**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

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**FORM 10-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 thetransition period from             to            **

** **

**Commission file number 000-52014**

 

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**Techwell, Inc.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                                    | ** ** | **77-0451738**                           |
|-----------------------------------------------------------------|------------|------------------------------------------|
| (State or other jurisdiction  of Incorporation or organization) |       | (I.R.S. Employer  Identification Number) |

** **

**408 E.Plumeria DriveSan Jose, California, 95134**

(Address of principalexecutive office and zip code)

 

**(408)435-3888**

(Registrant’s telephonenumber, including area code)

 

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Indicateby check mark whether the Registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tofiling requirements for the past 90 days. YES  x   NO  o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer or a non-accelerated filer (as defined in Rule 12b-2 ofthe Exchange Act).

LargeAccelerated Filer o     Accelerated Filer o     Non-Accelerated Filer x

 

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act).

Yes o Nox

 

As ofOctober 31, 2007, 20,881,205 shares of the Registrant’s common stock, $0.001par value, were outstanding.

 

 

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**TECHWELL, INC.**

 

**INDEX**

 
|                     | ** **                                                                                                        | **Page** |
|---------------------|-------------------------------------------------------------------------------------------------------------------|----------|
| PART I —  | FINANCIAL INFORMATION                                                                                             | 3        |
|                |                                                                                                              |     |
| Item 1.             | Financial Statements (Unaudited):                                                                                 | 3        |
|                |                                                                                                              |     |
|                | Condensed Consolidated  Balance Sheets at September 30, 2007 and December 31, 2006                                | 3        |
|                |                                                                                                              |     |
|                | Condensed Consolidated  Statements of Operations for the three and nine months ended September 30,  2007 and 2006 | 4        |
|                |                                                                                                              |     |
|                | Condensed Consolidated  Statements of Cash Flows for the nine months ended September 30, 2007 and  2006           | 5        |
|                |                                                                                                              |     |
|                | Notes to Condensed  Consolidated Financial Statements                                                             | 6        |
|                |                                                                                                              |     |
| Item 2.             | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                       | 11       |
|                |                                                                                                              |     |
| Item 3.             | Quantitative and Qualitative  Disclosures About Market Risk                                                       | 21       |
|                |                                                                                                              |     |
| Item 4.             | Controls and Procedures                                                                                           | 22       |
|                |                                                                                                              |     |
| PART II — | OTHER INFORMATION                                                                                                 | 22       |
|                |                                                                                                              |     |
| Item 1.             | Legal Proceedings                                                                                                 | 22       |
|                |                                                                                                              |     |
| Item 1A.            | Risk Factors                                                                                                      | 22       |
|                |                                                                                                              |     |
| Item 2.             | Unregistered Sales of Equity  Securities and Use of Proceeds                                                      | 34       |
|                |                                                                                                              |     |
| Item 3.             | Defaults Upon Senior  Securities                                                                                  | 34       |
|                |                                                                                                              |     |
| Item 4.             | Submission Of Matters To A  Vote Of Security Holders                                                              | 34       |
|                |                                                                                                              |     |
| Item 5.             | Other Information                                                                                                 | 34       |
|                |                                                                                                              |     |
| Item 6.             | Exhibits                                                                                                          | 34       |
|                |                                                                                                              |     |
|                | Signatures                                                                                                        | 35       |

 

2

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**PART I—FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**TECHWELL, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

**(In thousands, except share and pershare amounts)**

 
| ** **                                                                                                                         | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                         | ** ** | **2007**               | ** ** | **2006**              | ** ** |
| ** **                                                                                                                         | ** ** | ** **             | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                         | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                    |       |                   |       |                  |       |
| Cash and cash  equivalents                                                                                                         |       | $                      | 21,945     |                  | $          | 13,201 |   |
| Short-term  investments                                                                                                            |       | 37,186                 |       | 36,364                |       |
| Total cash, cash  equivalents and short-term investments                                                                           |       | 59,131                 |       | 49,565                |       |
| Accounts  receivable                                                                                                               |       | 1,946                  |       | 2,765                 |       |
| Inventory                                                                                                                          |       | 4,529                  |       | 4,584                 |       |
| Prepaid expenses  and other current assets                                                                                         |       | 1,382                  |       | 1,406                 |       |
| Total current  assets                                                                                                              |       | 66,988                 |       | 58,320                |       |
| Property and  equipment, net                                                                                                       |       | 1,389                  |       | 625                   |       |
| Long-term  investments                                                                                                             |       | 6,281                  |       | 4,963                 |       |
| Deferred income  taxes                                                                                                             |       | 5,133                  |       | —                |       |
| Other assets                                                                                                                       |       | 168                    |       | 85                    |       |
| Total assets                                                                                                                       |       | $                      | 79,959     |                  | $          | 63,993 |   |
|                                                                                                                               |       |                   |       |                  |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                         |       |                   |       |                  |       |
| Current  liabilities:                                                                                                              |       |                   |       |                  |       |
| Accounts payable                                                                                                                   |       | $                      | 3,205      |                  | $          | 3,503 |   |
| Accrued liabilities                                                                                                                |       | 2,690                  |       | 3,344                 |       |
| Income taxes  payable                                                                                                              |       | 1,490                  |       | —                |       |
| Total current  liabilities                                                                                                         |       | 7,385                  |       | 6,847                 |       |
| Deferred rent                                                                                                                      |       | 202                    |       | —                |       |
| Total  liabilities                                                                                                                 |       | 7,587                  |       | 6,847                 |       |
|                                                                                                                               |       |                   |       |                  |       |
| Stockholders’  equity:                                                                                                        |       |                   |       |                  |       |
| Preferred stock,  $0.001 par value; 10,000,000 shares authorized and no shares issued and  outstanding                             |       | —                 |       | —                |       |
| Common stock,  $0.001 par value; 250,000,000 shares authorized; 20,837,319 shares and  20,528,468 shares outstanding, respectively |       | 21                     |       | 21                    |       |
| Additional  paid-in capital                                                                                                        |       | 72,090                 |       | 67,734                |       |
| Deferred  stock-based compensation                                                                                                 |       | (225                   | )          | (546                  | )          |
| Accumulated  other comprehensive loss                                                                                              |       | (11                    | )          | (39                   | )          |
| Retained  earnings (accumulated deficit)                                                                                           |       | 497                    |       | (10,024               | )          |
| Total  stockholders’ equity                                                                                                   |       | 72,372                 |       | 57,146                |       |
| Total  liabilities and stockholders’ equity                                                                                   |       | $                      | 79,959     |                  | $          | 63,993 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

3

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**TECHWELL, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

**(Unaudited)**

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

 
| ** **                                                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                      | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                      | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                            |       |                             |       |                            |       |   |   |   |   |
| Revenues                                                        |       | $                                | 15,122     |                            | $          | 15,101 |   | $ | 43,382 |   | $ | 37,702 |   |
|                                                            |       |                             |       |                            |       |   |   |   |   |
| Cost of revenues                                                |       | 6,048                            |       | 6,374                           |       | 17,828 |   | 16,112 |   |
|                                                            |       |                             |       |                            |       |   |   |   |   |
| Gross profit                                                    |       | 9,074                            |       | 8,727                           |       | 25,554 |   | 21,590 |   |
|                                                            |       |                             |       |                            |       |   |   |   |   |
| Operating  expenses:                                            |       |                             |       |                            |       |   |   |   |   |
| Research and  development                                       |       | 3,496                            |       | 2,033                           |       | 8,581 |   | 6,984 |   |
| Selling, general  and administrative                            |       | 3,135                            |       | 2,362                           |       | 8,767 |   | 6,064 |   |
| Total operating  expenses                                       |       | 6,631                            |       | 4,395                           |       | 17,348 |   | 13,048 |   |
|                                                            |       |                             |       |                            |       |   |   |   |   |
| Income from  operations                                         |       | 2,443                            |       | 4,332                           |       | 8,206 |   | 8,542 |   |
| Interest income                                                 |       | 819                              |       | 617                             |       | 2,235 |   | 1,024 |   |
|                                                            |       |                             |       |                            |       |   |   |   |   |
| Income before  income taxes                                     |       | 3,262                            |       | 4,949                           |       | 10,441 |   | 9,566 |   |
| Income tax  (benefit) provision                                 |       | (2,154                           | )          | 440                             |       | (80 | ) | 1,194 |   |
|                                                            |       |                             |       |                            |       |   |   |   |   |
| Net income                                                      |       | $                                | 5,416      |                            | $          | 4,509 |   | $ | 10,521 |   | $ | 8,372 |   |
|                                                            |       |                             |       |                            |       |   |   |   |   |
| Basic net income  per share                                     |       | $                                | 0.26       |                            | $          | 0.22 |   | $ | 0.51 |   | $ | 0.82 |   |
| Diluted net  income per share                                   |       | $                                | 0.25       |                            | $          | 0.21 |   | $ | 0.48 |   | $ | 0.42 |   |
|                                                            |       |                             |       |                            |       |   |   |   |   |
| Weighed average  shares used in computing net income per share: |       |                             |       |                            |       |   |   |   |   |
| Basic                                                           |       | 20,822                           |       | 20,093                          |       | 20,741 |   | 10,213 |   |
| Diluted                                                         |       | 21,768                           |       | 21,787                          |       | 21,795 |   | 19,794 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

4

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**TECHWELL, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

**(In thousands)**

 
| ** **                                                                         | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                         | ** ** | **September 30,**          | ** ** |
| ** **                                                                         | ** ** | **2007**                        | ** ** | **2006** | ** ** |
| **Cash  flows from operating activities:**                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                               | 10,521     |   | $ | 8,372 |   |
|                                                                               |       |                            |       |   |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                            |       |   |   |
| Depreciation and  amortization                                                     |       | 325                             |       | 237 |   |
| Stock-based  compensation                                                          |       | 3,243                           |       | 1,788 |   |
| Tax benefit from  employee equity incentive plan                                   |       | 887                             |       | 190 |   |
| Excess tax  benefit from stock-based compensation                                  |       | —                          |       | (22 | ) |
| Changes in  assets and liabilities:                                                |       |                            |       |   |   |
| Accounts  receivable                                                               |       | 819                             |       | 777 |   |
| Inventory                                                                          |       | 55                              |       | (3,080 | ) |
| Prepaid expenses  and other current assets                                         |       | 24                              |       | (359 | ) |
| Deferred income  taxes                                                             |       | (5,133                          | )          | — |   |
| Other assets                                                                       |       | (83                             | )          | (22 | ) |
| Accounts payable                                                                   |       | (426                            | )          | 4,024 |   |
| Accrued  liabilities                                                               |       | (821                            | )          | 1,398 |   |
| Income taxes  payable                                                              |       | 1,490                           |       | 283 |   |
| Deferred rent                                                                      |       | 202                             |       | (41 | ) |
| Net cash  provided by operating activities                                         |       | 11,103                          |       | 13,545 |   |
| **Cash  flows from investing activities:**                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Purchase of  property and equipment                                                |       | (794                            | )          | (348 | ) |
| Purchase of  investments                                                           |       | (77,210                         | )          | (63,956 | ) |
| Proceeds from  maturities of investments                                           |       | 75,098                          |       | 32,392 |   |
| Net cash used in  investing activities                                             |       | (2,906                          | )          | (31,912 | ) |
| **Cash  flows from financing activities:**                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Proceeds from  initial public offering of common stock, net of offering costs      |       | —                          |       | 19,458 |   |
| Proceeds from  exercise of stock options                                           |       | 547                             |       | 294 |   |
| Excess tax  benefit from stock-based compensation                                  |       | —                          |       | 22 |   |
| Net cash  provided by financing activities                                         |       | 547                             |       | 19,774 |   |
| Net increase in  cash and cash equivalents                                         |       | 8,744                           |       | 1,407 |   |
| Cash and cash  equivalents at beginning of period                                  |       | 13,201                          |       | 15,982 |   |
| Cash and cash  equivalents at end of period                                        |       | $                               | 21,945     |   | $ | 17,389 |   |
| ** **                                                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Supplemental  cash flow information—income taxes paid**                     |       | $                               | 2,300      |   | $ | 695 |   |
| ** **                                                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Supplemental  disclosure of noncash investing and financing activities:**        | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Accrued offering  costs                                                            |       | $                               | —     |   | $ | 94 |   |
| Accrued  equipment purchases                                                       |       | $                               | 295        |   | $ | 33 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

5

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**TECHWELL, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

 

**Note 1.  Background and Basis of Presentation**

 

***The Company***

 

Techwell, Inc. (“Techwell”or the “Company”) was incorporated in California on March 7, 1997 andreincorporated in Delaware on March 30, 2006. Techwell is a fabless semiconductor company that designs, markets andsells mixed signal integrated circuits for multiple video applications in thesecurity surveillance, automotive and consumer markets.

 

The Company’sinternational offices include branch offices in South Korea and Taiwan andsubsidiaries in China and Japan.  Theseoffices provide marketing support to customers. The South Korea and Japanoffices are also involved in product development.  

 

***Basis of Presentation***

 

Theaccompanying condensed consolidated financial statements of the Company have beenprepared without audit in accordance with the rules and regulations of theSecurities and Exchange Commission.  The balance sheetat December 31, 2006 has been derived from the audited financialstatements as of and for the year then ended. Certain information and disclosures normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America have been condensed oromitted in accordance with these rules and regulations. The information inthis report should be read in conjunction with the Company’s consolidatedfinancial statements and notes thereto included in its Annual Report onForm 10-K for the year ended December 31, 2006.

 

In theopinion of management, the accompanying unaudited condensed consolidatedfinancial statements reflect all adjustments (consisting only of normalrecurring adjustments) necessary to summarize fairly the Company’s financialposition, results of operations and cash flows for the interim periods presented.The operating results for the three and nine months ended September 30, 2007are not necessarily indicative of the results that may be expected for the yearending December 31, 2007 or for any other future period.

 

***Principles of Consolidation and Year End***

 

Thecondensed consolidated financial statements include the accounts of the Companyand its subsidiaries. All significant intercompany balances and transactionshave been eliminated in consolidation. The Company reports its financialresults on a calendar fiscal year.

 

***Useof Estimates***

 

The preparation offinancial statements in accordance with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities, thedisclosure of contingent assets and liabilities at the date of the consolidatedfinancial statements and the reported amounts of revenues and expenses duringthe reporting period.  Actual resultscould differ from these estimates.

 

***Certain Significant Risks and Uncertainties***

 

TheCompany operates in a dynamic high technology industry and changes in any ofthe following areas could have a material adverse effect on the Company’sfinancial position and results of operations: unpredictable volume and timingof customer orders, which are not fixed by contract; loss of one or more of itscustomers; decrease in the overall average selling prices of its products;changes in the relative sales mix of its products; changes in its cost offinished goods; the availability, pricing and timeliness of delivery of othercomponents used in the Company’s customers’ products; the Company’s customers’sales outlook, purchasing patterns and inventory adjustments based on demandand general economic conditions; product obsolescence and the Company’s abilityto manage product transitions; the Company’s ability to successfully develop,introduce and sell new or enhanced products in a timely manner; and the timingof new product announcements or introductions by the Company or by itscompetitors.

 

6

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**Note 2. ****Stock-Based Compensation**

 

TheCompany has equity incentive plans (“Plans”) under which it may grant stockoptions, restricted stock awards, stock units and stock appreciation rights toemployees, consultants and directors.  AtSeptember 30, 2007, the total number of shares available for issuance under thePlans is 1,509,763.  Stock options andawards granted under the Plans may have a contractual term up to ten years,generally vest over four years at the rate of 25 percent on the one-yearanniversary of the vesting commencement date and ratably each month thereafterand are exercisable under conditions determined by the Board as permissibleunder the terms of the Plans. At September 30, 2007, 33,334 shares exercisedprior to vesting are subject to repurchase by the Company.

 

EffectiveJanuary 1, 2006, the Company adopted Statement of Financial AccountingStandards No. 123 (revised 2004), *Share-BasedPayment*, (“SFAS No. 123(R)”) which requires the measurement andrecognition of compensation expense for all share-based payment awards made toemployees and directors, including employee stock options, based on estimatedfair values recognized over the requisite service period. Prior to adoption ofSFAS No. 123(R), the Company accounted for stock-based compensation awardsissued to its employees using the intrinsic value measurement provisions ofAccounting Principles Board Opinion No. 25 (“APB Opinion No. 25”), *Accounting for Stock Issued to Employees*.  

 

TheCompany adopted SFAS No. 123(R) using the prospective transition method. Underthis method, SFAS No. 123(R) is applied to new awards and to awards modified,repurchased or cancelled after the adoption date of January 1, 2006.  Compensation cost previously recorded underAPB Opinion No. 25 for awards outstanding at the adoption date, such asunvested options, continues to be recognized as the options vest.  Accordingly, for the three and nine monthsended September 30, 2007 and 2006, stock-based compensation expense includescompensation cost related to estimated fair values of awards granted after thedate of adoption of SFAS No. 123(R) and compensation costs related to unvestedawards at the date of adoption based on the intrinsic values as previouslyrecorded under APB Opinion No. 25.

 

Thefollowing table summarizes the distribution of stock-based compensation expense(in thousands):

 
| ** **                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                              | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                              | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Cost of revenues                        |       | $                                | 77         |                            | $          | 35 |   | $ | 193 |   | $ | 72 |   |
| Research and  development               |       | 579                              |       | 174                             |       | 1,414 |   | 909 |   |
| Selling, general  and administrative    |       | 660                              |       | 342                             |       | 1,637 |   | 807 |   |
| Related tax  effect                     |       | (141                             | )          | (34                             | )          | (582 | ) | (60 | ) |
| Total stock-based  compensation expense |       | $                                | 1,175      |                            | $          | 517 |   | $ | 2,662 |   | $ | 1,728 |   |

 

Total compensation costattributable to activities capitalized into inventory was not significant inall periods presented.  Stock-basedcompensation expense in the nine months ended September 30, 2006 includes $0.6million for immediately vested options granted to consultants.

 

SFASNo. 123(R) requires the cash flows from the tax benefits for tax deductionsresulting from the exercise of stock options in excess of the compensationexpense recorded for these options (excess tax benefits) to be classified ascash from financing activities.  

 

**Note 3.  Net Income Per Share**

 

The Companycalculates net income per share in accordance with SFAS No. 128, *Earnings Per Share.*  Under SFAS No. 128, basic net income pershare is calculated by dividing net income for the period by the weightedaverage number of common stock shares outstanding during the period excludingshares subject to repurchase. Diluted net income per share reflects potentiallydilutive securities which consist of convertible preferred stock, common stockoptions, restricted stock awards and common stock subject to repurchase.

 

7

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Areconciliation of shares used in the calculation of basic and diluted netincome per share is as follows (in thousands):

 
| ** **                                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                              | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                              | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                    |       |                             |       |                            |       |   |   |   |   |
| Weighted average  common shares outstanding             |       | 20,860                           |       | 20,162                          |       | 20,787 |   | 10,290 |   |
| Weighted average  shares subject to repurchase          |       | (38                              | )          | (69                             | )          | (46 | ) | (77 | ) |
| Shares used to  calculate basic net income per share    |       | 20,822                           |       | 20,093                          |       | 20,741 |   | 10,213 |   |
| Effect of  dilutive securities:                         |       |                             |       |                            |       |   |   |   |   |
| Convertible  preferred stock                            |       | —                           |       | —                          |       | — |   | 7,866 |   |
| Common stock  options and restricted stock awards       |       | 946                              |       | 1,694                           |       | 1,054 |   | 1,715 |   |
| Dilutive  potential common stock                        |       | 946                              |       | 1,694                           |       | 1,054 |   | 9,581 |   |
| Shares used to  calculate dilutive net income per share |       | 21,768                           |       | 21,787                          |       | 21,795 |   | 19,794 |   |

 

Thecompletion of the Company’s initial public offering (“IPO”) in June 2006resulted in the conversion to common stock of all outstanding shares ofconvertible preferred stock.  As aconsequence, the shares used to calculate basic net income per share haveincreased by the weighted average impact of the 12,777,118 common shares issuedon conversion of the convertible preferred stock and the 2,540,225 sharesissued in the IPO and 130,000 shares of common stock issued in July 2006following the underwriters’ partial exercise of their over-allotment optionrelated to the IPO. 

 

**Note 4. Income Taxes**

 

The Company accounts forincome taxes under the provisions of SFAS No. 109,*Accounting for Income Taxes*. In applyingSFAS No. 109, the Company is required to estimate its current tax expensetogether with assessing temporary differences resulting from differingtreatments of items for tax and accounting purposes. These differences resultin deferred tax assets and liabilities. Significant management judgment isrequired to assess the likelihood that its deferred tax assets will berecovered from future taxable income. As of September 30, 2007, the Company’stotal deferred tax assets were principally comprised of net operating losscarryforwards, research and other credit carryforwards and expense accruals. 

 

As required under theprovisions of SFAS No.109, the Company assessed the recoverability of itsdeferred tax assets as of September 30, 2007. To assess the likelihood that thedeferred tax assets will be recovered from taxable income, the Company appliedthe guidance provided in SFAS No. 109 and considered both positiveevidence that indicates a valuation allowance is not needed and negativeevidence that indicates a valuation allowance is needed. As a result of this assessmentin which the Company considered its recent history of consecutive profitablequarters and anticipated profit in future periods, the Company released thevaluation allowance recorded against its deferred tax assets of approximately$5.5 million as it believes that it is more likely than not the deferred taxassets will be realized in the future. 

 

The Company and its subsidiaries fileincome tax returns in the U.S. federal jurisdiction, various states and foreignjurisdictions.  The Company has not been under the examination of U.S.federal, state or foreign jurisdictions.  

 

The Company adopted the provisions of FinancialAccounting Standards Board (“FASB”) Interpretation No. 48, *Accounting for Uncertainty in Income Taxes,* (“FIN No. 48”)on January 1, 2007.  FIN No. 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with SFAS No. 109*.* As aresult of the implementation of FIN No. 48, the Company recognized an increaseof approximately $0.2 million in the liability for unrecognized tax benefitsand a decrease in the related valuation allowance of the same amount.  Therefore upon implementation of FINNo. 48, the Company recognized no material adjustment to the January 1,2007 balance of retained earnings. The Company recognizes interest relatedto unrecognized tax benefits in its income tax expense and penalties related tounrecognized tax benefits in its operating expenses. For the three and ninemonths ended September 30, 2007, the Company did not recognize any interest orpenalties related to unrecognized tax benefits.

 

TheCompany’s effective tax rate is based on the estimated annual effective taxrate in accordance with SFAS No. 109. In the three and nine months endedSeptember 30, 2007, the effective tax rate differed from the statutory federalincome tax rate primarily because the Company recognized a benefit as a resultof the release of the valuation allowance for the deferred tax assets and theCompany utilized prior net operating losses to offset taxable income.  In the three and nine months ended September30, 2006, the effective tax rate differed from the statutory federal income taxrate primarily because the Company utilized prior net operating losses tooffset taxable income in the period.

 

8

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**Note 5. Investments**

 

TheCompany’s investments are considered available-for-sale and primarily consistof high grade debt securities. These securities are carried at fair marketvalue based on market quotes. Unrealized gains and losses, net of tax, arereported as a separate component of stockholders’ equity and included in “Accumulatedother comprehensive loss”.  Realizedgains and losses are recorded based on the specific identification method andare not significant in any period presented.

 

Thechange in unrealized losses on investments, net of tax, in the three and ninemonths ended September 30, 2007 was a decrease of $40,000 and $28,000,respectively. The change in unrealized losses on investments, net of tax, inthe three and nine months ended September 30, 2006 was an increase of $1,000and $14,000, respectively.  

 

**Note 6.  Detailsof Certain Balance Sheet Components**

 

**Inventory**(in thousands):

 
| ** **      | ** ** | **September 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|-----------------|------------|----------------------------------|------------|---------------------------------|------------|
| Finished goods  |       | $                                | 2,371      |                            | $          | 1,702 |   |
| Work in process |       | 2,158                            |       | 2,882                           |       |
|            |       |                             |       |                            |       |
|            |       | $                                | 4,529      |                            | $          | 4,584 |   |

 

**Propertyand equipment, net**(in thousands):

 
| ** **                                      | ** ** | **September 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Equipment                                       |       | $                                | 1,595      |                            | $          | 1,029 |   |
| Software                                        |       | 450                              |       | 215                             |       |
| Furniture and  fixtures                         |       | 259                              |       | 317                             |       |
| Leasehold  improvements                         |       | 411                              |       | 146                             |       |
|                                            |       |                             |       |                            |       |
|                                            |       | 2,715                            |       | 1,707                           |       |
| Less accumulated  depreciation and amortization |       | (1,326                           | )          | (1,082                          | )          |
|                                            |       |                             |       |                            |       |
|                                            |       | $                                | 1,389      |                            | $          | 625 |   |

 

**Accruedliabilities**(in thousands):

 
| ** **                            | ** ** | **September 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Accrued  compensation                 |       | $                                | 1,125      |                            | $          | 1,988 |   |
| Accrued  inventory purchases          |       | 293                              |       | 279                             |       |
| Customer  advances                    |       | 258                              |       | 325                             |       |
| Legal and  professional services fees |       | 246                              |       | 271                             |       |
| Exercise of  unvested stock options   |       | 74                               |       | 110                             |       |
| Accrued  equipment purchases          |       | 167                              |       | —                          |       |
| Accrued tape-out  expense             |       | 135                              |       | 6                               |       |
| Other                                 |       | 392                              |       | 365                             |       |
|                                  |       |                             |       |                            |       |
|                                  |       | $                                | 2,690      |                            | $          | 3,344 |   |

 

**Note 7.  Segment Information**

 

Asdefined by the requirements of SFAS No. 131, *DisclosureAbout Segments of an Enterprise and Related Information,* the Companycurrently operates in one reportable segment, the designing, marketing andselling of mixed signal integrated circuits for multiple video applications inthe security surveillance, automotive and consumer markets. The Company’s chiefoperating decision maker is its chief executive officer.  

 

9

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Thepercentages of total revenues by geographic area are as follows:

 
| ** **      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **      | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **      | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Taiwan          |       | 41                               | %          | 48                              | %          | 43 | % | 45 | % |
| South Korea     |       | 28                               |       | 26                              |       | 31 |   | 30 |   |
| China/Hong Kong |       | 26                               |       | 21                              |       | 21 |   | 20 |   |
| Japan           |       | 3                                |       | 4                               |       | 3 |   | 3 |   |
| United States   |       | 1                                |       | 1                               |       | 1 |   | 1 |   |
| Other           |       | 1                                |       | —                          |       | 1 |   | 1 |   |
| Total           |       | 100                              | %          | 100                             | %          | 100 | % | 100 | % |

 

Revenues by product line are as follows (inthousands):

 
| ** **                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Security  Surveillance(1) |       | $                                | 10,247     |                            | $          | 7,333 |   | $ | 28,250 |   | $ | 17,996 |   |
| Video  Decoders(2)        |       | 3,320                            |       | 5,667                           |       | 9,842 |   | 14,764 |   |
| LCD Display(3)            |       | 1,293                            |       | 2,001                           |       | 4,427 |   | 4,281 |   |
| Other(4)                  |       | 262                              |       | 100                             |       | 863 |   | 661 |   |
| Total                     |       | $                                | 15,122     |                            | $          | 15,101 |   | $ | 43,382 |   | $ | 37,702 |   |

 

----

(1)           Consists of application specificproducts designed for use in security surveillance systems.

 

(2)                                  Consistsof general purpose video decoders designed for use in the securitysurveillance, automotive and consumer markets. Revenues from general purposevideo decoders used in security surveillance systems and LCD displays arereported under the video decoder product line and not the security surveillanceor LCD display product lines.

 

(3)           Consists of application specificproducts designed for use in LCD displays.

 

(4)                                  Consistsof early generation mixed signal semiconductors for digital video applicationsand PCI video decoder products.

 

The following is a summary of long-lived assets bygeographic region (in thousands):

 

| **Country**   | ** ** | **September 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|---------------|------------|----------------------------------|------------|---------------------------------|------------|
| United States |       | $                                | 1,138      |                            | $          | 544 |   |
| Taiwan        |       | 65                               |       | 64                              |       |
| South Korea   |       | 51                               |       | 12                              |       |
| Japan         |       | 90                               |       | —                          |       |
| China         |       | 45                               |       | 5                               |       |
|          |       |                             |       |                            |       |
| Total         |       | $                                | 1,389      |                            | $          | 625 |   |

 

Therevenues and accounts receivable from customers representing 10% or more oftotal revenues and accounts receivable are as follows:

 
| ** **   | ** ** | **Accounts Receivable at** | ** ** | **Revenues**          | ** ** |
|--------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **   | ** ** | **September 30,**               | ** ** | **December 31,** | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
| **Customer** | ** ** | **2007**                             | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** |
| A            |       | *                                    | %          | 16                    | %          | 24 | % | 16 | % | 19 | % | 14 | % |
| B            |       | *                                    |       | 14                    |       | * |   | 11 |   | * |   | * |   |
| C            |       | 14                                   |       | *                     |       | * |   | * |   | * |   | * |   |
| D            |       | 13                                   |       | *                     |       | * |   | * |   | * |   | * |   |
| E            |       | 23                                   |       | 27                    |       | 12 |   | * |   | * |   | * |   |
| F            |       | *                                    |       | *                     |       | 11 |   | 17 |   | * |   | 14 |   |
| G            |       | 12                                   |       | *                     |       | * |   | * |   | * |   | * |   |
| H            |       | 12                                   |       | *                     |       | * |   | * |   | * |   | * |   |

 

----

*   less than 10%

 

10

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**Note 8. Related Party Transactions**

 

One ofthe Company’s Board members is a partner in a law firm that provides legal servicesto the Company. The Company incurred fees of nil and $21,000 from this law firmfor legal services in the three months ended September 30, 2007 and 2006,respectively. The Company incurred fees of $12,000 and $101,000 to this lawfirm for legal services in the nine months ended September 30, 2007 and 2006,respectively.  The amount payable to thislaw firm was $3,000 at September 30, 2007 and $17,000 at December 31,2006.  This Board member also receivescompensation in accordance with the Company’s compensation program fornon-employee directors.

 

**ITEM 2. Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

 

*The following discussion of our financial condition andresults of operations should be read in conjunction with the condensedconsolidated financial statements and notes to those statements includedelsewhere in this Quarterly Report on Form 10-Q as of September 30, 2007and our audited consolidated financial statements for the year endedDecember 31, 2006 included in our Annual Report on Form 10-K.*

 

*ThisReport contains forward-looking statements that involve risks anduncertainties. These statements relate to future periods, future events or ourfuture operating or financial plans or performance. These statements can oftenbe identified by the use of forward-looking terminology such as “expects,” “believes,”“intends,” “anticipates,” “estimates,” “plans,” “may,” or “will,” or thenegative of these terms, and other similar expressions. These forward-lookingstatements include statements as to the source of our revenues, our ability togenerate revenues, our ability to sustain our growth rate and profitability,our expectation regarding the increase in certain expenses, our cash needs, ourcapital requirements, our market risk sensitivity, our business and productstrategies, our anticipated tax rate, our intention to add integrated audiofunctionality to our general purpose decoders, industry trends and ouranticipation that developments in our technologies and new products willincrease our target market share.*

* *

*Theseforward-looking statements reflect our current views with respect to futureevents are based on assumptions and are subject to risks and uncertainties.These risks and uncertainties could cause actual results to differ materiallyfrom those projected and include, but are not limited to, fluctuations in ourrevenue and operating results, the demand for digital video applications forthe security surveillance, automotive and consumer markets, our ability tocompete, our dependence on key and highly skilled personnel, the ability todevelop new products and to enhance our existing products, the continuedseasonality of our business due to our target markets and location of ourcustomers, our ability to integrate businesses that we may acquire, our abilityto estimate and predict customer demand, economic volatility in either domesticor foreign markets, the impact of any change in United States federal incometax laws and the loss of any beneficial tax treatment that we currently enjoy,our reliance on independent foundries and subcontractors for the manufacture,assembly and testing of our products, the length of our sales cycle andreliance on distributors, our ability to protect our intellectual property, thecyclical nature of the semiconductor industry, our ability to raise capital,the potential volatility of our stock, the outcome of future litigation and therisks set forth under PART II – OTHER INFORMATION,  Item 1A. “Risk Factors.” Given these risks anduncertainties, you should not place undue reliance on these forward-lookingstatements. Except as required by federal securities laws, we undertake noobligation to update any forward-looking statements for any reason, even if newinformation becomes available or other events occur in the future.*

* *

*Inthis report all references to “Techwell,” “we,” “us” or “our” meanTechwell, Inc.*

* *

*Techwellis our registered trademark. We also refer to trademarks of other corporationsand organizations in thisForm 10-Q.*

 

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***Overview***

 

        Weare a fabless semiconductor company that designs, markets and sells mixedsignal integrated circuits for multiple video applications in the securitysurveillance, automotive and consumer markets. We target video applicationsbased on digital technologies that receive and process analog video signals.These video applications include advanced TVs, multifunction LCD monitors, DVDrecorders, camcorders, security surveillance systems and in-car displays. Theseapplications receive analog video signals commonly generated by over-the-air TVbroadcasts, by consumer electronics devices such as set-top boxes, DVD players,VCRs and camcorders and by surveillance cameras. We design both general purposeand application specific products that enable the conversion of analog videosources to digital form and perform advanced digital video processing tofacilitate the display, storage and transport of video content. We believe thisproduct strategy allows us to better address varying customer requirements,fully leverage our technology capabilities and achieve greater share within ourtarget markets. Our semiconductors are based on our proprietary architectureand mixed signal technologies that we believe provide high video quality undera wide range of signal conditions, enable high levels of integration and arecost effective.

 

We commenced operationsin 1997. From 1997 to 1999, we were primarily involved in developing ourtechnology. We shipped our first generation video decoder in 1999. Since 1999,our business has experienced significant growth primarily as a result of ourability to develop new products, obtain design wins and convert these designwins into revenues. We generated revenues from the sale of over 20 differentproducts in the quarter ended September 30, 2007.

 

We have three principalsemiconductor product lines: security surveillance products, liquid crystaldisplay, or LCD, products and video decoder products. Our security surveillanceproducts integrate important functions required to display, store and transportanalog video signals from security surveillance cameras.  For example, we integrate multiple videodecoders into a single semiconductor.  Asa result, this semiconductor is able to receive and decode analog video signalfrom multiple cameras into a standard digital format.  In addition, we integrate a multiplexer, akey technology required to combine multiple video signals into a single videosignal.  In 2006, we introduced two newsecurity surveillance products, each of which includes four video decoders anda system controller on a single semiconductor. We also have developed a motionJPEG, or MJPEG, encoder/decoder, or CODEC, that facilitates the storage andplayback of video from a hard disk drive and transport of video over theInternet.  We currently sell our securitysurveillance products to customers for the following applications:  embedded digital video recorders, or DVRs,PC-based DVRs, network video recorders, or NVRs and multiplexers.

 

Our LCD display productsintegrate important functions required to display analog TV broadcast, popularanalog video, high definition video and PC graphics signals on an LCDdisplay.  We have targeted our initialproducts for applications in the automotive markets.  Our first products in this market providedcustomers with an integrated video decoder and LCD display processor for  LCD display panels in vehicles that providerear seat entertainment.  In the firstquarter of 2007, we introduced our first two new LCD display processors thatcan be used in navigation systems for front seat consoles in the automotivemarket. These new products are designed to provide advanced image processing,an integrated programmable timing controller and multiple analog and digitalvideo inputs. 

 

Our video decoderproducts, which we view as general purpose products, are high-performance mixedsignal semiconductors that decode analog TV broadcast signals, includingNational Television Systems Committee, or NTSC, phase alternation line, or PAL,and sequential color with memory, or SECAM, and popular analog video signals,including composite, S-Video, component and Syndicate of Radio and TelevisionManufacturers, or SCART, into a standard digital format. Our other productsinclude early generation mixed signal semiconductors for digital videoapplications and PCI video decoder products, which are video decoders thatutilize peripheral component interconnect, or PCI, technology for personalcomputer applications.

 

Although our revenueshave grown rapidly in a short period of time, we do not expect to achievesimilar growth rates in the future. We currently expect to increase our expenselevels in each of the next several quarters to support increased research anddevelopment and sales and marketing efforts. These expenditures may not resultin increased revenue or profitability in the future. In addition, our abilityto increase our revenues will depend on increased demand for digital videoapplications in the security surveillance, automotive and consumer markets. Thegrowth of our target markets is uncertain. In addition, the timing of orders byand shipments to our customers, as well as general trends in our targetmarkets, can cause our revenue growth to be inconsistent.

 

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We undertake significantproduct development efforts well in advance of a product’s release, and inadvance of receiving purchase orders from our customers. Our productdevelopment efforts, which are focused on developing new designs with broaddemand and potential for future derivative products, typically take from sixmonths to two years until production begins, depending on the product’scomplexity. If we secure a design win, the system designer is likely tocontinue to use the same or enhanced versions of our product across a number oftheir models, which tends to extend the life cycles of our product. Conversely,if a competitor secures the design win, it may be difficult for us to sell intothe customer’s application for an extended period. Our sales cycle typicallyranges from six to 12 months. Due to the length of our product development andsales cycle, the majority of our revenues for any period is generally weightedtoward products introduced for sale, meaning products for which we commencedplacing orders with our manufacturing subcontractors, in the prior one or twoyears. As a result, our present revenues are not necessarily representative of futuresales because our future sales are likely to be comprised of a different mix ofproducts, some of which are now in the development stage.

 

As a fablesssemiconductor company, we outsource all of our manufacturing, assembly and testfunctions to third-party vendors primarily located in Taiwan. This businessmodel enables us to reduce our capital expenditures and fixed costs, whilefocusing our engineering and design resources on our core strength, the designof mixed signal semiconductors for digital video applications.

 

We sell our products to alimited number of distributors that fulfill third-party orders for ourproducts. We also sell directly, using independent sales representatives, toOEMs such as Samsung and LG Electronics, which have historically been some ofour largest customers, and to original design manufacturers, or ODMs.  In2006, we derived approximately 79% of our revenues from products sold todistributors and 21% from products sold to OEMs or ODMs. In the ninemonths ended September 30, 2007, we derived approximately 68% of our revenuesfrom products sold to distributors and 32% from products sold to OEMs orODMs. Our gross margins have not historically been significantly differentbetween sales to distributors and sales to OEMs or ODMs through orders procuredby independent sales representatives. However, our operating profit on salesthrough orders procured by independent sales representatives can be less due tothe payment of commissions to sales representatives which we record as salesand marketing expense.

 

Wereceived an aggregate of 84% and 81% of our revenues from our ten largestcustomers in the three months ended September 30, 2007 and 2006, respectively.For the three months ended September 30, 2007, three of our customers accountedfor 24%, 12% and 11%, respectively, of our revenues. For the three months endedSeptember 30, 2006, three of our customers accounted for 17%, 16% and 11%,respectively, of our revenues. For the nine months ended September 30, 2007,one of our customers accounted for 19% of our revenues.  For the nine months ended September 30, 2006,two of our customers each accounted for 14% of our revenues.

 

We derive substantiallyall of our revenues from sales to foreign customers, particularly in Asia,which sales accounted for approximately 98% of our revenues in both the threeand nine months ended September 30, 2007 compared to approximately 99% and 98%of our revenues in the three and nine months ended September 30, 2006,respectively. The table below indicates the percentage of total revenue by geographiclocation for the periods indicated:

 
| ** **      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **      | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **      | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Taiwan          |       | 41                               | %          | 48                              | %          | 43 | % | 45 | % |
| South Korea     |       | 28                               |       | 26                              |       | 31 |   | 30 |   |
| China/Hong Kong |       | 26                               |       | 21                              |       | 21 |   | 20 |   |
| Japan           |       | 3                                |       | 4                               |       | 3 |   | 3 |   |
| United States   |       | 1                                |       | 1                               |       | 1 |   | 1 |   |
| Other           |       | 1                                |       | —                          |       | 1 |   | 1 |   |
| Total           |       | 100                              | %          | 100                             | %          | 100 | % | 100 | % |

 

Webelieve that a substantial majority of our revenues will continue to come fromcustomers located in Asia, where most of the electronic devices that use ourintegrated circuits, or ICs, are manufactured. As a result of this regionalcustomer concentration, we may be subject to economic and political events andother developments that impact our customers in Asia. However, all of oursales, substantially all of our cost of revenues and a majority of ouroperating expenses are denominated in U.S. dollars. As a consequence, webelieve that our overall exposure to foreign exchange risk is low.

 

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We have internationalbranches in South Korea and Taiwan and we have subsidiaries in China and Japan.At September 30, 2007, 51 of our 125 employees were located in ourinternational offices. These offices provide marketing support to ourcustomers. Our South Korea and Japan offices also perform product developmentactivities.

 

It is difficult for us toforecast the demand for our products, in part because of the highly complexsupply chain between us and the end markets that incorporate our products.Demand for new features changes rapidly. Distributors and ODMs add anadditional layer of complexity. We must, therefore, forecast demand not onlyfrom our direct customers, but also from other participants in this multi-leveldistribution channel. Because of our lengthy product development cycle, it iscritical for us to anticipate changes in demand for our various productfeatures and the applications they serve, to allow sufficient time for productdesign. Our failure to accurately forecast demand can lead to product shortagesthat can impede production by our customers and harm our relationship withthese customers. Conversely, our failure to forecast declining demand or shiftsin product mix can result in excess or obsolete inventory.

 

Generally, the averageselling price of our products will decline over the life of the product. Ourexperience to date is that the decline has not had a material effect on ourgross margins, as price reductions have been mitigated by lower per unit costsassociated with both high unit volume and the transition of our products tosmaller process geometries. Our video decoder and LCD display products that aresold into consumer applications are subject to the seasonality connected withthe consumer market. As a result, revenues from these products are lower in thefirst calendar quarter of the year. In addition, a significant number of oursemiconductors are sold to customers located in Asia, primarily to customerslocated in regions that observe the Lunar New Year holiday. Typically, our customersare closed for a week or more during the extended holiday period, whichnegatively impacts our business. As a result of seasonality associated with theconsumer market and our customer concentration in Asia, we expect our revenuesto be lower in the first calendar quarter of each year. 

 

Our revenues increased by15% for the nine months ended September 30, 2007 compared to the nine monthsended September 30, 2006 but our revenues were flat for the three months endedSeptember 30, 2007 compared to the three months ended September 30, 2006. Ournet income increased to $5.4 million for the three months ended September 30,2007 from $4.5 million for the three months ended September 30, 2006, primarilyas a result of an income tax benefit related to the release of a valuationallowance on our deferred income taxes. We may not be able to maintain ourrecent growth and profitability and our limited operating history makes theprediction of future operating results very difficult. We believe that period-to-periodcomparisons of operating results should not be relied upon as predictive offuture performance.

 

**CriticalAccounting Policies**

 

Our discussion andanalysis of our financial condition and results of operations are based uponour condensed consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United States.The preparation of these financial statements requires us to make estimates andjudgments that affect the reported amount of assets, liabilities, revenues andexpenses and related disclosure of contingent assets and liabilities. Weevaluate our estimates on an on-going basis, including those related toinventory valuations, income taxes, warranty obligations and stock-based compensation.We base our estimates on historical experience and on various other assumptionsthat we believe to be reasonable under the circumstances, the results of whichform the basis for making the judgments we make about the carrying values ofassets and liabilities that are not readily apparent from other sources.Because these estimates can vary depending on the situation, actual results maydiffer from the estimates.

 

We believe the followingcritical accounting policies require our more significant judgments used in thepreparation of our condensed consolidated financial statements.

 

*RevenueRecognition.  * Revenues from product sales arerecognized upon shipment, provided that title and risk of loss has passed tothe customer, persuasive evidence of an arrangement exists, the price is fixedor determinable and collectibility is probable. We do not allow for priceprotection or stock rotation rights with any of our distributors. If we changeour practice and allow stock rotation or price protection in the future, wewould have to evaluate the consequences on the timing of our revenuerecognition, which could lead to the deferral of the revenues subject to suchuncertainties unless reasonable estimates can be made at the time of shipment.

 

*Warranty.  *We offer an 18 month product replacement warranty against any defectiveproduct. We accrue for estimated returns of defective products at the timerevenue is recognized, based on the rate of return for the prior 18 months. Asa consequence of standardized manufacturing processes and product testingprocedures, returns of defective product are infrequent and the quantities havenot been significant. Accordingly, historical warranty costs have not beensignificant in the fiscal periods presented. If our future experience withwarranty costs differs significantly from our historical experience, we wouldneed to exercise increased judgment in determining the appropriate warrantyaccrual.

 

14

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*InventoryValuation.  * Inventory is valued at the lower ofcost or market, computed on a first-in, first-out basis. We evaluate inventoryfor excess and obsolescence and write-off units that are unlikely to be soldbased upon a six months’ demand forecast. This evaluation may take into accountmatters including expected demand, anticipated sales price, productobsolescence and other factors. If actual future demand for our products isless than currently forecasted, additional inventory adjustments may berequired. Once a reserve is established, it is maintained until the product towhich it relates is sold or scrapped. If a unit that has been written down oroff is subsequently sold, the cost associated with the revenue from this unitis reduced to the extent of the write-off, resulting in an increase in grossprofit.

 

*Accountingfor Income Taxes.  * We account for income taxesunder the provisions of Statement of Financial Accounting Standards, or SFAS,No. 109,*Accounting for Income Taxes*.In applying SFAS No. 109, we are required to estimate our current taxexpense together with assessing temporary differences resulting from differingtreatments of items for tax and accounting purposes. These differences resultin deferred tax assets and liabilities. We must assess the likelihood that ourdeferred tax assets will be recovered from future taxable income and to theextent we believe that recovery is not likely, we must establish a valuationallowance. Significant management judgment is required to assess the likelihoodthat our deferred tax assets will be recovered from future taxable income. AtSeptember 30, 2007, our total deferred tax assets were principally comprised ofnet operating loss carryforwards, research and other credit carryforwards andexpense accruals. 

 

As required under theprovisions of SFAS No. 109, we assessed the recoverability of our deferred taxassets as of September 30, 2007. To assess the likelihood that the deferred taxassets will be recovered from taxable income, we applied the guidance providedin SFAS No. 109 and considered both positive evidence that indicates avaluation allowance is not needed and negative evidence that indicates avaluation allowance is needed. As a result of this assessment in which weconsidered our recent history of consecutive profitable quarters andanticipated profit in future periods, we released the valuation allowancerecorded against our deferred tax assets of approximately $5.5 million. 

 

We file income tax returns in the U.S.federal jurisdiction, various states and foreign jurisdictions.  We havenot been under the examination of U.S. federal, state or other foreignjurisdictions.  

 

On January 1, 2007, we adopted theprovisions of Financial Accounting Standards Board InterpretationNo. 48, *Accounting for Uncertainty in Income Taxes,*or FIN No. 48.  FIN No. 48 clarifies the accounting for uncertaintyin income taxes recognized in an enterprise’s financial statements inaccordance with SFAS No. 109*.*  As a result of the implementation of FIN No. 48, werecognized an increase in the liability for unrecognized tax benefits ofapproximately $0.2 million and a decrease in the related valuation allowance ofsame amount.  Therefore uponimplementation of FIN No. 48, we recognized no material adjustment to the January 1,2007 balance of retained earnings. We recognize interest related tounrecognized tax benefits in our income tax expense and penalties related tounrecognized tax benefits in our operating expenses. For the three and ninemonths ended September 30, 2007, we did not recognize any interest or penaltiesrelated to unrecognized tax benefits.

 

*Stock-BasedCompensation.  * Effective January 1, 2006, weadopted SFAS No. 123 (revised 2004),*Share-Based Payment*, or SFAS No. 123(R), which requires that wemeasure compensation expense for all share-based payment awards made toemployees and directors, including employee stock options, based on estimatedfair values and recognize that expense over the required service period. Priorto our adoption of SFAS No. 123(R), we accounted for stock-based compensationawards issued to our employees using the intrinsic value measurement provisionsof Accounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*, orOpinion 25.

 

We adopted SFAS No.123(R) using the prospective transition method. Under this method, SFASNo. 123(R) is applied to new awards and to awards modified, repurchased orcancelled after January 1, 2006. Compensation cost previously recordedunder Opinion 25 for unvested options will continue to be recognized as therequired services are rendered. Accordingly, for the three and nine monthsended September 30, 2007 and 2006, stock-based compensation expense includescompensation costs related to estimated fair values of awards granted after thedate of adoption of SFAS No. 123(R) and compensation costs related tounvested awards at the date of adoption based on the intrinsic values aspreviously recorded under Opinion 25.

 

For options granted afterJanuary 1, 2006, and valued in accordance with SFAS No. 123(R), we use thestraight-line method for expense attribution. For options granted prior toJanuary 1, 2006, we use the multiple grant approach for expenseattribution, which results in substantially higher amounts of amortization inearlier years as opposed to the straight-line method, which results in equalamortization over the vesting period of the options. 

 

15

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Thefair value of options granted after January 1, 2006 is estimated on the grantdate using the Black-Scholes option valuation model. Since our stock has beenactively traded for only a short period of time, we use the simplifiedcalculation of expected term described in Staff Accounting Bulletin No. 107 andvolatility is based on an average of the historical volatilities of the commonstock of several entities with characteristics similar to us. The risk-freerate is based on the U.S. Treasury yield curve in effect at the time of grantfor periods corresponding with the expected term of the option. The estimatedforfeiture rate is based on our historical forfeiture experience and isestimated at 10% for all periods presented. 

 

Thefollowing assumptions are used to value stock options granted in the periodspresented:

 
| ** **               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **               | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Expected term in  years  |       | 6.08                             |       | 6.08                            |       | 6.08 |   | 6.08 |   |
| Risk-free  interest rate |       | 4.78                             | %          | 4.85                            | %          | 4.60 – 4.78 | % | 4.55% - 5.0 | % |
| Expected  volatility     |       | 67.0                             | %          | 72.6                            | %          | 67.0 – 70.6 | % | 72.6% - 74.1 | % |
| Dividend yield           |       | 0                                | %          | 0                               | %          | 0 | % | 0 | % |

 

Compensation expense forrestricted stock awards is determined using the fair value of Techwell’s stockon the date of the grant and is recognized on a straight-line basis over theservice period. 

 

Stock-based compensation expenseis allocated among cost of revenues, research and development expenses andselling, general and administrative expenses, respectively, based upon theemployee’s job function. We expect to continue to recognize substantial amountsof stock-based compensation expense relating to our employee stock options andrestricted stock awards in future periods primarily as a result of our adoptionof SFAS No. 123(R).

 

***Results of Operations***

 

Thefollowing table is derived from our selected financial data and sets forth ourhistorical operating results as a percentage of revenues for the periodsindicated:

 
| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                         | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| **Consolidated Statement of Operations Data:** | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Revenues                                                           |       | 100.0                            | %          | 100.0                           | %          | 100.0 | % | 100.0 | % |
| Cost of  revenues*                                                 |       | 40.0                             |       | 42.2                            |       | 41.1 |   | 42.7 |   |
| Gross margin                                                       |       | 60.0                             |       | 57.8                            |       | 58.9 |   | 57.3 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| Operating  expenses:                                               |       |                             |       |                            |       |   |   |   |   |
| Research and  development*                                         |       | 23.1                             |       | 13.5                            |       | 19.8 |   | 18.5 |   |
| Selling, general  and administrative*                              |       | 20.7                             |       | 15.6                            |       | 20.2 |   | 16.1 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| Total operating  expenses                                          |       | 43.8                             |       | 29.1                            |       | 40.0 |   | 34.6 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| Income from  operations                                            |       | 16.2                             |       | 28.7                            |       | 18.9 |   | 22.7 |   |
| Interest income                                                    |       | 5.4                              |       | 4.1                             |       | 5.2 |   | 2.7 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| Income before  income taxes                                        |       | 21.6                             |       | 32.8                            |       | 24.1 |   | 25.4 |   |
| Income tax  (benefit) provision                                    |       | (14.2                            | )          | 2.9                             |       | (0.2 | ) | 3.2 |   |
| Net income                                                         |       | 35.8                             | %          | 29.9                            | %          | 24.3 | % | 22.2 | % |

 

----

(*)  Percentages include stock-based compensation.

 

16

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The table below indicates the percentage ofstock-based compensation attributed to each item as a percentage of revenuesfor the periods indicated:

 
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                           | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                 |       |                             |       |                            |       |   |   |   |   |
| Cost of revenues                     |       | 0.5                              | %          | 0.2                             | %          | 0.4 | % | 0.2 | % |
| Research and  development            |       | 3.8                              |       | 1.2                             |       | 3.3 |   | 2.4 |   |
| Selling, general  and administrative |       | 4.4                              |       | 2.3                             |       | 3.8 |   | 2.1 |   |

 

***Revenues by product line are as follows (in thousands):***

 
| ** **                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Security  Surveillance(1) |       | $                                | 10,247     |                            | $          | 7,333 |   | $ | 28,250 |   | $ | 17,996 |   |
| Video  Decoders(2)        |       | 3,320                            |       | 5,667                           |       | 9,842 |   | 14,764 |   |
| LCD Display(3)            |       | 1,293                            |       | 2,001                           |       | 4,427 |   | 4,281 |   |
| Other(4)                  |       | 262                              |       | 100                             |       | 863 |   | 661 |   |
| Total                     |       | $                                | 15,122     |                            | $          | 15,101 |   | $ | 43,382 |   | $ | 37,702 |   |

 

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(1)             Consists ofapplication specific products designed for use in security surveillancesystems.

 

(2)             Consists of generalpurpose video decoders designed for use in the security surveillance, automotiveand consumer markets. Revenues from general purpose video decoders used insecurity surveillance systems and LCD displays are reported under the videodecoder product line and not the security surveillance or LCD display productlines.

 

(3)             Consists ofapplication specific products designed for use in LCD displays.

 

(4)             Consists of earlygeneration mixed signal semiconductors for digital video and PCI video decoderproducts.

 

**Comparisonsof the Three Months Ended September 30, 2007 and 2006**

 

*Revenues.*    Our revenues consist of sales of ourmixed signal integrated circuits for digital video applications. We have threeprincipal product lines: security surveillance, LCD display and video decoders.All of our sales are denominated in U.S. dollars.

 

Revenues were $15.1 million for boththe three months ended September 30, 2007 and the three months ended September 30, 2006. Revenues from our securitysurveillance products were $10.2 million, an increase of approximately $2.9million, or 40%, in the three months ended September 30, 2007 compared to thethree months ended September 30, 2006, primarily as a result of the increase insales of our integrated four-in-one security surveillance products. Revenuesfrom our LCD display products were $1.3 million, a decrease of approximately$0.7 million, or 35%, in the three months ended September 30, 2007 compared tothe three months ended September 30, 2006, primarily as a result of reducedsales to our customers in the automotive market that install LCD displays invehicles due to the level of our product they hold in inventory relative totheir end-user demand. We expect these customer inventory issues to continuethroughout the remainder of 2007 and as a result will likely see weak ordervolume until the inventory issue is mitigated. Revenues from video decoder products were $3.3 million, a decrease ofapproximately $2.3 million, or 41%, in the three months ended September 30,2007 compared to the three months ended September 30, 2006.  Our general purpose video decoder revenueshave been impacted by the transition to integrated application specificproducts specifically designed for the LCD display and security surveillancemarkets. Our video decoder revenues have also been impacted by the delayedintroduction of our integrated audio/video decoder product that we now expectto be released in 2008.  Other revenueswere $0.3 million, an increase of $0.2 million, or 162%, in the three monthsended September 30, 2007 compared with the three months ended September 30, 2006,primarily as a result of increased sales of our PCI video decoder products.

 

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*GrossProfit and Gross Margin.*  Gross profit is thedifference between revenues and cost of revenues, and gross margin representsgross profit as a percentage of revenues. Cost of revenues, also known as costof goods sold, consists primarily of cost of processed silicon wafers, costsassociated with assembly, test and shipping of our production integratedcircuits, or ICs, cost of personnel and related expenses associated withsupporting our outsourced manufacturing activities and write-downs for excessand obsolete inventory.

 

Grossprofit was $9.1 million for the three months ended September 30, 2007and $8.7 million for the three months ended September 30, 2006, an increase of4%. Gross margin was 60% for the threemonths ended September 30, 2007 and 58% for the three months endedSeptember 30, 2006. The gross margin forthe three months ended September 30, 2007 was favorably impacted by cost savings from reduced materials costs partiallyattributable to increased volume purchases and the increasing transition of our products to smaller geometryprocess technologies that has occurred throughout 2007.

 

We incurred stock-based compensationincluded in cost of revenues associated with outsourced manufacturing supportand quality assurance personnel of $0.1 million and less than $0.1 millionin the three months ended September 30, 2007 and 2006, respectively.

 

*Researchand Development.*    Research anddevelopment expenses consist primarily of compensation and associated costs ofemployees engaged in research and development, contractor costs, tape-outcosts, development, testing and evaluation costs, occupancy costs and depreciationexpense. Before releasing new products, we incur charges for mask sets,prototype wafers and mask set revisions, which we refer to as tape-outcosts. Tape-out costs attributable to new product development may causeour research and development expenses to fluctuate because they are notincurred uniformly every quarter. We expect our research and developmentcosts to increase in absolute dollars in 2007 as we increase our investment indeveloping new products.

 

Research and development expenseswere $3.5 million, or 23% of revenues, for the three months ended September 30,2007 and $2.0 million, or 14% of revenues, for the three months ended September30, 2006, an increase of 72%.  Thisincrease primarily reflects $0.8 million of tape-out expenses that are notincurred uniformly each quarter and that have increased with our migration tosmaller geometry process technologies, compensation related expenses ofapproximately $0.4 million primarily as a result of stock-based compensationexpense and $0.2 million of expenses associated with development efforts byoutside consultants.

 

We incurred stock-based compensationexpense associated with research and development personnel of $0.6 million and$0.2 million in the three months ended September 30, 2007 and 2006,respectively.

 

*Selling, General andAdministrative.*     Selling, general andadministrative expenses consist primarily of compensation and associated costsfor marketing, selling and administrative personnel, sales commissions toindependent sales representatives, contractor compensation, public relations,promotional and other marketing expenses, insurance and fees paid forprofessional services, travel, depreciation expenses and occupancy costs. Costsassociated with audit and tax services, corporate governance and compliance andfinancial reporting are also included in selling, general and administrativeexpenses.

 

Selling,general and administrative expenses were $3.1 million, or 21% ofrevenues, for the three months ended September 30, 2007 and $2.4 million, or16% of revenues, for the three months ended September 30, 2006, an increase of33%. The increase in expense was primarily due to $0.4million in compensation related expenses primarily associated with stock-basedcompensation, $0.3 million associated with our foreign branches and oursubsidiaries in China and Japan and $0.1 million in professional servicesexpenses primarily for audit, tax and legal services. We expect selling,general and administrative expenses to continue to increase in the future insupport of our anticipated growth as wehire additional personnel and expand our sales and marketing efforts.Administrative expenses will also increase to cover additional costsassociated with operating as a public company, such as growth in our information technology infrastructure and increasedcosts associated with our efforts to comply with the Sarbanes-Oxley Act of2002.

 

We incurred stock-based compensationexpense associated with selling, general and administrative personnel of$0.7 million and $0.3 million in the three months ended September 30, 2007and 2006, respectively.

 

*Interest Income.*    Interestincome was $0.8 million for the three months ended September 30, 2007 and $0.6million for the three months ended September 30, 2006, an increase of 33%. Theincrease was primarily due to higher cash, cash equivalent and investmentbalances primarily as a result of our income from operations and higherinterest rates in the three months ended September 30, 2007.

 

18

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*IncomeTaxes.*    A benefit from income taxes of$2.2 million was recorded in the three months ended September 30, 2007. Aprovision for income taxes of $0.4 million was recorded in the three monthsended September 30, 2006.  In the threemonths ended September 30, 2007, the effective tax rate differed from thestatutory federal income tax rate primarily because we recognized a benefit asa result of the release of a valuation allowance on our deferred tax assets andwe utilized prior net operating losses to offset taxable income. In the threemonths ended September 30, 2006, the effective tax rate differed from thestatutory federal income tax rate primarily because we utilized prior netoperating losses and available tax credits to offset taxable income in theperiod. We expect our effective tax rate for the current year to be minimal asa result of the release of the valuation allowance.  We expect our effective tax rate to increasesignificantly beginning in the first quarter of 2008.  However, our future effective income tax ratewill be subject to many variables, including the absolute amount and futuregeographic distribution of our pre-tax income, our ability to take advantage ofthe available tax planning strategies and our ability to utilize our netoperating loss carryforwards.

 

**Comparisonsof the Nine Months Ended September 30, 2007 and 2006**

 

*Revenues.*   Revenues were $43.4 million for the ninemonths ended September 30, 2007 and $37.7 million for the nine months ended September30, 2006, an increase of 15%.  Revenuesfrom our security surveillance products were $28.3 million, an increase ofapproximately $10.3 million, or 57%, in the nine months ended September 30,2007 compared to the nine months ended September 30, 2006, primarily as aresult of the increase in sales of our integrated four-in-one securitysurveillance products.  Revenues from ofour LCD display products were $4.4 million, an increase of $0.1 million, or 3%,in the nine months ended September 30, 2007 compared to the nine months endedSeptember 30, 2006 primarily as a result of the increase in vehicles installedwith LCD displays attributable to earlier design wins in the automotive market.However in the three months ended September 30, 2007,  we experienced reduced sales to our customersin the automotive market that install LCD displays in vehicles due to the levelof our product they hold in inventory relative to their end-user demand.Revenues from video decoder products were $9.8 million, a decrease ofapproximately $4.9 million, or 33%, in the nine months ended September 30, 2007compared to the nine months ended September 30, 2006, primarily as a result ofthe delayed introduction of our integrated audio/video decoder that we nowexpect to be introduced in 2008. Additionally, our general purpose videodecoders revenues have been impacted by the transition to integratedapplication specific products specifically designed for the LCD display andsecurity surveillance markets. Other revenues were $0.9 million, an increase of$0.2 million, or 30%, in the nine months ended September 30, 2007 as comparedwith the nine months ended September 30, 2006, primarily as a result ofincreased sales of our PCI video decoder products.

 

*GrossProfit and Gross Margin.*  Gross profit was $25.6 million for the nine months ended September30, 2007 and $21.6 million for the nine months ended September 30, 2006, anincrease of 18%.  Gross margin was 59% for the nine months ended September 30, 2007increasing from 57% for the nine months ended September 30, 2006.  The increase in gross margin was primarily aresult of reduced materialscosts and production costs in the nine months ended September 30, 2007 comparedto the same period in 2006 partially attributable to increased volumepurchases and the transition of ourproducts to smaller geometry process technologies in the first quarter of 2007.

 

Weincurred stock-based compensation included in cost of revenues associated withoutsourced manufacturing support and quality assurance personnel of $0.2million and $0.1 million in the nine months ended September 30, 2007 and2006, respectively.

 

*Research andDevelopment.*  Researchand development expenses were $8.6 million, or 20% of revenues, for the ninemonths ended September 30, 2007 and $7.0 million, or 19% of revenues, for thenine months ended September 30, 2006.  Theincrease in expenseswas primarily due to $0.7 million ofcompensation related expenses attributable to the increase in engineeringheadcount and stock-based compensation, $0.7 million of tape-out expenses thatare not incurred uniformly each quarter and that have increased with ourmigration to smaller geometry process technologies and expenses of $0.2 millionassociated with development efforts by outside consultants.

 

Weincurred stock-based compensation expense associated with research anddevelopment personnel of $1.4 million and $0.9 million in the nine monthsended September 30, 2007 and 2006, respectively primarily as a result of theincrease in engineering headcount.

 

*Selling,General and Administrative*.  Selling, general and administrative expenses were$8.8 million, or 20% of revenues, for the nine months ended September 30, 2007and $6.1 million, or 16% of revenues, for the nine months ended

 

19

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September 30, 2006.  Theincrease in expense wasprimarily due to $1.1 million in compensation related expenses primarilyassociated with stock-based compensation, $0.7 million associated with ourforeign branches and our subsidiaries in China and Japan, $0.3 million ininsurance and administrative fees reflecting costs associated with being apublic company, $0.3 million in professional services expenses primarily foraudit, tax and legal services and $0.2 million of promotional expenses toincrease customer interest in our products.

 

Weincurred stock-based compensation expense associated with selling, general andadministrative personnel of $1.6 million and $0.8 million the ninemonths ended September 30, 2007 and 2006, respectively primarily as a result ofthe increase in sales personnel in our international operations.

 

*Interest Income.*    Interest income was $2.2million for the nine months ended September 30, 2007 and $1.0 million for thenine months ended September 30, 2006. The increase was due to higher cash, cash equivalent and investmentbalances as a result of our initial public offering and higher interest ratesin the nine months ended September 30, 2007.

 

*Income Taxes.*    Abenefit from income taxes of $0.1 million was recorded in the nine months endedSeptember 30, 2007. A provision for income taxes of $1.2 million was recordedin the nine months ended September 30, 2006. In the nine months ended September30, 2007, the effective tax rate differed from the statutory federal income taxrate primarily because we recognized a benefit as a result of the release of avaluation allowance on our deferred tax assets and we utilized prior netoperating losses to offset taxable income. In the nine months ended September 30, 2006, the effective tax ratediffered from the statutory federal income tax rate primarily because weutilized prior net operating losses to offset profits.  We expect our effective tax rate for the currentyear to be minimal as a result of the release of a valuation allowance on ourdeferred tax assets. We expect our effective tax rate to increase significantlybeginning in the first quarter of 2008. However, our future effective income tax rate will be subject to manyvariables, including the absolute amount and future geographic distribution ofour pre-tax income, our ability to take advantage of the available tax planningstrategies and our ability to utilize our net operating loss carryforwards.

 

***Liquidity and Capital Resources***

 

Since our inception, wehave financed our growth primarily with proceeds from the issuance of preferredstock and common stock and our cash flows from operations. Our cash and cashequivalents and both short and long-term investments were $65.4 million asof September 30, 2007.

 

Netcash provided by operating activities was $11.1 million in the nine monthsended September 30, 2007.  The net cashprovided by our operating activities in the nine months ended September 30,2007 was primarily due to our net income of $10.5 million, an increase inincome taxes payable of $1.5 million, a decrease in our accounts receivable of$0.8 million attributable to the timing of customer collections and an increasein deferred rent of $0.2 million. These were offset by an increase in deferredincome taxes of $5.1 million and a decrease in accounts payable and accruedliabilities of $1.2 million primarily attributable to a reduced compensationrelated liability which is accrued throughout the year and paid subsequent toyear end. We incurred non-cash expenses of $3.2 million for stock-basedcompensation expense and $0.3 million in depreciation expense in the ninemonths ended September 30, 2007.  We alsorecognized a tax benefit of $0.9 million attributable to our employee equityincentive plans.

 

Netcash provided by operating activities was $13.5 million in the nine monthsended September 30, 2006.  The net cashprovided by our operating activities in the nine months ended September 30,2006 was primarily due to our net income of $8.4 million and an increase inaccounts payable and accrued liabilities of $5.4 million associated withincreasing customer demand as a result of new product introductions andincreased sales of existing products, an increase in income taxes payable of$0.3 million and a decrease in accounts receivable of $0.8 million attributableto the timing of customer collections. These were offset in part by an increase in inventory of $3.1 million inresponse to increasing customer demand and an increase in prepaid expenses of$0.4 million. We incurred non-cash expenses of $1.8 million for stock-basedcompensation expenses and $0.2 million in depreciation expenses in the ninemonths ended September 30, 2006.

 

Netcash used in investing activities was $2.9 million in the nine months endedSeptember 30, 2007 reflecting purchases of investments of $77.2 million andcapital purchases of $0.8 million offset by maturities of investments of $75.1million. Net cash used in our investing activities was $31.9 million in thenine months ended September 30, 2006 reflecting purchases of investments of$64.0 million and capital purchases of $0.3 million offset by maturities ofinvestments of $32.4 million.

 

20

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Netcash provided by our financing activities was $0.5 million in the ninemonths ended September 30, 2007 and consisted of proceeds from the exercise ofstock options. Net cash provided by financing activities was $19.8 million inthe nine months ended September 30, 2006. The net cash provided by financingactivities in the nine months ended September 30, 2006 primarily consisted ofproceeds from our initial stock offering net of underwriting discounts,commissions and offering costs of $19.5 million and proceeds from the exerciseof stock options of $0.3 million.

 

We believe our existingcash and cash equivalents and investments balances, as well as cash expected tobe generated from operating activities, will be sufficient to meet ouranticipated cash needs for at least the next 12 months.

 

Our long-term futurecapital requirements will depend on many factors, including our level ofrevenues, the timing and extent of spending to support our product developmentefforts, the expansion of sales and marketing activities, the timing of ourintroductions of new products, the costs to ensure access to adequatemanufacturing capacity and the continuing market acceptance of our products. Wecould be required, or could elect, to seek additional funding through public orprivate equity or debt financing and additional funds may not be available onterms acceptable to us or at all.

 

***Off-Balance Sheet Arrangements***

 

As ofSeptember 30, 2007, we have no off-balance sheet arrangements as defined inItem 303(a)(4) of the Securities and Exchange Commission’s Regulation S-K.

 

***Contractual Obligations***

 

As ofDecember 31, 2006, we had $1.9 million of total future minimum leaseobligations. The following table identifies our commitments to settlecontractual obligations as of September 30, 2007:

 
| ** **                 | ** ** | **Payment Due by Period** | ** ** |
|----------------------------|------------|------------------------------------------|------------|
| ** **                 | ** ** | **Total**                                | ** ** | **Less than 1  year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
|                       |       |                                     |       |   |   |   |   |   |   |   |   |
| Minimum Lease  Obligations |       | $                                        | 1,624      |   | $ | 575 |   | $ | 969 |   | $ | 80 |   | $ | — |   |
| Purchase  Obligations      |       | 2,909                                    |       | 2,909 |   | — |   | — |   | — |   |
| Total Obligations          |       | $                                        | 4,533      |   | $ | 3,484 |   | $ | 969 |   | $ | 80 |   | $ | — |   |

 

This table excludes theliability for unrecognized income tax benefits of $0.2 million throughSeptember 30, 2007, since we cannot predict with reasonable reliability thetiming of cash settlements with the respective taxing authorities.

 

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

 

The primary objectives ofour investment activity are to preserve principal, provide liquidity andmaximize income without significantly increasing the risk. Some of thesecurities we invest in are subject to market risk. This means that a change inprevailing interest rates may cause the principal amount of our investments tofluctuate. To minimize this risk, we maintain our portfolio of cash equivalents,short and long-term investments in demand accounts, money market funds,commercial paper, corporate bonds, U.S. government agency securities andauction rate securities which are investment grade securities with a maximumdollar weighted maturity of two years or less. The risk associated withfluctuating interest rates is limited to our investment portfolio, and webelieve that a 10% change in interest rates would not have a significant impacton our interest income.

 

To date, ourinternational customer agreements have been denominated solely in U.S. dollarsand, accordingly, we have not been exposed to foreign currency exchange ratefluctuations from customer agreements and do not currently engage in foreigncurrency hedging transactions. However, the functional currency of ouroperations in Taiwan, South Korea, Japan and China is the U.S. dollar and ourlocal accounts are maintained in the local currency in Taiwan, South Korea,Japan and China, respectively, and thus we are subject to foreign currency exchangerate fluctuations associated with remeasurement to U.S. dollars. Suchfluctuations have not been significant historically and we believe that a 10%change in exchange rates would not have a significant impact on our operatingexpenses.

 

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**ITEM 4. Controls and Procedures**

 

(a)***   Evaluation ofdisclosure controls and procedures.***   We maintain “disclosurecontrols and procedures,” as such term is defined inRule 13a-15(e) under the Securities Exchange Act of 1934 (the “ExchangeAct”), that are designed to ensure that information required to be disclosed byus in reports that we file or submit under the Exchange Act is recorded,processed, summarized, and reported within the time periods specified in Securitiesand Exchange Commission rules and forms, and that such information isaccumulated and communicated to our management, including our chief executiveofficer and chief financial officer, as appropriate, to allow timely decisionsregarding required disclosure. In designing and evaluating our disclosurecontrols and procedures, management recognized that disclosure controls andprocedures, no matter how well conceived and operated, can provide onlyreasonable, not absolute, assurance that the objectives of the disclosurecontrols and procedures are met. Our disclosure controls and procedures havebeen designed to meet the reasonable assurance standards. Additionally, indesigning disclosure controls and procedures, our management necessarily wasrequired to apply its judgment in evaluating the cost-benefit relationship ofpossible disclosure controls and procedures. The design of any disclosurecontrols and procedures also is based in part upon certain assumptions aboutthe likelihood of future events, and there can be no assurance that any designwill succeed in achieving its stated goals under all potential futureconditions.

 

Based on their evaluationas of the end of the period covered by this Quarterly Report on Form 10-Q,our chief executive officer and chief financial officer have concluded that, asof such date, our disclosure controls and procedures were effective at thereasonable assurance level.

 

(b)***   Changes in internalcontrol over financial reporting.***   There was nochange in our internal control over financial reporting (as defined inRule 13a-15(f) under the Exchange Act) that occurred during theperiod covered by this Quarterly Report on Form 10-Q that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**PART II—OTHER INFORMATION**

 

**ITEM 1.****Legal Proceedings**

 

We arecurrently not a party to any material legal proceedings. We may from time totime become involved in litigation relating to claims arising from our ordinarycourse of business. These claims, even if not meritorious, could result in theexpenditure of significant financial and managerial resources.

 

**ITEM 1a.****Risk Factors**

 

If any of the followingrisks actually occur, our business, results of operations and financial conditioncould suffer significantly.

 

**RisksRelated to Our Business**

 

***Fluctuations in our revenue and operating results on aquarterly basis could cause the market price of our common stock to decline.***

 

Our revenue and operatingresults are difficult to predict, have in the past fluctuated, and may in thefuture fluctuate from quarter to quarter. It is possible that our operatingresults in some quarters will be below market expectations. This would likelycause the market price of our common stock to decline. Our quarterly operatingresults are affected by a number of factors, including:

 

•                     unpredictablevolume and timing of customer orders, which are not fixed by contract but varyon a purchase order basis;

•                     uncertaindemand in the consumer market for LCD display products;

•                     theloss of one or more of our customers, causing a significant reduction orpostponement of orders from these customers;

 

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•                     decreasesin the overall average selling prices of our products;

•                     changesin the relative sales mix of our products;

•                     changesin our cost of finished goods;

•                     theavailability, pricing and timeliness of delivery of other components used inour customers’ products;

•                     ourcustomers’ sales outlook, purchasing patterns and inventory adjustments basedon demand and general economic conditions;

•                     productobsolescence and our ability to manage product transitions;

•                     ourability to successfully develop, introduce and sell new or enhanced products ina timely manner;

•                     thetiming of new product announcements or introductions by us or by ourcompetitors; and

•                     fluctuationsin our effective tax rate.

 

We base our plannedoperating expenses in part on our expectations of future revenue, and asignificant portion of our expenses is relatively fixed in the short term. Wehave limited historical financial data from which to predict future sales forour products. As a result, it is difficult for us to forecast our futurerevenue and budget our operating expenses accordingly. If revenue for aparticular quarter is lower than we expect, we likely will be unable toproportionately reduce our operating expenses for that quarter, which wouldharm our operating results for that quarter.

 

***We have a history of losses, have only recently becomeprofitable and may not sustain or increase profitability in the future whichmay cause the market price of our common stock to decline.***

 

We first becameprofitable in the second quarter of 2005. We incurred significant net lossesprior to that quarter. To sustain or increase profitability, we will need togenerate and sustain substantially higher revenue while maintaining reasonablecost and expense levels. We currently expect to increase expense levels in eachof the next several quarters to support increased research and development andsales and marketing efforts. These expenditures may not result in increasedrevenue or customer growth. Because many of our expenses are fixed in the shortterm, or are incurred in advance of anticipated sales, we may not be able todecrease our expenses in a timely manner to offset any shortfall of sales. Wealso believe our effective tax rate will increase in the future, which willharm our financial results and negatively impact our profitability. We may notbe able to sustain or increase profitability on a quarterly or an annual basis.This may, in turn, cause the price of our common stock to decline.

 

***If the growth of demand for digital video applications forthe security surveillance, automotive and consumer markets does not continue,our ability to increase our revenue could suffer.***

 

Our ability to increaseour revenue will depend on increased demand for digital video applications inthe security surveillance, automotive and consumer markets. If our targetmarkets do not grow as rapidly or to the extent we anticipate, our businesscould suffer. The growth of our target markets is uncertain and will depend inparticular upon:

•                  consumerconfidence and the continued increase of consumer spending levels;

•                  thepace at which new digital video applications are adopted;

•                  acontinued reduction in the costs of products in these markets; and

•                  theavailability, at a reasonable price, of components required by such products,such as liquid crystal display, or LCD, panels.

 

***The average selling prices of our semiconductor products maybe subject to rapid price declines which could harm our revenue and grossprofits.***

 

The semiconductorproducts we develop and sell may be subject to rapid declines in averageselling prices. From time to time, we have had to reduce our pricessignificantly to meet customer requirements, and we may be required to reduceour prices in the future. This would cause our gross margins to decline whichin turn may negatively impact our operating results. Our financial results willsuffer if we are unable to offset any reductions in our average selling pricesby increasing our sales volumes, reducing our costs or developing new orenhanced products on a timely basis with higher selling prices or gross margins.

 

***We face intense competition and may not be able to competeeffectively, which could reduce our market share and decrease our net revenueand profitability.***

 

The markets in which weoperate are extremely competitive and are characterized by rapid technologicalchange, continuously evolving customer requirements and declining averageselling prices. We may not be able to compete 

 

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successfully againstcurrent or potential competitors. If we do not compete successfully, our marketshare and revenue may decline. We compete with large semiconductormanufacturers and designers. Most of our current and potential competitors havelonger operating histories, significantly greater resources and name recognitionand a larger base of customers than we do. This may allow them to respond morequickly than we can to new or emerging technologies or changes in customerrequirements. In addition, these competitors may have greater credibility withour existing and potential customers. Many of our current and potentialcustomers have their own internally developed semiconductor solutions and maychoose not to purchase products from third party suppliers like us.

 

***We depend on key and highly skilled personnel to operate ourbusiness, and if we are unable to retain our current personnel and hireadditional personnel, our ability to develop and market our products could beharmed.***

 

We believe our futuresuccess will depend in large part upon our ability to attract and retain highlyskilled managerial, engineering and sales and marketing personnel. The loss ofany key employees or the inability to attract or retain qualified personnel,including engineers and sales and marketing personnel, could delay thedevelopment and introduction of, and harm our ability to sell, our products andharm the market’s perception of us. We believe that our future success ishighly dependent on the contributions of Fumihiro Kozato, our president andchief executive officer, and Dr. Feng Kuo, our chief technical officer. Wedo not have long-term employment contracts with these or any other keypersonnel, and their knowledge of our business and industry would be extremelydifficult to replace.

 

***If we fail to develop new products and enhance our existingproducts in order to react to rapid technological change and market demands,our business will suffer.***

 

We must develop newproducts and enhance our existing products with improved technologies to meetrapidly evolving customer requirements. We need to design products forcustomers who continually require higher performance and functionality at lowercosts. We must, therefore, continue to cost-effectively add features thatenhance performance and functionality to our products. The development processfor these advancements is lengthy and requires us to accurately anticipatemarket trends. Our failure to accurately anticipate market trends in a timelymanner will harm the market acceptance of our products and the sales of ourproducts. We have been excluded from certain customer qualification processesdue to the lack of integrated audio functionality in our general purposedecoders. As part of our continued investment in new technologies, we intend toadd integrated audio functionality to our general purpose decoders in the nearterm to address the market requirements of our customers.

 

Developing and enhancingthese products is uncertain and can be time-consuming, costly and complex.There is a risk that these developments and enhancements will be late, fail tomeet customer or market specifications or not be competitive with products fromour competitors that offer comparable or superior performance andfunctionality. Any new products or product enhancements may not be accepted innew or existing markets. Our business will suffer if we fail to develop andintroduce new products or product enhancements on a cost-effective basis.

 

***If we fail to achieve initial design wins for our products,we may lose the opportunity for sales for a significant period of time tocustomers and be unable to recoup our investments in our products.***

 

We expend considerableresources in order to achieve design wins for our products, especially our newproducts and product enhancements. Once a customer designs a semiconductor intoa product, it is likely to continue to use the same semiconductor or enhancedversions of that semiconductor from the same supplier across a number ofsimilar and successor products for a lengthy period of time due to thesignificant costs associated with qualifying a new supplier and potentiallyredesigning the product to incorporate a different semiconductor. If we fail toachieve an initial design win in a customer’s qualification process, we maylose the opportunity for significant sales to that customer for a number of itsproducts and for a lengthy period of time. This may cause us to be unable torecoup our investments in our products, which would harm our business.

 

***If we fail to develop, in a timely manner, or at all,technologies that address the demands of a shift from analog broadcast TV todigital broadcast TV, our operating results could suffer.***

 

Our semiconductors areprincipally designed to decode analog broadcast TV signals into digital images.We believe the transmission of broadcast TV signals will over time shift fromanalog signals to digital signals. We are in the process of developing mixedsignal and digital technology to decode digital signals. However, transmissionof digital video involves a combination of emerging technologies. The complexitiesof these technologies and the variability in implementations

 

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between manufacturers maycause our development of semiconductors to be costly and time-consuming. We maynever obtain the benefits of our investment in developing this technology. Thecomplexities of digital broadcast technologies may also cause some of thesemiconductors we are developing to ultimately work incorrectly for reasonsthat may be either related or unrelated to our products, or not beinteroperable with other key products. Delays or difficulties in integratingour semiconductors into digital broadcast TV products or the failure ofproducts incorporating digital broadcast TV to achieve broad market acceptancecould have an adverse effect on our business.

 

***We may enter into agreements with third party vendors tolicense technologies to integrate into, or complement our own technology orproducts.***

 

Our future product requirements may require us tolicense technologies from other companies and integrate such technologies into,or as a complement to, our products. There can be no assurance that we can besuccessful in integrating these technologies with our products. Additionally,the integration of licensed technology in our products may infringe on othercompanies’ technologies or could even limit our ability to protect ourintellectual property rights in our own products.

 

***Our products are sold into the security surveillance,automotive and consumer markets, and if sales of our semiconductors into thesemarkets decline or do not increase, our business and financial results couldsuffer.***

 

We sell semiconductorstargeted for the security surveillance, automotive and consumer markets. Webelieve that for the year ended December 31, 2006 more than 80% of oursales were derived from the sale of our products designed for the consumer andsecurity surveillance markets. If sales of semiconductors into these marketsdecline or do not increase, or if demand slows in these markets generally, ouroperating results would suffer. In addition, we have increased our focus on theautomotive market and devoted substantial resources to the development ofsemiconductors for digital video applications that address this market. If weare not successful in selling our semiconductors into this market, we may notrecover the costs associated with our efforts in this area and our operatingresults could suffer.

 

***Our business is subject to seasonality, which is likely tocause our revenues to fluctuate.***

 

Our business is subjectto seasonality as a result of our target markets and the location of ourcustomers. We sell a significant number of our semiconductors into the consumermarket. Our customers who manufacture products for the consumer market experienceseasonality in the sales of their products, which in turn may affect the timingand volume of orders for our semiconductors. Because the consumer market fordigital video applications is characterized by this seasonality, our operatingresults may vary significantly from quarter to quarter. For example, wegenerally experience lower sales in the first calendar quarter with our videodecoder and LCD display products as a result of the seasonality associated withthe consumer markets. In addition, a significant number of our semiconductorsare sold to customers located in Asia, primarily to customers located inregions who observe the Lunar New Year holiday, also referred to as Chinese NewYear. Typically, our foreign offices and those of our customers are closed fora week or more during the extended holiday period. For the three months endedMarch 31, 2007, approximately 96% of our revenues were attributable tocustomers located in regions that observe the Lunar New Year holiday. As aresult, we typically experience fluctuations in our first calendar quarter duein part to a slowing of business activity around the period of the Lunar NewYear holiday. These sales fluctuations are expected to continue.

 

***We manufacture our products based on our estimates of customerdemand, and if our estimates are incorrect our financial results could benegatively impacted.***

 

Our sales are made on thebasis of purchase orders rather than long-term purchase commitments. Inaddition, our customers may cancel purchase orders or defer the shipments ofour products. We manufacture our products according to our estimates ofcustomer demand. This process requires us to make multiple demand forecastassumptions, each of which may introduce error into our estimates. If weoverestimate customer demand, we may manufacture products that we may not beable to sell. As a result, we would have excess inventory, which would increaseour losses. Conversely, if we underestimate customer demand or if sufficientmanufacturing capacity were unavailable, we would forego revenue opportunities,lose market share and damage our customer relationships.

 

***We do not expect to sustain the growth rate of our recentrevenues.***

 

Our revenues increasedapproximately 109% in 2005 from 2004 and approximately 49% in 2006 from 2005.We do not expect to achieve similar growth rates in future periods. You shouldnot rely on the results of any prior quarterly or annual periods as anindication of our future operating performance. If we are unable to maintainadequate revenue growth, our stock price may decline and we may not haveadequate financial resources to execute our business objectives.

 

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***We may pursue acquisitions or investments in complementarytechnologies and businesses, which could harm our operating results and maydisrupt our business.***

 

In the future, we maypursue acquisitions of, or investments in, complementary technologies andbusinesses. Acquisitions present a number of potential risks and challengesthat could, if not met, disrupt our business operations, increase our operatingcosts and reduce the value to us of the acquired company. Even if we aresuccessful, we may not be able to integrate the acquired businesses, productsor technologies into our existing business and products. Furthermore, potentialacquisitions and investments, whether or not consummated, may divert ourmanagement’s attention and require considerable cash outlays at the expense ofour existing operations. In addition, to complete future acquisitions, we mayissue equity securities, incur debt, assume contingent liabilities or haveamortization expenses and write-downs of acquired assets, which could adverselyaffect our profitability.

 

***Changes in our tax rates will affect our future results.***

 

Our future effective taxrates will be favorably or unfavorably affected by the absolute amount andfuture geographic distribution of our pre-tax income, our ability to takeadvantage of the available tax planning strategies and our ability to utilizeour net operating loss carryforwards. For example, at December 31, 2006,we had federal and state tax net operating loss carryforwards of approximately$6.5 million and $3.7 million, respectively. These net operating losscarryforwards may be used to offset future taxable income and thereby reduceour income taxes otherwise payable. Section 382 of the Internal RevenueCode of 1986, as amended (the “Code”), imposes an annual limit on the abilityof a corporation that undergoes an ‘‘ownership change’’ to use its netoperating loss carryforwards to reduce its tax liability. Due in part to equityfinancings, we experienced ‘‘ownership changes’’ as defined in Section 382of the Code. Accordingly, our use of the net operating loss carryforwards andcredit carryforwards is limited by the annual limitations as described inSections 382 and 383 of the Code. Nevertheless, we expect to utilize asubstantial portion of these net operating loss carryforwards in the currentyear resulting in lower net operating loss carryforwards available for lateryears. Our plans for continued international expansion may further limit ourability to utilize our remaining net operating loss carryforwards as our netincome increases. Our effective tax rate for the years ended December 31,2006 and 2005 was 8.9% and 3.4%, respectively. Prior to September 30, 2007, wedetermined that it was not more likely than not that our deferred tax assetswould be recovered from future taxable income. Therefore we provided avaluation allowance for our deferred tax assets. At September 30, 2007, we assessedthe recoverability of our deferred tax assets. As a result of this assessment,we released the valuation allowance recorded against our deferred tax assets ofapproximately $5.5 million. We expect our effective tax rate for the currentyear to be minimal as a result of the release of the valuation allowance on ourdeferred tax assets. However, we expect our effective tax rate to increasesignificantly in 2008. In addition, we are subject to the examination of ourincome tax returns by the Internal Revenue Service and other tax authorities.The outcomes of these examinations, if they occur, could harm our net incomeand financial condition.

 

***We may not be able to manage our future growth effectively, andwe may need to incur significant expenditures to address the additionaloperational and control requirements of our growth.***

 

We are experiencing aperiod of significant growth and expansion, which has placed, and any futureexpansion will continue to place, a significant strain on our management,personnel, systems and financial resources. We plan to hire additionalemployees to support an increase in research and development as well asincrease our selling and marketing efforts. To manage our growth successfullyand handle the responsibilities of being a public company, we believe we musteffectively:

 

•                  hire,train, integrate and manage additional qualified engineers for research anddevelopment activities, sales and marketing personnel and financial andinformation technology personnel;

•                  continueto enhance our customer resource management and manufacturing managementsystems;

•                  implementadditional and improve existing administrative, financial and operationssystems, procedures and controls, including the requirements of theSarbanes-Oxley Act of 2002;

•                  expandand upgrade our technological capabilities; and

•                  managemultiple relationships with our customers, distributors, suppliers and otherthird parties.

 

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Our efforts may requiresubstantial managerial and financial resources and may increase our operatingcosts even though these efforts may not be successful. If we are unable tomanage our growth effectively, we may not be able to take advantage of marketopportunities, develop new products, satisfy customer requirements, execute ourbusiness plan or respond to competitive pressures.

 

***We may experience unforeseen delays, expenses or lower thanexpected product yields for our semiconductors manufactured by our third partyvendors, which could increase our costs and prevent us from recognizing thebenefits of new technologies we develop.***

 

We occasionally haveexperienced delays in completing the development and introduction of newproducts and product enhancements, and we could experience delays in the futurethat may render our new or enhanced products, when introduced, obsolete andunmarketable. In addition, it is often difficult for semiconductor foundries toachieve satisfactory product yields. Product yields depend on both our productdesign and the manufacturing process technology unique to the semiconductorfoundry. Since low yields may result from either design or processdifficulties, identifying yield problems can only occur well into the productioncycle after a product that can be physically analyzed and tested exists. Pooryields from our foundry could cause us to sell our products at lower grossmargins and therefore harm our financial results.

 

***Defects in our products could increase our costs, causecustomer claims and delay our product shipments.***

 

Although we test ourproducts, they are complex and may contain defects and errors. In the past, wehave encountered defects and errors in our products. For example, in 2003 wewere unable to sell certain products to a customer for whom these products werespecifically designed as a result of our failure to produce a product that metthis customer’s specifications. We believe this customer secured the productfrom another vendor. Delivery of products with defects or reliability, qualityor compatibility problems may damage our reputation and our ability to retainexisting customers and attract new customers. In addition, product defects anderrors could result in additional development costs, diversion of technicalresources, delayed product shipments, increased product returns and productliability claims against us, which may not be fully covered by insurance. Anyof these could harm our business.

 

***We rely on a limited number of independent subcontractorsfor the manufacture, assembly and testing of our semiconductors, and thefailure of any of these third-party vendors to deliver products or otherwiseperform as requested could damage our relationships with our customers,decrease our sales and limit our growth.***

 

We do not have our ownmanufacturing or assembly facilities and have very limited in-house testingfacilities. Therefore, we must rely on third-party vendors to manufacture,assemble and test the products we design. We currently rely on TaiwanSemiconductor Manufacturing Corporation, or TSMC, to produce the majority ofour semiconductors. We rely on Advanced Semiconductor Engineering, Inc.,or ASE, to assemble, package and test many of our products. If these vendors donot provide us with high-quality products, services and production and testcapacity in a timely manner, or if one or more of these vendors terminates itsrelationship with us, we may be unable to obtain satisfactory replacements tofulfill customer orders on a timely basis, our relationships with our customerscould suffer and our sales could decrease. Other significant risks associatedwith relying on these third-party vendors include:

 

•                  reducedcontrol over product cost, delivery schedules and product quality;

•                  potentialprice increases;

•                  inabilityto achieve required production or test capacity and achieve acceptable yieldson a timely basis;

•                  longerdelivery times;

•                  increasedexposure to potential misappropriation of our intellectual property;

•                  shortagesof materials that foundries use to manufacture products;

•                  laborshortages or labor strikes; and

•                  quarantinesor closures of manufacturing facilities due to the outbreak of viruses, such asSARS, the avian flu or any similar future outbreaks in Asia.

 

We currently do not havelong-term supply contracts with any of our third-party vendors. Therefore, theyare not obligated to perform services or supply products to us for any specificperiod, in any specific quantities or at any specific price, except as may beprovided in a particular purchase order. Neither TSMC nor ASE has providedcontractual assurances to us that adequate capacity will be available for us tomeet future demand for our products. These third party vendors may allocatecapacity to the production of other companies’ products while reducingdeliveries to us on short notice. In particular, other customers that arelarger and better financed than we are or that have long-term agreements withTSMC or ASE may cause either or both of them to reallocate capacity to thosecustomers, decreasing the capacity available to us.

 

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***We plan to retain additional foundries to manufacture oursemiconductors, which could disrupt our current manufacturing process andnegatively impact our sales volumes and net revenue.***

 

As a result of thecomplexity in manufacturing our semiconductors, it is difficult to retain andrely on a new foundry. We may not be able to enter into a relationship with anew foundry that produces satisfactory yields on a cost-effective basis. If weneed another foundry because of increased demand, or the inability to obtaintimely and adequate deliveries from our current provider, we might not be ableto cost-effectively and quickly retain other vendors to satisfy ourrequirements. Any failure to successfully integrate a new foundry couldnegatively impact our sales volumes and net revenue.

 

***We may experience difficulties in transitioning to smallergeometry process technologies or in achieving higher levels of designintegration, which may result in reduced manufacturing yields, delays inproduct deliveries and increased expenses.***

 

To reduce costs andmaintain our gross margins, we intend to transition our semiconductors toincreasingly smaller geometries and achieve higher levels of designintegration. This transition requires us to modify the manufacturing processesfor our products and to redesign some products, which may result in delays inproduct deliveries. We periodically evaluate the benefits, on a product-by-productbasis, of migrating to smaller geometry process technologies to reduce ourcosts. In the past, we have experienced some difficulties in shifting tosmaller geometry process technologies and new manufacturing processes, whichresulted in reduced manufacturing yields, delays in product deliveries andincreased expenses. We may face similar difficulties, delays and expenses inthe future. If our foundry, or we, experience significant delays in thesetransitions or fail to efficiently implement these transitions, our business,financial condition and results of operations could suffer.

 

***Our business depends on international customers, suppliersand operations in Asia, and as a result we are subject to regulatory,operational, financial and political risks, which could adversely affect ourfinancial results.***

 

The percentage of ourrevenues attributable to sales to customers in Asia was approximately 98% forboth the three and nine months ended September 30, 2007. The percentage of ourrevenues attributable to sales to customers in Asia was approximately 99% and98% for the three and nine months ended September 30, 2006, respectively. Weexpect that revenues from customers in Asia will continue to account forsubstantially all of our revenues. All our sales currently are denominated inU.S. dollars. As a result, an increase in the value of the U.S. dollar relativeto foreign currencies could make our products less competitive in internationalmarkets.

 

Currently, we maintaininternational sales offices in Asia, and we rely on a network of third-partysales representatives to sell our products internationally. We have alsoestablished offices in China, Japan, Taiwan and South Korea, which servevarious aspects of our business. Moreover, we have in the past relied on, andexpect to continue to rely on, suppliers, manufacturers and subcontractorslocated in Asia, including Taiwan. Accordingly, we are subject to several risksand challenges, any of which could harm our business and financial results. Theserisks and challenges include:

 

•                  difficultiesand costs of staffing and managing international operations across differentgeographic areas and cultures;

•                  compliancewith a wide variety of domestic and foreign laws and regulations, includingthose relating to the import or export of semiconductor products;

•                  legaluncertainties regarding taxes, tariffs, quotas, export controls, exportlicenses and other trade barriers;

•                  ourability to receive timely payment and collect our accounts receivable;

•                  political,legal and economic instability, foreign conflicts and the impact of regionaland global infectious illnesses, such as the SARS outbreak or avian flu in thecountries in which we and our customers, suppliers, manufacturers andsubcontractors are located;

•                  legaluncertainties regarding protection for intellectual property rights in somecountries; and

•                  fluctuationsin freight rates and transportation disruptions.

 

***Our sales cycle can be lengthy, which could result inuncertainty and delays in generating revenue.***

 

Because our products arebased on constantly evolving technologies, we have experienced a lengthy salescycle for some of our semiconductors, particularly those designed for digitalvideo applications in the automotive market. Our sales 

 

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cycle typically rangesfrom six to 12 months. We may experience a delay between the time we increaseexpenditures for research and development, sales and marketing efforts andinventory and the time we generate revenue, if any, from these expenditures. Inaddition, because we do not have long-term commitments from our customers, wemust repeat our sales process on a continual basis even for current customerslooking to purchase a new product. As a result, our business could be harmed ifa customer reduces or delays its orders, chooses not to release productsincorporating our semiconductors or elects not to purchase a new product orproduct enhancements from us.

 

***We primarily sell our semiconductors through a limitednumbers of distributors, and if our relationships with one or more of thosedistributors were to terminate, our operating results may be harmed.***

 

We market and distributeour products primarily through a limited numbers of distributors, most of whichare located in Asia. This distribution channel has been characterized by rapidchange and consolidations. Distributors have accounted for a significantportion of our revenues in the past. Sales to our distributors representedapproximately 79% of our revenues in 2006 and 68% of our revenues in the ninemonths ended September 30, 2007. Moreover, one of our distributors represented19% of our revenues in the nine months ended September 30, 2007

 

Our operating results andfinancial condition could be significantly disrupted by the loss of one or moreof our current distributors and sales representatives, volume pricingdiscounts, order cancellations, delays in shipment by one of our majordistributors or sales representatives or the failure of our distributors orsales representatives to successfully sell our products.

 

***We rely primarily upon copyright and trade secret laws andcontractual restrictions to protect our proprietary rights, and, if theserights are not sufficiently protected, our ability to compete and generaterevenue could suffer.***

 

We seek to protect ourproprietary design processes, documentation and other written materialsprimarily under trade secret and copyright laws. We also typically requireemployees and consultants with access to our proprietary information to executeconfidentiality agreements. The steps taken by us to protect our proprietaryinformation may not be adequate to prevent misappropriation of our technology.In addition, our proprietary rights may not be adequately protected because:

 

•                  thelaws of other countries in which we market our semiconductors, such as somecountries in the Asia/Pacific region, may offer little or no protection for ourproprietary technologies;

•                  peoplemay not be deterred from misappropriating our technologies despite theexistence of laws or contracts prohibiting these actions; and

•                  policingunauthorized use of our intellectual property may be difficult, expensive andtime-consuming, and we may be unable to determine the extent of anyunauthorized use.

 

Reverse engineering,unauthorized copying or other misappropriation of our proprietary technologiescould enable third parties to benefit from our technologies withoutcompensating us for doing so. For example, if the foundry that manufactures oursemiconductors loses control of our intellectual property, it would be moredifficult for us to take remedial measures since it is located in Taiwan, whichdoes not have the same protection for intellectual property as is provided inthe United States. Any inability to adequately protect our proprietary rightscould harm our ability to compete, generate revenue and grow our business.

 

***We may not obtain sufficient patent protection on thetechnology embodied in the semiconductors we currently manufacture and market,which could harm our competitive position and increase our expenses.***

 

Although we relyprimarily on trade secret laws and contractual restrictions to protect thetechnology in the semiconductors we currently manufacture and market, oursuccess and ability to compete in the future may also depend to a significantdegree upon obtaining patent protection for our proprietary technology. As ofDecember 31, 2006, we had three issued patents in the United States andfive patent applications pending in the United States and three applicationspending in foreign jurisdictions. These patents and patent applications coveraspects of the technology in the semiconductors we currently manufacture andmarket, including a patent for our video decoding architecture. Patents that wecurrently own do not cover all of the semiconductors that we presentlymanufacture and market. Our patent applications may not result in issuedpatents, and even if they result in issued patents, the patents may not haveclaims of the scope we seek. In addition, any issued patents may be challenged,invalidated or declared unenforceable. The term of any issued patents would be20 years from its filing date and if our applications are pending for a longtime period, we may have a correspondingly shorter term for any patent that mayissue. Our issued patents have expiration dates ranging from September 2,2019 to March 27,

 

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2020. Our present andfuture patents may provide only limited protection for our technology and maynot be sufficient to provide us with competitive advantages. For example,competitors could be successful in challenging any issued patents or,alternatively, could develop similar or more advantageous technologies on theirown or design around our patents. Also, patent protection in certain foreigncountries may not be available or may be limited in scope and any patentsobtained may not be as readily enforceable as in the United States, making itdifficult for us to effectively protect our intellectual property from misuseor infringement by anyone in these countries. Our inability to obtain andenforce our intellectual property rights in some countries may harm ourbusiness. In addition, given the costs of obtaining patent protection, we maychoose not to protect certain innovations that later turn out to be importantto our business or our competitive position.

 

***Intellectual property litigation, which is common in ourindustry, could be costly, harm our reputation, limit our ability to sell ourproducts and divert the attention of management and technical personnel.***

 

Our industry ischaracterized by frequent litigation regarding patent and other intellectualproperty rights. In September 2000, we received a letter from another entityclaiming to have patents in certain technology and inviting us to take alicense under these patents that apply to comb filters, phase demodulation,oversampling and interpolation or scaling and deinterlacing. This third party,however, has failed to specify which of our products or technologies allegedlyinfringe on its patents. We cannot assess the potential impact on our businessbecause we cannot currently identify which of our products and technologies, ifany, might be impacted by the potential claim. Our discussions with this thirdparty are ongoing. We also were a party to an administrative proceeding infront of the intellectual property tribunal in South Korea in which anotherparty unsuccessfully sought a determination that our TW2824 and TW2834 productsinfringed a South Korean patent allegedly held by that party. We have certainindemnification obligations to customers under our contract developmentprojects with respect to any infringement of third-party patents andintellectual property rights by our products. If a lawsuit were to be filedagainst us in connection with an offer to license technology or claims ofinfringement, our business would be harmed.

 

Questions of infringementin the digital video applications market involve highly technical andsubjective analyses. Litigation may be necessary in the future to enforce anypatents we may receive and other intellectual property rights, to protect ourtrade secrets, to determine the validity and scope of the proprietary rights ofothers or to defend against claims of infringement or invalidity, and we maynot prevail in any future litigation. Litigation, whether or not determined inour favor or settled, could be costly, could harm our reputation, could causeour customers to use our competitors’ products and could divert the efforts andattention of our management and technical personnel from normal businessoperations. In addition, adverse determinations in litigation could result inthe loss of our proprietary rights, subject us to significant liabilities,require us to seek licenses from third parties or prevent us from licensing ourtechnology or selling our products, any of which could seriously harm ourbusiness.

 

***Our headquarters are located in the State of California andour third-party manufacturing, assembly and testing vendors have facilities inthe State of Washington and in Asia, areas subject to significant earthquakerisks. Any disruption to our or their operations resulting from earthquakes orother natural disasters could cause significant delays in the production orshipment of our products.***

 

TSMC, which manufacturesour semiconductors, has facilities in the State of Washington and in Taiwan.Our assembly and testing vendors’ facilities are primarily located in Taiwan.In addition, our headquarters are located in Northern California. The risk ofan earthquake or extreme weather in the Pacific Rim region or an earthquake inNorthern California or Washington state is significant due to the proximity ofmajor earthquake fault lines. In September 1999, a major earthquake inTaiwan affected the facilities of TSMC and ASE, our primary assembly vendor, aswell as other providers of foundry, packaging and test services. In 2005,several typhoons also disrupted the operations of TSMC and ASE. As a result ofthese natural disasters, these contractors suffered power outages anddisruptions that impaired their production capacity. In March 2002 andJune 2003, additional earthquakes occurred in Taiwan. The occurrence ofearthquakes or other natural disasters could result in the disruption of ourfoundry or assembly and test capacity. We may not be able to obtain alternatecapacity on favorable terms, if at all, which could harm our operating results.

 

***Changes to financial accounting standards may affect ourresults of operations and cause us to change our business practices.***

 

We prepare our financialstatements to conform with accounting principles generally accepted in theUnited States of America, or GAAP. These accounting principles are subject tointerpretation by the Financial Accounting Standards Board, or FASB, theSecurities and Exchange Commission, or SEC, and various bodies formed tointerpret and create appropriate accounting policies. A change in thosepolicies can have a significant effect on our reported results and may affectour 

 

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reporting of transactionscompleted before a change is announced. Changes to those rules or thequestioning of current practices may adversely affect our reported financialresults or the way we conduct our business. For example, accounting policiesaffecting many aspects of our business, including rules relating toemployee stock option grants, have recently been revised. The FASB and otheragencies have made changes to GAAP that required us, starting in our firstquarter of fiscal 2006, to record a charge to earnings for the estimated fairvalue of employee stock option grants and other equity incentives, whereasunder prior accounting rules charges were required only for the intrinsicvalue, if any, of such awards to employees. We may have significant and ongoingaccounting charges under the new rules resulting from option grant andother equity incentive expensing, which could reduce our overall net income. Inaddition, since we historically have used equity-related compensation as acomponent of our total employee compensation program, the accounting changecould make the use of equity-related compensation less attractive to us orrequire us to pay more cash compensation and therefore make it more difficultfor us to attract and retain employees.

 

***Management may apply our cash and equivalents, short-termand long-term investments to uses that do not increase our market value orimprove our operating results.***

 

We intend to use our cashand equivalents, short-term and long-term investments for general corporatepurposes, including working capital and capital expenditures. We may also use aportion of our cash and equivalents, short-term and long-term investments toacquire or invest in complementary technologies, businesses or other assets. Wehave not reserved or allocated our cash and equivalents, short-term andlong-term investments for any specific purpose, and we cannot state withcertainty how our management will use our cash and equivalents, short-term andlong-term investments. Accordingly, our management has considerable discretionin applying our cash and equivalents, short-term and long-term investments andmay use our cash and equivalents, short-term and long-term investments forpurposes that do not result in any increase in our results of operations ormarket value. Until the cash and equivalents, short-term and long-terminvestments are used, they may be placed in investments that do not produceincome or that lose value.

 

**RisksRelated to Our Industry**

 

***Due to the cyclical nature of the semiconductor industry,our operating results may fluctuate significantly, which could adversely affectthe market price of our common stock.***

 

The semiconductor industryis highly cyclical and subject to rapid change and evolving industry standardsand, from time to time, has experienced significant downturns. These downturnsare characterized by decreases in product demand, excess customer inventoriesand accelerated erosion of prices. These factors have caused and could causesubstantial fluctuations in our net revenue and in our operating results. Anydownturns in the semiconductor industry may be severe and prolonged, and anyfailure of this industry to fully recover from downturns could harm ourbusiness. The semiconductor industry also periodically experiences increaseddemand and production capacity constraints, which may affect our ability toship products. Accordingly, our operating results have varied and may varysignificantly as a result of the general conditions in the semiconductorindustry, which could cause our stock price to decline.

 

***The demand for semiconductors is affected by generaleconomic conditions, which could impact our business.***

 

The United States andinternational economies have recently experienced a period of slow economicgrowth. A sustained economic recovery is uncertain. In addition, terrorist actsand similar events, turmoil in the Middle East or war in general, couldcontribute to a slowdown of the market demand for our products. If the economicrecovery slows down as a result of the recent economic, political and socialturmoil, or if there are further terrorist attacks in the United States orelsewhere, we may experience decreases in the demand for our products, whichmay harm our operating results. Our business has been adversely affected byprevious economic downturns. For example, during the global economic downturnin 2002 to 2003, demand for many semiconductor and consumer electronicsproducts suffered as consumers delayed purchasing decisions or changed orreduced their discretionary spending. As a result, demand for our productssuffered and we had to implement restructuring initiatives to align ourcorporate spending with a slower than anticipated revenue growth during thattimeframe.

 

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**RisksRelated to Our Common Stock**

 

***Our stock price has been volatile and you may not be able toresell shares of our common stock at or above the price you paid, or at all.***

 

The trading price of ourcommon stock has experienced wide fluctuations due to the factors discussed inthis risk factors section and elsewhere in this Quarterly Report onForm 10-Q. For example, in the three months ended September 30, 2007, theclosing price of our stock ranged from a low of $8.98 on August 17, 2007 to ahigh of $14.34 on July 13, 2007. In addition, the stock market in general has,and The Nasdaq Global Market and technology companies in particular have, experiencedextreme price and volume fluctuations. These trading prices and valuations maynot be sustainable. These broad market and industry factors may decrease themarket price of our common stock, regardless of our actual operatingperformance. In addition, in the past, following periods of volatility in theoverall market and the market price of a company’s securities, securities classaction litigation has often been instituted against companies that experiencedsuch volatility. This litigation, if instituted against us, regardless of itsoutcome, could result in substantial costs and a diversion of our management’sattention and resources.

 

***If securities or industry analysts do not publish researchor reports about our business, or if they change their recommendationsregarding our stock adversely, our stock price and trading volume coulddecline.***

 

The trading market forour common stock is influenced by the research and reports that industry orsecurities analysts publish about us or our business. If one or more of theanalysts who cover us downgrade our stock, our stock price would likelydecline. If one or more of these analysts cease coverage of our company or failto regularly publish reports on us, we could lose visibility in the financialmarkets, which in turn could cause our stock price or trading volume todecline.

 

***Our ability to raise capital in the future may be limitedand our failure to raise capital when needed could prevent us from executingour growth strategy.***

 

We believe that ourexisting cash and cash equivalents and our investments will be sufficient tomeet our anticipated cash needs for at least the next 12 months. The timing andamount of our working capital and capital expenditure requirements may varysignificantly depending on numerous factors, including:

 

•                  marketacceptance of our products;

•                  theneed to adapt to changing technologies and technical requirements;

•                  theexistence of opportunities for expansion; and

•                  accessto and availability of sufficient management, technical, marketing andfinancial personnel.

 

If our capital resourcesare insufficient to satisfy our liquidity requirements, we may seek to selladditional equity securities or debt securities or obtain debt financing. Thesale of additional equity securities or convertible debt securities wouldresult in additional dilution to our stockholders. Additional debt would resultin increased expenses and could result in covenants that would restrict ouroperations. We have not made arrangements to obtain additional financing andthere is no assurance that financing, if required, will be available in amountsor on terms acceptable to us, if at all.

 

***Substantial future sales of our common stock in the publicmarket could cause our stock price to fall.***

 

Additional sales of ourcommon stock in the public market, or the perception that these sales couldoccur, could cause the market price of our common stock to decline. AtSeptember 30, 2007, we had 20,837,319 shares of common stock outstanding. Asubstantial portion of these shares of common stock are entitled to rights tocause us to register the sale of those shares under the Securities Act.Registration of these shares under the Securities Act would result in theseshares, other than shares purchased by our affiliates, becoming freely tradablewithout restriction under the Securities Act immediately upon the effectivenessof the registration.

 

Some of our officers anddirectors have entered into 10b5-1 trading plans, which generally provide forpre-determined sales of stock by these officers. The sales of stock by ourofficers and directors, even if made pursuant to these 10b5-1 trading plans maycause our stock price to fall.

 

***Our corporate actions are substantially controlled byofficers, directors, principal stockholders and affiliated entities.***

 

Our directors, executiveofficers and their affiliated entities beneficially own a significantpercentage of our outstanding common stock. These stockholders, if they actedtogether, could exert substantial control over matters requiring approval byour stockholders, including electing directors and approving mergers or otherbusiness combination transactions. This concentration of ownership may alsodiscourage, delay or prevent a change in control of our company, which could 

 

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deprive our stockholdersof an opportunity to receive a premium for their stock as part of a sale of ourcompany and might reduce our stock price. These actions may be taken even ifthey are opposed by our other stockholders.

 

***Delaware law and our corporate charter and bylaws containanti-takeover provisions that could delay or discourage takeover attempts thatstockholders may consider favorable.***

 

Provisions in ourcertificate of incorporation, as amended and restated, may have the effect ofdelaying or preventing a change of control or changes in our management. Theseprovisions include the following:

 

•                  theright of the board of directors to elect a director to fill a vacancy createdby the expansion of the board of directors;

•                  theprohibition of cumulative voting in the election of directors, which wouldotherwise allow less than a majority of stockholders to elect directorcandidates;

•                  therequirement for advance notice for nominations for election to the board ofdirectors or for proposing matters that can be acted upon at a stockholders’meeting;

•                  theability of the board of directors to alter our bylaws without obtainingstockholder approval;

•                  theability of the board of directors to issue, without stockholder approval, up to10,000,000 shares of preferred stock with terms set by the board of directors,which rights could be senior to those of common stock;

•                  therequired approval of holders of at least two-thirds of the shares entitled tovote at an election of directors to adopt, amend or repeal our bylaws or amendor repeal the provisions of our certificate of incorporation regarding theindemnification of directors and officers and the ability of stockholders totake action;

•                  therequired approval of holders of at least a majority of the shares entitled tovote at an election of directors to remove directors for cause; and

•                  theelimination of the right of stockholders to call a special meeting ofstockholders and to take action by written consent.

 

In addition, because weare incorporated in Delaware, we are governed by the provisions ofSection 203 of the Delaware General Corporation Law. These provisions mayprohibit or restrict large stockholders, in particular those owning 15% or moreof our outstanding voting stock, from merging or combining with us. Theseprovisions in our certificate of incorporation and bylaws and under Delawarelaw could discourage potential takeover attempts and could reduce the pricethat investors might be willing to pay for shares of our common stock in thefuture and result in our market price being lower than it would without theseprovisions.

 

***We have incurred and will continue to incur increased costsas a result of being a public company.***

 

As a public company, wehave incurred and will continue to incur significant legal, accounting andother expenses that we did not incur as a private company. In addition, theSarbanes-Oxley Act of 2002, as well as new rules subsequently implementedby the SEC and Nasdaq, have required changes in corporate governance practicesof public companies. We expect these new rules and regulations to increaseour legal and financial compliance costs and to make some activities moretime-consuming and costly. For example, as a result of becoming a publiccompany, we have added an independent director, created additional boardcommittees and adopted policies regarding internal controls and disclosurecontrols and procedures. In addition, we have incurred and will continue toincur additional costs associated with our public company reportingrequirements. We are currently evaluating and monitoring developments withrespect to these new rules, and we cannot predict or estimate the amount ofadditional costs we may incur or the timing of such costs.

 

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**ITEM 2.****  UnregisteredSales of Equity Securities and Use of Proceeds**

 

Not applicable.

 

**ITEM 3.****  Defaults UponSenior Securities**

 

Not applicable.

 

**ITEM 4.****  Submission ofMatters to a Vote of Security Holders**

 

Not applicable.

 

**ITEM 5.****  OtherInformation**

 

Not applicable.

 

**ITEM 6.****  Exhibits**

 

(a)                                   Exhibits

 

 
| Exhibit Number | ** ** | **Description**                                                                                                                                                       |
|----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **     | ** ** | ** **                                                                                                                                                            |
| 31.1           |       | Certification of Chief  Executive Officer pursuant to Securities Exchange Act Rules 13a-15(e), as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|           |       |                                                                                                                                                                  |
| 31.2           |       | Certification of Chief  Financial Officer pursuant to Securities Exchange Act Rules 13a-15(e), as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|           |       |                                                                                                                                                                  |
| 32.1 (1)       |       | Certification of Chief  Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                  |
|           |       |                                                                                                                                                                  |
| 32.2 (1)       |       | Certification of Chief  Financial Officer 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)          The material containedin Exhibit 32.1 and Exhibit 32.2 is not deemed “filed” with the SEC and is notto be incorporated by reference into any filing of the Company under theSecurities Act of 1933 or the Securities Exchange Act of 1934, whether madebefore or after the date hereof and irrespective of any general incorporationlanguage contained in such filing, except to the extent that the registrantspecifically incorporates it by reference. 

 

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**Signatures**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, as amended, the registranthas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.

 
| Dated: November  9, 2007 |                                                                      |
|--------------------------|---------------------------------------------------------------------------|
|                     |                                                                      |
|                     | /s/ Fumihiro  Kozato                                                      |   |
|                     | Fumihiro Kozato                                                           |
|                     | Chief Executive Officer                                                   |
|                     |                                                                      |
| Dated: November  9, 2007 |                                                                      |
|                     |                                                                      |
|                     | /s/ Mark Voll                                                             |   |
|                     | Mark Voll                                                                 |
|                     | Vice President of Finance and Administration  and Chief Financial Officer |

 

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