**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

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**FORM 10-Q**

 

**(MarkOne)**
| x          | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                          |
|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** **                                                                                                                                                                                                                                                                                                                                 |
| ** ** | **For the Quarterly Period Ended October 1, 2006**                                                                                                                                                                                                                                                                                         |
| ** ** | ** **                                                                                                                                                                                                                                                                                                                                 |
| **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 of registrant as specified in its charter)

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

 

**1277ORLEANS DRIVE SUNNYVALE, CA  94089**

(Address of principal executive offices, including Zip Code)

**(408) 990-4000**

(Registrant’s telephone number, including area code)

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to suchrequirements for the past 90 days. Yes x  No o

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

Large accelerated filer o                                   Acceleratedfiler x                                              Non-acceleratedfiler o

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

As of January 3,2007, 28,679,626 shares of the registrant’s common stock were outstanding.

 

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**QUICKLOGICCORPORATION**

**FORM10-Q**

**SEPTEMBER 30,2006**
|                                                                                                                                                   | **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 30, 2006 and 2005                  | 3        |
| Condensed  Unaudited Consolidated Balance Sheets as of September 30, 2006 and  December 31, 2005                                        | 4        |
| Condensed  Unaudited Consolidated Statements of Cash Flows for the nine months ended  September 30, 2006 and 2005                            | 5        |
| Condensed  Unaudited Consolidated Statements of Comprehensive Income (Loss) for the  three and nine months ended September 30, 2006 and 2005 | 6        |
| Notes to  Condensed Unaudited Consolidated Financial Statements                                                                                   | 7        |
|                                                                                                                                              |     |
| **Item 2. Management’s Discussion  and Analysis of Financial Condition and Results of Operations**                                      | 29       |
| ** **                                                                                                                                        |     |
| **Item 3.** Quantitative and Qualitative Disclosures about Market Risk                                                                            | 42       |
| ** **                                                                                                                                        |     |
| **Item 4.** Controls and Procedures                                                                                                               | 43       |
|                                                                                                                                              |     |
| **Part II. Other  Information**                                                                                                                   | 44       |
| ** **                                                                                                                                        |     |
| **Item 1.** Legal Proceedings                                                                                                                     | 44       |
| ** **                                                                                                                                        |     |
| **Item 1A.** Risk  Factors                                                                                                                        | 44       |
| ** **                                                                                                                                        |     |
| **Item 6.** Exhibits                                                                                                                              | 58       |
| ** **                                                                                                                                        |     |
| Signatures                                                                                                                                        | 59       |

 

2

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**PARTI. Financial Information**

**Item1. Financial Statements**

**QUICKLOGICCORPORATION**

**CONDENSED UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Inthousands, except per share amounts)**
| ** **                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Revenue                              |       | $                                                    | 8,598      |                                                | $          | 12,645 |   | $ | 27,180 |   | $ | 37,942 |   |
| Cost of revenue                      |       | 5,371                                                |       | 4,326                                               |       | 13,352 |   | 13,828 |   |
| Gross profit                         |       | 3,227                                                |       | 8,319                                               |       | 13,828 |   | 24,114 |   |
| Operating expenses:                  |       |                                                 |       |                                                |       |   |   |   |   |
| Research and  development            |       | 2,429                                                |       | 2,449                                               |       | 7,186 |   | 7,237 |   |
| Selling, general  and administrative |       | 3,994                                                |       | 4,140                                               |       | 13,205 |   | 12,480 |   |
| Income (loss) from  operations       |       | (3,196                                               | )          | 1,730                                               |       | (6,563 | ) | 4,397 |   |
| Write-down of  marketable securities |       | —                                               |       | —                                              |       | — |   | (1,466 | ) |
| Interest expense                     |       | (65                                                  | )          | (46                                                 | )          | (235 | ) | (152 | ) |
| Interest income and  other, net      |       | 333                                                  |       | 92                                                  |       | 966 |   | 262 |   |
| Income (loss) before  income taxes   |       | (2,928                                               | )          | 1,776                                               |       | (5,832 | ) | 3,041 |   |
| Provision for income  taxes          |       | 23                                                   |       | 154                                                 |       | 46 |   | 235 |   |
| Net income (loss)                    |       | $                                                    | (2,951     | )                                                   | $          | 1,622 |   | $ | (5,878 | ) | $ | 2,806 |   |
|                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Net income (loss) per  share:        |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                |       | $                                                    | (0.10      | )                                                   | $          | 0.06 |   | $ | (0.21 | ) | $ | 0.10 |   |
| Diluted                              |       | $                                                    | (0.10      | )                                                   | $          | 0.06 |   | $ | (0.21 | ) | $ | 0.10 |   |
|                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted average  shares:            |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                |       | 28,678                                               |       | 27,146                                              |       | 28,420 |   | 26,759 |   |
| Diluted                              |       | 28,678                                               |       | 28,313                                              |       | 28,420 |   | 27,889 |   |

 

See accompanyingNotes to Condensed Unaudited Consolidated Financial Statements.

3

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**QUICKLOGICCORPORATION**

**CONDENSED UNAUDITED CONSOLIDATED BALANCE SHEETS**

**(Inthousands, except par value amount)**
| ** **                                                                                                                | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                | ** ** | ** **                   | ** ** | ** **                  | ** ** |
|                                                                                                                      |       |                         |       |                        |       |
| Current assets:                                                                                                           |       |                         |       |                        |       |
| Cash and cash equivalents                                                                                                 |       | $                            | 29,849     |                        | $          | 28,283 |   |
| Short-term investment in Tower Semiconductor Ltd.                                                                         |       | 1,306                        |       | 1,297                       |       |
| Accounts receivable, net of allowances for doubtful  accounts of $730 and $1,042, respectively                            |       | 3,648                        |       | 5,556                       |       |
| Inventory                                                                                                                 |       | 6,877                        |       | 7,830                       |       |
| Other current assets                                                                                                      |       | 1,791                        |       | 1,265                       |       |
| Total current assets                                                                                                      |       | 43,471                       |       | 44,231                      |       |
| Property and  equipment, net                                                                                              |       | 5,896                        |       | 5,697                       |       |
| Investment in  Tower Semiconductor Ltd.                                                                                   |       | 657                          |       | 653                         |       |
| Other assets                                                                                                              |       | 4,653                        |       | 4,415                       |       |
| TOTAL ASSETS                                                                                                              |       | $                            | 54,677     |                        | $          | 54,996 |   |
|                                                                                                                      |       |                         |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                             | ** ** | ** **                   | ** ** | ** **                  | ** ** |
|                                                                                                                      |       |                         |       |                        |       |
| Current  liabilities:                                                                                                     |       |                         |       |                        |       |
| Trade payables                                                                                                            |       | $                            | 4,364      |                        | $          | 3,338 |   |
| Accrued liabilities                                                                                                       |       | 2,795                        |       | 3,434                       |       |
| Deferred income on shipments to distributors                                                                              |       | 1,404                        |       | 1,626                       |       |
| Current portion of debt and capital lease  obligations                                                                    |       | 2,418                        |       | 1,790                       |       |
| Total current liabilities                                                                                                 |       | 10,981                       |       | 10,188                      |       |
|                                                                                                                      |       |                         |       |                        |       |
| Long-term  liabilities:                                                                                                   |       |                         |       |                        |       |
| Debt and capital lease obligations, less current  portion                                                                 |       | 2,014                        |       | 1,163                       |       |
| Deferred royalty revenue                                                                                                  |       | 1,614                        |       | 1,408                       |       |
| Total long-term liabilities                                                                                               |       | 3,628                        |       | 2,571                       |       |
| Total liabilities                                                                                                         |       | 14,609                       |       | 12,759                      |       |
|                                                                                                                      |       |                         |       |                        |       |
| Commitments and  contingencies (see Notes 15 and 16)                                                                 |       |                         |       |                        |       |
|                                                                                                                      |       |                         |       |                        |       |
| Stockholders’  equity:                                                                                               |       |                         |       |                        |       |
| Common stock, $0.001 par value; 100,000 shares  authorized; 28,680 and 27,896 shares issued and outstanding, respectively |       | 29                           |       | 28                          |       |
| Additional paid-in capital                                                                                                |       | 163,838                      |       | 159,179                     |       |
| Accumulated other comprehensive income                                                                                    |       | 390                          |       | 377                         |       |
| Accumulated deficit                                                                                                       |       | (124,189                     | )          | (117,347                    | )          |
| Total stockholders’ equity                                                                                           |       | 40,068                       |       | 42,237                      |       |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                          |       | $                            | 54,677     |                        | $          | 54,996 |   |

 

See accompanyingNotes to Condensed Unaudited Consolidated Financial Statements.

4

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**QUICKLOGICCORPORATION**

**CONDENSED UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Inthousands)**
| ** **                                                                                | ** ** | **Nine Months Ended   September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2006**                                                  | ** ** | **2005** | ** ** |
| ** **                                                                                | ** ** | ** **                                                | ** ** | ** ** | ** ** |
| Cash flows from  operating activities:                                                    |       |                                                      |       |   |   |
| Net income (loss)                                                                         |       | $                                                         | (5,878     | ) | $ | 2,806 |   |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                                                      |       |   |   |
| Depreciation and amortization                                                             |       | 2,303                                                     |       | 2,012 |   |
| Loss on disposal of property and equipment                                                |       | —                                                    |       | 7 |   |
| Stock-based compensation                                                                  |       | 1,145                                                     |       | — |   |
| Utilization of wafer credits from Tower  Semiconductor Ltd.                               |       | 132                                                       |       | 233 |   |
| Inventory write-down                                                                      |       | 1,684                                                     |       | 290 |   |
| Write-down of marketable securities                                                       |       | —                                                    |       | 1,466 |   |
| Write-off of long-lived assets                                                            |       | 34                                                        |       | 66 |   |
| Changes in assets and liabilities:                                                        |       |                                                      |       |   |   |
| Accounts receivable, net of allowances for doubtful  accounts                             |       | 1,908                                                     |       | (2,416 | ) |
| Inventory                                                                                 |       | (731                                                      | )          | (1,926 | ) |
| Other assets                                                                              |       | (738                                                      | )          | 448 |   |
| Trade payables                                                                            |       | 1,026                                                     |       | (1,076 | ) |
| Accrued liabilities                                                                       |       | (639                                                      | )          | 588 |   |
| Deferred income and royalty revenue                                                       |       | (16                                                       | )          | 517 |   |
| Net cash provided by operating activities                                                 |       | 230                                                       |       | 3,015 |   |
|                                                                                      |       |                                                      |       |   |   |
| Cash flows from  investing activities:                                                    |       |                                                      |       |   |   |
| Capital expenditures for property and equipment                                           |       | (1,903                                                    | )          | (1,257 | ) |
| Net cash used for investing activities                                                    |       | (1,903                                                    | )          | (1,257 | ) |
|                                                                                      |       |                                                      |       |   |   |
| Cash flows from  financing activities:                                                    |       |                                                      |       |   |   |
| Payment of debt and capital lease obligations                                             |       | (1,802                                                    | )          | (1,884 | ) |
| Proceeds from debt obligations                                                            |       | 2,490                                                     |       | 550 |   |
| Net change in revolving line of credit                                                    |       | —                                                    |       | (2,000 | ) |
| Proceeds from issuance of common stock                                                    |       | 2,551                                                     |       | 2,055 |   |
| Net cash provided by (used for) financing activities                                      |       | 3,239                                                     |       | (1,279 | ) |
|                                                                                      |       |                                                      |       |   |   |
| Net increase in  cash and cash equivalents                                                |       | 1,566                                                     |       | 479 |   |
| Cash and cash equivalents at beginning of period                                          |       | 28,283                                                    |       | 24,914 |   |
| Cash and cash equivalents at end of period                                                |       | $                                                         | 29,849     |   | $ | 25,393 |   |
|                                                                                      |       |                                                      |       |   |   |
| Supplemental  disclosures of cash flow information:                                       |       |                                                      |       |   |   |
| Interest paid                                                                             |       | $                                                         | 284        |   | $ | 211 |   |
| Income taxes paid                                                                         |       | $                                                         | 42         |   | $ | 86 |   |
| Supplemental  schedule of non-cash investing and financing activities:               |       |                                                      |       |   |   |
| Capital lease  obligation to finance capital expenditures and related maintenance         |       | $                                                         | 791        |   | $ | — |   |

 

See accompanyingNotes to Condensed Unaudited Consolidated Financial Statements.

5

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**QUICKLOGICCORPORATION**

**CONDENSED UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVEINCOME (LOSS)**

**(Inthousands)**
| ** **                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Net income  (loss)                     |       | $                                                    | (2,951     | )                                                   | $          | 1,622 |   | $ | (5,878 | ) | $ | 2,806 |   |
| Other  comprehensive gain, net of tax: |       |                                                 |       |                                                |       |   |   |   |   |
| Unrealized gain on investments         |       | 81                                                   |       | 81                                                  |       | 13 |   | 81 |   |
| Total comprehensive  income (loss)     |       | $                                                    | (2,870     | )                                                   | $          | 1,703 |   | $ | (5,865 | ) | $ | 2,887 |   |

 

See accompanyingNotes to Condensed Unaudited Consolidated Financial Statements.

6

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**QUICKLOGIC CORPORATION**

**NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

**Note 1—The Company and Basis ofPresentation**

QuickLogicCorporation (“QuickLogic” or the “Company”), founded in 1988, is a Delawarecorporation. The Company operates in a single reportable industry segment whereit designs, develops, markets and supports advanced field programmable gatearrays (“FPGAs”), Embedded Standard Products (“ESPs”), associated softwaretools and programming hardware.

The accompanyinginterim consolidated financial statements are unaudited. In the opinion ofmanagement, these statements have been prepared in accordance with generallyaccepted accounting principles (“GAAP”) and include all adjustments, consistingonly of normal recurring adjustments, necessary to provide a fair statement ofresults for the interim periods presented. The Company recommends that theseconsolidated financial statements be read in conjunction with the Company’sForm 10-K for the year ended December 31, 2005. Operating results forthe three and nine months ended September 30, 2006 are not necessarilyindicative of the results that may be expected for the full year.

QuickLogic’sfiscal year ends on the Sunday closest to December 31.  QuickLogic’sfiscal third quarters for 2006 and 2005 ended Sunday, October 1, 2006 andOctober 2, 2005, respectively. For presentation purposes, theconsolidated financial statements and notes have been presented as ending onthe last day of the nearest calendar month.

*Cumulativeeffect adjustment upon the adoption of Staff Accounting Bulletin No. 108, “Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements” (“SAB No. 108”)*

Under thedirection of the Audit Committee of the Board of Directors, the Companyvoluntarily conducted an internal review of the Company’s historical stockoption granting practices and related accounting for the period from October15, 1999, the date of its initial public offering, through July 28, 2006. Thereview was initiated by the Audit Committee in response to media attentionabout stock option practices at other companies. The Company did not find anysystematic or pervasive practices to account for stock options in a mannerinconsistent with GAAP or the Company’s stated policies and procedures.However, based on the results of the review and the Company’s analysis of thefacts, the Company determined that there were certain errors committed in theprocess of documenting grants and accounting for stock options associated withmeasurement dates, grants prior to meeting the definition of an employee underGAAP, non-employee grants, modification of options and previously reporteddeferred stock compensation charges. A total pre-tax stock-based compensationcharge of $964,000 is associated with these identified errors that should havebeen reported in previously issued consolidated financial statements had theybeen identified in the proper period. After considering all of the quantitativeand qualitative factors in accordance with Staff Accounting Bulleting No. 99, “*Materiality,”* the Company determined thatthese adjustments were not material to any prior year and, thus, the Companyhas not restated its consolidated financial statements for prior periods.However, given that the effect of correcting these errors in 2006 would causethe 2006 consolidated financial statements to be materially misstated, theCompany concluded that the cumulative effect adjustment method of initiallyapplying the guidance of SAB No. 108 was appropriate. Accordingly, the Companyelected early adoption of SAB No. 108 in its quarterly report for the secondquarter of 2006 and the cumulative effect of the adjustment was reflected as anincrease to the carrying amount of additional paid-in capital as of January 1,2006, with an offsetting entry to accumulated deficit. In addition, less than$50,000 of the adjustment to previously issued consolidated financialstatements was due to errors that occurred after October 2002. See Note 3 foradditional information regarding the review conducted at the direction of theAudit Committee of the Board of Directors and the cumulative effect adjustmentto previously issued consolidated financial statements.

*Liquidity*

The Companyanticipates that its existing cash resources will fund operations, financepurchases of capital equipment and provide adequate working capital for thenext twelve months. The Company’s liquidity is affected by many factorsincluding, among others, the level of revenue and gross profit, marketacceptance of existing and new products including EclipseTM II, QuickPCI® II andPolarProTM devices, the decline in pASIC® 1 and pASIC 2 revenue as a resultof their end-of-life, costs of securing access to and availability of adequatemanufacturing capacity, inventory levels, wafer purchase commitments, customercredit terms, the amount and timing of research 

7

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**QUICKLOGIC CORPORATION**

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

and developmentexpenditures, the timing of new product introductions, production volumes,product quality, sales and marketing efforts, the amount and financingarrangements for purchases of capital equipment, changes in operating assetsand liabilities, the ability to obtain or renew debt financing and to remain incompliance with the terms of existing credit facilities, the ability to raisefunds from the sale of shares of Tower Semiconductor Ltd. (“Tower”) and equityin the Company, the issuance and exercise of stock options, the terms of andparticipation in the Company’s employee stock purchase plan, and other factorsrelated to the uncertainties of the industry and global economics. Accordingly,there can be no assurance that events in the future will not require theCompany to seek additional capital or, if so required, that such capital willbe available on terms acceptable to the Company.

*Principles of Consolidation*

The consolidated financial statements include the accounts ofQuickLogic Corporation and its wholly owned subsidiaries, QuickLogicInternational, Inc., QuickLogic Canada Company, QuickLogic KabushikiKaisha, QuickLogic Software (India) Private Ltd., and QuickLogic GmbH. TheCompany uses the U.S. dollar as its functional currency. All significantintercompany accounts and transactions are eliminated in consolidation.

*Uses of Estimates*

The preparation ofthese consolidated financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities, the disclosures ofcontingent assets and liabilities, and the reported amounts of revenue andexpenses during the period. Actual results could differ from those estimates,particularly in relation to revenue recognition, the allowance for doubtfulaccounts, sales returns, valuation of investments, valuation of long-livedassets, inventory valuation including identification of excess quantities andobsolescence, measurement of stock-based compensation awards, accounting forincome taxes and estimating accrued liabilities.

**Note 2—Significant AccountingPolicies**

*Revenue Recognition*

The Company suppliesstandard products which must be programmed before they can be used in anapplication. The Company’s products may be programmed by the Company,distributors, end customers or third parties. Once programmed, the Company’sparts cannot be erased and, therefore, programmed parts are only useful to aspecific customer.

The Companygenerally recognizes revenue as products are shipped if evidence of anarrangement exists, delivery has occurred, the sales price is fixed ordeterminable, collection of the resulting receivable is reasonably assured, andproduct returns are reasonably estimable.

Revenue isrecognized upon shipment of both programmed and unprogrammed parts to originalequipment manufacturer (“OEM”) customers, provided that legal title and risk ofownership have transferred.

The Company alsosells to distributors under agreements that allow for price adjustments and, inthe case of unprogrammed parts, certain rights of return on unsold inventory.

Because programmedparts can only be used by a specific customer, it is the Company’s practice toagree upon any price adjustments with a distributor prior to shipment.Furthermore, distributors are not allowed any future price adjustments and haveno rights of return on programmed parts. Accordingly, revenue is recognizedupon delivery to a distributor since title and risk of ownership havetransferred to the distributor, the price is fixed, no right of return exists,and collection of the resulting receivable is reasonably assured.

Unprogrammed partsshipped to distributors may be used by multiple end customers and distributorsmay have certain return and price adjustment privileges on unsold inventory.Accordingly, revenue associated with unprogrammed parts is deferred untilresale to the end customer.

8

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**QUICKLOGIC CORPORATION**

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

Software revenuefrom sales of design tools is recognized when persuasive evidence of anagreement exists, delivery of the software has occurred, no significant Companyobligations with regard to implementation or integration remain, the fee isfixed or determinable and collection is reasonably assured. Software revenueamounted to less than one percent of the Company’s revenue for the three andnine months ended September 30, 2006 and 2005.

*Long-lived Assets*

The Companyreviews the recoverability of its long-lived assets, such as property andequipment, prepaid wafer credits and investments, annually and when events orchanges in circumstances occur that indicate that the carrying value of theasset or asset group may not be recoverable. The assessment of possibleimpairment is based on the Company’s ability to recover the carrying value ofthe asset or asset group from the expected future pretax cash flows,undiscounted and without interest charges, of the related operations. If thesecash flows are less than the carrying value of the asset or asset group, animpairment loss is recognized for the difference between estimated fair valueand carrying value, and the carrying value of the related assets is reduced bythis difference. The measurement of impairment requires management to estimate futurecash flows and the fair value of long-lived assets.

*Comprehensive Income (Loss)*

Comprehensiveincome (loss) includes all changes in equity (net assets) during a period fromnon-owner sources. Comprehensive income (loss) for the Company has included realizedand unrealized holding gains or losses on Tower ordinary shares. See Note 5.

*Stock-Based Compensation*

EffectiveJanuary 2, 2006, the Company adopted the provisions of Statement ofFinancial Accounting Standards (“SFAS”) No. 123 (revised 2004), *“Share-Based Payment,”* (“SFAS No.123(R)”) which requires the measurement and recognition of expense related tothe fair value of stock-based compensation awards. Accordingly, stock-basedcompensation is measured at the grant date and re-measured upon modification,as appropriate, based on the fair value of the award using the Black-Scholesoption pricing model (“Black-Scholes”), and is recognized as expense over therequisite service period of the award. Black-Scholes requires the use of highlysubjective, complex assumptions, including expected term and the pricevolatility of the Company’s stock. The Company elected to use the modifiedprospective transition method upon implementation and, therefore, has notrestated its financial results for prior periods. The Company previouslyapplied Accounting Principles Board Opinion No. 25, *“Accounting for Stock Issued to Employees”*(“APB 25”) and related interpretations and provided the required pro formadisclosures of SFAS No. 123, *“Accounting forStock-Based Compensation”* (“SFAS No. 123”). In March 2005,the SEC issued Staff Accounting Bulletin No. 107 (“SAB No. 107”)relating to SFAS No. 123(R). The Company has applied the provisions ofSAB No. 107 in its adoption of SFAS No. 123(R). See Note 10.

*Foreign Currency Transactions*

All of the Company’ssales and cost of manufacturing are transacted in U.S. dollars. The Companyconducts a portion of its research and development activities in Canada andIndia and has sales and marketing activities in various countries outside ofthe United States. Most of these international expenses are incurred in localcurrency. The functional currency of the Company’s subsidiaries is the U.S.dollar. Foreign currency transaction gains and losses are included in interestincome and other, net, as they occur. The effect of foreign currency exchangerate fluctuations has not been significant to date. Operating expensesdenominated in foreign currencies were approximately 22% and 25% of totaloperating expenses for the nine months ended September 30, 2006 and 2005,respectively. The Company incurred a majority of these foreign currencyexpenses in Canada. The Company has not used derivative financial instrumentsto hedge its exposure to fluctuations in foreign currency.

*Concentration of Credit Risk*

Financialinstruments, which potentially subject the Company to concentrations of creditrisk, consist principally of cash and cash equivalents and accounts receivable.Cash and cash equivalents are maintained with high quality institutions. TheCompany’s accounts receivable are denominated in U.S. dollars and are derived 

9

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**QUICKLOGIC CORPORATION**

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

primarily from sales tocustomers located in North America, Europe, and Asia. The Company performsongoing credit evaluations of its customers and generally does not requirecollateral.

A contractmanufacturer purchasing product for use in a European OEM telecom design, adistributor and a healthcare manufacturing company accounted for 22%, 22% and12%, respectively, of the Company’s accounts receivable balance at September30, 2006.

Two distributorsof the Company’s products accounted for 25% and 13%, respectively, of theCompany’s accounts receivable balance at December 31, 2005. In addition, oneOEM customer accounted for 18% of the Company’s accounts receivable balance atDecember 31, 2005.

*Warranty Costs*

The Companygenerally warrants finished goods against defects in material and workmanshipunder normal use for twelve months from the date of shipment. The Companydoes not have significant product warranty related costs or liabilities. Theone-time-programmable nature of QuickLogic’s products minimizes warranty costs.

*RecentlyIssued Accounting Pronouncements*

OnDecember 16, 2004, the Financial Accounting Standards Board (“FASB”)issued Statement of Financial Accounting Standards No. 123(R), *“Share-Based Payment,”* which is a revisionof SFAS No. 123 and supersedes APB 25. SFAS No. 123(R) requiresall share-based payments (“SBPs”) to employees, including grants of employeestock options, to be valued at fair value on the date of grant, and to beexpensed over the requisite service period. Under SFAS No. 123(R), proforma disclosure of the income statement effects of share-based payments is nolonger an alternative. SFAS No. 123(R), as amended, is effective forall stock-based awards granted in fiscal years beginning after June 15, 2005.In addition, companies must also recognize compensation expense related to anyawards that are not fully vested as of the effective date. Compensation expensefor the unvested awards will be measured based on the fair value of the awardspreviously calculated in developing the pro forma disclosures in accordancewith the provisions of SFAS No. 123. Effective January 2, 2006, thefirst day of fiscal 2006, the Company adopted SFAS No. 123(R) on a modifiedprospective basis. As a result, the Company began to include stock-basedcompensation charges in its results of operations beginning in the quarterended March 31, 2006. See Note 10.

In November 2005,the FASB issued Staff Position (“FSP”) FAS123(R)-3, *“Transition Election to Accounting for the Tax Effects of Share-BasedPayment Awards.”* This FSP requires an entity to follow either thetransition guidance for the additional paid-in capital pool as prescribed inSFAS No. 123(R), or the alternative transition method as described in theFSP. An entity that adopts SFAS No. 123(R) using the modified prospectiveapplication may make a one-time election to adopt the transition methoddescribed in this FSP. An entity may take up to one year from the later of itsinitial adoption of SFAS No. 123(R) or the effective date of this FSP toevaluate its available transition alternatives and make its one-time election.The Company continues to evaluate the impact that the adoption of this FSPcould have on its consolidated financial statements.

On March 29,2005, the Securities and Exchange Commission (“SEC”) issued Staff AccountingBulletin No. 107 (“SAB No. 107”) which provides guidance on theinteraction between SFAS No. 123(R) and certain SEC rules and regulations.  SAB No. 107 provides guidance that maysimplify some of the SFAS No. 123(R) implementation challenges and enhancesthe information that investors receive. Effective January 2, 2006, thefirst day of fiscal 2006, the Company adopted SFAS No. 123(R) on a modifiedprospective basis and applied the principles of SAB No. 107 in conjunctionwith the adoption of SFAS No. 123(R).

In June 2006,the FASB issued FASB interpretation No. 48, *“Accountingfor Uncertainty in Income Taxes—an Interpretation of FASB StatementNo. 109,”* (“FIN No. 48”). FIN No. 48 requires thatthe Company recognize in the consolidated financial statements the impact of atax position that is more-likely-than-not to be sustained upon examinationbased on the technical merits of the position. The evaluation of a tax positionin accordance with this interpretation is a two-step process. In the firststep, recognition, the Company determines whether it is more-likely-than-notthat a tax position will be sustained upon examination, including resolution ofany related appeals or litigation processes, based on the technical merits ofthe position. The second step addresses measurement of a tax 

10

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**QUICKLOGIC CORPORATION**

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

position that meets themore-likely-than-not criteria. The tax position is measured at the largestamount of benefit that is greater than 50 percent likely of being realizedupon ultimate settlement. Tax positions that previously failed to meet themore-likely-than-not recognition threshold should be recognized in the firstsubsequent financial reporting period in which that threshold is met.Previously recognized tax positions that no longer meet themore-likely-than-not recognition threshold should be reversed in the firstsubsequent financial reporting period in which that threshold is no longer met.Use of a valuation allowance as described in FASB Statement No. 109 is notan appropriate substitute for the reversal of a tax position. The requirementto assess the need for a valuation allowance for deferred tax assets based onsufficiency of future taxable income is unchanged by this interpretation. FINNo. 48 is effective for fiscal years beginning after December 15,2006. The Company is currently evaluating the impact FIN No. 48 will haveon the Company’s consolidated financial statements.

In July 2006, theFASB issued Emerging Issues Task Force (“EITF”) Issue No. 06-3, *“How Taxes Collected from Customers are Remitted toGovernmental Authorities Should be Presented in the Income Statement (that isGross versus Net Presentation),”* (“EITF 06-3”). The adoption of EITF06-3 did not have an impact on the Company’s consolidated financial positionand results of operations.  The Company’saccounting policy has been to present the above mentioned taxes on a net basis,excluded from revenue.

In September 2006,the SEC issued Staff Accounting Bulletin No. 108, *“Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements,”* (“SAB No. 108”).SAB No. 108 was issued in order to eliminate the diversity of practicesurrounding how public companies quantify financial statement misstatements.Traditionally, there have been two recognized methods for quantifying theeffects of financial statement misstatements - the “rollover” method and the “ironcurtain” method. The rollover method focuses primarily on the impact of amisstatement on the income statement, including the reversing effect of priorperiod misstatements, but its use can lead to the accumulation of misstatementson the balance sheet. The iron curtain method, on the other hand, focusesprimarily on the effect of correcting the period-end balance sheet with lessemphasis on the reversing effects of prior year errors on the income statement.Prior to the application of the guidance in SAB No. 108, the Company used therollover method for quantifying the materiality of financial statementmisstatements.

In SAB No. 108,the SEC established an approach that requires quantification of financialstatement misstatements based on the effects of the misstatements on each ofthe Company’s consolidated financial statements and the related financialstatement disclosures. This model is commonly referred to as a “dual approach”because it requires quantification of errors under both the iron curtain andthe rollover methods. SAB No. 108 permits public companies to initially applyits provisions either by (i) restating prior financial statements as if the dualapproach had always been applied or (ii) recording the cumulative effect ofinitially applying the dual approach as an adjustment to the opening balance ofthe carrying values of assets and liabilities in the year of adoption with anoffsetting adjustment recorded to the opening balance of retained earnings(accumulated deficit). SAB No. 108 is effective for fiscal years ending afterNovember 15, 2006, and is encouraged in any report for an interim period in theyear of adoption. The Company has elected early adoption of SAB No. 108 inrelation to the results of its internal review of stock option grantingpractices and related accounting, and recorded the effects of applying SAB No.108 using the cumulative effect transition method in the quarterly report forthe second quarter of 2006. See Note 3.

In September 2006,the FASB issued Statement of Financial Accounting Standards No. 157, *“Fair Value Measurements,”* (“SFAS No. 157”).SFAS No. 157 establishes a framework for measuring fair value, and expandsdisclosures about fair value measurements. The changes to current practiceresulting from the application of SFAS No. 157 relate to the definition of fairvalue, the methods used to measure fair value, and expanded disclosures aboutfair value measurements. SFAS No. 157 is effective for fiscal years beginningafter November 15, 2007 and interim periods within those fiscal years. TheCompany is currently evaluating the impact that SFAS No. 157 will have on theCompany’s consolidated financial statements.

**Note 3—Cumulative Effect Adjustment under SAB No. 108**

Under thedirection of the Audit Committee of the Board of Directors, the Companyvoluntarily conducted an internal review of the Company’s historical stockoption granting practices and related accounting for the period from October15, 1999, the date of its initial public offering, through July 28, 2006. Thereview was initiated by the Audit Committee in response to media attention aboutstock option practices at other companies. The internal 

11

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**QUICKLOGIC CORPORATION**

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

review, conducted underthe guidance of outside legal counsel and with the assistance of outsideaccountants, is complete and the findings of the review were presented to theAudit Committee on November 16, 2006 and December 6, 2006.  The findings of the review, which werereported in the quarterly report for the second quarter of 2006, included, amongother things, the following:

·                  Therewas no systematic pattern of selecting an exercise price based on the loweststock price over the period preceding the grant.

·                  Therewere no pervasive practices to account for stock options in a manner inconsistentwith GAAP or the Company’s stated policies and procedures.

·                  Theerrors identified during the six year period covered by the review were errorscommitted in the process of documenting grants and accounting for stock optionsassociated with measurement dates, grants prior to meeting the definition of anemployee under GAAP, non-employee grants, modification of options andpreviously reported deferred stock compensation charges.

·                  Therewas no evidence that the errors were motivated by any intention to misleadinvestors or affect reported financial results.

·                  Less than$50,000 of the identified adjustments to previously issued consolidatedfinancial statements were due to errors that occurred after October 2002.

The Company shouldhave recorded additional non-cash stock-based compensation expense in thecumulative pre-tax amount of approximately $964,000 in its previously issuedconsolidated financial statements.  Thisamount consists of the following:

1.               FromOctober 1999 through May 2004, the date used to determine the exercise pricefor certain stock option grants preceded the finalization of the approvalprocess of those grants for accounting purposes due to administrative errors indocumenting or approving the grants.  Thetotal intrinsic value (the difference between the exercise price and the priceof the Company’s stock on the measurement date) of these “in-the-money” grants,which should have been amortized over their vesting period in the Company’spreviously issued consolidated financial statements, was approximately$787,000.

2.               FromOctober 1999 through July 2002, certain individuals were granted options priorto meeting all of the criteria of an employee under GAAP, as defined by APB 25and related interpretations, due to errors in documenting the individuals’start of employment.  The total intrinsicvalue of these grants, which should have been amortized over their vestingperiod in the Company’s previously issued consolidated financial statements,was approximately $449,000.

3.               TheCompany found accounting errors related to non-employee option grants fromJanuary 2000 through October 2002 which resulted in total charges of $328,000that should have been recorded over their vesting period.

4.               TheCompany found errors related to the modification of stock options to certainemployees between March 2001 and August 2005, which resulted in $132,000 ofcharges that should have been recorded. The errors were the result of uncleardocumentation and lapses in communication concerning employee termination agreements.Generally, these modifications were made in the context of separationagreements that permitted additional vesting and/or time to exercise optionsafter the employee had ceased performing services.

5.               Inaccordance with APB 25, the Company recorded deferred stock-based compensationin connection with grants of stock options to employees and directors prior tothe Company’s initial public offering if the fair market value of the Company’scommon stock determined for financial reporting purposes was greater than thefair value determined by the Board of Directors on the date of grant (commonlyknown as a “cheap stock” charge).  As ofOctober 15, 1999, the Company had approximately $1.6 million of deferredstock-based compensation recorded in the stockholders’ equity section of thebalance sheet, which was amortized over the original vesting period of thestock options.  During the review, theCompany determined that the reported deferred stock-based compensation account wasnot properly adjusted to reflect forfeitures. If an option is forfeited, the deferred stock-based compensation balancerelated to unvested options should be 

12

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**QUICKLOGIC CORPORATION**

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

reversed and no future expense recognized. As aresult, total stock-based compensation expense was overstated by approximately$732,000 from October 1999 through December 2003 due to this accounting errorin the application of the provisions of APB 25.

Effective with theCompany’s second quarter of 2006 consolidated financial statements, the Companyelected early adoption of SAB No. 108 (see Note 2). This accounting literatureprovides guidance on how to quantify the effects of prior year misstatements.At the time of the election, the Company had quantified the errors identifiedas a result of its stock option review and determined these errors to beindividually and in the aggregate immaterial, considering all the quantitativeand qualitative factors, to all fiscal years prior to fiscal 2006 under therollover method, the method which was historically used by the Company.However, given that the effect of correcting these errors in 2006 would causethe 2006 consolidated financial statements to be materially misstated, theCompany concluded that the cumulative effect adjustment method of initiallyapplying the guidance of SAB No. 108 was appropriate. Accordingly, the Companyelected to record the effects of applying SAB No. 108 using the cumulativeeffect transition method, which resulted in an increase to the carrying amountof the opening balance of additional paid-in capital and an offsetting entry toaccumulated deficit to correct these errors. The cumulative adjustment is notrecorded in the statements of operations. The impact on the previously reportedaccounts as of December 31, 2005, adjusted effective January 1, 2006, is asfollows (in thousands):
|                                  | ** ** | **December 31,   2005** | ** ** | **SAB No. 108   cumulative effect   adjustment** | ** ** | **January 1, 2006** | ** ** |
|----------------------------------|------------|-----------------------------------|------------|---------------------------------------------------------------------------|------------|-------------------------------|------------|
| Additional  paid-in capital      |       | $                                 | 159,179    |                                                                      | $          | 964                           |       | $ | 160,143 |   |
| Accumulated  deficit             |       | (117,347                          | )          | (964                                                                      | )          | (118,311                      | )          |
| Total stockholders’  equity |       | 42,237                            |       | —                                                                    |       | 42,237                        |       |
|                                  |            |                                   |            |                                                                           |            |                               |            |  |  |  |

 

The impact of theerrors if they had been appropriately recorded in the Company’s previouslyissued statements of operations is as follows (in thousands):
| Fiscal Year | ** ** | **Net Income (Loss)  (as previously reported)** | ** ** | **Adjustment** | ** ** | **Net Income (Loss)  (as adjusted)** | ** ** |
|------------------|------------|---------------------------------------------------------------------|------------|----------------|------------|-----------------------------------------------------|------------|
| 1999             |       |                                                                | $          | 3,161          |       | $                                                   | 45         |   | $ | 3,206 |   |
| 2000             |       |                                                                | 9,630      |           | (233       | )                                                   | 9,397      |   |
| 2001             |       |                                                                | (26,478    | )              | (195       | )                                                   | (26,673    | ) |
| 2002             |       |                                                                | (31,287    | )              | (148       | )                                                   | (31,435    | ) |
| 2003             |       |                                                                | (4,719     | )              | (118       | )                                                   | (4,837     | ) |
| 2004             |       |                                                                | (8,832     | )              | (230       | )                                                   | (9,062     | ) |
| 2005             |       |                                                                | 2,350      |           | (85        | )                                                   | 2,265      |   |
| ** **       | ** ** |                                                                |       |           | $          | (964                                                | )          |   |   |
|                  |            |                                                                     |            |                |            |                                                     |            |  |  |  |  |

 

The tax effect ofthe identified adjustments is not significant since the Company has a deferredtax asset with a full valuation allowance due to the Company’s net operatingloss carryforwards.

Enacted in October2004, Section 409A of the Internal Revenue Code significantly changed the rulesfor nonqualified deferred compensation plans. Section 409A imposes certain restrictions on stock awards thatconstitute deferred compensation.  TheCompany believes that the implications of Section 409A on grants with intrinsicvalue that vested after December 31, 2004 and modifications made to existinggrants after October 3, 2004 along with potential remedial actions is notmaterial to the 2006 consolidated financial statements.

*SECInquiry*

On July 26, 2006,the Company notified the Securities and Exchange Commission (“SEC”) that it wasconducting an internal review of its historical stock option practices andrelated accounting. On August 1, 2006, the Company received an informal inquiryfrom the SEC requesting certain documents and information relating to theCompany’s practices, procedures and disclosures regarding its stock optiongrants.  The Company complied with thisand subsequent requests made by the SEC and intends to cooperate fully with theSEC.

13

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**QUICKLOGIC CORPORATION**

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

**Note 4—NetIncome (Loss) Per Share**

Basic net income (loss)per share is computed by dividing net income (loss) available to commonstockholders by the weighted average number of common shares outstanding duringthe period. Diluted net income (loss) per share is computed using the weightedaverage number of common shares outstanding during the period plus potentiallydilutive common shares outstanding during the period under the treasury stockmethod. In computing diluted net income (loss) per share, the average stock pricefor the period is used in determining the number of shares assumed to bepurchased from the exercise of stock options. A reconciliation of the basic anddiluted per share computations is as follows (in thousands, except per shareamounts):
| ** **               | ** ** | **Three Months Ended September 30,** | ** ** |
|--------------------------|------------|----------------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                                 | ** ** | **2005** | ** ** |
| ** **               | ** ** | **Net Loss**                                        | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** | **Net Income** | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** |
| Basic                    |       | $                                                        | (2,951     | ) | 28,678 |   | $ | (0.10 | ) | $ | 1,622 |   | 27,146 |   | $ | 0.06 |   |
| Effect of stock  options |       | —                                                   |       | — |   | — |   | — |   | 1,167 |   | — |   |
| Diluted                  |       | $                                                        | (2,951     | ) | 28,678 |   | $ | (0.10 | ) | $ | 1,622 |   | 28,313 |   | $ | 0.06 |   |

 
| ** **               | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------|------------|---------------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| ** **               | ** ** | **Net Loss**                                       | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** | **Net Income** | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** |
| Basic                    |       | $                                                       | (5,878     | ) | 28,420 |   | $ | (0.21 | ) | $ | 2,806 |   | 26,759 |   | $ | 0.10 |   |
| Effect of stock  options |       | —                                                  |       | — |   | — |   | — |   | 1,130 |   | — |   |
| Diluted                  |       | $                                                       | (5,878     | ) | 28,420 |   | $ | (0.21 | ) | $ | 2,806 |   | 27,889 |   | $ | 0.10 |   |

 

For the three andnine months ended September 30, 2006, all vested and unvested optionsoutstanding were not included in the calculation of diluted net loss per share,as they were considered antidilutive due to the net loss the Companyexperienced during those periods. For the three and nine months endedSeptember 30, 2005, 3,799,000 and 4,536,000 shares, respectively, ofcommon stock subject to outstanding options were antidilutive and, therefore,were not included in the calculation of diluted net income per share, as theper share exercise price for such options exceeded the average trading price ofthe Company’s common stock during the respective period.

**Note 5—Investment in TowerSemiconductor Ltd.**

OnDecember 12, 2000, the Company entered into several agreements with Tower,as amended, under which the Company agreed to make a strategic investment inTower of up to $25 million as part of Tower’s plan to build and equip anew wafer fabrication facility. During 2001 and 2002, the Company paid a totalof $21.3 million to Tower to fulfill its investment requirements under theagreement. In partial consideration for the investment, the Company received1,757,368 Tower ordinary shares with an original cost of $16.6 million.Due to write-downs in fiscal years 2001, 2002, 2004 and 2005 as a result of “otherthan temporary” declines in market value, the adjusted cost of the Company’sTower ordinary shares is $1.17 per share. The Company sold a portion ofthe Tower ordinary shares in fiscal 2003.

As ofSeptember 30, 2006, the Company held 1,344,543 available for sale Towerordinary shares with an unrealized gain of $390,000 recorded in accumulatedother comprehensive income in the balance sheet, representing the differencebetween the adjusted cost per share and $1.46 per share, their market value onthe last trading day of the reporting period. The Company plans to continue tohold 450,000 of the Tower ordinary shares in order to receive competitiveproduct pricing under the agreements with Tower and has recorded these sharesas a long-term investment on the balance sheets. The remaining 894,543 sharesare classified as a short-term investment on the balance sheets.

The Company also received$4.7 million in prepaid wafer credits in partial consideration for theinvestment, $4.1 million of which remained available as ofSeptember 30, 2006. The credits have no stated maturity and the Companyhas guaranteed capacity at Tower through at least 2010. These credits arerecorded within long-term other assets on the balance sheets and can be appliedtoward wafer purchases from Tower at 15% of the value of future purchases.

14

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**QUICKLOGIC CORPORATION**

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

**Note 6—Balance Sheet Components**
| ** **                                | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **(in thousands)**      | ** ** |
| Inventory:                                |       |                         |       |                        |       |
| Raw materials                             |       | $                            | 748        |                        | $          | 916 |   |
| Work-in-process                           |       | 5,355                        |       | 6,314                       |       |
| Finished goods                            |       | 774                          |       | 600                         |       |
|                                      |       | $                            | 6,877      |                        | $          | 7,830 |   |
|                                      |       |                         |       |                        |       |
| Other current  assets:                    |       |                         |       |                        |       |
| Prepaid expenses                          |       | $                            | 1,464      |                        | $          | 1,064 |   |
| Employee receivables                      |       | 17                           |       | 20                          |       |
| Other                                     |       | 310                          |       | 181                         |       |
|                                      |       | $                            | 1,791      |                        | $          | 1,265 |   |
|                                      |       |                         |       |                        |       |
| Property and  equipment:                  |       |                         |       |                        |       |
| Equipment                                 |       | $                            | 13,807     |                        | $          | 13,264 |   |
| Software                                  |       | 9,285                        |       | 8,610                       |       |
| Furniture and fixtures                    |       | 824                          |       | 825                         |       |
| Leasehold improvements                    |       | 800                          |       | 802                         |       |
|                                      |       | 24,716                       |       | 23,501                      |       |
| Accumulated depreciation and amortization |       | (18,820                      | )          | (17,804                     | )          |
|                                      |       | $                            | 5,896      |                        | $          | 5,697 |   |
|                                      |       |                         |       |                        |       |
| Other assets:                             |       |                         |       |                        |       |
| Prepaid wafer credits                     |       | $                            | 4,095      |                        | $          | 4,227 |   |
| Other                                     |       | 558                          |       | 188                         |       |
|                                      |       | $                            | 4,653      |                        | $          | 4,415 |   |
|                                      |       |                         |       |                        |       |
| Accrued  liabilities:                     |       |                         |       |                        |       |
| Employee related accruals                 |       | $                            | 1,557      |                        | $          | 2,026 |   |
| Other                                     |       | 1,238                        |       | 1,408                       |       |
|                                      |       | $                            | 2,795      |                        | $          | 3,434 |   |

 

**Note 7—Obligations**
| ** **                                            | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                            | ** ** | **(in thousands)**      | ** ** |
|                                                  |       |                         |       |                        |       |
| Debt and capital  lease obligations:                  |       |                         |       |                        |       |
| Notes payable to bank                                 |       | $                            | 2,942      |                        | $          | 1,443 |   |
| Capital leases                                        |       | 1,490                        |       | 1,510                       |       |
|                                                  |       | 4,432                        |       | 2,953                       |       |
| Current portion of debt and capital lease obligations |       | (2,418                       | )          | (1,790                      | )          |
|                                                  |       | $                            | 2,014      |                        | $          | 1,163 |   |

 

15

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**QUICKLOGIC CORPORATION**

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

*Revolving Line of Credit and NotesPayable to Bank*

Effective June 2006,the Company entered into a Second Amended and Restated Loan and SecurityAgreement with Silicon Valley Bank. Terms of the agreement included a$5.0 million revolving line of credit that is available throughJune 2008 and an additional $2.0 million of borrowing capacity underthe equipment line of credit that is available to be drawn against throughJune 2007. Advances under the equipment line of credit must be repaid ineither 30 or 36 monthly equal installments, depending upon the nature ofthe items financed. Terms of the various advances under the agreement are asfollows (in thousands):
| ** **                 | ** ** | **Original  Balance** | ** ** | **Balance at  September 30,  2006** | ** ** | **Available  Credit** | ** ** | **Interest Rate**                 | ** ** | **Maturity Date**                                        |
|----------------------------|------------|-----------------------|------------|------------------------------------------|------------|-----------------------|------------|-----------------------------------|------------|----------------------------------------------------------|
| Revolving Line  of Credit: |       |                  |       |                                     |       |                  |       |                              |       |                                                     |
|                       |       |                  |       |                                     |       |                  |       |                              |       |                                                     |
| Non-formula advances       |       | n/a                   |       | —                                   |       | 5,000                 |       | Greater of Prime  + 0.50% or 8.5% |       | June 28, 2008                                       |
|                       |       |                  |       |                                     |       |                  |       |                              |       |                                                     |
| Equipment Line  of Credit: |       |                  |       |                                     |       |                  |       |                              |       |                                                     |
| Notes payable              |       | 2,136                 |       | 74                                       |       | n/a                   |       | Prime + 2.00%                     |       | Multiple draws maturing  on or before December 2006 |
| Notes payable              |       | 859                   |       | 268                                      |       | n/a                   |       | Prime + 2.00%                     |       | Multiple draws maturing  on or before December 2007 |
| Notes payable              |       | 550                   |       | 247                                      |       | n/a                   |       | Prime + 2.00%                     |       | Multiple draws maturing  on or before April 2008    |
| Notes payable              |       | 932                   |       | 795                                      |       | n/a                   |       | Prime + 1.75%                     |       | Multiple draws maturing  on or before April 2009         |
| Notes payable              |       | 1,558                 |       | 1,558                                    |       | n/a                   |       | Prime + 1.00%                     |       | Multiple draws maturing  on or before September 2009     |
| Notes payable              |       | n/a                   |       | —                                   |       | 442                   |       | Prime + 1.00% or  Treasury+ 4.00% |       | 30 or 36 months from  date of advance                    |
| Total                      |       |                  |       | $                                        | 2,942      |                  |       |                              |       |                                                     |   |
|                            |            |                       |            |                                          |            |                       |            |                                   |            |                                                          |  |

 

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, the Company must maintain a minimum tangible networth and adjusted quick ratio. The agreement also has certain restrictionsincluding, among others, on the incurrence of other indebtedness, themaintenance of depository accounts, the disposition of assets, mergers,acquisitions, investments, the granting of liens and the payment of dividends.The Company was in compliance with the financial covenants of the agreement asof September 30, 2006.

At September 30,2006, the prime rate under the credit facility was 8.25%. As ofSeptember 30, 2006 and December 31, 2005, $1.5 million and $387,000,respectively, of amounts outstanding under the equipment line of credit wereclassified as long-term obligations.

16

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**QUICKLOGIC CORPORATION**

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

*Capital Leases*

In December 2005, theCompany leased design software and related maintenance under a two-year capitallease at an imputed interest rate of 8.5% per annum. Terms of the agreementrequire the Company to make quarterly payments of approximately $204,000through November 2007. The Company recorded a capital asset for $1.2 millionthat is being depreciated over the term of the agreement, prepaid maintenanceof $272,000 that is being amortized over the term of the agreement and acapital lease obligation of $1.5 million. As of September 30, 2006,$960,000 was outstanding under the capital lease, $200,000 of which wasclassified as a long-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 require the Company to make semi-annual payments of approximately$148,000 through July 2008. The Company recorded a capital asset for $633,000that is being depreciated over the term of the agreement, prepaid maintenanceof $158,000 that is being amortized over the term of the agreement and acapital lease obligation of $791,000. As of September 30, 2006, $530,000was outstanding under the capital lease, $277,000 of which was classified as along-term obligation.

**Note 8—Deferred Royalty Revenue**

In October 2000, theCompany entered into a technology license and wafer supply agreement withAeroflex Incorporated (“Aeroflex”). Under the terms of the agreement, theCompany received $750,000 of prepaid royalties. In addition, Aeroflex receivesa prepaid royalty credit for a portion of the amounts paid for wafers purchasedfrom the Company under the agreement. These prepaid royalties are recorded as along-term liability and will be recognized as revenue when Aeroflex reports thesale of products incorporating the licensed technology to the Company. As ofSeptember 30, 2006 and December 31, 2005, the Company had recordedapproximately $1.6 million and $1.4 million, respectively, ofdeferred royalty revenue under this agreement. As of September 30, 2006,no royalty revenue had been earned under the agreement. In December 2006, theCompany received its first reported sales information from Aeroflex.

**Note 9—Employee Stock Plans**

*1989 Stock 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. InSeptember 1999, the Company adopted the 1999 Stock Plan and no furtherstock option grants were made under the 1989 Plan.

*1999 Stock 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 ofSeptember 30, 2006, approximately 13.6 million shares were reserved forissuance under the 1999 Plan. In addition, each January an annual increase isadded to the 1999 Plan equal to the lesser of (i) 5,000,000 shares,(ii) 5% of the Company’s outstanding shares on such date, or (iii) alesser amount determined by the Board of Directors. Options that are canceledunder the 1989 Plan also become available for grant under the1999 Plan. Options granted under the 1999 Plan have a term of up toten years. Options typically vest at a rate of 25% one year after thevesting commencement date, and one forty-eighth for each month of servicethereafter. However, the Company has implemented a different vestingschedule in the past and may implement different vesting schedules in thefuture with respect to any new stock option grant.

17

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**QUICKLOGIC CORPORATION**

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

*Employee Stock Purchase Plan*

The 1999 Employee StockPurchase Plan (“ESPP”) was adopted by the Board of Directors inAugust 1999 and was approved by the Company’s stockholders inSeptember 1999. As of September 30, 2006, approximately5.3 million shares were reserved for issuance under the ESPP. In addition,each August an annual increase is added to the ESPP equal to the lesser of(i) 1,500,000 shares, (ii) 4% of the Company’s outstanding shares onsuch date, or (iii) a lesser amount determined by the Board of Directors.

Through the purchaseperiod ending November 2005, the ESPP contained consecutive, overlapping,twenty-four month offering periods. Each offering period included foursix-month purchase periods. The ESPP permitted participants to purchase sharesthrough payroll deductions at 85% of the lower of the fair market value of thecommon stock at the beginning of an offering period or the end of a purchaseperiod.

Effective November 2005,the Board of Directors amended the ESPP to provide for six-month offeringperiods.  Participants purchase sharesthrough payroll deductions of up to 20% of an employee’s total compensation(maximum of 20,000 shares per offering period). The amended ESPP permits theBoard of Directors to determine whether participants purchase shares at: (i)85% of the fair market value of the common stock at the end of the offeringperiod; or (ii) 85% of the lower of the fair market value of the common stockat the beginning or the end of an offering period. The Board of Directors hasdetermined that, until further notice, future offering periods will be made at85% of the lower of the fair market value of the common stock at the beginningor the end of an offering period. As a result of the Company’s internal reviewof stock option grants and related accounting (see Note 3), employeecontributions to the ESPP were suspended effective August 2006 and amountspreviously withheld from employees were refunded in November 2006. In addition,the next offering period under the ESPP will commence once the Company hasfiled this quarterly report on Form 10-Q and will end on May 14, 2007, the nextregularly scheduled purchase date.

**Note 10—Stock-Based Compensation**

Effective January 2,2006, the Company adopted the provisions of SFAS No. 123(R), using themodified prospective transition method, which requires the measurement andrecognition of expense related to the fair value of stock-based compensationawards made to employees and directors, over the requisite service period.

18

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**QUICKLOGIC CORPORATION**

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

*Periods Prior to Adoption of SFASNo. 123(R)*

Prior to the adoption ofSFAS No. 123(R), the Company applied APB 25 and relatedinterpretations and provided the required pro forma disclosures of SFASNo. 123, as amended by SFAS No. 148, *“Accounting for Stock-Based Compensation — Transition and Disclosures.”*The pro forma information in the following table illustrates the effect on netincome and net income per share for the three and nine months endedSeptember 30, 2005 as if the Company had applied the fair valuerecognition provisions of SFAS No. 123 (in thousands, except per shareamounts):
| ** **                                                                                                                      | ** ** | **Three Months  Ended  September 30,   2005** | ** ** | **Nine Months  Ended  September 30,   2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
|                                                                                                                            |       |                                                         |       |                                                        |       |
| Net income – as  reported                                                                                        |       | $                                                            | 1,622      |                                                        | $          | 2,806 |   |
| Less: Stock-based compensation expense related to  stock option plans determined under the fair value based method, net of tax  |       | (642                                                         | )          | (2,119                                                      | )          |
| Less: Stock-based compensation expense related to  the stock purchase plan determined under fair value based method, net of tax |       | —                                                       |       | (336                                                        | )          |
| Net income – as  adjusted                                                                                        |       | $                                                            | 980        |                                                        | $          | 351 |   |
|                                                                                                                            |       |                                                         |       |                                                        |       |
| Net income per  share – as reported:                                                                                       |       |                                                         |       |                                                        |       |
| Basic                                                                                                                           |       | $                                                            | 0.06       |                                                        | $          | 0.10 |   |
| Diluted                                                                                                                         |       | $                                                            | 0.06       |                                                        | $          | 0.10 |   |
| Net income per  share – as adjusted:                                                                                       |       |                                                         |       |                                                        |       |
| Basic                                                                                                                           |       | $                                                            | 0.04       |                                                        | $          | 0.01 |   |
| Diluted                                                                                                                         |       | $                                                            | 0.03       |                                                        | $          | 0.01 |   |

 

In the pro formainformation required under SFAS No. 123 for the periods prior to fiscal2006, the Company used the Black-Scholes option pricing model to valuestock-based compensation awards and accounted for forfeitures as they occurred.

19

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**QUICKLOGIC CORPORATION**

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

*Impact of the Adoption of SFAS No.123(R)*

The Company adopted SFASNo. 123(R) using the modified prospective transition method beginningJanuary 2, 2006, the first day of the Company’s fiscal year 2006. Inaccordance with the modified prospective transition method, the Company’sconsolidated financial statements for prior periods have not been restated toreflect, and do not include, the impact of SFAS No. 123(R). Effectivewith the adoption of SFAS No. 123(R), stock-based compensation expense isrecognized in the Company’s consolidated statements of operations and includes(i) compensation expense for stock-based compensation awards granted priorto, but not yet vested as of January 1, 2006, based on the grant-date fairvalue estimated and re-measured upon modification in accordance with the proforma provisions of SFAS No. 123, and (ii) compensation expense forthe stock-based compensation awards granted or modified subsequent toJanuary 1, 2006, based on the grant-date fair value estimated inaccordance with the provisions of SFAS No. 123(R). The impact of SFASNo. 123(R) on the Company’s consolidated financial statements for thethree and nine months ended September 30, 2006 was as follows (inthousands, except per share amounts):
| ** **                           | ** ** | **Three Months   Ended  September 30,   2006** | ** ** | **Nine Months   Ended  September 30,   2006** | ** ** |
|--------------------------------------|------------|--------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
|                                 |       |                                                               |       |                                                              |       |
| Cost of revenue                      |       | $                                                                  | 36         |                                                              | $          | 138 |   |
| Research and  development            |       | 57                                                                 |       | 321                                                               |       |
| Selling, general  and administrative |       | 197                                                                |       | 686                                                               |       |
| Total costs and  expenses            |       | $                                                                  | 290        |                                                              | $          | 1,145 |   |
|                                 |       |                                                               |       |                                                              |       |
| Effect on net  loss per share:       |       |                                                               |       |                                                              |       |
| Basic                                |       | $                                                                  | (0.01      | )                                                                 | $          | (0.04 | ) |
| Diluted                              |       | $                                                                  | (0.01      | )                                                                 | $          | (0.04 | ) |

 

Stock-based compensationexpense recorded in the three and nine months ended September 30, 2006 hadno effect on the Company’s cash flows or its provision for income taxes.

As required bySFAS No. 123(R), the Company has made an estimate of expectedforfeitures and is recognizing compensation costs only for those equity awardsexpected to vest. The cumulative effect of forfeitures upon adoption ofSFAS No. 123(R) was not material.

*Valuation Assumptions*

SFAS No. 123(R) requirescompanies to estimate the fair value of stock-based compensation awards on thegrant date using an option pricing model. The value of the portion of the awardthat is ultimately expected to vest is recognized as expense over the requisiteservice periods in the Company’s consolidated statements of operations. TheCompany measures the fair value of stock-based compensation awards using theBlack-Scholes option pricing model. Black-Scholes, as well as other currentlyaccepted option valuation models, was developed to estimate the fair value offreely tradable, fully transferable options without vesting restrictions. Theseassumptions differ significantly from the characteristics of the Company’sstock-based compensation awards. Black-Scholes also requires the use of highlysubjective, complex assumptions, including expected term and the pricevolatility of the Company’s stock.

20

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**QUICKLOGIC CORPORATION**

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

The following weightedaverage assumptions are included in the estimated fair value calculations forstock option grants:
| ** **                                    | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                          |       |                                                 |       |                                                |       |   |   |   |   |
| Expected term  (years)                        |       | 5.75                                                 |       | 3.7                                                 |       | 5.75 |   | 4.0 |   |
| Risk-free  interest rate                      |       | 4.74                                                 | %          | 4.02                                                | %          | 4.80 | % | 3.83 | % |
| Expected  volatility                          |       | 82                                                   | %          | 95                                                  | %          | 82 | % | 92 | % |
| Estimated  pre-vesting annual forfeiture rate |       | 8.10                                                 | %          | —                                              |       | 8.10 | % | — |   |
| Dividend yield                                |       | —                                               |       | —                                              |       | — |   | — |   |

 

The methodologies fordetermining the above values were as follows:

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

·                  *Risk-free interest rate:*The risk-free interest rate assumption is based upon the observed interest rateappropriate for the expected term of the Company’s employee stock options.

·                  *Expected volatility:*The Company determines expected volatility based on historical volatility ofthe Company’s common stock, and other factors.

·                  *Dividend yield:*The dividend yield assumption is based on the Company’s intent not to issue adividend under its dividend policy.

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

21

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**QUICKLOGIC CORPORATION**

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

The weighted averageestimated fair value for options granted during the three months endedSeptember 30, 2006 and 2005 was $2.08 and $2.55 per option, respectively.The weighted average estimated fair value for options granted during the ninemonths ended September 30, 2006 and 2005 was $2.98 and $2.45 per option,respectively. As of September 30, 2006, the fair value of unvestedstock-based compensation awards, net of expected forfeitures, was approximately$1.2 million which is expected to be recognized over the next four years.

*Employee Stock Purchase Plan*

The offering periods ending May 2006and November 2006 under the ESPP provide that shares will be purchased at 85%of the fair market value of the common stock at the end of the offering period.Accordingly, the fair value of stock-based compensation awards under the ESPPwas recognized based upon employee deductions and the purchase discount, ratherthan using a pricing model. As a result of the Company’s internal review ofstock option grants and related accounting (see Note 3), employee contributionsto the ESPP were suspended effective August 2006 and amounts previouslywithheld from employees were refunded in November 2006. In addition, the nextoffering period under the ESPP will commence once the Company has filed thisquarterly report on Form 10-Q and will end on May 14, 2007, the next regularlyscheduled purchase date. In the three and nine months ended September 30,2006, stock-based compensation relating to the ESPP was $8,000 and $77,000,respectively.

The following weighted averageassumptions for three and nine months ended September 30, 2005 are included inthe estimated fair value calculations for rights to purchase stock under theESPP:
|                          | ** ** | **Three Months   Ended  September 30,   2005** | ** ** | **Nine Months   Ended  September 30,   2005** | ** ** |
|--------------------------|------------|--------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| Expected life  (months)  |       | 6.0                                                                |       | 6.0                                                               |       |
| Risk-free  interest rate |       | 3.13                                                               | %          | 3.13                                                              | %          |
| Volatility               |       | 65                                                                 | %          | 65                                                                | %          |
| Dividend yield           |       | —                                                             |       | —                                                            |       |

 

The methodologies fordetermining the above values were as follows:

·                  *Expected term:*The expected term represents the six-month purchase period contained in theESPP.

·                  *Risk-free interest rate:*The risk-free interest rate assumption is based upon observed interest rateappropriate for the six-month purchase period.

·                  *Expected volatility:*The Company determines expected volatility based on historical volatility ofthe Company’s common stock, and other factors, for the six-month purchaseperiod.

·                  *Dividend yield:* The dividend yield assumption is based onthe Company’s intent not to issue a dividend under its dividend policy.

Thepurchase discount of rights issued pursuant to the Company’s ESPP during thenine months ended September 30, 2006 was $0.84 per right. The weighted averageestimated fair value, as defined by SFAS No. 123, of rights issuedpursuant to the Company’s ESPP during the nine months ended September 30,2005 was $0.79 per right. During 2005, the fair value of rights granted wasestimated on the date of grant using Black-Scholes.

22

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**QUICKLOGIC CORPORATION**

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

*Stock-Based Compensation AwardActivity*

The following tablesummarizes stock-based compensation award activity under the 1989 Plan and the1999 Plan, and the related weighted average exercise price, for the nine monthsended September 30, 2006 and the year ended December 31, 2005:
| ** **                          | ** ** | ** **                                | ** ** | **Options Outstanding**   | ** ** |
|-------------------------------------|------------|-------------------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **Shares  Available for Grant** | ** ** | **Number of Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** |
| ** **                          | ** ** | **(in thousands)**                   | ** ** | **(in thousands)**        | ** ** | ** ** | ** ** |
| Balance at  January 1, 2005    |       | 4,010                                     |       | 8,888                          |       | $ | 5.48 |   |
| Authorized                          |       | 1,316                                     |       | —                         |       | — |   |
| Granted                             |       | (207                                      | )          | 207                            |       | 3.77 |   |
| Forfeited or  expired               |       | 1,539                                     |       | (1,539                         | )          | 7.45 |   |
| Exercised                           |       | —                                    |       | (821                           | )          | 2.20 |   |
| Balance at  December 31, 2005  |       | 6,658                                     |       | 6,735                          |       | 5.37 |   |
| Authorized                          |       | 1,394                                     |       | —                         |       | — |   |
| Granted                             |       | (379                                      | )          | 379                            |       | 4.15 |   |
| Forfeited or  expired               |       | 189                                       |       | (189                           | )          | 8.02 |   |
| Exercised                           |       | —                                    |       | (698                           | )          | 3.07 |   |
| Balance at  September 30, 2006 |       | 7,862                                     |       | 6,227                          |       | $ | 5.48 |   |

 

As of September 30,2006 and December 31, 2005, options to purchase 5,673,000 and 5,830,000shares were vested, respectively.

Significant exerciseprice ranges of options outstanding, related weighted average exercise prices,intrinsic value and contractual life information at September 30, 2006 wasas follows:
| ** **                                           | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                        | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|-----------------------------------------------------|------------|
| **Range of Exercise  Prices**              | ** ** | **Options  Outstanding**     | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise   Price** | ** ** | **Aggregate   Intrinsic   Value** | ** ** | **Options  Vested and  Exercisable** | ** ** | **Weighted   Average   Remaining   Contractual   Life** | ** ** | **Weighted   Average  Exercise   Price** | ** ** | **Aggregate   Intrinsic   Value** | ** ** |
| ** **                                           | ** ** | **(in thousands)**      | ** ** | **(in years)**                                 | ** ** | ** ** | ** ** | **(in** | ** ** | **(in** | ** ** | **(in years)** | ** ** | ** ** | ** ** | **(in** | ** ** |
| ** **                                           | ** ** | ** **                   | ** ** | ** **                                          | ** ** | ** ** | ** ** | **thousands)** | ** ** | **thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** | **thousands)** | ** ** |
| $0.97 — $  2.75                       |       |                         | 1,743      |                                                | 6.47       |   | $ | 2.15 |   | $ | 2,417 |   | 1,556 |   | 6.25 |   | $ | 2.12 |   | $ | 2,206 |   |
|   2.83 —     4.08 |       |                         | 1,692      |                                                | 6.40       |   | 3.42 |   | 502 |   | 1,504 |   | 6.05 |   | 3.44 |   | 431 |   |
|   4.25 —     6.04 |       |                         | 1,662      |                                                | 4.74       |   | 4.98 |   | — |   | 1,489 |   | 4.18 |   | 4.94 |   | — |   |
|   6.13 —   34.56            |       |                         | 1,130      |                                                | 3.98       |   | 14.42 |   | — |   | 1,124 |   | 3.95 |   | 14.47 |   | — |   |
| $0.97 — $34.56                                  |       |                         | 6,227      |                                                | 5.54       |   | $ | 5.48 |   | $ | 2,919 |   | 5,673 |   | 5.20 |   | $ | 5.66 |   | $ | 2,637 |   |

 

23

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**QUICKLOGIC CORPORATION**

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

The aggregate intrinsicvalue in the table above represents the total pretax intrinsic value, based onthe Company’s closing stock price of $3.54 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 totalnumber of shares of common stock underlying in-the-money options exercisable asof September 30, 2006 was 2,414,000.

The total intrinsic valueof options exercised during the three and nine months ended September 30,2006 was $27,000 and $1.6 million, respectively. Total cash received fromemployees as a result of employee stock option exercises during the three andnine months ended September 30, 2006 was approximately $25,000 and$2.1 million, respectively. The Company settles employee stock optionexercises with newly issued common shares. In connection with these exercises,there was no tax benefit realized by the Company due to the Company’s currentloss position.

The status of the Company’sunvested shares as of September 30, 2006 and changes during the ninemonths ended September 30, 2006 and the year ended December 31, 2005was as follows (in thousands, except per share amounts):
|                                      | ** ** | **Number of   Shares** | ** ** | **Weighted   Average Fair   Value** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|----------------------------------------------------|------------|
| Unvested at January 1,  2005    |       | 2,900                            |       | $                                                  | 1.97       |   |
| Granted                              |       | 207                              |       | 2.53                                               |       |
| Vested                               |       | (1,870                           | )          | 2.15                                               |       |
| Forfeited                            |       | (332                             | )          | 2.04                                               |       |
| Unvested at  December 31, 2005  |       | 905                              |       | 1.65                                               |       |
| Granted                              |       | 379                              |       | 2.98                                               |       |
| Vested                               |       | (660                             | )          | 1.67                                               |       |
| Forfeited                            |       | (70                              | )          | 1.52                                               |       |
| Unvested at  September 30, 2006 |       | 554                              |       | $                                                  | 2.56       |   |

 

On December 21,2005, the Compensation Committee of the Company’s Board of Directors approvedthe vesting acceleration of unvested, “out-of-the-money” stock options awardedunder its 1999 Stock Plan. The purpose of the accelerated vesting was to reducefuture compensation expense associated with the accelerated stock options uponadoption of SFAS No.123(R) by approximately $380,000 and because theoutstanding options were not fully achieving their original objective ofincentive compensation and employee retention due to exercise prices which werein excess of the current market value. A total of 187,703 shares with exerciseprices ranging from $4.08 to $8.70 were accelerated under the program. Theaccelerated stock options had a weighted average exercise price of $5.45. Onaverage, the accelerated options would otherwise have completed vesting over1.6 years from the date of acceleration.

**Note 11—Shelf RegistrationStatement**

OnJuly 12, 2005, the Company filed a shelf registration statement on Form S-3,which was declared effective on July 26, 2005 by the Securities andExchange Commission. Under this filing, the Company has the ability to raise upto $30.0 million, in one or more transactions, by selling common stock,preferred stock, depositary shares, or warrants. As of September 30, 2006,the Company had not raised any funds in connection with this filing.

**Note 12—Rights Plan**

InNovember 2001, the Board of Directors adopted a Rights Agreement, whichprovides for a dividend of one Preferred Stock Purchase Right (each a “Right”and collectively, the “Rights”) for each share of common stock of the Company.Each Right will entitle stockholders to buy one ten-thousandth of a share ofSeries A Junior Participating Preferred Stock of QuickLogic at an exerciseprice of $32.50 per share, subject to adjustment. The Rights will becomeexercisable only if a person or group becomes the beneficial owner of 15% ormore of the common stock, or commences a tender or exchange offer which wouldresult in the offeror beneficially owning 15% or more of the common stock,without the approval of the Board of Directors. The Company is entitled toredeem the Rights at $0.001 per Right up to ten business days after the publicannouncement of a 15% holder. If not earlier terminated or redeemed, the Rightswill expire on November 27, 2011.

24

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**QUICKLOGIC CORPORATION**

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

**Note 13—Income Taxes**

In the three months ended September 30, 2006 and 2005, the Companyrecorded income tax expense of $23,000 and $154,000, respectively, which consisted primarily of income taxes onforeign operations and federal alternative minimum taxes. In the nine monthsended September 30, 2006, the Company recorded income tax expense of $46,000 which consisted primarily of income taxes onforeign operations. In the nine months ended September 30, 2005, theCompany recorded income tax expense of $235,000 which consisted primarily of income taxes on foreign operations of$160,000 and federal alternative minimum income taxes of $75,000.

Due to theuncertainties surrounding the realization of the deferred tax assets resultingfrom the Company’s accumulated deficit and net tax losses in previous years,the Company has provided a full valuation allowance against the associateddeferred tax assets. The Company will continue to assess the realizability ofthe deferred tax assets in future periods.

AtDecember 31, 2005, the Company had net operating loss carryforwards forfederal and state income tax purposes of approximately $74.0 million and$17.0 million, respectively. These carryforwards, if not utilized tooffset future taxable income and income taxes payable, will expire beginning in2006 for federal and state purposes.

Under the TaxReform Act of 1986, the amount of and the benefit from net operating lossesthat can be carried forward may be impaired in certain circumstances. Eventswhich may cause changes in the Company’s tax carryforwards include, but are notlimited to, a cumulative ownership change of more than 50% over a three-yearperiod. Since inception, the Company has had cumulative changes in ownershipwhich will limit the loss carryforward deduction under IRC Section 382.However, the Company believes that such limitations will not have a materialeffect on the future utilization of the losses.

**Note 14—InformationConcerning Product Lines, Geographic Information and Revenue Concentration**

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

25

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**QUICKLOGIC CORPORATION**

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

The following is abreakdown of revenue by product family (in thousands):
| ** **                          | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                          | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                |       |                                                 |       |                                                |       |   |   |   |   |
| *Revenue  by product family (1):*   | * *   | * *                                             | * *   | * *                                            | * *   | * * | * * | * * | * * |
| Mature products                     |       | $                                                    | 3,850      |                                                | $          | 8,127 |   | $ | 13,024 |   | $ | 24,250 |   |
| Embedded standard products          |       | 1,953                                                |       | 3,252                                               |       | 6,934 |   | 9,080 |   |
| Advanced embedded standard products |       | 2,795                                                |       | 1,266                                               |       | 7,222 |   | 4,612 |   |
| Total revenue                       |       | $                                                    | 8,598      |                                                | $          | 12,645 |   | $ | 27,180 |   | $ | 37,942 |   |

 

----

*(1)*          The mature productsfamily includes pASIC 1, pASIC 2 and pASIC 3 products. Theembedded standard products family includes QuickRAM, QuickPCI, QuickDSP,QuickFC, and V3 products. The advanced embedded standard products familyincludes Eclipse, Eclipse II, QuickPCI II, PolarPro and QuickMIPSproducts, as well as programming hardware and software.

The following is abreakdown of revenue by shipment destination (in thousands):
| ** **               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                     |       |                                                 |       |                                                |       |   |   |   |   |
| *Revenue  by geography:* | * *   | * *                                             | * *   | * *                                            | * *   | * * | * * | * * | * * |
| United States            |       | $                                                    | 3,680      |                                                | $          | 6,749 |   | $ | 11,723 |   | $ | 18,617 |   |
| Europe                   |       | 3,435                                                |       | 3,690                                               |       | 9,481 |   | 9,054 |   |
| Japan                    |       | 584                                                  |       | 869                                                 |       | 2,526 |   | 4,975 |   |
| China                    |       | 464                                                  |       | 201                                                 |       | 1,584 |   | 1,577 |   |
| Rest of North America    |       | 202                                                  |       | 897                                                 |       | 1,140 |   | 2,622 |   |
| Rest of Asia Pacific     |       | 233                                                  |       | 239                                                 |       | 726 |   | 1,097 |   |
| Total revenue            |       | $                                                    | 8,598      |                                                | $          | 12,645 |   | $ | 27,180 |   | $ | 37,942 |   |

 

Two distributorsof the Company’s products accounted for 28% and 10% of revenue in the threemonths ended September 30, 2006 and for 28% and 12% of revenue in the ninemonths ended September 30, 2006. A contract manufacturer, purchasing theCompany’s products for use in a telecom design for an OEM application, and adomestic manufacturer accounted for 18% and 15% of revenue for the three monthsended September 30, 2006, respectively, and for 14% and 13% of revenue forthe nine months ended September 30, 2006, respectively.

Two distributorsof the Company’s products accounted for 29% and 23% of revenue in the threemonths ended September 30, 2005. The same two distributors of the Company’sproducts accounted for 23%, and 18% of revenue in the nine months endedSeptember 30, 2005. For the three and nine months ended September 30,2005, no single end customer accounted for 10% or more of the Company’srevenue.

As ofSeptember 30, 2006, less than 10% of the Company’s long-lived assets,including property and equipment and other assets, were located outside theUnited States.

**Note 15—Commitments**

Certain of theCompany’s wafer manufacturers require the Company to forecast wafer startsseveral months in advance. The Company is committed to take delivery of and payfor a portion of forecasted wafer volume. As of September 30, 2006and December 31, 2005, the Company had $5.2 million and$2.7 million, respectively, of outstanding commitments for the purchase ofwafer inventory.

The Companyleases, with an option to renew, its primary facility under a non-cancelableoperating lease that expires in 2009. In addition, the Company rentsdevelopment facilities in Canada and India as well as sales offices in Europeand Asia. Total rent expense, net of sublease income, for the three monthsended September 30, 2006 

26

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**QUICKLOGIC CORPORATION**

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

and 2005 wasapproximately $250,000 and $240,000, respectively, and for the nine monthsended September 30, 2006 and 2005 was approximately $740,000 and $720,000,respectively. The Company has subleased a portion of its primary facilities toa tenant until November 2007.

**Note 16—Litigation**

OnOctober 26, 2001, a putative securities class action was filed in the U.S.District Court for the Southern District of New York against certain investmentbanks that underwrote QuickLogic’s initial public offering, QuickLogic and someof QuickLogic’s officers and directors. The complaint alleges excessive andundisclosed commissions in connection with the allocation of shares of commonstock in QuickLogic’s initial and secondary public offerings and artificiallyhigh prices through “tie-in” arrangements which required the underwriters’customers to buy shares in the aftermarket at pre-determined prices inviolation of the federal securities laws. Plaintiffs seek an unspecified amountof damages on behalf of persons who purchased QuickLogic’s stock pursuant tothe registration statements between October 14, 1999 and December 6,2000. Various plaintiffs have filed similar actions asserting virtuallyidentical allegations against over 300 other public companies, theirunderwriters, and their officers and directors arising out of each company’spublic offering. These actions, including the action against QuickLogic, havebeen coordinated for pretrial purposes and captioned *In re Initial Public Offering Securities Litigation, 21 MC 92*.A stipulation of settlement for the claims against the issuer defendants,including the Company, has been signed and was submitted to the court. Underthe stipulation of settlement, the plaintiffs will dismiss and release allclaims against participating defendants in exchange for a contingent paymentguaranty by the insurance companies collectively responsible for insuring theissuers in all the related cases, and the assignment or surrender to theplaintiffs of certain claims the issuer defendants may have against theunderwriters. Under the guaranty, the insurers will be required to pay theamount, if any, by which $1.0 billion exceeds the aggregate amount ultimatelycollected by the plaintiffs from the underwriter defendants in all the cases.On February 15, 2005, the court preliminarily approved the settlementcontingent on specified modifications. The settlement is still subject to courtapproval and a number of other conditions. There is no guarantee that thesettlement will become effective. On December 5, 2006, the Court of Appeals forthe Second Circuit reversed the Court’s October 2004 order certifying a classin six test cases that were selected by the underwriter defendants andplaintiffs in the coordinated proceedings. QuickLogic is not among the test cases and it is unclear what impactthis will have on the class certified in the QuickLogic action or on theproposed settlement pending before the court.

No estimate can bemade of the possible loss or possible range of loss associated with theresolution of this contingency and, accordingly, the Company has not recorded aliability.

From time to time,the Company 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 mayadversely impact gross profit.

**Note 17—SubsequentEvents**

*NasdaqDelisting*

The Company hasreceived two Nasdaq Staff Determination notices stating that it is not incompliance with Marketplace Rule 4310(c)(14) because the Company had not timelyfiled its Forms 10-Q for the quarters ended June 30, 2006 and September 30,2006 and, therefore, that the Company’s securities are subject to delistingfrom The Nasdaq Global Market.

On September 26,2006, the Company attended a Nasdaq hearing at which it appealed the firstStaff Determination notice and requested an extension of time to satisfy thefiling requirement.  On December 13,2006, the Company received a decision from the Nasdaq Listing QualificationsPanel (the “Panel”) stating that the Company’s request for continued listing ofits securities on The Nasdaq Global Market had been granted subject to thefollowing conditions: (1) providing the Panel with a written response to theadditional questions set forth in the decision on or before December 22, 2006,which information has been provided; (2) filing the Company’s Form 10-Q for thesecond quarter on or before December 22, 2006, which filing has been made, and;(3) filing the Company’s Form 10-Q for the third quarter of 2006 on or beforeJanuary 12, 2007, which filing has been made.

27

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**QUICKLOGICCORPORATION**

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

*ShareholderDerivative Suits*

On November 2, 2006 andNovember 29, 2006, purported shareholder derivative complaints were filedagainst certain of the Company’s current and former officers and directors inthe U.S. District Court for the Northern District of California. The complaintsallege that the individual defendants violated the federal securities laws andbreached their duties to the Company in connection with the granting and/orreceipt of options for Company stock.  The complaints name the Company asa nominal defendant and seek unspecified monetary damages against theindividual defendants as well as various forms of injunctive relief.

Due to the preliminary status ofthese complaints and uncertainties related to litigation, the Company is unableto evaluate the likelihood of either a favorable or unfavorable outcome.Accordingly, the Company is unable at this time to estimate the effects ofthese complaints on it financial position, results of operations or cash flows.

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**Item 2. 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” inPart II, Item 1A and elsewhere in this Quarterly Report on Form 10-Q,contains “forward-looking statements” within the meaning of Section 27A ofthe Securities Act of 1933 and Section 21E of the Securities Exchange Actof 1934. We intend that these forward-looking statements be subject to the safeharbors created by those provisions. Forward-looking statements are generallywritten 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 include statementsregarding our revenue levels, our gross profit and factors thataffect gross profit, our level of operating expenses, our research anddevelopment efforts, our liquidity, our partners and suppliers, industrytrends, the competitive position and commercial success of our products, andthe expenses and management attention associated with our stock option review,related inquiries and litigation. The following discussion should be read inconjunction with the attached condensed unaudited consolidated financialstatements and notes thereto, with our audited consolidated financial statementsand notes thereto for the fiscal year ended December 31, 2005, found inour Annual Report on Form 10-K filed with the Securities and ExchangeCommission, or SEC, on March 17, 2006, and with our condensed unauditedconsolidated financial statements and notes thereto for the quarters endedMarch 31 and June 30, 2006 found in our Quarterly Reports on Form 10-Q filedwith the SEC.*

*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 the commercial andtechnical success of our new products such as PolarProTM, EclipseTM II and QuickPCI®II, our successful introduction of products and solutions incorporatingemerging technologies or standards, limited visibility into demand for ourproducts including demand from significant customers or for new products, theimpact of the decline in revenue from our pASIC®**1 and pASIC 2 products, our dependence uponsingle suppliers to fabricate and assemble our products, the success of ourpartnership efforts,  and the liquidityrequired to support our future operating and capital requirements. Although webelieve that the assumptions underlying the forward-looking statementscontained in this Quarterly Report are reasonable, any of the assumptions couldbe inaccurate, and therefore there can be no assurance that such statementswill be accurate. The risk, uncertainties and assumptions referred to abovethat could cause our results to differ materially from the results expressed orimplied by such forward looking statements include, but are not limited to,those discussed under the heading “Risk Factors” in Part II, Item 1Ahereto and the risks, uncertainties and assumptions discussed from time to timein our other public filings and public announcements. All forward-lookingstatements included in this document are based on information available to us asof the date hereof.  In light of thesignificant uncertainties inherent in the forward-looking statements includedherein, 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 operate in asingle reportable industry segment where we design and sell field programmablegate arrays, or FPGAs, embedded standard products, or ESPs, associated softwareand programming hardware. Our FPGA and ESP devices are standard products thatcan be programmed to perform desired logic functions or combined withintellectual property to provide customers with desired solutions. Theseproducts provide our customers with the opportunity to bring products to marketquickly and the ability to differentiate their products from competitors. Wedesign these devices based on our proprietary ViaLink technology. We believethat the underlying attributes of our ViaLink technology, including low powerconsumption, high reliability, design security and design efficiency enable usto differentiate our silicon solutions.

Under thedirection of the Audit Committee of the Board of Directors, we voluntarilyconducted an internal review of our historical stock option granting practicesand related accounting for the period from October 15, 1999, the date of ourinitial public offering, through July 28, 2006. The review was initiated by theAudit Committee in response to media attention about stock option practices atother companies. We did not find any systematic or pervasive practices toaccount for stock options in a manner inconsistent with generally acceptedaccounting principles, or GAAP, or our stated policies and procedures. However,based on our results of the review and analysis of the facts, we determinedthat there were certain errors committed in the process of documenting grantsand 

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

accounting for stockoptions associated with measurement dates, grants prior to meeting thedefinition of an employee under GAAP, non-employee grants, modification ofoptions and previously reported deferred stock compensation charges. A totalpre-tax stock-based compensation charge of $964,000 is associated with theseidentified errors that should have been reported in previously issuedconsolidated financial statements had they been identified in the properperiod. After considering all the quantitative and qualitative factors inaccordance with Staff Accounting Bulletin No. 99, *“Materiality,”* we determined that these adjustments were notmaterial to any prior year and, thus, have not restated our consolidatedfinancial statements for prior periods. However, given that the effect ofcorrecting these errors in 2006 would cause our 2006 consolidated financialstatements to be materially misstated, we concluded that the cumulative effectadjustment method of initially applying the guidance of SAB No. 108 wasappropriate. Accordingly, we elected early adoption of SAB No. 108 in thesecond quarter of 2006 and the cumulative affect of the adjustment wasreflected as in increase to the carrying amount of additional paid-in capitalas of January 1, 2006, with an offsetting entry to accumulated deficit. Inaddition, less than $50,000 of the adjustment to previously issued consolidatedfinancial statements was due to errors that occurred after October 2002. As aresult of our review and as part of our overall Sarbanes-Oxley complianceefforts, we are implementing enhanced controls and process improvements inconnection with the issuance of stock option grants and modifications.  See Note 3 of the consolidated financialstatements in Item 1 of this report for additional information regarding ourreview conducted at the direction of the Audit Committee of the Board ofDirectors and the cumulative effect adjustment to previously issuedconsolidated financial statements. See also Item 4, Controls and Procedures.

Our objective is to bethe leading provider of the lowest-power programmable logic solutions. Inaddition to offering the lowest-power, full-featured FPGAs, our products alsoprovide the following benefits.

·                  *“Bulletproof”Intellectual Property, or IP, Security—*We believe our productsprovide “bulletproof” programmable logic design security, since it is virtuallyimpossible to clone or reverse engineer designs implemented using our ViaLinktechnology.

·                  *Small Form Factor—*We can provide singlechip full-featured solutions, in packages as small as 6x6 millimeters, sinceour products do not require an additional device to store configuration data.

·                  *InstantOn—*Our ViaLink based products require no configuration bit streamand thus are fully functional at power up. This is critical in applicationsthat need to be active as soon as power is supplied.

·                  *High Reliability—*Our ViaLink-based devicesare consistently more robust in harsh environments than SRAM-based FPGAproducts, since ViaLink-based products do not rely on an SRAM-cell that issusceptible to alpha particles, or brownouts, to define and maintain theirfunctionality.

Competitively, ourproducts can offer significant power, performance and design security benefitswhen compared to traditional FPGAs; lower cost of ownership, quickertime-to-market and increased system flexibility benefits when compared to theuse of application specific integrated circuits, or ASICs; and increased systemflexibility, product differentiation and design security benefits when comparedto application specific standard products, or ASSPs. We believe that developingproducts around our ViaLink technology will continue to allow us to provideproducts that address the design flexibility, system power, performance,intellectual property security and price points demanded by our target markets.

It is our beliefthat important industry trends in our target markets include lower powerconsumption, higher performance, shorter time-to-market, increased intellectualproperty security, higher ASIC development expenses and higher productdevelopment risks. We believe our products are designed to address many ofthese trends.

The market forprogrammable logic devices is expected to grow more quickly than thesemiconductor industry, and we believe the FPGA programmable logic market willgrow more quickly than the market for complex programmable logic devices, orCPLDs. One factor fueling this high growth is the migration from ASIC circuitdesigns to programmable logic circuit designs. System designers often chooseprogrammable logic solutions over ASIC solutions, due to the relatively lowdevelopment cost, low development risk, quick time-to-market and highadaptability or flexibility of programmable logic devices, and due to theability of programmable logic suppliers to reduce the unit costs of theirproducts over time.

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

Within theprogrammable logic device market, we believe that the market for low-powerembedded applications will be a relatively high-growth market. We anticipatethat original design manufacturers, or ODMs, and original equipmentmanufacturers, or OEMs, will expand their offering of consumer or professionalportable products. These product offerings are expected to include smartphones,portable media players, personal video recorders, portable personal navigationproducts, handheld point-of-sale, or POS, terminals incorporating Wi-Fi andmicro hard drive capabilities and cellular data cards interfacing a processorand a cellular radio. The adoption of new features by embedded system designersis increasing the use of low-power programmable logic, to improve systemperformance by offloading the processor, or to interface to components such asWi-Fi modules or micro hard disk drives. Designers are also implementing newfeatures in their products using our devices. Our Eclipse II, QuickPCI II andPolarPro products offer compelling advantages against alternative solutions ascustomers benefit from their lowest power consumption, small form factor andhigh bandwidth.

In the fourthquarter of 2004, we completed the design of our Eclipse II andQuickPCI II products which provide a low-power solution for applicationsrequiring small to medium amounts of programmable logic. These devices offerthe lowest power consumption during all phases of operation — power-up,quiescent and dynamic operation — on the market today.

Our PolarProarchitecture and related products were announced in November 2005.  These products improve on our Eclipse II andQuickPCI II low-power leadership by providing lower power consumption and amore cost-effective architecture. Our PolarPro architecture combines theindustry’s lowest-power FPGA with embedded circuitry for implementinghigh-bandwidth bus-to-bus interfaces. All device circuitry is optimized for lowpower consumption through the innovative Very Low Power mode, or VLP, whichprovides an instant ability to lower power consumption when the device functionis not needed. When put in VLP mode, we believe that our PolarPro products drawless than 10 microamps of quiescent current. PolarPro products alsoexhibit the FPGA industry’s lowest dynamic power consumption, with operationalpower consumption up to three times lower than competing alternatives. Based onour engineering analysis of portable media players, we believe designers ofhandheld, battery-powered products using PolarPro products can now extendbattery life by as much as four times as compared to a standard productimplementation, setting a new standard for low power consumption through theuse of our FPGAs. We have released four PolarPro products to production sinceMarch 2006.

We market a range ofsolutions to our customers, including:

·                  *Complete Solutions*– Devices incorporatingintellectual property and software drivers. These complete solutions aretargeted at specific low-power application segments that have similarconnectivity and performance requirements. By providing solutions forcustomers, we increase their ability to meet the time-to-market pressuresassociated with their markets.

·                  *Embedded Standard Products*– Devicesincorporating a fixed function along with programmable logic in a low-powerdevice. Our customers build on the fixed function or “known good starting point”to develop unique solutions required for their products, which eliminates theneed to acquire and assemble industry standard IP, thus reducing design riskand improving time-to-market.

·                  *FPGAs*– General purpose devices used bycustomers who value their low power consumption, high intellectual propertysecurity, instant on capability and high reliability. These products givecustomers the ability to create a design specifically tailored to their needs.

Our new productsare also being designed into applications in our traditional markets, such asdata communications, instrumentation and test and military-aerospace, wherecustomers value the low power consumption, instant-on, IP security, reliabilityand fast time-to-market of our products.

In addition toworking directly with our customers, we partner with other technology companiesto develop intellectual property, reference platforms and system software toprovide application solutions. We work with processor manufacturers, such asIntel Corporation, Marvell Technologies, and Analog Devices, and companies thatsupply storage, networking or graphics components for embedded systems such asSeagate and Hitachi. The depth of these relationships varies depending on thepartner and the dynamics of the end market being targeted, but is typically aco-marketing program that incorporates engineering collaboration, such asreference designs, joint account calls and promotional activities.

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

Our proprietaryViaLink programmable metal-to-metal technology is the core of our FPGA productsand the foundation of our ESP products. Our ViaLink technology allows us tocreate devices smaller than competitors’ products on comparable technology,thereby minimizing silicon area and cost. In addition, our ViaLink technologyhas lower electrical resistance and capacitance than other programmabletechnologies and, consequently, supports higher signal-speed and low powerconsumption. Our software design tools facilitate full utilization of a device’slogic cells, clocks and input/output pins. Our logic cells have been optimizedto efficiently implement a wide range of logic functions at high speed, therebyenabling greater usable device density and design flexibility. Our architectureuses our ViaLink technology to maximize interconnects at every routing wireintersection, which allows more paths between logic cells. As a consequence,system designers are able to use our devices with smaller gate counts toimplement their designs than if they had used competing FPGAs. The abundance ofinterconnect resources also provides a dense connection between the ASSP andthe FPGA portions of ESPs.

Our ViaLinktechnology also provides our products with what we believe to be “bulletproof”intellectual property security, especially compared to SRAM-based FPGA and ASICsolutions, since it is virtually impossible to clone or reverse engineer designsimplemented using our ViaLink technology. We believe intellectual propertysecurity is important to system designers who choose to implement proprietaryalgorithms or features in programmable logic.

We sell programmedand unprogrammed products through distributors and directly to systemmanufacturers. We recognize revenue at the time of shipment of productsdirectly to system manufacturers. However, we sell the majority of our productsthrough distributors who earn a negotiated margin on the sale of our products.We defer recognition of revenue from sales of unprogrammed products todistributors until after they have sold our products to systems manufacturers.We recognize revenue on programmed products at the time of shipment to ourdistributors. During the nine months ended September 30, 2006 and 2005approximately 52% and 69%, respectively, of the units shipped to ourdistributors were programmed by us and, accordingly, are not returnable. Thepercentage of sales derived through distributors was 54% and 68% in the ninemonths ended September 30, 2006 and 2005, respectively.

Two distributorsof our products accounted for 28% and 10% of our revenue, respectively, in thethree months ended September 30, 2006. The same two distributors of ourproducts accounted for 28% and 12% of revenue in the nine months endedSeptember 30, 2006.  Two distributors ofour products accounted for 29% and 23% of our revenue, respectively, in thethree months ended September 30, 2005. The same two distributors of ourproducts accounted for 23% and 18% of revenue in the nine months endedSeptember 30, 2005.

A domesticmanufacturer accounted for 15% and 13% of revenue for the three and nine monthsended September 30, 2006, respectively. A European telecom original equipmentmanufacturer, or OEM, purchasing product through their contract manufacturer,accounted for 18% and 14% of our revenue in the three and nine months endedSeptember 30, 2006, respectively.  No endcustomer accounted for 10% or more of revenue in three and nine months endedSeptember 30, 2005. We anticipate that a limited number of distributors andcustomers will continue to account for a significant portion of our revenue andthat individual distributors could account for a larger portion of our revenue.

Our internationalsales were 57% and 51% of our revenue in the nine months endedSeptember 30, 2006 and 2005, respectively. We expect that revenue fromsales to international customers will continue to represent a significantportion of our revenue. All of our sales originate in the United States and aredenominated in U.S. dollars.

We outsource thewafer manufacturing, assembly and test of all of our products. We currentlyrely upon Taiwan Semiconductor Manufacturing Company Ltd., or TSMC, TowerSemiconductor Ltd., or Tower, Kawasaki Microelectronics, Inc. and SamsungSemiconductor, Inc. to manufacture our products, and we rely primarily uponAmkor Technology, Inc. to assemble, test and program our products. In 2001and 2002, we made a $21.3 million investment in Tower to obtain access tomanufacturing capacity and favorable pricing for our new products.  Our wafer suppliers’ lead times are often aslong as three months and sometimes longer. In addition, Tower requires us toprovide them with a monthly wafer start forecast. Under the terms of ouragreement with them, we are limited in the quantity that we can increase ordecrease our wafer forecast and we are committed to take delivery of and payfor a minimum portion of the forecasted wafer volume. Our long manufacturingcycle times conflict with our 

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

customers’ desire forshort delivery lead times and we periodically negotiate price discounts on highvolume wafer purchases. As a result, we typically purchase wafers based on ourinternal forecasts of customer demand.

**CriticalAccounting Policies and Estimates**

The methods,estimates and judgments we use in applying our most critical accountingpolicies have a significant impact on the results we report in our consolidatedfinancial statements. The U.S. Securities and Exchange Commission, or SEC, hasdefined critical accounting policies as those that are most important to theportrayal of our financial condition and results of operations and require usto make our most difficult and subjective judgments, often as a result ofthe need to make estimates of matters that are inherentlyuncertain. Based on this definition, our critical policies include revenuerecognition including sales returns and allowances, inventory valuationincluding identification of excess quantities and product obsolescence,allowance for doubtful accounts, valuation of investments, valuation oflong-lived assets, measurement of stock-based compensation, accounting forincome taxes, and estimating accrued liabilities. We believe that we applyjudgments and estimates in a consistent manner and that such consistentapplication results in consolidated financial statements and accompanying notesthat fairly represent all periods presented. However, any factual errors orerrors in these judgments and estimates may have a material impact on ourstatement of operations and financial condition. For a detailed discussion ofcritical accounting policies and estimates, please see Item 7 in ourAnnual Report on Form 10-K for the fiscal year ended December 31, 2005,filed with the SEC on March 17, 2006 and Item 2 of our Quarterly Reportson Form 10-Q for the fiscal quarters ended March 31 and June 30, 2006, filedwith the SEC.

**Results of Operations**

The following table setsforth the percentage of revenue for certain items in our statements ofoperations for the periods indicated:
| ** **                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenue                              |       | 100.0                                                | %          | 100.0                                               | %          | 100.0 | % | 100.0 | % |
| Cost of revenue                      |       | 62.5                                                 |       | 34.2                                                |       | 49.1 |   | 36.4 |   |
| Gross profit                         |       | 37.5                                                 |       | 65.8                                                |       | 50.9 |   | 63.6 |   |
| Operating  expenses:                 |       |                                                 |       |                                                |       |   |   |   |   |
| Research and development             |       | 28.2                                                 |       | 19.4                                                |       | 26.4 |   | 19.1 |   |
| Selling, general and administrative  |       | 46.5                                                 |       | 32.7                                                |       | 48.6 |   | 32.9 |   |
| Income (loss)  from operations       |       | (37.2                                                | )          | 13.7                                                |       | (24.1 | ) | 11.6 |   |
| Write-down of  marketable securities |       | —                                               |       | —                                              |       | — |   | (3.9 | ) |
| Interest expense                     |       | (0.8                                                 | )          | (0.4                                                | )          | (0.9 | ) | (0.4 | ) |
| Interest income  and other, net      |       | 3.9                                                  |       | 0.7                                                 |       | 3.6 |   | 0.7 |   |
| Income (loss)  before income taxes   |       | (34.1                                                | )          | 14.0                                                |       | (21.4 | ) | 8.0 |   |
| Provision for  income taxes          |       | 0.2                                                  |       | 1.2                                                 |       | 0.2 |   | 0.6 |   |
| Net income  (loss)                   |       | (34.3                                                | )%         | 12.8                                                | %          | (21.6 | )% | 7.4 | % |

 

**Three Months Ended September 30, 2006 and 2005**

*Revenue.*  Ourrevenue for the three months ended September 30, 2006 was$8.6 million, representing a decline of $4.0 million, or 32.0%, fromrevenue of $12.6 million in the three months ended September 30,2005. Our Mature product family revenue declined by $4.3 million as a result ofa $5.0 million decline in our pASIC 1 and pASIC 2 product revenue dueto their end-of-life, partially offset by a $760,000 increase in ourpASIC 3 product revenue, primarily due to higher demand and customersmigrating designs from pASIC 2 products to pASIC 3 products.  Our ESP product family revenue decreased byapproximately $1.3 million year-over-year primarily as a result of lower demandfor QuickRAM products from Military customers and for V3 products.  These decreases were partially offset by anincrease in our Advanced ESP product family revenue of approximately $1.5million due to an increase in sales of our new products, including Eclipse II,QuickPCI II and QuickMIPS, of approximately $1.8 million. Growth in our newproduct revenue was primarily due to higher demand from a European OEMpurchasing Eclipse II product through a contract manufacturer. This new productrevenue growth was partially offset by lower demand for Eclipse devices from aJapanese customer purchasing product through a distributor.

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

Our revenue forthe three months ended September 30, 2006 was 7% lower sequentially,declining by approximately $650,000 to $8.6 million from $9.2 millionin the three months ended June 30, 2006. This sequential revenue decreasewas primarily due to a $520,000 decline in our ESP revenue due to lower demandand a $240,000 decline in Mature product family revenue due to a $160,000reduction in pASIC 1 and pASIC 2 revenue due to the end-of-life of theseproducts and an $80,000 reduction in pASIC 3 revenue due to lower demand. Thesedeclines were partially offset by an increase of $110,000 in Advanced ESPproduct family revenue. New product sales to a European telecommunications OEM customer,purchasing Eclipse II product through their contract manufacturer, represented18% and 19% of revenue in the three months ending September 30 and June 30,2006, respectively.

Our foundryagreement with the supplier that fabricates our pASIC 1 and pASIC 2products expired at the end of 2005. We announced an end-of-life for theseproducts in 2004 and requested that our customers take delivery of lifetime buyorders before the end of 2005. These products contributed $980,000 and$6.0 million of our revenue in the three months ended September 30, 2006and 2005, respectively. A majority of our customers that use pASIC 1 andpASIC 2 products have either purchased sufficient quantities to satisfytheir demand throughout the expected life of their products or have convertedtheir designs to our other products, such as pASIC 3 which is pincompatible with pASIC 2. Because of the end-of-life of these products, wehave experienced a significant reduction in pASIC 1 and pASIC 2revenue since the third quarter of 2005. Further, we have stopped fabricatingwafers for these products and our future revenue is limited to inventory onhand. We currently are not forecasting significant revenue from pASIC 1 andpASIC 2 products after the fourth quarter of 2006.

In order tomaintain and grow our revenue from its current level after the end-of-lifeperiod for our pASIC 1 and pASIC 2 products, we are dependent uponincreased revenue from our existing products, especially our new PolarPro,Eclipse II and QuickPCI II products, and the development ofadditional products and solutions.

We continue toseek to expand our revenue, including the pursuit of high volume salesopportunities in the portable electronics market segment, by providinglow-power solutions offering new features or incorporating industry standardinterfaces such as Peripheral Component Interconnect, or PCI, Integrated DriveElectronics, or IDE, and Secure Digital Input/Output, or SDIO. Our industry ischaracterized by intense price competition and by lower prices as order volumesincrease. While winning large volume sales opportunities will increase ourrevenue, we believe these opportunities are likely to decrease our averageselling price and gross profit as a percentage of revenue.

*GrossProfit*.  Gross profit was $3.2 million and$8.3 million in the three months ended September 30, 2006 and 2005,respectively, which represented 37.5% and 65.8% of revenue for those periods.The $5.1 million decline in gross profit was primarily due to a decline inrevenue effecting gross profit by approximately $3.0 million, product mixcontributing $920,000 of lower gross profit, and higher inventory write-offs of$1.1 million. Cost of revenue for the three months ended September 30, 2006includes $36,000 related to the recognition of stock-based compensation inaccordance with SFAS No. 123(R). In the three months ended September 30,2006, we provided inventory reserves primarily for excess quantities of largedensity FPGA, pASIC 1 and pASIC 2 devices in the amount of $1.2 million andsold $90,000 of inventory that was previously reserved. In the three monthsended September 30, 2005, we provided inventory reserves in the amount of$90,000 and sold $190,000 of inventory that was previously reserved.

*Researchand Development Expense.*  Research and developmentexpense was $2.4 million and $2.4 million in the three months endedSeptember 30, 2006 and 2005, respectively, which represented 28.2% and19.4% of revenue for those periods. The decrease of approximately $20,000 wasprimarily due to $80,000 of higher project development expenses associated withthe development of our new PolarPro and other devices and the recognition ofstock-based compensation for the three months ended September 30, 2006 inaccordance with SFAS No. 123(R) of approximately $57,000, partially offset bylower other expenses, including test development expense and depreciation. Webelieve that continued or increased investments in product development andprocess technology are essential for us to remain competitive in the markets weserve. We expect that these development efforts will allow us to expand ourproduct offering, increase our revenue and provide additional value to ourcustomers and stockholders.

*Selling,General and Administrative Expense.*  Selling, generaland administrative expense was $4.0 million and $4.1 million for thethree months ended September 30, 2006 and 2005, respectively, whichrepresented 46.5% and 32.7% of revenue for those periods. The $146,000 decreasein selling, general and administrative expense was 

34

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

primarily the result oflower cash compensation of $300,000 associated with incentives and headcountand lower other expenses, primarily associated with representative commissions,legal expenses, and insurance expense, partially offset by stock-basedcompensation expense for the three months ended September 30, 2006 inaccordance with SFAS No. 123(R) of approximately $197,000 and higher otherexpenses, primarily for bad debt and depreciation.

*InterestExpense.*  Interest expense increased to $65,000 forthe three months ended September 30, 2006 as compared to $46,000 for thethree months ended September 30, 2005. This $19,000 increase wasprimarily due to higher average outstanding debt and capital lease balances andhigher interest rates.

*InterestIncome and Other, Net.*  Interest income and other,net increased to $333,000 of income for the three months endedSeptember 30, 2006 as compared to $92,000 of income for the three monthsended September 30, 2005. The $241,000 increase in interest income andother, net is primarily due to increased interest income received as a resultof higher interest rates and higher invested cash balances.

*Provision for Income Taxes.*  Forthe three months ended September 30, 2006, we incurred a net loss of$3.0 million and recorded a provision for income taxes of $23,000, which consisted of income taxes on foreignoperations. For the three months ended September 30, 2005, we realized netincome of $1.6 million and recorded a provision for income taxes of$154,000, which consisted of income taxeson foreign operations of $99,000 and federal alternative minimum income taxesof $55,000. Our ability to utilize our income tax loss carryforwards infuture periods is uncertain and, accordingly, we recorded a full valuationallowance against the related tax benefit. We will continue to assess therealizability of the deferred tax assets in future periods.

*Stock-Based Compensation.* EffectiveJanuary 2, 2006, we adopted the provisions of SFAS No. 123(R) whichrequires the measurement and recognition of expense related to the fair valueof stock-based compensation awards. Accordingly, stock-based compensation ismeasured at the grant date, based on the fair value of the award using theBlack-Scholes option pricing model, is re-measured upon modification, and isrecognized as expense over the requisite service period of the award.  Black-Scholes requires the use of highlysubjective, complex assumptions, including expected term and the pricevolatility of our stock. We elected to use the modified prospective transitionmethod as permitted by SFAS No. 123(R) and, therefore, we have not restated ourfinancial results for prior periods. We previously applied AccountingPrinciples Board Opinion No. 25,*“Accountingfor Stock Issued to Employees,”* or APB 25, and relatedinterpretations and provided the required pro forma disclosures of SFAS No.123, *“Accounting for Stock-Based Compensation.”*In March 2005, the SEC issued Staff Accounting Bulletin No. 107, orSAB No. 107, relating to SFAS No. 123(R). We have applied the provisionsof SAB No. 107 in our adoption of SFAS No. 123(R).

In the thirdquarter of 2006 and 2005, stock-based compensation totaled $290,000 and zero,respectively, and was included in the statement of operations as follows (inthousands):
| ** **                           | ** ** | **Three Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
|                                 |       |                                                 |       |   |   |
| Cost of revenue                      |       | $                                                    | 36         |   | $ | — |   |
| Research and  development            |       | 57                                                   |       | — |   |
| Selling, general  and administrative |       | 197                                                  |       | — |   |
| Total                                |       | $                                                    | 290        |   | $ | — |   |

 

**Nine Months Ended September 30, 2006 and 2005**

*Revenue.*  Ourrevenue for the nine months ended September 30, 2006 was$27.2 million, representing a decline of $10.8 million, or 28.4%,from revenue of $37.9 million in the nine months ended September 30,2005. Our Mature product family revenue declined by $11.2 million as a resultof a $13.1 million decline in our pASIC 1 and pASIC 2 product revenuedue to their end-of-life, partially offset by a $1.9 million increase in ourpASIC 3 product revenue, primarily due to higher demand and customersmigrating designs from pASIC 2 products to pASIC 3 products.  Our ESP product revenue declined by $2.1 millionin the nine months ending September 30, 

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

2006 compared to the sameperiod in 2005, due primarily to lower demand for QuickRAM product in China andlower sales of V3 products. These decreases were partially offset by anincrease in our Advanced ESP product family revenue of approximately $2.6million due to a $4.8 million increase in sales of our new products, includingEclipse II, QuickPCI II and QuickMIPS. A European telecommunications OEM customer,purchasing Eclipse II product through their contract manufacturer, contributed14% and 1% of revenue during the nine months ended September 30, 2006 and 2005,respectively. This new product revenue growth was partially offset by a $2.2million decline in revenue from other Advanced ESP products, primarily due tolower demand from a test equipment manufacturer purchasing Eclipse productthrough a distributor in Japan.

*GrossProfit*.  Gross profit was $13.8 million and$24.1 million in the nine months ended September 30, 2006 and 2005,respectively, which represented 50.9% and 63.6% of revenue for those periods.The $10.3 million decline in gross profit was primarily due to a declinein revenue effecting gross profit by approximately $7.6 million, product mixcontributing $1.4 million to the lower gross profit and $1.4 million of highercharges for the write-off of inventory for excess quantities. Cost of revenuefor the nine months ended September 30, 2006 includes $138,000 related to therecognition of stock-based compensation in accordance with SFAS No. 123(R). Inthe nine months ended September 30, 2006, we provided inventory reservesprimarily for excess quantities in the amount of $1.7 million and sold $710,000of inventory that was previously reserved. In the nine months endedSeptember 30, 2005, we provided inventory reserves primarily for excessquantities in the amount of $290,000 and sold $810,000 of inventory that waspreviously reserved.

*Researchand Development Expense.*  Research and developmentexpense was $7.2 million in each of the nine months endedSeptember 30, 2006 and 2005, which represented 26.4% and 19.1% of revenuefor those periods. The decrease of approximately $51,000 was primarily due tolower expenses for outside services and test development, partially offset byhigher project development expenses associated with the development of our newPolarPro devices. We recognized $321,000 of stock-based compensation for thenine months ended September 30, 2006 in accordance with SFAS No. 123(R). Webelieve that continued or increased investments in product development andprocess technology are essential for us to remain competitive in the markets weserve. We expect that these development efforts will allow us to expand ourproduct offering, increase our revenue and provide additional value to ourcustomers and stockholders.

*Selling,General and Administrative Expense.*  Selling,general and administrative expense was $13.2 million and$12.5 million for the nine months ended September 30, 2006 and 2005,respectively, which represented 48.6% and 32.9% of revenue for those periods.The $725,000 increase in selling, general and administrative expense wasprimarily the result of stock-based compensation for the nine months endedSeptember 30, 2006 in accordance with SFAS No. 123(R) of $686,000, highermarketing expenses of $280,000, primarily associated with the introduction ofour PolarPro products, and a $250,000 increase in net bad debt expenses, dueprimarily to the $140,000 recovery of an account receivable in the firstquarter of 2005 that did not repeat in 2006, partially offset by lower otherexpenses primarily related to incentives, headcount and representativecommissions.

*Write-downof Marketable Securities.*  In the second quarter of2005, we determined that our investment in Tower stock suffered a decline invalue that was determined to be “other than temporary.”  This determination included factors such asmarket value and the period of time that the market value had been below thecarrying value.  Accordingly, we recordedan impairment charge of $1.5 million in the second quarter of 2005 based on thequoted market price of the stock on the last trading day of the reportingperiod.

*InterestExpense.*  Interest expense increased to $235,000for the nine months ended September 30, 2006 as compared to $152,000 forthe nine months ended September 30, 2005. This $83,000 increase wasprimarily due to higher average outstanding debt and capital lease balances andhigher interest rates.

*InterestIncome and Other, Net.*  Interest income and other,net increased to $966,000 of income for the nine months endedSeptember 30, 2006 as compared to $262,000 of income for the nine monthsended September 30, 2005. The $704,000 increase in interest income and other,net is primarily due to increased interest income received as a result ofhigher invested cash balances and higher interest rates and lower expenseassociated with foreign exchange rate fluctuations.

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

*Provision for Income Taxes.*  Forthe nine months ended September 30, 2006, we incurred a net loss of$5.9 million and recorded a provision for income taxes of $46,000, which consisted of income taxes on foreignoperations. For the nine months ended September 30, 2005, we realized netincome of $2.8 million and recorded a provision for income taxes of$235,000, which consisted of income taxeson foreign operations of $160,000 and federal alternate minimum income taxes of$75,000. Our ability to utilize our income tax loss carryforwards infuture periods is uncertain and, accordingly, we recorded a full valuationallowance against the related tax benefit. We will continue to assess therealizability of the deferred tax assets in future periods.

*Stock-Based Compensation.*  For the nine monthsended September 30, 2006 and 2005, stock-based compensation totaled $1.1million and zero, respectively, and was included in the statement of operationsas follows (in thousands):
| ** **                           | ** ** | **Nine months Ended  September 30,** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
|                                 |       |                                                |       |   |   |
| Cost of revenue                      |       | $                                                   | 138        |   | $ | — |   |
| Research and  development            |       | 321                                                 |       | — |   |
| Selling, general  and administrative |       | 686                                                 |       | — |   |
| Total                                |       | $                                                   | 1,145      |   | $ | — |   |

 

**Liquidityand Capital Resources**

We have financedour operating losses and capital investments through sales of common stock,private equity investments, capital and operating leases, bank lines of creditand cash flow from operations. As of September 30, 2006, our principalsources of liquidity consisted of our cash and cash equivalents of$29.8 million, available credit under our revolving line of credit withSilicon Valley Bank of approximately $5.0 million, available credit underour equipment line of credit of approximately $442,000, and our investment inTower with a market value of approximately $2.0 million.

On July 12,2005, we filed a shelf registration statement on Form S-3 with the SEC, whichhas been declared effective. Under this filing, we may raise up to$30.0 million, in one or several transactions, by selling common stock,preferred stock, depositary shares, or warrants. As of September 30, 2006, wehad not raised any funds in connection with this filing.

As ofSeptember 30, 2006, our interest-bearing debt consisted of$2.9 million outstanding from Silicon Valley Bank and $1.5 millionoutstanding under capital leases. As of September 30, 2006, our accumulateddeficit was $124.2 million. Capital expenditures, which are largely drivenby the development of new products and manufacturing levels, could be up to$5.5 million in the next twelve months.

In June 2006,we entered into a Second Amended and Restated Loan and Security Agreement withSilicon Valley Bank. Terms of the agreement include a $5.0 millionrevolving line of credit available through June 2008 and an additional$2.0 million of borrowing capacity under an equipment financing line ofcredit that is available to be drawn against through June 2007. As ofSeptember 30, 2006, we had no balances outstanding under the revolvingline of credit. As of September 30, 2006, we had $2.9 millionoutstanding under the current and previous equipment lines of credit and$442,000 available to be drawn against future equipment purchases. Advancesunder the new equipment line of credit must be repaid in either 30 or 36 equalmonthly installments, depending upon the nature of the items financed. The bankhas a first priority security interest on substantially all of our tangible andintangible assets to secure any outstanding amounts under the agreement. Underthe terms of the agreement, we must maintain a minimum tangible net worth andan adjusted quick ratio. The agreement also has certain restrictions including,among others, on the incurrence of other indebtedness, the maintenance ofdepository accounts, the disposition of assets, mergers, acquisitions, thegranting of liens and the payment of dividends. We were in compliance with allloan covenants as of September 30, 2006.

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

As ofSeptember 30, 2006, we had $960,000 outstanding under a capital leaseobligation to finance design automation software and related maintenance. Thecapital lease obligation has an imputed interest rate of 8.5% per annum and isbeing repaid in quarterly amounts of $204,000 through November 2007.

As ofSeptember 30, 2006, we also had $530,000 outstanding under a capital leaseobligation to finance design software tools and related maintenance. Thecapital lease obligation has an imputed interest rate of 9.0% per annum and isbeing repaid in semi-annual amounts of $148,000 through July 2008.

*Net cashfrom operating activities*

Net cash providedby operating activities was $230,000 in the nine months ended September 30,2006. The cash provided by operating activities resulted primarily from a netloss of $5.9 million, adjusted for $5.3 million of non-cash chargesincluding depreciation and amortization of $2.3 million, reserves for excessinventory of $1.7 million, stock-based compensation of $1.1 million,utilization of wafer credits of $132,000, and $34,000 related to the write-downof long-lived assets. In addition, changes in working capital accounts providedcash in the amount of $810,000 primarily as a result of a decrease of$1.9 million in accounts receivable, net of allowances for doubtfulaccounts, due to a reduction in revenue levels and the timing of shipments inthe period and a $1.0 million increase in trade payables due to timing ofpurchases. These sources of cash were partially offset by a $738,000 increasein other assets, a $731,000 increase in inventory and a $639,000 decrease inaccrued liabilities.

Net cash providedby operating activities was $3.0 million in the nine months endedSeptember 30, 2005.  The cash provided resulted primarily from netincome of $2.8 million, adjusted for $4.1 million of non-cash charges includingdepreciation and amortization of $2.0 million, a $1.5 million write-down ofmarketable securities, $290,000 of reserves for excess inventory, $233,000 fromthe utilization of prepaid wafer credits, and $66,000 related to the write-downof long-lived assets. In addition, changes in working capital accounts used cashin the amount of $3.9 million primarily as a result of a $1.9 millionincrease in inventory, primarily due to wafer purchases in anticipation offuture sales of Eclipse II and QuickPCI II products, an increase of $2.4million in accounts receivable, net of allowances for doubtful accounts, due tothe increase in revenue levels and the timing of shipments in the period, and a$1.1 million reduction in trade payables, primarily due to the timing of waferpurchases. These uses in cash were partially offset by a $588,000 increase inaccrued liabilities, a $517,000 increase in deferred income and royalty revenuedue primarily to higher inventories at distributors on which revenue isdeferred and a $448,000 reduction in other current assets due to the amortizationof prepaid expenses.

*Net cash from investing activities*

Netcash used for investing activities for the nine months ended September 30,2006 and 2005 was $1.9 million and $1.3 million, respectively, as a result ofcapital expenditures made primarily to acquire equipment and software used inthe development and production of our products.

*Net cash from financing activities*

Net cash providedby financing activities was $3.2 million for the nine months endedSeptember 30, 2006, resulting from $2.6 million in proceeds relatedto the issuance of common shares upon the exercise of stock options byemployees and under our employee stock purchase program, and $2.5 million inproceeds from borrowings under our equipment line of credit, partially offsetby scheduled repayments of $1.8 million under the terms of our debt and capitallease obligations.

Net cash used forfinancing activities was $1.3 million for the nine months endedSeptember 30, 2005 resulting from a $2.0 million repayment of the balanceoutstanding under our revolving line of credit and scheduled repayments of $1.9million under the terms of our debt and capital lease obligations, partiallyoffset by $2.1 million in proceeds related to the issuance of common sharesunder our employee stock purchase program and upon the exercise of stockoptions by employees and $550,000 in proceeds from borrowings under ourequipment line of credit.

We requiresubstantial working capital to fund our business, particularly to finance ouroperations, to acquire property and equipment, to repay debt and for workingcapital requirements. Our future liquidity will depend on

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

many factors such asthese, as well as our level of revenue and gross profit, market acceptance ofour existing and new products, the decline in revenue from our pASIC 1 andpASIC 2 products, 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,our ability to obtain debt financing and to remain in compliance with the termsof our credit facilities, our ability to raise funds from the sale of Towershares and equity in the Company, the exercise of employee stock options andparticipation in our employee stock purchase plan, and other factors related tothe uncertainties of the industry and global economics. However, we believethat our existing cash resources will be sufficient to fund operations, capitalexpenditures of up to $5.5 million, and provide adequate working capitalfor at least the next twelve months. As our liquidity is affected by manyfactors as mentioned above and as discussed in our “Risk Factors,” 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. Afterthe next twelve months, our capital and operating requirements will dependon many factors, including our level of revenue and gross profit, the marketacceptance of our new products, the levels at which we maintain inventory andaccounts receivable, costs of securing access to adequate manufacturingcapacity, new product development efforts, capital expenditures and the levelof our operating expenses.

**Contractual Obligations andCommercial Commitments**

The following tablesummarizes our contractual obligations and commercial commitments as ofSeptember 30, 2006 and the effect such obligations and commitments areexpected to have on our liquidity and cash flows in future periods (inthousands):
| ** **                                                | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                | ** ** | **Total**                                 | ** ** | **Less than  1 Year** | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** | **More than  5 Years** | ** ** |
|                                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| *Contractual  cash obligations:*                          |       |                                      |       |   |   |   |   |   |   |   |   |
| Operating leases                                          |       | $                                         | 2,028      |   | $ | 735 |   | $ | 1,254 |   | $ | 39 |   | $ | — |   |
| Wafer purchases (1)                                       |       | 5,226                                     |       | 5,226 |   | — |   | — |   | — |   |
| Other purchase commitments                                |       | 2,369                                     |       | 2,016 |   | 353 |   | — |   | — |   |
| Total contractual cash obligations                        |       | 9,623                                     |       | 7,977 |   | 1,607 |   | 39 |   | — |   |
|                                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| *Other commercial  commitments*(2):                       | * *   | * *                                  | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| Notes payable to bank                                     |       | 2,942                                     |       | 1,405 |   | 1,537 |   | — |   | — |   |
| Capital lease obligations                                 |       | 1,490                                     |       | 1,013 |   | 477 |   | — |   | — |   |
| Total commercial commitments                              |       | 4,432                                     |       | 2,418 |   | 2,014 |   | — |   | — |   |
| Total  contractual obligations and commercial commitments |       | $                                         | 14,055     |   | $ | 10,395 |   | $ | 3,621 |   | $ | 39 |   | $ | — |   |

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(1)          Certainof our wafer manufacturers require us to forecast wafer starts several monthsin advance. We are committed to take delivery of and pay for a portion offorecasted wafer volume. Wafer purchase commitments of $5.2 millioninclude both firm purchase commitments and a portion of our forecasted waferstarts as of September 30, 2006.

(2)          Othercommercial commitments are included as liabilities on our balance sheet as ofSeptember 30, 2006.

**Inflation**

The impact ofinflation on our business has not been material for the periods presented.

**Off-Balance Sheet Arrangements**

We do not maintainany off-balance sheet partnerships, arrangements or other relationships withunconsolidated entities or others, often referred to as structured finance orspecial purpose entities, which are established for the purpose of facilitatingoff-balance sheet arrangements or other contractually narrow or limitedpurposes.

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

**Recently Issued AccountingPronouncements**

OnDecember 16, 2004, the Financial Accounting Standards Board, or FASB,issued Statement of Financial Accounting Standards No. 123(R), *“Share-Based Payment,”* or SFAS No. 123(R),which is a revision of SFAS No. 123 and supersedes APB 25. SFASNo. 123(R) requires all share-based payments, or SBPs, to employees,including grants of employee stock options, to be valued at fair value on thedate of grant, and to be expensed over the requisite service period. Under SFASNo. 123(R), pro forma disclosure of the income statement effects ofshare-based payments is no longer an alternative. SFAS No. 123(R), asamended, is effective for all stock-based awards granted in fiscal yearsbeginning after June 15, 2005. In addition, companies must also recognizecompensation expense related to any awards that are not fully vested as of theeffective date. Compensation expense for the unvested awards will be measuredbased on the fair value of the awards previously calculated in developing thepro forma disclosures in accordance with the provisions of SFAS No. 123.Effective January 2, 2006, the first day of fiscal 2006, we adopted SFASNo. 123(R) on a modified prospective basis. As a result, we began to includestock-based compensation charges in our results of operations beginning in thequarter ended March 31, 2006 (see Note 10 to the consolidatedfinancial statements in Item 1 of this report).

In November 2005,the FASB issued Staff Position, or FSP, FAS123(R)-3, *“Transition Election to Accounting for the Tax Effects of Share-BasedPayment Awards.”* This FSP requires an entity to follow either thetransition guidance for the additional paid-in capital pool as prescribed inSFAS No. 123(R), or the alternative transition method as described in theFSP. An entity that adopts SFAS No. 123(R) using the modified prospectiveapplication may make a one-time election to adopt the transition methoddescribed in this FSP. An entity may take up to one year from the later of itsinitial adoption of SFAS No. 123(R) or the effective date of this FSP toevaluate its available transition alternatives and make its one-time election.We continue to evaluate the impact that the adoption of this FSP could have onour consolidated financial statements.

On March 29,2005, the Securities and Exchange Commission, or SEC, issued Staff AccountingBulletin No. 107, or SAB No. 107, which provides guidance on theinteraction between SFAS No. 123(R) and certain SEC rules and regulations.  SAB No. 107 provides guidance that maysimplify some of the SFAS No. 123(R) implementation challenges andenhances the information that investors receive. Effective January 2,2006, the first day of fiscal 2006, we adopted SFAS No. 123(R) on a modifiedprospective basis and applied the principles of SAB No. 107 in conjunctionwith the adoption of SFAS No. 123(R).

In June 2006,the FASB issued FASB interpretation No. 48, *“Accountingfor Uncertainty in Income Taxes—an Interpretation of FASB StatementNo. 109,”* or FIN No. 48. FIN No. 48 requires us torecognize in our consolidated financial statements the impact of a tax positionthat is more-likely-than-not to be sustained upon examination based on thetechnical merits of the position. The evaluation of a tax position inaccordance with this interpretation is a two-step process. In the first step,recognition, we determine whether it is more-likely-than-not that a taxposition will be sustained upon examination, including resolution of any relatedappeals or litigation processes, based on the technical merits of the position.The second step addresses measurement of a tax position that meets themore-likely-than-not criteria. The tax position is measured at the largestamount of benefit that is greater than 50 percent likely of being realizedupon ultimate settlement. Tax positions that previously failed to meet themore-likely-than-not recognition threshold should be recognized in the firstsubsequent financial reporting period in which that threshold is met.Previously recognized tax positions that no longer meet themore-likely-than-not recognition threshold should be reversed in the firstsubsequent financial reporting period in which that threshold is no longer met.Use of a valuation allowance as described in FASB Statement No. 109 is notan appropriate substitute for the reversal of a tax position. The requirementto assess the need for a valuation allowance for deferred tax assets based onsufficiency of future taxable income is unchanged by this interpretation. FINNo. 48 is effective for fiscal years beginning after December 15,2006. We are currently evaluating the impact FIN No. 48 will have on ourconsolidated financial statements.

In July 2006, theFASB issued Emerging Issues Task Force, or EITF, Issue No. 06-3, *“How Taxes Collected from Customers are Remitted toGovernmental Authorities Should be Presented in the Income Statement (that isGross versus Net Presentation),”* or EITF 06-3. The adoption of EITF06-3 did not have an impact on our consolidated financial position and resultsof operations.  Our accounting policy hasbeen to present the above mentioned taxes on a net basis, excluded fromrevenues.

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

In September 2006,the SEC issued Staff Accounting Bulletin No. 108, *“Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements,”* or SAB No. 108.SAB No. 108 was issued in order to eliminate the diversity of practicesurrounding how public companies quantify financial statement misstatements.Traditionally, there have been two recognized methods for quantifying theeffects of financial statement misstatements - the “rollover” method and the “ironcurtain” method. The rollover method focuses primarily on the impact of amisstatement on the income statement, including the reversing effect of priorperiod misstatements, but its use can lead to the accumulation of misstatementson the balance sheet. The iron curtain method, on the other hand, focusesprimarily on the effect of correcting the period-end balance sheet with lessemphasis on the reversing effects of prior year errors on the income statement.Prior to the application of the guidance in SAB No. 108, we used the rollovermethod for quantifying the materiality of financial statement misstatements.

 In SAB No. 108, the SEC established anapproach that requires quantification of financial statement misstatementsbased on the effects of the misstatements on each of our consolidated financialstatements and the related financial statement disclosures. This model iscommonly referred to as a “dual approach” because it requires quantification oferrors under both the iron curtain and the rollover methods. SAB No. 108permits public companies to initially apply its provisions either by (i)restating prior financial statements as if the “dual approach” had always beenapplied or (ii) recording the cumulative effect of initially applying the “dualapproach” as an adjustment to the opening balance of the carrying values ofassets and liabilities in the year of adoption with an offsetting adjustmentrecorded to the opening balance of retained earnings (accumulated deficit). SABNo. 108 is effective for fiscal years ending after November 15, 2006, and isencouraged in any report for an interim period in the year of adoption. Weelected early adoption of SAB No. 108 in relation to the results of ourinternal review of stock option grant practices and related accounting, andrecorded the effects of applying SAB No. 108 using the cumulative effecttransition method in the second quarter of 2006 (see Note 3 of the consolidatedfinancial statements found in Item 1 of this report).

InSeptember 2006, the FASB issued Statement of Financial Accounting Standards No.157, *“Fair Value Measurements,”*or SFAS No. 157. SFAS No. 157 establishes a framework for measuring fair valueand expands disclosures about fair value measurements. The changes to currentpractice resulting from the application of SFAS No. 157 relate to thedefinition of fair value, the methods used to measure fair value, and theexpanded disclosures about fair value measurements. SFAS No. 157 is effectivefor fiscal years beginning after November 15, 2007 and interim periods withinthose fiscal years. We are currently evaluating the impact that SFAS No. 157will have on our consolidated financial statements.

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**Item 3.Quantitative and Qualitative Disclosures about Market Risk**

**Interest RateRisk**

Our exposure tomarket rate risk for changes in interest rates relates primarily to ourinvestment portfolio 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 and reinvestment risk. Our investment portfolio is generally comprisedof investments that meet high credit quality standards. Since these securitiesare subject to interest rate risk, they could decline in value if interestrates fluctuate. Due to the short duration and conservative nature of ourinvestment portfolio, we do not anticipate any material loss with respect toour investment portfolio. A 10% move in interest rates as of September 30,2006 would have an immaterial effect on our financial position, results ofoperations and cash flows.

**Foreign Currency Exchange Rate Risk**

All of our salesand cost of manufacturing are transacted in U.S. dollars. We conduct a portionof our research and development activities in Canada and India and have salesand marketing offices in several locations outside of the United States. We usethe U.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 22% and 25% of total operating expenses for the nine months endedSeptember 30, 2006 and 2005, respectively. A majority of these foreignexpenses were incurred in Canada. A currency exchange rate fluctuation of 10%would have caused our operating expenses to change by approximately $510,000 inthe nine months ended September 30, 2006.

**EquityPrice Risk**

Our exposure toequity price risk for changes in market value relates primarily to ourinvestment in Tower Semiconductor Ltd., or Tower. Tower’s ordinary shares tradeon The Nasdaq Global Market under the symbol “TSEM”.  Since these securities are publicly traded onthe open market, they are subject to market fluctuations.  Temporary market fluctuations are reflectedby increasing or decreasing the presented value of the related securities andrecording “other comprehensive income (loss)” in the equity section of thebalance sheet.  An “other than temporary”decline in market value is reflected by decreasing the adjusted cost of therelated securities and recording a charge to operating expenses on the incomestatement. We wrote down the value of the Tower shares due to an “other than temporary”decline in their market value by $1.5 million, $1.5 million,$3.8 million and $6.8 million in fiscal 2005, 2004, 2002and 2001, respectively. The determination that the decline in market valuewas “other than temporary” included factors such as the then current marketvalue and the period of time that the market value had been below the carryingvalue in each of the respective periods. A market value decrease of 10% wouldhave caused us to reduce accumulated other comprehensive income by approximately$200,000 in the nine months ended September 30, 2006.

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**Item 4. Controls and Procedures**

**Evaluation of Disclosure Controls andProcedures**

Our managementevaluated, with the participation of our Chief Executive Officer and ChiefFinancial Officer, the effectiveness of our disclosure controls and proceduresas of the end of the period covered by this Quarterly Report on Form 10-Q.Based upon that evaluation, our Chief Executive Officer and Chief FinancialOfficer concluded that our disclosure controls and procedures are effective toensure that information we are required to disclose in reports that we file orsubmit under the Securities Exchange Act of 1934, as amended, is(i) recorded, processed, summarized and reported within the time periodsspecified in Securities and Exchange Commission rules and forms, and(ii) accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate to allow timelydecisions regarding required disclosure. Based upon that evaluation, our Chief Executive Officer and ChiefFinancial Officer concluded that, while there can be no assurance that anycost-effective control system will succeed in achieving its stated goal underall potential future conditions, our current disclosure controls and proceduresare effective to provide reasonable assurance that the consolidated financialstatements and other disclosures in our SEC reports are reliable.

**Changes in Internal Control OverFinancial Reporting**

There were nochanges in our internal control over financial reporting that occurred duringthe period covered by this Quarterly Report on Form 10-Q that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting. As a result of our internal review of stock optionpractices and related accounting as described in more detail in Note 3 of theconsolidated financial statements found in Item 1 of this report, we haveidentified and are implementing enhanced controls and process improvements inconnection with the issuance of stock-based awards.

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**Part II. Other Information**

**Item 1.Legal Proceedings**

OnOctober 26, 2001, a putative securities class action was filed in the U.S.District Court for the Southern District of New York against certain investmentbanks that underwrote QuickLogic’s initial public offering, QuickLogic and someof QuickLogic’s officers and directors. The complaint alleges excessive andundisclosed commissions in connection with the allocation of shares of commonstock in QuickLogic’s initial and secondary public offerings and artificiallyhigh prices through “tie-in” arrangements which required the underwriters’customers to buy shares in the aftermarket at pre-determined prices inviolation of the federal securities laws. Plaintiffs seek an unspecified amountof damages on behalf of persons who purchased QuickLogic’s stock pursuant tothe registration statements between October 14, 1999 and December 6,2000. Various plaintiffs have filed similar actions asserting virtuallyidentical allegations against over 300 other public companies, theirunderwriters, and their officers and directors arising out of each company’spublic offering. These actions, including the action against QuickLogic, havebeen coordinated for pretrial purposes and captioned *In re Initial Public Offering Securities Litigation, 21 MC 92*.A stipulation of settlement for the claims against the issuer defendants,including the Company, has been signed and was submitted to the court. Underthe stipulation of settlement, the plaintiffs will dismiss and release allclaims against participating defendants in exchange for a contingent paymentguaranty by the insurance companies collectively responsible for insuring theissuers in all the related cases, and the assignment or surrender to theplaintiffs of certain claims the issuer defendants may have against theunderwriters. Under the guaranty, the insurers will be required to pay theamount, if any, by which $1.0 billion exceeds the aggregate amount ultimatelycollected by the plaintiffs from the underwriter defendants in all the cases.On February 15, 2005, the court preliminarily approved the settlementcontingent on specified modifications. The settlement is still subject to courtapproval and a number of other conditions. There is no guarantee that thesettlement will become effective. On December 5, 2006, the Court of Appeals forthe Second Circuit reversed the Court’s October 2004 order certifying a classin six test cases that were selected by the underwriter defendants andplaintiffs in the coordinated proceedings. QuickLogic is not among the test cases and it is unclear what impactthis will have on the class certified in the QuickLogic action or on theproposed settlement pending before the court.

On November 2,2006 and November 29, 2006, purported shareholder derivative complaints werefiled against certain of our current and former officers and directors in theU.S. District Court for the Northern District of California. The complaintsalleged that the individual defendants violated the federal securities laws andbreached their duties to the Company in connection with the granting and/orreceipt of options for Company stock.  The complaints named the Company asa nominal defendant and seek unspecified monetary damages against theindividual defendants as well as various forms of injunctive relief.

Due to thepreliminary status of these complaints and uncertainties related to litigation,we are unable to evaluate the likelihood of either a favorable or unfavorableoutcome. Accordingly, we are unable at this time to estimate the effects ofthese complaints on our financial position, results of operations or cashflows.

**Item 1A.Risk Factors**

This descriptionincludes any material changes to the description of the risk factors associatedwith our business previously disclosed in Item 1A of our 2005 Annual Report onForm 10-K, filed with the SEC on March 17, 2006, and our QuarterlyReports on Form 10-Q for the periods ended March 31 and June 30, 2006, filedwith the SEC. Because of the following risk factors, as well as other variablesaffecting our operating results, past financial performance may not be areliable indicator of future performance, and historical trends should not beused to anticipate results or trends in future periods.

**Risk Factors**

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

We operate in ahighly competitive, quickly changing environment marked by rapid obsolescenceof existing products. To compete successfully, we must obtain access toadvanced fabrication capacity and dedicate significant

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resources to specify,design, develop, manufacture and sell new or enhanced products and solutionsthat provide increasingly higher levels of performance, low power consumption,new features, reliability and/or cost savings to our customers. We experience along delay between the time when we expend these product definition anddevelopment resources and invest in related long-lived assets, and the timewhen we begin to generate revenue, if any, from these expenditures.

We are marketingour Eclipse II, QuickPCI II and PolarPro products to new customersand markets and expect a significant portion of our future revenues to begenerated from these new products. We believe our low-power Eclipse II,QuickPCI II and PolarPro products have a compelling advantage in low-powerapplications, and that this business will provide long-term revenue growth forQuickLogic, but there is no assurance when this will occur, if at all. Some ofthe opportunities for our new products are in the rapidly changing consumermarket, which typically has shorter product life cycles, higher volumes andgreater price pressure than our traditional business. In order to react quicklyto opportunities or to obtain favorable wafer prices, we have made significantinvestments in and commitments to purchase Eclipse II and PolarProinventory. In addition, the nature of the consumer market and the customersthat operate in this market may cause revenue to fluctuate significantly fromquarter to quarter. For example, our new product revenue increased in each ofthe first three quarters of 2006. However, we believe that new product revenuemay decline in the fourth quarter of 2006 due to the maturity and product lifecycle of a significant customer for these products. If we are unable to design,produce and sell new products and solutions that meet design specifications,address customer requirements, and generate sufficient revenue and grossprofit, if market demand for our products fails to materialize, if we areunable to obtain adequate capacity, 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 effected,we may be required to write-off related inventory and long-lived assets or haveother adverse effects on our business or the price of our common stock.

# *We willbe unable to compete effectively if we fail to anticipate product opportunitiesbased upon emerging technologies and standards or fail to develop products thatincorporate these technologies and standards in a timely manner*

We spendsignificant time and money to design and develop products and customersolutions around an industry standard, such as Peripheral ComponentInterconnect, or PCI, and Integrated Drive Electronics, or IDE, or emergingtechnologies, such as low-power programmable logic, advanced process technologyor lead-free packaging. We intend to develop additional products and solutionsand adopt new technologies in the future. We expect other programmable productcompanies to expand their low-power product offering and compete more directlywith our lowest-power products. If system manufacturers adopt alternativestandards or technologies, if an industry standard or emerging technology thatwe have targeted fails to achieve broad market acceptance, if customers chooselow-power offerings from our competitors, or if we are unable to bring thetechnologies or solutions to market in a timely and effective manner, we may beunable to generate significant revenue from our research and developmentefforts. As a result, our business would be materially harmed and we may berequired to write-off related inventory and long-lived assets.

# *We maybe unable to accurately estimate quarterly revenue, which could adverselyaffect the trading price of our stock*

We offer our customersa short delivery lead-time and a majority of our shipments during a quarter areordered by customers in that quarter. As a result, we often have low visibilityto the current quarter’s revenue, and our revenue levels can changesignificantly in a short period of time. Furthermore, our ability to respond toincreased demand is limited to inventory on hand or on order, the capacityavailable at our contract manufacturers and our capacity to program products tocustomer specifications. In addition, a significant portion of our revenue isdeferred until our distributors ship unprogrammed parts to end customers sincethe price is not fixed or determinable until that time. 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 inventory levels, could contributeto our difficulty in predicting and reporting our quarterly revenue and resultsof operations. If we fail to accurately estimate customer demand, recordrevenue, or if our available capacity is less than needed to meet customerdemand, our results of operations could be harmed and our stock price couldmaterially fluctuate.

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# *Theannounced end-of-life of our pASIC 1 and pASIC 2 products hasresulted in a decline in our revenue*

Our foundryagreement with the supplier that fabricates our pASIC 1 and pASIC 2products expired on December 31, 2005 and the supplier no longer has thenecessary equipment to manufacture our products. We announced an end-of-lifefor these products in 2004 and asked our customers to take delivery of lifetimebuy orders before the end of 2005. As a result, we have experienced a reductionin revenue from these products. Revenue from these products was $6.4 million,$5.1 million, $6.0 million and $3.5 million in the first, second, thirdand fourth quarters of 2005, respectively, and $2.3 million, $1.1 million,and $1.0 million in the first, second, and third quarters of 2006. Webelieve that a majority of our customers that use pASIC 1 and pASIC 2products have either purchased sufficient quantities to satisfy their demandthroughout the expected life of their products or have converted their designsto our other products, such as pASIC 3 which is pin compatible withpASIC 2. We currently expect that these products will not contributesignificant revenue after the fourth quarter of 2006. Our operating results andliquidity have been adversely affected by the end-of-life of our pASIC 1and pASIC 2 products as we are currently operating at a net loss andexpect negative cash flow at our current revenue level. To mitigate the affectsof the end-of-life of our pASIC 1 and pASIC 2 products, we plan todevelop customer demand for new products, such as PolarPro, Eclipse II andQuickPCI II, which have active customer designs but limited revenuehistory. The pASIC 1 and pASIC 2 revenue decline has been more rapidthan the revenue growth from our PolarPro, Eclipse II, QuickPCI IIand other products. While we expect revenue growth from PolarPro,Eclipse II, QuickPCI II, other products and new products will offsetthe decline in pASIC 1 and pASIC 2 revenue, there is no assurancewhen this will occur, if at all.

# *Wedepend upon third parties to fabricate, assemble, test and program ourproducts, and they may discontinue manufacturing our products, fail to give ourproducts priority, be unable to successfully manufacture our products to meetperformance, volume or cost targets, or inaccurately report inventory to us*

We contract withthird parties to fabricate, assemble, test and program our devices. Our devicesare generally 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. Tower solely manufactures our Eclipse II,PolarPro, certain QuickPCI II, QuickMIPS and other new products currentlyunder development. Furthermore, a single supplier fabricates our pASIC 1and pASIC 2 products under an agreement that expired inDecember 2005. While we purchased limited quantities of pASIC 1 andpASIC 2 wafers in 2006, this supplier has since taken the equipment usedto fabricate these products out of service. These products contributed 44% of 2005 revenue and we anticipate thatthese products will generate no significant revenue after 2006. In addition,demand for assembly capacity at one of our suppliers has increased. For thisand other reasons, capacity available to us may be constrained. Identifying andqualifying an additional assembly supplier is a time consuming and costlyprocess and may require volume commitments that we may be unwilling or unableto make. Programming capacity at our suppliers is also dependent on ourinvestment in sufficient programming hardware to meet fluctuating demand. Ourrelationship with our suppliers could change as a result of a merger oracquisition. If for any reason these suppliers or any other vendor becomesunable or unwilling to continue to provide services of acceptable quality, atacceptable costs and in a timely manner, our ability to operate our business ordeliver our products to our customers could be severely impaired. We would haveto identify 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, as we did with our pASIC 1 andpASIC 2 products. Alternate suppliers might not be available to fabricate,assemble, test and program our devices or, if available, might be unwilling orunable to offer services on acceptable terms.

In addition, ifcompetition for wafer manufacturing capacity increases, if we need to migrateto more advanced 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, in the second quarter of 2006, weentered into an agreement with Amkor to secure assembly capacity that requireda payment of $1.0 million that is refundable if we meet certain volumecommitments. The number of companies that provide these services is limited andsome of them have limited operating histories and financial resources. In theevent our current suppliers refuse or are unable to continue to provide theseservices to us, we may be unable to procure services from alternate suppliersin a timely manner, if at all. Furthermore, if customer demand for our productsincreases, we may be unable to secure sufficient additional capacity from ourcurrent suppliers on commercially reasonable terms, if at all.

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Moreover, our reliance ona limited number of suppliers subjects us to reduced control over deliveryschedules, quality assurance and costs. This lack of control may causeunforeseen product shortages or may increase our cost to manufacture and testour products, which would adversely affect our operating results and cashflows.

We record amajority of our inventory transactions based on information from oursubcontractors. If we do not receive prompt and accurate information from ourvendors, we could misstate inventory levels, incorrectly record gross profit,be unable to meet our delivery commitments to customers or commit tomanufacturing inventory that is not required to meet customer deliverycommitments, which could materially harm our business.

# *Our customersmay cancel or change their product plans after we have expended substantialtime and resources in the design of their products*

Our customersoften evaluate our products for six months or more before designing them intotheir systems, and they may not commence volume shipments for up to anadditional six to twelve months, if at all. During this lengthy sales cycle,our potential customers may cancel or change their product plans. In addition,customers may discontinue products incorporating our devices at any time orthey may choose to replace our products with lower cost semiconductors. Ifcustomers cancel, reduce or delay product orders from us or choose not torelease products that incorporate our devices after we have spent substantialtime and resources in assisting them with their product design, our revenuelevels may be less than anticipated and our business could be materiallyharmed.

# *We areexpending substantial time and effort to develop solutions with partners thatdepend on the availability and success of technology owned by the partner*

Our approach todeveloping system solutions for potential customers involves: embeddedprocessors developed by companies such as Marvell Semiconductor, Inc., whopurchased the XScale business unit from Intel, and Analog Devices, Inc.;peripheral devices developed by other parties such as micro hard disk drives,WI-FI devices and NAND flash memory; and, specific industry standards such asPCI, IDE and Secure Digital Input/Output, or SDIO. We have entered intoinformal partnerships with other parties that involve the development ofsolutions that interface with their devices or standards. These informalpartnerships also may involve joint marketing campaigns and sales calls. Forexample, we have developed a system solution incorporating a specific embeddedprocessor, a micro hard disk drive and our Eclipse II device that lowersthe overall power consumption of a system and improves system performance.Recently, one of our partners announced the sale of their embedded processorbusiness to another company, and we are focused on building a relationship withthe new owner. If our solution is not incorporated into customer products, ifour partners discontinue production of or incorporate our solution into their productofferings, or if the informal partnerships are significantly reduced orterminated, our revenue and gross margin will be materially harmed and we maybe required to write-off related long-lived assets.

# *We havesignificant customers and limited visibility into the long-term demand for ourproducts from these customers*

A few endcustomers can represent a significant portion of our total revenue in a givenreporting period and the likelihood of this occurring will increase in thefuture as we target high-volume consumer applications. As in the past, futuredemand from these customers may fluctuate significantly. These customerstypically order products with short requested delivery lead times, and do notprovide a firm commitment to purchase product past the period covered bypurchase orders. In addition, our manufacturing lead times are longer than thedelivery lead times requested by these customers, and we make significantinventory purchases and capital expenditures in anticipation of future demand.For example, a domestic manufacturer of instrumentation and test equipmentaccounted for 13% of revenue in fiscal 2005 and a Europeantelecommunications OEM customer, purchasing product through their contractmanufacturer, represented 14% of revenue in the first three quarters of 2006.If revenue from any significant customer were to decline substantially, we maybe unable to offset this decline with increased revenue from other customersand we may purchase excess inventory. These factors could severely harm ourbusiness.

In addition, wemay make a significant investment in long-lived assets for the production ofour products based upon historical and expected demand. If demand for 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 to

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write-off inventory,provide for uncollectible accounts receivable or incur charges againstlong-lived assets, which would materially harm our business.

# *We maynot have the liquidity to support our future operations and capitalrequirements*

Our cash and cashequivalents balance at September 30, 2006 was $29.8 million. AtSeptember 30, 2006, our interest-bearing debt consisted of$2.9 million outstanding from Silicon Valley Bank and $1.5 millionoutstanding under capital leases. On June 30, 2006, we amended andrestated our credit facility with Silicon Valley Bank. Terms of the agreementinclude a $5.0 million revolving line of credit available through June 2008and $2.0 million of borrowing capacity under the equipment line of creditthat is available to be drawn through June 2007. At September 30,2006, we had $5.0 million available to borrow under our revolving creditfacility and $442,000 available to borrow under our equipment line of credit.

At the end of thethird quarter of 2006, we held 1,344,543 Tower ordinary shares available forsale valued at approximately $2.0 million based upon the market closingprice of $1.46 per share on such date. Our ability to obtain competitivepricing from Tower is tied to our ownership of at least 450,000 of these Towershares.

Capitalexpenditures, which are largely driven by development activities and theintroduction and initial manufacturing of new products, could be up to$5.5 million in the next twelve months. As of September 30, 2006, wehad commitments to purchase $5.2 million of wafer inventory.

On July 12,2005, we filed a shelf registration statement on Form S-3 with the SEC, whichhas been declared effective. Under this filing, we may decide to raise up to$30.0 million, in one or several transactions, by selling common stock,preferred stock, depositary shares, or warrants.

As a result ofpotential investments, the reduction in revenue from our pASIC 1 andpASIC 2 products, operating expenses, changes in working capital andinterest and debt payments, we will need to generate significantly higherrevenue and gross profit, especially from our new Eclipse II,QuickPCI II and PolarPro products and products currently under development,to generate positive cash flow. In addition, these new products have beengenerating lower gross margin as a percentage of revenue than the rest of ourhistorical business due to the markets that we have targeted and the largerorder quantities required to meet customer demand. Whether we can achieve cashflow levels sufficient to support our operations cannot be accuratelypredicted. Unless such cash flow levels are achieved, we may borrow additionalfunds or sell debt or equity securities, or some combination thereof, toprovide funding for our operations. If adequate funds are not available whenneeded, our financial condition and operating results would be materiallyadversely affected and we may not be able to operate our business without significantchanges in our operations, or at all.

# *We maybe unable to successfully grow our business if we fail to compete effectivelywith others to attract and retain key personnel*

We believe ourfuture success will depend upon our ability to attract and retain engineers andother highly competent personnel. Our employees are at-will and not subject toemployment contracts. Hiring and retaining qualified sales, technical andfinancial personnel is difficult due to the limited number of qualifiedprofessionals, economic conditions and the size of our company. Competition forthese types of employees is intense. In addition, new hires frequently requireextensive training before they achieve desired levels of productivity. We havein the past experienced difficulty in recruiting and retaining qualified seniormanagement, sales, finance and technical personnel. Failure to attract, hire,train and retain personnel could materially harm our business.

# *Ourfuture 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, favorable wafer pricing, and committedproduction capacity in Tower’s foundry facility. We believe that Tower’slong-term operation of this fabrication facility depends on its ability toattract sufficient customer demand, to obtain additional financing, to increasecapacity, to obtain the release of grants and approvals for changes in grantprograms from the Israeli government’s Investment Center, and its ability toremain in compliance with the terms of its grant and credit agreements. Thecurrent political uncertainty and security situation

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in the Middle East whereTower’s fabrication facility is located, the cyclical nature of the market forfoundry manufacturing services, Tower’s financial condition, or other factorsmay adversely impact Tower’s business prospects and may discourage futureinvestments in Tower from outside sources. If Tower is unable to obtainadequate financing and increase production output in a timely manner, the valueof our investment in Tower may decline significantly or possibly becomeworthless, our wafer credit from Tower may decline in value or possibly becomeworthless, and we would have to identify and qualify a substitute supplier tomanufacture our products. This could require significant development time,cause product shipment delays, impair long-lived assets and the value of ourwafer credits, damage our liquidity and severely harm our business. In addition,Tower is the sole manufacturer of our Eclipse II, PolarPro, certainQuickPCI II, QuickMIPS and other new products currently under development.

The value of ourinvestment in Tower and its corresponding wafer credits may also be adverselyaffected by a deterioration of conditions in the market for foundrymanufacturing services and the market for semiconductor products. AtSeptember 30, 2006, the total value of our Tower investment and wafercredits recorded on our balance sheets was $6.1 million. If the fair valueof our Tower investment or our wafer credits are deemed to be impaired, we willrecord charges to our statement of operations. For instance, the fair value ofour Tower investment was $2.26 per share at the end of 2004 as compared to$1.17 per share at the end of the second quarter of 2005. Since the value ofour Tower investment remained below $2.26 per share for a period of time, werecorded a $1.5 million write-down of marketable securities in the secondquarter of 2005.

# *If wefail to adequately forecast demand for our products, we may incur productshortages or excess product inventory*

Our agreementswith certain third-party manufacturers require us to provide forecasts of ouranticipated manufacturing orders, and place binding manufacturing commitmentsin advance of receiving purchase orders from our customers. We are limited inour ability to increase or decrease our forecasts under such agreements. Othermanufacturers supply us product on a purchase order basis. The allocation ofcapacity is determined solely by our suppliers over which we have no directcontrol. Additionally, we may place orders on our vendors in advance ofcustomer orders to allow us to quickly respond to changing customer demand orto obtain favorable product pricing. Furthermore, we provide our suppliers withequipment which is used to program our products to customer specifications. Theprogramming equipment is manufactured to our specifications and has significantorder lead-times. These factors may result in product shortages or excessproduct inventory. Obtaining additional supply in the face of product,programming equipment or capacity shortages may be costly, or not possible,especially in the short term since most of our products and programmingequipment are supplied by a single vendor. Our failure to adequately forecastdemand for our products could materially harm our business.

# *Fluctuationsin our manufacturing processes, yields and quality, especially for newproducts, may increase our costs*

Difficultiesencountered during the complex semiconductor manufacturing process can render asubstantial percentage of semiconductor devices nonfunctional. Newmanufacturing techniques or manufacturing fluctuations may change theperformance distribution and yield of our products. We have, in the past,experienced manufacturing runs that have contained substantially reduced or nofunctioning devices, or that generated devices with below normal performancecharacteristics. In addition, manufacturing yield problems may take a significantperiod of time to analyze and correct. Our reliance on third party suppliersmay extend the period of time required to analyze and correct these problems.Once corrected, our customers may be required to redesign or requalify theirproducts. As a result, we may incur substantially higher manufacturing costs,inventory shortages or 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 products and products thatincorporate new intellectual property, such as our Eclipse II and PolarProproducts, are often more complex and more difficult to produce, increasing therisk of manufacturing-related defects. New manufacturing facilities orprocesses, such as at Tower, are often more complex and take a period of timeto achieve expected quality levels and manufacturing efficiencies. While wetest our products, including our software development tools, they may stillcontain errors or defects that are found after we have commenced commercialproduction, that occur due to manufacturing variations or that are identifiedas new intellectual property is incorporated into our products. If our productsor software

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development tools containundetected or unresolved defects, we may lose market share, experience delaysin or loss of market acceptance, reserve or scrap inventory, 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 havea history of losses and cannot assure you that we will again be profitable inthe future*

We incurredsignificant losses in 2004, 2003 and 2002. Our accumulated deficit as ofSeptember 30, 2006 was $124.2 million. Although we recorded netincome of $2.4 million for the year ended December 31, 2005, werecorded a net loss of $5.9 million in the nine months ended September 30,2006 and we may not return to profitability in any future periods. Ourprofitability for the year ended December 31, 2005 cannot be relied uponas any indication of our future operating results or prospects.

# *Wedepend upon third party distributors to market and sell our products, and theymay discontinue sale of our products, fail to give our products priority or beunable to successfully market, sell and support our products*

We contract withthird-party distributors to market and sell a significant portion of ourproducts. We typically have only a few distributors serving each geographicmarket, and, in the future, we may have a single distributor covering ageographic market. Although we have contracts with our distributors, ouragreements with them may be terminated on short notice by either party and, ifterminated, we may be unable to recruit additional or replacement distributors.Additionally, distributors that we have contracted with may acquire, beacquired or merge with other distributors which may result in the terminationof our contract or less effort being placed on the marketing, sale and supportof our products. As a result, our future performance will depend in part on ourability to retain our existing distributors and to attract new distributorsthat will be able to effectively market, sell and support our products. Theloss of one or more of our principal distributors, or our inability to attractnew distributors, could materially harm our business.

Many of ourdistributors, including our principal distributors, market and sell productsfor other companies. Many of these products may compete directly or indirectlywith our products. Also, we generally are not one of the principal suppliers ofproducts to our distributors. If our distributors give higher priority orgreater attention to the products of other companies, including products thatcompete with our products, our business would be materially harmed.

Individualdistributors and original equipment manufacturers often represent a significantportion of our accounts receivable. If we are unable to collect funds due fromthese distributors and customers, our financial results may be materiallyharmed.

# *Ourfuture operating results are likely to fluctuate and therefore may fail to meetexpectations, which could cause our stock price to decline*

Our operatingresults have varied 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 futureoperating results. Our future operating results will depend on many factors andmay fail to meet our expectations for a number of reasons, including those setforth in these risk factors. Any failure to meet expectations could cause ourstock price to significantly fluctuate or decline.

Factors that couldcause our operating results to fluctuate include:

·                                                      theeffect of end-of-life programs;

·                                                      asignificant change in sales to, or the collectibility of accounts receivablefrom, our largest customers;

·                                                      successfuldevelopment and market acceptance of our products and solutions;

·                                                      ourability to accurately forecast product volumes and mix, and to respond to rapidchanges in customer demand;

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·                                                     changesin sales volume, product mix, average selling prices or production variancesthat affect gross profit;

·                                                     ourability to adjust our product features, manufacturing capacity and costs inresponse to economic and competitive pressures;

·                                                     ourreliance on subcontract manufacturers for product capacity, yield and quality;

·                                                     ourcompetitors’ product portfolio and product pricing policies;

·                                                     timelyimplementation of efficient manufacturing technologies;

·                                                     changesin or errors in applying accounting and corporate governance rules;

·                                                     theissuance of stock options, or changes in the terms of our employee stockpurchase plan;

·                                                     mergersor acquisitions;

·                                                     theimpact of import and export laws and regulations;

·                                                     thecyclical nature of the semiconductor industry and general economic, market,political and social conditions in the countries where we sell our products andthe related effect on our customers, distributors and suppliers; and

·                                                     ourability to obtain capital, debt financing and insurance on commercially reasonableterms.

Although certainof these factors are out of our immediate control, unless we can anticipate andbe prepared with contingency plans that respond to these factors, our businessmay be materially harmed.

# *We mayencounter periods of industry-wide semiconductor oversupply, resulting inpricing pressure, as well as undersupply, resulting in a risk that we could beunable to fulfill our customers’ requirements*

The semiconductorindustry has historically been characterized by wide fluctuations in the demandfor, and supply of, its products. These fluctuations have resulted incircumstances when supply of and demand for semiconductors have been widely outof balance. An industry-wide semiconductor oversupply could result in severedownward pricing pressure from 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. Sincewe outsource all of our manufacturing and generally have a single-source ofwafer supply, 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 futureindustry-wide oversupply or undersupply of semiconductors could materially harmour business.

# *Customersmay cancel or defer significant purchase orders or our distributors may returnour products, which would cause our inventory levels to increase and ourrevenue to decline*

Our distributorsor customers 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 andinventories would increase, which would materially harm our business.

# *Problemsassociated with international business operations could affect our ability tomanufacture and sell our products*

Most of ourproducts are manufactured outside of the United States at manufacturingfacilities operated by our suppliers in Taiwan, South Korea, the Philippines,Israel and Malaysia. We expect to manufacture a majority of our new productsand the products that we currently have under development in Israel and toassemble these products in South Korea, the Philippines, Malaysia, or China. Asa result, these manufacturing operations and new

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product introductions aresubject to risks of political instability, including the risk of conflictbetween Taiwan and the People’s Republic of China, between South Korea andNorth Korea, and conflicts involving Israel or Malaysia.

A significantportion of our total revenue comes from sales to customers located outside theUnited States. We anticipate that sales to customers located outside the UnitedStates will continue to represent a significant portion of our total revenue infuture periods. 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 research and development activities in Canada andIndia. Accordingly, our operations and revenue are subject to a number of risksassociated with foreign commerce, including the following:

·                                                     managingforeign distributors;

·                                                     collectingamounts due;

·                                                     staffingand managing foreign offices;

·                                                     politicaland economic instability;

·                                                     foreigncurrency exchange fluctuations;

·                                                     changesin tax laws, import and export regulations, tariffs and freight rates;

·                                                     timingand availability of export licenses;

·                                                     supplyingproducts that meet local environmental regulations; and

·                                                     inadequateprotection of intellectual property rights.

In the past, wehave denominated 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. To the extent any such risks materialize, our businesscould be materially harmed.

In addition, weincur costs in foreign countries that may be difficult to reduce quicklybecause of employee-related laws and practices in those foreign countries.

# *Manysystem manufacturers may be unwilling to switch to our products because oftheir familiarity with the products offered by our direct competitors, such asXilinx and Altera, which dominate the programmable logic market*

The semiconductorindustry is intensely competitive and characterized by:

·                                                     erosionof selling prices over product lives;

·                                                     rapidtechnological change;

·                                                     shortproduct life cycles; and

·                                                     strongdomestic and foreign competition.

If we are not ableto compete successfully in this environment, our business will be materiallyharmed.

Many of our competitorshave substantially greater financial, technical, manufacturing, marketing,sales, distribution, name recognition and other resources than we do. Inaddition, many of our competitors have well-established relationships with ourcurrent and potential customers and have extensive knowledge of systemapplications. In the past, we have lost potential customers to competitors forvarious reasons, including, but not limited to, re-programmability and lowerprice. Our current direct competitors include suppliers of complex programmablelogic devices 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

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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.

We also facecompetition from companies that offer ASICs, which may be purchased for a lowerprice at higher volumes and typically have greater logic capacity, additionalfeatures and higher performance than those of our products. We may also facecompetition from suppliers of embedded microprocessors, such as FreescaleSemiconductor, Inc., or from suppliers of products based on new or emergingtechnologies. Our inability to successfully compete in any of the followingareas could materially harm our business:

·                                                     thedevelopment of new products and advanced manufacturing technologies;

·                                                     thequality, power characteristics, performance characteristics, price andavailability of devices, programming hardware and software development tools;

·                                                     theability to engage with companies that provide synergistic products andservices;

·                                                     theincorporation of industry standards in our products;

·                                                     thediversity of product offerings available to customers; or

·                                                     thequality and cost effectiveness of design, development, manufacturing andmarketing efforts.

# *We maybe unable to adequately protect our intellectual property rights, and may facesignificant expenses as a result of future litigation*

Protection ofintellectual property rights is crucial to our business, since that is how wekeep others from copying the innovations that are central to our existing andfuture products. From time to time, we receive letters alleging patentinfringement or inviting us to license other parties’ patents. We evaluatethese requests on a case-by-case basis. These situations may lead to litigationif we reject the offer to obtain the license.

In the past, wehave been involved in litigation relating to alleged infringement by us ofothers’ patents or other intellectual property rights. This kind of litigationis expensive and consumes large amounts of management’s time and attention.Additionally, matters that we initially consider not material to our businesscould become costly. For example, we incurred substantial costs associated withthe litigation and settlement of our dispute with Actel, which materiallyharmed our business. 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 kind of litigation could materially harm ourbusiness.

Although we mayseek to obtain a license under a third party’s intellectual property rights inorder to bring an end to certain claims or actions asserted against us, we maynot be able to obtain such a license on reasonable terms, or at all. We haveentered into technology license agreements with third parties which give thoseparties the right to use patents and other technology developed by us and whichgive us the right to use patents and other technology developed by them. Weanticipate that we will continue to enter into these kinds of licensingarrangements in the future; however, it is possible that desirable licenseswill not be available to us on commercially reasonable terms. If we loseexisting licenses to key technology, or are unable to enter into new licensesthat we deem important, our business could be materially harmed.

Because it iscritical to our success that we continue to prevent competitors from copyingour innovations, we intend to continue to seek patent and trade secretprotection for our products. The process of seeking patent protection can belong and expensive, and we cannot be certain that any currently pending orfuture applications will actually result in issued patents, or that, even ifpatents are issued, they will be of sufficient scope or strength to providemeaningful protection or any commercial advantage to us. Furthermore, othersmay develop technologies that are similar or superior to our technology ordesign around the patents we own. We also rely on trade secret protection forour technology, in part through confidentiality agreements with our employees,consultants and other third parties. However, these parties may breach theseagreements, and we may not have adequate remedies for any breach. In any case,others may come to know about or determine our trade secrets through a varietyof methods. In

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addition, the laws ofcertain territories in which we develop, manufacture or sell our products maynot protect our intellectual property rights to the same extent as the laws ofthe United States.

# *We mayengage in manufacturing, distribution or technology agreements that involvenumerous risks, including the use of cash, diversion of resources andsignificant write-offs*

We have enteredinto and, in the future, intend to enter into agreements that have involvednumerous risks, including the use of significant amounts of our cash; diversionof resources from other development projects or market opportunities; ourability to incorporate licensed technology in our products and solutions; ourability to introduce related products in a cost-effective and timely manner;our ability to collect amounts due under these contracts; and market acceptanceof related products. For instance, we have licensed certain microprocessortechnology from MIPS Technologies and obtained other elements of our productsfrom third-party companies. In the fourth quarter of 2004, we determined thatthe expected revenue and gross profit from these products would not besufficient to recover the full carrying value of the related third partyelements and other long-lived assets, and we recorded a $3.2 millionlong-lived asset impairment charge. If we fail to recover the cost of these orother assets from the cash flow generated by the related products, our assetswill become impaired and our financial results would be harmed.

# *Ourbusiness is subject to the risks of earthquakes, other catastrophic events andbusiness interruptions for which we may maintain limited insurance*

Our operations andthe operations of our suppliers are vulnerable to interruption by fire,earthquake, power loss, flood, terrorist acts and other catastrophic eventsbeyond our control. In particular, our headquarters is located near earthquakefault lines in the San Francisco Bay area. In addition, we rely on solesuppliers to manufacture our products and would not be able to qualify analternate supplier of our products for several quarters. Our suppliers oftenhold significant quantities of our inventory which, in the event of a disaster,could be destroyed. In addition, our business processes and systems arevulnerable to computer viruses, break-ins, and similar disruptions fromunauthorized tampering. Any catastrophic event, such as an earthquake or othernatural disaster, the failure of our computer systems, war or acts ofterrorism, could significantly impair our ability to maintain our records, payour suppliers, or design, manufacture or ship our products. The occurrence ofany of these events could also affect our customers, distributors and suppliersand produce similar disruptive effects upon their business. If there is anearthquake or other catastrophic event near our headquarters, our customers’facilities, our distributors’ facilities or our suppliers’ facilities, ourbusiness could be seriously harmed.

We do not have adetailed disaster recovery plan. In addition, we do not maintain sufficientbusiness interruption and other insurance policies to compensate us for alllosses that may occur. Any losses or damages incurred by us as a result of acatastrophic event or any other significant uninsured loss could have amaterial adverse effect on our business.

# *Ourprincipal stockholders have significant voting power and may vote for actionsthat may not be in the best interests of our other stockholders*

Our officers,directors and principal stockholders together control a significant portion ofour outstanding 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.

# *OurShareholder Rights Plan, Certificate of Incorporation, Bylaws and Delaware lawcontain provisions that could discourage a takeover that is beneficial tostockholders*

Our ShareholderRights Plan as well as provisions of our Certificate of Incorporation, our Bylawsand Delaware law could make it difficult for a third party to acquire us, evenif doing so would be beneficial to our stockholders.

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# *Themarket price of our common stock may fluctuate significantly and could lead tosecurities litigation*

Stock prices formany companies in the technology and emerging growth sectors have experiencedwide fluctuations that have often been unrelated to the operating performanceof such companies. In the past, securities class action litigation has oftenbeen brought against a company following periods of volatility in the marketprice of its securities. In the future, we may be the target of similarlitigation. Securities litigation could result in substantial costs and divertmanagement’s attention and resources.

# *Changesto existing accounting pronouncements or taxation rules or practices may causeadverse revenue fluctuations, affect our reported results of operations or howwe conduct our business*

Generally AcceptedAccounting Principles, or GAAP, are promulgated by, and are subject to theinterpretation of the Financial Accounting Standards Board, or FASB, and theSecurities and Exchange Commission, or SEC. New accounting pronouncements ortaxation rules and varying interpretations of accounting pronouncements ortaxation practice have occurred and may occur in the future. Any future changesin accounting pronouncements or taxation rules or practices may have asignificant effect on how we report our results and may even affect ourreporting of transactions completed before the change is effective. Inaddition, a review of existing or prior accounting practices may result in achange in previously reported amounts. This change to existing rules, future changes, if any, or the questioningof current practices may adversely affect our reported financial results, ourability to remain listed on The Nasdaq Global Market, or the way we conduct ourbusiness and subject us to regulatory inquiries or litigation.

For example, FASBhas issued SFAS No. 123(R), *“Share-BasedPayment,”* which we adopted in the first quarter of 2006. SFAS No.123(R) requires us to measure compensation costs for all stock-basedcompensation awards (including our stock options and our employee stockpurchase plan, as currently constructed) at fair value and record compensationexpense over the vesting period. If this accounting pronouncement had been ineffect during fiscal 2005, we estimate that we would have reported a net loss.

Additionally, inJuly 2006 we initiated a review of our historical stock option practices andrelated accounting.  This reviewidentified accounting and administrative errors that, if they had been recordedat the time they occurred, would have resulted in total additional charges ofapproximately $964,000 between October 1999 and December 2005.

*Compliancewith changing regulations related to corporate governance and public disclosuremay result in additional expenses*

Changing laws,regulations and standards relating to corporate governance and publicdisclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations andthe Nasdaq National Market rules, are creating uncertainty for companies suchas ours. These new or changed laws, regulations and standards are subject tovarying interpretations in many cases due to their lack of specificity and, asa result, their application in practice may evolve over time as new guidance isprovided by regulatory and governing bodies, which could result in continuinguncertainty regarding compliance matters and higher costs necessitated by ongoingrevisions to disclosure and governance practices. We are committed tomaintaining high standards of corporate governance and public disclosure. As aresult, we intend to invest resources to comply with evolving laws, regulationsand standards, and this investment may result in increased general andadministrative expenses and a diversion of management time and attention fromprofit-generating activities. If our efforts to comply with new or changedlaws, regulations and standards differ from the activities intended byregulatory or governing bodies due to ambiguities related to practice, ourreputation may be harmed and the market price of our common stock could beaffected.

# *Whilewe believe that we currently have adequate internal control procedures in place,we are still exposed to potential risks from legislation requiring companies toevaluate controls under Section 404 of the 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

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# involves human diligence and compliance and is subjectto lapses in judgment and breakdowns resulting from human failures. Internalcontrol over financial reporting also can be circumvented by collusion orimproper management override. Because of such limitations, there is a risk thatmaterial misstatements may not be prevented or detected on a timely basis byinternal control over financial reporting. However, these inherent limitationsare known features of the financial reporting process. Therefore, it ispossible to design into the process safeguards to reduce, though not eliminate,this risk.

As ofDecember 2005, we have evaluated our internal control systems in order toallow management to report on, and our independent registered public accountingfirm to attest to, our internal controls over financial reporting, as requiredby Section 404 of the Sarbanes-Oxley Act. As a result of our internalreview of stock option granting practices and related accounting, we haveidentified and are implementing enhanced controls and process improvements inconnection with the issuance of equity awards. However, our internal review hasnot identified any weaknesses in our existing internal control systems. Weperformed the system and process evaluation and testing required in an effort tocomply with the management certification and independent registered publicaccounting firm attestation requirements of Section 404. As a result, weincurred additional expenses and a diversion of management’s time. While webelieve that our internal control procedures are adequate and we intend tocontinue to fully comply with the requirements relating to internal control andall other aspects of Section 404, our controls necessary for continuedcompliance with the Act may not operate effectively at all times and may resultin a material control disclosure. The identification of a material weakness ininternal controls over financial reporting, if any, could indicate a lack ofproper controls to generate accurate consolidated financial statements.Furthermore, we cannot be certain as to the outcome of future evaluations,testing and remediation actions or the impact of the same on our operations. Ifwe are not able to remain in compliance with the requirements of Section 404,we might be subject to sanctions or investigation by regulatory authorities,such as the SEC or the Nasdaq National Market. Any such action could adverselyaffect our financial results and the market price of our common stock.

# *We haveimplemented import and export control procedures to comply with United Statesregulations but we are still exposed to potential risks from import and exportactivity*

Our products,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.

# *As aresult of our internal stock option review, the SEC has opened an informalinquiry into our stock option granting practices and related accounting thatmay not be resolved favorably and may require a significant amount ofmanagement time and attention and accounting and legal resources, which couldadversely affect our business, results of operations, and cash flows*

The SEC has openedan informal inquiry into our historical stock option practices and relatedaccounting. The period of time necessary to resolve the SEC inquiry isuncertain and could require significant management and financial resources thatcould otherwise be devoted to the operation of our business. In addition,considerable legal and accounting expenses related to these matters may beincurred in the future. We cannot predict the outcome of the SEC inquiry. If weor any of our current or former officers or directors is subject to an adversefinding resulting from the SEC inquiry, we could be required to pay damages orpenalties or have other remedies imposed upon us which could adversely affectour business, results of operations, financial position, cash flows and the tradingprice of our securities. In addition, if the inquiry continues for a prolongedperiod of time, this could have the same effects, regardless of the outcome.

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# *If wedo not maintain compliance with the listing requirements of The Nasdaq GlobalMarket, our common stock could be delisted, which could, among other things,reduce the price of our common stock and the levels of liquidity available toour stockholders*

In connection withthe internal review of our stock option grants and related accounting, we weredelinquent in filing certain of our periodic reports with the SEC, andconsequently we were not in compliance with the listing requirements under TheNasdaq Global Market’s Marketplace Rules. As a result, we requested andparticipated in a hearing with the Nasdaq to determine our listing status. TheNasdaq ultimately permitted our securities to remain listed provided that thefiling of our consolidated financial statements is current within a specifiedtime frame. However, our securities could be delisted in the future if we donot file our consolidated financial statements in an acceptable time frame orif we do not maintain compliance with other applicable listing requirements. Ifour securities were delisted from The Nasdaq Global Market, they would subsequentlybe transferred to the National Quotation Service Bureau, or “Pink Sheets.” Thetrading of our common stock on the Pink Sheets may reduce the price of ourcommon stock and the levels of liquidity available to our stockholders. Inaddition, the trading of our common stock on the Pink Sheets will materiallyadversely affect our access to capital markets and our ability to raise capitalthrough alternative financing sources on terms acceptable to us, or at all.Securities that trade on the Pink Sheets are no longer eligible for marginloans, and a company trading on the Pink Sheets cannot avail itself of federalpreemption of state securities, or “blue sky,” laws, which adds substantialcompliance costs to securities issuances, including shares issued pursuant toemployee option plans, stock purchase plans and private or public offerings ofsecurities. If we are delisted in the future from The Nasdaq Global Market andtransferred to the Pink Sheets, there may also be other negative implications,including the potential loss of confidence by suppliers, customers andemployees and the loss of institutional investor interest in our company.

# *Ourdirectors and management have been named parties to two lawsuits related to ourhistorical stock option practices and related accounting, and we may be namedin additional litigation in the future, all of which could result in anunfavorable outcome and have a material adverse effect on our business,financial condition, results of operations, cash flows and the trading pricefor our securities*

Two lawsuits havebeen filed against the Company, our current directors and officers and certainof our former directors and officers relating to our historical stock optionpractices and related accounting. See Part I, Item 1, Note 17 “SubsequentEvents” for a more detailed description of these proceedings. We may become thesubject of additional private or government actions regarding these matters inthe future. These actions are in the preliminary stages, and their ultimateoutcome could have a material adverse effect on our business, financialcondition, results of operations, cash flows and the trading price for oursecurities. Litigation may be time-consuming, expensive and disruptive tonormal business operations, and the outcome of litigation is difficult topredict. The defense of these lawsuits will result in significant expendituresand the continued diversion of our management’s time and attention from theoperation of our business, which could impede our business. All or a portion ofany amount we may be required to pay to satisfy a judgment or settlement, ofany or all of these claims, if any, may not be covered by insurance.

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**Item 6. Exhibits**

a.    Exhibits

The following Exhibitsare filed with this report:
| Exhibit  Number | ** ** | **Description** |
|-----------------|------------|-----------------|
| 3               | .1(1)      |            | Amended and Restated Certificate of Incorporation of  Registrant. |
| 3               | .2(2)      |            | Bylaws of Registrant. |
| 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 RegistrationStatement on Form S-1 declared effective October 14, 1999 (Commission FileNo. 333-28833).

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

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**Signatures**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                        | **QUICKLOGIC  CORPORATION**                                                                                                          |
|------------------------|--------------------------------------------------------------------------------------------------------------------------------------|
|                   |                                                                                                                                 |
|                   | /s/ CARL M.  MILLS                                                                                                                   |
| Date: January 10, 2007 | Carl M. Mills                                                                                                                        |
| * *               | *Vice  President, Finance and Chief Financial Officer  (as Principal Accounting and Financial Officer and on behalf of  Registrant)* |

 

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**EXHIBITINDEX**
| Exhibit  Number | ** ** | **Description** |
|-----------------|------------|-----------------|
| 3               | .1(1)      |            | Amended and Restated Certificate of Incorporation of  Registrant. |
| 3               | .2(2)      |            | Bylaws of Registrant. |
| 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)             Incorporated by reference to the Company’sCurrent Report on Form 8-K (Item 5.03) filed May 2, 2005.

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