**UNITEDSTATES****SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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

 

**(MarkOne)**

 
| **ý** | ** ** | **Quarterly  report pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934**                                                                         |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | **for  the quarterly period ended October 2, 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           ** |

 

**COMMISSIONFILE NUMBER: 000-22671**

 

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**QUICKLOGICCORPORATION**

(Exact name of registrant as specified in its charter)

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

 

**1277ORLEANS DRIVE SUNNYVALE, CA  94089**

(Address of principal executive offices, including Zip Code)

 

**(408) 990-4000**

(Registrant’s telephone number, including area code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such requirements for thepast 90 days. Yes ý  No o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act). Yes ý  No o

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theSecurities Exchange Act of 1934). Yes oNo ý

 

As of November 3,2005, 27,239,482 shares of the registrant’s common stock were outstanding.

 

 

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**QUICKLOGICCORPORATION**

 

**FORM 10-Q**

**SEPTEMBER 30,2005**

 
| ** **                                                                                                                                        | ** ** | **Page**   |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|                                                                                                                                              |       |       |
| **Part I. Financial Information**                                                                                                            |       | 3          |   |
| ** **                                                                                                                                        | ** ** | ** ** | ** ** |
| **Item 1. Financial Statements**                                                                                                                  |       | 3          |   |
| Condensed  Unaudited Consolidated Statements of Operations for the three and nine months  ended September 30, 2005 and 2004                  |       | 3          |   |
| Condensed  Unaudited Consolidated Balance Sheets as of September 30, 2005 and December 31,  2004                                        |       | 4          |   |
| Condensed  Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30,  2005 and 2004                            |       | 5          |   |
| Condensed  Unaudited Consolidated Statements of Comprehensive Income (Loss) for the  three and nine months ended September 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**                                                                                                              |       | 38         |   |
| ** **                                                                                                                                        | ** ** | ** ** | ** ** |
| **Item  1. Legal Proceedings**                                                                                                                    |       | 38         |   |
| ** **                                                                                                                                        | ** ** | ** ** | ** ** |
| **Item 6. Exhibits**                                                                                                                              |       | 38         |   |
| ** **                                                                                                                                        | ** ** | ** ** | ** ** |
| Signatures                                                                                                                                        |       | 39         |   |

 

2

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**PART I.Financial Information**

 

**Item 1.Financial Statements**

 

**QUICKLOGICCORPORATION**

**CONDENSEDUNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
| ** **                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                           | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                 |       |                                       |       |                                      |       |   |   |   |   |
| Revenue                              |       | $                                          | 12,645     |                                      | $          | 11,944 |   | $ | 37,942 |   | $ | 33,533 |   |
| Cost  of revenue                     |       | 4,326                                      |       | 6,059                                     |       | 13,828 |   | 15,079 |   |
| Gross  profit                        |       | 8,319                                      |       | 5,885                                     |       | 24,114 |   | 18,454 |   |
| Operating  expenses:                 |       |                                       |       |                                      |       |   |   |   |   |
| Research  and development            |       | 2,449                                      |       | 3,046                                     |       | 7,237 |   | 9,346 |   |
| Selling,  general and administrative |       | 4,140                                      |       | 3,729                                     |       | 12,480 |   | 11,832 |   |
| Income  (loss) from operations       |       | 1,730                                      |       | (890                                      | )          | 4,397 |   | (2,724 | ) |
| Write-down  of marketable securities |       | —                                     |       | —                                    |       | (1,466 | ) | — |   |
| Interest  expense                    |       | (46                                        | )          | (69                                       | )          | (152 | ) | (199 | ) |
| Interest  income and other, net      |       | 92                                         |       | 60                                        |       | 262 |   | 127 |   |
| Income  (loss) before income taxes   |       | 1,776                                      |       | (899                                      | )          | 3,041 |   | (2,796 | ) |
| Provision  for income taxes          |       | 154                                        |       | —                                    |       | 235 |   | — |   |
| Net  income (loss)                   |       | $                                          | 1,622      |                                      | $          | (899 | ) | $ | 2,806 |   | $ | (2,796 | ) |
|                                 |       |                                       |       |                                      |       |   |   |   |   |
| Net  income (loss) per share:        |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                |       | $                                          | 0.06       |                                      | $          | (0.03 | ) | $ | 0.10 |   | $ | (0.11 | ) |
| Diluted                              |       | $                                          | 0.06       |                                      | $          | (0.03 | ) | $ | 0.10 |   | $ | (0.11 | ) |
|                                 |       |                                       |       |                                      |       |   |   |   |   |
| Weighted  average shares:            |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                |       | 27,146                                     |       | 25,786                                    |       | 26,759 |   | 25,300 |   |
| Diluted                              |       | 28,313                                     |       | 25,786                                    |       | 27,889 |   | 25,300 |   |

 

See accompanyingNotes to Condensed Unaudited Consolidated Financial Statements.

 

3

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**QUICKLOGICCORPORATION**

**CONDENSEDUNAUDITED CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                 | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                 |       |                         |       |                        |       |
|                                                                                                                       |       |                         |       |                        |       |
| Current  assets:                                                                                                           |       |                         |       |                        |       |
| Cash  and cash equivalents                                                                                                 |       | $                            | 25,393     |                        | $          | 24,914 |   |
| Short-term  investment in Tower Semiconductor Ltd.                                                                         |       | 1,100                        |       | 2,022                       |       |
| Accounts  receivable, net of allowances for doubtful accounts of $923 and $1,088                                           |       | 7,202                        |       | 4,786                       |       |
| Inventory                                                                                                                  |       | 8,377                        |       | 6,741                       |       |
| Other  current assets                                                                                                      |       | 1,057                        |       | 1,506                       |       |
| Total  current assets                                                                                                      |       | 43,129                       |       | 39,969                      |       |
| Property  and equipment, net                                                                                               |       | 4,575                        |       | 5,403                       |       |
| Investment  in Tower Semiconductor Ltd.                                                                                    |       | 554                          |       | 1,017                       |       |
| Other  assets                                                                                                              |       | 4,320                        |       | 4,552                       |       |
|                                                                                                                       |       |                         |       |                        |       |
| TOTAL  ASSETS                                                                                                              |       | $                            | 52,578     |                        | $          | 50,941 |   |
|                                                                                                                       |       |                         |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                             |       |                         |       |                        |       |
|                                                                                                                       |       |                         |       |                        |       |
| Current  liabilities:                                                                                                      |       |                         |       |                        |       |
| Revolving  line of credit                                                                                                  |       | $                            | —     |                        | $          | 2,000 |   |
| Trade  payables                                                                                                            |       | 3,043                        |       | 4,119                       |       |
| Accrued  liabilities                                                                                                       |       | 3,099                        |       | 2,511                       |       |
| Deferred  income on shipments to distributors                                                                              |       | 1,996                        |       | 1,667                       |       |
| Current  portion of debt and capital lease obligations                                                                     |       | 1,399                        |       | 2,286                       |       |
| Total  current liabilities                                                                                                 |       | 9,537                        |       | 12,583                      |       |
|                                                                                                                       |       |                         |       |                        |       |
| Long-term  liabilities:                                                                                                    |       |                         |       |                        |       |
| Debt  and capital lease obligations, less current portion                                                                  |       | 589                          |       | 1,036                       |       |
| Deferred  royalty revenue                                                                                                  |       | 1,344                        |       | 1,156                       |       |
| Total  long-term liabilities                                                                                               |       | 1,933                        |       | 2,192                       |       |
| Total  liabilities                                                                                                         |       | 11,470                       |       | 14,775                      |       |
|                                                                                                                       |       |                         |       |                        |       |
| Commitments  and contingencies (see Notes 14 and 15)                                                                       |       |                         |       |                        |       |
|                                                                                                                       |       |                         |       |                        |       |
| Stockholders’  equity:                                                                                                |       |                         |       |                        |       |
| Common  stock, $0.001 par value; 100,000 shares authorized; 27,227 and 26,313 shares  issued and outstanding, respectively |       | 27                           |       | 26                          |       |
| Additional  paid-in capital                                                                                                |       | 157,891                      |       | 155,837                     |       |
| Accumulated  other comprehensive income                                                                                    |       | 81                           |       | —                      |       |
| Accumulated  deficit                                                                                                       |       | (116,891                     | )          | (119,697                    | )          |
| Total  stockholders’ equity                                                                                           |       | 41,108                       |       | 36,166                      |       |
|                                                                                                                       |       |                         |       |                        |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                           |       | $                            | 52,578     |                        | $          | 50,941 |   |

 

See accompanyingNotes to Condensed Unaudited Consolidated Financial Statements.

 

4

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**QUICKLOGICCORPORATION**

**CONDENSEDUNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Inthousands)**

 
| ** **                                                                                | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| ** **                                                                                | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Cash  flows from operating activities:                                                    |       |                                      |       |   |   |
| Net  income (loss)                                                                        |       | $                                         | 2,806      |   | $ | (2,796 | ) |
| Adjustments  to reconcile net income (loss) to net cash provided by operating activities: |       |                                      |       |   |   |
| Depreciation  and amortization                                                            |       | 2,012                                     |       | 3,336 |   |
| Loss  on disposal of property and equipment                                               |       | 7                                         |       | 20 |   |
| Utilization  of wafer credits from Tower Semiconductor Ltd.                               |       | 233                                       |       | 138 |   |
| Inventory  write-down                                                                     |       | 290                                       |       | 385 |   |
| Write-down  of marketable securities                                                      |       | 1,466                                     |       | — |   |
| Write-off  of long-lived assets                                                           |       | 66                                        |       | 165 |   |
| Changes  in assets and liabilities:                                                       |       |                                      |       |   |   |
| Accounts  receivable, net of allowances for doubtful accounts                             |       | (2,416                                    | )          | 1,246 |   |
| Inventory                                                                                 |       | (1,926                                    | )          | (2,066 | ) |
| Other  assets                                                                             |       | 448                                       |       | 931 |   |
| Trade  payables                                                                           |       | (1,076                                    | )          | (118 | ) |
| Accrued  liabilities                                                                      |       | 588                                       |       | 923 |   |
| Deferred  income and royalty revenue                                                      |       | 517                                       |       | 777 |   |
| Net  cash provided by operating activities                                                |       | 3,015                                     |       | 2,941 |   |
|                                                                                      |       |                                      |       |   |   |
| Cash  flows from investing activities:                                                    |       |                                      |       |   |   |
| Capital  expenditures for property and equipment                                          |       | (1,257                                    | )          | (1,199 | ) |
| Net  cash used for investing activities                                                   |       | (1,257                                    | )          | (1,199 | ) |
|                                                                                      |       |                                      |       |   |   |
| Cash  flows from financing activities:                                                    |       |                                      |       |   |   |
| Payment  of debt and capital lease obligations                                            |       | (1,884                                    | )          | (2,319 | ) |
| Proceeds  from debt and capital lease obligations                                         |       | 550                                       |       | 655 |   |
| Net  change in revolving line of credit                                                   |       | (2,000                                    | )          | (900 | ) |
| Proceeds  from issuance of common stock, net                                              |       | 2,055                                     |       | 1,401 |   |
| Net  cash used for financing activities                                                   |       | (1,279                                    | )          | (1,163 | ) |
|                                                                                      |       |                                      |       |   |   |
| Net  increase in cash and cash equivalents                                                |       | 479                                       |       | 579 |   |
| Cash  and cash equivalents at beginning of period                                         |       | 24,914                                    |       | 26,443 |   |
| Cash  and cash equivalents at end of period                                               |       | $                                         | 25,393     |   | $ | 27,022 |   |
|                                                                                      |       |                                      |       |   |   |
| Supplemental  schedule of non-cash activities:                                       |       |                                      |       |   |   |
| Capital  lease obligation to finance capital expenditures and related maintenance         |       | $                                         | —     |   | $ | 1,482 |   |

 

See accompanyingNotes to Condensed Unaudited Consolidated Financial Statements.

 

5

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**QUICKLOGICCORPORATION**

**CONDENSEDUNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)**

**(Inthousands)**

 
| ** **                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income (loss)                      |       | $                                          | 1,622      |                                      | $          | (899 | ) | $ | 2,806 |   | $ | (2,796 | ) |
| Other comprehensive  gain, net of tax: |       |                                       |       |                                      |       |   |   |   |   |
| Unrealized  gain (loss) on investments |       | 81                                         |       | (3,187                                    | )          | 81 |   | (1,193 | ) |
| Total comprehensive  income (loss)     |       | $                                          | 1,703      |                                      | $          | (4,086 | ) | $ | 2,887 |   | $ | (3,989 | ) |

 

See accompanyingNotes to Condensed Unaudited Consolidated Financial Statements.

 

6

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**QUICKLOGICCORPORATION**

**NOTES TOCONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

QuickLogic Corporation (“QuickLogic”or the “Company”), founded in 1988, is a Delaware corporation. The Companyoperates in a single industry segment where it designs, develops, markets andsupports advanced field programmable gate arrays (“FPGAs”), Embedded StandardProducts (“ESPs”), associated software tools and programming hardware.

 

The accompanying interimfinancial statements are unaudited. In the opinion of management, thesestatements have been prepared in accordance with generally accepted accountingprinciples and include all adjustments, consisting only of normal recurringadjustments, necessary to provide a fair statement of results for the interimperiods presented. The Company recommends that these financial statements beread in conjunction with the Company’s Form 10-K for the year ended December 31,2004. Operating results for the three and nine months ended September 30,2005 are not necessarily indicative of the results that may be expected for thefull year.

 

QuickLogic’sfiscal year ends on the Sunday closest to December 31.  QuickLogic’sthird fiscal quarter for 2005 ended Sunday, October 2, 2005.  Forpresentation purposes, the financial statements and notes have been presentedas ending on the last day of the nearest calendar month.

 

*Liquidity*

 

The Company anticipatesthat its existing cash resources will fund operations, finance purchases ofcapital equipment and provide adequate working capital for the next twelvemonths. The Company’s liquidity is affected by many factors including, amongothers, the level of revenue and gross profit, market acceptance of existingand new products including Eclipse II and QuickPCI II devices, the expecteddecline in pASIC1 and pASIC2 revenue resulting from the end-of-life of theseproducts, costs of securing access to adequate manufacturing capacity,inventory levels, wafer purchase commitments, customer credit terms, the amountand timing of research and development expenditures, the timing of new productintroductions, production volumes, product quality, sales and marketingefforts, the amount and financing arrangements for purchases of capitalequipment, changes in operating assets and liabilities, the ability to obtainor renew debt financing and to remain in compliance with the terms of creditfacilities, the ability to raise funds from the sale of shares of TowerSemiconductor Ltd. (“Tower”) and equity in the Company, the exercise ofemployee stock options and participation in the Company’s employee stockpurchase plan, and other factors related to the uncertainties of the industryand global economics. Accordingly, there can be no assurance that events in thefuture will not require the Company to seek additional capital or, if sorequired, that such capital will be available on terms acceptable to the Company.

 

*Principlesof Consolidation*

 

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

 

*Uses ofEstimates*

 

The preparation of thesefinancial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities, the disclosures of contingentassets and liabilities, and the reported amounts of revenue and expenses duringthe period. Actual results could differ from those estimates, particularly inrelation to revenue recognition, the allowance for doubtful accounts, salesreturns, valuation of investments, valuation of long-lived assets, inventoryvaluation including identification of excess quantities and obsolescence,accounting for income taxes and estimating accrued liabilities.

 

**Note 2—SignificantAccounting Policies**

 

*RevenueRecognition*

 

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

 

7

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**QUICKLOGICCORPORATION**

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

 

The Company generallyrecognizes revenue as products are shipped if evidence of an arrangementexists, delivery has occurred, the sales price is fixed or determinable,collection of the resulting receivable is reasonably assured, and productreturns are reasonably estimable.

 

Revenue is recognizedupon shipment to original equipment manufacturer (“OEM”) customers, for bothprogrammed and unprogrammed parts, provided that legal title and risk ofownership have transferred.

 

The Company also sells todistributors under agreements that allow for price adjustments and, in the caseof unprogrammed parts, certain rights of return on unsold inventory.

 

Because programmed partscan only be used by a specific customer, it is the Company’s practice to agreeupon any price adjustments with a distributor prior to shipment. Furthermore,distributors are not allowed any future price adjustments and have no rights ofreturn on programmed parts. Accordingly, revenue is recognized upon delivery toa distributor since title and risk of ownership have transferred to thedistributor, the price is fixed, no right of return exists, and collection ofthe resulting receivable is reasonably assured.

 

Unprogrammed partsshipped to distributors may be used by multiple end customers and distributorsmay have certain return and price adjustment privileges on unsold inventory.Accordingly, revenue of unprogrammed parts is deferred until resale to the endcustomer.

 

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

 

*Long-livedAssets*

 

The Company reviews therecoverability of its long-lived assets, such as property and equipment andinvestments, annually and when events or changes in circumstances occur thatindicate that the carrying value of the asset or asset group may not berecoverable. The assessment of possible impairment is based on the Company’sability to recover the carrying value of the asset or asset group from theexpected future pre-tax cash flows, undiscounted and without interest charges,of the related operations. If these cash flows are less than the carrying valueof such asset, an impairment loss is recognized for the difference betweenestimated fair value and carrying value, and the carrying value of the relatedassets is reduced by this difference. The measurement of impairment requiresmanagement to estimate future cash flows and the fair value of long-livedassets. See Note 5.

 

*ComprehensiveIncome (Loss)*

 

Comprehensive income(loss) includes all changes in equity (net assets) during a period fromnon-owner sources. Comprehensive income (loss) for the Company has includedrealized and unrealized holding gains or losses on Tower Semiconductor Ltd. (“Tower”)ordinary shares. See Note 4.

 

*Stock-BasedCompensation*

 

The Company has electedto measure employees’ stock-based compensation costs using the intrinsic valuemethod prescribed by the Accounting Principles Board (“APB”) Opinion No. 25,*“Accounting for Stock Issued to Employees”*and to comply with the pro forma disclosure requirements of Statement ofFinancial Accounting Standards (“SFAS”) No. 123, *“Accounting for Stock-Based Compensation.”*Stock-based compensation to non-employees is based on the fair value of theoption, estimated using the Black-Scholes Option-Pricing Model on the date ofgrant, and re-measured until vested. The related stock-based compensationexpense is recognized over the vesting period.

 

8

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**QUICKLOGICCORPORATION**

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

 

The following tableillustrates the effect on net income (loss) and net income (loss) per share ifthe Company had applied the fair value recognition provisions of SFAS No. 123to stock-based employee compensation, which may not be representative of thefair value determined under SFAS No. 123(R) (see “Recently IssuedAccounting Pronouncements” below) (in thousands except per share amounts):

 
| ** **                                                                                                                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net  income (loss) – as reported                                                                                                |       | $                                          | 1,622      |                                      | $          | (899 | ) | $ | 2,806 |   | $ | (2,796 | ) |
|                                                                                                                                      |       |                                       |       |                                      |       |   |   |   |   |
| Less:  Stock-based employee compensation expense related to stock option plans  determined under the fair value based method, net of tax  |       | (642                                       | )          | (1,127                                    | )          | (2,119 | ) | (3,381 | ) |
| Less:  Stock-based employee compensation expense related to the stock purchase plan  determined under fair value based method, net of tax |       | —                                     |       | —                                    |       | (336 | ) | (457 | ) |
| Net  income (loss) – as adjusted                                                                                                |       | $                                          | 980        |                                      | $          | (2,026 | ) | $ | 351 |   | $ | (6,634 | ) |
|                                                                                                                                      |       |                                       |       |                                      |       |   |   |   |   |
| Net  income (loss) per share – as reported:                                                                                          |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                                                                                                                     |       | $                                          | 0.06       |                                      | $          | (0.03 | ) | $ | 0.10 |   | $ | (0.11 | ) |
| Diluted                                                                                                                                   |       | $                                          | 0.06       |                                      | $          | (0.03 | ) | $ | 0.10 |   | $ | (0.11 | ) |
| Net  income (loss) per share – as adjusted:                                                                                          |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                                                                                                                     |       | $                                          | 0.04       |                                      | $          | (0.08 | ) | $ | 0.01 |   | $ | (0.26 | ) |
| Diluted                                                                                                                                   |       | $                                          | 0.03       |                                      | $          | (0.08 | ) | $ | 0.01 |   | $ | (0.26 | ) |
|                                                                                                                                      |       |                                       |       |                                      |       |   |   |   |   |
| Weighted  average shares – as reported:                                                                                              |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                                                                                                                     |       | 27,146                                     |       | 25,786                                    |       | 26,759 |   | 25,300 |   |
| Diluted                                                                                                                                   |       | 28,313                                     |       | 25,786                                    |       | 27,889 |   | 25,300 |   |
|                                                                                                                                      |       |                                       |       |                                      |       |   |   |   |   |
| Weighted  average shares – as adjusted:                                                                                              |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                                                                                                                     |       | 27,146                                     |       | 25,786                                    |       | 26,759 |   | 25,300 |   |
| Diluted                                                                                                                                   |       | 28,066                                     |       | 25,786                                    |       | 26,967 |   | 25,300 |   |

 

*ForeignCurrency Transactions*

 

All of the Company’ssales and cost of manufacturing are transacted in U.S. dollars. The Companyconducts a portion of its research and development activities in Canada andIndia and has sales and marketing activities in various countries outside ofthe United States. Most of these costs are incurred in local currency. Foreigncurrency transaction gains and losses are included in interest income andother, net, as they occur. The effect of foreign currency exchange ratefluctuations has not been significant to date. Operating expenses denominatedin foreign currencies were approximately 25% and 23% of total operatingexpenses for the nine months ended September 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.

 

*Concentrationof Credit Risk*

 

Financial instruments,which potentially subject the Company to concentrations of credit risk, consistprincipally of cash and cash equivalents and accounts receivable. Cash and cashequivalents are maintained with high quality institutions. The Company’saccounts receivable are denominated in U.S. dollars and are derived primarilyfrom sales to customers located in North America, Europe, and Asia. The Companyperforms ongoing credit evaluations of its customers and generally does notrequire collateral.

 

Two distributors of theCompany’s products accounted for 30% and 17% of the Company’s accountsreceivable balance at September 30, 2005. Two distributors of the Company’sproducts accounted for 24% and 22% of the Company’s accounts receivable balanceat December 31, 2004.

 

9

----

 

**QUICKLOGICCORPORATION**

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

 

*WarrantyCosts*

 

The Company generallywarrants finished goods against defects in material and workmanship undernormal use for 12 months from the date of shipment. The Company does nothave significant product warranty related costs or liabilities. Theone-time-programmable nature of QuickLogic’s products minimizes warranty costs.

 

***Recently IssuedAccounting Pronouncements***

 

On December 16,2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R),*“Share-Based Payment,”*which is arevision of SFAS No. 123 and supersedes Accounting Principals Board (“APB”)Opinion No. 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 expensed over the applicable vestingperiod. Under SFAS No. 123(R), pro forma disclosure of the incomestatement effects of share-based payments is no longer an alternative. SFAS No. 123(R),as amended, is effective for all stock-based awards granted in fiscalyears beginning after June 15, 2005. In addition, companies must alsorecognize compensation expense related to any awards that are not fully vestedas of the effective date. Compensation expense for the unvested awards will bemeasured based on the fair value of the awards previously calculated indeveloping the pro forma disclosures in accordance with the provisions of SFAS No. 123.The Company is currently assessing the impact of adopting SFAS No. 123(R) andexpects the impact upon adoption in fiscal year 2006 to be significant toits results of operations.

 

On March 29, 2005,the Securities and Exchange Commission, or SEC, issued Staff AccountingBulletin (“SAB”) No. 107, which provides guidance on the interactionbetween SFAS No. 123(R), *“Shared-BasedPayment,”* and certain SEC rules and regulations. SAB No. 107provides guidance that may simplify some of the SFAS No. 123(R)implementation challenges and enhance the information that investors receive.The Company will apply the principles of SAB No. 107 in conjunction withthe adoption of SFAS No. 123(R).

 

**Note 3—Net Income (Loss) Per Share**

 

Basic net income (loss)per share is computed by dividing net income (loss) available to commonstockholders by the weighted average number of common shares outstanding duringthe period. Diluted net income (loss) per share is computed using the weightedaverage number of common shares outstanding during the period plus potentiallydilutive common shares outstanding during the period under the treasury stockmethod. In computing diluted net income (loss) per share, the average stockprice for the period is used in determining the number of shares assumed to bepurchased from the exercise of stock options. A reconciliation of the basic anddiluted per share computations is as follows (in thousands, except per shareamounts):

 
| ** **              | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------|------------|-------------------------------------------|------------|
| ** **              | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| ** **              | ** ** | **Net Income**                            | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** | **Net Loss** | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** |
| Basic                   |       | $                                         | 1,622      |   | 27,146 |   | $ | 0.06 |   | $ | (899 | ) | 25,786 |   | $ | (0.03 | ) |
| Effect of stock options |       | —                                    |       | 1,167 |   | — |   | — |   | — |   | — |   |
| Diluted                 |       | $                                         | 1,622      |   | 28,313 |   | $ | 0.06 |   | $ | (899 | ) | 25,786 |   | $ | (0.03 | ) |

 
| ** **              | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------|------------|------------------------------------------|------------|
| ** **              | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| ** **              | ** ** | **Net Income**                           | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** | **Net Loss** | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** |
| Basic                   |       | $                                        | 2,806      |   | 26,759 |   | $ | 0.10 |   | $ | (2,796 | ) | 25,300 |   | $ | (0.11 | ) |
| Effect of stock options |       | —                                   |       | 1,130 |   | — |   | — |   | — |   | — |   |
| Diluted                 |       | $                                        | 2,806      |   | 27,889 |   | $ | 0.10 |   | $ | (2,796 | ) | 25,300 |   | $ | (0.11 | ) |

 

For the three and ninemonths ended September 30, 2005, 3,799,000 and 4,536,000 shares,respectively, of common stock subject to outstanding options were antidilutiveand, therefore, were not included in the calculation of diluted net income pershare, as the per share exercise price for such options exceeded the averagetrading price of the Company’s common stock during the respective period. Forthe three and nine months ended September 30, 2004, 6,318,000 and5,111,000 shares, respectively, of common stock subject to outstanding optionswere antidilutive as the per share exercise price for such options exceeded theaverage trading price of the Company’s common stock during the respectiveperiod. Additionally, for the three and nine months ended September 30,2004, potential common shares of 739,000 and 1,210,000,

 

10

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**QUICKLOGICCORPORATION**

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

 

respectively, were notincluded in the calculation of diluted net loss per share, as they wereconsidered antidilutive due to the net loss the Company experienced in theperiod.

 

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

 

The Company has a SharePurchase Agreement (the “Agreement”), Foundry Agreement and other relatedagreements with Tower. Under the Agreement, the Company made a strategicinvestment in Tower as part of Tower’s plan to build and equip a new waferfabrication facility. The facility produces 200-mm wafers in geometries of0.18 micron and below, using advanced complementary metal oxidesemiconductor (“CMOS”) technology acquired from Toshiba.

 

During 2001 and 2002, theCompany paid a total of $21.3 million to Tower to fulfill its investmentrequirements under the Agreement. In partial consideration for the investment,the Company received 1,757,368 Tower ordinary shares with an original cost of$16.6 million. The Company wrote down the Tower shares by$1.5 million, $3.8 million and $6.8 million in 2004, 2002 and2001, respectively, due to an “other than temporary” decline in their marketvalue. In the second quarter of 2005, the Company determined that itsinvestment 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. Thenet cumulative effect of these write-downs resulted in an adjusted cost of theCompany’s Tower ordinary shares of $1.6 million, or $1.17 per share.

 

During the year ended December 31,2003, the Company sold 412,825 of the Tower ordinary shares for total proceedsof approximately $2.1 million and recognized a gain of $719,000 in thestatements of operations.

 

As of September 30,2005, the Company held 1,344,543 available for sale Tower ordinary shares withan accumulated other comprehensive income of $81,000, representing thedifference between the adjusted cost per share and the carrying cost of $1.23per share, their market value on the last trading day of the reporting period.The Company intends to hold 450,000 Tower ordinary shares in order to receivecompetitive product pricing under the Agreement and has recorded these sharesas a long-term investment on the balance sheets. The remaining 894,543 sharesare classified as a short-term investment on the balance sheets.

 

The Company also received$4.7 million in prepaid wafer credits in consideration for the investment,$4.3 million of which remained available as of September 30, 2005.These credits are recorded in other assets on the balance sheets and can beapplied toward wafer purchases from Tower at 15% of the value of futurepurchases.

 

**Note5—Long-lived Asset Impairment**

 

During the fourth quarterof 2004, the Company evaluated the revenue potential of its product familiesbased upon discussions with potential customers, consultations with externaladvisors, review of actual sales levels and analysis of current and futuredesign opportunities. Based upon this evaluation, the Company determined thatthe future 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 aprobability-weighted assessment of the expected revenue and related cash flows,discounted using a risk-free interest rate. Based upon this assessment, theCompany recorded a $3.2 million long-lived asset impairment charge as anoperating expense, which was allocated to the related long-lived assets on apro rata basis using the carrying value of the assets immediately before theimpairment charge. This $3.2 million impairment charge was reflected on theCompany’s balance sheets as a reduction in the carrying value of the relatedlong-term assets. This write-down did not affect the carrying value of relatedinventory.

 

11

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**QUICKLOGICCORPORATION**

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

 

**Note 6—BalanceSheet Components**

 
| ** **                                 | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                 | ** ** | **(in thousands)**           | ** ** |
| Inventory:                                 |       |                         |       |                        |       |
| Raw  materials                             |       | $                            | 964        |                        | $          | 1,024 |   |
| Work-in-process                            |       | 6,888                        |       | 4,908                       |       |
| Finished  goods                            |       | 525                          |       | 809                         |       |
|                                       |       | $                            | 8,377      |                        | $          | 6,741 |   |
|                                       |       |                         |       |                        |       |
| Other current assets:                      |       |                         |       |                        |       |
| Prepaid  expenses                          |       | $                            | 911        |                        | $          | 1,278 |   |
| Employee  receivables                      |       | 21                           |       | 15                          |       |
| Other                                      |       | 125                          |       | 213                         |       |
|                                       |       | $                            | 1,057      |                        | $          | 1,506 |   |
|                                       |       |                         |       |                        |       |
| Property and equipment:                    |       |                         |       |                        |       |
| Equipment                                  |       | $                            | 12,874     |                        | $          | 12,620 |   |
| Software                                   |       | 8,459                        |       | 8,647                       |       |
| Furniture  and fixtures                    |       | 825                          |       | 851                         |       |
| Leasehold  improvements                    |       | 802                          |       | 813                         |       |
|                                       |       | 22,960                       |       | 22,931                      |       |
| Accumulated  depreciation and amortization |       | (18,385                      | )          | (17,528                     | )          |
|                                       |       | $                            | 4,575      |                        | $          | 5,403 |   |
|                                       |       |                         |       |                        |       |
| Other assets:                              |       |                         |       |                        |       |
| Prepaid  wafer credits                     |       | $                            | 4,268      |                        | $          | 4,501 |   |
| Other                                      |       | 52                           |       | 51                          |       |
|                                       |       | $                            | 4,320      |                        | $          | 4,552 |   |
|                                       |       |                         |       |                        |       |
| Accrued liabilities:                       |       |                         |       |                        |       |
| Employee  related accruals                 |       | $                            | 2,148      |                        | $          | 1,400 |   |
| Accrued  adverse purchase commitments      |       | —                       |       | 70                          |       |
| Other                                      |       | 951                          |       | 1,041                       |       |
|                                       |       | $                            | 3,099      |                        | $          | 2,511 |   |

 

12

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**QUICKLOGICCORPORATION**

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

 

**Note 7—Obligations**

 
| ** **                                | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **(in thousands)**           | ** ** |
|                                      |       |                         |       |                        |       |
| Revolving line of  credit                 |       | $                            | —     |                        | $          | 2,000 |   |
|                                      |       |                         |       |                        |       |
| Debt and capital lease  obligations:      |       |                         |       |                        |       |
| Notes  payable to bank                    |       | $                            | 1,795      |                        | $          | 2,567 |   |
| Capital  lease                            |       | 193                          |       | 755                         |       |
|                                      |       | 1,988                        |       | 3,322                       |       |
| Current  portion of long-term obligations |       | (1,399                       | )          | (2,286                      | )          |
|                                      |       | $                            | 589        |                        | $          | 1,036 |   |

 

*RevolvingLine of Credit and Notes Payable to Bank*

 

Effective June 2005,the Company modified its Amended and Restated Loan and Security Agreement withSilicon Valley Bank. Terms of the modified agreement include an $8.0 millionrevolving line of credit available through June 2006, and an additional$3.0 million of borrowing capacity under the equipment line of credit thatis available to be drawn against through June 2006. The revolving line ofcredit provides for formula advances based upon a percentage of eligibleaccounts receivable and for non-formula advances not to exceed$4.0 million. Advances under the new equipment line of credit must berepaid in either 30 or 36 equal monthly installments, depending upon thenature of the items financed. Terms of the various advances under the modifiedagreement are as follows (in thousands):

 
| ** **                 | ** ** | **Original  Balance** | ** ** | **Balance at  September 30,  2005** | ** ** | **Available  Credit** | ** ** | **Interest Rate** | ** **    | **Maturity Date**                                            | ** **                                                   |
|----------------------------|------------|-----------------------|------------|------------------------------------------|------------|-----------------------|------------|-------------------|---------------|--------------------------------------------------------------|--------------------------------------------------------------|
| Revolving Line of  Credit: |       |                  |       |                                     |       |                  |       |              |          |                                                         |                                                         |
| Formula  advances          |       | n/a                   |       | $                                        | —     |                  | $          | 3,759             |          | 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      |                                     | 25         |                  | n/a        |              | Prime + 0.75% |                                                         | Multiple draws  maturing on or before December 31, 2005 |   |
| Notes  payable             |       | 2,136                 |       | 745                                      |       | n/a                   |       | Prime + 2.00%     |          | Multiple draws  maturing on or before December 1, 2006  |                                                         |
| Notes  payable             |       | 859                   |       | 564                                      |       | n/a                   |       | Prime + 2.00%     |          | Multiple draws  maturing on or before December 31, 2007 |                                                         |
| Notes  payable             |       | 550                   |       | 461                                      |       | 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                      |       |                  |       | $                                        | 1,795      |                  |       |              |          |                                                         |                                                         |   |
|                            |            |                       |            |                                          |            |                       |            |                   |               |                                                              |                                                              |  |  |  |

 

The bank has a firstpriority security interest in substantially all of the Company’s tangible and intangibleassets to secure any outstanding amounts under the modified agreement. Underthe terms of the modified agreement, the Company must maintain a minimumtangible net worth and an adjusted quick ratio. The modified agreement also hascertain restrictions including, among others, on the incurrence of otherindebtedness, the maintenance of depository accounts, the disposition ofassets, mergers, acquisitions, investments, the granting of liens and thepayment of dividends. The Company was in compliance with the financialcovenants of the modified agreement as of September 30, 2005.

 

13

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**QUICKLOGICCORPORATION**

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

 

AtSeptember 30, 2005, the prime rate under the credit facility was 6.75%. Asof September 30, 2005 and December 31, 2004, $589,000 and$1.0 million, respectively, of amounts outstanding under the equipmentline of credit were classified as long-term liabilities.

 

*CapitalLease*

 

In January 2004, theCompany leased design software and related maintenance under a two-year capitallease at an interest rate of 6.0% per annum. Terms of the agreement require theCompany to make quarterly principal and interest payments of approximately$196,000 through October 2005. Accordingly, the Company recorded a capitalasset for $1.2 million that is being amortized over the term of theagreement, prepaid maintenance of $280,000 that is being amortized over theterm of the agreement and a capital lease obligation of $1.5 million. As of September 30,2005, the outstanding balance under the capital lease was $193,000, all ofwhich was classified as a short-term liability.

 

**Note 8—DeferredRoyalty Revenue**

 

In 2000, the Companyentered into a technology license and wafer supply agreement with AeroflexIncorporated (“Aeroflex”). Under the terms of the agreement, the Companyreceived $750,000 of prepaid royalties. In addition, Aeroflex receives aprepaid royalty credit for a portion of the amounts paid for wafers purchasedfrom the Company under the agreement. These prepaid royalties are recorded as along-term liability and will be recognized as revenue when Aeroflex sellsproducts incorporating the licensed technology. As of September 30, 2005and December 31, 2004, the Company had recorded approximately$1.3 million and $1.2 million, respectively, of deferred royaltyrevenue under this agreement. As of September 30, 2005, no royalty revenuehad been earned under the agreement.

 

**Note 9 —Employee Stock Plans**

 

The Company has adoptedthe disclosure-only provisions of SFAS No. 123. If the Company had electedto recognize compensation expense under SFAS No. 123, net income for thethree and nine months ended September 30, 2005 would have been $980,000and $351,000, respectively. If the Company had elected to recognizecompensation expense under SFAS No. 123, net loss for the three andnine months ended September 30, 2004 would have been $2.0 million and$6.6 million, respectively (see Note 2).

 

*1989Stock Option Plan*

 

The 1989 StockOption Plan (the “1989 Plan”) provided for the issuance of incentive andnonqualified options for the purchase of up to approximately 4.6 millionshares of common stock. Options granted under the 1989 Plan have a term ofup to 10 years, and typically vest at a rate of 25% of the total grant per yearover a four-year period. In September 1999, the Company adopted the1999 Stock Plan and no further stock option grants were made under the1989 Plan.

 

*1999Stock Plan*

 

The 1999 Stock Plan(the “1999 Plan”) was adopted by the board of directors in August 1999 andwas approved by the Company’s stockholders in September 1999.  As of September 30,2005, approximately 12.7 million shares were reserved for issuance underthe 1999 Plan. In addition, each January an annual increase is addedto the 1999 Plan equal to the lesser of (i) 5.0 million shares, (ii) 5%of the Company’s outstanding shares on such date, or (iii) a lesser amountdetermined by the board of directors. Options that are cancelled under the 1989Plan also become available for grant under the 1999 Plan. Options grantedunder the 1999 Plan have a term of up to 10 years. Options typically vestat a rate of 25% of the total grant one year after the vesting commencement date,and one forty-eighth for each month of service thereafter. However, the Companyhas implemented different vesting schedules in the past and may implementdifferent vesting schedules in the future with respect to any new stock optiongrant.

 

The weighted average estimatedfair value, as defined by SFAS No. 123, for options granted during thethree months ended September 30, 2005 and 2004 was $2.55 and $1.87 peroption, respectively. The weighted average estimated fair value, as defined bySFAS No. 123, for options granted during the nine months ended September 30,2005 and 2004 was $2.45 and $1.98 per option, respectively. The fair value ofeach option grant is estimated on the date of grant using the Black-ScholesOption-Pricing Model. The Black-Scholes Model, as well as other currentlyaccepted option valuation models, was developed to estimate the fair value offreely tradable, fully transferable options without restrictions. Theseassumptions differ significantly from the characteristics of the Company’sstock option grants.

 

14

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**QUICKLOGICCORPORATION**

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

 

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

 
| ** **              | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **              | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Expected life (years)   |       | 3.7                                        |       | 5.2                                       |       | 4.0 |   | 5.2 |   |
| Risk-free interest rate |       | 4.02                                       | %          | 3.59                                      | %          | 3.83 | % | 3.78 | % |
| Volatility              |       | 95                                         | %          | 82                                        | %          | 92 | % | 79 | % |
| Dividend yield          |       | —                                     |       | —                                    |       | — |   | — |   |

 

*EmployeeStock Purchase Plan*

 

The1999 Employee Stock Purchase Plan (“ESPP”) was adopted by the board ofdirectors in August 1999 and was approved by the Company’s stockholders inSeptember 1999. As of September 30, 2005, approximately4.5 million shares were reserved for issuance under the ESPP. Inaddition, each August an annual increase is added to the ESPP equal to thelesser of (i) 1.5 million shares, (ii) 4% of the Company’soutstanding shares on such date, or (iii) a lesser amount determined bythe board of directors. Under this provision, approximately 1.1 millionshares were added to the ESPP in August 2005. The ESPP containsconsecutive, overlapping, twenty-four month offering periods. Each offeringperiod includes four six-month purchase periods. The ESPP permits participantsto purchase shares through payroll deductions of up to 20% of an employee’stotal compensation (maximum of 20,000 shares per purchase period) at 85% of thelower of the fair market value of the common stock at the beginning of anoffering period or the end of a purchase period.

 

Theweighted average estimated fair value, as defined by SFAS No. 123, ofrights issued pursuant to the Company’s ESPP during the nine months ended September 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.

 

Thefollowing weighted average assumptions are included in the estimated fair valuecalculations for rights to purchase stock under the ESPP:

 
| ** **              | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **              | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Expected life (months)  |       | 6.0                                        |       | 6.0                                       |       | 6.0 |   | 6.0 |   |
| Risk-free interest rate |       | 3.13                                       | %          | 1.34                                      | %          | 3.13 | % | 1.34 | % |
| Volatility              |       | 65                                         | %          | 81                                        | %          | 65 | % | 81 | % |
| Dividend yield          |       | —                                     |       | —                                    |       | — |   | — |   |

 

**Note 10—ShelfRegistration Statement**

 

OnJuly 12, 2005, the Company filed a shelf registration statement on Form S-3,which was declared effective on July 26, 2005 by the Securities andExchange Commission. Under this filing, the Company has the ability to raise upto $30.0 million, in one or more transactions, by selling common stock,preferred stock, depositary shares, and warrants. As of September 30,2005, the Company had not raised any funds in connection with this filing andhad incurred expenses of approximately $68,000.

 

**Note 11—RightsPlan**

 

In2001, the board of directors adopted a Rights Agreement, which provides for adividend of one Preferred Stock Purchase Right (each a “Right” andcollectively, the “Rights”) for each share of common stock of the Company. EachRight will entitle stockholders to buy one ten-thousandth of a share of Series AJunior Participating Preferred Stock of QuickLogic at an exercise price of$32.50, subject to adjustment. The Rights will become exercisable only if aperson or group becomes the beneficial owner of 15% or more of the commonstock, or commences a tender or exchange offer which would result in theofferor beneficially owning 15% or more of the common stock, without theapproval of the board of directors. The Company is entitled to redeem theRights at $0.001 per Right up to ten business days after the publicannouncement of a 15% holder. If not earlier terminated or redeemed, the Rightswill expire on November 27, 2011.

 

15

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**QUICKLOGICCORPORATION**

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

 

**Note 12—IncomeTaxes**

 

Inthe nine months ended September 30, 2005, the Company recorded income taxexpense of approximately $235,000,which consisted of income taxes on foreign operations of $160,000 and federalalternative minimum income taxes of $75,000.

 

Due to the uncertaintiessurrounding the realization of the deferred tax assets resulting from theCompany’s accumulated deficit and net tax losses in prior years, the Companyhas provided a full valuation allowance against the associated deferred taxassets. The Company will continue to assess the realizability of the deferredtax assets in future periods.

 

At December 31,2004, the Company had net operating loss carryforwards for federal and stateincome tax purposes of approximately $79 million and $14 million,respectively. These carryforwards, if not utilized to offset future taxableincome and income taxes payable, will expire beginning in 2006 for federalpurposes and 2005 for state purposes.

 

Under the Tax Reform Actof 1986, the amount of and the benefit from net operating losses that can becarried forward may be impaired in certain circumstances. Events which maycause changes in the Company’s tax carryovers include, but are not limited to,a cumulative ownership change of more than 50% over a three-year period. Sinceinception, the Company believes cumulative changes in ownership may havetriggered the loss carryforward deduction limitation under IRC Section 382.However, the Company believes that such limitations will not have a materialeffect on the future utilization of the losses.

 

**Note13—Information Concerning Product Lines, Geographic Information and RevenueConcentration**

 

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

 

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

 
| ** **                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                           | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue by product  family:          |       |                                       |       |                                      |       |   |   |   |   |
| Mature  products                     |       | $                                          | 8,127      |                                      | $          | 7,362 |   | $ | 24,250 |   | $ | 19,384 |   |
| Embedded  standard products          |       | 3,252                                      |       | 3,548                                     |       | 9,080 |   | 10,032 |   |
| Advanced  embedded standard products |       | 1,266                                      |       | 1,034                                     |       | 4,612 |   | 4,117 |   |
| Total  revenue                       |       | $                                          | 12,645     |                                      | $          | 11,944 |   | $ | 37,942 |   | $ | 33,533 |   |
|                                      |            |                                            |            |                                           |            |  |  |  |  |  |  |  |  |  |

 

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

 
| ** **             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **             | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue by geography:  |       |                                       |       |                                      |       |   |   |   |   |
| United  States         |       | $                                          | 6,749      |                                      | $          | 4,919 |   | $ | 18,617 |   | $ | 15,256 |   |
| Europe                 |       | 3,690                                      |       | 3,616                                     |       | 9,054 |   | 7,870 |   |
| Japan                  |       | 869                                        |       | 1,829                                     |       | 4,975 |   | 5,747 |   |
| China                  |       | 201                                        |       | 441                                       |       | 1,577 |   | 1,128 |   |
| Rest  of North America |       | 897                                        |       | 622                                       |       | 2,622 |   | 1,805 |   |
| Rest  of Asia Pacific  |       | 239                                        |       | 517                                       |       | 1,097 |   | 1,727 |   |
| Total  revenue         |       | $                                          | 12,645     |                                      | $          | 11,944 |   | $ | 37,942 |   | $ | 33,533 |   |
|                        |            |                                            |            |                                           |            |  |  |  |  |  |  |  |  |  |

 

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

 

Two distributors of theCompany’s products accounted for approximately 29% and 15% of revenue in thethree months ended September 30, 2004. Three distributors of the Company’sproducts accounted for approximately 23%, 16%,

 

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**QUICKLOGICCORPORATION**

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

 

and 11% of revenue in thenine months ended September 30, 2004. For the three and nine months ended September 30,2004, no single end customer accounted for 10% or more of the Company’srevenue.

 

As of September 30,2005 less than 10% of the Company’s long-lived assets, including property andequipment and other assets, were located outside the United States.

 

**Note14—Commitments**

 

Certain of the Company’swafer manufacturers require the Company to forecast wafer starts several monthsin advance. The Company is committed to take delivery of and pay for a portionof forecasted wafer volume. As of September 30, 2005 and December 31,2004, the Company had $3.0 million and $6.4 million, respectively, ofoutstanding commitments for the purchase of wafers.

 

The Company leases, withan option to renew, its primary facility under a non-cancelable operating leasethat expires in 2009. In addition, the Company rents development facilities inCanada and India as well as sales offices in Europe and Asia. Total rentexpense, net of sublease income, for the three months ended September 30,2005 and 2004 was approximately $240,000 and $230,000, respectively, and forthe nine months ended September 30, 2005 and 2004 was approximately$720,000 and $690,000, respectively.

 

**Note 15—Litigation**

 

On October 26, 2001,a putative securities class action was filed in the U.S. District Court for theSouthern District of New York against certain investment banks that underwroteQuickLogic’s initial public offering, QuickLogic and some of QuickLogic’sofficers and directors. The complaint alleges excessive and undisclosedcommissions in connection with the allocation of shares of common stock inQuickLogic’s initial and secondary public offerings and artificially high pricesthrough “tie-in” arrangements which required the underwriters’ customers to buyshares in the aftermarket at pre-determined prices in violation of the federalsecurities laws. Plaintiffs seek an unspecified amount of damages on behalf ofpersons who purchased QuickLogic’s stock pursuant to the registrationstatements between October 14, 1999, and December 6, 2000. Variousplaintiffs have filed similar actions asserting virtually identical allegationsagainst over 300 other public companies, their underwriters, and their officersand directors arising out of each company’s public offering. These actions,including the action against QuickLogic, have been coordinated for pretrialpurposes and captioned In re Initial Public Offering Securities Litigation, 21 MC92. A stipulation of settlement for the claims against the issuer defendants,including the Company, has been signed and was submitted to the court. Underthe stipulation of settlement, the plaintiffs will dismiss and release allclaims against participating defendants in exchange for a contingent paymentguaranty by the insurance companies collectively responsible for insuring theissuers in all the related cases, and the assignment or surrender to theplaintiffs of certain claims the issuer defendants may have against theunderwriters. Under the guaranty, the insurers will be required to pay theamount, if any, by which $1.0 billion exceeds the aggregate amountultimately collected by the plaintiffs from the underwriter defendants in allthe cases. On February 15, 2005, the court preliminarily approved thesettlement contingent on specified modifications. The settlement is stillsubject to court approval and a number of other conditions. There is noguarantee that the settlement will become effective.

 

On July 3, 2003, aputative securities class action was filed in the U.S. District Court for theSouthern District of New York by shareholders of Tower Semiconductor Ltd.against Tower, several of its directors, and several of its investors,including QuickLogic. QuickLogic was named solely as an alleged control person.On August 19, 2004, the court dismissed the claims against all defendants,including QuickLogic, with prejudice. On September 29, 2004 one of theplaintiffs filed a notice of appeal from the judgment.

 

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

 

From time to time, theCompany is involved in legal actions arising in the ordinary course ofbusiness, including but not limited to intellectual property infringement andcollection matters. Absolute assurance cannot be given that third partyassertions will be resolved without costly litigation in a manner that is notadverse to the Company or without requiring future royalty payments.

 

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**Item 2. Management’s Discussionand Analysis of Financial Condition and Results of Operations**

 

*Thefollowing Management’s Discussion and Analysis of Financial Condition andResults of Operations, as well as information contained in “Risk Factors” belowand elsewhere in this Quarterly Report on Form 10-Q, contains “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933 and Section 21E of the Securities Exchange Act of 1934. We intendthat these forward-looking statements be subject to the safe harbors created bythose provisions. Forward-looking statements are generally written in thefuture tense and/or are preceded by words such as “will,” “may,” “should,” “forecast,”“could,” “expect,” “suggest,” “believe,” “anticipate,” “intend,” “plan,” orother similar words. Forward-looking statements include statements regarding (1) ourrevenue levels, (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) thecommercial success of our products. The following discussion should be read inconjunction with the attached condensed unaudited consolidated financialstatements and notes thereto, and with our audited financial statements andnotes thereto for the fiscal year ended December 31, 2004, found in ourAnnual Report on Form 10-K filed on March 17, 2005.*

 

*The forward-lookingstatements contained in this Quarterly Report involve a number of risks anduncertainties, many of which are outside of our control. Factors that couldcause actual results to differ materially from projected results include, butare not limited to, risks associated with (1) the expected decline inrevenue from our pASIC1 and pASIC2 products, (2) the commercial andtechnical success of our new products such as Eclipse II and QuickPCI II, (3) limitedvisibility into demand for our products, including demand from significantcustomers or for new products, (4) our relationship with and themanufacturing of our products by Tower Semiconductor Ltd., (5) ourdependence upon single suppliers to fabricate and assemble a substantialportion of our products, and (6) the liquidity required to support ourfuture operating and capital requirements. Although we believe that theassumptions underlying the forward-looking statements contained in thisQuarterly Report are reasonable, any of the assumptions could be inaccurate,and therefore there can be no assurance that such statements will be accurate.In light of the significant uncertainties inherent in the forward-lookingstatements included herein, the inclusion of such information should not beregarded as a representation by us or any other person that the results orconditions described in such statements or our objectives and plans will beachieved. Furthermore, past performance in operations and share price is notnecessarily indicative of future performance. QuickLogic disclaims anyintention or obligation to update or revise any forward-looking statements,whether as a result of new information, future events or otherwise.*

 

**Overview**

 

QuickLogic Corporation, foundedin April 1988, operates in a single industry segment where it designs andsells field programmable gate arrays, embedded standard products, associatedsoftware and programming hardware. In 1991, we introduced our first line offield programmable gate array products, or FPGAs, based upon our ViaLink®technology. Our Mature product family consists of our pASIC1, pASIC2 and pASIC3products.

 

Our objective is to bethe leading provider of the lowest-power programmable logic solutions. Webelieve that our Embedded Standard Products, which are products that integratestandard functions and programmable logic, provide our customers with low powerconsumption, IP security and flexibility at cost-effective prices while meetingsystem performance requirements. We believe these devices enable systemmanufacturers to improve time-to-market, lower power consumption and addfeatures or performance to their embedded applications.

 

In September 1998,we introduced our first line of Embedded Standard Products, or ESPs, to addressthe design community’s demand for an alternative to existing options:Application Specific Integrated Circuits, or ASICs, and system-on-a-chipproducts. ESP products embed standard functions on programmable logic devices.These products provide engineers with the ease-of-use, guaranteedfunctionality, high performance, low non-recurring engineering charges andimmediate availability of application specific standard products, or ASSPs,combined with the flexibility and time-to-market advantages of programmablelogic. Our ESP product family includes QuickRAM, QuickPCI, and V3 products. OurAdvanced ESP product family includes QuickMIPS, Eclipse, Eclipse II, QuickPCIII and PolarProTM products.  We announcedour new PolarPro architecture and related products in November 2005.  We believe our PolarPro architecture allowsfor cost effective, ultra-low power, small form factor products that addressthe need for power conservation in portable applications, while maintaining thefunctionality and time-to-market advantages of traditional FPGAs.  We also license our QuickWorks and QuickToolsdesign software and sell our programming hardware and include these sales asAdvanced ESP revenue.

 

Ournewest products target low-power, high-performance applications where systemdesigners want to add features to or improve the performance of a systemthrough the use of programmable devices. Our products generally target complex,high-performance embedded systems in rapidly changing markets where systemmanufacturers seek to minimize time-to-market and maximize productdifferentiation and functionality. Our product offering includes thelowest-power FPGAs available in the industry today, enabling designers toutilize the high performance of our FPGA architecture in low-power

 

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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 and telecommunications;consumer applications; video, audio and graphics imaging; high-performancecomputing; and military and aerospace systems. Based on current customer designactivity, we expect that consumer applications will represent a higherproportion of our revenue in the future.

 

Our proprietary ViaLinkprogrammable metal-to-metal technology is the core of our FPGA products and thefoundation of our ESP products. Our ViaLink technology allows us to createdevices smaller than competitors’ comparable products, thereby minimizingsilicon area and cost. In addition, our ViaLink technology has lower electricalresistance and capacitance than other programmable technologies and,consequently, supports higher signal-speed and lower power consumption. Ouruser-programmable platform and design software facilitates full utilization ofa device’s logic cells, clocks and input/output pins. These logic cells havebeen optimized to efficiently implement a wide range of logic functions at highspeed, thereby enabling greater usable device density and design flexibility.Our architecture uses our ViaLink technology to maximize interconnects at everyrouting wire intersection, which allows more paths between logic cells. As aconsequence, system designers are able to use our devices with smaller gatecounts to implement their designs than if they had used competing FPGAs. Theabundance of interconnect resources also provides a dense connection betweenthe ASSP and the FPGA portions of Embedded Standard Products.

 

Our ViaLink technologyalso provides our products with what we believe to be bulletproof intellectualproperty security, especially compared to SRAM-based FPGA or ASIC solutions. Webelieve intellectual property security is important to system designers whochoose to implement proprietary algorithms or features in programmable logic.

 

We believe that importantindustry trends in our target markets include lower power consumption, higherperformance, shorter time to market, increased intellectual property security,higher development expenses and increased product development risks. We believeour products are designed to address many of these trends.

 

The market forprogrammable logic devices is expected to grow more quickly than thesemiconductor industry, and we believe the FPGA programmable logic market willgrow more quickly than the market for complex programmable logic devices. Onefactor fueling this high growth is the migration from ASIC circuit designs toprogrammable logic circuit designs. System designers often choose programmablelogic solutions over ASIC solutions, due to the relatively low developmentcost, low development risk, quick time to market and high adaptability orflexibility of programmable logic devices, and due to the ability ofprogrammable logic suppliers to reduce the unit costs of their products overtime.

 

Within the programmablelogic device market, we believe that the market for low power embeddedapplications will be a relatively high-growth market, as original equipmentmanufacturers, or OEMs, serving the consumer or professional portable marketsaccelerate the offering of devices such as PDAs incorporating Wi-Fi or microhard drive capability, wireless VoIP telephones, or consumer products utilizinga micro hard drive. This adoption of new features by embedded system designersis increasing the use of programmable logic, since embedded processors often donot have the native ability to interface to components such as Wi-Fi modules ormicro hard disk drives, which were designed to work in a personal computerenvironment. Our Eclipse II, QuickPCI II and PolarPro devices offer compellingadvantages in these programmable interconnect applications, where customersbenefit from their low power consumption, small form factor and high bandwidth.

 

In 2000, we entered intoa Share Purchase Agreement, Foundry Agreement and other related agreements, asamended, with Tower Semiconductor Ltd., or Tower. Under the terms of theagreements, we made a strategic investment in Tower as part of Tower’s plan tobuild and equip a new wafer fabrication facility. The facility produces 200-mmwafers in geometries of 0.18 micron, using advanced complementary metal oxidesemiconductor, or CMOS, technology acquired from Toshiba.

 

During 2001 and 2002, wepaid Tower a total of $21.3 million to fulfill our investment requirementsunder the terms of our agreements with them. In partial consideration for theinvestment, we purchased 1,757,368 Tower ordinary shares for $16.6 million. Wewrote down the Tower shares due to an “other than temporary” decline in theirmarket value by $1.5 million, $3.8 million and $6.8 million in fiscal2004, 2002 and 2001, respectively. In the second quarter of 2005, we determinedthat our investment in Tower stock had suffered a further decline in value thatwas determined to be “other than temporary.” This determination includedfactors such as market value and the period of time that the market value hadbeen below the carrying value. Accordingly, we recorded an impairment charge of$1.5 million in the second quarter of 2005 based on the quoted marketprice of the stock on the last trading day of the reporting period. Thecumulative effect of these write-downs is that the adjusted cost of our Towerordinary shares is $1.6 million or $1.17 per share.

 

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During 2003, we sold412,825 of the available for sale Tower ordinary shares for total proceeds ofapproximately $2.1 million and recognized a gain in the amount of$719,000.

 

As of September 30,2005, we held 1,344,543 available for sale Tower ordinary shares valued at$1.23 per share, the market value of these shares at the end of our thirdfiscal quarter of 2005. We intend to continue to hold 450,000 Tower ordinaryshares in order to receive competitive product pricing and, accordingly, haveclassified these shares as a long-term investment on our balance sheets. Theremaining 894,543 shares are recorded as a short-term investment on our balancesheets.

 

We also received fromTower $4.7 million in prepaid wafer credits in partial consideration forthe investment. These credits can be applied toward wafer purchases from Towerat 15% of the value of future purchases. As of September 30, 2005, we had$4.3 million of prepaid wafer credits classified as other long-term assetson our balance sheets.

 

We sell programmed andunprogrammed products through distributors and directly to OEMs. However,we sell the majority of our products through distributors. The percentage ofsales derived through distributors was 68% and 75% in the nine months ended September 30,2005 and 2004, respectively. For the nine months ended September 30, 2005and 2004, approximately 69% and 67%, respectively, of the units shipped to ourpoint-of-sale distributors were programmed by us.

 

Two distributors of ourproducts accounted for 29% and 23% of revenue in the three months ended September 30,2005. The same two distributors of our products accounted for 23%, and 18% ofrevenue in the nine months ended September 30, 2005. Two distributors ofour products accounted for approximately 29% and 15% of revenue in the threemonths ended September 30, 2004. Three distributors of our productsaccounted for approximately 23%, 16%, and 11% of revenue in the nine monthsended September 30, 2004. We anticipate that a limited number ofdistributors will continue to account for a significant portion of our totalsales and that individual distributors could account for a larger portion ofour revenue.

 

For the three and ninemonths ended September 30, 2005 and 2004, no one end customer accountedfor 10% or more of our revenue. In the future, we anticipate that an endcustomer could account for a significant portion of our revenue, especially aswe continue to pursue more consumer application opportunities withlarger volume requirements.

 

Our international saleswere 51% and 55% of our revenue in the nine months ended September 30,2005 and 2004, respectively. Revenue from sales to international customers isexpected to continue to represent a significant portion of our revenue. All ofour sales originate in the United States and are denominated in U.S. dollars.

 

We outsource the wafermanufacturing, assembly and test of all of our products. We currently rely uponTaiwan Semiconductor Manufacturing Company Ltd., or TSMC, Cypress SemiconductorCorporation, Tower, Samsung Semiconductor, Inc. and KawasakiMicroelectronics to manufacture our products, and we rely primarily upon AmkorTechnology, Inc. and to a lesser extent Advanced Semiconductor EngineeringInc., or ASE, to assemble, test and program our products. Our wafer suppliers’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 wafer startforecast. Under the terms of our agreements with them, we are limited in thequantity that we can increase or decrease our wafer forecast and we arecommitted to take delivery of and pay for a minimum portion of the forecastedwafer volume. 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, estimatesand judgments we use in applying our most critical accounting policies have asignificant impact on the results we report in our financial statements. TheU.S. Securities and Exchange Commission, or SEC, has defined criticalaccounting policies as those that are most important to the portrayal of ourfinancial condition and results of operations and require us to make our mostdifficult and subjective judgments, often as a result of the need to makeestimates of matters that are inherently uncertain.  Based on this definition,our critical policies include revenue recognition including sales returns andallowances, inventory valuation including identification of excess quantitiesand product obsolescence, allowance for doubtful accounts, valuation ofinvestments, valuation of long-lived assets, accounting for income taxes, andestimating accrued liabilities.  Webelieve that we apply judgments and estimates in a consistent manner and thatsuch consistent application results in financial statements and accompanyingnotes that fairly represent all periods presented.

 

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However, any factualerrors or errors in these judgments and estimates may have a material impact onour statement of operations and financial condition. For a discussion of oursignificant accounting policies, please see Note 2 to the Condensed UnauditedConsolidated Financial Statements in this Quarterly Report on Form 10-Q.For a discussion of critical accounting policies and estimates, please see Item7 in our Annual Report on Form 10-K for the fiscal year ended December 31,2004 filed on March 17, 2005.

 

**Results of Operations**

 

The following table setsforth the percentage of revenue for certain items in our statements ofoperations for the periods indicated:

 
| ** **                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                           | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue                              |       | 100.0                                      | %          | 100.0                                     | %          | 100.0 | % | 100.0 | % |
| Cost of revenue                      |       | 34.2                                       |       | 50.7                                      |       | 36.4 |   | 45.0 |   |
| Gross profit                         |       | 65.8                                       |       | 49.3                                      |       | 63.6 |   | 55.0 |   |
| Operating expenses:                  |       |                                       |       |                                      |       |   |   |   |   |
| Research  and development            |       | 19.4                                       |       | 25.5                                      |       | 19.1 |   | 27.8 |   |
| Selling,  general and administrative |       | 32.7                                       |       | 31.2                                      |       | 32.9 |   | 35.3 |   |
| Income (loss) from  operations       |       | 13.7                                       |       | (7.4                                      | )          | 11.6 |   | (8.1 | ) |
| Write-down of  marketable securities |       | —                                     |       | —                                    |       | (3.9 | ) | — |   |
| Interest expense                     |       | (0.4                                       | )          | (0.6                                      | )          | (0.4 | ) | (0.6 | ) |
| Interest income and  other, net      |       | 0.7                                        |       | 0.5                                       |       | 0.7 |   | 0.4 |   |
| Income (loss) before  income taxes   |       | 14.0                                       |       | (7.5                                      | )          | 8.0 |   | (8.3 | ) |
| Provision for income  taxes          |       | 1.2                                        |       | —                                    |       | 0.6 |   | — |   |
| Net income (loss)                    |       | 12.8                                       | %          | (7.5                                      | )%         | 7.4 | % | (8.3 | )% |

 

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

 

*Revenue.*  Ourrevenue for the three months ended September 30, 2005 was$12.6 million, representing a growth of $700,000, or 5.9%, from revenue of$11.9 million in the three months ended September 30, 2004. Thisrevenue increase was due to a $760,000 increase in our Mature product familyrevenue, primarily related to higher customer demand and end-of-life purchasesof our pASIC1 and pASIC2 products, and a $230,000 increase in our Advanced ESPproduct family revenue, primarily due to sales of our new Eclipse II andQuickPCI II products. These increases were partially offset by a $300,000 declinein revenue from our ESP product family, primarily due to the decline in revenueattributable to a systems manufacturer located in China purchasing QuickRAMproduct through a distributor.

 

Our revenue for the threemonths ended September 30, 2005 was 1% lower sequentially, declining by$125,000 to $12.6 million from $12.8 million in the three monthsended June 30, 2005. This sequential revenue decrease was primarily due toa $490,000 decline in Advanced ESP product family revenue. Advanced ESP productfamily revenue declined primarily due to a decrease in revenue attributable toa systems manufacturer purchasing Eclipse product through a distributor. OurESP product family revenue decreased by $190,000, primarily due to a decline incustomer demand for these products. These decreases were partially offset by anincrease of $550,000 in Mature product family revenue due primarily toend-of-life purchases of our pASIC1 and pASIC2 products.

 

Our foundry agreementwith the supplier that fabricates our pASIC1 and pASIC2 products expires at theend of 2005. We have announced an end-of-life for these products and have askedour customers to take delivery of lifetime buy orders before the end of 2005.These products contributed $6.0 million and $5.2 million of ourrevenue in the three months ended September 30, 2005 and 2004,respectively. While we may have limited production capacity for these productsbeyond 2005, we expect to experience a significant reduction in pASIC1 and pASIC2revenue during the fourth quarter of 2005. We currently believe that a majorityof our customers that use pASIC1 and pASIC2 products have purchased enoughproduct to satisfy their demand throughout the expected life of their products,and that pASIC1 and pASIC2 products will contribute less than 10% of ourrevenue by the second quarter of 2006 and no revenue by the third quarter of2006. As a result, we expect fluctuations in demand as customers buildinventory of these products, design systems using devices supplied by others orreduce purchases of our products.

 

In order to maintain orgrow our revenue from its current level after the pASIC1 and pASIC2 productend-of-life period, we are dependent upon increased revenue from our existingproducts, especially our new Eclipse II and QuickPCI II products, and thedevelopment of additional commercially successful new products such as PolarPro.

 

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We continue to seek toexpand our revenue, including the pursuit of high volume sales opportunities inthe consumer market segment, by providing low power solutions incorporatingindustry standards such as PCI or IDE. Our industry is characterized by intenseprice competition and by lower prices as order volumes increase. While winninglarge volume sales opportunities will increase our revenue, we believe theseopportunities may decrease our average selling price and gross profit as apercentage of revenue.

 

*GrossProfit*.  Gross profit was $8.3 million and$5.9 million in the three months ended September 30, 2005 and 2004,respectively, which represented 65.8% and 49.3% of revenue for those periods.The $2.4 million improvement in gross profit was primarily due to: higherrevenue and better product mix, which contributed approximately $1.2 million ofthis improvement; lower inventory reserves and adverse purchase commitments of$780,000; lower depreciation and amortization of $220,000; lower scrap expenseof $170,000; and other favorable production variances; partially offset byhigher expensed production material required to increase programming capacityfor our new products and consulting services to qualify lead-free packages. Inthe three months ended September 30, 2004, we provided inventory reservesand recorded an adverse purchase commitment for product that was determined toprovide no usable die totaling $870,000. Our lower depreciation andamortization expense was largely a result of the impairment of long-livedassets recorded in the fourth quarter of 2004.

 

*Researchand Development Expense.*  Research and developmentexpense was $2.4 million and $3.0 million in the three months ended September 30,2005 and 2004, respectively, which represented 19.4% and 25.5% of revenue forthose periods. The decrease of approximately $600,000 was primarily due to $480,000 of lower charges for pre-production material and other expensesassociated with the development of our 0.18-micron products, which werereleased for production in late 2004, and $220,000 of lower depreciationexpense, partially offset by higher consulting expenses of $110,000. We believethat continued or increased investments in product development and processtechnology are essential for us to remain competitive in the markets we serve.We expect that these development efforts will allow us to expand our productoffering and provide additional value to our customers and stockholders.

 

*Selling,General and Administrative Expense.*  Selling,general and administrative expense was $4.1 million and $3.7 millionfor the three months ended September 30, 2005 and 2004, respectively,which represented 32.7% and 31.2% of revenue for those periods. The $410,000increase in selling, general and administrative expense was primarily theresult of higher salaries and personnel costs of $220,000, higher commissionsto outside representatives of $120,000 due to higher revenue fromcommissionable sales, and higher legal expenses of $40,000 primarily due to thefiling of a shelf registration statement on Form S-3 with the Securitiesand Exchange Commission.

 

*InterestExpense.*  Interest expense declined to $46,000 forthe three months ended September 30, 2005 compared to $69,000 for thethree months ended September 30, 2004. This $23,000 decrease wasprimarily due to lower average outstanding debt balances, partially offset byhigher interest rates.

 

*InterestIncome and Other, Net.*  Interest income and other,net increased to $92,000 of income for the three months ended September 30,2005 as compared to $60,000 of income for the three months ended September 30,2004. The $32,000 increase in interest income and other, net is primarily dueto increased interest income received as a result of higher invested cashbalances and higher interest rates.

 

*Provisionfor Income Taxes.*  We recorded a provision forincome taxes of $154,000 for the three months ended September 30, 2005, which consisted of income taxes on foreignoperations of $99,000 and federal alternate minimum income taxes of $55,000. Weincurred a tax loss in the three months ended September 30, 2004. Ourability to utilize our income tax loss carryforwards in future periods isuncertain and, accordingly, we recorded a full valuation allowance against therelated tax benefit. We will continue to assess the realizability of thedeferred tax assets in future periods.

 

**Nine Months Ended September 30, 2005 and 2004**

 

*Revenue.*  Ourrevenue for the nine months ended September 30, 2005 was$37.9 million, representing a growth of $4.4 million, or 13.1%, fromrevenue of $33.5 million in the nine months ended September 30, 2004.This revenue increase was due to a $4.9 million increase in our Matureproduct family revenue primarily related to higher customer demand andend-of-life purchases of our pASIC1 and pASIC2 products and a $490,000 increasein Advanced ESP product family revenue primarily related to sales of our newEclipse II and QuickPCI II products. These increases were partially offset by a$950,000 decline in our ESP product family revenue primarily due to changes incustomer demand.

 

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*GrossProfit*.  Gross profit was $24.1 million and$18.5 million in the nine months ended September 30, 2005 and 2004,respectively, which was 63.6% and 55.0% of revenue for those periods. The$5.7 million improvement in gross profit was primarily due to: higherrevenue and better product mix, which contributed approximately$4.0 million of this improvement; lower inventory reserves and adversepurchase commitments of $710,000; lower unabsorbed overhead of approximately$670,000 which was primarily due to lower depreciation and amortization expenseof $600,000, and approximately $220,000 of lower production variances. The ninemonths ended September 30, 2004 includes an adverse purchase commitmentfor product that was determined to provide no usable die and provisions forinventory reserves in the total amount of $1.0 million. Our lowerdepreciation and amortization expense was largely a result of the impairment oflong-lived assets recorded in the fourth quarter of 2004.

 

*Researchand Development Expense.*  Research and developmentexpense was $7.2 million and $9.3 million in the nine months ended September 30,2005 and 2004, respectively, which was 19.1% and 27.8% of revenue for thoseperiods. The decrease of $2.1 million was primarily due to$1.9 million of lower charges for pre-production material and otherexpenses associated with the development of our 0.18 micron products,which were released for production in late 2004, and $670,000 of lower depreciationexpense, partially offset by $310,000 of higher consulting services used todesign our next generation product.

 

*Selling,General and Administrative Expense.*  Selling,general and administrative expense was $12.5 million and$11.8 million for the nine months ended September 30, 2005 and 2004,respectively, which was 32.9% and 35.3% of revenue for those periods. The$650,000 increase in selling, general and administrative expense was primarilythe result of: higher legal expenses of $250,000 due to compliance activitiesand the filing of a shelf registration statement on Form S-3 with theSecurities and Exchange Commission; higher commissions to sales representativesof $240,000 due to higher revenue amounts; higher independent auditor fees of$150,000 due to compliance activities; higher salaries and personnel costs of$150,000; and higher fees of $90,000 for board of director compensation;partially offset by the recovery of a previously reserved accounts receivablein the amount of $140,000.

 

*Write-down of MarketableSecurities.  *In the second quarter of 2005,we determined that our investment in Tower stock had suffered a decline invalue that was determined to be “other than temporary.” Accordingly, werecorded an impairment charge of $1.5 million in the second quarter of2005 based on the quoted market price of the stock on the last trading day ofthe reporting period. As a result of this write-down, the adjusted cost of ourTower ordinary shares was $1.6 million, or $1.17 per share, as of September 30,2005.

 

*InterestExpense.*  Interest expense was $152,000 for thenine months ended September 30, 2005 as compared to $199,000 for the ninemonths ended September 30, 2004. This decrease was primarily due tolower average outstanding debt balances, partially offset by higher interestrates.

 

*InterestIncome and Other, Net.*  Interest income and other,net was $262,000 of income for the nine months ended September 30, 2005 ascompared to $127,000 of income for the nine months ended September 30,2004. The $135,000 increase in interest income and other, net is primarily dueto increased interest income received as a result of higher invested cashbalances and higher interest rates, partially offset by foreign exchange ratelosses.

 

*Provisionfor Income Taxes.*  We recorded a provision for incometaxes of $235,000 for the nine months ended September 30, 2005, which consisted of $160,000 for income taxes onforeign operations and $75,000 of federal alternative minimum income taxes.We incurred a tax loss in the nine months ended September 30, 2004. Ourability to utilize our income tax loss carryforwards in future periods isuncertain and, accordingly, we recorded a full valuation allowance against therelated tax benefit. We will continue to assess the realizability of thedeferred tax assets in future periods.

 

**Liquidity and Capital Resources**

 

We have financed ouroperating losses and capital investments through sales of common stock, privateequity investments, capital and operating leases, bank lines of credit and cashflow from operations. As of September 30, 2005, our principal sources ofliquidity consisted of our cash and cash equivalents of $25.4 million,available credit under our revolving line of credit with Silicon Valley Bank ofapproximately $7.8 million, available credit under our equipment line ofcredit of approximately $3.0 million, and our investment in Tower with amarket value of approximately $1.7 million. On July 12, 2005, wefiled a shelf registration statement on Form S-3, which has been declaredeffective. Under this filing, we may raise up to $30.0 million, in one orseveral transactions, by selling common stock, preferred stock, depositaryshares, and warrants.

 

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As of September 30,2005, our interest-bearing debt consisted of $1.8 million outstanding fromSilicon Valley Bank and $193,000 outstanding under a capital lease. As of September 30,2005, our accumulated deficit was $116.9 million. Capital expenditures,which are largely driven by the development of new products and manufacturinglevels, could be up to $5.0 million in the next twelve months.

 

In June 2005, wemodified our Amended and Restated Loan and Security Agreement with SiliconValley Bank. Terms of the modified agreement include an $8.0 million revolvingline of credit available through June 2006 and an additional$3.0 million of borrowing capacity under an equipment financing line ofcredit that is available to be drawn against through June 2006. Therevolving line of credit provides for formula advances based upon a percentageof eligible accounts receivable and for non-formula advances not to exceed$4.0 million. As of September 30, 2005, we had no balancesoutstanding under the revolving line of credit and had available formula andnon-formula advances totaling $7.8 million. As of September 30, 2005,we had $1.8 million outstanding under previous equipment lines of creditand $3.0 million available to be drawn against future equipment purchases.Advances under the new equipment line of credit must be repaid in either 30 or36 equal monthly installments, depending upon the nature of the items financed.The bank has a first priority security interest on substantially all of ourtangible and intangible assets to secure any outstanding amounts under themodified agreement. Under the terms of the modified agreement, we must maintaina minimum tangible net worth and an adjusted quick ratio. The modifiedagreement also has certain restrictions including, among others, on the incurrenceof other indebtedness, the maintenance of depository accounts, the dispositionof assets, mergers, acquisitions, the granting of liens and the payment ofdividends. We were in compliance with all loan covenants as of September 30,2005.

 

As of September 30,2005, we also had $193,000 outstanding under a capital lease obligation, whichwas repaid under the terms of the agreement in October 2005. The capitallease obligation bore interest at 6.0% per annum.

 

*Net cash from operating activities*

 

Net cash provided byoperating activities was $3.0 million in the nine months ended September 30,2005. The cash provided by operating activities resulted primarily from netincome of $2.8 million, adjusted for $4.1 million of non-cash chargesincluding depreciation and amortization of $2.0 million, a$1.5 million write-down of marketable securities, $290,000 of reserves forexcess inventory, $233,000 from the utilization of prepaid wafer credits, and$66,000 related to the write-down of long-lived assets. In addition, changes inworking capital accounts used cash in the amount of $3.9 million primarilyas a result of: a $1.9 million increase in inventory, primarily due towafer purchases in anticipation of future sales of Eclipse II andQuickPCI II products; an increase of $2.4 million in accountsreceivable, net of allowances for doubtful accounts, due to an increase inrevenue levels and the timing of shipments in the period; and a$1.1 million reduction in trade payables, primarily due to the timing ofwafer purchases.  These uses of cash werepartially offset by: a $588,000 increase in accrued liabilities; a $517,000increase in deferred income and royalty revenue due primarily to higherinventories at distributors on which revenue is deferred; and a $448,000 reductionin other current assets due to the amortization of prepaid expenses.

 

Net cash provided byoperating activities was $2.9 million in the nine months ended September 30,2004. The cash provided by operating activities resulted primarily from the netloss of $2.8 million, adjusted for $4.0 million of non-cash chargesincluding depreciation and amortization of $3.3 million and reserves forexcess inventory of $385,000. In addition, changes in working capital accountsprovided cash in the amount of $1.7 million primarily as a result of: anincrease of $920,000 in accrued liabilities primarily due to the accrual of anadverse purchase commitment; a $780,000 increase in deferred revenue fromshipments made to our distributors; a decrease in accounts receivable of$1.2 million due to improved collections efforts and the timing ofshipments in the period; and a decrease in other assets of $931,000 primarilydue to the amortization of prepaid expenses and the repayment of a relatedparty loan.  The cash provided by theseactivities was partially offset by: an increase in inventory of$2.1 million, principally 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 $118,000,primarily due to the timing of wafer receipts and vendor payments.

 

*Netcash from investing activities*

 

Netcash used for investing activities for the nine months ended September 30,2005 was $1.3 million as a result of capital expenditures made primarilyto acquire equipment and software used in the development and production of ourproducts. Net cash used for investing activities for the nine months ended September 30,2004 was $1.2 million as a result of capital expenditures made primarilyto acquire equipment and software used in the development and production of ourproducts. Also in the nine months ended September 30, 2004, we enteredinto a capital lease obligation to acquire design

 

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software and related maintenance. At the inception of thisagreement, we recorded a capital lease obligation for $1.5 million,property and equipment of $1.2 million, and prepaid maintenance expensesof $280,000 on the balance sheet. This transaction was treated as a non-cashtransaction in our statement of cash flows.

 

*Netcash from financing activities*

 

Net cash used forfinancing activities was $1.3 million for the nine months ended September 30,2005, resulting from a $2.0 million repayment of the balance outstandingunder our revolving line of credit and scheduled repayments of$1.9 million under the terms of our debt and capital lease obligations,partially offset by $2.1 million in proceeds related to the issuance ofcommon shares under our employee stock purchase program and upon the exerciseof stock options by employees and $550,000 in proceeds from borrowings underour equipment line of credit.

 

Net cash used byfinancing activities was $1.2 million for the nine months ended September 30,2004. The use of funds was due to scheduled repayments of $2.3 millionunder the terms of our long-term obligations and a $900,000 reduction in ourrevolving line of credit, partially offset by $1.4 million of proceedsrelated to the issuance of common shares under our employee stock purchaseprogram and upon the exercise of stock options by employees and $655,000 ofproceeds from borrowings under our equipment line of credit.

 

We require substantialworking capital to fund our business, particularly to finance our operations,the acquisition of property and equipment, the repayment of debt and workingcapital requirements. Our future liquidity will depend on many factors such asthese, as well as our level of revenue and gross profit, market acceptance ofour existing and new products including our Eclipse II, QuickPCI II andPolarPro devices, the expected decline in pASIC1 and pASIC2 revenue resultingfrom the end-of-life of these products, costs and investments to secure accessto adequate manufacturing capacity, inventory levels, wafer purchasecommitments, customer credit terms, the amount and timing of research anddevelopment expenditures, the timing of new product introductions, productionvolumes, the quality of our products, sales and marketing efforts, changes inoperating assets and liabilities, our ability to obtain or renew debt financingand to remain in compliance with the terms of our credit facilities, ourability to raise funds from the sale of Tower shares and equity in the Company,the exercise of employee stock options and participation in our employee stockpurchase plan, and other factors related to the uncertainties of the industryand global economics. However, we believe that our existing cash resources willbe 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. Underthis filing, we may decide to raise up to $30.0 million, in one or severaltransactions, by selling common stock, preferred stock, depositary shares, andwarrants. We cannot assure you that capital will be made available on termsacceptable to us.

 

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**ContractualObligations and Commercial Commitments**

 

The following tablesummarizes our contractual obligations and commercial commitments as of September 30,2005 and the effect such obligations and commitments are expected to have onour liquidity and cash flows in future periods (in thousands):

 
| ** **                                                | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                | ** ** | **Total**                  | ** ** | **Less than  1 Year** | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** | **More than  5 Years** | ** ** |
|                                                      |       |                       |       |   |   |   |   |   |   |   |   |
| *Contractual cash obligations:*                           |       |                       |       |   |   |   |   |   |   |   |   |
| Operating  leases                                         |       | $                          | 2,639      |   | $ | 715 |   | $ | 1,435 |   | $ | 489 |   | $ | — |   |
| Wafer  purchases (1)                                      |       | 2,981                      |       | 2,981 |   | — |   | — |   | — |   |
| Other  purchase commitments                               |       | 3,324                      |       | 3,324 |   | — |   | — |   | — |   |
| *Total contractual cash obligations*                      |       | 8,944                      |       | 7,020 |   | 1,435 |   | 489 |   | — |   |
|                                                      |       |                       |       |   |   |   |   |   |   |   |   |
| *Other commercial commitments*(2):                        |       |                       |       |   |   |   |   |   |   |   |   |
| Notes  payable to bank                                    |       | 1,795                      |       | 1,206 |   | 589 |   | — |   | — |   |
| Capital  lease obligations                                |       | 193                        |       | 193 |   | — |   | — |   | — |   |
| *Total commercial commitments*                            |       | 1,988                      |       | 1,399 |   | 589 |   | — |   | — |   |
| Total  contractual obligations and commercial commitments |       | $                          | 10,932     |   | $ | 8,419 |   | $ | 2,024 |   | $ | 489 |   | $ | — |   |

 

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(1)          Certain of our wafermanufacturers require us to forecast wafer starts several months in advance. Weare committed to take delivery of and pay for a portion of forecasted wafervolume. Wafer purchase commitments of $3.0 million include both firmpurchase commitments and a portion of our forecasted wafer starts as of September 30,2005.

 

(2)          Other commercialcommitments are included as liabilities on our balance sheets as of September 30,2005.

 

**Inflation**

 

The impact of inflationon our business has not been material for the periods presented.

 

**Off-Balance Sheet Arrangements**

 

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

 

**Recently Issued Accounting Pronouncements**

 

On December 16,2004, the Financial Accounting Standards Board, or FASB, issued SFAS No. 123(R),*“Share-Based Payment,”*which is arevision of SFAS No. 123 and supersedes Accounting Principals Board, orAPB, Opinion No. 25. SFAS No. 123(R) requires all share-basedpayments to employees, including grants of employee stock options, to be valuedat fair value on the date of grant, and to be expensed over the applicablevesting period. Pro forma disclosure of the income statement effects ofshare-based payments is no longer an alternative. SFAS No. 123(R), asamended, is effective for all stock-based awards granted in fiscal yearsbeginning after December 15, 2005. In addition, companies must alsorecognize compensation expense related to any awards that are not fully vestedas of the effective date. Compensation expense for the unvested awards will bemeasured based on the fair value of the awards previously calculated indeveloping the pro forma disclosures in accordance with the provisions of SFAS No. 123.See Notes 2 and 9 to our Condensed Unaudited Consolidated Financial Statementsfor information related to the pro forma effects on our reported net income (loss)and net income (loss) per share of applying the fair value recognitionprovisions of the previous SFAS No. 123, *“Accountingfor Stock-Based Compensation,”* to stock-based employee compensation.We are currently assessing the impact of adopting SFAS No. 123(R) andexpect the impact upon adoption in fiscal year 2006 to be significant to ourresults of operations.

 

On March 29, 2005,the SEC issued Staff Accounting Bulletin (“SAB”) No. 107, which providesguidance on the interaction between SFAS No. 123(R), *“Shared-Based Payment,”* and certain SEC rules andregulations.  SAB No. 107provides guidance that may simplify some of the SFAS No. 123(R)implementation challenges and enhance the information that investors receive.We will apply the principles of SAB No. 107 in conjunction with theadoption of SFAS No. 123(R).

 

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**Risk Factors**

 

# *We expect theannounced end-of-life of our pASIC1 and pASIC2 products will result influctuations or a decline in our revenue*

 

Our foundry agreementwith the supplier that fabricates our pASIC1 and pASIC2 products expires on December 31,2005. While we may have limited fabrication capacity for these products beyond2005, we have announced an end-of-life for these products and have asked ourcustomers to take delivery of lifetime buy orders before the end of 2005.Revenue from these products was $5.2 million and $5.1 million in the last twoquarters of 2004, and $6.4 million, $5.1 million and $6.0 million in the first,second and third quarters of 2005, respectively. We believe that a majority ofour customers that use pASIC1 and pASIC2 products have planned to purchaseenough pASIC1 and pASIC2 product to satisfy demand through the expected life oftheir products rather than migrate to other QuickLogic products. As a result,we expect to experience fluctuations in demand as these customers buildinventory of these products, design systems using devices supplied by others orreduce purchases of our products. Many customers took delivery of life-time-buyquantities by the third quarter of 2005, and we believe that revenue from theseproducts may decline sequentially during the fourth quarter of 2005, accountfor less than 10% of our revenue by the second quarter of 2006 and contribute norevenue by the third quarter of 2006. If we are unable to: migrate customers toother products; develop customer demand for new products, such as Eclipse IIand QuickPCI II which have strong customer design activity but have notcontributed significant revenue or gross profit to date; increase revenue andgross profit from our other products; our revenue and gross profit will declineand our operating results and liquidity would be adversely affected. The pASIC1and pASIC2 revenue decline that we expect may be more rapid than the revenuegrowth from our Eclipse II, QuickPCI II, PolarPro and other products. While weexpect revenue growth from Eclipse II, QuickPCI II, other products and newproducts such as PolarPro, will offset the expected decline in pASIC1 andpASIC2 revenue, there is no assurance when this will occur, if at all.

 

# *If we fail tosuccessfully develop, introduce and sell new products, we may be unable tocompete effectively in the future*

 

We operate in a highlycompetitive, quickly changing environment marked by rapid obsolescence ofexisting products. To compete successfully, we must obtain access to advancedfabrication capacity and dedicate significant resources to specify, design,develop, manufacture and sell new or enhanced products and solutions thatprovide increasingly higher levels of performance, low power consumption, newfeatures, reliability and/or cost savings to our customers. We experience along delay between the time when we expend these development resources andinvest in related long-lived assets, and the time when we begin to generaterevenue, 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 newproducts. We believe our low-power Eclipse II, QuickPCI II and other newproducts under development such as PolarPro have a compelling advantage inlow-power applications, and that this business will provide long-term revenuegrowth for QuickLogic. Some of these opportunities are in the rapidly changingconsumer market, which typically has shorter product life cycles, highervolumes and greater price pressure than our traditional business. If we areunable to design, produce and sell new products and solutions that meet designspecifications, address customer requirements, and generate sufficient revenueand gross profit, if market demand for our products fails to materialize, or ifour customers do not successfully introduce products incorporating our devices,our revenue and gross margin will be materially harmed and we may be requiredto write-off related inventory and long-lived assets or have other adverseeffects on our business. For example, in the fourth quarter of 2004 we recordeda $3.2 million long-lived asset impairment charge related to our QuickMIPSproducts.

 

# *We may beunable to accurately estimate quarterly revenue, which could adversely affectthe trading price of our stock*

 

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

 

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# *Our futureresults depend on our relationship with Tower*

 

We have investedapproximately $21.3 million in Tower. In return for our investment, wehave received equity, prepaid wafer credits and committed production capacityin Tower’s foundry facility. We believe that Tower’s long-term operation ofthis fabrication facility depends on its ability to attract sufficient customerdemand, to obtain additional financing, the release of grants and approvals forchanges in grant programs from the Israeli government’s Investment Center, andits ability to remain in compliance with the terms of its grant and creditagreements. The current political uncertainty and security situation in theMiddle East where Tower’s fabrication facility is located, the cyclical natureof the market for foundry manufacturing services, the early stage of operationof Tower’s fabrication facility, Tower’s financial condition, or other factorsmay adversely impact Tower’s business prospects and may discourage futureinvestments in Tower from outside sources. We may decide to invest additionalfunds in Tower, which could have an impact on our cash position and liquidity.If Tower is unable to obtain adequate financing and increase production outputin a timely manner, the value of our investment in Tower may declinesignificantly or possibly become worthless, our wafer credit from Tower maydecline in value or possibly become worthless, and we would have to identifyand qualify a substitute supplier to manufacture our products. This couldrequire significant development time, cause product shipment delays, impairlong-lived assets and the value of our wafer credits, damage our liquidity andseverely harm our business.

 

The value of ourinvestment in Tower and its corresponding wafer credits may also be adverselyaffected by a deterioration of conditions in the market for foundrymanufacturing services and the market for semiconductor products. At September 30,2005, the aggregated value of our Tower investment and wafer credits recordedon our balance sheets was $5.9 million. If the fair value of our Towerinvestment or our wafer credits are deemed to be impaired, we will recordcharges to our statement of operations. For instance, the fair value of ourTower investment was $2.26 per share and $1.17 per share at December 31,2004 and July 1, 2005, respectively. Since the value of our Towerinvestment remained below $2.26 per share for a period of time, we recorded a$1.5 million write-down of marketable securities in the second quarter of2005. In addition, Tower solely manufactures our Eclipse II, certain QuickPCIII, QuickMIPS and other new products currently under development, and we havemade significant purchases and purchase commitments to Tower for these devices.As these are new products being manufactured in a new facility, there aresignificant 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, wafer credits and other long-livedassets.

 

# *We will beunable to compete effectively if we fail to anticipate product opportunitiesbased upon emerging technologies and standards and fail to develop productsthat incorporate these technologies and standards in a timely manner*

 

We may spend significanttime and money to design and develop products and customer solutions around anindustry standard or emerging technology. To date, we have developed systemsolutions that incorporate specific industry standards such as PCI and IDE andwe intend to develop additional system solutions in the future. Additionally,customers may shift their demand to environmentally friendly products, such asproducts manufactured with lead-free assembly components that we may not havedeveloped. If an industry standard or emerging technology that we have targetedfails to achieve broad market acceptance, or if we are unable to bring thetechnology or solutions to market in a timely manner, we may be unable togenerate significant revenue from our research and development efforts. As aresult, our business would be materially harmed and we may be required towrite-off related inventory and long-lived assets.

 

We have the capabilityand capacity to design and develop only a limited number of products andsolutions that support specific industry standards. If system manufacturersmove away from the use of industry standards that we support with our productsand solutions and adopt alternative standards, we may be unable to design anddevelop new products and solutions that conform to these new standards.Typically, the expertise required is unique to each industry standard, and wewould likely have to either hire individuals with the required expertise oracquire such expertise through a licensing arrangement. The demand forindividuals with the necessary expertise to develop a product or solutionrelating to a particular industry standard is generally high, and we may not beable to hire such individuals. The cost to acquire such expertise throughlicensing or other means may be high and such arrangements may not be possiblein a timely manner, if at all.

 

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

 

Our customers oftenevaluate our products for six months or more before designing them into theirsystems, and they may not commence volume shipments for up to an additional sixto twelve months, if at all. During this lengthy sales cycle, our potentialcustomers may also cancel or change their product plans. For example, weexpended considerable resources over several quarters to assist a potential PDAcustomer in its system design and this customer decided to target a moreadvanced design that does not include one of our products. Even when customersincorporate one or more of our products into their systems, they maydiscontinue production at any time. Customers whose products achieve highvolume production may choose to replace our products with lower costsemiconductors. If customers cancel, reduce or delay product orders from us orchoose not to release equipment that incorporates our products after we havespent substantial time and resources in assisting them with their productdesign, our business could be materially harmed.

 

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

 

Our approach todeveloping system solutions for potential customers involves embeddedprocessors or peripheral devices developed by other parties and specificindustry standards such as PCI, IDE and SDIO. We have entered into informalpartnerships with these other parties that involve the development of solutionsthat interface with their devices. These informal partnerships also may involvejoint marketing campaigns and sales calls. For example, we have developed asystem solution incorporating a specific embedded processor, a Wi-Fi module andour Eclipse II device that lowers the overall power requirements of a systemand improves system performance. If our solution is not incorporated intocustomer products, if our partners discontinue production of their products, ifour customers do not incorporate our solution into their product, or if theinformal partnership is significantly reduced or terminated, our revenue andgross margin will be materially harmed and we may be required to write-offrelated long-lived assets.

 

# *We depend uponthird parties to fabricate, assemble, test and program our products, and theymay discontinue manufacturing our products, fail to give our products priority,be unable to successfully manufacture our products to meet performance, volumeor cost targets, or inaccurately report inventory to us*

 

We contract with thirdparties to fabricate, assemble, test and program our devices. Our devices aregenerally fabricated, assembled and programmed by single suppliers, and theloss of a supplier, expiration of a supply agreement or the inability of oursuppliers to manufacture our products to meet volume, performance and costtargets could have a material adverse effect on our business. For instance, asingle supplier fabricates our pASIC1 and pASIC2 products under an agreementthat expires in December 2005. While we may be able to purchase wafersafter 2005, we do not have a firm capacity commitment from the supplier. Inaddition, demand for assembly capacity at one of our suppliers recentlyincreased due to a fire at the facility of another supplier. As a result,capacity available to us may be constrained. Programming capacity at oursuppliers is also dependent on our investment in sufficient programminghardware to meet fluctuating demand. If for any reason these or any othersupplier becomes unable or unwilling to continue to provide services ofacceptable quality, at acceptable costs and in a timely manner, our ability todeliver our products to our customers could be severely impaired. We would haveto identify and qualify substitute suppliers, which could be time consuming anddifficult and could result in unforeseen operational problems, or we couldannounce an end-of-life program for these products, as we did with our pASIC1and pASIC2 products. Alternate suppliers might not be available to fabricate,assemble, test and program our devices or, if available, might be unwilling orunable to offer services on acceptable terms.

 

In addition, ifcompetition for wafer manufacturing capacity increases, or if we need tomigrate to more advanced wafer manufacturing technology, we may be required topay or invest significant amounts to secure access to this capacity. The numberof companies that provide these services is limited and some of them havelimited operating histories and financial resources. In the event our currentsuppliers refuse or are unable to continue to provide these services to us, wemay be unable to procure services from alternate suppliers in a timely manner,if at all. Furthermore, if customer demand for our products increases, we maybe unable to secure sufficient additional capacity from our current supplierson commercially reasonable terms, if at all. Moreover, our reliance on alimited number of suppliers subjects us to reduced control over deliveryschedules, quality assurance and costs. This lack of control may causeunforeseen product shortages or may increase our cost to manufacture and testour products, which would adversely affect our operating results and cashflows.

 

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

 

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# *We may nothave the liquidity to support our future operations and capital requirements*

 

Our cash and cashequivalents balance at September 30, 2005 was $25.4 million. At September 30,2005, our interest-bearing debt consisted of $1.8 million outstanding fromSilicon Valley Bank and $193,000 outstanding under a capital lease. On June 27,2005, we modified our credit facility with Silicon Valley Bank. Terms of themodified agreement include an $8.0 million revolving line of creditavailable through June 2006 and $3.0 million of borrowing capacityunder the equipment line of credit that is available to be drawn through June 2006.The credit facility expires on June 26, 2006. At September 30, 2005,we had approximately $7.8 million available to borrow under our revolvingcredit facility and approximately $3.0 million available to borrow underour equipment line of credit.

 

At the end of the thirdquarter of 2005, we held 1,344,543 Tower Ordinary Shares available for saleworth approximately $1.7 million based upon the market closing price of$1.23 per share on such date. Our ability to obtain competitive pricing fromTower is tied to our ownership of at least 450,000 of these Tower shares.

 

Capital expenditures,which are largely driven by the introduction and initial manufacturing of newproducts and development activities, could be up to $5.0 million in thenext twelve months. As of September 30, 2005, we had commitments topurchase $3.0 million of wafer inventory.

 

On July 12, 2005, wefiled a shelf registration statement on Form S-3, which has been declaredeffective. Under this filing, we may decide to raise up to $30.0 million,in one or several transactions, by selling common stock, preferred stock,depositary shares, and warrants.

 

As a result of potentialinvestments, the expected fluctuation in revenue from our pASIC1 and pASIC2products, operating expenses, changes in working capital and interest and debtpayments, we will need to generate higher revenue and gross profit, especiallyfrom our Eclipse II products, QuickPCI II products and products underdevelopment, 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 toadequately forecast demand for our products, we may incur product shortages orexcess product inventory*

 

Our agreements withthird-party manufacturers require us to provide forecasts of our anticipatedmanufacturing orders, and place binding manufacturing commitments in advance ofreceiving purchase orders from our customers. This may result in productshortages or excess product inventory because we are limited in our ability toincrease or decrease our forecasts under such agreements. Additionally, weprovide programming equipment to our suppliers to program our products tocustomer specifications.  The programmingequipment is manufactured to our specifications and has significant orderlead-times.  This requires us to makepurchase commitments prior to having actual customer demand. Obtainingadditional supply in the face of product, programming equipment or capacityshortages may be costly, or not possible, especially in the short term sincemost of our products and programming equipment have only a single fabricationand assembly source. Our failure to adequately forecast demand for our productscould materially harm our business.

 

# *Fluctuationsin our manufacturing processes and product yields and quality, especially fornew products, may increase our costs*

 

Difficulties encounteredduring the complex semiconductor manufacturing process can render a substantialpercentage of semiconductor wafers nonfunctional, and manufacturingfluctuations may change the performance distribution of manufactured products.We have, in the recent past, experienced manufacturing runs that have containedsubstantially reduced or no functioning devices, or that generated devices withbelow normal performance. In addition, yield problems may take a significantperiod of time to analyze and correct. Our reliance on third party suppliersmay extend the period of time required to analyze and correct these problems. Oncecorrected, our customers may be required to redesign or requailify theirproducts. As a result, we may incur substantially higher manufacturing costs,inventory shortages or reduced customer demand.

 

Yield fluctuationsfrequently occur in connection with the manufacture of newly introducedproducts, with changes in product architecture, with manufacturing at newfacilities or on new manufacturing processes. Newly introduced products andproducts that incorporate new intellectual property, such as our QuickMIPS,QuickPCI II and Eclipse II products, are often more complex and more

 

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difficult to produce,increasing the risk of manufacturing-related defects. New manufacturingfacilities or processes, such as at Tower, are often more complex and take aperiod of time to achieve expected quality levels and product costs. While wetest our products, they may still contain errors or defects that are foundafter we have commenced commercial production, that occur due to manufacturingvariations or as new intellectual property is incorporated into our products.If our products contain undetected or unresolved defects, we may lose marketshare, experience delays in or loss of market acceptance, reserve or scrap inventory,or be required to issue a product recall. In addition, we would be at risk ofproduct liability litigation if defects in our products are discovered.Although we attempt to limit our liability to end users through disclaimers ofspecial, consequential and indirect damages and similar provisions, we cannotassure you that such limitations of liability will be legally enforceable.

 

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

 

A few of our endcustomers can represent a significant portion of our total revenue in a givenreporting period and the likelihood of this occurring will increase in thefuture as we target high-volume consumer applications. As in the past, futuredemand from these customers may fluctuate significantly. These customerstypically order products with short requested delivery lead times, and do notprovide a firm commitment to purchase product past the period covered bypurchase orders. In addition, our manufacturing lead times are longer than thedelivery lead times requested by these customers, and we make significantinventory purchases in anticipation of future demand. For example, a Chinesecustomer, purchasing product through a distributor, represented 14% of ourtotal revenue in 2003, but only 3% of revenue in 2004. If revenue from anysignificant customer were to decline substantially, we may be unable to offsetthis decline with increased revenue from other customers and we may purchaseexcess inventory. These factors could severely harm our business.

 

In addition, we may havemade a significant investment in long-lived assets for the production of ourproducts based upon historical and expected demand. If demand for or grossmargin generated from our products does not meet our expectations, we may berequired to write-off inventory or incur charges against long-lived assets,which would materially harm our business.

 

# *We have ahistory of losses and cannot assure you that we will remain profitable in thefuture*

 

We incurred significantlosses in 2004, 2003 and 2002. Our accumulated deficit as of September 30,2005 was $116.9 million. Although we recorded net income of$2.8 million for the nine months ended September 30, 2005, we may notremain profitable in any future periods. Our recent revenue growth, net incomefor the nine months ended September 30, 2005 and our profitability incertain years prior to 2001 cannot be relied upon as any indication of ourfuture operating results or prospects.

 

# *We depend uponthird party distributors to market and sell our products, and they maydiscontinue sale of our products, fail to give our products priority or beunable to successfully market, sell and support our products*

 

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

 

Many of our distributors,including our principal distributors, market and sell products for othercompanies, and many of these products may compete directly or indirectly withour products. We generally are not one of the principal suppliers of productsto our distributors. If our distributors give higher priority or greaterattention to the products of other companies, including products that competewith our products, our business would be materially harmed.

 

Individual distributorsand OEM customers often represent a significant portion of our accountsreceivable. If we are unable to collect funds due from these distributors andcustomers, our financial results may be materially harmed.

 

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

 

Our operating resultshave varied widely in the past and are likely to do so in the future. Inaddition, our past operating results may not be an indicator of futureoperating results. Our future operating results will depend on many factors andmay fail to meet our expectations for a number of reasons, including those setforth in these risk factors. Any failure to meet expectations could cause ourstock price to significantly fluctuate or decline.

 

Factors that could causeour operating results to fluctuate include:

 

•                  a significant change in sales to ourlargest customers;

 

•                  successful development and marketacceptance of our products and system solutions incorporating our products;

 

•                  our ability to accurately forecastproduct volumes and mix, and to respond to rapid changes in customer demand;

 

•                  the effect of end-of-life programs;

 

•                  changes in product mix or productionvariances that affect gross profit;

 

•                  our ability to adjust ourmanufacturing capacity and costs in response to economic and competitivepressures;

 

•                  our reliance on subcontractmanufacturers for product capacity, yield and quality;

 

•                  our competitors’ product portfolio andproduct pricing policies;

 

•                  timely implementation of efficientmanufacturing technologies;

 

•                  changes in accounting and corporategovernance rules;

 

•                  impact of import and export laws andregulations;

 

•                  the cyclical nature of thesemiconductor industry and general economic, market, political and socialconditions in the countries where we sell our products and the related effecton our customers, distributors and suppliers; and

 

•                  our ability to obtain capital, debtfinancing and insurance on commercially reasonable terms.

 

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

 

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

 

The semiconductorindustry has historically been characterized by wide fluctuations in the demandfor, and supply of, its products. These fluctuations have resulted incircumstances when supply of and demand for semiconductors have been widely outof balance. An industry-wide semiconductor oversupply could result in severedownward pricing pressure from customers. In a market with undersupply ofmanufacturing capacity, we would have to compete with larger foundry customersfor limited manufacturing resources. In such an environment, we may be unableto have our products manufactured in a timely manner, at a cost that generatesadequate gross profit, or in sufficient quantities. Since we outsource all ofour manufacturing and have only a single-source of wafer supply, test, assemblyand programming for most of our products, we are particularly vulnerable tosuch supply shortages and capacity limitations. As a result, we may be unableto fulfill orders and may lose customers. Any future industry-wide oversupplyor undersupply of semiconductors could materially harm our business.

 

# *Customers maycancel or defer significant purchase orders or our distributors may return ourproducts, which would cause our inventory levels to increase and our revenue todecline*

 

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

 

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

 

Most of our products aremanufactured outside of the United States at manufacturing facilities operatedby our suppliers in Taiwan, South Korea, the Philippines, Israel and Malaysia.We expect to manufacture a majority of the products that we currently haveunder development in Israel and to assemble these products in South Korea, thePhilippines or Malaysia. As a result, these manufacturing operations and newproduct introductions are subject to risks of political instability, includingthe risk of conflict between Taiwan and the People’s Republic of China, betweenSouth Korea and North Korea, and conflicts involving Israel or Malaysia.

 

A significant portion ofour total revenue comes from sales to customers located outside the UnitedStates. We anticipate that sales to customers located outside the United Stateswill continue to represent a significant portion of our total revenue in futureperiods. In addition, most of our domestic customers sell their productsoutside of North America, thereby indirectly exposing us to risks associatedwith foreign commerce and economic instability. In addition to overseas salesoffices, we have significant research and development activities in Canada andIndia. Accordingly, our operations and revenue are subject to a number of risksassociated with foreign commerce, including the following:

 

•                  managing foreign distributors;

 

•                  staffing and managing foreignoffices;

 

•                  political and economic instability;

 

•                  foreign currency exchangefluctuations;

 

•                  changes in tax laws, import andexport regulations, tariffs and freight rates;

 

•                  timing and availability of exportlicenses;

 

•                  supplying products that meet localenvironmental regulations;

 

•                  inadequate protection of intellectualproperty rights; and

 

•                  obtaining governmental approvals forcertain products.

 

In the past, we havedenominated sales of our products to foreign countries exclusively in U.S.dollars. As a result, any increase in the value of the U.S. dollar relative tothe local currency of a foreign country will increase the price of our productsin that country so that our products become relatively more expensive tocustomers in the local currency of that foreign country. As a result, sales ofour products in that foreign country may decline. To the extent any such risksmaterialize, our business could be materially harmed.

 

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

 

# *Many systemmanufacturers may be unwilling to switch to our products because of theirfamiliarity with the products offered by our direct competitors, such as Xilinxand Altera, which dominate the programmable logic market*

 

The semiconductorindustry is intensely competitive and characterized by:

 

•                  erosion of selling prices overproduct lives;

 

•                  rapid technological change;

 

•                  short product life cycles; and

 

•                  strong domestic and foreigncompetition.

 

If we are not able to competesuccessfully in this environment, our business will be materially harmed.

 

Manyof our competitors have substantially greater financial, technical,manufacturing, marketing, sales, distribution, name recognition and otherresources than we do. In addition, many of our competitors havewell-established relationships with our current and potential customers andhave extensive knowledge of system applications. In the past, we have lostpotential customers to competitors for various reasons, including, but notlimited to, re-programmability and lower price. Our current direct competitorsinclude suppliers of complex programmable logic devices and field programmablegate arrays, such as Xilinx, Inc., Altera Corporation, Actel Corporation,and Lattice Semiconductor Corporation. Xilinx and Altera together have amajority share of the programmable logic market. Many system manufacturers maybe unwilling or unable to switch to our products due to their familiarity withcompetitors’ products or other inhibiting factors.

 

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We also face competitionfrom companies that offer ASICs, which may be purchased for a lower price athigher volumes and typically have greater logic capacity, additional featuresand higher performance than those of our products. We may also face competitionfrom suppliers of embedded microprocessors, such as Freescale Semiconductor, Inc.(formerly Motorola), or from suppliers of products based on new or emergingtechnologies. Our inability to successfully compete in any of the followingareas could materially harm our business:

 

•                  the development of new products andadvanced manufacturing technologies;

 

•                  the quality, performancecharacteristics, price and availability of devices, programming hardware andsoftware development tools;

 

•                  the ability to engage with companiesthat provide synergistic products and services;

 

•                  the incorporation of industrystandards in our products;

 

•                  the diversity of product offeringsavailable to customers; or

 

•                  the quality and cost effectiveness ofdesign, development, manufacturing and marketing efforts.

 

# *We may beunable to successfully grow our business if we fail to compete effectively withothers to attract and retain key personnel*

 

We believe our futuresuccess will depend upon our ability to attract and retain engineers and otherhighly competent personnel. Our employees are at-will and not subject toemployment contracts. Hiring and retaining qualified sales and technicalpersonnel is difficult due to the limited number of qualified professionals,economic conditions and the size of our company. Competition for these types ofemployees is intense. In addition, new hires frequently require extensivetraining before they achieve desired levels of productivity. We have in thepast experienced difficulty in recruiting and retaining qualified seniormanagement, sales and technical personnel. Failure to attract, hire, train andretain personnel could materially harm our business.

 

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

 

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

 

We have in the past andare currently involved in litigation relating to alleged infringement by us ofothers’ patents or other intellectual property rights. This kind of litigationis expensive and consumes large amounts of management’s time and attention.Additionally, matters that we initially consider not material to our businesscould become costly. For example, we incurred substantial costs associated withthe litigation and settlement of our dispute with Actel, which materiallyharmed our business. In addition, if the letters we sometimes receive allegingpatent infringement or other similar matters result in litigation that we lose,a court could order us to pay substantial damages and/or royalties, andprohibit us from making, using, selling or importing essential technologies.For these and other reasons, this kind of litigation could materially harm ourbusiness.

 

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

 

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

 

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agreements with ouremployees, consultants and other third parties. However, employees may breachthese agreements, and we may not have adequate remedies for any breach. In anycase, others may come to know about or determine our trade secrets through avariety of methods. In addition, the laws of certain territories in which wedevelop, manufacture or sell our products may not protect our intellectualproperty rights to the same extent as the laws of the United States.

 

# *We may engagein manufacturing, distribution or technology agreements that involve numerousrisks, including the use of cash, diversion of resources and significantwrite-offs*

 

We have entered into and,in the future, intend to enter into agreements that have involved numerousrisks, including the use of significant amounts of our cash; diversion fromother development projects or market opportunities; our ability to incorporatelicensed technology in our products; our ability to introduce related productsin a cost-effective and timely manner; our ability to collect amounts due underthese contracts; and market acceptance of related products. For instance, wehave licensed certain microprocessor technology from MIPS Technologies andobtained other elements of our products from third-party companies. In thefourth quarter of 2004, we determined that the expected revenue and grossprofit from these products would not be sufficient to recover the full carryingvalue of the related third party elements and other long-lived assets, and werecorded a $3.2 million long-lived asset impairment charge. If we fail torecover the cost of these or other assets from the cash flow generated by therelated products, our assets will become impaired and our financial resultswould be harmed.

 

# *Our businessis subject to the risks of earthquakes, other catastrophic events and businessinterruptions for which we may maintain limited insurance*

 

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

 

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

 

# *Our principalstockholders have significant voting power and may vote for actions that maynot be in the best interests of our other stockholders*

 

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

 

# *OurShareholder Rights Plan, certificate of incorporation, bylaws and Delaware lawcontain provisions that could discourage a takeover that is beneficial tostockholders*

 

Our Shareholder RightsPlan as well as provisions of our certificate of incorporation, our bylaws andDelaware law could make it difficult for a third party to acquire us, even ifdoing so would be beneficial to our stockholders.

 

# *The marketprice of our common stock may fluctuate significantly and could lead tosecurities litigation*

 

Stock prices for manycompanies in the technology and emerging growth sectors have experienced widefluctuations that have often been unrelated to the operating performance ofsuch companies. In the past, securities class action litigation has often beenbrought against a company following periods of volatility in the market priceof its securities. In the future, we may be the target of similar litigation.Securities litigation could result in substantial costs and divert management’sattention and resources.

 

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# *Changes toexisting accounting pronouncements or taxation rules or practices maycause adverse revenue fluctuations, affect our reported results of operationsor how we conduct our business*

 

FASB has issued Statement123R, *“Share-Based Payment,”*which will require us to measure compensation costs for all stock basedcompensation (including our stock options and our employee stock purchase plan,as currently constructed) at fair value and take a compensation charge equal tothat value beginning on January 1, 2006. If this accounting pronouncementhad been in effect during the current period, we estimate that we would havereported a significantly lower net income.

 

New accountingpronouncements or taxation rules and varying interpretations of accountingpronouncements or taxation practice have occurred and may occur in the future.Any future changes in accounting pronouncements or taxation rules orpractices may have a significant effect on how we report our results and mayeven affect our reporting of transactions completed before the change iseffective. This change to existing rules, future changes, if any, or thequestioning of current practices may adversely affect our reported financialresults or the way we conduct our business.

 

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

 

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

 

# *While webelieve that we currently have adequate internal control procedures in place,we are still exposed to potential risks from recent legislation requiringcompanies to evaluate controls under Section 404 of the Sarbanes-Oxley Actof 2002*

 

As of December 2004,we have evaluated our internal control systems in order to allow management toreport on, and our independent registered public accounting firm to attest to,our internal control over financial reporting, as required by Section 404of the Sarbanes-Oxley Act. We performed the system and process evaluation andtesting required in an effort to comply with the management certification andindependent registered public accounting firm attestation requirements of Section 404.As a result, we incurred additional expenses and a diversion of management’stime. 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 tothe outcome of future evaluations, testing and remediation actions or theimpact of the same on our operations. If we are not able to remain incompliance with the requirements of Section 404, we might be subject tosanctions or investigation by regulatory authorities, such as the SEC or TheNasdaq National Market. Any such action could adversely affect our financialresults and the market price of our common stock.

 

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

 

Ourproducts, technology and software are subject to U.S. import and export controllaws and regulations which, in some instances, may impose restrictions onbusiness activities, or otherwise require licenses or other authorizations fromagencies such as the U.S. Department of State, U.S. Department of Commerce andU.S. Department of the Treasury. We have import and export licensing andcompliance procedures in place for purposes of conducting our businessconsistent with U.S. laws and regulations, and we periodically review theseprocedures to maintain compliance with the requirements relating to import andexport regulations. If we are not able to remain in compliance with import andexport regulations, we might be subject to investigation, sanctions orpenalties by regulatory authorities. Such penalties can include civil, criminalor administrative remedies (such as loss of export privileges). We cannot becertain as to the outcome of an evaluation, investigation, inquiry or otheraction or the impact of these items on our operations. Any such action couldadversely affect our financial results and the market price of our commonstock.

 

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**Item3. Quantitative and Qualitative Disclosures about Market Risk**

 

**Interest Rate Risk**

 

Our exposure to marketrate risk for changes in interest rates relates primarily to our investmentportfolio and variable rate debt. We do not use derivative financialinstruments to manage our interest rate risk. We are adverse to principal lossand ensure the safety and preservation of invested funds by limiting default,market and reinvestment risk. Our investment portfolio is generally comprisedof investments that meet high credit quality standards. Since these securitiesare subject to interest rate risk, they could decline in value if interestrates fluctuate. Due to the short duration and conservative nature of our investmentportfolio, we do not anticipate any material loss with respect to ourinvestment portfolio. A 10% move in interest rates as of September 30,2005 would have an immaterial effect on our financial position, results ofoperations and cash flows.

 

**ForeignCurrency Exchange Rate Risk**

 

All of our sales and costof manufacturing are transacted in U.S. dollars. We conducted a portion of ourresearch and development activities in Canada and India and have sales andmarketing offices in several locations outside of the United States. We use theU.S. dollar as our functional currency. Most of the costs incurred at theseinternational locations are in local currency. If these local currenciesstrengthen against the U.S. dollar, our payroll and other local expenses willbe higher than we currently anticipate. Since our sales are transacted in U.S.dollars, this negative impact on expenses would not be offset by any positiveeffect on revenue. Operating expenses denominated in foreign currencies wereapproximately 25% and 23% of total operating expenses for the nine months endedSeptember 30, 2005 and 2004, respectively. A majority of these foreignexpenses were incurred in Canada. A currency exchange rate fluctuation of 10%would have caused our operating expenses to change by approximately $560,000 inthe nine months ended September 30, 2005.

 

**EquityPrice Risk**

 

Our exposure to equityprice risk for changes in market value relates primarily to our investment inTower Semiconductor Ltd., or Tower. Tower’s ordinary shares trade on the NasdaqStock Market’s National Market under the symbol “TSEM”.  Since these securities are publicly traded onthe open market, they are subject to market fluctuations.  Temporary market fluctuations are reflectedby increasing or decreasing the presented value of the related securities andrecording “other comprehensive income (loss)” in the equity section of thebalance sheet.  An “other than temporary”decline in market value is reflected by decreasing the carrying value of therelated securities and recording a charge to operating expenses on the incomestatement. We wrote down the Tower shares due to an “other than temporary”decline in their market value by $1.5 million, $1.5 million,$3.8 million and $6.8 million in the second quarter offiscal 2005, fiscal 2004, fiscal 2002 and fiscal 2001,respectively. The determination that the decline in market value was “otherthan temporary” included factors such as market value and the period of timethat the market value had been below the carrying value in each of therespective periods. A market value fluctuation of 10% would have caused us torecord an additional charge of approximately $170,000 in the nine months ended September 30,2005.

 

**Item 4.Controls and Procedures**

 

**Evaluationof Disclosure Controls and Procedures**

 

Our management evaluated,with the participation of our Chief Executive Officer and Chief FinancialOfficer, the effectiveness of our disclosure controls and procedures as of theend of the period covered by this Quarterly Report on Form 10-Q. Basedupon that evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures are effective to ensurethat information we are required to disclose in reports that we file or submitunder the Securities Exchange Act of 1934, as amended, is (i) recorded,processed, summarized and reported within the time periods specified inSecurities and Exchange Commission rules and forms, and (ii) accumulatedand communicated to our management, including our Chief Executive Officer andChief Financial Officer, as appropriate to allow timely decisions regardingrequired disclosure.  Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat, while no cost-effective control system will preclude all errors andirregularities, our current disclosure controls and procedures are effective toprovide reasonable assurance that the financial statements and otherdisclosures in our SEC reports are reliable.

 

**Changes in Internal Control OverFinancial Reporting**

 

There were no changes inour internal control over financial reporting that occurred during the periodcovered by this Quarterly Report on Form 10-Q that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

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**Part II. Other Information**

 

**Item 1. Legal Proceedings**

 

On October 26, 2001,a putative securities class action was filed in the U.S. District Court for theSouthern District of New York against certain investment banks that underwroteQuickLogic’s initial public offering, QuickLogic and some of QuickLogic’sofficers and directors. The complaint alleges excessive and undisclosedcommissions in connection with the allocation of shares of common stock inQuickLogic’s initial and secondary public offerings and artificially highprices through “tie-in” arrangements which required the underwriters’ customersto buy shares in the aftermarket at pre-determined prices in violation of thefederal securities laws. Plaintiffs seek an unspecified amount of damages onbehalf of persons who purchased QuickLogic’s stock pursuant to the registrationstatements between October 14, 1999 and December 6, 2000. Variousplaintiffs have filed similar actions asserting virtually identical allegationsagainst over 300 other public companies, their underwriters, and their officersand directors arising out of each company’s public offering. These actions,including the action against QuickLogic, have been coordinated for pretrialpurposes and captioned *In re Initial PublicOffering Securities Litigation, 21 MC 92*. A stipulation ofsettlement for the claims against the issuer defendants, including the Company,has been signed and was submitted to the court. Under the stipulation ofsettlement, the plaintiffs will dismiss and release all claims againstparticipating defendants in exchange for a contingent payment guaranty by theinsurance companies collectively responsible for insuring the issuers in allthe related cases, and the assignment or surrender to the plaintiffs of certainclaims the issuer defendants may have against the underwriters. Under theguaranty, the insurers will be required to pay the amount, if any, by which$1.0 billion exceeds the aggregate amount ultimately collected by theplaintiffs from the underwriter defendants in all the cases. On February 15,2005, the court preliminarily approved the settlement contingent on specifiedmodifications. The settlement is still subject to court approval and a numberof other conditions. There is no guarantee that the settlement will becomeeffective.

 

On July 3, 2003, aputative securities class action was filed in the U.S. District Court for theSouthern District of New York by shareholders of Tower Semiconductor Ltd.against Tower, several of its directors, and several of its investors,including QuickLogic. QuickLogic was named solely as an alleged control person.On August 19, 2004, the court dismissed the claims against all defendants,including QuickLogic, with prejudice. On September 29, 2004, one of theplaintiffs filed a notice of appeal from the judgment.

 

**Item 6. Exhibits**

 

a.     Exhibits

 

The following Exhibitsare filed with this report:

 
| **Exhibit  Number** | ** ** | **Description** |
|---------------------|------------|-----------------|
|                | 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 therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
| ** **              | **QUICKLOGIC CORPORATION**                                                                                                           |
|-------------------------|--------------------------------------------------------------------------------------------------------------------------------------|
|                    |                                                                                                                                 |
|                    | /s/ CARL M.  MILLS                                                                                                                   |
| Date: November 10, 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** |
|---------------------|------------|-----------------|
|                | 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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