | —                       |       | 3,278                       |       |
| Capital leases                                        |       | 950                          |       | 1,746                       |       |
|                                                  |       | 2,950                        |       | 5,024                       |       |
| Current portion of debt and capital lease obligations |       | (2,764                       | )          | (2,497                      | )          |
|                                                  |       | $                            | 186        |                        | $          | 2,527 |   |

 

*RevolvingLine of Credit and Notes Payable to Bank*

 

Effective August 2008,the Company amended its Second Amended and Restated Loan and Security Agreementwith Silicon Valley Bank. Terms of the amended agreement include a$6.0 million revolving line of credit available through June 2010.Upon each advance the Company can elect a variable interest rate, which is thegreater of six percent or the prime rate plus one percent, or a fixed ratewhich is the LIBOR plus 3.50%. During the third quarter of 2008, the Companyrepaid notes payable of $2,514,000 and borrowed $2,000,000 of revolving debtthrough a prime rate plus one percent advance under its revolving line ofcredit (6% as of September 28, 2008).

 

The bank has a firstpriority security interest in substantially all of the Company’s tangible andintangible assets to secure any outstanding amounts under the agreement. Underthe terms of the agreement, except as noted above, the Company must maintain aminimum tangible net worth and adjusted quick ratio. The agreement also hascertain restrictions including, among others, on the incurrence of otherindebtedness, the maintenance of depository accounts, the disposition ofassets, mergers, acquisitions, investments, the granting of liens and thepayment of dividends. The Company was in compliance with the financialcovenants of the agreement as of the end of the current reporting period.

 

At September 28,2008, the prime rate under the credit facility was 5.00%. As of September 28,2008 and December 30, 2007, zero and $1.8 million, respectively, ofamounts outstanding under the equipment line of credit were classified aslong-term obligations.

 

*CapitalLeases*

 

In December 2007,the Company leased design software and related maintenance under a two yearcapital lease at an imputed interest rate of 7.1% per annum. Terms of theagreement require the Company to make quarterly payments of approximately$190,000 through November 2009. The Company recorded a capital asset of$1.2 million, prepaid maintenance of $256,000 and a capital leaseobligation of $1.4 million. In the second quarter of 2008, the Companydecided to outsource its physical silicon design activity. As a result of thisdecision, the Company determined that a portion of the capital asset wasunutilized. As a result, the Company recorded a long-lived asset impairment of$468,000 for the unutilized portion. See Note 12. As of September 28,2008, $901,000 was outstanding under the capital lease, $186,000 of which wasclassified as a long-term obligation.

 

In the fourth quarter of2006, the Company entered into a capital lease obligation in the amount of$77,000 to finance design software. The capital lease obligation has an imputedinterest rate of 9.25% per annum and is being repaid in annual amounts of$28,000 through January 2009. As of September 28, 2008, $49,000 wasoutstanding under the capital lease, zero of which was classified as along-term obligation.

 

In January 2006, theCompany leased design software tools and related maintenance under a three yearcapital lease at an imputed interest rate of 9.0% per annum. Terms of theagreement required the Company to make semi-annual payments of approximately$148,000 through July 2008. The Company recorded a capital asset of$633,000, prepaid maintenance of $158,000 and a capital lease obligation of$791,000. There was no outstanding balance under the capital lease as of September 28,2008.

 

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**QUICKLOGIC CORPORATION**

**NOTESTO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

 

**Note 7—DeferredRoyalty Revenue**

 

In October 2000, theCompany entered into a technology license and wafer supply agreement withAeroflex Incorporated (“Aeroflex”). Under the terms of the agreement, the Companyreceived $750,000 of prepaid royalties. In addition, Aeroflex receives aprepaid royalty credit for a portion of the amounts paid for wafers purchasedfrom the Company under the agreement. Prepaid royalties are recognized asrevenue when Aeroflex reports the sale of products incorporating the licensedtechnology. As of September 28, 2008 and December 30, 2007, theCompany had classified as a current liability zero and $431,000, respectively,of deferred royalty revenue under this agreement. The Company recognized$420,000 and $520,000 of royalty revenue under the agreement in the first ninemonths of 2008 and 2007, respectively.

 

**Note8—Fair Value Measurements**

 

In September 2006,the FASB issued SFAS 157. SFAS 157 establishes a framework for measuring fairvalue and expands disclosures about fair value measurements. The changes tocurrent practice resulting from the application of SFAS 157 relate to thedefinition of fair value, the methods used to measure fair value and expandeddisclosures about fair value measurements. In February 2008, the FASBissued FSP FAS No. 157-1, “*Applicationof FASB Statement No. 157 to FASB Statement No. 13 and Its RelatedInterpretive Accounting Pronouncements That Address Leasing Transactions,”*(“FSP FAS 157-1”) and FASB FSP FAS No. 157-2, “*Effective Date of FASB Statement No.157,”*(“FSP FAS 157-2”).FSP FAS 157-1 removes leasing from the scope of SFAS 157. FSP FAS 157-2 delaysthe effective date of SFAS 157 from 2008 to 2009 for all nonfinancial assetsand nonfinancial liabilities, except those that are recognized or disclosed atfair value in the consolidated financial statements on a recurring basis.  SFAS 157 is effective for fiscal yearsbeginning after November 15, 2007 and interim periods within those fiscalyears for financial assets and liabilities, as well as for any other assets andliabilities that are carried at fair value on a recurring basis in theconsolidated financial statements.

 

Effective December 31,2007, the Company adopted the provisions of SFAS 157 as amended by FSP FAS157-1 and FSP FAS 157-2. The adoption of this standard in fiscal 2008 waslimited to financial assets and liabilities. The adoption of SFAS 157 did nothave a material effect on the Company’s financial condition or results ofoperations.  The Company is in theprocess of evaluating the impact of this standard with respect to the Company’snonfinancial assets and liabilities and the effect it will have on itsconsolidated financial statements.

 

SFAS157 specifies a hierarchy of valuation techniques based upon whether the inputsto those valuation techniques reflect assumptions other market participantswould use based upon market data obtained from independent sources (observableinputs) or reflect the Company’s own assumption of market participant valuation(unobservable inputs). The fair value hierarchy consists of the following threelevels:

 

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

 

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

 

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

 

The following tablepresents the Company’s financial assets that are measured at fair value on arecurring basis as of the end of the third quarter of 2008 consistent with thefair value hierarchy provisions of SFAS 157 (in thousands):

 
| ** **                             | ** ** | **Total** | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|----------------------------------------|------------|-----------|------------|------------------|------------|------------------|------------|------------------|------------|
| Assets:                                |       |      |       |             |       |             |       |             |       |
| Cash equivalents                       |       | $         | 16,256     |             | $          | 16,256           |       | $                | —     |   | $ | — |   |
| Investment in Tower Semiconductor Ltd. |       | 780       |       | 780              |       | —           |       | —           |       |
| Total assets                           |       | $         | 17,036     |             | $          | 17,036           |       | $                | —     |   | $ | — |   |

 

As of the end of thethird quarter of 2008, the Company did not have any financial liabilities thatare subject to the provisions of SFAS 157.

 

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**QUICKLOGIC CORPORATION**

**NOTESTO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

 

In February 2007,the FASB issued SFAS 159. SFAS 159 permits companies to choose to measurecertain financial instruments and certain other items at fair value. Thestandard requires that unrealized gains and losses on items for which the fairvalue option has been elected be reported in earnings. SFAS 159 is effectivefor fiscal years beginning after November 15, 2007, although earlieradoption is permitted. Effective December 31, 2007, the Company adoptedthe provisions of SFAS 159.  The adoptionof SFAS 159 did not have an effect on the Company’s financial condition orresults of operations as it did not elect the fair value option.

 

**Note9—Employee Stock Plans**

 

*1989Stock Option Plan*

 

The 1989 Stock OptionPlan (the “1989 Plan”) provided for the issuance of incentive and nonqualifiedoptions for the purchase of up to 4.6 million shares of common stock. Optionsgranted under the 1989 Plan have a term of up to ten years, and typicallyvest at a rate of 25% of the total grant per year over a four year period. In September 1999,the Company adopted the 1999 Stock Plan and no further stock option grants weremade under the 1989 Plan.

 

*1999Stock Plan*

 

The 1999 Stock Plan (the “1999Plan”) was adopted by the Board of Directors in August 1999 and wasapproved by the Company’s stockholders in September 1999. As of September 28,2008, approximately 16.3 million shares were reserved for issuance under the1999 Plan. In addition, each January an annual increase is added to the1999 Plan equal to the lesser of (i) 5,000,000 shares, (ii) 5% of theCompany’s outstanding shares on such date, or (iii) a lesser amountdetermined by the Board of Directors. Equity awards that are cancelled,forfeited or repurchased under the 1989 Plan also become available forgrant under the 1999 Plan. Equity awards granted under the 1999 Planhave a term of up to ten years. Options typically vest at a rate of 25%one year after the vesting commencement date, and one forty-eighth for eachmonth of service thereafter. The Company has implemented a different vestingschedule in the past and may implement different vesting schedules in thefuture with respect to any new equity awards.

 

*EmployeeStock Purchase Plan*

 

The 1999 Employee StockPurchase Plan (“ESPP”) was adopted by the Board of Directors in August 1999and was approved by the Company’s stockholders in September 1999. As of September 28,2008, approximately 7.2 million shares were reserved for issuance underthe ESPP. In addition, each August an annual increase is added to the ESPPequal to the lesser of (i) 1,500,000 shares, (ii) 4% of the Company’soutstanding shares on such date, or (iii) a lesser amount determined bythe Board of Directors.

 

The ESPP, as amended,provides for six month offering periods. Participants purchase shares throughpayroll deductions of up to 20% of an employee’s total compensation (maximum of20,000 shares per offering period). The amended ESPP permits the Board ofDirectors to determine, prior to each offering period, whether participantspurchase shares at: (i) 85% of the fair market value of the common stockat the end of the offering period; or (ii) 85% of the lower of the fairmarket value of the common stock at the beginning or the end of an offeringperiod. The Board of Directors has determined that, until further notice,future offering periods will be made at 85% of the lower of the fair marketvalue of the common stock at the beginning or the end of an offering period.

 

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**QUICKLOGIC CORPORATION**

**NOTESTO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

 

**Note10—Stock-Based Compensation**

 

Theimpact of SFAS 123(R) on the Company’s consolidated financial statementsfor the third quarter and first nine months of 2008 and 2007 was as follows (inthousands):

 
| ** **                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                          | ** ** | **September 28,  2008**     | ** ** | **September 30,  2007**    | ** ** | **September 28,  2008** | ** ** | **September 30,  2007** | ** ** |
| Cost of revenue                     |       | $                                | 49         |                            | $          | 67 |   | $ | 220 |   | $ | 176 |   |
| Research and development            |       | 89                               |       | 94                              |       | 443 |   | 273 |   |
| Selling, general and administrative |       | 251                              |       | 291                             |       | 1,308 |   | 812 |   |
| Total costs and expenses            |       | $                                | 389        |                            | $          | 452 |   | $ | 1,971 |   | $ | 1,261 |   |

 

Theamount of stock-based compensation included in inventories as of September 28,2008 and December 30, 2007 was not material.

 

*ValuationAssumptions*

 

SFAS 123(R) requirescompanies to estimate the fair value of stock-based compensation awards. Thefair value of stock-based compensation awards is measured at the grant date andre-measured upon modification, as appropriate. The Company uses theBlack-Scholes option pricing model to estimate the fair value of stock optionsand rights to purchase shares under the Company’s ESPP, consistent with theprovisions of SFAS 123(R). Using Black-Scholes requires the Company to develophighly subjective assumptions including the expected term of awards, expectedvolatility of its stock, expected risk-free interest rate and expected dividendrate over the term of the award. The Company’s expected term of awardsassumption is based primarily on its historical experience with similar grants.The Company’s expected stock price volatility assumption for both stock optionsand ESPP shares is based on the historical volatility of the Company’s stock,using the daily average of the opening and closing prices and measured usinghistorical data appropriate for the expected life. The risk-free interest rateassumption approximates the risk-free interest rate of a Treasury ConstantMaturity bond with a maturity approximately equal to the expected term of thestock option or ESPP shares. This fair value is expensed over the requisiteservice period of the award. The fair value of restricted stock awards (“RSAs”)and restricted stock units (“RSUs”) is based on the closing price of theCompany’s common stock on the date of grant. Equity compensation awards whichvest with service are expensed using the straight-line attribution method overthe requisite service period. RSU awards which are expected to vest based onthe achievement of a performance goal are expensed over the estimated vestingperiod.

 

In addition to theassumptions used in Black-Scholes, SFAS 123(R) requires that the Companyrecognize expense for awards ultimately expected to vest; therefore we arerequired to develop an estimate of the number of awards expected to beforfeited prior to vesting (“forfeiture rate”). The forfeiture rate isestimated based on historical pre-vest cancellation experience and is appliedto all share-based awards.

 

Thefollowing weighted average assumptions are included in the estimated fair valuecalculations for stock option grants:

 
| ** **              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **September 28,  2008**     | ** ** | **September 30,  2007**    | ** ** | **September 28,  2008** | ** ** | **September 30,  2007** | ** ** |
|                    |       |                             |       |                            |       |   |   |   |   |
| Expected term (years)   |       | 5.00                             |       | 5.07                            |       | 5.62 |   | 5.09 |   |
| Risk-free interest rate |       | 3.11                             | %          | 4.51                            | %          | 2.92 | % | 4.62 | % |
| Expected volatility     |       | 50.68                            | %          | 80.00                           | %          | 52.68 | % | 80.00 | % |
| Expected dividend       |       | —                           |       | —                          |       | — |   | — |   |

 

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**QUICKLOGIC CORPORATION**

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

 

The methodologies fordetermining the above values were as follows:

 

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

 

·                  *Risk-free interestrate:*Therisk-free interest rate assumption is based upon the risk-free rate of aTreasury Constant Maturity bond with a maturity appropriate for the expectedterm of the Company’s employee stock options.

 

·                  *Expected volatility:*The expected volatility is based onhistorical volatility of the Company’s common stock.

 

·                  *Expected dividend:*The expected dividend assumption is basedon the Company’s intent not to issue a dividend under its dividend policy.

 

Theweighted average estimated fair value for options granted during third quarterof 2008 and 2007 was $0.74 and $2.35 per option, respectively. The weightedaverage estimated fair value for options granted during the first nine monthsof 2008 and 2007 was $1.38 and $2.10 per option, respectively. As of the end ofthe third quarter of 2008, the fair value of unvested stock options, net ofexpected forfeitures, was approximately $3.6 million. This unrecognizedstock-based compensation expense is expected to be recorded over a weightedaverage period of approximately 2.6 years.

 

*Stock-BasedCompensation Award Activity*

 

The following tablesummarizes the shares available for grant under the 1989 Plan and the 1999 Planfor the first nine months of 2008:

 
| ** **                                  | ** ** | **Shares  Available for Grant** | ** ** |
|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                  | ** ** | **(in thousands)**                   | ** ** |
| Balance at December 30, 2007           |       | 6,588                                     |       |
| Authorized                                  |       | 1,470                                     |       |
| Options granted                             |       | (248                                      | )          |
| Options forfeited or expired                |       | 1,195                                     |       |
| RSAs granted                                |       | (8                                        | )          |
| RSUs granted                                |       | (339                                      | )          |
| RSUs withheld for employee tax withholdings |       | 109                                       |       |
| RSUs forfeited or expired                   |       | 353                                       |       |
| Balance at September 28, 2008          |       | 9,120                                     |       |

 

*StockOptions*

 

The following tablesummarizes stock options outstanding and stock option activity under the 1989Plan and the 1999 Plan, and the related weighted average exercise price, forthe first nine months of 2008:

 
| ** **                                             | ** ** | **Number of  Shares** | ** ** | **Weighted  Average Exercise  Price** | ** ** | **Weighted  Average  Remaining Term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------|------------|
| ** **                                             | ** ** | **(in thousands)**    | ** ** | ** **                                 | ** ** | **(in years)**                        | ** ** | **(in thousands)**             | ** ** |
| Balance outstanding at December 30, 2007          |       | 7,594                      |       | $                                          | 4.72       |                                       |       |                                |       |   |
| Granted                                                |       | 248                        |       | 2.72                                       |       |                                       |       |                                |       |
| Forfeited or expired                                   |       | (1,195                     | )          | 4.24                                       |       |                                       |       |                                |       |
| Exercised                                              |       | (69                        | )          | 1.57                                       |       |                                       |       |                                |       |
| Balance outstanding at September 28, 2008         |       | 6,578                      |       | $                                          | 4.76       |                                       | 5.45       |                                | $          | — |   |
| Exercisable at September 28, 2008                 |       | 4,792                      |       | $                                          | 5.22       |                                       | 4.22       |                                | $          | — |   |
| Vested and expected to vest at September 28, 2008 |       | 6,106                      |       | $                                          | 4.86       |                                       | 5.20       |                                | $          | — |   |

 

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**QUICKLOGIC CORPORATION**

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

 

The aggregate intrinsicvalue in the table above represents the total pretax intrinsic value based onthe Company’s closing stock price of $1.03 as of the end of the Company’scurrent reporting period, which would have been received by the option holdershad all option holders exercised their options as of that date.

 

The total intrinsic valueof options exercised during the third quarter of 2008 and 2007 was $7,000 and$55,000, respectively. The total intrinsic value of options exercised duringthe first nine months of 2008 and 2007 was $42,000 and $345,000 respectively.

 

*RestrictedStock Awards and Restricted Stock Units*

 

The Company began issuingRSAs and RSUs in 2007. RSAs entitle the holder to purchase shares of commonstock at par value during a short period of time, and purchased shares are heldin escrow until they vest. RSUs entitle the holder to receive, at no cost, onecommon share for each restricted stock unit as it vests. A summary of theCompany’s RSA and RSU activity and related information for the first ninemonths of 2008 follows:

 
| ** **                                                    | ** ** | **RSAs and RSUs Outstanding** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                    | ** ** | **Number of Shares**               | ** ** | **Weighted Average  Grant Date Fair Value** | ** ** |
| ** **                                                    | ** ** | **(in thousands)**                      | ** ** | ** ** | ** ** |
| Nonvested at December 30, 2007                           |       | 937                                          |       | $ | 3.60 |   |
| Granted, net of shares withheld for employee tax withholdings |       | 238                                          |       | 2.14 |   |
| Vested                                                        |       | (186                                         | )          | 2.01 |   |
| Forfeited                                                     |       | (353                                         | )          | 3.57 |   |
| Nonvested at September 28, 2008                          |       | 636                                          |       | $ | 3.55 |   |

 

As of the end of thethird quarter of 2008, the unrecognized stock-based compensation expenserelated to outstanding performance based RSUs, which are not currently expectedto vest, was $2.3 million. The Company will recognize this expense to theextent it determines these performance based RSUs are likely to vest.

 

*EmployeeStock Purchase Plan*

 

The offering periodending May 14, 2007 commenced on January 24, 2007, once the Companyhad completed its stock option review and was current with its filings asrequired by the SEC and Nasdaq. Offering periods beginning May 15, 2007 orlater are standard six month offering periods. Employees participating in theseoffering periods purchase common stock at 85% of the lower of the fair marketvalue of the common stock at the beginning or the end of the offering period.

 

The weighted averageestimated fair value, as defined by SFAS 123(R), of rights issued pursuant tothe Company’s ESPP during the third quarter of 2008 and 2007 was $0.53 and$0.90 per right, respectively. The weighted average estimated fair value, asdefined by SFAS 123(R) of rights issued during the first nine months of2008 and 2007 was $0.53 and $0.88 per right, respectively. For the first ninemonths of 2008, 139,000 shares of common stock were purchased under the ESPP at$1.65 per share.

 

The following weightedaverage assumptions are included in the estimated fair value calculations forrights to purchase stock under the ESPP as of the grant date:

 
| ** **              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **September 28,  2008**     | ** ** | **September 30,  2007**    | ** ** | **September 28,  2008** | ** ** | **September 30,  2007** | ** ** |
|                    |       |                             |       |                            |       |   |   |   |   |
| Expected term (months)  |       | 6.00                             |       | 6.00                            |       | 6.00 |   | 5.10 |   |
| Risk-free interest rate |       | 3.56                             | %          | 5.00                            | %          | 3.56 | % | 5.00 | % |
| Expected volatility     |       | 49.57                            | %          | 55.00                           | %          | 49.57 | % | 55.00 | % |
| Expected dividend       |       | —                           |       | —                          |       | — |   | — |   |

 

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**QUICKLOGIC CORPORATION**

**NOTESTO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

 

The methodologies fordetermining the above values were as follows:

 

·                  *Expected term:*The expected term represents the lengthof the purchase period contained in the ESPP.

 

·                  *Risk-free interestrate:*Therisk-free interest rate assumption is based upon the risk-free rate of aTreasury Constant Maturity bond with a maturity appropriate for the term of thepurchase period.

 

·                  *Expected volatility:*The expected volatility is based onhistorical volatility of the Company’s common stock for the term of thepurchase period.

 

·                  *Expected dividend:*The expected dividend assumption is basedon the Company’s intent not to issue a dividend under its dividend policy.

 

As of the end of thethird quarter of 2008, the unrecognized stock-based compensation expenserelating to the Company’s ESPP was $13,000 and is expected to be recognizedover a weighted average period of approximately 1.5 months.

 

**Note 11—IncomeTaxes**

 

In thethird quarter of 2008, the Company recorded an income tax benefit of $58,000which consisted primarily of a domestic tax benefit from refundable tax creditsnetted with income taxes on foreign operations. In the third quarter of 2007,the Company recorded income tax expense of $29,000 which consisted primarily ofincome taxes on foreign operations. In the first nine months of 2008, theCompany recorded an income tax benefit of $24,000 which consisted primarily ofa domestic tax benefit from refundable tax credits netted with income taxes onforeign operations. In the first nine months of 2007, the Company recordedincome tax expense of $71,000 which consisted primarily of income taxes onforeign operations.

 

Due tothe uncertainties surrounding the realization of the deferred tax assetsresulting from the Company’s accumulated deficit and net tax losses in previousyears, the Company has provided a full valuation allowance against theassociated deferred tax assets. The Company will continue to assess therealizability of the deferred tax assets in future periods.

 

The Company hadapproximately $64,000 and $78,000 of unrecognized tax benefits at September 28,2008 and December 30, 2007, respectively. The total amount of unrecognizedtax benefits that would affect our effective tax rate, if recognized, isapproximately $64,000 as of September 28, 2008. The Company recognizesinterest and penalties related to uncertain tax positions in income taxexpense. As of September 28, 2008, the Company had approximately $7,000 ofaccrued interest and penalties related to uncertain tax positions.

 

The Company is no longersubject to U.S. federal, state and non-U.S. income tax audits by taxingauthorities for fiscal years through 1992. The Company estimates that anyunrecognized tax benefit will not change significantly within the next twelvemonths.

 

**Note 12—Long-LivedAsset Impairment**

 

The Company reviews therecoverability of its long-lived assets annually and when events or changes incircumstances occur that indicate that the carrying value of the asset or assetgroup may not be recoverable. The assessment of possible impairment is based onthe Company’s ability to recover the carrying value of the asset or asset groupfrom expected future pre-tax cash flows, undiscounted and without interestcharges, of the related operations. If these cash flows are less than thecarrying value of such asset, an impairment loss is recognized for the differencebetween estimated fair value and carrying value. The measurement of impairmentrequires management to estimate future cash flows and the fair value oflong-lived assets.

 

The Company did not incurlong-lived asset impairment charges in the third quarter of 2008. During thesecond quarter of 2008, the Company recorded $2.0 million of long-lived assetimpairment charges to cost of revenue for Tower prepaid wafer credits andcertain assets used in production and to operating expenses for EDA software licenses.The Company evaluated the revenue potential of its products based ondiscussions with customers, review of actual sales levels and analysis ofcurrent and future design opportunities. Based on this evaluation, the Companydetermined that the future revenue outlook for products fabricated at Tower waslower than previously expected. Accordingly, the Company performed animpairment analysis on the prepaid wafer credits associated with theseproducts. Factors considered in this analysis included the Company’s salesforecast of products to be manufactured at Tower, the timing and quantity ofplanned wafer purchases and general economic conditions.

 

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**QUICKLOGIC CORPORATION**

**NOTESTO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

 

A preliminary assessment,based on undiscounted cash flows, indicated that these assets were impaired. Inorder to determine the fair value of these assets, which are non-transferrable,the Company performed a probability-weighted assessment of expected wafercredit utilization and related cash flows, discounted using a risk-freeinterest rate. Based on this assessment, the Company recorded a long-livedasset impairment charge of $1.3 million to cost of revenue and reduced thecarrying value of the prepaid wafer credits during the second quarter of 2008.

 

The Company determinedthat equipment used in the production of a particular silicon device wasimpaired based on sales expectations for this device. As a result, the Companyrecorded a long-lived asset impairment charge of $199,000 to cost of revenuefor these assets, and reduced the carrying value of the associated assetsduring the second quarter of 2008.

 

 During the second quarter of 2008 the Companydecided to outsource its physical silicon design activity while retaining corecompetencies in-house. See Note 14. As a result of this decision, the Companydetermined that it had unutilized EDA licenses, recorded a long-lived assetimpairment charge of $468,000 within operating expenses and reduced thecarrying value of the related assets during the second quarter of 2008.

 

**Note 13—InformationConcerning Product Lines, Geographic Information and Revenue Concentration**

 

TheCompany identifies its business segments based on business activities,management responsibility and geographic location. For all periods presented,the Company operated in a single business segment.

 

Thefollowing is a breakdown of revenue by product line (in thousands):

 
| ** **                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                    | ** ** | **September 28,  2008**     | ** ** | **September 30,  2007**    | ** ** | **September 28,  2008** | ** ** | **September 30,  2007** | ** ** |
| *Revenue by product line(1):* |       |                             |       |                            |       |   |   |   |   |
| New products                  |       | $                                | 1,422      |                            | $          | 1,620 |   | $ | 6,584 |   | $ | 2,837 |   |
| Mature products               |       | 4,619                            |       | 4,536                           |       | 13,533 |   | 12,418 |   |
| End-of-life products          |       | 189                              |       | 2,869                           |       | 5,879 |   | 8,417 |   |
| Total revenue                 |       | $                                | 6,230      |                            | $          | 9,025 |   | $ | 25,996 |   | $ | 23,672 |   |

 

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| (1) | For all periods  presented: New products include ArcticLink, PolarPro, EclipseTM II and  QuickPCI® II products; mature products include pASIC®  3, QuickRAM®, Eclipse, QuickDSP and QuickFC products, as well as  royalty revenue, programming hardware and design software; end-of-life  products include pASIC 1, pASIC 2, V3, QuickMIPS and QuickPCI  products. |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Thefollowing is a breakdown of revenue by shipment destination (in thousands):

 
| ** **              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **September 28,  2008**     | ** ** | **September 30,  2007**    | ** ** | **September 28,  2008** | ** ** | **September 30,  2007** | ** ** |
| *Revenue by geography:* |       |                             |       |                            |       |   |   |   |   |
| United States           |       | $                                | 1,955      |                            | $          | 4,133 |   | $ | 9,646 |   | $ | 11,031 |   |
| Europe                  |       | 878                              |       | 1,961                           |       | 4,024 |   | 4,507 |   |
| Taiwan                  |       | 1,306                            |       | 794                             |       | 5,282 |   | 2,152 |   |
| Japan                   |       | 703                              |       | 805                             |       | 2,261 |   | 1,394 |   |
| China                   |       | 711                              |       | 433                             |       | 2,888 |   | 1,234 |   |
| Rest of North America   |       | 87                               |       | 386                             |       | 642 |   | 2,638 |   |
| Rest of Asia Pacific    |       | 590                              |       | 513                             |       | 1,253 |   | 716 |   |
| Total revenue           |       | $                                | 6,230      |                            | $          | 9,025 |   | $ | 25,996 |   | $ | 23,672 |   |

 

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**QUICKLOGIC CORPORATION**

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

 

Thefollowing distributors and customers accounted for 10% or more of the Company’srevenue for the periods presented:

 
| ** **                        | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                        | ** ** | **September 28,  2008**     | ** ** | **September 30,  2007**    | ** ** | **September 28,  2008** | ** ** | **September 30,  2007** | ** ** |
| Distributor “A”         |       | 13                               | %          | 24                              | %          | 14 | % | 22 | % |
| Distributor “B”         |       | 11                               | %          | 16                              | %          | 13 | % | 17 | % |
| Customer “A” – OEM |       | 13                               | %          | *                               |       | 17 | % | 11 | % |
| Customer “B” – OEM |       | 28                               | %          | *                               |       | 18 | % | * |   |

 

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*Represents less than 10% of revenue for the period presented.

 

Thefollowing distributors and customers accounted for 10% or more of the Company’saccounts receivable as of the dates presented:

 
| ** **                        | ** ** | **September 28,  2008** | ** ** | **December 30,  2007** | ** ** |
|-----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Distributor “A”         |       | *                            |       | 31                          | %          |
| Customer “A” – OEM |       | 22                           | %          | 22                          | %          |
| Customer “C” – OEM |       | 13                           | %          | *                           |       |
| Customer “D” – OEM |       | 11                           | %          | *                           |       |
| Customer “E” – OEM |       | 10                           | %          | *                           |       |

 

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*Represents less than 10% of accounts receivable as of the date presented.

 

As of September 28,2008, less than 10% of the Company’s long-lived assets, including property andequipment and other assets, were located outside of the United States.

 

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**QUICKLOGIC CORPORATION**

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

 

**Note 14—RestructuringCharges**

 

In April 2008, theCompany decided to outsource certain development functions that were previouslyperformed in-house. The Company has retained its core competencies and does notexpect this change to have a material impact on its product introductionschedules for 2008. This reorganization resulted in a headcount reduction ofapproximately 13% of employees worldwide. On June 3, 2008, the Company announced the completion of its CSSPfocused operational realignment which included a 17% reduction in headcountworldwide, resulting in a total reduction in worldwide headcount ofapproximately 30%. The purpose of the operational realignment is to lower fixedcosts in order to conserve cash, to reduce the Company’s break-even revenuelevel and enable a quicker return to profitability, to provide optimalprofitability scaling with revenue growth and to provide greater headroom fordiscretionary costs to enable new product revenue growth. In connection withthis decision, the Company recorded a $452,000 restructuring charge foremployee severance benefits in the second quarter of 2008. During the secondand third quarter of 2008, the Company paid $150,000 and $195,000 of thesebenefits, respectively.  As of September 28,2008, the Company has $107,000 of restructuring costs recorded as accruedliabilities on the unaudited consolidated balance sheet and anticipates thatfinal payments will be made by the end of the first quarter in 2009.

 

**Note 15—Commitmentsand Contingencies**

 

Certain of the Company’swafer manufacturers require the Company to forecast wafer starts several monthsin advance. The Company is committed to take delivery of and pay for a portionof forecasted wafer volume. As of September 28, 2008 and December 30,2007, the Company had $2.4 million and $4.3 million, respectively, ofoutstanding commitments for the purchase of wafer inventory.

 

Our principaladministrative, sales, marketing, research and development and final testingfacility is located in a building of approximately 42,600 square feet inSunnyvale, California. During the third quarter of 2008, we extended the leasefor this facility until December 2012. We have sublet approximately 8,000square feet of this facility through March 2009. Our research anddevelopment facility in Toronto, Canada, consisting of approximately 8,400square feet, is leased through February 2010. We lease a 4,500 square footfacility in Bangalore, India for the purpose of software development. Thisfacility is leased through November 2009. We also lease office space inHong Kong, China; Taipei, Taiwan; and London, England. We believe that ourexisting facilities are adequate for our current needs. Total rent expense, netof sublease income, for the third quarter of 2008 and 2007 was approximately$130,000 and $225,000, respectively, and rent expense for the first nine monthsof 2008 and 2007 was approximately $490,000 and $665,000, respectively.

 

**Note 16—Litigation**

 

On October 26, 2001,a putative securities class action was filed in the U.S. District Court for theSouthern District of New York against certain investment banks that underwroteQuickLogic’s initial public offering, QuickLogic and some of QuickLogic’sofficers and directors. The complaint alleges excessive and undisclosedcommissions in connection with the allocation of shares of common stock inQuickLogic’s initial and secondary public offerings and artificially highprices through “tie-in” arrangements which required the underwriters’ customersto buy shares in the aftermarket at pre-determined prices in violation of thefederal securities laws. Plaintiffs seek an unspecified amount of damages onbehalf of persons who purchased QuickLogic’s stock pursuant to the registrationstatements between October 14, 1999 and December 6, 2000. Variousplaintiffs have filed similar actions asserting virtually identical allegationsagainst over 300 other public companies, their underwriters, and their officersand directors arising out of each company’s public offering. These actions,including the action against QuickLogic, have been coordinated for pretrialpurposes and captioned *In re Initial PublicOffering Securities Litigation, 21 MC 92*. In June 2004, astipulation of settlement and release of claims against the issuer defendants,including QuickLogic, was submitted to the court for approval. On August 31,2005, the court preliminarily approved the settlement. In December 2006,the appellate court overturned the certification of classes in the six testcases that 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 would 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 filed amended master allegations and amendedcomplaints, which the defendants in those cases have opposed. On March 26,2008, the Court denied the defendants’ motion to dismiss the amendedcomplaints. If a settlement does not occur and litigation against QuickLogiccontinues, the Company intends to defend the case vigorously.

 

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**QUICKLOGIC CORPORATION**

**NOTESTO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

 

No estimate can be madeof the possible loss or possible range of loss associated with the resolutionof these contingencies and, accordingly, the Company has not recorded aliability.

 

From time to time, theCompany is involved in legal actions arising in the ordinary course ofbusiness, including but not limited to intellectual property infringement andcollection matters. Absolute assurance cannot be given that third partyassertions will be resolved without costly litigation in a manner that is notadverse to the Company’s financial position, results of operations or cashflows or without requiring royalty or other payments in the future which may adverselyimpact gross profit.

 

**Note 17—ShelfRegistration Statement**

 

On July 12,2005, the Company filed a shelf registration statement on Form S-3, whichwas declared effective on July 26, 2005 by the SEC. Under the shelfregistration statement, the Company has the ability to raise up to $30.0million, in one or more transactions, by selling common stock, preferred stock,depositary shares, or warrants. The Company has not raised any funds inconnection with this filing. Under the Securities Offering Reform of 2005, theCompany may offer and sell securities registered under this shelf registrationstatement through November 30, 2008.

 

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**Item2.    Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

 *Thefollowing Management’s Discussion and Analysis of Financial Condition andResults of Operations, as well as information contained in “Risk Factors” in Part II,Item 1A and elsewhere in this Quarterly Report on Form 10-Q, contains “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. We intend that these forward-looking statements be subject to thesafe harbors created by those provisions. Forward-looking statements aregenerally written in the future tense and/or are preceded by words such as “will,”“may,” “should,” “forecast,” “could,” “expect,” “suggest,” “believe,” “anticipate,”“intend,” “plan,” or other similar words. Forward-looking statements includestatements regarding (1) the conversion of our design opportunities intorevenue, (2) our revenue levels, including the commercial success of ourCustomer Specific Standard Products, or**CSSPs, and new products, and the effect of our end-of-life products, (3) ourliquidity, (4) our gross profit and breakeven revenue level andfactors that affect gross profit and the breakeven revenue level, (5) ourlevel of operating expenses, (6) our research and development efforts, (7) ourpartners and suppliers and (8) industry trends. The following discussionshould be read in conjunction with the attached condensed unaudited consolidatedfinancial statements and notes thereto, and with our audited consolidatedfinancial statements and notes thereto for the fiscal year ended December 30,2007, found in our Annual Report on Form 10-K filed with the Securitiesand Exchange Commission, or SEC, on March 11, 2008 and with our condensedunaudited consolidated financial statements and notes thereto for the quartersended March 30, 2008 and June 29, 2008 found in our Quarterly Reportson Form 10-Q filed with the SEC on May 8, 2008 and August 7,2008, respectively.*

 

*Theforward-looking statements contained in this Quarterly Report involve a numberof risks and uncertainties, many of which are outside of our control. Factorsthat could cause actual results to differ materially from projected resultsinclude, but are not limited to, risks associated with (1) the conversionof CSSP design opportunities into revenue, (2) the adverse affects of thecurrent financial crisis (3) the commercial and technical success of ourCSSPs and new products such as ArcticLinkTM and PolarPro®, (4) our abilityto accurately estimate quarterly revenue, (5) the liquidity required tosupport our future operating and capital requirements, (6) our dependenceupon single suppliers to fabricate and assemble our products, (7) ourdependence on our relationship with Tower, and (8) our successfulintroduction of products and CSSPs incorporating emerging technologies orstandards.  Although we believe that theassumptions underlying the forward-looking statements contained in thisQuarterly Report are reasonable, any of the assumptions could be inaccurate,and therefore there can be no assurance that such statements will be accurate.The risks, uncertainties and assumptions referred to above that could cause ourresults to differ materially from the results expressed or implied by suchforward-looking statements include, but are not limited to, those discussedunder the heading “Risk Factors” in Part II, Item 1A hereto and the risks,uncertainties and assumptions discussed from time to time in our other publicfilings and public announcements. All forward-looking statements included inthis document are based on information available to us as of the date hereof.In light of the significant uncertainties inherent in the forward-looking statementsincluded herein, the inclusion of such information should not be regarded as arepresentation by us or any other person that the results or conditionsdescribed in such statements or our objectives and plans will be achieved.Furthermore, past performance in operations and share price is not necessarilyindicative of future performance. We disclaim any intention or obligation toupdate or revise any forward-looking statements, whether as a result of newinformation, future events or otherwise.*

 

**Overview**

 

We are a fablesssemiconductor company that operates in a single industry segment where wedesign, market and support CSSPs, Field Programmable Gate Arrays, or FPGAs,application solutions, associated design software and programming hardware. Ournew product family includes ArcticLink, PolarPro, EclipseTM II and QuickPCI® II;our mature product family includes pASIC® 3, QuickRAM®, Eclipse, QuickDSP andQuickFC, as well as royalty revenue, programming hardware and design software;our end-of-life product family includes pASIC 1, pASIC 2, V3, QuickMIPS andQuickPCI. We develop CSSPs using our ArcticLink and PolarPro solutionplatforms.

 

Customer SpecificStandard Products, or CSSPs, are customer specific complete solutions thatinclude our silicon solution platform, proven system blocks, custom logic andsoftware drivers. Our ArcticLink and PolarPro solution platforms are standardsilicon products and must be programmed to be effective in a system. Our provensystem blocks range from intellectual property, or IP, which improves videoimages to IP which implements commonly used mobile system interfaces, such assecure digital input output, or SDIO, or universal serial bus 2.0 on-the-go, orUSB 2.0 OTG. We provide complete solutions by selecting the appropriate solutionplatform and

 

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**Item 2.    Management’s Discussion and Analysis ofFinancial Condition and Results of Operations — (Continued)**

 

proven system blocks,providing custom logic, integrating logic, programming the device and providingsoftware drivers required for the customers’ application. 

 

CSSPs, which we pioneeredand introduced in the first quarter of 2007, are developed for specific lowpower application markets that have similar differentiated IP, intelligent dataprocessing or connectivity requirements. Target customers value CSSPs for theability to provide a range of products from a single platform and the flexibilityto address specific product requirements. Market leading original equipmentmanufacturers, or OEMs, and original design manufacturers, or ODMs, seek todevelop product platforms from which several products can be introduced. Forexample, multimedia phone companies may plan to introduce products offeringmobile TV, WiMAX, Bluetooth 2.1 and USB 2.0 OTG. These customers value ourability to provide a range of products from a single platform design byincorporating different features in the programmable fabric of our solutionplatforms. Other customers value the flexibility of programmable fabric toaddress specific product requirements. By providing customized solutions forthese customers we increase their ability to meet the time-to-market and time-in-marketpressures associated with their markets. In addition to CSSPs, we sell products to industrial, military and othercustomers who do their own selection and integration of IP cores and addsoftware drivers to their application. We market FPGAs, IP cores and softwaredrivers to these customers, who value the low power consumption, reduceddevelopment risk through the use of proven IP cores, fast time-to-market, highIP security, instant-on and reliability of our devices.

 

This range of offerings allowscustomers to acquire a solution tailored for their needs. Mobile product OEMsand ODMs tend to prefer a complete solution, and purchase CSSPs. Othercustomers with proprietary IP requirements choose to purchase our FPGAs orArcticLink solution platforms and utilize our IP cores as appropriate. Whethera customer uses our CSSPs as a complete solution, or proven IP cores with ourFPGAs, we believe our solutions and products enable system manufacturers toimprove their time-to-market, lower total system power consumption, reducetheir development risk and total cost of ownership, and add features orperformance to their embedded applications.

 

Our CSSPs and the rest ofour product offerings are based on our patented ViaLink® metal-to-metalprogrammable technology. ViaLink is the foundation of our competitive advantagein providing energy efficient devices and solutions that deliver the highperformance, high reliability, IP security and instant-on features that ourcustomers value. Our ViaLink technology allows us to create devices smallerthan competitors’ products on comparable technology, thereby minimizing siliconarea and cost. In addition, our ViaLink technology has lower electricalresistance and capacitance than other programmable technologies and thereforesupports higher signal speed and low power consumption. Our architecture usesour ViaLink technology to maximize interconnects at every routing wireintersection, which allows more paths between logic cells. As a result, systemdesigners are able to use our devices with smaller gate counts to implementtheir designs than if they had used competing FPGAs. The abundance ofinterconnect resources also provides an efficient connection between theApplication Specific Standard Product, or ASSP, and the FPGA portions of CSSPs.

 

We believe that theunderlying attributes of our ViaLink technology, including low powerconsumption, high reliability, design security and design efficiency, enable usto deliver differentiated silicon solutions to our customers.

 

Our CSSPs provide:

 

·                  *Complete FlexibleSolutions –* wepartner with customers to bring their differentiated products to market quicklyand to adapt these products to meet changing market conditions;

 

·                  *Platform DesignCapability*– wepartner with customers to develop a range of solutions from a single hardwareplatform, enabling these manufacturers to bring several products to marketquickly and cost effectively through the use of our programmable fabric;

 

·                  *Reduced Design Expenseand Risk*– weprovide proven system blocks addressing a range of video, network, storage andcustom logic requirements, along with software drivers, thereby reducing thetime and cost of product development;

 

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**Item2.    Management’s Discussion and Analysisof Financial Condition and Results of Operations — (Continued)**

 

·                  *Small Form Factor*– we manufacture single chip solutions inpackages as small as 5x5 millimeters, wafer level, chip scale packaging , or WLCSP,  and known good die;

 

·                  *Energy Efficiency –* our ViaLink technology is the lowestpower consumption full featured programmable logic technology on the markettoday, allowing the time-to-market and time-in-market advantages ofprogrammable logic for differentiated mobile products;

 

·                  *Low Total Cost ofOwnership –* CSSPsreduce time-to-market and lower the risk and expense associated with newproduct development. In platform designs these savings are leveraged overseveral products. The flexible nature of CSSPs enables new features in existingdesigns, which can be used to extend time-in-market and delay the cost of newproduct development. In addition, CSSPs often reduce bill of materials, or BOM,costs by combining the function of several ASSPs into one cost effectivedevice; a simplified BOM also leads to lower printed circuit board, or PCB,costs;

 

·                  *Instant-on –* our products are live at power upbecause ViaLink based products require no configuration bit stream;

 

·                  *High Reliability –* ViaLink based products do not rely on aSRAM cell that is susceptible to alpha particles, or brownouts, to define andmaintain their functionality; and

 

·                  *Unmatched IP Security –* our ViaLink technology makes itvirtually impossible to clone or reverse engineer designs implemented in ourprogrammable fabric.

 

We offer a range of CSSPsbuilt on our PolarPro and ArcticLink solutions platforms. Our PolarProarchitecture provides low power consumption and a cost effective device forpure digital applications. CSSPs developed using our PolarPro solutionimplement proven system blocks and custom logic in programmable fabric. Basedon our engineering analysis of portable media player applications, we believedesigners using PolarPro can extend battery life by as much as four times ascompared to a standard product implementation, setting a new standard for lowpower consumption through the use of programmable logic.

 

We started shipping CSSPsbased on our ArcticLink architecture in 2007. ArcticLink solution platformscombine mixed signal physical layers, hard-wired logic and programmable fabricon one device. Mixed signal capability supports the trend toward serialconnectivity in mobile applications, where designers benefit from lower pincounts, simplified PCB layout, lower cost PCB interconnect and reduced signalnoise. Adding hard-wired IP enables us to deliver more logic per die area,while the programmable fabric allows us to provide CSSPs that can be rapidlycustomized to differentiate products, add features and reduce systemdevelopment costs. Market leading companies seek to develop product platformsfrom which several products can be introduced. This combination of mixed signalphysical layer, hard-wired logic and programmable fabric enables us to deliverlow cost, small form factor solutions that can be customized for a particularcustomer or market requirements.

 

We are marketing CSSPs toOEMs and ODMs offering differentiated mobile products. Our target mobilemarkets include:

 

·                  *Cellular –* including multimedia and smartphones;

 

·                  *Consumer Electronics –* including personal media players, orPMPs, personal navigation devices, or PNDs, and wireless hard disk drives orwireless storage devices; and

 

·                  *Computing –* including ultra mobile PCs, or UMPCs,mobile internet devices, or MIDS, industrial personal digital assistants, orPDAs, handheld point-of-sales, or POS, terminals and broadband data cards.

 

Examples of how existingand potential customers benefit from CSSPs are:

 

·                  *Multimedia Phones*– we have been marketing our recentlyannounced Visual Enhancement Engine, or VEETM, a proven system block built uponan IP core we licensed, to enable improved video image, color, contrast andresolution with longer battery life;

 

·                  *Smartphones –* our solutions enable the simultaneousdisplay of video on the handset and an external display;

 

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**Item2.    Management’s Discussion and Analysisof Financial Condition and Results of Operations — (Continued)**

 

·                  *Personal NavigationDevices –*oursolutions allow the incorporation of the latest storage technology, managedNAND, and access to the latest high capacity SD cards and SDIO basedperipherals;

 

·                  *Portable Media Players* –our solutions allow a processor toaccess and efficiently control a micro hard disk drive;

 

·                  *Wireless Hard DiskDrives –*oursolutions allow for the intelligent transfer of data, which improves the datatransfer rate, virtually eliminates the CPU cycles associated with datatransfer and improves battery life;

 

·                  *Handheld POS Terminals –*our solutions enable high speedconnectivity to Wi-Fi and BlueTooth chipsets as well as storage connectivity;and

 

·                  *Cellular Data Cards –*our solutions provide the lowest powerinterface between a cellular radio and a laptop card slot.

 

Our CSSPs and newproducts are also being designed into applications in our traditional markets,such as data communications, instrumentation and test, and military-aerospace,where customers value the low power consumption, instant-on, IP security,reliability and fast time-to-market of our products.

 

In addition to workingdirectly with our customers, we partner with other technology companies todevelop additional intellectual property, reference platforms and systemsoftware to provide application solutions. We partner with companies that areexperts in certain technologies. For instance, we licensed elements of our VEEtechnology from Apical Limited, a U.K. company that markets enhanced videoimage capability to companies such as Nikon, Olympus and Sony Ericsson. We alsowork with processor manufacturers, such as Marvell Technology Group Ltd., andcompanies that supply storage, networking or graphics components for embeddedsystems. The depth of these relationships varies depending on the partner andthe dynamics of the end market being targeted, but is typically a co-marketingprogram that includes joint account calls, promotional activities and/orengineering collaboration, such as reference designs.

 

Wesell programmed and unprogrammed products through distributors and directly toOEMs. We recognize revenue at the time of shipment of products directly tosystem manufacturers. However, we have historically sold a significant portionof our products through distributors who earn a negotiated margin on the saleof our products and who have stock rotation and price protection privileges. Wedefer recognition of income from sales of unprogrammed products to thesedistributors, other than end-of-life products, until after they have sold ourproducts to systems manufacturers. During the third quarter of 2008, we changedour standard distribution agreement from a sell-through to a sell-in model andbegan to enter into new agreements with our distributors. Under theseagreements all products are sold to the distributor at fixed prices withoutreturn or price adjustment privileges. We expect to complete the process ofmoving all of our distributors to the new agreement by the first quarter of2009. We recognize revenue on programmed products and certain unprogrammedproducts, for which the price is fixed or determinable and there are no returnprivileges, at the time of shipment to our distributors. During the first ninemonths of 2008 and 2007, approximately 70% and 60%, respectively, of the unitsshipped to our distributors were programmed by us and, accordingly, are notreturnable. The percentage of sales derived through distributors was 50% and60% during the first nine months of 2008 and 2007, respectively.

 

Twodistributors, Avnet, Inc. and Future Electronics, accounted for 14% and13% of revenue in the first nine months of 2008. These distributors accountedfor 22% and 17% of revenue in the first nine months of 2007. We anticipate thata limited number of distributors will continue to account for a significantportion of our revenue and that individual distributors could account for alarger portion of our revenue.

 

Ourinternational sales were 63% and 53% of our revenue in the first nine months of2008 and 2007, respectively. We expect that revenue from sales to internationalcustomers will continue to represent a significant portion of our revenue. Allof our sales originate in the United States and are denominated in U.S.dollars.

 

We outsource the wafermanufacturing, assembly and testing of all of our products. We currently relyupon Taiwan Semiconductor Manufacturing Company Ltd., or TSMC, Tower, KawasakiMicroelectronics, Inc. and Samsung Semiconductor, Inc. to manufactureour products, and we rely upon Amkor Technology, Inc. and Unisem

 

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**Item2.    Management’s Discussion and Analysisof Financial Condition and Results of Operations — (Continued)**

 

(M) Berhad toassemble, test and program our products. Our wafer suppliers’ lead times areoften as long as three months and sometimes longer. In addition, Tower requiresus to provide them with a monthly wafer start forecast. Under the terms of ouragreement with Tower, our ability to increase or decrease our wafer forecast islimited and we are committed to take delivery of and pay for a minimum portionof the forecasted wafer volume. Our long manufacturing cycle times are at oddswith our customers’ desire for short delivery lead times and, as a result, wetypically purchase wafers based on our internal forecasts of customer demand.

 

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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 percentage ofrevenue for certain items in our statements of operations for the periodsindicated:

 
| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **September 28,  2008**     | ** ** | **September 30,  2007**    | ** ** | **September 28,  2008** | ** ** | **September 30,  2007** | ** ** |
| Revenue                                          |       | 100.0                            | %          | 100.0                           | %          | 100.0 | % | 100.0 | % |
| Cost of revenue (1)                              |       | 44.6                             |       | 47.8                            |       | 46.2 |   | 57.8 |   |
| Long-lived asset impairment                      |       | —                           |       | —                          |       | 6.0 |   | — |   |
| Gross profit                                     |       | 55.4                             |       | 52.2                            |       | 47.8 |   | 42.2 |   |
| Operating expenses:                              |       |                             |       |                            |       |   |   |   |   |
| Research and development                         |       | 21.7                             |       | 26.0                            |       | 26.1 |   | 29.4 |   |
| Selling, general and administrative              |       | 42.8                             |       | 43.7                            |       | 42.2 |   | 54.7 |   |
| Long-lived asset impairment                      |       | —                           |       | —                          |       | 1.8 |   | — |   |
| Restructuring costs                              |       | —                           |       | —                          |       | 1.7 |   | — |   |
| Loss from operations                             |       | (9.1                             | )          | (17.5                           | )          | (24.0 | ) | (41.9 | ) |
| Write-down of marketable securities              |       | —                           |       | —                          |       | (1.6 | ) | — |   |
| Interest expense                                 |       | (1.0                             | )          | (0.8                            | )          | (0.8 | ) | (1.0 | ) |
| Interest income and other, net                   |       | (0.7                             | )          | 2.1                             |       | 0.4 |   | 3.2 |   |
| Loss before income taxes                         |       | (10.8                            | )          | (16.2                           | )          | (26.0 | ) | (39.7 | ) |
| Provision for (benefit from) income taxes        |       | (0.9                             | )          | 0.3                             |       | (0.1 | ) | 0.3 |   |
| Net loss                                         |       | (9.9                             | )%         | (16.5                           | )%         | (25.9 | )% | (40.0 | )% |
|                                             |       |                             |       |                            |       |   |   |   |   |
|                                             |       | **Three Months Ended** |       | **Nine Months Ended** |       |
|                                             |       | **September 28,  2008**     | ** ** | **September 30,  2007**    | ** ** | **September 28,  2008** | ** ** | **September 30,  2007** |   |
| Revenue by product line (2) (in thousands): |       |                             |       |                            |       |   |   |   |   |
| New products                                     |       | $                                | 1,422      |                            | $          | 1,620 |   | $ | 6,584 |   | $ | 2,837 |   |
| Mature products                                  |       | 4,619                            |       | 4,536                           |       | 13,533 |   | 12,418 |   |
| End-of-life products                             |       | 189                              |       | 2,869                           |       | 5,879 |   | 8,417 |   |
| Total revenue                                    |       | $                                | 6,230      |                            | $          | 9,025 |   | $ | 25,996 |   | $ | 23,672 |   |

 

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(1) The third quarter of 2008 and 2007 includes$203,000 and $309,000 of costs for the write-down of inventories and relatedcharges, which represents 3.3% and 3.4% of revenue, respectively. The firstnine months of 2008 and 2007 includes $1.3 million and $3.5 million of costsfor the write-down of inventories and related charges, which represents 5.1%and 14.9% of revenue, respectively.

 

(2) For all periods presented:  New products include ArcticLink, PolarPro,Eclipse II and QuickPCI II products; mature products include pASIC 3, QuickRAM,Eclipse, QuickDSP and QuickFC products, as well as royalty revenue, programminghardware and design software; end-of-life products include pASIC 1,pASIC 2, V3, QuickMIPS and QuickPCI products.

 

**Three Months Ended September 28, 2008 and September 30,2007**

 

*Revenue.*  Our revenue for the third quarterof 2008 was $6.2 million, representing a decline of approximately $2.8million, or 31.0%, from revenue of $9.0 million in the third quarter of2007. The decline in revenue is primarily due to a decrease in demand forend-of-life products, which declined by $2.7 million compared with the thirdquarter of 2007. New product revenue declined by $200,000 compared with thethird quarter of 2007; lower demand for Eclipse II products was partiallyoffset by higher demand for PolarPro and ArcticLink products. Our matureproduct revenue increased by $80,000 compared with the third quarter of 2007. APND manufacturer contributed 13% and 5% of total revenue in the third quarterof 2008 and 2007, respectively. A worldwide customer purchasing primarily pASIC3 devices contributed 28% and 9% of total revenue in the third quarter of 2008and 2007, respectively.

 

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**Item 2.    Management’sDiscussion and Analysis of Financial Condition and Results of Operations —(Continued)**

 

Ourrevenue for the third quarter of 2008 was 28.7% lower sequentially, decreasingby approximately $2.5 million to $6.2 million from $8.7 million in thesecond quarter of 2008. This sequential revenue decline was primarily due to ananticipated $1.4 million decline in end-of-life product revenue. New productrevenue also decreased by $1.1 million sequentially due to an anticipated $1.1million decrease in demand from a large PND OEM customer. This decrease indemand resulted from the late stage of their product life cycle. End-of-lifeproducts contributed $189,000 of revenue in the third quarter. Revenue fromthese products is expected to fluctuate and contribute less than 10% of totalquarterly revenue.

 

Wecontinue to seek to expand our revenue, including the pursuit of high volumesales opportunities in the consumer market segment, by providing CSSPsincorporating intellectual property such as VEE and boot from managed NAND, orindustry standard interfaces such as USB 2.0 OTG, SDIO and integrated driveelectronics, or IDE. Our industry is characterized by intense price competitionand by lower margins as order volumes increase. While winning large volumesales opportunities will increase our revenue, we believe these opportunitiesmay decrease our gross profit as a percentage of revenue.

 

*Gross Profit*.  Gross profit was $3.5 million and $4.7 million in thethird quarter of 2008 and 2007, respectively, which represented 55.4% and 52.2%of revenue for those periods. The $1.3 million decline in gross profit wasprimarily due to lower revenue and product mix, which decreased gross profit by$1.4 million, offset by $100,000 of lower charges for the write-down of inventories.

 

*Research and Development Expense.*  Research and development expensewas $1.4 million and $2.3 million in the third quarter of 2008 and2007, respectively, which represented 21.7% and 26.0% of revenue for thoseperiods. The decrease of approximately $1.0 million was primarily due tosavings associated with the operational realignment that we undertook in thesecond quarter of 2008. This change reduced cash compensation costs by $500,000and depreciation by $90,000 compared with the third quarter of 2007. Inaddition, project expenses were $160,000 lower compared with the third quarterof 2007 due primarily to a delay in the start of a new project.

 

Inthe second quarter of 2008, we implemented a plan to outsource certaindevelopment functions that were previously performed in-house. Moving certaindevelopment activities to an on-demand, outsourced model from an in-house,fixed cost model resulted in a reduction in our research and developmentstaffing in Toronto, Canada. We also reduced other development expenses in thesecond quarter as we realigned resources throughout the Company with ourexpected revenue outlook. We retained our core competencies and do not expectthis change to have a material adverse impact on our product introductionschedules for the remainder of 2008. We believe this realignment of resourceswill lower our development expense per project, lower fixed costs, reduce ourcash consumption and lower our break-even revenue level, enable a more rapidreturn to profitability and profit scalability, and allow room fordiscretionary spending in response to market demands. Our project expenses,which typically include the purchase of intellectual property, prototype costsand outsourced research and development activity, were less than $100,000 inthe third quarter of 2008. We believe that investments in product andintellectual property development, including project expenses, are essentialfor us to remain competitive in the markets we serve. We expect that ourdevelopment efforts will allow us to expand our product and solution offerings,increase our revenue and provide additional value to our customers andstockholders.

 

*Selling, General andAdministrative Expense.*  Selling,general and administrative expense was $2.7 million and $4.0 millionfor the third quarter of 2008 and 2007, respectively, which represented 42.8%and 43.7% of revenue for those periods. The decrease of approximately $1.3million in selling, general and administrative expense was primarily due to a$600,000 decrease in cash compensation expenses and a $700,000 decrease inoutside service expenses such as consulting, temporary help, sales commissions,and legal expenses.

 

*Interest Expense.*  Interest expense of $59,000 inthe third quarter of 2008 was flat compared with $69,000 in the third quarterof 2007.

 

*Interest Income and Other, Net.*  Interest income and other, netdecreased to $46,000 of expense for the third quarter of 2008 as compared to$189,000 of income for the third quarter of 2007. The $235,000 decrease in interestincome and other, net is primarily due to decreased interest income received asa result of lower average cash balances and interest rates and foreign exchangelosses.

 

*Provision for Income Taxes.*  For the third quarter of 2008 and2007, we incurred a loss before income taxes of $673,000 and $1.5 million,respectively. We recorded a benefit from income taxes of $58,000 in the thirdquarter 

 

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**Item 2.    Management’sDiscussion and Analysis of Financial Condition and Results of Operations —(Continued)**

 

of2008 due primarily to a domestic tax benefit from refundable tax credits nettedwith income taxes on foreign operations. We recorded a provision for incometaxes of $29,000 for the third quarter of 2007 which consisted primarily ofincome taxes on foreign operations. Our ability to utilize our income tax losscarryforwards in future periods is uncertain and, accordingly, we recorded afull valuation allowance against the related tax benefit. We will continue toassess the realizability of deferred tax assets in future periods.

 

*Stock-Based Compensation.*  For the third quarter of 2008 and2007, stock-based compensation totaled $389,000 and $452,000, respectively, andwas included in the statements of operations as follows (in thousands):

 
| ** **                          | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **September 28,  2008**     | ** ** | **September 30,  2007** | ** ** |
|                                |       |                             |       |   |   |
| Cost of revenue                     |       | $                                | 49         |   | $ | 67 |   |
| Research and development            |       | 89                               |       | 94 |   |
| Selling, general and administrative |       | 251                              |       | 291 |   |
| Total                               |       | $                                | 389        |   | $ | 452 |   |

 

Theamount of stock-based compensation included in inventories at the end of thethird quarter of 2008 and 2007 was not material.

 

**Nine Months Ended September 28, 2008 and September 30,2007**

 

*Revenue.*  Our revenue for the first ninemonths of 2008 was $26.0 million, representing an increase of$2.3 million, or 9.8%, from revenue of $23.7 million in the firstnine months of 2007. Revenue from new products increased $3.7 million, or 132%,due to $4.1 million of higher demand in Asia from a PND manufacturer thatpurchases CSSPs based on our PolarPro solution platform. Mature product revenueincreased $1.1 million compared with the first nine months of 2007 dueprimarily to higher demand for pASIC 3 products. Revenue from end-of-lifeproducts declined by $2.5 million compared with 2007 due to the timing of endof life purchases.

 

*Gross Profit*.  Gross profit was $12.4 million and $10.0 million in thefirst nine months of 2008 and 2007, respectively, which represented 47.8% and42.2% of revenue for those periods. The $2.5 million increase in grossprofit was primarily due to $2.2 million of lower charges for inventoryreserves, $1.1 million due to higher revenue and product mix, and $1.1 millionfor lower unabsorbed overhead costs, partially offset by a $1.5 millionlong-lived asset impairment charge associated with the write-down of prepaidwafer credits and certain assets used in production and by higher purchaseprice variances. During the first nine months of 2008, the Company recordedinventory related charges totaling $1.3 million, or 5.1% of revenue, primarilyfor excess quantities due to a reduction in expected demand for inventories onhand, and cost of revenue was reduced by $440,000, or 1.7% of revenue, throughthe sale of inventories that were previously written down.

 

*Research and Development Expense.*  Research and development expensewas $6.8 million and $7.0 million for the first nine months of 2008and 2007, respectively, which represented 26.1% and 29.4% of revenue for thoseperiods. The decrease of $180,000 was primarily due to $520,000 of lower cashcompensation costs, partially offset by $280,000 of higher project relatedexpenses.

 

*Selling, General and AdministrativeExpense.*  Selling,general and administrative expense was $11.0 million and$12.9 million for the first nine months of 2008 and 2007, respectively,which represented 42.2% and 54.7% of revenue for those periods. The $2.0million decrease in selling, general and administrative expense was primarilydue to $1.2 million of lower expense for outside services including legal,recruiting, consulting and temporary help, $1.0 million of lower cashcompensation expense and lower depreciation expense of $220,000, partiallyoffset by $470,000 of higher stock based compensation expense.

 

*Long-Lived Asset Impairment.*  In the second quarter of 2008, werecorded a $468,000 long-lived asset impairment charge to operating expenses asa result of our decision to outsource design implementation activity, whichresulted in unutilized EDA software licenses.

 

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**Item 2.    Management’sDiscussion and Analysis of Financial Condition and Results of Operations —(Continued)**

 

*Restructuring Costs.*  In the second quarter of 2008, wereduced our worldwide headcount by approximately 30% in order to lower fixedcosts; enable a lower break-even revenue level and optimal profitabilityscaling with revenue growth and provide greater headroom for discretionarycosts, resulting in improved agility to pursue CSSP and new product marketopportunities and conservation of cash by reducing operating expenses, andenabling a quicker return to profitability. In connection with this decision,we recorded a $452,000 restructuring charge for employee severance benefits;these benefits are expected to be paid by the end of the first quarter of 2009.

 

*Write-down of Marketable Securities.*  In the second quarter of 2008, wedetermined that our investment in Tower had suffered a decline in value thatwas “other than temporary.” This determination included factors such as marketvalue and the period of time that the market value has been below the carryingvalue. Accordingly, we recorded a write-down of $417,000 in the second quarterof 2008 based on the quoted market price of the stock on the last day of thereporting period. As a result of this write-down, the carrying value of theTower ordinary shares was $0.86 per share as of the end of the second quarterof 2008. The market value of Tower ordinary shares declined to $0.58 per shareas of September 28, 2008, and the market value was $0.22 per share on October 31,2008. If the value per share remains below $0.86 at the end of our fiscalfourth quarter, we may incur a charge for the “other than temporary” decline inmarket value since June 28, 2008.

 

*Interest Expense.*  Interest expense decreased to $202,000 for the first ninemonths of 2008 as compared to $226,000 for the first nine months of2007. This $24,000 decline was primarily due to lower interest rates.

 

*Interest Income and Other, Net.*  Interest income and other, netdecreased to $88,000 of income for the first nine months of 2008 as compared to$752,000 of income for the first nine months of 2007. The $664,000 decrease ininterest income and other, net is primarily due to decreased interest incomeresulting from lower average cash balances and lower interest rates.

 

*Provision for Income Taxes.*  For the first nine months of 2008and 2007, we incurred a loss before income taxes of $6.8 million and $9.4million, respectively. We recorded a benefit from income taxes of $24,000 inthe first nine months of 2008 due primarily to a domestic tax benefit fromrefundable tax credits netted with income taxes on foreign operations.  We recorded a provision for income taxes of$71,000 for the first nine months of 2007, which consisted primarily of incometaxes on foreign operations.

 

*Stock-Based Compensation.*  For the first nine months of 2008and 2007, stock-based compensation totaled $2.0 million and $1.3 million,respectively, and was included in the statements of operations as follows (inthousands):

 
| ** **                          | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------|------------|---------------------------------|------------|
| ** **                          | ** ** | **September 28,  2008**    | ** ** | **September 30,  2007** | ** ** |
|                                |       |                            |       |   |   |
| Cost of revenue                     |       | $                               | 220        |   | $ | 176 |   |
| Research and development            |       | 443                             |       | 273 |   |
| Selling, general and administrative |       | 1,308                           |       | 812 |   |
| Total                               |       | $                               | 1,971      |   | $ | 1,261 |   |

 

Theincrease in stock-based compensation was primarily due to the issuance of fullyvested restricted stock units, or RSUs, in lieu of cash compensation in thesecond quarter of 2008. Total stock-based compensation related to fully vestedRSUs was $570,000 for the first nine months of 2008.

 

##### **Liquidity and Capital Resources**

#####  

Wehave financed our operating losses and capital investments through sales ofcommon stock, private equity investments, capital and operating leases, banklines of credit and cash flow from operations. As of September 28, 2008,our principal sources of liquidity consisted of our cash and cash equivalentsof $18.8 million, available credit under our revolving line of credit withSilicon Valley Bank of approximately $4.0 million, and our investment inTower with a market value of approximately $780,000. We intend to hold 450,000shares in Tower, valued at $261,000 as of the end of the third quarter of 2008,in order to obtain preferred wafer pricing from Tower. Pursuant 

 

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**Item 2.    Management’sDiscussion and Analysis of Financial Condition and Results of Operations —(Continued)**

 

toSFAS 157, the fair value of our cash equivalents and marketable securities asof September 28, 2008 was determined based on “Level 1” inputs asdescribed in Note 8 to our consolidated financial statements.

 

Asof September 28, 2008, our interest-bearing debt consisted of$2.0 million of revolving debt outstanding from Silicon Valley Bank and$950,000 outstanding under capital leases. The term of the revolving debtfacility runs until June 2010. Our accumulated deficit was$145.4 million as of September 28, 2008. Capital expenditures, whichare largely driven by the development of new products and manufacturingactivity, could be up to $1.2 million in the next twelve months.

 

OnAugust 13, 2008, we entered into a Fourth Amendment to Second AmendedRestated Loan and Security Agreement (the “Agreement”) with Silicon ValleyBank. The amended facility includes a $6.0 million revolving line of creditthat is available until June 2010. Advances under the line of credit maybe either prime rate plus one percent advances, which accrue interest at avariable interest rate of the prime rate plus one percent, or fixed rateadvances, which earn interest at LIBOR plus 3.5%. Prime rate plus one percentadvances may be prepaid without penalty, and the Company pays interest at arate of 0.25% for the unused portion of its line of credit. As of September 28,2008, the Company has $2.0 million of prime rate plus one percent advancesunder the line of credit, which are classified as a short term liability on thebalance sheets. The bank has a first priority security interest onsubstantially all of our tangible and intangible assets to secure anyoutstanding amounts under the agreement. Under the terms of the agreement, wemust maintain a minimum tangible net worth and an adjusted quick ratio. Theagreement also has certain restrictions including, among others, the incurrenceof other indebtedness, the maintenance of depository accounts, the dispositionof assets, mergers, acquisitions, the granting of liens and the payment ofdividends. We were in compliance with all loan covenants as of the end of thecurrent reporting period.

 

Duringthe third quarter of 2008, the Company repaid notes payable of $2.5 millionand, as noted above, borrowed $2.0 million of revolving debt through a primerate plus one percent advance under its revolving line of credit.  At June 29, 2008, the prior line ofcredit terms included a $5.0 million revolving line of credit, $870,000 ofborrowing capacity under an equipment line of credit that could be drawnthrough July 31, 2008, and a waiver of the tangible net worth covenant throughJuly 31, 2008. In July 2008, the Company entered into a thirdamendment to the loan and security agreement to extend the available draw dateand waive the tangible net worth covenant through August 31, 2008.

 

*Net cash from operating activities*

 

Operating activitiesprovided $451,000 of cash and used $2.3 million of cash in the first ninemonths of 2008 and 2007, respectively. The primary reason for the $2.8improvement in cash flow from operations was a $2.7 million reduction in ournet loss. The adjustments to reconcile net loss to net cash provided by (usedfor) operating activities totaled $7.8 million in both the first nine months of2008 and 2007. Changes in working capital used cash of $606,000 and $688,000 inthe first nine months of 2008 and 2007, respectively.

 

Netcash provided by operating activities was $451,000 in the first nine months of2008. The Company’s net loss of $6.7 million, excluding non-cash charges of$7.8 million, provided $1.1 million of cash flow. This was reduced by $606,000for changes in working capital accounts. The non-cash charges included $2.0million of long-lived asset impairment, stock-based compensation of $2.0million, depreciation and amortization of $1.7 million, write-down ofinventories of $1.3 million, write-down of marketable securities of $417,000and decrease in wafer credits of $254,000. Changes in working capital accounts used cash as a result of a decreasein accounts payable of $2.7 million due to timing of expenditures and purchasesof inventories and a decrease in deferred income and royalty revenue of$708,000. These cash uses were partially offset by a decrease in inventories of$2.0 million, a decrease in other assets of $725,000 and a decrease in accountsreceivable of $311,000.

 

Net cash used for operating activities was $2.3million for the first nine months of 2007. The cash used for operatingactivities resulted primarily from a net loss of $9.5 million, which included$7.8 million of non-cash charges including write-down of inventories of $3.5million, depreciation and amortization of $2.3 million, stock-basedcompensation of $1.3 million, and a decrease in wafer credits of $681,000 andbad debt reserves of $163,000. In addition, changes in working capital accountsused cash in the amount of $688,000 primarily as a result of a $2.0 milliondecrease in accounts payable due to timing of expenditures and purchases ofinventories and a $405,000 decrease in deferred income and royalty revenue dueprimarily to royalty revenue recognized under the Aeroflex 

 

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**Item 2.    Management’s Discussion and Analysis ofFinancial Condition and Results of Operations — (Continued)**

 

agreement.These uses of cash were partially offset by a $714,000 decrease in other assetsand $693,000 decrease in inventories.

 

*Net cash from investing activities*

 

Netcash used for investing activities for the first nine months of 2008 and 2007was $541,000 and $926,000, respectively, as a result of capital expendituresmade primarily to acquire equipment and software used in the development andproduction of our products and solutions.

 

*Net cash from financing activities*

 

Net cash used for financing activities was $1.9million for the first nine months of 2008, resulting from payments of $4.1million under the terms of our debt and capital lease obligations, partiallyoffset by $2.0 million in proceeds from the revolving line of credit and $129,000in proceeds related to the issuance of common shares to employees under ourequity plans.

 

Net cash used for financing activities was $539,000for the first nine months of 2007, resulting from scheduled payments of $1.9million under the terms of our debt and capital lease obligations, partiallyoffset by $915,000 in proceeds related to the issuance of common shares toemployees under our equity plans and $442,000 in proceeds from borrowings underour equipment line of credit.

 

Werequire substantial cash to fund our business, particularly to finance ouroperations, to acquire property and equipment, for the repayment of debt andfor working capital requirements. Our future liquidity will depend on manyfactors such as these, as well as our level of revenue and gross profit, marketacceptance of our existing and new products, the decline in revenue underend-of-life programs, wafer purchase commitments, the amount and timing ofresearch and development expenditures, the timing of new product introductions,production volumes, the quality of our products, sales and marketing efforts,the capital preservation and liquidity of our investment portfolio, our abilityto obtain debt financing and to remain in compliance with the terms of ourcredit facilities, our ability to raise funds from the sale of Tower shares andequity in the Company, the exercise of employee stock options and participationin our employee stock purchase plan, and other factors related to theuncertainties of the industry and global economics. However, we believe thatour existing cash resources will be sufficient to fund operations, capitalexpenditures of up to $1.2 million, and provide adequate working capitalfor at least the next twelve months. As our liquidity is affected by many factorsas mentioned above and as discussed in our “Risk Factors” section, there can beno assurance that we will not seek additional capital during the next twelvemonths or that such capital will be available on terms acceptable to us.

 

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**Item 2.    Management’sDiscussion and Analysis of Financial Condition and Results of Operations —(Continued)**

 

**Contractual Obligations and Commercial Commitments**

 

Thefollowing table summarizes our contractual obligations and commercialcommitments as of September 28, 2008 and the effect such obligations andcommitments are expected to have on our liquidity and cash flows in futurefiscal periods (in thousands):

 
| ** **                                                    | ** ** | **Payments Due by Period** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                    | ** ** | **Total**                                 | ** ** | **Less than  1 Year** | ** ** | **1-3  Years** | ** ** | **More than  3 Years** | ** ** |
|                                                          |       |                                      |       |   |   |   |   |   |   |
| *Contractual cash obligations:*                               |       |                                      |       |   |   |   |   |   |   |
| Operating leases                                              |       | $                                         | 1,920      |   | $ | 587 |   | $ | 838 |   | $ | 495 |   |
| Wafer purchases (1)                                           |       | 2,435                                     |       | 2,435 |   | — |   | — |   |
| Other purchase commitments                                    |       | 979                                       |       | 979 |   | — |   | — |   |
| *Total contractual cash obligations*                          |       | 5,334                                     |       | 4,001 |   | 838 |   | 495 |   |
|                                                          |       |                                      |       |   |   |   |   |   |   |
| *Other commercial commitments*(2):                            |       |                                      |       |   |   |   |   |   |   |
| Revolving line of credit                                      |       | 2,000                                     |       | 2,000 |   | — |   | — |   |
| Capital lease obligations                                     |       | 950                                       |       | 764 |   | 186 |   | — |   |
| *Total commercial commitments*                                |       | 2,950                                     |       | 2,764 |   | 186 |   | — |   |
| Total contractual obligations and  commercial commitments (3) |       | $                                         | 8,284      |   | $ | 6,765 |   | $ | 1,024 |   | $ | 495 |   |

 

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| (1)    | Certain of our wafer manufacturers require us to forecast wafer  starts several months in advance. We are committed to take delivery of and  pay for a portion of forecasted wafer volume. Wafer purchase commitments of  $2.4 million include both firm purchase commitments and a portion of our  forecasted wafer starts as of September 28, 2008. |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                            |
| (2)    | Other commercial commitments are included as liabilities on our  balance sheet as of September 28, 2008.                                                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                                            |
| (3)    | Does not include unrecognized tax benefits of $64,000 as of  September 28, 2008.                                                                                                                                                                                                                                                                           |

 

**Off-Balance Sheet Arrangements**

 

Wedo not maintain any off-balance sheet partnerships, arrangements or otherrelationships with unconsolidated entities or others, often referred to asstructured finance or special purpose entities, which are established for thepurpose of facilitating off-balance sheet arrangements or other contractuallynarrow or limited purposes.

 

**Recently Issued Accounting Pronouncements**

 

InOctober 2008, the Financial Accounting Standards Board, or (“FASB”),  issued FSP No. 157-3, “*Determining the Fair Value of a Financial Asset Whenthe Market for That Asset is Not Active”,*FSP No. 157-3clarifies the application of SFAS No. 157, which we adopted as of December 31,2007, in cases where a market is not active. We considered FSB No. 157-3in the determination of estimated fair values as of September 28, 2008,and the impact was not significant.

 

In May 2008,FASB issued Statement of Financial Accounting Standards, or SFAS, No. 162,“*The Hierarchy of Generally AcceptedAccounting Principles*,” or SFAS 162. This standard reorganizes theGAAP hierarchy in order to improve financial reporting by providing aconsistent framework for determining what accounting principles should be usedwhen preparing U.S. GAAP financial statements. SFAS 162 shall be effective 60days after the SEC’s approval of the Public Company Accounting Oversight Board’samendments to Interim Auditing Standard, AU Section 411, “*The Meaning of Present Fairly in Conformity withGenerally Accepted Accounting Principles*.” We are currentlyevaluating the impact SFAS 162 will have on our consolidated financialstatements.

 

In April 2008,the FASB issued FASB Staff Position, or FSP, SFAS No. 142-3, “*Determination of the Useful Life of Intangible Assets*,”or FSP FAS 142-3. FSP FAS 142-3 amends the list of factors an entity shouldconsider in 

 

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**Item 2.    Management’sDiscussion and Analysis of Financial Condition and Results of Operations —(Continued)**

 

developingrenewal or extension assumptions used in determining the useful life ofrecognized intangible assets under SFAS No. 142, “*Goodwill and Other Intangible Assets*,” orSFAS 142. The intent of FSP FAS 142-3 is to improve the consistency between theuseful life of a recognized intangible asset under SFAS 142 and the period ofexpected cash flows used to measure the fair value of the asset under SFAS No. 141,“*Business Combinations*.” FSP FAS142-3 is effective for fiscal years beginning after December 15, 2008 andinterim periods within those fiscal years. We are currently evaluating theimpact FSP FAS 142-3 will have on our consolidated financial statements.

 

**Critical Accounting Policies and Estimates**

 

The methods, estimates and judgments we use inapplying our most critical accounting policies have a significant impact on theresults we report in our consolidated financial statements. The SEC has definedcritical accounting policies as those that are most important to the portrayalof our financial condition and results of operations and require us to make ourmost difficult and subjective judgments, often as a result of the need tomake estimates of matters that are inherently uncertain. Based on thisdefinition, our critical policies include revenue recognition including salesreturns and allowances, valuation of inventories including identification ofexcess quantities, market value and product obsolescence, allowance fordoubtful accounts, valuation of investments, valuation of long-lived assets,measurement of stock-based compensation, accounting for income taxes, fairvalue measurements of financial assets and liabilities, and estimating accruedliabilities. We believe that we apply judgments and estimates in a consistent mannerand that such consistent application results in consolidated financialstatements and accompanying notes that fairly represent all periods presented.However, any factual errors or errors in these judgments and estimates may havea material impact on our statements of operations and financial condition. Fora discussion of critical accounting policies and estimates, please seeItem 7 in our Annual Report on Form 10-K for the fiscal year ended December 30,2007 filed with the SEC on March 11, 2008.

 

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**Item 3. Quantitative and Qualitative Disclosures about MarketRisk**

 

**Interest Rate Risk**

 

Our exposure to market raterisk for changes in interest rates relates primarily to our investmentportfolio and variable rate debt. We do not use derivative financialinstruments to manage our interest rate risk. We are adverse to principal lossand ensure the safety and preservation of invested funds by limiting default,market risk and reinvestment risk. Our investment portfolio is generallycomprised of investments that meet high credit quality standards and haveactive secondary and resale markets. At September 28, 2008, our portfolioof investments was classified as “Level 1” under SFAS 157 (see Note 8 to ourconsolidated financial statements). Since these securities are subject tointerest rate risk, they could decline in value if interest rates fluctuate orif the liquidity of the investment portfolio were to change. Due to the shortduration and conservative nature of our investment portfolio, we do notanticipate any material loss with respect to our investment portfolio. A 10%move in interest rates as of September 28, 2008 would have an immaterialeffect on our financial position, results of operations and cash flows.

 

**Foreign Currency Exchange Rate Risk**

 

All of our sales and cost ofmanufacturing are transacted in U.S. dollars. We conduct a portion of ourresearch and development activities in Canada and India and have sales andmarketing offices in several locations outside of the United States. We use theU.S. dollar as our functional currency. Most of the costs incurred at theseinternational locations are in local currency. If these local currenciesstrengthen against the U.S. dollar, our payroll and other local expenses willbe higher than we currently anticipate. Since our sales are transacted in U.S.dollars, this negative impact on expenses would not be offset by any positiveeffect on revenue. Operating expenses denominated in foreign currencies wereapproximately 26% and 24% of total operating expenses for the first nine months2008 and 2007, respectively. A majority of these foreign expenses were incurredin Canada. A currency exchange rate fluctuation of 10% would have caused ouroperating expenses to change by approximately $540,000, or 2.9%, in the firstnine months of 2008.

 

**Equity Price Risk**

 

Our exposure to equity pricerisk for changes in market value relates primarily to our investment in TowerSemiconductor Ltd., or Tower. Tower’s ordinary shares trade on the NasdaqGlobal Market under the symbol “TSEM”. At September 28, 2008, our Towerinvestment was classified as “Level 1” under SFAS 157 (see Note 8 to ourconsolidated financial statements). Since these securities are publicly tradedon the open market, they are subject to market fluctuations. Temporary marketfluctuations are reflected by increasing or decreasing the presented value ofthe related securities and recording “accumulated other comprehensive income(loss)” in the equity section of the balance sheet. An “other than temporary”decline in market value is reflected by decreasing the carrying value of therelated securities and recording a charge to net loss before income taxes inthe income statement. We wrote down the value of the Tower shares due to an “otherthan temporary” decline in their market value by $417,000 in the second quarterof 2008 and by $13.7 million between 2001 and 2005. The determination that thedecline in market value was “other than temporary” included factors such as thethen current market value and the period of time that the market value had beenbelow the carrying value in each of the respective periods. At June 29,2008, the market value of our Tower investment was $0.86 per share, or $1.2million. As of September 28, 2008, the market value of our Towerinvestment had declined to $0.58 per share; and the resulting $376,000reduction in value was recorded as accumulated other comprehensive loss on thebalance sheet. A market value fluctuation of 10% would have a $78,000 impact onaccumulated other comprehensive loss as of September 28, 2008. At October 31,2008, the market value of Tower ordinary shares was $0.22 per share. If thevalue of Tower ordinary shares remains below $0.86 per share at December 28,2008, we may record a charge to our statement of operations for the decline invalue since June 28, 2008.

 

**Item 4. Controls and Procedures**

 

**Evaluation of Disclosure Controls and Procedures**

 

We maintain disclosurecontrols and procedures designed to ensure that information required to bedisclosed in the reports we file or submit pursuant to the Securities andExchange Act of 1934, as amended,  isrecorded, processed, summarized and reported within the time periods specifiedin the rules and forms of the Securities and Exchange Commission, and thatsuch information is accumulated and communicated to our management, including

 

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our Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure.

 

Management, with theparticipation of the Chief Executive Officer and Chief Financial Officer, hasperformed an evaluation of our disclosure controls and procedures. Basedon this evaluation, our Chief Executive Officer and Chief Financial Officerhave concluded that, as of September 28, 2008, our disclosure controls andprocedures were effective.

 

**Changes in Internal Control Over Financial Reporting**

 

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

 

**Part II. Other Information**

 

**Item 1. Legal Proceedings**

 

On October 26, 2001, aputative securities class action was filed in the U.S. District Court for theSouthern District of New York against certain investment banks that underwroteQuickLogic’s initial public offering, QuickLogic and some of QuickLogic’sofficers and directors. The complaint alleges excessive and undisclosedcommissions in connection with the allocation of shares of common stock inQuickLogic’s initial and secondary public offerings and artificially highprices through “tie-in” arrangements which required the underwriters’ customersto buy shares in the aftermarket at pre-determined prices in violation of thefederal securities laws. Plaintiffs seek an unspecified amount of damages onbehalf of persons who purchased QuickLogic’s stock pursuant to the registrationstatements between October 14, 1999 and December 6, 2000. Variousplaintiffs have filed similar actions asserting virtually identical allegationsagainst over 300 other public companies, their underwriters, and their officersand directors arising out of each company’s public offering. These actions,including the action against QuickLogic, have been coordinated for pretrialpurposes and captioned *In re Initial PublicOffering Securities Litigation, 21 MC 92*. In June 2004, astipulation of settlement and release of claims against the issuer defendants,including QuickLogic, was submitted to the court for approval. On August 31,2005, the court preliminarily approved the settlement. In December 2006,the appellate court overturned the certification of classes in the six testcases that 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 would 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 filed amended master allegations and amendedcomplaints in the six test cases, which the defendants in those cases haveopposed. On March 26, 2008, the Court denied the defendants’ motion todismiss the amended complaints. If a settlement does not occur and litigationagainst QuickLogic continues, we intend to defend the case vigorously.

 

No estimate can be made ofthe possible loss or possible range of loss associated with the resolution ofthese contingencies and, accordingly, we have not recorded a liability.

 

From time to time, theCompany is involved in legal actions arising in the ordinary course ofbusiness, including but not limited to intellectual property infringement andcollection matters. Absolute assurance cannot be given that third partyassertions will be resolved without costly litigation in a manner that is notadverse to our financial position, results of operations or cash flows orwithout requiring royalty or other payments in the future which may adverselyimpact gross profit.

 

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**Item 1A. Risk Factors**

 

This description includesany material changes to and supersedes the description of the risk factorsassociated with our business previously disclosed in Item 1A of our 2007 AnnualReport on Form 10-K filed with the SEC on March 11, 2008 and ourquarterly reports on Form 10-Q for the periods ended March 30, 2008and June 29, 2008, filed with the SEC on May 8, 2008 and August 7,2008, respectively. Because of the following risk factors, as well as othervariables affecting our operating results, past financial performance may notbe a reliable indicator of future performance, and historical trends should notbe used to anticipate results or trends in future periods.

 

**RiskFactors**

 

# *Our CSSP design opportunities may not result in the revenuewe expect*

#  

# Weare transitioning to becoming a supplier of CSSPs that addresses the mobilemarket from being a broad-based supplier of FPGA devices. We have developed asignificant pipeline of design opportunities for CSSPs in our target markets,and we are focused on converting these design opportunities into revenue.Revenue contributions from new mobile products will be important over the nexttwo to four quarters in order to grow our business, obtain profitability andmaintain or increase our cash position. Mobile product life cycles are short, and we must replace revenue lostat the end of these product life cycles with sales from new design wins.**In addition, we expect revenue from therest of our business to decline due to the stage of our customers’ product lifecycles.

#  

Thegeneration of revenue from mobile market design opportunities is influenced bya number of factors, such as our ability to supply solutions that meetcustomers’ cost targets and performance requirements, the value and price ofour solutions relative to competing solutions, our customers’ decisions whetherto produce in volume the products utilizing our solution, the timing of ourcustomers’ product introduction dates, the market success of our customers’products and general economic conditions. If these design opportunities resultin revenue that is later or significantly lower than we expect, our results ofoperations and financial condition will be adversely affected.

 

*Ourbusiness may be adversely affected by the current financial crisis*

 

Recently general worldwide economic conditions have experienced adownturn due to the credit conditions impacted by the subprime-mortgage turmoiland other factors, slower economic activity, concerns about inflation anddeflation, decreased consumer confidence, reduced corporate profits and capitalspending, adverse business conditions, a rise in unemployment, lower investmentvaluations and liquidity concerns. The current financial crisis may cause areduction in the consumption of the products that use our devices, causecancellation or delay of our customers’ introduction of new products using ourdevices, disrupt supply chains and affect the financial health of our customersor suppliers. As such, the financial crisis my adversely impact our customerand supplier relationships, revenue level, product prices, the value of ourinventories and long-lived assets, reserves for excess and obsolete inventory,production capability, collectability of accounts receivable, access toinventory or equipment at suppliers and liquidity, which may materially harmour business.

 

# *If we fail to successfully develop, introduce and sell CSSPsand new products, we may be unable to compete effectively in the future*

#  

We have focused thedevelopment and marketing of our CSSPs to address the needs of OEMs and ODMsthat offer differentiated mobile products such as personal navigation devices,multimedia phones, portable media players, data cards and wireless hard diskdrives. These are new customers and markets for us and we currently have asmall customer base for CSSPs. While we believe that this business will providelong-term revenue growth for our Company, there is no assurance when this willoccur.

 

The market for these mobiledevices is highly competitive and dynamic, with short product life cycles andrapid obsolescence of existing products. To compete successfully, we mustefficiently create CSSPs from our existing silicon platforms to meet the needsof customers in our sales pipeline. In addition, we must obtain access toadvanced fabrication capacity and dedicate significant resources to specify,design, develop, manufacture and sell new or enhanced silicon platforms andCSSPs that provide increasingly higher levels of performance, low powerconsumption, new features, reliability and/or cost savings to our customers.Due to the short product life cycle of these devices our revenue is subject tofluctuation in a short period of time and our ability to grow our businessdepends on accelerating our design win activity. We often make significantinvestments in CSSP and silicon

 

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platform development, selling and marketinglong before we generate revenue, if any, from these efforts. These marketstypically have higher volumes and greater price pressure than our traditionalbusiness; we quote opportunities in anticipation of future cost reductions andmay aggressively price products to gain market share. In order to react quicklyto opportunities or to obtain favorable wafer prices, we make significantinvestments in and commitments to purchase inventories and capital equipmentbefore we have firm commitments from customers. Our gross margin and valuationof inventories may be affected by these strategies if, for instance, wegenerate significant business before we are able to reduce our costs or if anopportunity priced to gain market share becomes significant to our quarterlyrevenue.

 

In the second quarter of2008, we realigned our operating model in order to reduce our fixed costs,lower our breakeven revenue level, increase our profit scalability with growthbeyond breakeven and improve our agility. As a result of the operationalrealignment, which included a significant reduction in staffing, we lowered ournon-GAAP breakeven revenue level to approximately $8.5 million per quarter inlight of our expected revenue mix, gross margin and operating expenses. Ourrevenue in the third quarter of 2008 was $6.2 million, consisting of $1.4million in new product revenue, including CSSPs, $4.6 million in mature productrevenue and $189,000 in end-of-life product revenue. We expect our businessgrowth to be driven by CSSPs, and CSSP revenue growth needs to be strong enoughto achieve profitability while offsetting expected declines in other parts ofour business. The gross margin associated with our CSSPs and new products isgenerally lower than the gross margin of our mature and end-of-life products,due primarily to the price sensitive nature of the higher volume mobileconsumer opportunities that we are pursuing with CSSPs. If our mature productrevenue were to decline more quickly than expected, it could have a significanteffect on our results of operations and cash flows. Because the product lifecycle of mobile products is short, we must replace revenue at the end of aproduct life cycle with sales from new design opportunities. In addition, salesof our mature product family could decline if competitors replace us in thesedesign opportunities. While we expect revenue and gross profit growth fromCSSPs will offset the expected decline in revenue and gross profit from ourmature products and the effect of short mobile product life cycles, there is noassurance when this will occur. In order to grow our revenue from its currentlevel, we are dependent upon increased revenue from our existing products,especially CSSPs based on our ArcticLink and PolarPro solution platforms, andthe development of CSSPs, additional new products and solutions.

 

If we are unable to design,produce and sell new CSSPs that meet design specifications, address customerrequirements and generate sufficient revenue and gross profit; if market demandfor our CSSPs and other products fails to materialize; if we are unable toobtain adequate capacity on a timely basis; if we are unable to develop CSSPsor solutions in a timely manner; or if our customers do not successfullyintroduce products incorporating our devices, our revenue and gross margin willbe materially harmed, our liquidity and cash flows will be materially affected,we may be required to write-off related inventories and long-lived assets orthere may be other adverse effects on our business or the price of our commonstock.

 

# *We may be unable to accurately estimate quarterly revenue,which could adversely affect our financial results or the trading price of ourstock*

#  

We offer our customers ashort delivery lead time and a significant portion of our shipments during aquarter are ordered by customers in that quarter. In addition, our customersmay cancel orders with little or no penalty. As a result, we often have lowvisibility to revenue in the current quarter and our revenue levels can changesignificantly in a short period of time. Furthermore, our ability to respond toincreased demand is limited to inventories on hand or on order, the capacityavailable at our contract manufacturers and our capacity to program products tocustomer specifications. In addition, a portion of our revenue is deferred untilour distributors ship unprogrammed parts to end customers. Therefore, we arehighly dependent on the accuracy and timeliness of resale and inventory reportsfrom our distributors. Inaccurate distributor resale or inventory reports, aswell as unanticipated changes in distributor levels of inventory, couldcontribute to our difficulty in predicting and reporting our quarterly revenueand results of operations. If we fail to accurately estimate customer demand,if there is a deterioration in the demand for or supply of our products, if wefail to adequately record revenue, or if our available capacity is less thanneeded to meet customer demand, our results of operations could be harmed andour stock price could materially fluctuate.

 

# *We may not have the liquidity to support our futureoperations and capital requirements*

#  

At September 28, 2008,our cash and cash equivalents balance was $18.8 million and ourinterest-bearing debt consisted of $2.0 million outstanding from SiliconValley Bank and $950,000 outstanding under capital leases.

 

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In August 2008, we amended our creditfacility with Silicon Valley Bank and at September 28, 2008, we had$4.0 million available to borrow under our revolving credit facility andoutstanding revolving debt of $2.0 million.

 

At September 28, 2008,we held 1,344,543 Tower ordinary shares, valued at approximately $780,000 basedupon the market closing price of $0.58 per share at the end of the reportingperiod. The market value of Tower ordinary shares was $0.22 per share on October 31,2008. If the value per share remains below $0.86 at the end of our fiscalfourth quarter, we may incur a charge for the “other than temporary” decline inmarket value since June 28, 2008. Our ability to continue to obtainpreferred pricing from Tower is tied to our ownership of at least 450,000 ofthese Tower shares.

 

While our primary investmentobject is the preservation of cash and our portfolio is comprised of securitieswith active secondary and resale markets, any investment is subject to a degreeof interest rate and liquidity risk. Capital expenditures, which are largelydriven by development activities and the introduction and initial manufacturingof new products, could total $1.2 million in the next twelve months. Atthe end of the third quarter of 2008, we had commitments to purchase $2.4million of wafer inventory.

 

As a result of potential investments,expected revenue and operating expense levels, changes in working capital andinterest and debt payments, we will need to generate significantly higherrevenue and gross profit, especially from our ArcticLink and PolarPro solutionplatforms and products currently under development, to generate positive cashflow. In addition, our new products have been generating lower gross margin asa percentage of revenue than the rest of our historical business due to thecompetitive and cost-sensitive markets that we have targeted and the largerorder quantities associated with these applications. Based on our currentexpectations for revenue, gross profit and expense levels, we have sufficientliquidity for the next twelve months. These expectations may be adverselyeffected by a recession. Whether we can achieve cash flow levels sufficient tosupport our operations cannot be accurately predicted. Unless such cash flowlevels are achieved and our investment portfolio remains liquid and its capitalis preserved, we may have to borrow additional funds or sell debt or equitysecurities, or some combination thereof, to provide funding for our operations.If adequate funds are not available when needed, our financial condition andoperating results would be materially and adversely affected and we may not beable to operate our business without significant changes in our operations, orat all.

 

# *We depend upon third parties to fabricate, assemble, testand program our products, and they may discontinue manufacturing our products,fail to give our products priority, be unable to successfully manufacture ourproducts to meet performance, volume or cost targets, or inaccurately reportinventories to us*

#  

We contract with thirdparties to fabricate, assemble, test and program our devices. Our devices aregenerally fabricated, assembled and programmed by single suppliers, and theloss of a supplier, transfer of manufacturing to a new location, expiration ofa supply agreement or the inability of our suppliers to manufacture ourproducts to meet volume, performance and cost targets could have a materialadverse effect on our business. We sell programmers to customers that aresupplied by a single source. Programming capacity at our subcontractors is alsodependent on our investment in sufficient programming hardware to meetfluctuating demand. Our relationship with our suppliers could change as aresult of a merger or acquisition or due to a supplier’s financial condition.If for any reason these suppliers or any other vendor becomes unable orunwilling to continue to provide services of acceptable quality, at acceptablecosts and in a timely manner, our ability to operate our business or deliverour products to our customers could be severely impaired. We would have toidentify and qualify substitute suppliers, which could be time consuming,difficult and result in unforeseen operational problems, or we could announcean end-of-life program for these products. Alternate suppliers might not beavailable to fabricate, assemble, test and program our devices or, ifavailable, might be unwilling or unable to offer services on acceptable terms.We have announced an end-of-life for several products, due primarily to certainsuppliers’ decisions to stop manufacturing these products, and the loss of thisrevenue has significantly harmed our business.

 

In addition, if competitionfor wafer manufacturing capacity increases, if we need to migrate to moreadvanced wafer manufacturing technology, or if competition for assemblyservices increases, we may be required to pay or invest significant amounts tosecure access to this capacity. For example, between 2001 and 2002 we invested$21.3 million in equity and prepaid wafer credits to obtain guaranteed waferfabrication capacity at Tower Semiconductor. The number of companies thatprovide these services is limited and some of them have limited operatinghistories and financial resources. In the event our current suppliers refuse orare unable to continue to

 

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provide these services to us, or if we areunable to secure sufficient capacity from our current suppliers on commerciallyreasonable terms, we may be unable to procure services from alternate suppliersin a timely manner, if at all. Moreover, our reliance on a limited number ofsuppliers subjects us to reduced control over delivery schedules, qualityassurance and costs. This lack of control may cause unforeseen productshortages or may increase our cost to manufacture and test our products, whichwould adversely affect our operating results and cash flows.

 

We record a majority of ourinventory transactions based on information from our subcontractors. If we donot receive prompt and accurate information from our suppliers, we couldmisstate our inventories, incorrectly record gross profit, be unable to meetour delivery commitments to customers or commit to manufacturing inventoriesthat are not required to meet customer delivery commitments, which couldmaterially harm our business.

 

# *Our future results depend on our relationship with Tower*

#  

We have investedapproximately $21.3 million in Tower. In return for our investment, wereceived equity, prepaid wafer credits, preferred wafer pricing and committedproduction capacity in Tower’s foundry facility.  We believe that Tower’s long-term operationof this fabrication facility depends on its ability to attract sufficientcustomer demand, to obtain additional financing, to increase capacity, toobtain the release of grants and approvals for changes in grant programs fromthe Israeli government’s Investment Center and its ability to remain incompliance with the terms of its grant and credit agreements. The currentpolitical uncertainty and security situation in the Middle East where Tower’sfabrication facility is located, the cyclical nature of the market for foundrymanufacturing services, Tower’s financial condition, or other factors mayadversely impact Tower’s business prospects and may discourage futureinvestments in Tower from outside sources. If Tower is unable to obtainadequate financing or generate adequate cash flow, the value of our investmentin Tower may decline significantly or possibly become worthless, our wafercredit from Tower may decline in value or possibly become worthless, and wewould have to identify and qualify a substitute supplier to manufacture ourproducts. This could require significant development time, cause productshipment delays, impair long-lived assets and the value of our wafer credits,damage our liquidity and severely harm our business. In addition, Tower is thesole manufacturer of our new products, CSSP silicon platforms and other newsilicon platforms currently under development.

 

At the end of the thirdquarter of 2008 we have $950,000 of prepaid wafer credits reported as otherassets on our balance sheet, and we hold 1.3 million tower ordinary shares witha value $0.58 per share. The value of our investment in Tower and itscorresponding wafer credits may also be adversely affected by a deteriorationof conditions in the market for foundry manufacturing services, the market forsemiconductor products, Tower’s financial health and Tower’s ability to remainin compliance with Nasdaq listing standards. If Tower does not remain incompliance with Nasdaq listing standards, or if Tower’s financial position isdetermined to be significantly impaired, the liquidity of our investment andour ability to utilize the remaining prepaid wafer credits may be adverselyaffected. We wrote down the Tower shares to their fair market value of $0.86per share, or $1.2 million, in the second quarter of 2008 due to an “other thantemporary” decline in their market value. The value of Tower ordinary shareswas $0.58 per share at the end of our third fiscal quarter and was $0.22 pershare as of October 31, 2008. If the value per share remains below $0.86per share at the end of our fiscal fourth quarter, we may incur a charge forthe “other than temporary” decline in market value since June 28, 2008.

 

# *We will be unable to compete effectively if we fail toanticipate product opportunities based upon emerging technologies and standardsor fail to develop products and solutions that incorporate these technologiesand standards in a timely manner*

#  

We spend significant timeand money to design and develop silicon solution platforms such as ArcticLinkand PolarPro and proven system blocks, such as our VEE technology, USB and IDE,or emerging technologies, such as low power programmable logic, advancedprocess technology or small form factor packaging. We intend to developadditional products and solutions and to adopt new technologies in the future.If system manufacturers adopt alternative standards or technologies, if anindustry standard or emerging technology that we have targeted fails to achievebroad market acceptance, if customers choose low power offerings from ourcompetitors, or if we are unable to bring the technologies or solutions to marketin a timely and effective manner, we may be unable to generate significantrevenue from our sales pipeline or from our research and development efforts.As a result, our business would be materially harmed and we may be required towrite-off related inventories and long-lived assets.

 

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# *We have a limited number of significant customers andlimited visibility into the long-term demand for our products from thesecustomers*

#  

A few end customers canrepresent a significant portion of our total revenue in a given reportingperiod and the likelihood of this occurring will increase in the future as wetarget market leading manufacturers of high volume mobile applications. As inthe past, future demand from these customers may fluctuate significantly fromquarter to quarter. These customers typically order products with shortrequested delivery lead times, and do not provide a commitment to purchaseproduct past the period covered by purchase orders, which may be rescheduled orcancelled. In addition, our manufacturing lead times are longer than thedelivery lead times requested by these customers, and we make significant purchasesof inventory and capital expenditures in anticipation of future demand. Ifrevenue from any significant customer were to decline substantially, we may beunable to offset this decline with increased revenue and gross margin fromother customers and we may purchase excess inventories. These factors couldseverely harm our business.

 

In addition, we may make asignificant investment in long-lived assets for the production of our productsbased upon historical and expected demand. If demand for our products or grossmargin generated from our products does not meet our expectations or if we areunable to collect amounts due from significant customers, we may be required towrite-off inventories, provide for uncollectible accounts receivable or incurcharges against long-lived assets, which would materially harm our business.

 

# *Our customers may cancel or change their product plans afterwe have expended substantial time and resources in the design of their products*

#  

Our customers often evaluateour products for six months or more before designing them into their systems,and they may not commence volume shipments for up to an additional six totwelve months, if at all. During this lengthy sales cycle, our potentialcustomers may cancel or change their product plans. Customers may alsodiscontinue products incorporating our devices at any time or they may chooseto replace our products with lower cost semiconductors. In addition, we areworking with leading customers in our target markets to define our future products.If customers cancel, reduce or delay product orders from us or choose not torelease products that incorporate our devices after we have spent substantialtime and resources developing products or assisting customers with theirproduct design, our revenue levels may be less than anticipated and ourbusiness could be materially harmed.

 

# *If we fail to adequately forecast demand for our products,we may incur product shortages or excess product inventories*

#  

Our agreements with certainsuppliers require us to provide forecasts of our anticipated manufacturingorders, and place binding manufacturing commitments in advance of receivingpurchase orders from our customers. We are limited in our ability to increaseor decrease our forecasts under such agreements. Other manufacturers supply usproduct on a purchase order basis. The allocation of capacity is determinedsolely by our suppliers over which we have no direct control. Additionally, wemay place orders with our suppliers in advance of customer orders to allow usto quickly respond to changing customer demand or to obtain favorable productcosts. Furthermore, we provide our suppliers with equipment which is used toprogram our products to customer specifications. The programming equipment ismanufactured to our specifications and has significant order lead times. Thesefactors may result in product shortages or excess product inventories.Obtaining additional supply in the face of product, programming equipment orcapacity shortages may be costly, or not possible, especially in the short termsince most of our products and programming equipment are supplied by a singlesupplier. In the first nine months of 2008, we wrote down approximately $1.3million of inventories due primarily to changes in forecasted demand. Ourfailure to adequately forecast demand for our products could materially harmour business.

 

Our distributors orcustomers may cancel purchase orders at any time with little or no penalty.Contractually, our distributors are generally permitted to return unprogrammedproducts worth up to 10%, by value, of the products they purchase from us. Ifour distributors or customers cancel or defer significant purchase orders orreturn our products, our accounts receivable collections would decrease and inventorieswould increase, which would materially harm our business.

 

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# *We are expending substantial time and effort to developsolutions with partners that depend on the availability and success oftechnology owned by the partner*

#  

Our approach to developingsolutions for potential customers involves: (1) embedded processorsdeveloped by companies such as Marvell Semiconductor, Inc.; (2) peripheraldevices developed by other parties such as micro hard disk drives, Wi-Fidevices and NAND flash memory; (3) proprietary intellectual property suchas key elements of our VEE technology; and (4) specific industry standardssuch as USB 2.0 OTG, Serial Digital High Capacity, or SDHC, IDE and SDIO. Wehave entered into informal partnerships with other parties that involve thedevelopment of solutions that interface with their devices or standards. Theseinformal partnerships also may involve joint marketing campaigns and salescalls. If our solutions are not incorporated into customer products, if ourpartners discontinue production of or develop and integrate a competingsolution into their product offerings, or if the informal partnerships do notgrow as expected or if they are significantly reduced or terminated byacquisition or other means, our revenue and gross margin will be materiallyharmed and we may be required to write-off related inventories and long-livedassets.

 

# *We may be unable to successfully grow our business if wefail to compete effectively with others to attract and retain key personnel*

#  

We believe our futuresuccess depends upon our ability to attract and retain highly competentpersonnel. Our employees are at-will and not subject to employment contracts.While our recent operational realignment has reduced our fixed costs, it hasincreased our need to retain qualified personnel. Hiring and retainingqualified sales, technical and financial personnel is difficult due to thelimited number of qualified professionals, economic conditions and the size ofour company. Competition for these types of employees is intense. In addition,new hires frequently require extensive training before they achieve desiredlevels of productivity. Failure to attract, hire, train and retain personnelcould materially harm our business.

 

# *Fluctuations in our manufacturing processes, yields andquality, especially for new products, may increase our costs*

#  

Difficulties encounteredduring the complex semiconductor manufacturing process can render a substantialpercentage of semiconductor devices nonfunctional. New manufacturing techniquesor fluctuations in the manufacturing process may change the performancedistribution and yield of our products. We have, in the past, experiencedmanufacturing runs that have contained substantially reduced or no functioningdevices, or that generated devices with below normal performancecharacteristics. Our reliance on third party suppliers may extend the period oftime required to analyze and correct these problems. Once corrected, ourcustomers may be required to redesign or requalify their products. As a result,we may incur substantially higher manufacturing costs, shortages of inventoriesor reduced customer demand.

 

Yield fluctuationsfrequently occur in connection with the manufacture of newly introducedproducts, with changes in product architecture, with manufacturing at newfacilities, on new fabrication processes or in conjunction with new backendmanufacturing processes. Newly introduced solutions and products, such as ourCSSPs and ArcticLink and PolarPro solution platforms, are often more complexand more difficult to produce, increasing the risk of manufacturing relateddefects. New manufacturing facilities or processes are often more complex andtake a period of time to achieve expected quality levels and manufacturingefficiencies. While we test our products, including our software developmenttools, they may still contain errors or defects that are found after we havecommenced commercial production. Undetected errors or defects may also resultfrom new manufacturing processes or when new intellectual property isincorporated into our products. If our products or software development tools containundetected or unresolved defects, we may lose market share, experience delaysin or loss of market acceptance, reserve or scrap inventories or be required toissue a product recall. In addition, we would be at risk of product liabilitylitigation if defects in our products were discovered. Although we attempt tolimit our liability to end users through disclaimers of special, consequentialand indirect damages and similar provisions, we cannot assure you that suchlimitations of liability will be legally enforceable.

 

# *We have a history of losses and cannot assure you that wewill again be profitable in the future*

#  

We incurred significantlosses in 2007, 2006 and certain years prior to 2005. Our accumulated deficitas of September 28, 2008 was $145.4 million. Although we recorded netincome of $2.4 million in 2005, we recorded a net loss of$6.7 million in the first nine months of 2008, and we may not return toprofitability in any future periods.

 

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# *Our future operating results are likely to fluctuate andtherefore may fail to meet expectations, which could cause our stock price todecline*

#  

Our operating results havevaried widely in the past and are likely to do so in the future. In addition,our past operating results may not be an indicator of future operating results.Our future operating results will depend on many factors and may fail to meetour expectations for a number of reasons, including those set forth in theserisk factors. Any failure to meet expectations could cause our stock price tosignificantly fluctuate or decline.

 

Factors that could cause ouroperating results to fluctuate include:

 

·                 the effect of end-of-life programs;

 

·                 a significant change in sales to, or thecollectability of accounts receivable from, our largest customers;

 

·                 successful development and market acceptanceof our products and solutions;

 

·                 our ability to accurately forecast productvolumes and mix, and to respond to rapid changes in customer demand;

 

·                 changes in sales volume or expected salesvolume, product mix, average selling prices or production variances that affectgross profit;

 

·                 our ability to adjust our product features,manufacturing capacity and costs in response to economic and competitivepressures;

 

·                 our reliance on subcontract manufacturers forproduct capacity, yield and quality;

 

·                 our competitors’ product portfolio andproduct pricing policies;

 

·                 timely implementation of efficientmanufacturing technologies;

 

·                 errors in applying or changes in accountingand corporate governance rules;

 

·                 the issuance of equity compensation awards orchanges in the terms of our stock plan or employee stock purchase plan;

 

·                 mergers or acquisitions;

 

·                 the impact of import and export laws andregulations;

 

·                 the cyclical nature of the semiconductorindustry and general economic, market, political and social conditions in thecountries where we sell our products and the related effect on our customers,distributors and suppliers;

 

·                 our ability to obtain capital, debt financingand insurance on commercially reasonable terms; and

 

·                 the impact of restructuring activities.

 

During the second quarter of2008 we realigned our resources to be consistent with our CSSP business modeland incurred restructuring costs. The intent of the realignment is to lower ourfixed costs, reduce spending, provide a faster return to profitability, enableus to scale profits with revenue growth and provide the room to makediscretionary expenditures in response to market opportunities. The realignmentincludes outsourcing some development functions to lower our per projectdevelopment expense. The restructuring costs adversely affected our secondquarter financial performance. The restructuring costs recorded in the secondquarter of 2008 are only an estimate of charges and actual amounts maydiffer.  While we believe the realignmentenables us to accomplish our business objectives, the realignment could bedisruptive to our business and cause actual results to differ from our expectedresults.

 

We may encounter periods ofindustry wide semiconductor oversupply, resulting in pricing pressure, as wellas undersupply, resulting in a risk that we could be unable to fulfill ourcustomers’ requirements. The semiconductor industry has historically beencharacterized by wide fluctuations in the demand for, and supply of, itsproducts. These fluctuations have resulted in circumstances when supply of anddemand for semiconductors have been widely out of balance. An industry widesemiconductor oversupply could result in severe downward pricing pressure from

 

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customers. In a market with undersupply ofmanufacturing capacity, we would have to compete with larger foundry andassembly customers for limited manufacturing resources. In such an environment,we may be unable to have our products manufactured in a timely manner, at acost that generates adequate gross profit or in sufficient quantities. Since weoutsource all of our manufacturing and generally have a single source of wafersupply, test, assembly and programming for our products, we are particularlyvulnerable to such supply shortages and capacity limitations. As a result, wemay be unable to fulfill orders and may lose customers. Any future industrywide oversupply or undersupply of semiconductors could materially harm ourbusiness.

 

Although certain of thesefactors are out of our immediate control, unless we can anticipate and beprepared with contingency plans that respond to these factors, our business maybe materially harmed.

 

# *Problems associated with international business operationscould affect our ability to manufacture and sell our products*

#  

Most of our products aremanufactured outside of the United States at manufacturing facilities operatedby our suppliers in Taiwan, South Korea, the Philippines, China and Israel. Weexpect to manufacture a majority of our new products and the products that wecurrently have under development in Israel and to assemble these products inSouth Korea or China. As a result, these manufacturing operations and new productintroductions are subject to risks of political instability, including the riskof conflict between Taiwan and the People’s Republic of China, between SouthKorea and North Korea, and conflicts involving Israel.

 

A significant portion of ourtotal revenue comes from sales to customers located outside the United States.We anticipate that sales to customers located outside the United States willcontinue to represent a significant portion of our total revenue in futureperiods. In addition, most of our domestic customers sell their productsoutside of North America, thereby indirectly exposing us to risks associatedwith foreign commerce and economic instability. In addition to overseas salesoffices, we have significant marketing and research and development activitiesin Canada and India. Accordingly, our operations and revenue are subject to anumber of risks associated with foreign commerce, including the following:

 

·                 managing foreign distributors and suppliers;

 

·                 collecting amounts due;

 

·                 staffing and managing foreign offices;

 

·                 political and economic instability;

 

·                 foreign currency exchange fluctuations;

 

·                 changes in tax laws, import and exportregulations, tariffs and freight rates;

 

·                 timing and availability of export licenses;

 

·                 supplying products that meet localenvironmental regulations; and

 

·                 inadequate protection of intellectualproperty rights.

 

In the past, we havedenominated sales of our products to foreign countries exclusively in U.S.dollars. As a result, any increase in the value of the U.S. dollar relative tothe local currency of a foreign country will increase the price of our productsin that country so that our products become relatively more expensive tocustomers in their local currency. As a result, sales of our products in thatforeign country may decline. If the local currency of a foreign country inwhich we conduct business strengthens against the U.S. dollar, our payroll andother local expenses will be higher, and since sales are transacted in U.S.dollars, would not be offset by any increase in revenue. To the extent any suchrisks materialize, our business could be materially harmed.

 

In addition, we incur costsin foreign countries that may be difficult to reduce quickly because ofemployee related laws and practices in those foreign countries.

 

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# *Our CSSPs face competition from suppliers of ASSPs such asCypress Semiconductor Corporation, suppliers of integrated applicationprocessors such as Texas Instruments Inc., and suppliers of ASICs such as LSILogic Corporation*

#  

We face competition fromcompanies that offer ASSPs, such as Cypress Semiconductor and OxfordSemiconductor. While it is difficult to provide a unique solution through theuse of ASSPs, they generally are cost effective standard products and haveshort lead times. In certain design opportunities, ASSPs can be combined toachieve system design objectives. Some manufacturers of integrated applicationprocessors, such as Texas Instruments, often integrate new features when theyintroduce new products. A system designer could elect the use of an integratedprocessor that includes the features offered in our CSSPs. Companies such asLSI Logic supply Application Specific Integrated Circuits, or ASICs, which maybe purchased for a lower unit price at higher volumes and typically have greaterlogic capacity, additional features and higher performance than our products,but have larger development risk, longer time to market and often charge NREfees for development. Our inability to successfully compete in any of thefollowing areas could materially harm our business:

 

·                 the development of new products, CSSPs andadvanced manufacturing technologies;

 

·                 the quality, power characteristics,performance characteristics, price and availability of devices, programminghardware and software development tools;

 

·                 the ability to engage with companies thatprovide synergistic products and services;

 

·                 the incorporation of industry standards inour products and solutions;

 

·                 the diversity of product offerings availableto customers; or

 

·                 the quality and cost effectiveness of design,development, manufacturing and marketing efforts.

 

# *Many system manufacturers may be unwilling to switch to ourproducts because of their familiarity with the products offered by our directcompetitors, such as Xilinx, Inc. and Altera Corporation, which competewith us in the sale of FPGAs*

#  

Companies that compete withour mature product family and end-of-life product family, and certain CSSP andnew product opportunities, include suppliers of complex programmable logicdevices and field programmable gate arrays, such as Xilinx, Inc., AlteraCorporation, Actel Corporation and Lattice Semiconductor Corporation. Xilinxand Altera together have a majority share of the programmable logic market.Many system manufacturers may be unwilling or unable to switch to our productsdue to their familiarity with competitors’ products or other inhibitingfactors.

 

The semiconductor industryis intensely competitive and characterized by:

 

·                 erosion of selling prices over product lives;

 

·                 rapid technological change;

 

·                 short product life cycles; and

 

·                 strong domestic and foreign competition.

 

Ifwe are not able to compete successfully in this environment, our business willbe materially harmed.

 

Many of the companies thatcompete with CSSPs and our new product, mature and end-of-life families havesubstantially greater financial, technical, manufacturing, marketing, sales,distribution, name recognition and other resources than we do. In addition,many of our competitors have well established relationships with our currentand potential customers and have extensive knowledge of system applications. Inthe past, we have lost potential customers to competitors for various reasons,including, but not limited to, re-programmability and lower price.

 

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# *We depend upon third party distributors and independentsales representatives to market and sell our products, and they may discontinuesale of our products, fail to give our products priority or be unable tosuccessfully market, sell and support our products*

#  

We contract with third partydistributors and independent sales representatives to market and sell asignificant portion of our products. We typically have only a few distributorsand a single representative serving each geographic market and, in the future,we may have a single distributor covering a geographic market. Although we havecontracts with our distributors and representatives, our agreements with themmay be terminated on short notice by either party and, if terminated, we may beunable to recruit additional or replacement distributors or representatives. Asa result, our future performance will depend in part on our ability to retainour existing distributors and representatives and to attract new distributorsand representatives that will be able to effectively market, sell and supportour products and solutions. The loss of one or more of our principaldistributors or representatives, or our inability to attract new distributorsor representatives, could materially harm our business.

 

Many of our distributors andrepresentatives, including our principal distributors and representatives,market and sell products for other companies. Many of these products maycompete directly or indirectly with our products and solutions. Also, wegenerally are not one of the principal suppliers of products to ourdistributors or representatives. If our distributors or representatives givehigher priority or greater attention to the products of other companies,including products that compete with our products and solutions, our businesswould be materially harmed.

 

Individual distributors andOEMs often represent a significant portion of our accounts receivable. If weare unable to collect funds due from these distributors and customers, due forinstance to their financial health or the liquidity of their investments, ourfinancial results may be materially harmed.

 

# *We may be unable to adequately protect our intellectualproperty rights and may face significant expenses as a result of futurelitigation*

#  

Protection of intellectualproperty rights is crucial to our business, since that is how we keep othersfrom copying the innovations that are central to our existing and futureproducts. From time to time, we receive letters alleging patent infringement orinviting us to license other parties’ patents. We evaluate these requests on acase-by-case basis. These situations may lead to litigation if we reject theoffer to obtain the license.

 

In the past, we have beeninvolved in litigation relating to our alleged infringement of third partypatents or other intellectual property rights. This type of litigation isexpensive and consumes large amounts of management time and attention.Additionally, matters that we initially consider not material to our businesscould become costly. In addition, if the letters we sometimes receive allegingpatent infringement or other similar matters result in litigation that we lose,a court could order us to pay substantial damages and/or royalties, andprohibit us from making, using, selling or importing essential technologies.For these and other reasons, this type of litigation could materially harm ourbusiness.

 

Although we may seek toobtain a license under a third party’s intellectual property rights in order tobring an end to certain claims or actions asserted against us, we may not beable to obtain such a license on reasonable terms, or at all. We have enteredinto technology license agreements with third parties which give those partiesthe right to use patents and other technology developed by us and which give usthe right to use patents and other technology developed by them. We anticipatethat we will continue to enter into these kinds of licensing arrangements inthe future; however, it is possible that desirable licenses will not beavailable to us on commercially reasonable terms. If we lose existing licensesto key technology, or are unable to enter into new licenses that we deemimportant, our business could be materially harmed.

 

Because it is critical toour success that we continue to prevent competitors from copying ourinnovations, we intend to continue to seek patent and trade secret protectionfor our products. The process of seeking patent protection can be long andexpensive, and we cannot be certain that any currently pending or futureapplications will actually result in issued patents or that, even if patentsare issued, they will be of sufficient scope or strength to provide meaningfulprotection or any commercial advantage to us. Furthermore, others may developtechnologies that are similar or superior to our technology or design aroundthe patents we own. We also rely on trade secret protection for our technology,in part through confidentiality agreements with our employees, consultants andother

 

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third parties. However, these parties maybreach these agreements and we may not have adequate remedies for any breach.In any case, others may come to know about or determine our trade secretsthrough a variety of methods. In addition, the laws of certain territories inwhich we develop, manufacture or sell our products may not protect ourintellectual property rights to the same extent as the laws of the UnitedStates.

 

# *We may engage in manufacturing, distribution or technologyagreements that involve numerous risks, including the use of cash, diversion ofresources and significant write-offs*

#  

We have entered into and, inthe future, intend to enter into agreements that involve numerous risks,including the use of significant amounts of our cash; diversion of resourcesfrom other development projects or market opportunities; our ability toincorporate licensed technology in our products and solutions; our ability tointroduce related products in a cost effective and timely manner; our abilityto collect amounts due under these contracts; and market acceptance of relatedproducts and solutions. If we fail to recover the cost of these or other assetsfrom the cash flow generated by the related products, our assets will becomeimpaired and our financial results would be harmed.

 

# *Our business is subject to the risks of earthquakes, othercatastrophic events and business interruptions for which we may maintainlimited insurance*

#  

Our operations and theoperations of our suppliers are vulnerable to interruption by fire, earthquake,power loss, flood, terrorist acts and other catastrophic events beyond ourcontrol. In particular, our headquarters are located near earthquake faultlines in the San Francisco Bay Area. In addition, we rely on sole suppliers tomanufacture our products and would not be able to qualify an alternate supplierof our products for several quarters. Our suppliers often hold significantquantities of our inventories which, in the event of a disaster, could bedestroyed. In addition, our business processes and systems are vulnerable tocomputer viruses, break-ins and similar disruptions from unauthorizedtampering. Any catastrophic event, such as an earthquake or other naturaldisaster, the failure of our computer systems, war or acts of terrorism, couldsignificantly impair our ability to maintain our records, pay our suppliers, ordesign, manufacture or ship our products. The occurrence of any of these eventscould also affect our customers, distributors and suppliers and produce similardisruptive effects upon their business. If there is an earthquake or othercatastrophic event near our headquarters, our customers’ facilities, ourdistributors’ facilities or our suppliers’ facilities, our business could beseriously harmed.

 

We do not have a detaileddisaster recovery plan. In addition, we do not maintain sufficient businessinterruption and other insurance policies to compensate us for all losses thatmay occur. Any losses or damages incurred by us as a result of a catastrophicevent or any other significant uninsured loss could have a material adverseeffect on our business.

 

# *Our principal stockholders have significant voting power andmay vote for actions that may not be in the best interests of our otherstockholders*

#  

Our officers, directors andprincipal stockholders together control a significant portion of ouroutstanding common stock. As a result, these stockholders, if they acttogether, will be able to significantly influence our operations, affairs andall matters requiring stockholder approval, including the election of directorsand approval of significant corporate transactions. This concentration ofownership may have the effect of delaying or preventing a change in control andmight affect the market price of our common stock. This concentration ofownership may not be in the best interest of our other stockholders.

 

# *Our Shareholder Rights Plan, Certificate of Incorporation,Bylaws and Delaware law contain provisions that could discourage a takeoverthat is beneficial to stockholders*

#  

Our Shareholder Rights Planas well as provisions of our Certificate of Incorporation, our Bylaws andDelaware law could make it difficult for a third party to acquire us, even ifdoing so would be beneficial to our stockholders.

 

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*Our Common Stock may become ineligible for listing on the NasdaqGlobal Market or alternatively the Nasdaq Capital Market if it does not tradeat or above $1.00, which would materially adversely affect the liquidity andprice of our Common Stock.*

 

Weare listed on the Nasdaq Global Market. Our continued listing is contingent onmeeting specific quantitative standards, including a minimum closing bid priceof $1.00. Our Common Stock has at times traded below $1.00 during the fiscalfourth quarter of 2008.  In the event thatour stock fails to maintain a minimum closing bid price of at least $1.00 for30 consecutive business days, we may receive a deficiency notice from theListing Qualifications Department of the Nasdaq Stock Market.  If we receive a deficiency notice, our stockwill have to achieve a minimum closing bid price of at least $1.00 for at least10 consecutive business days within 180 calendar days, or else we may bedelisted from the Nasdaq Global Market. Should we be delisted from the Nasdaq Global Market, we may be eligiblefor listing on the Nasdaq Capital Market, subject to meeting specificquantitative standards, including maintaining a minimum closing bid price of$1.00, and would have to achieve that within the 180 calendar days of initiallisting on the Nasdaq Capital Market. The Nasdaq Stock Market suspended the minimum closing bid requirementsuntil January 2009.

 

Ifour Common Stock becomes ineligible for listing on either the Nasdaq GlobalMarket or the Nasdaq Capital Market, and is thereafter traded only on theover-the-counter market, our stockholders’ abilities to purchase and sell ourCommon Stock could be less orderly and efficient and more costly. Furthermore,a delisting of our Common Stock could have a materially adverse impact on ourbusiness operations by damaging our general business reputation, impairing ourability to obtain additional capital, reducing the incentives that equityownership is intended to provide to our employees, and causing a loss ofconfidence by investors, suppliers and employees. As a result of the negativeimpact on the liquidity of our Common Stock and on our business, a delistingwould also likely decrease the market price of our Common Stock and increasethe volatility of our stock price.

 

# *The market price of our common stock may fluctuatesignificantly and could lead to securities litigation*

#  

Stock prices for manycompanies in the technology and emerging growth sectors have experienced widefluctuations that have often been unrelated to the operating performance ofsuch companies. Our stock is thinly traded and the decisions by significantshareholders to acquire or dispose of our stock can have a material impact onstock price. In the past, securities class action litigation has often beenbrought against a company following periods of volatility in the market priceof its securities. In the future, we may be the subject of similar litigation.Securities litigation could result in substantial costs and divert management’sattention.

 

# *Changes to existing accounting pronouncements or taxation rules orpractices may cause adverse revenue fluctuations, affect our reported financialresults or how we conduct our business*

#  

Generally acceptedaccounting principles are promulgated by, and are subject to the interpretationof the FASB and the SEC. New accounting pronouncements or taxation rules andvarying interpretations of accounting pronouncements or taxation practices haveoccurred and may occur in the future. Any future changes in accountingpronouncements or taxation rules or practices may have a significant effecton how we report our results and may even affect our reporting of transactionscompleted before the change is effective. In addition, a review of existing orprior accounting practices may result in a change in previously reportedamounts. This change to existing rules, future changes, if any, or thequestioning of current practices may adversely affect our reported financialresults, our ability to remain listed on the Nasdaq Global Market, or the waywe conduct our business and subject us to regulatory inquiries or litigation.

 

*Compliancewith regulations related to corporate governance and public disclosure mayresult in additional expenses*

 

Federal securities laws, rules andregulations, as well as Nasdaq rules and regulations, require companies tomaintain extensive corporate governance measures, impose comprehensivereporting and disclosure requirements, set strict independence and financialexpertise standards for audit and other committee members and impose civil andcriminal penalties for companies and their chief executive officers, chieffinancial officers and directors for securities law violations. These laws, rules andregulations have increased and will continue to increase the scope, complexityand cost of our corporate governance, reporting and disclosure practices, whichcould harm our results of operations and divert management’s attention frombusiness operations. We are committed to maintaining high

 

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standards of corporate governance and publicdisclosure. If our efforts to comply with new or changed laws, regulations andstandards differ from the activities intended by regulatory or governing bodiesdue to ambiguities related to practice, our reputation may be harmed and themarket price of our common stock could be affected.

 

# *While we believe that we currently have adequate internalcontrol procedures in place, we are still exposed to potential risks fromlegislation requiring companies to evaluate controls under Section 404 ofthe Sarbanes-Oxley Act of 2002*

#  

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting. Internal control over financial reporting cannot provideabsolute assurance of achieving financial reporting objectives because of itsinherent limitations. Internal control over financial reporting is a processthat involves human diligence and compliance and is subject to lapses injudgment and breakdowns resulting from human failures. Internal control overfinancial reporting also can be circumvented by collusion or impropermanagement override. Because of such limitations, there is a risk that materialmisstatements may not be prevented or detected on a timely basis by internalcontrol over financial reporting. However, these inherent limitations are knownfeatures of the financial reporting process. Therefore, it is possible todesign into the process safeguards to reduce, though not eliminate, this risk.

 

We have evaluated ourinternal control systems in order to allow management to report on our internalcontrol over financial reporting, as required by Section 404 of theSarbanes-Oxley Act. We performed the system and process evaluation and testingrequired in an effort to comply with the management certification of Section 404.While we believe that our internal control procedures are adequate and weintend to continue to fully comply with the requirements relating to internalcontrol and all other aspects of Section 404, our controls necessary forcontinued compliance with the Sarbanes-Oxley Act may not operate effectively atall times and may result in a material control disclosure. The identificationof a material weakness in internal control over financial reporting, if any,could indicate a lack of proper controls to generate accurate consolidatedfinancial statements. Furthermore, we cannot be certain as to the outcome offuture evaluations, testing and remediation actions or the impact of the sameon our operations. If we are not able to remain in compliance with therequirements of Section 404, we might be subject to sanctions orinvestigation by regulatory authorities, such as the SEC or the Nasdaq GlobalMarket. Any such action could adversely affect our financial results and themarket price of our common stock.

 

# *We have implemented import and export control procedures tocomply with United States regulations but we are still exposed to potentialrisks from import and export activity*

#  

Our products, solutions,technology and software are subject to import and export control laws andregulations which, in some instances, may impose restrictions on businessactivities, or otherwise require licenses or other authorizations from agenciessuch as the U.S. Department of State, U.S. Department of Commerce and U.S.Department of the Treasury. These restrictions may impact deliveries tocustomers or limit development and manufacturing alternatives. We have importand export licensing and compliance procedures in place for purposes ofconducting our business consistent with U.S. and applicable international lawsand regulations, and we periodically review these procedures to maintaincompliance with the requirements relating to import and export regulations. Ifwe are not able to remain in compliance with import and export regulations, wemight be subject to investigation, sanctions or penalties by regulatoryauthorities. Such penalties can include civil, criminal or administrativeremedies such as loss of export privileges. We cannot be certain as to theoutcome of an evaluation, investigation, inquiry or other action or the impactof these items on our operations. Any such action could adversely affect ourfinancial results and the market price of our common stock.

 

# *The Company, our directors and management have in the pastbeen named parties to lawsuits and may be subject to future litigation, whichcould result in an unfavorable outcome and have a material adverse effect onour business, financial condition, results of operations, cash flows and thetrading price for our securities*

#  

The Company and certain ofour directors and officers are named in a lawsuit relating to the initialpublic offering laddering litigation. We may become the subject of otherprivate or government actions in the future. Litigation may be time consuming,expensive and disruptive to normal business operations and the outcome oflitigation is difficult to predict. Any expenses associated with litigation orthe outcome relating to any such actions could have a material adverse effecton our business, financial condition, results of operations, cash flows and thetrading price for our securities.

 

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**Item 6. Exhibits**

 

a.     Exhibits

 

The following Exhibits arefiled with this report:

 
| **Exhibit  Number** | ** ** | **Description** |
|---------------------|------------|-----------------|
|                | 3.1(1)     |            | Amended and Restated  Certificate of Incorporation of Registrant. |
|                | 3.2(2)     |            | Bylaws of Registrant. |
|                | 10.20      |            | Second Amendment to Lease  Agreement between NetApp, Inc. and the registrant effective  September 25, 2008. |
|                | 31.1       |            | CEO Certification pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002. |
|                | 31.2       |            | CFO Certification pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002. |
|                | 32         |            | CEO and CFO Certifications  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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(1)        Incorporated by reference to the Company’sRegistration Statement on Form S-1 declared effective October 14,1999 (Commission File No. 333-28833).

(2)        Incorporatedby reference to the Company’s Current Report on Form 8-K (Item 5.03)filed May 2, 2005.

 

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**Signatures**

 

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

 
|                         | **QUICKLOGIC CORPORATION**                                         |
|------------------------------|--------------------------------------------------------------------|
|                         |                                                               |
|                         | /s/ CARL M. MILLS                                                  |
| Date:  November 6, 2008 | Carl M. Mills                                                      |
|                         | *Chief Financial Officer*                                          |
| * *                     | *(as Principal Accounting and Financial Officer and  on behalf of* |
| * *                     | *Registrant)*                                                      |

 

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Description** |
|---------------------|------------|-----------------|
|                | 3.1(1)     |            | Amended  and Restated Certificate of Incorporation of Registrant. |
|                | 3.2(2)     |            | Bylaws  of Registrant. |
|                | 10.20      |            | Second  Amendment to Lease Agreement between NetApp, Inc. and the registrant  effective September 25, 2008. |
|                | 31.1       |            | CEO  Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|                | 31.2       |            | CFO  Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|                | 32         |            | CEO  and CFO Certifications pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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(1)        Incorporated by reference to the Company’s Registration Statement on Form S-1declared effective October 14, 1999 (Commission File No. 333-28833).

(2)        Incorporated by reference to the Company’s Current Report on Form 8-K(Item 5.03) filed May 2, 2005.

 

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