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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 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  June 30, 2009**                                                                                                                                                                                                                                                        |
| **OR**                                                                                                                                                                                                                                                                                                        |
| **o**                                                                                                                                                                                                                                                                                                         | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
| ** **                                                                                                                                                                                                                                                                                                    |
| **For the Transition Period  From                      To                      ** |

 

**COMMISSION FILE NUMBER: 000-52014**

 

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**Techwell, Inc.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                                   | ** ** | **77-0451738**                       |
|----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction ofincorporation  or organization) |       | (I.R.S. Employer Identification No.) |

 

**408 E. Plumeria Drive**

**San Jose, CA  94134**

(Address of principal executive offices,including Zip Code)

 

**(408) 435-3888**

(Registrant’s telephone number, including areacode)

 

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

 

Indicate by check mark whether the registrant has submittedelectronically and posted on its corporate website, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T (§ 229.405 of this chapter) during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files). Yes o No o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See definition of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large Accelerated filer  o                                            |   | Accelerated filer  x         |
|---------------------------------------------------------------------------------|--------|----------------------------------------|
|                                                                            |   |                                   |
| Non-Accelerated filer  o  (Do not check if smaller reporting company) |   | Smaller Reporting Company  o |

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Securities Exchange Act). Yes o No x

 

As of July 31, 2009, 21,562,355 shares of the registrant’s commonstock were outstanding.

 

 

 

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**TECHWELL,INC.**

**FORM 10-Q**

**June 30, 2009**

 
| ** **                                                                                                                | ** ** | **Page** |
|---------------------------------------------------------------------------------------------------------------------------|------------|----------|
|                                                                                                                      |       |     |
| **Part I. Financial Information**                                                                                    |       | 3        |
|                                                                                                                      |       |     |
| **Item 1. Financial Statements**                                                                                          |       | 3        |
| Condensed Unaudited Consolidated Balance Sheets  as of June 30, 2009 and December 31, 2008                      |       | 3        |
| Condensed Unaudited Consolidated Statements of Operations for the  three and six months ended June 30, 2009 and 2008 |       | 4        |
| Condensed Unaudited Consolidated Statements of Cash Flows for the six  months ended June 30, 2009 and 2008           |       | 5        |
| Notes to  Condensed Unaudited Consolidated Financial Statements                                                           |       | 6        |
|                                                                                                                      |       |     |
| **Item 2. Management’s Discussion  and Analysis of Financial Condition and Results of Operations**                   |       | 15       |
|                                                                                                                      |       |     |
| **Item 3. Quantitative and  Qualitative Disclosures about Market Risk**                                                   |       | 25       |
|                                                                                                                      |       |     |
| **Item 4. Controls and Procedures**                                                                                       |       | 26       |
|                                                                                                                      |       |     |
| **Part II.  Other Information**                                                                                      |       | 26       |
|                                                                                                                      |       |     |
| **Item 1. Legal Proceedings**                                                                                             |       | 26       |
|                                                                                                                      |       |     |
| **Item 1A. Risk Factors**                                                                                                 |       | 27       |
|                                                                                                                      |       |     |
| **Item 2. Unregistered Sales of  Equity Securities and Use of Proceeds**                                                  |       | 38       |
|                                                                                                                      |       |     |
| **Item 3. Defaults Upon Senior  Securities**                                                                              |       | 38       |
|                                                                                                                      |       |     |
| **Item 4. Submission of Matters  to a Vote of Security Holders**                                                          |       | 38       |
|                                                                                                                      |       |     |
| **Item 5. Other Information**                                                                                             |       | 38       |
|                                                                                                                      |       |     |
| **Item 6. Exhibits**                                                                                                      |       | 39       |
|                                                                                                                      |       |     |
| Signatures                                                                                                                |       | 40       |

 

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**PART I. Financial Information**

 

**Item 1. Financial Statements**

 

**TECHWELL, INC.**

**CONDENSEDUNAUDITED CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                                                                         | ** ** | **June 30,********2009** | ** ** | **December 31,********2008** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|-----------------------------------|------------|
| **ASSETS**                                                                                                                                                                         |       |                          |       |                              |       |
|                                                                                                                                                                               |       |                          |       |                              |       |
| Current assets:                                                                                                                                                                    |       |                          |       |                              |       |
| Cash and cash equivalents                                                                                                                                                          |       | $                             | 26,295     |                              | $          | 44,485 |   |
| Short-term investments                                                                                                                                                             |       | 37,013                        |       | 17,582                            |       |
| Accounts receivable                                                                                                                                                                |       | 919                           |       | 1,985                             |       |
| Inventory                                                                                                                                                                          |       | 5,790                         |       | 4,780                             |       |
| Deferred income tax assets                                                                                                                                                         |       | 1,402                         |       | 1,353                             |       |
| Prepaid expenses and other current assets                                                                                                                                          |       | 1,624                         |       | 1,200                             |       |
| Total current assets                                                                                                                                                               |       | 73,043                        |       | 71,385                            |       |
| Property and equipment, net                                                                                                                                                        |       | 1,126                         |       | 1,290                             |       |
| Long-term investments                                                                                                                                                              |       | 23,643                        |       | 19,350                            |       |
| Deferred income tax assets                                                                                                                                                         |       | 4,904                         |       | 4,031                             |       |
| Other assets                                                                                                                                                                       |       | 201                           |       | 1,308                             |       |
| TOTAL ASSETS                                                                                                                                                                       |       | $                             | 102,917    |                              | $          | 97,364 |   |
|                                                                                                                                                                               |       |                          |       |                              |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                      |       |                          |       |                              |       |
|                                                                                                                                                                               |       |                          |       |                              |       |
| Current liabilities:                                                                                                                                                               |       |                          |       |                              |       |
| Accounts payable                                                                                                                                                                   |       | $                             | 3,243      |                              | $          | 2,221 |   |
| Accrued liabilities                                                                                                                                                                |       | 4,437                         |       | 2,117                             |       |
| Total current liabilities                                                                                                                                                          |       | 7,680                         |       | 4,338                             |       |
|                                                                                                                                                                               |       |                          |       |                              |       |
| Deferred rent                                                                                                                                                                      |       | 95                            |       | 122                               |       |
| Total liabilities                                                                                                                                                                  |       | 7,775                         |       | 4,460                             |       |
|                                                                                                                                                                               |       |                          |       |                              |       |
| Contingencies (see Note 9)                                                                                                                                                         |       |                          |       |                              |       |
|                                                                                                                                                                               |       |                          |       |                              |       |
| Stockholders’ equity:                                                                                                                                                         |       |                          |       |                              |       |
| Preferred stock, $0.001 par value; 10,000  shares authorized and no shares issued and outstanding                                                                                  |       | —                        |       | —                            |       |
| Common stock, $0.001 par value; 250,000  shares authorized; 21,511 shares and 21,347 shares issued and outstanding at  June 30, 2009 and December 31, 2008, respectively |       | 22                            |       | 21                                |       |
| Additional paid-in capital                                                                                                                                                         |       | 83,455                        |       | 80,240                            |       |
| Deferred stock-based compensation                                                                                                                                                  |       | (3                            | )          | (19                               | )          |
| Retained earnings                                                                                                                                                                  |       | 11,380                        |       | 12,493                            |       |
| Accumulated other comprehensive income                                                                                                                                             |       | 288                           |       | 169                               |       |
| Total stockholders’ equity                                                                                                                                                    |       | 95,142                        |       | 92,904                            |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                    |       | $                             | 102,917    |                              | $          | 97,364 |   |

 

See accompanying notes to condensed unauditedconsolidated financial statements.

 

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**TECHWELL, INC.**

**CONDENSEDUNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
| ** **                                                              | ** ** | **Three  Months Ended********June 30,** | ** ** | **Six  Months Ended********June 30,** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                              | ** ** | **2009**                                     | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                    |       |                                         |       |                                       |       |   |   |   |   |
| Revenues                                                                |       | $                                            | 12,038     |                                       | $          | 17,006 |   | $ | 22,377 |   | $ | 32,613 |   |
| Cost of revenues                                                        |       | 4,841                                        |       | 6,503                                      |       | 8,942 |   | 12,564 |   |
| Gross profit                                                            |       | 7,197                                        |       | 10,503                                     |       | 13,435 |   | 20,049 |   |
| Operating expenses:                                                     |       |                                         |       |                                       |       |   |   |   |   |
| Research and development                                                |       | 4,319                                        |       | 4,208                                      |       | 8,633 |   | 7,757 |   |
| Selling, general and administrative                                     |       | 3,722                                        |       | 3,765                                      |       | 7,255 |   | 7,457 |   |
| Total operating expenses                                                |       | 8,041                                        |       | 7,973                                      |       | 15,888 |   | 15,214 |   |
| Income (loss) from operations                                           |       | (844                                         | )          | 2,530                                      |       | (2,453 | ) | 4,835 |   |
| Interest income                                                         |       | 330                                          |       | 540                                        |       | 698 |   | 1,295 |   |
| Income (loss) before income taxes                                       |       | (514                                         | )          | 3,070                                      |       | (1,755 | ) | 6,130 |   |
| Income tax provision (benefit)                                          |       | (98                                          | )          | 1,228                                      |       | (642 | ) | 2,417 |   |
| Net income (loss)                                                       |       | $                                            | (416       | )                                          | $          | 1,842 |   | $ | (1,113 | ) | $ | 3,713 |   |
|                                                                    |       |                                         |       |                                       |       |   |   |   |   |
| Net income (loss) per share:                                            |       |                                         |       |                                       |       |   |   |   |   |
| Basic                                                                   |       | $                                            | (0.02      | )                                          | $          | 0.09 |   | $ | (0.05 | ) | $ | 0.18 |   |
| Diluted                                                                 |       | $                                            | (0.02      | )                                          | $          | 0.08 |   | $ | (0.05 | ) | $ | 0.17 |   |
|                                                                    |       |                                         |       |                                       |       |   |   |   |   |
| Weighted average shares used in computing  net income (loss) per share: |       |                                         |       |                                       |       |   |   |   |   |
| Basic                                                                   |       | 21,467                                       |       | 21,065                                     |       | 21,425 |   | 20,995 |   |
| Diluted                                                                 |       | 21,467                                       |       | 22,099                                     |       | 21,425 |   | 21,956 |   |

 

See accompanying notes to condensed unauditedconsolidated financial statements.

 

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**TECHWELL, INC.**

**CONDENSEDUNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

 
| ** **                                                                                | ** ** | **Six  Months Ended********June 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                | ** ** | **2009**                                   | ** ** | **2008** | ** ** |
| ** **                                                                                | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| **Cash flows from  operating activities**:                                                |       |                                       |       |   |   |
| Net income (loss)                                                                         |       | $                                          | (1,113     | ) | $ | 3,713 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities: |       |                                       |       |   |   |
| Depreciation and amortization                                                             |       | 365                                        |       | 363 |   |
| Stock-based compensation                                                                  |       | 3,610                                      |       | 3,585 |   |
| Tax benefit from employee equity incentive  plan                                          |       | 27                                         |       | 191 |   |
| Realized gain on investments                                                              |       | —                                     |       | (18 | ) |
| Put option loss                                                                           |       | 350                                        |       | — |   |
| Gain from trading securities                                                              |       | (350                                       | )          | — |   |
| Changes in assets and liabilities:                                                        |       |                                       |       |   |   |
| Accounts receivable                                                                       |       | 1,066                                      |       | (432 | ) |
| Inventory                                                                                 |       | (1,010                                     | )          | (500 | ) |
| Prepaid expenses and other current assets                                                 |       | (424                                       | )          | (41 | ) |
| Other assets                                                                              |       | 757                                        |       | (33 | ) |
| Deferred income tax assets                                                                |       | (922                                       | )          | 17 |   |
| Accounts payables                                                                         |       | 1,024                                      |       | (451 | ) |
| Accrued liabilities                                                                       |       | 2,320                                      |       | (107 | ) |
| Deferred rent                                                                             |       | (27                                        | )          | (22 | ) |
| Net cash provided by operating activities                                                 |       | 5,673                                      |       | 6,265 |   |
|                                                                                      |       |                                       |       |   |   |
| **Cash flows from  investing activities:**                                                |       |                                       |       |   |   |
| Purchase of property and equipment                                                        |       | (203                                       | )          | (243 | ) |
| Purchase of investments                                                                   |       | (33,675                                    | )          | (30,992 | ) |
| Proceeds from maturities of investments                                                   |       | 10,420                                     |       | 37,280 |   |
| Net cash provided by (used in) investing  activities                                      |       | (23,458                                    | )          | 6,045 |   |
|                                                                                      |       |                                       |       |   |   |
| **Cash flows from  financing activities:**                                                |       |                                       |       |   |   |
| Proceeds from exercise of stock options                                                   |       | 49                                         |       | 334 |   |
| Repurchases of common stock upon release of  stock awards                                 |       | (454                                       | )          | (596 | ) |
| Net cash used in financing activities                                                     |       | (405                                       | )          | (262 | ) |
|                                                                                      |       |                                       |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                                     |       | (18,190                                    | )          | 12,048 |   |
| Cash and cash equivalents at beginning of  period                                         |       | 44,485                                     |       | 27,177 |   |
| Cash and cash equivalents at end of period                                                |       | $                                          | 26,295     |   | $ | 39,225 |   |
|                                                                                      |       |                                       |       |   |   |
| **Supplemental  disclosure of non-cash investing and financing activity:**                |       |                                       |       |   |   |
| Gross issuance of restricted stock awards                                                 |       | $                                          | 2,429      |   | $ | 2,558 |   |

 

See accompanying notes to condensed unauditedconsolidated financial statements.

 

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

 

***The Company***

 

Techwell, Inc.(“Techwell” or the “Company”) was incorporated in California on March 7,1997 and reincorporated in Delaware on March 30, 2006. The Company is afabless semiconductor company that designs, markets and sells mixed signalintegrated circuits for two primary markets: security surveillance andautomotive infotainment.

 

TheCompany’s headquarters is located in San Jose, California.  The Company’s international offices includebranch offices in South Korea and Taiwan and subsidiaries in China and Japan.These offices provide marketing support to customers. The China and Japanoffices are also involved in product development.

 

In May 2009,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 165, *Subsequent Events*,(“SFAS 165”). SFAS 165 establishes general accounting standards and disclosurefor subsequent events. The Company adopted SFAS 165 during the secondquarter of 2009. In accordance with SFAS 165, the Company has evaluatedsubsequent events through the date and time the financial statements wereissued on August 6, 2009.

 

***Basis of Presentation***

 

Theaccompanying condensed unaudited consolidated financial statements of theCompany have been prepared without audit in accordance with the rules andregulations of the Securities and Exchange Commission. The consolidated balancesheet at December 31, 2008 has been derived from the audited consolidatedfinancial statements as of and for the year then ended. Certain information anddisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States of Americahave been condensed or omitted in accordance with these rules andregulations. The information in this report should be read in conjunction withthe Company’s consolidated financial statements and notes thereto included inits Annual Report on Form 10-K for the year ended December 31, 2008.

 

In theopinion of management, the accompanying condensed unaudited 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 periodspresented. The operating results for the three and six months ended June 30,2009 are not necessarily indicative of the results that may be expected for theyear ended December 31, 2009 or for any other future period.

 

***Principles of Consolidation***

 

Thecondensed unaudited consolidated financial statements include the accounts ofthe Company and its subsidiaries. All significant intercompany transactions andbalances have been eliminated in consolidation. The Company reports itsfinancial results on a calendar fiscal year.

 

***Use of Estimates***

 

Thepreparation of condensed unaudited consolidated financial statements inaccordance with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities, the disclosure of contingentassets and liabilities at the date of the condensed unaudited consolidatedfinancial statements and the reported amounts of revenues and expenses duringthe reporting period. Actual results could differ from these estimates.

 

***CertainSignificant 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 

 

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goods; the quality andtimely service of third-party vendors that manufacture, assemble and test theCompany’s products; the Company’s customers’ sales outlook, purchasing patternsand inventory adjustments based on demand and general economic conditions;product obsolescence and the Company’s ability to manage product transitions;the Company’s ability to successfully develop, introduce and sell new orenhanced products in a timely manner; and the timing of new productannouncements or introductions by the Company or by its competitors.

 

***Accumulated Other Comprehensive Income(Loss)***

 

Accumulatedother comprehensive income (loss) consists of net unrealized gains (losses) onavailable-for-sale investments. The change in unrealized gains on investmentsfor the three and six months ended June 30, 2009 was an increase of $0.3million and $0.1 million, respectively. The change in unrealized losses for thethree and six months ended June 30, 2008 was an increase of $0.2 millionand $0.4 million, respectively. Total comprehensive loss for the three and sixmonths ended June 30, 2009 was $0.1 million and $1.0 million,respectively. Total comprehensive income for the three and six months ended June 30,2008 was $1.6 million and $3.3 million, respectively.

 

**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. At June 30, 2009, the total numberof shares available for issuance under the Plans was 2.4 million.  Stock options and awards granted under thePlans have a contractual term of up to ten years, generally vest over fouryears at the rate of 25 percent on the one-year anniversary of the vestingcommencement date and ratably each month thereafter and are exercisable underconditions determined by the Board of Directors or committee thereof aspermissible under the terms of the Plans. At June 30, 2009, 3,334 sharesexercised prior to vesting are subject to repurchase by the Company.

 

For the three and sixmonths ended June 30, 2009 and 2008, stock-based compensation expenseincludes compensation cost related to estimated fair values of stock optionsand awards granted after the date of adoption of SFAS No. 123 (revised2004), *Share-Based Payment*, (“SFAS123 (R)”) and stock-based compensation costs related to unvested stock optionsat the date of adoption based on the intrinsic values as previously recordedunder Accounting Principles Board Opinion (“APB”) No. 25, *Accounting for Stock Issued to Employees*,(“APB 25”).

 

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

 
| ** **                           | ** ** | **Three  Months Ended********June 30,** | ** ** | **Six  Months Ended********June 30,** | ** ** |
|--------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                           | ** ** | **2009**                                     | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| Cost of revenues                     |       | $                                            | 117        |                                       | $          | 131 |   | $ | 239 |   | $ | 244 |   |
| Research and  development            |       | 845                                          |       | 859                                        |       | 1,745 |   | 1,552 |   |
| Selling, general and  administrative |       | 804                                          |       | 918                                        |       | 1,626 |   | 1,789 |   |
| Related tax-effect                   |       | (310                                         | )          | (683                                       | *)*        | (1,057 | ) | (1,281 | *)* |
| Total costs and  expenses            |       | $                                            | 1,456      |                                       | $          | 1,225 |   | $ | 2,553 |   | $ | 2,304 |   |

 

Totalcompensation cost attributable to activities capitalized into inventory was notsignificant in any period presented.

 

SFAS123(R) requires the cash flows resulting from the tax benefits for taxdeductions resulting from the exercise of stock options in excess of thecompensation expense recorded for those options (excess tax benefits) to beclassified as cash from financing activities.

 

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

** **

TheCompany calculates net income (loss) per share in accordance with SFAS No. 128,*Earnings Per Share,*(“SFAS 128”).Under SFAS 128, basic net income (loss) per common share is calculated bydividing net income (loss) by the weighted-average number of common sharesoutstanding during the reporting period excluding shares subject to repurchase.Diluted net income (loss) per common share reflects the effects of potentiallydilutive securities, which consist of common stock options (calculated usingthe treasury stock method) and restricted awards and shares subject torepurchase. A reconciliation of shares used in the calculation of basic anddiluted net income (loss) per share is as follows (in thousands):

 
| ** **                                                                                                     | ** ** | **Three  Months Ended********June 30,** | ** ** | **Six  Months Ended********June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                     | ** ** | **2009**                                     | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| Weighted average common  shares outstanding                                                                    |       | 21,472                                       |       | 21,082                                     |       | 21,430 |   | 21,015 |   |
| Weighted average shares  subject to repurchase                                                                 |       | (5                                           | )          | (17                                        | )          | (5 | ) | (20 | ) |
| Shares used to  calculate basic net income (loss) per share                                                    |       | 21,467                                       |       | 21,065                                     |       | 21,425 |   | 20,995 |   |
| Effect of dilutive  securities:                                                                                |       |                                         |       |                                       |       |   |   |   |   |
| Common stock options  and restricted awards and unvested common shares subject to repurchase or  cancellations |       | —                                       |       | 1,034                                      |       | — |   | 961 |   |
| Shares used to  calculate diluted net income (loss) per share                                                  |       | 21,467                                       |       | 22,099                                     |       | 21,425 |   | 21,956 |   |

 

Forthe three and six months ended June 30, 2009 and 2008, respectively,3.2 million and 1.2 million shares associated with stock options andrestricted awards outstanding and unvested shares subject to repurchase havebeen excluded from the weighted-average number of common shares outstanding forthe diluted net loss per share computation as they are anti-dilutive.

 

**Note 4—Income Taxes**

 

TheCompany accounts for income taxes under the provisions of SFAS No. 109,*Accounting for Income Taxes,*(“SFAS 109”).In applying SFAS 109, the Company is required to estimate its 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. Significant management judgment isrequired to assess the likelihood that its deferred tax assets will berecovered from future taxable income. As of June 30, 2009, the Company’stotal deferred tax assets were principally comprised of research and othercredit carryforwards, stock-based compensation and expense accruals.

 

TheCompany applies the provisions of FASB Interpretation No. 48, *Accounting for Uncertainty in Income Taxes,*(“FIN 48”), which clarifies the accounting for uncertainty in income taxesrecognized in an enterprise’s consolidated financial statements in accordancewith SFAS 109.

 

TheCompany and its subsidiaries file income tax returns in the U.S. federaljurisdiction, various states and foreign jurisdictions.  The Company hasnot been under the examination of U.S. federal, state or foreign jurisdictionstax authorities.

 

TheCompany’s effective tax rate is based on the estimated annual effective taxrate. The effective tax rate was 19% and 40% for the three months ended June 30,2009 and 2008, respectively. For the three months ended June 30, 2009, theeffective rate approach was modified by paragraphs 13 and 14 of  FASB Interpretation No. 18,*Accounting for Income Taxes in Interim Periods aninterpretation of APB Opinion No. 28* (“FIN 48”). FIN 48paragraph 13 provides if the year-to-date “ordinary” loss exceeds theanticipated “ordinary” loss for the fiscal year, the tax benefit recognized forthe year-to-date shall not exceed the tax benefit determined, based on theyear-to-date “ordinary” loss, in accordance with paragraphs 14 and 15. Paragraph 14 provides that a tax benefit is recognized for a loss that arisesearly in a fiscal year if the tax benefits are expected to be (a) realizedduring the year or (b) recognizable as a deferred tax asset at the end ofthe year in accordance with the provisions of SFAS 109. The effective tax ratewas 37% and 39% for the six months ended June 30, 2009 and 2008,respectively. In the three and six months ended June 30, 2009 and 2008 theeffective tax rate differed from the statutory federal income tax rate primarilydue to stock-based compensation, research and development credits and stateincome taxes.

 

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**Note 5—Financial Instruments**

 

TheCompany’s investments consist of corporate bonds, US government agencysecurities, commercial paper and auction rate securities (“ARS”). Investments,with the exception of ARS which are currently classified as trading, areconsidered available-for-sale. With the exception of ARS, they are all carriedat fair market value based on market quotes. The Company’s investment in ARSwas intended to provide liquidity via an auction process that resets theapplicable interest rate at predetermined calendar intervals, allowinginvestors to either roll over their holdings or gain immediate liquidity byselling such interests at par. During 2008, uncertainties in the credit marketsaffected all of the Company’s holdings in ARS investments and auctions for theCompany’s investments in these securities failed to settle on their respectivesettlement dates. Consequently, the investments are not currently liquid andthe Company will not be able to access these funds until a future auction ofthese investments is successful or a buyer is found outside of the auctionprocess. All of the ARS investments were investment grade quality and were incompliance with the Company’s investment policy at the time of acquisition.

 

During the fourth quarterof 2008, the Company entered into an agreement with one of its investmentproviders, which currently holds its ARS and from whom it had purchased theARS, to sell, at the Company’s discretion, at par value all of the ARS theCompany currently holds back to the investment provider at anytime starting in June 2010.The rights granted under the agreement represent a firm agreement in accordancewith SFAS No. 133, *Accounting forDerivative Instruments and Hedging Activities* (“SFAS 133”), whichdefines a firm agreement as an agreement with an unrelated party, binding onboth parties and usually legally enforceable, with the followingcharacteristics: a) the agreement specifies all significant terms, includingthe quantity to be exchanged, the fixed price and the time of transaction andb) the agreement includes a disincentive for nonperformance that issufficiently large to make performance probable. The enforceability of theagreement results in a put option and should be recognized as a free standingasset separate from the ARS. The put option does not meet the definition of aderivative instrument under SFAS 133. Therefore, the Company has elected tomeasure the put option at fair value under SFAS No. 159, *The Fair Value Option for Financial Assets andFinancial Liabilities — including an Amendment of FASB Statement No. 115,(“*SFAS 159”), which permits an entity to elect the fair value optionfor recognized financial assets. As a result, realized gains and losses will beincluded in earnings in the period in which they arise.

 

Inconnection with the acceptance of the offer, the Company recorded $1.0 millionas the fair value of the put option asset with a corresponding gain to interestincome. Additionally, the Company transferred its ARS from investmentsclassified as available-for-sale to trading. The transfer to trading reflectsthe Company’s intent to exercise the put option, whereas, prior to theagreement, the Company’s intent was to hold the ARS until the market recovered.Upon transfer to trading, the Company recognized a loss of $1.0 million,included in interest income, for the amount of unrealized loss not previouslyrecognized in earnings. As a result of this transfer unrealized gains or losseswill be included in earnings in future periods, and the Company anticipatesfuture changes in fair value of the put option will approximate the fair valuemovement of the related ARS. The net impact of the change in fair value of theARS and related put option to the Company’s operating results was nil for thethree and six months ended June 30, 2009.

 

As of June 30,2009, the entire ARS investment balance of $6.3 million is classified asshort-term investments on the condensed unaudited consolidated balance sheetbecause the sale of the ARS back to the investment provider is expected tooccur in June 2010.

 

Typicallythe fair value of ARS investments approximates par value due to the frequentresets through the auction process. While the Company continues to earninterest on its ARS investments at the maximum contractual rate, theseinvestments are not currently trading and therefore do not currently have areadily determinable market value. Accordingly, the estimated fair value of ARSno longer approximates par value.

 

TheCompany has used a discounted cash flow model to determine the estimated fairvalue of its investment in ARS as of June 30, 2009. The assumptions usedin preparing the discounted cash flow model include estimates for interestrates, estimates for discount rates using yields of comparable tradedinstruments adjusted for illiquidity and other risk factors, amount of cashflows and expected holding periods of the ARS. These inputs reflect the Company’sown assumptions about the assumptions market participants would use in pricingthe ARS, including assumptions about risk, developed based on the bestinformation available in the circumstances.

 

Theput option is a free standing asset separate from the ARS, and represents theCompany’s contractual right to require its investment provider to purchase theARS at par at anytime starting in June 2010. The Company values the putoption based on  amount of cash flows andexpected holding periods of the related ARS, time value of money and theCompany’s assessment of the credit worthiness of its investment provider.

 

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The following is a summary of the Company’savailable-for-sale securities as of June 30, 2009 (in thousands):

 
| ** **                       | ** ** | ** **          | ** ** | ** **            | ** ** | **Less  than  12 Months** | ** ** | **12  Months  or Longer** | ** ** | ** **                | ** ** |
|----------------------------------|------------|---------------------|------------|-----------------------|------------|---------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                       | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses**    | ** ** | **Unrealized  Losses**    | ** ** | **Estimated  Fair Value** | ** ** |
|                             |       |                |       |                  |       |                      |       |                      |       |                      |       |
| Money market  funds              |       | $                   | 20,474     |                  | $          | —                    |       | $                         | —     |                      | —     |   | $ | 20,474 |   |
| Corporate bonds                  |       | 32,026              |       | 238                   |       | (45                       | )          | —                    |       | 32,219                    |       |
| Treasuries and  federal agencies |       | 19,002              |       | 97                    |       | (2                        | )          | —                    |       | 19,097                    |       |
| Commercial paper                 |       | 2,991               |       | —                |       | —                    |       | —                    |       | 2,991                     |       |
| Total                            |       | $                   | 74,493     |                  | $          | 335                       |       | $                         | (47        | )                         | $          | — |   | $ | 74,781 |   |
|                                  |            |                     |            |                       |            |                           |            |                           |            |                           |            |  |  |  |  |  |

 

Thefollowing is a summary of the Company’s available-for-sale securities as of December 31,2008 (in thousands):

 
| ** **                      | ** ** | ** **          | ** ** | ** **            | ** ** | **Less than  12 Months** | ** ** | **12 Months  or Longer** | ** ** | ** **                | ** ** |
|---------------------------------|------------|---------------------|------------|-----------------------|------------|--------------------------|------------|--------------------------|------------|---------------------------|------------|
| ** **                      | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses**   | ** ** | **Unrealized  Losses**   | ** ** | **Estimated  Fair Value** | ** ** |
|                            |       |                |       |                  |       |                     |       |                     |       |                      |       |
| Money market funds              |       | $                   | 33,998     |                  | $          | —                   |       | $                        | —     |                      | —     |   | $ | 33,998 |   |
| Corporate bonds                 |       | 19,710              |       | 97                    |       | (57                      | )          | —                   |       | 19,750                    |       |
| Treasuries and federal agencies |       | 5,023               |       | 103                   |       | —                   |       | —                   |       | 5,126                     |       |
| Commercial paper                |       | 12,061              |       | 26                    |       | —                   |       | —                   |       | 12,087                    |       |
| Total                           |       | $                   | 70,792     |                  | $          | 226                      |       | $                        | (57        | )                         | $          | — |   | $ | 70,961 |   |
|                                 |            |                     |            |                       |            |                          |            |                          |            |                           |            |  |  |  |  |  |

 

As of June 30,2009, the unrealized losses on our available-for-sale securities were insignificantin relation to our total available-for-sale securities. Substantially all ofour unrealized losses on our available-for-sale investments can be attributedto fair value fluctuations in an unstable credit environment. The Companyconsiders the declines in market value of its available-for-sale securities tobe temporary in nature. In addition, it is not more likely than not that theCompany will be required to sell its securities that have unrealized losses inaccumulated other comprehensive income (loss) before the Companyrecovers  the entire amortized cost basisof the security and as such there is no credit loss associated with theseavailable-for-sale securities. The Company believes that the unrealized lossesare temporary and do not require an other-than-temporary impairment. During thethree and six months ended June 30, 2009 and June 30, 2008, theCompany did not recognize any impairment charges on outstandingavailable-for-sale securities.

 

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EffectiveJanuary 1, 2008, the Company adopted the provisions of SFAS No. 157, *Fair Value Measurement,(“*SFAS 157”) whichdefines fair value. In accordance with SFAS 157, the table below represents thefair value hierarchy of the Company’s financial instruments measured at fairvalue as of June 30, 2009 (in thousands):

** **
| ** **                                 | ** ** | **Total** | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|--------------------------------------------|------------|-----------|------------|-------------|------------|-------------|------------|-------------|------------|
| Money market  funds                        |       | $         | 20,474     |        | $          | 20,474      |       | $           | —     |   | $ | — |   |
| Corporate bonds                            |       | 32,219    |       | 32,219      |       | —      |       | —      |       |
| Treasuries and  federal agencies           |       | 19,097    |       | 19,097      |       | —      |       | —      |       |
| Commercial paper                           |       | 2,991     |       | 2,991       |       | —      |       | —      |       |
| Put option                                 |       | 751       |       | —      |       | —      |       | 751         |       |
| Auction rate  securities                   |       | 6,349     |       | —      |       | —      |       | 6,349       |       |
| Total                                      |       | $         | 81,881     |        | $          | 74,781      |       | $           | —     |   | $ | 7,100 |   |
| Amount included  in:                       |       |      |       |        |       |        |       |        |       |
| Cash and cash  equivalents                 |       | $         | 20,474     |        | $          | 20,474      |       | $           | —     |   | $ | — |   |
| Short-term  investments                    |       | 37,013    |       | 30,664      |       | —      |       | 6,349       |       |
| Long-term  investments                     |       | 23,643    |       | 23,643      |       | —      |       | —      |       |
| Prepaid expenses  and other current assets |       | 751       |       | —      |       | —      |       | 751         |       |
| Total                                      |       | $         | 81,881     |        | $          | 74,781      |       | $           | —     |   | $ | 7,100 |   |

 

Thefollowing table provides a reconciliation of the beginning and ending balancesfor the assets measured at fair value using significant unobservable inputs(Level 3) (in thousands):

 
| ** **                                      | ** ** | ******Put Option** | ** ** | **Auction  Rate  Securities** | ** ** |
|-------------------------------------------------|------------|--------------------|------------|-------------------------------|------------|
| Balances as of  December 31, 2008          |       | $                  | 1,101      |                          | $          | 5,999 |   |
| Unrealized gains  (losses) included in earnings |       | (304               | )          | 304                           |       |
| Balances as of  March 31, 2009             |       | 797                |       | 6,303                         |       |
| Unrealized gains  (losses) included in earnings |       | (46                | )          | 46                            |       |
| Balances as of  June 30, 2009              |       | $                  | 751        |                          | $          | 6,349 |   |

 

**Note 6—Details of CertainBalance Sheet Components**

 
| ** **                                 | ** ** | **June 30,********2009** | ** **  | **December 31,********2008** | ** ** |
|--------------------------------------------|------------|-------------------------------|-------------|-----------------------------------|------------|
| ** **                                 | ** ** | **(in  thousands)**           | ** **  |
| Inventory:                                 |       |                          |        |                              |       |
| Finished goods                             |       | $                             | 3,481       |                              | $          | 2,750 |   |
| Work-in-process                            |       | 2,309                         |        | 2,030                             |       |
|                                       |       | $                             |  5,790 |                              | $          | 4,780 |   |
|                                       |       |                          |        |                              |       |
| Property and equipment,  net:              |       |                          |        |                              |       |
| Equipment                                  |       | $                             | 2,053       |                              | $          | 1,888 |   |
| Software                                   |       | 804                           |        | 779                               |       |
| Furniture and fixtures                     |       | 309                           |        | 308                               |       |
| Leasehold improvements                     |       | 464                           |        | 454                               |       |
|                                       |       | 3,630                         |        | 3,429                             |       |
| Accumulated  depreciation and amortization |       | (2,504                        | )           | (2,139                            | )          |
|                                       |       | $                             |  1,126 |                              | $          | 1,290 |   |
|                                       |       |                          |        |                              |       |
| Accrued liabilities:                       |       |                          |        |                              |       |
| Accrued compensation                       |       | $                             | 854         |                              | $          | 1,168 |   |
| Accrued inventory  purchases               |       | 180                           |        | 104                               |       |
| Customer advance                           |       | 2,498                         |        | —                            |       |
| Legal and professional  service fees       |       | 246                           |        | 320                               |       |
| Other                                      |       | 659                           |        | 525                               |       |
|                                       |       | $                             |  4,437 |                              | $          | 2,117 |   |

 

**Note 7—Segment Information**

 

TheCompany currently operates in one reportable segment, the designing, marketingand selling of mixed signal integrated circuits for multiple video applicationsprimarily for the security surveillance and automotive infotainment markets.The Company’s chief operating decision maker is the Chief Executive Officer.

 

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Thepercentage of total revenues by geographic location is as follows:

** **
| ** **     | ** ** | **Three  Months Ended********June 30,** | ** ** | **Six  Months Ended********June 30,** | ** ** |
|----------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **     | ** ** | **2009**                                     | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| China          |       | 53                                           | %          | 34                                         | %          | 50 | % | 31 | % |
| South Korea    |       | 21                                           |       | 28                                         |       | 23 |   | 29 |   |
| Taiwan         |       | 17                                           |       | 31                                         |       | 16 |   | 33 |   |
| Japan          |       | 5                                            |       | 5                                          |       | 7 |   | 5 |   |
| United States  |       | 2                                            |       | 1                                          |       | 2 |   | 1 |   |
| Other          |       | 2                                            |       | 1                                          |       | 2 |   | 1 |   |
| Total revenues |       | 100                                          | %          | 100                                        | %          | 100 | % | 100 | % |

 

Revenues by product line are as follows (inthousands):

** **
| ** **              | ** ** | **Three  Months Ended********June 30,** | ** ** | **Six  Months Ended********June 30,** | ** ** |
|-------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **              | ** ** | **2009**                                     | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| Security surveillance   |       | $                                            | 8,353      |                                       | $          | 12,855 |   | $ | 15,842 |   | $ | 24,464 |   |
| Automotive infotainment |       | 2,345                                        |       | 1,963                                      |       | 4,032 |   | 3,660 |   |
| Consumer                |       | 1,335                                        |       | 2,144                                      |       | 2,491 |   | 4,256 |   |
| Other (1)               |       | 5                                            |       | 44                                         |       | 12 |   | 233 |   |
| Total revenues          |       | $                                            | 12,038     |                                       | $          | 17,006 |   | $ | 22,377 |   | $ | 32,613 |   |

 

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(1) Consists of contract development projects,early generation mixed signal semiconductors for digital video applications andPCI video decoder products.

 

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

 
| ** **   | ** ** | **Accounts  Receivable at** | ** ** | **Revenues**     | ** ** |
|--------------|------------|-----------------------------|------------|------------------|------------|
| ** **   | ** ** | ** **                  | ** ** | ** **       | ** ** | **Three Months  ended** | ** ** | **Six Months  ended** | ** ** |
| ** **   | ** ** | **June 30,**                | ** ** | **December 31,** | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| **Customer** | ** ** | **2009**                    | ** ** | **2008**         | ** ** | **2009** | ** ** | **2008** | ** ** | **2009** | ** ** | **2008** | ** ** |
| A            |       | *                           | %          | 21               | %          | 37 | % | 31 | % | 36 | % | 29 | % |
| B            |       | 17                          |       | *                |       | * |   | * |   | * |   | * |   |
| C            |       | 16                          |       | 11               |       | * |   | * |   | * |   | * |   |
| D            |       | 13                          |       | *                |       | * |   | * |   | * |   | * |   |
| E            |       | 12                          |       | *                |       | * |   | * |   | * |   | * |   |
| F            |       | 12                          |       | *                |       | * |   | * |   | * |   | * |   |
| G            |       | 11                          |       | *                |       | * |   | * |   | * |   | * |   |
| H            |       | *                           |       | 20               |       | * |   | * |   | * |   | * |   |
| I            |       | *                           |       | *                |       | * |   | 10 |   | * |   | 11 |   |

 

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* lessthan 10%

 

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

** **
| ** **    | ** ** | **June 30,********2009** | ** ** | **December 31,  2008** | ** ** |
|---------------|------------|-------------------------------|------------|-----------------------------|------------|
| United States |       | $                             | 941        |                        | $          | 1,069 |   |
| China         |       | 78                            |       | 73                          |       |
| Taiwan        |       | 58                            |       | 79                          |       |
| Japan         |       | 43                            |       | 60                          |       |
| South Korea   |       | 6                             |       | 9                           |       |
| Total         |       | $                             | 1,126      |                        | $          | 1,290 |   |

 

**Note 8—Related PartyTransactions**

** **

One ofthe Company’s Board members is a partner in a law firm that provides servicesto the Company. The Company incurred fees of nil and $5,000 from this law firmfor legal services in the three months ended June 30, 2009 and 2008,respectively. The Company incurred fees of $7,000 and $13,000 from this lawfirm for legal services in the six months ended June 30, 2009 and 2008,respectively. The amount payable to this law firm was nil and $8,000 at June 30,2009 and December 31, 2008, respectively.

 

**Note 9—Contingencies**

** **

***Indemnification Obligations***

 

Subjectto certain limitations, the Company is obligated to indemnify its current andformer directors, officers and employees in connection with governmentinquiries and litigation.  These obligations arise under the terms of theCompany’s certificate of incorporation, its bylaws, applicable contracts, andDelaware and California law.  The obligation to indemnify generally meansthat the Company is required to pay or reimburse the individuals’ reasonablelegal expenses and possibly damages and other liabilities incurred inconnection with these matters.  Additionally, the Company has certain indemnificationobligations to customers under its contract development projects with respectto any infringement of third-party patents and intellectual property rights byits products.

 

***Other Legal Matters***

 

TheCompany is currently not a party to any material legal proceedings. The Companymay be named from time to time as a party to lawsuits in the normal course ofits business. Litigation in general and intellectual property and securitieslitigation in particular, can be expensive and disruptive to normal businessoperations.  Moreover, the results of legal proceedings are difficult topredict.

 

**Note 10—Recent Accounting Pronouncements**

** **

EffectiveJanuary 1, 2008, the Company adopted SFAS 157 with respect to itsfinancial assets and liabilities. In February 2008, the FASB issued FASBStaff Position (“FSP”) No. SFAS 157-2, *EffectiveDate of FASB Statement No. 157*, which provided a one yeardeferral of the effective date of SFAS 157 for non-financial assets andnon-financial liabilities, except those that are recognized or disclosed in thefinancial statements at fair value at least annually. The Company adopted theprovisions of SFAS 157 for non-financial assets and non-financial liabilitieseffective January 1, 2009. The adoption of SFAS 157 for non-financialassets and non-financial liabilities did not have an impact on the condensedunaudited consolidated financial position, results of operations or cash flows.

 

In December 2007,the FASB issued SFAS No. 141(R), *BusinessCombinations*, (“SFAS 141(R)”). SFAS 141(R) establishesprinciples and requirements for how an acquirer recognizes and measures in itsconsolidated financial statements the identifiable assets acquired, theliabilities assumed, contractual contingencies and contingent consideration attheir fair value on the acquisition date, any controlling interest in theacquiree and the goodwill acquired. SFAS 141(R) also establishesdisclosure requirements to enable the evaluation of the nature and financialeffects of the business combination. SFAS 141(R) is effective for fiscalyears beginning after December 15, 2008. The Company will apply theprovisions of SFAS 141(R) to any acquisitions occurring subsequent to January 1,2009.

 

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In April 2009the FASB issued FSP No. SFAS 141(R)-1, *Accountingfor Assets Acquired and Liabilities Assumed in a Business Combination ThatArise from Contingencies*, (“FSP 141(R)-1”). FSP 141(R)-1 amends theprovisions in SFAS 141(R) for the initial recognition and measurement,subsequent measurement and accounting, and disclosures for assets andliabilities arising from contingencies in business combinations. FSP 141(R)-1eliminates the distinction between contractual and non-contractualcontingencies, including the initial recognition and measurement criteria inSFAS 141(R) and instead carries forward most of the provisions in SFAS 141for acquired contingencies. FSP 141(R)-1 is effective for contingent assets andcontingent liabilities acquired in business combinations for which theacquisition date is on or after the beginning of the first annual reportingperiod beginning on or after December 15, 2008. The Company will assessthe impact of FSP 141(R)-1 at the time of any such acquisition.

 

In April 2009the FASB issued three related FSPs: (i) FSP No. SFAS 157-4, *Determining Fair Value When the Volume and Level ofActivity for the Asset or Liability have Significantly Decreased andIdentifying Transactions That Are Not Orderly*, (“FSP 157-4”), (ii) FSPNo. SFAS 115-2 and FSP No. SFAS 124-2, *Recognition and Presentation of Other-Than-Temporary Impairments*,(“FSP 115-2 and 124-2”), and (iii) FSP No. SFAS 107-1 and APB No. 28-1,*Interim Disclosures about Fair Value ofFinancial Instruments*, (“FSP 107-1 and APB 28-1”), which areeffective for interim and annual periods ending after June 15, 2009. FSP157-4 provides guidance on how to determine the fair value of assets andliabilities under SFAS 157 in the current economic environment and reemphasizesthat the objective of a fair value measurement remains an exit price. FSP 115-2and 124-2 modifies the requirements for recognizing other-than-temporarilyimpaired debt securities and revises the existing impairment model for suchsecurities, by modifying the current intent and ability indicator indetermining whether a debt security is other-than-temporarily impaired. FSP107-1 and APB 28-1 enhances the disclosure of instruments under the scope ofSFAS 157 for both interim and annual periods. Effective April 1, 2009, theCompany adopted the provisions of FSP 157-4, FSP 115-2 and 124-2 and FSP 107-1and APB 28-1. The adoption of FSP 157-4, FSP 115-2 and 124-2 and FSP 107-1 andAPB 28-1 did not have an impact on the condensed unaudited consolidatedfinancial position, results of operations or cash flows.

 

In June 2009,the FASB issued SFAS No. 168, *The FASB AccountingStandards Codification TM and the Hierarchy of Generally Accepted AccountingPrinciples* (“SFAS 168”). SFAS 168 establishes the FASB AccountingStandards Codification (the “Codification”) as the source of authoritativeaccounting principles recognized by the FASB to be applied by nongovernmentalentities in the preparation of financial statements in conformity with U.S.GAAP. Rules and interpretive releases of the SEC under authority offederal securities laws are also sources of authoritative U.S. GAAP for SECregistrants. All guidance contained in the Codification carries an equal levelof authority. SFAS 168 is effective for financial statements issued for interimand annual periods ending after September 15, 2009. The Codification willsupersede all existing non-SEC accounting and reporting standards. All othernon-grandfathered, non-SEC accounting literature not included in theCodification will become non-authoritative. Following SFAS 168, the FASB willnot issue new standards in the form of Statements, FSPs, or Emerging IssuesTask Force Abstracts. Instead, it will issue Accounting Standards Updates. TheFASB will not consider Accounting Standards Updates as authoritative in theirown right. Accounting Standards Updates will serve only to update theCodification, provide background information about the guidance and provide thebases for conclusions on the change(s) in the Codification. The Companywill update its disclosures to conform to the Codification in its Form 10-Qfor the third quarter of 2009.

 

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

 

*Thefollowing discussion of our financial condition and results of operationsshould be read in conjunction with the condensed unaudited consolidatedfinancial statements and notes to those statements included elsewhere in thisQuarterly Report on Form 10-Q for the three and six months ended June 30,2009 and our audited consolidated financial statements for the year ended December 31,2008 included in our Annual Report on Form 10-K.*

 

*ThisQuarterly Report on Form 10-Q contains forward-looking statements thatinvolve risks and uncertainties. These statements relate to futureperiods, future events or our future operating or financial plans orperformance. These statements can often be identified by the use offorward-looking terminology such as “expects,” “believes,” “intends,” “anticipates,”“estimates,” “plans,” “may,” or “will,” or the negative of these terms, andother similar expressions. These forward-looking statements includestatements as to the source of our revenues, our ability to generate revenues,our ability to sustain our growth rate and return to profitability, expectedgrowth in our target markets and application-specific products, our expectationregarding the increase in certain expenses, our cash needs, our capitalrequirements, our market risk sensitivity, our business and product strategies,our anticipated tax rate, industry trends and our anticipation thatdevelopments in our technologies and new products will increase our targetmarket share.*

 

*Theseforward-looking statements reflect our current views with respect to futureevents, are based on assumptions and are subject to risks anduncertainties. These risks and uncertainties could cause actual results todiffer materially from those projected and include, but are not limited to,fluctuations in our revenue and operating results, our ability to return toprofitability, the demand for our products in our target markets, our abilityto compete, 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,**economicvolatility in either domestic or foreign markets, the impact of any change inUnited States federal income tax laws and the loss of any beneficial taxtreatment that we currently enjoy, our reliance on independent foundries andsubcontractors for the manufacture, assembly and testing of our products, thelength of our sales cycle and reliance on distributors, our ability to protectour intellectual property, the cyclical nature of the semiconductor industry,our ability to raise capital, the potential volatility of our stock, theoutcome of future litigation and the other risks set forth under PART II —OTHER INFORMATION,  Item 1A. “RiskFactors.” Given these risks and uncertainties, you should not place unduereliance on these forward-looking statements. Except as required byfederal securities laws, we undertake no obligation to update anyforward-looking statements for any reason, even if new information becomesavailable or other events occur in the future.*

 

*In thisreport all references to “Techwell,” “we,” “us” or “our” mean Techwell, Inc.*

 

*Techwellis our registered trademark. We also refer to trademarks of othercorporations and organizations in this Form 10-Q.*

 

***Overview***

 

We area fabless semiconductor company that designs, markets and sells mixed signalintegrated circuits for two primary markets: security surveillance andautomotive infotainment. We design application-specific products for our twoprimary markets that enable the conversion of analog video signals to digitalform and perform advanced digital video processing to facilitate the display,storage and transport of video content. We believe this application specificproduct strategy allows us to better address varying customer requirements,fully leverage our technology capabilities and achieve greater share within ourtwo core markets. To a lesser extent, we market and sell video decoders to theconsumer market. 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.

 

Since 1999, our businesshas experienced significant growth primarily as a result of our ability todevelop new products, obtain design wins and convert these design wins intorevenues. We generated revenues from the sale of over 25 different products in thequarter ended June 30, 2009.

 

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Wehave three principal semiconductor product lines: security surveillance products,automotive infotainment products and consumer products. Our securitysurveillance products integrate important functions required to display, storeand transport analog video signals from security surveillance cameras. Forexample, we integrate multiple video decoders into a single semiconductor. As aresult, this semiconductor is able to receive and decode analog video signalsfrom multiple cameras into a standard digital format. In addition, we integratea multiplexor, a key technology required to combine multiple video signals intoa single video signal, and a display processor, a key technology required todisplay multiple video channels. In 2007, we introduced our first integratedsecurity surveillance product, which integrated four video decoders and asystem controller and a multiplexor on a single semiconductor. In December 2008,we introduced a new security surveillance product which includes a 16 channelmultiplexer and supports the display of multiple standard definition and highdefinition video sources. We currently sell our security surveillance productsto customers for the following applications: embedded digital video recorders,or DVRs, PC-based DVRs, networked video recorders, or NVRs, and multiplexors.

 

Ourautomotive infotainment products integrate important functions required todisplay popular analog video, high definition video and PC graphics signals ona LCD display. These key functions include a video decoder, deinterlacer andscaler. In addition, our newer generation automotive infotainment productsintegrate a timing controller to interface directly with certain types of LCDdisplays and image enhancement functionality to improve overall video quality.In January 2008, we announced the introduction of five new LCD display processorsdesigned for the automotive end market. These new products are designed toprovide advanced image processing, an integrated programmable timing controllerand multiple analog and digital video inputs.

 

Ourconsumer products are high performance mixed signal semiconductors that decodeanalog TV broadcast signals, including NTSC, PAL and SECAM, and popular analogvideo signals, including composite, S-Video, component and SCART, into astandard digital format. Our consumer products integrate proprietary syncprocessing, color demodulating and digital 2D and 3D comb filtering, which arethe key technologies required for high performance video decoding. We offer abroad range of consumer products at various price points and with varyingfeatures. We have developed our video decoder products for applications withinthe consumer markets such as advanced TV, multifunction LCD monitor, DVDrecorder and camcorders. In the future, however, we intend to focus ourdevelopment efforts specifically on applications for the security surveillanceand automotive infotainment markets and as a result, we anticipate our consumerrevenues will decline over the next several quarters.

 

Ourother products include early generation mixed signal semiconductors for digitalvideo applications and PCI video decoder products, which are video decodersthat utilize 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 efforts. These expenditures may not result in increased revenue orprofitability in the future. In addition, our ability to increase our revenueswill depend on increased demand for digital video applications in the securitysurveillance and automotive infotainment markets. The growth of our targetmarkets is uncertain. In addition, the timing of orders by and shipments to ourcustomers, as well as general trends in our target markets, can cause ourrevenue growth to be inconsistent.

 

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 24 months 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 products.Conversely, if a competitor secures the design win, it may be difficult for usto sell into the customer’s application for an extended period. Our sales cycletypically ranges from six to 24 months. Due to the length of our productdevelopment and sales cycle, the majority of our revenues for any period isgenerally weighted toward products introduced for sale, meaning products forwhich we commenced placing orders with our manufacturing subcontractors, in theprior one or two years. As a result, our present revenues are not necessarilyrepresentative of future sales because our future sales are likely to becomprised of a different mix of products, some of which are now in thedevelopment stage.

 

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As afabless semiconductor company, we outsource all of our manufacturing, assemblyand test functions to third-party vendors primarily located in Taiwan. Thisbusiness model enables us to reduce our capital expenditures and fixed costs,while focusing our engineering and design resources on our core strength, thedesign of mixed signal semiconductors for digital video applications.

 

Wesell our products to distributors that fulfill third-party orders for ourproducts. We also sell directly, using independent sales representatives, tooriginal equipment manufacturers, or OEMs, and to original designmanufacturers, or ODMs. For the six months ended June 30, 2009, wederived 77% of our revenues from products sold to distributors and 23% fromproducts sold to OEMs or ODMs. For the year ended December 31, 2008,we derived 79% of our revenues from products sold to distributors and 21% fromproducts sold to OEMs or ODMs.  Our gross margins have not historicallybeen significantly different between sales to distributors and sales to OEMs orODMs through orders procured by independent sales representatives. However, ouroperating profit on sales through orders procured by independent salesrepresentatives can be less due to the payment of commissions to salesrepresentatives which we record as sales and marketing expense.

 

Wereceived an aggregate of 74% and 83% of our revenues from our ten largestcustomers for the three months ended June 30, 2009 and 2008, respectively.For the three months ended June 30, 2009, Lacewood InternationalCorporation, or Lacewood, a distributor, accounted for 37% of our revenues. Forthe three months ended June 30, 2008, Lacewood and AV Tech Corporation, orAV Tech, accounted for 31% and 10% of our revenues, respectively. For the sixmonths ended June 30, 2009, Lacewood accounted for 36% of our revenues.For the six months ended June 30, 2008, Lacewood and AV Tech accounted for29% and 11% of our revenues, respectively.

 

Wederive substantially all of our revenues from sales to foreign customers,particularly in Asia, which sales accounted for 96% and 98% of our revenues forthe three and six months ended June 30, 2009 and 2008, respectively. Thetable below indicates the percentage of total revenues by geographic locationfor the periods indicated:

 
| ** **     | ** ** | **Three  Months Ended********June 30,** | ** ** | **Six  Months Ended********June 30,** | ** ** |
|----------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **     | ** ** | **2009**                                     | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| China          |       | 53                                           | %          | 34                                         | %          | 50 | % | 31 | % |
| South Korea    |       | 21                                           |       | 28                                         |       | 23 |   | 29 |   |
| Taiwan         |       | 17                                           |       | 31                                         |       | 16 |   | 33 |   |
| Japan          |       | 5                                            |       | 5                                          |       | 7 |   | 5 |   |
| United States  |       | 2                                            |       | 1                                          |       | 2 |   | 1 |   |
| Other          |       | 2                                            |       | 1                                          |       | 2 |   | 1 |   |
| Total revenues |       | 100                                          | %          | 100                                        | %          | 100 | % | 100 | % |

 

We received 50% and 31%of our revenues from China in the six months ended June 30, 2009 and 2008,respectively.  The increase was primarilydue to an increase in revenues from our security surveillance market, whoseproducts were primarily sold to customers in China. We received 16% and 33% ofour revenues from Taiwan in the six months ended June 30, 2009 and 2008,respectively.  The decrease was primarilydue to a decline in revenues from consumer markets, whose products wereprimarily sold to customers in Taiwan.

 

We believe that asubstantial majority of our revenues will continue to come from customerslocated in Asia, where most of the electronic devices that use oursemiconductors are manufactured. As a result of this regional customerconcentration, we may be subject to environmental, economic, cultural andpolitical events as well as other developments that impact our customers inAsia. All of our sales currently are denominated in U.S. dollars. Therefore, anincrease in the value of the U.S. dollar relative to foreign currencies couldmake our products less competitive in international markets. Substantially allof our cost of revenues and a majority of our operating expenses are alsodenominated in U.S. dollars. As a result, we believe that our overall exposureto foreign exchange risk is low.

 

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We have two internationalsubsidiaries, one in Japan and one in China. We also have two internationalbranches, one in South Korea and one in Taiwan. At June 30, 2009, 62 ofour 165 employees were located in our international subsidiaries and branchoffices. Our China and Japan subsidiaries are involved in both productdevelopment and technical marketing support. Our Taiwan and Korea branchesprimarily provide marketing support.

 

It isdifficult for us to forecast the demand for our products, in part because ofthe highly complex supply chain between us and the end markets that incorporateour products. Demand for new features changes rapidly. Distributors and ODMsadd an additional layer of complexity. We must, therefore, forecast demand notonly from our direct customers, but also from other participants in thismulti-level distribution channel. Because of our lengthy product developmentcycle, it is critical for us to anticipate changes in demand for our variousproduct features and the applications they serve, to allow sufficient time forproduct design. Our failure to accurately forecast demand can lead to productshortages that can impede production by our customers and harm our relationshipwith these customers. Conversely, our failure to forecast declining demand orshifts in product mix can result in excess or obsolete inventory.

 

Generally,the average selling price of our products will decline over the life of theproduct. Our experience to date is that the decline has not had a materialeffect on our gross margins, as price reductions have been mitigated by lowerper unit costs associated with both high unit volume and the transition of ourproducts to smaller process geometries.

 

Weexpect our revenues to be lower in the first calendar quarter of each year. Themost significant factor for this decline is because most of our semiconductorsare sold to customers located in Asia, primarily to customers located inregions who observe the Lunar New Year holiday. Typically, our customers’offices are closed for a week or more during the extended holiday period, whichnegatively impacts our business during the first calendar quarter of the year.As a result of seasonality associated with our customer concentration in Asia,we expect our revenues to be lower in the first calendar quarter of each year.

 

***Critical Accounting Policies***

 

Ourdiscussion and analysis of our financial condition and results of operationsare based upon our condensed unaudited consolidated financial statements, whichhave been prepared in accordance with accounting principles generally acceptedin the United States. The preparation of these condensed unaudited consolidatedfinancial statements requires us to make estimates and judgments that affectthe reported amount of assets, liabilities, revenues and expenses and relateddisclosure of contingent assets and liabilities. We evaluate our estimates onan on-going basis, including those related to inventory valuations, valuation ofinvestments, income taxes and stock-based compensation. We base our estimateson historical experience and on various other assumptions that we believe to bereasonable under the circumstances, the results of which form the basis formaking the judgments we make about the carrying values of assets andliabilities that are not readily apparent from other sources. Because theseestimates can vary depending on the situation, actual results may differ fromthe estimates.

 

Webelieve the following critical accounting policies affect our more significantjudgments used in the preparation of our condensed unaudited consolidatedfinancial statements.

 

*RevenueRecognition.  *Revenues from product sales are recognized upon shipment, provided thattitle and risk of loss has passed to the customer, persuasive evidence of anarrangement exists, the price is fixed or determinable and collectibility isprobable. We do not allow for price protection or stock rotation rights withany of our distributors. If we change our practice and allow stock rotation orprice protection in the future, we would have to evaluate the consequences onthe timing of our revenue recognition, which could lead to the deferral of therevenues subject to such uncertainties unless reasonable estimates of returnsor price reductions can be made at the time of shipment.

 

*Fair Value Measurements. *Effective January 1,2008, we adopted the provisions of Statement of Financial Accounting Standards,or SFAS, No. 157,*Fair ValueMeasurements*, or SFAS 157, which defines fair value, establishes aframework for measuring fair value and expands disclosures about fair valuemeasurements required under other accounting pronouncements.  SFAS 157 clarifies that fair value is an exitprice, representing the amount that would be received to sell an asset or paidto transfer a liability in an orderly transaction between market 

 

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participants.SFAS 157 also requires that a fair value measurement reflect theassumptions market participants would use in pricing an asset or liabilitybased on the best information available. Assumptions include the risks inherentin a particular valuation technique (such as a pricing model) and/or the risksinherent in the inputs to the model. Refer to Note 2 to our consolidatedfinancial statements included in our Annual Report on Form 10-K for theyear ended December 31, 2008 for the fair value hierarchy, and Note 5 toour condensed unaudited consolidated financial statements included in thisQuarterly Report on Form 10-Q for inputs to valuation techniques and fairvalue measurements of financial assets carried at fair value.

 

*Inventory Valuation.  * Inventory is valued at the lower of costor market, computed on a first-in, first-out basis. We evaluate inventory forexcess and obsolescence and write-down units that are unlikely to be sold basedupon a six month demand forecast. This evaluation may take into account mattersincluding expected demand, anticipated sales price, product obsolescence andother factors. If actual future demand for our products is less than currentlyforecasted, additional inventory write-downs may be required. Once inventory costsare written down, such revised costs are maintained until the product is soldor scrapped. If a unit that has been written down is subsequently sold, thecost associated with the revenue from this unit is reduced to the extent of thewrite-down, resulting in an increase in gross profit. Changes in the inputs tosuch valuation models could cause the fair value to change.

 

*Accounting for Income Taxes.  *We account for income taxes under theprovisions of SFAS No. 109, *Accountingfor Income Taxes*, or SFAS 109. In applying SFAS 109, we are requiredto estimate our current tax expense together with assessing temporarydifferences resulting from differing treatments of items for tax and accountingpurposes. These differences result in deferred tax assets and liabilities. Wemust assess the likelihood that our deferred tax assets will be recovered fromfuture taxable income and to the extent we believe that recovery is not likely,we must establish a valuation allowance. Significant management judgment is requiredto assess the likelihood that our deferred tax assets will be recovered fromfuture taxable income. At June 30, 2009, our total deferred tax assetswere principally comprised of research and other credit carryforwards,stock-based compensation and expense accruals.

 

Asrequired under the provisions of SFAS 109, we assess the recoverability of ourdeferred tax assets. To assess the likelihood that the deferred tax assets willbe recovered from future taxable income, we applied the guidance provided in SFAS109 and considered both positive evidence that indicates a valuation allowanceis not needed and negative evidence that indicates a valuation allowance isneeded. As of June 30, 2009, we believe that our predictable strongearnings provide ample evidence that no valuation allowance is required at thistime as it is more likely than not the deferred tax assets will be realized inthe future.

 

Werecognize and measures uncertain tax positions in accordance with the FinancialAccounting Standards Board, or FASB issued Interpretation No. 48, A*ccounting for Uncertainty in Income Taxes - aninterpretation of FASB Statement No. 109*, or FIN 48, whereby weonly recognizes the tax benefit from an uncertain tax position if it is morelikely than not that the tax position will be sustained on examination by thetaxing authorities, based on the technical merits of the position. The taxbenefits recognized in the financial statements from such positions are thenmeasured based on the largest benefit that has a greater than 50% likelihood ofbeing realized upon ultimate settlement.

 

Managementbelieves it is more likely than not that forecasted income, including incomethat may be generated as a result of certain tax planning strategies, togetherwith the tax effects of the deferred tax liabilities, will be sufficient tofully recover the remaining deferred tax assets. In the event that we determineall or part of the net deferred tax assets are not realizable in the future, wewill make an adjustment to the valuation allowance that would be charged toearnings in the period such determination is made. In addition, the calculationof tax liabilities involves significant judgment in estimating the impact ofuncertainties in the application of FIN 48 and other complex tax laws.Resolution of these uncertainties in a manner inconsistent with management’sexpectations could have a material impact on our financial condition andoperating results.

 

Wefile income tax returns in the U.S. federal jurisdiction, various states andforeign jurisdictions. We have not been under the examination of U.S. federal,state or other foreign jurisdictions tax authorities.

 

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*Stock-BasedCompensation.  * For the three and six months ended June 30, 2009 and 2008,stock-based compensation expense includes compensation costs related to estimatedfair values of stock options and awards granted after the date of adoption ofSFAS No. 123 (revised 2004), *Share-BasedPayment*, or SFAS 123(R), and compensation costs related tounvested stock options at the date of adoption based on the intrinsic values aspreviously recorded under Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees*,or APB 25.

 

For options granted afterJanuary 1, 2006, and valued in accordance with SFAS 123(R), we use thestraight-line method for expense attribution. For options granted prior to January 1,2006, we use the multiple grant approach for expense attribution, which resultsin substantially higher amounts of amortization in earlier years as opposed tothe straight-line method, which results in equal amortization over the vestingperiod of the options.

 

The fair value of optionsgranted after January 1, 2006 is estimated on the grant date using theBlack-Scholes option valuation model. The expected term assumption calculationwas based on historical data as suggested by Staff Accounting Bulletin No. 107adjusted for any changes in future expectations. We relied exclusively onhistorical volatility in the expected volatility assumption calculation sincewe do not have any publicly traded options. The risk-free rate is based on theU.S. Treasury yield curve in effect at the time of grant for periodscorresponding with the expected term of the option and the estimated forfeiturerate is based on our historical forfeiture experience.

 

The following assumptionsare used to value stock options granted in the periods presented:

 
| ** **               | ** ** | **Three  Months Ended********June 30,** | ** ** | **Six  Months Ended********June 30,** | ** ** |
|--------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **               | ** ** | **2009**                                     | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| Expected  term (years)   |       | 4.34                                         |       | 4.28                                       |       | 4.34 |   | 4.28 |   |
| Risk-free  interest rate |       | 1.87                                         | %          | 2.86                                       | %          | 1.52 — 1.87 | % | 2.57 — 2.86 | % |
| Expected  volatility     |       | 54.00                                        | %          | 51.00                                      | %          | 54.00 | % | 51.00 — 64.00 | % |
| Expected  dividend       |       | —                                       |       | —                                     |       | — |   | — |   |

 

Stock-based compensationexpense for restricted stock awards is determined using the fair value of ourstock on the date of the grant and is recognized on a straight-line basis overthe service period.

 

Stock-based compensationexpense is allocated among cost of revenues, research and development expensesand selling, 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 andawards in future periods.

 

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**Resultsof Operations**

 

The following table isderived from our selected financial data and sets forth our historicaloperating results as a percentage of revenues:

 
| ** **                            | ** ** | **Three  Months Ended********June 30,** | ** ** | **Six  Months Ended********June 30,** | ** ** |
|---------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                            | ** ** | **2009**                                     | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenues                              |       | 100.0                                        | %          | 100.0                                      | %          | 100.0 | % | 100.0 | % |
| Cost  of revenues*                    |       | 40.2                                         |       | 38.2                                       |       | 40.0 |   | 38.5 |   |
| Gross  profit                         |       | 59.8                                         |       | 61.8                                       |       | 60.0 |   | 61.5 |   |
| Operating  expenses:                  |       |                                         |       |                                       |       |   |   |   |   |
| Research  and development*            |       | 35.9                                         |       | 24.7                                       |       | 38.6 |   | 23.8 |   |
| Selling,  general and administrative* |       | 30.9                                         |       | 22.2                                       |       | 32.4 |   | 22.9 |   |
| Total  operating expenses             |       | 66.8                                         |       | 46.9                                       |       | 71.0 |   | 46.7 |   |
| Income  (loss) from operations        |       | (7.0                                         | )          | 14.9                                       |       | (11.0 | ) | 14.8 |   |
| Interest  income                      |       | 2.7                                          |       | 3.2                                        |       | 3.1 |   | 4.0 |   |
| Income  (loss) before income taxes    |       | (4.3                                         | )          | 18.1                                       |       | (7.9 | ) | 18.8 |   |
| Income  tax provision (benefit)       |       | (0.8                                         | )          | 7.2                                        |       | (2.9 | ) | 7.4 |   |
| Net  income (loss)                    |       | (3.5                                         | )%         | 10.9                                       | %          | (5.0 | )% | 11.4 | % |

 

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* Percentages includestock-based compensation

 

The following tableindicates the percentage of stock-based compensation attributed to each item asa percentage of revenues:

 
| ** **                           | ** ** | **Three  Months Ended********June 30,** | ** ** | **Six  Months Ended********June 30,** | ** ** |
|--------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                           | ** ** | **2009**                                     | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| Cost  of revenues                    |       | 1.0                                          | %          | 0.8                                        | %          | 1.1 | % | 0.7 | % |
| Research  and development            |       | 7.0                                          |       | 5.1                                        |       | 7.8 |   | 4.8 |   |
| Selling,  general and administrative |       | 6.7                                          |       | 5.4                                        |       | 7.3 |   | 5.5 |   |

 

Revenues by product lineare as follows (in thousands):

 
| ** **               | ** ** | **Three  Months Ended********June 30,** | ** ** | **Six  Months Ended********June 30,** | ** ** |
|--------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **               | ** ** | **2009**                                     | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| Security  surveillance   |       | $                                            | 8,353      |                                       | $          | 12,855 |   | $ | 15,842 |   | $ | 24,464 |   |
| Automotive  infotainment |       | 2,345                                        |       | 1,963                                      |       | 4,032 |   | 3,660 |   |
| Consumer                 |       | 1,335                                        |       | 2,144                                      |       | 2,491 |   | 4,256 |   |
| Other  (1)               |       | 5                                            |       | 44                                         |       | 12 |   | 233 |   |
| Total  revenues          |       | $                                            | 12,038     |                                       | $          | 17,006 |   | $ | 22,377 |   | $ | 32,613 |   |

 

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(1) Consistsof contract development projects, early generation mixed signal semiconductorsfor digital video applications and PCI video decoder products.

 

**Comparisonsof the Three Months Ended June 30, 2009 and June 30, 2008**

 

*Revenues.*   Our revenues consist ofsales of our mixed signal integrated circuits for digital video applications.We have three principal product lines: security surveillance, automotiveinfotainment and consumer. All of our sales are denominated in U.S. dollars.

 

Revenues were $12.0million for the three months ended June 30, 2009 and $17.0 million for thethree months ended June 30, 2008, a decrease of 29% due to a generaldecrease in demand for our security surveillance and consumer productsprimarily as a result of current economic conditions, partially offset by anincrease in demand for our automotive infotainment products.  Revenues from our security surveillanceproducts decreased $4.5 million, or 35%, in the three months ended June 30,2009 compared to the three months ended June 30, 2008. 

 

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Revenues from of ourautomotive infotainment products increased $0.4 million, or 19%, in the threemonths ended June 30, 2009 compared to the three months ended June 30,2008 due primarily to previously awarded design wins with customers now goinginto volume production. Revenues from consumer products decreased $0.8 million,or 38%, in the three months ended June 30, 2009 compared to the threemonths ended June 30, 2008. Other revenues decreased by $39,000, or 87%,in the three months ended June 30, 2009 compared with the three monthsended June 30, 2008.

 

*GrossProfit and Gross Margin*.  Gross profit is the difference between revenues and costof revenues, and gross margin represents gross profit as a percentage ofrevenues. Costs of revenues, also known as costs of goods sold, consistsprimarily of cost of processed silicon wafers, costs associated with assembly,test and shipping of our production semiconductors, cost of personnel andrelated expenses associated with supporting our outsourced manufacturingactivities and write-downs for excess and obsolete inventory.

 

Gross profit was $7.2million for the three months ended June 30, 2009 and $10.5 million for thethree months ended June 30, 2008, a decrease of 31%. Gross margin was 60%for the three months ended June 30, 2009 decreasing from 62% for the threemonths ended June 30, 2008 due to changes in product mix. The decrease ingross profit was primarily due to a decrease in revenues of $5.0 million, or29%.

 

We incurred stock-basedcompensation included in cost of revenues associated with outsourcedmanufacturing support and quality assurance personnel of $0.1 million in thethree months ended June 30, 2009 and 2008.

 

*Researchand Development Expenses.*  Research and development expenses consist primarily ofcompensation and associated costs of employees engaged in research anddevelopment, contractor costs, tape-out costs, development testing andevaluation costs, occupancy costs and depreciation expense. Beforereleasing new products, we incur charges for mask sets, prototype wafers andmask set revisions, which we refer to as tape-out costs. Tape-out costscause our 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 the future as we increase ourinvestment in developing new products.

 

Research and developmentexpenses were $4.3 million, or 36% of revenues, for the three months ended June 30,2009 and $4.2 million, or 25% of revenues, for the three months ended June 30,2008, an increase of 3%. The slight increase in research and developmentexpense was primarily attributable to increased compensation-related expensesof $0.2 million reflecting an increase in headcount to support the developmentof new products and technologies.

 

We incurred stock-basedcompensation expense associated with research and development personnel of $0.8million and $0.9 million in the three months ended June 30, 2009 and 2008,respectively.

 

*Selling,General and Administrative Expenses.*  Selling, general and administrativeexpenses consist primarily of compensation and associated costs for marketing,selling and administrative personnel, sales commissions to independent salesrepresentatives, public relations, promotional and other marketing expenses,insurance and fees paid for professional services, travel, depreciationexpenses and occupancy costs. Costs associated with audit and tax services,corporate governance and compliance and financial reporting are also includedin selling, general and administrative expenses. We expect selling, general andadministrative expenses to remain flat in absolute dollars throughout the restof fiscal 2009.

 

Selling, general andadministrative expenses were $3.7 million, or 31% of revenues, for the threemonths ended June 30, 2009 and $3.8 million, or 22% of revenues, for thethree months ended June 30, 2008, a decrease of 1%.

 

We incurred stock-basedcompensation expense associated with selling, general and administrativepersonnel of $0.8 million and $0.9 million in the three months ended June 30,2009 and 2008, respectively.

 

*InterestIncome.*  Interestincome was $0.3 million for the three months ended June 30, 2009 and $0.5million for the three months ended June 30, 2008, a decrease of 39%. Thedecrease was primarily due to lower rates of returns on our cash equivalentsand investments partially offset by higher cash equivalents and investmentbalances.

 

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*Provision(Benefit) for Income Taxes.*  Our benefit for income taxes was $0.1million for the three months ended June 30, 2009 compared with a provisionfor income taxes of $1.2 million for the three months ended June 30, 2008.Our effective tax rate was 19% and 40% for the three months ended June 30,2009 and 2008, respectively. For the three months ended June 30, 2009, theeffective rate approach was modified by paragraphs 13 and 14 of  FASB Interpretation No. 18,*Accounting for Income Taxes in Interim Periods aninterpretation of APB Opinion No. 28,*or FIN 18. FIN 48paragraph 13 provides if the year-to-date “ordinary” loss exceeds theanticipated “ordinary” loss for the fiscal year, the tax benefit recognized forthe year-to-date shall not exceed the tax benefit determined, based on theyear-to-date “ordinary” loss, in accordance with paragraphs 14 and 15. Paragraph 14 provides that a tax benefit is recognized for a loss that arisesearly in a fiscal year if the tax benefits are expected to be (a) realizedduring the year or (b) recognizable as a deferred tax asset at the end ofthe year in accordance with the provisions of SFAS 109. The effective tax ratefor both the three months ended June 30, 2009 and 2008 differed from thestatutory federal income tax rate primarily due to stock-based compensation,research and development credits and state income taxes.

 

**Comparisonsof the Six Months Ended June 30, 2009 and June 30, 2008**

 

*Revenues.*   Revenues were $22.4 millionfor the six months ended June 30, 2009 and $32.6 million for the sixmonths ended June 30, 2008, a decrease of 31% due to a general decrease indemand for our security surveillance and consumer products primarily as aresult of current economic conditions, partially offset by an increase indemand for our automotive infotainment products.  Revenues from our security surveillance productsdecreased $8.6 million, or 35%, in the six months ended June 30, 2009compared to the six months ended June 30, 2008. Revenues from of ourautomotive infotainment products increased $0.4 million, or 10%, in the sixmonths ended June 30, 2009 compared to the six months ended June 30,2008 primarily due to previously awarded design wins with customers now goinginto volume production. Revenues from consumer products decreased $1.8 million,or 41%, in the six months ended June 30, 2009 compared to the six monthsended June 30, 2008. Other revenues decreased by $0.2 million, or 95%, inthe six months ended June 30, 2009 compared with the six months ended June 30,2008.

 

*GrossProfit and Gross Margin*.  Gross profit was $13.4 million for the six months ended June 30,2009 and $20.0 million for the six months ended June 30, 2008, a decreaseof 33%. Gross margin was 60% for the six months ended June 30, 2009decreasing slightly from 61% for the six months ended June 30, 2008. Thedecrease in gross profit was primarily due to a decrease in revenues of $10.2million, or 31%.

 

We incurred stock-basedcompensation included in cost of revenues associated with outsourcedmanufacturing support and quality assurance personnel of $0.2 million in thesix months ended June 30, 2009 and 2008.

 

*Researchand Development Expenses.*  Research and development expenses were $8.6 million, or 39%of revenues, for the six months ended June 30, 2009 and $7.8 million, or24% of revenues, for the six months ended June 30, 2008, an increase of11%. The increase in research and development expense was primarilyattributable to increased compensation-related expenses of $0.7 million,reflecting both increases in stock-based compensation and in headcount tosupport the development of new products and technologies, and an increase of$0.2 million of tape-out expenses as a result of our development of newproducts and our migration to smaller geometry process technologies.

 

We incurred stock-basedcompensation expense associated with research and development personnel of $1.7million and $1.6 million in the six months ended June 30, 2009 and 2008,respectively.

 

*Selling,General and Administrative Expenses.*   Selling, general and administrativeexpenses were $7.3 million, or 32% of revenues, for the six months ended June 30,2009 and $7.5 million, or 23% of revenues, for the six months ended June 30,2008, a decrease of 3%. The slight decrease in selling, general andadministrative expenses was attributable to a decrease of $0.5 million incompensation-related expenses, partially offset by a $0.4 million increase inprofessional services expenses.

 

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We incurred stock-basedcompensation expense associated with selling, general and administrativepersonnel of $1.6 million and $1.8 million in the six months ended June 30,2009 and 2008, respectively.

 

*InterestIncome.*  Interestincome was $0.7 million for the six months ended June 30, 2009 and $1.3million for the six months ended June 30, 2008, a decrease of 46%. Thedecrease was primarily due to lower rates of returns on our cash equivalentsand investments partially offset by higher cash equivalents and investmentbalances.

 

*Provision(Benefit) for Income Taxes.*  Our benefit for income taxes was $0.6million in the six months ended June 30, 2009 compared with a provisionfor income taxes of $2.4 million for the six months ended June 30, 2008.Our effective tax rate was 37% and 39% for the six months ended June 30,2009 and 2008, respectively. The effective tax rate for both the six monthsended June 30, 2009 and 2008 differed from the statutory federal incometax rate primarily due to stock-based compensation, research and developmentcredits and state income taxes.

 

##### **Liquidity and Capital Resources**

##### ** **

Since our inception, wehave financed our growth primarily with proceeds from the issuance of preferredstock and common stock and cash flow generated by our operations. Our cash andcash equivalents and short-term and long-term investments were $87.0 million asof June 30, 2009.

 

*Netcash from operating activities*

 

Net cash provided byoperating activities was $5.7 million in the six months ended June 30,2009. The net cash provided by operating activities in the six months ended June 30,2009 was primarily due to non-cash charges for stock-based compensation of $3.6million, an increase in accrued liabilities of $2.3 million due to increases incustomer advances, a decrease in accounts receivable of $1.1 million due totiming of customer collections, and an increase in accounts payable of $1.0million due to timing of purchases. These were partially offset by our net lossof $1.1 million, an increase in inventory of $1.0 million due to increasedpurchases and an increase in deferred income tax assets of $1.0 million,resulting from differing treatments of items for tax and accounting purposes.

 

Net cash provided byoperating activities was $6.3 million in the six months ended June 30,2008. The net cash provided by our operating activities in the six months endedJune 30, 2008 was primarily due to our net income of $3.7 million, aswell as non-cash charges for stock-based compensation of $3.6 million. Thesewere partially offset by increases in inventory of $0.5 million and accountsreceivable of $0.4 million, both of which are attributable to the growth in ourrevenue during this period, and decreases in accounts payable of $0.5 millionand accrued liabilities of $0.1 million, primarily due to the timing ofpayments to vendors and tax authorities.

 

*Netcash from investing activities*

 

Net cash used ininvesting activities was $23.5 million in the six months ended June 30,2009 due to the purchases of our investments of $33.7 million partially offsetby maturities of our investments of $10.4 million.

 

Net cash provided by ourinvesting activities was $6.0 million in the six months ended June 30,2008 due to the maturities of our investments of $37.3 million partiallyoffset by purchases of short and long-term investments of $31.0 million.

 

*Netcash from financing activities*

 

Net cash used infinancing activities of $0.4 million in the six months ended June 30, 2009primarily consisted of repurchases of common stock upon release of restrictedstock awards.

 

Net cash used infinancing activities of $0.3 million in the six months ended June 30, 2008consisted of repurchases of common stock upon release of restricted stockawards of $0.6 million partially offset by proceeds from the exercise of stockoptions of $0.3 million.

 

At June 30, 2009, weheld $6.3 million of investments with an auction reset feature, which arereferred to as auction rate securities, or ARS, whose underlying assets aregenerally student loans which are substantially backed by the federalgovernment. In February and March of 2008, auctions failed for ourARS, and there is no assurance that successful auctions of any ARS in ourinvestment portfolio will occur in the future. An auction failure means thatthe parties wishing to sell securities could not. All of our ARS were rated AAAat the time of purchase, and continue to be rated AAA, the highest rating, by arating agency.

 

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During the fourth quarterof 2008, we entered into an agreement with one of our investment providers,which currently holds all of our ARS and from whom we had purchased the ARS, tosell, at our discretion, at par value all of the ARS we currently hold back tothe investment provider at anytime starting in June 2010. Our ability toliquidate our ARS investment and fully recover the carrying value of ourinvestment in the near term may be limited or not existent. We have classifiedthese ARS investments as short-term investments because our sale of the ARSback to the our investment provider is expected to occur in June 2010. Weare continuing to evaluate the credit quality, classification and valuation ofour ARS, but based on our expected operating cash flows, and our other sourcesof cash, we do not anticipate the potential near term lack of liquidity onthese investments will affect our ability to execute our current business plan.

 

We believe our existingcash and cash equivalents and short-term and long-term investments, as well ascash expected to be generated from operating activities will be sufficient tomeet our anticipated cash needs for at least the next 12 months. Our long-termfuture capital 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 SheetArrangements**

** **

As of June 30, 2009,we have no off-balance sheet arrangements as defined in Item 303(a)(4) ofthe Securities and Exchange Commission’s Regulation S-K.

 

**ContractualObligations**

 

The following tableidentifies our commitments to settle contractual obligations as of June 30,2009 (in thousands):

 
| ** **                 | ** ** | **Payments  Due by Period** | ** ** |
|----------------------------|------------|-----------------------------|------------|
| ** **                 | ** ** | **Total**                   | ** ** | **Less  than********1 Year** | ** ** | **1-3********Years** | ** ** |
| Minimum  lease commitments |       | $                           | 1,670      |   | $ | 670 |   | $ | 1,000 |   |
| Purchase  commitments      |       | 3,201                       |       | 3,201 |   | — |   |
| Total  commitments         |       | $                           | 4,871      |   | $ | 3,871 |   | $ | 1,000 |   |

 

**Recent AccountingPronouncements**

** **

For a description ofrecent accounting pronouncements, including the expected dates of adoption andestimated effects, if any, on our condensed unaudited consolidated financialstatements, refer to Note 10 to our condensed unaudited consolidated financialstatements.

 

**Item 3. Quantitative andQualitative Disclosures about Market Risk**

** **

The primary objectives ofour investment activities 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 the investment tofluctuate. To minimize this risk, we maintain our portfolio of cashequivalents, short and long-term investments in demand accounts, money marketfunds, commercial paper, corporate bonds, U.S. government agency securities andARS which are investment grade securities with a maximum dollar weightedmaturity of two years or less. The risk associated with fluctuating interestrates is limited to our investment portfolio, and we believe that a 10% changein interest rates would not have a significant impact on our interest income.

 

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At June 30, 2009, weheld $6.3 million of investments with an auction reset feature (ARS), whoseunderlying assets are generally student loans which are substantially backed bythe federal government. In February and March of 2008, auctionsfailed for our ARS. An auction failure means that the parties wishing to sellsecurities could not. All of our ARS were rated AAA at the time of purchase,the highest rating, by a rating agency. During the fourth quarter of 2008, weentered into an agreement with one of our investment providers, which currentlyholds all of our ARS and from whom we had purchased the ARS, to sell, at ourdiscretion, at par value the ARS we currently hold back to the investmentprovider at anytime starting in June 2010. We have classified our ARSinvestment as a short-term investment on the condensed unaudited consolidatedbalance sheet because the sale of the ARS back to our investment provider isexpected to occur in June 2010. Refer to Note 5 to our condensed unaudited consolidated financialstatements for additional discussions regarding our ARS and related put option.

 

To date, ourinternational customer agreements have been denominated solely in U.S. dollars,and accordingly, we have not been exposed to foreign currency exchange ratefluctuations from customer agreements, and do not currently engage in foreign currencyhedging transactions. However, the functional currency of our foreignoperations is the U.S. dollar and our local accounts are maintained in thelocal currency, and thus we are subject to foreign currency exchange ratefluctuations associated with remeasurement to U.S. dollars. Such fluctuationshave not been significant historically, and we believe that a 10% change inexchange rates would not have a significant impact on our operating expenses.

 

**Item4. Controls and Procedures**

 

**Evaluationof Disclosure Controls and Procedures**

 

We maintain “disclosurecontrols and procedures,” as such term is defined in Rule 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”),that are designed to ensure that information required to be disclosed by us inreports that we file or submit under the Exchange Act is recorded, processed,summarized, and reported within the time periods specified in Securities andExchange 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 potential future conditions.

 

Based on the 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.

 

**Changesin Internal Control Over Financial Reporting**

 

There was no change inour internal control over financial reporting (as defined in Rule 13a-15(f) and15d-15(f) under the Exchange Act) that occurred during the period coveredby this Quarterly Report on Form 10-Q that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

**Part II.Other Information**

 

**Item1. Legal Proceedings**

 

We are currently not aparty to any material legal proceedings. We may from time to time becomeinvolved in litigation relating to claims arising from our ordinary course ofbusiness. These claims, even if not meritorious, could result in theexpenditure of significant financial and managerial resources.

 

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**Item 1A. Risk Factors**

 

If any of the following risks actually occur, ourbusiness, results of operations and financial condition could suffersignificantly.

 

**Risks Related to Our Business**

 

***Fluctuations in ourrevenue and operating results on a quarterly basis could cause the market priceof 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:

 

·                     unpredictable volume and timing of customer orders,which are not fixed by contract and vary on a purchase order basis;

·                     uncertain demand in the automotive infotainment marketfor our products;

·                     the loss of one or more of our customers, causing asignificant reduction or postponement of orders from these customers;

·                     decreases in the overall average selling prices of ourproducts;

·                     changes in the relative sales mix of our products;

·                     changes in our cost of finished goods;

·                     the availability, pricing and timeliness of deliveryof other components used in our customers’ products;

·                     our customers’ sales outlook, purchasing patterns andinventory adjustments based on demands and general economic conditions;

·                     product obsolescence and our ability to manage producttransitions;

·                     our ability to successfully develop, introduce andsell new or enhanced products in a timely manner;

·                     the timing of new product announcements orintroductions by us or by our competitors; and

·                     fluctuations in 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 incurred a netloss for the three and six months ended June 30, 2009, and may not returnto profitability in the future, which may cause the market price of our commonstock to decline.***

 

We first becameprofitable in the second quarter of 2005. We incurred significant net lossesprior to that quarter and incurred a net loss for the three and six monthsended June 30, 2009. To return to profitability, we will need to generateand sustain substantially higher revenue while maintaining reasonable cost andexpense levels. We currently expect to increase expense levels in each of thenext several quarters to support increased research and development efforts.These expenditures may not result in increased revenue or customer growth.Because many of our expenses are fixed in the short-term, or are incurred inadvance of anticipated sales, we may not be able to decrease our expenses in atimely manner to offset any shortfall of sales. We also believe our futureeffective tax rate will be at or near the current statutory tax rate, which ishigher than our average historical annual effective tax rate which has beenless than 10% of our pre-tax income since our inception. This will harm our futurefinancial results and negatively impact our profitability. We may not be ableto return to profitability on a quarterly or an annual basis. This may, inturn, cause the price of our common stock to decline.

 

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***The demand for ourproducts is affected by general economic conditions, which could impact ourbusiness.***

 

The United States andinternational economies are currently experiencing a period of economicdownturn. The timing of sustained economic recovery, if any, is uncertain. Inaddition, terrorist acts and similar events, turmoil in the Middle East or warin general, could contribute to a slowdown of the market demand for ourproducts. If the economy continues to slow down as a result of the recenteconomic, political and social turmoil, or if there are further terroristattacks in the United States or elsewhere, we may experience decreases in thedemand for our products, which may harm our operating results. Our business hasbeen adversely affected by the current economic downturn. Demand for ourproducts has suffered as consumers delay purchasing decisions or change orreduce their discretionary spending.

 

***Fluctuations in demand for our products may harm ourfinancial results and are difficult to forecast.***

 

Current uncertainty inglobal economic conditions pose a risk to the overall economy as consumers andbusinesses may delay or postpone purchases in response to tighter credit andnegative financial news, which could negatively affect demand for our products.Consequently, demand could be different from our expectations due to manyfactors including:

 

·                     changes in business and economic conditions, includingconditions in the credit market that could affect consumer confidence;

·                     customer acceptance of our products;

·                     changes in customer order patterns including ordercancellations; and

·                     changes in the level of inventory at customers.

 

***If the growth ofdemand for digital video applications for the security surveillance andautomotive infotainment markets does not continue, our ability to increase ourrevenue could suffer.***

 

Our ability to increaseour revenue will depend on increased demand for digital video applications inthe security surveillance and automotive infotainment 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:

 

·                     the pace at which new digital video applications areadopted;

·                     a continued reduction in the costs of products inthese markets;

·                     the availability, at a reasonable price, of componentsrequired by such products, such as LCD panels; and

·                     consumer confidence and the continued increase ofconsumer spending levels.

 

***Our success dependson our ability to develop and introduce new products, which we may not be ableto do in a timely manner, as product development in smaller wafer fabricationgeometries becomes more complex and costly.***

 

The development of new products is highly complex, andwe have experienced some delays in bringing new products to the market in thepast. As our products integrate new, more advanced functions, they become morecomplex and increasingly difficult to design. In addition, in our effort todecrease cost, we intend to design new products in smaller fabricationgeometries, some of which we may have no prior experience of success. In thepast, we have experienced some difficulties in shifting to smaller geometryprocess technologies.

 

Completing these projectsis extremely challenging, time-consuming and expensive, and we can give noassurance that we will succeed or succeed in a timely and cost-effectivemanner. Product development delays may result from unanticipated engineeringcomplexities, changing market or competitive product requirements orspecifications, difficulties in overcoming resource limitations, the inabilityto license third-party technology or other factors. If we are unable to developproducts successfully, in a timely and cost-effective manner, our business,financial condition and results of operations could suffer.

 

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***The average sellingprices of our semiconductor products may be subject to rapid price declines,which could harm our revenue and gross profits.***

 

The semiconductor products we develop and sell may besubject to rapid declines in average selling prices. From time to time, we havehad to reduce our prices significantly to meet customer requirements, and wemay be required to reduce our prices in the future. This would cause our grossmargins to decline which in turn may negatively impact our operating results.Our financial results will suffer if we are unable to offset any reductions inour average selling prices by increasing our sales volumes, reducing our costsor developing new or enhanced products on a timely basis with higher sellingprices or gross margins.

 

***We face intensecompetition and may not be able to compete effectively, which could reduce ourmarket share and decrease our revenue and profitability.***

 

The markets in which weoperate are extremely competitive and are characterized by rapid technologicalchange, continuous evolving customer requirements and declining average sellingprices. We may not be able to compete successfully against current or potentialcompetitors. If we do not compete successfully, our market share and revenuemay decline. We compete with large semiconductor manufacturers and designers,and our current and potential competitors have longer operating histories, significantlygreater resources and name recognition and a larger base of customers than wedo. This may allow them to respond more quickly than we can to new or emergingtechnologies or changes in customer requirements. In addition, thesecompetitors may have greater credibility with our existing and potentialcustomers. Many of our current and potential customers have their owninternally developed semiconductor solutions and may choose not to purchaseproducts from third-party suppliers like us.

 

***We depend on keyand highly skilled personnel to operate our business, and if we are unable toretain our current personnel and hire additional personnel, our ability todevelop and market our products could be harmed.***

 

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 personnelcould delay the development and introduction of, and harm our ability to sell,our products and harm the market’s perception of us. We believe that our futuresuccess is highly dependent on the contributions of Fumihiro Kozato, ourpresident and chief executive officer, and Dr. Feng Kuo, our chief technicalofficer. We do not have long-term employment contracts with these or any otherkey personnel, and their knowledge of our business and industry would beextremely difficult to replace.

 

***If we fail todevelop new products and enhance our existing products in order to react torapid 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.

 

Developing and enhancing these products is uncertainand can be time-consuming, costly and complex. There is a risk that thesedevelopments and enhancements will be late, fail to meet customer or marketspecifications or not be competitive with products from our competitors that offercomparable or superior performance and functionality. Any new products orproduct enhancements may not be accepted in new or existing markets. Ourbusiness will suffer if we fail to develop and introduce new products orproduct enhancements on a cost-effective basis.

 

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***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 the significantcosts associated with qualifying a new supplier and potentially redesigning theproduct to incorporate a different semiconductor. If we fail to achieve aninitial design win in a customer’s qualification process, we may lose theopportunity for significant sales to that customer for a number of its productsand for a lengthy period of time. This may cause us to be unable to recoup ourinvestments in our products, which would harm our business.

 

***If we fail todevelop, in a timely manner, or at all, technologies that address the demandsof a shift from analog video signals to digital video signals our operatingresults could suffer.***

 

Our semiconductors areprincipally designed to decode analog video signals into digital images. On June 12,2009, transmission of broadcast TV signals were no longer permitted in analogand all broadcast signals must be in a digital format. Current forecastsproject that many other electronic products and applications will similarlytransition to digital transmission.  Weare developing mixed signal and digital technologies to decode digital signals.However, transmission of digital video involves a combination of emergingtechnologies. The complexities of these technologies and the variability inimplementations between manufacturers may cause our development ofsemiconductors to be costly and time-consuming. We may never obtain thebenefits of our investment in developing these technologies. The complexitiesof digital broadcast technologies may also cause some of the semiconductors weare developing to ultimately work incorrectly for reasons that may be eitherrelated or unrelated to our products, or not be interoperable with other keyproducts. Delays or difficulties in integrating our semiconductors into digitalbroadcast products or the failure of products incorporating digital video toachieve broad market acceptance could have an adverse effect on our business.

 

***A significantportion of our products are sold into the security surveillance market, and ifsales of our semiconductors into this market decline or do not increase, or ifwe do not increase our sales into the automotive infotainment market, ourbusiness and financial results could suffer.***

 

We sell semiconductorstargeted for the security surveillance and automotive infotainment markets. Forthe three and six months ended June 30, 2009, 69% and 71% of our revenues,respectively, was derived from the sale of our products designed for thesecurity surveillance market. If sales of semiconductors into this market declineor do not increase, or if demand slows in this market generally, our operatingresults would suffer. In addition, we have increased our focus on theautomotive infotainment market and devoted substantial resources to thedevelopment of semiconductors for digital video applications that address thismarket. If we are not successful in selling our semiconductors into thismarket, or if the automotive infotainment industry in general continues toexperience weak demand, we may not recover the costs associated with ourefforts in this area and our operating results could suffer.

 

***Our business issubject to seasonality, which is likely to cause 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 to customerslocated in Asia, primarily to customers located in regions who observe theLunar New Year holiday, also referred to as Chinese New Year. Typically, ourforeign offices and those of our customers are closed for a week or more duringthe extended holiday period. For the three and six months ended June 30,2009, 91% and 89% of our revenues, respectively, was attributable to customerslocated in regions that observe the Lunar New Year holiday. As a result, wetypically experience fluctuations in our first calendar quarter due in part toa slowing of business activity around the period of the Lunar New Year holiday.

 

***We manufacture ourproducts based on our estimates of customer demand, and if our estimates areincorrect our financial results could be negatively 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.

 

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***We do not expect tosustain the growth rate of our recent revenues.***

 

Our revenues increased109% in 2005 from 2004 and 49% in 2006 from 2005. We do not expect to achievesimilar growth rates in future periods. For example, our revenues increased 11%in 2007 from 2006 and 13% in 2008 compared to 2007 and decreased 31% in the sixmonths ended June 30, 2009 compared to six months ended June 30,2008. You should not rely on the results of any prior quarterly or annualperiods as an indication of our future operating performance. If we are unableto maintain adequate revenue growth, our stock price may decline and we may nothave adequate financial resources to execute our business objectives.

 

***We may pursueacquisitions or investments in complementary technologies and businesses, whichcould harm our operating results and may disrupt 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 successfully addressed, disrupt our business operations,increase our operating costs and reduce the value to us of the acquiredcompany. Even if we are successful, we may not be able to integrate theacquired businesses, products or technologies into our existing business andproducts. Furthermore, potential acquisitions and investments, whether or notconsummated, may divert management’s attention and require considerable cashoutlays at the expense of existing operations. In addition, to complete futureacquisitions, we may issue equity securities, incur debt, assume contingentliabilities or have amortization expenses and write-downs of acquired assets,which could adversely affect 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 the availability of taxcredits. In addition, we are subject to the examination of our income taxreturns by the Internal Revenue Service and other tax authorities. The outcomesof these examinations, if they occur, could harm our financial condition.

 

***We may not be ableto manage our future growth effectively, and we may need to incur significantexpenditures to address the additional operational and control requirements ofour growth.***

 

We have experienced aperiod of significant growth and expansion, which has placed, and any futureexpansion will continue to place, a significant strain on management,personnel, systems and financial resources. We have hired additional employeesto support an increase in research and development as well as increase oursales and marketing efforts, which resulted in increasing our headcount from 96employees at the end of 2006 to 165 employees at June 30, 2009. To manageour growth successfully, we believe we must effectively:

 

·                     train, integrate and manage additional qualifiedengineers for research and development activities, sales and marketingpersonnel and financial and information technology personnel;

·                     continue to enhance our customer resource managementand manufacturing management systems;

·                     implement additional and improve existingadministrative, financial and operations systems, procedures and controls,including the requirements of the Sarbanes-Oxley Act of 2002;

·                     expand and upgrade our technological capabilities; and

·                     manage multiple relationships with our customers,distributors, suppliers and other third-parties.

 

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.

 

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***We may experience unforeseen delays,expenses or lower than expected product yields for our semiconductorsmanufactured by our third-party vendors, which could increase our costs andprevent us from recognizing the benefits of new technologies we develop.***

 

Weoccasionally have experienced delays in completing the development andintroduction of new products and product enhancements, and we could experiencedelays in the future that may render our new or enhanced products, whenintroduced, obsolete and unmarketable. In addition, it is often difficult forsemiconductor foundries to achieve satisfactory product yields. Product yieldsdepend on both our product design and the manufacturing process technologyunique to the semiconductor foundry. Since low yields may result from eitherdesign or process difficulties, identifying yield problems can only occur wellinto the production cycle after a product that can be physically analyzed andtested exists. Poor yields from our foundry could cause us to sell our productsat lower gross margins and therefore harm our financial results.

 

***Defects in our products couldincrease our costs, cause customer claims and delay our product shipments.***

 

Although we test our products, they are complex andmay contain defects and errors. In the past, we have encountered defects anderrors in our products. For example, in the past, we were unable to sellcertain products to a customer for whom these products were specificallydesigned as a result of our failure to produce a product that met this customer’sspecifications. We believe this customer secured the product from anothervendor. Delivery of products with defects or reliability, quality orcompatibility 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 subcontractors for themanufacture, assembly and testing of our semiconductors, and the failure of anyof these third-party vendors to deliver products or otherwise perform asrequested could damage our relationships with our customers, decrease our salesand limit our growth.***

 

We do not have our own manufacturing or assemblyfacilities and have very limited in-house testing facilities. Therefore, wemust rely on third-party vendors to manufacture, assemble and test the productswe design. We currently rely on Taiwan Semiconductor Manufacturing Company, orTSMC, to produce the majority of our semiconductors. We rely on AdvancedSemiconductor Engineering, Inc., or ASE, to assemble, package and testmany of our products. If these vendors do not provide us with high-qualityproducts, services and production and test capacity in a timely manner, or ifone or more of these vendors terminates its relationship with us, we may beunable to obtain satisfactory replacements to fulfill customer orders on atimely basis, our relationships with our customers could suffer and our salescould decrease. Other significant risks associated with relying on thesethird-party vendors include:

 

·                     reduced control over product cost, delivery schedules and productquality;

·                     potential price increases;

·                     inability to achieve required production ortest capacity and achieve acceptable yields on a timely basis;

·                     longer delivery times;

·                     increased exposure to potentialmisappropriation of our intellectual property;

·                     shortages of materials that foundries use tomanufacture products;

·                     labor shortages or labor strikes; and

·                     quarantines or closures of manufacturingfacilities due to the outbreak of viruses, such as SARS, the avian flu or anysimilar future outbreaks in Asia.

 

We currently do not have long-term supply contractswith any of our third-party vendors. Therefore, they are not obligated toperform services or supply products to us for any specific period, in anyspecific quantities or at any specific price, except as may be provided in aparticular purchase order. Neither TSMC nor ASE has provided contractualassurances to us that adequate capacity will be available for us to meet futuredemand for our products. These third-party vendors may allocate capacity to theproduction of other companies’ products while reducing deliveries to us onshort notice. In particular, other customers that are larger and betterfinanced than we are or that have long-term agreements with TSMC or ASE maycause either or both of them to reallocate capacity to those customers,decreasing the capacity available to us.

 

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***We plan to retain additional foundries tomanufacture our semiconductors, which could disrupt our current manufacturingprocess and negatively impact our sales volumes and revenue.***

 

Weare a fabless semiconductor company which relies on third-party manufacturersor foundries to manufacture our semiconductors. We are reliant on thesefoundries for the manufacture of our products as well as providing services toassist us in getting our products into production. As a result of thecomplexity in manufacturing our semiconductors, it is difficult to determine ifa new foundry will be able to successfully produce our products. We may not beable to enter into a relationship with a new foundry that produces satisfactoryyields on a cost-effective basis. If we need another foundry because ofincreased demand, or the inability to obtain timely and adequate deliveriesfrom our current provider, we might not be able to cost-effectively and quicklyretain other vendors to satisfy our requirements. Any failure to successfullyintegrate a new foundry could negatively impact our sales volumes and revenue.

 

***Our business depends on customers,suppliers and 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 our revenues attributable to salesto customers in Asia was 96% and 98% for the six months ended June 30,2009 and 2008, respectively. We expect that revenues from customers in Asiawill continue to account for substantially all of our revenues. All our salescurrently are denominated in U.S. dollars. As a result, an increase in thevalue of the U.S. dollar relative to foreign currencies could make our productsless competitive in international markets.

 

Currently,we maintain international sales offices in Asia, and we rely on a network ofthird-party sales representatives to sell our products internationally. We havealso established 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 subcontractorsprimarily located in Taiwan. Accordingly, we are subject to several risks andchallenges, any of which could harm our business and financial results. Theserisks and challenges include:

 

·                     difficulties and costs of staffing and managing internationaloperations across different geographic areas and cultures;

·                     compliance with a wide variety of domesticand foreign laws and regulations, including those relating to the import orexport of semiconductor products;

·                     legal uncertainties regarding taxes, tariffs,quotas, export controls, export licenses and other trade barriers;

·                     foreign currency exchange fluctuationsrelating to our international operating activities;

·                     our ability to receive timely payment andcollect our accounts receivable;

·                     political, legal and economic instability,foreign conflicts and the impact of regional and global infectious illnesses,such as the SARS outbreak or avian flu in the countries in which we and ourcustomers, suppliers, manufacturers and subcontractors are located;

·                     legal uncertainties regarding protection forintellectual property rights in some countries; and

·                     fluctuations in freight rates andtransportation disruptions.

 

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

 

Because our products are based on constantlyevolving technologies, we have experienced a lengthy sales cycle for some ofour semiconductors, particularly those designed for digital video applicationsin the automotive infotainment market. Our sales cycle typically ranges fromsix to 24 months. We may experience a delay between the time we increaseexpenditures for research and development, sales and marketing efforts andinventory to 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.

 

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***We primarily sell our semiconductorsthrough a limited number of distributors, and if our relationships with one ormore of those distributors were to terminate, our operating results may beharmed.***

 

Wemarket and distribute our products primarily through a limited number ofdistributors, most of which are located in Asia. This distribution channel hasbeen characterized by rapid change and consolidations. Distributors haveaccounted for a significant portion of our revenues in the past. Sales to ourdistributors represented 77% and 75% of our revenues for the six months ended June 30,2009 and 2008, respectively.

 

Our operating results and financial condition couldbe significantly disrupted by the loss of one or more of our currentdistributors and sales representatives, volume pricing discounts, ordercancellations, delays in shipment by one of our major distributors or salesrepresentatives or the failure of our distributors or sales representatives tosuccessfully sell our products.

 

***We rely primarily upon copyright and tradesecret laws and contractual restrictions to protect our proprietary rights andif these rights are not sufficiently protected, our ability to compete andgenerate revenue could suffer.***

 

We seek to protect our proprietary design processes,documentation and other written materials primarily under trade secret andcopyright laws. We also typically require employees and consultants with accessto our proprietary information to execute confidentiality agreements. The stepstaken by us to protect our proprietary information may not be adequate toprevent misappropriation of our technology. In addition, our proprietary rightsmay not be adequately protected because:

 

·                     the laws of other countries in which we market our semiconductors, suchas some countries in the Asia/Pacific region, may offer little or no protectionfor our proprietary technologies;

·                     people may not be deterred frommisappropriating our technologies despite the existence of laws or contractsprohibiting these actions; and

·                     policing unauthorized use of our intellectualproperty may be difficult, expensive and time-consuming, and we may be unableto determine the extent of any unauthorized use.

 

Reverse engineering, unauthorized copying or othermisappropriation of our proprietary technologies could enable third-parties tobenefit from our technologies without compensating us for doing so. Forexample, if the foundry that manufactures our semiconductors loses control ofour intellectual property, it would be more difficult for us to take remedialmeasures since it is located in Taiwan, which does not have the same protectionfor intellectual property as is provided in the United States. Any inability toadequately protect our proprietary rights could harm our ability to compete,generate revenue and grow our business.

 

***We may not obtain sufficient patentprotection on the technology embodied in the semiconductors we currentlymanufacture and market, which could harm our competitive position and increaseour expenses.***

 

Although we rely primarily on trade secret laws andcontractual restrictions to protect the technology in the semiconductors wecurrently manufacture and market, our success and ability to compete in thefuture may also depend to a significant degree upon obtaining patent protectionfor our proprietary technology. As of December 31, 2008, we had two issuedpatents in the United States and five patent applications pending in the UnitedStates and two applications pending in foreign jurisdictions. These patents andpatent applications cover aspects of the technology in the semiconductors wecurrently manufacture and market, including a patent for our video decodingarchitecture. Patents that we currently own do not cover all of thesemiconductors that we presently manufacture and market. Our patentapplications may not result in issued patents, and even if they result inissued patents, the patents may not have claims of the scope we seek. In addition,any issued patents may be challenged, invalidated or declared unenforceable.The term of any issued patents would be 20 years from its filing date and ifour applications are pending for a long time period, we may have acorrespondingly shorter term for any patent that may issue. Our issued patentshave expiration dates ranging from September 2, 2019 to March 27,2020. Our present and future patents may provide only limited protection forour technology and may not be sufficient to provide us with 

 

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competitiveadvantages. For example, competitors could be successful in challenging anyissued patents or, alternatively, could develop similar or more advantageoustechnologies on their own or design around our patents. Also, patent protectionin certain foreign countries may not be available or may be limited in scopeand any patents obtained may not be as readily enforceable as in the UnitedStates, making it difficult for us to effectively protect our intellectualproperty from misuse or infringement by anyone in these countries. Our inabilityto obtain and enforce our intellectual property rights in some countries mayharm our business. In addition, given the costs of obtaining patent protection,we may choose not to protect certain innovations that later turn out to beimportant to our business or our competitive position.

 

***Intellectual property litigation, which iscommon in our industry, could be costly, harm our reputation, limit our abilityto sell our products and divert the attention of management and technicalpersonnel.***

 

Our industry is characterized by frequent litigationregarding patent and other intellectual property rights. For example, during2005 and 2006, we were a party to an administrative proceeding in front of theintellectual property tribunal in South Korea in which another partyunsuccessfully 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 claims of infringement, our business would beharmed.

 

Questions of infringement in the digital videoapplications market involve highly technical and subjective analyses.Litigation may be necessary in the future to enforce any patents we may receiveand other intellectual property rights, to protect our trade secrets, todetermine the validity and scope of the proprietary rights of others or todefend against claims of infringement or invalidity, and we may not prevail inany future litigation. Litigation, whether or not determined in our favor orsettled, could be costly, could harm our reputation, could cause our customersto use our competitors’ products and could divert the efforts and attention ofmanagement and technical personnel from normal business operations. Inaddition, adverse determinations in litigation could result in the loss of ourproprietary rights, subject us to significant liabilities, require us to seeklicenses from third-parties or prevent us from licensing our technology orselling our products, any of which could seriously harm our business.

 

***Our headquarters are located in the State of California and ourthird-party manufacturing, assembly and testing vendors have facilities in theState of Washington and in Taiwan, 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 product.***

 

TSMC,which manufactures substantially all of our semiconductors, has facilities inthe State of Washington and in Taiwan. Our assembly and testing vendors’facilities are primarily located in Taiwan. In addition, our headquarters arelocated in Northern California. The risk of an earthquake or extreme weather inthe Pacific Rim region or an earthquake in Northern California or WashingtonState is significant due to the proximity of major earthquake fault lines. In September 1999,a major earthquake in Taiwan affected the facilities of TSMC and ASE, ourprimary assembly vendor, as well as other providers of foundry, packaging andtest services. In March 2002 and June 2003, additional earthquakesoccurred in Taiwan. In 2005, several typhoons also disrupted the operations ofTSMC and ASE. As a result of these natural disasters, these contractorssuffered power outages and disruptions that impaired their production capacity.The occurrence of earthquakes or other natural disasters could result in thedisruption of our foundry or assembly and test capacity. We may not be able toobtain alternate capacity on favorable terms, if at all, which could harm our operatingresults.

 

***Management may apply our cash, cashequivalents and short-term and long-term investments to uses that do notincrease our market value or improve our operating results.***

 

We intend to use our cash, cash equivalents andshort-term and long-term investments for general corporate purposes, includingworking capital and capital expenditures. We may also use a portion of ourcash, cash equivalents and short-term and long-term investments to acquire orinvest in complementary technologies, businesses or other assets. We have notreserved or allocated our cash, cash equivalents and short-term and long-terminvestments for any specific purpose, and we cannot state with certainty howmanagement will use our cash, cash equivalents and short-term and long-terminvestments. Accordingly, management has considerable discretion 

 

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inapplying our cash, cash equivalents and short-term and long-term investmentsand may use our cash, cash equivalents and short-term and long-term investmentsfor purposes that do not result in any increase in our results of operations ormarket value. Until the cash, cash equivalents and short-term and long-terminvestments are used, they may be placed in investments that do not produceincome or lose value.

 

**Risks Related to Our Industry**

 

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

 

The semiconductor industry is highly cyclical andsubject to rapid change and evolving industry standards and, from time to time,has experienced significant downturns. These downturns are characterized bydecreases in product demand, excess customer inventory and accelerated erosionof prices. These factors have caused and could cause substantial fluctuationsin our revenue and in our operating results. Any downturns in the semiconductorindustry may be severe and prolonged, and any failure of this industry to fullyrecover from downturns could harm our business. The semiconductor industry alsoperiodically experiences increased demand and production capacity constraints,which may affect our ability to ship products. Accordingly, our operatingresults have varied and may vary significantly as a result of the generalconditions in the semiconductor industry, which could cause our stock price todecline.

 

***The recent financial crisis couldnegatively affect our business, results of operations and financial condition.***

 

Therecent financial crises affecting the banking system and financial markets andthe going concern threats to investment banks and other financial institutionshave resulted in a tightening in the credit markets, a low level of liquidityin many financial markets and extreme volatility in credit and equity markets.There could be a number of follow on effects from the credit crisis on ourbusiness, including insolvency of key suppliers resulting in product delays,inability of customers to obtain credit to finance purchases of our productsand customer insolvencies.

 

**Risks Related to Our Common Stock**

 

***Our stock price has been volatileand you may not be able to resell shares of our common stock at or above theprice you paid, or at all.***

 

The trading price of our common stock hasexperienced wide fluctuations due to the factors discussed in this risk factorssection and elsewhere in this Quarterly Report on Form 10-Q. For example,in the three months ended June 30, 2009, the closing price of our stockranged from a low of $6.05 on April 7, 2009 to a high of $8.89 on June 26,2009. In addition, the stock market in general has, and The NASDAQ GlobalMarket and technology companies in particular have, experienced extreme priceand volume fluctuations. These trading prices and valuations may not besustainable. These broad market and industry factors may decrease the marketprice of our common stock, regardless of our actual operating performance. Inaddition, in the past, following periods of volatility in the overall marketand the market price of a company’s securities, securities class actionlitigation has often been instituted against companies that experienced suchvolatility. This litigation, if instituted against us, regardless of itsoutcome, could result in substantial costs and a diversion of management’sattention and resources.

 

***If securities or industry analysts do notpublish research or reports about our business, or if they change theirrecommendations regarding our stock adversely, our stock price and tradingvolume could decline.***

 

The trading market for ourcommon 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.

 

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***Our ability to raise capital in the future may be limited and ourfailure to raise capital when needed could prevent us from executing our growthstrategy.***

 

We believe that our existing cash and cashequivalents and short-term and long-term investments will be sufficient to meetour 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:

 

·                     market acceptance of our products;

·                     the need to adapt to changing technologiesand technical requirements;

·                     the existence of opportunities for expansion;and

·                     access to and availability of sufficientmanagement, technical, marketing and financial personnel.

 

If our capital resources are insufficient to satisfyour liquidity requirements, we may seek to sell additional equity securities ordebt securities or obtain debt financing. The sale of additional equitysecurities or convertible debt securities would result in additional dilutionto our stockholders. Additional debt would result in increased expenses andcould result in covenants that would restrict our operations. We have not madearrangements to obtain additional financing and there is no assurance thatfinancing, if required, will be available in amounts or on terms acceptable tous, if at all.

 

***Substantial future sales of ourcommon stock in the public market could cause our stock price to fall.***

 

Additional sales of our common stock in the publicmarket, or the perception that these sales could occur, could cause the marketprice of our common stock to decline. At June 30, 2009, we had 21.5million shares of common stock outstanding. A substantial portion of theseshares of common stock are entitled to rights to cause us to register the saleof those shares under the Securities Act. Registration of these shares underthe Securities Act would result in these shares, other than shares purchased byour affiliates, becoming freely tradable without restriction under theSecurities Act immediately upon the effectiveness of the registration.

 

***Our corporate actions are substantiallycontrolled by officers, directors, principal stockholders and affiliatedentities.***

 

Our directors, executiveofficers and affiliated entities beneficially own a significant percentage ofour outstanding common stock. These stockholders, if they acted together, couldexert substantial control over matters requiring approval by our stockholders,including electing directors and approving mergers or other businesscombination transactions. This concentration of ownership may also discourage,delay or prevent a change in control of our company, which could deprive ourstockholders of an opportunity to receive a premium for their stock as part ofa sale of our company and might reduce our stock price. These actions may betaken even if they are opposed by our other stockholders.

 

***Certain provisions of Delaware law,our corporate charter and bylaws, and our shareholder rights plan containanti-takeover provisions that could delay or discourage takeover attempts thatstockholders may consider favorable.***

 

Provisions in our certificate of incorporation, asamended and restated, may have the effect of delaying or preventing a change ofcontrol or changes in our management. These provisions include the following:

 

·                     the right of the board of directors to elect a director to fill avacancy created by the expansion of the board of directors;

·                     the prohibition of cumulative voting in theelection of directors, which would otherwise allow less than a majority ofstockholders to elect director candidates;

·                     the requirement for advance notice fornominations for election to the board of directors or for proposing mattersthat can be acted upon at a stockholders’ meeting;

·                     the ability of the board of directors toalter our bylaws without obtaining stockholder approval;

·                     the ability of the board of directors toissue, without stockholder approval, up to 10,000,000 shares of preferred stockwith terms set by the board of directors, which rights could be senior to thoseof common stock;

 

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·                     the required approval of holders of at leasttwo-thirds of the shares entitled to vote at an election of directors to adopt,amend or repeal our bylaws or amend or repeal the provisions of our certificateof incorporation regarding the indemnification of directors and officers andthe ability of stockholders to take action;

·                     the required approval of holders of at leasta majority of the shares entitled to vote at an election of directors to removedirectors for cause; and

·                     the elimination of the right of stockholdersto call a special meeting of stockholders and to take action by writtenconsent.

 

In addition, our stockholder rights plan would causesubstantial dilution to any person or group who attempts to acquire asignificant interest in us without advance approval from our board ofdirectors. 

 

While these provisions and our stockholder rightsplan have the effect of encouraging persons seeking to acquire control of ourcompany to negotiate with our board of directors, the provisions could enablethe board of directors to hinder or frustrate a transaction that some, or amajority, of the stockholders might believe to be in their best interests and,in that case, may prevent or discourage attempts to remove and replaceincumbent directors.

 

Because we are incorporated in Delaware, we aregoverned by the provisions of Section 203 of the Delaware GeneralCorporation Law. These provisions may prohibit or restrict large stockholders,in particular those owning 15% or more of our outstanding voting stock, frommerging or combining with us. 

 

These provisions in our certificate of incorporationand bylaws, stockholder rights plan and under Delaware law could discouragepotential takeover attempts and could reduce the price that investors might bewilling to pay for shares of our common stock in the future and result in ourmarket price being lower than it would without these provisions.

 

**Item 2. Unregistered Sales ofEquity Securities and Use of Proceeds**

 

Not applicable

 

**Item 3. Defaults Upon SeniorSecurities**

 

Not applicable

 

**Item 4. Submission of Matters to aVote of Security Holders**

 

The annual meeting of stockholders was held at ourprincipal executive offices in San Jose, California on June 16, 2009. Sixincumbent directors were re-elected to serve until our next annual meeting ofstockholders, or until their successors are duly elected and qualified. Theresults of this election, which no abstention votes were cast, are as follows:

 
| **Names of Director**      | ** ** | **Votes  for********(shares)** | ** ** | **Votes  against********(shares)** | ** ** |
|----------------------------|------------|--------------------------------|------------|------------------------------------|------------|
| Fumihiro  Kozato           |       | 18,968,043                     |       | 82,611                             |       |
| Robert  D. Cochran         |       | 18,896,839                     |       | 153,815                            |       |
| Richard  H. Kimball        |       | 18,100,972                     |       | 949,682                            |       |
| Dr. C.J.  Koomen      |       | 18,945,826                     |       | 104,828                            |       |
| Justine  Lien              |       | 18,945,806                     |       | 104,848                            |       |
| Dr. Phillip  Salsbury |       | 18,945,826                     |       | 104,828                            |       |

 

The results on the proposal to ratify theappointment of Deloitte & Touche LLP as our independent registeredpublic accounting firm for the current fiscal year are as follows:

 
| Votes  for     |   | 19,008,946 |   |
|----------------|--------|------------|--------|
| Votes  against |   | 40,455     |   |
| Abstentions    |   | 1,253      |   |

 

**Item 5. Other Information**

 

Not applicable

 

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**Item 6. Exhibits**

 

a.     Exhibits

 
| **Exhibit********Number** | ** ** | **Description** |
|---------------------------|------------|-----------------|
|                      |       |            |
| 3.1                       |       |            | Certificate  of Designation of Techwell, Inc. classifying and designating the Series A  Participating Preferred Stock, as filed with the Secretary of State of the  State of Delaware on August 4, 2009 (incorporated by reference to Exhibit 3.1  to the Company’s Current Report on Form 8-K which was filed on August 5,  2009). |
| 4.1                       |       |            | Rights  Agreement, dated as of August 4, 2009, between Techwell, Inc. and  Computershare Trust Company, N.A., as Rights Agent (which  includes as Exhibit A the Certificate of Designation of Series A  Participating Stock, as Exhibit B the form of Rights Certificate, and  as Exhibit C the Summary of Rights) (incorporated by reference to  Exhibit 4.1 to the Company’s Registration Statement on Form 8-A relating to  the Series A Participating Preferred Stock Purchase Rights which was filed on  August 5, 2009). |
| 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 contained in Exhibit 32.1 and Exhibit 32.2 isnot deemed “filed” with the SEC and is not to be incorporated by reference intoany filing of the Company under the Securities Act of 1933 or the SecuritiesExchange Act of 1934, whether made before or after the date hereof andirrespective of any general incorporation language contained in such filing,except to the extent that the registrant specifically incorporates it byreference.

 

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**Signatures**

 

Pursuant to the requirements of the SecuritiesExchange Act, as amended, the registrant has duly caused this report to besigned on its behalf by the undersigned thereunto duly authorized.

 

 
|  Date:  August 6, 2009 | /s/ Fumihiro Kozato                                                       |
|----------------------------------|---------------------------------------------------------------------------|
|                             | Fumihiro Kozato                                                           |
|                             | President and Chief Executive Officer                                     |
|                             |                                                                      |
|                             |                                                                      |
|  Date:  August 6, 2009 | /s/ Mark Voll                                                             |
|                             | Mark Voll                                                                 |
| * *                         | Vice President of Finance and Administration and Chief Financial  Officer |

 

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**EXHIBITINDEX**

 
| **Exhibit********Number** | ** ** | **Description** |
|---------------------------|------------|-----------------|
|                      |       |            |
| 3.1                       |       |            | Certificate  of Designation of Techwell, Inc. classifying and designating the Series A  Participating Preferred Stock, as filed with the Secretary of State of the  State of Delaware on August 4, 2009 (incorporated by reference to Exhibit 3.1  to the Company’s Current Report on Form 8-K which was filed on August 5,  2009). |
| 4.1                       |       |            | Rights  Agreement, dated as of August 4, 2009, between Techwell, Inc. and  Computershare Trust Company, N.A., as Rights Agent (which  includes as Exhibit A the Certificate of Designation of Series A  Participating Stock, as Exhibit B the form of Rights Certificate, and  as Exhibit C the Summary of Rights) (incorporated by reference to  Exhibit 4.1 to the Company’s Registration Statement on Form 8-A relating to  the Series A Participating Preferred Stock Purchase Rights which was filed on  August 5, 2009). |
| 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 contained in Exhibit 32.1 and Exhibit 32.2is not deemed “filed” with the SEC and is not to be incorporated by referenceinto any filing of the Company under the Securities Act of 1933 or theSecurities Exchange Act of 1934, whether made before or after the date hereofand irrespective of any general incorporation language contained in suchfiling, except to the extent that the registrant specifically incorporates itby reference.

 

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