**UNITEDSTATESSECURITIES 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 July 2, 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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**QUICKLOGICCORPORATION**

(Exact name of registrant as specified in its charter)

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

 

**1277ORLEANS DRIVE SUNNYVALE, CA  94089**(Address of principalexecutive offices, including Zip Code)

**(408) 990-4000**(Registrant’stelephone 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 o  No x

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 oNo x

As of December 14, 2006, 28,679,626shares of the registrant’s common stock were outstanding.

 

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**QUICKLOGICCORPORATION**

**FORM10-Q**

**JUNE30, 2006**
|                                                                                                                                             | ** ** | **Page** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
|                                                                                                                                        |       |     |
| **Part I. Financial Information**                                                                                                           |       | 3        |
| ** **                                                                                                                                  |       |     |
| **Item 1. Financial  Statements**                                                                                                           |       | 3        |
| Condensed Unaudited Consolidated Statements of  Operations for the three and six months ended June 30, 2006 and 2005                   |       | 3        |
| Condensed Unaudited Consolidated Balance Sheets as of  June 30, 2006 and December 31, 2005                                        |       | 4        |
| Condensed Unaudited Consolidated Statements of Cash  Flows for the six months ended June 30, 2006 and 2005                             |       | 5        |
| Condensed Unaudited Consolidated Statements of  Comprehensive Income (Loss) for the three and six months ended June 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**                                |       | 28       |
| ** **                                                                                                                                  |       |     |
| **Item 3. Quantitative  and Qualitative Disclosures about Market Risk**                                                                |       | 41       |
| ** **                                                                                                                                  |       |     |
| **Item 4. Controls  and Procedures**                                                                                                   |       | 42       |
|                                                                                                                                        |       |     |
| **Part  II. Other Information**                                                                                                        |       | 43       |
| ** **                                                                                                                                  |       |     |
| **Item  1. Legal Proceedings**                                                                                                         |       | 43       |
| ** **                                                                                                                                  |       |     |
| **Item  1A. Risk Factors**                                                                                                             |       | 44       |
| ** **                                                                                                                                  |       |     |
| **Item 4. Submission of Matters to a Vote of Security Holders**                                                                        |       | 57       |
| ** **                                                                                                                                  |       |     |
| **Item 6. Exhibits**                                                                                                                   |       | 58       |
| ** **                                                                                                                                  |       |     |
| Signatures                                                                                                                                  |       | 59       |

 

2

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**PARTI. Financial Information**

**Item1. Financial Statements**

**QUICKLOGIC CORPORATIONCONDENSED UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share amounts)**
| ** **                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                 |       |                                            |       |                                          |       |   |   |   |   |
| Revenue                              |       | $                                               | 9,249      |                                          | $          | 12,770 |   | $ | 18,582 |   | $ | 25,297 |   |
| Cost of revenue                      |       | 4,221                                           |       | 4,614                                         |       | 7,981 |   | 9,502 |   |
| Gross profit                         |       | 5,028                                           |       | 8,156                                         |       | 10,601 |   | 15,795 |   |
| Operating expenses:                  |       |                                            |       |                                          |       |   |   |   |   |
| Research and  development            |       | 2,357                                           |       | 2,334                                         |       | 4,757 |   | 4,788 |   |
| Selling, general  and administrative |       | 4,594                                           |       | 4,042                                         |       | 9,211 |   | 8,340 |   |
| Income (loss) from  operations       |       | (1,923                                          | )          | 1,780                                         |       | (3,367 | ) | 2,667 |   |
| Write-down of  marketable securities |       | —                                          |       | (1,466                                        | )          | — |   | (1,466 | ) |
| Interest expense                     |       | (96                                             | )          | (53                                           | )          | (170 | ) | (106 | ) |
| Interest income and  other, net      |       | 341                                             |       | 90                                            |       | 633 |   | 170 |   |
| Income (loss) before  income taxes   |       | (1,678                                          | )          | 351                                           |       | (2,904 | ) | 1,265 |   |
| Provision for income  taxes          |       | 21                                              |       | 31                                            |       | 23 |   | 81 |   |
| Net income (loss)                    |       | $                                               | (1,699     | )                                             | $          | 320 |   | $ | (2,927 | ) | $ | 1,184 |   |
|                                 |       |                                            |       |                                          |       |   |   |   |   |
| Net income (loss) per  share:        |       |                                            |       |                                          |       |   |   |   |   |
| Basic                                |       | $                                               | (0.06      | )                                             | $          | 0.01 |   | $ | (0.10 | ) | $ | 0.04 |   |
| Diluted                              |       | $                                               | (0.06      | )                                             | $          | 0.01 |   | $ | (0.10 | ) | $ | 0.04 |   |
|                                 |       |                                            |       |                                          |       |   |   |   |   |
| Weighted average  shares:            |       |                                            |       |                                          |       |   |   |   |   |
| Basic                                |       | 28,519                                          |       | 26,747                                        |       | 28,290 |   | 26,566 |   |
| Diluted                              |       | 28,519                                          |       | 27,921                                        |       | 28,290 |   | 27,678 |   |

 

See accompanyingNotes to Condensed Unaudited Consolidated Financial Statements.

3

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**QUICKLOGIC CORPORATIONCONDENSED UNAUDITED CONSOLIDATED BALANCE SHEETS(In thousands, except par value amount)**
| ** **                                                                                                                | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                | ** ** | ** **              | ** ** | ** **                  | ** ** |
|                                                                                                                      |       |                    |       |                        |       |
| Current assets:                                                                                                           |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                 |       | $                       | 30,173     |                        | $          | 28,283 |   |
| Short-term investment in Tower Semiconductor Ltd.                                                                         |       | 1,252                   |       | 1,297                       |       |
| Accounts receivable, net of allowances for doubtful  accounts of $669 and $1,042, respectively                            |       | 4,475                   |       | 5,556                       |       |
| Inventory                                                                                                                 |       | 7,433                   |       | 7,830                       |       |
| Other current assets                                                                                                      |       | 1,206                   |       | 1,265                       |       |
| Total current assets                                                                                                      |       | 44,539                  |       | 44,231                      |       |
| Property and  equipment, net                                                                                              |       | 6,019                   |       | 5,697                       |       |
| Investment in  Tower Semiconductor Ltd.                                                                                   |       | 630                     |       | 653                         |       |
| Other assets                                                                                                              |       | 4,385                   |       | 4,415                       |       |
| TOTAL ASSETS                                                                                                              |       | $                       | 55,573     |                        | $          | 54,996 |   |
|                                                                                                                      |       |                    |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                             | ** ** | ** **              | ** ** | ** **                  | ** ** |
|                                                                                                                      |       |                    |       |                        |       |
| Current  liabilities:                                                                                                     |       |                    |       |                        |       |
| Trade payables                                                                                                            |       | $                       | 3,806      |                        | $          | 3,338 |   |
| Accrued liabilities                                                                                                       |       | 2,686                   |       | 3,434                       |       |
| Deferred income on shipments to distributors                                                                              |       | 1,498                   |       | 1,626                       |       |
| Current portion of debt and capital lease  obligations                                                                    |       | 1,970                   |       | 1,790                       |       |
| Total current liabilities                                                                                                 |       | 9,960                   |       | 10,188                      |       |
|                                                                                                                      |       |                    |       |                        |       |
| Long-term  liabilities:                                                                                                   |       |                    |       |                        |       |
| Debt and capital lease obligations, less current  portion                                                                 |       | 1,488                   |       | 1,163                       |       |
| Deferred royalty revenue                                                                                                  |       | 1,502                   |       | 1,408                       |       |
| Total long-term liabilities                                                                                               |       | 2,990                   |       | 2,571                       |       |
| Total liabilities                                                                                                         |       | 12,950                  |       | 12,759                      |       |
|                                                                                                                      |       |                    |       |                        |       |
| Commitments and  contingencies (see Notes 15 and 16)                                                                      |       |                    |       |                        |       |
|                                                                                                                      |       |                    |       |                        |       |
| Stockholders’  equity:                                                                                               |       |                    |       |                        |       |
| Common stock, $0.001 par value; 100,000 shares  authorized; 28,668 and 27,896 shares issued and outstanding, respectively |       | 29                      |       | 28                          |       |
| Additional paid-in capital                                                                                                |       | 163,523                 |       | 159,179                     |       |
| Accumulated other comprehensive income                                                                                    |       | 309                     |       | 377                         |       |
| Accumulated deficit                                                                                                       |       | (121,238                | )          | (117,347                    | )          |
| Total stockholders’ equity                                                                                           |       | 42,623                  |       | 42,237                      |       |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                          |       | $                       | 55,573     |                        | $          | 54,996 |   |

 

See accompanyingNotes to Condensed Unaudited Consolidated Financial Statements.

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**QUICKLOGIC CORPORATIONCONDENSED UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)**
| ** **                                                                                | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                | ** ** | **2006**                                      | ** ** | **2005** | ** ** |
| ** **                                                                                | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Cash flows from  operating activities:                                                    |       |                                          |       |   |   |
| Net income (loss)                                                                         |       | $                                             | (2,927     | ) | $ | 1,184 |   |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                                          |       |   |   |
| Depreciation and amortization                                                             |       | 1,491                                         |       | 1,359 |   |
| Loss on disposal of property and equipment                                                |       | —                                        |       | 7 |   |
| Stock-based compensation                                                                  |       | 855                                           |       | — |   |
| Utilization of wafer credits from Tower  Semiconductor Ltd.                               |       | 56                                            |       | 215 |   |
| Inventory write-down                                                                      |       | 470                                           |       | 205 |   |
| Write-down of marketable securities                                                       |       | —                                        |       | 1,466 |   |
| Changes in assets and liabilities:                                                        |       |                                          |       |   |   |
| Accounts receivable, net of allowances for doubtful  accounts                             |       | 1,081                                         |       | (1,716 | ) |
| Inventory                                                                                 |       | (73                                           | )          | (2,051 | ) |
| Other assets                                                                              |       | 191                                           |       | 452 |   |
| Trade payables                                                                            |       | 468                                           |       | (824 | ) |
| Accrued liabilities                                                                       |       | (748                                          | )          | (490 | ) |
| Deferred income and royalty revenue                                                       |       | (34                                           | )          | 465 |   |
| Net cash provided by operating activities                                                 |       | 830                                           |       | 272 |   |
|                                                                                      |       |                                          |       |   |   |
| Cash flows from  investing activities:                                                    |       |                                          |       |   |   |
| Capital expenditures for property and equipment                                           |       | (1,180                                        | )          | (682 | ) |
| Net cash used for investing activities                                                    |       | (1,180                                        | )          | (682 | ) |
|                                                                                      |       |                                          |       |   |   |
| Cash flows from  financing activities:                                                    |       |                                          |       |   |   |
| Payment of debt and capital lease obligations                                             |       | (1,218                                        | )          | (1,370 | ) |
| Proceeds from debt obligations                                                            |       | 932                                           |       | 550 |   |
| Proceeds from issuance of common stock                                                    |       | 2,526                                         |       | 1,424 |   |
| Net cash provided by financing activities                                                 |       | 2,240                                         |       | 604 |   |
|                                                                                      |       |                                          |       |   |   |
| Net increase in  cash and cash equivalents                                                |       | 1,890                                         |       | 194 |   |
| Cash and cash equivalents at beginning of period                                          |       | 28,283                                        |       | 24,914 |   |
| Cash and cash equivalents at end of period                                                |       | $                                             | 30,173     |   | $ | 25,108 |   |
|                                                                                      |       |                                          |       |   |   |
| Supplemental  disclosures of cash flow information:                                       |       |                                          |       |   |   |
| Interest paid                                                                             |       | $                                             | 126        |   | $ | 115 |   |
| Income taxes paid                                                                         |       | $                                             | 11         |   | $ | 24 |   |
| 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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**QUICKLOGIC CORPORATIONCONDENSED UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)(In thousands)**
| ** **                                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                          |       |                                            |       |                                          |       |   |   |   |   |
| Net income  (loss)                            |       | $                                               | (1,699     | )                                             | $          | 320 |   | $ | (2,927 | ) | $ | 1,184 |   |
| Other  comprehensive gain (loss), net of tax: |       |                                            |       |                                          |       |   |   |   |   |
| Unrealized gain (loss) on investments         |       | 161                                             |       | 592                                           |       | (68 | ) | — |   |
| Total comprehensive  income (loss)            |       | $                                               | (1,538     | )                                             | $          | 912 |   | $ | (2,995 | ) | $ | 1,184 |   |

 

See accompanyingNotes to Condensed Unaudited Consolidated Financial Statements.

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**QUICKLOGIC CORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

**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 solutions,software tools 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 these consolidatedfinancial statements be read in conjunction with the Company’s Form 10-Kfor the year ended December 31, 2005 and Form 10-Q for the first fiscalquarter ended March 31, 2006. Operating results for the three and six monthsended June 30, 2006 are not necessarily indicative of the results that maybe expected for the full year.

QuickLogic’sfiscal year ends on the Sunday closest to December 31.  QuickLogic’sfiscal second quarters for 2006 and 2005 ended Sunday, July 2, 2006 andJuly 3, 2005, respectively. For presentation purposes, the consolidatedfinancial statements and notes have been presented as ending on the last day ofthe nearest calendar month.

*Cumulativeeffect adjustment upon the adoption of Staff Accounting Bulletin No. 108,“Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements” (“SAB No. 108”)*

Under the direction of theAudit Committee of the Board of Directors, the Company voluntarily conducted aninternal review of the Company’s historical stock option granting practices andrelated accounting for the period from October 15, 1999, the date of itsinitial public offering, through July 28, 2006. The review was initiated by theAudit Committee in response to media attention about stock option practices atother companies. The Companydid not find any systematic or pervasive practices to account for stock optionsin a manner inconsistent with GAAP  orthe Company’s stated policies and procedures. However, based on the results ofthe review and the Company’s analysis of the facts, the Company determined thatthere were certain errors committed in the process of documenting grants andaccounting for stock options associated with measurement dates, grants prior tomeeting the definition of an employee under GAAP, non-employee grants,modification of options and previously reported deferred stock compensationcharges. A total pre-tax stock-based compensation charge of $964,000 isassociated with these identified errors that should have been reported inpreviously issued consolidated financial statements had they been identified inthe proper period. After considering all of the quantitative and qualitativefactors in accordance with Staff Accounting Bulletin 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 cause the 2006consolidated financial statements to be materially misstated, the Companyconcluded that the cumulative effect adjustment method of initially applyingthe guidance of SAB No. 108 was appropriate. Accordingly, 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 for additional informationregarding the review conducted at the direction of the Audit Committee of theBoard of Directors and the cumulative effect adjustment to previously issuedconsolidated 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 and development expenditures,the timing of new product introductions, production volumes, product quality,sales and marketing efforts, the amount and financing arrangements forpurchases of capital equipment, changes in operating assets and liabilities,the ability to obtain or renew debt financing and to remain in compliance withthe terms of existing credit facilities, the ability to raise funds from thesale of shares of Tower Semiconductor Ltd. (“Tower”) and equity in the Company,the issuance and exercise of stock options, the terms of and participation inthe Company’s employee stock purchase plan, and other factors related to theuncertainties of the industry and global economics. Accordingly, there can beno assurance that events in the future will not require the Company to seekadditional capital or, if so required, that such capital will be available onterms acceptable to the Company.

7

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

*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.

Software revenuefrom the sale 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 andsix months ended June 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 

8

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

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 estimatefuture cash 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 includedrealized and unrealized holding gains or losses on Tower ordinary shares. SeeNote 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 of SAB No. 107in 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 26% of totaloperating expenses for the six months ended June 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 derivedprimarily from sales to customers located in North America, Europe and Asia.The Company performs ongoing credit evaluations of its customers and generallydoes not require collateral.

One contractmanufacturer, purchasing the Company’s products for use in a telecom design foran OEM application, accounted for 22% of the Company’s accounts receivablebalance at June 30, 2006. In addition, one distributor of the Company’sproducts accounted for 25% of the Company’s accounts receivable balance atJune 30, 2006.

9

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

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 amodified prospective 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 Accounting Bulletin (“SAB”) No. 107, which provides guidanceon the interaction between SFAS No. 123(R), *“Shared-BasedPayment,”* 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, the Company adopted SFAS No. 123(R) ona modified prospective basis and applied the principles of SAB No. 107 inconjunction with the adoption of SFAS No. 123(R).

In June 2006,the FASB issued FASB interpretation No. 48 (FIN No. 48) *“Accounting for Uncertainty in Income Taxes—anInterpretation of FASB Statement No. 109.”* FIN No. 48requires that the Company recognize in the consolidated financial statementsthe impact of a tax position that is more likely than not to be sustained uponexamination based on the technical merits of the position. The evaluation of atax position in accordance with this interpretation is a two-step process. Inthe first step, recognition, the Company determines whether it ismore-likely-than-not that a tax position will be sustained upon examination,including resolution of any related appeals or litigation processes, based on thetechnical merits of the position. The second step addresses measurement of atax position that meets the more-likely-than-not criteria. The tax position ismeasured at the largest amount of benefit that is greater than 50 percentlikely of being realized upon ultimate settlement. Tax positions thatpreviously failed to meet the more-likely-than-not recognition threshold shouldbe recognized in the first subsequent financial reporting period in which thatthreshold 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.

10

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

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 EITF 06-3 didnot have an impact on our consolidated financial position and results ofoperations.  The Company’s accountingpolicy has been to present the above mentioned taxes on a net basis, excludedfrom revenues.

In September 2006,the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects ofPrior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statements” (“SAB No. 108”). SAB No. 108 was issued inorder to eliminate the diversity of practice surrounding how public companiesquantify financial statement misstatements. Traditionally, there have been tworecognized methods for quantifying the effects of financial statementmisstatements - the “rollover” method and the “iron curtain” method. Therollover method focuses primarily on the impact of a misstatement on the incomestatement, including the reversing effect of prior period misstatements, butits use can lead to the accumulation of misstatements on the balance sheet. Theiron curtain method, on the other hand, focuses primarily on the effect ofcorrecting the period-end balance sheet with less emphasis on the reversingeffects of prior year errors on the income statement. Prior to the applicationof the guidance in SAB No. 108, the Company used the rollover method forquantifying the materiality of financial statement misstatements.

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 initiallyapply its provisions either by (i) restating prior financial statements as ifthe “dual approach” had always been applied or (ii) recording the cumulativeeffect of initially applying the “dual approach” as an adjustment to theopening balance of the carrying values of assets and liabilities in the year ofadoption with an offsetting adjustment recorded to the opening balance ofretained earnings (accumulated deficit). SAB No. 108 is effective forfiscal years ending after November 15, 2006, and is encouraged in any reportfor an interim period in the year of adoption. The Company has elected earlyadoption of  SAB No. 108 in relationto the results of  its internal review ofstock option grant practices and related accounting, and recorded the effectsof applying SAB No. 108 using the cumulative effect transition method (seeNote 3) in the second quarter of 2006.

In September 2006,the FASB issued Statement of Financial Accounting Standards No. 157, “FairValue Measurements”, (“SFAS No. 157”). SFAS No. 157 establishes aframework for measuring fair value, and expands disclosures about fair valuemeasurements. The changes to current practice resulting from the application ofSFAS No. 157 relate to the definition of fair value, the methods used tomeasure fair value, and expanded disclosures about fair value measurements.SFAS No. 157 is effective for fiscal years beginning after November 15,2007 and interim periods within those fiscal years. The Company is currentlyevaluating the impact that SFAS No. 157 will have on the Company’s consolidatedfinancial 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 fromOctober 15, 1999, the date of its initial public offering, through July28, 2006. The review was initiated by the Audit Committee in response to mediaattention about stock option practices at other companies.  The internal review, conducted under theguidance 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 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 mannerinconsistent with GAAP or the Company’s stated policies and procedures.

11

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

·                  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.

·                  Lessthan $50,000 of the identified adjustments to previously issued consolidated financialstatements 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 issued consolidatedfinancial statements.  This amountconsists of the following:

1.               From October 1999through May 2004, the date used to determine the exercise price for certainstock option grants preceded the finalization of the approval process of thosegrants for accounting purposes due to administrative errors in documenting orapproving the grants.  The totalintrinsic value (the difference between the exercise price and the price of theCompany’s stock on the measurement date) of these “in-the-money” grants, whichshould have been amortized over their vesting period in the Company’s previouslyissued consolidated financial statements, was approximately $787,000.

2.               From October 1999through July 2002, certain individuals were granted options prior to meetingall of the criteria of an employee under GAAP, as defined by APB 25 and relatedinterpretations, due to errors in documenting the individuals’ start ofemployment.  The total intrinsic value ofthese grants, which should have been amortized over their vesting period in theCompany’s previously issued consolidated financial statements, wasapproximately $449,000.

3.               The Company foundaccounting errors related to non-employee option grants from January 2000 untilOctober 2002 which resulted in total charges of $328,000 that should have beenrecorded over their vesting period.

4.               The Company found errorsrelated to the modification of stock options to certain employees between March2001 and August 2005, which resulted in $132,000 of charges which should havebeen recorded. The errors were the result of unclear documentation and lapsesin communication concerning employee termination agreements. Generally, thesemodifications were made in the context of separation agreements that permittedadditional vesting and/or time to exercise options after the employee hadceased performing services.

5.               In accordance withAPB 25, the Company recorded deferred stock-based compensation in connectionwith grants of stock options to employees and directors prior to the Company’sinitial public offering if the fair market value of the Company’s common stockdetermined for financial reporting purposes was greater than the fair valuedetermined by the Board of Directors on the date of grant (commonly known as a “cheapstock” charge).  As of October 15, 1999,the Company had approximately $1.6 million of deferred stock-based compensationrecorded in the stockholders’ equity section of the balance sheets, which wasamortized over the original vesting period of the stock options.  During the review, the Company determinedthat the reported deferred stock-based compensation account was not properlyadjusted to reflect forfeitures.  If anoption is forfeited, the deferred stock-based compensation balance related tounvested options should be reversed and no future expense recognized. As aresult, total stock-based compensation expense was overstated by approximately$732,000 from October 1999 to December 2003 due to this accounting error in theapplication 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 correctingthese errors in 2006 would cause the 2006 consolidated financial statements tobe materially misstated, the Company concluded that the cumulative effectadjustment method of initially applying the guidance of SAB No. 108 wasappropriate.

12

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

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.

13

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED 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 stockprice for 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 June 30,** | ** ** |
|--------------------------|------------|-----------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| ** **               | ** ** | **Net Loss**                                   | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** | **Net Income** | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** |
| Basic                    |       | $                                                   | (1,699     | ) | 28,519 |   | $ | (0.06 | ) | $ | 320 |   | 26,747 |   | $ | 0.01 |   |
| Effect of stock  options |       | —                                              |       | — |   | — |   | — |   | 1,174 |   | — |   |
| Diluted                  |       | $                                                   | (1,699     | ) | 28,519 |   | $ | (0.06 | ) | $ | 320 |   | 27,921 |   | $ | 0.01 |   |

 
| ** **               | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------|------------|---------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| ** **               | ** ** | **Net Loss**                                 | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** | **Net Income** | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** |
| Basic                    |       | $                                                 | (2,927     | ) | 28,290 |   | $ | (0.10 | ) | $ | 1,184 |   | 26,566 |   | $ | 0.04 |   |
| Effect of stock  options |       | —                                            |       | — |   | — |   | — |   | 1,112 |   | — |   |
| Diluted                  |       | $                                                 | (2,927     | ) | 28,290 |   | $ | (0.10 | ) | $ | 1,184 |   | 27,678 |   | $ | 0.04 |   |

 

As ofJune 30, 2006, all vested and unvested options outstanding were notincluded in the calculation of diluted net loss per share, as they were consideredantidilutive due to the net loss the Company experienced during the period. Forthe three and six months ended June 30, 2005, 4,437,000 and4,783,000 shares, respectively, of common stock subject to outstandingoptions were antidilutive and, therefore, were not included in the calculationof diluted net income per share, as the per share exercise price for suchoptions exceeded the average trading price of the Company’s common stock duringthe 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 of the Tower ordinary shares in fiscal 2003.

As ofJune 30, 2006, the Company held 1,344,543 available for sale Towerordinary shares with an unrealized gain of $309,000 recorded in accumulatedother comprehensive income in the balance sheet, representing the differencebetween the adjusted cost per share and $1.40 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 alsoreceived $4.7 million in prepaid wafer credits in partial considerationfor the investment, $4.2 million of which remained available as ofJune 30, 2006. The credits have no stated maturity and the Company hasguaranteed capacity at Tower through at least 2010. These credits are recordedwithin long-term other assets on the balance sheets and can be applied towardwafer purchases from Tower at 15% of the value of future purchases.

14

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

**Note 6—BalanceSheet Components**
| ** **                                | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **(in thousands)** | ** ** |
| Inventory:                                |       |                    |       |                        |       |
| Raw materials                             |       | $                       | 827        |                        | $          | 916 |   |
| Work-in-process                           |       | 6,115                   |       | 6,314                       |       |
| Finished goods                            |       | 491                     |       | 600                         |       |
|                                      |       | $                       | 7,433      |                        | $          | 7,830 |   |
|                                      |       |                    |       |                        |       |
| Other current  assets:                    |       |                    |       |                        |       |
| Prepaid expenses                          |       | $                       | 1,016      |                        | $          | 1,064 |   |
| Employee receivables                      |       | 18                      |       | 20                          |       |
| Other                                     |       | 172                     |       | 181                         |       |
|                                      |       | $                       | 1,206      |                        | $          | 1,265 |   |
|                                      |       |                    |       |                        |       |
| Property and  equipment:                  |       |                    |       |                        |       |
| Equipment                                 |       | $                       | 14,342     |                        | $          | 13,264 |   |
| Software                                  |       | 9,340                   |       | 8,610                       |       |
| Furniture and fixtures                    |       | 827                     |       | 825                         |       |
| Leasehold improvements                    |       | 805                     |       | 802                         |       |
|                                      |       | 25,314                  |       | 23,501                      |       |
| Accumulated depreciation and amortization |       | (19,295                 | )          | (17,804                     | )          |
|                                      |       | $                       | 6,019      |                        | $          | 5,697 |   |
|                                      |       |                    |       |                        |       |
| Other assets:                             |       |                    |       |                        |       |
| Prepaid wafer credits                     |       | $                       | 4,171      |                        | $          | 4,227 |   |
| Other                                     |       | 214                     |       | 188                         |       |
|                                      |       | $                       | 4,385      |                        | $          | 4,415 |   |
|                                      |       |                    |       |                        |       |
| Accrued  liabilities:                     |       |                    |       |                        |       |
| Employee related accruals                 |       | $                       | 1,450      |                        | $          | 2,026 |   |
| Other                                     |       | 1,236                   |       | 1,408                       |       |
|                                      |       | $                       | 2,686      |                        | $          | 3,434 |   |

 

15

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

**Note 7—Obligations**

 
| ** **                                             | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                             | ** ** | **(in thousands)** | ** ** |
|                                                   |       |                    |       |                        |       |
| Debt and capital  lease obligations:                   |       |                    |       |                        |       |
| Notes payable to bank                                  |       | $                       | 1,668      |                        | $          | 1,443 |   |
| Capital leases                                         |       | 1,790                   |       | 1,510                       |       |
|                                                   |       | 3,458                   |       | 2,953                       |       |
| Current portion of debt and capital lease  obligations |       | (1,970                  | )          | (1,790                      | )          |
|                                                   |       | $                       | 1,488      |                        | $          | 1,163 |   |

 

*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 $5.0million revolving line of credit that is available through June 2008 andan additional $2.0 million of borrowing capacity under the equipment line ofcredit that is available to be drawn against through June 2007. Advancesunder the equipment line of credit must be repaid in either 30 or 36 monthlyequal installments, depending upon the nature of the items financed. Terms ofthe various advances under the agreement are as follows (in thousands):
| ** **                 | ** ** | **Original  Balance** | ** ** | **Balance at  June 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                 |       | 149                                      |       | n/a                   |       | Prime + 2.00%                     |       | Multiple draws  maturing on or before  December 2006 |       |
| Notes payable              |       | 859                   |       | 342                                      |       | n/a                   |       | Prime + 2.00%                     |       | Multiple draws  maturing on or before  December 2007 |       |
| Notes payable              |       | 550                   |       | 300                                      |       | n/a                   |       | Prime + 2.00%                     |       | Multiple draws  maturing on or before  April 2008    |       |
| Notes payable              |       | 932                   |       | 877                                      |       | n/a                   |       | Prime + 1.75%                     |       | Multiple draws  maturing on or before  April 2009         |       |
| Notes payable              |       | n/a                   |       | —                                   |       | 2,000                 |       | Prime +1.00% or  Treasury +4.00%  |       | 30 or 36 months from  date of advance                     |       |
| Total                      |       |                  |       | $                                        | 1,668      |                  |       |                              |       |                                                      |       |   |
|                            |            |                       |            |                                          |            |                       |            |                                   |            |                                                           |            |  |

 

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 ofdividends.  The Company was in compliancewith the financial covenants of the agreement as of June 30, 2006.

At June 30, 2006,the prime rate under the credit facility was 8.25%. As of June 30, 2006and December 31, 2005, $685,000 and $387,000, respectively, of amountsoutstanding under the equipment line of credit were classified as long-termobligations.

16

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

*CapitalLease*

InDecember 2005, the Company leased design software and related maintenance undera two-year capital lease at an imputed interest rate of 8.5% per annum. Termsof the agreement require the Company to make quarterly payments ofapproximately $204,000 through November 2007. The Company recorded a capitalasset for $1.2 million that is being depreciated over the term of theagreement, prepaid maintenance of $272,000 that is being amortized over theterm of the agreement and a capital lease obligation of $1.5 million. Asof June 30, 2006, $1.1 million was outstanding under the capitallease, $396,000 of which was classified as a long-term obligation.

InJanuary 2006, the Company leased design software tools and related maintenanceunder a three-year capital lease at an imputed interest rate of 9.0% per annum.Terms of the agreement 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 a capitallease obligation of $791,000. As of June 30, 2006, $649,000 wasoutstanding under the capital lease, $407,000 of which was classified as along-term obligation.

**Note 8—DeferredRoyalty Revenue**

InOctober 2000, the Company entered into a technology license and wafersupply agreement with Aeroflex Incorporated (“Aeroflex”). Under the terms ofthe agreement, the Company received $750,000 of prepaid royalties. In addition,Aeroflex receives a prepaid royalty credit for a portion of the amounts paidfor wafers purchased from the Company under the agreement. These prepaidroyalties are recorded as a long-term liability and will be recognized asrevenue when Aeroflex reports the sale of products incorporating the licensedtechnology to the Company. As of June 30, 2006 and December 31, 2005, theCompany had recorded approximately $1.5 million and $1.4 million,respectively, of deferred royalty revenue under this agreement. As ofJune 30, 2006, no royalty revenue had been earned under the agreement.

**Note9—Employee Stock Plans**

*1989Stock Option Plan*

The1989 Stock Option Plan (the “1989 Plan”) provided for the issuance of incentiveand nonqualified options for the purchase of up to 4.6 million shares of commonstock. Options granted under the 1989 Plan have a term of up to 10 years,and typically vest at a rate of 25% of the total grant per year over afour-year period. In September 1999, the Company adopted the 1999 StockPlan and no further stock option grants were made under the 1989 Plan.

*1999Stock Plan*

The1999 Stock Plan (the “1999 Plan”) was adopted by the Board of Directors inAugust 1999 and was approved by the Company’s stockholders inSeptember 1999. As of June 30, 2006, approximately 13.6 millionshares were reserved for issuance under the 1999 Plan. In addition, eachJanuary an annual increase is added to the 1999 Plan equal to the lesser of(i) 5,000,000 shares, (ii) 5% of the Company’s outstanding shares onsuch date, or (iii) a lesser amount determined by the Board of Directors.Options that are canceled under the 1989 Plan also become available for grantunder the 1999 Plan. Options granted under the 1999 Plan have a term of up to10 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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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

*EmployeeStock Purchase Plan*

The1999 Employee Stock Purchase Plan (“ESPP”) was adopted by the Board of Directorsin August 1999 and was approved by the Company’s stockholders in September 1999.As of June 30, 2006, approximately 4.1 million shares were reservedfor issuance under the ESPP. In addition, each August an annual increase isadded to the ESPP equal to the lesser of (i) 1,500,000 shares,(ii) 4% of the Company’s outstanding shares on such date, or (iii) alesser amount determined by the Board of Directors.

Throughthe purchase period ending November 2005, the ESPP contained consecutive,overlapping, twenty-four month offering periods. Each offering period includedfour six-month purchase periods. The ESPP permitted participants to purchaseshares through payroll deductions at 85% of the lower of the fair market valueof the common stock at the beginning of an offering period or the end of apurchase period.

EffectiveNovember 2005, the Board of Directors amended the ESPP to provide for six-monthoffering periods.  Participants purchaseshares through payroll deductions of up to 20% of an employee’s totalcompensation (maximum of 20,000 shares per offering period). The amended ESPPpermits the Board of Directors to determine whether participants purchaseshares at: (i) 85% of the fair market value of the common stock at the end ofthe offering period; or (ii) 85% of the lower of the fair market value of thecommon stock at the beginning or the end of an offering period. The Board of Directorshas determined that, until further notice, future offering periods will be madeat 85% of the lower of the fair market value of the common stock at thebeginning or the end of an offering period. As a result of the Company’sinternal review of stock option grants and related accounting (see Note 3),employee contributions to the ESPP were suspended effective August 2006 andamounts previously withheld from employees were refunded in November 2006. Inaddition, the next offering period under the ESPP will commence once theCompany has filed all required quarterly reports on Form 10-Q  and will end on May 14, 2007, the nextregularly scheduled purchase date.

**Note10—Stock-Based Compensation**

EffectiveJanuary 2, 2006, the Company adopted the provisions of SFAS No.123(R), using the modified prospective transition method, which requires themeasurement and recognition of expense related to the fair value of stock-basedcompensation awards made to employees and directors, over the requisite serviceperiod.

18

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

*PeriodsPrior to Adoption of SFAS No. 123(R)*

Priorto the adoption of SFAS No. 123(R), the Company applied APB 25 and relatedinterpretations and provided the required pro forma disclosures of SFAS No.123, as amended by SFAS No. 148, *“Accountingfor Stock-Based Compensation — Transition and Disclosures.”* The proforma information in the following table illustrates the effect on net income(loss) and net income (loss) per share for the three and six months ended June30, 2005 as if the Company had applied the fair value recognition provisions ofSFAS No. 123 (in thousands, except per share amounts):
| ** **                                                                                                                       | ** ** | **Three Months  Ended  June 30, 2005** | ** ** | **Six Months   Ended  June 30, 2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------------|------------|
|                                                                                                                             |       |                                                  |       |                                                      |       |
| Net income – as reported                                                                                          |       | $                                                     | 320        |                                                      | $          | 1,184 |   |
| Less: Stock-based  compensation expense related to stock option plans  determined under the fair value based method, net of tax  |       | (607                                                  | )          | (1,477                                                    | )          |
| Less: Stock-based  compensation expense related to the stock purchase plan  determined under fair value based method, net of tax |       | (336                                                  | )          | (336                                                      | )          |
| Net loss – as adjusted                                                                                            |       | $                                                     | (623       | )                                                         | $          | (629 | ) |
|                                                                                                                             |       |                                                  |       |                                                      |       |
| Net income per share – as reported:                                                                                         |       |                                                  |       |                                                      |       |
| Basic                                                                                                                            |       | $                                                     | 0.01       |                                                      | $          | 0.04 |   |
| Diluted                                                                                                                          |       | $                                                     | 0.01       |                                                      | $          | 0.04 |   |
| Net loss per share – as adjusted:                                                                                           |       |                                                  |       |                                                      |       |
| Basic                                                                                                                            |       | $                                                     | (0.02      | )                                                         | $          | (0.02 | ) |
| Diluted                                                                                                                          |       | $                                                     | (0.02      | )                                                         | $          | (0.02 | ) |

 

In thepro forma information required under SFAS No. 123 for the periods prior tofiscal 2006, 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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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

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

TheCompany adopted SFAS No. 123(R) using the modified prospectivetransition method beginning January 2, 2006, the first day of the Company’sfiscal year 2006. In accordance with the modified prospective transitionmethod, the Company’s consolidated financial statements for prior periods havenot been restated to reflect, and do not include, the impact ofSFAS No. 123(R). Effective with the adoption of SFAS No. 123(R),stock-based compensation expense is recognized in the Company’s consolidatedstatements of operations and includes (i) compensation expense forstock-based compensation awards granted prior to, but not yet vested as ofJanuary 1, 2006, based on the grant-date fair value estimated andre-measured upon modification in accordance with the pro forma provisions ofSFAS No. 123 and (ii) compensation expense for the stock-basedcompensation awards granted or modified subsequent to January 1, 2006,based on the grant-date fair value estimated and re-measured in accordance withthe provisions of SFAS No. 123(R). The impact of SFAS No. 123(R) onthe Company’s consolidated financial statements for the three and six monthsended June 30, 2006 was as follows (in thousands, except per shareamounts):
| ** **                          | ** ** | **Three Months  Ended  June 30, 2006** | ** ** | **Six Months  Ended  June 30, 2006** | ** ** |
|-------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
|                                |       |                                                  |       |                                                |       |
| Cost of revenue                     |       | $                                                     | 53         |                                                | $          | 102 |   |
| Research and development            |       | 118                                                   |       | 264                                                 |       |
| Selling, general and administrative |       | 232                                                   |       | 489                                                 |       |
| Total costs and expenses            |       | $                                                     | 403        |                                                | $          | 855 |   |
|                                |       |                                                  |       |                                                |       |
| Effect on net loss per share:       |       |                                                  |       |                                                |       |
| Basic                               |       | $                                                     | (0.01      | )                                                   | $          | (0.03 | ) |
| Diluted                             |       | $                                                     | (0.01      | )                                                   | $          | (0.03 | ) |

 

Stock-basedcompensation expense recorded in the three and six months ended June 30,2006 had no effect on cash flows or the provision for income taxes.

Uponthe adoption of SFAS No. 123(R), the Company has made an estimate ofexpected forfeitures and is recognizing compensation costs only for thoseequity awards expected to vest. The cumulative effect of forfeitures uponadoption of SFAS No. 123(R) was not material.

*ValuationAssumptions*

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 othercurrently accepted option valuation models, was developed to estimate the fairvalue of freely tradable, fully transferable options without vestingrestrictions. These assumptions differ significantly from the characteristicsof the Company’s stock-based compensation awards. Black-Scholes also requiresthe use of highly subjective, complex assumptions, including expected term andthe price volatility of the Company’s stock.

20

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

The following weightedaverage assumptions are included in the estimated fair value calculations forstock option grants:

 
| ** **                                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                   | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                         |       |                                            |       |                                          |       |   |   |   |   |
| Expected term (years)                        |       | 5.75                                            |       | 4.02                                          |       | 5.75 |   | 4.05 |   |
| Risk-free interest rate                      |       | 4.95                                            | %          | 3.80                                          | %          | 4.87 | % | 3.79 | % |
| Expected volatility                          |       | 82                                              | %          | 92                                            | %          | 82 | % | 92 | % |
| Estimated pre-vesting annual forfeiture rate |       | 8.10                                            | %          | —                                        |       | 8.10 | % | — |   |
| Dividend yield                               |       | —                                          |       | —                                        |       | — |   | — |   |

 

Themethodologies for determining the above values were as follows:

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

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

·                  *Expected volatility:* The Company determines expectedvolatility based on historical volatility of the Company’s common stock, andother factors.

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

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

Theweighted average estimated fair value for options granted during the threemonths ended June 30, 2006 and 2005 was $4.11 and $2.45 per option,respectively. The weighted average estimated fair value for options grantedduring the six months ended June 30, 2006 and 2005 was $3.89 and $2.44 peroption, respectively. As of June 30, 2006, the fair value of unvestedstock-based compensation awards, net of expected forfeitures, was$1.1 million which is expected to be recognized over the next four years.

*EmployeeStock Purchase Plan*

Theoffering periods ending in May 2006 and November 2006 under the ESPP providethat shares will be purchased at 85% of the fair market value of the commonstock at the end of the offering period. Accordingly, the fair value of stock-basedcompensation awards under the ESPP was recognized based upon employeedeductions and the purchase discount, rather than using a pricing model. In thethree and six months ended June 30, 2006, stock-based compensationrelating to the ESPP was $34,000 and $69,000, respectively.

The following weighted average assumptions are included inthe estimated fair value calculations for rights to purchase stock under theESPP during the three and six months ending June 30, 2005:

|                         | ** ** | **Three Months  Ended  June 30, 2005** | ** ** | **Six Months  Ended  June 30, 2005** | ** ** |
|-------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| Expected life (months)  |       | 6.0                                                   |       | 6.0                                                 |       |
| Risk-free interest rate |       | 3.13                                                  | %          | 3.13                                                | %          |
| Volatility              |       | 65                                                    | %          | 65                                                  | %          |
| Dividend yield          |       | —                                                |       | —                                              |       |

 

Themethodologies for determining the above values were as follows:

·                  *Expected term:* The expected term represents the six-monthpurchase period contained in the ESPP.

·                  *Risk-free interest rate:* The risk-free interest rateassumption is based upon observed interest rate appropriate for the six-monthpurchase period.

21

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

·                  *Expected volatility:* The Company determines expectedvolatility based on historical volatility of the Company’s common stock, andother factors for the six-month purchase period.

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

The purchase discount of rights issued pursuant to theCompany’s ESPP during the three and six months ended June 30, 2006 was$0.84  per right, respectively. Theweighted average estimated fair value, as defined by SFAS No. 123, ofrights issued pursuant to the Company’s ESPP during the three and six monthsended June 30, 2005 was $0.79 per right, respectively. During 2005, the fairvalue of rights granted was estimated on the date of grant using Black-Scholes.

*Stock-BasedCompensation Award Activity*

Thefollowing table summarizes stock-based compensation award activity under the1989 Plan and the 1999 Plan, and the related weighted average exercise price,for the six months ended June 30, 2006 and the year endedDecember 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                           |       | (187                                      | )          | 187                            |       | 5.43 |   |
| Forfeited or expired              |       | 139                                       |       | (139                           | )          | 7.49 |   |
| Exercised                         |       | —                                    |       | (687                           | )          | 3.09 |   |
| Balance at June 30, 2006     |       | 8,004                                     |       | 6,096                          |       | $ | 5.59 |   |

 

As ofJune 30, 2006 and December 31, 2005, options to purchase 5,571,000and 5,830,000 shares were vested, respectively.

Significantexercise price ranges of options outstanding, related weighted average exerciseprices, intrinsic value and contractual life information at June 30, 2006was as 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  thousands)** | ** ** | **(in  thousands)** | ** ** | **(in years)** | ** ** | ** ** | ** ** | **(in  thousands)** | ** ** |
| $0.97 — $  2.75                  |       | 1,672                        |       | 6.54                                                |       | $ | 2.12 |   | $ | 4,629 |   | 1,434 |   | 6.46 |   | $ | 2.12 |   | $ | 3,966 |   |
|   2.83 —     4.08 |       | 1,599                        |       | 6.43                                                |       | 3.45 |   | 2,302 |   | 1,493 |   | 6.26 |   | 3.44 |   | 2,167 |   |
|   4.25 —     6.04      |       | 1,671                        |       | 4.98                                                |       | 4.98 |   | 326 |   | 1,496 |   | 4.42 |   | 4.93 |   | 325 |   |
|   6.13 —   34.56            |       | 1,154                        |       | 4.22                                                |       | 14.45 |   | — |   | 1,148 |   | 4.19 |   | 14.50 |   | — |   |
| $0.97 — $34.56                             |       | 6,096                        |       | 5.64                                                |       | $ | 5.59 |   | $ | 7,257 |   | 5,571 |   | 5.39 |   | $ | 5.78 |   | $ | 6,458 |   |

 

22

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

Theaggregate intrinsic value in the table above represents the total pretaxintrinsic value, based on the Company’s closing stock price of $4.89 as of theend of the Company’s current reporting period which would have been received bythe option holders had all option holders exercised their options as of thatdate. The total number of shares of common stock underlying in-the-moneyoptions exercisable as of June 30, 2006 was 3,990,000.

Thetotal intrinsic value of options exercised during the three and six monthsended June 30, 2006 was $700,000 and $1.5 million, respectively. Totalcash received from employees as a result of employee stock option exercisesduring the three and six months ended June 30, 2006 was approximately$1.1 million and $2.1 million, respectively. The Company settlesemployee stock option exercises with newly issued common shares. In connectionwith these exercises, there was no tax benefit realized by the Company due tothe Company’s current loss position.

Thestatus of the Company’s nonvested shares as of June 30, 2006 and changesduring the six months ended June 30, 2006 and the year endedDecember 31, 2005 was as follows (in thousands, except per share amounts):
| ** **                           | ** ** | **Number of  Shares** | ** ** | **Weighted  Average Grant Date Fair Value** | ** ** |
|--------------------------------------|------------|----------------------------|------------|---------------------------------------------|------------|
| Nonvested at  January 1, 2005   |       | 2,900                      |       | $                                           | 1.97       |   |
| Granted                              |       | 207                        |       | 2.42                                        |       |
| Vested                               |       | (1,870                     | )          | 2.15                                        |       |
| Forfeited                            |       | (332                       | )          | 2.04                                        |       |
| Nonvested at  December 31, 2005 |       | 905                        |       | 1.65                                        |       |
| Granted                              |       | 187                        |       | 3.89                                        |       |
| Vested                               |       | (506                       | )          | 1.67                                        |       |
| Forfeited                            |       | (61                        | )          | 1.51                                        |       |
| Nonvested at  June 30, 2006     |       | 525                        |       | $                                           | 2.45       |   |

 

OnDecember 21, 2005, the Compensation Committee of the Company’s Board ofDirectors approved the vesting acceleration of unvested, “out-of-the-money”stock options awarded under its 1999 Stock Plan. The purpose of the acceleratedvesting was to reduce future compensation expense associated with theaccelerated stock options upon adoption of SFAS No.123(R) by approximately$380,000 and because the outstanding options were not fully achieving theiroriginal objective of incentive compensation and employee retention due toexercise prices which were in excess of the current market value. A total of187,703 shares with exercise prices ranging from $4.08 to $8.70 wereaccelerated under the program. The accelerated stock options had a weightedaverage exercise price of $5.45. On average, the accelerated options wouldotherwise have completed vesting over 1.6 years from the date of acceleration.

**Note 11—ShelfRegistration Statement**

On July 12, 2005, the Company filed a shelf registrationstatement on Form S-3, which was declared effective on July 26, 2005by the Securities and Exchange Commission. Under this filing, the Company hasthe ability to raise up to $30.0 million, in one or more transactions, byselling common stock, preferred stock, depositary shares, or warrants. As ofJune 30, 2006, the Company had not raised any funds in connection withthis filing.

**Note 12—RightsPlan**

In November 2001, the Board of Directors adopted aRights Agreement, which provides for a dividend of one Preferred Stock PurchaseRight (each a “Right” and collectively, the “Rights”) for each share of commonstock of the Company. Each Right will entitle stockholders to buy oneten-thousandth of a share of Series A Junior Participating Preferred Stockof QuickLogic at an exercise price of $32.50, subject to adjustment. The Rightswill become exercisable only if a person or group becomes the beneficial owner of15% or more of the common stock, or commences a tender or exchange offer whichwould result in the offeror beneficially owning 15% or more of the commonstock, without the approval of the Board of Directors. The Company is entitledto redeem the Rights at $0.001 per Right up to ten business days after thepublic announcement of a 15% holder. If not earlier terminated or redeemed, theRights will expire on November 27, 2011.

23

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

**Note 13—Income Taxes**

In the three months ended June 30, 2006 and 2005,the Company recorded income tax expense of $21,000 and $31,000,respectively, which consisted of incometaxes on foreign operations. In the six months ended June 30, 2006 and2005, the Company recorded income tax expense of $23,000 and $81,000,respectively, which consisted primarily ofincome taxes on foreign operations.

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

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.

Underthe Tax Reform Act of 1986, the amount of and the benefit from net operatinglosses that can be carried forward may be impaired in certain circumstances.Events which may cause changes in the Company’s tax carryforwards include, butare not limited to, a cumulative ownership change of more than 50% over athree-year period. Since inception, the Company has had cumulative changes inownership which will limit the loss carryforward deduction under IRCSection 382. However, the Company believes that such limitations will nothave a material effect on the future utilization of the losses.

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

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

24

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

Thefollowing is a breakdown of revenue by product family (in thousands):
| ** **                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                          | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                |       |                                            |       |                                          |       |   |   |   |   |
| *Revenue  by product family (1):*   | * *   | * *                                        | * *   | * *                                      | * *   | * * | * * | * * | * * |
| Mature products                     |       | $                                               | 4,092      |                                          | $          | 7,575 |   | $ | 9,174 |   | $ | 16,123 |   |
| Embedded standard products          |       | 2,473                                           |       | 3,441                                         |       | 4,981 |   | 5,828 |   |
| Advanced embedded standard products |       | 2,684                                           |       | 1,754                                         |       | 4,427 |   | 3,346 |   |
| Total revenue                       |       | $                                               | 9,249      |                                          | $          | 12,770 |   | $ | 18,582 |   | $ | 25,297 |   |

 

----

(1)          The matureproducts family includes pASIC 1, pASIC 2 and pASIC 3 products.The embedded 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.

Thefollowing is a breakdown of revenue by shipment destination (in thousands):
| ** **               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **               | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|                     |       |                                            |       |                                          |       |   |   |   |   |
| *Revenue  by geography:* | * *   | * *                                        | * *   | * *                                      | * *   | * * | * * | * * | * * |
| United States            |       | $                                               | 3,207      |                                          | $          | 5,987 |   | $ | 8,043 |   | $ | 11,868 |   |
| Europe                   |       | 4,013                                           |       | 2,227                                         |       | 6,046 |   | 5,364 |   |
| Japan                    |       | 954                                             |       | 2,023                                         |       | 1,942 |   | 4,106 |   |
| China                    |       | 515                                             |       | 1,235                                         |       | 1,120 |   | 1,376 |   |
| Rest of North America    |       | 344                                             |       | 1,011                                         |       | 938 |   | 1,725 |   |
| Rest of Asia Pacific     |       | 216                                             |       | 287                                           |       | 493 |   | 858 |   |
| Total revenue            |       | $                                               | 9,249      |                                          | $          | 12,770 |   | $ | 18,582 |   | $ | 25,297 |   |

 

Twodistributors of the Company’s products accounted for 23% and 12% of revenue,respectively, in the three months ended June 30, 2006 and for 28% and 13%of revenue, respectively, in the six months ended June 30, 2006. Acontract manufacturer, purchasing the Company’s products for use in a telecomdesign for an OEM application, and a domestic manufacturer accounted for 19%and 12% of revenue for the three months ended June 30, 2006, respectively,and each of these entities accounted for 12% of revenue for the six monthsended June 30, 2006.

Threedistributors of the Company’s products accounted for 17%, 16% and 11% ofrevenue in the three months ended June 30, 2005. The same threedistributors of the Company’s products accounted for 20%, 16% and 12% ofrevenue in the six months ended June 30, 2005. For the three and sixmonths ended June 30, 2005, one domestic manufacturer accounted for 10%and 11% of the Company’s revenue, respectively.

As ofJune 30, 2006 less than 10% of the Company’s long-lived assets, includingproperty and equipment and other assets, were located outside the UnitedStates.

**Note 15—Commitments**

Certainof the Company’s wafer manufacturers require the Company to forecast waferstarts several months in advance. The Company is committed to take delivery ofand pay for a portion of forecasted wafer volume. As of June 30, 2006and December 31, 2005, the Company had $5.1 million and $2.7 million,respectively, of outstanding commitments for the purchase of wafer inventory.

TheCompany leases, with an option to renew, its primary facility under anon-cancelable operating lease that expires in 2009. In addition, the Companyrents development facilities in Canada and India as well as sales offices inEurope and Asia. Total rent expense, net of sublease income, for the threemonths ended June 30, 2006 and 2005

25

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

was approximately$250,000 and $230,000, respectively, and for the six months ended June 30,2006 and 2005 was approximately $485,000 and $490,000, respectively. TheCompany has subleased a portion of its primary facilities to a tenant untilNovember 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.

OnJuly 3, 2003, a putative securities class action was filed in the U.S.District Court for the Southern District of New York by shareholders of TowerSemiconductor Ltd. against Tower, several of its directors, and several of itsinvestors, including QuickLogic. QuickLogic was named solely as an allegedcontrol person. On August 19, 2004, the court dismissed the claims againstall defendants, including QuickLogic, with prejudice. On September 29,2004, one of the plaintiffs filed a notice of appeal from the judgment. On June 1,2006, the court of appeals affirmed the dismissal.

Noestimate can be made of the possible loss or possible range of loss associatedwith the resolution of these contingencies and, accordingly, the Company hasnot recorded a liability.

Fromtime to time, the Company is involved in legal actions arising in the ordinarycourse of business, including but not limited to intellectual propertyinfringement and collection matters. Absolute assurance cannot be giventhat third party assertions will be resolved without costly litigation in amanner that is not adverse to the Company’s financial position, results ofoperations or cash flows or without requiring royalty or other payments in thefuture which may adversely impact gross profit.

**Note 17—SubsequentEvents**

*SECInquiry*

OnJuly 26, 2006, the Company notified the Securities and Exchange Commission (“SEC”)that it was conducting an internal review of its historical stock optionpractices and related accounting (see Note 3). On August 1, 2006, the Company received an informal inquiry from the SECrequesting certain documents and information relating to the Company’spractices, procedures and disclosures regarding its stock option grants.  The Company complied with this and subsequentrequests made by the SEC and intends to cooperate fully with the SEC.

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**QUICKLOGICCORPORATIONNOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

*NasdaqDelisting*

TheCompany has received two Nasdaq Staff Determination notices stating that it isnot in compliance with Marketplace Rule 4310(c)(14) because the Company had nottimely filed its Forms 10-Q for the quarters ended June 30, 2006 and September30, 2006 and, therefore, that the Company’s securities are subject to delistingfrom the NASDAQ Global Market.

OnSeptember 26, 2006, the Company attended a Nasdaq hearing at which it appealedthe first Staff Determination notice and requested an extension of time tosatisfy the filing requirement.  OnDecember 13, 2006, the Company received a decision from the Nasdaq ListingQualifications Panel (the “Panel”) stating that the Company’s request forcontinued listing of its securities on the NASDAQ Global Market had beengranted subject to the following conditions: (1) providing the Panel with anupdate of the internal review on or before December 22, 2006; (2) filing theCompany’s Form 10-Q for the second quarter of 2006 on or before December 22,2006, and; (3) filing the Company’s Form 10-Q for the third quarter of 2006 onor before January 12, 2007.

*ShareholderDerivative Suits*

OnNovember 2, 2006 and November 29, 2006, purported shareholder derivativecomplaints were filed against certain of the Company’s current and formerofficers and directors in the U.S. District Court for the Northern District ofCalifornia. The complaints allege that the individual defendants violated thefederal securities laws and breached their duties to the Company in connectionwith the granting and/or receipt of options for Company stock.  Thecomplaints name the Company as a nominal defendant and seek unspecifiedmonetary damages against the individual defendants as well as various forms ofinjunctive relief.

Due tothe preliminary status of these complaints and uncertainties related tolitigation, the Company is unable to evaluate the likelihood of either afavorable or unfavorable outcome. Accordingly, the Company is unable at thistime to estimate the effects of these complaints on its financial position, resultsof operations or cash flows.

*Borrowingunder Notes Payable to Bank*

InSeptember 2006, the Company borrowed $1.6 million under the terms of its SecondAmended and Restated Loan and Security Agreement with Silicon Valley Bank, andhas $0.4 million of borrowing capacity remaining under the equipment line ofcredit that is available to be drawn against through June 2007.

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**Item2. Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

*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, and the expenses and managementattention associated with our stock option review, related inquiries andlitigation. The following discussion should be read in conjunction with theattached condensed unaudited consolidated financial statements and notesthereto, with our audited consolidated financial statements and notes theretofor the fiscal year ended December 31, 2005, found in our Annual Report onForm 10-K filed with the Securities and Exchange Commission, or SEC, onMarch 17, 2006, and with our condensed unaudited consolidated financialstatements and notes thereto for the quarter ended March 31, 2006 found in ourQuarterly Report on Form 10-Q filed with the SEC on May 12, 2006.*

*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 decline in revenuefrom our pASIC®**1 andpASIC 2 products, the commercial and technical success of our new productssuch as PolarProTM, EclipseTM II and QuickPCI® II, limited visibility into demandfor our products including demand from significant customers or for newproducts, our dependence upon single suppliers to fabricate and assemble ourproducts, our relationship with and the manufacturing of our products by TowerSemiconductor Ltd., and the liquidity required to support our future operatingand capital requirements. Although we believe that the assumptions underlyingthe forward-looking statements contained in this Quarterly Report arereasonable, any of the assumptions could be inaccurate, and therefore there canbe no assurance that such statements will be accurate. The risks, uncertaintiesand assumptions referred to above that could cause our results to differmaterially from the results expressed or implied by such forward lookingstatements include, but are not limited to, those discussed under the heading “RiskFactors” in Part II, Item 1A hereto and the risks, uncertainties andassumptions discussed from time to time in our other public filings and publicannouncements. All forward-looking statements included in this document arebased on information available to us as of 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 industry segment where we design and sell field programmable gatearrays, or FPGAs, embedded standard products, or ESPs, associated software andprogramming hardware. Our FPGA and ESP devices are standard products that canbe programmed to perform desired logic functions or combined with intellectualproperty to provide customers with desired solutions. These products provideour customers with the opportunity to bring products to market quickly and theability to differentiate their products from competitors. We design thesedevices based on our proprietary ViaLink technology. We believe that theunderlying 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 ofour initial public offering, through July 28, 2006. The review was initiated bythe Audit Committee in response to media attention about stock option practicesat other 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 accounting for stock options associated with measurement dates, grantsprior to meeting the definition of an employee under GAAP, non-

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employee grants,modification of options and previously reported deferred stock compensationcharges. A total pre-tax stock-based compensation charge of $964,000 isassociated with these identified errors that should have been reported inpreviously issued consolidated financial statements had they been identified inthe proper period. After considering all the quantitative and qualitativefactors in accordance with Staff Accounting Bulletin No. 99, “*Materiality*,” we determined that these adjustments were notmaterial to any prior year and, thus, have not restated our consolidated financialstatements for prior periods. However, given that the effect of correctingthese errors in 2006 would cause our 2006 consolidated financial statements tobe materially misstated, we concluded that the cumulative effect adjustmentmethod of initially applying the guidance of SAB No. 108 was appropriate. Accordingly,the cumulative affect of the adjustment was reflected as an increase to thecarrying amount of additional paid-in capital as of January 1, 2006, with anoffsetting entry to accumulated deficit. In addition, less than $50,000 of theadjustment to previously issued consolidated financial statements was due toerrors that occurred after October 2002. As a result of our review and as partof our overall Sarbanes-Oxley compliance efforts, we are implementing enhancedcontrols and process improvements in connection with the issuance of stockoption grants and modifications.  SeeNote 3 of the consolidated financial statements in Item 1 of this report foradditional information regarding our review conducted at the direction of theAudit Committee of the Board of Directors and the cumulative effect adjustmentto previously issued consolidated 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:

·      *“Bulletproof” Intellectual Property, or IP, Security—*webelieve our products provide “bulletproof” design security, since it isvirtually impossible to clone or reverse engineer designs implemented using ourViaLink technology;

·      *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;

·      *Instant On—*our ViaLink based productsrequire no configuration bit stream and thus are fully functional at power up.This is critical in applications that need to be active as soon as power issupplied; and

·      *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 is susceptibleto alpha particles, or brownouts, to define and maintain their functionality.

Competitively, ourproducts can offer significant power, performance and design security benefitswhen compared to traditional FPGAs; lower cost of ownership, quicker time-to-marketand increased system flexibility benefits when compared to the use ofapplication 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, time-to-market and price points demanded by ourtarget markets.

It is our beliefthat important industry trends in our target markets include lower powerconsumption, higher performance, shorter time-to-market, increased intellectualproperty security, small form factor, higher ASIC development expenses andhigher product development risks. We believe our products are designed toaddress many of these 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.

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 

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features by embeddedsystem designers is increasing the use of low-power programmable logic, toimprove system performance by offloading the processor, or to interface tocomponents such as Wi-Fi modules or micro hard disk drives. Designers are alsoimplementing new features in their products using our devices. Our Eclipse II,QuickPCI II and PolarPro products offer compelling advantages againstalternative solutions as customers benefit from their lowest power consumption,small form factor and high 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 offeredthe lowest power consumption during all phases of operation – power-up,quiescent and dynamic operation – in the market.

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*incorporating ourdevices, intellectual property and software drivers. These complete solutions aretargeted at specific low-power application segments that have similarconnectivity and performance requirements. By providing solutions for customerswe increase their ability to meet the time-to-market pressures associated withtheir markets;

·      *Embedded Standard Products*incorporating afixed function along with programmable logic in a low-power device. Ourcustomers build on the fixed function or “known good starting point” by usingour  programmable logic to develop uniquesolutions required for their products. ESPs reduce the need to acquire andassemble industry standard IP, thus reducing design risk and improvingtime-to-market; and

·      *FPGAs*which are general purpose devicesused by customers who value the low power consumption, high intellectual propertysecurity, instant on and reliability of our FPGAs. 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.

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’s

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logic cells, clocks andinput/output pins. Our logic cells have been optimized to efficiently implementa wide range of logic functions at high speed, thereby enabling greater usabledevice density and design flexibility. Our architecture uses our ViaLinktechnology to maximize interconnects at every routing wire intersection, whichallows more paths between logic cells. As a consequence, system designers areable to use our devices with smaller gate counts to implement their designsthan if they had used competing FPGAs. The abundance of interconnect resourcesalso provides a dense connection between the ASSP and the FPGA portions ofESPs.

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 engineerdesigns implemented using our ViaLink technology. We believe intellectualproperty security is important to system designers who choose to implementproprietary algorithms and 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 six months ended June 30, 2006 and 2005,approximately 51% and 73%, respectively, of the units shipped to ourdistributors were programmed by us and, accordingly, are not returnable. Thepercentage of sales derived through distributors was 57% and 69% in the sixmonths ended June 30, 2006 and 2005, respectively.

Two distributorsof our products accounted for 23% and 12% of our revenue in the three monthsended June 30, 2006. The same two distributors of our products accountedfor 28% and 13% of revenue in the six months ended June 30, 2006. Threedistributors of our products accounted for 17%, 16% and 11% of our revenue inthe three months ended June 30, 2005. The same three distributors of ourproducts accounted for 20%, 16% and 12% of revenue in the six months ended June30, 2005. One domestic manufacturer accounted for 12% and 10% of revenue forthe three months ended June 30, 2006 and 2005, respectively. One Europeantelecom original equipment manufacturer, or OEM, purchasing product throughtheir contract manufacturer, accounted for 19% and zero percent of revenue inthe three months ended June 30, 2006 and 2005, respectively. The same OEMaccounted for 12% and zero percent of revenue in the six months ended June 30,2006 and 2005, respectively. We anticipate that a limited number ofdistributors and customers will continue to account for a significant portionof our revenue and that individual distributors could account for a largerportion of our revenue.

Our internationalsales were 57% and 53% of our revenue in the six months ended June 30,2006 and 2005, respectively. We expect that revenue from sales to internationalcustomers will continue to represent a significant portion of our revenue. Allof our sales originate in the United States and are denominated in U.S.dollars.

We outsource 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 wafer pricing for our 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 customers’ desire for short delivery lead timesand we periodically negotiate price discounts on high volume wafer purchases.As a result, we typically purchase wafers based on our internal forecasts ofcustomer 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, 

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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 Reporton Form 10-Q for the fiscal quarter ended March 31, 2006, filed with the SEC onMay 12, 2006.

**Results ofOperations**

The following table setsforth the percentage of revenue for certain items in our statements ofoperations for the periods indicated:
| ** **                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenue                              |       | 100.0                                           | %          | 100.0                                         | %          | 100.0 | % | 100.0 | % |
| Cost of revenue                      |       | 45.6                                            |       | 36.1                                          |       | 43.0 |   | 37.6 |   |
| Gross profit                         |       | 54.4                                            |       | 63.9                                          |       | 57.0 |   | 62.4 |   |
| Operating  expenses:                 |       |                                            |       |                                          |       |   |   |   |   |
| Research and development             |       | 25.5                                            |       | 18.3                                          |       | 25.6 |   | 18.9 |   |
| Selling, general and administrative  |       | 49.7                                            |       | 31.7                                          |       | 49.6 |   | 33.0 |   |
| Income (loss)  from operations       |       | (20.8                                           | )          | 13.9                                          |       | (18.2 | ) | 10.5 |   |
| Write-down of  marketable securities |       | —                                          |       | (11.5                                         | )          | — |   | (5.8 | ) |
| Interest expense                     |       | (1.1                                            | )          | (0.4                                          | )          | (0.9 | ) | (0.4 | ) |
| Interest income  and other, net      |       | 3.7                                             |       | 0.7                                           |       | 3.4 |   | 0.7 |   |
| Income (loss)  before income taxes   |       | (18.2                                           | )          | 2.7                                           |       | (15.7 | ) | 5.0 |   |
| Provision for  income taxes          |       | 0.2                                             |       | 0.2                                           |       | 0.1 |   | 0.3 |   |
| Net income  (loss)                   |       | (18.4                                           | )%         | 2.5                                           | %          | (15.8 | )% | 4.7 | % |

 

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

*Revenue.*  Ourrevenue for the three months ended June 30, 2006 was $9.2 million,representing a decline of approximately $3.5 million, or 27.6%, fromrevenue of $12.8 million in the three months ended June 30, 2005. OurMature product family revenue declined by $3.5 million as a result of a $3.9million decline in our pASIC 1 and pASIC 2 product revenue due totheir end-of-life, partially offset by a $450,000 increase in our pASIC 3product revenue, primarily due to higher demand and customers migrating pASIC 2designs to pASIC 3 products. Our Advanced ESP product family revenue increasedby approximately $930,000 due to a $2.1 million increase in sales of our newproducts, including Eclipse II, QuickPCI II, QuickMIPS and PolarPro, partiallyoffset by a $1.0 million decline in our Eclipse product revenue as a result oflower demand from a Japanese customer purchasing product through a distributor.  Our ESP product family revenue decreased byapproximately $970,000 year-over-year primarily as a result of $990,000 inlower demand from a Chinese customer purchasing QuickRAM product through adistributor.

Our revenue forthe three months ended June 30, 2006 was 1% lower sequentially, decliningby approximately $80,000 to $9.2 million from $9.3 million in thethree months ended March 31, 2006. This sequential revenue decrease wasprimarily due to a $990,000 decline in Mature product family revenue,principally due to a $1.1 million reduction in pASIC 1 and pASIC 2 revenue dueto the end-of-life of these products, which was partially offset by a $140,000increase in pASIC 3 revenue due to higher demand and the conversion of customerpASIC 2 designs to pASIC 3 products. Advanced ESP revenue increased by $940,000sequentially due primarily to $1.2 million higher demand for new products. Newproduct sales to a European telecommunications OEM customer, purchasing productthrough their contract manufacturer, represented 19% and 6% of revenue in thethree months ending June 30 and March 31, 2006, respectively.

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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 $1.1 million and$5.1 million of our revenue in the three months ended June 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 will be limited to inventoryon hand. We currently are not forecasting significant revenue from pASIC 1 andpASIC 2 products after the fourth quarter of 2006.

In order tomaintain or 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 providing low-powersolutions providing new features or incorporating industry standard interfacessuch 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 our revenue,we believe these opportunities are likely to decrease our average selling priceand gross profit as a percentage of revenue.

*GrossProfit*.  Gross profit was $5.0 million and$8.2 million in the three months ended June 30, 2006 and 2005,respectively, which represented 54.4% and 63.9% of revenue for those periods.The approximately $3.1 million decline in gross profit was primarily dueto a $3.5 million decline in revenue which reduced gross profit byapproximately $2.4 million and changes in product mix contributing $710,000 oflower gross profit. Cost of revenue for the three months ended June 30, 2006,includes $53,000 related to the recognition of stock-based compensation inaccordance with Statement of Financial Accounting Standard No. 123(R), “*Share-Based Payment*,” or SFAS No.123(R).  In the three months endedJune 30, 2006, we provided inventory reserves primarily for excessquantities in the amount of $238,000 and sold $300,000 of inventory that waspreviously reserved. In the three months ended June 30, 2005, we providedno new inventory reserves and sold $370,000 of inventory that was previouslyreserved.

*Researchand Development Expense.*  Research and developmentexpense was $2.4 million and $2.3 million in the three months endedJune 30, 2006 and 2005, respectively, which represented 25.5% and 18.3% ofrevenue for those periods. The increase of approximately $20,000 was primarilydue to $150,000 of higher project development expenses associated with thedevelopment of our new PolarPro devices and $118,000 of stock-basedcompensation charges in accordance with SFAS No. 123(R), partially offset bylower other expenses including consulting expenses. We believe that continuedor increased investments in product and solution development and process technologyare essential for us to remain competitive in the markets we serve. We expectthat these development efforts will allow us to expand our product and solutionoffering, increase our revenue and provide additional value to our customersand stockholders.

*Selling,General and Administrative Expense.*  Selling,general and administrative expense was $4.6 million and $4.0 millionfor the three months ended June 30, 2006 and 2005, respectively, whichrepresented 49.7% and 31.7% of revenue for those periods. The $550,000 increasein selling, general and administrative expense was primarily the result of therecognition of stock-based compensation in accordance with SFAS No. 123(R) of$232,000, higher legal expenses of $200,000 associated with international operationsand protection of our products against alleged patent infringement, and highermarketing expenses of $170,000 associated with the introduction of our PolarProproducts, partially offset by lower other expenses including travel andentertainment.

*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.

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*InterestExpense.*  Interest expense increased to $96,000 forthe three months ended June 30, 2006 as compared to $53,000 for the threemonths ended June 30, 2005. This $43,000 increase was primarily dueto higher average outstanding debt and capital lease balances and higherinterest rates.

*InterestIncome and Other, Net.*  Interest income and other,net increased to $341,000 of income for the three months ended June 30,2006 as compared to $90,000 of income for the three months ended June 30,2005. The $251,000 increase in interest income and other, net is primarily dueto increased interest income received as a result of higher invested cashbalances and higher interest rates and lower expense associated with foreignexchange rate fluctuations.

*Provision for Income Taxes.*  Forthe three months ended June 30, 2006 we incurred a net loss of$1.7 million and recorded a provision for income taxes of $21,000, which consisted of income taxes on foreignoperations. For the three months ended June 30, 2005 we realized net income of$320,000 and recorded a provision for income taxes of $31,000, which consisted of income taxes on foreignoperations. Our ability to utilize our income tax loss carryforwards infuture periods is uncertain and, accordingly, we have recorded a full valuationallowance against the related tax benefit. We will continue to assess therealizability of the deferred tax assets in future periods.

*Stock-basedCompensation.*Effective January 2, 2006, we adopted the provisions of SFAS No. 123(R)which requires the measurement and recognition of expense related to the fairvalue of stock-based compensation awards. Accordingly, stock-based compensationis measured at the grant date and re-measured upon modification as appropriate,based on the fair value of the award using the Black-Scholes option pricingmodel, and is recognized as expense over the requisite service period of theaward.  Black-Scholes requires the use ofhighly subjective, complex assumptions, including expected term, forfeituresand the price volatility of our stock. We elected to use the modifiedprospective transition method as permitted by SFAS No. 123(R) and,therefore, we have not restated our financial results for prior periods. Wepreviously applied Accounting Principles Board Opinion No. 25, *“Accounting forStock Issued to Employees,”* or APB 25, and relatedinterpretations and provided the required pro forma disclosures of SFAS No.123, *“Accounting for Stock-BasedCompensation.”* In March 2005, the SEC issued Staff AccountingBulletin No. 107, or SAB No. 107, relating to SFAS No. 123(R).We have applied the provisions of SAB No. 107 in our adoption of SFAS No. 123(R).

In the secondquarter of 2006 and 2005, stock-based compensation totaled $403,000 and zero,respectively, and was included in the statement of operations as follows (inthousands):
| ** **                           | ** ** | **Three Months Ended  June 30,** | ** ** |
|--------------------------------------|------------|-------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                        | ** ** | **2005** | ** ** |
|                                 |       |                                            |       |   |   |
| Cost of revenue                      |       | $                                               | 53         |   | $ | — |   |
| Research and  development            |       | 118                                             |       | — |   |
| Selling, general  and administrative |       | 232                                             |       | — |   |
| Total                                |       | $                                               | 403        |   | $ | — |   |

 

**Six Months Ended June 30, 2006 and 2005**

*Revenue.*  Ourrevenue for the six months ended June 30, 2006 was $18.6 million,representing a decline of $6.7 million, or 26.5%, from revenue of$25.3 million in the six months ended June 30, 2005. Our Mature productfamily revenue declined by $6.9 million as a result of a $8.1 million declinein our pASIC 1 and pASIC 2 product revenue due to their end-of-life,which was caused by the expiration of a wafer supply agreement, partiallyoffset by a $1.1 million increase in our pASIC 3 product revenue primarilydue to higher demand and customers migrating pASIC 2 designs topASIC 3 products.  Our Advanced ESPproduct family revenue increased by approximately $1.1 million due to a $3.0million increase in revenue from our new products, which include Eclipse II,QuickPCI II, QuickMIPS and PolarPro. Revenue from a European telecommunicationsOEM customer, purchasing Eclipse II product through their contractmanufacturer, contributed 12% of revenue during the six months ended June 30,2006 

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and no revenue in thefirst half of 2005. Our Eclipse product revenue declined by $1.9 millionyear-over-year primarily due to lower demand from a Japanese customerpurchasing product through a distributor. Our ESP product family revenue decreased by approximately $850,000year-over-year primarily as a result of lower demand from a Chinese customerpurchasing QuickRAM product through a distributor.

*GrossProfit*.  Gross profit was $10.6 million and$15.8 million in the six months ended June 30, 2006 and 2005,respectively, which represented 57.0% and 62.4% of revenue for those periods.The $5.2 million decline in gross profit was primarily due to the declinein revenue which effected gross profit by approximately $4.6 million, changes inproduct mix contributing $470,000 to the lower gross profit and lower absorbedoverhead of approximately $510,000 which was partially offset by favorableproduction variances. Cost of revenue for the six months ended June 30, 2006,includes $102,000 related to the recognition of stock-based compensation inaccordance with SFAS No. 123(R). In the six months ended June 30, 2006, weprovided inventory reserves primarily for excess quantities in the amount of$470,000 and sold $630,000 of inventory that was previously reserved. In thesix months ended June 30, 2005, we provided inventory reserves primarilyfor excess quantities in the amount of $205,000 and sold $630,000 of inventorythat was previously reserved.

*Researchand Development Expense.*  Research and developmentexpense was $4.8 million in each of the six months ended June 30,2006 and 2005, which represented 25.6% and 18.9%, respectively, of revenue forthose periods. Expenses were reduced by approximately $30,000 year-over-year,primarily due to lower payroll and consulting expenses, partially offset by$270,000 of higher project development expenses associated with the developmentof our new PolarPro devices and $264,000 of higher expense due to stock-basedcompensation in accordance with SFAS No. 123(R). We believe that continued orincreased investments in product and solution development and processtechnology are essential for us to remain competitive in the markets we serve.We expect that these development efforts will allow us to expand our solutionoffering, increase our revenue and provide additional value to our customersand stockholders.

*Selling,General and Administrative Expense.*  Selling,general and administrative expense was $9.2 million and $8.3 millionfor the six months ended June 30, 2006 and 2005, respectively, whichrepresented 49.6% and 33.0% of revenue for those periods. The $870,000 increasein selling, general and administrative expense was primarily the result of$489,000 of 2006 expenses for stock-based compensation under SFAS No. 123(R),$240,000 of higher legal expenses associated with international operations andprotection of our products against alleged patent infringement, a $240,000increase in marketing expenses associated with the introduction of our PolarProproducts, and a $140,000 recovery of an account receivable in the first quarterof 2005 that did not repeat in 2006, partially offset by lower other expensessuch as expenses for payroll and temporary contractors.

*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 $170,000for the six months ended June 30, 2006 as compared to $106,000 for the sixmonths ended June 30, 2005. This $64,000 increase was primarily dueto higher average outstanding debt and capital lease balances and higher interestrates.

*InterestIncome and Other, Net.*  Interest income and other,net increased to $633,000 of income for the six months ended June 30, 2006as compared to $170,000 of income for the six months ended June 30, 2005.The $463,000 increase in interest income and other, net is primarily due toincreased interest income received as a result of higher invested cash balancesand higher interest rates and lower expense associated with foreign exchangerate fluctuations.

*Provision for Income Taxes.*  Forthe six months ended June 30, 2006, we incurred a net loss of$2.9 million and recorded a provision for income taxes of $23,000, which consisted of income taxes on foreignoperations. For the six months ended June 30, 2005, we realized net income of$1.2 million and recorded a provision for income taxes of $81,000, which consisted of income taxes on foreignoperations of $61,000 and federal alternate minimum income taxes of $20,000. Ourability to utilize our income tax loss carryforwards in future periods is uncertainand, accordingly, we recorded a full valuation allowance against the relatedtax benefit. We will continue to assess the realizability of the deferred taxassets in future periods.

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*Stock-basedCompensation.  *For the six months ended June 30,2006 and 2005, stock-based compensation totaled $855,000 and zero,respectively, and was included in the statement of operations as follows (inthousands):
| ** **                           | ** ** | **Six months Ended  June 30,** | ** ** |
|--------------------------------------|------------|-----------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                      | ** ** | **2005** | ** ** |
|                                 |       |                                          |       |   |   |
| Cost of revenue                      |       | $                                             | 102        |   | $ | — |   |
| Research and  development            |       | 264                                           |       | — |   |
| Selling, general  and administrative |       | 489                                           |       | — |   |
| Total                                |       | $                                             | 855        |   | $ | — |   |

 

**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 June 30, 2006, our principal sourcesof liquidity consisted of our cash and cash equivalents of $30.2 million,available credit under our revolving line of credit with Silicon Valley Bank ofapproximately $5.0 million, available credit under our equipment line ofcredit of approximately $2.0 million, and our investment in Tower with amarket value of approximately $1.9 million. In September 2006, we borrowed$1.6 million under our equipment line of credit.

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 June 30, 2006, wehad not raised any funds in connection with this filing.

As ofJune 30, 2006, our interest-bearing debt consisted of $1.7 millionoutstanding from Silicon Valley Bank and $1.8 million outstanding undercapital leases. As of June 30, 2006, our accumulated deficit was$121.2 million. Capital expenditures, which are largely driven by thedevelopment 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 ofJune 30, 2006, we had no balances outstanding under the revolving line ofcredit. As of June 30, 2006, we had $1.7 million outstanding underprevious equipment lines of credit and $2.0 million available to be drawnagainst future equipment purchases. Advances under the new equipment line ofcredit must be repaid in either 30 or 36 equal monthly installments, dependingupon the nature of the items financed. The bank has a first priority securityinterest on substantially all of our tangible and intangible assets to secureany outstanding amounts under the agreement. Under the terms of the agreement,we must maintain a minimum tangible net worth and an adjusted quick ratio. Theagreement also has certain restrictions including, among others, on theincurrence of other indebtedness, the maintenance of depository accounts, thedisposition of assets, mergers, acquisitions, the granting of liens and the paymentof dividends. We were in compliance with all loan covenants as of June 30,2006.

As ofJune 30, 2006, we had $1.1 million 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 ofJune 30, 2006, we also had $649,000 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.

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*Net cashfrom operating activities*

Net cash providedby operating activities was $830,000 in the six months ended June 30, 2006. Thecash provided by operating activities resulted primarily from a net loss of$2.9 million, adjusted for $2.9 million of non-cash charges includingdepreciation and amortization of $1.5 million, stock-based compensation of$855,000 and reserves for excess inventory of $470,000. In addition, changes inworking capital accounts provided cash in the amount of $885,000 primarily dueto a $1.1 million decrease in accounts receivable, net of allowances fordoubtful accounts, due to a reduction in revenue levels and the timing ofshipments in the period, a $468,000 increase in accounts payable due to thetiming of purchases and payments in the period, and a $191,000 decrease inother assets due to the amortization of prepaid expenses.  These sources of cash were partially offsetby a $748,000 decrease in accrued liabilities.

Net cash providedby operating activities was $272,000 in the six months ended June 30,2005.  The cash provided resulted primarily from net income of $1.2million, adjusted for $3.3 million of non-cash charges including a $1.5 millionwrite-down of marketable securities, depreciation and amortization of $1.4million, $215,000 from the utilization of prepaid wafer credits and reservesfor excess inventory of $205,000. In addition, changes in working capitalaccounts used cash in the amount of $4.2 million primarily as a result ofa $2.1 million increase in inventory due to wafer purchases of Eclipse II,QuickPCI II, and PolarPro products and of pASIC 1 and pASIC 2 under their endof life program and an increase of $1.7 million in accounts receivable, net ofallowances for doubtful accounts, due to an increase in revenue levels, a$824,000 reduction in trade payables and a $490,000 reduction in accrued liabilities,partially offset by a $465,000 increase in deferred income and royalty revenuedue primarily to higher inventories at distributors on which revenue isdeferred and a $452,000 reduction in other current assets due to theamortization prepaid expenses.

*Net cash from investing activities*

Netcash used for investing activities for the six months ended June 30, 2006and 2005 was $1.2 million and $682,000, respectively, as a result of capitalexpenditures made primarily to acquire equipment and software used in thedevelopment and production of our products.

*Net cash from financing activities*

Net cash providedby financing activities was $2.2 million for the six months endedJune 30, 2006, resulting from $2.5 million in proceeds related to theissuance of common shares under our employee stock purchase program and uponthe exercise of stock options by employees and $932,000 in proceeds fromborrowings under our equipment line of credit, partially offset by scheduledrepayments of $1.2 million under the terms of our debt and capital leaseobligations.

Net cash providedby financing activities was $604,000 for the six months ended June 30,2005 resulting from $1.4 million in proceeds related to the issuance of commonshares under our employee stock purchase program and upon the exercise of stockoptions by employees and $550,000 in proceeds from debt and capital leaseobligations, partially offset by scheduled repayments of $1.4 million under theterms of our debt and capital lease obligations.

We require substantialworking capital to fund our business, particularly to finance our operations,the acquisition of property and equipment, the repayment of debt and forworking capital requirements. Our future liquidity will depend on many factorssuch as these, as well as our level of revenue and gross profit, marketacceptance of our existing and new products, the decline in revenue from ourpASIC 1 and pASIC 2 products under their end of life program, waferpurchase commitments, the amount and timing of research and developmentexpenditures, the timing of new product introductions, production volumes, thequality of our products, our sales and marketing efforts, our ability to obtaindebt financing and to remain in compliance with the terms of our credit facilities,our ability to raise funds from the sale of Tower shares and equity in theCompany, the exercise of employee stock options and participation in ouremployee stock purchase plan, and other factors related to the uncertainties ofthe industry and global economics. However, we believe that our existing cashresources will be sufficient to fund operations, capital expenditures of up to$5.5 million, and provide adequate working capital for at least the nexttwelve months. As our liquidity is affected by many factors as mentioned aboveand as discussed in 

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our “Risk Factors,” therecan be no assurance that we will not seek additional capital during the nexttwelve months or that such capital will be available on terms acceptable to us.After the next twelve months, our capital and operating requirements willdepend on many factors, including our level of revenue and gross profit, themarket acceptance of our new products, the levels at which we maintaininventory and accounts receivable, costs of securing access to adequatemanufacturing capacity, new product development efforts, capital expendituresand the level of our operating expenses.

**ContractualObligations and Commercial Commitments**

The following tablesummarizes our contractual obligations and commercial commitments as ofJune 30, 2006 and the effect such obligations and commitments are expectedto have on our liquidity and cash flows in future periods (in thousands):
|                                                           | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                | ** ** | **Total**                                 | ** ** | **Less than  1 Year** | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** | **More than  5 Years** | ** ** |
|                                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| *Contractual  cash obligations:*                          |       |                                      |       |   |   |   |   |   |   |   |   |
| Operating leases                                          |       | $                                         | 2,158      |   | $ | 714 |   | $ | 1,365 |   | $ | 79 |   | $ | — |   |
| Wafer purchases (1)                                       |       | 5,132                                     |       | 5,132 |   | — |   | — |   | — |   |
| Other purchase commitments                                |       | 3,723                                     |       | 3,342 |   | 381 |   | — |   | — |   |
| Total contractual cash obligations                        |       | 11,013                                    |       | 9,188 |   | 1,746 |   | 79 |   | — |   |
|                                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| *Other  commercial commitments (2):*                      | * *   | * *                                  | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| Notes payable to bank                                     |       | 1,668                                     |       | 983 |   | 685 |   | — |   | — |   |
| Capital lease obligations                                 |       | 1,790                                     |       | 987 |   | 803 |   | — |   | — |   |
| Total commercial commitments                              |       | 3,458                                     |       | 1,970 |   | 1,488 |   | — |   | — |   |
| Total  contractual obligations and commercial commitments |       | $                                         | 14,471     |   | $ | 11,158 |   | $ | 3,234 |   | $ | 79 |   | $ | — |   |

 

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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 $5.1 millioninclude both firm purchase commitments and a portion of our forecasted waferstarts as of June 30, 2006.

(2)   Othercommercial commitments are included as liabilities on our balance sheet as ofJune 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.

**Recently Issued AccountingPronouncements**

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 

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beginning after June 15,2005. In addition, companies must also recognize compensation expense relatedto any awards that are not fully vested as of the effective date. Compensationexpense for the unvested awards will be measured based on the fair value of theawards previously calculated in developing the pro forma disclosures inaccordance with the provisions of SFAS No. 123. Effective January 2,2006, the first day of fiscal 2006, we adopted SFAS No. 123(R) on amodified prospective basis. As a result, we began to include stock-basedcompensation charges in our results of operations beginning in the quarterended March 31, 2006 (see Note 10 to the consolidated financialstatements in Item 1 of this report).

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.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 (“*SEC*”)issued Staff Accounting Bulletin (“SAB”) No. 107, which provides guidanceon the interaction between SFAS No. 123(R), *“Shared-BasedPayment,”* 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 amodified prospective basis and applied the principles of SAB No. 107 inconjunction with the adoption of SFAS No. 123(R).

In June 2006,the FASB issued FASB interpretation No. 48 (FIN No. 48) *“Accounting for Uncertainty in Income Taxes—anInterpretation of FASB Statement No. 109.”* FIN No. 48requires us to recognize in our consolidated financial statements the impact ofa tax 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, we determine whether it is more-likely-than-not that a taxposition will be sustained upon examination, including resolution of anyrelated appeals or litigation processes, based on the technical merits of theposition. The second step addresses measurement of a tax position that meetsthe more-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 our consolidatedfinancial 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 EITF 06-3 didnot have an impact on our consolidated financial position and results of operations.  Our accounting policy has been to present theabove mentioned taxes on a net basis, excluded from revenues.

In September 2006,the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects ofPrior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statements,” or SAB No. 108. SAB No. 108 was issued inorder to eliminate the diversity of practice surrounding how public companiesquantify financial statement misstatements. Traditionally, there have been tworecognized methods for quantifying the effects of financial statementmisstatements - the “rollover” method and the “iron curtain” method. Therollover method focuses primarily on the impact of a misstatement on the incomestatement, including the reversing effect of prior period misstatements, butits use can lead to the accumulation of misstatements on the balance sheet. Theiron curtain method, on the other hand, focuses primarily on the effect ofcorrecting the period-end balance sheet with 

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less emphasis on thereversing effects of prior year errors on the income statement. Prior to theapplication 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 an approach that requires quantification of financialstatement misstatements based on the effects of the misstatements on each ofour consolidated financial statements and the related financial statementdisclosures. This model is commonly referred to as a “dual approach” because itrequires quantification of errors under both the iron curtain and the rollovermethods. SAB No. 108 permits public companies to initially apply itsprovisions 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 balanceof the carrying values of assets and liabilities in the year of adoption withan offsetting adjustment recorded to the opening balance of retained earnings(accumulated deficit). SAB No. 108 is effective for fiscal years endingafter November 15, 2006, and is encouraged in any report for an interim periodin the year of adoption. We elected early adoption of SAB No. 108 inrelation to the results of our internal review of stock option grant practicesand related accounting, and recorded the effects of applying SAB No. 108using the cumulative effect transition method in the second quarter of 2006 (seeNote 3 of the consolidated financial statements found in Item 1 of thisreport).

InSeptember 2006, the FASB issued Statement of Financial Accounting Standards No.157, “Fair Value Measurements”, (“SFAS No. 157”). SFAS No. 157establishes a framework for measuring fair value and expands disclosures aboutfair value measurements. The changes to current practice resulting from theapplication of SFAS No. 157 relate to the definition of fair value, themethods used to measure fair value, and the expanded disclosures about fairvalue measurements. SFAS No. 157 is effective for fiscal years beginningafter November 15, 2007 and interim periods within those fiscal years. We arecurrently evaluating the impact that SFAS No. 157 will have on our consolidatedfinancial statements.

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

**InterestRate Risk**

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 June 30, 2006would 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 26% of total operating expenses for the six months endedJune 30, 2006 and 2005, respectively. A majority of these foreign expenseswere incurred in Canada. A currency exchange rate fluctuation of 10% would havecaused our operating expenses to change by approximately $350,000 in the sixmonths ended June 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 thantemporary” decline in their market value by $1.5 million,$1.5 million, $3.8 million and $6.8 million in fiscal 2005,2004, 2002 and 2001, respectively. The determination that the declinein market value was “other than temporary” included factors such as the thencurrent market value and the period of time that the market value had beenbelow the carrying value in each of the respective periods. A market valuefluctuation of 10% would have caused us to reduce accumulated othercomprehensive income by approximately $190,000 in the six months endedJune 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 no cost-effective control system willpreclude all errors and irregularities, our current disclosure controls andprocedures are effective to provide reasonable assurance that the consolidated financialstatements and other disclosures in our SEC reports are reliable.

**Changesin Internal Control Over Financial 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 the consolidatedfinancial statements found in Item 1 of this report, we have identifiedand are implementing enhanced controls and process improvements in connectionwith 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 common stockin QuickLogic’s initial and secondary public offerings and artificially highprices through “tie-in” arrangements which required the underwriters’ customersto buy shares in the aftermarket at pre-determined prices in violation of thefederal securities laws. Plaintiffs seek an unspecified amount of damages onbehalf of persons who purchased QuickLogic’s stock pursuant to the registrationstatements between October 14, 1999 and December 6, 2000. Variousplaintiffs have filed similar actions asserting virtually identical allegationsagainst over 300 other public companies, their underwriters, and their officersand directors arising out of each company’s public offering. These actions,including the action against QuickLogic, have been coordinated for pretrialpurposes and captioned *In re Initial PublicOffering Securities Litigation, 21 MC 92*. A stipulation ofsettlement for the claims against the issuer defendants, including the Company,has been signed and was submitted to the court. Under the stipulation ofsettlement, the plaintiffs will dismiss and release all claims againstparticipating defendants in exchange for a contingent payment guaranty by theinsurance companies collectively responsible for insuring the issuers in allthe related cases, and the assignment or surrender to the plaintiffs of certainclaims the issuer defendants may have against the underwriters. Under theguaranty, the insurers will be required to pay the amount, if any, by which$1.0 billion exceeds the aggregate amount ultimately collected by theplaintiffs from the underwriter defendants in all the cases. OnFebruary 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 July 3,2003, a putative securities class action was filed in the U.S. District Courtfor the Southern District of New York by shareholders of Tower SemiconductorLtd. against Tower, several of its directors, and several of its investors,including QuickLogic. QuickLogic was named solely as an alleged control person.On August 19, 2004, the court dismissed the claims against all defendants,including QuickLogic, with prejudice. On September 29, 2004, one of theplaintiffs filed a notice of appeal from the judgment. On June 1, 2006,the court of appeals affirmed the dismissal.

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 the preliminarystatus of these complaints and uncertainties related to litigation, we ourunable to evaluate the likelihood of either a favorable or unfavorable outcome.Accordingly, we are unable at this time to estimate the effects of thesecomplaints on our financial position, results of operations or cash flows.

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**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 QuarterlyReport on Form 10-Q for the period ended March 31, 2006, filed with the SEC onMay 12, 2006. 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 to advancedfabrication capacity and dedicate significant resources to specify, design,develop, manufacture and sell new or enhanced products and solutions thatprovide increasingly higher levels of performance, low power consumption, newfeatures, 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 Component Interconnect,or PCI, and Integrated Drive Electronics, or IDE, or emerging technologies,such as low-power programmable logic, advanced process technology or lead-freepackaging. We intend to develop additional products and solutions and adopt newtechnologies in the future. We expect other programmable product companies toexpand their low-power product offering and compete more directly with ourlowest-power products. If system manufacturers adopt alternative standards ortechnologies, if an industry standard or emerging technology that we havetargeted 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.

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

We offer ourcustomers a short delivery lead-time and a majority of our shipments during aquarter are ordered by customers in that quarter. As a result, we often havelow visibility to the current quarter’s revenue, and our revenue levels canchange significantly in a short period of time. Furthermore, our ability torespond to increased 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.

# *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 and$1.1 million in the first and second quarters of 2006. We believe that amajority of our customers that use pASIC 1 and pASIC 2 products haveeither purchased sufficient quantities to satisfy their demand throughout theexpected life of their products or have converted their designs to our otherproducts, such as pASIC 3 which is pin compatible with pASIC 2. Wecurrently expect that these products will not contribute significant revenueafter the fourth quarter of 2006. Our operating results and liquidity have beenadversely affected by the end-of-life of our pASIC 1 and pASIC 2products as we are currently operating at a net loss and expect negative cashflow at our current revenue level. To mitigate the affects of the end-of-lifeof our pASIC 1 and pASIC 2 products, we plan to develop customerdemand 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 not be unwilling orunable to 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 

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products to our customerscould be severely impaired. We would have to identify and qualify substitutesuppliers, which could be time consuming, difficult and result in unforeseenoperational problems, or we could announce an end-of-life program for theseproducts, as we did with our pASIC 1 and pASIC 2 products. Alternatesuppliers might not be available to fabricate, assemble, test and program ourdevices or, if available, might be unwilling or unable to offer services onacceptable 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 the eventour 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. Moreover, ourreliance on a limited number of suppliers subjects us to reduced control overdelivery schedules, 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 to manufacturinginventory that is not required to meet customer delivery commitments, whichcould materially harm our business.

# *Ourcustomers may cancel or change their product plans after we have expendedsubstantial time 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 embedded processorsdeveloped by companies such as Marvell Semiconductor, Inc., who purchased theXScale business unit from Intel, and Analog Devices, Inc., peripheral devicesdeveloped by other parties such as micro hard disk drives, WI-FI devices andNAND flash memory and specific industry standards such as PCI, IDE and SecureDigital Input/Output, or SDIO. We have entered into informal partnerships withthese other parties that involve the development of solutions that interfacewith their devices or standards. These informal partnerships also may involvejoint marketing campaigns and sales calls. For example, we have developed asystem solution incorporating a specific embedded processor, a micro hard diskdrive and our Eclipse II device that lowers the overall power consumptionof a system and improves system performance. Recently, one of our partnersannounced the sale of their embedded processor business to another company, andwe are focused on building a relationship with the new owner. If our solutionis not incorporated into customer products, if our partners discontinueproduction of or incorporate our solution into their product offerings, or ifthe informal partnerships are significantly reduced or terminated, our revenueand gross margin will be materially harmed and we may be required to write-offrelated long-lived assets.

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# *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 equipment accountedfor 13% of revenue in fiscal 2005 and a European telecommunications OEMcustomer, purchasing product through their contract manufacturer, represented19% of revenue in the second quarter of 2006. If revenue from any significantcustomer were to decline substantially, we may be unable to offset this declinewith increased revenue from other customers and we may purchase excessinventory. These factors could severely harm our business.

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 towrite-off inventory, provide for uncollectible accounts receivable or incurcharges against long-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 June 30, 2006 was $30.2 million. AtJune 30, 2006, our interest-bearing debt consisted of $1.7 millionoutstanding from Silicon Valley Bank and $1.8 million outstanding undercapital leases. On June 30, 2006, we amended and restated our creditfacility with Silicon Valley Bank. Terms of the agreement include a$5.0 million revolving line of credit available through June 2008 and$2.0 million of borrowing capacity under the equipment line of credit thatis available to be drawn through June 2007. At June 30, 2006, we hadapproximately $5.0 million available to borrow under our revolving creditfacility and approximately $2.0 million available to borrow under ourequipment line of credit. In September 2006, we borrowed $1.6 million under ourequipment line of credit.

At the end of thesecond quarter of 2006, we held 1,344,543 Tower ordinary shares available forsale valued at approximately $1.9 million based upon the market closingprice of $1.40 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 June 30, 2006, we hadcommitments to purchase $5.1 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 underdevelopment, to generate positive cash flow. In addition, these new productshave been generating lower gross margin as a percentage of revenue than therest of our historical business due to the markets that we have targeted andthe larger order quantities required to meet customer demand. Whether we canachieve cash flow levels sufficient to support our operations cannot beaccurately predicted. Unless such cash flow levels are achieved, we may borrowadditional funds or sell debt or equity securities, or some combinationthereof, to provide funding for our operations. If adequate funds are notavailable when needed, our financial condition and operating results would bematerially adversely affected and we may not be able to operate our businesswithout significant changes in our operations, or at all.

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# *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 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. Inaddition, 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. AtJune 30, 2006, the aggregated 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, especiallyin the short term since most of our products and programming equipment aresupplied by a single vendor. Our failure to adequately forecast demand for ourproducts could materially harm our business.

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# *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 asignificant period of time to analyze and correct. Our reliance on third partysuppliers may extend the period of time required to analyze and correct theseproblems. Once corrected, our customers may be required to redesign orrequalify their products. As a result, we may incur substantially highermanufacturing 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 productscontain undetected or unresolved defects, we may lose market share, experiencedelays in or loss of market acceptance, reserve or scrap inventory, or berequired to issue a product recall. In addition, we would be at risk of productliability litigation if defects in our products were discovered. Although weattempt to limit our liability to end users through disclaimers of special,consequential and indirect damages and similar provisions, we cannot assure youthat such limitations 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 ofJune 30, 2006 was $121.2 million. Although we recorded net income of$2.4 million for the year ended December 31, 2005, we recorded a netloss of $2.9 million in the first half of 2006 and we may not return toprofitability in any future periods. Our profitability for the year endedDecember 31, 2005 cannot be relied upon as any indication of our futureoperating 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, be acquiredor merge with other distributors which may result in the termination of ourcontract or less effort being placed on the marketing, sale and support of ourproducts. 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.

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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:

·                  the effect ofend-of-life programs;

·                  a significantchange in sales to, or the collectibility of accounts receivable from, ourlargest customers;

·                  successfuldevelopment and market acceptance of our products and solutions;

·                  our ability toaccurately forecast product volumes and mix, and to respond to rapid changes incustomer demand;

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

·                  our ability toadjust our product features, manufacturing capacity and costs in response toeconomic and competitive pressures;

·                  our reliance onsubcontract manufacturers for product capacity, yield and quality;

·                  our competitors’product portfolio and product pricing policies;

·                  timelyimplementation of efficient manufacturing technologies;

·                  changes in orerrors in applying accounting and corporate governance rules;

·                  the issuance ofstock options, or changes in the terms of our employee stock purchase plan;

·                  mergers oracquisitions;

·                  impact of importand export laws and regulations;

·                  the cyclicalnature of the semiconductor industry and general economic, market, politicaland social conditions in the countries where we sell our products and therelated effect on our customers, distributors and suppliers; and

·                  our ability toobtain capital, debt financing and insurance on commercially reasonable terms.

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 

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single-source of wafersupply, test, assembly and programming for our products, we are particularlyvulnerable to such supply shortages and capacity limitations. As a result, wemay be unable to fulfill orders and may lose customers. Any 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 to assemblethese products in South Korea, the Philippines, Malaysia, or China. As aresult, these manufacturing operations and new 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:

·                  managing foreigndistributors;

·                  collectingamounts due;

·                  staffing andmanaging foreign offices;

·                  political andeconomic instability;

·                  foreign currencyexchange fluctuations;

·                  changes in taxlaws, import and export regulations, tariffs and freight rates;

·                  timing andavailability 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, ourbusiness could 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.

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# *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:

·                  erosion ofselling prices over product lives;

·                  rapidtechnological change;

·                  short productlife cycles; and

·                  strong domesticand foreign competition.

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

Many of ourcompetitors have substantially greater financial, technical, manufacturing,marketing, sales, distribution, name recognition and other resources than wedo. In addition, many of our competitors have well-established relationshipswith our current 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 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:

·                  the developmentof new products and advanced manufacturing technologies;

·                  the quality,power characteristics, performance characteristics, price and availability ofdevices, programming hardware and software development tools;

·                  the ability toengage with companies that provide synergistic products and services;

·                  theincorporation of industry standards in our products;

·                  the diversity ofproduct offerings available to customers; or

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

We have in thepast and are currently involved in litigation relating to alleged infringementby us of others’ patents or other intellectual property rights. This kind oflitigation is expensive and consumes large amounts of management’s time andattention. Additionally, matters that we initially consider not material to ourbusiness could become costly. For example, we incurred substantial costsassociated with the litigation and settlement of our dispute with Actel, whichmaterially harmed our business. In addition, if the letters we sometimesreceive alleging patent infringement or other similar matters result inlitigation that we lose, a court could order us to pay substantial damagesand/or royalties, and prohibit us from making, using, selling or importingessential technologies. For these and other reasons, this kind of litigationcould materially harm our business.

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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 be longand expensive, and we cannot be certain that any currently pending or futureapplications will actually result in issued patents, or that, even if patentsare issued, they will be of sufficient scope or strength to provide meaningfulprotection or any commercial advantage to us. Furthermore, others may developtechnologies that are similar or superior to our technology or design aroundthe patents we own. We also rely on trade secret protection for our technology,in part through confidentiality agreements with our employees, consultants andother third parties. However, these parties may breach these agreements, and wemay not have adequate remedies for any breach. In any case, others may come toknow about or determine our trade secrets through a variety of methods. Inaddition, the laws of certain territories in which we develop, manufacture orsell our products may not protect our intellectual property rights to the sameextent as the laws of the 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.

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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 of ownershipmay 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, ourBylaws and Delaware law could make it difficult for a third party to acquireus, even if doing so would be beneficial to our stockholders.

# *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.  Thischange to existing rules, future changes, if any, or the questioning of currentpractices may adversely affect our reported financial results, our ability toremain listed on the NASDAQ Global Market, or the way we conduct our businessand subject us to regulatory inquiries or litigations.

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.

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*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 byongoing revisions 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 inplace, we are still exposed to potential risks from legislation requiringcompanies to evaluate controls under Section 404 of the Sarbanes-Oxley Act of2002*

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

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 effortto comply 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

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of conducting ourbusiness consistent with U.S. and applicable international laws andregulations, and we periodically review these procedures to maintain compliancewith the requirements relating to import and export regulations. If we are notable to remain in compliance with import and export regulations, we might besubject to investigation, sanctions or penalties by regulatory authorities.Such penalties can include civil, criminal or administrative remedies such asloss of export privileges. We cannot be certain as to the outcome of anevaluation, investigation, inquiry or other action or the impact of these itemson our operations. Any such action could adversely affect our financial resultsand 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 could adverselyaffect 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 resourcesthat  could otherwise be devoted to theoperation of our business. In addition, considerable legal and accountingexpenses related to these matters may be incurred in the future. We cannotpredict the outcome of the SEC inquiry. If we or any of our current or formerofficers or directors is subject to an adverse finding resulting from the SECinquiry, we could be required to pay damages or penalties or have otherremedies imposed upon us which could adversely affect our business, results ofoperations, financial position, cash flows and the trading price of oursecurities. In addition, if the inquiry continues for a prolonged period oftime, this could have the same effects, regardless of the outcome.

# *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 wouldsubsequently be transferred to the National Quotation Service Bureau, or “PinkSheets.” The trading of our common stock on the Pink Sheets may reduce theprice of our common stock and the levels of liquidity available to ourstockholders. In addition, the trading of our common stock on the Pink Sheetswill materially adversely affect our access to capital markets and our abilityto raise capital through alternative financing sources on terms acceptable tous, or at all. Securities that trade on the Pink Sheets are no longer eligiblefor margin loans, and a company trading on the Pink Sheets cannot avail itselfof federal preemption of state securities, or “blue sky,” laws, which addssubstantial compliance costs to securities issuances, including shares issuedpursuant to employee option plans, stock purchase plans and private or publicofferings of securities. If we are delisted in the future from the NASDAQGlobal Market and transferred to the Pink Sheets, there may also be othernegative implications, including the potential loss of confidence by suppliers,customers and employees and the loss of institutional investor interest in ourcompany.

# *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 4.Submission of Matters to a Vote of Security Holders**

TheAnnual Meeting of Stockholders of QuickLogic was held on April 25, 2006. The following matters were voted upon at the meeting:

(i)                          Thefollowing nominee was elected to hold office as a Class I director until 2009:
| Nominee              | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** |
|----------------------|------------|--------------------|------------|-------------------------|------------|
| Michael J.  Callahan |       | 24,261,170         |       | 9,342                   |       |

 

ArturoKrueger, E. Thomas Hart and Christine Russell will continue to serve asdirectors. Additionally on May 26, 2006, the Board of Directors, uponrecommendation by the Nominating and Corporate Governance Committee, appointedNicholas Aretakis to serve as a director of the Company.

(ii)                       Theratification of PricewaterhouseCoopers LLP as the independent registered publicaccounting firm of QuickLogic for the fiscal year ending December 31, 2006.
| Votes For     |   | 24,262,817 |   |
|---------------|--------|------------|--------|
| Votes Against |   | 1,835      |   |
| Abstentions   |   | 5,860      |   |

 

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**Item6. 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. |
| 10.1                 |       |            | Second Amended and Restated Loan and Security  Agreement between Silicon Valley Bank and the registrant effective June 30,  2006. |
| 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)          Incorporatedby reference to the Company’s Registration Statement on Form S-1 declaredeffective 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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**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: December  22, 2006 |     | 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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**EXHIBIT INDEX**
| Exhibit  Number      | ** ** | **Description** |
|----------------------|------------|-----------------|
| 3.1                  | (1)        |            | Amended and Restated Certificate of Incorporation of  Registrant. |
| 3.2                  | (2)        |            | Bylaws of Registrant. |
| 10.1                 |       |            | Second Amended and Restated Loan and Security Agreement  between Silicon Valley Bank and the registrant effective June 30, 2006. |
| 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 byreference to the Company’s Current Report on Form 8-K (Item 5.03)filed May 2, 2005.

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