**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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

 

**(Mark One)**

 

| **x**      | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                                                 |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | **For the  Quarterly Period Ended September 30, 2007**                                                                                                                        |
| ** ** | ** ** | ** **                                                                                                                                                                         |
| ** ** | ** ** | **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**

(Exactname 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**

(Addressof principal executive offices, including Zip Code)

 

**(408) 990-4000**

(Registrant’stelephone number, including area code)

 

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

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act.

 

        Large accelerated filer o                                           Acceleratedfiler x                                              Non-acceleratedfiler o

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Securities Exchange Act of1934). Yes o No x

 

As of November 1, 2007, 29,151,979 shares of theregistrant’s common stock were outstanding.

 

 

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**QUICKLOGICCORPORATION**

**FORM10-Q**

**September30, 2007**

 
| ** **                                                                                                                                     | **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, 2007 and October  1, 2006         | 3        |
| Condensed Unaudited Consolidated Balance Sheets as of  September 30, 2007 and December 31, 2006                                           | 4        |
| Condensed Unaudited Consolidated Statements of Cash  Flows for the nine months ended September 30, 2007 and October 1, 2006                    | 5        |
| Condensed Unaudited Consolidated Statements of  Comprehensive Loss for the three and nine months ended September 30, 2007 and  October 1, 2006 | 6        |
| Notes to Condensed Unaudited Consolidated Financial  Statements                                                                                | 7        |
|                                                                                                                                           |     |
| **Item 2. Management’s  Discussion and Analysis of Financial Condition and Results of Operations**                                        | 22       |
|                                                                                                                                           |     |
| **Item 3. Quantitative  and Qualitative Disclosures about Market Risk**                                                                        | 33       |
|                                                                                                                                           |     |
| **Item 4. Controls and  Procedures**                                                                                                           | 34       |
|                                                                                                                                           |     |
| **Part  II. Other Information**                                                                                                                | 35       |
|                                                                                                                                           |     |
| **Item  1. Legal Proceedings**                                                                                                                 | 35       |
|                                                                                                                                           |     |
| **Item  1A. Risk Factors**                                                                                                                     | 36       |
|                                                                                                                                           |     |
| **Item 6. Exhibits**                                                                                                                           | 49       |
|                                                                                                                                           |     |
| Signatures                                                                                                                                     | 50       |

 

2

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**PART I.Financial Information**

 

**Item 1.Financial Statements**

 

**QUICKLOGICCORPORATION**

**CONDENSED UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
| ** **                           | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **September 30,  2007** | ** ** | **October 1,  2006**  | ** ** | **September 30,  2007** | ** ** | **October 1,  2006** | ** ** |
|                                 |       |                    |       |                  |       |   |   |   |   |
| Revenue                              |       | $                       | 9,025      |                  | $          | 8,598 |   | $ | 23,672 |   | $ | 27,180 |   |
| Cost of revenue                      |       | 4,314                   |       | 5,371                 |       | 13,690 |   | 13,352 |   |
| Gross profit                         |       | 4,711                   |       | 3,227                 |       | 9,982 |   | 13,828 |   |
| Operating expenses:                  |       |                    |       |                  |       |   |   |   |   |
| Research and  development            |       | 2,342                   |       | 2,429                 |       | 6,968 |   | 7,186 |   |
| Selling, general  and administrative |       | 3,953                   |       | 3,994                 |       | 12,933 |   | 13,205 |   |
| Loss from operations                 |       | (1,584                  | )          | (3,196                | )          | (9,919 | ) | (6,563 | ) |
| Interest expense                     |       | (69                     | )          | (65                   | )          | (226 | ) | (235 | ) |
| Interest income and other, net       |       | 189                     |       | 333                   |       | 752 |   | 966 |   |
| Loss before income taxes             |       | (1,464                  | )          | (2,928                | )          | (9,393 | ) | (5,832 | ) |
| Provision for income taxes           |       | 29                      |       | 23                    |       | 71 |   | 46 |   |
| Net loss                             |       | $                       | (1,493     | )                     | $          | (2,951 | ) | $ | (9,464 | ) | $ | (5,878 | ) |
|                                 |       |                    |       |                  |       |   |   |   |   |
| Net loss per share:                  |       |                    |       |                  |       |   |   |   |   |
| Basic                                |       | $                       | (0.05      | )                     | $          | (0.10 | ) | $ | (0.33 | ) | $ | (0.21 | ) |
| Diluted                              |       | $                       | (0.05      | )                     | $          | (0.10 | ) | $ | (0.33 | ) | $ | (0.21 | ) |
|                                 |       |                    |       |                  |       |   |   |   |   |
| Weighted average shares:             |       |                    |       |                  |       |   |   |   |   |
| Basic                                |       | 29,116                  |       | 28,678                |       | 28,966 |   | 28,420 |   |
| Diluted                              |       | 29,116                  |       | 28,678                |       | 28,966 |   | 28,420 |   |
|                                      |            |                         |            |                       |            |  |  |  |  |  |  |  |  |  |  |

 

See accompanying Notes toCondensed Unaudited Consolidated Financial Statements.

 

3

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**QUICKLOGICCORPORATION**

**CONDENSED UNAUDITED CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                 | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                 | ** ** | ** **              | ** ** | ** **                  | ** ** |
|                                                                                                                       |       |                    |       |                        |       |
| Current assets:                                                                                                            |       |                    |       |                        |       |
| Cash and cash  equivalents                                                                                                 |       | $                       | 20,846     |                        | $          | 24,621 |   |
| Short-term  investment in Tower Semiconductor Ltd.                                                                         |       | 1,601                   |       | 1,530                       |       |
| Accounts  receivable, net of allowances for doubtful accounts of $274 and $861,  respectively                              |       | 2,583                   |       | 2,839                       |       |
| Inventory                                                                                                                  |       | 4,838                   |       | 9,064                       |       |
| Other current  assets                                                                                                      |       | 1,395                   |       | 1,894                       |       |
| Total current  assets                                                                                                      |       | 31,263                  |       | 39,948                      |       |
| Property and  equipment, net                                                                                               |       | 4,786                   |       | 5,480                       |       |
| Investment in  Tower Semiconductor Ltd.                                                                                    |       | 806                     |       | 769                         |       |
| Other assets                                                                                                               |       | 3,142                   |       | 4,038                       |       |
| TOTAL ASSETS                                                                                                               |       | $                       | 39,997     |                        | $          | 50,235 |   |
|                                                                                                                       |       |                    |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                              | ** ** | ** **              | ** ** | ** **                  | ** ** |
|                                                                                                                       |       |                    |       |                        |       |
| Current  liabilities:                                                                                                      |       |                    |       |                        |       |
| Trade payables                                                                                                             |       | $                       | 3,002      |                        | $          | 4,383 |   |
| Accrued  liabilities                                                                                                       |       | 2,644                   |       | 2,462                       |       |
| Deferred income  on shipments to distributors                                                                              |       | 1,159                   |       | 1,152                       |       |
| Deferred royalty  revenue                                                                                                  |       | 548                     |       | 960                         |       |
| Current portion  of debt and capital lease obligations                                                                     |       | 1,544                   |       | 2,292                       |       |
| Total current  liabilities                                                                                                 |       | 8,897                   |       | 11,249                      |       |
|                                                                                                                       |       |                    |       |                        |       |
| Long-term  liabilities:                                                                                                    |       |                    |       |                        |       |
| Debt and capital  lease obligations, less current portion                                                                  |       | 912                     |       | 1,618                       |       |
| Total  liabilities                                                                                                         |       | 9,809                   |       | 12,867                      |       |
|                                                                                                                       |       |                    |       |                        |       |
| Commitments and  contingencies (see Notes 12 and 13)                                                                       |       |                    |       |                        |       |
|                                                                                                                       |       |                    |       |                        |       |
| Stockholders’  equity:                                                                                                |       |                    |       |                        |       |
| Common stock,  $0.001 par value; 100,000 shares authorized; 29,152 and 28,680 shares issued  and outstanding, respectively |       | 29                      |       | 29                          |       |
| Additional  paid-in capital                                                                                                |       | 166,314                 |       | 164,138                     |       |
| Accumulated  other comprehensive income                                                                                    |       | 834                     |       | 726                         |       |
| Accumulated  deficit                                                                                                       |       | (136,989                | )          | (127,525                    | )          |
| Total  stockholders’ equity                                                                                           |       | 30,188                  |       | 37,368                      |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                           |       | $                       | 39,997     |                        | $          | 50,235 |   |

 

See accompanying Notes toCondensed Unaudited Consolidated Financial Statements.

 

4

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**QUICKLOGICCORPORATION**

**CONDENSED UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Inthousands)**

 
| ** **                                                                                  | ** ** | **Nine Months Ended**   | ** ** |
|---------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                  | ** ** | **September 30,  2007** | ** ** | **October 1,  2006** | ** ** |
| ** **                                                                                  | ** ** | ** **              | ** ** | ** ** | ** ** |
| Cash flows from  operating activities:                                                      |       |                    |       |   |   |
| Net loss                                                                                    |       | $                       | (9,464     | ) | $ | (5,878 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used for) operating activities: |       |                    |       |   |   |
| Depreciation and  amortization                                                              |       | 2,292                   |       | 2,303 |   |
| Gain on sale of  equipment                                                                  |       | (95                     | )          | — |   |
| Stock-based  compensation                                                                   |       | 1,261                   |       | 1,145 |   |
| Inventory  write-down                                                                       |       | 3,533                   |       | 1,684 |   |
| Decrease in  wafer credits from Tower Semiconductor Ltd.                                    |       | 681                     |       | 132 |   |
| Bad debt expense                                                                            |       | 163                     |       | 110 |   |
| Write-off of  long-lived assets                                                             |       | 7                       |       | 34 |   |
| Changes in  assets and liabilities:                                                         |       |                    |       |   |   |
| Accounts  receivable                                                                        |       | 93                      |       | 1,798 |   |
| Inventory                                                                                   |       | 693                     |       | (731 | ) |
| Other assets                                                                                |       | 714                     |       | (738 | ) |
| Trade payables                                                                              |       | (1,965                  | )          | 1,026 |   |
| Accrued  liabilities                                                                        |       | 182                     |       | (639 | ) |
| Deferred income  and royalty revenue                                                        |       | (405                    | )          | (16 | ) |
| Net cash  provided by (used for) operating activities                                       |       | (2,310                  | )          | 230 |   |
|                                                                                        |       |                    |       |   |   |
| Cash flows from  investing activities:                                                      |       |                    |       |   |   |
| Capital  expenditures for property and equipment                                            |       | (1,021                  | )          | (1,903 | ) |
| Proceeds from  sale of equipment                                                            |       | 95                      |       | — |   |
| Net cash used  for investing activities                                                     |       | (926                    | )          | (1,903 | ) |
|                                                                                        |       |                    |       |   |   |
| Cash flows from  financing activities:                                                      |       |                    |       |   |   |
| Payment of debt  and capital lease obligations                                              |       | (1,896                  | )          | (1,802 | ) |
| Proceeds from  debt obligations                                                             |       | 442                     |       | 2,490 |   |
| Proceeds from  issuance of common stock                                                     |       | 915                     |       | 2,551 |   |
| Net cash  provided by (used for) financing activities                                       |       | (539                    | )          | 3,239 |   |
|                                                                                        |       |                    |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                       |       | (3,775                  | )          | 1,566 |   |
| Cash and cash equivalents  at beginning of period                                           |       | 24,621                  |       | 28,283 |   |
| Cash and cash  equivalents at end of period                                                 |       | $                       | 20,846     |   | $ | 29,849 |   |
|                                                                                        |       |                    |       |   |   |
| Supplemental  disclosures of cash flow information:                                         |       |                    |       |   |   |
| Interest paid                                                                               |       | $                       | 245        |   | $ | 284 |   |
| Income taxes  paid                                                                          |       | $                       | 132        |   | $ | 42 |   |
| Supplemental  schedule of non-cash investing and financing activities:                 |       |                    |       |   |   |
| Capital lease  obligation to finance capital expenditures and related maintenance           |       | $                       | —     |   | $ | 791 |   |

 

See accompanying Notes toCondensed Unaudited Consolidated Financial Statements.

 

5

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**QUICKLOGICCORPORATION**

**CONDENSED UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVELOSS**

**(Inthousands)**

 
| ** **                             | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **September 30,  2007** | ** ** | **October 1,  2006**  | ** ** | **September 30,  2007** | ** ** | **October 1,  2006** | ** ** |
|                                   |       |                    |       |                  |       |   |   |   |   |
| Net loss                               |       | $                       | (1,493     | )                     | $          | (2,951 | ) | $ | (9,464 | ) | $ | (5,878 | ) |
| Other  comprehensive gain, net of tax: |       |                    |       |                  |       |   |   |   |   |
| Unrealized gain  on investments        |       | 484                     |       | 81                    |       | 108 |   | 13 |   |
| Total  comprehensive loss              |       | $                       | (1,009     | )                     | $          | (2,870 | ) | $ | (9,356 | ) | $ | (5,865 | ) |
|                                        |            |                         |            |                       |            |  |  |  |  |  |  |  |  |  |

 

See accompanying Notes toCondensed Unaudited Consolidated Financial Statements.

 

6

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**Quicklogic corporation**

**Notes tocondensed unaudited consolidated financial statements**

 

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

QuickLogic Corporation (“QuickLogic” or the “Company”)was founded in 1988 and reincorporated in Delaware in 1999. The Companydevelops and markets low power programmable solutions that enable customers toadd features to their mobile, consumer and industrial products. The Company isa fabless semiconductor company that operates in a single industry segmentwhere it designs, markets and supports Customer Specific Standard Products (“CSSPs”),Embedded Standard Products (“ESPs”), Field Programmable Gate Arrays (“FPGAs”),application solutions, associated design software and programming hardware.

 

The accompanying interim consolidated financialstatements are unaudited. In the opinion of management, these statements havebeen prepared in accordance with generally accepted accounting principles (“GAAP”)and include all adjustments, consisting only of normal recurring adjustments,necessary to provide a fair statement of results for the interim periodspresented. The Company recommends that these consolidated financial statementsbe read in conjunction with the Company’s Form 10-K for the year endedDecember 31, 2006. Operating results for the three and nine months endedSeptember 30, 2007 are not necessarily indicative of the results that may beexpected for the full year.

 

QuickLogic’s fiscal year ends on theSunday closest to December 31. QuickLogic’s fiscal third quarter for2007 and 2006 ended Sunday, September 30, 2007 and October 1, 2006,respectively. Beginning with fiscal year 2006, the Company changed itsreporting convention to utilize the actual closing dates for all periodspresented in its consolidated financial statements and accompanying notes. Thischange had no impact on the Company’s financial position, results of operationor cash flows for any of the periods presented.

* *

*Liquidity*

 

The Company anticipates that itsexisting cash resources will fund operations, finance purchases of capitalequipment and provide adequate working capital for the next twelve months. TheCompany’s liquidity is affected by many factors including, among others, thelevel of revenue and gross profit, market acceptance of existing and newproducts including ArcticLinkTM, PolarProTM, EclipseTM II and QuickPCI®II devices, fluctuations in revenue as a result of product end-of-life,fluctuations in revenue as a result of the stage in the product life cycle ofits customers’ products, costs of securing access to and availability ofadequate manufacturing capacity, inventory levels, wafer purchase commitments,customer credit terms, the amount and timing of research and developmentexpenditures, the timing of new product introductions, production volumes, productquality, sales and marketing efforts, the amount and financing arrangements forpurchases of capital equipment, changes in operating assets and liabilities,the ability to obtain or renew debt financing and to remain in compliance withthe terms of existing credit facilities, the ability to raise funds from thesale of shares of Tower Semiconductor Ltd. (“Tower”) and equity in the Company,the issuance and exercise of stock options, the terms of and participation inthe Company’s employee stock purchase plan, and other factors related to theuncertainties of the industry and global economics. Accordingly, there can beno assurance that events in the future will not require the Company to seekadditional capital or, if so required, that such capital will be available onterms acceptable to the Company.

 

*Principles of Consolidation*

 

Theconsolidated financial statements include the accounts of QuickLogicCorporation and its wholly owned subsidiaries, QuickLogicInternational, Inc., QuickLogic Canada Company, QuickLogic KabushikiKaisha, QuickLogic Software (India) Private Ltd. and QuickLogic GmbH. TheCompany and its subsidiaries use the U.S. dollar as its functional currency.All intercompany accounts and transactions are eliminated in consolidation.

 

*Use of Estimates*

 

The preparation of these consolidated financialstatements in conformity with GAAP requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities, thedisclosures of contingent assets and liabilities and the reported amounts ofrevenue and expenses during the period. Actual results could differ from thoseestimates, particularly in relation to revenue recognition, the allowance fordoubtful accounts, sales returns, valuation of investments, valuation oflong-lived assets, inventory valuation including identification of excessquantities, market value and obsolescence, measurement of stock-basedcompensation awards, accounting for income taxes and estimating accruedliabilities.

* *

*7*

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** **

**Quicklogic corporation**

**Notes to condensed unaudited consolidatedfinancial statements — (****Continued)**

* *

*Reclassifications*

For presentation purposes, certain amounts in priorperiod financial statements, referred to in these financial statements, havebeen reclassified to conform to the reporting in current period financialstatements.

 

**Note 2—Significant AccountingPolicies**

*Revenue Recognition*

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

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

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

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

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

Unprogrammed partsshipped to distributors may be used by multiple end customers and distributorsmay have certain return and price adjustment privileges on unsold inventory.Accordingly, revenue associated with unprogrammed parts is deferred untilresale to the end customer. Deferred income on shipments to distributorsreflects the amount of gross margin expected to be realized when distributorssell through these products purchased from the Company.

Software revenue from sales of design tools isrecognized when persuasive evidence of an agreement exists, delivery of thesoftware has occurred, no significant Company obligations with regard toimplementation or integration remain, the fee is fixed or determinable andcollection is reasonably assured. Software revenue amounted to less than onepercent of the Company’s revenue for the third quarter and the first ninemonths of 2007 and 2006.

 

*Inventory*

Inventory is stated atthe lower of standard cost or net realizable value. Standard cost approximatesactual cost on a first-in, first-out basis. The Company routinely evaluatesquantities and values of its inventory in light of current market conditionsand market trends and records reserves for quantities in excess of demand andproduct obsolescence. The evaluation may take into consideration historicusage, expected demand, anticipated sales price, the stage in the product lifecycle of its customers’ products, new product development schedules, the effectnew products might have on the sale of existing products, product obsolescence,customer design activity, customer concentrations, product merchantability andother factors. Market conditions are subject to change and actual consumptionof inventory could differ from forecasted demand. The Company’s semiconductorproducts have historically had an unusually long product life cycle andobsolescence has not been a significant factor in the valuation of inventories.However, as the Company pursues opportunities in the mobile market, its productlife cycle may be shorter and increase the potential for obsolescence. TheCompany also regularly reviews the cost of inventory against estimated marketvalue and records a lower of cost or market reserve for inventories that have acost in excess of estimated market value.

 

8

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** **

**Quicklogic corporation**

**Notes to condensed unaudited consolidatedfinancial statements — (****Continued)**

 

*Long-Lived Assets*

The Company reviews the recoverability of itslong-lived assets, such as property and equipment, prepaid wafer credits 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 the asset or asset group, an impairment loss is recognized for thedifference between the estimated fair value and the carrying value, and thecarrying value of the related assets is reduced by this difference. Themeasurement of impairment requires management to estimate future cash flows andthe fair value of long-lived assets.

 

*Comprehensive Income (Loss)*

 

Comprehensive income (loss) includes all changes inequity (net assets) during a period from non-owner sources. Comprehensiveincome (loss) for the Company has included realized and unrealized holdinggains or losses on its holdings of Tower ordinary shares. See Note 4.

 

*Stock-Based Compensation*

 

The Company accounts for stock-based compensationunder the provisions of Statement of Financial Accounting Standards (“SFAS”)No. 123 (revised 2004), “*Share-Based Payment*,”(“SFAS 123(R)”) and related interpretations which requires the measurement andrecognition of expense related to the fair value of stock-based compensationawards. Accordingly, stock-based compensation for awards other than restrictedstock awards (“RSAs”) and restricted stock units (“RSUs”) is measured at thegrant date and re-measured upon modification, as appropriate, based on the fairvalue of the award using the Black-Scholes option pricing model (“Black-Scholes”),and is recognized as expense over the requisite service period of the award.Stock-based compensation for RSAs and RSUs is equal to the closing price of theCompany’s common stock on the date of grant; RSA and RSU awards which vest withservice are expensed over the requisite service period. RSA and RSU awardswhich are expected to vest based on performance to a goal are expensed over theestimated vesting period. See Note 9.

 

*Foreign Currency Transactions*

 

All of the Company’ssales and cost of manufacturing are transacted in U.S. dollars. The Companyconducts a portion of its research and development activities in Canada andIndia and has sales and marketing activities in various countries outside ofthe United States. Most of these international expenses are incurred in localcurrency. Foreign currency transaction gains and losses are included ininterest income and other, net, as they occur. Operating expenses denominatedin foreign currencies were approximately 24% and 22% of total operatingexpenses for the first nine months of 2007 and 2006, respectively. The Companyincurred a majority of these foreign currency expenses in Canada. The Companyhas not used derivative financial instruments to hedge its exposure tofluctuations in foreign currency and, therefore, is susceptible to fluctuationsin foreign exchange gains or losses in its results of operations in futurereporting periods.

*Concentration of Credit Risk*

 

Financial instruments, which potentially subject theCompany to concentrations of credit risk, consist principally of cash and cashequivalents, investment in Tower and accounts receivable. Cash and cashequivalents are maintained with high quality institutions. See Note 4 forinformation regarding the Company’s investment in Tower. The Company’s accountsreceivable are denominated in U.S. dollars and are derived primarily from salesto customers located in North America, Europe and Asia Pacific. The Companyperforms ongoing credit evaluations of its customers and generally does notrequire collateral. See Note 11 for information regarding concentrationsassociated with accounts receivable.

 

*Warranty Costs*

 

The Company generally warrants finished goods againstdefects in material and workmanship under normal use for twelve monthsfrom the date of shipment. The Company does not have significant productwarranty related costs or liabilities. The one-time programmable nature ofQuickLogic’s products minimizes warranty costs.

 

9

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** **

**Quicklogic corporation**

**Notes to condensed unaudited consolidatedfinancial statements — (****Continued)**

 

***Recently Issued Accounting Pronouncements***

InSeptember 2006, the Financial Accounting Standards Board (“FASB”) issued SFASNo. 157, *“Fair Value Measurements,”*(“SFAS 157”). SFAS 157 establishes a framework for measuring fair value andexpands disclosures about fair value measurements. The changes to currentpractice resulting from the application of SFAS 157 relate to the definition offair value, the methods used to measure fair value and expanded disclosuresabout fair value measurements. SFAS 157 is effective for fiscal years beginningafter November 15, 2007 and interim periods within those fiscal years. TheCompany is currently evaluating the impact that SFAS 157 will have on itsconsolidated financial statements.

In February 2007, theFASB issued SFAS No. 159, *“The Fair ValueOption for Financial Assets and Financial Liabilities,*” (“SFAS 159”).SFAS 159 permits companies to choose to measure certain financial instrumentsand certain other items at fair value. The standard requires that unrealizedgains and losses on items for which the fair value option has been elected bereported in earnings. SFAS 159 is effective for fiscal years beginning afterNovember 15, 2007, although earlier adoption is permitted. The Company iscurrently evaluating the impact that SFAS 159 will have on its consolidatedfinancial statements.

 

**Note 3—Net Loss Per Share**

Basic net loss per share is computed by dividing netloss available to common stockholders by the weighted average number of commonshares outstanding during the period. Diluted net loss per share is computedusing the weighted average number of common shares outstanding during theperiod plus potentially dilutive common shares outstanding during the periodunder the treasury stock method. In computing diluted net loss per share, theaverage stock price for the period is used in determining the number of sharesassumed to be purchased from the exercise of stock options. A reconciliation ofthe basic and diluted per share computations is as follows (in thousands, exceptper share amounts):

 
| ** **               | ** ** | **Three Months Ended** | ** ** |
|--------------------------|------------|------------------------|------------|
| ** **               | ** ** | **September 30, 2007** | ** ** | **October 1, 2006** | ** ** |
| ** **               | ** ** | **Net Loss**           | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** | **Net Loss** | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** |
| Basic                    |       | $                      | (1,493     | ) | 29,116 |   | $ | (0.05 | ) | $ | (2,951 | ) | 28,678 |   | $ | (0.10 | ) |
| Effect of stock  options |       | —                 |       | — |   | — |   | — |   | — |   | — |   |
| Diluted                  |       | $                      | (1,493     | ) | 29,116 |   | $ | (0.05 | ) | $ | (2,951 | ) | 28,678 |   | $ | (0.10 | ) |
|                     |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                     |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| ** **               | ** ** | **Nine Months Ended**  | ** ** |
| ** **               | ** ** | **September 30, 2007** | ** ** | **October 1, 2006** | ** ** |
| ** **               | ** ** | **Net Loss**           | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** | **Net Loss** | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** |
| Basic                    |       | $                      | (9,464     | ) | 28,966 |   | $ | (0.33 | ) | $ | (5,878 | ) | 28,420 |   | $ | (0.21 | ) |
| Effect of stock  options |       | —                 |       | — |   | — |   | — |   | — |   | — |   |
| Diluted                  |       | $                      | (9,464     | ) | 28,966 |   | $ | (0.33 | ) | $ | (5,878 | ) | 28,420 |   | $ | (0.21 | ) |
|                          |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

For the third quarter and first nine months of 2007, 7.8million shares associated with equity awards outstanding and the estimatednumber of shares to be purchased under the current offering period of the 1999Employee Stock Purchase Plan were not included in the calculation of dilutednet loss per share, as they were considered antidilutive due to the net lossthe Company experienced during this period. For the third quarter and firstnine months of 2006, 6.2 million shares associated with options outstandingwere not included in the calculation of diluted net loss per share, as theywere considered antidilutive due to the net loss the Company experienced duringthis period.

 

**Note 4—Investment in TowerSemiconductor Ltd.**

On December 12, 2000, the Company entered intoseveral agreements with Tower, as amended, under which the Company agreed tomake a strategic investment in Tower of up to $25 million as part of Tower’splan to build and equip a new wafer fabrication facility. During 2001 and 2002,the Company paid a total of $21.3 million to Tower to fulfill itsinvestment requirements under the agreement. In partial consideration for theinvestment, the Company received 1,757,368 Tower ordinary shares with anoriginal cost of $16.6 million. Due to write-downs in

 

10

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** **

**Quicklogic corporation**

**Notes to condensed unaudited consolidatedfinancial statements — (****Continued)**

 

prior periods as a result of “other than temporary” declines in marketvalue, the adjusted cost of the Company’s Tower ordinary shares is$1.17 per share. The Company sold a portion of the Tower ordinary sharesin fiscal 2003.

 

As of September 30, 2007, the Company held 1,344,543available for sale Tower ordinary shares with an unrealized gain of $834,000recorded in accumulated other comprehensive income, representing the differencebetween the adjusted cost per share and $1.79 per share, their market value onthe last trading day of the reporting period. The Company plans to hold 450,000of the Tower ordinary shares in order to receive competitive product pricingunder the Agreement and has recorded these shares as a long-term investment onthe balance sheets. The remaining 894,543 shares are classified as a short-terminvestment on the balance sheets.

 

The Company also received$4.7 million in prepaid wafer credits in partial consideration for theinvestment. As of September 30, 2007, the prepaid wafer credits balance was$3.0 million. The Company has guaranteed capacity at Tower through atleast 2010. These credits are recorded within long-term other assets on thebalance sheets and can be applied toward wafer purchases from Tower at 15% ofthe value of purchases made through 2010.

**Note 5—Balance Sheet Components**
| ** **                                 | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                 | ** ** | **(in thousands)**      | ** ** |
| Inventory:                                 |       |                    |       |                        |       |
| Raw materials                              |       | $                       | 254        |                        | $          | 791 |   |
| Work-in-process                            |       | 4,008                   |       | 7,845                       |       |
| Finished goods                             |       | 576                     |       | 428                         |       |
|                                       |       | $                       | 4,838      |                        | $          | 9,064 |   |
|                                       |       |                    |       |                        |       |
| Other current  assets:                     |       |                    |       |                        |       |
| Prepaid expenses                           |       | $                       | 1,261      |                        | $          | 1,566 |   |
| Other                                      |       | 134                     |       | 328                         |       |
|                                       |       | $                       | 1,395      |                        | $          | 1,894 |   |
|                                       |       |                    |       |                        |       |
| Property and  equipment:                   |       |                    |       |                        |       |
| Equipment                                  |       | $                       | 14,401     |                        | $          | 13,477 |   |
| Software                                   |       | 9,384                   |       | 9,370                       |       |
| Furniture and  fixtures                    |       | 824                     |       | 824                         |       |
| Leasehold  improvements                    |       | 803                     |       | 803                         |       |
|                                       |       | 25,412                  |       | 24,474                      |       |
| Accumulated  depreciation and amortization |       | (20,626                 | )          | (18,994                     | )          |
|                                       |       | $                       | 4,786      |                        | $          | 5,480 |   |
|                                       |       |                    |       |                        |       |
| Other assets:                              |       |                    |       |                        |       |
| Prepaid wafer  credits                     |       | $                       | 2,953      |                        | $          | 3,634 |   |
| Other                                      |       | 189                     |       | 404                         |       |
|                                       |       | $                       | 3,142      |                        | $          | 4,038 |   |
|                                       |       |                    |       |                        |       |
| Accrued  liabilities:                      |       |                    |       |                        |       |
| Employee related  accruals                 |       | $                       | 1,775      |                        | $          | 1,150 |   |
| Other                                      |       | 869                     |       | 1,312                       |       |
|                                       |       | $                       | 2,644      |                        | $          | 2,462 |   |
|                                            |            |                         |            |                             |            |  |  |  |  |

 

11

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** **

**Quicklogic corporation**

**Notes to condensed unaudited consolidatedfinancial statements — (****Continued)**

 

**Note 6—Obligations**
| ** **                                             | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                             | ** ** | **(in thousands)**      | ** ** |
|                                                   |       |                    |       |                        |       |
| Debt and capital  lease obligations:                   |       |                    |       |                        |       |
| Notes payable to  bank                                 |       | $                       | 1,930      |                        | $          | 2,526 |   |
| Capital leases                                         |       | 526                     |       | 1,384                       |       |
|                                                   |       | 2,456                   |       | 3,910                       |       |
| Current portion  of debt and capital lease obligations |       | (1,544                  | )          | (2,292                      | )          |
|                                                   |       | $                       | 912        |                        | $          | 1,618 |   |

 

*Revolving Line of Credit and NotesPayable to Bank*

Effective June 2006, the Company entered into aSecond Amended and Restated Loan and Security Agreement with Silicon ValleyBank. Terms of the agreement included a $5.0 million revolving line ofcredit that is available through June 2008 and an additional$2.0 million of borrowing capacity under the equipment line of credit thatwas available to be drawn against through June 2007. Advances under theequipment line of credit must be repaid in either 30 or 36 equal monthlyinstallments, depending upon the nature of the items financed. The agreementwas amended in June 2007 to include an additional $2.5 million of borrowingcapacity under the equipment line of credit that is available to be drawnagainst through June 2008 and provides that future advances under the equipmentline of credit be repaid in 36 equal monthly installments. Terms of the variousadvances under the agreement are as follows (in thousands):

 
| ** **                | ** ** | **Original  Balance** | ** ** | **Balance at  September 30,  2007** | ** ** | **Available  Credit** | ** ** | **Interest Rate**                   | ** **    | **Maturity Date**                                     |
|---------------------------|------------|-----------------------|------------|-------------------------------------|------------|-----------------------|------------|-------------------------------------|---------------|-------------------------------------------------------|
| Revolving Line of Credit: |       |                  |       |                                |       |                  |       |                                |          |                                                  |
| Non-formula  advances     |       | n/a                   |       | $                                   | —     |                  | $          | 5,000                               |          | Greater of Prime  + 0.50% or  8.50%                   |   | June 28, 2008 |
|                      |       |                  |       |                                |       |                  |       |                                |          |                                                  |
| Equipment Line of Credit: |       |                  |       |                                |       |                  |       |                                |          |                                                  |
|                      |       |                  |       |                                |       |                  |       |                                |          |                                                  |
| Notes payable             |       | $                     | 1,409      |                                | 40         |                  | n/a        |                                | Prime + 2.00% |                                                  | Multiple draws  maturing on or before  April 2008 |
| Notes payable             |       | 932                   |       | 466                                 |       | n/a                   |       | Prime + 1.75%                       |          | Multiple draws  maturing on or before  April 2009     |
| Notes payable             |       | 1,558                 |       | 1,031                               |       | n/a                   |       | Prime + 1.00%                       |          | Multiple draws  maturing on or before  September 2009 |
| Notes payable             |       | 442                   |       | 393                                 |       | n/a                   |       | Prime + 1.00%                       |          | Multiple draws  maturing on or before  May 2010  |
|                      |       |                  |       |                                |       |                  |       |                                |          |                                                  |
| Notes payable             |       | n/a                   |       | —                              |       | 2,500                 |       | Prime + 1.00%  or Treasury  + 4.00% |          | 36 months from  date of advance                       |
| Total                     |       |                  |       | $                                   | 1,930      |                  |       |                                |          |                                                  |   |
|                           |            |                       |            |                                     |            |                       |            |                                     |               |                                                       |  |  |  |

 

12

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** **

**Quicklogic corporation**

**Notes to condensed unaudited consolidatedfinancial statements — (****Continued)**

 

The bank has a first priority security interest insubstantially all of the Company’s tangible and intangible assets to secure anyoutstanding amounts under the agreement. Under the terms of the agreement, theCompany must maintain a minimum tangible net worth and adjusted quick ratio.The agreement also has certain restrictions including, among others, on theincurrence of other indebtedness, the maintenance of depository accounts, thedisposition of assets, mergers, acquisitions, investments, the granting ofliens and the payment of dividends. The Company was in compliance with thefinancial covenants of the agreement as of September 30, 2007.

 

At September 30, 2007, the prime rate under the creditfacility was 7.75%. As of September 30, 2007 and December 31, 2006,$886,000 and $1.3 million, respectively, of amounts outstanding under theequipment line of credit were classified as long-term obligations.

 

*Capital Lease*

In December 2005, the Company leased design softwareand related maintenance under a two-year capital lease at an imputed interestrate of 8.5% per annum. Terms of the agreement require the Company to makequarterly payments of approximately $204,000 through November 2007. The Companyrecorded a capital asset for $1.2 million that is being depreciated overthe term of the agreement, prepaid maintenance of $272,000 that is beingamortized over the term of the agreement and a capital lease obligation of$1.5 million. As of September 30, 2007, $200,000 was outstanding under thecapital lease, zero of which was classified as a long-term obligation.

 

In January 2006, the Company leased designsoftware tools and related maintenance under a three-year capital lease at animputed interest rate of 9.0% per annum. Terms of the agreement require theCompany to make semi-annual payments of approximately $148,000 through July2008. The Company recorded a capital asset for $633,000 that is beingdepreciated over the term of the agreement, prepaid maintenance of $158,000that is being amortized over the term of the agreement and a capital leaseobligation of $791,000. As of September 30, 2007, $277,000 was outstandingunder the capital lease, zero of which was classified as a long-termobligation.

 

In the fourth quarter of 2006, the Company enteredinto a capital lease obligation in the amount of $77,000 to finance designsoftware. The capital lease obligation has an imputed interest rate of 9.25%per annum and is being repaid in annual amounts of $28,000 through January2009. As of September 30, 2007, $49,000 was outstanding under the capitallease, $26,000 of which was classified as a long-term obligation.

 

**Note 7—Deferred Royalty Revenue**

In October 2000, the Company entered into atechnology license and wafer supply agreement with Aeroflex Incorporated (“Aeroflex”).Under the terms of the agreement, the Company received $750,000 of prepaidroyalties. In addition, Aeroflex receives a prepaid royalty credit for a portionof the amounts paid for wafers purchased from the Company under the agreement.As of September 30, 2007 and December 31, 2006, the Company had recordedapproximately $548,000 and $960,000, respectively, of deferred royalty revenueunder this agreement which is classified as a current liability. The Companyrecognized $520,000 and zero royalty revenue in the first nine months of 2007and 2006, respectively.

 

**Note 8—Employee Stock Plans**

*1989 Stock Option Plan*

The 1989 Stock Option Plan (the “1989 Plan”) providedfor the issuance of incentive and nonqualified options for the purchase of upto 4.6 million shares of common stock. Options granted under the 1989 Plan havea term of up to ten years, and typically vest at a rate of 25% of thetotal grant per year over a four-year period. In September 1999, theCompany adopted the 1999 Stock Plan and no further stock option grants weremade under the 1989 Plan.

 

*1999 Stock Plan*

The 1999 Stock Plan (the “1999 Plan”) was adopted bythe Board of Directors in August 1999 and was approved by the Company’sstockholders in September 1999. The Company may issue stock options, RSAsor RSUs under the terms of the 1999 Plan. As of September 30, 2007,approximately 14.8 million shares were reserved for issuance under the 1999Plan. In addition, each January an annual increase is added to the 1999 Planequal to the

 

13

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** **

**Quicklogic corporation**

**Notes to condensed unaudited consolidatedfinancial statements — (****Continued)**

 

lesser of (i) 5,000,000 shares, (ii) 5% of the Company’soutstanding shares on such date, or (iii) a lesser amount determined bythe Board of Directors. Equity awards that are cancelled, forfeited orrepurchased under the 1989 Plan also become available for grant under the1999 Plan. Equity awards granted under the 1999 Plan have a term ofup to ten years. Options typically vest at a rate of 25% one year afterthe vesting commencement date, and one forty-eighth for each month of servicethereafter. During the third quarter of 2007, the Company granted performancebased RSUs which will vest upon achievement of a revenue goal. The Company hasimplemented a different vesting schedule in the past and may implementdifferent vesting schedules in the future with respect to any new equityawards.

 

*Employee Stock Purchase Plan*

The 1999 Employee Stock Purchase Plan (“ESPP”) wasadopted by the Board of Directors in August 1999 and was approved by theCompany’s stockholders in September 1999. As of September 30, 2007,approximately 6.3 million shares were reserved for issuance under theESPP. In addition, each August an annual increase is added to the ESPP equal tothe lesser of (i) 1,500,000 shares, (ii) 4% of the Company’soutstanding shares on such date, or (iii) a lesser amount determined bythe Board of Directors.

The Board of Directors amended the ESPP in November2005 to provide for six-month offering periods. Participants purchase sharesthrough payroll deductions of up to 20% of an employee’s total compensation(maximum of 20,000 shares per offering period). The amended ESPP permits theBoard of Directors to determine, prior to each offering period, whetherparticipants purchase shares at: (i) 85% of the fair market value of the commonstock at the end of the offering period; or (ii) 85% of the lower of the fairmarket value of the common stock at the beginning or the end of an offeringperiod. The Board of Directors has determined that, until further notice,future offering periods will be made at 85% of the lower of the fair marketvalue of the common stock at the beginning or the end of an offering period.

 

**Note 9—Stock-Based Compensation**

Effective January 2, 2006, the Company adoptedthe provisions of SFAS 123(R) which requires the measurement andrecognition of expense related to the fair value of stock-based compensationawards made to employees and directors over the requisite service period. UnderSFAS 123(R), stock-based compensation expense is recognized in the Company’sconsolidated statements of operations and includes: (i) compensationexpense for stock-based compensation awards granted prior to, but not yetvested as of January 1, 2006, based on the grant date fair value estimatedand re-measured upon modification in accordance with the pro forma provisionsof SFAS 123, and (ii) compensation expense for the stock-basedcompensation awards granted or modified subsequent to January 1, 2006,based on the grant date fair value estimated in accordance with the provisionsof SFAS 123(R). The impact of SFAS 123(R) on the Company’s consolidatedfinancial statements for the third quarter and first nine months of 2007 and2006 was as follows (in thousands):

 
| ** **                           | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **September 30,  2007** | ** ** | **October 1,  2006**  | ** ** | **September 30,  2007** | ** ** | **October 1,  2006** | ** ** |
| Cost of revenue                      |       | $                       | 67         |                  | $          | 36 |   | $ | 176 |   | $ | 138 |   |
| Research and  development            |       | 94                      |       | 57                    |       | 273 |   | 321 |   |
| Selling, general  and administrative |       | 291                     |       | 197                   |       | 812 |   | 686 |   |
| Total costs and  expenses            |       | $                       | 452        |                  | $          | 290 |   | $ | 1,261 |   | $ | 1,145 |   |

 

The amount ofstock-based compensation included in inventory for the third quarter and firstnine months of 2007 and 2006 was not material.

 

14

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** **

**Quicklogic corporation**

**Notes to condensed unaudited consolidatedfinancial statements — (****Continued)**

 

*Valuation Assumptions*

SFAS 123(R) requires companies to estimatethe fair value of stock-based compensation awards, other than RSA and RSUawards, on the grant date using an option pricing model. As required bySFAS 123(R), the Company has made an estimate of expected forfeitures andis recognizing compensation costs only for those equity awards expected tovest. The Company measures the fair value of stock-based compensation awards,other than RSA and RSU awards, using the Black-Scholes option pricing model.Black-Scholes, as well as other currently accepted option valuationmodels, was developed to estimate the fair value of freely tradable, fullytransferable options without vesting restrictions. These assumptions differsignificantly from the characteristics of the Company’s stock-basedcompensation awards. Black-Scholes also requires the use of highly subjective,complex assumptions, including expected term and the price volatility of theCompany’s stock. The estimated fair value of RSAs and RSUs is equal to theclosing price of the Company’s common stock on the date of grant; awards whichvest with service are expensed over the requisite service period. RSA and RSUawards which are expected to vest based on performance to a goal are expensedover the estimated vesting period.

 

The following weighted average assumptions areincluded in the estimated fair value calculations for stock option grants:

 
| ** **               | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended** | ** ** |
|--------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **September 30,  2007** | ** ** | **October 1,  2006**  | ** ** | **September 30,  2007** | ** ** | **October 1,  2006** | ** ** |
| Expected term  (years)   |       | 5.07                    |       | 5.75                  |       | 5.09 |   | 5.75 |   |
| Risk-free  interest rate |       | 4.51                    | %          | 4.74                  | %          | 4.62 | % | 4.80 | % |
| Volatility               |       | 80.00                   | %          | 82.00                 | %          | 80.00 | % | 82.00 | % |
| Dividend yield           |       | —                  |       | —                |       | — |   | — |   |

 

The methodologies for determining theabove values were as follows:

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

•                  *Risk-free interest rate:* The risk-free interest rate assumptionis based upon the observed interest rate appropriate for the expected term ofthe Company’s employee stock options.

•                  *Volatility:* The Company determines expectedvolatility based primarily on historical volatility of the Company’s commonstock.

•                  *Dividend yield:* The dividend yield assumption is basedon the Company’s intent not to issue a dividend under its dividend policy.

The weighted average estimated fair value for optionsgranted during the third quarter of 2007 and 2006 was $2.35 and $2.08 peroption, respectively. The weighted average estimated fair value for optionsgranted during the first nine months of 2007 and 2006 was $2.10 and $2.98 peroption, respectively. As of the end of the third quarter of 2007, the fairvalue of unvested stock options, net of expected forfeitures, was $3.3 millionwhich is expected to be recognized over the next four years.

 

15

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** **

**Quicklogic corporation**

**Notes to condensed unaudited consolidatedfinancial statements — (****Continued)**

 

*Stock-Based Compensation AwardActivity*

 

The following table summarizes stock-basedcompensation award activity under the 1989 Plan and the 1999 Plan for the firstnine months of 2007 and fiscal year 2006:

 
| ** **                         | ** ** | ** **                                | ** ** | **Options Outstanding**   | ** ** |
|------------------------------------|------------|-------------------------------------------|------------|--------------------------------|------------|
| ** **                         | ** ** | **Shares  Available for Grant** | ** ** | **Number of Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** |
| ** **                         | ** ** | **(in thousands)**                   | ** ** | **(in thousands)**        | ** ** | ** ** | ** ** |
| Balance at  January 2, 2006        |       | 6,658                                     |       | 6,735                          |       | $ | 5.37 |   |
| Authorized                         |       | 1,394                                     |       | —                         |       | — |   |
| Granted                            |       | (1,711                                    | )          | 1,711                          |       | 3.25 |   |
| Forfeited or  expired              |       | 284                                       |       | (284                           | )          | 9.02 |   |
| Exercised                          |       | —                                    |       | (698                           | )          | 3.07 |   |
| Balance at  December 31, 2006 |       | 6,625                                     |       | 7,464                          |       | 4.97 |   |
| Authorized                         |       | 1,434                                     |       | —                         |       | — |   |
| Options granted                    |       | (424                                      | )          | 424                            |       | 3.11 |   |
| RSAs and RSUs  granted             |       | (961                                      | )          | —                         |       | — |   |
| Forfeited or  expired              |       | 933                                       |       | (933                           | )          | 6.43 |   |
| Exercised                          |       | —                                    |       | (309                           | )          | 1.89 |   |
| Balance at  September 30, 2007     |       | 7,607                                     |       | 6,646                          |       | $ | 4.79 |   |

 

        For thefirst nine months of 2007, the Company granted an aggregate of 32,000 fullyvested restricted stock awards and 929,000 restricted stock units under the1999 Plan.  Refer to the table below fora summary of the Company’s restricted stock award and restricted stock unitactivity.

 

The total intrinsic value of options exercised duringthe third quarter of 2007 and 2006 was $55,000 and $27,000 respectively. Thetotal intrinsic value of options exercised during the first nine months of 2007and 2006 was $345,000 and $1.6 million, respectively. Total cash received fromemployees as a result of employee stock option exercises during the thirdquarter and first nine months of 2007 was approximately $140,000 and $585,000,respectively. Total cash received from employees as a result of employee stockoption exercises during the third quarter and first nine months of 2006 wasapproximately $25,000 and $2.1 million, respectively. The Company settlesemployee stock option exercises, restricted stock awards and restricted stockunits that vest with newly issued common shares. In connection with the issuanceof these shares, there was no tax benefit realized by the Company due to theCompany’s current loss position.

 

*Restricted Stock Awards andRestricted Stock Units*

 

The Company began issuing RSAs in the second quarterof 2007 and RSUs in the third quarter of 2007. A summary of the Company’s RSAand RSU activity and related information are as follows:

 
| ** **                         | ** ** | **RSAs and RSUs Outstanding** | ** ** |
|------------------------------------|------------|------------------------------------|------------|
| ** **                         | ** ** | **Number of Shares**     | ** ** | **Weighted Average  Grant Date Fair Value** | ** ** |
| ** **                         | ** ** | **(in thousands)**            | ** ** | ** ** | ** ** |
| Balance at  December 31, 2006 |       | —                             |       | $ | — |   |
| Granted                            |       | 961                                |       | 3.58 |   |
| Exercised/Issued                   |       | (32                                | )          | 3.05 |   |
| Forfeited                          |       | —                             |       | — |   |
| Balance at  September 30, 2007     |       | 929                                |       | $ | 3.60 |   |

 

16

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** **

**Quicklogic corporation**

**Notes to condensed unaudited consolidatedfinancial statements — (****Continued)**

 

The outstanding balance at September30, 2007 consists of performance based RSUs; the $3.3 million fair value ofthese awards will be expensed over the next fifteen months based on the numberof awards which vest.

*Employee Stock Purchase Plan*

The offering period ending May 2006 under the ESPP providedthat shares were purchased at 85% of the fair market value of the common stockat the end of the offering period. Accordingly, the fair value of stock-basedcompensation awards under the ESPP was recognized based upon employeedeductions and the purchase discount, rather than using a pricing model.Stock-based compensation relating to the ESPP was $8,000 and $77,000 in thethird quarter and first nine months of 2006, respectively. The purchasediscount of rights issued pursuant to the Company’s ESPP during the thirdquarter and first nine months of 2006 was $0.84 per right.

The Company cancelled the offering period endedNovember 2006 due to its internal review of stock option granting practices andrelated accounting.

 

The offering period ending May 14, 2007 commenced onJanuary 24, 2007, once the Company had completed its stock option review andwas current with its filings as required by the Securities and ExchangeCommission (“SEC”) and Nasdaq. The current offering period ending November 14,2007 is a standard six-month offering period. Employees participating in theseoffering periods purchase common stock at 85% of the lower of the fair marketvalue of the common stock at the beginning or the end of the offering period.Stock-based compensation relating to the ESPP was $110,000 and $273,000 in thethird quarter and first nine months of 2007, respectively. The weighted averageestimated fair value, as defined by SFAS 123(R), of rights issued pursuant tothe Company’s ESPP during the third quarter and first nine months of 2007 was$0.90 and $0.88 per right, respectively.

 

The following weighted average assumptions areincluded in the estimated fair value calculations for rights to purchase stockunder the ESPP as of the grant date:

 

| ** **               | ** ** | **Three Months Ended  September 30, 2007** | ** ** | **Nine Months Ended  September 30, 2007** | ** ** |
|--------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| Expected life  (months)  |       | 6.                                         | 0          |                                      | 5.         | 1 |   |
| Risk-free  interest rate |       | 5.                                         | 00         | %                                         | 5.         | 00 | % |
| Volatility               |       | 55.                                        | 00         | %                                         | 55.        | 00 | % |
| Dividend yield           |       | —                                     |       |                                      | —     |   |   |

 

The methodologies fordetermining the above values were as follows:

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

•                  *Risk-free interest rate:*The risk-free interest rate assumption isbased upon the observed interest rate appropriate for the term of the purchaseperiod.

•                  *Volatility:*The Company determines expectedvolatility based primarily on historical volatility of the Company’s commonstock for the term of the purchase period.

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

 

**Note 10—IncomeTaxes**

In the third quarter of 2007 and2006, the Company recorded income tax expense of $29,000 and $23,000, respectively, which consisted primarily of income taxes onforeign operations. In the first nine months of 2007 and 2006, the Companyrecorded income tax expense of $71,000 and $46,000, respectively, whichconsisted primarily of income taxes on foreign operations.

 

Due to the uncertainties surrounding the realizationof the deferred tax assets resulting from the Company’s accumulated deficit andnet tax losses in previous years, the Company has provided a full valuationallowance against the associated deferred tax assets. The Company will continueto assess the realizability of the deferred tax assets in future periods.

 

17

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** **

**Quicklogic corporation**

**Notes to condensed unaudited consolidatedfinancial statements — (****Continued)**

 

At December 31,2006, the Company had net operating loss carryforwards for federal and stateincome tax purposes of approximately $82.2 million and $19.1 million,respectively. These carryforwards, if not utilized to offset future taxableincome and income taxes payable, will expire beginning in 2007 for federal andstate purposes. Included in the net operating loss carryforward amount is $4.3million and $3.1 million for federal and state income tax purposes,respectively, of stock option deductions that, when recognized, will result ina credit to stockholders’ equity.

OnJanuary 1, 2007, the Company adopted the provisions of FASB Interpretation No.48, *“Accounting for Uncertainty in IncomeTaxes”* (“FIN 48”), an interpretation of FASB Statement No. 109 (“SFAS109”). FIN 48 addressed the determination of how tax benefitsclaimed or expected to be claimed on a tax return should be recorded in theconsolidated financial statements. Under FIN 48, the Company must recognize thetax benefit from an uncertain tax position only if it is more likely than notthat the tax position will be sustained on examination by the taxingauthorities, based on the technical merits of the position. The tax benefitsrecognized in the consolidated financial statements from such a position aremeasured based on the largest benefit that has a greater than 50% likelihood ofbeing realized upon ultimate resolution. TheCompany did not recognize material additional liability as a result of theimplementation of FIN 48. The Company had approximately $111,000 ofunrecognized tax benefits at January 1, 2007, the adoption date. The Companyrecognizes interest and penalties related to uncertain tax positions in incometax expense. As of January 1, 2007, the Company had approximately $9,000 ofaccrued interest and penalties related to uncertain tax positions.There were nosignificant changes to any of these amounts during the first nine months of2007. In May 2007, the FASB issued FASB Staff Position (“FSP”) FIN 48-1 “Definitionof Settlement in FASB Interpretation No. 48” (“FSP FIN 48-1”) relating to FIN48. The Company has applied the provisions of FSP FIN48-1 in its adoption ofFIN 48.

TheCompany is no longer subject to U.S. federal, state and non-U.S. income taxaudits by taxing authorities for fiscal years through 1992. The Companyestimates that any unrecognized tax benefit will not change significantlywithin the next twelve months.

Under the Tax Reform Act of 1986, the amount of andthe benefit from net operating losses that can be carried forward may beimpaired in certain circumstances. Events which may cause changes in theCompany’s tax carryforwards include, but are not limited to, a cumulativeownership change of more than 50% over a three year period. Since inception,the Company has had cumulative changes in ownership which will limit the losscarryforward deduction under IRC Section 382. However, the Companybelieves that such limitations will not have a material effect on the futureutilization of losses.

 

Enacted in October 2004,Section 409A of the Internal Revenue Code significantly changed the rules fornonqualified deferred compensation plans. Section 409A imposes certainrestrictions on stock awards that constitute deferred compensation. As a resultof the Company’s stock option review in 2006, the Board of Directors modifiedoptions granted to two executive officers that resulted in an increase to theirexercise price in order to eliminate any additional tax exposure under Section409A and thereby maintain the incentive value of the options. The Companybelieves that the implications of Section 409A on grants with intrinsic valuethat vested after December 31, 2004 and modifications made to existing grantsafter October 3, 2004, along with potential remedial actions, is not materialto its consolidated financial statements.

 

18

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** **

**Quicklogic corporation**

**Notes to condensed unaudited consolidatedfinancial statements — (****Continued)**

 

**Note 11—Information ConcerningProduct Lines, Geographic Information and Revenue Concentration**

The Company identifies its business segments based onbusiness activities, management responsibility and geographic location. For allperiods presented, the Company operated in a single business segment.

 

The following is a breakdown of revenue by productfamily (in thousands):

 
| ** **                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **September 30, 2007** | ** ** | **October 1, 2006**   | ** ** | **September 30, 2007** | ** ** | **October 1, 2006** | ** ** |
| *Revenue  by product family*(1)*:* | * *   | * *               | * *   | * *              | * *   | * * | * * | * * | * * |
| New products                       |       | $                      | 1,620      |                  | $          | 2,135 |   | $ | 2,837 |   | $ | 5,376 |   |
| Mature products                    |       | 4,536                  |       | 4,297                 |       | 12,418 |   | 13,398 |   |
| End-of-life  products              |       | 2,869                  |       | 2,166                 |       | 8,417 |   | 8,406 |   |
| Total revenue                      |       | $                      | 9,025      |                  | $          | 8,598 |   | $ | 23,672 |   | $ | 27,180 |   |

----

                        (1)  TheCompany changed the definition of its product families in the third quarter of2007 and has restated prior periods to conform with the new definitions. Newproducts include ArcticLink, PolarPro, Eclipse II and QuickPCI II products.Mature products include pASIC® 3, QuickRAM, Eclipse, QuickDSP andQuickFC products, as well as royalty revenue, programming hardware and designsoftware. End-of-life products include pASIC 1, pASIC 2, V3, QuickMIPS andQuickPCI products.

The following is a quarterly breakdown of revenue byproduct family for 2007 and 2006 (in thousands):

 
| ** **                    | ** ** | **Three Months Ended**  | ** ** |
|-------------------------------|------------|-------------------------|------------|
| ** **                    | ** ** | **September 30,  2007** | ** ** | **July 1,  2007** | ** ** | **April 1,  2007** | ** ** |
| *Revenue  by product family:* | * *   | * *                | * *   | * * | * * | * * | * * |
| New products                  |       | $                       | 1,620      |   | $ | 611 |   | $ | 606 |   |
| Mature products               |       | 4,536                   |       | 4,376 |   | 3,506 |   |
| End-of-life  products         |       | 2,869                   |       | 3,418 |   | 2,130 |   |
| Total revenue                 |       | $                       | 9,025      |   | $ | 8,405 |   | $ | 6,242 |   |

 
| ** **                    | ** ** | **Three Months Ended** | ** ** |
|-------------------------------|------------|------------------------|------------|
| ** **                    | ** ** | **December 31,  2006** | ** ** | **October 1,  2006** | ** ** | **July 2,  2006** | ** ** | **April 2,  2006** | ** ** |
| *Revenue  by product family:* | * *   | * *               | * *   | * * | * * | * * | * * | * * | * * |
| New products                  |       | $                      | 1,171      |   | $ | 2,135 |   | $ | 2,225 |   | $ | 1,016 |   |
| Mature products               |       | 4,062                  |       | 4,297 |   | 4,571 |   | 4,530 |   |
| End-of-life  products         |       | 2,511                  |       | 2,166 |   | 2,453 |   | 3,787 |   |
| Total revenue                 |       | $                      | 7,744      |   | $ | 8,598 |   | $ | 9,249 |   | $ | 9,333 |   |

 

The following is a breakdown of revenue by shipmentdestination (in thousands):

 
| ** **               | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended** | ** ** |
|--------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **September 30,  2007** | ** ** | **October 1,  2006**  | ** ** | **September 30,  2007** | ** ** | **October 1,  2006** | ** ** |
| *Revenue  by geography:* | * *   | * *                | * *   | * *              | * *   | * * | * * | * * | * * |
| United States            |       | $                       | 4,133      |                  | $          | 3,680 |   | $ | 11,031 |   | $ | 11,723 |   |
| Europe                   |       | 1,961                   |       | 3,435                 |       | 4,507 |   | 9,481 |   |
| Japan                    |       | 794                     |       | 584                   |       | 2,152 |   | 2,526 |   |
| Taiwan                   |       | 805                     |       | 77                    |       | 1,394 |   | 213 |   |
| China                    |       | 433                     |       | 464                   |       | 1,234 |   | 1,584 |   |
| Rest of North  America   |       | 386                     |       | 202                   |       | 2,638 |   | 1,140 |   |
| Rest of Asia  Pacific    |       | 513                     |       | 156                   |       | 716 |   | 513 |   |
| Total revenue            |       | $                       | 9,025      |                  | $          | 8,598 |   | $ | 23,672 |   | $ | 27,180 |   |

 

19

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** **

**Quicklogic corporation**

**Notes to condensed unaudited consolidatedfinancial statements — (****Continued)**

 

The followingdistributors and customers accounted for 10% or more of the Company’s revenuefor the periods presented: 
| ** **                         | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **September 30,  2007** | ** ** | **October 1,  2006**  | ** ** | **September 30,  2007** | ** ** | **October 1,  2006** | ** ** |
| Distributor “A”          |       | 24                      | %          | 28                    | %          | 22 | % | 28 | % |
| Distributor “B”          |       | 16                      | %          | 10                    | %          | 17 | % | 12 | % |
| Customer “A” —  OEM |       | *                       |       | 15                    | %          | 11 | % | 13 | % |
| Customer “B” —  OEM |       | *                       |       | 18                    | %          | * |   | 14 | % |

----

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

 

The followingdistributors and customers accounted for 10% or more of the Company’s accountsreceivable as of the dates presented: 
| ** **                         | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------|------------|-------------------------|------------|------------------------|------------|
| Distributor “A”          |       | 29                      | %          | 15                     | %          |
| Distributor “B”          |       | 16                      | %          | *                      |       |
| Customer “B” —  OEM |       | *                       |       | 12                     | %          |
| Customer “C” —  OEM |       | 11                      | %          | *                      |       |
| Customer “D” —  OEM |       | *                       |       | 13                     | %          |
| Customer “E” —  OEM |       | *                       |       | 11                     | %          |

----

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

 

As of September 30, 2007, less than 10% of the Company’slong-lived assets, including property and equipment and other assets, werelocated outside the United States.

 

**Note 12—Commitments**

Certain of the Company’s wafer manufacturers requirethe Company to forecast wafer starts several months in advance. The Company iscommitted to take delivery of and pay for a portion of forecasted wafervolume. As of September 30, 2007 and December 31, 2006, the Companyhad $6.9 million and $2.1 million, respectively, of outstandingcommitments for the purchase of wafer inventory.

 

The Company leases, with an option to renew, itsprimary facility under a non-cancelable operating lease that expires in March2009. In addition, the Company rents development facilities in Canada and Indiaas well as sales offices in Europe and Asia. Total rent expense, net ofsublease income, for the third quarter of 2007 and 2006 was approximately$225,000 and $210,000, respectively, and rent expense for the first nine monthsof 2007 and 2006 was approximately $665,000 and $640,000, respectively. TheCompany has subleased a portion of its primary facilities to a tenant untilMarch 2009.

 

**Note 13—Litigation**

On October 26, 2001,a putative securities class action was filed in the U.S. District Court for theSouthern District of New York against certain investment banks that underwroteQuickLogic’s initial public offering, QuickLogic and some of QuickLogic’sofficers and directors. The complaint alleges excessive and undisclosedcommissions in connection with the allocation of shares of common stock inQuickLogic’s initial and secondary public offerings and artificially highprices through “tie-in” arrangements which required the underwriters’ customersto buy shares in the aftermarket at pre-determined prices in violation of thefederal securities laws. Plaintiffs seek an unspecified amount of damages onbehalf of persons who purchased QuickLogic’s stock pursuant to the registrationstatements between October 14, 1999 and December 6, 2000. Variousplaintiffs have filed similar actions asserting virtually identical allegationsagainst over 300 other public companies, their underwriters, and their officersand directors arising out of each company’s public offering. These actions,including the action against QuickLogic, have been coordinated for pretrialpurposes and captioned *In re Initial PublicOffering Securities Litigation, 21 MC 92*. In June 2004, astipulation of settlement and release of claims against the issuer defendants,

 

20

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** **

**Quicklogic corporation**

**Notes to condensed unaudited consolidatedfinancial statements — (****Continued)**

 

including QuickLogic, was submitted to the court for approval. OnAugust 31, 2005, the court preliminarily approved the settlement. InDecember 2006, the appellate court overturned the certification of classes inthe six test cases that were selected by the underwriter defendants andplaintiffs in the coordinated proceedings. Because class certification was acondition of the settlement, it was unlikely that the settlement would receivefinal Court approval. On June 25, 2007, the Court entered an order terminatingthe proposed settlement based upon a stipulation among the parties to thesettlement. Plaintiffs have filed amended master allegations and amendedcomplaints in the six test cases for class certification. It is uncertainwhether there will be any revised or future complaints. If a settlement doesnot occur and litigation against QuickLogic continues, the Company intends to defendthe case vigorously.

 

OnNovember 2, 2006 and November 29, 2006, purported shareholder derivativecomplaints were filed against certain of the Company’s current and formerofficers and directors in the U.S. District Court for the Northern District ofCalifornia.  The complaints alleged thatthe individual defendants had violated the federal securities laws and breachedtheir duties to the Company in connection with the granting and/or receipt ofoptions for Company stock. The complaints named the Company as a nominaldefendant and sought unspecified monetary damages against the individualdefendants as well as various forms of injunctive relief.  On August 7, 2007, the parties submitted tothe Court a stipulation and proposed order to dismiss the case in its entiretyand without prejudice.  On August 13,2007, the Court entered the order dismissing the case in its entirety andwithout prejudice.

 

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, the Company is involved in legalactions arising in the ordinary course of business, including but not limitedto intellectual property infringement and collection matters. Absoluteassurance cannot be given that third party assertions will be resolved withoutcostly litigation in a manner that is not adverse to the Company’s financialposition, results of operations or cash flows or without requiring royalty orother payments in the future which may adversely impact gross profit.

 

**Note 14—ShelfRegistration Statement**

On July 12, 2005, the Company filed a shelfregistration statement on Form S-3, which was declared effective onJuly 26, 2005 by the SEC.  The Companysubsequently suspended the use of the shelf registration statement after thevoluntary internal review of historical stock option granting practices andrelated accounting caused delays in the filing of its periodic reports with theSEC. The Company expects to be eligible to use the shelf registration statementagain on January 10, 2008, at which time it will have timely filed all periodicreports during the preceding 12 months. Under the shelf registration statement, the Company has the ability toraise up to $30.0 million, in one or more transactions, by selling commonstock, preferred stock, depositary shares, or warrants. As ofSeptember 30, 2007, the Company had not raised any funds in connectionwith this filing.  Under the SecuritiesOffering Reform of 2005, the Company may offer and sell securities registeredunder this shelf registration statement through November 30, 2008. 

 

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**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

*Thefollowing Management’s Discussion and Analysis of Financial Condition andResults of Operations, as well as information contained in “Risk Factors” inPart II, Item 1A and elsewhere in this Quarterly Report on Form 10-Q,contains “forward-looking statements” within the meaning of Section 27A ofthe Securities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended. We intend that these forward-lookingstatements be subject to the safe harbors created by those provisions.Forward-looking statements are generally written in the future tense and/or arepreceded by words such as “will,” “may,” “should,” “forecast,” “could,” “expect,”“suggest,” “believe,” “anticipate,” “intend,” “plan” or other similar words.Forward-looking statements include statements (1) regarding our revenuelevels, including the commercial success of our new products, and the effect ofour end-of-life products, (2) our gross profit and factors that affectgross profit, (3) our level of operating expenses, (4) our research anddevelopment efforts, (5) our liquidity, (6) our partners and suppliers and (7)industry trends. The following discussion should be read in conjunction withthe attached condensed unaudited consolidated financial statements and notesthereto, and with our audited consolidated financial statements and notesthereto for the fiscal year ended December 31, 2006, found in our AnnualReport on Form 10-K filed with the Securities and Exchange Commission, orSEC, on March 15, 2007 and with our condensed unaudited consolidatedfinancial statements and notes thereto for the quarters ended April 1, 2007 andJuly 1, 2007 found in our Quarterly Report on Form 10-Q filed with the SEC onMay 10, 2007 and August 10, 2007, respectively.*

 

*Theforward-looking statements contained in this Quarterly Report involve a numberof risks and uncertainties, many of which are outside of our control. Factorsthat could cause actual results to differ materially from projected resultsinclude, but are not limited to, risks associated with (1) the commercial andtechnical success of our new products such as ArcticLinkTM, PolarProTM, EclipseTMII and QuickPCI® II, (2) our successful introduction of products andsolutions incorporating emerging technologies or standards, (3) limitedvisibility into demand for our products including demand from significantcustomers or for new products, (4) the liquidity required to support our futureoperating and capital requirements, (5) our ability to accurately estimatequarterly revenue and (6) our dependence upon single suppliers to fabricate andassemble our products. Although we believe that the assumptions underlying theforward-looking statements contained in this Quarterly Report are reasonable,any of the assumptions could be inaccurate, and therefore there can be noassurance that such statements will be accurate. The risks, uncertainties andassumptions referred to above that could cause our results to differ materiallyfrom the results expressed or implied by such forward-looking statementsinclude, but are not limited to, those discussed under the heading “RiskFactors” in Part II, Item 1A hereto and the risks, uncertainties and assumptionsdiscussed from time to time in our other public filings and publicannouncements. All forward-looking statements included in this document arebased on information available to us as of the date hereof. In light of thesignificant uncertainties inherent in the forward-looking statements includedherein, the inclusion of such information should not be regarded as arepresentation by us or any other person that the results or conditionsdescribed in such statements or our objectives and plans will be achieved.Furthermore, past performance in operations and share price is not necessarilyindicative of future performance. We disclaim any intention or obligation toupdate or revise any forward-looking statements, whether as a result of newinformation, future events or otherwise.*

 

**Overview**

 

We develop and market low power programmable solutionsthat enable customers to add features to their mobile, consumer and industrialproducts. We are a fabless semiconductor company that operates in a singleindustry segment where we design and sell Customer Specific Standard Products,or CSSPs, Embedded Standard Products, or ESPs, Field Programmable Gate Arrays,or FPGAs, associated design software and programming hardware. CSSPs implementcustomer specific solutions as a standard product. Our ESP and FPGA devices arealso standard products that can be programmed to perform desired logicfunctions. In 1991, we introduced our first FPGA products based upon ourViaLink® technology. We believe that the underlying attributes ofour ViaLink technology, including low power consumption, high reliability,design security and design efficiency, enable us to deliver differentiatedsilicon solutions to our customers.

 

Consumer products are the new driver for semiconductorsales, and the needs of the consumer market bring a unique set of requirementsas compared to traditional FPGA markets. One important trend in the consumermarket is towards mobile, hand-held devices. Important industry trendsaffecting this market include the use of platforms to enable rapid productproliferation, miniaturization and the need to increase battery life. Anequally important trend is shrinking product life cycles, which drives a needfor faster, lower risk product development. And of course, there is intensepressure on the total product cost, including per unit component costs andnon-recurring development expenses. As more people experience the advantages ofa mobile lifestyle at home, they demand the same

 

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

 

advantages in theirprofessional lives. Therefore, we believe that these trends toward mobile,hand-held products which have a small form factor and maximize battery lifewill also be evident in the industrial, medical and military markets.

Wemarket a range of solutions to our customers, including:

•                  *Customer Specific Standard Products*, or CSSPs*,* incorporating our devices, intellectual property, or IP,and software drivers. These complete solutions are targeted at specific lowpower application segments that have similar connectivity and performancerequirements. Target customers value CSSPs for either of two primary reasons.Market leading companies seek to develop product platforms from which severalproducts can be introduced. For example, smartphone companies may plan tointroduce products offering mobile TV, WiMAX, Bluetooth 2.0 and UniversalSerial Bus 2.0 On-the-Go, or USB 2.0 OTG. These customers value our ability toprovide a range of products from a platform design by incorporating differentfeatures in the programmable fabric of our solution platforms. Other customersvalue the use of programmable fabric to address specific customer requirements.By providing customized solutions for these customers we increase their abilityto meet the time-to-market pressures associated with their markets;

•                  *Embedded Standard Products*, or ESPs,**incorporating a fixed function along with programmablelogic in a low power device. Our customers build on this “known good startingpoint” to develop unique solutions required for their products, whicheliminates the need to acquire and assemble industry standard IP, thus reducingdesign risk and improving time-to-market; and

•                  *Field Programmable Gate Arrays*, or FPGAs*,*which are general purpose FPGAs used by customers whovalue the low power consumption, high IP security, instant on and reliabilityof our devices.

This range of solutionsallows customers to acquire a solution tailored for their needs. Mobile productoriginal design manufacturers, or ODMs, tend to prefer a complete solution, andpurchase CSSPs. Other customers, such as a European cellular data cardmanufacturer, choose our ESP solutions, while military and gaming customerstend to prefer FPGAs.

 

Whether a customer uses our CSSPs as a completesolution, our ESPs as a “known good starting point” in their design, or ourFPGAs as a “blank slate” to design their unique application, we believe oursolutions and products enable system manufacturers to improve theirtime-to-market, lower total system power consumption and add features orperformance to their embedded applications. In addition, we believe that ourproducts and solutions provide our customers with the lowest power consumptionand highest IP security of all full featured FPGAs.

 

Ourpatented ViaLink metal-to-metal programmable technology is the foundation ofour competitive advantage in providing energy efficient devices and solutions thatdeliver high performance, high reliability, IP security and instant on featuresthat our customers value. Our ViaLink technology allows us to create devicessmaller than competitors’ products on comparable technology, 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 low power consumption. Ourarchitecture uses our ViaLink technology to maximize interconnects at everyrouting wire intersection, which allows more paths between logic cells. As aresult, system designers are able to use our devices with smaller gate countsto implement their designs than if they had used competing FPGAs. The abundanceof interconnect resources also provides a dense connection between theApplication Specific Standard Product, or ASSP, and the FPGA portions of CSSPsand ESPs.

Our CSSPs provide:

•                  *Proven System Solutions*— out-of-the-boxsolutions based on industry standard interfaces and intellectual property alongwith proven software and drivers;

•                  *Flexibility* — solutions can be combined as requiredto meet a customer’s specific needs;

•                  *Small Form Factor* — single chip solutions in packages assmall as 6x6 millimeters;

•                  *Instant On* — live at power up because ViaLink basedproducts require no configuration bit stream;

 

23

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

 

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

•                  *Unmatched IP Security* —it is virtually impossible to clone orreverse engineer designs implemented using our ViaLink technology.

Our PolarPro architecturebuilds on our low power Eclipse II architecture to provide lower powerconsumption and a more cost effective device. All PolarPro devices include thenew and innovative Very Low Power, or VLP, mode, power aware placement andglitch free clock gating. Based on our engineering analysis of portable mediaplayer applications, we believe designers using PolarPro can extend batterylife by as much as four times as compared to a standard product implementation,setting a new standard for low power consumption through the use ofprogrammable logic.

We announced our firstSolution Platform product offering, ArcticLink, in March 2007 and released theproduct to production in July 2007. Our Solution Platforms combine hard-wiredlogic and programmable fabric on one device. Adding hard-wired intellectualproperty enables us to deliver more logic, while the programmable fabric allowsus to provide CSSPs that can be rapidly customized to differentiate products,add features and reduce system development costs. This combination ofhard-wired and programmable fabric enables us to deliver low cost, small formfactor solutions that can be customized for particular customer or marketrequirements. The high routing density and flexibility of our ViaLinktechnology is critical to the efficient interface between the hard-wired logicand the programmable fabric. Market leading companies seek to develop productplatforms from which several products can be introduced. For example,smartphone companies may plan to introduce products offering mobile TV, WiMAX,Bluetooth 2.0 and USB 2.0 OTG. These customers value our Solution Platforms,since the programmable fabric can be used to introduce a range of products froma single platform design.

The low powerconsumption, high performance, small form factor and fast time-to-market of oursolutions are ideal for power sensitive mobile applications that need toefficiently integrate storage, networking and/or graphics capabilities. Theseproducts are being designed into applications for markets and customers thatare new to us. Examples of how our new customers have utilized our new productsare:

•                  s*martphones*— where our solutions enable the simultaneous display of video on the handsetand an external display;

•                  *portable navigationproducts*— whereour solutions allow the incorporation of the latest storage technology, managedNAND flash memory, and access to the latest high capacity SD cards andSecure/Digital Input/Output, or SDIO, based peripherals;

•                  *portable media players* — where our solutions allow a processorto access and efficiently control a micro hard disk drive;

•                  *cellular data cards* — where our solutions provide the lowestpower interface between a cellular radio and a laptop card slot; and

•                  *handheld point-of-sale, or POS,terminals* — whereour solutions enable high speed connectivity to Wi-Fi and BlueTooth chipsets aswell as storage connectivity*.*

Our new products are alsobeing designed into applications in our traditional markets, such as datacommunications, instrumentation and test and military-aerospace, wherecustomers value the low power consumption, instant-on, IP security, reliabilityand fast time-to-market of our products.

In addition to working directly with our customers, wepartner with other technology companies to develop additional intellectualproperty, reference platforms and system software to provide applicationsolutions. We work with processor manufacturers, such as Marvell TechnologyGroup Ltd. and Analog Devices, Inc., and companies that supply storage,networking or graphics components for embedded systems. The depth of theserelationships varies depending on the partner and the dynamics of the endmarket being targeted, but is typically a co-marketing program that includesjoint account calls, promotional activities and/or engineering collaboration,such as reference designs.

 

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

 

We sell programmed and unprogrammed products throughdistributors and directly to original equipment manufacturers, or OEMs. Werecognize revenue at the time of shipment of products directly to systemmanufacturers. However, we sell the majority of our products throughdistributors who earn a negotiated margin on the sale of our products. We deferrecognition of income from sales of unprogrammed products to distributors untilafter they have sold our products to systems manufacturers. We recognizerevenue on programmed products at the time of shipment to our distributors.During the first nine months of 2007 and 2006, approximately 57% and 52%,respectively, of the units shipped to our distributors were programmed by usand, accordingly, are not returnable. The percentage of sales derived throughdistributors was 59% and 54% in the first nine months of 2007 and 2006,respectively.

 

Two distributors, Avnet, Inc. and Future Electronics,accounted for 22% and 17% of revenue in the first nine months of 2007. Thesedistributors accounted for 28% and 12% of revenue in the first nine months of2006. We anticipate that a limited number of distributors will continue toaccount for a significant portion of our revenue and that individualdistributors could account for a larger portion of our revenue.

 

Our international sales were 53% and 57% of ourrevenue in the first nine months of 2007 and 2006, respectively. We expect thatrevenue from sales to international customers will continue to represent asignificant portion of our revenue. All of our sales originate in the UnitedStates and are denominated in U.S. dollars.

 

We outsource the wafer manufacturing, assembly andtesting of all of our products. We currently rely upon Taiwan SemiconductorManufacturing Company Ltd., or TSMC, Tower, Kawasaki Microelectronics, Inc. andSamsung Semiconductor, Inc. to manufacture our products, and we rely upon AmkorTechnology, Inc. and Unisem (M) Berhad to assemble, test and program ourproducts. Our wafer suppliers’ lead times are often as long as three months andsometimes longer. In addition, Tower requires us to provide them with a monthlywafer start forecast. Under the terms of our agreement with them, we arelimited in the quantity that we can increase or decrease our wafer forecast andwe are committed to take delivery of and pay for a minimum portion of theforecasted wafer volume. Our long manufacturing cycle times are at odds withour customers’ desire for short delivery lead times and, as a result, wetypically purchase wafers based on our internal forecasts of customer demand.

 

**CriticalAccounting Policies and Estimates**

The methods, estimates and judgments we use inapplying our most critical accounting policies have a significant impact on theresults we report in our consolidated financial statements. The SEC has definedcritical accounting policies as those that are most important to the portrayalof our financial condition and results of operations and require us to make ourmost difficult and subjective judgments, often as a result of the need tomake estimates of matters that are inherently uncertain. Based on thisdefinition, our critical policies include revenue recognition including salesreturns and allowances, inventory valuation including identification of excessquantities, market value and product obsolescence, allowance for doubtfulaccounts, valuation of investments, valuation of long-lived assets, measurementof stock-based compensation, accounting for income taxes and estimating accruedliabilities. We believe that we apply judgments and estimates in a consistentmanner and that such consistent application results in consolidated financialstatements and accompanying notes that fairly represent all periods presented.However, any factual errors or errors in these judgments and estimates may havea material impact on our statement of operations and financial condition.**For a discussion of critical accounting policies andestimates, please see Item 7 in our Annual Report on Form 10-K for thefiscal year ended December 31, 2006 filed with the SEC on March 15,2007.

 

25

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

 

**Results ofOperations**

 

The following table sets forth the percentage ofrevenue for certain items in our statements of operations for the periodsindicated:

 
| ** **                           | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **September 30,  2007** | ** ** | **October 1,  2006**  | ** ** | **September 30,  2007** | ** ** | **October 1,  2006** | ** ** |
| Revenue                              |       | 100.0                   | %          | 100.0                 | %          | 100.0 | % | 100.0 | % |
| Cost of revenue (1)                  |       | 47.8                    |       | 62.5                  |       | 57.8 |   | 49.1 |   |
| Gross profit                         |       | 52.2                    |       | 37.5                  |       | 42.2 |   | 50.9 |   |
| Operating  expenses:                 |       |                    |       |                  |       |   |   |   |   |
| Research and  development            |       | 26.0                    |       | 28.2                  |       | 29.4 |   | 26.4 |   |
| Selling, general  and administrative |       | 43.7                    |       | 46.5                  |       | 54.7 |   | 48.6 |   |
| Loss from  operations                |       | (17.5                   | )          | (37.2                 | )          | (41.9 | ) | (24.1 | ) |
| Interest expense                     |       | (0.8                    | )          | (0.8                  | )          | (1.0 | ) | (0.9 | ) |
| Interest income  and other, net      |       | 2.1                     |       | 3.9                   |       | 3.2 |   | 3.6 |   |
| Loss before  income taxes            |       | (16.2                   | )          | (34.1                 | )          | (39.7 | ) | (21.4 | ) |
| Provision for  income taxes          |       | 0.3                     |       | 0.2                   |       | 0.3 |   | 0.2 |   |
| Net loss                             |       | (16.5                   | )%         | (34.3                 | )%         | (40.0 | )% | (21.6 | )% |
|                                 |       |                    |       |                  |       |   |   |   |   |
|                                 |       |                    |       |                  |       |   |   |   |   |
| ** **                           | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended** | ** ** |
| ** **                           | ** ** | **September 30,  2007** | ** ** | **October 1,  2006**  | ** ** | **September 30,  2007** | ** ** | **October 1,  2006** | ** ** |
| *Revenue  by product family*(2)*:*   | * *   | * *                | * *   | * *              | * *   | * * | * * | * * | * * |
| New products                         |       | $                       | 1,620      |                  | $          | 2,135 |   | $ | 2,837 |   | $ | 5,376 |   |
| Mature products                      |       | 4,536                   |       | 4,297                 |       | 12,418 |   | 13,398 |   |
| End-of-life  products                |       | 2,869                   |       | 2,166                 |       | 8,417 |   | 8,406 |   |
| Total revenue                        |       | $                       | 9,025      |                  | $          | 8,598 |   | $ | 23,672 |   | $ | 27,180 |   |

 

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(1)       The third quarter of 2007 and 2006 include $309,000and $1.2 million of costs for inventory write-down and related charges, whichrepresent 3.4% and 14.1% of revenue, respectively. The first nine months of2007 and 2006 include $3.5 million and $1.7 million of costs for inventorywrite-down and related charges, which represent 14.9% and 6.2% of revenue,respectively.

(2)       The Company changed the definition of its productfamilies in the third quarter of 2007 and has restated prior periods to conformwith the new definitions. New products include ArcticLink, PolarPro, Eclipse IIand QuickPCI II products. Mature products include pASIC® 3, QuickRAM, Eclipse,QuickDSP and QuickFC products, as well as royalty revenue, programming hardwareand design software. End-of-life products include pASIC 1, pASIC 2, V3,QuickMIPS and QuickPCI products. See Note 11 in our Notes to CondensedUnaudited Consolidated Financial Statements for a quaterly breakdown of revenueby product family for 2007 and 2006.

**Three MonthsEnded September 30, 2007 and October 1, 2006**

 

*Revenue.*  Our revenue for the thirdquarter of 2007 was $9.0 million, representing an increase ofapproximately $430,000, or 5.0%, from revenue of $8.6 million in the thirdquarter of 2006. Our end-of-life product revenue increased by $700,000 comparedto the third quarter of 2006 as result of the end-of-life announced earlierthis year for our V3 and QuickPCI products, partially offset by a $580,000decrease in pASIC 1 and pASIC 2 product revenue. Our mature product revenueincreased by $240,000 compared to the third quarter of 2006 due to $300,000 inroyalty revenue recognized in the third quarter of 2007. These increases arepartially offset by a $510,000 decrease in new product revenue. In the thirdquarter of 2006, a European telecommunications customer, purchasing our EclipseII devices through a contract manufacturer, represented a significant portionof our new product revenue. This customer represented $1.5 million, or 18% ofour total revenue in the third quarter of 2006 and, due to the late stage oftheir product life cycle, only represented $270,000 of revenue in the thirdquarter of 2007. A domestic manufacturer of instrumentation and test equipment,purchasing primarily mature products, contributed nine percent and 15% of ourtotal revenue in the third quarter of 2007 and 2006, respectively. Avnet, Inc.and Future Electronics accounted for 24% and 16% of revenue in the thirdquarter of 2007. These two distributors accounted for 28% and 10% of revenue inthe third quarter of 2006.

 

26

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

 

Our revenue for the third quarter of 2007 was 7.4%higher sequentially, increasing by $620,000 to $9.0 million from$8.4 million in the second quarter of 2007. This sequential revenueincrease was primarily due to a $1.0 million increase in new product revenue asa result of an increase in our Eclipse II and PolarPro revenue. We had ourfirst significant CSSP revenue in the third quarter of 2007; target customersin the portable navigation device and smartphone/PDA markets purchased ourCSSPs in the quarter. CSSP revenue accounted for nearly 50% of the sequentialrevenue increase. This new product revenue increase was partially offset by a$550,000 decrease in end-of life product revenue.

 

Our decision to end-of-life our pASIC 1, pASIC 2 andV3 products has been driven by our suppliers. Our foundry agreement with thesupplier that fabricated our pASIC 1 and pASIC 2 products expired atthe end of 2005, and we announced an end-of-life for these products in 2004. Wehave no further manufacturing capacity for our pASIC 1 and pASIC 2 products andany future revenue is limited to inventory on hand. In January 2007, weannounced the end-of-life for our V3 products, primarily due to the loss ofmanufacturing capacity for these products, and asked our customers to takedelivery of lifetime buy orders before the end of 2007. We announced additionalend-of-life products as a result of our decision to focus on customers in the hand-heldmobile and military markets. In the second quarter of 2007, we announced theend-of-life of our QuickPCI products, due to assembly capacity considerations,and asked customers to take delivery of lifetime buy orders before the end of2007. In the fourth quarter of 2007, we announced the end-of-life of ourQuickMIPS products, due to a small customer base, and asked customers to takedelivery of these products between now and the first half of 2008. Due to thenature of end-of-life purchases, revenue levels from these products couldfluctuate significantly on a sequential basis.

 

The following is a breakdown of end-of-life productrevenue (in thousands):

 
| ** **                 | ** ** | **Three Months Ended**  | ** ** |
|----------------------------|------------|-------------------------|------------|
| ** **                 | ** ** | **September 30,  2007** | ** ** | **October 1,  2006** | ** ** |
| pASIC 1 and  pASIC 2       |       | $                       | 403        |   | $ | 978 |   |
| V3                         |       | 947                     |       | 328 |   |
| QuickPCI                   |       | 1,346                   |       | 677 |   |
| QuickMIPS                  |       | 173                     |       | 183 |   |
| Total  end-of-life revenue |       | $                       | 2,869      |   | $ | 2,166 |   |

 

We have high demand for end-of-life products, which weoriginally planned to meet in the fourth quarter of 2007. However, based inpart on supply constraints and in part on customer feedback regarding therequired timing of end-of-life shipments, we decided to meet this demand in thefourth quarter of 2007 and the first half of 2008. Based on current demand forthe fourth quarter, we expect that between $2.7 million and $3.5 million ofdemand for end-of-life products will be met in the fourth quarter of 2007, and$2.0 million to $2.5 million will be met in the first half of 2008. We expectany additional end-of-life product demand to be delivered in 2008. After thesecond quarter of 2008, we expect that end-of-life products will contributeless than ten percent of quarterly revenue.

 

We continue to seek to expand our revenue, includingthe pursuit of high volume sales opportunities in the consumer market segment,by providing CSSPs incorporating industry standard interfaces such as USB 2.0OTG, SDIO and Integrated Drive Electronics, or IDE. Our industry ischaracterized by intense price competition and by lower prices as order volumesincrease. While winning large volume sales opportunities will increase ourrevenue, we believe these opportunities may decrease our average selling priceand gross profit as a percentage of revenue.

 

*GrossProfit*.  Grossprofit was $4.7 million and $3.2 million in the third quarter of 2007 and2006, respectively, which represented 52.2% and 37.5% of revenue for thoseperiods. The $1.5 million increase in gross profit was primarily due to a$910,000 million decrease in inventory write-downs, a $380,000 increase ingross profit associated with higher revenue and $270,000 higher benefit fromthe sale of reserved inventory.

 

*Researchand Development Expense.*  Research and development expense was $2.3 million and$2.4 million in the third quarter of 2007 and 2006, respectively, whichrepresented 26.0% and 28.2% of revenue for those periods. The decrease ofapproximately $90,000 was primarily a result of lower outside servicesassociated with specific development projects. We believe that continued orincreased investments in product development and process technology areessential for us to remain competitive in the markets we serve. We expect thatthese development efforts will allow us to expand our product and solutionofferings, increase our revenue and provide additional value to our customersand stockholders.

 

27

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

 

*Selling,General and Administrative Expense.*   Selling, general and administrativeexpense was $4.0 million and $4.0 million for the third quarter of2007 and 2006, respectively, which represented 43.7% and 46.5% of revenue forthose periods. The decrease of approximately $40,000 in selling, general andadministrative expense was primarily due to lower selling compensation expenseand administrative consulting expenses, partially offset by an increase incompensation expense for new marketing employees.

 

*InterestExpense.*  Interestexpense of $69,000 for the third quarter of 2007 was flat compared to $65,000for the third quarter of 2006.

 

*InterestIncome and Other, Net.*  Interest income and other, net decreased to $189,000 forthe third quarter of 2007 as compared to $333,000 for the third quarter of2006. The $144,000 decrease in interest income and other, net is primarily dueto decreased interest income received as a result of lower invested cashbalances.

 

*Provisionfor Income Taxes.*  Forthe third quarter of 2007, we incurred a net loss of $1.5 million andrecorded a provision for income taxes of $29,000, which consisted of income taxes on foreign operations. For the thirdquarter of 2006, we incurred a net loss of $3.0 million and recorded aprovision for income taxes of $23,000, whichconsisted of income taxes on foreign operations. Our ability to utilizeour income tax loss carryforwards in future periods is uncertain and,accordingly, we recorded a full valuation allowance against the related taxbenefit. We will continue to assess the realizability of the deferred taxassets in future periods.

 

*Stock-BasedCompensation.*  Forthe third quarter of 2007 and 2006, stock-based compensation totaled $452,000and $290,000, respectively, and was included in the statement of operations asfollows (in thousands):

 
| ** **                           | ** ** | **Three Months Ended**  | ** ** |
|--------------------------------------|------------|-------------------------|------------|
| ** **                           | ** ** | **September 30,  2007** | ** ** | **October 1,  2006** | ** ** |
|                                 |       |                    |       |   |   |
| Cost of revenue                      |       | $                       | 67         |   | $ | 36 |   |
| Research and  development            |       | 94                      |       | 57 |   |
| Selling, general  and administrative |       | 291                     |       | 197 |   |
| Total                                |       | $                       | 452        |   | $ | 290 |   |

 

**Nine Months Ended September 30, 2007 and October 1, 2006**

*             Revenue.*  Our revenue for the firstnine months of 2007 was $23.7 million, representing a decline of$3.5 million, or 12.9%, from revenue of $27.2 million for the firstnine months of 2006. Our mature product revenue declined by $980,000 dueprimarily to lower customer demand for our pASIC 3 and QuickRAM products. Ournew product revenue declined by $2.5 million primarily due to a $3.6 milliondecline in revenue from one customer as result of the late stage of its productlife cycle, as discussed above, partially offset by revenue growth from othercustomers. This European telecommunications customer, purchasing our Eclipse II devices through a contractmanufacturer, accounted for one percent and 14% of revenue in thefirst nine months of 2007 and 2006, respectively. Our end-of-life productrevenue was flat for the first nine months of 2007 compared with the first ninemonths of 2006. Revenue from pASIC 1 and pASIC 2 products declined by $2.9million due to lower demand for these products. This decline was offset byhigher demand for V3, QuickMIPS and QuickPCI products. A domestic manufacturerof instrumentation and test equipment, purchasing primarily mature products,contributed 11% and 13% of revenue in the first nine months of 2007 and 2006,respectively.

 

*GrossProfit*.  Grossprofit was $10.0 million and $13.8 million in the first nine months of2007 and 2006, respectively, which represented 42.2% and 50.9% of revenue forthose periods. The $3.8 million decline in gross profit was primarily dueto lower revenue and overhead absorption, which contributed $1.8 million, andincreased inventory write-down of $1.8 million, primarily for excessquantities.

 

*Researchand Development Expense.*  Research and development expense was $7.0 million and $7.2million for the first nine months of 2007 and 2006, respectively, whichrepresented 29.4% and 26.4% of revenue for those periods, respectively. Theprimary reason for the increase in research and development expense as apercentage of revenue is due to lower revenue in the first nine months of 2007as compared to the first nine months of 2006. The $220,000 decline in researchand development expense was primarily a result of lower compensation expensesdue to lower payroll.

 

*Selling,General and Administrative Expense.*  Selling, general and administrativeexpense was $12.9 million and $13.2 million for the first nine monthsof 2007 and 2006, respectively, which represented 54.7% and 48.6% of revenuefor those periods. The primary reason for the increase in selling, general andadministrative expense as a

 

28

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

 

percentage of revenue was due to lower revenue in the first nine monthsof 2007 as compared to the first nine months of 2006. The $270,000 decline inselling, general and administrative expense was primarily the result of lowercommissions paid to independent sales representatives and lower administrativeexpense for outside services, partially offset by higher compensation expensesfor new marketing and administrative personnel.

 

*InterestExpense.*  Interestexpense declined to $226,000 for the first nine months of 2007 as compared to$235,000 for the first nine months of 2006.

 

*InterestIncome and Other, Net.*  Interest income and other, net declined to $752,000 for thefirst nine months of 2007 as compared to $966,000 for the first nine months of2006. The $214,000 decrease in interest income and other, net is primarily dueto lower invested cash balances, partially offset by a gain on the sale of testequipment.

 

*Provisionfor Income Taxes.*  Forthe first nine months of 2007, we incurred a net loss of $9.5 million andrecorded a provision for income taxes of $71,000, which consisted of incometaxes on foreign operations. For the first nine months of 2006, we incurred anet loss of $5.9 million and recorded a provision for income taxes of$46,000, which consisted of income taxes onforeign operations. Our ability to utilize our income tax losscarryforwards in future periods is uncertain and, accordingly, we recorded afull valuation allowance against the related tax benefit. We will continue toassess the realizability of the deferred tax assets in future periods.

 

*Stock-BasedCompensation.*  Forthe first nine months of 2007 and 2006, stock-based compensation totaled $1.3million and  $1.1 million, respectively,and was included in the statement of operations as follows (in thousands):

 
| ** **                           | ** ** | **Nine Months Ended**   | ** ** |
|--------------------------------------|------------|-------------------------|------------|
| ** **                           | ** ** | **September 30,  2007** | ** ** | **October 1,  2006** | ** ** |
|                                 |       |                    |       |   |   |
| Cost of revenue                      |       | $                       | 176        |   | $ | 138 |   |
| Research and  development            |       | 273                     |       | 321 |   |
| Selling, general  and administrative |       | 812                     |       | 686 |   |
| Total                                |       | $                       | 1,261      |   | $ | 1,145 |   |

 

**Liquidityand Capital Resources**

We have financed our operating losses and capitalinvestments through sales of common stock, private equity investments, capitaland operating leases, bank lines of credit and cash flow from operations. As ofSeptember 30, 2007, our principal sources of liquidity consisted of our cashand cash equivalents of $20.8 million, available credit under ourrevolving line of credit with Silicon Valley Bank of approximately$5.0 million, available credit under our equipment line of credit ofapproximately $2.5 million, and our investment in Tower with a market value ofapproximately $2.4 million.

 

As of September 30, 2007, our interest-bearing debtconsisted of $1.9 million outstanding from Silicon Valley Bank and $526,000outstanding under capital leases. As of September 30, 2007, our accumulateddeficit was $137.0 million. Capital expenditures, which are largely driven bythe development of new products and manufacturing levels, could total$4.0 million in the next twelve months.

 

In June 2006, we entered into a Second Amended andRestated Loan and Security Agreement with Silicon Valley Bank. Terms of theagreement included a $5.0 million revolving line of credit that is availablethrough June 2008 and an additional $2.0 million of borrowing capacity under anequipment line of credit that is available to be drawn against through June2007. Advances under the equipment line of credit are repaid in either 30 or 36equal monthly installments, depending upon the nature of the items financed.The agreement was amended in June 2007 to include an additional $2.5 million ofborrowing capacity under the equipment line of credit that is available to bedrawn against through June 2008. Future advances against the equipment line ofcredit will be repaid in 36 equal monthly installments. As of September 30,2007, we had no balances outstanding under the revolving line of credit,$1.9 million outstanding under the current and previous equipment lines ofcredit and $2.5 million available to be drawn against future equipmentpurchases. The bank has a first priority security interest on substantially allof our tangible and intangible assets to secure any outstanding amounts underthe agreement. Under the terms of the

 

29

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

 

agreement, we must maintain a minimum tangible net worth and anadjusted quick ratio. The agreement also has certain restrictions including,among others, the incurrence of other indebtedness, the maintenance ofdepository accounts, the disposition of assets, mergers, acquisitions, thegranting of liens and the payment of dividends. We were in compliance with allloan covenants as of September 30, 2007.

 

*Net cash from operating activities*

Net cash used for operating activities was $2.3 millionfor the first nine months of 2007. The cash used for operating activitiesresulted primarily from a net loss of $9.5 million, adjusted for$7.8 million of non-cash charges including inventory write-downs of $3.5million, depreciation and amortization of $2.3 million, stock-basedcompensation of $1.3 million, decrease in wafer credits of $681,000 and baddebt reserves of $163,000. In addition, changes in working capital accountsused cash in the amount of $688,000 primarily as a result of a $2.0 milliondecrease in accounts payable due to timing of inventory purchases and expendituresand a $405,000 decrease in deferred income and royalty revenue due primarily toroyalty revenue recognized under the Aeroflex agreement. These uses of cashwere partially offset by a $714,000 decrease in prepaid expenses and a $693,000decrease in inventory.

 

Net cash provided by operating activities was $230,000for the first nine months of 2006. The cash provided by operating activitiesresulted primarily from a net loss of $5.9 million, adjusted for$5.4 million of non-cash charges including depreciation and amortizationof $2.3 million, reserves for excess inventory of $1.7 million, stock-basedcompensation of $1.1 million and a decrease in Tower wafer credits of $132,000.In addition, changes in working capital accounts provided cash in the amount of$700,000 primarily due to a $1.8 million decrease in accounts receivableresulting from a reduction in revenue levels and the timing of shipments in theperiod and a $1.0 million increase in accounts payable due to the timing ofpurchases and payments in the period. These sources of cash were partially offset by a $738,000 increase inother assets, a $731,000 increase in inventory and a $639,000 decrease inaccrued liabilities.

 

*Net cash from investing activities*

Net cash used for investing activitiesfor the first nine months of 2007 and 2006 was $926,000 and $1.9 million,respectively, as a result of capital expenditures made primarily to acquireequipment and software used in the development and production of our products.

 

*Net cash from financing activities*

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

 

Net cash provided by financing activities was$3.2 million for the first nine months of 2006, resulting from$2.6 million in proceeds related to the issuance of common shares toemployees under our equity plans and $2.5 million in proceeds from borrowingsunder our equipment line of credit, partially offset by scheduled repayments of$1.8 million under the terms of our debt and capital lease obligations.

 

We require substantial cash to fund our business,particularly to finance our operations, to acquire property and equipment, therepayment of debt and for working capital requirements. Our future liquidity willdepend on many factors such as these, as well as our level of revenue and grossprofit, market acceptance of our existing and new products, the decline inrevenue under end-of-life programs, wafer purchase commitments, the amount andtiming of research and development expenditures, the timing of new productintroductions, production volumes, the quality of our products, sales andmarketing efforts, our ability to obtain debt financing and to remain incompliance with the terms of our credit facilities, our ability to raise fundsfrom the sale of Tower shares and equity in the Company, the exercise ofemployee stock options and participation in our employee stock purchase plan,and other factors related to the uncertainties of the industry and global economics.However, we believe that our existing cash resources will be sufficient to fundoperations, capital expenditures of up to $4.0 million, and provideadequate working capital for at least the next twelve months. As our liquidityis affected by many factors as mentioned above and as discussed in our “RiskFactors” section, there can be no assurance that we will not seek additionalcapital during the next twelve months or that such capital will be available onterms acceptable to us. After the next

 

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

 

twelve months, our cash requirements will depend on many factors,including our level of revenue and gross profit, the market acceptance of ournew products, the levels at which we maintain inventory and accountsreceivable, costs of securing access to adequate manufacturing capacity, newproduct development efforts, capital expenditures and the level of ouroperating expenses.

 

**Contractual Obligations and Commercial Commitments**

 

The following table summarizes our contractualobligations and commercial commitments as of September 30, 2007 and the effectsuch obligations and commitments are expected to have on our liquidity and cashflows in future fiscal periods (in thousands):

 
| ** **                                                | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                | ** ** | **Total**                  | ** ** | **Less than  1 Year** | ** ** | **1-3  Years** | ** ** | **More than  3 Years** | ** ** |
| * *                                                  | * *   | * *                   | * *   | * * | * * | * * | * * | * * | * * |
| *Contractual  cash obligations:*                          | * *   | * *                   | * *   | * * | * * | * * | * * | * * | * * |
| Operating leases                                          |       | $                          | 1,279      |   | $ | 766 |   | $ | 513 |   | $ | — |   |
| Wafer  purchases(1)                                       |       | 6,875                      |       | 6,875 |   | — |   | — |   |
| Other purchase  commitments                               |       | 3,861                      |       | 3,861 |   | — |   | — |   |
| Total  contractual cash obligations                       |       | 12,015                     |       | 11,502 |   | 513 |   | — |   |
|                                                      |       |                       |       |   |   |   |   |   |   |
| *Other  commercial commitments*(2)*:*                     | * *   | * *                   | * *   | * * | * * | * * | * * | * * | * * |
| Notes payable to  bank                                    |       | 1,930                      |       | 1,044 |   | 886 |   | — |   |
| Capital lease  obligations                                |       | 526                        |       | 500 |   | 26 |   | — |   |
| Total commercial  commitments                             |       | 2,456                      |       | 1,544 |   | 912 |   | — |   |
| Total  contractual obligations and commercial commitments |       | $                          | 14,471     |   | $ | 13,046 |   | $ | 1,425 |   | $ | — |   |
|                                                           |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)         Certain of our wafer manufacturers require us toforecast wafer starts several months in advance. We are committed to takedelivery of and pay for a portion of forecasted wafer volume. Wafer purchasecommitments of $6.9 million include both firm purchase commitments and aportion of our forecasted wafer starts as of September 30, 2007.

 

(2)         Other commercial commitments are included asliabilities on our balance sheet as of September 30, 2007.

 

**Inflation**

The impact of inflation on ourbusiness has not been material for the periods presented.

 

**Off-BalanceSheet Arrangements**

We do not maintain any off-balance sheet partnerships,arrangements or other relationships with unconsolidated entities or others,often referred to as structured finance or special purpose entities, which areestablished for the purpose of facilitating off-balance sheet arrangements orother contractually narrow or limited purposes.

 

**RecentlyIssued Accounting Pronouncements**

In September 2006, theFinancial Accounting Standards Board, or FASB, issued Statement of FinancialAccounting Standards No. 157, *“Fair ValueMeasurements,”* or SFAS 157. SFAS 157 establishes a framework formeasuring fair value, and expands disclosures about fair value measurements.The changes to current practice resulting from the application of SFAS 157relate to the definition of fair value, the methods used to measure fair valueand expanded disclosures about fair value measurements. SFAS 157 is effectivefor fiscal years beginning after November 15, 2007 and interim periods withinthose fiscal years. We are currently evaluating the impact that SFAS 157 willhave on our consolidated financial statements.

 

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

 

In February 2007, theFASB issued Statement of Financial Accounting Standards No. 159, *“The Fair Value Option for Financial Assets andFinancial Liabilities,*” or SFAS 159. SFAS 159 permits companies tochoose to measure certain financial instruments and certain other items at fairvalue. The standard requires that unrealized gains and losses on items forwhich the fair value option has been elected be reported in earnings. SFAS 159is effective for fiscal years beginning after November 15, 2007, althoughearlier adoption is permitted. We are currently evaluating the impact that SFAS159 will have on our consolidated financial statements.

 

32

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

**Interest Rate Risk**

Our exposure to market rate risk for changes ininterest rates relates primarily to our investment portfolio and variable ratedebt. We do not use derivative financial instruments to manage our interestrate risk. We are adverse to principal loss and ensure the safety andpreservation of invested funds by limiting default, market risk andreinvestment risk. Our investment portfolio is generally comprised ofinvestments that meet high credit quality standards. Since these securities aresubject to interest rate risk, they could decline in value if interest ratesfluctuate. 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, 2007would have an immaterial effect on our financial position, results ofoperations and cash flows.

 

**Foreign Currency Exchange Rate Risk**

All of our sales and cost of manufacturing aretransacted in U.S. dollars. We conduct a portion of our research anddevelopment activities in Canada and India and have sales and marketing officesin several locations outside of the United States. We use the U.S. dollar asour functional currency for all of our foreign locations. Most of the costsincurred at these international locations are in local currency. If these localcurrencies strengthen against the U.S. dollar, our payroll and other localexpenses will be higher than we currently anticipate. Since our sales aretransacted in U.S. dollars, this negative impact on expenses would not beoffset by any positive effect on revenue. Additionally, if the U.S. dollarstrengthens against the local currency of a foreign country, the price of ourproducts will become relatively more expensive to customers in their currency.Operating expenses denominated in foreign currencies were approximately 24% and22% of total operating expenses for the first nine months of 2007 and 2006,respectively. A majority of these foreign expenses were incurred in Canada. Acurrency exchange rate fluctuation of 10% would have caused our operatingexpenses to change by approximately $540,000 in the first nine months of 2007.

 

**EquityPrice Risk**

Our exposure to equity price risk for changes inmarket value relates primarily to our investment in Tower Semiconductor Ltd.,or Tower. Tower’s ordinary shares trade on the Nasdaq Global Market under thesymbol “TSEM”. Since these securities are publicly traded on the open market,they are subject to market fluctuations. Temporary market fluctuations arereflected by increasing or decreasing the presented value of the relatedsecurities and recording “accumulated other comprehensive income (loss)” in theequity section of the balance sheet. An “other than temporary” decline inmarket value is reflected by decreasing the adjusted cost of the relatedsecurities and recording a charge to operating expenses in the incomestatement. A market value fluctuation of 10% would have a $240,000 impact onaccumulated other comprehensive income as of September 30, 2007.

 

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**Item 4. Controls and Procedures**

**Evaluation of Disclosure Controls and Procedures**

Our management evaluated, with the participation ofour Chief Executive Officer and Chief Financial Officer, the effectiveness ofour disclosure controls and procedures as of the end of the period covered bythis Quarterly Report on Form 10-Q. Based upon that evaluation, ourChief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures are effective to ensure that information weare required to disclose in reports that we file or submit under the SecuritiesExchange Act of 1934, as amended, is (i) recorded, processed, summarizedand reported within the time periods specified in Securities and ExchangeCommission rules and forms and (ii) accumulated and communicated toour management, including our Chief Executive Officer and Chief FinancialOfficer, as appropriate to allow timely decisions regarding requireddisclosure. Based upon that evaluation, our Chief Executive Officer and ChiefFinancial Officer concluded that, our current disclosure controls andprocedures are effective at the reasonable assurance level.

 

**Changes in Internal Control Over Financial Reporting**

 

There were no changes in our internal control overfinancial reporting that occurred during the period covered by this QuarterlyReport on Form 10-Q that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

 

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**Part II. Other Information**

**Item 1.Legal Proceedings**

OnOctober 26, 2001, a putative securities class action was filed in the U.S.District Court for the Southern District of New York against certain investmentbanks that underwrote QuickLogic’s initial public offering, QuickLogic and someof QuickLogic’s officers and directors. The complaint alleges excessive andundisclosed commissions in connection with the allocation of shares of commonstock in QuickLogic’s initial and secondary public offerings and artificiallyhigh prices through “tie-in” arrangements which required the underwriters’customers to buy shares in the aftermarket at pre-determined prices inviolation of the federal securities laws. Plaintiffs seek an unspecified amountof damages on behalf of persons who purchased QuickLogic’s stock pursuant tothe registration statements between October 14, 1999 and December 6,2000. Various plaintiffs have filed similar actions asserting virtuallyidentical allegations against over 300 other public companies, theirunderwriters, and their officers and directors arising out of each company’spublic offering. These actions, including the action against QuickLogic, havebeen coordinated for pretrial purposes and captioned *In re Initial Public Offering Securities Litigation, 21 MC 92*.In June 2004, a stipulation of settlement and release of claims against theissuer defendants, including QuickLogic, was submitted to the court forapproval. On August 31, 2005, the court preliminarily approved thesettlement. In December 2006, the appellate court overturned the certificationof classes in the six test cases that were selected by the underwriterdefendants and plaintiffs in the coordinated proceedings. Because classcertification was a condition of the settlement, it was unlikely that thesettlement would receive final Court approval. On June 25, 2007, the Courtentered an order terminating the proposed settlement based upon a stipulationamong the parties to the settlement. Plaintiffs have filed amended masterallegations and amended complaints in the six test cases for classcertification. It is uncertain whether there will be any revised or futurecomplaints. If a settlement does not occur and litigation against QuickLogiccontinues, the Company intends to defend the case vigorously.

On November 2, 2006 and November 29, 2006, purported shareholderderivative complaints were filed against certain of the Company’s current andformer officers and directors in the U.S. District Court for the NorthernDistrict of California.  The complaintsalleged that the individual defendants had violated the federal securities lawsand breached their duties to the Company in connection with the granting and/orreceipt of options for Company stock. The complaints named the Company as anominal defendant and sought unspecified monetary damages against theindividual defendants as well as various forms of injunctive relief. On August7, 2007, the parties submitted to the Court a stipulation and proposed order todismiss the case in its entirety and without prejudice. On August 13, 2007, theCourt entered the order dismissing the case in its entirety and withoutprejudice.

No estimate can bemade of the possible loss or possible range of loss associated with theresolution of these contingencies and, accordingly, the Company has notrecorded a liability.

From time to time, the Company is involved in legalactions arising in the ordinary course of business, including but not limitedto intellectual property infringement and collection matters. Absoluteassurance cannot be given that third party assertions will be resolved withoutcostly litigation in a manner that is not adverse to the Company’s financialposition, results of operations or cash flows or without requiring royalty orother payments in the future which may adversely impact gross profit.

 

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**Item 1A. Risk Factors**

This description includes any material changes to andsupersedes the description of the risk factors associated with our businesspreviously disclosed in Item 1A of our 2006 Annual Report on Form 10-Kfiled with the SEC on March 15, 2007 and our Quarterly Report on Form 10-Qfor the period ended April 1, 2007 and July 1, 2007 filed with the SEC on May10, 2007 and August 10, 2007. Because of the following risk factors, as well asother variables affecting our operating results, past financial performance maynot be a reliable indicator of future performance, and historical trends shouldnot be used to anticipate results or trends in future periods.

 

##### **Risk Factors**

# * *

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

We operate in ahighly competitive, quickly changing environment marked by rapid obsolescenceof existing products. To compete successfully, we must obtain access toadvanced fabrication capacity and dedicate significant resources to specify,design, develop, manufacture and sell new or enhanced products and solutionsthat provide increasingly higher levels of performance, low power consumption,new features, reliability and/or cost savings to our customers. We experience along delay between the time when we expend these product definition anddevelopment resources and invest in related long-lived assets, and the timewhen we begin to generate revenue, if any, from these expenditures.

We are marketing our newproducts - ArcticLink, PolarPro, Eclipse II and QuickPCI II - to newcustomers and markets and expect a significant portion of our future revenuesto be generated from these new products. We believe our new products andsolutions have a compelling advantage in mobile applications, and that thisbusiness will provide long-term revenue growth for QuickLogic, but there is noassurance when this will occur. We have focused the marketing of our newproduct solutions on the market for hand-held, battery powered applicationssuch as portable navigation devices, smartphones, portable media players, datacards and portable industrial products. The market for these mobile devices isdynamic; these markets typically have shorter product life cycles, highervolumes and greater price pressure than our traditional business. We pursuecustomer opportunities in anticipation of future cost reductions and mayaggressively price products to gain market share. In order to react quickly toopportunities or to obtain favorable wafer prices, we make significantinvestments in and commitments to purchase inventory and capital equipmentbefore we have firm commitments from customers. Our gross margin and inventoryvaluation may be affected by these strategies if, for instance, we generatesignificant revenue before we are able to reduce our costs or if an opportunitypriced to gain market share becomes significant to our quarterly revenue.

 

In addition, the nature of the mobile market and thecustomers that operate in this market may cause revenue to fluctuatesignificantly from quarter to quarter. For example, while our new productrevenue increased sequentially in the third quarter of 2007, it declined in thefirst quarter of 2007 due to the product life cycle of a significant customerfor these products. If we are unable to design, produce and sell new solutionsand products that meet design specifications, address customer requirements andgenerate sufficient revenue and gross profit, if market demand for our productsfails to materialize, if we are unable to obtain adequate capacity on a timelybasis, if we are unable to develop Customer Specific Standard Products, orCSSPs, or solutions in a timely manner, or if our customers do not successfullyintroduce products incorporating our devices, our revenue and gross margin willbe materially harmed, our liquidity and cash flows will be materially effected,we may be required to write-off related inventory and long-lived assets orthere may be other adverse effects on our business or the price of our commonstock.

# *Wewill be unable to compete effectively if we fail to anticipate productopportunities based upon emerging technologies and standards or fail to developproducts and solutions that incorporate these technologies and standards in atimely manner*

We spend significant timeand money to design and develop products and solutions around an industrystandard, such as USB and IDE, or emerging technologies, such as low powerprogrammable logic, advanced process technology or small form factor packaging.We intend to develop additional products and solutions and adopt newtechnologies in the future. If system manufacturers adopt alternative standardsor technologies, if an industry standard or emerging technology that we havetargeted fails to achieve broad market acceptance, if

 

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customers choose lowpower offerings from our competitors, or if we are unable to bring thetechnologies or solutions to market in a timely and effective manner, we may beunable to generate significant revenue from our research and developmentefforts. As a result, our business would be materially harmed and we may berequired to write-off related inventory and long-lived assets.

# *Wehave significant customers and limited visibility into the long-term demand forour products from these customers*

A few end customers can represent a significantportion of our total revenue in a given reporting period and the likelihood ofthis occurring will increase in the future as we target high volume mobileapplications. Our marketing and sales efforts are focused on the leadingsuppliers in our target markets, and future revenue and gross profit growth istied to our success at these focus accounts. Our success at these accounts willdepend on our ability to bring value added solutions to these customers, and onour ability to compete with companies such as Cypress SemiconductorCorporation. As in the past, future demand from these customers may fluctuatesignificantly. These customers typically order products with short requesteddelivery lead times, and do not provide a commitment to purchase product pastthe period covered by purchase orders, which may be rescheduled or cancelled.In addition, our manufacturing lead times are longer than the delivery leadtimes requested by these customers, and we make significant inventory purchasesand capital expenditures in anticipation of future demand. For example, adomestic OEM of instrumentation and test equipment accounted for more than 11%of revenue in 2006 and in the first nine months of 2007 and a Europeantelecommunications OEM customer, purchasing product through their contractmanufacturer, represented 14% of revenue in 2006 and did not contributesignificant revenue in the first nine months of 2007. 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, wemay make a significant investment in long-lived assets for the production ofour products based upon historical and expected demand. If demand for ourproducts or gross margin generated from our products does not meet ourexpectations or if we are unable to collect amounts due from significantcustomers, we may be required to write-off inventory, provide for uncollectibleaccounts receivable or incur charges against long-lived assets, which wouldmaterially harm our business.

# *Wemay not have the liquidity to support our future operations and capitalrequirements*

Our cash and cashequivalents balance at September 30, 2007 was $20.8 million. At September30, 2007, our interest-bearing debt consisted of $1.9 million outstandingfrom Silicon Valley Bank and $526,000 outstanding under capital leases. InJune 2007, we amended our credit facility with Silicon Valley Bank. AtSeptember 30, 2007, we had $5.0 million available to borrow under ourrevolving credit facility and $2.5 million available to borrow under ourequipment line of credit under the amended agreement.

At September 30,2007, we held 1,344,543 Tower ordinary shares, valued at approximately$2.4 million based upon the market closing price of $1.79 per share at theend of the reporting period. 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 development activities and the introduction andinitial manufacturing of new products, could total $4.0 million in thenext twelve months. As of September 30, 2007, we had commitments to purchase$6.9 million of wafer inventory.

 

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As a result of potential investments, current revenueand operating expense levels, changes in working capital and interest and debtpayments, we will need to generate significantly higher revenue and grossprofit, especially from our new ArcticLink, PolarPro, Eclipse II and QuickPCI IIproducts and products currently under development, to generate positive cashflow. In addition, these new products have been generating lower gross marginas a percentage of revenue than the rest of our historical business due to themarkets that we have targeted and the larger order quantities associated withthese applications. Whether we can achieve cash flow levels sufficient tosupport our operations cannot be accurately predicted. Unless such cash flowlevels are achieved, we may borrow additional funds or sell debt or equitysecurities, or some combination thereof, to provide funding for our operations.If adequate funds are not available when needed, our financial condition andoperating results would be materially and adversely affected and we may not beable to operate our business without significant changes in our operations, orat all.

# *We may be unable to accurately estimate quarterly revenue, which couldadversely affect the trading price of our stock*

We offer our customers a short delivery lead time and amajority of our shipments during a quarter are ordered by customers in thatquarter. As a result, we often have low visibility to the current quarter’srevenue, and our revenue levels can change significantly in a short period oftime. Furthermore, our ability to respond to increased demand is limited toinventory on hand or on order, the capacity available at our contractmanufacturers and our capacity to program products to customer specifications.In addition, a significant portion of our revenue is deferred until ourdistributors ship unprogrammed parts to end customers since the price is notfixed or determinable until that time. Therefore, we are highly dependent onthe accuracy and timeliness of resale and inventory reports from our distributors.Inaccurate distributor resale or inventory reports, as well as unanticipatedchanges in distributor inventory levels, could contribute to our difficulty inpredicting and reporting our quarterly revenue and results of operations. If wefail to accurately estimate customer demand, record revenue, or if ouravailable capacity is less than needed to meet customer demand, our results ofoperations could be harmed and our stock price could materially fluctuate.

# *We depend upon third parties to fabricate, assemble, test and programour products, and they may discontinue manufacturing our products, fail to giveour products priority, be unable to successfully manufacture our products tomeet performance, volume or cost targets, or inaccurately report inventory tous*

We contract with thirdparties to fabricate, assemble, test and program our devices. Our devices aregenerally fabricated, assembled and programmed by single suppliers, and theloss of a supplier, transfer of manufacturing to a new location, expiration ofa supply agreement or the inability of our suppliers to manufacture ourproducts to meet volume, performance and cost targets could have a materialadverse effect on our business. Tower solely manufactures our ArcticLink,PolarPro, Eclipse II, certain QuickPCI II, other new products currentlyunder development and QuickMIPS. Our pASIC 1 and pASIC 2 devices werefabricated by a single supplier, and the expiration of this supply agreementhas had a significant effect on our business. We recently announced theend-of-life of our V3 products, due primarily to a supplier’s decision to stopmanufacturing these products. V3 products contributed $3.6 million and $1.9million of revenue in the first nine months of 2007 and 2006, respectively, andwe currently do not expect these devices to contribute significant revenueafter the second quarter of 2008. In addition, demand for assembly capacity atour primary supplier may increase. For this and other reasons, capacityavailable to us may be constrained. Identifying and qualifying an additionalassembly supplier is a time consuming and costly process and may require volumecommitments that we may be unwilling or unable to make. We sell programmers tocustomers that are made by a single supplier. Programming capacity at oursubcontractors is also dependent on our investment in sufficient programminghardware to meet fluctuating demand. Our relationship with our suppliers couldchange as a result of a merger or acquisition. If for any reason thesesuppliers or any other vendor becomes unable or unwilling to continue toprovide services of acceptable quality, at acceptable costs and in a timelymanner, our ability to operate our business or deliver our products to ourcustomers could be severely impaired. We would have to identify and qualifysubstitute suppliers, which could be time consuming, difficult and result inunforeseen operational problems, or we could announce an end-of-life programfor these 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.

 

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

We record a majorityof our inventory transactions based on information from our subcontractors. Ifwe do not receive prompt and accurate information from our suppliers, we couldmisstate inventory levels, incorrectly record gross profit, be unable to meetour delivery commitments to customers or commit to manufacturing inventory thatis not required to meet customer delivery commitments, which could materiallyharm our business.

# *Ourfuture results depend on our relationship with Tower*

We have investedapproximately $21.3 million in Tower. In return for our investment, wereceived equity, prepaid wafer credits, favorable wafer pricing and committedproduction capacity in Tower’s foundry facility. We believe that Tower’slong-term operation of this fabrication facility depends on its ability toattract sufficient customer demand, to obtain additional financing, to increasecapacity, to obtain the release of grants and approvals for changes in grantprograms from the Israeli government’s Investment Center and its ability to remainin compliance with the terms of its grant and credit agreements. The currentpolitical uncertainty and security situation in the Middle East where Tower’sfabrication facility is located, the cyclical nature of the market for foundrymanufacturing services, Tower’s financial condition, or other factors mayadversely impact Tower’s business prospects and may discourage futureinvestments in Tower from outside sources. If Tower is unable to obtainadequate financing and increase production output in a timely manner, the valueof our investment in Tower may decline significantly or possibly becomeworthless, our wafer credit from Tower may decline in value or possibly becomeworthless, and we would have to identify and qualify a substitute supplier tomanufacture our products. This could require significant development time,cause product shipment delays, impair long-lived assets and the value of ourwafer credits, damage our liquidity and severely harm our business. Inaddition, Tower is the sole manufacturer of our ArcticLink, PolarPro, EclipseII, certain QuickPCI II, other new products currently under developmentand QuickMIPS.

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 September30, 2007, the value of our Tower investment was $2.4 million and the value ofour wafer credits recorded on our balance sheet was $3.0 million. If thefair value of our Tower investment or our wafer credits are deemed to beimpaired, we will record charges to our statement of operations. For instance,we wrote down the Tower shares due to an “other than temporary” decline intheir market value by $1.5 million, $1.5 million, $3.8 million and $6.8million in fiscal 2005, 2004, 2002 and 2001, respectively.

# *Ourcustomers may cancel or change their product plans after we have expendedsubstantial time 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 cancel or change their product plans. Customers may alsodiscontinue products incorporating our devices at any time or they may chooseto replace our products with lower cost semiconductors. In addition, we areworking with leading customers in our target markets to define our futureproducts. If customers cancel, reduce or delay product orders from us or choosenot to release products that incorporate our devices after we have spentsubstantial time and resources developing products or assisting customers withtheir product design, our revenue levels may be less than anticipated and ourbusiness could be materially harmed.

 

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

Our agreementswith certain suppliers require us to provide forecasts of our anticipatedmanufacturing orders, and place binding manufacturing commitments in advance ofreceiving purchase orders from our customers. We are limited in our ability toincrease or decrease our forecasts under such agreements. Other manufacturerssupply us product on a purchase order basis. The allocation of capacity isdetermined solely by our suppliers over which we have no direct control.Additionally, we may place orders with our suppliers in advance of customerorders to allow us to quickly respond to changing customer demand or to obtainfavorable product costs. Furthermore, we provide our suppliers with equipmentwhich is used to program our products to customer specifications. Theprogramming equipment is manufactured to our specifications and has significantorder lead times. These factors may result in product shortages or excessproduct inventory. Obtaining additional supply in the face of product,programming equipment or capacity shortages may be costly, or not possible,especially in the short term since most of our products and programmingequipment are supplied by a single supplier. For example, in the first ninemonths of 2007, we reserved $3.5 million of inventory due primarily to changesin forecasted demand. Our failure to adequately forecast demand for ourproducts could materially harm our business.

# *The end-of-life of our pASIC 1 and pASIC 2 products hasresulted in a decline in our revenue and we have announced the end-of-life forour V3 products, QuickPCI products, QuickMIPS and certain other products*

# *Our foundry agreement with the supplier that fabricates ourpASIC 1 and pASIC 2 products expired on December 31, 2005 andthe supplier no longer has the necessary equipment to manufacture our products.We announced an end-of-life for these products in 2004 and asked our customersto take delivery of lifetime buy orders before the end of 2005. As a result, wehave experienced a reduction in revenue from these products. These productscontributed 44% of our 2005 revenue and six percent of revenue in the firstnine months of 2007, and future sales of these products are limited toinventory on hand.*

In January 2007, we announced the end-of-life for ourV3 products, primarily due to the loss of manufacturing capacity for theseproducts, and asked our customers to take delivery of lifetime buy ordersbefore the end of 2007. We announced additional end-of-life products as result ofour decision to focus on customers in the hand-held mobile and militarymarkets. In the second quarter of 2007, we announced the end-of-life of ourQuickPCI products, due to assembly capacity considerations, and asked customersto take delivery of lifetime buy orders before the end of 2007. In the fourthquarter of 2007, we announced the end-of-life of our QuickMIPS products, due tolow customer demand, and asked customers to take delivery of these productsbetween now and the first half of 2008. These products contributed $2.5 millionand $1.2 million of revenue in the third quarter of 2007 and 2006,respectively. Due to the nature of end-of-life purchases, revenue levels fromthese products could fluctuate significantly on a sequential basis.  After the second quarter of 2008, we expectthat our end-of-life products and certain other products will contribute lessthan ten percent of quarterly revenue.

 

Our operating results and liquidity have beenadversely affected by the end-of-life of the pASIC 1 and pASIC 2 products,as we are currently operating at a net loss and expect negative cash flow atour current revenue level. We expect a decline in V3, QuickPCI and QuickMIPSproduct revenue and gross profit in 2008 as a result of the announced end-of-lifeof these products. While we expect revenue and gross profit growth from newproducts and mature products will offset these declines in revenue and grossprofit, there is no assurance when this will occur.  In order to grow our revenue from its currentlevel, we are dependent upon increased revenue from our existing products,especially our new ArcticLink, PolarPro, Eclipse II and QuickPCI IIproducts, and the development of additional new products and solutions.

 

# *Weare expending substantial time and effort to develop solutions with partnersthat depend on the availability and success of technology owned by the partner*

Our approach todeveloping solutions for potential customers involves: (1) embedded processorsdeveloped by companies such as Marvell Semiconductor, Inc., who purchased theXScale business unit from Intel, and Analog Devices, Inc.; (2) peripheraldevices developed by other parties such as micro hard disk drives, Wi-Fidevices and NAND flash memory; and (3) specific industry standards such as USB 2.0OTG, Serial Digital High Capacity, or SDHC, IDE and SDIO. We have entered intoinformal partnerships with other parties that involve the development ofsolutions that interface with their devices or standards. These informalpartnerships also may involve joint marketing campaigns and sales calls. Forexample, we have developed a solution incorporating a specific embedded

 

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processor, a micro harddisk drive and our Eclipse II device that improves performance and lowersthe overall power consumption of an application. If our solutions are notincorporated into customer products, if our partners discontinue production ofor integrate our solution into their product offerings, or if the informalpartnerships are significantly reduced or terminated by acquisition or othermeans, our revenue and gross margin will be materially harmed and we may berequired to write-off related inventory and long-lived assets.

# *Wemay be unable to successfully grow our business if we fail to competeeffectively with others to attract and retain key personnel*

Webelieve our future success will depend upon our ability to attract and retainengineers and other highly competent personnel. Our employees are at-will andnot subject to employment contracts. Hiring and retaining qualified sales,technical and financial personnel is difficult due to the limited number ofqualified professionals, economic conditions and the size of our company.Competition for these types of employees is intense. In addition, new hiresfrequently require extensive training before they achieve desired levels ofproductivity. We have in the past experienced difficulty in recruiting andretaining qualified senior management, sales, finance and technical personnel.Failure to attract, hire, train and retain personnel could materially harm ourbusiness.

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

Difficultiesencountered during the complex semiconductor manufacturing process can render asubstantial percentage of semiconductor devices nonfunctional. Newmanufacturing techniques or fluctuations in the manufacturing process maychange the performance distribution and yield of our products. We have, in thepast, experienced manufacturing runs that have contained substantially reducedor no functioning devices, or that generated devices with below normalperformance characteristics. Our reliance on third party suppliers may extendthe period of time required to analyze and correct these problems. Oncecorrected, our customers may be required to redesign or requalify theirproducts. As a result, we may incur substantially higher manufacturing costs,inventory shortages or reduced customer demand.

Yield fluctuationsfrequently occur in connection with the manufacture of newly introducedproducts, with changes in product architecture, with manufacturing at newfacilities, on new fabrication processes or in conjunction with new backendmanufacturing processes. Newly introduced solutions and products, such as ourCSSPs, ArcticLink, and PolarPro products, are often more complex and moredifficult to produce, increasing the risk of manufacturing related defects. Newmanufacturing facilities or processes are often more complex and take a periodof time to achieve expected quality levels and manufacturing efficiencies.While we test our products, including our software development tools, they maystill contain errors or defects that are found after we have commencedcommercial production, that occur due to manufacturing variations or that areidentified as new intellectual property is incorporated into our products. Ifour products or software development tools contain undetected or unresolveddefects, we may lose market share, experience delays in or loss of marketacceptance, reserve or scrap inventory or be required to issue a productrecall. In addition, we would be at risk of product liability litigation ifdefects in our products were discovered. Although we attempt to limit ourliability to end users through disclaimers of special, consequential andindirect damages and similar provisions, we cannot assure you that suchlimitations of liability will be legally enforceable.

# *Wehave a history of losses and cannot assure you that we will again be profitablein the future*

We incurredsignificant losses in 2006, 2004, 2003 and 2002. Our accumulated deficit as ofSeptember 30, 2007 was $137.0 million. Although we recorded net income of$2.4 million in 2005, we recorded a net loss of $9.5 million in thefirst nine months of 2007 and we may not return to profitability in any futureperiods.

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

We contract with thirdparty distributors and independent sales representatives to market and sell asignificant portion of our products. We typically have only a few distributorsand a single representative serving each geographic market and, in the future,we may have a single distributor covering a geographic market. Although we havecontracts with our distributors and representatives, our agreements with themmay be terminated on short

 

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notice by either partyand, if terminated, we may be unable to recruit additional or replacementdistributors or representatives. Additionally, these third parties that we havecontracted with may acquire, be acquired or merge with other parties which may resultin the termination of our contract or less effort being placed on themarketing, sale and support of our products and solutions. As a result, ourfuture performance will depend in part on our ability to retain our existingdistributors and representatives and to attract new distributors andrepresentatives that will be able to effectively market, sell and support ourproducts and solutions. The loss of one or more of our principal distributorsor representatives, or our inability to attract new distributors orrepresentatives, could materially harm our business.

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

Individualdistributors and OEMs 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.

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

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

Factors that could causeour operating results to fluctuate include:

•                  the effect of end-of-life programs;

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

•                  successful development and marketacceptance of our products and solutions;

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

•                  changes in sales volume, product mix,average selling prices or production variances that affect gross profit;

•                  our ability to adjust our productfeatures, manufacturing capacity and costs in response to economic andcompetitive pressures;

•                  our reliance on subcontract manufacturersfor product capacity, yield and quality;

•                  our competitors’ product portfolio andproduct pricing policies;

•                  timely implementation of efficient manufacturingtechnologies;

•                  errors in applying or changes inaccounting and corporate governance rules;

•                  the issuance of equity compensationawards or changes in the terms of our stock plan or employee stock purchaseplan;

•                  mergers or acquisitions;

•                  the impact of import and export laws andregulations;

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

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

 

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

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

The semiconductorindustry has historically been characterized by wide fluctuations in the demandfor, and supply of, its products. These fluctuations have resulted incircumstances when supply of and demand for semiconductors have been widely outof balance. An industry wide semiconductor oversupply could result in severedownward pricing pressure from customers. In a market with undersupply ofmanufacturing capacity, we would have to compete with larger foundry andassembly customers for limited manufacturing resources. In such an environment,we may be unable to have our products manufactured in a timely manner, at acost that generates adequate gross profit or in sufficient quantities. Since weoutsource all of our manufacturing and generally have a single source of wafersupply, test, assembly and programming for our products, we are particularlyvulnerable to such supply shortages and capacity limitations. As a result, wemay be unable to fulfill orders and may lose customers. Any future industrywide oversupply or undersupply of semiconductors could materially harm ourbusiness.

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

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

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

Most of ourproducts are manufactured outside of the United States at manufacturingfacilities operated by our suppliers in Taiwan, South Korea, the Philippinesand Israel. We expect to manufacture a majority of our new products and theproducts that we currently have under development in Israel and to assemblethese products in South Korea or China. As a result, these manufacturingoperations and new product introductions are subject to risks of politicalinstability, including the risk of conflict between Taiwan and the People’sRepublic of China, between South Korea and North Korea, and conflicts involvingIsrael.

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

•                  managing foreign distributors;

•                  collecting amounts due;

•                  staffing and managing foreign offices;

•                  political and economic instability;

•                  foreign currency exchange fluctuations;

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

•                  timing and availability of export licenses;

•                  supplying products that meet localenvironmental regulations; and

•                  inadequate protection of intellectualproperty rights.

 

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

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

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

The semiconductorindustry is intensely competitive and characterized by:

•                  erosion of selling prices over productlives;

•                  rapid technological change;

•                  short product life cycles; and

•                  strong domestic and foreign competition.

If we are not able tocompete successfully in this environment, our business will be materiallyharmed.

Many of ourcompetitors have substantially greater financial, technical, manufacturing,marketing, sales, distribution, name recognition and other resources than wedo. In addition, many of our competitors have well established relationshipswith our current and potential customers and have extensive knowledge of systemapplications. In the past, we have lost potential customers to competitors forvarious reasons, including, but not limited to, re-programmability and lowerprice. Our current direct competitors include suppliers of complex programmablelogic devices and field programmable gate arrays, such as Xilinx, Inc., AlteraCorporation, Actel Corporation and Lattice Semiconductor Corporation. Xilinxand Altera together have a majority share of the programmable logic market.Many system manufacturers may be unwilling or unable to switch to our productsdue to their familiarity with competitors’ products or other inhibitingfactors.

We also face competitionfrom companies that offer Application Specific Integrated Circuits, or ASICs,which may be purchased for a lower price at higher volumes and typically havegreater logic capacity, additional features and higher performance than ourproducts. We may also face competition from suppliers of embeddedmicroprocessors, such as Freescale Semiconductor, Inc., or from suppliers ofproducts based on new or emerging technologies, such as Cypress SemiconductorCorporation. Our inability to successfully compete in any of the followingareas could materially harm our business:

•                  the development of new products,solutions and advanced manufacturing technologies;

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

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

•                  the incorporation of industry standardsin our products and solutions;

•                  the diversity of product offeringsavailable to customers; or

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

 

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# *Wemay be unable to adequately protect our intellectual property rights and mayface significant expenses as a result of future litigation*

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

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

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

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

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

We have enteredinto and, in the future, intend to enter into agreements that involve numerousrisks, including the use of significant amounts of our cash; diversion ofresources from other development projects or market opportunities; our abilityto incorporate licensed technology in our products and solutions; our abilityto introduce related products in a cost effective and timely manner; ourability to collect amounts due under these contracts; and market acceptance ofrelated products and solutions. If we fail to recover the cost of these orother assets from the cash flow generated by the related products, our assetswill become impaired and our financial results would be harmed.

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

Our operations and theoperations of our suppliers are vulnerable to interruption by fire, earthquake,power loss, flood, terrorist acts and other catastrophic events beyond ourcontrol. In particular, our headquarters are located near earthquake faultlines in the San Francisco Bay Area. In addition, we rely on sole suppliers tomanufacture our products and would not be able to qualify an alternate supplierof our products for several quarters. Our suppliers often hold significantquantities of our 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

 

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unauthorized tampering.Any catastrophic event, such as an earthquake or other natural disaster, thefailure of our computer systems, war or acts of terrorism, could significantlyimpair our ability to maintain our records, pay our suppliers, or design,manufacture or ship our products. The occurrence of any of these events couldalso 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 adetailed disaster recovery plan. In addition, we do not maintain sufficientbusiness interruption and other insurance policies to compensate us for alllosses that may occur. Any losses or damages incurred by us as a result of acatastrophic event or any other significant uninsured loss could have amaterial adverse effect on our business.

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

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

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

Our ShareholderRights Plan as well as provisions of our Certificate of Incorporation, ourBylaws and Delaware law could make it difficult for a third party to acquireus, even if doing so would be beneficial to our stockholders.

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

Stock prices for many companies in the technology andemerging growth sectors have experienced wide fluctuations that have often beenunrelated to the operating performance of such companies. In the past,securities class action litigation has often been brought against a companyfollowing periods of volatility in the market price of its securities. In thefuture, we may be the subject of similar litigation. Securities litigationcould result in substantial costs and divert management’s attention.

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

GAAP arepromulgated by, and are subject to the interpretation of the FinancialAccounting Standards Board, or FASB, and the Securities and ExchangeCommission, or SEC. New accounting pronouncements or taxation rules and varyinginterpretations of accounting pronouncements or taxation practices haveoccurred and may occur in the future. Any future changes in accountingpronouncements or taxation rules or practices may have a significant effect onhow we report our results and may even affect our reporting of transactionscompleted before the change is effective. In addition, a review of existing orprior accounting practices may result in a change in previously reportedamounts. This change to existing rules, future changes, if any, or thequestioning of current practices may adversely affect our reported financialresults, our ability to remain listed on the Nasdaq Global Market, or the waywe conduct our business and subject us to regulatory inquiries or litigation.

For example, the FASB hasissued SFAS 123(R), *“Share-Based Payment,”*which we adopted in the first quarter of 2006. SFAS 123(R) requires us tomeasure compensation costs for all stock-based compensation awards (includingour stock options and our employee stock purchase plan, as currentlyconstructed) at fair value and record compensation expense over the vestingperiod. If this accounting pronouncement had been in effect during 2005, wewould have reported a net loss.

 

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Additionally, inJuly 2006 we initiated a review of our historical stock option practices andrelated accounting. This review identified accounting and administrative errorsthat, if they had been recorded at the time they occurred, would have resultedin total additional charges of approximately $964,000 between October 1999 andDecember 2005.

*Compliance withregulations related to corporate governance and public disclosure may result inadditional expenses*

Federal securities laws,rules and regulations, as well as Nasdaq rules and regulations, requirecompanies to maintain extensive corporate governance measures, imposecomprehensive reporting and disclosure requirements, set strict independenceand financial expertise standards for audit and other committee members andimpose civil and criminal penalties for companies and their chief executiveofficers, chief financial officers and directors for securities law violations.These laws, rules and regulations have increased and will continue to increasethe scope, complexity and cost of our corporate governance, reporting anddisclosure practices, which could harm our results of operations and divertmanagement’s attention from business operations. We are committed tomaintaining high standards of corporate governance and public disclosure. Ifour efforts to comply with new or changed laws, regulations and standardsdiffer from the activities intended by regulatory or governing bodies due toambiguities related to practice, our reputation may be harmed and the marketprice of our common stock could be affected.

# * *

# *Whilewe believe that we currently have adequate internal control procedures inplace, we are still exposed to potential risks from legislation requiringcompanies to evaluate controls under Section 404 of the Sarbanes-Oxley Act of2002*

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

As of December 2006, we have evaluated ourinternal control systems in order to allow management to report on, and ourindependent registered public accounting firm to attest to, our internalcontrol over financial reporting, as required by Section 404 of theSarbanes-Oxley Act. We performed the system and process evaluation and testingrequired in an effort to comply with the management certification andindependent registered public accounting firm attestation requirements ofSection 404. As a result, we incurred additional expenses and a diversionof management’s time. While we believe that our internal control procedures areadequate and we intend to continue to fully comply with the requirementsrelating to internal control and all other aspects of Section 404, our controlsnecessary for continued compliance with the Sarbanes-Oxley Act may not operateeffectively at all times and may result in a material control disclosure. Theidentification of a material weakness in internal control over financialreporting, if any, could indicate a lack of proper controls to generateaccurate consolidated financial statements. Furthermore, we cannot be certainas to the 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.

# *Wehave implemented import and export control procedures to comply with UnitedStates regulations but we are still exposed to potential risks from import andexport activity*

Our products, solutions,technology and software are subject to import and export control laws andregulations which, in some instances, may impose restrictions on businessactivities, or otherwise require licenses or other authorizations from agenciessuch as the U.S. Department of State, U.S. Department of Commerce and U.S.Department of the Treasury. These restrictions may impact deliveries tocustomers or limit development and manufacturing alternatives. We have importand export licensing and compliance procedures in place for purposes

 

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of conducting ourbusiness consistent with U.S. and applicable international laws andregulations, and we periodically review these procedures to maintain compliancewith the requirements relating to import and export regulations. If we are notable to remain in compliance with import and export regulations, we might besubject to investigation, sanctions or penalties by regulatory authorities.Such penalties can include civil, criminal or administrative remedies such asloss of export privileges. We cannot be certain as to the outcome of anevaluation, investigation, inquiry or other action or the impact of these itemson our operations. Any such action could adversely affect our financial resultsand the market price of our common stock.

# *TheCompany and our directors and management have in the past been named parties tolawsuits and may be subject to future litigation, which could result in anunfavorable outcome and have a material adverse effect on our business,financial condition, results of operations, cash flows and the trading pricefor our securities*

TheCompany and certain of our directors and officers are named in a lawsuitrelating to the initial public offering laddering litigation and certainofficers and directors were named in litigation, which has been dismissed, relatingto our historical stock option practices and related accounting. We may becomethe subject of other private or government actions in the future. Litigationmay be time consuming, expensive and disruptive to normal business operationsand the outcome of litigation is difficult to predict. Any expenses associatedwith litigation or the outcome relating to any such actions could have amaterial adverse effect on our business, financial condition, results ofoperations, cash flows and the trading price for our securities.

 

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**Item 6.Exhibits**

 

a.     Exhibits

 

The following Exhibits are filed with this report:

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                       |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                  |
|   3.1(1)  |       | Amended and Restated Certificate of Incorporation of  Registrant.                                                                                     |
|   3.2(2)  |       | Bylaws of Registrant.                                                                                                                                 |
| 31.1                |       | CEO Certification pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.                                                                    |
| 31.2                |       | CFO Certification pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.                                                                    |
| 32                  |       | CEO and CFO Certifications pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002. |

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

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

 

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**Signatures**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
| ** **             | **QUICKLOGIC  CORPORATION**                                                                                                           |
|------------------------|---------------------------------------------------------------------------------------------------------------------------------------|
|                   |                                                                                                                                  |
|                   | /s/ CARL M. MILLS                                                                                                                     |
| Date: November 8, 2007 | Carl M. Mills                                                                                                                         |
| * *               | *Vice  President, Finance and Chief Financial Officer**(as Principal Accounting and Financial  Officer and on behalf of**Registrant)* |

 

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**EXHIBITINDEX**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                       |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                  |
|   3.1(1)  |       | Amended and Restated  Certificate of Incorporation of Registrant.                                                                                     |
|   3.2(2)  |       | Bylaws of Registrant.                                                                                                                                 |
| 31.1                |       | CEO Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                    |
| 31.2                |       | CFO Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                    |
| 32                  |       | CEO and CFO  Certifications pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

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

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

 

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