**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

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**FORM 10-Q**

| **(Mark one)**                                                                                                                                                                            |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **x**                                                                                                                                                                                     | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                |
| **For the  quarterly period ended June 30, 2007**                                                                                                                                         |
| ** **                                                                                                                                                                                |
| **OR**                                                                                                                                                                                    |
| ** **                                                                                                                                                                                |
| **o**                                                                                                                                                                                     |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                |   | ** ** |
| **For the  transition period from               to             ** |
|                                                                                                                                                                                      |
| **Commission  file number 000-52014**                                                                                                                                                     |

 

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**Techwell, Inc.**

(Exact name of registrant asspecified in its charter)

| **Delaware**                                                     |   | **77-0451738**                           |
|------------------------------------------------------------------|--------|------------------------------------------|
| (State or other  jurisdiction  of Incorporation or organization) |   | (I.R.S. Employer  Identification Number) |
|                                                             |   |                                     |
| **408 E.  Plumeria Drive  San Jose, California, 95134**          |
| (Address of  principal executive office and zip code)            |
|                                                             |   |                                     |
| **(408)  435-3888**                                              |
| (Registrant’s  telephone number, including area code)       |

 

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Indicate by check mark whether the Registrant(1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to filing requirements forthe past 90 days.     YES  x   NO  o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer or a non-accelerated filer (asdefined in Rule 12b-2 of the Exchange Act).

Large Accelerated Filer o      AcceleratedFiler****o     Non-Accelerated Filer** **x

Indicate by check mark whether the registrant is a shellcompany (as defined in Rule 12b-2 of the Exchange Act).

Yes o Nox

As of July 31, 2007, 20,853,028 shares of theRegistrant’s common stock, $0.001 par value, were outstanding.

 

 

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**TECHWELL, INC.**

**INDEX**
|                     | ** ** | ** **                                                                                                  | **Page** |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------|----------|
| PART I —  |       | FINANCIAL  INFORMATION                                                                                      | 3        |
|                |       |                                                                                                        |     |
| Item 1.             |       | Financial  Statements (Unaudited):                                                                          | 3        |
|                |       |                                                                                                        |     |
|                |       | Condensed  Consolidated Balance Sheets at June 30, 2007 and December 31, 2006                               | 3        |
|                |       |                                                                                                        |     |
|                |       | Condensed  Consolidated Statements of Operations for the three and six months ended June  30, 2007 and 2006 | 4        |
|                |       |                                                                                                        |     |
|                |       | Condensed  Consolidated Statements of Cash Flows for the six months ended June 30, 2007  and 2006           | 5        |
|                |       |                                                                                                        |     |
|                |       | Notes to  Condensed Consolidated Financial Statements                                                       | 6        |
|                |       |                                                                                                        |     |
| Item 2.             |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                 | 12       |
|                |       |                                                                                                        |     |
| Item 3.             |       | Quantitative  and Qualitative Disclosures About Market Risk                                                 | 22       |
|                |       |                                                                                                        |     |
| Item 4.             |       | Controls and  Procedures                                                                                    | 22       |
|                |       |                                                                                                        |     |
| PART II — |       | OTHER INFORMATION                                                                                           | 23       |
|                |       |                                                                                                        |     |
| Item 1.             |       | Legal Proceedings                                                                                           | 23       |
|                |       |                                                                                                        |     |
| Item  1A.           |       | Risk  Factors                                                                                               | 23       |
|                |       |                                                                                                        |     |
| Item 2.             |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                | 34       |
|                |       |                                                                                                        |     |
| Item 3.             |       | Defaults  Upon Senior Securities                                                                            | 34       |
|                |       |                                                                                                        |     |
| Item 4.             |       | Submission  Of Matters To A Vote Of Security Holders                                                        | 34       |
|                |       |                                                                                                        |     |
| Item 5.             |       | Other Information                                                                                           | 34       |
|                |       |                                                                                                        |     |
| Item  6.            |       | Exhibits                                                                                                    | 34       |
|                |       |                                                                                                        |     |
|                |       | Signatures                                                                                                  | 36       |

 

2

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**PART I—FINANCIAL INFORMATION**

**Item 1. Financial Statements**

**TECHWELL, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

**(Inthousands, except share and per share amounts)**
| ** **                                                                                                                         | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                         | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| ** **                                                                                                                         | ** ** | ** **        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                         | ** ** | ** **        | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                    |       |              |       |                  |       |
| Cash and cash  equivalents                                                                                                         |       | $                 | 13,177     |                  | $          | 13,201 |   |
| Short-term  investments                                                                                                            |       | 39,095            |       | 36,364                |       |
| Total cash, cash  equivalents and short-term investments                                                                           |       | 52,272            |       | 49,565                |       |
| Accounts  receivable                                                                                                               |       | 2,438             |       | 2,765                 |       |
| Inventory                                                                                                                          |       | 4,791             |       | 4,584                 |       |
| Prepaid expenses  and other current assets                                                                                         |       | 1,976             |       | 1,406                 |       |
| Total current  assets                                                                                                              |       | 61,477            |       | 58,320                |       |
| Property and equipment,  net                                                                                                       |       | 1,003             |       | 625                   |       |
| Long-term investments                                                                                                              |       | 8,634             |       | 4,963                 |       |
| Other assets                                                                                                                       |       | 160               |       | 85                    |       |
| Total assets                                                                                                                       |       | $                 | 71,274     |                  | $          | 63,993 |   |
|                                                                                                                               |       |              |       |                  |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                         |       |              |       |                  |       |
| Current liabilities:                                                                                                               |       |              |       |                  |       |
| Accounts payable                                                                                                                   |       | $                 | 3,341      |                  | $          | 3,503 |   |
| Accrued  liabilities                                                                                                               |       | 2,167             |       | 3,344                 |       |
| Total current  liabilities                                                                                                         |       | 5,508             |       | 6,847                 |       |
| Deferred rent                                                                                                                      |       | 212               |       | —                |       |
| Total  liabilities                                                                                                                 |       | 5,720             |       | 6,847                 |       |
|                                                                                                                               |       |              |       |                  |       |
| Commitments and  contingencies                                                                                                     |       |              |       |                  |       |
|                                                                                                                               |       |              |       |                  |       |
| Stockholders’ equity:                                                                                                         |       |              |       |                  |       |
| Preferred stock,  $0.001 par value; 10,000,000 shares authorized and no shares issued and  outstanding                             |       | —            |       | —                |       |
| Common stock,  $0.001 par value; 250,000,000 shares authorized; 20,811,194 shares and  20,528,468 shares outstanding, respectively |       | 21                |       | 21                    |       |
| Additional  paid-in capital                                                                                                        |       | 70,807            |       | 67,734                |       |
| Deferred  stock-based compensation                                                                                                 |       | (304              | )          | (546                  | )          |
| Accumulated  other comprehensive loss                                                                                              |       | (51               | )          | (39                   | )          |
| Accumulated  deficit                                                                                                               |       | (4,919            | )          | (10,024               | )          |
| Total  stockholders’ equity                                                                                                   |       | 65,554            |       | 57,146                |       |
| Total liabilities and  stockholders’ equity                                                                                   |       | $                 | 71,274     |                  | $          | 63,993 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

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**TECHWELL, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

**(Unaudited)**

**(Inthousands, except per share amounts)**
| ** **                                                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                      | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                      | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                            |       |                             |       |                           |       |   |   |   |   |
| Revenues                                                        |       | $                                | 14,743     |                           | $          | 12,800 |   | $ | 28,260 |   | $ | 22,601 |   |
|                                                            |       |                             |       |                           |       |   |   |   |   |
| Cost of revenues                                                |       | 5,989                            |       | 5,241                          |       | 11,780 |   | 9,738 |   |
|                                                            |       |                             |       |                           |       |   |   |   |   |
| Gross profit                                                    |       | 8,754                            |       | 7,559                          |       | 16,480 |   | 12,863 |   |
|                                                            |       |                             |       |                           |       |   |   |   |   |
| Operating  expenses:                                            |       |                             |       |                           |       |   |   |   |   |
| Research and development                                        |       | 2,870                            |       | 2,461                          |       | 5,085 |   | 4,951 |   |
| Selling, general and administrative                             |       | 2,874                            |       | 1,884                          |       | 5,632 |   | 3,702 |   |
| Total operating expenses                                        |       | 5,744                            |       | 4,345                          |       | 10,717 |   | 8,653 |   |
|                                                            |       |                             |       |                           |       |   |   |   |   |
| Income from  operations                                         |       | 3,010                            |       | 3,214                          |       | 5,763 |   | 4,210 |   |
| Interest income                                                 |       | 737                              |       | 252                            |       | 1,416 |   | 407 |   |
|                                                            |       |                             |       |                           |       |   |   |   |   |
| Income before  income taxes                                     |       | 3,747                            |       | 3,466                          |       | 7,179 |   | 4,617 |   |
| Income taxes                                                    |       | 1,106                            |       | 588                            |       | 2,074 |   | 754 |   |
|                                                            |       |                             |       |                           |       |   |   |   |   |
| Net income                                                      |       | $                                | 2,641      |                           | $          | 2,878 |   | $ | 5,105 |   | $ | 3,863 |   |
|                                                            |       |                             |       |                           |       |   |   |   |   |
| Basic net income  per share                                     |       | $                                | 0.13       |                           | $          | 0.52 |   | $ | 0.25 |   | $ | 0.77 |   |
| Diluted net  income per share                                   |       | $                                | 0.12       |                           | $          | 0.15 |   | $ | 0.23 |   | $ | 0.20 |   |
|                                                            |       |                             |       |                           |       |   |   |   |   |
| Weighed average  shares used in computing net income per share: |       |                             |       |                           |       |   |   |   |   |
| Basic                                                           |       | 20,765                           |       | 5,521                          |       | 20,701 |   | 4,995 |   |
| Diluted                                                         |       | 21,826                           |       | 19,163                         |       | 21,810 |   | 19,022 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

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**TECHWELL, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

**(In thousands)**
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                         | ** ** | **June 30,**              | ** ** |
| ** **                                                                         | ** ** | **2007**                       | ** ** | **2006** | ** ** |
| **Cash  flows from operating activities:**                                         | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                              | 5,105      |   | $ | 3,863 |   |
|                                                                               |       |                           |       |   |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                           |       |   |   |
| Depreciation and amortization                                                      |       | 185                            |       | 143 |   |
| Stock-based compensation                                                           |       | 1,928                          |       | 1,237 |   |
| Tax benefit from employee equity incentive plan                                    |       | 872                            |       | — |   |
| Changes in assets and liabilities:                                                 |       |                           |       |   |   |
| Accounts receivable                                                                |       | 327                            |       | 550 |   |
| Inventory                                                                          |       | (207                           | )          | 86 |   |
| Prepaid expenses and other current assets                                          |       | (347                           | )          | 56 |   |
| Other assets                                                                       |       | (75                            | )          | (12 | ) |
| Accounts payable                                                                   |       | (277                           | )          | 1,053 |   |
| Accrued liabilities                                                                |       | (1,182                         | )          | 1,172 |   |
| Deferred rent                                                                      |       | (11                            | )          | (27 | ) |
| Net cash provided by operating activities                                          |       | 6,318                          |       | 8,121 |   |
| **Cash  flows from investing activities:**                                         | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Purchase of property and equipment                                                 |       | (443                           | )          | (205 | ) |
| Purchase of investments                                                            |       | (42,872                        | )          | (19,265 | ) |
| Proceeds from maturities of investments                                            |       | 36,458                         |       | 2,306 |   |
| Net cash used in investing activities                                              |       | (6,857                         | )          | (17,164 | ) |
| **Cash  flows from financing activities:**                                         | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Proceeds from initial public offering of common  stock, net of offering costs      |       | —                         |       | 19,274 |   |
| Proceeds from exercise of stock options                                            |       | 515                            |       | 250 |   |
| Net cash provided by financing activities                                          |       | 515                            |       | 19,524 |   |
| Net increase  (decrease) in cash and cash equivalents                              |       | (24                            | )          | 10,481 |   |
| Cash and cash  equivalents at beginning of period                                  |       | 13,201                         |       | 15,982 |   |
| Cash and cash  equivalents at end of period                                        |       | $                              | 13,177     |   | $ | 26,463 |   |
| ** **                                                                         | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Supplemental  cash flow information—income taxes paid**                     |       | $                              | 1,430      |   | $ | 245 |   |
| ** **                                                                         | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Supplemental  disclosure of noncash investing and financing activities:**        | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Accrued offering costs                                                             |       | $                              | —     |   | $ | 943 |   |
| Accrued  equipment purchase costs                                                  |       | $                              | 120        |   | $ | 19 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

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**TECHWELL, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

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

***The Company***

Techwell, Inc.(“Techwell” or the “Company”) was incorporated in California on March 7, 1997and reincorporated in Delaware on March 30, 2006.  Techwell is a fabless semiconductor companythat designs, markets and sells mixed signal integrated circuits for multiplevideo applications in the consumer, security surveillance and automotivemarkets.

TheCompany’s international offices include branch offices in South Korea andTaiwan and subsidiaries in China and Japan. These offices provide marketing support to customers. The South Koreaand Japan offices are also involved in product development activities.

***Basis of Presentation***

The accompanying condensed consolidated financialstatements of the Company have been prepared without audit in accordance withthe rules and regulations of the Securities and Exchange Commission.  The balance sheet at December 31, 2006 has been derived from theaudited financial statements as of and for the year then ended.  Certain information and disclosuresnormally included in financial statements prepared in accordance withaccounting principles generally accepted in the United States of America havebeen condensed or omitted in accordance with these rules and regulations.The information 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, 2006.

In the opinion of management, the accompanyingunaudited condensed consolidated financial statements reflect all adjustments(consisting only of normal recurring adjustments) necessary to summarize fairlythe Company’s financial position, results of operations and cash flows for theinterim periods presented. The operating results for the three and six monthsended June 30, 2007 are not necessarily indicative of the results that may beexpected for the year ending December 31, 2007 or for any other futureperiod.

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

The condensed consolidated financial statementsinclude the accounts of the Company and its subsidiaries. All significantintercompany balances and transactions have been eliminated in consolidation.The Company reports its financial results on a calendar fiscal year.

***Use of Estimates***

Thepreparation of financial statements in accordance with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from these estimates.

***Certain Significant Risks andUncertainties***

The Company operates in a dynamic high technologyindustry and changes in any of the following areas could have a materialadverse effect on the Company’s financial position and results of operations:unpredictable volume and timing of customer orders, which are not fixed bycontract; loss of one or more of its customers; decrease in the overall averageselling prices of its products; changes in the relative sales mix of itsproducts; changes in its cost of finished goods; the availability, pricing andtimeliness of delivery of other components used in the Company’s customers’products; the Company’s customers’ sales outlook, purchasing patterns andinventory adjustments based on consumer demand and general economic conditions;product obsolescence and the Company’s ability to manage product transitions;the Company’s ability to successfully develop, introduce and sell new orenhanced products in a timely manner; and the timing of new productannouncements or introductions by the Company or by its competitors.

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

The Company has equity incentive plans (“Plans”) underwhich it may grant stock options, restricted stock awards, stock units andstock appreciation rights to employees, consultants and directors.  At June 30, 2007, the total number of sharesavailable for issuance under the Plans is 1,544,428.  Stock options granted under the Plans mayhave a contractual term up to ten years, generally vest over four years at therate of 25 percent on the one-year anniversary of the vesting commencementdate and ratably each month thereafter and are exercisable under conditionsdetermined by the Board as permissible under the terms of the Plans. At June30, 2007, 40,834 shares exercised prior to vesting are subject to repurchase bythe Company.

Effective January 1, 2006, the Company adoptedStatement of Financial Accounting Standards No. 123 (revised 2004), *Share-Based Payment*, (“SFAS No. 123(R)”)which requires the measurement and recognition of compensation expense for allshare-based payment awards made to employees and directors, including employeestock options, based on estimated fair values recognized over the requisiteservice period. Prior to adoption of SFAS No. 123(R), the Company accounted forstock-based compensation awards issued to its employees using theintrinsic value measurement provisions of Accounting Principles Board OpinionNo. 25 (“APB Opinion No. 25”), *Accountingfor Stock Issued to Employees*.

The Company adopted SFAS No. 123(R) using theprospective transition method. Under this method, SFAS No. 123(R) is applied tonew awards and to awards modified, repurchased or cancelled after the adoptiondate of January 1, 2006.  Compensationcost previously recorded under APB Opinion No. 25 for awards outstanding at theadoption date, such as unvested options, continues to be recognized as theoptions vest.  Accordingly, for the threeand six months ended June 30, 2007 and 2006, stock-based compensation expenseincludes compensation cost related to estimated fair values of awards grantedafter the date of adoption of SFAS No. 123(R) and compensation costs related tounvested awards at the date of adoption based on the intrinsic values aspreviously recorded under APB Opinion No. 25.

The following table summarizes the distribution ofstock-based compensation expense (in thousands):
| ** **                              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                              | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                              | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Cost of revenues                        |       | $                                | 71         |                           | $          | 24 |   | $ | 116 |   | $ | 37 |   |
| Research and development                |       | 517                              |       | 138                            |       | 835 |   | 735 |   |
| Selling, general and administrative     |       | 591                              |       | 252                            |       | 977 |   | 465 |   |
| Related tax effect                      |       | (283                             | )          | (20                            | )          | (441 | ) | (26 | ) |
| Total  stock-based compensation expense |       | $                                | 896        |                           | $          | 394 |   | $ | 1,487 |   | $ | 1,211 |   |

 

Total compensationcost attributable to activities capitalized into inventory was not significantin all periods presented.  Stock-basedcompensation expense in the six months ended June 30, 2006 includes $0.5 millionfor immediately vested options granted to consultants.

SFASNo. 123(R) requires the cash flows resulting from the tax benefits for taxdeductions resulting from the exercise of stock options in excess of thecompensation expense recorded for these options (excess tax benefits) to beclassified as cash from financing activities.

***StockOptions***

For options granted after January1, 2006, and valued in accordance with SFAS No. 123(R), the Company uses the straight-line method forexpense attribution. For options granted prior to January 1, 2006, the Companyuses the multiple grant approach for expense attribution, which results insubstantially higher amounts of amortization in earlier years as opposed to thestraight-line method, which results in equal amortization over the vestingperiod of the options. Under the multiple grant approach, forfeitures ofunvested options resulting from employee terminations result in the reversalduring the period of previously expensed stock-based compensation associatedwith the unvested options.

Thefair value of options granted after January 1, 2006 is estimated on the grantdate using the Black-Scholes option valuation model.  Since the Company’s stock has been activelytraded for only a short period of time, the Company uses the simplifiedcalculation of expected term described in Staff Accounting Bulletin (‘SAB”)No. 107 and volatility is based on an average of the historicalvolatilities of the common stock of several entities with characteristicssimilar to those of the 

7

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Company. Therisk-free rate is based on the U.S. Treasury yield curve in effect at the timeof grant for periods corresponding with the expected term of the option. Theestimated forfeiture rate is based on the Company’s historical forfeitureexperience and is estimated at 10%.

Thefollowing assumptions are used to value stock options granted in the periodspresented:
| ** **               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **               | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **               | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Expected term in  years  |       | 6.08                             |       | 6.08                           |       | 6.08 |   | 6.08 |   |
| Risk-free  interest rate |       | 4.65                             | %          | 5.00                           | %          | 4.60% - 4.65 | % | 4.55% - 5.00 | % |
| Expected  volatility     |       | 68.4                             | %          | 73.8                           | %          | 68.4% - 70.6 | % | 73.8% - 74.1 | % |
| Dividend yield           |       | 0                                | %          | 0                              | %          | 0 | % | 0 | % |

 

The weighted-average grant-date fair value of options granted in the sixmonths ended June 30, 2007 and 2006 is $9.28 and $7.33, respectively. Totalcompensation cost of options granted but not yet vested as of June 30,2007 was $8.9 million, which is expected to be recognized over theweighted-average period of 1.70 years.

***RestrictedStock Awards***

Compensationexpense for restricted stock awards is determined using the fair value of theCompany’s stock on the date of the grant and is recognized on a straight-linebasis over the service period.

**Note 3.  Net Income Per Share**

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

A reconciliation of shares used in the calculation ofbasic and diluted net income per share is as follows (in thousands):
| ** **                                              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                              | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                              | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                    |       |                             |       |                           |       |   |   |   |   |
| Weighted average  common shares outstanding             |       | 20,810                           |       | 5,597                          |       | 20,750 |   | 5,076 |   |
| Weighted average  shares subject to repurchase          |       | (45                              | )          | (76                            | )          | (49 | ) | (81 | ) |
| Shares used to  calculate basic net income per share    |       | 20,765                           |       | 5,521                          |       | 20,701 |   | 4,995 |   |
| Effect of  dilutive securities:                         |       |                             |       |                           |       |   |   |   |   |
| Convertible preferred stock                             |       | —                           |       | 12,067                         |       | — |   | 12,422 |   |
| Common stock options and restricted stock awards        |       | 1,061                            |       | 1,575                          |       | 1,109 |   | 1,605 |   |
| Dilutive  potential common stock                        |       | 1,061                            |       | 13,642                         |       | 1,109 |   | 14,027 |   |
| Shares used to  calculate dilutive net income per share |       | 21,826                           |       | 19,163                         |       | 21,810 |   | 19,022 |   |

 

The completion of the Company’s initial publicoffering (“IPO”) in June 2006 resulted in the conversion to common stock of alloutstanding shares of convertible preferred stock.  As a consequence, the shares used tocalculate basic net income per share have increased by the weighted averageimpact of the 12,777,118 common shares issued on conversion of the convertiblepreferred stock and the 2,540,225 shares issued in the IPO.

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# **Note 4.  Income Taxes**

The Companyaccounts for income taxes under the provisions of SFAS No. 109,*Accounting for Income Taxes*. In applyingSFAS No. 109, the Company is required to estimate its current tax expensetogether with assessing temporary differences resulting from differingtreatments of items for tax and accounting purposes. These differences resultin deferred tax assets and liabilities. Significant management judgment isrequired to assess the likelihood that its deferred tax assets will berecovered from future taxable income. As of June 30, 2007, the Company’s totaldeferred tax assets were principally comprised of net operating losscarryforwards, research and other credit carryforwards and expense accruals. Toassess the likelihood that the deferred tax assets will be recovered fromtaxable income, the Company applied the guidance provided in SFAS No. 109and considered both positive evidence that indicates a valuation allowance isnot needed and negative evidence that indicates a valuation allowance isneeded.

At June 30, 2007based on the available objective evidence, the Company believed it is morelikely than not that its deferred tax assets will not be realized. Accordingly,the Company continued to provide a full valuation allowance against its netdeferred tax assets. Should sufficient positive, objectively verifiableevidence of the realization of the net deferred tax assets exist at a futuredate, the Company would reverse any remaining valuation allowance to the extentsupported by estimates of future taxable income at that time.

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

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

The Company’s effective tax rate is based on the estimatedannual effective tax rate in accordance with SFAS No. 109. A provision forincome taxes of $1.1 million and $588,000 was recorded in the three monthsended June 30, 2007 and 2006, respectively. A provision for income taxes of$2.1 million and $754,000 was recorded in the six months ended June 30, 2007and 2006, respectively. The effective tax rate for all periods differed fromthe statutory federal income tax rate primarily because the Company utilizedprior net operating losses to offset taxable income in the current period.

# **Note 5. Investments**

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

The change in unrealized losses on investments, net oftax, in the three and six months ended June 30, 2007 was an increase of $18,000and $12,000, respectively. The change in unrealized losses on investments, netof tax, in the three and six months ended June 30, 2006 was an increase of$13,000.

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

**Inventory**(in thousands):
|                 | ** ** | **June 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|-----------------|------------|-----------------------------|------------|---------------------------------|------------|
| Finished goods  |       | $                           | 2,468      |                            | $          | 1,702 |   |
| Work in process |       | 2,323                       |       | 2,882                           |       |
|            |       |                        |       |                            |       |
|            |       | $                           | 4,791      |                            | $          | 4,584 |   |

 

**Propertyand equipment, net**(in thousands):
|                                                 | ** ** | **June 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Equipment                                       |       | $                           | 1,335      |                            | $          | 1,029 |   |
| Software                                        |       | 324                         |       | 215                             |       |
| Furniture and  fixtures                         |       | 231                         |       | 317                             |       |
| Leasehold  improvements                         |       | 380                         |       | 146                             |       |
|                                            |       |                        |       |                            |       |
|                                            |       | 2,270                       |       | 1,707                           |       |
| Less accumulated  depreciation and amortization |       | (1,267                      | )          | (1,082                          | )          |
|                                            |       |                        |       |                            |       |
|                                            |       | $                           | 1,003      |                            | $          | 625 |   |

 

**Accruedliabilities**(in thousands):
|                                       | ** ** | **June 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|---------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Accrued  compensation                 |       | $                           | 998        |                            | $          | 1,988 |   |
| Accrued  inventory purchases          |       | 252                         |       | 279                             |       |
| Customer  advances                    |       | 253                         |       | 325                             |       |
| Legal and  professional services fees |       | 214                         |       | 271                             |       |
| Exercise of  unvested stock options   |       | 86                          |       | 110                             |       |
| Other                                 |       | 364                         |       | 371                             |       |
|                                  |       |                        |       |                            |       |
|                                  |       | $                           | 2,167      |                            | $          | 3,344 |   |

 

**Note 7.  SegmentInformation**

As defined by the requirements of SFAS No. 131, *Disclosure About Segments of an Enterprise andRelated Information,* the Company currently operates in onereportable segment, the designing, marketing and selling of mixed signalintegrated circuits for multiple video applications in the consumer, securitysurveillance and automotive markets. The Company’s chief operating decisionmaker is its chief executive officer.

The percentages of total revenues by geographic areaare as follows:
| ** **      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **      | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **      | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Taiwan          |       | 45                               | %          | 51                             | %          | 44 | % | 44 | % |
| South Korea     |       | 31                               | %          | 28                             | %          | 32 | % | 33 | % |
| China/Hong Kong |       | 19                               | %          | 17                             | %          | 19 | % | 19 | % |
| Japan           |       | 3                                | %          | 3                              | %          | 3 | % | 3 | % |
| United States   |       | 1                                | %          | —                         | %          | 1 | % | — | % |
| Other           |       | 1                                | %          | 1                              | %          | 1 | % | 1 | % |
| Total           |       | 100                              | %          | 100                            | %          | 100 | % | 100 | % |

 

Revenues by product line are as follows (in thousands):
| ** **                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Security  Surveillance(1) |       | $                                | 9,095      |                           | $          | 5,711 |   | $ | 18,003 |   | $ | 10,663 |   |
| Video  Decoders(2)        |       | 3,883                            |       | 5,445                          |       | 6,522 |   | 9,097 |   |
| LCD Display(3)            |       | 1,527                            |       | 1,288                          |       | 3,134 |   | 2,280 |   |
| Other(4)                  |       | 238                              |       | 356                            |       | 601 |   | 561 |   |
| Total                     |       | $                                | 14,743     |                           | $          | 12,800 |   | $ | 28,260 |   | $ | 22,601 |   |

 

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(1)           Consists of applicationspecific products designed for use in security surveillance systems.

(2)           Consists ofgeneral-purpose video decoders designed for use in the consumer, securitysurveillance and automotive markets. Revenues from general purpose videodecoders used in security surveillance systems and LCD displays are reportedunder the video decoder product line and not the security surveillance or LCDdisplay product lines.

(3)           Consists of applicationspecific products designed for use in LCD displays.

(4)           Consists of earlygeneration mixed signal semiconductors for digital video applications and PCIvideo decoder products.

The following is a summary of long-lived assets by geographicregion (in thousands):
| Country       | ** ** | **June 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|---------------|------------|-----------------------------|------------|---------------------------------|------------|
| United States |       | $                           | 797        |                            | $          | 544 |   |
| Taiwan        |       | 66                          |       | 64                              |       |
| South Korea   |       | 11                          |       | 12                              |       |
| Japan         |       | 89                          |       | —                          |       |
| China         |       | 40                          |       | 5                               |       |
|          |       |                        |       |                            |       |
| Total         |       | $                           | 1,003      |                            | $          | 625 |   |

 

The revenues and accounts receivable from customersrepresenting 10% or more of total revenues and accounts receivable are asfollows:
| ** **   | ** ** | **Accounts Receivable at** | ** ** | **Revenues**          | ** ** |
|--------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **   | ** ** | **June 30,**                    | ** ** | **December 31,** | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
| **Customer** | ** ** | **2007**                             | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** |
| A            |       | *                                    | %          | 16                    | %          | 16 | % | 11 | % | 16 | % | 12 | % |
| B            |       | *                                    |       | 14                    |       | 11 |   | * |   | * |   | * |   |
| C            |       | 12                                   |       | *                     |       | * |   | 10 |   | * |   | 11 |   |
| D            |       | 13                                   |       | *                     |       | * |   | * |   | * |   | 10 |   |
| E            |       | *                                    |       | 27                    |       | * |   | * |   | * |   | * |   |
| F            |       | *                                    |       | *                     |       | * |   | 15 |   | * |   | 12 |   |
| G            |       | 18                                   |       | *                     |       | * |   | * |   | * |   | * |   |
| H            |       | 14                                   |       | *                     |       | * |   | * |   | * |   | * |   |

 

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*   less than 10%

# **Note 8.  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 $6,000 and $45,000 to this law firmfor legal services in the three months ended June 30, 2007 and 2006,respectively. The Company incurred fees of $12,000 and $80,000 to this law firmfor legal services in the six months ended June 30, 2007 and 2006,respectively.  The amount payable to thislaw firm was $3,000 at June 30, 2007 and $17,000 at December 31,2006.  This Board member also receivescompensation in accordance with the Company’s compensation program fornon-employee directors.

****Note 9.  Recent AccountingPronouncements****

In September 2006,the FASB issued SFAS No. 157,*Fair ValueMeasurements (“*SFAS No. 157”).SFAS No. 157 defines fair value, establishes a framework for measuring fairvalue in generally accepted accounting principles, and expands 

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disclosures about fairvalue measurements. This statement applies under other accountingpronouncements that require or permit fair value measurements, the FASB havingpreviously concluded in those accounting pronouncements that fair value is therelevant measurement attribute. Accordingly, this Statement does not requireany new fair value measurements. SFAS No. 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007, andinterim periods within those fiscal years. The Company is required to adoptthis statement in its first fiscal quarter of 2008. The Company is evaluatingthe potential impact of SFAS No. 157 on its results of operations and financialposition.

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities – including an Amendment of FASBStatement No. 115*, (“SFAS No. 159”), to permit all entities tochoose to elect, at specified election dates, to measure eligible financialinstruments at fair value, to report unrealized gains and losses on items forwhich the fair value option has been elected in earnings at each subsequentreporting date, and recognize upfront costs and fees related to those items inearnings as incurred and not deferred. SFAS No. 159 applies to fiscal years beginningafter November 15, 2007, with early adoption permitted for an entity that hasalso elected to apply the provisions of SFAS No. 157. An entity is prohibitedfrom retrospectively applying SFAS No. 159, unless it chooses early adoption.The Company is evaluating the potential impact of SFAS No. 159 on its resultsof operations and financial position.

**ITEM 2. Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

*The following discussion of our financialcondition and results of operations should be read in conjunction with thecondensed consolidated financial statements and notes to those statementsincluded elsewhere in this Quarterly Report on Form 10-Q as of June 30,2007 and our audited consolidated financial statements for the year endedDecember 31, 2006 included in our Annual Report on Form 10-K.*

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

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

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

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

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***Overview***

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

We commencedoperations in 1997. From 1997 to 1999, we were primarily involved in developingour technology. We shipped our first generation video decoder in 1999. Since1999, our business has experienced significant growth primarily as a result ofour ability to develop new products, obtain design wins and convert thesedesign wins into revenues. We generated revenues from the sale of over 20different products in the quarter ended June 30, 2007.

We have threeprincipal semiconductor product lines: video decoder products, securitysurveillance products and liquid crystal display, or LCD, products. Our videodecoder products, which we view as general purpose products, arehigh-performance mixed signal semiconductors that decode analog TV broadcastsignals, including National Television Systems Committee, or NTSC, phasealternation line, or PAL, and sequential color with memory, or SECAM, andpopular analog video signals, including composite, S-Video, component andSyndicate of Radio and Television Manufacturers, or SCART, into a standarddigital format. Our security surveillance products integrate importantfunctions required to display, store and transport analog video signals fromsecurity surveillance cameras. In 2006, we introduced two new securitysurveillance products, each of which includes four video decoders and a systemcontroller on a single semiconductor. We also have developed a motion JPEG, orMJPEG, encoder/decoder, or CODEC, that facilitates the storage and playback ofvideo from a hard disk drive and transport of video over the Internet. Our LCDdisplay products integrate important functions required to display analog TVbroadcast, popular analog video, high definition video and PC graphics signalson an LCD display. In the first quarter of 2007, we introduced our first twonew LCD display processors that can be used in navigation systems for frontseat consoles in the automotive market. These new products are designed toprovide advanced image processing, an integrated programmable timing controllerand multiple analog and digital video inputs. Our other products include earlygeneration mixed signal semiconductors for digital video applications and PCIvideo decoder products, which are video decoders that utilize peripheralcomponent interconnect, or PCI, technology for personal computer applications.

Although ourrevenues have grown rapidly in a short period of time, we do not expect toachieve similar growth rates in the future. We currently expect to increase ourexpense levels in each of the next several quarters to support increasedresearch and development and sales and marketing efforts. These expendituresmay not result in increased revenue or profitability in the future. Inaddition, our ability to increase our revenues will depend on increased demandfor digital video applications in the consumer, security surveillance andautomotive markets. The growth of our target markets is uncertain. In addition,the timing of orders by and shipments to our customers, as well as generaltrends in our target markets, can cause our revenue growth to be inconsistent.

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

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

We sell ourproducts to distributors that fulfill third-party orders for our products. Wealso sell directly, using independent sales representatives, to OEMs such asSamsung and LG Electronics, which have historically been some of our largest customers,and to original design manufacturers, or ODMs.  In 2006, we derivedapproximately 79% of our revenues from products sold to distributors and 21%from products sold to OEMs or ODMs. In the six months ended June 30, 2007,we derived approximately 67% of our revenues from products sold to distributorsand 33% from products sold to OEMs or ODMs. Our gross margins have nothistorically been significantly different between sales to distributors andsales to OEMs or ODMs through orders procured by independent salesrepresentatives. However, our operating profit on sales through orders procuredby independent sales representatives can be less due to the payment ofcommissions to sales representatives which we record as sales and marketingexpense.

Wereceived an aggregate of 80% and 75% of our revenues from our ten largestcustomers in the three months ended June 30, 2007 and 2006, respectively. Forthe three months ended June 30, 2007, two of our customers accounted for 16%and 11%, respectively, of our revenues. For the three months ended June 30,2006, three of our customers accounted for 15%, 11% and 10%, respectively, ofour revenues. For the six months ended June 30, 2007, one of our customersaccounted for 16% of our revenues.  Forthe six months ended June 30, 2006, four of our customers accounted for 12%,12%, 11% and 10%, respectively, of our revenues.

We derivesubstantially all of our revenues from sales to foreign customers, particularlyin Asia, which sales accounted for approximately 98% of our revenues in boththe three and six months ended June 30, 2007 and which sales accounted forapproximately 99% of our revenues in both the three and six months ended June30, 2006. The table below indicates the percentage of total revenue bygeographic location for the periods indicated:
| ** **      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **      | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **      | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Taiwan          |       | 45                               | %          | 51                             | %          | 44 | % | 44 | % |
| South Korea     |       | 31                               | %          | 28                             | %          | 32 | % | 33 | % |
| China/Hong Kong |       | 19                               | %          | 17                             | %          | 19 | % | 19 | % |
| Japan           |       | 3                                | %          | 3                              | %          | 3 | % | 3 | % |
| United States   |       | 1                                | %          | —                         | %          | 1 | % | — | % |
| Other           |       | 1                                | %          | 1                              | %          | 1 | % | 1 | % |
| Total           |       | 100                              | %          | 100                            | %          | 100 | % | 100 | % |

 

Webelieve that a substantial majority of our revenues will continue to come fromcustomers located in Asia, where most of the consumer electronic devices thatuse our integrated circuits, or ICs, are manufactured. As a result of thisregional customer concentration, we may be subject to economic and politicalevents and other developments that impact our customers in Asia. However, allof our sales, substantially all of our cost of revenues and a majority of ouroperating expenses are denominated in U.S. dollars. As a consequence, webelieve that our overall exposure to foreign exchange risk is low.

We haveinternational branches in South Korea and Taiwan and we have subsidiaries inChina and Japan. At June 30, 2007, 41 of our 108 employees were located in ourinternational offices. These offices provide marketing support to ourcustomers. Our South Korea and Japan offices also perform product developmentactivities.

It is difficultfor us to forecast the demand for our products, in part because of the highlycomplex supply chain between us and the end markets that incorporate ourproducts. Demand for new features changes rapidly. Distributors and ODMs add anadditional layer of complexity. We must, therefore, forecast demand not onlyfrom our direct customers, but also from other participants in this multi-leveldistribution channel. Because of our lengthy product development cycle, it iscritical for us to anticipate changes in demand for our various productfeatures and the applications they serve, to allow sufficient time for productdesign. Our failure to accurately forecast demand can lead to product shortagesthat can impede 

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production by ourcustomers and harm our relationship with these customers. Conversely, ourfailure to forecast declining demand or shifts in product mix can result inexcess or obsolete inventory.

Generally, theaverage 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. Our video decoder and LCD displayproducts that are sold into consumer applications are subject to theseasonality connected with the consumer market. As a result, revenues fromthese products are lower in the first calendar quarter of the year. In addition,a significant number of our semiconductors are sold to customers located inAsia, primarily to customers located in regions that observe the Lunar New Yearholiday. Typically, our customers are closed for a week or more during theextended holiday period, which negatively impacts our business. As a result ofseasonality associated with the consumer market and our customer concentrationin Asia, we expect our revenues to be lower in the first calendar quarter ofeach year.

Our revenuesincreased by 15% for the three months ended June 30, 2007 compared to the threemonths ended June 30, 2006 but our net income decreased to $2.6 million for thethree months ended June 30, 2007 from $2.9 million for the three months endedJune 30, 2006 primarily as a result of higher income taxes in 2007. Ourrevenues increased by 25% for the six months ended June 30, 2007 compared tothe six months ended June 30, 2006 and net income increased to $5.1 million forthe six months ended June 30, 2007 from $3.9 million for the six months endedJune 30, 2006. We had an accumulated deficit of $4.9 million as of June 30,2007 and we may not be able to maintain our recent growth and profitability. Inthe past, we have been able to utilize our net operating loss carryforwards tooffset our taxable income and thereby reduce our income taxes otherwisepayable. However, our use of the net operating loss carryforwards and creditcarryforwards is limited by the annual limitations as described in Sections 382and 383 of the Internal Revenue Code, or the Code. Our plans for continuedinternational expansion may further limit our ability to utilize our netoperating loss carryforwards as our net income increases. Our limited operatinghistory makes the prediction of future operating results very difficult. Webelieve that period-to-period comparisons of operating results should not berelied upon as predictive of future performance.

**CriticalAccounting Policies**

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

We believe thefollowing critical accounting policies require our more significant judgmentsused in the preparation of our condensed consolidated financial statements.

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

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

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

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

At June 30, 2007based on the available objective evidence, we believed it is more likely thannot that our deferred tax assets will not be realized. Accordingly, wecontinued to provide a full valuation allowance against our net deferred taxassets at June 30, 2007. Should sufficient positive, objectively verifiableevidence of the realization of our net deferred tax assets exist at a futuredate, we would reverse any remaining valuation allowance to the extentsupported by estimates of future taxable income at that time.

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

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

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

We adopted SFASNo. 123(R) using the prospective transition method. Under this method,SFAS No. 123(R) is applied to new awards and to awards modified,repurchased or cancelled after January 1, 2006. Compensation costpreviously recorded under Opinion 25 for unvested options will continue to berecognized as the required services are rendered. Accordingly, for the threeand six months ended June 30, 2007 and 2006, stock-based compensation expenseincludes compensation costs related to estimated fair values of awards grantedafter the date of adoption of SFAS No. 123(R) and compensation costsrelated to unvested awards at the date of adoption based on the intrinsicvalues as previously recorded under Opinion 25.

For optionsgranted after January 1, 2006, and valued in accordance with SFAS No.123(R), we use the straight-line method for expense attribution. For optionsgranted prior to January 1, 2006, we use the multiple grant approach forexpense attribution, which results in substantially higher amounts ofamortization in earlier years as opposed to the straight-line method, whichresults in equal amortization over the vesting period of the options.

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

Thefollowing assumptions are used to value stock options granted in the periodspresented:
| ** **              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **              | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **              | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Expected term in years  |       | 6.08                             |       | 6.08                           |       | 6.08 |   | 6.08 |   |
| Risk-free interest rate |       | 4.65                             | %          | 5.0                            | %          | 4.60 – 4.65 | % | 4.55% – 5.0 | % |
| Expected volatility     |       | 68.4                             | %          | 73.8                           | %          | 68.4 – 70.6 | % | 73.8% – 74.1 | % |
| Dividend yield          |       | 0                                | %          | 0                              | %          | 0 | % | 0 | % |

 

Compensationexpense for restricted stock awards is determined using the fair value ofTechwell’s stock on the date of the grant and is recognized on a straight-linebasis over the service period.

Stock-basedcompensation expense is allocated among cost of revenues, research anddevelopment expenses and selling, general and administrative expenses,respectively, based upon the employee’s job function. We expect to continue torecognize substantial amounts of stock-based compensation expense relating toour employee stock options and restricted stock awards in future periodsprimarily as a result of our adoption of SFAS No. 123(R).

***Resultsof Operations***

Thefollowing table is derived from our selected financial data and sets forth ourhistorical operating results as a percentage of revenues for the periodsindicated:
| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                         | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| **Consolidated Statement of Operations Data:** | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Revenues                                                           |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |
| Cost of revenues*                                                  |       | 40.6                             |       | 40.9                           |       | 41.7 |   | 43.1 |   |
| Gross margin                                                       |       | 59.4                             |       | 59.1                           |       | 58.3 |   | 56.9 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| Operating expenses:                                                |       |                             |       |                           |       |   |   |   |   |
| Research and  development*                                         |       | 19.5                             |       | 19.2                           |       | 18.0 |   | 21.9 |   |
| Selling, general  and administrative*                              |       | 19.5                             |       | 14.7                           |       | 19.9 |   | 16.4 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| Total operating  expenses                                          |       | 39.0                             |       | 33.9                           |       | 37.9 |   | 38.3 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| Income from operations                                             |       | 20.4                             |       | 25.2                           |       | 20.4 |   | 18.6 |   |
| Interest income                                                    |       | 5.0                              |       | 1.9                            |       | 5.0 |   | 1.8 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| Income before income  taxes                                        |       | 25.4                             |       | 27.1                           |       | 25.4 |   | 20.4 |   |
| Income taxes                                                       |       | 7.5                              |       | 4.6                            |       | 7.3 |   | 3.3 |   |
| Net Income                                                         |       | 17.9                             | %          | 22.5                           | %          | 18.1 | % | 17.1 | % |

 

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(*)  Percentages include stock-based compensation.The table below indicates the percentage of stock-based compensation attributedto each item as a percentage of revenues for the periods indicated:

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| ** **                          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                          | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                |       |                             |       |                           |       |   |   |   |   |
| Cost of revenues                    |       | 0.5                              | %          | 0.2                            | %          | 0.4 | % | 0.2 | % |
| Research and  development           |       | 3.5                              |       | 1.1                            |       | 3.0 |   | 3.3 |   |
| Selling, general and administrative |       | 4.0                              |       | 2.0                            |       | 3.5 |   | 2.1 |   |

 

***Revenues by product line are as follows (inthousands):***
| ** **                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Security  Surveillance(1) |       | $                                | 9,095      |                           | $          | 5,711 |   | $ | 18,003 |   | $ | 10,663 |   |
| Video Decoders(2)         |       | 3,883                            |       | 5,445                          |       | 6,522 |   | 9,097 |   |
| LCD Display(3)            |       | 1,527                            |       | 1,288                          |       | 3,134 |   | 2,280 |   |
| Other(4)                  |       | 238                              |       | 356                            |       | 601 |   | 561 |   |
| Total                     |       | $                                | 14,743     |                           | $          | 12,800 |   | $ | 28,260 |   | $ | 22,601 |   |

 

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

(2)             Consists ofgeneral-purpose video decoders designed for use in the consumer, securitysurveillance and automotive markets. Revenues from general purpose videodecoders used in security surveillance systems and LCD displays are reportedunder the video decoder product line and not the security surveillance or LCDdisplay product lines.

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

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

**Comparisons of the Three Months Ended June 30, 2007 and 2006**

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

Revenueswere $14.7 million for the three months ended June 30, 2007 and $12.8 millionfor the three months ended June 30, 2006, an increase of 15%. Revenues from oursecurity surveillance products increased approximately $3.4 million, or 59%, inthe three months ended June 30, 2007 compared to the three months ended June30, 2006, primarily as a result of the increased revenues from our integratedfour-in-one security surveillance products. Revenues from video decoderproducts decreased approximately $1.6 million, or 29%, in the three monthsended June 30, 2007 compared to the three months ended June 30, 2006, primarilyas a result of a general decrease in demand for our video decoders due to alack of integrated audio functionality. Additionally,  sales of our general-purpose video decodershave been impacted by the shift to application specific products specificallydesigned for the LCD display and security surveillance markets. We intend toadd integrated audio functionality to our general purpose decoders in the nearterm. Revenues from of our LCD display products increased approximately $0.2million, or 19%, in the three months ended June 30, 2007 compared to the threemonths ended June 30, 2006, primarily as a result of the increase in vehiclesinstalled with LCD displays attributable to earlier design wins in theautomotive market. Other revenues decreased $0.1 million, or 33%, in the threemonths ended June 30, 2007 compared with the three months ended June 30, 2006,primarily as a result of decreased sales of our PCI video decoder products.

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

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Gross profit was $8.8 million for thethree months ended June 30, 2007 and $7.6 million for the three months endedJune 30, 2006, an increase of 16%. Grossmargin was 59% for both the three months ended June 30, 2007 and 2006. The gross margin for the threemonths ended June 30, 2007 wasfavorably impacted by reduced materialscosts partially attributable to increased volume purchases and the transition of our products to lowerprocess geometries in the first quarter of 2007. The gross margin for the three months ended June 30, 2006 was favorably impacted by $0.3 million fromsales of inventory that had been previously written-off.

Weincurred stock-based compensation included in cost of revenues associated withoutsourced manufacturing support and quality assurance personnel of $0.1million and less than $0.1 million in the three months ended June 30, 2007and 2006, respectively.

*Researchand Development.*    Research anddevelopment expenses consist primarily of compensation and associated costs ofemployees engaged in research and development, contractor costs, tape-outcosts, development, testing and evaluation costs, occupancy costs anddepreciation expense. Before releasing new products, we incur charges for masksets, prototype wafers and mask set revisions, which we refer to as tape-outcosts. Tape-out costs may cause our research and development expenses tofluctuate because they are not incurred uniformly every quarter. We expectour research and development costs to increase in absolute dollars in 2007 aswe increase our investment in developing new products.

Researchand development expenses were $2.9 million, or 20% of revenues, for the threemonths ended June 30, 2007 and $2.5 million, or 19% of revenues, for the threemonths ended June 30, 2006, an increase in absolute dollars of 17%.  This increase primarily reflects increasedcompensation related expenses of approximately $0.4 million primarily as aresult of stock-based compensation expense.

Weincurred stock-based compensation expense associated with research anddevelopment personnel of $0.5 million and $0.1 million in the three months endedJune 30, 2007 and 2006, respectively.

*Selling, General andAdministrative.*     Selling, general andadministrative expenses consist primarily of compensation and associated costsfor marketing, selling and administrative personnel, sales commissions to independentsales representatives, contractor compensation, public relations, promotionaland other marketing expenses, insurance and fees paid for professionalservices, travel, depreciation expenses and occupancy costs. Costs associatedwith audit and tax services, corporate governance and compliance and financialreporting are also included in selling, general and administrative expenses.

Selling, general and administrative expenses were $2.9 million,or 20% of revenues, for the three months ended June 30, 2007 and $1.9 million,or 15% of revenues, for the three months ended June 30, 2006, an increase of53%. The increase in expense was primarily due to $0.5million in compensation related expenses primarily associated with stock-basedcompensation, $0.2 million in insurance and administrative fees reflectingcosts associated with being a public company, $0.2 million associated with ourforeign branches and our subsidiaries in China and Japan and $0.1 million inprofessional services expenses primarily for audit, tax and legal services. Weexpect selling, general and administrative expenses to continue to increase inthe future in support of our anticipated growth as we hire additional personnel and expand our sales and marketingefforts. Administrative expenses will also increase to cover additionalcosts associated with operating as a public company, such as growth in our information technologyinfrastructure and increased costs associated with our efforts to complywith the Sarbanes-Oxley Act of 2002.

We incurredstock-based compensation expense associated with selling, general andadministrative personnel of $0.6 million and $0.3 million in the threemonths ended June 30, 2007 and 2006, respectively.

*Interest Income.*    Interest income was $0.7million for the three months ended June 30, 2007 and $0.3 million for the threemonths ended June 30, 2006, an increase of 193%. The increase was primarily dueto higher cash, cash equivalent and investment balances primarily as a resultof our initial public offering in June 2006 and income from operations andhigher interest rates in the three months ended June 30, 2007.

*IncomeTaxes.*    Our provision for income taxeswas $1.1 million for the three months ended June 30, 2007 and $0.6 million forthe three months ended June 30, 2006. The effective tax rate for both periodsdiffered from the statutory federal income tax rate primarily because weutilized prior net operating losses to offset profits. Our future effectiveincome tax rate will be subject to many variables, including the absoluteamount and future geographic distribution of our pre-tax income, our ability 

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to take advantage of theavailable tax planning strategies and our ability to utilize our net operatingloss carryforwards. As a result of these factors, our effective tax rateincreased to approximately 30% in the three months ended June 30, 2007.

**Comparisons of the Six Months Ended June 30, 2007 and 2006**

*Revenues.*   Revenues were $28.3million for the six months ended June 30, 2007 and $22.6 million for the sixmonths ended June 30, 2006, an increase of 25%. Revenues from our security surveillance products increased approximately$7.3 million, or 69%, in the six months ended June 30, 2007 compared to the sixmonths ended June 30, 2006, primarily as a result of the increase in sales ofour integrated four-in-one security surveillance products.  Revenues from video decoder productsdecreased approximately $2.6 million, or 28%, in the six months ended June 30,2007 compared to the six months ended June 30, 2006, primarily as a result of ageneral decrease in demand for our decoders due to a lack of integrated audiofunctionality. Additionally, sales of our general-purpose video decoders havebeen impacted by the shift to application specific products specificallydesigned for the LCD display and security surveillance markets. Revenues fromof our LCD display products increased by $0.9 million, or 38%, in the sixmonths ended June 30, 2007 compared to the six months ended June 30, 2006primarily as a result of the increase in vehicles installed with LCD displaysattributable to earlier design wins in the automotive market. Other revenuesincreased less than $0.1 million, or 7%, in the six months ended June 30, 2007as compared with the six months ended June 30, 2006, primarily as a result ofincreased sales of our PCI video decoder products.

*GrossProfit and Gross Margin.*  Gross profit was $16.5 million for the six months ended June 30,2007 and $12.9 million for the six months ended June 30, 2006, an increase of28%.  Gross margin was 58% for the six months ended June 30, 2007 increasingfrom 57% for the six months ended June 30, 2006.  The increase in gross margin was primarily aresult of reduced materialscosts and production costs in the six months ended June 30, 2007 compared tothe same period in 2006 partially attributable to increased volumepurchases and the transition of ourproducts to lower process geometries in the first quarter of 2007.

We incurred stock-based compensation included in cost of revenuesassociated with outsourced manufacturing support and quality assurancepersonnel of $0.1 million and less than $0.1 million in the six monthsended June 30, 2007 and 2006, respectively.

*Research and Development.*  Research and developmentexpenses were $5.1 million, or 18% of revenues, for the six months ended June30, 2007 and $5.0 million, or 22% of revenues, for the six months ended June30, 2006.  Theincrease in expenseswas primarily due to $0.2 million ofcompensation related expenses attributable to the increase in engineeringheadcount and stock-based compensation and $0.1 million of increased expensesassociated with our new subsidiary in Japan. These increases in expenses arepartially offset by a decrease of $0.1 million in tape-out expenses that arenot incurred uniformly every quarter.

We incurred stock-based compensation expense associated withresearch and development personnel of $0.8 million and $0.7 million in thesix months ended June 30, 2007 and 2006, respectively.

*Selling,General and Administrative*.  Selling, general and administrative expenses were$5.6 million, or 20% of revenues, for the six months ended June 30, 2007 and$3.7 million, or 16% of revenues, for the six months ended June 30, 2006.  Theincrease in expense was primarilydue to $0.7 million in compensation related expenses primarilyassociated with stock-based compensation, $0.3 million in insurance andadministrative fees reflecting costs associated with being a public company,$0.3 million associated with our foreign branches and our subsidiaries in Chinaand Japan and $0.2 million in professional services expenses primarily foraudit, tax and legal services.

We incurred stock-based compensation expense associated withselling, general and administrative personnel of $1.0 million and $0.5 millionthe six months ended June 30, 2007 and 2006, respectively.

*Interest Income.*    Interestincome was $1.4 million for the six months ended June 30, 2007 and $0.4 millionfor the six months ended June 30, 2006. The increase was due to higher cash, cash equivalent and investmentbalances as a result of our initial public offering and higher interest ratesin the six months ended June 30, 2007.

*IncomeTaxes.*    Our provision for income taxeswas $2.1 million for the six months ended June 30, 2007 and $0.8 million forthe six months ended June 30, 2006.  Theeffective tax rate for both periods differed from the statutory federal incometax rate primarily because we utilized prior net operating losses to offsetprofits.  Our future effective income taxrate will be 

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subject to manyvariables, including the absolute amount and future geographic distribution ofour pre-tax income, our ability to take advantage of the available tax planningstrategies and our ability to utilize our net operating loss carryforwards. Asa result of these factors, our effective tax rate increased to approximately29% in the six months ended June 30, 2007.

***Liquidityand Capital Resources***

Since ourinception, we have financed our growth primarily with proceeds from theissuance of preferred stock and common stock and our cash flows fromoperations. Our cash and cash equivalents and short-term investments were$52.3 million as of June 30, 2007.

Netcash provided by operating activities was $6.3 million in the six months endedJune 30, 2007.  The net cash provided byour operating activities in the six months ended June 30, 2007 was primarilydue to our net income of $5.1 million and a decrease in our accounts receivableof $0.3 million attributable to the timing of customer collections which wasoffset by a decrease in accounts payable and accrued liabilities of $1.5million primarily attributable to a reduced compensation related liabilitywhich is accrued throughout the year and paid subsequent to year end and anincrease in prepaid expenses of $0.3 million associated with a tax asset, anincrease in inventory of $0.2 million to support an increase in revenues  and an increase in other assets of $0.1million attributable to new lease deposits. We incurred non-cash expenses of$1.9 million for stock-based compensation expense and $0.2 million indepreciation expense in the six months ended June 30, 2007.  We also recognized a tax benefit of $0.9million attributable to our employee equity incentive plans.

Net cashprovided by operating activities was $8.1 million in the six months ended June30, 2006.  The net cash provided by ouroperating activities in the six months ended June 30, 2006 was primarily due toour net income of $3.9 million and an increase in accounts payable and accruedliabilities of $2.2 million associated with increasing customer demand as aresult of new product introductions and increased sales of existing productsand a decrease in inventory of $0.1 million. The net cash provided by our operating activities was also due to adecrease in accounts receivable of $0.6 million attributable to the timing ofcustomer collections. We incurred non-cash expenses of $1.2 million for stockcompensation expenses and $0.1 million in depreciation expenses in the sixmonths ended June 30, 2006.

Net cash used in investing activities was $6.9 millionin the six months ended June 30, 2007 reflecting purchases of investments of$42.9 million and capital purchases of $0.4 million offset by maturities ofinvestments of $36.4 million. Net cash used in our investing activities was$17.2 million in the six months ended June 30, 2006 reflecting purchases ofinvestments of $19.3 million and capital purchases of $0.2 million offset bymaturities of investments of $2.3 million.

Netcash provided by our financing activities was $0.5 million in the sixmonths ended June 30, 2007 and consisted of proceeds from the exercise of stockoptions. Net cash provided by financing activities was $19.5 million in the sixmonths ended June 30, 2006 and consisted of proceeds from our initial stockoffering net of underwriting discounts, commissions and offering costs of $19.3million and proceeds from the exercise of stock options of $0.3 million.

We believe ourexisting cash and cash equivalents and investments balances, as well as cashexpected to be generated from operating activities, will be sufficient to meetour 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 adequate manufacturingcapacity and the continuing market acceptance of our products. We could berequired, or could elect, to seek additional funding through public or privateequity or debt financing and additional funds may not be available on termsacceptable to us or at all.

***Off-Balance Sheet Arrangements***

As of June 30, 2007, we have no off-balance sheetarrangements as defined in Item 303(a)(4) of the Securities and ExchangeCommission’s Regulation S-K.

** *Contractual Obligations***

As of December 31, 2006, we had $1.9 million of totalfuture minimum lease obligations. The following table 

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identifiesour commitments to settle contractual obligations as of June 30, 2007:
| ** **                 | ** ** | **Payment Due by Period** | ** ** |
|----------------------------|------------|------------------------------------------|------------|
| ** **                 | ** ** | **Total**                                | ** ** | **Less than 1  year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than   5 years** | ** ** |
|                       |       |                                     |       |   |   |   |   |   |   |   |   |
| Minimum Lease  Obligations |       | $                                        | 1,795      |   | $ | 633 |   | $ | 1,002 |   | $ | 160 |   | $ | — |   |
| Purchase  Obligations      |       | 2,379                                    |       | 2,379 |   | — |   | — |   | — |   |
| Total Obligations          |       | $                                        | 4,174      |   | $ | 3,012 |   | $ | 1,002 |   | $ | 160 |   | $ | — |   |

 

This tableexcludes the liability for unrecognized income tax benefits of $0.2 millionthrough June 30, 2007, since we cannot predict with reasonable reliability thetiming of cash settlements with the respective taxing authorities.

****RecentAccounting Pronouncements****

In September 2006,the FASB issued SFAS No. 157,*Fair ValueMeasurements,* or SFAS No.157. SFAS No. 157 defines fair value, establishes a framework formeasuring fair value in generally accepted accounting principles, and expandsdisclosures about fair value measurements. This statement applies under otheraccounting pronouncements that require or permit fair value measurements, theFASB having previously concluded in those accounting pronouncements that fairvalue is the relevant measurement attribute. Accordingly, this Statement doesnot require any new fair value measurements. SFAS No. 157 is effective forfinancial statements issued for fiscal years beginning after November 15, 2007,and interim periods within those fiscal years. We are required to adopt thisstatement in our first fiscal quarter of 2008. We are evaluating the potentialimpact of SFAS No. 157 on our results of operations and financial position.

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities – including an Amendment of FASBStatement No. 115*, or SFAS No. 159, to permit all entities to chooseto elect, at specified election dates, to measure eligible financialinstruments at fair value, to report unrealized gains and losses on items forwhich the fair value option has been elected in earnings at each subsequentreporting date, and recognize upfront costs and fees related to those items inearnings as incurred and not deferred. SFAS No. 159 applies to fiscal yearsbeginning after November 15, 2007, with early adoption permitted for an entitythat has also elected to apply the provisions of SFAS No. 157. An entity isprohibited from retrospectively applying SFAS No. 159, unless it chooses earlyadoption. We are evaluating the potential impact of SFAS No. 159 on our resultsof operations and financial position.

**ITEM 3. Quantitative and QualitativeDisclosures about Market Risk**

The primaryobjectives of our investment activity are to preserve principal, provideliquidity and maximize income without significantly increasing the risk. Someof the securities we invest in are subject to market risk. This means that achange in prevailing interest rates may cause the principal amount of theinvestment to fluctuate. To minimize this risk, we maintain our portfolio ofcash equivalents, short and long-term investments in demand accounts, moneymarket funds, commercial paper, corporate bonds, U.S. government agencysecurities and auction rate securities which are investment grade securitieswith a maximum dollar weighted maturity of two years or less. The riskassociated with fluctuating interest rates is limited to our investmentportfolio, and we believe that a 10% change in interest rates would not have asignificant impact on our interest income.

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 ouroperations in Taiwan, South Korea, Japan and China is the U.S. dollar and ourlocal accounts are maintained in the local currency in Taiwan, South Korea,Japan and China, respectively, and thus we are subject to foreign currencyexchange rate fluctuations associated with remeasurement to U.S. dollars. Suchfluctuations have not been significant historically and we believe that a 10%change in exchange rates would not have a significant impact on our operatingexpenses.

**ITEM 4. Controls and Procedures**

(a)***   Evaluation ofdisclosure controls and procedures.***   We maintain “disclosurecontrols and procedures,” as such term is defined inRule 13a-15(e) under the Securities Exchange Act of 1934 (the “ExchangeAct”), that are designed to 

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ensure that informationrequired to be disclosed by us in reports that we file or submit under theExchange Act is recorded, processed, summarized, and reported within the timeperiods specified in Securities and Exchange Commission rules and forms,and that such information is accumulated and communicated to our management,including our chief executive officer and chief financial officer, asappropriate, to allow timely decisions regarding required disclosure. Indesigning and evaluating our disclosure controls and procedures, managementrecognized that disclosure controls and procedures, no matter how wellconceived and operated, can provide only reasonable, not absolute, assurancethat the objectives of the disclosure controls and procedures are met. Ourdisclosure controls and procedures have been designed to meet the reasonableassurance standards. Additionally, in designing disclosure controls andprocedures, our management necessarily was required to apply its judgment inevaluating the cost-benefit relationship of possible disclosure controls andprocedures. The design of any disclosure controls and procedures also is basedin part upon certain assumptions about the likelihood of future events, andthere can be no assurance that any design will succeed in achieving its statedgoals under all potential future conditions.

Based on theirevaluation as of the end of the period covered by this Quarterly Report onForm 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.

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

**PART II—OTHER INFORMATION**

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

We are currently not a party to any material legalproceedings. We may from time to time become involved in litigation relating toclaims arising from our ordinary course of business. These claims, even if notmeritorious, could result in the expenditure of significant financial andmanagerial resources.

**ITEM 1a.****        RiskFactors**

If any of thefollowing risks actually occur, our business, results of operations andfinancial condition 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.***

Our revenue andoperating results are difficult to predict, have in the past fluctuated, andmay in the future fluctuate from quarter to quarter. It is possible that ouroperating results in some quarters will be below market expectations. Thiswould likely cause the market price of our common stock to decline. Ourquarterly operating results are affected by a number of factors, including:

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

·                     uncertain demand in the consumer andautomotive markets for our products;

·                     the loss of one or more of ourcustomers, causing a significant reduction or postponement of orders from thesecustomers;

·                     decreases in the overall averageselling prices of our products;

·                     changes in the relative sales mixof our products;

·                     changes in our cost of finishedgoods;

·                     the availability, pricing andtimeliness of delivery of other components used in our customers’ products;

·                     our customers’ sales outlook,purchasing patterns and inventory adjustments based on consumer demands andgeneral economic conditions;

·                     productobsolescence and our ability to manage product transitions;

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·                     our ability to successfullydevelop, introduce and sell new or enhanced products in a timely manner; and

·                     thetiming of new product announcements or introductions by us or by ourcompetitors.

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

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

We first became profitablein the second quarter of 2005. We incurred significant net losses prior to thatquarter. As of June 30, 2007, we had an accumulated deficit of approximately$4.9 million. To sustain or increase profitability, we will need to generateand sustain substantially higher revenue while maintaining reasonable cost andexpense levels. We currently expect to increase expense levels in each of thenext several quarters to support increased research and development and salesand marketing efforts. These expenditures may not result in increased revenueor customer growth. Because many of our expenses are fixed in the short term,or are incurred in advance of anticipated sales, we may not be able to decreaseour expenses in a timely manner to offset any shortfall of sales. We alsobelieve our effective tax rate will increase in the near term, which will harmour financial results and negatively impact our profitability. We may not beable to sustain or increase profitability on a quarterly or an annual basis. Thismay, in turn, cause the price of our common stock to decline.

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

Our ability toincrease our revenue will depend on increased demand for digital videoapplications in the consumer, security surveillance and automotive markets. Ifour target markets do not grow as rapidly or to the extent we anticipate, ourbusiness could suffer. The growth of our target markets is uncertain and willdepend in particular upon:

·                  consumer confidence and the continuedincrease of consumer spending levels;

·                  the pace at which new digital videoapplications are adopted;

·                  a continued reduction in the costs ofproducts in these markets; and

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

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

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

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

The markets inwhich we operate are extremely competitive and are characterized by rapidtechnological change, continuously evolving customer requirements and decliningaverage selling prices. We may not be able to compete successfully againstcurrent or potential competitors. If we do not compete successfully, our marketshare and revenue may decline. We compete with large semiconductormanufacturers and designers. Most of our current and potential competitors havelonger operating histories, significantly greater resources and 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.

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

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

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

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

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

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

We expendconsiderable 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 broadcast TV todigital broadcast TV, our operating results could suffer.***

Our semiconductorsare principally designed to decode analog broadcast TV signals into digitalimages. We believe the transmission of broadcast TV signals will over timeshift from analog signals to digital signals. We are in the process ofdeveloping mixed signal and digital technology to decode digital signals.However, transmission of digital video involves a combination of emergingtechnologies. The complexities of these technologies and the variability inimplementations between manufacturers may cause our development ofsemiconductors to be costly and time-consuming. We may never obtain the benefitsof our investment in developing this technology. The complexities of digitalbroadcast technologies may also cause some of the semiconductors we aredeveloping to ultimately work incorrectly for reasons that may be eitherrelated or unrelated to our products, or not be interoperable with other keyproducts. Delays or difficulties in integrating our semiconductors into digitalbroadcast TV products or the failure of products incorporating digitalbroadcast TV to achieve broad market acceptance could have an adverse effect onour business.

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***A significant portion of our products are sold into theconsumer and security surveillance markets, and if sales of our semiconductorsinto these markets decline or do not increase, or if we do not increase oursales into the automotive market, our business and financial results couldsuffer.***

We sellsemiconductors targeted for the consumer, security surveillance and automotivemarkets. We believe that for the year ended December 31, 2006 more than80% of our sales were derived from the sale of our products designed for theconsumer and security surveillance markets. If sales of semiconductors intothese markets decline or do not increase, or if demand slows in these marketsgenerally, our operating results would suffer. In addition, we have increasedour focus on the automotive market and devoted substantial resources to thedevelopment of semiconductors for digital video applications that address thismarket. If we are not successful in selling our semiconductors into this market,we may not recover the costs associated with our efforts in this area and ouroperating results could suffer.

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

Our business issubject to seasonality as a result of our target markets and the location ofour customers. We sell a significant number of our semiconductors into theconsumer market. Our customers who manufacture products for the consumer marketexperience seasonality in the sales of their products, which in turn may affectthe timing and volume of orders for our semiconductors. Because the consumermarket for digital video applications is characterized by this seasonality, ouroperating results may vary significantly from quarter to quarter. For example,we generally experience lower sales in the first calendar quarter with ourvideo decoder and LCD display products as a result of the seasonalityassociated with the consumer markets. In addition, a significant number of oursemiconductors are sold to customers located in Asia, primarily to customerslocated in regions who observe the Lunar New Year holiday, also referred to asChinese New Year. Typically, our foreign offices and those of our customers areclosed for a week or more during the extended holiday period. For the threemonths ended March 31, 2007, approximately 96% of our revenues wereattributable 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. These sales fluctuations are expected tocontinue.

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

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

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

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

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

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

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

Our futureeffective tax rates will be favorably or unfavorably affected by the absoluteamount and future geographic distribution of our pre-tax income, our ability totake advantage of the available tax planning strategies and our ability toutilize our net operating loss carryforwards. For example, at December 31,2006, we had federal and state tax net operating loss carryforwards ofapproximately $6.7 million and $3.2 million, respectively. These net operatingloss carryforwards may be used to offset future taxable income and therebyreduce our income taxes otherwise payable. Section 382 of the InternalRevenue Code of 1986, as amended (the “Code”), imposes an annual limit on theability of a corporation that undergoes an ‘‘ownership change’’ to use its netoperating loss carryforwards to reduce its tax liability. Due in part to equityfinancings, we experienced ‘‘ownership changes’’ as defined in Section 382of the Code. Accordingly, our use of the net operating loss carryforwards andcredit carryforwards is limited by the annual limitations as described inSections 382 and 383 of the Code. Our plans for continued internationalexpansion may further limit our ability to utilize our net operating losscarryforwards as our net income increases. Our effective tax rate for the yearsended December 31, 2006 and 2005 was 8.9% and 3.4%, respectively. As a resultof the factors discussed above, we anticipate the effective tax rate for fiscal2007 to be in excess of 25%. 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, if they occur, could harm ournet income and financial condition.

***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.***

We areexperiencing a period of significant growth and expansion, which has placed,and any future expansion will continue to place, a significant strain on ourmanagement, personnel, systems and financial resources. We plan to hireadditional employees to support an increase in research and development as wellas increase our selling and marketing efforts. To manage our growthsuccessfully and handle the responsibilities of being a public company, webelieve we must effectively:

·                  hire, train, integrate and manageadditional qualified engineers for research and development activities, salesand marketing personnel and financial and information technology personnel;

·                  continue to enhance our customerresource management and manufacturing management systems;

·                  implement additional and improveexisting administrative, financial and operations systems, procedures andcontrols, including the requirements of the Sarbanes-Oxley Act of 2002;

·                  expand and upgrade our technologicalcapabilities; and

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

Our efforts mayrequire substantial managerial and financial resources and may increase ouroperating costs even though these efforts may not be successful. If we areunable to manage our growth effectively, we may not be able to take advantageof market opportunities, develop new products, satisfy customer requirements,execute our business 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.***

Although we testour products, they are complex and may contain defects and errors. In the past,we have encountered defects and errors in our products. For example, in 2003 wewere unable to sell certain products to a customer for whom these products werespecifically designed as a result of our failure to produce a product that metthis customer’s specifications. We believe this customer secured the productfrom another vendor. Delivery of products with defects or 

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reliability, quality orcompatibility problems may damage our reputation and our ability to retainexisting customers and attract new customers. In addition, product defects anderrors could result in additional development costs, diversion of technicalresources, delayed product shipments, increased product returns and productliability claims against us, which may not be fully covered by insurance. Anyof these could harm our business.

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

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

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

·                  potential price increases;

·                  inability to achieve requiredproduction or test capacity and achieve acceptable yields on a timely basis;

·                  longer delivery times;

·                  increased exposure to potentialmisappropriation of our intellectual property;

·                  shortages of materials that foundriesuse to manufacture products;

·                  labor shortages or labor strikes; and

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

We currently donot have long-term supply contracts with any of our third-party vendors.Therefore, they are not obligated to perform services or supply products to usfor any specific period, in any specific quantities or at any specific price,except as may be provided in a particular purchase order. Neither TSMC nor ASEhas provided contractual assurances to us that adequate capacity will beavailable for us to meet future demand for our products. These third partyvendors may allocate capacity to the production of other companies’ productswhile reducing deliveries to us on short notice. In particular, other customersthat are larger and better financed than we are or that have long-termagreements with TSMC or ASE may cause either or both of them to reallocatecapacity to those customers, decreasing the capacity available to us.

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

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

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

To reduce costsand maintain our gross margins, we intend to transition our semiconductors toincreasingly smaller geometries and achieve higher levels of designintegration. This transition requires us to modify the manufacturing processesfor our products and to redesign some products, which may result in delays inproduct deliveries. We periodically evaluate the benefits, on aproduct-by-product basis, of migrating to smaller geometry process technologiesto reduce our costs. In the past, we have experienced some difficulties inshifting to smaller geometry process technologies and new manufacturingprocesses, which resulted in reduced manufacturing yields, delays in productdeliveries and increased expenses. We may face similar difficulties, delays andexpenses in the future. If our foundry, or we, experience significant delays inthese transitions or fail to efficiently implement these transitions, ourbusiness, financial condition and results of operations could suffer.

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

The percentage ofour revenues attributable to sales to customers in Asia was approximately 98%for both the three and six months ended June 30, 2007.  The percentage of our revenues attributableto sales to customers in Asia was approximately 99% for both the three and sixmonths ended June 30, 2006. We expect that revenues from customers in Asia willcontinue to account for substantially all of our revenues. All our salescurrently are denominated in U.S. dollars. As a result, an increase in thevalue of the U.S. dollar relative to foreign currencies could make our productsless competitive in international markets.

Currently, wemaintain international sales offices in Asia, and we rely on a network ofthird-party sales representatives to sell our products internationally. We havealso established offices in China, Taiwan and South Korea, which serve variousaspects of our business. Moreover, we have in the past relied on, and expect tocontinue to rely on, suppliers, manufacturers and subcontractors located inAsia, including Taiwan. Accordingly, we are subject to several risks andchallenges, any of which could harm our business and financial results. Theserisks and challenges include:

·                  difficulties and costs of staffingand managing international operations across different geographic areas andcultures;

·                  compliance with a wide variety ofdomestic and foreign laws and regulations, including those relating to theimport or export of semiconductor products;

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

·                  our ability to receive timely paymentand collect our accounts receivable;

·                  political, legal and economicinstability, foreign conflicts and the impact of regional and global infectiousillnesses, such as the SARS outbreak or avian flu in the countries in which weand our customers, suppliers, manufacturers and subcontractors are located;

·                  legal uncertainties regardingprotection for intellectual property rights in some countries; and

·                  fluctuationsin freight rates and transportation disruptions.

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

Because ourproducts are based on constantly evolving technologies, we have experienced alengthy sales cycle for some of our semiconductors, particularly those designedfor digital video applications in the automotive market. Our sales cycle typicallyranges from six to 12 months. We may experience a delay between the time weincrease expenditures for research and development, sales and marketing effortsand inventory and the time we generate revenue, if any, from theseexpenditures. In addition, because we do not have long-term commitments fromour customers, we must repeat our sales process on a continual basis even forcurrent customers looking to purchase a new product. As a result, our businesscould be harmed if a customer reduces or delays its orders, chooses not torelease products incorporating our semiconductors or elects not to purchase anew product or product enhancements from us.

***We primarily sell our semiconductors through distributors,and if our relationships with one or more of those distributors were toterminate, our operating results may be harmed.***

We market anddistribute our products primarily through distributors. This distributionchannel has been characterized by rapid change and consolidations. Distributorshave accounted for a significant portion of our revenues in the past. Sales toour distributors represented approximately 79% of our revenues in 2006 and 67%of our revenues in the six months ended June 30, 2007.

Our operatingresults and financial condition could be significantly disrupted by the loss ofone or more of our current distributors and sales representatives, volumepricing discounts, order cancellations, delays in shipment by one of our majordistributors or sales representatives or the failure of our distributors orsales representatives to successfully sell our products.

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

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

·                  the laws of other countries in whichwe market our semiconductors, such as some countries in the Asia/Pacificregion, may offer little or no protection for our proprietary technologies;

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

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

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.***

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

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

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Questions ofinfringement in the digital video applications market involve highly technicaland subjective analyses. Litigation may be necessary in the future to enforceany patents we may receive and other intellectual property rights, to protectour trade secrets, to determine the validity and scope of the proprietaryrights of others or to defend against claims of infringement or invalidity, andwe may not prevail in any future litigation. Litigation, whether or notdetermined in our favor or settled, could be costly, could harm our reputation,could cause our customers to use our competitors’ products and could divert theefforts and attention of our management and technical personnel from normalbusiness operations. In addition, adverse determinations in litigation couldresult in the loss of our proprietary rights, subject us to significantliabilities, require us to seek licenses from third parties or prevent us fromlicensing our technology or selling our products, any of which could seriouslyharm our business.

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

TSMC, whichmanufactures our semiconductors, has facilities in the State of Washington andin Taiwan. Our assembly and testing vendors’ facilities are primarily locatedin Taiwan. In addition, our headquarters are located in Northern California. Therisk of an earthquake or extreme weather in the Pacific Rim region or anearthquake in Northern California or Washington state is significant due to theproximity of major earthquake fault lines. In September 1999, a majorearthquake in Taiwan affected the facilities of TSMC and ASE, our primaryassembly vendor, as well as other providers of foundry, packaging and testservices. In 2005, several typhoons also disrupted the operations of TSMC andASE. As a result of these natural disasters, these contractors suffered poweroutages and disruptions that impaired their production capacity. InMarch 2002 and June 2003, additional earthquakes occurred in Taiwan.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.

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

We prepare ourfinancial statements to conform with accounting principles generally acceptedin the United States of America, or GAAP. These accounting principles aresubject to interpretation by the Financial Accounting Standards Board, or FASB,the Securities and Exchange Commission, or SEC, and various bodies formed tointerpret and create appropriate accounting policies. A change in thosepolicies can have a significant effect on our reported results and may affectour reporting of transactions completed before a change is announced. Changesto those rules or the questioning of current practices may adverselyaffect our reported financial results or the way we conduct our business. Forexample, accounting policies affecting many aspects of our business, includingrules relating to employee stock option grants, have recently beenrevised. The FASB and other agencies have made changes to GAAP that requiredus, starting in our first quarter of fiscal 2006, to record a charge to earningsfor the estimated fair value of employee stock option grants and other equityincentives, whereas under prior accounting rules charges were requiredonly for the intrinsic value, if any, of such awards to employees. We may havesignificant and ongoing accounting charges under the new rules resultingfrom option grant and other equity incentive expensing, which could reduce ouroverall net income. In addition, since we historically have used equity-relatedcompensation as a component of our total employee compensation program, theaccounting change could make the use of equity-related compensation lessattractive to us or require us to pay more cash compensation and therefore makeit more difficult for us to attract and retain employees.

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

We intend to useour cash and equivalents, short-term and long-term investments for generalcorporate purposes, including working capital and capital expenditures. We mayalso use a portion of our cash and equivalents, short-term and long-terminvestments to acquire or invest in complementary technologies, businesses orother assets. We have not reserved or allocated our cash and equivalents,short-term and long-term investments for any specific purpose, and we cannotstate with certainty how our management will use our cash and equivalents,short-term and long-term investments. Accordingly, our management has considerablediscretion in applying our cash and equivalents, short-term and long-terminvestments and may use our cash and equivalents, short-term and long-terminvestments for purposes that do not result in any increase in our results ofoperations or market value. Until the cash and equivalents, short-term andlong-term investments are used, they may be placed in investments that do notproduce income or that lose value.

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**RisksRelated to Our Industry**

***Due to the cyclical nature of the semiconductor industry, ouroperating results may fluctuate significantly, which could adversely affect themarket price of our common stock.***

The semiconductorindustry is highly cyclical and subject to rapid change and evolving industrystandards and, from time to time, has experienced significant downturns. Thesedownturns are characterized by decreases in product demand, excess customerinventories and accelerated erosion of prices. These factors have caused andcould cause substantial fluctuations in our net revenue and in our operatingresults. Any downturns in the semiconductor industry may be severe andprolonged, 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 demand for semiconductors is affected by generaleconomic conditions, which could impact our business.***

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

**RisksRelated to Our Common Stock**

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

The trading priceof our common stock has experienced wide fluctuations due to the factorsdiscussed in this risk factors section and elsewhere in this Quarterly Reporton Form 10-Q. For example, in the three months ended June 30, 2007, theclosing price of our stock ranged from a low of $12.30 on May 17, 2007 to ahigh of $15.25 on June 21, 2007. In addition, the stock market in general has,and The Nasdaq Global Market and technology companies in particular have,experienced extreme price and volume fluctuations. These trading prices andvaluations may not be sustainable. These broad market and industry factors maydecrease the market price of our common stock, regardless of our actualoperating performance. In addition, in the past, following periods ofvolatility in the overall market and the market price of a company’ssecurities, securities class action litigation has often been instituted againstcompanies that experienced such volatility. This litigation, if institutedagainst us, regardless of its outcome, could result in substantial costs and adiversion of our 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 coulddecline.***

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

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

We believe thatour existing cash and cash equivalents and our investments will be sufficientto meet our anticipated cash needs for at least the next 12 months. The timingand amount of our working capital and capital expenditure requirements may varysignificantly depending on numerous factors, including:

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·                  market acceptance of our products;

·                  the need to adapt to changingtechnologies and technical requirements;

·                  the existence of opportunities forexpansion; and

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

If our capitalresources are insufficient to satisfy our liquidity requirements, we may seekto 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.***

Additional salesof our common stock in the public market, or the perception that these salescould occur, could cause the market price of our common stock to decline. AtJune 30, 2007, we had 20,811,194 shares of common stock outstanding. Asubstantial portion of these shares of common stock are entitled to rights tocause us to register the sale of those shares under the Securities Act.Registration of these shares under the Securities Act would result in theseshares, other than shares purchased by our affiliates, becoming freely tradablewithout restriction under the Securities Act immediately upon the effectivenessof the registration.

Some of ourofficers and directors have entered into 10b5-1 trading plans, which generallyprovide for pre-determined sales of stock by these officers. The sales of stockby our officers and directors, even if made pursuant to these 10b5-1 tradingplans may cause our stock price to fall.

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

Our directors,executive officers and their affiliated entities beneficially own a significantpercentage of our outstanding common stock. These stockholders, if they acted together,could exert substantial control over matters requiring approval by ourstockholders, including electing directors and approving mergers or otherbusiness combination transactions. This concentration of ownership may alsodiscourage, delay or prevent a change in control of our company, which coulddeprive our stockholders of an opportunity to receive a premium for their stockas part of a sale of our company and might reduce our stock price. Theseactions may be taken even if they are opposed by our other stockholders.

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

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

·                  the right of the board of directorsto elect a director to fill a vacancy created by the expansion of the board ofdirectors;

·                  the prohibition of cumulative votingin the election of directors, which would otherwise allow less than a majorityof stockholders to elect director candidates;

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

·                  the ability of the board of directorsto alter our bylaws without obtaining stockholder approval;

·                  the ability of the board of directorsto issue, without stockholder approval, up to 10,000,000 shares of preferredstock with terms set by the board of directors, which rights could be senior tothose of common stock;

·                  the required approval of holders ofat least two-thirds of the shares entitled to vote at an election of directorsto adopt, amend or repeal our bylaws or amend or repeal the provisions of ourcertificate of incorporation regarding the indemnification of directors andofficers and the ability of stockholders to take action;

·                  the required approval of holders ofat least a majority of the shares entitled to vote at an election of directorsto remove directors for cause; and

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

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

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

As a publiccompany, we have incurred and will continue to incur significant legal,accounting and other expenses that we did not incur as a private company. Inaddition, the Sarbanes-Oxley Act of 2002, as well as newrules subsequently implemented by the SEC and Nasdaq, have requiredchanges in corporate governance practices of public companies. We expect thesenew rules and regulations to increase our legal and financial compliancecosts and to make some activities more time-consuming and costly. For example,as a result of becoming a public company, we have added an independentdirector, created additional board committees and adopted policies regardinginternal controls and disclosure controls and procedures. In addition, we haveincurred and will continue to incur additional costs associated with our publiccompany reporting requirements. We are currently evaluating and monitoringdevelopments with respect to these new rules, and we cannot predict or estimatethe amount of additional costs we may incur or the timing of such costs.

**ITEM 2.****          Unregistered Sales of Equity Securities and Use of Proceeds**

Not applicable.

**ITEM 3.****          Defaults Upon Senior Securities**

Not applicable.

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

Theannual meeting of stockholders was held at our principal executive offices inSan Jose, California on June 11, 2007. Six incumbent directors were re-electedto serve until our next annual meeting of stockholders, or until theirsuccessors are duly elected and qualified. The results of this election are as follows:
| Name of Director | ** ** | **Votes for   (shares)** | ** ** | **Votes against   (shares)** | ** ** |
|----------------------------|------------|------------------------------------|------------|----------------------------------------|------------|
| Fumihiro Kozato            |       | 17,176,634                         |       | 69,638                                 |       |
| Robert D.  Cochran         |       | 16,937,356                         |       | 308,916                                |       |
| Richard H.  Kimball        |       | 16,869,802                         |       | 376,470                                |       |
| Dr. C.J. Koomen            |       | 17,089,321                         |       | 156,951                                |       |
| Justine Lien               |       | 17,156,801                         |       | 89,471                                 |       |
| Dr. Phillip Salsbury       |       | 17,089,321                         |       | 156,951                                |       |

 

On aproposal to ratify the appointment of Deloitte & Touche LLP as ourindependent registered public accounting firm for the current fiscal year,there were 17,244,571 votes cast in favor, 1,701 votes cast against and noabstentions.

**ITEM 5.****          Other Information**

Not applicable.

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

(a)                                   Exhibits

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| Exhibit  Number | ** ** | **Description**                                                                                                                                                       |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **      | ** ** | ** **                                                                                                                                                            |
| 31.1            |       | Certification of Chief Executive Officer pursuant to  Securities Exchange Act Rules 13a-15(e), as adopted pursuant to Section 302  of the Sarbanes-Oxley Act of 2002. |
|            |       |                                                                                                                                                                  |
| 31.2            |       | Certification of Chief Financial Officer pursuant to  Securities Exchange Act Rules 13a-15(e), as adopted pursuant to Section 302  of the Sarbanes-Oxley Act of 2002. |
|            |       |                                                                                                                                                                  |
| 32.1 (1)        |       | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                  |
|            |       |                                                                                                                                                                  |
| 32.2 (1)        |       | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                  |

 

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| (1) | The material contained in Exhibit 32.1 and Exhibit  32.2 is not deemed “filed” with the SEC and is not to be incorporated by  reference into any filing of the Company under the Securities Act of 1933 or  the Securities Exchange Act of 1934, whether made before or after the date  hereof and irrespective of any general incorporation language contained in  such filing, except to the extent that the registrant specifically  incorporates it by reference. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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**Signatures**

Pursuantto the requirements of the Securities Exchange Act of 1934, as amended, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.
| Dated: August 9, 2007 |                                                                                   |
|----------------------------|----------------------------------------------------------------------------------------|
|                       |                                                                                   |
|                       |                                                                                   |
|                       | /s/ Fumihiro Kozato                                                                    |   |
|                       | Fumihiro Kozato                                                                        |
|                       | Chief Executive Officer                                                                |
|                       |                                                                                   |
| Dated: August 9, 2007 |                                                                                   |
|                       |                                                                                   |
|                       |                                                                                   |
|                       | /s/ Mark Voll                                                                          |   |
|                       | Mark Voll   Vice President of Finance and Administration   and Chief Financial Officer |

 

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