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** **

**UNITED STATES**

**SECURITIES AND 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 September 30,2009**

** **

**OR**

 
| **o** | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|------------|----------------------------------------------------------------------------------------------------------|

 

**Forthe Transition PeriodFrom                      To                 **

 

**COMMISSION FILE NUMBER: 000-52014**

** **

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** **

**Techwell, Inc.**

(Exact name ofregistrant as specified in its charter)

 

| **Delaware**                                                      | ** ** | **77-0451738**                        |
|-------------------------------------------------------------------|------------|---------------------------------------|
| (State  or other jurisdiction of

incorporation  or organization) |       | (I.R.S.  Employer Identification No.) |

 

**408 E. Plumeria Drive**

**San Jose, CA  94134**

(Address ofprincipal executive offices, including Zip Code)

 

**(408) 435-3888**

(Registrant’stelephone number, including area code)

 

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

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate website, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files). Yes o No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinition 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                      |   | Smaller Reporting  Company o |
| (Do not check if  smaller reporting company) |   |                              |

 

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

 

As of October 31,2009, 21,659,281 shares of the registrant’s common stock were outstanding.

 

 

 

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**TECHWELL, INC.**

**FORM 10-Q**

**September 30, 2009**

 
| ** **                                                                                                                      | **Page** |
|---------------------------------------------------------------------------------------------------------------------------------|----------|
|                                                                                                                            |     |
| **Part I.  Financial Information**                                                                                         | 3        |
|                                                                                                                            |     |
| **Item 1. Financial Statements**                                                                                                | 3        |
| Condensed Unaudited Consolidated Balance Sheets as of  September 30, 2009 and December 31, 2008                       | 3        |
| Condensed Unaudited Consolidated Statements of  Operations for the three and nine months ended September 30,2009  and 2008 | 4        |
| Condensed Unaudited Consolidated Statements of Cash  Flows for the nine months ended September 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**                                                                                            | 25       |
|                                                                                                                            |     |
| **Part II.  Other Information**                                                                                            | 26       |
|                                                                                                                            |     |
| **Item  1. Legal Proceedings**                                                                                                  | 26       |
|                                                                                                                            |     |
| **Item  1A. Risk Factors**                                                                                                      | 26       |
|                                                                                                                            |     |
| **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**                                                                                                            | 38       |
|                                                                                                                            |     |
| Signatures                                                                                                                      | 39       |

 

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**PART I. Financial Information**

 

**Item 1. Financial Statements**

 

**TECHWELL, INC.**

**CONDENSED UNAUDITED CONSOLIDATEDBALANCE SHEETS**

**(in thousands, except par valueamount)**

 
| ** **                                                                                                                                                                              | ** ** | **September 30,********2009** | ** ** | **December 31,********2008** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|-----------------------------------|------------|
| **ASSETS**                                                                                                                                                                              | ** ** | ** **                         | ** ** | ** **                        | ** ** |
|                                                                                                                                                                                    |       |                               |       |                              |       |
| Current assets:                                                                                                                                                                         |       |                               |       |                              |       |
| Cash and cash equivalents                                                                                                                                                               |       | $                                  | 16,027     |                              | $          | 44,485 |   |
| Short-term investments                                                                                                                                                                  |       | 48,089                             |       | 17,582                            |       |
| Accounts receivable                                                                                                                                                                     |       | 977                                |       | 1,985                             |       |
| Inventory                                                                                                                                                                               |       | 6,706                              |       | 4,780                             |       |
| Deferred income tax assets                                                                                                                                                              |       | 1,322                              |       | 1,353                             |       |
| Prepaid expenses and other current assets                                                                                                                                               |       | 1,972                              |       | 1,200                             |       |
| Total current assets                                                                                                                                                                    |       | 75,093                             |       | 71,385                            |       |
| Property and equipment, net                                                                                                                                                             |       | 1,063                              |       | 1,290                             |       |
| Long-term investments                                                                                                                                                                   |       | 26,053                             |       | 19,350                            |       |
| Deferred income tax assets                                                                                                                                                              |       | 3,873                              |       | 4,031                             |       |
| Other assets                                                                                                                                                                            |       | 243                                |       | 1,308                             |       |
| TOTAL ASSETS                                                                                                                                                                            |       | $                                  | 106,325    |                              | $          | 97,364 |   |
|                                                                                                                                                                                    |       |                               |       |                              |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                          |       |                               |       |                              |       |
|                                                                                                                                                                                    |       |                               |       |                              |       |
| Current liabilities:                                                                                                                                                                    |       |                               |       |                              |       |
| Accounts payable                                                                                                                                                                        |       | $                                  | 4,450      |                              | $          | 2,221 |   |
| Accrued liabilities                                                                                                                                                                     |       | 3,985                              |       | 2,117                             |       |
| Total current liabilities                                                                                                                                                               |       | 8,435                              |       | 4,338                             |       |
|                                                                                                                                                                                    |       |                               |       |                              |       |
| Deferred rent                                                                                                                                                                           |       | 81                                 |       | 122                               |       |
| Total liabilities                                                                                                                                                                       |       | 8,516                              |       | 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; 21,633 shares and 21,347 shares issued and outstanding at  September 30, 2009 and December 31, 2008, respectively |       | 22                                 |       | 21                                |       |
| Additional paid-in capital                                                                                                                                                              |       | 84,985                             |       | 80,240                            |       |
| Deferred stock-based compensation                                                                                                                                                       |       | —                             |       | (19                               | )          |
| Retained earnings                                                                                                                                                                       |       | 12,439                             |       | 12,493                            |       |
| Accumulated other comprehensive income                                                                                                                                                  |       | 363                                |       | 169                               |       |
| Total stockholders’ equity                                                                                                                                                         |       | 97,809                             |       | 92,904                            |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                         |       | $                                  | 106,325    |                              | $          | 97,364 |   |

 

See accompanying notes to condensed unaudited consolidated financialstatements.

 

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**TECHWELL, INC.**

**CONDENSED UNAUDITED CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(in thousands, except per shareamounts)**

 
| ** **                                                              | ** ** | **Three  Months Ended********September 30,** | ** ** | **Nine  Months Ended********September 30,** | ** ** |
|-------------------------------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                              | ** ** | **2009**                                          | ** ** | **2008**                                         | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                    |       |                                              |       |                                             |       |   |   |   |   |
| Revenues                                                                |       | $                                                 | 18,015     |                                             | $          | 18,520 |   | $ | 40,392 |   | $ | 51,133 |   |
| Cost of revenues                                                        |       | 7,035                                             |       | 6,859                                            |       | 15,977 |   | 19,423 |   |
| Gross profit                                                            |       | 10,980                                            |       | 11,661                                           |       | 24,415 |   | 31,710 |   |
| Operating expenses:                                                     |       |                                              |       |                                             |       |   |   |   |   |
| Research and development                                                |       | 5,274                                             |       | 4,442                                            |       | 13,907 |   | 12,199 |   |
| Selling, general and administrative                                     |       | 3,835                                             |       | 3,576                                            |       | 11,090 |   | 11,033 |   |
| Total operating expenses                                                |       | 9,109                                             |       | 8,018                                            |       | 24,997 |   | 23,232 |   |
| Income (loss) from operations                                           |       | 1,871                                             |       | 3,643                                            |       | (582 | ) | 8,478 |   |
| Interest income                                                         |       | 357                                               |       | 507                                              |       | 1,055 |   | 1,802 |   |
| Income before income taxes                                              |       | 2,228                                             |       | 4,150                                            |       | 473 |   | 10,280 |   |
| Income tax provision                                                    |       | 1,169                                             |       | 1,634                                            |       | 527 |   | 4,051 |   |
| Net income (loss)                                                       |       | $                                                 | 1,059      |                                             | $          | 2,516 |   | $ | (54 | ) | $ | 6,229 |   |
|                                                                    |       |                                              |       |                                             |       |   |   |   |   |
| Net income (loss) per share:                                            |       |                                              |       |                                             |       |   |   |   |   |
| Basic                                                                   |       | $                                                 | 0.05       |                                             | $          | 0.12 |   | $ | 0.00 |   | $ | 0.30 |   |
| Diluted                                                                 |       | $                                                 | 0.05       |                                             | $          | 0.11 |   | $ | 0.00 |   | $ | 0.28 |   |
|                                                                    |       |                                              |       |                                             |       |   |   |   |   |
| Weighted average shares used in computing net income  (loss) per share: |       |                                              |       |                                             |       |   |   |   |   |
| Basic                                                                   |       | 21,560                                            |       | 21,169                                           |       | 21,471 |   | 21,054 |   |
| Diluted                                                                 |       | 22,315                                            |       | 22,080                                           |       | 21,471 |   | 22,038 |   |

 

See accompanying notes to condensed unaudited consolidated financialstatements.

 

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**TECHWELL, INC.**

**CONDENSED UNAUDITED CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(in thousands)**

 
| ** **                                                                                | ** ** | **Nine  Months Ended********September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| ** **                                                                                | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| **Cash flows from operating  activities**:                                                |       |                                             |       |   |   |
| Net income (loss)                                                                         |       | $                                                | (54        | ) | $ | 6,229 |   |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                                             |       |   |   |
| Depreciation and amortization                                                             |       | 538                                              |       | 526 |   |
| Stock-based compensation                                                                  |       | 5,429                                            |       | 5,433 |   |
| Tax benefit from employee equity incentive plan                                           |       | 78                                               |       | 211 |   |
| Realized gain on investments                                                              |       | —                                           |       | (18 | ) |
| Put option loss                                                                           |       | 316                                              |       | — |   |
| Gain from trading securities                                                              |       | (316                                             | )          | — |   |
| Changes in assets and liabilities:                                                        |       |                                             |       |   |   |
| Accounts receivable                                                                       |       | 1,008                                            |       | (268 | ) |
| Inventory                                                                                 |       | (1,926                                           | )          | (1,261 | ) |
| Prepaid expenses and other current assets                                                 |       | (772                                             | )          | (310 | ) |
| Other assets                                                                              |       | 749                                              |       | (72 | ) |
| Deferred income tax assets                                                                |       | 189                                              |       | 25 |   |
| Accounts payable                                                                          |       | 2,187                                            |       | 360 |   |
| Accrued liabilities                                                                       |       | 1,854                                            |       | (135 | ) |
| Deferred rent                                                                             |       | (41                                              | )          | (32 | ) |
| Net cash provided by operating activities                                                 |       | 9,239                                            |       | 10,688 |   |
|                                                                                      |       |                                             |       |   |   |
| **Cash flows from investing  activities:**                                                |       |                                             |       |   |   |
| Purchase of property and equipment                                                        |       | (255                                             | )          | (413 | ) |
| Purchase of investments                                                                   |       | (56,619                                          | )          | (46,357 | ) |
| Proceeds from maturities of investments                                                   |       | 19,919                                           |       | 54,149 |   |
| Net cash provided by (used in) investing activities                                       |       | (36,955                                          | )          | 7,379 |   |
|                                                                                      |       |                                             |       |   |   |
| **Cash flows from financing  activities:**                                                |       |                                             |       |   |   |
| Proceeds from exercise of stock options                                                   |       | 95                                               |       | 354 |   |
| Repurchases of common stock upon release of stock  awards                                 |       | (837                                             | )          | (923 | ) |
| Net cash used in financing activities                                                     |       | (742                                             | )          | (569 | ) |
|                                                                                      |       |                                             |       |   |   |
| Net increase (decrease) in cash and cash equivalents                                      |       | (28,458                                          | )          | 17,498 |   |
| Cash and cash equivalents at beginning of period                                          |       | 44,485                                           |       | 27,177 |   |
| Cash and cash equivalents at end of period                                                |       | $                                                | 16,027     |   | $ | 44,675 |   |
|                                                                                      |       |                                             |       |   |   |
| **Supplemental disclosure of non-cash  investing and financing activity:**                |       |                                             |       |   |   |
| Gross issuance of restricted stock awards                                                 |       | $                                                | 3,933      |   | $ | 3,773 |   |
| Accrued equipment purchase costs                                                          |       | 56                                               |       | $ | 19 |   |

 

See accompanying notes to condensed unaudited consolidated financialstatements.

 

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** **

**TECHWELL, INC.**

**NOTES TO CONDENSED UNAUDITEDCONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

***The Company***

 

Techwell, Inc. (“Techwell”or the “Company”) was incorporated in California in 1997 and reincorporated inDelaware in 2006. The Company is a fabless semiconductor company that designs,markets and sells mixed signal integrated circuits for two primary markets:security surveillance and automotive infotainment.

 

The Company’sheadquarters 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.

 

The Company has evaluatedsubsequent events through the date and time the financial statements wereissued on November 6, 2009.

 

***Basis of Presentation***

 

The accompanyingcondensed unaudited consolidated financial statements of the Company have beenprepared without audit in accordance with the rules and regulations of theSecurities and Exchange Commission. The consolidated balance sheet at December 31,2008 has been derived from the audited consolidated financial statements as ofand for the year then ended. Certain information and disclosures normallyincluded in financial statements prepared in accordance with accountingprinciples generally accepted in the United States of America have beencondensed or omitted in accordance with these rules and regulations. Theinformation in this report should be read in conjunction with the Company’sconsolidated financial statements and notes thereto included in its AnnualReport on Form 10-K for the year ended December 31, 2008.

 

In the opinion ofmanagement, the accompanying condensed unaudited consolidated financialstatements reflect all adjustments (consisting only of normal recurringadjustments) necessary to summarize fairly the Company’s financial position,results of operations and cash flows for the interim periods presented. Theoperating results for the three and nine months ended September 30, 2009 arenot necessarily indicative of the results that may be expected for the yearended December 31, 2009 or for any other future period.

 

***Principles of Consolidation***

 

The condensed unauditedconsolidated financial statements include the accounts of the Company and itssubsidiaries. All significant intercompany transactions and balances have beeneliminated in consolidation. The Company reports its financial results on acalendar fiscal year.

 

***Use of Estimates***

 

The preparation ofcondensed unaudited consolidated financial statements in accordance withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities, the disclosure of contingent assets andliabilities at the date of the condensed unaudited consolidated financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from these estimates.

 

***Certain Significant Risks and Uncertainties***

 

The Company operates in adynamic high technology industry and changes in any of the following areascould have a material adverse effect on the Company’s financial position andresults of operations: unpredictable volume and timing of customer orders,which are not fixed by contract; loss of one or more of its customers; decreasein the overall average selling prices of its products; changes in the relativesales mix of its products; changes in its cost of finished goods; the qualityand timely service of third-party vendors that manufacture, assemble and testthe Company’s products; the Company’s customers’ sales outlook, purchasingpatterns and inventory adjustments based on demand and general economicconditions; product obsolescence and the Company’s ability to manage producttransitions; the Company’s ability to successfully develop, introduce and sellnew or enhanced products in a timely manner; and the timing of new productannouncements or introductions by the Company or by its competitors.

 

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**TECHWELL, INC.**

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

 

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

 

Accumulated othercomprehensive income (loss) consists of net unrealized gains (losses) onavailable-for-sale investments. The change in unrealized gains on investmentsfor the three and nine months ended September, 2009 was an increase of $0.1million and $0.2 million, respectively. The change in unrealized losses for thethree and nine months ended September 30, 2008 was an increase of $0.4million and $0.8 million, respectively. Total comprehensive income for thethree and nine months ended September 30, 2009 was $1.1 million and $0.1 million,respectively. Total comprehensive income for the three and nine months ended September 30,2008 was $2.1 million and $5.4 million, respectively.

 

**Note 2—Stock-BasedCompensation**

 

The Company has equityincentive plans under which it may grant stock options, restricted stockawards, stock units and stock appreciation rights to employees, consultants anddirectors. Currently, the Company is granting stock options, restricted stockawards, stock units and stock appreciation rights under its 2006 stockincentive plan (“Plan”) which was adopted by the Board of Directors in November 2005.At September 30, 2009, the total number of shares available for issuanceunder the Plan was 2.4 million.  Stockoptions and awards granted under the Plans have a contractual term of up to tenyears, generally vest over four years at the rate of 25 percent on theone-year anniversary of the vesting commencement date and ratably each monththereafter and are exercisable under conditions determined by the Board of Directorsor committee thereof as permissible under the terms of the Plan. At September 30,2009, 834 shares exercised prior to vesting are subject to repurchase by theCompany.

 

For the three and ninemonths ended September 30, 2009 and 2008, stock-based compensation expenseincludes compensation cost related to estimated fair values of stock optionsand awards granted after January 1, 2006 and stock-based compensationcosts based on intrinsic value related to unvested stock options at January 1,2006.

 

The following tablesummarizes the distribution of stock-based compensation expense (in thousands):

 
| ** **                           | ** ** | **Three  Months Ended********September 30,** | ** ** | **Nine  Months Ended********September 30,** | ** ** |
|--------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                           | ** ** | **2009**                                          | ** ** | **2008**                                         | ** ** | **2009** | ** ** | **2008** | ** ** |
| Cost  of revenues                    |       | $                                                 | 122        |                                             | $          | 122 |   | $ | 361 |   | $ | 366 |   |
| Research  and development            |       | 881                                               |       | 901                                              |       | 2,626 |   | 2,453 |   |
| Selling,  general and administrative |       | 816                                               |       | 825                                              |       | 2,442 |   | 2,614 |   |
| Related  tax-effect                  |       | (888                                              | )          | (616                                             | *)*        | (1,673 | ) | (1,957 | ) |
| Total  costs and expenses            |       | $                                                 | 931        |                                             | $          | 1,232 |   | $ | 3,756 |   | $ | 3,476 |   |

 

Total compensation costattributable to activities capitalized into inventory was not significant inany period presented.

 

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**TECHWELL,INC.**

**NOTESTO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

 

**Note 3—NetIncome (Loss) Per Share**

 

Basic net income (loss)per common share is calculated by dividing net income (loss) by theweighted-average number of common shares outstanding during the reporting periodexcluding shares subject to repurchase. Diluted net income (loss) per commonshare reflects the effects of potentially dilutive securities, which consist ofcommon stock options (calculated using the treasury stock method) andrestricted awards and shares subject to repurchase. A reconciliation of sharesused in the calculation of basic and diluted net income (loss) per share is asfollows (in thousands):

 
| ** **                                                                                                     | ** ** | **Three  Months Ended********September 30,** | ** ** | **Nine  Months Ended********September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                     | ** ** | **2009**                                          | ** ** | **2008**                                         | ** ** | **2009** | ** ** | **2008** | ** ** |
| Weighted  average common shares outstanding                                                                    |       | 21,563                                            |       | 21,181                                           |       | 21,476 |   | 21,071 |   |
| Weighted  average shares subject to repurchase                                                                 |       | (3                                                | )          | (12                                              | )          | (5 | ) | (17 | ) |
| Shares  used to calculate basic net income (loss) per share                                                    |       | 21,560                                            |       | 21,169                                           |       | 21,471 |   | 21,054 |   |
| Effect  of dilutive securities:                                                                                |       |                                              |       |                                             |       |   |   |   |   |
| Common  stock options and restricted awards and unvested common shares subject to  repurchase or cancellations |       | 755                                               |       | 911                                              |       | — |   | 984 |   |
| Shares  used to calculate diluted net income (loss) per share                                                  |       | 22,315                                            |       | 22,080                                           |       | 21,471 |   | 22,038 |   |

 

For the three monthsended September 30, 2009 and 2008, 1.7 million and 1.5 million shares,respectively, associated with stock options and restricted awards outstandingand unvested shares subject to repurchase have been excluded from theweighted-average number of common shares outstanding for the diluted net incomeper share computation as they are anti-dilutive. For the nine months ended September 30,2009 and 2008, 3.0 million and 1.2 million shares, respectively,associated with stock options and restricted awards outstanding and unvestedshares subject to repurchase have been excluded from the weighted-averagenumber of common shares outstanding for the diluted net income (loss) per sharecomputation as they are anti-dilutive.

 

**Note4—Income Taxes**

 

In accounting for incometaxes, the Company is required to estimate its current tax expense togetherwith assessing temporary differences resulting from differing treatments ofitems for tax and accounting purposes. These differences result in deferred taxassets and liabilities. Significant management judgment is required to assessthe likelihood that its deferred tax assets will be recovered from futuretaxable income. As of September 30, 2009, the Company’s total deferred taxassets were principally comprised of research and other credit carryforwards,stock-based compensation and expense accruals.

 

The Company and itssubsidiaries file income tax returns in the U.S. federal jurisdiction, variousstates and foreign jurisdictions.  The Company is currently underexamination by the Internal Revenue Service for the tax years 2007 and 2008.The outcome of the examination is not known, and therefore, the Company isunable to estimate the effect of the audit to the Company’s financial position,results of operations or cash flows.

 

The Company’s effectivetax rate is based on the estimated annual effective tax rate. The effective taxrate was 52% and 39% for the three months ended September 30, 2009 and2008, respectively. The effective tax rate was 112% and 39% for the nine monthsended September 30, 2009 and 2008, respectively. For the nine months endedSeptember 2009, the Company had a significant discrete tax expense relatedto stock-based compensation of approximately $0.5 million that impacted theCompany’s effective tax rate. In the three and nine months ended September 30,2009 and 2008 the effective tax rate differed from the statutory federal incometax rate primarily due to stock-based compensation, research and developmentcredits and state income taxes.

 

**Note 5—FinancialInstruments**

 

The Company’s investmentsconsist of corporate bonds, US government agency securities, commercial paperand auction rate securities (“ARS”). Investments, with the exception of ARSwhich are currently classified as trading, are considered available-for-sale.With the exception of ARS, they are all carried at fair market value based onmarket quotes. The Company’s investment in ARS was intended to provideliquidity via an auction process that resets the applicable interest rate at predeterminedcalendar intervals, allowing investors to either roll over their holdings orgain immediate liquidity by selling such interests at par. During 2008,uncertainties in the credit markets affected all of the Company’s holdings inARS investments and auctions for the Company’s investments in these securitiesfailed to settle on their respective settlement dates. Consequently, theinvestments are not currently liquid and the Company will not be able to accessthese funds until a future auction of these investments is successful or abuyer is found outside of the auction process. All of the ARS investments wereinvestment grade quality and were in compliance with the Company’s investmentpolicy at the time of acquisition.

 

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**TECHWELL,INC.**

**NOTESTO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

 

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, which is asan agreement with an unrelated party, binding on both parties and legallyenforceable, with the following characteristics: a) the agreement specifies allsignificant terms, including the quantity to be exchanged, the fixed price andthe time of transaction and b) the agreement includes a disincentive fornonperformance that is sufficiently large to make performance probable. Theenforceability of the agreement results in a put option and should berecognized as a free standing asset separate from the ARS. The put option doesnot meet the definition of a derivative instrument. Therefore, the Company haselected to measure the put option at fair value, based on authoritativeguidance which permits an entity to elect the fair value option for recognizedfinancial assets. As a result, realized gains and losses will be included inearnings in the period in which they arise.

 

In connection with the acceptanceof the offer, the Company recorded $1.0 million as the fair value of the putoption asset with a corresponding gain to interest income. Additionally, theCompany transferred its ARS from investments classified as available-for-saleto trading. The transfer to trading reflects the Company’s intent to exercisethe put option, whereas, prior to the agreement, the Company’s intent was tohold the ARS until the market recovered. Upon transfer to trading, the Companyrecognized a loss of $1.0 million, included in interest income, for the amountof unrealized loss not previously recognized in earnings. As a result of thistransfer unrealized gains or losses will be included in earnings in futureperiods, and the Company anticipates future changes in fair value of the putoption will approximate the fair value movement of the related ARS. The netimpact of the change in fair value of the ARS and related put option to theCompany’s operating results was nil for the three and nine months ended September 30,2009.

 

As of September 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.

 

Typically the fair valueof ARS investments approximates par value due to the frequent resets throughthe auction process. While the Company continues to earn interest on its ARSinvestments at the maximum contractual rate, these investments are notcurrently trading and therefore do not currently have a readily determinablemarket value. Accordingly, the estimated fair value of ARS no longerapproximates par value.

 

The Company has used adiscounted cash flow model to determine the estimated fair value of itsinvestment in ARS as of September 30, 2009. The assumptions used inpreparing the discounted cash flow model include estimates for interest rates,estimates for discount rates using yields of comparable traded instrumentsadjusted for illiquidity and other risk factors, amount of cash flows andexpected holding periods of the ARS. These inputs reflect the Company’s ownassumptions about the assumptions market participants would use in pricing theARS, including assumptions about risk, developed based on the best informationavailable in the circumstances.

 

The put option is a freestanding asset separate from the ARS, and represents the Company’s contractualright to require its investment provider to purchase the ARS at par at anytimestarting in June 2010. The Company values the put option based on amountof cash flows and expected holding periods of the related ARS, time value ofmoney and the Company’s assessment of the credit worthiness of its investmentprovider.

 

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**TECHWELL,INC.**

**NOTESTO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

 

The following is asummary of the Company’s available-for-sale securities as of September 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              |       | $                   |  9,555  |                  | $          |  —              |       | $                         |  — |                      | $          |  — |   | $ |  9,555 |   |
| Corporate  bonds                 |       | 34,342              |         | 276                   |       | (9                        | )          | —                    |         | 34,609                    |       |
| Municipal  bonds                 |       | 1,500               |         | 7                     |       | —                    |       | —                    |         | 1,507                     |       |
| Treasuries  and federal agencies |       | 28,631              |         | 91                    |       | (2                        | )          | —                    |         | 28,720                    |       |
| Commercial  paper                |       | 2,991               |         | —                |       | —                    |       | —                    |         | 2,991                     |       |
| Total                            |       | $                   |  77,019 |                  | $          |  374                 |       | $                         |  (11    | )                         | $          |  — |   | $ |  77,382 |   |

 

The following is asummary 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 September 30,2009, the unrealized losses on our available-for-sale securities wereinsignificant in relation to our total available-for-sale securities.Substantially all of our unrealized losses on our available-for-saleinvestments can be attributed to fair value fluctuations in an unstable creditenvironment. The Company considers the declines in market value of itsavailable-for-sale securities to be temporary in nature. When evaluating theinvestments for other-than-temporary impairment, the Company reviews factorssuch as the length of time and extent to which fair value has been below costbasis, the financial condition of the issuer and any changes thereto, and theCompany’s intent to sell, or whether it is more likely than not it will berequired to sell, the investment before recovery of the investment’s amortizedcost basis. The Company believes that the unrealized losses are temporary anddo not require an other-than-temporary impairment. During the three and ninemonths ended September 30, 2009 and 2008, the Company did not recognizeany other-than-temporary impairment charges on outstanding available-for-salesecurities.

 

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**TECHWELL,INC.**

**NOTESTO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

 

Effective January 1,2008, the Company adopted the authoritative guidance for fair valuemeasurements and the fair value option for financial assets and financialliabilities. The table below represents the fair value hierarchy of the Company’sfinancial instruments measured at fair value as of September 30, 2009 (inthousands):

** **
| ** **                                 | ** ** | **Total** | ** **   | **Level  1** | ** ** | **Level  2** | ** ** | **Level  3** | ** **   |
|--------------------------------------------|------------|-----------|--------------|--------------|------------|--------------|------------|--------------|--------------|
| Money  market funds                        |       | $         |  9,555  |         | $          |  9,555  |       | $            |  — |   | $ |  — |   |
| Corporate  bonds                           |       | 34,609    |         | 34,609       |       | —       |       | —       |         |
| Municipal  bonds                           |       | 1,507     |         | 1,507        |       |         |       |         |         |
| Treasuries  and federal agencies           |       | 28,720    |         | 28,720       |       | —       |       | —       |         |
| Commercial  paper                          |       | 2,991     |         | 2,991        |       | —       |       | —       |         |
| Put  option                                |       | 785       |         | —       |       | —       |       | 785          |         |
| Auction  rate securities                   |       | 6,315     |         | —       |       | —       |       | 6,315        |         |
| Total                                      |       | $         |  84,482 |         | $          |  77,382 |       | $            |  — |   | $ |  7,100 |   |
| Amount  included in:                       |       |      |         |         |       |         |       |         |         |
| Cash  and cash equivalents                 |       | $         |  9,555  |         | $          |  9,555  |       | $            |  — |   | $ |  — |   |
| Short-term  investments                    |       | 48,089    |         | 41,774       |       | —       |       | 6,315        |         |
| Long-term  investments                     |       | 26,053    |         | 26,053       |       | —       |       | —       |         |
| Prepaid  expenses and other current assets |       | 785       |         | —       |       | —       |       | 785          |         |
| Total                                      |       | $         |  84,482 |         | $          |  77,382 |       | $            |  — |   | $ |  7,100 |   |

 

The following tableprovides a reconciliation of the beginning and ending balances for the assetsmeasured at fair value using significant unobservable inputs (Level 3) (inthousands):

 
| ** **                                      | ** ** | **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                         |       |
| Unrealized  gains (losses) included in earnings |       | 34              |        | (34                           | )          |
| Balances  as of September 30, 2009         |       | $               |  785   |                          | $          |  6,315 |   |

 

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

 
| ** **                                 | ** ** | **September 30,********2009** | ** **  | **December 31,********2008** | ** ** |
|--------------------------------------------|------------|------------------------------------|-------------|-----------------------------------|------------|
| ** **                                 | ** ** | **(in  thousands)**                | ** **  |
| Inventory:                                 |       |                               |        |                              |       |
| Finished  goods                            |       | $                                  |  4,501 |                              | $          |  2,750 |   |
| Work-in-process                            |       | 2,205                              |        | 2,030                             |       |
|                                       |       | $                                  |  6,706 |                              | $          |  4,780 |   |
|                                       |       |                               |        |                              |       |
| Property  and equipment, net:              |       |                               |        |                              |       |
| Equipment                                  |       | $                                  |  2,034 |                              | $          |  1,888 |   |
| Software                                   |       | 820                                |        | 779                               |       |
| Furniture  and fixtures                    |       | 320                                |        | 308                               |       |
| Leasehold  improvements                    |       | 414                                |        | 454                               |       |
|                                       |       | 3,588                              |        | 3,429                             |       |
| Accumulated  depreciation and amortization |       | (2,525                             | )           | (2,139                            | )          |
|                                       |       | $                                  |  1,063 |                              | $          |  1,290 |   |
|                                       |       |                               |        |                              |       |
| Accrued  liabilities:                      |       |                               |        |                              |       |
| Accrued  compensation                      |       | $                                  |  1,150 |                              | $          |  1,168 |   |
| Accrued  inventory purchases               |       | 100                                |        | 104                               |       |
| Customer  advance                          |       | 1,624                              |        | —                            |       |
| Legal  and professional service fees       |       | 170                                |        | 320                               |       |
| Other                                      |       | 941                                |        | 525                               |       |
|                                       |       | $                                  |  3,985 |                              | $          |  2,117 |   |

 

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**TECHWELL,INC.**

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

 

**Note 7—SegmentInformation**

 

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.

 

Thepercentage of total revenues by geographic location is as follows:

** **
| ** **     | ** ** | **Three  Months Ended********September 30,** | ** ** | **Nine  Months Ended********September 30,** | ** ** |
|----------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **     | ** ** | **2009**                                          | ** ** | **2008**                                         | ** ** | **2009** | ** ** | **2008** | ** ** |
| China          |       | 53                                                | %          | 41                                               | %          | 51 | % | 35 | % |
| South Korea    |       | 20                                                |       | 25                                               |       | 22 |   | 28 |   |
| Taiwan         |       | 20                                                |       | 29                                               |       | 18 |   | 31 |   |
| Japan          |       | 5                                                 |       | 3                                                |       | 6 |   | 4 |   |
| United States  |       | 1                                                 |       | 1                                                |       | 1 |   | 1 |   |
| Other          |       | 1                                                 |       | 1                                                |       | 2 |   | 1 |   |
| Total revenues |       | 100                                               | %          | 100                                              | %          | 100 | % | 100 | % |

 

Revenues by product lineare as follows (in thousands):

** **
| ** **              | ** ** | **Three  Months Ended********September 30,** | ** ** | **Nine  Months Ended********September 30,** | ** ** |
|-------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **              | ** ** | **2009**                                          | ** ** | **2008**                                         | ** ** | **2009** | ** ** | **2008** | ** ** |
| Security surveillance   |       | $                                                 | 13,287     |                                             | $          | 14,409 |   | $ | 29,129 |   | $ | 38,873 |   |
| Automotive infotainment |       | 3,172                                             |       | 1,995                                            |       | 7,204 |   | 5,655 |   |
| Consumer                |       | 1,543                                             |       | 2,100                                            |       | 4,034 |   | 6,356 |   |
| Other (1)               |       | 13                                                |       | 16                                               |       | 25 |   | 249 |   |
| Total revenues          |       | $                                                 | 18,015     |                                             | $          | 18,520 |   | $ | 40,392 |   | $ | 51,133 |   |

 

----

(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**          | ** ** |
|--------------|------------|----------------------------|------------|-----------------------|------------|
| ** **   | ** ** | **September 30,**     | ** ** | **December 31,** | ** ** | **Three  Months ended********September 30,** | ** ** | **Nine  Months ended********September 30,** | ** ** |
| **Customer** | ** ** | **2009**                   | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** | **2009** | ** ** | **2008** | ** ** |
| A            |       | *                          | %          | 21                    | %          | 38 | % | 37 | % | 37 | % | 32 | % |
| B            |       | *                          |       | 11                    |       | * |   | * |   | * |   | * |   |
| C            |       | 14                         |       | *                     |       | * |   | * |   | * |   | * |   |
| D            |       | 11                         |       | *                     |       | * |   | * |   | * |   | * |   |
| E            |       | *                          |       | 20                    |       | * |   | * |   | * |   | * |   |
| F            |       | 18                         |       | *                     |       | * |   | 11 |   | * |   | 11 |   |
| G            |       | 13                         |       | *                     |       | * |   | * |   | * |   | * |   |

 

----

* lessthan 10%

 

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**TECHWELL,INC.**

**NOTES TO CONDENSED UNAUDITEDCONSOLIDATED FINANCIAL STATEMENTS — (Continued)**

 

Thefollowing is a summary of long-lived assets by geographic region (inthousands):

** **
| ** **    | ** ** | **September 30,********2009** | ** ** | **December 31,  2008** | ** ** |
|---------------|------------|------------------------------------|------------|-----------------------------|------------|
| United States |       | $                                  | 873        |                        | $          | 1,069 |   |
| China         |       | 63                                 |       | 73                          |       |
| Taiwan        |       | 56                                 |       | 79                          |       |
| Japan         |       | 36                                 |       | 60                          |       |
| South Korea   |       | 35                                 |       | 9                           |       |
| Total         |       | $                                  | 1,063      |                        | $          | 1,290 |   |

 

**Note8—Related Party Transactions**

 

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 $8,000 from this law firmfor legal services in the three months ended September 30, 2009 and 2008,respectively. The Company incurred fees of $7,000 and $21,000 from this lawfirm for legal services in the nine months ended September 30, 2009 and2008, respectively. The amount payable to this law firm was nil and $8,000 at September 30,2009 and December 31, 2008, respectively.

 

**Note9—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 certainindemnification obligations to customers under its contract developmentprojects with respect to any infringement of third-party patents andintellectual property rights by its 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.

 

**Note10—Recent Accounting Pronouncements**

 

In September 2006,the Financial Accounting Standards Board (“FASB”) issued authoritative guidancefor fair value measurements, which defines fair value, establishes a frameworkfor measuring fair value and expands disclosures about assets and liabilitiesmeasured at fair value in the financial statements. In February 2008, theFASB issued authoritative guidance, which allows for the delay of the effectivedate of the authoritative guidance for fair value measurements for one year forall non-financial assets and liabilities, except those that are recognized ordisclosed at fair value in the financial statements on a recurring basis. TheCompany adopted the provisions of the guidance for financial assets andliabilities effective January 1, 2008 and the provisions of the guidancefor non-financial assets and non-financial liabilities effective January 1,2009. The application of the guidance to non-financial assets and non-financialliabilities did not have an impact on the condensed unaudited consolidatedfinancial position, results of operations or cash flows.

 

In December 2007,the FASB revised the authoritative guidance for business combinations, whichestablishes principles and requirements for how an acquirer recognizes andmeasures in its consolidated financial statements the identifiable assetsacquired, the liabilities assumed, contractual contingencies and contingentconsideration at their fair value on the acquisition date, any controllinginterest in the acquiree and the goodwill acquired. The guidance alsoestablishes disclosure requirements to enable the evaluation of the nature andfinancial effects of the business combination. The guidance is effective forfiscal years beginning after December 15, 2008. The Company will apply theprovisions of the guidance to any acquisitions occurring subsequent to January 1,2009.

 

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**TECHWELL,INC.**

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

 

In April 2009,the FASB issued authoritative guidance on accounting for assets acquired andliabilities assumed in a business combination that arise from contingencies,which amends the guidance for the initial recognition and measurement,subsequent measurement and accounting, and disclosures for assets andliabilities arising from contingencies in business combinations. The guidanceeliminates the distinction between contractual and non-contractualcontingencies, including the initial recognition and measurement criteria. Theguidance is effective for contingent assets and contingent liabilities acquiredin business combinations for which the acquisition date is on or after thebeginning of the first annual reporting period beginning on or after December 15,2008. The Company will assess the impact of this guidance at the time of anysuch acquisition.

 

In April 2009,the FASB issued three related authoritative guidance for determining fair valuewhen the volume and level of activity for an asset or liability havesignificantly decreased and identifying transactions that are not orderly,recognition and presentation of other-than-temporary impairments and interimdisclosures about fair value of financial instruments, which are effective forinterim and annual periods ending after June 15, 2009. These authoritativeguidance provides guidance on how to determine the fair value of assets andliabilities in the current economic environment and reemphasizes that theobjective of a fair value measurement remains an exit price, modifies therequirements for recognizing other-than-temporarily impaired debt securitiesand revises the existing impairment model for such securities, by modifying thecurrent intent and ability indicator in determining whether an investment indebt security is other-than-temporarily impaired, and enhances the disclosureof instruments for both interim and annual periods. Effective April 1,2009, the Company adopted the provisions of the guidance. The adoption of thethree guidance did not have an impact on the condensed unaudited consolidatedfinancial position, results of operations or cash flows.

 

**Note11—Subsequent Events**

 

On October 9,2009, the Company acquired substantially all of the assets of a developmentstage company based in China. The purchase price for the acquisition was $4.2million, less assumed liabilities of approximately $0.8 million.. The Companypaid the purchase price in cash and agreed to make restricted stock awards,which will vest over four years, to employees in connection with their newemployment with the Company. The acquired company is focused on developingvideo solutions for the security surveillance market. As part of the purchaseagreement, the Company extended employment offers to approximately 40employees.

 

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

 

*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 nine months ended September 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.

 

Our business hasexperienced significant growth primarily as a result of our ability to developnew products, obtain design wins and convert these design wins into revenues.We generated revenues from the sale of over 25 different products in thequarter ended September 30, 2009.

 

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Wehave three principal semiconductor product lines: security surveillanceproducts, 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 displayprocessors designed for the automotive end market. These new products aredesigned to provide advanced image processing, an integrated programmabletiming controller and 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 since 2004, we do not expect to achieve similar growth ratesin the future. We currently expect to increase our expense levels in the futureto support increased research and development efforts in order to bring newproducts to our primary markets. These expenditures may not result in increasedrevenue or profitability in the future. In addition, our ability to increaseour revenues will depend on increased demand for digital video applications inthe security surveillance and automotive infotainment markets. Although webelieve our two primary markets will experience growth in the next few years,actual growth of these markets is uncertain. In addition, the timing of ordersby and shipments to our customers, as well as general trends in our two primarymarkets, can cause our revenue 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 six to24 months until production begins, depending on the product’s complexity. If wesecure a design win, the system designer is likely to continue to use the sameor enhanced versions of our product across a number of their models, whichtends to extend the life cycles of our products. Conversely, if a competitorsecures the design win, it may be difficult for us to sell into the customer’sapplication for an extended period. Our sales cycle typically ranges from sixto 24 months. Due to the length of our product development and sales cycle, themajority of our revenues for any period is generally weighted toward productsintroduced for sale, meaning products for which we commenced placing orderswith our manufacturing subcontractors, in the prior one or two years. As aresult, our present revenues are not necessarily representative of future salesbecause our future sales are likely to be comprised of a different mix ofproducts, some of which are now in the development 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 nine months ended September 30, 2009,we derived 76% of our revenues from products sold to distributors and 24% 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 75% and 80% of our revenues from our ten largestcustomers for the three months ended September 30, 2009 and 2008,respectively. For the three months ended September 30, 2009, LacewoodInternational Corporation, or Lacewood, a distributor, accounted for 38% of ourrevenues. For the three months ended September 30, 2008, Lacewood and AVTech Corporation, or AV Tech, accounted for 37% and 11% of our revenues,respectively. For the nine months ended September 30, 2009, Lacewoodaccounted for 37% of our revenues. For the nine months ended September 30,2008, Lacewood and AV Tech accounted for 32% and 11% of our revenues,respectively.

 

Wederive substantially all of our revenues from sales to foreign customers,particularly in Asia, which sales accounted for 97% and 98% of our revenues forthe nine months ended September 30, 2009 and 2008, respectively. The tablebelow indicates the percentage of total revenues by geographic location for theperiods indicated:

 
| ** **     | ** ** | **Three  Months Ended********September 30,** | ** ** | **Nine  Months Ended********September 30,** | ** ** |
|----------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **     | ** ** | **2009**                                          | ** ** | **2008**                                         | ** ** | **2009** | ** ** | **2008** | ** ** |
| China          |       | 53                                                | %          | 41                                               | %          | 51 | % | 35 | % |
| South Korea    |       | 20                                                |       | 25                                               |       | 22 |   | 28 |   |
| Taiwan         |       | 20                                                |       | 29                                               |       | 18 |   | 31 |   |
| Japan          |       | 5                                                 |       | 3                                                |       | 6 |   | 4 |   |
| United States  |       | 1                                                 |       | 1                                                |       | 1 |   | 1 |   |
| Other          |       | 1                                                 |       | 1                                                |       | 2 |   | 1 |   |
| Total revenues |       | 100                                               | %          | 100                                              | %          | 100 | % | 100 | % |

 

We received 51% and 35%of our revenues from China in the nine months ended September 30, 2009 and2008, respectively.  The percentageincrease between 2009 and 2008 was primarily due to an increase in revenue fromour security surveillance customers in China who are benefitting from therelative strength in the Chinese domestic economy. We received 18% and 31% ofour revenues from Taiwan in the nine months ended September 30, 2009 and2008, respectively.  The decrease wasprimarily due to a decline in revenues from consumer markets, whose productswere primarily 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 and politicalevents as well as other developments that impact our customers in Asia. All ofour sales currently are denominated in U.S. dollars. Therefore, an increase inthe value of the U.S. dollar relative to foreign currencies could make ourproducts less competitive in international markets. Substantially all of ourcost of revenues and a majority of our operating expenses are also denominatedin U.S. dollars. As a result, we believe that our overall exposure to foreignexchange risk is low.

 

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At September 30,2009, we had two international subsidiaries, one in Japan and one in China. Wealso have two international branches, one in South Korea and one in Taiwan. At September 30,2009, 64 of our 165 employees were located in our international subsidiariesand branch offices. Our China and Japan subsidiaries are involved in bothproduct development and technical marketing support. Our Taiwan and Koreabranches primarily provide technical 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, valuationof investments, income taxes and stock-based compensation. We base ourestimates on historical experience and on various other assumptions that webelieve to be reasonable under the circumstances, the results of which form thebasis for making 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.

 

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*FairValue Measurements. *Effective January 1, 2008, weadopted the authoritative guidance for fair value measurements and the fairvalue option for financial assets and financial liabilities. The guidancedefines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements required under otheraccounting guidance.  The guidanceclarifies that fair value is an exit price, representing the amount that wouldbe received to sell an asset or paid to transfer a liability in an orderlytransaction between market participants and also requires that a fair valuemeasurement reflect the assumptions market participants would use in pricing anasset or liability based on the best information available. Assumptions includethe risks inherent in a particular valuation technique (such as a pricingmodel) and/or the risks inherent in the inputs to the model. These assumptions arevolatile and subject to change as the underlying sources of these assumptionsand market conditions change.  Refer toNote 2 to our consolidated financial statements included in our Annual Reporton Form 10-K for the year ended December 31, 2008 for the fair valuehierarchy, and Note 5 to our condensed unaudited consolidated financialstatements included in this Quarterly Report on Form 10-Q for inputs tovaluation techniques and fair value measurements of financial assets carried atfair value.

 

*InventoryValuation.  * Inventory is valued at the lower of cost or market, computed on afirst-in, first-out basis. We evaluate inventory for excess and obsolescenceand write-down units that are unlikely to be sold based upon a six month demandforecast. This evaluation may take into account matters including expecteddemand, anticipated sales price, product obsolescence and other factors. Ifactual future demand for our products is less than currently forecasted,additional inventory write-downs may be required. Once inventory costs arewritten down, such revised costs are maintained until the product is sold orscrapped. If a unit that has been written down is subsequently sold, the costassociated with the revenue from this unit is reduced to the extent of the write-down,resulting in an increase in gross profit.

 

*Accountingfor Income Taxes.  *In accounting for income taxes, we are required toestimate our current tax expense together with assessing temporary differencesresulting from differing treatments of items for tax and accounting purposes.These differences result in deferred tax assets and liabilities. We must assessthe likelihood that our deferred tax assets will be recovered from futuretaxable income and to the extent we believe that recovery is not likely, wemust establish a valuation allowance. Significant management judgment isrequired to assess the likelihood that our deferred tax assets will berecovered from future taxable income. At September 30, 2009, our totaldeferred tax assets were principally comprised of research and other creditcarryforwards, stock-based compensation and expense accruals.

 

We assess therecoverability of our deferred tax assets. To assess the likelihood that thedeferred tax assets will be recovered from future taxable income, we consideredboth positive evidence that indicates a valuation allowance is not needed andnegative evidence that indicates a valuation allowance is needed. As of September 30,2009, we believe that our predictable strong earnings provide ample evidencethat no valuation allowance is required at this time as it is more likely thannot the deferred tax assets will be realized in the future.

 

Management believes it ismore likely than not that forecasted income, including income that may begenerated as a result of certain tax planning strategies, together with the taxeffects of the deferred tax liabilities, will be sufficient to fully recoverthe remaining deferred tax assets. In the event that we determine all or partof the net deferred tax assets are not realizable in the future, we will makean adjustment to the valuation allowance that would be charged to earnings inthe period such determination is made. In addition, the calculation of taxliabilities involves significant judgment in estimating the impact ofuncertainties. Resolution of these uncertainties in a manner inconsistent withmanagement’s expectations could have a material impact on our financialcondition and operating results.

 

We file income taxreturns in the U.S. federal jurisdiction, various states and foreignjurisdictions. We are currently under examination by the Internal RevenueService for the tax years 2007 and 2008. The outcome of the examination is notknown, and therefore, we are unable to estimate the effect of the audit to ourfinancial position, results of operations or cash flows.

 

*Stock-BasedCompensation.  * For the three and nine months ended September 30, 2009 and 2008,stock-based compensation expense includes compensation costs related toestimated fair values of stock options and awards granted after January 1,2006 and compensation costs related to unvested stock options at January 1,2006 based on the intrinsic values.

 

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For options granted afterJanuary 1, 2006, we use the straight-line method for expense attribution.For options granted prior to January 1, 2006, we use the multiple grantapproach for expense attribution, which results in substantially higher amountsof amortization in earlier years as opposed to the straight-line method, whichresults in equal amortization over the vesting period 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 adjusted for any changes in futureexpectations. We relied exclusively on historical volatility in the expectedvolatility assumption calculation since we do not have any publicly tradedoptions. The risk-free rate is based on the U.S. Treasury yield curve in effectat the time of grant for periods corresponding with the expected term of theoption and the estimated forfeiture rate is based on our historical forfeitureexperience.

 

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

 
| ** **               | ** ** | **Three  Months Ended********September 30,** | ** ** | **Nine  Months Ended********September 30,** | ** ** |
|--------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **               | ** ** | **2009**                                          | ** ** | **2008**                                         | ** ** | **2009** | ** ** | **2008** | ** ** |
| Expected  term (years)   |       | 4.34                                              |       | 4.28                                             |       | 4.34 |   | 4.28 |   |
| Risk-free  interest rate |       | 2.01                                              | %          | 2.79                                             | %          | 1.52 – 2.01 | % | 2.57 – 2.86 | % |
| Expected  volatility     |       | 53.00                                             | %          | 51.00                                            | %          | 53.00 – 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.

 

**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********September 30,** | ** ** | **Nine  Months Ended********September 30,** | ** ** |
|---------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                            | ** ** | **2009**                                          | ** ** | **2008**                                         | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenues                              |       | 100.0                                             | %          | 100.0                                            | %          | 100.0 | % | 100.0 | % |
| Cost  of revenues*                    |       | 39.1                                              |       | 37.0                                             |       | 39.6 |   | 38.0 |   |
| Gross  profit                         |       | 60.9                                              |       | 63.0                                             |       | 60.4 |   | 62.0 |   |
| Operating  expenses:                  |       |                                              |       |                                             |       |   |   |   |   |
| Research  and development*            |       | 29.3                                              |       | 24.0                                             |       | 34.4 |   | 23.9 |   |
| Selling,  general and administrative* |       | 21.3                                              |       | 19.3                                             |       | 27.4 |   | 21.5 |   |
| Total  operating expenses             |       | 50.6                                              |       | 43.3                                             |       | 61.8 |   | 45.4 |   |
| Income  (loss) from operations        |       | 10.3                                              |       | 19.7                                             |       | (1.4 | ) | 16.6 |   |
| Interest  income                      |       | 2.0                                               |       | 2.7                                              |       | 2.6 |   | 3.5 |   |
| Income  before income taxes           |       | 12.3                                              |       | 22.4                                             |       | 1.2 |   | 20.1 |   |
| Income  tax provision                 |       | 6.4                                               |       | 8.8                                              |       | 1.3 |   | 7.9 |   |
| Net  income (loss)                    |       | 5.9                                               | %          | 13.6                                             | %          | (0.1 | )% | 12.2 | % |

 

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* Percentages includestock-based compensation

 

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

 
| ** **                           | ** ** | **Three  Months Ended********September 30,** | ** ** | **Nine  Months Ended********September 30,** | ** ** |
|--------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                           | ** ** | **2009**                                          | ** ** | **2008**                                         | ** ** | **2009** | ** ** | **2008** | ** ** |
| Cost  of revenues                    |       | 0.7                                               | %          | 0.7                                              | %          | 0.9 | % | 0.7 | % |
| Research  and development            |       | 4.9                                               |       | 4.9                                              |       | 6.5 |   | 4.8 |   |
| Selling,  general and administrative |       | 4.5                                               |       | 4.5                                              |       | 6.0 |   | 5.1 |   |

 

Revenues by product line are as follows (inthousands):

 
| ** **               | ** ** | **Three  Months Ended********September 30,** | ** ** | **Nine  Months Ended********September 30,** | ** ** |
|--------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **               | ** ** | **2009**                                          | ** ** | **2008**                                         | ** ** | **2009** | ** ** | **2008** | ** ** |
| Security  surveillance   |       | $                                                 | 13,287     |                                             | $          | 14,409 |   | $ | 29,129 |   | $ | 38,873 |   |
| Automotive  infotainment |       | 3,172                                             |       | 1,995                                            |       | 7,204 |   | 5,655 |   |
| Consumer                 |       | 1,543                                             |       | 2,100                                            |       | 4,034 |   | 6,356 |   |
| Other  (1)               |       | 13                                                |       | 16                                               |       | 25 |   | 249 |   |
| Total  revenues          |       | $                                                 | 18,015     |                                             | $          | 18,520 |   | $ | 40,392 |   | $ | 51,133 |   |

 

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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 September 30, 2009 and 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 $18.0million for the three months ended September 30, 2009 and $18.5 millionfor the three months ended September 30, 2008, a decrease of 3% due to ageneral decrease in demand for our security surveillance and consumer products primarilyas a result of current economic conditions, partially offset by an increase indemand for our automotive infotainment products.  Revenues from our security surveillanceproducts decreased $1.1 million, or 8%, in the three months ended September 30,2009 compared to the three months ended September 30, 2008. Revenues fromof our automotive infotainment products increased $1.2 million, or 59%, in thethree months ended September 30, 2009 compared to the three months ended September 30,2008 due primarily to previously awarded design wins with customersincreasingly moving into volume production. Revenues from consumer productsdecreased $0.6 million, or 27%, in the three months ended September 30,2009 compared to the three months ended September 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 $11.0million and $11.7 million for the three months ended September 30, 2009and 2008, respectively, a decrease of 6%. Gross margin was 61% for the threemonths ended September 30, 2009 decreasing from 63% for the three monthsended September 30, 2008 due to production variances and changes inproduct mix.

 

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 September 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 and headcount to support our developmentefforts.

 

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Research and development expenses were $5.3 million,or 29% of revenues, for the three months ended September 30, 2009 and $4.4million, or 24% of revenues, for the three months ended September 30,2008, an increase of 19%. The increase in research and development expenses wasprimarily attributable to increased tape-out expenses of $0.8 million as aresult of our development of new products and our migration to smaller geometryprocess technologies.

 

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

 

*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, corporategovernance and compliance and financial reporting are also included in selling,general and administrative expenses. We expect selling, general andadministrative expenses to remain relatively constant in absolute dollarsthroughout the rest of fiscal 2009.

 

Selling, general andadministrative expenses were $3.8 million, or 21% of revenues, for the threemonths ended September 30, 2009 and $3.6 million, or 19% of revenues, forthe three months ended September 30, 2008, an increase of 7%. The increasein selling, general and administrative expenses was primarily due to increasedprofessional service expenses of $0.5 million, primarily for legal andaccounting services, partially offset by a decrease in compensation-relatedexpenses of $0.1 million.

 

We incurred stock-basedcompensation expense associated with selling, general and administrativepersonnel of $0.8 million in the three months ended September 30, 2009 and2008.

 

*InterestIncome.*  Interestincome was $0.4 million and $0.5 million for the three months ended September 30,2009 and 2008, respectively, a decrease of 30%. The decrease was primarily dueto lower rates of returns on our cash equivalents and investments partiallyoffset by higher cash equivalents and investment balances.

 

*Provisionfor Income Taxes.*  Ourprovision for income taxes was $1.2 million and $1.6 million for the threemonths ended September 30, 2009 and 2008, respectively. Our effective taxrate was 52% and 39% for the three months ended September 30, 2009 and2008, respectively. The effective tax rate for the three months ended September 30,2009 and 2008 differed from the statutory federal income tax rate primarily dueto stock-based compensation, research and development credits and state incometaxes.

 

**Comparisonsof the Nine Months Ended September 30, 2009 and 2008**

 

*Revenues.*   Revenues were $40.4 millionfor the nine months ended September 30, 2009 and $51.1 million for thenine months ended September 30, 2008, a decrease of 21% 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 $9.7 million, or 25%, in the nine months ended September 30,2009 compared to the nine months ended September 30, 2008. Revenues fromof our automotive infotainment products increased $1.5 million, or 27%, in thenine months ended September 30, 2009 compared to the nine months ended September 30,2008 primarily due to previously awarded design wins with customersincreasingly moving into volume production. Revenues from consumer productsdecreased $2.3 million, or 37%, in the nine months ended September 30,2009 compared to the nine months ended September 30, 2008. Other revenuesdecreased by $0.2 million, or 90%, in the nine months ended September 30,2009 compared with the nine months ended September 30, 2008.

 

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*GrossProfit and Gross Margin*.  Gross profit was $24.4 million and $31.7 million for thenine months ended September 30, 2009 and 2008, respectively, a decrease of23%. Gross margin was 60% for the nine months ended September 30, 2009decreasing from 62% for the nine months ended September 30, 2008 due toproduction variances and changes in product mix.

 

We incurred stock-basedcompensation included in cost of revenues associated with outsourcedmanufacturing support and quality assurance personnel of $0.4 million in thenine months ended September 30, 2009 and 2008.

 

*Researchand Development Expenses.*  Research and development expenses were $13.9 million, or34% of revenues, for the nine months ended September 30, 2009 and $12.2million, or 24% of revenues, for the nine months ended September 30, 2008,an increase of 14%. The increase in research and development expenses wasprimarily attributable to an increase of $1.0 million of tape-out expenses as aresult of our development of new products and our migration to smaller geometryprocess technologies and increased compensation-related expenses of $0.8million, reflecting both increases in stock-based compensation and in headcountto support the development of new products and technologies.

 

We incurred stock-basedcompensation expense associated with research and development personnel of $2.6million and $2.5 million in the nine months ended September 30, 2009 and2008, respectively.

 

*Selling,General and Administrative Expenses.*   Selling, general and administrativeexpenses were $11.1 million, or 27% of revenues, for the nine months ended September 30,2009 and $11.0 million, or 22% of revenues, for the nine months ended September 30,2008, an increase of 1%.

 

We incurred stock-basedcompensation expense associated with selling, general and administrativepersonnel of $2.4 million and $2.6 million in the nine months ended September 30,2009 and 2008, respectively.

 

*InterestIncome.*  Interestincome was $1.1 million and $1.8 million for the nine months ended September 30,2009 and 2008, respectively, a decrease of 41%. The decrease was primarily dueto lower rates of returns on our cash equivalents and investments partiallyoffset by higher cash equivalents and investment balances.

 

*Provisionfor Income Taxes.*  Ourprovision for income taxes was $0.5 million and $4.1 million in the nine monthsended September 30, 2009 and 2008, respectively. Our effective tax ratewas 112% and 39% for the nine months ended September 30, 2009 and 2008,respectively. For the nine months ended September 2009, we had asignificant discrete tax expense related to stock-based compensation ofapproximately $0.5 million that impacted our effective tax rate. The effectivetax rate for the nine months ended September 30, 2009 and 2008 differedfrom the statutory federal income tax rate primarily due to stock-basedcompensation, research and development credits and state income taxes.

 

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

#####  

Since our inception, we have financed our growthprimarily with proceeds from the issuance of preferred stock and common stockand cash flow generated by our operations. Our cash and cash equivalents andshort-term and long-term investments were $90.2 million as of September 30,2009.

 

*Netcash from operating activities*

 

Net cash provided byoperating activities was $9.2 million in the nine months ended September 30,2009. The net cash provided by operating activities in the nine months ended September 30,2009 was primarily due to non-cash charges for stock-based compensation of $5.4million, an increase in accounts payable of $2.2 million due to timing ofpurchases, an increase in accrued liabilities of $1.9 million due to increasesin customer advances and a decrease in accounts receivable of $1.0 million dueto timing of customer collections. These were partially offset by an increasein inventory of $1.9 million due to increased purchases.

 

Net cash provided byoperating activities was $10.7 million in the nine months ended September 30,2008. The net cash provided by our operating activities in the nine monthsended September 30, 2008 was primarily due to our net income of$6.2 million and non-cash charges for stock-based compensation of $5.4million. These were partially offset by an increase in inventory of $1.3million attributable to the growth in our revenue during this period.

 

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*Netcash from investing activities*

 

Net cash used ininvesting activities was $37.0 million in the nine months ended September 30,2009 due to the purchases of our investments of $56.6 million partially offsetby maturities of our investments of $19.9 million.

 

Net cash provided by ourinvesting activities was $7.4 million in the nine months ended September 30,2008 due to the maturities of our investments of $54.1 million partiallyoffset by purchases of short and long-term investments of $46.4 million andcapital expenditures of $0.4 million.

 

*Netcash from financing activities*

 

Net cash used infinancing activities was $0.7 million in the nine months ended September 30,2009 due to repurchases of common stock upon release of restricted stockawards.

 

Net cash used infinancing activities was $0.6 million in the nine months ended September 30,2008 due to repurchases of common stock upon release of restricted stock awardspartially offset by proceeds from the exercise of stock options.

 

At September 30,2009, we held $6.3 million of investments with an auction reset feature, whichare referred 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.

 

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 investment provider is expected to occur in June 2010. We arecontinuing to evaluate the credit quality, classification and valuation of ourARS, but based on our expected operating cash flows, and our other sources ofcash, we do not anticipate the potential near term lack of liquidity on theseinvestments 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-BalanceSheet Arrangements**

 

As of September 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.

 

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**ContractualObligations**

 

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

 
| ** **                | ** ** | **Payments  Due by Period** | ** ** |
|---------------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **Total**                   | ** ** | **Less  than********1 Year** | ** ** | **1-3********Years** | ** ** | **4-5********Years** | ** ** |
| Minimum lease commitments |       | $                           | 1,656      |   | $ | 683 |   | $ | 909 |   | $ | 64 |   |
| Purchase commitments      |       | 2,880                       |       | 2,880 |   | — |   | — |   |
| Total commitments         |       | $                           | 4,536      |   | $ | 3,563 |   | $ | 909 |   | $ | 64 |   |

 

**RecentAccounting Pronouncements**

 

For adescription of recent accounting pronouncements, including the expected datesof adoption and estimated effects, if any, on our condensed unauditedconsolidated financial statements, refer to Note 10 to our condensed unauditedconsolidated financial statements.

 

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

 

Theprimary objectives of our investment activities are to preserve principal,provide liquidity and maximize income without significantly increasing therisk. Some of the securities we invest in are subject to market risk. Thismeans that a change in prevailing interest rates may cause the principal amountof the investment to fluctuate. To minimize this risk, we maintain ourportfolio of cash equivalents, short and long-term investments in demandaccounts, money market funds, commercial paper, corporate bonds, U.S.government agency securities and ARS which are investment grade securities witha maximum dollar weighted maturity of two years or less. The risk associatedwith fluctuating interest rates is limited to our investment portfolio, and webelieve that a 10% change in interest rates would not have a significant impacton our interest income.

 

At September 30,2009, we held $6.3 million of investments with an auction reset feature (ARS),whose underlying assets are generally student loans which are substantiallybacked by the federal government. In February and March of 2008,auctions failed for our ARS. An auction failure means that the parties wishingto sell securities could not. All of our ARS were rated AAA at the time ofpurchase and are still rated AAA as of September 30, 2009, the highestrating, by a rating agency. During the fourth quarter of 2008, we entered intoan agreement with one of our investment providers, which currently holds all ofour ARS and from whom we had purchased the ARS, to sell, at our discretion, atpar value the ARS we currently hold back to the investment provider at anytimestarting in June 2010. We have classified our ARS investment as ashort-term investment on the condensed unaudited consolidated balance sheetbecause the sale of the ARS back to our investment provider is expected tooccur in June 2010.  Refer to Note 5to our condensed unaudited consolidated financial statements for additional discussionsregarding 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 foreigncurrency hedging 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.

 

**Item 4. Controls and Procedures**

 

**Evaluationof Disclosure Controls and Procedures**

 

Wemaintain “disclosure controls 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

 

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forms, and that suchinformation is accumulated and communicated to our management, including ourchief executive officer and chief financial officer, as appropriate, to allowtimely decisions regarding required disclosure. In designing and evaluating ourdisclosure controls and procedures, management recognized that disclosurecontrols and procedures, no matter how well conceived and operated, can provideonly reasonable, 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 disclosure controlsand procedures also is based in part upon certain assumptions about thelikelihood of future events, and there can be no assurance that any design willsucceed in achieving its stated goals under potential future conditions.

 

Basedon the evaluation as of the end of the period covered by this Quarterly Reporton Form 10-Q, our chief executive officer and chief financial officer haveconcluded that, as of such date, our disclosure controls and procedures wereeffective at the reasonable assurance level.

 

**Changesin Internal Control Over Financial Reporting**

 

Therewas no change in our 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 arecurrently not a party to any material legal proceedings. We may from time totime become involved in litigation relating to claims arising from our ordinarycourse of business. These claims, even if not meritorious, could result in theexpenditure of significant financial and managerial resources.

 

**Item1A. Risk Factors**

 

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

 

**RisksRelated to Our Business**

 

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

 

Ourrevenue and operating results are difficult to predict, have in the pastfluctuated, and may in the future fluctuate from quarter to quarter. It ispossible that our operating results in some quarters will be below marketexpectations. This would likely cause the market price of our common stock todecline. Our quarterly operating results are affected by a number of factors,including:

 

·                     unpredictable volume and timing ofcustomer orders, which are not fixed by contract and vary on a purchase orderbasis;

·                     uncertain demand in our two primary end markets forour 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;

 

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·                     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.

 

Webase our planned operating expenses in part on our expectations of futurerevenue, and a significant portion of our expenses is relatively fixed in theshort-term. We have limited historical financial data from which to predictfuture sales for our products. As a result, it is difficult for us to forecastour future revenue and budget our operating expenses accordingly. If revenuefor a particular 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 net loss for the nine months ended September 30,2009, and may not return to profitability in the future, which may cause themarket price of our common stock to decline.***

 

Wefirst became profitable in the second quarter of 2005. We incurred significantnet losses prior to that quarter and incurred a net loss for the nine monthsended September 30, 2009. To return to profitability, we will need togenerate and sustain substantially higher revenue while maintaining reasonablecost and expense levels. We currently expect to increase expense levels in eachof the next several quarters to support increased research and developmentefforts. These expenditures may not result in increased revenue or customergrowth. Because many of our expenses are fixed in the short-term, or areincurred in advance of anticipated sales, we may not be able to decrease ourexpenses in a timely manner to offset any shortfall of sales. We also believeour future effective tax rate will be at or near the current statutory taxrate, which is higher than our average historical annual effective tax rate,which has been less than 10% of our pre-tax income since our inception. Thiswill harm our future financial results and negatively impact our profitability.We may not be able to return to profitability on a quarterly or an annualbasis. This may, in turn, cause the price of our common stock to decline.

 

***The demand for our products is affected by general economicconditions, which could impact our business.***

 

TheUnited States and international economies are currently experiencing a periodof economic downturn. The timing of sustained economic recovery, if any, isuncertain. In addition, terrorist acts and similar events, turmoil in theMiddle East or war in general, could contribute to a slowdown of the marketdemand for our products. If the economy continues to slow down as a result ofthe recent economic, political and social turmoil, or if there are furtherterrorist attacks in the United States or elsewhere, we may experiencedecreases in the demand for our products, which may harm our operating results.Our business has been adversely affected by the current economic downturn.Demand for our products has suffered as customers delay purchasing decisions orchange or reduce their discretionary spending.

 

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

 

Currentuncertainty in global economic conditions pose a risk to the overall economy asconsumers and businesses may delay or postpone purchases in response to tightercredit and negative financial news, which could negatively affect demand forour products. Consequently, demand could be different from our expectations dueto many factors including:

 

·                     changes in business and economicconditions, including conditions in the credit market that could affectconsumer confidence;

·                     customer acceptance of our products;

·                     changes in customer order patterns including ordercancellations; and

·                     changes in the level of inventory at customers.

 

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***If the growth of demand for digital video applications forthe security surveillance and automotive infotainment markets does notcontinue, our ability to increase our revenue could suffer.***

 

Our ability to increaseour revenue will depend on increased demand for digital video applications inthe security surveillance and automotive infotainment markets. For the threeand nine months ended September 30, 2009, 74% and 72% of our revenues,respectively, was derived from the sale of our products designed for thesecurity surveillance market. If our products sold into this market decline ordo 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 products for digital video applications that address thismarket. If we are not successful in selling our products into this market, orif the automotive infotainment industry in general continues to experience weakdemand, we may not recover the costs associated with our efforts in this areaand our operating results could suffer.

 

Thegrowth of our target markets is uncertain and will depend in particular upon:

 

·                     the pace at which new digital videoapplications are adopted;

·                     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 depends on our ability to develop and introducenew products, which we may not be able to do in a timely manner, as productdevelopment in smaller wafer fabrication geometries becomes more complex andcostly.***

 

The development of newproducts is highly complex, and we have experienced some delays in bringing newproducts to the market in the past. As our products integrate new, moreadvanced functions, they become more complex and increasingly difficult todesign. In addition, in our effort to decrease cost, we intend to design newproducts in smaller fabrication geometries, some of which we may have no priorexperience of success. In the past, we have experienced some difficulties in shiftingto smaller geometry process technologies.

 

Completingthese projects is extremely challenging, time-consuming and expensive, and wecan give no assurance that we will succeed or succeed in a timely andcost-effective manner. Product development delays may result from unanticipatedengineering complexities, changing market or competitive product requirementsor specifications, difficulties in overcoming resource limitations, theinability to license third-party technology or other factors. If we are unableto develop products successfully, in a timely and cost-effective manner, ourbusiness, financial condition and results of operations could suffer.

 

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

 

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

 

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

 

Themarkets in which we operate are extremely competitive and are characterized byrapid technological change, continuous evolving customer requirements anddeclining average selling prices. We may not be able to compete successfullyagainst current or potential competitors. If we do not compete successfully,our market share and revenue may decline. We compete with large semiconductormanufacturers and designers, and our current and

 

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potential competitorshave longer operating histories, significantly greater resources and namerecognition and a larger base of customers than we do. This may allow them torespond more quickly than we can to new or emerging technologies or changes incustomer requirements. In addition, these competitors may have greatercredibility with our existing and potential customers. Many of our current andpotential customers have their own internally developed semiconductor solutionsand may choose not to purchase products from third-party suppliers like us.

 

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

 

Webelieve our future success will depend in large part upon our ability toattract and retain highly skilled managerial, engineering and sales andmarketing personnel. The loss of any key employees or the inability to attractor retain qualified personnel could delay the development and introduction of,and harm our ability to sell, our products and harm the market’s perception ofus. We believe that our future success is highly dependent on the contributionsof Fumihiro Kozato, our president and chief executive officer, and Dr. FengKuo, our chief technical officer. We do not have long-term employment contractswith these or any other key personnel, and their knowledge of our business andindustry would be extremely difficult to replace.

 

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

 

Wemust develop new products and enhance our existing products with improvedtechnologies to meet rapidly evolving customer requirements. We need to designproducts for customers who continually require higher performance andfunctionality at lower costs. We must, therefore, continue to cost-effectivelyadd features that enhance performance and functionality to our products. Thedevelopment process for these advancements is lengthy and requires us toaccurately anticipate market trends. Our failure to accurately anticipatemarket trends in a timely manner will harm the market acceptance of ourproducts and the sales of our products.

 

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

 

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

 

Weexpend considerable resources in order to achieve design wins for our products,especially our new products and product enhancements. Once a customer designs asemiconductor into a product, it is likely to continue to use the samesemiconductor or enhanced versions of that semiconductor from the same supplieracross a number of similar and successor products for a lengthy period of timedue to the significant costs associated with qualifying a new supplier andpotentially redesigning the product to incorporate a different semiconductor.If we fail to achieve an initial design win in a customer’s qualificationprocess, we may lose the opportunity for significant sales to that customer fora number of its products and for a lengthy period of time. This may cause us tobe unable to recoup our investments in our products, which would harm ourbusiness.

 

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

 

Oursemiconductors are principally designed to decode analog video signals intodigital images. On June 12, 2009, transmission of broadcast TV signalswere no longer permitted in analog and all broadcast signals must be in adigital format. Current forecasts project that many other electronic productsand applications will similarly transition to digital transmission.  We are developing mixed signal and digitaltechnologies to decode digital signals. However, transmission of digital videoinvolves a combination of emerging technologies. The complexities of thesetechnologies and the variability in implementations between manufacturers maycause our development of semiconductors to be costly and time-consuming. We maynever obtain the benefits of our investment in developing

 

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these technologies. Thecomplexities of digital broadcast technologies may also cause some of thesemiconductors we are developing to ultimately work incorrectly for reasonsthat may be either related or unrelated to our products, or not beinteroperable with other key products. Delays or difficulties in integratingour semiconductors into digital broadcast products or the failure of productsincorporating digital video to achieve broad market acceptance could have anadverse effect on our business.

 

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

 

Ourbusiness is subject to seasonality as a result of our target markets and thelocation of our customers. We sell a significant number of our semiconductorsto customers located in Asia, primarily to customers located in regions whoobserve the Lunar New Year holiday, also referred to as Chinese New Year.Typically, our foreign offices and those of our customers are closed for a weekor more during the extended holiday period. For the three and nine months endedSeptember 30, 2009, 93% and 91% of our revenues, respectively, wasattributable to customers located in regions that observe the Lunar New Yearholiday. As a result, we typically experience fluctuations in our firstcalendar quarter due in part to a slowing of business activity around theperiod of the Lunar New Year holiday.

 

***We manufacture our products based on our estimates ofcustomer demand, and if our estimates are incorrect our financial results couldbe negatively impacted.***

 

Oursales are made on the basis of purchase orders rather than long-term purchasecommitments. In addition, our customers may cancel purchase orders or defer theshipments of our products. We manufacture our products according to ourestimates of customer demand. This process requires us to make multiple demandforecast assumptions, each of which may introduce error into our estimates. Ifwe overestimate customer demand, we may manufacture products that we may not beable to sell. As a result, we would have excess inventory, which would increaseour losses. Conversely, if we underestimate customer demand or if sufficientmanufacturing capacity were unavailable, we would forego revenue opportunities,lose market share and damage our customer relationships.

 

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

 

Ourrevenues increased 109% in 2005 from 2004 and 49% in 2006 from 2005. We do notexpect to achieve similar growth rates in future periods. For example, ourrevenues increased 11% in 2007 from 2006 and 13% in 2008 compared to 2007 anddecreased 21% in the nine months ended September 30, 2009 compared to thenine months ended September 30, 2008. You should not rely on the resultsof any prior quarterly or annual periods as an indication of our futureoperating performance. If we are unable to maintain adequate revenue growth,our stock price may decline and we may not have adequate financial resources toexecute our business objectives.

 

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

 

Wehave pursued and may continue to pursue acquisitions of, or investments in,complementary technologies and businesses. Acquisitions present a number ofpotential risks and challenges that could, if not successfully addressed,disrupt our business operations, increase our operating costs and reduce thevalue to us of the acquired company. Even if we are successful, we may not beable to integrate the acquired businesses, products or technologies into ourexisting business and products. Furthermore, potential acquisitions andinvestments, whether or not consummated, may divert management’s attention andrequire considerable cash outlays at the expense of existing operations. Inaddition, to complete future acquisitions, we may issue equity securities,incur debt, assume contingent liabilities or have amortization expenses andwrite-downs of acquired assets, which could adversely affect our profitability.

 

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

 

Ourfuture effective tax rates will be favorably or unfavorably affected by theabsolute amount and future geographic distribution of our pre-tax income, ourability to take advantage of the available tax planning strategies and theavailability of tax credits. In addition, we are subject to the examination ofour income tax returns by the Internal Revenue Service and other taxauthorities. The outcomes of these examinations, when and if they occur, couldharm our financial condition.

 

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

 

Wehave experienced a period of significant growth and expansion, which hasplaced, and any future expansion will continue to place, a significant strainon management, personnel, systems and financial resources. We have hiredadditional employees to support an increase in research and development as wellas increase our sales and marketing efforts, which resulted in increasing ourheadcount from 96 employees at the end of 2006 to 165 employees at September 30,2009. As a result of a recent acquisition, we added approximately 40 employeesin October 2009. To manage our growth successfully, we believe we musteffectively:

 

·                     train, integrate and manage additionalqualified engineers for research and development activities, sales andmarketing personnel 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.

 

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

 

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

 

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

 

Althoughwe test our products, they are complex and may contain defects and errors. Inthe past, we have encountered defects and errors in our products. For example,in the past, we were unable to sell certain products to a customer for whomthese products were specifically designed as a result of our failure to producea product that met this customer’s specifications. We believe this customersecured the product from another vendor. Delivery of products with defects orreliability, quality or compatibility problems may damage our reputation andour ability to retain existing customers and attract new customers. Inaddition, product defects and errors could result in additional developmentcosts, diversion of technical resources, delayed product shipments, increasedproduct returns and product liability claims against us, which may not be fullycovered by insurance. Any of these could harm our business.

 

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***We rely on a limited number of independent subcontractors forthe manufacture, assembly and testing of our semiconductors, and the failure ofany of 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 donot have our own manufacturing or assembly facilities and have very limitedin-house testing facilities. Therefore, we must rely on third-party vendors tomanufacture, assemble and test the products we design. We currently rely onTaiwan Semiconductor Manufacturing Company, or TSMC, to produce the majority ofour semiconductors. We rely on Advanced Semiconductor Engineering, Inc.,or ASE, to assemble, package and test many of our products. If these vendors donot provide us with high-quality products, services and production and testcapacity in a timely manner, or if one or more of these vendors terminates itsrelationship with us, we may be unable to obtain satisfactory replacements tofulfill customer orders on a timely basis, our relationships with our customerscould suffer and our sales could decrease. Other significant risks associatedwith relying on these third-party vendors include:

 

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

·                     potential price increases;

·                     inability to achieve required production or testcapacity and achieve acceptable yields on a timely basis;

·                     longer delivery times;

·                     increased exposure to potential misappropriation ofour intellectual property;

·                     shortages of materials that foundries use tomanufacture products;

·                     labor shortages or labor strikes; and

·                     quarantines or closures of manufacturing facilitiesdue to the outbreak of viruses, such as SARS, the avian flu or any similarfuture outbreaks in Asia.

 

Wecurrently do not have long-term supply contracts with any of our third-partyvendors. Therefore, they are not obligated to perform services or supplyproducts to us for any specific period, in any specific quantities or at anyspecific price, except as may be provided in a particular purchase order.Neither TSMC nor ASE has provided contractual assurances to us that adequatecapacity will be available for us to meet future demand for our products. Thesethird-party vendors may allocate capacity to the production of other companies’products while reducing deliveries to us on short notice. In particular, othercustomers that are larger and better financed than we are or that havelong-term agreements with TSMC or ASE may cause either or both of them toreallocate capacity to those customers, decreasing the capacity available tous.

 

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

 

We are a fablesssemiconductor company which relies on third-party manufacturers or foundries tomanufacture our semiconductors. We are reliant on these foundries for themanufacture of our products as well as providing services to assist us ingetting our products into production. As a result of the complexity inmanufacturing our semiconductors, it is difficult to determine if a new foundrywill be able to successfully produce our products. We may not be able to enterinto a relationship with a new foundry that produces satisfactory yields on acost-effective basis. If we need another foundry because of increased demand,or the inability to obtain timely and adequate deliveries from our currentprovider, we might not be able to cost-effectively and quickly retain othervendors to satisfy our requirements. Any failure to successfully integrate anew foundry could negatively impact our sales volumes and revenue.

 

***Our business depends on customers, suppliers and operationsin Asia, and as a result we are subject to regulatory, operational, financialand political risks, which could adversely affect our financial results.***

 

Thepercentage of our revenues attributable to sales to customers in Asia was 97%and 98% for the nine months ended September 30, 2009 and 2008,respectively. We expect that revenues from customers in Asia will continue toaccount for substantially all of our revenues. All our sales currently aredenominated in U.S. dollars. As a result, an increase in the value of the U.S.dollar relative to foreign currencies could make our products less competitivein international markets.

 

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Currently, we maintaininternational sales offices in Asia, and we rely on a network of third-partysales representatives to sell our products internationally. We have offices inChina, Japan, Taiwan and South Korea, which serve various aspects of ourbusiness. Moreover, we have in the past relied on, and expect to continue torely on, suppliers, manufacturers and subcontractors primarily located inTaiwan. Accordingly, we are subject to several risks and challenges, any ofwhich could harm our business and financial results. These risks and challengesinclude:

 

·                     difficulties and costs of staffing andmanaging international operations across different geographic areas andcultures;

·                     compliance with a wide variety of domestic and foreignlaws and regulations, including those relating to the import or export of semiconductorproducts;

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

·                     foreign currency exchange fluctuations relating to ourinternational operating activities;

·                     our ability to receive timely payment and collect ouraccounts receivable;

·                     political, legal and economic instability, foreignconflicts and the impact of regional and global infectious illnesses, such asthe SARS outbreak or avian flu in the countries in which we and our customers,suppliers, manufacturers and subcontractors are located;

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

·                     fluctuations in freight rates and transportationdisruptions.

 

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

 

Becauseour products are based on constantly evolving technologies, we have experienceda lengthy sales cycle for some of our semiconductors, particularly thosedesigned for digital video applications in the automotive infotainment market.Our sales cycle typically ranges from six to 24 months. We may experience adelay between the time we increase expenditures for research and development,sales and marketing efforts and inventory to the time we generate revenue, ifany, from these expenditures. In addition, because we do not have long-termcommitments from our customers, we must repeat our sales process on a continualbasis even for current customers looking to purchase a new product. As aresult, our business could be harmed if a customer reduces or delays itsorders, chooses not to release products incorporating our semiconductors orelects not to purchase a new product or product enhancements from us.

 

***We primarily sell our products through a limited number ofdistributors, and if our relationships with one or more of those distributorswere to terminate, our operating results may be harmed.***

 

We market and distributeour products primarily through a limited number of distributors, most of whichare located in Asia. This distribution channel has been characterized by rapidchange and consolidations. Distributors have accounted for a significantportion of our revenues in the past. Sales to our distributors represented 76%and 77% of our revenues for the nine months ended September 30, 2009 and2008, respectively. For the nine months ended September 30, 2009, LacewoodInternational Corporation accounted for 37% of our revenues.

 

Ouroperating results and financial condition could be significantly disrupted bythe loss of one or more of our current distributors and sales representatives,volume pricing discounts, order cancellations, delays in shipment by one of ourmajor distributors or sales representatives or the failure of our distributorsor sales representatives to successfully sell our products.

 

***We rely primarily upon copyright and trade secret laws andcontractual restrictions to protect our proprietary rights and if these rightsare not sufficiently protected, our ability to compete and generate revenuecould suffer.***

 

Weseek to protect our proprietary design processes, documentation and otherwritten materials primarily under trade secret and copyright laws. We alsotypically require employees and consultants with access to our proprietaryinformation to execute confidentiality agreements. The steps taken by us toprotect our proprietary information may not be adequate to preventmisappropriation of our technology. In addition, our proprietary rights may notbe adequately protected because:

 

·                     the laws of other countries in which wemarket our semiconductors, such as some countries in the Asia/Pacific region,may offer little or no protection for our proprietary technologies;

·                     people may not be deterred from misappropriating ourtechnologies despite the existence of laws or contracts prohibiting theseactions; and

·                     policing unauthorized use of our intellectual propertymay be difficult, expensive and time-consuming, and we may be unable todetermine the extent of any unauthorized use.

 

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Reverseengineering, unauthorized copying or other misappropriation of our proprietarytechnologies could enable third-parties to benefit from our technologieswithout compensating us for doing so. For example, if the foundry thatmanufactures our semiconductors loses control of our intellectual property, itwould be more difficult for us to take remedial measures since it is located inTaiwan, which does not have the same protection for intellectual property as isprovided in the United States. Any inability to adequately protect ourproprietary rights could harm our ability to compete, generate revenue and growour business.

 

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

 

Althoughwe rely primarily on trade secret laws and contractual restrictions to protectthe technology in the semiconductors we currently manufacture and market, oursuccess and ability to compete in the future may also depend to a significantdegree upon obtaining patent protection for our proprietary technology. As of December 31,2008, we had two issued patents in the United States and five patentapplications pending in the United States and two applications pending inforeign jurisdictions. These patents and patent applications cover aspects ofthe technology in the semiconductors we currently manufacture and market,including a patent for our video decoding architecture. Patents that wecurrently own do not cover all of the semiconductors that we presentlymanufacture and market. Our patent applications may not result in issuedpatents, and even if they result in issued patents, the patents may not haveclaims of the scope we seek. In addition, any issued patents may be challenged,invalidated or declared unenforceable. The term of any issued patents would be20 years from its filing date and if our applications are pending for a longtime period, we may have a correspondingly shorter term for any patent that mayissue. Our issued patents have expiration dates ranging from September 2,2019 to March 27, 2020. Our present and future patents may provide onlylimited protection for our technology and may not be sufficient to provide uswith competitive advantages. For example, competitors could be successful inchallenging any issued patents or, alternatively, could develop similar or moreadvantageous technologies on their own or design around our patents. Also,patent protection in certain foreign countries may not be available or may belimited in scope and any patents obtained may not be as readily enforceable asin the United States, making it difficult for us to effectively protect ourintellectual property from misuse or infringement by anyone in these countries.Our inability to obtain and enforce our intellectual property rights in somecountries may harm our business. In addition, given the costs of obtainingpatent protection, we may choose not to protect certain innovations that laterturn out to be important to our business or our competitive position.

 

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

 

Ourindustry is characterized by frequent litigation regarding patent and otherintellectual property rights. For example, during 2005 and 2006, we were aparty to an administrative proceeding in front of the intellectual propertytribunal in South Korea in which another party unsuccessfully sought adetermination that our TW2824 and TW2834 products infringed a South Koreanpatent allegedly held by that party. We have certain indemnificationobligations to customers under our contract development projects with respectto any infringement of third-party patents and intellectual property rights byour products. If a lawsuit were to be filed against us in connection withclaims of infringement, our business would be harmed.

 

Questionsof infringement in the digital video applications market involve highlytechnical and subjective analyses. Litigation may be necessary in the future toenforce any patents we may receive and other intellectual property rights, toprotect our trade secrets, to determine the validity and scope of theproprietary rights of others or to defend against claims of infringement orinvalidity, and we may not prevail in any future litigation. Litigation,whether or not determined in our favor or settled, could be costly, could harmour reputation, could cause our customers to use our competitors’ products andcould divert the efforts and attention of management and technical personnelfrom normal business operations. In addition, adverse determinations inlitigation could result in the loss of our proprietary rights, subject us tosignificant liabilities, require us to seek licenses from third-parties orprevent us from licensing our technology or selling our products, any of whichcould seriously harm our business.

 

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***Our headquarters are located in the State of California andour third-party manufacturing, assembly and testing vendors have facilities inthe State of Washington and in 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 manufacturessubstantially all of our semiconductors, has facilities in the State ofWashington and in Taiwan. Our assembly and testing vendors’ facilities areprimarily located in Taiwan. In addition, our headquarters are located inNorthern California. The risk of an earthquake or extreme weather in thePacific Rim region or an earthquake in Northern California or Washington Stateis 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 ouroperating results.

 

***Management may apply our cash, cash equivalents andshort-term and long-term investments to uses that do not increase our marketvalue or improve our operating results.***

 

Weintend to use our cash, cash equivalents and short-term and long-terminvestments for general corporate purposes, including working capital andcapital expenditures. We may also use a portion of our cash, cash equivalentsand short-term and long-term investments to acquire or invest in complementarytechnologies, businesses or other assets. We have not reserved or allocated ourcash, cash equivalents and short-term and long-term investments for anyspecific purpose, and we cannot state with certainty how management will useour cash, cash equivalents and short-term and long-term investments.Accordingly, management has considerable discretion in applying our cash, cashequivalents and short-term and long-term investments and may use our cash, cashequivalents and short-term and long-term investments for purposes that do notresult in any increase in our results of operations or market value. Until thecash, cash equivalents and short-term and long-term investments are used, theymay be placed in investments that do not produce income or lose value.

 

**RisksRelated to Our Industry**

 

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

 

Thesemiconductor industry is highly cyclical and subject to rapid change andevolving industry standards and, from time to time, has experienced significantdownturns. These downturns are characterized by decreases in product demand,excess customer inventory and accelerated erosion of prices. These factors havecaused and could cause substantial fluctuations in our revenue and in ouroperating results. Any downturns in the semiconductor industry may be severeand prolonged, and any failure of this industry to fully recover from downturnscould harm our business. The semiconductor industry also periodicallyexperiences increased demand and production capacity constraints, which mayaffect our ability to ship products. Accordingly, our operating results havevaried and may vary significantly as a result of the general conditions in thesemiconductor industry, which could cause our stock price to decline.

 

***The recent financial crisis could negatively affect ourbusiness, results of operations and financial condition.***

 

The recent financialcrises affecting the banking system and financial markets and the going concernthreats to investment banks and other financial institutions have resulted in atightening in the credit markets, a low level of liquidity in many financialmarkets and extreme volatility in credit and equity markets. There could be anumber of follow on effects from the credit crisis on our business, includinginsolvency of key suppliers resulting in product delays, inability of customersto obtain credit to finance purchases of our products and customerinsolvencies.

 

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**RisksRelated to Our Common Stock**

 

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

 

Thetrading price of our common stock has experienced wide fluctuations due to thefactors discussed in this risk factors section and elsewhere in this QuarterlyReport on Form 10-Q. For example, in the three months ended September 30,2009, the closing price of our stock ranged from a low of $8.03 on July 7,2009 to a high of $11.09 on September 28, 2009. In addition, the stockmarket in general has, and The NASDAQ Global Market and technology companies inparticular have, experienced extreme price and volume fluctuations. Thesetrading prices and valuations may not be sustainable. These broad market andindustry factors may decrease the market price of our common stock, regardlessof our actual operating performance. In addition, in the past, followingperiods of volatility in the overall market and the market price of a company’ssecurities, securities class action litigation has often been institutedagainst companies that experienced such volatility. This litigation, ifinstituted against us, regardless of its outcome, could result in substantialcosts and a diversion of management’s attention and resources.

 

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

 

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

 

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

 

Webelieve that our existing cash and cash equivalents and short-term andlong-term investments will be sufficient to meet our anticipated cash needs forat least the next 12 months. The timing and amount of our working capital andcapital expenditure requirements may vary significantly depending on numerousfactors, including:

 

·                     market acceptance of our products;

·                     the need to adapt to changing technologies andtechnical requirements;

·                     the existence of opportunities for expansion; and

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

 

If ourcapital resources are insufficient to satisfy our liquidity requirements, wemay seek to sell additional equity securities or debt securities or obtain debtfinancing. The sale of additional equity securities or convertible debtsecurities would result in additional dilution to our stockholders. Additionaldebt would result in increased expenses and could result in covenants thatwould restrict our operations. We have not made arrangements to obtainadditional financing and there is no assurance that financing, if required,will be available in amounts or on terms acceptable to us, if at all.

 

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

 

Additionalsales of our common stock in the public market, or the perception that thesesales could occur, could cause the market price of our common stock to decline.At September 30, 2009, we had 21.6 million shares of common stockoutstanding. A substantial portion of these shares of common stock are entitledto rights to cause us to register the sale of those shares under the SecuritiesAct. Registration of these shares under the Securities Act would result inthese shares, other than shares purchased by our affiliates, becoming freelytradable without restriction under the Securities Act immediately upon theeffectiveness of the registration.

 

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

 

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 charterand bylaws and our shareholder rights plan contain anti-takeover provisionsthat could delay or discourage takeover attempts that stockholders may considerfavorable.***

 

Provisionsin our certificate of incorporation, as amended and restated, may have theeffect of delaying or preventing a change of control or changes in ourmanagement. These provisions include the following:

 

·                     the right of the board of directors toelect a director to fill a vacancy created by the expansion of the board ofdirectors;

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

·                     the requirement for advance notice for nominations forelection to the board of directors or for proposing matters that can be actedupon at a stockholders’ meeting;

·                     the ability of the board of directors to alter ourbylaws without obtaining stockholder approval;

·                     the ability of the board of directors to issue,without stockholder approval, up to 10,000,000 shares of preferred stock withterms set by the board of directors, which rights could be senior to those ofcommon stock;

·                     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 least amajority of the shares entitled to vote at an election of directors to removedirectors for cause; and

·                     the elimination of the right of stockholders to call aspecial meeting of stockholders and to take action by written consent.

 

Inaddition, our stockholder rights plan would cause substantial dilution to anyperson or group who attempts to acquire a significant interest in us withoutadvance approval from our board of directors.

 

Whilethese provisions and our stockholder rights plan have the effect of encouragingpersons seeking to acquire control of our company to negotiate with our boardof directors, the provisions could enable the board of directors to hinder orfrustrate a transaction that some, or a majority, of the stockholders mightbelieve to be in their best interests and, in that case, may prevent ordiscourage attempts to remove and replace incumbent directors.

 

Becausewe are incorporated in Delaware, we are governed by the provisions of Section 203of the Delaware General Corporation Law. These provisions may prohibit orrestrict large stockholders, in particular those owning 15% or more of ouroutstanding voting stock, from merging or combining with us.

 

Theseprovisions in our certificate of incorporation and bylaws, stockholder rightsplan and under Delaware law could discourage potential takeover attempts andcould reduce the price that investors might be willing to pay for shares of ourcommon stock in the future and result in our market price being lower than itwould without these provisions.

 

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**Item2. Unregistered Sales of Equity Securities and Use of Proceeds**

 

Not applicable

 

**Item 3. Defaults Upon Senior Securities**

 

Notapplicable

 

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

 

Notapplicable

 

**Item 5. Other Information**

 

Notapplicable

 

**Item6. 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 32.1and Exhibit 32.2 is not deemed “filed” with the SEC and is not to beincorporated by reference into any filing of the Company under the SecuritiesAct of 1933 or the Securities Exchange Act of 1934, whether made before orafter the date hereof and irrespective of any general incorporation languagecontained in such filing, except to the extent that the registrant specificallyincorporates it by reference.

 

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**Signatures**

 

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

 

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

 

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**EXHIBIT INDEX**

 
| **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 32.1and Exhibit 32.2 is not deemed “filed” with the SEC and is not to beincorporated by reference into any filing of the Company under the SecuritiesAct of 1933 or the Securities Exchange Act of 1934, whether made before orafter the date hereof and irrespective of any general incorporation languagecontained in such filing, except to the extent that the registrant specificallyincorporates it by reference.

 

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