**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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###### **FORM10-Q**

###### ** **

**(Mark One)**

 
| **ý** | ** ** | **Quarterly  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934**                                                                                            |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                    |
| ** ** | ** ** | **for  the quarterly period ended July 3, 2005**                                                                                                                                         |
| ** ** | ** ** | ** **                                                                                                                                                                                    |
| **OR**     |
| ** ** | ** ** | ** **                                                                                                                                                                                    |
| **o**      | ** ** | **Transition  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934**                                                                                           |
| ** ** | ** ** | ** **                                                                                                                                                                                    |
| ** ** | ** ** | **for  the transition period from                           to** |

 

**COMMISSION FILE NUMBER: 000-22671**

 

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**QUICKLOGICCORPORATION**

(Exact name of registrant asspecified in its charter)

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

 

**1277 ORLEANS DRIVE SUNNYVALE, CA  94089**

(Address of principal executiveoffices, including Zip Code)

 

**(408) 990-4000**

(Registrant’s telephone number,including area code)

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchrequirements for the past 90 days. Yes ý  No o

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined in Rule12b-2 of the Exchange Act). Yes ý  No o

 

As of August 5, 2005, 27,159,992 shares of the registrant’s commonstock were outstanding.

 

 

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**QUICKLOGIC CORPORATION**

 

**FORM 10-Q**

**JUNE 30, 2005**

 
| ** **                                                                                                                                  | **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, 2005 and 2004                       | 3        |
| Condensed  Unaudited Consolidated Balance Sheets as of June 30, 2005 and  December 31, 2004                                            | 4        |
| Condensed  Unaudited Consolidated Statements of Cash Flows for the six months ended June  30, 2005 and 2004                                 | 5        |
| Condensed  Unaudited Consolidated Statements of Comprehensive Income (Loss) for the  three and six months ended June 30, 2005 and 2004 | 6        |
| Notes  to Condensed Unaudited Consolidated Financial Statements                                                                             | 7        |
|                                                                                                                                        |     |
| **Item  2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations**                                    | 18       |
| **Item 3. Quantitative and Qualitative Disclosures about  Market Risk**                                                                     | 37       |
| **Item 4. Controls and Procedures**                                                                                                         | 37       |
|                                                                                                                                        |     |
| **Part II. Other Information**                                                                                                              | 39       |
| **Item  1. Legal Proceedings**                                                                                                              | 39       |
| **Item 4. Submission of Matters to a Vote of Security  Holders**                                                                            | 39       |
| **Item 6. Exhibits**                                                                                                                        | 40       |
| Signatures                                                                                                                                  | 41       |

 

2

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**PARTI. Financial Information**

 

**Item1. Financial Statements**

 

**QUICKLOGIC CORPORATION**

**CONDENSED UNAUDITED CONSOLIDATED STATEMENTSOF OPERATIONS**

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

 
| ** **                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                |       |                             |       |                           |       |   |   |   |   |
| Revenue                             |       | $                                | 12,770     |                           | $          | 11,221 |   | $ | 25,297 |   | $ | 21,589 |   |
| Cost of revenue                     |       | 4,614                            |       | 4,465                          |       | 9,502 |   | 9,020 |   |
| Gross profit                        |       | 8,156                            |       | 6,756                          |       | 15,795 |   | 12,569 |   |
| Operating expenses:                 |       |                             |       |                           |       |   |   |   |   |
| Research and development            |       | 2,334                            |       | 3,052                          |       | 4,788 |   | 6,300 |   |
| Selling, general and administrative |       | 4,042                            |       | 4,194                          |       | 8,340 |   | 8,103 |   |
| Income (loss) from operations       |       | 1,780                            |       | (490                           | )          | 2,667 |   | (1,834 | ) |
| Write-down of marketable securities |       | (1,466                           | )          | —                         |       | (1,466 | ) | — |   |
| Interest expense                    |       | (53                              | )          | (62                            | )          | (106 | ) | (130 | ) |
| Interest income and other, net      |       | 90                               |       | 23                             |       | 170 |   | 67 |   |
| Income (loss) before income taxes   |       | 351                              |       | (529                           | )          | 1,265 |   | (1,897 | ) |
| Provision for income taxes          |       | 31                               |       | —                         |       | 81 |   | — |   |
| Net income (loss)                   |       | $                                | 320        |                           | $          | (529 | ) | $ | 1,184 |   | $ | (1,897 | ) |
|                                |       |                             |       |                           |       |   |   |   |   |
| Net income (loss) per share:        |       |                             |       |                           |       |   |   |   |   |
| Basic                               |       | $                                | 0.01       |                           | $          | (0.02 | ) | $ | 0.04 |   | $ | (0.08 | ) |
| Diluted                             |       | $                                | 0.01       |                           | $          | (0.02 | ) | $ | 0.04 |   | $ | (0.08 | ) |
| Weighted average shares:            |       |                             |       |                           |       |   |   |   |   |
| Basic                               |       | 26,747                           |       | 25,231                         |       | 26,566 |   | 25,039 |   |
| Diluted                             |       | 27,921                           |       | 25,231                         |       | 27,678 |   | 25,039 |   |

 

See accompanying Notes to Condensed Unaudited Consolidated FinancialStatements.

 

3

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**QUICKLOGIC CORPORATION**

**CONDENSED UNAUDITED CONSOLIDATED BALANCE SHEETS**

**(In thousands, except par value amount)**

 
| ** **                                                                                                                 | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                 |       |                    |       |                        |       |
|                                                                                                                       |       |                    |       |                        |       |
| Current assets:                                                                                                            |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                  |       | $                       | 25,108     |                        | $          | 24,914 |   |
| Short-term investment in Tower  Semiconductor Ltd.                                                                         |       | 1,047                   |       | 2,022                       |       |
| Accounts receivable, net of allowances for  doubtful accounts of $925 and $1,088                                           |       | 6,502                   |       | 4,786                       |       |
| Inventory                                                                                                                  |       | 8,587                   |       | 6,741                       |       |
| Other current assets                                                                                                       |       | 1,053                   |       | 1,506                       |       |
| Total current assets                                                                                                       |       | 42,297                  |       | 39,969                      |       |
| Property and equipment, net                                                                                                |       | 4,719                   |       | 5,403                       |       |
| Investment in Tower Semiconductor Ltd.                                                                                     |       | 526                     |       | 1,017                       |       |
| Other assets                                                                                                               |       | 4,338                   |       | 4,552                       |       |
|                                                                                                                       |       |                    |       |                        |       |
| TOTAL ASSETS                                                                                                               |       | $                       | 51,880     |                        | $          | 50,941 |   |
|                                                                                                                       |       |                    |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                             |       |                    |       |                        |       |
|                                                                                                                       |       |                    |       |                        |       |
| Current liabilities:                                                                                                       |       |                    |       |                        |       |
| Revolving line of credit                                                                                                   |       | $                       | 2,000      |                        | $          | 2,000 |   |
| Trade payables                                                                                                             |       | 3,295                   |       | 4,119                       |       |
| Accrued liabilities                                                                                                        |       | 2,021                   |       | 2,511                       |       |
| Deferred income on shipments to  distributors                                                                              |       | 1,992                   |       | 1,667                       |       |
| Current portion of debt and capital lease  obligations                                                                     |       | 1,736                   |       | 2,286                       |       |
| Total current liabilities                                                                                                  |       | 11,044                  |       | 12,583                      |       |
|                                                                                                                       |       |                    |       |                        |       |
| Long-term liabilities:                                                                                                     |       |                    |       |                        |       |
| Debt and capital lease obligations, less  current portion                                                                  |       | 766                     |       | 1,036                       |       |
| Deferred royalty revenue                                                                                                   |       | 1,296                   |       | 1,156                       |       |
| Total long-term liabilities                                                                                                |       | 2,062                   |       | 2,192                       |       |
| Total liabilities                                                                                                          |       | 13,106                  |       | 14,775                      |       |
|                                                                                                                       |       |                    |       |                        |       |
| Commitments and contingencies (see Notes 13  and 14)                                                                       |       |                    |       |                        |       |
|                                                                                                                       |       |                    |       |                        |       |
| Stockholders’ equity:                                                                                                 |       |                    |       |                        |       |
| Common stock, $0.001 par value; 100,000  shares authorized; 27,002 and 26,313 shares issued and outstanding,  respectively |       | 27                      |       | 26                          |       |
| Additional paid-in capital                                                                                                 |       | 157,260                 |       | 155,837                     |       |
| Accumulated deficit                                                                                                        |       | (118,513                | )          | (119,697                    | )          |
| Total stockholders’ equity                                                                                            |       | 38,774                  |       | 36,166                      |       |
|                                                                                                                       |       |                    |       |                        |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                            |       | $                       | 51,880     |                        | $          | 50,941 |   |

 

See accompanying Notes to Condensed Unaudited Consolidated FinancialStatements.

 

4

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**QUICKLOGIC CORPORATION**

**CONDENSED UNAUDITED CONSOLIDATED STATEMENTSOF CASH FLOWS**

**(In thousands)**

 
| ** **                                                                                | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                       | ** ** | **2004** | ** ** |
| ** **                                                                                | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                                     |       |                           |       |   |   |
| Net income (loss)                                                                         |       | $                              | 1,184      |   | $ | (1,897 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities: |       |                           |       |   |   |
| Depreciation and amortization                                                             |       | 1,359                          |       | 2,279 |   |
| (Gain) loss on disposal of property and  equipment                                        |       | 7                              |       | 20 |   |
| Utilization of wafer credits from Tower  Semiconductor Ltd.                               |       | 215                            |       | 62 |   |
| Inventory write-down                                                                      |       | 205                            |       | 130 |   |
| Write-down of marketable securities                                                       |       | 1,466                          |       | — |   |
| Changes in assets and liabilities:                                                        |       |                           |       |   |   |
| Accounts receivable, net of allowances for  doubtful accounts                             |       | (1,716                         | )          | 24 |   |
| Inventory                                                                                 |       | (2,051                         | )          | (1,214 | ) |
| Other assets                                                                              |       | 452                            |       | 862 |   |
| Trade payables                                                                            |       | (824                           | )          | (640 | ) |
| Accrued liabilities                                                                       |       | (490                           | )          | 88 |   |
| Deferred income and royalty revenue                                                       |       | 465                            |       | 793 |   |
| Net cash provided by operating activities                                                 |       | 272                            |       | 507 |   |
|                                                                                      |       |                           |       |   |   |
| Cash flows from investing activities:                                                     |       |                           |       |   |   |
| Capital expenditures for property and  equipment                                          |       | (682                           | )          | (754 | ) |
| Net cash used for investing activities                                                    |       | (682                           | )          | (754 | ) |
|                                                                                      |       |                           |       |   |   |
| Cash flows from financing activities:                                                     |       |                           |       |   |   |
| Payment of debt and capital lease obligations                                             |       | (1,370                         | )          | (1,463 | ) |
| Proceeds from debt and capital lease  obligations                                         |       | 550                            |       | — |   |
| Proceeds from issuance of common stock, net                                               |       | 1,424                          |       | 1,356 |   |
| Net cash provided by (used for) financing  activities                                     |       | 604                            |       | (107 | ) |
|                                                                                      |       |                           |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                                     |       | 194                            |       | (354 | ) |
| Cash and cash equivalents at beginning of  period                                         |       | 24,914                         |       | 26,443 |   |
| Cash and cash equivalents at end of period                                                |       | $                              | 25,108     |   | $ | 26,089 |   |
|                                                                                      |       |                           |       |   |   |
| Supplemental schedule of non-cash  activities:                                       |       |                           |       |   |   |
| Capital lease obligation to finance capital  expenditures and related maintenance         |       | $                              | —     |   | $ | 1,482 |   |

 

See accompanying Notes to Condensed Unaudited Consolidated FinancialStatements.

 

5

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**QUICKLOGIC CORPORATION**

**CONDENSED UNAUDITED CONSOLIDATED STATEMENTSOF COMPREHENSIVE INCOME (LOSS)**

**(In thousands)**

 
| ** **                                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                    | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income (loss)                             |       | $                                | 320        |                           | $          | (529 | ) | $ | 1,184 |   | $ | (1,897 | ) |
| Other comprehensive gain (loss), net of  tax: |       |                             |       |                           |       |   |   |   |   |
| Unrealized gain (loss) on investments         |       | 592                              |       | (1,694                         | )          | — |   | 1,994 |   |
| Total comprehensive income (loss)             |       | $                                | 912        |                           | $          | (2,223 | ) | $ | 1,184 |   | $ | 97 |   |

 

See accompanying Notes to Condensed UnauditedConsolidated Financial Statements.

 

6

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**QUICKLOGIC CORPORATION**

**NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1—The Company and Basis of Presentation**

 

QuickLogicCorporation (“QuickLogic” or the “Company”), founded in 1988, is a Delawarecorporation. The Company operates in a single industry segment where itdesigns, develops, markets and supports advanced field programmable gate arrays(“FPGAs”), Embedded Standard Products (“ESPs”), associated software tools andprogramming hardware.

 

The accompanying interim financial statements are unaudited. In theopinion of management, these statements have been prepared in accordance withgenerally accepted accounting principles and include all adjustments,consisting only of normal recurring adjustments, necessary to provide a fairstatement of results for the interim periods presented. The Company recommendsthat these financial statements be read in conjunction with the Company’sForm 10-K for the year ended December 31, 2004. Operating results forthe three and six months ended June 30, 2005 are not necessarilyindicative of the results that may be expected for the full year.

 

QuickLogic’s fiscal yearends on the Sunday closest to December 31.  QuickLogic’s secondfiscal quarter for 2005 ended Sunday, July 3, 2005.  For presentationpurposes, the financial statements and notes have been presented as ending onthe last day of the nearest calendar month.

 

*Liquidity*

* *

The Company anticipates that its existing cash resources will fundoperations, finance purchases of capital equipment and provide adequate workingcapital for the next twelve months. The Company’s liquidity is affected by manyfactors including, among others, the level of revenue and gross profit, marketacceptance of existing and new products including Eclipse II and QuickPCI IIdevices, the expected decline in pASIC1 and pASIC2 revenue resulting from theend-of-life of these products, costs of securing access to 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, changes in operating assets and liabilities, theability to obtain or renew debt financing and to remain in compliance with theterms of our credit facilities, the ability to raise funds from the sale ofshares of Tower Semiconductor Ltd. (“Tower”) and equity in the Company, theexercise of employee stock options and participation in the Company’s employeestock purchase plan, and other factors related to the uncertainties of theindustry and global economics. Accordingly, there can be no assurance thatevents in the future will not require the Company to seek additional capitalor, if so required, that such capital will be available on terms acceptable tothe Company.

 

*Principles of Consolidation*

 

Theconsolidated financial statements include the accounts of QuickLogicCorporation 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 of these financial statements in conformity withgenerally accepted accounting principles requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities, thedisclosures of contingent assets and liabilities, and the reported amounts ofrevenue and expenses during the period. Actual results could differ from thoseestimates, particularly in relation to revenue recognition, the allowance fordoubtful accounts, sales returns, valuation of investments, valuation oflong-lived assets, inventory valuation including identification of excessquantities and obsolescence, accounting for income taxes and estimating accruedliabilities.

 

**Note 2—Significant Accounting Policies**

 

*Revenue Recognition*

 

The Company supplies standard products which must be programmed beforethey can be used in an application. The Company’s products may be programmed bythe Company, distributors, end customers or third parties. Once programmed, theCompany’s parts cannot be erased and, therefore, programmed parts are onlyuseful to a specific customer.

 

The Company generally recognizes revenue as products are shipped ifevidence of an arrangement exists, delivery has

 

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**QUICKLOGIC CORPORATION**

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

 

occurred, the sales price isfixed or determinable, collection of the resulting receivable is reasonablyassured, and product returns are reasonably estimable.

 

Revenue is recognized upon shipment to original equipment manufacturer(“OEM”) customers, for both programmed and unprogrammed parts, provided thatlegal title and risk of ownership have transferred.

 

The Company also sells to distributors under agreements that allow forprice adjustments and, in the case of unprogrammed parts, certain rights ofreturn on unsold inventory.

 

Because programmed parts can only be used by a specific customer, it isthe Company’s practice to agree upon any price adjustments with a distributorprior to shipment. Furthermore, distributors are not allowed any future priceadjustments and have no rights of return on programmed parts. Accordingly,revenue is recognized upon delivery to a distributor since title and risk ofownership have transferred to the distributor, the price is fixed, no right ofreturn exists, and collection of the resulting receivable is reasonablyassured.

 

Unprogrammed parts shipped to distributors may be used by multiple endcustomers and may have certain return and price adjustment privileges on unsoldinventory. Accordingly, revenue of unprogrammed parts is deferred until resaleto the end customer.

 

Software revenue from sales of design tools is recognized whenpersuasive evidence of an agreement exists, delivery of the software hasoccurred, no significant Company obligations with regard to implementation orintegration remain, the fee is fixed or determinable and collection isreasonably assured. Software revenue amounts to less than 1% of revenue.

 

*Long-lived Assets*

 

The Company reviews the recoverability of its long-lived assets, suchas property and equipment and investments, annually and when events or changesin circumstances occur that indicate that the carrying value of the asset orasset group may not be recoverable. The assessment of possible impairment isbased on the Company’s ability to recover the carrying value of the asset orasset group from the expected future pre-tax cash flows, undiscounted andwithout interest charges, of the related operations. If these cash flows areless than the carrying value of such asset, an impairment loss is recognizedfor the difference between estimated fair value and carrying value, and thecarrying value of the related assets is reduced by this difference. Themeasurement of impairment requires management to estimate future cash flows andthe fair value of long-lived assets. See Note 5.

 

*Comprehensive Income (Loss)*

 

Comprehensive income (loss) includes all changes in equity (net assets)during a period from non-owner sources. Comprehensive income (loss) for theCompany has included realized and unrealized holding gains or losses on Towerordinary shares. See Note 4.

 

*Stock-Based Compensation*

 

The Company has elected to measure employees’ stock-based compensationcosts using the intrinsic value method prescribed by the Accounting PrinciplesBoard (“APB”) Opinion No. 25, *“Accountingfor Stock Issued to Employees”* and to comply with the pro formadisclosure requirements of Statement of Financial Accounting Standards (“SFAS”)No. 123, *“Accounting for Stock-BasedCompensation.”* Stock-based compensation to non-employees is based onthe fair value of the option, estimated using the Black-Scholes Option-PricingModel on the date of grant, and re-measured until vested. The relatedstock-based compensation expense is recognized over the vesting period.

 

8

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**QUICKLOGIC CORPORATION**

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

 

The following table illustrates the effect on net income (loss) and netincome (loss) per share if the Company had applied the fair value recognitionprovisions of SFAS No. 123 to stock-based employee compensation, which maynot be representative of the fair value determined under SFAS No. 123(R)(see “Recently Issued Accounting Pronouncements” below) (in thousands exceptper share amounts):

 
| ** **                                                                                                                                | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                                | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income (loss)—as reported                                                                                                        |       | $                                | 320        |                           | $          | (529 | ) | $ | 1,184 |   | $ | (1,897 | ) |
|                                                                                                                                      |       |                             |       |                           |       |   |   |   |   |
| Less: Stock-based employee compensation  expense related to stock option plans determined under the fair value based  method, net of tax  |       | (607                             | )          | (960                           | )          | (1,477 | ) | (2,254 | ) |
| Less: Stock-based employee compensation  expense related to the stock purchase plan determined under fair value based  method, net of tax |       | (336                             | )          | (457                           | )          | (336 | ) | (457 | ) |
| Net loss—as adjusted                                                                                                                 |       | $                                | (623       | )                              | $          | (1,946 | ) | $ | (629 | ) | $ | (4,608 | ) |
|                                                                                                                                      |       |                             |       |                           |       |   |   |   |   |
| Net income (loss) per share – as reported:                                                                                           |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                                                                                     |       | $                                | 0.01       |                           | $          | (0.02 | ) | $ | 0.04 |   | $ | (0.08 | ) |
| Diluted                                                                                                                                   |       | $                                | 0.01       |                           | $          | (0.02 | ) | $ | 0.04 |   | $ | (0.08 | ) |
| Net loss per share – as adjusted:                                                                                                    |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                                                                                     |       | $                                | (0.02      | )                              | $          | (0.08 | ) | $ | (0.02 | ) | $ | (0.18 | ) |
| Diluted                                                                                                                                   |       | $                                | (0.02      | )                              | $          | (0.08 | ) | $ | (0.02 | ) | $ | (0.18 | ) |

 

*Foreign Currency Transactions*

 

All of the Company’s sales and cost of manufacturing are transacted inU.S. dollars. The Company conducts a portion of its research and developmentactivities in Canada and India and has sales and marketing activities invarious countries outside of the United States. Most of these costs areincurred in local currency. Foreign currency transaction gains and losses areincluded in interest income and other, net, as they occur. The effect of foreigncurrency exchange rate fluctuations has not been significant to date. Operatingexpenses denominated in foreign currencies were approximately 26% and 23% oftotal operating expenses for the six months ended June 30, 2005 and 2004,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*

 

Financial instruments, which potentially subject the Company toconcentrations of credit risk, consist principally of cash and cash equivalentsand accounts receivable. Cash and cash equivalents are maintained with highquality institutions. The Company’s accounts receivable are denominated in U.S.dollars and are derived primarily from sales to customers located in NorthAmerica, Europe, and Asia. The Company performs ongoing credit evaluations ofits customers and generally does not require collateral.

 

Two distributors of the Company’s products accounted for 25% and 19% ofthe Company’s accounts receivable balance at June 30, 2005. Twodistributors of the Company’s products accounted for 24% and 22% of the Company’saccounts receivable balance at December 31, 2004.

 

*Warranty Costs*

 

The Company generally warrants finished goods against defects inmaterial and workmanship under normal use for 12 months from the date ofshipment. The Company does not have significant product warranty related costsor liabilities. The one-time-programmable nature of QuickLogic’s productsminimizes warranty costs.

 

***Recently Issued Accounting Pronouncements***

** **

On December 16, 2004, the Financial Accounting Standards Board("FASB") issued SFAS No. 123(R), *“Share-Based Payment,”*which is a revision of SFASNo. 123 and supersedes Accounting Principals Board (“APB”) OpinionNo. 25. SFAS No. 123(R) requires all share-based payments toemployees, including grants of employee stock options, to be valued at fairvalue on the date of grant, and to be

 

9

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**QUICKLOGIC CORPORATION**

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

 

expensed over the applicablevesting period. Under SFAS No. 123(R), pro forma disclosure of the incomestatement effects of share-based payments is no longer an alternative. SFASNo. 123(R), as amended, is effective for all stock-based awardsgranted in fiscal years beginning after June 15, 2005. In addition,companies must also recognize compensation expense related to any awards thatare not fully vested as of the effective date. Compensation expense for theunvested 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. The Company is currently assessingthe impact of adopting SFAS No. 123(R) and expects the impact uponadoption in fiscal year 2006 to be significant to its results of operations.

 

On March 29, 2005, the Securities and Exchange Commission, or SEC,issued Staff Accounting Bulletin (“SAB”) No. 107, which provides guidanceon the interaction between SFAS No. 123(R), *“Shared-Based Payment,”* and certain SECrules and regulations.  SAB No. 107provides guidance that may simplify some of SFAS No. 123(R)’s implementationchallenges and enhance the information that investors receive. The Company willapply the principles of SAB No. 107 in conjunction with the adoption ofSFAS No. 123(R).

 

On December 21, 2004, the FASB issued Staff Position No. FAS 109-2, “*Accounting and Disclosure Guidance for the ForeignEarnings Repatriation Provision within the American Jobs Creation Act of 2004.”*The American Jobs Creation Act introduces a special one-time dividends receiveddeduction on the repatriation of certain foreign earnings to a U.S. taxpayer(repatriation provision), provided certain criteria are met. FSP FAS 109-2provides accounting and disclosure guidance for the repatriation provision. TheCompany may elect to apply this provision to qualifying earnings repatriationsin fiscal 2006. The Company plans to evaluate the effects of the repatriationprovision and in particular of the limitation of the deduction to certainqualifying expenses incurred in the United States. The Company does not expectto be able to complete this evaluation until late in fiscal 2006 when ourqualifying expenses for 2006 will be known. The Company is currently assessingthe impact of adopting FSP FAS 109-2.

 

On May 30, 2005, the FASB issued SFAS No. 154, *“Accounting Changes and Error Corrections,”*a replacement of APB Opinion No. 20 and FASB Statement No. 3, whichchanges the requirements for the accounting and reporting of a change inaccounting principle effective for fiscal years beginning after December 15,2005. SFAS No. 154 applies to all voluntary changes in accountingprinciple as well as to changes required by an accounting pronouncement thatdoes not include specific transition provisions. SFAS No. 154 eliminatesthe requirement in APB Opinion No. 20, *“AccountingChanges,”* to include the cumulative effect of changes in accountingprinciple in the income statement in the period of change. Instead, to enhancethe comparability of prior period financial statements, SFAS No. 154requires that changes in accounting principle be retrospectively applied. Underretrospective application, the new accounting principle is applied as of thebeginning of the first period presented as if that principle had always beenused. Under SFAS No. 154, a change in reporting entity is alsoretrospectively applied as of the beginning of the first period presented. Achange in accounting estimate continues to be accounted for in the period ofchange, and future periods if necessary. The Company is currently assessing theimpact of adopting SFAS No. 154.

 

**Note 3—NetIncome (Loss) Per Share**

** **

Basic net income (loss) per share is computed by dividing net income(loss) available to common stockholders by the weighted average number ofcommon shares outstanding during the period. Diluted net income (loss) pershare is computed using the weighted average number of common sharesoutstanding during the period plus potentially dilutive common sharesoutstanding during the period under the treasury stock method. In computingdiluted net income (loss) per share, the average stock price for the period isused in determining the number of shares assumed to be purchased from theexercise of stock options. A reconciliation of the basic and diluted per sharecomputations is as follows (in thousands, except per share amounts):

 
| ** **              | ** ** | **Three Months Ended June 30,** | ** ** |
|-------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **2005**                        | ** ** | **2004** | ** ** |
| ** **              | ** ** | **Net Income**                  | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** | **Net Loss** | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** |
| Basic                   |       | $                               | 320        |   | 26,747 |   | $ | 0.01 |   | $ | (529 | ) | 25,231 |   | $ | (0.02 | ) |
| Effect of stock options |       | —                          |       | 1,174 |   | — |   | — |   | — |   | — |   |
| Diluted                 |       | $                               | 320        |   | 27,921 |   | $ | 0.01 |   | $ | (529 | ) | 25,231 |   | $ | (0.02 | ) |

 

10

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**QUICKLOGIC CORPORATION**

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

 
| ** **              | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------|------------|------------------------------------|------------|
| ** **              | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| ** **              | ** ** | **Net Income**                     | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** | **Net Loss** | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** |
| Basic                   |       | $                                  | 1,184      |   | 26,566 |   | $ | 0.04 |   | $ | (1,897 | ) | 25,039 |   | $ | (0.08 | ) |
| Effect of stock options |       | —                             |       | 1,112 |   | — |   | — |   | — |   | — |   |
| Diluted                 |       | $                                  | 1,184      |   | 27,678 |   | $ | 0.04 |   | $ | (1,897 | ) | 25,039 |   | $ | (0.08 | ) |

 

For the three and six months ended June 30, 2005,4,437,000 and 4,783,000 shares, respectively, of common stock subjectto outstanding options were antidilutive and, therefore, were not included inthe calculation of diluted net income per share, as the per share exerciseprice for such options exceeded the average trading price of the Company’scommon stock during the respective period. For the three and six months endedJune 30, 2004, 5,137,000 and 4,900,000 shares, respectively, of common stocksubject to outstanding options were anitdilutive as the per share exerciseprice for such options exceeded the average trading price of the Company’scommon stock during the respective period. Additionally, for the three and sixmonths ended June 30, 2004, potential common shares of 1,164,000 and1,399,000, respectively, were not included in the calculation of diluted netloss per share, as they were considered antidilutive due to the net loss theCompany experienced in the period. While these potential common shares arecurrently antidilutive, they could be dilutive in the future.

 

**Note 4—Investment in Tower Semiconductor Ltd.**

 

The Company has entered into a Share Purchase Agreement (the “Agreement”),Foundry Agreement and other related agreements with Tower, as amended. Underthe Agreement, the Company made a strategic investment in Tower as part ofTower’s plan to build and equip a new wafer fabrication facility. The facilityproduces 200-mm wafers in geometries of 0.18 micron and below, usingadvanced complementary metal oxide semiconductor (“CMOS”) technology acquiredfrom Toshiba.

 

During 2001 and 2002, the Company paid a total of $21.3 million toTower to fulfill its investment requirements under the Agreement. In partialconsideration for the investment, the Company received 1,757,368 Tower ordinaryshares with an original cost of $16.6 million. The Company wrote down theTower shares by $1.5 million, $3.8 million and $6.8 million in2004, 2002 and 2001, respectively, due to an “other than temporary” decline intheir market value. In the second quarter of 2005, the Company determined thatits investment in Tower stock had suffered a further decline in value that wasdetermined to be “other than temporary.” This determination included factorssuch as market value and the period of time that the market value had beenbelow the carrying value. Accordingly, the Company recorded an impairmentcharge of $1.5 million in the second quarter of 2005 based on the quotedmarket price of the stock on the last trading day of the reporting period. As aresult of this write-down, the carrying value of the Company’s Tower ordinaryshares was $1.17 per share at July 1, 2005.

 

During the year ended December 31, 2003, the Company sold 412,825of the Tower ordinary shares for total proceeds of approximately$2.1 million and recognized a gain of $719,000 in the statements ofoperations. As of June 30, 2005, the Company held 1,344,543 available forsale Tower ordinary shares.

 

The Company intends to hold 450,000 Tower ordinary shares in order toreceive competitive product pricing under the Agreement and has recorded theseshares as a long-term investment on the balance sheets. The remaining 894,543shares are classified as a short-term investment on the balance sheets.

 

The Company also received $4.7 million in prepaid wafer credits inconsideration for the investment, $4.3 million of which remained availableas of June 30, 2005. These credits are recorded in other assets on the balancesheets and can be applied toward wafer purchases from Tower at 15% of the valueof future purchases.

 

**Note 5—Long-lived Asset Impairment**

 

During the fourth quarter of 2004,the Company evaluated the revenue potential of its product families based upondiscussions with potential customers, consultations with external advisors,review of actual sales levels and analysis of current and future designopportunities. Based upon this evaluation, the Company determined that thefuture revenue outlook for the QuickMIPS products was lower than previouslyexpected. Accordingly, the Company performed an impairment assessment on thelong-lived assets associated with these products. A preliminary assessment,based upon undiscounted cash flows, indicated that these assets were impaired.In order to determine the fair value of these assets, the Company performed

 

11

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**QUICKLOGIC CORPORATION**

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

 

a probability-weighted assessment of the expected revenue andrelated cash flows, discounted using a risk-free interest rate. Based upon thisassessment, the Company recorded a $3.2 million long-lived assetimpairment charge as an operating expense, which was allocated to the relatedlong-lived assets on a pro rata basis using the carrying value of the assetsimmediately before the impairment charge. This $3.2 million impairment chargewas reflected on the Company’s balance sheets as a reduction in the carryingvalue of the related long-term assets. This write-down did not affect thecarrying value of related inventory.

 

**Note 6—Balance Sheet Components**

 

| ** **                                | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **(in thousands)**      | ** ** |
| Inventory:                                |       |                    |       |                        |       |
| Raw materials                             |       | $                       | 985        |                        | $          | 1,024 |   |
| Work-in-process                           |       | 7,006                   |       | 4,908                       |       |
| Finished goods                            |       | 596                     |       | 809                         |       |
|                                      |       | $                       | 8,587      |                        | $          | 6,741 |   |
|                                      |       |                    |       |                        |       |
| Other current assets:                     |       |                    |       |                        |       |
| Prepaid expenses                          |       | $                       | 937        |                        | $          | 1,278 |   |
| Employee receivables                      |       | 14                      |       | 15                          |       |
| Other                                     |       | 102                     |       | 213                         |       |
|                                      |       | $                       | 1,053      |                        | $          | 1,506 |   |
|                                      |       |                    |       |                        |       |
| Property and equipment:                   |       |                    |       |                        |       |
| Equipment                                 |       | $                       | 13,026     |                        | $          | 12,620 |   |
| Software                                  |       | 8,910                   |       | 8,647                       |       |
| Furniture and fixtures                    |       | 840                     |       | 851                         |       |
| Leasehold improvements                    |       | 813                     |       | 813                         |       |
|                                      |       | 23,589                  |       | 22,931                      |       |
| Accumulated depreciation and amortization |       | (18,870                 | )          | (17,528                     | )          |
|                                      |       | $                       | 4,719      |                        | $          | 5,403 |   |
|                                      |       |                    |       |                        |       |
| Other assets:                             |       |                    |       |                        |       |
| Prepaid wafer credits                     |       | $                       | 4,286      |                        | $          | 4,501 |   |
| Other                                     |       | 52                      |       | 51                          |       |
|                                      |       | $                       | 4,338      |                        | $          | 4,552 |   |
|                                      |       |                    |       |                        |       |
| Accrued liabilities:                      |       |                    |       |                        |       |
| Employee related accruals                 |       | $                       | 1,485      |                        | $          | 1,400 |   |
| Accrued adverse purchase commitments      |       | —                  |       | 70                          |       |
| Other                                     |       | 536                     |       | 1,041                       |       |
|                                      |       | $                       | 2,021      |                        | $          | 2,511 |   |

 

12

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**QUICKLOGIC CORPORATION**

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

 

**Note 7—Obligations**

 
| ** **                               | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                               | ** ** | **(in thousands)**      | ** ** |
|                                     |       |                    |       |                        |       |
| Revolving line of credit                 |       | $                       | 2,000      |                        | $          | 2,000 |   |
|                                     |       |                    |       |                        |       |
| Debt and capital lease obligations:      |       |                    |       |                        |       |
| Notes payable to bank                    |       | $                       | 2,119      |                        | $          | 2,567 |   |
| Capital lease                            |       | 383                     |       | 755                         |       |
|                                     |       | 2,502                   |       | 3,322                       |       |
| Current portion of long-term obligations |       | (1,736                  | )          | (2,286                      | )          |
|                                     |       | $                       | 766        |                        | $          | 1,036 |   |

 

*Revolving Line of Credit and Notes Payable toBank*

 

Effective June 2005, the Company modified its Amended and RestatedLoan and Security Agreement with Silicon Valley Bank. Terms of the modifiedagreement include an $8.0 million revolving line of credit available throughJune 2006, and an additional $3.0 million of borrowing capacity under theequipment line of credit that is available to be drawn against throughJune 2006.  The revolving line of credit provides for formulaadvances based upon a percentage of eligible accounts receivable and fornon-formula advances not to exceed $4.0 million.  Advances under the newequipment line of credit must be repaid in either 30 or 36 equal monthlyinstallments, depending upon the nature of the items financed. Terms of thevarious advances under the modified agreement are as follows (in thousands):

 
| ** **                | ** ** | **Original  Balance** | ** ** | **Balance at  June 30,  2005** | ** ** | **Available  Credit** | ** ** | **Interest Rate** | ** **    | **Maturity Date**                                           | ** **                                                  |
|---------------------------|------------|-----------------------|------------|--------------------------------|------------|-----------------------|------------|-------------------|---------------|-------------------------------------------------------------|-------------------------------------------------------------|
| Revolving Line of Credit: |       |                  |       |                           |       |                  |       |              |          |                                                        |                                                        |
| Formula advances          |       | n/a                   |       | $                              | 2,000      |                  | $          | 1,894             |          | Prime + 0.50%                                               |                                                        | June 26, 2006 |   |
| Non-formula advances      |       | n/a                   |       | —                         |       | 4,000                 |       | Prime + 1.50%     |          | June 26, 2006                                          |                                                        |
|                      |       |                  |       |                           |       |                  |       |              |          |                                                        |                                                        |
| Equipment Line of Credit: |       |                  |       |                           |       |                  |       |              |          |                                                        |                                                        |
| Notes payable             |       | $                     | 2,332      |                           | 89         |                  | n/a        |              | Prime + 0.75% |                                                        | Multiple draws maturing on or before December 31, 2005 |   |
| Notes payable             |       | 2,136                 |       | 878                            |       | n/a                   |       | Prime + 2.00%     |          | Multiple draws maturing on or before December 1, 2006  |                                                        |
| Notes payable             |       | 859                   |       | 638                            |       | n/a                   |       | Prime + 2.00%     |          | Multiple draws maturing on or before December 31, 2007 |                                                        |
| Notes payable             |       | 550                   |       | 514                            |       | n/a                   |       | Prime + 2.00%     |          | Multiple draws maturing on or before June 30, 2008     |                                                        |
| Notes payable             |       | n/a                   |       | —                         |       | 3,000                 |       | Prime +1.75%      |          | 30 or 36 months from date of advance                        |                                                        |
| Total                     |       |                  |       | $                              | 4,119      |                  |       |              |          |                                                        |                                                        |   |
|                           |            |                       |            |                                |            |                       |            |                   |               |                                                             |                                                             |  |  |  |

 

The bank has a first priority security interest in substantially all ofthe Company’s tangible and intangible assets to secure any outstanding amountsunder the modified agreement. Under the terms of the modified agreement, theCompany must maintain a minimum tangible net worth and an adjusted quick ratio.The modified agreement also has certain restrictions including, among others,on the incurrence of other indebtedness, the maintenance of depositoryaccounts, the disposition of assets, mergers, acquisitions, investments, thegranting of liens and the payment of dividends. The Company was in compliancewith the modified agreement as of June 30, 2005.

 

13

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**QUICKLOGIC CORPORATION**

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

 

At June 30, 2005, the prime rateunder the credit facility was 6.25%. As of June 30, 2005 andDecember 31, 2004, $766,000 and $1.0 million, respectively, ofamounts outstanding under the equipment line of credit were classified aslong-term liabilities.

 

*Capital Lease*

 

In January 2004, the Company leased design software and relatedmaintenance under a two-year capital lease at an interest rate of 6.0% perannum. Terms of the agreement require the Company to make quarterly principaland interest payments of approximately $196,000 through October 2005.Accordingly, the Company recorded a capital asset for $1.2 million that isbeing amortized over the term of the agreement, prepaid maintenance of $280,000that is being amortized over the term of the agreement and a capital leaseobligation of $1.5 million. As of June 30, 2005, the outstanding balanceunder the capital lease was $383,000, all of which was classified as ashort-term liability.

 

**Note 8—Deferred Royalty Revenue**

 

In 2000, the Company entered into a technology license and wafer supplyagreement with Aeroflex Incorporated (“Aeroflex”). Under the terms of theagreement, the Company received $750,000 of prepaid royalties. In addition,Aeroflex receives prepaid royalty credit for a portion of the amounts paid forwafers purchased from the Company under the agreement. These prepaid royaltiesare recorded as a long-term liability and will be recognized as revenue whenAeroflex sells products incorporating the licensed technology. As ofJune 30, 2005 and December 31, 2004, the Company had recordedapproximately $1.3 million and $1.2 million, respectively, ofdeferred royalty revenue under this agreement. As of June 30, 2005, noroyalty revenue had been earned under the agreement.

 

**Note 9 — Employee Stock Plans**

 

The Company has adopted the disclosure-only provisions of SFASNo. 123. If the Company had elected to recognize compensation expenseunder SFAS No. 123, net loss for the three months ended June 30, 2005and 2004 would have been $623,000 and $1.9 million, respectively. If theCompany had elected to recognize compensation expense under SFAS No. 123,net loss for the six months ended June 30, 2005 and 2004 would have been$629,000 and $4.6 million, respectively (see Note 2).

 

*1989 Stock Option Plan*

 

The 1989 Stock Option Plan (the “1989 Plan”) provided for the issuanceof incentive and nonqualified options for the purchase of up to approximately4.6 million shares of common stock. Options granted under the 1989 Planhave a term of up to 10 years, and typically vest at a rate of 25% of the totalgrant per year over a four-year period. In September 1999, the Companyadopted the 1999 Stock Plan and no further stock option grants were made underthe 1989 Plan.

 

*1999 Stock Plan*

 

The 1999 Stock Plan (the “1999 Plan”) was adopted by the board ofdirectors in August 1999 and was approved by the Company’s stockholders inSeptember 1999.  As of June 30, 2005, approximately12.9 million shares were reserved for issuance under the 1999 Plan. Inaddition, each January an annual increase is added to the 1999 Plan equal tothe lesser of (i) 5,000,000 shares, (ii) 5% of the Company’s outstanding shareson such date, or (iii) a lesser amount determined by the board of directors.Options that are cancelled under the 1989 Plan also become available for grantunder the 1999 Plan.  Options granted under the 1999 Plan have a term ofup to 10 years. Options typically vest at a rate of 25% of the total grant oneyear after the vesting commencement date, and one forty-eighth for each monthof service thereafter. However, the Company has implemented different vestingschedules in the past and may implement different vesting schedules in thefuture with respect to any new stock option grant.

 

The weighted average estimated fair value, as defined by SFAS No. 123,for options granted during the three months ended June 30, 2005 and 2004was $2.45 and $1.99 per option, respectively. The weighted average estimatedfair value, as defined by SFAS No. 123, for options granted during the sixmonths ended June 30, 2005 and 2004 was $2.44 and $1.99 per option,respectively. The fair value of each option grant is estimated on the date ofgrant using the Black-Scholes Option-Pricing Model. The Black-Scholes Model, aswell as other currently accepted option valuation models, was developed toestimate the fair value of freely tradable, fully transferable options withoutrestrictions. These assumptions differ significantly from the characteristicsof the Company’s stock option grants.

 

14

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**QUICKLOGIC CORPORATION**

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

 

The following weighted average assumptions are included in theestimated fair value calculations for stock option grants:

 
| ** **              | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **              | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Expected life (years)   |       | 4.02                             |       | 5.18                           |       | 4.05 |   | 5.18 |   |
| Risk-free interest rate |       | 3.80                             | %          | 3.81                           | %          | 3.79 | % | 3.81 | % |
| Volatility              |       | 92                               | %          | 79                             | %          | 92 | % | 78 | % |
| Dividend yield          |       | —                           |       | —                         |       | — |   | — |   |

 

*Employee Stock Purchase Plan*

 

The 1999 Employee Stock Purchase Plan(“ESPP”) was adopted by the board of directors in August 1999 and wasapproved by the Company’s stockholders in September 1999.  As ofJune 30, 2005, approximately 3.4 million shares were reserved forissuance 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 theCompany’s outstanding shares on such date, or (iii) a lesser amount determinedby the board of directors. The ESPP contains consecutive, overlapping,twenty-four month offering periods. Each offering period includes foursix-month purchase periods. The ESPP permits participants to purchase sharesthrough payroll deductions of up to 20% of an employee’s total compensation(maximum of 20,000 shares per purchase period) at 85% of the lower of the fairmarket value of the common stock at the beginning of an offering period or theend of a purchase period.

 

The weighted average estimated fairvalue, as defined by SFAS No. 123, of rights issued pursuant to theCompany’s ESPP during the three months ended June 30, 2005 and 2004 was $0.79and $2.24 per right, respectively, and during the six months ended June 30,2005 and 2004 was $0.79 and $2.24 per right, respectively. The fair value ofrights granted is estimated on the date of grant using the Black-ScholesOption-Pricing Model.

 

The following weighted averageassumptions are included in the estimated fair value calculations for rights topurchase stock under the ESPP:

 
| ** **              | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **              | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Expected life (months)  |       | 6.00                             |       | 6.00                           |       | 6.00 |   | 6.00 |   |
| Risk-free interest rate |       | 3.13                             | %          | 1.34                           | %          | 3.13 | % | 1.34 | % |
| Volatility              |       | 65                               | %          | 81                             | %          | 65 | % | 81 | % |
| Dividend yield          |       | —                           |       | —                         |       | — |   | — |   |

 

**Note 10—Rights Plan**

 

In 2001, the board of directorsadopted a Rights Agreement, which provides for a dividend of one PreferredStock Purchase Right (each a “Right” and collectively, the “Rights”) for eachshare of common stock of the Company. Each Right will entitle stockholders tobuy one ten-thousandth of a share of Series A Junior ParticipatingPreferred Stock of QuickLogic at an exercise price of $32.50, subject toadjustment. The Rights will become exercisable only if a person or groupbecomes the beneficial owner of 15% or more of the common stock, or commences atender or exchange offer which would result in the offeror beneficially owning15% or more of the common stock, without the approval of the board ofdirectors. The Company is entitled to redeem the Rights at $0.001 per Right upto ten business days after the public announcement of a 15% holder. If notearlier terminated or redeemed, the Rights will expire on November 27,2011.

 

**Note 11—Income Taxes**

 

In the six months ended June 30, 2005,the Company recorded income tax expense of approximately $81,000, whichconsisted of income taxes on foreign operations of $61,000 and federalalternative minimum income taxes of $20,000.

 

Due to the uncertainties surrounding the realization of the deferredtax assets resulting from the Company’s accumulated deficit and net tax lossesin prior years, 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.

 

15

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**QUICKLOGIC CORPORATION**

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

 

At December 31, 2004, the Company had net operating losscarryforwards for federal and state income tax purposes of approximately$79 million and $14 million, respectively. These carryforwards, ifnot utilized to offset future taxable income and income taxes payable, willexpire beginning in 2006 for federal purposes and 2005 for state purposes.

 

Under the Tax Reform Act of 1986, the amount of and the benefit fromnet operating losses that can be carried forward may be impaired in certaincircumstances. Events which may cause changes in the Company’s tax carryoversinclude, but are not limited to, a cumulative ownership change of more than 50%over a three-year period. Since inception, the Company believes cumulativechanges in ownership may have triggered the loss carryforward deductionlimitation under IRC Section 382. However, the Company believes that suchlimitations will not have a material effect on the future utilization of thelosses.

 

**Note 12—Information Concerning GeographicInformation and Major Customers**

 

The following is a breakdown ofrevenue by product families (in thousands):

 
| ** **                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue by product family:          |       |                             |       |                           |       |   |   |   |   |
| Mature products                     |       | $                                | 7,575      |                           | $          | 6,749 |   | $ | 16,123 |   | $ | 12,021 |   |
| Embedded standard products          |       | 3,441                            |       | 3,467                          |       | 5,828 |   | 6,484 |   |
| Advanced embedded standard products |       | 1,754                            |       | 1,005                          |       | 3,346 |   | 3,084 |   |
| Total revenue                       |       | $                                | 12,770     |                           | $          | 11,221 |   | $ | 25,297 |   | $ | 21,589 |   |

 

The following is a breakdown ofrevenue by shipment destination (in thousands):

 
| ** **            | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **            | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue by geography: |       |                             |       |                           |       |   |   |   |   |
| United States         |       | $                                | 5,987      |                           | $          | 5,377 |   | $ | 11,868 |   | $ | 10,337 |   |
| Japan                 |       | 2,023                            |       | 1,481                          |       | 4,106 |   | 3,918 |   |
| Europe                |       | 2,227                            |       | 2,449                          |       | 5,364 |   | 4,254 |   |
| China                 |       | 1,235                            |       | 597                            |       | 1,376 |   | 687 |   |
| Rest of North America |       | 1,011                            |       | 468                            |       | 1,725 |   | 1,183 |   |
| Rest of Asia Pacific  |       | 287                              |       | 849                            |       | 858 |   | 1,210 |   |
| Total revenue         |       | $                                | 12,770     |                           | $          | 11,221 |   | $ | 25,297 |   | $ | 21,589 |   |

 

Three distributors of the Company’s products accounted for 17%, 16% and11% of revenue 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.

 

Two distributors of the Company’s products accounted for approximately20% and 16% of revenue in the three months ended June 30, 2004. Threedistributors of the Company’s products accounted for 19%, 16% and 11% ofrevenue in the six months ended June 30, 2004.

 

As of June 30, 2005 less than 10% of the Company’s long-livedassets, including property and equipment and other assets, were located outsidethe United States.

 

**Note 13—Commitments**

 

Certain of the Company’s wafer manufacturers require the Company toforecast wafer starts several months in advance. The Company is committed totake delivery of and pay for a portion of forecasted wafer volume. As ofJune 30, 2005 and December 31, 2004, the Company had $4.3 million and$6.4 million, respectively, of outstanding commitments for the purchase ofwafers.

 

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**QUICKLOGIC CORPORATION**

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

 

The Company leases, with an option to renew, its primary facility undera non-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, 2005 and 2004 was approximately $230,000 and $240,000,respectively, and for the six months ended June 30, 2005 and 2004 wasapproximately $490,000 and $470,000, respectively.

 

**Note 14—Litigation**

 

On October 26, 2001, a putative securities class action was filedin the U.S. District Court for the Southern District of New York againstcertain investment banks that underwrote QuickLogic’s initial public offering,QuickLogic and some of QuickLogic’s officers and directors. The complaintalleges excessive and undisclosed commissions in connection with the allocationof shares of common stock in QuickLogic’s initial and secondary publicofferings and artificially high prices through “tie-in” arrangements whichrequired the underwriters’ customers to buy shares in the aftermarket atpre-determined prices in violation of the federal securities laws. Plaintiffsseek an unspecified amount of damages on behalf of persons who purchasedQuickLogic’s stock pursuant to the registration statements betweenOctober 14, 1999, and December 6, 2000. Various plaintiffs have filedsimilar actions asserting virtually identical allegations against over 300other public companies, their underwriters, and their officers and directorsarising out of each company’s public offering. These actions, including theaction against QuickLogic, have been coordinated for pretrial purposes andcaptioned In re Initial Public Offering Securities Litigation, 21 MC 92. Astipulation of settlement for the claims against the issuer defendants,including the Company, has been signed and was submitted to the court. Underthe stipulation of settlement, the plaintiffs will dismiss and release allclaims against participating defendants in exchange for a contingent paymentguaranty by the insurance companies collectively responsible for insuring theissuers in all the related cases, and the assignment or surrender to theplaintiffs of certain claims the issuer defendants may have against theunderwriters. Under the guaranty, the insurers will be required to pay theamount, if any, by which $1.0 billion exceeds the aggregate amount ultimatelycollected by the plaintiffs from the underwriter defendants in all the cases.On February 15, 2005, the court preliminarily approved the settlementcontingent on specified modifications. The settlement is still subject to courtapproval and a number of other conditions. There is no guarantee that thesettlement will become effective.

 

On July 3, 2003, a putative securities class action was filed inthe U.S. District Court for the Southern District of New York by shareholdersof Tower Semiconductor Ltd. against Tower, several of its directors, andseveral of its investors, including QuickLogic. QuickLogic was named solely asan alleged control person. On August 19, 2004, the court dismissed theclaims against all defendants, including QuickLogic, with prejudice. OnSeptember 29, 2004 one of the plaintiffs filed a notice of appeal from thejudgment.

 

No estimate can be made of the possible loss or possible range of lossassociated with the resolution of these contingencies and, accordingly, theCompany has not recorded a liability.

 

From time to time, the Company is involved in legal actions arising inthe ordinary course of business, including but not limited to intellectualproperty infringement and collection matters. Absolute assurance cannot begiven that third party assertions will be resolved without costly litigation ina manner that is not adverse to the Company or without requiring future royaltypayments.

 

**Note 15—Subsequent Events**

 

On July 12, 2005, the Company filed a shelf registration statementon Form S-3, which was declared effective on July 26, 2005 by theSecurities and Exchange Commission. Under this filing, the Company has theability to raise up to $30.0 million, in one or more transactions, byselling common stock, preferred stock, depositary shares, and warrants. TheCompany expects to incur expenses of approximately $170,000 in connection withthis filing.

 

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**Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

*The following Management’s Discussion andAnalysis of Financial Condition and Results of Operations, as well asinformation contained in “Risk Factors” below and elsewhere in this QuarterlyReport on Form 10-Q, contains “forward-looking statements” within themeaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934. We intend that these forward-lookingstatements be subject to the safe harbors created by those provisions.Forward-looking statements are generally written in the future tense and/or arepreceded by words such as “will,” “may,” “should,” “forecast,” “could,” “expect,”“suggest,” “believe,” “anticipate,” “intend,” “plan,” or other similar words.Forward-looking statements include statements regarding (1) our revenuelevels, (2) our gross profit and factors that affect gross profit,(3) our level of operating expenses, (4) our research and developmentefforts, (5) our liquidity, (6) our partners and suppliers, and(7) the commercial success of our products. The following discussionshould be read in conjunction with the attached condensed unauditedconsolidated financial statements and notes thereto, and with our auditedfinancial statements and notes thereto for the fiscal year endedDecember 31, 2004, found in our Annual Report on Form 10-K filed onMarch 17, 2005.*

 

*The forward-looking statements contained in thisQuarterly Report involve a number of risks and uncertainties, many of which areoutside of our control. Factors that could cause actual results to differmaterially from projected results include, but are not limited to, risksassociated with (1) the expected decline in revenue from our pASIC1 andpASIC2 products, (2) the commercial and technical success of our newproducts, (3) limited visibility into demand for our products, includingdemand from significant customers or for new products such as Eclipse II orQuickPCI II, (4) our relationship with and the manufacturing of ourproducts by Tower Semiconductor Ltd., (5) our dependence upon singlesuppliers to fabricate and assemble a substantial portion of our products, and(6) the liquidity required to support our future operating and capitalrequirements. Although we believe that the assumptions underlying theforward-looking statements contained in this Quarterly Report are reasonable,any of the assumptions could be inaccurate, and therefore there can be noassurance that such statements will be accurate. In light of the significantuncertainties inherent in the forward-looking statements included herein, theinclusion of such information should not be regarded as a representation by usor any other person that the results or conditions described in such statementsor our objectives and plans will be achieved. Furthermore, past performance inoperations and share price is not necessarily indicative of future performance.QuickLogic disclaims any intention or obligation to update or revise any forward-lookingstatements, whether as a result of new information, future events or otherwise.*

* *

**Overview**

 

QuickLogic Corporation, founded in April 1988, operates in a singleindustry segment where it designs and sells field programmable gate arrays,embedded standard products, associated software and programming hardware. In1991, we introduced our first line of field programmable gate array products,or FPGAs, based upon our ViaLink® technology. Our Mature product familyconsists of our pASIC1, pASIC2 and pASIC3 products. Our Eclipse IIdevices, introduced in 2003, are moderate to low density FPGAs that aresmaller, faster and consume less power than competing products.

 

In September 1998, we introduced our first line of EmbeddedStandard Products, or ESPs, to address the design community’s demand for analternative to existing options: Application Specific Integrated Circuits, orASICs, and system-on-a-chip products. ESP products embed standard functions onprogrammable logic devices. These products provide engineers with theease-of-use, guaranteed functionality, high performance, low non-recurringengineering charges and immediate availability of application specific standardproducts, or ASSPs, combined with the flexibility and time-to-market advantagesof programmable logic. Our ESP product family includes QuickRAM, QuickPCI, andV3 products. Our Advanced ESP product family includes QuickMIPS, Eclipse,Eclipse II and QuickPCI II products. We also license our QuickWorks andQuickTools design software and sell our programming hardware and include thesesales as Advanced ESP revenue.

 

Our newest products target low-power,high-performance applications where system designers want to add features to orimprove the performance of a system through the use of programmable devices.Our products generally target complex, high-performance embedded systems inrapidly changing markets where system manufacturers seek to minimizetime-to-market and maximize product differentiation and functionality. Ourproduct offering includes the lowest-power FPGAs available in the industrytoday, enabling designers to utilize the high performance of our FPGAarchitecture in low-power embedded systems. Compared to our competitors’ SRAM-based FPGAs, our devices provide ahigher level of intellectual property security since it is extremely difficultto clone or reverse engineer intellectual property that is implemented usingour one-time-programmable ViaLink technology. We compete in various markets,including: instrumentation and test; data communications andtelecommunications; consumer applications; video, audio and graphics imaging;high-performance

 

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computing; and military and aerospace systems. Based oncurrent customer design activity, we expect that consumer applications willrepresent a higher proportion of our revenue in the future.

 

Our proprietary ViaLink programmable metal-to-metal technology is thecore of our FPGA products and the foundation of our ESP products. Our ViaLinktechnology allows us to create devices smaller than competitors’ comparableproducts, thereby minimizing silicon area and cost. In addition, our ViaLinktechnology has lower electrical resistance and capacitance than otherprogrammable technologies and, consequently, supports higher signal-speed andlower power consumption. Our user-programmable platform and design softwarefacilitates full utilization of a device’s logic cells, clocks and input/outputpins. These logic cells have been optimized to efficiently implement a widerange of logic functions at high speed, thereby enabling greater usable devicedensity and design flexibility. Our architecture uses our ViaLink technology tomaximize interconnects at every routing wire intersection, which allows morepaths between logic cells. As a consequence, system designers are able to useour devices with smaller gate counts to implement their designs than if theyhad used competing FPGAs. The abundance of interconnect resources also providesa dense connection between the ASSP and the FPGA portions of Embedded StandardProducts.

 

We believe that important industry trends in our target markets includelower power consumption, higher performance, shorter time to market, increasedintellectual property security, higher development expenses and increasedproduct development risks. We believe our products are designed to address manyof these trends.

 

The market for programmable logic devices is expected to grow morequickly than the semiconductor industry, and we believe the FPGA programmablelogic market will grow more quickly than the market for complex programmablelogic devices. One factor fueling this high growth is the migration from ASICcircuit designs to programmable logic circuit designs. System designers oftenchoose programmable logic solutions over ASIC solutions, due to the relativelylow development 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.

 

Technology developed for personal computer applications, such as microhard disk drives and Wi-Fi communication modules, is being designed intoembedded applications, as embedded system designers seek to improve the valueof their systems by incorporating these features. This adoption of new featuresby embedded system designers is increasing the use of programmable logic, sinceembedded processors often do not have the native ability to interface tocomponents such as Wi-Fi modules or micro hard disk drives, which were designedto work in a personal computer environment. Our Eclipse II and QuickPCI IIdevices have compelling advantages in these programmable interconnectapplications, where customers benefit from their low power consumption, smallform factor and high bandwidth.

 

Our objective is to be the indispensable provider of intelligent,programmable interconnect solutions, primarily for low-power embedded systems.We believe that our ESPs—products that integrate standard functions andprogrammable logic—provide our customers with low power consumption, IPsecurity and flexibility at cost-effective prices while meeting systemperformance requirements. We believe these devices enable systems manufacturersto improve time-to-market and add features or performance to their embeddedapplications.

 

We believe that the market for low power embedded applications will bea relatively high-growth market, as OEMs serving the consumer or professionalportable markets accelerate the offering of devices such as PDAs incorporatingWi-Fi or micro hard drive capability, wireless VoIP telephones, or consumerproducts utilizing a micro hard drive.

 

We believe our products offer bulletproof intellectual propertysecurity compared to SRAM-based FPGA or ASIC solutions. We believe intellectualproperty security will be important to system designers who choose to implementproprietary algorithms or features in programmable logic rather than ASICdevices.

 

In 2000, we entered into a Share Purchase Agreement, Foundry Agreementand other related agreements, as amended, with Tower Semiconductor Ltd., orTower. Under the terms of the agreements, we made a strategic investment inTower as part of Tower’s plan to build and equip a new wafer fabricationfacility. The facility produces 200-mm wafers in geometries of 0.18 micron,using advanced complementary metal oxide semiconductor, or CMOS, technologyacquired from Toshiba.

 

During 2001 and 2002, we paid Tower a total of $21.3 million to fulfillour investment requirements under the terms of the agreement. In partialconsideration for the investment, we received 1,757,368 Tower ordinary shareswith an original cost of $16.6 million. We wrote down the Tower shares due toan “other than temporary” decline in their market value by $1.5 million,$3.8 million and $6.8 million in fiscal 2004, 2002 and 2001, respectively. Inthe second quarter of 2005, we

 

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determined that our investmentin Tower stock had suffered a further decline in value that was determined tobe “other than temporary.” This determination included factors such as marketvalue and the period of time that the market value had been below the carryingvalue. Accordingly, we recorded an impairment charge of $1.5 million inthe second quarter of 2005 based on the quoted market price of the stock on thelast trading day of the reporting period. As a result of this write-down, thecarrying value of our Tower ordinary shares was $1.17 per share atJuly 1, 2005.

 

During 2003, we sold 412,825 of the available for sale Tower ordinaryshares for total proceeds of approximately $2.1 million and recognized a gainin the amount of $719,000. As of June 30, 2005, we held 1,344,543available for sale Tower ordinary shares valued at $1.17 per share, the marketvalue of these shares at the end of our second fiscal quarter of 2005. Weintend to continue to hold 450,000 Tower ordinary shares in order to receivecompetitive product pricing and, accordingly, have classified these shares as along-term investment on our balance sheets. The remaining 894,543 shares arerecorded as a short-term investment on our balance sheets.

 

We also received $4.7 million in prepaid wafer credits in partialconsideration for the investment. These credits can be applied toward waferpurchases from Tower at 15% of the value of future purchases. As ofJune 30, 2005, we had $4.3 million of prepaid wafer creditsclassified as other long-term assets on our balance sheets.

 

We sell programmed and unprogrammed products through distributors anddirectly to original equipment manufacturers. However, we sell the majority ofour products through point-of-sale distributors. The percentage of salesderived through distributors was 69% and 74% in the six months endedJune 30, 2005 and 2004, respectively. For the six months endedJune 30, 2005 and 2004, approximately 73% and 66%, respectively, of theunits shipped to our point-of-sale distributors were programmed by us.

 

Three distributors of our products accounted for 17%, 16% and 11% ofrevenue in the three months ended June 30, 2005. The same threedistributors of our products accounted for 20%, 16% and 12% of revenue in thesix months ended June 30, 2005. Two distributors of the Company’s productsaccounted for approximately 20% and 16% of revenue in the three months endedJune 30, 2004. Three distributors of our products accounted for 19%, 16% and11% of revenue in the six months ended June 30, 2004. We anticipate that alimited number of distributors will continue to account for a significantportion of our total sales and that individual distributors could account for alarger portion of our revenue.

 

For the three and six months ended June 30, 2005, one domesticmanufacturer accounted for 10% and 11% of our revenue, respectively. For the three and six months ended June 30, 2004, no one manufacturer accountedfor 10% or more of our revenue. In the future, we anticipate that this domesticmanufacturer, and other manufacturers, especially as we continue topursue more consumer application opportunities with larger volumerequirements, could continue to account for a significant portion of ourrevenues.

 

Our international sales were 53% and 52% of our revenue in the six monthsended June 30, 2005 and 2004, respectively. Revenue from sales tointernational customers is expected to continue to represent a significantportion of our revenue. All of our sales originate in the United States and aredenominated in U.S. dollars.

 

We outsource the wafer manufacturing, assembly and test of all of ourproducts. We currently rely upon Taiwan Semiconductor Manufacturing CompanyLtd., or TSMC, Cypress Semiconductor Corporation, Tower, Samsung Semiconductor,Inc. and Kawasaki Microelectronics to manufacture our products, and we relyprimarily upon Amkor Technology, Inc. and also Advanced SemiconductorEngineering Inc., or ASE, to assemble, test and program our products. Our wafersuppliers’ lead times are often as long as three months and sometimes longer.In addition, Cypress and Tower require us to provide them with a monthly waferstart forecast. Under the terms of our agreements with them, we are limited inthe quantity that we can increase or decrease our wafer forecast and we are committedto take delivery of and pay for a minimum portion of the forecasted wafervolume. Our long manufacturing cycle times are at odds with our customers’desire for short delivery lead times and, as a result, we typically purchasewafers based on our internal forecasts of customer demand.

 

**Critical Accounting Policies and Estimates**

 

The methods, estimates and judgments we use in applying our mostcritical accounting policies have a significant impact on the results we reportin our financial statements. The U.S. Securities and Exchange Commission, orSEC, has defined critical accounting policies as those that are most importantto the portrayal of our financial condition and results of operations andrequire us to make our most difficult and subjective judgments, often as aresult of the need to make estimates

 

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of matters that are inherentlyuncertain.  Based on this definition, our critical policies includerevenue recognition 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, accounting for income taxes, and estimating accrued liabilities.  We believe that we apply judgments andestimates in a consistent manner and that such consistent application resultsin financial statements and accompanying notes that fairly represent allperiods presented. However, any factual errors or errors in these judgments andestimates may have a material impact on our statement of operations andfinancial condition. For a discussion of our significant accounting policies,please see Note 2 to the Condensed Unaudited Consolidated Financial Statementsin this Quarterly Report on Form 10-Q. For a discussion of critical accountingpolicies and estimates, please see Item 7 in our Annual Report on Form 10-K forthe fiscal year ended December 31, 2004 filed on March 17, 2005.

 

**Results of Operations**

 

The following table sets forth the percentage of revenue for certainitems in our statements of operations for the periods indicated:

 

| ** **                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue                             |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |
| Cost of revenue                     |       | 36.1                             |       | 39.8                           |       | 37.6 |   | 41.8 |   |
| Gross profit                        |       | 63.9                             |       | 60.2                           |       | 62.4 |   | 58.2 |   |
| Operating expenses:                 |       |                             |       |                           |       |   |   |   |   |
| Research and development            |       | 18.3                             |       | 27.2                           |       | 18.9 |   | 29.2 |   |
| Selling, general and administrative |       | 31.7                             |       | 37.4                           |       | 33.0 |   | 37.5 |   |
| Income (loss) from operations       |       | 13.9                             |       | (4.4                           | )          | 10.5 |   | (8.5 | ) |
| Write-down of marketable securities |       | (11.5                            | )          | —                         |       | (5.8 | ) | — |   |
| Interest expense                    |       | (0.4                             | )          | (0.5                           | )          | (0.4 | ) | (0.6 | ) |
| Interest income and other, net      |       | 0.7                              |       | 0.2                            |       | 0.7 |   | 0.3 |   |
| Income (loss) before income taxes   |       | 2.7                              |       | (4.7                           | )          | 5.0 |   | (8.8 | ) |
| Provision for income taxes          |       | 0.2                              |       | —                         |       | 0.3 |   | — |   |
| Net income (loss)                   |       | 2.5                              | %          | (4.7                           | )%         | 4.7 | % | (8.8 | )% |

 

**Three Months Ended June 30, 2005 and 2004**

 

*Revenue.*  Ourrevenue for the three months ended June 30, 2005 was $12.8 million,representing a growth of $1.5 million, or 13.8%, from revenue of$11.2 million in the three months ended June 30, 2004. This revenueincrease was due to a $830,000 increase in our Mature product revenue,primarily related to higher customer demand and end-of-life purchases of ourpASIC1 products, and a $750,000 increase in our Advanced ESP product revenue,primarily due to an increase in revenue from a systems manufacturer purchasingproduct through a distributor and due to sales of our new Eclipse II andQuickPCI II products. ESP product revenue in the three months ended June 30,2005 was comparable to the three months ended June 30, 2004.

 

Our revenue for the three months ended June 30, 2005 was 1.9%higher sequentially, increasing to $12.8 million from $12.5 million in thethree months ended March 31, 2005.  This revenue increase was due toa $1.1 million increase in our ESP product revenue, primarily due to anincrease in revenue from a Chinese systems manufacturer purchasing productthrough a distributor, and a $160,000 increase in Advance ESP product revenues,primarily due to an increase in revenue from a systems manufacturer purchasingproduct through a distributor.  Theseincreases were partially offset by a decrease in Mature products revenue dueprimarily to a decrease in pASIC1 and pASIC2 product revenue as a result of ourcustomers’ requested delivery dates of last time buy orders.

 

Our foundry agreement with the supplier that fabricates our pASIC1 andpASIC2 products expires at the end of 2005. We have announced an end-of-lifefor these products and have asked our customers to take delivery of lifetimebuy orders before the end of 2005. These product families contributed$5.1 million and $4.3 million of our revenue in the three monthsended June 30, 2005 and 2004, respectively. While we may have limitedproduction capacity for these products beyond 2005, we expect to experience asignificant reduction in pASIC1 and pASIC2 revenue by the fourth quarter of2005. We currently believe that a majority of our customers that use pASIC1 andpASIC2 products will purchase enough product to satisfy their demand throughoutthe expected life of their products rather than migrate to other QuickLogicproducts, and that pASIC1 and pASIC2 products will contribute less than 10% ofour revenue by the second quarter of 2006 and no revenue by the end of

 

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2006. As a result, we couldexperience fluctuations in demand as customers build inventory of theseproducts, design systems using devices supplied by others or reduce purchasesof our products.

 

In order to maintain or grow our revenue from its current level afterthe pASIC1 and pASIC2 products end-of-life period in 2005, we are dependentupon increased revenue from our existing products, especially our new EclipseII and QuickPCI II products, and the development of additional commerciallysuccessful new products.

 

We continue to seek to expand our revenue, including the pursuit ofhigh volume sales opportunities in the consumer market segment. Our industry ischaracterized by intense price competition and by lower prices as order volumesincrease. While winning large volume sales opportunities will increase ourrevenue, we believe these opportunities may decrease our average selling priceand gross profit as a percentage of revenue.

 

*Gross Profit*.  Grossprofit was $8.2 million and $6.8 million in the three months endedJune 30, 2005 and 2004, respectively, which was 63.9% and 60.2% of revenuefor those periods. The $1.4 million improvement in gross profit wasprimarily due to higher revenue, which contributed approximately$1.1 million of this improvement, lower depreciation and amortizationexpense of $170,000 and higher absorbed overhead on higher production volumes.  These improvements were partially offset byhigher yield variances and lower benefit from the sale of previously reservedinventory.  Our lower depreciation andamortization expense was largely a result of the impairment of long-livedassets recorded in the fourth quarter of 2004.

 

*Research and Development Expense.*  Researchand development expense was $2.3 million and $3.1 million in thethree months ended June 30, 2005 and 2004, respectively, which was 18.3%and 27.2% of revenue for those periods. The decrease of approximately $720,000was primarily due to lower charges for pre-production material and otherexpenses associated with the development of our 0.18 micron products which werereleased for production in late 2004 and lower depreciation expense. We believethat continued investments in product development and process technology areessential for us to remain competitive in the markets we serve. We expect thatthese development efforts will allow us to expand our product offering andprovide additional value to our customers and stockholders.

 

*Selling, General and Administrative Expense.*  Selling,general and administrative expense was $4.0 million and $4.2 millionfor the three months ended June 30, 2005 and 2004, respectively, which was31.7% and 37.4% of revenue for those periods. The $150,000 decrease in selling,general and administrative expense was primarily the result of lower salaryexpense due to lower headcount, lower consulting fees and lower insuranceexpense, partially offset by higher independent auditor fees and commissions tosales representatives on the higher revenue levels.

 

*Write-down of Marketable Securities.  *Inthe second quarter of 2005, we determined that our investment in Tower stockhad suffered a decline in value that was determined to be “other thantemporary.” This determination included factors such as market value and theperiod of time that the market value had been below the carrying value.Accordingly, we recorded an impairment charge of $1.5 million in thesecond quarter of 2005 based on the quoted market price of the stock on thelast trading day of the reporting period. As a result of this write-down, thecarrying value of our Tower ordinary shares was $1.17 per share at the endof the second quarter of 2005, compared to $2.26 per share at the end of 2004.

 

*Interest Expense.* Interest expense was $53,000 for the three months ended June 30, 2005compared to $62,000 for the three months ended June 30, 2004.  Thisdecrease was primarily due to lower average outstanding balances, partiallyoffset by higher interest rates.

 

*Interest and Other Income, Net.*  Interestand other income, net was $90,000 of income for the three months endedJune 30, 2005 as compared to $23,000 of income for the three months endedJune 30, 2004. The $67,000 increase in interest and other income, net isprimarily due to increased interest income received as a result of higherinvested cash balances and higher interest rates, partially offset by foreignexchange rate losses.

 

*Provision for Income Taxes.*  Werecorded a provision for income taxes of $31,000 for the three months endedJune 30, 2005, which consistedprimarily of income taxes on foreign operations. We incurred a tax lossin the three months ended June 30, 2004. Our ability to utilize our incometax loss carryforwards in future periods is uncertain and, accordingly, werecorded a full valuation allowance against the related tax benefit. We willcontinue to assess the realizability of the deferred tax assets in futureperiods.

 

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**Six Months Ended June 30, 2005 and 2004**

 

*Revenue.*  Ourrevenue for the six months ended June 30, 2005 was $25.3 million,representing a growth of $3.7 million, or 17.2%, from revenue of$21.6 million in the six months ended June 30, 2004. This revenueincrease was due to a $4.1 million increase in our Mature product revenueprimarily related to higher customer demand and end-of-life purchases of ourpASIC1 and pASIC2 products and a $260,000 increase in Advanced ESP productrevenue primarily related to sales of our new Eclipse II and QuickPCI IIproducts. These increases were partially offset by a decline in our ESPproduct revenue of $660,000, primarily due to changes in customer demand.

 

*Gross Profit*.  Grossprofit was $15.8 million and $12.6 million in the six months endedJune 30, 2005 and 2004, respectively, which was 62.4% and 58.2% of revenuefor those periods. The $3.2 million improvement in gross profit wasprimarily due to higher revenue, which contributed approximately $2.5 millionof this improvement, lower depreciation and amortization expense of $380,000,higher absorbed overhead on higher production volumes and lower productionvariances. Our lower depreciation and amortization expense was largely a resultof the impairment of long-lived assets recorded in the fourth quarter of 2004.

 

*Research and Development Expense.*  Researchand development expense was $4.8 million and $6.3 million in the sixmonths ended June 30, 2005 and 2004, respectively, which was 18.9% and29.2% of revenue for those periods. The decrease of approximately$1.5 million was primarily due to lower charges for pre-productionmaterial and other expenses associated with the development of our0.18 micron products, which were released for production in late 2004, andlower depreciation expense.

 

*Selling, General and Administrative Expense.*  Selling,general and administrative expense was $8.3 million and $8.1 millionfor the six months ended June 30, 2005 and 2004, respectively, which was33.0% and 37.5% of revenue for those periods. The $240,000 increase in selling,general and administrative expense was primarily the result of higher legal andindependent auditor fees and commissions to sales representatives on the higherrevenue levels, partially offset by lower salary expense due to lowerheadcount, the benefit from collecting a previously reserved accountsreceivable in the first quarter of 2005, lower depreciation expense and lowerinsurance expense.

 

*Write-down of Marketable Securities.  *Inthe second quarter of 2005, we determined that our investment in Tower stockhad suffered a decline in value that was determined to be “other thantemporary.” Accordingly, we recorded an impairment charge of $1.5 millionin the second quarter of 2005 based on the quoted market price of the stock onthe last trading day of the reporting period. As a result of this write-down,the carrying value of our Tower ordinary shares was $1.17 per share at theend of the second quarter of 2005, compared to $2.26 per share at the end of2004.

 

*Interest Expense.*  Interestexpense was $106,000 for the six months ended June 30, 2005 compared to$130,000 for the six months ended June 30, 2004.  This decrease wasprimarily due to lower average outstanding balances, partially offset by higherinterest rates.

 

*Interest and Other Income, Net.*  Interestand other income, net was $170,000 of income for the six months endedJune 30, 2005 as compared to $67,000 of income for the six months endedJune 30, 2004. The $103,000 increase in interest and other income, net isprimarily due to increased interest income received as a result of higherinvested cash balances and higher interest rates, partially offset by foreignexchange rate losses.

 

*Provision for Income Taxes.* We recorded a provision for income taxes of $81,000 for the six months endedJune 30, 2005, which consisted ofincome taxes on foreign operations and federal alternative minimum income taxes.We incurred a tax loss in the six months ended June 30, 2004. Our abilityto 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.

 

**Liquidity and Capital Resources**

 

We have financed our operating losses and capital investments throughsales of common stock, private equity investments, capital and operatingleases, bank lines of credit and cash flow from operations. As of June 30,2005, our principal sources of liquidity consisted of our cash and cashequivalents of $25.1 million, available credit under our revolving line ofcredit with Silicon Valley Bank of approximately $5.9 million, available creditunder our equipment line of credit of approximately $3.0 million, and ourinvestment in Tower with a market value of approximately $1.6 million. OnJuly 12, 2005, the Company filed a shelf registration statement on Form S-3, whichhas been declared effective. Under this filing, we

 

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may raise up to $30.0 million,in one or several transactions, by selling common stock, preferred stock,depositary shares, and warrants.

 

As of June 30, 2005, our interest-bearing debt consisted of$4.1 million outstanding from Silicon Valley Bank and $383,000 outstandingunder a capital lease. As of June 30, 2005, our accumulated deficit was$118.5 million. Capital expenditures, which are largely driven by thedevelopment of new products and manufacturing levels, could be up to$5.0 million in the next twelve months.

 

In June 2005, we modified our Amended and Restated Loan andSecurity Agreement with Silicon Valley Bank. Terms of the modified agreementinclude an $8.0 million revolving line of credit available throughJune 2006 and an additional $3.0 million of borrowing capacity underan equipment financing line of credit that is available to be drawn againstthrough June 2006. The revolving line of credit provides for formulaadvances based upon a percentage of eligible accounts receivable and fornon-formula advances not to exceed $4.0 million. As of June 30, 2005 underthe revolving line of credit, we had borrowed $2.0 million and hadavailable formula and non-formula advances totaling $5.9 million. As ofJune 30, 2005, we had  $2.1 millionoutstanding under previous equipment lines of credit and $3.0 millionavailable to be drawn against future equipment purchases. Advances under thenew equipment line of credit must be repaid in either 30 or 36 equal monthlyinstallments, depending upon the nature of the items financed. The bank has afirst priority security interest on substantially all of our tangible andintangible assets to secure any outstanding amounts under the modifiedagreement. Under the terms of the modified agreement, we must maintain aminimum tangible net worth and an adjusted quick ratio. The modified agreementalso has certain restrictions including, among others, on the incurrence ofother indebtedness, the maintenance of depository accounts, the disposition ofassets, mergers, acquisitions, the granting of liens and the payment ofdividends. We were in compliance with all loan covenants as of June 30,2005.

 

As of June 30, 2005, we also had $383,000 outstanding under acapital lease obligation. The capital lease obligation bears interest at 6.0%per annum and is being repaid in quarterly amounts of $196,000 throughOctober 2005.

 

*Net cashfrom operating activities*

* *

Net cash provided by operating activities was $272,000 in the sixmonths ended June 30, 2005.  The cash provided resulted primarilyfrom net income of $1.2 million, adjusted for $3.3 million ofnon-cash charges including a $1.5 million write-down of marketablesecurities, depreciation and amortization of $1.4 million, $215,000 fromthe utilization of prepaid wafer credit and reserves for excess inventory of$205,000.  In addition, changes in working capital accounts used cash inthe amount of $4.2 million primarily as a result of a $2.1 millionincrease in inventory due to wafer purchases in anticipation of future sales ofEclipse II and QuickPCI II and last time buy sales of pASIC1 and pASIC2, anincrease of $1.7 million in accounts receivable, net of allowances fordoubtful accounts due to an increase in revenue levels, a $824,000 reduction intrade payables and a $490,000 reduction in accrued liabilities, partiallyoffset by a $465,000 increase in deferred income and royalty revenue dueprimarily to higher inventories at distributors on which revenue is deferredand a $452,000 reduction in other current assets due to the amortization ofprepaid expenses.

 

Net cash provided by operating activities was $507,000 in the sixmonths ended June 30, 2004.  The cash provided resulted primarily from thenet loss of $1.9 million, adjusted for non-cash charges and other itemsincluding depreciation and amortization of $2.3 million and reserves for excessinventory of $130,000.  In addition, changes in working capital accountsused cash in the amount of $87,000 primarily as a result of higher inventorylevels of $1.2 million primarily due to an increase in raw materials andwork-in-process inventory to fulfill customer demand and to acquire programminghardware for sale to customers; and a decrease in accounts payable of $640,000primarily due to the timing of wafer receipts and vendor payments.  Thesechanges in working capital were partially offset by a decrease in other assetsof $862,000 primarily due to the amortization of prepaid expenses and therepayment of a related party loan and a $793,000 increase in deferred income androyalty revenue primarily due to an increase in deferred revenue from shipmentsmade to our distributors.

 

*Net cash from investing activities*

 

Net cash used for investingactivities for the six months ended June 30, 2005 was $682,000 as a resultof capital expenditures made primarily to acquire equipment and software usedin the development and production of our products. Net cash used for investingactivities for the six months ended June 30, 2004 was $754,000 as a result ofcapital expenditures made primarily to acquire equipment and software used inthe development and production of our products.  Also, in the six monthsended June 30, 2004, we entered into a capital lease obligation to acquiredesign software and related maintenance. As a result of this agreement, werecorded a capital lease obligation for $1.5 million, property andequipment of $1.2 million

 

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and prepaid maintenance of $280,000 on the balancesheets.  This transaction was treated as a non-cash transaction in ourstatement of cash flows for the six months ended June 30, 2004.

 

*Net cash from financing activities*

 

Net cash provided by financing activities was $604,000 for the sixmonths ended June 30, 2005 resulting from $1.4 million in proceedsrelated to the issuance of common shares under our employee stock purchaseprogram and upon the exercise of stock options by employees and $550,000 inproceeds from debt and capital lease obligations, partially offset by scheduledrepayments of $1.4 million under the terms of our obligations.

 

Net cash used by financing activities was $107,000 for the six monthsended June 30, 2004.  The use of funds was due to scheduled repayments of$1.5 million under the terms of our obligations, partially offset by $1.4million of proceeds related to the issuance of common shares under our employeestock purchase program and upon the exercise of stock options by employees.

 

We require substantial working capital to fund our business,particularly to finance our operations, the acquisition of property andequipment, the repayment of debt and working capital requirements. Our futureliquidity will depend on many factors such as these, as well as our level ofrevenue and gross profit, market acceptance of our existing and new productsincluding our Eclipse II and QuickPCI II devices, the expected decline inpASIC1 and pASIC2 revenue resulting from the end-of-life of these products,costs of securing access to adequate manufacturing capacity, inventory levels,wafer purchase commitments, customer credit terms, the amount and timing ofresearch and development expenditures, the timing of new product introductions,production volumes, the quality of our products, sales and marketing efforts,changes in operating assets and liabilities, our ability to obtain or renewdebt financing and to remain in compliance with the terms of our creditfacilities, our ability to raise funds from the sale of Tower shares and equityin the Company, 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$5.0 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 our “Risk Factors,” we filed a shelf registration statementon Form S-3 in July 2005, which has been declared effective. Under this filing,we may decide to raise up to $30.0 million, in one or several transactions, byselling common stock, preferred stock, depositary shares, and warrants.  We cannot assure you that capital will be madeavailable on terms acceptable to us.

 

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**Contractual Obligations and CommercialCommitments**

 

The following table summarizes our contractual obligations andcommercial commitments as of June 30, 2005 and the effect such obligationsand commitments are expected to have on our liquidity and cash flows in futureperiods (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                                          |       | $                          | 2,771      |   | $ | 695 |   | $ | 1,407 |   | $ | 669 |   | $ | — |   |
| Wafer purchases (1)                                       |       | 4,286                      |       | 4,286 |   | — |   | — |   | — |   |
| Other purchase commitments                                |       | 1,723                      |       | 1,723 |   | — |   | — |   | — |   |
| *Total contractual cash obligations*                      |       | 8,780                      |       | 6,704 |   | 1,407 |   | 669 |   | — |   |
|                                                      |       |                       |       |   |   |   |   |   |   |   |   |
| *Other commercial commitments*(2)*:*                      |       |                       |       |   |   |   |   |   |   |   |   |
| Revolving line of credit                                  |       | 2,000                      |       | 2,000 |   | — |   | — |   | — |   |
| Notes payable to bank                                     |       | 2,119                      |       | 1,353 |   | 766 |   | — |   | — |   |
| Capital lease obligations                                 |       | 383                        |       | 383 |   | — |   | — |   | — |   |
| *Total commercial commitments*                            |       | 4,502                      |       | 3,736 |   | 766 |   | — |   | — |   |
| Total contractual obligations and  commercial commitments |       | $                          | 13,282     |   | $ | 10,440 |   | $ | 2,173 |   | $ | 669 |   | $ | — |   |
|                                                           |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)          Certain of our wafer manufacturers require usto forecast wafer starts several months in advance.  We are committed totake delivery of and pay for a portion of forecasted wafer volume.  Waferpurchase commitments of $4.3 million include both firm purchase commitments anda portion of our forecasted wafer starts as of June 30, 2005.

 

(2)          Other commercial commitments are included asliabilities on our balance sheets as of June 30, 2005.

 

**Inflation**

** **

The impact of inflation on our business has not been material for theperiods presented.

 

**Off-BalanceSheet Arrangements**

** **

We do not maintain any off-balance sheet partnerships, arrangements orother relationships with unconsolidated entities or others, often referred toas structured finance or special purpose entities, which are established forthe purpose of facilitating off-balance sheet arrangements or othercontractually narrow or limited purposes.

 

**RecentlyIssued Accounting Pronouncements**

** **

On December 16, 2004, the Financial Accounting Standards Board, orFASB, issued SFAS No. 123(R), *“Share-BasedPayment,”*which is a revision of SFAS No. 123 and supersedesAccounting Principals Board, or APB, Opinion No. 25. SFASNo. 123(R) requires all share-based payments to employees, includinggrants of employee stock options, to be valued at fair value on the date ofgrant, and to be expensed over the applicable vesting period. Pro formadisclosure of the income statement effects of share-based payments is no longeran alternative. SFAS No. 123(R), as amended, is effective for allstock-based awards granted in fiscal years beginning after December 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. See Notes 2 and 7 to our CondensedUnaudited Consolidated Financial Statements for information related to the proforma effects on our reported net income (loss) and net income (loss) per shareof applying the fair value recognition provisions of the previous SFASNo. 123, *“Accounting for Stock-BasedCompensation,”* to stock-based employee compensation. We arecurrently assessing the impact of adopting SFAS No. 123(R) and expectthe impact upon adoption in fiscal year 2006 to be significant to our resultsof operations.

 

On March 29, 2005, the SEC issued Staff Accounting Bulletin (“SAB”)No. 107, which provides guidance on the interaction between SFAS No.123(R), *“Shared-Based Payment,”*and certain SEC rules and regulations. SAB No. 107 provides guidance that may simplify some of SFASNo. 123(R)’s implementation

 

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challenges and enhance theinformation that investors receive. We will apply the principles of SABNo. 107 in conjunction with the adoption of SFAS No. 123(R).

 

On December 21, 2004, the FASB issued Staff Position No. FAS 109-2, “*Accounting and Disclosure Guidance for the ForeignEarnings Repatriation Provision within the American Jobs Creation Act of 2004.”*The American Jobs Creation Act introduces a special one-time dividends receiveddeduction on the repatriation of certain foreign earnings to a U.S. taxpayer(repatriation provision), provided certain criteria are met. FSP FAS 109-2provides accounting and disclosure guidance for the repatriationprovision.  We may elect to apply thisprovision to qualifying earnings repatriations in fiscal 2006. We plan toevaluate the effects of the repatriation provision and in particular of thelimitation of the deduction to certain qualifying expenses incurred in theUnited States. We do not expect to be able to complete this evaluation untillate in fiscal 2006 when our qualifying expenses for 2006 will be known. We arecurrently assessing the impact of adopting FSP FAS 109-2.

 

On May 30, 2005, the FASB issued SFAS No. 154, *“Accounting Changes and Error Corrections,”*a replacement of APB Opinion No. 20 and FASB Statement No. 3, whichchanges the requirements for the accounting and reporting of a change inaccounting principle effective for fiscal years beginning after December 15,2005. SFAS No. 154 applies to all voluntary changes in accountingprinciple as well as to changes required by an accounting pronouncement that doesnot include specific transition provisions. SFAS No. 154 eliminates therequirement in APB Opinion No. 20, *“AccountingChanges,”* to include the cumulative effect of changes in accountingprinciple in the income statement in the period of change. Instead, to enhancethe comparability of prior period financial statements, SFAS No. 154requires that changes in accounting principle be retrospectively applied. Underretrospective application, the new accounting principle is applied as of thebeginning of the first period presented as if that principle had always beenused. Under SFAS No. 154, a change in reporting entity is alsoretrospectively applied as of the beginning of the first period presented. Achange in accounting estimate continues to be accounted for in the period ofchange, and future periods if necessary. We are currently assessing the impactof adopting SFAS No. 154 and do not expect the impact upon adoption infiscal year 2005 to be significant to our results of operations.

 

**Risk Factors**

 

# *We expect the announced end-of-life of ourpASIC1 and pASIC2 products will result in fluctuations or a decline in ourrevenue*

# * *

Our foundry agreement with the supplier that fabricates our pASIC1 andpASIC2 products expires on December 31, 2005. We have announced anend-of-life for these products and have asked our customers to take delivery oflifetime buy orders before the end of 2005. While we may have limitedproduction capacity for these products beyond 2005, we currently expect thatrevenue from these products may decline by the fourth quarter of 2005, accountfor less than 10% of our revenue by the second quarter of 2006 and contributeno revenue by the end of 2006. Revenue from these products was $5.2 million inthe third quarter of 2004, $5.1 million in the fourth quarter of 2004,$6.4 million in the first quarter of 2005 and $5.1 million in thesecond quarter of 2005. We currently expect that a majority of our customersthat use pASIC1 and pASIC2 products will purchase enough products to satisfytheir demand throughout the expected life of their products rather than migrateto other QuickLogic products. As a result, we expect to experience fluctuationsin demand as these customers build inventory of these products, design systemsusing devices supplied by others or reduce purchases of our products. If we areunable to: migrate customers to other products; develop customer demand for ourEclipse II and QuickPCI II products, which have strong customer design activitybut have not contributed significant revenue or gross profit to date; increaserevenue and gross profit from our other products; or obtain adequate productioncapacity; our revenue and gross profit will decline and our operating resultsand liquidity would be adversely affected. While we expect revenue growth fromEclipse II, QuickPCI II, other products and new products, will offset theexpected decline in pASIC1 and pASIC2 quarterly revenue, there is no assurancewhen this will occur, if at all.

 

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

# * *

We operate in a highly competitive, quickly changing environment markedby rapid obsolescence of existing products. To compete successfully, we mustobtain access to advanced fabrication capacity and dedicate significantresources to specify, design, develop, manufacture and sell new or enhancedproducts that provide increasingly higher levels of performance, low powerconsumption, new features, reliability and/or cost savings to our customers. Weexperience a long delay between the time when we expend these developmentresources and invest in related long-lived assets, and the time when we beginto generate revenue, if any, from these expenditures. We are introducing ourEclipse II and QuickPCI II products to new customers and markets and expect asignificant portion of our future revenues to be generated from these

 

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new products. Some of theseopportunities are in the rapidly changing consumer market which typically hasshorter product life cycles, higher volumes and greater price pressure than ourtraditional business. If we are unable to design, produce and sell new productsthat meet design specifications, address customer requirements, and generatesufficient revenue and gross profit, if market demand for our products fails tomaterialize, or if our customers do not successfully introduce productsincorporating our devices, our revenue and gross margin will be materiallyharmed and we may be required to write-off related inventory and long-livedassets. For example, in the fourth quarter of 2004 we recorded a$3.2 million long-lived asset impairment charge related to our QuickMIPSproducts.

 

# *We may be unable to accurately estimate quarterlyrevenue, which could adversely affect the trading price of our stock*

# * *

We offer our customers a short delivery lead-time and a majority of ourshipments during a quarter are ordered by the customer in that quarter. As aresult, we often have low visibility to the current quarter’s revenue, and ourrevenue levels can change significantly in a short period of time. Furthermore,our ability to respond to increased demand is limited to inventory on hand oron order and the capacity available at our contract manufacturers. In addition,a significant portion of our revenue is deferred until our distributors shipunprogrammed parts to end customers since the price is not fixed ordeterminable until that time. Therefore, we are highly dependent on the accuracyand timeliness of resale and inventory reports from our distributors.Inaccurate distributor resale or inventory reports, as well as unanticipatedchanges in distributor inventory levels, could contribute to our difficulty inpredicting and reporting our quarterly revenue and results of operations. If wefail to accurately estimate customer demand, record revenue, or if ouravailable capacity is less than needed to meet customer demand, our results ofoperations could be harmed and our stock price could materially fluctuate.

 

# *Our future results depend on our relationshipwith Tower*

# * *

We have invested approximately $21.3 million in Tower. In returnfor our investment, we have received equity, prepaid wafer credits andcommitted production capacity in Tower’s foundry facility. We believe thatTower’s long-term operation of this fabrication facility depends on its abilityto attract sufficient customer demand, to obtain additional financing, therelease of grants and approvals for changes in grant programs from the Israeligovernment’s Investment Center, and its ability to remain in compliance withthe terms of its grant and credit agreements. The current political uncertaintyand security situation in the Middle East where Tower’s fabrication facility islocated, the cyclical nature of the market for foundry manufacturing services,the early stage of operation of Tower’s fabrication facility, Tower’s financialcondition, or other factors may adversely impact Tower’s business prospects andmay discourage future investments in Tower from outside sources. We may decideto invest additional funds in Tower, which could have an impact on our cashposition and liquidity. If Tower is unable to obtain adequate financing andincrease production output in a timely manner, the value of our investment inTower may decline significantly or possibly become worthless, our wafer creditfrom Tower may decline in value or possibly become worthless, and we would haveto identify and qualify a substitute supplier to manufacture our products. Thiscould require significant development time, cause product shipment delays,impair long-lived assets, damage our liquidity and severely harm our business.

 

The value of our investment in Tower and its corresponding wafercredits may also be adversely affected by a deterioration of conditions in themarket for foundry manufacturing services and the market for semiconductorproducts generally. At June 30, 2005, the aggregated value of our Towerinvestment and wafer credits recorded on our balance sheets was$5.9 million. If the fair value of our Tower investment or our wafercredits are deemed to be impaired, we will record charges to our statement ofoperations. For instance, the fair value of our Tower investment was $2.26 pershare and $1.17 per share at December 31, 2004 and July 1, 2005,respectively. Since the value of our Tower investment remained below $2.26 pershare for a period of time, we recorded a $1.5 million write-down ofmarketable securities in the second quarter of 2005. In addition, Tower solelymanufactures our Eclipse II, certain QuickPCI II and QuickMIPS products, and wehave made significant purchases and purchase commitments to Tower for thesedevices. As these are new products being manufactured in a new facility, thereare significant manufacturing and engineering risks associated with thesepurchases. We expect these devices to be a source of significant long-termrevenue. If Tower is unable to produce these devices, demand for these productsdoes not meet our expectations or if we are unable to achieve productperformance or cost targets, our revenue, gross margin, research anddevelopment expenses and liquidity will be affected and we may record lossesagainst inventory, purchase commitments and long-lived assets.

 

# *We will be unable to compete effectively ifwe fail to anticipate product opportunities based upon emerging technologiesand standards and fail to develop products that incorporate these technologiesand standards in a timely manner*

# * *

We may spend significant time and money to design and develop productsand customer solutions around an industry standard or emerging technology. Todate, we have introduced products, such as QuickPCI, that are designed tosupport a

 

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specific industry standard andwe have developed system solutions targeted at specific application segments.Additionally, customers may shift their demand to environmentally friendlyproducts, such as products manufactured with lead-free assembly components thatwe may not have developed. If an industry standard or emerging technology thatwe have targeted fails to achieve broad market acceptance, or if we are unableto bring the technology or solutions to market in a timely manner, we may beunable to generate significant revenue from our research and developmentefforts. As a result, our business would be materially harmed and we may berequired to write-off related inventory and long-lived assets.

 

We have the capability and capacity to design and develop only alimited number of products that support specific industry standards. If systemsmanufacturers move away from the use of industry standards that we support withour products and adopt alternative standards, we may be unable to design anddevelop new products that conform to these new standards. Typically, theexpertise required is unique to each industry standard, and we would likelyhave to either hire individuals with the required expertise or acquire suchexpertise through a licensing arrangement. The demand for individuals with thenecessary expertise to develop a product relating to a particular industrystandard is generally high, and we may not be able to hire such individuals.The cost to acquire such expertise through licensing or other means may be highand such arrangements may not be possible in a timely manner, if at all.

 

# *Our customers may cancel or change theirproduct plans after we have expended substantial time and resources in thedesign of their products*

# * *

If one of our potential customers cancels, reduces or delays productorders from us or chooses not to release equipment that incorporates ourproducts after we have spent substantial time and resources in assisting themwith their product design, our business could be materially harmed. Ourcustomers often evaluate our products for six months or more before designingthem into their systems, and they may not commence volume shipments for up toan additional six to twelve months, if at all. During this lengthy sales cycle,our potential customers may also cancel or change their product plans. Forexample, we expended considerable resources over several quarters to assist apotential PDA customer in its system design and this customer recently decidedto target a more advanced design that does not include one of our products.Even when customers incorporate one or more of our products into their systems,they may discontinue production. Customers whose products achieve high volumeproduction may choose to replace our products with lower cost semiconductors.

 

# *We depend upon third parties to fabricate,assemble, test and program our products, and they may discontinue manufacturingour products, fail to give our products priority, be unable to successfullymanufacture our products to meet performance, volume or cost targets, orinaccurately report inventory to us*

# * *

We contract with third parties to fabricate, assemble, test and programour devices. Our devices are generally fabricated and assembled by singlesuppliers, and the loss of a supplier, expiration of a supply agreement or theinability of our suppliers to manufacture our products to meet volume,performance and cost targets could have a material adverse effect on ourbusiness. For instance, a single supplier fabricates our pASIC1 and pASIC2products under an agreement that expires in December 2005. While we may be ableto purchase wafers after 2005, we do not have a firm capacity commitment fromthe supplier. In addition, demand for assembly capacity at one of our suppliersrecently increased due to a fire at the facility of another supplier. As aresult, capacity available to us may be constrained. If for any reason these orany other supplier becomes unable or unwilling to continue to provide servicesof acceptable quality, at acceptable costs and in a timely manner, our abilityto deliver our products to our customers could be severely impaired. We wouldhave to identify and qualify substitute suppliers, which could be timeconsuming and difficult and could result in unforeseen operational problems, orwe could announce an end-of-life program for these products, as we did with ourpASIC1 and pASIC2 products. Alternate suppliers might not be available tofabricate, assemble, test and program our devices or, if available, might be unwillingor unable to offer services on acceptable terms.

 

In addition, if competition for wafer manufacturing capacity increases,or if we need to migrate to more advanced wafer manufacturing technology, wemay be required to pay or invest significant amounts to secure access to thiscapacity. The number of companies that provide these services is limited andsome of them have limited operating histories and financial resources. In theevent our current suppliers refuse or are unable to continue to provide theseservices to us, we may be unable to procure services from alternate suppliersin a timely manner, if at all. Furthermore, if customer demand for our productsincreases, we may be unable to secure sufficient additional capacity from ourcurrent suppliers on commercially reasonable terms, if at all. 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, assembleor test our products, which would adversely affect our operating results andcash flows.

 

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We record a majority of our inventorytransactions based on information from our subcontractors. If we do not receiveprompt and accurate information from our vendors, we could misstate inventorylevels, incorrectly record gross profit, be unable to meet our deliverycommitments to customers or commit to manufacturing inventory that is notrequired to meet customer delivery commitments, which could materially harm ourbusiness.

 

# *We may not have the liquidity to support ourfuture operations and capital requirements*

# * *

Our cash and cash equivalents balance at June 30, 2005 was $25.1 million.At June 30, 2005, our interest-bearing debt consisted of $4.1 millionoutstanding from Silicon Valley Bank and $383,000 outstanding under a capitallease. On June 27, 2005, we modified our credit facility with Silicon ValleyBank. Terms of the modified agreement include an $8.0 million revolvingline of credit available through June 2006, and $3.0 million ofborrowing capacity under the equipment line of credit that is available to bedrawn through June 2006. The credit facility expires on June 26,2006. At June 30, 2005, we had approximately $5.9 million availableto borrow under our revolving credit facility and approximately$3.0 million available to borrow under our equipment line of credit.

 

At the end of the second quarter of 2005, we held 1,344,543 TowerOrdinary Shares available for sale worth approximately $1.6 million basedupon the market closing price of $1.17 per share on such date. Our ability toobtain competitive pricing from Tower is tied to our ownership of at least450,000 of these Tower shares.

 

Capital expenditures, which are largely driven by the introduction andinitial manufacturing of new products, could be up to $5.0 million in thenext twelve months. As of June 30, 2005, we had commitments to purchase$4.3 million of wafer inventory.

 

On July 12, 2005, the Company filed a shelf registration statement onForm S-3, which has been declared effective. Under this filing, we may decideto raise up to $30.0 million, in one or several transactions, by selling commonstock, preferred stock, depositary shares, and warrants.

 

As a result of potential investments, the expected fluctuation inrevenue from our pASIC1 and pASIC2 products, operating expenses, changes inworking capital and interest and debt payments, we will need to generate higherrevenue and gross profit, especially from our Eclipse II and QuickPCI IIproducts, to maintain positive cash flow. Whether we can achieve cash flowlevels sufficient to support our operations cannot be accurately predicted.Unless such cash flow levels are achieved, we may borrow additional funds orsell debt or equity securities, or some combination thereof, to provide fundingfor our operations. If adequate funds are not available when needed, ourfinancial condition and operating results would be materially adverselyaffected and we may not be able to operate our business without significantchanges in our operations, or at all.

 

# *If we fail to adequately forecast demand forour products, we may incur product shortages or excess product inventory*

# * *

Our agreements with third-party manufacturers require us to provideforecasts of our anticipated manufacturing orders, and place bindingmanufacturing commitments in advance of receiving purchase orders from ourcustomers. This may result in product shortages or excess product inventorybecause we are limited in our ability to increase or decrease our forecastsunder such agreements. Obtaining additional supply in the face of product orcapacity shortages may be costly, or not possible, especially in the short termsince most of our products have only a single fabrication and assembly source.Our failure to adequately forecast demand for our products could materiallyharm our business.

 

# *Fluctuations in our manufacturing processesand product yields and quality, especially for new products, may increase ourcosts*

# * *

Difficulties encountered during the complex semiconductor manufacturingprocess can render a substantial percentage of semiconductor wafersnonfunctional, and manufacturing fluctuations may change the performancedistribution of manufactured products. We have, in the recent past, experiencedmanufacturing runs that have contained substantially reduced or no functioningdevices, or that generated devices with below normal performance. In addition,yield problems may take a significant period of time to analyze and correct.Our reliance on third party suppliers may extend the period of time required toanalyze and correct these problems. As a result, we may incur substantiallyhigher manufacturing costs and inventory shortages.

 

Yield fluctuations frequently occur in connection with the manufactureof newly introduced products, with manufacturing at new facilities or on newmanufacturing processes. Newly introduced products and products that incorporate

 

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new intellectual property, suchas our QuickMIPS, QuickPCI II and Eclipse II products, are often more complexand more difficult to produce, increasing the risk of manufacturing-relateddefects. New manufacturing facilities or processes, such as at Tower, are oftenmore complex and take a period of time to achieve expected quality levels andproduct costs. While we test our products, they may still contain errors ordefects that are found after we have commenced commercial production, thatoccur due to manufacturing variations or as new intellectual property isincorporated into our products. If our products contain undetected orunresolved defects, we may lose market share, experience delays in or loss ofmarket acceptance, reserve or scrap inventory, or be required to issue aproduct recall. In addition, we would be at risk of product liabilitylitigation if defects in our products are discovered. Although we attempt tolimit our liability to end users through disclaimers of special, consequentialand indirect damages and similar provisions, we cannot assure you that suchlimitations of liability will be legally enforceable.

 

# *We have significant customers and limitedvisibility into the long-term demand for our products from these customers*

# * *

A few of our end customers can represent a significant portion of ourtotal revenue in a given reporting period. As in the past, future demand fromthese customers may fluctuate significantly. These customers typically orderproducts with short requested delivery lead times, and do not provide a firmcommitment to purchase product past the period covered by purchase orders. Inaddition, our manufacturing lead times are longer than the delivery lead timesrequested by these customers, and we make significant inventory purchases inanticipation of future demand. For example, a Chinese customer, purchasingproduct through a distributor, represented 14% of our total revenue in 2003,but only 3% of revenue in 2004. If revenue from any significant customer wereto decline substantially, we may be unable to offset this decline withincreased revenue from other customers and we may purchase excess inventory.These factors could severely harm our business.

 

In addition, we may have made a significant investment in long-livedassets for the production of our products based upon historical and expecteddemand. If demand for or gross margin generated from our products does not meetour expectations, we may be required to write-off inventory or incur chargesagainst long-lived assets, which would materially harm our business.

 

# *We have a history of losses and cannot assureyou that we will remain profitable in the future*

# * *

We incurred significant losses in 2004, 2003 and 2002. Our accumulateddeficit as of June 30, 2005 was $118.5 million. Although we recordednet income of  $1.2 million for thesix months ended June 30, 2005, we may not remain profitable in any futureperiods. Our recent revenue growth, net income for the six months endedJune 30, 2005 and our profitability in certain years prior to 2001 cannotbe relied upon as any indication of our future operating results or prospects.

 

# *We depend upon third party distributors tomarket and sell our products, and they may discontinue sale of our products,fail to give our products priority or be unable to successfully market, selland support our products*

# * *

We contract with third-party distributors to market and sell asignificant portion of our products. We typically have only a few distributorsserving each geographic market, and, in the future, we may have a singledistributor covering a geographic market. Although we have contracts with ourdistributors, our agreements with them may be terminated on short notice byeither party and, if terminated, we may be unable to recruit additional orreplacement distributors. Additionally, distributors that we have contractedwith may acquire, be acquired or merge with other distributors which may resultin the termination of our contract or less effort being placed on themarketing, sale and support of our products. As a result, our futureperformance will depend in part on our ability to retain our existingdistributors and attract new distributors that will be able to effectivelymarket, sell and support our products. The loss of one or more of our principaldistributors, or our inability to attract new distributors, could materiallyharm our business.

 

Many of our distributors, including our principal distributors, marketand sell products for other companies, and many of these products may competedirectly or indirectly with our products. We generally are not one of theprincipal suppliers of products to our distributors. If our distributors givehigher priority or greater attention to the products of other companies,including products that compete with our products, our business would bematerially harmed.

 

Individual distributors and OEM customers 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.

 

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# *Our future operating results are likely tofluctuate and therefore may fail to meet expectations, which could cause ourstock price to decline*

# * *

Our operating results have varied widely in the past and are likely todo so in the future. In addition, our past operating results may not be anindicator of future operating results. Our future operating results will dependon many factors and may fail to meet our expectations for a number of reasons,including those set forth in these risk factors. Any failure to meetexpectations could cause our stock price to significantly fluctuate or decline.

 

Factors that could cause our operating results to fluctuate include:

 

•                  a significantchange in sales to our largest customers;

 

•                  successfuldevelopment and market acceptance of our products;

 

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

 

•                  the effect ofend-of-life programs;

 

•                  changes inproduct mix or production variances that affect gross profit;

 

•                  our ability toadjust our manufacturing capacity and costs in response to economic andcompetitive 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 inaccounting and corporate governance rules;

 

•                  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 certain of these factors are out of our immediate control,unless we can anticipate and be prepared with contingency plans that respond tothese factors, our business may be materially harmed.

 

# *We may encounter periods of industry-widesemiconductor oversupply, resulting in pricing pressure, as well asundersupply, resulting in a risk that we could be unable to fulfill ourcustomers’ requirements*

# * *

The semiconductor industry has historically been characterized by widefluctuations in the demand for, and supply of, its products. These fluctuationshave resulted in circumstances when supply of and demand for semiconductorshave been widely out of balance. An industry-wide semiconductor oversupplycould result in severe downward pricing pressure from customers. In a marketwith undersupply of manufacturing capacity, we would have to compete withlarger foundry customers for limited manufacturing resources. In such anenvironment, we may be unable to have our products manufactured in a timelymanner, at a cost that generates adequate gross profit, or in sufficientquantities. Since we outsource all of our manufacturing and have only asingle-source of wafer supply, test and assembly for most of our products, weare particularly vulnerable to such supply shortages and capacity limitations.As a result, we may be unable to fulfill orders and may lose customers. Anyfuture industry-wide oversupply or undersupply of semiconductors couldmaterially harm our business.

 

# *Customers may cancel or defer significantpurchase orders or our distributors may return our products, which would causeour inventory levels to increase and our revenue to decline*

# * *

Our distributors or customers may cancel purchase orders at any timewith little or no penalty. Contractually, our distributors are generallypermitted to return unprogrammed products worth up to 10%, by value, of theproducts they purchase from us. If our distributors or customers cancel ordefer significant purchase orders or return our products, our accountsreceivable collections would decrease and inventories would increase, whichwould materially harm our business.

 

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# *Problems associated with internationalbusiness operations could affect our ability to manufacture and sell ourproducts*

# * *

Most of our products are manufactured outside of the United States atmanufacturing facilities operated by our suppliers in Taiwan, South Korea, thePhilippines, Israel and Malaysia. We expect to manufacture a majority of theproducts that we currently have under development in Israel and to assemblethese products in South Korea, the Philippines or Malaysia. As a result, thesemanufacturing operations and new product introductions are subject to risks ofpolitical instability, including the risk of conflict between Taiwan and thePeople’s Republic of China, between South Korea and North Korea, and conflictsinvolving Israel or Malaysia.

 

A significant portion of our total revenue comes from sales tocustomers located outside the United States. We anticipate that sales tocustomers located outside the United States will continue to represent asignificant portion of our total revenue in future periods. In addition, mostof our domestic customers sell their products outside of North America, therebyindirectly exposing us to risks associated with foreign commerce and economicinstability. In addition to overseas sales offices, we have significantresearch and development activities in Canada and India. Accordingly, ouroperations and revenue are subject to a number of risks associated with foreigncommerce, including the following:

 

•                  managing foreigndistributors;

 

•                  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;

 

•                  inadequateprotection of intellectual property rights; and

 

•                  obtaininggovernmental approvals for certain products.

 

In the past, we have denominated sales of our products to foreigncountries exclusively in U.S. dollars. As a result, any increase in the valueof the U.S. dollar relative to the local currency of a foreign country willincrease the price of our products in that country so that our products becomerelatively more expensive to customers in the local currency of that foreigncountry. As a result, sales of our products in that foreign country maydecline. To the extent any such risks materialize, our business could bematerially harmed.

 

In addition, we incur costs in foreign countries that may be difficultto reduce quickly because of employee-related laws and practices in thoseforeign countries.

 

# *Many systems manufacturers may be unwillingto switch to our products because of their familiarity with the productsoffered by our direct competitors, such as Xilinx and Altera, which dominatethe programmable logic market*

# * *

The semiconductor industry is intensely competitive and characterizedby:

 

•                  erosion ofselling prices over product lives;

 

•                  rapidtechnological change;

 

•                  short productlife cycles; and

 

•                  strong domesticand foreign competition.

 

If we are not able to compete successfully in this environment, ourbusiness will be materially harmed.

 

Many of our competitors havesubstantially greater financial, technical, manufacturing, marketing, sales,distribution, name recognition and other resources than we do. In addition,many of our competitors have well-established relationships with our currentand potential customers and have extensive knowledge of system applications. Inthe past, we have lost potential customers to competitors for various reasons,including, but not limited to, re-programmability and lower price. Our currentdirect competitors include suppliers of complex programmable logic devices andfield programmable gate arrays, such as Xilinx, Inc., Altera Corporation, ActelCorporation, and Lattice Semiconductor Corporation. Xilinx and Altera

 

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together have a majority share of the programmable logicmarket. Many systems manufacturers may be unwilling or unable to switch to ourproducts due to their familiarity with competitors’ products or otherinhibiting factors.

 

We also face competition from companies that offer ASICs, which may bepurchased for a lower price at higher volumes and typically have greater logiccapacity, additional features and higher performance than those of ourproducts. We may also face competition from suppliers of embeddedmicroprocessors, such as Freescale Semiconductor, Inc. (formerly Motorola), orfrom suppliers of products based on new or emerging technologies. Our inabilityto successfully compete in any of the following areas could materially harm ourbusiness:

 

•                  the developmentof new products and advanced manufacturing technologies;

 

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

 

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

 

•                  the incorporationof 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 may be unable to successfully grow ourbusiness if we fail to compete effectively with others to attract and retainkey personnel*

# * *

We believe our future success will depend upon our ability to attractand retain engineers and other highly competent personnel. Our employees areat-will and not subject to employment contracts. Hiring and retaining qualifiedsales and technical personnel is difficult due to the limited number ofqualified professionals. Competition for these types of employees is intense.In addition, new hires frequently require extensive training before theyachieve desired levels of productivity. We have in the past experienceddifficulty in recruiting and retaining qualified senior management, sales andtechnical personnel. Failure to attract, hire, train and retain personnel couldmaterially harm our business.

 

# *We may be unable to adequately protect ourintellectual property rights, and may face significant expenses as a result offuture litigation*

# * *

Protection of intellectual property rights is crucial to our business,since that is how we keep others from copying the innovations that are centralto our existing and future products. From time to time, we receive lettersalleging patent infringement or inviting us to license other parties’ patents.We evaluate these requests on a case-by-case basis. These situations may leadto litigation if we reject the offer to obtain the license.

 

We have in the past and are currently involved in litigation relatingto alleged infringement by us of others’ patents or other intellectual propertyrights. This kind of litigation is expensive and consumes large amounts ofmanagement’s time and attention. Additionally, matters that we initiallyconsider not material to our business could become costly. For example, weincurred substantial costs associated with the litigation and settlement of ourdispute with Actel, which materially harmed our business. In addition, if theletters we sometimes receive alleging patent infringement or other similarmatters result in litigation that we lose, a court could order us to paysubstantial damages and/or royalties, and prohibit us from making, using,selling or importing essential technologies. For these and other reasons, thiskind of litigation could materially harm our business.

 

Also, although we may seek to obtain a license under a third party’sintellectual property rights in order to bring an end to certain claims oractions asserted against us, we may not be able to obtain such a license onreasonable terms, or at all. We have entered into technology license agreementswith third parties which give those parties the right to use patents and othertechnology developed by us, and which give us the right to use patents andother technology developed by them. We anticipate that we will continue toenter into these kinds of licensing arrangements in the future; however, it ispossible that desirable licenses will not be available to us on commerciallyreasonable terms. If we lose existing licenses to key technology, or are unableto enter into new licenses that we deem important, it could materially harm ourbusiness.

 

Because it is critical to our success that we continue to preventcompetitors from copying our innovations, we intend to continue to seek patentand trade secret protection for our products. The process of seeking patentprotection can be long and expensive, and we cannot be certain that anycurrently pending or future applications will actually result in issuedpatents, or that, even if patents are issued, they will be of sufficient scopeor strength to provide meaningful protection or any

 

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commercial advantage to us.Furthermore, others may develop technologies that are similar or superior toour technology or design around the patents we own. We also rely on tradesecret protection for our technology, in part through confidentialityagreements with our employees, consultants and other third parties. However,employees may breach these agreements, and we may not have adequate remediesfor any breach. In any case, others may come to know about or determine ourtrade secrets through a variety of methods. In addition, the laws of certainterritories in which we develop, manufacture or sell our products may notprotect our intellectual property rights to the same extent as the laws of theUnited States.

 

# *We may engage in manufacturing, distributionor technology agreements that involve numerous risks, including the use ofcash, diversion of resources and significant write-offs*

# * *

We have entered into and, in the future, intend to enter intoagreements that have involved numerous risks, including the use of significantamounts of our cash; diversion from other development projects or marketopportunities; our ability to incorporate licensed technology in our products;our ability to introduce related products in a cost-effective and timelymanner; our ability to collect amounts due under these contracts; and marketacceptance of related products. For instance, we have licensed certainmicroprocessor technology from MIPS Technologies and obtained other elements ofour products from third-party companies. In the fourth quarter of 2004, wedetermined that the expected revenue and gross profit from these products wouldnot be sufficient 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 assets willbecome impaired and our financial results would be harmed.

 

# *Our business is subject to the risks ofearthquakes, other catastrophic events and business interruptions for which wemay maintain limited insurance*

# * *

Our operations and the operations of our suppliers are vulnerable tointerruption by fire, earthquake, power loss, flood, terrorist acts and othercatastrophic events beyond our control. In particular, our headquarters islocated near earthquake fault lines in the San Francisco Bay area. In addition,we rely on sole suppliers to manufacture our products and would not be able toqualify an alternate supplier of our products for several quarters. Oursuppliers often hold significant quantities of our inventory which, in theevent of a disaster, could be destroyed. In addition, our business processesand systems are vulnerable to computer viruses, break-ins, and similardisruptions from unauthorized tampering. Any catastrophic event, such as anearthquake or other natural disaster, the failure of our computer systems, waror acts of terrorism, could significantly impair our ability to maintain ourrecords, pay our suppliers, or design, manufacture or ship our products. Theoccurrence of any of these events could also affect our customers, distributorsand suppliers and produce similar disruptive effects upon their business. Ifthere is an earthquake or other catastrophic event near our headquarters, ourcustomers’ facilities, our distributors’ facilities or our suppliers’facilities, our business could be seriously harmed.

 

We do not have a detailed disaster recovery plan. In addition, we donot maintain sufficient business interruption and other insurance policies tocompensate us for all losses that may occur. Any losses or damages incurred byus as a result of a catastrophic event or any other significant uninsured losscould have a material adverse effect on our business.

 

# *Our principal stockholders have significantvoting power and may vote for actions that may not be in the best interests ofour other stockholders*

# * *

Our officers, directors and principal stockholders together control asignificant portion of our outstanding common stock. As a result, thesestockholders, if they act together, will be able to significantly influence ouroperations, affairs and all matters requiring stockholder approval, includingthe election of directors and approval of significant corporate transactions.This concentration of ownership may have the effect of delaying or preventing achange in control and might affect the market price of our common stock. Thisconcentration of ownership may not be in the best interest of our otherstockholders.

 

# *Our Shareholder Rights Plan, certificate ofincorporation, bylaws and Delaware law contain provisions that could discouragea takeover that is beneficial to stockholders*

# * *

Our Shareholder Rights Plan as well as provisions of our certificate ofincorporation, our bylaws and Delaware law could make it difficult for a thirdparty to acquire us, even if doing so would be beneficial to our stockholders.

 

# *The market price of our common stock mayfluctuate significantly and could lead to securities litigation*

# * *

Stock prices for many companies in the technology and emerging growthsectors have experienced wide fluctuations that have often been unrelated tothe operating performance of such companies. In the past, securities classaction litigation

 

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has often been brought againsta company following periods of volatility in the market price of itssecurities. In the future, we may be the target of similar litigation.Securities litigation could result in substantial costs and divert management’sattention and resources.

 

# *Changes to existing accounting pronouncementsor taxation rules or practices may cause adverse revenue fluctuations, affectour reported results of operations or how we conduct our business*

# * *

FASB has issued Statement 123R, *“Share-BasedPayment,”* which will require us to measure compensation costs forall stock based compensation (including stock options and our employee stockpurchase plan, as currently constructed) at fair value and take a compensationcharge equal to that value beginning on January 1, 2006. If thisaccounting pronouncement had been in effect during the current period, weestimate that we would have reported a significantly lower net income or even anet loss.

 

New accounting pronouncements or taxation rules and varyinginterpretations of accounting pronouncements or taxation practice have occurredand may occur in the future. Any future changes in accounting pronouncements ortaxation rules or practices may have a significant effect on how we report ourresults and may even affect our reporting of transactions completed before thechange is effective. This change to existing rules, future changes, if any, orthe questioning of current practices may adversely affect our reportedfinancial results or the way we conduct our business.

 

# *Compliance with changing regulations relatedto corporate governance and public disclosure may result in additional expenses*

# * *

Changing laws, regulations and standards relating to corporategovernance and public disclosure, including the Sarbanes-Oxley Act of 2002, newSEC regulations and The Nasdaq National Market rules, are creating uncertaintyfor companies such as ours. These new or changed laws, regulations andstandards are subject to varying interpretations in many cases due to theirlack of specificity, and as a result, their application in practice may evolveover time as new guidance is provided by regulatory and governing bodies, whichcould result in continuing uncertainty regarding compliance matters and highercosts necessitated by ongoing revisions to disclosure and governance practices.We are committed to maintaining high standards of corporate governance andpublic disclosure. As a result, we intend to invest resources to comply withevolving laws, regulations and standards, and this investment may result inincreased general and administrative expenses and a diversion of managementtime and attention from profit-generating activities. If our efforts to complywith new or changed laws, regulations and standards differ from the activitiesintended by regulatory or governing bodies due to ambiguities related topractice, our reputation may be harmed.

 

# *While we believe that we currently haveadequate internal control procedures in place, we are still exposed topotential risks from recent legislation requiring companies to evaluatecontrols under Section 404 of the Sarbanes-Oxley Act of 2002*

# * *

As of December 2004, we have evaluated our internal controlsystems in order to allow management to report on, and our independentregistered public accounting firm to attest to, our internal control overfinancial reporting, as required by Section 404 of the Sarbanes-Oxley Act.We performed the system and process evaluation and testing required in aneffort to comply with the management certification and independent registeredpublic accounting firm attestation requirements of Section 404. As aresult, we incurred additional expenses and a diversion of management’s time.While we believe that our internal control procedures are adequate and weintend to continue to fully comply with the requirements relating to internalcontrol and all other aspects of Section 404, we cannot be certain as to theoutcome of future evaluations, testing and remediation actions or the impact ofthe same on our operations. If we are not able to remain in compliance with therequirements of Section 404, we might be subject to sanctions or investigationby regulatory authorities, such as the SEC or The Nasdaq National Market. Anysuch action could adversely affect our financial results and the market priceof our common stock.

 

# *We have implemented import and export controlprocedures to comply with United States regulations but we are still exposed topotential risks from import and export activity*

# * *

Our products, technology and software are subject to U.S. import andexport control laws and regulations which, in some instances, may imposerestrictions on business activities, or otherwise require licenses or otherauthorizations from agencies such as the U.S. Department of State, U.S.Department of Commerce and U.S. Department of the Treasury. We have import andexport licensing and compliance procedures in place for purposes of conductingour business consistent with U.S. laws and regulations, and we periodicallyreview these procedures to maintain compliance with the requirements relatingto import and export regulations. If we are not able to remain in compliancewith import and export regulations, we might be subject to investigation,sanctions or penalties by regulatory authorities. Such penalties can includecivil, criminal or administrative remedies (such as loss of export privileges).We cannot be certain as to the outcome of an evaluation, investigation, inquiryor other action or the impact of these items on our operations. Any such actioncould adversely affect our financial results and the market price of our commonstock.

 

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

** **

**InterestRate Risk**

** **

Our exposure to market rate risk for changes in interest rates relatesprimarily to our investment portfolio and variable rate debt. We do not usederivative financial instruments to manage our interest rate risk. We areadverse to principal loss and ensure the safety and preservation of investedfunds by limiting default, market and reinvestment risk. Our investmentportfolio is generally comprised of investments that meet high credit qualitystandards. Since these securities are subject to interest rate risk, they coulddecline in value if interest rates fluctuate. Due to the short duration andconservative nature of our investment portfolio, we do not anticipate anymaterial loss with respect to our investment portfolio. A 10% move in interestrates as of June 30, 2005 would have an immaterial effect on our financialposition, results of operations and cash flows.

 

**Foreign Currency Exchange Rate Risk**

 

All of our sales and cost of manufacturing are transacted in U.S.dollars. We conducted a portion of our research and development activities inCanada and India and have sales and marketing offices in several locationsoutside of the United States. Most of the costs incurred at these internationallocations are in local currency. If these local currencies strengthen againstthe dollar, our payroll and other local expenses will be higher than wecurrently anticipate. Since our sales are transacted in U.S. dollars, thisnegative impact on expenses would not be offset by any positive effect onrevenue. Operating expenses denominated in foreign currencies wereapproximately 26% and 23% of total operating expenses for the six months endedJune 30, 2005 and 2004, 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 $382,000 in the six monthsended June 30, 2005.

 

**Equity Price Risk**

 

Our exposure to equity price risk for changes in market value relatesprimarily to our investment in Tower Semiconductor Ltd., or Tower. Tower’sordinary shares trade on the Nasdaq Stock Market’s National Market under thesymbol “TSEM”.  Since these securitiesare publicly traded on the open market, they are subject to marketfluctuations.  Temporary marketfluctuations are reflected by increasing or decreasing the presented value ofthe related securities and recording “other comprehensive income (loss)” in theequity section of the balance sheet.  An “otherthan temporary” decline in market value is reflected by decreasing the carryingvalue of the related securities and recording a charge to operating expenses onthe income statement. We wrote down 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 the second quarter of fiscal 2005,fiscal 2004, fiscal 2002 and fiscal 2001, respectively. The determinationthat the decline in market value was “other than temporary” included factorssuch as market value and the period of time that the market value had beenbelow the carrying value in each of the respective periods. An additionalmarket value fluctuation of 10% would have caused our operating expenses tochange by approximately $157,000 in the six months ended June 30, 2005.

 

**Item4. Controls and Procedures**

 

**Evaluation of Disclosure Controls andProcedures**

 

Our management evaluated, with the participation of our Chief ExecutiveOfficer and Chief Financial Officer, the effectiveness of our disclosurecontrols and procedures as of the end of the period covered by this QuarterlyReport on Form 10-Q. Based upon that evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures are effective to ensure that information we are required to disclosein reports that we file or submit under the Securities Exchange Act of 1934, asamended, is (i) recorded, processed, summarized and reported within thetime periods specified in Securities and Exchange Commission rules andforms, and (ii) accumulated and communicated to our management, includingour Chief Executive Officer and Chief Financial Officer, as appropriate toallow timely decisions regarding required disclosure.  Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that, while nocost-effective control system will preclude all errors and irregularities, ourcurrent disclosure controls and procedures are effective to provide reasonableassurance that the financial statements and other disclosures in our SECreports are reliable.

 

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**Changes in Internal Control Over FinancialReporting**

 

There were no changes in our internal control over financial reportingthat occurred during the period covered by this Quarterly Report on Form 10-Qthat have materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

 

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**Part II.Other Information**

 

**Item1. Legal Proceedings**

 

On October 26, 2001, a putative securities class action was filedin the U.S. District Court for the Southern District of New York againstcertain investment banks that underwrote QuickLogic’s initial public offering,QuickLogic and some of QuickLogic’s officers and directors. The complaintalleges excessive and undisclosed commissions in connection with the allocationof shares of common stock in QuickLogic’s initial and secondary publicofferings and artificially high prices through “tie-in” arrangements whichrequired the underwriters’ customers to buy shares in the aftermarket atpre-determined prices in violation of the federal securities laws. Plaintiffsseek an unspecified amount of damages on behalf of persons who purchasedQuickLogic’s stock pursuant to the registration statements betweenOctober 14, 1999 and December 6, 2000. Various plaintiffs have filedsimilar actions asserting virtually identical allegations against over 300other public companies, their underwriters, and their officers and directorsarising out of each company’s public offering. These actions, including theaction against QuickLogic, have been coordinated for pretrial purposes andcaptioned *In re Initial Public OfferingSecurities Litigation, 21 MC 92*. A stipulation of settlement for theclaims against the issuer defendants, including the Company, has been signedand was submitted to the court. Under the stipulation of settlement, theplaintiffs will dismiss and release all claims against participating defendantsin exchange for a contingent payment guaranty by the insurance companiescollectively responsible for insuring the issuers in all the related cases, andthe assignment or surrender to the plaintiffs of certain claims the issuerdefendants may have against the underwriters. Under the guaranty, the insurerswill be required to pay the amount, if any, by which $1.0 billion exceeds theaggregate amount ultimately collected by the plaintiffs from the underwriterdefendants in all the cases. On February 15, 2005, the court preliminarilyapproved the settlement contingent on specified modifications. The settlementis still subject to court approval and a number of other conditions. There isno guarantee that the settlement will become effective.

 

On July 3, 2003, a putative securities class action was filed inthe U.S. District Court for the Southern District of New York by shareholdersof Tower Semiconductor Ltd. against Tower, several of its directors, andseveral of its investors, including QuickLogic. QuickLogic was named solely asan alleged control person. On August 19, 2004, the court dismissed the claimsagainst all defendants, including QuickLogic, with prejudice. OnSeptember 29, 2004, one of the plaintiffs filed a notice of appeal fromthe judgment.

 

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

** **

The Annual Meeting of Stockholders of QuickLogic was held on April 26,2005.  The following matters were voted upon at the meeting:

 

(i)                          Thefollowing nominee was elected to hold office as a Class III director until2008:

 
| **Nominee**    | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** |
|----------------|------------|---------------|------------|--------------------|------------|
| E. Thomas Hart |       | 24,633,142    |       | 101,659            |       |

 

(ii)        The ratification ofPricewaterhouseCoopers LLP as the independent registered public accounting firmof QuickLogic for the fiscal year ending December 31, 2005.

 
| Votes For     |   | 24,722,282 | ** ** |
|---------------|--------|------------|------------|
| Votes Against |   | 5,021      |       |
| Abstentions   |   | 7,498      |       |

 

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**Item6. Exhibits**

 

a.      Exhibits

 

The following Exhibits are filed with this report:

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                       |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                  |
| 10.1                |       | Loan Modification Agreement between Silicon Valley Bank and the  registrant effective June 27, 2005.                                                  |
| 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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**Signatures**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
| ** **            | **QUICKLOGIC CORPORATION**                                                                                                           |
|-----------------------|--------------------------------------------------------------------------------------------------------------------------------------|
|                  |                                                                                                                                 |
|                  | /s/ CARL M. MILLS                                                                                                                    |
| Date: August 11, 2005 | 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**                                                                                                                                       |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                |       | Loan Modification Agreement between Silicon Valley Bank and the  registrant effective June 27, 2005.                                                  |
| 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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